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Planning Profit and Budgeting McGraw-Hill/Irwin Copyright 2006, The McGraw-Hill Companies, Inc. The Basic Framework of Budgeting What is a budget? What was your Spring Break spending budget? Did you spend within or over your budget? To be effective, a good budgeting system must provide for what two things? How long should the budget period be? McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Advantages of Budgeting Define goal and objectives Communicate Plans #1 Think about and plan for the future Advantages Coordinate activities Means of allocating resources Uncover potential bottlenecks McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Other Terminology Related to Budgeting What is the premise underlying responsibility accounting? McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Master Budget: An Overview Sales Budget Ending Finished Goods Budget Production Budget Direct Materials Budget Direct Labor Budget Selling and Administrative Budget Manufacturing Overhead Budget Cash Budget Budgeted Financial Statements McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Budgeting Example Royal Company is preparing budgets for the quarter ending June 30. Budgeted sales for the next five months are: April May June July August 20,000 units 50,000 units 30,000 units 25,000 units 15,000 units. The selling price is $10 per unit. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Expected Cash Collections All sales are on account. Royal's collection pattern is: 70% collected in the month of sale, 25% collected in the month following sale, 5% uncollectible. The March 31 accounts receivable balance of $30,000 will be collected in full. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Sales Budget The individual months of April, May, and June are summed to obtain the total projected sales in units and dollars for the quarter ended June 30th McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Expected Cash Collections McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Production Budget The management at Royal Company wants ending inventory to be equal to 20% of the following month's budgeted sales in units. On March 31, 4,000 units were on hand. Let's prepare the production budget. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Production Budget March 31 ending inventory McGraw-Hill/Irwin Budgeted May sales Desired ending inventory % Desired ending inventory 50,000 20% 10,000 Copyright 2006 The McGraw-Hill Companies, Inc. The Production Budget McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Production Budget Assumed ending inventory. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Direct Materials Budget At Royal Company, five pounds of material are required per unit of product. Management wants materials on hand at the end of each month equal to 10% of the following month's production. On March 31, 13,000 pounds of material are on hand. Material cost is $0.40 per pound. Let's prepare the direct materials budget. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Direct Materials Budget March 31 inventory 10% of following months production needs. McGraw-Hill/Irwin Calculate the materials to by purchased in May. Copyright 2006 The McGraw-Hill Companies, Inc. The Direct Materials Budget Assumed ending inventory McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Problem 9-11 Production and Direct Materials Budget Pearl products limited of Shenzhen, China , manufacturers and distributes toys throughout South East Asia. Three cubic centimeters (cc) of solvent H300 are required to manufacture each unit of Supermix, one of the company's products. The company is now planning raw materials needs for the 3 rd quarter, the quarter in which peak sales of Supermix occur. To keep production and sales moving smoothly, the company has the following inventory requirements: a. The finished goods inventory on hand at the end of each month must be equal to 3,000 units of Supermix plus 20% of the next month's sales. The finished goods inventory on June 30 is budgeted to be10,000 units. b. The raw materials on hand at the end of each month must be equal to of the following month's production needs for raw materials. The raw materials inventory on June 30 is budgeted to be 54,000 cc of solvent H300. c. The company maintains no work in process inventories. A sales budget for Supermix (in units) for the last six months of the year follows: July........35,000 August.......40,000 September....50,000 October...30,000 November...20,000 December.....10,000 1. Prepare a production budget for Supermix for the months of July, August, September, and October. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Problem 9-11 Production and Direct Materials Budget 2. Examine the production budget that you prepared in (1) above. Why will the company produce more units that it sells in July and August, and fewer units than it sells in September and October? 3. Prepare a direct materials budget showing the quantity of solvent H300 to be purchased for July, August, and September, and for the quarter in total. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Expected Cash Disbursement for Materials Royal pays $0.40 per pound for its materials. One-half of a month's purchases is paid for in the month of purchase; the other half is paid in the following month. The March 31 accounts payable balance is $12,000. Let's calculate expected cash disbursements. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Expected Cash Disbursement for Materials 140,000 lbs. $.40/lb. = $56,000 McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Expected Cash Disbursement for Materials McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Problem 9-14 Schedule of Expected Cash Collections & Disbursements You have been asked to prepare a December cash budget for Ashton Co., a distributor of exercise equipment. The following info is available: a. The cash balance on Dec 1 is $40,000. b. Actual sales for Oct. & Nov. and expected sales for Dec. are: October November Cash December sales $65,000 $70,000 $83,000 Sales on account $400,000 $525,000 $600,000 Sales on acct are collected over a 3-month period as follows: 20% collected in the month of sale, 60% collected in the month following sale, and 18% collected in the second month following sale. The remaining 2% is uncollectible. c. Purchases of inventory will total $280,000 for Dec. Thirty percent of a month's inventory purchases are paid during the month of purchase. The accounts payable remaining from Nov.'s inventory purchases total $161,000, all of which is paid in Dec. Required: i) Prepare a schedule of cash collections for December ii) Prepare a schedule of cash disbursements for merchandise purchases for Dec. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Direct Labor Budget At Royal, each unit of product requires 0.05 hours (3 minutes) of direct labor. The Company has a "no layoff" policy so all employees will be paid for 40 hours of work each week. In exchange for the "no layoff" policy, workers agree to a wage rate of $10 per hour regardless of the hours worked (No overtime pay). For the next three months, the direct labor workforce will be paid for a minimum of 1,500 hours per month. Let's prepare the direct labor budget. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Direct Labor Budget McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Manufacturing Overhead Budget At Royal manufacturing overhead is applied to units of product on the basis of direct labor hours. The variable manufacturing overhead rate is $20 per direct labor hour. Fixed manufacturing overhead is $50,000 per month and includes $20,000 of noncash costs (primarily depreciation of plant assets). Let's prepare the manufacturing overhead budget. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Manufacturing Overhead Budget McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Ending Finished Goods Inventory Budget Production costs per unit Quantity Direct materials 5.00 lbs. Direct labor Manufacturing overhead Budgeted finished goods inventory Ending inventory in units Unit product cost Ending finished goods inventory Cost $ 0.40 $ Total 2.00 McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Selling and Administrative Expense Budget At Royal, the selling and administrative expenses budget is divided into variable and fixed components. The variable selling and administrative expenses are $0.50 per unit sold. Fixed selling and administrative expenses are $70,000 per month. The fixed selling and administrative expenses include $10,000 in costs primarily depreciation that are not cash outflows of the current month. Let's prepare the company's selling and administrative expense budget. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Selling and Administrative Expense Budget McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Format of the Cash Budget The cash budget is divided into four sections: 1. Cash receipts listing all cash inflows excluding borrowing 2. Cash disbursements listing all payments excluding repayments of principal and interest 3. Cash excess or deficiency 4. The financing section listing all borrowings, repayments and interest McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Cash Budget Royal: Maintains a 16% open line of credit for $75,000 Maintains a minimum cash balance of $30,000 Borrows on the first day of the month and repays loans on the last day of the month Pays a cash dividend of $49,000 in April Purchases $143,700 of equipment in May and $48,300 in June paid in cash Has an April 1 cash balance of $40,000 McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Cash Budget McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Problem 9-14 Contd. d. Selling & Admin expenses are budgeted at $430,000 for Dec. Of this amount $50,000 is for depreciation. e. A new web server for the Marketing Dept. costing $76,000 will be purchased for cash during Dec., and dividends totaling $9,000 will be paid during the month. f. The co. maintains a minimum cash balance of $20,000. An open line of credit is available from the co.'s bank to bolster the cash position as needed. Required: Prepare a cash budget for December. Indicate in the financing section any borrowing that will be needed during the month. McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Budgeted Income Statement Royal Company Budgeted Income Statement For the Three Months Ended June 30 Sales Cost of goods sold Gross margin Selling and administrative expenses Operating income Interest expense Net income McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. The Budgeted Balance Sheet Royal reported the following account balances prior to preparing its budgeted financial statements: Land - $50,000 Common stock - $200,000 Retained earnings - $146,150 Equipment - $175,000 McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc. Royal Company Budgeted Balance Sheet June 30 Current assets Cash Accounts receivable Raw materials inventory Finished goods inventory Total current assets Property and equipment Land Equipment Total property and equipment Total assets Accounts payable Common stock Retained earnings Total liabilities and equities McGraw-Hill/Irwin 25% of June sales of $300,000 43,000 75,000 4,600 24,950 147,550 $ 11,500 lbs. at $0.40/lb. 5,000 units at $4.99 each 50,000 367,000 417,000 $ 564,550 28,400 200,000 336,150 $ 564,550 $ 50% of June purchases of $56,800 Copyright 2006 The McGraw-Hill Companies, Inc. Royal Company Budgeted Balance Sheet June 30 Current assets Cash Accounts receivable Raw materials inventory Finished goods inventory Total current assets Property and equipment Land Equipment Total property and equipment Total assets Accounts payable Common stock Retained earnings Total liabilities and equities McGraw-Hill/Irwin $ 43,000 Beginning balance 75,000 Add: net income 4,600 Deduct: dividends 24,950 balance Ending 147,550 $146,150 239,000 (49,000) $336,150 50,000 367,000 417,000 $ 564,550 28,400 200,000 336,150 $ 564,550 Copyright 2006 The McGraw-Hill Companies, Inc. $ End of Chapter McGraw-Hill/Irwin Copyright 2006 The McGraw-Hill Companies, Inc.

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