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11 th EditionChapter 9

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Chapter Nine

Profit Planning

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The Basic Fram ew ork of Budg e ting

A budg e t is a detailed quantitative plan for acquiring and using financial and other resources

over a specified forthcoming time period.

1. The act of preparing a budget is calledbudg e ting .

2. The use of budgets to control anorganizations activity is known asbudg e tary control .

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Planning and Control

Planning Planning

involves developinginvolves developingobjectives andobjectives andpreparing variouspreparing variousbudgets to achievebudgets to achievethese objectives.these objectives.

Control Control

involves the stepsinvolves the stepstaken bytaken bymanagement thatmanagement thatattempt to ensureattempt to ensurethe objectives arethe objectives areattained.attained.

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Advantag e s of Budg e ting

Advantag e s

Define goalDefine goaland objectivesand objectives

Uncover potentialUncover potentialbottlenecksbottlenecks

CoordinateCoordinateactivitiesactivities

CommunicateCommunicate

plansplans

Think about andThink about and

plan for the futureplan for the future

Means of allocatingMeans of allocatingresourcesresources

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Re sponsi b ility Accounting

Managers should be held responsible for thoseManagers should be held responsible for thoseitemsitems andand only only those itemsthose items thatthat

the manager can actually controlthe manager can actually control

to a significant extent.to a significant extent.

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Ch oosing t he Budg e t P e riod

Op e rating Budg e tOp e rating Budg e t

2003 2004 2005 2006

The annual operating budgetThe annual operating budgetmay be divided into quarterlymay be divided into quarterlyor monthly budgets.or monthly budgets.

A continuous budget is a 12 A continuous budget is a 12- -month budget that rolls forwardmonth budget that rolls forwardone month (or quarter) as theone month (or quarter) as thecurrent month (or quarter) iscurrent month (or quarter) is

completed.completed.

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Se lf-Impos e d Budg e t

A budget is prepared with the full cooperation and A budget is prepared with the full cooperation andparticipation of managers at all levels. A participativeparticipation of managers at all levels. A participative

budget is also known as abudget is also known as a self self--imposed budgetimposed budget ..

Supervisor Supervisor

iddleanagement

Supervisor Supervisor

iddleanagement

Top anagement

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Advantag e s of Se lf-Impos e d Budg e ts

1.1. Individuals at all levels of the organization are viewedIndividuals at all levels of the organization are viewedas members of the team whose judgments are valuedas members of the team whose judgments are valuedby top management.by top management.

2.2. Budget estimates prepared by frontBudget estimates prepared by front- -line managers areline managers areoften more accurate than estimates prepared by topoften more accurate than estimates prepared by topmanagers.managers.

3.3. Motivation is generally higher when individualsMotivation is generally higher when individualsparticipate in setting their own goals than when theparticipate in setting their own goals than when thegoals are imposed from above.goals are imposed from above.

4.4. A manager who is not able to meet a budget imposed A manager who is not able to meet a budget imposedfrom above can claim that it was unrealistic. elf from above can claim that it was unrealistic. elf- -

imposed budgets eliminate this excuse.imposed budgets eliminate this excuse.

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Se lf-Impos e d Budg e ts

Most companies do not rely exclusively uponMost companies do not rely exclusively uponself self--imposed budget in the sense that topimposed budget in the sense that top

managers usually initiate the budget processmanagers usually initiate the budget process

by issuing broad guidelines in terms of overallby issuing broad guidelines in terms of overallprofits or sales.profits or sales.

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Human Factors in Budg e ting

The success of budgeting depends upon threeThe success of budgeting depends upon threeimportant factors:important factors:

1.1. Top management must be enthusiastic andTop management must be enthusiastic and

committed to the budget process.committed to the budget process.2.2. Top management must not use the budget toTop management must not use the budget topressure employees or blame them whenpressure employees or blame them whensomething goes wrong.something goes wrong.

3.3. Highly achievable budget targets are usuallyHighly achievable budget targets are usuallypreferred when managers are rewarded basedpreferred when managers are rewarded basedon meeting budget targets.on meeting budget targets.

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Ze ro Bas e d Budg e ting

A zero-based budget requires managers to justify all budgeted expenditures, not justchanges in the budget from the prior year.

Most managers argue thatMost managers argue thatzerozero--based budgeting is toobased budgeting is too

time consuming and costly totime consuming and costly to

justify on an annual basis. justify on an annual basis.

Most managers argue thatMost managers argue thatzerozero--based budgeting is toobased budgeting is too

time consuming and costly totime consuming and costly to

justify on an annual basis. justify on an annual basis.

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The Budg e t Committ ee

A standing committee responsible for A standing committee responsible for overall policy matters relating to theoverall policy matters relating to the

budgetbudgetcoordinating the preparation of thecoordinating the preparation of thebudgetbudget

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The Mast e r Budg e t: An Ov e rview

ProductionBudg e t

ProductionBudg e t

Se lling and

Administrativ eBudg e t

Se lling and

Administrativ eBudg e t

Dir e ctMat e rialsBudg e t

Dir e ctMat e rialsBudg e t

ManufacturingOve r he ad

Budg e t

ManufacturingOve r he ad

Budg e t

Dir e ctLabor

Budg e t

Dir e ctLabor

Budg e t

Cas hBudg e tCas h

Budg e t

S ale sBudg e tS ale s

Budg e t

Budg e te d Financial S tat e me ntsBudg e te d Financial S tat e me nts

EndingFinis he d Goods

Budg e t

EndingFinis he d Goods

Budg e t

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Budg e ting Exampl e

Royal Company is preparing budgets for theRoyal Company is preparing budgets for thequarter ending June 30.quarter ending June 30.Budgeted sales for the next five months are:Budgeted sales for the next five months are:

AprilApril 20,000 units20,000 unitsMayMay 50,000 units50,000 unitsJun e Jun e 30,000 units30,000 units

JulyJuly 25,000 units25,000 unitsAugustAugust 15,000 units.15,000 units.The selling price is $10 per unit.The selling price is $10 per unit.

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The Sal e s Budg e t

The individual months of April, May, and June aresummed to obtain the total projected sales in units

and dollars for the quarter ended June 30 th

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Exp e ct e d Cas h Coll e ctions

All sales are on account. All sales are on account.Royals collection pattern is:Royals collection pattern is:

70% collected in the month of sale,70% collected in the month of sale,25% collected in the month following sale,25% collected in the month following sale,5% uncollectible.5% uncollectible.

The March 31 accounts receivable balance of The March 31 accounts receivable balance of $30,000 will be collected in full.$30,000 will be collected in full.

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Exp e ct e d Cas h Coll e ctions

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Exp e ct e d Cas h Coll e ctions

From the Sales Budget for April.From the Sales Budget for April.

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Exp e ct e d Cas h Coll e ctions

From the Sales Budget for May.From the Sales Budget for May.

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Quick C he ck

What will be the total cash collections for theWhat will be the total cash collections for thequarter?quarter?a. $700,000a. $700,000b. $220,000b. $220,000c. $190,000c. $190,000d. $905,000d. $905,000

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What will be the total cash collections for theWhat will be the total cash collections for thequarter?quarter?a. $700,000a. $700,000b. $220,000b. $220,000c. $190,000c. $190,000d. $905,000d. $905,000

Quick C he ck

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Exp e ct e d Cas h Coll e ctions

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The Production Budg e t

ProductionProductionBudg e tBudg e t

Sale sSale sBudg e tBudg e t

andandExp e ct e dExp e ct e dCas hCas h

Coll e ctionsColl e ctions

Production must be adequate to meet budgetedProduction must be adequate to meet budgetedsales and provide for sufficient ending inventory.sales and provide for sufficient ending inventory.

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The Production Budg e t

The management at Royal Company wantsThe management at Royal Company wantsending inventory to be equal toending inventory to be equal to 20%20% of theof thefollowing months budgeted sales in units.following months budgeted sales in units.

On March 31, 4,000 units were on hand.On March 31, 4,000 units were on hand.

Lets prepare the production budget.Lets prepare the production budget.

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The Production Budg e t

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The Production Budg e t

March 31March 31ending inventoryending inventory

Budg e te d ay sal e s 50,000 e sir e d e nding inv e ntory % 20%e sir e d e nding inv e ntory 10,000

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Quick C he ck

What is the required production for May?What is the required production for May?a. 56,000 unitsa. 56,000 unitsb. 46,000 unitsb. 46,000 unitsc. 62,000 unitsc. 62,000 unitsd. 52,000 unitsd. 52,000 units

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What is the required production for May?What is the required production for May?a. 56,000 unitsa. 56,000 unitsb. 46,000 unitsb. 46,000 unitsc. 62,000 unitsc. 62,000 unitsd. 52,000 unitsd. 52,000 units

Quick C he ck

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The Production Budg e t

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The Production Budg e t

Assumed ending inventory. Assumed ending inventory.

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The Dir e ct Mat e rials Budg e t

At Royal Company, At Royal Company, f ive poundsf ive pounds of materialof materialare required per unit of product.are required per unit of product.

Management wants materials on hand atManagement wants materials on hand atthe end of each month equal tothe end of each month equal to 10%10% of theof thefollowing months production.following months production.

On March 31, 13,000 pounds of materialOn March 31, 13,000 pounds of materialare on hand. Material cost isare on hand. Material cost is $ 0.40 $ 0.40 per per pound.pound.

Lets prepare the direct materials budget.Lets prepare the direct materials budget.

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The Dir e ct Mat e rials Budg e t

From production budgetFrom production budget

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The Dir e ct Mat e rials Budg e t

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The Dir e ct Mat e rials Budg e t

Calculate the materials toCalculate the materials toby purchased in May.by purchased in May.

March 31 inventoryMarch 31 inventory

10% of following monthsproduction needs.

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Quick C he ck

How much materials should be purchased in May?How much materials should be purchased in May?a. 221,500 poundsa. 221,500 pounds

b. 240,000 poundsb. 240,000 poundsc. 230,000 poundsc. 230,000 poundsd. 211,500 poundsd. 211,500 pounds

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How much materials should be purchased in May?How much materials should be purchased in May?a. 221,500 poundsa. 221,500 pounds

b. 240,000 poundsb. 240,000 poundsc. 230,000 poundsc. 230,000 poundsd. 211,500 poundsd. 211,500 pounds

Quick C he ck

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The Dir e ct Mat e rials Budg e t

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The Dir e ct Mat e rials Budg e t

Assumed ending inventory Assumed ending inventory

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Exp e ct e d Cas h Dis burs e me nt for Mat e rials

Royal paysRoyal pays $ 0.40 per pound $ 0.40 per pound for its materials.for its materials.OneOne--hal f hal f of a months purchases is paid for inof a months purchases is paid for inthe month of purchase; the other half is paidthe month of purchase; the other half is paidin the following month.in the following month.The March 31 accounts payable balance isThe March 31 accounts payable balance is$12,000.$12,000.

Lets calculate expected cash disbursements.Lets calculate expected cash disbursements.

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Exp e ct e d Cas h Dis burs e me nt for Mat e rials

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Exp e ct e d Cas h Dis burs e me nt for Mat e rials

140,000 lbs.140,000 lbs. $.40/lb. = $56,000$.40/lb. = $56,000

Compute the expected cashCompute the expected cashdisbursements for materialsdisbursements for materials

for the quarter.for the quarter.

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Quick C he ck

What are the total cash disbursements for theWhat are the total cash disbursements for thequarter?quarter?a. $185,000a. $185,000b. $ 68,000b. $ 68,000c. $ 56,000c. $ 56,000d. $201,400d. $201,400

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What are the total cash disbursements for theWhat are the total cash disbursements for thequarter?quarter?a. $185,000a. $185,000b. $ 68,000b. $ 68,000c. $ 56,000c. $ 56,000d. $201,400d. $201,400

Quick C he ck

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Exp e ct e d Cas h Dis burs e me nt for Mat e rials

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The Dir e ct La bor Budg e t

At Royal, each unit of product requires 0.05 hours (3minutes) 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 toa wage rate of $10 per hour regardless of the hoursworked (No overtime pay).

For the next three months, the direct labor workforce willbe paid for a minimum of 1,500 hours per month.

Le ts pr e par e the dir e ct la bor budg e t.Le ts pr e par e the dir e ct la bor budg e t.

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The Dir e ct La bor Budg e t

From production budgetFrom production budget

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The Dir e ct La bor Budg e t

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The Dir e ct La bor Budg e t

Greater of labor hours requiredGreater of labor hours requiredor labor hours guaranteed.or labor hours guaranteed.

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The Dir e ct La bor Budg e t

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Quick C he ck

What would be the total direct labor cost for theWhat would be the total direct labor cost for thequarter if the company follows its no layquarter if the company follows its no lay- -off policy,off policy,but pays $15 (timebut pays $15 (time- -andand--aa--half) for every hour half) for every hour

worked in excess of 1,500 hours in a month?worked in excess of 1,500 hours in a month?a. $79,500a. $79,500b. $64,500b. $64,500c. $61,000c. $61,000

d. $57,000d. $57,000

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What would be the total direct labor cost for theWhat would be the total direct labor cost for thequarter if the company follows its no layquarter if the company follows its no lay- -off policy,off policy,but pays $15 (timebut pays $15 (time- -andand--aa--half) for every hour half) for every hour

worked in excess of 1,500 hours in a month?worked in excess of 1,500 hours in a month?a. $79,500a. $79,500b. $64,500b. $64,500c. $61,000c. $61,000

d. $57,000d. $57,000

Quick C he ck

April May June Quarter Labor hours required 1,300 2,300 1,450

egular hours paid 1,500 1,500 1,500 4,500 vertime hours paid - 800 - 800

Total regular hours 4,500 $10 45,000$

Total overtime hours 800 $15 12,000$Total pay 57,000$

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Manufacturing Ov e r he ad Budg e t

At Royal manufacturing overhead is applied to units At Royal manufacturing overhead is applied to unitsof product on the basis of direct labor hours.of product on the basis of direct labor hours.

The variable manufacturing overhead rate is $20 per The variable manufacturing overhead rate is $20 per

direct labor hour.direct labor hour.Fixed manufacturing overhead is $50,000 per monthFixed manufacturing overhead is $50,000 per monthand includes $20,000 of noncash costs (primarilyand includes $20,000 of noncash costs (primarilydepreciation of plant assets).depreciation of plant assets).

Lets prepare the manufacturing overhead budget.Lets prepare the manufacturing overhead budget.

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Manufacturing Ov e r he ad Budg e t

Direct Labor BudgetDirect Labor Budget

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Manufacturing Ov e r he ad Budg e t

Total mfg. OH for quarter $251,000Total labor hours required 5,050 = $49.70 per hour*

**round e dround e d

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Manufacturing Ov e r he ad Budg e t

Depreciation is a noncash charge.Depreciation is a noncash charge.

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Production costs per unit uantity Cost TotalDirect materials 5.00 l s. 0.40$ 2.00$Direct la or Manufacturing overhead

udgeted finished goods inventoryEnding inventory in unitsUnit product costEnding finished goods inventory

Ending Finished Goods Inventory udget

Direct materialsDirect materialsbudget and informationbudget and information

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Production costs per unit uantity Cost TotalDirect materials 5.00 l s. 0.40$ 2.00$Direct la or 0.05 hrs. 10.00$ 0.50 Manufacturing overhead

udgeted finished goods inventoryEnding inventory in unitsUnit product costEnding finished goods inventory

Ending Finished Goods Inventory udget

Direct labor budgetDirect labor budget

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Production costs per unit Quantity Cost TotalDirect materials 5.00 lbs. 0.40$ 2.00$Direct labor 0.05 hrs. 10.00$ 0.50 Manufacturing overhead 0.05 hrs. 49.70$ 2.49

4.99$Budgeted finished goods inventory

Ending inventory in unitsUnit product cost 4.99$Ending finished goods inventory ?

Ending Finished Goods Inventory Budget

Total mfg. OH for quarter $251,000Total labor hours required 5,050 = $49.70 per hour*

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Production costs per unit uantity Cost TotalDirect materials 5.00 l s. 0.40$ 2.00$Direct la or 0.05 hrs. 10.00$ 0.50 Manufacturing overhead 0.05 hrs. 49.70$ 2.49

4.99$udgeted finished goods inventoryEnding inventory in units 5,000 Unit product cost 4.99$Ending finished goods inventory 24,950 $

Ending Finished Goods Inventory udget

Production BudgetProduction Budget

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Se lling and Administrativ e Exp e ns e Budg e t

At Royal, the selling and administrative expenses budget is At Royal, the selling and administrative expenses budget isdivided into variable and fixed components.divided into variable and fixed components.

The variable selling and administrative expenses are $0.50The variable selling and administrative expenses are $0.50per unit sold.per unit sold.

Fixed selling and administrative expenses are $70,000 per Fixed selling and administrative expenses are $70,000 per month.month.

The fixed selling and administrative expenses includeThe fixed selling and administrative expenses include$10,000 in costs$10,000 in costs primarily depreciationprimarily depreciation that are not cashthat are not cash

outflows of the current monthoutflows of the current month ..

Lets prepare the companys selling and administrativeLets prepare the companys selling and administrativeexpense budget.expense budget.

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Se lling and Administrativ e Exp e ns e Budg e t

Calculate the selling and administrativeCalculate the selling and administrativecash expenses for the quarter.cash expenses for the quarter.

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Quick C he ck

What are the total cash disbursements for sellingWhat are the total cash disbursements for sellingand administrative expenses for the quarter?and administrative expenses for the quarter?a. $180,000a. $180,000b. $230,000b. $230,000c. $110,000c. $110,000d. $ 70,000d. $ 70,000

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What are the total cash disbursements for sellingWhat are the total cash disbursements for sellingand administrative expenses for the quarter?and administrative expenses for the quarter?a. $180,000a. $180,000b. $230,000b. $230,000c. $110,000c. $110,000d. $ 70,000d. $ 70,000

Quick C he ck

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Se lling and Administrativ e Exp e ns e Budg e t

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Format of t he Cas h Budg e t

The cash budget is divided intoThe cash budget is divided into four four sections:sections:

1.1. Cash receipts listing all cash inflows excludingCash receipts listing all cash inflows excludingborrowingborrowing

2.2. Cash disbursements listing all paymentsCash disbursements listing all paymentsexcluding repayments of principal and interestexcluding repayments of principal and interest

3.3. Cash excess or deficiencyCash excess or deficiency

4.4. The financing section listing all borrowings,The financing section listing all borrowings,repayments and interestrepayments and interest

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The Cas h Budg e t

Royal:Royal:

Maintains a 16% open line of credit for $75,000Maintains a 16% open line of credit for $75,000Maintains a minimum cash balance of $30,000Maintains a minimum cash balance of $30,000Borrows on the first day of the month and repaysBorrows on the first day of the month and repaysloans on the last day of the monthloans on the last day of the monthPays a cash dividend of $49,000 in AprilPays a cash dividend of $49,000 in April

Purchases $143,700 of equipment in May andPurchases $143,700 of equipment in May and$48,300 in June paid in cash$48,300 in June paid in cashHas an April 1 cash balance of $40,000Has an April 1 cash balance of $40,000

d

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The Cas h Budg e t

S chedule of ExpectedS chedule of ExpectedCash CollectionsCash Collections

d

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The Cas h Budg e t

Direct Labor Direct Labor BudgetBudget

ManufacturingManufacturing

Overhead BudgetOverhead Budget

S elling and AdministrativeS elling and AdministrativeExpense BudgetExpense Budget

S chedule of ExpectedS chedule of ExpectedCash DisbursementsCash Disbursements

h C h B d

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The Cas h Budg e t

Because Royal maintainsBecause Royal maintainsa cash balance of $30,000,a cash balance of $30,000,the company must borrowthe company must borrow$50,000 on it line$50,000 on it line- -of of--credit.credit.

h C h B d

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The Cas h Budg e t

Ending cash balance for AprilEnding cash balance for Aprilis the beginning May balance.is the beginning May balance.

Th C h B d

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The Cas h Budg e t

Q i k C h k

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Quick C he ck

What is the excess (deficiency) of cash availableWhat is the excess (deficiency) of cash availableover disbursements for June?over disbursements for June?a. $ 85,000a. $ 85,000b. $(10,000)b. $(10,000)c. $ 75,000c. $ 75,000d. $ 95,000d. $ 95,000

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What is the excess (deficiency) of cash availableWhat is the excess (deficiency) of cash availableover disbursements for June?over disbursements for June?a. $ 85,000a. $ 85,000b. $(10,000)b. $(10,000)c. $ 75,000c. $ 75,000d. $ 95,000d. $ 95,000

Quick C he ck

Th C h B d t

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The Cas h Budg e t

$50,000$50,000 16%16% 3/12 = $2,0003/12 = $2,000Borrowings on April 1 andBorrowings on April 1 and

repayment on June 30.repayment on June 30.

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The Budg e te d Incom e S tat e me nt

Cas h Budg e t

Budg e te dIncom e

S tat e me nt

Afte r we compl e te the cas h budg e t,Afte r we compl e te the cas h budg e t,we can pr e par e the budg e te d incom e we can pr e par e the budg e te d incom e

stat e me nt for Royal.stat e me nt for Royal.

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The Budg e te d Incom e S tat e me nt

Ro a om anBudg e te d Incom e S ta t e m e nt

o t he Three ont hs nd e d un e

S a e s ( un t s @ $ ) $o s t o good s s o d ( @ $ 99) 99 r o ss ma r g n

S elli ng and adm in is tr a t ive expe n se s 260,000 pe r a t ing incom e 241,000

Interes t expe n se 2,000 Ne t incom e 23 9 ,000$

S ales BudgetS ales Budget

Ending FinishedEnding Finished

Goods InventoryGoods Inventory S elling andS elling and

Administrative AdministrativeExpense BudgetExpense Budget

Cash BudgetCash Budget

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The Budg e te d Balanc e Shee t

Royal reported the following accountRoyal reported the following accountbalances prior to preparing its budgetedbalances prior to preparing its budgeted

financial statements:financial statements:

LandLand -- $50,000$50,000Common stockCommon stock - - $200,000$200,000Retained earningsRetained earnings - - $146,150$146,150EquipmentEquipment - - $175,000$175,000

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Int e rnational Asp e cts of Budg e ting

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Int e rnational Asp e cts of Budg e ting

When a multinational company enters into thebudgeting process there are at least threemajor problems that must be dealt with . . .

1. Fluctuations in foreign currencyexchange rates.

2. High inflation rates.

3. Local economic conditions andgovernmental policies.

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