Chapter 20

The Budgeting Process

Planning and the Use of Budgets

• Companies spend a lot of time on _______ planning, which requires Setting goals and objectives.

• Long and short term. Developing strategies to achieve those

goals.• Budgets

are a ______ statement of a company’s future plans

show how _______ will be used to implement the strategy.

The Budget• A budget is a quantified statement of

an entity’s _______ plans (typically 1 year).

• Its components include data that can be financial (budgeted sales activity) or non-financial (budgeted production levels).

• It allows companies to formally set _____ for _______.

• The budget provides a means of performance _______.

Advantages of Budgets• It requires management to ___ ____

Identify goals and objectives Evaluate risks and opportunities

• It serves as an early warning system if deviations from the budgets are

examined• It _______ documents management

plans and specific action plans. Informal communication of business

plans can create uncertainty and confusion

Advantages of Budgets• It _______ employees in a positive way if

implemented correctly:– Based on realistic level of performance– Prepared using participatory budgeting– Evaluated carefully and allowing employees to

provide explanations for variances• Effective Management Tool

– All departments should contribute to meeting company-wide goals.

– Budgeting achieves coordination.

Advantages of Budgets• Provides performance criteria -

__________. Compare actual results to the past

results or budget (expected results) and assign responsibility.

Assists in identification of problems and corrective actions.

Provides _______ for future decisions.

Things to Watch for• ____ levels of management should be

involved in developing the budget so they buy into the budget.

• _______ _______ should be tied, in part, to meeting budgetary goals.

• Conditions are not static, and the company must be able to respond to unforeseen events.

Time Horizon for Budgeting• The _______ length of time will

depend on the events being budgeted. Single event (party). On-going activities – short-term.

• Annually, quarterly, monthly. On-going activities – long-term.

• 5 year business plan. Continuous or Rolling Budgets

Master Budgets• A formal, _________

plan for a company’s future.

• Contains several _______ budgets that are linked to each other.

• Sequencing of preparation is essential.

Master Budgets• Master budgets consist of the

following elements: _______ Budgets

• Those supporting budgets which contribute directly to the budgeted income statement

_______ _______ Budget _______ Budgets

• Cash budget which leads to • Budgeted balance sheet and

cash flow statements• Budgeted Income Statement

Sales or Revenues Budget• This is the _______ of the operating

budgets to determine.• It is important to set accurate sales

estimates because everything else is based on this one .

• Budgeted revenue = (units sold)*(price).• Sales budgeting is complex and depends

on many things such as; Economy, competition, competing products,

capacity, price of product, new products.

In September 2008, Hockey Den sold 700 hockey sticks at $100 each. Hockey Den prepared the following sales budget for the next four months:

Sales BudgetP1

HOCKEY DENMonthly Sales Budget

October 2008 – January 2009

Budgeted Budgeted BudgetedUnit Sales Unit Price Total Sales

September 2008 (actual) 700 100$ 70,000$

October 2008 1,000 100$ 100,000$ November 2008 800 100 80,000 December 2008 1,400 100 140,000 Total 3,200 100$ 320,000$

January 2009 900 100$ 90,000$

Sales BudgetExh. 20-6

P1

Merchandise Purchases Budget

• Budgeted future sales volume is the primary factor in inventory management decisions Merchandise Purchase Budget (retailer) Production Budget (manufacturer)

Hockey Den buys hockey sticks for $60.00 each and maintains an ending inventory equal

to 90 percent of the next month’s budgeted sales. 900 hockey sticks are on hand on

September 30.

Inventoryto be

purchased =Budgetedending

inventory +Budgeted

cost of salesfor the period –

Budgetedbeginninginventory

Let’s prepare the purchases budget for Hockey Den.

Merchandise Purchases Budget Exh.

20-7

P1

HOCKEY DENMerchandise Purchases BudgetOctober 2008 – December 2008

October November DecemberNext month's unit sales 800 1,400 900 Ending inventory percentage × 90% × 90% × 90%Budgeted ending inventory units 720 1,260 810 Add current month's unit salesTotal units neededDeduct beginning inventory unitsNumber of units to be purchasedBudgeted cost per unitBudgeted cost of purchases

Merchandise Purchases Budget Exh.

20-8

P1

HOCKEY DENMerchandise Purchases BudgetOctober 2008 – December 2008

October November DecemberNext month's unit sales 800 1,400 900 Ending inventory percentage × 90% × 90% × 90%Budgeted ending inventory units 720 1,260 810 Add current month's unit sales 1,000 800 1,400 Total units needed 1,720 2,060 2,210 Deduct beginning inventory unitsNumber of units to be purchasedBudgeted cost per unitBudgeted cost of purchases

Exh. 20-8

Merchandise Purchases Budget

P1

HOCKEY DENMerchandise Purchases BudgetOctober 2008 – December 2008

October November DecemberNext month's unit sales 800 1,400 900 Ending inventory percentage × 90% × 90% × 90%Budgeted ending inventory units 720 1,260 810 Add current month's unit sales 1,000 800 1,400 Total units needed 1,720 2,060 2,210 Deduct beginning inventory units 900 Number of units to be purchased 820 Budgeted cost per unit × $ 60Budgeted cost of purchases 49,200$

Beginning inventory is last month's ending inventory.

Exh. 20-8

Merchandise Purchases Budget

P1

HOCKEY DENMerchandise Purchases BudgetOctober 2008 – December 2008

October November DecemberNext month's unit sales 800 1,400 900 Ending inventory percentage × 90% × 90% × 90%Budgeted ending inventory units 720 1,260 810 Add current month's unit sales 1,000 800 1,400 Total units needed 1,720 2,060 2,210 Deduct beginning inventory units 900 720 1,260 Number of units to be purchased 820 1,340 950 Budgeted cost per unit × $ 60 × $ 60 × $ 60Budgeted cost of purchases 49,200$ 80,400$ 57,000$

Beginning inventory is last month's ending inventory.

Exh. 20-8

Merchandise Purchases Budget

P1

Production Budgets (Appendix 20A)

• What production levels must be achieved to support the sales budget? Production = budgeted sales + desired

ending inventory - beginning inventory• Production costs include:

Materials costs Direct labor Manufacturing overhead

• We will need budgets for _____ of these

Production Budget:Direct Materials Purchases

• How much material do we need to support the production level?

• How much do we need to purchase to maintain desired inventory level?

• Units purchased = projected material usage + desired ending inventory level – beginning inventory.

• Calculate in units first, then convert to cost.

Production Budget:Direct Materials Purchases

• Steps to prepare a direct materials purchasing budget

1. Calculate each period’s total production needs in units of direct materials

2. Determine the total number of units of direct materials to be purchased during each accounting period in the budget

3. Calculate the cost of the direct materials purchases

Total Units of Direct

Materials to Be Purchased

= Total Production Needs in Units of Direct Materials

+

Desired Units of Ending

Direct Materials Inventory

–

Desired Units of Beginning

Direct Materials Inventory

Production Budget:Direct Labor

• Direct labor costs will depend on the units to be produced and the time allowed for each unit in the various departments.

• Figure the time to complete the units and then convert them to costs.

Production Budget:Direct Labor

• Steps in preparing a direct labor budget

1. Estimate the total direct labor hours– Multiply estimated direct labor hours per

unit by the anticipated units of production

2. Calculate the total budgeted direct labor cost

Total Budgeted Direct Labor Cost

= Estimated Total

Direct Labor Hours x Estimated Direct

Labor Cost per Hour

Production Budget: Factory Overhead

• Using the relationships which exist and the estimated cost functions, determine what overhead costs will be incurred in producing the number of units needed. Variable overhead costs per unit. Fixed overhead costs per period.

• Determine budgeted overhead and divide by the estimated activity level to come up with the overhead application rate.

Other Elements of Operating Budgets

• Using cost behavior analysis, calculate the budgeted nonmerchandising or nonmanufacturing manufacturing costs Selling Expense Budget General & Administrative Expense Budget

Financial Budget Components• Capital Budgeting – budget of capital

expenditures needed to support company activity

• Cash Budget • Budgeted Income Statement

Information comes from already prepared budgets.

• Budgeted Balance Sheet & Cash Flow Final step Information comes from already prepared

budgets.

Cash Budgeting• Purpose of the cash budget is to determine whether

or not there will be excess cash to invest and/or deficiencies of cash requiring short term borrowing.

Beginning balance Plus: Budgeted Receipts

Less: Budgeted Disbursements = Estimated ending cash balance.

• Compare estimated ending balance with the required cash balance. Do we need to borrow money?

Cash Budgeting Information• Budgeted Cash Receipts & Expected Collection

Point Expected cash sales? Expected collections from credit sales?

• Budgeted Cash Disbursements & Expected Disbursement Point SG&A Expenses Cash Purchases Cash Payments on Accounts Payable Cash purchases of fixed assets, Payment of interest costs, loan principal and

income taxes?

HOCKEY DENBudgeted Income Statement

For Three Months Ended December 31, 2008

Sales (3,200 units @ $100) 320,000$ Cost of goods sold (3,200 units @ $60) 192,000 Gross profit 128,000$ Operating expenses: Sales commissions 32,000$ Sales salaries 6,000 Administrative salaries 13,500 Equipment depreciation 4,500 Interest expense 328 56,328 Net income before taxes 71,672$ Income tax expense 28,669 Net income 43,003$

From the Sales BudgetP2

Exhibit 20-14

HOCKEY DENBudgeted Income Statement

For Three Months Ended December 31, 2008

Sales (3,200 units @ $100) 320,000$ Cost of goods sold (3,200 units @ $60) 192,000 Gross profit 128,000$ Operating expenses: Sales commissions 32,000$ Sales salaries 6,000 Administrative salaries 13,500 Equipment depreciation 4,500 Interest expense 328 56,328 Net income before taxes 71,672$ Income tax expense 28,669 Net income 43,003$

From the Merchandise Purchases Budget

P2Exhibit 20-14

HOCKEY DENBudgeted Income Statement

For Three Months Ended December 31, 2008

Sales (3,200 units @ $100) 320,000$ Cost of goods sold (3,200 units @ $60) 192,000 Gross profit 128,000$ Operating expenses: Sales commissions 32,000$ Sales salaries 6,000 Administrative salaries 13,500 Equipment depreciation 4,500 Interest expense 328 56,328 Net income before taxes 71,672$ Income tax expense 28,669 Net income 43,003$

From the SellingExpense Budget

P2Exhibit 20-14

HOCKEY DENBudgeted Income Statement

For Three Months Ended December 31, 2008

Sales (3,200 units @ $100) 320,000$ Cost of goods sold (3,200 units @ $60) 192,000 Gross profit 128,000$ Operating expenses: Sales commissions 32,000$ Sales salaries 6,000 Administrative salaries 13,500 Equipment depreciation 4,500 Interest expense 328 56,328 Net income before taxes 71,672$ Income tax expense 28,669 Net income 43,003$

From the General and Administrative Expense Budget

Depreciation is a non-cash expense.

P2Exhibit 20-14

HOCKEY DENBudgeted Income Statement

For Three Months Ended December 31, 2008

Sales (3,200 units @ $100) 320,000$ Cost of goods sold (3,200 units @ $60) 192,000 Gross profit 128,000$ Operating expenses: Sales commissions 32,000$ Sales salaries 6,000 Administrative salaries 13,500 Equipment depreciation 4,500 Interest expense 328 56,328 Net income before taxes 71,672$ Income tax expense 28,669 Net income 43,003$ From the Cash Budget

P2Exhibit 20-14

HOCKEY DENBudgeted Income Statement

For Three Months Ended December 31, 2008

Sales (3,200 units @ $100) 320,000$ Cost of goods sold (3,200 units @ $60) 192,000 Gross profit 128,000$ Operating expenses: Sales commissions 32,000$ Sales salaries 6,000 Administrative salaries 13,500 Equipment depreciation 4,500 Interest expense 328 56,328 Net income before taxes 71,672$ Income tax expense 28,669 Net income 43,003$

$71,672 × .40

P2Exhibit 20-14

Budgeted Balance Sheet

• The budgeted account balances will depend on previous budget schedules cash balance: cash budget accounts receivable balance: sales

budget and pattern of collections inventory amounts: operating budgets borrowing: cash budget retained earnings: effects of income and

dividends

Budget Process - Summary

• Budgeting is a company-wide effort• Goals often come from the top• Different parts of the organization

participate to budget specific activities/units.

• All this information must be tied together in the master budget. This is where the accountants come in.

Let’s take a closer look at this chapter!!!