Chapter 23khuram.synthasite.com/.../Chapter_Slides/… · PPT file · Web view · 2009-10-12Title: Chapter 23 Subject: Operational Budgeting Author: Charles Caldwell Last modified

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Financial & Managerial Accounting

The Basis for Business DecisionsFOURTEENTH EDITION

Williams Haka Bettner Carcello


OPERATIONAL BUDGETING

Chapter

23


Learning Objective

LO1

To explain how acompany can be

“profit rich, yet cash poor.”


Profit Rich, Yet Cash Poor

Conditions leading to cashshortages when profits are high.

Consider the following cash-to-cash cycle

Large investmentsin assets to support

rapid revenue growth.

Long operating cycles(cash-to-cash cycles).


Cash

InventoriesDMWIPFG

166 days

Accounts Receivable81 days

Cash

247 Days

Even if salesare growing rapidly,cash is tied up in

inventory andreceivables for so long that a cashshortage will bethe likely result.

Profit Rich, Yet Cash Poor


Learning Objective

LO2

To discuss the benefitsthat a company may derive from a formalbudgeting process


Control Steps taken by

management to ensure that

objectives are attained.

Planning Developing objectives for

acquisitionand use of resources.

A budget is a comprehensive financialplan for achieving the financial and

operational goals of an organization.

Budgeting: The Basis forPlanning and Control


BenefitsCoordinationof activities

Performanceevaluation

Enhanced managementresponsibility

Assignment of decision-making responsibilities

Benefits Derived from Budgeting


Learning Objective

LO3

To explain two philosophiesthat may be used in

setting budgeted amounts.


Budget Problems Perceived unfair or

unrealistic goals. Poor management-

employee communications.

Solution Reasonable and

achievable budgets. Employee

participation in budgeting process.

Establishing Budgeted Amounts: Behavioral Approach


Establishing Budgeted Amounts: Total Quality Management Approach

A commitment to thegoal of completely

eliminating inefficiency.

Budgeted amounts setat levels representingabsolute efficiency.

Small failures toachieve budgeted

amounts directmanagement to

areas where improvement is

possible.


Flow of Budget Data

S u p erv iso r S u p erv is o r

M id d leM a na ge m e nt

S u p erv iso r S u p erv is o r

M id d leM a na ge m e nt

T o p M an a ge m e nt

Participation in Budget Process


2005 2006 2007 2008C a p i t a l B u d g e t s

A continuous budget is usually a twelve-month budget that adds one month as the current month is completed.

The annual operating budget may be divided into quarterly or monthly budgets.

The Budget Period


Ethics, Fraud, andCorporate Governance

Budgets are often included in documents given to investors when governmental and not-for-profit entities seek to obtain debt financing.

Material misstatements in these budgets act as a fraud upon the purchasers of bonds

issued by the governmental or not-for-profit entities and expose both individuals and

organizations to civil and criminal penalties.


Learning Objective

LO4

To describe the elementsof a master budget.


Salesbudget

Productionbudgets

Financial budgets: cash flow income balance sheet

Cashbudget

Selling andadministrative

budget

Cost of goodsmanufactured

and soldbudget

The Master Budget


Learning Objective

LO5

To prepare the budgets andsupporting schedules

included in amaster budget.


SalesBudget

EstimatedUnit Sales

EstimatedUnit Price

Analysis of economic and market conditions+

Forecasts of customer needs from marketing personnel

Preparing the Master Budget


Basket, Inc. is preparing budgets for the quarter ending June 30. The sales price is $10 per magnet. Budgeted

sales for the next four months are:

April 20,000 magnets @ $10 = $200,000May 50,000 magnets @ $10 = $500,000June 30,000 magnets @ $10 = $300,000July 25,000 magnets @ $10 = $250,000

The Sales BudgetJuly is needed for June ending inventory computations.

Preparing the Master Budget


Sales Budget

Completed

ProductionBudgets

The Production Budget


The management of Basket wants ending inventory to be 20 percent of the next

month’s budgeted sales in units.

4,000 units were on hand March 31.

Let’s prepare the production budget.



Production must be adequate to meet budgeted sales and to provide sufficient

ending inventory.

Budgeted product sales in units+ Desired product units in ending inventory= Total product units needed– Product units in beginning inventory= Product units to produce



April May JuneBudgeted unit sales 20,000 50,000 30,000Desired ending inventoryTotal units neededLess beginning inventoryUnits to produce



April May JuneBudgeted unit sales 20,000 50,000 30,000 Desired ending inventory 10,000 6,000 5,000 Total units needed 30,000 56,000 35,000 Less beginning inventoryUnits to produce

Ending inventory = 20% of next month's sales needs.June ending inventory = .20 × 25,000 July units = 5,000 units.



April May JuneBudgeted unit sales 20,000 50,000 30,000 Desired ending inventory 10,000 6,000 5,000 Total units needed 30,000 56,000 35,000 Less beginning inventory 4,000 10,000 6,000 Units to produce 26,000 46,000 29,000

Ending inventory = 20% of next month's sales needs.June ending inventory = .20 × 25,000 July units = 5,000 units.Beginning inventory is last month's ending inventory.



ProductionBudgetsMaterial

Purchases

Production BudgetUnits

Completed



The material purchases budget is based on production quantity and desired material

inventory levels.

Units to produce × Material needed per unit = Material needed for units to produce+ Desired units of material in ending

inventory= Total units of material needed– Units of material in beginning inventory= Units of material to purchase

The Production BudgetMaterial Purchases


Five pounds of material are needed for each unit produced.

The management at Basket wants to have materials on hand at the end of each month equal to 10 percent of the following month’s

production needs.

The materials inventory on March 31 is 13,000 pounds. July production is

budgeted for 23,000 units.




April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventoryTotal material needs (lbs.)Less beginning inventoryMaterial purchases (lbs.)



April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventory 23,000 14,500 11,500 Total material needs (lbs.) 153,000 244,500 156,500Less beginning inventoryMaterial purchases (lbs.)

Ending inventory = 10% of next month's material needs.June ending inventory = .10 × (23,000 units × 5 lbs. per unit).June ending inventory = 11,500 lbs.



April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventory 23,000 14,500 11,500 Total material needs (lbs.) 153,000 244,500 156,500Less beginning inventory 13,000 23,000 14,500 Material purchases (lbs.) 140,000 221,500 142,000

Ending inventory = 10% of next month's material needs.June ending inventory = .10 × (23,000 units × 5 lbs. per unit).June ending inventory = 11,500 lbs.Beginning inventory is last month's ending inventory.


Cash Payments forMaterial Purchases

Materials used in production cost $0.40per pound. One-half of a month’s

purchases are paid for in the month of purchase; the other half is paid for in the

following month.

No discount terms are available.

The accounts payable balance onMarch 31 is $12,000.


April May JuneMaterial purchases (lbs.) 140,000 221,500 142,000Cost per pound 0.40$ 0.40$ 0.40$ Total cost 56,000$ 88,600$ 56,800$

Payables from March 12,000$April purchasesMay purchasesJune purchasesTotal payments in month




Payables from March 12,000$April purchases 28,000 28,000$May purchasesJune purchasesTotal payments in month

½ × $56,000 = $28,000




Payables from March 12,000$April purchases 28,000 28,000$May purchases 44,300 44,300$June purchasesTotal payments in month

½ × $56,000 = $28,000½ × $88,600 = $44,300




Payables from March 12,000$April purchases 28,000 28,000$May purchases 44,300 44,300$June purchases 28,400 Total payments in month 40,000$ 72,300$ 72,700$

½ × $56,000 = $28,000½ × $88,600 = $44,300½ × $56,800 = $28,400



ProductionBudgetLabor

Production BudgetUnits

Material

Completed



Each unit produced requires 3 minutes (.05 hours) of direct labor. Basket employs 30

persons for 40 hours each week at a rate of $10 per hour. Any extra hours needed are

obtained by hiring temporary workers also at $10 per hour.

The Production BudgetDirect Labor


April May JuneUnits to produce 26,000 46,000 29,000 Hours per unit 0.05 0.05 0.05 Total hours required 1,300 2,300 1,450 Wage rate per hourDirect labor cost

Cash Payments forDirect Labor


April May JuneUnits to produce 26,000 46,000 29,000 Hours per unit 0.05 0.05 0.05 Total hours required 1,300 2,300 1,450 Wage rate per hour 10$ 10$ 10$ Direct labor cost 13,000$ 23,000$ 14,500$

Cash Payments forDirect Labor


Production Budget

UnitsMaterialLabor

Completed

ProductionBudget

ManufacturingOverhead



Variable manufacturing overhead is $1 per unit produced and fixed manufacturing

overhead is $50,000 per month.

Fixed manufacturing overhead includes $20,000 in depreciation which does not

require a cash outflow.

The Production BudgetManufacturing Overhead


April May JuneUnits to produce 26,000 46,000 29,000 Variable overhead rate 1.00$ 1.00$ 1.00$ Variable overhead cost 26,000$ 46,000$ 29,000$Fixed overheadTotal mfg. overhead costDeduct depreciationManufacturing overhead - cash

Cash Payments forManufacturing Overhead


April May JuneUnits to produce 26,000 46,000 29,000 Variable overhead rate 1.00$ 1.00$ 1.00$ Variable overhead cost 26,000$ 46,000$ 29,000$Fixed overhead 50,000 50,000 50,000 Total mfg. overhead cost 76,000$ 96,000$ 79,000$Deduct depreciationManufacturing overhead - cash



April May JuneUnits to produce 26,000 46,000 29,000 Variable overhead rate 1.00$ 1.00$ 1.00$ Variable overhead cost 26,000$ 46,000$ 29,000$Fixed overhead 50,000 50,000 50,000 Total mfg. overhead cost 76,000$ 96,000$ 79,000$Deduct depreciation 20,000 20,000 20,000 Manufacturing overhead - cash 56,000$ 76,000$ 59,000$



Production Budget

Completed

Sellingand

AdministrativeExpenseBudget

Selling and Administrative(S&A) Expense Budget


Selling expense budgets contain both variable and fixed items. Variable items: shipping costs and sales

commissions. Fixed items: advertising and sales salaries.

Administrative expense budgets contain mostly fixed items. Executive salaries and depreciation on

company offices.

Selling and Administrative(S&A) Expense Budget


Variable selling and administrative expenses are $0.50 per unit sold and fixed selling and

administrative expenses are $70,000 per month.

Fixed selling and administrative expenses include $10,000 in depreciation which does not

require a cash outflow.

Cash Payments for(S&A) Expenses


April May JuneBudgeted unit sales 20,000 50,000 30,000 Variable S&A per unit 0.50$ 0.50$ 0.50$ Variable S&A expense 10,000$ 25,000$ 15,000$Fixed S&A expense 70,000 70,000 70,000 Total S&A expense 80,000$ 95,000$ 85,000$Deduct depreciationS&A expense - cash



April May JuneBudgeted unit sales 20,000 50,000 30,000 Variable S&A per unit 0.50$ 0.50$ 0.50$ Variable S&A expense 10,000$ 25,000$ 15,000$Fixed S&A expense 70,000 70,000 70,000 Total S&A expense 80,000$ 95,000$ 85,000$Deduct depreciation 10,000 10,000 10,000 S&A expense - cash 70,000$ 85,000$ 75,000$



All sales are on account.

Basket’s collection pattern is:

70 percent collected in month of sale

25 percent collected in month after sale

5 percent will be uncollectible

Accounts receivable on March 31 is $30,000, all of which is collectible.

Cash Receipts Budget


April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$

Receipts from March sales 30,000$ Receipts from April salesReceipts from May salesReceipts from June salesTotal cash receipts




Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000$ Receipts from May salesReceipts from June salesTotal cash receipts 170,000$

April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000




Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000$ Receipts from May sales 350,000 125,000$Receipts from June salesTotal cash receipts 170,000$ 400,000$

April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000 May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000




Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000$ Receipts from May sales 350,000 125,000$Receipts from June sales 210,000 Total cash receipts 170,000$ 400,000$ 335,000$

April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000 May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000 June: .70 × $300,000 = $210,000



Basket Company:Has a $100,000 line of credit at its bank, with a zero

balance on April 1.Maintains a $30,000 minimum cash balance.Borrows at the beginning of a month and repays at the

end of a month.Pays interest at 16 percent when a principal payment is

made.Pays a $51,000 cash dividend in April.Purchases equipment costing $143,700 in May and

$48,800 in June.Has a $40,000 cash balance on April 1.

Comprehensive Cash BudgetAdditional Information


Comprehensive Cash BudgetApril May June

Beginning cash balance 40,000$ Cash receiptsCash availableCash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases DividendsTotal cash paymentsBalance before financingBorrowingPrincipal repaymentInterestEnding cash balance



Beginning cash balance 40,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases DividendsTotal cash paymentsBalance before financingBorrowingPrincipal repaymentInterestEnding cash balance



Beginning cash balance 40,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0Total cash payments 230,000$ 400,000$ 270,000$Balance before financing (20,000)$ BorrowingPrincipal repaymentInterestEnding cash balance



Beginning cash balance 40,000$ 30,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$ 430,000$Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0Total cash payments 230,000$ 400,000$ 270,000$Balance before financing (20,000)$ 30,000$ Borrowing 50,000 Principal repayment 0Interest 0Ending cash balance 30,000$



Beginning cash balance 40,000$ 30,000$ 30,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$ 430,000$ 365,000$Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0Total cash payments 230,000$ 400,000$ 270,000$Balance before financing (20,000)$ 30,000$ 95,000$ Borrowing 50,000 0Principal repayment 0 0Interest 0 0Ending cash balance 30,000$ 30,000$



Beginning cash balance 40,000$ 30,000$ 30,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$ 430,000$ 365,000$Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0Total cash payments 230,000$ 400,000$ 270,000$Balance before financing (20,000)$ 30,000$ 95,000$ Borrowing 50,000 0 0Principal repayment 0 0 (50,000) Interest 0 0 (2,000) Ending cash balance 30,000$ 30,000$ 43,000$

$50,000 × .16 × 3/12 = $2,000


BudgetedIncome

Statement

Cash Budget

Completed

The BudgetedIncome Statement


Basket CompanyBudgeted Income Statement

For the Three Months Ended June 30

Sales (100,000 units @ $10) 1,000,000$





Sales (100,000 units @ $10) 1,000,000$ Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000$

Computation of unit cost follows



Production costs per unit Quantity Cost Total Direct 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 Total unit cost 4.99$

Total mfg. OH for quarter $251,000 Total labor hours required 5,050 hrs.

= $49.70 per hr.

From labor and Mfg. OH budgetsLabor Hours Mfg. OH

April 1,300 76,000$ May 2,300 96,000 June 1,450 79,000 Total 5,050 251,000$

Manufacturingoverhead is applied

based ondirect labor hours.





Sales (100,000 units @ $10) 1,000,000$ Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000$ Selling and administrative expenses 260,000 Operating income 241,000$

From S&A Expense BudgetApril 80,000$ May 95,000 June 85,000 Total 260,000$





Sales (100,000 units @ $10) 1,000,000$ Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000$ Selling and administrative expenses 260,000 Operating income 241,000$ Interest expense 2,000 Net income 239,000$



BudgetedBalance

Sheet

Completed

BudgetedIncome

Statement

The BudgetedBalance Sheet


Basket reports the following account balances on June 30, prior to preparing its

budgeted financial statements: Land - $50,000 Building (net) - $174,500 Common stock - $200,000 Equipment (net) - $192,500 Retained earnings - $148,150Paid dividends of $51,000

The BudgetedBalance Sheet


Basket CompanyBudgeted Balance Sheet

June 30, 2004Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Total current assets 147,550$ Property and equipment Land 50,000$ Building 174,500 Equipment 192,500 Total property and equipment 417,000$ Total assets 564,550$

Liabilities and Equities Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$

25% of Junesales of $300,000

11,500 lbs. @ $.40 per lb.

50% of Junepurchases of $56,800

5,000 units@ $4.99 each


Basket CompanyBudgeted Balance Sheet

June 30, 2004Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Total current assets 147,550$ Property and equipment Land 50,000$ Building 174,500 Equipment 192,500 Total property and equipment 417,000$ Total assets 564,550$

Liabilities and Equities Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$

Beginning balance 148,150$Add: net income 239,000 Deduct: dividends (51,000) Ending balance 336,150$


Learning Objective

LO6

To prepare a flexiblebudget and explain

its uses.


Performance evaluation is difficult when actual activity differs from the

activity originally budgeted.

Flexible Budgeting

Hmm! Comparingcosts at differentlevels of activity is like comparing

apples with oranges.

Consider the followingcondensed examplefrom Barton, Inc. . . .


Flexible Budgeting

Original ActualBudget Results Variances

Units of Activity 10,000 8,000 2,000 U

Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F

Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0

Total overhead costs 89,000$ 77,300$ $11,700 F







U = Unfavorable variance – Barton, Inc. was unable to achieve the

budgeted level of activity.

Flexible Budgeting







F = Favorable variance: actual costs are less than budgeted costs.

Flexible Budgeting







Since cost variances are favorable, havewe done a good job controlling costs?

Flexible Budgeting


I don’t think I can answer the question

using the originalbudget.

How much ofthe favorable cost

variance is due to loweractivity, and how much is due

to good cost control?

Flexible Budgeting


Flexible Budgeting

I don’t think I can answer the question

using the originalbudget.

How much ofthe favorable cost

variance is due to loweractivity, and how much is due

to good cost control?

To answer the question, we mustthe budget to the actual level of activity.


Central Concept

If you can tell me what your activity wasfor the period, I will tell you what your costs and revenue should have been.

Flexible Budgeting


Improve performance evaluation.

May be prepared for any activity level in the relevant range.

Show expenses that should haveoccurred at the actual level ofactivity.

Reveal variances due to good costcontrol or lack of cost control.

Flexible Budgeting


To a budget for different activity levels, we must know how costs behave with changes in activity levels.Total variable costs change

in direct proportion to changes in activity.

Total fixed costs remainunchanged within therelevant range.

FixedVariable

Flexible Budgeting


Let’s prepare budgets for Barton, Inc.

Flexible Budgeting


Flexible Budgeting

Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours

Units of Activity 8,000 10,000 12,000

Variable costs Indirect labor 4.00 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$

Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs

Variable costs are expressed as a constant amount per hour.

In the original budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of

$4.00 per hour.


Flexible Budgeting



Variable costs Indirect labor 4.00 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$






Flexible Budgeting

Total variable cost = $7.50 per unit × budget level in units


Flexible Budgeting





Fixed costs are expressed as a total amount that does not change within the relevant

range of activity.


Now let’s prepare a budget performance report at 8,000 actual units for Barton, Inc.

Flexible BudgetingPerformance Report



Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances

Units of Activity 8,000 8,000 0

Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Costs Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U





Indirect labor and indirect material have unfavorable variances because actual costs

are more than the flexible budget costs.






Power has a favorable variance because the

actual cost is less than the flexible budget cost.



End of Chapter 23

Documents

Chapter 23khuram.synthasite.com/.../Chapter_Slides/… · PPT file · Web view · 2009-10-12Title: Chapter 23 Subject: Operational Budgeting Author: Charles Caldwell Last modified