22 Budgeting

Describe the nature of the adjusting process. Learning Objective 1 Learning Objective 1 Budgeting 3-1 3-1 After studying this chapter, you should be able to: 1 Describe budgeting, its objective, and its impact on human behavior. Insert Chapter Objectives Describe the nature of the adjusting process. Describe the nature of the adjusting process. 2 Describe the basic elements of the budget process, the two major types of budgeting, and the use of computers in budgeting. 3 Describe the master budget for a manufacturing company. 22-2

Budgeting (continued) 4 Prepare the basic income statement budgets for a manufacturing company. 5 Prepare balance sheet budgets for a manufacturing company. 22-3

Describe budgeting, its objectives, and its impact on human behavior. 1 Describe budgeting, its objectives, and its impact on human behavior. 22-4

1 Budgets Budgets play an important role for organizations of all sizes and forms. Budgets are used in managing the operations of government agencies, churches, hospitals, and other nonprofit organizations.

1 Estimated Portion of Your Total Monthly Income That Should Be Budgeted for Various Living Expenses

Objectives of Budgeting 1 Objectives of Budgeting Planning involves setting goals as a guide for making decisions. Directing involves decisions and actions to achieve budgeted goals. Controlling involves comparing actual performance against the budgeted goals.

1 Exhibit 1 Planning, Directing, and Controlling

Responsibility Centers 1 Responsibility Centers A budgetary unit of a company is called responsibility center. Each responsibility center is led by a manager who has the authority and responsibility for achieving the center’s budgeted goals.

Controlling Through Feedback 1 Controlling Through Feedback As time passes, the actual performance of an operation can be compared against the planned goals. This provides prompt feedback to employees about their performance. If necessary, employees can use such feedback to adjust their activities in the future.

Human behavior problems can arise if— 1 Exhibit 2 Human Behavior Problems in Budgeting Human behavior problems can arise if— the budget goal is too tight and very hard for the employee to achieve. (continued)

Human behavior problems can arise if— 1 Exhibit 2 Human Behavior Problems in Budgeting (continued) Human behavior problems can arise if— the budget goal is too loose and very easy for the employee to achieve. (continued on Slide 14)

1 Budgetary Slack Although it is desirable to establish attainable goals, it is undesirable to plan lower goals than may be possible. Such budget “padding” is termed budgetary slack.

Human behavior problems can arise if— 1 Exhibit 2 Human Behavior Problems in Budgeting (concluded) Human behavior problems can arise if— the budget goals of a business conflict with the objectives of the employees.

1 Goal Conflict Goal conflict occurs when individual self-interest differs from business objectives or when different departments are given conflicting objectives.

2 Describe the basic elements of the budget process, the two major types of budgeting, and the use of computers in budgeting. 22-16

2 Continuous Budgeting A variation of fiscal-year budgeting, called continuous budgeting, maintains a twelve-month projection into the future.

2 Exhibit 3 Continuous Budgeting

2 Zero-Based Budgeting Zero-based budgeting requires managers to estimate sales, production, and other operating data as though operations are being started for the first time.

2 Static Budget A static budget shows the expected results of a responsibility center for only one activity level. The budget does not change even if the activity changes.

2 A static budget is used by many service companies and for some administrative functions of manufacturing companies.

2 Exhibit 4 Static Budget

Weakness of the Static Budget 2 Weakness of the Static Budget A static budget does not adjust for changes in revenues and expenses that occur as volumes change.

2 Flexible Budget Flexible budgets show the expected results of a responsibility center for several activity levels. A flexible budget is, in effect, a series of static budgets for different levels of activity.

2 Exhibit 5 Flexible Budget

Static and Flexible Budgets 2 Static and Flexible Budgets If Coulter Manufacturing Company’s Assembly Department spent $72,000 to produce 10,000 units, how much over or under budget would the department manager be when using a static budget? $12,000 (refer to Slide 22)

2 Exhibit 6 Static and Flexible Budgets

2 Example Exercise 22-1 Flexible Budgeting At the beginning of the period, the Assembly Department budgeted direct labor of $45,000 and supervisor salaries of $30,000 for 5,000 hours of production. The department actually completed 6,000 hours of production. Determine the budget for the department, assuming that it uses flexible budgeting. 22-28

2 Follow My Example 22-1 Variable cost: Example Exercise 22-1 (continued) 2 Follow My Example 22-1 Variable cost: Direct labor (6,000 hours × $9.00* per hour)……………………………… $54,000 Fixed cost: Supervisor salaries…………………. 30,000 Total department costs………………… $84,000 *45,000/5,000 hours For Practice: PE 22-1A, PE 22-1B 22-29

Computerized Budgeting Systems 2 Computerized Budgeting Systems Integrated computerized budget and planning systems speed up and reduce the cost of preparing the budget.

Describe the master budget for a manufacturing company. 3 Describe the master budget for a manufacturing company. 22-31

3 Master Budget The master budget is an integrated set of operating, investing, and financing budgets for a period of time.

Budgets That Are Linked Together in a Master Budget 3 Budgets That Are Linked Together in a Master Budget Operating Budgets Sales budget Cost of goods sold budget: Production budget Direct materials purchases budget Direct labor cost budget Factory overhead cost budget Selling and administrative expenses budget Financing Budget Cash budget Investing Budget Capital expenditures budget Budgeted Income Statement Budgeted Balance Sheet

3 Exhibit 7 Income Statement Budgets

4 Prepare the basic income statement budgets for a manufacturing company. 22-35

4 Sales Budget The sales budget begins by estimating the quantity of sales. Once sales quantities are estimated, the expected sales revenue can be determined by multiplying the volume by the expected unit sales price.

4 Factors expected to affect future sales include— Backlog of unfilled sales orders Planned advertising and promotion Productive capacity Projected pricing changes Findings of market research studies Expected industry and general economic conditions

4 Exhibit 8 Sales Budget

4 Production Budget The production budget estimates the number of units to be manufactured to meet budgeted sales and desired inventory levels.

Exhibit 9 Production Budget

+ Desired units in ending inventory 4 Sales Budget Production Budget Expected units of sales + Desired units in ending inventory – Estimated units in beginning inventory Total units to be produced

+ Desired units in ending inventory 4 Wallets Sales Budget Production Budget From Exhibit 8 (Slide 38) 528,000 + Desired units in ending inventory – Estimated units in beginning inventory Total units to be produced

+ Desired ending inventory 80,000 4 Wallets Sales Budget Production Budget From Exhibit 8 528,000 + Desired ending inventory 80,000 – Estimated units in beginning inventory Total units to be produced

+ Desired ending inventory 80,000 – Est. beginning inventory (88,000) 4 Wallets Sales Budget Production Budget From Exhibit 8 528,000 + Desired ending inventory 80,000 – Est. beginning inventory (88,000) Total units to be produced

+ Desired ending inventory 80,000 – Est. beginning inventory (88,000) 4 Wallets Sales Budget Production Budget From Exhibit 8 528,000 + Desired ending inventory 80,000 – Est. beginning inventory (88,000) Total units to be produced 520,000

+ Desired ending inventory 60,000 – Est. beginning inventory (48,000) Handbags Sales Budget Production Budget From Exhibit 8 280,000 + Desired ending inventory 60,000 – Est. beginning inventory (48,000) Total units to be produced 292,000

4 Example Exercise 22-2 Production Budget Landon Awards Co. projected sales of 45,000 brass plaques for 2010. The estimated January 1, 2010 inventory is 3,000 units, and the desired December 31, 2010 inventory is 5,000 units. What is the budgeted production (in units) for 2010? 22-47

4 Follow My Example 22-2 Expected units to be sold………………… 45,000 Example Exercise 22-2 (continued) 4 Follow My Example 22-2 Expected units to be sold………………… 45,000 Plus desired ending inventory, December 31, 2010………………...…… 5,000 Total…………………………………………... 50,000 Less estimated beginning inventory, January 1, 2010…………………………. 3,000 Total units to be produced……………….. 47,000 For Practice: PE 22-2A, PE 22-2B 22-48

Direct Materials Purchases Budget 4 Direct Materials Purchases Budget Sales Budget Production Budget Direct Materials Purchases Budget Materials needed for production + Desired ending materials inventory – Estimated beginning materials inventory Direct materials to be purchased

4 Exhibit 10 Direct Materials Purchase Budget Note A: 520,000 units × 0.30 sq. yd. per unit = 156,000 sq. yds. (continued)

4 Exhibit 10 Direct Materials Purchase Budget (continued) Note A: 520,000 units × 0.10 sq. yd. per unit = 52,000 sq. yds. (continued)

4 Exhibit 10 Direct Materials Purchase Budget (continued) Note B: 292,000 units × 1.25 sq. yd. per unit = 365,000 sq. yds. (continued)

4 Exhibit 10 Direct Materials Purchase Budget (concluded) Note B: 292,000 units × .50 sq. yd. per unit = 146,000 sq. yds.

4 Example Exercise 22-3 Direct Materials Purchases Budget Landon Awards Co. budgeted production of 47,000 brass plaques in 2010. Brass sheet is required to produce a brass plaque. Assume 96 square inches of brass sheet is required for each brass plaque. The estimated January 1, 2010 brass sheet inventory is 240,000 square inches. The desired December 31, 2010 brass sheet inventory is 200,000 square inches. If brass sheets costs $0.12 per square inch, determine the materials purchases budget for 2010. 22-54

Example Exercise 22-3 (continued) 4 Follow My Example 22-3 Square inches required for production: Brass sheet (47,000 × 96 sq. in.)…...…… 4,512,000 Plus: desired ending inventory, December 31, 2010………………………... 200,000 Total………………………………………… 4,712,000 Less estimated beginning inventory, January 1, 2010……………………………. 240,000 Total square inches to purchase……... 4,472,000 Unit price (per square inch)……………….. × $0.12 Total direct materials to be purchased….. $ 536,640 For Practice: PE 22-3A, PE 22-3B 22-55

Direct Labor Cost Budget 4 Direct Labor Cost Budget The direct labor cost budget estimates the direct labor hours and related cost needed to support budgeted production.

4 Budget Sales Production Budget Direct Materials Purchases Budget Direct Labor Cost Budget

Note A: 520,000 units × 0.10 hr. per unit = 52,000 hrs. 4 Exhibit 11 Direct Labor Cost Budget Note A: 520,000 units × 0.10 hr. per unit = 52,000 hrs. (continued)

Note A: 520,000 units × 0.25 hr. per unit = 130,000 hrs. 4 Exhibit 11 Direct Labor Cost Budget (continued) Note A: 520,000 units × 0.25 hr. per unit = 130,000 hrs. (continued)

4 Exhibit 11 Direct Labor Cost Budget (continued) Note B: 292,000 units × 0.15 hr. per unit = 43,800 hrs. (continued)

Note B: 292,000 units × 0.40 hr. per unit = 116,800 hrs. Exhibit 11 Direct Labor Cost Budget (concluded) Note B: 292,000 units × 0.40 hr. per unit = 116,800 hrs.

4 Example Exercise 22-4 Example Exercise 10-2 Follow My Example 22-4 Direct Labor Cost Budget Landon Awards Co. budgeted production of 47,000 brass plaques in 2010. Each plaque requires engraving. Assume that 12 minutes are required to engrave each plaque. If engraving labor costs $11.00 per hour, determine the direct labor cost budget for 2010. Follow My Example 6-1 Follow My Example 22-4 Hours required for engraving: Brass plaque (47,000 × 12 min.)…………….. 564,000 min. Convert minutes to hour……………………... ÷ 60 min. Engraving hours……………………………….. 9,400 hrs. Hourly rate……………………………………………. × $11.00 Total direct labor cost………………………………. $103,400 For Practice: PE 22-4A, PE22-4B 22-62

Factory Overhead Cost Budget 4 Factory Overhead Cost Budget The factory overhead cost budget estimates the cost for each item of factory overhead needed to support budgeted production.

4 Budget Sales Production Budget Direct Materials Purchases Budget Direct Labor Cost Budget Factory Overhead Cost Budget

4 Exhibit 12 Factory Overhead Cost Budget

Cost of Goods Sold Budget 4 Cost of Goods Sold Budget The cost of goods sold budget is prepared by integrating the following budgets: Direct materials purchases budget (Exhibit 10) Direct labor cost budget (Exhibit 11) Factory overhead cost budget (Exhibit 12) Press the blue key to examine the exhibits, then type “66” and “Enter” to return to this slide.

4 Budget Sales Cost of Goods Sold Budget Production Budget Direct Materials Purchases Budget Cost of Goods Sold Budget Direct Labor Cost Budget Factory Overhead Cost Budget

Direct labor cost budget 4 Exhibit 13 Cost of Goods Sold Budget Direct materials purchases budget Direct labor cost budget Factory overhead cost budget

Type “69” and press “Enter” to return to this slide. 4 Example Exercise 22-5 Cost of Goods Sold Budget Prepare a cost of goods sold budget for Landon Awards Co. using the information in Example Exercise 22-3 (Slide 54) and 22-4 (Slide 62). Assume the estimated inventories on January 1, 2010 for finished goods and work in process were $54,000 and $47,000, respectively. Also assume the desired inventories on December 31, 2010 for finished goods and work in process were $50,000 and $49,000, respectively. Factory overhead was budgeted for $126,000. Go to Slide 54 Go to Slide 62 Type “69” and press “Enter” to return to this slide. 22-69

4 Follow My Example 22-5 22-70 For Practice: PE 22-5A, PE 22-5B Example Exercise 22-5 (continued) 4 Follow My Example 22-5 Finished goods inventory, Jan. 1, 2010 $ 54,000 Work in process inventory, Jan. 1, 2010 $ 47,000 Direct materials: Direct materials inventory, Jan. 1, 2010 (240,000 × $0.12) $ 28,800 Direct materials purchases (EE 22-3) 536,640 Cost of direct materials available for use $565,440 Less direct materials inventory, Dec. 31, 2010 (200,000 x $0.12) 24,000 Cost of direct materials placed in production $541,440 Direct labor (EE 22-4) 103,400 Factory overhead 126,000 Total manufacturing costs 770,840 Total work in process during period $817,840 Less work in process inventory, December 31, 2010 49,000 Cost of goods manufactured 768,840 Cost of finished goods available for sale $822,840 Less finished goods inventory, December 31, 2010 50,000 Cost of goods sold $772,840 For Practice: PE 22-5A, PE 22-5B 22-70

Selling and Administrative Expenses Budget 4 Selling and Administrative Expenses Budget The sales budget is often used as the starting point for the selling and administrative expenses budget. This budget is normally supported by departmental schedules.

Selling & Administrative 4 Sales Budget Production Budget Direct Materials Purchases Budget Cost of Goods Sold Budget Direct Labor Cost Budget Factory Overhead Cost Budget Selling & Administrative Expenses Budget

4 Exhibit 14 Selling and Administrative Expenses Budget

4 Exhibit 15 Budgeted Income Statement Sales budget Cost of goods sold budget Selling and administrative expenses budget

Prepare balance sheet budgets for a manufacturing company. 5 Prepare balance sheet budgets for a manufacturing company. 22-75

5 Cash Budget The cash budget is one of the most important elements of the budgeted balance sheet. The cash budget estimates the expected receipts (inflows) and payments (outflows) of cash for a period of time.

Estimated Cash Receipts 5 Estimated Cash Receipts January February March Receipts from cash sales: Cash sales (10% × current month’s sales—Note A)……. $108,000 $124,000 $ 97,000 Note A: $108,000 = $1,080,000 × 10% $124,000 = $1,240,000 × 10% $ 97,000 = $ 970,000 × 10% 22-77

Estimated Cash Receipts 5 Estimated Cash Receipts January February March Receipts from cash sales: Cash sales (10% × current month’s sales—Note A)……. $108,000 $124,000 $ 97,000 Receipts from sales on account: Collections from prior month’s sales (40% of previous month’s credit sales—Note B)……….. $370,000 $388,800 $446,400 Note B: $370,000, given as Jan. 1, 2010 Accts. Rec. balance $388,800 = $1,080,000 × 90% × 40% $446,400 = $1,240,000 × 90% × 40% 22-78

Estimated Cash Receipts 5 Estimated Cash Receipts January February March Receipts from cash sales: Cash sales (10% × current month’s sales—Note A)……. $108,000 $124,000 $ 97,000 Receipts from sales on account: Collections from prior month’s sales (40% of previous month’s credit sales—Note B)……….. $370,000 $388,800 $446,400 Collections from current month’s sales (60%) (Note C)…………………………… 583,200 669,600 523,800 Note C: $583,200 = $1,080,000 × 90% × 60% $669,600 = $1,240,000 × 90% × 60% $523,800 = $ 970,000 × 90% × 60% 22-79

5 Exhibit 16 Schedule of Collections from Sales

Estimated Cash Payments 5 Estimated Cash Payments January February March Payments of prior months’ manu- facturing costs {[25% × previous month’s manufacturing costs (less depreciation)]—Note A}….. $190,000 $204,000 $189,000 Note A: $190,000, given as January 1, 2010 Accounts Payable balance $204,000 = ($840,000 – $24,000) × 25% $189,000 = ($780,000 – $24,000) × 25%

Estimated Cash Payments 5 Estimated Cash Payments January February March Payments of prior months’ manu- facturing costs {[25% × previous month’s manufacturing costs (less depreciation)]—Note A}….. $190,000 $204,000 $189,000 Payments of current month’s manufacturing costs {[75% × current month’s manufacturing costs (less depreciation)]— Note B}…………….…………… $612,000 $567,000 $591,000 Note B: $612,000 = ($840,000 – $24,000) × 75% $567,000 = ($780,000 – $24,000) × 75% $591,000 = ($812,000 – $24,000) × 75% 22-82

5 Exhibit 17 Schedule of Payments for Manufacturing Costs

5 Exhibit 18 Cash Budget Schedule of collections from sales Schedule of cash payments for manufacturing costs

5 Example Exercise 22-6 Example Exercise 10-2 Follow My Example 22-6 Cash Budget Landon Awards Co. collects 25% of its sales on account in the month of the sale and 75% in the month following the sale. If sales on account are budgeted to be $100,000 for March and $126,000 for April, what are the budgeted cash receipts from sales on account for April? Follow My Example 22-6 April Collections from March sales (75% × $100,000)……... $ 75,000 Collections from April sales (25% × $126,000)……….. 31,500 Total receipts from sales on account………………….. $106,500 For Practice: PE 22-6A, PE22-6B 22-85

Capital Expenditure Budget 5 Capital Expenditure Budget The capital expenditure budget summarizes plans for acquiring fixed assets. Such expenditures are necessary as machinery and other fixed assets wear out or become obsolete.

5 Exhibit 19 Capital Expenditures Budget

Budgeted Balance Sheet 5 Budgeted Balance Sheet The budgeted balance sheet is prepared and based on the operating, financing, and investing budgets of the master budget. It is similar to a normal balance sheet except that estimated amounts are used.