Budgeting and Standard Cost Accounting Chapter 27 Budgeting and Standard Cost Accounting

Budgets Definition: A financial plan for the future. Budgets involve all financial areas of business. It is just as important to plan future revenues as it is to plan future costs and expenses. Similarly, it is essential to plan both cash receipts and cash payments. Chapter 27

Standard Cost Accounting Definition: A system in which manufacturing costs are budgeted at the start of a year and then compared with actual costs during the year. The analysis of variances from standard costs allows management to constantly monitor the efficiency of the production process. Chapter 27

Value of Budgeting Any type of organization—a business, a school, a hospital, or a governmental unit—can benefit from budgeting. Budgeting allows the organization to set clear financial goals. Budgeting also provides a basis for judging the financial performance of the organization. Chapter 27

Budgets The types of budgets used by businesses vary somewhat according to the nature of their operations. Common types of budgets are: Budgets for sales, purchases, operating expenses, and cost of goods sold. Budgets for cash and capital expenditures. Budgets for production, materials, labor, overhead, and cost of goods manufactured. Chapter 27

Budget Period Businesses usually budget for the fiscal year. However, a year’s budget is often broken down into quarterly or monthly segments. This practice makes it possible for management to monitor progress during the year and take corrective action if there are any problems in meeting goals. Chapter 27

Income Statement Budgets Many businesses prepare a series of budgets involving revenue, costs, and expenses. These individual budgets allow the firm to produce a budgeted income statement for the next fiscal year. Chapter 27

Sales Budget The first of the income statement budgets to be prepared. An estimate of the total dollar amount of the sales revenue for the next fiscal year. To prepare a sales budget, management must forecast the number of units of each product that will be sold and the selling price. Chapter 27

Sales Budget Tech Cameras recently started operations. It makes one type of digital camera. Its sales budget for the next fiscal year is as follows. Chapter 27

Sales Budget Sales Budget 20X3 Sales price per unit $ 1,500 Projected units to be sold  620 Budgeted sales $930,000 Chapter 27

Production Budget An estimate of the number of units to be produced in the next fiscal year. This budget is determined as follows. Chapter 27

Production Budget Projected units to be sold + Desired number of units in ending inventory = Units needed  Projected units in beginning inventory = Projected production Chapter 27

Production Budget Tech Cameras prepared the following production budget for the next fiscal year. Chapter 27

Production Budget Production Budget 20X3 Projected sales 620 Projected ending inventory 130 Units needed 750 Less: Beginning inventory 50 Projected production 700 Chapter 27

Direct Materials Purchases Budget Provides an estimate of the dollar amount of the direct materials to be purchased in the next fiscal year. This budget is determined as follows. Chapter 27

Direct Materials Purchases Budget Amount to be used in production + Amount needed for ending inventory = Total amount needed  Amount of beginning inventory = Projected purchases Chapter 27

Direct Materials Purchases Budget Tech Cameras prepared the following direct materials purchases budget for the next fiscal year. Chapter 27

Direct Materials Purchases Budget 20X3 To be used in production $231,000 Needed for ending inventory 16,000 Total needed $247,000 Less: Beginning inventory 14,000 Projected purchases $233,000 Chapter 27

Direct Labor Cost Budget Provides an estimate of the cost of the direct labor that must be used in the next fiscal year. Can be based on an estimated direct labor cost for each unit or an estimated number of direct labor hours for each unit. Chapter 27

Direct Labor Cost Budget Tech Cameras estimates its direct labor cost at $350 per unit. Thus, its direct labor cost budget for the next fiscal year is as follows. Chapter 27

Direct Labor Cost Budget 20X3 Estimated direct labor cost per unit $ 350 Projected production (units)  700 Projected direct labor cost $245,000 Chapter 27

Factory Overhead Budget Provides an estimate of the factory overhead cost that will be incurred in the next fiscal year. Can be based on a predetermined overhead rate, which is usually a percentage of the estimated direct labor cost. Can also be prepared by estimating the individual overhead items and then adding the projected amounts. Chapter 27

Factory Overhead Budget Tech Cameras estimates its factory overhead at 80% of the projected direct labor cost. Chapter 27

Factory Overhead Budget 20X3 Projected direct labor cost $245,000 Predetermined overhead rate  .80 Projected factory overhead $196,000 Chapter 27

Cost of Goods Manufactured Budget Brings together the projected amounts for direct materials, direct labor, and factory overhead from the other manufacturing budgets. The three amounts are added to find the estimated cost of goods manufactured for the next fiscal year. Chapter 27

Cost of Goods Manufactured Budget Tech Cameras has an estimated cost of goods manufactured of $672,000 for the next fiscal year. Chapter 27

Cost of Goods Manufactured Budget 20X3 Direct materials to be used in production $231,000 Direct labor 245,000 Factory overhead 196,000 Budgeted cost of goods manufactured $672,000 Chapter 27

Cost of Goods Sold Budget Tech Cameras has an estimated unit cost of $960 for the cameras to be produced in 20X3. The unit cost is found by dividing the budgeted cost of goods manufactured by the number of units to be produced in 20X3 ($672,000  700 units). The budgeted cost of goods sold is calculated by multiplying the estimated unit cost ($960) by the projected units to be sold (620). Chapter 27

Cost of Goods Sold Budget Tech Cameras has a budgeted cost of goods sold of $595,200 for the next fiscal year. Chapter 27

Cost of Goods Sold Budget 20X3 Cost per unit $ 960 Projected units to be sold  620 Budgeted cost of goods sold $595,200 Chapter 27

Operating Expenses Budget Tech Cameras estimated that in 20X3 its selling expenses will be $165 per unit and its general expenses will be $110 per unit. To find its budgeted operating expenses for 20X3, Tech Cameras must multiply the total of the selling and general expenses for each unit ($275) by the projected units to be sold (620). Chapter 27

Operating Expenses Budget Expenses per unit: Selling expenses $ 165 General expenses 110 Total operating expenses per unit $ 275 Projected sales (units)  620 Budgeted operating expenses $170,500 Chapter 27

Budgeted Income Statement Ties together all the budgeted amounts for revenue, costs, and expenses calculated previously. Chapter 27

Tech Cameras Budgeted Income Statement For Year Ending December 31, 20X3 Sales $930,000 Cost of goods sold 595,200 Gross profit $334,800 Operating expenses 170,500 Net income $164,300 Chapter 27

Budgeted Income Statement Shows the operating results that management can expect for the upcoming fiscal year. If these results are not satisfactory, management can revise its plans. It may want to raise selling prices or cut expenses. Chapter 27

Balance Sheet Budgets The budgeted income statement and its supporting projections are one part of a firm’s budgeting activities. Another part of budgeting activities is the preparation of balance sheet budgets. The most widely used balance sheet budgets are the cash budget and the capital expenditures budget. Chapter 27

Cash Budget Provides a month-by-month breakdown of expected cash receipts and payments during the fiscal year. An important tool for managing short-term cash needs. Chapter 27

Capital Expenditures Budget Shows planned outlays for plant assets over a period of several years, such as five years. Provides a long-term plan for acquiring the plant assets needed for a firm’s operations. Chapter 27

Flexible Budget Sometimes changes in the level of production occur after the budget period begins. To deal with this situation in advance, many firms prepare a flexible budget. Chapter 27

Flexible Budget The flexible budget provides estimates for several levels of production. Example: A flexible budget might include estimates for 8,000 units, 9,000 units, and 10,000 units. Chapter 27

Variable and Fixed Costs To prepare a flexible budget, it is necessary to classify costs as variable or fixed. Chapter 27

Variable Cost Definition: Cost that changes in response to a change in the level of production. Examples: direct materials and direct labor Variable costs vary in total with changes in production level, but they remain constant on a per-unit basis. Chapter 27

Variable Cost Example The Wilson Company has a cost of $52 per unit for direct materials. If the firm produces 4,000 units, the total cost of direct materials is $208,000 ($52  4,000). If the firm produces 5,000 units, the total cost of direct materials is $260,000 ($52  5,000). Chapter 27

Fixed Cost Definition: Cost that does not change if the level of production changes. Example: Rent and depreciation Fixed costs remain constant in total no matter what the production level, but they vary on a per-unit basis. Chapter 27

Fixed Cost Example The Wilson Company has total fixed factory overhead of $120,000. If the firm produces 4,000 units, the per-unit cost of fixed factory overhead is $30 ($120,000  4,000). If the firm produces 5,000 units, the per-unit cost of fixed factory overhead is $24 ($120,000  5,000). Chapter 27

Flexible Budget for Wilson Company Cost of Goods Manufactured 20X1 4,000 5,000 Units Units Direct materials: $52 per unit $208,000 $260,000 Direct labor: $64 per unit 256,000 320,000 Variable overhead: $40 per unit 160,000 200,000 Fixed overhead 120,000 120,000 Total cost $744,000 $900,000 Per-unit cost $186.00 $180.00 Chapter 27

Standard Cost Accounting Can be used with either a job order system or a process system. Budgeted (standard) costs are assigned to all products in advance. When the products are manufactured, the actual and standard costs are compared. Chapter 27

Favorable and Unfavorable Variances Any difference between an actual cost and a budgeted (standard) cost is called a variance. All variances must be analyzed. If an actual cost exceeds a standard cost, the difference is an unfavorable variance. If an actual cost is less than a standard cost, the difference is a favorable variance. Chapter 27

Variance Analysis Suppose the Wilson Company’s standard for direct materials is one set of materials at $52 for each unit produced. In 20X1, the firm produced 5,000 units and used 5,300 sets of materials at a price of $50 per set. Chapter 27

Variance Analysis The quantity of the materials used was 300 sets above the standard. The price of the materials used was $2 per unit below the standard. Chapter 27

Calculating the Direct Materials Variance The Wilson Company had an unfavorable direct materials variance of $5,000. Actual cost: 5,300 sets at $50 each $265,000 Standard cost: 5,000 sets at $52 each 260,000 Direct materials variance—unfavorable $ 5,000 Chapter 27

Calculating a Quantity Variance The Wilson Company’s direct materials variance is made up of a quantity variance and a price variance. There is an unfavorable quantity variance of $15,600 for direct materials. Chapter 27

Calculating a Quantity Variance Actual quantity 5,300 Standard quantity  5,000 Excess quantity 300 Standard Cost  Excess Quantity = Quantity Variance $52  300 = $15,600 Chapter 27

Calculating a Price Variance Standard price $52 Actual price  50 Savings per unit $ 2 Savings per unit  Actual Quantity = Price Variance $2  5,300 = $10,600 Chapter 27

Summary of Direct Materials Variances Unfavorable quantity variance $15,600 Favorable price variance  10,600 Unfavorable variance $ 5,000 Chapter 27

Recording the Variances The total standard cost for materials is debited to Work-in-Process Inventory. The total actual cost is credited to Raw Materials Inventory. The variances are recorded in separate accounts for quantity and price variances. Chapter 27

Recording the Variances 20X1 Dec. 31 Work-in-Process Inventory 260,000 Direct Materials Quantity Variance 15,600 Direct Materials Price Variance 10,600 Raw Materials Inventory 265,000 Chapter 27

Variance Accounts Temporary owner’s equity accounts. Unfavorable variances are recorded as debits because they decrease owner’s equity. Favorable variances are recorded as credits because they increase owner’s equity. The variance accounts are closed into Cost of Goods Sold at the end of the accounting period. Chapter 27