c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeting Chapter 21

Learning Objectives 1. Describe budgeting, its objectives, and its impact on human behavior. 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. 4. Prepare the basic income statement budgets for a manufacturing company. 5. Prepare balance sheet budgets for a manufacturing company.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe budgeting, its objectives, and its impact on human behavior. 1

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Nature and Objectives of Budgeting o Budgets play an important role for organizations of all sizes and forms. For example, budgets are used in managing the operations of government agencies, churches, hospitals, small businesses, and manufacturing companies.

O BJECTIVES OF B UDGETING Estimated Portion of Your Total Monthly Income That Should Be Budgeted for Various Living Expenses Source: Consumer Credit Counseling Service

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Objectives of Budgeting o Budgeting involves:  Establishing specific goals.  Executing plans to achieve the goals.  Periodically comparing actual results with the goals.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Objectives of Budgeting o Budgeting affects the following managerial functions:  Planning, which involves setting goals to guide decisions and help motivate employees.  Directing, which involves decisions and actions to achieve budgeted goals.  Controlling, which involves comparing actual performance against the budgeted goals.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Objectives of Budgeting o A budgetary unit of a company is called a responsibility center. o Each responsibility center is led by a manager who has the authority and responsibility for achieving the center’s budgeted goals.

O BJECTIVES OF B UDGETING

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Objectives of Budgeting o As time passes, the actual performance of a responsibility center can be compared against the budgeted goals. This provides prompt feedback to managers and employees about their performance. o If necessary, responsibility centers can use such feedback to adjust their activities in the future.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Human Behavior and Budgeting o Human behavior problems can arise in the budgeting process in the following situations:  The budgeted goals are set too tight, which are very hard or impossible to achieve.  This may have a negative effect on the company achieving its goals.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Human Behavior and Budgeting o Human behavior problems can arise in the budgeting process in the following situations:  The budgeted goals are set too loose, which are very easy to achieve.  Budget “padding” iscalled budgetary slack.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Human Behavior and Budgeting o Human behavior problems can arise in the budgeting process in the following situations:  The budgeted goals conflict with the objectives of the company and employees.  Goal conflict occurs when employees’ or managers’ self-interest differs from the company’s goals.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe the basic elements of the budget process, the two major types of budgeting, and the use of computers in budgeting. 2

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeting Systems o The budgetary period for operating activities normally includes the fiscal year of a company. o A variation of fiscal-year budgeting, called continuous budgeting, maintains a 12-month projection into the future.

B UDGETING S YSTEMS

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeting Systems o Zero-based budgeting requires managers to estimate sales, production, and other operating data as though operations are being started for the first time.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Static Budget o 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. o A static budget is used by many service companies and for some administrative functions of manufacturing companies.

S TATIC B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Static Budget o The disadvantage of static budgets is that they do not adjust for changes in revenues and expenses that occur as volumes change.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Flexible Budget o Flexible budgets show the expected results of a responsibility center for several activity levels. o A flexible budget is, in effect, a series of static budgets for different levels of activity.

F LEXIBLE B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Flexible Budget o If Colter Manufacturing Company’s Assembly Department spent $70,800 to produce 10,000 units, how much over or under budget would the department manager be when using a flexible budget? The firm would be under budget by $200 ($71,000 – $70,800).

F LEXIBLE B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Describe the master budget for a manufacturing company. 3

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Master Budget o The master budget is an integrated set of operating, investing, and financing budgets for a period of time.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. 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 Master Budget o For a manufacturing company, the master budget consists of the following integrated budgets:

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Prepare the basic income statement budgets for a manufacturing company. 4

I NCOME S TATEMENT B UDGETS

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Sales Budgets o 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.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Sales Budgets o The prior year’s sales quantities are revised for such factors as the following:  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

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Sales Budgets o Elite Accessories Inc. manufactures wallets and handbags that are sold in two regions, the East and West regions. Elite Accessories estimates the following sales quantities and prices for 2014.

S ALES B UDGETS

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Production Budget o The production budget estimates the number of units to be manufactured to meet budgeted sales and desired inventory levels.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Production Budget o Elite Accessories Inc. expects the following inventories of wallets and handbags:

P RODUCTION B UDGET

Production Budget Expected units to be sold +Desired units in ending inventory –Estimated units in beginning inventory Total units to be produced Expected units to be sold +Desired units in ending inventory –Estimated units in beginning inventory Total units to be produced Sales Budget P RODUCTION B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Direct Materials Purchases Budget o The direct materials purchases budget estimates the quantities of direct materials to be purchased to support the budgeted production and desired inventory levels.

Production Budget Direct Materials Purchases Budget Direct Materials Purchases Budget Materials needed for production +Desired ending materials inventory –Estimated beginning materials inventory Direct materials to be purchased Materials needed for production +Desired ending materials inventory –Estimated beginning materials inventory Direct materials to be purchased Sales Budget D IRECT M ATERIALS P URCHASES B UDGET

Note A: 520,000 units x 0.30 sq. yd. per unit = 156,000 sq. yds. D IRECT M ATERIALS P URCHASES B UDGET

Note A: 520,000 units x 0.10 sq. yd. per unit = 52,000 sq. yds. D IRECT M ATERIALS P URCHASES B UDGET

Note B: 292,000 units x 1.25 sq. yd. per unit = 365,000 sq. yds. D IRECT M ATERIALS P URCHASES B UDGET

Note B: 292,000 units x 0.50 sq. yd. per unit = 146,000 sq. yds. D IRECT M ATERIALS P URCHASES B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Direct Labor Cost Budget o The direct labor cost budget estimates the direct labor hours and related cost needed to support budgeted production.

Production Budget Direct Materials Purchases Budget Direct Materials Purchases Budget Direct Labor Cost Budget Direct Labor Cost Budget Sales Budget D IRECT L ABOR C OST B UDGET

Note A: 520,000 units x 0.10 hr. per unit = 52,000 hrs. D IRECT L ABOR C OST B UDGET

Note A: 520,000 units x 0.25 hr. per unit = 130,000 hrs. D IRECT L ABOR C OST B UDGET

Note B: 292,000 units x 0.15 hr. per unit = 43,800 hrs. D IRECT L ABOR C OST B UDGET

Note B: 292,000 units x 0.40 hr. per unit = 116,800 hrs. D IRECT L ABOR C OST B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Factory Overhead Cost Budget o The factory overhead cost budget estimates the cost for each item of factory overhead needed to support budgeted production.

Production Budget Direct Materials Purchases Budget Direct Materials Purchases Budget Direct Labor Cost Budget Direct Labor Cost Budget Factory Overhead Cost Budget Factory Overhead Cost Budget Sales Budget F ACTORY O VERHEAD C OST B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Cost of Goods Sold Budget o The cost of goods sold budget is prepared by integrating the following budgets:  Direct materials purchases budget  Direct labor cost budget  Factory overhead cost budget

Cost of Goods Sold Budget Production Budget Direct Materials Purchases Budget Direct Materials Purchases Budget Direct Labor Cost Budget Direct Labor Cost Budget Factory Overhead Cost Budget Factory Overhead Cost Budget Sales Budget C OST OF G OODS S OLD B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Selling and Administrative Expenses Budget o The selling and administrative expenses budget is normally supported by departmental schedules. The sales budget is often used as the starting point for this budget.

Production Budget Direct Materials Purchases Budget Direct Materials Purchases Budget Direct Labor Cost Budget Direct Labor Cost Budget Factory Overhead Cost Budget Factory Overhead Cost Budget Cost of Goods Sold Budget Selling & Administrative Expenses Budget Sales Budget S ELLING AND A DMINISTRATIVE E XPENSES B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeted Income Statement o The budgeted income statement is prepared by integrating the following budgets:  Sales budget  Cost of goods sold budget  Selling and administrative expenses budget

B UDGET I NCOME S TATEMENT

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objective Prepare balance sheet budgets for a manufacturing company. 5

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Cash Budget o The cash budget estimates the expected receipts (inflows) and payments (outflows) of cash for a period of time.

E STIMATED C ASH R ECEIPTS Receipts from cash sales: Cash sales (10% x current month’s sales—Note A)……. $108,000$124,000$ 97,000 JanuaryFebruaryMarch Note A: $108,000 = $1,080,000 x 10% $124,000 = $1,240,000 x 10% $ 97,000 = $ 970,000 x 10% Part of Exhibit 16

Receipts from cash sales: Cash sales (10% x current month’s sales—Note A)…….$108,000$124,000$ 97,000 JanuaryFebruaryMarch 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, 2014, Accts. Rec. balance $388,800 = $1,080,000 x 90% x 40% $446,400 = $1,240,000 x 90% x 40% E STIMATED C ASH R ECEIPTS

Receipts from cash sales: Cash sales (10% x current month’s sales—Note A)…….$108,000$124,000$ 97,000 JanuaryFebruaryMarch 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% of current month’s credit sales—Note C)…………583, , ,800 Note C: $583,200 = $1,080,000 x 90% x 60% $669,600 = $1,240,000 x 90% x 60% $523,800 = $ 970,000 x 90% x 60% E STIMATED C ASH R ECEIPTS

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Estimated Cash Payments o To estimate cash payments for manufacturing costs, a schedule of payments for manufacturing costs is prepared.

JanuaryFebruaryMarch Note A: $190,000, given as January 1, 2014, Accounts Payable balance $204,000 = ($840,000 – $24,000) x 25% $189,000 = ($780,000 – $24,000) x 25% Payments of prior month’s manu- facturing costs {[25% x previous month’s manufacturing costs (less depreciation)]—Note A}…..$190,000$204,000$189,000 From Exhibit 17 E STIMATED C ASH P AYMENTS

Payments of prior month’s manu- facturing costs {[25% x previous month’s manufacturing costs (less depreciation)]—Note A}…..$190,000$204,000$189,000 JanuaryFebruaryMarch Payments of current month’s manufacturing costs {[75% x current month’s manufacturing costs (less depreciation)]— Note B}…………….…………… $612,000$567,000$591,000 Note B: $612,000 = ($840,000 – $24,000) x 75% $567,000 = ($780,000 – $24,000) x 75% $591,000 = ($812,000 – $24,000) x 75% E STIMATED C ASH P AYMENTS

C ASH B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Capital Expenditures Budget o The capital expenditures budget summarizes plans for acquiring fixed assets. Such expenditures are necessary as machinery and other fixed assets wear out or become obsolete. o In addition, purchasing additional fixed assets may be necessary to meet increasing demand for the company’s product.

C APITAL E XPENDITURES B UDGET

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeted Balance Sheet o The budgeted balance sheet is prepared 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.

c Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeting The End