Budgeting: The Basis for Planning and Control – Planning Developing objectives for acquisition and use of resources. – Control Steps taken by management to ensure that objectives are attained. Benefits Derived from Budgeting Establishing Budgeted Amounts: The “Behavioral” Approach – Problems & Solution 1

Participation in Budget Process The Budget Period (Time) The Master Budget Sales Budget The Production Budget The Production Budget Material Purchases Cash Payments for Material Purchases The Production Budget 2

The Production Budget Direct Labor Cash Payments for Direct Labor The Production Budget Manufacturing Overhead Cash Payments for Manufacturing Overhead Selling and Administrative (S&A) Expense Budget Cash Payments for (S&A) Expenses Cash Receipts Budget 3

Comprehensive Cash Budget Chapter 22 4

Comprehensive Cash Budget With just a little more information we will be able to prepare a comprehensive cash budget. 5

Ellis Magnet 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 Budget Additional Information 6

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$50,000 ×.16 × 3/12 = $2,000 12

Budgeted Income Statement Cash Budget Completed The Budgeted Income Statement 13

The Budgeted Income Statement 14

Computation of unit cost follows The Budgeted Income Statement 15

Total mfg. OH for quarter $251,000 Total labor hours required 5,050 hrs. = $49.70 per hr. Manufacturing overhead is applied based on direct labor hours. The Budgeted Income Statement 16

The Budgeted Income Statement 17

The Budgeted Income Statement 18

Budgeted Balance Sheet Completed Budgeted Income Statement The Budgeted Balance Sheet 19

The Budgeted Balance Sheet Ellis 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 - $148,150 Ellis 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 - $148,150 20

25% of June sales of $300,000 11,500 $.40 per lb. 50% of June purchases of $56,800 5,000 $4.99 each 21

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Flexible Budgeting Let’s change topics. 23

Flexible Budgeting Performance evaluation is difficult when actual activity differs from the activity originally budgeted. Hmm! Comparing costs at different levels of activity is like comparing apples with oranges. Consider the following condensed example from the Cheese Company... 24

Flexible Budgeting 25

U = Unfavorable variance – Cheese Company was unable to achieve the budgeted level of activity. Flexible Budgeting 26

F = Favorable variance: actual costs are less than budgeted costs. Flexible Budgeting 27

Since cost variances are favorable, have we done a good job controlling costs? Flexible Budgeting 28

I don’t think I can answer the question using the original budget. How much of the favorable cost variance is due to lower activity, and how much is due to good cost control? Flexible Budgeting 29

Flexible Budgeting I don’t think I can answer the question using the original budget. How much of the favorable cost variance is due to lower activity, and how much is due to good cost control? To answer the question, we must the budget to the actual level of activity. 30

Flexible Budgeting Central Concept If you can tell me what your activity was for the period, I will tell you what your costs and revenue should have been. 31

Improve performance evaluation. May be prepared for any activity level in the relevant range. Show expenses that should have occurred at the actual level of activity. Reveal variances due to good cost control or lack of cost control. Flexible Budgeting 32

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 remain unchanged within the relevant range. Fixed Variable 33

Let’s prepare budgets for the Cheese Company. Flexible Budgeting 34

Flexible Budgeting 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. 35

Flexible Budgeting 36

Flexible Budgeting Total variable cost = $7.50 per unit × budget level in units 37

Flexible Budgeting Fixed costs are expressed as a total amount that does not change within the relevant range of activity. 38

Now let’s prepare a budget performance report at 8,000 actual machine hours for the Cheese Co. Flexible Budgeting Performance Report 39

Flexible Budgeting Performance Report 40

Indirect labor and indirect material have unfavorable variances because actual costs are more than the flexible budget costs. Flexible Budgeting Performance Report 41

Power has a favorable variance because the actual cost is less than the flexible budget cost. Flexible Budgeting Performance Report 42

End of Chapter # 22 Allah Hafiz 43