Chapter 7 Profit Planning Chapter 7: Profit Planning.

Chapter 7 Profit Planning Chapter 7: Profit Planning.
This chapter focuses on the steps taken by businesses to achieve their planned levels of profits – a process called profit planning. Profit planning is accomplished by preparing numerous budgets, which, when brought together, form an integrated business plan known as a master budget.

Learning Objective 1 Understand why organizations budget and the processes they use to create budgets. Learning objective number 1 is to understand why organizations budget and the processes they use to create budgets.

The Basic Framework of Budgeting
A budget is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period. The act of preparing a budget is called budgeting. The use of budgets to control an organization’s activity is known as budgetary control. A budget is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period. The act of preparing a budget is called budgeting. The use of budgets to control an organization’s activities is known as budgetary control.

Planning and Control Planning – involves developing objectives and preparing various budgets to achieve these objectives. Control – involves the steps taken by management that attempt to ensure the objectives are attained. Planning involves developing objectives and preparing various budgets to achieve those objectives. Control involves the steps taken by management to increase the likelihood that the objectives set down at the planning stage are attained and that all parts of the organization are working together toward that goal. To be effective, a good budgeting system must provide for both planning and control. Good planning without effective control is time wasted.

Advantages of Budgeting
Define goals and objectives Communicate plans Think about and plan for the future Advantages Coordinate activities Means of allocating resources The advantages of budgeting are: Budgets communicate management’s plans throughout the organization. Budgets force managers to think about and plan for the future. The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively. The budgeting process can also uncover potential bottlenecks before they occur. Budgets coordinate the activities of the entire organization by integrating the plans of its various parts. Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance. Uncover potential bottlenecks

Responsibility Accounting
Managers should be held responsible for those items — and only those items — that the manager can actually control to a significant extent. The premise of responsibility accounting is that managers should be held responsible only for those items that they can control to a significant extent. Responsibility accounting systems enable organizations to react quickly to deviations from feedback obtained by comparing budgeted goals to actual results. The point is not to penalize individuals for missing targets.

Choosing the Budget Period
Operating Budget 2003 2004 2005 2006 Operating budgets ordinarily cover a one-year period corresponding to a company’s fiscal year. Many companies divide their annual budget into four quarters. In this chapter, we focus on one-year operating budgets. The annual operating budget may be divided into quarterly or monthly budgets.

Self-Imposed Budget A self-imposed budget or participative budget is a budget that is prepared with the full cooperation and participation of managers at all levels. It is a particularly useful approach if the budget will be used to evaluate managerial performance. A participative budget is prepared with the full cooperation and participation of managers at all levels. A participative budget is also known as a self-imposed budget.

Advantages of Self-Imposed Budgets
Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management. Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers. Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this explanation. The advantages of self-imposed budgets include: Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management. Budget estimates prepared by front-line managers (who have intimate knowledge of day-to-day operations) are often more accurate than estimates prepared by top managers. Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this explanation.

Managers should watch our for budgetary slack.
Self-Imposed Budgets Most companies do not rely exclusively upon self-imposed budget in the sense that top managers usually initiate the budget process by issuing broad guidelines in terms of overall target profits or sales. Self-imposed budgets should be reviewed by higher levels of management. Self-imposed budgets should be reviewed by higher levels of management. Without such a review, self-imposed budgets may have too much “budgetary slack,” or may not be aligned with the overall strategic objectives. Most companies do not rely exclusively upon self-imposed budgets, given that top managers usually initiate the budget process by issuing broad guidelines based on the overall target profits or sales. Lower level managers are directed to prepare budgets that meet those targets. Managers should watch our for budgetary slack.

Human Factors in Budgeting
The success of budgeting depends upon three important factors: Top management must be enthusiastic and committed to the budget process. Top management must not use the budget to pressure employees or blame them when something goes wrong. Highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget targets. The success of a budget program depends on three important factors: Top management must be enthusiastic and committed to the budgeting process, otherwise nobody will take it seriously. Top management must not use the budget to pressure employees or blame them when something goes wrong. This breeds hostility and mistrust rather than cooperative and coordinated efforts. Highly achievable budget targets are usually preferred (rather than “stretch budget” targets) when managers are rewarded based on meeting budget targets.

The Budget Committee A standing committee responsible for
overall policy matters relating to the budget coordinating the preparation of the budget A budget committee is usually responsible for overall policy relating to the budget program, for coordinating the preparation of the budget, for resolving disputes related to the budget, and for approving the final budget. This committee may consist of the president, vice presidents in charge of various functions, such as sales, production, purchasing, and the controller.

The Master Budget: An Overview
Sales budget Ending inventory budget Selling and administrative expense budget Production budget Direct materials budget Direct labor budget Manufacturing overhead budget The master budget consists of a number of separate but interdependent budgets. The sales budget shows the expected sales for the budget period expressed in dollars and units. It is usually based on a company’s sales forecast. All other parts of the master budget are dependent on the sales budget. The production budget is prepared after the sales budget. It lists the number of units that must be produced during each budget period to meet sales needs and to provide for the desired ending inventory. The production budget in turn directly influences the direct materials, direct labor, and manufacturing overhead budgets, which in turn enable the preparation of the ending finished goods inventory budget. These budgets are then combined with data from the sales budget and the selling and administrative expense budget to determine the cash budget. The cash budget is a detailed plan showing how cash resources will be acquired and used over a specified time period. All of the operating budgets have an impact on the cash budget. The last step of the process is to prepare a budgeted income statement and a budgeted balance sheet. Cash budget Budgeted income statement Budgeted balance sheet

Learning Objective 2 Prepare a sales budget, including a schedule of expected cash collections. Learning objective number 2 is to prepare a sales budget, including a schedule of expected cash collections.

Budgeting Example Royal Company is preparing budgets for the quarter ending June 30. Budgeted sales for the next five months are: April 20,000 units May 50,000 units June 30,000 units July 25,000 units August 15,000 units. The selling price is $10 per unit. Royal company’s marketing department has developed the information shown that will be used to prepare a budget for the quarter ending June 30th.

The Sales Budget The individual months of April, May, and June are summed to obtain the total projected sales in units and dollars for the quarter ended June 30th Royal sells only one product and that product has a selling price of $10 per unit. The sales budget is prepared by multiplying the budgeted sales in units for each month by the selling price per unit. The total sales budget for the quarter ($1,000,000) is calculated by multiplying the budgeted sales in units for the quarter (100,000) by the selling price per unit ($10). Once we complete the sales budget, we can move on to the expected cash collections from sales.

Expected Cash Collections
All sales are on account. Royal’s collection pattern is: 70% collected in the month of sale, 25% collected in the month following sale, 5% uncollectible. The March 31 accounts receivable balance of $30,000 will be collected in full. All sales at Royal are made on account. The company collects 70 percent of the sales revenue in the month of sale, 25 percent in the following month, and estimates that 5 percent of all credit sales will prove uncollectible. At the start of the quarter Royal had $30,000 in accounts receivable that were deemed to be fully collectible. Let’s prepare the budget of expected cash collections on sales using five steps.

The first step in calculating Royal’s cash collections is to insert the beginning accounts receivable balance ($30,000) into the April column of the cash collections schedule. This balance will be collected in full in April.

From the Sales Budget for April. The second step is to calculate the April credit sales that will be collected during each month of the quarter. $140,000 ($200,000 × 70%) will be collected in April and $50,000 ($200,000 × 25%) will be collected in May. $10,000 ($200,000 × 5%) will be uncollectible.

The third step is to calculate the May credit sales that will be collected during each month of the quarter. $350,000 ($500,000 × 70%) will be collected in May and $125,000 ($500,000 × 25%) will be collected in June. $25,000 ($500,000 × 5%) will be uncollectible. From the Sales Budget for May.

Quick Check  What will be the expected cash collections in June from the June sales? a. $125,000 b. $210,000 c. $335,000 d. $905,000 What will be the expected cash collections in June from June sales?

Quick Check  What will be the expected cash collections in June from the June sales? a. $125,000 b. $210,000 c. $335,000 d. $905,000 The answer is $210,000. We will look at the computations on the next slide.

The fourth step is to calculate the June credit sales that will be collected during the month of June. $210,000 ($300,000 × 70%) will be collected in June from the June sales. The fifth step is to calculate the total for each column in the schedule. Notice that for the quarter, we expect to collect a total of $905,000. Now let’s turn our attention to the production budget.

Budget and Expected Cash Collections
The Production Budget Sales Budget and Expected Cash Collections Production Budget Completed The production budget (must be adequate to meet budgeted sales and provide for adequate ending inventory) Production must be adequate to meet budgeted sales and provide for sufficient ending inventory.

Prepare a production budget.
Learning Objective 3 Prepare a production budget. Learning objective number 3 is to prepare a production budget.

Let’s prepare the production budget.
The management at Royal Company wants ending inventory to be equal to 20% of the following month’s budgeted sales in units. On March 31, 4,000 units were on hand. Let’s prepare the production budget. To minimize the probability of a stock out of inventory items, the management at Royal Company has implemented a policy that requires the company to maintain ending inventory of 20 percent of the following month’s budgeted sales. At the beginning of the quarter, Royal had 4,000 units in inventory. If Royal was a merchandising company, it would prepare a merchandise purchases budget, instead of a production budget.

The Production Budget The first step in preparing the production budget is to insert the budgeted sales in units from the sales budget.

The Production Budget March 31 ending inventory Part I
The second step is to calculate the required production in units for April (26,000 units). Part II The desired ending inventory is recognition of management’s policy against stock-out of inventory. We determine the number of ending inventory units by multiplying May’s projected unit sales times the 20 percent established by management as part of its policy. We add the desired ending inventory in units to the projected sales to get our total unit needs for the month. Part III Finally, we subtract the current period’s beginning inventory. In our case, Royal had 4,000 units in inventory at the end of March.

Quick Check  What is the required production for May? a. 56,000 units
b. 46,000 units c. 62,000 units d. 52,000 units What is the required production for May?

Quick Check  What is the required production for May? a. 56,000 units
b. 46,000 units c. 62,000 units d. 52,000 units The correct answer is 46,000 units. We will show you the calculation of this amount on the next screen.

The Production Budget The third step is to calculate the required production for May (46,000 units). Notice, April’s desired ending inventory (10,000 units) becomes May’s beginning inventory.

Assumed ending inventory.
The Production Budget Assumed ending inventory. Part I The fourth step is to calculate the required production for June (29,000 units). Notice, we are assuming a desired ending inventory of 5,000 units which implies that projected sales in July are 25,000 units. Part II The fifth step is to complete the “Quarter” column. Notice, April’s beginning inventory and June’s ending inventory are carried over to this column. For the quarter we will need to produce 101,000 units to meet our sales and inventory goals. Now that we know our required production, let’s look at the direct materials budget.

Learning Objective 4 Prepare a direct materials budget, including a schedule of expected cash disbursements for purchases of materials. Learning objective number 4 is to prepare a direct materials budget, including a schedule of expected cash disbursements for purchases of materials.

The Direct Materials Budget
At Royal Company, five pounds of material are required per unit of product. Management wants materials on hand at the end of each month equal to 10% of the following month’s production. On March 31, 13,000 pounds of material are on hand. Material cost is $0.40 per pound. Let’s prepare the direct materials budget. Royal Company’s direct materials budget quantifies the raw materials that must be purchased to fulfill the production budget and to provide for adequate inventories. Each good unit of output requires 5 pounds of direct material. Management does not want to run out of direct materials, so a policy has been established that materials on hand at the end of each month must be equal to 10 percent of the following month’s production. At the beginning of the month, Royal has 13,000 pounds of direct material on hand. Each pound of direct material costs 40cents.

From production budget The first step in preparing the direct materials budget is to insert the required production in units from the production budget.

The second step is to calculate the monthly and quarterly production needs, which in this case are stated in terms of pounds of direct material. We multiply the required unit production by the number of pounds of direct materials needed (5 pounds per unit.)

10% of following month’s production needs. Part I The third step is to calculate the materials to be purchased for April (140,000 pounds). Part II The ending inventory for April is equal to 10 percent of May’s production needs, or 23,000 pounds. The total number of pounds needed in April is 153,000 pounds. Part III Finally, we subtract our materials on hand to arrive at the number of pounds of material that must be purchased. During April, Royal must purchase 140,000 pounds of direct materials. Now let’s calculate the materials to be purchased in May. March 31 inventory Calculate the materials to by purchased in May.

Quick Check  How much materials should be purchased in May?
a. 221,500 pounds b. 240,000 pounds c. 230,000 pounds d. 211,500 pounds How many pounds of materials must be purchased in May?

Quick Check  How much materials should be purchased in May?
a. 221,500 pounds b. 240,000 pounds c. 230,000 pounds d. 211,500 pounds The correct answer is 221,500 pounds. Let’s see how we arrive at this value.

The fourth step is to calculate the materials to be purchased for May (221,500 pounds). Notice that April’s desired ending inventory becomes May’s beginning inventory.

The fifth step is to calculate the materials to be purchased for June ($142,000) and to calculate the quarterly totals. Notice that we are assuming a desired ending inventory for June of 11,500 pounds. April’s beginning inventory and June’s ending inventory are carried over to the “Quarter” column. Assumed ending inventory

Expected Cash Disbursement for Materials
Royal pays $0.40 per pound for its materials. One-half of a month’s purchases is paid for in the month of purchase; the other half is paid in the following month. The March 31 accounts payable balance is $12,000. Let’s calculate expected cash disbursements. Recall that Royal pays 40 cents per pound for direct materials. It pays for its purchases one-half in the month of the purchase and one-half in the following month. At the beginning of the quarter, Royal owed creditors $12,000 for purchases of direct materials. Let’s begin the expected cash disbursement for direct materials schedule.

The first step in calculating Royal’s cash disbursements is to insert the beginning accounts payable balance ($12,000) into the April column of the cash disbursements schedule. This balance will be paid in full in April.

140,000 lbs. × $.40/lb. = $56,000 The second step is to calculate the April credit purchases that will be paid during each month of the quarter. $28,000 ($56,000 × 50%) will be paid in April and $28,000 ($56,000 × 50%) will be paid in May Note that $56,000 is derived by multiplying 140,000 pounds by the $0.40 per pound purchase price. Let’s compute the expected total cash disbursements for the quarter. Compute the expected cash disbursements for materials for the quarter.

Quick Check  What are the total cash disbursements for the quarter?

Quick Check  What are the total cash disbursements for the quarter?
The correct answer is $185,000. Let’s look at the completed schedule to see how we arrived at this answer.

The remaining steps include: Calculating the May and June credit purchases that are paid during each month of the quarter. Calculating the totals for all columns in the schedule.

Prepare a direct labor budget.
Learning Objective 5 Prepare a direct labor budget. Learning objective number 5 is to prepare a direct labor budget.

The Direct Labor Budget
At Royal, each unit of product requires 0.05 hours (3 minutes) of direct labor. The Company has a “no layoff” policy so all employees will be paid for 40 hours of work each week. In exchange for the “no layoff” policy, workers agree to a wage rate of $10 per hour regardless of the hours worked (No overtime pay). For the next three months, the direct labor workforce will be paid for a minimum of 1,500 hours per month. Let’s prepare the direct labor budget. Royal’s direct labor budget enables the company to match its direct labor hours provided with its production needs. A unique aspect of direct labor at Royal is the no overtime policy. The company agrees to no layoffs of employees if work is slow, but in return, pays its employees at the regular rate of $10 per hour for all hours worked. With the current work force, Royal will have to pay for a minimum of 1,500 hours of direct labor regardless of the work available.

From production budget The first step in preparing the direct labor budget is to insert the production in units from the production budget.

The second step is to compute the direct labor hours required to meet the production needs. Notice that 0.05 direct labor hours are needed per unit. We multiply the number of units to produce by the time required to produce one unit and see that we will require 1,300 direct labor hours in April, 2,300 hours in May and 1,450 hours in June.

The third step, in this particular example, is to compute the direct labor hours paid. Because of the no layoff policy, Royal is committed to paying for a minimum of 1,500 hours per month. The number of hours paid will be the greater of the direct labor hours required, or 1,500 hours. In April, Royal will pay for 1,500 direct labor hours when there is only work for 1,300 hours. In May and June, Royal will pay for 2,300 hours and 1,500 hours, respectively. For the quarter, the company will pay for 5,300 direct labor hours. Greater of labor hours required or labor hours guaranteed.

The fourth step is to compute the total direct labor cost. Notice that with direct labor, we computed all three months at the same time. This is because there is no beginning and ending inventory to consider.

Quick Check  What would be the total direct labor cost for the quarter if the company follows its no lay-off policy, but pays $15 (time-and-a-half) for every hour worked in excess of 1,500 hours in a month? a. $79,500 b. $64,500 c. $61,000 d. $57,000 Determine the total direct labor costs if Royal were to pay time-and-one-half for all hours in excess of 1,500 hours per month.

Quick Check  What would be the total direct labor cost for the quarter if the company follows its no lay-off policy, but pays $15 (time-and-a-half) for every hour worked in excess of 1,500 hours in a month? a. $79,500 b. $64,500 c. $61,000 d. $57,000 The correct answer is $57, Now let’s look at the manufacturing overhead budget.

Prepare a manufacturing overhead budget.
Learning Objective 6 Prepare a manufacturing overhead budget. Learning objective number 6 is to prepare a manufacturing overhead budget.

Manufacturing Overhead Budget
At Royal manufacturing overhead is applied to units of product on the basis of direct labor hours. The variable manufacturing overhead rate is $20 per direct labor hour. Fixed manufacturing overhead is $50,000 per month and includes $20,000 of noncash costs (primarily depreciation of plant assets). Let’s prepare the manufacturing overhead budget. Royal’s manufacturing overhead budget. This budget provides a schedule of all costs of production other than direct materials and direct labor. Royal applies overhead on the basis of direct labor hours. The variable manufacturing overhead rate is $20 per direct labor hour. The fixed overhead is $50,000 per month, of which $20,000 is noncash costs, primarily depreciation on the factory assets.

Direct Labor Budget The first step in preparing the manufacturing overhead budget is to calculate the variable manufacturing overhead costs for each month and in total. This is accomplished by multiplying our variable manufacturing overhead rate of $20 times the number of direct labor hours used in the month. Notice that the direct labor hours required are taken directly from the direct labor budget.

Part I The second step is to add the fixed manufacturing overhead costs ($50,000 per month) to the variable overhead costs to arrive at total manufacturing overhead costs for each month and in total. Part II If we divide the manufacturing overhead of $251,000 by the total labor hours required during the quarter (5,050), we get a predetermined overhead rate of $49.70 (rounded). Remember, when determining the overhead rate we use the total labor hours required rather than the hours paid. Once the level of fixed costs has been determined in the budget, the costs really are fixed; hence, the time to adjust fixed costs is during the budgeting process. Total mfg. OH for quarter $251,000 Total labor hours required 5,050 = $49.70 per hour* *rounded

The third step is to calculate the cash disbursements for manufacturing overhead by subtracting noncash expenses from the total manufacturing overhead costs computed in step two. In this example, $20,000 of depreciation is deducted from each month’s total overhead costs to arrive at the cash disbursements for manufacturing overhead costs. Depreciation is a noncash charge.

Ending Finished Goods Inventory Budget
Now Royal can complete the ending finished goods inventory budget. The first step in preparing this budget is to compute the direct materials cost per unit which is 5 pounds of direct material at 40 cents per pound, for a total of $2.00 per unit. The information needed can be derived by referring back to the direct materials budget. Direct materials budget and information

The second step is to compute the direct labor cost per unit which is 0.05 hours at a labor rate of $10 per hour for a total of 50 cents per unit. The information needed can be derived by referring back to the direct labor budget. Direct labor budget

Total mfg. OH for quarter $251,000 Total labor hours required 5,050 = $49.70 per hour* The third step is to compute the manufacturing overhead cost per unit and the total inventoriable cost per unit. Notice that Royal is using an absorption costing approach to valuing its inventory. The quantities shown for direct labor and manufacturing overhead are the same (0.05 hours) because direct labor hours is the overhead allocation base.The predetermined overhead rate of $49.70 per direct labor hour was calculated when we prepared the manufacturing overhead budget. We apply overhead on the basis of direct labor hours, so we multiply 0.05 hours times the predetermined rate of $49.70, and get overhead cost per unit of $2.49. Adding the unit material cost ($2.00), the unit labor cost ($0.50) and the unit overhead cost ($2.49), we find that the total unit cost is $4.99. Next, let’s calculate the cost of our ending finished goods inventory.

The fourth step is to calculate the cost of the ending finished goods inventory. Notice that the ending inventory in units (5,000) is derived from the production budget. At a per unit cost of $4.99, the 5,000 units ending inventory will have a cost of $24,950, an amount that will be shown in the budgeted balance sheet. Production Budget

Prepare a selling and administrative expense budget.
Learning Objective 7 Prepare a selling and administrative expense budget. Learning objective number 7 is to prepare a selling and administrative expense budget.

Selling and Administrative Expense Budget
At Royal, the selling and administrative expenses budget is divided into variable and fixed components. The variable selling and administrative expenses are $0.50 per unit sold. Fixed selling and administrative expenses are $70,000 per month. The fixed selling and administrative expenses include $10,000 in costs – primarily depreciation – that are not cash outflows of the current month. Let’s prepare the company’s selling and administrative expense budget. Royal’s selling and administrative expense budget lists the budgeted expenses for areas other than manufacturing and it is typically a compilation of many smaller, individual budgets. Royal has a variable and fixed component to its selling and administrative expenses. The company estimates variable selling and administrative expenses at 50 cents per unit sold. Fixed selling and administrative expenses are estimated at $70,000 per month. Of this amount, $10,000 are noncash expenses, primarily depreciation.

The first step in preparing this budget is to multiply the variable selling and administrative expense rate by the number of units sold. The second step is to add in the fixed selling and administrative expenses to arrive at total selling and administrative expenses. The third step is to deduct noncash selling and administrative expenses to arrive at cash disbursements for selling and administrative expenses. Calculate the selling and administrative cash expenses for the quarter.

Quick Check  What are the total cash disbursements for selling and administrative expenses for the quarter? a. $180,000 b. $230,000 c. $110,000 d. $ 70,000 What are the total cash selling and administrative expenses for the quarter?

Quick Check  What are the total cash disbursements for selling and administrative expenses for the quarter? a. $180,000 b. $230,000 c. $110,000 d. $ 70,000 The correct answer is $230,000. Let’s look at the schedule on the next screen to see the completed selling and administrative budget.

The same steps are followed for the months of May and June to arrive at total cash disbursements for selling and administrative expenses for the quarter of $230,000.

Learning Objective 8 Prepare a cash budget.
Learning objective number 8 is to prepare a cash budget.

Format of the Cash Budget
The cash budget is divided into four sections: Cash receipts listing all cash inflows excluding borrowing; Cash disbursements listing all payments excluding repayments of principal and interest; Cash excess or deficiency; and The financing section listing all borrowings, repayments and interest. The cash budget should be broken down into time periods that are as short as feasible. It consists of four major sections: The receipts section lists all cash inflows excluding cash received from financing. The disbursements section consists of all cash payments excluding repayments of principal and interest. The cash excess or deficiency section determines if the company will need to borrow money or if it will be able to repay funds previously borrowed. The financing section details the borrowings and repayments projected to take place during the budget period.

The Cash Budget Royal: Maintains a 16% open line of credit for $75,000
Maintains a minimum cash balance of $30,000 Borrows on the first day of the month and repays loans on the last day of the month Pays a cash dividend of $49,000 in April Purchases $143,700 of equipment in May and $48,300 in June paid in cash Has an April 1 cash balance of $40,000 The following information is necessary to begin preparation of Royal’s cash budget for the quarter. Royal: Maintains a 16% open line of credit for $75,000 Maintains a minimum cash balance of $30,000 Borrows on the first day of the month and repays loans on the last day of the month Pays a cash dividend of $49,000 in April Purchases $143,700 of equipment in May and $48,300 in June paid in cash Has an April 1 cash balance of $40,000

The Cash Budget Schedule of Expected Cash Collections
The first step in preparing this budget is to calculate the total cash available. We began April with $40,000 in cash. To this amount, we add the cash collections for April ($170,000) from the schedule of expected cash collections. The total cash available is $210,000.

Selling and Administrative
The Cash Budget Direct Labor Budget Schedule of Expected Cash Disbursements Manufacturing Overhead Budget Selling and Administrative Expense Budget The second step is to calculate the total cash disbursements. Notice that each cash disbursement, except dividends, comes from a schedule or budget that had already been prepared. During April, we expect to pay $40,000 for raw materials, $15,000 in direct labor, $56,000 in cash manufacturing overhead, and $70,000 for selling and administrative expense. This is not the total manufacturing overhead because we have excluded noncash depreciation costs. During April, the Board of Directors paid a cash dividend of $49,000. Total disbursements are $230,000.

The Cash Budget In the month of April will expect to have a cash deficiency of $20,000. The third section of the cash budget is to determine any cash excess or deficiency. In the month of April, we expect to have a $20,000 cash deficiency.

The Cash Budget Because Royal maintains a cash balance of $30,000,
the company must borrow $50,000 on it line-of-credit. The fourth step is to determine the financing requirements and the ending cash balance. Notice that since Royal has a policy that the company will always maintain an ending cash balance of $30,000, the company will have to borrow $50,000 on its line-of-credit in April. After Royal borrows on its line-of-credit, it will have an ending cash balance of $30,000. The ending cash balance for April becomes the beginning cash balance for May. Ending cash balance for April is the beginning May balance.

The Cash Budget These four steps are repeated for the month of May. The result is a $30,000 excess of cash available over disbursements for May. Notice that Royal has a large equipment purchase in May that will require a $143,700 cash disbursement. Since Royal must maintain a minimum cash balance of $30,000, it will not repay any of its loan in May.

Quick Check  What is the excess (deficiency) of cash available over disbursements for June? a. $ 85,000 b. $(10,000) c. $ 75,000 d. $ 95,000 What is the excess (deficiency) of cash available over disbursements for June?

Quick Check  What is the excess (deficiency) of cash available over disbursements for June? a. $ 85,000 b. $(10,000) c. $ 75,000 d. $ 95,000 The correct answer is $95,000. Let’s look at the completed schedule on the next screen.

The Cash Budget $50,000 × 16% × 3/12 = $2,000 Borrowings on April 1 and repayment on June 30. The same four steps are repeated for June. The result is an excess of cash available of $95,000. This excess enables Royal to repay the $50,000 in principal that was borrowed plus interest on the loan of $2,000 ($50,000 × 16% × 3/12). The ending cash balance for the quarter is $43,000.

Prepare a budgeted income statement.
Learning Objective 9 Prepare a budgeted income statement. Learning objective number 9 is to prepare a budgeted income statement.

The Budgeted Income Statement
Cash Budget Budgeted Income Statement Completed Once the cash budget is complete, we are ready to compile our budgeted financial statements. Let’s begin with the budgeted income statement. The cash budget must be prepared first so that the interest expense can be determined for the budgeted income statement. After we complete the cash budget, we can prepare the budgeted income statement for Royal.

The Budgeted Income Statement
Sales Budget Ending Finished Goods Inventory Selling and Administrative Expense Budget The numbers for the budgeted income statement come from other budgets that have already been prepared. More specifically: 1. The sale revenue comes from the sales budget. Royal planned to sell ,000 units during the quarter at $10 per unit. 2. The cost of goods sold, on a per unit basis, comes from the ending finished goods inventory budget. The unit cost is $4.99, so cost of goods sold will be $499, The selling and administrative expenses come from the selling and administrative expenses budget. Selling and administrative expenses, including depreciation, total $260,000, 4. The $2,000 interest expense comes from the cash budget. Cash Budget

Prepare a budgeted balance sheet.
Learning Objective 10 Prepare a budgeted balance sheet. Learning objective number 10 is to prepare a budgeted balance sheet.

The Budgeted Balance Sheet
Royal reported the following account balances prior to preparing its budgeted financial statements: Land - $50,000 Common stock - $200,000 Retained earnings - $146,150 Equipment - $175,000 This additional information will enable us to prepare the budgeted balance sheet. Royal reported the following account balances prior to preparing its budgeted financial statements: Land - $50,000 Common stock - $200,000 Retained earnings - $146,150 Equipment - $175,000

25% of June sales of $300,000 11,500 lbs. at $0.40/lb. 5,000 units
at $4.99 each The budgeted balance sheet is prepared as follows: Cash ($43,000) is taken from the ending cash balance of the cash budget. Accounts Receivable ($75,000) is 25% of June’s sales ($300,000). Raw materials inventory ($4,600) is calculated by multiplying the ending inventory of raw material in pounds (11,500) by the cost per pound ($0.40). The finished goods inventory ($24,950) is taken from the ending finished goods inventory budget. Land, equipment, and common stock are all given. Accounts payable ($28,400) is 50% of June’s purchases ($56,800). 50% of June purchases of $56,800

The ending retained earnings ($336,150) is calculated by adding net income ($239,000) to the beginning retained earnings ($146,150), and then subtracting dividends ($49,000).

End of Chapter 7 End of chapter 7.

Chapter 7 Profit Planning Chapter 7: Profit Planning.

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Chapter 7 Profit Planning Chapter 7: Profit Planning.

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Presentation on theme: "Chapter 7 Profit Planning Chapter 7: Profit Planning."— Presentation transcript:

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