2. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 8 Budgetary Planning

3. 8-3 Describe (a) how and why organizations use budgets for planning and control and (b) potential behavioral issues to consider when implementing a budget. Learning Objective 8-1

4. 8-4 Role of Budgets in the Planning and Control Cycles Planning Developing objectives for acquisition and use of resources. Control Steps taken by management to ensure that objectives are attained. A budget is a comprehensive financial plan for achieving the financial and operational goals of an organization.

5. 8-5 Planning and Control Cycle

6. 8-6 Planning Process Tactics Long-term Objectives Short-term Objectives Strategic Plan

7. 8-7 Benefits of Budgeting

8. 8-8 Behavioral Effects of Budgets Budget Problems Perceived unfair or unrealistic goals. Poor management- employee communications. Budget Problems Perceived unfair or unrealistic goals. Poor management- employee communications. Solution Reasonable and attainable budgets. Employee participation in budgeting process. Solution Reasonable and attainable budgets. Employee participation in budgeting process.

9. 8-9 Budget Problems Building budget slack into budgets. A “use-it-or-lose-it” mentality. Budget Problems Building budget slack into budgets. A “use-it-or-lose-it” mentality. Solution Different budgets for planning and for performance evaluation. Continuous, or rolling budgets. Zero-based budgeting. Solution Different budgets for planning and for performance evaluation. Continuous, or rolling budgets. Zero-based budgeting. Behavioral Effects of Budgets

10. 8-10 Describe the major components of the master budget and their interrelationships. Learning Objective 8-2

11. 8-11 Components of the Master Budget

12. 8-12 Prepare the following components of the operating budget: a.Sales budget. b.Production budget. c.Raw materials purchases budget. d.Direct labor budget. e.Manufacturing overhead budget. f.Cost of goods sold budget. g.Selling and administrative budget. h.Budgeted income statement. Learning Objective 8-3

13. 8-13 Preparation of the Operating Budgets Let’s take a closer look at the operating budgets using Cold Stone Creamery as our example.

14. 8-14 Sales Budget Estimated Unit Sales Estimated Unit Price Analysis of economic and market conditions + Forecasts of customer needs from marketing personnel Sales Budget

15. 8-15 Sales Budget We prepare the sales budget by multiplying the number of units we expect to sell times the budgeted unit price. We begin the preparation of operating budgets with the sales budget using information from a single Cold Stone Creamery location.

16. 8-16 Production Budget The production budget is directly related to the sales budget and to the quantity of inventory the company wants to have on hand at the beginning and end of each period. The relationship between budgeted production, sales, and inventory is summarized in the following formula:

17. 8-17 Prepare a production budget for Cold Stone Creamery using the sales budget and the following inventory policy: Cold Stone maintains an ending inventory of finished goods equal to 5 percent of budgeted sales in units for the current period. The beginning inventory for Quarter 1 (for the year) is 900 units. Production Budget

18. 8-18 5% of 15,0005% of 20,0005% of 27,0005% of 23,000 Production Budget

19. 8-19 Raw Materials Purchases Budget Next, we must determine what quantity of raw materials to purchase to use for the production budget. Budgeted material purchases will depend on budgeted production needs, as well as on the planned levels for beginning and ending raw materials inventory. The relationship between budgeted raw material purchases, budgeted production, and raw materials inventory is summarized in the following formula:

20. 8-20 Prepare a raw materials purchases budget for Cold Stone Creamery using the production budget and the following inventory policy: Cold Stone maintains an ending inventory of materials equal to 3 percent of the next quarter’s production needs, making the beginning inventory for each quarter equal to 3 percent of the current quarter’s production needs. The ending inventory for Quarter 4 (for the year) is assumed to be 3,510 ounces. Each Cold Stone ice cream creation requires a total of 10 ounces of raw materials (ice cream, candy, fruit, nuts, caramel, etc.) at an average cost of $0.05 per ounce. Raw Materials Purchases Budget

21. 8-21 From Production Budget Raw Materials Purchases Budget 3% of 202,500 3% of 273,500 3% of 228,000 3% of 148,500

22. 8-22 Raw Materials Purchases Budget

23. 8-23 Direct Labor Budget Each Cold Stone Creamery creation requires 0.10 hour (6 minutes) of direct labor (DL) time to take customers’ orders and payments, to mix and serve the ice cream, and to clean up. The direct labor rate is $10.00 per hour. Let’s prepare the direct labor budget.

24. 8-24 Manufacturing Overhead Cost Budget Cold Stone Creamery’s variable manufacturing overhead cost is $0.10 per unit and the fixed manufacturing overhead cost is $8,525 per quarter. Let’s prepare the manufacturing overhead budget.

25. 8-25 Budgeted Cost of Goods Sold First, let’s compute the manufacturing cost per unit, and then we will compute cost of goods sold for each period.

26. 8-26 Budgeted Cost of Goods Sold Using the unit manufacturing cost of $2.00 and the budgeted sales in units, we can compute cost of goods sold for each period by multiplying the unit cost times the budgeted sales for the period.

27. 8-27 Selling and Administrative Expense Budget Variable selling expenses for a period are 5 percent of sales revenue for that same period. Fixed administrative expenses are $10,000 per quarter. 5% of $75,000 5% of $100,000 5% of $135,000 5% of $115,000

28. 8-28 Budgeted Income Statement

29. 8-29 Prepare the cash budget and describe the relationships among the operating budgets, cash budget, and budgeted balance sheet. Learning Objective 8-4

30. 8-30 Preparation of the Financial Budgets Now, let’s focus on the financial budgets for Cold Stone Creamery.

31. 8-31 Cash Budget Our focus is on cash flows that arise from operating activities and are directly related to the operating budgets for Cold Stone Creamery. The relationship between budgeted cash collections and budgeted cash payments from operating activities and cash balances is summarized in the following formula:

32. 8-32 All budgeted cash collections will come from sales revenue. To calculate the budgeted cash collections, we will assume that 40% of Cold Stone's revenue is from cash sales. The other 60% is from sales on credit, which is collected as follows: 75% of credit sales collected in the quarter of sale. 25% of credit sales collected in the quarter following the sale. Budgeted sales for four quarters of the year are as follows: Cash Budget

33. 8-33 Budgeted Cash Collections 40% of $75,000 (60% of $75,000) × 0.75) (60% of $75,000) × 0.25)

34. 8-34 Budgeted Cash Payments We will use the following additional information to develop a cash payments budget for Cold Stone Creamery: 20% of raw materials purchases are paid for during the quarter purchased; 80% are paid for in the following quarter. Raw material purchases for the fourth quarter of the previous year were $6,250. Direct labor, manufacturing overhead costs, and selling and administrative costs are paid for during the quarter incurred. The operating budgets include $3,000 in depreciation (a noncash expense). Management plans to invest in a new refrigeration system during Quarter 1 at a total cost of $120,000. The company will pay 50 percent cash and the balance evenly across Quarters 2, 3, and 4.

35. 8-35 Budgeted Cash Payments for Merchandise Purchases 80% of $7,506 20% of $7,506

36. 8-36 Budgeted Cash Payments

37. 8-37 Cash Budget We will use the following additional information to develop the cash budget for Cold Stone Creamery: At the beginning of the first quarter, the cash account balance was $55,200. Cold Stone Creamery has a bank agreement enabling the company to borrow and repay cash in increments of $5,000 as needed to maintain a minimum cash balance of $50,000. No interest is charged if the loan is repaid by the end of the next quarter. The balance on the loan at the beginning of Quarter 1 is zero.

38. 8-38 Cash Budget

39. 8-39 Budgeted Balance Sheet From Cash Budget. (60% of $115,000) × 0.25) 3,510 ounces @ $0.05 1,150 units @ $2.00 80% × $11,233

40. 8-40 Prepare a merchandise purchases budget for a merchandising firm. Learning Objective 8-5

41. 8-41 Budgeting in Non-Manufacturing Firms The primary operating budget for a merchandiser is a merchandise purchases budget, which is similar in form to a raw materials purchases budget for a manufacturer. Since a merchandising company does not manufacture, it does not have raw material, direct labor, and manufacturing overhead budgets.

42. 8-42 Budgeting in Non-Manufacturing Firms Assume that you are a purchasing manager for a Gap retail store responsible for purchasing denim jeans and preparing the merchandise purchases budget. In your experience, inventory on hand at the beginning of each quarter should be equal to 20 percent of that quarter’s sales. In other words, ending inventory should be equal to 20 percent of next quarter’s sales.

43. 8-43 Budgeting in Non-Manufacturing Firms 20% of $30,000 20% of $20,000

44. 8-44 End of Chapter 8