1. John Wiley & Sons, Inc. Prepared by Karleen Nordquist.. The College of St. Benedict... and St. John’s University... with contributions by Marianne Bradford.. The University of Tennessee... Gregory K. Lowry…. Macon Technical Institute….. Managerial Accounting Weygandt, Kieso, & Kimmel

2. Chapter 6 Budgetary Planning

3. After studying this chapter, you should be able to: 1Indicate the benefits of budgeting. 2State the essentials of effective budgeting. 3Identify the budgets the comprise the master budget. 4Describe the sources for preparing the budgeted income statement. 5Explain the principal sections of a cash budget. 6Indicate the applicability of budgeting in nonmanufacturing companies. Chapter 6 Budgetary Planning

4. Preview of Chapter 6 Budgeting Basics Budgets and Accounting Benefits Essentials of Effective Budgeting Length of Budget Period Budgeting Process Budgeting and Human Behavior Budgeting and Long-Range Planning The Master Budget BUDGETARY PLANNING

5. Preview of Chapter 6 Preparing the Operating Budgets Sales Production Direct Materials Manufacturing Overhead Selling and Administrative Expense Budgeted Income Statement BUDGETARY PLANNING

6. Preview of Chapter 6 Preparing the Financial Budgets Cash Budgeted Balance Sheet Budgeting in Nonmanufacturing Companies Merchandising Service Non-for-profit BUDGETARY PLANNING

7. Budgeting Basics  Budgeting is used as a planning tool.  A budget is a formal written summary (or statement) of management’s plans for a specified time period, expressed in financial terms.  It normally represents the primary means of communicating agreed-upon objectives throughout the business organization.  Accounting information makes major contributions to the budgeting process.

8. Indicate the benefits of budgeting. Study Objective 1

9. Benefits of Budgeting The primary benefits of budgeting are as follows:  It requires all levels of management to plan ahead.  It provides definite objectives for evaluating performance.  It creates an early warning system for potential problems.  It facilitates the coordination of activities within the business.  It results in greater management awareness of the entity’s overall operations.  It contributes to positive behavior patterns throughout the organization.

10. State the essentials of effective budgeting. Study Objective 2

11. Essentials of Effective Budgeting  Effective budgeting depends on a sound organizational structure in which authority and responsibility over all phases of operations are clearly defined.  Budgets based on research and analysis should result in realistic goals that will contribute to the growth and profitability of the company.  The effectiveness of a budget program is directly related to its acceptance by all levels of management.

12. Length of the Budget Period  The most common budget period is one year, but a budget may be prepared for any period of time.  The annual budget is often supplemented by monthly and quarterly budgets.  A continuous twelve-month budget results from dropping the month just ended and adding a future month.

13. The Budgeting Process  In many companies, the responsibility for coordinating the preparation of the budget is assigned to a budget committee.  The budget committee is headed by a budget director and usually includes the president, treasurer, chief accountant (controller), and management personnel from each major area of the company.

14. The Budgeting Process  The budget is developed within the framework of a sales forecast that shows potential sales for the industry and the company’s expected share of such sales.  Sales forecasting involves consideration of such factors as – general economic conditions, – industry trends, – market research studies, – anticipated advertising and promotion, – previous market share, – changes in prices, and – technological developments.

15. Budgeting and Human Behavior  A budget can have a significant effect on human behavior.  A budget may have a strong positive influence on a manager when: – Each level of management is invited and encouraged to participate in developing the budget. – The budget has the complete support of top management and it is an important basis for evaluating performance. – Criticism of a manager’s performance is tempered with advice and assistance. – Top management is sensitive to the behavioral implications of its actions.

16. Budgeting and Long-Range Plans  Budgeting and long-range planning are not the same.  The maximum length of a budget is usually a year, while long-range planning usually encompasses at least five years.  With budgeting the emphasis is on the achievement of specific short-term goals. Long-range planning is a formalized process of selecting strategies to achieve long-term goals and developing policies and plans to implement the strategies.  Long-range plans contain considerably less detail than budgets.

17. Identify the budgets that comprise the master budget. Study Objective 3

18. The Master Budget  The master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period.  The individual budgets included in a master budget are shown on the next slide.  Hayes Company, which sells a single product, Kitchen-mate, will be used as an example.

19. Components of the Master Budget Sales Budget Production Budget Direct Labor Budget Selling & Administrative Expense Budget Budget Income Statement Cash Budget Budgeted Balance Sheet Capital Expenditure Budget Direct Labor Budget Operating Budgets Financial Budgets Illustration 6-2

20. Two Classes of Budgets in the Master Budget  Operating budgets include the individual budgets that culminate in the preparation of the budgeted income statement.  Financial budgets include the cash budget and the budgeted balance sheet. These budgets focus primarily on the cash resources needed to fund expected operations and planned capital expenditures.

21. Preparing the Operating Budgets: Sales Budget  The sales budget is the first budget prepared.  Each of the other budgets depends on the sales budget.  It is derived from the sales forecast, and it represents management’s best estimate of sales revenue for the budget period.

22. Preparing the Operating Budgets: Sales Budget The sales budget is prepared by multiplying the expected unit sales volume for each product by its anticipated unit selling price.  For Hayes Company, sales volume is expected to be 3,000 units in the first quarter with 500-unit increments in each succeeding year. Based on a sales price of $60 per unit, the sales budget for the year by quarters is shown below: Hayes Company Sales Budget For the Year Ending December 31, 1999 Expected unit sales Unit selling price Total sales 1 3,000 x $60 $180,000 2 3,500 x $60 $210,000 3 4,000 x $60 $240,000 4 4,500 x $60 $270,000 Year 15,000 x $60 $900,000 Quarter Illustration 6-3

23.  The production budget shows the units that must be produced to meet anticipated sales.  A realistic estimate of ending inventory is essential in scheduling production requirements.  The production requirements formula is: Preparing the Operating Budgets: Production Budget Desired Ending Finished Goods Units Beginning Finished Goods Units Budgeted Sales Units Required Production Units Illustration 6-4

24. Preparing the Operating Budgets: Production Budget  Hayes believes it can meet future sales requirements by maintaining an ending inventory equal to 20% of the next quarter’s budgeted sales volume.  For example, the ending finished goods inventory for the first quarter is 700 units (20% x anticipated second-quarter sales of 3,500 units).  The production budget is shown on the next slide.

25. Preparing the Operating Budgets: Production Budget Hayes Company Production Budget For the Year Ending December 31, 1999 Expected unit sales (sales budget) Add: Desired ending FG units a Total required units Less: Beginning FG units Required production units 1 3,000 700 3,700 600 c 3,100 Quarter Illustration 6-5 2 3,500 800 4,300 700 3,600 3 4,000 900 4,900 800 4,100 4 4,500 1,000 b 5,500 900 4,600 Year 15,400 a 20% of next quarter’s sales b Expected 2000 first-quarter sales, 5000 units x 20% c 20% of estimated first-quarter 1999 sales units

26.  The direct materials budget contains both the quantity and cost of direct materials to be purchased.  It is derived from the direct materials units required for production (per production budget) plus the desired ending direct materials units less the beginning direct materials units. Desired Ending Direct Materials Units Beginning Direct Materials Units Direct Materials Units Required for Production Required Direct Materials Purchases Units Illustration 6-6 Preparing the Operating Budgets: Direct Materials Budget

27.  Because of its close proximity to its suppliers, Hayes Company has found that an ending inventory of raw materials equal to 10% of the next quarter’s production is sufficient.  The manufacture of each Kitchen-mate requires 2 pounds of raw materials and the expected cost per pound is $4.  The direct materials budget is shown on the next slide.

28. Preparing the Operating Budgets: Direct Materials Budget Hayes Company Direct Materials Budget For the Year Ending December 31, 1999 Units to be produced (from production budget) Direct materials per unit Total pounds needed for production Add: Desired ending DM Total materials required Direct materials purchases Cost per pound Total cost of DM purchases 1 3,100 x 2 6,200 720 6,920 620 c 6,300 x $4 $25,200 Quarter Illustration 6-7 a 10% of next quarter’s production b Estimated 2000 first-quarter pounds needed for production, 10,200 x 10% c 10% of estimated first-quarter 1999 pounds needed for production 2 3,600 x 2 7,200 820 8,020 720 7,300 x $4 $29,200 3 4,100 x 2 8,200 920 9,120 820 8,300 x $4 $33,200 4 4,600 x 2 9,200 1,020 b 10,220 920 9,300 x $4 $37,200 Year $124,800

29. Preparing the Operating Budgets: Direct Labor Budget The direct labor budget contains the quantities (hours) and cost of direct labor necessary to meet production requirements.  At Hayes Company, two hours of direct labor are required to produce each unit of finished goods, and the anticipated hourly wage rate is $10. The direct labor budget is shown below: Hayes Company Direct Labor Budget For the Year Ending December 31, 1999 Units to be produced (from production budget) Direct labor time per unit Total required direct labor hours Direct labor cost per hour Total direct labor cost 1 3,100 x 2 6,200 x $10 $62,000 Quarter 2 3,600 x 2 7,200 x $10 $72,000 3 4,100 x 2 8,200 x $10 $82,000 4 4,600 x 2 9,200 x $10 $92,000 Year $308,000 Illustration 6-8

30.  The manufacturing overhead budget on the next slide shows the expected manufacturing overhead costs for the budget period.  This budget distinguishes between fixed and variable overhead costs.  The fixed cost amounts are assumed, and Hayes expects the following variable costs per direct labor hour: – indirect materials: $1.00 – indirect labor: $1.40 – utilities: $0.40 – maintenance: $0.20 Preparing the Operating Budgets: Manufacturing Overhead Budget

31. Hayes Company Manufacturing Budget For the Year Ending December 31, 1999 Variable Costs Indirect materials Indirect labor Utilities Maintenance Total variable Fixed costs Supervisory salaries Depreciation Property tax and insurance Maintenance Total manufacturing overhead 1 $ 6,200 8,680 2,480 1,240 18,600 20,000 3,800 9,000 5,700 38,500 $57,100 Quarter Illustration 6-9 Year $246,400 2 $ 7,200 10,080 2,880 1,440 21,600 20,000 3,800 9,000 5,700 38,500 $60,100 3 $ 8,200 11,480 3,280 1,640 24,600 20,000 3,800 9,000 5,700 38,500 $63,100 4 $ 9,200 12,880 3,680 1,840 27,600 20,000 3,800 9,000 5,700 38,500 $66,100 9,2008,2007,2006,20030,800Direct Labor hours $ 8.00 Manufacturing overhead rate per direct labor hour ($246,400  30,000)

32.  The selling and administrative expense budget on the next slide is a projection of anticipated operating expenses.  This budget also distinguishes between fixed and variable costs.  Once again, the fixed cost amounts are assumed, and Hayes expects the following variable costs per unit sold (from sales budget): – sales commissions: $3.00 – freight-out: $1.00 Preparing the Operating Budgets: Selling & Administrative Budget

33. Hayes Company Selling & Administrative Budget For the Year Ending December 31, 1999 Variable Costs Sales commissions Freight-out Total variable Fixed costs Advertising Sales salaries Depreciation Property taxes and insurance Total fixed Total selling and administrative expenses 1 $ 9,000 3,000 12,000 5,000 15,000 7,500 1,000 1,500 30,000 $42,000 Quarter Illustration 6-10 Year $180,000 2 $ 10,500 3,500 14,000 5,000 15,000 7,500 1,000 1,500 30,000 $44,000 3 $ 12,000 4,000 16,000 5,000 15,000 7,500 1,000 1,500 30,000 $46,000 4 $ 13,500 4,500 18,000 5,000 15,000 7,500 1,000 1,500 30,000 $48,000

34. Describe the sources for preparing the budgeted income statement. Study Objective 4

35. Budgeted Income Statement  The budgeted income statement is the important end- product in preparing operating budgets.  This budget indicates the expected profitability of operations and it provides a basis for evaluating company performance.  Hayes’ budgeted income statement is prepared with data from all of the detailed operating budgets and the following additional information: – Interest expense is expected to be $100. – Income tax expense is expected to be $12,000.

36. Budgeted Income Statement Hayes Company Budgeted Income Statement For the Year Ending December 31, 1999 Illustration 6-12 Sales Cost of goods sold (15,000 x $44) Gross profit Selling & administrative expenses Income from operations Interest expense Income before income taxes Income tax expense Net income $900,000 660,000 240,000 180,000 60,000 100 59,900 12,000 $ 47,900

37. Explain the principal sections of a cash budget. Study Objective 5

38. Preparing the Financial Budgets: Cash Budget  The cash budget shows anticipated cash flows.  Because cash is so vital in a company, this budget is often considered to be the most important output in preparing financial budgets.  A cash budget contributes to more effective cash management.  The cash budget contains three sections: – cash receipts. – cash disbursements. – financing.

39. Preparing the Financial Budgets: Basic Form of Cash Budget The cash receipts section includes expected receipts from cash sales,collections from customers, interest and dividends, and proceeds from sales of assets and stock. Any Company Cash Budget Beginning cash balance Add: Cash receipts (itemized) Total cash available Less: Cash disbursements (itemized) Excess (deficiency) of available cash over cash disbursements Financing Ending cash balance $x,xxx x,xxx x,xxx x,xxx x,xxx x,xxx $x,xxx Illustration 6-13 The cash disbursements section shows expected payments for direct materials, direct labor, manufacturing overhead, selling & administrative expenses, income taxes, dividends, and assets. The financing section shows expected borrowings and the repayment of borrowed funds plus interest. This section is needed when there is a cash deficiency or when the cash balance is below management’s minimum required balance.

40. Collections from Customers Preparing a schedule of cash collections from customers is useful in preparing a cash budget. Assume that Hayes’ credit sales per the Sales Budget (amounts shown in parentheses below) are collected 60% in the quarter sold and 40% in the following quarter. Accounts Receivable of $60,000 at December 31, 1998 are expected to be collected in full the first quarter of 1999. Accounts receivable, 12/31/98 First quarter ($180,000) Second quarter ($240,000) Third quarter ($240,000) Fourth quarter ($270,000) Total collections 1 $ 60,000 108,000 $168,000 Quarter 2 $ 72,000 126,000 $198,000 3 $ 84,000 144,000 $228,000 4 $ 96,000 162,000 $258,000 Schedule of Expected Collections from Customers Illustration 6-14

41. Payments for Direct Materials Preparing a schedule of payments for direct materials is also useful in preparing a cash budget. Assume that Hayes’ purchases of direct materials per the Direct Materials Budget (amounts shown in parentheses below) are paid 50% in the quarter purchased and 50% in the following quarter. Accounts Payable of $10,600 at December 31, 1998 are expected to be paid in full the first quarter of 1999. Accounts payable, 12/31/98 First quarter ($180,000) Second quarter ($240,000) Third quarter ($240,000) Fourth quarter ($270,000) Total collections 1 $ 10,600 12,600 $23,200 Quarter 2 $ 12,600 14,600 $27,200 3 $ 14,600 16,600 $31,200 4 $ 16,600 18,600 $35,200 Schedule of Expected Payments for Direct Materials Illustration 6-14

42. Other Assumptions for Hayes Company Cash Budget  The January 1, 1999, cash balance is expected to be $38,000.  Management wishes to maintain a $15,000 minimum cash balance.  Marketable securities are expected to be sold for $2,000 cash in the first quarter.  All direct labor is paid in the quarter incurred.  All manufacturing overhead and selling & administrative expenses except depreciation are paid in the quarter incurred.  Management plans to purchase a new truck in the second quarter for $10,000 cash.  The company makes equal quarterly payments of its estimated annual income taxes.  Loans are repaid in the first subsequent quarter in which there is sufficient cash.

43. Hayes Company Cash Budget For the Year Ending December 31, 1999 Beginning cash balance Add: Receipts Collections from customers Sale of securities Total receipts Total available cash Less: Disbursements Direct materials Direct labor Manufacturing overhead Selling & administrative expenses Purchase of truck Income tax expense Total disbursements Excess (deficiency) of available cash over disbursements Financing Borrowings Repayments (plus $100 interest) Ending cash balance 1 $ 38,000 168,000 2,000 170,000 208,000 23,200 62,000 53,300 41,000 0 3,000 182,500 25,500 0 0 $ 25,500 Quarter Illustration 6-16 4 $ 19,400 258,000 0 258,000 277,400 35,200 92,000 62,300 47,000 0 3,000 239,500 37,900 0 0 $ 37,900 3 $ 15,000 228,000 0 228,000 243,000 31,200 82,000 59,300 45,000 0 3,000 220,500 22,500 0 3,100 $ 19,400 2 $ 25,500 198,000 0 198,000 223,500 27,200 72,000 56,300 43,000 10,000 3,000 211,500 12,000 3,000 0 $ 15,000

44. Budgeted Balance Sheet The budgeted balance sheet is a projection of financial position at the end of the budget period. It is developed from the budgeted balance sheet for the preceding year and the budgets for the current year.  Pertinent data for Haye’s balance sheet which follows are: Building and equipment$182,000 Accumulated depreciation 28,000 Common stock225,000 Retained earnings 46,480

45. Hayes Company Budgeted Balance Sheet December 31, 1999 Illustration 6-17 Cash (Cash budget) Accounts receivable (Schedule of collections from customers) Finished goods inventory (Production budget x $44) Raw materials inventory (DM budget x $4) Buildings & Equipment (Beg balance on previous slide plus new truck on Cash budget)) Less: Accumulated Depreciation (Beg balance on previous slide plus depr exp from MO and S&A exp budgets) Total assets $ 192,000 48,000 $ 37,900 108,000 44,000 5,080 144,000 $337,980 Accounts payable (Schedule of payments) Common stock (previous slide) Retained earnings (Beginning balance on previous slide plus NI from Budgeted income statement) Total liabilities and stockholders’ equity $ 18,600 225,000 94,380 $337,980 ASSETS LIABILITIES AND STOCKHOLDERS’ EQUITY

46. Indicate the applicability of budgeting in nonmanufacturing companies Study Objective 6

47. Budgeting in Nonmanufacturing Companies  Budgeting is not limited to manufacturing companies.  Budgets may also be used in profit planning by: – merchandising companies. – service enterprises. – not-for-profit organizations.

48. Budgeting in Merchandising Companies The major differences between the budgets of a merchandising company and a manufacturing company are that a merchandiser:  uses a merchandise purchases budget instead of a production budget, and  does not use the manufacturing budgets (direct materials, direct labor, and manufacturing overhead). The formula for determining budgeted merchandise purchases is: Desired Ending Merchandise Inventory Beginning Merchandise Inventory Budgeted Cost of Goods Sold Required Merchandise Purchases Illustration 6-18

49. Budgeting in Service Enterprises In service enterprises, such as a public accounting firm, a law office, or a medical practice, the critical factor in budgeting is coordinating professional staff needs with anticipated services.

50. Service Enterprises If a firm is overstaffed:  Labor costs will be disproportionately high.  Profits will be lower because of the additional salaries.  Staff turnover will increase because of lack of challenging work. If an enterprise is understaffed:  Revenue may be lost because existing and prospective client needs for service cannot be met, and  Professional staff may seek other positions because of excessive work loads.

51. Budgeting in Not-for-Profit Organizations  Budgeting is just as important for not-for- profit organizations as for profit- oriented enterprises.  In most cases, not-for-profit entities budget on the basis of cash flows (expenditures and receipts), rather than on a revenue and expense basis.  The starting point in the budgeting process is usually expenditures, not receipts.

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53. Chapter 6 Budgetary Planning