1. 7-1 Profit Planning Master Budget Chapter 7 Adapted by Cynthia Fortin, CPA, CMA Cost Management, Eldenburg, Wolcott, Chen and Cook

2. 7-2 Video preparation  http://video.wileyaccountingupdates.com /2011/06/15/standard-costs/ http://video.wileyaccountingupdates.com /2011/06/15/standard-costs/

3. 7-3Planning  Develop objectives  Prepare various budgets  To achieve those objectives Planning  Develop objectives  Prepare various budgets  To achieve those objectives

4. 7-4 Control Take steps to meet objectives Take steps to meet objectives Control

5. 7-5 Budgeting allows a company to 5. Define and communicate objectives 3. Uncover potential bottlenecks 4. Coordinate activities 1. Think about and plan for the future 2. Allocate resources

6. 7-6 Responsibility Accounting Managers should be held responsible for only those items that they can actually control to a significant extent. Managers should be held responsible for only those items that they can actually control to a significant extent.

7. 7-7 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.

8. 7-8 Advantages of Self-Imposed Budgets 1.Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management. 2.Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers. 3.Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. 4.A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse. 1.Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management. 2.Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers. 3.Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. 4.A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse.

9. 7-9 Self-Imposed Budgets Self-imposed budgets should be reviewed by higher levels of management to prevent “budgetary slack.” Most companies issue broad guidelines in terms of overall profits or sales. Lower- level managers are directed to prepare budgets that meet those targets. Self-imposed budgets should be reviewed by higher levels of management to prevent “budgetary slack.” Most companies issue broad guidelines in terms of overall profits or sales. Lower- level managers are directed to prepare budgets that meet those targets.

10. 7-10 Human Factors in Budgeting The success of a budget program depends on three important factors: 1. Top management must be enthusiastic and committed to the budget process. 2. Top management must not use the budget to pressure employees or blame them when something goes wrong. 3. Highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget targets.

11. 7-11 Master Budget  A comprehensive plan for the upcoming accounting period  Usually prepared for a one-year period  Based on a series of budget assumptions © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 11

12. 7-12 The Master Budget: An Overview Production budget Selling and administrative budget Selling and administrative budget Direct materials budget Direct materials budget Manufacturing overhead budget Manufacturing overhead budget Direct labor budget Cash budget Sales budget Ending inventory budget Ending inventory budget Budgeted balance sheet Budgeted income statement

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14. 7-14 Basis for assumptions Sales Forecasting  Project past sales trends using judgment or statistical methods.  Estimate sales based on industry data for similar businesses.  Predict sales based on forecasted economic variables.  Gather sales predictions from sales and other personnel.  Conduct market research to estimate customer demand.. © John Wiley & Sons, 2012Eldenburg, Cost Management, 2ce, Chapter 10Slide 14

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16. 7-16 Basis for assumptions Cost Forecasting  Budget individual costs as % of revenues or % change from the prior year  Evaluate cost behaviour

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18. 7-18 Basis for assumptions Cash flow forecasting Identify the expected sources and uses of cash Estimate timing of receipts and disbursements

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20. 7-20 Operating Budgets  Sales  Production Direct materials Direct labor ○ Manufacturing overhead  Ending Finished Goods Inventory  Sales and Administration © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 20

21. 7-21 Financial Budgets  Cash  Budgeted financial statements Income Balance Sheet © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 21

22. 7-22 Revenue and Production Budgets SJ, Inc., makes a tool used by auto mechanics that sells for $68/unit. It expects to sell 6,000 units in April and 7,000 units in May. SJ prefers to end each period with a finished goods inventory equal to 10% of the next period’s sales in units and a direct materials inventory equal to 20% of the direct materials required for the next period’s production. The company never has any beginning or ending work-in-process inventories. There were 400 units in finished goods inventory on April 1. Prepare the revenue and production budgets for April. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 22 How much Revenue will SJ earn? How many units will SJ produce?

23. 7-23 Direct Materials Purchase Budget SJ’s product uses 0.3 kg of direct material per unit, at a cost of $4/kg. There were 220 kg of direct material on hand on April 1. Assume that budgeted production for May is 6,500 units. Prepare the direct materials budget for April. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 23 From production budget Given 6500*0.3*20% given How much DM must SJ purchase to produce the budget units?

24. 7-24 Direct Labour Budget © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 24 SJ’s product uses 0.2 hours of direct labour at a cost of $12/hr. Prepare the direct labour budget for April. How many labour hours are needed? How much will DL cost?

25. 7-25 Manufacturing Overhead Budget SJ’s budgeted fixed manufacturing overhead for April is $167,000, and variable manufacturing overhead is budgeted at $6 per direct labour hour. Prepare the manufacturing overhead budget for April. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 25 From labor budget Given given How much total overhead will be incurred?

26. 7-26 Direct Materials Used and Ending inventory budget Prepare the April ending inventories budget for direct materials. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 26 From DM budget 220 * $4 390 * $4 How much DM will be used to produce the budget units?

27. 7-27 Finished Goods Ending Inventory Budget Prepare the April ending inventories budget for finished goods. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 27 First compute unit cost of FG then apply it to FG ending inventory units Total cost Unit cost What will the ending inventory of FG be? Divided by Multiply by

28. 7-28 Cost of goods sold Budget Assume that SJ’s April 1 finished goods inventory had a cost of $12,146. Prepare the cost of goods sold budget for April. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 28 We need cost of goods sold for the Income statement budget Given Previous slide

29. 7-29 Selling & Administration Budget SJ’s budget for April includes $22,000 for administrative costs, $34,000 for fixed distribution costs, $18,000 for research and development, and $13,000 for fixed marketing costs. Additionally, the budgeted variable costs for distribution are $0.75/unit sold and the budgeted variable costs for marketing are 4% of sales revenue. Prepare the support department budget for April. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 29

30. 7-30 Income Statement Budget Suppose that SJ’s income tax rate is 28%. Prepare the budgeted income statement for April. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 30

31. 7-31 How is a cash budget is developed?

32. 7-32 Cash Budgets  Summary of the expected amounts and timing of cash receipts and disbursements.  Operating cash receipts estimated from budgeted revenues.  Operating cash disbursements estimated from the budgets for DM, DL, O/H and support departments. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 32

33. 7-33 Cash budgets 1. Cash receipts 2. Cash disbursements 3. Short-term borrowings or investments © John Wiley & Sons, 2012Eldenburg, Cost Management, 2ce, Chapter 10Slide 33

34. 7-34 Cash Budget Example Race Manufacturing is preparing a cash budget for a new division that will begin operations on January 1, 2015. Race expects sales to be 40% cash and 60% on account, with 45% of credit sales are collected in the month of the sale. In the month after the sale, 50% of credit sales should be collected, with the remainder collected two months after the sale. Budgeted sales for the first three months are $100,000, $150,000 and $200,000. Prepare a cash receipts budget for the first three months of 2015. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 34

35. 7-35 Cash Budget Example Race Manufacturing budgets direct labour costs to be 30% of sales revenue and expects to pay this in the month the costs are incurred. Direct materials purchases will be on account, and paid as follows: 40% in the month of the purchase, 50% the following month, and 10% in the second month following the purchase. Budgeted direct material purchases for the first 3 months of 2010 are $20,000, $35,000 and $45,000. Compute the budgeted cash disbursements for direct materials and labour for the first 3 months of 2012. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 35

36. 7-36 Cash Budget Example Race Manufacturing budgets other variable costs at 4% of sales revenue and will be paid in the month after the costs are incurred. Other budgeted fixed costs are $6,000 per month and will be paid in the month incurred. Prepare a cash disbursements budget for all costs, including direct materials and labour. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 36

37. 7-37 Cash Budget Example Using the information from the prior slides, prepare a schedule of budgeted cash flows for Race Manufacturing’s new division for the first three months of 2012. © John Wiley & Sons, 2012 Eldenburg, Cost Management, 2ce, Chapter 10 Slide 37