Chapter Chapter 1212

Planning and Planning and BudgetingBudgeting

12-2

Learning ObjectivesLearning Objectives

4.Develop production and cost budgets.

2.Understand the importance of people in the budgeting process.

3.Estimate sales.

5.Estimate cash flows.

1.Understand the role of budgets in overall organization plans.

6.Develop budgeted financial statements.

7.Explain budgeting in service, retail, and wholesale organizations.

8.Explain why ethical issues arise in budgeting.

9.Explain how to use sensitivity analysis to budget under uncertainty.

12-3

BudgetsBudgetsL.O. 1 Understand the role of budgets in overall organization plans.

Financial plan of the resources needed to carry out activities and meet financial goals

Budget

Strengths of a company that enable it to outperform competitors

Critical Success Factors

Goals

Plans

Decision making

Performance evaluations

12-4

Financial plan of an organization for the coming year or other planning period

Company’s broad objectives established by management that employees work to achieve

Statement detailing steps to take to achieve a company’s organization goals

Organizational PlanOrganizational Plan

Master Budget

Organization Goals

Strategic Long-Range Plan

12-5

Organization and Individual Organization and Individual InteractionInteractionOrganization Individual

Organization goals

Long-range strategic plans

Individual goals and values

Anticipated conditions for the

budget period

Master budget

Actual reported results for period

Individual beliefs and expectations

Strategic evaluation

Periodic performance evaluation

12-6

Master BudgetMaster Budget

Tactical short range plan that ties the strategic plan to operating plan

Static Budget

Budget Plan

Planning Budget

Income statement portion of the master budget

Profit Plan

12-7Human Element in Human Element in BudgetingBudgetingL.O. 2 Understand the importance of people in the

budgeting process.

Organization goals

Individual goals

Goal congruence

Use of input from lower- and middle-management employees; also called grass roots budgeting

Participative Budgeting

12-8

Sales BudgetSales BudgetL.O. 3 Estimate

sales.

Staff

Delphi Technique

Trend analysis

Econometric models

Sales is the most difficult aspect of budgeting.

12-9

Forecast by StaffForecast by Staff

Number of units Sales price of a unitx

Sales personnel have knowledge about customers.

Market researchers have knowledge about the market.

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Delphi TechniqueDelphi Technique

Forecasting method in which individual forecasts of group members are submitted anonymously and evaluated by the group as a whole.

Reduces bias of individual forecasts

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Trend AnalysisTrend Analysis

Forecast method based on past data

Simple visual extrapolation of points on a graph

Highly sophisticated computerized time series analysis.

to

12-12

Econometric ModelsEconometric Models

Statistical methods of forecasting economic data using regression models

Cost versus benefit

12-13Sales Budget: An Sales Budget: An IllustrationIllustration

Estimated sales

= Number of units x Price per unit

$7,200,000 = 160,000 x $45

12-14

Production BudgetProduction BudgetL.O. 4 Develop production and cost

budgets.

Production plan of resources needed to meet current sales demand and ensure that inventory levels are sufficient for future sales

Units in beginning inventory

Required production

(units)

Budgeted sales (units)

Units in ending

inventory

=+ -

Inventories

BB TI TO EB

12-15Production Budget Production Budget ContinuedContinued

Units in beginning inventory

Required production

(units)

Budgeted sales (units)

Units in ending

inventory

-= +

5,000 units (beginning Inventory)

Required production

(units)

160,000 units (sales)

15,000 units (ending

inventory)-= +

BBTI TO EB

BB TI TO EB

Required production

(units)

170,000 units

=

12-16

Production BudgetProduction Budget

Expected sales 160,000 Add desired ending inventory of finished goods 15,000

Total needs 175,000

Less beginning inventory of finished goods 5,000

Units to be produced 170,000

Santiago PantsProduction Budget (in

units)For the Budget Year Ended December 31

12-17

Production CostsProduction Costs

Labor

Direct Materials

Overheadsantiago

12-18Direct Materials: An Direct Materials: An ExampleExample

Cotton Fine CottonMaterial per unit of output 3.0 yards 0.2 yardsBeginning materials inventory 10,000 yards 1,000 yardsEnding inventory 15,000 yards 1,000 yards

Cost per yard 3$ 5$

Santiago PantsMaterial Data

Estimated Production

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Direct Materials: An Example Direct Materials: An Example ContinuedContinued

Yards needed

Fine cotton = 170,000 x 0.2

+ 1,000 - 1,000

= 34,000 yards

= 515,000 yards

Cotton = 170,000 x 3.0

+ 15,000

- 10,000

Santiago PantsMaterial Data

Estimated Production

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Direct Material ContinuedDirect Material Continued

Cotton Fine CottonDirect materials needed per unit 3.0 yards 0.2 yardsTotal production needsa 510,000 a 34,000 b

Add desired ending inventory 15,000 1,000

Total direct materials needs 525,000 35,000 Less beginning inventory of materials 10,000 1,000

Total yards to be purchased 515,000 34,000 Cost of materials, per yard $3 $5Cost of direct materials to be purchased $1,545,000 $170,000

Total cost of direct materials 1,715,000$

a 3.0 yards x 170,000 unitsb 0.2 yards x 170,000 units

Santiago PantsDirect Materials

BudgetFor the Budget Year Ended December 31

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Direct LaborDirect Labor

Units to be produced 170,000 Direct labor time per unit (in hours) 0.50

Total direct labor-hours needed 85,000 Direct labor cost per hour 22$

Total direct labor cost 1,870,000$

Santiago PantsDirect Labor Budget

For the Budget Year Ended December 31

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OverheadOverhead

Variable overhead needed to produce 170,000 units

Indirect materials and supplies 36,000 Materials handing 70,000 Other indirect labor 30,000 136,000$

Fixed manufacturing overhead

Supervisory labor 102,000 Maintenance and repairs 50,000 Plant administration 85,000 Utilities 55,000 Depreciation 140,000 Insurance 30,000 Property taxes 60,000 Other indirect labor 22,000 544,000

Total manufacturing overhead 680,000$

Santiago PantsOverhead Budget

For the Budget Year Ended December 31

santiago

12-23

Cost of Goods SoldCost of Goods Sold

Beginning work in process inventoryManufacturing costsDirect materials

Beginning inventory (10,000 cotton @ $3 + 1,000 f ine cotton @ $5) 35,000 Purchases 1,715,000

Materials available for manufacturing 1,750,000$ Less ending inventory (15,000 cotton @ $3 + 1,000 fine cotton @ $5) (50,000)

Total direct material costs 1,700,000$ Direct labor 1,870,000 Manufacturing overhead 680,000

Total manufacturing costs 4,250,000$ Less ending work in process inventory -

Cost of goods manufactured 4,250,000$

Add beginning finished goods inventory (5,000 units)a 120,000 Less ending finished goods inventory (@ 15,000 units)b (375,000)

Cost of goods sold 3,995,000$

a Management estimateb Finished goods are valued at $15 per unit ($4,250,000/170,000 units produced) assuming FIFO. Hence, ending finished goods inventory is estimated to be $375,000 (15,000 units x $25).

Santiago PantsBudgeted Statement of Cost of Goods

SoldFor the Budget Year Ended December 31

12-24Marketing and Administrative Marketing and Administrative BudgetBudget

Variable marketing costsSales commissions 240,000$ Other marketing 120,000

Total variable marketing costs 360,000$ Fixed marketing costsSales salaries 130,000$ Advertising 153,000 Other marketing 67,000

Total fixed marketing costs 350,000

Total marketing costs 710,000$ Administrative costs (all fixed)Administrative salaries 241,000$ Legal and accounting staff 136,000 Data processing services 127,000 Outside professional services 32,000 Depreciation: building, furniture, and equipment 84,000 Other, including interest 36,000 Taxes-other than income 140,000

Total administrative costs 796,000

Total budgeted marketing and administrative costs 1,506,000$

Santiago PantsSchedule of Budgeted Marketing and Administrative Costs For the Budget Year Ended December 31

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Income StatementIncome Statement

Budgeted revenuesSales (160,000 units at $45) 7,200,000$ CostsCost of goods sold 3,995,000$ Marketing and administrative costs 1,506,000

Total budgeted costs 5,501,000 Operating profit 1,699,000 Federal and other income taxesa

550,000

Operating profit after taxes 1,149,000$

a Computed by the compay's tax staff

Santiago PantsBudgeted Income Statement

For the Budget Year Ended December 31

12-26

Cash BudgetCash BudgetL.O. 5 Estimate cash flows.

Statement of cash on hand at the start of the budget period, expected cash receipts, expected cash disbursements, and the resulting cash balance at the end of the budget period.

Collections of accounts receivable

Cash sales

Sales of assets

Borrowing

Issuing stock

Other

12-27

Acquire new assets

Cash Budget ContinuedCash Budget Continued

Materials purchases

Manufacturing costs

Operating activities

Debt repayment

Income taxes

Dividends

Other

12-28

Cash Budget ContinuedCash Budget Continued

Cash balance beginning of perioda 830,000$ Receipts

Collections on accountsa 6,840,000 Collection on employee loansa

100,000

Total receipts 6,940,000

Less disbursements

Payments for accounts payablea 1,694,000 Direct labor 1,870,000 Manufacturing overhead requiring cash 540,000 Marketing and administrative costs requiring cash 1,422,000

Payments for federal income taxesb 350,000

Dividendsa 30,000

Reduction in long-term debtsa 23,000 Acquisition of new assetsc

1,470,000

Total disbursements 7,399,000

Budgeted ending cash balance 371,000$

a Estimated by the treasurer's officeb Per discussion with the tax staffc Estimated by the treasurer's office per the capital budget

Santiago PantsCash Budget

For the Budget Year Ended December 31

12-29Cash Collections From Credit Cash Collections From Credit SalesSales

Santiago PantsCollection of Credit

Sales

January sales 500,000$ February sales 450,000$ March sales 600,000$

Cash collected from current month's sales 20 % Cash collected from last month's sales 75Cash discounts taken (percentage of gross sales) 2Written off as a bad debt 3

Total disposition of credit sales in current month 100 %

12-30

Cash Collections ContinuedCash Collections ContinuedSantiago PantsSchedule of Cash Collections

For the Quarter Ended March 31

January February March Total for Quarter

Beginning accounts receivable January 1 500,000$ 500,000$ January sales, $500,000a

100,000 375,000$ 475,000

February sales, $450,000b90,000 337,500$ 427,500

March sales, $600,000c120,000 120,000

Total cash collections 600,000$ 465,000$ 457,500$ 1,522,500$

a 20 percent collected in January, 75 percent collected in February, and 5 percent not collected b 20 percent collected in February, 75 percent collected in March, and 5 percent not collectedc 20 percent collected in March, 75 percent collected in April, and 5 percent not collected

12-31

Santiago PantsCash Disbursements for

Purchases

Cash DisbursementsCash Disbursements

January 120,000$ February 200,000$ March 250,000$

Cash disbursement for current month's purchases 50 %Cash disbursement for prior month's purchases 48Cash discounts taken 2

Total cash disbursement for purchases 100 %

12-32Cash Disbursements Cash Disbursements ContinuedContinued

Santiago PantsSchedule of Cash

DisbursementsFor the Quarter Ended March 31

January February MarchTotal for Quarter

Beginning accounts payable, January 1 256,000$ 256,000$ January purchases, $120,000a 60,000 57,600$ 117,600 February purchases, $200,000b 100,000 96,000$ 196,000 March purchases, $250,000c 125,000 125,000 Additional cash payments 250,000 250,000 250,000 750,000

Total cash disbursements 566,000$ 407,600$ 471,000$ 1,444,600$

a 50 percent paid in January, 48 percent paid in February, and 2 percent discounts taken b 50 percent paid in February, 48 percent paid in March, and 2 percent discounts takenc 50 percent paid in March, 48 percent paid in April, and 2 percent discounts taken

12-33

Budget Balance SheetBudget Balance SheetL.O. 6 Develop budgeted financial statements.

Balance Balance

(January 1) Additions Subtractions (December 31)

AssetsCurrent assets

Casha 830$ 6,940$ 7,399$ 371$

Accounts receivable 540 b 7,200 c 6,840 a 900 b

Inventories 155 d 4,265 e 3,995 f 425 g

Other current assets 161 b - b 100 h 61 b

Total current assets 1,686$ 18,405$ 18,334$ 1,757$

Long-term assets

Property, plant and equipment 1,866 b 1,470 a - b 3,336 b

Less accumulated depreciation (1,246) b (224) i - b (1,470) b

Total assets 2,306$ 19,651$ 18,334$ 3,623$ a From cash budgetb Estimated by personnel in the company's accounting departmentc From budgeted income statement. Assumes that all sales are on accountd From budgeted statement of cost of goods sold, sum of beginning direct materials, work in process, and finished goods inventories ($35 + 0 + $120 = $155)e From budgeted statement of costs of goods sold, sum of materials purchases, direct labor and manufacturing overhead ($1,715 + $1,870 + $680 = $4,265) f From budgeted statement of cost of goods soldg From budgeted statement of cost of goods sold, sum of ending direct materials, work in process, finished goods inventories ($50 + 0 + $375 = $425)h From employee loansi Depreciation of $140 from schedule of budgeted manufacturing overhead plus $84 from the schedule of budgeted marketing and administrative costs

Santiago PantsBudgeted Balance Sheet ($000)

Year Ended December 31

12-34Budget Balance Sheet Budget Balance Sheet ContinuedContinued

Liabilities and shareholders equity

Current liabilities

Accounts payable 256$ b 1,715$ j 1,694$ a 277$ b

Taxes payable 187 b 550 b 350 a 387 b

Current portion of long-term debt 23 b 23 b 23 a 23 b

Total current liabilities 466 2,288 2,067 687

Long-term liabilities 258 b - b 23 b 235 b

Total liabilities 724 2,288 2,090 922

Shareholders equity

Common stock 437 b - b - b 437 b

Retained earnings 1,145 b 1,149 k 30 a 2,264 b

Total shareholders equity 1,582 1,149 30 2,701

Total liabilities and shareholders equity 2,306$ 3,437$ 2,120$ 3,623$

a From cash budgetb Estimated by personnel in the company's accounting departmentj From budgeted statement of cost of goods sold. Accounts payable increases are assumed to be for materials purchases onlyk From budgeted income statement, operating profit after taxes.

12-35

Master Budget for a Master Budget for a Manufacturing FirmManufacturing Firm

Sales Forecast

Production budget

Marketing and administrative

cost budget

Required direct material, direct labor,

and manufacturing overhead budgets

Budgeted cost of goods sold

Budgeted income

statement

Cash budget

Budgeted balance sheet

12-36Budgeting in Service Budgeting in Service OrganizationsOrganizationsL.O. 7 Explain budgeting in service, retail, and wholesale organizations.

Sales Forecast

Labor budget

Marketing and administrative

cost budget

Budgeted cost of services

Budgeted income statement

Cash budget

Budgeted balance sheet

12-37

Budgeting Retail and Wholesale Budgeting Retail and Wholesale OrganizationsOrganizations

Sales Forecast

PurchasesMarketing and administrative

cost budget

Budgeted income statement

Cash budget

Budgeted balance sheet

12-38

Ethical Issues in BudgetingEthical Issues in BudgetingL.O. 8 Explains why ethical issues arise in budgeting.

Budgets can create serious ethical issues for many people. The company must recognize the trade-off between encouraging unbiased reporting by managers and the use of budget information in performance evaluation and rewards.

12-39Budgeting Under Budgeting Under UncertaintyUncertaintyL.O. 9 Explain how to use sensitivity analysis to budget under uncertainty.

Sales Sales Cost of Gross Marketing Operating Price Quantity Revenue Goods Sold Margin & Admin Profit

40$ 150,000 6,000,000$ 3,600,000$ 2,400,000$ 1,483,500$ 916,500$ 45$ 150,000 6,750,000$ 3,600,000$ 3,150,000$ 1,483,500$ 1,666,500$ 50$ 150,000 7,500,000$ 3,600,000$ 3,900,000$ 1,483,500$ 2,416,500$

40$ 160,000 6,400,000$ 3,840,000$ 2,560,000$ 1,506,000$ 1,054,000$ 45$ 160,000 7,200,000$ 3,840,000$ 3,360,000$ 1,506,000$ 1,854,000$ 50$ 160,000 8,000,000$ 3,840,000$ 4,160,000$ 1,506,000$ 2,654,000$

40$ 170,000 6,800,000$ 4,080,000$ 2,720,000$ 1,528,500$ 1,191,500$ 45$ 170,000 7,650,000$ 4,080,000$ 3,570,000$ 1,528,500$ 2,041,500$ 50$ 170,000 8,500,000$ 4,080,000$ 4,420,000$ 1,528,500$ 2,891,500$

Santiago PantsAlternative Budgeting

Scenarios

12-40

Chapter 12Chapter 12