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Financial & Managerial Accounting
The Basis for Business DecisionsFOURTEENTH EDITION
Williams Haka Bettner Carcello
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Learning Objective
LO1
To explain how acompany can be
“profit rich, yet cash poor.”
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Profit Rich, Yet Cash Poor
Conditions leading to cashshortages when profits are high.
Consider the following cash-to-cash cycle
Large investmentsin assets to support
rapid revenue growth.
Long operating cycles(cash-to-cash cycles).
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Cash
InventoriesDMWIPFG
166 days
Accounts Receivable81 days
Cash
247 Days
Even if salesare growing rapidly,cash is tied up in
inventory andreceivables for so long that a cashshortage will bethe likely result.
Profit Rich, Yet Cash Poor
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Learning Objective
LO2
To discuss the benefitsthat a company may derive from a formalbudgeting process
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Control Steps taken by
management to ensure that
objectives are attained.
Planning Developing objectives for
acquisitionand use of resources.
A budget is a comprehensive financialplan for achieving the financial and
operational goals of an organization.
Budgeting: The Basis forPlanning and Control
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BenefitsCoordinationof activities
Performanceevaluation
Enhanced managementresponsibility
Assignment of decision-making responsibilities
Benefits Derived from Budgeting
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Learning Objective
LO3
To explain two philosophiesthat may be used in
setting budgeted amounts.
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Budget Problems Perceived unfair or
unrealistic goals. Poor management-
employee communications.
Solution Reasonable and
achievable budgets. Employee
participation in budgeting process.
Establishing Budgeted Amounts: Behavioral Approach
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Establishing Budgeted Amounts: Total Quality Management Approach
A commitment to thegoal of completely
eliminating inefficiency.
Budgeted amounts setat levels representingabsolute efficiency.
Small failures toachieve budgeted
amounts directmanagement to
areas where improvement is
possible.
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Flow of Budget Data
S u p erv iso r S u p erv is o r
M id d leM a na ge m e nt
S u p erv iso r S u p erv is o r
M id d leM a na ge m e nt
T o p M an a ge m e nt
Participation in Budget Process
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2005 2006 2007 2008C a p i t a l B u d g e t s
A continuous budget is usually a twelve-month budget that adds one month as the current month is completed.
The annual operating budget may be divided into quarterly or monthly budgets.
The Budget Period
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Ethics, Fraud, andCorporate Governance
Budgets are often included in documents given to investors when governmental and not-for-profit entities seek to obtain debt financing.
Material misstatements in these budgets act as a fraud upon the purchasers of bonds
issued by the governmental or not-for-profit entities and expose both individuals and
organizations to civil and criminal penalties.
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Learning Objective
LO4
To describe the elementsof a master budget.
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Salesbudget
Productionbudgets
Financial budgets: cash flow income balance sheet
Cashbudget
Selling andadministrative
budget
Cost of goodsmanufactured
and soldbudget
The Master Budget
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Learning Objective
LO5
To prepare the budgets andsupporting schedules
included in amaster budget.
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SalesBudget
EstimatedUnit Sales
EstimatedUnit Price
Analysis of economic and market conditions+
Forecasts of customer needs from marketing personnel
Preparing the Master Budget
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Basket, Inc. is preparing budgets for the quarter ending June 30. The sales price is $10 per magnet. Budgeted
sales for the next four months are:
April 20,000 magnets @ $10 = $200,000May 50,000 magnets @ $10 = $500,000June 30,000 magnets @ $10 = $300,000July 25,000 magnets @ $10 = $250,000
The Sales BudgetJuly is needed for June ending inventory computations.
Preparing the Master Budget
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Sales Budget
Completed
ProductionBudgets
The Production Budget
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The management of Basket wants ending inventory to be 20 percent of the next
month’s budgeted sales in units.
4,000 units were on hand March 31.
Let’s prepare the production budget.
The Production Budget
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Production must be adequate to meet budgeted sales and to provide sufficient
ending inventory.
Budgeted product sales in units+ Desired product units in ending inventory= Total product units needed– Product units in beginning inventory= Product units to produce
The Production Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000Desired ending inventoryTotal units neededLess beginning inventoryUnits to produce
The Production Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Desired ending inventory 10,000 6,000 5,000 Total units needed 30,000 56,000 35,000 Less beginning inventoryUnits to produce
Ending inventory = 20% of next month's sales needs.June ending inventory = .20 × 25,000 July units = 5,000 units.
The Production Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Desired ending inventory 10,000 6,000 5,000 Total units needed 30,000 56,000 35,000 Less beginning inventory 4,000 10,000 6,000 Units to produce 26,000 46,000 29,000
Ending inventory = 20% of next month's sales needs.June ending inventory = .20 × 25,000 July units = 5,000 units.Beginning inventory is last month's ending inventory.
The Production Budget
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ProductionBudgetsMaterial
Purchases
Production BudgetUnits
Completed
The Production Budget
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The material purchases budget is based on production quantity and desired material
inventory levels.
Units to produce × Material needed per unit = Material needed for units to produce+ Desired units of material in ending
inventory= Total units of material needed– Units of material in beginning inventory= Units of material to purchase
The Production BudgetMaterial Purchases
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Five pounds of material are needed for each unit produced.
The management at Basket wants to have materials on hand at the end of each month equal to 10 percent of the following month’s
production needs.
The materials inventory on March 31 is 13,000 pounds. July production is
budgeted for 23,000 units.
The Production BudgetMaterial Purchases
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The Production BudgetMaterial Purchases
April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventoryTotal material needs (lbs.)Less beginning inventoryMaterial purchases (lbs.)
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The Production BudgetMaterial Purchases
April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventory 23,000 14,500 11,500 Total material needs (lbs.) 153,000 244,500 156,500Less beginning inventoryMaterial purchases (lbs.)
Ending inventory = 10% of next month's material needs.June ending inventory = .10 × (23,000 units × 5 lbs. per unit).June ending inventory = 11,500 lbs.
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The Production BudgetMaterial Purchases
April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventory 23,000 14,500 11,500 Total material needs (lbs.) 153,000 244,500 156,500Less beginning inventory 13,000 23,000 14,500 Material purchases (lbs.) 140,000 221,500 142,000
Ending inventory = 10% of next month's material needs.June ending inventory = .10 × (23,000 units × 5 lbs. per unit).June ending inventory = 11,500 lbs.Beginning inventory is last month's ending inventory.
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Cash Payments forMaterial Purchases
Materials used in production cost $0.40per pound. One-half of a month’s
purchases are paid for in the month of purchase; the other half is paid for in the
following month.
No discount terms are available.
The accounts payable balance onMarch 31 is $12,000.
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April May JuneMaterial purchases (lbs.) 140,000 221,500 142,000Cost per pound 0.40$ 0.40$ 0.40$ Total cost 56,000$ 88,600$ 56,800$
Payables from March 12,000$April purchasesMay purchasesJune purchasesTotal payments in month
Cash Payments forMaterial Purchases
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April May JuneMaterial purchases (lbs.) 140,000 221,500 142,000Cost per pound 0.40$ 0.40$ 0.40$ Total cost 56,000$ 88,600$ 56,800$
Payables from March 12,000$April purchases 28,000 28,000$May purchasesJune purchasesTotal payments in month
½ × $56,000 = $28,000
Cash Payments forMaterial Purchases
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April May JuneMaterial purchases (lbs.) 140,000 221,500 142,000Cost per pound 0.40$ 0.40$ 0.40$ Total cost 56,000$ 88,600$ 56,800$
Payables from March 12,000$April purchases 28,000 28,000$May purchases 44,300 44,300$June purchasesTotal payments in month
½ × $56,000 = $28,000½ × $88,600 = $44,300
Cash Payments forMaterial Purchases
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April May JuneMaterial purchases (lbs.) 140,000 221,500 142,000Cost per pound 0.40$ 0.40$ 0.40$ Total cost 56,000$ 88,600$ 56,800$
Payables from March 12,000$April purchases 28,000 28,000$May purchases 44,300 44,300$June purchases 28,400 Total payments in month 40,000$ 72,300$ 72,700$
½ × $56,000 = $28,000½ × $88,600 = $44,300½ × $56,800 = $28,400
Cash Payments forMaterial Purchases
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ProductionBudgetLabor
Production BudgetUnits
Material
Completed
The Production Budget
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Each unit produced requires 3 minutes (.05 hours) of direct labor. Basket employs 30
persons for 40 hours each week at a rate of $10 per hour. Any extra hours needed are
obtained by hiring temporary workers also at $10 per hour.
The Production BudgetDirect Labor
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April May JuneUnits to produce 26,000 46,000 29,000 Hours per unit 0.05 0.05 0.05 Total hours required 1,300 2,300 1,450 Wage rate per hourDirect labor cost
Cash Payments forDirect Labor
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April May JuneUnits to produce 26,000 46,000 29,000 Hours per unit 0.05 0.05 0.05 Total hours required 1,300 2,300 1,450 Wage rate per hour 10$ 10$ 10$ Direct labor cost 13,000$ 23,000$ 14,500$
Cash Payments forDirect Labor
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Production Budget
UnitsMaterialLabor
Completed
ProductionBudget
ManufacturingOverhead
The Production Budget
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Variable manufacturing overhead is $1 per unit produced and fixed manufacturing
overhead is $50,000 per month.
Fixed manufacturing overhead includes $20,000 in depreciation which does not
require a cash outflow.
The Production BudgetManufacturing Overhead
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April May JuneUnits to produce 26,000 46,000 29,000 Variable overhead rate 1.00$ 1.00$ 1.00$ Variable overhead cost 26,000$ 46,000$ 29,000$Fixed overheadTotal mfg. overhead costDeduct depreciationManufacturing overhead - cash
Cash Payments forManufacturing Overhead
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April May JuneUnits to produce 26,000 46,000 29,000 Variable overhead rate 1.00$ 1.00$ 1.00$ Variable overhead cost 26,000$ 46,000$ 29,000$Fixed overhead 50,000 50,000 50,000 Total mfg. overhead cost 76,000$ 96,000$ 79,000$Deduct depreciationManufacturing overhead - cash
Cash Payments forManufacturing Overhead
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April May JuneUnits to produce 26,000 46,000 29,000 Variable overhead rate 1.00$ 1.00$ 1.00$ Variable overhead cost 26,000$ 46,000$ 29,000$Fixed overhead 50,000 50,000 50,000 Total mfg. overhead cost 76,000$ 96,000$ 79,000$Deduct depreciation 20,000 20,000 20,000 Manufacturing overhead - cash 56,000$ 76,000$ 59,000$
Cash Payments forManufacturing Overhead
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Production Budget
Completed
Sellingand
AdministrativeExpenseBudget
Selling and Administrative(S&A) Expense Budget
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Selling expense budgets contain both variable and fixed items. Variable items: shipping costs and sales
commissions. Fixed items: advertising and sales salaries.
Administrative expense budgets contain mostly fixed items. Executive salaries and depreciation on
company offices.
Selling and Administrative(S&A) Expense Budget
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Variable selling and administrative expenses are $0.50 per unit sold and fixed selling and
administrative expenses are $70,000 per month.
Fixed selling and administrative expenses include $10,000 in depreciation which does not
require a cash outflow.
Cash Payments for(S&A) Expenses
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Variable S&A per unit 0.50$ 0.50$ 0.50$ Variable S&A expense 10,000$ 25,000$ 15,000$Fixed S&A expense 70,000 70,000 70,000 Total S&A expense 80,000$ 95,000$ 85,000$Deduct depreciationS&A expense - cash
Cash Payments for(S&A) Expenses
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Variable S&A per unit 0.50$ 0.50$ 0.50$ Variable S&A expense 10,000$ 25,000$ 15,000$Fixed S&A expense 70,000 70,000 70,000 Total S&A expense 80,000$ 95,000$ 85,000$Deduct depreciation 10,000 10,000 10,000 S&A expense - cash 70,000$ 85,000$ 75,000$
Cash Payments for(S&A) Expenses
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All sales are on account.
Basket’s collection pattern is:
70 percent collected in month of sale
25 percent collected in month after sale
5 percent will be uncollectible
Accounts receivable on March 31 is $30,000, all of which is collectible.
Cash Receipts Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April salesReceipts from May salesReceipts from June salesTotal cash receipts
Cash Receipts Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000$ Receipts from May salesReceipts from June salesTotal cash receipts 170,000$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000
Cash Receipts Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000$ Receipts from May sales 350,000 125,000$Receipts from June salesTotal cash receipts 170,000$ 400,000$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000 May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000
Cash Receipts Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000$ Receipts from May sales 350,000 125,000$Receipts from June sales 210,000 Total cash receipts 170,000$ 400,000$ 335,000$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000 May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000 June: .70 × $300,000 = $210,000
Cash Receipts Budget
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Basket Company:Has a $100,000 line of credit at its bank, with a zero
balance on April 1.Maintains a $30,000 minimum cash balance.Borrows at the beginning of a month and repays at the
end of a month.Pays interest at 16 percent when a principal payment is
made.Pays a $51,000 cash dividend in April.Purchases equipment costing $143,700 in May and
$48,800 in June.Has a $40,000 cash balance on April 1.
Comprehensive Cash BudgetAdditional Information
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ Cash receiptsCash availableCash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases DividendsTotal cash paymentsBalance before financingBorrowingPrincipal repaymentInterestEnding cash balance
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases DividendsTotal cash paymentsBalance before financingBorrowingPrincipal repaymentInterestEnding cash balance
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0Total cash payments 230,000$ 400,000$ 270,000$Balance before financing (20,000)$ BorrowingPrincipal repaymentInterestEnding cash balance
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ 30,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$ 430,000$Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0Total cash payments 230,000$ 400,000$ 270,000$Balance before financing (20,000)$ 30,000$ Borrowing 50,000 Principal repayment 0Interest 0Ending cash balance 30,000$
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ 30,000$ 30,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$ 430,000$ 365,000$Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0Total cash payments 230,000$ 400,000$ 270,000$Balance before financing (20,000)$ 30,000$ 95,000$ Borrowing 50,000 0Principal repayment 0 0Interest 0 0Ending cash balance 30,000$ 30,000$
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ 30,000$ 30,000$ Cash receipts 170,000 400,000 335,000 Cash available 210,000$ 430,000$ 365,000$Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0Total cash payments 230,000$ 400,000$ 270,000$Balance before financing (20,000)$ 30,000$ 95,000$ Borrowing 50,000 0 0Principal repayment 0 0 (50,000) Interest 0 0 (2,000) Ending cash balance 30,000$ 30,000$ 43,000$
$50,000 × .16 × 3/12 = $2,000
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BudgetedIncome
Statement
Cash Budget
Completed
The BudgetedIncome Statement
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Basket CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$
The BudgetedIncome Statement
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Basket CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$ Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000$
Computation of unit cost follows
The BudgetedIncome Statement
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Production costs per unit Quantity Cost Total Direct materials 5.00 lbs. 0.40$ 2.00$ Direct labor 0.05 hrs. 10.00$ 0.50 Manufacturing overhead 0.05 hrs. 49.70$ 2.49 Total unit cost 4.99$
Total mfg. OH for quarter $251,000 Total labor hours required 5,050 hrs.
= $49.70 per hr.
From labor and Mfg. OH budgetsLabor Hours Mfg. OH
April 1,300 76,000$ May 2,300 96,000 June 1,450 79,000 Total 5,050 251,000$
Manufacturingoverhead is applied
based ondirect labor hours.
The BudgetedIncome Statement
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Basket CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$ Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000$ Selling and administrative expenses 260,000 Operating income 241,000$
From S&A Expense BudgetApril 80,000$ May 95,000 June 85,000 Total 260,000$
The BudgetedIncome Statement
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Basket CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$ Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000$ Selling and administrative expenses 260,000 Operating income 241,000$ Interest expense 2,000 Net income 239,000$
The BudgetedIncome Statement
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BudgetedBalance
Sheet
Completed
BudgetedIncome
Statement
The BudgetedBalance Sheet
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Basket reports the following account balances on June 30, prior to preparing its
budgeted financial statements: Land - $50,000 Building (net) - $174,500 Common stock - $200,000 Equipment (net) - $192,500 Retained earnings - $148,150Paid dividends of $51,000
The BudgetedBalance Sheet
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Basket CompanyBudgeted Balance Sheet
June 30, 2004Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Total current assets 147,550$ Property and equipment Land 50,000$ Building 174,500 Equipment 192,500 Total property and equipment 417,000$ Total assets 564,550$
Liabilities and Equities Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$
25% of Junesales of $300,000
11,500 lbs. @ $.40 per lb.
50% of Junepurchases of $56,800
5,000 units@ $4.99 each
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Basket CompanyBudgeted Balance Sheet
June 30, 2004Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Total current assets 147,550$ Property and equipment Land 50,000$ Building 174,500 Equipment 192,500 Total property and equipment 417,000$ Total assets 564,550$
Liabilities and Equities Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$
Beginning balance 148,150$Add: net income 239,000 Deduct: dividends (51,000) Ending balance 336,150$
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Learning Objective
LO6
To prepare a flexiblebudget and explain
its uses.
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Performance evaluation is difficult when actual activity differs from the
activity originally budgeted.
Flexible Budgeting
Hmm! Comparingcosts at differentlevels of activity is like comparing
apples with oranges.
Consider the followingcondensed examplefrom Barton, Inc. . . .
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Flexible Budgeting
Original ActualBudget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
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Original ActualBudget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
U = Unfavorable variance – Barton, Inc. was unable to achieve the
budgeted level of activity.
Flexible Budgeting
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Original ActualBudget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
F = Favorable variance: actual costs are less than budgeted costs.
Flexible Budgeting
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Original ActualBudget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
Since cost variances are favorable, havewe done a good job controlling costs?
Flexible Budgeting
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
I don’t think I can answer the question
using the originalbudget.
How much ofthe favorable cost
variance is due to loweractivity, and how much is due
to good cost control?
Flexible Budgeting
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Flexible Budgeting
I don’t think I can answer the question
using the originalbudget.
How much ofthe favorable cost
variance is due to loweractivity, and how much is due
to good cost control?
To answer the question, we mustthe budget to the actual level of activity.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Central Concept
If you can tell me what your activity wasfor the period, I will tell you what your costs and revenue should have been.
Flexible Budgeting
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Improve performance evaluation.
May be prepared for any activity level in the relevant range.
Show expenses that should haveoccurred at the actual level ofactivity.
Reveal variances due to good costcontrol or lack of cost control.
Flexible Budgeting
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
To a budget for different activity levels, we must know how costs behave with changes in activity levels.Total variable costs change
in direct proportion to changes in activity.
Total fixed costs remainunchanged within therelevant range.
FixedVariable
Flexible Budgeting
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Let’s prepare budgets for Barton, Inc.
Flexible Budgeting
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Flexible Budgeting
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Variable costs are expressed as a constant amount per hour.
In the original budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of
$4.00 per hour.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Flexible Budgeting
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$
Flexible Budgeting
Total variable cost = $7.50 per unit × budget level in units
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Flexible Budgeting
Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$
Fixed costs are expressed as a total amount that does not change within the relevant
range of activity.
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Now let’s prepare a budget performance report at 8,000 actual units for Barton, Inc.
Flexible BudgetingPerformance Report
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Flexible BudgetingPerformance Report
Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Costs Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Costs Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U
Indirect labor and indirect material have unfavorable variances because actual costs
are more than the flexible budget costs.
Flexible BudgetingPerformance Report
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Costs Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U
Power has a favorable variance because the
actual cost is less than the flexible budget cost.
Flexible BudgetingPerformance Report