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Difference Between Planning and

The Basic Framework of Budgeting Control
A budget is a detailed quantitative plan for Planning – Control –
Short-term acquiring and using financial and other resources
over a specified forthcoming time period.
involves developing involves the steps taken
objectives and by management to
Financial Planning 1. The act of preparing a budget is called
preparing various
budgets to achieve
increase the likelihood that
the objectives set down
budgeting.
those objectives. while planning are attained
Financial Management, Part 1
August 8, 2018
2. The use of budgets to control an and that all parts of the
organization’s activities is known organization are working
as budgetary control. together toward that goal.

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Advantages of Budgeting Responsibility Accounting Choosing the Budget Period

Define goals
and objectives
Managers should be held Operating Budget

Communicate Think about and responsible for those items -

plans plan for the future and only those items - that
they can actually control 2014 2015 2016 2017
Advantages
Coordinate Means of allocating to a significant extent. Operating budgets ordinarily
activities resources Responsibility accounting cover a one-year period
A continuous budget is a
enables organizations to react 12-month budget that rolls
corresponding to a company’s
Uncover potential forward one month (or quarter)
bottlenecks quickly to deviations from their fiscal year. Many companies
as the current month (or quarter)
plans and to learn from divide their annual budget
is completed.
into four quarters.
feedback.
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The Master Budget: An Overview Budgeting Example The Sales Budget

Sales budget
 Royal Company is preparing budgets for the The individual months of April, May, and June are
Selling and summed to obtain the total budgeted sales in units
Ending inventory
Production budget administrative quarter ending June 30th.
budget budget  Budgeted sales for the next five months are: and dollars for the quarter ended June 30th
April 20,000 units
Direct materials Direct labor Manufacturing
overhead budget
May 50,000 units
budget budget
June 30,000 units
July 25,000 units
Cash Budget
August 15,000 units
Budgeted  The selling price is $10 per unit.
Budgeted
income
balance sheet
statement

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Expected Cash Collections Expected Cash Collections Expected Cash Collections

• All sales are on account.
• Royal’s collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale,
5% uncollectible.
• In April, the March 31st accounts receivable
balance of $30,000 will be collected in full.
From the Sales Budget for April.
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Expected Cash Collections Expected Cash Collections The Production Budget

Sales Production
Budget Budget
and
Expected
Cash
Collections

The production budget must be adequate to

From the Sales Budget for May. meet budgeted sales and to provide for
the desired ending inventory.

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The Production Budget The Production Budget The Production Budget

• The management at Royal Company wants
ending inventory to be equal to 20% of the
following month’s budgeted sales in units.

• On March 31st, 4,000 units were on hand.

Let’s prepare the production budget.

Budgeted May sales 50,000
Desired ending inventory % 20%
If Royal was a merchandising company it would prepare a March 31
merchandise purchase budget instead of a production budget. Desired ending inventory 10,000
ending inventory.
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The Production Budget The Direct Materials Budget The Direct Materials Budget
• At Royal Company, five pounds of material
are required per unit of product.
• Management wants materials on hand at the
end of each month equal to 10% of the
following month’s production.
• On March 31, 13,000 pounds of material are
on hand. Material cost is $0.40 per pound.

Let’s prepare the direct materials budget.

Assumed ending inventory.

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The Direct Materials Budget The Direct Materials Budget The Direct Materials Budget

March 31 inventory.

10% of following month’s Calculate the materials to

production needs. be purchased in May. Assumed ending inventory.
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Expected Cash Disbursement for Expected Cash Disbursement for Expected Cash Disbursement for
Materials Materials Materials
• Royal pays $0.40 per pound for its materials.
• One-half of a month’s purchases is paid for in
the month of purchase; the other half is paid in
the following month.
• The March 31 accounts payable balance is
$12,000. Compute the expected cash
disbursements for materials
Let’s calculate expected cash disbursements. for the quarter.

140,000 lbs. × $0.40/lb. = $56,000

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The Direct Labor Budget The Direct Labor Budget Manufacturing Overhead Budget
• At Royal, each unit of product requires 0.05 hours (3 • At Royal, manufacturing overhead is applied to
minutes) of direct labor. units of product on the basis of direct labor hours.
• The Company has a “no layoff” policy so all employees will • The variable manufacturing overhead rate is $20
be paid for 40 hours of work each week.
per direct labor hour.
• For purposes of our illustration assume that Royal has a “no
layoff” policy, workers are paid at the rate of $10 per hour • Fixed manufacturing overhead is $50,000 per
regardless of the hours worked. month, which includes $20,000 of noncash costs
• For the next three months, the direct labor workforce will be (primarily depreciation of plant assets).
paid for a minimum of 1,500 hours per month.
Let’s prepare the direct labor budget. Let’s prepare the manufacturing overhead budget.
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Manufacturing Overhead Budget Ending Finished Goods Inventory

Manufacturing Overhead Budget Budget
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
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory ?
Total mfg. OH for quarter $251,000
= $49.70 per hour *
Total labor hours required 5,050
Total mfg. OH for quarter $251,000
= $49.70 per hour
Total labor hours required 5,050
Depreciation is a noncash charge.
* rounded

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Ending Finished Goods Inventory Selling and Administrative Expense Selling and Administrative Expense
Budget Budget Budget
Production costs per unit Quantity Cost Total • At Royal, the selling and administrative expense budget is
Direct materials 5.00 lbs. $ 0.40 $ 2.00 divided into variable and fixed components.
Direct labor 0.05 hrs. $ 10.00 0.50
• The variable selling and administrative expenses are $0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
per unit sold.
Budgeted finished goods inventory • Fixed selling and administrative expenses are $70,000 per
Ending inventory in units 5,000 month.
Unit product cost $ 4.99
Ending finished goods inventory $ 24,950 • The fixed selling and administrative expenses include
$10,000 in costs – primarily depreciation – that are not cash
outflows of the current month.
Production Budget.
Let’s prepare the company’s selling and administrative
Calculate the selling and administrative
expense budget.
cash expenses for the quarter.
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Selling Administrative Expense Budget Format of the Cash Budget The Cash Budget
The cash budget is divided into four sections: Assume the following information for Royal:
1. Cash receipts section lists all cash inflows excluding cash ➢ Maintains a 16% open line of credit for $75,000.
received from financing; ➢ Maintains a minimum cash balance of $30,000.
2. Cash disbursements section consists of all cash payments ➢ Borrows on the first day of the month and repays
excluding repayments of principal and interest; loans on the last day of the quarter.
3. Cash excess or deficiency section determines if the ➢ Pays a cash dividend of $49,000 in April.
company will need to borrow money or if it will be able to
repay funds previously borrowed; and ➢ Purchases $143,700 of equipment in May and
$48,300 in June (both purchases paid in cash).
4. Financing section details the borrowings and repayments
projected to take place during the budget period. ➢ Has an April 1 cash balance of $40,000.

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The Cash Budget The Budgeted Income Statement The Budgeted Income Statement
Sales Budget.
Royal Company
Budgeted Income Statement
Cash Budgeted For the Three Months Ended June 30
Budget Ending Finished
Income Sales (100,000 units @ $10) $ 1,000,000 Goods Inventory.
$50,000 × 16% × 3/12 = $2,000 Statement Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
Borrowings on April 1 and Selling and
repayment on June 30. Selling and administrative expenses 260,000
Operating income 241,000 Administrative
Interest expense 2,000 Expense Budget.
Net income $ 239,000
With interest expense from the cash
budget, Royal can prepare the budgeted Cash Budget.
income statement.
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The Budgeted Balance Sheet Royal Company

Budgeted Balance Sheet 25% of June
Royal Company
Budgeted Balance Sheet
June 30 sales of June 30
Royal reported the following account $300,000. Beginning balance $146,150
Assets: Assets:
balances prior to preparing its budgeted Cash $ 43,000 Cash $
Add: net income
43,000 dividends
Deduct:
239,000
(49,000)
financial statements: Accounts receivable 75,000 11,500 lbs. Accounts receivable Ending
75,000balance $336,150
Raw materials inventory 4,600 at $0.40/lb. Raw materials inventory 4,600
• Land - $50,000 Finished goods inventory
Land
24,950
50,000 5,000 units
Finished goods inventory
Land
24,950
50,000
• Common stock - $200,000 Equipment 367,000 at $4.99 each. Equipment 367,000

• Retained earnings - $146,150 (April 1) Total assets 564,550 Total assets 564,550

• Equipment - $175,000 Liabilities and Stockholders' Equity 50% of June Liabilities and Stockholders' Equity
Accounts payable $ 28,400 Accounts payable $ 28,400
purchases
Common stock 200,000 Common stock 200,000
Retained earnings 336,150
of $56,800. Retained earnings 336,150
Total liabilities and stockholders' equity $ 564,550 Total liabilities and stockholders' equity $ 564,550