Profit Planning

Chapter 8

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 8-2

Learning Objective 1

Understand why
organizations budget and
the processes they use
to create budgets.
 8-3

The Basic Framework of Budgeting

A budget is a detailed quantitative plan for
acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activities is known
as budgetary control.
 8-4

Planning and Control

Planning – Control –
involves developing involves the steps taken
objectives and by management to
preparing various increase the likelihood that
budgets to achieve the objectives set down
those objectives. while planning are attained
and that all parts of the
organization are working
together toward that goal.
 8-5

Advantages of Budgeting
Define goals
and objectives
Communicate Think about and
plans plan for the future

Advantages
Coordinate Means of allocating
activities resources

Uncover potential
bottlenecks
 8-6

Responsibility Accounting

Managers should be
held responsible for
those items - and only
those items - that they
can actually control
to a significant extent.
 8-7

Choosing the Budget Period

Operating Budget

2011 2012 2013 2014

Operating budgets ordinarily

A continuous budget is a
cover a one-year period
12-month budget that rolls
corresponding to a company’s
forward one month (or quarter)
fiscal year. Many companies
as the current month (or quarter)
divide their annual budget
is completed.
into four quarters.
 8-8

Self-Imposed Budget
Top Management

Middle Middle
Management Management

Supervisor Supervisor Supervisor Supervisor

A self-imposed budget or participative budget is a budget that is
prepared with the full cooperation and participation of managers
at all levels.
 8-9

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.
 8-10

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.
 8-11

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.
 8-12

The Budget Committee

A standing committee responsible for
❖ overall policy matters relating to the budget
❖ coordinating the preparation of the budget
❖ resolving disputes related to the budget
❖ approving the final budget
 8-13

The Master Budget: An Overview

Sales budget

Selling and
Ending inventory administrative
Production budget
budget budget

Direct materials Direct labor Manufacturing

budget budget overhead budget

Cash Budget

Budgeted
Budgeted
income
balance sheet
statement
 8-14

Learning Objective 2

Prepare a sales budget,

including a schedule of
expected cash
collections.
 8-15

Budgeting Example
 Royal Company is preparing budgets for the
quarter ending June 30th.
 Budgeted sales for the next five months are:
April 20,000 units
May 50,000 units
June 30,000 units
July 25,000 units
August 15,000 units
 The selling price is $10 per unit.
 8-16

The Sales Budget

The individual months of April, May, and June are
summed to obtain the total budgeted sales in units
and dollars for the quarter ended June 30th
 8-17

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.
 8-18

Expected Cash Collections

 8-19

Expected Cash Collections

From the Sales Budget for April.

 8-20

Expected Cash Collections

From the Sales Budget for May.

 8-21

Quick Check ✓
What will be the total cash collections for
the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
 8-22

Quick Check ✓
What will be the total cash collections for
the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
 8-23

Expected Cash Collections

 8-24

Learning Objective 3

Prepare a production
budget.
 8-25

The Production Budget

Sales Production
Budget Budget
and
Expected
Cash
Collections

The production budget must be adequate to

meet budgeted sales and to provide for
the desired ending inventory.
 8-26

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.

 8-27

The Production Budget

 8-28

The Production Budget

Budgeted May sales 50,000

Desired ending inventory % 20%
March 31
Desired ending inventory 10,000
ending inventory.
 8-29

Quick Check ✓
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
 8-30

Quick Check ✓
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
 8-31

The Production Budget

 8-32

The Production Budget

Assumed ending inventory.

 8-33

Learning Objective 4

Prepare a direct
materials budget,
including a schedule of
expected cash
disbursements for
purchases of materials.
 8-34

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.

 8-35

The Direct Materials Budget

From production budget.

 8-36

The Direct Materials Budget

 8-37

The Direct Materials Budget

March 31 inventory.

10% of following month’s Calculate the materials to

production needs. be purchased in May.
 8-38

Quick Check ✓
How much materials should be purchased in May?
a. 221,500 pounds
b. 240,000 pounds
c. 230,000 pounds
d. 211,500 pounds
 8-39

Quick Check ✓
How much materials should be purchased in May?
a. 221,500 pounds
b. 240,000 pounds
c. 230,000 pounds
d. 211,500 pounds
 8-40

The Direct Materials Budget

 8-41

The Direct Materials Budget

Assumed ending inventory.

 8-42

Expected Cash Disbursement for

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.

Let’s calculate expected cash disbursements.

 8-43

Expected Cash Disbursement for

Materials
 8-44

Expected Cash Disbursement for

Materials

Compute the expected cash

disbursements for materials
for the quarter.

140,000 lbs. × $0.40/lb. = $56,000

 8-45

Quick Check ✓
What are the total cash disbursements for
the quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
 8-46

Quick Check ✓
What are the total cash disbursements for
the quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
 8-47

Expected Cash Disbursement for

Materials
 8-48

Learning Objective 5

Prepare a direct labor

budget.
 8-49

The Direct Labor Budget

• At Royal, each unit of product requires 0.05 hours (3
minutes) of direct labor.
• The Company has a “no layoff” policy so all employees will
be paid for 40 hours of work each week.
• For purposes of our illustration assume that Royal has a “no
layoff” policy, workers are paid at the rate of $10 per hour
regardless of the hours worked.
• For the next three months, the direct labor workforce will be
paid for a minimum of 1,500 hours per month.
Let’s prepare the direct labor budget.
 8-50

The Direct Labor Budget

From production budget.

 8-51

The Direct Labor Budget

 8-52

The Direct Labor Budget

Greater of labor hours required

or labor hours guaranteed.
 8-53

The Direct Labor Budget

 8-54

Quick Check ✓
What would be the total direct labor cost for
the quarter if the company follows its no lay-
off policy, but pays $15 (time-and-a-half) for
every hour worked in excess of 1,500 hours
in a month?
a. $79,500
b. $64,500
c. $61,000
d. $57,000
 8-55

Quick Check ✓
What would be the total direct labor cost for
the quarter if the company follows its no lay-
off policy, but pays $15 (time-and-a-half) for
every hour worked in excess April ofMay
1,500 hours
June Quarter
Labor hours required 1,300 2,300 1,450
in a month?Regular hours paid 1,500 1,500 1,500 4,500
a. $79,500 Overtime hours paid - 800 - 800

b. $64,500 Total regular hours 4,500 $10 $ 45,000

Total overtime hours 800 $15 $ 12,000
c. $61,000 Total pay $ 57,000
d. $57,000
 8-56

Learning Objective 6

Prepare a manufacturing
overhead budget.
 8-57

Manufacturing Overhead Budget

• At Royal, manufacturing overhead is applied to
units of product on the basis of direct labor hours.
• The variable manufacturing overhead rate is $20
per direct labor hour.
• Fixed manufacturing overhead is $50,000 per
month, which includes $20,000 of noncash costs
(primarily depreciation of plant assets).

Let’s prepare the manufacturing overhead budget.

 8-58

Manufacturing Overhead Budget

Direct Labor Budget.

 8-59

Manufacturing Overhead Budget

Total mfg. OH for quarter $251,000

= $49.70 per hour *
Total labor hours required 5,050

* rounded
 8-60

Manufacturing Overhead Budget

Depreciation is a noncash charge.

 8-61

Ending Finished Goods Inventory

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 $ 24,950

Direct materials
budget and information.
 8-62

Ending Finished Goods Inventory

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 $ 24,950

Direct labor budget.

 8-63

Ending Finished Goods Inventory

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
 8-64

Ending Finished Goods Inventory

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 $ 24,950

Production Budget.
 8-65

Learning Objective 7

Prepare a selling and

administrative expense
budget.
 8-66

Selling and Administrative Expense

Budget
• At Royal, the selling and administrative expense budget is
divided into variable and fixed components.
• The variable selling and administrative expenses are $0.50
per unit sold.
• Fixed selling and administrative expenses are $70,000 per
month.
• The fixed selling and administrative expenses include
$10,000 in costs – primarily depreciation – that are not cash
outflows of the current month.

Let’s prepare the company’s selling and administrative

expense budget.
 8-67

Selling and Administrative Expense

Budget

Calculate the selling and administrative

cash expenses for the quarter.
 8-68

Quick Check ✓
What are the total cash disbursements for
selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
 8-69

Quick Check ✓
What are the total cash disbursements for
selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
 8-70

Selling Administrative Expense Budget

 8-71

Learning Objective 8

Prepare a cash budget.

 8-72

Format of the Cash Budget

The cash budget is divided into four sections:
1. Cash receipts section lists all cash inflows excluding cash
received from financing;
2. Cash disbursements section consists of all cash payments
excluding repayments of principal and interest;
3. Cash excess or deficiency section determines if the
company will need to borrow money or if it will be able to
repay funds previously borrowed; and
4. Financing section details the borrowings and repayments
projected to take place during the budget period.
 8-73

The Cash Budget

Assume the following information for Royal:
➢ Maintains a 16% open line of credit for $75,000
➢ Maintains a minimum cash balance of $30,000
➢ Borrows on the first day of the month and repays
loans on the last day of the month
➢ Pays a cash dividend of $49,000 in April
➢ Purchases $143,700 of equipment in May and
$48,300 in June (both purchases paid in cash)
➢ Has an April 1 cash balance of $40,000
 8-74

The Cash Budget

Schedule of Expected
Cash Collections.
 8-75

The Cash Budget

Schedule of Expected
Cash Disbursements.
Direct Labor
Budget.
Manufacturing
Overhead Budget.

Selling and Administrative

Expense Budget.
 8-76

The Cash Budget

Because Royal maintains

a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.
 8-77

The Cash Budget

Because Royal maintains

a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.

Ending cash balance for April

is the beginning May balance.
 8-78

The Cash Budget

 8-79

Quick Check ✓
What is the excess (deficiency) of cash
available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
 8-80

Quick Check ✓
What is the excess (deficiency) of cash
available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
 8-81

The Cash Budget

$50,000 × 16% × 3/12 = $2,000

Borrowings on April 1 and
repayment on June 30.
 8-82

The Budgeted Income Statement

Cash Budgeted
Budget Income
Statement

With interest expense from the cash

budget, Royal can prepare the budgeted
income statement.
 8-83

Learning Objective 9

Prepare a budgeted
income statement.
 8-84

The Budgeted Income Statement

Sales Budget.
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Ending Finished
Sales (100,000 units @ $10) $ 1,000,000 Goods Inventory.
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
Selling and
Selling and administrative expenses 260,000
Operating income 241,000 Administrative
Interest expense 2,000 Expense Budget.
Net income $ 239,000

Cash Budget.
 8-85

Learning Objective 10

Prepare a budgeted
balance sheet.
 8-86

The Budgeted Balance Sheet

Royal reported the following account
balances prior to preparing its budgeted
financial statements:
• Land - $50,000
• Common stock - $200,000
• Retained earnings - $146,150 (April 1)
• Equipment - $175,000
 8-87

Royal Company
Budgeted Balance Sheet 25% of June
June 30 sales of
Assets: $300,000.
Cash $ 43,000
Accounts receivable 75,000 11,500 lbs.
Raw materials inventory 4,600 at $0.40/lb.
Finished goods inventory 24,950
Land 50,000 5,000 units
Equipment 3,67,000 at $4.99 each.
Total assets 5,64,550

Liabilities and Stockholders' Equity 50% of June

Accounts payable $ 28,400
purchases
Common stock 2,00,000
Retained earnings 3,36,150 of $56,800.
Total liabilities and stockholders' equity $ 5,64,550
 8-88

Royal Company
Budgeted Balance Sheet
June 30
Beginning balance $146,150
Assets: Add: net income 239,000
Cash $ 43,000
Deduct: dividends (49,000)
Accounts receivable Ending balance
75,000 $336,150
Raw materials inventory 4,600
Finished goods inventory 24,950
Land 50,000
Equipment 367,000
Total assets 564,550

Liabilities and Stockholders' Equity

Accounts payable $ 28,400
Common stock 200,000
Retained earnings 336,150
Total liabilities and stockholders' equity $ 564,550
Sales and Production Budgets: The marketing department of Graber
8-89

Corporation has submitted the following sales forecast for the upcoming fiscal
year
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Budgeted Unit Sales 16,000 15,000 14,000 15,000

• The selling price of the company’s product is $22.00 per unit.

• Management expects to collect 75% of sales in the quarter in which the
sales are made, 20% in the following quarter, and 5% of sales are expected
to be uncollectible.
• The beginning balance of accounts receivable, all of which is expected to
be collected in the first quarter, is $66,000.
• The company expects to start the first quarter with 3,200 units in finished
goods inventory.
• Management desires an ending finished goods inventory in each quarter
equal to 20% of the next quarter’s budgeted sales. The desired ending
finished goods inventory for the fourth quarter is 3,400 units.
Required:
1. Prepare the company’s sales budget and schedule of expected cash
collections.
2. Prepare the company’s production budget for the upcoming fiscal year.
8-90
Direct Materials and Direct Labor Budgets: The production department of Priston
8-91

Company has submitted the following forecast of units to be produced by quarter for
the upcoming fiscal year

• The beginning raw materials inventory for the 1st Quarter is budgeted to be 3,600
pounds and the beginning accounts payable for the 1st Quarter is budgeted to be
$11,775.
• Each unit requires three pounds of raw material that costs $2.50 per pound.
Management desires to end each quarter with a raw materials inventory equal to
20% of the following quarter’s production needs.
• The desired ending inventory for the 4th Quarter is 3,700 pounds.
• Management plans to pay for 70% of raw material purchases in the quarter
acquired and 30% in the following quarter.
• Each unit requires 0.50 direct labor-hours and direct labor-hour workers are paid
$12 per hour.

Required: Prepare the company’s

1. Direct materials budget and schedule of expected cash disbursements for
purchases of materials for the upcoming fiscal year.
2. Direct labor budget for the upcoming fiscal year, assuming that the direct labor
workforce is adjusted each quarter to match the number of hours required to
produce the forecasted number of units produced.
8-92