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ACT 5140 - Accounting for Decision Makers HW #2 - Chapter 9 Directions: Answer all the questions. Please submit your work in Word or PDF formats only. You can submit an Excel file to support calculations, but please \"cut and paste\" your solutions into the Word or PDF file. Be sure to show how you did your calculations. Also, please be sure to include your name at the top of the first page of your file. Question #1 List and describe four potential advantages of budgeting and four potential disadvantages of budgeting. As part of your description, you should provide examples of the advantages and disadvantages. Question #2 Describe the strengths and weaknesses of the three general types of budgeting processes we discussed. As part of your description, you should provide examples of the strengths and weaknesses. MANAGERIAL ACCOUNTING Al L. Hartgraves Wayne J. Morse CHAPTER 9 Operational Budgeting and Profit Planning Cambridge Business Publishers, 2015 7e Learning Objective 1 Discuss the importance of budgets. Cambridge Business Publishers, 2015 2 Reasons for Budgeting Budgets Require people to think about the future Move a company from a reactive to a proactive style of management Improve communication and coordination Provide a guide to action Provide a basis of performance evaluation Aid in risk management Cambridge Business Publishers, 2015 3 Management by Exception Management compares results with budgeted amounts Attention is directed only to those activities not proceeding as planned Saves time by not requiring management to examine every past activity Cambridge Business Publishers, 2015 4 Risk Management RISK is the danger that things will not go according to plan. Risk can be associated with positive impact: Increase in sales volume Increase in selling prices Risk is more commonly associated with negative impact: Work stoppage at a key supplier Fire Hackers Cambridge Business Publishers, 2015 5 Aid in Risk Management Risk management, or enterprise risk management, is the process of identifying, evaluating, and planning possible responses to risks. Useful tools to manage risk: An organization's budget model can: Evaluate the financial impact of risk Determine best response from a financial perspective Performance evaluation procedures, if completed on a timely basis, assist in monitoring risk Cambridge Business Publishers, 2015 6 Aid in Risk Management RISK IDENTIFICATION Identify possible risks and their implications. RISK ASSESSMENT AND QUANTIFICATION Predict each risk's probability and impact, including financial impacts. Classify risks by importance to the organization. RISK RESPONSE Select a response to each risk: Avoid risk, e.g. do not accept project Transfer risk, e.g. purchase insurance Mitigate risk, e.g. contingency plans Accept risk, e.g. risk low, risk will not have a significant impact, or risk unavoidable RISK MONITORING Develop procedures to continuously monitor important risks with the goal of facilitating a timely response. Cambridge Business Publishers, 2015 Alan J. Chilcott, \"Risk Management - A Developing Field of Study and Application,\" Cost Engineering September 9, 2010, pp. 9-16; Neville Turbit, \"Basics of Managing Risk,\" The Project Perfect White Paper Collection, www.projectperfect.com.au. 7 Learning Objective 2 Describe basic approaches to budgeting. Cambridge Business Publishers, 2015 8 Approaches to Budgeting Output/Input Approach Activity-Based Approach Incremental Approach Minimum Level Approach Cambridge Business Publishers, 2015 9 Output/Input Approach to Budgeting Budgets physical inputs and costs as a function of planned input (unit-level) activities Often used for service, merchandising, manufacturing and distribution activities Works effectively with activities that have defined relationships between effort and accomplishment Starts with the planned outputs Works backward to budget the inputs Cambridge Business Publishers, 2015 10 Activity-Based Approach to Budgeting Type of output/input method Reduces distortions in the transformation Emphasis placed on the expected costs of the planned activities that will be consumed by the cost objective How it works Overhead costs are budgeted based on anticipated consumption of activities Consumption of activity cost drive determined Budgeted activity cost based on units of activity and related cost per unit of activity cost driver Cambridge Business Publishers, 2015 11 Incremental Approach to Budgeting Budgets costs for a coming period as a dollar or percentage change from the amount budgeted for a previous period Used when relationship between inputs and outputs is weak or nonexistent Widely used in government and not-for-profit organizations Advantage Simplifies the budget process by considering only the increments Cambridge Business Publishers, 2015 12 Minimum Level Approach to Budgeting Establishes a base amount for budget items and requires explanation or justification for any budgeted amount above the minimum base Corrects deficiencies in the incremental approach Questions the necessity for costs included in the base budget of the incremental approach Very time consuming Cambridge Business Publishers, 2015 13 Variations of the Minimum Level Approach Zero-based budgeting Every dollar of expenditures must be justified Breaks total budget into program packages wit related costs Budgeting for objectives Combines elements of activity-based and zerobased budgeting with a need to live within fixed financial constraints Cambridge Business Publishers, 2015 14 Learning Objective 3 Explain the relations among elements of a master budget and develop a basic budget. Cambridge Business Publishers, 2015 15 The Master Budget The culmination of the budgeting process Groups all budgets and supporting schedules together Coordinates all financial and operational activities placing them into an organization-wide set of budgets for a givenGoal period A Major time Ensure the smooth functioning of a business throughout the budget period and the organization's operation cycle Cambridge Business Publishers, 2015 16 Operating Cycle of a Manufacturing or Merchandising Operation Involves the conversion of cash into other assets, which are intended to produce revenues in excess of their costs Cambridge Business Publishers, 2015 17 Budget Process for a Merchandiser Sales Budget Purchases Budget Special Budgets Cambridge Business Publishers, 2015 Selling Expense Budget General & Administrative Expense Budget Cash Budget Pro Forma Statements Income Statement Balance Sheet 18 Sales Budget Starting point for the budgeting process Includes a forecast of sales revenue Normally includes a forecast of unit sales Best available information used to forecast Future market conditions Merchandise available Promotion and advertising plans Expected pricing policies Cambridge Business Publishers, 2015 19 Sales Budget Example BC Carts distributes plastic carts to retailers. For June, estimated sales are 9,000 carts at a selling price of $10 each with an estimated cost of $4 per cart. BC Carts Sales Budget For Month of June 2015 Sales in units Selling price per unit Sales revenue 9,000 $ 10.00 $90,000 Budget revenue for June is $90,000 Cambridge Business Publishers, 2015 20 Purchases Budget Indicates the merchandise to be purchased to meet sales needs and ending inventory requirements Often referred to as 'merchandise purchases budget' Considers Budgeted sales Desired ending inventory Planned beginning inventory Cambridge Business Publishers, 2015 21 Purchases Budget Example BC Carts desires to have 20% of the carts needed for the next month's sales in stock at the end of each month. At the beginning of June, 1,800 carts are on hand. Each cart costs $4. Sales are planned to increase 10% per month. BC Carts Purchases Budget For Month of June 2015 Units Sales needs Desired ending inventory Total Less beginning inventory Purchases Sales for July: 9,000 + (9,000 0.10) = 9,900 carts Ending inventory = 9,900 0.20 = 1,980 carts Cambridge Business Publishers, 2015 9,000. 1,980. 10,980. (1,800) 9,180. Dollars $36,000. 7,920. 43,920. (7,200) $36,720. Number of units times the cost per unit of $4 22 Selling Expense Budget Presents the expenses the organization plans to incur in connection with sales and distribution Costs are broken into variable and fixed costs Variable selling costs Developed as a percent of sales or an amount per unit sold Fixed selling costs Often based on an estimate obtained from the sales manager Cambridge Business Publishers, 2015 23 Selling Expense Budget Example BC Carts desires to have 20% of the carts needed for the next month's sales in stock at the end of each month. At the beginning of June, 1,800 carts are on hand. Each cart costs $4. Sales are planned to increase 10% per month. Cambridge Business Publishers, 2015 BC Carts Selling Expense Budget For Month of June 2015 Budgeted sales $90,000 Variable selling expenses Commissions (4%) $3,600 Miscellaneous (1.5%) 1,350 Total variable expenses 4,950 Fixed selling expenses Depreciation 3,500 Advertising 2,000 Miscellaneous 1,200 Total fixed expenses 6,700 Total selling expenses $11,650 Commissions: $90,000 x 0.04 = $3,600 Miscellaneous: $90,000 x 0.015 = $1,350 24 General and Administrative Expense Budget Presents the expenses planned in connection with the general administration of the organization Includes expenses for Compensation Insurance Depreciation Utilities Miscellaneous Most often the costs are fixed Because they do not vary with unit-level cost drivers Cambridge Business Publishers, 2015 25 General and Administrative Expense Budget Example BC Carts estimates the following monthly general and administrative costs: $5,000 for salaries, $800 for insurance, $1,100 for depreciation, $600 for utilities, and $900 for miscellaneous. BC Carts General and Administrative Expense Budget For Month of June 2015 Salaries Insurance Depreciation Utilities Miscellaneous Total general and administrative expenses Cambridge Business Publishers, 2015 $5,000 800 1,100 600 900 $8,400 26 Cash Budget Summarizes all cash receipts and disbursements expected to occur during the budget period Because of issues related to the timing of sales and collections on account Collections on sales may not equal sales revenue Because of issues related to the timing of payments for purchases and other expense items Disbursements may not equal expenses Cash is critical to survival. Cambridge Business Publishers, 2015 27 Cash Receipts Budget Example BC Carts budgeted its June sales at $90,000. It estimates that 40% of sales are cash and 60% are on credit. 30% of credit sales are collected in the month of sale and 70% are collected in the following month. Beginning cash balance is $15,000 and sales during May were $86,000. Sales 40% Cash Sales 60% Credit Sales 30% Collected current month 70% Collected following month Cash Receipts Budget for June 2015 Collections on sales Cash sales Credit sales Current month (30% of credit sales) Prior month (70% of credit sales) Total Cambridge Business Publishers, 2015 $90,000 x 0.40 $36,000 $90,000 x 0.60 x 0.30 = $16,200 16,200 36,120 $88,320 $86,000 x 0.60 x 0.70 = $36,120 28 Cash Disbursements Budget Example BC Carts estimates that 25% of its current month inventory purchases will be paid during the month incurred and 75% are paid in the following month. During May, purchases were $32,000. Budgeted purchases for June are $36,720 (from the purchases budget.) Inventory purchases section of the cash disbursements section of the cash budget: Cash Disbursements Budget for June 2015 Disbursements Purchases Current month (25% of purchases) Prior month (75% of purchases) Total Cambridge Business Publishers, 2015 $36,720 x 0.25 = $9,180 $ 9,180 24,000 $33,180 $32,000 x 0.75 = $24,000 Continued 29 Cash Disbursements Budget Example cont. BC Carts' general and administrative costs were $8,200 during May, and $8,400 during June, $1,100 of each which is depreciation. Income taxes were $15,500 during May. The company pays for selling costs in the month incurred, and 60% of the general and administrative costs in the month incurred with the remaining 40% the following month. Income taxes are taxed at 30% of income before taxes and are paid the month following accrual. Cash Disbursements Budget for June 2015 Selling expenses $ 8,150 General and administrative expenses Current month (60%) $4,380 Prior month (40%) 2,840 Income taxes 15,500 General and administrative expenses = $4,380 0.60 x ($8,400 - $1,100) Cambridge Business Publishers, 2015 $22,720 0.40 x ($8,200 - $1,100) = $2,840 Continued 30 Financing Section of Cash Budget BC Carts' repays $5,000 of the principal on its bank loan on June 30 and December 31, and any accrued interest. Cash Disbursements Budget for June 2015 Short-term financing Loan repayments Interest Net cash used for financing $5,000 750 $5,750 $25,000 x 0.60 x 1/2 Cambridge Business Publishers, 2015 Continued 31 Complete Cash Budget BC Carts Cash Budget For Month of June 2015 Cash balance, beginning Cash receipts section $15,000. Collections on sales Cash sales (40%) $36,000. Credit sales Current month (30% of credit sales) Prior month (70% of credit sales) Cash disbursements section 16,200. 36,120. Total 88,320. Cash available for operations 103,320. Disbursements Purchases Financing section Current month (25% of purchases) Prior month (75% of purchases) Total Cambridge Business Publishers, 2015 Selling expenses 9,180. 24,000. 33,180. 8,150. 32 Budgeted Financial Statements Are pro forma statements that reflect the \"as-if\" effects of the budgeted activities on the actual financial position of organization Reflect the actual results if all budgetary projections are correct Include Budgeted income statement Budgeted balance sheet Cambridge Business Publishers, 2015 33 Budgeted Income Statement Example Beginning inventory totaled $7,200 and ending inventory totaled $7,920. BC Carts Budgeted Income Statement For Month of June 2015 Sales Budget Sales $90,000. Cost of goods sold Beginning inventory Purchases Budget $ 7,200. Purchases 36,720. Cost of merchandise available Ending inventory 43,920. (7,920) Gross profit Other expenses: Selling expenses General and administrative expenses Income from operations Interest expense Cambridge Business Publishers, 2015 (36,000) 54,000. Selling and General & Administrative Budget 11,650. 8,400. 25,000 x 6% x 1/12 30% of income before taxes (20,050) 33,950. (125) 34 Budgeted Income Statement Example Beginning balance sheet amounts at May 31 and where to find information for the June 30 balance sheet: Cash Accounts receivable Inventory Equipment, net Total assets Accounts payable Income taxes payable Accrued expenses $15,000 In addition to the beginning balance sheet: 36,120 7,200 95,000 $153,320 $24,000 Cash budget Cash receipts, sales budgets Purchases budget, income statement Income statement 15,500 2,840 Cash disbursements and purchases budget 625 Income statement and cash disbursements Notes payable 25,000 Income statement and cash disbursements Common stock 22,000 Cash disbursements Retained earnings 63,355 Only the beginning balance sheet Calculated from prior retained earnings and net income Accrued Interest Total liabilities & equities Cambridge Business Publishers, 2015 $153,320 35 Budgeted Balance Sheet BC Carts Budgeted Balance Sheet June 30, 2015 Assets Current assets Cash Accounts receivable Inventory Cash Budget Given $90,000 x 0.60 x 0.70 $33,520 37,800 7,920 $ 79,240 $95,000 - $3,500 - $1,100 Fixed assets Equipment, net 90,400 Total assets $169,640 $36,720 x 0.75 Liabilities and Stockholders' Equity Current liabilities Income Stmt. ($8,400 - $1,100) x 0.40 Accounts payable $27,540 Income taxes payable Accrued expenses 10,148 2,920 Long-term liabilities Notes payable Total liabilities Cambridge Business Publishers, 2015 $ 40,608 Given 20,000 $25,000 - $5,000 $63,355 + $23,678 60,608 36 Finalizing the Budget Before finalizing the budget, two questions must be addressed Is the proposed budget feasible? Cambridge Business Publishers, 2015 Is the proposed budget acceptable? 37 Learning Objective 4 Explain and develop a basic manufacturing budget. Cambridge Business Publishers, 2015 38 Production Budget Additional steps are required to develop master budgets for manufacturing organizations Due to conversion of raw materials into finished goods Must determine production volume To support sales To meet finished goods inventory Cambridge Business Publishers, 2015 39 Budget Assembly for a Manufacturer Cambridge Business Publishers, 2015 40 Production Budget Example BC Carts produces plastic carts and has estimated sales of 9,000 carts for June and 9,900 for July. BC wants to have 10% of the materials needed for the next month's production and 20% of the carts needed for the next month's sales in stock at the end of each month. BC Carts Production Budget For Month of June 2015 Sales in units Desired ending inventory of carts Total cart requirements Less beginning inventory of carts Budgeted production Cambridge Business Publishers, 2015 9,000. 1,980. 10,980. (1,800) 9,180. 0.20 x 9,900 (July sales) 0.20 x 9,000 (June sales) 41 Purchases Budget Example - Resin Assume BC Carts plans to produce 10,098 carts in July. It wants to have 10% of the materials needed for the next month's production in stock at the end of each month. Each cart requires 6 pounds of plastic resin and two wheels. At June 1, BC had 5,508 pounds of resin and 1,836 wheels on hand. Wheels cost $0.30 each and resin costs $0.21 per pound. BC Carts Purchases Budget For Month of June 2015 Resin: Pounds of resin needs (6 lbs. x 9,180 carts) Desired ending resin inventory Total resin requirements in pounds Less beginning resin inventory Resin purchases in pounds Cambridge Business Publishers, 2015 55,080. 6,059. 61,139. (5,508) 55,631. 6 x 10,098 x 0.10 Given Continued 42 Purchases Budget Example - Wheels BC Carts plans to produce 10,098 carts in July. It wants to have 10% of the materials needed for the next month's production in stock at the end of each month. Each cart requires 6 pounds of plastic resin and two wheels. At June 1, BC had 5,508 pounds of resin and 1,836 wheels on hand. Wheels cost $0.30 each and resin costs $0.21 per pound. Wheels: Number of wheels needed (2 x 9,180 carts) Desired ending wheel inventory Total wheel requirements Less beginning wheel inventory Wheels purchases Cambridge Business Publishers, 2015 18,360. 2,020. 20,380. (1,836) 18,544. 2 x 10,098 x 0.10 Given Continued 43 Purchases Budget Example Complete materials purchases budget: BC Carts Purchases Budget For Month of June 2015 Resin: Pounds of resin needs (6 lbs. x 9,180 carts) Desired ending resin inventory Total resin requirements in pounds Less beginning resin inventory Resin purchases in pounds 55,080. 6,059. 61,139. (5,508) 55,631. Wheels: Number of wheels needed (2 x 9,180 carts) Desired ending wheel inventory Total wheel requirements Less beginning wheel inventory Wheels purchases 18,360. 2,020. 20,380. (1,836) 18,544. Purchases (Dollars): Resin at $0.21 per pound Wheels at $0.30 each Total purchases in dollars Cambridge Business Publishers, 2015 $11,683. 5,563. $17,246. $0.21 x 55,631 = $11,683 $0.30 x 18,544 = $5,563 44 Manufacturing Cost Budget Example BC Carts have the following costs per unit: Direct materials Resin: Wheels: Direct labor Variable overhead Fixed overhead 6 pounds @ $0.21 a pound 2 @ $0.30 each 0.075 hrs. @ $10 per hour $0.43 per unit $8,262 BC Carts Manufacturing Cost Budget For Month of June 2015 Direct materials Resin used in production (9,180 6 lbs. $0.21) Wheels used in production (9,180 2 $0.30) Total direct materials Direct labor (9,180 0.075 $10) $11,567 5,508 17,075 6,885 Manufacturing overhead Variable ($0.43 per unit) Fixed Total manufacturing costs 3,947 8,262 $36,169 Cambridge Business Publishers, 2015 45 Learning Objective 5 Describe the relationship between budget development manager behavior. Cambridge Business Publishers, 2015 and 46 Employee Participation Budgets used to promote productive employee behavior directed toward meeting goals Two approaches to employee involvement Top-Down Budget Known also as an imposed budget Top management identifies primary goals and objectives and communicates to lower management Cambridge Business Publishers, 2015 Bottom-Up Budget Known also as a participative budget Managers at all levels are involved in budget preparation Ensures that employees understand their roles in meeting goals 47 Budgetary Slack The tendency of some managers to intentionally understate revenues or overstate expenses Why might managers do this? To make it easier to obtain favorable performance reviews A disadvantage of participative budgeting Cambridge Business Publishers, 2015 48 Budgeting Periods Fixed-length periods Most companies use a one-year budget period; some shorter and longer Life-cycle budgeting Developing a budget for a project's entire life Continuous budgeting Based on a moving time frame When one period passes, one more period is added Sometimes called a rolling budget Managers forced to focus on future Cambridge Business Publishers, 2015 49 Forecasts Budget preparation requires forecasts Based on a variety of factors Historical trends Product innovation Economic conditions Industry conditions Company's strategic position for competing Forecast Industry forecast is often the starting point for forecasting. Cambridge Business Publishers, 2015 50 Types of Forecasts Used in Budgeting The collection period for sales on account Percent of uncollectible sales on account Cost of materials, supplies, utilities, etc. Employee turnover Time required to perform activities. Interest rates Forecast Development time for new products or services Cambridge Business Publishers, 2015 51 Ethics Falsifying budgets is grounds for dismissal Building slack into budgets Padding the budget Including unneeded expense categories in budgets Subsequently using these to pad other budget categories Unethical tactics in performance reporting Misclassification of expenses Overstating revenues Understating expenses Postponing or accelerating recording of activities Cambridge Business Publishers, 2015 52 Open Book Management Obtain employee support for the budget The sharing of financial and related information with employees Teaching employees to understand financial numbers Encouraging employees to use the information in their work Sharing financial results with employees Bonus program Properly used, an operating budget is an effective mechanism for motivating employees to higher levels of performance and productivity. Cambridge Business Publishers, 2015 53 The End MANAGERIAL ACCOUNTING Al L. Hartgraves Wayne J. Morse CHAPTER 9 Operational Budgeting and Profit Planning Cambridge Business Publishers, 2015 7e Learning Objective 1 Discuss the importance of budgets. Cambridge Business Publishers, 2015 2 Reasons for Budgeting Budgets Require people to think about the future Move a company from a reactive to a proactive style of management Improve communication and coordination Provide a guide to action Provide a basis of performance evaluation Aid in risk management Cambridge Business Publishers, 2015 3 Management by Exception Management compares results with budgeted amounts Attention is directed only to those activities not proceeding as planned Saves time by not requiring management to examine every past activity Cambridge Business Publishers, 2015 4 Risk Management RISK is the danger that things will not go according to plan. Risk can be associated with positive impact: Increase in sales volume Increase in selling prices Risk is more commonly associated with negative impact: Work stoppage at a key supplier Fire Hackers Cambridge Business Publishers, 2015 5 Aid in Risk Management Risk management, or enterprise risk management, is the process of identifying, evaluating, and planning possible responses to risks. Useful tools to manage risk: An organization's budget model can: Evaluate the financial impact of risk Determine best response from a financial perspective Performance evaluation procedures, if completed on a timely basis, assist in monitoring risk Cambridge Business Publishers, 2015 6 Aid in Risk Management RISK IDENTIFICATION Identify possible risks and their implications. RISK ASSESSMENT AND QUANTIFICATION Predict each risk's probability and impact, including financial impacts. Classify risks by importance to the organization. RISK RESPONSE Select a response to each risk: Avoid risk, e.g. do not accept project Transfer risk, e.g. purchase insurance Mitigate risk, e.g. contingency plans Accept risk, e.g. risk low, risk will not have a significant impact, or risk unavoidable RISK MONITORING Develop procedures to continuously monitor important risks with the goal of facilitating a timely response. Cambridge Business Publishers, 2015 Alan J. Chilcott, \"Risk Management - A Developing Field of Study and Application,\" Cost Engineering September 9, 2010, pp. 9-16; Neville Turbit, \"Basics of Managing Risk,\" The Project Perfect White Paper Collection, www.projectperfect.com.au. 7 Learning Objective 2 Describe basic approaches to budgeting. Cambridge Business Publishers, 2015 8 Approaches to Budgeting Output/Input Approach Activity-Based Approach Incremental Approach Minimum Level Approach Cambridge Business Publishers, 2015 9 Output/Input Approach to Budgeting Budgets physical inputs and costs as a function of planned input (unit-level) activities Often used for service, merchandising, manufacturing and distribution activities Works effectively with activities that have defined relationships between effort and accomplishment Starts with the planned outputs Works backward to budget the inputs Cambridge Business Publishers, 2015 10 Activity-Based Approach to Budgeting Type of output/input method Reduces distortions in the transformation Emphasis placed on the expected costs of the planned activities that will be consumed by the cost objective How it works Overhead costs are budgeted based on anticipated consumption of activities Consumption of activity cost drive determined Budgeted activity cost based on units of activity and related cost per unit of activity cost driver Cambridge Business Publishers, 2015 11 Incremental Approach to Budgeting Budgets costs for a coming period as a dollar or percentage change from the amount budgeted for a previous period Used when relationship between inputs and outputs is weak or nonexistent Widely used in government and not-for-profit organizations Advantage Simplifies the budget process by considering only the increments Cambridge Business Publishers, 2015 12 Minimum Level Approach to Budgeting Establishes a base amount for budget items and requires explanation or justification for any budgeted amount above the minimum base Corrects deficiencies in the incremental approach Questions the necessity for costs included in the base budget of the incremental approach Very time consuming Cambridge Business Publishers, 2015 13 Variations of the Minimum Level Approach Zero-based budgeting Every dollar of expenditures must be justified Breaks total budget into program packages wit related costs Budgeting for objectives Combines elements of activity-based and zerobased budgeting with a need to live within fixed financial constraints Cambridge Business Publishers, 2015 14 Learning Objective 3 Explain the relations among elements of a master budget and develop a basic budget. Cambridge Business Publishers, 2015 15 The Master Budget The culmination of the budgeting process Groups all budgets and supporting schedules together Coordinates all financial and operational activities placing them into an organization-wide set of budgets for a givenGoal period A Major time Ensure the smooth functioning of a business throughout the budget period and the organization's operation cycle Cambridge Business Publishers, 2015 16 Operating Cycle of a Manufacturing or Merchandising Operation Involves the conversion of cash into other assets, which are intended to produce revenues in excess of their costs Cambridge Business Publishers, 2015 17 Budget Process for a Merchandiser Sales Budget Purchases Budget Special Budgets Cambridge Business Publishers, 2015 Selling Expense Budget General & Administrative Expense Budget Cash Budget Pro Forma Statements Income Statement Balance Sheet 18 Sales Budget Starting point for the budgeting process Includes a forecast of sales revenue Normally includes a forecast of unit sales Best available information used to forecast Future market conditions Merchandise available Promotion and advertising plans Expected pricing policies Cambridge Business Publishers, 2015 19 Sales Budget Example BC Carts distributes plastic carts to retailers. For June, estimated sales are 9,000 carts at a selling price of $10 each with an estimated cost of $4 per cart. BC Carts Sales Budget For Month of June 2015 Sales in units Selling price per unit Sales revenue 9,000 $ 10.00 $90,000 Budget revenue for June is $90,000 Cambridge Business Publishers, 2015 20 Purchases Budget Indicates the merchandise to be purchased to meet sales needs and ending inventory requirements Often referred to as 'merchandise purchases budget' Considers Budgeted sales Desired ending inventory Planned beginning inventory Cambridge Business Publishers, 2015 21 Purchases Budget Example BC Carts desires to have 20% of the carts needed for the next month's sales in stock at the end of each month. At the beginning of June, 1,800 carts are on hand. Each cart costs $4. Sales are planned to increase 10% per month. BC Carts Purchases Budget For Month of June 2015 Units Sales needs Desired ending inventory Total Less beginning inventory Purchases Sales for July: 9,000 + (9,000 0.10) = 9,900 carts Ending inventory = 9,900 0.20 = 1,980 carts Cambridge Business Publishers, 2015 9,000. 1,980. 10,980. (1,800) 9,180. Dollars $36,000. 7,920. 43,920. (7,200) $36,720. Number of units times the cost per unit of $4 22 Selling Expense Budget Presents the expenses the organization plans to incur in connection with sales and distribution Costs are broken into variable and fixed costs Variable selling costs Developed as a percent of sales or an amount per unit sold Fixed selling costs Often based on an estimate obtained from the sales manager Cambridge Business Publishers, 2015 23 Selling Expense Budget Example BC Carts desires to have 20% of the carts needed for the next month's sales in stock at the end of each month. At the beginning of June, 1,800 carts are on hand. Each cart costs $4. Sales are planned to increase 10% per month. Cambridge Business Publishers, 2015 BC Carts Selling Expense Budget For Month of June 2015 Budgeted sales $90,000 Variable selling expenses Commissions (4%) $3,600 Miscellaneous (1.5%) 1,350 Total variable expenses 4,950 Fixed selling expenses Depreciation 3,500 Advertising 2,000 Miscellaneous 1,200 Total fixed expenses 6,700 Total selling expenses $11,650 Commissions: $90,000 x 0.04 = $3,600 Miscellaneous: $90,000 x 0.015 = $1,350 24 General and Administrative Expense Budget Presents the expenses planned in connection with the general administration of the organization Includes expenses for Compensation Insurance Depreciation Utilities Miscellaneous Most often the costs are fixed Because they do not vary with unit-level cost drivers Cambridge Business Publishers, 2015 25 General and Administrative Expense Budget Example BC Carts estimates the following monthly general and administrative costs: $5,000 for salaries, $800 for insurance, $1,100 for depreciation, $600 for utilities, and $900 for miscellaneous. BC Carts General and Administrative Expense Budget For Month of June 2015 Salaries Insurance Depreciation Utilities Miscellaneous Total general and administrative expenses Cambridge Business Publishers, 2015 $5,000 800 1,100 600 900 $8,400 26 Cash Budget Summarizes all cash receipts and disbursements expected to occur during the budget period Because of issues related to the timing of sales and collections on account Collections on sales may not equal sales revenue Because of issues related to the timing of payments for purchases and other expense items Disbursements may not equal expenses Cash is critical to survival. Cambridge Business Publishers, 2015 27 Cash Receipts Budget Example BC Carts budgeted its June sales at $90,000. It estimates that 40% of sales are cash and 60% are on credit. 30% of credit sales are collected in the month of sale and 70% are collected in the following month. Beginning cash balance is $15,000 and sales during May were $86,000. Sales 40% Cash Sales 60% Credit Sales 30% Collected current month 70% Collected following month Cash Receipts Budget for June 2015 Collections on sales Cash sales Credit sales Current month (30% of credit sales) Prior month (70% of credit sales) Total Cambridge Business Publishers, 2015 $90,000 x 0.40 $36,000 $90,000 x 0.60 x 0.30 = $16,200 16,200 36,120 $88,320 $86,000 x 0.60 x 0.70 = $36,120 28 Cash Disbursements Budget Example BC Carts estimates that 25% of its current month inventory purchases will be paid during the month incurred and 75% are paid in the following month. During May, purchases were $32,000. Budgeted purchases for June are $36,720 (from the purchases budget.) Inventory purchases section of the cash disbursements section of the cash budget: Cash Disbursements Budget for June 2015 Disbursements Purchases Current month (25% of purchases) Prior month (75% of purchases) Total Cambridge Business Publishers, 2015 $36,720 x 0.25 = $9,180 $ 9,180 24,000 $33,180 $32,000 x 0.75 = $24,000 Continued 29 Cash Disbursements Budget Example cont. BC Carts' general and administrative costs were $8,200 during May, and $8,400 during June, $1,100 of each which is depreciation. Income taxes were $15,500 during May. The company pays for selling costs in the month incurred, and 60% of the general and administrative costs in the month incurred with the remaining 40% the following month. Income taxes are taxed at 30% of income before taxes and are paid the month following accrual. Cash Disbursements Budget for June 2015 Selling expenses $ 8,150 General and administrative expenses Current month (60%) $4,380 Prior month (40%) 2,840 Income taxes 15,500 General and administrative expenses = $4,380 0.60 x ($8,400 - $1,100) Cambridge Business Publishers, 2015 $22,720 0.40 x ($8,200 - $1,100) = $2,840 Continued 30 Financing Section of Cash Budget BC Carts' repays $5,000 of the principal on its bank loan on June 30 and December 31, and any accrued interest. Cash Disbursements Budget for June 2015 Short-term financing Loan repayments Interest Net cash used for financing $5,000 750 $5,750 $25,000 x 0.60 x 1/2 Cambridge Business Publishers, 2015 Continued 31 Complete Cash Budget BC Carts Cash Budget For Month of June 2015 Cash balance, beginning Cash receipts section $15,000. Collections on sales Cash sales (40%) $36,000. Credit sales Current month (30% of credit sales) Prior month (70% of credit sales) Cash disbursements section 16,200. 36,120. Total 88,320. Cash available for operations 103,320. Disbursements Purchases Financing section Current month (25% of purchases) Prior month (75% of purchases) Total Cambridge Business Publishers, 2015 Selling expenses 9,180. 24,000. 33,180. 8,150. 32 Budgeted Financial Statements Are pro forma statements that reflect the \"as-if\" effects of the budgeted activities on the actual financial position of organization Reflect the actual results if all budgetary projections are correct Include Budgeted income statement Budgeted balance sheet Cambridge Business Publishers, 2015 33 Budgeted Income Statement Example Beginning inventory totaled $7,200 and ending inventory totaled $7,920. BC Carts Budgeted Income Statement For Month of June 2015 Sales Budget Sales $90,000. Cost of goods sold Beginning inventory Purchases Budget $ 7,200. Purchases 36,720. Cost of merchandise available Ending inventory 43,920. (7,920) Gross profit Other expenses: Selling expenses General and administrative expenses Income from operations Interest expense Cambridge Business Publishers, 2015 (36,000) 54,000. Selling and General & Administrative Budget 11,650. 8,400. 25,000 x 6% x 1/12 30% of income before taxes (20,050) 33,950. (125) 34 Budgeted Income Statement Example Beginning balance sheet amounts at May 31 and where to find information for the June 30 balance sheet: Cash Accounts receivable Inventory Equipment, net Total assets Accounts payable Income taxes payable Accrued expenses $15,000 In addition to the beginning balance sheet: 36,120 7,200 95,000 $153,320 $24,000 Cash budget Cash receipts, sales budgets Purchases budget, income statement Income statement 15,500 2,840 Cash disbursements and purchases budget 625 Income statement and cash disbursements Notes payable 25,000 Income statement and cash disbursements Common stock 22,000 Cash disbursements Retained earnings 63,355 Only the beginning balance sheet Calculated from prior retained earnings and net income Accrued Interest Total liabilities & equities Cambridge Business Publishers, 2015 $153,320 35 Budgeted Balance Sheet BC Carts Budgeted Balance Sheet June 30, 2015 Assets Current assets Cash Accounts receivable Inventory Cash Budget Given $90,000 x 0.60 x 0.70 $33,520 37,800 7,920 $ 79,240 $95,000 - $3,500 - $1,100 Fixed assets Equipment, net 90,400 Total assets $169,640 $36,720 x 0.75 Liabilities and Stockholders' Equity Current liabilities Income Stmt. ($8,400 - $1,100) x 0.40 Accounts payable $27,540 Income taxes payable Accrued expenses 10,148 2,920 Long-term liabilities Notes payable Total liabilities Cambridge Business Publishers, 2015 $ 40,608 Given 20,000 $25,000 - $5,000 $63,355 + $23,678 60,608 36 Finalizing the Budget Before finalizing the budget, two questions must be addressed Is the proposed budget feasible? Cambridge Business Publishers, 2015 Is the proposed budget acceptable? 37 Learning Objective 4 Explain and develop a basic manufacturing budget. Cambridge Business Publishers, 2015 38 Production Budget Additional steps are required to develop master budgets for manufacturing organizations Due to conversion of raw materials into finished goods Must determine production volume To support sales To meet finished goods inventory Cambridge Business Publishers, 2015 39 Budget Assembly for a Manufacturer Cambridge Business Publishers, 2015 40 Production Budget Example BC Carts produces plastic carts and has estimated sales of 9,000 carts for June and 9,900 for July. BC wants to have 10% of the materials needed for the next month's production and 20% of the carts needed for the next month's sales in stock at the end of each month. BC Carts Production Budget For Month of June 2015 Sales in units Desired ending inventory of carts Total cart requirements Less beginning inventory of carts Budgeted production Cambridge Business Publishers, 2015 9,000. 1,980. 10,980. (1,800) 9,180. 0.20 x 9,900 (July sales) 0.20 x 9,000 (June sales) 41 Purchases Budget Example - Resin Assume BC Carts plans to produce 10,098 carts in July. It wants to have 10% of the materials needed for the next month's production in stock at the end of each month. Each cart requires 6 pounds of plastic resin and two wheels. At June 1, BC had 5,508 pounds of resin and 1,836 wheels on hand. Wheels cost $0.30 each and resin costs $0.21 per pound. BC Carts Purchases Budget For Month of June 2015 Resin: Pounds of resin needs (6 lbs. x 9,180 carts) Desired ending resin inventory Total resin requirements in pounds Less beginning resin inventory Resin purchases in pounds Cambridge Business Publishers, 2015 55,080. 6,059. 61,139. (5,508) 55,631. 6 x 10,098 x 0.10 Given Continued 42 Purchases Budget Example - Wheels BC Carts plans to produce 10,098 carts in July. It wants to have 10% of the materials needed for the next month's production in stock at the end of each month. Each cart requires 6 pounds of plastic resin and two wheels. At June 1, BC had 5,508 pounds of resin and 1,836 wheels on hand. Wheels cost $0.30 each and resin costs $0.21 per pound. Wheels: Number of wheels needed (2 x 9,180 carts) Desired ending wheel inventory Total wheel requirements Less beginning wheel inventory Wheels purchases Cambridge Business Publishers, 2015 18,360. 2,020. 20,380. (1,836) 18,544. 2 x 10,098 x 0.10 Given Continued 43 Purchases Budget Example Complete materials purchases budget: BC Carts Purchases Budget For Month of June 2015 Resin: Pounds of resin needs (6 lbs. x 9,180 carts) Desired ending resin inventory Total resin requirements in pounds Less beginning resin inventory Resin purchases in pounds 55,080. 6,059. 61,139. (5,508) 55,631. Wheels: Number of wheels needed (2 x 9,180 carts) Desired ending wheel inventory Total wheel requirements Less beginning wheel inventory Wheels purchases 18,360. 2,020. 20,380. (1,836) 18,544. Purchases (Dollars): Resin at $0.21 per pound Wheels at $0.30 each Total purchases in dollars Cambridge Business Publishers, 2015 $11,683. 5,563. $17,246. $0.21 x 55,631 = $11,683 $0.30 x 18,544 = $5,563 44 Manufacturing Cost Budget Example BC Carts have the following costs per unit: Direct materials Resin: Wheels: Direct labor Variable overhead Fixed overhead 6 pounds @ $0.21 a pound 2 @ $0.30 each 0.075 hrs. @ $10 per hour $0.43 per unit $8,262 BC Carts Manufacturing Cost Budget For Month of June 2015 Direct materials Resin used in production (9,180 6 lbs. $0.21) Wheels used in production (9,180 2 $0.30) Total direct materials Direct labor (9,180 0.075 $10) $11,567 5,508 17,075 6,885 Manufacturing overhead Variable ($0.43 per unit) Fixed Total manufacturing costs 3,947 8,262 $36,169 Cambridge Business Publishers, 2015 45 Learning Objective 5 Describe the relationship between budget development manager behavior. Cambridge Business Publishers, 2015 and 46 Employee Participation Budgets used to promote productive employee behavior directed toward meeting goals Two approaches to employee involvement Top-Down Budget Known also as an imposed budget Top management identifies primary goals and objectives and communicates to lower management Cambridge Business Publishers, 2015 Bottom-Up Budget Known also as a participative budget Managers at all levels are involved in budget preparation Ensures that employees understand their roles in meeting goals 47 Budgetary Slack The tendency of some managers to intentionally understate revenues or overstate expenses Why might managers do this? To make it easier to obtain favorable performance reviews A disadvantage of participative budgeting Cambridge Business Publishers, 2015 48 Budgeting Periods Fixed-length periods Most companies use a one-year budget period; some shorter and longer Life-cycle budgeting Developing a budget for a project's entire life Continuous budgeting Based on a moving time frame When one period passes, one more period is added Sometimes called a rolling budget Managers forced to focus on future Cambridge Business Publishers, 2015 49 Forecasts Budget preparation requires forecasts Based on a variety of factors Historical trends Product innovation Economic conditions Industry conditions Company's strategic position for competing Forecast Industry forecast is often the starting point for forecasting. Cambridge Business Publishers, 2015 50 Types of Forecasts Used in Budgeting The collection period for sales on account Percent of uncollectible sales on account Cost of materials, supplies, utilities, etc. Employee turnover Time required to perform activities. Interest rates Forecast Development time for new products or services Cambridge Business Publishers, 2015 51 Ethics Falsifying budgets is grounds for dismissal Building slack into budgets Padding the budget Including unneeded expense categories in budgets Subsequently using these to pad other budget categories Unethical tactics in performance reporting Misclassification of expenses Overstating revenues Understating expenses Postponing or accelerating recording of activities Cambridge Business Publishers, 2015 52 Open Book Management Obtain employee support for the budget The sharing of financial and related information with employees Teaching employees to understand financial numbers Encouraging employees to use the information in their work Sharing financial results with employees Bonus program Properly used, an operating budget is an effective mechanism for motivating employees to higher levels of performance and productivity. Cambridge Business Publishers, 2015 53 The End