Question

AGENDA: PROFIT PLANNING (BUDGETING)

Building a master budget.

1. Sales budget

2. Production budget

3. Direct materials budget

4. Direct labor budget

5. Manufacturing overhead budget

6. Ending finished goods inventory budget

7. Selling and administrative expenses budget

8. Cash budget

9. Budgeted income statement

10. Budgeted balance sheet

OVERVIEW OF BUDGETING

A budget is a detailed plan for acquiring and using financial and other

resources over a specified period. Budgeting involves two stages:

• Planning: Developing objectives and preparing various detailed

budgets to achieve those objectives.

• Control: The steps taken by management to attain the objectives set

down at the planning stage.

PURPOSES OF BUDGETING

• Budgets communicate management’s plans throughout the

organization.

• Budgeting forces managers to give planning top priority.

• Budgets provide a means of allocating resources to their most effective

uses.

• Budgeting uncovers potential bottlenecks.

• Budgeting coordinates the activities of the entire organization.

• Budgeting provides goals that serve as benchmarks for evaluating

subsequent performance.

COMPREHENSIVE BUDGETING EXAMPLE

Royal Company is preparing budgets for the second quarter ending June

30.

• Budgeted sales of the company’s only product for the next five months

are:

April ......

20,000 units

May .......

50,000 units

June ......

30,000 units

July

.......

25,00

0 units

August ...

15,000 units

• The selling price is $10 per unit.

• The following elements of the master budget will be prepared in this

example:

1. Sales budget (with a schedule of expected cash collections).

2. Production budget.

3. Direct materials budget (with a schedule of expected cash

disbursements for materials).

4. Direct labor budget.

5. Manufacturing overhead budget.

6. Ending finished goods inventory budget.

7. Selling and administrative expense budget.

8. Cash budget.

9. Budgeted income statement.

10. Budgeted balance sheet.

SALES BUDGET

April

May

June Quarter

Budgeted sales (units)

...

20,000

50,000

30,000

100,000

Selling price per unit ......

× $10

× $10

× $10

× $10

Total sales ....................

$200,000

$500,000

$300,000

$1,000,000

SCHEDULE OF EXPECTED CASH COLLECTIONS

Additional data:

• All sales are on account.

• The company collects 70% of these credit sales in the month of the sale;

25% are collected in the month following sale; and the remaining 5%

are uncollectible.

• The accounts receivable balance on March 31 was $30,000. All of this

balance was collectible.

April

May

June Quarter

Accounts receivable

beginning balance ..........

$ 30,000

$ 30,000

April sales

70% × $200,000 ...........

140,000

140,000

25% × $200,000 ...........

$ 50,000

50,000

May sales

70%

×

$500,000

...........

350,000

350,000

25% × $500,000 ...........

$125,000

125,000

June sales

70% × $300,000 ...........

210,000

210,000

Total cash collections ........

$170,000

$400,000

$335,000

$905,000

25% of the $300,000 will be your 6/30 AR balance.

PRODUCTION BUDGET

Additional data:

• The company desires to have inventory on hand at the end of each

month equal to 20% of the following month’s budgeted unit sales.

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

April

May

June

July

Budgeted sales ......................

20,000

50,000

30,000

25,000

Add desired ending inventory ..

10,000

6,000

5,000

3,000*

Total needs ............................

30,000

56,000

35,000

28,000

Less beginning inventory .........

4,000

10,000

6,000

5,000

Required production

...............

26,000

46,000

29,000

23,000

* Budgeted sales in August = 15,000 units.

Desired ending inventory in July = 15,000 units × 20% = 3,000 units.

6/30 inventory of finished goods is the 5,000 units

DIRECT MATERIALS BUDGET

Additional data:

• 5 pounds of material are required per unit of product.

• Management desires to have materials on hand at the end of each

month equal to 10% of the following month’s production needs.

• The beginning materials inventory was 13,000 pounds.

• The material costs $0.40 per pound.

April May June Quarter

Required production in units ....

26,000

46,000

29,000

101,000

Raw materials per unit (pounds)

× 5

× 5

× 5

× 5

Production needs (pounds)

.......

130,000

230,000

145,000

505,000

Add desired ending inventory

(pounds)* .............................

23,000

14,500

11,500

11,500

Total needs (pounds) ................

153,000

244,500

156,500

516,500

Less beginning inventory

(pounds) ...............................

13,000

23,000

14,500

13,000

Raw materials to be purchased

(pounds) ...............................

140,000

221,500

142,000

503,500

Cost of raw materials to be

purchased at $0.40 per pound

$56,000

$88,600

$56,800

$201,400

* For June: 23,000 units produced in July × 5 pounds per unit = 115,000

pounds; 115,000 pounds × 10% = 11,500 pounds

June 30 raw materials inventory 11,500 pounds

SCHEDULE OF EXPECTED CASH DISBURSEMENTS FOR

MATERIAL

Additional data:

• 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 discounts are given for early payment.

• The accounts payable balance on March 31 was $12,000.

April May June Quarter

Accounts payable beginning

balance ...........................

$12,000

$ 12,000

April purchases:

50% × $56,000 ...............

28,000

28,000

50% × $56,000 ...............

$28,000

28,000

May purchases:

50% × $88,600 ...............

44,300

44,300

50% × $88,600 ...............

$44,300

44,300

June purchases:

50% × $56,800 ...............

28,400

28,400

Total cash disbursements

for materials ....................

$40,000

$72,300

$72,700

$185,000

The June 30 AP will be the other half of the $56,800 ($28,400).

DIRECT LABOR BUDGET

Additional data:

• Each unit produced requires 0.05 hour of direct labor.

• Each hour of direct labor costs the company $10.

• Management fully adjusts the workforce to the workload each month.

April

May

June

Quarter

Required production ........

26,000

46,000

29,000

101,000

Direct labor-hours per unit

× 0.05

× 0.05

× 0.05

× 0.05

Total direct labor–hours

needed ..........................

1,300

2,300

1,450

5,050

Direct labor cost per hour

.

×

$10

×

$10

×

$10

×

$10

Total direct labor cost .......

$13,000

$23,000

$14,500

$50,500

Note: Many companies do not fully adjust their direct labor workforce every

month and in such companies direct labor behaves more like a fixed cost,

with additional cost if overtime is necessary.

MANUFACTURING OVERHEAD BUDGET

Additional data:

• Variable manufacturing overhead is $20 per direct labor-hour.

• Fixed manufacturing overhead is $50,500 per month. This includes

$20,500 in depreciation, which is not a cash outflow.

April

May

June

Quarter

Budgeted direct labor-hours ....

1,300

2,300

1,450

5,050

Variable manufacturing

overhead rate ......................

× $20

× $20

× $20

× $20

Variable manufacturing

overhead .............................

$26,000

$46,000

$29,000

$101,000

Fixed manufacturing overhead

50,500

50,500

50,500

151,500

Total manufacturing overhead .

76,500

96,500

79,500

252,500

Less depreciation ....................

20,500

20,500

20,500

61,500

Cash disbursements for

manufacturing overhead .......

$56,000

$76,000

$59,000

$191,000

ENDING FINISHED GOODS INVENTORY BUDGET

Additional data:

• Royal Company uses absorption costing in its budgeted income

statement and balance sheet.

• Manufacturing overhead is applied to units of product on the basis of

direct labor-hours.

• The company has no work in process inventories.

Computation of absorption unit product cost:

Quantity

Cost

Total

Direct materials .............

5

pounds $0.40

per pound $2.00

Direct labor ...................

0.05

hours $10.00

per hour 0.50

Manufacturing overhead .

0.05

hours $50.00

per hour* 2.50

Unit product cost

...........

$5.00

*

Total manufacturing overhead

Predetermined

=

overhead rate

Total direct labor hours

$252,500

=

= $50.00 per hour

5,050 hours

Budgeted ending finished goods inventory:

Ending finished goods inventory in units ...............

5,000

Unit product cost [see above]

..............................

×

$5

Ending finished goods inventory in dollars ............

$25,000

SELLING AND ADMINISTRATIVE EXPENSE BUDGET

Additional data:

• Variable selling and administrative expenses are $0.50 per unit

sold

.

• Fixed selling and administrative expenses are $70,000 per month and

include $10,000 in depreciation.

April

May

June

Quarter

Budgeted sales in units .......

20,000

50,000

30,000

100,000

Variable selling and

administrative expense

per unit ............................

× $0.50

× $0.50

× $0.50

× $0.50

Variable selling and

administrative expense ......

$10,000

$25,000

$15,000

$ 50,000

Fixed selling and

administrative expense ......

70,000

70,000

70,000

210,000

Total selling and

administrative expense ......

80,000

95,000

85,000

260,000

Less depreciation

.................

10,000

10,000

10,000

30,000

Cash disbursements for

selling and administrative

expenses ..........................

$70,000

$85,000

$75,000

$230,000

CASH BUDGET

Additional data:

1. A line of credit is available at a local bank that allows the company to

borrow up to $75,000.

a. All borrowing occurs at the beginning of the month, and all

repayments occur at the end of the month.

b. The interest rate is 1% per month.

c. The company does not have to make any payments until the end

of the quarter.

2. Royal Company desires a cash balance of at least $30,000 at the end

of each month. The cash balance at the beginning of April was

$40,000.

3. Cash dividends of $51,000 are to be paid to stockholders in April.

4. Equipment purchases of $143,700 are scheduled for May and $48,800

for June. This equipment will be installed and tested during the second

quarter and will not become operational until July, when depreciation

charges will commence.

CASH BUDGET

Royal Company

Cash Budget

For the Quarter Ending June 30

April May June Quarter

Cash balance, beginning .......

$ 40,000 $ 30,000

$ 30,000 $ 40,000

Add receipts:

Cash

collections

....................

170,000

400,000

335,000

905,000

Total cash available ..............

210,000

430,000

365,000

945,000

Less disbursements:

Direct materials

....................

40,000 72,300

72,700 185,000

Direct labor

...........................

13,000 23,000

14,500 50,500

Manufacturing overhead

....

56,000 76,000

59,000 191,000

Selling & administrative

.......

70,000 85,000

75,000 230,000

Equipment purchases .........

0 143,700

48,800 192,500

Dividends

..........................

51,000

0

0

51,000

Total disbursements .............

230,000

400,000

270,000

900,000

Excess (deficiency) of cash

available over

disbursements ...................

(20,000)

30,000

95,000

45,000

Financing:

Borrowings ........................

50,000

0

0 50,000

Repayments ......................

0

0

(50,000)

(50,000)

Interest* ...........................

0

0

( 1,500)

( 1,500)

Total financing .....................

50,000

0

(51,500)

( 1,500)

Cash balance, ending ............

$ 30,000

$ 30,000

$ 43,500

$ 43,500

* $50,000 × 1% × 3 = $1,500.

BEGINNING BALANCE SHEET

Royal Company

Balance Sheet

March 31

Current assets:

Cash ...............................................

$ 40,000

(a)

Accounts receivable..........................

30,000

(b)

Raw materials inventory ...................

5,200

(c)

Finished goods inventory

..................

20,000

(d)

$

95,200

Plant and equipment:

Land ...............................................

400,000

(e)

Buildings and equipment ..................

1,610,000

(f)

Accumulated depreciation .................

(750,000)

(g)

1,260,000

Total assets

................................

........

$1,355,200

Liabilities:

Accounts payable .............................

$ 12,000

(h)

Stockholders’ equity:

Common stock .................................

$ 200,000

(i)

Retained earnings ............................

1,143,200

(j)

1,343,200

Total liabilities and stockholders’ equity

$1,355,200

(a)

Given

(f)

Given

(b)

Given

(g)

Given

(c) Given

(h)

See

MATERIALS

DISBURSE-

MENTS

(d)

Given

(i)

Given

(e)

Given

(j)

Given

Prepare a budgeted income statement for the three months ended in June 30 and budgeted balance sheet dated June 30.

Answer 1