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Chapter 21

Budgeting
Accounting, 21st Edition
Warren Reeve Fess

© Copyright 2004 South-Western, a division


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Objectives
Objectives
1. Describe budgeting, its objectives, and its impact on
After
human behavior.After studying
studying this
this
2. Describe the basic elements of the budget process,
chapter,
chapter, you
you should
should
the two major types of budgeting, and the use of
be
be able
computers in budgeting. able to:
to:
3. Describe the master budget for a manufacturing
business.
4. Prepare the basic income statement budgets for a
manufacturing business.
5. Prepare balance sheet budgets for a manufacturing
business.
Nature
Nature and
and Objectives
Objectives of
of Budgeting
Budgeting
Savings
8%
Entertainment Housing
6% 30%

Transportation
15%

Estimated
portion of Clothing
Utilities
your total 7%
5%
monthly Other
income that 4% Food
should be 20%
Medical
budgeted 5%
Nature
Nature and
and Objectives
Objectives of
of Budgeting
Budgeting
Objectives of Budgeting
• Establishing specific goals
• Executing plans to achieve the goals
• Periodically comparing actual results to the goals

Feedback

CONTROLLIN
PLANNING DIRECTING
G
Nature
Nature and
and Objectives
Objectives of
of Budgeting
Budgeting

Human Behavior and Budgeting


Setting budget goals too tightly
Setting budget goals too loosely
Setting conflicting budget goals
Nature
Nature and
and Objectives
Objectives of
of Budgeting
Budgeting

Goal conflict occurs


when individual self-
interest differs from
business objectives.

A student’s question, “Will this be on the


test?” is evidence of goal conflict.
Continuous
Continuous Budgeting
Budgeting
One-Year Budget

Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec. Jan.
2006 2006 2006 2006 2006 2998 2006 2006 2006 2006 2006 2007

Delete on
February 28
Continuous
Continuous Budgeting
Budgeting
One-Year Budget

Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec. Jan. Feb.
2006 2006 2006 2006 2998 2006 2006 2006 2006 2006 2007 2007

Add February 2007


Static
Static Budgets
Budgets
Description: A budget that does not reflect
potential changes in volume or
activity level

Strength: It is simple—all expenses are


budgeted as fixed costs

Weakness: It does not reflect changes in


revenues and expenses that occur as
volumes change

Typical usage: Service organizations or


administrative departments of
retailers and manufacturers
Static
Static Budgets
Budgets

Colter Manufacturing Company


Assembly Department Budget
For the Month Ending July 31, 2006
Direct labor $40,000
Electric Power 5,000
Supervisor salaries 15,000
Total department costs $60,000
Flexible
Flexible Budgets
Budgets
Description: A budget that shows revenues and expenses
for a variety of volumes or activity levels
Strength: Provides information needed to analyze the
impact of volume changes on actual
operating results
Weakness: Requires greater research into costs—must
differentiate fixed and variable costs
Typical usage: Operational departments of retailers and
manufacturers whose costs change with
sales and production
Colter Manufacturing Company
Assembly Department Budget
For the Month Ending July 31, 2006
Units of production 8,000 9,000 10,000
Variable cost:
Direct labor $40,000 $45,000 $50,000
Electric power 4,000 4,500 5,000
Total variable cost $44,000 $49,500 $55,000

Cost
Cost per
per unit
unit isis $5.50
$5.50 at
at all
all levels
levels of
of activity
activity
Colter Manufacturing Company
Assembly Department Budget
For the Month Ending July 31, 2006
Units of production 8,000 9,000 10,000
Variable cost:
Direct labor $40,000 $45,000 $50,000
Electric power 4,000 4,500 5,000
Total variable cost $44,000 $49,500 $55,000
Fixed cost:
Electric power $ 1,000 $ 1,000 $ 1,000
Supervisor salaries 15,000 15,000 15,000
Total fixed cost $16,000 $16,000 $16,000
Colter Manufacturing Company
Assembly Department Budget
For the Month Ending July 31, 2006
Units of production 8,000 9,000 10,000
Variable cost:
Direct labor $40,000 $45,000 $50,000
Electric power 4,000 4,500 5,000
Total variable cost $44,000 $49,500 $55,000
Fixed cost:
Electric power $ 1,000 $ 1,000 $ 1,000
Supervisor salaries 15,000 15,000 15,000
Total fixed cost $16,000 $16,000 $16,000
Total department costs $60,000 $65,500 $71,000
Static
Static and
and Flexible
Flexible Budgets
Budgets

Overbudget

u a l
Act lts
es u
R
Static
Budget

$60,000 $72,000
Static
Static and
and Flexible
Flexible Budgets
Budgets
Overbudget

u a l
Flexible Budget Act lts
es u
9,000 10,000 R
8,000
units units units

$60,000 $65,500 $71,000 $72,000


Master
Master Budget
Budget
Budgeted Income Budgeted Balance
Statement Sheet
Sales budget Cash budget
Cost of goods sold budget: Capital expenditure
Production budget budget
Direct materials purchases
budget
Direct labor cost budget
Selling and administrative
expense budget
Income
Statement
Budgets
Sales
Sales
Budget Production Budget
Budget

Expected units of sales


+ Desired units in ending inventory
– Estimated units in beginning inventory
Total units to be produced
Sales
Sales
Budget Production Budget
Budget
Direct
DirectMaterials
Materials
Purchases
PurchasesBudget
Budget

Materials needed for production


+ Desired ending materials inventory
– Est. beginning materials inventory
Direct materials to be purchased
Sales
Sales
Budget Production Budget
Budget
Direct
DirectMaterials
Materials
Purchases
PurchasesBudget
Budget
Cost
Costof
ofGoods
Goods Direct
DirectLabor
Labor
Sold
SoldBudget
Budget Cost
CostBudget
Budget

Selling Factory
FactoryOverhead
Selling&
& Overhead
Administrative Cost
CostBudget
Budget
Administrative
Expenses
Expenses
Budget
Budget
Elite Accessories Inc.
Sales Budget
For the Year Ending December 31, 2006
Unit Sales Unit Selling Total
Product and Region Volume Price Sales

Wallet:
East………………..287,000 $12.00 $ 3,444,000
West……………….241,000 12.00 2,892,000
Total…………….528,000 $ 6,336,000
Handbag:
East………………..156,400 $25.00 $ 3,910,000
West……………….123,600 25.00 3,090,000
Total…………….280,000 $ 7,000,000
Total revenue from
Sales……………….. $13,336,000
Elite Accessories Inc.
Production Budget
For the Year Ending December 31, 2006
Units
Wallet Handbag

Expected units to be sold 528,000 280,000

From
Fromsales
salesbudget
budget
Elite Accessories Inc.
Production Budget
For the Year Ending December 31, 2006
Units
Wallet Handbag

Expected units to be sold………….528,000 280,000


Plus desired ending inventory,
December 31, 2006……………. 80,000 60,000
Total 608,000 340,000
Elite Accessories Inc.
Production Budget
For the Year Ending December 31, 2006
Units
Wallet Handbag

Expected units to be sold………….528,000 280,000


Plus desired ending inventory,
December 31, 2006……………. 80,000 60,000
Total………………………………. 608,000 340,000
Less estimated beginning inventory,
January 1, 2006…………………. 88,000 48,000
Total units to be produced…………520,000 292,000
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A)………………….. 156,000 52,000

Note A: Leather: 520,000 units x 0.30 sq. yd. per unit = 156,000 sq. yds.
Lining: 520,000 units x 0.10 sq. yd. Per unit = 52,000 sq. yds.
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A)……..……..…….. 156,000 52,000
Handbag (Note B)……………….. 365,000 146,000

Note B: Leather: 292,000 units x 1.25 sq. yd. per unit = 365,000 sq. yds.
Lining: 292,000 units x 0.50 sq. yd. Per unit = 146,000 sq. yds.
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A)……....………….. 156,000 52,000
Handbag (Note B).………………. 365,000 146,000
Plus desired inventory, Dec. 31, 2006 20,000 12,000
Total……………………………… 541,000 210,000
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A) …………………. 156,000 52,000
Handbag (Note B) ………………. 365,000 146,000
Plus desired inventory, Dec. 31, 2006 20,000 12,000
Total……………………………… 541,000 210,000
Less estimated inventory, Jan. 1, 2006 18,000 15,000
Total square yards to be produced.. 523,000 195,000
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A)………………….. 156,000 52,000
Handbag (Note B).………………. 365,000 146,000
Plus desired inventory, Dec. 31, 2006 20,000 12,000
Total……………………………… 541,000 210,000
Less estimated inventory, Jan. 1, 2006 18,000 15,000
Total square yards to be produced.. 523,000 195,000
Unit price (per square yard)…………. x $4.50 x $1.20
Total direct materials to be purchased. $2,353,500 $234,000 $2,587,500
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Cutting Sewing Total

Hours required for production:


Wallet (Note A)…………. 52,000 130,000

Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs.
Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs.
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Cutting Sewing Total

Hours required for production:


Wallet (Note A)…………. 52,000 130,000
Handbag (Note B)……….. 43,800 116,800

Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs.
. Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs.
Note B: Cutting Department: 292,000 units x 0.15 hr. per unit = 43,800
hrs.
Sewing Department: 292,000 units x 0.40 hr. per unit = 116,800 hrs
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Cutting Sewing Total

Hours required for production:


Wallet (Note A)…………. 52,000 130,000
Handbag (Note B)……….. 43,800 116,800
Total……………………... 95,800 246,800

Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs.
. Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs.
Note B: Cutting Department: 520,000 units x 0.15 hr. per unit = 43,800
hrs.
Sewing Department: 520,000 units x 0.40 hr. per unit = 116,800 hrs
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Cutting Sewing Total

Hours required for production:


Wallet (Note A)…………. 52,000 130,000
Handbag (Note B)……….. 43,800 116,800
Total……………………... 95,800 246,800
Hourly rate…………………… x $12.00 x $15.00
Total direct labor cost………… $1,149,600 $3,702,000 $4,851,600
Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs.
Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs.
Note B: Cutting Department: 520,000 units x 0.15 hr. per unit = 43,800 hrs.
Sewing Department: 520,000 units x 0.40 hr. per unit = 116,800 hrs
Elite Accessories Inc.
Factory Overhead Cost Budget
For the Year Ending December 31, 2006
Indirect factory wages……………………... $ 732,800
Supervisory salaries………………………... 360,000
Power and light…………………………….. 306,000
Depreciation of plant and equipment………. 288,000
Indirect materials…………………………… 182,800
Maintenance………………………………... 140,280
Insurance and property taxes………………. 79,200
Total factory overhead cost………………... $2,089,080
Elite Accessories Inc.
Cost of Goods Sold Budget
For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006….. $ 1,095,600
Work in process inventory, January 1, 2006… $ 214,400
Direct materials:
Direct materials inventory, January 1, 2006
(Note A)………………………………….$ 99,000

Note
NoteA:
A: Leather:
Leather: 18,000
18,000sq.
sq.yds.
yds.xx$4.50
$4.50per
persq.
sq.yd
yd $81,000
$81,000
Lining:
Lining: 15,000
15,000sq.
sq.yds.
yds.xx$1.20
$1.20per
persq.
sq.yd
yd 18,000
18,000
Direct
Directmaterials
materials
inventory,
inventory,
January
January1,1,2006
2006 $99,000
$99,000
Elite Accessories Inc.
Cost of Goods Sold Budget
For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006….. $ 1,095,600
Work in process inventory, January 1, 2006… $ 214,400
Direct materials:
Direct materials inventory, January 1, 2006
(Note A)………………………………….$ 99,000

Note
NoteB:
B: Leather:
Leather: 20,000
20,000sq.
sq.yds.
yds.xx$4.50
$4.50per
persq.
sq.yd
yd $$ 90,000
90,000
Lining:
Lining: 12,000
12,000sq.
sq.yds.
yds.xx$1.20
$1.20per
persq.
sq.yd
yd 14,400
14,400
Direct
Directmaterials
materialsinventory,
inventory,December
December31, 31,2006
2006 $104,400
$104,400
Elite Accessories Inc.
Cost of Goods Sold Budget
For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006…. $ 1,095,600
Work in process inventory, January 1, 2006... $ 214,400
Direct materials:
Direct materials inventory, January 1, 2006
(Note A)…………………………………. $ 99,000
Direct materials purchases (Slide 3)…….. 2,587,500
Cost of direct materials available for use…. $2,686,500
Less direct materials inventory,
December 31, 2006 (Note B)……………. 104,400
Cost of direct materials placed in production $2,582,100
Direct labor (Slide 35)………………………. 4,851,600
Factory overhead (Slide 36)………………….. 2,089,080
Total manufacturing costs……………………. 9,522,780
Total work in process during period…………. $9,737,180
Elite Accessories Inc.
Cost of Goods Sold Budget
For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006………... $ 1,095,600

Work in process inventory, January 1, 2006……….. $ 214,500


Total manufacturing costs………………………….. 9,522,780
Total work in process during period……………….. $9,737,180
Less work in process inventory, December 31, 2006 220,000
Cost of goods manufactured………………………... 9,517,180
Cost of finished goods available for sale…………... $10,612,780
Less finished goods inventory, December 31, 2006.. 1,565,000
Cost of goods sold………………………………….. $ 9,047,780
Elite Accessories Inc.
Selling and Administrative Expenses Budget
For the Year Ending December 31, 2006
Selling expenses:
Sales salaries expense…………………………. $715,000
Advertising expense…………………………... 360,000
Travel expense…………………………………. 115,000
Total selling expenses………………………... $1,190,000
Administrative expenses:
Officers’ salaries expense………………………. $360,000
Office salaries expense…………………………. 258,000
Office rent expense……………………………... 34,500
Office supplies expense…………………………. 17,500
Miscellaneous administrative expense………….. 25,000
Total administrative expenses………………… 695,000
Total selling and administrative expenses………… $1,885,000
Elite Accessories Inc.
Budgeted Income Statement
For the Year Ending December 31, 2006
Revenue from sales (slide 23) $13,336,000
Cost of goods sold (slide 40) 9,047,780
Gross profit $ 4,288,220
Selling & administrative expenses:
Selling expenses (slide 41) $1,190,000
Administrative expenses (slide 41) 695,000
Total sell. & Admin. Expenses 1,885,000
Income from operations $ 2,403,220
Other income:
Interest revenue $ 98,000
Other expense:
Interest expense 90,000 8,000
Income before income tax $ 2,411,220
Income tax 600,000
Net income $ 1,811,220
The
The cash
cash budget
budget isis one
one of
of the
the
most
most important
important elements
elements ofof the
the
budgeted
budgeted balance
balance sheet.
sheet. We’ll
We’ll
begin
begin with
with aa schedule
schedule ofof
collection
collection from
from sales.
sales.
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January February March
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………...$108,000 $ 124,000 $ 97,000

Note
NoteA:
A: $108,000
$108,000==$1,080,000
$1,080,000xx10%
10%
$124,000
$124,000==$1,240,000
$1,240,000xx10%
10%
$$ 97,000
97,000==$$ 970,000
970,000xx10%
10%
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January February March
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………...$108,000 $ 124,000 $ 97,000
Receipts from sales on account:
Collections from prior month’s
sales (40%)(see Note B)…….$370,000$ 388,800 $446,400

ote B:
Note B: $370,000,
$370,000,given
givenas
asJanuary
January1,1,2006
2006 Accounts
Accounts
Receivable
Receivablebalance
balance
$388,800
$388,800==$1,080,000
$1,080,000xx90%
90%xx40%40%
$446,400
$446,400==$1,240,000
$1,240,000xx90%
90%xx40%40%
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January February March
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………...$108,000$ 124,000$ 97,000
Receipts from sales on account:
Collections from prior month’s
sales (40%)(see Note B)…….$370,000$ 388,800 $446,400
Collections from current month’s sales (60%)(see
Note
C)…………………………… 583,200 669,600 523,800

Note
NoteC:
C: $583,200
$583,200==$1,080,000
$1,080,000xx90%
90%xx60%
60%
$669,600
$669,600==$1,240,000
$1,240,000xx90%
90%xx60%
60%
$523,800
$523,800==$$ 970,000
970,000xx90%
90%xx60%
60%
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January February March
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………... $108,000$ 124,000$ 97,000
Receipts from sales on account:
Collections from prior month’s
sales (40%)(see Note B)……. $370,000$ 388,800$446,400
Collections from current month’s sales (60%)(see Note
C)…………………………… 583,200 669,600 523,800
Total receipts from sales on account……………………...
$953,200 $1,058,400$970,200
Elite Accessories Inc.
Schedule of Payments for Manufacturing Costs
For the Three Months Ending March 31, 2006
January February March
Payment of prior month’s
manufacturing costs (25%)
(see Note A)………………… $190,000 $204,000 $189,000

Note
NoteA:
A: $190,000,
$190,000,given
givenas
asJanuary
January1,1,2006
2006Accounts
Accounts
Payable
Payablebalance
balance
$204,000
$204,000==($840,000
($840,000–$24,000)
–$24,000)xx25%
25%
$189,000
$189,000==($780,000
($780,000––$24,000)
$24,000)xx75%
75%
Elite Accessories Inc.
Schedule of Payments for Manufacturing Costs
For the Three Months Ending March 31, 2006
January February March
Payment of prior month’s
manufacturing costs (25%)
(see Note A)………………… $190,000 $204,000 $189,000
Payment of current month’s
manufacturing costs (75%)
(see Note B)…………………. 612,000 567,000 591,000

Note
NoteB:
B: $612,000
$612,000==($840,000
($840,000––$24,000)
$24,000)xx75%
75%
$567,000
$567,000==($780,000
($780,000––$24,000)
$24,000)xx75%
75%
$591,000
$591,000==($812,000
($812,000––$24,000)
$24,000)xx75%
75%
Elite Accessories Inc.
Schedule of Payments for Manufacturing Costs
For the Three Months Ending March 31, 2006
January February March
Payment of prior month’s
manufacturing costs (25%)
(see Note A)………………… $190,000 $204,000 $189,000
Payment of current month’s
manufacturing costs (75%)
(see Note B)…………………. 612,000 567,000 591,000
Total payments………………. $802,000 $771,000 $780,000
Elite Accessories Inc.
Cash Budget
For the Three Months Ending March 31, 2006
Estimated cash receipts: January February March
Cash sales (Slide 45)………….. $ 108,000 $ 124,000 $ 97,000
Collections of accounts
receivable (Slide 48)………... 953,200 1,058,400 970,200
Interest revenue………………... — — 24,500
Total cash receipts…………….$1,061,200 $1,182,400 $1,091,700
Elite Accessories Inc.
Cash Budget
For the Three Months Ending March 31, 2006
Estimated cash receipts: January February March
Cash sales (Slide 45)………….. $ 108,000 $ 124,000 $ 97,000
Collections of accounts
receivable (Slide 48)………... 953,200 1,058,400 970,200
Interest revenue………………... — — 24,500
Total cash receipts…………….$1,061,200 $1,182,400 $1,091,700
Estimated cash payments for:
Manufacturing costs (Slide 51).. $ 802,000$ 771,000$ 780,000
Selling and administrative expenses………………………
160,000 165,000145,000
Capital additions 274,000
Interest expense 22,500
Income taxes 150,000
Elite Accessories Inc.
Cash Budget
For the Three Months Ending March 31, 2006
Estimated cash receipts: January February March
Cash sales (Slide 45)………….. $ 108,000 $ 124,000 $ 97,000
Collections of accounts
receivable (Slide 48)………... 953,200 1,058,400 970,200
Interest revenue………………... — — 24,500
Total cash receipts…………….$1,061,200 $1,182,400 $1,091,700
Estimated cash payments for:
Manufacturing costs (Slide 51).. $ 802,000$ 771,000$ 780,000
Selling and administrative expenses……………………… 160,000 165,000
145,000
Capital additions 274,000
Interest expense 22,500
Income taxes 150,000
Total cash payments…………. $ 984,500$1,210,000$1,075,000
Elite Accessories Inc.
Cash Budget
For the Three Months Ending March 31, 2006
Estimated cash receipts: January February March
Cash sales (Slide 45)………….. $ 108,000 $ 124,000 $ 97,000
Collections of accounts
receivable (Slide 48)………... 953,200 1,058,400 970,200
Capital additions 274,000
Interest expense……………….. 22,500
Income taxes…………………... 150,000
Total cash payments………….$ 984,500 $1,210,000 $1,075,000

Cash increase (decrease)…………. $ 76,700 $ (27,600) $ 16,700


Cash balance at beginning of month 280,000 356,700 329,100
Cash balance at end of month……. $ 356,700 $ 329,100 $ 345,800
Minimum cash balance…………… 340,000 340,000 340,000
Excess (deficiency)………………. $ 16,700 $ (10,900) $ 5,800
Chapter 21

The
The End
End