MS-12: OPERATIONAL BUDGETING

BUDGET is a management plan, expressed in quantitative terms, used for both planning and control of operations
for given period of time. The budget is a plan or standard at the start of the period but it serves at the end of the
period as a control device to help management measure its performance against the plan so that future performance
may be improved. The term budgeting is used to denote the process of coming up with budgets.

Advantages and Limitations of Budgeting

Uses/Advantages of Budgeting Limitations of Budgeting

It compels periodic planning Considerable time and costs are required

It provides a means of allocating resources
efficiently and effectively
It enhances cooperation, coordination,
communication and motivation
It provides network for performance evaluation
It satisfies some legal and contractual requirements
the activities toward the achievement of
organizational goals
Budgets are merely estimates that require judgment
and might be modified or revised if necessary
A successful budgetary system requires cooperation
of all members of the organization
Budgets sometimes restrict decision-making process
The budget program is merely a guide, not a It directs
substitute for good management ability

THE MASTER BUDGET

Master Budget is a comprehensive budget that consolidates the overall plan of the organization within a budget
period. It consists of all individual budgets for each of the segments of the organization aggregated or consolidated
into one overall budget for the entire firm. (Other terms: pro forma budget, planning budget, forecast budget, master
profit plan).

BUDGETING-RELATED TERMINOLOGIES

FIXED BUDGET - A budget prepared for a one level of activity within a certain period. (other term: static budget).

FLEXIBLE BUDGET A budget prepared for different levels of activity within a certain period. (other terms:
variable budget, sliding scale budget).

CONTINUOUS BUDGET A 12-month budget that rolls forward one month as the current month is completed
(other term: perpetual budget)

ZERO-BASED BUDGET A method of budgeting in which managers are required to justify all costs as if
programs involved were being proposed for the first time.

IMPOSED BUDGETING - A process wherein budgets are prepared by the top management with little or no inputs
from operating personnel.

PARTICPATORY BUDGETING - A process wherein budgets are developed through joint decisions by top
management and operating personnel.

BUDGET COMMITTEE A group of key management persons responsible for overall policy matters relating to
the budget program and for coordinating the budget preparation.

BUDGET MANUALThis describes how a budget is prepared and includes a planning calendar and distribution
instructions for all budget schedules.

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 EXERCISES

1. Lubriderm Corporation has the following budgeted sales for the next six-month period:

Month Unit Sales

June 90,000
July 120,000
August 210,000
September 150,000
October 180,000
November 120,000

There were 30,000 units of finished goods in inventory at the beginning of June. Plans are to have an
inventory of finished products that equal 20% of the unit sales for the next month.

Five pounds of materials are required for each unit produced. Each pound of material costs P 8. Inventory
levels for materials are equal to 30% of the needs for the next month. Materials inventory on June 1 was
15,000 pounds.

Required:
a. Prepare production budgets in units for July, August, and September.
b. Prepare a purchases budget in pounds for July, August, and September, and give total purchases in both
pounds and pesos for each month.

2. Gerdie Company has the following information:

Month Budgeted Sales

March P 50,000
April 53,000
May 51,000
June 54,500
July 52,500

In addition, the gross profit rate is 40% and the desired inventory level is 30% of next month's cost of sales.

Required:
Prepare a purchases budget for April through June.

3. Picture Pretty manufactures picture frames. Sales for August are expected to be 10,000 units of various sizes.
Historically, the average frame requires four feet of framing, one square foot of glass, and two square feet of
backing. Beginning inventory includes 1,500 feet of framing, 500 square feet of glass, and 500 square feet of
backing. Current prices are P 0.30 per foot of framing, P 6.00 per square foot of glass, and P 2.25 per square
foot of backing. Ending inventory should be 150% of beginning inventory. Purchases are paid for in the
month acquired.

Required:

a. Determine the quantity of framing, glass, and backing that is to be purchased during August.
b. Determine the total costs of direct materials for August purchases.

4. Michelle Enterprises reports the year-end information from 2011 as follows:

Sales (100,000 units) P 250,000

Less: Cost of goods sold 150,000
Gross profit 100,000
Operating expenses (includes P10,000 of Depreciation) 60,000
Net income P 40,000

Michelle is developing the 2012 budget. In 2012 the company would like to increase selling prices by 10%,
and as a result expects a decrease in sales volume of 5%. Cost of goods sold as a percentage of sales is
expected to increase to 62%. Other than depreciation, all operating costs are variable.

Required:

Prepare a budgeted income statement for 2012.

5. Shamokin Manufacturing produces two products, Big and Bigger. Shamokin expects to sell 20,000 units of
Big and 10,000 units of Bigger. Shamokin plans on having an ending inventory of 4,000 units of Big and

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 2,000 units of Bigger. Currently, Shamokin has 1,000 units of Big in its inventory and 800 units of Bigger.
Each product requires two labor operations: molding and polishing. Product Big requires one hour of
molding time and one hour of polishing time. Product Bigger requires one hour of molding time and two
hours of polishing time. The direct labor rate for molders is P20 per molding hour, and the direct labor rate
for polishers is P25 per polishing hour.

Required: Prepare a direct labor budget in hours and pesos for each product.

6. The following information pertains to Amigo Corporation:

Month Sales Purchases

July P 30,000 P 10,000
August 34,000 12,000
September 38,000 14,000
October 42,000 16,000
November 48,000 18,000
December 60,000 20,000

Cash is collected from customers in the following manner:

Month of sale (2% cash discount) 30%

Month following sale 50%

Two months following sale 15%

Amount uncollectible 5%

40% of purchases are paid for in cash in the month of purchase, and the balance is paid the following
month.

Required:
a. Prepare a summary of cash collections for the 4th quarter.
b. Prepare a summary of cash disbursements for the 4th quarter.

7. Westrum estimates production overhead costs equal to P300, 000 + P2X, where X is the number of
machine hours used. Westrum budgeted 40,000 machine hours for 2014. Westrum produced 23,000 units
in 2014, each requiring 3 machine hours. Actual production costs were P420,000.

a. Calculate the flexible budget allowance for production overhead costs for 2014.

b. Find the amount and direction of the budget variance for 2014 for production overhead.

SAMPLE QUESTIONS TO ANSWER

1. Budgets are related to which of the following management functions?

a. Planning c. Performance evaluation
b. Control d. All of the above

2. Which of the following is NOT an advantage of budgeting?

a. It requires managers to state their objectives.
b. It facilitates control by performing comparisons of budgeted and actual results.
c. It facilitates performance evaluation by permitting comparisons of budgeted and actual results.
d. It provides a check-up device those allowas managers to keep close tabs on their subordinates.

3. Budgets are a necessary component of financial decisions making because they help provide a (n)
a. Efficient allocation of resources
b. Means to use all the firms resources.
c. Automatic corrective mechanism for errors.
d. Means to check managerial discretion.

4. The starting point in preparing a comprehensive budget is

a. The sales forecast c. The budgeted income statement
b. The cash budget d. The flexible expense budget.

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5. The sales budget is classified as
a. Financial budget c. An operating budget
b. A Flexible budget d. A program budget.

6. Junior Company developed the following sales forecasts and associated probabilities.

Sales Forecast Probability

P 600,000 x 10%
650,000 x 50%
700,000 x 35%
800,000 x 5%
The expected value of sales is

a. P 650,000 c. P 667,500
b. P 670,000 d. Some other number
7. Which of these budgets is usually prepared first?
a. Cash disbursement budget c. Production budget
b. Materials purchases budget d. Cash budget
8. Which of the following equations can be used to budget purchases? (BI = Beginning inventory, EI = ending
inventory desired, CGS = Budgeting cost of goods sold)
a. Budgeted purchases = CGS + BI EI
b. Budgeted purchases = CGS + BI
c. Budgeted purchases = CGS + EI + BI
d. Budgeted purchases= CGS + EI BI
9. Ron Company desires an ending inventory of P 60,000. It expects sales of P 120,000 and has a beginning
inventory of P 40,000. Cost of sales is 60% of sales. Budgeted purchase are
a. P 60,000 c. P 92,000
b. P 72,000 d. P 132,000
10. Gladys Company budgeted sales of 22,000 units for January, 30,000 for February. The budgeted beginning
inventory for January 1 was 7,000 units. Gladys desires an ending inventory equal to one half of the
following months sales needs. Budgeted production for January is
a. 37,000 units c. 26,000 units
b. 30,000 units d. 14,000 units
11. A flexible budget is
a. One that can be changed whenever a manager so desires.
b. Adjusted to reflect expected cost at the actual level of activity.
c. One that uses the formula total cost=cost per unit X units produced.
d. The same as a continuous budget
12. A static budget allowance is LEAST objectionable in an annual budget for
a. Property taxes c. Direct labor
b. Advertising d. Sales Commission
13. Which of the following is a difference between a static budget and a flexible budget?
a. A flexible budget includes only variable costs, a static budget includes only fixed costs.
b. A flexible budget includes all costs, a static budget includes only fixed costs.
c. A flexible budget gives allowance for different levels of activity while a static budget does not.
d. None of the above
14. Jen Company manufactures a single product. Jen keeps its inventory of finished goods at 75% of the
coming months budgeted sales and inventory of raw materials at 50% of the coming months budgeted
production needs. Each unit of product requires two pounds of materials. The production budget is, in units:
May 1,000; June 1,200; July 1,300; August, 1,600. Raw materials purchases in June would be
a. P 1,525 pounds c. 2,800 pounds
b. 2,500 pounds d. 3,050 pounds
15. Chirs Company manufactures a single product. Chris keeps inventory of raw materials at 50% of the
coming months budgeted production needs. Each unit of product revenues three pounds of materials. The
production budget is, in units. May, 1,000; June 1,200; July 1,300; August 1,600. Raw materials purchases
in July would be
a. 1,450 pounds c. 3,900 pounds
b. 2,400 pounds d. Some other number
16. The cash budget for 2012 would be affected in some way by all of the following EXCEPT
a. A cash dividend declared in 2011 for payment in 2012.
b. A cash dividend declared in 2012 for payment in 2013.
c. Interest expense on loans taken out and repaid during 2012.
d. The sales forecast for the first month in 2013.
17. A rapidly growing company will probably have
a. Increasing cash, receivables, and inventory
b. Increasing cash, decreasing receivables and inventory
c. Decreasing cash, receivables and inventory
d. Decreasing cash, increasing receivables and inventory

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18. A Company has prepared a cash budget for January through June of 2013. Which of the following
discovered in February 2003, is LEAST likely to require revising the cash budget?
a. February sales are lower than budgeted
b. The interest rate on short term borrowing is higher than budgeted
c. The company increased from10% to 20%, the down payment it requires from customers.
d. The company changed inventory method from weighted average to FIFO.
19. Gemma Inc. has projected sales to be P 260,000 in June, P 270,000 in July and P 300,000 in August.
Gemma Collects 30% of a month sales in the month of sale, 50% in the month of following the sale, and
16% in the second month following the sale. Cash collection in August would be
a. P 90,000 c. P 266,600
b. P 254,600 d. P 277,000
20. David Inc. has projected sales to be P 260,000 in June, P 270,000 in July and P 300,000 in August. David
Collects 30% of a months sales in the month of sale, 50% in the month following the sale, and 20% in the
second month following the sale. The accounts receivable balance on August 31 would be
a. P 90,000 c. P 264,000
b. P 210,000 d. P Some other Answer
21. A company that uses zero based budgeting has
a. An expense budget of zero
b. Zero as the starting point of budgeting the coming years experience
c. A zero variance between budgeted and actual performance
d. An assumed sales level of zero
22. The budget method that maintains a constant twelve month planning horizon by adding a new month on the
end as the current month is completed is called
a. An operating budget c. A continuous budget
b. A capital budget d. A master budget
23. Potter Co has projected sales to be P 60,000 in January, P 75,000 in February, and P 80,000 in March. Potter
wants to have 25% of next months sales needs on hand at the end of the a month. If Potter has an average
gross profit of 40%, what are the February purchases?
a. P 30,500 c. P 76,250
b. P 45,750 d. P 46,250
24. Weasly Co makes payments for purchase 30% during the month of purchases and the remainder the
following month. April purchases are projected to be P 80,000; May purchases will be P 120,000. Cash
payments on account for May will be
a. P 36,000 c. P 84,000
b. P 54,000 d. P 92,000
25. Precious Inc, has projected sales to be: February, P 10,000; March, P 9,000; April, P 8,000; May, P 10,000;
and June, P 11,000. Precious has 30% cash sales and 70% sales on account. Accounts are collected 40% in
the month following the sale and 55% collected the second month. Total cash receipts for May would be
a. P 3,000 c. P 8,705
b. P 8,150 d. Some other number