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Chapter 22

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Learn why managers use budgets Understand the components of the master budget Prepare an operating budget Prepare a financial budget Use sensitivity analysis in budgeting

Prepare performance reports for responsibility centers and account for traceable and common shared fixed costs
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1
Learn why managers use budgets

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To plan and control actions and the related revenues and expenses To incorporate managements strategic and operational plans
Planning technology upgrades Planning capital asset replacements, improvements, or expansions

Compare actual results with budgeted amounts to determine corrective actions

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Identifies areas where the actual results differed from the budget

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Understand the components of the master budget

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Master budgetthe set of budgeted financial statements and supporting schedules for the entire organization Budget includes three types of budgets: The operating budget
Projects sales revenue, cost of goods sold, and operating expenses

The capital expenditures budget


The plan for purchasing property, plant, equipment, and other long-term assets

The financial budget


Plans for raising cash and paying debts

Contain projected amounts, not actual amounts


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The following are some of the components included in the master budget.
a. b. c. d. e. f. Budgeted balance sheet Sales budget Capital expenditures budget Budgeted income statement Cash budget Inventory, purchases, and cost of goods sold budget g. Budgeted statement of cash flows

1. ______ B
2. ______ F 3. ______ D 4. ______ C 5. ______ E 6. ______ A 7. ______ G

List in order of preparation the items of the master budget.


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3
Prepare an operating budget

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First three components


Sales budget Inventory, purchases, and cost of goods sold budget Operating expenses

Feed into the budgeted income statement

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Cornerstone of master budget


Level of sales affect all other elements

Projected sales are calculated as:


Each product multiplied by expected units sold

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Budget determines:
Cost of goods sold for the budgeted income statement Ending inventory for the budgeted balance sheet Purchases for the cash budget

Familiar equation is used


Beginning inventory + Purchases Ending inventory = Cost of goods sold

Rearrange equation to solve for unknowns


Purchases = Cost of goods sold + Ending inventory Beginning inventory
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70% cost of goods sold figure uses sales budget created earlier

Desired ending inventory is derived from company policies Desired ending inventory becomes beginning inventory for next period (month, quarter, or year) 16

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Prepared after sales budget and cost of goods sold budget Shows estimated expenses for the period Includes fixed and/or variable expenses Examples:
Fixed and variable salaries, commissions Rent Insurance Advertising Miscellaneous

Look at prior income statements


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Prepared after sales budget, cost of goods sold budget and operating expense budget

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Grippers sells its rock-climbing shoes worldwide. Grippers expects to sell 8,500 pairs of shoes for $180 each in January, and 3,500 pairs of shoes for $190 each in February. All sales are cash only. Prepare the sales budget for January and February.
Grippers Sales Budget January February Total $ 180 $ 190 8,500 3,500 $1,530,000 $665,000 $2,195,000

Sales price per pair Number of pairs Total sales

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Review your results from S22-3. Grippers expects cost of goods sold to average 60% of sales revenue, and the company expects to sell 4,100 pairs of shoes in March for $260 each. Grippers target ending inventory is $10,000 plus 50% of the next months cost of goods sold. Use this information and the sales budget prepared in S22-3 to prepare Grippers inventory, purchases, and cost of goods sold budget for January and February.
Grippers Inventory, Purchases, and Cost of Goods Sold Budget January February Cost of goods sold (0.60 sales from S 21-3) $ 918,000 $ 399,000 + Desired ending inventory ($10,000 + 0.50 Cost of goods sold for next month) 209,500 329,800 = Total inventory required 1,127,500 728,800 Beginning inventory (469,000) (209,500) = Purchases $ 658,500 $ 519,300
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4
Prepare a financial budget

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Cash budget
Project cash receipts and payments

Budgeted balance sheet


Project each asset, liability, and stockholders equity account

Budgeted statement of cash flows


Project cash flows from operating, investing, and financing activities
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Statement of budgeted cash receipts and payments Details how to go from the beginning cash balance to the desired ending balance Four major parts:
Cash collections from customers Cash payments for purchases Cash payments for operating expenses Cash payments for capital expenditures

Depends on operating budget


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Cash collections from customers


Cash sales from the sales budget Collections of prior months credit sales

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Payments for operating expenses


Payments during the month of purchaseassume 50% Payments following the month of purchaseassume 50%

x 50%

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Use the operating expenses budget and payment information to compute cash payments for operating expenses Payment of 50% of current months salary and commissions Payment of 50% of prior months salary and commissions Payment for rent and miscellaneous expenses in the same month

Depreciation is a non-cash expense Insurance was prepaid in the prior quarter


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8. Gregs plans to purchase a used delivery truck in April for $3,000 cash. 9. Gregs requires a minimum cash balance of $10,000 before financing at the end of each month.

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Most important part of the budgeting system


Getting managers and employees to accept the budget Managers must motivate employees to accept the budgets goals How?
Managers must support the budget themselves, or no one else will Managers must show employees how budgets can help them achieve better results Managers must have employees participate in developing the budget

Do not build in slackbecomes less accurate

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Refer to the Grippers sales budget that you prepared in S22-3. Now assume that Grippers sales are collected as follows: November sales totaled $400,000 and December sales were $425,000. 50% in the month of the sale 30% in the month after the sale 18% two months after the sale 2% never collected Prepare a schedule for the budgeted cash collections for January and February. Round answers to the nearest dollar.
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Grippers Budgeted Cash Collections from Customers January February Cash sales (50% of current month ) $ 765,000 $ 332,500
Collection of sales: 30% of prior month credit sales 18% of sales two months ago Total cash collections 127,500 72,000 $ 964,500 459,000 76,500 $ 868,000

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Refer to the Grippers inventory, purchases, and cost of goods sold budget your prepared in S22-4. Assume Grippers pays for inventory purchases 50% in the month of purchase and 50% in the month after purchase.
Prepare a schedule for the budgeted cash payments for purchases for January and February.
Grippers Budgeted Cash Payments for Purchases January February 50% of last month $ 293,250 $ 329,250 50% of current month Total cash payments
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329,250 $ 622,500

259,650 $ 588,900

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Grippers has $12,500 in cash on hand on January 1. Refer to S22-5 and S22-6 for cash collections and cash payment information. Assume Grippers has cash payment for operating expenses including salaries of $50,000 plus 1% of sales, all paid in the month of sale. The company requires a minimum cash balance of $10,000. Prepare a cash budget for January and February. Will Grippers need to borrow cash by the end of February?
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Grippers Cash Budget January and February 2012 January Beginning cash balance $ 12,500 Cash collections from customers 1,077,600 Cash available 1,090,100 Cash payments Purchases of inventory 622,500 Operating expenses 65,300 Total cash payments 687,800 Ending cash balance 402,300 Less: Minimum cash balance desired (10,000) Cash excess (deficiency) $ 392,300
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February $ 402,300 827,400 1,229,700 588,900 56,650 645,550 584,150 (10,000) $ 574,150

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5
Use sensitivity analysis in budgeting

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Technology makes it more cost-effective for managers to:


Conduct sensitivity analysis on their own units budget Combine individual unit budgets to create the companywide master budget

Master budget models the companys planned activities Must support key strategies
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Sensitivity analysis
What-if technique that determines the result if predicted amounts differ from those budgeted

Spreadsheet programs used for budgeting make sensitivity analysis cost-effective


What-if budget questions easily changed within Excel with a few keystrokes Makes it cost-effective to perform more comprehensive sensitivity analyses Managers react quickly if key assumptions underlying the master budget (such as sales price or quantity) turn out to be wrong
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Individual operating units roll up budgets to prepare company-wide budget Budget management software is used
Often part of Enterprise Resource Planning (ERP) system

Allows management to conduct sensitivity analysis on unit data Managers can spend less time compiling and summarizing data and more time analyzing it
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Maplehaven Sporting Goods Store has the following sales budget:


Riverbed Sporting Goods Store Sales Budget April - July April $40,800 10,200 $51,000 May $64,000 16,000 $80,000 June $51,200 12,800 $64,000 July $40,800 10,200 $51,000 April-July Total

Cash sales, 80% Credit sales, 20% Total sales, 100%

$246,000

Suppose June sales are expected to be $80,000 rather than $64,000.


Riverbed Sporting Goods Store Revised Sales Budget April - July April $40,800 10,200 $51,000 May $64,000 16,000 $80,000 June $64,000 16,000 $80,000 July $40,800 10,200 $51,000

April-July Total

Cash sales, 80% Credit sales, 20% Total sales, 100%


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$262,000

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6
Prepare performance reports for responsibility centers and account for traceable and common shared fixed costs

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A system for evaluating the performance of each responsibility center and its manager
A responsibility center is the part of the organization for which a particular manager is responsible
Is a part of the organization for which a manager has decision-making authority and accountability

Four types:
Cost center Revenue center Profit center Investment center

Decentralization highlights the need for reports on individual segments


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Goal is to control cost

Goal is to increase revenues

Goal is to increase profits

Goal is to increase ROI, EVA, & residual income

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Performance reports compare budgeted and actual amounts Reporting at all levels:
Division (investment centers) Product lines (profit centers) Production (cost centers) Sales (revenue centers)

Management by exception
Shows variances between actual and budgeted amounts
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Departments that provide services to multiple departments or divisions for the company
Usually do not generate revenues Similar to the shared production overhead Nonproduction related service departments

Examples:
Payroll and Human Resources Accounting Copying/Graphic Services Physical Plant (repairs and maintenance) Advertising (companywide, not specific products) Mail and Shipping Services Shared Facilities (meeting rooms used by various departments) Legal Services Travel Booking Services
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Costs directly associated with an individual product, division, or business segment Would disappear if the company discontinued the product , division or segment Assigning traceable fixed costs
Splitting the cost equallynot fair Based on use of the servicesfair Small users charged less Larger users charged more Identify cost drivers (ABC costing) suitable for assigning traceable service department charges

Common service departments listed on next slide


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Traceable service costs = $30,000 Base is number of orders

$30,000 / $400,000 equals $0.075 cost per order


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$30,000 / $400,000 equals $0.075 cost per order Apply to divisions based upon number of orders

The DVD division can further split the traceable cost between Excel DVDs and Specialty DVDs $10,500 - $3,500 known untraceable = $7,000 Calculate a cost per order as ($7,000/140,000) = $0.05

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Show the results of the segment or division for which a particular manager is responsible

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A budgeted income statement shows estimated amounts, whereas the income statement shows actual results. Managers use budgets to develop strategies (overall business goals) and to create plans and follow actions that enable them to achieve those goals. They also review results against the goals (control), often using a performance report that compares budgeted amounts to actual amounts.

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The master budget is the set of budgeted financial statements and supporting schedules for the entire organization. It contains the operating budget, the capital expenditures budget, and the financial budget. There are many budgets that compose each of the three types. Each budget provides a portion of the plan that maps the companys planned direction and goals for a period of time.

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The first three components of the operating budget include the sales budget; the inventory, purchases, and cost of goods sold budget; and the operating expenses budget. The sales budget depicts the breakdown of sales based on the terms of collection. The inventory, purchases, and cost of goods sold budget aids in planning for adequate inventory to meet sales (COGS) and for inventory purchases. The operating expenses budget captures the planned variable and fixed operating expenses necessary for normal operations. The three budgets help to form the budgeted income statement. Together these form the operational budget that depicts the companys operational strategy for a period of time.
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The cash budget details how the business expects to go from the beginning cash balance to the desired ending balance each period. The cash budget has four major partscash collections from customers, cash payments for purchases, cash payments for operating expenses, and cash payments for capital expenditures. The results of these budgets are combined to form the cash budget. After preparing the cash budget, the rest of the financial statement budgets are prepared, including the budgeted balance sheet and budgeted statement of cash flows. These budgets depict the financial plan that implements the strategic goals of the company.
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Sensitivity budgeting was once a time-consuming task. Now, with technology, modifying the budget assumptions is easy. Individual managers can easily modify the budgets of their specific units, and that data is automatically updated in the companywide budget plans. Being able to modify this data easily allows managers to be more responsive to business changes and plan better; thus, better, more timely decisions that benefit the company may be made.

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Responsibility centers are parts of the company for which managers have decision-making authority and accountability. Responsibility accounting is performance reporting for those responsibility centers. There are four types of responsibility centerscost centers, revenue centers, profit centers, and investment centers. Traceable fixed costs are those costs that would disappear if a company quit making a particular product or discontinued a division or segment. Common fixed costs (untraceable) are those costs that arent traceable to a specific product, division, or segment.
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Copyright

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.
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