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BUDGETING

Purposes of Budgeting Systems

Budget
a detailed plan,
expressed in
quantitative terms,
that specifies how
resources will be
acquired and used
during a specified
period of time.
Purposes of Budgeting Systems

Budget  Planning
a detailed plan,  Facilitating
expressed in Communication and
Coordination
quantitative terms,
 Allocating Resources
that specifies how
resources will be  Controlling Profit and
acquired and used Operations
during a specified  Evaluating Performance
period of time. and Providing Incentives
Types of Budgets
Detail
Budget
Detail

Materials
Budget
Detail

Production
Budget
Master
Budget
Covering all Sales
phases of
a company’s
operations.
Types of Budgets

Operating Budget

2009 2010 2011 2012

The annual operating budget


may be divided into quarterly
or monthly budgets.
Exh.
9-1
Sales of Services or Goods

Ending
Inventory
Budget Production
Work in Process Budget
and Finished
Goods
Exh.
9-1
Sales of Services or Goods

Ending
Inventory
Budget Production
Work in Process Budget
and Finished
Goods

Direct Direct Selling and


Overhead
Materials Labor Administrative
Budget Budget Budget
Budget

Ending
Inventory
Budget
Direct Materials
Exh.
9-1
Sales of Services or Goods

Ending
Inventory
Budget Production
Work in Process Budget
and Finished
Goods

Direct Direct Selling and


Overhead
Materials Labor Administrative
Budget Budget Budget
Budget

Cash Budget
Ending
Inventory
Budget
Direct Materials Budgeted Financial Statements
Sales Budget
Breakers, Inc. is preparing budgets for the
quarter ending June 30.
Budgeted sales for the next five months are:
April 20,000 units
May 50,000 units
June 30,000 units
July 25,000 units
August 15,000 units.
 The selling price is $10 per unit.
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
Revenue $200,000 $500,000 $300,000 $1,000,000
Production Budget

Sales Production
Budget Budget
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Production must be adequate to meet budgeted


sales and provide for sufficient ending inventory.
Production Budget
The management of Breakers, Inc. wants
ending inventory to be equal to 20% of the
following month’s budgeted sales in units.

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

Let’s prepare the production


budget.
Production Budget
April May June Quarter
Sales in units 20,000
Add: desired
end. inventory
Total needed
Less: beg.
inventory
Units to be
started

From sales
budget
Production Budget
April May June Quarter
Sales in units 20,000
Add: desired
end. inventory 10,000
Total needed 30,000
Less: beg.
inventory
Units to be
started
Production Budget
April May June Quarter
Sales in units 20,000
Add: desired
end. inventory 10,000
Total needed 30,000
Less: beg.
inventory 4,000
Units to be
started 26,000

March 31
ending inventory
Production Budget
April May June Quarter
Sales in units 20,000 50,000
Add: desired
end. inventory 10,000
Total needed 30,000
Less: beg.
inventory 4,000
Units to be
started 26,000
Production Budget
April May June Quarter
Sales in units 20,000 50,000
Add: desired
end. inventory 10,000 6,000
Total needed 30,000 56,000
Less: beg.
inventory 4,000
Units to be
started 26,000
Production Budget
April May June Quarter
Sales in units 20,000 50,000
Add: desired
end. inventory 10,000 6,000
Total needed 30,000 56,000
Less: beg.
inventory 4,000 10,000
Units to be
started 26,000 46,000
Production Budget
April May June Quarter
Sales in units 20,000 50,000 30,000 100,000
Add: desired
end. inventory 10,000 6,000 5,000 5,000
Total needed 30,000 56,000 35,000 105,000
Less: beg.
inventory 4,000 10,000 6,000 4,000
Units to be
started 26,000 46,000 29,000 101,000
Production Budget
April May June Quarter
Sales in units 20,000 50,000 30,000 100,000
Add: desired
end. inventory 10,000 6,000 5,000 5,000
Total needed 30,000 56,000 35,000 105,000
Less: beg.
inventory 4,000 10,000 6,000 4,000
Units to be
started 26,000 46,000 29,000 101,000
Direct-Material Budget
At Breakers, five pounds of material are
required per unit of product.
Management wants materials on hand at the
end of each month equal to 10% of the
following month’s production.
On March 31, 13,000 pounds of material are on
hand. Material cost $.40 per pound.

Let’s prepare the direct materials budget.


Direct-Material Budget

From our production


Budget (units to be started)
Direct-Material Budget
Direct-Material Budget

10% of the following


month’s production
Direct-Material Budget

March 31
inventory
Direct-Material Budget
Direct-Material Budget
July Production
Sales in units 25,000
Add: desired ending inventory 3,000
Total units needed 28,000
Less: beginning inventory 5,000
Production in units 23,000
Direct-Material Budget
June Ending Inventory
July production in units 23,000
Materials per unit 5
Total units needed 115,000
Inventory percentage 10%
June desired ending inventory 11,500
Direct-Labor Budget
 At Breakers, each unit of product requires 0.1
hours of direct labor.
 The Company has a “no layoff” policy so all
employees will be paid for 40 hours of work each
week.
 In exchange for the “no layoff” policy, workers
agreed to a wage rate of $8 per hour regardless of
the hours worked (No overtime pay).
 For the next three months, the direct-labor
workforce will be paid for a minimum of 3,000
hours per month.
Let’s prepare the direct-labor budget.
Direct-Labor Budget

From our
production
budget
Direct-Labor Budget
Direct-Labor Budget
Direct-Labor Budget

This is the greater of


labor hours required or
labor hours guaranteed.
Direct-Labor Budget
Overhead Budget
Here is Breakers’ Overhead Budget for the quarter.
Selling and Administrative
Expense Budget
At Breakers, variable selling and
administrative expenses are $0.50 per unit
sold.
Fixed selling and administrative expenses
are $70,000 per month.
The $70,000 fixed expenses include
$10,000 in depreciation expense that does
not require a cash outflow for the month.
Selling and Administrative
Expense Budget

From our
Sales budget
Selling and Administrative
Expense Budget
Selling and Administrative
Expense Budget
Selling and Administrative
Expense Budget
Cash Receipts Budget
At Breakers, all sales are on account.
The company’s collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale,
5% is uncollected.
The March 31 accounts receivable
balance of $30,000 will be collected in full.
Cash Receipts Budget
Cash Receipts Budget
Cash Receipts Budget
Cash Receipts Budget
Cash Disbursements Budget
Breakers pays $0.40 per pound for its
materials.
One-half of a month’s purchases are paid for in
the month of purchase; the other half is paid in
the following month.
No discounts are available.
The March 31 accounts payable balance is
$12,000.
Cash Disbursements Budget
Cash Disbursements Budget

140,000 lbs. × $.40/lb. = $56,000


Cash Disbursements Budget
Cash Disbursements Budget
Cash Disbursements Budget
Continued
Breakers:
 Maintains a 12% open line of credit for $75,000.
 Maintains a minimum cash balance of $30,000.
 Borrows on the first day of the month and repays
loans on the last day of the month.
 Pays a cash dividend of $25,000 in April.
 Purchases $143,700 of equipment in May and
$48,300 in June paid in cash.
 Has an April 1 cash balance of $40,000.
Cash Disbursements Budget
Continued

From our Cash


Receipts Budget
Cash Disbursements Budget
Continued

From our Cash


Disbursements
Budget
Cash Disbursements Budget
Continued

From our Direct


Labor Budget
Cash Disbursements Budget
Continued

From our
Overhead Budget
Cash Disbursements Budget
Continued

From our
Selling and Administrative
Expense Budget
Cash Disbursements Budget
Continued

To maintain a cash
balance of $30,000,
Breakers must borrow
$35,000 on its line of credit.
Cash Disbursements Budget
Financing and Repayment

Ending cash balance for April


is the beginning May balance.
Cash Disbursements Budget
Continued
Cash Disbursements Budget
Continued

Breakers must
borrow an
additional $13,800
to maintain a
cash balance
of $30,000.
Cash Disbursements Budget
Financing and Repayment
Cash Disbursements Budget
Continued
Cash Disbursements Budget
Continued

At the end of June, Breakers has enough cash


to repay the $48,800 loan plus interest at 12%.
Cash Disbursements Budget
Financing and Repayment
Cash Disbursements Budget
Continued
Cash Disbursements Budget
Financing and Repayment
Budgeted Income Statement

Cash Budgeted
Budget Income
Statement
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After we complete the cash budget, we can prepare


the budgeted income statement for Breakers.
Budgeted Ending Inventory
Manufacturing overhead is applied on the basis of direct labor hours.
Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.10 hrs. $ 8.00 0.80
Manufacturing overhead 0.10 hrs. $18.02 1.80
$ 4.60
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.60
Ending finished goods inventory $23,000

Total overhead $191,000


= $18.02 per hr.*
Total labor hours 10,600 hrs.

*rounded
Budgeted Income Statement
Breakers, Inc.
Budgeted Income Statement
For the Three Months Ended June 30
Revenue (100,000 × $10) $ 1,000,000
Cost of goods sold (100,000 × $4.60) 460,000
Gross margin $ 540,000
Operating expenses:
Selling and admin. Expenses $ 260,000
Interest expense 838
Total operating expenses 260,838
Net income $ 279,162
Budgeted Balance Sheet
Breakers reports the following account
balances on June 30 prior to preparing its
budgeted financial statements:
 Land - $50,000
 Building (net) - $148,000

 Common stock - $200,000

 Retained earnings - $46,400


25%of June
sales of
$300,000
11,500 lbs. at
$.40 per lb.
5,000 units at
$4.60 per unit.
50% of June
purchases
of $56,800
Budget Administration

The Budget Committee is a standing


committee responsible for . . .
 overall policy matters relating to the budget.
 coordinating the preparation of the budget.
Zero-Base Budgeting
To receive funding during the budgeting
process, each activity must be justified in
terms of its continued usefulness.
International Aspects of Budgeting

Firms with international operations face special


problems when preparing a budget.
 Fluctuations in foreign currency exchange
rates.
 High inflation rates in some foreign countries.
 Differences in local economic conditions.
Budgeting Product Life-Cycle Costs
Product planning
and concept
design

Distribution
Preliminary
and customer
design.
service.

Detailed design
Production.
and testing.
Behavioral Impact of Budgets
Budgetary Slack: Padding the Budget
People often perceive that their performance will
look better in their superiors’ eyes if they can
“beat the budget.”
Participative Budgeting

T o p M a n a g e m e n t

M i d d l e M i d d l e
M a n a g e m e n t M a n a g e m e n

S u p e r v Si s u o p r e r v Si s u o p r e r v Si s u o p r e r v i s
Participative Budgeting

T o p M a n a g e m e n t

M i d d l e M i d d l e
M a n a g e m e n t M a n a g e m e n

S u p e r v Si s u o p r e r v Si s u o p r e r v Si s u o p r e r v i s

Flow of Budget Data


Sales budget
Production budget
Raw materials usage and purchase budget
Direct labour budget
Production overhead budget
Cash budget
Budgeted income statement
Budgeted balance sheet
Production budget

Expected sales xx
(+) desired closing inventory of finished goods xx
Total needs xx
(-) opening inventory of finished goods x
Units to be produced xx
Raw materials usage and purchase
budget
Raw materials needed for production xx
(+) desired closing inventory xx
Total raw materials needed xx
(-) Opening inventory xx
Raw materials to purchase xx
Comprehensive example 2
Feb Mar Apr May Jun Jul
Sales 18 000 20 000 20 000 22 000 25 000 24 000
(unit)

Selling price per unit $5

Sales budget
Apr May Jun Total
Sales (unit) 20 000 22 000 25 000 67 000
Total sales 100 000 110 000 125 000 335 000
(RM)
60% is paid in the current month,
30% is paid one month after the month of sale
9% is paid two month after the month of sale
1% is never paid

Cash receipt budget


Apr May Jun
60% x current month sales 60 000 66 000 75 000
30% x previous month’s sales 30 000 30 000 33 000
9% x previous 2 months sales 8 100 9 000 9 000
98 100 105 000 117 000
Closing stock of finished product for the current month
is expected to be 20% of the following moth’s sales.
Stock of finished goods at 31st March is 5 000 units.
Closing stock = Production + Opening stock – Sales
Or units to be produced:
Production budget
April May June Total
Sales (units) 20 000 22 000 25 000 67 000
+ CS (20% of next month 4 400 5 000 4 800 4 800
sales)
- OS (5 000) (4 400) (5 000) (5 000)
Units to be produced 19 400 22 600 24 800 66 800
Stock of raw materials at 31 March is 4 000 kg. The company
anticipates that the CS of raw materials for each month to be 30%
of the following month’s production requirements. Cost of raw
materials per kg is RM4. One unit of completed product requires
½ kg of materials. Closing balance of creditors for purchase of
raw materials on 31 March is RM30 000. Payment on purchases
is made in the following month of the purchase.
Direct materials purchases budget

April May June


Units to be produced 19 400 22 600 24 800
Material required (x ½ kg material) 9 700 11 300 12 400
+ CS (30% of next month production 3 390 3720 3 600
requirement)
- OS (4 000) (3 390) (3 720)
Materials to purchase (kg) 9 090 11 630 12 280
Total purchase (kg x cost per kg) 36 360 46 520 49 120
Expected production OH cost for each month is RM5 000.
From this amount RM2 000 is expected to be the
depreciation expense for the factory equipment. Variable
selling price is 1% of sales while fixed selling expenses are
estimated at RM7 000 per month. Administration expenses
are expected to be RM10 000 per month, out of which
RM8 000 is fixed. The fixed admin exp include RM500
depreciation exp for office.

Salaries, direct labour wages, selling and administration exp


as well as production OH are paid in the month they are
incurred.

Closing cash balance at 31 March RM5 000.


Apr May June
Opening cash balance 5 000 23 500 37 640
Receipt 98 100 105 000 117 000
Payment:
Purchases 30 000 36 360 46 520
Direct labour (RM1 per unit) 19 400 22 600 24 800
Variable overhead (RM0.50 per unit) 9 700 11 300 12 400
Fixed OH 3 000 3 000 3 000
Selling & administration
Variable 3 000 3 100 3 250
Fixed 14 500 14 500 14 500
Closing balance 23 500 37 640 50 170
RM
Sales 335 000
(-) COGS (67 000 x RM3.50) + 15 000 249 500
Gross Profit 85 500
(-) Expenses:
Bad debt 3 350
Variable selling expenses 3 350
Fixed selling expenses 21 000
Administration expenses 30 000
Net profit 27 800
Example 1

Sales budget

Product Units Selling price Total sales

A 2 500 RM263.50 RM658 750


B 500 RM410.00 RM205 000

Production budget

Product A (units) B (units)


Sales 2 500 500
+Closing stock 550 25
3 050 525
(-) Opening stock (50) (25)
3 000 500
Direct material usage budget
A B ∑ Cost Total
Material per (RM)
unit
Production (in units) 3 000 500
Material X (6 units for each A, B) 18 000 3 000 21 000 6 126 000
Material Y (3 units A, 4 units B) 9 000 2 000 11 000 13 143 000
Total costs 269 000

CL ∑ ∑ OS Purchases Cost per ∑ purchases


unit
Units Units Units Units Units RM RM
X 1 500 21 000 22 500 1 250 21 250 6 127 500
Y 250 11 000 11 250 1 250 10 000 3 130 000
Total 257 500
Direct Labour Budget

Product Production Direct Total Rate per Labour cost


(units) labour Hours hour (RM) (RM)
Hours per
unit

Aee 3,000 7 21,000 5 105,000

Bee 500 10 5,000 5 25,000

Total 26,000 130,000


Closing Stock of Finished Goods Budget

Direct materials Closing Cost per Total


unit RM Cost RM

X 1,500 600 9,000

Y 250 130 3,250 12,250

Finished product

Aee 550 180.00* 99,000

Bee 25 238.00* 5,950 104,950

Total 117,200
Cost of Goods Sold Budget
RM RM

Cost of material used 269,000

Direct labour cost 130,000

Production overhead 260,000

Total production cost 659,000

Increase in stock of finished goods 18,100

Less Closing stock of finished goods 104,950

(86,850)
Cost of goods sold 572,150
Cash Budget
1st 2nd Quarter 3rd Quarter 4th Quarter
Quarter

Opening cash balance 12 500 (6 250) (6 250) 6 250

Receipts 156 250 187 500 200 000 276 250


168 750 181 250 193 750 282 500

Less: Payments

Materials 25 000 43 750 43 750 55 250

Salaries and wages 112 500 118 750 118 750 116 500

Other expenses 31 250 25 000 25 000 33 750

Tax expense 6 250 - - -


Additional plant & machinery - 25 000

Total payments 175 000 187 500 187 500 230 500
Closing cash balance (6 250) (6 250) 6 250 52 000

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