Chapter
22
McGraw-Hill/Irwin
Operational Budgeting
© The McGraw-Hill Companies, Inc., 2002
Budgeting: The Basis for
Planning and Control
A budget is a comprehensive financial
plan for achieving the financial and
operational goals of an organization.
Planning
Control
Developing
objectives for
acquisition
and use of
resources.
Steps taken by
management to
ensure that
objectives are
attained.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Benefits Derived from Budgeting
Enhanced managerial
responsibility
Coordination
of activities
Performance
evaluation
Benefits
Assignment of decision
making responsibilities
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Establishing Budgeted Amounts:
The “Behavioral” Approach
Budget Problems
Solution

Perceived unfair or
unrealistic goals.

Reasonable and
achievable budgets.

Poor managementemployee
communications.

Employee participation
in budgeting process.
McGraw-Hill/Irwin
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Participation in Budget Process
Top Management
Middle
Management
Supervisor
Supervisor
Middle
Management
Supervisor
Supervisor
Flow of Budget Data
McGraw-Hill/Irwin
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The Budget Period
The annual operating budget may be
divided into quarterly or monthly budgets.
2001
2002
2003
2004
Capital Budgets
A continuous budget is usually a twelve-month budget
that adds one month as the current month is completed.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Master Budget
Sales
forecast
Production
schedule
Cost of goods
sold and ending
inventory
budgets
Budgeted
financial
budgets:
 cash
 income
 balance sheet
Capital
expenditures
budget
Operating
expense
budgets
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Preparing the Master Budget:
An Illustration
That’s enough talking
about budgets, now
show me an example!
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Preparing the Master Budget:
An Illustration
Sales
Budget
Estimated
Unit Sales
Estimated
Unit Price
Analysis of economic and market conditions
+
Forecasts of customer needs from marketing personnel
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Preparing the Master Budget:
An Illustration
Ellis Magnet Co. is preparing budgets for the quarter
ending June 30. The sales price is $10 per magnet.
Budgeted sales for the next four months are:
April
May
June
July
20,000 magnets
50,000 magnets
30,000 magnets
25,000 magnets
@ $10 =
@ $10 =
@ $10 =
@ $10 =
$200,000
$500,000
$300,000
$250,000
The Sales Budget
July is needed for June ending inventory computations.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Sales
Budget
McGraw-Hill/Irwin
Production
Budget
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Ellis wants ending inventory
to be 20 percent of the next month’s
budgeted sales in units.
4,000 units were on hand March 31.
Let’s prepare the production budget.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Production must be adequate to meet
budgeted sales and to provide sufficient
ending inventory.
Budgeted product sales in units
+ Desired product units in ending inventory
= Total product units needed
– Product units in beginning inventory
= Product units to produce
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Budgeted unit sales
Desired ending inventory
Total units needed
Less beginning inventory
Units to produce
McGraw-Hill/Irwin
April
20,000
May
50,000
June
30,000
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Budgeted unit sales
Desired ending inventory
Total units needed
Less beginning inventory
Units to produce
April
20,000
10,000
30,000
May
50,000
6,000
56,000
June
30,000
5,000
35,000
Ending inventory = 20% of next month's production needs.
June ending inventory = .20 × 25,000 July units = 5,000 units.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Budgeted unit sales
Desired ending inventory
Total units needed
Less beginning inventory
Units to produce
April
20,000
10,000
30,000
4,000
26,000
May
50,000
6,000
56,000
10,000
46,000
June
30,000
5,000
35,000
6,000
29,000
Ending inventory = 20% of next month's production needs.
June ending inventory = .20 × 25,000 July units = 5,000 units.
Beginning inventory is last month's ending inventory.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Production
Budget
Units
McGraw-Hill/Irwin
Production
Budget
Material
Purchases
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Material Purchases
The material purchases budget is based on
production quantity and desired material
inventory levels.
×
=
+
=
–
=
Units to produce
Material needed per unit
Material needed for units to produce
Desired units of material in ending inventory
Total units of material needed
Units of material in beginning inventory
Units of material to purchase
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Material Purchases
Five pounds of material are needed for each
unit produced.
Ellis wants to have materials on hand at the
end of each month equal to 10 percent of
the following month’s production needs.
The materials inventory on March 31 is
13,000 pounds. July production is
budgeted for 23,000 units.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Material Purchases
Units to produce
Pounds per unit
Material needs (lbs.)
Desired ending inventory
Total material needs (lbs.)
Less beginning inventory
Material purchases (lbs.)
McGraw-Hill/Irwin
April
26,000
5
130,000
May
46,000
5
230,000
June
29,000
5
145,000
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Material Purchases
Units to produce
Pounds per unit
Material needs (lbs.)
Desired ending inventory
Total material needs (lbs.)
Less beginning inventory
Material purchases (lbs.)
April
26,000
5
130,000
23,000
153,000
May
46,000
5
230,000
14,500
244,500
June
29,000
5
145,000
11,500
156,500
Ending inventory = 10% of next month's material needs.
June ending inventory = .10 × (23,000 units × 5 lbs. per unit).
June ending inventory = 11,500 lbs.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Material Purchases
Units to produce
Pounds per unit
Material needs (lbs.)
Desired ending inventory
Total material needs (lbs.)
Less beginning inventory
Material purchases (lbs.)
April
26,000
5
130,000
23,000
153,000
13,000
140,000
May
46,000
5
230,000
14,500
244,500
23,000
221,500
June
29,000
5
145,000
11,500
156,500
14,500
142,000
Ending inventory = 10% of next month's material needs.
June ending inventory = .10 × (23,000 units × 5 lbs. per unit).
June ending inventory = 11,500 lbs.
Beginning inventory is last month's ending inventory.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Material Purchases
Materials used in production cost $.40
per pound. One-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 discount terms are available.
The accounts payable balance on
March 31 is $12,000.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Material Purchases
Material purchases (lbs.)
Cost per pound
Total cost
Payables from March
April purchases
May purchases
June purchases
Total payments in month
McGraw-Hill/Irwin
April
140,000
$ 0.40
$ 56,000
May
221,500
$ 0.40
$ 88,600
June
142,000
$ 0.40
$ 56,800
$ 12,000
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Material Purchases
Material purchases (lbs.)
Cost per pound
Total cost
Payables from March
April purchases
May purchases
June purchases
Total payments in month
April
140,000
$ 0.40
$ 56,000
May
221,500
$ 0.40
$ 88,600
$ 12,000
28,000
$ 28,000
June
142,000
$ 0.40
$ 56,800
½ × $56,000 = $28,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Material Purchases
Material purchases (lbs.)
Cost per pound
Total cost
Payables from March
April purchases
May purchases
June purchases
Total payments in month
April
140,000
$ 0.40
$ 56,000
$ 12,000
28,000
May
221,500
$ 0.40
$ 88,600
June
142,000
$ 0.40
$ 56,800
$ 28,000
44,300
$ 44,300
½ × $56,000 = $28,000
½ × $88,600 = $44,300
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Material Purchases
Material purchases (lbs.)
Cost per pound
Total cost
Payables from March
April purchases
May purchases
June purchases
Total payments in month
April
140,000
$ 0.40
$ 56,000
$ 12,000
28,000
$ 40,000
May
221,500
$ 0.40
$ 88,600
$ 28,000
44,300
$ 72,300
June
142,000
$ 0.40
$ 56,800
$ 44,300
28,400
$ 72,700
½ × $56,000 = $28,000
½ × $88,600 = $44,300
½ × $56,800 = $28,400
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Production
Budget
Units
Material
McGraw-Hill/Irwin
Production
Budget
Labor
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Direct Labor
Each unit produced requires 3 minutes (.05
hours) of direct labor. Ellis employs 30
persons for 40 hours each week at a rate of
$10 per hour. Any extra hours needed are
obtained by hiring temporary workers also
at $10 per hour.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Direct Labor
Units to produce
Hours per unit
Total hours required
Wage rate per hour
Direct labor cost
McGraw-Hill/Irwin
April
26,000
0.05
1,300
May
46,000
0.05
2,300
June
29,000
0.05
1,450
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Direct Labor
Units to produce
Hours per unit
Total hours required
Wage rate per hour
Direct labor cost
McGraw-Hill/Irwin
April
26,000
0.05
1,300
$
10
$ 13,000
May
46,000
0.05
2,300
$
10
$ 23,000
June
29,000
0.05
1,450
$
10
$ 14,500
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Production
Budget
Production
Budget
Units
Material
Labor
Manufacturing
Overhead
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Production Budget
Manufacturing Overhead
Variable manufacturing overhead is $1 per
unit produced and fixed manufacturing
overhead is $50,000 per month.
Fixed manufacturing overhead includes
$20,000 in depreciation which does not
require a cash outflow.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Manufacturing Overhead
Units to produce
Variable overhead rate
Variable overhead cost
Fixed overhead
Total mfg. overhead cost
Deduct depreciation
Manufacturing overhead - cash
McGraw-Hill/Irwin
April
26,000
$ 1.00
$ 26,000
May
46,000
$ 1.00
$ 46,000
June
29,000
$ 1.00
$ 29,000
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Manufacturing Overhead
Units to produce
Variable overhead rate
Variable overhead cost
Fixed overhead
Total mfg. overhead cost
Deduct depreciation
Manufacturing overhead - cash
McGraw-Hill/Irwin
April
26,000
$ 1.00
$ 26,000
50,000
$ 76,000
May
46,000
$ 1.00
$ 46,000
50,000
$ 96,000
June
29,000
$ 1.00
$ 29,000
50,000
$ 79,000
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
Manufacturing Overhead
April
Units to produce
26,000
Variable overhead rate
$ 1.00
Variable overhead cost
$ 26,000
Fixed overhead
50,000
Total mfg. overhead cost
$ 76,000
Deduct depreciation
20,000
Manufacturing overhead - cash $ 56,000
McGraw-Hill/Irwin
May
46,000
$ 1.00
$ 46,000
50,000
$ 96,000
20,000
$ 76,000
June
29,000
$ 1.00
$ 29,000
50,000
$ 79,000
20,000
$ 59,000
© The McGraw-Hill Companies, Inc., 2002
Selling and Administrative
(S&A) Expense Budget
Production
Budget
McGraw-Hill/Irwin
Selling
and
Administrative
Expense
Budget
© The McGraw-Hill Companies, Inc., 2002
Selling and Administrative
(S&A) Expense Budget
 Selling expense budgets contain both
variable and fixed items.

Variable items: shipping costs and sales
commissions.

Fixed items: advertising and sales salaries.
 Administrative expense budgets contain
mostly fixed items.

Executive salaries and depreciation on company
offices.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
(S&A) Expenses
Variable selling and administrative
expenses are $.50 per unit sold and fixed
selling and administrative expenses are
$70,000 per month.
Fixed selling and administrative expenses
include $10,000 in depreciation which does
not require a cash outflow.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
(S&A) Expenses
Budgeted unit sales
Variable S&A per unit
Variable S&A expense
Fixed S&A expense
Total S&A expense
Deduct depreciation
S&A expense - cash
McGraw-Hill/Irwin
April
20,000
$ 0.50
$ 10,000
70,000
$ 80,000
May
50,000
$ 0.50
$ 25,000
70,000
$ 95,000
June
30,000
$ 0.50
$ 15,000
70,000
$ 85,000
© The McGraw-Hill Companies, Inc., 2002
Cash Payments for
(S&A) Expenses
Budgeted unit sales
Variable S&A per unit
Variable S&A expense
Fixed S&A expense
Total S&A expense
Deduct depreciation
S&A expense - cash
McGraw-Hill/Irwin
April
20,000
$ 0.50
$ 10,000
70,000
$ 80,000
10,000
$ 70,000
May
50,000
$ 0.50
$ 25,000
70,000
$ 95,000
10,000
$ 85,000
June
30,000
$ 0.50
$ 15,000
70,000
$ 85,000
10,000
$ 75,000
© The McGraw-Hill Companies, Inc., 2002
Cash Receipts Budget
I have seen a lot of cash
payments but no cash
receipts. Show me some
cash receipts!
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Receipts Budget
All sales are on account.
Ellis’s collection pattern is:
70 percent collected in month of sale
25 percent collected in month after sale
5 percent will be uncollectible
Accounts receivable on March 31 is
$30,000, all of which is collectible.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Receipts Budget
Budgeted unit sales
Price per unit
Budgeted sales revenue
Receipts from March sales
Receipts from April sales
Receipts from May sales
Receipts from June sales
Total cash receipts
McGraw-Hill/Irwin
April
20,000
$
10
$ 200,000
May
50,000
$
10
$ 500,000
June
30,000
$
10
$ 300,000
$ 30,000
© The McGraw-Hill Companies, Inc., 2002
Cash Receipts Budget
Budgeted unit sales
Price per unit
Budgeted sales revenue
Receipts from March sales
Receipts from April sales
Receipts from May sales
Receipts from June sales
Total cash receipts
April
20,000
$
10
$ 200,000
May
50,000
$
10
$ 500,000
$ 30,000
140,000
$ 50,000
June
30,000
$
10
$ 300,000
$ 170,000
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Receipts Budget
Budgeted unit sales
Price per unit
Budgeted sales revenue
Receipts from March sales
Receipts from April sales
Receipts from May sales
Receipts from June sales
Total cash receipts
April
20,000
$
10
$ 200,000
$ 30,000
140,000
$ 170,000
May
50,000
$
10
$ 500,000
June
30,000
$
10
$ 300,000
$ 50,000
350,000
$ 125,000
$ 400,000
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000
May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Cash Receipts Budget
Budgeted unit sales
Price per unit
Budgeted sales revenue
Receipts from March sales
Receipts from April sales
Receipts from May sales
Receipts from June sales
Total cash receipts
April
20,000
$
10
$ 200,000
$ 30,000
140,000
$ 170,000
May
50,000
$
10
$ 500,000
$ 50,000
350,000
$ 400,000
June
30,000
$
10
$ 300,000
$ 125,000
210,000
$ 335,000
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000
May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000
June: .70 × $300,000 = $210,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Comprehensive Cash Budget
With just a little
more information
we will be able to
prepare a
comprehensive
cash budget.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Comprehensive Cash Budget
Additional Information
Ellis Magnet Company:
 Has a $100,000 line of credit at its bank, with a zero
balance on April 1.
 Maintains a $30,000 minimum cash balance.
 Borrows at the beginning of a month and repays at the
end of a month.
 Pays interest at 16 percent when a principal payment is
made.
 Pays a $51,000 cash dividend in April.
 Purchases equipment costing $143,700 in May and
$48,800 in June.
 Has a $40,000 cash balance on April 1.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Comprehensive Cash Budget
Beginning cash balance
Cash receipts
Cash available
April
$ 40,000
May
June
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
Balance before financing
Borrowing
Principal repayment
Interest
Ending cash balance
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Comprehensive Cash Budget
Beginning cash balance
Cash receipts
Cash available
April
$ 40,000
170,000
$ 210,000
May
400,000
June
335,000
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
Balance before financing
Borrowing
Principal repayment
Interest
Ending cash balance
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Comprehensive Cash Budget
Beginning cash balance
Cash receipts
Cash available
April
$ 40,000
170,000
$ 210,000
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
$ 40,000
13,000
56,000
70,000
0
51,000
$ 230,000
Balance before financing
$ (20,000)
May
June
400,000
335,000
$ 72,300
23,000
76,000
85,000
143,700
0
$ 400,000
$ 72,700
14,500
59,000
75,000
48,800
0
$ 270,000
Borrowing
Principal repayment
Interest
Ending cash balance
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Comprehensive Cash Budget
Beginning cash balance
Cash receipts
Cash available
April
$ 40,000
170,000
$ 210,000
May
$ 30,000
400,000
$ 430,000
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
$ 40,000
13,000
56,000
70,000
0
51,000
$ 230,000
$ 72,300
23,000
76,000
85,000
143,700
0
$ 400,000
Balance before financing
$ (20,000)
$ 30,000
Borrowing
Principal repayment
Interest
Ending cash balance
50,000
0
0
$ 30,000
McGraw-Hill/Irwin
June
335,000
$ 72,700
14,500
59,000
75,000
48,800
0
$ 270,000
© The McGraw-Hill Companies, Inc., 2002
Comprehensive Cash Budget
Beginning cash balance
Cash receipts
Cash available
April
$ 40,000
170,000
$ 210,000
May
$ 30,000
400,000
$ 430,000
June
$ 30,000
335,000
$ 365,000
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
$ 40,000
13,000
56,000
70,000
0
51,000
$ 230,000
$ 72,300
23,000
76,000
85,000
143,700
0
$ 400,000
$ 72,700
14,500
59,000
75,000
48,800
0
$ 270,000
Balance before financing
$ (20,000)
$ 30,000
$ 95,000
Borrowing
Principal repayment
Interest
Ending cash balance
50,000
0
0
$ 30,000
0
0
0
$ 30,000
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Comprehensive Cash Budget
Beginning cash balance
Cash receipts
Cash available
April
$ 40,000
170,000
$ 210,000
May
$ 30,000
400,000
$ 430,000
June
$ 30,000
335,000
$ 365,000
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
$ 40,000
13,000
56,000
70,000
0
51,000
$ 230,000
$ 72,300
23,000
76,000
85,000
143,700
0
$ 400,000
$ 72,700
14,500
59,000
75,000
48,800
0
$ 270,000
Balance before financing
$ (20,000)
$ 30,000
$ 95,000
Borrowing
50,000
0
Principal repayment
0
0
$50,000 × .16 × 3/12
= $2,000
Interest
0
0
Ending cash balance
$ 30,000
$ 30,000
McGraw-Hill/Irwin
0
(50,000)
(2,000)
$ 43,000
© The McGraw-Hill Companies, Inc., 2002
The Budgeted
Income Statement
Cash
Budget
McGraw-Hill/Irwin
Budgeted
Income
Statement
© The McGraw-Hill Companies, Inc., 2002
The Budgeted
Income Statement
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10)
McGraw-Hill/Irwin
$ 1,000,000
© The McGraw-Hill Companies, Inc., 2002
The Budgeted
Income Statement
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10)
Cost of goods sold (100,000 @ $4.99)
Gross margin
$ 1,000,000
499,000
$ 501,000
Computation of unit cost follows
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
The Budgeted
Income Statement
Production costs per unit
Direct materials
Direct labor
Manufacturing overhead
Total unit cost
Quantity
Cost
5.00 lbs. $ 0.40
0.05 hrs. $ 10.00
0.05 hrs. $ 49.70
Total
$ 2.00
0.50
2.49
$ 4.99
Total mfg. OH for quarter $251,000 = $49.70 per hr.
Total labor hours required 5,050 hrs.
From labor and Mfg. OH budgets
April
May
June
Total
McGraw-Hill/Irwin
Labor Hours
1,300
2,300
1,450
5,050
Mfg. OH
$ 76,000
96,000
79,000
$ 251,000
Manufacturing
overhead is applied
based on
direct labor hours.
© The McGraw-Hill Companies, Inc., 2002
The Budgeted
Income Statement
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10)
$ 1,000,000
Cost of goods sold (100,000 @ $4.99)
499,000
Gross margin
$ 501,000
Selling and administrative expenses
260,000
Operating income
$ 241,000
McGraw-Hill/Irwin
From S&A Expense Budget
April
$ 80,000
May
95,000
June
85,000
Total
$ 260,000
© The McGraw-Hill Companies, Inc., 2002
The Budgeted
Income Statement
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10)
Cost of goods sold (100,000 @ $4.99)
Gross margin
Selling and administrative expenses
Operating income
Interest expense
Net income
McGraw-Hill/Irwin
$ 1,000,000
499,000
$ 501,000
260,000
$ 241,000
2,000
$ 239,000
© The McGraw-Hill Companies, Inc., 2002
The Budgeted
Balance Sheet
Budgeted
Income
Statement
McGraw-Hill/Irwin
Budgeted
Balance
Sheet
© The McGraw-Hill Companies, Inc., 2002
The Budgeted
Balance Sheet
Ellis reports the following account balances
on June 30, prior to preparing its budgeted
financial statements:





McGraw-Hill/Irwin
Land - $50,000
Building (net) - $174,500
Common stock - $200,000
Equipment (net) - $192,500
Retained earnings - $148,150
© The McGraw-Hill Companies, Inc., 2002
Ellis Magnet Company
Budgeted Balance Sheet
June 30, 2002
Current assets
Cash
$ 43,000
Accounts receivable
75,000
Raw materials inventory
4,600
Finished goods inventory
24,950
Total current assets
$ 147,550
Property and equipment
Land
$ 50,000
Building
174,500
Equipment
192,500
Total property and equipment $ 417,000
Total assets
$ 564,550
Liabilities and Equities
Accounts payable
Common stock
Retained earnings
Total liabilities and equities
McGraw-Hill/Irwin
$ 28,400
200,000
336,150
$ 564,550
25% of June
sales of
$300,000
11,500 lbs.
@ $.40 per lb.
5,000 units
@ $4.99 each
50% of June
purchases
of $56,800
© The McGraw-Hill Companies, Inc., 2002
Ellis Magnet Company
Budgeted Balance Sheet
June 30, 2002
Current assets
Cash
$ 43,000
Accounts receivable
75,000
Raw materials inventory
4,600
Finished goods inventory
24,950
Total current assets
$ 147,550
Property and equipment
Beginning balance $ 148,150
Land
$ 50,000
Add:
net income
239,000
Building
174,500
Deduct:
dividends
(51,000)
Equipment
192,500
Ending
balance
$ 336,150
Total
property and
equipment $ 417,000
Total assets
$ 564,550
Liabilities and Equities
Accounts payable
Common stock
Retained earnings
Total liabilities and equities
McGraw-Hill/Irwin
$ 28,400
200,000
336,150
$ 564,550
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Let’s
change
topics.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Consider the following
condensed example
from the Cheese
Company . . .
Hmm! Comparing
costs at different
levels of activity
is like comparing
apples with oranges.
Performance
evaluation is difficult
when actual activity
differs from the activity
originally budgeted.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Units of Activity
Variable costs
Indirect labor
Indirect materials
Power
Fixed costs
Depreciation
Insurance
Total overhead costs
McGraw-Hill/Irwin
Original
Budget
Actual
Results
Variances
10,000
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
$6,000 F
4,500 F
1,200 F
12,000
2,000
12,000
2,000
$ 89,000
$ 77,300
0
0
$11,700 F
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Units of Activity
Original
Budget
Actual
Results
Variances
10,000
8,000
2,000 U
Variable costs
U = Unfavorable variance – Cheese
Indirect labor
$ 40,000
$ 34,000
Company was
unable to achieve
Indirect materials
30,000
25,500
the budgeted5,000
level of activity.
Power
3,800
Fixed costs
Depreciation
Insurance
Total overhead costs
McGraw-Hill/Irwin
12,000
2,000
12,000
2,000
$ 89,000
$ 77,300
$6,000 F
4,500 F
1,200 F
0
0
$11,700 F
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Units of Activity
Variable costs
Indirect labor
Indirect materials
Power
Original
Budget
Actual
Results
Variances
10,000
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
$6,000 F
4,500 F
1,200 F
F = Favorable variance: actual costs
than budgeted
12,000 costs.
12,000
Fixed costs
are less
Depreciation
Insurance
Total overhead costs
McGraw-Hill/Irwin
2,000
2,000
$ 89,000
$ 77,300
0
0
$11,700 F
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Units of Activity
Variable costs
Indirect labor
Indirect materials
Power
Original
Budget
Actual
Results
Variances
10,000
8,000
2,000 U
$ 40,000
30,000
5,000
$ 34,000
25,500
3,800
$6,000 F
4,500 F
1,200 F
Since cost variances are favorable, have
job controlling
costs?
12,000
12,000
Fixed costs
we
done a good
Depreciation
Insurance
2,000
2,000
Total overhead costs
$ 89,000
$ 77,300
McGraw-Hill/Irwin
0
0
$11,700 F
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
I don’t think I can
answer the question
using the original
budget.
McGraw-Hill/Irwin
How much of
the favorable cost
variance is due to lower
activity, and how much is due
to good cost control?
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
I don’t think I can
answer the question
using the original
budget.
How much of
the favorable cost
variance is due to lower
activity, and how much is due
to good cost control?
To answer the question, we must
the budget to the actual level of activity.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Central Concept
If you can tell me what your activity was
for the period, I will tell you what your costs
and revenue should have been.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Show expenses that should have
occurred at the actual level of
activity.
May be prepared for any activity
level in the relevant range.
Reveal variances due to good cost
control or lack of cost control.
Improve performance evaluation.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
To
a budget for different activity
levels, we must know how costs behave
with changes in activity levels.

Total variable costs change
in direct proportion to
changes in activity.

Total fixed costs remain
unchanged within the
relevant range.
McGraw-Hill/Irwin
Fixed
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Cost
Formula
Per Hour
Units of Activity
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
Total
Fixed
Cost
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
10,000
12,000
Variable8,000
costs are
expressed
as
a constant amount per hour.
$
4.00
3.00
0.50
7.50
$ 32,000
In the24,000
original budget, indirect
labor 4,000
was $40,000 for 10,000
$ 60,000
hours resulting in a rate of
$4.00 per hour.
$12,000
2,000
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Cost
Formula
Per Hour
Total
Fixed
Cost
Units of Activity
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
$
4.00
3.00
0.50
7.50
$12,000
2,000
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Cost
Formula
Per Hour
Total
Fixed
Cost
Units of Activity
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
$
Fixed costs
Depreciation
Insurance
Total fixed cost
Total
costs
Totaloverhead
variable
cost
McGraw-Hill/Irwin
4.00
3.00
0.50
7.50
$12,000
2,000
= $7.50 per
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
10,000
12,000
$ 32,000
24,000
4,000
$ 60,000
$ 40,000
30,000
5,000
$ 75,000
$ 48,000
36,000
6,000
$ 90,000
$ 12,000
$ 12,000
2,000
2,000
$ 14,000
$ 14,000
$ 74,000
$ 89,000
unit
× budget
level
$ 12,000
2,000
$ 14,000
in$ 104,000
units
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Cost
Formula
Per Hour
Total
Fixed
Cost
Units of Activity
Variable costs
Indirect labor
Indirect material
Power
Total variable cost
Fixed costs
Depreciation
Insurance
Total fixed cost
Total overhead costs
McGraw-Hill/Irwin
Flexible Budgets
8,000
10,000
12,000
Hours
Hours
Hours
8,000
$
4.00
3.00
0.50
7.50
10,000
12,000
Fixed costs are expressed as a
40,000
48,000
total$ 32,000
amount $that
does $not
24,000
30,000
36,000
change
within the
relevant6,000
4,000
5,000
range of$ activity.
$ 60,000
75,000
$ 90,000
$12,000
2,000
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 89,000
$ 12,000
2,000
$ 14,000
$ 104,000
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Performance Report
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Performance Report
Cost
Formula
Per Hour
Total
Fixed
Costs
Units of Activity
Variable costs
Indirect labor
$
Indirect material
Power
Total variable costs $
Fixed Costs
Depreciation
Insurance
Total fixed costs
Total overhead costs
McGraw-Hill/Irwin
4.00
3.00
0.50
7.50
$12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 77,300
0
0
0
$ 3,300 U
Variances
0
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Performance Report
Cost
Total
Formula Fixed
labor
and Costs
Per Hour
Indirect
indirect material have
Units of Activity
unfavorable variances
Variable costs
because
costs
Indirect
labor actual
$ 4.00
are
more than3.00
the
Indirect
material
Power
flexible budget 0.50
costs.
Total variable costs $
Fixed Costs
Depreciation
Insurance
Total fixed costs
Total overhead costs
McGraw-Hill/Irwin
7.50
$12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 77,300
0
0
0
$ 3,300 U
Variances
0
© The McGraw-Hill Companies, Inc., 2002
Flexible Budgeting
Performance Report
Cost
Formula
Per Hour
Total
Fixed
Costs
Units of Activity
Power has a favorable
Variable costs
variance because
the
Indirect labor
$ 4.00
actualmaterial
cost is less
than
Indirect
3.00
Power
0.50
the flexible budget
cost.
Total variable costs $
Fixed Costs
Depreciation
Insurance
Total fixed costs
Total overhead costs
McGraw-Hill/Irwin
7.50
$12,000
2,000
Flexible
Budget
Actual
Results
8,000
8,000
$ 32,000
24,000
4,000
$ 60,000
$ 34,000
25,500
3,800
$ 63,300
$ 2,000 U
1,500 U
200 F
$ 3,300 U
$ 12,000
2,000
$ 14,000
$ 74,000
$ 12,000
2,000
$ 14,000
$ 77,300
0
0
0
$ 3,300 U
Variances
0
© The McGraw-Hill Companies, Inc., 2002
End of Chapter 22
I would be happy to assist
you with your cash budget!
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2002