Chapter 20
Budgeting
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
1
Objectives
1. Describe budgeting, its objectives, and its
impact on human behavior.
2. Describe the basic elements of the budget
process, the two major types of budgeting,
and the use of computers in budgeting.
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.
2
Nature and Objectives of Budgeting
Objectives of Budgeting
Establishing
specific goals
Executing plans to achieve the goals
Periodically comparing actual results to
the goals
PLANNING
DIRECTING
CONTROLLING
3
Nature and Objectives of Budgeting
Human Behavior and Budgeting
Setting budget goals too tightly
Setting budget goals too loosely
Setting conflicting budget goals
4
Nature and Objectives of Budgeting
Goal conflict occurs
when individual selfinterest differs from
business objectives.
A student’s question, “Will this be on the
test?” is evidence of goal conflict.
5
Static Budgets
Description:
Strength:
Weakness:
Typical usage:
A budget that does not
reflect potential changes in
volume or activity level
It is simple—all expenses
are budgeted as fixed costs
It does not reflect changes in
revenues and expenses that
occur as volumes change
Service organizations or
administrative departments of
retailers and manufacturers
6
Static Budgets
Colter Manufacturing Company
Assembly Department Budget
For the Month Ending July 31, 2006
Direct labor
Electric Power
Supervisor salaries
Total department costs
$40,000
5,000
15,000
$60,000
7
Flexible 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
8
Flexible Budgets
Colter Manufacturing Company
Assembly Department Budget
For the Month Ending July 31, 2006
Units of production
Variable cost:
Direct labor
Electric power
Total variable cost
8,000
9,000
10,000
$40,000
4,000
$44,000
$45,000
4,500
$49,500
$50,000
5,000
$55,000
Cost per unit is $5.50 at all levels of activity
Fixed cost:
Electric power
Supervisor salaries
Total fixed cost
$ 1,000
15,000
$16,000
$ 1,000
15,000
$16,000
Total department costs
$60,000
$65,500 $71,000
$ 1,000
15,000
$16,000
9
Static and Flexible Budgets
Manufacturing Costs
Over budget
by $12,000
Static
Budget
$60,000
Based on 8,000 units
$72,000
Based on 10,000 units
10
Static and Flexible Budgets
Manufacturing Costs
Over budget by
only $1,000
Flexible Budget
8,000
units
9,000
units
10,000
units
10,000
units
$60,000
$65,500
$71,000
$72,000
11
Master Budget
Budgeted Income
Statement requires
Budgeted Balance
Sheet requires
•Sales budget
•Cash budget
•Cost of goods sold budget:
•Capital expenditure budget
• Production budget
• Direct materials purchases budget
• Direct labor cost budget
•Selling and administrative expense budget
12
Income
Statement
Budgets
13
Data for Elite Accessories
Direct Materials sq yd usage
Direct Materials
cost per sq yd
per unit
Wallet Handbag
Leather
0.30
1.25
$4.50
Lining
0.10
0.50
$1.20
Direct labour hours required
per unit
Wallet Handbag
Cutting Dept
0.10
0.15
Sewing Dept
0.25
0.40
Direct labour
cost per hour
$12.00
$15.00
14
Sales
Budget
Production Budget
Expected units of sales
+ Desired units in ending Finished goods inventory
– Estimated units in beginning Finished goods inventory
= Total units to be produced
15
Sales
Budget
Production Budget
Direct Materials
Purchases Budget
Materials needed for production
+ Desired ending materials inventory
– Est. beginning materials inventory
= Direct materials to be purchased
16
Sales
Budget
Production Budget
Direct Materials
Purchases Budget
Cost of Goods
Sold Budget
Selling &
Administrative
Expenses
Budget
Direct Labor
Cost Budget
Factory Overhead
Cost Budget
17
Elite Accessories Inc.
Sales Budget
For the Year Ending December 31, 2006
Product and Region
Unit Sales
Volume
Wallet:
East……………….. 287,000
West………………. 241,000
Total……………. 528,000
Handbag:
East……………….. 156,400
West………………. 123,600
Total……………. 280,000
Total revenue from
Sales………………..
Unit Selling
Price
Total
Sales
$12.00
12.00
$ 3,444,000
2,892,000
$ 6,336,000
$25.00
25.00
$ 3,910,000
3,090,000
$ 7,000,000
$13,336,000
18
Elite Accessories Inc.
Production Budget
For the Year Ending December 31, 2006
From Sales Budget
Expected units to be sold………….
Plus desired ending inventory,
December 31, 2006…………….
Total……………………………….
Less estimated beginning inventory,
January 1, 2006………………….
Total units to be produced…………
Units
Wallet
Handbag
528,000
280,000
80,000
608,000
60,000
340,000
88,000
520,000
48,000
292,000
19
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather
Lining
Square yards required for production:
Wallet (Note A)…………………..
156,000
Total
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.
20
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather
Lining
Square yards required for production:
Wallet (Note A)……..……..……..
Handbag (Note B)………………..
156,000
365,000
Total
52,000
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.
21
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather
Lining
Square yards required for production:
Wallet (Note A)……....…………..
Handbag (Note B).……………….
Plus desired inventory, Dec. 31, 2006
Total………………………………
156,000
365,000
20,000
541,000
Total
52,000
146,000
12,000
210,000
22
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather
Lining
Square yards required for production:
Wallet (Note A) ………………….
Handbag (Note B) ……………….
Plus desired inventory, Dec. 31, 2006
Total………………………………
Less estimated inventory, Jan. 1, 2006
Total square yards to be purchased..
156,000
365,000
20,000
541,000
18,000
523,000
Total
52,000
146,000
12,000
210,000
15,000
195,000
23
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 purchased
523,000 195,000
Unit price (per square yard)…………. x
$4.50 x $1.20
Total value of materials to be purchased. $2,353,500 $234,000 $2,587,500
24
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Hours required for production:
Wallet (Note A)………….
Cutting
Sewing
52,000
130,000
Total
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.
25
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Hours required for production:
Wallet (Note A)………….
Handbag (Note B)………..
Cutting
Sewing
52,000
43,800
130,000
116,800
Total
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
26
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Hours required for production:
Wallet (Note A)………….
Handbag (Note B)………..
Total……………………...
Cutting
Sewing
52,000
43,800
95,800
130,000
116,800
246,800
Total
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
27
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Cutting
Hours required for production:
Wallet (Note A)………….
52,000
Handbag (Note B)………..
43,800
Total……………………...
95,800
Hourly rate…………………… x $12.00
Total direct labor cost………… $1,149,600
Note A: Cutting Department:
Sewing Department:
Note B: Cutting Department:
Sewing Department:
Sewing
Total
130,000
116,800
246,800
x $15.00
$3,702,000 $4,851,600
520,000 units x 0.10 hr. per unit = 52,000 hrs.
520,000 units x 0.25 hr. per unit = 130,000 hrs.
520,000 units x 0.15 hr. per unit = 43,800 hrs.
520,000 units x 0.40 hr. per unit = 116,800 hrs
28
Elite Accessories Inc.
Factory Overhead Cost Budget
For the Year Ending December 31, 2006
Indirect factory wages……………………...$ 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
29
Data for Elite Accessories – cont’d
Estimated Inventories:
January 1, 2006 December 31, 2006
Finished
Goods
Work in
Process
$1,095,600
$1,565,000
$214,400
$220,000
30
Elite Accessories Inc.
Cost of Goods Sold Budget
For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006…..
Work in process inventory, January 1, 2006…
Direct materials:
Direct materials inventory, January 1, 2006
(Note A)…………………………………. $
$ 1,095,600
$ 214,400
99,000
Note A: Leather:
18,000 sq. yds. x $4.50 per sq. yd
Lining:
15,000 sq. yds. x $1.20 per sq. yd
Direct materials
inventory,
January 1, 2006
$81,000
18,000
$99,000
31
Elite Accessories Inc.
Cost of Goods Sold Budget
For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006…..
Work in process inventory, January 1, 2006…
Direct materials:
Direct materials inventory, January 1, 2006
(Note A)…………………………………. $
$ 1,095,600
$ 214,400
99,000
Note B: Leather:
20,000 sq. yds. x $4.50 per sq. yd
Lining:
12,000 sq. yds. x $1.20 per sq. yd
Direct materials inventory, December 31, 2006
$ 90,000
14,400
$104,400
32
Elite Accessories Inc.
Cost of Goods Sold Budget
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 24)……..
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 28)………………………. 4,851,600
Factory overhead (Slide 29)………………….. 2,089,080
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
33
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
34
Elite Accessories Inc.
Budgeted Income Statement
For the Year Ending December 31, 2006
Revenue from sales (slide 18)
$13,336,000
Cost of goods sold (slide 33)
9,047,780
Gross profit
$ 4,288,220
Selling & administrative expenses:
Selling expenses (slide 34)
$1,190,000
Administrative expenses (slide 34)
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
35
The cash budget is one of the
most important elements of the
budgeted balance sheet. We’ll
begin with a schedule of
collection from sales.
36
Data for Elite Accessories – cont’d
Account Receivable, January 1, 2006 = $370,000
January
Budgeted Sales
February
March
$1,080,000 $1,240,000 $970,000
10% of each month’s sales are cash sales, while 90% are credit sales. Of
the credit sales, 60% are collected during the current month while the
other 40% are collected during the following month
Accounts Payable, January 1, 2006 = $190,000
Manufacturing Costs
January
February
March
$840,000
$780,000 $812,000
Depreciation of $24,000 is a non-cash manufacturing cost. Of the cash
manufacturing costs, 75% are paid in the current month while 25% are
37
paid in the following month
Data for Elite Accessories – cont’d
Cash balance on January 1, 2006
$280,000
Quarterly Taxes paid on March 31
$150,000
Quarterly interest expense paid on Jan 10
$22,500
Quarterly interest revenue received on Mar 21
$24,500
Sewing equipment purchased in Feb
$274,000
38
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 A: $108,000 = $1,080,000 x 10%
$124,000 = $1,240,000 x 10%
$ 97,000 = $ 970,000 x 10%
39
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………... $108,000
Receipts from sales on account:
Collections from prior month’s
sales (40%)(see Note B)……. $370,000
Note B:
February
March
$ 124,000
$ 97,000
$ 388,800
$446,400
$370,000, given as January 1, 2006 Accounts
Receivable balance
$388,800 = $1,080,000 x 90% x 40%
$446,400 = $1,240,000 x 90% x 40%
40
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………... $108,000
Receipts from sales on account:
Collections from prior month’s
sales (40%)(see Note B)……. $370,000
Collections from current
month’s sales (60%)(see Note
C)…………………………… 583,200
February
March
$ 124,000
$ 97,000
$ 388,800
$446,400
669,600
523,800
Note C: $583,200 = $1,080,000 x 90% x 60%
$669,600 = $1,240,000 x 90% x 60%
$523,800 = $ 970,000 x 90% x 60%
41
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………...
Receipts from sales on account:
Collections from prior month’s
sales (40%)(see Note B)…….
Collections from current
month’s sales (60%)(see Note
C)……………………………
Total receipts from sales on
account……………………...
January
February
March
$108,000
$ 124,000
$ 97,000
$370,000
$ 388,800
$446,400
583,200
669,600
523,800
$953,200 $1,058,400
$970,200
42
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 A: $190,000, given as January 1, 2006 Accounts
Payable balance
$204,000 = ($840,000 –$24,000) x 25%
$189,000 = ($780,000 – $24,000) x 25%
43
Elite Accessories Inc.
Schedule of Payments for Manufacturing Costs
For the Three Months Ending March 31, 2006
January
Payment of prior month’s
manufacturing costs (25%)
(see Note A)………………… $190,000
Payment of current month’s
manufacturing costs (75%)
(see Note B)…………………. 612,000
February
March
$204,000
$189,000
567,000
591,000
Note B: $612,000 = ($840,000 – $24,000) x 75%
$567,000 = ($780,000 – $24,000) x 75%
$591,000 = ($812,000 – $24,000) x 75%
44
Elite Accessories Inc.
Schedule of Payments for Manufacturing Costs
For the Three Months Ending March 31, 2006
January
Payment of prior month’s
manufacturing costs (25%)
(see Note A)………………… $190,000
Payment of current month’s
manufacturing costs (75%)
(see Note B)…………………. 612,000
Total payments………………. $802,000
February
March
$204,000
$189,000
567,000
$771,000
591,000
$780,000
45
Elite Accessories Inc.
Cash Budget
For the Three Months Ending March 31, 2006
January
Estimated cash receipts:
Cash sales (Slide 42)………….. $ 108,000
Collections of accounts
receivable (Slide 42)………... 953,200
Interest revenue………………...
—
Total cash receipts……………. $1,061,200
Estimated cash payments for:
Manufacturing costs (Slide 45).. $ 802,000
Selling and administrative
expenses……………………… 160,000
Capital additions
Interest expense
22,500
Income taxes
Total cash payments…………. $ 984,500
February
March
$ 124,000
$
1,058,400
—
$1,182,400
970,200
24,500
$1,091,700
$ 771,000
$ 780,000
165,000
274,000
145,000
$1,210,000
97,000
150,000
$1,075,000
46
Elite Accessories Inc.
Cash Budget
For the Three Months Ending March 31, 2006
January
Total cash receipts……………. $1,061,200
Estimated cash payments for:
Manufacturing costs (Slide 45).. $ 802,000
Selling and administrative
expenses……………………… 160,000
Capital additions
Interest expense
22,500
Income taxes
Total cash payments…………. $ 984,500
Cash increase (decrease)………….$ 76,700
Cash balance at beginning of month 280,000
Cash balance at end of month…….$ 356,700
Minimum cash balance…………… 340,000
Excess (deficiency)……………….$
16,700
February
March
$1,182,400
$1,091,700
$ 771,000
$ 780,000
165,000
274,000
145,000
$1,210,000
$ (27,600)
356,700
$ 329,100
340,000
$ (10,900)
150,000
$1,075,000
$ 16,700
329,100
$ 345,800
340,000
$
5,800
47
Software
Spreadsheet software for personal computers
is a powerful and flexible tool for budgeting.
Sensitivity analysis is the systematic varying
of budget data input to determine the effects
of each change on the budget.
Class Example
48