PROFIT PLANNING/
BUDGETING
ACC 2203 Review Workshop
Sindhu Bala
BUDGETING – DEFINITIONS
Master Budget – a comprehensive plan of all aspects of a firm’s future
business and production operations
Master budget comprises of many separate budgets. These budgets
include:
 Sales Budget – forecasts future sales quantities, selling prices, and
sales revenues
 Production Budget – shows the number of units of each good
expected to be produced
 Budgeted Manufacturing Costs – prediction of the amounts and
costs of each input required to manufacture expected production
quantities
 Direct Materials Budget
 Direct Labor Budget
 Manufacturing Overhead Budget
 Selling and Administrative Expense Budget – prediction of all
selling costs required for attaining forecasted sales levels; prediction of
administrative costs
 Budgeted Income Statement
 Capital Expenditure Budget
 Cash Budget
 Budgeted Balance Sheet
BUDGETING – DEFINITIONS
All firms make plans and decisions, such as
 Deciding what to produce and how much to produce (production
capacity)
 Deciding what inputs and how much of each input to use
 Deciding what prices to charge and what type of a marketing strategy to
pursue
Budgets allow firms to see the impact of their decisions and plans and to
improve on their decisions and plans (planning function of budgets).
Firms that systematically prepare budgets can:
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See projected earnings and cash flows from the plans
Detect potential problems before they occur
Line-up additional financing that may be needed
Coordinate actions of different division within the firm
Budgets set benchmarks for evaluating subsequent performance
(control function of budgeting)
THE MASTER BUDGET: AN OVERVIEW
Sales
Budget
Ending
Finished Goods
Budget
Direct
Materials
Budget
Production
Budget
Selling and
Administrative
Budget
Direct
Labor
Budget
Manufacturing
Overhead
Budget
Cash
Budget
Budgeted Financial Statements
MASTER BUDGET FOR A SAMPLE
COMPANY
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The Foster Company is a manufacturer of cashmere
sweaters. Each year in October, Foster put together its
Master Budget for the four quarters of the following
year.
SALES BUDGET – predicts sales quantities and
selling prices to determine the amount of sales revenue
the company expects to generate
What factors do companies take into account when they
decide how many units they can sell and what price to
charge for each unit?
Customers tastes
Production and advertising strategies
Competitors
Production capacity
Changes in the economy
FOSTER COMPANY - SALES
BUDGET
The Foster Company has predicted that it can maximize its profits if it
charges $200 for its sweaters. The marketing manager of the
company has indicated that at a price of $200 the company can sell
1,000 sweaters in the first quarter of 2007. Due to an emerging
trend observed in fashion houses toward using cashmere sweaters
in their creations, the marketing manager predicts to increase its
sales by 100 sweaters each quarter.
1st
Expected Sales
(in units)
Selling price
per unit
Total Sales
Revenue
Foster Company
Sales Budget for 2007
Quarter
nd
2
3rd
4th
Year
1,000
x $200
x $200
x $200
x $200
x $200
FOSTER COMPANY - COLLECTIONS
BUDGET
SCHEDULE OF EXPECTED CASH COLLECTIONS
– when do we expect to receive cash for the sales we
have made?
Cash collection information:
1.
Of all sales 80% are on credit
2.
70% of credit sales are collected in the quarter in
which the sale is made and 30% are collected in the
following quarter
3.
Accounts receivable is estimated to be $60,000 on
December 31, 2006; the company expects to collect
the outstanding receivables in the first quarter of
2007
FOSTER COMPANY - COLLECTIONS
BUDGET
Quarter
Foster Company
Schedule of Expected Cash Collections for 2007
Expected
Credit
Cash Collections By Quarter
st
Sales
Sales
1
2nd
3rd
A/R
1st
2nd
3rd
4th
Cash collected on credit sales & A/P
Cash collected on cash sales
Total cash collected
4th
FOSTER COMPANY - PRODUCTION
BUDGET
PRODUCTION BUDGET – predicts the number
of units the firm plans to produce during the
budget period.
Finished Goods Inventory
Beginning F.G Inventory
Units Produced
Ending F.G Inventory
Units Sold
FOSTER COMPANY - PRODUCTION
BUDGET
Note that the number of units a firm plans to
produce many not equal the number of units it
plans to sell. Explain why?
FOSTER COMPANY - PRODUCTION
BUDGET
Foster maintains at the end of each quarter an inventory of
10% of the next quarter’s sales. This allows the company to
better meet its customers’ needs in case the customers
experience a sudden surge in demand.
Foster Company
Production Budget for 2007
Quarters
1st
2nd
3rd
Expected sales
(in units)
Add desired units
in ending finished
goods inventory
Total units needed
Less units in
beginning finished
goods inventory
Units to be
produced
4th
Year
FOSTER COMPANY – MANUFACTURING
COSTS
BUDGETED MANUFACTURING COSTS – Estimated amounts and costs
of inputs necessary to produce the budgeted production quantities
Companies estimate the amounts and costs of DL, DM, and OH they expect
to use to make one unit of a product. These estimates are called standard
quantity of input and standard cost of input (per unit of output).
Direct Materials (cashmere): Foster expects to use on average ½ lb. of
cashmere to make one sweater. Expected price for a pound of raw
cashmere is $30.
Direct Labor: Although somewhat automated, dying, combing, knitting,
and weaving cashmere is a tedious process that requires some direct
labor. Each sweater on average requires 1 hour of skilled labor. Foster
pays its skilled workers $20/hour.
Variable Overhead: Foster expects to incur $1 per machine hour for
indirect materials such as lubricants and cooling fluids, $1.5 per machine
hour for utilities, and $2.5 per machine hour for indirect labor. On
average it takes 2 hours of machine time to make one cashmere sweater
(primarily due to the delicate nature of cashmere and the attention it
requires)
FOSTER COMPANY – MANUFACTURING
COSTS
Fixed Overhead: Foster expects to incur $69,600 in machine depreciation,
$60,000 in factory supervisor salary, and $56,000 in factory rent and
insurance. Foster allocates OH on the basis of machine hours.
FOH =
FOH Rate =
FOSTER COMPANY – BUDGETED COSTS
Foster Company
Budgeted (standard) cost for one cashmere sweater in 2007
Budgeted quantity
of input to make one
sweater
Direct Materials
Direct Labor
Variable overhead
Fixed overhead
Total budgeted cost
per unit
Budgeted cost of
input
Total budgeted cost
FOSTER COMPANY – DM BUDGET
DIRECT MATERIALS BUDGET – Estimated
amounts and costs of direct materials that need to be
purchased to manufacture the budgeted units and to
maintain a materials inventory
Materials Inventory
Beginning Inventory
Materials used in production
Materials Purchased
Ending Inventory
Foster keeps at the beginning of each quarter a materials
inventory of 10% of the quarter’s raw materials needs.
FOSTER COMPANY – DM BUDGET
Foster Company
Direct Materials Budget for 2007
Quarter
st
nd
1
2
3rd
Units to be
produced
DM needed per
unit
DM needed for
production
Add desired ending
inv. of materials
Total DM required
Less beginning DM
inventory
DM to be
purchased
Cost per pound
Total cost of DM
purchases
4th
Year
FOSTER COMPANY – CASH
DISBURSEMENTS
SCHEDULE OF EXPECTED CASH
DISBURSEMENTS FOR MATERIALS –
shows the amount and timing of cash payments
the firm has to make to its suppliers.
Cash Disbursement Information:
1. Direct materials are all purchased on credit
2. Foster usually pays 60% of its purchases in the
same quarter as the purchase and the rest is
paid in the following quarter
3. The company expects to have an accounts
payable balance of $40,000 on December 31,
2002; and all outstanding payables are expected
to be paid in the first quarter of 2007
FOSTER COMPANY – CASH
DISBURSEMENTS
Foster Company
Schedule Of Expected Cash Disbursements For Materials, 2007
Quarter of
Total
Quarter in which cash is paid
st
purchases
purchases
1
2nd
3rd
A/P, beginning
1st quarter
2nd quarter
3rd quarter
4th quarter
Total cash
disbursements
4th
FOSTER COMPANY – DL BUDGET
DIRECT LABOR BUDGET – provides an
estimate of the amount and cost of direct labor
time required to fulfill the budgeted production
Each cashmere sweater requires 1 hour of skilled
labor. Foster pays its skilled workers $20/hour.
FOSTER COMPANY – DL BUDGET
Foster Company
Direct Labor Budget for 2007
Quarter
st
nd
1
2
3rd
4th
1 DLH
1 DLH
Year
Units to be
produced
DL hours per unit
Total DL hours
needed for
production
Cost per DL hour
Total cost of DL
1 DLH
1 DLH
1 DLH
FOSTER COMPANY – MOH BUDGET
MANUFACTURING OVERHEAD BUDGET - provides an
estimate of the cost of variable and fixed overhead required to
fulfill the budgeted production
Variable overhead rate is $5 per machine hour (costs of indirect
materials, utilities, and indirect labor combined). Foster
expects to use 2 MHs per unit.
Fixed overhead cost is $185,600 ($69,600 in machine
depreciation, $60,000 in factory supervisor salary, and
$56,000 in factory rent and insurance combined). Fixed
overhead is allocated on the basis of machine hours at a
predetermined OH rate of $20/MH.
Fixed OH rate for cash items:
FOH rate =
Fixed OH rate for non-cash items:
FOH =
FOSTER COMPANY – MOH BUDGET
Foster Company
Manufacturing Overhead Budget for 2007
Quarter
st
nd
1
2
3rd
4th
Units to be
produced
Total VOH
costs
Total cash
FOH costs
Total cash OH
Total non-cash
FOH costs
Total OH costs
Year
FOSTER COMPANY – S&A BUDGET
SELLING AND ADMINISTRATIVE EXPENSE BUDGET – Estimates of all costs
necessary to attain the sales levels in the sales budget and to deliver the goods to
the customer (selling expenses) and estimates of all administrative activities
(administrative expenses)
Variable selling and administrative expenses for each cashmere sweater are 10%
sales commission and an average shipping costs of $10 per sweater.
Fixed selling and administrative expenses for the year are:
Advertising
Executive salaries
Insurance
Depreciation
Total fixed S&A
$60,000
$120,000
$40,000
$20,000
$240,000
Fixed S&A expenses are assumed to be the same in each quarter
Fixed cash S&A expenses for each quarter:
Fixed non-cash S&A expenses for each quarter:
FOSTER COMPANY – S&A BUDGET
Foster Company
Selling and Administrative Expense Budget for 2007
Quarter
st
nd
1
2
3rd
4th
Units to be sold
Total variable S&A
expenses
Total fixed S&A
expenses – cash
Total fixed S&A
expenses – non-cash
Total S&A expenses
Total cash S&A
expenses
Year
CASH BUDGET – EXPECTED CASH OUTFLOWS TO AND
INFLOWS FROM OPERATIONS AND FINANCING
Add
Less
Add
Less
CASH BUDGET
Cash balance, beginning
Cash receipts:
Cash sales
Collections on credit sales
Receipts of dividends and/or interest
Receipts from sales of equipment and/or other assets
Total cash available before financing
Cash disbursements:
Payments for direct materials
Payments for direct labor
Payments for manufacturing overhead
Payments for selling and administrative expenses
Payments for equipment purchases, dividends, and income taxes
Total cash disbursements
Excess (deficiency) of cash available over disbursements
Financing:
New borrowings
Interest payments and/or repayments of principal
Total financing
Cash balance, ending
FOSTER COMPANY – CASH BUDGET
The Foster Company has provided the following information for preparing a cash budget:
 Expected cash balance on 1/1/2007 = $40,000 (1)
Information on cash receipts:
 80% of all sales are on credit. 70% of credit sales are collected in the quarter in which the
sale is made and 30% are collected in the following quarter. A/R is estimated to be
$60,000 on 12/31/2006; the company expects to collect the outstanding A/R in the 1st
quarter of 2007.
 In the 1st quarter of 2007, Foster expects to sell marketable securities that are valued at
$10,000. (2)
Information on cash disbursements:
 Direct materials are all purchased on credit. Foster usually pays 60% of its purchases in
the same quarter as the purchase and the rest is paid in the following quarter. The
company expects to have an accounts payable balance of $40,000 on December 31, 2006;
and all outstanding payables are expected to be paid in the first quarter of 2007.
 All employees – direct laborers, supervisors, S&A staff – are all paid in the quarter in
which their services are used.
 Overhead costs and S&A expenses are paid in the quarter in which they are incurred
 On April 1, 2007, the company plans to spend $90,000 to buy a high-end knitting
machine, which has a 10-year useful life. (3)
Information on financing:
 The company expects to obtain a loan for the full amount of the knitting machine on April
1, 2007. No principal will be repaid during the year; interest at an annual rate of 10% is
due quarterly. The company does not expect to issue stock or pay any dividends in 2007.
(4)
FOSTER COMPANY – CASH BUDGET
Foster Company
Cash Budget for 2007
Quarter
1st
CASH – BEGINNING
Cash receipts:
Cash sales
Collections on credit sales
Sale of securities
TOTAL CASH RECEIPTS
TOTAL CASH AVAILABLE
Cash disbursements:
Payments for DM
Payments for DL
Payments for OH
Payments for S&A
Purchase of machine
TOTAL CASH DISBURSED
Excess (deficiency) of cash
available over disbursements
2nd
3rd
$119,970
4th
FOSTER COMPANY – CASH BUDGET
Excess (deficiency) of
cash available over
disbursements
Excess (deficiency) of
cash available over
disbursements
Financing:
Borrowings
Interest payments
TOTAL FINANCING
CASH - ENDING
FOSTER COMPANY – BUDGETED
INCOME STATEMENT
BUDGETED INCOME STATEMENT – projection
of net income the company expects to earn as a
result of all the budgeted activities
Foster Company
Budgeted Income Statement for 2007
Sales
COGS
Gross Margin
S&A expense
Net operating income
Interest expense
Net income
FOSTER COMPANY – BUDGET
BALANCE SHEET
BUDGETED BALANCE SHEET – projection of the company’s assets, liabilities, and
shareholders’ equity at the end of the budget period
The Foster Inc.’s balance sheet for 12/31/2006 includes the following items:
Plant. Property, and equipment
$560,000
Common stock
$450,000
Accumulated depreciation
$77,150
Retained earnings $112,865
FOSTER COMPANY – BUDGET
BALANCE SHEET
Foster Company
Budgeted Balance Sheet for 2007
TOTAL ASSETS
Cash
Accounts receivable
Finished goods inventory
Raw materials inventory
Plant, property, and equipment
Less: Accumulated depreciation
Total Assets
FOSTER COMPANY – BUDGET
BALANCE SHEET
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable
Long term debt
Common stock
Retained earnings
Total liabilities and equity