Accounting 203 – Management Accounting
Chapter 8: Profit Planning (the Budget Chapter)
What is a budget?
Define
Example
Advantages
Responsibility Accounting
Self-Imposed Budget
Human Factor (Know
your Culture!)
The Master Budget
Royal Company (not in book) –
ASP = $10
COGS - $4.99
Product = Cheesecakes
Sales Pattern: seasonal
Budgeting Example
Royal Company is preparing budgets for the
quarter ending June 30.
Budgeted sales for the next five months are:
April
May
June
July
August
20,000 units
50,000 units
30,000 units
25,000 units
15,000 units.
Expected Cash Collections
All sales are on account.
Royal’s collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale,
5% is uncollectible.
The March 31 accounts receivable
balance of $30,000 will be collected in full.
The selling price is $10 per unit.
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The Production Budget
The management at Royal Company 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.
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Expected Cash Disbursement for
Materials
Royal 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.
The March 31 accounts payable balance
is $12,000.
Let’s calculate expected cash
disbursements.
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The Direct Materials Budget
At Royal Company, 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 is $0.40 per
pound.
Let’s prepare the direct materials budget.
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The Direct Labor Budget
At Royal, each unit of product requires 0.05 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 $10 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 1,500 hours per month.
Let’s prepare the direct labor budget.
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Manufacturing Overhead
Budget
Ending Finished Goods Inventory
Budget
Royal Company uses a variable
manufacturing overhead rate of $1 per unit
produced.
Now, Royal can complete the ending
finished goods inventory budget.
Fixed manufacturing overhead is $50,000 per
month and includes $20,000 of noncash costs
(primarily depreciation of plant assets).
At Royal, manufacturing overhead is
applied to units of product on the basis of
direct labor hours.
Let’s prepare the manufacturing
overhead budget.
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Let’s calculate ending finished goods
inventory.
McGraw-Hill/Irwin
Selling and Administrative Expense
Budget
At Royal, variable selling and administrative
expenses are $0.50 per unit sold.
Fixed selling and administrative expenses are
$70,000 per month.
The fixed selling and administrative expenses
include $10,000 in costs – primarily depreciation –
that are not cash outflows of the current month.
Let’s prepare the company’s selling and
administrative expense budget.
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The Budgeted Income
Statement
Cash
Budget
Budgeted
Income
Statement
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The Cash Budget
Royal:

Maintains a 16% 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 $49,000 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.
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The Budgeted Balance Sheet
Royal reported the following account
balances prior to preparing its budgeted
financial statements:
Land - $50,000
Common stock - $200,000
 Retained earnings - $146,150
 Equipment - $175,000


After we complete the cash budget,
we can prepare the budgeted income
statement for Royal.
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McGraw-Hill/Irwin
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The Master Budget - worksheet - Chapter 9 - Accounting 230
The Sales Budget:
page 1
April
May
June
Quarter
April
May
June
Quarter
April
May
June
Quarter
April
May
June
Quarter
Budgeted Sales (units)
SP/unit
Total Sales
The Production Budget:
Budgeted Sales (units)
Add: desired ending Inventory
Total needed
Less: Beg. Inventory
Required Production
Expected Cash Collections
Accounts Receivable 3/31
April Sales:
May Sales:
June Sales:
Total Cash collections:
The Direct Materials Budget:
Production (units)
Materials per unit
Production Needs
Add: desired ending Inventory
Total needed
Less: Beg. Inventory
Materials to be purchased
The Master Budget - worksheet - Chapter 9 - Accounting 230
Expected Cast Disbursements
page 2
April
May
June
Quarter
April
May
June
Quarter
April
May
June
Quarter
Accounts Payable 3/31
April Purchases:
May Purchases:
June Purchases:
Total Cash disbursements:
The Direct Labor Budget
Production (units)
Direct labor hours
Labor hours required
Guaranteed labor hours:
Labor hours paid
Wage rate
Total direct labor cost
Manufacturing Overhead Budget
Production (units)
Variable mfg OH rate
Variable mfg OH costs
Fixed mfg OH costs
Total mfg OH costs
Less: noncash costs
Cash disbursements for mfg. OH
The Master Budget - worksheet - Chapter 9 - Accounting 230
page 3
Ending Finished Goods
Inventory Budget
Total
Quantity
Costs
Production costs per unit:
Direct Materials
Direct Labor
Manufacturing OH
Budgeted finished goods
inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory
Selling & Administration Budget April
Budgeted Sales (units)
Variable S&A rate per unit
Variable Expense
Fixed S&A Expense
Total Expense
Less: Non Cash Expenses
Cash Disbursements for S&A
May
June
Quarter
page 4
The CASH Budget
Beginning cash balance
Add: cash collections
Total available:
Less: Disbursements
Materials
Direct labor
Mfg. Overhead
S&A
Equipment purchase
Dividends
Total disbursements
Excess (deficiency) of cash
available over disbursements
Financing:
Borrowing
Repayments
Interest
Total Financing
Ending cash balance:
April
May
June
Quarter
The Master Budget - worksheet - Chapter 9 - Accounting 230
The Budgeted Income Statement & Balance Sheet
page 5
______________________________________________________
______________________________________________________
______________________________________________________
Sales (100,000 @$10)
$
1,000,000
$
43,000
Cost of goods sold
Gross margin
Selling & Administrative expenses
Operating Income
Interest expense
Net Income
______________________________________________________
______________________________________________________
______________________________________________________
Current Assets:
Cash
Accounts Receivable
Raw materials inventory
Finish Goods inventory
Total current assets
Property and equipment
Land
Building
Equipment
Total property and equipment
Total Assets
Accounts Payable
Common stock
Retained earnings
Total Liabilities and Stockholders' Equity
HAYES CORPORATION
CASH BUDGET
FOR THE YEAR ENDED 12/31/2000
BEGINNING CASH BALANCE
$
Q1
38,000
$
Q2
25,500
$
Q3
15,000
$
Q4
19,400
ADD: CASH RECEIPTS
TOTAL AVAILABLE CASH
170,000
208,000
198,000
223,500
228,000
243,000
258,000
277,400
LESS: CASH DISBURSEMENTS (ITEMIZED)
Materials
Salaries
Selling and Administrative
Purchase of Equipment
Income tax expense
TOTAL DISBURSEMENTS
23,200
62,000
94,300
3,000
182,500
27,200
72,000
99,300
10,000
3,000
211,500
31,200
82,000
104,300
3,000
220,500
35,200
92,000
109,300
3,000
239,500
EXCESS(DEFICIENCY) OF AVAILABLE CASH
OVER CASH DISBURSEMENTS
25,500
12,000
22,500
37,900
FINANCING
Add: Borrowings
Less: Repayments
ENDING CASH BALANCE
0
0
$
25,500
3000
0
$
What if I said to keep a MINIMUM cash balance of $15,000?
SOUND CASH MANAGEMENT:
1. Increase speed of collection on ACCOUNTS RECEIVABLE.
2. Keep INVENTORY levels low (but at optimal levels)
3. Delay payment of LIABILITIES.
4. Plan the timing of MAJOR EXPENDITURES.
5. INVEST IDLE CASH--but pick liquid investments!, e.g., US Gov't Securities
15,000
0
3100
$
19,400
0
0
$
37,900
Budgeting Lessons:
Note: this is a true story although some of the details were altered due to memory failure of the writer.
Some of the names are changed.
Once upon a time in the late 80s there was a small hi-tech company located in the Bay Area (California) with some 200
employees at its corporate office. We’ll call it the GuyTech. It had 380 employees worldwide located in sales/service
offices and one remote R&D office in Japan. It had the usual organization structure:
President (background in R&D and Engineering), CFO, COO (background in Manufacturing), VP-Engineering, VPOperations (Manufacturing, Planning/Purchasing, Shipping/Receiving), R&D, VP-Sales & Marketing, VP-Human
Resources.
The Budgeting process consisted of the following:
 Accounting would provide information for each VP above which included:
o Current costs (salary by employee plus other actual expenses—travel, supplies, depreciation) for the past 3
quarters
o Managers were told to assume a 6% across the board salary increase (to be allocated to the employees
based on performance)
o Managers were told that the Sales Budget would assume a 15% increase in Sales Volume over the prior
year
 Managers were to work with their accounting liaison and jointly prepare a budget for each of their functional areas,
with proposed headcount increases, and other expenses.
Steve (VP of Engineering) and Jack (VP of Manufacturing) individually worked with one of the Accounting Managers,
Ray, to develop their proposed budgets and take it into the Executive Committee (President, CFO, and COO) along with
Ray. Note: Ray is 28 years old and considered to be one of the more “green” (inexperienced) managers.
Here is how each of them prepared for and conducted their meeting with the Executive Committee:
Jack: Jack worked closely with Ray, having her check and double check his arithmetic and logic (“I don’t want to look
ridiculous in there!”). He met with Ray the morning of his Executive Committee meeting and ran through his presentation.
He went into the meeting with all the required documents and a few backup documents. During the meeting the President,
CFO, and COO had a few questions and Jack was ready with his answers:
“Why does travel go up from last year?” Jack could easily refer to a supporting schedule and note the 4-5 trips
planned for conferences, or customer visits, or visits to remote offices. There were a few more questions along
this line.
“Why are you adding headcount in Planning/Purchasing?” Jack discussed that with the 15% increase in Sales
Volume, he felt it was reasonable to add on another Purchasing Agent.
“Why is there an additional Manufacturing supervisor?” Jack gave the same reason as the previous question,
supported this time by handwritten spreadsheets which showed the ratio of number of work orders per supervisor
and how a 15% increase in work orders (to go along with the 15% in sales).
Jack’s meeting was punctual; the Executive Committee recommended he eliminate about 10% of his costs, specifically
identifying a few areas—cut trips in half, and skip the headcount increases. Jack’s budget was approved (after the 10%
cuts). Jack left the meeting congratulating himself that all had gone well and that “he hadn’t looked stupid.”
Steve: Steve’s department was one of the first to have desktop computers, Macintoshes, which came preloaded with Word
and Excel. Steve quickly mastered Excel and took the budget data provided by Accounting and re-keyed it into Excel. He
created a multi-dimensional spreadsheet with page one representing all of his departments, and the other pages representing
the individual departments (drafting, design, pre-production, software engineering, etc.).
Ray attempted to work with him and ended up just getting an Excel lesson on how to link spreadsheets. Steve came to the
meeting with multiple copies of his spreadsheets for all attendees. As the format was original, much of the meeting was
spent in explaining how to read his spreadsheets. As the spreadsheets were not stapled together, some of the managers
were on the wrong page, and this also had to be explained. As everyone got comfortable (sort of) with Steve’s documents,
the President, CFO, and COO had a few questions.
“Why does travel go up from last year?”
C:\Users\jpaquett\Documents\AASpring 2012\handouts\Budget - Jack Steve.doc
“Why are you adding headcount in Software Engineering?”
“Why is there an additional CAD design supervisor?”
Steve answered all questions with reference to an engineering project (while manufacturing works on work orders,
engineering focuses on key projects, with the intent of turning them into a viable product sometime in the future). At
GuyTech, many of the projects were customer driven, ideas from companies such as IBM, Motorola, etc. which Steve also
made reference to. The President was very emphatic that we review all projects and, if necessary make cuts, however, he
wanted to be able to support the maximum level of projects as “this is our future.”
The COO asked which of Steve’s department were working on which projects and Steve responded that all of his
department were working on all the projects, dividing up their time and resources on each project, as necessary. The COO
then suggested that Steve re-cast his budget, instead of by department, come back with an individual spreadsheet by
project, so that the Executive Committee could get a better idea of the budget needs of each project. Everyone thought this
was a good idea and an additional meeting was scheduled for Steve, giving him a week to re-cast the numbers into a new
spreadsheet.
As Steve and Ray left the meeting and discussed how it went, Steve suggested she accompany him to his office. He sat
down at his desk and fired up his computer, only to reveal that he had already prepared his budget by project, anticipating
this request.
Ray asked, “Why didn’t you tell them this?”
Steve, “Why should I? It buys me time, gets ‘em off my back and I look good.”
A week later Steve and Ray returned to the budget meeting. Steve fumbled with some numbers and the COO found an
error in some of his math. The meeting was mostly spent in explaining the format of the new spreadsheets and, when the
error was discovered, adjourned and rescheduled for a 3rd meeting.
A week later Steve and Ray returned for a 3rd budget meeting. Steve’s budget was reviewed, by project. Some minor cuts
to Steve’s budget were suggested; Steve reminded them that this would have an impact on some key projects. One trip was
cut from the travel budget. The President then reminded Steve of another project he had omitted and suggested that Steve
keep with his proposed budget (less the one trip for a conference) but also add on another $50,000 “just in case” a new
project came up.
Steve’s budget was approved. When Steve left the meeting he bragged to Ray, “That cut is okay, I just stuck it in as an
extra. They always cut something.”
1. Which manager, in your opinion, is the successful one here? How do you define success?
2. From the point of view of Ray, what could she have learned in terms of how to successfully obtain budget approval
for her own department in the future.
3. From the point of view of the CFO, based on the experiences of Jack and Steve, how could you improve the budget
process to assure the maximum level of fairness, efficiency, motivation, compliance with overall company
goals/objectives.
C:\Users\jpaquett\Documents\AASpring 2012\handouts\Budget - Jack Steve.doc