7-1
Today’s LEcture
Management Accounting
Lecture 11
n  What is a budget
n  Why and how organizations budget
n  Budgeting
n  Sales
(Chapter 7)
n  Production
n  Sales & Administration
n  Balance Sheet Budget Items
n  Working Capital
Profit Planning
n  Capital Equipment
n  Financing
n  Financial Statements
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Budget
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Advantages of Budgeting
n  A budget is a detailed quantitative plan for acquiring and using
financial and other resources over a specified forthcoming time
period
n  Its purpose is to plan for the future and control behaviour and costs
n  Planning to prepare for objectives and setting out a framework
to achieve the objectives
n  Providing incentives to managers to achieve the objectives
n  Control by holding people to account with respect to their
objectives
n  Cost control
n  Revenue generation
n  The budgeting process forces managers to think through a plan
from their perspective
n  It provides a forum for people to interact and determine how to best
allocate limited resources
n  Defines a set of consistent goals and objectives
n  Communicated throughout the organization for common
understanding and cooperation
n  The budget provides a document against which to measure
performance
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Planning and Control
Planning –
involves
developing
objectives and
preparing various
budgets to achieve
these objectives.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Advantages of Budgeting
Control –
involves the steps
taken by
management that
attempt to ensure
the objectives are
attained.
Communicate
plans
Define goals
and objectives
Think about and
plan for the future
Advantages
Coordinate
activities
Means of allocating
resources
Uncover potential
bottlenecks
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-2
Responsibility Accounting
Choosing the Budget Period
Managers should be held responsible
for those items — and only those items
— that the manager can actually control
to a significant extent.
Operating Budget
2003
2004
2005
2006
The annual operating budget
may be divided into quarterly
or monthly budgets.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Self-Imposed Budget
Middle
Management
Supervisor
1.  Individuals at all levels of the organization are viewed
as members of the team whose judgments are valued
by top management.
Middle
Management
Supervisor
Supervisor
A participative budget is prepared with the full cooperation
and participation of managers at all levels. A participative
budget is also known as a self-imposed budget.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Self-Imposed Budgets
McGraw-Hill /Irwin
2.  Budget estimates prepared by front-line managers are
often more accurate than estimates prepared by top
managers.
3.  Motivation is generally higher when individuals
participate in setting their own goals than when the
goals are imposed from above.
4.  A manager who is not able to meet a budget imposed
from above can claim that it was unrealistic. Selfimposed budgets eliminate this explanation.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Human Factors in Budgeting
Most companies do not rely exclusively upon
self-imposed budget in the sense that top
managers usually initiate the budget process by
issuing broad guidelines in terms of overall
target profits or sales.
Self-imposed
budgets should be
reviewed by higher
levels of
management.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Advantages of Self-Imposed Budgets
Top Management
Supervisor
McGraw-Hill /Irwin
Managers should
watch our for
budgetary slack.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The success of budgeting depends upon three
important factors:
1.  Top management must be enthusiastic and
committed to the budget process.
2.  Top management must not use the budget to
pressure employees or blame them when
something goes wrong.
3.  Highly achievable budget targets are usually
preferred when managers are rewarded based
on meeting budget targets.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-3
The Budget Committee
The Master Budget: An Overview
Sales
budget
A standing committee responsible for
n  overall policy matters relating to the budget
n  coordinating the preparation of the budget
Ending
inventory
budget
Production
budget
Direct
materials
budget
Direct
labor
budget
Selling and
administrative
expense budget
Manufacturing
overhead
budget
Cash
budget
Budgeted
income
statement
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Sales Budget
Budgeted
balance
sheet
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Expected Cash Collections
The individual months of April, May, and June are
summed to obtain the total projected sales in units
and dollars for the quarter ended June 30th
n  All sales are on account.
n  Royal’s collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale,
5% uncollectible.
n  The March 31 accounts receivable balance of
$30,000 will be collected in full.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Expected Cash Collections
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Expected Cash Collections
From the Sales Budget for April.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-4
Expected Cash Collections
Expected Cash Collections
From the Sales Budget for May.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Production Budget
Sales
Budget
d
te
and
le
p
Expected
om
CCash
Collections
Production
Budget
n The management at Royal Company wants
ending inventory to be equal to 20% of the
following month’s budgeted sales in units.
n On March 31, 4,000 units were on hand.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Production Budget
Let’s prepare the production budget.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Production Budget
March 31
ending inventory
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Production Budget
Production must be adequate to meet budgeted
sales and provide for sufficient ending inventory.
McGraw-Hill /Irwin
McGraw-Hill /Irwin
McGraw-Hill /Irwin
Budgeted May sales
Desired ending inventory %
Desired ending inventory
50,000
20%
10,000
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-5
The Production Budget
The Production Budget
Assumed ending inventory.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Direct Materials Budget
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Direct Materials Budget
n  At Royal Company, five pounds of material
are required per unit of product.
n  Management wants materials on hand at
the end of each month equal to 10% of the
following month’s production.
n  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.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Direct Materials Budget
From production budget
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Direct Materials Budget
March 31 inventory
10% of following
month’s production
needs.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
Calculate the materials to
by purchased in May.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-6
The Direct Materials Budget
The Direct Materials Budget
Assumed ending inventory
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Expected Cash Disbursement for
Materials
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Expected Cash Disbursement for
Materials
n  Royal pays $0.40 per pound for its materials.
n  One-half of a month’s purchases is paid for in
the month of purchase; the other half is paid in
the following month.
n  The March 31 accounts payable balance is
$12,000.
Let’s calculate expected cash disbursements.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Expected Cash Disbursement for
Materials
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Expected Cash Disbursement for
Materials
Compute the expected cash
disbursements for materials
for the quarter.
140,000 lbs. × $.40/lb. = $56,000
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-7
The Direct Labor Budget
The Direct Labor Budget
n  At Royal, each unit of product requires 0.05 hours (3
minutes) of direct labor.
n  The Company has a “no layoff” policy so all
employees will be paid for 40 hours of work each week.
n  In exchange for the “no layoff” policy, workers agree to
a wage rate of $10 per hour regardless of the hours
worked (No overtime pay).
n  For the next three months, the direct labor workforce
will be paid for a minimum of 1,500 hours per month.
McGraw-Hill /Irwin
From production budget
Let’s prepare the direct labor budget.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
The Direct Labor Budget
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Direct Labor Budget
Greater of labor hours required
or labor hours guaranteed.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
The Direct Labor Budget
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Manufacturing Overhead Budget
n  At Royal manufacturing overhead is applied to
units of product on the basis of direct labor hours.
n  The variable manufacturing overhead rate is $20
per direct labor hour.
n  Fixed manufacturing overhead is $50,000 per
month and includes $20,000 of noncash costs
(primarily depreciation of plant assets).
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Let’s prepare the manufacturing overhead budget.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-8
Manufacturing Overhead Budget
Manufacturing Overhead Budget
Total mfg. OH for quarter $251,000
= $49.70 per hour*
Total labor hours required 5,050
*rounded
Direct Labor Budget
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Ending Finished Goods Inventory
Budget
Manufacturing Overhead Budget
Production costs per unit
Direct materials
Direct labor
Manufacturing overhead
Quantity
Cost
5.00 lbs. $ 0.40
$
Total
2.00
Budgeted finished goods inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory
Direct materials
budget and information
Depreciation is a noncash charge.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Ending Finished Goods Inventory
Budget
Production costs per unit
Direct materials
Direct labor
Manufacturing overhead
Quantity
Cost
5.00 lbs. $ 0.40
0.05 hrs. $ 10.00
McGraw-Hill /Irwin
Ending Finished Goods Inventory
Budget
$
Total
2.00
0.50
Budgeted finished goods inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory
Production costs per unit
Direct materials
Direct labor
Manufacturing overhead
Quantity
Cost
5.00 lbs. $ 0.40
0.05 hrs. $ 10.00
0.05 hrs. $ 49.70
Budgeted finished goods inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory
Direct labor budget
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Total
2.00
0.50
2.49
$ 4.99
$
$
4.99
Total mfg. OH for quarter $251,000
= $49.70 per hour*
Total labor hours required 5,050
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-9
Ending Finished Goods Inventory
Budget
Selling and Administrative Expense
Budget
n  At Royal, the selling and administrative expenses
Production costs per unit
Direct materials
Direct labor
Manufacturing overhead
Quantity
Cost
5.00 lbs. $ 0.40
0.05 hrs. $ 10.00
0.05 hrs. $ 49.70
Budgeted finished goods inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory
Total
$ 2.00
0.50
2.49
$ 4.99
5,000
$ 4.99
$ 24,950
Production Budget
budget is divided into variable and fixed components.
n  The variable selling and administrative expenses are
$0.50 per unit sold.
n  Fixed selling and administrative expenses are $70,000
per month.
n  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.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Selling and Administrative Expense
Budget
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Selling and Administrative Expense
Budget
Calculate the selling and administrative
cash expenses for the quarter.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Format of the Cash Budget
The cash budget is divided into four sections:
1.  Cash receipts listing all cash inflows excluding
borrowing;
2.  Cash disbursements listing all payments
excluding repayments of principal and interest;
3.  Cash excess or deficiency; and
4.  The financing section listing all borrowings,
repayments and interest.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Cash Budget
Royal:
q  Maintains a 16% open line of credit for $75,000
q  Maintains a minimum cash balance of $30,000
q  Borrows on the first day of the month and
repays loans on the last day of the month
q  Pays a cash dividend of $49,000 in April
q  Purchases $143,700 of equipment in May and
$48,300 in June paid in cash
q  Has an April 1 cash balance of $40,000
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-10
The Cash Budget
The Cash Budget
Schedule of Expected
Cash Disbursements
Schedule of Expected
Cash Collections
Direct Labor
Budget
Manufacturing
Overhead Budget
Selling and Administrative
Expense Budget
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Cash Budget
McGraw-Hill /Irwin
The Cash Budget
In the month of April will
expect to have a cash
deficiency of $20,000.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Cash Budget
Because Royal maintains
a cash balance of $30,000,
the company must borrow
$50,000 on it line-of-credit.
McGraw-Hill /Irwin
Ending cash balance for April
is the beginning May balance.
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
The Cash Budget
$50,000 × 16% × 3/12 = $2,000
Borrowings on April 1 and
repayment on June 30.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
7-11
Review
Tutorial
n  Review of today’s lecture
n  What is a budget
n  Problems
n  Why and how organizations budget
n  Budgeting
n  7-3
n  Sales
n  7-6
n  Production
n  Sales & Administration
n  Balance Sheet Budget Items
n  Working Capital
n  Capital Equipment
n  Financing
n  Financial Statements
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill /Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.