Budgetary Planning
Budget
A formal written statement of management’s
plans for a specified future time period,
expressed in financial terms.
Primary way to communicate agreed-upon
objectives to all parts of the company.
Promotes efficiency.
Control device - important basis for
performance evaluation once adopted.
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Unlike some chapters, most students are
familiar with the theme of this chapter.
Also, most of the material is self explanatory.
Consequently, this presentation will only
highlight the concepts of the book, focusing
on problems.
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Involve the department managers.
Train.
Have the budget forms build on one another.
Get the sequence of activities right.
Document all calculations.
Provide important assumptions on inflation,
volume growth and so on.
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Make reports provided during user friendly.
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Use graphics where possible.
Make sure the account names are the same.
Hold department heads accountable.
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Golden watch.
Cut essential services—Mayor Koch.
Claim someone above the reviewer wants a
line item.
Pad each line just a little.
Wait until the last minute to turn it in so there
can be no review.
Participative Budgeting
May inspire higher levels of performance or
discourage additional effort.
Depends on how budget developed and
administered.
Invite each level of management to
participate.
This “bottom-to-top” approach is called
Participative Budgeting
LO 2: State the essentials of effective budgeting.
A set of interrelated budgets that constitutes a
plan of action for a specified time period
Contains two classes of budgets:
Operating budgets:
Individual budgets that result in the
preparation of the budgeted income statement
– establish goals for sales and production
personnel
Financial budgets:
The capital expenditures budget, the cash
budget, and the budgeted balance sheet –
focus primarily on cash needs to fund
operations and capital expenditures
LO 3: Identify the budgets that comprise the master budget.
LO 3: Identify the budgets that comprise the master budget.
First budget prepared
Derived from the sales forecast
Management’s best estimate of sales
revenue for the budget period
Every other budget depends on the sales
budget
Prepared by multiplying
expected unit sales volume for each product
times
anticipated unit selling price
LO 3: Identify the budgets that comprise the master budget.
Shows the units that must be produced to meet
anticipated sales
Derived from sales budget plus the desired
change in ending finished goods (ending finished
goods less the beginning finished goods units)
Required production in units formula:
Essential to have a realistic estimate of ending
inventory
LO 3: Identify the budgets that comprise the master budget.
Shows both the quantity and cost of direct
materials to be purchased
Derived from the direct materials units required
for production (from the production budget) plus
the desired change in ending direct materials
units
Budgeted cost of direct materials to be
purchased = required units of direct materials X
anticipated cost per unit
LO 3: Identify the budgets that comprise the master budget.
Shows both the quantity of hours and cost of
direct labor necessary to meet production
requirements
Critical in maintaining a labor force that can
meet expected production
Total direct labor cost formula:
LO 3: Identify the budgets that comprise the master budget.
Shows the expected manufacturing overhead
costs for the budget period
Distinguishes between fixed and variable
overhead costs
Example – Hayes Company
Fixed cost amounts are assumed
Expected variable costs per direct
labor hour:
indirect materials: $1.00
indirect labor:
$1.40
utilities:
$0.40
maintenance:
$0.20
LO 3: Identify the budgets that comprise the master budget.
LO 3: Identify the budgets that comprise the master budget.
Important end-product of the operating budgets
Indicates expected profitability of operations
Provides a basis for evaluating company
performance
Prepared from the operating budgets
Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Manufacturing Overhead Budget
Selling and Administrative Expense Budget
LO 4: Describe the sources for preparing the budgeted income statement.
Example – Hayes Company
To find cost of goods sold:
First, determine the unit cost of one Kitchen-mate
Second, determine Cost of Goods Sold by multiplying
units sold times unit cost:
15,000 units X $44 = $660,000
LO 4: Describe the sources for preparing the budgeted income statement.
LO 4: Describe the sources for preparing the budgeted income statement.
Shows anticipated cash flows
Often considered to be the most important output
in preparing financial budgets
Contains three sections:
 Cash Receipts
 Cash Disbursements
 Financing
Shows beginning and ending cash balances
LO 5: Explain the principal sections of a cash budget.
LO 5: Explain the principal sections of a cash budget.
Cash Receipts Section
Includes expected receipts from the principal sources of
revenue – usually cash sales and collections on credit
sales
Shows expected interest and dividends receipts as well
as proceeds from planned sales of investments, plant
assets, and capital stock
Cash Disbursements Section
Includes expected cash payments for direct materials
and labor, taxes, dividends, plant assets, etc.
Financing Section
Shows expected borrowings and repayments of borrowed
funds plus interest
LO 5: Explain the principal sections of a cash budget.
Must prepare in
sequence.
Ending cash balance of
one period is the
beginning cash balance
for the next.
Data obtained from
other budgets and
from management.
Often prepared for
the year on a monthly
basis.
LO 5: Explain the principal sections of a cash budget.
A projection of
financial position at the
end of the budgeted
period.
Developed from the
budgeted balance sheet
for the preceding year
and the budgets for the
current year.
LO 5: Explain the principal sections of a cash budget.
LO 5: Explain the principal sections of a cash budget.
Sales Budget: Starting point and key factor in
developing the master budget
Use a purchases budget instead of a production
budget
Does not use the manufacturing budgets (direct
materials, direct labor, manufacturing overhead)
To determine budgeted merchandise purchases:
LO 6: Indicate the applicability of budgeting in nonmanufacturing
companies.
Critical factor in budgeting is coordinating
professional staff needs with anticipated services
Problems if overstaffed:
Disproportionately high labor costs
Lower profits due to additional salaries
Increased staff turnover due to lack of
challenging work
Problems if understaffed:
Lost revenues because existing and future
client needs for services cannot be met
Loss of professional staff due to excessive
work loads
LO 6: Indicate the applicability of budgeting in manufacturing
companies.
Just as important as for profit-oriented company
However, budget process differs significantly from
that of a profit-oriented company
Budget on the basis of cash flows (expenditures
and receipts), not on a revenue and expense basis
The starting point is usually
expenditures, not receipts
Management’s task is to find
receipts needed to support
planned expenditures
Budget must be strictly followed,
overspending often illegal
LO 6:
Indicate the applicability of budgeting in nonmanufacturing
companies.
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
XYZ, CPAs are preparing their service
revenue (sales) budget for the coming year.
The practice is divided into three departments
auditing, tax, and consulting.
Billable hours for each department, by
quarter, are provided on the following slide..
Of a
Department
Quarter One
Quarter Two
Quarter
Three
Quarter Four
Auditing
2200
1600
2000
2400
Tax
3000
2400
2000
2500
Consulting
1500
1500
1500
1500
Average hourly billing rates are: auditing $80, tax $90, and consulting
$100.
Prepare a sales budget for 2008 by listing the departments and
showing for each quarter and the year in total, billable hours, billable
rate, and total revenue.
Department
Billable
hours
Rate
Revenue
Quarter
One
Quarter
Two
Quarter
Three
Quarter
Four
Total
2200
1600
2000
2400
8200
$80
$80
$80
$80
$80
$176,000
$128,000
$160,000
$192,000
$656,000
Simple formula: hours x billing rate equals revenue.
Department
Billable
hours
Rate
Revenue
Quarter
One
Quarter
Two
Quarter
Three
Quarter
Four
Total
3000
2400
2000
2500
9900
$90
$90
$90
$90
$90
$270,000
$216,000
$180,000
$225,000
$891,000
Quarter
One
Quarter
Two
Quarter
Three
Quarter
Four
Total
Billable
hours
1500
1500
1500
1500
6000
Rate
$100
$100
$100
$100
$100
$150,000
$150,000
$150,000
$150,000
$600,000
Department
Revenue
Quarter
Two
Quarter
Three
Quarter
Four
Total
Department
Quarter
One
Auditing
$176,000
$128,000
$160,000
$192,000
$656,000
Tax
$270,000
$216,000
$180,000
$225,000
$891,000
Consulting
$150,000
$150,000
$150,000
$150,000
$600,000
Total
$596,000
$494,000
$490,000
$567,000
$2,147,000

XYZ company has adopted the following
production budget for the first four months of
2009.
Month
Units Month
Units
January
10,000 March
5,000
February
8,000 April
4,000
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Each unit requires 3 pounds of raw materials
costing $2.00 per pound.
On December 31, 2008, the ending raw
material inventory was 9000 pounds.
Management wants to have a raw materials
inventory at the end of the month equal to
30% of the next months production
requirement.
Prepare a direct materials purchase budget by
month for the first quarter.
Units to be produced
Direct materials per unit
Total pounds needed for production
January
February
10,000
X
3
30,000
8,000
X
3
24,000
March
5,000
X
3
15,000
First remember the formula:
Direct
material
units
required for
production
+
Desired
ending direct
material
units
+
Beginning
direct
material
units
=
Required
direct
material
units to be
purchased
Units to be produced
Direct materials per unit
Total pounds needed for production
January
February
10,000
X
3
30,000
8,000
X
3
24,000
March
5,000
X
3
15,000
Thus, in this step we calculate the direct materials
needed for production by multiplying the units to be
produced by the direct materials per unit.
Units to be produced
Direct materials per unit
Total pounds needed for production
Add: Desired ending direct materials
(pounds)*
Total materials required
January
February
March
10,000
X
3
30,000
8,000
X
3
24,000
5,000
X
3
15,000
7,200
37,200
4,500
28,500
3,600
18,600
To total pounds needed for production, we now add
the desired ending inventory in pounds.
Units to be produced
Direct materials per unit
Total pounds needed for production
Add: Desired ending direct materials
(pounds)*
Total materials required
January
February
March
10,000
X
3
30,000
8,000
X
3
24,000
5,000
X
3
15,000
7,200
37,200
4,500
28,500
3,600
18,600
This gives us the total materials required for the
period.
Units to be produced
Direct materials per unit
Total pounds needed for production
Add: Desired ending direct materials
(pounds)*
Total materials required
January
February
March
10,000
X
3
30,000
8,000
X
3
24,000
5,000
X
3
15,000
7,200
37,200
4,500
28,500
3,600
18,600
However, some of the material required for production
can come from beginning inventory. Subtracting
inventorying will, therefore, be our next step.
Units to be produced
Direct materials per unit
Total pounds needed for production
Add: Desired ending direct materials
(pounds)*
Total materials required
Less: Beginning direct materials
(pounds)
Direct materials purchases
January
February
March
10,000
X
3
30,000
8,000
X
3
24,000
5,000
X
3
15,000
7,200
37,200
4,500
28,500
3,600
18,600
9,000
28,200
7,200
21,300
4,500
14,100
Now we know how many pounds are needed, what we
do not know is the cost.
Units to be produced
Direct materials per unit
Total pounds needed for production
Add: Desired ending direct materials
(pounds)*
Total materials required
Less: Beginning direct materials
(pounds)
Direct materials purchases
Cost per pound
Total cost of direct materials
purchases
January
February
March
10,000
X
3
30,000
8,000
X
3
24,000
5,000
X
3
15,000
7,200
37,200
4,500
28,500
3,600
18,600
9,000
28,200
X
$2
7,200
21,300
X
$2
4,500
14,100
X
$2
$56,400
$42,600
$28,200
Multiply pounds by costs per pound to get total cost.
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XYZ Company is preparing its manufacturing
overhead budget for 2008.
Relevant cost data consists of the following:
Units to be produced (by quarters): 10,000,
12,000, 14,000, 16,000.
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Direct labor: time is 1.5 hours per unit.
Variable overhead costs per direct labor hour;
indirect materials $0.70; indirect labor $1.20:
and maintenance $0.50.
Fixed overhead costs per quarter: supervisor
salaries $35,000,;depreciation $16,000; and
maintenance $12,000.
Prepare the manufacturing overhead budget
for the year, showing quarterly data.
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Things to remember when preparing an
overhead budget:
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
Overhead budgets are flexible budgets. This means
that variable costs vary with some unit of input
(like direct hours) or some unit of output (like
product produced).
The overhead rate is calculated by dividing the
total overhead budget by the total base (direct
labor hours, direct labor dollars, and so on).
Direct hours = 1.5 x direct
labor hours.
Quarter
One
Two
Units to be Produced
10,000
12,000
Direct Labor Hours
15,000
18,000
Three
Four
Total
14,000
16,000
52,000
21,000
24,000
78,000
We will multiply direct labor hours by variable cost/hour on the next slide.
Variable Costs:
Costs/Hour
Indirect Materials
$
0.70
Indirect Labor
$
1.20
Maintenance
$
0.50
Total Variable Costs
$
2.40
One
Two
Three
Four
Costs per hour are
given in the problem
Fixed Costs:
Supervisory Salaries
Depreciation
Maintenance
Total Fixed Costs
In the next slide we will
multiply them by hours
shown on previous slide to
get variable costs.
Total Manufacturing Overhead
Direct Labor Hours
Overhead Rate per Hour
Let’s do it!
Total
Variable Costs:
Costs/Hour
One
Two
Indirect Materials
$
0.70 $
10,500 $
12,600 $
Indirect Labor
$
1.20 $
18,000 $
Maintenance
$
0.50 $
7,500 $
Total Variable Costs
$
2.40
Three
Four
Total
14,700 $
16,800 $
54,600
21,600 $
25,200 $
28,800 $
93,600
9,000 $
10,500 $
12,000 $
39,000
Fixed Costs:
Supervisory Salaries
Depreciation
Maintenance
Total Fixed Costs
Total Manufacturing Overhead
Direct Labor Hours
Overhead Rate per Hour
Let’s sum each quarter next!
Variable Costs:
Costs/Hour
One
Two
Indirect Materials
$
0.70 $
10,500 $
12,600 $
Indirect Labor
$
1.20 $
18,000 $
Maintenance
$
0.50 $
Total Variable Costs
$
2.40 $
Three
Four
Total
14,700 $
16,800 $
54,600
21,600 $
25,200 $
28,800 $
93,600
7,500 $
9,000 $
10,500 $
12,000 $
39,000
36,000 $
43,200 $
50,400 $
57,600 $ 187,200
Fixed Costs:
Supervisory Salaries
Depreciation
Maintenance
Total Fixed Costs
Total Manufacturing Overhead
Direct Labor Hours
Overhead Rate per Hour
Fixed costs are easy, they are
the same each month
regardless of production
volume or direct labor hours.
Variable Costs:
Costs/Hour
Indirect Materials
$
0.70
$
10,500 $
12,600 $
14,700 $
16,800 $
54,600
Indirect Labor
$
1.20
$
18,000 $
21,600 $
25,200 $
28,800 $
93,600
Maintenance
$
0.50
$
7,500 $
9,000 $
10,500 $
12,000 $
39,000
2.40 $
36,000 $
43,200 $
50,400 $
57,600 $ 187,200
$
35,000 $
35,000 $
35,000 $
35,000 $ 140,000
$
16,000 $
16,000 $
16,000 $
16,000 $
64,000
$
12,000 $
12,000 $
12,000 $
12,000 $
48,000
$
63,000 $
63,000 $
63,000 $
63,000 $ 252,000
Total Variable Costs
$
One
Two
Three
Four
Total
Fixed Costs:
Supervisory Salaries
Now we total
Depreciation
fixed and
Maintenance variable
Total Fixed Costs overhead to
get total
Total Manufacturing Overhead
overhead
Direct Labor Hours
Overhead Rate per Hour
Variable Costs:
Costs/Hour
Indirect Materials
$
0.70
$
10,500 $
12,600 $
14,700 $
16,800 $
54,600
Indirect Labor
$
1.20
$
18,000 $
21,600 $
25,200 $
28,800 $
93,600
Maintenance
$
0.50
$
7,500 $
9,000 $
10,500 $
12,000 $
39,000
2.40 $
36,000 $
43,200 $
50,400 $
57,600 $ 187,200
Supervisory Salaries
$
35,000 $
35,000 $
35,000 $
35,000 $ 140,000
Depreciation
$
16,000 $
16,000 $
16,000 $
16,000 $
64,000
Maintenance
$
12,000 $
12,000 $
12,000 $
12,000 $
48,000
$
63,000 $
63,000 $
63,000 $
63,000 $ 252,000
$
99,000 $ 106,200 $ 113,400 $ 120,600 $ 439,200
Total Variable Costs
$
One
Two
Three
Four
Total
Fixed Costs:
Add hours
for each
Total Manufacturing Overhead
quarter.
Total Fixed Costs
Direct Labor Hours
Overhead Rate per Hour
The suspense is killing me!
Variable Costs:
Costs/Hour
Indirect Materials
$
0.70
$
10,500 $
12,600 $
14,700 $
16,800 $
54,600
Indirect Labor
$
1.20
$
18,000 $
21,600 $
25,200 $
28,800 $
93,600
Maintenance
$
0.50
$
7,500 $
9,000 $
10,500 $
12,000 $
39,000
2.40 $
36,000 $
43,200 $
50,400 $
57,600 $ 187,200
Supervisory Salaries
$
35,000 $
35,000 $
35,000 $
35,000 $ 140,000
Depreciation
$
16,000 $
16,000 $
16,000 $
16,000 $
64,000
Maintenance
$
12,000 $
12,000 $
12,000 $
12,000 $
48,000
Total Fixed Costs
$
63,000 $
63,000 $
63,000 $
63,000 $ 252,000
Total Manufacturing Overhead
$
99,000 $ 106,200 $ 113,400 $ 120,600 $ 439,200
Total Variable Costs
$
One
Two
Three
Four
Total
Fixed Costs:
Direct Labor Hours
Overhead Rate per Hour
15,000
18,000
Last of all calculate rate (OH$/DLH)
21,000
24,000
78,000
Variable Costs:
Costs/Hour
Indirect Materials
$
0.70
$
10,500 $
12,600 $
14,700 $
16,800 $
54,600
Indirect Labor
$
1.20
$
18,000 $
21,600 $
25,200 $
28,800 $
93,600
Maintenance
$
0.50
$
7,500 $
9,000 $
10,500 $
12,000 $
39,000
2.40 $
36,000 $
43,200 $
50,400 $
57,600 $ 187,200
Supervisory Salaries
$
35,000 $
35,000 $
35,000 $
35,000 $ 140,000
Depreciation
$
16,000 $
16,000 $
16,000 $
16,000 $
64,000
Maintenance
$
12,000 $
12,000 $
12,000 $
12,000 $
48,000
Total Fixed Costs
$
63,000 $
63,000 $
63,000 $
63,000 $ 252,000
Total Manufacturing Overhead
$
99,000 $ 106,200 $ 113,400 $ 120,600 $ 439,200
Total Variable Costs
$
One
Two
Three
Four
Total
Fixed Costs:
Direct Labor Hours
Overhead Rate per Hour
15,000
18,000
21,000
24,000
78,000
$
5.63



XYZ is preparing its annual budgets for the
year ending 31/12/2009.
Accounting assistants furnish the data show
on the next slide.
An accounting assistant has prepared the
detailed manufacturing overhead budgets
and the selling and administrative expense
budget.



The latter shows selling expenses of $660,000
for product JB 50 and $360,000 for product
JB 60, and administrative expenses of $540,000
for product JB 50 and $340,000 for JB 60.
Income taxes are expected to be 30%.
Prepare the budgets asked for in the textbook.
Product JB 50
Product JB 60
400,000
200,000
$20
$25
Desired ending finished goods units
25,000
15,000
Beginning finished good units
30,000
10,000
2
3
Desired ending direct material pounds
30,000
15,000
Beginning direct material pounds
40,000
10,000
$3
$4
Sales Budget:
Anticipated volume in units
Unit selling price
Production Budget:
Direct materials budget:
Direct materials per unit (pounds)
Cost per pound
Product JB 50
Product JB 60
Direct labor time per unit
0.4
0.6
Direct labor rate per hour
$12
$12
$12
$21
Direct labor budget:
Budgeted income statement:
Total unit cost
Expected unit sales
Unit selling price
Total sales
JB 50
JB 60
Total
400,000
X $20
$8,000,000
200,000
X $25
$5,000,000
$13,000,000
Simple calculation: units x sales price = total sales
dollars.





There is a generic formula we use in many of the
budgets, it is:
Transferred out + ending inventory – beginning
inventory = transferred in.
Converting this generic formula to terms consistent
with the production budget:
Units sold + ending inventory – beginning inventory =
units to be produced.
Knowing the generic formula will help you if you get
a “brain cramp” on the test and forget a specific
formula.
We use the formula:
Sales + ending inventory – beginning inventory = production in units
Expected unit sales
Add: Desired ending finished
goods units
Total required units
Less: Beginning finished goods
units
Required production units
JB 50
JB 60
400,000
200,000
25,000
425,000
15,000
215,000
30,000
395,000
10,000
205,000
Total
600,000
Direct Materials Budget
For the Year Ending December 31, 2009
__
Units to be produced
Direct materials per unit
Total pounds needed for
production
JB 50
JB 60
395,000
X 2
205,000
X 3
790,000
615,000
Total
Our first step is to calculate total pounds needed for production by multiplying
units to be produced (calculated in the sales budget) by the direct materials
per unit given in the problem.
Direct Materials Budget
For the Year Ending December 31, 2009
__
Units to be produced
Direct materials per unit
Total pounds needed for
production
Add: Desired ending direct
materials (pounds)
Total materials required
Less: Beginning direct
materials (pounds)
Direct materials purchases
JB 50
JB 60
395,000
X 2
205,000
X 3
790,000
615,000
30,000
820,000
15,000
630,000
40,000
780,000
10,000
620,000
Once we have the direct material in pounds, we need to
calculate the dollar amount.
Total
Now we
use the
formula we
learned
earlier:
units
transferred
out +
ending
inventory –
beginning
inventory =
units
transferred
in.
Direct Materials Budget
For the Year Ending December 31, 2009
__
Units to be produced
Direct materials per unit
Total pounds needed for
production
Add: Desired ending direct
materials (pounds)
Total materials required
Less: Beginning direct
materials (pounds)
Direct materials purchases
Cost per pound
Total cost of direct materials
purchases
JB 50
JB 60
395,000
X 2
790,000
205,000
X 3
615,000
30,000
820,000
15,000
630,000
40,000
780,000
X $3
10,000
620,000
X $4
$2,340,000
$2,480,000
Total
$4,820,000
Direct Labor Budget
For the Year Ending December 31, 2009
Units to be produced
Direct labor time (hours) per
unit
Total required direct labor
hours
Direct labor cost per hour
Total direct labor cost
JB 50
JB 60
Total
395,000
205,000
650,000
X .4
X .6
158,000
X $12
$1,896,000
123,000
X $12
$1,476,000
301,000
X
$10
$3,372,000
Two steps: Calculate hours first and then calculate dollar
amount.
Now all we have to do is put this all together in
the form of an income statement!
JB 50
Sales
Cost of goods sold
Gross profit
Operating expenses
Selling expenses
Administrative
expenses
Total operating
expenses
Income before income
taxes
Income tax expense
(30%)
Net income
$8,000,000
4,800,000
3,200,000
JB 60
(
1
$5,000,000
4,200,000
800,000
)
660,000
Total
(
2
$13,000,000
9,000,000
4,000,000
)
360,000
1,020,000
340,000
880,000
540,000
700,000
1,900,000
1,200,000
$ 100,000
2,100,000
$2,000,000
630,000
$ 1,470,000