Chapter 20
The Budgeting Process
Planning and the Use of Budgets
• Companies spend a lot of time on _______
planning, which requires
 Setting goals and objectives.
• Long and short term.
 Developing strategies to achieve those goals.
• Budgets
 are a ______ statement of a company’s future plans
 show how _______ will be used to implement the
strategy.
The Budget
• A budget is a quantified statement of an
entity’s _______ plans (typically 1 year).
• Its components include data that can be
financial (budgeted sales activity) or nonfinancial (budgeted production levels).
• It allows companies to formally set _____ for
_______.
• The budget provides a means of performance
_______.
Advantages of Budgets
• It requires management to ___ ____
 Identify goals and objectives
 Evaluate risks and opportunities
• It serves as an early warning system
 if deviations from the budgets are examined
• It _______ documents management plans
and specific action plans.
 Informal communication of business plans can
create uncertainty and confusion
Advantages of Budgets
• It _______ employees in a positive way if implemented
correctly:
– Based on realistic level of performance
– Prepared using participatory budgeting
– Evaluated carefully and allowing employees to provide
explanations for variances
• Effective Management Tool
– All departments should contribute to meeting company-wide
goals.
– Budgeting achieves coordination.
Advantages of Budgets
• Provides performance criteria __________.
 Compare actual results to the past results
or budget (expected results) and assign
responsibility.
 Assists in identification of problems and
corrective actions.
 Provides _______ for future decisions.
Things to Watch for
• ____ levels of management should be involved
in developing the budget so they buy into the
budget.
• _______ _______ should be tied, in part, to
meeting budgetary goals.
• Conditions are not static, and the company must
be able to respond to unforeseen events.
Time Horizon for Budgeting
• The _______ length of time will depend on
the events being budgeted.
 Single event (party).
 On-going activities – short-term.
• Annually, quarterly, monthly.
 On-going activities – long-term.
• 5 year business plan.
 Continuous or Rolling Budgets
Master Budgets
• A formal, _________
plan for a company’s
future.
• Contains several
_______ budgets that
are linked to each other.
• Sequencing of
preparation is essential.
Master Budgets
• Master budgets consist of the following
elements:
 _______ Budgets
• Those supporting budgets which contribute directly to
the budgeted income statement
 _______ _______ Budget
 _______ Budgets
• Cash budget which leads to
• Budgeted balance sheet and
cash flow statements
• Budgeted Income Statement
Sales or Revenues Budget
• This is the _______ of the operating budgets to
determine.
• It is important to set accurate sales estimates
because everything else is based on this one .
• Budgeted revenue = (units sold)*(price).
• Sales budgeting is complex and depends on many
things such as;
 Economy, competition, competing products, capacity,
price of product, new products.
P1
Sales Budget
In September 2008, Hockey Den sold 700
hockey sticks at $100 each. Hockey Den
prepared the following sales budget for
the next four months:
Sales Budget
P1
Exh.
20-6
HOCKEY DEN
Monthly Sales Budget
October 2008 – January 2009
September 2008 (actual)
October 2008
November 2008
December 2008
Total
January 2009
Budgeted
Unit Sales
700
Budgeted
Budgeted
Unit Price Total Sales
$
100 $
70,000
1,000 $
800
1,400
3,200 $
100 $
100
100
100 $
100,000
80,000
140,000
320,000
900 $
100 $
90,000
Merchandise Purchases Budget
• Budgeted future sales volume is the primary
factor in inventory management decisions
 Merchandise Purchase Budget (retailer)
 Production Budget (manufacturer)
P1
Merchandise Purchases Budget
Exh.
20-7
Inventory
to be
purchased
=
Budgeted
ending
inventory
+
Budgeted
cost of sales
for the period
–
Budgeted
beginning
inventory
Hockey Den buys hockey sticks for $60.00 each and
maintains an ending inventory equal to 90 percent of the
next month’s budgeted sales. 900 hockey sticks are on
hand on September 30.
Let’s prepare the purchases budget for Hockey Den.
P1
Merchandise Purchases Budget
Exh.
20-8
HOCKEY DEN
Merchandise Purchases Budget
October 2008 – December 2008
Next month's unit sales
Ending inventory percentage
Budgeted ending inventory units
Add current month's unit sales
Total units needed
Deduct beginning inventory units
Number of units to be purchased
Budgeted cost per unit
Budgeted cost of purchases
October
800
× 90%
720
November
1,400
× 90%
1,260
December
900
× 90%
810
P1
Merchandise Purchases Budget
Exh.
20-8
HOCKEY DEN
Merchandise Purchases Budget
October 2008 – December 2008
Next month's unit sales
Ending inventory percentage
Budgeted ending inventory units
Add current month's unit sales
Total units needed
Deduct beginning inventory units
Number of units to be purchased
Budgeted cost per unit
Budgeted cost of purchases
October
800
× 90%
720
1,000
1,720
November
1,400
× 90%
1,260
800
2,060
December
900
× 90%
810
1,400
2,210
P1
Merchandise Purchases Budget
Exh.
20-8
HOCKEY DEN
Merchandise Purchases Budget
October 2008 – December 2008
Next month's unit sales
Ending inventory percentage
Budgeted ending inventory units
Add current month's unit sales
Total units needed
Deduct beginning inventory units
Number of units to be purchased
Budgeted cost per unit
Budgeted cost of purchases
October
800
× 90%
720
1,000
1,720
900
820
× $ 60
$ 49,200
November
1,400
× 90%
1,260
800
2,060
Beginning inventory is last month's ending inventory.
December
900
× 90%
810
1,400
2,210
P1
Merchandise Purchases Budget
Exh.
20-8
HOCKEY DEN
Merchandise Purchases Budget
October 2008 – December 2008
Next month's unit sales
Ending inventory percentage
Budgeted ending inventory units
Add current month's unit sales
Total units needed
Deduct beginning inventory units
Number of units to be purchased
Budgeted cost per unit
Budgeted cost of purchases
October
800
× 90%
720
1,000
1,720
900
820
× $ 60
$ 49,200
November
1,400
× 90%
1,260
800
2,060
720
1,340
× $ 60
$ 80,400
Beginning inventory is last month's ending inventory.
December
900
× 90%
810
1,400
2,210
1,260
950
× $ 60
$ 57,000
Production Budgets (Appendix 20A)
• What production levels must be achieved to
support the sales budget?
 Production = budgeted sales + desired ending
inventory - beginning inventory
• Production costs include:
 Materials costs
 Direct labor
 Manufacturing overhead
• We will need budgets for _____
of these
•
•
•
•
Production Budget:
Direct Materials Purchases
How much material do we need to support
the production level?
How much do we need to purchase to
maintain desired inventory level?
Units purchased = projected material usage +
desired ending inventory level – beginning
inventory.
Calculate in units first, then convert to cost.
Production Budget:
Direct Materials Purchases
• Steps to prepare a direct materials purchasing
budget
1. Calculate each period’s total production needs in units
of direct materials
2. Determine the total number of units of direct
materials to be purchased during each accounting
period in the budget
Total Units
of Direct
=
Materials to
Be Purchased
Total Production
Needs in Units of
Direct Materials
Desired Units
of Ending
+
Direct Materials
Inventory
–
Desired Units
of Beginning
Direct Materials
Inventory
3. Calculate the cost of the direct materials purchases
Production Budget:
Direct Labor
• Direct labor costs will depend on the units to be
produced and the time allowed for each unit in
the various departments.
• Figure the time to complete the units and then
convert them to costs.
Production Budget:
Direct Labor
• Steps in preparing a direct labor budget
1. Estimate the total direct labor hours
– Multiply estimated direct labor hours per unit by the
anticipated units of production
2. Calculate the total budgeted direct labor cost
Total Budgeted
Direct Labor Cost
=
Estimated Total
Direct Labor Hours
x
Estimated Direct
Labor Cost per Hour
Production Budget: Factory Overhead
• Using the relationships which exist and the
estimated cost functions, determine what
overhead costs will be incurred in producing the
number of units needed.
 Variable overhead costs per unit.
 Fixed overhead costs per period.
• Determine budgeted overhead and divide by the
estimated activity level to come up with the
overhead application rate.
Other Elements of Operating Budgets
• Using cost behavior analysis, calculate the
budgeted nonmerchandising or
nonmanufacturing manufacturing costs
 Selling Expense Budget
 General & Administrative Expense Budget
Financial Budget Components
• Capital Budgeting – budget of capital expenditures
needed to support company activity
• Cash Budget
• Budgeted Income Statement
 Information comes from already prepared budgets.
• Budgeted Balance Sheet & Cash Flow
 Final step
 Information comes from already prepared budgets.
Cash Budgeting
• Purpose of the cash budget is to determine whether or not
there will be
 excess cash to invest and/or
 deficiencies of cash requiring short term borrowing.
Beginning balance
Plus: Budgeted Receipts
Less: Budgeted Disbursements
= Estimated ending cash balance.
• Compare estimated ending balance
with the required cash balance.
Do we need to borrow money?
Cash Budgeting Information
• Budgeted Cash Receipts & Expected Collection Point
 Expected cash sales?
 Expected collections from credit sales?
• Budgeted Cash Disbursements & Expected Disbursement
Point
 SG&A Expenses
 Cash Purchases
 Cash Payments on Accounts Payable
 Cash purchases of fixed assets,
 Payment of interest costs, loan principal and income
taxes?
From the Sales Budget
P2
Exhibit 20-14
HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2008
Sales (3,200 units @ $100)
Cost of goods sold (3,200 units @ $60)
Gross profit
Operating expenses:
Sales commissions
Sales salaries
Administrative salaries
Equipment depreciation
Interest expense
Net income before taxes
Income tax expense
Net income
$ 320,000
192,000
$ 128,000
$ 32,000
6,000
13,500
4,500
328
56,328
$ 71,672
28,669
$ 43,003
P2
From the Merchandise
Purchases Budget
Exhibit 20-14
HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2008
Sales (3,200 units @ $100)
Cost of goods sold (3,200 units @ $60)
Gross profit
Operating expenses:
Sales commissions
Sales salaries
Administrative salaries
Equipment depreciation
Interest expense
Net income before taxes
Income tax expense
Net income
$ 320,000
192,000
$ 128,000
$ 32,000
6,000
13,500
4,500
328
56,328
$ 71,672
28,669
$ 43,003
Exhibit 20-14
P2
HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2008
Sales (3,200 units @ $100)
Cost of goods sold (3,200 units @ $60)
Gross profit
Operating expenses:
Sales commissions
$ 32,000
Sales salaries
6,000
Administrative salaries
13,500
Equipment depreciation
4,500
Interest expense
328
Net income before taxes
From the Selling
Income tax expense
Expense Budget
Net income
$ 320,000
192,000
$ 128,000
56,328
$ 71,672
28,669
$ 43,003
Exhibit 20-14
P2
HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2008
Sales (3,200 units @ $100)
Cost of goods sold (3,200 units @ $60)
Gross profit
Operating expenses:
Sales commissions
$ 32,000
Sales salaries
6,000
Administrative salaries
13,500
Equipment depreciation
4,500
Interest expense
328
From thetaxes
General and Administrative Expense
Net income before
Budget
Income tax expense
Depreciation is a non-cash expense.
Net income
$ 320,000
192,000
$ 128,000
56,328
$ 71,672
28,669
$ 43,003
Exhibit 20-14
P2
HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2008
Sales (3,200 units @ $100)
Cost of goods sold (3,200 units @ $60)
Gross profit
Operating expenses:
Sales commissions
$ 32,000
Sales salaries
6,000
Administrative salaries
13,500
Equipment depreciation
4,500
Interest expense
328
Net income before taxes
Income tax expense
From the Cash Budget
Net income
$ 320,000
192,000
$ 128,000
56,328
$ 71,672
28,669
$ 43,003
Exhibit 20-14
P2
HOCKEY DEN
Budgeted Income Statement
For Three Months Ended December 31, 2008
Sales (3,200 units @ $100)
Cost of goods sold (3,200 units @ $60)
Gross profit
Operating expenses:
Sales commissions
Sales salaries
Administrative salaries
Equipment depreciation
Interest expense
Net income before taxes
$71,672 × .40
Income tax expense
Net income
$ 320,000
192,000
$ 128,000
$ 32,000
6,000
13,500
4,500
328
56,328
$ 71,672
28,669
$ 43,003
Budgeted Balance Sheet
• The budgeted account balances will depend on
previous budget schedules
 cash balance: cash budget
 accounts receivable balance: sales budget and
pattern of collections
 inventory amounts: operating budgets
 borrowing: cash budget
 retained earnings: effects of income and dividends
Budget Process - Summary
• Budgeting is a company-wide effort
• Goals often come from the top
• Different parts of the organization participate to
budget specific activities/units.
• All this information must be tied together in the
master budget.
 This is where the accountants come in.
Let’s take a closer look at this
chapter!!!