Planning for Profit and Cost Control
Chapter 7
Introduction
Detail
Budget
Detail
Budget
7-2
Production
Master
Budget
Combination
of numerous
specific
budgets
Detail
Budget
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
The Budget Committee
A standing committee responsible for


7-3
overall policy matters relating to the
budget.
coordinating the preparation of the
budget.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
The Planning Process

7-4
Planning -involves
developing
objectives and
preparing various
budgets to
achieve these
objectives.

Control -- involves
the steps taken by
management that
attempt to ensure
the objectives are
attained.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Three Levels of Planning for Business
Activity
Strategic Planning
Top management long-range
decisions.
Capital Budgeting
Intermediate-range planning
Operations Budgeting
Direct firm’s activity in
the short-range
7-5
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Three Levels of Planning for Business
Activity
Operating Budget
1999
2000
2001
2002
The annual operating budget may be divided
into quarterly or monthly budgets.
7-6
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Three Levels of Planning for Business
Activity
Continuous or
Perpetual Budget
1999
2000
2001
2002
This budget is usually a twelve-month
budget that rolls forward one month
as the current month is completed.
7-7
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Advantages of Budgeting
Corrective
Action
Performance
Measurement
Coordination
Planning
7-8
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Consideration for the Human Factor
Participative Budget System
Top Management
Middle
Management
Supervisor
Middle
Management
Supervisor
Supervisor
Supervisor
Flow of Budget Data
7-9
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
The Master Budget


7-10
The master budget consists of a series of
detailed schedules and budgets that
describe the company’s overall financial
plans for the coming accounting period.
The three major budget categories are
 Operating budget
 Capital budgets
 Financial statement budgets
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Information Flow in the Master Budget
Cash Receipts
and Payments
Schedules
Operating
Budgets
Start
Pro forma
Financial
Statements
Cash
Receipts
Sales
Budget
Income
Statement
Cash
Payments
for Inventory
Inventory
Purchases
Budget
Balance
Sheet
Cash
Payments
for S & A
S&A
Expense
Budget
Cash Flow
Statement
Cash
Budget
7-11
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Sales Budget
Detailed schedule showing expected
sales for the coming periods.
7-12
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Sales Budget
 Web Company is preparing budgets for the
quarter ending June 30.
 Budgeted sales for the next five months are:
April
May
June
July
August
$200,000
$500,000
$300,000
$250,000
$150,000.
 Cash sales are 20% of the total and credit
sales are 80%.
7-13
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Sales Budget
April
Budgeted Cash Sales
$ 40,000
Budgeted Sales on Account
160,000
Total Budgeted Sales
$ 200,000
May
$ 100,000
400,000
$ 500,000
June
$ 60,000
240,000
$ 300,000
Quarter
$ 200,000
800,000
$1,000,000
$200,000 × 20% = $40,000
Accounts receivable
at June 30
7-14
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Schedule of Cash Receipts
Sales
Budget
Schedule
of
Cash
Receipts
Cash receipts flow from expected sales.
7-15
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Schedule of Cash Receipts

Web expects to collect its accounts
receivable in the month following the
month of sale.

On March 31, accounts receivable
totaled $100,000.
Let’s prepare the cash receipts
budget.
7-16
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Schedule of Cash Receipts
April
$ 40,000
Current Month's Cash Sales
Accounts Receivable from
Previous Month
100,000
Total Budgeted Collections $ 140,000
May
$ 100,000
June
$ 60,000
Quarter
$ 200,000
160,000
$ 260,000
400,000
$ 460,000
660,000
$ 860,000
From the Sales Budget
7-17
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Purchases Budget
The total amount of inventory needed for
each month is equal to the amount of
budgeted sales plus the desired ending
inventory.
Cost of Budgeted Sales
Plus Desired Ending
Inventory
Inventory Needed
Less Beginning Inventory
Amount of Purchase
7-18
XXX
XXX
XXX
(XXX)
XXX
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Purchases Budget



At Web, cost of sales is equal to 70% of
total budgeted sales.
Management wants to maintain an
ending inventory that is equal to 20% of
the current month’s cost of budgeted
sales.
The ending inventory at March 31 is
$15,000.
Let’s prepare the purchases budget.
7-19
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Purchases Budget
Budgeted Sales
Cost of Sales %
Budgeted Cost of Sales
Desired Ending Inventory
Inventory Needed
Less: Beginning Inventory
Required Purchases
April
$ 200,000
70%
$ 140,000
28,000
168,000
(15,000)
$ 153,000
May
June
Budgeted Cost of Sales
Desired Ending Inventory %
Desired Ending Inventory
7-20
Quarter
$140,000
20%
$ 28,000
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Purchases Budget
Budgeted Sales
Cost of Sales %
Budgeted Cost of Sales
Desired Ending Inventory
Inventory Needed
Less: Beginning Inventory
Required Purchases
April
$ 200,000
70%
$ 140,000
28,000
168,000
(15,000)
$ 153,000
May
$ 500,000
70%
$ 350,000
70,000
420,000
(28,000)
$ 392,000
June
Quarter
The ending inventory for April is the
beginning inventory for May.
7-21
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Purchases Budget
Budgeted Sales
Cost of Sales %
Budgeted Cost of Sales
Desired Ending Inventory
Inventory Needed
Less: Beginning Inventory
Required Purchases
April
$ 200,000
70%
$ 140,000
28,000
168,000
(15,000)
$ 153,000
May
$ 500,000
70%
$ 350,000
70,000
420,000
(28,000)
$ 392,000
June
$ 300,000
70%
$ 210,000
42,000
252,000
(70,000)
$ 182,000
Quarter
$1,000,000
70%
$ 700,000
42,000
742,000
(15,000)
$ 727,000
Now we can move on to the Schedule
of Cash payments for Inventory Purchases.
7-22
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cash Payments for Inventory Purchases


Web pays 80% of inventory purchases in
the month of acquisition and the
remaining 20% in the month following
acquisition.
On March 31, Web owed $14,000 for
purchases of inventory.
Let’s prepare the Cash Payments for
Inventory Purchases schedule.
7-23
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cash Payments for Inventory Purchases
Inventory Purchases
Paid in Current Month %
80% of Current Purchases
20% of Prior Month's Pur.
Total Budgeted Payments
April
$153,000
80%
$122,400
14,000
$136,400
May
June
March 31
accounts payable
for inventory
purchases
7-24
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cash Payments for Inventory Purchases
Inventory Purchases
Paid in Current Month %
80% of Current Purchases
20% of Prior Month's Pur.
Total Budgeted Payments
April
$153,000
80%
$122,400
14,000
$136,400
May
$ 392,000
80%
$ 313,600
30,600
$ 344,200
June
April Inventory Purchases
$153,000
Percent Paid in Following Month
20%
May Payment for April Purchases $ 30,600
7-25
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cash Payments for Inventory Purchases
Inventory Purchases
Paid in Current Month %
80% of Current Purchases
20% of Prior Month's Pur.
Total Budgeted Payments
April
$153,000
80%
$122,400
14,000
$136,400
May
$ 392,000
80%
$ 313,600
30,600
$ 344,200
June Inventory Purchases
Percent Paid in July
Accounts Payable at June 30
7-26
June
$182,000
80%
$145,600
78,400
$224,000
$182,000
20%
$ 36,400
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Selling and Administrative Expense
Budget




Sales commissions are 2% of sales and are
paid in the month after they are earned.
Supplies expense is 1% of sales.
Utilities are paid the month after they are used.
On March 31, Web owed $3,000 in sales
commissions and $1,200 in utilities.
Web has developed the selling and
administrative expense budget shown on the
next screen.
7-27
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Selling and Administrative Expense
Budget
Salary Expense
Sales Commissions
Supplies Expense
Utilities
Amortization
Rent
Miscellaneous
Total S&A Expense
7-28
April
$ 30,000
4,000
May
June
Quarter
$200,000 Sales × 2% = $4,000
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Selling and Administrative Expense
Budget
April
$ 30,000
4,000
2,000
Salary Expense
Sales Commissions
Supplies Expense
Utilities
$200,000
Amortization
Rent
Miscellaneous
Total S&A Expense
May
June
Quarter
Sales × 1% = $2,000
Let’s see how these expenses translate into cash
payments for selling and administrative expenses.
7-29
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Selling and Administrative Expense
Budget
Salary Expense
Sales Commissions
Supplies Expense
Utilities
Amortization
Rent
Miscellaneous
Total S&A Expense
April
$ 30,000
4,000
2,000
1,700
1,500
3,000
1,000
$ 43,200
May
$ 30,000
10,000
5,000
1,800
1,500
3,000
1,000
$ 52,300
June
$ 30,000
6,000
3,000
1,700
1,500
3,000
1,000
$ 46,200
Quarter
$ 90,000
20,000
10,000
5,200
4,500
9,000
3,000
$ 141,700
Let’s see how these expenses translate into cash
payments for selling and administrative expenses.
7-30
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Schedule of Cash Payments for S&A
Expenses
Salary Expense
Sales Commissions
Supplies Expense
Utilities
Amortization
Rent
Miscellaneous
Total S&A Expense
April
$ 30,000
3,000
2,000
1,200
3,000
1,000
$ 40,200
May
June
Quarter
March 31 Sales Commissions
and Utilities.
Amortization Expense is a
non-cash expense.
7-31
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Schedule of Cash Payments for S&A
Expenses
Salary Expense
Sales Commissions
Supplies Expense
Utilities
Amortization
Rent
Miscellaneous
Total S&A Expense
7-32
April
$ 30,000
3,000
2,000
1,200
3,000
1,000
$ 40,200
May
$ 30,000
4,000
5,000
1,700
3,000
1,000
$ 44,700
June
Quarter
April
Sales Commissions
and Utilities.
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Schedule of Cash Payments for S&A
Expenses
Salary Expense
Sales Commissions
Supplies Expense
Utilities
Amortization
Rent
Miscellaneous
Total S&A Expense
April
$ 30,000
3,000
2,000
1,200
3,000
1,000
$ 40,200
May
$ 30,000
4,000
5,000
1,700
3,000
1,000
$ 44,700
June
$ 30,000
10,000
3,000
1,800
3,000
1,000
$ 48,800
Quarter
$ 90,000
17,000
10,000
4,700
9,000
3,000
$ 133,700
The total quarterly expenses of $141,700, Web will pay
$133,700 in cash and record liabilities of $6,000
for June sales commissions and $1,700 for June utilities.
7-33
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cash Budget




Web want to maintain a $10,000 balance in its
cash account before any interest payments.
The company has a $100,000 line-of-credit that
requires 12% interest on any outstanding
balance payable monthly.
Web plans to purchase $50,000 of equipment
on April 1.
On March 31, Web’s cash balance is $18,000.
Let’s put together the information developed so far
and prepare Web’s cash budget.
7-34
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cash Budget
April
Cash Receipts
Beginning Balance
Cash Receipts
Cash Available
Cash Payments
Inventory Purchases
S&A Expenses
Purchase Equipment
Total Payments
Cash Needs
Shortage (Surplus)
Plus Desired Cash
Financing Actitity
Amount Borrowed (Repaid)
Interest Expense
Ending Balance
7-35
May
June
Cash Receipts Budget
$ 18,000
140,000
158,000
Payment for Inventory
Purchases Schedule
136,400
40,200
50,000
226,600
Cash Payments for
S&A Schedule
68,600
10,000
78,600
$ 10,000
$
-
$
-
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cash Budget
Cash Receipts
Beginning Balance
Cash Receipts
Cash Available
Cash Payments
Inventory Purchases
S&A Expenses
Purchase Equipment
Total Payments
Cash Needs
Shortage (Surplus)
Plus Desired Cash
Financing Actitity
Amount Borrowed (Repaid)
Interest Expense
Ending Balance
7-36
April
May
June
$ 18,000
140,000
158,000
$ 10,000
260,000
270,000
136,400
40,200
50,000
226,600
344,200
44,700
388,900
224,000
48,800
272,800
68,600
10,000
118,900
10,000
(196,414)
10,000
78,600
$ 10,000
128,900
786
$ 9,214
(186,414)
2,075
$
7,925
$
9,214
460,000
469,214
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cash Budget
Cash Receipts
Beginning Balance
Cash Receipts
Cash Available
Cash Payments
Inventory Purchases
S&A Expenses
Purchase Equipment
Total Payments
Cash Needs
Shortage (Surplus)
($78,600 +
Plus Desired Cash
Financing Actitity
Amount Borrowed (Repaid)
Interest Expense
Ending Balance
7-37
April
May
$ 18,000
140,000
158,000
$ 10,000
260,000
270,000
136,400
40,200
50,000
226,600
344,200
44,700
388,900
June
$
9,214
460,000
469,214
224,000
48,800
272,800
68,600
118,900
(196,414)
$128,900)
× 1% = $2,075
10,000
10,000
10,000
78,600
$ 10,000
128,900
786
$ 9,214
(186,414)
2,075
$
7,925
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Pro Forma Income Statement
Cash
Budget
Pro Forma
Income
Statement
After we complete the cash budget, we
can prepare the pro forma income
statement for Web.
7-38
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Pro Forma Income Statement
Web Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales
Cost of goods sold
Gross margin
Selling and administrative expenses
Operating income
Interest expense
Net income
$ 1,000,000
700,000
300,000
141,700
158,300
2,861
$ 155,439
S&A Expense Budget
7-39
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Pro Forma Balance Sheet
On March 31, Web had the following
account balances:



Equipment $100,000,
Capital stock $200,000, and
Retained earnings $19,300.
With this data and the information
developed in our budgets, we can prepare Web’s
Pro Forma Balance Sheet.
7-40
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Web Company
Pro Forma Balance Sheet
June 30
Assets
Cash
Accounts receivable
Inventory
Equipment (net)
Total assets
Liabilities
Accounts payable
Sales commissions payable
Utilities payable
Line-of-credit borrowing
Total liabilities
Equity
Capital stock
Retained earnings
Total equity
Total liabilities and equity
7-41
$
7,925
240,000
42,000
150,000
439,925
36,400
6,000
1,700
21,086
65,186
Cash Receipts
Budget
200,000
174,739
374,739
$ 439,925
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Web Company
Pro Forma Balance Sheet
June 30
Assets
Cash
Accounts receivable
Inventory
Equipment (net)
Total assets
Liabilities
Accounts payable
Sales commissions payable
Utilities payable
Line-of-credit borrowing
Total liabilities
Equity
Capital stock
Retained earnings
Total equity
Total liabilities and equity
7-42
$
7,925
240,000
42,000
150,000
439,925
Sales Budget
36,400
6,000
1,700
21,086
65,186
Cash Payments
for Inventory
Purchases
Budget
Cash Payments
for S&A
200,000
174,739
374,739
$ 439,925
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Web Company
Pro Forma Balance Sheet
June 30
Assets
Cash
$
Accounts receivable
Inventory
Equipment (net)
Total assets
Liabilities
Accounts payable
Beginning retained
Sales commissions
payable earnings
Net income for quarter
Utilities payable
Ending retained earnings
Line-of-credit borrowing
Total liabilities
Equity
Capital stock
Retained earnings
Total equity
Total liabilities and equity
$
7-43
7,925
240,000
42,000
150,000
439,925
36,400
$ 19,300
6,000
155,439
1,700
$174,739
21,086
65,186
200,000
174,739
374,739
439,925
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Web Company
Pro Forma Cash Flow Statement
For the Three Months Ended June 30
Cash flow from operating activities
Cash from customers
Cash payments for inventory
Cash payments for S&A expenses
Cash payments for interest
Net cash flows from operations
Cash flow from investing activities
Purchase
of equipment
Cash
Payment
for Inventory
Cash flow from financing activities
Borrowing on line-of-credit
Repayment of line-of-credit
Net cash flows from financing
Net decrease in cash
Beginning cash balance
Ending cash balance
7-44
$
Cash Receipts
Budget
860,000
(704,600)
(133,700)
(2,861)
18,839
Cash Payments
for S&A
(50,000)
207,500
(186,414)
21,086
(10,075)
18,000
$
7,925
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Web Company
Pro Forma Statement of Cash Flows
For the Three Months Ended June 30
Cash flow from operating activities
Cash from customers
Cash payments for inventory
Cash payments for S&A expenses
Cash payments for interest
Net cash flows from operations
Cash flow from investing activities
Purchase of equipment
Cash flow from financing activities
Borrowing on line-of-credit
Repayment of line-of-credit
Net cash flows from financing
Net decrease in cash
Beginning cash balance
Ending cash balance
7-45
$
860,000
(704,600)
(133,700)
(2,861)
18,839
(50,000)
207,500
(186,414)
21,086
(10,075)
18,000
$
7,925
Cash Budget
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
End of Chapter 7
7-46
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada