Profit Planning
Chapter 10
Garrison, Noreen, Brewer, Cheng & Yuen
© 2012 McGraw-Hill Education (Asia)
Learning Objective 1
Understand why
organizations budget and
the processes they use to
create budgets.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 2
The Basic Framework of Budgeting
A budget is a detailed quantitative plan for
acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activities is known
as budgetary control.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 3
Planning and Control
Control –
Planning –
involves developing
objectives and
preparing various
budgets to achieve
those objectives.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
involves the steps taken by
management to increase
the likelihood that the
objectives set down while
planning are attained and
that all parts of the
organization are working
together toward that goal.
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 4
Advantages of Budgeting
Define goals
and objectives
Communicate
plans
Think about and
plan for the future
Advantages
Coordinate
activities
Means of allocating
resources
Uncover potential
bottlenecks
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 5
Responsibility Accounting
Managers should be held
responsible for those
items - and only those
items - that they can
actually control
to a significant extent.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 6
Choosing the Budget Period
Operating Budget
2011
2012
Operating budgets ordinarily
cover a one-year period
corresponding to a company’s
fiscal year. Many companies
divide their annual budget
into four quarters.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
2013
2014
A continuous budget is a
12-month budget that rolls
forward one month (or quarter)
as the current month (or quarter)
is completed.
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 7
Learning Objective 2
Understand Basic
Budgeting Terms and the
Behavioral Aspects of
Budgeting.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 8
Bottom-up and Top-down Budgeting
Bottom-up budgeting
(Self-imposed budget or
Participative budget )
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Top-down budgeting
Top
Management
Top
Management
Middle
Management
Middle
Management
Lower-level
Management
Lower-level
Management
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 9
Advantages of the Bottom-up Budgeting
(Self-Imposed Budgets)
1. Individuals at all levels of the organization are viewed as
members of the team whose judgments are valued by top
management.
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. Self-imposed
budgets eliminate this excuse.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 10
How to overcome problems of selfimposed budgets
Self-imposed budgets should be reviewed
by higher levels of management to
prevent “budgetary slack (or budget
padding).”
Most companies issue broad guidelines in
terms of overall profits or sales. Lower
level managers are directed to prepare
budgets that meet those targets.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 11
Advantages of the Top-down Budgeting
1. Avoid the potential budgetary slack (budget padding).
2. Provide a clearer performance goals and expectations
from the top management.
3. May provide better budget due to top management’s
access to privileged/confidential market and organization
information .
4. Provide an efficient budgetary process.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 12
Budget Lapsing
• A popular method among government agencies,
universities and organizations relying on allocated funds.
• Any unused funding at the end of the financial period
cannot be carried forward to the following year.
• As a result, the following year’s budget may be cut because
of the under-expenditure in the previous year.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 13
Budget Lapsing: Advantages
• Budget lapsing helps ensure that the appropriate level of
resources is utilized in each period. Without budget lapsing,
risk-averse managers may unnecessarily accumulate funds
and this may adversely affect the performance of the
organization.
• It helps provide an opportunity for a clean cut-off of
expenditures and to reallocate any unused resources for
other more appropriate requirements.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 14
Budget Lapsing: Potential Problem &
Solution
• Budget lapsing can cause undesired behavior effects. For
example, managers may wastefully spend their entire
budget before the end of the period in order to avoid budget
cuts.
• A system of reviewing the expenditures near end of the
period may uncover unnecessary expenditures and
discourage managers to wastefully spend because of budget
lapsing.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 15
Incremental versus Zero-based Budgets
• Incremental method of budgeting is most commonly
used by companies. Companies start off one year’s budget
by referring back to the previous year’s figures.
Adjustments are then made to the budget to account for
the expected changes such as prices for the next year.
• While incremental method of budgeting is practical and
fast, any inefficiency in the previous year’s figures may be
carried forward. For example, if all along the organization is
over staffed, then the budget will continually to be allowing
for the over staffing situation under this method.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 16
Incremental versus Zero-based Budgets
• Zero-Based Budgets are prepared based on the
assumption that the company has just started. Therefore,
resources required have to be justified from scratch.
• For example, when budgeting for staff cost for a restaurant,
managers using the zero-based budgeting approach will
ignore the existing staff level and expenses, rather, they
will examine factors such as opening hours, number of
tables, expected patron numbers to work out the number of
staff required at each position and level, hence the
associate costs, to produce a budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 17
Incremental versus Zero-based Budgets
• Companies using the zero-based method do not simply
ignore previous years’ figures. Figures generated by the
zero-based method are usually compared with previous
years’ figures. Any large differences are investigated.
• As zero-based budgeting is time consuming and costly,
companies tend to use this method for the relatively large
items and the incremental method for the rest.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 18
Top Management Attitude:
Human Factors in Budgeting
The success of a budget program depends on 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. Budget targets should be challenging but
achievable in order to have good motivational
effects.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 19
The Budget Committee
A standing committee responsible for
 overall policy matters relating to the budget
 coordinating the preparation of the budget
 resolving disputes related to the budget
 approving the final budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 20
Learning Objective 3
Understand the Key
Components of Master
Budget in Manufacturing,
Merchandising and
Service Industries
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 21
Understand the key components of master budget in
Manufacturing, Merchandising, and Service Industries
The first step of budgeting for every business is to budget for the
revenue, whether it is a sales budget for providing goods or services or
a funding budget. Although operational budgets are adapted
according to the industries, they are very similar and typically comprise
of budgets for
• Income statement
• Cash
• Balance sheet.
The major differences of different industries include:
• Manufacturing: production budget is involved
• Merchandising: no production budget, only purchase budget of
merchandise is required.
• Service Industries: budget for revenue and cost of providing services
• Not-for-profit: expected funding available and plan usage of funding.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 22
Learning Objective 4
Prepare a Master Budget
for a Manufacturing
Company.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 23
The Master Budget: An Overview
Sales budget
Ending inventory
budget
Direct materials
budget
Production budget
Direct labor
budget
Selling and
administrative
budget
Manufacturing
overhead budget
Cash Budget
Budgeted
income
statement
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Budgeted
balance sheet
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 24
Learning Objective 4 (a)
Prepare a sales budget,
including a schedule of
expected cash collections.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 25
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.
 The selling price is $10 per unit.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 26
The Sales Budget
The individual months of April, May, and June are
summed to obtain the total budgeted sales in units
and dollars for the quarter ended June 30th
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 27
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% uncollectible.
 The March 31 accounts receivable
balance of $30,000 will be collected in full.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 28
Expected Cash Collections
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 29
Expected Cash Collections
From the Sales Budget for April.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 30
Expected Cash Collections
From the Sales Budget for May.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 31
Quick Check 
What will be the total cash collections for
the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 32
Quick Check 
What will be the total cash collections for
the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 33
Expected Cash Collections
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 34
Learning Objective 4 (b)
Prepare a
production budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 35
The Production Budget
Sales
Budget
and
Expected
Cash
Collections
Production
Budget
The production budget must be adequate to
meet budgeted sales and to provide for
the desired ending inventory.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 36
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 37
The Production Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 38
The Production Budget
March 31
ending inventory
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Budgeted May sales
Desired ending inventory %
Desired ending inventory
Garrison, Noreen, Brewer, Cheng & Yuen
50,000
20%
10,000
Slide 39
Quick Check 
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 40
Quick Check 
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 41
The Production Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 42
The Production Budget
Assumed ending inventory.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 43
Learning Objective 4 (c)
Prepare a direct materials
budget, including a
schedule of expected cash
disbursements for
purchases of materials.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 44
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 45
The Direct Materials Budget
From production budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 46
The Direct Materials Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 47
The Direct Materials Budget
March 31 inventory
10% of following month’s
production needs.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Calculate the materials to
be purchased in May.
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 48
Quick Check 
How much materials should be purchased in May?
a. 221,500 pounds
b. 240,000 pounds
c. 230,000 pounds
d. 211,500 pounds
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 49
Quick Check 
How much materials should be purchased in May?
a. 221,500 pounds
b. 240,000 pounds
c. 230,000 pounds
d. 211,500 pounds
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 50
The Direct Materials Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 51
The Direct Materials Budget
Assumed ending inventory
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 52
Expected Cash Disbursement for Materials

Royal pays $0.40 per pound for its materials.

One-half of a month’s purchases is 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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 53
Expected Cash Disbursement for Materials
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 54
Expected Cash Disbursement for Materials
Compute the expected cash
disbursements for materials
for the quarter.
140,000 lbs. × $0.40/lb. = $56,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 55
Quick Check 
What are the total cash disbursements for the
quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 56
Quick Check 
What are the total cash disbursements for the
quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 57
Expected Cash Disbursement for Materials
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 58
Learning Objective 4 (d)
Prepare a direct
labor budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 59
The Direct Labor Budget

At Royal, each unit of product requires 0.05 hours (3
minutes) of direct labor.

The Company has a “no layoff” policy so all employees
will be paid for 40 hours of work each week.

For purposes of our illustration assume that Royal has a
“no layoff” policy, workers are pay at the rate of $10 per
hour regardless of the hours worked.

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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 60
The Direct Labor Budget
From production budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 61
The Direct Labor Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 62
The Direct Labor Budget
Greater of labor hours required
or labor hours guaranteed.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 63
The Direct Labor Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 64
Quick Check 
What would be the total direct labor cost for
the quarter if the company follows its no layoff policy, but pays $15 (time-and-a-half) for
every hour worked in excess of 1,500 hours
in a month?
a. $79,500
b. $64,500
c. $61,000
d. $57,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 65
Quick Check 
What would be the total direct labor cost for
the quarter if the company follows its no layoff policy, but pays $15 (time-and-a-half) for
April ofMay
Quarter
every hour worked in excess
1,500June
hours
Labor hours required 1,300
2,300
1,450
in a month? Regular hours paid 1,500 1,500 1,500 4,500
800
800
a. $79,500 Overtime hours paid
b. $64,500 Total regular hours 4,500 $10 $ 45,000
Total overtime hours
800
$15 $ 12,000
c. $61,000 Total pay
$ 57,000
d. $57,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 66
Learning Objective 4 (e)
Prepare a
manufacturing
overhead budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 67
Manufacturing Overhead Budget
 At Royal, manufacturing overhead is applied to units
of product on the basis of direct labor hours.
 The variable manufacturing overhead rate is $20 per
direct labor hour.
 Fixed manufacturing overhead is $50,000 per month,
which includes $20,000 of noncash costs (primarily
depreciation of plant assets).
Let’s prepare the manufacturing overhead budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 68
Manufacturing Overhead Budget
Direct Labor Budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 69
Manufacturing Overhead Budget
Total mfg. OH for quarter $251,000
= $49.70 per hour *
Total labor hours required 5,050
* rounded
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 70
Manufacturing Overhead Budget
Depreciation is a noncash charge.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 71
Ending Finished Goods Inventory Budget
Production costs per unit Quantity
Cost
Direct materials
5.00 lbs. $ 0.40
Direct labor
0.05 hrs. $ 10.00
Manufacturing overhead
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
Direct materials
budget and information.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 72
Ending Finished Goods Inventory Budget
Production costs per unit Quantity
Cost
Direct materials
5.00 lbs. $ 0.40
Direct labor
0.05 hrs. $ 10.00
Manufacturing overhead
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
Direct labor budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 73
Ending Finished Goods Inventory Budget
Production costs per unit Quantity
Cost
Direct materials
5.00 lbs. $ 0.40
Direct labor
0.05 hrs. $ 10.00
Manufacturing overhead
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
?
Total mfg. OH for quarter $251,000
= $49.70 per hour *
Total labor hours required 5,050
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 74
Ending Finished Goods Inventory Budget
Production costs per unit Quantity
Cost
Direct materials
5.00 lbs. $ 0.40
Direct labor
0.05 hrs. $ 10.00
Manufacturing overhead
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 75
Learning Objective 4 (f)
Prepare a selling and
administrative
expense budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 76
Selling and Administrative Expense Budget

At Royal, the selling and administrative expense budget is
divided into variable and fixed components.

The 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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 77
Selling and Administrative Expense Budget
Calculate the selling and administrative
cash expenses for the quarter.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 78
Quick Check 
What are the total cash disbursements for
selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 79
Quick Check 
What are the total cash disbursements for
selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 80
Selling Administrative Expense Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 81
Learning Objective 4 (g)
Prepare a cash
budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 82
Format of the Cash Budget
The cash budget is divided into four sections:
1. Cash receipts section lists all cash inflows excluding cash
received from financing;
2. Cash disbursements section consists of all cash payments
excluding repayments of principal and interest;
3. Cash excess or deficiency section determines if the
company will need to borrow money or if it will be able to
repay funds previously borrowed; and
4. Financing section details the borrowings and repayments
projected to take place during the budget period.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 83
The Cash Budget
Assume the following information for 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 (both purchases paid in cash)
 Has
an April 1 cash balance of $40,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 84
The Cash Budget
Schedule of Expected
Cash Collections.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 85
The Cash Budget
Schedule of Expected
Cash Disbursements.
Direct Labor
Budget.
Manufacturing
Overhead Budget.
Selling and Administrative
Expense Budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 86
The Cash Budget
Because Royal maintains
a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 87
The Cash Budget
Because Royal maintains
a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.
Ending cash balance for April
is the beginning May balance.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 88
The Cash Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 89
Quick Check 
What is the excess (deficiency) of cash
available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 90
Quick Check 
What is the excess (deficiency) of cash
available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 91
The Cash Budget
$50,000 × 16% × 3/12 = $2,000
Borrowings on April 1 and
repayment on June 30.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 92
The Budgeted Income Statement
Cash
Budget
Budgeted
Income
Statement
With interest expense from the cash
budget, Royal can prepare the budgeted
income statement.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 93
Learning Objective 4(h)
Prepare a budgeted
income statement.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 94
The Budgeted Income Statement
Sales Budget.
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10)
Cost of goods sold (100,000 @ $4.99)
Gross margin
Selling and administrative expenses
Operating income
Interest expense
Net income
$ 1,000,000
499,000
501,000
260,000
241,000
2,000
$ 239,000
Ending Finished
Goods Inventory.
Selling and
Administrative
Expense Budget.
Cash Budget.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 95
Learning Objective 4 (i)
Prepare a
budgeted balance
sheet.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 96
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 (April 1)
• Equipment - $175,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 97
Royal Company
Budgeted Balance Sheet
June 30
Assets:
Cash
Accounts receivable
Raw materials inventory
Finished goods inventory
Land
Equipment
Total assets
$
Liabilities and Stockholders' Equity
Accounts payable
Common stock
Retained earnings
Total liabilities and stockholders' equity
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
25% of June
sales of
$300,000.
43,000
75,000
4,600
24,950
50,000
367,000
564,550
$
28,400
200,000
336,150
$ 564,550
Garrison, Noreen, Brewer, Cheng & Yuen
11,500 lbs.
at $0.40/lb.
5,000 units
at $4.99 each.
50% of June
purchases
of $56,800.
Slide 98
Royal Company
Budgeted Balance Sheet
June 30
Assets:
Cash
Accounts receivable
Raw materials inventory
Finished goods inventory
Land
Equipment
Total assets
$
$146,150
239,000
(49,000)
$336,150
4,600
24,950
50,000
367,000
564,550
Liabilities and Stockholders' Equity
Accounts payable
Common stock
Retained earnings
Total liabilities and stockholders' equity
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Beginning balance
Add: net income
43,000
Deduct: dividends
Ending balance
75,000
$
28,400
200,000
336,150
$ 564,550
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 99
Learning Objective 5
Prepare Budget on
the Key
Components for the
Service Industry
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 100
Key Budget Components for the Service Industry
Wonder World, a hypothetical theme park, has the following data:
Main Sources of
Revenue
• Ticketing
• Food &
Beverages
• Souvenir Shop
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Major
Expenses
•
•
•
•
•
•
•
Salaries
Rent
Cost of Sales
Advertising
Maintenance
Depreciation
Utilities
Departments
•
•
•
•
•
•
Finance & Administration
Operations
Marketing
Souvenir Shop
Food and Beverages
Maintenance
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 101
Learning Objective 5 (a)
Prepare a
Visitorship Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 102
Visitorship Budget
Based on historical records, economic outlook, tourist
arrival expectations, the following visitorship budget for the
coming year is prepared:
Number of Visitors
Adults
750,000
Children
250,000
Total Visitors
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
1,000,000
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 103
Learning Objective 5 (b)
Prepare a Revenue
Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 104
Revenue Budget
Based on the average price charged by Wonder World and
other historical data, the following revenues per visitor are
budgeted and approved by the top management:
Revenue per visitor
Gate Collections : Adults
$13
Gate Collections : Children $9
Souvenir Shop
$4
Food and Beverages
$6
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 105
Revenue Budget
With the budgeted number of visitors and revenues per visitor
from each category, the budgeted revenues are computed:
Revenue
Gate Collections : Adults1
Gate Collections : Children2
Souvenir Shop3
Food and Beverages4
Total Revenue
$9,750,000
$2,250,000
$4,000,000
$6,000,000
$22,000,000
Note
1 750,000 X $13
2 250,000 X $9
3 1,000,000 X $4
4 1,000,000 X $6
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 106
Learning Objective 5 (c)
Prepare a Cost of
Sales Budget and
Expense Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 107
Cost of Sales Budget
For cost of sales on souvenirs and food and beverages, the
company normally makes use of the historical cost of sales
% and takes into account of any expected price changes
from the suppliers. For the coming year, the expected cost of
sales % is 50% on sales for both the souvenir shop and food
and beverages.
Cost of Sales
Souvenir Shop
$2,000,000
Food and Beverage $3,000,000
Total
$5,000,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 108
Expenses Budget
How the items are budgeted will depend on the nature of the items.
Nature of expense
Rental
Amount
Budget approach
$1,100,000
5% of revenue as agreed with the landlord.
Salaries
$3,500,000
Zero based approach by reviewing the
actual requirement of each position and its
suitable rate of pay.
Advertising
$1,200,000
Proposed by marketing manager.
Maintenance
$980,000
Proposed by maintenance manager.
Depreciation
$890,000
Computed by the finance manager by
taking into account of existing assets and
proposed new assets.
Utilities
$580,000
Computed by maintenance manager based
on the rates and usage expectations.
Other operating expenses
$490,000
Based on judgment and any specific
requirements such as legal expenses.
Total
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
$8,740,000
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 109
Learning Objective 5 (d)
Prepare a
Budgeted Income
Statement
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 110
Budgeted Income Statement
Budgeted Income Statement can be prepared by putting all
previous budgeted information together.
Budgeted Income Statement
Revenue
$22,000,000
Cost of goods sold
$5,000,000
Expenses
$8,740,000
Net income
$8,260,000
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 111
Learning Objective 6
Explain the Costs
and Benefits of
Budgeting
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 112
Costs and Benefits of Budgeting
• Budgeting is time-consuming and costly.
• Budgetary slack or padding is an inherent problem of
budgeting.
• Despite the drawbacks of budgeting, most companies are
still using budgets to plan, communicate, set objectives
and allocate resources etc.
• Since budgets are still commonly used, benefits of
budgeting are high and drawbacks of budgeting can be
minimized by having a good budgeting system.
• For a good budgeting system, it is critical to have effective
communication and mutual trust between the top
management and its staff.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 113
End of Chapter 10
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin
Garrison, Noreen, Brewer, Cheng & Yuen
Slide 114