AGENDA: PROFIT PLANNING (BUDGETING)

Building a master budget.

  1. Sales budget
  2. Production budget
  3. Direct materials budget
  4. Direct labor budget
  5. Manufacturing overhead budget
  6. Ending finished goods inventory budget
  7. Selling and administrative expenses budget
  8. Cash budget
  9. Budgeted income statement
  10. Budgeted balance sheet

OVERVIEW OF BUDGETING

A budget is a detailed plan for acquiring and using financial and other resources over a specified period. Budgeting involves two stages:

  • Planning: Developing objectives and preparing various detailed budgets to achieve those objectives.
  • Control: The steps taken by management to attain the objectives set down at the planning stage.

PURPOSES OF BUDGETING

  • Budgets communicate management’s plans throughout the organization.
  • Budgeting forces managers to give planning top priority.
  • Budgets provide a means of allocating resources to their most effective uses.
  • Budgeting uncovers potential bottlenecks.
  • Budgeting coordinates the activities of the entire organization.
  • Budgeting provides goals that serve as benchmarks for evaluating subsequent performance.

COMPREHENSIVE BUDGETING EXAMPLE

Royal Company is preparing budgets for the second quarter ending June 30.

  • Budgeted sales of the company’s only product for the next five months are:
April…… 20,000 units
May…… 50,000 units
June….. 30,000 units
July…… 25,000 units
August.. 15,000 units

 

  • The selling price is $10 per unit.
  • The following elements of the master budget will be prepared in this example:
  1. Sales budget (with a schedule of expected cash collections).
  2. Production budget.
  3. Direct materials budget (with a schedule of expected cash disbursements for materials).
  4. Direct labor budget.
  5. Manufacturing overhead budget.
  6. Ending finished goods inventory budget.
  7. Selling and administrative expense budget.
  8. Cash budget.
  9. Budgeted income statement.
  10. Budgeted balance sheet.

 

 

 

 

 

 

 

SALES BUDGET

  April May June Quarter
Budgeted sales (units).. 20,000 50,000 30,000  100,000
Selling price per unit…..     × $10     × $10     × $10        × $10
Total sales………………. $200,000 $500,000 $300,000 $1,000,000

 

SCHEDULE OF EXPECTED CASH COLLECTIONS

Additional data:

  • All sales are on account.
  • The company collects 70% of these credit sales in the month of the sale; 25% are collected in the month following sale; and the remaining 5% are uncollectible.
  • The accounts receivable balance on March 31 was $30,000. All of this balance was collectible.

 

  April May June Quarter
Accounts receivable beginning balance……… $ 30,000 $ 30,000
April sales
70% × $200,000……….. 140,000 140,000
25% × $200,000……….. $ 50,000 50,000
May sales
70% × $500,000……….. 350,000 350,000
25% × $500,000……….. $125,000 125,000
June sales
70% × $300,000………..
                             210,000  210,000
Total cash collections……. $170,000 $400,000 $335,000 $905,000

 

25% of the $300,000 will be your 6/30 AR balance.

 

 

 

 

 

 

PRODUCTION BUDGET

Additional data:

  • The company desires to have inventory on hand at the end of each month equal to 20% of the following month’s budgeted unit sales.
  • On March 31, 4,000 units were on hand.

 

  April May June July
Budgeted sales ………………. 20,000 50,000 30,000 25,000
Add desired ending inventory 10,000  6,000  5,000  3,000*
Total needs…………………….. 30,000 56,000 35,000 28,000
Less beginning inventory…….  4,000 10,000  6,000  5,000
Required production…………. 26,000 46,000 29,000 23,000

 

*  Budgeted sales in August = 15,000 units.
Desired ending inventory in July = 15,000 units × 20% = 3,000 units.

 

6/30 inventory of finished goods is the 5,000 units

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DIRECT MATERIALS BUDGET

Additional data:

  • 5 pounds of material are required per unit of product.
  • Management desires to have materials on hand at the end of each month equal to 10% of the following month’s production needs.
  • The beginning materials inventory was 13,000 pounds.
  • The material costs $0.40 per pound.

 

April May June Quarter
Required production in units … 26,000 46,000 29,000 101,000
Raw materials per unit (pounds)………………………..       × 5       × 5       × 5       × 5
Production needs (pounds)…… 130,000 230,000 145,000 505,000
Add desired ending inventory (pounds)*………………………  23,000  14,500  11,500  11,500
Total needs (pounds)………….. 153,000 244,500 156,500 516,500
Less beginning inventory (pounds)………………………..  13,000  23,000  14,500  13,000
Raw materials to be purchased (pounds)……………………….. 140,000 221,500 142,000 503,500
Cost of raw materials to be purchased at $0.40 per pound…………………………… $56,000 $88,600 $56,800 $201,400

 

*  For June: 23,000 units produced in July × 5 pounds per unit = 115,000 pounds; 115,000 pounds × 10% = 11,500 pounds

 

June 30 raw materials inventory 11,500 pounds

 

 

 

 

 

 

 

 

 

SCHEDULE OF EXPECTED CASH DISBURSEMENTS FOR MATERIAL

Additional data:

  • Half of a month’s purchases are paid for in the month of purchase; the other half is paid for in the following month.
  • No discounts are given for early payment.
  • The accounts payable balance on March 31 was $12,000.

 

April May June Quarter
Accounts payable beginning balance………. $12,000 $ 12,000
April purchases:
50% × $56,000………….. 28,000 28,000
50% × $56,000………….. $28,000 28,000
May purchases:
50% × $88,600………….. 44,300 44,300
50% × $88,600………….. $44,300 44,300
June purchases:
50% × $56,800…………..                          28,400    28,400
Total cash disbursements for materials……………… $40,000 $72,300 $72,700 $185,000

 

 

The June 30 AP will be the other half of the $56,800 ($28,400).

 

 

 

 

 

 

 

 

 

 

 

 

DIRECT LABOR BUDGET

Additional data:

  • Each unit produced requires 0.05 hour of direct labor.
  • Each hour of direct labor costs the company $10.
  • Management fully adjusts the workforce to the workload each month.

 

April May June Quarter
Required production ……. 26,000 46,000 29,000 101,000
Direct labor-hours per unit  × 0.05  × 0.05  × 0.05  × 0.05
Total direct labor–hours needed…………………… 1,300 2,300 1,450 5,050
Direct labor cost per hour.   × $10   × $10   × $10   × $10
Total direct labor cost……. $13,000 $23,000 $14,500 $50,500

 

Note: Many companies do not fully adjust their direct labor workforce every month and in such companies direct labor behaves more like a fixed cost, with additional cost if overtime is necessary.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MANUFACTURING OVERHEAD BUDGET

Additional data:

  • Variable manufacturing overhead is $20 per direct labor-hour.
  • Fixed manufacturing overhead is $50,500 per month. This includes $20,500 in depreciation, which is not a cash outflow.

 

April May June Quarter
Budgeted direct labor-hours.. 1,300 2,300 1,450 5,050
Variable manufacturing overhead rate………………..   × $20   × $20   × $20     × $20
Variable manufacturing overhead…………………….. $26,000 $46,000 $29,000 $101,000
Fixed manufacturing overhead……………………..  50,500  50,500  50,500  151,500
Total manufacturing overhead 76,500 96,500 79,500 252,500
Less depreciation………………  20,500  20,500  20,500    61,500
Cash disbursements for manufacturing overhead….. $56,000 $76,000 $59,000 $191,000

 


ENDING FINISHED GOODS INVENTORY BUDGET

Additional data:

  • Royal Company uses absorption costing in its budgeted income statement and balance sheet.
  • Manufacturing overhead is applied to units of product on the basis of direct labor-hours.
  • The company has no work in process inventories.

 

Computation of absorption unit product cost:

Quantity Cost Total
Direct materials………… 5 pounds $0.40 per pound $2.00
Direct labor……………… 0.05 hours $10.00 per hour 0.50
Manufacturing overhead 0.05 hours $50.00 per hour*  2.50
Unit product cost……….   $5.00

 

*

Budgeted ending finished goods inventory:

Ending finished goods inventory in units………… 5,000
Unit product cost [see above]………………………     × $5
Ending finished goods inventory in dollars………. $25,000

 

 

 

 

 

 

 

 

 

 

SELLING AND ADMINISTRATIVE EXPENSE BUDGET

Additional data:

  • Variable selling and administrative expenses are $0.50 per unit sold.
  • Fixed selling and administrative expenses are $70,000 per month and include $10,000 in depreciation.

 

  April May June Quarter
Budgeted sales in units ….. 20,000 50,000 30,000 100,000
Variable selling and administrative expense
per unit……………………..
× $0.50 × $0.50 × $0.50 × $0.50
Variable selling and administrative expense…. $10,000 $25,000 $15,000 $ 50,000
Fixed selling and administrative expense….  70,000  70,000  70,000  210,000
Total selling and administrative expense…. 80,000 95,000 85,000 260,000
Less depreciation……………  10,000  10,000  10,000    30,000
Cash disbursements for selling and administrative expenses………………….. $70,000 $85,000 $75,000 $230,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CASH BUDGET

Additional data:

  1. A line of credit is available at a local bank that allows the company to borrow up to $75,000.
  2. All borrowing occurs at the beginning of the month, and all repayments occur at the end of the month.
  3. The interest rate is 1% per month.
  4. The company does not have to make any payments until the end of the quarter.
  5. Royal Company desires a cash balance of at least $30,000 at the end of each month. The cash balance at the beginning of April was $40,000.
  6. Cash dividends of $51,000 are to be paid to stockholders in April.
  7. Equipment purchases of $143,700 are scheduled for May and $48,800 for June. This equipment will be installed and tested during the second quarter and will not become operational until July, when depreciation charges will commence.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CASH BUDGET

Royal Company
Cash Budget
For the Quarter Ending June 30

 

  April May June Quarter
Cash balance, beginning….. $ 40,000 $ 30,000 $ 30,000 $ 40,000
Add receipts:
Cash collections………………  170,000  400,000  335,000  905,000
Total cash available…………  210,000  430,000  365,000  945,000
Less disbursements:
Direct materials………………. 40,000 72,300 72,700 185,000
Direct labor……………………. 13,000 23,000 14,500 50,500
Manufacturing overhead .. 56,000 76,000 59,000 191,000
Selling & administrative….. 70,000 85,000 75,000 230,000
Equipment purchases……. 0 143,700 48,800 192,500
Dividends…………………..    51,000            0            0    51,000
Total disbursements………..  230,000  400,000  270,000  900,000
       
Excess (deficiency) of cash available over disbursements……………..  (20,000)   30,000    95,000    45,000
Financing:
Borrowings…………………. 50,000 0 0 50,000
Repayments……………….. 0 0 (50,000) (50,000)
Interest*…………………….           0            0  ( 1,500)  ( 1,500)
Total financing……………….   50,000            0  (51,500)  ( 1,500)
       
Cash balance, ending……… $ 30,000 $ 30,000 $ 43,500 $ 43,500

 

* $50,000 × 1% × 3 = $1,500.

 

 

 

 

 

 

BEGINNING BALANCE SHEET

 

Royal Company
Balance Sheet
March 31
Current assets:
Cash…………………………………….. $   40,000 (a)
Accounts receivable………………….. 30,000 (b)
Raw materials inventory…………….. 5,200 (c)
Finished goods inventory……………      20,000 (d) $    95,200
Plant and equipment:
Land…………………………………….. 400,000 (e)
Buildings and equipment…………… 1,610,000 (f)
Accumulated depreciation…………..   (750,000) (g)  1,260,000
Total assets……………………………… $1,355,200
Liabilities:
Accounts payable…………………….. $    12,000 (h)
Stockholders’ equity:
Common stock………………………… $  200,000 (i)
Retained earnings…………………….  1,143,200 (j)  1,343,200
Total liabilities and stockholders’ equity…………………………………… $1,355,200

 

(a) Given (f) Given
(b) Given (g) Given
(c) Given (h) See MATERIALS DISBURSE-

MENTS

(d) Given (i) Given
(e) Given (j) Given

 

 

Prepare Budgeted Income Statement and Balance Sheet.

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