CHAPTER 9

1. CHAPTER 9 Budgetary Planning

2. Budgeting Basics 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.

3. Concepts from the Book • 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.

4. What I learned from my first budget experience • 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.

5. What I learned from my first budget experience • Make reports provided during user friendly. • Use graphics where possible. • Make sure the account names are the same. • Hold department heads accountable.

6. Games People Play • 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.

7. Budgeting and Human Behavior 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.

8. The Master Budget • 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.

9. The Master Budget - Components LO 3: Identify the budgets that comprise the master budget.

10. Operating Budgets: Sales Budget • First budget prepared • Derived from the sales forecast Management’s best estimateof 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.

11. Operating Budgets: Production Budget • Shows the units that must be producedto 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.

12. Operating Budgets: Direct Materials Budget • Shows both the quantityandcostof 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.

13. Operating Budgets: Direct Labor Budget • Shows both the quantity of hours and cost of direct labornecessary 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.

14. Operating Budgets: Manufacturing Overhead • Shows the expected manufacturing overhead costs for the budget period • Distinguishes between fixedandvariableoverhead 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.

15. Operating Budgets: Manufacturing Overhead LO 3: Identify the budgets that comprise the master budget.

16. Operating Budgets: Budgeted Income Statement • Important end-product of the operating budgets • Indicates expected profitabilityof operations • Provides a basis for evaluatingcompany 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.

17. Operating Budgets: 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.

18. Operating Budgets: Budgeted Income Statement LO 4: Describe the sources for preparing the budgeted income statement.

19. Financial Budgets: Cash Budget • Shows anticipatedcash 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.

20. Operating Budgets: Budgeted Income Statement LO 5: Explain the principal sections of a cash budget.

21. Financial Budgets: Cash Budget • Cash Receipts Section • Includes expected receipts from the principal sourcesof 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 paymentsfor direct materials and labor, taxes, dividends, plant assets, etc. • Financing Section • Shows expected borrowings and repaymentsof borrowed funds plus interest LO 5: Explain the principal sections of a cash budget.

22. Financial Budgets: 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.

23. Financial Budgets: Budgeted Balance Sheet • 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.

24. LO 5: Explain the principal sections of a cash budget.

25. Budgeting: Merchandisers • Sales Budget: Starting point and key factor in developing the master budget • Use a purchases budgetinstead of a production budget • Doesnotuse the manufacturing budgets (direct materials, direct labor, manufacturing overhead) • To determine budgeted merchandise purchases: LO 6: Indicate the applicability of budgeting in nonmanufacturing companies.

26. Budgeting: Service 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.

27. Budgeting: Not-for-Profit 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.

28. Exercise 9-3 • 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

29. Exercise 9-3 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.

30. Budget--Auditing Simple formula: hours x billing rate equals revenue.

31. Budget--Tax

32. Budget--Consulting

33. Budget—Total Dollars

34. Exercise 9-5 • XYZ company has adopted the following production budget for the first four months of 2009.

35. Exercise 9-5 • 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.

36. Exercise 9-5 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 + + =

37. Exercise 9-5 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.

38. Exercise 9-5 To total pounds needed for production, we now add the desired ending inventory in pounds.

39. Exercise 9-5 This gives us the total materials required for the period.

40. Exercise 9-5 However, some of the material required for production can come from beginning inventory. Subtracting inventorying will, therefore, be our next step.

41. Exercise 9-5 Now we know how many pounds are needed, what we do not know is the cost.

42. Exercise 9-5 Multiply pounds by costs per pound to get total cost.

43. Exercise 9-8 • 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.

44. Exercise 9-8 • 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.

45. Exercise 9-8 • Things to remember when preparing an overhead budget: • 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).

46. Since the base is direct labor hours, let us calculate that first. Direct hours = 1.5 x direct labor hours. We will multiply direct labor hours by variable cost/hour on the next slide.

47. Now let’s calculate variable overhead costs Costs per hour are given in the problem In the next slide we will multiply them by hours shown on previous slide to get variable costs. Let’s do it!

48. Now let’s calculate variable overhead costs Let’s sum each quarter next!

49. Now let’s calculate variable overhead costs Fixed costs are easy, they are the same each month regardless of production volume or direct labor hours.

50. Now let’s calculate variable overhead costs Now we total fixed and variable overhead to get total overhead