Internal Planning and Measurement Tools

1. Internal Planning and Measurement Tools Chapter 10

2. Learning Objective 1 • Discuss some of the benefits • of the operating budget.

3. Operating Budget It is the plan for a firm’s operating activities for a specified period of time. Forecasted or pro forma financial statements estimate what may happen in the future.

4. Benefits of Budgeting Budgeting serves as a guide. It assists in resource allocation. It fosters communication and coordination. Budgeting establishes performance standards.

5. Learning Objective 2 • Compare and contrast various • approaches to the preparation • and use of the operating budget.

6. Different Approachesto Budgeting Perpetual budgeting (rolling budgeting): As one month ends, another month is added to the end of the budget. Incremental budgeting is the process of using the prior year’s budget to build the new operating budget.

7. Different Approachesto Budgeting Zero-based budgeting is an alternative to incremental budgeting. Managers must start from scratch, or zero, when preparing a new budget. In top-down budgeting, the top executives prepare the budget. Imposed budget

8. Different Approachesto Budgeting In bottom-up budgeting, lower-level managers and employees prepare the initial budget. Bottom-up budgeting is always a participative budgeting process. To empower employees means to give them the authority to make decisions concerning their job responsibilities.

9. Learning Objectives 3 & 4 • Construct the three budgeted • financial statements contained • in the operating budget and • the other budget schedules. Demonstrate the role of the sales forecast in the budgeting process.

10. Other budgets Cost of goods sold budget Production budget Sales budget The Sales Forecast Sales forecast

11. Different Budgets Sales budget Production or purchases budget Cost of goods sold or cost of services budget Selling and administrative expense budget Cash budget

12. Budgeted Financial Statements Budgeted income statement Budgeted balance sheet Budgeted cash flow statement

13. Budgeted income statement Sales budget Production (purchases) budget Budgeted balance sheet Cost of goods sold (Cost of services) budget Budgeted statement of cash flows Selling and administrative expense budget InterrelationshipAmong the Budgets Sales forecast Cash budget

14. Learning Objective 5 • Prepare the budgets included • in the operating budget.

15. Quarter First Second Third Fourth Total Budgeted unit sales: Wholesale S 50 250 1,000 600 Selling price $ 95$ 95$ 95$ 95 Subtotal $ 4,750 $ 23,750 $ 95,000 $ 57,000 $ 180,500 Retail S 80 300 1,500 1,200 Selling price $ 135$ 140$ 140$ 140 Subtotal $ 10,800 $ 42,000 $210,000 $168,000 $ 430,800 Wholesale M 500 300 200 250 Selling price $ 120$ 120$ 120$ 120 Subtotal $ 60,000 $ 36,000 $ 24,000 $ 30,000 Retail M 550 400 225 400 Selling price $ 180$ 180$ 180$ 180 Subtotal $ 99,000 $ 72,000 $ 40,500 $ 72,000 $ 283,500 Budgeted sales ($): Retail goods $ 10,500 $ 18,300$ 34,600$ 13,700$ 77,100 Total $185,050 $192,050 $404,100 $340,700 $1,121,900 Elevation Sports, Inc.Sales BudgetFor the Year Ended May 31, 2006

16. Elevation Sports, Inc.Cost of Goods Sold BudgetFor the Year Ended May 31, 2006 Quarter First Second Third Fourth Total Budgeted unit sales: Wholesale S 50 250 1,000 600 Retail S 80 300 1,500 1,200 Total S 130 550 2,500 1,800 Mfg. cost $ 65$ 65$ 65$ 65 Subtotal $ 8,450 $ 35,750 $162,500 $117,000 $323,700 Wholesale M 500 300 200 250 Retail M 550 400 225 400 Total M 1,050 700 425 650 Mfg. cost $ 90$ 90$ 90$ 90 Subtotal $ 94,500 $ 63,000 $ 38,250 $ 58,500 $254,250 Budgeted sales ($): Retail goods$ 10,500 $ 18,300 $ 34,600 $ 13,700 Purchase cost 60% 60% 60% 60% Subtotal $ 6,300$ 10,980$ 20,760$ 8,220$ 46,260 Total $109,250 $109,730 $221,510 $183,720 $624,210

17. Elevation Sports, Inc.Selling and Admin. Expense BudgetFor the Year Ended May 31, 2006 Quarter First Second Third Fourth Total Selling expenses: Advertising $ 8,300 $17,000 $18,000 $12,000 $ 55,300 Discounts 2,800 2,400 5,300 3,900 14,400 Rent 900 900 900 900 3,600 Sales salaries 7,500 11,500 15,000 11,800 45,800 Internet expenses 900 900 900 900 3,600 Utilities 1,000 1,000 1,000 1,000 4,000 Depreciation 300 300 300 300 1,200 Other expenses 600 920 1,200 944 3,664 Total $22,300 $34,920 $42,600 $31,744 $131,564 Administrative exp.: Officers’ salaries $48,000 $48,000 $48,000 $48,000 $192,000 Employee benefits 6,000 6,000 6,000 6,000 24,000 Insurance 2,050 2,050 2,050 2,050 8,200 Utilities 600 600 600 600 2,400 Depr. and amort. 706 706 706 706 2,824 Other expenses 6,350 6,350 6,350 6,350 25,400 Total $63,706 $63,706 $63,706 $63,706 $254,824

18. Elevation Sports, Inc.Budgeted Income StatementFor the Year Ended May 31, 2006 Quarter First Second Third Fourth Total Sales $185,050 $192,050 $404,100 $340,700 $1,121,900 Cost of goods sold 109,250 109,730 221,510 183,720 624,210 Gross profit $ 75,800 $ 82,320 $182,590 $156,980 $ 497,690 Selling expense 22,300 34,920 42,600 31,744 131,564 Admin. expense 63,706 63,706 63,706 63,706 254,824 Taxable income $(10,206) $(16,306) $ 76,284 $ 61,530 $ 111,302 Income taxes (4,082) (6,523) 30,514 24,612 44,521 Net income $ (6,124) $ (9,783) $ 45,770 $ 36,918 $ 66,781

19. Elevation Sports, Inc.Production BudgetFor the Year Ended May 31, 2006 Quarter First Second Third Fourth Total Snowboards: Forecasted sales 130 550 2,500 1,800 4,980 Desired ending inv. 220 1,000 480 60 60 Total units needed 350 1,550 2,980 1,860 5,040 Beg. inventory (80) (220) (1,000) (480) (80) To be produced 270 1,330 1,980 1,380 4,960 Cost per unit $ 65$ 65$ 65$ 65$ 65 Cost of production $ 17,550 $ 86,450 $128,700 $ 89,700 $322,400 Mountain boards: Forecasted sales 1,050 700 425 650 2,825 Desired ending inv. 280 170 260 440 440 Total units needed 1,330 870 685 1,090 3,265 Beg. inventory (150) (280) (170) (260) (150) To be produced 1,180 590 515 830 3,115 Cost per unit $ 90$ 90 $ 90$ 90$ 90 Cost of production $106,200 $ 53,100 $ 46,350 $ 74,700 $280,350 Total prod. cost $123,750 $139,550 $175,050 $164,400 $605,750

20. Elevation Sports, Inc.Purchases BudgetFor the Year Ended May 31, 2006 Quarter First Second Third Fourth Total Forecasted sales $10,500 $18,300 $34,600 $13,700 $77,100 Cost of sales $ 6,300 $10,980 $20,760 $ 8,220 $46,260 Desired ending inv. 4,392 8,304 3,288 2,600 2,600 Inventory needed $10,692 $19,284 $24,048 $10,820 $48,860 Beg. inventory 5,600 4,392 8,304 3,288 5,600 Inventory to be purchased $ 5,092 $14,892 $15,744 $ 7,532 $43,260

21. Elevation Sports, Inc.Partial Cash Receipts ScheduleFor the Year Ended May 31, 2006 Quarter Prior First Second Total forecasted sales $185,050 $192,050 Credit sales (30%) $80,000 55,515 57,615 Forecasted cash sales (70%) $129,535 $134,435 Credit sales collected: From accounts receivable at 5/31/05: (20% of $80,000) From new credit sales: $ 16,000 First quarter credit sales: Collected – first quarter (80%) 44,412 Collected – second quarter (20%) $ 11,103 Second quarter credit sales: Collected – second quarter (80%) 46,092 Budgeted receipts from credit sales 60,412 57,195 Total budgeted cash receipts $189,947 $191,630

22. Elevation Sports, Inc.Partial Cash Payments ScheduleFor the Year Ended May 31, 2006 Quarter Prior First Second Purchases $ 6,500 $ 5,092 $ 14,892 Production costs 150,000 123,750 139,550 Total $156,500 $128,842 $154,442 Amount paid: (35% of prior) 54,775 First quarter: Paid in first quarter (65%) 83,747 Paid in second quarter (35%) 45,095 Second quarter: Paid in second quarter (65%) 100,387 Less: Depreciation (3,700) (3,700) Total paid for production costs and purchases $134,822 $141,782 Total paid for selling and administrative expense 85,000 97,620 Total paid for other expenses 15,000 0 Budgeted cash payments $234,822 $239,402

23. Elevation Sports, Inc.Cash BudgetFor the Year Ended May 31, 2006 Quarter First Second Third Fourth Total Beg. cash balance $124,000 $ 79,125 $ 40,000 $123,150 $ 124,000 Add: Cash receipts 189,947 191,630 391,377 344,504 1,117,458 Cash available $313,947 $270,755 $431,377 $467,654 $1,241,458 Less: Cash pmts. 234,822 239,402 299,580 423,890 1,197,694 Balance before borrowing $ 79,125 $ 31,353 $131,797 $ 43,764 $ 43,764 Borrowing/ (repayment) -0- 8,647 (8,647) -0- -0- Ending cash balance $ 79,125 $ 40,000 $123,150 $ 43,764 $ 43,764

24. Elevation Sports, Inc.Budgeted Balance Sheet Assets Aug. 31, 2005 Nov. 30, 2005 Feb. 28, 2006 May 31, 2006 Current assets: Cash $ 79,125 $ 40,000 $123,150 $ 43,764 Accounts receivable 11,103 11,523 24,246 20,442 Mdse. inventory 4,392 8,304 3,288 2,600 Mfg. inventories 59,500 100,300 74,600 63,500 Tax refund due 4,082 10,605 -0- -0- Prepaid expenses 45,000 45,000 45,000 45,000 Total current assets $203,202 $215,732 $270,284 $175,306 Equipment: Equip. and furniture $103,100 $103,100 $103,100 $223,100 Less: Acc. depreciation 75,650 80,100 84,550 89,000 Total equipment $ 27,450 $ 23,000 $ 18,550 $134,100 Intangible assets $ 8,756$ 8,500$ 8,244$ 7,988 Total assets $239,408 $247,232 $297,078 $317,394

25. Elevation Sports, Inc.Budgeted Balance Sheet Liabilities and Stockholders’ Equity Aug. 31, 2005 Nov. 30, 2005 Feb. 28, 2006 May 31, 2006 Current liabilities: Accounts payable $ 45,095 $ 54,055 $ 66,778 $ 60,176 Note payable -0- 8,647 -0- -0- Total current liabilities $ 45,095 $ 62,702 $ 66,778 $ 60,176 Stockholders’ equity: Paid-in capital: Common stock $ 60,000 $ 60,000 $ 60,000 $ 60,000 Paid-in capital 40,000 40,000 40,000 40,000 Total paid-in capital $100,000 $100,000 $100,000 $100,000 Retained earnings 94,313 84,530 130,300 157,218 Total stockholders equity $194,313$184,530$230,300$257,218 Total liabilities and stockholders’ equity $239,408 $247,232 $297,078 $317,394

26. Elevation Sports, Inc.Budgeted Statement of Cash FlowsFor the Year Ended May 31, 2006 Quarter First Second Third Fourth Cash flows from operating activities: Net income $ (6,124) $ (9,783) $45,770 $36,918 Add: Depreciation 4,450 4,450 4,450 4,450 Amortization 256 256 256 256 Changes in working capital: Accounts receivable 4,897 (420) (12,723) 3,804 Mdse. inventory 1,208 (3,912) 5,016 688 Mfg. inventories (20,800) (40,800) 25,700 11,100 Tax refunds due (4,082) (6,523) 10,605 -0- Accounts payable (9,680) 8,960 12,723 (6,602) Net cash flow from operating activities $(29,875) $(47,772) $91,797 $50,614

27. Elevation Sports, Inc.Budgeted Statement of Cash FlowsFor the Year Ended May 31, 2006 Quarter First Second Third Fourth Cash flows from investing activities: Cash paid for equipment $(120,000) Net cash used by investing activities $(120,000) Cash flows from financing activities: Borrowing $ 8,647 Loan payments $(15,000) $ (8,647) Dividends paid $(10,000) Net cash flow from financing activities $(15,000) $ 8,647 $ (8,647) $(10,000) Increase/(decrease) in cash $(44,875) $(39,125) $ 83,150 $(79,386) Budgeted beg. cash balance 124,000 79,125 40,000 123,500 Budgeted ending cash balance $ 79,125 $ 40,000 $123,500 $ 43,764

28. Learning Objective 6 • Integrate the operating • budget into the overall • management process.

29. Connecting the Budgetto the Strategic Plan One of the most important budgeting functions is for top management to ensure that each budget aligns with the goals and objectives of the strategic plan. The strategic plan and the master budget control the allocation of resources. They must be in conformity with one another.

30. Learning Objective 7 • Analyze budget variances.

31. The Budget Performance Report The difference between the actual and budgeted amounts for a budget category is known as a budget variance.

32. The Budget Performance Report Elevation Sports, Inc. Budget Performance Report for Sales For the Year Ended May 31, 2005 Description Budget Actual Variance Snowboard sales – retail $350,000 $372,600 $22,600 Snowboard sales – wholesale 180,000 170,100 (9,900) Mountain board sales – retail 240,000 225,000 (15,000) Mountain board sales – wholesale 150,000 120,000 (30,000) Other merchandise 60,000 63,400 3,400

33. The Budget Performance Report Possible causes of variances: The number of units of product remained the same but the price increased or decreased. The price remained the same, but due to uncontrollable forces, the number of units sold varied from the budgeted amounts.

34. Appendix:Snowboards Standard Cost Direct materials: Wood 3.00 sq. ft. × $2/sq. ft. = $ 6.00 Binding set 1.00 × $4 each = 4.00 Direct labor 2.5 × $10.00 = 25.00Variable overhead 2.5 × $6.20 = 15.50 Fixed overhead 2.5 × $7.80 = 19.50Total $70.00 Budgeted monthly direct labor hours = 1,000

35. Appendix:Snowboards Actual Results Quantity Actual cost Standard cost Units produced 250 Materials used: Wood 600 sq. ft. $ 1,200 $ 1,500 Bindings 252 756 1,000 Direct labor: 750 hrs. 7,500 6,250Variable overhead 3,600 3,875 Fixed overhead 7,800 4,875Total $20,856 $17,500

36. Standard quantity per unit: 3 sq. ft. × Number of units produced: 250 = Standard quantity of direct material allowed: 750 sq. ft. Standard quantity allowed: 750 sq. ft. – Actual quantity used: 600 sq. ft. = Quantity variance in square feet: 150 favorable Direct Material Quantity Variance: Wood

37. Quantity variance in square feet: 150 F × Standard price per square foot: $2.00 = Quantity variance in dollars: $300 F Direct Material Quantity Variance: Wood How much is the variance in dollars?

38. Material Price Variance: Bindings 252 AQ × $4 SP = $1,008 AQ at SP $1,008 – $756 = $252 favorable

39. Direct LaborEfficiency Variance 2.5 SH × 250 units = 625 SH 625 SH – 750 AH = 125 hours unfavorable 125 × $10 SR = $1,250 unfavorable

40. Variable Overhead Variances 125 × $6.20 SR = $775 unfavorable efficiency variance 750 AH × $6.20 SR = $4,650 SV for AH $4,650 SV for AH – $3,600 = $1,050 favorable spending variance

41. Fixed OverheadVolume Variance 400 plant production capacity – 250 actual units = 150 units under 150 × $2.5 hours/unit = 375 hours 375 × $7.80 = $2,925 unfavorable

42. Elevation Sports, Inc.Performance ReportFor October 2005 Direct material quantity variance: Wood $ 300 Bindings 8 Direct material price variance: Wood -0- Bindings 252 F Direct labor efficiency variance 1,250 U Direct labor rate variance -0- Variable overhead efficiency variance 775 U Variable overhead spending variance 1,050 F Fixed overhead budget variance -0- Fixed overhead volume variance 2,925 U Total $3,356 U

43. End of Chapter 10