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PROFIT PLANNING/ BUDGETING ACC 2203 Review Workshop Sindhu Bala

Acc 2203 Workshop Budgeting

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Page 1: Acc 2203 Workshop Budgeting

PROFIT PLANNING/ BUDGETING

ACC 2203 Review WorkshopSindhu Bala

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BUDGETING – DEFINITIONS

Master Budget – a comprehensive plan of all aspects of a firm’s future business and production operationsMaster budget comprises of many separate budgets. These budgets include: Sales Budget – forecasts future sales quantities, selling prices, and sales revenues Production Budget – shows the number of units of each good expected to be produced Budgeted Manufacturing Costs – prediction of the amounts and costs of each input required to manufacture expected production quantities

Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget

Selling and Administrative Expense Budget – prediction of all selling costs required for attaining forecasted sales levels; prediction of administrative costs Budgeted Income Statement Capital Expenditure Budget Cash Budget Budgeted Balance Sheet

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BUDGETING – DEFINITIONSAll firms make plans and decisions, such as Deciding what to produce and how much to produce (production capacity) Deciding what inputs and how much of each input to use Deciding what prices to charge and what type of a marketing strategy to pursueBudgets allow firms to see the impact of their decisions and plans and to improve on their decisions and plans (planning function of budgets). Firms that systematically prepare budgets can: See projected earnings and cash flows from the plans Detect potential problems before they occur Line-up additional financing that may be needed Coordinate actions of different division within the firm

Budgets set benchmarks for evaluating subsequent performance (control function of budgeting)

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THE MASTER BUDGET: AN OVERVIEW

ProductionBudget

Selling andAdministrative

Budget

DirectMaterialsBudget

ManufacturingOverhead

Budget

DirectLabor

Budget

CashBudget

SalesBudget

Budgeted Financial StatementsBudgeted Financial Statements

EndingFinished GoodsBudget

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MASTER BUDGET FOR A SAMPLE COMPANY

The Foster Company is a manufacturer of cashmere sweaters. Each year in October, Foster put together its Master Budget for the four quarters of the following year. SALES BUDGET – predicts sales quantities and selling prices to determine the amount of sales revenue the company expects to generate What factors do companies take into account when they decide how many units they can sell and what price to charge for each unit? Customers tastes Production and advertising strategies Competitors Production capacity Changes in the economy

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FOSTER COMPANY - SALES BUDGETThe Foster Company has predicted that it can maximize its profits if

it charges $200 for its sweaters. The marketing manager of the company has indicated that at a price of $200 the company can sell 1,000 sweaters in the first quarter of 2007. Due to an emerging trend observed in fashion houses toward using cashmere sweaters in their creations, the marketing manager predicts to increase its sales by 100 sweaters each quarter.

Foster Company Sales Budget for 2007

Quarter 1st 2nd 3rd 4th

Year

Expected Sales (in units)

1,000

Selling price per unit

x $200

x $200

x $200

x $200

x $200

Total Sales Revenue

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FOSTER COMPANY - COLLECTIONS BUDGETSCHEDULE OF EXPECTED CASH COLLECTIONS –

when do we expect to receive cash for the sales we have made?

Cash collection information:1. Of all sales 80% are on credit2. 70% of credit sales are collected in the quarter

in which the sale is made and 30% are collected in the following quarter

3. Accounts receivable is estimated to be $60,000 on December 31, 2006; the company expects to collect the outstanding receivables in the first quarter of 2007

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FOSTER COMPANY - COLLECTIONS BUDGET

Foster Company Schedule of Expected Cash Collections for 2007

Cash Collections By Quarter Quarter Expected Sales

Credit Sales 1st 2nd 3rd 4th

A/R

1st

2nd

3rd

4th

Cash collected on credit sales & A/P

Cash collected on cash sales

Total cash collected

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FOSTER COMPANY - PRODUCTION BUDGETPRODUCTION BUDGET – predicts the number

of units the firm plans to produce during the budget period.

Finished Goods Inventory

Units Produced

Beginning F.G Inventory

Ending F.G Inventory

Units Sold

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FOSTER COMPANY - PRODUCTION BUDGETNote that the number of units a firm plans to

produce many not equal the number of units it plans to sell. Explain why?

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FOSTER COMPANY - PRODUCTION BUDGETFoster maintains at the end of each quarter an inventory

of 10% of the next quarter’s sales. This allows the company to better meet its customers’ needs in case the customers experience a sudden surge in demand.

Foster Company Production Budget for 2007

Quarters 1st 2nd 3rd 4th

Year

Expected sales (in units)

Add desired units in ending finished goods inventory

Total units needed

Less units in beginning finished goods inventory

Units to be produced

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FOSTER COMPANY – MANUFACTURING COSTS

BUDGETED MANUFACTURING COSTS – Estimated amounts and costs of inputs necessary to produce the budgeted production quantitiesCompanies estimate the amounts and costs of DL, DM, and OH they expect to use to make one unit of a product. These estimates are called standard quantity of input and standard cost of input (per unit of output).Direct Materials (cashmere): Foster expects to use on average ½ lb. of cashmere to make one sweater. Expected price for a pound of raw cashmere is $30.Direct Labor: Although somewhat automated, dying, combing, knitting, and weaving cashmere is a tedious process that requires some direct labor. Each sweater on average requires 1 hour of skilled labor. Foster pays its skilled workers $20/hour.Variable Overhead: Foster expects to incur $1 per machine hour for indirect materials such as lubricants and cooling fluids, $1.5 per machine hour for utilities, and $2.5 per machine hour for indirect labor. On average it takes 2 hours of machine time to make one cashmere sweater (primarily due to the delicate nature of cashmere and the attention it requires)

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FOSTER COMPANY – MANUFACTURING COSTS

Fixed Overhead: Foster expects to incur $69,600 in machine depreciation, $60,000 in factory supervisor salary, and $56,000 in factory rent and insurance. Foster allocates OH on the basis of machine hours.FOH =

FOH Rate =

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FOSTER COMPANY – BUDGETED COSTS

Foster Company Budgeted (standard) cost for one cashmere sweater in 2007

Budgeted quantity

of input to make one sweater

Budgeted cost of

input

Total budgeted cost

Direct Materials

Direct Labor

Variable overhead

Fixed overhead

Total budgeted cost per unit

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FOSTER COMPANY – DM BUDGETDIRECT MATERIALS BUDGET – Estimated

amounts and costs of direct materials that need to be purchased to manufacture the budgeted units and to maintain a materials inventory

Materials Inventory

Foster keeps at the beginning of each quarter a materials inventory of 10% of the quarter’s raw materials needs.

Materials Purchased

Beginning Inventory

Ending Inventory

Materials used in production

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FOSTER COMPANY – DM BUDGETFoster Company

Direct Materials Budget for 2007 Quarter

1st 2nd 3rd 4th

Year Units to be produced

DM needed per unit

DM needed for production

Add desired ending inv. of materials

Total DM required

Less beginning DM inventory

DM to be purchased

Cost per pound

Total cost of DM purchases

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FOSTER COMPANY – CASH DISBURSEMENTS

SCHEDULE OF EXPECTED CASH DISBURSEMENTS FOR MATERIALS – shows the amount and timing of cash payments the firm has to make to its suppliers.

Cash Disbursement Information:1. Direct materials are all purchased on credit2. Foster usually pays 60% of its purchases in

the same quarter as the purchase and the rest is paid in the following quarter

3. The company expects to have an accounts payable balance of $40,000 on December 31, 2002; and all outstanding payables are expected to be paid in the first quarter of 2007

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FOSTER COMPANY – CASH DISBURSEMENTS

Foster Company Schedule Of Expected Cash Disbursements For Materials, 2007

Quarter in which cash is paid Quarter of purchases

Total purchases 1st 2nd 3rd 4th

A/P, beginning

1st quarter

2nd quarter

3rd quarter

4th quarter

Total cash disbursements

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FOSTER COMPANY – DL BUDGETDIRECT LABOR BUDGET – provides an

estimate of the amount and cost of direct labor time required to fulfill the budgeted production

Each cashmere sweater requires 1 hour of skilled labor. Foster pays its skilled workers $20/hour.

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FOSTER COMPANY – DL BUDGETFoster Company

Direct Labor Budget for 2007 Quarter

1st 2nd 3rd 4th

Year Units to be produced

DL hours per unit

1 DLH

1 DLH

1 DLH

1 DLH

1 DLH

Total DL hours needed for production

Cost per DL hour

Total cost of DL

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FOSTER COMPANY – MOH BUDGETMANUFACTURING OVERHEAD BUDGET - provides an

estimate of the cost of variable and fixed overhead required to fulfill the budgeted production

Variable overhead rate is $5 per machine hour (costs of indirect materials, utilities, and indirect labor combined). Foster expects to use 2 MHs per unit.

Fixed overhead cost is $185,600 ($69,600 in machine depreciation, $60,000 in factory supervisor salary, and $56,000 in factory rent and insurance combined). Fixed overhead is allocated on the basis of machine hours at a predetermined OH rate of $20/MH.

Fixed OH rate for cash items:FOH rate = Fixed OH rate for non-cash items:FOH = FOH rate =

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FOSTER COMPANY – MOH BUDGETFoster Company

Manufacturing Overhead Budget for 2007 Quarter

1st 2nd 3rd 4th

Year Units to be produced

Total VOH costs

Total cash FOH costs

Total cash OH

Total non-cash FOH costs

Total OH costs

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FOSTER COMPANY – S&A BUDGETSELLING AND ADMINISTRATIVE EXPENSE BUDGET – Estimates of all costs

necessary to attain the sales levels in the sales budget and to deliver the goods to the customer (selling expenses) and estimates of all administrative activities (administrative expenses)

Variable selling and administrative expenses for each cashmere sweater are 10% sales commission and an average shipping costs of $10 per sweater.

Fixed selling and administrative expenses for the year are:

Advertising $60,000 Executive salaries $120,000 Insurance $40,000 Depreciation $20,000 Total fixed S&A $240,000

Fixed S&A expenses are assumed to be the same in each quarter

Fixed cash S&A expenses for each quarter:

Fixed non-cash S&A expenses for each quarter:

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FOSTER COMPANY – S&A BUDGETFoster Company

Selling and Administrative Expense Budget for 2007 Quarter

1st 2nd 3rd 4th

Year Units to be sold

Total variable S&A expenses

Total fixed S&A expenses – cash

Total fixed S&A expenses – non-cash

Total S&A expenses

Total cash S&A expenses

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CASH BUDGET – EXPECTED CASH OUTFLOWS TO AND INFLOWS FROM OPERATIONS AND FINANCING

CASH BUDGET Cash balance, beginning Add Cash receipts: Cash sales Collections on credit sales Receipts of dividends and/or interest Receipts from sales of equipment and/or other assets Total cash available before financing Less Cash disbursements: Payments for direct materials Payments for direct labor Payments for manufacturing overhead Payments for selling and administrative expenses Payments for equipment purchases, dividends, and income taxes Total cash disbursements Excess (deficiency) of cash available over disbursements Financing: Add New borrowings Less Interest payments and/or repayments of principal Total financing Cash balance, ending

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FOSTER COMPANY – CASH BUDGETThe Foster Company has provided the following information for preparing a cash budget: Expected cash balance on 1/1/2007 = $40,000 (1)Information on cash receipts: 80% of all sales are on credit. 70% of credit sales are collected in the quarter in which the sale is made and 30% are collected in the following quarter. A/R is estimated to be $60,000 on 12/31/2006; the company expects to collect the outstanding A/R in the 1st quarter of 2007. In the 1st quarter of 2007, Foster expects to sell marketable securities that are valued at $10,000. (2)Information on cash disbursements: Direct materials are all purchased on credit. Foster usually pays 60% of its purchases in the same quarter as the purchase and the rest is paid in the following quarter. The company expects to have an accounts payable balance of $40,000 on December 31, 2006; and all outstanding payables are expected to be paid in the first quarter of 2007. All employees – direct laborers, supervisors, S&A staff – are all paid in the quarter in which their services are used. Overhead costs and S&A expenses are paid in the quarter in which they are incurred On April 1, 2007, the company plans to spend $90,000 to buy a high-end knitting machine, which has a 10-year useful life. (3) Information on financing: The company expects to obtain a loan for the full amount of the knitting machine on April 1, 2007. No principal will be repaid during the year; interest at an annual rate of 10% is due quarterly. The company does not expect to issue stock or pay any dividends in 2007. (4)

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FOSTER COMPANY – CASH BUDGETFoster Company

Cash Budget for 2007 Quarter 1st 2nd 3rd 4th CASH – BEGINNING $119,970 Cash receipts: Cash sales Collections on credit sales Sale of securities TOTAL CASH RECEIPTS TOTAL CASH AVAILABLE Cash disbursements: Payments for DM Payments for DL Payments for OH Payments for S&A Purchase of machine TOTAL CASH DISBURSED Excess (deficiency) of cash available over disbursements

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FOSTER COMPANY – CASH BUDGETExcess (deficiency) of cash available over disbursements

Excess (deficiency) of cash available over disbursements

Financing: Borrowings Interest payments TOTAL FINANCING CASH - ENDING

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FOSTER COMPANY – BUDGETED INCOME STATEMENTBUDGETED INCOME STATEMENT – projection

of net income the company expects to earn as a result of all the budgeted activities

Foster Company Budgeted Income Statement for 2007

Sales

COGS

Gross Margin

S&A expense

Net operating income

Interest expense

Net income

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FOSTER COMPANY – BUDGET BALANCE SHEET

BUDGETED BALANCE SHEET – projection of the company’s assets, liabilities, and shareholders’ equity at the end of the budget period The Foster Inc.’s balance sheet for 12/31/2006 includes the following items: Plant. Property, and equipment $560,000 Common stock $450,000 Accumulated depreciation $77,150 Retained earnings $112,865

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FOSTER COMPANY – BUDGET BALANCE SHEET

Foster Company Budgeted Balance Sheet for 2007

TOTAL ASSETS

Cash

Accounts receivable

Finished goods inventory

Raw materials inventory

Plant, property, and equipment

Less: Accumulated depreciation

Total Assets

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FOSTER COMPANY – BUDGET BALANCE SHEET

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

Accounts payable

Long term debt

Common stock

Retained earnings

Total liabilities and equity