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Copyright

2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 9

Profit Planningand

Activity-Based

Budgeting

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LearningObjective

1

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Purposes of Budgeting Systems

1-3

Budget

a detailed plan,expressed in

quantitative terms,that specifies howresources will be

acquired and usedduring a specifiedperiod of time.

1. Planning

2. Facilitating

Communication andCoordination

3. Allocating Resources

4. Controlling Profit and

Operations5. Evaluating

Performance andProviding Incentives

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Types of Budgets

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DetailBudget

DetailBudget

DetailBudget

MasterBudget

Covering allphases of

a companysoperations.

Production

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Types of Budgets

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BudgetedFinancial

Statements

BalanceSheet

IncomeStatement

Statement ofCash Flows

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Types of Budgets

1-6

1999 2000 2001 2002

Continuous orRolling Budget

This budget is usually a twelve-monthbudget that rolls forward one monthas the current month is completed.

L o n g R a n g e B u d g e t s

Capital budgets with acquisitions

that normally cover several years.

Financial budgets with financialresource acquisitions.

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LearningObjective

2

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1-8

Budgeted IncomeStatement

Cash Budget

Sales of Services or Goods

Ending

InventoryBudgetWork in Process

and FinishedGoods

ProductionBudget

Direct

MaterialsBudget

Selling and

AdministrativeBudget

Direct

LaborBudget

OverheadBudget

Ending

InventoryBudget

Direct Materials

Budgeted BalanceSheet

Budgeted Statementof Cash Flows

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LearningObjective

3

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Activity-Based Costing versusActivity-Based Budgeting

Resources

Cost objects:

products and services

produced, and

customers served.

Activities

Resources

Forecast of products

and services to be

produced and

customers served.

Activities

Activity-BasedCosting (ABC)

Activity-Based

Budgeting (ABB)

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LearningObjective

4

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Sales Budget

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Breakers, Inc. is preparing budgets for the quarterending June 30.

Budgeted sales for the next five months are:

April 20,000 unitsMay 50,000 units

June 30,000 units

July 25,000 unitsAugust 15,000 units.

The selling price is $10 per unit.

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Sales Budget

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April May June Quarter

Budgeted

sales (units) 20,000 50,000 30,000 100,000

Selling priceper unit 10$ 10$ 10$ 10$Total

Revenue 200,000$ 500,000$ 300,000$ 1,000,000$

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Production Budget

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The management of Breakers, Inc. wants endinginventory to be equal to 20% of the following

months budgeted sales in units.

On March 31, 4,000 units were on hand.

Lets prepare the production budget.

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Production Budget

1-15


Sales in units 20,000 50,000 30,000 100,000

Add: desiredend. inventory 10,000 6,000 5,000 5,000

Total needed 30,000 56,000 35,000 105,000

Less: beg.

inventory 4,000 10,000 6,000 4,000Units to be

produced 26,000 46,000 29,000 101,000

From

salesbudget

March 31

ending inventory

Ending inventory becomesbeginning inventory the nextmonth

May sales 50,000 units

Desired percent 20%Desired inventory 10,000 units

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Direct-Material Budget

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At Breakers, five pounds of material are requiredper unit of product.

Management wants materials on hand at the end

of each month equal to 10% of the followingmonths production.

On March 31, 13,000 pounds of material are on

hand. Material cost $.40 per pound.

Lets prepare the direct materials budget.

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1-17

April May June Quarter Production in units 26,000 46,000 29,000 101,000

Materials per unit 5 5 5 5

Production needs 130,000 230,000 145,000 505,000

Add: desiredendinginventory 23,000 14,500 11,500 11,500

Total needed 153,000 244,500 156,500 516,500

Less: beginning

inventory 13,000 23,000 14,500 13,000

Materials to bepurchased 140,000 221,500 142,000 503,500

From ourproduction

budget

10% of the following

months production

March 31inventory

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Production in units 26,000 46,000 29,000 101,000

Materials per unit 5 5 5 5

Production needs 130,000 230,000 145,000 505,000

Add: desired

endinginventory 23,000 14,500 11,500 11,500

Total needed 153,000 244,500 156,500 516,500

Less: beginning

inventory 13,000 23,000 14,500 13,000Materials to be

purchased 140,000 221,500 142,000 503,500

June Ending Inventory

July production in units 23,000

Materials per unit 5Total units needed 115,000

Inventory percentage 10%

June desired ending inventory 11,500

July ProductionSales in units 25,000

Add: desired ending inventory 3,000

Total units needed 28,000

Less: beginning inventory 5,000

Production in units 23,000

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Direct-Labor Budget

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At Breakers, each unit of product requires 0.1 hoursof direct labor.

The Company has a no layoff policy so allemployees will be paid for 40 hours of work each

week.

In exchange for the no layoff policy, workers agreedto a wage rate of $8 per hour regardless of the hoursworked (No overtime pay).

For the next three months, the direct labor workforcewill be paid for a minimum of 3,000 hours per month.

Lets prepare the direct labor budget.

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Direct-Labor Budget

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April May June Quarter Production in units 26,000 46,000 29,000 101,000

Direct labor hours 0.10 0.10 0.10 0.10

Labor hours required 2,600 4,600 2,900 10,100

Guaranteed labor

hours 3,000 3,000 3,000Labor hours paid 3,000 4,600 3,000 10,600

Wage rate 8$ 8$ 8$ 8$

Total direct labot cost 24,000$ 36,800$ 24,000$ 84,800$

From ourproduction

budget

This is the greater oflabor hours required orlabor hours guaranteed.

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Overhead Budget

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Here is Breakers Overhead Budget for the quarter.


Indirect labor 17,500$ 26,500$ 17,900$ 61,900$

Indirect material 7,000 12,600 8,600 28,200Utilities 4,200 8,400 5,200 17,800

Rent 13,300 13,300 13,300 39,900

Insurance 5,800 5,800 5,800 17,400

Maintenance 8,200 9,400 8,200 25,800

56,000$ 76,000$ 59,000$ 191,000$

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Selling and AdministrativeExpense Budget

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At Breakers, variable selling and administrativeexpenses are $0.50 per unit sold.

Fixed selling and administrative expenses are$70,000 per month.

The $70,000 fixed expenses include $10,000 in

depreciation expense that does not require a cashoutflows for the month.

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Selling and AdministrativeExpense Budget

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Sales in units 20,000 50,000 30,000 100,000

Variable S&A rate 0.50$ 0.50$ 0.50$ 0.50$

Variable expense 10,000$ 25,000$ 15,000$ 50,000$

Fixed S&Aexpense 70,000 70,000 70,000 210,000

Total expense 80,000 95,000 85,000 260,000

Less: noncash

expenses 10,000 10,000 10,000 30,000Cash

disbursements 70,000$ 85,000$ 75,000$ 230,000$

From our

Sales budget

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Cash Receipts Budget

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At Breakers, all sales are on account. The companys collection pattern is:

70% collected in the month of sale,

25% collected in the month following sale,5% is uncollected.

The March 31 accounts receivable balance of

$30,000 will be collected in full.

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Cash Receipts Budget

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April May June Quarter Accounts rec. - 3/31 30,000$ 30,000$

April sales

70% x $200,000 140,000 140,000

25% x $200,000 50,000$ 50,000

May sales

70% x $500,000 350,000 350,000

25% x $500,000 125,000$ 125,000

June sales

70% x $300,000 210,000 210,000

Total cash collections 170,000$ 400,000$ 335,000$ 905,000$

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Cash Disbursement Budget

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Breakers pays $0.40 per pound for its materials.

One-half of a months purchases are paid for in themonth of purchase; the other half is paid in thefollowing month.

No discounts are available.

The March 31 accounts payable balance is

$12,000.

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Accounts pay. 3/31 12,000$ 12,000$

April purchases

50% x $56,000 28,000 28,000

50% x $56,000 28,000$ 28,000

May purchases

50% x $88,600 44,300 44,300

50% x $88,600 44,300$ 44,300

June purchases

50% x $56,800 28,400 28,400Total cash payments

for materials 40,000$ 72,300$ 72,700$ 185,000$

140,000 lbs. $.40/lb. = $56,000

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Breakers:

Maintains a 12% open line of credit for $75,000.

Maintains a minimum cash balance of $30,000.

Borrows and repays loans on the last day of themonth.

Pays a cash dividend of $25,000 in April.

Purchases $143,700 of equipment in May and$48,300 in June paid in cash.

Has an April 1 cash balance of $40,000.

From our Cash

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Cash Budget(Collections and Disbursements)

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April May June Quarter Beginning cash balance 40,000$

Add: cash collections 170,000

Total cash available 210,000

Less: disbursements

Materials 40,000Direct labor 24,000

Mfg. overhead 56,000

Selling and admin. 70,000

Equipment purchase -

Dividends 25,000Total disbursements 215,000

Excess (deficiency) of

Cash available over

disbursements (5,000)$

To maintain a cashbalance of $30,000,

Breakers must borrow$35,000 on its line of credit.

From our CashReceipts Budget

From our Cash DisbursementsBudget

From our Direct Labor Budget

From our Overhead Budget

From our Selling andAdministrative Expense

Budget

C h B d

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1-30

April May June Quarter Beginning cash balance 40,000$ 30,000$

Add: cash collections 170,000 400,000

Total cash available 210,000 430,000

Less: disbursements

Materials 40,000 72,300Direct labor 24,000 36,800

Mfg. overhead 56,000 76,000

Selling and admin. 70,000 85,000

Equipment purchase - 143,700

Dividends 25,000 -Total disbursements 215,000 413,800


Cash available over

disbursements (5,000)$ 16,200$

Breakers mustborrow an

addition $13,800to maintain a

cash balanceof $30,000.

C h B d t

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April May June Quarter Beginning cash balance 40,000$ 30,000$ 30,000$

Add: cash collections 170,000 400,000 335,000

Total cash available 210,000 430,000 365,000

Less: disbursements

Materials 40,000 72,300 72,700Direct labor 24,000 36,800 24,000

Mfg. overhead 56,000 76,000 59,000

Selling and admin. 70,000 85,000 75,000

Equipment purchase - 143,700 48,300

Dividends 25,000 - -Total disbursements 215,000 413,800 279,000


Cash available over

disbursements (5,000)$ 16,200$ 86,000$

At the end of June, Breakershas enough cash to repay

the $48,800 loan plus interest

at 12%.

C h B d t

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April May June Quarter Beginning cash balance 40,000$ 30,000$ 30,000$ 40,000$

Add: cash collections 170,000 400,000 335,000 905,000

Total cash available 210,000 430,000 365,000 945,000

Less: disbursements

Materials 40,000 72,300 72,700 185,000Direct labor 24,000 36,800 24,000 84,800

Mfg. overhead 56,000 76,000 59,000 191,000

Selling and admin. 70,000 85,000 75,000 230,000

Equipment purchase - 143,700 48,300 192,000

Dividends 25,000 - - 25,000Total disbursements 215,000 413,800 279,000 907,800


Cash available over

disbursements (5,000)$ 16,200$ 86,000$ 37,200$

Ending cash

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Cash Budget(Financing and Repayment)

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Borrowing RateAnnualInterest

MonthsOutstanding

InterestExpense

35,000$ 12% = 4,200$ 2 mths = 700$

13,800 12% = 1,656 1 mth. = 138

838$



Cash available overdisbursements (5,000)$ 16,200$ 86,000$ 37,200$

Financing: Borrowing 35,000 13,800 48,800

Repayments - - (48,800) (48,800)

Interest - - (838) (838)

Total financing 35,000 13,800 (49,638) (838)

Ending cash balance 30,000$ 30,000$ 36,362$ 36,362$

Ending cashbalance for Aprilis the beginningMay balance.

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Cost of Goods Manufactured

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Direct material:

Beg.material inventory 5,200$ 9,200$ 5,800$ 5,200$

Add: Materials purchases 56,000 88,600 56,800 201,400

Material available for use 61,200 97,800 62,600 206,600

Deduct: End. material inventory 9,200 5,800 4,600 4,600Direct material used 52,000 92,000 58,000 202,000

Direct labor 24,000 36,800 24,000 84,800

Manufacturing overhead 56,000 76,000 59,000 191,000

Total manufacturing costs 132,000 204,800 141,000 477,800

Add: Beg. Work-in-process inventory 3,800 16,200 9,400 3,800

Subtotal 135,800 221,000 150,400 481,600Deduct: End.Work-in-process inventory 16,200 9,400 17,000 17,000

Cost of goods manufactured 119,600$ 211,600$ 133,400$ 464,600$

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Cost of Goods Sold

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Cost of goods manufactured 119,600$ 211,600$ 133,400$ 464,600$

Add: Beg. finished-goods inventory 18,400 46,000 27,600 18,400

Cost of goods available for sale 138,000 257,600 161,000 483,000

Deduct: End. finished-goods inventory 46,000 27,600 23,000 23,000

Cost of goods sold 92,000$ 230,000$ 138,000$ 460,000$

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Budgeted Income Statement

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Revenue (100,000 $10) 1,000,000$

Cost of goods sold 460,000

Gross margin 540,000Operating expenses:

Selling and admin. expenses 260,000$

Interest expense 838

Total operating expenses 260,838

Net income 279,162$

Breakers, Inc.

Budgeted Income Statement

For the Three Months Ended June 30

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Budgeted Statement of Cash Flows

1-37


Cash flows from operating activities:

Cash receipts from customers 170,000$ 400,000$ 335,000$ 905,000$

Cash payments:

To suppliers of raw material (40,000) (72,300) (72,700) (185,000)

For direct labor (24,000) (36,800) (24,000) (84,800)

For manufacturing-overhead expenditures (56,000) (76,000) (59,000) (191,000)

For selling and administrative expenses (70,000) (85,000) (75,000) (230,000)

For interest - - (838) (838)

Total cash payments (190,000) (270,100) (231,538) (691,638)

Net cash flow from operating activities (20,000)$ 129,900$ 103,462$ 213,362$

Cash flows from investing activities:

Purchase of equipment - (143,700) (48,300) (192,000)

Net cash used by investing activities -$ (143,700)$ (48,300)$ (192,000)$

Cash flows from financing activities:Payment of dividends (25,000) - - (25,000)

Principle of bank loan 35,000 13,800 - 48,800

Repayment of bank loan - - (48,800) (48,800)

Net cash provided by financing activit ies 10,000$ 13,800$ (48,800)$ -$

Net increase in cash (10,000)$ -$ 6,362$ (3,638)$

Balance in cash, beginning 40,000 30,000 30,000 40,000

Balance in cash. end of month 30,000$ 30,000$ 36,362$ 36,362$

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Budgeted Balance Sheet

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Breakers reports the following account balanceson June 30 prior to preparing its budgetedfinancial statements:

Land - $50,000 Building (net) - $148,000

Common stock - $217,000

Retained earnings - $46,400

25%of June

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Breakers, Inc.

Budgeted Balance Sheet

June 30

Current assets

Cash 36,362$

Accounts receivable 75,000

Raw materials inventory 4,600

Work-in-process inventory 17,000

Finished goods inventory 23,000

Total current assets 155,962Property and equipment

Land 50,000

Building 148,000

Equipment 192,000

Tota l property and equipment 390,000Total assets 545,962$

Accounts payable 28,400$

Common stock 217,000

Retained earnings 300,562

Total liabilities and equities 545,962$

25%of Junesales of$300,000

11,500 lbs. at$.40 per lb.

5,000 units at$4.60 per unit.

50% of Junepurchasesof $56,800

Beginning balance 46,400$

Add: net income 279,162

Deduct: dividends (25,000)

Ending balance 300,562$

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Learning

Objective5

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1-41

Budgeted IncomeStatement

Cash Budget

Sales of Services or Goods

EndingInventoryBudget

Work in Processand Finished

Goods

Production

Budget

Direct

MaterialsBudget

Selling and

AdministrativeBudget

Direct

LaborBudget

OverheadBudget

Ending

InventoryBudget

Direct Materials

Budgeted BalanceSheet

Budgeted Statementof Cash Flows

When the interactions of the elementsof the master budget are expressed as

a set of mathematical relations, itbecomes a financial planning modelthat can be used to answer what if

questions about unknown variables.

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Learning

Objective6

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Budget Administration

1-43

The Budget Committee is a standing

committee responsible for . . .

overall policy matters relating to the budget. coordinating the preparation of the budget.

International Aspects of

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International Aspects ofBudgeting

1-44

Firms with international operations face special problemswhen preparing a budget.

1. Fluctuations in foreign currency exchange

rates.2. High inflation rates in some foreign countries.

3. Differences in local economic conditions.

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Learning

Objective7

Budgeting Product Life Cycle

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Budgeting Product Life-CycleCosts

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Product planningand concept

Design.

Preliminary

design.

Detailed design

and testing.Production.

Distributionand customer

service.

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Learning

Objective8

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Behavioral Impact of Budgets

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Budgetary Slack: Padding the BudgetPeople often perceive that their performance will

look better in their superiors eyes if they can

beat the budget.

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Participative Budgeting

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Flow of Budget Data

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End of Chapter 9

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Chapter 09 n