MANAGERIAL ACCOUNTING 2.1 BUDGET PLANNING · PDF fileMANAGERIAL ACCOUNTING MICROSOFT ... Chapter 1 project any additional skills that the work of a budget analyst ... not-for-proﬁt

Microsoft Corporation is a world-wide provider of software, services,and Internet technologies for personaland business computing. Founded in1975, the company operates sub-sidiary offices in more than 60 foreigncountries and employs nearly 44,000people worldwide. Microsoft is wellknown for its Windows and MicrosoftOffice software, among other products.

Financial Analysts at Microsoft pro-vide strategic and business develop-ment analysis, reporting, accountingsupport, adherence to internal con-trols, and strategic counsel. They cre-ate and publish the budgets andcommunicate the process and results.

Senior Financial Analysts need adegree in accounting, finance, or aclosely related field, and a minimum of3 years of experience. Ideal candi-dates should have excellent communi-cation skills and the ability to workindependently. Microsoft is looking forindividuals with high-caliber analyticalskills and the ability to think strategi-cally. Applicants should have a flexible,can-do attitude and be able to workwell with other groups.

THINK CRITICALLY1. Would you be interested in working

for Microsoft? Why or why not?2. What do you think is meant by a

“flexible, can-do attitude”?

2.1 BUDGET PLANNING

2.2 BUDGETED INCOMESTATEMENT

2.3 CASH BUDGETS

MANAGERIAL ACCOUNTING

MICROSOFTCORPORATION

BudgetingPROJECT OBJECTIVES

■ Become aware of the budgeting process and the purposes of budgeting■ Create and analyze a budgeted income statement■ Create and analyze a cash budget and performance report

GETTING STARTED

Read through the Project Process below. Make a list of any materials you willneed. Decide how you will get the needed materials or information.■ Add to your list of Personal Skills and Accounting-Related Skills created in the

Chapter 1 project any additional skills that the work of a budget analystrequires.

■ Use the income statement showing results for two years created in theChapter 1 project or create a new company and income statement.

PROJECT PROCESS

Part 1 LESSON 2.1 Discuss in class the purposes of budgeting. Create a chartthat summarizes the purposes. Delete the component percentagecolumns from the comparative income statement prepared in Chapter 1.Add the Increase/(Decrease) columns shown in the comparative incomestatement in Lesson 2.1. Create formulas to calculate the amounts andpercentages in these columns.

Part 2 LESSON 2.2 Write an operational plan for the business. Consider cur-rent economic conditions and the analysis of the comparative incomestatement. Create budget schedules for sales, purchases, sellingexpenses, administrative expenses, and other revenue and expenses.Compile a budgeted income statement from these budget schedules.Make a list of all assumptions you made.

Part 3 LESSON 2.3 Use the schedules and budgeted income statement to cre-ate cash payments and cash receipts budget schedules. Make a list of allassumptions you made. Create a performance report and analyze theresult, recommending action where needed.

CHAPTER REVIEW

Project Wrap-up Hold a class debate on the following statement or a similarone: “A company’s budget should be distributed to employees at all levels of thecompany so that they can perform their jobs efficiently.”

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The Chapter 2 video forthis module introduces theconcepts in this chapter.

PURPOSE OF BUDGETING

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LESSON 2.1

BUDGET PLANNING

DESCRIBE five purposes of budgeting

LIST sources of budgetinformation

PREPARE AND ANALYZE a comparative income statement

D epartment managers in a business make decisions every day that affect theprofitability of the business. In order to make effective decisions and coor-

dinate the decisions and actions of the various departments, a business needsto have a plan for its operations. Planning the financial operations of a busi-ness is called budgeting.

A budget is a written financial plan of a business for a specific period oftime, expressed in dollars. Each area of a business’s operations typically has aseparate budget. For example, a business might have an advertising budget, apurchasing budget, a sales budget, a manufacturing budget, a research anddevelopment budget, and a cash budget. New and ongoing projects wouldeach have a detailed budget. Each budget would then be compiled into amaster budget for the operations of the entire company.

Anthony Sanchez is the creative director in the advertising department of alarge merchandising business. His boss told him in a meeting that he

would have to estimate the costs of each advertising campaign that isplanned for next year. Anthony replied, “I’m not a numbers person. I’m the creative guy! Why are you asking me?” Should Anthony participate in estimat-ing the costs of advertising for his company? Why or why not?

CHAPTER 2 BUDGETING

33

2.1 BUDGET PLANNING

A business that does not have a budget or a plan will make decisions thatdo not contribute to the profitability of the business because managers lack aclear idea of goals of the business. A budget serves five main purposes—com-munication, coordination, planning, control, and evaluation.

COMMUNICATION◆

In the budgeting process, managers in every department justify the resourcesthey need to achieve their goals. They explain to their superiors the scope andvolume of their activities as well as how their tasks will be performed. Thecommunication between superiors and subordinates helps affirm theirmutual commitment to company goals. In addition, different departmentsand units must communicate with each other during the budget process tocoordinate their plans and efforts. For example, the MIS department and themarketing department have to agree on how to coordinate their efforts aboutthe need for services and the resources required.

COORDINATION◆

Different units in the company must also coordinate the many different tasksthey perform. For example, the number and types of products to be marketedmust be coordinated with the purchasing and manufacturing departments toensure goods are available. Equipment may have to be purchased andinstalled. Advertising promotions may need to be planned and implemented.And all tasks have to be performed at the appropriate times.

PLANNING◆

A budget is ultimately the plan for the operations of an organization for aperiod of time. Many decisions are involved, and many questions must beanswered. Old plans and processes are questioned as well as new plans andprocesses. Managers decide the most effective ways to perform each task.They ask whether a particular activity should still be performed and, if so,how. Managers ask what resources are available and what additional resourceswill be needed.

CONTROL◆

Once a budget is finalized, it is the plan for the operations of the organiza-tion. Managers have authority to spend within the budget and responsibilityto achieve revenues specified within the budget. Budgets and actual revenuesand expenditures are monitored constantly for variations and to determinewhether the organization is on target. If performance does not meet the bud-get, action can be taken immediately to adjust activities. Without constantmonitoring, a company does not realize it is not on target until it is too lateto make adjustments.

EVALUATION◆

One way to evaluate a manager is to compare the budget with actual perfor-mance. Did the manager reach the target revenue within the constraints ofthe targeted expenditures? Of course, other factors, such as market and gen-eral economic conditions, affect a manager’s performance. Whether a man-ager achieves targeted goals is an important part of managerial responsibility.

Budgets can be pre-pared by any financialentity, from an individ-ual, family, or businessto a governmental ornot-for-profit group.

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CHAPTER 2 BUDGETING

BUDGET PERIOD◆

Budgets are usually prepared for a period of one year. An annual budget isalso usually broken down into smaller periods of time, such as quarterly andmonthly budgets, to provide frequent opportunities to compare actual per-formance with budgeted performance.

Weekly and daily budget reports may also be distributed to managers tocompare actual performance with the budget on a year-to-date basis.Frequent updates remind managers of the goals set at the beginning of theyear and keep them up to date on the progress toward those goals.

B udget planners use many information sources, such as company records,general economic information, and information from staff and managers,

to help determine company goals and strategies and to prepare a final budget.

COMPANY RECORDS◆

The accounting and sales records of a business contain much of the informa-tion needed to prepare budgets. Accounting information about previousyears’ operations is used to determine trends in sales, purchases, and operat-ing expenses. Expected price changes, sales promotion plans, and marketresearch studies are also important in projecting activity for a budget period.

GENERAL ECONOMIC INFORMATION◆

A general slowdown or speedup in the national economy may affect budgetdecisions. Unusually high inflation rates affect budgeted amounts. A laborstrike may affect some related industries and thus affect company operations.Rising fuel prices may make it more expensive to ship and receive products.Energy shortages and utility rate increases also make operations more expen-sive. New product development, changes in consumer buying habits, avail-ability of merchandise, international trade, and general business conditionsall must be considered when preparing budgets.

COMPANY STAFF AND MANAGERS◆

Sales personnel estimate the amount of projected sales. Project managers esti-mate costs of making new products. Considering projected sales for the newbudget period, other department managers project budget items for theirareas of responsibility within the business.

Why are annual budgets usually broken down into smaller periods oftime, such as quarterly or monthly budgets?

SOURCES OF BUDGET INFORMATION

As a class, discussways that managers

can obtain general eco-nomic information as

well as information spe-cific to the market of a

particular industry.

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2.1 BUDGET PLANNING

GOOD JUDGMENT◆

Good judgment by the individuals preparing the budgets is essential to realis-tic budgets. Even after evaluating all available information, answers to manybudget questions are seldom obvious. Some proposed projects may be moreworthy than others, and some worthy projects may not be possible to achievefrom projected revenues and profit. Some information will conflict withother information. Ultimately, final budget decisions are based on good judgment in selecting the best alternatives from the many possible options.

P reparation for planning a budget involves analyzing existing financialinformation. An analysis of previous years’ sales, cost, and expense

amounts is an impor-tant part of budgetpreparation. One analytical tool is thecomparative incomestatement, which is anincome statement containing sales, cost,and expense informa-tion for two or moreyears.

Reflections, Inc., is acorporation that sellsmirror glass. The com-parative income state-ment |for Reflections,shown on the nextpage, provides twoyears of informationabout sales, costs, and expenses. Thisstatement shows trendsthat may be takingplace in these items. The statement also highlights items that may be increas-ing or decreasing at a higher rate than other items on the statement.

Why is good judgment important to making budget decisions?

COMPARATIVE INCOME STATEMENT

PREPARING A COMPARATIVE INCOME STATEMENT◆

The first column of Reflections’ comparative income statement shows actualsales, costs, and expenses for the most current year, 20X2. The second col-umn shows the actual amounts for the previous year, 20X1. The Increase/(Decrease) columns show both the dollar amount and the percentage by

CHAPTER 2 BUDGETING

36

Reflections, Inc.Comparative Income Statement

for Years Ended December 31, 20X1 and 20X2

Increase (Decrease)20X2 20X1 Amount Percentage

Operating RevenueNet Sales $1,880,000 $1,700,000 $180,000 10.6Cost of Merchandise Sold 1,231,720 1,105,000 126,720 11.5Gross Profit on Operations $ 648,280 $ 595,000 $ 53,280 9.0

Operating ExpensesSelling Expenses

Advertising Expense $ 45,120 $ 37,800 $ 7,320 19.4Delivery Expense 150,410 140,640 9,770 6.9Depr. Expense—Delivery Equipment 7,200 7,000 200 2.9Depr. Expense—Warehouse Equipment 10,800 10,800 0 0.0Miscellaneous Expense—Sales 11,490 11,960 (470) (3.9)Salary Expense—Commissions 75,200 68,000 7,200 10.6Salary Expense—Regular 34,160 28,320 5,840 20.6Supplies Expense—Sales 11,280 10,850 430 4.0

Total Selling Expenses $345,660 $315,370 $30,290 9.6Administrative Expenses

Depr. Expense—Office Equipment $ 14,400 $ 12,000 $ 2,400 20.0Depr. Expense—Computer System 19,200 19,200 0 0.0Insurance Expense 4,800 4,500 300 6.7Miscellaneous Expense—Administrative 38,770 33,640 5,130 15.2Payroll Taxes Expense 22,540 20,590 1,950 9.5Rent Expense 30,000 30,000 0 0.0Salary Expense—Administrative 77,830 75,240 2,590 3.4Supplies Expense—Administrative 13,620 14,600 (980) (6.7)Uncollectible Accounts Expense 11,280 10,230 1,050 10.3Utilities Expense 10,080 7,320 2,760 37.7

Total Administrative Expenses $242,520 $227,320 $15,200 6.7Total Operating Expenses $588,180 $542,690 $45,490 8.4

Income from Operations $ 60,100 $ 52,310 $ 7,790 14.9

Other ExpensesInterest Expense $ 3,000 $ 6,500 ($ 3,500) (53.8)

Net Income before Federal Income Tax $ 57,100 $ 45,810 $11,290 24.6

Federal Income Tax Expense 9,280 6,870 2,410 35.1

Net Income after Federal Income Tax $ 47,820 $ 38,940 $ 8,880 22.8

Units (sq. ft.) of Mirror Sold 376,000 340,000 36,000 10.6

which an item in 20X2 has increased or decreased over 20X1. The parenthe-ses around the word Decrease in the column heading indicate that anyamounts or percentages that are decreases will be enclosed in parentheses.

Calculating Amounts Amounts are calculated by subtracting the pre-vious year’s (20X1) amount from the current year’s (20X2) amount. Forexample, the amount of increase for Net Sales is $1,880,000 minus$1,700,000, or $180,000.

Current Year � Previous Year � Increase/(Decrease)$1,880,000 � $1,700,000 � $180,000

Whenever the 20X1 amount is greater than the 20X2 amount, the itemhas decreased, and the amount is placed in parentheses. For example, theamount of decrease for Interest Expense is $3,000 minus $6,500, or $3,500,which is shown on the comparative income statement as ($3,500).

Current Year � Previous Year � Increase/(Decrease)$3,000 � $6,500 � ($3,500)

Calculating Percentages The percentage of increase or decrease iscalculated by dividing the amount of increase or decrease by the previousyear’s amount and then multiplying by 100. For example, the amount ofincrease for Net Sales, $180,000 is divided by the 20X1 Net Sales amount,$1,700,000 as shown below. Percentages are also rounded to the nearest tenthof a percent, so 10.59% is shown as 10.6%.

Increase/(Decrease) � Previous Year � 100 � Percent of Inc./(Dec.)$180,000 � $1,700,000 � 100� 10.6%

Percentages for amounts that are decreases are also enclosed in parentheses.

Increase/(Decrease) � Previous Year � 100 � Percent of Inc./(Dec.)($3,500) � $6,500 � 100� (53.8%)

2.1 BUDGET PLANNING

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ANALYZING A COMPARATIVE INCOME STATEMENT◆

Managers review each increase or decrease amount on the comparativeincome statement. The percentage increase or decrease also indicateswhether a change is favorable, unfavorable, or normal compared with netsales. If a cost or expense percentage increase is higher than the percentageincrease for net sales, net income is unfavorably affected. But if a cost orexpense percentage increase is lower than the percentage increase in sales,net income is favorably affected. Decreases have the opposite effect. If acost or expense item decrease is a higher percentage than the net salesdecrease, net income is favorably affected. If the net sales decrease is ahigher percentage than cost and expense items, net income is unfavorablyaffected. The effect of these changes in net sales, cost, and expense items isshown in the following table.

Unfavorable results require further inquiry to determine the cause.Reflections’ net sales for 20X2 increased 10.6% over net sales for 20X1.The goal for 20X2 was to increase sales volume by 10.0%. The actual10.6% increase resulted from an increase in units sold from 340,000 to376,000 square feet of mirrors. The unit sales price remained at $5.00.Management attributed the increase to two factors: (1) A more intensiveadvertising campaign increased market share from 42.0% to 45.0%. (2)Favorable economic conditions spurred new home building and created agreater demand for mirrors.

Reflections, Inc., analyzes each cost and expense amount and percent-age. For example, the cost of merchandise sold increased 11.5% from20X1 to 20X2. Most of the increase resulted from the 10.6% increase inthe number of units sold. In addition, the purchase price per square footincreased during 20X2 from $3.25 per square foot to $3.30. Advertisingexpense increased 19.4% from 20X1 to 20X2. The increase is consistentwith the successful effort to expand market share. Management believesthat the more expensive television advertising resulted in a significantincrease in third and fourth quarter unit sales.

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38

Cost or Expense Less Than or Net Sales Net Effect onPercentage Greater Than Percentage Income Net Income

Increase Greater than Increase Decreases Unfavorable

Increase Less than Increase Increases Favorable

Decrease Greater than Decrease Increases Favorable

Decrease Less than Decrease Decreases Unfavorable

On a comparative income statement, if the percentage increase in netsales is less than the percentage increase in Salary Expense, is this favor-able or unfavorable? Why?

THINK CRITICALLY1. Dana Washington runs a small metal fabricating business. He employs

three workers in the metal shop, but performs all management,accounting, and sales functions himself. He says that he never createsa budget because he just doesn’t have the time. How would Mr.Washington benefit from preparing a budget?

2. Sportif has two sales departments—clothing and accessories. Themanager of the clothing department distributes copies of the annualbudget to the employees and discusses it and the year’s plans with thesales associates. The manager of the accessories department does notcommunicate the budget to the sales associates. What effect do youthink this has on the associates in the two departments?

3. Elizabeth Tanaka is a retired widow who receives a monthly SocialSecurity check. Each month she cashes the check and puts the cashinto different envelopes for expenses such as food, rent, and trans-portation. One envelope is for savings for a trip to visit her family. IsMrs. Tanaka budgeting? How?

4. For each of the following increases and decreases on a comparativeincome statement, indicate whether the effect on net income is favor-able or unfavorable.

MAKE CONNECTIONS5. RESEARCH Use an Internet search engine to find an organization that

describes its budgeting process. Write a brief description of the process.

6. ANALYSIS Obtain the annual report of a company and review its com-parative income statement. Using word-processing software, write abrief analysis of the major increases and decreases on the statement.

2.1 BUDGET PLANNING

39

Net Sales Effect on NetIncome

Cost of Merchandise Sold, increase 6% increase 5% Unfavorable

Advertising Expense, increase 3% increase 6% Favorable

Salary Expense, decrease 3% decrease 2% Favorable

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CHAPTER 2 BUDGETING

LESSON 2.2

BUDGETED INCOME STATEMENT

DESCRIBE the purposeof an operational plan

PREPARE sales andpurchases budgetschedules

PREPARE expensesbudget schedules

PREPARE a budgetedincome statement

Patricia Parker is a very autocratic manager, always preferring to make deci-sions on her own without consulting anyone she supervises. She also car-

ries this style through the budgeting process, making all decisions about netsales, costs, and expenses without consulting sales representatives, advertis-ing managers, marketers, and purchasers. She begrudgingly asks theaccounting department what depreciation figures she should use for equip-ment on the selling expenses budget. She frequently says, “I am the one whois responsible for meeting the budget, so I will be the one who creates it.”Does Patricia’s attitude take full advantage of the benefits of the budgetingprocess?

OPERATIONAL PLANS AND GOALS

A fter analyzing the previous years’ records, a business sets goals, developsoperational plans for meeting the goals, and prepares projections of sales,

costs, and expenses for the coming year. Goals are broad statements of what a business wishes to accomplish. An operational plan is a statement of how a company will meet its goals. An annual operational plan establishes targetsthat the company will work toward in the coming year. A planning groupconsisting of the company’s executive officers and department managers generally determines operational plans and goals.

At Reflections, Inc., the planning group includes the president and alldepartment managers. The planning group reviews the analysis of the previ-ous years’ comparative income statement and considers possible changes ineconomic conditions that may affect the company. From these discussions,the company’s operational plan and goals for the coming year are determined.The planning committee developed the following planning guidelines.

The operational plan is converted into a more precise plan, expressed indollars, by preparing a budgeted income statement. Reflections prepares sepa-rate budget schedules for the major parts of the budgeted income statement.Budget schedules are detailed statements of the operations of a specific seg-ment of a business for a period of time. Reflections prepares budget schedulesfor sales, purchases, selling expenses, administrative expenses, and other rev-enue and expenses. To permit frequent comparisons of actual with budgetedamounts, schedules are separated into quarterly projections.

At Reflections, the accounting department coordinates budget preparation.The sales manager prepares the sales, purchases, and selling expenses budgetschedules. The administrative manager prepares the administrative expensesbudget schedule and the other revenue and expenses budget schedules. Theaccounting department prepares the budgeted income statement from theseschedules. The completed budget, with attached schedules, is submitted tothe budget committee for approval. The budget committee consists of thepresident and two members of Reflections’ board of directors.

2.2 BUDGETED INCOME STATEMENT

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Write an operationalplan for a servicebusiness that you

could be operating,such as a landscaping,

painting, or wordprocessing business.

Consider thepercentage increase in

sales, equipmentpurchases, advertisingstrategies, and so onthat would be neededto achieve the plan.Present your plan to

the class.

Operational Plan for 20X3

■ The economy is projected to remain strong throughout 20X3. Therefore,

the sales goal is to increase unit sales to 400,000 units, about a 6.4%

increase. The unit sales price will be increased in the second quarter

from $5.00 to $5.25 per square foot to recover mechandise cost

increases in 20X2 and projected increases in the budget year.

■ Sales distribution by quarters is projected to be consistent with prior

quarters.

■ The unit cost of merchandise is projected to rise from $3.30 to $3.40 in

the first quarter, a 3.0% increase.

■ An automated cutting machine has been ordered. It will cost $20,000

and is projected to save about $10,000 per year in salary expense.

■ All employees on salary will receive a 5.0% salary increase.

What is the relationship between a company’s operational plan and abudgeted income statement?

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CHAPTER 2 BUDGETING

The sales budgetschedule is preparedfirst because many

other budget estimatesdepend on the amount

of sales. As a class,brainstorm to deter-

mine which other oper-ating elements of abusiness depend onsales revenue. Thendiscuss which ele-

ments do not dependon sales revenue.

SALES AND PURCHASES BUDGET SCHEDULES

T he sales manager prepares the sales andpurchases budget schedules. The sales

budget schedule is prepared first becausethe other schedules are affected by theprojected net sales. For example, pro-jected net sales is used to estimate theamount of merchandise that must be

Purchased and the amount that may bespent for sales, advertising, and other sell-ing and administrative expenses.

PREPARING THE SALES BUDGET SCHEDULE◆

Procedures for completing the sales budget schedule are shown below.

1. Actual Unit Sales, 20X2 Enter the actual annual and quarterly unit salesfor the current year. Because there will be a price increase, unit sales ratherthan dollar sales are used. Changes in selling prices would make it difficultto see actual increases in unit sales if the amounts were expressed only asdollars.

2. Sales Percentage by Quarter Divide each quarter’s actual unit sales for20X2 by the annual sales for 20X2 and multiply by 100 to determinewhat percentage of the year’s unit sales will be realized in each quarter.Round percentages to the nearest tenth of a percent.

3. Projected Unit Sales, 20X3 Multiply each quarter’s sales percentage bythe projected unit sales for the year to calculate the quarterly unit sales.Reflections, Inc., rounds all unit calculations to the nearest 100 units.

4. Unit Sales Price Enter the unit sales price for each quarter. The unit salesprice increases to $5.25 in the second quarter.

5. Net Sales Calculate the sales dollar amount for each quarter by multiply-ing projected unit sales times unit sales price. Reflections, Inc. rounds alldollar calculations to the nearest $10. Calculate the Annual Budgetamount for net sales by adding the four quarterly amounts.

Reflections, Inc.Sales Budget Schedule

For Year Ended December 31, 20X3 Schedule 1Annual QuarterBudget 1st 2d 3d 4th

Actual Unit Sales, 20X2 376,000 91,600 99,000 103,800 81,600Sales Percentage by Quarter 24.4% 26.3% 27.6% 21.7%Projected Unit Sales, 20X3 400,000 97,600 105,200 110,400 86,800Times Unit Sales Price $5.00 $5.25 $5.25 $5.25Net Sales $2,075,600 $488,000 $552,300 $579,600 $455,700

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PREPARING THE PURCHASES BUDGET SCHEDULE◆

Procedures for completing the purchases budgetschedule are shown below.

1. Unit Sales for Quarter (second line) Enter theprojected quarterly unit sales from the sales bud-get schedule. Because there will be a priceincrease, unit sales rather than dollar sales areused.

2. Ending Inventory (first line) Calculate theending inventory for each quarter. The salesmanager estimates that ending inventory for onequarter should be about 40% of the units re-quired for the next quarter’s sales. The calcula-tion is shown for the first quarter, rounded tothe nearest hundred. Use 40,000 units for thefourth quarter’s ending inventory.

Ending Inventory � Next Quarter’s � Ending InventoryPercentage Sales Units

40% � 105,200 � 42,080 (rounded to 42,100)

3. Total Units Needed Add the ending inventory and the unit sales for the quarter.

4. Less Beginning Inventory The beginning inventory for each quarter is the ending inventory from the previous quarter. The beginning inven-tory for the first quarter, 39,200, is the ending inventory for December 31 of the previous year, taken from company records.

5. Purchases The purchases that need to be made in a quarter are the totalunits needed less the beginning inventory.

6. Times Unit Cost: Enter the unit cost for each quarter. Unit cost isexpected to increase to $3.40 in the first quarter and remain the same forthe rest of the year.

7. Cost of Purchases Multiply the unit purchases for the quarter by the unit cost.

Reflections, Inc.Purchases Budget Schedule

For Year Ended December 31, 20X3 Schedule 2Quarter

1st 2d 3d 4thEnding Inventory 42,100 44,200 34,700 40,000Unit Sales for Quarter 97,600 105,200 110,400 86,800Total Units Needed 139,700 149,400 145,100 126,800Less Beginning Inventory 39,200 42,100 44,200 34,700Purchases 100,500 107,300 100,900 92,100Times Unit Cost $3.40 $3.40 $3.40 $3.40Cost of Purchases $341,700 $364,820 $343,060 $313,140

EXPENSES BUDGET SCHEDULES

T he sales manager prepares the selling expenses budget schedule while theadministrative manager prepares the administrative expenses budget sched-

ule. However, both managers depend on other company managers for inputinto these budgets. For example, the sales personnel may provide informationabout needed supplies, the advertising manager may supply much of theadvertising expense information, and the accounting department may pro-vide information about depreciation.

PREPARING THE SELLING EXPENSES BUDGET SCHEDULE◆

Some selling expenses are very stable and require little planning, such asdepreciation expense. Others are closely related to sales and fluctuate as salesincrease and decrease.

1. Advertising Expense Advertising expense in 20X2 was 2.4% of net sales($45,120 � $1,880,000). The same level of promotion will be maintainedfor the new year. Therefore, Advertising Expense for each quarter will be2.4% of each quarter’s dollar net sales as shown on the sales budget sched-

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44

On a purchases budget schedule, what amount is used for the beginninginventory for each quarter?

For budgets, accuracy is a relative term. All budget amounts are forecasts, esti-mates, or predictions. So a number rounded to the nearest 100 may be as

accurate as a prediction needs to be. Each business decides how far to round anumber or calculation based on the relative size of the business. The CookieCutter, a small, family-owned bake shop specializing in gourmet cookies, roundsall units to the nearest 100 and rounds all dollar calculations to the nearest $10.The company’s projected unit sales for 20X3 are listed as 247,300 units. Of thoseunits, first quarter projections represent 24.3%. If each cookie (unit) retails for$2.29, what are the projected net sales for the first quarter of 20X3?

SOLUTION

24.3% � 247,300 � 60,093.9, rounded to 60,10060,100 � $2.29 � $137,629, rounded to $137,630 in first quarter net sales


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ule. For the first quarter, the calculation is 2.4% � $488,000 � $11,712($11,710 rounded to the nearest $10).

2. Delivery Expense Experience shows that delivery is about $0.40 per unitsold. Therefore, quarterly forecasts for delivery expense are calculated bymultiplying $0.40 times the number of units expected to be sold in thequarter. For the first quarter, $0.40 � 97,600 � $39,040.

3. Depreciation Expense—Delivery Equipment No new delivery equip-ment will be added, so depreciation expense for the year remains the sameas it appears on the income statement for 20X2, $7,200. The amount isdivided equally among the four quarters.

4. Depreciation Expense—Warehouse Equipment A new automated cutter will be acquired at the beginning of the second quarter, increasingquarterly depreciation expense in the second, third, and fourth quartersfrom $2,700 to $3,700 per quarter.

5. Miscellaneous Expense—Sales Miscellaneous expense was 0.6%($11,490 � $1,880,000) of net sales in 20X2. Management wants toreduce miscellaneous expense to 0.5% of net sales. The first quarter’s mis-cellaneous expense is calculated as 0.5% � $488,000 � $2,440.

6. Salary Expense—Commissions Salespersons will continue to earn a4.0% commission on net sales. First quarter commissions are calculated as4.0% � $488,000 � $19,520.

7. Salary Expense—Regular The new automated cutter will reduce salaryexpense by $10,000, and a 5.0% increase will be added to the remainingsalaries. The annual regular salary expense is calculated below.

Salary Expense (from 20X2 income statement) $34,160Less Reduction from automated cutter �10,000Total $24,160Plus 5.0% rate increase ($24,160 � 5.0%, rounded) � 1,210Projected Salary Expense—Regular $25,370

The projected amount is then allocated among the four quarters based oneach quarter’s sales percentage from the sales budget schedule. First quarterregular salaries are calculated as $25,370 � 24.4% � $6,190.

Budget analysts heldabout 59,000 jobs in private industry andgovernment in 1998.

Governments accountfor one-third of all

budget analyst jobs.The Department ofDefense employed

seven out of every tenbudget analysts in thefederal government.

Reflections, Inc.Selling Expenses Budget Schedule


Advertising Expense $ 49,820 $11,710 $13,260 $ 13,910 $10,940Delivery Expense 160,000 39,040 42,080 44,160 34,720Depr. Expense—Delivery Equipment 7,200 1,800 1,800 1,800 1,800

Depr. Expense—Warehouse Equipment 13,800 2,700 3,700 3,700 3,700

Miscellaneous Expense—Sales 10,380 2,440 2,760 2,900 2,280Salary Expense—Commissions 83,020 19,520 22,090 23,180 18,230Salary Expense—Regular 25,370 6,190 6,670 7,000 5,510Supplies Expense—Sales 12,450 2,930 3,310 3,480 2,730Total Selling Expenses $362,040 $86,330 $95,670 $100,130 $79,910

8. Supplies Expense—Sales In 20X2, supplies expense was 0.6% of netsales ($11,280 � $1,880,000). The same percentage is expected in 20X3.First quarter supplies expense is 0.6% � $488,000 � $2,928 (rounded to$2,930).

PREPARING THE ADMINISTRATIVE EXPENSES BUDGET◆

SCHEDULEMany of Reflections’ administrative expenses are known and remain aboutthe same each period. The annual budget amount for these items is shownbelow. These expenses are divided equally among the four quarters.

■ Depreciation Expense—Office Equipment $14,400

■ Depreciation Expense—Computer System $19,200

■ Rent Expense $30,000

Many other administrative expenses are closely related to some other itemon the income statement. These expenses are calculated each quarter basedon a percentage of the budget estimate for the other item for each quarter.These expenses are as follows.

■ Miscellaneous Expense 49.8% of administrative salaries for each quarter.Management is committed to reducing this percentage to 45.0% in 20X3.Note that quarterly administrative salary expense must be calculatedbefore this item can be calculated.

■ Payroll Taxes Expense 12.0% of total quarterly salaries, including SalaryExpense—Commissions, Salary Expense—Regular, and Salary Expense—Administrative.

■ Supplies Expense—Administrative 0.7% of net sales for each quarter.

■ Uncollectible Accounts Expense 0.6% of net sales for each quarter.

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Reflections, Inc.Selling Expenses Budget Schedule


Depr. Expense—Office Equipment $ 14,400 $ 3,600 $ 3,600 $ 3,600 $ 3,600Depr. Expense—Computer System 19,200 4,800 4,800 4,800 4,800Insurance Expense 5,600 1,400 1,400 1,400 1,400Miscellaneous Expense—Administrative 36,760 9,190 9,190 9,190 9,190

Payroll Taxes Expense 22,810 5,540 5,900 6,070 5,300Rent Expense 30,000 7,500 7,500 7,500 7,500Salary Expense—Administrative 81,720 20,430 20,430 20,430 20,430Supplies Expense—Administrative 14,540 3,420 3,870 4,060 3,190Uncollectible Accounts Expense 12,450 2,930 3,310 3,480 2,730Utilities Expense 10,980 4,870 1,470 1,610 3,030Total Administrative Expenses $248,460 $63,680 $61,470 $62,140 $61,170

Other administrative expenses are estimated as shown below.

1. Insurance Expense Annual insurance premiumcost is projected to increase to $5,600, distrib-uted equally among the quarters.

2. Salary Expense—Administrative No newadministrative personnel will be hired in 20X3.The 20X2 amount, $77,830, is thereforeincreased by 5.0% and distributed equally eachquarter.

3. Utilities Expense Utilities expense is based onthe amount of power, heat, telephone, and otherutilities used in 20X2. Costs are projected toincrease by 9.0%, consisting of a 5.0% increasein activity and a 4.0% increase in rates.Company records show the following utilitiescosts for 20X2 for each quarter. Each is multi-plied by 109% to calculate 20X3 projected quar-terly expenses.

20X2 Actual 20X3 ProjectedUtilities Expense � 109% � Utilities Expense

1st Quarter $ 4,470 � 109% � $ 4,8702d Quarter 1,350 � 109% � 1,4703d Quarter 1,480 � 109% � 1,6104th Quarter 2,780 � 109% � 3,030Total $10,080 � 109% � $10,980


47

FORMAT SPREADSHEETS TO COMMUNICATE Budget spreadsheetsare printed and used by managers at many levels of a company, and theymay also be available online for quick reference. Therefore, the formatting ofthe spreadsheets must be clear so that readers of the spreadsheets caneasily understand them. Formats may consist of the size and style of typeused, the way borders and rules are applied, and the character formatting ofnumbers. Currency may be expressed with or without decimals, with or with-out commas for separating thousands, and with or without dollar signs.Percentages also have decimal options and options for using a percent sign.Negative numbers may be indicated with minus signs or parentheses oreven with different colors. Managers should also consider whether budgetswill be printed or only displayed online. For example, the color red may beused to indicate negative numbers, but the color may appear as black on aprinted copy. Thus, negative numbers may need to be formatted differently ifthe budgets are to be printed.

THINK CRITICALLY Select one of the reports in this chapter. Describewhat kinds of formats have been used, and suggest any improvements thatmight be needed.

PREPARING THE OTHER REVENUE AND EXPENSES BUDGET◆

SCHEDULEThe other revenue and expenses budget schedule shows activities other thannormal operations. Typical items are interest income, interest expense, andgains and losses on the sale of plant assets. Reflections has no other revenueitems and only one other expense item. This is the interest due on the$20,000 loan used to acquire the automated cutter. Reflections plans to repay the loan at the beginning of the fourth quarter, so the budget scheduleallocates the $2,250 interest equally over the first three quarters.

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Reflections, Inc.Other Revenue and Expenses Budget Schedule


Other ExpensesInterest Expense $2,250 $750 $750 $750

Why are some expenses distributed over quarters using each quarter’spercentage of total net sales while other expenses are distributed equally?

PREPARING THE BUDGETED INCOMESTATEMENT

As a class, discuss how different cate-gories of expenses may affect the sales

revenue and net incomeof a company. Identifywhich expenses might

lead to increased sales.Determine whether a

certain increase in a category automati-

cally increases (or decreases) sales bythe same percentage.

T he budget schedules for revenue, cost, and expense items show the detaileditems. Therefore, the budgeted income statement is shortened, and the

budget schedules are then attached to it. Most of the information on theincome statement is copied directly from the budget schedules. However,three items need to be calculated as shown below.

Beginning Inventory The beginning inventory for the first quarter isshown in units on the purchases budget schedule, 39,200 units. These itemswere on hand at the end of 20X2 and, therefore, are multiplied by the 20X2inventory cost of $3.30 (39,200 � $3.30 � $129,360). The beginninginventory for the first quarter is the same as the beginning inventory for theyear. The beginning inventory for each of the next three quarters is the samenumber as the ending inventory for the preceding quarter. The beginninginventory for the second, third, and fourth quarters are multiplied by the20X3 unit cost of $3.40.

Ending Inventory The ending inventory amounts are calculated bymultiplying the ending inventory unit amounts from the purchases budgetschedule by the 20X3 unit cost of $3.40. The ending inventory for theannual budget is the same as the ending inventory for the fourth quarter.

Reflections, Inc.Budgeted Income Statement

For Year Ended December 31, 20X3Annual QuarterBudget 1st 2d 3d 4th

Operating RevenueNet Sales (Schedule 1) $2,075,600 $488,000 $552,300 $579,600 $455,700Cost of Merchandise Sold

Beginning Inventory $ 129,360 $129,360 $143,140 $150,280 $117,980Purchases (Schedule 2) 1,362,720 341,700 364,820 343,060 313,140Total Merchandise Avail.

for Sale $1,492,080 $471,060 $507,960 $493,340 $431,120Less Ending Inventory 136,000 143,140 150,280 117,980 136,000

Cost of Merchandise Sold $1,356,080 $327,920 $357,680 $375,360 $295,120Gross Profit on Operations $ 719,520 $160,080 $194,620 $204,240 $160,580

Operating ExpensesSelling Expenses (Schedule 3) $ 362,040 $ 86,330 $ 95,670 $100,130 $ 79,910Administrative Expenses

(Schedule 4) 248,460 63,680 61,470 62,140 61,170Total Operating Expenses $ 610,500 $150,010 $157,140 $162,270 $141,080

Income from Operations $ 109,020 $ 10,070 $ 37,480 $ 41,970 $ 19,500

Net Deduction (Schedule 5) $ 2,250 $ 750 $ 750 $ 750

Net Income before Fed. Income Tax $ 106,770 $ 9,320 $ 36,730 $ 41,220 $ 19,500

Federal Income Tax Expense 24,890 6,220 6,220 6,220 6,230

Net Income after Fed. Income Tax $ 81,880 $ 3,100 $ 30,510 $ 35,000 $ 13,270


49

Most amounts on a budgeted income statement are copied from budgetschedules. Which amounts need to be calculated and why?

Federal Income Tax Federal income tax is calculated on total netincome using tax rates from the Internal Revenue Service. The amount is dis-tributed equally among the four quarters. Because of rounding, the sum ofthe four quarters is less than the actual calculated amount by $10. Therefore,it is desirable to increase the fourth quarter’s amount by $10 so that theannual budget equals the sum of the quarterly amounts.

15% of net income before taxes, zero to $50,00025% of net income before taxes less $5,000, $50,001 to $75,00034% of net income before taxes less $11,750, $75,001 to $100,00039% of net income before taxes less $16,750, $100,001 to $335,000Net Income before Fed. Inc. Tax � Tax Rate � Amount � Fed. Inc. Tax

$106,770 � 39% � $16,750 � 24,890, rounded

THINK CRITICALLY1. Complete the sales, cost, and expenses budget schedules for Photex

Corporation on the next two pages. Round units to the nearest 100 anddollars to the nearest $10. Some information has already been com-pleted for you. Then use the budget schedules to prepare a budgetedincome statement.

a. Sales Budget Schedule

b. Purchases Budget Schedule: The sales manager requests that40.0% of each quarter’s unit sales be available in the prior quarter’sending inventory.

c. Expenses Budget Schedules: Payroll taxes expense is 12.0% oftotal company salaries. Other expenses are based on a percentageof net sales for each quarter.

Advertising Expense, 1.2%Delivery Expense, 0.6%Miscellaneous Expense—Sales, 0.4%Salary Expense—Sales, 5.0%Supplies Expense—Sales, 0.8%Uncollectible Accounts Expense, 0.6%Utilities Expense, 1.8%

d. Other Revenue and Expenses Budget Schedule: This schedule isalready completed.

e. Budgeted Income Statement: The units in beginning inventory forthe first quarter were on hand at the end of 20X2 when the unit costwas $4.00. Use the tax rate table in this lesson to calculate FederalIncome Tax Expense and distribute it equally among the quarters.

2. When preparing an administrative expenses budget schedule, what aresome of the factors that should be considered?

MAKE CONNECTIONS3. PERSONAL FINANCE Make a list of your personal income and expendi-

tures for a week and then project them for a quarter. Be sure to considerall sources of income, such as allowances, earnings from a job, and gifts.Make a personal operational plan for the next year, being sure to includeany long-term goals such as purchasing a car or taking a trip. Then createan annual budget, showing income and expenditures for each quarter.

4. GOVERNMENT Search the Internet to locate the most current budget ofthe U.S. government. Review the budget and furnish the following informa-tion. Then write a brief report about parts of the budget that interest you.

Budget year Total Revenues Amount allocated to Defense Amount allocated to Education

5. STATISTICS Use the graphics functions of spreadsheet software to pre-pare a bar graph of the selling expenses budget schedule in this lesson.

CHAPTER 2 BUDGETING

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51

Photex CorporationSales Budget Schedule


Actual Unit Sales, 20X2 120,000 22,000 34,400 34,800 28,800Sales Percentage by Quarter 18.3% 28.7% 29.0% 24.0%Projected Unit Sales, 20X3 130,000 23,800 37,300 37,700 31,200Times Unit Sales Price $6.00 $6.00 $6.00 $6.00Net Sales $780,000 $142,800 $223,800 $226,200 $187,200

Photex CorporationSelling Expenses Budget Schedule


Advertising Expense $ 9,360 $ 1,710 $ 2,690 $ 2,710 $ 2,250Delivery Expense 4,680 860 1,340 1,360 1,120Depr. Expense—Delivery

Equipment 2,400 600 600 600 600Depr. Expense—Store

Equipment 6,680 1,670 1,670 1,670 1,670Miscellaneous Expense—Sales 3,120 570 900 900 750Salary Expense—Sales 39,000 7,140 11,190 11,310 9,360Supplies Expense—Sales 6,240 1,140 1,790 1,810 1,500Total Selling Expenses $71,480 $13,690 $20,180 $20,360 $17,250

Photex CorporationPurchases Budget Schedule

For Year Ended December 31, 20X3 Schedule 2Quarter

1st 2d 3d 4thEnding Inventory 14,900 15,100 12,500 9,600Unit Sales for Quarter 23,800 37,300 37,700 31,200Total Units Needed 38,700 52,400 50,200 40,800Less Beginning Inventory 12,500 14,900 15,100 12,500Purchases 26,200 37,500 35,100 28,300Times Unit Cost $4.25 $4.25 $4.25 $4.25Cost of Purchases $111,350 $159,380 $149,180 $120,280

Photex CorporationOther Revenue and Expenses Budget Schedule


Other ExpensesInterest Expense $5,000 $1,250 $1,250 $1,250 $1,250

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52

Photex CorporationAdministrative Expenses Budget Schedule


Depr. Expense—Office Equipment $ 3,600 $ 900 $ 900 $ 900 $ 900

Insurance Expense 4,200 1,050 1,050 1,050 1,050Miscellaneous Expense—

Administrative 3,000 750 750 750 750Payroll Taxes Expense 7,700 1,610 2,100 2,110 1,880Rent Expense 9,600 2,400 2,400 2,400 2,400Salary Expense—

Administrative 25,200 6,300 6,300 6,300 6,300Supplies Expense—

Administrative 2,800 700 700 700 700Uncollectible Accounts Expense 4,680 860 1,340 1,360 1,120Utilities Expense 14,040 2,570 4,030 4,070 3,370Total Administrative Expenses $74,820 $17,140 $19,570 $19,640 $18,470

Photex CorporationBudgeted Income Statement

For Year Ended December 31, 20X3Annual QuarterBudget 1st 2d 3d 4th

Operating RevenueNet Sales (Schedule 1) $780,000 $142,800 $223,800 $226,200 $187,200Cost of Merchandise Sold

Beginning Inventory $ 50,000 $ 50,000 $ 63,330 $ 64,180 $ 53,130Purchases (Schedule 2) 540,190 111,350 159,380 149,180 120,280Total Merchandise Avail.

for Sale $590,190 $161,350 $222,710 $213,360 $173,410Less Ending Inventory 40,800 63,330 64,180 53,130 40,800

Cost of Merchandise Sold $549,390 $ 98,020 $158,530 $160,230 $132,610Gross Profit on Operations $230,610 $ 44,780 $ 65,270 $ 65,970 $ 54,590

Operating ExpensesSelling Expenses (Schedule 3) $ 71,480 $ 13,690 $ 20,180 $ 20,360 $ 17,250Administrative Expenses

(Schedule 4) 74,820 17,140 19,570 19,640 18,470Total Operating Expenses $146,300 $ 30,830 $ 39,750 $ 40,000 $ 35,720

Income from Operations $ 84,310 $ 13,950 $ 25,520 $ 25,970 $ 18,870

Net Deduction (Schedule 5) $ 5,000 $ 1,250 $ 1,250 $ 1,250 $ 1,250

Net Income before Fed. Income Tax $ 79,310 $ 12,700 $ 24,270 $ 24,720 $ 17,620

Federal Income Tax Expense 15,220 3,810 3,810 3,810 3,790

Net Income after Fed. Income Tax $ 64,090 $ 8,890 $ 20,460 $ 20,910 $ 13,830

2.3 CASH BUDGETS

53

LESSON 2.3

CASH BUDGETS

PREPARE a cash budget

PREPARE AND ANALYZE a performance report

G ood cash management requires planning and controlling cash so that itwill be available to meet obligations when they come due. Therefore,

Reflections, Inc., prepares a cash budget to help analyze cash inflows and cashoutflows. A cash budget is a budget that details the cash receipts and cashpayments a business expects in a specific period of time.

The treasurer prepares the cash budget in consultation with the budgetcommittee. A corporation treasurer is an officer of the corporation who isusually responsible for planning the corporation’s requirement for and use ofcash.

L ily Wu manages the cash functions of a small business. She does notbelieve in preparing annual cash budgets because she says that keeping

good records of cash receipts, cash payments, and the current checkingaccount balance is an accurate method of ensuring there is always enoughcash to make the required payments. When receipts are slow, she postponespaying suppliers and occasionally delays paying the other three employees fora few days. Discuss the advantages and disadvantages of Mrs. Wu’s practices.

PLANNING THE CASH BUDGET

The treasurer must analyze the following cashitems.

1. Projected receipts from cash sales, cus-tomers on account,and other sources.

2. Projected cash pay-ments for ordinaryexpenses such as rent,payroll, and paymentsto vendors on account.

3. Other cash paymentssuch as buying plantassets or supplies.

A cash receipts budget schedule and a cash payments budget schedule areprepared in order to compile the cash budget.

CASH RECEIPTS BUDGET SCHEDULE◆

A cash receipts budget schedule shows all projected cash receipts for a budgetperiod. Projections on a cash receipts budget schedule are composed of thefollowing items.

1. Quarterly cash sales

2. Quarterly collections on account from customers The amounts receivedfrom customers will not be the same as the amount of sales on account.Normally, cash is received for sales on account made during the previousone or two months. In addition, some sales returns and allowances anduncollectible accounts are likely.

3. Cash received from other sources Such as from bank loans.

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Reflections, Inc.Cash Receipts Budget Schedule

For Year Ended December 31, 20X3 Schedule AQuarter

1st 2d 3d 4thFrom Sales

Prior Year’s 4th Quarter ($408,000) $79,1501st Quarter Sales ($488,000) 390,400 $94,6702d Quarter Sales ($552,300) 441,840 $107,1503d Quarter Sales ($579,600) 463,680 $112,4404th Quarter Sales ($455,700) 364,560

Total Receipts from Sales $469,550 $536,510 $570,830 $477,000

From Other SourcesNote Payable to Bank 20,000

Total Cash Receipts $489,550 $536,510 $570,830 $477,000

55

2.3 CASH BUDGETS

Analysis of Cash Receipts from Sales An analysis of Reflections’sales for previous years shows the following pattern of cash receipts for netsales per quarter.

1. About 60.0% of all net sales are cash sales.

2. About 20.0% of all net sales are sales on account collected in the samequarter as the sale. Therefore, 80.0% = 60.0% + 20.0% of a quarter’s netsales are collected during the same quarter as the sale.

3. About 19.4% of sales on account are collected in the following quarter.

4. About 0.6% of net sales prove to be uncollectible.

Calculating Cash Receipts from Sales A quarter’s cash receiptsfrom sales, as shown in the cash receipts budget schedule, are calculated intwo steps.

1. Cash receipts for 19.4% of the previous quarter’s net sales are collected inthe following quarter. For the first quarter in 20X3, 19.4% of the fourthquarter of 20X2 is calculated as 19.4% � $408,000 � $79,152, roundedto $79,150.

2. Cash receipts for 80.0% of the current quarter’s net sales are received inthe current quarter. For the first quarter in 20X3, this is calculated as80.0% � $488,000 � $390,400.

Cash Receipts fromOther Sources Cashsales and collections onaccount provide most ofthe cash receipts. Whenadditional cash is needed,other sources of cashshould be planned. Re-flections’ treasurer made apreliminary plan of pro-jected cash receipts andcash payments. The treas-urer then determined thatcash on hand could beunusually low at the end of the first quarter as peaksales begin in the secondquarter. The treasurer,therefore, plans to borrow$20,000 during the firstquarter. This is recorded as a note payable on thecash receipts budget schedule.

A 1995 Price Water-house study found

that budgeting costslarge multinational

enterprises a median of $63,000 for every$100 million of base

revenue within financedepartments alone andthat budget preparationtook an average of 110

days from start to finish.

56

CASH PAYMENTS BUDGET SCHEDULE◆

A cash payments budget schedule shows all projected cash payments for abudget period. Projections on a cash payments budget schedule are composedof the following items.

1. Quarterly cash payments for accounts payable or notes payable to vendors

2. Quarterly cash payments for each expense item This projection requiresan analysis of the selling expenses, administrative expenses, and other rev-enue and expenses budget schedules.

3. Quarterly cash payments for buying equipment and other assets.

4. Quarterly cash payments for dividends

5. Quarterly cash payments for investments

Quarterly Cash Payments for Merchandise An analysis of pastrecords for payments to vendors shows the following cash payment pattern.

1. About 10.0% of all purchases are cash purchases.

2. About 60.0% of all purchases are purchases on account paid for in thecurrent quarter. Therefore, 70.0% (10.0% � 60.0%) of a quarter’s pur-chases are paid for during the same quarter.

3. The remaining 30.0% of purchases on account in one quarter are paid forin the following quarter.

CHAPTER 2 BUDGETING

Reflections, Inc.Cash Payments Budget Schedule

For Year Ended December 31, 20X3 Schedule BQuarter

1st 2d 3d 4thFor Merchandise

Prior Year’s 4th Quarter Purchases ($212,600) $ 63,780

1st Quarter Purchases ($341,700) 239,190 $102,5102d Quarter Purchases ($364,820) 255,370 $109,4503d Quarter Purchases ($343,060) 240,140 $102,9204th Quarter Purchases ($313,140) 219,200

Total Cash Payments for Purchases $302,970 $357,880 $349,590 $322,120For Operating Expenses

Cash Selling Expenses $ 81,830 $ 90,170 $ 94,630 $ 74,410Cash Administrative Expenses 52,350 49,760 50,260 50,040

Total Cash Operating Expenses $134,180 $139,930 $144,890 $124,450

For Other Cash PaymentsFederal Income Tax Expense $ 6,220 $ 6,220 $ 6,220 $ 6,230Automated Cutting Machine 20,000Cash Dividend 50,000 50,000Investment 25,000Note Payable and Interest 22,250

Total Other Cash Payments $ 26,220 $ 56,220 $ 6,220 $103,480Total Cash Payments for Purchases $463,370 $554,030 $500,700 $550,050

57

2.3 CASH BUDGETS

Cash payments for purchases are calculated using the same procedure usedfor cash receipts. Purchase amounts are from the purchases budget schedule.

Cash Payments for Operating Expenses Cash payments for mostoperating expenses are made in the quarter in which the expense is incurred.However, both the selling and administrative expenses budget schedulesinclude items for which cash will not be paid, such as depreciation anduncollectible accounts expenses. Therefore, these amounts are not included inthe cash payments budget schedule. The first quarter’s cash payments for sell-ing and administrative expenses are calculated as shown below.

Selling Expenses $86,330Less: Depr. Exp.—Delivery Equipment $1,800

Depr. Exp.—Warehouse Equipment $2,700 $4,500Cash Payment for Selling Expenses $81,830Administrative Expenses $63,680

Less: Depr. Exp.—Office Equipment $3,600Depr. Exp.—Computer System 4,800Uncollectible Accounts Expense 2,930 11,330

Cash Payment for Admin. Expenses $52,350

Other Cash Payments Other cash payments are made for federalincome tax, plant assets, dividends, investments, and repayments of loans.Reflections, Inc., has the following additional cash payments.

1. Federal Income Tax Ex-pense: Payments for federalincome tax are on the bud-geted income statement.

2. The new automated cut-ting machine will bebought for $20,000 at theend of the first quarter.

3. The company will pay a$50,000 dividend to stock-holders in both the secondand fourth quarters.

4. Projections indicate thatthere will be a large cashbalance in the third quar-ter. Therefore, a $25,000interest-earning invest-ment will be made in the fourth quarter.

5. The promissory note and interest, $22,250, will be repaid at the begin-ning of the fourth quarter.

The last line of the cash payments budget schedule shows the total cashpayments projected each quarter. This total indicates the minimum amountof cash that must be available each quarter.

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58

BUDGETING WITH FOREIGNCURRENCY

Companies with significant operations in other countries face a unique budget-ing problem. They have to merge budgets expressed in different currencies

into one master budget. A U.S.-based company would prefer to express themaster budget in U.S. dollars. Budget schedules for operations in other coun-tries could be converted to U.S. dollars before being merged with the other budget schedules. However, currency exchange rates fluctuate from day to daydepending on economic conditions and the political situation in other countries.Most experts recommend that the foreign operations prepare their budgets inthe local currency. Then at the end of a budget period, managers are evaluatedon the basis of their actual performance in the local currency. For the masterbudget, however, conversion to the dominant currency is necessary. Companiesmight use the current exchange rate or an average predicted exchange rate fora year. At the end of a reporting period, the amounts could be adjusted to reflectthe current exchange rate. As an alternative, some companies keep the originalconverted amount on the budget and add a column for tracking differences dueto changing exchange rates.

THINK CRITICALLY Would a U.S. company that buys goods from anothercountry to sell in the United States have the same problem budgeting for foreigncurrency as a U.S. company that operates a factory in another country?

CASH BUDGET◆

A cash budget shows for each budget period a projection of a company’sbeginning cash balance, cash receipts, cash payments, and ending cash bal-ance. A cash budget is prepared from the information in the cash receipts andcash payments budget schedules. The first quarter beginning cash balance istaken from the balance sheet for the last day of the previous period.

At the end of each quarter, the actual cash balance is compared with theprojected cash balance on the cash budget. If the actual balance is less thanthe projected balance, the reasons must be determined so that action can betaken to correct the problem. Some customers may not be paying on time, orexpenses may be exceeding budget projections. Frequent comparisons alertmanagers to the need to either take corrective action or borrow additionalcash until receipts and payments are brought into balance.

2.3 CASH BUDGETS

59

As a class, discuss reasons why a

company’s cash balance might fall

below the projectedbalance. Then dis-

cuss the conse-quences of a cash

shortfall.

Reflections, Inc.Cash Budget

For Year Ended December 31, 20X3Quarter

1st 2d 3d 4thCash Balance—Beginning $ 21,780 $ 47,960 $ 30,440 $100,570Cash Receipts (Schedule A) 489,550 536,510 570,830 477,000Cash Available $511,330 $584,470 $601,270 $577,570Less Cash Payments (Schedule B) 463,370 554,030 500,700 550,050Cash Balance—Ending $ 47,960 $ 30,440 $100,570 $ 27,520

Why is the quarterly ending cash balance on a cash budget comparedwith the actual ending cash balance?

\

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PERFORMANCE REPORT

A report that compares budgeted and actual amounts for a specific period oftime is a performance report. It can be prepared anytime, but usually is

prepared quarterly or monthly. The purpose is to determine whether actualperformance matches the budget so that corrective action can be taken if itdoes not. When large variations are identified early, managers may makechanges to correct negative effects on net income for the year. If conditionschange significantly, the budget for the remainder of the year can be revised.

Reflections, Inc.Performance Report

For Quarter Ended March 31, 20X3Increase (Decrease)

Budget Actual Amount PercentageUnit Sales (sq. ft.) 97,600 98,500 900 0.9

Operating RevenueNet Sales $488,000 $492,500 $4,500 0.9Cost of Merchandise Sold 327,920 330,680 2,760 0.8Gross Profit on Operations $160,080 $161,820 $1,740 1.1

Operating ExpensesSelling Expenses

Advertising Expense $ 11,710 $ 12,050 $ 340 2.9Delivery Expense 39,040 38,730 (310) (0.8)Depr. Expense—Delivery Equipment 1,800 1,800 0 0.0Depr. Expense—Warehouse Equipment 2,700 2,700 0 0.0Miscellaneous Expense—Sales 2,440 2,530 90 3.7Salary Expense—Commissions 19,520 19,620 100 0.5Salary Expense—Regular 6,190 6,190 0 0.0Supplies Expense—Sales 2,930 2,900 (30) (1.0)

Total Selling Expenses $ 86,330 $ 86,520 $ 190 0.2Administrative Expenses

Depr. Expense—Office Equipment $ 3,600 $ 3,600 $ 0 0.0Depr. Expense—Computer System 4,800 4,800 0 0.0Insurance Expense 1,400 1,400 0 0.0Miscellaneous Expense—Administrative 9,190 9,350 160 1.7Payroll Taxes Expense 5,540 5,550 10 0.2Rent Expense 7,500 7,500 0 0.0Salary Expense—Administrative 20,430 20,430 0 0.0Supplies Expense—Administrative 3,420 3,490 70 2.0Uncollectible Accounts Expense 2,930 2,800 (130) (4.4)Utilities Expense 4,870 5,180 310 6.4

Total Administrative Expenses $ 63,680 $ 64,100 $ 420 0.7Total Operating Expenses $150,010 $150,620 $ 610 0.4

Income from Operations $ 10,070 $ 11,200 $1,130 11.2

Net Deduction $ 750 $ 750 $ 0 0.0

Net Income before Federal Income Tax $ 9,320 $ 10,450 $1,130 12.1Federal Income Tax Expense 6,220 6,220 0 0.0Net Income after Federal Income Tax $ 3,100 $ 4,230 $1,130 36.5

A performance report is similar to a comparative income statement.However, a performance report compares actual amounts with projectedamounts for the same period. A comparative income statement, on the otherhand, compares actual performance in one period with actual performance inanother period.

The first amount column of the performance report shows amounts pro-jected for the first quarter. The second amount column shows the actual sales,costs, and expenses for the quarter. The third amount column shows howmuch the actual amount varies from the projected amount. For example,actual net sales, $492,500, less projected net sales, $488,000, equals theincrease, $4,500. The fourth column shows the percentage the actual amountincreased or decreased from the projected amount. For example, the net salesincrease, $4,500, divided by projected net sales, $488,000, equals the per-centage of increase, 0.9%. Percentages are rounded to the nearest tenth of apercent. Decreases are indicated by parentheses.

It is important to understand that the meaning of increases and decreasesdiffers depending on the item being considered. For example, an increase innet sales is a favorable result while an increase in cost of merchandise sold oran expense is unfavorable.

ANALYZING THE PERFORMANCE REPORT◆

All significant differences should be analyzed to determine why the differ-ences occurred. Normally, Reflections only considers changes of 5.0% ormore to be significant. However, items that influence gross profit are largedollar amounts, and small percentage changes affect net income significantly.Therefore, Reflections’ sales manager reviews changes in net sales and cost ofmerchandise sold regardless of the amount of change.

Reflections’ performance report indicates that three items should bereviewed.

1. Net sales

2. Cost of merchandise sold

3. Utilities expense

Managers should determine what actions can correct unfavorable resultssuch as the 6.4% increase in utilities expense. If the utility service cost hasincreased, the manager cannot change that. However, if power is beingwasted, procedures may need to be changed to avoid the waste.

Managers should also determine what actions caused favorable results,such as the 0.9% increase in net sales, and encourage a continuation of thosefavorable actions.

2.3 CASH BUDGETS

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Why is a performance report prepared?

THINK CRITICALLY1. Complete the cash receipts and cash payments budget schedules on

the next page. Round dollars to the nearest $10. Some information hasalready been completed for you. Then use the completed cash budgetschedules to prepare a cash budget.

a. Cash Receipts Budget Schedule: In each quarter, cash sales are10.0% and collections of accounts receivable are 40.0% of the pro-jected net sales for the current quarter. Collections from the pre-ceding quarter’s net sales are 49.4% of that quarter. Uncollectibleaccounts expense is 0.6% of net sales.

b. Cash Payments Budget Schedule: In each quarter, cash paymentsfor cash purchases are 10.0%, and cash payments for accountspayable are 55.0% of the purchases for the current quarter. Cashpayments for purchases of the preceding quarter are 35.0% of thatquarter.

In the first quarter, $40,000 will be borrowed on a promissory note,and equipment costing $30,000 will be purchased for cash. In eachquarter, dividends of $10,000 will be paid in cash. In the fourthquarter, the promissory note and $5,000 interest will be paid.

c. Cash Budget

2. It is often said that the primary cause of business failure is lack of cashflow. Others say that poor planning is the primary cause. Explain youropinion about these statements?

3. Orpheon Corporation’s first quarter performance report shows a netsales increase of 4.5%, a cost of merchandise sold decrease of 0.7%,and an advertising expense increase of 12.4%. Net income before fed-eral income tax exceeds the budgeted amount by 8.7%. All otherincreases and decreases are less than 2.0%. What action would yousuggest?

MAKE CONNECTIONS4. CONSUMER ECONOMICS Find textbooks or magazine articles that

explain why individuals and families should protect their credit rating.Then write a brief comparison about how this information relates tocash flow for a business.

5. COMMUNICATION Use presentation software to explain how a cashreceipts budget schedule is prepared.

6. BUSINESS Search the Internet to find information about how smallbusinesses use credit cards to help their cash flow. Write a brief reporton your findings.

CHAPTER 2 BUDGETING

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2.3 CASH BUDGETS

63

Photex CorporationCash Receipts Budget Schedule

For Year Ended December 31, 20X3 Schedule AQuarter

1st 2d 3d 4thFrom Sales

Prior Year’s 4th Quarter ($161,280) $ 79,6701st Quarter Sales ($142,800) 71,400 $ 70,5402d Quarter Sales ($223,800) 111,900 $110,5603d Quarter Sales ($226,200) 113,100 $111,7404th Quarter Sales ($187,200) 93,600

Total Receipts from Sales $151,070 $182,440 $223,660 $205,340

From Other SourcesNote Payable to Bank 40,000

Total Cash Receipts $191,070 $182,440 $223,660 $205,340

Photex CorporationCash Budget

For Year Ended December 31, 20X3Quarter

1st 2d 3d 4thCash Balance—Beginning $ 41,600 $ 52,720 $ 43,540 $ 65,170Cash Receipts (Schedule A) 191,070 182,440 223,660 205,340Cash Available $232,670 $235,160 $267,200 $270,510Less Cash Payments (Schedule B) 179,950 191,620 202,030 220,610Cash Balance—Ending $ 52,720 $ 43,540 $ 65,170 $ 49,900

Photex CorporationCash Payments Budget Schedule

For Year Ended December 31, 20X3 Schedule BQuarter

1st 2d 3d 4thFor Merchandise

Prior Year’s 4th Quarter Purchases($105,600) $ 36,960

1st Quarter Purchases ($111,350) 72,380 $ 38,9702d Quarter Purchases ($159,380) 103,600 $ 55,7803d Quarter Purchases ($149,180) 96,970 $ 52,2104th Quarter Purchases ($120,280) 78,180

Total Cash Payments for Purchases $109,340 $142,570 $152,750 $130,390

For Operating ExpensesCash Selling Expenses $ 11,420 $ 17,910 $ 18,090 $ 14,980Cash Administrative Expenses 15,380 17,330 17,380 16,450

Total Cash Operating Expenses $ 26,800 $ 35,240 $ 35,470 $ 31,430

For Other Cash PaymentsFederal Income Tax Expense $ 3,810 $ 3,810 $ 3,810 $ 3,790Equipment Purchases 30,000Cash Dividend 10,000 10,000 10,000 10,000Note Payable and Interest 45,000

Total Other Cash Payments $ 43,810 $ 13,810 $ 13,810 $ 58,790Total Cash Payments for Purchases $179,950 $191,620 $202,030 $220,610

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CHAPTER SUMMARYLESSON 2.1 Budget PlanningA. A budget is a written financial plan of a business that provides communi-

cation between levels of a business, coordination between departments,planning of operations, control of operations, and evaluation of perfor-mance. Budgets are usually prepared for a period of one year but mayalso be broken down into smaller periods, such as months or quarters.

B. Sources of budget information include company records, general eco-nomic information, company staff and managers, and good judgment.

C. A comparative income statement compares two years of sales, cost, andexpense amounts and provides information for planning operations.

LESSON 2.2 Budgeted Income StatementA. Businesses set goals and formulate an operational plan as a foundation

for budgeting.B. A sales budget schedule provides information needed for other budget

schedules. A purchases budget schedule forecasts cost of merchandise.C. Selling expenses, administrative expenses, and other revenue and

expenses budget schedules show the planned expenses of a business.D. A budgeted income statement shows the forecasted operations of a

business and is compiled from the other budget schedules.

LESSON 2.3 Cash BudgetsA. Cash receipts and cash payments budget schedules show forecasted

cash inflows and outflows for each quarter. They are used to preparethe cash budget to manage the flow of cash.

B. A performance report compares actual performance with budgeted per-formance for a specific period of time. It is analyzed carefully in order totake corrective action where needed.

VOCABULARY BUILDERChoose the term that best fits the definition. Write the letter of the answerin the space provided. Some terms may not be used.

1. Written financial plan of a busi-ness for a specific period of time,expressed in dollars

2. Statement of how a company willmeet its goals

3. Report that compares budgetedand actual amounts for a specificperiod of time

4. Detailed statements of the oper-ations of a specific segment of abusiness for a period of time

5. Budget that details the cashreceipts and cash payments a business expects in a specificperiod of time

6. Planning the financial operations of a business

7. Broad statements of what a business wishes to accomplish

8. Income statement containing sales, cost, and expense infor-mation for two or more years

a

a

a

a

a

a

a

aa. budget

b. budget schedules

c. budgeting

d. cash budget

e. comparative income statement

f. goals

g. operational plan

h. performance report

REVIEW CONCEPTS9. How does a budget serve the purpose of control?

10. Give three examples of general economic trends that can affect acompany’s performance.

11. What information about sales, costs, and expenses can a comparativeincome statement provide?

12. How are amounts and percentages in the Increase/(Decrease)columns of a comparative income statement calculated?

13. In the sales budget schedule, how are the sales percentages by quartercalculated?

14. Why would a sales budget schedule state sales amounts in both unitsand dollars?

15. Why is the sales budget schedule prepared before other budgetschedules?

16. When an item on an expenses budget schedule is expressed as a per-centage of net sales, how is each quarter’s amount calculated?

17. What are the usual sources of cash on a cash receipts budget schedule?

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18. When preparing a cash payments budget schedule, why aren’t the totalsfrom the selling and administrative expenses budget schedules used?

19. When a performance report is analyzed, why do managers examinethe variations in net sales and cost of merchandise sold even if thepercentage of change is relatively low?

APPLY WHAT YOU LEARNED20. Within a company, a budget serves five main purposes: communica-

tion, coordination, planning, control, and evaluation. Do these sameelements apply to families when budgeting? Why or why not?

21. In the last month of a fiscal year, Ellen Shaw, sales manager, saw thatunless extraordinary measures were taken, the store would not meetbudgeted net sales for the year. Therefore, she cut selling prices toproduce more sales. Is this an appropriate way to meet a budget?

22. Budget World is a small discount store in a mall. In October, a firecaused so much damage that the store was closed for one month. InDecember, the owner gave the sales manager a bad review becausesales did not reach the budgeted amount for the year. What is youropinion of this scenario?

23. Toward the end of a fiscal year, it is apparent that the company will notreach its budgeted net income. The sales manager, therefore, requiresthat sales representatives cut all long-distance travel for the last twomonths to keep expenses lower. Is this a good idea?

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MAKE CONNECTIONS24. TECHNOLOGY People in high-tech industries often criticize the budget

process because they say that the average life of a new technologyproduct is six months. Is this criticism justified? What process could beused instead?

25. ETHICS Thomas Gradison is the sales manager and is responsible forboth sales and cost of merchandise on the annual budget. In the lastthree months of the fiscal year, he delays purchasing any new mer-chandise so that cost of merchandise will be under budget and willresult in a good performance review for him. Is this ethical?

26. SCIENCE Conduct a library or Internet search to determine the U.S.budget for the human genome research project. Describe your findings.

27. HISTORY The Falkland Islands war between Great Britain andArgentina in 1982 cost Great Britain more than 1.6 billion pounds andthe loss of 255 lives, 6 ships, and 9 aircraft. Create a slide show pre-sentation of this information and include your ideas on the difficultiesof budgeting for a war.

28. TECHNOLOGY Create a spreadsheet for the cash budget and budgetschedules in this chapter, or create one using your own information.Design the spreadsheet in such a way that formulas and cell refer-ences create all the amounts in the cash budget, with the exception ofthe beginning cash balance for the first quarter.

29. CAREERS Conduct research at the library to learn about a career asa budget analyst. Write a brief report summarizing the educationalrequirements, employment outlook, and salary ranges from entry-levelemployees to experienced budget analysts.

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