Bab 2

© 2012 McGraw-Hill Education (Asia)Garrison, Noreen, Brewer, Cheng & Yuen

Profit Planning

Chapter 10

McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 2

Learning Objective 1

Understand why organizations budget and the processes they use to

create budgets.


The Basic Framework of Budgeting

A budget is a detailed quantitative plan for acquiring and using financial and other resources

over a specified forthcoming time period.

1. The act of preparing a budget is called budgeting.

2. The use of budgets to control an organization’s activities is known as budgetary control.


Planning and Control

Planning – involves developing objectives and preparing various budgets to achieve those objectives.

Planning – involves developing objectives and preparing various budgets to achieve those objectives.

Control – involves the steps taken by management to increase the likelihood that the objectives set down while planning are attained and that all parts of the organization are working together toward that goal.

Control – involves the steps taken by management to increase the likelihood that the objectives set down while planning are attained and that all parts of the organization are working together toward that goal.


Advantages of Budgeting

Advantages

Define goalsand objectives

Uncover potentialbottlenecks

Coordinateactivities

Communicateplans

Think about andplan for the future

Means of allocatingresources


Responsibility Accounting

Managers should be held responsible for those items - and only those items -

that they can actually control to a significant

extent.


Choosing the Budget Period

Operating Budget

2011 2012 2013 2014

Operating budgets ordinarily cover a one-year period

corresponding to a company’s fiscal year. Many companies divide their annual budget

into four quarters.

A continuous budget is a12-month budget that rolls

forward one month (or quarter)as the current month (or quarter)

is completed.



Understand Basic Budgeting Terms and the

Behavioral Aspects of Budgeting.


Bottom-up and Top-down BudgetingBottom-up budgeting

(Self-imposed budget or Participative

budget )

Top-down budgeting

Top Management

Middle Management

Lower-levelManagement

Top Management

Middle Management

Lower-levelManagement


Advantages of the Bottom-up Budgeting (Self-Imposed Budgets)

1. Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management.

2. Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers.

3. Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above.

4. A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse.

1. Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management.

2. Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers.

3. Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above.

4. A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse.


How to overcome problems of self-imposed budgets

Self-imposed budgets should be reviewed by higher levels of management to prevent “budgetary slack (or budget

padding).”

Most companies issue broad guidelines in terms of overall profits or sales. Lower level managers are directed to prepare

budgets that meet those targets.

Self-imposed budgets should be reviewed by higher levels of management to prevent “budgetary slack (or budget

padding).”

Most companies issue broad guidelines in terms of overall profits or sales. Lower level managers are directed to prepare

budgets that meet those targets.


Advantages of the Top-down Budgeting

1. Avoid the potential budgetary slack (budget padding).

2. Provide a clearer performance goals and expectations from the top management.

3. May provide better budget due to top management’s access to privileged/confidential market and organization information .

4. Provide an efficient budgetary process.

1. Avoid the potential budgetary slack (budget padding).

2. Provide a clearer performance goals and expectations from the top management.

3. May provide better budget due to top management’s access to privileged/confidential market and organization information .

4. Provide an efficient budgetary process.


Budget Lapsing

• A popular method among government agencies, universities and organizations relying on allocated funds.

• Any unused funding at the end of the financial period cannot be carried forward to the following year.

• As a result, the following year’s budget may be cut because of the under-expenditure in the previous year.


Budget Lapsing: Advantages

• Budget lapsing helps ensure that the appropriate level of resources is utilized in each period. Without budget lapsing, risk-averse managers may unnecessarily accumulate funds and this may adversely affect the performance of the organization.

• It helps provide an opportunity for a clean cut-off of expenditures and to reallocate any unused resources for other more appropriate requirements.


Budget Lapsing: Potential Problem & Solution

• Budget lapsing can cause undesired behavior effects. For example, managers may wastefully spend their entire budget before the end of the period in order to avoid budget cuts.

• A system of reviewing the expenditures near end of the period may uncover unnecessary expenditures and discourage managers to wastefully spend because of budget lapsing.


Incremental versus Zero-based Budgets

• Incremental method of budgeting is most commonly used by companies. Companies start off one year’s budget by referring back to the previous year’s figures. Adjustments are then made to the budget to account for the expected changes such as prices for the next year.

• While incremental method of budgeting is practical and fast, any inefficiency in the previous year’s figures may be carried forward. For example, if all along the organization is over staffed, then the budget will continually to be allowing for the over staffing situation under this method.



• Zero-Based Budgets are prepared based on the assumption that the company has just started. Therefore, resources required have to be justified from scratch.

• For example, when budgeting for staff cost for a restaurant, managers using the zero-based budgeting approach will ignore the existing staff level and expenses, rather, they will examine factors such as opening hours, number of tables, expected patron numbers to work out the number of staff required at each position and level, hence the associate costs, to produce a budget.



• Companies using the zero-based method do not simply ignore previous years’ figures. Figures generated by the zero-based method are usually compared with previous years’ figures. Any large differences are investigated.

• As zero-based budgeting is time consuming and costly, companies tend to use this method for the relatively large items and the incremental method for the rest.


Top Management Attitude:Human Factors in Budgeting

The success of a budget program depends on three important factors:1. Top management must be enthusiastic and

committed to the budget process.2. Top management must not use the budget to

pressure employees or blame them when something goes wrong.

3. Budget targets should be challenging but achievable in order to have good motivational effects.


The Budget Committee

A standing committee responsible for overall policy matters relating to the

budget coordinating the preparation of the

budget resolving disputes related to the

budget approving the final budget

A standing committee responsible for overall policy matters relating to the

budget coordinating the preparation of the

budget resolving disputes related to the

budget approving the final budget



Understand the Key Components of Master

Budget in Manufacturing, Merchandising and Service Industries


Understand the key components of master budget in Manufacturing, Merchandising, and Service Industries

The first step of budgeting for every business is to budget for the revenue, whether it is a sales budget for providing goods or services or a funding budget. Although operational budgets are adapted according to the industries, they are very similar and typically comprise of budgets for • Income statement• Cash• Balance sheet.

The major differences of different industries include:• Manufacturing: production budget is involved• Merchandising: no production budget, only purchase budget of

merchandise is required.• Service Industries: budget for revenue and cost of providing

services• Not-for-profit: expected funding available and plan usage of funding.



Prepare a Master Budget for a Manufacturing

Company.


The Master Budget: An Overview

Production budget

Selling andadministrative

budget

Direct materialsbudget

Manufacturingoverhead budget

Direct laborbudget

Cash Budget

Sales budget

Ending inventorybudget

Budgetedbalance sheet

Budgetedincome

statement


Learning Objective 4 (a)

Prepare a sales budget, including a schedule of

expected cash collections.


Budgeting Example

Royal Company is preparing budgets for the quarter ending June 30.

Budgeted sales for the next five months are: April 20,000 units May 50,000 units June 30,000 units July 25,000 units August 15,000 units.

The selling price is $10 per unit.


The Sales Budget

The individual months of April, May, and June are summed to obtain the total budgeted sales in units

and dollars for the quarter ended June 30th


Expected Cash Collections

All sales are on account.Royal’s collection pattern is:

70% collected in the month of sale, 25% collected in the month following

sale, 5% uncollectible.

The March 31 accounts receivable balance of $30,000 will be collected in full.





From the Sales Budget for April.



From the Sales Budget for May.


Quick Check

What will be the total cash collections for the quarter? a. $700,000b. $220,000c. $190,000d. $905,000


What will be the total cash collections for the quarter? a. $700,000b. $220,000c. $190,000d. $905,000

Quick Check




Learning Objective 4 (b)

Prepare a production budget.


The Production Budget

ProductionBudget

Sales Budget

andExpected

CashCollections

Complete

d

The production budget must be adequate to meet budgeted sales and to provide for

the desired ending inventory.



The management at Royal Company wants ending inventory to be equal to 20% of the following month’s budgeted sales in units.

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

Let’s prepare the production budget.





March 31ending inventory

March 31ending inventory

Budgeted May sales 50,000

Desired ending inventory % 20%Desired ending inventory 10,000


Quick Check

What is the required production for May? a. 56,000 unitsb. 46,000 unitsc. 62,000 unitsd. 52,000 units





Quick Check





Assumed ending inventory.Assumed ending inventory.


Learning Objective 4 (c)

Prepare a direct materials budget, including a

schedule of expected cash disbursements for

purchases of materials.


The Direct Materials Budget

At Royal Company, five pounds of material are required per unit of product.

Management wants materials on hand at the end of each month equal to 10% of the following month’s production.

On March 31, 13,000 pounds of material are on hand. Material cost is $0.40 per pound.

Let’s prepare the direct materials budget.



From production budget





Calculate the materials tobe purchased in May.

March 31 inventoryMarch 31 inventory

10% of following month’s production needs.

10% of following month’s production needs.


Quick Check

How much materials should be purchased in May? a. 221,500 poundsb. 240,000 poundsc. 230,000 poundsd. 211,500 pounds





Quick Check





Assumed ending inventoryAssumed ending inventory


Expected Cash Disbursement for Materials

Royal pays $0.40 per pound for its materials. One-half of a month’s purchases is paid for in the

month of purchase; the other half is paid in the following month.

The March 31 accounts payable balance is $12,000.

Let’s calculate expected cash disbursements.





140,000 lbs. × $0.40/lb. = $56,000140,000 lbs. × $0.40/lb. = $56,000

Compute the expected cashdisbursements for materials

for the quarter.

Compute the expected cashdisbursements for materials

for the quarter.


Quick Check

What are the total cash disbursements for the quarter? a. $185,000b. $ 68,000c. $ 56,000d. $201,400





Quick Check




Learning Objective 4 (d)

Prepare a direct labor budget.


The Direct Labor Budget

At Royal, each unit of product requires 0.05 hours (3 minutes) of direct labor.

The Company has a “no layoff” policy so all employees will be paid for 40 hours of work each week.

For purposes of our illustration assume that Royal has a “no layoff” policy, workers are pay at the rate of $10 per hour regardless of the hours worked.

For the next three months, the direct labor workforce will be paid for a minimum of 1,500 hours per month.

Let’s prepare the direct labor budget.



From production budget.From production budget.





Greater of labor hours requiredor labor hours guaranteed.

Greater of labor hours requiredor labor hours guaranteed.




Quick Check

What would be the total direct labor cost for the quarter if the company follows its no lay-off policy, but pays $15 (time-and-a-half) for every hour worked in excess of 1,500 hours in a month? a. $79,500b. $64,500c. $61,000d. $57,000


What would be the total direct labor cost for the quarter if the company follows its no lay-off policy, but pays $15 (time-and-a-half) for every hour worked in excess of 1,500 hours in a month? a. $79,500b. $64,500c. $61,000d. $57,000

Quick Check

April May June QuarterLabor hours required 1,300 2,300 1,450 Regular hours paid 1,500 1,500 1,500 4,500

Overtime hours paid - 800 - 800

Total regular hours 4,500 $10 45,000$ Total overtime hours 800 $15 12,000$

Total pay 57,000$


Learning Objective 4 (e)

Prepare a manufacturing

overhead budget.


Manufacturing Overhead Budget

At Royal, manufacturing overhead is applied to units of product on the basis of direct labor hours.

The variable manufacturing overhead rate is $20 per direct labor hour.

Fixed manufacturing overhead is $50,000 per month, which includes $20,000 of noncash costs (primarily depreciation of plant assets).

Let’s prepare the manufacturing overhead budget.

At Royal, manufacturing overhead is applied to units of product on the basis of direct labor hours.

The variable manufacturing overhead rate is $20 per direct labor hour.

Fixed manufacturing overhead is $50,000 per month, which includes $20,000 of noncash costs (primarily depreciation of plant assets).

Let’s prepare the manufacturing overhead budget.



Direct Labor Budget.



Total mfg. OH for quarter $251,000Total labor hours required 5,050

= $49.70 per hour *

* rounded



Depreciation is a noncash charge.Depreciation is a noncash charge.


Production costs per unit Quantity Cost Total Direct materials 5.00 lbs. 0.40$ 2.00$ Direct labor 0.05 hrs. 10.00$ 0.50 Manufacturing overhead 0.05 hrs. 49.70$ 2.49

4.99$

Budgeted finished goods inventory Ending inventory in units 5,000 Unit product cost 4.99$ Ending finished goods inventory 24,950$

Ending Finished Goods Inventory Budget

Direct materialsbudget and information.



4.99$



Direct labor budget.



4.99$

Budgeted finished goods inventory Ending inventory in units 5,000 Unit product cost 4.99$ Ending finished goods inventory ?


Total mfg. OH for quarter $251,000Total labor hours required 5,050

= $49.70 per hour *



4.99$



Production Budget.


Learning Objective 4 (f)

Prepare a selling and administrative

expense budget.


Selling and Administrative Expense Budget At Royal, the selling and administrative expense budget is

divided into variable and fixed components. The variable selling and administrative expenses are $0.50

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

month. The fixed selling and administrative expenses include

$10,000 in costs – primarily depreciation – that are not cash outflows of the current month.

Let’s prepare the company’s selling and administrative expense budget.


Selling and Administrative Expense Budget

Calculate the selling and administrativecash expenses for the quarter.

Calculate the selling and administrativecash expenses for the quarter.


Quick Check

What are the total cash disbursements for selling and administrative expenses for the quarter? a. $180,000b. $230,000c. $110,000d. $ 70,000





Quick Check


Selling Administrative Expense Budget


Learning Objective 4 (g)

Prepare a cash budget.


Format of the Cash Budget

The cash budget is divided into four sections:

1. Cash receipts section lists all cash inflows excluding cash received from financing;

2. Cash disbursements section consists of all cash payments excluding repayments of principal and interest;

3. Cash excess or deficiency section determines if the company will need to borrow money or if it will be able to repay funds previously borrowed; and

4. Financing section details the borrowings and repayments projected to take place during the budget period.

The cash budget is divided into four sections:

1. Cash receipts section lists all cash inflows excluding cash received from financing;

2. Cash disbursements section consists of all cash payments excluding repayments of principal and interest;

3. Cash excess or deficiency section determines if the company will need to borrow money or if it will be able to repay funds previously borrowed; and

4. Financing section details the borrowings and repayments projected to take place during the budget period.


The Cash Budget

Assume the following information for Royal: Maintains a 16% open line of credit for

$75,000 Maintains a minimum cash balance of

$30,000 Borrows on the first day of the month and

repays loans on the last day of the month Pays a cash dividend of $49,000 in April Purchases $143,700 of equipment in May

and $48,300 in June (both purchases paid in cash)

Has an April 1 cash balance of $40,000


The Cash Budget

Schedule of ExpectedCash Collections.

Schedule of ExpectedCash Collections.


The Cash Budget

Direct LaborBudget.

Direct LaborBudget.

ManufacturingOverhead Budget.

ManufacturingOverhead Budget.

Selling and AdministrativeExpense Budget.

Selling and AdministrativeExpense Budget.

Schedule of ExpectedCash Disbursements.Schedule of ExpectedCash Disbursements.


The Cash Budget

Because Royal maintainsa cash balance of $30,000,the company must borrow

$50,000 on its line-of-credit.




The Cash Budget

Ending cash balance for Aprilis the beginning May balance.Ending cash balance for Aprilis the beginning May balance.






The Cash Budget


Quick Check

What is the excess (deficiency) of cash available over disbursements for June? a. $ 85,000b. $(10,000)c. $ 75,000d. $ 95,000


What is the excess (deficiency) of cash available over disbursements for June? a. $ 85,000b. $(10,000)c. $ 75,000d. $ 95,000

Quick Check


The Cash Budget

$50,000 × 16% × 3/12 = $2,000Borrowings on April 1 and

repayment on June 30.

$50,000 × 16% × 3/12 = $2,000Borrowings on April 1 and

repayment on June 30.


The Budgeted Income Statement

Cash Budget

BudgetedIncome

Statement

Complete

d

With interest expense from the cash budget, Royal can prepare the budgeted

income statement.


Learning Objective 4(h)

Prepare a budgeted income statement.


The Budgeted Income Statement

Royal CompanyBudgeted Income Statement

For the Three Months Ended June 30

Sales (100,000 units @ $10) 1,000,000$ Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000 Selling and administrative expenses 260,000 Operating income 241,000 Interest expense 2,000 Net income 239,000$

Sales Budget.Sales Budget.

Ending FinishedGoods Inventory.Ending FinishedGoods Inventory.

Selling and Administrative

Expense Budget.

Selling and Administrative

Expense Budget.

Cash Budget.Cash Budget.


Learning Objective 4 (i)

Prepare a budgeted balance

sheet.


The Budgeted Balance Sheet

Royal reported the following account balances prior to preparing its budgeted

financial statements:

• Land - $50,000• Common stock - $200,000• Retained earnings - $146,150 (April 1)• Equipment - $175,000


Royal CompanyBudgeted Balance Sheet

June 30

Assets: Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Land 50,000 Equipment 367,000 Total assets 564,550

Liabilities and Stockholders' EquityAccounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and stockholders' equity 564,550$

11,500 lbs.at $0.40/lb.

5,000 unitsat $4.99 each.

50% of Junepurchases of $56,800.

25% of Junesales of

$300,000.


Royal CompanyBudgeted Balance Sheet

June 30

Assets: Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Land 50,000 Equipment 367,000 Total assets 564,550

Liabilities and Stockholders' EquityAccounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and stockholders' equity 564,550$

Beginning balance 146,150$ Add: net income 239,000 Deduct: dividends (49,000) Ending balance 336,150$



Prepare Budget on the Key

Components for the Service Industry


Key Budget Components for the Service Industry

Wonder World, a hypothetical theme park, has the following data:

Main Sources of Revenue

Major Expenses

Departments

• Ticketing• Food &

Beverages• Souvenir Shop

• Salaries• Rent • Cost of Sales• Advertising• Maintenance• Depreciation• Utilities

• Finance & Administration• Operations• Marketing• Souvenir Shop• Food and Beverages• Maintenance


Learning Objective 5 (a)

Prepare a Visitorship Budget


Visitorship Budget

Number of Visitors

Adults 750,000

Children 250,000

Total Visitors 1,000,000

Based on historical records, economic outlook, tourist arrival expectations, the following visitorship budget for the coming year is prepared:


Learning Objective 5 (b)

Prepare a Revenue Budget


Revenue Budget

Revenue per visitorGate Collections : Adults $13 Gate Collections : Children $9 Souvenir Shop $4 Food and Beverages $6

Based on the average price charged by Wonder World and other historical data, the following revenues per visitor are budgeted and approved by the top management:


Revenue Budget

RevenueGate Collections : Adults1 $9,750,000 Gate Collections : Children2 $2,250,000 Souvenir Shop3 $4,000,000 Food and Beverages4 $6,000,000 Total Revenue $22,000,000

With the budgeted number of visitors and revenues per visitor from each category, the budgeted revenues are computed:

Note1 750,000 X $132 250,000 X $93 1,000,000 X $44 1,000,000 X $6


Learning Objective 5 (c)

Prepare a Cost of Sales Budget and Expense Budget


Cost of Sales Budget

Cost of SalesSouvenir Shop $2,000,000 Food and Beverage $3,000,000 Total $5,000,000

For cost of sales on souvenirs and food and beverages, the company normally makes use of the historical cost of sales % and takes into account of any expected price changes from the suppliers. For the coming year, the expected cost of sales % is 50% on sales for both the souvenir shop and food and beverages.


Expenses BudgetHow the items are budgeted will depend on the nature of the items.

Nature of expense Amount Budget approach

Rental $1,100,000 5% of revenue as agreed with the landlord.

Salaries $3,500,000 Zero based approach by reviewing the actual requirement of each position and its suitable rate of pay.

Advertising $1,200,000 Proposed by marketing manager.

Maintenance $980,000 Proposed by maintenance manager.

Depreciation $890,000 Computed by the finance manager by taking into account of existing assets and proposed new assets.

Utilities $580,000 Computed by maintenance manager based on the rates and usage expectations.

Other operating expenses $490,000 Based on judgment and any specific requirements such as legal expenses.

Total $8,740,000


Learning Objective 5 (d)

Prepare a Budgeted Income

Statement


Budgeted Income Statement

Budgeted Income Statement

Revenue $22,000,000

Cost of goods sold $5,000,000

Expenses $8,740,000

Net income $8,260,000

Budgeted Income Statement can be prepared by putting all previous budgeted information together.



Explain the Costs and Benefits of

Budgeting


Costs and Benefits of Budgeting

• Budgeting is time-consuming and costly.

• Budgetary slack or padding is an inherent problem of budgeting.

• Despite the drawbacks of budgeting, most companies are still using budgets to plan, communicate, set objectives and allocate resources etc.

• Since budgets are still commonly used, benefits of budgeting are high and drawbacks of budgeting can be minimized by having a good budgeting system.

• For a good budgeting system, it is critical to have effective communication and mutual trust between the top management and its staff.


End of Chapter 10

Bab 2

Education

month budget

budget period operating

organizations budget

budget estimates

participative budget

annual budget

continuous budget

education asiagarrison