PROFIT PLANNING

TOPIC 9
Learning Objective 7-1

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 – Control –
involves developing involves the steps taken by
objectives and management to increase
preparing various the likelihood that the
budgets to achieve objectives set down while
those objectives. planning are attained and
that all parts of the
organization are working
together toward that goal.
Advantages of Budgeting

Define goals
and objectives
Communicate Think about and
plans plan for the future

Advantages
Coordinate Means of allocating
activities resources

Uncover potential
bottlenecks
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

A continuous budget is a
12-month budget that rolls
cover a one-year period
forward one month (or quarter)
corresponding to a
as the current month (or
company’s fiscal year. Many
quarter) is completed.
companies divide their
annual budget
into four quarters.
Self-Imposed Budget
Top M an ag em en t

M id d le M id d le
M an ag em en t M an ag em en t

S u p ervisor S u p ervisor S u p ervisor S u p ervisor

A self-imposed budget or participative budget is a budget

that is prepared with the full cooperation and participation of
managers at all levels.
Advantages of Self-Imposed Budgets
1.
1. Individuals
Individuals at
at all
all levels
levels of
of the
the organization
organization are
are viewed
viewed as
as
members
members of of the
the team
team whose
whose judgments
judgments are
are valued
valued by
by
top
top management.
management.
2.
2. Budget
Budget estimates
estimates prepared
prepared by
by front-line
front-line managers
managers are
are
often
often more
more accurate
accurate than
than estimates
estimates prepared
prepared by
by top
top
managers.
managers.
3.
3. Motivation
Motivation is
is generally
generally higher
higher when
when individuals
individuals
participate
participate in
in setting
setting their
their own
own goals
goals than
than when
when the
the goals
goals
are
are imposed
imposed from
from above.
above.
4.
4. AA manager
manager who
who is
is not
not able
able to to meet
meet aa budget
budget imposed
imposed
from
from above
above can
can claim
claim that
that itit was
was unrealistic.
unrealistic. Self-
Self-
imposed
imposed budgets
budgets eliminate
eliminate thisthis excuse.
excuse.
Self-Imposed Budgets

Self-imposed budgets should be reviewed

by higher levels of management to
prevent “budgetary slack.”
Most companies issue broad guidelines in
terms of overall profits or sales. Lower
level managers are directed to prepare
budgets that meet those targets.
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. Highly achievable budget targets are usually
preferred when managers are rewarded based on
meeting budget targets.
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
The Master Budget: An Overview
Sales budget

Selling and
Ending inventory administrative
Production budget
budget budget

Direct materials Direct labor Manufacturing

budget budget overhead budget

Cash Budget

Budgeted
Budgeted
income
balance sheet
statement
Learning Objective 7-2

Prepare a sales
budget, including a
schedule of
expected cash
collections.
Budgeting Example
 Royal Company is preparing budgets for the
quarter ending June 30th.
 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 30 th
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.
• In April, the March 31st accounts receivable
balance of $30,000 will be collected in full.
Expected Cash Collections
Expected Cash Collections

From the Sales Budget for April.

Expected Cash Collections

From the Sales Budget for May.

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

What will be the total cash collections for

the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
Expected Cash Collections
Learning Objective 7-3

Prepare a
production budget.
The Production Budget

Sales Production
Budget Budget
andleted
p
Expected
m
Co
Cash
Collections

The production budget must be adequate to

meet budgeted sales and to provide for
the desired ending inventory.
The Production Budget
• The management at Royal Company wants
ending inventory to be equal to 20% of the
following month’s budgeted sales in units.

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

Let’s prepare the production budget.

The Production Budget
The Production Budget

Budgeted May sales 50,000

Desired ending inventory % 20%
March 31 Desired ending inventory 10,000
ending inventory.
Quick Check 
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
Quick Check 

What is the required production for May?

a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
The Production Budget
The Production Budget

Assumed ending inventory.

Learning Objective 7-4

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.

The Direct Materials Budget

From production budget.

The Direct Materials Budget
The Direct Materials Budget

March 31 inventory.

10% of following month’s Calculate the materials to

production needs. be purchased in May.
Quick Check 

How
How much
much materials
materials should
should be
be purchased
purchased in
in
May?
May?
a.
a. 221,500
221,500 pounds
pounds
b.
b. 240,000
240,000 pounds
pounds
c.
c. 230,000
230,000 pounds
pounds
d.
d. 211,500
211,500 pounds
pounds
Quick Check 

How
How much
much materials
materials should
should be
be purchased
purchased in
in
May?
May?
a.
a. 221,500
221,500 pounds
pounds
b.
b. 240,000
240,000 pounds
pounds
c.
c. 230,000
230,000 pounds
pounds
d.
d. 211,500
211,500 pounds
pounds
The Direct Materials Budget
The Direct Materials Budget

Assumed 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.

Expected Cash Disbursement for Materials
Expected Cash Disbursement for Materials

Compute the expected cash

disbursements for materials
for the quarter.

140,000 lbs. × $0.40/lb. = $56,000

Quick Check 

What are the total cash disbursements for the

quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
Quick Check 

What are the total cash disbursements for

the quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
Expected Cash Disbursement for Materials
Learning Objective 7-5

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 paid 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.
The Direct Labor Budget

From production budget.

The Direct Labor Budget
The Direct Labor Budget

Greater
Greater of
of labor
labor hours
hours required
required
or
or labor
labor hours
hours guaranteed.
guaranteed.
The Direct Labor Budget
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. $79,500
b. $64,500
c. $61,000
d. $57,000
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? April May June Quarter
Labor hours required 1,300 2,300 1,450
a. $79,500 Regular hours paid 1,500 1,500 1,500 4,500
b. $64,500 Overtime hours paid - 800 - 800

c. $61,000 Total regular hours 4,500 $10 $ 45,000

Total overtime hours 800 $15 $ 12,000
d. $57,000 Total pay $ 57,000
Learning Objective 7-6

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.

Manufacturing Overhead Budget

Direct Labor Budget.

Manufacturing Overhead Budget

Total mfg. OH for quarter $251,000

= $49.70 per hour *
Total labor hours required 5,050

* rounded
Manufacturing Overhead Budget

Depreciation
Depreciation is
is aa noncash
noncash charge.
charge.
Ending Finished Goods Inventory Budget

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

Direct materials
budget and information.
Ending Finished Goods Inventory Budget

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

Direct labor budget.

Ending Finished Goods Inventory Budget

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 ?

Total mfg. OH for quarter $251,000

= $49.70 per hour
Total labor hours required 5,050
Ending Finished Goods Inventory Budget

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

Production Budget.
Learning Objective 7-7

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 administrative

cash expenses for the quarter.
Quick Check 

What are the total cash disbursements for

selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
Quick Check 

What are the total cash disbursements for

selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
Selling Administrative Expense Budget
Learning Objective 7-8

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
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
Schedule of
of Expected
Expected
Cash
Cash Collections.
Collections.
The Cash Budget

Schedule of Expected
Cash Disbursements.
Direct Labor
Budget.

Manufacturing
Overhead Budget.

Selling and Administrative

Expense Budget.
The Cash Budget

Because Royal maintains

a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.
The Cash Budget

Because Royal maintains

a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.

Ending cash balance for April

is the beginning May balance.
The Cash Budget
Quick Check 
What is the excess (deficiency) of cash
available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
Quick Check 

What is the excess (deficiency) of cash

available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
The Cash Budget

$50,000 × 16% × 3/12 = $2,000

Borrowings on April 1 and
repayment on June 30.
The Budgeted Income Statement

Cash Budgeted
Budget Income
Statement
ted
ple
o m
C

With interest expense from the cash

budget, Royal can prepare the budgeted
income statement.
Learning Objective 7-9

Prepare a budgeted
income statement.
 The Budgeted Income Statement

Sales Budget.
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Ending Finished
Sales (100,000 units @ $10) $ 1,000,000 Goods Inventory.
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
Selling and
Selling and administrative expenses 260,000
Operating income 241,000 Administrative
Interest expense 2,000 Expense Budget.
Net income $ 239,000

Cash Budget.
Learning Objective 7-10

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 Company
Budgeted Balance Sheet 25% of June
June 30 sales of
Assets: $300,000.
Cash $ 43,000
Accounts receivable 75,000 11,500 lbs.
Raw materials inventory 4,600 at $0.40/lb.
Finished goods inventory 24,950
Land 50,000 5,000 units
Equipment 367,000 at $4.99 each.
Total assets 564,550

Liabilities and Stockholders' Equity

50% of June
Accounts payable $ 28,400
Common stock 200,000
purchases
Retained earnings 336,150 of $56,800.
Total liabilities and stockholders' equity $ 564,550
 Royal Company
Budgeted Balance Sheet
June 30
Beginning balance $146,150
Assets: Add: net income 239,000
Cash $ 43,000dividends
Deduct: (49,000)
Accounts receivable 75,000
Ending balance $336,150
Raw materials inventory 4,600
Finished goods inventory 24,950
Land 50,000
Equipment 367,000
Total assets 564,550

Liabilities and Stockholders' Equity

Accounts payable $ 28,400
Common stock 200,000
Retained earnings 336,150
Total liabilities and stockholders' equity $ 564,550
End of TOPIC 9