© the mcgraw-hill companies, inc., 2002 mcgraw-hill/irwin operational budgeting chapter 22
TRANSCRIPT
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Control Steps taken by
management to ensure that
objectives are attained.
Planning Developing objectives for
acquisitionand use of resources.
A budget is a comprehensive financialplan for achieving the financial and
operational goals of an organization.
A budget is a comprehensive financialplan for achieving the financial and
operational goals of an organization.
Budgeting: The Basis forPlanning and Control
Budgeting: The Basis forPlanning and Control
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BenefitsCoordinationof activities
Performanceevaluation
Enhanced managerialresponsibility
Assignment of decisionmaking responsibilities
Benefits Derived from BudgetingBenefits Derived from Budgeting
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Budget Problems
Perceived unfair or unrealistic goals.
Poor management-employee communications.
Solution
Reasonable and achievable budgets.
Employee participation in budgeting process.
Establishing Budgeted Amounts: The “Behavioral” Approach
Establishing Budgeted Amounts: The “Behavioral” Approach
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Flow of Budget Data
S u p ervisor S u p ervisor
M id d leM an ag em en t
S u p ervisor S u p ervisor
M id d leM an ag em en t
Top M an ag em en t
Participation in Budget ProcessParticipation in Budget Process
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2001 2002 2003 2004
C a p i t a l B u d g e t s
A continuous budget is usually a twelve-month budget that adds one month as the current month is completed.
The annual operating budget may be divided into quarterly or monthly budgets.
The Budget PeriodThe Budget Period
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Salesforecast
Productionschedule
Budgeted financial budgets: cash income balance sheet
Capitalexpenditures
budget
Operatingexpensebudgets
Cost of goodssold and ending
inventorybudgets
The Master BudgetThe Master Budget
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That’s enough talkingabout budgets, now
show me an example!
Preparing the Master Budget:An Illustration
Preparing the Master Budget:An Illustration
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SalesBudget
EstimatedUnit Sales
EstimatedUnit Price
Analysis of economic and market conditions
+Forecasts of customer needs from marketing personnel
Preparing the Master Budget:An Illustration
Preparing the Master Budget:An Illustration
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Ellis Magnet Co. is preparing budgets for the quarter ending June 30. The sales price is $10 per magnet.
Budgeted sales for the next four months are:
April 20,000 magnets @ $10 = $200,000May 50,000 magnets @ $10 = $500,000June 30,000 magnets @ $10 = $300,000July 25,000 magnets @ $10 = $250,000
The Sales Budget
July is needed for June ending inventory computations.
Preparing the Master Budget:An Illustration
Preparing the Master Budget:An Illustration
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Sales Budget
Complete
d
ProductionBudget
The Production BudgetThe Production Budget
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Ellis wants ending inventoryto be 20 percent of the next month’s
budgeted sales in units.
4,000 units were on hand March 31.
Let’s prepare the production budget.
The Production BudgetThe Production Budget
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Production must be adequate to meet budgeted sales and to provide sufficient
ending inventory.
Production must be adequate to meet budgeted sales and to provide sufficient
ending inventory.
Budgeted product sales in units
+ Desired product units in ending inventory
= Total product units needed
– Product units in beginning inventory
= Product units to produce
The Production BudgetThe Production Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000Desired ending inventoryTotal units neededLess beginning inventoryUnits to produce
The Production BudgetThe Production Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000Desired ending inventory 10,000 6,000 5,000 Total units needed 30,000 56,000 35,000Less beginning inventoryUnits to produce
Ending inventory = 20% of next month's production needs.June ending inventory = .20 × 25,000 July units = 5,000 units.
The Production BudgetThe Production Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000Desired ending inventory 10,000 6,000 5,000 Total units needed 30,000 56,000 35,000Less beginning inventory 4,000 10,000 6,000 Units to produce 26,000 46,000 29,000
Ending inventory = 20% of next month's production needs.June ending inventory = .20 × 25,000 July units = 5,000 units.Beginning inventory is last month's ending inventory.
The Production BudgetThe Production Budget
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ProductionBudgetMaterial
Purchases
Production BudgetUnits
Complete
d
The Production BudgetThe Production Budget
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The material purchases budget is based on production quantity and desired material
inventory levels.
The material purchases budget is based on production quantity and desired material
inventory levels.
Units to produce × Material needed per unit = Material needed for units to produce+ Desired units of material in ending
inventory= Total units of material needed– Units of material in beginning inventory= Units of material to purchase
The Production BudgetMaterial Purchases
The Production BudgetMaterial Purchases
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Five pounds of material are needed for each unit produced.
Ellis wants to have materials on hand at the end of each month equal to 10 percent of the following month’s production needs.
The materials inventory on March 31 is 13,000 pounds. July production is
budgeted for 23,000 units.
Five pounds of material are needed for each unit produced.
Ellis wants to have materials on hand at the end of each month equal to 10 percent of the following month’s production needs.
The materials inventory on March 31 is 13,000 pounds. July production is
budgeted for 23,000 units.
The Production BudgetMaterial Purchases
The Production BudgetMaterial Purchases
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The Production BudgetMaterial Purchases
The Production BudgetMaterial Purchases
April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventoryTotal material needs (lbs.)Less beginning inventoryMaterial purchases (lbs.)
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The Production BudgetMaterial Purchases
The Production BudgetMaterial Purchases
April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventory 23,000 14,500 11,500 Total material needs (lbs.) 153,000 244,500 156,500Less beginning inventoryMaterial purchases (lbs.)
Ending inventory = 10% of next month's material needs.June ending inventory = .10 × (23,000 units × 5 lbs. per unit).June ending inventory = 11,500 lbs.
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The Production BudgetMaterial Purchases
The Production BudgetMaterial Purchases
April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventory 23,000 14,500 11,500 Total material needs (lbs.) 153,000 244,500 156,500Less beginning inventory 13,000 23,000 14,500 Material purchases (lbs.) 140,000 221,500 142,000
Ending inventory = 10% of next month's material needs.June ending inventory = .10 × (23,000 units × 5 lbs. per unit).June ending inventory = 11,500 lbs.Beginning inventory is last month's ending inventory.
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Materials used in production cost $.40per pound. One-half of a month’s
purchases are paid for in the month of purchase; the other half is paid for in the
following month.
No discount terms are available.
The accounts payable balance onMarch 31 is $12,000.
Materials used in production cost $.40per pound. One-half of a month’s
purchases are paid for in the month of purchase; the other half is paid for in the
following month.
No discount terms are available.
The accounts payable balance onMarch 31 is $12,000.
Cash Payments forMaterial PurchasesCash Payments forMaterial Purchases
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April May JuneMaterial purchases (lbs.) 140,000 221,500 142,000Cost per pound 0.40$ 0.40$ 0.40$ Total cost 56,000$ 88,600$ 56,800$
Payables from March 12,000$April purchasesMay purchasesJune purchasesTotal payments in month
Cash Payments forMaterial PurchasesCash Payments forMaterial Purchases
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April May JuneMaterial purchases (lbs.) 140,000 221,500 142,000Cost per pound 0.40$ 0.40$ 0.40$ Total cost 56,000$ 88,600$ 56,800$
Payables from March 12,000$April purchases 28,000 28,000$May purchasesJune purchasesTotal payments in month
½ × $56,000 = $28,000
Cash Payments forMaterial PurchasesCash Payments forMaterial Purchases
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April May JuneMaterial purchases (lbs.) 140,000 221,500 142,000Cost per pound 0.40$ 0.40$ 0.40$ Total cost 56,000$ 88,600$ 56,800$
Payables from March 12,000$April purchases 28,000 28,000$May purchases 44,300 44,300$June purchasesTotal payments in month
½ × $56,000 = $28,000½ × $88,600 = $44,300
Cash Payments forMaterial PurchasesCash Payments forMaterial Purchases
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April May JuneMaterial purchases (lbs.) 140,000 221,500 142,000Cost per pound 0.40$ 0.40$ 0.40$ Total cost 56,000$ 88,600$ 56,800$
Payables from March 12,000$April purchases 28,000 28,000$May purchases 44,300 44,300$June purchases 28,400 Total payments in month 40,000$ 72,300$ 72,700$
½ × $56,000 = $28,000½ × $88,600 = $44,300½ × $56,800 = $28,400
Cash Payments forMaterial PurchasesCash Payments forMaterial Purchases
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ProductionBudgetLabor
Production BudgetUnits
Material
Complete
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The Production BudgetThe Production Budget
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Each unit produced requires 3 minutes (.05 hours) of direct labor. Ellis employs 30
persons for 40 hours each week at a rate of $10 per hour. Any extra hours needed are obtained by hiring temporary workers also
at $10 per hour.
The Production BudgetDirect Labor
The Production BudgetDirect Labor
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April May JuneUnits to produce 26,000 46,000 29,000 Hours per unit 0.05 0.05 0.05 Total hours required 1,300 2,300 1,450 Wage rate per hourDirect labor cost
Cash Payments forDirect Labor
Cash Payments forDirect Labor
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April May JuneUnits to produce 26,000 46,000 29,000 Hours per unit 0.05 0.05 0.05 Total hours required 1,300 2,300 1,450 Wage rate per hour 10$ 10$ 10$ Direct labor cost 13,000$ 23,000$ 14,500$
Cash Payments forDirect Labor
Cash Payments forDirect Labor
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Production Budget
UnitsMaterialLabor
Complete
d
ProductionBudget
ManufacturingOverhead
The Production BudgetThe Production Budget
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Variable manufacturing overhead is $1 per unit produced and fixed manufacturing
overhead is $50,000 per month.
Fixed manufacturing overhead includes $20,000 in depreciation which does not
require a cash outflow.
The Production BudgetManufacturing OverheadThe Production Budget
Manufacturing Overhead
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April May JuneUnits to produce 26,000 46,000 29,000 Variable overhead rate 1.00$ 1.00$ 1.00$ Variable overhead cost 26,000$ 46,000$ 29,000$Fixed overheadTotal mfg. overhead costDeduct depreciationManufacturing overhead - cash
Cash Payments forManufacturing Overhead
Cash Payments forManufacturing Overhead
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April May JuneUnits to produce 26,000 46,000 29,000 Variable overhead rate 1.00$ 1.00$ 1.00$ Variable overhead cost 26,000$ 46,000$ 29,000$Fixed overhead 50,000 50,000 50,000 Total mfg. overhead cost 76,000$ 96,000$ 79,000$Deduct depreciationManufacturing overhead - cash
Cash Payments forManufacturing Overhead
Cash Payments forManufacturing Overhead
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April May JuneUnits to produce 26,000 46,000 29,000 Variable overhead rate 1.00$ 1.00$ 1.00$ Variable overhead cost 26,000$ 46,000$ 29,000$Fixed overhead 50,000 50,000 50,000 Total mfg. overhead cost 76,000$ 96,000$ 79,000$Deduct depreciation 20,000 20,000 20,000 Manufacturing overhead - cash 56,000$ 76,000$ 59,000$
Cash Payments forManufacturing Overhead
Cash Payments forManufacturing Overhead
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Production Budget
Complete
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Sellingand
AdministrativeExpenseBudget
Selling and Administrative(S&A) Expense Budget
Selling and Administrative(S&A) Expense Budget
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Selling expense budgets contain both variable and fixed items. Variable items: shipping costs and sales
commissions.
Fixed items: advertising and sales salaries.
Administrative expense budgets contain mostly fixed items. Executive salaries and depreciation on company
offices.
Selling and Administrative(S&A) Expense Budget
Selling and Administrative(S&A) Expense Budget
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Variable selling and administrative expenses are $.50 per unit sold and fixed selling and administrative expenses are
$70,000 per month.
Fixed selling and administrative expenses include $10,000 in depreciation which does
not require a cash outflow.
Cash Payments for(S&A) Expenses
Cash Payments for(S&A) Expenses
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Variable S&A per unit 0.50$ 0.50$ 0.50$ Variable S&A expense 10,000$ 25,000$ 15,000$Fixed S&A expense 70,000 70,000 70,000 Total S&A expense 80,000$ 95,000$ 85,000$Deduct depreciationS&A expense - cash
Cash Payments for(S&A) Expenses
Cash Payments for(S&A) Expenses
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Variable S&A per unit 0.50$ 0.50$ 0.50$ Variable S&A expense 10,000$ 25,000$ 15,000$Fixed S&A expense 70,000 70,000 70,000 Total S&A expense 80,000$ 95,000$ 85,000$Deduct depreciation 10,000 10,000 10,000 S&A expense - cash 70,000$ 85,000$ 75,000$
Cash Payments for(S&A) Expenses
Cash Payments for(S&A) Expenses
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I have seen a lot of cashpayments but no cash
receipts. Show me somecash receipts!
Cash Receipts BudgetCash Receipts Budget
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All sales are on account.
Ellis’s collection pattern is:
70 percent collected in month of sale
25 percent collected in month after sale
5 percent will be uncollectible
Accounts receivable on March 31 is $30,000, all of which is collectible.
All sales are on account.
Ellis’s collection pattern is:
70 percent collected in month of sale
25 percent collected in month after sale
5 percent will be uncollectible
Accounts receivable on March 31 is $30,000, all of which is collectible.
Cash Receipts BudgetCash Receipts Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April salesReceipts from May salesReceipts from June salesTotal cash receipts
Cash Receipts BudgetCash Receipts Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000$ Receipts from May salesReceipts from June salesTotal cash receipts 170,000$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000
Cash Receipts BudgetCash Receipts Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000$ Receipts from May sales 350,000 125,000$Receipts from June salesTotal cash receipts 170,000$ 400,000$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000 May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000
Cash Receipts BudgetCash Receipts Budget
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000$ Receipts from May sales 350,000 125,000$Receipts from June sales 210,000 Total cash receipts 170,000$ 400,000$ 335,000$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000 May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000 June: .70 × $300,000 = $210,000
Cash Receipts BudgetCash Receipts Budget
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With just a little more information we will be able to
prepare a comprehensive cash budget.
Comprehensive Cash BudgetComprehensive Cash Budget
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Ellis Magnet Company:Has a $100,000 line of credit at its bank, with a zero
balance on April 1.Maintains a $30,000 minimum cash balance.Borrows at the beginning of a month and repays at the
end of a month.Pays interest at 16 percent when a principal payment is
made.Pays a $51,000 cash dividend in April.Purchases equipment costing $143,700 in May and
$48,800 in June.Has a $40,000 cash balance on April 1.
Comprehensive Cash BudgetAdditional Information
Comprehensive Cash BudgetAdditional Information
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ Cash receipts
Cash available
Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases Dividends
Total cash payments
Balance before financing
BorrowingPrincipal repaymentInterest
Ending cash balance
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ Cash receipts 170,000 400,000 335,000
Cash available 210,000$
Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases Dividends
Total cash payments
Balance before financing
BorrowingPrincipal repaymentInterest
Ending cash balance
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ Cash receipts 170,000 400,000 335,000
Cash available 210,000$
Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0
Total cash payments 230,000$ 400,000$ 270,000$
Balance before financing (20,000)$
BorrowingPrincipal repaymentInterest
Ending cash balance
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ 30,000$ Cash receipts 170,000 400,000 335,000
Cash available 210,000$ 430,000$
Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0
Total cash payments 230,000$ 400,000$ 270,000$
Balance before financing (20,000)$ 30,000$
Borrowing 50,000 Principal repayment 0Interest 0
Ending cash balance 30,000$
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ 30,000$ 30,000$ Cash receipts 170,000 400,000 335,000
Cash available 210,000$ 430,000$ 365,000$
Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0
Total cash payments 230,000$ 400,000$ 270,000$
Balance before financing (20,000)$ 30,000$ 95,000$
Borrowing 50,000 0Principal repayment 0 0Interest 0 0
Ending cash balance 30,000$ 30,000$
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Comprehensive Cash BudgetApril May June
Beginning cash balance 40,000$ 30,000$ 30,000$ Cash receipts 170,000 400,000 335,000
Cash available 210,000$ 430,000$ 365,000$
Cash payments: Materials budget 40,000$ 72,300$ 72,700$ Labor budget 13,000 23,000 14,500 Manufacturing OH budget 56,000 76,000 59,000 S&A expense budget 70,000 85,000 75,000 Equipment purchases 0 143,700 48,800 Dividends 51,000 0 0
Total cash payments 230,000$ 400,000$ 270,000$
Balance before financing (20,000)$ 30,000$ 95,000$
Borrowing 50,000 0 0Principal repayment 0 0 (50,000) Interest 0 0 (2,000)
Ending cash balance 30,000$ 30,000$ 43,000$
$50,000 × .16 × 3/12 = $2,000
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BudgetedIncome
Statement
Cash Budget
Complete
d
The BudgetedIncome Statement
The BudgetedIncome Statement
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Ellis Magnet CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$
The BudgetedIncome Statement
The BudgetedIncome Statement
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Ellis Magnet CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000$
Computation of unit cost follows
The BudgetedIncome Statement
The BudgetedIncome Statement
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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 Total unit cost 4.99$
Total mfg. OH for quarter $251,000 Total labor hours required 5,050 hrs.
= $49.70 per hr.
From labor and Mfg. OH budgets
Labor Hours Mfg. OHApril 1,300 76,000$ May 2,300 96,000 June 1,450 79,000 Total 5,050 251,000$
Manufacturingoverhead is applied
based ondirect labor hours.
The BudgetedIncome Statement
The BudgetedIncome Statement
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Ellis Magnet 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$
From S&A Expense Budget
April 80,000$ May 95,000 June 85,000 Total 260,000$
The BudgetedIncome Statement
The BudgetedIncome Statement
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Ellis Magnet 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$
The BudgetedIncome Statement
The BudgetedIncome Statement
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BudgetedBalance
Sheet
Complete
d
BudgetedIncome
Statement
The BudgetedBalance SheetThe BudgetedBalance Sheet
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Ellis reports the following account balances on June 30, prior to preparing its budgeted
financial statements: Land - $50,000 Building (net) - $174,500 Common stock - $200,000 Equipment (net) - $192,500 Retained earnings - $148,150
Ellis reports the following account balances on June 30, prior to preparing its budgeted
financial statements: Land - $50,000 Building (net) - $174,500 Common stock - $200,000 Equipment (net) - $192,500 Retained earnings - $148,150
The BudgetedBalance SheetThe BudgetedBalance Sheet
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Ellis Magnet CompanyBudgeted Balance Sheet
June 30, 2002Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950
Total current assets 147,550$ Property and equipment Land 50,000$ Building 174,500 Equipment 192,500 Total property and equipment 417,000$
Total assets 564,550$
Liabilities and Equities Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$
25% of Junesales of $300,000
11,500 lbs. @ $.40 per lb.
50% of Junepurchases of $56,800
5,000 units@ $4.99 each
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Ellis Magnet CompanyBudgeted Balance Sheet
June 30, 2002Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950
Total current assets 147,550$ Property and equipment Land 50,000$ Building 174,500 Equipment 192,500 Total property and equipment 417,000$
Total assets 564,550$
Liabilities and Equities Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$
Beginning balance 148,150$Add: net income 239,000 Deduct: dividends (51,000) Ending balance 336,150$
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Let’s change
topics.
Flexible BudgetingFlexible Budgeting
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Performance evaluation is difficult when actual activity
differs from the activity originally budgeted.
Flexible BudgetingFlexible Budgeting
Hmm! Comparingcosts at differentlevels of activity is like comparing
apples with oranges.
Consider the followingcondensed example
from the CheeseCompany . . .
Consider the followingcondensed example
from the CheeseCompany . . .
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Flexible BudgetingFlexible Budgeting
Original ActualBudget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
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Original ActualBudget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
U = Unfavorable variance – Cheese Company was unable to achieve the budgeted level of activity.
Flexible BudgetingFlexible Budgeting
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Original ActualBudget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
F = Favorable variance: actual costs are less than budgeted costs.
Flexible BudgetingFlexible Budgeting
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Original ActualBudget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F
Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
Since cost variances are favorable, havewe done a good job controlling costs?
Flexible BudgetingFlexible Budgeting
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I don’t think I can answer the question
using the originalbudget.
How much ofthe favorable cost
variance is due to loweractivity, and how much is due
to good cost control?
Flexible BudgetingFlexible Budgeting
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Flexible BudgetingFlexible Budgeting
I don’t think I can answer the question
using the originalbudget.
How much ofthe favorable cost
variance is due to loweractivity, and how much is due
to good cost control?
To answer the question, we mustthe budget to the actual level of activity.
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Central Concept
If you can tell me what your activity wasfor the period, I will tell you what your costs
and revenue should have been.
Flexible BudgetingFlexible Budgeting
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Improve performance evaluation.
May be prepared for any activity level in the relevant range.
Show expenses that should haveoccurred at the actual level ofactivity.
Reveal variances due to good costcontrol or lack of cost control.
Flexible BudgetingFlexible Budgeting
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To a budget for different activity levels, we must know how costs behave with changes in activity levels. Total variable costs change
in direct proportion to changes in activity.
Total fixed costs remainunchanged within therelevant range.
FixedVaria
ble
Flexible BudgetingFlexible Budgeting
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Let’s prepare budgets for the Cheese Company.
Flexible BudgetingFlexible Budgeting
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Flexible BudgetingFlexible BudgetingCost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ Indirect material 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$
Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs
Variable costs are expressed as a constant amount per hour.
In the original budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of
$4.00 per hour.
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Flexible BudgetingFlexible BudgetingCost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Flexible BudgetingFlexible BudgetingCost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$Total variable cost = $7.50 per unit × budget level in units
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Flexible BudgetingFlexible BudgetingCost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Indirect labor 4.00 32,000$ 40,000$ 48,000$ Indirect material 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$
Fixed costs are expressed as a total amount that does not change within the relevant
range of activity.
© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin
Now let’s prepare a budget performance report at 8,000 actual machine hours for the Cheese Co.
Flexible BudgetingPerformance ReportFlexible BudgetingPerformance Report
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Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Costs Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U
Flexible BudgetingPerformance ReportFlexible BudgetingPerformance Report
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Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Costs Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U
Indirect labor and indirect material have unfavorable variances because actual costs
are more than the flexible budget costs.
Flexible BudgetingPerformance ReportFlexible BudgetingPerformance Report
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Cost TotalFormula Fixed Flexible ActualPer Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable costs 7.50$ 60,000$ 63,300$ $ 3,300 UFixed Costs Depreciation 12,000$ 12,000$ 12,000$ 0 Insurance 2,000 2,000 2,000 0Total fixed costs 14,000$ 14,000$ 0Total overhead costs 74,000$ 77,300$ $ 3,300 U
Power has a favorable variance because the
actual cost is less than the flexible budget cost.
Flexible BudgetingPerformance ReportFlexible BudgetingPerformance Report