hhofma3e ch22 inst

7/30/2019 Hhofma3e Ch22 Inst

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Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 22

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Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall.2

Learn why managers use budgetsUnderstand the components of the master

budget

Prepare an operating budgetPrepare a financial budget

Use sensitivity analysis in budgeting

Prepare performance reports for responsibility

centers and account for traceable and common

shared fixed costs


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Learn why managers use budgets

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To plan and control actions and the related

revenues and expensesTo incorporate managements strategic andoperational plans

Planning technology upgradesPlanning capital asset replacements, improvements,or expansions

Compare actual results with budgeted amounts

to determine corrective actions

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7/61Copyright 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Identifies areas where the actual results differed

from the budget

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Understand the components of the master budget

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Master budgetthe set of budgeted financial

statements and supporting schedules for the entireorganization

Budget includes three types of budgets:

The operating budget

Projects sales revenue, cost of goods sold, and operatingexpenses

The capital expenditures budget

The plan for purchasing property, plant, equipment, and

other long-term assetsThe financial budget

Plans for raising cash and paying debts

Contain projected amounts, not actual amounts9



The following are some of the componentsincluded in the master budget.a. Budgeted balance sheet

b. Sales budget

c. Capital expenditures budgetd. Budgeted income statement

e. Cash budget

f. Inventory, purchases, and cost of goods soldbudget

g. Budgeted statement of cash flows

List in order of preparation the items of themaster budget.

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1. ______

2. ______

3. ______

4. ______

5. ______

6. ______

7. ______

B

F

D

C

E

A

G



Prepare an operating budget

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First three componentsSales budget

Inventory, purchases, and cost of goods sold budget

Operating expenses

Feed into the budgeted income statement

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Cornerstone of master budgetLevel of sales affect all other elements

Projected sales are calculated as:

Each product multiplied by expected units sold

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Budget determines:

Cost of goods sold for the budgeted incomestatement

Ending inventory for the budgeted balance sheetPurchases for the cash budget

Familiar equation is used

Beginning inventory + PurchasesEnding

inventory = Cost of goods sold

Rearrange equation to solve for unknowns

Purchases = Cost of goods sold + Ending

inventoryBeginning inventory15



70% cost of goods sold figure uses sales budget createdearlier

Desired ending inventory is derived from companypolicies

Desired ending inventory becomes beginning inventory

for next period (month, quarter, or year)16



Prepared after sales budget and cost of goods

sold budgetShows estimated expenses for the period

Includes fixed and/or variable expenses

Examples:Fixed and variable salaries, commissions

Rent

InsuranceAdvertising

Miscellaneous

Look at prior income statements17



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Prepared after sales budget, cost of goods sold budget

and operating expense budget



Grippers sells its rock-climbing shoes worldwide.

Grippers expects to sell 8,500 pairs of shoes for $180each in January, and 3,500 pairs of shoes for $190 eachin February. All sales are cash only.

Prepare the sales budget for January and February.

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Grippers

Sales Budget

January February Total

Sales price per pair $ 180 $ 190Number of pairs 8,500 3,500

Total sales $1,530,000 $665,000 $2,195,000



Review your results from S22-3. Grippers expects cost of goods soldto average 60% of sales revenue, and the company expects to sell

4,100 pairs of shoes in March for $260 each. Grippers target endinginventory is $10,000 plus 50% of the next months cost of goods sold.

Use this information and the sales budget prepared in S22-3 to prepareGrippers inventory, purchases, and cost of goods sold budget forJanuary and February.

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GrippersInventory, Purchases, and Cost of Goods Sold Budget

January February

Cost of goods sold

(0.60 sales from S 21-3) $ 918,000 $ 399,000

+ Desired ending inventory($10,000 + 0.50 Cost of goods

sold for next month) 209,500 329,800

= Total inventory required 1,127,500 728,800

Beginning inventory (469,000) (209,500)

= Purchases $ 658,500 $ 519,300


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Prepare a financial budget

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Cash budgetProject cash receipts and payments

Budgeted balance sheetProject each asset, liability, and stockholders equity account

Budgeted statement of cash flowsProject cash flows from operating, investing, and financing

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Statement of budgeted cash receipts andpayments

Details how to go from the beginning cashbalance to the desired ending balance

Four major parts:Cash collections from customers

Cash payments for purchases

Cash payments for operating expensesCash payments for capital expenditures

Depends on operating budget

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Cash collections from customers

Cash sales from the sales budgetCollections of prior months credit sales

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Payments for operating expenses

Payments during the month of purchaseassume 50%Payments following the month of purchaseassume 50%

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x 50%


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Use the operating expenses budget and payment information tocompute cash payments for operating expenses

Payment of 50% of current months salary and commissions

Payment of 50% of prior months salary and commissions

Payment for rent and miscellaneous expenses in the same month

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Insurance was prepaid in the prior quarterDepreciation is a non-cash expense


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8. Gregs plans to purchase a used delivery

truck in April for $3,000 cash.

9. Gregs requires a minimum cash

balance of $10,000 before financing at the

end of each month.


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Most important part of the budgeting system

Getting managers and employees to accept the budget

Managers must motivate employees to accept the budgetsgoals

How?

Managers must support the budget themselves, or no oneelse will

Managers must show employees how budgets can help themachieve better results

Managers must have employees participate in developing

the budget

Do not build in slackbecomes less accurate

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Refer to the Grippers sales budget that you prepared in

S22-3. Now assume that Grippers sales are collected asfollows:

November sales totaled $400,000 and December saleswere $425,000.

50% in the month of the sale30% in the month after the sale

18% two months after the sale

2% never collectedPrepare a schedule for the budgeted cash collections forJanuary and February. Round answers to the nearestdollar.

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Grippers

Budgeted Cash Collections from Customers

January February

Cash sales (50% of current month ) $ 765,000 $ 332,500

Collection of sales:

30% of prior month credit sales 127,500 459,000

18% of sales two months ago 72,000 76,500

Total cash collections $ 964,500 $ 868,000

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Refer to the Grippers inventory, purchases, and cost of

goods sold budget your prepared in S22-4. AssumeGrippers pays for inventory purchases 50% in the monthof purchase and 50% in the month after purchase.

Prepare a schedule for the budgeted cash payments forpurchases for January and February.

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Grippers

Budgeted Cash Payments for Purchases

January February50% of last month $ 293,250 $ 329,250

50% of current month 329,250 259,650

Total cash payments $ 622,500 $ 588,900


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Grippers has $12,500 in cash on hand on January

1. Refer to S22-5 and S22-6 for cash collectionsand cash payment information. Assume Grippershas cash payment for operating expenses including

salaries of $50,000 plus 1% of sales, all paid in themonth of sale. The company requires a minimumcash balance of $10,000.

Prepare a cash budget for January and February.

Will Grippers need to borrow cash by the end ofFebruary?

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Grippers

Cash Budget

January and February 2012

January February

Beginning cash balance $ 12,500 $ 402,300

Cash collections from customers 1,077,600 827,400Cash available 1,090,100 1,229,700

Cash payments

Purchases of inventory 622,500 588,900

Operating expenses 65,300 56,650Total cash payments 687,800 645,550

Ending cash balance 402,300 584,150

Less: Minimum cash balance desired (10,000) (10,000)

Cash excess (deficiency) $ 392,300 $ 574,15038


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Use sensitivity analysis in budgeting

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Technology makes it more cost-effective formanagers to:

Conduct sensitivity analysis on their own units

budgetCombine individual unit budgets to create thecompanywide master budget

Master budget models the companys plannedactivities

Must support key strategies

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Sensitivity analysis

What-if technique that determines the result ifpredicted amounts differ from those budgeted

Spreadsheet programs used for budgeting make

sensitivity analysis cost-effectiveWhat-if budget questions easily changed withinExcel with a few keystrokes

Makes it cost-effective to perform more

comprehensive sensitivity analysesManagers react quickly if key assumptionsunderlying the master budget (such as sales price orquantity) turn out to be wrong

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Individual operating units roll up budgets toprepare company-wide budget

Budget management software is used

Often part of Enterprise Resource Planning (ERP)system

Allows management to conduct sensitivityanalysis on unit data

Managers can spend less time compiling andsummarizing data and more time analyzing it

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Maplehaven Sporting Goods Store has the following sales budget:

Suppose June sales are expected to be $80,000 rather than $64,000.

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Riverbed Sporting Goods Store

Sales Budget

April - July

April May June July

April-July

Total

Cash sales, 80% $40,800 $64,000 $51,200 $40,800

Credit sales, 20% 10,200 16,000 12,800 10,200Total sales, 100% $51,000 $80,000 $64,000 $51,000 $246,000

Riverbed Sporting Goods Store

Revised Sales Budget

April - July

April May June July

April-July

Total

Cash sales, 80% $40,800 $64,000 $64,000 $40,800

Credit sales, 20% 10,200 16,000 16,000 10,200

Total sales, 100% $51,000 $80,000 $80,000 $51,000 $262,000


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Prepare performance reports for responsibilitycenters and account for traceable and common

shared fixed costs

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A system for evaluating the performance of each

responsibility center and its managerA responsibility center is the part of the organization forwhich a particular manager is responsible

Is a part of the organization for which a manager has decision-makingauthority and accountability

Four types:Cost center

Revenue center

Profit centerInvestment center

Decentralization highlights the need for reports onindividual segments

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Goal is tocontrol cost

Goal is toincrease

revenues

Goal is toincrease

profits

Goal is toincrease ROI,

EVA, &

residual

income


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Performance reports compare budgeted andactual amounts

Reporting at all levels:

Division (investment centers)

Product lines (profit centers)

Production (cost centers)

Sales (revenue centers)

Management by exceptionShows variances between actual and budgetedamounts

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Departments that provide services to multipledepartments or divisions for the company

Usually do not generate revenues

Similar to the shared production overhead

Nonproduction related service departments

Examples:Payroll and Human Resources

Accounting

Copying/Graphic Services

Physical Plant (repairs and maintenance)

Advertising (companywide, not specific products)Mail and Shipping Services

Shared Facilities (meeting rooms used by various departments)

Legal Services

Travel Booking Services50


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Costs directly associated with an individual product,

division, or business segmentWould disappear if the company discontinued the

product , division or segment

Assigning traceable fixed costs

Splitting the cost equallynot fairBased on use of the servicesfair

Small users charged less

Larger users charged more

Identify cost drivers (ABC costing) suitable forassigning traceable service department charges

Common service departments listed on next slide

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Traceable service costs = $30,000

Base is number of orders

$30,000 / $400,000 equals $0.075 cost per order

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$30,000 / $400,000 equals $0.075 cost per order

Apply to divisions based upon number of orders

The DVD division can further split the traceable costbetween Excel DVDs and Specialty DVDs

$10,500 - $3,500 known untraceable = $7,000

Calculate a cost per order as ($7,000/140,000) = $0.05

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Show the results of the segment or division for which a particularmanager is responsible

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A budgeted income statement shows estimatedamounts, whereas the income statement shows actualresults. Managers use budgets to develop strategies(overall business goals) and to create plans and follow

actions that enable them to achieve those goals. Theyalso review results against the goals (control), oftenusing a performance report that compares budgetedamounts to actual amounts.

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The master budget is the set of budgeted financialstatements and supporting schedules for the entireorganization. It contains the operating budget, thecapital expenditures budget, and the financial budget.There are many budgets that compose each of the

three types. Each budget provides a portion of theplan that maps the companys planned direction andgoals for a period of time.

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The first three components of the operating budget

include the sales budget; the inventory, purchases, andcost of goods sold budget; and the operating expensesbudget. The sales budget depicts the breakdown ofsales based on the terms of collection. The inventory,

purchases, and cost of goods sold budget aids inplanning for adequate inventory to meet sales (COGS)and for inventory purchases. The operating expenses

budget captures the planned variable and fixedoperating expenses necessary for normal operations.

The three budgets help to form the budgeted incomestatement. Together these form the operational budgetthat depicts the companys operational strategy for a

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The cash budget details how the business expects to

go from the beginning cash balance to the desiredending balance each period. The cash budget has fourmajor partscash collections from customers, cash

payments for purchases, cash payments for operating

expenses, and cash payments for capital expenditures.The results of these budgets are combined to form thecash budget. After preparing the cash budget, the restof the financial statement budgets are prepared,

including the budgeted balance sheet and budgetedstatement of cash flows. These budgets depict thefinancial plan that implements the strategic goals ofthe company.

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Sensitivity budgeting was once a time-consuming

task. Now, with technology, modifying the budgetassumptions is easy. Individual managers can easilymodify the budgets of their specific units, and thatdata is automatically updated in the companywide

budget plans. Being able to modify this data easilyallows managers to be more responsive to businesschanges and plan better; thus, better, more timelydecisions that benefit the company may be made.

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Responsibility centers are parts of the company for

which managers have decision-making authority andaccountability. Responsibility accounting is

performance reporting for those responsibility centers.There are four types of responsibility centerscost

centers, revenue centers, profit centers, andinvestment centers. Traceable fixed costs are thosecosts that would disappear if a company quit making a

particular product or discontinued a division or

segment. Common fixed costs (untraceable) are thosecosts that arent traceable to a specific product,division, or segment.

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Copyright

All rights reserved. No part of this publication may be reproduced,

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otherwise, without the prior written permission of the publisher.

Printed in the United States of America.

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