Budgeting

1
Chapter 20
Budgeting
Financial and Managerial Accounting 8th
Edition Warren Reeve Fess
2
Objectives
1. Describe budgeting, its objectives, and its
impact on human behavior. 2. Describe the basic
elements of the budget process, the two major
types of budgeting, and the use of computers in
budgeting. 3. Describe the master budget for a
manufacturing business. 4. Prepare the basic
income statement budgets for a manufacturing
business. 5. Prepare balance sheet budgets for a
manufacturing business.
3
Nature and Objectives of Budgeting
Objectives of Budgeting

• Establishing specific goals
• Executing plans to achieve the goals
• Periodically comparing actual results to the goals

PLANNING
4
Nature and Objectives of Budgeting
Human Behavior and Budgeting
Setting budget goals too tightly Setting budget
goals too loosely Setting conflicting budget goals
5
Nature and Objectives of Budgeting
Goal conflict occurs when individual
self-interest differs from business objectives.
A students question, Will this be on the test?
is evidence of goal conflict.
6
Static Budgets

• Description A budget that does not reflect
  potential changes in volume or activity level

Strength It is simpleall expenses are
budgeted as fixed costs
Weakness It does not reflect changes in
revenues and expenses that occur as volumes
change
Typical usage Service organizations or
administrative departments of retailers and
manufacturers
7
Static Budgets
Colter Manufacturing Company Assembly Department
Budget For the Month Ending July 31, 2006
Direct labor 40,000 Electric
Power 5,000 Supervisor salaries 15,000
Total department costs 60,000
8
Flexible Budgets

• Description A budget that shows revenues and
  expenses for a variety of volumes or activity
  levels
• Strength Provides information needed to analyze
  the impact of volume changes on actual operating
  results
• Weakness Requires greater research into
  costsmust differentiate fixed and variable costs
• Typical usage Operational departments of
  retailers and manufacturers whose costs change
  with sales and production

9
Flexible Budgets
Colter Manufacturing Company Assembly Department
Budget For the Month Ending July 31, 2006
Units of production 8,000 9,000 10,000

• Variable cost
• Direct labor 40,000 45,000 50,000
• Electric power 4,000 4,500 5,000
• Total variable cost 44,000 49,500 55,000
• Fixed cost
• Electric power 1,000 1,000 1,000
• Supervisor salaries 15,000 15,000 15,000
• Total fixed cost 16,000 16,000 16,000
• Total department costs 60,000 65,500
  71,000

10
Static and Flexible Budgets
Manufacturing Costs
60,000
72,000
Based on 8,000 units
Based on 10,000 units
11
Static and Flexible Budgets
Manufacturing Costs
Flexible Budget
10,000 units
60,000
72,000
65,500
71,000
12
Master Budget
Budgeted Income Statement requires
Budgeted Balance Sheet requires

• Sales budget
• Cost of goods sold budget
• Production budget
• Direct materials purchases budget
• Direct labor cost budget
• Selling and administrative expense budget

• Cash budget
• Capital expenditure budget

13
Income Statement Budgets
14
Data for Elite Accessories
Direct Materials sq yd usage per unit Direct Materials sq yd usage per unit Direct Materials sq yd usage per unit Direct Materials cost per sq yd
Wallet Handbag
Leather 0.30 1.25 4.50
Lining 0.10 0.50 1.20

Direct labour hours required per unit Direct labour hours required per unit Direct labour hours required per unit Direct labour cost per hour
Wallet Handbag
Cutting Dept 0.10 0.15 12.00
Sewing Dept 0.25 0.40 15.00
15
Sales Budget
Expected units of sales Desired units in
ending Finished goods inventory Estimated units
in beginning Finished goods inventory Total
units to be produced
16
Sales Budget
Direct Materials Purchases Budget
17
Sales Budget
Direct Materials Purchases Budget
Direct Labor Cost Budget
Factory Overhead Cost Budget
Selling Administrative Expenses Budget
18
Elite Accessories Inc. Sales Budget For the Year
Ending December 31, 2006
Unit Sales Unit Selling Total Product and
Region Volume Price Sales

• Wallet
• East.. 287,000 12.00 3,444,000
• West. 241,000 12.00 2,892,000
• Total. 528,000 6,336,000
• Handbag
• East.. 156,400 25.00 3,910,000
• West. 123,600 25.00 3,090,000
• Total. 280,000 7,000,000
• Total revenue from
• Sales.. 13,336,000

19
Elite Accessories Inc. Production Budget For the
Year Ending December 31, 2006
From Sales Budget
Units Wallet Handbag
Expected units to be sold. 528,000 280,000 Plu
s desired ending inventory, December 31,
2006. 80,000 60,000 Total. 6
08,000 340,000 Less estimated beginning
inventory, January 1, 2006. 88,000
48,000 Total units to be produced 520,000 292,
000
20
Elite Accessories Inc. Direct Materials Purchases
Budget For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production Wallet
(Note A).. 156,000 52,000
Note A Leather 520,000 units x 0.30 sq. yd.
per unit 156,000 sq. yds. Lining 520,000
units x 0.10 sq. yd. Per unit 52,000 sq. yds.
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Elite Accessories Inc. Direct Materials Purchases
Budget For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production Wallet
(Note A)...... 156,000 52,000 Handbag
(Note B).. 365,000 146,000
Note B Leather 292,000 units x 1.25 sq. yd.
per unit 365,000 sq. yds. Lining 292,000
units x 0.50 sq. yd. Per unit 146,000 sq. yds.
22
Elite Accessories Inc. Direct Materials Purchases
Budget For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production Wallet
(Note A)...... 156,000 52,000 Handbag
(Note B).. 365,000 146,000 Plus desired
inventory, Dec. 31, 2006 20,000
12,000 Total 541,000 210,000
23
Elite Accessories Inc. Direct Materials Purchases
Budget For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production Wallet
(Note A) . 156,000 52,000 Handbag (Note
B) . 365,000 146,000 Plus desired
inventory, Dec. 31, 2006 20,000
12,000 Total 541,000 210,000 Less
estimated inventory, Jan. 1, 2006 18,000
15,000 Total square yards to be
purchased.. 523,000 195,000
24
Elite Accessories Inc. Direct Materials Purchases
Budget For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production Wallet
(Note A).. 156,000 52,000 Handbag (Note
B).. 365,000 146,000 Plus desired
inventory, Dec. 31, 2006 20,000
12,000 Total 541,000 210,000 Less
estimated inventory, Jan. 1, 2006 18,000
15,000 Total square yards to be
purchased 523,000 195,000 Unit price (per square
yard). x 4.50 x 1.20 Total value
of materials to be purchased. 2,353,500 234,000
2,587,500
25
Elite Accessories Inc. Direct Labor Cost
Budget For the Year Ending December 31, 2006
Cutting Sewing Total
Hours required for production Wallet (Note
A). 52,000 130,000
Note A Cutting Department 520,000 units x
0.10 hr. per unit 52,000 hrs. Sewing
Department 520,000 units x 0.25 hr. per unit
130,000 hrs.
26
Elite Accessories Inc. Direct Labor Cost
Budget For the Year Ending December 31, 2006
Cutting Sewing Total
Hours required for production Wallet (Note
A). 52,000 130,000 Handbag (Note B)..
43,800 116,800
Note A Cutting Department 520,000 units x
0.10 hr. per unit 52,000 hrs. Sewing
Department 520,000 units x 0.25 hr. per unit
130,000 hrs.
. Note B Cutting Department 292,000
units x 0.15 hr. per unit 43,800 hrs. Sewing
Department 292,000 units x 0.40 hr. per unit
116,800 hrs
27
Elite Accessories Inc. Direct Labor Cost
Budget For the Year Ending December 31, 2006
Cutting Sewing Total
Hours required for production Wallet (Note
A). 52,000 130,000 Handbag (Note B)..
43,800 116,800 Total...
95,800 246,800
28
Elite Accessories Inc. Direct Labor Cost
Budget For the Year Ending December 31, 2006
Cutting Sewing Total
Hours required for production Wallet (Note
A). 52,000 130,000 Handbag (Note B)..
43,800 116,800 Total...
95,800 246,800 Hourly rate x 12.00 x
15.00 Total direct labor cost 1,149,600
3,702,000 4,851,600
Note A Cutting Department 520,000 units x
0.10 hr. per unit 52,000 hrs. Sewing
Department 520,000 units x 0.25 hr. per unit
130,000 hrs. Note B Cutting Department
520,000 units x 0.15 hr. per unit 43,800
hrs. Sewing Department 520,000 units x 0.40
hr. per unit 116,800 hrs
29
Elite Accessories Inc. Factory Overhead Cost
Budget For the Year Ending December 31, 2006

• Indirect factory wages... 732,800
• Supervisory salaries... 360,000
• Power and light.. 306,000
• Depreciation of plant and equipment
  288,000
• Indirect materials 182,800
• Maintenance. 140,280
• Insurance and property taxes. 79,200
• Total factory overhead cost .. 2,089,080

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Data for Elite Accessories contd
Estimated Inventories Estimated Inventories Estimated Inventories
January 1, 2006 December 31, 2006
Finished Goods 1,095,600 1,565,000
Work in Process 214,400 220,000
31
Elite Accessories Inc. Cost of Goods Sold
Budget For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006..
1,095,600 Work in process inventory, January 1,
2006 214,400 Direct materials Direct
materials inventory, January 1, 2006 (Note
A). 99,000
Note A Leather 18,000 sq. yds. x 4.50 per sq.
yd 81,000 Lining 15,000 sq. yds. x 1.20 per
sq. yd 18,000 Direct materials
inventory, January 1, 2006 99,000
32
Elite Accessories Inc. Cost of Goods Sold
Budget For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006..
1,095,600 Work in process inventory, January 1,
2006 214,400 Direct materials Direct
materials inventory, January 1, 2006 (Note
A). 99,000
Note B Leather 20,000 sq. yds. x 4.50 per sq.
yd 90,000 Lining 12,000 sq. yds. x 1.20 per
sq. yd 14,400 Direct materials inventory,
December 31, 2006 104,400
33
Elite Accessories Inc. Cost of Goods Sold Budget
Finished goods inventory, January 1 ,2006.
1,095,600 Work in process inventory, January 1,
2006... 214,400 Direct materials Direct
materials inventory, January 1, 2006 (Note
A). 99,000 Direct materials
purchases (Slide 24).. 2,587,500 Cost of
direct materials available for use. 2,686,500 L
ess direct materials inventory, December 31,
2006 (Note B). 104,400
Cost of direct materials placed in
production 2,582,100 Direct labor (Slide
28). 4,851,600 Factory overhead (Slide
29).. 2,089,080 Total manufacturing
costs. 9,522,780 Total work in process
during period. 9,737,180
Less work in process inventory, December 31,
2006 220,000 Cost of goods
manufactured... 9,517,180 Cost of
finished goods available for sale... 10,612
,780 Less finished goods inventory, December 31,
2006.. 1,565,000 Cost of goods
sold.. 9,047,780
34
Elite Accessories Inc. Selling and Administrative
Expenses Budget For the Year Ending December 31,
2006
Selling expenses Sales salaries
expense. 715,000 Advertising
expense... 360,000 Travel
expense. 115,000 Total selling
expenses... 1,190,000 Administrative
expenses Officers salaries expense. 3
60,000 Office salaries expense. 258,000
Office rent expense... 34,500 Office
supplies expense. 17,500 Miscellaneous
administrative expense.. 25,000 Total
administrative expenses
695,000 Total selling and administrative
expenses 1,885,000
35
Elite Accessories Inc. Budgeted Income
Statement For the Year Ending December 31, 2006

• Revenue from sales (slide 18) 13,336,000
• Cost of goods sold (slide 33) 9,047,780
• Gross profit 4,288,220
• Selling administrative expenses
• Selling expenses (slide 34) 1,190,000
• Administrative expenses (slide 34) 695,000
• Total sell. Admin. Expenses 1,885,000
• Income from operations 2,403,220
• Other income
• Interest revenue
  98,000
• Other expense
• Interest expense 90,000 8,000
• Income before income tax 2,411,220
• Income tax 600,000
• Net income 1,811,220

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Budgeted Balance Sheet
The cash budget is one of the most important
elements of the budgeted balance sheet. Well
begin with a schedule of collection from sales.
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Data for Elite Accessories contd
Account Receivable, January 1, 2006 370,000 Account Receivable, January 1, 2006 370,000 Account Receivable, January 1, 2006 370,000 Account Receivable, January 1, 2006 370,000 Account Receivable, January 1, 2006 370,000 Account Receivable, January 1, 2006 370,000
January January February February March
Budgeted Sales 1,080,000 1,080,000 1,240,000 1,240,000 970,000
10 of each months sales are cash sales, while 90 are credit sales. Of the credit sales, 60 are collected during the current month while the other 40 are collected during the following month 10 of each months sales are cash sales, while 90 are credit sales. Of the credit sales, 60 are collected during the current month while the other 40 are collected during the following month 10 of each months sales are cash sales, while 90 are credit sales. Of the credit sales, 60 are collected during the current month while the other 40 are collected during the following month 10 of each months sales are cash sales, while 90 are credit sales. Of the credit sales, 60 are collected during the current month while the other 40 are collected during the following month 10 of each months sales are cash sales, while 90 are credit sales. Of the credit sales, 60 are collected during the current month while the other 40 are collected during the following month 10 of each months sales are cash sales, while 90 are credit sales. Of the credit sales, 60 are collected during the current month while the other 40 are collected during the following month
Accounts Payable, January 1, 2006 190,000 Accounts Payable, January 1, 2006 190,000 Accounts Payable, January 1, 2006 190,000 Accounts Payable, January 1, 2006 190,000 Accounts Payable, January 1, 2006 190,000 Accounts Payable, January 1, 2006 190,000
January January February March
Manufacturing Costs Manufacturing Costs 840,000 840,000 780,000 812,000
Depreciation of 24,000 is a non-cash manufacturing cost. Of the cash manufacturing costs, 75 are paid in the current month while 25 are paid in the following month Depreciation of 24,000 is a non-cash manufacturing cost. Of the cash manufacturing costs, 75 are paid in the current month while 25 are paid in the following month Depreciation of 24,000 is a non-cash manufacturing cost. Of the cash manufacturing costs, 75 are paid in the current month while 25 are paid in the following month Depreciation of 24,000 is a non-cash manufacturing cost. Of the cash manufacturing costs, 75 are paid in the current month while 25 are paid in the following month Depreciation of 24,000 is a non-cash manufacturing cost. Of the cash manufacturing costs, 75 are paid in the current month while 25 are paid in the following month Depreciation of 24,000 is a non-cash manufacturing cost. Of the cash manufacturing costs, 75 are paid in the current month while 25 are paid in the following month
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Data for Elite Accessories contd
Cash balance on January 1, 2006 280,000
Quarterly Taxes paid on March 31 150,000
Quarterly interest expense paid on Jan 10 22,500
Quarterly interest revenue received on Mar 21 24,500
Sewing equipment purchased in Feb 274,000
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Elite Accessories Inc. Schedule of Collections
from Sales For the Three Months Ending March 31,
2006
January February March
Receipts from cash sales Cash sales (10)(see
Note A)... 108,000 124,000
97,000
Note A 108,000 1,080,000 x 10 124,000
1,240,000 x 10 97,000 970,000 x 10
40
Elite Accessories Inc. Schedule of Collections
from Sales For the Three Months Ending March 31,
2006
January February March
Receipts from cash sales Cash sales (10)(see
Note A)... 108,000 124,000
97,000 Receipts from sales on account Collection
s from prior months sales (40)(see Note
B). 370,000 388,800 446,400
Note B 370,000, given as January 1, 2006
Accounts Receivable balance 388,800
1,080,000 x 90 x 40 446,400 1,240,000 x
90 x 40
41
Elite Accessories Inc. Schedule of Collections
from Sales For the Three Months Ending March 31,
2006
January February March
Receipts from cash sales Cash sales (10)(see
Note A)... 108,000 124,000
97,000 Receipts from sales on account Collection
s from prior months sales (40)(see Note
B). 370,000 388,800 446,400 Collections
from current months sales (60)(see
Note C) 583,200 669,600
523,800
Note C 583,200 1,080,000 x 90 x
60 669,600 1,240,000 x 90 x 60 523,800
970,000 x 90 x 60
42
Elite Accessories Inc. Schedule of Collections
from Sales For the Three Months Ending March 31,
2006
January February March
Receipts from cash sales Cash sales (10)(see
Note A)... 108,000 124,000
97,000 Receipts from sales on account Collection
s from prior months sales (40)(see Note
B). 370,000 388,800 446,400 Collections
from current months sales (60)(see
Note C) 583,200 669,600
523,800 Total receipts from sales on
account... 953,200 1,058,400 970,200
43
Elite Accessories Inc. Schedule of Payments for
Manufacturing Costs For the Three Months Ending
March 31, 2006
January February March
Payment of prior months manufacturing costs
(25) (see Note A) 190,000 204,000 18
9,000
Note A 190,000, given as January 1, 2006
Accounts Payable balance 204,000
(840,000 24,000) x 25 189,000 (780,000
24,000) x 25
44
Elite Accessories Inc. Schedule of Payments for
Manufacturing Costs For the Three Months Ending
March 31, 2006
January February March
Payment of prior months manufacturing costs
(25) (see Note A) 190,000 204,000 18
9,000 Payment of current months manufacturing
costs (75) (see Note B). 612,000
567,000 591,000
Note B 612,000 (840,000 24,000) x
75 567,000 (780,000 24,000) x
75 591,000 (812,000 24,000) x 75
45
Elite Accessories Inc. Schedule of Payments for
Manufacturing Costs For the Three Months Ending
March 31, 2006
January February March
Payment of prior months manufacturing costs
(25) (see Note A) 190,000 204,000 18
9,000 Payment of current months manufacturing
costs (75) (see Note B). 612,000
567,000 591,000 Total payments. 802,000
771,000 780,000
46
Elite Accessories Inc. Cash Budget For the Three
Months Ending March 31, 2006
January February March
Estimated cash receipts Cash sales (Slide
42).. 108,000 124,000
97,000 Collections of accounts receivable
(Slide 42)... 953,200 1,058,400 970,200 Intere
st revenue...
24,500 Total cash
receipts. 1,061,200 1,182,400 1,091,700
Estimated cash payments for Manufacturing costs
(Slide 45).. 802,000 771,000
780,000 Selling and administrative
expenses 160,000 165,000 145,000 Ca
pital additions 274,000 Interest
expense 22,500 Income taxes 150,000 Total
cash payments. 984,500 1,210,000 1,075,0
00
47
Elite Accessories Inc. Cash Budget For the Three
Months Ending March 31, 2006
January February March
Total cash receipts. 1,061,200 1,182
,400 1,091,700
Estimated cash payments for Manufacturing costs
(Slide 45).. 802,000 771,000
780,000 Selling and administrative
expenses 160,000 165,000 145,000 Ca
pital additions 274,000 Interest
expense 22,500 Income taxes 150,000 Total
cash payments. 984,500 1,210,000 1,075,0
00
Cash increase (decrease). 76,700
(27,600) 16,700 Cash balance at beginning
of month 280,000 356,700
329,100 Cash balance at end of month.
356,700 329,100 345,800 Minimum cash
balance 340,000 340,000
340,000 Excess (deficiency).
16,700 (10,900) 5,800
48
Software
Spreadsheet software for personal computers is a
powerful and flexible tool for budgeting.
Sensitivity analysis is the systematic varying of
budget data input to determine the effects of
each change on the budget.
Class Example