Profit Planning

1
Profit Planning
2
LEARNING OBJECTIVES
After studying this chapter, you should be able
to

• 1. Understand why organizations budget and the
  processes they use to create budgets.
• 2. Prepare the various steps in a master budget.
• 3. Describe variations in the master budget
  process when applying it to not-for-profit and
  activity-based situations.

3
The Basic Framework of Budgeting
4
Planning and Control

• Planning -- involves developing objectives and
  preparing various budgets to achieve these
  objectives.

• Control -- involves the steps taken by management
  that attempt to ensure the objectives are
  attained.

5
Advantages of Budgeting
Define goal and objectives
Communicating plans
Think about and plan for the future
Advantages
Means of allocating resources
Coordinate activities
Uncover potential bottlenecks
6
Responsibility Accounting

• Managers should be held responsible for those
  items and only those items thatthe manager
  can actually controlto a significant extent.

7
Choosing the Budget Period
Operating Budget
2004
2005
2006
2006
The annual operating budget may be divided into
quarterly or monthly budgets.
8
Choosing the Budget Period
Continuous or Perpetual Budget
2004
2005
2006
2007
This budget is usually a 12-month budget that
rolls forward one month as the current month is
completed.
9
Participative Budget System
Flow of Budget Data
10
Zero-Base Budgeting

• Managers are required to justify all budgeted
  expenditures, not just changes in the budget from
  the previous year. The baseline is zero rather
  than last years budget.

11
The Budget Committee

• A standing committee responsible for
• overall policy matters relating to the budget
• coordinating the preparation of the budget

12
The Master Budget
Selling and Administrative Budget
13
The Master Budget
Ending Inventory Budget
Selling and Administrative Budget
Production Budget
Direct Materials Budget
Direct Labour Budget
Manufacturing Overhead Budget
14
The Master Budget
Ending Inventory Budget
Selling and Administrative Budget
Production Budget
Direct Materials Budget
Direct Labour Budget
Manufacturing Overhead Budget
Cash Budget
Budgeted Financial Statements
15
The Sales Budget

• Detailed schedule showing expected sales for
  the coming periods expressed in units and dollars.

16
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.

17
The Sales Budget
18
The Sales Budget
19
Expected Cash Collections

• All sales are on account.
• Royals collection pattern is
• 70 collected in the month of sale,
• 25 collected in the month following sale,
• 5 is uncollectible.
• The March 31 accounts receivable balance of
  30,000 will be collected in full.

20
Expected Cash Collections
21
Expected Cash Collections
From sales budget
22
Expected Cash Collections
23
Expected Cash Collections
24
The Production Budget
Production must be adequate to meet
budgeted sales and provide for sufficient ending
inventory.
25
The Production Budget

• Royal Company wants ending inventory to be equal
  to 20 of the following months budgeted sales in
  units.
• On March 31, 4,000 units were on hand.
• Lets prepare the production budget.

26
The Production Budget
Budgeted sales 50,000 Desired percent
20 Desired inventory 10,000
27
The Production Budget
March 31 ending inventory
28
The Production Budget
20
29
The Production Budget
30
The Production Budget
31
The Direct Materials Budget

• At Royal Company, five kilograms 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 months
  production.
• On March 31, 13,000 kilograms of material are on
  hand. Material cost is 0.40 per kilogram.
  Lets prepare the direct materials budget.

32
The Direct Materials Budget
From production budget
33
The Direct Materials Budget
34
The Direct Materials Budget
10 of the following months production
35
The Direct Materials Budget
March 31 inventory
36
The Direct Materials Budget
37
The Direct Materials Budget
38
Expected Cash Disbursement for Materials

• Royal pays 0.40 per kilogram for its materials.
• One-half of a months purchases are 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.
• Lets calculate expected cash disbursements.

39
Expected Cash Disbursement for Materials
40
Expected Cash Disbursement for Materials
140,000 kgs. .40/kg. 56,000
41
Expected Cash Disbursement for Materials
42
Expected Cash Disbursement for Materials
43
The Direct Labour Budget

• At Royal, each unit of product requires 0.05
  hours of direct labour.
• The Company has a no layoff policy so all
  employees will be paid for 40 hours of work each
  week.
• In exchange for the no layoff policy, workers
  agreed to a wage rate of 10 per hour regardless
  of the hours worked (No overtime pay).
• For the next three months, the direct labour
  workforce will be paid for a minimum of 1,500
  hours per month.
• Lets prepare the direct labour budget.

44
The Direct Labour Budget
From production budget
45
The Direct Labour Budget
46
The Direct Labour Budget
Higher of labour hours required or labour hours
guaranteed.
47
The Direct Labour Budget
48
Manufacturing Overhead Budget

• Royal Company uses a variable manufacturing
  overhead rate of 1 per unit produced.
• Fixed manufacturing overhead is 50,000 per month
  and includes 20,000 of non-cash costs (primarily
  depreciation of plant assets).
• Lets prepare the manufacturing overhead budget.

49
Manufacturing Overhead Budget
From production budget
50
Manufacturing Overhead Budget
51
Manufacturing Overhead Budget
Depreciation is a non-cash charge.
52
Ending Finished Goods Inventory Budget

• Now, Royal can complete the ending finished goods
  inventory budget.
• At Royal, manufacturing overhead is applied to
  units of product on the basis of direct labour
  hours.
• Lets calculate ending finished goods inventory.

53
Ending Finished Goods Inventory Budget
Direct materials budget and information
54
Ending Finished Goods Inventory Budget
Direct labour budget
55
Ending Finished Goods Inventory Budget
56
Ending Finished Goods Inventory Budget
Production Budget
57
Selling and Administrative Expense Budget

• At Royal, 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.
• Lets prepare the companys selling and
  administrative expense budget.

58
Selling and Administrative Expense Budget
59
Selling and Administrative Expense Budget
60
The Cash Budget

• 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 paid in cash.
• Has an April 1 cash balance of 40,000.

61
The Cash Budget
Schedule of Expected Cash Disbursements
Schedule of Expected Cash Collections
62
The Cash Budget
Direct Labour Budget
Manufacturing Overhead Budget
Selling and Administrative Expense Budget
63
The Cash Budget
Because Royal maintains a cash balance of
30,000, the company must borrow on
its line-of-credit.
64
Financing and Repayment
Ending cash balance for April is the beginning
May balance.
65
The Cash Budget
66
Financing and Repayment
Because the ending cash balance is exactly
30,000, Royal will not repay the loan this month.
67
The Cash Budget
68
The Cash Budget
At the end of June, Royal has enough cash to
repay the 50,000 loan plus interest at 16.
69
Financing and Repayment
50,000 16 3/12 2,000Borrowings on April
1 andrepayment of June 30.
70
The Budgeted Income Statement
Completed
After we complete the cash budget, we can prepare
the budgeted income statement for Royal.
71
The Budgeted Income Statement
72
The Budgeted Balance Sheet

• Royal reported the following account balances on
  June 30 prior to preparing
• its budgeted financial statements
• Land - 50,000
• Building (net) - 175,000
• Common stock - 200,000
• Retained earnings - 146,150

73
25of June sales of 300,000
11,500 kg at 0.40/kg
5,000 units at 4.99 each
50 of June purchases of 56,800
74
(No Transcript)
75
Budgeting for Not-for-Profit Entities

• Often no relationship between revenues expected
  to be received (e.g., donations) and expenditures
  expected to be incurred.
• Budgets can be prepared either on an expenditure
  basis or on a program basis.

76
Activity-Based Budgeting

• Emphasis is placed in budgeting the costs of
  activities needed to produce and market the
  firms goods and services.

77
International Aspects of Budgeting

• Multinational companies face special problems
  when preparing a budget.
• Fluctuations in foreign currency exchange rates.
• High inflation rates in some foreign countries.
• Differences in local economic conditions.
• Local governmental policies.

78
End of Chapter 9