Chapter 9

Profit Planning and Activity-Based Budgeting

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Purposes of Budgeting Systems

Budget Budget a detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time.
1. Planning 2. Facilitating Communication and Coordination 3. Allocating Resources 4. Controlling Profit and Operations 5. Evaluating Performance and Providing Incentives
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Types of Budgets
Detail Budget Detail Budget
Materials

Master Budget
Covering all phases of a companys operations.

Detail Budget
Sales

Production

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Types of Budgets
Income Statement

Budgeted Financial Statements Balance Sheet Statement of Cash Flows

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Sales of Services or Goods Ending Inventory Budget Production Budget

Work in Process and Finished Goods

Direct Materials

Ending Inventory Budget

Direct Materials Budget

Direct Labor Budget

Overhead Budget

Selling and Administrative Budget

Cash Budget Budgeted Balance Sheet Budgeted Statement of Cash Flows

Budgeted Income Statement

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Activity-Based Costing versus Activity-Based Budgeting

Resources Resources
Activity-Based Activity-Based Costing (ABC) Costing (ABC)

Resources Resources

Activities Activities

Activities Activities
Activity-Based Activity-Based Budgeting (ABB) Budgeting (ABB)

Cost objects: Cost objects: products and services products and services produced, and produced, and customers served. customers served.

Forecast of products Forecast of products and services to be and services to be produced and produced and customers served. customers served.
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Sales Budget
Breakers, Inc. is preparing budgets for the quarter Breakers, Inc. is preparing budgets for the quarter ending June 30. ending June 30. Budgeted sales for the next five months are: Budgeted sales for the next five months are: April 20,000 units April 20,000 units May 50,000 units May 50,000 units June 30,000 units June 30,000 units July 25,000 units July 25,000 units August 15,000 units. August 15,000 units. The selling price is $10 per unit. The selling price is $10 per unit.
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Sales Budget
April Budgeted sales (units) Selling price per unit T otal Rev enue May June Quarter

20,000 $ 10 $

50,000 10 $

30,000 10 $

100,000 10

$ 200,000

$ 500,000

$ 300,000

$ 1,000,000

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Production Budget
The management of Breakers, Inc. wants ending The management of Breakers, Inc. wants ending inventory to be equal to 20% of the following inventory to be equal to 20% of the following months budgeted sales in units. months budgeted sales in units. On March 31, 4,000 units were on hand. On March 31, 4,000 units were on hand. Lets prepare the production budget. Lets prepare the production budget.

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From sales budget

Production Budget
April 20,000 10,000 30,000 4,000 26,000 May 50,000 6,000 56,000 10,000 46,000 June 30,000 Quarter 100,000

Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be produced

5,000 5,000 Ending inventory becomes 35,000 105,000 beginning inventory the next month 6,000 29,000 4,000 101,000

March 31 ending inventory

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Direct-Material Budget
At Breakers, five pounds of material are required At Breakers, five pounds of material are required per unit of product. per unit of product. Management wants materials on hand at the end Management wants materials on hand at the end of each month equal to 10% of the following of each month equal to 10% of the following months production. months production. On March 31, 13,000 pounds of material are on On March 31, 13,000 pounds of material are on hand. Material cost $.40 per pound. hand. Material cost $.40 per pound. Lets prepare the direct materials budget. Lets prepare the direct materials budget.
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From our production budget

Direct-Material Budget

10% of the following months production

March 31 inventory
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Direct-Material Budget
July Production Sales in units Add: desired ending inventory Total units needed Less: beginning inventory Production in units 25,000 3,000 28,000 5,000 23,000

June Ending Inventory July production in units 23,000 Materials per unit 5 Total units needed 115,000 Inventory percentage 10% June desired ending inventory 11,500

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Direct-Labor Budget
At Breakers, each unit of product requires 0.1 hours of direct labor. 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 $8 per hour regardless of the hours worked (No overtime pay). For the next three months, the direct labor workforce will be paid for a minimum of 3,000 hours per month. Lets prepare the direct labor budget.
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Direct-Labor Budget

From our production budget

This is the greater of labor hours required or labor hours guaranteed.

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Overhead Budget
Here is Breakers Overhead Budget for the quarter.

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Selling and Administrative Expense Budget

At Breakers, variable selling and administrative At Breakers, variable selling and administrative expenses are $0.50 per unit sold. expenses are $0.50 per unit sold. Fixed selling and administrative expenses are Fixed selling and administrative expenses are $70,000 per month. $70,000 per month. The $70,000 fixed expenses include $10,000 in The $70,000 fixed expenses include $10,000 in depreciation expense that does not require a cash depreciation expense that does not require a cash outflows for the month. outflows for the month.

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Selling and Administrative Expense Budget

From our Sales budget

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Cash Receipts Budget

At Breakers, all sales are on account. At Breakers, all sales are on account. The companys collection pattern is: The companys collection pattern is: 70% collected in the month of sale, 70% collected in the month of sale, 25% collected in the month following sale, 25% collected in the month following sale, 5% is uncollected. 5% is uncollected. The March 31 accounts receivable balance of The March 31 accounts receivable balance of $30,000 will be collected in full. $30,000 will be collected in full.

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Cash Receipts Budget

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Cash Disbursement Budget

Breakers pays $0.40 per pound for its materials. Breakers pays $0.40 per pound for its materials. One-half of a months purchases are paid for in the One-half of a months purchases are paid for in the month of purchase; the other half is paid in the month of purchase; the other half is paid in the following month. following month. No discounts are available. No discounts are available. The March 31 accounts payable balance is The March 31 accounts payable balance is $12,000. $12,000.

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Cash Disbursement Budget

140,000 lbs. $.40/lb. = $56,000

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Cash Disbursement Budget

Breakers: Breakers: Maintains a 12% open line of credit for $75,000. Maintains a 12% open line of credit for $75,000. Maintains a minimum cash balance of $30,000. Maintains a minimum cash balance of $30,000. Borrows and repays loans on the last day of the Borrows and repays loans on the last day of the month. month. Pays a cash dividend of $25,000 in April. Pays a cash dividend of $25,000 in April. Purchases $143,700 of equipment in May and Purchases $143,700 of equipment in May and $48,300 in June paid in cash. $48,300 in June paid in cash. Has an April 1 cash balance of $40,000. Has an April 1 cash balance of $40,000.
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From our Cash Receipts Budget

(Collections and Disbursements)

From our Cash Disbursements Budget From our Direct Labor Budget From our Overhead Budget From our Selling and Administrative Expense Budget

Cash Budget

To maintain a cash balance of $30,000, Breakers must borrow $35,000 on its line of credit.
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(Collections and Disbursements)

Cash Budget

Breakers must borrow an addition $13,800 to maintain a cash balance of $30,000.

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(Collections and Disbursements) At the end of June, Breakers has enough cash to repay the $48,800 loan plus interest at 12%.

Cash Budget

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(Collections and Disbursements)

Cash Budget

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Ending cash balance for April is the beginning May balance.

(Financing and Repayment)

Cash Budget

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Cost of Goods Manufactured

April Direct material: Beg.material inventory Add: Materials purchases Material available for use Deduct: End. material inventory Direct material used Direct labor Manufacturing overhead Total manufacturing costs Add: Beg. Work-in-process inventory Subtotal Deduct: End.Work-in-process inventory Cost of goods manufactured $ 5,200 56,000 61,200 9,200 52,000 24,000 56,000 132,000 3,800 135,800 16,200 $ 119,600 $ May 9,200 88,600 97,800 5,800 92,000 36,800 76,000 204,800 16,200 221,000 9,400 $ 211,600 $ June 5,800 56,800 62,600 4,600 58,000 24,000 59,000 141,000 9,400 150,400 17,000 $ 133,400 Quarter $ 5,200 201,400 206,600 4,600 202,000 84,800 191,000 477,800 3,800 481,600 17,000 $ 464,600

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Cost of Goods Sold

April May Cost of goods manufactured $ 119,600 $ 211,600 $ Add: Beg. finished-goods inventory 18,400 46,000 Cost of goods available for sale 138,000 257,600 Deduct: End. finished-goods inventory 46,000 27,600 Cost of goods sold $ 92,000 $ 230,000 $ June Quarter 133,400 $ 464,600 27,600 18,400 161,000 483,000 23,000 23,000 138,000 $ 460,000

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Budgeted Income Statement

Breakers, Inc. Budgeted Income Statement For the Three Months Ended June 30 Revenue (100,000 $10) Cost of goods sold Gross margin Operating expenses: Selling and admin. expenses Interest expense Total operating expenses Net income $ 1,000,000 460,000 540,000 $ 260,000 838 $ 260,838 279,162

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Budgeted Balance Sheet

Breakers reports the following account balances Breakers reports the following account balances on June 30 prior to preparing its budgeted on June 30 prior to preparing its budgeted financial statements: financial statements: Land -- $50,000 Land $50,000 Building (net) -- $148,000 Building (net) $148,000 Common stock -- $217,000 Common stock $217,000 Retained earnings -- $46,400 Retained earnings $46,400

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25%of June sales of $300,000 11,500 lbs. at $.40 per lb. 5,000 units at $4.60 per unit. 50% of June purchases of $56,800

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Budget Administration
The Budget Committee is a standing committee responsible for . . .
overall policy matters relating to the budget. overall policy matters relating to the budget. q coordinating the preparation of the budget. q coordinating the preparation of the budget.
q q

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International Aspects of Budgeting

Firms with international operations face special problems Firms with international operations face special problems when preparing a budget. when preparing a budget. 1. Fluctuations in foreign currency exchange 1. Fluctuations in foreign currency exchange
2. 2. 3. 3.

rates. rates. High inflation rates in some foreign countries. High inflation rates in some foreign countries. Differences in local economic conditions. Differences in local economic conditions.

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Behavioral Impact of Budgets

Budgetary Slack: Padding the Budget
People often perceive that their performance will look better in their superiors eyes if they can beat the budget.

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Participative Budgeting
T M o p M a n a g e m M e n t

M S

i d d l e a n a g e m

e n t M

i d d l e a n a g e m

e n

u p e r v Si s u o p r e r v Si s u o p r e r v Si s u o p r e r v i s

Flow of Budget Data

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End of Chapter 9

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