PROFIT

PLANNING/
BUDGETING

ACC 2203 Review Workshop

Sindhu Bala

BUDGETING
DEFINITIONS

Master Budget a comprehensive plan of all aspects of a firms future

business and production operations
Master budget comprises of many separate budgets. These budgets
include:
Sales Budget forecasts future sales quantities, selling prices, and
sales revenues
Production Budget shows the number of units of each good expected
to be produced
Budgeted Manufacturing Costs prediction of the amounts and
costs of each input required to manufacture expected production
quantities
Direct Materials Budget
Direct Labor Budget
Manufacturing Overhead Budget
Selling and Administrative Expense Budget prediction of all
selling costs required for attaining forecasted sales levels; prediction of
administrative costs
Budgeted Income Statement
Capital Expenditure Budget
Cash Budget
Budgeted Balance Sheet

BUDGETING
DEFINITIONS

All firms make plans and decisions, such as

Deciding what to produce and how much to produce (production
capacity)
Deciding what inputs and how much of each input to use
Deciding what prices to charge and what type of a marketing strategy to
pursue
Budgets allow firms to see the impact of their decisions and plans and to
improve on their decisions and plans (planning function of budgets).
Firms that systematically prepare budgets can:

See projected earnings and cash flows from the plans

Detect potential problems before they occur
Line-up additional financing that may be needed
Coordinate actions of different division within the firm
Budgets set benchmarks for evaluating subsequent performance (control
function of budgeting)

THE MASTER BUDGET: AN

OVERVIEW
Ending
Finished
Goods
Budget

Direct
Materials
Budget

Sales
Budget

Production
Budget

Selling and
Administrative
Budget

Direct
Labor
Budget

Manufacturing
Overhead
Budget

Cash
Budget

Budgeted Financial Statements

MASTER BUDGET FOR A

SAMPLE COMPANY

The Foster Company is a manufacturer of cashmere

sweaters. Each year in October, Foster put together its
Master Budget for the four quarters of the following
year.
SALES BUDGET predicts sales quantities and
selling prices to determine the amount of sales revenue
the company expects to generate
What factors do companies take into account when they
decide how many units they can sell and what price to
charge for each unit?
Customers tastes
Production and advertising strategies
Competitors
Production capacity
Changes in the economy

FOSTER COMPANY - SALES

BUDGET
The Foster Company has predicted that it can maximize its profits if it
charges $200 for its sweaters. The marketing manager of the
company has indicated that at a price of $200 the company can sell
1,000 sweaters in the first quarter of 2007. Due to an emerging
trend observed in fashion houses toward using cashmere sweaters in
their creations, the marketing manager predicts to increase its sales
by 100 sweaters each quarter.

FOSTER COMPANY COLLECTIONS BUDGET

SCHEDULE OF EXPECTED CASH COLLECTIONS
when do we expect to receive cash for the sales we
have made?
Cash collection information:
1.
Of all sales 80% are on credit
2.
70% of credit sales are collected in the quarter in
which the sale is made and 30% are collected in the
following quarter
3.
Accounts receivable is estimated to be $60,000 on
December 31, 2006; the company expects to collect
the outstanding receivables in the first quarter of
2007

FOSTER COMPANY COLLECTIONS BUDGET

FOSTER COMPANY PRODUCTION BUDGET

PRODUCTION BUDGET predicts the number
of units the firm plans to produce during the
budget period.
Finished Goods Inventory
Beginning F.G Inventory
Units Produced
Ending F.G Inventory

Units Sold

FOSTER COMPANY PRODUCTION BUDGET

Note that the number of units a firm plans to
produce many not equal the number of units it
plans to sell. Explain why?

FOSTER COMPANY PRODUCTION BUDGET

Foster maintains at the end of each quarter an inventory of
10% of the next quarters sales. This allows the company to
better meet its customers needs in case the customers
experience a sudden surge in demand.

FOSTER COMPANY
MANUFACTURING COSTS

BUDGETED MANUFACTURING COSTS Estimated amounts and costs

of inputs necessary to produce the budgeted production quantities
Companies estimate the amounts and costs of DL, DM, and OH they expect
to use to make one unit of a product. These estimates are called standard
quantity of input and standard cost of input (per unit of output).
Direct Materials (cashmere): Foster expects to use on average lb. of
cashmere to make one sweater. Expected price for a pound of raw
cashmere is $30.
Direct Labor: Although somewhat automated, dying, combing, knitting,
and weaving cashmere is a tedious process that requires some direct labor.
Each sweater on average requires 1 hour of skilled labor. Foster pays its
skilled workers $20/hour.
Variable Overhead: Foster expects to incur $1 per machine hour for
indirect materials such as lubricants and cooling fluids, $1.5 per machine
hour for utilities, and $2.5 per machine hour for indirect labor. On average
it takes 2 hours of machine time to make one cashmere sweater (primarily
due to the delicate nature of cashmere and the attention it requires)

FOSTER COMPANY
MANUFACTURING COSTS
Fixed Overhead: Foster expects to incur $69,600 in machine depreciation,
$60,000 in factory supervisor salary, and $56,000 in factory rent and
insurance. Foster allocates OH on the basis of machine hours.
FOH =
FOH Rate =

FOSTER COMPANY BUDGETED

COSTS

FOSTER COMPANY DM BUDGET

DIRECT MATERIALS BUDGET Estimated
amounts and costs of direct materials that need to be
purchased to manufacture the budgeted units and to
maintain a materials inventory
Materials Inventory
Beginning Inventory

Materials used in production

Materials Purchased
Ending Inventory

Foster keeps at the beginning of each quarter a materials

inventory of 10% of the quarters raw materials needs.

FOSTER COMPANY DM BUDGET

FOSTER COMPANY CASH

DISBURSEMENTS
SCHEDULE OF EXPECTED CASH
DISBURSEMENTS FOR MATERIALS
shows the amount and timing of cash payments
the firm has to make to its suppliers.
Cash Disbursement Information:
1. Direct materials are all purchased on credit
2. Foster usually pays 60% of its purchases in the
same quarter as the purchase and the rest is
paid in the following quarter
3. The company expects to have an accounts
payable balance of $40,000 on December 31,
2002; and all outstanding payables are expected
to be paid in the first quarter of 2007

FOSTER COMPANY CASH

DISBURSEMENTS

FOSTER COMPANY DL BUDGET

DIRECT LABOR BUDGET provides an
estimate of the amount and cost of direct labor
time required to fulfill the budgeted production
Each cashmere sweater requires 1 hour of skilled
labor. Foster pays its skilled workers $20/hour.

FOSTER COMPANY DL BUDGET

FOSTER COMPANY MOH BUDGET

MANUFACTURING OVERHEAD BUDGET - provides an
estimate of the cost of variable and fixed overhead required to
fulfill the budgeted production
Variable overhead rate is $5 per machine hour (costs of indirect
materials, utilities, and indirect labor combined). Foster
expects to use 2 MHs per unit.
Fixed overhead cost is $185,600 ($69,600 in machine

depreciation, $60,000 in factory supervisor salary, and

$56,000 in factory rent and insurance combined). Fixed
overhead is allocated on the basis of machine hours at a
predetermined OH rate of $20/MH.

Fixed OH rate for cash items:

FOH rate =
Fixed OH rate for non-cash items:
FOH =

FOSTER COMPANY MOH BUDGET

FOSTER COMPANY S&A BUDGET

SELLING AND ADMINISTRATIVE EXPENSE BUDGET Estimates of all costs
necessary to attain the sales levels in the sales budget and to deliver the goods to
the customer (selling expenses) and estimates of all administrative activities
(administrative expenses)
Variable selling and administrative expenses for each cashmere sweater are 10%
sales commission and an average shipping costs of $10 per sweater.
Fixed selling and administrative expenses for the year are:

Fixed S&A expenses are assumed to be the same in each quarter

Fixed cash S&A expenses for each quarter:
Fixed non-cash S&A expenses for each quarter:

FOSTER COMPANY S&A BUDGET

CASH BUDGET EXPECTED CASH OUTFLOWS

TO AND INFLOWS FROM OPERATIONS AND
FINANCING

FOSTER COMPANY CASH BUDGET

The Foster Company has provided the following information for preparing a cash budget:
Expected cash balance on 1/1/2007 = $40,000 (1)
Information on cash receipts:
80% of all sales are on credit. 70% of credit sales are collected in the quarter in which the
sale is made and 30% are collected in the following quarter. A/R is estimated to be
$60,000 on 12/31/2006; the company expects to collect the outstanding A/R in the 1st
quarter of 2007.
In the 1st quarter of 2007, Foster expects to sell marketable securities that are valued at
$10,000. (2)
Information on cash disbursements:
Direct materials are all purchased on credit. Foster usually pays 60% of its purchases in
the same quarter as the purchase and the rest is paid in the following quarter. The
company expects to have an accounts payable balance of $40,000 on December 31, 2006;
and all outstanding payables are expected to be paid in the first quarter of 2007.
All employees direct laborers, supervisors, S&A staff are all paid in the quarter in
which their services are used.
Overhead costs and S&A expenses are paid in the quarter in which they are incurred
On April 1, 2007, the company plans to spend $90,000 to buy a high-end knitting
machine, which has a 10-year useful life. (3)
Information on financing:
The company expects to obtain a loan for the full amount of the knitting machine on April
1, 2007. No principal will be repaid during the year; interest at an annual rate of 10% is
due quarterly. The company does not expect to issue stock or pay any dividends in 2007.
(4)

FOSTER COMPANY CASH BUDGET

FOSTER COMPANY CASH BUDGET

FOSTER COMPANY BUDGETED

INCOME STATEMENT
BUDGETED INCOME STATEMENT projection
of net income the company expects to earn as a
result of all the budgeted activities

FOSTER COMPANY BUDGET

BALANCE SHEET

FOSTER COMPANY BUDGET

BALANCE SHEET

FOSTER COMPANY BUDGET

BALANCE SHEET