2. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 2
Learning Objective 1
Understand why
organizations budget and
the processes they use to
create budgets.
3. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 3
The Basic Framework of Budgeting
A budget is a detailed quantitative plan for
acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activities is known
as budgetary control.
4. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 4
Planning and Control
Planning –
involves developing
objectives and
preparing various
budgets to achieve
those objectives.
Control –
involves the steps taken by
management to increase
the likelihood that the
objectives set down while
planning are attained and
that all parts of the
organization are working
together toward that goal.
5. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 5
Advantages of Budgeting
Advantages
Define goals
and objectives
Uncover potential
bottlenecks
Coordinate
activities
Communicate
plans
Think about and
plan for the future
Means of allocating
resources
6. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 6
Responsibility Accounting
Managers should be
held responsible for
those items - and only
those items - that they
can actually control
to a significant extent.
7. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 7
Choosing the Budget Period
Operating Budget
2011 2012 2013 2014
Operating budgets ordinarily
cover a one-year period
corresponding to a company’s
fiscal year. Many companies
divide their annual budget
into four quarters.
A continuous budget is a
12-month budget that rolls
forward one month (or quarter)
as the current month (or quarter)
is completed.
8. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 8
Learning Objective 2
Understand Basic
Budgeting Terms and the
Behavioral Aspects of
Budgeting.
9. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 9
Bottom-up and Top-down Budgeting
Bottom-up budgeting
(Self-imposed budget or
Participative budget )
Top-down budgeting
Top
Management
Middle
Management
Lower-level
Management
Top
Management
Middle
Management
Lower-level
Management
10. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 10
Advantages of the Bottom-up Budgeting
(Self-Imposed Budgets)
1. Individuals at all levels of the organization are viewed as
members of the team whose judgments are valued by top
management.
2. Budget estimates prepared by front-line managers are
often more accurate than estimates prepared by top
managers.
3. Motivation is generally higher when individuals participate
in setting their own goals than when the goals are
imposed from above.
4. A manager who is not able to meet a budget imposed
from above can claim that it was unrealistic. Self-imposed
budgets eliminate this excuse.
11. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 11
How to overcome problems of self-
imposed budgets
Self-imposed budgets should be reviewed
by higher levels of management to
prevent “budgetary slack (or budget
padding).”
Most companies issue broad guidelines in
terms of overall profits or sales. Lower
level managers are directed to prepare
budgets that meet those targets.
12. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 12
Advantages of the Top-down Budgeting
1. Avoid the potential budgetary slack (budget padding).
2. Provide a clearer performance goals and expectations
from the top management.
3. May provide better budget due to top management’s
access to privileged/confidential market and organization
information .
4. Provide an efficient budgetary process.
13. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 13
Budget Lapsing
• A popular method among government agencies,
universities and organizations relying on allocated funds.
• Any unused funding at the end of the financial period
cannot be carried forward to the following year.
• As a result, the following year’s budget may be cut because
of the under-expenditure in the previous year.
14. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 14
Budget Lapsing: Advantages
• Budget lapsing helps ensure that the appropriate level of
resources is utilized in each period. Without budget lapsing,
risk-averse managers may unnecessarily accumulate funds
and this may adversely affect the performance of the
organization.
• It helps provide an opportunity for a clean cut-off of
expenditures and to reallocate any unused resources for
other more appropriate requirements.
15. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 15
Budget Lapsing: Potential Problem &
Solution
• Budget lapsing can cause undesired behavior effects. For
example, managers may wastefully spend their entire
budget before the end of the period in order to avoid budget
cuts.
• A system of reviewing the expenditures near end of the
period may uncover unnecessary expenditures and
discourage managers to wastefully spend because of budget
lapsing.
16. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 16
Incremental versus Zero-based Budgets
• Incremental method of budgeting is most commonly
used by companies. Companies start off one year’s budget
by referring back to the previous year’s figures.
Adjustments are then made to the budget to account for
the expected changes such as prices for the next year.
• While incremental method of budgeting is practical and
fast, any inefficiency in the previous year’s figures may be
carried forward. For example, if all along the organization is
over staffed, then the budget will continually to be allowing
for the over staffing situation under this method.
17. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 17
Incremental versus Zero-based Budgets
• Zero-Based Budgets are prepared based on the
assumption that the company has just started. Therefore,
resources required have to be justified from scratch.
• For example, when budgeting for staff cost for a restaurant,
managers using the zero-based budgeting approach will
ignore the existing staff level and expenses, rather, they
will examine factors such as opening hours, number of
tables, expected patron numbers to work out the number of
staff required at each position and level, hence the
associate costs, to produce a budget.
18. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 18
Incremental versus Zero-based Budgets
• Companies using the zero-based method do not simply
ignore previous years’ figures. Figures generated by the
zero-based method are usually compared with previous
years’ figures. Any large differences are investigated.
• As zero-based budgeting is time consuming and costly,
companies tend to use this method for the relatively large
items and the incremental method for the rest.
19. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 19
Top Management Attitude:
Human Factors in Budgeting
The success of a budget program depends on three
important factors:
1. Top management must be enthusiastic and
committed to the budget process.
2. Top management must not use the budget to
pressure employees or blame them when
something goes wrong.
3. Budget targets should be challenging but
achievable in order to have good motivational
effects.
20. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 20
The Budget Committee
A standing committee responsible for
overall policy matters relating to the budget
coordinating the preparation of the budget
resolving disputes related to the budget
approving the final budget
21. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 21
Learning Objective 3
Understand the Key
Components of Master
Budget in Manufacturing,
Merchandising and
Service Industries
22. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 22
Understand the key components of master budget in
Manufacturing, Merchandising, and Service Industries
The first step of budgeting for every business is to budget for the
revenue, whether it is a sales budget for providing goods or services or
a funding budget. Although operational budgets are adapted
according to the industries, they are very similar and typically comprise
of budgets for
• Income statement
• Cash
• Balance sheet.
The major differences of different industries include:
• Manufacturing: production budget is involved
• Merchandising: no production budget, only purchase budget of
merchandise is required.
• Service Industries: budget for revenue and cost of providing services
• Not-for-profit: expected funding available and plan usage of funding.
23. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 23
Learning Objective 4
Prepare a Master Budget
for a Manufacturing
Company.
24. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 24
The Master Budget: An Overview
Production budget
Selling and
administrative
budget
Direct materials
budget
Manufacturing
overhead budget
Direct labor
budget
Cash Budget
Sales budget
Ending inventory
budget
Budgeted
balance sheet
Budgeted
income
statement
25. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 25
Learning Objective 4 (a)
Prepare a sales budget,
including a schedule of
expected cash collections.
26. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 26
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.
27. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 27
The Sales Budget
The individual months of April, May, and June are
summed to obtain the total budgeted sales in units
and dollars for the quarter ended June 30th
28. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 28
Expected Cash Collections
All sales are on account.
Royal’s collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale,
5% uncollectible.
The March 31 accounts receivable
balance of $30,000 will be collected in full.
30. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 30
Expected Cash Collections
From the Sales Budget for April.
31. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 31
Expected Cash Collections
From the Sales Budget for May.
32. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 32
Quick Check
What will be the total cash collections for
the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
33. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 33
What will be the total cash collections for
the quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
Quick Check
35. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 35
Learning Objective 4 (b)
Prepare a
production budget.
36. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 36
The Production Budget
Production
Budget
Sales
Budget
and
Expected
Cash
Collections
The production budget must be adequate to
meet budgeted sales and to provide for
the desired ending inventory.
37. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 37
The Production Budget
The management at Royal Company wants
ending inventory to be equal to 20% of the
following month’s budgeted sales in units.
On March 31, 4,000 units were on hand.
Let’s prepare the production budget.
38. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 38
The Production Budget
39. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 39
The Production Budget
March 31
ending inventory
Budgeted May sales 50,000
Desired ending inventory % 20%
Desired ending inventory 10,000
40. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 40
Quick Check
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
41. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 41
What is the required production for May?
a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
Quick Check
42. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 42
The Production Budget
43. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 43
The Production Budget
Assumed ending inventory.
44. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 44
Learning Objective 4 (c)
Prepare a direct materials
budget, including a
schedule of expected cash
disbursements for
purchases of materials.
45. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 45
The Direct Materials Budget
At Royal Company, five pounds 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 month’s production.
On March 31, 13,000 pounds of material are
on hand. Material cost is $0.40 per pound.
Let’s prepare the direct materials budget.
46. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 46
The Direct Materials Budget
From production budget
47. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 47
The Direct Materials Budget
48. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 48
The Direct Materials Budget
Calculate the materials to
be purchased in May.
March 31 inventory
10% of following month’s
production needs.
49. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 49
Quick Check
How much materials should be purchased in May?
a. 221,500 pounds
b. 240,000 pounds
c. 230,000 pounds
d. 211,500 pounds
50. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 50
How much materials should be purchased in May?
a. 221,500 pounds
b. 240,000 pounds
c. 230,000 pounds
d. 211,500 pounds
Quick Check
51. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 51
The Direct Materials Budget
52. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 52
The Direct Materials Budget
Assumed ending inventory
53. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 53
Expected Cash Disbursement for Materials
Royal pays $0.40 per pound for its materials.
One-half of a month’s purchases is 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.
Let’s calculate expected cash disbursements.
55. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 55
Expected Cash Disbursement for Materials
140,000 lbs. × $0.40/lb. = $56,000
Compute the expected cash
disbursements for materials
for the quarter.
56. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 56
Quick Check
What are the total cash disbursements for the
quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
57. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 57
What are the total cash disbursements for the
quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
Quick Check
60. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 60
The Direct Labor Budget
At Royal, each unit of product requires 0.05 hours (3
minutes) of direct labor.
The Company has a “no layoff” policy so all employees
will be paid for 40 hours of work each week.
For purposes of our illustration assume that Royal has a
“no layoff” policy, workers are pay at the rate of $10 per
hour regardless of the hours worked.
For the next three months, the direct labor workforce will
be paid for a minimum of 1,500 hours per month.
Let’s prepare the direct labor budget.
61. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 61
The Direct Labor Budget
From production budget.
62. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 62
The Direct Labor Budget
63. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 63
The Direct Labor Budget
Greater of labor hours required
or labor hours guaranteed.
64. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 64
The Direct Labor Budget
65. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 65
Quick Check
What would be the total direct labor cost for
the quarter if the company follows its no lay-
off policy, but pays $15 (time-and-a-half) for
every hour worked in excess of 1,500 hours
in a month?
a. $79,500
b. $64,500
c. $61,000
d. $57,000
66. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 66
What would be the total direct labor cost for
the quarter if the company follows its no lay-
off policy, but pays $15 (time-and-a-half) for
every hour worked in excess of 1,500 hours
in a month?
a. $79,500
b. $64,500
c. $61,000
d. $57,000
Quick Check
April May June Quarter
Labor hours required 1,300 2,300 1,450
Regular hours paid 1,500 1,500 1,500 4,500
Overtime hours paid - 800 - 800
Total regular hours 4,500 $10 45,000$
Total overtime hours 800 $15 12,000$
Total pay 57,000$
68. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 68
Manufacturing Overhead Budget
At Royal, manufacturing overhead is applied to units
of product on the basis of direct labor hours.
The variable manufacturing overhead rate is $20 per
direct labor hour.
Fixed manufacturing overhead is $50,000 per month,
which includes $20,000 of noncash costs (primarily
depreciation of plant assets).
Let’s prepare the manufacturing overhead budget.
77. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 77
Selling and Administrative Expense Budget
At Royal, the selling and administrative expense budget is
divided into variable and fixed components.
The 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.
Let’s prepare the company’s selling and administrative
expense budget.
78. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 78
Selling and Administrative Expense Budget
Calculate the selling and administrative
cash expenses for the quarter.
79. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 79
Quick Check
What are the total cash disbursements for
selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
80. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 80
What are the total cash disbursements for
selling and administrative expenses for the
quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
Quick Check
83. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 83
Format of the Cash Budget
The cash budget is divided into four sections:
1. Cash receipts section lists all cash inflows excluding cash
received from financing;
2. Cash disbursements section consists of all cash payments
excluding repayments of principal and interest;
3. Cash excess or deficiency section determines if the
company will need to borrow money or if it will be able to
repay funds previously borrowed; and
4. Financing section details the borrowings and repayments
projected to take place during the budget period.
84. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 84
The Cash Budget
Assume the following information for 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 (both purchases paid in cash)
Has an April 1 cash balance of $40,000
85. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 85
The Cash Budget
Schedule of Expected
Cash Collections.
86. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 86
The Cash Budget
Direct Labor
Budget.
Manufacturing
Overhead Budget.
Selling and Administrative
Expense Budget.
Schedule of Expected
Cash Disbursements.
87. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 87
The Cash Budget
Because Royal maintains
a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.
88. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 88
The Cash Budget
Ending cash balance for April
is the beginning May balance.
Because Royal maintains
a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.
90. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 90
Quick Check
What is the excess (deficiency) of cash
available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
91. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 91
What is the excess (deficiency) of cash
available over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
Quick Check
92. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 92
The Cash Budget
$50,000 × 16% × 3/12 = $2,000
Borrowings on April 1 and
repayment on June 30.
93. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 93
The Budgeted Income Statement
Cash
Budget
Budgeted
Income
Statement
With interest expense from the cash
budget, Royal can prepare the budgeted
income statement.
94. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 94
Learning Objective 4(h)
Prepare a budgeted
income statement.
95. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 95
The Budgeted Income Statement
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
Selling and administrative expenses 260,000
Operating income 241,000
Interest expense 2,000
Net income 239,000$
Sales Budget.
Ending Finished
Goods Inventory.
Selling and
Administrative
Expense Budget.
Cash Budget.
97. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 97
The Budgeted Balance Sheet
Royal reported the following account
balances prior to preparing its budgeted
financial statements:
• Land - $50,000
• Common stock - $200,000
• Retained earnings - $146,150 (April 1)
• Equipment - $175,000
98. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 98
Royal Company
Budgeted Balance Sheet
June 30
Assets:
Cash 43,000$
Accounts receivable 75,000
Raw materials inventory 4,600
Finished goods inventory 24,950
Land 50,000
Equipment 367,000
Total assets 564,550
Liabilities and Stockholders' Equity
Accounts payable 28,400$
Common stock 200,000
Retained earnings 336,150
Total liabilities and stockholders' equity 564,550$
11,500 lbs.
at $0.40/lb.
5,000 units
at $4.99 each.
50% of June
purchases
of $56,800.
25% of June
sales of
$300,000.
99. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 99
Royal Company
Budgeted Balance Sheet
June 30
Assets:
Cash 43,000$
Accounts receivable 75,000
Raw materials inventory 4,600
Finished goods inventory 24,950
Land 50,000
Equipment 367,000
Total assets 564,550
Liabilities and Stockholders' Equity
Accounts payable 28,400$
Common stock 200,000
Retained earnings 336,150
Total liabilities and stockholders' equity 564,550$
Beginning balance 146,150$
Add: net income 239,000
Deduct: dividends (49,000)
Ending balance 336,150$
100. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 100
Learning Objective 5
Prepare Budget on
the Key
Components for the
Service Industry
101. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 101
Key Budget Components for the Service Industry
Wonder World, a hypothetical theme park, has the following data:
Main Sources of
Revenue
Major
Expenses
Departments
• Ticketing
• Food &
Beverages
• Souvenir Shop
• Salaries
• Rent
• Cost of Sales
• Advertising
• Maintenance
• Depreciation
• Utilities
• Finance & Administration
• Operations
• Marketing
• Souvenir Shop
• Food and Beverages
• Maintenance
103. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 103
Visitorship Budget
Number of Visitors
Adults 750,000
Children 250,000
Total Visitors 1,000,000
Based on historical records, economic outlook, tourist
arrival expectations, the following visitorship budget for the
coming year is prepared:
105. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 105
Revenue Budget
Revenue per visitor
Gate Collections : Adults $13
Gate Collections : Children $9
Souvenir Shop $4
Food and Beverages $6
Based on the average price charged by Wonder World and
other historical data, the following revenues per visitor are
budgeted and approved by the top management:
106. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 106
Revenue Budget
Revenue
Gate Collections : Adults1 $9,750,000
Gate Collections : Children2 $2,250,000
Souvenir Shop3 $4,000,000
Food and Beverages4 $6,000,000
Total Revenue $22,000,000
With the budgeted number of visitors and revenues per visitor
from each category, the budgeted revenues are computed:
Note
1 750,000 X $13
2 250,000 X $9
3 1,000,000 X $4
4 1,000,000 X $6
107. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 107
Learning Objective 5 (c)
Prepare a Cost of
Sales Budget and
Expense Budget
108. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 108
Cost of Sales Budget
Cost of Sales
Souvenir Shop $2,000,000
Food and Beverage $3,000,000
Total $5,000,000
For cost of sales on souvenirs and food and beverages, the
company normally makes use of the historical cost of sales
% and takes into account of any expected price changes
from the suppliers. For the coming year, the expected cost of
sales % is 50% on sales for both the souvenir shop and food
and beverages.
109. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 109
Expenses Budget
How the items are budgeted will depend on the nature of the items.
Nature of expense Amount Budget approach
Rental $1,100,000 5% of revenue as agreed with the landlord.
Salaries $3,500,000
Zero based approach by reviewing the
actual requirement of each position and its
suitable rate of pay.
Advertising $1,200,000 Proposed by marketing manager.
Maintenance $980,000 Proposed by maintenance manager.
Depreciation $890,000
Computed by the finance manager by
taking into account of existing assets and
proposed new assets.
Utilities $580,000
Computed by maintenance manager based
on the rates and usage expectations.
Other operating expenses $490,000
Based on judgment and any specific
requirements such as legal expenses.
Total $8,740,000
111. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 111
Budgeted Income Statement
Budgeted Income Statement
Revenue $22,000,000
Cost of goods sold $5,000,000
Expenses $8,740,000
Net income $8,260,000
Budgeted Income Statement can be prepared by putting all
previous budgeted information together.
112. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 112
Learning Objective 6
Explain the Costs
and Benefits of
Budgeting
113. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 113
Costs and Benefits of Budgeting
• Budgeting is time-consuming and costly.
• Budgetary slack or padding is an inherent problem of
budgeting.
• Despite the drawbacks of budgeting, most companies are
still using budgets to plan, communicate, set objectives
and allocate resources etc.
• Since budgets are still commonly used, benefits of
budgeting are high and drawbacks of budgeting can be
minimized by having a good budgeting system.
• For a good budgeting system, it is critical to have effective
communication and mutual trust between the top
management and its staff.
114. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 114
End of Chapter 10
Editor's Notes
Chapter 10: Profit planning.
This chapter focuses on the steps taken by businesses to achieve their planned levels of profits - a process called profit planning. Profit planning is accomplished by preparing numerous budgets, which, when brought together, form an integrated business plan known as a master budget.
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Bottom-up budgeting
The initial flow of budget data in a bottom up budgeting system is from lower levels of management to higher levels of management. Each person with responsibility for cost or revenue will prepare his or her own budget estimates and submit them to the next higher level of management. These estimates are reviewed and consolidated as they move upward in the organization. Therefore, it is also called a self-imposed budget or participative budget that requires the full cooperation and participation of managers at all levels. It is a particularly useful approach if the budget will be used to evaluate managerial performance.
Top-down budgeting
Top management sets all the key targets for the entire company. These key targets are then move downwards for the middle and lower-level management to come up with other detailed budgeted figures. Under this approach, middle and lower-level management are tasked to complete the budget plan towards meeting the key targets set by the top management.
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Problems of self-imposed budget can be solved by the top-down budgeting approach. For example, it can:
avoid the potential budgetary slack (budget padding).
provide a clearer performance goals and expectations from the top management.
provide better budget due to top management’s access to privileged/confidential market and organization information .
provide an efficient budgetary process.
A popular method among government agencies, universities and organizations relying on allocated funds.
Any unused funding at the end of the financial period cannot be carried forward to the following year.
As a result, the following year’s budget may be cut because of the under-expenditure in the previous year.
Budget Lapsing: Advantages
Budget lapsing helps ensure that the appropriate level of resources is utilized in each period. Without budget lapsing, risk-averse managers may unnecessarily accumulate funds just in case of any sudden fund requirements. Unnecessary savings from, for example, essential repair and maintenance, may adversely affect the organization.
It helps provide an opportunity for a clean cut-off of expenditures and to reallocate any unused resources for other more appropriate requirements.
Budget Lapsing: Potential Problem & Solution
Budget lapsing can cause undesired behavior effects. For example, managers may wastefully spend their entire budget before the end of the period in order to avoid budget cuts.
A system of reviewing the expenditures near end of the period may uncover unnecessary expenditures and discourage managers to wastefully spend because of budget lapsing.
Incremental method of budgeting is most commonly used by companies. Companies start off one year’s budget by referring back to the previous year’s figures. Adjustments are then made to the budget to account for the expected changes such as prices for the next year.
While incremental method of budgeting is practical and fast, any inefficiency in the previous year’s figures may be carried forward. For example, if all along the organization is over staffed, then the budget will continually to be allowing for the over staffing situation under this method.
Zero-Based Budgets are prepared based on the assumption that the company has just started. Therefore, resources required have to be justified from scratch.
For example, when budgeting for staff cost for a restaurant, managers using the zero-based budgeting approach will ignore the existing staff level and expenses, rather, they will examine factors such as opening hours, number of tables, expected patron numbers to work out the number of staff required at each position and level, hence the associate costs, to produce a budget.
Companies using the zero-based method do not simply ignore previous years’ figures. Figures generated by the zero-based method are usually compared with previous years’ figures. Any large differences are investigated.
As zero-based budgeting is time consuming and costly, companies tend to use this method for the relatively large items and the incremental method for the rest.
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The master budget consists of a number of separate but interdependent budgets that formally lay out the company’s sales, production, and financial goals. The master budget culminates in a cash budget, a budgeted income statement, and a budgeted balance sheet. Exhibit 10-2 provides an overview of the various parts of the master budget and how they are related. Companies in different industries adapt this master budget based on their particular needs.
For a manufacturer, the first step in the budgeting process is the preparation of the sales budget, which is a detailed schedule showing the expected sales for the budget period. An accurate sales budget is the key to the entire budgeting process as all other budgets such as the production budget and the income statement budget depend on the sales budget. The sales budget is compiled by taking into account, for example, past sales levels, general economic trends, competitors’ actions and pricing strategies. Once the sales budget is done, a manufacturer will do the production budget based on the sales budget and the required finished goods inventory. Finished goods inventory is necessary to cater for any unexpected change in demand. Thereafter, the production budget is utilized to determine the budgets for direct materials, direct labor and manufacturing overheads. A budget for selling and administrative expenses will then be prepared. Finally, budgeted cash statement, income statement and balance sheet are compiled.
For a merchandiser, the first step is also the preparation of the sales budget. After the sales budget, a merchandiser will do a budget for the merchandise purchases. The sales budget and the inventory required are utilized to compile the budget for merchandise purchases. Production, direct materials, direct labor and manufacturing overhead budgets are not applicable for a merchandiser. Similar to a manufacturer, other budgets including selling and administrative expenses, cash, income statement and balance sheet are prepared.
For a service provider, same as a manufacturer or a merchandiser, a sales budget is done first. The sales budget gives details of the services to be provided and the related income. Based on the sales budget, other budgets are then prepared. To most service providers, human capital (or human resources) budgeting/planning could be one of the most important budget after sales budget.
A not-for-profit organization budget has many similarities with other organizations. The major difference is that this organization normally does not charge for its goods and services. Instead, funding is obtained from government bodies or donors. Therefore, there is no sales budget for a not-for-profit organization. Instead, it will have a budget for revenue or funding. From this budget, the organization will then plan for its activities accordingly by producing a budget for activities and expenses.
Therefore, the first step of budgeting for every business is to budget for the revenue, whether it is a sales budget for providing goods or services or a funding budget. Although operational budgets are adapted according to the industries, they are very similar and typically comprise of budgets for income statement, cash and balance sheet. We will next describe the detailed budgeted information for a manufacturer.
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This section illustrates the essential aspects of budgeting of a theme park (a hypothetical one). Wonder World is a theme park which has some mechanical rides, an aquarium and a dolphin pool. On average, about one million visitors including locals and tourists are attracted to the theme park annually. Wonder World is a very profitable company.
Wonder World has three main sources of revenue, namely, ticketing, food and beverages and the souvenir shop. For expenses, the major ones are salaries, rent and cost of sales for selling food and beverages and souvenir items.
Wonder World has a number of departments, Finance and Administration, Operations, Marketing, Souvenir Shop, Food and Beverages and Maintenance. Each of the department head provides input of his or her area of responsibility for the company’s annual budget.
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Based on historical records, economic outlook, tourist arrival expectations, the visitorship budget is then prepared. This is the important first step of the budgeting process for a theme park as revenue and expenses are driven by these numbers. In this example, Adults and Children numbers are estimated as 750,000 and 250,000 respectively, totaling 1,000,000 .
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Based on the average price charged by Wonder World and other historical data, the revenues budget, including gate collection (i.e. entrance ticket), souvenir shop revenue, and food and beverages revenue per visitor are prepared and approved by the top management.
With the budgeted number of visitors and revenues per visitor from each category, the budgeted revenues are computed. In this example, a total of $22,000,000 is budgeted.
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For cost of sales on souvenirs and food and beverages, the company normally makes use of the historical cost of sales percentage and takes into account of any expected price changes from the suppliers. For the coming year, the expected cost of sales percentage is is budgeted at 50% on sales for both the souvenir shop and food and beverages.
Regarding rental expense, Wonder World has an agreement with its landlord to pay either a lump sum of $200,000 or 5% of the revenue, whichever is higher. Since opening of the attraction, Wonder World’s 5% of revenue has always exceeded the $200,000 lump sum by a very far amount, therefore, its budgeted rent can simply be computed at 5% of sales.
Salary expense is a top expense item for Wonder World. Each year, the head of finance will analyze and discuss salary expense with top management and recommend the appropriate amount to be budgeted for next year. Generally, for salaries, the zero-based approach is used to estimate the budgeted figure. For incremental approach, we take last year’s expense and adjust for changes in headcounts and rate of pay. For the zero-based approach, we do not start off with last year’s figure; instead, we review from scratch the number of staff required based on tasks and duties to be performed. Suitable rates of pay for different levels of staff are discussed. With this method, any inappropriate staff number or pay will not be carried forward into next year.
Advertising is more of a discretionary item for Wonder World. The marketing manager will propose the amount to be spent and estimate the effect of the advertising before seeking the approval of the top management. For TV advertising, viewership demography together with detailed costing will have to be presented to the top management for approval. In the end, the top management will decide on the types of advertisement and the total to be spent.
Maintenance expenditure is more of a technical area and safety cannot be compromised. The maintenance manager has a bigger role to play in terms of the amount required. The maintenance manager will list down the various maintenance and enhancement jobs required to be done next year and estimate the total budget required for these jobs. Top management will go through the list and discuss with the maintenance manager to decide on the timing of the jobs. For maintenance jobs, they normally get approved and for the enhancement jobs, top management may decide to delay the jobs for a while.
Depreciation expense is mainly computed by the Finance Department. The expense can be computed by using all the existing depreciable assets’ values and depreciation policies plus any applicable additional depreciation for assets to be acquired in the coming year. If all planned purchases are according to the original plan, depreciation expense budget can be fairly accurate.
The maintenance department is also responsible for estimating the amount to be budgeted for utilities. Current facilities, planned new facilities, change in rates of utilities will be taken into account to estimate the utilities expense for next year. It should be noted that Wonder World utilities are not so sensitive to change in number of visitors. Even with a very low level of visitors, air conditioning and lightings for all the indoor facilities have to be kept on, the life support system, which consumes a lot of electricity, has to be kept on for fishes and dolphins.
Other operating expenses such as legal and audit fees, travel and fish food are estimated based on a combination of historical information and human judgment. In general, the smaller items require less time to estimate based on the cost and benefit rule.
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Budgeted Income Statement can be prepared by putting all previous budgeted information together.
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Budgeting is time-consuming and costly.
Budgetary slack or padding is an inherent problem of budgeting.
Despite the drawbacks of budgeting, most companies are still using budgets to plan, communicate, set objectives and allocate resources etc.
Since budgets are still commonly used, benefits of budgeting must be high and drawbacks of budgeting can be minimized by having a good budgeting system.
For a good budgeting system, it is critical to have effective communication and mutual trust between the top management and its staff.
