Chapter 20: Master Budgets and Planning (Profit Plan) Game Plan

Overview of Budgeting

  • Budgeting: A process of planning future business actions and expressing them as formal plans.

  • Budget: A formal statement of a company’s plans in monetary terms.

  • Budgetary Control Process: The management’s use of budgets to ensure that planned objectives are met.

Benefits of Budgeting

Communication

  • Budgets communicate specific action plans to all employees.

Control

  • Provides benchmarks for evaluating performance.

Planning

  • Focuses on future opportunities and threats.

Motivation

  • Budgeting performance levels provide goals for employees to attain or exceed.

Coordination

  • Coordinates the activities of all employees and departments towards the company’s overall goals.

Positive and Negative Outcomes of Budgeting

Positive Motivating Factors

  1. Goals reflected in the budget are challenging but attainable.

  2. Employees involved in preparing the budget have a sense of ownership.

  3. Evaluations offer opportunities to explain differences between actual and budgeted amounts.

Potential Negative Outcomes

  1. Pressure to meet budgets may lead employees to engage in unethical behavior or commit fraud.

  2. Employees might understate sales budgets and overstate expense budgets to create a cushion.

  3. Employees might spend budgets on unnecessary items to avoid budget cuts in the next period.

Master Budget Components

Definition

  • A master budget encompasses all operating budgets for a manufacturing company.

Sales Budget Example

  • Toronto Sticks Company: Sold 700 hockey sticks at $60 each.

    • Prepares a sales budget for the next three months based on this data.

Production Budget

  • Purpose: The production budget indicates the number of units to be produced in a period.

  • Basis: It is based on the unit sales projected in the sales budget and inventory considerations.

    • Note: The production budget does not show costs; it is expressed in units of product.

Direct Materials Budget

Purpose

  • The direct materials budget shows the budgeted costs for direct materials needed to satisfy estimated production for the period.

    • Based on the production budget.

Direct Labor Budget

Purpose

  • The direct labor budget shows the budgeted costs for direct labor required to satisfy the estimated production for the period.

    • Based on the production budget.

Factory Overhead Budget

Content

  • The factory overhead budget outlines the budgeted costs for factory overhead needed to complete the estimated production.

    • Variable Portion: Assigned at a rate of $2.50 per unit of production.

    • Fixed Overhead: $1,500 per month.

Product Cost Per Unit Calculation

  • Components: Product cost per unit is computed from:

    • Direct materials budget

    • Direct labor budget

    • Factory overhead budget

  • TSC assumes it will produce 3,000 units each quarter, leading to a fixed overhead of $1.50 per unit.

    • Other product costs are variable.

Cost of Goods Sold Budget

  • The product cost per unit is utilized to formulate:

    • Cost of goods sold budget

    • Budgeted income statement.

Selling Expense Budget

Components

  • Sales commissions equal 10 percent of total sales.

  • Monthly salary of sales manager is $2,000.

General and Administrative Expense Budget

  • General and administrative salaries are $54,000 per year or $4,500 per month.

Capital Expenditures Budget

  • Reports expected cash receipts and cash payments related to the sale and purchase of plant assets.

Cash Budget (Financing Budget)

Definition

  • The cash budget shows budgeted cash receipts and cash payments during the budget period.

  • General Formula:

    • The specific equation or layout will depend on the various cash flows recognized in the budget process.

Budgeted Cash Receipts from Sales

  • The accounts receivable balance at the end of each month is 60% of that month’s budgeted sales.

    • Cash sales constitute 40% of each month’s sales.

Budgeted Income Statement

  • Comprises all information from the component budgets discussed in previous slides.

    • Includes a prediction of income tax expense for the quarter, calculated as 40% of the budgeted pretax income.

Budgeted Balance Sheet Example

Toronto Sticks Company Balance Sheet as of December 31

  • Assets:

    • Cash: $44,706

    • Accounts receivable: $50,400

    • Raw materials inventory: $4,950

    • Finished goods inventory: $13,770

    • Equipment: $225,000

    • Less: Accumulated depreciation: $(40,500)

    • Total assets: $298,326

  • Liabilities and Equity:

    • Accounts payable: $39,502

    • Income taxes payable: $9,700

    • Common stock: $150,000

    • Retained earnings: $99,124

    • Total liabilities and equity: $298,326

Budgeting for Service Companies

  • Service providers use master budgets but typically require fewer operating budgets than manufacturers.

  • Essential budgets for service companies include the direct labor budget and revenue per employee analysis.

Merchandise Purchases Budget for Merchandisers

  • A merchandiser prepares a merchandise purchases budget instead of a production budget.

  • Ending inventory for a month should equal 90% of next month’s unit sales.

Schedule of Cash Payments for Merchandise Purchases

  • Subtract beginning inventory to determine the budgeted number of units to be purchased.

  • This analysis is crucial for ensuring that the company will maintain inventory levels to meet sales demands.