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PROFIT PLANNING/ BUDGETING
ACC 2203 Review WorkshopSindhu Bala
BUDGETING – DEFINITIONS
Master Budget – a comprehensive plan of all aspects of a firm’s future business and production operationsMaster 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 – DEFINITIONSAll 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 pursueBudgets 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
ProductionBudget
Selling andAdministrative
Budget
DirectMaterialsBudget
ManufacturingOverhead
Budget
DirectLabor
Budget
CashBudget
SalesBudget
Budgeted Financial StatementsBudgeted Financial Statements
EndingFinished GoodsBudget
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 BUDGETThe 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 Sales Budget for 2007
Quarter 1st 2nd 3rd 4th
Year
Expected Sales (in units)
1,000
Selling price per unit
x $200
x $200
x $200
x $200
x $200
Total Sales Revenue
FOSTER COMPANY - COLLECTIONS BUDGETSCHEDULE 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 credit2. 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 Schedule of Expected Cash Collections for 2007
Cash Collections By Quarter Quarter Expected Sales
Credit Sales 1st 2nd 3rd 4th
A/R
1st
2nd
3rd
4th
Cash collected on credit sales & A/P
Cash collected on cash sales
Total cash collected
FOSTER COMPANY - PRODUCTION BUDGETPRODUCTION BUDGET – predicts the number
of units the firm plans to produce during the budget period.
Finished Goods Inventory
Units Produced
Beginning F.G Inventory
Ending F.G Inventory
Units Sold
FOSTER COMPANY - PRODUCTION BUDGETNote 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 BUDGETFoster maintains at the end of each quarter an inventory
of 10% of the next quarter’s sales. This allows the company to better meet its customers’ needs in case the customers experience a sudden surge in demand.
Foster Company Production Budget for 2007
Quarters 1st 2nd 3rd 4th
Year
Expected sales (in units)
Add desired units in ending finished goods inventory
Total units needed
Less units in beginning finished goods inventory
Units to be produced
FOSTER COMPANY – MANUFACTURING COSTS
BUDGETED MANUFACTURING COSTS – Estimated amounts and costs of inputs necessary to produce the budgeted production quantitiesCompanies 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 ½ 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 Budgeted (standard) cost for one cashmere sweater in 2007
Budgeted quantity
of input to make one sweater
Budgeted cost of
input
Total budgeted cost
Direct Materials
Direct Labor
Variable overhead
Fixed overhead
Total budgeted cost per unit
FOSTER COMPANY – DM BUDGETDIRECT 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
Foster keeps at the beginning of each quarter a materials inventory of 10% of the quarter’s raw materials needs.
Materials Purchased
Beginning Inventory
Ending Inventory
Materials used in production
FOSTER COMPANY – DM BUDGETFoster Company
Direct Materials Budget for 2007 Quarter
1st 2nd 3rd 4th
Year Units to be produced
DM needed per unit
DM needed for production
Add desired ending inv. of materials
Total DM required
Less beginning DM inventory
DM to be purchased
Cost per pound
Total cost of DM purchases
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 credit2. 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 Schedule Of Expected Cash Disbursements For Materials, 2007
Quarter in which cash is paid Quarter of purchases
Total purchases 1st 2nd 3rd 4th
A/P, beginning
1st quarter
2nd quarter
3rd quarter
4th quarter
Total cash disbursements
FOSTER COMPANY – DL BUDGETDIRECT 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 BUDGETFoster Company
Direct Labor Budget for 2007 Quarter
1st 2nd 3rd 4th
Year Units to be produced
DL hours per unit
1 DLH
1 DLH
1 DLH
1 DLH
1 DLH
Total DL hours needed for production
Cost per DL hour
Total cost of DL
FOSTER COMPANY – MOH BUDGETMANUFACTURING 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 = FOH rate =
FOSTER COMPANY – MOH BUDGETFoster Company
Manufacturing Overhead Budget for 2007 Quarter
1st 2nd 3rd 4th
Year Units to be produced
Total VOH costs
Total cash FOH costs
Total cash OH
Total non-cash FOH costs
Total OH costs
FOSTER COMPANY – S&A BUDGETSELLING 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:
Advertising $60,000 Executive salaries $120,000 Insurance $40,000 Depreciation $20,000 Total fixed S&A $240,000
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 BUDGETFoster Company
Selling and Administrative Expense Budget for 2007 Quarter
1st 2nd 3rd 4th
Year Units to be sold
Total variable S&A expenses
Total fixed S&A expenses – cash
Total fixed S&A expenses – non-cash
Total S&A expenses
Total cash S&A expenses
CASH BUDGET – EXPECTED CASH OUTFLOWS TO AND INFLOWS FROM OPERATIONS AND FINANCING
CASH BUDGET Cash balance, beginning Add Cash receipts: Cash sales Collections on credit sales Receipts of dividends and/or interest Receipts from sales of equipment and/or other assets Total cash available before financing Less Cash disbursements: Payments for direct materials Payments for direct labor Payments for manufacturing overhead Payments for selling and administrative expenses Payments for equipment purchases, dividends, and income taxes Total cash disbursements Excess (deficiency) of cash available over disbursements Financing: Add New borrowings Less Interest payments and/or repayments of principal Total financing Cash balance, ending
FOSTER COMPANY – CASH BUDGETThe 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 BUDGETFoster Company
Cash Budget for 2007 Quarter 1st 2nd 3rd 4th CASH – BEGINNING $119,970 Cash receipts: Cash sales Collections on credit sales Sale of securities TOTAL CASH RECEIPTS TOTAL CASH AVAILABLE Cash disbursements: Payments for DM Payments for DL Payments for OH Payments for S&A Purchase of machine TOTAL CASH DISBURSED Excess (deficiency) of cash available over disbursements
FOSTER COMPANY – CASH BUDGETExcess (deficiency) of cash available over disbursements
Excess (deficiency) of cash available over disbursements
Financing: Borrowings Interest payments TOTAL FINANCING CASH - ENDING
FOSTER COMPANY – BUDGETED INCOME STATEMENTBUDGETED INCOME STATEMENT – projection
of net income the company expects to earn as a result of all the budgeted activities
Foster Company Budgeted Income Statement for 2007
Sales
COGS
Gross Margin
S&A expense
Net operating income
Interest expense
Net income
FOSTER COMPANY – BUDGET BALANCE SHEET
BUDGETED BALANCE SHEET – projection of the company’s assets, liabilities, and shareholders’ equity at the end of the budget period The Foster Inc.’s balance sheet for 12/31/2006 includes the following items: Plant. Property, and equipment $560,000 Common stock $450,000 Accumulated depreciation $77,150 Retained earnings $112,865
FOSTER COMPANY – BUDGET BALANCE SHEET
Foster Company Budgeted Balance Sheet for 2007
TOTAL ASSETS
Cash
Accounts receivable
Finished goods inventory
Raw materials inventory
Plant, property, and equipment
Less: Accumulated depreciation
Total Assets
FOSTER COMPANY – BUDGET BALANCE SHEET
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable
Long term debt
Common stock
Retained earnings
Total liabilities and equity