Chapter 20

1. Chapter 20 Master Budgets and Performance Planning

2. Conceptual Learning Objectives C1: Describe the importance and benefits of budgeting. Self-Study => QUIZ C2: Explain the process of budget administration.Self-Study => QUIZ C3: Describe a master budget and the process of preparing it. => Quiz

3. Analytical Learning Objectives A1:Analyze expense planning using activity-based budgeting.

4. Procedural Learning Objectives P1:Prepare each component of a master budget and link each to the budgeting process. P2:Link both operating and capital expenditures budgets to budgeted financial statements. P3: Appendix 20A:Prepare production and manufacturing budgets.

5. Budget Process C 1 Defines goals and objectives Communicates plansand instructions Promotes analysis anda focus on the future Advantages Coordinates business activities Motivates employees Provides a basis forevaluating performance againstpast or expected results

6. Budget Timing Many companies apply continuous budgeting by preparing rolling budgets. As each budget period passes: New monthly or quarterly budgets are prepared to replace those that have lapsed. Entire set of budgets for months or quarters that remain is revised. Management is continuously planning ahead.

7. Budget Timing C 2 Continuous or Rolling Budget 2009 2010 2011 2012 The budget may be a twelve-month budget that rolls forward one month as the current month is completed.

8. The Master Budget Formal, comprehensive plan for a company’s future. Contains several individual budgets that are sequentially linked with each other to provide a coordinated plan for the company. Typically includes individual budgets for sales, purchases, production, various expenses, capital expenditures, and cash.

9. Master Budget Components A: Operating Budgets* Four major types: 1. Sales budget 2. Merchandiser: Merchandise Purchases Budget Manufacturer: Production and Manufacturing Budgets. 3. Selling expense budget 4. General and administrative expense budget *Each component linked to budgeting process.

10. Master Budget Components B. Capital Expenditures Budget C. Financial Budgets (Three major types) 1. Cash Budget 2. Budgeted Income Statement 3. Budgeted Balance Sheet

11. Salesbudget MerchandisePurchases • Prepare financial budgets: • cash • income • balance sheet Prepareselling andgeneraladministrativebudgets Preparecapitalexpenditurebudget Master Budget Components C 3

12. EXAMPLE Hockey Den (HD)A retailer of youth Hockey Sticks Preparation of Master Budget Reference Point Balance Sheet at the start of the Budgeting Period(Exhibit 20.5: Page 831)

13. Sales budget First step in preparing master budget. Requires careful analysis of forecasted economic and market conditions, plant capacity,proposed selling expenses, and predictions of unit sales. Participatory budgeting approach ensures greater commitment to goals, and draws on knowledge and experience of people involved in activity.

14. Sales Budget P1

15. Quick Study 20 - 10

16. Merchandise Purchases Budget Sales budget used as a basis for merchandise purchases budget. Inventory to be purchased is determined by adding budgeted ending inventory to budgeted sales, and then subtracting beginning inventory. Multiply by budgeted cost per unit to obtain budgeted cost of merchandise purchases.

17. Merchandise Purchases Budget P1 Inventory to be purchased Budgeted ending inventory Budgeted cost of salesfor the period Budgetedbeginning inventory Hockey Den buys hockey sticks for $60.00 each and maintains an ending inventory equal to 90 percent of the next month’s budgeted sales. 900 hockey sticks are on hand on September 30. = + – Let’s prepare the purchases budget for Hockey Den.

18. Merchandise Purchases Budget P1

19. Selling Expense Budget • Types and amounts of selling expenses expected during budget period. • Created to provide sufficient selling expenses to meet sales goals reflected in sales budget. • For HD, Selling expenses consist of: • -10% Commissions paid to sales personnel based on month's sale; • -$2,000 monthly salary paid to the sales manager.

20. Selling Expense Budget P1 From Hockey Den’s sales budget

21. Quick Study 20 - 11

22. General and Administrative Expense Budget Plan showing predicted operating expenses not included in selling expenses budget. Consists of items variable or fixed in terms of sales volume. Interest expense and income tax expense cannot be planned at this stage of budgeting process.

23. General and Administrative Expense Budget Salaries of $54,000 per year: => $4,500 per month Using Balance Sheet information form Exhibit 20.5, the depreciation on equipment is computed as $1,500/per month. =>[( 200,000 – 20,0000) / 10 Years] / 12 Months

24. General and Administrative Expense Budget P1

25. Problem 1A

26. Capital Expenditures Budget 1. Includes amounts to be received from disposing of equipment, and to be spent on purchasing additional equipment; assumes proposed production program is carried out. 2. Affected by long-range plans for business instead of short-term sales budgets. 3. Capital budgeting is process of evaluating and planning for capital (plant and equipment) expenditures, which involve long-run commitments of large amounts.

27. Capital Expenditures Budget 1. Hockey Den does not anticipate disposal of any plant assets through December 2009. 2. But it plan to acquire $25,000 of equipment for cash near the end of December 2009. 3. Since this is the only budgeted capital expenditure from Oct – Dec, 2009, no separate budget is shown. 4. The Cash Budget will reflect this $25,000 planned expenditure.

28. Capital Expenditures Budget 1. Hockey Den does not anticipate disposal of any plant assets through December 2009. 2. But it plan to acquire $25,000 of equipment for cash near the end of December 2009. 3. Since this is the only budgeted capital expenditure from Oct – Dec, 2009, no separate budget is shown. 4. The Cash Budget will reflect this $25,000 planned expenditure.

29. Cash Budget (ExpectedReceipts & Disbursements) BudgetedIncomeStatement BudgetedBalanceSheet Financial Budgets P2

30. Cash Budget Shows expected cash inflows and outflows during budget period:Beginning cash balance plus Expected receipts less Expected expenditures equals Expected final cash balanceCash Budget may include: Planned receipts from short-term loans (if expected final cash balance is inadequate), ORUse of cash to repay loans or acquire short-term investments (if expected final cash balance is in excess of requirements).

31. Cash Budget • Budgeted cash receipts: • -Expected cash sales; • -Expected cash collections of accounts • receivable.

32. Budgeted Cash Receipts P2 • 40% of Hockey Den’s sales are for cash. • 60% are credit sales (collected in full in the month following sale). Let’s prepare the cash receipts budget for Hockey Den.

33. Budgeted Cash Receipts P2 From Hockey Den’s sales budget 60 percent of September sales are collected in October 40% of sales 60% of sales

34. Budgeted Cash Receipts P2

35. Cash Budget • Budgeted cash disbursements • Budgeted cash disbursements from: -Selling expense budget, and -General & administrative expense budget. • Expected cash disbursements for: -Interest expense and -Income taxes. • Expected cash purchases; • Expected cash payments on accounts payable.

36. Cash Disbursements for Purchases P2 • Hockey Den’s purchases of merchandise are entirely on account. • Full payment is made in the month following purchase. • The September 30 balance of Accounts Payable is $58,200. Let’s look at cash disbursementsfor purchases for Hockey Den.

37. Cash Disbursements for Purchases P2 From merchandise purchases budget

38. Continue Cash Budget P2 Hockey Den: • Will pay a cash dividend of $3,000 in November. • Will purchase $25,000 of equipment in December. • Has an income tax liability of $20,000 from the previous quarter that will be paid in October. • Has a September 30 cash balance of $20,000. • Has an agreement with its bank for loans at the end of each month to enable a minimum cash balance of $20,000.

39. Cash Budget P2 Hockey Den: • Pays interest equal to one percent of the prior month’s ending loan balance. • Repays loans when the ending cash balance exceeds $20,000. • Owes $10,000 on this loan arrangement on September 30. • Has 40 percent income tax rate. • Will pay taxes for current quarter next year. Let’s prepare the cash budget for Hockey Den.

40. P2 From Cash Receipts Budget From Cash Disbursementsfor Purchases

41. P2 From Selling Expense Budget

42. P2 Because Hockey Denmaintains a minimumcash balance of $20,000, the company must borrow $12,800. .01 × $10,000

43. Cash Budget Continued P2 Ending cash balance for October is the beginning November balance.

44. P2 Cash balanceis sufficientto repay the$22,800 loan. .01 × $22,800

45. P2

46. Cash Budget Continued P2

47. EXERCISE 2 EXERCISE 3

48. Budgeted Income Statement Managerial accounting report showing predicted amounts of: -Sales; -Expenses. Information comes from already prepared budgets. Income tax expense predicted at this level.

49. From the Sales Budget P2 From the Merchandise Purchases Budget

50. P2 From the SellingExpense Budget