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Chapter 8

Chapter 8. Budgetary Planning. Learning Objective 8-1. Describe (a) how and why organizations use budgets for planning and control and (b) potential behavioral issues to consider when implementing a budget. Planning Developing objectives for acquisition and use of resources. Control

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Chapter 8

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  1. Chapter 8 Budgetary Planning

  2. Learning Objective 8-1 Describe (a) how and why organizations use budgets for planning and control and (b) potential behavioral issues to consider when implementing a budget.

  3. Planning Developing objectives for acquisitionand use of resources. Control Steps taken by management to ensure that objectives are attained. Role of Budgets in the Planning and Control Cycles A budget is a comprehensive financialplan for achieving the financial andoperational goals of an organization.

  4. Planning and Control Cycle

  5. Planning Process StrategicPlan Long-termObjectives Short-termObjectives Tactics

  6. Benefits of Budgeting

  7. Budget Problems Perceived unfair or unrealistic goals. Poor management-employee communications. Solution Reasonable and attainable budgets. Employee participation in budgeting process. Behavioral Effects of Budgets

  8. Budget Problems Building budget slack into budgets. A “use-it-or-lose-it” mentality. Solution Different budgets for planning and for performance evaluation. Continuous, or rolling budgets. Zero-based budgeting. Behavioral Effects of Budgets

  9. Learning Objective 8-2 Describe the major components of the master budget and their interrelationships.

  10. Components of the Master Budget

  11. Learning Objective 8-3 • Prepare the following components of the operating budget: • Sales budget. • Production budget. • Raw materials purchases budget. • Direct labor budget. • Manufacturing overhead budget. • Cost of goods sold budget. • Selling and administrative budget. • Budgeted income statement.

  12. Preparation of the Operating Budgets Let’s take a closer look at the operating budgets using Cold Stone Creamery as our example.

  13. EstimatedUnit Sales EstimatedUnit Price Analysis of economic and market conditions+Forecasts of customer needs from marketing personnel Sales Budget SalesBudget

  14. Sales Budget We begin the preparation of operating budgets with the sales budget using information from a single Cold Stone Creamery location. We prepare the sales budget by multiplying the number of units we expect to sell times the budgeted unit price.

  15. Production Budget The production budget is directly related to the sales budget and to the quantity of inventory the company wants to have on hand at the beginning and end of each period. The relationship between budgeted production, sales, and inventory is summarized in the following formula:

  16. Production Budget Prepare a production budget for Cold Stone Creamery using the sales budget and the following inventory policy: Cold Stone maintains an ending inventory of finished goods equal to 5 percent of budgeted sales in units for the current period. The beginning inventory for Quarter 1 (for the year) is 900 units.

  17. Production Budget 5% of 15,000 5% of 20,000 5% of 27,000 5% of 23,000

  18. Raw Materials Purchases Budget Next, we must determine what quantity of raw materials to purchase to use for the production budget. Budgeted material purchases will depend on budgeted production needs, as well as on the planned levels for beginning and ending raw materials inventory. The relationship between budgeted raw material purchases, budgeted production, and raw materials inventory is summarized in the following formula:

  19. Raw Materials Purchases Budget Prepare a raw materials purchases budget for Cold Stone Creamery using the production budget and the following inventory policy: Cold Stone maintains an ending inventory of materials equal to 3 percent of the next quarter’s production needs, making the beginning inventory for each quarter equal to 3 percent of the current quarter’s production needs. The ending inventory for Quarter 4 (for the year) is assumed to be 3,510 ounces. Each Cold Stone ice cream creation requires a total of 10 ounces of raw materials (ice cream, candy, fruit, nuts, caramel, etc.) at an average cost of $0.05 per ounce.

  20. Raw Materials Purchases Budget From Production Budget 3% of 148,500 3% of 202,500 3% of 273,500 3% of 228,000

  21. Raw Materials Purchases Budget

  22. Direct Labor Budget Each Cold Stone Creamery creation requires 0.10 hour (6 minutes) of direct labor (DL) time to take customers’ orders and payments, to mix and serve the ice cream, and to clean up. The direct labor rate is $10.00 per hour. Let’s prepare the direct labor budget.

  23. Manufacturing Overhead Cost Budget Cold Stone Creamery’s variable manufacturing overhead cost is $0.10 per unit and the fixed manufacturing overhead cost is $8,525 per quarter. Let’s prepare the manufacturing overhead budget.

  24. Budgeted Cost of Goods Sold First, let’s compute the manufacturing cost per unit, and then we will compute cost of goods sold for each period.

  25. Budgeted Cost of Goods Sold Using the unit manufacturing cost of $2.00 and the budgeted sales in units, we can compute cost of goods sold for each period by multiplying the unit cost times the budgeted sales for the period.

  26. Selling and Administrative Expense Budget Variable selling expenses for a period are 5 percent ofsales revenue for that same period. Fixed administrativeexpenses are $10,000 per quarter. 5% of $135,000 5% of $75,000 5% of $100,000 5% of $115,000

  27. Budgeted Income Statement

  28. Learning Objective 8-4 Prepare the cash budget and describe the relationships among the operating budgets, cash budget, and budgeted balance sheet.

  29. Preparation of the Financial Budgets Now, let’s focus on the financial budgets for Cold Stone Creamery.

  30. Cash Budget Our focus is on cash flows that arise from operating activities and are directly related to the operating budgets for Cold Stone Creamery. The relationship between budgeted cash collections and budgeted cash payments from operating activities and cash balances is summarized in the following formula:

  31. Cash Budget Budgeted sales for four quarters of the year are as follows: • All budgeted cash collections will come from sales revenue. To calculate the budgeted cash collections, we will assume that 40% of Cold Stone's revenue is from cash sales. The other 60% is from sales on credit, which is collected as follows: • 75% of credit sales collected in the quarter of sale. • 25% of credit sales collected in the quarter following the sale.

  32. Budgeted Cash Collections (60% of $75,000) × 0.75) 40% of $75,000 (60% of $75,000) × 0.25)

  33. Budgeted Cash Payments • We will use the following additional information to develop a cash payments budget for Cold Stone Creamery: • 20% of raw materials purchases are paid for during the quarter purchased; 80% are paid for in the following quarter.Raw material purchases for the fourth quarter of the previous year were $6,250. • • Direct labor, manufacturing overhead costs, and selling and administrative costs are paid for during the quarter incurred. • The operating budgets include $3,000 in depreciation (a noncash expense). • Management plans to invest in a new refrigeration system during Quarter 1 at a total cost of $120,000. The company will pay 50 • percent cash and the balance evenly across Quarters 2, 3, and 4.

  34. Budgeted Cash Payments for Merchandise Purchases 20% of $7,506 80% of $7,506

  35. Budgeted Cash Payments

  36. Cash Budget • We will use the following additional information todevelop the cash budget for Cold Stone Creamery: • At the beginning of the first quarter, the cash account balance was$55,200. • Cold Stone Creamery has a bank agreement enabling the company to borrow and repay cash in increments of $5,000 as needed to maintain a minimum cash balance of $50,000. No interest is charged if the loan is repaid by the end of the next quarter. • The balance on the loan at the beginning of Quarter 1 is zero.

  37. Cash Budget

  38. Budgeted Balance Sheet (60% of $115,000) × 0.25) From Cash Budget. 3,510 ounces @ $0.05 1,150 units @ $2.00 80% × $11,233

  39. Learning Objective 8-5 Prepare a merchandise purchases budget for a merchandising firm.

  40. Budgeting in Non-Manufacturing Firms The primary operating budget for a merchandiser is amerchandise purchases budget, which is similar in formto a raw materials purchases budget for a manufacturer. Since a merchandising company does not manufacture, it does not have raw material, direct labor, and manufacturing overhead budgets.

  41. Budgeting in Non-Manufacturing Firms Assume that you are a purchasing manager for a Gap retail store responsible for purchasing denim jeans and preparing the merchandise purchases budget. In your experience, inventory on hand at the beginning of each quarter should be equal to 20 percent of that quarter’s sales. In other words, ending inventory should be equal to 20 percent of next quarter’s sales.

  42. Budgeting in Non-Manufacturing Firms 20% of $20,000 20% of $30,000

  43. End of Chapter 8

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