The direct labor budget is based on

Managerial Accounting

Master Budgeting

Chapter 8

PowerPoint Authors:

Susan Coomer Galbreath, Ph.D., CPA

Charles W. Caldwell, D.B.A., CMA

Jon A. Booker, Ph.D., CPA, CIA

Cynthia J. Rooney, Ph.D., CPA

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Learning Objective 1

Understand why organizations budget and the processes they use to create budgets.

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.

The act of preparing a budget is called budgeting.

The use of budgets to control an organization’s activities is known as budgetary control.

Difference Between 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.

Advantages of Budgeting

Advantages

Define goals

and objectives

Uncover potential

bottlenecks

Coordinate

activities

Communicate

plans

Means of allocating

resources

Responsibility Accounting

Managers should be held responsible for those items - and only those items - that they can actually control to a significant extent. Responsibility accounting enables organizations to react quickly to deviations from their plans and to learn from feedback.

Choosing the Budget Period

Operating Budget

2014

2015

2016

2017

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.

Self-Imposed Budget

A self-imposed budget or participative budget is a budget that is prepared with the full cooperation and participation of managers at all levels.

Advantages of Self-Imposed Budgets

Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management.

Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers.

Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above.

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.

Self-Imposed Budgets

Self-imposed budgets should be reviewed by higher levels of management to prevent “budgetary slack.”

Most companies issue broad guidelines in terms of overall profits or sales. Lower level managers are directed to prepare budgets that meet those targets.

Human Factors in Budgeting

The success of a budget program depends on three important factors:

Top management must be enthusiastic and committed to the budget process.

Top management must not use the budget to pressure employees or blame them when something goes wrong.

Highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget targets.

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

Seeing the Big Picture

To help you see the “big picture” keep in mind that the 10 schedules in the master budget are designed to answer the 10 questions shown on the next screen.

Seeing the Big Picture

How much sales revenue will we earn?

How much cash will we collect from customers?

How much raw material will we need to purchase?

How much manufacturing costs will we incur?

How much cash will we pay to our suppliers and our direct laborers, and how much cash will we pay for manufacturing overhead resources?

What is the total cost that will be transferred from finished goods inventory to cost of good sold?

How much selling and administrative expense will we incur and how much cash will be pay related to those expenses?

How much money will we borrow from or repay to lenders – including interest?

How much operating income will we earn?

What will our balance sheet look like at the end of the budget period?

The Master Budget: An Overview

A master budget is based on various estimates and assumptions. For example, the sales budget requires three estimates/assumptions as follows:

What are the budgeted unit sales?

What is the budgeted selling price per unit?

What percentage of accounts receivable will be collected in the current and subsequent periods.

The Master Budget: An Overview

When Microsoft Excel© is used to create a master budget, these types of assumptions can be depicted in a Budget Assumptions tab, thereby enabling Excel-based budget to answer “what-if” questions.

Learning Objective 2

Prepare a sales budget, including a schedule of expected cash collections.

Budgeting Example

Royal Company is preparing budgets for the quarter ending June 30th.

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.

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

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.

In April, the March 31st accounts receivable balance of $30,000 will be collected in full.

Expected Cash Collections

Expected Cash Collections

From the Sales Budget for April.

Expected Cash Collections

From the Sales Budget for May.

Quick Check ✓

What will be the total cash collections for the quarter?

a. $700,000

b. $220,000

c. $190,000

d. $905,000

What will be the total cash collections for the quarter?

a. $700,000

b. $220,000

c. $190,000

d. $905,000

Quick Check ✓

Expected Cash Collections

Learning Objective 3

Prepare a production budget.

The Production Budget

Production

Budget

Sales

Budget and Expected Cash Collections

Completed

The production budget must be adequate to

meet budgeted sales and to provide for

the desired ending inventory.

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 31st, 4,000 units were on hand.

Let’s prepare the production budget.

If Royal was a merchandising company it would prepare a merchandise purchase budget instead of a production budget.

The Production Budget

The Production Budget

March 31

ending inventory.

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

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 ✓

The Production Budget

The Production Budget

Assumed ending inventory.

Learning Objective 4

Prepare a direct materials budget, including a schedule of expected cash disbursements for purchases of materials.

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.

The Direct Materials Budget

From production budget.

The Direct Materials Budget

The Direct Materials Budget

Calculate the materials to be purchased in May.

March 31 inventory.

10% of following month’s production needs.

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

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 ✓

The Direct Materials Budget

The Direct Materials Budget

Assumed ending inventory.

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.

Expected Cash Disbursement for Materials

Expected Cash Disbursement for Materials

140,000 lbs. × $0.40/lb. = $56,000

Compute the expected cash disbursements for materials for the quarter.

Quick Check ✓

What are the total cash disbursements for the quarter?

a. $185,000

b. $ 68,000

c. $ 56,000

d. $201,400

What are the total cash disbursements for the quarter?

a. $185,000

b. $ 68,000

c. $ 56,000

d. $201,400

Quick Check ✓

Expected Cash Disbursement for Materials

Learning Objective 5

Prepare a direct labor budget.

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 paid 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.

The Direct Labor Budget

From production budget.

The Direct Labor Budget

The Direct Labor Budget

Greater of labor hours required

or labor hours guaranteed.

The Direct Labor Budget

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

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 ✓

Learning Objective 6

Prepare a manufacturing overhead budget.

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.

Manufacturing Overhead Budget

Direct Labor Budget.

Manufacturing Overhead Budget

Total mfg. OH for quarter $251,000 Total labor hours required 5,050

= $49.70 per hour *

* rounded

Manufacturing Overhead Budget

Depreciation is a noncash charge.

Ending Finished Goods Inventory Budget

Direct materials

budget and information.

Ending Finished Goods Inventory Budget

Direct labor budget.

Ending Finished Goods Inventory Budget

Total mfg. OH for quarter $251,000 Total labor hours required 5,050

= $49.70 per hour

Ending Finished Goods Inventory Budget

Production Budget.

Learning Objective 7

Prepare a selling and administrative expense budget.

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.

Selling and Administrative Expense Budget

Calculate the selling and administrative cash expenses for the quarter.

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

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 ✓

Selling Administrative Expense Budget

Learning Objective 8

Prepare a cash budget.

Format of the Cash Budget

The cash budget is divided into four sections:

Cash receipts section lists all cash inflows excluding cash received from financing;

Cash disbursements section consists of all cash payments excluding repayments of principal and interest;

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

Financing section details the borrowings and repayments projected to take place during the budget period.

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.

The Cash Budget

Schedule of Expected

Cash Collections.

The Cash Budget

Direct Labor

Budget.

Manufacturing

Overhead Budget.

Selling and Administrative

Expense Budget.

Schedule of Expected

Cash Disbursements.

The Cash Budget

Because Royal maintains

a cash balance of $30,000,

the company must borrow $50,000 on its line-of-credit.

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.

The Cash Budget

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

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 ✓

The Cash Budget

$50,000 × 16% × 3/12 = $2,000 Borrowings on April 1 and repayment on June 30.

The Budgeted Income Statement

Cash

Budget

Budgeted

Income

Statement

Completed

With interest expense from the cash budget, Royal can prepare the budgeted income statement.

Learning Objective 9

Prepare a budgeted income statement.

The Budgeted Income Statement

Sales Budget.

Ending Finished Goods Inventory.

Selling and Administrative Expense Budget.

Cash Budget.

Learning Objective 10

Prepare a budgeted balance sheet.

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

Questions

Page 372

8-1 8-2

8-3 8-4

8-6

Pages 374-379

8-1 8-2

8-3 8-4

8-5 8-6

8-7 8-12(1-3 )

8-13 (1-3 )

Exercises

End of Chapter 8