PROFIT

PLANNING/
BUDGETING
ACC 2203 Review Workshop
Sindhu Bala
BUDGETING –
DEFINITIONS
Master Budget – a comprehensive plan of all aspects of a firm’s future business and
production operations
Master 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 – DEFINITIONS
All 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 pursue
Budgets 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
Sales
Budget
Ending
Finished Goods
Budget Selling and
Production
Administrative
Budget
Budget

Direct Direct Manufacturing

Materials Labor Overhead
Budget Budget Budget

Cash
Budget

Budgeted Financial Statements

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
BUDGET
The 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 2 nd
3rd 4th Year

Expected Sales 1,000

(in units)

Selling price x $200 x $200 x $200 x $200 x $200

per unit

Total Sales
Revenue
FOSTER COMPANY - COLLECTIONS
BUDGET
SCHEDULE 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 credit
2. 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
Quarter Expected Credit Cash Collections By Quarter
st
Sales Sales 1 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
BUDGET
PRODUCTION BUDGET – predicts the number of units
the firm plans to produce during the budget period.

Finished Goods Inventory

Beginning F.G Inventory Units Sold

Units Produced

Ending F.G Inventory

FOSTER COMPANY - PRODUCTION
BUDGET
Note 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
BUDGET
Foster 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 quantities
Companies 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 Budgeted cost of Total budgeted cost

of input to make one input
sweater

Direct Materials

Direct Labor

Variable overhead

Fixed overhead

Total budgeted cost

per unit
 FOSTER COMPANY – DM BUDGET
DIRECT 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

Beginning Inventory Materials used in production

Materials Purchased

Ending Inventory

Foster keeps at the beginning of each quarter a materials

inventory of 10% of the quarter’s raw materials needs.
FOSTER COMPANY – DM BUDGET
Foster Company
Direct Materials Budget for 2007
Quarter
st nd
1 2 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 credit
2. 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 of Total Quarter in which cash is paid
st
purchases purchases 1 2nd 3rd 4th

A/P, beginning

1st quarter

2nd quarter

3rd quarter

4th quarter

Total cash
disbursements
FOSTER COMPANY – DL BUDGET
DIRECT 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 BUDGET
Foster Company
Direct Labor Budget for 2007
Quarter
st nd
1 2 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 BUDGET
MANUFACTURING 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 BUDGET
Foster Company
Manufacturing Overhead Budget for 2007
Quarter
st nd
1 2 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 BUDGET
SELLING 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 BUDGET
Foster Company
Selling and Administrative Expense Budget for 2007
Quarter
st nd
1 2 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 BUDGET
The 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 BUDGET
Foster 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 BUDGET
Excess (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 STATEMENT
BUDGETED 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