Budgeting Handout2

STUDY OBJECTIVES 1. Identify the benefits of budgeting. The primary advantages of budgeting are that it (a) requires management to plan ahead, (b) provides definite objectives for evaluating performance, (c) creates an early warning system for potential problems, (d) facilitates coordination of activities, (e) results in greater management awareness, and (f) contributes to positive behavior patterns. 2. Describe the essentials of effective budgeting. The essentials of effective budgeting are (a) sound organizational structure, (b) research and analysis, and (c) acceptance by all levels of management. 3. Identify the budgets that comprise the master budget. The master budget consists of the following budgets: (a) sales, (b) production, (c) direct materials, (d) direct labor, (e) manufacturing overhead, (f) selling and administrative expense, (g) budgeted income statement, (h) capital expenditure budget, (i) cash budget, and (j) budgeted balance sheet. 4. Describe the sources for preparing the budgeted income statement. The budgeted income statement is prepared from (a) the sales budget, (b) the budgets for direct materials, direct labor, and manufacturing overhead, and (c) the selling and administrative expense budget. 5. Explain the principal sections of a cash budget. The cash budget has three sections (receipts, disbursements, and financing) and the beginning and ending cash balances. 6. Indicate the applicability of budgeting in nonmanufacturing companies. Budgeting may be used by merchandisers for development of a master budget. In service enterprises, budgeting is a critical factor in coordinating staff needs with anticipated services. In not-for-profit organizations, the starting point in budgeting is usually expenditures, not receipts. Components of the Master Budget: A. Operating Budget 1. Sales Budget 2. Purchases Budget 3. Cost of Goods Sold Budget 4. Operating Expenses Budget 5. Budgeted Income Statement B. Financial Budget 1. Cash Budget (Cash Receipts and Disbursements0 2. Capital Budget 3. Budgeted Balance Sheet

TRUE-FALSE STATEMENTS 1.

Budgets represent management’s plans in financial terms.

2.

Budgets promote efficiency and serve as a deterrent to waste.

3.

A budget can be a means of communicating a company's objectives to external parties.

4.

A budget facilitates coordination of activities within the business but is a poor tool for evaluating performance.

5.

A budget is more beneficial if accepted by lower level management.

6.

The budget itself and the administration of the budget are the responsibility of management.

7.

The most common budget period is one year.

8.

The flow of input data for budgeting should be from the lowest levels of responsibility to the highest level.

9.

Budgets, by their very nature, create a negative effect on human behavior within companies because they imply that management is trying to control.

10.

A budget committee coordinates the budget activities of a company.

11.

The shorter the budget period, the more reliable the estimates of future outcomes.

12.

Upper level managers are responsible for preparing the entire budget.

13.

The last step in the budgeting process is developing a sales forecast.

14.

Budgeting and long-range planning differ in the emphasis and the time period involved.

15.

Long-range plans are used primarily as an evaluation of specific results to be achieved.

16.

Long-range plans reflect management's long-term plans encompassing five years or more.

17.

The master budget consists of a plan of action for a specified time period.

18.

Operating budgets must be completed before the financial budgets can be prepared.

19.

The production budget must be completed before the materials purchases budget because the number of units to be produced must be known to determine how much material to buy.

20.

The number of direct labor hours needed for production is obtained from the direct labor budget.

21.

Companies can use either a predetermined overhead rate or a manufacturing overhead budget. The manufacturing overhead budget generally has separate sections for variable and fixed costs.

22. 23.

A sales budget should be prepared before the production budget.

24.

The direct materials budget contains only quantity data so the purchasing department knows how much materials should be purchased.

25.

The budgeted income statement indicates the expected amount of cash expected to be acquired from operations.

26.

Companies that do not prepare cash budgets have significant cash deficiencies.

27.

In preparing the budgeted balance sheet, management should not be concerned if it does not balance since it does not reflect actual results.

28.

The first budget prepared should be the sales budget.

29.

A merchandiser has a merchandise purchases budget, and a manufacturer has a materials purchases budget.

30.

A service company has no purchases budget.

Problem I (Sales Budget) Chem-Tech is a wholesaler for three chemical compounds, Rev-X, Sip-X, and Tok-Y. The following information on these products relates to the year 2010: Product Rev-X Sip-X Tok-Y

Sales (lbs) 10,000 9,000 7,500

Average Selling Price(per lbs) $30 23 18

Gross Profit $10 8 5

Demand for Rev-X has greatly increased and its expected to double in 2011. Sip-X will probably experience a 40% increase in demand, while demand for Tok-Y is expected to remain constant. In line with the industry, sales prices for Sip-X and Tok-Y will increase by 5%; the sale price for Rev-X will increase by 15%. Unit costs of goods sold are expected to increase as follows: Rev-X, 25%; Sip-X, 20%; Tok-Y, 10%. Instructions Prepare a schedule presenting budgeted sales revenue and gross profit, by product, for 2011. Problem II (Sales, Production, and Purchases Budget) The Wilton Company manufactures and sells products: J, C, and P. In September 2010, the company’s budget department gathered the following forecast data for operations of the coming year. Projected Sales for Fourth Quarter Product Quantity Price Product J 4,000 $12 Product C 2,000 25 Product P 3,000 20

Product J Product C Product P Material A Material B Material C

Inventories Beginning 600 500 400 2,000 1,500 2,500

Desired Ending 900 400 500 2,500 2,000 2,000

Material Production Requirements for Each Unit of Product Product Material A Material B Material C Product J 3 1 2 Product C 2 2 4 Product P 1 3 2 There is no beginning or ending inventory of work in process. Budgeted unit costs for materials A, B, and C are $0.50, $2.00, and $1.50, respectively. Required: 1) Prepare a sales budget that includes quantities and revenues for each of the three products. 2) Prepare a production budget for all three products. 3) Prepare a material usage budget. 4) Prepare a materials purchases budget.

Problem III ( Operating Budget, Budgeted Income Statement) Ladderton Electronics, Inc., manufactures three models for electric power supply units, Economy, Standard, and Deluxe. They are sold in four different markets, Eastern United Sates, Western United States, Europe, and Asia. Each unit converts electric current from AC to DC for use in various types of electronic equipment ranging from radios and televisions to computers. The three different units produce DC output at different wattage levels. The product is manufactured in two producing departments, Assembly and Testing. Estimates for the coming year follow: a) Sales Forecast by territory: Model Economy Standard Deluxe

Eastern US 60,000 40,000 20,000

Western US 50,000 45,000 25,000

Units_________________________ Europe Asia Sales Price/Unit 75,000 25,000 $50.00 60,000 35,000 70.00 35,000 30,000 90.00

b) Inventories: Beginning (Units) Materials: Boxes 10,000 Transformers 15,000 Diode Rectifiers 25,000 Filters 25,000 Resistors 10,000 Wire (in feet) 30,000

Unit Cost $1.50 4.50 0.70 1.75 0.20 0.50

Desired Ending (Units) 5,000 10,000 25,000 20,000 50,000 40,000

Work in process: None at the beginning and end of the period. Finished Goods (FIFO): Beginning (Units) Economy Model 15,000 Standard Model 15,000 Deluxe Model 15,000

Unit Cost – Beginning Desired Ending (Units) $25.00 20,000 38.50 15,000 55.25 10,000

c) Material requirements for products and estimated material costs: Economy Standard Deluxe Estimated Cost Model__ Model__ Model_ Per Unit of Material Boxes 1 1 1 $1.50 Transformers 1 2 3 4.50 Diode Rectifiers 2 4 5 0.70 Filters 2 3 6 1.75 Resistors 5 8 10 0.20 Wires (in feet) 5 6 8 0.50 d) Estimated labor time requirements and rates in hours Assembly Dept. Testing Dept. Economy Model 0.50 0.05 Standard Model 0.75 0.05 Deluxe Model 1.00 0.05 Direct labor per hour $10 $12 e) Estimated machine time in Testing Department: Hours Required Economy Model 0.15 Standard Model 0.25 Deluxe Model 0.35

f)

Budgeted factory overhead Assembly Department Fixed Cost Variable/LH Indirect Materials $158,000 $1.50 Indirect labor 350,000 0.50 Payroll taxes 382,500 0.05 Employee fringe benefits 347,500 -Equipment depreciation 65,000 -Repairs and Maintenance 25,000 0.40 Allocated building costs 12,000 -Allocated gen. factory costs 241,125 --

Testing Department Fixed Cost Variable/MH $157,000 $0.35 250,000 1.00 55,000 0.10 114,000 -215,000 -35,000 1.50 9,000 -82,700 --

Overhead is allocated to production on the basis of direct labor hours in the Assembly Department and on the basis of machine hours in the Testing Department. g) Budgeted commercial expenses: Marketing : $145,000 Administration : $2,330,500 h) Income tax rate is 40% Required: Prepare annual budget schedules. The schedules should be designed to provide essential data in a form that is easily understood and should include the following: 1) Sales budget – by models and by sales territories 2) Production budget – by models and by units 3) Direct materials budget in units – by materials and by models 4) Materials purchases budget – by materials and by cost 5) Cost of materials required for production – by materials and by models 6) Direct labor budget – by models and departments, with costs and hours 7) Budgeted machine hours in the Testing Department 8) Budgeted factory overhead and department rates 9) Budgeted unit product costs 10) Beginning and Ending inventories 11) Budgeted cost of goods manufactured and sold 12) Budgeted Income Statement Problem IV (Production Budget) The budget components for McLeod Company for the quarter ended June 30 appear below. McLeod sells trash cans for $12 each. Budgeted sales of trash cans for the next four months are: April May June July

20,000 units 50,000 units 30,000 units 25,000 units

McLeod desires to have trash cans on hand at the end of each month equal to 20 percent of the following month’s budgeted sales in units. On March 31, McLeod had 4,000 completed units on hand. The number of trashcans to be produced in April and May are 26,000 and 46,000, respectively. Seven pounds of plastic are required for each trash can. At the end of each month, McLeod desires to have 10 percent of the following month’s production material needs on hand. At March 31, McLeod had 18,200 pounds of plastic on hand. The material used in production costs $0.60 per pound. Each trashcan produced requires 0.10 hours of direct labor. Required: How many trashcans should McLeod produce during the month of June?

Problem IV (Purchases Budget)

The budget components for McLeod Company for the quarter ended June 30 appear below. McLeod sells trash cans for $12 each. Budgeted sales and production of trash cans for the next four months are: April May June July

Sales 20,000 units 50,000 units 30,000 units 25,000 units

Production 26,000 units 46,000 units 29,000 units 20,000 units

McLeod desires to have trash cans on hand at the end of each month equal to 20 percent of the following month’s budgeted sales in units. On March 31, McLeod had 4,000 completed units on hand. The number of trashcans to be produced in April and May are 26,000 and 46,000, respectively. Seven pounds of plastic are required for each trash can. At the end of each month, McLeod desires to have 10 percent of the following month’s production material needs on hand. At March 31, McLeod had 18,200 pounds of plastic on hand. The material used in production costs $0.60 per pound. Each trashcan produced requires 0.10 hours of direct labor. Required: Determine how much the materials purchases budget will be for the month ending April 30. Problem V (Manufacturing Budget) The Hammer Division of Stanton Tool Company makes a variety of hammers. All have wooden handles and steel heads. The division makes no distinction between types of hammers when preparing budgets. On average, each hammer requires a one-foot piece of wood stock and 1.5 pounds of steel. Direct labor averages 0.25 hours per hammer and is paid $16 per hour, including fringe benefits. All quarterly overhead costs except depreciation are paid in cash as incurred. The factory overhead costs include: Fixed Variable per unit Rent $12,000 -Indirect labor 17,000 $0.25 Depreciation 10,000 -Supplies 4,000 0.20 Repairs and maintenance 7,500 0.05 Total overhead $50,500 $0.50 ====== ==== The Hammer Division is planning for the second quarter of 2010. Projected sales are 20,000 hammers at $15 each. Half the sales are for cash, and half are on credit. On the credit sales, 75% are collected in the quarter of sale and 25% in the following quarter. No uncollectible accounts are anticipated. Accounts receivable at the beginning of the quarter are $25,000 (i.e. 25% of last quarter’s $100,000 credit sales). Wood stock costs $1 per foot, and the beginning inventory is 500 feet. Steel costs $2 per pound, and the beginning inventory is 1,000 pounds. The desired ending inventory amounts are: wood stock, 400 feet; steel, 800 pounds. Wood stock and steel are paid for in cash when they are purchased. The beginning finished goods inventory ahs 200 hammers ($2,200), and the desired ending inventory is 400 finished hammers. Work-in-process inventory is neglible. Selling and administrative costs for the quarter include: Salaries $6,000 Commissions 8% of sales revenue Advertising $9,000 Shipping $0.20 per hammer They are paid for in cash when incurred.

The beginning cash balance is $25,000, and the minimum desired balance is $20,000. Required: Prepare the following budgets: 1) Sales budget 2) Manufacturing budget (including production budget, direct materials usage and purchases budget, direct labor budget, and factory overhead budget) 3) Cost of goods manufactured and sold budget 4) Selling and administrative expenses budget 5) Budgeted income statement 6) Cash budget. Assume that there are no financing activities to be shown on the cash budget Problem VI (AICPA, Cash Budget) A. Prepare a statement of cash receipts and disbursements for October 2011 for the Rourk Company, which sells one product. On October 1, 2011, part of the trial balance showed: Cash $ 6,000 Accounts Receivable 19,500 Allowance for bad debts $2,400 Merchandise Inventory 12,000 Accounts payable, merchandise 9,000 The company’s purchases are payable within ten days. Assume that one-third of the purchases of any month are due and paid for in the following month. The unit invoice cost of the merchandise purchased is $10. At the end of each month it is desired to have an inventory equal in units to 50% of the following month’s sales in units. Sales terms include a 1% discount if payment is made by the end of the calendar month. Past experience indicates that 60% of the billings will be collected during the month of sale, 30% in the following calendar month, 6% in the next following calendar month. Four percent will be uncollectible. The company’s fiscal year begins August 1. Unit selling price $15 August actual sales $15,000 September actual sales 45,000 October estimated sales 36,000 November estimated sales 27,000 Total sales expected in the fiscal year 450,000 Exclusive of bad debts, total budgeted selling and general administrative expenses for the fiscal year are estimated at $68,500, of which $21,000 is fixed (inclusive of a $9,000 annual depreciation charge). These fixed expenses are incurred uniformly throughout the year. The balance of the selling and general administrative expenses varies with sales. Expenses are paid as incurred. B. Markus Corporation's sales of gizmos are 25% for cash and 75% on credit. Past collection history indicates that credit sales are collected as follows: 30% in the month of sale 60% in the month following sale 10% in the second month following sale In January, sales were $42,000 and February sales were $45,000. Projected sales for March are 3,000 gizmos at $10 each. Projected sales for April are 4,500 gizmos at $12 each. The cash balance at March 1 was $5,785. Markus expects to purchase $24,000 of materials in February and $21,000 of materials in March. Three-quarters of all purchases are paid for in the month of purchase, and the other one-fourth are paid for in the month following the month of purchase. In addition, a 2% discount is allowed for

payments made in the month of purchase. All other fixed expenses are $7,000 per month and are paid in the month of purchase. Instructions A. Prepare a cash budget for March. B. Why is the cash budget important? C. Problem VII (Master Budget) The Loebl Company wants a master budget for the next three months, beginning January 1, 2011. It desires an ending minimum cash balance of $4,000 each month. Sales are forecasted at an average selling price of $4 per unit. Inventories are supposed to equal to 125% of the next month’s sales in units except for the end of March. The March 31 inventory in units should be 75% of the next month’s sales. Merchandise costs are $2 per unit. Purchases during any given month are paid in full during the following month. All sales are on credit, payable within thirty days, but experience has shown that 40% of current sales is collected in the current month, 40% in the next month, and 20% in the month thereafter. Bad debts are negligible. Monthly operating expenses are as follows: Wages and salaries Insurance expired Depreciation Miscellaneous Rent

$12,000 100 200 2,000 100 + 10% of sales

Cash dividends of $1,000 are pad quarterly, beginning January 15, and are declared on the fifteen of the previous month. All operating expenses are paid as incurred, except insurance, depreciation, and rent. Rent of $100 is paid at the beginning of each month, and the additional 10% of sales is paid quarterly on the tenth of the following quarter. The next settlement is due January 10. The company plans to buy some new fixtures, for $2,000 cash, in March. Money can be borrowed and repaid in multiples of $500, at an interest rate of 18% per annum. Management wants to minimize borrowing and repay rapidly. Interest is computed and paid when the principal is repaid. Assume that borrowing takes place at the beginning, and repayment is at the end, of the months in question. Money is never borrowed at the beginning and repaid at the end of the same month. Interest is computed to the nearest dollar. The abridged balance sheet as of December 31, 2010 is as follows: Cash $4,000 Accounts receivable 16,000 Inventory 31,250 Unexpired Insurance 1,200 Fixed Assets, net 10,000 Total Assets $62,450 ===== Accounts Payable (merchandise) $28,750 Dividends Payable 1,000 Rent Payable 7,000 Recent and forecasted sales: October - $30,000 November - 20,000

December - $20,000 January - 50,000

February – $60,000 March - 30,000 April - 36,000

Required: 1. Prepare a master budget, including a budgeted income statement, balance sheet, statement of cash receipts and disbursements, and supporting schedules. 2. Explain why there is a need for a bank loan and what operating sources provide the cash for the repayment of the bank loan. Problem VIII (Case of Hospital) Voorhees Hospital provides a wide range of health services in its community. Voorhees’ board of directors has authorized the following capital expenditures: Inter-aortic balloon pump $1,100,000 CT Scanner 700,000 X-ray Equipment 600,000 Laboratory Equipment 1,400,000 The expenditures are planned for October 1, 2010, and the board wishes to k now the amount of borrowing, if any, necessary on that date. Marc Kelly, hospital controller, has gathered the following information to be used in preparing an analysis of future cash flows. 1. Billings, made in the month of the service, for the first six months of 2010 are: January $4,400,000 February 4,400,000 March 4,500,000 April 4,500,000 May 5,000,000 June 5,000,000 Ninety percent of Voorhees’ billings are made to third parties such as Blue Cross, federal/state governments, and private insurance companies. The remaining 10% of the billings are made directly to patients. Historical patterns of billing collections are: Third Party Billings Direct Patient Billings Month of Service 20% 10% Month following service 50% 40% Second Month following service 20% 40% Uncollectible 10% 10% Estimated billings for the last six months of 2010 are listed next. The same billing and collection patterns that have been experienced during the first six months of 2010 are expected to continue during the last six months of the year. Month Estimated Amount July $4,500,000 August 5,000,000 September 5,500,000 October 5,700,000 November 5,800,000 December 5,500,000 2. The purchases that have been made during the past three months and the planned purchases for the last six months of 2010 are presented in the following schedules. Month April May June July August September October November December

Purchases $1,100,000 1,200,000 1,200,000 1,250,000 1,500,000 1,850,000 1,950,000 2,250,000 1,750,000

All purchases are made on account, and accounts payable are remitted in the month following the purchase. 3. Salaries for each month during the remainder of 2010 are expected to be $1,500,000 per month plus 20% of that month’s billings. Salaries are paid in the month of service. 4. Voorhees’s monthly depreciation charges are $125,000 5. Voorhees incurs interest expense of $150,000 per month and makes interest payments of $450,000 on the last day of each calendar year. 6. Endowment fund income is expected to continue to total $175,000 each month. 7. Voorhees has a cash balance of $300,000 on July 1, 2010, and has policy of maintaining a minimum end-of-month cash balance of 10$ of the current month’s purchases. 8. Voorhees Hospital employs a calendar-year reporting period. Required: 1. Prepare a schedule of budgeted cash receipts by month for the third quarter of 2010. 2. Prepare a schedule of budgeted cash disbursements by month for the third quarter of 2010. 3. Determine the amount of borrowing, if any, necessary on October 1, 2010, to acquire the capital items totaling $3,800,000. Problem IX (AICPA, Adapted- University Budgeting) Suppose you are the controller of Northern Alaska University. The university president, George Klobuchar, is preparing his annual fund-raising campaign for 2010-2011. To set an appropriate target, he has asked you to prepare a budget for the academic year. You have collected the following data for the current year 2009-2010; (1) Undergraduate Division Average salary of faculty member $40,000 Average faculty teaching load in semester credit hours per year (eight undergraduate or six graduate courses) 24 Average number of students per class 30 Total enrolment (full-time and part-time Students) 3,000 Average number of semester credit hours Carried each year per student 25 Full-time load, semester hours per year 30

Graduate Division $40,000 18 20 1,200 20 24

For 2010-2011, all faculty and staff will receive a 5% salary increase. Undergraduate enrolment is expected by 10%, but no change in graduate enrolment is expected. (2) The 2009-2010 budget for operation and maintenance of facilities is $450,000, which includes $220,000 for salaries and wages. Experience so far this year indicates that the budget is accurate. Salaries and wages will increase by 5% and other operating costs by $10,000 in 2010-2011. (3) The 2009-2010 and 2010-2011 budgets for the remaining expenditures are:

General and Administrative Library: Acquisitions Operations Health Services Intramural athletics Intercollegiate athletics Insurance and Retirement Interest

2009-2010 $455,000 136,000 172,000 43,000 51,000 218,000 475,000 10,000

2010-2011 $475,000 140,000 180,000 45,000 55,000 220,000 510,000 10,000

(4) Tuition is $60 per credit hour. In addition, the state legislature provides $700 per full-time equivalent student. (A full-time equivalent is 30 undergraduate hours or 24 graduate hours) Tuition scholarships are given to 30 full-time undergraduates and 50 full-time graduate students. (5) Revenues other than tuition and the legislative apportionment are:

Endowment income Net income from Auxiliary services Intercollegiate Athletic receipts

2009-010 $180,000

2010-2011 $190,000

295,000

305,000

260,000

270,000

(6) The chemistry/physics classroom building needs remodeling during 2010-2011 period. Projected cost is $500,000. Required: 1. Prepare a schedule for 2010-2011 that shows, by division, a) expected enrolment, b)total credit hours, c) full-time-equivalent enrolment, d) number of faculty members needed. Assume that part time faculty can be hired at the same salary per credit hour as full time faculty. 2. Calculate the budget for faculty salaries for 2010-2011 by division 3. Calculate the budget for tuition revenue and legislative apportionment for 2010-2011 by division 4. Prepare a schedule for President Klobuchar showing the amount that must be raised by the annual fund raising campaign.