Chapter 9 Profit Planning.pdf

Chapter

9 Profit Planning

9-2

LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Understand why organizations budget and the processes they use to create budgets. 2. Prepare a sales budget, including a schedule of expected cash receipts. 3. Prepare a production budget.. 4. Prepare a direct materials budget, including a schedule of expected cash disbursements for purchases of materials. 5. Prepare a direct labour budget.

© McGraw-Hill Ryerson Limited., 2001

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LEARNING OBJECTIVES After studying this chapter, you should be able to: 6. Prepare a manufacturing overhead budget. 7. Prepare an ending finished goods inventory budget. 8. Prepare a selling and administrative expense budget. 9. Prepare a cash budget. 10. Prepare a budgeted income statement and a budgeted balance sheet. 11. (Appendix 9A) Compute the optimum inventory level and order size. © McGraw-Hill Ryerson Limited., 2001

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The Basic Framework of Budgeting Detail Budget

Production

Sales

Master Budget Summary of a company’s plans.

Detail Budget

Ma terials

Detail Budget

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Planning and Control ! Planning --

involves developing objectives and preparing various budgets to achieve these objectives.

! Control -- involves

the steps taken by management that attempt to ensure the objectives are attained.

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Advantages of Budgeting Define goal and objectives Communicating plans

Think about and plan for the future

Advantages Coordinate activities

Means of allocating resources Uncover potential bottlenecks

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Responsibility Accounting Managers should be held responsible for those items — and only those items — that the manager can actually control to a significant extent.

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Choosing the Budget Period

Operating Budget

1999

2000

2001

2002

The annual operating budget may be divided into quarterly or monthly budgets.

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9-9

Choosing the Budget Period Continuous or Perpetual Budget

1999

2000

2001

2002

This budget is usually a twelve-month budget that rolls forward one month as the current month is completed.

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Participative Budget System Top Management

Middle Management

Supervisor

Supervisor

Middle Management

Supervisor

Supervisor

Flow of Budget Data © McGraw-Hill Ryerson Limited., 2001

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The Budget Committee A standing committee responsible for "overall policy matters relating to the budget "coordinating the preparation of the budget

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The Master Budget Sales B udget

Selling and A dm inistrative B udget

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The Master Budget Sales B udget

Ending Inventory B udget

Production B udget

Selling and A dm inistrative B udget

D irect M aterials B udget

D irect Labour B udget

M anufacturing O verhead B udget

© McGraw-Hill Ryerson Limited., 2001

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The Master Budget Sales B udget

Ending Inventory B udget

Production B udget

Selling and A dm inistrative B udget

D irect M aterials B udget

D irect Labor B udget

M anufacturing O verhead B udget

C ash B udget

Budgeted Financial Statements © McGraw-Hill Ryerson Limited., 2001

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The Sales Budget Detailed schedule showing expected sales for the coming periods expressed in units and dollars.

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Budgeting Example #Royal Company is preparing budgets for the quarter ending June 30. $Budgeted sales for the next five months are: April May June July August

20,000 units 50,000 units 30,000 units 25,000 units 15,000 units.

%The selling price is $10 per unit. © McGraw-Hill Ryerson Limited., 2001

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The Sales Budget

Budgeted sales (units) Selling price per unit Total sales

April

May

June

20,000

50,000

30,000

Quarter 100,000

© McGraw-Hill Ryerson Limited., 2001

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The Sales Budget

Budgeted sales (units) Selling price per unit Total sales

April

May

June

Quarter

20,000

50,000

30,000

100,000

$ 10 $ 200,000

$ 10 $ 500,000

$ 10 $ 300,000

$ 10 $ 1,000,000

© McGraw-Hill Ryerson Limited., 2001

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The Production Budget Sales Budget p m o C

Production Budget

ed t le

Production must be adequate to meet budgeted sales and provide for sufficient ending inventory. © McGraw-Hill Ryerson Limited., 2001

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The Production Budget ! Royal Company wants ending inventory

to be equal to 20% of the following month’s budgeted sales in units. ! On March 31, 4,000 units were on hand.

Let’s prepare the production budget.

© McGraw-Hill Ryerson Limited., 2001

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The Production Budget Budgeted sales Add desired ending inventory Total needed Less beginning inventory Required production

April 20,000

May 50,000

June 30,000

Quarter 100,000

10,000 30,000 4,000 26,000 Budgeted Budgeted sales sales Desired Desired percent percent Desired Desired inventory inventory

50,000 50,000 20% 20% 10,000 10,000

© McGraw-Hill Ryerson Limited., 2001

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The Production Budget Budgeted sales Add desired ending inventory Total needed Less beginning inventory Required production

April 20,000

May 50,000

June 30,000

Quarter 100,000

10,000 30,000 4,000 26,000

March March 31 31 ending ending inventory inventory © McGraw-Hill Ryerson Limited., 2001

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The Production Budget Budgeted sales Add desired ending inventory Total needed Less beginning inventory Required production

April 20,000

May 50,000

June 30,000

Quarter 100,000

20%

10,000 30,000

6,000 56,000

4,000 26,000

© McGraw-Hill Ryerson Limited., 2001

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The Production Budget Budgeted sales Add desired ending inventory Total needed Less beginning inventory Required production

April 20,000

May 50,000

10,000 30,000

6,000 56,000

4,000 26,000

10,000 46,000

June 30,000

Quarter 100,000

© McGraw-Hill Ryerson Limited., 2001

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The Production Budget Budgeted sales Add desired ending inventory Total needed Less beginning inventory Required production

April 20,000

May 50,000

June 30,000

Quarter 100,000

10,000 30,000

6,000 56,000

5,000 35,000

5,000 105,000

4,000 26,000

10,000 46,000

6,000 29,000

4,000 101,000

© McGraw-Hill Ryerson Limited., 2001

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Expected Cash Collections ! All sales sales are are on on account. account. ! All ! Royal’s collection collection pattern pattern is: is: ! Royal’s 70% 70% collected collected in in the the month month of of sale, sale, 25% 25% collected collected in in the the month month following following sale, sale, 5% 5% is is uncollectible. uncollectible. ! The March March 31 31 accounts accounts receivable receivable ! The

balance balance of of $30,000 $30,000 will will be be collected collected in in full. full. © McGraw-Hill Ryerson Limited., 2001

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Expected Cash Collections Accounts rec. - 3/31

April $ 30,000

May

June

Quarter $ 30,000

Total cash collections

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Expected Cash Collections Accounts rec. - 3/31 April sales 70% x $200,000 25% x $200,000

Total cash collections

April $ 30,000

May

140,000 $ 50,000

June

Quarter $ 30,000 140,000 50,000

$ 170,000

© McGraw-Hill Ryerson Limited., 2001

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Expected Cash Collections Accounts rec. - 3/31 April sales 70% x $200,000 25% x $200,000 May sales 70% x $500,000 25% x $500,000

Total cash collections

April $ 30,000

May

June

140,000

140,000 50,000

$ 50,000 350,000 $ 125,000

$ 170,000

Quarter $ 30,000

350,000 125,000

$ 400,000

© McGraw-Hill Ryerson Limited., 2001

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Expected Cash Collections Accounts rec. - 3/31 April sales 70% x $200,000 25% x $200,000 May sales 70% x $500,000 25% x $500,000 June sales 70% x $300,000 Total cash collections

April $ 30,000

May

June

140,000

140,000 50,000

$ 50,000 350,000

$ 170,000

$ 400,000

Quarter $ 30,000

$ 125,000

350,000 125,000

210,000 $ 335,000

210,000 $ 905,000

© McGraw-Hill Ryerson Limited., 2001

9-31

The Direct Materials Budget ! At Royal Royal Company, Company, five five kilograms kilograms of of ! At

material material are are required required per per unit unit of of product. product. ! Management wants wants materials materials on on hand hand at at ! Management the the end end of of each each month month equal equal to to 10% 10% of of the the following following month’s month’s production. production. ! On March March 31, 31, 13,000 13,000 kilograms kilograms of of material material ! On are are on on hand. hand. Material Material cost cost $0.40 $0.40 per per kilogram. kilogram. Let’s Let’s prepare prepare the the direct direct materials materials budget. budget. © McGraw-Hill Ryerson Limited., 2001

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The Direct Materials Budget Production Materials per unit Production needs Add desired ending inventory Total needed Less beginning inventory Materials to be purchased

April 26,000

May 46,000

June 29,000

Quarter 101,000

From From production production budget budget © McGraw-Hill Ryerson Limited., 2001

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The Direct Materials Budget Production Materials per unit Production needs Add desired ending inventory Total needed Less beginning inventory Materials to be purchased

April 26,000 5 130,000

May 46,000 5 230,000

June 29,000 5 145,000

Quarter 101,000 5 505,000

© McGraw-Hill Ryerson Limited., 2001

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The Direct Materials Budget Production Materials per unit Production needs Add desired ending inventory Total needed Less beginning inventory Materials to be purchased

April 26,000 5 130,000

May 46,000 5 230,000

June 29,000 5 145,000

Quarter 101,000 5 505,000

23,000 153,000

10% 10% of of the the following following month’s month’s production production © McGraw-Hill Ryerson Limited., 2001

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The Direct Materials Budget Production Materials per unit Production needs Add desired ending inventory Total needed Less beginning inventory Materials to be purchased

April 26,000 5 130,000

May 46,000 5 230,000

June 29,000 5 145,000

Quarter 101,000 5 505,000

23,000 153,000 13,000 140,000

March March 31 31 inventory inventory © McGraw-Hill Ryerson Limited., 2001

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The Direct Materials Budget Production Materials per unit Production needs Add desired ending inventory Total needed Less beginning inventory Materials to be purchased

April 26,000 5 130,000

May 46,000 5 230,000

June 29,000 5 145,000

Quarter 101,000 5 505,000

23,000 153,000

14,500 244,500

11,500 156,500

11,500 516,500

13,000

23,000

14,500

13,000

140,000

221,500

142,000

503,500

© McGraw-Hill Ryerson Limited., 2001

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The Direct Materials Budget April 26,000 5 130,000

May 46,000 5 230,000

Production Materials per unit Production needs Add desired ending inventory 23,000 14,500 July Production a nd Inve ntory Total needed 153,000 244,500 Salesbeginning in units 25,000 Less Add desire d ending inventory 3,000 inventory 13,000 23,000 Tota l units 28,000 Materials tonee be ded Le ss beginning inve ntory 5,000 purchased 140,000 221,500 Production in units Kilograms per unit Tota l kilogra ms, July Desired pe rcent Desired ending inve ntory, June

June 29,000 5 145,000

Quarter 101,000 5 505,000

11,500 156,500

11,500 516,500

14,500

13,000

142,000

503,500

23,000 5 115,000 10% 11,500 © McGraw-Hill Ryerson Limited., 2001

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Expected Cash Disbursement for Materials ! Royal pays pays $0.40 $0.40 per per kilogram kilogram for for its its ! Royal

materials. materials. ! One-half of of aa month’s month’s purchases purchases are are paid paid ! One-half for for in in the the month month of of purchase; purchase; the the other other half half is is paid paid in in the the following following month. month. ! The March March 31 31 accounts accounts payable payable balance balance ! The is is $12,000. $12,000.

Let’s Let’s calculate calculate expected expected cash cash disbursements. disbursements. © McGraw-Hill Ryerson Limited., 2001

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Expected Cash Disbursement for Materials Accounts pay. 3/31 April purchases

April $ 12,000

May

June

Quarter $ 12,000

May purchases

June purchases Total cash disbursements

© McGraw-Hill Ryerson Limited., 2001

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Expected Cash Disbursement for Materials Accounts pay. 3/31 April purchases 50% x $56,000 50% x $56,000 May purchases

April $ 12,000

May

28,000 $ 28,000

June

Quarter $ 12,000 28,000 28,000

June purchases Total cash disbursements

$ 40,000

140,000 lbs. × $.40/lb. = $56,000 © McGraw-Hill Ryerson Limited., 2001

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Expected Cash Disbursement for Materials Accounts pay. 3/31 April purchases 50% x $56,000 50% x $56,000 May purchases 50% x $88,600 50% x $88,600 June purchases Total cash disbursements

April $ 12,000

May

June

28,000

28,000 28,000

$ 28,000 44,300 $ 44,300

$ 40,000

Quarter $ 12,000

44,300 44,300

$ 72,300

© McGraw-Hill Ryerson Limited., 2001

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Expected Cash Disbursement for Materials Accounts pay. 3/31 April purchases 50% x $56,000 50% x $56,000 May purchases 50% x $88,600 50% x $88,600 June purchases 50% x $56,800 Total cash disbursements

April $ 12,000

May

June

28,000

28,000 28,000

$ 28,000 44,300

$ 40,000

$ 72,300

Quarter $ 12,000

$ 44,300

44,300 44,300

28,400

28,400

$ 72,700

$185,000

© McGraw-Hill Ryerson Limited., 2001

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The Direct Labour Budget ! At Royal, Royal, each each unit unit of of product product requires requires 0.05 0.05 hours hours of of ! At

direct direct labour. labour. ! The Company Company has has aa “no “no layoff” layoff” policy policy so so all all employees employees ! The will will be be paid paid for for 40 40 hours hours of of work work each each week. week. ! In exchange exchange for for the the “no “no layoff” layoff” policy, policy, workers workers agreed agreed to to ! In aa wage wage rate rate of of $10 $10 per per hour hour regardless regardless of of the the hours hours worked worked (No (No overtime overtime pay). pay). ! For the the next next three three months, months, the the direct direct labour labour workforce workforce ! For will will be be paid paid for for aa minimum minimum of of 1,500 1,500 hours hours per per month. month.

Let’s Let’s prepare prepare the the direct direct labour labour budget. budget.

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The Direct Labour Budget Production Direct labour hours Labour hours required Guaranteed labour hours Labour hours paid Wage rate Total direct labour cost

April 26,000

May 46,000

June 29,000

Quarter 101,000

From production budget

© McGraw-Hill Ryerson Limited., 2001

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The Direct Labour Budget Production Direct labour hours Labour hours required Guaranteed labour hours Labour hours paid Wage rate Total direct labour cost

April 26,000 0.05 1,300

May 46,000 0.05 2,300

June 29,000 0.05 1,450

Quarter 101,000 0.05 5,050

© McGraw-Hill Ryerson Limited., 2001

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The Direct Labour Budget Production Direct labour hours Labour hours required Guaranteed labour hours Labour hours paid Wage rate Total direct labour cost

April 26,000 0.05 1,300 1,500 1,500

May 46,000 0.05 2,300 1,500 2,300

June 29,000 0.05 1,450 1,500 1,500

Quarter 101,000 0.05 5,050 5,300

Higher Higher of of labour labour hours hours required required or or labour labour hours hours guaranteed. guaranteed. © McGraw-Hill Ryerson Limited., 2001

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The Direct Labour Budget April Production 26,000 Direct labour hours 0.05 Labour hours required 1,300 Guaranteed labour hours 1,500 Labour hours paid 1,500 Wage rate $ 10 Total direct labour cost $ 15,000

May 46,000 0.05 2,300 1,500 2,300 $ 10 $ 23,000

June 29,000 0.05 1,450 1,500 1,500 $ 10 $ 15,000

Quarter 101,000 0.05 5,050 5,300 $ 10 $ 53,000

© McGraw-Hill Ryerson Limited., 2001

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Manufacturing Overhead Budget ! Royal Company uses a variable

manufacturing overhead rate of $1 per unit produced. produced ! Fixed manufacturing overhead is $50,000 per

month and includes $20,000 of non-cash costs (primarily amortization of plant assets).

Let’s prepare the manufacturing overhead budget. © McGraw-Hill Ryerson Limited., 2001

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Manufacturing Overhead Budget April Production in units 26,000 Variable mfg. OH rate $ 1 Variable mfg. OH costs $ 26,000 Fixed mfg. OH costs Total mfg. OH costs Less noncash costs Cash disbursements for manufacturing OH

May 46,000 $ 1 $ 46,000

June 29,000 $ 1 $ 29,000

Quarter 101,000 $ 1 $ 101,000

From production budget

© McGraw-Hill Ryerson Limited., 2001

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Manufacturing Overhead Budget April Production in units 26,000 Variable mfg. OH rate $ 1 Variable mfg. OH costs $ 26,000 Fixed mfg. OH costs 50,000 Total mfg. OH costs 76,000 Less noncash costs Cash disbursements for manufacturing OH

May 46,000 $ 1 $ 46,000 50,000 96,000

June 29,000 $ 1 $ 29,000 50,000 79,000

Quarter 101,000 $ 1 $ 101,000 150,000 251,000

© McGraw-Hill Ryerson Limited., 2001

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Manufacturing Overhead Budget April Production in units 26,000 Variable mfg. OH rate $ 1 Variable mfg. OH costs $ 26,000 Fixed mfg. OH costs 50,000 Total mfg. OH costs 76,000 Less noncash costs 20,000 Cash disbursements for manufacturing OH $ 56,000

May 46,000 $ 1 $ 46,000 50,000 96,000 20,000

June 29,000 $ 1 $ 29,000 50,000 79,000 20,000

Quarter 101,000 $ 1 $ 101,000 150,000 251,000 60,000

$ 76,000

$ 59,000

$ 191,000

Amortization Amortization is is aa non-cash non-cash charge. charge. © McGraw-Hill Ryerson Limited., 2001

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Ending Finished Goods Inventory Budget ! Now, Royal can complete the ending

finished goods inventory budget. ! At Royal, manufacturing overhead is

applied to units of product on the basis of direct labour hours. Let’s calculate ending finished goods inventory. © McGraw-Hill Ryerson Limited., 2001

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Ending Finished Goods Inventory Budget Production costs per unit Quantity Cost Direct materials 5.00 lbs. $ 0.40 Direct labour Manufacturing overhead

$

Total 2.00

Budgeted finished goods inventory Ending inventory in units Unit product cost Ending finished goods inventory

Direct materials budget and information © McGraw-Hill Ryerson Limited., 2001

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Ending Finished Goods Inventory Budget Production costs per unit Quantity Cost Direct materials 5.00 lbs. $ 0.40 Direct labour 0.05 hrs. $ 10.00 Manufacturing overhead

$

Total 2.00 0.50

Budgeted finished goods inventory Ending inventory in units Unit product cost Ending finished goods inventory

Direct labour budget © McGraw-Hill Ryerson Limited., 2001

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Ending Finished Goods Inventory Budget Production costs per unit Quantity Cost Direct materials 5.00 lbs. $ 0.40 Direct labour 0.05 hrs. $ 10.00 Manufacturing overhead 0.05 hrs. $ 49.70 Budgeted finished goods inventory Ending inventory in units Unit product cost Ending finished goods inventory

Total mfg. OH for quarter Total labour hours required

$

Total 2.00 0.50 2.49 4.99

$

4.99

$

$251,000 = $49.70 per hr.* 5,050 hrs. *rounded © McGraw-Hill Ryerson Limited., 2001

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Ending Finished Goods Inventory Budget Production costs per unit Quantity Cost Direct materials 5.00 lbs. $ 0.40 Direct labour 0.05 hrs. $ 10.00 Manufacturing overhead 0.05 hrs. $ 49.70

$

$ Budgeted finished goods inventory Ending inventory in units Unit product cost Ending finished goods inventory

Total 2.00 0.50 2.49 4.99

5,000 $ 4.99 $ 24,950

Production Budget © McGraw-Hill Ryerson Limited., 2001

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Selling and Administrative Expense Budget ! At Royal, Royal, variable variable selling selling and and administrative administrative ! At

expenses expenses are are $0.50 $0.50 per per unit unit sold. sold. ! Fixed selling selling and and administrative administrative expenses expenses are are ! Fixed

$70,000 $70,000 per per month. month. ! The fixed fixed selling selling and and administrative administrative expenses expenses ! The

include include $10,000 $10,000 in in costs costs –– primarily primarily amortization amortization –– that that are are not not cash cash outflows outflows of of the the current current month. month. Let’s Let’s prepare prepare the the company’s company’s selling selling and and administrative administrative expense expense budget. budget.

© McGraw-Hill Ryerson Limited., 2001

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Selling and Administrative Expense Budget Budgeted sales Variable selling and admin. rate Variable expense Fixed selling and admin. expense Total expense Less noncash expenses Cash disbursements for selling & admin.

April 20,000

May 50,000

June 30,000

Quarter 100,000

$ 0.50 $10,000

$ 0.50 $25,000

$ 0.50 $15,000

$ 0.50 $ 50,000

70,000 80,000

70,000 95,000

70,000 85,000

210,000 260,000

© McGraw-Hill Ryerson Limited., 2001

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Selling and Administrative Expense Budget Budgeted sales Variable selling and admin. rate Variable expense Fixed selling and admin. expense Total expense Less noncash expenses Cash disbursements for selling & admin.

April 20,000

May 50,000

June 30,000

Quarter 100,000

$ 0.50 $10,000

$ 0.50 $25,000

$ 0.50 $15,000

$ 0.50 $ 50,000

70,000 80,000

70,000 95,000

70,000 85,000

210,000 260,000

10,000

10,000

10,000

30,000

$70,000

$85,000

$75,000

$230,000

© McGraw-Hill Ryerson Limited., 2001

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The Cash Budget Royal: ● Maintains aa 16% 16% open open line line of of credit credit for for $75,000. $75,000. ● Maintains ● Maintains aa minimum minimum cash cash balance balance of of $30,000. $30,000. ● Maintains ● Borrows on on the the first first day day of of the the month month and and repays repays ● Borrows

loans loans on on the the last last day day of of the the month. month. ● Pays aa cash cash dividend dividend of of $49,000 $49,000 in in April. April. ● Pays ● Purchases $143,700 $143,700 of of equipment equipment in in May May and and ● Purchases

$48,300 $48,300 in in June June paid paid in in cash. cash. ● Has an an April April 11 cash cash balance balance of of $40,000. $40,000. ● Has © McGraw-Hill Ryerson Limited., 2001

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The Cash Budget April $ 40,000 170,000 210,000

May

June

Qua rte r

Be ginning cash bala nce Add cash collections Total ca sh ava ila ble Less disbursem ents Ma te ria ls 40,000 Dire ct la bour Mfg. overhea d Se lling a nd a dm in. Equipm ent purcha se Schedule Schedule of of Expected Expected Divide nds Cash Cash Disbursements Disbursements Total disbursem ents Exce ss (de ficie ncy) of cash a vailable over Schedule Schedule of of Expected Expected disburse me nts Cash Cash Collections Collections

© McGraw-Hill Ryerson Limited., 2001

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The Cash Budget Be ginning cash bala nce Add cash collections Total ca sh ava ila ble Less disbursem ents Ma te ria ls Dire ct la bour Mfg. overhea d Se lling a nd a dm in. Equipm ent purcha se Divide nds Total disbursem ents Exce ss (de ficie ncy) of cash a vailable over disburse me nts

April $ 40,000 170,000 210,000 40,000 15,000 56,000 70,000

May

June

Qua rte r

Direct Labour Budget Manufacturing Overhead Budget

Selling and Administrative Expense Budget

© McGraw-Hill Ryerson Limited., 2001

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The Cash Budget Be ginning cash bala nce Add cash collections Total ca sh ava ila ble Less disbursem ents Ma te ria ls Dire ct la bour Mfg. overhea d Se lling a nd a dm in. Equipm ent purcha se Divide nds Total disbursem ents Exce ss (de ficie ncy) of cash a vailable over disburse me nts

April $ 40,000 170,000 210,000 40,000 15,000 56,000 70,000 49,000 230,000

May

June

Qua rte r

Because Royal maintains a cash balance of $30,000, the company must borrow on its line-of-credit

$ (20,000)

© McGraw-Hill Ryerson Limited., 2001

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Financing and Repayment April Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance

May

June

Quarter

$(20,000) 50,000 50,000 $ 30,000

$30,000

$

-

$

-

Ending cash balance for April is the beginning May balance. © McGraw-Hill Ryerson Limited., 2001

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The Cash Budget Be ginning cash bala nce Add cash collections Total ca sh ava ila ble Less disbursem ents Ma te ria ls Dire ct la bour Mfg. overhea d Se lling a nd a dm in. Equipm ent purcha se Divide nds Total disbursem ents Exce ss (de ficie ncy) of cash a vailable over disburse me nts

April $ 40,000 170,000 210,000

May $ 30,000 400,000 430,000

40,000 15,000 56,000 70,000 49,000 230,000

72,300 23,000 76,000 85,000 143,700 400,000

$ (20,000)

$ 30,000

June

Qua rte r

© McGraw-Hill Ryerson Limited., 2001

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Financing and Repayment Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance

April

May

$(20,000)

$30,000

50,000 50,000 $ 30,000

$30,000

June

Quarter

Because the ending cash balance is exactly $30,000, Royal will not repay the loan this month.

© McGraw-Hill Ryerson Limited., 2001

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The Cash Budget Be ginning cash bala nce Add cash collections Total ca sh ava ila ble Less disbursem ents Ma te ria ls Dire ct la bour Mfg. overhea d Se lling a nd a dm in. Equipm ent purcha se Divide nds Total disbursem ents Exce ss (de ficie ncy) of cash a vailable over disburse me nts

April $ 40,000 170,000 210,000

May $ 30,000 400,000 430,000

June $ 30,000 335,000 365,000

Qua rte r $ 40,000 905,000 945,000

40,000 15,000 56,000 70,000 49,000 230,000

72,300 23,000 76,000 85,000 143,700 400,000

72,700 15,000 59,000 75,000 48,300 270,000

185,000 53,000 191,000 230,000 192,000 49,000 900,000

$ (20,000)

$ 30,000

$ 95,000

$ 45,000

© McGraw-Hill Ryerson Limited., 2001

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The Cash Budget April $ 40,000 170,000 210,000

May $ 30,000 400,000 430,000

June $ 30,000 335,000 365,000

Qua rte r $ 40,000 905,000 945,000

Be ginning cash bala nce Add cash collections Total ca sh ava ila ble Less disbursem ents Ma te ria ls 40,000 72,300 72,700 185,000 Dire ct la bour 15,000 23,000 15,000 53,000 Mfg. overhea d 56,000 76,000 59,000 191,000 Se lling a nd a dm in. 70,000 85,000 75,000 230,000 At the end of June, Royal has enough cash At the Royal has48,300 enough192,000 cash Equipm ent purcha se end of- June,143,700 $50,000 at 16%. to repay repay the the49,000 $50,000 loan loan plus interest interest at49,000 16%. Divide nds to - plus Total disbursem ents 230,000 400,000 270,000 900,000 Exce ss (de ficie ncy) of cash a vailable over disburse me nts $ (20,000) $ 30,000 $ 95,000 $ 45,000

© McGraw-Hill Ryerson Limited., 2001

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Financing and Repayment Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance

April

May

June

Quarter

$(20,000)

$30,000

$95,000

$45,000

50,000 50,000 $ 30,000

$30,000

(50,000) (2,000) (52,000) $ 43,000

50,000 (50,000) (2,000) (2,000) $43,000

$50,000 × 16% × 3/12 = $2,000 Borrowings on April 1 and repayment of June 30. © McGraw-Hill Ryerson Limited., 2001

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The Budgeted Income Statement Cash Budget p m Co

ed t le

Budgeted Income Statement

After we complete the cash budget, we can prepare the budgeted income statement for Royal. © McGraw-Hill Ryerson Limited., 2001

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The Budgeted Income Statement Royal Company Budgeted Income Statement For the Three Months Ended June 30 Sales (100,000 units @ $10) Cost of goods sold (100,000 @ $4.99) Gross margin Selling and administrative expenses Operating income Interest expense Net income

$1,000,000 499,000 501,000 260,000 241,000 2,000 $ 239,000

© McGraw-Hill Ryerson Limited., 2001

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The Budgeted Balance Sheet Royal Royal reported reported the the following following account account balances balances on on June June 30 30 prior prior to to preparing preparing its its budgeted budgeted financial financial statements: statements: " "Land Land -- $50,000 $50,000 " "Building Building (net) (net) -- $175,000 $175,000 " "Common Common stock stock -- $200,000 $200,000 " "Retained Retained earnings earnings -- $146,150 $146,150

© McGraw-Hill Ryerson Limited., 2001

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Royal Company Budgeted Balance Sheet June 30 Current assets Cash Accounts receivable Raw materials inventory Finished goods inventory Total current assets Property and equipment Land Building Equipment Total property and equipment Total assets Accounts payable Common stock Retained earnings Total liabilities and equities

$

43,000 75,000 4,600 24,950 147,550

50,000 175,000 192,000 417,000 $ 564,550 $

28,400 200,000 336,150 $ 564,550

25%of 25%of June June sales sales of of $300,000 $300,000 11,500 11,500 kg kg at at $0.40/kg $0.40/kg 5,000 5,000 units units at at $4.99 $4.99 each each

50% 50% of of June June purchases purchases of of $56,800 $56,800 © McGraw-Hill Ryerson Limited., 2001

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Royal Company Budgeted Balance Sheet June 30 Current assets Cash Accounts receivable Raw materials inventory Finished goods inventory Total current assets Property and equipment Land Building Equipment Total property and equipment Total assets Accounts payable Common stock Retained earnings Total liabilities and equities

$

43,000 75,000 Beginning balance 4,600 Add: net income 24,950 Deduct: dividends Ending balance 147,550

$146,150 239,000 (49,000) $336,150

50,000 175,000 192,000 417,000 $ 564,550 $

28,400 200,000 336,150 $ 564,550 © McGraw-Hill Ryerson Limited., 2001

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Zero-Base Budgeting Managers are required to justify all budgeted expenditures, not just changes in the budget from the previous year. The baseline is zero rather than last year’s budget.

© McGraw-Hill Ryerson Limited., 2001

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International Aspects of Budgeting Multinational companies face special problems when preparing a budget. " Fluctuations in foreign currency exchange rates. " High inflation rates in some foreign countries. " Differences in local economic conditions. " Local governmental policies.

© McGraw-Hill Ryerson Limited., 2001

Appendix

9A Inventory Decisions

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Costs Associated with Inventory Clerical Costs

Transportation Costs

Inventory Ordering Costs

© McGraw-Hill Ryerson Limited., 2001

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Costs Associated with Inventory Storage Space

Handling Cost Insurance

Property Taxes

Inventory Carrying Costs

Obsolescence Losses

Interest on Capital invested in Inventory © McGraw-Hill Ryerson Limited., 2001

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Costs Associated with Inventory Quantity discounts lost

Customer ill will

Lost sales

Erratic production

Cost of not carrying sufficient inventory

Added transportation costs

Inefficiency of production runs © McGraw-Hill Ryerson Limited., 2001

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Inventory Problems ! How much to order - Economic Order

Quantity (EOQ) and ! When to order - Reorder Point

© McGraw-Hill Ryerson Limited., 2001

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Economic Order Quantity (EOQ) ! Tabular approach "Tabulates total cost at various order sizes. "Lowest cost indicates EOQ. "Requires trial and error to determine exact order quantity.

© McGraw-Hill Ryerson Limited., 2001

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Economic Order Quantity (EOQ) ! Graphic approach " Graph cost relationships between total cost, annual carrying cost and annual purchase order cost. " Total cost is minimized where annual carrying cost equals annual purchase order cost

© McGraw-Hill Ryerson Limited., 2001

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Economic Order Quantity (EOQ) ! Formula approach " E= 2QP C where E= order size in units Q= annual quantity used in units P= cost of placing one order C= annual cost of carrying one unit in stock

© McGraw-Hill Ryerson Limited., 2001

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Reorder Point/ Safety Stock ! Reorder Point - tells manager when to

place an order "Depends on economic order quantity, lead

times and rate of usage during lead time

! Safety Stock - provides a buffer to protect

against a stock-out "Reorder point is then calculated by adding

the safety stock to the average usage during the lead time © McGraw-Hill Ryerson Limited., 2001

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End of Chapter 9

© McGraw-Hill Ryerson Limited., 2001