Planning for Profit and Cost Control

Planning for Profit and Cost Control

Chapter 7

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada7-2

Introduction

DetailBudget

DetailBudget

DetailBudget

MasterBudget

Combinationof numerous

specificbudgets

Sales

Pro

du

ction

Inven

tory


The Budget Committee

A standing committee responsible for overall policy matters relating to the

budget. coordinating the preparation of the

budget.


The Planning Process

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

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


Three Levels of Planning for Business Activity

Strategic PlanningTop management long-range

decisions.

Capital BudgetingIntermediate-range planning

Operations BudgetingDirect firm’s activity in

the short-range



Operating BudgetOperating Budget

1999 2000 2001 2002

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

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



Continuous or Perpetual Budget

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

1999 2000 2001 2002


Advantages of Budgeting

CorrectiveAction

CorrectiveAction

PerformanceMeasurementPerformanceMeasurement

CoordinationCoordination

PlanningPlanning


Consideration for the Human Factor

Flow of Budget DataFlow of Budget Data

S u p ervisor S u p ervisor

M id d leM an ag em en t

S u p ervisor S u p ervisor

M id d leM an ag em en t

Top M an ag em en t

Participative Budget System


The Master Budget

The master budget consists of a series of detailed schedules and budgets that describe the company’s overall financial plans for the coming accounting period.

The three major budget categories are Operating budget Capital budgets Financial statement budgets


Information Flow in the Master Budget

CashPaymentsfor S & A

CashPayments

for Inventory

InventoryPurchases

Budget

IncomeStatement

S & AExpenseBudget

BalanceSheet

CashReceipts

SalesBudget

CashBudget

Cash Flow Statement

Cash Receiptsand Payments

Schedules

OperatingBudgets

Pro formaFinancial

StatementsStartStart


Sales Budget

Detailed schedule showing expected sales for the coming periods.


Sales Budget Web Company is preparing budgets for the

quarter ending June 30. Budgeted sales for the next five months are:

April $200,000 May $500,000 June $300,000 July $250,000 August $150,000.

Cash sales are 20% of the total and credit sales are 80%.


Sales Budget

$200,000 × 20% = $40,000$200,000 × 20% = $40,000

Accounts receivableat June 30

Accounts receivableat June 30


Schedule of Cash Receipts

Sales Budget

Scheduleof

CashReceipts

Complete

d

Cash receipts flow from expected sales.



Web expects to collect its accounts receivable in the month following the month of sale.

On March 31, accounts receivable totaled $100,000.

Let’s prepare the cash receipts budget.



From the Sales BudgetFrom the Sales Budget


Purchases Budget

The total amount of inventory needed for each month is equal to the amount of

budgeted sales plus the desired ending inventory.


Purchases Budget

At Web, cost of sales is equal to 70% of total budgeted sales.

Management wants to maintain an ending inventory that is equal to 20% of the current month’s cost of budgeted sales.

The ending inventory at March 31 is $15,000.

Let’s prepare the purchases budget.


Purchases Budget

April May June QuarterBudgeted Sales 200,000$ Cost of Sales % 70%Budgeted Cost of Sales 140,000$ Desired Ending Inventory 28,000 Inventory Needed 168,000 Less: Beginning Inventory (15,000) Required Purchases 153,000$

Budgeted Cost of Sales $140,000Desired Ending Inventory % 20%Desired Ending Inventory $ 28,000


Purchases Budget

April May June QuarterBudgeted Sales 200,000$ 500,000$ Cost of Sales % 70% 70%Budgeted Cost of Sales 140,000$ 350,000$ Desired Ending Inventory 28,000 70,000 Inventory Needed 168,000 420,000 Less: Beginning Inventory (15,000) (28,000) Required Purchases 153,000$ 392,000$

The ending inventory for April is thebeginning inventory for May.

The ending inventory for April is thebeginning inventory for May.


Purchases Budget

April May June QuarterBudgeted Sales 200,000$ 500,000$ 300,000$ 1,000,000$ Cost of Sales % 70% 70% 70% 70%Budgeted Cost of Sales 140,000$ 350,000$ 210,000$ 700,000$ Desired Ending Inventory 28,000 70,000 42,000 42,000 Inventory Needed 168,000 420,000 252,000 742,000 Less: Beginning Inventory (15,000) (28,000) (70,000) (15,000) Required Purchases 153,000$ 392,000$ 182,000$ 727,000$

Now we can move on to the Scheduleof Cash payments for Inventory Purchases.

Now we can move on to the Scheduleof Cash payments for Inventory Purchases.


Cash Payments for Inventory Purchases

Web pays 80% of inventory purchases in the month of acquisition and the remaining 20% in the month following acquisition.

On March 31, Web owed $14,000 for purchases of inventory.

Let’s prepare the Cash Payments for Inventory Purchases schedule.



March 31accounts payable

for inventorypurchases

March 31accounts payable

for inventorypurchases



April Inventory Purchases $153,000Percent Paid in Following Month 20%May Payment for April Purchases $ 30,600

April Inventory Purchases $153,000Percent Paid in Following Month 20%May Payment for April Purchases $ 30,600



June Inventory Purchases $182,000Percent Paid in July 20%Accounts Payable at June 30 $ 36,400

June Inventory Purchases $182,000Percent Paid in July 20%Accounts Payable at June 30 $ 36,400


Selling and Administrative Expense Budget Sales commissions are 2% of sales and are

paid in the month after they are earned. Supplies expense is 1% of sales. Utilities are paid the month after they are used. On March 31, Web owed $3,000 in sales

commissions and $1,200 in utilities.

Web has developed the selling and administrative expense budget shown on the

next screen..


Selling and Administrative Expense Budget

April May June Quarter

Salary Expense 30,000$ Sales Commissions 4,000 Supplies ExpenseUtilitiesAmortizationRentMiscellaneousTotal S&A Expense

$200,000 Sales × 2% = $4,000$200,000 Sales × 2% = $4,000



Let’s see how these expenses translate into cashLet’s see how these expenses translate into cashpayments for selling and administrative expenses.payments for selling and administrative expenses.


Salary Expense 30,000$ Sales Commissions 4,000 Supplies Expense 2,000 UtilitiesAmortizationRentMiscellaneousTotal S&A Expense

$200,000 Sales × 1% = $2,000$200,000 Sales × 1% = $2,000




Salary Expense 30,000$ 30,000$ 30,000$ 90,000$ Sales Commissions 4,000 10,000 6,000 20,000 Supplies Expense 2,000 5,000 3,000 10,000 Utilities 1,700 1,800 1,700 5,200 Amortization 1,500 1,500 1,500 4,500 Rent 3,000 3,000 3,000 9,000 Miscellaneous 1,000 1,000 1,000 3,000 Total S&A Expense 43,200$ 52,300$ 46,200$ 141,700$

Let’s see how these expenses translate into cashpayments for selling and administrative expenses.


Schedule of Cash Payments for S&A Expenses

Amortization Expense is anon-cash expense.


Salary Expense 30,000$ Sales Commissions 3,000 Supplies Expense 2,000 Utilities 1,200 Amortization - Rent 3,000 Miscellaneous 1,000 Total S&A Expense 40,200$

March 31 Sales Commissionsand Utilities.

March 31 Sales Commissionsand Utilities.




Salary Expense 30,000$ 30,000$ Sales Commissions 3,000 4,000 Supplies Expense 2,000 5,000 Utilities 1,200 1,700 Amortization - - Rent 3,000 3,000 Miscellaneous 1,000 1,000 Total S&A Expense 40,200$ 44,700$

AprilSales Commissions

and Utilities.

AprilSales Commissions

and Utilities.




Salary Expense 30,000$ 30,000$ 30,000$ 90,000$ Sales Commissions 3,000 4,000 10,000 17,000 Supplies Expense 2,000 5,000 3,000 10,000 Utilities 1,200 1,700 1,800 4,700 Amortization - - - - Rent 3,000 3,000 3,000 9,000 Miscellaneous 1,000 1,000 1,000 3,000 Total S&A Expense 40,200$ 44,700$ 48,800$ 133,700$

The total quarterly expenses of $141,700, Web will pay$133,700 in cash and record liabilities of $6,000

for June sales commissions and $1,700 for June utilities.

The total quarterly expenses of $141,700, Web will pay$133,700 in cash and record liabilities of $6,000

for June sales commissions and $1,700 for June utilities.


Cash Budget

Web want to maintain a $10,000 balance in its cash account before any interest payments.

The company has a $100,000 line-of-credit that requires 12% interest on any outstanding balance payable monthly.

Web plans to purchase $50,000 of equipment on April 1.

On March 31, Web’s cash balance is $18,000.

Let’s put together the information developed so far and prepare Web’s cash budget.


Cash Budget

Cash Receipts BudgetCash Receipts Budget

Payment for InventoryPurchases Schedule

Payment for InventoryPurchases Schedule

Cash Payments forS&A Schedule

Cash Payments forS&A Schedule


Cash Budget


Cash Budget

($78,600 + $128,900) × 1% = $2,075($78,600 + $128,900) × 1% = $2,075


Pro Forma Income Statement

Cash Cash BudgetBudgetCash Cash

BudgetBudgetPro FormaPro Forma

IncomeIncomeStatementStatement

Pro FormaPro FormaIncomeIncome

StatementStatement

Complete

d

After we complete the cash budget, we After we complete the cash budget, we can prepare the pro forma income can prepare the pro forma income

statement for Web.statement for Web.


Pro Forma Income StatementWeb Company

Budgeted Income StatementFor the Three Months Ended June 30

Sales 1,000,000$ Cost of goods sold 700,000 Gross margin 300,000 Selling and administrative expenses 141,700 Operating income 158,300 Interest expense 2,861 Net income 155,439$

S&A Expense BudgetS&A Expense Budget


Pro Forma Balance Sheet

On March 31, Web had the following account balances:

Equipment $100,000, Capital stock $200,000, and Retained earnings $19,300.

With this data and the informationdeveloped in our budgets, we can prepare Web’s

Pro Forma Balance Sheet.


Web CompanyPro Forma Balance Sheet

June 30

Assets Cash 7,925$ Accounts receivable 240,000 Inventory 42,000 Equipment (net) 150,000 Total assets 439,925

Liabilities Accounts payable 36,400 Sales commissions payable 6,000 Utilities payable 1,700 Line-of-credit borrowing 21,086 Total liabilities 65,186 Equity Capital stock 200,000 Retained earnings 174,739 Total equity 374,739 Total liabilities and equity 439,925$

Cash ReceiptsBudget

Cash ReceiptsBudget



June 30



Sales BudgetSales Budget

PurchasesBudget

PurchasesBudget

Cash Paymentsfor S&A


Cash Paymentsfor Inventory

Cash Paymentsfor Inventory



June 30



Beginning retained earnings $ 19,300Net income for quarter 155,439Ending retained earnings $174,739

Beginning retained earnings $ 19,300Net income for quarter 155,439Ending retained earnings $174,739


Cash ReceiptsBudget

Cash ReceiptsBudget



Cash Paymentfor Inventory

Cash Paymentfor Inventory


Cash BudgetCash Budget


End of Chapter 7End of Chapter 7

Planning for Profit and Cost Control

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