CHAPTER 10

Budgetary Planning

Part one

Prepared by: Dr.Riham Muqattash

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 Study Objective 1 INDICATE THE BENEFITS OF BUDGETING.

Budgeting Basics

1. A budget is a formal written statement of management's plans for a specified time period,
expressed in financial terms.

2. The role of accounting during the budgeting process is to (a) provide historical data on
revenues, costs, and expenses, (b) express management's plans in financial terms, and (c)
prepare periodic budget reports.

Benefits of Budgeting

3. The primary benefits of budgeting are as follows:

a. It requires all levels of management to plan ahead.
b. It provides definite objectives for evaluating performance.
c. It creates an early warning system for potential problems.
d. It facilitates the coordination of activities within the business.
e. It results in greater management awareness of the entity's overall operations.
f. It motivates personnel throughout the organization.
.STATE THE ESSENTIALS OF EFFECTIVE BUDGETING
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1. In order to be effective management tools, budgets must be based upon:

a. A sound organizational structure in which authority and responsibility are clearly
defined.
b. Research and analysis to determine the feasibility of new products, services, and
operating techniques.
c. Management acceptance which is enhanced when all levels of management
participate in the preparation of the budget, and the budget has the support of top
management.

2. The most common budget period is one year. A continuous twelve-month budget results
from dropping the month just ended and adding a future month. The annual budget is often
supplemented by monthly and quarterly budgets.

3. The responsibility for coordinating the preparation of the budget is assigned to a budget
committee. The budget committee usually includes the president, treasurer, chief
accountant (controller), and management personnel from each major area of the company.

4. A budget can have a significant effect on human behavior. A budget may have a strong
positive influence on a manager when:
a. Each level of management is invited and encouraged to participate in developing the
budget.
b. Criticism of a manager's performance is tempered with advice and assistance.
c. Top management is sensitive to the behavioral implications of its actions.

5. Long-range planning involves the selection of strategies to achieve long-term goals and
the development of policies and plans to implement the strategies. Long-range plans
contain considerably less detail than budgets.

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 IDENTIFY THE BUDGETS THAT COMPRISE THE MASTER BUDGET.
Study Objective 3

The Master Budget

9. (S.O. 3) The master budget is a set of interrelated budgets that constitutes a plan of action
for a specified time period. It is developed within the framework of a sales forecast which
shows potential sales for the industry and the company's expected share of such sales.

10. There are two classes of budgets in the master budget.

a. Operating budgets include the individual budgets that result in the preparation of the
budgeted income statement.
b. Financial budgets focus primarily on the cash resources needed to fund expected
operations and planned capital expenditures.

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 Components of the
Master Budget

Preparing the Operating Budgets

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 Sales Budget:

The sales budget is the first budget prepared. It is derived from the
sales forecast, and it represents management's best estimate of sales
revenue for the budget period. t is prepared by multiplying the expected
unit sales volume for each product by its anticipated unit selling price.
Example:

For Hayes Company, sales volume is expected to be 3,000 units in the first
quarter with 500-unit increments in each succeeding year. Based on a sales
price of $60 per unit, the sales budget for the year by quarters is shown
below:

HAYES COMPANY
Sales Budget
For the Year Ending December 31, 2005
Quarter
1 2 3 4 Year
Expected unit sales
Unit selling price
Total sales

Production Budget:

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 The production budget shows the units that must be produced to meet anticipated sales. It
is derived from the budgeted sales units plus the desired ending finished goods units less
the beginning finished goods units.

Desired Beginning Required

Budgete Ending Finished Production
d Sales
Finished Goods Units
Units
Goods Units Units

Example:

Hayes believes it can meet future sales requirements by maintaining an ending

inventory equal to 20% of the next quarter’s budgeted sales volume. The production
budget is shown below.

HAYES COMPANY
Production Budget
For the Year Ending December 31, 2005
Quarter
1 2 3 4 Year
Expected unit sales
Add: Desired ending
finished good units
Total required units
Less: Beginning finished
goods units
Required production
units

Direct Materials Budget

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 The direct materials budget contains both the quantity and cost of direct materials to be
purchased. It is derived from the direct materials units required for production plus
the desired ending direct materials units less the beginning direct materials units.

Direct Desired Required

Materials Ending Beginning
Direct
Units Direct Direct
Materials
Required for Material Materials
Purchases
Production Units Units
Units
Example:

Hayes has found that an ending inventory of raw materials equal to 10% of
the next quarter’s production is sufficient. The manufacture of Kitchen-mate
requires 2 pounds of raw materials and the expected cost per pound is $4.
Assume ending direct materials for the 4th quarter are 1,020 pounds. The direct
materials budget is shown below:

QUARTER 1 2 3 4 Year
Units to be produced 3,100 3,600 4,100 4,600
Direct materials per unit
Total pounds needed for
production
Add: Desired ending direct
materials (pounds)
Total materials required
Less: Beginning direct
materials (pounds)
Direct materials purchases
Cost per pound

Direct labor budget:

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 The direct labor budget contains the quantity (hours) and cost of direct labor necessary to meet
production requirements. The direct labor budget is critical in maintaining a labor force that can
meet expected levels of production.

Example:
At Hayes Company, two hours of direct labor are required to
produce each unit of finished goods, and the anticipated
hourly wage rate is $10. The direct labor budget is shown
below.

HAYES COMPANY
Direct Labor Budget
For the Year Ending December 31, 2005
QUARTER 1 2 3 4 Year
Units to be produced
(from Production Budget) 3,100 3,600 4,100 4,600
Direct Labor time (hours)
per unit 2 2 2 2
Total required direct labor 6,200 7,200 8,200 9,200
hours
Direct labor cost per hour $10 $10 $10 $10

Total direct labor cost $62,000 $72,000 $82,000 $92,000 $308,000

Manufacturing overhead budget:

The manufacturing overhead budget shows the expected manufacturing overhead costs. The
selling and administrative expense budget projects anticipated operating expenses. Both
budgets distinguish between fixed and variable costs.

Example:
Hayes Company expects variable costs to fluctuate with production
volume on the basis of the following rates per direct labor hour (as
calculated in the Direct Labor Budget).
Indirect materials $1.00/hr
Indirect labor $1.40/hr Utilities $.40/hr
Maintenance $ .20/hr

HAYES COMPANY
Manufacturing Overhead Budget (Variable portion)
For the Year Ending December 31, 2005
Quarter
1 2 3 4 Year
Variable costs
Indirect materials
Example: Indirect labor
Utilities
Fixed costs complete the manufacturing overhead budget and
Maintenance
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 the totals are used to calculate an overhead rate, which will be
applied to production on the basis of direct labor hours.

HAYES COMPANY
Manufacturing Overhead Budget (Fixed portion and Totals)
For the Year Ending December 31, 2005
Quarter
1 2 3 4 Year
Fixed Costs
Supervisory salaries
Depreciation
Property taxes and
insurance
Maintenance
Total fixed

Example:

Variable expenses are based on the unit sales projected in the

sales budget. The rates per unit of sales are sales commissions
$3.00 and freight-out $1.00. Fixed costs are based on assumed data and
include $1,000 of depreciation per quarter.

HAYES COMPANY
Selling and Administrative Expense Budget
For the Year Ending December 31, 2005
Quarter
1 2 3 4 Year
Variable expenses
Sales Commissions
Freight-out
Total variable

Fixed expenses

Exercise
1:

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 Colter Company has budgeted the following unit sales:
2005 Units
April 20,000
May 40,000
June 60,000
July 35,000
Instructions
Prepare separate sales budgets for the company in total for the second quarter of 2005.
April May June Total

Exercise
2: Walker, Inc. makes and sells a single product, widgets. Three pounds of wackel are
needed to make one widget. Budgeted production of widgets for the next few months
follows:
September 14,500 units
October 15,500 units
The company wants to maintain monthly ending inventories of wackel equal to 20% of
the following month's production needs. On August 31, 4,500 pounds of wackel were on
hand.
Instructions
How much wackel should be purchased in September?

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Exercise4
:

Zedco Company has budgeted the following unit sales:

2005 Units
January 10,000
February 8,000
March 9,000
April 11,000
May 15,000
The finished goods units on hand on December 31, 2004, was 2,000 units. Each unit
requires 2 pounds of raw materials that are estimated to cost an average of $4 per pound.
It is the company's policy to maintain a finished goods inventory at the end of each
month equal to 20% of next month's anticipated sales. They also have a policy of
maintaining a raw materials inventory at the end of each month equal to 30% of the
pounds needed for the following month's production. There were 5,760 pounds of raw
materials on hand at December 31, 2004.

Instructions
For the first quarter of 2005, prepare (1) a production budget and (2) a direct materials
budget.

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Exercise
5:

Beeson Company has budgeted the following unit sales:

2005 2006
Quarter Units Quarter Units
1 70,000 1 60,000
2 30,000
3 50,000
4 90,000

The finished goods inventory on hand on December 31, 2004 was 14,000 units. It is the
company's policy to maintain a finished goods inventory at the end of each quarter equal
to 20% of the next quarter's anticipated sales.

Instructions
Prepare a production budget for 2005.

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Exercise
6: Flyer, Inc. produces rulers from plastic resin. Flyer has estimated production and sales
of rulers in units for the next 2 months as:
May June
Estimated production 30,000 32,000
Estimated sales 33,000 24,000
Each ruler requires 0.25 pounds of resin. The cost of resin is $4.40 per pound. Flyer
wants to have 20% of the next month's materials requirements on hand at the end of
each month.

Instructions
Prepare a direct materials purchases budget for the month of May.

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Exercise
7:
Oswald Company is preparing its direct labor budget for 2005 from the following
production budget based on a calendar year:
Quarter Units
1 40,000
2 20,000
3 30,000
4 50,000
Each unit requires 2 hours of direct labor. The union contract provides for a 10% increase
in wage rate to $11 per hour on October 1.

Instructions
Prepare a direct labor budget for 2005.

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Exercise
8:
Foley Company is preparing its master budget for 2005. Relevant data pertaining to its
sales budget are as follows:

Sales for the year are expected to total 4,000,000 units. Quarterly sales are 25%, 30%,
15%, and 30%, respectively. The sales price is expected to be $2.00 per unit for the first
quarter and then be increased to $2.30 per unit in the second quarter.

Instructions
Prepare a sales budget for 2005 for Foley Company.

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