The Master Budget

Sales forecast Production schedule Cost of goods sold and ending inventory budgets

Budgeted financial budgets: cash income balance sheet

McGraw-Hill/Irwin

Capital expenditures budget

Operating expense budgets

The McGraw-Hill Companies, Inc., 2002

Preparing the Master Budget: An Illustration

Sales Budget
Estimated Unit Sales Estimated Unit Price

Analysis of economic and market conditions

+
Forecasts of customer needs from marketing personnel
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Preparing the Master Budget: An Illustration

Ellis Magnet Co. is preparing budgets for the quarter ending June 30. The sales price is $10 per magnet. Budgeted sales for the next four months are:
April May June July 20,000 magnets @ $10 = $200,000 50,000 magnets @ $10 = $500,000 30,000 magnets @ $10 = $300,000 25,000 magnets @ $10 = $250,000

The Sales Budget

July is needed for June ending inventory computations.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

The Production Budget

Sales Budget

Production Budget

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget

Ellis wants ending inventory to be 20 percent of the next months budgeted sales in units.

4,000 units were on hand March 31.

Lets prepare the production budget.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget

Production must be adequate to meet budgeted sales and to provide sufficient ending inventory.
Budgeted product sales in units

+ Desired product units in ending inventory

= Total product units needed Product units in beginning inventory = Product units to produce
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

The Production Budget

Budgeted unit sales Desired ending inventory Total units needed Less beginning inventory Units to produce April 20,000 May 50,000 June 30,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget

Budgeted unit sales Desired ending inventory Total units needed Less beginning inventory Units to produce April 20,000 10,000 30,000 May 50,000 6,000 56,000 June 30,000 5,000 35,000

Ending inventory = 20% of next month's production needs. June ending inventory = .20 25,000 July units = 5,000 units.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget

Budgeted unit sales Desired ending inventory Total units needed Less beginning inventory Units to produce April 20,000 10,000 30,000 4,000 26,000 May 50,000 6,000 56,000 10,000 46,000 June 30,000 5,000 35,000 6,000 29,000

Ending inventory = 20% of next month's production needs. June ending inventory = .20 25,000 July units = 5,000 units. Beginning inventory is last month's ending inventory.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget

Production Budget Units

Production Budget Material Purchases

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget Material Purchases

The material purchases budget is based on production quantity and desired material inventory levels.
= + = = Units to produce Material needed per unit Material needed for units to produce Desired units of material in ending inventory Total units of material needed Units of material in beginning inventory Units of material to purchase
The McGraw-Hill Companies, Inc., 2002

McGraw-Hill/Irwin

The Production Budget Material Purchases

Five pounds of material are needed for each unit produced. Ellis wants to have materials on hand at the end of each month equal to 10 percent of the following months production needs. The materials inventory on March 31 is 13,000 pounds. July production is budgeted for 23,000 units.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

The Production Budget Material Purchases

Units to produce Pounds per unit Material needs (lbs.) Desired ending inventory Total material needs (lbs.) Less beginning inventory Material purchases (lbs.) April 26,000 5 130,000 May 46,000 5 230,000 June 29,000 5 145,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget Material Purchases

Units to produce Pounds per unit Material needs (lbs.) Desired ending inventory Total material needs (lbs.) Less beginning inventory Material purchases (lbs.) April 26,000 5 130,000 23,000 153,000 May 46,000 5 230,000 14,500 244,500 June 29,000 5 145,000 11,500 156,500

Ending inventory = 10% of next month's material needs. June ending inventory = .10 (23,000 units 5 lbs. per unit). June ending inventory = 11,500 lbs.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

The Production Budget Material Purchases

Units to produce Pounds per unit Material needs (lbs.) Desired ending inventory Total material needs (lbs.) Less beginning inventory Material purchases (lbs.) April 26,000 5 130,000 23,000 153,000 13,000 140,000 May 46,000 5 230,000 14,500 244,500 23,000 221,500 June 29,000 5 145,000 11,500 156,500 14,500 142,000

Ending inventory = 10% of next month's material needs. June ending inventory = .10 (23,000 units 5 lbs. per unit). June ending inventory = 11,500 lbs. Beginning inventory is last month's ending inventory.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Cash Payments for Material Purchases

Materials used in production cost $.40 per pound. One-half of a months purchases are paid for in the month of purchase; the other half is paid for in the following month.

No discount terms are available.

The accounts payable balance on March 31 is $12,000.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for Material Purchases

Material purchases (lbs.) Cost per pound Total cost Payables from March April purchases May purchases June purchases Total payments in month April 140,000 $ 0.40 $ 56,000 $ 12,000 May 221,500 $ 0.40 $ 88,600 June 142,000 $ 0.40 $ 56,800

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for Material Purchases

Material purchases (lbs.) Cost per pound Total cost Payables from March April purchases May purchases June purchases Total payments in month $56,000 = $28,000 April 140,000 $ 0.40 $ 56,000 $ 12,000 28,000 May 221,500 $ 0.40 $ 88,600 $ 28,000 June 142,000 $ 0.40 $ 56,800

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for Material Purchases

Material purchases (lbs.) Cost per pound Total cost Payables from March April purchases May purchases June purchases Total payments in month $56,000 = $28,000 $88,600 = $44,300
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

April 140,000 $ 0.40 $ 56,000 $ 12,000 28,000

May 221,500 $ 0.40 $ 88,600 $ 28,000 44,300

June 142,000 $ 0.40 $ 56,800

$ 44,300

Cash Payments for Material Purchases

Material purchases (lbs.) Cost per pound Total cost Payables from March April purchases May purchases June purchases Total payments in month $56,000 = $28,000 $88,600 = $44,300 $56,800 = $28,400
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

April 140,000 $ 0.40 $ 56,000 $ 12,000 28,000

May 221,500 $ 0.40 $ 88,600 $ 28,000 44,300 $ 72,300

June 142,000 $ 0.40 $ 56,800

$ 40,000

$ 44,300 28,400 $ 72,700

The Production Budget

Production Budget Units Material

Production Budget Labor

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget Direct Labor

Each unit produced requires 3 minutes (.05 hours) of direct labor. Ellis employs 30 persons for 40 hours each week at a rate of $10 per hour. Any extra hours needed are obtained by hiring temporary workers also at $10 per hour.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for Direct Labor

Units to produce Hours per unit Total hours required Wage rate per hour Direct labor cost April 26,000 0.05 1,300 May 46,000 0.05 2,300 June 29,000 0.05 1,450

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for Direct Labor

Units to produce Hours per unit Total hours required Wage rate per hour Direct labor cost April 26,000 0.05 1,300 $ 10 $ 13,000 May 46,000 0.05 2,300 $ 10 $ 23,000 June 29,000 0.05 1,450 $ 10 $ 14,500

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget

Production Budget
Units Material Labor

Production Budget
Manufacturing Overhead

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Production Budget Manufacturing Overhead

Variable manufacturing overhead is $1 per unit produced and fixed manufacturing overhead is $50,000 per month. Fixed manufacturing overhead includes $20,000 in depreciation which does not require a cash outflow.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for Manufacturing Overhead

Units to produce Variable overhead rate Variable overhead cost Fixed overhead Total mfg. overhead cost Deduct depreciation Manufacturing overhead - cash April 26,000 $ 1.00 $ 26,000 May 46,000 $ 1.00 $ 46,000 June 29,000 $ 1.00 $ 29,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for Manufacturing Overhead

Units to produce Variable overhead rate Variable overhead cost Fixed overhead Total mfg. overhead cost Deduct depreciation Manufacturing overhead - cash April 26,000 $ 1.00 $ 26,000 50,000 $ 76,000 May 46,000 $ 1.00 $ 46,000 50,000 $ 96,000 June 29,000 $ 1.00 $ 29,000 50,000 $ 79,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for Manufacturing Overhead

April Units to produce 26,000 Variable overhead rate $ 1.00 Variable overhead cost $ 26,000 Fixed overhead 50,000 Total mfg. overhead cost $ 76,000 Deduct depreciation 20,000 Manufacturing overhead - cash $ 56,000 May 46,000 $ 1.00 $ 46,000 50,000 $ 96,000 20,000 $ 76,000 June 29,000 $ 1.00 $ 29,000 50,000 $ 79,000 20,000 $ 59,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Selling and Administrative (S&A) Expense Budget

Production Budget

Selling and Administrative Expense Budget

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Selling and Administrative (S&A) Expense Budget

Selling expense budgets contain both variable and fixed items.
Variable items: shipping costs and sales commissions.

Fixed items: advertising and sales salaries.

Administrative expense budgets contain mostly fixed items.

Executive salaries and depreciation on company offices.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Cash Payments for (S&A) Expenses

Variable selling and administrative expenses are $.50 per unit sold and fixed selling and administrative expenses are $70,000 per month.

Fixed selling and administrative expenses include $10,000 in depreciation which does not require a cash outflow.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for (S&A) Expenses

Budgeted unit sales Variable S&A per unit Variable S&A expense Fixed S&A expense Total S&A expense Deduct depreciation S&A expense - cash April 20,000 $ 0.50 $ 10,000 70,000 $ 80,000 May 50,000 $ 0.50 $ 25,000 70,000 $ 95,000 June 30,000 $ 0.50 $ 15,000 70,000 $ 85,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Payments for (S&A) Expenses

Budgeted unit sales Variable S&A per unit Variable S&A expense Fixed S&A expense Total S&A expense Deduct depreciation S&A expense - cash April 20,000 $ 0.50 $ 10,000 70,000 $ 80,000 10,000 $ 70,000 May 50,000 $ 0.50 $ 25,000 70,000 $ 95,000 10,000 $ 85,000 June 30,000 $ 0.50 $ 15,000 70,000 $ 85,000 10,000 $ 75,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Receipts Budget

I have seen a lot of cash payments but no cash receipts. Show me some cash receipts!

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Receipts Budget

All sales are on account. Elliss collection pattern is:
70 percent collected in month of sale

25 percent collected in month after sale

5 percent will be uncollectible

Accounts receivable on March 31 is $30,000, all of which is collectible.

McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Cash Receipts Budget

Budgeted unit sales Price per unit Budgeted sales revenue Receipts from March sales Receipts from April sales Receipts from May sales Receipts from June sales Total cash receipts April 20,000 $ 10 $ 200,000 $ 30,000 May 50,000 $ 10 $ 500,000 June 30,000 $ 10 $ 300,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Receipts Budget

Budgeted unit sales Price per unit Budgeted sales revenue Receipts from March sales Receipts from April sales Receipts from May sales Receipts from June sales Total cash receipts April 20,000 $ 10 $ 200,000 $ 30,000 140,000 May 50,000 $ 10 $ 500,000 $ 50,000 June 30,000 $ 10 $ 300,000

$ 170,000

April: .70 $200,000 = $140,000 and .25 $200,000 = $50,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Cash Receipts Budget

Budgeted unit sales Price per unit Budgeted sales revenue Receipts from March sales Receipts from April sales Receipts from May sales Receipts from June sales Total cash receipts April 20,000 $ 10 $ 200,000 $ 30,000 140,000 May 50,000 $ 10 $ 500,000 $ 50,000 350,000 $ 400,000 June 30,000 $ 10 $ 300,000

$ 125,000

$ 170,000

April: .70 $200,000 = $140,000 and .25 $200,000 = $50,000 May: .70 $500,000 = $350,000 and .25 $500,000 = $125,000
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Cash Receipts Budget

Budgeted unit sales Price per unit Budgeted sales revenue Receipts from March sales Receipts from April sales Receipts from May sales Receipts from June sales Total cash receipts April 20,000 $ 10 $ 200,000 $ 30,000 140,000 May 50,000 $ 10 $ 500,000 $ 50,000 350,000 $ 400,000 June 30,000 $ 10 $ 300,000

$ 170,000

$ 125,000 210,000 $ 335,000

April: .70 $200,000 = $140,000 and .25 $200,000 = $50,000 May: .70 $500,000 = $350,000 and .25 $500,000 = $125,000 June: .70 $300,000 = $210,000
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Comprehensive Cash Budget

With just a little more information we will be able to prepare a comprehensive cash budget.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Comprehensive Cash Budget Additional Information

Ellis Magnet Company: Has a $100,000 line of credit at its bank, with a zero balance on April 1. Maintains a $30,000 minimum cash balance. Borrows at the beginning of a month and repays at the end of a month. Pays interest at 16 percent when a principal payment is made at end of June Pays a $51,000 cash dividend in April. Purchases equipment costing $143,700 in May and $48,800 in June. Has a $40,000 cash balance on April 1.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Comprehensive Cash Budget

Beginning cash balance Cash receipts Cash available Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases Dividends Total cash payments Balance before financing Borrowing Principal repayment Interest Ending cash balance
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

April $ 40,000

May

June

Comprehensive Cash Budget

Beginning cash balance Cash receipts Cash available Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases Dividends Total cash payments Balance before financing Borrowing Principal repayment Interest Ending cash balance
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

April $ 40,000 170,000 $ 210,000

May 400,000

June 335,000

Comprehensive Cash Budget

Beginning cash balance Cash receipts Cash available Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases Dividends Total cash payments Balance before financing Borrowing Principal repayment Interest Ending cash balance
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

April $ 40,000 170,000 $ 210,000 $ 40,000 13,000 56,000 70,000 0 51,000 $ 230,000 $ (20,000)

May 400,000

June 335,000

$ 72,300 23,000 76,000 85,000 143,700 0 $ 400,000

$ 72,700 14,500 59,000 75,000 48,800 0 $ 270,000

Comprehensive Cash Budget

Beginning cash balance Cash receipts Cash available Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases Dividends Total cash payments Balance before financing Borrowing Principal repayment Interest Ending cash balance
McGraw-Hill/Irwin

April $ 40,000 170,000 $ 210,000 $ 40,000 13,000 56,000 70,000 0 51,000 $ 230,000 $ (20,000) 50,000 0 0 $ 30,000

May $ 30,000 400,000 $ 430,000 $ 72,300 23,000 76,000 85,000 143,700 0 $ 400,000 $ 30,000

June 335,000

$ 72,700 14,500 59,000 75,000 48,800 0 $ 270,000

The McGraw-Hill Companies, Inc., 2002

Comprehensive Cash Budget

Beginning cash balance Cash receipts Cash available Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases Dividends Total cash payments Balance before financing Borrowing Principal repayment Interest Ending cash balance
McGraw-Hill/Irwin

April $ 40,000 170,000 $ 210,000 $ 40,000 13,000 56,000 70,000 0 51,000 $ 230,000 $ (20,000) 50,000 0 0 $ 30,000

May $ 30,000 400,000 $ 430,000 $ 72,300 23,000 76,000 85,000 143,700 0 $ 400,000 $ 30,000 0 0 0 $ 30,000

June $ 30,000 335,000 $ 365,000 $ 72,700 14,500 59,000 75,000 48,800 0 $ 270,000 $ 95,000

The McGraw-Hill Companies, Inc., 2002

Comprehensive Cash Budget

Beginning cash balance Cash receipts Cash available Cash payments: Materials budget Labor budget Manufacturing OH budget S&A expense budget Equipment purchases Dividends Total cash payments Balance before financing April $ 40,000 170,000 $ 210,000 $ 40,000 13,000 56,000 70,000 0 51,000 $ 230,000 $ (20,000) May $ 30,000 400,000 $ 430,000 $ 72,300 23,000 76,000 85,000 143,700 0 $ 400,000 $ 30,000 June $ 30,000 335,000 $ 365,000 $ 72,700 14,500 59,000 75,000 48,800 0 $ 270,000 $ 95,000 0 (50,000) (2,000) $ 43,000

Borrowing 50,000 0 Principal repayment 0 0 $50,000 .16 3/12 = $2,000 Interest 0 0 Ending cash balance $ 30,000 $ 30,000
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Budgeted Income Statement

Cash Budget

Budgeted Income Statement

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Budgeted Income Statement

Ellis Magnet Company Budgeted Income Statement For the Three Months Ended June 30 Sales (100,000 units @ $10) $ 1,000,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Budgeted Income Statement

Ellis Magnet 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 $ 1,000,000 499,000 $ 501,000

Computation of unit cost follows

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Budgeted Income Statement

Production costs per unit Direct materials Direct labor Manufacturing overhead Total unit cost Quantity Cost 5.00 lbs. $ 0.40 0.05 hrs. $ 10.00 0.05 hrs. $ 49.70 Total $ 2.00 0.50 2.49 $ 4.99

Total mfg. OH for quarter $251,000 = $49.70 per hr. Total labor hours required 5,050 hrs.
From labor and Mfg. OH budgets April May June Total
McGraw-Hill/Irwin

Labor Hours 1,300 2,300 1,450 5,050

Mfg. OH $ 76,000 96,000 79,000 $ 251,000

Manufacturing overhead is applied based on direct labor hours.

The McGraw-Hill Companies, Inc., 2002

The Budgeted Income Statement

Ellis Magnet Company Budgeted Income Statement For the Three Months Ended June 30 Sales (100,000 units @ $10) $ 1,000,000 Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin $ 501,000 Selling and administrative expenses 260,000 Operating income $ 241,000
From S&A Expense Budget April $ 80,000 May 95,000 June 85,000 Total $ 260,000

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Budgeted Income Statement

Ellis Magnet 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/Irwin

The McGraw-Hill Companies, Inc., 2002

The Budgeted Balance Sheet

Budgeted Income Statement

Budgeted Balance Sheet

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

The Budgeted Balance Sheet

Ellis reports the following account balances on June 30, prior to preparing its budgeted financial statements:

McGraw-Hill/Irwin

Land - $50,000 Building (net) - $174,500 Common stock - $200,000 Equipment (net) - $192,500 Retained earnings - $148,150
The McGraw-Hill Companies, Inc., 2002

Ellis Magnet Company Budgeted Balance Sheet June 30, 2002 Current assets Cash $ 43,000 Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Total current assets $ 147,550 Property and equipment Land $ 50,000 Building 174,500 Equipment 192,500 Total property and equipment $ 417,000 Total assets $ 564,550 Liabilities and Equities Accounts payable Common stock Retained earnings Total liabilities and equities
McGraw-Hill/Irwin

25% of June sales of $300,000 11,500 lbs. @ $.40 per lb.

5,000 units @ $4.99 each

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

50% of June purchases of $56,800

The McGraw-Hill Companies, Inc., 2002

Ellis Magnet Company Budgeted Balance Sheet June 30, 2002 Current assets Cash $ 43,000 Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950 Total current assets $ 147,550 Property and equipment Beginning balance $ 148,150 Land $ 50,000 Add: net income 239,000 Building 174,500 Deduct: dividends (51,000) Equipment 192,500 Ending balance $ equipment $ 417,000 Total property and336,150 Total assets $ 564,550 Liabilities and Equities Accounts payable Common stock Retained earnings Total liabilities and equities
McGraw-Hill/Irwin

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

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting

Lets change topics.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Consider the following condensed example from the Cheese Company . . .

Hmm! Comparing costs at different levels of activity is like comparing apples with oranges.

Performance evaluation is difficult when actual activity differs from the activity originally budgeted.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Original Budget Units of Activity Variable costs Indirect labor Indirect materials Power Fixed costs Depreciation Insurance Total overhead costs
McGraw-Hill/Irwin

Actual Results 8,000 $ 34,000 25,500 3,800 12,000 2,000 $ 77,300

Variances 2,000 U $6,000 F 4,500 F 1,200 F 0 0 $11,700 F

10,000 $ 40,000 30,000 5,000 12,000 2,000 $ 89,000

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Original Budget Units of Activity 10,000 Actual Results 8,000 Variances 2,000 U $6,000 F 4,500 F 1,200 F 0 0 $11,700 F

Variable costs U = Unfavorable variance Cheese Indirect labor $ 40,000 $ 34,000 Company Indirect materials was unable to achieve 30,000 25,500 the budgeted level of activity. Power 5,000 3,800 Fixed costs Depreciation Insurance Total overhead costs
McGraw-Hill/Irwin

12,000 2,000 $ 89,000

12,000 2,000 $ 77,300

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Original Budget Units of Activity Variable costs Indirect labor Indirect materials Power Fixed costs are less Depreciation Insurance 10,000 $ 40,000 30,000 5,000 Actual Results 8,000 $ 34,000 25,500 3,800 Variances 2,000 U $6,000 F 4,500 F 1,200 F 0 0 $11,700 F

F = Favorable variance: actual costs than budgeted costs. 12,000 12,000

2,000 $ 89,000 2,000 $ 77,300

Total overhead costs

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Original Budget Units of Activity Variable costs Indirect labor Indirect materials Power Fixed costs we done a good Depreciation Insurance 10,000 $ 40,000 30,000 5,000 Actual Results 8,000 $ 34,000 25,500 3,800 Variances 2,000 U $6,000 F 4,500 F 1,200 F 0 0 $11,700 F

Since cost variances are favorable, have job controlling costs? 12,000 12,000
2,000 $ 89,000 2,000 $ 77,300

Total overhead costs

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
I dont think I can answer the question using the original budget.

How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
I dont think I can answer the question using the original budget.

How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?

To answer the question, we must the budget to the actual level of activity.
McGraw-Hill/Irwin
The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Central Concept
If you can tell me what your activity was for the period, I will tell you what your costs and revenue should have been.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Show expenses that should have occurred at the actual level of activity. May be prepared for any activity level in the relevant range. Reveal variances due to good cost control or lack of cost control. Improve performance evaluation.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
To a budget for different activity levels, we must know how costs behave with changes in activity levels.
Total variable costs change in direct proportion to changes in activity. Total fixed costs remain unchanged within the relevant range.
Fixed

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Cost Formula Per Hour Units of Activity Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs
McGraw-Hill/Irwin

Total Fixed Cost

Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours

8,000 10,000 12,000 Variable costs are expressed as a constant amount per hour. 4.00 3.00 0.50 7.50 $ 32,000 In the24,000 original budget, indirect labor 4,000 $40,000 for 10,000 was $ 60,000

hours resulting in a rate of $4.00 per hour.

$12,000 2,000

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Cost Formula Per Hour Units of Activity Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs
McGraw-Hill/Irwin

Total Fixed Cost

Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 10,000 $ 40,000 30,000 5,000 $ 75,000 $ 12,000 2,000 $ 14,000 $ 89,000 12,000 $ 48,000 36,000 6,000 $ 90,000 $ 12,000 2,000 $ 14,000 $ 104,000

4.00 3.00 0.50 7.50 $12,000 2,000

$ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Cost Formula Per Hour Units of Activity Variable costs Indirect labor Indirect material Power Total variable cost 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 $ 32,000 24,000 4,000 $ 60,000 10,000 $ 40,000 30,000 5,000 $ 75,000 12,000 $ 48,000 36,000 6,000 $ 90,000 $ 12,000 2,000 $ 14,000 $ units in 104,000

Fixed costs Depreciation Insurance Total fixed cost Total overhead costs Total variable cost
McGraw-Hill/Irwin

= $7.50 per

$ 12,000 $ 12,000 2,000 2,000 $ 14,000 $ 14,000 $ 74,000 $ 89,000 unit budget level

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting
Cost Formula Per Hour Units of Activity Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs
McGraw-Hill/Irwin

Total Fixed Cost

Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 10,000 12,000

4.00 3.00 0.50 7.50

Fixed costs are expressed as a $ amount 40,000 total 32,000 $that does $ 48,000 not 24,000 30,000 36,000 change within the relevant 4,000 5,000 6,000 range $ 75,000 $ 60,000 of activity. $ 90,000
$12,000 2,000 $ 12,000 2,000 $ 14,000 $ 74,000 $ 12,000 2,000 $ 14,000 $ 89,000 $ 12,000 2,000 $ 14,000 $ 104,000

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting Performance Report

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting Performance Report

Cost Formula Per Hour Units of Activity Variable costs Indirect labor $ Indirect material Power Total variable costs $ Fixed Costs Depreciation Insurance Total fixed costs Total overhead costs
McGraw-Hill/Irwin

Total Fixed Costs

Flexible Budget 8,000

Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300

Variances 0 $ 2,000 U 1,500 U 200 F $ 3,300 U 0 0 0 $ 3,300 U

4.00 3.00 0.50 7.50 $12,000 2,000

$ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting Performance Report

Indirect indirect material have Units of Activity unfavorable variances Variable costs because costs Indirect labor actual4.00 $ are more Indirect material than the 3.00 Power flexible budget 0.50 costs.
Total variable costs $ Fixed Costs Depreciation Insurance Total fixed costs Total overhead costs
McGraw-Hill/Irwin

Cost Total Formula Fixed laborHour Costs Per and

Flexible Budget 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000

Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300

Variances 0 $ 2,000 U 1,500 U 200 F $ 3,300 U 0 0 0 $ 3,300 U

7.50 $12,000 2,000

The McGraw-Hill Companies, Inc., 2002

Flexible Budgeting Performance Report

Cost Formula Per Hour Units of Activity Total Fixed Costs Flexible Budget 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300 Variances 0 $ 2,000 U 1,500 U 200 F $ 3,300 U 0 0 0 $ 3,300 U

Power has a favorable Variable costs variance because the Indirect labor $ 4.00 actual cost is Indirect material less than 3.00 Power 0.50 the flexible budget cost.
Total variable costs $ Fixed Costs Depreciation Insurance Total fixed costs Total overhead costs
McGraw-Hill/Irwin

7.50 $12,000 2,000

The McGraw-Hill Companies, Inc., 2002

End of Chapter 22
I would be happy to assist you with your cash budget!

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2002