Figure 7.1A is the relevant part of the overall budgeting process illustrated in Figure 7.1 emphasizing the importance of preparing the revenue budget before preparing the production budget. Amarillo's production manager and purchasing supervisor estimate that at the beginning of next year, the company will have the following direct materials in beginning inventory:.
The preparation of the labor budget therefore requires close coordination between the Production Department, which determines labor requirements for production, and the Human Resources Department, which has information on labor costs and helps ensure the availability of labor.
Check It! exercise #3
In addition to variable overhead costs, Amarillo also expects costs related to machinery, employees, warehousing, and other facilities. As shown in the bottom half of Figure 7.7, fixed overhead costs include cash costs related to wages, rent, and property taxes, as well as noncash costs related to equipment depreciation.
Note that Exhibit 7.8 separates the total costs of dyes and packaging boxes from Exhibit 7.5 into portions attributable to the two product lines. For example, $480,900 of variable overhead for BuildIT is the product of $961,800 of BuildIT's direct labor costs from Exhibit 7.6 multiplied by a variable overhead rate of $0.50 per dollar of direct labor.
The variable cost of goods manufactured is the sum of several cost items: material, labor and variable overhead. The costs of the materials used are obtained from the direct materials consumption budget in Exhibit 7.5.
Beginning Finished goods Inventory
As shown in Exhibit 7.12, other marketing and administrative expenses, such as administrative salaries and office space, are fixed. Exhibit 7.12 also shows that Amanda plans to invest $1 million in research and development (fixed R&D expenses).
BUdgeted InCome stAtement
Projected contribution margins provide a good basis for evaluating the performance of Amarillo's two product managers in the coming year. Amanda and other senior managers would evaluate this assessment in light of the company's overall goals and plans. Sales analysts may believe that the company's reputation is driving some consumers away, so sales of the basic kit are expected to fall by 10%, while sales of the plus kit are expected to increase by 20%.
In general, a careful review of assumptions and operating estimates adds value to the budgeting process. In addition to the overall budgets we prepared for Amarillo, companies prepare numerous other budgets for subunits.
Firms often prepare similar statements for each quarter or month to facilitate timely monitoring of results. Exhibits 7.3 through 7.13 provide an orderly way to arrive at Amarillo's budgeted income statement for the coming year. The sales staff, the marketing manager and Amanda will go through several iterations before agreeing to the revenue budget.
They can also reassess the budget to see if they made the correct assumptions. Even individual employees may have detailed budgets for their time, sales quotas, or expenses related to travel.
Connecting to Practice
The cash budget allows companies to determine whether they will have enough cash on hand to support projected operations. As shown at the end of Exercise 7.14, the cash budget has three main components: inflows from operations, outflows from operations, and special items. Each of them is related to a specific part of the budgets that we have prepared to arrive at the income statement.
We treat each path and the accompanying set of decisions by Amarillo's employees as a decision option. Amanda is satisfied that the budgets in Exhibits 7.3 through 7.13 represent the best possible use of Amarillo's resources in the coming year.
Cash Budget
As the exhibit shows, we must adjust revenues and costs to determine cash inflows or outflows. However, to calculate the expected cash inflow, we need to adjust the income according to the firm's credit policy. In Amarillo, experience shows that 60% of revenue is collected in the sales quarter, 35% is collected in the post-sales quarter, and 5% in the following quarter.
Exhibit 7.15 builds on the income budget in Exhibit 7.3 to show Amarillo's estimated cash inflows from operations for the coming year. However, companies often encounter bad credit sales because some customers are late with their payments.
Check It! exercise #4
In addition, Amarillo brings in 35% of sales in the fourth quarter of the previous year and 5% of sales in the third quarter of the previous year. From an accounting perspective, we also need to adjust the accounts receivable balance and reported income to reflect bad debts. There are four types of cash outflows from operating activities: purchases of direct materials, payments for labor, expenditures on manufacturing overhead, and outflows for marketing and administrative expenses.
Purchases of direct materials
Using the information in Exhibit 7.16 and Amarillo's payment policy, we can plan cash outflows for material purchases over the coming year.
Check It! exercise #5
PUllIng It All together
CHAPTer COnneCTIOnS
Financing needs
Amarillo may want to arrange a line of credit of perhaps $200,000 now so it can bridge the cash shortfall in the 2nd quarter. In particular, it seems wise to postpone the dividend payment until the fourth quarter, when there is sufficient cash. Verify that Amarillo will not need to take out a loan if it can defer paying the dividend to the fourth quarter.
With this change, the cash outflow due to special items will be $50,000 in the first quarter.
Check It! exercise #6
Factors Influencing the Budgeting Process
Cost centers: Organizational units that have control over the costs incurred in offering products or services. A production plant is a classic example
Profit centers: Organizational units that have control over both revenue and costs. A region or a product line is an example
It means that Amanda will use Amarillo's budgets to motivate, evaluate and reward her employees. Under responsibility accounting, Amanda will hold managers accountable for the revenues and expenses they control; the BuildIT production manager would be held responsible for differences between the actual and budgeted costs of producing BuildIT, but not BuildIT-PLUS. Likewise, product managers would be held responsible for differences between actual and budgeted profits for their specific products.
The structure of the organization also dictates who is responsible for preparing specific budgets and the extent of communication and coordination required to consolidate budgets. For example, to obtain an overall revenue budget, Amanda would need to consolidate the individual revenue budgets prepared by the BuildIT and BuildIT-plus marketing managers.
Bottom-up Budgeting
Why would employees do this when they know that not disclosing their information would lead to inaccurate planning data. For example, cost center managers have incentives to overestimate costs, or to over budget, making it easier to beat budget and create the appearance of better than expected performance. Recognizing these incentives, organizations using participatory budgeting go through several iterations to get as good a forecast as possible.
P articiPative B udgeting
Budget goals
LO1. What is a budget?
LO1. What are the three reasons firms use budgets?
Premium's inventory on March 1 is 1,750 windows, and its budgeted production for the month is 8,000 windows. Premium believes that if it prices each window at $60, then it will sell 2,500 windows in January and that sales will increase by 100 units per month through August. Sales would increase at a rate of 125 per units per month to August and then decline at a rate of 150 units per month to December.
The following table shows selected information for three of Premium Windows' monthly budgets for the coming year. The following table shows selected information for three of Premium Windows' monthly budgets for the upcoming selected information for three of Premium Windows' monthly budgets for the upcoming year.
LO4 (Advanced). Investigate line-item budgeting
LO4. (Advanced) A criticism of budget lapsing is that it forces decision makers to find ways to spend the
You also know that the monthly fee for an individual membership is $100 and the fee for a family membership is $160. If they run the ads in September, they expect to get 10 additional individual members and 5 additional family memberships each month.
Purchases and overhead, Hercules (LO2). Tom and Lynda own Hercules Health Club
However, Gantz still expects to start April with 15,000 units because it is too late in the month to change March production. Bruce sells most of his products on credit; he estimates that he collects 30% of his income in the month of the sale, 40% the month after, 25% two months after the sale and the remaining 5% the month after. The following cash budget for the fourth quarter of this year has some information missing.
Fill in the missing information and calculate the value of each "?". Assume that the company started in October with no loans. Gilbert expects to receive 70% of his proceeds in cash in the month of sale and 30% in the following month.
Cash receipts and disbursements, integration with the balance sheet (LO4, Advanced)
Any necessary short-term borrowing is done using the firm's line of credit, which is $40,000. The firm prefers to pay off its loans as quickly as possible, without violating its minimum cash policy. Furthermore, the firm expects to realize the same level of sales for each of the three months within each quarter.
The firm's CEO is considering moving to a "no inventory" policy because she is convinced that inventory simply ties up valuable capital. Gary pays for 50% of his purchases in the month of purchase and 50% in the following month.
Cost of goods manufactured and cost of goods sold budgets (LO2). Kincaid Casting Works provides you with the following information from the company’s monthly
Naomi believes that while the costs of direct materials and direct labor vary with the number of units, the costs of variable selling and administrative expenses are proportional to revenues. In particular, the sales manager looks at differences in sales growth and corrects low projections to be in line with the average. The usual result is a 3 to 7% increase in expected sales, which the sales manager divides equally among the five salespeople.
Of course, Tim insists that the sales manager discuss and negotiate any changes with the sales force. Drawing on his experience as a successful salesperson who has never missed a target, Tim believes the fix is to correct the stuffing from the sales manager.
Flexible budgeting, subjective nature of the budgeting Process (LO2, LO4, Advanced)
Dan provides you with the following information about Spudcity franchise activities. Peterson expects to earn the same amount of revenue for each of the three months of the quarter. Peterson expects to make the same amount of material purchases for each of the three months during the quarter.
Prepare Pumpkin Patch's income statement for the contribution margin for each of the last six months of 2008. It was clear to Mary that the sales team had "lowered" the target so that she could comfortably meet it and qualify for the bonus.
