SCM-4-Master Budget - SCM PDF

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Strategic Cost Management The Master Budget

Terminologie s: • Budgets – are financial plans for the future and are a key component of planning. They identify objectives and the actions needed to achieve them. • Strategic plan – plots a direction for an organization’s future activities and operations; it generally covers at least 5 years. The overall strategy is then translated into the long and short term objectives that form the basis of the budget. • Planning – looking ahead to see what actions should be taken to realize particular goals. • Control – looking backward, determining what actually happened and comparing it with the previously planned outcomes. • Master Budget – the comprehensive financial plan for the organization as a whole. Typically, the master budget is for a 1-year period, corresponding to the fiscal year of the company. • Continuous Budget – a moving 12 month budget. As a month expires in the budget, an additional month in the future is added so that the company always has a 12-month plan on hand. It forces managers to plan ahead constantly – something especially needed when firms operate in rapidly changing environments. • Budget committee – reviews the budget, provides policy guidelines and budgetary goals, resolves differences that arise as the budget is prepared, approves the final budget, and monitors the actual performance of the organization as the year unfolds. • Budget director – the controller, the person responsible for directing and coordinating the organization’s overall budgeting process. Key points: Advantages of Budgeting • Planning – encourages managers to develop an overall direction for the organization, foresee problems, and develop future policies. • Information for Decision Making – For example, a restaurant owner who knows the expected revenues and the costs of meat, vegetables, cheeses, and so on might make menu changes that play up the less expensive items and reduce the use of more expensive ingredients. • Standards for Performance Evaluation – budget set standards that can control the use of a company’s resources and motivate employees. A large difference between actual and planned results is feedback that prompts managers to take corrective actions. • Improved Communication and Coordination – the budgets serve to communicate and coordinate the plans of the organization to each employee. Accordingly, employees can be aware of their particular role in achieving those objectives.

The Master Budget I. Operating budgets – describe the income-generating activities of a firm: sales, production, and finished goods inventories. The ultimate outcome of the operating budget is a pro forma or budgeted income statement. A. Sales Budget – approved by the budget committee and describes expected sales in units and dollars. Since it is the basis for all of the other operating budgets and most of the financial budgets, it is important that it be as accurate as possible. B. Production Budget – tells how many units must be produced to meet sales needs and to satisfy ending inventory requirements. Formula: Units to be Produced = Expected Unit Sales + Units in Desired Ending Inventory (EI) – Units in Beginning Inventory (BI) C. Direct Materials Purchases Budget – tells the amount and cost of raw materials to be purchased in each time period. Formula: Direct Materials Needed for Production + Direct Materials in Desired Ending Inventory – Direct Materials in Beginning Inventory D. Direct Labor Budget – shows the total direct labor hours and the direct labor cost needed for the number of units in the production budget. E. Overhead Budget – shows the expected cost of all production costs other than direct materials and direct labor. F. Ending Finished Goods Inventory Budget – supplies information needed for the balance sheet and also serves as an important input for the preparation of the cost of goods sold budget. G. Cost of Goods Sold Budget – reveals the expected cost of the goods to be sold. H. Selling and Administrative Expenses Budget – outlines planned expenditures for nonmanufacturing activities. I. Budgeted Income Statement – With the completion of the budgeted cost of goods sold schedule and the budgeted selling and administrative expenses budget, an estimate of the operating income can now be prepared. Take note that operating income is not e  quivalent to the net income of a firm. To yield net income, interest expense and taxes must be subtracted from operating income. II. Financial Budget or Capital Budget A. Cash budget – one of the most important budgets in the master budget because cash flow is the lifeblood of an organization. The basic structure of a cash budget includes cash receipts, disbursements, any excess or deficiency of cash, and financing. At its simplest, a cash budget is cash inflows minus cash outflows. Terminologies: Cash Available – consists of the beginning cash balance and the expected cash receipts Cash Disbursements – lists all planned cash outlays for the period. All expenses that do not require a cash outlay are excluded from the list (e.g., depreciation is never included in the disbursements section) Cash Excess or Deficiency – The cash excess or deficiency line is compared to the minimum cash balance required by company policy. Minimum cash balance – the lowest amount of cash on hand that the firm finds acceptable. Borrowings and Repayments – If there is a deficiency, this section shows the necessary amount to be borrowed. When excess cash is available, this section shows planned repayments, including interest expense. Ending Cash Balance – the planned amount of cash to be on hand at the end of the period after all receipts and disbursements, as well as borrowings and repayments, are considered. Formulas: Cash

Available = Beginning Cash Balance + Expected Cash Receipts Ending Cash Balance = Cash Available – Expected Cash Disbursements B. Budgeted Balance Sheet C. Budget for Capital Expenditures (to be discussed after midterm) Illustration: (Note that these are interrelated problems. This illustration shows the flow of the preparation of a master budget. A. Operating Budget 1. Sales Budget – used to determine units to be sold and forecast prices for the coming year. Information: Prepare the sales budget for Texas Rex’s standard t-shirt line. For simplicity, assume that Texas Rex has only one product: a standard short-sleeved t-shirt with the Texas Rex logo screen printed on the back. Budgeted units to be sold for each quarter of the year 2014: 1,000, 1,200, 1,500, and 2,000. Selling price is P10 per t-shirt. Solution : Texas Rex Inc. Sales Budget For the Year Ended December 31, 2020 Quarte r Units Unit selling price Budgeted sales

2 1,200 x P10 P12,00 0 2 1,200 x P10 P12,00 0 3 1,500 x P10 P15,00 0 3 1,500

x P10 P15,00 0 3 1,500 x P10 P15,00 0 4 2,000 x P10 P20,00 0 4 2,000 x P10 P20,00 0 4 2,000 x P10 P20,00 0 4 2,000 x

P10 P20,00 0 Year 5,700 x P10 P57,00 0 Year 5,700 x P10 P57,00 0 Year

5,700 x P10 P57,00 0 Year 5,700 x P10 P57,00 0 Year 5,700 x P10 P57,00 0

Note: This reveals that Texas Rex’s sales fluctuate seasonally. Most sales take place in the summer and fall quarters. This is due to the popularity of the t-shirts in the summer and the sales promotions that Texas Rex puts on for “back to school” and Christmas. 2. Production Budget – once a sales budget has been prepared, a production budget tells managers how many units must be produced to satisfy anticipated sales and ending inventory needs. Information: Budgeted units to be sold for each quarter: 1,000, 1,200, 1,500, and 2,000. Assume that company policy requires 20% of the next quarter’s sales in ending inventory and that beginning inventory of t-shirts for the first quarter of the year was 180. Assume also that sales for the first quarter of 2015 are estimated at 1,000 units. Require d: a. Calculate the desired ending inventory in units for each quarter of the year. What is the ending inventory in unit for the year? b. Prepare a production budget for each quarter and for the year. Solution : a. Ending inventory, Quarter 1 = 0.20 x 1,200 units = 240 Ending inventory, Quarter 2 = 0.20 x 1,500 units = 300 Ending inventory, Quarter 3 = 0.20 x 2,000 units = 400 Ending inventory, Quarter 4 = 0.20 x 1,000 units = 200 Ending inventory for the year = Ending inventory for Quarter 4 = 200 units b. Production budget Texas Rex Inc. Production Budget For the Year Ended December 31, 2020 Quarter Sales in units Desired ending inventory Total needs Less: Beginning inventory Units to be produced

1 2 3 4 1,000 1,200 1,500 2,000 240 300 400 200 1,240 1,500 1,900 2,200 (180) (240) (300) (400) 1,060 1,260 1,600 1,800 Year 5,700 200 5,900 (180) 5,720 *Beginning inventory for Quarter 1 is given in information. Beginning inventory for the remaining quarters is equal to ending inventory for the previous quarter.

Note: Consider the first column (Quarter 1) of the budget. Texas Rex anticipates sales of 1,000 t-shirts. In addition, the company wants 240 t-shirts in ending inventory at the end of the first quarter (0.20 x 1,200). Thus 1,240 t-shirts are needed during the first quarter. Where will these 1,240 t-shirts come from? Beginning inventory can provide 180of them, leaving 1,060 to be produced during the quarter. Notice that the production budget is expressed in terms of units. Two important points regarding the production budget example should be emphasized: • The beginning inventory for one quarter is always equal to the ending inventory of the previous quarter. For Quarter 2, the beginning inventory is 240 t-shirts, which is identical to the desired ending inventory for Quarter 1. • The column for the year is not simply the addition of the amounts for the four quarters. Notice that the desired ending inventory for the year is 200 t-shirts, which is, of course, equal to the desired ending inventory for the fourth quarter. 3. Direct Materials Purchases Budget – shows managers how much must be bought to support production and ending inventory needs for materials. Information: Budgeted units to be produced for each quarter: 1,060, 1,260, 1,600, and 1,800. Plain t-shirts cost P3 each, and ink (for the screen printing) costs P0.20 per ounce. On a per-unit basis, the factory needs one plain t-shirt and five ounces of ink for each logoed t-shirt that it produces. Texas Rex’s policy is to have 10% of the following quarter’s production needs in ending inventory. The factory has 58 plain t-shirts and 390 ounces of ink on hand on January 1. At the end of the year, the desired ending inventory is 106 plain t-shirts and 530 ounces of ink. Required: a. Calculate the ending inventory of plain t-shirts and of ink for Quarters 2 and 3. b. Prepare a direct materials purchases budget for plain t-shirts and one for ink. Solution: a. Ending inventory plain t-shirts, Quarter 2 = 0.10 x (1,600 x 1 t-shirt) = 160 Ending inventory plain t-shirts, Quarter 3 = 0.10 x (1,800 x 1 t-shirt) = 180 Ending inventory ink, Quarter 2 = 0.10 x (1,600 x 5

ounces) = 800 Ending inventory ink, Quarter 3 = 0.10 x (1,800 x 5 ounces) = 900 b. Direct materials purchases budget Texas Rex Inc. Direct Materials Purchases Budget For the Year Ended December 31, 2020 Plain t-shirts Quarter Units to be produced Direct materials per unit Production needs Desired ending inventory Total needs Less: Beginning inventory Direct materials to be purchased Cost per t-shirt Total Purchase cost plain t-shirts 1 1,060 x 1 1,060 126 1,186 (58) 1,128 x P3 P3,384 2 1,260 x 1 1,260 160 1,420 (126) 1,294 x P3 P3,882 3 1,600 x 1 1,600 180 1,780 (160) 1,620 x P3 P4,860 4 1,800 x 1 1,800 106 1,906 (180) 1,726 x P3 P5,178 Year 5,720 x 1 5,720 106 5,826 (58) 5,768 x P3 P17,304 4 Ink 1 2 3 Units to be produced 1,060 1,260 1,600 1,800 Direct materials per unit x5 x5 x5 x 5 Production needs 5,300 6,300 8,000 9,000 Desired ending inventory 630 800 900 530 Total needs 5,930 7,100 8,900 9,530 Less: Beginning inventory (390) (630) (800) (900) Direct materials to be purchased 5,540 6,470 8,100 8,630 Cost per ounce x P0.20 x P0.20 x P0.20 x P0.20 Total Purchase cost of ink

P1,108 P1,294 P1,620 P1,726 Total direct materials purchase cost P4,492 P5,176 P6,480 P6,904 Year 5,720 x 5 28,600 530 29,130 (390) 28,740 x P0.20 P5,748 P23,052 Note: Notec how similar the direct materials purchases budge is to the production budget. Consider the first quarter, starting with the plain t-shirts. It takes on plain t-shirt for every log t-shirt, so the 1,060 logo t-shirts to be produced are multiplied by one to obtain the number of plain t-shirts needed for production. Next, the desired ending inventory of 126 (10% of the next quarter’s production needs) is added. Thus, 1,186 plain t-shirts are needed during the first quarter. Of this total, 8 are already in beginning inventory, meaning that the remaining 1,128 must be purchased. Multiplying the 1,128 plain t-shirts by the cost of P3 each gives Texas Rex the P3,384 expected cost of plain t-shirt purchases for the first quarter of the year. The direct materials purchases budget for ink is done in the same way as t-shirts except that each unit produced requires 5 ounces of ink. So the total units to be produced must be multiplied by 5 to get the production needs of ink. 1. Direct Labor Budget – shows how many hours are required for production in the coming year. The average wage is multiplied by direct labor hours to determine total anticipated direct labor cost. Information: Recall that budgeted units to be produced for each quarter are: 1,060, 1,260, 1,600 and 1,800. It takes 0.12 hour to produce one t-shirt. The average wage cost per hour is P10. Required: Prepare a direct labor budget Texas Rex Inc. Direct Labor Budget For the Year Ended December 31, 2020 Quarter Units to be produced Direct labor time per unit in hours Total hours needed Average wage per hour Total direct labor cost 1 1,060 X 0.12 127.2 X P10 P1,272 2 1,260 X 0.12 151.2 X P10 P1,512 3 1,600 X 0.12 192.0 X P10 P1,920 4 1,800 X 0.12 216.0 X P10 P2,160 Year 5,720 X 0.12 686.4 X P10 P6,864 2. Overhead Budget –The overhead budget shows forecast variable and fixed overhead costs for the coming year. Taken together with the materials and labor budgets, total production cost can be determined. Information: Refer to the direct labor budget. The variable overhead rate is P5 per direct labor hour. Fixed overhead is budgeted at P1,645 per quarter (this amount includes P540 per quarter for depreciation). Required: prepare and overhead budget. Texas Rex Inc. Overhead Budget For the Year Ended December 31, 2020 Quarter Budgeted direct labor hours Variable overhead rate Budgeted variable overhead Budgeted fixed overhead* Total Overhead 1 127.2 X P5 P636 1,645 P2,281

2 151.2 X P 5 756 1,645 P2,401 3 192.0 X P 5 960 1,645 P2,605 4 216.0 X P 5 1,080 1,645 P2,725 Year 686.4 X P 5 3,432 6,580 P10,012 * Includes P540 of depreciation in each quarter. 3. Ending Finished Goods Inventory Budget – helps managers determine the predicted unit cost of production. This amount is used in valuing ending inventory on the budgeted balance sheet. Information: Refer to the direct materials, direct labor, and overhead budgets. Required: a. Calculate the unit product cost. b. Prepare an ending finished goods inventory budget. Solution: a. Direct materials Plain t-shirt P3 Ink (5 oz. @ P0.20) 1 P4.00 Direct Labor (0.12hr @ P10) 1.20 Overhead: Variable (0.12hr @ P5) 0.60 Fixed (0.12hr @ P9.59*) 1.15** Total unit cost P6.95 *Budgeted Fixed Overhead/ Budgeted Direct Labor Hours = P6,580/686.4 = P9. **Rounded

b. Ending Finished Goods Inventory Budget Texas Rex Inc. Ending Finished Goods Inventory Budget For the Year Ended December 31, 2020 Logo t-shirts Unit Cost Total ending inventory 200 X P6.95 P1,390 4. Cost of Goods Sold Budget – is used to determine the predicted cost of units to be sold in the coming year. It is an input to the budgeted income statement. Information: Refer to the direct materials, direct labor, overhead, and ending finished goods budgets. The cost of beginning finished goods inventory is P1,251. Required: Prepare a cost of goods sold budget. Solution: Texas Rex Inc. Cost of Goods Sold Budget For the Year Ended December 31, 2020 Direct materials used Direct labor used Overhead Budgeted manufacturing costs Beginning finshed goods Cost of goods available for sale Less: Ending finished goods Budgeted cost of goods sold P22,880 6,864 10,012 P39,756 1,251 P41,007 (1,390) P39,617 *Production needs = (5,720 plain t-shirts X P3) + (28,600 oz ink X P0.20)

5. Selling and Administrative Expenses Budget – is becoming a larger portion of modern business. This budget helps manages determine the amounts to be spent on these nonproduction categories. Information: Refer to the sales budget. Variable expenses are P0.10 per unit sold. Salaries average P1,420 per quarter, utilities, P50 per quarter, and depreciation, P150 per quarter. Advertising for Quarters 1 through 4 is P100, P200, P800, and P500, respectively. Required: Prepare a selling and administrative expenses budget. Solution: Texas Rex Inc. Selling and Administrative Expenses Budget For the Year Ended December 31, 2020 Quarter Planned sales in units Variable S&A expenses per unit Total variable expenses Fixed S&A expenses Salaries Utilities Advertising Depreciation Total fixed expenses Total S&A expenses

1 1,000 X P0.10 P100 P1,420 50 100 150 P1,720 P1,820  2 1,200 X P0.10 P120 P1,420 50 200 150 P1,820 P1,940  3 1,500 X P0.10 P150 P1,420 50 800 150 P2,420 P2,570  4 2,000 X P0.10 P200 P1,420 50 500 150 P2,120 P2,320  Year 5,700 X P0.10 P570 P5,680 200 1,600 600 P8,080 P8,650 Note: Notice how the S&A expenses budget follows a very similar format as that of the overhead budget. In both cases, variable and fixed expenses are calculated. Notice also that depreciation, a non-cash expense, is shown separately. This will be important later on when the company prepares the cash budget. 6. Budgeted Income Statement – helps managers determined how profitable the coming year will be. If budgeted income is not high enough, adjustments to the budgets can be made after this budget has been completed. Information: Refer to the sales budget, cost of goods sold budget, the selling and administrative expenses budget, and the cash budget. Assume that the tax rate is 40%. Required: Prepare a budgeted income statement. Solution: Texas Rex Inc. Budgeted Income Statement For the Year Ended December 31, 2020 Sales Less: Cost of Goods Sold Gross margin Less: S&A expenses Operating income Less: Interest expense Income before income taxes Less: Income taxes (0.40 x P8,673) Net Income P57,000 (39,617) P17,383 (8,650) P8,733 (60) P8,673 (3,469)* P5,204 *Rounded B. Financial Budget 1. Cash Budget • Preparing a Schedule for Cash Collections on Accounts Receivable – predicted collections of cash on account are an important part of the cash budget. Information: From past experience, Texas Rex expects that, on average, 25% of total sales are cash and 75% of total sales are on credit. Of the credit sales, Texas Rex expects that 90% will be paid in cash during the quarter of sale, and the remaining 10% will be paid in the following quarter. Recall from the sales budget that Texas Rex expects the following total sales: Quarter 1 P10,000 Quarter 2 P12,000 Quarter 3 P15,000 Quarter 4 P20,000 The balance in accounts receivable as of the last quarter of 2013 was P1,350. This will be collected in cash during the first quarter of 2020. Required: a. Calculate cash sales expected in each quarter of 2020 b. Prepare a schedule showing cash receipts from sales expected in each quarter of 2020. Solution: a. Cash sales expected in Quarter 1 = P10,000 x 0.25 = P2,500 Cash sales expected in Quarter 2 = P12,000 x 0.25 = P3,000 Cash sales expected in Quarter 3 = P15,000 x 0.25 = P3,750 Cash sales expected in Quarter 1 = P20,000 x 0.25 = P5,000

b. Schedule of Cash receipts from sales Quarter Source 1 2 3 4 Cash Sales Received on account from: Quarter 4, 2019 Quarter 1, 2020 Quarter 2, 2020 Quarter 3, 2020 Quarter 4, 2020 P2,500 1,350 6,750a P3,000  c 750b 8,100  P3,750  e 900d 10,125  P5,000  g 1,125f 13,500  Tota...