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Chapter 9
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  1. Chapter 9 The Operating Budget

  2. Learning Objective 1 Describe some of the benefits of the operating budget.

  3. Benefits of Budgeting Budgeting serves as a guide. Helps organizations allocate resources. It encourages communication and coordination. Budgeting sets performance standards or benchmarks.

  4. Learning Objective 2 Describe the three budgeted financial statements contained in the operating budget and the other budgets that support the budgeted financial statements.

  5. Operating Budget The operating budget is a set of estimated financial statements. It includes several detailed schedules that provide the backup documentation for the financial statements.

  6. Contents of Operating Budget Budgeted Balance Sheet Budgeted Income Statement Budgeted Statement of Cash Flows

  7. Supporting Schedules Sales Budget Production or Purchases Budget Cost of Goods Sold or Cost of Services Budget

  8. Supporting Schedules Selling and Administrative Expense Budget Cash Budget  Budgeted Statement of Cash Flows

  9. Sales Forecast Cash Budget Sales Budget Budgeted Income Statement Production Budget Budgeted Balance Sheet Cost of Goods Sold Budget Budgeted Statement of Cash Flows Selling and Admin. Expense Budget InterrelationshipAmong the Budgets

  10. Learning Objective 3 Compare and contrast various approaches to preparing and using the operating budget.

  11. Different Approachesto Budgeting Perpetual budgeting is also called continual budgeting. The operating budget is continually updated and extended. As one month or quarter ends, another month or quarter is added to the end of the budget.

  12. Different Approachesto Budgeting In incremental budgeting, the prior year’s budget is used as a starting point for the current year. Only the changes (increments) need to be justified.

  13. Different Approachesto Budgeting Zero-based budgeting is an alternative to incremental budgeting. Each year, the full amount of each budget item needs to be justified.

  14. Different Approachesto Budgeting Top-down budgeting occurs when the budget is prepared by the top executives. Lower management and employees work to meet the budget.

  15. Different Approachesto Budgeting Many top-down budgets are also imposed budgets. Top managers set the budget amounts without any input from the lower-level managers.

  16. Different Approachesto Budgeting Bottom-up budgeting is a budget prepared by the lower-level managers of the firm. This is a participative budget.

  17. Learning Objective 4 Describe the role of the sales forecast in the budgeting process.

  18. Sales Forecast All of the different parts of the operating budget depend upon the sales forecast, thus it is often called the cornerstone of the budget.

  19. Budgeted Statement of Cash Flows Budgeted Balance Sheet Budgeted Income Statement Cash Budget S&A Expense Budget Cost of Goods Sold Budget Production Budget Sales Budget Sales Forecast The Sales Forecast as theCornerstone of Budgeting

  20. The Sales Forecast as theCornerstone of Budgeting Sales Forecast

  21. Factors Affecting the Accuracyof the Sales Forecast General economy: Inflation, recession, etc.? Industry conditions: Strength or weakness? Actions of competitors: Increase or decrease market share? Technological developments: Cutting edge or being left behind?

  22. Learning Objective 5 Prepare the budgets included in the operating budget.

  23. Preparing a MasterOperating Budget Marcy’s Surf Shop sells only one product, surfboards. The fiscal year ends June 30. We will prepare the operating budget for the quarter ending September 30, 2004.

  24. MARCY’S SURF SHOP Sales Forecast and Sales Budget For the Quarter Ended September 30, 2004 JulAugSepTotal Forecasted sales in units 30 50 40 120 Selling price $ 200$ 200$ 200$ 200 Budgeted sales dollars $6,000 $10,000 $8,000 $24,000 Sales Forecast and Sales Budget

  25. MARCY’S SURF SHOP Cost of Goods Sold Budget For the Quarter Ended September 30, 2004 JulAugSepTotal Forecasted sales in units 30 50 40 120 Unit cost $ 120$ 120$ 120$ 120 Budgeted cost of goods sold $3,600 $6,000 $4,800 $14,400 Cost of Goods Sold Budget

  26. MARCY’S SURF SHOP Selling and Administrative Expense Budget For the Quarter Ended September 30, 2004 JulAugSepTotal Salaries and wages $1,600 $2,000 $1,800 $5,400 Rent 200 200 200 600 Depreciation 100 100 104 304 Others 800 1,000 900 2,700 Total $2,700 $3,300 $3,004 $9,004 Selling and AdministrativeExpense Budget

  27. MARCY’S SURF SHOP Budgeted Income Statement For the Quarter Ended September 30, 2004 JulAugSepTotal Sales $6,000 $10,000 $8,000 $24,000 Cost of goods sold 3,600 6,000 4,800 14,400 Gross profit $2,400 $ 4,000 $3,200 $ 9,600 S&A expenses 2,700 3,300 3,004$ 9,004 Net income $ (300) $ 700 $ 196 $ 596 Budgeted Income Statement

  28. MARCY’S SURF SHOP Purchases Budget For the Quarter Ended September 30, 2004 JulAugSepTotal Forecasted unit sales 30 50 40 120 Desired ending inventory 20 16 24 24 Total units needed 50 66 64 144 Beginning inventory – 8 – 20 – 16 – 8 Units to be purchased 42 46 48 136 Cost per unit $ 120$ 120$ 120 $120 Cost of purchases $5,040 $5,520 $5,760 $16,320 Purchases Budget

  29. Cash Budget Cash receipts from sales tend to be collected 30% in the month of sale, 60% in the following month, and 10% in the second month following the sale. May credit sales were $4,500 and June credit sales were $6,000.

  30. Cash Budget We assume that Marcy pays for the surfboards in the month following the purchase. Purchases of merchandise in June totaled $5,200.

  31. MARCY’S SURF SHOP Cash Receipts Schedule For the Quarter Ended September 30, 2004 JulAugSepTotal Credit sales collected: From accts. receivable: May credit sales ($4,500) $ 450 $ 450 Jun credit sales ($6,000) 3,600 $ 600 4,200 From new credit sales: Jul ($4,500) 1,350 2,700 $ 450 4,500 Aug ($7,500) 2,250 4,500 6,750 Sep ($6,000) 1,800 1,800 Receipts for credit sales $5,400 $5,550 $6,750 $17,700 Cash sales 1,500 2,500 2,000 6,000 Budgeted cash receipts $6,900 $8,050 $8,750 $23,700 Cash Receipts Schedule

  32. MARCY’S SURF SHOP Cash Payments Schedule For the Quarter Ended September 30, 2004 JulAugSepTotal Purchases $5,200 $5,040 $5,520 $15,760 S&A expense: Salaries and wages 1,600 2,000 1,800 5,400 Rent 200 200 200 600 Other S&A expense 800 1,000 900 2,700 Purchases 240 Budgeted cash payments $7,800 $8,480 $8,420 $24,700 Cash Payments Schedule

  33. MARCY’S SURF SHOP Cash Budget For the Quarter Ended September 30, 2004 JulAugSepTotal Beg. cash balance $2,170 $1,900 $ 1,900 $ 2,170 Cash receipts 6,900 8,050 8,750 23,700 Cash available $9,070 $9,950 $10,650 $25,870 Cash payments 7,800 8,480 8,420 24,700 Bal. before borrowing 1,270 $1,470 $ 2,230 $ 1,170 Borrowing/(repayment) 630$ 430 (330) 730 Ending cash balance $1,900 $1,900 $ 1,900 $24,700 Cash Budget

  34. Marcy’s Surf Shop Balance Sheet June 30, 2004 Assets: Current assets Cash $ 2,170 Accounts receivable 4,650 Inventory 960 Total current assets $ 7,780 Property, plant, and equipment Equipment $ 6,000 Less: Accumulated depreciation – 1,200 Equipment (net) $ 4,800 Total assets $12,580

  35. Marcy’s Surf Shop Balance Sheet June 30, 2004 Liabilities: Accounts payable 5,200 Total liabilities $ 5,200 Owner’s equity: Paid-in capital Common stock $ 1,000 Additional paid-in capital 5,475 Total paid-in capital $ 6,475 Retained earnings $ 905 Total equity $ 7,380 Total liabilities and owner’s equity $12,580

  36. Budgeted Balance Sheet Quarter Ended September 30, 2004 JulAugSep Assets: Current assets Cash $ 1,900 $ 1,900 $ 1,900 Accounts receivable, net 3,750 5,700 4,950 Inventory 2,400 1,920 2,880 Total current assets $ 8,050 $ 9,520 $ 9,730 Property, plant, and equipment Equipment $ 6,000 $ 6,240 $ 6,240 Less depreciation – 1,300 – 1,400 – 1,504 Equipment, net $ 4,700 $ 4,840 $ 4,736 Total assets $12,750 $14,360 $14,466

  37. Budgeted Balance Sheet Quarter Ended September 30, 2004 JulAugSep Liabilities: Current liabilities Accounts payable $ 5,040 $ 5,520 $ 5,760 Bank loan payable 630 1,060 730 Total liabilities $ 5,670 $ 6,580 $ 6,490 Owner’s equity: Paid-in capital Common stock $ 1,000 $ 1,000 $ 1,000 Additional paid-in capital 5,475 5,475 5,475 Total paid-in capital $ 6,475 $ 6,475 $ 6,475 Retained earnings $ 605$ 1,305$ 1,501 Total equity $ 7,080 $ 7,780 $ 7,976 Total liabilities and equity $12,750 $14,360 $14,466

  38. Accounts Receivable JulAugSep Beginning balance $4,650 $3,750 $5,700 Credit sales 4,500 7,500 6,000 Collections –5,400–5,550–6,750 Ending balance $3,750 $5,700 $4,950

  39. Inventory JulAugSep Beginning balance $ 960 $2,400 $1,920 Purchases 5,040 5,520 5,760 Cost of goods sold –3,600–6,000–4,800 Ending balance $2,400 $1,920 $2,880

  40. Accounts Payable JulAugSep Beginning balance $5,200 $5,040 $5,520 Purchases 5,040 5,520 5,760 Payments –5,200–5,040–5,520 Ending balance $5,040 $5,520 $5,760

  41. Bank Loan Payable JulAugSep Beginning balance $ 0 $ 630 $1,060 Borrowing 630 430 0 Repayments 0 0 – 330 Ending balance $ 630 $1,060 $ 730

  42. Retained Earnings JulAugSep Beginning balance $ 905 $ 605 $1,305 Income/loss – 300 700 196 Dividends 0 0 0 Ending balance $ 605 $1,305 $1,501

  43. Budgeted Statement of Cash Flows Quarter Ended Sept. 30, 2004 Cash flows from operating activities: JulAugSepTotal Net income $ (300) $ 700 $ 196 $ 596 Add: Depreciation 100 100 104 304 Changes in CA & CL: Accounts receivable 900 (1,950) 750 (300) Inventory (1,440) $ 480 $ (960) $(1,920) Accounts payable (160)$ 480 0 560 Net cash flow from operating activities $ (900) $ (190) $ 330 $ (760)

  44. Budgeted Statement of Cash Flows Quarter Ended Sept. 30, 2004 Cash flows from investing activities: JulAugSepTotal Cash paid for showcase $ (240)$ (240) Net cash flow from investing activities $ (240) $ (240) Cash flows from financing activities: Borrowing $ 630 $ 430 $1,060 Loan payments $ (330) (330) Net cash flow from financing activities $ 630$ 430$ (330) $ 730 Inc./(dec.) in cash $ (270) $ 0 $ 0 $ (270) Beginning cash balance 2,170 1,900 1,900 2,170 Ending cash balance $1,900 $1,900 $1,900 $1,900

  45. Learning Objective 6 Describe the appropriate use of the operating budget in the overall management process.

  46. Budget Performance Report A major part of the control function of management is the performance against budget. The main instrument used in this evaluation is the budget performance report. This report indicates any variances between actual results and budgeted results.

  47. Budget Performance Report MARCY’S SURF SHOP Performance Report For the Quarter Ended September 30, 2004 DescriptionBudgetActualVariance Salaries and wages $25,000 $23,000 $2,000 F Office rent 10,000 10,000 0 Office supplies 1,000 1,200 200 U

  48. End of Chapter 9