AFM481 - Advanced Cost Accounting Professor Grant Russell Final Exam Material. Chapter 10: Static and Flexible Budgets

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1 AFM481 - Advanced Cost Accounting Professor Grant Russell Final Exam Material Chapter 10: Static and Flexible Budgets Budget: formalized financial plan for operations of an organization for a specified future period Budgets for revenues, costs and cash flows help managers carry out short-term operating plans. Forecast events and develop plans to determine the resources an organization needs Compare actual results to budgets and use variance information to improve operations. Budget Cycle: Reconsider Long-Term strategies Develop operating plans. Translate strategies and operating plans into master budget. Monitor actual results compared to budget. Investigate differences between actual and budget. Evaluate and reward performance. Master Budget: A comprehensive plan for a year, developed using budget assumptions about next period's operating activities Operating Budget: plan for revenues, production and operating costs 1) Revenues Budget 2) Production Budget (in units) 3) DM Costs Budget, DL Costs Budget, Indirect Manufacturing Costs Budget 4) Ending Inventory Schedules 5) COGS Budget 6) Operating Expense (Period Cost) Budget 7) Prepare the budgeted income statement Financial Budget: plan for capital expenditures, long-term financing, cash flows and shortterm financing. Based on the operating budgets above, prepare: 1) Capital expenditures budget 2) Cash budget 3) Budgeted Balance Sheet 4) Budgeted Statement of Cash Flows 5) Pro-Forma Statement of Net Income Budgeted financial statements: forecasts of the future income statement, balance sheet, and cash flows Developing a Master Budget: 1. Revenue Budget: Sales Forecast (units) * Selling Price Plans per unit = Expected Total Sales Revenue

2 2. Volume of Production Budget: Sales Forecast (units) + Desired Ending Inventory Levels = Total units needed - Beginning Inventory Levels = Production required E.g. Berol Company plans to sell 200,000 units of finished product in July of this year and anticipates a growth rate in sales of 5% per month. The target monthly ending inventory in units of finished product is 80% of the next month s estimated sales. There are 150,000 finished units in inventory on June 30th. REQUIRED: Calculate the production requirement in units of finished product for the quarter ending September 30th. Production Requirement for July = Sales + Ending Beginning = 200,000 + (80% * 200,000 * 1.05) 150,000 = 218,000 Production Requirement for August = 210,000 + (80% * 210,000 * 1.05) 168,000 = 218,400 Production Requirement for September = 220,500 + (80% * 220,500 * 1.05) 176,400 = 229,320 Quarter Production Requirement (July - September) = 665, Direct Material Budget: Determine the amount of DM that must be purchased. Production required in units + Desired Ending Inventory Levels = Total DM needed - Beginning Inventory Levels = Purchases of DM needed in units * $ cost per DM unit = Cost 4. Direct Labour Budget Assembly Costs = Assembly Hours Expected * Cost $ per Assembly Hour Testing Costs = Testing Hours Expected * Cost $ per Testing Hour 5. Manufacturing Overhead Budget Variable Overhead: Supplies: $ Cost per unit * production required Indirect Labour: $ Cost per unit * production required Maintenance: $ Cost per unit * production required Fixed Overhead: Amortization Property Taxes Insurance Plant Supervision Fringe Benefits Total Overhead Costs

3 Fixed Overhead Allocation Rate = Budgeted Fixed Manufacturing Overhead Costs / Budgeted Volume of Production in Units 6. Budget for Ending Inventory: Forecasted costs for ending inventories Unit Costs: Direct Materials Direct Labour Variable Overhead Fixed Overhead Total Unit Cost Finished Goods in $ = Total Unit Cost * Finished Goods in Units + Raw Materials in $ = Total Ending Inventory $ 7. Budget for COGS: (using forecasted sale of 100,000 units) Beginning Finished Goods Inventory + Direct Materials Used (multiply the unit costs by the units to be produced) + Direct Labour + Variable Overhead + Fixed Overhead Total Goods Available - Less: Ending Finished Goods (Total Unit Cost * Ending FG units) = COGS 8. Support Department Budgets Administration Marketing Distribution Customer Service = Total Support Department Costs 9. Short-term Financing Budget: Expected operating cash receipts and disbursements, planned capital expenditures and long-term financing 10. Budgeted Financial Statements Cash Budget: to ensure adequate levels of cash for day-to-day operations To prepare a cash budget, 3 types of cash transactions are planned: Expected amounts and timing of cash receipts Operating cash receipts are estimated from budgeted revenues. Expected amounts and timing of cash disbursements Operating cash disbursements are estimated from the budgets for DM, DL, MO and support departments. (Amortization will not be paid in cash, so ignore)

4 Short-term borrowings or investments Cash Flows: purchasing or selling property, plant and equipment borrowing or repaying long-term debt paying interest on debt issuing or redeeming capital stock paying dividends to shareholders Developing a Cash Budget 1. Summary of Cash Receipts and Disbursements Beginning Cash Balance + Cash Collections = Total Cash Available Less: Cash Disbursements: Direct Materials Purchases Direct Labour Variable Overhead Supplies Indirect Labour Maintenance Fixed Overhead Property taxes Insurance Plant supervisor Fringe benefits Administration, Marketing, Distribution, Customer Service Purchase of Equipment Total Cash Disbursements = Excess Receipts (Disbursements) 2. Short-Term Financing Budget Excess receipts (disbursements) Line of Credit + Borrowing - Interest on borrowing - Repayment = Ending Cash Balance and Short-Term Borrowing 3. Budgeted Income Statement Sales Revenue - COGS = Gross Margin - Operating Costs (Admin, Marketing, Distribution, Customer Service) = Operating Income/Loss

5 - Interest Expense - Income Taxes = Net Income E.g. Developing a Cash Budget Month Sales Purchases pril $72,000 $42,000 May 66,000 48,000 June 60,000 36,000 July 78,000 54,000 Cash collections from customers are normally 70% in the month of sale, 20% in the month after, and 9% in the second month after the sale. The remainder is not collected. All purchases are on account and are made on the 1 st business day of each month. *For all purchases, management takes complete advantage of the 2% purchase discount by paying on the 10 th business day of the month after purchase.* Purchases for August are budgeted at $60,000 and sales are forecast to be $66,000. Cash disbursements in August are expected to be $14,400. The cash balance on August 1 was $22,000. What is the budgeted cash balance for August 31? August 1 Cash Balance $22,000 - Cash Disbursements in August: (14,400) + Cash Received in August: $67200 June: 9% of $60,000 sales collected = $5400 cash collected by August 31 July: 20% of $78,000 sales collected = $15600 cash collected by August 31 August: 70% of $66,000 sales collected = $46200 cash collected on August 31 - Cash Disbursements: DM Purchases August $60,000 * 0.98 = ($58,800) =August 31 Cash Balance $16,000 Static Budget: a budget based on forecasts of specific volumes of production Flexible Budget: a set of revenue and cost relationships that can be used to estimate costs and cash flows for any level of operations A flexible budget uses the variable revenue and cost information from the master budget but adjusts sales information and variable costs to reflect actual volumes Flexible budget variances are based on the budget that is adjusted for actual sales or production volume. Variable costs are adjusted for actual volume of activity. Budget Sensitivity Analysis: Estimate the effects of deviations from budget assumptions. E.g. How profits or cash flows would be affected if DM prices increase or if sales volumes fall. Sales revenue and COGS would change whereas the fixed operating costs (admin, marketing, customer service) would stay the same. Benchmarks for performance: comparing actual results to the original budget forecasts Find out whether desired sales volumes are achieved or whether costs are under control. Budget Variances: differences between budgeted and actual results

6 May be calculated by comparing actual results to a static budget, a flexible budget or a budget that has been adjusted for a benchmark Favourable variance: Actual Revenues > Budget Actual Costs < Budget Unfavourable Variance: Actual Revenues < Budget Actual Costs > Budget When evaluating actual results at the end of a period, a flexible budget is set at the actual sales or production volume and used as a benchmark for analyzing variances. An organization that uses a static budget transforms it into a benchmark by adjusting its variable costs to reflect actual volume. A flexible budget uses actual volume for variable costs and the budgeted fixed costs. Participative Budgeting: managers who are responsible for meeting budgets also prepare the initial budget forecasts, setting targets for themselves Budgetary Slack: set the goals low and easy so there is room for slack Budget Ratcheting: Raise targets high When measuring a manager's performance: Use a flexible budget to determine expected revenues based on budgeted prices and actual volumes Use a flexible budget to determine expected variable costs based on budgeted variable cost rates and actual volumes Remove allocated costs that are not controllable by managers in the departments receiving allocations Zero-based Budgeting: Justify budget amounts as if no information about budgets or costs from prior budget cycles were available. Cut costs and improve quality. Rolling Budget: prepared monthly or quarterly, reflects planning changes going forward more current information and reflects the most recent results Activity-Based Budgeting: uses activity cost pools and cost drivers to anticipate the costs for individual activities. The costs for each activity would be budgeted separately. Kaizen Budgets for decreasing prices or increasing quality across time (e.g. cell phones and computers): set targeted cost reductions across time, anticipating market price reductions across the product life. Quality improvements are also targeted. Key From Questions (10.30, 10.36, 10.38, 10.49) 10.30: Production, DM, and DL Budget Projected sales of product for the next 6 months Product sells for $100, variable expenses are $70

7 January: 40 units February: 90 units March: 100 units April: 80 units May: 30 units June: 70 units per unit, fixed expenses are $1500 per month. Finished product requires 3 units of RM (DM) and 10 hours of DL. Trying to maintain an ending inventory of FG equal to the next 2 months of sales and an ending inventory of RM equal to 1/2 of the current month's usage. Production Budget for February, March and April February March April + Planned Sales Desired Ending March's April's = = 100 Inventory 80 = 180 = Total Units Needed Planned Beginning Inventory January ending inventory = February's ending inventory 180 March's ending inventory 110 = Production requirements DM Unit Forecast February March April Planned Usage Current production 80 * = Desired Ending Current planned usage Inventory 240 * 1/2 = 120 Total units needed Planned beginning January production inventory requirement * 3 units RM * 0.5 = 150 Materials acquisitions Labour Requirements Budget: Finished product requires 10 hours of DL. February March April DL hours needed 80 * 10 hours = *10 = * 10 = : Cash Receipts Budget for Q1 Credit sales for the quarter = $640,000 A/R balance from Q4 = $600,000 All other A/R from the prior year collected or written off Collections of 50% occur during the quarter, 30% in the next quarter, 15% 2 quarters after a sale, at the end of the year, 5% are written off as uncollectible Q1 Sales $640,000 * 50% collections = $320,000 Cash Collected from Q1 Q4 A/R Balance from Q4 $600,000 / 0.5 = $1,200,000 Q4 Credit Sales 1,200,000 * 0.3 = $360,000 Cash Collected from Q4 Total Cash Collected = $680,000