1. Chapter Ten BUDGETING: THE PLANNING & CONTROLLING TOOL
2. Outline <ul><li>The concept of budgeting </li></ul><ul><li>The benefits of budgeting </li></ul><ul><li>Preparing master budget for merchandising firm: </li></ul><ul><ul><li>Operational budget </li></ul></ul><ul><ul><li>Financial budget </li></ul></ul>
3. Budgeting A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms. The role of accounting during the budgeting process is to: (a) provide historical data on revenues, costs, and expenses, (b) express management’s plans in financial terms, and (c) prepare periodic budget reports.
4. Benefits of Budgeting Requires all levels of management to plan ahead . Provides definite objectives for evaluating performance. Creates an early warning system for potential problems. Facilitates the coordination of activities within the business. Results in greater management awareness of the entity’s overall operations. Motivates personnel throughout the organization to meet planned objectives.
6. Master Budget The master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period. It is developed within the framework of a sales forecast which shows potential sales for the industry and the company’s expected share of such sales.
7. Operating Budgets Operating budgets show the individual budgets that result in the preparation of the budgeted income statement. Sales Budget Purchase Budget, Finished Goods Inventory Budget, Cost of Goods Sold Budget. Selling and Administrative Expenses Budget Income Statement Budget
8. Sales Budget The sales budget is the first budget prepared. Each of the other budgets depends on the sales budget. It is derived from the sales forecast. It represents management’s best estimate of sales revenue for the budget period.
9. Sales Budget Expected Sales = Estimated Quantity x Estimated Selling Price Illustration 1: October 2,000 pairs November 2,500 “ December 3,800 “ Syarikat Sang Bedal is a shoes merchandiser. It sells “smart shoes” at a price of RM40.00 per pair. Its estimated sales quantity for next three months are as follows:
10. Syarikat Sang Bedal Sales Budget for the month of October, November And December 2002 October November December Total Quantity Selling Price (RM) Sales Revenue (RM) 2,000 2,500 3,800 8,300 40.00 40.00 40.00 40.00 80,000 100,000 152,000 332,000
11. Schedule of Cash Collection Preparing a schedule of cash collections from customers is useful in preparing a cash budget. Assuming that credit sales per the Sales Budget are collected 60% in the month sold and 40% in the following month. Accounts Receivable of RM30,000 at September 30, 2002 are expected to be collected in full in October 2002. Illustration 2:
12. Syarikat Sang Bedal Schedule of Cash Collection for the month of October, November and December 2002 October November December Total Current Month Sales (60%) Previous Month Sales (40%) Total Collection 48,000 60,000 91,200 199,200 30,000 32,000 40,000 102,000 78,000 92,000 131,200 301,200 Sales 80,000 100,000 152,000 332,000
13. Purchases Budget It is prepared based on sales budget. It also depends on the estimated beginning inventory and the desired ending inventory as a preparation for the following sales. It estimates the quantity of merchandises needed in order to fulfill the estimated sales.
14. Purchases Budget Purchases Needed = Cost of Goods Sold + Ending Inventory - Beginning Inventory Illustration 3: The company’s policy regarding inventories and cost of goods sold: 1. Cost of goods sold is 45% of the sales. <ul><li>The company decided to keep an inventory of at least 30% of the expected cost of goods sold of the following month. </li></ul>Opening inventory for Oct 2002 = RM9,800. The expected sales for January 2003 = RM160,000.
15. Syarikat Sang Bedal Finished Goods Purchase Budget for the month of October, November and December 2002 October November December Total Sales 80,000 100,000 152,000 332,000 COGS 45% 36,000 (+) End. Inv. 30% F. G. needed (-) Beginning Inv. F. G. Purchases 45,000 68,400 149,400 13,500 20,250 21,600 55,350 49,500 65,250 90,000 204,750 9,800 13,500 20,250 43,550 39,700 51,750 69,750 161,200
16. Schedule of Purchase Payments Preparing a schedule of cash payments to suppliers is useful in preparing a cash budget. Illustration 4: Assuming that the company pays 65% of the purchases in the month of purchase, and the balance will be settled in the following month. The amount outstanding for September purchase was RM10,500.
17. Syarikat Sang Bedal Schedule of Purchase Payments for the month of October, November and December 2002 October November December Total Purchases 39,700 51,750 69,750 161,200 Current month Purchase 65% Previous month Purchase 35% Total payment 25,805 10,500 36,305 33,638 13,895 47,533 45,338 18,112 63,450 104,781 42,507 147,288
18. Selling and Administrative Expenses Budget The selling and administrative expense budget is a projection of anticipated operating expenses. It distinguishes between fixed and variable costs.
19. Selling and Administrative Expenses Budget The company pays sales commission at the rate of 15% of the current month sales. Advertising expense is expected to be 5% from the following month sales. Expected sales for January 2003 is RM160,000 Other expenses : Admin salary RM25,000; Depreciation RM15,000. Illustration 5:
20. Syarikat Sang Bedal Selling and Administrative Budget for the month of October, November and December 2002 October November December Total Sales Comm. Advertising Admin Salary Total Expenses Depreciation 12,000 15,000 22,800 49,800 5,000 7,600 8,000 20,600 18,000 18,000 18,000 54,000 10,000 10,000 10,000 36,000 45,000 50,600 58,800 154,400
21. Income Statement Budget The budgeted income statement is the important end- product of the operating budgets . This budget indicates the expected profitability of operations and it provides a basis for evaluating company performance. The budget is prepared from the: Sales budget Purchases budget Selling and administrative expenses budget
22. Syarikat Sang Bedal Budgeted Income Statement for the three months ended 31 December 2002 Sales revenue 332,000 (-) Cost of goods sold 149,400 Gross profit 182,600 (-) Operating expenses: Selling and administrative expenses 154,400 Interest expense 180 Net income 28,020
23. Financial Budgets Financial budgets focus primarily on the cash resources needed to fund expected operations and planned capital expenditures. Cash Budget Balance Sheet Budget
24. Cash Budget The cash budget shows anticipated cash flows. Because cash is so vital, this budget is often considered to be the most important output in preparing financial budgets. The cash budget contains three sections: (1) Cash receipts. (2) Cash disbursements. (3) Financing.
25. Cash Budget Illustration 6: 1. The company requires a minimum of RM70,000 cash at the end of each month. 2. The company plans to purchase fixed assets in November 2002 amounting to RM50,000. 3. In the case of cash deficit, the company can obtain bank loan in multiples of RM1,000 with expected interest rate of 8% p.a. It is assumed that the loan can be obtained at the end of the month and payment of the loan will be paid in full at the end of the following month whenever possible. 4. Cash in hand as at 1 October 2002 RM83,000.
26. Syarikat Sang Bedal Cash Budget for the month of October, November and December 2002 Opening balance Cash collection Sales of assets Purchase payment Operating expenses Purchase of assets Excess / deficit Financing Loan repayment Interest Closing balance October November December 83,000 78,000 - 161,000 36,305 35,000 - 89,695 71,305 - - - 89,695 89,695 92,000 - 181,695 47,533 40,600 50,000 138,133 43,562 27,000 - - 70,562 70,562 131,200 - 201,762 63,450 48,800 - 112,250 89,512 - - (180) 89,332
27. Budgeted Balance Sheet The budgeted balance sheet is a projection of financial position at the end of the budget period. It is developed from the budgeted balance sheet for the preceding year and the budgets for the current year.