The document outlines the process and importance of operational budgeting, emphasizing planning, control, and objective attainment through comprehensive financial planning. It discusses the roles of management in budgeting, the behavioral approach to budget setting, and various types of budgets including sales, production, and administrative expenses. Additionally, it includes practical examples of preparing a master budget and details on material purchases, direct labor, and manufacturing overhead costs.

1. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Operational Budgeting
Chapter
22

2. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Control
Steps taken by
management to
ensure that
objectives are
attained.
Planning
Developing
objectives for
acquisition
and use of
resources.
A budget is a comprehensive financial
plan for achieving the financial and
operational goals of an organization.
Budgeting: The Basis for
Planning and Control

3. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Benefits
Coordination
of activities
Performance
evaluation
Enhanced managerial
responsibility
Assignment of decision
making responsibilities
Benefits Derived from Budgeting

4. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Budget Problems
 Perceived unfair or
unrealistic goals.
 Poor management-
employee
communications.
Solution
 Reasonable and
achievable budgets.
 Employee participation
in budgeting process.
Establishing Budgeted Amounts:
The “Behavioral” Approach

5. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Flow of Budget Data
Supervisor Supervisor
Middle
Management
Supervisor Supervisor
Middle
Management
Top Management
Participation in Budget Process

6. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
2001 2002 2003 2004
C a p i t a l B u d g e t s
A continuous budget is usually a twelve-month budget
that adds one month as the current month is completed.
The annual operating budget may be
divided into quarterly or monthly budgets.
The Budget Period

7. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Sales
forecast
Production
schedule
Budgeted
financial
budgets:
 cash
 income
 balance sheet
Capital
expenditures
budget
Operating
expense
budgets
Cost of goods
sold and ending
inventory
budgets
The Master Budget

8. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
That’s enough talking
about budgets, now
show me an example!
Preparing the Master Budget:
An Illustration

9. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Sales
Budget
Estimated
Unit Sales
Estimated
Unit Price
Analysis of economic and market conditions
+
Forecasts of customer needs from marketing personnel
Preparing the Master Budget:
An Illustration

10. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis Magnet Co. is preparing budgets for the quarter
ending June 30. The sales price is $10 per magnet.
Budgeted sales for the next four months are:
April 20,000 magnets @ $10 = $200,000
May 50,000 magnets @ $10 = $500,000
June 30,000 magnets @ $10 = $300,000
July 25,000 magnets @ $10 = $250,000
The Sales Budget
July is needed for June ending inventory computations.
Preparing the Master Budget:
An Illustration

11. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Sales
Budget
Production
Budget
The Production Budget

12. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis wants ending inventory
to be 20 percent of the next month’s
budgeted sales in units.
4,000 units were on hand March 31.
Let’s prepare the production budget.
The Production Budget

13. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Production must be adequate to meet
budgeted sales and to provide sufficient
ending inventory.
Budgeted product sales in units
+ Desired product units in ending inventory
= Total product units needed
– Product units in beginning inventory
= Product units to produce
The Production Budget

14. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Budgeted unit sales 20,000 50,000 30,000
Desired ending inventory
Total units needed
Less beginning inventory
Units to produce
The Production Budget

15. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Budgeted unit sales 20,000 50,000 30,000
Desired ending inventory 10,000 6,000 5,000
Total units needed 30,000 56,000 35,000
Less beginning inventory
Units to produce
Ending inventory = 20% of next month's production needs.
June ending inventory = .20 × 25,000 July units = 5,000 units.
The Production Budget

16. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Budgeted unit sales 20,000 50,000 30,000
Desired ending inventory 10,000 6,000 5,000
Total units needed 30,000 56,000 35,000
Less beginning inventory 4,000 10,000 6,000
Units to produce 26,000 46,000 29,000
Ending inventory = 20% of next month's production needs.
June ending inventory = .20 × 25,000 July units = 5,000 units.
Beginning inventory is last month's ending inventory.
The Production Budget

17. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Production
Budget
Material
Purchases
Production
Budget
Units
The Production Budget

18. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
The material purchases budget is based on
production quantity and desired material
inventory levels.
Units to produce
× Material needed per unit
= Material needed for units to produce
+ Desired units of material in ending inventory
= Total units of material needed
– Units of material in beginning inventory
= Units of material to purchase
The Production Budget
Material Purchases

19. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Five pounds of material are needed for each
unit produced.
Ellis wants to have materials on hand at the
end of each month equal to 10 percent of
the following month’s production needs.
The materials inventory on March 31 is
13,000 pounds. July production is
budgeted for 23,000 units.
The Production Budget
Material Purchases

20. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
The Production Budget
Material Purchases
April May June
Units to produce 26,000 46,000 29,000
Pounds per unit 5 5 5
Material needs (lbs.) 130,000 230,000 145,000
Desired ending inventory
Total material needs (lbs.)
Less beginning inventory
Material purchases (lbs.)

21. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
The Production Budget
Material Purchases
April May June
Units to produce 26,000 46,000 29,000
Pounds per unit 5 5 5
Material needs (lbs.) 130,000 230,000 145,000
Desired ending inventory 23,000 14,500 11,500
Total material needs (lbs.) 153,000 244,500 156,500
Less beginning inventory
Material purchases (lbs.)
Ending inventory = 10% of next month's material needs.
June ending inventory = .10 × (23,000 units × 5 lbs. per unit).
June ending inventory = 11,500 lbs.

22. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
The Production Budget
Material Purchases
April May June
Units to produce 26,000 46,000 29,000
Pounds per unit 5 5 5
Material needs (lbs.) 130,000 230,000 145,000
Desired ending inventory 23,000 14,500 11,500
Total material needs (lbs.) 153,000 244,500 156,500
Less beginning inventory 13,000 23,000 14,500
Material purchases (lbs.) 140,000 221,500 142,000
Ending inventory = 10% of next month's material needs.
June ending inventory = .10 × (23,000 units × 5 lbs. per unit).
June ending inventory = 11,500 lbs.
Beginning inventory is last month's ending inventory.

23. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Materials used in production cost $.40
per pound. One-half of a month’s
purchases are paid for in the month of
purchase; the other half is paid for in the
following month.
No discount terms are available.
The accounts payable balance on
March 31 is $12,000.
Cash Payments for
Material Purchases

24. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Material purchases (lbs.) 140,000 221,500 142,000
Cost per pound 0.40
$ 0.40
$ 0.40
$
Total cost 56,000
$ 88,600
$ 56,800
$
Payables from March 12,000
$
April purchases
May purchases
June purchases
Total payments in month
Cash Payments for
Material Purchases

25. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Material purchases (lbs.) 140,000 221,500 142,000
Cost per pound 0.40
$ 0.40
$ 0.40
$
Total cost 56,000
$ 88,600
$ 56,800
$
Payables from March 12,000
$
April purchases 28,000 28,000
$
May purchases
June purchases
Total payments in month
½ × $56,000 = $28,000
Cash Payments for
Material Purchases

26. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Material purchases (lbs.) 140,000 221,500 142,000
Cost per pound 0.40
$ 0.40
$ 0.40
$
Total cost 56,000
$ 88,600
$ 56,800
$
Payables from March 12,000
$
April purchases 28,000 28,000
$
May purchases 44,300 44,300
$
June purchases
Total payments in month
½ × $56,000 = $28,000
½ × $88,600 = $44,300
Cash Payments for
Material Purchases

27. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Material purchases (lbs.) 140,000 221,500 142,000
Cost per pound 0.40
$ 0.40
$ 0.40
$
Total cost 56,000
$ 88,600
$ 56,800
$
Payables from March 12,000
$
April purchases 28,000 28,000
$
May purchases 44,300 44,300
$
June purchases 28,400
Total payments in month 40,000
$ 72,300
$ 72,700
$
½ × $56,000 = $28,000
½ × $88,600 = $44,300
½ × $56,800 = $28,400
Cash Payments for
Material Purchases

28. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Production
Budget
Labor
Production
Budget
Units
Material
The Production Budget

29. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Each unit produced requires 3 minutes (.05
hours) of direct labor. Ellis employs 30
persons for 40 hours each week at a rate of
$10 per hour. Any extra hours needed are
obtained by hiring temporary workers also
at $10 per hour.
The Production Budget
Direct Labor

30. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Units to produce 26,000 46,000 29,000
Hours per unit 0.05 0.05 0.05
Total hours required 1,300 2,300 1,450
Wage rate per hour
Direct labor cost
Cash Payments for
Direct Labor

31. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Units to produce 26,000 46,000 29,000
Hours per unit 0.05 0.05 0.05
Total hours required 1,300 2,300 1,450
Wage rate per hour 10
$ 10
$ 10
$
Direct labor cost 13,000
$ 23,000
$ 14,500
$
Cash Payments for
Direct Labor

32. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Production
Budget
Units
Material
Labor
Production
Budget
Manufacturing
Overhead
The Production Budget

33. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Variable manufacturing overhead is $1 per
unit produced and fixed manufacturing
overhead is $50,000 per month.
Fixed manufacturing overhead includes
$20,000 in depreciation which does not
require a cash outflow.
The Production Budget
Manufacturing Overhead

34. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Units to produce 26,000 46,000 29,000
Variable overhead rate 1.00
$ 1.00
$ 1.00
$
Variable overhead cost 26,000
$ 46,000
$ 29,000
$
Fixed overhead
Total mfg. overhead cost
Deduct depreciation
Manufacturing overhead - cash
Cash Payments for
Manufacturing Overhead

35. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Units to produce 26,000 46,000 29,000
Variable overhead rate 1.00
$ 1.00
$ 1.00
$
Variable overhead cost 26,000
$ 46,000
$ 29,000
$
Fixed overhead 50,000 50,000 50,000
Total mfg. overhead cost 76,000
$ 96,000
$ 79,000
$
Deduct depreciation
Manufacturing overhead - cash
Cash Payments for
Manufacturing Overhead

36. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Units to produce 26,000 46,000 29,000
Variable overhead rate 1.00
$ 1.00
$ 1.00
$
Variable overhead cost 26,000
$ 46,000
$ 29,000
$
Fixed overhead 50,000 50,000 50,000
Total mfg. overhead cost 76,000
$ 96,000
$ 79,000
$
Deduct depreciation 20,000 20,000 20,000
Manufacturing overhead - cash 56,000
$ 76,000
$ 59,000
$
Cash Payments for
Manufacturing Overhead

37. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Production
Budget
Selling
and
Administrative
Expense
Budget
Selling and Administrative
(S&A) Expense Budget

38. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
 Selling expense budgets contain both
variable and fixed items.
 Variable items: shipping costs and sales
commissions.
 Fixed items: advertising and sales salaries.
 Administrative expense budgets contain
mostly fixed items.
 Executive salaries and depreciation on company
offices.
Selling and Administrative
(S&A) Expense Budget

39. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Variable selling and administrative
expenses are $.50 per unit sold and fixed
selling and administrative expenses are
$70,000 per month.
Fixed selling and administrative expenses
include $10,000 in depreciation which does
not require a cash outflow.
Cash Payments for
(S&A) Expenses

40. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Budgeted unit sales 20,000 50,000 30,000
Variable S&A per unit 0.50
$ 0.50
$ 0.50
$
Variable S&A expense 10,000
$ 25,000
$ 15,000
$
Fixed S&A expense 70,000 70,000 70,000
Total S&A expense 80,000
$ 95,000
$ 85,000
$
Deduct depreciation
S&A expense - cash
Cash Payments for
(S&A) Expenses

41. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Budgeted unit sales 20,000 50,000 30,000
Variable S&A per unit 0.50
$ 0.50
$ 0.50
$
Variable S&A expense 10,000
$ 25,000
$ 15,000
$
Fixed S&A expense 70,000 70,000 70,000
Total S&A expense 80,000
$ 95,000
$ 85,000
$
Deduct depreciation 10,000 10,000 10,000
S&A expense - cash 70,000
$ 85,000
$ 75,000
$
Cash Payments for
(S&A) Expenses

42. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
I have seen a lot of cash
payments but no cash
receipts. Show me some
cash receipts!
Cash Receipts Budget

43. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
All sales are on account.
Ellis’s collection pattern is:
70 percent collected in month of sale
25 percent collected in month after sale
5 percent will be uncollectible
Accounts receivable on March 31 is
$30,000, all of which is collectible.
Cash Receipts Budget

44. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Budgeted unit sales 20,000 50,000 30,000
Price per unit 10
$ 10
$ 10
$
Budgeted sales revenue 200,000
$ 500,000
$ 300,000
$
Receipts from March sales 30,000
$
Receipts from April sales
Receipts from May sales
Receipts from June sales
Total cash receipts
Cash Receipts Budget

45. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Budgeted unit sales 20,000 50,000 30,000
Price per unit 10
$ 10
$ 10
$
Budgeted sales revenue 200,000
$ 500,000
$ 300,000
$
Receipts from March sales 30,000
$
Receipts from April sales 140,000 50,000
$
Receipts from May sales
Receipts from June sales
Total cash receipts 170,000
$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000
Cash Receipts Budget

46. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Budgeted unit sales 20,000 50,000 30,000
Price per unit 10
$ 10
$ 10
$
Budgeted sales revenue 200,000
$ 500,000
$ 300,000
$
Receipts from March sales 30,000
$
Receipts from April sales 140,000 50,000
$
Receipts from May sales 350,000 125,000
$
Receipts from June sales
Total cash receipts 170,000
$ 400,000
$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000
May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000
Cash Receipts Budget

47. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
April May June
Budgeted unit sales 20,000 50,000 30,000
Price per unit 10
$ 10
$ 10
$
Budgeted sales revenue 200,000
$ 500,000
$ 300,000
$
Receipts from March sales 30,000
$
Receipts from April sales 140,000 50,000
$
Receipts from May sales 350,000 125,000
$
Receipts from June sales 210,000
Total cash receipts 170,000
$ 400,000
$ 335,000
$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000
May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000
June: .70 × $300,000 = $210,000
Cash Receipts Budget

48. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
With just a little
more information
we will be able to
prepare a
comprehensive
cash budget.
Comprehensive Cash Budget

49. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis Magnet Company:
 Has a $100,000 line of credit at its bank, with a zero
balance on April 1.
 Maintains a $30,000 minimum cash balance.
 Borrows at the beginning of a month and repays at the
end of a month.
 Pays interest at 16 percent when a principal payment is
made.
 Pays a $51,000 cash dividend in April.
 Purchases equipment costing $143,700 in May and
$48,800 in June.
 Has a $40,000 cash balance on April 1.
Comprehensive Cash Budget
Additional Information

50. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Comprehensive Cash Budget
April May June
Beginning cash balance 40,000
$
Cash receipts
Cash available
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
Balance before financing
Borrowing
Principal repayment
Interest
Ending cash balance

51. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Comprehensive Cash Budget
April May June
Beginning cash balance 40,000
$
Cash receipts 170,000 400,000 335,000
Cash available 210,000
$
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
Balance before financing
Borrowing
Principal repayment
Interest
Ending cash balance

52. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Comprehensive Cash Budget
April May June
Beginning cash balance 40,000
$
Cash receipts 170,000 400,000 335,000
Cash available 210,000
$
Cash payments:
Materials budget 40,000
$ 72,300
$ 72,700
$
Labor budget 13,000 23,000 14,500
Manufacturing OH budget 56,000 76,000 59,000
S&A expense budget 70,000 85,000 75,000
Equipment purchases 0 143,700 48,800
Dividends 51,000 0 0
Total cash payments 230,000
$ 400,000
$ 270,000
$
Balance before financing (20,000)
$
Borrowing
Principal repayment
Interest
Ending cash balance

53. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Comprehensive Cash Budget
April May June
Beginning cash balance 40,000
$ 30,000
$
Cash receipts 170,000 400,000 335,000
Cash available 210,000
$ 430,000
$
Cash payments:
Materials budget 40,000
$ 72,300
$ 72,700
$
Labor budget 13,000 23,000 14,500
Manufacturing OH budget 56,000 76,000 59,000
S&A expense budget 70,000 85,000 75,000
Equipment purchases 0 143,700 48,800
Dividends 51,000 0 0
Total cash payments 230,000
$ 400,000
$ 270,000
$
Balance before financing (20,000)
$ 30,000
$
Borrowing 50,000
Principal repayment 0
Interest 0
Ending cash balance 30,000
$

54. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Comprehensive Cash Budget
April May June
Beginning cash balance 40,000
$ 30,000
$ 30,000
$
Cash receipts 170,000 400,000 335,000
Cash available 210,000
$ 430,000
$ 365,000
$
Cash payments:
Materials budget 40,000
$ 72,300
$ 72,700
$
Labor budget 13,000 23,000 14,500
Manufacturing OH budget 56,000 76,000 59,000
S&A expense budget 70,000 85,000 75,000
Equipment purchases 0 143,700 48,800
Dividends 51,000 0 0
Total cash payments 230,000
$ 400,000
$ 270,000
$
Balance before financing (20,000)
$ 30,000
$ 95,000
$
Borrowing 50,000 0
Principal repayment 0 0
Interest 0 0
Ending cash balance 30,000
$ 30,000
$

55. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Comprehensive Cash Budget
April May June
Beginning cash balance 40,000
$ 30,000
$ 30,000
$
Cash receipts 170,000 400,000 335,000
Cash available 210,000
$ 430,000
$ 365,000
$
Cash payments:
Materials budget 40,000
$ 72,300
$ 72,700
$
Labor budget 13,000 23,000 14,500
Manufacturing OH budget 56,000 76,000 59,000
S&A expense budget 70,000 85,000 75,000
Equipment purchases 0 143,700 48,800
Dividends 51,000 0 0
Total cash payments 230,000
$ 400,000
$ 270,000
$
Balance before financing (20,000)
$ 30,000
$ 95,000
$
Borrowing 50,000 0 0
Principal repayment 0 0 (50,000)
Interest 0 0 (2,000)
Ending cash balance 30,000
$ 30,000
$ 43,000
$
$50,000 × .16 × 3/12 = $2,000

56. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Budgeted
Income
Statement
Cash
Budget
The Budgeted
Income Statement

57. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000
$
The Budgeted
Income Statement

58. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000
$
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
$
Computation of unit cost follows
The Budgeted
Income Statement

59. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. 0.40
$ 2.00
$
Direct labor 0.05 hrs. 10.00
$ 0.50
Manufacturing overhead 0.05 hrs. 49.70
$ 2.49
Total unit cost 4.99
$
Total mfg. OH for quarter $251,000
Total labor hours required 5,050 hrs.
= $49.70 per hr.
From labor and Mfg. OH budgets
Labor Hours Mfg. OH
April 1,300 76,000
$
May 2,300 96,000
June 1,450 79,000
Total 5,050 251,000
$
Manufacturing
overhead is applied
based on
direct labor hours.
The Budgeted
Income Statement

60. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000
$
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
$
Selling and administrative expenses 260,000
Operating income 241,000
$
From S&A Expense Budget
April 80,000
$
May 95,000
June 85,000
Total 260,000
$
The Budgeted
Income Statement

61. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000
$
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
$
Selling and administrative expenses 260,000
Operating income 241,000
$
Interest expense 2,000
Net income 239,000
$
The Budgeted
Income Statement

62. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Budgeted
Balance
Sheet
Budgeted
Income
Statement
The Budgeted
Balance Sheet

63. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis reports the following account balances
on June 30, prior to preparing its budgeted
financial statements:
 Land - $50,000
 Building (net) - $174,500
 Common stock - $200,000
 Equipment (net) - $192,500
 Retained earnings - $148,150
The Budgeted
Balance Sheet

64. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis Magnet Company
Budgeted Balance Sheet
June 30, 2002
Current assets
Cash 43,000
$
Accounts receivable 75,000
Raw materials inventory 4,600
Finished goods inventory 24,950
Total current assets 147,550
$
Property and equipment
Land 50,000
$
Building 174,500
Equipment 192,500
Total property and equipment 417,000
$
Total assets 564,550
$
Liabilities and Equities
Accounts payable 28,400
$
Common stock 200,000
Retained earnings 336,150
Total liabilities and equities 564,550
$
25% of June
sales of
$300,000
11,500 lbs.
@ $.40 per lb.
50% of June
purchases
of $56,800
5,000 units
@ $4.99 each

65. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Ellis Magnet Company
Budgeted Balance Sheet
June 30, 2002
Current assets
Cash 43,000
$
Accounts receivable 75,000
Raw materials inventory 4,600
Finished goods inventory 24,950
Total current assets 147,550
$
Property and equipment
Land 50,000
$
Building 174,500
Equipment 192,500
Total property and equipment 417,000
$
Total assets 564,550
$
Liabilities and Equities
Accounts payable 28,400
$
Common stock 200,000
Retained earnings 336,150
Total liabilities and equities 564,550
$
Beginning balance 148,150
$
Add: net income 239,000
Deduct: dividends (51,000)
Ending balance 336,150
$

66. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Let’s
change
topics.
Flexible Budgeting

67. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Performance
evaluation is difficult
when actual activity
differs from the activity
originally budgeted.
Flexible Budgeting
Hmm! Comparing
costs at different
levels of activity
is like comparing
apples with oranges.
Consider the following
condensed example
from the Cheese
Company . . .

68. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Flexible Budgeting
Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
Indirect labor 40,000
$ 34,000
$ $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Fixed costs
Depreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs 89,000
$ 77,300
$ $11,700 F

69. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
Indirect labor 40,000
$ 34,000
$ $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Fixed costs
Depreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs 89,000
$ 77,300
$ $11,700 F
U = Unfavorable variance – Cheese
Company was unable to achieve
the budgeted level of activity.
Flexible Budgeting

70. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
Indirect labor 40,000
$ 34,000
$ $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Fixed costs
Depreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs 89,000
$ 77,300
$ $11,700 F
F = Favorable variance: actual costs
are less than budgeted costs.
Flexible Budgeting

71. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
Indirect labor 40,000
$ 34,000
$ $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Fixed costs
Depreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs 89,000
$ 77,300
$ $11,700 F
Since cost variances are favorable, have
we done a good job controlling costs?
Flexible Budgeting

72. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
I don’t think I can
answer the question
using the original
budget.
How much of
the favorable cost
variance is due to lower
activity, and how much is due
to good cost control?
Flexible Budgeting

73. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Flexible Budgeting
I don’t think I can
answer the question
using the original
budget.
How much of
the favorable cost
variance is due to lower
activity, and how much is due
to good cost control?
To answer the question, we must
the budget to the actual level of activity.

74. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Central Concept
If you can tell me what your activity was
for the period, I will tell you what your costs
and revenue should have been.
Flexible Budgeting

75. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Improve performance evaluation.
May be prepared for any activity
level in the relevant range.
Show expenses that should have
occurred at the actual level of
activity.
Reveal variances due to good cost
control or lack of cost control.
Flexible Budgeting

76. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
To a budget for different activity
levels, we must know how costs behave
with changes in activity levels.
 Total variable costs change
in direct proportion to
changes in activity.
 Total fixed costs remain
unchanged within the
relevant range.
Fixed
Flexible Budgeting

77. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Flexible Budgeting

78. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Flexible Budgeting
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000
$
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost 7.50
$ 60,000
$
Fixed costs
Depreciation 12,000
$
Insurance 2,000
Total fixed cost
Total overhead costs
Variable costs are expressed as
a constant amount per hour.
In the original budget, indirect
labor was $40,000 for 10,000
hours resulting in a rate of
$4.00 per hour.

79. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Flexible Budgeting
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000
$ 40,000
$ 48,000
$
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost 7.50
$ 60,000
$ 75,000
$ 90,000
$
Fixed costs
Depreciation 12,000
$ 12,000
$ 12,000
$ 12,000
$
Insurance 2,000 2,000 2,000 2,000
Total fixed cost 14,000
$ 14,000
$ 14,000
$
Total overhead costs 74,000
$ 89,000
$ 104,000
$

80. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Flexible Budgeting
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000
$ 40,000
$ 48,000
$
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost 7.50
$ 60,000
$ 75,000
$ 90,000
$
Fixed costs
Depreciation 12,000
$ 12,000
$ 12,000
$ 12,000
$
Insurance 2,000 2,000 2,000 2,000
Total fixed cost 14,000
$ 14,000
$ 14,000
$
Total overhead costs 74,000
$ 89,000
$ 104,000
$
Total variable cost = $7.50 per unit × budget level in units

81. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Flexible Budgeting
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000
$ 40,000
$ 48,000
$
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost 7.50
$ 60,000
$ 75,000
$ 90,000
$
Fixed costs
Depreciation 12,000
$ 12,000
$ 12,000
$ 12,000
$
Insurance 2,000 2,000 2,000 2,000
Total fixed cost 14,000
$ 14,000
$ 14,000
$
Total overhead costs 74,000
$ 89,000
$ 104,000
$
Fixed costs are expressed as a
total amount that does not
change within the relevant
range of activity.

82. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Flexible Budgeting
Performance Report

83. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Cost Total
Formula Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs
Indirect labor 4.00
$ 32,000
$ 34,000
$ $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs 7.50
$ 60,000
$ 63,300
$ $ 3,300 U
Fixed Costs
Depreciation 12,000
$ 12,000
$ 12,000
$ 0
Insurance 2,000 2,000 2,000 0
Total fixed costs 14,000
$ 14,000
$ 0
Total overhead costs 74,000
$ 77,300
$ $ 3,300 U
Flexible Budgeting
Performance Report

84. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Cost Total
Formula Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs
Indirect labor 4.00
$ 32,000
$ 34,000
$ $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs 7.50
$ 60,000
$ 63,300
$ $ 3,300 U
Fixed Costs
Depreciation 12,000
$ 12,000
$ 12,000
$ 0
Insurance 2,000 2,000 2,000 0
Total fixed costs 14,000
$ 14,000
$ 0
Total overhead costs 74,000
$ 77,300
$ $ 3,300 U
Indirect labor and
indirect material have
unfavorable variances
because actual costs
are more than the
flexible budget costs.
Flexible Budgeting
Performance Report

85. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
Cost Total
Formula Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs
Indirect labor 4.00
$ 32,000
$ 34,000
$ $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs 7.50
$ 60,000
$ 63,300
$ $ 3,300 U
Fixed Costs
Depreciation 12,000
$ 12,000
$ 12,000
$ 0
Insurance 2,000 2,000 2,000 0
Total fixed costs 14,000
$ 14,000
$ 0
Total overhead costs 74,000
$ 77,300
$ $ 3,300 U
Power has a favorable
variance because the
actual cost is less than
the flexible budget cost.
Flexible Budgeting
Performance Report

86. © The McGraw-Hill Companies, Inc., 2002
McGraw-Hill/Irwin
I would be happy to assist
you with your cash budget!
End of Chapter 22