chapter 10 budgetary planning and control. budgeting basics components of the master budget

CHAPTER 10CHAPTER 10CHAPTER 10CHAPTER 10

Budgetary Planning and Control

Budgetary Planning and Control

Budgeting BasicsBudgeting Basics

Components of the Master

Budget.

Expected sales volume: 3,000 units in the first quarter with 500-unit increments for each following quarter.

Sales price: $60 per unit.

Illustration – Hayes Company manufactures and sells a single product, Kitchen-Mate. The budgets are prepared by quarters for the year ending December 31, 2011. Hayes company begins its annual budgeting process on September 1, 2010, and it completes the budget for 2011 by December 1, 2010.

Preparing the Operating Budget

Shows units that must be produced to meet anticipated sales.

Derived from sales budget plus the desired change in ending finished goods.

Required production in units formula:

Essential to have a realistic estimate of ending inventory.

Production Budget

Preparing the Operating BudgetsPreparing the Operating Budgets

Hayes Co. believes it can meet future sales needs with an ending inventory of 20% of next quarter’s sales.

Illustration – Hayes Company

Preparing the Operating BudgetsPreparing the Operating Budgets

Shows both the quantity and cost of direct materials to be purchased.

Formula for direct materials quantities.

Direct Materials Budget

Budgeted cost of direct materials to be purchased = required units of direct materials x anticipated cost per unit.

Preparing Operating BudgetsPreparing Operating Budgets

Inadequate inventories could result in temporary shutdowns of production. Because of its close proximity to suppliers,

Hayes Company maintains an ending inventory of raw materials equal to 10% of the next quarter’s production requirements.

The manufacture of each Kitchen-Mate requires 2 pounds of raw materials, and the expected cost per pound is $4.

Assume that the desired ending direct materials amount is 1,020 pounds for the fourth quarter of 2011.

Prepare a Direct Materials Budget.



Shows both the quantity of hours and cost of direct labor necessary to meet production requirements.

Critical in maintaining a labor force that can meet expected production.

Total direct labor cost formula:

Direct Labor Budget

Preparing Operating BudgetPreparing Operating Budget

Illustration: Direct labor hours are determined from the production budget. At Hayes Company, two hours of direct labor are required to produce each unit of finishedgoods. The anticipated hourly wage rate is $10.

Preparing Operating BudgetPreparing Operating Budget

Projection of anticipated operating expenses.

Distinguishes between fixed and variable costs.

Selling and Administrative Expense Budget

Illustration: Variable expense rates per unit of sales are sales commissions $3 and freight-out $1. Variable expenses per quarter are based on the unit sales from the sales budget (Illustration 9-3). Hayes expects sales in the first quarter to be 3,000 units. Fixed expenses are based on assumed data.

Prepare a selling and administrative expense budget.


Selling and Administrative Expense Budget


Important end-product of the operating budgets.

Indicates expected profitability of operations.

Provides a basis for evaluating company performance.

Prepared from the operating budgets:

Budgeted Income Statement

Manufacturing Overhead

Selling and Administrative Expense

Sales

Direct Materials

Direct Labor


Illustration: To find the cost of goods sold, it is first necessary to determine the total unit cost of producing one Kitchen-Mate, as follows.

Second, determine Cost of Goods Sold by multiplying units sold times unit cost: 15,000 units X $44 = $660,000

Budgeted Income Statement


Illustration: All data for the income statement come from the individual operating budgets except the following: (1) interest expense is expected to be $100, and (2) income taxes are estimated to be $12,000.


Shows anticipated cash flows.

Often considered to be the most important output in preparing financial budgets.

Contains three sections:

Cash Receipts

Cash Disbursements

Financing

Shows beginning and ending cash balances.

Cash Budget

Preparing Financial BudgetsPreparing Financial Budgets

Cash Budget - Basic Format


Cash Receipts Section Includes expected receipts from the principal sources of

revenue.

Shows expected interest and dividends receipts as well as proceeds from planned sales of investments, plant assets, and capital stock.

Cash Disbursements Section Includes expected cash payments for direct materials

and labor, taxes, dividends, plant assets, etc.

Financing Section Shows expected borrowings and repayments of

borrowed funds plus interest.


Must prepare in sequence.

Ending cash balance of one period is the

beginning cash balance for the next.

Data obtained from other budgets and from

management.

Often prepared for the year on a monthly

basis.

Cash Budget


Illustration – Hayes Company Assumptions

1. The January 1, 2011, cash balance is expected to be $38,000. Hayes wishes to maintain a balance of at least $15,000.

2. Sales: 60% are collected in the quarter sold and 40% are collected in the following quarter. Accounts receivable of $60,000 at December 31, 2010, are expected to be collected in full in the first quarter of 2011.

3. Short-term investments are expected to be sold for $2,000 cash in the first quarter.

Continued



4. Direct materials: 50% are paid in the quarter purchased and 50% are paid in the following quarter. Accounts payable of $10,600 at December 31, 2010, are expected to be paid in full in the first quarter of 2011.

5. Direct labor: 100% is paid in the quarter incurred.

6. Manufacturing overhead and selling and administrative expenses: All items except depreciation are paid in the quarter incurred.

7. Management plans to purchase a truck in the second quarter for $10,000 cash.



8. Hayes makes equal quarterly payments of its estimated annual income taxes.

9. Loans are repaid in the earliest quarter in which there is sufficient cash (that is, when the cash on hand exceeds the $15,000 minimum required balance).

Prepare a schedule of collections from customers.


Illustration – Prepare a schedule of collections from customers.


Illustration – Prepare a schedule of cash payments for direct materials.


Illustration – Cash Budget based on the assumptions and preceding schedules.

Preparing the Financial BudgetsPreparing the Financial Budgets

CHAPTER 11CHAPTER 11CHAPTER 11CHAPTER 11

Standard Costs and Variance Analysis

Standard Costs and Variance Analysis

Both standards and budgets are predetermined costs, and both contribute to management planning and control.

There is a difference:

A standard is a unit amount.

A budget is a total amount

Distinguishing between Standards and Budgets

The Need for StandardsThe Need for Standards

Setting Standard Costs—a Difficult TaskSetting Standard Costs—a Difficult Task

Ideal versus Normal Standards Companies set standards at one of two levels:

Ideal standards represent optimum levels of performance under perfect operating conditions.

Normal standards represent efficient levels of performance that are attainable under expected operating conditions.

Properly set, normal standards should be rigorous but attainable.


A Case Study

To establish the standard cost of producing a product, it is necessary to establish standards for each manufacturing cost element—

direct materials,

direct labor, and

manufacturing overhead.

The standard for each element is derived from the standard price to be paid and the standard quantity to be used.


Direct Materials

The direct materials price standard is the cost per unit of direct materials that should be incurred.


Direct Materials

The direct materials quantity standard is the quantity of direct materials that should be used per unit of finished goods.

The standard direct materials cost is $12.00 ($3.00 x 4.0 pounds).

One of the major management uses of standard costs is to identify variances from standards.

Variances are the differences between total actual costs and total standard costs.

Analyzing and Reporting Variances From StandardsAnalyzing and Reporting Variances From Standards

Illustration: Assume that in producing 1,000 gallons of Weed-O in the month of June, Xonic, Inc. incurred the following costs.

Analyzing and Reporting VariancesAnalyzing and Reporting Variances

The total standard cost of Weed-O is $42,000 (1,000 gallons x $42). Thus, total variance is $2,500.

When actual costs exceed standard costs, the variance is unfavorable.

When actual costs are less than standard costs, the variance is favorable.

To interpret properly the significance of a variance, you must analyze it to determine the underlying factors. Analyzing variances begins by determining the cost elements that comprise the variance.


Direct Materials Variances

In completing the order for 1,000 gallons of Weed-O, Xonic used 4,200 pounds of direct materials. These were purchased at a cost of $3.10 per unit. Standard price is $3.


Total Materials Variance (TMV)

Actual Quantity x Actual Price (AQ) x

(AP)

Standard Quantity x Standard Price (SQ) x

(SP)- =

$1,020 U$13,020

(4,200 x $3.10)$12,000

(4,000 x $3.00)- =

Direct Materials VariancesNext, the company analyzes the total variance to determine the amount attributable to price (costs) and to quantity (use). The materials price variance is computed from the following formula.


Materials Price Variance (MPV)

Actual Quantity x Actual Price (AQ) x

(AP)

Actual Quantity x Standard Price (AQ) x

(SP)- =

$420 U$13,020 (4,200 x $3.10)

$12,600 (4,200 X $3.00)

- =

Direct Materials VariancesThe materials quantity variance is determined from the following formula.


Materials Quantity Variance (MQV)Actual Quantity x

Standard Price (AQ) x (SP)

Standard Quantity x Standard Price (SQ) x

(SP)- =

$600 U$12,600

(4,200 X $3.00)$12,000

(4,000 x $3.00)- =

Price Variance

$13,020 – $12,600 = $420 U

Quantity Variance

$12,600 – $12,000 = $600 U

Total Variance

$13,020 – $12,000 = $1,020 U

Matrix for Direct Materials VariancesMatrix for Direct Materials Variances

1 2 3

1 2- 2 3-

1 3-

Actual Quantity× Actual Price(AQ) × (AP)

4,200 x $3.10 = $13,020

Standard Quantity× Standard Price(SQ) × (SP)

4,000 x $3.00 = $12,000

Actual Quantity× Standard Price(AQ) × (SP)

4,200 x $3.00 = $12,600

The standard cost of Product XX includes two units of direct materials at $8.00 per unit. During July, the company buys 22,000 units of direct

materials at $7.50 and uses those materials to produce 10,000 units. Compute the total, price, and quantity variances for materials.


Direct Labor VariancesIn completing the Weed-O order, Xonic, Inc. incurred 2,100 direct labor hours at an average hourly rate of $9.80. The standard hours allowed for the units produced were 2,000 hours (1,000 gallons x 2 hours). The standard labor rate was $10 per hour. The total labor variance is computed as follows.


(2,100 x $9.80) - (2,000 x $10.00) = $580 U

Direct Labor Variances

Next, the company analyzes the total variance to determine the amount attributable to price (costs) and to quantity (use). The labor price variance is computed from the following formula.


(2,100 x $9.80) - (2,100 x $10.00) = $420 F

Direct Labor Variances

The labor quantity variance is determined from the following formula.


(2,100 x $10.00) - (2,000 x $10.00) = $1,000 U

Manufacturing Overhead Variances

Manufacturing overhead variances involves total overhead variance, overhead controllable variance, and overhead volume variance.

Manufacturing overhead costs are applied to work in process on the basis of the standard hours allowed for the work done.


Total Overhead VarianceThe total overhead variance is the difference between actual overhead costs and overhead costs applied to work done. The computation of the actual overhead is comprised of a variable and a fixed component.


The predetermined rate for Weed-O is $5, comprised of a variable overhead rate of $3 and a fixed rate of $2.

Total Overhead VarianceThe formula for the total overhead variance and the calculation for Xonic, Inc. for the month of June.


The overhead variance is generally analyzed through a price variance and a quantity variance.

Overhead controllable variance (price variance) shows whether overhead costs are effectively controlled.

Overhead volume variance (quantity variance) relates to whether fixed costs were under- or over-applied during the year.


Total Overhead Variance

The standard cost of Product YY includes 3 hours of direct labor at $12.00 per hour. The

predetermined overhead rate is $20.00 per direct labor hour. During July, the company incurred 3,500 hours of direct labor at an average rate of $12.40 per hour and $71,300 of manufacturing overhead costs. It produced 1,200 units. (a) Compute the total, price, and quantity variances for labor. (b) Compute the total overhead variance.


Reporting Variances

All variances should be reported to appropriate levels of management as soon as possible.

The form, content, and frequency of variance reports vary considerably among companies.

Facilitate the principle of “management by exception.”

Top management normally looks for significant variances.


Reporting Variances


Materials price variance report for Xonic, Inc., with the materials for the Weed-O order listed first.

chapter 10 budgetary planning and control. budgeting basics components of the master budget

Documents

unit of sales

unit sales

direct materials quantities

operating budgetsshows

anticipated sales

direct labor budgetpreparing

direct labor hours

hours of direct labor