Profit Planning and Budgeting

By: Dr. Kanhaiya Singh Professor Finance Fore School of Mgt

McGraw-Hill/Irwin

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Purposes of Budgeting Systems

Budget a detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time.
Planning Facilitating Communication and Coordination Allocating Resources Controlling Profit and Operations Evaluating Performance and Providing Incentives

Types of Budgets
Detail Budget
Detail Budget Detail Budget

Production

Master Budget
Covering all phases of a companys operations.

Types of Budgets
Income Statement

Budgeted Financial Statement s

Balance Sheet

Statement of Cash Flows

Types of Budgets
Capital budgets with acquisitions that normally cover several years. Financial budgets with financial resource acquisitions.

Long Range Budgets

Continuous or 1999Rolling Budget2000

2001

2002

This budget is usually a twelve-month budget that rolls forward one month as the current month is completed.

Sales of Services or Goods Ending Inventory Budget

Work in Process and Finished Goods

Production Budget

Ending Inventory Budget

Direct Materials

Direct Materials Budget

Direct Labor Budget

Overhead Budget

Selling and Administrative Budget

Cash Budget

Budgeted Income Statement

Budgeted Balance Sheet

Budgeted Statement of Cash Flows

Activity-Based Costing versus Activity-Based Budgeting

Resources
Activity-Based Costing (ABC)

Resources

Activities

Activities

Cost objects: products and services produced, and customers served.

Activity-Based Budgeting (ABB)

Forecast of products and services to be produced and customers served.

Sales Budget
Breakers, Inc. is preparing budgets for the quarter ending June 30. Budgeted sales for the next five months are: April 20,000 units May 50,000 units June 30,000 units July 25,000 units August 15,000 units. The selling price is $10 per unit.

Sales Budget
April Budgeted sales (units) 20,000 Selling price per unit $ 10 Total Revenue $ 200,000 May June Quarter

50,000 $ 10 $

30,000 10 $

100,000 10

$ 500,000

$ 300,000

$ 1,000,000

Production Budget
Sales Budget Production Budget

Production must be adequate to meet budgeted sales and provide for sufficient ending inventory.

Production Budget
The management of Breakers, Inc. wants ending inventory to be equal to 20% of the following months budgeted sales in units. On March 31, 4,000 units were on hand.

Lets prepare the production budget.

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be produced April 20,000 May June Quarter

From sales budget

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be produced April 20,000 10,000 30,000 May June Quarter

May sales Desired percent Desired inventory

50,000 units 20% 10,000 units

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be produced April 20,000 10,000 30,000 4,000 26,000 May June Quarter

March 31 ending inventory

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be produced April 20,000 10,000 30,000 4,000 26,000 May 50,000 6,000 56,000 10,000 46,000 June Quarter

Production Budget
Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be produced April 20,000 10,000 30,000 4,000 26,000 May 50,000 6,000 56,000 10,000 46,000 June 30,000 5,000 35,000 6,000 29,000 Quarter 100,000 5,000 105,000 4,000 101,000

Direct-Material Budget
At Breakers, five pounds of material are required per unit of product. Management wants materials on hand at the end of each month equal to 10% of the following months production. On March 31, 13,000 pounds of material are on hand. Material cost $.40 per pound. Lets prepare the direct materials budget.

Direct-Material Budget
Production in units Materials per unit Production needs Add: desired ending inventory Total needed Less: beginning inventory Materials to be purchased April 26,000 May 46,000 June 29,000 Quarter 101,000

From our production budget

Direct-Material Budget
Production in units Materials per unit Production needs Add: desired ending inventory Total needed Less: beginning inventory Materials to be purchased April 26,000 5 130,000 23,000 153,000 May 46,000 5 230,000 June Quarter

10% of the following months production

Direct-Material Budget
Production in units Materials per unit Production needs Add: desired ending inventory Total needed Less: beginning inventory Materials to be purchased April 26,000 5 130,000 23,000 153,000 13,000 140,000 May 46,000 5 230,000 June 29,000 5 145,000 Quarter 101,000 5 505,000

March 31 inventory

Direct-Material Budget
Production in units Materials per unit Production needs Add: desired ending inventory Total needed Less: beginning inventory Materials to be purchased April 26,000 5 130,000 23,000 153,000 13,000 140,000 May 46,000 5 230,000 14,500 244,500 23,000 221,500 June 29,000 5 145,000 11,500 156,500 14,500 142,000 Quarter 101,000 5 505,000 11,500 516,500 13,000 503,500

Direct-Material Budget
July Production

April 25,000 May Sales in units Add: Production in units desired ending inventory 26,000 3,000 46,000 TotalMaterials per unit units needed 528,000 5 Less:Productioninventory 130,000 5,000 230,000 beginning needs Production in units 23,000

June 29,000 5 145,000

Quarter 101,000 5 505,000 11,500 516,500 13,000 503,500

Add: desired ending inventory 23,000 14,500 11,500 Total needed 153,000 244,500 156,500 Less: beginning June Ending Inventory inventory 13,000 23,000 14,500 July be 23,000 Materials toproduction in units Materials per unit 5 purchased 140,000 221,500 142,000 Total units needed 115,000 Inventory percentage 10% June desired ending inventory 11,500

Direct-Labor Budget
At Breakers, each unit of product requires 0.1 hours of direct labor.

The Company has a no layoff policy so all employees will be paid for 40 hours of work each week.
In exchange for the no layoff policy, workers agreed to a wage rate of $8 per hour regardless of the hours worked (No overtime pay). For the next three months, the direct labor workforce will be paid for a minimum of 3,000 hours per month. Lets prepare the direct labor budget.

Direct-Labor Budget
Production in units Direct labor hours Labor hours required Guaranteed labor hours Labor hours paid Wage rate Total direct labot cost April 26,000 May 46,000 June 29,000 Quarter 101,000

From our production budget

Direct-Labor Budget
Production in units Direct labor hours Labor hours required Guaranteed labor hours Labor hours paid Wage rate Total direct labot cost April 26,000 0.10 2,600 May 46,000 0.10 4,600 June 29,000 0.10 2,900 Quarter 101,000 0.10 10,100

Direct-Labor Budget
Production in units Direct labor hours Labor hours required Guaranteed labor hours Labor hours paid Wage rate Total direct labot cost April 26,000 0.10 2,600 3,000 3,000 May 46,000 0.10 4,600 3,000 4,600 June 29,000 0.10 2,900 3,000 3,000 Quarter 101,000 0.10 10,100

10,600

This is the greater of labor hours required or labor hours guaranteed.

Direct-Labor Budget
Production in units Direct labor hours Labor hours required Guaranteed labor hours 3,000 Labor hours paid 3,000 Wage rate $ 8 Total direct labot cost $ 24,000 April 26,000 0.10 2,600 May 46,000 0.10 4,600 3,000 4,600 $ 8 $ 36,800 June 29,000 0.10 2,900 3,000 3,000 $ 8 $ 24,000 Quarter 101,000 0.10 10,100

10,600 $ 8 $ 84,800

Overhead Budget
Here is Breakers Overhead Budget for the quarter.
April Indirect labor Indirect material Utilities Rent Insurance Maintenance $ 17,500 7,000 4,200 13,300 5,800 8,200 56,000 $ May 26,500 12,600 8,400 13,300 5,800 9,400 76,000 $ June 17,900 8,600 5,200 13,300 5,800 8,200 59,000 $ Quarter 61,900 28,200 17,800 39,900 17,400 25,800 $ 191,000

Selling and Administrative Expense Budget

At Breakers, variable selling and administrative expenses are $0.50 per unit sold. Fixed selling and administrative expenses are $70,000 per month. The $70,000 fixed expenses include $10,000 in depreciation expense that does not require a cash outflows for the month.

Selling and Administrative Expense Budget

Sales in units Variable S&A rate Variable expense Fixed S&A expense Total expense Less: noncash expenses Cash disbursements April 20,000 May 50,000 June 30,000 Quarter 100,000

From our Sales budget

Selling and Administrative Expense Budget

Sales in units Variable S&A rate Variable expense Fixed S&A expense Total expense Less: noncash expenses Cash disbursements April 20,000 $ 0.50 $ 10,000 70,000 80,000 May 50,000 $ 0.50 $ 25,000 70,000 95,000 June 30,000 $ 0.50 $ 15,000 70,000 85,000 Quarter 100,000 $ 0.50 $ 50,000 210,000 260,000

Selling and Administrative Expense Budget

Sales in units Variable S&A rate Variable expense Fixed S&A expense Total expense Less: noncash expenses Cash disbursements April 20,000 $ 0.50 $ 10,000 70,000 80,000 10,000 $ 70,000 May 50,000 $ 0.50 $ 25,000 70,000 95,000 10,000 $ 85,000 June 30,000 $ 0.50 $ 15,000 70,000 85,000 10,000 $ 75,000 Quarter 100,000 $ 0.50 $ 50,000 210,000 260,000 30,000 $ 230,000

Cash Receipts Budget

At Breakers, all sales are on account. The companys collection pattern is: 70% collected in the month of sale, 25% collected in the month following sale, 5% is uncollected. The March 31 accounts receivable balance of $30,000 will be collected in full.

Cash Receipts Budget

Accounts rec. - 3/31 April sales 70% x $200,000 25% x $200,000 April $ 30,000 140,000 $ 50,000 May June Quarter $ 30,000 140,000 50,000

Total cash collections

$ 170,000

Cash Receipts Budget

Accounts rec. - 3/31 April sales 70% x $200,000 25% x $200,000 May sales 70% x $500,000 25% x $500,000 June sales 70% x $300,000 Total cash collections April $ 30,000 140,000 $ 50,000 350,000 $ 125,000 210,000 $ 335,000 May June Quarter $ 30,000 140,000 50,000 350,000 125,000 210,000 $ 905,000

$ 170,000

$ 400,000

Cash Disbursement Budget

Breakers pays $0.40 per pound for its materials. One-half of a months purchases are paid for in the month of purchase; the other half is paid in the following month. No discounts are available.

The March 31 accounts payable balance is $12,000.

Cash Disbursement Budget

Accounts pay. 3/31 April purchases 50% x $56,000 50% x $56,000 April $ 12,000 28,000 $ 28,000 May June Quarter $ 12,000 28,000 28,000

Total cash payments for materials

$ 40,000

140,000 lbs. $.40/lb. = $56,000

Cash Disbursement Budget

Accounts pay. 3/31 April purchases 50% x $56,000 50% x $56,000 May purchases 50% x $88,600 50% x $88,600 June purchases 50% x $56,800 Total cash payments for materials April $ 12,000 28,000 $ 28,000 44,300 $ 44,300 28,400 $ 40,000 $ 72,300 $ 72,700 May June Quarter $ 12,000 28,000 28,000 44,300 44,300 28,400 $ 185,000

Cash Disbursement Budget

Breakers: Maintains a 12% open line of credit for $75,000.

Maintains a minimum cash balance of $30,000.

Borrows and repays loans on the last day of the month.

Pays a cash dividend of $25,000 in April.

Purchases $143,700 of equipment in May and $48,300 in June paid in cash. Has an April 1 cash balance of $40,000.

Cash Budget
(Collections and Disbursements)
April May June Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials Direct labor From our Cash Mfg. overhead Selling and admin. Receipts Budget Equipment purchase Dividends Total disbursements Excess (deficiency) of Cash available over disbursements Quarter

Cash Budget
(Collections and Disbursements)
April May June Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor Mfg. overhead Selling and admin. Equipment purchase Dividends From our Cash Total disbursements Excess (deficiency) of Disbursements Cash available over Budget disbursements Quarter

Cash Budget
(Collections and Disbursements)
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead Selling and admin. Equipment purchase Dividends Total disbursements Excess (deficiency) of Cash available over disbursements May June Quarter

From our Direct Labor Budget

Cash Budget
(Collections and Disbursements)
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. Equipment purchase Dividends Total disbursements Excess (deficiency) of Cash available over disbursements May June Quarter

From our Overhead Budget

Cash Budget
(Collections and Disbursements)
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends Total disbursements Excess (deficiency) of Cash available over disbursements May June Quarter

From our Selling and Administrative Expense Budget

Cash Budget
(Collections and Disbursements)
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 Excess (deficiency) of Cash available over disbursements $ (5,000) May June Quarter

To maintain a cash balance of $30,000, Breakers must borrow $35,000 on its line of credit.

Cash Budget
(Financing and Repayment)
April Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance May June Quarter

$ (5,000) 35,000 35,000 $ 30,000

Ending cash balance for April is the beginning May balance.

Cash Budget
(Collections and Disbursements)
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 Excess (deficiency) of Cash available over disbursements $ (5,000) May $ 30,000 400,000 430,000 72,300 36,800 76,000 85,000 143,700 413,800 June Quarter

Breakers must borrow an addition $13,800 to maintain a cash balance of $30,000.

$ 16,200

Cash Budget
(Financing and Repayment)
April Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance May June Quarter

$ (5,000) 35,000 35,000 $ 30,000

$ 16,200 13,800 13,800 $ 30,000

Cash Budget
(Collections and Disbursements)
April May Beginning cash balance $ 40,000 $ At the end of June, Breakers 30,000 Add: cash collections 170,000 has enough cash to repay 400,000 Total cash available 210,000 430,000 the $48,800 loan plus interest Less: disbursements at 12%. 40,000 Materials 72,300 Direct labor 24,000 36,800 Mfg. overhead 56,000 76,000 Selling and admin. 70,000 85,000 Equipment purchase 143,700 Dividends 25,000 Total disbursements 215,000 413,800 Excess (deficiency) of Cash available over disbursements $ (5,000) $ 16,200 June $ 30,000 335,000 365,000 72,700 24,000 59,000 75,000 48,300 279,000 Quarter

$ 86,000

Cash Budget
(Financing and Repayment)
April Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance
Borrowing $ 35,000 13,800

May

June

Quarter

$ (5,000) 35,000 35,000 $ 30,000

$ 16,200 13,800 13,800 $ 30,000

$ 86,000

(48,800) (838) (49,638) $ 36,362

Annual Rate Interest 12% = $ 4,200 12% = 1,656

Months Interest Outstanding Expense 2 mths = $ 700 1 mth. = 138 $ 838

Cash Budget
(Collections and Disbursements)
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 Excess (deficiency) of Cash available over disbursements $ (5,000) May $ 30,000 400,000 430,000 72,300 36,800 76,000 85,000 143,700 413,800 June $ 30,000 335,000 365,000 72,700 24,000 59,000 75,000 48,300 279,000 Quarter $ 40,000 905,000 945,000 185,000 84,800 191,000 230,000 192,000 25,000 907,800

$ 16,200

$ 86,000

$ 37,200

Cash Budget
(Financing and Repayment)
April Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance May June Quarter

$ (5,000) 35,000 35,000 $ 30,000

$ 16,200 13,800 13,800 $ 30,000

$ 86,000

$ 37,200 48,800 (48,800) (838) (838) $ 36,362

(48,800) (838) (49,638) $ 36,362

Cost of Goods Manufactured

April Direct material: Beg.material inventory $ 5,200 Add: Materials purchases 56,000 Material available for use 61,200 Deduct: End. material inventory 9,200 Direct material used 52,000 Direct labor 24,000 Manufacturing overhead 56,000 Total manufacturing costs 132,000 Add: Beg. Work-in-process inventory 3,800 Subtotal 135,800 Deduct: End.Work-in-process inventory 16,200 Cost of goods manufactured $ 119,600 $ May 9,200 88,600 97,800 5,800 92,000 36,800 76,000 204,800 16,200 221,000 9,400 $ 211,600 $ June 5,800 56,800 62,600 4,600 58,000 24,000 59,000 141,000 9,400 150,400 17,000 $ 133,400 Quarter $ 5,200 201,400 206,600 4,600 202,000 84,800 191,000 477,800 3,800 481,600 17,000 $ 464,600

Cost of Goods Sold

April May $ 119,600 $ 211,600 $ 18,400 46,000 138,000 257,600 46,000 27,600 $ 92,000 $ 230,000 $ June Quarter 133,400 $ 464,600 27,600 18,400 161,000 483,000 23,000 23,000 138,000 $ 460,000

Cost of goods manufactured Add: Beg. finished-goods inventory Cost of goods available for sale Deduct: End. finished-goods inventory Cost of goods sold

Budgeted Income Statement

Cost of Goods Manufactured and Sold Budgeted Income Statement

After we complete the cost of goods manufactured and sold schedules, we can prepare the budgeted income statement for Breakers.

Budgeted Income Statement

Breakers, Inc. Budgeted Income Statement For the Three Months Ended June 30 Revenue (100,000 $10) Cost of goods sold Gross margin Operating expenses: Selling and admin. expenses Interest expense Total operating expenses Net income $ 1,000,000 460,000 540,000 $ 260,000 838 $ 260,838 279,162

Budgeted Statement of Cash Flows

April Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers of raw material For direct labor For manufacturing-overhead expenditures For selling and administrative expenses For interest Total cash payments Net cash flow from operating activities Cash flows from investing activities: Purchase of equipment Net cash used by investing activities Cash flows from financing activities: Payment of dividends Principle of bank loan Repayment of bank loan Net cash provided by financing activities Net increase in cash Balance in cash, beginning Balance in cash. end of month $ $ 170,000 $ (40,000) (24,000) (56,000) (70,000) (190,000) (20,000) $ $ May 400,000 $ (72,300) (36,800) (76,000) (85,000) (270,100) 129,900 $ (143,700) June 335,000 $ (72,700) (24,000) (59,000) (75,000) (838) (231,538) 103,462 $ (48,300) (48,300) $ (48,800) (48,800) $ 6,362 $ 30,000 36,362 $ Quarter 905,000 (185,000) (84,800) (191,000) (230,000) (838) (691,638) 213,362 (192,000) (192,000) (25,000) 48,800 (48,800) (3,638) 40,000 36,362

- $ (143,700) $ (25,000) 35,000 13,800 13,800 $ - $ 30,000 30,000 $

$ $ $

10,000 $ (10,000) $ 40,000 30,000 $

Budgeted Balance Sheet

Breakers reports the following account balances on June 30 prior to preparing its budgeted financial statements: Land - $50,000 Building (net) - $148,000 Common stock - $217,000 Retained earnings - $46,400

Breakers, Inc. Budgeted Balance Sheet June 30

25%of June sales of $300,000 11,500 lbs. at $.40 per lb. 5,000 units at $4.60 per unit.

Current assets Cash Accounts receivable Raw materials inventory Work-in-process inventory Finished goods inventory Total current assets Property and equipment Land Building Equipment Total property and equipment Total assets Accounts payable Common stock Retained earnings Total liabilities and equities

36,362 75,000 4,600 17,000 23,000 155,962 50,000 148,000 192,000 390,000 545,962 28,400 217,000 300,562 545,962

$ $

Breakers, Inc. Budgeted Balance Sheet June 30 Current assets Cash Accounts receivable Raw materials inventory Work-in-process inventory Finished goods inventory Total current assets Property and equipment Land Building Beginning balance $ 46,400 Equipment Add: net income 279,162 Total property and equipment Deduct: dividends (25,000) Total assets Ending balance $300,562 Accounts payable Common stock Retained earnings Total liabilities and equities

50% of June purchases of $56,800

36,362 75,000 4,600 17,000 23,000 155,962 50,000 148,000 192,000 390,000 545,962 28,400 217,000 300,562 545,962

$ $

Sales of Services or Goods Ending Inventory Budget

Work in Process and Finished Goods

Production Budget

When the interactions of the elements Selling and Ending Direct Direct Overhead of the master budget are expressed as Inventory Materials Labor Administrative Budget Budgeta set of mathematical relations, it Budget Budget Budget Direct Materials becomes a financial planning model that can be used to answer what if Cash Budget Budgeted Income questions about unknown variables.
Statement

Budgeted Balance Sheet

Budgeted Statement of Cash Flows

Budget Administration
The Budget Committee is a standing committee responsible for . . .
overall policy matters relating to the budget. coordinating the preparation of the budget.

E-Budgeting
Employees throughout an organization can submit and retrieve budget information electronically. This tends to streamline the entire budgeting process.

Firewalls and Information Security

Budget information is extremely sensitive and confidential. A firewall is a computer or router placed between a companys internal network and the internet to control all information between the outside world and the companys local network.

Zero-Base Budgeting
To receive funding during the budgeting process, each activity must be justified in terms of its continued usefulness.

International Aspects of Budgeting

Firms with international operations face special problems when preparing a budget.
Fluctuations in foreign currency exchange

rates. High inflation rates in some foreign countries. Differences in local economic conditions.

Budgeting Product Life-Cycle Costs

Product planning and concept Design. Distribution and customer service.

Preliminary design.

Production.

Detailed design and testing.

Participative Budgeting
Top Management

Middle Management

Middle Management

Supervisor

Supervisor

Supervisor

Supervisor

Flow of Budget Data

Flexible Budgets
Static budgets are prepared for a single, planned level of activity.
Performance evaluation for overhead is difficult when actual activity differs from the planned level of activity.

Static Budgets and Performance Reports

Static Budget Machine hours Variable costs Indirect labor Indirect materials Power Fixed costs Depreciation Insurance Total overhead costs 10,000 $ 40,000 30,000 5,000 12,000 2,000 $ 89,000 Actual Results 8,000 Variances 2,000 U

U = Unfavorable variance Cheese Company was unable to achieve the budgeted level of activity.

Static Budgets and Performance Reports

F = Favorable variance since actual costs Static Actual are less than budgeted costs.
Budget Machine hours Variable costs Indirect labor Indirect materials Power Fixed costs Depreciation Insurance Total overhead costs 10,000 $ 40,000 30,000 5,000 12,000 2,000 $ 89,000 Results 8,000 $ 34,000 25,500 3,800 12,000 2,000 $ 77,300 Variances 2,000 U $6,000 F 4,500 F 1,200 F 0 0 $11,700 F

Static Budgets and Performance Reports

Static Budget Machine hours Variable costs Indirect labor Indirect materials Power Fixed costs we done a good Depreciation Insurance 10,000 $ 40,000 30,000 5,000 Actual Results 8,000 $ 34,000 25,500 3,800 Variances 2,000 U $6,000 F 4,500 F 1,200 F 0 0 $11,700 F

Since cost variances are favorable, have job controlling costs? 12,000 12,000
2,000 $ 89,000 2,000 $ 77,300

Total overhead costs

 The relevant question is . . .

Static Budgets and Performance Reports

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.

Flexible Budgets
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.

Advantages of Flexible Budgets

Show revenues and expenses that should have occurred at the actual level of activity. May be prepared for any activity level in the relevant range. Reveal variances due to good cost control or lack of cost control. Improve performance evaluation.

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 10,000 12,000

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours

8,000 10,000 12,000 Variable costs are expressed as a constant amount per hour. $ 32,000 24,000 4,000 $ 60,000

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 3.00 0.50 7.50 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 10,000 12,000

Fixed costs are expressed as a $ amount that does not total 32,000 24,000 change within the relevant 4,000 range $ 60,000 of activity.
$12,000 2,000

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 10,000 12,000

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 10,000 $ 40,000 30,000 5,000 $ 75,000 $ 12,000 2,000 $ 14,000 $ 89,000 12,000 $ 48,000 36,000 6,000 $ 90,000 $ 12,000 2,000 $ 14,000 $ 104,000

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Variable costs Indirect labor Note: There is no Indirect material in the fixed costs. Power Total variable cost $ Fixed costs Depreciation Insurance Total fixed cost Total overhead costs 4.00 flex 3.00 0.50 7.50 $12,000 2,000 Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 10,000 $ 40,000 30,000 5,000 $ 75,000 $ 12,000 2,000 $ 14,000 $ 89,000 12,000 $ 48,000 36,000 6,000 $ 90,000 $ 12,000 2,000 $ 14,000 $ 104,000

Preparing a Flexible Budget

Variable Cost Per Hour Machine hours Total Fixed Cost Flexible Budgets 8,000 10,000 12,000 Hours Hours Hours 8,000 10,000 $ 40,000 30,000 5,000 Budgeted $ 75,000 $ 12,000 2,000 $ 14,000 $ 89,000 12,000 $ 48,000 36,000 6,000 fixed90,000 $ $ 12,000 2,000 $ 14,000 $ 104,000

Total budgeted Variable costs Indirect labor 4.00 $ 32,000 overhead cost Indirect material 3.00 24,000 Power 0.50 Budgeted variable Total 4,000 Total variable cost cost per $ overhead $ 7.50 activity60,000 activity unit Fixed costs
Depreciation Insurance Total fixed cost Total overhead costs

units

overhead cost

$12,000 2,000

$ 12,000 2,000 $ 14,000 $ 74,000

Flexible Budget Performance Report

Variable Cost Per Hour Machine hours Variable costs Indirect labor $ Indirect material Power Total variable costs $ Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Costs Flexible Budget Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300 Variances 0

Flexible Budget Performance Report

Total FlexibleVariable is budget Fixed Cost prepared for the Per Hour Costs same activity level Machine hours (8,000 hours) as Variable costs actually$achieved. Indirect labor 4.00 Indirect material Power Total variable costs $ Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs 3.00 0.50 7.50 $12,000 2,000 Flexible Budget 8,000 Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300 Variances 0

Flexible Budget Performance Report

Variable Cost Per Hour Machine hours Variable costs Indirect labor $ Indirect material Power Total variable costs $ Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs 4.00 3.00 0.50 7.50 $12,000 2,000 Total Fixed Costs Flexible Budget 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300 Variances 0 $ 2,000 U 1,500 U 200 F $ 3,300 U 0 0 0 $ 3,300 U

Flexible Budget Performance Report

Indirect indirect material have Machine hours unfavorable variances Variable costs because costs Indirect labor actual4.00 $ are more Indirect material than the 3.00 Power flexible budget 0.50 costs.
Total variable costs $ Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs 7.50 $12,000 2,000 Variable Total Cost Fixed laborHour Costs Per and Flexible Budget 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300 Variances 0 $ 2,000 U 1,500 U 200 F $ 3,300 U 0 0 0 $ 3,300 U

Flexible Budget Performance Report

Variable Cost Per Hour Machine hours Total Fixed Costs Flexible Budget 8,000 $ 32,000 24,000 4,000 $ 60,000 $ 12,000 2,000 $ 14,000 $ 74,000 Actual Results 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 14,000 $ 77,300 Variances 0 $ 2,000 U 1,500 U 200 F $ 3,300 U 0 0 0 $ 3,300 U

Power has a favorable Variable costs variance because the Indirect labor $ 4.00 actual cost is Indirect material less than 3.00 Power 0.50 the flexible budget cost.
Total variable costs $ Fixed Expenses Depreciation Insurance Total fixed costs Total overhead costs 7.50 $12,000 2,000