Management Advisory Services: Operational Budgeting

Batangas CPA Review

Center
“Committed to your CPA review needs”
RLCAPUNO, CPA, LLB
Budgeting Basics
A budget is a formal written statement of management’s plans for a specified 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.

Benefits of Budgeting
The primary benefits of budgeting are as follows:
 It requires all levels of management to plan ahead.
 It provides definite objectives for evaluating performance.
 It creates an early warning system for potential problems.
 It facilitates the coordination of activities within the business.
 It results in greater management awareness of the entity’s overall operations.
 It motivates personnel throughout the organization.

Essentials of Effective Budgeting

In order to be effective management tools, budgets must be based upon
 A sound organizational structure in which authority and responsibility are clearly defined.
 Research and analysis to determine the feasibility of new products, services, and operating
techniques.
 Management acceptance which is enhanced when all levels of management participate in the
preparation of the budget, and the budget has the support of top management.

The most common budget period is one year. A continuous twelve-month budget results from dropping the
month just ended and adding a future month. The annual budget is often supplemented by monthly and
quarterly budgets.

The responsibility for coordinating the preparation of the budget is assigned to a budget committee. The
budget committee usually includes the president, treasurer, chief accountant (controller), and management
personnel from each major area of the company.

A budget can have a significant impact on human behavior. A budget may have a strong positive influence on
a manager when
 Each level of management is invited and encouraged to participate in developing the budget.
 Criticism of a manager’s performance is tempered with advice and assistance.

Long-range planning involves the selection of strategies to achieve long-term goals and the development of
policies and plans to implement the strategies. Long-range plans contain considerably less detail than
budgets.

The 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.

There are two classes of budgets in the master budget.

 Operating budgets are the individual budgets that result in the preparation of the budgeted income
statement.
 Financial budgets focus primarily on the cash resources needed to fund expected operations and
planned capital expenditures.

The sales budget is the first budget prepared. It is derived from the sales forecast, and it represents
management’s best estimate of sales revenue for the budget period. It is prepared by multiplying the
expected unit sales volume for each product by its anticipated unit selling price.

The production budget shows the units that must be produced to meet anticipated sales. It is derived from the
budgeted sales units plus the desired ending finished goods units less the beginning finished goods units.

The direct materials budget shows both the quantity and cost of direct materials to be purchased. It is derived
from the direct materials units required for production plus the desired ending direct materials units less the
beginning direct materials units.

The direct labor budget shows the quantity (hours) and cost of direct labor necessary to meet production
requirements. The direct labor budget is critical in maintaining a labor force that can meet expected levels of
production.

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The manufacturing overhead budget shows the expected manufacturing overhead costs. The selling and
administrative expense budget is a projection of anticipated operating expenses. Both budgets distinguish
between fixed and variable costs.

Budgeted Income Statement

The budgeted income statement is the important end-product in preparing 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 budgets described in review points 11-15.
 For example, to find cost of goods sold, it is necessary to determine the total unit cost of a finished
product using the direct materials, direct labor, and manufacturing overhead budgets.

Cash Budget
The cash budget shows anticipated cash flows. It contains three sections (cash receipts, cash disbursements,
and financing) and the beginning and ending cash balances. Data for preparing this budget are obtained from
the other budgets.

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.

Budgeting in Nonmanufacturing Companies

The major differences in the master budget of a merchandiser and a manufacturing company are that a
merchandiser (a) uses a merchandise purchases budget instead of a production budget and (b) does not use
the manufacturing budgets (direct materials, direct labor, and manufacturing overhead).

In service enterprises, the critical factor in budgeting is coordinating professional staff needs with anticipated
services. Budget data for service revenue may be obtained from expected output or expected input.

In the budget process for not-for-profit organizations, the emphasis is on cash flows rather than on a revenue
and expense basis. For governmental units, the budget must be strictly followed and overspending is often
illegal.

LET’s REVIEW
Theory

1. Kerner Manufacturing uses a process cost system to manufacture laptop computers. The following
information summarizes operations relating to laptop computer model #KJK20 during the quarter
ending March 31:
Units Direct Materials
Work in process inventory, January 1 100 P70,000
Started during the quarter 500
Completed during the quarter 400
Work-in-process inventory, March 31 200
Costs added during the quarter P750,000

Beginning work in process inventory was 50% complete for direct materials. Ending work in process
inventory was 75% complete for direct materials. What were the equivalent units of production with
regard to materials for March?
a. 450
b. 500
c. 550
d. 600

2. Kerner Manufacturing uses a process cost system to manufacture laptop computers. The following
information summarizes operations relating to laptop computer model #KJK20 during the quarter
ending March 31:
Units Direct Materials
Work in process inventory, January 1 100 P50,000
Started during the quarter 500
Completed during the quarter 400
Work in process inventory, March 31 200
Costs added during the quarter P720,000

Beginning work in process inventory was 50% complete for direct materials. Ending work in process
inventory was 75% complete for direct materials. What is the total value of material costs in ending
work in process inventory using the FIFO unit cost, inventory valuation method?
a. P183,000
b. P194,000
c. P210,000
d. P216,000

3. In a process cost system, the application of factory overhead usually would be recorded as an increase
in
a. Finished goods inventory control.

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b. Factory overhead control.
c. Cost of goods sold.
d. Work in process inventory control.

4. The following information pertains to Lap Co.’s Palo Division for the month of April:
Number of units Cost of materials
Beginning work in process 15,000 P 5,500
Started in April 40,000 18,000
Units completed 42,500
Ending work in process 12,500

All materials are added at the beginning of the process. Using the weighted-average method, the cost
per equivalent unit for materials is
a. P0.59
b. P0.55
c. P0.45
d. P0.43

5. The Forming Department is the first of a two-stage production process. Spoilage is identified when the
units have completed the Forming process. Costs of spoiled units are assigned to units completed and
transferred to the second department in the period spoilage is identified. The following information
concerns Forming’s conversion costs in May 2003:
Units Conversion costs
Beginning work in process (50% complete) 2,000 P10,000
Units started during May 8,000 75,500
Spoilage—normal 500
Units completed and transferred 7,000
Ending work in process (80% complete) 2,500

Using the weighted-average method, what was Forming’s conversion cost transferred to the second
production department?
a. P59,850
b. P64,125
c. P67,500
d. P71,250

6. In computing the current period’s manufacturing cost per equivalent unit, the FIFO method of process
costing considers current period costs
a. Only.
b. Plus cost of beginning work in process inventory.
c. Less cost of beginning work in process inventory.
d. Plus cost of ending work in process inventory.

7. In process 2, material G is added when a batch is 60% complete. Ending work in process units, which
are 50% complete, would be included in the computation of equivalent units for
Conversion costs Material G
a. Yes No
b. No Yes
c. No No
d. Yes Yes

8. A process costing system was used for a department that began operations in January 2003.
Approximately the same number of physical units, at the same degree of completion, were in work in
process at the end of both January and February. Monthly conversion costs are allocated between
ending work in process and units completed. Compared to the FIFO method, would the weighted-
average method use the same or a greater number of equivalent units to calculate the monthly
allocations?
Equivalent units for weighted average compared to FIFO
January February
a. Same Same
b. Greater number Greater number
c. Greater number Same
d. Same Greater number

9. A department adds material at the beginning of a process and identifies defective units when the
process is 40% complete. At the beginning of the period, there was no work in process. At the end of
the period, the number of work in process units equaled the number of units transferred to finished
goods. If all units in ending work in process were 66 2/3% complete, then ending work in process
should be allocated
a. 50% of all normal defective unit costs.
b. 40% of all normal defective unit costs.
c. 50% of the material costs and 40% of the conversion costs of all normal defective unit costs.
d. None of the normal defective unit costs.

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10. Why are budgets useful in the planning process?

a. They provide management with information about the company's past performance.
b. They help communicate goals and provide a basis for evaluation.
c. They guarantee the company will be profitable if it meets its objectives.
d. They enable the budget committee to earn their paycheck.

11. A budget
a. is a substitute for management.
b. is an aid to management.
c. can operate or enforce itself.
d. is the responsibility of the accounting department.

12. Accounting generally has the responsibility for

a. setting company goals.
b. expressing the budget in financial terms.
c. enforcing the budget.
d. administration of the budget.

13. Which one of the following is not a benefit of budgeting?

a. It facilitates the coordination of activities.
b. It provides definite objectives for evaluating performance.
c. It provides assurance that the company will achieve its objectives.
d. It requires all levels of management to plan ahead on a recurring basis.

14. Budgeting is usually most closely associated with which management function?
a. Planning
b. Directing
c. Motivating
d. Controlling

15. Which of the following items does not follow from the adoption of a budget?
a. Promote efficiency
b. Deterrent to waste
c. Basis for performance evaluation
d. Guarantee of accomplishing the profit objective

16. Which is true of budgets?

a. They are voted on and approved by stockholders.
b. They are used in the planning, but not in the control, process.
c. There is a standard form and structure for budgets.
d. They are used in performance evaluation.

17. A common starting point in the budgeting process is

a. expected future net income.
b. past performance.
c. to motivate the sales force.
d. a clean slate, with no expectations.

18. If budgets are to be effective, all of the following must be present except
a. acceptance at all levels of management.
b. research and analysis in setting realistic goals.
c. stockholders' approval of the budget.
d. sound organizational structure.

19. If budgets are to be effective, there must be

a. a history of successful operations.
b. independent verification of budget goals.
c. an organizational structure with clearly defined lines of authority and responsibility.
d. excess plant capacity.

20. It is important that budgets be accepted by

a. division managers.
b. department heads.
c. supervisors.
d. all of these.

21. Which of the following statements about budget acceptance in an organization is true?
a. The most widely accepted budget by the organization is the one prepared by top management.
b. The most widely accepted budget by the organization is the one prepared by the department
heads.
c. Budgets are hardly ever accepted by anyone except top management.

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d. Budgets have a greater chance of acceptance if all levels of management have provided input into
the budgeting process.

22. Top management notices a variation from budget and an investigation of the difference reveals that
the department manager could not be expected to have controlled the variation. Which of the
following statements is applicable?
a. Department managers should be held accountable for all variances from budgets for their
departments.
b. Department managers should only be held accountable for controllable variances for their
departments.
c. Department managers should be credited for favorable variances even if they are beyond their
control.
d. Department managers' performances should not be evaluated based on actual results to budgeted
results.

23. An unrealistic budget is more likely to result when it

a. has been developed in a top down fashion.
b. has been developed in a bottom up fashion.
c. has been developed by all levels of management.
d. is developed with performance appraisal usages in mind.

24. A budget is most likely to be effective if

a. it is used to assess blame when things do not occur according to plans.
b. it is not used to evaluate a manager's performance.
c. employees and managers at the lower levels do not get involved in the budgeting process.
d. it has top management support.

25. In many companies, responsibility for coordinating the preparation of the budget is assigned to
a. the company's independent certified public accountants.
b. the company's internal auditors.
c. the company's board of directors.
d. a budget committee.

26. A budget period should be

a. monthly.
b. for a year or more.
c. long-term.
d. long enough to provide an obtainable goal under normal business conditions.

27. If a company has adopted continuous budgeting, the budget will show plans for
a. every day.
b. a full year ahead.
c. the current year and the next year.
d. at least five years.

28. The most common budget period is

a. one month.
b. three months.
c. six months.
d. one year.

29. Budget development for the coming year usually starts

a. a year in advance.
b. the first month of the year to be budgeted.
c. several months before the end of the current year.
d. the last month of the previous year.

30. The budget committee would not normally include the

a. research director.
b. treasurer.
c. sales manager.
d. external auditor.

31. The budget committee in a company is often headed by the

a. president.
b. controller.
c. treasurer.
d. budget director.

32. Long-range planning

a. generally presents more detailed information than an annual budget.
b. generally encompasses a longer period of time than an annual budget.
c. is usually more accurate than an annual budget.
d. is prepared on a quarterly basis if the budget is prepared on a quarterly basis.

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Problems
Problem 1
Prime Company has the following budgeted sales for the selected six-month period:
Month Units Month Units
September 40,000 December 50,000
October 50,000 January 60,000
November 70,000 February 40,000

There were 10,000 units of finished goods in inventory at the beginning of September. Plans are to have an
inventory of finished product equal to 25 percent of the units sales for the next month.

Three pounds of materials are required for each unit produced. Each pound of material costs P15. Inventory
levels for materials equal 20 percent of the needs for the next month. Materials inventory on September 1 was
25,000 pounds.
a. Prepare production budgets in units for the third quarter by month
b. Prepare a purchase budget in pounds and pesos for the third quarter by month.

Problem 2
Sylvia Milan manufactures and distributes perfume throughout the country. Each unit of Conquest, one of the
company’s products, requires 8 cc (cubic centimeters) of alcohol. The company is now planning raw material
needs for the third quarter, the quarter in which peak sales of Conquest occur. To keep production and sales
moving smoothly, the company has the following inventory requirements.

a. The finished goods inventory on hand at the end of each month must be equal to 2,000 units of
Conquest plus 25% of the next month’s sales. The finished goods inventory on June 30 is budgeted to
be 5,500 units.
b. The raw materials inventory on hand at the end of each month must be equal to 55% of the following
moth’s production needs for raw materials. The raw materials inventory on June 30 is budgeted to be
63,360 cc of alcohol
c. The company maintains no work in process inventories.

A sales budget for Conquest for the last six months of the year follows:
Budgeted Sales in units
July 14,000
August 15,600
September 22,000
October 18,000
November 16,200
December 14,800
Required:
1. Prepare a production budget for Conquest for the months July-October
2. Examine the production budget that you have prepared in (1) above. Why will the company produce
more units than it sells in July and August, and fewer units than it sells in September and October?
3. Prepare a budget showing the quantity of alcohol to be purchased for July, August and September and
for the quarter in total.

Problem 3
Coyote Loco, Inc., a manufacturer of salsa, has the following historical collection pattern for its credit sales.

70% collected in the month of sales

15% collected in the first month after sale
10% collected in the second month after sale
4% collected in the third month after sale
1% uncollectible

The sales on account have been budgeted for the last seven months of 2007 as follows:
June 490,000 October 900,000
July 600,000 November 1,000,000
August 700,000 December 850,000
September 800,000
Required
1. Compute the estimated total cash collections during October from credit sale during 2007
2. Compute the estimated total cash collections during the fourth quarter from sales made on account
during the fourth quarter
3. Compute the estimated total cash collections during the fourth quarter from sales made on account
during 2007.

Problem 4
Helsen, Inc., manufactures lampshades. The company is now preparing detailed budgets for the third quarter
and has assembled the following information to assist in the budget preparation.
a. The Marketing Department has estimated sales as follows for the remainder of the year (in units)
July 18,000 October 23,000

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August 20,000 November 21,000
September 25,000 December 18,000

The selling price of the lampshades is P18 per unit.

b. All sales are on account. Based on past experience, sales are collected in the following pattern.
25% in the month of sale
70% in the month following sale
5% uncollectible

Sales for June totaled P315,000

c. The company maintains finished goods inventories equal to 25% of the following month’s sales. This
requirement will be met at the end of June.
d. Each lampshade requires 1.5 feet of PTX, a material that is sometimes hard to get. Therefore the
company requires that the inventory of PTX on hand at the end of month be equal to 40% of the
following month’s production needs. The inventory of PTX on hand at the beginning and end of the
quarter will be
June 30 1 1,100 feet
September 30 ? feet
e. The PTX costs P6.00 per foot. 35% of a month’s purchases of PTX is paid for in the month of
purchase; the remainder is paid in the following month. The accounts payable on July 1 for purchases
of PTX during June will be P81,000.
Required:
1. Prepare a sales budget, by month and in total, for the third quarter. (Show your budget in both units
and pesos.) Also prepare a schedule of expected cash collections, by month and in total, for the third
quarter.
2. Prepare a production budget for each of the months July-October.
3. Prepare a material purchases budget for PTX, by month and in total for the third quarter. Also prepare
a schedule of expected cash payments for PTX, by month and in total, for the third quarter.

Problem 5
Eye Care Company, distributor of eye care products, is ready to begin its third quarter, in which peak sales
occur. The company has requested a P30,000, 90-day loan from its bank to help meet cash requirements
during the quarter. Since Eye Care Company has experienced difficulty in paying off its loan in the past, the
loan officer at the bank has asked the company to prepare a cash budget for the quarter. In response to this
request, the following data have been assembled:

a. On July 1, the beginning of the third quarter, the company will have a cash balance of P46,000.
b. Actual sales for the last two months and budgeted sales for the third quarter follow:
May (actual) P200,000
June (actual) 240,000
July (budgeted) 350,000
August (budgeted) 410,000
September 340,000

Past experience shows that 25% of a month’s sales are collected in the month of sale, 65% in the
month following the sale, and 5% in the second month following sale. The remainder is uncollectible.
c. Budgeted merchandise purchases and budgeted expenses for the third quarter are given below:
July August September
Merchandise purchases 210,000 246,000 204,000
Salaries and wages 29,000 30,000 30,000
Advertising 78,000 91,000 67,000
Rent payments 7,000 7,000 7,000
Depreciation 8,000 8,000 8,000

Merchandise purchases are paid in full during the month following purchase. Accounts payable for
merchandise purchases on June 30, which will be paid during July, total P157,500.
d. Equipment costing P47,000 will be purchased for cash during July
e. In preparing the cash budget, assume that the P30,000 loan will be made in July and repaid in
September. Interest on the loan will total P900.
Required:
1. Prepare a schedule of expected cash collections for July, August and September and for the quarter in
total.
2. Prepare a cash budget, by month and in total for the third quarter
3. If the company needs a minimum cash balance of P10,000 to start each month, can the loan be repaid
as planned? Explain.

>>>END<<<

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