Topic 7Profit PlanningMohamad Tarmizi bin Hj Waropis - 815736Mohd Azmi bin Abu Bakar - 815511Mohd Fauzi bin Abdul Aziz - 815510Hj Mohammad Saimi bin Mat Som - 814646BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

Chapter 9: Profit Planning1

2BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGBASIC FRAMEWORK OF BUDGETING

Purposes of Budgeting SystemsBudget- a detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time.

Master budget - a summary of a companys plans that sets specific targets for sales, production, distribution, and financing activities.PlanningFacilitating Communication and CoordinationAllocating ResourcesControlling Profit and OperationsEvaluating Performance and Providing IncentivesBKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

Advantages of Budgeting

AdvantagesCommunicatingplansThink about andplan for the futureMeans of allocatingresourcesUncover potentialbottlenecksCoordinateactivitiesDefine goaland objectives

BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

- Budgets communicate managements plans throughout the organization.- Budgets force managers to think about and plan for the future. In the absence of thenecessity to prepare a budget, many managers would spend all of their time dealingwith daily emergencies.- The budgeting process provides a means of allocating resources to those parts of theorganization where they can be used most effectively.- The budgeting process can uncover potential bottlenecks before they occur.- Budgets coordinate the activities of the entire organization by integrating the plansof its various parts. Budgeting helps to ensure that everyone in the organization ispulling in the same direction.- Budgets define goals and objectives that can serve as benchmarks for evaluating subsequentperformance.

Choosing the Budget Period

Operating Budget

2008200920102011

Operating budgets

- Ordinarily cover a one-year period corresponding to a companys fiscal year. Many companies divide their annual budget into four quarters.A continuous budget -12 month budget that rollsforward one month (or quarter)as the current month (or quarter)is completed.BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

9-55Part IOperating budgets ordinarily cover a one-year period corresponding to a companys fiscal year. Many companies divide their annual budget into four quarters. In this chapter, we focus on one-year operating budgets.

Part IIA continuous or perpetual budget is a 12-month budget that rolls forward one month (or quarter) as the current month (or quarter) is completed. This approach keeps managers focused on the future at least one year ahead.

Self-Imposed BudgetA self-imposed budget or participative budget is a budget that is prepared with the full cooperation and participation of managers at all levels.

BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

9-66A self-imposed budget or participative budget is a budget that is prepared with the full cooperation and participation of managers at all levels. It is a particularly useful approach if the budget will be used to evaluate managerial performance.

7BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGPREPARING THE MASTER BUDGET

A set of interconnected budgets of sales, production costs, purchases, incomes and it also includes pro forma financial statements.

Serves as planning and control tool to the management since they can plan the business activities during the period on the basis of master budget.

At the end of each period, actual results can be compared with the master budget and necessary control actions can be taken.The Master BudgetBKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

The Master Budget: An OverviewProduction budgetSelling andadministrativebudgetDirect materialsbudgetManufacturingoverhead budgetDirect laborbudgetCash BudgetSales budgetEnding inventorybudgetBudgetedbalance sheetBudgetedincomestatementBKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

9-99- The master budget consists of a number of separate but interdependent budgets. This schematic of the budgeting process to illustrate the interdependency of the various individual budgets. The sales budget shows the expected sales for the budget period expressed in dollars and units. It is usually based on a companys sales forecast. All other parts of the master budget are dependent on the sales budget.The production budget is prepared after the sales budget. It lists the number of units that must be produced during each budget period to meet sales needs and to provide for the desired ending inventory. The production budget in turn directly influences the direct materials, direct labor, and manufacturing overhead budgets, which in turn enable the preparation of the ending finished goods inventory budget. These budgets are then combined with data from the sales budget and the selling and administrative expense budget to determine the cash budget. The cash budget is a detailed plan showing how cash resources will be acquired and used over a specified time period. All of the operating budgets have an impact on the cash budget. - The last step of the process is to prepare a budgeted income statement and a budgeted balance sheet.

General economic conditions Industry trendsMarket research studiesAnticipated advertising and promotionPrevious market share Price changes Technological developmentsBKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGFactors considered in Sales Forecasting

Sales BudgetApproved by the budget committee and describes expected sales in units and dollars.

The basis for all of the other operating budgets and most of the financial budgets.

The first step in creating a sales budget is to develop the sales forecast.

The sales forecast is just the initial estimate and it is often adjusted by the budget committee.BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

The sales budget is approved by the budget committee and describes expected sales in units and dollars. Because the sales budget is the basis for all of the other operating budgets and most of the financial budgets, it is important that it be as accurate as possible. The first step in creating a sales budget is to develop the sales forecast. The sales forecast is just the initial estimate, and it is often adjusted by the budget committee.

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BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGSales Budget for Jerrys Ice Cream

Sales manager at Jerrys Ice Cream, assumes the company will increase sales 15 percent this coming year. Thus, to get projected sales for quarter 1, he multiplied last years first quarter sales by 1.15. The average price per unit last year was $6 (1unit = 1 gallon).

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Production BudgetBKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING Production budget is prepared after the sales budget. Production budget lists the number of units that must be produced during each budget period to meet sales needs and to provide for the desired ending inventory.

Key Equation

Unitstobe produced=Expectedsales inunits + Desiredunits ofendinginventoryUnitsin beginninginventory

The production budget is prepared after the sales budget. The production budget lists the number of units that must be produced during each budget period to meet sales needs and to provide for the desired ending inventory as summarized in the following:

Units to be produced = Expected unit sales + Units in desired ending inventory (EI) Units in beginning inventory (BI)

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BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGProduction Budget for Jerrys Ice Cream*Information from"Sales Budget for Jerrys Ice Cream".**Desired ending inventory = 10 percent Next quarter sales; for the first quarter, 4,800 = 0.10 48,000. Fourth quarter desired ending inventory of 4,400 units is based on an estimate of sales in the first quarter of next year.***Beginning inventory = Inventory at end of previous quarter; for example, second quarter beginning inventory = First quarter ending inventory.

- Jerrys Ice Cream plans to sell 40,000 units in the first quarter, as shown in"Sales Budget for Jerrys Ice Cream".- For the sake of simplicity, assume work-in-process inventory is insignificant, and therefore beginning and ending work-in-process inventory is zero. (We assume beginning and ending work-in-process inventory is zero throughout.) - The management prefers to maintain 10 percent of next quarters sales in ending inventory. Thus 4,800 units will be in inventory at the end of the first quarter (= 48,000 unit sales in second quarter 10 percent). Units needed for the first quarter total 44,800 (= 40,000 unit sales + 4,800 units desired ending inventory). However, Jerrys will not produce 44,800 units because inventory will be left over from the fourth quarter of last year. This beginning inventory will be 4,000 units (= 40,000 unit sales in first quarter 10 percent). Thus actual production will total 40,800 units:40,800 Unitstobe produced=40,000 Expectedsales inunits+4,800 Desiredunitsof endinginventory4,000 Unitsin beginninginventory "Production Budget for Jerrys Ice Cream" presents the production budget for each of the 4 quarters of the coming year. Examine this figure carefully, particularly the last line labeledunits to be produced. The production manager, will be concerned about the spike in production during the third quarter of 59,200 units. The third quarter, from July 1 through September 30, is the peak sales season for ice cream. It will be difficult for manager to plan for this increase in production from the first and second quarters to the third quarter. However, this is exactly why companies prepare budgetsto plan for the future. Once Jerrys Ice Cream knows how many units it must produce each quarter, budgets are established for the individual components of production: direct materials, direct labor, and manufacturing overhead.

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BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGDirect Materials Budget The direct materials budget details the raw materials that must be purchased to fulfill the production budget and to provide for adequate inventories.

Direct materials purchased is based on materials needed in production.

Key Equation

Materialsto bepurchased=Materialsneeded inproduction + Desiredmaterials inendinginventoryMaterialsin beginninginventory

- After the production budget is completed, the budgets for direct materials, direct labor, and overhead can be prepared. - The direct materials purchases budget tells the amount and cost of raw materials to be purchased in each time period.

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BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING*Information from "Production Budget for Jerrys Ice Cream".**Desired ending inventory = 20 percent Next quarter production needs; for the first quarter, 19,680 = 0.20 98,400. Fourth quarter desired ending inventory of 20,000 pounds is based on an estimate of materials needed in production first quarter of next year.***Beginning inventory = Inventory at end of previous quarter; for example, Second quarter beginning inventory = First quarter ending inventory.****$2 direct materials cost per unit = 2 pounds of materials required per unit $1 per pound.Direct Materials Budget for Jerrys Ice Cream

Thedirect materials purchases budgetis an estimate of raw materials needed to achieve a desired level of production."Production Budget for Jerrys Ice Cream", the production budget, shows that 40,800 finished units will be produced in the first quarter. We will now establish a direct materials purchases budget that answers the questions: how many pounds of material must be purchased during the first quarter to achieve this production, and what is the cost of these materials?Assume two pounds of material are required to produce one unit of product. Thus the amount of materials required to produce 40,800 units of ice cream is 81,600 pounds (= 40,800 units 2 pounds per unit). This amount is labeled asmaterials needed in productionin the direct materials purchases budget shown inFigure 9.5 "Direct Materials Purchases Budget for Jerrys Ice Cream". (To simplify this example, assume sugar is the only material used. However, other materials, such as cream and vanilla, are typically required to produce ice cream.) - Assume the management prefers to maintain raw materials ending inventory equal to 20 percent of next quarters materials needed in production. Thus 19,680 pounds of material will be in inventory at the end of the first quarter (= 98,400 pounds of materials needed in production in second quarter 20 percent). Materials needed in inventory total 101,280 pounds (= 81,600 pounds of materials needed in production + 19,680 pounds of material in desired ending inventory). However, Jerrys will not purchase 101,280 pounds of materials because inventory will be left over from the fourth quarter of last year. This beginning inventory will be 16,320 pounds (= 81,600 pounds of material needed in production in first quarter 20 percent). Thus direct materials purchased in the first quarter will total 84,960 pounds:84,960Materials=81,600 Materialsneeded inproduction+19,680 Desiredmaterials inendinginventory16,320 Materialsin beginninginventoryTo estimate the cost of purchasing 84,960 pounds of material, multiply the number of pounds to be purchased by the cost per pound. Assume the cost per pound of material for Jerrys is $1. This results in a cost of $84,960 for materials to be purchased during the first quarter, as shown at the bottom of"Direct Materials Purchases Budget for Jerrys Ice Cream"(= 84,960 pounds to be purchased $1 per pound). Review the direct materials purchases budget shown in"Direct Materials Purchases Budget for Jerrys Ice Cream" carefully, particularly the line labeleddirect materials to be purchased. The purchasing manager at Jerrys Ice Cream uses this information, along with the price per pound, to negotiate the purchase of materials with suppliers.16

Direct Labor Budget The total direct labor hours and the direct labor cost needed for the number of units in the production budget.

The budgeted hours of direct labor are determined by the relationship between labor and output.BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

The direct labor budget shows the total direct labor hours and the direct labor cost needed for the number of units in the production budget. As with direct materials, the budgeted hours of direct labor are determined by the relationship between labor and output.

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BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGDirect Labor Budget for Jerrys Ice Cream

*From "Production Budget for Jerrys Ice Cream".**$1.30 direct labor cost per unit = 0.10 direct labor hours per unit $13 per hour.

- Knowing Jerrys Ice Cream plans to produce 40,800 units of ice cream during the first quarter- Assume it takes 0.10 direct labor hours (or 6 minutes) to produce 1 unit of product. Thus 4,080 hours of direct labor will be required to produce 40,800 units of product (= 40,800 finished units produced 0.10 direct labor hours per unit). Given an average hourly rate of $13, the direct labor cost for the first quarter totals $53,040 (= 4,080 hours $13 per hour). This information is shown in the direct labor budget presented in"Direct Labor Budget for Jerrys Ice Cream".Carefully review the direct labor budget shown in"Direct Labor Budget for Jerrys Ice Cream". The production manager at Jerrys Ice Cream, uses this information to ensure the appropriate number of employees is available to meet production goals. Notice that the number of direct labor hours needed in production for the third quarter is significantly higher than each of the two previous quarters. Again, this is why organizations prepare budgets: to plan for these types of events. Manager will have to start planning for this spike in direct labor hours, either by asking employees to work overtime or by hiring additional employees.

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Manufacturing Overhead BudgetThe overhead budget shows the expected cost of all production costs other than direct materials and direct labor.

Many companies use direct labor hours as the driver for overhead.

Then costs that vary with direct labor hours are pooled and called variable overhead.

The remaining overhead items are pooled into fixed overhead.BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

The overhead budget shows the expected cost of all production costs other than direct materials and direct labor. Many companies use direct labor hours as the driver for overhead. Then costs that vary with direct labor hours are pooled and called variable overhead. The remaining overhead items are pooled into fixed overhead.19

Manufacturing Overhead Budget for Jerrys Ice CreamBKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING*From"Production Budget for Jerrys Ice Cream".**$1.20 = $240,480 total overhead cost 200,400 units to be produced for the year.^Deduct depreciation to get the actual cash payment for overhead. This information is needed for the cash budget presented in"Cash Budget for Jerrys Ice Cream".

Total variable overhead costs change with changes in production and are calculated by multiplying units to be produced by the cost per unit. For example, indirect materials cost for the first quarter of $6,120 is calculated by taking 40,800 units to be produced $0.15 cost per unit. Fixed costs generally donotchange with changes in production and therefore remain the same each quarter. (Note: In some situations, fixed overhead costs can change from one quarter to the next. For example, hiring additional salaried personnel during the year would increase fixed overhead costs, and purchasing equipment during the year would increase depreciation costs. In this example, we assume fixed overhead costs do not change during the year.) Depreciation is deducted at the bottom of the manufacturing overhead budget to determine cash payments for overhead because depreciation is not a cash transaction. We use this information later in the chapter for the cash budget.

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Selling and Administrative Budget The selling and administrative expenses budget outlines planned expenditures for non manufacturing activities.

Selling and administrative expenses can be broken down into fixed and variable components.

Such items as sales commissions, freight and supplies vary with sales activity.BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

The selling and administrative expenses budget outlines planned expenditures for nonmanufacturing activities. As with overhead, selling and administrative expenses can be broken down into fixed and variable components. Such items as sales commissions, freight, and supplies vary with sales activity.

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BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

*Deduct depreciation to get the actual cash payment for selling and administrative costs.**This information is needed for the cash budget presented in "Cash Budget for Jerrys Ice Cream".Selling and Administrative Budget for Jerrys Ice Cream

Although many organizations may have variable and fixed costs in this budget, Jerrys Ice Cream treats all selling and administrative costs as fixed costs. Once again, depreciation is deducted at the bottom of this budget to determine cash payments for selling and administrative costs, which we use later in the chapter for the cash budget.

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Cash BudgetThecash budgetis an estimate of the amount and timing of cash inflows and outflows for the budget period.

A section of the cash budget will show when cash from sales will be received.

The cash budget has the following sections:Cash collections from salesCash payments for purchases of materialsOther cash collections and paymentsBKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

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*Based on sales budget shown in"Sales Budget for Jerrys Ice Cream". All sales are on credit: 60 percent collected in the quarter of sale and 40 percent collected the following quarter.

**Based on purchases budget shown in"Direct Materials Purchases Budget for Jerrys Ice Cream". All purchases are on credit: 70 percent paid in the quarter of purchase and 30 percent paid the following quarter.

***Does not include depreciation since depreciation expense does not involve a cash payment.

^Excess of collections over payments = Cash collections from sales Cash payments for materials purchases Other cash payments.

^^ Beginning cash balance = Cash balance at end of previous period. Balance for first quarter is given.

^^^ Ending cash balance = Excess of collections over payments for the quarter + Beginning cash balance.BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGCash Budget for Jerrys Ice Cream

Thecash budgetis an estimate of the amount and timing of cash inflows and outflows for the budget period. Although the budgeted income statement provides an estimate of profitability, it stops short of providing cash flow information. For example, some of the $240,000 in first quarter sales revenue will be collected during the first quarter and some will be collected the following quarter.

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BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGBudgeted Income Statement Thebudgeted income statementis an estimate of the organizations profit for a given budget period.

Most organizations, prepare the budgeted income statement using the accrual basis of accounting.

Revenues are recorded when earned and expenses are recorded when incurred.

The management and employees throughout the organization use this information for planning purposes and to evaluate company performance.

The board of directors and budget committee are responsible for approving the budget .

Thebudgeted income statementis an estimate of the organizations profit for a given budget period. Most organizations, prepare the budgeted income statement using the accrual basis of accounting: revenues are recorded when earned and expenses are recorded when incurred. - The budgeted income statement is perhaps the most carefully scrutinized component of the master budget. The management and employees throughout the organization use this information for planning purposes and to evaluate company performance. - The board of directors and budget committee are responsible for approving the budget and often review periodic reports comparing actual net income to budgeted net income to determine if profit goals are being achieved. Lenders and owners often review the budget to ensure the organization is on track to meet its goals.

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BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

*Cost of goods sold = Per unit cost of $4.50 (see above) Units sold (from"Sales Budget for Jerrys Ice Cream"); for the first quarter, $180,000 cost of goods sold = $4.50 unit cost 40,000 units.Budgeted Income Statement for Jerrys Ice Cream

BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING The budgeted balance sheet is developed by beginning with the balance sheet from the beginning of the budget period and adjusting it for the data contained in the variousschedules.

Thebudgeted balance sheetis an estimate of the ending balances for all balance sheet accounts. Managers use this to assess the impact that budgeted sales and costs will have on the financial condition of the organization. Budgeted Balance Sheet

BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

*$124,800 = $312,000 in fourth quarter sales ("Sales Budget for Jerrys Ice Cream") 40 percent to be collected next quarter ("Cash Budget for Jerrys Ice Cream").

**$20,000 = 20,000 pounds ("Direct Materials Purchases Budget for Jerrys Ice Cream") $1 per pound ("Direct Materials Purchases Budget for Jerrys Ice Cream").

***$19,800 = 4,400 units ("Production Budget for Jerrys Ice Cream") $4.50 ( "Budgeted Income Statement for Jerrys Ice Cream").

^Given.

^^ $30,576 = $101,920 in fourth quarter purchases ("Direct Materials Purchases Budget for Jerrys Ice Cream") 30 percent to be paid next quarter ("Cash Budget for Jerrys Ice Cream").

^^^$169,600 = $101,600 in retained earnings at end of last year (given) + $68,000 budgeted net income for the year Budgeted Balance Sheet for Jerrys Ice CreamBudgeted Balance Sheet for Jerrys Ice Cream

^ Given- Information needed to prepare the budgeted balance sheet for Jerrys Ice Cream is shown throughout the chapter and is referenced in"Budgeted Balance Sheet for Jerrys Ice Cream". - Additional information is provided here:Plant and equipment (net) expected at the end of the budget period (December 31) is $530,000.Common stock issued and outstanding at the end of the budget period (December 31) is expected to be $650,000.Actual retained earnings at the end of last year totaled $101,600, and no cash dividends will be paid during the current budget period ending December 31.

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Benefits of Budgeting

Requires managers to plan

Promotes coordinationand communication

Helps managersevaluate performance

motivates employees toachieve company goalsBKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING

BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNING This topic is just an introduction to budgeting and profit planning.

This topic presents an overview of the budgeting process and shows how the various operating budgets relate to each other.

The sales budget forms the foundation for profit planning. Once the sales budget has been set, the production budget and the selling and administrative expense budget can be prepared since they depend on how many units are to be sold.

All of these various budgets feed into the cash budget and the budgeted income statement and balance sheet.

Conclusion

The material in this chapter is just an introduction to budgeting and profit planning. This chapter presents an overview of the budgeting process and shows how the various operating budgets relate to each other. The sales budget forms the foundation for profit planning. Once the sales budget has been set, the production budget and the selling and administrative expense budget can be prepared since they depend on how many units are to be sold. The production budget determines how many units are to be produced, so after it is prepared, the various manufacturing cost budgets can be prepared. All of these various budgets feed into the cash budget and the budgeted income statement and balance sheet. There are many connections between these various parts of the master budget. For example, the schedule of expected cash collections, which is completed in connection with the sales budget, provides data for both the cash budget and the budgeted balance sheet. 30

BKBM 5013 MANAGEMENT ACCOUNTING FOR MANAGERSTOPIC 7 : PROFIT PLANNINGThank You