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MAS – LECTURE NOTES ARMIN GLENN ARANETA, CPA

OPERATING AND FINANCIAL BUDGETING

BUDGET – a plan expressed in quantitative terms, on how to acquire and use the resources of
an entity during a budget period, a certain future period of time.

Advantages of Budgeting:
1) It compels periodic planning.
a. Strategic Budgeting – a form of long-range planning based on identifying and
specifying organizational goal and objectives.
2) It enhances cooperation, coordination, and communication.
3) It forces quantification of plans and proposals.
4) It provides a framework for performance evaluation.
5) It enables members of the organization to be aware of business costs.
6) It satisfies some legal and contractual requirements.
7) It directs the activities toward the achievement of organizational goals.

Limitations of Budgeting:
1) Since budgeting means planning for future, the plans itself, as well as the figures therein,
are merely estimates, requiring a certain amount of judgment.
2) To be successful, a budgetary system requires the cooperation and participation of all
members of the organization.
3) Some managers think that budget restricts their investments and limits their decision-
making power, making it difficult to sell the idea of budgeting to some people in the
organization.
4) The development and installation of a good budgetary system may be time-consuming
and too costly for some organizations, such that the benefits that can be derived from
budgeting may be outweighed by its costs.

THE BUDGET COMMITTEE – usually composed of the sales manager, production manager,
chief engineer, treasurer, and controller.

The Budget Committee’s Principal Function:

1) Formulate and decide on general policies relating to the firm’s budgetary system.
2) Request, review, and revise (if necessary) individual budget estimates form the different
segments of the organization.
3) Approve budgets and subsequent revisions therein.
4) Receive, evaluate, and analyze budget reports.
5) Recommend necessary actions to improve operational efficiency and effectiveness.

Master Budget – represents the overall plan of the organization for a given budget period. It
consists of all the individual budgets for each of the segment of the organization aggregated or
consolidated into on overall budget for the entire firm.

 Budget Report – compares actual performance with budgeted performance.

 Continuous (Rolling) Budget – one that is revised on a regular (continuous)

basis; typically, the budget is extended for another month or quarter in
accordance with the new data as the current month or quarter ends.

 Fixed(Static) Budget – based on only one level of activity or production.

 Flexible(Variable, Dynamic) Budget – a series of budgets prepared for many

levels of activity.
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 Zero-base Budgeting (ZBB) – a budget and planning process in which each

manager must justify a department’s entire budget from a base of zero every
period; all expenditures must be justified regardless of the variance from the
previous period; the objective is to encourage periodic re-examination of all
costs in the hope that some can be reduced or eliminated.

 Life-cycle Budgeting – estimates a product’s revenues and expenses over its

entire life cycle, beginning with research and development, proceeding
through the introduction and growth stages, into the maturity stage, and
finally, into the harvest or decline stage.

 Activity-based Budgeting – applies activity-based costing principles to

budgeting.

 Kaizen Budgeting – assumes the continuous improvement of products and

processes, usually by way of many small innovations rather than major
changes; it incorporates expectations for continuous improvement into
budgetary estimates.

Practice Problems:

1. A manufacturing company has budgeted its sales of its product for the next four months as
follows:

Sales in Units
April 50, 000
May 75, 000
June 90, 000
July 80, 000

The company is now in the process of preparing a production budget for the second quarter. Past
experience has shown the end-of-month inventory levels must equal 10% of the following
month’s sales. The inventory at the end of March was 5, 000 units.

Required: Prepare a production budget for the second quarter; in your budget, show the number
of units to be produced each month and for the quarter in total.

2. Three grams of musk oil is required for each bottle of Amoi Futok, a very popular perfume
made by a small company in Manila. The cost of the musk oil is P150 per kilogram. Budgeted
production of Amoi Futok is given below by quarters for Year 2 and for the first quarter of Year
3:

Year 2 Year 3
First Second Third Fourth First
Budgeted production, in bottles 60, 000 90, 000 150, 000 100, 000 70, 000

Musk oil has become so popular as a perfume ingredient, that it has become necessary to carry
large inventories as a precaution against stock-outs. For this reason, the inventory of musk oil at
the end of the quarter must be equal to 20% of the following quarter’s production needs. Some
36, 000 grams of musk oil will be on hand to start the quarter of Year 2.

Required: Prepare a direct materials budget for musk oil, by quarter and in total, for Year 2. At
the bottom of your budget, show the amount of purchases in pesos for each quarter and for the
year in total.
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3. The production manager of a company has submitted the following forecast of units to be
produced by quarter for the upcoming fiscal year:

First Second Third Fourth

Units to be produced 8, 000 6, 500 7, 000 7, 500

Each unit requires 0.35 direct labor hours, and direct laborers are paid P12.00 per hour.

Required:
1. Construct the company’s direct labor budget for the upcoming fiscal year, assuming
that the direct labor workforce is adjusted each quarter to match the number of hours
required to produce the forecasted number of units produced.

2. Construct the company’s direct labor budget for the upcoming fiscal year, assuming
that the direct labor workforce is not adjusted each quarter. Instead, assume that the
company’s direct labor workforce consists of permanent employees who are guaranteed
to be paid for at least 2, 600 hours of work each quarter. If the number of required direct
labor hours is less than this number, the workers are paid for 2, 600 anyway. Any hour
worked in excess of 2, 600 hours in a quarter is paid at the rate of 1.5 times the normal
hourly rate for direct labor.

4. The direct labor budget of a corporation for the upcoming fiscal year contains the following
details concerning budgeted direct labor hours:

1Q 2Q 3Q 4Q
Budgeted direct labor hours 8, 000 8, 200 8, 500 7, 800

The company’s variable manufacturing overhead rate is P3. 25 per direct labor hour and the
company’s fixed manufacturing overhead is P48, 000 per quarter. The only non-cash item
included in fixed manufacturing overhead is depreciation, which is P16, 000 per quarter.

Required:
1. Construct the company’s manufacturing overhead budget for the upcoming fiscal year.

2. Construct the company’s manufacturing rate (including both variable and fixed
manufacturing overhead) for the upcoming fiscal year. Round off to the nearest whole
cent.

5. Ikaw Na Inc., a one-product mail-order firm, buys its product for P75 per unit and sells it for
P140 per unit. The sales staff receives a 10% commission on the sale of each unit. Its March
income statement shows the following information:

Sale P1, 400, 000

Cost of goods sold 750, 000
Gross profit P 650, 000
Expenses
Sales commissions (10%) 140, 000
Advertising 215, 000
Store rent 26, 000
Administrative salaries 42, 000
Depreciation 52, 000
Other expenses 13, 000
Total expenses 488, 000
Net income P 162, 000
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Management expects March’s results to be repeated in April, May, and June of 2014 without any
changes in strategy. Management, however, has an alternative plan. It believes that unit sales will
increase at a rate of 100% each month for the next three months (beginning with April) if the
item’s selling price is reduced to P130 per unit and advertising expenses are increased by 20%
and remain at that level for all three months. The cost of its product will remain at P75 per unit,
the sales staff will continue to earn 10% commission, and the remaining expenses will stay the
same.

Required: Prepare budgeted income statements for each of the months of April, May, and June
that show the expected results from implementing that proposed changes. Use a three-column
format, with one column for each column.

6. A company is preparing its budget for the upcoming fiscal year. Management has prepared the
following summary of its budgeted cash flows:
1Q 2Q 3Q 4Q
Total cash receipts P180, 000 P330, 000 P210, 000 P230, 000
Total cash disbursements P260, 000 P230, 000 P220, 000 P240, 000

The company’s beginning cash balance for the upcoming fiscal year will be P20, 000. The
company requires a minimum cash balance of P10, 000 and may borrow any amount needed
from a local bank at a quarterly interest rate of 3%. The company may borrow any amount at the
beginning of any quarter and may repay its loans, or any part of it, at the end of any quarter.
Interest payments are due on any principal at the time it is repaid. For simplicity, assume the
interest is not compounded.

Required: Prepare the company’s cash budget for the upcoming fiscal year.

“To teach is to learn twice over.”

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