2.1 BUDGET PLANNING 2.2 BUDGETED INCOME STATEMENT 2.3 CASH BUDGETS MICROSOFT CORPORATION MANAGERIAL ACCOUNTING

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1 MANAGERIAL ACCOUNTING MICROSOFT CORPORATION Microsoft Corporation is a worldwide provider of software, services, and Internet technologies for personal and business computing. Founded in 1975, the company operates subsidiary offices in more than 60 foreign countries and employs nearly 44,000 people worldwide. Microsoft is well known for its Windows and Microsoft Office software, among other products. Financial Analysts at Microsoft provide strategic and business development analysis, reporting, accounting support, adherence to internal controls, and strategic counsel. They create and publish the budgets and communicate the process and results. Senior Financial Analysts need a degree in accounting, finance, or a closely related field, and a minimum of 3 years of experience. Ideal candidates should have excellent communication skills and the ability to work independently. Microsoft is looking for individuals with high-caliber analytical skills and the ability to think strategically. Applicants should have a flexible, can-do attitude and be able to work well with other groups. THINK CRITICALLY 1. Would you be interested in working for Microsoft? Why or why not? 2. What do you think is meant by a flexible, can-do attitude? 2.1 BUDGET PLANNING 2.2 BUDGETED INCOME STATEMENT 2.3 CASH BUDGETS

2 The Chapter 2 video for this module introduces the concepts in this chapter. Budgeting PROJECT OBJECTIVES Become aware of the budgeting process and the purposes of budgeting Create and analyze a budgeted income statement Create and analyze a cash budget and performance report GETTING STARTED Read through the Project Process below. Make a list of any materials you will need. Decide how you will get the needed materials or information. Add to your list of Personal Skills and Accounting-Related Skills created in the Chapter 1 project any additional skills that the work of a budget analyst requires. Use the income statement showing results for two years created in the Chapter 1 project or create a new company and income statement. PROJECT PROCESS Part 1 LESSON 2.1 Discuss in class the purposes of budgeting. Create a chart that summarizes the purposes. Delete the component percentage columns from the comparative income statement prepared in Chapter 1. Add the Increase/(Decrease) columns shown in the comparative income statement in Lesson 2.1. Create formulas to calculate the amounts and percentages in these columns. Part 2 Part 3 LESSON 2.2 Write an operational plan for the business. Consider current economic conditions and the analysis of the comparative income statement. Create budget schedules for sales, purchases, selling expenses, administrative expenses, and other revenue and expenses. Compile a budgeted income statement from these budget schedules. Make a list of all assumptions you made. LESSON 2.3 Use the schedules and budgeted income statement to create cash payments and cash receipts budget schedules. Make a list of all assumptions you made. Create a performance report and analyze the result, recommending action where needed. CHAPTER REVIEW Project Wrap-up Hold a class debate on the following statement or a similar one: A company s budget should be distributed to employees at all levels of the company so that they can perform their jobs efficiently. 31

3 CHAPTER 2 BUDGETING LESSON 2.1 BUDGET PLANNING DESCRIBE five purposes of budgeting LIST sources of budget information PREPARE AND ANALYZE a comparative income statement D PURPOSE OF BUDGETING epartment managers in a business make decisions every day that affect the profitability of the business. In order to make effective decisions and coordinate the decisions and actions of the various departments, a business needs to have a plan for its operations. Planning the financial operations of a business is called budgeting. A budget is a written financial plan of a business for a specific period of time, expressed in dollars. Each area of a business s operations typically has a separate budget. For example, a business might have an advertising budget, a purchasing budget, a sales budget, a manufacturing budget, a research and development budget, and a cash budget. New and ongoing projects would each have a detailed budget. Each budget would then be compiled into a master budget for the operations of the entire company. Anthony Sanchez is the creative director in the advertising department of a large merchandising business. His boss told him in a meeting that he would have to estimate the costs of each advertising campaign that is planned for next year. Anthony replied, I m not a numbers person. I m the creative guy! Why are you asking me? Should Anthony participate in estimating the costs of advertising for his company? Why or why not? 32

4 2.1 BUDGET PLANNING A business that does not have a budget or a plan will make decisions that do not contribute to the profitability of the business because managers lack a clear idea of goals of the business. A budget serves five main purposes communication, coordination, planning, control, and evaluation. COMMUNICATION In the budgeting process, managers in every department justify the resources they need to achieve their goals. They explain to their superiors the scope and volume of their activities as well as how their tasks will be performed. The communication between superiors and subordinates helps affirm their mutual commitment to company goals. In addition, different departments and units must communicate with each other during the budget process to coordinate their plans and efforts. For example, the MIS department and the marketing department have to agree on how to coordinate their efforts about the need for services and the resources required. COORDINATION Different units in the company must also coordinate the many different tasks they perform. For example, the number and types of products to be marketed must be coordinated with the purchasing and manufacturing departments to ensure goods are available. Equipment may have to be purchased and installed. Advertising promotions may need to be planned and implemented. And all tasks have to be performed at the appropriate times. PLANNING A budget is ultimately the plan for the operations of an organization for a period of time. Many decisions are involved, and many questions must be answered. Old plans and processes are questioned as well as new plans and processes. Managers decide the most effective ways to perform each task. They ask whether a particular activity should still be performed and, if so, how. Managers ask what resources are available and what additional resources will be needed. CONTROL Once a budget is finalized, it is the plan for the operations of the organization. Managers have authority to spend within the budget and responsibility to achieve revenues specified within the budget. Budgets and actual revenues and expenditures are monitored constantly for variations and to determine whether the organization is on target. If performance does not meet the budget, action can be taken immediately to adjust activities. Without constant monitoring, a company does not realize it is not on target until it is too late to make adjustments. EVALUATION One way to evaluate a manager is to compare the budget with actual performance. Did the manager reach the target revenue within the constraints of the targeted expenditures? Of course, other factors, such as market and general economic conditions, affect a manager s performance. Whether a manager achieves targeted goals is an important part of managerial responsibility. Budgets can be prepared by any financial entity, from an individual, family, or business to a governmental or not-for-profit group. 33

5 CHAPTER 2 BUDGETING BUDGET PERIOD Budgets are usually prepared for a period of one year. An annual budget is also usually broken down into smaller periods of time, such as quarterly and monthly budgets, to provide frequent opportunities to compare actual performance with budgeted performance. Weekly and daily budget reports may also be distributed to managers to compare actual performance with the budget on a year-to-date basis. Frequent updates remind managers of the goals set at the beginning of the year and keep them up to date on the progress toward those goals. Why are annual budgets usually broken down into smaller periods of time, such as quarterly or monthly budgets? SOURCES OF BUDGET INFORMATION 34 As a class, discuss ways that managers can obtain general economic information as well as information specific to the market of a particular industry. B udget planners use many information sources, such as company records, general economic information, and information from staff and managers, to help determine company goals and strategies and to prepare a final budget. COMPANY RECORDS The accounting and sales records of a business contain much of the information needed to prepare budgets. Accounting information about previous years operations is used to determine trends in sales, purchases, and operating expenses. Expected price changes, sales promotion plans, and market research studies are also important in projecting activity for a budget period. GENERAL ECONOMIC INFORMATION A general slowdown or speedup in the national economy may affect budget decisions. Unusually high inflation rates affect budgeted amounts. A labor strike may affect some related industries and thus affect company operations. Rising fuel prices may make it more expensive to ship and receive products. Energy shortages and utility rate increases also make operations more expensive. New product development, changes in consumer buying habits, availability of merchandise, international trade, and general business conditions all must be considered when preparing budgets. COMPANY STAFF AND MANAGERS Sales personnel estimate the amount of projected sales. Project managers estimate costs of making new products. Considering projected sales for the new budget period, other department managers project budget items for their areas of responsibility within the business.

6 2.1 BUDGET PLANNING GOOD JUDGMENT Good judgment by the individuals preparing the budgets is essential to realistic budgets. Even after evaluating all available information, answers to many budget questions are seldom obvious. Some proposed projects may be more worthy than others, and some worthy projects may not be possible to achieve from projected revenues and profit. Some information will conflict with other information. Ultimately, final budget decisions are based on good judgment in selecting the best alternatives from the many possible options. Why is good judgment important to making budget decisions? P COMPARATIVE INCOME STATEMENT reparation for planning a budget involves analyzing existing financial information. An analysis of previous years sales, cost, and expense amounts is an important part of budget preparation. One analytical tool is the comparative income statement, which is an income statement containing sales, cost, and expense information for two or more years. Reflections, Inc., is a corporation that sells mirror glass. The comparative income statement for Reflections, shown on the next page, provides two years of information about sales, costs, and expenses. This statement shows trends that may be taking place in these items. The statement also highlights items that may be increasing or decreasing at a higher rate than other items on the statement. 35

7 CHAPTER 2 BUDGETING Reflections, Inc. Comparative Income Statement for Years Ended December 31, 20X1 and 20X2 Increase (Decrease) 20X2 20X1 Amount Percentage Operating Revenue Net Sales $1,880,000 $1,700,000 $180, Cost of Merchandise Sold 1,231,720 1,105, , Gross Profit on Operations $ 648,280 $ 595,000 $ 53, Operating Expenses Selling Expenses Advertising Expense $ 45,120 $ 37,800 $ 7, Delivery Expense 150, ,640 9, Depr. Expense Delivery Equipment 7,200 7, Depr. Expense Warehouse Equipment 10,800 10, Miscellaneous Expense Sales 11,490 11,960 (470) (3.9) Salary Expense Commissions 75,200 68,000 7, Salary Expense Regular 34,160 28,320 5, Supplies Expense Sales 11,280 10, Total Selling Expenses $345,660 $315,370 $30, Administrative Expenses Depr. Expense Office Equipment $ 14,400 $ 12,000 $ 2, Depr. Expense Computer System 19,200 19, Insurance Expense 4,800 4, Miscellaneous Expense Administrative 38,770 33,640 5, Payroll Taxes Expense 22,540 20,590 1, Rent Expense 30,000 30, Salary Expense Administrative 77,830 75,240 2, Supplies Expense Administrative 13,620 14,600 (980) (6.7) Uncollectible Accounts Expense 11,280 10,230 1, Utilities Expense 10,080 7,320 2, Total Administrative Expenses $242,520 $227,320 $15, Total Operating Expenses $588,180 $542,690 $45, Income from Operations $ 60,100 $ 52,310 $ 7, Other Expenses Interest Expense $ 3,000 $ 6,500 ($ 3,500) (53.8) Net Income before Federal Income Tax $ 57,100 $ 45,810 $11, Federal Income Tax Expense 9,280 6,870 2, Net Income after Federal Income Tax $ 47,820 $ 38,940 $ 8, Units (sq. ft.) of Mirror Sold 376, ,000 36, PREPARING A COMPARATIVE INCOME STATEMENT The first column of Reflections comparative income statement shows actual sales, costs, and expenses for the most current year, 20X2. The second column shows the actual amounts for the previous year, 20X1. The Increase/ (Decrease) columns show both the dollar amount and the percentage by 36

8 2.1 BUDGET PLANNING which an item in 20X2 has increased or decreased over 20X1. The parentheses around the word Decrease in the column heading indicate that any amounts or percentages that are decreases will be enclosed in parentheses. Calculating Amounts Amounts are calculated by subtracting the previous year s (20X1) amount from the current year s (20X2) amount. For example, the amount of increase for Net Sales is $1,880,000 minus $1,700,000, or $180,000. Current Year Previous Year Increase/(Decrease) $1,880,000 $1,700,000 $180,000 Whenever the 20X1 amount is greater than the 20X2 amount, the item has decreased, and the amount is placed in parentheses. For example, the amount of decrease for Interest Expense is $3,000 minus $6,500, or $3,500, which is shown on the comparative income statement as ($3,500). Current Year Previous Year Increase/(Decrease) $3,000 $6,500 ($3,500) Calculating Percentages The percentage of increase or decrease is calculated by dividing the amount of increase or decrease by the previous year s amount and then multiplying by 100. For example, the amount of increase for Net Sales, $180,000 is divided by the 20X1 Net Sales amount, $1,700,000 as shown below. Percentages are also rounded to the nearest tenth of a percent, so 10.59% is shown as 10.6%. Increase/(Decrease) Previous Year 100 Percent of Inc./(Dec.) $180,000 $1,700, % Percentages for amounts that are decreases are also enclosed in parentheses. Increase/(Decrease) Previous Year 100 Percent of Inc./(Dec.) ($3,500) $6, (53.8%) 37

9 CHAPTER 2 BUDGETING ANALYZING A COMPARATIVE INCOME STATEMENT Managers review each increase or decrease amount on the comparative income statement. The percentage increase or decrease also indicates whether a change is favorable, unfavorable, or normal compared with net sales. If a cost or expense percentage increase is higher than the percentage increase for net sales, net income is unfavorably affected. But if a cost or expense percentage increase is lower than the percentage increase in sales, net income is favorably affected. Decreases have the opposite effect. If a cost or expense item decrease is a higher percentage than the net sales decrease, net income is favorably affected. If the net sales decrease is a higher percentage than cost and expense items, net income is unfavorably affected. The effect of these changes in net sales, cost, and expense items is shown in the following table. Cost or Expense Less Than or Net Sales Net Effect on Percentage Greater Than Percentage Income Net Income Increase Greater than Increase Decreases Unfavorable Increase Less than Increase Increases Favorable Decrease Greater than Decrease Increases Favorable Decrease Less than Decrease Decreases Unfavorable Unfavorable results require further inquiry to determine the cause. Reflections net sales for 20X2 increased 10.6% over net sales for 20X1. The goal for 20X2 was to increase sales volume by 10.0%. The actual 10.6% increase resulted from an increase in units sold from 340,000 to 376,000 square feet of mirrors. The unit sales price remained at $5.00. Management attributed the increase to two factors: (1) A more intensive advertising campaign increased market share from 42.0% to 45.0%. (2) Favorable economic conditions spurred new home building and created a greater demand for mirrors. Reflections, Inc., analyzes each cost and expense amount and percentage. For example, the cost of merchandise sold increased 11.5% from 20X1 to 20X2. Most of the increase resulted from the 10.6% increase in the number of units sold. In addition, the purchase price per square foot increased during 20X2 from $3.25 per square foot to $3.30. Advertising expense increased 19.4% from 20X1 to 20X2. The increase is consistent with the successful effort to expand market share. Management believes that the more expensive television advertising resulted in a significant increase in third and fourth quarter unit sales. On a comparative income statement, if the percentage increase in net sales is less than the percentage increase in Salary Expense, is this favorable or unfavorable? Why? 38

10 2.1 BUDGET PLANNING THINK CRITICALLY 1. Dana Washington runs a small metal fabricating business. He employs three workers in the metal shop, but performs all management, accounting, and sales functions himself. He says that he never creates a budget because he just doesn t have the time. How would Mr. Washington benefit from preparing a budget? 2. Sportif has two sales departments clothing and accessories. The manager of the clothing department distributes copies of the annual budget to the employees and discusses it and the year s plans with the sales associates. The manager of the accessories department does not communicate the budget to the sales associates. What effect do you think this has on the associates in the two departments? 3. Elizabeth Tanaka is a retired widow who receives a monthly Social Security check. Each month she cashes the check and puts the cash into different envelopes for expenses such as food, rent, and transportation. One envelope is for savings for a trip to visit her family. Is Mrs. Tanaka budgeting? How? 4. For each of the following increases and decreases on a comparative income statement, indicate whether the effect on net income is favorable or unfavorable. Net Sales Effect on Net Income Cost of Merchandise Sold, increase 6% increase 5% Unfavorable Advertising Expense, increase 3% increase 6% Favorable Salary Expense, decrease 3% decrease 2% Favorable MAKE CONNECTIONS 5. RESEARCH Use an Internet search engine to find an organization that describes its budgeting process. Write a brief description of the process. 6. ANALYSIS Obtain the annual report of a company and review its comparative income statement. Using word-processing software, write a brief analysis of the major increases and decreases on the statement. 39

11 CHAPTER 2 BUDGETING LESSON 2.2 BUDGETED INCOME STATEMENT DESCRIBE the purpose of an operational plan PREPARE sales and purchases budget schedules PREPARE expenses budget schedules PREPARE a budgeted income statement A OPERATIONAL PLANS AND GOALS fter analyzing the previous years records, a business sets goals, develops operational plans for meeting the goals, and prepares projections of sales, costs, and expenses for the coming year. Goals are broad statements of what a business wishes to accomplish. An operational plan is a statement of how a company will meet its goals. An annual operational plan establishes targets that the company will work toward in the coming year. A planning group consisting of the company s executive officers and department managers generally determines operational plans and goals. Patricia Parker is a very autocratic manager, always preferring to make decisions on her own without consulting anyone she supervises. She also carries this style through the budgeting process, making all decisions about net sales, costs, and expenses without consulting sales representatives, advertising managers, marketers, and purchasers. She begrudgingly asks the accounting department what depreciation figures she should use for equipment on the selling expenses budget. She frequently says, I am the one who is responsible for meeting the budget, so I will be the one who creates it. Does Patricia s attitude take full advantage of the benefits of the budgeting process? 40

12 2.2 BUDGETED INCOME STATEMENT At Reflections, Inc., the planning group includes the president and all department managers. The planning group reviews the analysis of the previous years comparative income statement and considers possible changes in economic conditions that may affect the company. From these discussions, the company s operational plan and goals for the coming year are determined. The planning committee developed the following planning guidelines. Operational Plan for 20X3 The economy is projected to remain strong throughout 20X3. Therefore, the sales goal is to increase unit sales to 400,000 units, about a 6.4% increase. The unit sales price will be increased in the second quarter from $5.00 to $5.25 per square foot to recover mechandise cost increases in 20X2 and projected increases in the budget year. Sales distribution by quarters is projected to be consistent with prior quarters. The unit cost of merchandise is projected to rise from $3.30 to $3.40 in the first quarter, a 3.0% increase. An automated cutting machine has been ordered. It will cost $20,000 and is projected to save about $10,000 per year in salary expense. All employees on salary will receive a 5.0% salary increase. The operational plan is converted into a more precise plan, expressed in dollars, by preparing a budgeted income statement. Reflections prepares separate budget schedules for the major parts of the budgeted income statement. Budget schedules are detailed statements of the operations of a specific segment of a business for a period of time. Reflections prepares budget schedules for sales, purchases, selling expenses, administrative expenses, and other revenue and expenses. To permit frequent comparisons of actual with budgeted amounts, schedules are separated into quarterly projections. At Reflections, the accounting department coordinates budget preparation. The sales manager prepares the sales, purchases, and selling expenses budget schedules. The administrative manager prepares the administrative expenses budget schedule and the other revenue and expenses budget schedules. The accounting department prepares the budgeted income statement from these schedules. The completed budget, with attached schedules, is submitted to the budget committee for approval. The budget committee consists of the president and two members of Reflections board of directors. Write an operational plan for a service business that you could be operating, such as a landscaping, painting, or word processing business. Consider the percentage increase in sales, equipment purchases, advertising strategies, and so on that would be needed to achieve the plan. Present your plan to the class. What is the relationship between a company s operational plan and a budgeted income statement? 41

13 CHAPTER 2 BUDGETING SALES AND PURCHASES BUDGET SCHEDULES The sales budget schedule is prepared first because many other budget estimates depend on the amount of sales. As a class, brainstorm to determine which other operating elements of a business depend on sales revenue. Then discuss which elements do not depend on sales revenue. he sales manager prepares the sales and T purchases budget schedules. The sales budget schedule is prepared first because the other schedules are affected by the projected net sales. For example, projected net sales is used to estimate the amount of merchandise that must be Purchased and the amount that may be spent for sales, advertising, and other selling and administrative expenses. PREPARING THE SALES BUDGET SCHEDULE Procedures for completing the sales budget schedule are shown below. 1. Actual Unit Sales, 20X2 Enter the actual annual and quarterly unit sales for the current year. Because there will be a price increase, unit sales rather than dollar sales are used. Changes in selling prices would make it difficult to see actual increases in unit sales if the amounts were expressed only as dollars. 2. Sales Percentage by Quarter Divide each quarter s actual unit sales for 20X2 by the annual sales for 20X2 and multiply by 100 to determine what percentage of the year s unit sales will be realized in each quarter. Round percentages to the nearest tenth of a percent. 3. Projected Unit Sales, 20X3 Multiply each quarter s sales percentage by the projected unit sales for the year to calculate the quarterly unit sales. Reflections, Inc., rounds all unit calculations to the nearest 100 units. 4. Unit Sales Price Enter the unit sales price for each quarter. The unit sales price increases to $5.25 in the second quarter. 5. Net Sales Calculate the sales dollar amount for each quarter by multiplying projected unit sales times unit sales price. Reflections, Inc. rounds all dollar calculations to the nearest $10. Calculate the Annual Budget amount for net sales by adding the four quarterly amounts. Reflections, Inc. Sales Budget Schedule For Year Ended December 31, 20X3 Schedule 1 Annual Quarter Budget 1st 2d 3d 4th Actual Unit Sales, 20X2 376,000 91,600 99, ,800 81,600 Sales Percentage by Quarter 24.4% 26.3% 27.6% 21.7% Projected Unit Sales, 20X3 400,000 97, , ,400 86,800 Times Unit Sales Price $5.00 $5.25 $5.25 $5.25 Net Sales $2,075,600 $488,000 $552,300 $579,600 $455,700 42

14 PREPARING THE PURCHASES BUDGET SCHEDULE Procedures for completing the purchases budget schedule are shown below. 1. Unit Sales for Quarter (second line) Enter the projected quarterly unit sales from the sales budget schedule. Because there will be a price increase, unit sales rather than dollar sales are used. 2. Ending Inventory (first line) Calculate the ending inventory for each quarter. The sales manager estimates that ending inventory for one quarter should be about 40% of the units required for the next quarter s sales. The calculation is shown for the first quarter, rounded to the nearest hundred. Use 40,000 units for the fourth quarter s ending inventory. Ending Inventory Next Quarter s Ending Inventory Percentage Sales Units 40% 105,200 42,080 (rounded to 42,100) 3. Total Units Needed Add the ending inventory and the unit sales for the quarter. 4. Less Beginning Inventory The beginning inventory for each quarter is the ending inventory from the previous quarter. The beginning inventory for the first quarter, 39,200, is the ending inventory for December 31 of the previous year, taken from company records. 5. Purchases The purchases that need to be made in a quarter are the total units needed less the beginning inventory. 6. Times Unit Cost: Enter the unit cost for each quarter. Unit cost is expected to increase to $3.40 in the first quarter and remain the same for the rest of the year. 7. Cost of Purchases Multiply the unit purchases for the quarter by the unit cost. Reflections, Inc. Purchases Budget Schedule For Year Ended December 31, 20X3 Schedule 2 Quarter 1st 2d 3d 4th Ending Inventory 42,100 44,200 34,700 40,000 Unit Sales for Quarter 97, , ,400 86,800 Total Units Needed 139, , , ,800 Less Beginning Inventory 39,200 42,100 44,200 34,700 Purchases 100, , ,900 92,100 Times Unit Cost $3.40 $3.40 $3.40 $3.40 Cost of Purchases $341,700 $364,820 $343,060 $313, BUDGETED INCOME STATEMENT 43

15 CHAPTER 2 BUDGETING For budgets, accuracy is a relative term. All budget amounts are forecasts, estimates, or predictions. So a number rounded to the nearest 100 may be as accurate as a prediction needs to be. Each business decides how far to round a number or calculation based on the relative size of the business. The Cookie Cutter, a small, family-owned bake shop specializing in gourmet cookies, rounds all units to the nearest 100 and rounds all dollar calculations to the nearest $10. The company s projected unit sales for 20X3 are listed as 247,300 units. Of those units, first quarter projections represent 24.3%. If each cookie (unit) retails for $2.29, what are the projected net sales for the first quarter of 20X3? SOLUTION 24.3% 247,300 60,093.9, rounded to 60,100 60,100 $2.29 $137,629, rounded to $137,630 in first quarter net sales On a purchases budget schedule, what amount is used for the beginning inventory for each quarter? EXPENSES BUDGET SCHEDULES 44 he sales manager prepares the selling expenses budget schedule while the T administrative manager prepares the administrative expenses budget schedule. However, both managers depend on other company managers for input into these budgets. For example, the sales personnel may provide information about needed supplies, the advertising manager may supply much of the advertising expense information, and the accounting department may provide information about depreciation. PREPARING THE SELLING EXPENSES BUDGET SCHEDULE Some selling expenses are very stable and require little planning, such as depreciation expense. Others are closely related to sales and fluctuate as sales increase and decrease. 1. Advertising Expense Advertising expense in 20X2 was 2.4% of net sales ($45,120 $1,880,000). The same level of promotion will be maintained for the new year. Therefore, Advertising Expense for each quarter will be 2.4% of each quarter s dollar net sales as shown on the sales budget sched-

16 2.2 BUDGETED INCOME STATEMENT ule. For the first quarter, the calculation is 2.4% $488,000 $11,712 ($11,710 rounded to the nearest $10). 2. Delivery Expense Experience shows that delivery is about $0.40 per unit sold. Therefore, quarterly forecasts for delivery expense are calculated by multiplying $0.40 times the number of units expected to be sold in the quarter. For the first quarter, $ ,600 $39, Depreciation Expense Delivery Equipment No new delivery equipment will be added, so depreciation expense for the year remains the same as it appears on the income statement for 20X2, $7,200. The amount is divided equally among the four quarters. 4. Depreciation Expense Warehouse Equipment A new automated cutter will be acquired at the beginning of the second quarter, increasing quarterly depreciation expense in the second, third, and fourth quarters from $2,700 to $3,700 per quarter. 5. Miscellaneous Expense Sales Miscellaneous expense was 0.6% ($11,490 $1,880,000) of net sales in 20X2. Management wants to reduce miscellaneous expense to 0.5% of net sales. The first quarter s miscellaneous expense is calculated as 0.5% $488,000 $2, Salary Expense Commissions Salespersons will continue to earn a 4.0% commission on net sales. First quarter commissions are calculated as 4.0% $488,000 $19, Salary Expense Regular The new automated cutter will reduce salary expense by $10,000, and a 5.0% increase will be added to the remaining salaries. The annual regular salary expense is calculated below. Salary Expense (from 20X2 income statement) $34,160 Less Reduction from automated cutter 10,000 Total $24,160 Plus 5.0% rate increase ($24, %, rounded) 1,210 Projected Salary Expense Regular $25,370 The projected amount is then allocated among the four quarters based on each quarter s sales percentage from the sales budget schedule. First quarter regular salaries are calculated as $25, % $6,190. Budget analysts held about 59,000 jobs in private industry and government in Governments account for one-third of all budget analyst jobs. The Department of Defense employed seven out of every ten budget analysts in the federal government. Reflections, Inc. Selling Expenses Budget Schedule For Year Ended December 31, 20X3 Schedule 3 Annual Quarter Budget 1st 2d 3d 4th Advertising Expense $ 49,820 $11,710 $13,260 $ 13,910 $10,940 Delivery Expense 160,000 39,040 42,080 44,160 34,720 Depr. Expense Delivery Equipment 7,200 1,800 1,800 1,800 1,800 Depr. Expense Warehouse Equipment 13,800 2,700 3,700 3,700 3,700 Miscellaneous Expense Sales 10,380 2,440 2,760 2,900 2,280 Salary Expense Commissions 83,020 19,520 22,090 23,180 18,230 Salary Expense Regular 25,370 6,190 6,670 7,000 5,510 Supplies Expense Sales 12,450 2,930 3,310 3,480 2,730 Total Selling Expenses $362,040 $86,330 $95,670 $100,130 $79,910 45

17 CHAPTER 2 BUDGETING 8. Supplies Expense Sales In 20X2, supplies expense was 0.6% of net sales ($11,280 $1,880,000). The same percentage is expected in 20X3. First quarter supplies expense is 0.6% $488,000 $2,928 (rounded to $2,930). PREPARING THE ADMINISTRATIVE EXPENSES BUDGET SCHEDULE Many of Reflections administrative expenses are known and remain about the same each period. The annual budget amount for these items is shown below. These expenses are divided equally among the four quarters. Depreciation Expense Office Equipment $14,400 Depreciation Expense Computer System $19,200 Rent Expense $30,000 Reflections, Inc. Selling Expenses Budget Schedule For Year Ended December 31, 20X3 Schedule 4 Annual Quarter Budget 1st 2d 3d 4th Depr. Expense Office Equipment $ 14,400 $ 3,600 $ 3,600 $ 3,600 $ 3,600 Depr. Expense Computer System 19,200 4,800 4,800 4,800 4,800 Insurance Expense 5,600 1,400 1,400 1,400 1,400 Miscellaneous Expense Administrative 36,760 9,190 9,190 9,190 9,190 Payroll Taxes Expense 22,810 5,540 5,900 6,070 5,300 Rent Expense 30,000 7,500 7,500 7,500 7,500 Salary Expense Administrative 81,720 20,430 20,430 20,430 20,430 Supplies Expense Administrative 14,540 3,420 3,870 4,060 3,190 Uncollectible Accounts Expense 12,450 2,930 3,310 3,480 2,730 Utilities Expense 10,980 4,870 1,470 1,610 3,030 Total Administrative Expenses $248,460 $63,680 $61,470 $62,140 $61,170 Many other administrative expenses are closely related to some other item on the income statement. These expenses are calculated each quarter based on a percentage of the budget estimate for the other item for each quarter. These expenses are as follows. Miscellaneous Expense 49.8% of administrative salaries for each quarter. Management is committed to reducing this percentage to 45.0% in 20X3. Note that quarterly administrative salary expense must be calculated before this item can be calculated. Payroll Taxes Expense 12.0% of total quarterly salaries, including Salary Expense Commissions, Salary Expense Regular, and Salary Expense Administrative. Supplies Expense Administrative 0.7% of net sales for each quarter. Uncollectible Accounts Expense 0.6% of net sales for each quarter. 46

18 2.2 BUDGETED INCOME STATEMENT Other administrative expenses are estimated as shown below. 1. Insurance Expense Annual insurance premium cost is projected to increase to $5,600, distributed equally among the quarters. 2. Salary Expense Administrative No new administrative personnel will be hired in 20X3. The 20X2 amount, $77,830, is therefore increased by 5.0% and distributed equally each quarter. 3. Utilities Expense Utilities expense is based on the amount of power, heat, telephone, and other utilities used in 20X2. Costs are projected to increase by 9.0%, consisting of a 5.0% increase in activity and a 4.0% increase in rates. Company records show the following utilities costs for 20X2 for each quarter. Each is multiplied by 109% to calculate 20X3 projected quarterly expenses. 20X2 Actual 20X3 Projected Utilities Expense 109% Utilities Expense 1st Quarter $ 4, % $ 4,870 2d Quarter 1, % 1,470 3d Quarter 1, % 1,610 4th Quarter 2, % 3,030 Total $10, % $10,980 FORMAT SPREADSHEETS TO COMMUNICATE Budget spreadsheets are printed and used by managers at many levels of a company, and they may also be available online for quick reference. Therefore, the formatting of the spreadsheets must be clear so that readers of the spreadsheets can easily understand them. Formats may consist of the size and style of type used, the way borders and rules are applied, and the character formatting of numbers. Currency may be expressed with or without decimals, with or without commas for separating thousands, and with or without dollar signs. Percentages also have decimal options and options for using a percent sign. Negative numbers may be indicated with minus signs or parentheses or even with different colors. Managers should also consider whether budgets will be printed or only displayed online. For example, the color red may be used to indicate negative numbers, but the color may appear as black on a printed copy. Thus, negative numbers may need to be formatted differently if the budgets are to be printed. THINK CRITICALLY Select one of the reports in this chapter. Describe what kinds of formats have been used, and suggest any improvements that might be needed. 47

19 CHAPTER 2 BUDGETING PREPARING THE OTHER REVENUE AND EXPENSES BUDGET SCHEDULE The other revenue and expenses budget schedule shows activities other than normal operations. Typical items are interest income, interest expense, and gains and losses on the sale of plant assets. Reflections has no other revenue items and only one other expense item. This is the interest due on the $20,000 loan used to acquire the automated cutter. Reflections plans to repay the loan at the beginning of the fourth quarter, so the budget schedule allocates the $2,250 interest equally over the first three quarters. Reflections, Inc. Other Revenue and Expenses Budget Schedule For Year Ended December 31, 20X3 Schedule 5 Annual Quarter Budget 1st 2d 3d 4th Other Expenses Interest Expense $2,250 $750 $750 $750 Why are some expenses distributed over quarters using each quarter s percentage of total net sales while other expenses are distributed equally? 48 As a class, discuss how different categories of expenses may affect the sales revenue and net income of a company. Identify which expenses might lead to increased sales. Determine whether a certain increase in a category automatically increases (or decreases) sales by the same percentage. PREPARING THE BUDGETED INCOME STATEMENT T he budget schedules for revenue, cost, and expense items show the detailed items. Therefore, the budgeted income statement is shortened, and the budget schedules are then attached to it. Most of the information on the income statement is copied directly from the budget schedules. However, three items need to be calculated as shown below. Beginning Inventory The beginning inventory for the first quarter is shown in units on the purchases budget schedule, 39,200 units. These items were on hand at the end of 20X2 and, therefore, are multiplied by the 20X2 inventory cost of $3.30 (39,200 $3.30 $129,360). The beginning inventory for the first quarter is the same as the beginning inventory for the year. The beginning inventory for each of the next three quarters is the same number as the ending inventory for the preceding quarter. The beginning inventory for the second, third, and fourth quarters are multiplied by the 20X3 unit cost of $3.40. Ending Inventory The ending inventory amounts are calculated by multiplying the ending inventory unit amounts from the purchases budget schedule by the 20X3 unit cost of $3.40. The ending inventory for the annual budget is the same as the ending inventory for the fourth quarter.

20 2.2 BUDGETED INCOME STATEMENT Federal Income Tax Federal income tax is calculated on total net income using tax rates from the Internal Revenue Service. The amount is distributed equally among the four quarters. Because of rounding, the sum of the four quarters is less than the actual calculated amount by $10. Therefore, it is desirable to increase the fourth quarter s amount by $10 so that the annual budget equals the sum of the quarterly amounts. 15% of net income before taxes, zero to $50,000 25% of net income before taxes less $5,000, $50,001 to $75,000 34% of net income before taxes less $11,750, $75,001 to $100,000 39% of net income before taxes less $16,750, $100,001 to $335,000 Net Income before Fed. Inc. Tax Tax Rate Amount Fed. Inc. Tax $106,770 39% $16,750 24,890, rounded Reflections, Inc. Budgeted Income Statement For Year Ended December 31, 20X3 Annual Quarter Budget 1st 2d 3d 4th Operating Revenue Net Sales (Schedule 1) $2,075,600 $488,000 $552,300 $579,600 $455,700 Cost of Merchandise Sold Beginning Inventory $ 129,360 $129,360 $143,140 $150,280 $117,980 Purchases (Schedule 2) 1,362, , , , ,140 Total Merchandise Avail. for Sale $1,492,080 $471,060 $507,960 $493,340 $431,120 Less Ending Inventory 136, , , , ,000 Cost of Merchandise Sold $1,356,080 $327,920 $357,680 $375,360 $295,120 Gross Profit on Operations $ 719,520 $160,080 $194,620 $204,240 $160,580 Operating Expenses Selling Expenses (Schedule 3) $ 362,040 $ 86,330 $ 95,670 $100,130 $ 79,910 Administrative Expenses (Schedule 4) 248,460 63,680 61,470 62,140 61,170 Total Operating Expenses $ 610,500 $150,010 $157,140 $162,270 $141,080 Income from Operations $ 109,020 $ 10,070 $ 37,480 $ 41,970 $ 19,500 Net Deduction (Schedule 5) $ 2,250 $ 750 $ 750 $ 750 Net Income before Fed. Income Tax $ 106,770 $ 9,320 $ 36,730 $ 41,220 $ 19,500 Federal Income Tax Expense 24,890 6,220 6,220 6,220 6,230 Net Income after Fed. Income Tax $ 81,880 $ 3,100 $ 30,510 $ 35,000 $ 13,270 Most amounts on a budgeted income statement are copied from budget schedules. Which amounts need to be calculated and why? 49

21 CHAPTER 2 BUDGETING THINK CRITICALLY 1. Complete the sales, cost, and expenses budget schedules for Photex Corporation on the next two pages. Round units to the nearest 100 and dollars to the nearest $10. Some information has already been completed for you. Then use the budget schedules to prepare a budgeted income statement. a. Sales Budget Schedule b. Purchases Budget Schedule: The sales manager requests that 40.0% of each quarter s unit sales be available in the prior quarter s ending inventory. c. Expenses Budget Schedules: Payroll taxes expense is 12.0% of total company salaries. Other expenses are based on a percentage of net sales for each quarter. Advertising Expense, 1.2% Delivery Expense, 0.6% Miscellaneous Expense Sales, 0.4% Salary Expense Sales, 5.0% Supplies Expense Sales, 0.8% Uncollectible Accounts Expense, 0.6% Utilities Expense, 1.8% d. Other Revenue and Expenses Budget Schedule: This schedule is already completed. e. Budgeted Income Statement: The units in beginning inventory for the first quarter were on hand at the end of 20X2 when the unit cost was $4.00. Use the tax rate table in this lesson to calculate Federal Income Tax Expense and distribute it equally among the quarters. 2. When preparing an administrative expenses budget schedule, what are some of the factors that should be considered? 50 MAKE CONNECTIONS 3. PERSONAL FINANCE Make a list of your personal income and expenditures for a week and then project them for a quarter. Be sure to consider all sources of income, such as allowances, earnings from a job, and gifts. Make a personal operational plan for the next year, being sure to include any long-term goals such as purchasing a car or taking a trip. Then create an annual budget, showing income and expenditures for each quarter. 4. GOVERNMENT Search the Internet to locate the most current budget of the U.S. government. Review the budget and furnish the following information. Then write a brief report about parts of the budget that interest you. Budget year Total Revenues Amount allocated to Defense Amount allocated to Education 5. STATISTICS Use the graphics functions of spreadsheet software to prepare a bar graph of the selling expenses budget schedule in this lesson.

22 2.2 BUDGETED INCOME STATEMENT Photex Corporation Sales Budget Schedule For Year Ended December 31, 20X3 Schedule 1 Annual Quarter Budget 1st 2d 3d 4th Actual Unit Sales, 20X2 120,000 22,000 34,400 34,800 28,800 Sales Percentage by Quarter 18.3% 28.7% 29.0% 24.0% Projected Unit Sales, 20X3 130,000 23,800 37,300 37,700 31,200 Times Unit Sales Price $6.00 $6.00 $6.00 $6.00 Net Sales $780,000 $142,800 $223,800 $226,200 $187,200 Photex Corporation Purchases Budget Schedule For Year Ended December 31, 20X3 Schedule 2 Quarter 1st 2d 3d 4th Ending Inventory 14,900 15,100 12,500 9,600 Unit Sales for Quarter 23,800 37,300 37,700 31,200 Total Units Needed 38,700 52,400 50,200 40,800 Less Beginning Inventory 12,500 14,900 15,100 12,500 Purchases 26,200 37,500 35,100 28,300 Times Unit Cost $4.25 $4.25 $4.25 $4.25 Cost of Purchases $111,350 $159,380 $149,180 $120,280 Photex Corporation Selling Expenses Budget Schedule For Year Ended December 31, 20X3 Schedule 3 Annual Quarter Budget 1st 2d 3d 4th Advertising Expense $ 9,360 $ 1,710 $ 2,690 $ 2,710 $ 2,250 Delivery Expense 4, ,340 1,360 1,120 Depr. Expense Delivery Equipment 2, Depr. Expense Store Equipment 6,680 1,670 1,670 1,670 1,670 Miscellaneous Expense Sales 3, Salary Expense Sales 39,000 7,140 11,190 11,310 9,360 Supplies Expense Sales 6,240 1,140 1,790 1,810 1,500 Total Selling Expenses $71,480 $13,690 $20,180 $20,360 $17,250 Photex Corporation Other Revenue and Expenses Budget Schedule For Year Ended December 31, 20X3 Schedule 5 Annual Quarter Budget 1st 2d 3d 4th Other Expenses Interest Expense $5,000 $1,250 $1,250 $1,250 $1,250 51

23 CHAPTER 2 BUDGETING Photex Corporation Administrative Expenses Budget Schedule For Year Ended December 31, 20X3 Schedule 4 Annual Quarter Budget 1st 2d 3d 4th Depr. Expense Office Equipment $ 3,600 $ 900 $ 900 $ 900 $ 900 Insurance Expense 4,200 1,050 1,050 1,050 1,050 Miscellaneous Expense Administrative 3, Payroll Taxes Expense 7,700 1,610 2,100 2,110 1,880 Rent Expense 9,600 2,400 2,400 2,400 2,400 Salary Expense Administrative 25,200 6,300 6,300 6,300 6,300 Supplies Expense Administrative 2, Uncollectible Accounts Expense 4, ,340 1,360 1,120 Utilities Expense 14,040 2,570 4,030 4,070 3,370 Total Administrative Expenses $74,820 $17,140 $19,570 $19,640 $18,470 Photex Corporation Budgeted Income Statement For Year Ended December 31, 20X3 Annual Quarter Budget 1st 2d 3d 4th Operating Revenue Net Sales (Schedule 1) $780,000 $142,800 $223,800 $226,200 $187,200 Cost of Merchandise Sold Beginning Inventory $ 50,000 $ 50,000 $ 63,330 $ 64,180 $ 53,130 Purchases (Schedule 2) 540, , , , ,280 Total Merchandise Avail. for Sale $590,190 $161,350 $222,710 $213,360 $173,410 Less Ending Inventory 40,800 63,330 64,180 53,130 40,800 Cost of Merchandise Sold $549,390 $ 98,020 $158,530 $160,230 $132,610 Gross Profit on Operations $230,610 $ 44,780 $ 65,270 $ 65,970 $ 54,590 Operating Expenses Selling Expenses (Schedule 3) $ 71,480 $ 13,690 $ 20,180 $ 20,360 $ 17,250 Administrative Expenses (Schedule 4) 74,820 17,140 19,570 19,640 18,470 Total Operating Expenses $146,300 $ 30,830 $ 39,750 $ 40,000 $ 35,720 Income from Operations $ 84,310 $ 13,950 $ 25,520 $ 25,970 $ 18,870 Net Deduction (Schedule 5) $ 5,000 $ 1,250 $ 1,250 $ 1,250 $ 1,250 Net Income before Fed. Income Tax $ 79,310 $ 12,700 $ 24,270 $ 24,720 $ 17,620 Federal Income Tax Expense 15,220 3,810 3,810 3,810 3,790 Net Income after Fed. Income Tax $ 64,090 $ 8,890 $ 20,460 $ 20,910 $ 13,830 52

24 2.3 CASH BUDGETS LESSON 2.3 CASH BUDGETS PREPARE a cash budget PREPARE AND ANALYZE a performance report G PLANNING THE CASH BUDGET ood cash management requires planning and controlling cash so that it will be available to meet obligations when they come due. Therefore, Reflections, Inc., prepares a cash budget to help analyze cash inflows and cash outflows. A cash budget is a budget that details the cash receipts and cash payments a business expects in a specific period of time. The treasurer prepares the cash budget in consultation with the budget committee. A corporation treasurer is an officer of the corporation who is usually responsible for planning the corporation s requirement for and use of cash. Lily Wu manages the cash functions of a small business. She does not believe in preparing annual cash budgets because she says that keeping good records of cash receipts, cash payments, and the current checking account balance is an accurate method of ensuring there is always enough cash to make the required payments. When receipts are slow, she postpones paying suppliers and occasionally delays paying the other three employees for a few days. Discuss the advantages and disadvantages of Mrs. Wu s practices. 53

25 CHAPTER 2 BUDGETING The treasurer must analyze the following cash items. 1. Projected receipts from cash sales, customers on account, and other sources. 2. Projected cash payments for ordinary expenses such as rent, payroll, and payments to vendors on account. 3. Other cash payments such as buying plant assets or supplies. A cash receipts budget schedule and a cash payments budget schedule are prepared in order to compile the cash budget. CASH RECEIPTS BUDGET SCHEDULE A cash receipts budget schedule shows all projected cash receipts for a budget period. Projections on a cash receipts budget schedule are composed of the following items. 1. Quarterly cash sales 2. Quarterly collections on account from customers The amounts received from customers will not be the same as the amount of sales on account. Normally, cash is received for sales on account made during the previous one or two months. In addition, some sales returns and allowances and uncollectible accounts are likely. 3. Cash received from other sources Such as from bank loans. Reflections, Inc. Cash Receipts Budget Schedule For Year Ended December 31, 20X3 Schedule A Quarter 1st 2d 3d 4th From Sales Prior Year s 4th Quarter ($408,000) $79,150 1st Quarter Sales ($488,000) 390,400 $94,670 2d Quarter Sales ($552,300) 441,840 $107,150 3d Quarter Sales ($579,600) 463,680 $112,440 4th Quarter Sales ($455,700) 364,560 Total Receipts from Sales $469,550 $536,510 $570,830 $477,000 From Other Sources Note Payable to Bank 20,000 Total Cash Receipts $489,550 $536,510 $570,830 $477,000 54