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CHAPTER23
Budgetary Planning

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PreviewofCHAPTER23

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Budget
Formal written statement of management’s plans for a specified future time period, expressed in financial terms.
Primary way to communicate agreed-upon objectives to all parts of the company.
Promotes efficiency.
Control device – important basis for performance evaluation once adopted.
Budgeting Basics

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Historical accounting data on revenues, costs, and expenses help in formulating future budgets.
Accountants normally responsible for presenting management’s budgeting goals in financial terms.
The budget and its administration are, however, entirely management’s responsibility.
Budgeting and Accounting
Budgeting Basics

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Requires all levels of management to plan ahead.
Provides definite objectives for evaluating performance.
Creates an early warning system for potential problems.
Facilitates coordination of activities within the business.
The Benefits of Budgeting
SO 1 Indicate the benefits of budgeting.
Budgeting Basics

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Results in greater management awareness of the entity’s overall operations.
Motivates personnel throughout organization to meet planned objectives.
SO 1 Indicate the benefits of budgeting.
A budget is an aid to management; not a substitute for management.
Budgeting Basics
The Benefits of Budgeting

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a. Management can plan ahead.
b. An early warning system is provided for potential problems.
c. It enables disciplinary action to be taken at every level of responsibility.
d. The coordination of activities is facilitated.
Which of the following is not a benefit of budgeting?
SO 1 Indicate the benefits of budgeting.
Budgeting Basics
Question

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Depends on a sound organizational structure with authority and responsibility for all phases of operations clearly defined.
Based on research and analysis with realistic goals.
Accepted by all levels of management.
Essentials of Effective Budgeting
SO 2 State the essentials of effective budgeting.
Budgeting Basics

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May be prepared for any period of time.
Most common – one year.
Supplement with monthly and quarterly budgets.
Different budgets may cover different time periods.
Long enough to provide an attainable goal and minimize seasonal or cyclical fluctuations.
Short enough for reliable estimates.
Continuous twelve-month budget.
Length of the Budget Period
SO 2 State the essentials of effective budgeting.
Budgeting Basics

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Base budget goals on past performance
Collect data from organizational units.
Begin several months before end of current year.
Develop budget within the framework of a sales forecast.
Shows potential industry sales.
Shows company’s expected share.
The Budgeting Process
SO 2 State the essentials of effective budgeting.
Budgeting Basics

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Factors considered in Sales Forecasting:
General economic conditions
Industry trends
Market research studies
Anticipated advertising and promotion
Previous market share
Price changes
Technological developments
The Budgeting Process
SO 2 State the essentials of effective budgeting.
Budgeting Basics

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Participative Budgeting
May inspire higher levels of performance or discourage additional effort.
Depends on how budget developed and administered.
Invite each level of management to participate.
Budgeting and Human Behavior
SO 2 State the essentials of effective budgeting.
This “bottom-to-top” approach is called Participative Budgeting.
Budgeting Basics

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Advantages:
More accurate budget estimates.
Tendency to perceive process as fair due to involvement of lower level management.
Overall goal – produce a budget considered fair and achievable by managers while still meeting goals.
Risk of unreliable budgets greater when they are “top-down.”
Participative Budgeting
SO 2 State the essentials of effective budgeting.
Budgeting Basics

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Disadvantages:
Can be time consuming and costly.
Can foster budgetary “gaming” through budgetary slack.
Participative Budgeting
SO 2 State the essentials of effective budgeting.
Budgeting Basics

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Flow of budget data from lower management to top levels.
Illustration 23-1
SO 2 State the essentials of effective budgeting.
Budgeting Basics

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Three basic differences between Budgeting and Long Range Planning:
Time period involved.
Emphasis.
Detail presented.
Time period:
Budgeting is short-term – usually one year.
Long range planning – at least five years.
Budgeting and Long-Range Planning
SO 2 State the essentials of effective budgeting.
Budgeting Basics

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a. Top-down budgeting.
b. Management acceptance.
c. Research and analysis.
d. Sound organizational structure.
The essentials of effective budgeting do not include:
SO 2 State the essentials of effective budgeting.
Budgeting Basics
Question

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Set of interrelated budgets that constitutes a plan of action for a specified time period.
Contains two classes of budgets:
Operating budgets.
Financial budgets.
SO 3 Identify the budgets that comprise the master budget.
The Master Budget
The capital expenditures budget, the cash budget, and the budgeted balance sheet – focus primarily on cash needs to fund operations and capital expenditures.
Budgeting Basics

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Illustration 23-2
SO 3
Components of the Master
Budget.
Budgeting Basics

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A sales forecast shows potential sales for the industry and a company’s expected share of such sales.
Operating budgets are used as the basis for the preparation of the budgeted income statement.
Use this list of terms to complete the sentences that follow.
SO 3 Identify the budgets that comprise the master budget.
Budgeting Basics
2.
Long-range planning Participative budgeting
Sales forecast Operating budgets
Master budget Financial budgets

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The master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period.
Long-range planning identifies long-term goals, selects strategies to achieve these goals, and develops policies and plans to implement the strategies.

SO 3 Identify the budgets that comprise the master budget.
Budgeting Basics
Use this list of terms to complete the sentences that follow.
4.
Long-range planning Participative budgeting
Sales forecast Operating budgets
Master budget Financial budgets

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Lower-level managers are more likely to perceive results as fair and achievable under a participative budgeting approach.
Financial budgets focus primarily on the cash resources needed to fund expected operations and planned capital expenditures.

SO 3 Identify the budgets that comprise the master budget.
Use this list of terms to complete the sentences that follow.
Budgeting Basics
.
6.
Long-range planning Participative budgeting
Sales forecast Operating budgets
Master budget Financial budgets

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First budget prepared.
Derived from the sales forecast.
Management’s best estimate of sales revenue for the budget period.
Every other budget depends on the sales budget.
Prepared by multiplying expected unit sales volume for each product times anticipated unit selling price.
Preparing the Operating Budgets
Sales Budget
SO 3 Identify the budgets that comprise the master budget.

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Expected sales volume: 3,000 units in the first quarter with 500-unit increments for each following quarter.
Sales price: $60 per unit.
Illustration 23-3
Sales Budget
SO 3 Identify the budgets that comprise the master budget.
Illustration – Hayes Company
Preparing the Operating Budgets
Preparing the Operating Budgets

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Shows units that must be produced to meet anticipated sales.
Derived from sales budget plus the desired change in ending finished goods.
Required production in units formula:
Illustration 23-4
Production Budget
SO 3 Identify the budgets that comprise the master budget.
Preparing the Operating Budgets
Essential to have a realistic estimate of ending inventory.

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Hayes Co. believes it can meet future sales needs with an ending inventory of 20% of next quarter’s sales.
Illustration 23-5
SO 3 Identify the budgets that comprise the master budget.
Illustration – Hayes Company
Preparing the Operating Budgets

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Shows both the quantity and cost of direct materials to be purchased.
Formula for direct materials quantities.
Direct Materials Budget
SO 3 Identify the budgets that comprise the master budget.
Budgeted cost of direct materials to be purchased = required units of direct materials x anticipated cost per unit.
Preparing the Operating Budgets
Illustration 23-6

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Inadequate inventories could result in temporary shutdowns of production. Because of its close proximity to suppliers,
Hayes maintains an ending inventory of raw materials equal to 10% of the next quarter’s production requirements.
The manufacture of each Kitchen-Mate requires 2 pounds of raw materials, and the expected cost per pound is $4.
Assume the desired ending direct materials amount is 1,020 pounds for the fourth quarter of 2011.
Prepare a Direct Materials Budget.
SO 3 Identify the budgets that comprise the master budget.
Preparing the Operating Budgets
Illustration – Hayes Company

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SO 3 Identify the budgets that comprise the master budget.
Illustration 23-7
Preparing the Operating Budgets
Illustration – Hayes Company

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Soriano Company is preparing its master budget for 2012. Relevant data pertaining to its sales, production, and direct materials budgets are as follows:
Sales: Sales for the year are expected to total 1,200,000 units. Quarterly sales are 20%, 25%, 30%, and 25% respectively. The sales price is expected to be $50 per unit for the first three quarters and $55 per unit beginning in the fourth quarter. Sales in the first quarter of 2013 are expected to be 10% higher than the budgeted sales for the first quarter of 2012.
Production: Management desires to maintain ending finished goods inventories at 25% of next quarter’s budgeted sales volume.
Direct materials: Each unit requires 3 pounds of raw materials at a cost of $5 per pound. Management desires to maintain raw materials inventories at 5% of the next quarter’s production requirements. Assume the production requirements for the first quarter of 2013 are 810,000 pounds.
Preparing the Operating Budgets
SO 3 Identify the budgets that comprise the master budget.

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Prepare the sales, production, and direct materials budgets by quarters for 2012.

Preparing the Operating Budgets
SO 3 Identify the budgets that comprise the master budget.

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Prepare the sales, production, and direct materials budgets by quarters for 2012.

Preparing the Operating Budgets
SO 3 Identify the budgets that comprise the master budget.

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SO 3
Prepare the sales, production, and direct materials budgets by quarters for 2012.
Preparing the Operating Budgets

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Shows both the quantity of hours and cost of direct labor necessary to meet production requirements.
Critical in maintaining a labor force that can meet expected production.
Total direct labor cost formula:
Illustration 23-8
Direct Labor Budget
SO 3 Identify the budgets that comprise the master budget.
Preparing the Operating Budgets

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SO 3 Identify the budgets that comprise the master budget.
Illustration: Direct labor hours are determined from the production budget. At Hayes Company, two hours of direct labor are required to produce each unit of finished goods. The anticipated hourly wage rate is $10.
Illustration 23-9
Preparing the Operating Budgets

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Shows the expected manufacturing overhead costs for the budget period.
Distinguishes between fixed and variable overhead costs.
Manufacturing Overhead Budget
SO 3 Identify the budgets that comprise the master budget.
Preparing the Operating Budgets

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Manufacturing Overhead Budget
SO 3 Identify the budgets that comprise the master budget.
Illustration: Hayes Company expects variable costs to fluctuate with production volume on the basis of the following rates per direct labor hour: indirect materials $1.00, indirect labor $1.40, utilities $0.40, and maintenance $0.20. Thus, for the 6,200 direct labor hours to produce 3,100 units, budgeted indirect materials are $6,200 (6,200 x $1), and budgeted indirect labor is $8,680 (6,200 x $1.40). Hayes also recognizes that some maintenance is fixed. The amounts reported for fixed costs are assumed.
Prepare a Manufacturing Overhead Budget.
Preparing the Operating Budgets

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SO 3
Illustration 23-10
Preparing the Operating Budgets
Manufacturing Overhead Budget

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Projection of anticipated operating expenses.
Distinguishes between fixed and variable costs.
Selling and Administrative Expense Budget
SO 3 Identify the budgets that comprise the master budget.
Illustration: Variable expense rates per unit of sales are sales commissions $3 and freight-out $1. Variable expenses per quarter are based on the unit sales from the sales budget (Illustration 23-3). Hayes expects sales in the first quarter to be 3,000 units. Fixed expenses are based on assumed data.
Prepare a selling and administrative expense budget.
Preparing the Operating Budgets

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Selling and Administrative Expense Budget
SO 3
Illustration 23-11
Preparing the Operating Budgets

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a. Derived from the production budget.
b. Management’s best estimate of sales revenue for the year.
c. Not the starting point for the master budget.
d. Prepared only for credit sales.
A sales budget is:
SO 3 Identify the budgets that comprise the master budget.
Preparing the Operating Budgets
Question

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SO 4 Describe the sources for preparing the budgeted income statement.
Important end-product of the operating budgets.
Indicates expected profitability of operations.
Provides a basis for evaluating company performance.
Prepared from the operating budgets:
Budgeted Income Statement
Manufacturing Overhead
Selling and Administrative Expense
Sales
Direct Materials
Direct Labor
Preparing the Operating Budgets

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Illustration: To find the cost of goods sold, it is first necessary to determine the total unit cost of producing one Kitchen-Mate, as follows.
SO 4 Describe the sources for preparing the budgeted income statement.
Second, determine Cost of Goods Sold by multiplying units sold times unit cost: 15,000 units X $44 = $660,000
Illustration 23-12
Preparing the Operating Budgets
Budgeted Income Statement

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Illustration: All data for the income statement come from the individual operating budgets except the following: (1) interest expense is expected to be $100, and (2) income taxes are estimated to be $12,000.
SO 4 Describe the sources for preparing the budgeted income statement.
Illustration 23-13
Preparing the Operating Budgets

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a. Sales budget.
b. Selling and administrative budget.
c. Capital expenditure budget.
d. Direct labor budget.
Each of the following budgets is used in preparing the budgeted income statement except the:
SO 4 Describe the sources for preparing the budgeted income statement.
Preparing the Operating Budgets
Question

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Soriano Company is preparing its budgeted income statement for 2012. Relevant data pertaining to its sales, production, and direct materials budgets can be found in the Do it! exercise on slide 36. Soriano budgets 0.5 hours of direct labor per unit, labor costs at $15 per hour, and manufacturing overhead at $25 per direct labor hour. Its budgeted selling and administrative expenses for 2012 are $12,000,000.
Calculate the budgeted total unit cost.
Prepare the budgeted income statement for 2012.
SO 4 Describe the sources for preparing the budgeted income statement.
Preparing the Operating Budgets

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Calculate the budgeted total unit cost and Prepare the budgeted income statement for 2012.
SO 4
Preparing the Operating Budgets
(a)
(b)

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Shows anticipated cash flows.
Often considered to be the most important output in preparing financial budgets.
Contains three sections:
Cash Receipts
Cash Disbursements
Financing
Shows beginning and ending cash balances.
Cash Budget
SO 5 Explain the principal sections of a cash budget.
Preparing the Financial Budgets

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Cash Budget
SO 5 Explain the principal sections of a cash budget.
Preparing the Financial Budgets
Illustration 23-14
Basic form of a cash budget

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Cash Receipts Section
Expected receipts from the principal sources of revenue.
Expected interest and dividends receipts, proceeds from planned sales of investments, plant assets, and capital stock.
Cash Disbursements Section
Expected cash payments for direct materials and labor, taxes, dividends, plant assets, etc.
Financing Section
Expected borrowings and repayments of borrowed funds plus interest.
SO 5 Explain the principal sections of a cash budget.
Preparing the Financial Budgets
Cash Budget

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Must prepare in sequence.
Ending cash balance of one period is the beginning cash balance for the next.
Data obtained from other budgets and from management.
Often prepared for the year on a monthly basis.
SO 5 Explain the principal sections of a cash budget.
Cash Budget
Preparing the Financial Budgets

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Contributes to more effective cash management.
Shows managers the need for additional financing before actual need arises.
Indicates when excess cash will be available.
SO 5 Explain the principal sections of a cash budget.
Cash Budget
Preparing the Financial Budgets

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The January 1, 2012, cash balance is expected to be $38,000. Hayes wishes to maintain a balance of at least $15,000.
Sales (Illustration 23-3): 60% are collected in the quarter sold and 40% are collected in the following quarter. Accounts receivable of $60,000 at December 31, 2011, are expected to be collected in full in the first quarter of 2012.
Short-term investments are expected to be sold for $2,000 cash in the first quarter.
SO 5 Explain the principal sections of a cash budget.
Preparing the Financial Budgets
Illustration – Hayes Company
Continued

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Direct materials (Illustration 23-7): 50% are paid in the quarter purchased and 50% are paid in the following quarter. Accounts payable of $10,600 at December 31, 2011, are expected to be paid in full in the first quarter of 2012.
Direct labor (Illustration 23-9): 100% is paid in the quarter incurred.
Manufacturing overhead (Illustration 23-10) and selling and administrative expenses (Illustration 23-11): All items except depreciation are paid in the quarter incurred.
Management plans to purchase a truck in the second quarter for $10,000 cash.
SO 5 Explain the principal sections of a cash budget.
Preparing the Financial Budgets
Illustration – Hayes Company
Continued

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Hayes makes equal quarterly payments of its estimated annual income taxes.
Loans are repaid in the earliest quarter in which there is sufficient cash (that is, when the cash on hand exceeds the $15,000 minimum required balance).
Prepare a schedule of collections from customers.
SO 5 Explain the principal sections of a cash budget.
Preparing the Financial Budgets
Illustration – Hayes Company

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Illustration – Schedule of collections from customers.
SO 5 Explain the principal sections of a cash budget.
Illustration 23-15

Preparing the Financial Budgets

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Illustration – Schedule of cash payments for direct materials.
SO 5 Explain the principal sections of a cash budget.
Illustration 23-16

Preparing the Financial Budgets

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SO 5
Illustration 23-17
Preparing the Financial Budgets
Illustration – Cash Budget

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Developed from the budgeted balance sheet for the preceding year and the budgets for the current year.
SO 5 Explain the principal sections of a cash budget.
Budgeted Balance Sheet
Preparing the Financial Budgets

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Illustration: Pertinent data from the budgeted balance sheet at December 31, 2012, are as follows.
Illustration 23-13
SO 5 Explain the principal sections of a cash budget.
Cash: Ending cash balance $37,900, shown in the cash budget (Illustration 23-17).
Accounts receivable: 40% of fourth-quarter sales $270,000, shown in the schedule of expected collections from customers (Illustration 23-15).
Continued
Preparing the Financial Budgets

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SO 5 Explain the principal sections of a cash budget.
Finished goods inventory: Desired ending inventory 1,000 units, shown in the production budget (Illustration 23-5) times the total unit cost $44 (shown in Illustration 23-12).
Raw materials inventory: Desired ending inventory 1,020 pounds, times the cost per pound $4, shown in the direct materials budget (Illustration 23-7).
Buildings and equipment: December 31, 2010, balance $182,000, plus purchase of truck for $10,000 (Illustration 23-17).

Continued
Preparing the Financial Budgets

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SO 5 Explain the principal sections of a cash budget.
Accumulated depreciation: December 31, 2012, balance $28,800, plus $15,200 depreciation shown in manufacturing overhead budget (Illustration 23-10) and $4,000 depreciation shown in selling and administrative expense budget (Illustration 23-11).
Accounts payable: 50% of fourth-quarter purchases $37,200, shown in schedule of expected payments for direct materials (Illustration 23-16).
Common stock: Unchanged from the beginning of the year.
Retained earnings: December 31, 2012, balance $46,480, plus net income $47,900, shown in budgeted income statement (Illustration 23-13).
Preparing the Financial Budgets

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Illustration: Budgeted Balance Sheet
Illustration 23-18
SO 5 Explain the principal sections of a cash budget.
Preparing the Financial Budgets

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a. $96,000
b. $90,000
c. $78,000
d. $72,000
Expected direct materials purchases in Read Company are $70,000 in the first quarter and $90,000 in the second quarter. Forty percent of the purchases are paid in cash as incurred, and the balance is paid in the following quarter. The budgeted cash payments for purchases in the second quarter are:
SO 5 Explain the principal sections of a cash budget.
Preparing the Financial Budgets
Question

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Martian Company management wants to maintain a minimum monthly cash balance of $15,000. At the beginning of March, the cash balance is $16,500, expected cash receipts for March are $210,000, and cash disbursements are expected to be $220,000. How much cash, if any, must be borrowed to maintain the desired minimum monthly balance?
SO 5 Explain the principal sections of a cash budget.

Preparing the Financial Budgets

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Sales Budget: starting point and key factor in developing the master budget.
Use a purchases budget instead of a production budget.
Do not use the manufacturing budgets (direct materials, direct labor, manufacturing overhead).
To determine budgeted merchandise purchases:
Illustration 23-19
Merchandisers
SO 6 Indicate the applicability of budgeting in non-manufacturing companies.
Budgeting in Nonmanufacturing Companies

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Illustration: Lima’s budgeted sales for July, $300,000 and for August, $320,000. Cost of Goods Sold: 70% of sales. Desired ending inventory is 30% of next month’s Cost of Goods Sold. Required merchandise purchases for July are computed as follows.
SO 6 Indicate the applicability of budgeting in non-manufacturing companies.
Budgeting in Nonmanufacturing Companies
Illustration 23-20

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Critical factor in budgeting is coordinating professional staff needs with anticipated services.
Problems if overstaffed:
Disproportionately high labor costs.
Lower profits due to additional salaries.
Increased staff turnover due to lack of challenging work.
Problems if understaffed:
Lost revenues because existing and future client needs for services cannot be met.
Loss of professional staff due to excessive work loads.
Service Enterprises
SO 6
Budgeting in Nonmanufacturing Companies

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Just as important as for profit-oriented company.
Budget process differs from profit-oriented company.
Budget on the basis of cash flows (expenditures and receipts), not on a revenue and expense basis.
Starting point is usually expenditures, not receipts.
Management’s task is to find receipts needed to support planned expenditures.
Budget must be followed, overspending often illegal.
Not-For-Profit Organizations
SO 6 Indicate the applicability of budgeting in non-manufacturing companies.
Budgeting in Nonmanufacturing Companies

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a. A merchandise purchases budget replaces the production budget.
b. The manufacturing budgets are not applicable.
c. None of the above.
d. Both (a) and (b) above.
The budget for a merchandiser differs from a budget for a manufacturer because:
SO 6 Indicate the applicability of budgeting in non-manufacturing companies.
Budgeting in Nonmanufacturing Companies
Question

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