Budgets in Merchandising Companies

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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Learn why managers use budgets
Understand the components of the master
budget
Prepare an operating budget
Prepare a financial budget
Use sensitivity analysis in budgeting
Prepare performance reports for responsibility
centers and account for traceable and common
shared fixed costs
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Learn why managers use budgets
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To plan and control actions and the related
revenues and expenses
To incorporate management’s strategic and
operational plans
Planning technology upgrades
Planning capital asset replacements, improvements,
or expansions
Compare actual results with budgeted amounts
to determine corrective actions
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5
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Identifies areas where the actual results differed
from the budget
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Understand the components of the master budget
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Master budget—the set of budgeted financial
statements and supporting schedules for the entire
organization
Budget includes three types of budgets:
The operating budget
Projects sales revenue, cost of goods sold, and operating
expenses
The capital expenditures budget
The plan for purchasing property, plant, equipment, and
other long-term assets
The financial budget
Plans for raising cash and paying debts
Contain projected amounts, not actual amounts
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The following are some of the components
included in the master budget. 1. ______
B
a. Budgeted balance sheet
b. Sales budget 2. ______
F
c. Capital expenditures budget 3. ______

D
d. Budgeted income statement
4. ______
C
e. Cash budget
f. Inventory, purchases, and cost of goods sold 5. ______
E
budget 6. ______
A
g. Budgeted statement of cash flows
7. ______
G
List in order of preparation the items of the
master budget.
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3
Prepare an operating budget
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First three components
Sales budget
Inventory, purchases, and cost of goods sold budget
Operating expenses
Feed into the budgeted income statement
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Cornerstone of master budget
Level of sales affect all other elements
Projected sales are calculated as:
Each product multiplied by expected units sold
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Budget determines:
Cost of goods sold for the budgeted income
statement
Ending inventory for the budgeted balance sheet
Purchases for the cash budget
Familiar equation is used
Beginning inventory + Purchases – Ending
inventory = Cost of goods sold
Rearrange equation to solve for unknowns
Purchases = Cost of goods sold + Ending
inventory – Beginning inventory
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70% cost of goods sold figure uses sales budget created
earlier
Desired ending inventory is derived from company

policies
Desired ending inventory becomes beginning inventory
for16 next period (month, quarter, or year)
Prepared after sales budget and cost of goods
sold budget
Shows estimated expenses for the period
Includes fixed and/or variable expenses
Examples:
Fixed and variable salaries, commissions
Rent
Insurance
Advertising
Miscellaneous
Look at prior income statements
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Prepared after sales budget, cost of goods sold budget
and operating expense budget
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Grippers sells its rock-climbing shoes worldwide.
Grippers expects to sell 8,500 pairs of shoes for $180
each in January, and 3,500 pairs of shoes for $190 each
in February. All sales are cash only.
Prepare the sales budget for January and February.
Grippers
Sales Budget
January February Total
Sales price per pair $ 180 $ 190
Number of pairs × 8,500 × 3,500
Total sales $1,530,000 $665,000 $2,195,000
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Review your results from S22-3. Grippers expects cost of goods sold
to average 60% of sales revenue, and the company expects to sell
4,100 pairs of shoes in March for $260 each. Grippers’ target ending
inventory is $10,000 plus 50% of the next month’s cost of goods sold.
Use this information and the sales budget prepared in S22-3 to prepare
Grippers’ inventory, purchases, and cost of goods sold budget for
January and February.
Grippers
Inventory, Purchases, and Cost of Goods Sold Budget
January February
Cost of goods sold
(0.60 × sales from S 21-3) $ 918,000 $ 399,000
+ Desired ending inventory
($10,000 + 0.50× Cost of goods
sold for next month) 209,500 329,800
= Total inventory required 1,127,500 728,800
− Beginning inventory (469,000) (209,500)
= Purchases $ 658,500 $ 519,300
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Prepare a financial budget
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Cash budget
Project cash receipts and payments
Budgeted balance sheet
Project each asset, liability, and stockholders’ equity account
Budgeted statement of cash flows
Project cash flows from operating, investing, and financing
activities
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Statement of budgeted cash receipts and
payments
Details how to go from the beginning cash
balance to the desired ending balance
Four major parts:
Cash collections from customers
Cash payments for purchases
Cash payments for operating expenses
Cash payments for capital expenditures
Depends on operating budget
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Cash collections from customers
Cash sales from the sales budget
Collections of prior month’s credit sales
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Payments for operating expenses
Payments during the month of purchase—assume 50%
Payments following the month of purchase—assume 50%
x 50%
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Use the operating expenses budget and payment information to
compute cash payments for operating expenses
Payment of 50% of current month’s salary and commissions
Payment of 50% of prior months salary and commissions
Payment for rent and miscellaneous expenses in the same month
Depreciation is a non-cash expense

Insurance was prepaid in the prior quarter
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8. Greg’s plans to purchase a used delivery
truck in April for $3,000 cash.
9. Greg’s requires a minimum cash
balance of $10,000 before financing at the
end of each month.
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Most important part of the budgeting system
Getting managers and employees to accept the budget
Managers must motivate employees to accept the budget’s
goals
How?
Managers must support the budget themselves, or no one
else will
Managers must show employees how budgets can help them
achieve better results
Managers must have employees participate in developing
the budget
Do not build in slack–becomes less accurate
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Refer to the Grippers sales budget that you prepared in
S22-3. Now assume that Grippers’ sales are collected as
follows:
November sales totaled $400,000 and December sales
were $425,000.
50% in the month of the sale
30% in the month after the sale
18% two months after the sale
2% never collected
Prepare a schedule for the budgeted cash collections for
January and February. Round answers to the nearest
dollar.
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Grippers
Budgeted Cash Collections from Customers
January February
Cash sales (50% of current month ) $ 765,000 $ 332,500
Collection of sales:
30% of prior month credit sales 127,500 459,000
18% of sales two months ago 72,000 76,500
Total cash collections $ 964,500 $ 868,000
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Refer to the Grippers inventory, purchases, and cost of
goods sold budget your prepared in S22-4. Assume
Grippers pays for inventory purchases 50% in the month
of purchase and 50% in the month after purchase.
Prepare a schedule for the budgeted cash payments for

purchases for January and February.
Grippers
Budgeted Cash Payments for Purchases
January February
50% of last month $ 293,250 $ 329,250
50% of current month 329,250 259,650
Total cash payments $ 622,500 $ 588,900
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Grippers has $12,500 in cash on hand on January
1. Refer to S22-5 and S22-6 for cash collections
and cash payment information. Assume Grippers
has cash payment for operating expenses including
salaries of $50,000 plus 1% of sales, all paid in the
month of sale. The company requires a minimum
cash balance of $10,000.
Prepare a cash budget for January and February.
Will Grippers need to borrow cash by the end of
February?
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Grippers
Cash Budget
January and February 2012
January February
Beginning cash balance $ 12,500 $ 402,300
Cash collections from customers 1,077,600 827,400
Cash available 1,090,100 1,229,700
Cash payments
Purchases of inventory 622,500 588,900
Operating expenses 65,300 56,650
Total cash payments 687,800 645,550
Ending cash balance 402,300 584,150
Less: Minimum cash balance desired (10,000) (10,000)
Cash excess (deficiency) $ 392,300 $ 574,150
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5
Use sensitivity analysis in budgeting
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Technology makes it more cost-effective for
managers to:
Conduct sensitivity analysis on their own unit’s
budget
Combine individual unit budgets to create the
companywide master budget
Master budget models the company’s planned
activities
Must support key strategies
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Sensitivity analysis
What-if technique that determines the result if
predicted amounts differ from those budgeted
Spreadsheet programs used for budgeting make
sensitivity analysis cost-effective
What-if budget questions easily changed within
Excel with a few keystrokes
Makes it cost-effective to perform more
comprehensive sensitivity analyses
Managers react quickly if key assumptions
underlying the master budget (such as sales price or
quantity) turn out to be wrong
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Individual operating units roll up budgets to
prepare company-wide budget
Budget management software is used
Often part of Enterprise Resource Planning (ERP)
system
Allows management to conduct sensitivity
analysis on unit data
Managers can spend less time compiling and
summarizing data and more time analyzing it
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Maplehaven Sporting Goods Store has the following sales budget:
Riverbed Sporting Goods Store
Sales Budget
April - July
April-July
April May June July Total
Cash sales, 80% $40,800 $64,000 $51,200 $40,800
Credit sales, 20% 10,200 16,000 12,800 10,200
Total sales, 100% $51,000 $80,000 $64,000 $51,000 $246,000
Suppose June sales are expected to be $80,000 rather than $64,000.
Riverbed Sporting Goods Store
Revised Sales Budget
April - July
April-July
April May June July Total
Cash sales, 80% $40,800 $64,000 $64,000 $40,800
Credit sales, 20% 10,200 16,000 16,000 10,200
Total sales, 100% $51,000 $80,000 $80,000 $51,000 $262,000
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Prepare performance reports for responsibility
centers and account for traceable and common
shared fixed costs
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A system for evaluating the performance of each
responsibility center and its manager
A responsibility center is the part of the organization for
which a particular manager is responsible
Is a part of the organization for which a manager has decision-making
authority and accountability
Four types:
Cost center
Revenue center
Profit center
Investment center
Decentralization highlights the need for reports on
individual segments
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Goal is to Goal is to Goal is to Goal is to
control cost increase increase increase ROI,
revenues profits EVA, &
residual
income
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Performance reports compare budgeted and
actual amounts
Reporting at all levels:
Division (investment centers)
Product lines (profit centers)
Production (cost centers)
Sales (revenue centers)
Management by exception
Shows variances between actual and budgeted
amounts
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Departments that provide services to multiple
departments or divisions for the company
Usually do not generate revenues
Similar to the shared production overhead
Nonproduction related service departments
Examples:
Payroll and Human Resources
Accounting
Copying/Graphic Services
Physical Plant (repairs and maintenance)
Advertising (companywide, not specific products)
Mail and Shipping Services
Shared Facilities (meeting rooms used by various departments)
Legal Services
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Travel Booking Services
Costs directly associated with an individual product,
division, or business segment
Would disappear if the company discontinued the
product , division or segment
Assigning traceable fixed costs
Splitting the cost equally–not fair
Based on use of the services–fair
Small users charged less
Larger users charged more
Identify cost drivers (ABC costing) suitable for
assigning traceable service department charges
Common service departments listed on next slide
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Traceable service costs = $30,000
Base is number of orders
$30,000 / $400,000 equals $0.075 cost per order

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$30,000 / $400,000 equals $0.075 cost per order
Apply to divisions based upon number of orders
The DVD division can further split the traceable cost

between Excel DVDs and Specialty DVDs
$10,500 - $3,500 known untraceable = $7,000
Calculate a cost per order as ($7,000/140,000) = $0.05
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Show the results of the segment or division for which a particular
manager is responsible
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A budgeted income statement shows estimated
amounts, whereas the income statement shows actual
results. Managers use budgets to develop strategies
(overall business goals) and to create plans and follow
actions that enable them to achieve those goals. They
also review results against the goals (control), often
using a performance report that compares budgeted
amounts to actual amounts.
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The master budget is the set of budgeted financial
statements and supporting schedules for the entire
organization. It contains the operating budget, the
capital expenditures budget, and the financial budget.
There are many budgets that compose each of the
three types. Each budget provides a portion of the
plan that maps the company’s planned direction and
goals for a period of time.
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The first three components of the operating budget
include the sales budget; the inventory, purchases, and
cost of goods sold budget; and the operating expenses
budget. The sales budget depicts the breakdown of
sales based on the terms of collection. The inventory,
purchases, and cost of goods sold budget aids in
planning for adequate inventory to meet sales (COGS)
and for inventory purchases. The operating expenses
budget captures the planned variable and fixed
operating expenses necessary for normal operations.
The three budgets help to form the budgeted income
statement. Together these form the operational budget
that depicts the company’s operational strategy for a
period of time.
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The cash budget details how the business expects to
go from the beginning cash balance to the desired
ending balance each period. The cash budget has four
major parts—cash collections from customers, cash
payments for purchases, cash payments for operating
expenses, and cash payments for capital expenditures.
The results of these budgets are combined to form the
cash budget. After preparing the cash budget, the rest
of the financial statement budgets are prepared,
including the budgeted balance sheet and budgeted
statement of cash flows. These budgets depict the
financial plan that implements the strategic goals of
the company.
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Sensitivity budgeting was once a time-consuming
task. Now, with technology, modifying the budget
assumptions is easy. Individual managers can easily
modify the budgets of their specific units, and that
data is automatically updated in the companywide
budget plans. Being able to modify this data easily
allows managers to be more responsive to business
changes and plan better; thus, better, more timely
decisions that benefit the company may be made.
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Responsibility centers are parts of the company for
which managers have decision-making authority and
accountability. Responsibility accounting is
performance reporting for those responsibility centers.
There are four types of responsibility centers—cost
centers, revenue centers, profit centers, and
investment centers. Traceable fixed costs are those
costs that would disappear if a company quit making a
particular product or discontinued a division or
segment. Common fixed costs (untraceable) are those
costs that aren’t traceable to a specific product,
division, or segment.
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61 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Copyright
All rights reserved. No part of this publication may be reproduced,

stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording, or
otherwise, without the prior written permission of the publisher.
Printed in the United States of America.
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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

c. Capital expenditures budget 3. ______

Desired ending inventory is derived from company

Depreciation is a non-cash expense

Prepare a schedule for the budgeted cash payments for

$30,000 / $400,000 equals $0.075 cost per order

The DVD division can further split the traceable cost

All rights reserved. No part of this publication may be reproduced,

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