CA 51014 – STRATEGIC COST MANAGEMENT

Budgeting

Definition of Budget
• A budget is a plan, expressed in quantitative terms, on how to acquire and use the resources of an entity during a certain
future period of time.
• Sometimes called as Master Budget
o Operation Budget
▪ Seen in the Income Statement
▪ Sales, COGS, Expenses, and budgeted Income Statement
o Financial Budget
▪ Seen in the Financial Position
o Appropriation – Type Budget
▪ Minsan lang ginagamit

Uses of Budgeting
☺ It compels periodic planning.
☺ It provides a means of allocating resources efficiently and effectively.
o Ma-a-allocate na agad yung mga kailangan sa production based on the given assumptions
☺ It enhances cooperation, coordination, communication and motivation.
☺ It provides network for performance evaluation.
☺ It satisfies some legal and contractual requirements.
☺ It directs the activities toward the achievement of organizational goals.

Limitations of Budgeting
 Considerable time and costs are required.
 Budgets are mere estimates, employing certain amount of judgment, requiring certain modification or revision if necessary.
o Commonly, the basis used for budgeting is the company’s past performances
 To be successful, budgetary system requires cooperation of all members of the organization.
o Job of accountants is to consolidate all the proposed budget
 Budgets sometimes restrict decision-making process.
 The budget program is merely a guide, not a substitute for good management ability.

Budgets vs. Standards

BUDGETS STANDARDS – Standard Costs

1. Purpose Budgets are statements of expected Standards pertain to what costs ‘might be’ if
costs. certain highly desirable performances are
attained.

Budgeted Cost ÷ Budgeted Hours =

Standard Rate per Hour

Favorable vs. Unfavorable Variances

2. Emphasis Budgets emphasize cost levels that Standards emphasize the levels to which
should not be exceeded. costs should be reduced.

From the favo vs. unfavo, where should

we reduce?
3. Completeness Budgets are customarily set for all Standards are usually set only for the
departments in the firm – from sales, manufacturing divisions of the firm.
administration, to manufacturing.

Standard DM, Standard DL, Standard OH

(All manufacturing costs only)
4. Analysis & Breakdown When actual costs differ from the budget, When actual costs differ from standards, the
it may be an indication of either good or nature and cause of the difference or
bad performance. variance is investigated so that necessary
corrective actions are taken in time.

Based on the foregoing comparisons between budgets and standards, the following general statements may be made:
• Standards cannot be used for forecasting.
• Costs are not to exceed budgets; they are to approach standards.
• Budgets include both income and expenses, while standards are normally set for costs and expenses only.
o Standards for Manufacturing Costs only

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 o Budget includes expenses, sales, and collections
• Budgets help us to keep away from trouble, while standards lead us to the right road to improvement.

Master Budget | Pro Forma Budget, Planning Budget, Forecast Budget, Master Profit Plan
• Master Budget is a comprehensive budget that consolidates the overall plan of the organization within a budget period.
• It consists of all the individual budgets for each of the segments of the organization aggregated or consolidated into
one overall budget for the entire firm.
o (Other terms: pro forma budget, planning budget, forecast budget, master profit plan)
• Like mentioned above, there are two classifications
o Operating Budget
▪ Income Statement
o Financial Budget
o Appropriation-Type

Operating Budget
 All relates to the Income Statement
 Detailed projection of what a company expects its revenue and expenses will be over a period of time
 Sales budget
 Production budget (Direct materials budget, Direct labor budget, Factory overhead budget, Inventory budget)
 Budgeted cost of goods sold
 Budgeted operating expense
 Budgeted operating income
 Budgeted net income
 Budgeted income statement

Financial Budget Appropriation-type budget

 All relates to the Cash Flow Accounts  Retained Earnings with specific purposes
 For the income and expenses of the business on o Ex. Acquisition of additional land
a long-term and short-term basis  Advertising budget
o Accumulated  Research and development budget
 Cash budget  Joint venture budget
 Working capital budget
 Budgeted Cash Flow Statement
 Capital Expenditure

Budgeting-Related Terminologies:

Fixed Budget A budget prepared for one level of activity within a certain period. (Other term: static budget)
• Isang amount lang
• Fixed Cost
o Di siya magiging affected nung mga actual units produced and the like

Flexible Budget A budget prepared for different levels of activity within a certain period. (Other terms: variable budget,
sliding scale budget)
• Adjusted based on the number of units / Based on the actual activity
• Opposite of the Fixed Budget
• y = a + bx
o y = flexible fixed cost
o a = fixed cost
o b = variable cost
o x = actual number of units

Continuous Budget A 12-month budget that rolls forward one month as the current month is completed (Other terms: perpetual
budget, rolling budget)
• Gagawa ka ng budget for 12 months, tas idudugtong mo yung budget for the next months
• Comprehensive

Incremental A budgeting process wherein the current period’s budget is simply adjusted to allow for changes planned for
Budgeting the coming period.

Zero-Based Budget A method of budgeting in which managers are required to justify all costs as if the programs involved were
being proposed for the first time.
• Gagawa ka ng budget assuming na it’s the first year of operations (not strictly Dapat first year
pero ganon yung assumption)

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Life-Cycle Budget A product’s revenues and expenses are estimated over its entire life cycle (from research and development
to withdrawal of customer support).
• Used estimates for revenues and expenses of the product line

Activity-Based A budgeting that applies the ABC principles and procedures to budgeting.
Budgeting

Kaizen Budgeting Kaizen is a Japanese term that means continuous improvement. Thus, Kaizen budgeting assumes the
continuous improvement of products and processes; the effects of improvement and the costs of their
implementation are estimated.
• Kung magkakaroon tayo ng biglaang cost savings, ano yung magiging epekto nun sa budget
natin

Imposed Budgeting A process wherein budgets are prepared by top management with little or no inputs from operating
personnel.
• Opposite of the participatory budgeting
• Walang input yung operating, only from top management

Participatory A process wherein budgets are developed through joint decisions by top management and
Budgeting operating personnel.
• May participation yung lower level management

Budget Committee A group of key management persons (usually composed of the sales manager, production manager, chief
engineer, treasurer and controller) responsible for over-all policy matters relating to the budget program
and for coordinating the budget preparation.
• Hindi lang yung accountant yung involved dito

Budget Manual This describes how a budget is prepared and includes a planning calendar and distribution for all budget
schedules.

Budget Report It shows a comparison of the actual and budget performance. The budget variances are also shown on
the report.

Budgetary Slack Results when revenues are intentionally underestimated, or expenses are intentionally overestimated
during the budgeting process
• Revenues ➔ Underestimated
o Kaunti lang magiging revenues ko ah, kaya kailangan magdagdag nap era
▪ Pinapababa mo yung revenue mo para magkaroon ka ng additional budget
▪ So magkakaroon ka ng mas maraming budget = Budgetary Slack

Brief Exercise on the Concepts

1. All of the following are considered operating budgets, except the:

a. Sales Budget
b. Materials Budget
c. Production Budget
d. Capital Budget

2. The Production Budget process usually begins with the

a. Direct Labor Budget
b. Direct Materials Budget
c. FOH Budget
d. Sales Budget

3. Type of Budget Plan that is updated monthly or quarterly and where one month or quarter is dropped, another is
added is called:
a. Master Budget
b. Operating and Financial Budget
c. Continuous Budget
d. Zero Based Budget

4. The most important budget in the master budget is likely the

a. Cash Budget
b. Capital Budget
c. Personnel budget

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 d. Purchases Budget

5. The use of Standard Costs in Budgeting Process signifies that an organization has most likely implemented a
a. Flexible Budget
b. Capital Budget
c. Zero Based Budget
d. Static Budget

6. Common starting point in the Budgeting Process is:

a. Expected Future Net Income
b. Past Performance
c. Total Market Size
d. A clean slate, with no expectations

7. Budget that includes costs for the actual number of units produced is called a
a. Static Budget
b. Summary Cash Budget
c. Master Budget
d. Flexible Budget

8. Using the concept of “Expected Value” in sales forecasting means that the sales forecast to be used is:
a. Developed using the indicator method
b. The sum of the sales expected by individual managers
c. Based on expected selling prices of the products
d. Based on probabilities

Illustration: Production Budget

Pig Company budgets sales at P100,000 and expects a profit before tax of 10% of the sales. Expenses are estimated as follows:
Selling = 15% of Sales; Administrative = 10% of Sales’ Labor is expected to be 40% of the total manufacturing costs. Factory overhead
is to be applied at 75% of direct labor costs. Inventories are to be as follows:
January 1 December 31
Materials P 25,000 P 30,000
Work-in-process 8,000 13,000
Finished goods 15,000 20,000

Required: Determine the following:

1. Cost of goods sold 65,000 3. Factory overhead 22,500
2. Total manufacturing cost 75,000 4. Materials purchases 27,500

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Illustration: Cash Budget

Past collections experienced by Wolf Company proved that 60% of the net sales billed in a month are collected during the month of
sales, 30% are collected in the following month, and 10% are collected in the second following month. A record on monthly net sales of
previous months is as follows:

2014: November P 450,000 2015: March P 500,000

December 460,000 April 550,000
2015: January 480,000 May 600,000
February 420,000 June 700,000

On January 1, 2015, the net accounts receivable balance showed P229,000.

Required: Determine the following:

1. Cash collections on accounts receivable during:
a. January 2015 471,000 b. March 2015 474,000 c. May 2015 575,000

2. Accounts receivable balance at the end of:

a. February 2015 216,000 b. April 2015 270,000 c. June 2015 340,000

*Add all those of the same color*

Alternative Solution:
AR, Feb 28
From Feb 420,000 x 40% = 168,000
From Jan 480,000 x 10% = 48,000
216,000
AR, April 30
From April 550,000 x 40% = 220,000
From March 500,000 x 10% = 50,000
270,000
AR, June 30
From June 700,000 x 40% = 280,000
From Jan 600,000 x 10% = 60,000
340,000

Note: In the illustration above, the percentage of cash collected equals to 100%. There could be instances wherein the percentages
would not be equal to 100%, and in these cases, assume that the balance would be appropriated to Bad Debts.

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Illustration: Purchases Budget

The sales manager of Fox Merchandising has budgeted the following sales for the 4th quarter of 2014: October, P123,500; November,
P156,000; December, P208,000.

Other estimates are:

• All merchandise are to sell at its invoice cost plus 30% mark-up.
• Beginning inventories of each month are budgeted at 40% of that particular month’s projected cost of goods sold.

Required: Determine the following:

1. Projected merchandise purchases for the month of October. 105,000
2. Projected merchandise purchases for the month of November. 136,000

Note: Remember that the Beginning Inventory of the next period is the Ending Inventory of the prior period

Budgeted Cash Flow Statement

Review of Cash Flows

Cash, Beg XX
Cash, End (XX)
Net Increase / Decrease XX

The Net Increase / Decrease must be explained in the Cash Flow Statement with the three activities
• Operating
o Cash involved in the operation
o Revenues and Expenses
• Investing
o From sale/acquisition of Fixed Assets - PPE
• Financing
o Investment of owners or financing talaga
o Nontrade liabilities and equity

Illustration: Budgeted Cash Flow Statement

The following information is taken from Swan Corporation’s accounting records for the year ended December 31, 2014. These data
would be used as the basis for the next year’s cash budget.
1. Customer sales receipts for P870,000. Operating + 7. Issued 500 shares of common stock for P250,000.
2. Purchased machinery & equipment for P125,000 cash. Financing +
Investing - 8. Paid a sum of P100,000 due to suppliers and payroll to
3. Settled income taxes of P110,000. Operating - employees. Operating -
4. Sold investment securities for P500,000. Investing + 9. Purchased real estate for P550,000 cash that was
5. Paid dividends of P600,000. Financing - borrowed from a bank. Investing – and Financing +
6. Received rentals of P105,000. Operating + 10. Paid P450,000 for treasury shares. Financing -

Required: Determine the following:

1. Net cash provided by operating activities. 765,000 3. Net cash used in financing activities. – 250,000
2. Net cash used in investing activities. – 175,000 4. Net cash increase or decrease 340,000

1. 870,000 – 110,000 + 105,000 – 100,000 = 765,000

2. -125,000 + 500,000 – 550,000 = - 175,000
3. - 600,000 + 250,000 + 550,000 – 450,000 = - 250,000
4. 765,000 – 175,000 – 250,000 = 340,000
Note: Negative Values are Outflows and Positive Values are Inflows
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 EXERCISES - BUDGETING

1. The master budget usually begins with the

a. Production budget b. Operating budget c. Financial budget d. Sales budget

2. The production budget process usually begins with the

a. Direct labor budget b. Direct materials budget c. FOH budget d. Sales budget

3. All of the following are considered operating budgets, except the

a. Sales budget b. Materials budget c. Production budget d. Capital budget

o Operating budgets are those in the Income Statement

4. Which of these budgets is usually prepared first?

a. Production budget b. Mat. purchases budget c. Cash disb. budget d. Cash budget

5. Hawaii Inc. has projected sales to be P260,000 in June, P270,000 in July and P300,000 in August. Hawaii collects 30% of a
month’s sales in the month of sale, 50% in the month following the sale, and 20% in the second month following the sale.
What is the accounts receivable balance on August 31?
a. P90,000 b. P210,000 c. P264,000 d. Some other amount

6. Arizona, Inc. has projected sales: February, P10,000; March, P9,000; April, P8,000; May, P10,000; and June, P11,000.
Arizona has 30% cash sales and 70% sales on account. Accounts are collected 40% in the month following the sale and 55%
collected the second month. What would be the total cash receipts in May?
a. P3,000 b. P8,150 c. P8,705 d. Some other amount

7. The Ohio Company has the following historical pattern on its credit sales: 70% are collected in the month of sale, 15% in the
month following the sale, 10% in the second following month and 4% in the third following month. Ohio Company has
budgeted the following sales:
July P 60,000 October P 90,000
August 70,000 November 100,000
September 80,000 December 85,000

What would be the estimated total cash collections during the fourth quarter from sales made on open account during the
fourth quarter?
a. P172,500 b. P230,000 c. P251,400 d. P265,400

8. Alabama Consortium is constructing a corporate planning model. Cash sales are 30% of the company’s sales, with the
remainder subject to the following collection pattern:
One month after sale 60% Three months after sale 8%
Two months after sale 30% Uncollectible 2%

If Sn is defined as total assets in month ‘n’, which of the following expressions correctly describes Alabama’s collection on
account in any given month?
a. 0.6 S n-1 + 0.3 S n-2 + 0.08 S n-3 c. 0.42 S n-1 + 0.21 S n-2 + 0.056 S n-3
b. 0.42 S n+1 + 0.21 S n+2 + 0.056 S n+3 d. 0.6 S n-1 + 0.3 S n-2 + 0.08 S n-3 – 0.02 S

o From sales one month before (n-1) = 60% x 70% = 0.42

o From sales two months before (n-2) = 30% x 70% = 0.21
o From sales three months before (n-3) = 8% x 70% = 0.056

9. Nevada Company manufactures a single product. Nevada keeps inventory of raw materials at 50% of the coming month’s
budgeted production needs. Each unit of product requires three pounds of materials. The production budget is, in units: May
1,000; June, 1,200; July, 1,300; August, 1,600.

Determine the raw materials purchases in July.

a. 1,450 pounds b. 2,400 pounds c. 3,900 pounds d. Some other amount

“Each unit of production requires three pounds of materials” = 3:1 Ratio for RM Used to the Production

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10. Georgia Co. has projected sales to be P60,000 in January, P75,000 in February, and P80,000 in March. Georgia wants to
have 25% of next month’s sales needs on hand at the end of a month.

If Georgia has an average gross profit of 40%, what are the February purchases?
a. P30,500 b. P45,750 c. P46,250 d. P76,250

11. Philadelphia Company has budgeted sales of 24,000 finished units for the forthcoming 6-month period. It takes 4 lbs. of direct
materials to make one finished unit. Given the following:
Finished Units Direct Materials (pounds)
Beginning inventory 14,000 44,000
Target ending inventory 12,000 48,000

How many pounds of direct materials should be budgeted for purchase during the 6-month period?
a. 92,000 b. 88,000 c. 96,000 d. 100,000

12. Michigan Merchandising is preparing its cash budget for January 2015 and made the following projections:
Sales P 1,500,000 Decrease in inventories P 70,000
Gross profit rate 25% Decrease in Trade Accounts Payable 120,000

For January 2015, what were the estimated cash disbursements for inventories?
a. P935,000 b. P1,050,000 c. P1,055,000 d. P1,175,000

13. Comparing actual results with a budget based on achieved volume is possible with the use of a
a. Monthly budget b. Master budget c. Rolling budget d. Flexible budget

14. Texas Company has prepared the following flexible budget for production costs: costs = P340,000 + P9X, where X is the
number of units produced. Texas produced 20,000 units at a total cost of P490,000.

What is the variance of actual costs from budgeted costs?

a. P150,000 F b. P30,000 F c. P30,000 U d. P90,000 U

15. The use of standard costs in the budgeting process signifies that an organization has most likely implemented a
a. Flexible budget b. Capital budget c. Zero-based budget d. Static budget

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16. A type of budget plan that is updated monthly or quarterly and where one month or quarter is dropped, another is added is
called:
a. Master budget c. Continuous budget
b. Operating and financial budget d. Zero-based budget

17. The most important budget in the master budget is likely the
a. Cash budget b. Capital budget c. Personnel budget d. Purchases budget

18. A common starting point in the budgeting process is

a. expected future net income c. total market size
b. past performance d. a clean slate, with no expectations

19. A budget that includes costs for the actual number of units produced is called a
a. Master budget b. Summary cash budget c. Static budget d. Flexible budget

20. Using the concept of “expected value” in sales forecasting means that the sales forecast to be used is
a. developed using the indicator method c. based on expected selling prices of the products
b. the sum of the sales expected by individual managers d. based on probabilities