BUDGET - is a realistic quantitative plan useful for planning and controlling company expenses, cash

flows and earnings for a specific period. The term budgeting refers to the process of coming up with
budgets.
Terms and Definition:
BUDGET PERIOD The length of time for which a budget is to be
prepared and implemented
BUDGET COMMITTEE Key management personnel responsible for drafting
the budget manual, and coordinating/approving
budgets submitted by managers.
BUDGET MANUAL A written description on how to prepare budgets
that includes a planning calendar and distribution
instructions for budget schedules.
BUDGETARY CONTROL Involves the use of budgets to control the actual
activities of a firm.
AUTHORITATIVE BUDGETING A process wherein budgets are prepared by top
management with little or no inputs from operating
(Top-Down Budgeting)
personnel (i.e., imposed budgeting)
PARTICIPATORY BUDGETING A process wherein budgets are developed through
joint decisions by top management and operating
(Bottom-Up Budgeting)
personnel (i.e., consensus budgeting)
ZERO-BASED BUDGETING A process of starting over each budget and
justifying each budgeted item as if the programs
involved were being proposed for the first time
every period
CONTINUOUS BUDGET An incremental budget that adds the current period
and drops the older period to maintain a constant
(Rolling Budget)
budget period of usually 12 months.
KAIZEN BUDGETING A process that assumes continuous improvement of
products and/or processes so that budgets are not
based on existing system but on changes to be made.
ACTIVITY BASED BUDGETING A process that applies mostly Activity-Based
Costing (ABC) principles and procedures to come
up with budgets
LIFE-CYCLE BUDGETING A process wherein a product’s revenues and
expenses are budgeted over its entire life cycle from
R&D to production to marketing to customer
 service.
STRATEGIC BUDGET A long-term budget based on the identifications of
action plans to achieve company goals and,
ultimately, its mission.
BUDGETARY SLACK A practice of underestimating revenues or
overestimating costs to make budget targets easily
achievable in order to project a seemingly favorable
performance.
STATIC BUDGET A budget prepared for a single level of activity that
does not change even when actual activity differs
(Fixed Budget)
from planned activity.
FLEXIBLE BUDGET A budget that adjusts revenues and costs when
actual activity differs from the planned activity
(Variable Budget)
stated in the fixed budget.
MASTER BUDGET A static budget that is based on the comprehensive
plan for the overall activities of a company. The
(Pro-Forma Budget)
major components of a master budget are:
(Comprehensive Budget)
 OPERATING budget – sales forecast, sales
budget, production budget, inventory budget, CGS
budget, selling & administrative expense budget
 FINANCIAL budget – cash budget, working
capital budget, capital expenditures budget*, pro-
forma balance sheet, pro-forma statement of cash
flows

* The capital expenditures budget, prepared mainly

for the acquisition and maintenance of long-term
assets, may be shown as a separate major
component of the master budget, alongside
operating and financial budgets.

Major benefits gained from budgeting:

a. Budgets provide a means of communicating management’s plans throughout the
organization.
b. Budgets force managers to think about and plan for the future.
c. The budgeting process provides a means of allocating resources to those parts of the
organization where they can be most effectively used.
 d. The budgeting process can uncover potential bottlenecks before they occur.
e. Budgets coordinate the activities of the entire organization by integrating the plans of the
various parts. Budgeting helps to ensure that everyone in the organization is pulling in the
same direction.
f. Budgets define goals and objectives that can serve as benchmarks for evaluating
subsequent performance.
Reasons for budgeting:
Budgeting forces managers to plan, provides resource information for decision making,
sets benchmarks for control and evaluation, and improves the functions of communication and
coordination.

EXERCISES
Exercise 1
A company makes one product and it provided the following information to help prepare the
master budget:
● The budgeted selling price per unit is P70. Budgeted unit sales for June, July, August,
and September are 8,400, 10,000, 12,000, and 13,000 units, respectively. All sales are on
credit.
● Forty percent of credit sales are collected in the month of the sale and 60% in the
following month.
● The ending finished goods inventory equals 20% of the following month’s unit sales.

● The ending raw materials inventory equals 10% of the following month’s raw materials
production needs. Each unit of finished goods requires 5 pounds of raw materials. The
raw materials cost P2.00 per pound.
● Thirty percent of raw materials purchases are paid for in the month of purchase and 70%
in the following month.
● The direct labor wage rate is P15 per hour. Each unit of finished goods requires two
direct labor-hours.
● The variable selling and administrative expense per unit sold is P1.80. The fixed selling
and administrative expense per month is P60,000.

Required:
1. What are the budgeted sales for July?
2. What are the expected cash collections for July?
3. What is the accounts receivable balance at the end of July?
4. According to the production budget, how many units should be produced in July?
 5. If 61,000 pounds of raw materials are needed to meet production in August, how
many pounds of raw materials should be purchased in July?
6. What is the estimated cost of raw materials purchases for July?
7. In July what are the total estimated cash disbursements for raw materials purchases?
Assume the cost of raw material purchases in June is P88,880.
8. What is the estimated accounts payable balance at the end of July?
9. What is the estimated raw materials inventory balance at the end of July?
10. What is the total estimated direct labor cost for July assuming the direct labor
workforce is adjusted to match the hours required to produce the forecasted number
of units produced?
11. If we assume that there is no fixed manufacturing overhead and the variable
manufacturing overhead is P10 per direct labor-hour, what is the estimated unit
product cost?
12. What is the estimated finished goods inventory balance at the end of July?
13. What is the estimated cost of goods sold and gross margin for July?
14. What is the estimated total selling and administrative expense for July?
15. 15. What is the estimated net operating income for July?

Exercise 2

The following data relate to the operations of JKL Company, a wholesale distributor of
consumer goods:

Current assets as of March 31:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P8,000
Accounts receivable . . . . . . . . . . . . . . . . P20,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . P36,000
Building and equipment, net . . . . . . . . . . . P120,000
Accounts payable . . . . . . . . . . . . . . . . . . . . . P21,750
Common stock . . . . . . . . . . . . . . . . . . . . . . . P150,000
Retained earnings . . . . . . . . . . . . . . . . . . . . P12,250

a. The gross margin is 25% of sales.

b. Actual and budgeted sales data:
March (actual) . . . . . . . . . . . . . . P50,000
April . . . . . . . . . . . . . . . . . . . . . . P60,000
May . . . . . . . . . . . . . . . . . . . . . . . P72,000
June . . . . . . . . . . . . . . . . . . . . . . P90,000
July . . . . . . . . . . . . . . . . . . . . . . . P48,000

c. Sales are 60% for cash and 40% on credit. Credit sales are collected in the month
following sale. The accounts receivable at March 31 are a result of March credit sales.
d. Each month’s ending inventory should equal 80% of the following month’s budgeted cost
of goods sold.
 e. One-half of a month’s inventory purchases is paid for in the month of purchase; the other
half is paid for in the following month. The accounts payable at March 31 are the result
of March purchases of inventory.
f. Monthly expenses are as follows: commissions, 12% of sales; rent, P2,500 per month;
other expenses (excluding depreciation), 6% of sales. Assume that these expenses are
paid monthly. Depreciation is P900 per month (includes depreciation on new assets).
g. Equipment costing P1,500 will be purchased for cash in April.
h. Management would like to maintain a minimum cash balance of at least P4,000 at the end
of each month. The company has an agreement with a local bank that allows the company
to borrow in increments of P1,000 at the beginning of each month, up to a total loan
balance of P20,000. The interest rate on these loans is 1% per month and for simplicity
we will assume that interest is not compounded. The company would, as far as it is able,
repay the loan plus accumulated interest at the end of the quarter.

Required:
Using the preceding data, complete the following:

1. Schedule of Expected Cash Collections

April May June Quarter
Cash sales . . . . . . . . . . . . . . . . . . . . . . . . . P 36,000
Credit sales . . . . . . . . . . . . . . . . . . . . . . . . P20,000
Total collections . . . . . . . . . . . . . . . . . . . . P56 ,000

2. Merchandise Purchases Budget

April May June Quarter
Budgeted cost of goods sold . . . . . . . . . P 45,000* P54,000
Add desired ending inventory . . . . . . . . 43,200**
Total needs . . . . . . . . . . . . . . . . . . . . . . . P 88,200
Less beginning inventory . . . . . . . . . . . . 36,000
Required purchases . . . . . . . . . . . . . . . . . P 52,200
*For April sales: P60,000 sales × 75% cost ratio = P45,000.
**54,000 × 80% = P43,200

3. Schedule of Expected Cash Disbursements—Merchandise Purchases

April May June Quarter
March purchases . . . . . . . . . . . . . . . . . . . .P 21,750 P21,750
April purchases . . . . . . . . . . . . . . . . . . . . . . 26,100 P26,100 52,200
May purchases . . . . . . . . . . . . . . . . . . . . . .
June purchases . . . . . . . . . . . . . . . . . . . . .
Total disbursements . . . . . . . . . . . . . . . . . . P 47,850

4. Cash Budget
April May June Quarter
Beginning cash balance . . . . . . . . . . . . . . . . . . .P 8,000
Add cash collections . . . . . . . . . . . . . . . . . . . . . . 56,000
Total cash available . . . . . . . . . . . . . . . . . . . . . . .64,000
 Less cash disbursements:
For inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,850
For expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 13,300
For equipment . . . . . . . . . . . . . . . . . . . . . . . . . 1,500
Total cash disbursements . . . . . . . . . . . . . . . . . . 62,650
Excess (deficiency) of cash . . . . . . . . . . . . . . . . . 1,350
Financing:
Etc.

5. Prepare the budgeted income statement.

6. Prepare the budgeted balance sheet as of June 30.

Exercise 3

You have just been hired as a new management trainee by LMN, a distributor of earrings to
various retail outlets located in shopping malls across the country. In the past, the company has
done very little in the way of budgeting and at certain times of the year has experienced a
shortage of cash. Since you are well trained in budgeting, you have decided to prepare a master
budget for the upcoming second quarter. To this end, you have worked with accounting and
otherareas to gather the information assembled below.

The company sells many styles of earrings, but all are sold for the same price—P10 per pair.
Actual sales of earrings for the last three months and budgeted sales for the next six months
follow
(in pairs of earrings):

January (actual) . . . . . . . . . . . . . . 20,000 June (budget) . . . . . . . . . . . . . . . . 50,000

February (actual) . . . . . . . . . . . . . 26,000 July (budget) . . . . . . . . . . . . . . . . . 30,000
March (actual) . . . . . . . . . . . . . . . 40,000 August (budget) . . . . . . . . . . . . . . 28,000
April (budget) . . . . . . . . . . . . . . . 65,000 September (budget) . . . . . . . . . . . 25,000
May (budget) . . . . . . . . . . . . . . . . 100,000

The concentration of sales before and during May is due to Mother’s Day. Sufficient inventory
should be on hand at the end of each month to supply 40% of the earrings sold in the following
month. Suppliers are paid P4 for a pair of earrings. One-half of a month’s purchases is paid for in
the month of purchase; the other half is paid for in the following month. All sales are on credit.
Only 20% of a month’s sales are collected in the month of sale. An additional 70% is collected in
the following month, and the remaining 10% is collected in the second month following sale.
Bad debts have been negligible.

Monthly operating expenses for the company are given below:

Variable:
Sales commissions . . . . . . . . . . . . . . . . . 4% of sales
Fixed:
Advertising . . . . . . . . . . . . . . . . . . . . . . . P200,000
 Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P18,000
Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . P106,000
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . P7,000
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . P3,000
Depreciation . . . . . . . . . . . . . . . . . . . . . . P14,000

Insurance is paid on an annual basis, in November of each year. The company plans to purchase
P16,000 in new equipment during May and $40,000 in new equipment during June; both
purchases will be for cash. The company declares dividends of P15,000 each quarter, payable in
the first month of the following quarter.

The company’s balance sheet as of March 31 is given below:

Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 74,000
Accounts receivable (P26,000 February sales; P320,000 March sales) . . . . . 346,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104,000
Prepaid insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,000
Property and equipment (net) . . . . . . . . . . . . . . . . . . . . . . . . . . 950,000
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 1,495,000
Liabilities and Stockholders’ Equity
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 100,000
Dividends payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 580,000
Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . P 1,495,000

The company maintains a minimum cash balance of P50,000. All borrowing is done at the
beginning of a month; any repayments are made at the end of a month. The company has an
agreement with a bank that allows the company to borrow in increments of P1,000 at the
beginning of each month. The interest rate on these loans is 1% per month and for simplicity we
will assume that interest is not compounded. At the end of the quarter, the company would pay
the bank all of the accumulated interest on the loan and as much of the loan as possible (in
increments of P1,000), while still retaining at least P50,000 in cash.

Required:
Prepare a master budget for the three-month period ending June 30. Include the following
detailed

1. a. A sales budget, by month and in total.

b. A schedule of expected cash collections, by month and in total.
c. A merchandise purchases budget in units and in dollars. Show the budget by month
and
in total.
d. A schedule of expected cash disbursements for merchandise purchases, by month and
in total.
2. A cash budget. Show the budget by month and in total. Determine any borrowing that
would be needed to maintain the minimum cash balance of P50,000.

3. A budgeted income statement for the three-month period ending June 30. Use the
contribution approach.

4. A budgeted balance sheet as of June 30.