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Chapter 7 Lecture Notes
12
4. The fourth step is to calculate the materials
to be purchased for May (221,500 pounds).
Notice:
a. April’s desired ending inventory
becomes May’s beginning inventory.
5. The fifth step is to calculate the materials to
be purchased for June (142,000 pounds) and
to calculate the quarterly totals. Notice:
a. We are assuming a desired ending
inventory for June of 11,500 pounds.
b. April’s beginning inventory and
June’s ending inventory carry over to
the “Quarter” column.
Helpful Hint: Tell the students that the inventory
purchases budget or the raw materials purchase budget
are really just the elements of a cost of goods sold
schedule in a different order.
ii. Assume the information as shown regarding
Royal’s expected cash disbursements for materials.
1. The first step in calculating Royal’s cash
disbursements is to insert the beginning
accounts payable balance ($12,000) into
the April column of the cash disbursements
schedule.
a. This balance will be paid in full in
April.
2. The second step is to calculate the April
credit purchases that will be paid during
each month of the quarter.
a. $28,000 ($56,000 × 50%) will be
paid in April and $28,000 ($56,000 ×
50%) will be paid in May.
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Chapter 7 Lecture Notes
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(1). The $56,000 is derived by
multiplying 140,000 pounds by
the $0.40 per pound purchase
price.
Quick Check – cash disbursements calculations
3. The remaining steps include:
a. Calculating the May and June credit
purchases that are paid during each
month of the quarter.
b. Calculating the totals for all columns
in the schedule and the total for the
quarter ($185,000).
Learning Objective 7-5: Prepare a direct labor budget.
D. The direct labor budget
i. Assume the information as shown to enable the
preparation of Royal’s direct labor budget which
enables the company to match its direct labor hours
provided with its production needs.
1. The first step in preparing the direct labor
budget is to insert the production in units
from the production budget.
2. The second step is to compute the direct
labor hours required to meet the production
needs. Notice:
a. 0.05 direct labor hours are needed per
unit.
3. The third step, in this particular example, is
to compute the direct labor hours paid.
Notice:
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Chapter 7 Lecture Notes
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a. In this example, there are
guaranteed labor hours that will be
paid for regardless of production
needs.
4. The fourth step is to compute the total
direct labor cost. Notice:
a. With direct labor, we computed all
three months at the same time. This is
because there is no beginning and
ending inventory to consider.
Quick Check – direct labor cost calculations
Learning Objective 7-6: Prepare a manufacturing
overhead budget.
E. The manufacturing overhead budget
i. Assume the information as shown to enable the
preparation of Royal’s manufacturing overhead
budget. This budget provides a schedule of all
costs of production other than direct materials and
direct labor.
1. The first step in preparing the
manufacturing overhead budget is to
calculate the variable manufacturing
overhead costs for each month and in total.
Notice:
a. The direct labor hours required is
taken directly from the direct labor
budget.
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Chapter 7 Lecture Notes
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2. The second step is to add the fixed
manufacturing overhead costs ($50,000 per
month) to the variable overhead costs to
arrive at total manufacturing overhead costs
for each month and in total. Notice:
a. We can determine the predetermined
overhead rate for the quarter
($49.70).
b. Once the level of fixed costs has been
determined in the budget, the costs
really are fixed; hence, the time to
adjust fixed costs is during the
budgeting process.
3. The third step is to calculate the cash
disbursements for manufacturing overhead
by subtracting noncash expenses from the
total manufacturing overhead costs
computed in step two.
a. In this example, $20,000 of
depreciation is deducted from each
month’s total overhead costs to arrive
at the cash disbursements for
manufacturing overhead costs.
Helpful Hint: Have the students trace the amounts from
the raw materials purchase, direct labor, and
manufacturing overhead budgets to the cash budget.
Information from some of the budgets is needed by
more than one individual—in this case the
manufacturing department—and the controller would
require the information from these budgets.
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Chapter 7 Lecture Notes
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F. The ending finished goods inventory budget
i. Now Royal can complete the ending finished goods
inventory budget.
1. The first step in preparing this budget is to
compute the direct materials cost per unit
($2.00).
a. The information needed can be
derived by referring back to the direct
materials budget.
2. The second step is to compute the direct
labor cost per unit ($0.50).
a. The information needed can be
derived by referring back to the direct
labor budget.
3. The third step is to compute the
manufacturing overhead cost per unit
($2.49) and the total inventoriable cost per
unit ($4.99). Notice:
a. Royal is using an absorption costing
approach to valuing its inventory.
b. The quantities shown for direct labor
and manufacturing overhead are the
same (0.05 hours) because direct
labor hours is the overhead allocation
base.
c. The predetermined overhead rate was
calculated when we prepared the
manufacturing overhead budget.
4. The fourth step is to calculate the value of
the ending finished goods inventory
($24,950). Notice:
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Chapter 7 Lecture Notes
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a. The ending inventory in units (5,000)
is derived from the production
budget.
Learning Objective 7-7: Prepare a selling and
administrative expense budget.
G. The selling and administrative expense budget
i. Assume the information as shown to enable the
preparation of Royal’s selling and administrative
expense budget. This budget lists the budgeted
expenses for areas other than manufacturing and it
is typically a compilation of many smaller,
individual budgets.
1. The first step in preparing this budget is to
multiply the variable S & A rate by the
number of units sold.
2. The second step is to add in the fixed S & A
expenses to arrive at total S & A expenses.
3. The third step is to deduct noncash S & A
expenses to arrive at cash disbursements for
S & A expenses.
Quick Check – S & A expense calculations
4. The same steps are followed for the months
of May and June to arrive at total cash
disbursements for S & A expenses for the
quarter of $230,000.
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Chapter 7 Lecture Notes
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Learning Objective 7-8: Prepare a cash budget.
H. The cash budget
i. The format of the cash budget
1. This budget should be broken down into
time periods that are as short as feasible. It
consists of four major sections:
a. The receipts section lists all cash
inflows excluding cash received from
financing.
b. The disbursements section consists
of all cash payments excluding
repayments of principal and interest.
c. The cash excess or deficiency
section determines if the company
will need to borrow money or if it
will be able to repay funds previously
borrowed.
d. The financing section details the
borrowings and repayments projected
to take place during the budget
period.
Helpful Hint: The idea that the cash budget should
cover time periods as a short as possible should be
understood by students with checking accounts.
Fluctuations in cash flows can lead to a negative
balance during the month even though the balance is
positive at both the beginning and end of the month.
ii. Assume the information as shown to enable the
preparation of Royal’s cash budget.
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Chapter 7 Lecture Notes
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1. The first step in preparing this budget is to
calculate the total cash available ($210,000).
Notice:
a. The cash collections for April
($170,000) come from the schedule
of expected cash collections.
2. The second step is to calculate the total cash
disbursements ($230,000). Notice:
a. Each cash disbursement, except
dividends, comes from a schedule or
budget that had already been
prepared.
3. The third step is to calculate the excess
(deficiency) of cash available over
disbursements ($20,000).
4. The fourth step is to determine the
financing requirements and the ending cash
balance. Notice:
a. Because Royal maintains a $30,000
cash balance, it must borrow
$50,000 on its line-of-credit.
b. The ending cash balance ($30,000)
coincides with Royal’s minimum
requirement.
c. The ending cash balance for April
will carry forward to become the
beginning balance for May.
5. These four steps are repeated for the month
of May. The result is a $30,000 excess of
cash available over disbursements for May.
a. Since Royal must maintain a
minimum cash balance of $30,000, it
will not repay any of its loan in May.
Quick Check – cash budgeting calculations
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Chapter 7 Lecture Notes
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6. The same four steps are repeated for June.
The result is an excess of cash available of
$95,000.
a. This excess enables Royal to repay
the $50,000 in principal that was
borrowed plus interest on the loan of
$2,000 ($50,000 × 16% × 3/12).
b. The ending cash balance for the
quarter is $43,000.
7. Once the cash budget has been completed,
the budgeted income statement can be
prepared. The cash budget must be prepared
first so that the interest expense can be
determined for the budgeted income
statement.
Learning Objective 7-9: Prepare a budgeted income
statement.
I. The budgeted income statement
i. The numbers for the budgeted income statement
come from other budgets that have already been
prepared. More specifically:
1. The sale revenue comes from the sales
budget.
2. The cost of goods sold, on a per unit basis,
comes from the ending finished goods
inventory budget.
3. The selling and administrative expenses
come from the selling and administrative
expenses budget.
4. The interest expense comes from the cash
budget.
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Chapter 7 Lecture Notes
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Helpful Hint: Indicate that, for simplicity, income taxes
were not included in these budgets, but taxes must be
considered in a company’s budgeting process.
Learning Objective 7-10: Prepare a budgeted balance
sheet.
J. The budgeted balance sheet
i. Assume the information as shown to enable the
preparation of the budgeted balance sheet.
1. The budgeted balance sheet is prepared as
follows:
a. Cash ($43,000) is taken from the
ending cash balance of the cash
budget.
b. Accounts Receivable ($75,000) is
25% of June’s sales ($300,000).
c. Raw materials inventory ($4,600) is
calculated by multiplying the ending
inventory of raw material in pounds
(11,500) by the cost per pound
($0.40).
d. The finished goods inventory
($24,950) is taken from the ending
finished goods inventory budget.
e. Land, equipment, and common stock
are all given.
f. Accounts payable ($28,400) is 50%
of June’s purchases ($56,800).
g. The ending retained earnings
($336,150) is calculated by adding
net income ($239,000) to the
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Chapter 7 Lecture Notes
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beginning retained earnings
($146,150), and then subtracting
dividends ($49,000).
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