REVIEWER: CHAPTER 9 – BUDGETARY
PLANNING
PLANNING – one of the management’s major
responsibilities. A process of establishing
company-wide objectives.
MINIMUM TRANSFER PRICE = Opportunity cost
+ variable cost
BUDGETING BASICS
BUDGET – a formal written statement of
management’s plans for specified future time
period, expressed in financial terms.
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Primary way to communicate agreedupon objectives to all parts of the
company.
Promotes efficiency
Control device – important basis for
performance evaluation once adopted.
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Which of the following is not a benefit of
budgeting? It enables disciplinary action to be
taken at every level of responsibility
ESSENTIALS OF EFFECTIVE BUDGETING
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Historical accounting data on revenues,
costs, and expenses helps in
formulating future budgets.
Accountants normally responsible for
presenting management’s budget goals
in financial terms.
The budget and its administration are
the responsibility of management.
BENEFITS
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Requires all level 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
Results in greater management
awareness of the entity’s overall
operations
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
LENGTH OF THE BUDGET PERIOD
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BUDGET and ACCOUNTING
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Motivates personnel throughout
organization to meet planned
objectives
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May be prepared for any period of time
➢ One year – most common
➢ 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
THE BUDGET PROCESS
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Based 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
Factors considered in SALE
FORECASTING:
1. General economic conditions
2. Industry trends
3. Market research studies
4. Anticipated advertising and
promotion
5. Previous market share
6. Price changes
7. Technological developments
BUDGETING AND HUMAN BEHAVIOR
Participative Budgeting: each level of
management should be invited to participate
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May inspire higher levels of
performance or discourage additional
effort
Depends on how budget developed and
administered
ADVANTAGES:
➢ More accurate budget estimates
because lower-level managers have
more detailed knowledge of their
area
➢ Tendency to perceive process as
fair due to involvement of lowerlevel management
OVERALL GOAL – produce budget
considered fair and achievable by
managers while still meeting corporate
goals
Risk of unreliable budgets greater when
they are “top-down”
DISADVANTAGES
➢ Can be time consuming and
costly
➢ can foster budgetary “gaming”
through budgetary slacks
BUDGETING AND LONG-RANGE PLANNING
Three basic differences:
1. Time period involved
➢ budgeting is short-term –
usually one year
➢ long range planning – at least
five years
2. Emphasis
3. Detail presented
REVIEW QUESTION: The essentials of effective
budgeting do not include? Top-down
budgeting
THE MASTER BUDGET
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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 – individual
budgets that result in the
preparation of the budgeted
income statement – establish
goals for sales and production
personnel.
➢ Financial budgets – the capital
expenditures budget, the cash
budget, and the budgeted
balance sheet – focus primarily
on cash needs to fund
operations and capital
expenditures.
REVIEW QUESTION:
1. A SALES FORECAST shows potential
sales for the industry and company’s
expected share of such sales.
2. OPERATING BUDGET are used as the
basis for the preparation of the
budgeted income statement.
3. The MASTER BUDGET is a set of
interrelated budgets that constitutes a
plan of action for a specified time
period.
4. LONG-RANGE PLANNING identifies
long-term goals, selects strategies to
achieve these goals, and develops
policies and plans to implement the
strategies.
5. Lower-level managers are more likely
to perceive results as fair and
achievable under a LONG-RANGE
PLANNING approach.
6. FINANCIAL BUDGET focus primarily on
the cash resources needed to fund
expected operations and planned
capital expenditures.
PREPARING THE OPERATING BUDGETS
PRODUCTION BUDGET
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Shows units that must be produced
to meet anticipated sales
Derived from sales budget plus the
desired change in ending FGI
Essential to have a realistic estimate
of ending inventory.
REQUIRED PRODUCTION UNITS =
budgeted sales units + desired ending
FG units – beginning FG units
DIRECT MATERIALS BUDGET
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Shows both the quantity and cost of
direct materials to be purchased
Formula for direct materials quantities
SALES BUDGET
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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
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Budgeted costs of direct materials to
be purchased = units of DM x
anticipated cost per unit
Inadequate inventories could result in
temporary shutdowns of production
DIRECT LABOR BUDGET
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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 FROMULA:
TDLC = Units to be produced x DL time per
unit x DL cost per hour
REVIEW QUESTION: Sales budget is
management’s best estimate of sales revenue
for the year
BUDGETED INCOME STATEMENT
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MANUFACTURING OVERHEAD BUDGET
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Shows the expected manufacturing
overhead costs for budget period
Distinguishes between fixed and
variable overhead costs
Important end-product of the operating
budgets
Indicated expected profitability of
operations
Provides a basis for evaluating
company performance
Prepared from the operating budgets:
➢ Sales
➢ Direct materials
➢ Direct labor
➢ Manufacturing overhead
➢ Selling and Administrative
expense
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REVIEW QUESTION: Each of the following
budgets is used in preparing the budgeted
income statement except the: Capital
expenditure budget
CASH BUDGET
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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 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
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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
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
Contributes to more effective cash
management
Shows managers the need for
additional financing before actual need
arises
Indicates when excess cash will be
available
REVIEW QUESTION: 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: $78,000
BUDGETING IN NONMANUFACTURING
COMPANIES
MERCHANDISERS
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BUDGETED BALANCE SHEET
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Developed from the budgeted balance
sheet for the preceding year and the
budgets for the current year
Sales Budget: starting point and key
factor in developing the master budget
Use a purchases budget instead of a
production budget.
Does not use the manufacturing
budgets (direct materials, direct labor,
manufacturing overhead)
To determine budgeted merchandise
purchases:
REQUIRED MERCHANDISE PURCHASE =
budgeted COGS + desired ending merchandise
inventory – beginning merchandise inventory
SERVICE ENTERPRISES
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Critical factor in budgeting is
coordinating professional staff needs
with anticipated services.
Problems if overstaffed:
➢ Disproportionately high labor
costs
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➢ 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 workloads.
NOT-FOR-PROFIT ORGANIZATION
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Just as important as for profit-oriented
company
Budget process differs from profitoriented 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
REVIEW QUESTION: The budget for a
merchandiser differs from a budget for a
manufacturer because: A merchandise
purchases budget replaces the production
budget & The manufacturing budgets are not
applicable
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Such as the sales budget or
the manufacturing
overhead budget
Frequency of the report
• Weekly or monthly
Purchase of the report
Receipt(s) of the report
BUDGETARY CONTROL REPORTING SYSTEM
STATIC BUDGET REPORTS
CHAPTER 10 – BUDGETARY CONTROL AND
RESPONSIBILITY ACCOUNTING
BUDGET REPORTS – compare actual results
with planned objectives.
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Provides management with feedback
on operations.
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Projection of budget data at one level
of activity.
Data for different levels of activity are
ignored.
Actual results are always compared
with the budget data at the activity
level in the master budget.
BUDGET AND ACTUAL SALES DATA:
To illustrate the role of a static budget in
budgetary control, we will use selected data
for Hayes Company prepared in Chapter 9.
Budget and actual sales data for the Kitchen
mate product in the first and second quarters
of 2005 are as follows:
Budgetary control works best when a company
has a formalized reporting system. The system
does the following:
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Identify the name of the budget report
SALES BUDGET REPORT: First Quarter
STATIC OVERHEAD BUDGET
SALES BUDGET REPORT: Second Quarter
Borton Steel prepares the above static budget
for manufacturing overhead based on a
production volume of 10,000 units of steel
ingots.
USES AND LIMITATIONS
A static budget evaluates a manager’s
effectiveness in controlling costs when:
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Actual level of activity closely
approximates the master budget
activity level, and/or
Behavior of the costs in response to
changes in activity is fixed.
FLEXIBLE BUDGET – are static budgets at
different activity level.
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Is a projects budget data for various
levels of activity.
recognizes that the budgetary process is
more useful if it is adaptable to changed
operating conditions.
If demand for steel ingots has increased and
12,000 units are produced during the year,
rather than 10,000, the budget report will
show very large variances. This is because the
comparison is based on budget data based on
the original activity level (10,000 steel ingots).
Variable budget allowances have increased
with production.
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It indicates that the Assembly
Department is significantly over budget
for three of the six overhead costs.
There is a total unfavorable difference
of $132,000, which is 12% over budget
($132,000 / $1,100,000).
DEVELOPING THE FLEXIBLE BUDGET
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VARIABLE COSTS PER UNIT
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Identify the activity index and the
relevant range of activity.
Identify the variable costs, and
determine the budgeted variable cost
per unit of activity for each cost
Identify the fixed costs, and determine
the budgeted amount for each cost.
Prepare the budget for selected
increments of activity within the
relevant range.
SAMPLE ILLUSTRATION:
Fox Company wants to use a flexible budget
for monthly comparisons of actual and
budgeted manufacturing overhead costs. The
master budget for the year ended December
31, 2005 is prepared using 120,000 direct labor
hours and the following overhead costs.
STEP 1: Identify the activity index and the
relevant range of activity.
The activity index is direct labor hours and
management concludes that the relevant
range is 8,000-12,000 direct labor hours.
STEP 2: Identify the variable costs and
determine the budgeted variable cost per unit
of activity for each cost.
There are 3 variable costs and the per unit
variable cost is found by dividing each total
budgeted cost by the direct labor hours used in
preparing the master budget (120,000 hours).
This budget report based on the flexible
budget for 12,000 units of production shows
that the Forging Department is below
budget-a favorable difference.
STEP 3: Identify the fixed costs and determine
the budgeted amount for each cost.
There are three fixed costs and since Fox
desires monthly budget data, the budgeted
amount is found by dividing each annual
budgeted cost by 12 ($180,000/12 =$15,000).
FLEXIBLE BUDGET REPORT
Another type of internal report produced by
managerial accounting. Two sections:
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Production data such as direct labor
hours
Cost data for variable and fixed costs
Flexible budgets are used to evaluate a
manager’s performance in production control
and cost control.
MANAGEMENT BY EXCEPTION
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STEP 4: Prepare the budget for selected
increments of activity within the relevant
range.
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Review of a budget report
➢ Focus on differences between
actual results and planned
objectives
Guidelines for identifying an exception
➢ Materiality – expressed as a
percentage difference from
budget
➢ Controllability – more
restrictive for controllable items
than for items that are not
controllable by manager.
RESPONSIBILITY ACCOUNTING – involves
accumulating and reporting costs (and
revenues, where relevant) on the basis of the
manager who has the authority to make the
day-to-day decisions about the items.
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Used at every level of management in
which the following conditions exist:
➢ Costs and revenues associated
with the specific level of
management responsibility.
➢ The costs and revenues are
controllable at the level of
responsibility with which they
are associated.
➢ Budget data can be developed
for evaluating the manager's
effectiveness in controlling the
costs and revenues.
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Valuable in a decentralized company.
Decentralization – control of
operations delegated to many
managers throughout the organization
Segment – an identified area of
responsibility in decentralized
operations
Responsibility accounting differs from
budgeting in two respects: Distinction
between controllable and
noncontrollable items
➢ Controllable – manager has the
power to incur it within a given
period of time.
➢ Noncontrollable – costs
incurred indirectly and
allocated to a responsibility
level.
Performance reports – either
emphasize or include only items
controllable by the individual manager
Involves preparation of a report for
each level of responsibility in the
company's organization chart.
Permits management by exception at
each level of responsibility.
INVESTMENT CENTER – the manager can
control or significantly influence the investment
funds available for use
NECESSARY TO DISTINGUISH BETWEEN DIRECT
AND INDEIRECT FIXED COSTS:
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Direct fixed costs or traceable costs
➢ costs that relate specifically to a
responsibility center and are
incurred for the sole benefit of
the center.
Indirect fixed costs
➢ pertain to a company's overall
operating activities
➢ incurred for the benefit of more
than one profit center
➢ most indirect costs are not
controllable by the profit center
manager.
Return on Investment (ROI)
➢ Basis for evaluating the performance of
a manger of an investment center
➢ considered superior to any other
performance measurement
➢ shows the effectiveness of the manager
in utilizing the assets at his or her
disposal
The return-on-investment approach includes
two judgmental factors:
COST CENTER – usually a production or service
center
PROFIT CENTER – the operating revenues and
variable expenses are controllable by the
manager of the profit center.
1. Valuation of operating assets –
operating assets may be valued at
acquisition cost, book value, appraised
value, or market value.
2. Margin (income) measure – this
measure may be controllable margin,
income from operations, or net income.
Operating assets
➢ Current assets and plant assets used in
operations by the center.
(Nonoperating assets such as idle plant
assets and land held for future use are
excluded)
Average operating assets
➢ usually based on the beginning and
ending cost or book values of the assets
Performance evaluation
➢ a management function that compares
actual results with budget goals.
➢ includes both behavioral and reporting
principles.