Study Guide in Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
HRDM Elec 102: Managerial Accounting
Module 7: Operating Budget
Module No. 7
BUDGETING: OPERATING BUDGET
MODULE OVERVIEW
For businesses of all sizes and types, budgets are essential. Government agencies, churches,
hospitals, and other nonprofit groups, for example, use budgets to run their operations. Individuals
and families also utilize budgeting to manage their finances. This topic describes and illustrates
budgeting for a manufacturing company.
LEARNING OBJECTIVES
1.
2.
3.
4.
Understand and define the idea of budgeting.
List the different sorts of budgets and budgeting principles.
Examine the Master Budget and its Sub-Budgets.
Create a budget based on the income statement.
LEARNING CONTENTS
Budgeting Objectives
Budgeting entails (1) creating explicit goals, (2) putting plans in place to attain the goals, and (3)
comparing actual results to the goals on a regular basis. Budgeting has an impact on the following
managerial functions:
 Organizing,
 directing, and
 controlling
Setting goals to guide choices and inspire personnel is part of planning. Often, the planning process
reveals areas where operations could be enhanced. Making judgments and taking steps to attain
budgeted goals is what directing entails. A responsibility center is a budgetary unit of a firm. Each
responsibility center is overseen by a manager who is responsible for fulfilling the center's budgeted
objectives. Controlling entails comparing actual performance to budgeted objectives. Managers and
staff receive feedback on their performance because of these comparisons. Such input can be used
by responsibility centers to adapt their operations in the future if necessary.
Budgeting and Human Behavior
In the budgeting process, the following scenarios can cause human behavior issues:
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
▪ Budgeted goals are set excessively high, making them difficult or impossible to meet.
▪ In the budget, goals are specified excessively broadly, making them relatively easy to achieve.
▪ Budgeted objectives are at contrast with the aspirations of the organization and its personnel.
Setting Budget Objectives That Are Too Strict If budgetary targets are set too high, employees
and supervisors may become disheartened. If projected goals are regarded unrealistic or
impossible, the budget may have a negative impact on the company's ability to achieve its goals..
Employees and managers are more likely to be motivated by reasonable, attainable goals. As a
result, employee and management participation in the budgeting process is crucial. Employee
participation in the budgeting process offers them a sense of control, and as a result, they are more
committed to meeting budgeted goals.
Budgeting Objectives That Are Too Vague Although setting reasonable goals is essential,
planning financial goals that are too simple is not. Budgetary slack is the word for this type of budget
"padding." Budget slack may be built into managers' budgets to give a "cushion" for unanticipated
events. Slack budgets, on the other hand, may lead to inefficiency by lowering the fiscal incentive
to cut spending.
Setting Budget Objectives That Are Incompatible When the self-interest of employees or
management clashes with the company's aims or goals, goal conflict arises. As an example,
suppose the Sales Department manager is assigned a higher sales goal and, as a result, accepts
customers with bad credit. As a result, while the Sales Department may fulfill sales targets, the
overall profitability of the company may be harmed due to bad debts.
Budgeting Systems
Companies and industries have different budgeting procedures. Continuous budgeting is a form of
fiscal-year budgeting that maintains a 12-month projection into the future. The 12-month budget is
updated on a regular basis by substituting the data from the previous month with the data for the
same month the following year.
The process of creating an annual budget normally begins many months before the current year's
end. Normally, a budget committee is in charge of this task. The budget director, controller,
treasurer, production manager, and sales manager are frequently members of such a group. The
Accounting Department, which reports to the committee, oversees and summarizes the budget
process. Budget estimates can be created in a variety of ways. Managers must estimate sales,
production, and other operating data as though activities are being launched for the first time using
an approach known as zero-based budgeting. This method has the advantage of providing a fresh
perspective on operations each year. Starting with last year's budget and revising it for actual
performance and predicted changes for the coming year is a more common technique.
STATIC BUDGET
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
A static budget depicts a responsibility center's predicted results for only one activity level. Even if
the activity changes, the budget is not adjusted once it has been established. Many service
organizations and government agencies, as well as some manufacturing processes including
purchasing, engineering, and accounting, use static budgeting. Static budgets have the
disadvantage of not adjusting for changes in activity levels.
Assume that Colter Manufacturing's Assembly Department spent $70,800 in the fiscal year that
ended on July 31, 2008. As a result, the Assembly Department overspent by $10,800 ($70,800 –
$60,000), or 18% ($10,800 4 $60,000). Is this a good or negative thing? The first thought is that this
is bad news, and that the Assembly Department was inefficient in exceeding its budget. Assume,
however, that the Assembly Department's budget was predicated on the expectation of assembling
8,000 units this year. If 10,000 units were built, the extra $10,800 spent above budget might be a
positive thing. That is, the Assembly Department produced 25% (2,000 units out of 48,000 units)
more than expected for only 18% more money. In this scenario, a fixed budget might not be the
best way to keep costs under control.
FLEXIBLE BUDGET
Flexible budgets, as opposed to static budgets, show a responsibility center's expected results at
varying activity levels. A flexible budget is essentially a set of static budgets for varying levels of
activity.
The following is how a flexible budget is put together:
▪ Step 1. Determine the appropriate activity levels. Units, machine hours, direct labor hours, or
another activity metric could be used to indicate the required activity levels. Exhibit 5 shows three
levels of activity: 8,000, 9,000, and 10,000 units of manufacturing.
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
▪ Step 2. Identify the cost components of the budgeted costs that are constant and variable. Exhibit
5 shows the cost of electric power as a fixed cost ($1,000 per year) and a variable cost ($0.50 per
unit). The supervisor wages are entirely fixed costs, while direct labor is a variable cost.
▪ Step 3. Multiply the variable cost per unit by the activity level, then add the monthly fixed cost to
create the budget for each activity level. Actual expenses for actual activities can be compared to
the budgeted expenditures with a flexible budget.
As an example, suppose the Assembly Department paid $70,800 on 10,000 units. According to
Exhibit 5, the Assembly Department was $200 under budget ($71,000 – $70,800). According to the
table, the Assembly Department was $200 under budget ($71,000 – $70,800). The Assembly
Department was $10,800 above budget under the static budget.
The Assembly Department's flexible budget is far more accurate and valuable than the static
budget. This is due to the flexible budget's ability to react to changes in activity levels. When variable
expenses can be linked to an activity, flexible budgets can be employed in service businesses. For
example, hospital room charges are proportional to the number of patients admitted, and
transportation fuel costs are proportional to the number of miles traveled.
THE MASTER BUDGET
A master budget is a collection of operating and financial budgets for a specific time period. The
majority of businesses create a master budget once a year. The operating budgets can be used to
generate a budgeted income statement, while the financial budgets can be used to prepare a
planned balance sheet, as shown in Exhibit 7.
The operations budgets, which create the budgeted income statement, are the first step in creating
the master budget. The income statement budget is formed by the linkages between the operating
budgets.
The Operating Budget
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
1. Sales Budget - Begin by estimating the amount of sales that will be made. Sales from the
previous year are frequently utilized as a starting point. These sales figures are then
adjusted to account for things like planned advertising and promotion, pricing changes, and
expected industry and general economic conditions.
Budgeted Sales/Revenue = Expected Sales Volume X Expected unit sales price
Elite Accessories Inc., for example, makes wallets and purses that are sold in two regions:
the East and the West. For 20Y1, Elite Accessories forecasts the following sales volumes
and pricing.:
2. Production Budget - To keep production and sales in balance throughout the year, the
production budget should relate to the sales budget. The production budget calculates the
number of units that must be produced to achieve sales targets and inventory levels.
Elite Accessories Inc. anticipates the following wallet and handbag inventories:
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
3. Direct Materials Purchases Budget - To guarantee that production is not disrupted
throughout the year, the direct materials procurement budget should relate to the production
budget. The direct materials purchase budget, which can be developed in three parts,
estimates the amounts of direct materials to be acquired to support budgeted production
and desired inventory levels.
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
PANGASINAN STATE UNIVERSITY
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
So that production is not disrupted, the time of direct materials purchases should be
coordinated between the purchasing and production divisions.
4. Direct Labor Cost Budget - The direct labor cost budget calculates the number of direct
work hours and associated costs required to meet the budgeted output. Production
managers research work practices in order to provide estimations for the direct labor cost
budget.
Step 1 Calculate the budgeted direct labor hours necessary for manufacturing using the
following formula:
Budgeted Direct Labor Hours Required for Production= Budgeted Production Volume ×
Direct Labor Hours Expected per Unit
For example, Elite Accessories Inc.'s production managers predict that a wallet and handbag
will require the following direct work hours:
The budgeted direct labor hours required for production are calculated as follows for the
wallet:
Cutting: 520,000 units × 0.10 hr. per unit = 52,000 direct labor hours
Sewing: 520,000 units × 0.25 hr. per unit = 130,000 direct labor hours
The budgeted direct labor hours required for production of the handbag are calculated as
follows:
Cutting: 292,000 units × 0.15 hr. per unit = 43,800 direct labor hours
Sewing: 292,000 units × 0.40 hr. per unit = 116,800 direct labor hours
Step 2 To calculate the entire direct labor cost, do the following:
Direct Labor Cost = Direct Labor Required for Production (Step 1) × Hourly Rate
The following are the expected direct labor hourly rates for Elite Accessories Inc.'s Cutting
and Sewing divisions in 20Y1:
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
So that there is enough labor available for production, the direct labor needs should be
coordinated between the production and personnel departments.
5. Factory Overhead Cost Budget - The cost of each item of factory overhead required to
sustain planned production is estimated in the factory overhead cost budget.
Departmental schedules may be used to support the plant overhead cost budget. These
schedules usually divide manufacturing overhead costs into fixed and variable costs, making
it easier for department managers to track and assess costs throughout the year. To
guarantee that production is not disrupted throughout the year, the factory overhead cost
budget should be integrated with the production budget.
6. Cost of Goods Sold Budget - The budget for cost of products sold is created by combining
the following budgets:
▪ Direct materials purchases budget
▪ Direct labor cost budget
▪ Factory overhead cost budget
In addition, the cost of goods sold budget must include the expected and desired inventories
for direct materials, work in process, and finished goods.
The following direct materials, work-in-process, and final goods inventories are expected by
Elite Accessories Inc.:
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
Departmental schedules may be able to sustain the plant overhead cost budget mentioned
above. These schedules usually divide manufacturing overhead costs into fixed and variable
costs, making it easier for department managers to track and assess costs throughout the
year. To guarantee that production is not disrupted throughout the year, the factory overhead
cost budget should be integrated with the production budget.
7. Selling and Administrative Expense Budget - The budget for selling and administrative
expenses is frequently based on the sales budget. A forecasted rise in sales, for example,
may need increased advertising costs.
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Study Guide in Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
HRDM Elec 102: Managerial Accounting
Module 7: Operating Budget
Departmental schedules usually support the selling and administrative expenses budget
mentioned above. An advertising expense plan for the Marketing Department, for example,
would include the advertising media to be used (newspaper, direct mail, television),
quantities (column inches, number of pieces, minutes), and associated unit costs.
8. Budgeted Income Statement - The budgeted income statement, also known as a pro forma
income statement, is a financial statement that is prepared according to a set of
assumptions.
LEARNING ACTIVITIES
Cooperstown Retros creates reproduction big league baseball jerseys that look just like the ones
that were worn in the 1950s. In 20Y1, the company planned to produce 15,000 jerseys. A total of
1.5 square yards of wool fabric is required for each jersey. The price of a square yard of wool
fabric is $14. Cutting and assembly are required for each jersey. Assume that each jersey will take
3.5 hours to cut and assemble. Labor costs are estimated at $20 per hour. Factory overhead was
budgeted for $210,000.
The following are the estimated January 1 and targeted December 31 inventories:
Direct Materials:
Wool Fabric
2,250 sq. yds.
Estimated inventory,
January 1, 20Y1
Desired inventory, 2,340 sq. yds.
December 31, 20Y1
Work-in-process
Finished Goods
20,000
200,000
24,500
230,000
Prepare:
A. Direct Materials Purchases Inventory
B. Direct Labor Cost Budget
C. Cost of Goods Sold
REFERENCES
1. Managerial Accounting (The cornerstone of business decision making) Seventh Edition
2016 by: Mowen; Hansen; Heitger
2. Financial and Managerial Accounting, 15th Edition 2018 by: Carl S. Warren; Jefferson P.
Jones; William B. Tayler
3. ACCOUNTING 27th Edition 2016 by Carl S. Warren, James M. Reeve, Jonathan E. Duchac
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Study Guide in Managerial Accounting
HRDM Elec 102: Managerial Accounting
FM-AA-CIA-15 Rev. 0 03-June-2020
Module 7: Operating Budget
4. Century 21 Accounting 11th Edition 2019, by Claudia Bienias Gilbertson, Mark W. Lehman
5. https://www.oercommons.org/courses/principles-of-managerial-accounting-videoetext
6. https://www.de-brouwer.com/assets/students/uw_eMBA_wikibook-managerialaccounting.pdf
7. https://library.ku.ac.ke/wpcontent/downloads/2011/08/Bookboon/Accounting/managerial-and-costaccounting.pdf
8. https://open.umn.edu/opentextbooks/textbooks/managerial-accounting
9. https://www.oercommons.org/courses/managerial-accounting
10. https://www.oercommons.org/courses/ba-213-principles-of-accounting-managerial
11. https://corporatefinanceinstitute.com/resources/knowledge/accounting/managerialaccounting/
12. https://www.investopedia.com/articles/professionals/041713/what-managementaccountants-do.asp
13. https://www.aiuniv.edu/degrees/business/articles/functions-of-management
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