Budgeting
Learning Objectives
LO 13-1 Understand the role of budgets in overall organization plans.
LO 13-2 Understand the importance of people in the budgeting process.
LO 13-3 Estimate sales.
LO 13-4 Develop production and cost budgets.
LO 13-5 Estimate cash flows.
LO 13-6 Develop budgeted financial statements.
LO 13-7 Explain budgeting in merchandising and service organizations.
LO 13-8 Explain why ethical issues arise in budgeting.
LO 13-9 Explain how to use sensitivity analysis to budget under uncertainty.
Budgeting - Definition
LO 13-1 Understand the role of budgets in overall organization plans.
• a budget is simply the plan, stated in financial terms, of how the
organization expects to carry out its activities and meet the
financial goals established in the planning process.
• process of allocating finite resources to the prioritized needs of an
organization.
• an estimation of revenue and expenses over a specified future
period of time and is usually compiled and re-evaluated on a
periodic basis.
Overall Plan
A master budget is part of an overall organization plan
for the next year made up of three components:
(1) the organization goals,
(2) the strategic long-range profit plan, and
(3) the tactical short-range profit plan.
Top managers establish broad objectives, which serve as organization goals
that company employees work to achieve.
It is important to detail the specific steps required to achieve the goals.
These steps are expressed in a strategic long-range plan.
The plan for the coming year, which is more specific than long-range plans,
is called the master budget, also known as the static budget, the budget
plan, or the planning budget .
Organizational and Individual Interaction:
Developing the Master Budget
Human Element in Budgeting
LO 13-2 Understand the importance of people in the budgeting process.
Organization
goals
Goal congruence
Individual
goals
Participative Budgeting
Use of input from lower- and middle-management
employees; also called grass roots budgeting
Sales Forecasting
LO 13-3
Estimate sales.
How do we forecast sales?
Sales staff
Market researchers
Delphi technique
Trend analysis
Econometric models
Forecasting by Sales Staff
After evaluating the sales forecasts derived from various sources, the budgeting
task force at Santiago Pants arrived at the following sales budget for the next
budget year:
Forecasting Production
LO 13-4
Develop production and cost budgets.
A production budget is a plan of resources needed to meet current
sales demand and ensure that inventory levels are sufficient for future
sales.
Basic inventory formula:
Beginning balance
+
BB
Transfers in
TI
–
Transfers out
=
TO
Ending balance
For inventories, production, and sales:
Units in beginning
+
inventory
Required
production
–
Budgeted
sales
=
Units in ending
inventory
Production Budget
Rearranging for required production:
Budgeted
sales
+
Units in ending
inventory
–
Units in beginning
=
inventory
Required
production
• Santiago Pants' sales budget is 160,000 units
• Management estimates that there will be 5,000 units
in beginning inventory and 15,000 in ending inventory.
160,000
units
+
15,000
units
–
5,000
units
=
170,000
units
Production Budget
Production Costs
Direct
materials
Direct
labor
Manufacturing
overhead
Indirect Indirect
Other
labor materials
Direct Materials Example
Direct Materials Example
Santiago Pants
Estimated Production
Materials Data
Yards needed:
Direct Materials Example
$
$
Direct Labor Example
Overhead Example
Santiago Pants
Schedule of Budgeted Manufacturing Overhead
For the Budget Year Ended December 31
Variable overhead needed to product 170,000 units:
Indirect materials and supplies @ $0.30 per unit
Materials handling @ $0.40 per unit
Other indirect labor @ $0.10 per unit
Total variable overhead
$ 51,000
68,000
$ 17,000
$136,000
Fixed manufacturing overhead (supervisory labor $102M,
maintenance and repairs $50M, plant administration $85M,
utilities $55M, depreciation $140M, insurance $30M,
property taxes $60M, and other $22M)
Total manufacturing overhead
$544,000
$680,000
Cost of Goods Sold Example
Santiago Pants
Budgeted Statement of Cost of Goods Sold
For the Budget Year Ended December 31
Beginning work-in-process inventory
Manufacturing costs:
Direct materials:
Beginning inventory
Purchases
Materials available for manufacturing
Less: Ending inventory
Total direct materials costs
Direct labor
Manufacturing overhead
Total manufacturing costs
Less: Ending work-in-process
Cost of goods manufactured
Add: Beginning finished goods inventory
Less: Ending finished goods inventory
Cost of goods sold
a
Management estimate
b
$
-0-
$
35,000
1,715,000
$1,750,000
(50,000)
$1,700,000
1,870,000
680,000
Estimate: (15,000 units × $25 = value of finished goods)
$4,250,000
-0$4,250,000
120,000a
(375,000)b
$3,995,000
Marketing and Administrative
Budget Example
Income Statement Example
Cash Budget
LO 13-5 Estimate cash flows.
The cash budget is a statement of cash on hand at the
start of the budget period, expected cash receipts,
expected cash disbursements, and the resulting cash
balance at the end of the budget period.
• Cash receipts:
– Collection of accounts receivable
– Cash sales
– Sales of assets
– Borrowing
– Issuing stock
– Other
Cash Budget
Some cash disbursements:
– Materials purchases
– Manufacturing costs
– Operating activities
– Debt repayment
– Acquisition of new assets
– Income taxes
– Dividends
– Other activities
Cash Budget
Santiago Pants
Cash Budget
For the Budget Year Ended December 31
Cash balance beginning of period
Receipts:
Collections on accounts
Collections employee loans
Total receipts
Less: Disbursements:
Payments for accounts payable
Direct labor
Manufacturing overhead less noncash depreciation charges
Marketing and administrative costs less noncash charges
Payments for federal income taxes
Dividends
Reduction in long-term debt
Acquisition of new assets
Total disbursements
Budgeted ending cash balance
$ 830,000
$6,840,000
100,000
6,940,000
1,694,000
1,870,000
540,000
1,422,000
350,000
30,000
23,000
1,470,000
7,399,000
$ 371,000
Cash Collections Example
Santiago Pants
Monthly Collection Experience
Sales on Credit
Expected Sales for Three Months
Cash Collections Example
Santiago Pants
Multiperiod Schedule of Cash Collections
For the Quarter Ended March 31
Month
January
Beginning accounts receivable,
January 1, $540,000
January sales, $500,000a
February sales, $450,000b
March sales, $600,000c
Total cash collections
a
$540,000
100,000
$640,000
20% collected in January, 75% collected in February, and 5% not collected
20% collected in February, 75% collected in March, and 5% not collected
c 20% collected in March, 75% collected in April, and 5% not collected
b
February
$375,000
90,000
$465,000
March
Total for
Quarter
$ 540,000
475,000
$337,500
427,500
120,000
120,000
$457,500 $1,562,500
Cash Disbursements Example
Santiago Pants
Monthly Disbursements for Purchases Experience
Cash disbursement for current month's purchases
50%
Cash disbursement for prior month's purchases
48
Cash discounts taken
2
Total cash disbursement for purchases
100%
Expected Purchases for Three Months
January sales
$120,000
February sales
$200,000
March sales
$250,000
Cash Disbursements Example
Santiago Pants
Multiperiod Schedule of Cash Disbursements
For the Quarter Ended March 31
Month
January
Beginning accounts payable,
January 1, $256,000
January purchases, $120,000a
February purchases, $200,000b
March purchases, $250,000c
Additional cash payments
Total cash disbursements
a
$256,000
60,000
250,000
$566,000
50% paid in January, 48% paid in February, and 2% discounts taken
50% paid in February, 48% paid in March, and 2% discounts taken
c 50% paid in March, 48% paid in April, and 2% discounts taken
b
February
$ 57,600
100,000
250,000
$407,600
March
Total for
Quarter
$ 96,000
125,000
250,000
$471,000
$ 256,000
117,600
196,000
125,000
750,000
$1,444,600
Budgeted Balance Sheet Example
LO 13-6 Develop budgeted financial statements.
Santiago Pants
Budget Balance Sheet (Assets)
For the Budget Year Ended December 31 ($000)
Budget Year
Assets
Current assets:
Cash
Accounts receivable
Inventories
Other current assets
Total current assets
Long-term assets:
Property, plant, equipment
Less: Accumulated depreciation
Total assets
Balance
Jan 1
Additions Subtractions
Balance
Dec 31
$ 830
540
155
161
$1,686
$ 6,940 $ 7,399
7,200
6,840
4,265
3,995
-0100
$18,405 $18,334
$ 371
900
425
61
$1,757
1,866
(1,246)
$2,306
1,470
-0(220)
-0$19,651 $18,334
3,336
(1,470)
$3,623
Budgeted Balance Sheet Example
Santiago Pants
Budget Balance Sheet (Liabilities and Equity)
For the Budget Year Ended December 31 ($000)
Liabilities and Shareholders Equity
Current liabilities:
Accounts payable
Taxes payable
Current portion of long-term debt
Total current liabilities
Long-term liabilities
Total liabilities
Shareholders' equity
Common stock
Retained earnings
Total shareholders
Total liabilities and shareholders equity
Budget Year
Balance
Jan 1
Additions Subtractions
Balance
Dec 31
$ 256
187
23
$ 466
258
$ 724
$1,715
550
23
$2,288
-0$2,288
$1,694
350
23
$2,067
23
$2,090
$ 277
387
23
$ 687
235
$ 922
$ 437
1,145
$1,582
$2,306
$ -01,149
$1,149
$3,437
$ -030
30
$2,120
$ 437
2,264
$2,701
$3,623
Assembling the Master Budget
for a Manufacturing Firm
Budgeting in Service Organizations
LO 13-7 Explain budgeting in merchandising and service organizations.
Sales forecast
Budgeted cost
of services
Budgeted
income
statement
Cash budget
Marketing and
administrative
cost budget
Budgeted
balance sheets
Budgeting Retail and Wholesale Organizations
Sales forecast
Marketing and
administrative
cost budget
Purchases
Budgeted
income
statement
Cash budget
Budgeted
balance sheets
Budgeting Retail and Wholesale Organizations
Castro Audio & Video, Inc.
Estimated Information for Retail Operations
Budgeting Retail and Wholesale Organizations
Ethical Problems in Budgeting
LO 13-8
Explain why ethical issues arise in budgeting.
Budgets can create serious
ethical issues for many people.
The company must recognize
the trade-off between
encouraging unbiased reporting
by managers and the use of
budget information in
performance evaluation and
rewards.
Budgeting Under Uncertainty
LO 13-9 Explain how to use sensitivity analysis
to budget under uncertainty.
Budgets allow management to explore many
alternatives.
Spreadsheets are helpful in preparing budgets
and quantifying “what-if” conditions. Questions
like what if labor costs are 10 percent higher (or
lower) than projected?
SENSITIVITY ANALYSIS
a financial model that determines how target
variables are affected based on changes in
other variables known as input variables.
Alternative Budgeting Scenarios
Santiago Pants Alternative Budget Scenarios
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