Budgetary Planning and
Control
Budgets
 The formal documents that quantify
a company’s plans for achieving its
goals.
 For many companies, the planning
and control process is built around
budgets.
Use of Budgets in Planning
 Enhances communication and
coordination
 Forces managers to consider:
 Goals
 Objectives
 Specify means of achieving them
Use of Budgets in Control
 Provide a basis for evaluating performance
by comparing the actual with the planned
performance
 Deviations from planned performance have
three potential causes:
 Plan or budget was poorly conceived
 Conditions have changed
 Managers have done a particularly good or poor
job managing operations
Developing the Budget
Budgets are prepared for:
 Departments
 Divisions of a company
 For the entire company
Developing the Budget
 Budget Committee
 Responsible for approval of various
budgets
 Made up of senior managers
(Presidents, CFO, controller, etc.)
 Typically works with departments to
develop realistic plans
Role of Budgets in
Planning and
Control
Budget Time Period
 Management must first decide on a
budget time period
 Long-run budgets (3-year, 5-year)
 Short-run budgets (month, quarter)
 Length of time period determines
the amount of detail in a budget
Five-Year Budgets
Better Budgets
Zero Base Budgeting
 Managers must start at zero in developing
their budgets and justify budgeted
amounts
 Provides validation for budgeted amounts
 Time consuming and expensive process
 Not widely used by business enterprises
Master Budget
Sales Budget
 First budget prepared since most
budgets cannot be prepared without
an estimate of sales
 A variety of methods are used to
estimate sales:




Economic models
Sales trends
Trade journals
Sales force estimates
Production Budget
Quantity to be produced based on
following formula:
Example Exercise #1
 VitaPup produces a vitamin-enhanced
dog food that is sold in Kansas. The
company expects sales to be 12,600 bags
in January, 14,500 bags in February, and
19,000 bags in March. There are 1,260
bags on hand at the start of January.
VitaPup desires to maintain monthly
ending inventory equal to 10% of next
month’s expected sales.
 Prepare the production budget for
VitaPup for the months of January and
February.
Example Exercise #1 Solution
 Production Budget for January
Expected Sales
+Desired Ending Inventory
- Beginning Inventory
Total Production
12,600
1,450
(1,260)
12,790
 Production Budget for February
Expected Sales
+ Desired Ending Inventory
- Beginning Inventory
Total Production
14,500
1,900
(1,450)
14,950
Direct Material Purchase Budget
 Depends upon the amount needed
for production and the amount
needed for ending inventory
 The following formula can be used:
Direct Labor Budget
 Direct labor can be calculated using
the following formula:
 Number of units produced x Labor
hours per unit x Rate per hour
 Once calculated, can be used to
determine the approximate number
of employees needed
Manufacturing Overhead Budget
 Variable Costs
 Multiply variable cost per unit by
quantity produced
 Fixed Costs
 Remain relatively constant
 Depreciation could fluctuate based on
planned acquisitions
Selling and Administrative
Expense Budget
Includes the following:
 Salaries
 Advertising
 Office Expenses
 Other General Expenses
Budgeted Income Statement
Compilation of information
provided by previously prepared
budgets



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Sales Budget
Direct Materials Budget
Direct Labor Budget
Manufacturing Overhead Budget
Selling and Administrative Expense
Budget
Capital Acquisitions Budget
 Acquisitions include:
 Property
 Plant
 Equipment
 Must be carefully planned due to the
large amounts of cash that could be
used
Cash Receipts and Disbursements
Budget
 Managers must plan for two items:
 Amount of Cash Flows
 Timing of Cash Flows
 Importance
 Differences between cash flows and
income
 Anticipate cash shortages or surpluses
Example Exercise #2
 The Warrenburg Antique Mall budgeted
credit sales in the first quarter of 2009 to
be as follows:
January
$150,000
February
$160,000
March
$172,000
Credit sales in December of 2008 are expected
to be $200,000. The company expects to
collect 75% of a month’s sales in the month of
sale and 25% in the following month.
 Estimate the cash receipts for January
and February.
Example Exercise #2 Solution
 January Estimated Cash Receipts
December (200,000 x 25%)
January (150,000 x 75%)
Total
$50,000
$112,500
$162,500
 February Estimated Cash Receipts
January (150,000 x 25%)
February (160,000 x 75%)
Total
$37,500
$120,000
$157,500
Budgeted Balance Sheet
 Last budget prepared
 Sometimes referred to as the pro
forma balance sheet
 Used to assess the effect of planned
decisions on the future financial
position of the firm
Study Break #1
Which of the following statements
regarding budgets is false?
a. They are formal documents that quantify a
company’s plans.
b. They enhance communication and
coordination.
c. They are useful in planning but not in control.
d. They provide a basis for evaluating
performance.
Answer:
c. They are useful in planning but not in
control
Study Break #2
Which of the following items do not
require a cash outflow?
a.
b.
c.
d.
Salaries
Purchase of raw materials
Advertising
Depreciation
Answer:
d. Depreciation
Use of Computers in the Budget
Planning Process
 Extremely useful in budgeting
process
 Excel Spreadsheet
 Other specialized program
 Allows for company to determine
effects of a decision on entire budget
 “What if” Analysis
Budgetary Control
 Budgets as a Standard for Evaluation
 Actual amounts are compared with
budgeted amounts
 Differences between actual and budgeted
amounts are referred to as budget
variances
 Budget variances should be investigated
when they are material
Budgetary Control
 Management must make sure the level of
activity in the budget is equal to the actual
level of activity
 Static Budget
 Not adjusted for the actual level of production
 Flexible Budget
 A set of budget relationships that can be
adjusted for various production activity levels
Spreadsheets
Investigating Budget Variances
Causes of Budget Variances
 Budget may not have been well
conceived
 Conditions may have changed
 Managers may have performed
particularly well or poorly
Investigating Budget Variances
Management by Exception
 Economical approach
 Only exceptional variances are
investigated
 Must investigate both unfavorable and
favorable exceptional variances
“Unfavorable” Budget Variance
Conflict in Planning and Control
Uses of Budgets
 Budgets used for planning and
control
 Focus of management on meeting or
beating budgeted targets
 Compensation could be dependent upon
this
 Creates an inherent conflict
Common Budget-based
Compensation Scheme
Issues With Budget-based
Compensation
 Managers have incentive to pad a budget
 Lower sales forecasts and increasing cost
forecasts
 Makes budget targets easier to achieve
creating budget slack
 Managers may have incentive to shift
income from one period to another
Study Break #3
Differences between budget and
actual amounts are referred to as:
a.
b.
c.
d.
An error
A variance
A flexible budget
A static budget
Answer:
b. A variance
Study Break #4
A ____ budget is not adjusted for
the actual level of production.
a.
b.
c.
d.
Static
Flexible
Pro forma
None of the above
Answer:
a. Static
Budget Padding