Cornerstones of Managerial
Accounting 2e
Chapter Eight
Profit Planning
Mowen/Hansen
Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation.
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license.
1
Objective # 1
Define budgeting and discuss its
role in planning, control, and
decision making.
2
Planning as it Relates to Budgeting
Planning and control are tied together
Planning — Looking ahead to see what actions
should be taken to realize particular
goals
3
Controlling as it Relates to Budgeting
Planning and control are tied together
Control – Looking backward determining what
actually happened and comparing it
with the previously planned
outcomes
4
Budgets
•
•
•
A key component of planning
Financial plans for the future
Identify the objectives and the
actions needed to achieve them
Before a budget is
prepared, a strategic plan
should be developed.
5
Strategic Plan
Identifies strategies for future activities and
operations.
This can be translated into long- and
short-term objectives.
Objectives form the
basis of the budget.
6
Advantages of Budgeting
1. Forces managers to plan
2. Provides information that can be used to
improve decision making
3. Provides a standard for performance
evaluation
4. Improves communication and coordination
7
Master Budget
Comprehensive financial plan for the
organization as a whole
Can be broken down into quarterly and
monthly budgets
8
Continuous Budget
A moving 12-month budget.
January February
December January
2007
2007
2008
2007 …………….
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Budget Committee
• Reviews the budget
• Provides policy guidelines and budgetary
goals
• Resolves differences that arise as the budget
is prepared
• Approves the final budget
• Monitors the actual performance of the
organization as the year unfolds
10
Budget Director
• Responsible for directing and
coordinating the organization’s overall
budgeting process
• Usually the controller
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Major Components of the Master
Budget
Master budget can be divided into……
• Operational budgets
◦ Describe the income-generating
activities of a firm
• Financial budgets
◦ Detail the inflows and outflows of
cash and the overall financial
position
12
Objective # 2
Define and prepare the operating
budget, identify its major
components, and explain the
interrelationships of it various
components.
13
Sales Budget
• Projection approved by the budget
committee that describes expected sales in
units and dollars
• It is the basis for all of the other operating
and most of the financial budgets
14
Sales Budget Preparation Steps
1. Develop a sales forecast
• Usually the responsibility of the marketing
department
• Bottom-up approach
◦ Salespeople submit sales projections
2. Forecast is reviewed by the budget committee
3. Budget Committee recommends changes
prior to approval
15
Texas Rex, Inc.
Sales Budget
For the Year Ended December 31, 2007
Quarter
1
2
3
4
Year
Units
1,000
1,200
1,500
2,000
5,700
Unit selling
price
x $10
x $10
x $10
x $10
x $10
Budgeted
sales
$10,000 $12,000 $15,000 $20,000 $57,000
Most sales happen in
summer and fall.
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Production Budget
Describes how many units must be produced
in order to meet sales needs and satisfy
ending inventory requirements
Formula:
Units to
Expected
be
unit
+
=
produced
sales
Units in
Units in
ending - beginning
inventory
inventory
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Direct Materials Purchases Budget
Tells the amount and cost of raw materials to
be purchased in each time period.
Formula:
Direct materials needed for production
+ Desired direct materials in ending inventory
- Direct materials in beginning inventory
Direct Materials to be purchased
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Direct Labor Budget
Shows the total direct labor hours needed
and the associated cost for the number of
units in the production budget
19
Overhead Budget
Shows the expected cost of all production costs
other than direct materials and direct labor.
Overhead costs are separated into fixed and
variable costs and a variable rate is calculated
20
Ending Finished Goods Inventory
Budget
• Supplies information needed for the
balance sheet
• Serves as an important input for the
preparation of the cost of goods sold
budget
21
Cost of Goods Sold Budget
Reveals the expected cost of the goods
to be sold.
22
Selling and Administrative Expenses
Budget
Outlines planned expenditures for
nonmanufacturing activities
Selling and administrative expenses can
be broken down into fixed and variable
components
23
Objective # 3
Define and prepare the financial
budget, identify its major
components, and explain the
interrelationships of its various
components.
24
Preparing the Financial Budget
The usual financial budgets prepared are:
1. The cash budget
2. The budgeted balance sheet
3. The budget for capital expenditures
25
Objective # 4
Describe the behavioral
dimension of budgeting.
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Using Budgets for Performance
Evaluation
Goal congruence --- The alignment of
managerial and
organizational goals.
Dysfunctional
--behavior
The individual behavior
that is in basic conflict
with the goals of the
organization.
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Using Budgets for Performance
Evaluation
Managers need frequent timely
performance reports to:
• Know how successful their efforts have
been
• Take corrective action
• Change plans as necessary
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Using Budgets for Performance
Evaluation
Incentives --- The means an organization
uses to influence a
manager to exert effort to
achieve an organization’s
goal.
Both monetary and nonmonetary
incentives are used
29
Participative Budgeting
Allows subordinate managers considerable say
in how the budgets are established.
Advantages:
• Communicates a sense of responsibility
to subordinate managers
• Fosters creativity
• Budget goals will more likely become
the manager’s personal goals
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Participative Budgeting
Allows subordinate managers considerable say
in how the budgets are established.
Disadvantages:
• Setting standards that are either too
high or too low
• Tempted to build slack in the budget
• Pseudoparticipation
Top management assumes total
control of the budgeting process.
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Realistic Standards
Budgeted objectives are used to gauge
performance. They should be based on
realistic conditions and expectations.
32
Controllability of Costs
Ideally, managers are held accountable only for
costs they can control.
Controllable costs – the costs whose level a
manger can influence.
33
Multiple Measures of Performance
Overemphasis on financial measures can lead
to a form of dysfunctional behavior called
“milking the firm” or myopia.
Myopia – when a manager takes actions that
improve budgetary performance in the short
run but bring long-run harm to the firm.
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