Managerial Accounting
Weygandt • Kieso • Kimmel
CHAPTER 9
BUDGETARY PLANNING
Prepared by
Dan R. Ward
Suzanne P. Ward
University of Louisiana at Lafayette
John Wiley & Sons, Inc. © 2005
CHAPTER 9
BUDGETARY PLANNING
Study Objectives
Indicate the benefits of budgeting.
State the essentials of effective budgeting.
Identify the budgets that comprise the master
budget
Describe the sources for preparing the budgeted
income statement.
Study Objectives: Continued
Explain the principal sections of a cash budget.
Indicate the applicability of budgeting in
nonmanufacturing companies.
BUDGETING BASICS
Budget
 A formal written statement of management’s
plans for a specified future time period,
expressed in financial terms
 Primary way to communicate agreed-upon
objectives to all parts of the company
 Promotes efficiency
 Control device - important basis for performance
evaluation once adopted
BUDGETING BASICS
Role of Accounting
 Historical accounting data on
revenues, costs, and expenses
help in formulating future
budgets
 Accountants normally
responsible for presenting
management’s budgeting goals
in financial terms
 The budget and its
administration are, however,
entirely management’s
responsibility
BUDGETING BASICS
Benefits of Budgeting
Study Objective 1
Requires all levels of management to plan
ahead and formalize goals on a
recurring basis
Provides definite objectives for evaluating
performance at each level of
responsibility
Creates an early warning system
for potential problems
BUDGETING BASICS
Benefits of Budgeting
Facilitates coordination of activities
within the business
Results in greater management
awareness of the entity’s overall
operations and the impact of
external factors
Motivates personnel throughout
organization to meet planned
objectives
BUDGETING BASICS
Benefits of Budgeting
A budget is
an aid to management
not a substitute for management
BUDGETING BASICS
Essentials of Effective Budgeting
Study Objective 2
 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
BUDGETING BASICS
Length of Budget Period
 May be prepared for any period of time
 Most common - one year
 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
 Continuous twelve-month budget
 Drop the month just ended and add a future month
 Keeps management planning a full year ahead
BUDGETING BASICS
Budgeting Process
 Base budget goals on past
performance
 Collect data from
organizational units
 Begins 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
BUDGETING BASICS
Budgeting Process
Factors considered in Sales Forecasting:







General economic conditions
Industry trends
Market research studies
Anticipated advertising and promotion
Previous market share
Price changes
Technological developments
BUDGETING BASICS
Budgeting Process
 Usually informal in small companies
 Assigned to a budget committee in
larger companies
 Include the president, treasurer, chief
accountant (controller), and management
personnel from each major area of the
company
 Review board where managers defend
budget goals and requests
BUDGETING BASICS
Budgeting and Human Behavior
 May inspire higher levels of performance or
discourage additional effort
 Depends on how budget developed and
administered
 Invite each level of management to participate
This “bottom-to-top” approach is called
Participative Budgeting
BUDGETING BASICS
Budgeting and Human Behavior
Participative Budgeting
 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 lower level management
 Overall goal - produce a budget considered fair
and achievable by managers while still meeting
corporate goals
 Risk of unreliable budgets greater when they are
“top-down”
BUDGETING BASICS
Budgeting and Human Behavior
Participative Budgeting
 Disadvantages:
 Can be time consuming and costly
 Can foster budgetary “gaming”
through budgetary slack
 situation where managers
intentionally underestimate
budgeted revenues or
overestimate budgeted expenses
so that budget goals are easier to
meet
BUDGETING BASICS
Budgeting and Human Behavior
Participative Budgeting
Flow of budget data from lower management to top levels
BUDGETING BASICS Budgeting and Long-Range Planning
 Three basic differences between the two:
 Time period involved
 Emphasis
 Detail presented
Time period:
Budgeting is short-term –
usually one year
Long-range planning usually
at least five years
BUDGETING BASICS Budgeting and Long-Range Planning
 Emphasis:
 Budgeting - achievement of specific
short-term goals
 Long-range planning identifies long
term goals, selects strategies to
achieve goals, and develops policies
and plans to implement strategies
 Detail presented:
 Budgets – very detailed
 Long-range plans - contain less detail
review of progress toward long
term goals
BUDGETING BASICS The Master Budget
Study Objective 3
 A 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
BUDGETING BASICS The Master Budget - Components
Let’s Review
The essentials of effective budgeting do not
include:
a. Top-down budgeting
b. Management acceptance
c. Research and analysis
d. Sound organizational structure
Let’s Review
The essentials of effective budgeting do not
include:
a. Top-down budgeting
b. Management acceptance
c. Research and analysis
d. Sound organizational structure
OPERATING BUDGETS:
Sales Budget
 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
OPERATING BUDGETS:
Sales Budget
Example – Hayes Company
 Expected sales volume: 3,000 units in the first quarter with
500-unit increments for each following quarter
 Sales price: $60 per unit
Hayes Company
Sales Budget
For the Year Ending December 31, 2005
Quarter
Expected unit sales
Unit selling price
Total sales
1
3,000
x $60
2
3,500
x $60
3
4,000
x $60
4
4,500
x $60
Year
15,000
x $60
$180,000 $210,000 $240,000 $270,000
$900,000
OPERATING BUDGETS:
Production Budget
 Shows the units that must be produced to meet
anticipated sales
 Derived from sales budget plus the desired change in
ending finished goods (ending finished goods less the
beginning finished goods units)
 Required production in units formula:
OPERATING BUDGETS:
Production Budget
Example – Hayes Company
Hayes Co. believes it can meet future sales needs with an
ending inventory of 20% of next quarter’s sales
Hayes Company
Production Budget
For the Year Ending December 31, 2005
Expected unit sales
Add: Desired ending finished goods units*
Total required units
Less: Beginning finished goods inventory **
Required production units
*20% of next quarter’s sales
**20% of estimated first-quarter 2005 sales
1
3,000
700
3,700
600
3,100
Quarter
2
3
3,500
4,000
800
900
4,300
4,900
700
800
3,600
4,100
4
Year
4,500
1,000
5,500
900
4,600 15,400
OPERATING BUDGETS:
Direct Materials Budget
 Shows both the quantity and cost of direct materials to be
purchased
 Derived from the direct materials units required for
production (from the production budget) plus the desired
change in ending direct materials units
 Budgeted cost of direct materials to be purchased = required
units of direct materials X anticipated cost per unit
OPERATING BUDGETS:
Direct Materials Budget
Example – Hayes Company
An ending inventory of 10% of next quarter’s
production requirements is sufficient
The manufacturing of each unit requires 2 pounds
of raw materials at an expected price of $4 per
pound
OPERATING BUDGETS:
Direct Materials Budget
Example – Hayes Company
Hayes Company
Direct Materials Budget
For the Year Ending December 31, 2005
Units to be produced
Direct materials per unit
Total pounds needed for production
Add: Desired ending direct materials*
Total materials required
Less: Beginning direct materials***
Direct materials purchases
Cost per pound
Total cost direct materials purchased
1
3,100
x 2
6,200
720
6,920
620
6,300
x $4
$25,200
Quarter
2
3
3,600
4,100
x 2
x 2
7,200
8,200
820
920
8,020
9,120
720
820
7,300
8,300
x $4
x $4
$29,200 $33,200
4
Year
4,600
x 2
9,200
1,020**
10,220
920
9,300
x $4
$37,200
$124,800
*10% of next quarter’s production requirements
**Estimated 2006 first-quarter pounds need for production – 10,200 x 10%
***10% of estimated first-quarter pounds needed for production
OPERATING BUDGETS:
Direct Labor Budget
 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 formula:
OPERATING BUDGETS:
Direct Labor Budget
Example – Hayes Company
 Direct labor hours from the production budget
 Two hours of direct labor required for each unit
 Hourly wage rate $10
Hayes Company
Direct Labor Budget
For the Year Ending December 31, 2005
Quarter
1
2
Units to be produced
3,100
3,600
Direct labor hours per unit
x 2
x 2
Total required direct labor hours 6,200
7,200
Direct labor cost per hour
x $10
x $10
Total direct labor cost
$62,000 $72,000
3
4,100
x 2
8,200
x $10
$82,000
4
4,600
x 2
9,200
x $10
$92,000
Year
$308,000
OPERATING BUDGETS:
Manufacturing Overhead Budget
 Shows the expected manufacturing overhead costs for
the budget period
 Distinguishes between fixed and variable overhead
costs
Example – Hayes Company
 Fixed cost amounts are assumed
 Expected variable costs per direct labor hour:




Indirect materials: $1.00
Indirect labor: $1.40
Utilities: $0.40
Maintenance: $0.20
Hayes Company
Manufacturing Budget
For the Year Ending December 31, 2005
Quarter
Variable Costs
Indirect materials ($1.00 per DLH)
Indirect labor ($1.40 per DLH)
Utilities ($ .40 per DLH)
Maintenance ($.20 per DLH)
Total variable
Fixed costs
Supervisory salaries
Depreciation
Property tax and insurance
Maintenance
Total fixed
Total manufacturing overhead
Direct Labor hours
1
$ 6,200
8,680
2,480
1,240
18,600
2
$ 7,200
10,080
2,880
1,440
21,600
3
$ 8,200
11,480
3,280
1,640
24,600
4
$ 9,200
12,880
3,680
1,840
27,600
Year
$ 30,800
43,120
12,320
6,160
92,400
20,000
3,800
9,000
5,700
38,500
20,000
3,800
9,000
5,700
38,500
20,000
3,800
9,000
5,700
38,500
20,000
3,800
9,000
5,700
38,500
80,000
15,200
36,000
22,800
154,000
$57,100
$60,100
$63,100
$66,100
$246,400
6,200
7,200
8,200
9,200
30,800
Manufacturing overhead rate per direct labor hour ($246,400  30,800)
$8.00
OPERATING BUDGETS:
Selling & Administrative Expense Budget
 Projection of anticipated operating expenses
 Distinguishes between fixed and variable costs
Example – Hayes Company
 Fixed cost amounts are assumed
 Expected variable costs per unit sold (from sales budget):
 Sales commissions: $3.00
 Freight-out: $1.00
Hayes Company
Selling & Administrative Budget
For the Year Ending December 31, 2005
Quarter
Variable Costs
Sales commissions ($3 per unit)
Freight-out ($1 per unit)
Total variable
Fixed costs
Advertising
Sales salaries
Office Salaries
Depreciation
Property taxes and insurance
Total Fixed Expenses
1
$ 9,000
3,000
12,000
2
$ 10,500
3,500
14,000
3
$ 12,000
4,000
16,000
4
$ 13,500
4,500
18,000
Year
$ 45,000
15,000
60,000
5,000
15,000
7,500
1,000
1,500
30,000
5,000
15,000
7,500
1,000
1,500
30,000
5,000
15,000
7,500
1,000
1,500
30,000
5,000
15,000
7,500
1,000
1,500
30,000
20,000
60,000
30,000
4,000
6,000
120,000
Total Selling/Admin. Expenses
$42,000
$44,000
$46,000
$48,000
$180,000
OPERATING BUDGETS:
Budgeted Income Statement
Study Objective 4
Important end-product of the operating budgets
Indicates expected profitability of operations
Provides a basis for evaluating company
performance
Prepared from the operating budgets






Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Manufacturing Overhead Budget
Selling and Administrative Expense Budget
OPERATING BUDGETS:
Budgeted Income Statement
Example – Hayes Company
To find cost of goods sold:
 First determine the unit cost of one Kitchen-mate
 Determine Cost of goods sold by multiplying units sold
times unit cost:
15,000 units X $44 = $660,000
OPERATING BUDGETS:
Budgeted Income Statement
Example – Hayes Company
 Additional estimated data for budgeted income statement:
 Interest expense - $100
Income taxes - $12,000
FINANCIAL BUDGETS:
Cash Budget
 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
FINANCIAL BUDGETS:
Cash Budget
Basic Format
FINANCIAL BUDGETS:
Cash Budget
 Cash receipts section
 Includes expected receipts from the principal sources of
revenue - usually cash sales and collections on credit sales
 Shows expected interest and dividend receipts as well as
proceeds from planned sales of investments, plant assets,
and capital stock
 Cash disbursements section
 Includes expected cash payments for direct materials and
labor, taxes, dividends, plant assets, etc.
 Financing section
 Shows expected borrowings and repayments of borrowed
funds plus interest
FINANCIAL BUDGETS:
Cash Budget
 Must prepare in sequence
 Ending cash balance of one
period = beginning cash
balance for next
 Obtain information from
other budgets and from
management
 Often prepared for the year on
a monthly basis
FINANCIAL BUDGETS:
Cash Budget
Example – Hayes Company
Assumptions
January 1, 2005 cash balance: $38,000
Sales: collect 60% in quarter sold; 40% in next quarter
Collect $60,000 in Accounts Receivable at December 31, 2004, in Qtr 1
Expected sale of short term investments: $2,000 in Quarter 1
Direct Materials: pay 50% in quarter purchased; 50% in next
Pay $10,600 in Accts Payable at December 31, 2004, in Quarter 1
Direct Labor: pay 100% in quarter incurred
Manufacturing Overhead and Selling/Administrative Expenses: Pay (except
depreciation) in quarter incurred
Expected purchase of truck: $10,000 cash in Quarter 2
Estimated annual income taxes: Equal payment each quarter
Loans: Pay in earliest quarter with sufficient cash (i.e., cash on hand
exceeds the $15,000 minimum required balance)
FINANCIAL BUDGETS:
Cash Budget
Example – Hayes Company
Usually prepare schedule of collections from customers:
FINANCIAL BUDGETS:
Cash Budget
Example – Hayes Company
Prepare schedule of cash payments for direct materials:
Now prepare the Cash Budget based on the assumptions
and the preceding schedules
FINANCIAL BUDGETS:
Cash Budget
 Contributes to more effective cash
management
 Shows managers need for additional
financing before actual need arises
 Indicates when excess cash will be
available
FINANCIAL BUDGETS:
Budgeted Balance Sheet
 A projection of financial position at the end of
the budget period
 Developed from the budgeted balance sheet for
the preceding year and the budgets for the
current year
FINANCIAL BUDGETS:
Budgeted Balance Sheet
Example – Hayes Company
Additional data:
Let’s Review
A sales budget is:
a. Derived from the production budget
b. Management’s best estimate of sales revenue
for the year
c. Not the starting point for the master budget
d. Prepared only for credit sales
Let’s Review
A sales budget is:
a. Derived from the production budget
b. Management’s best estimate of sales revenue
for the year
c. Not the starting point for the master budget
d. Prepared only for credit sales
BUDGETING - Merchandisers
Study Objective 6
 Sales Budget: starting point and key factor in
developing master budget
 Use a purchases budget instead of a production
budget
 Does not use the manufacturing budgets (direct
materials, direct labor, and manufacturing
overhead)
 To determine budgeted merchandise purchases:
BUDGETING - Merchandisers
Example – Lima Company
 Budgeted sales for July $300,000 and August
$320,000
 Cost of goods sold: 70% of sales
 Desired ending inventory: 30% of next month’s
cost of goods sold
BUDGETING - Service Companies
 Critical factor in budgeting is coordinating
professional staff needs with anticipated services
 Problems if overstaffed:
 Disproportionately high labor costs
 Lower profits due to additional salaries
 Increased staff turnover due to no challenging
work
 Problems if understaffed:
 Lost revenue because existing and prospective
client needs for service cannot be met
 Loss of professional staff due to excessive work
loads
BUDGETING
Not-for-Profit Companies
 Important process that differs
significantly from that of a profitoriented company
 Budget on the basis of cash flows
(expenditures and receipts), rather
than on a revenue and expense basis
 The starting point is expenditures,
not receipts
 Significantly different activity index
Summary of Study Objectives
 Indicate the benefits of budgeting
 Requires management to plan ahead
 Provides definite objectives for
evaluating performance
 Creates early warning system for
potential problems
 Facilitates coordination of activities
 Results in greater management
awareness
 Motivates personnel to meet planned
objectives
Summary of Study Objectives
 State the essentials of effective
budgeting
 Sound organizational structure
 Research and analysis
 Acceptance by all levels of
management
Summary of Study Objectives
 Identify the budgets that comprise
the master budget.










Sales budget
Production budget
Direct materials budget
Direct labor budget
Manufacturing overhead budget
Selling and administrative expense
budget
Budgeted income statement
Capital expenditures budget
Cash budget
Budgeted balance sheet
Summary of Study Objectives
 Describe the sources for preparing
the budgeted income statement.
 Sales budget
 Budgets for
• Direct materials
• Direct labor
• Manufacturing
 Selling and administrative expense
budget
 Explain the principal sections of a
cash budget.
 Cash receipts
 Cash disbursements
 Financing
Summary of Study Objectives
 Describe the sources for preparing
the budgeted income statement.
 Sales budget
 Budgets for
• Direct materials
• Direct labor
• Manufacturing
 Selling and administrative expense
budget
 Explain the principal sections of a
cash budget.
 Cash receipts
 Cash disbursements
 Financing
Summary of Study Objectives
 Indicate the applicability of
budgeting in
nonmanufacturing
companies.
 In service firms, critical in
coordinating staff needs with
anticipated services
 In not-for-profit, starting point
is usually expenditures not
receipts
Let’s Review
The budget for a merchandiser differs from
a budget for a manufacturer because:
a. A merchandise purchases budget replaces the
production budget
b. The manufacturing budgets are not applicable
c. None of the above
d. Both (a) and (b) above
Let’s Review
The budget for a merchandiser differs from
a budget for a manufacturer because:
a. A merchandise purchases budget replaces the
production budget
b. The manufacturing budgets are not applicable
c. None of the above
d. Both (a) and (b) above
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