COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan
Chapter 8
Budgeting for Planning
and Control
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
1
Study Objectives
1. Define budgeting, and discuss its role in planning, controlling, and
decision making.
2. Prepare the operating budget, identify its major components, and
explain the interrelationships of the various components.
3. Identify the components of the financial budget, and prepare a cash
budget.
4. Define flexible budgeting, and discuss its role in planning, control,
and decision making.
5. Define activity-based budgeting, and discuss its role in planning,
control, and decision making.
6. Identify and discuss the key features that a budgetary system
should have to encourage managers to engage in goal-congruent
behavior.
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The Role of Budgeting
in Planning and Control
3
The Role of Budgeting
in Planning and Control
• Types of budgets
– Master budget
• Operating budgets
• Financial budgets
• Time frame
– Annual period
– Multi-year rolling budget
4
The Role of Budgeting
in Planning and Control
• Gathering information
– Forecasting sales
– Forecasting other variables
The master budget starts with the sales
forecast, which is basis for the sales
budget.
All other operating and most financial
budgets are generated from the sales
budget.
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The Role of Budgeting
in Planning and Control
6
Preparing the Operating Budget
The first budget is the sales budget which is based on the
sales forecast.
Schedule 1 (in thousands)
Starting point for Production Budget
Starting point for Marketing Expense Budget
Goes to Budgeted Income Statement
7
Preparing the Operating Budget
Schedule 2 (in thousands)
Starting point for Direct Materials Purchases Budget
Starting point for Direct Labor Budget
8
Preparing the Operating Budget
Schedule 3 (in thousands)
* Follows the inventory policy of having 8 million pounds of materials on hand at the end of the first and second quarters and 5 million pounds on hand
at the end of the third and fourth quarters.
Goes to Cost of Goods Sold Budget
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Preparing the Operating Budget
Schedule 4 (in thousands)
Starting point for Overhead Budget
Goes to Cost of Goods Sold Budget
10
Preparing the Operating Budget
Schedule 5 (in thousands)
*Includes $200,000 of depreciation in each quarter.
Goes to Cost of Goods Sold Budget
11
Preparing the Operating Budget
Schedule 6 (in thousands)
aAmounts
taken from Schedule 3.
bAmounts
taken from Schedule 4.
cAmounts
taken from Schedule 5.
dBudgeted
fixed overhead (Schedule 5)/Budgeted direct labor hours (Schedule 4) = $1,280/240 = $5.33.
Goes to Cost of Goods Sold Budget
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Preparing the Operating Budget
Schedule 7 (in thousands)
*Production needs  $0.01 = 416,000  $0.01.
Goes to Budgeted Income Statement
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Preparing the Operating Budget
Schedule 8 (in thousands)
Goes to Budgeted Income Statement
14
Preparing the Operating Budget
Schedule 9 (in thousands)
Goes to Budgeted Income Statement
15
Preparing the Operating Budget
Schedule 10 (in thousands)
Goes to Budgeted Income Statement
16
Preparing the Operating Budget
Schedule 11 (in thousands)
17
Operating Budgets for
Merchandising and Service Firms
• Merchandising
– Merchandise purchases replaces production
– Direct materials and direct labor are not required
• For-profit service:
– Sales budget is the production budget
– Inventories are nonexistent
• Not-for-profit service:
– Budget for level and types of services provided
– Statement of sources and uses replaces income
statement
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Preparing the Financial Budget
Cash budget
– Break down into short time periods
– Forecast need for short-term borrowing
– Forecast periods of high cash balances
+
–
–
–
+
+
Beginning cash balance
Cash receipts
Cash available
Cash disbursements
Minimum cash balance
Excess or deficiency of cash
Repayments
Loans
Minimum cash balance
Ending cash balance
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Preparing the Financial Budget
Schedule 12 (in thousands)
(Continued on next slide)
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Preparing the Financial Budget
Schedule 12 (in thousands)
(Continued from previous slide)
(Continued on next slide)
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Preparing the Financial Budget
Schedule 12 (in thousands)
(Continued from previous slide)
22
Preparing the Financial Budget
• Budgeted balance sheet
– Current (actual) balance sheet
– Integrate data from all other budgets
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Preparing the Financial Budget
Schedule 13 (in thousands)
a Ending balance from Schedule 12.
b 30 percent of fourth-quarter credit
sales (0.30 × $800,000); see
Schedules 1 and 12.
c From Schedule 3 (5,000,000 lbs.
× $0.01).
d From Schedule 6.
e From the December 31, 2009,
balance sheet.
f December 31, 2009, balance
($9,000,000) plus new equipment
acquisition of $600,000; see the
2009 ending balance sheet and
Schedule 12.
g From the December 31, 2009,
balance sheet and Schedules 5, 8,
and 10 ($4,500,000 + $800,000 +
$20,000 + $40,000).
h 20% of fourth-quarter purchases;
see Schedules 3 and 12.
i From the December 31, 2009,
balance sheet.
j $6,825,000 + $894,000 (December
31, 2009, balance plus net income
from Schedule 11).
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Shortcomings of the Traditional
Master Budget Process
• Departmental orientation
– Plan from resources to outputs
– Does not recognize interdependencies among
departments
• Static budgets
– Developed for a single level of activity
– Based on incremental adjustments
• Results orientation
– Disconnects the process from its output
– Cost-cutting accomplished by across-the-board cuts
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Flexible Budgets
for Planning and Control
Static budget
• Vital for planning
• Less useful for control
• Master budget
• Developed around a
single level of activity
• Budgeted activity
level rarely equals
actual activity
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Flexible Budgets
for Planning and Control
27
Flexible Budgets
for Planning and Control
Static budgets
• Master budget
• Vital for planning
• Less useful for control
• Developed around a
single level of activity
• Budgeted activity
level rarely equals
actual activity
Flexible budgets
• Variable budget
• Provides expected
costs for a range of
activity
• Provides budgeted
costs for the actual
activity level
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Flexible Budgets
for Planning and Control
29
Flexible Budgets
for Planning and Control
• Flexible budget
performance report
– Compare budgeted costs
given the actual level of
activity to the actual costs
for the same level
– Locate possible problem
areas by examining the
flexible budget variances
– Examines efficiency
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Flexible Budgets
for Planning and Control
Managerial Performance Report: Quarterly Production
(in thousands)
Actual
results
3,000
Units produced
Production costs:
Direct materials $ 927.3
Direct labor
360.0
Supplies
80.0
Indirect labor
220.0
Power
40.0
Supervision
90.0
Depreciation
200.0
Rent
30.0
Total Costs
$ 1,947.3
Flexible
budget
3,000
$
780.0
360.0
90.0
210.0
60.0
100.0
200.0
20.0
$ 1,820.0
Flexible
budget
variances
$ 147.3
(10.0)
10.0
(20.0)
(10.0)
10.0
$ 127.3
U
U
F
U
F
F
U
U
31
Flexible Budgets
for Planning and Control
• Flexible budget
performance report
– Compare budgeted costs
given the actual level of
activity to the actual costs
for the same level
– Locate possible problem
areas by examining the
flexible budget variances
– Examines efficiency
• Managerial
performance report
– Flexible budget variances
– Actual results vs.
flexible budget
– Examines efficiency
– Volume variances
– Static budget vs.
flexible budget
– Examines effectiveness
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Flexible Budgets
for Planning and Control
Managerial Performance Report: Quarterly Production
(in thousands)
Actual
results
3,000
Units produced
Production costs:
Direct materials $ 927.3
Direct labor
360.0
Supplies
80.0
Indirect labor
220.0
Power
40.0
Supervision
90.0
Depreciation
200.0
Rent
30.0
Total Costs
$ 1,947.3
Flexible
budget
3,000
$
780.0
360.0
90.0
210.0
60.0
100.0
200.0
20.0
$ 1,820.0
Flexible
budget
variances
$ 147.3
(10.0)
10.0
(20.0)
(10.0)
10.0
$ 127.3
U
U
F
U
F
F
U
U
Static
budget
2,400
$
624.0
288.0
72.0
168.0
48.0
100.0
200.0
20.0
$ 1,520.0
Volume
variances
600 F
$ 156.0
72.0
18.0
42.0
12.0
$ 300.0
U
U
U
U
U
U
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Flexible Budgets
for Planning and Control
A flexible budget can be built for five overhead activities using three
drivers; each is budgeted for two activity levels.
34
Flexible Budgets
for Planning and Control
The activity-based performance report measures budget variances for
each of the overhead activities.
35
Activity-Based Budgets
• ABB begins with output and then
determines the resources necessary to
created that output.
• ABB works backwards from activities and
their drivers to the underlying costs
– Traditional budgeting relies on functionalbased line items (salaries, supplies, etc.)
– Flexible budget uses cost behavior to split
functional-based line items into fixed and
variable
36
Activity-Based Budgets
Traditional budgeting relies on functional-based
line items.
37
Activity-Based Budgets
Flexible budgeting uses cost behavior to split
functional-based line items into fixed and
variable costs.
38
Activity-Based Budgets
Steps to construct an ABB
1. Determine the unit’s output
2. Identify the activities (and related drivers)
needed to deliver the output
3. Estimate the demand for each activity
4. Determine the cost of resources required to
produce the relevant activities
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Activity-Based Budgets
40
The Behavioral Dimension
of Budgeting
• Characteristics of a good budgetary
system
– Frequent feedback on performance
– Monetary and nonmonetary incentives
– Participative budgeting
– Realistic standards
– Controllability of costs
– Multiple measures of performance
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COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan
End Chapter 8
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
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