CHAPTER 10
Budgetary Planning and Control
Slide 10-2
Budgetary Planning and Control
 Budgets are the formal documents that
quantify a company’s plans for achieving its
goals
 For many companies, the entire planning and
control process is built around budgets.
Slide 10-3
Learning objective 1: Discuss the use of
budgets in planning and control.
Use of Budgets in Planning and
Control
 Planning
 Budgets enhance communication and
coordination
 The process of developing a formal plan
forces managers to consider their goals and
objectives and to specify means of achieving
them
 Budgets become the vehicle for
communicating information about where the
company is heading
Slide 10-4
Learning objective 1: Discuss the use of
budgets in planning and control.
Use of Budgets in Planning and
Control
 Control
 Budgets provide a basis for evaluating
performance
 Control makes sure the company is heading in
the proper direction and operating efficiently
 To control a company, it is essential to assess
the performance of managers and their
operations for which they are responsible
Slide 10-5
Learning objective 1: Discuss the use of
budgets in planning and control.
Use of Budgets in Control
 Often performance evaluation is carried out by
comparing actual with planned or budgeted
performance
 Significant deviations from planned performance
associated with three potential causes:
1. The budget was poorly conceived
2. Conditions have changed
3. Managers have done a particularly good or poor job
managing operations
Slide 10-6
Learning objective 1: Discuss the use of
budgets in planning and control.
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 AND in control
Slide 10-7
Learning objective 1: Discuss the use of
budgets in planning and control.
Developing the Budget
 Budgets are prepared for:
 Departments
 Divisions of a company
 For the entire company
 Often the group within a company that is
responsible for approval of the various
budgets is the budget committee
Slide 10-8
Learning objective 1: Discuss the use of
budgets in planning and control.
Developing the Budget
 The budget committee consists of senior
managers
 The budget committee works with
departments to develop realistic plans that are
consistent with overall company goals
 In some cases the budget committee may
impose a budget without soliciting input from
department managers
Slide 10-9
Learning objective 1: Discuss the use of
budgets in planning and control.
Developing the Budget
 In a top-down approach budgets are
developed at higher operational levels
without substantial input from lower level
managers
 In a bottom-up approach, lower level
managers are the primary source of
information used in setting the budget
Slide 10-10
Learning objective 1: Discuss the use of
budgets in planning and control.
Budget Time Period
 Managers must decide on an appropriate
budget period
 Depending on needs, budgets can be
prepared for a variety of time periods
 Long run budgets are prepared for a three or
even a five year period
 Short run budgets may cover a month, a
quarter, or a year
 Generally, the longer the time period, the
less detailed the budget
Slide 10-11
Learning objective 1: Discuss the use of
budgets in planning and control.
Five-Year Budgets
Slide 10-12
Learning objective 1: Discuss the use of
budgets in planning and control.
Zero Base Budgeting
 A common starting point in budgeting is
previous period revenues and costs
 Zero base requires budgeted amounts to be
justified by each department at the start of each
period
 This results in a fresh consideration for the
validity of budgeted amounts
 It is a time consuming and expensive process
 Not widely used by business enterprises
Slide 10-13
Learning objective 1: Discuss the use of
budgets in planning and control.
The Master Budget
 The master budget is a comprehensive planning
document that incorporates a number of
individual budgets
 Typically, it includes budgets for sales,
production, direct materials, direct labor,
manufacturing overhead, selling and
administrative expense, capital acquisitions, and
cash receipts and disbursements
 Also includes budgeted income statement and
balance sheet
Slide 10-14
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Master Budget
Slide 10-15
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Sales Budget
 The first step involved preparation of sales
forecasts and a sales budget
 Prepared first because an estimate of sales is
needed for other budgets
 Companies use numerous methods to
estimate sales, including
 Economic models
 Sales trends
 Trade journals, among others
Slide 10-16
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Sales Budget
Budgeted sales revenue:
Budgeted sales (units) x budgeted sales price
Slide 10-17
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Production Budget
 The production budget can be developed
once the sales budget has been prepared
 In deciding how much to produce, managers
must take into account how much they expect
to sell, how much is in beginning inventory,
and how much they want in ending inventory
Slide 10-18
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Production Budget
 The quantity that must be produced is
calculated using the following formula
Finished
Expected
units to be = sales in +
produced
units
Slide 10-19
Desired
ending
inventory of
finished
goods
Beginning
inventory of
finished
units
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Production Budget
 Preston Joystick budget plan, Quarter 1
 Ending inventory of finished goods = 10% of next
quarter’s sales (25,000 X 10% = 2,500)
 Budgeted unit sales,Q1 = 21,000 units
 Budgeted unit sales, Q2 = 25,000 units
 Beginning inventory Q1 = 2,100 units
 Budget finished units to be produced
Expected sales in units
Add: Desired ending inventory of finished goods
Subtract: Beginning inventory of finished units
Finished units to be produced
Slide 10-20
21,000
2,500
(2,100)
21,400
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Production Budget
Slide 10-21
Learning objective 2: Prepare the budget
schedules that make up a master budget.
Mason Manufacturing expects to sell 10,000 units in the first
quarter and 14,000 in the second quarter. The company desires
beginning inventory equal to 20% of sales for the coming quarter.
Finished goods on hand at the start of the first quarter equals
2,000 units. How many units should be produced in the first
quarter?
a. 14,000 units
b. 16,000 units
c. 10,800 units
d. 12,000 units
Answer: c
10,800 units = 10,000 + 2,800 – 2,000
Slide 10-22
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Direct Material Purchases Budget
 The amount of direct materials that must be
purchased depends on
 The amount needed for production, and
 The amount needed for ending inventory
 The amount that must be purchased can be
calculated from the following formula
Required
purchases of
=
direct
materials
Slide 10-23
Amount
required for
production
Desired
ending
+ inventory of
direct
materials
-
Beginning
inventory of
direct
materials
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Direct Material Purchases Budget
Slide 10-24
Learning objective 2: Prepare the budget
schedules that make up a master budget.
Budgeted production: Q1= 50,000; Q2= 60,000
Parts per unit= 3 , cost per part= $5
Ending inventory = 20% of next month’s production
Number of parts required for Q1 production is:
a. 50,000
b. 150,000
c. 60,000
d. 180,000
Answer: b
Q1 production 50,000 x 3 parts per unit = 150,000
Slide 10-25
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Budgeted production: Q1= 50,000; Q2= 60,000
Parts/unit= 3, cost/part= $5
Ending inventory = 20% of next month’s required parts
Desired ending inventory of parts for Q1 in units is:
a. 10,000
b. 12,000
c. 30,000
d. 36,000
Answer: d
Q2 parts = 60,000 x 3 = 180,000 x 20% = 36,000
Slide 10-26
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Budgeted production: Q1= 50,000; Q2= 60,000
Parts/unit= 3, cost/per part= $5
Ending inventory = 20% of next month’s required part
Beginning parts inventory, Q1= 30,000 units
Budgeted cost of purchases for Q1 is:
a. $750,000
b. $900,000
c. $780,000
d. $1,650,000
Answer: c
156,000 parts to purchase = 150,000 + 36,000 – 30,000
156,000 parts to purchase x $5 cost = $780,000
Slide 10-27
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Direct Labor Budget
 The direct labor budget presents the direct labor
cost by quarter
 Direct labor cost is calculated by multiplying the
number of units produced each quarter by the
labor hours per unit and the rate per hour
 The direct labor budget can be used to budget
the number of employees needed
Slide 10-28
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Direct Labor Budget
Slide 10-29
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Manufacturing Overhead Budget
 The manufacturing overhead budget
separates variable and fixed costs
 The cost per unit of production of each variable
cost item is multiplied by the quantity produced
each quarter
 The fixed costs are identical each quarter except
for the amount of depreciation
 Budget information is also needed for selling and
administrative expenses
Slide 10-30
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Manufacturing Overhead Budget
Slide 10-31
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Selling and Administrative Expense
Budget
Slide 10-32
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Budgeted Income Statement
 Much of the information contained in the
budgets already described is utilized in the
preparation of a budgeted income statement
 The sales figures come directly from the sales
budget
 Cost of goods sold requires a calculation of
the unit cost of production
Slide 10-33
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Budgeted Income Statement
 Calculation of the unit cost of production
 The direct materials budget indicates the
materials cost per unit
 The direct labor budget indicates the labor
cost per unit
 The manufacturing overhead budget indicates
the overhead cost per unit
Slide 10-34
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Budgeted Income Statement
Slide 10-35
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Capital Acquisitions Budget
 For decisions with respect to long-lived
assets such as plant and equipment
 Incremental cash flows along with net present
value and internal rate of return are used for
evaluation
 The final list of approved projects is
documented in the capital acquisitions budget
Slide 10-36
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Capital Acquisitions Budget
Slide 10-37
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Cash Budget
 Managers must plan for the amount and
timing of cash flows
 Careful planning of receipts and
disbursements is necessary to:
 Anticipate cash shortages and arrange to
borrow funds
 Anticipate cash surpluses and seek
productive uses
Slide 10-38
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Which of the following items does not require a
cash outflow?
a.
b.
c.
d.
Salaries
Purchase of raw materials
Advertising
Depreciation
Answer: d
Depreciation
Slide 10-39
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Estimate Cash Collections
 To prepare an estimate of cash collections,
management must determine the percent of
credit sales revenue that is collected in the
period of sale and the percent collected in the
subsequent period
 The percentage can be estimated based on
past collection experience
Slide 10-40
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Estimate Cash Disbursements
 To prepare an estimate of cash
disbursements, management must determine
the percent of material purchases that is paid
in the period of purchase and the percent that
is paid in the subsequent period
 The timing of all other cash disbursements
must also be considered
Slide 10-41
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Estimate Cash Disbursements
 In preparing a cash budget, it is important to
remember that some expenses do not require
cash outlays
 For example, depreciation is a part of
manufacturing overhead but does not require a
current outlay of cash
 Another example of a noncash expense is the
amortization of prepaid insurance
Slide 10-42
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Cash Budget
Slide 10-43
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Mason Manufacturing expects sales of $100,000 in the first
quarter and $140,000in the second quarter. The company
collects 70% of sales in the quarter sold and 30% in the
subsequent quarter. What are expected cash collections in the
second quarter?
a.
b.
c.
d.
$128,000
$30,000
$98,000
$142,000
Answer: a
$128,000 = (.3 * $100,000) + (.7 * $140,000)
Slide 10-44
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Budgeted Balance Sheet
 The last component of the master budget is
the budgeted balance sheet
 This is simply a planned balance sheet
 Sometimes called a pro forma balance sheet
 Managers can use this budget to assess the
effect of their planned decisions on the future
financial position of the firm
Slide 10-45
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Budgeted Balance Sheet
Slide 10-46
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Use of Computers in the Budget
Planning Process
 Budget committee may review a budget and
decide it is inconsistent with company goals
 This conclusion may lead managers to
explore a variety of actions that affect future
costs and revenues
 If managers decide to make changes, they
must also revise the budget
Slide 10-47
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Use of Computers in the Budget
Planning Process
 Computers are very useful in this situation
 Most companies define the budget
relationships in a computer model
 With computerized budget information, an
item can be changed and the computer can
recalculate that budget and any other budget
affected by the change
Slide 10-48
Learning objective 2: Prepare the budget schedules
that make up a master budget.
Spreadsheets for Budgeting
Slide 10-49
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Budgetary Control
 Budgets facilitate control by providing a standard
for evaluation
 The standard is the budgeted amount, against
which actual results are compared
 Differences between budgeted and actual
amounts are referred to as budget variances
Slide 10-50
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Static and Flexible Budgets
 In evaluating performance, care must be
taken to make sure that the level of activity
used in the budget is equal to the actual level
of activity
 A static budget is not adjusted for the actual
level of production
 A more appropriate analysis would make use
of a flexible budget
Slide 10-51
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Flexible Budgets
 A flexible budget is a set of budget
relationships that can be adjusted to various
activity levels
 Thus, flexible budgets take into account the
fact that when production increases or
decreases, variable costs can change
 Fixed costs, however, stay the same
Slide 10-52
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Flexible Budget
Slide 10-53
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
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
Slide 10-54
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Investigating Budget Variances
 Significant deviations from the budget, called
budget variances, may have three causes
1. The budget may not have been well
conceived
2. Conditions may have changed
3. Managers may have performed their jobs
particularly well or poorly
Slide 10-55
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Investigating Budget Variances
 Using a management by exception approach,
only exceptional variances are investigated
 Generally, variances that are large in absolute
dollars or relative to budgeted amounts are
considered exceptional
 It is important to point out that both exceptional
“unfavorable” and exceptional “favorable”
variances should be investigated
Slide 10-56
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
“Unfavorable” Budget Variance
Slide 10-57
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Conflict in Planning and Control Uses
of Budgets
 Budgets are used for both planning and control
 With respect to planning, they communicate
company goals and help coordinate various
activities
 With respect to control, they focus the attention of
managers on meeting or beating budget targets
 There are inherent conflicts when budgets are
used for both planning and control
Slide 10-58
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Issues With Budget-Based
Compensation
 The following slide helps understanding of
the two related problems
 The illustration shows a common budget
based compensation scheme in which a
manager receives a “hurdle” bonus once a
target is hit
 Performance better than 80% of budgeted
profit results in additional “variable” bonus
Slide 10-59
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Common Budget-based Compensation
Scheme
Slide 10-60
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Issues With Budget-Based
Compensation
 The first problem is that managers have
incentive to pad a budget and create budget
slack
 Budget slack is a budget with targets that are
easy to achieve
 The lower the budget target, the more likely it
is that managers will receive the hurdle and
variable bonus
 Managers can create slack by lowering sales
and increasing cost forecasts
Slide 10-61
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Issues With Budget-Based
Compensation
 The second problem relates to the fact that
managers who are evaluated may have an
incentive to shift income from one period to
another
 Consider a manager who estimates that it is
unlikely that the target will be met
 The manager has an incentive to shift income
from a future period to the current period
Slide 10-62
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Issues With Budget-Based
Compensation
 The best that can be done to mitigate the
conflict between the planning and control
uses of budgets is to assure managers that
their performance in comparison to the
budget will be fairly evaluated and
compensated
 Managers should be confident that they will
be allowed to comment on the real causes of
budget variances and tell their side of the
story
Slide 10-63
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
Budget Padding
Slide 10-64
Learning objective 3: Explain why flexible budgets are
needed for performance evaluation, and discuss the
conflict between the planning and control uses of budgets.
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Slide 10-65