Chapter

9-1
 CHAPTER 9

Budgetary Planning

Managerial Accounting, Fourth Edition

Chapter
9-2
 Study Objectives

1. Indicate the benefits of budgeting.

2. State the essentials of effective budgeting.
3. Identify the budgets that comprise the master
budget.
4. Describe the sources for preparing the
budgeted income statement.
5. Explain the principal sections of a cash budget.
6. Indicate the applicability of budgeting in
nonmanufacturing companies.

Chapter
9-3
 Preview of Chapter

Budgeting is critical to financial well-

well-being

Use budgets in planning and controlling operations

Specific focus is on how budgeting is used as a

planning tool by management.

Chapter
9-4
 Budgetary Planning

Budgeting in
Preparing the Preparing the
Budgeting Non--
Non
Operating Financial
Basics manufacturing
Budgets Budgets
Companies

Budgeting & accounting Sales Cash Merchandisers

Benefits Production Budgeted Service
Essentials of effective Direct materials balance sheet Not--for
Not for--profit
budgeting Direct labor
Length of budget period Manufacturing
Budgeting process overhead
Budgeting and human Selling and
behavior administrative
expense
Budgeting and long-
long-
range planning Budgeted income
statement
The master budget
Chapter
9-5
 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-
agreed-upon
objectives to all parts of the company
Promotes efficiency
Control device - important basis for performance
evaluation once adopted

Chapter
9-6
 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

Chapter
9-7
 Budgeting Basics - Benefits

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

Chapter
9-8 LO 1: Indicate the benefits of budgeting.
 Budgeting Basics - Benefits

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

Chapter
9-9 LO 1: Indicate the benefits of budgeting.
 Budgeting Basics - Benefits

A budget is
an aid to management
not a substitute for management.

Chapter
9-10 LO 1: Indicate the benefits of budgeting.
 Review Question

Which of the following is not a benefit of budgeting?

a. Management can plan ahead.

ahead
b. An early warning system is provided for
potential problems.
c. It enables disciplinary action to be taken at
every level of responsibility.
d. The coordination of activities is facilitated.

Chapter
9-11 LO 1: Indicate the benefits of budgeting.
 Effective Budgeting

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

Chapter
9-12 LO 2: State the essentials of effective budgeting.
 The 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-
twelve-month budget
Drop the month just ended and add a future
month
Keeps management planning a full year ahead
Chapter
9-13 LO 2: State the essentials of effective budgeting.
 The Budgeting Process

Base budget goals on past performance

Collect data from organizational
units
Begin 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

Chapter LO 2: State the essentials of effective budgeting.

9-14
 The 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

Chapter LO 2: State the essentials of effective budgeting.

9-15
 Budgeting and Human Behavior

Participative Budgeting
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
“bottom--to
to-
-top” approach is called
Participative Budgeting

Chapter LO 2: State the essentials of effective budgeting.

9-16
 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-
“top-down”
Chapter LO 2: State the essentials of effective budgeting.
9-17
 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

Chapter LO 2: State the essentials of effective budgeting.

9-18
 Participative Budgeting

Flow of budget data from lower management to top levels

Chapter LO 2: State the essentials of effective budgeting.

9-19
 Budgeting Versus Long Range Planning

Three basic differences between Budgeting

and Long Range Planning:
Time period involved
Emphasis
Detail presented

Budgeting is short-term – usually one year

Long range planning - at least five years

Chapter LO 2: State the essentials of effective budgeting.

9-20
 Review Question

The essentials of effective budgeting do not include:

a. Top--down budgeting.
Top budgeting
b. Management acceptance.
c. Research and analysis.
d. Sound organizational structure.

Chapter
9-21 LO 2: State the essentials of effective budgeting.
 The Master Budget

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

Chapter LO 3: Identify the budgets that comprise the master budget.

9-22
 The Master Budget - Components

Chapter
9-23
LO 3: Identify the budgets that comprise the master budget.
 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

Chapter LO 3: Identify the budgets that comprise the master budget.

9-24
 Operating Budgets: Sales Budget

Example – Hayes Company

Expected sales volume: 3,000 units in the first
quarter with 500-
500-unit increments for each
following quarter
Sales price: $60 per unit

Chapter
9-25 LO 3: Identify the budgets that comprise the master budget.
 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:

Essential to have a realistic estimate of ending

inventory
Chapter LO 3: Identify the budgets that comprise the master budget.
9-26
 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.

Chapter
9-27 LO 3: Identify the budgets that comprise the master budget.
 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

Chapter LO 3: Identify the budgets that comprise the master budget.

9-28
 Operating Budgets: Direct Materials Budget

Example – Hayes Company

Key component in budgeting process –
desired ending inventory

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

Chapter LO 3: Identify the budgets that comprise the master budget.

9-29
 Operating Budgets: Direct Materials Budget
Example – Hayes Company

Chapter
9-30 LO 3: Identify the budgets that comprise the master budget.
 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:

Chapter
9-31 LO 3: Identify the budgets that comprise the master budget.
 Operating Budgets: Direct Labor Budget

Example – Hayes Company

Direct labor hours from the production budget
Two hours of direct labor required for each unit
Anticipated hourly wage rate $10

Chapter
9-32 LO 3: Identify the budgets that comprise the master budget.
 Operating Budgets: Manufacturing Overhead

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
Chapter LO 3: Identify the budgets that comprise the master budget.
9-33
 Operating Budgets: Manufacturing Overhead

Chapter LO 3: Identify the budgets that comprise the master budget.

9-34
 Operating Budgets: Selling and Administrative

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

Chapter LO 3: Identify the budgets that comprise the master budget.

9-35
 Operating Budgets: Selling and Administrative

Chapter LO 3: Identify the budgets that comprise the master budget.

9-36
 Review Question

A sales budget is:

a. Derived from the production budget.

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.

Chapter
9-37 LO 3: Identify the budgets that comprise the master budget.
 Operating Budgets:
Budgeted Income Statement
Important end
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

Chapter LO 4: Describe the sources for preparing the budgeted income statement.
9-38
 Operating Budgets:
Budgeted Income Statement
Example – Hayes Company
To find cost of goods sold:
First, determine the unit cost of one Kitchen-
Kitchen-mate

Second, determine Cost of Goods Sold by multiplying units

sold times unit cost:

15,000 units X $44 = $660,000

Chapter
9-39 LO 4: Describe the sources for preparing the budgeted income statement.
 Operating Budgets:
Budgeted Income Statement

Additional estimated data for budgeted income statement:

Interest Expense - $100 Income Taxes - $12,000
Chapter
9-40 LO 4: Describe the sources for preparing the budgeted income statement.
 Review Question

Each of the following budgets is used in preparing the

budgeted income statement except the:

a. Sales budget.
budget
b. Selling and administrative budget.
c. Capital expenditure budget.
d. Direct labor budget.

Chapter
9-41 LO 4: Describe the sources for preparing the budgeted income statement.
 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

Chapter LO 5: Explain the principal sections of a cash budget.

9-42
 Operating Budgets:
Budgeted Income Statement

Basic Format

Chapter
9-43 LO 5: Explain the principal sections of a cash budget.
 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 dividends 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

Chapter LO 5: Explain the principal sections of a cash budget.

9-44
 Financial Budgets: Cash Budget

Must prepare in
sequence
Ending cash balance of
one period is the
beginning cash balance
for the next
Data obtained from
other budgets and from
management
Often prepared for the
year on a monthly basis

Chapter LO 5: Explain the principal sections of a cash budget.

9-45
 Financial Budgets: Cash Budget

Example – Hayes Company Assumptions

January 1, 2008 cash balance: $38,000
Sales: collect 60% in quarter sold; 40% in next quarter;
collect December 31, 2007 Accounts Receivable in Quarter 1
Expected sale of short term investments: $2,000 in Quarter 1
Direct Materials: pay 50% in quarter purchased; 50% in next
pay December 31, 2007 Accounts Payable 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)
Chapter
9-46 LO 5: Explain the principal sections of a cash budget.
 Financial Budgets: Cash Budget

Example – Hayes Company

Usually prepare schedule of collections from customers

Chapter LO 5: Explain the principal sections of a cash budget.

9-47
 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 preceding schedules
Chapter LO 5: Explain the principal sections of a cash budget.
9-48
 Financial Budgets: Cash Budget

Chapter
9-49 LO 5: Explain the principal sections of a cash budget.
 Financial Budgets: Cash Budget

Contributes to more effective cash management

Shows managers the need for additional financing

before actual need arises

Indicates when excess cash will be available

Chapter LO 5: Explain the principal sections of a cash budget.

9-50
 Financial Budgets: Budgeted Balance Sheet

A projection of financial
position at the end of
the budgeted period

Developed from the

budgeted balance sheet
for the preceding year
and the budgets for the
current year

Chapter LO 5: Explain the principal sections of a cash budget.

9-51
 Financial Budgets: Budgeted Balance Sheet
Example – Hayes Company

Additional data:

Chapter
9-52 LO 5: Explain the principal sections of a cash budget.
 Review Question

Expected direct materials purchases in Read Company

are $70,000 in the first quarter and $90,000 in the
second quarter. Forty percent of the purchases are
paid in cash as incurred, and the balance is paid in the
following quarter. The budgeted cash payments for
purchases in the second quarter are:

a. $96,000
b. $90,000
c. $78,000
d. $72,000

Chapter
9-53 LO 5: Explain the principal sections of a cash budget.
 Budgeting: Merchandisers

Sales Budget:
Budget starting point and key factor in
developing the master budget
Use a purchases budget instead of a production
budget
Does not use the manufacturing budgets (direct
materials, direct labor, manufacturing overhead)
To determine budgeted merchandise purchases:

LO 6: Indicate the applicability of budgeting in nonmanufacturing

Chapter
9-54 companies.
 Budgeting: Merchandisers

Example – Lima Company

Budgeted sales for July $300,000 and for August $320,000
Cost of Goods Sold: 70% of sales
Desired ending inventory: 30% of next month’s Cost of
Goods Sold

LO 6: Indicate the applicability of budgeting in nonmanufacturing

Chapter
9-55 companies.
 Budgeting: Service Companies

Critical factor in budgeting is coordinating

professional staff needs with anticipated services
Problems if overstaffed
overstaffed:
Disproportionately high labor costs
Lower profits due to additional salaries
Increased staff turnover due to lack of
challenging work
Problems if understaffed
understaffed:
Lost revenues because existing and future client
needs for services cannot be met
Loss of professional staff due to excessive work
loads
LO 6: Indicate the applicability of budgeting in manufacturing
Chapter
9-56 companies.
 Budgeting: Not-
Not-for
for-
-Profit Companies
Just as important as for profit-oriented company
However, budget process differs significantly from
that of a profit-oriented company
Budget on the basis of cash flows (expenditures and
receipts), not on a revenue and expense basis
The starting point is usually
expenditures, not receipts
Management’s task is to find
receipts needed to support
planned expenditures
Budget must be strictly followed,
overspending often illegal

Chapter LO 6: Indicate the applicability of budgeting in nonmanufacturing

9-57 companies.
 Review Question

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

LO 6: Indicate the applicability of budgeting in nonmanufacturing

Chapter
9-58 companies.
 Chapter Review

Perine Company has completed all of its operating

budgets. The sales budget for the year shows 50,000
units and total sales of $2,000,000. The total unit
cost of making one unit of sales is $22. Selling and
administrative expenses are expected to be
$300,000. Income taxes are estimated to be
$150,000.
Prepare a budgeted income statement for the year
ending December 31, 2008.

Chapter
9-59
 Chapter Review - Solution

Perine Company
Budgeted Income Statement
For Year Ending December 31, 2008

Sales $2,000,000
Cost of Goods Sold (50,000 units @ $22) 1,100,000
Gross Profit 900,000
Selling & Administrative Expenses 300,000
Income from Operations 600,000
Income Tax Expense 150,000
Net Income $450,000

Chapter
9-60
 All About YOU: Avoiding Personal Financial Disaster

The average American household income is $49,430, before

taxes.
The average family spends $5,375 on food, $1,283 on
housing, and $7,759 on transportation.

Chapter
9-61
 Copyright

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Chapter
9-62