Manacc Budgeting

BUDGETARY
PLANNING
Accounting Principles, Eighth Edition
Chapter
23-1
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
23-2
Preview of Chapter
Budgeting is critical to financial well-being
Use budgets in planning and controlling operations
Specific focus is on how budgeting is used as a
planning tool by management.
Chapter
23-3
Budgetary Planning
Budgeting
Basics
Budgeting & accounting

Benefits
Essentials of effective
budgeting
Length of budget period
Budgeting process
Budgeting and human
behavior
Budgeting and longrange planning
The master budget
Chapter
23-4
Preparing the
Operating
Budgets
Sales
Production
Direct materials
Direct labor
Manufacturing
overhead
Selling and
administrative
expense
Budgeted income
statement
Preparing the
Financial
Budgets
Cash
Budgeted
balance sheet
Budgeting in
Nonmanufacturing
Companies
Merchandisers
Service
Not-for-profit
Budgeting Basics
Budget
A formal written statement of managements 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
Chapter
23-5
Budgeting Basics Role of Accounting

Historical accounting data on revenues, costs, and
expenses help in formulating future budgets
Accountants normally responsible for presenting
managements budgeting goals in financial terms
The budget and its administration are, however,
entirely managements responsibility
Chapter
23-6
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
23-7
LO 1: Indicate the benefits of budgeting.

Facilitates coordination of activities within the
business
Results in greater management awareness of the
entitys overall operations and the impact of
external factors
Motivates personnel throughout organization to

meet planned objectives
Chapter
23-8
A budget is
an aid to management
not a substitute for management.
Chapter
23-9
Lets Review
Which of the following is not a benefit of budgeting?
a.
Management can plan 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
23-10
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
23-11
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-month budget
Drop the month just ended and add a future

month
Keeps management planning a full year ahead
Chapter
23-12
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 companys expected share
Chapter
23-13
The Budgeting Process

Factors considered in Sales Forecasting:
Chapter
23-14
General economic conditions
Industry trends
Market research studies
Anticipated advertising and promotion
Previous market share
Price changes
Technological developments
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-to-top approach is called

Chapter
23-15
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
Chapter
23-16
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
23-17
Flow of budget data from lower management to top levels
Chapter
23-18
Budgeting Versus Long Range Planning

Three basic differences between Budgeting
and Long Range Planning:
Time period involved
Emphasis
Detail presented
Time period:
Budgeting is short-term usually one year
Long range planning - at least five years
Chapter
23-19
Lets Review
The essentials of effective budgeting do not include:
a.
Top-down budgeting.
b. Management acceptance.
c.
Research and analysis.
d. Sound organizational structure.
Chapter
23-20
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
23-21
LO 3: Identify the budgets that comprise the master budget.
The Master Budget - Components
Chapter
23-22
Operating Budgets: Sales Budget

First budget prepared
Derived from the sales forecast
Managements 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
23-23
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
Chapter
23-24
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
23-25
Operating Budgets: Production Budget

Hayes Co. believes it can meet future sales needs with
an ending inventory of 20% of next quarters sales
Chapter
23-26
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
23-27

Key component in budgeting process
desired ending inventory
An ending inventory of 10% of next
quarters production requirements is
sufficient
The manufacturing of each unit
requires 2 pounds of raw materials at
an expected price of $4 per pound
Chapter
23-28

Chapter
23-29
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
23-30
Operating Budgets: Direct Labor Budget

Direct labor hours from the production budget
Two hours of direct labor required for each unit
Anticipated hourly wage rate $10
Chapter
23-31
Operating Budgets: Manufacturing Overhead

Shows the expected manufacturing overhead
costs for the budget period
Distinguishes between fixed and variable
overhead costs
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
23-32
Operating Budgets: Manufacturing Overhead
Chapter
23-33
Operating Budgets: Selling and Administrative

Projection of anticipated operating expenses
Distinguishes between fixed and variable costs
Fixed cost amounts are assumed
Expected variable costs per unit sold
(from sales budget):
sales commissions: $3.00
freight-out:
$1.00
Chapter
23-34
Operating Budgets: Selling and Administrative
Chapter
23-35
Lets Review
A sales budget is:
a.
Derived from the production budget.
b. Managements best estimate of sales revenue for

the year.
c.
Not the starting point for the master budget.
d. Prepared only for credit sales.
Chapter
23-36
Operating Budgets:
Budgeted Income Statement
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
Chapter
23-37
LO 4: Describe the sources for preparing the budgeted income statement.
Operating Budgets:
To find cost of goods sold:
First, determine the unit cost of one Kitchen-mate
Second, determine Cost of Goods Sold by multiplying units

sold times unit cost:
15,000 units X $44 = $660,000
Chapter
23-38
Operating Budgets:
Additional estimated data for budgeted income statement:

Interest Expense - $100
Income Taxes - $12,000
Chapter
23-39
Lets Review
Each of the following budgets is used in preparing the
budgeted income statement except the:
a.
Sales budget.
b. Selling and administrative budget.
c.
Capital expenditure budget.
d. Direct labor budget.
Chapter
23-40
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
23-41
LO 5: Explain the principal sections of a cash budget.
Operating Budgets:
Basic Format
Chapter
23-42

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
23-43

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
23-44

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
23-45

Usually prepare schedule of collections from customers
Chapter
23-46

Prepare schedule of cash payments for direct materials
Now prepare the Cash Budget based on the assumptions

and preceding schedules
Chapter
23-47
Chapter
23-48

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
23-49
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
23-50
Financial Budgets: Budgeted Balance Sheet

Additional data:
Chapter
23-51
Lets Review
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
23-52
Budgeting: Merchandisers
Sales 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:
Chapter
23-53
LO 6: Indicate the applicability of budgeting in

non-manufacturing 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 months Cost of
Goods Sold
Chapter
23-54
LO 6: Indicate the appliability of budgeting in

nonmanufacturing companies.
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 lack of
challenging work
Problems if understaffed:
Lost revenues because existing and future client
needs for services cannot be met
Loss of professional staff due to excessive work
loads
Chapter
23-55

Budgeting: Not-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
Managements task is to find
receipts needed to support
planned expenditures
Budget must be strictly followed,
overspending often illegal
Chapter
23-56

Lets 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
Chapter
23-57

Chapter Review - Brief Exercise 23-8

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
23-58
Chapter Review - Brief Exercise 23-8

Perine Company
For Year Ending December 31, 2008
Sales
Cost of Goods Sold (50,000 units @ $22)
Gross Profit
Selling & Administrative Expenses
Income from Operations
Income Tax Expense
Net Income
Chapter
23-59
$2,000,000
1,100,000
900,000
300,000
600,000
150,000
$450,000
Copyright
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use of these programs or from the use of the information
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Chapter
23-60

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BUDGETARY

Indicate the benefits of budgeting.

2. State the essentials of effective budgeting.

Budgeting & accounting

Budgeting Basics Role of Accounting

The budget and its administration are, however,

entirely managements responsibility

Budgeting Basics - Benefits

Creates an early warning system for potential

LO 1: Indicate the benefits of budgeting.

Budgeting Basics - Benefits

Motivates personnel throughout organization to

LO 1: Indicate the benefits of budgeting.

Budgeting Basics - Benefits

LO 1: Indicate the benefits of budgeting.

Management can plan ahead.

b. An early warning system is provided for

It enables disciplinary action to be taken at

d. The coordination of activities is facilitated.

LO 1: Indicate the benefits of budgeting.

Accepted by all levels of

LO 2: State the essentials of effective budgeting.

The Budget Period

Long enough to provide an attainable goal and

Continuous twelve-month budget

Drop the month just ended and add a future

LO 2: State the essentials of effective budgeting.

The Budgeting Process

Develop budget within the framework of

Shows companys expected share

LO 2: State the essentials of effective budgeting.

The Budgeting Process

General economic conditions

Market research studies

Anticipated advertising and promotion

Previous market share

LO 2: State the essentials of effective budgeting.

Budgeting and Human Behavior

Invite each level of management to participate

This bottom-to-top approach is called

LO 2: State the essentials of effective budgeting.

More accurate budget estimates because lower

Tendency to perceive process as fair due to

Overall goal - produce a budget considered fair

Risk of unreliable budgets greater when they are

LO 2: State the essentials of effective budgeting.

situation where managers intentionally

LO 2: State the essentials of effective budgeting.

Flow of budget data from lower management to top levels

LO 2: State the essentials of effective budgeting.

Budgeting Versus Long Range Planning

Long range planning - at least five years

LO 2: State the essentials of effective budgeting.

Research and analysis.

d. Sound organizational structure.

LO 2: State the essentials of effective budgeting.

The Master Budget

Individual budgets that result in the preparation

The capital expenditures budget, the cash

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