1. Using Budgets for Planning and Coordination
CHAPTER 10
Using Budgets for Planning and Coordination

2. Budgets and Budgeting Process
Formal documents that quantify a company’s plans for achieving its goals
Budgeting process enhances communication and coordination by forcing managers to consider their goals and objectives carefully and specify means of achieving goals and objectives.

3. The Master Budget The master budget includes: See handout for details.
Sales budget
Production budget
Direct materials purchases budget
Direct labor budget
Manufacturing overhead budget
Selling and administrative expense budget
Capital acquisitions budget
Cash budget
See handout for details.

4. Master Budget

5. Sales Budget
First budget prepared since most budgets cannot be prepared without an estimate of sales
P6 in handout: Bottled Water Company part 1

6. Production Budget Quantity to be produced based on following formula:
Desired ending inventory of finished goods becomes beginning inventory for the next period
Bottled Water Company part 2

7. Direct Material Purchases Budget
Depends upon amount needed for production and ending inventory
The following formula can be used:
Bottled Water Company part 3

8. Review 1 Budgeted production: Q1= 50,000; Q2= 60,000
Parts/unit= 3 , cost/part= $5
Ending inventory = 20% of next month’s production
Number of parts required for Q1 production is:
50,000
150,000
60,000
180,000
Answer: b
Q1 production 50,000 x 3 parts/unit = 150,000

9. Review 2 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:
10,000
12,000
30,000
36,000
Answer: d
Q2 parts = 60,000 x 3 = 180,000 x 20% = 36,000

10. Review 3 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:
$750,000
$900,000
$780,000
$1,650,000
Answer: c
150,000 (review 2) + 36,000 (review 3) – 30,000 =
156,000 parts to purchase x $5 cost = $780,000

11. Direct Labor Budget
Direct labor cost can be budgeted using the following formulas:
- Units to be produced* direct labor hours per unit * labor rate
Bottled Water Company part 4 (no calculation required)

12. Manufacturing Overhead Budget
Separate costs into fixed and variable:
Variable costs
cost/unit * units produced
Fixed costs
- Identical each period except for depreciation
Depreciation may vary due to planned acquisitions or disposals
Bottled Water Company part 5 (no calculation required)

13. Selling & Administrative Expenses Budget
Separate costs into fixed and variable:
Variable costs
cost/unit * units sold
Fixed costs
Identical each period
Bottled Water Company part 6 (no calculation required)

14. Budgeted Income Statement
Compilation of information provided by previously prepared budgets:
Sales from Sales Budget
Cost of goods sold calculated from:
- Direct Materials Budget
- Direct Labor Budget
- Manufacturing Overhead Budget
Other expenses from Selling and Administrative Expense Budget
Bottled Water Company part 8 ((no calculation required))

15. Capital Acquisitions Budget
Decisions with respect to long lived assets
- Use present value concepts to make capital acquisition decisions
Must be carefully planned since it may substantially reduce cash reserves

16. Cash Receipts and Disbursements Budget
Managers must plan for amount and timing of cash flows
Careful planning of receipts and disbursements necessary to:
- Anticipate cash shortages and arrange to borrow funds
- Anticipate cash surpluses and seek productive uses

17. Estimate Cash Collections and Cash Disbursements
Estimate % of credit sales collected in the period of sale and subsequent periods
Cash disbursements
Estimate % of materials purchases paid in the period of purchase and subsequent periods
Handout: E10-11 & 12; E10-13 & 14

18. Budgeted Balance Sheet
Last component of master budget prepared
Sometimes referred to as the pro forma balance sheet
Used to assess the effect of planned decisions on the future financial position of the firm

19. Budgetary Control Budgets as a Standard for Evaluation
The standard is the budgeted amount
Standards for DM and DL are usually set up at unit level
Differences between budgeted and actual amounts are called budget variances
Budget variances should be investigated when they are material

20. Investigating Budget Variances
Variances are differences between budgeted and actual amounts
Causes of Budget Variances
- Budget may not have been well conceived
- Conditions may have changed
- Managers may have performed particularly well or poorly

21. A General Approach to Variance Analysis
Variance analysis: an analysis of the difference between a standard and an actual cost. The process breaks down the difference into two components: price (spending) and quantity (efficiency) variance.
Direct material variances
- Material price variance
Material quantity variance
Direct labor variances
- Labor rate variance
-Labor efficiency variance
Manufacturing overhead variances
Controllable overhead variance
Overhead volume variance

22. A General Approach to Variance Analysis

23. Material Variances

24. Material Variances Standard for 1 unit: 400 lbs @ $10 per lb
Materials purchased: 200,000 $9.90 per lb
Materials used: 181,000 lbs to produce 450 units
Slide 11-24

25. Exercise 1 Data for chips used in the production of computers
Standard: 3 chips per $6.50 per chip
Quantity purchased: 200 chips for total of $1,350
Quantity used: 123 chips for production of 40 units
Calculate the material price variance:

26. Exercise 1 continued
Data for chips used in the production of computers
Standard: 3 chips per $6.50 per chip
Quantity purchased: 200 chips for $1,350 total
Quantity used: 123 chips for production of 40 units
Calculate the material quantity variance:
Learning objective 2: Calculate and interpret variances for direct material

27. Direct Labor Variances

28. Review 4 A favorable labor efficiency variance means:
Labor rates were higher than called for by standards
Inexperienced labor was used, causing the rate to be lower than standard
More labor was used than called for by standards
Less labor was used than called for by standards
Answer: d

29. Direct Labor Variances
Standard for 1 unit: 4 $15 per hour
Actual labor: 1,700 $15.50 per hour to produce 450 units
Slide 11-29

30. Exercise 2 Data for labor used in the production of sneakers
Standard: .25 hours per sneaker at $12.00 per hour
Actual quantity produced: 24,500 sneakers
Quantity used: 6,000 hours, total cost $69,000
Calculate the labor rate variance:

31. Exercise 2 continued Data for labor used in the production of sneakers
Standard: .25 hours per sneaker at $12.00 per hour
Actual quantity produced: 24,500 sneakers
Quantity used: 6,000 hours, total cost $69,000
Calculate the labor efficiency variance:

32. “Favorable” Variances May Be Unfavorable
A variance that is “favorable” should not be exempt from investigation. It could indicate poor management decision
E.g. Suppose inferior, low-priced materials are ordered.
On one hand, a favorable price variance will arise.
On the other hand, most likely there will be substantially more scrap and rework, and thus a higher quantity variance.

33. You Get What You Measure!
Slide 11-33 33

34. Incremental VS. Zero Base Budgeting (ZBB)
Incremental Budgeting: budgeting with a starting point from previous period revenues and costs (e.g. + or -10% )
ZBB requires budgeted amounts to be justified each period
- Provides fresh consideration for validity of budgeted amounts
- Time consuming and expensive process
- Not widely used by business enterprises