1. OPERATIONAL BUDGETING
Chapter 23
OPERATIONAL BUDGETING 2

2. Budgeting: The Basis for Planning and Control
A budget is a comprehensive financial plan for achieving the financial and operational goals of an organization.
Planning
Developing objectives for acquisition and use of resources.
Control
Steps taken by management to ensure that objectives are attained.

3. Operating Cash Flows Cash Inventories DMWIPFG 166 days 247 Days
Accounts Receivable 81 days
247 Days

4. Benefits Derived from Budgeting
Enhanced managerial responsibility
Coordination of activities
Performance evaluation
Benefits
Assignment of decision making responsibilities

5. Establishing Budgeted Amounts: The “Behavioral” Approach
Budget Problems
Perceived unfair or unrealistic goals.
Poor management-employee communications.
Solution
Reasonable and achievable budgets.
Employee participation in budgeting process.

6. Participation in Budget Process
Flow of Budget Data

7. The Budget Period
The annual operating budget may be divided into quarterly or monthly budgets.
2005
2006
2007
2008
C a p i t a l B u d g e t s
A continuous budget is usually a twelve-month budget that adds one month as the current month is completed.

8. The Master Budget Sales forecast Production budgets
Cost of goods sold and ending inventory budgets
Operating expense budgets
Budgeted
financial budgets:
cash
income
balance sheet
Capital expenditures budget

9. Preparing the Master Budget
Sales Budget
Estimated Unit Sales
Estimated Unit Price
Analysis of economic and market conditions + Forecasts of customer needs from marketing personnel

10. Preparing the Master Budget
Basket, Inc. is preparing budgets for the quarter ending June 30. The sales price is $10 per magnet. Budgeted sales for the next four months are:
April 20,000 magnets @ $10 = $200,000 May 50,000 magnets @ $10 = $500,000 June 30,000 magnets @ $10 = $300,000 July 25,000 magnets @ $10 = $250,000
The Sales Budget
July is needed for June ending inventory computations.

11. The Production Budget
Sales
Budget
Completed
Production
Budgets

12. Let’s prepare the production budget.
The management of Basket wants ending inventory to be 20 percent of the next month’s budgeted sales in units.
4,000 units were on hand March 31.
Let’s prepare the production budget.

13. The Production Budget
Production must be adequate to meet budgeted sales and to provide sufficient ending inventory.
Budgeted product sales in units
+ Desired product units in ending inventory
= Total product units needed
– Product units in beginning inventory
= Product units to produce

14. The Production Budget

15. The Production Budget

16. The Production Budget

17. The Production Budget Production Production Budget Budgets Units
Completed
Production
Budgets
Material Purchases

18. The Production Budget Material Purchases
The material purchases budget is based on production quantity and desired material inventory levels.
Units to produce
× Material needed per unit
= Material needed for units to produce
+ Desired units of material in ending inventory
= Total units of material needed
– Units of material in beginning inventory
= Units of material to purchase

19. The Production Budget Material Purchases
Five pounds of material are needed for each unit produced.
The management at Basket wants to have materials on hand at the end of each month equal to 10 percent of the following month’s production needs.
The materials inventory on March 31 is 13,000 pounds. July production is budgeted for 23,000 units.

20. The Production Budget Material Purchases

21. The Production Budget Material Purchases

22. The Production Budget Material Purchases

23. Cash Payments for Material Purchases
Materials used in production cost $0.40 per pound. One-half of a month’s purchases are paid for in the month of purchase; the other half is paid for in the following month.
No discount terms are available.
The accounts payable balance on March 31 is $12,000.

24. Cash Payments for Material Purchases

25. Cash Payments for Material Purchases

26. Cash Payments for Material Purchases

27. Cash Payments for Material Purchases

28. The Production Budget Production Production Budget Budget
Units Material
Completed
Production
Budget
Labor

29. The Production Budget Direct Labor
Each unit produced requires 3 minutes (.05 hours) of direct labor. Basket employs 30 persons for 40 hours each week at a rate of $10 per hour. Any extra hours needed are obtained by hiring temporary workers also at $10 per hour.

30. Cash Payments for Direct Labor

31. Cash Payments for Direct Labor

32. Manufacturing Overhead
The Production Budget
Production
Budget
Units Material Labor
Completed
Production
Budget
Manufacturing Overhead

33. The Production Budget Manufacturing Overhead
Variable manufacturing overhead is $1 per unit produced and fixed manufacturing overhead is $50,000 per month.
Fixed manufacturing overhead includes $20,000 in depreciation which does not require a cash outflow.

34. Cash Payments for Manufacturing Overhead

35. Cash Payments for Manufacturing Overhead

36. Cash Payments for Manufacturing Overhead

37. Selling and Administrative (S&A) Expense Budget
Production
Budget
Completed
Selling and Administrative Expense Budget

38. Selling and Administrative (S&A) Expense Budget
Selling expense budgets contain both variable and fixed items.
Variable items: shipping costs and sales commissions.
Fixed items: advertising and sales salaries.
Administrative expense budgets contain mostly fixed items.
Executive salaries and depreciation on company offices.

39. Cash Payments for (S&A) Expenses
Variable selling and administrative expenses are $0.50 per unit sold and fixed selling and administrative expenses are $70,000 per month.
Fixed selling and administrative expenses include $10,000 in depreciation which does not require a cash outflow.

40. Cash Payments for (S&A) Expenses

41. Cash Payments for (S&A) Expenses

42. Cash Receipts Budget All sales are on account.
Basket’s collection pattern is:
70 percent collected in month of sale
25 percent collected in month after sale
5 percent will be uncollectible
Accounts receivable on March 31 is $30,000, all of which is collectible.

43. Cash Receipts Budget

44. Cash Receipts Budget

45. Cash Receipts Budget

46. Cash Receipts Budget

47. Comprehensive Cash Budget Additional Information
Basket Company:
Has a $100,000 line of credit at its bank, with a zero balance on April 1.
Maintains a $30,000 minimum cash balance.
Borrows at the beginning of a month and repays at the end of a month.
Pays interest at 16 percent when a principal payment is made.
Pays a $51,000 cash dividend in April.
Purchases equipment costing $143,700 in May and $48,800 in June.
Has a $40,000 cash balance on April 1.

53. $50,000 × .16 × 3/12 = $2,000

54. The Budgeted Income Statement
Cash
Budget
Completed
Budgeted
Income
Statement

55. The Budgeted Income Statement

56. The Budgeted Income Statement
Computation of unit cost follows

57. The Budgeted Income Statement
Total mfg. OH for quarter $251,000
Total labor hours required 5,050 hrs.
= $49.70 per hr.
Manufacturing overhead is applied based on direct labor hours.

58. The Budgeted Income Statement

59. The Budgeted Income Statement

60. The Budgeted Balance Sheet
Completed
Budgeted
Income
Statement
Budgeted
Balance Sheet

61. The Budgeted Balance Sheet
Basket reports the following account balances on June 30, prior to preparing its budgeted financial statements:
Land - $50,000
Building (net) - $174,500
Common stock - $200,000
Equipment (net) - $192,500
Retained earnings - $148,150
Paid dividends of $51,000

62. 25% of June
sales of
$300,000
11,500 lbs. @ $.40 per lb.
5,000 units
@ $4.99 each
50% of June
purchases
of $56,800

64. Consider the following condensed example from Barton, Inc. . . .
Flexible Budgeting
Hmm! Comparing costs at different levels of activity is like comparing apples with oranges.
Consider the following condensed example from Barton, Inc
Performance evaluation is difficult when actual activity differs from the activity originally budgeted.

65. Flexible Budgeting

66. Flexible Budgeting
U = Unfavorable variance – Barton, Inc. was unable to achieve the budgeted level of activity.

67. F = Favorable variance: actual costs are less than budgeted costs.
Flexible Budgeting
F = Favorable variance: actual costs are less than budgeted costs.

68. Flexible Budgeting
Since cost variances are favorable, have we done a good job controlling costs?

69. I don’t think I can answer the question using the original budget.
Flexible Budgeting
How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?
I don’t think I can answer the question using the original budget.

70. I don’t think I can answer the question using the original budget.
Flexible Budgeting
How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?
I don’t think I can answer the question using the original budget.
To answer the question, we must
the budget to the actual level of activity.

71. Flexible Budgeting Central Concept
If you can tell me what your activity was for the period, I will tell you what your costs and revenue should have been.

72. Flexible Budgeting
Show expenses that should have occurred at the actual level of activity.
May be prepared for any activity level in the relevant range.
Reveal variances due to good cost
control or lack of cost control.
Improve performance evaluation.

73. Flexible Budgeting
To a budget for different activity levels, we must know how costs behave with changes in activity levels.
Total variable costs change in direct proportion to changes in activity.
Total fixed costs remain unchanged within the relevant range.
Variable
Fixed

74. Flexible Budgeting
Let’s prepare budgets Barton, Inc.

75. Variable costs are expressed as a constant amount per hour.
Flexible Budgeting
Variable costs are expressed as a constant amount per hour.
In the original budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of $4.00 per hour.

76. Flexible Budgeting

77. Flexible Budgeting
Total variable cost = $7.50 per unit × budget level in units

78. Flexible Budgeting
Fixed costs are expressed as a total amount that does not change within the relevant range of activity.

79. Flexible Budgeting Performance Report
Now let’s prepare a budget performance report at 8,000 actual machine hours for Barton, Inc.

80. Flexible Budgeting Performance Report

81. Flexible Budgeting Performance Report
Indirect labor and indirect material have unfavorable variances because actual costs are more than the flexible budget costs.

82. Flexible Budgeting Performance Report
Power has a favorable variance because the actual cost is less than the flexible budget cost.

83. End of Chapter 23 4