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.PlanningDeveloping objectives for acquisition and use of resources.ControlSteps taken by management to ensure that objectives are attained.
3 Operating Cash Flows Cash Inventories DMWIPFG 166 days 247 Days Accounts Receivable 81 days247 Days
4 Benefits Derived from Budgeting Enhanced managerial responsibilityCoordination of activitiesPerformance evaluationBenefitsAssignment of decision making responsibilities
5 Establishing Budgeted Amounts: The “Behavioral” Approach Budget ProblemsPerceived unfair or unrealistic goals.Poor management-employee communications.SolutionReasonable and achievable budgets.Employee participation in budgeting process.
6 Participation in Budget Process Flow of Budget Data
7 The Budget PeriodThe annual operating budget may be divided into quarterly or monthly budgets.2005200620072008C a p i t a l B u d g e t sA 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 budgetsOperating expense budgetsBudgetedfinancial budgets:cashincomebalance sheetCapital expenditures budget
9 Preparing the Master Budget Sales BudgetEstimated Unit SalesEstimated Unit PriceAnalysis 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 = $250,000The Sales BudgetJuly is needed for June ending inventory computations.
11 The Production BudgetSalesBudgetCompletedProductionBudgets
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 BudgetProduction 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
17 The Production Budget Production Production Budget Budgets Units CompletedProductionBudgetsMaterial 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.
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.
28 The Production Budget Production Production Budget Budget Units MaterialCompletedProductionBudgetLabor
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.
32 Manufacturing Overhead The Production BudgetProductionBudgetUnits Material LaborCompletedProductionBudgetManufacturing 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.
37 Selling and Administrative (S&A) Expense Budget ProductionBudgetCompletedSelling 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.
42 Cash Receipts Budget All sales are on account. Basket’s collection pattern is:70 percent collected in month of sale25 percent collected in month after sale5 percent will be uncollectibleAccounts receivable on March 31 is $30,000, all of which is collectible.
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.
60 The Budgeted Balance Sheet CompletedBudgetedIncomeStatementBudgetedBalance Sheet
61 The Budgeted Balance Sheet Basket reports the following account balances on June 30, prior to preparing its budgeted financial statements:Land - $50,000Building (net) - $174,500Common stock - $200,000Equipment (net) - $192,500Retained earnings - $148,150Paid dividends of $51,000
62 25% of Junesales of$300,00011,500 lbs. @ $.40 per lb.5,000 units@ $4.99 each50% of Junepurchasesof $56,800
64 Consider the following condensed example from Barton, Inc. . . . Flexible BudgetingHmm! Comparing costs at different levels of activity is like comparing apples with oranges.Consider the following condensed example from Barton, IncPerformance evaluation is difficult when actual activity differs from the activity originally budgeted.
66 Flexible BudgetingU = 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 BudgetingF = Favorable variance: actual costs are less than budgeted costs.
68 Flexible BudgetingSince 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 BudgetingHow 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 BudgetingHow 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 mustthe 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 BudgetingShow 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 costcontrol or lack of cost control.Improve performance evaluation.
73 Flexible BudgetingTo 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.VariableFixed
74 Flexible BudgetingLet’s prepare budgets Barton, Inc.
75 Variable costs are expressed as a constant amount per hour. Flexible BudgetingVariable 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.