1. Chapter 9 BUDGETING
A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms
Control Device & Planning Tool

2. BUDGETING BASICS Benefits of Budgeting
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

3. BUDGETING BASICS Benefits of Budgeting
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

4. BUDGETING BASICS Length of 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
Continuous twelve-month budget
Drops the month just ended and adds a future month
This keeps management planning a full year ahead

5. BUDGETING BASICS Budgeting Process
Base budget goals on past performance
Collect data from organizational units
Begins several months before the end of the current year
Start with the Sales Budget

6. BUDGETING BASICS 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

7. BUDGETING BASICS Budgeting Process
The budgeting process is usually informal in small companies
Assigned to a budget committee in larger companies

8. BUDGETING BASICS Budgeting and Human Behavior Participative Budgeting
“bottom-to-top” approach is called
Participative Budgeting
Advantages:
Leads to more accurate budget estimates because lower level managers have more detailed knowledge of their area
Employees perceive the 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

9. BUDGETING BASICS Budgeting and Human Behavior Participative Budgeting
Disadvantages:
Can be time consuming and costly
Can foster budgetary “gaming” through budgetary slack
This is a situation where managers intentionally underestimate budgeted revenues or overestimate budgeted expenses so that budget goals are easier to meet

10. BUDGETING BASICS - 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
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

11. BUDGETING BASICS - The Master Budget - Components

12. OPERATING BUDGETS: Sales Budget
The sales budget is the first budget prepared
It is derived from the sales forecast
The sales forecast is management’s best estimate of sales revenue for the budget period
Every other budget depends on the sales budget

13. OPERATING BUDGETS: Sales Budget Example – Hayes Company
Expected sales volume: 3,000 units in the first quarter with 500-unit increment increases for each following quarter
Sales price: $60 per unit
Hayes Company Sales Budget For the Year Ending December 31, 2005
Expected unit sales Unit selling price
Total sales
, x $60
$180,000
, x $60
$210,000
, x $60
$240,000
, x $60
$270,000
Year , x $60
$900,000
Quarter

14. OPERATING BUDGETS: Production Budget
The production budget shows the units that must be produced to meet anticipated sales
It is derived from sales budget plus the desired finished goods
Required production in units formula:

15. 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

16. OPERATING BUDGETS: Direct Materials Budget
The direct materials budget shows both the quantity and cost of direct materials to be purchased
It is derived from the direct materials units required for production (from the production budget) and desired ending materials inventory
Budgeted cost of direct materials to be purchased = required units of direct materials X anticipated cost per unit

17. OPERATING BUDGETS: Direct Materials Budget Example – Hayes Company
Desires an ending inventory of 10% of the next quarter’s production requirements
The manufacturing of each unit requires 2 pounds of raw materials at an expected price of $4 per pound

18. OPERATING BUDGETS: Direct Materials Budget Example – Hayes Company

19. OPERATING BUDGETS: Direct Labor Budget
The direct labor budget shows both the quantity of hours and cost of direct labor necessary to meet production requirements
The total direct labor cost formula is:

20. OPERATING BUDGETS: Direct Labor Budget Example – Hayes Company
Direct labor hours from the production budget
Two hours of direct labor required for each unit
Hourly wage rate $10

21. OPERATING BUDGETS: Manufacturing Overhead Budget
The manufacturing overhead budget shows the expected manufacturing overhead costs for the budget period
It 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

22. Hayes Company Manufacturing Budget For the Year Ending December 31, 2005
Quarter
1 $ 6,200 8,680 2, , , ,000 3,800 9, , ,500
$57,100
2 $ 7,200 10,080 2, , , ,000 3,800 9, , ,500
$60,100
3 $ 8,200 11,480 3, , , ,000 3,800 9, , ,500
$63,100
4 $ 9,200 12,880 3, , , ,000 3,800 9, , ,500
$66,100
Year $ 30,800 43,120 12, , , ,000 15,200 36, , ,000
$246,400
Variable Costs Indirect materials ($1.00 per DLH) Indirect labor ($1.40 per DLH) Utilities ($ .40 per DLH) Maintenance ($.20 per DLH) Total variable Fixed costs Supervisory salaries Depreciation Property tax and insurance Maintenance
Total fixed
Total manufacturing overhead
Direct Labor hours
6,200
7,200
8,200
9,200
30,800
Manufacturing overhead rate per direct labor hour ($246,400  30,800) $8.00

23. OPERATING BUDGETS: Selling & Administrative Expense Budget
Is a 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

24. Hayes Company Selling & Administrative Budget For the Year Ending December 31, 2005
Quarter
Variable Costs Sales commissions ($3 per unit) Freight-out ($1 per unit) Total variable Fixed costs Advertising Sales salaries Office Salaries Depreciation Property taxes and insurance
Total Fixed Expenses
Total Selling/Admin. Expenses
1 $ 9, , ,000 5,000 15,000 7,500 1, , ,000
$42,000
$ 10, , ,000 5,000 15,000 7,500 1, , ,000
$44,000
$ 12, , ,000 5,000 15,000 7,500 1, , ,000
$46,000
$ 13, , ,000 5,000 15,000 7,500 1, , ,000
$48,000
Year $ 45, , , ,000 60,000 30,000 4, , ,000
$180,000

25. OPERATING BUDGETS: Budgeted Income Statement
The budgeted income statement is prepared from the operating budgets
Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Manufacturing Overhead Budget
Selling and Administrative Expense Budget

26. FLEXIBLE BUDGETS
Projects budget data for various levels of activity
Essentially, a series of static budgets at different activity levels
The budgetary process is more useful if it is adaptable to changes in operating conditions
Flexible budgets can be prepared for each type of budget in the master budget
Flexible budgets are static budgets at different activity levels

27. DEVELOPING THE FLEXIBLE BUDGET Steps
Identify the activity level and the relevant range of activity
Identify the variable costs and determine the budgeted variable cost per unit of activity for each cost
Identify the fixed costs and determine the budgeted amount for each cost
Prepare the budget for selected increments of the activity level within the relevant range

28. FLEXIBLE BUDGET – A CASE STUDY Example – Fox Manufacturing Co.
Monthly comparisons of actual and budgeted manufacturing overhead costs for Finishing Department
2007 master budget
Expected annual operating capacity of 120,000 direct labor hours
Overhead costs:

29. FLEXIBLE BUDGET – A CASE STUDY Example – Fox Manufacturing Co.
Identify the activity level and the relevant range
activity level: direct labor hours
relevant range: 8,000 – 12,000 direct labor hours per month
Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost

30. FLEXIBLE BUDGET – A CASE STUDY Example – Fox Manufacturing Co.
Identify the fixed costs and determine the budgeted amount for each cost
Three fixed costs per month:
depreciation $15,000
property taxes $5,000
supervision $10,000
Prepare the budget for selected increments of activity within the relevant range
Prepared in increments of 1,000 direct labor hours

31. FLEXIBLE BUDGET – A CASE STUDY Example – Fox Manufacturing Co.
Formula to determine total budgeted costs from the budget at any level of activity:
* Total variable cost per unit X activity level
Determine total budgeted costs for Fox Manufacturing Company with fixed costs of $30,000 and total variable cost $4 per unit
At 9,000 direct labor hours : $30,000 + ($4 X 9,000) = $66,000
At 8,622 direct labor hours: $30,000 + ($4 X 8,622) = $64,488