1. Managerial Accounting Balakrishnan | Sivaramakrishnan | Sprinkle | Carty | Ferraro Chapter 7: Operating Budgets: Bridging Planning and Control Prepared by Debbie Musil, Kwantlen Polytechnic University

2. Definition A budget is a plan for using limited resources −Takes a set of assumptions −Formulates targets −For a specific period Wide variation in use −We discuss two major aspects Mechanics Process LO1: Understand the role budgets play in organizations

3. Roles for Budgets Planning −Organization-wide planning Coordination −Different business units can communicate and synchronize their actions Control (performance evaluation & feedback) −Provide a benchmark to evaluate performance Complements and Conflicts −Dual planning and control roles of budgets can create conflicts in budget process LO1: Understand the role budgets play in organizations

4. A Budget Has Many Steps LO1: Understand the role budgets play in organizations

5. Planning Strategic plans and multi-year budgets Operating budgets bridge shorter-term decisions and long-term plans Financial budgets quantify operating budgets in financial statements The master budget is the plan for revenues, costs and profits −A comprehensive set of operating and financial budgets

6. Linking Role for Operational Budgets LO1: Understand the role budgets play in organizations

7. Revenue Foundational step −Customer / region / product forecasts Triangulate using −Local knowledge −Macro trends −Market research LO2: Link individual budgets to form an organization-wide plan

8. Production Inventory equation  Applying inventory equation to sales targets gets production plans LO2: Link individual budgets to form an organization-wide plan

9. 50 500 x 0.10 = 50 1 1 1 1 40 (the ending inventory from quarter 1) 2 2 3 3 50 (the ending inventory from quarter 2) 4 4 2 2 3 3 4 4 40 70 570 450 50 700 x 0.10 = 70

10. Budget Input Resources Materials −Bill of materials to determine need −Inventory equation to determine purchases MRP III and other systems Labour −Routing sheet Overhead −Cost of capacity LO2: Link individual budgets to form an organization-wide plan

11. Materials and Labour Budgets LO2: Link individual budgets to form an organization-wide plan

12. 2,000 1,575 BuildIT + 425 BuildIT-PLUS = 2,000 1 1 1 1 2,000 lots X $500 per lot 2 2 3 3 1,960 lots X $500 per lot 4 4 2 2 3 3 4 4 1,960 500 1,550 BuildIT + 410 BuildIT-PLUS = 1,960

13. 425 12 $15 $76,500 410 12 $15 $73,800 520 12 $15 $93,600 650 12 $15 $117,000

14. Manufacturing Overhead Cost Budget Consists of both variable and fixed costs Cannot be directly traced to a specific product Variable overhead is included in variable cost of goods manufactured −And from there, to variable cost of goods sold using the inventory equation Fixed overhead flows directly to budgeted income statement

15. Budgeting for Overhead Costs LO2: Link individual budgets to form an organization-wide plan

16. Flowing Costs to Income Statement Add materials, labour and (applied) overhead to calculate COGM Use inventory equation to calculate COGS and flow these product costs to income statement LO2: Link individual budgets to form an organization-wide plan

17. Selling and Administrative Costs Sales projections are the basis for estimating required selling and administration costs These period costs flow directly through to income statement LO2: Link individual budgets to form an organization-wide plan

18. Consolidate for Financial Budgets LO2: Link individual budgets to form an organization-wide plan

19. Consolidated Income Statement LO2: Link individual budgets to form an organization-wide plan

20. Iterative Nature of Budget Process Budgets are rarely linear −Each step goes through revisions −Entire cycles are repeated Benefit comes from −Intense examination of targets −Challenging assumptions −Examining alternatives & making choices LO2: Link individual budgets to form an organization-wide plan

21. Cash Budget Important for managing working capital Apply inventory equation to cash −Cash flow statement Three components −Inflows −Outflows −Special items LO3: Construct a cash budget and understand cash management

22. A Cash Budget has Many Steps LO3: Construct a cash budget and understand cash management

23. Operating Inflows Adjust sales receipt for collection schedule LO3: Construct a cash budget and understand cash management

24. $6,270,000 0.05 $6,270,000 0.35 $8,200,000 0.60 $20,740,000 1.00

25. Operating Outflows Materials: Adjust for credit purchases Labour Manufacturing overhead (capacity) costs  Adjust for non-cash items Non-manufacturing costs  Marketing, distribution and administration LO3: Construct a cash budget and understand cash management

26. Materials LO3: Construct a cash budget and understand cash management

27. Materials LO3: Construct a cash budget and understand cash management

28. Labour, Overhead & Other LO3: Construct a cash budget and understand cash management

29. 196 1 1 2 2 3 3 1,960 x 0.10 = 196 1 1 2,620 (from quarter 3) x 0.10 = 262 2 2 3 3 3,440 (from quarter 4) x 0.10 = 344 2,196 2,071 262 2,222 196 2,026 344 2,964 262 2,702 3,565 344 3,221

30. Summary of Cash Flows LO3: Construct a cash budget and understand cash management

31. Special Items Capital expenses −Adjust capacity levels −Part of capital budgeting (Chapter 11) Financing flows −Receipts from issuing stock, debt −Outflows for dividends, debt payments LO3: Construct a cash budget and understand cash management

32. Summary of Cash Flows LO3: Construct a cash budget and understand cash management

33. $429,690 ($50,000 + $118,000) 1 1 ($175,000 + $118,000) 2 2 1 1 $429,690 $97,690 $168,000 2 2 (293,000)

34. The Budgeting Process Wide variation across firms and industries Some factors that influence process −Organizational structure −Management style −Past Performance LO3: Construct a cash budget and understand cash management

35. Organizational Structure Strategy leads to structure −Structure influences planning & control Co-locate knowledge and decisions Responsibility Centres  Cost, profit, and investment centres Centre managers responsible for −Using knowledge to set best plan −Delivering results per plan LO4: Describe factors affecting the budgeting process

36. Management Style Information flow −Top down budgeting −Bottom up or participative budgeting −Most firms employ a mix Goal setting −“Tight but attainable” LO4: Describe factors affecting the budgeting process

37. Past Performance Many firms use the previous period as the base line Advantages −Reflects operations “on the ground” −Budgeting becomes easy Disadvantages −Encourages game playing (“ratcheting effects”) −Across the board changes instead of focused resource allocations −Miss the forest for the trees LO4: Describe factors affecting the budgeting process

38. Exercise 7.31 Revenue Budget (LO2). Premium Windows makes one type of standard windows for residential buildings. Premium desires to end March with 2,500 windows in stock. Premium’s inventory on March 1 is 1,750 windows, and its budgeted production for the month is 8,000 windows. Each window sells for $60. Required: Prepare Premium’s revenue budget for March.

39. In solving budgeting exercises, we repeatedly use the “inventory equation.” In its simplest form, the inventory equation is: Exercise 7.31 (Continued)

40. We replace these terms with the appropriate account- specific terms when computing specific revenue and cost budgets. For Premium, we have:

41. Exercise 7.31 (Concluded) Thus, we find Sales for March = 7,250 windows. Multiplying 7,250 windows by the $60 price per window gives budgeted March revenue of $435,000.

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