6 Budgeting

Budget 6-1 A budget charts a course for a business by outlining the plans of the business in financial terms.

Establishing specific goals Objectives of Budgeting 6-1 Establishing specific goals Executing plans to achieve the goals Periodically comparing actual results to the goals

Planning 6-1 Budgeting supports the planning process by requiring all organizational units to establish their goals for the upcoming period. These goals motivate individuals and groups to perform at high levels. Planning also motivates employees to attain goals and improve overall decision making.

Directing 6-1 The budget can be used to direct and coordinate operations in order to achieve the stated goals.

Responsibility Centers 6-1 The budgetary units of an organization are called responsibility centers. Each responsibility center is led by a manager who has the authority over and responsibility for the unit’s performance.

Controlling 6-1 As time passes, the actual performance of an operation can be compared against the planned goals. This provides prompt feedback to employees about their performance. If necessary, employees can use such feedback to adjust their activities in the future.

Human behavior problems can arise if— Human Behavior and Budgeting 6-1 Human behavior problems can arise if— the budget goal is too tight and very hard for the employee to achieve. 13

Human behavior problems can arise if— 6-1 Human behavior problems can arise if— the budget goal is too loose and very easy for the employee to achieve. 14

6-1 It is undesirable to plan lower goals than may be possible. Such budget “padding” is termed budgetary slack.

Human behavior problems can arise if— 6-1 Human behavior problems can arise if— the budget goals of a business conflict with the objectives of the employees. 16

6-1 Goal conflict occurs when individual self-interest differs from business objectives. A manager pushing for maximum production (to increase his/her bonus) may not have the same production goals as the company’s (trying to control the size of its inventory).

Budgeting Systems 6-2 A variation of fiscal-year budgeting, called continuous budgeting, maintains a twelve-month projection into the future.

Zero-Based Budgeting 6-2 Zero-based budgeting requires managers to estimate sales, production, and other operating data as though operations are being started for the first time.

Static Budget 6-2 A static budget shows the expected results of a responsibility center for only one activity level. The budget does not change as the activity increases or decreases. A static budget is used by many service companies and for some administrative functions of manu-facturing companies.

6-2 Strength: A static budget is simple—all expenses are budgeted as fixed costs. Weakness: A static budget does not adjust for changes in revenues and expenses that occur as volumes change.

Flexible Budget 6-2 A flexible budget shows the expected results of a responsibility center for several activity levels. A flexible budget is especially useful in estimating and controlling factory costs and operating expenses.

6-2 Strength: Flexible budgeting provides information needed to analyze the impact of volume changes on actual operating results. Weakness: Flexible budgeting requires greater research into costs. There must be a differentiation between fixed and variable costs.

Budgeted Income Statement Budgeted Balance Sheet Budgets That Are Linked Together in a Master Budget 6-3 Budgeted Income Statement Sales budget Cost of goods sold budget: Production budget Direct materials purchases budget Direct labor cost budget Factory overhead cost budget Selling and administrative expense budget Budgeted Balance Sheet Cash budget Capital expenditures budget

The sales budget normally indicates for each product— Sales Budget 6-4 The sales budget normally indicates for each product— (1) the quantity of estimated sales and (2) the expected unit selling price.

backlog of unfilled sales orders planned advertising and promotion Factors Expected to Affect Future Sales include— 6-4 backlog of unfilled sales orders planned advertising and promotion expected industry and general economic conditions productive capacity projected pricing policy findings of market research studies

Production Budget 6-4 The number of units to be manufactured to meet budgeted sales and inventory needs for each product is set forth in the production budget.

+ Desired units in ending inventory 6-4 Sales Budget Production Budget Expected units of sales + Desired units in ending inventory – Estimated units in beginning inventory Total units to be produced 42

– Estimated beginning materials inventory Direct Materials Purchases Budget 6-4 Sales Budget Production Budget Direct Materials Purchases Budget Materials needed for production + Desired ending materials inventory – Estimated beginning materials inventory Direct materials to be purchased 45

Budget Sales Production Budget Direct Labor Cost Budget 6-4 Direct Labor Cost Budget 6-4 Sales Budget Production Budget Direct Materials Purchases Budget Direct Labor Cost Budget 50

Budget Sales Production Budget Factory Overhead Cost Budget 6-4 Factory Overhead Cost Budget 6-4 Sales Budget Production Budget Direct Materials Purchases Budget Direct Labor Cost Budget Factory Overhead Cost Budget 54

Budget Sales Production Budget Cost of Goods Sold Budget Factory Overhead Cost Budget 6-4 Sales Budget Production Budget Direct Materials Purchases Budget Cost of Goods Sold Budget Direct Labor Cost Budget Factory Overhead Cost Budget 56

Selling & Administrative Selling and Administrative Expense Budget 6-4 Sales Budget Production Budget Direct Materials Purchases Budget Cost of Goods Sold Budget Direct Labor Cost Budget Selling & Administrative Expenses Budget Factory Overhead Cost Budget 61

Cash Budget 6-5 The cash budget is one of the most important elements of the budgeted balance sheet. The cash budget presents the expected receipts (inflows) and payments (outflows) of cash for a period of time.

Estimated Cash Receipts 6-5 Estimated Cash Receipts 6-5 January February March Receipts from cash sales: Cash sales (10% x current month’s sales—Note A)……. $108,000 $124,000 $ 97,000 Note A: $108,000 = $1,080,000 x 10% $124,000 = $1,240,000 x 10% $ 97,000 = $ 970,000 x 10% 65

6-5 January February March Receipts from cash sales: 6-5 January February March Receipts from cash sales: Cash sales (10% x current month’s sales—Note A)……. $108,000 $124,000 $ 97,000 Receipts from sales on account: Collections from prior month’s sales (40% of previous month’s credit sales—Note B)……….. $370,000 $388,800 $446,400 Note B: $370,000, given as Jan. 1, 2008 Accts. Rec. balance $388,800 = $1,080,000 x 90% x 40% $446,400 = $1,240,000 x 90% x 40% 66

6-5 January February March Receipts from cash sales: 6-5 January February March Receipts from cash sales: Cash sales (10% x current month’s sales—Note A)……. $108,000 $124,000 $ 97,000 Receipts from sales on account: Collections from prior month’s sales (40% of previous month’s credit sales—Note B)………... $370,000 $388,800 $446,400 Collections from current month’s sales (60%) (see Note C)…………………………… 583,200 669,600 523,800 Note C: $583,200 = $1,080,000 x 90% x 60% $669,600 = $1,240,000 x 90% x 60% $523,800 = $ 970,000 x 90% x 60% 67

Estimated Cash Payments 6-5 Estimated Cash Payments 6-5 January February March Payments of prior months’ manu- facturing costs {[25% x previous month’s manufacturing costs (less depreciation)]—Note A}….. $190,000 $204,000 $189,000 Note A: $190,000, given as January 1, 2006 Accounts Payable balance $204,000 = ($840,000 – $24,000) x 25% $189,000 = ($780,000 – $24,000) x 75% 69

6-5 January February March Payments of prior months’ manu- 6-5 January February March Payments of prior months’ manu- facturing costs {[25% x previous month’s manufacturing costs (less depreciation)]—Note A}….. $190,000 $204,000 $189,000 Payments of current month’s manufacturing costs {[75% x current month’s manufacturing costs (less depreciation)]— Note B}…………….…………… $612,000 $567,000 $591,000 Note B: $612,000 = ($840,000 – $24,000) x 75% $567,000 = ($780,000 – $24,000) x 75% $591,000 = ($812,000 – $24,000) x 75% 70

Completing the Cash Budget 6-5 Completing the Cash Budget 6-5 January February March Estimated cash receipts from: Cash sales (Slide 68) $ 108,000 $ 124,000 $ 97,000 Collections of accounts receivable (Slide 68). 953,200 1,058,400 970,200 Interest revenue — — 24,500 Total cash receipts $1,061,200 $1,182,400 $1,091,700 Estimated cash payments for: Manufacturing costs (Slide 71).. $ 802,000 $ 771,000 $ 780,000 Selling and administrative expenses 160,000 165,000 145,000 Capital additions 274,000 Interest expense 22,500 Income taxes 150,000 74

Budgeted Balance Sheet 6-5 The budgeted balance sheet estimates the financial condition at the end of a budget period.