CHAPTER 21: BUDGETARY PLANNING

Budgeting Basics A budget is a formal written statement of management’s plans, expressed in financial terms, for a specified future time period. The main benefits of budgeting include: all levels of management must plan ahead and formalize future goals on a recurring basis provides definite objectives for evaluating performance creates an early warning system for potential problems easier to coordinate activities within the business greater management awareness of the company’s overall operations and motivates personnel to meet planned objectives John Wiley & Sons, 2016

Essentials of Effective Budgeting Budgeting Basics Essentials of Effective Budgeting Budgeting process Collect past data from each organizational unit of the company as a starting point for developing future budget goals. Develop the budget based on a sales forecast that reflects expected industry and economic conditions, with input from sales personnel and top management. Assign responsibility for coordinating the budget preparation, usually to a budget committee. John Wiley & Sons, 2016

Essentials of Effective Budgeting Budgeting Basics Essentials of Effective Budgeting Budgeting and Human Behaviour Each level of management should be invited to participate in developing the budget. Agreement should be reached on a budget that management considers fair and achievable. The budget should provide the management tool for performance evaluation. Length of the Budget Period The budget period should be long enough to provide an attainable goal under normal business conditions, usually one year. John Wiley & Sons, 2016

Essentials of Effective Budgeting Budgeting Basics Essentials of Effective Budgeting Budgeting and Long-Range Planning Budgeting and long-range planning are not the same. Important differences include: Time period involved. Budgets are usually prepared for a one-year or shorter period while long range plans cover a period of at least five years. Emphasis. Achieving specific short term goals for budgeting compared to developing long term goals and strategies. Amount of detail presented. Budgets are very detailed in order to provide a basis for control while long range plans are considerably less detailed. John Wiley & Sons, 2016

The Master Budget The master budget is a set of interrelated budgets that constitute a plan of action for a specified time period. The master budget contains two classes of budgets: Operating budgets are the individual budgets (sales budget, production budget, direct materials budget, direct labour budget, manufacturing overhead budget, and selling and administrative expenses budget) that result in the preparation of the budgeted income statement. Financial budgets include the capital expenditures budget, the cash budget, and the budgeted balance sheet. These budgets focus primarily on the cash resources needed to fund expected operations and capital expenditures. John Wiley & Sons, 2016

Illustration 21-1 The Master Budget Sales Budget The master budget is prepared in sequence, with the operating budgets prepared first, starting with the sales budget. Once the operating budgets are completed then the financial budgets are prepared. Production Budget Operating Budgets Direct Materials Budget Direct Labour Budget Manufacturing Overhead Budget Selling and Admin Expenses Budget Budgeted Income Statement Capital Expenditures Budget Budgeted Balance Sheet Cash Budget Financial Budgets John Wiley & Sons, 2016

Illustration 21-2: Preparing the Operating Budgets Sales Budget The sales budget is the first budget prepared and is derived from the sales forecast. Each of the other budgets depends on the sales budget. The sales budget is prepared by multiplying the expected unit sales volume for each product by its anticipated unit selling price. The sales budget for the Wei Corporation is as follows: John Wiley & Sons, 2016

Illustration 21-4: Preparing the Operating Budgets Production Budget The production budget shows the units that must be produced to meet anticipated sales. The production budget for the Wei Corporation is as follows: Per sales budget John Wiley & Sons, 2016

Illustration 21-6: Preparing the Operating Budgets Direct Materials Budget The direct materials budget contains both the quantity and cost of direct materials to be purchased. The direct materials budget for the Wei Corporation is as follows: from production budget John Wiley & Sons, 2016

Illustration 21-7: Preparing the Operating Budgets Direct Labour Budget The direct labour budget contains the quantity (hours) and cost of direct labour necessary to meet production requirements, based on the production budget. Wei Corporation’s budget is as follows: John Wiley & Sons, 2016

Illustration 21-8: Preparing the Operating Budgets Manufacturing Overhead Budget The manufacturing overhead budget shows expected fixed and variable overhead costs. Manufacturing overhead rate per unit = $246,400/ 15,400 units (illustration 21-4) = $16.00 John Wiley & Sons, 2016

Illustration 21-9: Preparing the Operating Budgets Selling and Administrative Expenses The selling and administrative expenses budget shows expected fixed and variable selling and administrative costs. The fixed expenses, such as depreciation, property taxes, and office salaries, would be detailed on the budget. John Wiley & Sons, 2016

Illustration 21-10: Preparing the Operating Budgets Budgeting Income Statement The budgeted income statement is the important end product in preparing operating budgets. It is prepared from the previous budgets. To calculate cost of goods sold, it is first necessary to determine the total unit cost of producing one Kitchenmate, the product sold by Wei Corporation: John Wiley & Sons, 2016

Illustration 21-11: Preparing the Operating Budgets Budgeting Income Statement Cost of goods sold can then be determined by multiplying the units sold by the unit cost. All data for the statement are obtained from the operating budgets except: bad debts expense, interest expense, and income taxes. (From sales budget) (15,000 x $44) John Wiley & Sons, 2016

Illustration 21-12: Preparing the Financial Budgets Capital Expenditure Budget The capital expenditures budget details: the cash anticipated to be received from the sale of property, plant, and equipment and, the cash to be spent on purchasing additional property, plant, and equipment. As cash is affected, this budget must be prepared before the cash budget. Amortization on the new forklift was included in the manufacturing overhead budget (Illustration 21-8). John Wiley & Sons, 2016

Illustration 21-13: Preparing the Financial Budgets Cash Budget The cash budget shows anticipated cash flows. It is the most important budget when preparing financial budgets due to the vital importance of cash to a company. The financing section shows expected borrowings and the repayment of the borrowed funds plus interest. It is needed when there is a cash deficiency or the cash balance is below the minimum required balance. John Wiley & Sons, 2016

Illustration 21-13: Preparing the Financial Budgets Cash Budget The cash budget shows anticipated cash flows. It is the most important budget when preparing financial budgets due to the vital importance of cash to a company. Assume the company started the month with $6,000, received $23,000 cash and disbursed $32,000. If the company requires an ending cash balance of $5,000, then a total of $8,000 will need to be borrowed as shown to the right. John Wiley & Sons, 2016

Illustration 21-13: Preparing the Financial Budgets Cash Budget The cash budget shows anticipated cash flows. It is the most important budget when preparing financial budgets due to the vital importance of cash to a company. In the next month, the company will start with $5,000 cash (last months ending balance). If $35,000 cash was received and $33,000 was disbursed then the company will be able to repay $2,000 of its debt. Remember the company desires an ending cash balance of $5,000. John Wiley & Sons, 2016

Illustration 21-17: Preparing the Financial Budgets Budgeted Balance Sheet The budgeted balance sheet is a projection of financial position at the end of the budget period. John Wiley & Sons, 2016

Budgeting in Nonmanufacturing Companies As in manufacturing operations, the sales budget is the starting point in the development of the master budget for a merchandising company. The major differences between the two companies’ master budgets are that a merchandiser: uses a merchandise purchases budget instead of a production budget and, does not use the manufacturing budgets (direct materials, direct labour, and manufacturing overhead). John Wiley & Sons, 2016

Budgeting in Nonmanufacturing Companies In service companies such as a public accounting firm, a law office, or a medical practice, the critical factor in budgeting is coordinating professional staff needs with anticipated services. The goal is to be neither overstaffed nor understaffed. Budgeting is important for not-for-profit organizations but the budget process is significantly different. Usually they budget on the basis of cash flows (expenditures and receipts) rather than on a revenue and expense basis. John Wiley & Sons, 2016