Master Budgeting Chapter 8 ACTG 202 – Principles of Managerial Accounting “Good plans shape good decisions. That’s why good planning helps make elusive dreams come true.” -Geoffrey Fische 6 icqs

Learning Objective 1 Understand why organizations budget and the processes they use to create budgets.

The Basic Framework of Budgeting A budget is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period. The act of preparing a budget is called budgeting. The use of budgets to control an organization’s activities is known as budgetary control.

Difference Between Planning and Control Planning – involves developing objectives and preparing various budgets to achieve those objectives. Control – involves the steps taken by management to increase the likelihood that the objectives set down while planning are attained and that all parts of the organization are working together toward that goal.

Responsibility Accounting Managers should be held responsible for those items - and only those items - that they can actually control to a significant extent. Responsibility accounting enables organizations to react quickly to deviations from their plans and to learn from feedback. Hotel example

Choosing the Budget Period Operating Budget 2014 2015 2016 2017 Operating budgets ordinarily cover a one-year period corresponding to a company’s fiscal year. Many companies divide their annual budget into four quarters. A continuous budget is a 12-month budget that rolls forward one month (or quarter) as the current month (or quarter) is completed.

Self-Imposed Budget A self-imposed budget or participative budget is a budget that is prepared with the full cooperation and participation of managers at all levels.

Advantages of Self-Imposed Budgets Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management. Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers. Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse.

Self-Imposed Budgets Self-imposed budgets should be reviewed by higher levels of management to prevent “budgetary slack.” Most companies issue broad guidelines in terms of overall profits or sales. Lower level managers are directed to prepare budgets that meet those targets.

Human Factors in Budgeting The success of a budget program depends on three important factors: Top management must be enthusiastic and committed to the budget process. Top management must not use the budget to pressure employees or blame them when something goes wrong. Highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget targets.

The Master Budget: An Overview Sales budget Selling and administrative budget Ending inventory budget Production budget Direct materials budget Direct labor budget Manufacturing overhead budget The Budget must be prepared in a specific order Cash Budget Budgeted income statement Budgeted balance sheet

Learning Objective 2 Prepare a sales budget, including a schedule of expected cash collections.

9-13 The Sales Budget The sales budget is the starting point in preparing a master budget All other steps in the budgeting process depend on the sales budget Most big budgeting problems result from a poor sales budget Spend time on this!! Do actual calculations. Who should be involved in creating the sales budget? What if sales are overbudgeted? How does this impact expenses?

9-14 The Sales Budget A sales budget is constructed by multiplying budgeted unit sales by the selling price Revenue and cash receipts may happen in different time periods Both are important E8-1 (page 372) Sales numbers should not be pulled out of thin air Burger King Law Firm Engineering Firm Retail candy store Talk about revenue and cash receipts timing differences – Ski manufacturing

Prepare a production budget. Learning Objective 3 Prepare a production budget.

Budget and Expected Cash Collections The Production Budget Sales Budget and Expected Cash Collections Production Budget Completed The production budget must be adequate to meet budgeted sales and to provide for the desired ending inventory.

Calculating Production Needs 9-17 Calculating Production Needs Budgeted unit sales + Ending inventory requirements = Total needs - Beginning inventory = Required production NEEDS compared to SOURCES E 8-2 (page 373) Not dollars – focus is on quantities

9-18 Production Budget Determines Need for Manufacturing Materials, Labor & Overhead Once the production needs are determined this can be converted into dollar amounts that need to be spent The next step is calculating: Direct materials budget Direct labor budget Manufacturing overhead budget

Learning Objectives 4, 5, and 6 Prepare a direct materials budget, labor budget, and manufacturing overhead budget

The Direct Materials Budget 9-20 The Direct Materials Budget Raw materials needed for production + Desired ending inventory of raw materials = Total raw material needs - Beginning inventory of raw materials = Raw materials to be purchased NEEDS compared to SOURCES (in dollars) E8-3 (page 373)

The Direct Labor Budget 9-21 The Direct Labor Budget To create a direct labor budget we need Required production (from Production Budget) Number of labor hours required per unit The direct labor rate per hour Note: if production labor amounts are fixed than there may be a minimum total labor cost E8-4 (page 373) Usually there is not much timing difference between labor expense and cash payment of wages

Manufacturing Overhead Budget 9-22 Manufacturing Overhead Budget A manufacturing overhead budget should be divided into: Variable costs, and Fixed costs Which costs are fixed and which are variable should be reviewed and adjusted during the budgeting process All manufacturing costs other than direct materials and direct labor

Manufacturing Overhead Budget 9-23 Manufacturing Overhead Budget The manufacturing overhead budget is used to calculate the predetermined overhead rate As illustrated in Chapter 3, the predetermined overhead rate is used to allocate overhead to products Often, some of the fixed overhead costs, such as depreciation, are noncash items E8-5 (page 374) Need to calculate cost AND cash Discuss the fact that depreciation is a noncash item POHR = estimated total manufacturing overhead costs / estimated tot units of allocation base

Prepare a selling and administrative expense budget. Learning Objective 7 Prepare a selling and administrative expense budget.

Selling and Administrative Expense Budget 9-25 Selling and Administrative Expense Budget The selling and administrative expense budget lists the budgeted expenses for areas other than manufacturing In large organizations, this budget would be a compilation of many smaller, individual budgets submitted by different departments To complete the selling and administrative expense budget, costs should be divided into variable and fixed costs There may be noncash selling and administrative expenses such as depreciation E 8-6 (page 374)

Learning Objective 8 Prepare a cash budget.

Format of the Cash Budget The cash budget is divided into four sections: Cash receipts section lists all cash inflows excluding cash received from financing; Cash disbursements section consists of all cash payments excluding repayments of principal and interest; Cash excess or deficiency section determines if the company will need to borrow money or if it will be able to repay funds previously borrowed; and Financing section details the borrowings and repayments projected to take place during the budget period.

Determining the Cash Excess or Deficiency 9-28 Determining the Cash Excess or Deficiency Cash balance, beginning + Cash receipts = Total cash available - Cash disbursements = Excess (def.) of cash available for disbursements +/- Financing = Cash balance, ending E8-7 (page 374) If there is a cash deficiency it means the company needs to find financing from outside Debt or equity Discuss line of credit financing

The Budgeted Income Statement Cash Budget Budgeted Income Statement Completed With interest expense from the cash budget, Royal can prepare the budgeted income statement.

Prepare a budgeted income statement. Learning Objective 9 Prepare a budgeted income statement. E8-8 (page 375) P8-17 (page 379)

The Budgeted Income Statement Sales Budget. Ending Finished Goods Inventory. Selling and Administrative Expense Budget. Cash Budget.

Steps in Budgeting Process - Summary Sales Budget Production Budget Direct materials, direct labor and manufacturing overhead budget Selling and administrative expenses budget Cash budget Budgeted income statement Budgeted balance sheet Perform Sensitivity Analysis