6-1 Operational and Financial Budgeting Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine University 6

6-2  Explain how budgeting relates to the major functions of management.  Describe the components and organization of a comprehensive budget.  Describe several methods managers use to forecast sales and some of the problems of using each method.  Describe two approaches to setting budget allowances for costs and the types of costs for which each is appropriate. ObjectivesObjectives After reading this chapter, you should be able to: ContinuedContinued

6-3  Describe behavioral problems associated with budgeting.  Prepare a budgeted income statement, a purchases budget, a cash budget, and a budgeted balance sheet.  Describe the leads and lags that complicate the budgeting of cash receipts and disbursement. ObjectivesObjectives ContinuedContinued

6-4  List several ways that managers might resolve cash deficiencies revealed by a cash budget.  Describe similarities and differences between budgeting in for-profit and not-for-profit entities.  State how zero-based-budgeting and program budgeting differ from other budgeting processes. ObjectivesObjectives

6-5 Budgets often reveal incompatibilities and conflicts.

6-6 Comprehensive Budget comprehensive budgetmaster budget A comprehensive budget or master budget is a set of financial statements and other schedules showing the expected, or pro forma, results for a future period.

6-7 Comprehensive Budget Sales forecast Assumptions about cost behavior Pro forma income statement Assumptions about levels of inventory, collections of receivables, and payments of expenses and liabilities Balance sheet at beginning of budget period Budgets for purchases and production Budgets for cash and requirements for short-term financing Pro forma balance sheet Plans for long-term financing and for capital spending +

Continuous Budgets Continuous budgets are maintained by adding a budget for a month (or quarter) as one of these periods goes by. Thus, a 12- month budget exists at all times.

6-9 Sales Forecasters External Indicators Historical Analysis Judgment

6-10 Interim Period Forecasts Three distinct types of sales forecasting methods: 1.Annual forecasts 2.Longer-term forecasts (three to five years) 3. Quarterly or monthly forecasts Once a forecast for the year has been approved as a basis for planning, it is necessary to break it down into interim periods.

6-11 Expense Budget Indirect labor$2,400$0.40 Supplies Maintenance1, Depreciation1, Miscellaneous Total$6,100$1.10 Cost Fixed Amount per Month Direct Labor per Hour

6-12 Expense Budget Flexible budget allowance = fixed cost per month + direct labor hours x variable cost per hour Example: Indirect labor $6,100 + (1,000 x $1.10) Flexible budget allowance = $7,200

6-13 Production Performance Report Direct labor hours 1,0001,300 Indirect labor $2,800$2,920$2,870$50 Supplies Maintenance 1,8001,8601,900(40) Depreciation 1,2001,2001,2000 Miscellaneous (10) Total $7,200$7,530$7,515$15 Month____________________ Department________________ Manager__________________ MarchMixing E. Jones Budget Allowances Budgeted Actual Actual Costs Hours Hours Incurred Variance

6-14 Budgeting and Behavior Conflict Behavioral problems arise when:  When managers’ interests conflict  When budgets are imposed from above  When stretch goals are used  When budgets are viewed as checkup devices

6-15 Imposed budgets are when senior managers set performance goals (budgets) without consulting the individuals who will be responsible for meeting those goals. Serious behavioral problems can arise (or be avoided) depending on the attitudes of managers imposing the performance goals. Imposed Budgets

6-16 S t r e t c h g o a l s are exceptionally ambitious targets not likely to be achieved without making fundamental changes in the way a job is done. Stretch Goals

6-17 “Checkup” Devices Behavioral problems arise when managers compare budgeted and actual results and subsequently evaluate the performance of their subordinates.

6-18 “Spend IT or Lose It” Expense budgets set limits on levels of costs to be incurred, allowances managers are not supposed to exceed. If managers view their budget allowances as strict limits on spending, they may spend either too little or too much.

6-19 Budgeting and Ethics  Managers in some areas might consider preparing—and ask management accountants to help them in doing so—budgets with a great deal of slack so that managers will be able to meet them with minimum effort.  Top-level management impose budgets on subordinates so tight that there is little chance of achieving them.  Ethical issues also arise about the reporting of actual results for a budget period.

6-20 Exhibit 6-3 January$400 February 500 March 800 April700 May600 Cost of goods sold will be 60% of sales dollars. Total fixed costs will be $150, of which $15 per month is depreciation expense. Month Sales Budget

6-21 Budgeted Income Statement Sales$400$500$800$1,700 Cost of goods sold ,020 Gross profit and contribution margin Fixed costs Income$ 10$ 50$170$ 230 Exhibit 6-4 Three-Month January February March Total

6-22 Cost of goods sold$ 240$ 300$ 480$1,020 Budgeted ending inven Total requirements1,0201,2001,2601,800 Beginning inventory Purchases$ 480$ 420$ 360$1,260 Purchases Budget Exhibit 6-5 Three-Month January February March Total

6-23 Sales$400$500$800$1,700 Collections: From prior years, 30%$310$120$150$ 580 From current month, 70% ,190 Total receipts$590$470$710$1,770 Cash Receipts Budget Exhibit 6-6 Three-Month January February March Total

6-24 From prior month, 40%$195$192$168$ 555 From current month, 60% Total$483$444$384$1,311 Cash Disbursements for Purchases Exhibit 6-7 Three-Month January February March Total

6-25 For merchandise, see Exhibit 6-7$483$444$384$1,311 Fixed costs requiring cash $618$579$519$1,716 Cash Disbursements Budget Exhibit 6-8 Three-Month January February March Total

6-26 Beginning balance, Exhibit 6-3$ 80$ 52$ 50$ 80 Cash receipts, Exhibit ,770 Total available$670$522$760$1,850 Cash disbursements, Exhibit ,716 Indicated balance$ 52$(57)$241$ 134 Excess (deficiency)2(107)191 Borrow Repay Ending balance$ 52$ 50$134$ 134 Cash Budget Exhibit 6-9 Three-Month January February March Total

6-27 Pro Forma Balance Sheet As of March 31, 20X6 Exhibit 6-10 Assets Cash (Exhibit 6-9)$ 134 Accounts receivable (March sales x 30%)240 Inventory (Exhibit 6-5)780 Fixed assets (beginning balance less $45 depreciation for 3 months) 1,535 Total assets$2,689 Equities Accounts payable (March purchases x 40%)$ 144 Stockholders’ equity 2,545 Total equities$2,689

6-28 Zero-based budgeting means that managers must justify every dollar they request in a budget proposal for a given year.

6-29 Program budgeting requires that a budget indicate not only how the requested funds are to be spent, but also why the funds are to be spent in those ways.

6-30 The End Chapter 6

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