1. MANAGEMENT ACCOUNTING
Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse

2. Management Accounting Budgeting (Planning and control)
Chapter 8

3. Objectives Use budgeting for planning purposes
Use budgeting for control purposes
Identify the conflicts that exist between planning and control in the budgeting process
Describe the benefits of having both short-term and long-term budgets
Explain the responsibility implications of a line-item budget
Identify the costs and benefits of budget lapsing
Develop flexible budgets and identify when flexible budgeting should be used instead of static budgeting
Explain the costs and benefits of using zero-based budgeting
Create a master budget for an organisation
Create pro-forma financial statements based on data provided

4. Budgets are forecasts of future revenues and expenses
The Purpose of Budgets
Budgets are a key component of the organization’s planning and control system
Budgets are forecasts of future revenues and expenses
Budgeting is the process of gathering information to assist in making forecasts

5. Budgeting for Planning Decisions
Budgets play an integral role in making planning decisions
Budgets are a used to transfer information to individual decision makers in the organization

6. Budgeting for Planning Decisions
Encourage top-down flow of information and plans
Budgets
attempt to
Encourage bottom-up flow of information

7. Budgeted amounts can be used as goals to motivate
Budgeting for Control
Budgets are often used to assign responsibilities by allocating resources to managers
Budgeted amounts can be used as goals to motivate
Budgeted amounts can be used as targets by which performance is evaluated and rewarded

8. Variances
The difference between budgeted performance and actual performance is called the variance
An adverse variance occurs when Actual costs > Budgeted costs or Actual revenues < Budgeted revenues
A favorable variance occurs when Actual costs < Budgeted costs or Actual revenues > Budgeted revenues
Variances are commonly calculated on a monthly basis to identify how successfully an organization is meeting its goals

9. Variances Numerical Example
Budgeted (£)
Actual (£)
Variance (£)
Revenues
450,000
453,000
3,000 F
Cost of goods sold
(235,000)
(248,000)
13,000 A
General administration
(80,000)
(132,000)
52,000 A
Selling expenses
(100,000)
(90,000)
10,000 F
Profit
35,000
(17,000)
Administration Costs differ greatly from those expected and would be investigated

10. Conflict between Planning and Control
For control, budgets serve as the benchmark for performance measurement
For planning, budgets communicate specialized knowledge from one area to another
Over reliance on performance measurement will lead to a reduction in knowledge transfer

11. Conflict between Planning and Control
To manage the conflict between planning and control many organizations put the Chief Executive in change of the budgeting process and the chief financial officer in charge of the collection and preparation of data
The budget is an informal set of contracts between the units of the organization
Most budgets are set in a negotiation process

12. Participative Budgeting
Participative Budgeting is a bottom-up process
With Participative Budgeting the person ultimately being held responsible for meeting the target makes the initial budget forecast
Motivation to achieve the target is higher

13. How Budgeting Helps Resolve Organizational Problems
Links knowledge with responsibility to make planning decisions
Measures and rewards performance for control
Budgeting Systems
An administrative device to resolve organizational problems
Distributes Responsibilities

14. Short-Term versus Long-Term Budgets
1. Selecting overall objectives
2. Choosing markets
Selecting products to produce
Determining price/quality mix
Choosing technologies
Strategic Planning
Forecasts of large asset acquisitions
Financing plans
Research and development plans
Long-term Budgets (more than one year)
Short-term Budgets (1 year or less)
Quantities to produce
Quantities to sell
Supplies acquisitions

15. Line-Item Budgets
Budgets that authorize the manager to spend only up to the specified amount on each line item
Managers cannot spend savings from one line item on another line item
The manager does not have the responsibility to substitute resources among line items as circumstances change
Impose more control on Managers
Prevalent in government organizations

16. Line-Item Budgets Numerical Example
Line item budgets reduce management incentives to search for cost savings and reduce the organisation flexibility
Line item
Amount (£)
Salaries
185,000
Office supplies
12,000
Office equipment
3,000
Postage
1,900
Maintenance
350
Utilities
1,200
Rent
900
Total
204,350

17. Budget Lapsing
Funds that have not been spent at year-end do not carry over to the next year
Managers have incentive to spend at the end of each year
Operating efficiency is reduced
Managers have less discretion in the timing of expenditures

18. Static versus Flexible Budgets
Static budgets do not vary with volume and are used when a manager has control over volume or the consequences thereof
Flexible budgets are adjusted for changes in volume and are used mainly in manufacturing where the manager does not have control over volume

19. Static versus Flexible Budgets Numerical Example
Each line item in the budget varies with volume. Then a budget is prepared at different volume levels
Ticket Sales (€)
(Formula)
3,000
4,000
5,000
Revenues
€18N*
54,000
72,000
90,000
Band
€20, N
(28,100)
(30,800)
(33,500)
Auditorium
€5, N
(7,700)
(8,600)
(9,500)
Security
€80(N/200)
(1,200)
(1,600)
(2,000)
Other costs
€28,000
(28,000)
Profit/Loss
(11,000)
17,000
*N is the number of tickets sold

20. Static versus Flexible Budgets
Show revenues and expenses that should have occurred at the actual level of activity
Flexible Budgets
May be prepared for any activity level in the relevant range
Reveal variances due to good cost control or lack of cost control
Improve performance evaluation

21. Static versus Flexible Budgets
Central Concept
If you can tell me what your activity was for the period, I will tell you what your costs and revenue should have been

22. Incremental versus Zero-Base Budgets
Base budget is the previous budget
Only incremental changes from the previous budget are examined in detail
Each line item is set at zero each year
Every line item must be justified and renewed each year
Incremental Budgets
Zero-Base Budgets

23. Zero-Base Budgets
ZBB Motivates managers to maximize firm value by identifying and eliminating those expenditures whose total costs exceed total benefits
Incremental expenditures are deleted when their costs exceed their incremental benefits
Inefficient base budgets are not eliminated
In practice ZBB is used infrequently
Most useful when new top-level management come from outside the firm
Costly to conduct

24. Serves as a guide and benchmark for the entire organization
The Master Budget
Integrates the estimates from each department to predict production requirements, financing, cash flows and financial statements at the end of the period.
Serves as a guide and benchmark for the entire organization

25. Comprehensive Master Budget Illustration
The following slides provide an illustration of the Master Budget
The Master Budget is prepared for a simple firm NaturApples (an apple processor)

26. Master Budget Illustration Budgeting process - NaturApples
Sales budget
Production budget
Apple procurement
Factory overhead budget
Direct labour budget
Direct materials budget
Selling and administrative budget
Capital investment budget
Financial Budget
Beginning balance sheet
Budgeted profit and loss Statement
Budgeted cash flows
Budgeted Balance Sheet

27. Master Budget Numerical Example
Expected beginning Balance Sheet
Assets
Cash
100,000
Accounts receivable
200,000
Inventory
Sauce (13,500 cases x £58/case)
783,000
Pie Filling (2,500 cases x £48/case)
120,000
903,000
Property, plant and equipment (net)
2,300,000
3,503,000
Liabilities and shareholders equity
Accounts payable
Long-term debt
1,000,000
Shareholders equity
2,403,00

28. Master Budget Numerical Example
Sales Budget
Budgeted cases
Budgeted price/case (£)
Budgeted revenue (£)
Sauce
140,000 68
9,520,000
Pie Filling
60,000 53
3,180,000
Total
12,700,000

29. Master Budget Numerical Example
Production Budget – Production volume
Beginning inventory + Production = Sales + Desired ending inventory or
Production = Sales + Desired ending inventory – beginning inventory
Product
Sales
Ending inventory
Beginning inventory
Production
Sauce
140,000
5,000
13,500
131,500
Pie Filling
60,000
1,000
2,500
58,500

30. Master Budget Numerical Example
Production Budget
Raw Materials
Product
Kilograms per case x
Cases =
Kilograms x
Cost Per Kilogram (£) =
Cost (£)
Sauce 25
131,500
3,287,500
0.80
2,630,000
Pie Filling 20
58,500
1,170,000
936,000
Total
4,457,500
3,566,000
Direct Labour
Product
Hours per case x
Cases =
Hours x
Cost Per hour (£) =
Cost (£)
Sauce
0.60
131,500
78,900 10
789,000
Pie Filling
0.50
58,500
29,250
292,500
Total
108,150
1,081,500

31. Master Budget Numerical Example
Production Budget
Overhead
Product
Direct labour cost x
Overhead per £ of direct labour =
Cost (£)
Sauce
£789,000 2
1,578,000
Pie Filling
£292,500
585,000
Total
2,163,000
Product Costs
Product
Total product cost (£)
Materials + Labour + Overhead /
Cases =
Cost per case (£)
Sauce
4,997,000
131,500 38
Pie Filling
1,813,500
58,500 31
Total
6,810,500

32. Materials + Labour + Overhead /
Production Budget
Raw Materials
Product
Kilograms per case x
Cases =
Kilograms x
Cost Per Kilogram (£) =
Cost (£)
Sauce 25
131,500
3,287,500
0.80
2,630,000
Pie Filling 20
58,500
1,170,000
936,000
Total
4,457,500
3,566,000
Direct Labour
Product
Hours per case x
Cases =
Hours x
Cost Per hour (£) =
Cost (£)
Sauce
0.60
131,500
78,900 10
789,000
Pie Filling
0.50
58,500
29,250
292,500
Total
108,150
1,081,500
Overhead
Product
Direct labour cost x
Overhead per £ of direct labour =
Cost (£)
Sauce
£789,000 2
1,578,000
Pie Filling
£292,500
585,000
Total
2,163,000
Product Costs
Product
Total product cost (£)
Materials + Labour + Overhead /
Cases =
Cost per case (£)
Sauce
4,997,000
131,500 38
Pie Filling
1,813,500
58,500 31
Total
6,810,500

33. Master Budget Numerical Example
Selling and Administration Budget
Selling and administrative areas
Marketing
470,000
Finance
160,000
Shipping
380,000
Chairman's office
180,000
Total selling and administration
1,190,000

34. Master Budget Numerical Example
Capital Investment Budget
Capital investment project
Purchase date
Cost (£)
Coring machine
05/10/2008
40,000
Dicing machine
80,000
Total
120,000

35. Master Budget Numerical Example
Financial Budget
Financial transactions
Date
Amount (£)
Loan from bank
05/10/2008
100,000
Repayment of bank loan
05/04/2009
(100,000)
Retirement of long-term debt
01/06/2009
(200,000)
Payment of interest
31/12/2009
(50,000)
30/06/2009
Payment of dividends
30/09/2009
(2,000,000)
Net cash flow from financial transactions
(2,300,000)

36. Master Budget -Numerical Example
Budgeted profit and loss statement
Revenues (Sales budget)
Cost of goods sold
12,700,000
Beginning inventory (Beg, balance sheet)
903,000
+ Production costs (production budget)
6,810,500
- Ending inventory (Production budget)
Sauce (£38/case x 5,000 cases)
190,000
Pie Filling (£31/case x 1,000 cases)
31,000
(221,000)
(7,492,500)
Gross Margin
5,207,500
Selling and administrative expenses (Selling and admin. budget)
(1,190,000)
Interest expense (Financial budget)
(100,000)
Net profit before taxes
3,917,500
Taxes (£3,917,500 x 0.40)
1,567,000
Net Profit
2,350,500
Beginning shareholders’ equity (Beg Balance sheet)
2,403,000
+ Net Profit
Dividends
2,000,000
Ending shareholders equity
2,753,500

37. Master Budget -Numerical Example
Budgeted cash flow statement
Cash Flow from Operations
Net Income (Income Statement)
2,350,500
Add:
Depreciation
400,000
Inventory Decrease
682,000
Accounts Payable Increase
50,000
Less:
Accounts Receivable Increase
(100,000)
Total Cash Flow from Operations
3,382,500
Cash Flow from Investments
Coring Machine Purchase (Capital Investment Budget)
(40,000)
Dicing Machine Purchase (Capital Investment Budget)
(80,000)
(120,000)
Cash Flow from Financial Transactions
Bank Loan (Financial Budget)
100,000
Bank Loan Repayment (Financial Budget)
Long-term Debt Retirement (Financial Budget)
(200,000)
Dividend Payment (Financial Budget)
(2,000,000)
(2,200,000)
Change in Cash Balance
1,062,500
Beginning Cash Balance (Beginning Balance Sheet)
Ending Cash Balance
1,162,500

38. Master Budget - Numerical Example
Budgeted Balance Sheet
Assets  £
Cash (Cash Flow Statement)
1,162,500
Accounts Receivable (Predicted)
300,000
Inventory: Applesauce 5,000 £38
190,000
Apple Pie filling 1,000 £31
31,000
221,000
Property, Plant and Equipment (net)
Beginning Balance (Beginning Balance Sheet)
2,300,000
Capital Investments (Capital Investment Budget)
120,000
Depreciation for the Year
(400,000)
2,020,000
Total Assets
3,703,500
Liabilities and Stockholders' Equity
Accounts Payable (Predicted)
150,000
Long-Term Debt
1,000,000
Retirement (Financial Budget)
(200,000)
800,000
Total Liabilities
950,000
Stockholders' Equity (Income Statement)
2,753,500
Total Liabilities and Stockholders' Equity

39. Management Accounting Budgeting (Planning and controlling)
End of Chapter 8