1. Budgeting

2. Learning Objectives
Explain the use of a budget as a tool for planning and performance evaluation.
Explain how a budget can affect employee motivation.
Compare the four types of responsibility centers.
Describe the master budget.

3. Organizational Plan Consists of three parts
Organization Goals - Broad objectives established by mgmt. that company employees work to achieve
Strategic long-range plan - Intermediate and distant future plans stated in broad terms
Master Budget - Specific plan for the coming year

4. Master Budget Also known as the static budget
Indicates sales, production and cost levels, income and cash flows anticipated for the following year
Also includes an income statement and balance sheet based on budget data

5. Performance Evaluation
Budgets provide estimates of expected performance
Comparing budgeted with actual results provides a basis for evaluating performance
Budgets must be prepared for individual responsibility centers in order to use them to evaluate performance

6. Flexible Budgets Shows the expected relation between costs and volumes
Has two components:
Fixed cost - expected to be incurred regardless of the activity level
Variable cost - costs change in total as the activity level changes

7. Cost Hierarchies
When preparing a master budget, it is important to understand how costs are affected by changes in activity levels
The following cost hierarchy is helpful in understanding cost behavior:
Unit-level activities
Batch-level activities
Product-level activities
Customer-level activities
Facility-level activities

8. Forecasting Sales
Developing the master budget starts with forecasting sales
Various methods and sources used to obtain sales forecasts include:
Sales staff
Market research
Delphi technique
Trend analysis
Econometric Models

9. Production Budget (Slide 1 of 2)
The production budget is based on the sales budget and estimates of beginning and desired ending inventories
Production is calculated as follows:
Number of Units to Be Sold
+Units in Ending Inventory
-Units in Beginning Inventory
Units to Be Produced

10. Production Budget (Slide 2 of 2)
After determining the number of units to be produced, we can budget for the following:
Direct materials - traceable to units produced and almost always a variable cost
Direct labor - traceable to units produced; usually a variable cost but could be a fixed cost
We assume direct labor is a variable cost in this chapter
Manufacturing overhead - typically has both variable and fixed components; variable overhead varies with units produced, fixed overhead gives a firm production capacity

11. Marketing and Administrative Budgets
Budgeted marketing costs might include the following:
Facility-level activities - salaries, advertising, sales office costs
Unit-level activities - sales commissions, shipping
Administrative costs include both fixed and variable costs

12. Discretionary Fixed Costs
Many “fixed” costs are really discretionary costs
They are budgeted as fixed costs but if, for example, the economic conditions look bad, these costs can be reduced
Examples: maintenance, advertising
Discretionary fixed costs should be distinguished from committed fixed costs, like rent on a factory building, which are required to run the firm

13. Budgeted Income Statement
Also called the profit plan
Prepared using a contribution margin format
If management is satisfied with the budget, it is approved
If not, management can look for ways to improve budget profits through, for example, sales increases or cost reductions

14. Accurate Forecasts
An accurate sales forecast is critical to the entire budget process
If forecast is too low, sales may be lost because purchasing and production have been planned at too low a level
If forecast is too high, excess inventory may result

15. Using the Master Budget
Master budget includes budgeted financial statements as well as other relevant budgets
Once adopted, the master budget becomes a major planning tool
Essentially, becomes authorization to produce and sell goods, purchase materials, hire employees

16. Comparison of Flexible and Master Budgets
The flexible budget is based on actual sales and production volumes
Indicates expected revenue and costs at the actual level of activity
Comparison of master budget to the flexible budget forms the basis for analyzing differences in planned and actual results