1. 5
C H A P T E R
Operating Budgets

2. Learning Objective 1
Describe different types of budgeting and identify the purposes of budgeting.

3. What is Budgeting?
Budget: A quantitative expression of a plan of action that shows how a firm or an organization will acquire and use resources over some specified period of time.
The budget identifies and allocates resources necessary to effectively and efficiently carry out the mission of the organization.
Successful budgeting is absolutely critical to the success of a business.

4. Describe Three Types of Budgets
Strategic Plan: Broad, long-run planning, usually prepared by top management.
Capital Budget: Systematic plan for long-term investments in operating assets.
Operations (Master) Budget: Details the immediate goals for revenues, production, expenses, and cash for the next period. This budget is the most detailed and the most heavily used budget an organization has.

5. What are the Purposes of Budgeting ?
OVERALL PURPOSE:
To quantify a general plan so that performance in relation to a goal can be carefully monitored.
TWOFOLD PURPOSE
FIRST:
To allow individuals or companies to develop a plan to meet a specified goal.
SECOND:
To allow ongoing comparison between actual results and the plan in order to control operations or activities.

6. Example: Monthly Budget
Gross salary $2,000
Withholdings:
Federal income taxes $250
State income taxes
Other withholdings (550)
Net take-home pay $1,450
Fixed expenses:
House mortgage expense $450
Car payment expense
Insurance expense (800)
Disposable income $ 650
Utilities expense $ 65
Food expense
Miscellaneous expenses (615)
Net surplus $

7. List Reasons for Budgeting
Planning and setting objectives
Communication
Coordination
Authorization
Motivation
Conflict resolution
Performance measurement (evaluation)

8. Learning Objective 2
Describe the budgeting process and its behavioral implications.

9. Budgeting Process Who or what is the budget committee?
- A management group responsible for establishing budgeting policy and for coordinating the preparation of budgets.
What are two issues of the budgeting process?
- Behavioral considerations
- Delegation of responsibility for preparing the budget top-down versus bottom-up issue

10. List Behavioral Considerations
1. Top management support
2. Employee participation
3. Addressing budget deviations

11. Describe the Top-Down Approach to Budgeting
Top management prepares the entire budget and distributes it to division managers.
Top
Management
Manager
Manager
Manager

12. Describe the Bottom-Up Approach to Budgeting
Each manager prepares a budget request, from which management creates an overall budget.
Top
Management
Manager
Manager
Manager

13. Learning Objective 3
Explain the master budget and its components for manufacturing firms, merchandising firms, and service firms.

14. Master Budget—Manufacturing
Sales Budget
Selling/Admin.
Expense Budget
Production
Budget
Direct Labor
Budget
Manufacturing
Overhead Budget
Direct Materials
Cash Budget
Pro-Forma Income
Statement
Pro-Forma
Balance Sheet
Cash Flows

15. Master Budget—Manufacturing Define each budget.
Sales Budget
A schedule of projected sales over the budget period.

16. Example: Sales Budget Selling price per bike . . . . . . $ 100
Expected sales (units) x 100
Expected revenues $10,000

17. Master Budget—Manufacturing Define each budget.
Sales Budget
Production
Budget
A schedule of production
requirements for the budget period.

18. Example: Production Budget
Expected sales
Add desired ending inventory
Total number of bikes needed
Less beginning inventory
Bikes to be produced
Note: Ending inventory is estimated at 80%
of the next period’s sales.

19. Master Budget—Manufacturing Define each budget.
Sales Budget
Production
Budget
A schedule of direct materials to be used and purchased during the budget period.
Direct Materials
Budget

20. Example: Direct Materials Budget
Direct materials usage:
Direct Amount Unit Total
Materials Required Cost Cost
Metal ,700 lbs $2.00/ft. $5,400
Plastic lbs $1.00/ft. $ 405

21. Example: Direct Materials Budget
Direct materials purchases:
Metal Plastic
Desired ending inventory ,
Needed for production ,
Total needed ,
Less beginning inventory ,
Materials to be purchased ,
Unit cost x $2 x $1
Total cost $4,000 $ 510

22. Master Budget—Manufacturing Define each budget.
Sales Budget
Production
Budget
A schedule of direct labor requirements for the budget period.
Direct Materials
Budget
Direct Labor
Budget

23. Example: Direct Labor Budget
Number of bikes to produce
Direct labor hours per bike x
Total hours required
Rate per hour x $5
Total direct labor cost $2,025

24. Master Budget—Manufacturing Define each budget.
A schedule of production costs other than those for direct labor and direct materials.
Sales Budget
Production
Budget
Direct Materials
Budget
Direct Labor
Budget
Manufacturing
Overhead
Budget

25. Example: Manufacturing Overhead Budget
Variable costs:
Indirect materials costs $ 220
Indirect labor costs
Total variable costs $ 820
Fixed costs:
Insurance expense
Depreciation expense $ 600
Total fixed costs $ 800
Total manufacturing overhead $1,620

26. Master Budget—Manufacturing Define each budget.
Sales Budget
A schedule of all nonproduction spending expected to occur during the budget period.
Production
Budget
Selling and
Administrative
Expense Budget
Direct Materials
Budget
Direct Labor
Budget
Manufacturing
Overhead
Budget

27. Example: Per-Unit Cost
Direct materials usage:
Input Required Cost
Cost Inputs per Bike
Metal $2.00/ft $40.00
Plastic $1.00/ft
Direct labor $5.00/hr
Fixed OH $1.98/hr
Variable OH $2.02/hr
Total unit cost $70.00

28. Example: Selling and Administrative Budget
Variable expenses:
Sales commissions $
Total variable expenses $
Fixed expenses:
Salaries expense $1,000
Depreciation
Advertising expense
Total fixed expenses $1,300
Total selling and
administrative expenses $1,700

29. Master Budget—Manufacturing Define each budget.
Sales Budget
A schedule of expected cash receipts and
disbursements during the budget period.
Production
Budget
Selling and
Administrative
Expense Budget
Direct Materials
Budget
Direct Labor
Budget
Manufacturing
Overhead
Budget
Cash Budget

30. Example: Cash Budget Cash balance, beginning . . . . . . . . . $ 4,900
Add collections from customers ,100
(1)Total cash available $15,000
Less disbursements for:
Direct materials $ 3,000
Direct labor ,000
Equipment purchase ,000
(2)Total disbursements $ 7,000
Minimum cash balance desired ,000
Total cash needed $13,000
Excess (or deficiency) of cash available before financing $ 2,000
(3) Financing needed Ending cash balance [(1) – (2) + (3)] $ 2,000

31. Master Budget—Merchandising Define each budget.
Sales Budget
Purchases
Budget
Selling and
Administrative
Expense Budget
A schedule of projected purchases over the budget period.
Cash Budget

32. Master Budget—Merchandising Define each budget.
Pro-forma financial statements “budget” financial information for the coming period.
Sales Budget
Purchases
Budget
Cash Budget
Pro-Forma
Statement of
Cash Flows
Selling and
Administrative
Expense Budget
Balance
Sheet
Income
Statement

33. Master Budget—Service Define each budget.
A service entity’s budget that identifies how much revenue will be generated during a period.
Pro-Forma Income
Statement
Revenue Budget
Wages and
Salaries Budget
Production
Budget
Cash Budget
Pro-Forma
Balance Sheet
Selling/Admin.
Expense Budget
Overhead
Supplies
Pro-Forma Statement
of Cash Flows

34. Expanded Material Learning Objective 4
Prepare pro-forma financial statements.

35. Example: Pro-Forma Income Statement
Sales revenue $10,000
Cost of goods sold:
Beginning finished goods inventory $ 4,900
Manufacturing costs:
Direct materials used $ 5,805
Direct labor ,025
Manufacturing overhead , ,450
Total cost of goods available for sale $14,350
Less ending finished goods inventory (7,350)
Cost of goods sold (7,000)
Gross margin $ 3,000
Selling and administrative expenses ,700
Operating income $ 1,300
Interest expense
Income before taxes $ 1,300

36. Example: Pro-Forma Balance Sheet
ASSETS
Current assets:
Cash $ 15,000
Accounts receivable ,000
Finished goods ,350 $ 25,350
Long-term operating assets:
Equipment $ 12,000
Less accumulated depreciation (3,300) ,700
Total assets $ 34,050
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable $ 8,000
Notes payable ,000 $ 15,000
Stockholders’ equity:
Common stock $ 11,850
Retained earnings , ,050
Total liabilities and stockholders’ equity $ 34,050

37. Example: Pro-Forma Statement of Cash Flows
Cash flows from operating activities:
Net income $ 1,300
Add (subtract) adjustments:
Depreciation $ 700
Increase in finished goods (2,450)
Increase in accounts receivable , ,800
Net cash provided by operating activities $ 5,100
Cash flows from investing activities:
Purchase of equipment $(2,000)
Net cash used in investing activities (2,000)
Cash flows from financing activities:
Cash obtained from borrowing $ 7,000
Net cash used in financing activities ,000
Net increase in cash $ 10,100

38. Expanded Material Learning Objective 5
Distinguish between static and flexible budgets.

39. Define Static versus Flexible Budgeting
Static Budgeting:
A quantified plan that projects revenues and costs for only one level of activity.
Not useful for controlling costs and measuring performance because the actual level of activity may have differed significantly from the planned level.
Flexible Budgeting:
A quantified plan that projects revenues and costs for varying levels of activity.
More useful for control and performance evaluation because it is not confined to one level of activity.

40. Static Budget Cost per unit:
Direct materials
Direct labor
Manufacturing overhead
Total unit cost $2.50
Budgeting production (units) ,000
Budgeted manufacturing costs:
Direct materials $ 6,000
Direct labor ,000
Manufacturing overhead ,500
Total manufacturing costs $12,500

41. Static Budget— Performance Report
Actual Budgeted Difference
Production (units) , , (200)
Manufacturing costs:
Direct materials $ 5,500 $ 6, $ (500)
Direct labor , , (200)
Manufacturing overhead , , (50)
Total actual and budgeted
manufacturing costs $11,750 $12, $ (750)

42. What are the three steps to prepare a
Flexible Budget
What are the three steps to prepare a
flexible budget?
Determine a relevant range over which production is expected to vary during the coming period.
Analyze the projected manufacturing costs for the coming period.
Using the per-unit costs for each element, prepare a budget showing what costs are expected to be incurred at several points within the relevant range.

43. Flexible Budget Manufacturing Range of Production (units)
Costs per Unit 4,800 5,000 5,200
Direct materials . $1.20 $ 5,760 $ 6,000 $ 6,240
Direct labor ,840 4,000 4,160
Manufacturing
overhead , , ,600
Total $2.50 $12,000 $12,500 $13,000

44. Flexible Budget— Performance Report
Actual production (units) ,800
Budgeted production (units) ,000
Difference (200)
Actual Budgeted Difference
Direct materials $ 5,500 $ 5,760 $ (260)
Direct labor ,800 3,840 (40)
Manufacturing overhead , ,
Total costs $11,750 $12, $ 250