11-1 Operational Budgeting C hapter 11 Prepared by Douglas Cloud Pepperdine University.

11-1

Operational Operational BudgetingBudgeting

Operational Operational BudgetingBudgeting

CChaptehapterr

1111

Prepared by Douglas Cloud

Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

11-2

1. Discuss why budgets are important.2. Describe the basic approaches to budgeting.3. Develop an activity-based budget.4. Explain the interrelationships between the

elements of a master budget and develop a basic budget.

5. Discuss the interrelationship between budget development and human behavior.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

11-3

General Approach to BudgetingGeneral Approach to BudgetingGeneral Approach to BudgetingGeneral Approach to Budgeting

1. Budgeting with unit level cost drivers

2. Budgeting with unit and nonunit level cost drivers

11-4

Reasons for BudgetingReasons for BudgetingReasons for BudgetingReasons for Budgeting Budgets compel planning

Budgets improve communication and coordination

Budgets provide a guide to action

Budgets provide a basis of performance

11-5

Some of the Characteristics of a Some of the Characteristics of a Good Multi-User Budgeting SystemGood Multi-User Budgeting System

Some of the Characteristics of a Some of the Characteristics of a Good Multi-User Budgeting SystemGood Multi-User Budgeting System

1. Support changes to hierarchy to that different levels of budgets can be examined.

2. Shared access to common data warehouses.

3. Automatic mapping of imported data for use in multiple applications.

4. Lots of what-if commands.

11-6

In the output/input approach physical inputs and costs are

budgeted as a function of planned unit level activities.

In the output/input approach physical inputs and costs are

budgeted as a function of planned unit level activities.

The incremental approach budgets costs for a coming period as a dollar

or percentage change from the amount budgeted for (or spent during) some previous period.

The incremental approach budgets costs for a coming period as a dollar

or percentage change from the amount budgeted for (or spent during) some previous period.

Using the minimum level approach, an organization

establishes a base amount for budget items and requires

explanation or justification for any budgeted amount above the

minimum (base).

Using the minimum level approach, an organization

establishes a base amount for budget items and requires

explanation or justification for any budgeted amount above the

minimum (base).

11-7

Activity-Based BudgetingActivity-Based BudgetingActivity-Based BudgetingActivity-Based Budgeting

Atlantic Magnetic, Inc.Activity-Based Budget for Compact DisksFor the Year Ending December 31, 2004

Unit level costs:Direct materials $180,000Assembly 245,000Packaging 380,000Distribution 60,000

$ 865,000

ContinuedContinued

11-8

Activity-Based BudgetingActivity-Based BudgetingActivity-Based BudgetingActivity-Based Budgeting

Batch level costs:Procurement $ 30,000Setup 80,000Inspection 70,000

$ 180,000

Product level costs:Development and design $ 50,000Product advertising 120,000

170,000Total product costs

$1,215,000

11-9

Activity-Based BudgetingActivity-Based BudgetingActivity-Based BudgetingActivity-Based Budgeting

Atlantic Magnetic, Inc.Activity-Based Budget for Purchasing Dept.

For the Year Ending December 31, 2004

Budgeted activities:New vendors screened

130Orders placed

1,200Shipments received and inspected

1,400ContinuedContinued

11-10

Activity-Based BudgetingActivity-Based BudgetingActivity-Based BudgetingActivity-Based Budgeting

Budgeted costs:Vendor screening and quality certification (unit level per vendor)$ 30,000Procurement (unit level per pur. order):

Placing orders $50,000Verifying orders 25,000Receiving orders 16,000Inspecting orders 8,00099,000

General administration and maintenance (facility level)

25,000Total purchasing department costs

$154,000

Activity-based budgeting focuses on redesigning products or improving processes rather than simply cutting costs.

Activity-based budgeting focuses on redesigning products or improving processes rather than simply cutting costs.

11-11

The Master BudgetThe Master BudgetThe Master BudgetThe Master Budget

The master budget groups all budgets and supporting schedules together and

coordinates all financial and operational activities, placing them into an

organization-wide set of budgets for a given time period.

The master budget groups all budgets and supporting schedules together and

coordinates all financial and operational activities, placing them into an

organization-wide set of budgets for a given time period.

A major goal of developing a master budget is to ensure the smooth functioning of a business throughout the budget period

and the organization’s operation cycle.

11-12

Operating Cycle of a Manufacturing or Merchandising Operation

Operating Cycle of a Manufacturing or Merchandising Operation

Accts.Accts.Rec.Rec.

Inven-Inven-torytory

CashCash

Sales or Sales or ServicesServices

CollectionCollection

Purchases or Purchases or merchandise merchandise

functionfunction

11-13

Cash BudgetCash Budget

Overview of Budget Assembly Process in a Merchandising Firm

Overview of Budget Assembly Process in a Merchandising Firm

Purchases Purchases BudgetBudget

Selling Expense Selling Expense BudgetBudget

General and General and Administrative Administrative

Expense BudgetExpense Budget

Sales BudgetSales Budget

ContinuedContinued

11-14

Cash BudgetCash Budget

Other Special Budgets: Other Special Budgets: Taxes, Dividends, Capital Taxes, Dividends, Capital

Improvements, etc.Improvements, etc.

Pro Forma Statements: Pro Forma Statements: Income Statement and Income Statement and

Balance SheetBalance Sheet

from Sales Budget from Purchases, Selling Expense, and General and Administrative

Expense Budgets

Overview of Budget Assembly Process in a Merchandising Firm

Overview of Budget Assembly Process in a Merchandising Firm

11-15

Initial Balance SheetInitial Balance SheetInitial Balance SheetInitial Balance SheetBackpacks Galore, Inc.Balance SheetDecember 31, 2004AssetsCurrent assets:

Cash $ 15,000Accounts receivable (net) 21,600Inventory

School backpacks $ 50,000Hiking backpacks 96,000 146,000 $182,600

Property and equipment:Land 60,000Buildings and equipment 260,000Less accum. depreciation 124,800 135,200 195,200

Total assets $377,800

Continued on next slide

Continued on next slide

11-16

Liabilities and stockholders’ equityCurrent liabilities:

Accounts payable $ 40,000Stockholders’ equity:

Capital stock $150,000Retained earnings 187,800 337,800

Total liabilities and stockholders’ equity $377,800

Initial Balance SheetInitial Balance SheetInitial Balance SheetInitial Balance Sheet

11-17

Sales BudgetSales BudgetSales BudgetSales BudgetBackpacks Galore, Inc.Sales BudgetFor the Year Ending December 31, 2005

First Second Third Fourth YearQuarter Quarter Quarter Quarter Total

Sales (units);School backpacks 4,000 3,400 3,650 3,950 15,000Hiking backpacks 1,100 1,600 2,500 1,300 6,500

Sales (dollars):School backpacks $ 80,000 $ 68,000 $ 73,000 $ 79,000 $300,000Hiking backpacks 110,000 160,000 250,000 130,000 650,000

Total $190,000 $228,000 $323,000 $209,000 $950,000

The sales budget contains a forecast of unit sale volume and sale revenue.

The sales budget contains a forecast of unit sale volume and sale revenue.

11-18

• Management desires to have all inventory needed to fill the following quarter’s sales in stock at the end of the previous quarter.

• To provide for a possible delay in the receipt of inventory, BGI also carries a safety stock of 1,000 stock backpacks and 500 hiking backpacks.

• Management desires to have all inventory needed to fill the following quarter’s sales in stock at the end of the previous quarter.

• To provide for a possible delay in the receipt of inventory, BGI also carries a safety stock of 1,000 stock backpacks and 500 hiking backpacks.

Assumptions for Assumptions for Purchases BudgetPurchases BudgetAssumptions for Assumptions for

Purchases BudgetPurchases Budget

ContinuedContinued

11-19

• The total inventory needs are equal to current sales plus desired ending inventory, including the safety stock.

• Budgeted purchases are computed as total inventory needs less the beginning inventory.

• The total inventory needs are equal to current sales plus desired ending inventory, including the safety stock.

• Budgeted purchases are computed as total inventory needs less the beginning inventory.

Assumptions for Assumptions for Purchases BudgetPurchases BudgetAssumptions for Assumptions for

Purchases BudgetPurchases Budget

11-20

Partial Purchases BudgetPartial Purchases BudgetPartial Purchases BudgetPartial Purchases Budget

Backpacks Galore, Inc.Purchases BudgetFor the Year Ending December 31, 2005

First Second Third Four Year Quarter Quarter Quarter Quarter Total

Purchases (units):

School backpacks:Current qtr. sales 4,000 3,400 3,650 3,950Desired end. inv. 4,400 4,650 4,950 5,100

Total needs 8,400 8,050 8,600 9,050 Less beg. inv. -5,000 -4,400 -4,650 -4,950

Purchases 3,400 3,650 3,950 4,100 15,100

11-21

Partial Selling Expense BudgetPartial Selling Expense BudgetPartial Selling Expense BudgetPartial Selling Expense BudgetBackpacks Galore, Inc.Selling Expense BudgetFor the Year Ending December 31, 2005

First Second Third Fourth YearQuarter Quarter Quarter Quarter Total

Budgeted sales $190,000 $228,000 $323,000 $209,000 $950,000Variable costs:Setup/Display $ 1,900 $ 2,280 $ 3,230 $ 2,090 $ 9,500Commissions 3,800 4,560 6,460 4,180 19,000Miscellaneous 1,900 2,280 3,230 2,090 9,500Total 7,600 9,120 12,920 8,360 18,000

Fixed costs (total) 4,500 4,500 4,500 4,500 4,500Total selling exp. $12,100 $13,620 $17,420 $12,860 $56,000

11-22

Assumptions for Cash BudgetAssumptions for Cash BudgetAssumptions for Cash BudgetAssumptions for Cash Budget

The cash budget summarizes all cash receipts and disbursements expected to occur during the budget period.

Cash is critical to survival.

The cash budget summarizes all cash receipts and disbursements expected to occur during the budget period.

Cash is critical to survival.

11-23

Partial Cash BudgetPartial Cash BudgetPartial Cash BudgetPartial Cash BudgetBackpacks Galore, Inc.Cash BudgetFor the Year Ending December 31, 2005

First First QuarterQuarter

First First QuarterQuarter

11-24

Partial Cash BudgetPartial Cash BudgetPartial Cash BudgetPartial Cash Budget

Cash balance, beginning $ 15,000Collection on sales:

Cash sales $ 95,000From credit sales:

Current quarter 71,250Prior quarter 21,500

Total $187,850Total available from operations $202,850

ContinuedContinued

11-25

Total available from operations $202,850Less budgeted disbursements:

Purchasing, current quarter $ 65,000Purchasing, previous quarter 40,000

Total $105,000Selling 12,100General and administrative 31,000Other:

Income taxes 22,000Dividends 20,000

Total disbursements -$190,100

ContinuedContinued

11-26

Total disbursements -$190,100Excess cash available for disbursements $ 12,750Short-term financing:

New loans $ 3,000Net cash flow from financing $ 3,000Cash balance, ending $ 15,750

This amount becomes the beginning balance for the

second quarter.

11-27

Budgeted Income StatementBudgeted Income StatementBudgeted Income StatementBudgeted Income StatementBackpacks Galore, Inc.Budgeted Income Statement (Functional Format)For the Year Ending December 31, 2005Sales $950,000Expenses:

Cost of goods sold:Beginning inventory $146,000Purchases 547,000Cost of merchandise avail. $693,000Ending inventory -153,000 $540,000

Selling operations 56,000General and administrative 132,000Bad debt expense 4,750 -732,750

Income from operations $217,250continuedcontinued

11-28

Income from operations $217,250Other expenses:

Interest expense - 1,590Net income before taxes $215,660Allowance for income taxes - 77,200Net income $138,460

11-29

Budgeted Balance SheetBudgeted Balance SheetBudgeted Balance SheetBudgeted Balance SheetBackpacks Galore, Inc.Budgeted Balance SheetDecember 31, 2005Assets

Current assets:Cash $ 77,480Accounts receivable (net) 25,080Merchandise inventory 153,000 $255,560

Property and equipment:Land $ 60,000Building and equipment $260,000Less accumulated depr. - 132,800 127,200 187,200

Total assets $442,760

continuedcontinued

11-30

Liabilities and stockholders’ equityCurrent liabilities:

Accounts payable $ 56,500Stockholders’ equity:

Capital stock $150,000Retained earnings 236,260 386,260

Total liabilities and stockholders’ equity $442,760

11-31

Finalizing the BudgetFinalizing the Budget

Before finalizing the budget, two questions

must be addressed.

Before finalizing the budget, two questions

must be addressed.

Is the proposed budget feasible?

Is the proposed budget feasible?

Is the proposed budget

acceptable?

Is the proposed budget

acceptable?

11-32

The sales forecast is primary to most organizations.

The collection period for sales on account. Percent of uncollectible sales on account. Cost of materials, supplies, utilities, etc. Employee turnover. Time required to perform activities. Interest rates. Development time for new products or

services.

The sales forecast is primary to most organizations.

The collection period for sales on account. Percent of uncollectible sales on account. Cost of materials, supplies, utilities, etc. Employee turnover. Time required to perform activities. Interest rates. Development time for new products or

services.

Types of Forecasts Types of Forecasts Used in BudgetingUsed in Budgeting

Types of Forecasts Types of Forecasts Used in BudgetingUsed in Budgeting

11-33

Developing Budgets that WorkDeveloping Budgets that WorkDeveloping Budgets that WorkDeveloping Budgets that Work

1. Emphasize the importance of budgeting as a planning device.

2. Encourage wide participation in budget preparation at all levels of the organization.

3. Demonstrate that the budget has the complete support of top management.

4. Recognize that the budget is not unalterable.

ContinuedContinued

11-34

5. Use budget performance reports not just to identify poor performers, but also to recognize good performance.

6. Conduct programs in budget education to provide new managers with information about the purposes of budgets and to dispel erroneous misconceptions that may exist.

Developing Budgets that WorkDeveloping Budgets that WorkDeveloping Budgets that WorkDeveloping Budgets that Work

11-35

CChapter

1111

The The EndEndThe The EndEnd

11-36