Chapter 22 1. To plan and control actions and the related revenues and expenses To incorporate managements strategic and operational plans Planning technology.

The Master Budget and Responsibility Accounting

Chapter 22

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Why Managers Use BudgetsTo plan and control actions and the related revenues and expensesTo incorporate management’s strategic and operational plans

Planning technology upgradesPlanning capital asset replacements, improvements, or expansions

Compare actual results with budgeted amounts to determine corrective actions(performance reporting)

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How Managers Use Budgets

Benefits of Budgeting

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Performance ReportIdentifies areas where the actual results differed from the budget

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Steps Managers Take To Prepare A BudgetMaster budget—the set of budgeted financial statements and supporting schedules for the entire organizationBudget includes three types of budgets:

The operating budget Projects sales revenue, cost of goods sold, and operating expenses

The capital expenditures budget The plan for purchasing property, plant, equipment, and other long-term assets

The financial budgetPlans for raising cash and paying debts

Contain projected amounts, not actual amounts

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Master Budget

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(Merchandising Co.)

Master Budget

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(Manufacturer)

Prepare an operating budget

First three componentsSales budgetInventory, purchases, and cost of goods sold budgetOperating expenses

Feed into the budgeted income statement

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Sales Budget

Cornerstone of master budgetLevel of sales affect all other elements

Projected sales are calculated as:Each product multiplied by expected units sold

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Inventory, Purchases, and Cost of Goods Sold Budget

Budget determines:Cost of goods sold for the budgeted income statementEnding inventory for the budgeted balance sheetPurchases for the cash budget

Familiar equation is usedBeginning inventory + Purchases – Ending inventory = Cost of goods sold

Rearrange equation to solve for unknownsPurchases = Cost of goods sold + Ending inventory – Beginning inventory

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Inventory, Purchases, and Cost of Goods Sold Budget

70% cost of goods sold figure uses sales budget created earlier

Desired ending inventory is derived from company policiesDesired ending inventory becomes beginning inventory for next period (month, quarter, or year)

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Operating Expense BudgetPrepared after sales budget and cost of goods sold budgetShows estimated expenses for the periodIncludes fixed and/or variable expensesExamples:

Fixed and variable salaries, commissionsRentInsuranceAdvertisingMiscellaneous

Look at prior income statements 14

Operating Expense Budget

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The Budgeted Income Statement

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Prepared after sales budget, cost of goods sold budget and operating expense budget

S22-3: PREPARING AN OPERATING BUDGET

Grippers sells its rock-climbing shoes worldwide. Grippers expects to sell 8,500 pairs of shoes for $180 each in January, and 3,500 pairs of shoes for $190 each in February. All sales are cash only.Prepare the sales budget for January and February.

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GrippersSales BudgetJanuary February Total

Sales price per pair $ 180 $ 190Number of pairs × 8,500 × 3,500Total sales $1,530,000 $665,000 $2,195,000

S22-4: PREPARING AN OPERATING BUDGET

Review your results from S22-3. Grippers expects cost of goods sold to average 60% of sales revenue, and the company expects to sell 4,100 pairs of shoes in March for $260 each. Grippers’ target ending inventory is $10,000 plus 50% of the next month’s cost of goods sold.Use this information and the sales budget prepared in S22-3 to prepare Grippers’ inventory, purchases, and cost of goods sold budget for January and February.

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GrippersInventory, Purchases, and Cost of Goods Sold Budget

January FebruaryCost of goods sold

(0.60 × sales from S 21-3) $ 918,000 $ 399,000+ Desired ending inventory

($10,000 + 0.50× Cost of goodssold for next month) 209,500 329,800

= Total inventory required 1,127,500 728,800− Beginning inventory (469,000) (209,500)= Purchases $ 658,500 $ 519,300

Financial Budget

Cash budgetProject cash receipts and payments

Budgeted balance sheetProject each asset, liability, and stockholders’ equity account

Budgeted statement of cash flowsProject cash flows from operating, investing, and financing activities

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Cash BudgetStatement of budgeted cash receipts and paymentsDetails how to go from the beginning cash balance to the desired ending balanceFour major parts:

Cash collections from customersCash payments for purchasesCash payments for operating expensesCash payments for capital expenditures

Depends on operating budget

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Budgeted Cash Collections from CustomersCash collections from customers

Cash sales from the sales budgetCollections of prior month’s credit sales

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Budgeted Cash Payments for PurchasesPayments for operating expenses

Payments during the month of purchase—assume 50% Payments following the month of purchase—assume 50%

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x 50%

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Budgeted Cash Payments for Operating ExpensesUse the operating expenses budget and payment information to compute cash payments for operating expensesPayment of 50% of current month’s salary and commissionsPayment of 50% of prior months salary and commissionsPayment for rent and miscellaneous expenses in the same month

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Insurance was prepaid in the prior quarter

Depreciation is a non-cash expense

The Cash Budget

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8. Greg’s plans to purchase a used delivery truck in April for $3,000 cash.9. Greg’s requires a minimum cash balance of $10,000 before financing at the end of each month.

BudgetedBalance Sheet

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Budgeted Statement of Cash Flows

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Getting Employees to Accept the BudgetMost important part of the budgeting system

Getting managers and employees to accept the budgetManagers must motivate employees to accept the budget’s goalsHow?

Managers must support the budget themselves, or no one else willManagers must show employees how budgets can help them achieve better results Managers must have employees participate in developing the budget

Do not build in slack–becomes less accurate

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S22-5: PREPARING A FINANCIAL BUDGET

Refer to the Grippers sales budget that you prepared in S22-3. Now assume that Grippers’ sales are collected as follows: November sales totaled $400,000 and December sales were $425,000.

50% in the month of the sale30% in the month after the sale18% two months after the sale2% never collected

Prepare a schedule for the budgeted cash collections for January and February. Round answers to the nearest dollar.

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S22-5: PREPARING A FINANCIAL BUDGET

GrippersBudgeted Cash Collections from Customers

January FebruaryCash sales (50% of current month ) $ 765,000 $ 332,500

Collection of sales:

30% of prior month credit sales 127,500 459,000

18% of sales two months ago 72,000 76,500

Total cash collections $ 964,500 $ 868,000

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GrippersSales BudgetJanuary February Total

Sales price per pair $ 180 $ 190Number of pairs × 8,500 × 3,500Total sales $1,530,000 $665,000 $2,195,000

S22-6: PREPARING A FINANCIAL BUDGET

Refer to the Grippers inventory, purchases, and cost of goods sold budget your prepared in S22-4. Assume Grippers pays for inventory purchases 50% in the month of purchase and 50% in the month after purchase.

Prepare a schedule for the budgeted cash payments for purchases for January and February.

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GrippersInventory, Purchases, and Cost of Goods Sold Budget

January FebruaryCost of goods sold

(0.60 × sales from S 21-3) $ 918,000 $ 399,000+ Desired ending inventory

($10,000 + 0.50× Cost of goodssold for next month) 209,500 329,800

= Total inventory required 1,127,500 728,800− Beginning inventory (469,000) (209,500)= Purchases $ 658,500 $ 519,300

GrippersBudgeted Cash Payments for Purchases

January February50% of last month $ 293,250 $ 329,250

50% of current month 329,250 259,650

Total cash payments $ 622,500 $ 588,900

S22-7: PREPARING A FINANCIAL BUDGET

Grippers has $12,500 in cash on hand on January 1. Refer to S22-5 and S22-6 for cash collections and cash payment information. Assume Grippers has cash payment for operating expenses including salaries of $50,000 plus 1% of sales, all paid in the month of sale. The company requires a minimum cash balance of $10,000.Prepare a cash budget for January and February. Will Grippers need to borrow cash by the end of February?

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S22-7: PREPARING A FINANCIAL BUDGET

GrippersCash Budget

January and February 2012January February

Beginning cash balance $ 12,500 $ 402,300  Cash collections from customers 1,077,600 827,400  Cash available 1,090,100 1,229,700  Cash payments Purchases of inventory 622,500 588,900 Operating expenses 65,300 56,650Total cash payments 687,800 645,550  Ending cash balance 402,300 584,150  Less: Minimum cash balance desired (10,000) (10,000)  Cash excess (deficiency) $ 392,300 $ 574,150  

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Using Information Technology for Sensitivity Analysis and Rolling Up Unit Budgets

Technology makes it more cost-effective for managers to:

Conduct sensitivity analysis on their own unit’s budgetCombine individual unit budgets to create the companywide master budget

Master budget models the company’s planned activitiesMust support key strategies

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Sensitivity Analysis and Rolling Up Unit Budgets

Sensitivity analysisWhat-if technique that determines the result if predicted amounts differ from those budgeted

Spreadsheet programs used for budgeting make sensitivity analysis cost-effective

What-if budget questions easily changed within Excel with a few keystrokesMakes it cost-effective to perform more comprehensive sensitivity analysesManagers react quickly if key assumptions underlying the master budget (such as sales price or quantity) turn out to be wrong

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Rolling Up Individual Budgets

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Rolling Up Individual Budgets

Individual operating units roll up budgets to prepare company-wide budgetBudget management software is used

Often part of Enterprise Resource Planning (ERP) system

Allows management to conduct sensitivity analysis on unit dataManagers can spend less time compiling and summarizing data and more time analyzing it

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S22-9: USING SENSITIVITY ANALYSIS IN BUDGETING

Maplehaven Sporting Goods Store has the following sales budget:

Suppose June sales are expected to be $80,000 rather than $64,000.

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Riverbed Sporting Goods StoreSales BudgetApril - July

April May June JulyApril-July

TotalCash sales, 80% $40,800 $64,000 $51,200 $40,800Credit sales, 20% 10,200 16,000 12,800 10,200Total sales, 100% $51,000 $80,000 $64,000 $51,000 $246,000

Riverbed Sporting Goods StoreRevised Sales Budget

April - July

April May June JulyApril-July

TotalCash sales, 80% $40,800 $64,000 $64,000 $40,800Credit sales, 20% 10,200 16,000 16,000 10,200Total sales, 100% $51,000 $80,000 $80,000 $51,000 $262,000

Responsibility AccountingA system for evaluating the performance of each responsibility center and its manager

A responsibility center is the part of the organization for which a particular manager is responsible

Is a part of the organization for which a manager has decision-making authority and accountability

Four types:Cost centerRevenue centerProfit centerInvestment center

Decentralization highlights the need for reports on individual segments

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Responsibility Centers

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Goal is to control cost

Goal is to increase revenues

Goal is to increase profits

Goal is to increase ROI, EVA, & residual income

Responsibility Accounting Performance Reports

Performance reports compare budgeted and actual amountsReporting at all levels:

Division (investment centers)Product lines (profit centers)Production (cost centers)Sales (revenue centers)

Management by exceptionShows variances between actual and budgeted amounts

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Level of report detail decreases as reports go to higher levels

Learn about Service DepartmentsDepartments that provide services to multiple departments or divisions for the company

Usually do not generate revenuesSimilar to the shared production overheadNonproduction related service departments

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Traceable Fixed CostsCosts directly associated with an individual product, division, or business segmentWould disappear if the company discontinued the product , division or segmentAssigning traceable fixed costs

Splitting the cost equally–not fairBased on use of the services–fair

Small users charged lessLarger users charged more

Identify cost drivers (ABC costing) suitable for assigning traceable service department charges

Common service departments listed on next slide

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Responsibility Accounting ReportsShow the results of the segment or division for which a particular manager is responsible

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