Prepared by Debby Bloom-Hill CMA, CFM. Slide 10-2 CHAPTER 10 Budgetary Planning and Control.

Prepared by Debby Bloom-Hill CMA, CFM

Slide 10-2

CHAPTER 10CHAPTER 10

Budgetary Planning and ControlBudgetary Planning and Control

Learning objective 1: Discuss the use of budgets in planning and control

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Budgetary Planning and Control

Budgetary Planning and Control

Budgets are the formal documents that quantify a company’s plans for achieving its goals

For many companies, the entire planning and control process is built around budgets.

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Use of Budgets in Planning and Control


Planning Budgets enhance communication

and coordination The process of developing a formal

plan forces managers to consider their goals and objectives and to specify means of achieving them

Budgets become the vehicle for communicating information about where the company is heading


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Control Budgets provide a basis for

evaluating performance Control makes sure the company is

heading in the proper direction and operating efficiently To control a company, it is essential to

assess the performance of managers and their operations for which they are responsible


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Use of Budgets in ControlUse of Budgets in Control

Often performance evaluation is carried out by comparing actual with planned or budgeted performance Significant deviations from planned

performance associated with three potential causes:

1. The budget was poorly conceived2. Conditions have changed3. Managers have done a particularly good

or poor job managing operationsLearning objective 1: Discuss the use of budgets in planning and control

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Which of the following statements regarding budgets is false?

a. They are formal documents that quantify a company’s plans.

b. They enhance communication and coordination.

c. They are useful in planning but not in control.

d. They provide a basis for evaluating performance.

Answer: c They are useful in planning AND in control


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Developing the BudgetDeveloping the Budget

Budgets are prepared for: Departments Divisions of a company For the entire company

Often the group within a company that is responsible for approval of the various budgets is the budget committee


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The budget committee consists of senior managers The budget committee works with

departments to develop realistic plans that are consistent with overall company goals In some cases the budget committee

may impose a budget without soliciting input from department managers


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In a top-down approach budgets are developed at higher operational levels without substantial input from lower level managers

In a bottom-up approach, lower level managers are the primary source of information used in setting the budget


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Budget Time PeriodBudget Time Period

Managers must decide on an appropriate budget period Depending on needs, budgets can

be prepared for a variety of time periods Long run budgets are prepared for a

three or even a five year period Short run budgets may cover a month,

a quarter, or a year Generally, the longer the time

period, the less detailed the budget Learning objective 1: Discuss the use of

budgets in planning and control

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Five-Year BudgetsFive-Year Budgets


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Zero Base BudgetingZero Base Budgeting

A common starting point in budgeting is previous period revenues and costs

Zero base requires budgeted amounts to be justified by each department at the start of each period This results in a fresh consideration

for the validity of budgeted amounts It is a time consuming and expensive

process Not widely used by business enterprises


Learning objective 2: Prepare the budget schedules that make up the master budget

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The Master BudgetThe Master Budget

The master budget is a comprehensive planning document that incorporates a number of individual budgets Typically, it includes budgets for sales,

production, direct materials, direct labor, manufacturing overhead, selling and administrative expense, capital acquisitions, and cash receipts and disbursements

Also includes budgeted income statement and balance sheet

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Master BudgetMaster Budget


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Sales BudgetSales Budget

The first step involved preparation of sales forecasts and a sales budget Prepared first because an estimate

of sales is needed for other budgets Companies use numerous methods

to estimate sales, including Economic models Sales trends Trade journals, among others


Sales BudgetSales Budget

Budgeted sales revenue:Budgeted sales (units) x budgeted sales price


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Production BudgetProduction Budget

The production budget can be developed once the sales budget has been prepared In deciding how much to produce,

managers must take into account how much they expect to sell, how much is in beginning inventory, and how much they want in ending inventory


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Production BudgetProduction Budget

The quantity that must be produced is calculated using the following formula


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Finished units to

be produced

=Expected sales in units

+

Desired ending

inventory of finished

goods

-

Beginning

inventory of

finished units

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Production BudgetProduction Budget Preston Joystick budget plan, Quarter 1

Ending inventory of finished goods = 10% of next quarter’s sales (25,000 X 10% = 2,500)

Budgeted unit sales,Q1 = 21,000 units Budgeted unit sales, Q2 = 25,000 units Beginning inventory Q1 = 2,100 units

Budget finished units to be producedExpected sales in units 21,000 Add: Desired ending inventory of finished goods 2,500 Subtract: Beginning inventory of finished units (2,100) Finished units to be produced 21,400


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Mason Manufacturing expects to sell 10,000 units in the first quarter and 14,000 in the second quarter. The company desires beginning inventory equal to 20% of sales for the coming quarter. Finished goods on hand at the start of the first quarter equals 2,000 units. How many units should be produced in the first quarter?

a. 14,000 unitsb. 16,000 unitsc. 10,800 unitsd. 12,000 units

Answer: c10,800 units = 10,000 + 2,800 – 2,000


Direct Material Purchases Budget

Direct Material Purchases Budget

The amount of direct materials that must be purchased depends on The amount needed for production,

and The amount needed for ending

inventory The amount that must be purchased

can be calculated from the following formula


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Required purchases of direct materials

=

Amount required

for productio

n

+

Desired ending

inventory of direct materials

-

Beginning inventory of direct materials

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Budgeted production: Q1= 50,000; Q2= 60,000Parts per unit= 3 , cost per part= $5 Ending inventory = 20% of next month’s production

Number of parts required for Q1 production is:a. 50,000b. 150,000c. 60,000d. 180,000

Answer: bQ1 production 50,000 x 3 parts per unit = 150,000


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Budgeted production: Q1= 50,000; Q2= 60,000Parts/unit= 3, cost/part= $5 Ending inventory = 20% of next month’s required

partsDesired ending inventory of parts for Q1 in units is:

a. 10,000b. 12,000c. 30,000d. 36,000

Answer: dQ2 parts = 60,000 x 3 = 180,000 x 20% = 36,000


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Budgeted production: Q1= 50,000; Q2= 60,000Parts/unit= 3, cost/per part= $5Ending inventory = 20% of next month’s required

partBeginning parts inventory, Q1= 30,000 unitsBudgeted cost of purchases for Q1 is:

a. $750,000b. $900,000c. $780,000d. $1,650,000

Answer: c156,000 parts to purchase = 150,000 + 36,000 –

30,000156,000 parts to purchase x $5 cost = $780,000


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Direct Labor BudgetDirect Labor Budget

The direct labor budget presents the direct labor cost by quarter Direct labor cost is calculated by

multiplying the number of units produced each quarter by the labor hours per unit and the rate per hour

The direct labor budget can be used to budget the number of employees needed


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Direct Labor BudgetDirect Labor Budget


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Manufacturing Overhead Budget


The manufacturing overhead budget separates variable and fixed costs The cost per unit of production of each

variable cost item is multiplied by the quantity produced each quarter

The fixed costs are identical each quarter except for the amount of depreciation

Budget information is also needed for selling and administrative expenses


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Selling and Administrative Expense Budget

Selling and Administrative Expense Budget


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Budgeted Income Statement


Much of the information contained in the budgets already described is utilized in the preparation of a budgeted income statement The sales figures come directly from

the sales budget Cost of goods sold requires a

calculation of the unit cost of production


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Calculation of the unit cost of production The direct materials budget

indicates the materials cost per unit The direct labor budget indicates

the labor cost per unit The manufacturing overhead budget

indicates the overhead cost per unit


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Capital Acquisitions BudgetCapital Acquisitions Budget

For decisions with respect to long-lived assets such as plant and equipment Incremental cash flows along with

net present value and internal rate of return are used for evaluation

The final list of approved projects is documented in the capital acquisitions budget


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Cash Receipts and Disbursements Budget

Cash Receipts and Disbursements Budget

Managers must plan for the amount and timing of cash flows

Careful planning of receipts and disbursements is necessary to: Anticipate cash shortages and

arrange to borrow funds Anticipate cash surpluses and seek

productive uses


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Which of the following items does not require a cash outflow?

a. Salariesb. Purchase of raw materialsc. Advertisingd. Depreciation

Answer: dDepreciation


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Estimate Cash CollectionsEstimate Cash Collections

To prepare an estimate of cash collections, management must determine the percent of credit sales revenue that is collected in the period of sale and the percent collected in the subsequent period The percentage can be estimated

based on past collection experience


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Estimate Cash DisbursementsEstimate Cash Disbursements

To prepare an estimate of cash disbursements, management must determine the percent of material purchases that is paid in the period of purchase and the percent that is paid in the subsequent period The timing of all other cash

disbursements must also be considered


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Estimate Cash DisbursementsEstimate Cash Disbursements

In preparing a cash budget, it is important to remember that some expenses do not require cash outlays For example, depreciation is a part

of manufacturing overhead but does not require a current outlay of cash

Another example of a noncash expense is the amortization of prepaid insurance


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Mason Manufacturing expects sales of $100,000 in the first quarter and $140,000in the second quarter. The company collects 70% of sales in the quarter sold and 30% in the subsequent quarter. What are expected cash collections in the second quarter?

a. $128,000b. $30,000c. $98,000d. $142,000

Answer: a$128,000 = (.3 * $100,000) + (.7 * $140,000)


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Budgeted Balance SheetBudgeted Balance Sheet

The last component of the master budget is the budgeted balance sheet This is simply a planned balance

sheet Sometimes called a pro forma balance

sheet Managers can use this budget to

assess the effect of their planned decisions on the future financial position of the firm


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Use of Computers in the Budget Planning ProcessUse of Computers in the Budget Planning Process

Budget committee may review a budget and decide it is inconsistent with company goals This conclusion may lead managers

to explore a variety of actions that affect future costs and revenues If managers decide to make changes,

they must also revise the budget


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Use of Computers in the Budget Planning ProcessUse of Computers in the Budget Planning Process

Computers are very useful in this situation Most companies define the budget

relationships in a computer model With computerized budget

information, an item can be changed and the computer can recalculate that budget and any other budget affected by the change


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Budgetary ControlBudgetary Control

Budgets facilitate control by providing a standard for evaluation The standard is the budgeted

amount, against which actual results are compared

Differences between budgeted and actual amounts are referred to as budget variances


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Static and Flexible BudgetsStatic and Flexible Budgets

In evaluating performance, care must be taken to make sure that the level of activity used in the budget is equal to the actual level of activity A static budget is not adjusted for

the actual level of production A more appropriate analysis would

make use of a flexible budget

Learning objective 3: Explain why flexible budgets are needed for performance evaluation

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Flexible BudgetsFlexible Budgets

A flexible budget is a set of budget relationships that can be adjusted to various activity levels Thus, flexible budgets take into

account the fact that when production increases or decreases, variable costs can change

Fixed costs, however, stay the same


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Flexible BudgetFlexible Budget


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A ____ budget is not adjusted for the actual level of production.

a. Staticb. Flexiblec. Pro formad. None of the above

Answer: aStatic


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SpreadsheetsSpreadsheets


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Investigating Budget Variances


Significant deviations from the budget, called budget variances, may have three causes1. The budget may not have been well

conceived2. Conditions may have changed3. Managers may have performed

their jobs particularly well or poorly


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Using a management by exception approach, only exceptional variances are investigated Generally, variances that are large

in absolute dollars or relative to budgeted amounts are considered exceptional It is important to point out that both

exceptional “unfavorable” and exceptional “favorable” variances should be investigated Learning objective 3: Explain why flexible budgets are

needed for performance evaluation

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“Unfavorable” Budget Variance“Unfavorable” Budget Variance


Learning objective 4: Discuss the conflict between the planning and control uses of budgets

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Conflict in Planning and Control Uses of BudgetsConflict in Planning and Control Uses of Budgets

Budgets are used for both planning and control With respect to planning, they

communicate company goals and help coordinate various activities

With respect to control, they focus the attention of managers on meeting or beating budget targets There are inherent conflicts when

budgets are used for both planning and control

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Issues With Budget-Based Compensation


The following slide helps understanding of the two related problems The illustration shows a common

budget based compensation scheme in which a manager receives a “hurdle” bonus once a target is hit Performance better than 80% of

budgeted profit results in additional “variable” bonus


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Common Budget-based Compensation SchemeCommon Budget-based Compensation Scheme


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The first problem is that managers have incentive to pad a budget and create budget slack Budget slack is a budget with

targets that are easy to achieve The lower the budget target, the

more likely it is that managers will receive the hurdle and variable bonus Managers can create slack by lowering

sales and increasing cost forecastsLearning objective 4: Discuss the conflict between the planning and control uses of budgets

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The second problem relates to the fact that managers who are evaluated may have an incentive to shift income from one period to another Consider a manager who estimates

that it is unlikely that the target will be met

The manager has an incentive to shift income from a future period to the current period Learning objective 4: Discuss the conflict between the planning

and control uses of budgets

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The best that can be done to mitigate the conflict between the planning and control uses of budgets is to assure managers that their performance in comparison to the budget will be fairly evaluated and compensated Managers should be confident that

they will be allowed to comment on the real causes of budget variances and tell their side of the storyLearning objective 4: Discuss the conflict between the planning

and control uses of budgets

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Budget PaddingBudget Padding


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Prepared by Debby Bloom-Hill CMA, CFM. Slide 10-2 CHAPTER 10 Budgetary Planning and Control.

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