Slide 10-2 CHAPTER 10 Budgetary Planning and Control.

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CHAPTER 10

Budgetary Planning and Control

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

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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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Use of Budgets in Planning and Control

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 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 operations


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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 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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Developing the Budget 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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Developing the Budget 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 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


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Five-Year Budgets


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Zero 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 a master budget.Slide 10-14

The 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 Budget

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

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Sales 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 BudgetBudgeted sales revenue:

Budgeted sales (units) x budgeted sales price

Slide 10-17Learning objective 2: Prepare the budget schedules that make up a master budget.

Production 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

Slide 10-18Learning objective 2: Prepare the budget schedules that make up a master budget.

Production 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 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 produced

Expected 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


Production Budget


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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 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 production

+

Desired ending

inventory of direct materials

-Beginning

inventory of direct

materials


Direct Material Purchases Budget


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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 parts

Desired 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 units

Budgeted 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 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 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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Manufacturing Overhead Budget


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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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Budgeted Income Statement 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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Budgeted Income Statement


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Capital 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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Capital Acquisitions Budget


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Cash 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 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 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 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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Cash Budget


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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 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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Budgeted Balance Sheet


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Use 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 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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Spreadsheets for Budgeting

Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets.

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Budgetary 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 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


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Flexible 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 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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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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Investigating Budget Variances

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


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“Unfavorable” Budget Variance


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Conflict 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 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 3: Explain why flexible budgets are needed for performance evaluation, and 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


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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 story


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Budget Padding


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Slide 10-2 CHAPTER 10 Budgetary Planning and Control.

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