The Budgeting Process Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University Chapter 21.

The Budgeting Process

Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University

Chapter 21

Gail Mestas

Replace book cover with POA 2005e

21–2Copyright © Houghton Mifflin Company. All rights reserved.

Learning Objective

1. Define budgeting and explain its role in the management cycle.

2. Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets.

3. Prepare the operating budgets that support the financial budgets.


Learning Objective (cont’d)

4. Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet.

5. Describe management’s role in budget implementation.



• Objective 1– Define budgeting and explain its role in the

management cycle


Budgeting

… is the process of identifying, gathering, summarizing, and communicating

financial and nonfinancial information about an organization's future activities

• Is essential part of the continuous planning for an organization in order to accomplish long-term goals



• Budgets– Plans of action based on forecasted

transactions, activities, and events

– Are synonymous with managing an organization

• Essential to accomplishing goals in the strategic plan


The Budgeting Process (cont’d)

• Budgets are used to– Communicate information

– Coordinate activities and resource usage

– Motivate employees

– Evaluate performance

– Manage and account for cash• Establish minimum levels of cash receipts and

expenditures


The Budgeting Process (cont’d)

• Many forms of budgets – Examples

• Cash budget– Focuses on financial information

» Shows, among other things, how cash resources will be allotted to operating, investing, and financing activities over a future period

• Production budget– Focuses on nonfinancial information

» Shows planned production in units

» Identifies activities needed to meet certain requirements or standards


Budgeting and Goals

• Strategic planning– Process by which management establishes

an organization’s long-term goals


Long-Term Goals

… define the strategic direction an organization will take over

a five- to ten-year period

• Are the basis for – Making annual operating plans

– Preparing budgets


Long-Term Goals (cont’d)

• Should take into consideration– Economic and industry forecasts

– Employee-management relations

– Structure and role of management

– Value chain considerations

– Organizational capacity

– Any other operational and tactical issues facing the organization

• Expected quality of products or services

• Growth rates

• Desired market share


Long-Term Goals (cont’d)

• Must set specific targets and timetables

• Must assign responsibility for achieving the goals to specific personnel

• A range of long-term goals should be included in the organization's strategic plan– Should give direction to efforts to achieve

these goals


Short-Term Goals

• Involve every part of an enterprise

• Much more detailed than long-term goals

• To formulate an annual operating plan, long-term goals must be restated in terms of what needs to be accomplished during the next year

Short-term goals are the basis of an organization’s operating budgets for the year


Short-Term Goals (cont’d)

• Organization’s controller takes charge of coordinating the budget process– Designs a complete set of budget-development

directions• Timetable with deadlines

– Assigns clearly defined responsibilities for carrying out each part of the budget’s development

• To specific individuals or management teams

– The budget may be reviewed and revised during the year


Importance of Participation

• The key to a successful budget is participative budgeting– Process in which personnel at all levels of

an organization actively engage in making decisions about the budget

• Gives a sense of ownership– Helps ensure that departments will attain targets and

stay within the budget


Importance of Participation (cont’d)

• Participative budgeting depends on joint decision making– Controller must be able to communicate

and negotiate effectively with people in all levels of an organization

• Senior managers– Formulate organizational long-and short-term goals

• Middle managers

• Supervisors– Responsible for daily operations


Importance of Participation (cont’d)

• Authoritative budgeting– Senior executives dictate targets

• Do not allow middle managers and supervisors a voice in setting them

• Targets may be unrealistic and impossible to attain– Will undermine motivation of managers and supervisors

» Cooperation is essential for successful budget implementation

– Senior executives allow controller to develop budget without consulting other managers

• Managers may feel budgeting is not a top priority

21–18

Budgeting and the

Management Cycle

Gail Mestas

Insert updated Exhibit 1, segment information for Goodyear Tire & rubber co., chapter 18, POA, 2005e


Budgeting and the Management Cycle

• Planning– Budgeting

• Originates in this stage

• Helps managers to– Relate the organization’s long-term goals to its short-

term activities

– Distribute resources and workloads

– Communicate responsibilities

– Select performance measures

– Set goals for bonuses and rewards



• Executing– Budgeting helps managers to

• Communicate expectations

• Measure performance and motivate employees

• Coordinate activities and allot resources



• Reporting– Budgeting helps managers to

• Communicate budget information

• Provide continuous feedback

• Support operating decisions



• Reviewing– Budgeting helps managers to

• Evaluate performance

• Determine timeliness

• Find variances and create solutions

• Compare planned performance with actual performance


Discussion

Q. How are short-term goals related to strategic planning?

A. Short-term goals define the strategic direction an organization will take over the next year. They are determined to help accomplish the long-term goals that are established during the strategic planning process


The Master Budget

• Objective 2– Identify the elements of a master budget in

different types of organizations and the guidelines for preparing budgets


The Master Budget

… consists of a set of operating budgets and a set of financial budgets

that detail an organization’s financial plans

for a specific accounting period, generally a year


The Master Budget (cont’d)

• Operating budgets– Plans used in daily operations

– Basis for financial budgets

• Financial budgets– Projections of financial results for the accounting

period

– Include• Budgeted income statement

• Capital expenditures budget

• Cash budget

• Budgeted balance sheet



• Process of preparing a master budget is similar in all three types of organizations– Manufacturing

– Retail

– Service

• The process differs mainly in the kinds of operating budgets each type of organization prepares

21–28

Preparation of a Master

Budget for a Manufacturing Organization

Gail Mestas


21–29

Preparation of a Master

Budget for a Retail

Organization

Gail Mestas



Preparation of a Master Budget for a Service Organization

Gail Mestas

Inset updated figure 4, preparation of a master budget for a service organization, chpater 24, POA, 2005e



• Sales budget– Is prepared first

• Used to estimate sales volume and revenues

• Once developed, other budgets can be developed

– These other budgets will help manage the organization's resources so that profits can be generated on sales

In a service organization, the sales budget is called the service revenue budget



• No standard format for budget preparation– Procedures vary from organization to

organization

– Only universal requirement is that budgets communicate the appropriate information to the reader in a clear and understandable manner



• Managers can improve the quality of budgets by using the following guidelines

1. Know the purpose of the budget

2. Identify the user group and its information needs

3. Identify sources of accurate, meaningful budget information

4. Establish a clear format for the budget

5. Use appropriate formulas and calculations to derive quantitative information

6. Revise the budget until it includes all planning decisions


Discussion

Q. Which budget must be prepared first?

A. The sales budget. This budget is used to estimate sales volume and revenues. Once established, the other budgets can be developed


Operating Budgets

• Objective 3– Prepare the operating budgets that support

the financial budgets


Operating Budgets

… are a set of budgets that are used in planning the daily operations of an

organization

• Are part of the master budget


Operating Budgets

• Procedures for preparing operating budgets include– Cost behavior analysis

– Cost-volume-profit analysis

– A product costing method

• Organizations that manufacture a variety of products or services may prepare– Separate operating budgets, or

– One comprehensive budget for each product or service


Sales Budget

… is a detailed plan, expressed in both units and dollars, that identifies

the product (or service) sales expected in an accounting period


Sales Budget (cont’d)

• Sales mangers use the information to– Plan sales- and marketing-related activities

– Determine human, physical, and technical resource needs

• Accountants use the information to– Determine estimated cash receipts for the cash

budget

• To determine the total budgeted sales Total

Budgeted Sales

= Estimated

Selling Price per Unit

x Estimated Sales in

Units



• Selecting the best estimates for selling price per unit and the sales demand in units can be difficult– If the organization wants to increase its share in

the market• An estimated selling price below the current selling price

may be needed

– If the organization has improved the product’s quality by using more expensive materials or production processes

• The estimated selling price may have to be higher than the current price



• Estimated sales volume is very important– Will affect the level of operating activities

and amount of resources needed for operations

– Managers may use a sales forecast• A projection of sales demand based on an

analysis of internal and external factors



• External factors taken into consideration in a sales forecast include

1. The state of the local and national economies

2. The state of the industry’s economy

3. The nature of the competition and its sales volume and selling price



• Internal factors include

1. The number of units sold in prior periods

2. The organization’s credit policies

3. The organization’s collection policies

4. The organization’s pricing policies

5. Any new products the organization plans to introduce to the market

6. The capacity of the organization’s manufacturing facilities



Gail Mestas

Insert exhibit 1, sales budget, chapter 25, POA, 2005e


The Production Budget

… is a detailed plan showing the number of units a company must produce

to meet budgeted sales and inventory levels

• Production managers use this information to plan for the materials and human resources that production activities will require


The Production Budget (cont’d)

• To prepare a production budget, managers must know– Budgeted number of sales units

• From the sales budget

– Desired level of ending finished goods inventory for each period in the budget year

• Often stated as a percentage of the next period’s budgeted unit sales


The Production Budget (cont’d)

• To determine the production needs for an accounting period

Total Production

Units =

Budgeted Sales in Units

+ Desired Units of Ending Finished Goods Inventory

– Desired Units of

Beginning Finished Goods Inventory


Production Budget

Gail Mestas

Insert updated exhibit 2, production budget, chapter 24, POA, 2005e


The Direct Materials Purchases Budget

… is a detailed plan that identifies the quantity of purchases required to meet budgeted production and inventory needs and the costs associated with those purchases


The Direct Materials Purchases Budget (cont’d)

• Purchasing department– Uses information to plan purchases of

direct materials

• Accountants– Use information to estimate cash payments

to suppliers



• To prepare a direct materials purchases budget managers must know – What production needs will be in the next

accounting period• Provided in the production budget

– Desired level of direct materials inventory for each period

– Per unit cost of direct materials

– Desired level of ending direct materials inventory• Usually stated as a percentage of the next period’s

production



• Steps to prepare a direct materials purchasing budget

1. Calculate each period’s total production needs in units of direct materials

2. Determine the total number of units of direct materials to be purchased during each accounting period in the budget

3. Calculate the cost of the direct materials purchases

Total Units of Direct

Materials to Be Purchased

= Total Production Needs in Units of Direct Materials

+

Desired Units of Ending

Direct Materials Inventory

–

Desired Units of Beginning

Direct Materials Inventory


Direct Materials Purchases Budget

Gail Mestas

Insert updated exhibit 3, direct materials purchases budget, chpater 24, POA, 2005e


The Direct Labor Budget

… is a detailed plan that estimates the direct labor hours needed in an accounting period

and the associated costs


The Direct Labor Budget (cont’d)

• Production managers use estimated direct labor hours to plan – How many employees will be required during the period

– The hours each employee will work

• Accountants use estimated direct labor costs to plan – For cash payments to workers

• Human resource managers use information on the direct labor budget to– Decide whether to hire new employees

– Reduce the existing work force

– Train employees

– Prepare schedules of employee fringe benefits


The Direct Labor Budget (cont’d)

• Steps in preparing a direct labor budget

1. Estimate the total direct labor hours– Multiply estimated direct labor hours per

unit by the anticipated units of production

2. Calculate the total budgeted direct labor cost

Total Budgeted Direct Labor Cost

= Estimated Total

Direct Labor Hours x Estimated Direct

Labor Cost per Hour


Direct Labor Budget

Gail Mestas

Insert updated exhibit 4, direct labor budget, chapter 24, POA, 2005e


The Manufacturing Overhead Budget

… is a detailed plan of anticipated manufacturing costs,

other than direct materials and direct labor costs,

that must be incurred to meet budgeted production needs


The Manufacturing Overhead Budget (cont’d)

• Two purposes

1. Integrate the overhead cost budgets developed by managers of production and production-related departments

2. Group information for the calculation of manufacturing overhead rates for the forthcoming accounting period


The Manufacturing Overhead Budget (cont’d)

• Presentation of information is flexible– Grouping by activities is useful for

organizations using activity-based costing


Manufacturing Overhead Budget

Gail Mestas

Insert updated exhibit 5, manufacturing overhead budget, chapter 24, POA, 2005e


The Selling and Administrative Expense Budget

… is a detailed plan of operating expenses,

other than those related to production, that are needed to support sales

and overall operations in an accounting period

• Accountants use this budget to estimate cash payments for products or services used in nonproduction-related activities


Selling and Administrative Expense Budget

Gail Mestas

Insert exhibit 6, selling and admin. expense budget, chapter 24, POA, 2005e


The Cost of Goods Manufactured Budget

… is a detailed plan that summarizes the estimated costs of production in an

accounting period

• Sources of information– Direct materials, direct labor, and manufacturing

overhead budgets


Cost of Goods Manufactured Budget

Note that most companies anticipate some work in process at the beginning or end of a period covered by the budget

Gail Mestas

Insert updated exhibit 7, cost of goods manufactured budget, chapter 24, POA, 2005e. Insert so that exhibit fits between title bar and text box at bottom of page


Discussion

Q. What are the sources of information for preparing the cost of goods manufactured budget?

A. Direct materials budget

Direct labor budget

Manufacturing overhead budget


Financial Budgets

• Objective 4– Prepare a budgeted income statement, a

cash budget, and a budgeted balance sheet


Financial Budgets

… are projections of financial results for an accounting period

• Include– Budgeted income statement

– Capital expenditures budget

– Cash budget

– Budgeted balance sheet


The Budgeted Income Statement

… projects an organization’s net income in an accounting period based on revenues and expenses

estimated for that period


Budgeted Income Statement

Gail Mestas

Insert updated exhibit 8, budgeted income statement, chapter 24, POA, 2005e


The Capital Expenditures Budget

…. is a detailed plan outlining the anticipated amount and timing of

capital outlays for long-term assets in an accounting period


The Capital Expenditures Budget (cont’d)

• Managers rely on information in a capital expenditures budget when making decisions about such matters as– Buying equipment

– Building a new plant

– Purchasing and installing a materials handling system

– Acquiring another business


The Cash Budget

… is a projection of the cash an organization will receive

and the cash it will pay out in an accounting period

• Summarizes the cash flow prospects of all transactions considered in the master budget


The Cash Budget (cont’d)

• Information it provides enables managers to plan for– Short-term loans when the cash balance is

low

– Short-term investments when the cash balance is high


Gateway_User

Insert updated Figure 2, Common-size balance sheets presented graphically, chapter 18, POA, 2005e



• Excludes some planned noncash transactions– Depreciation expense

– Issuance and receipt of stock dividends

– Uncollectible accounts expense

– Gains and losses on sales of assets

• May also exclude– Deferred taxes

– Accrued interest



• To calculate the estimated ending cash balance

Estimated Ending

Cash Balance =

Total Estimated

Cash Receipts –

Total Estimated

Cash Payments +

Estimated Beginning

Cash Balance



• Sources for estimating cash receipts– Sales budget

– Budgeted income statement

– Cash budgets from previous periods

– Cash collection records and analyses of collection trends

– Records pertaining to notes, stocks, and bonds



• Sources for estimating cash payments– Operating budgets

– Budgeted income statement

– Capital expenditures budget

– Previous year’s financial statements

– Loan records



• Supporting schedules– Schedule of expected cash collections

from customers

– Schedule of expected cash payments for direct materials

– Cash budget


Schedule of Expected Cash Collections from Customers

Gail Mestas

Insert updated exhibit 9, schedule of expected cash collected from customers, chapter 24, POA, 2005e


Schedule of Expected Cash Payments for Direct Materials

Gail Mestas

Insert updated exhibit 10, schedule of expected cash payments for direct materials, chapter 24, POA, 2005e


Cash Budget

Gail Mestas

Insert updated exhibit 11, cash budget, chapter 24, POA, 2005e



• Organizations may maintain a minimum cash balance– To cover unusual expenditures

• If the ending cash balance on the cash budget– Falls below the minimum level required

• Short-term borrowing may be necessary

– Is significantly larger than the minimum level required

• May invest excess in short-term securities to generate additional income


The Budgeted Balance Sheet

… projects an organization’s financial position

at the end of an accounting period

• Uses all estimated data compiled in the course of preparing a master budget– Is the final step in that process


Budgeted Balance Sheet

Gail Mestas

Insert updated exhibit 12, budgeted balance sheet, chapter 24, POA, 2005e


Discussion

Q. How is the ending cash balance estimated?

A. Subtract total estimated cash payments from total estimated cash receipts, then, add the estimated beginning cash balance


Budget Implementation

• Objective 5– Describe management’s role in budget

implementation


Budget Implementation

• Budget committee– Oversees each stage in the master budget

preparation

– Decides any departmental disputes that might arise in the process

– Gives final approval to the budget


Budget Implementation (cont’d)

• Budget committee members– Controller

• Has overall responsibility for budget implementation

– President

– Vice presidents

The make-up of the committee ensures that the budgeting process has a companywide perspective



• A master budget may go through many revisions after approval– Budget committee monitors the progress

the company is making in attaining budget targets

• Using periodic reports from department managers



• Successful budget implementation depends on two factors

1. Clear communication

2. Support of top management– Middle- and lower-level managers must see

that top management supports the budget and encourages its implementation


Discussion

Q. What two factors are necessary for successful budget implementation?

A. Clear communication and support of top management


Time for Review

1. Define budgeting and explain its role in the management cycle

2. Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets

3. Prepare the operating budgets that support the financial budgets


And Finally…

4. Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet

5. Describe management’s role in budget implementation

The Budgeting Process Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University Chapter 21.

Documents

budgeting processobjective

budgeting process contdbudgets

financial budgets

operating budgets

longterm goals contdshould

unitsidentifies activities

financing activities

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