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CHAPTER 10: STATIC AND FLEXIBLE BUDGETS
Cost Management, Canadian Edition
© John Wiley & Sons, 2009Chapter 10: Static and Flexible Budgets
Cost Management, Cdn Ed, by Eldenburg et alSlide # 1
Learning Objectives
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 2
• Q1: What are the relationships among budgets, long-term strategies, and short-term operating plans?• Q2: What is a master budget and how is it prepared? How are operating budgets prepared?
• Q3: How is the cash budget developed?
• Q4: What are budget variances and how are they calculated?• Q5: What are the differences between static and flexible budgets?
• Q6: How are budgets used to monitor and motivate performance?
• Q7: What are other approaches to budgeting?
© John Wiley & Sons, 2009Chapter 10: Static and Flexible Budgets
Cost Management, Cdn Ed, by Eldenburg et alSlide 3
Q1: What are the relationships among budgets, long-term
strategies, and short-term operating plans?
Budgets, Strategies, & Operating Plans
• A budget is – A formalized financial plan.– A translation of an organization’s strategies.– A method of communicating.– A way to define areas of responsibility and
decision rights.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 4
• The budget cycle is the series of sequential steps followed to create and use budgets.
© John Wiley & Sons, 2009Chapter 10: Static and Flexible Budgets
Cost Management, Cdn Ed, by Eldenburg et alSlide 5
Q2: What is a master budget and how is it prepared? How are operating budgets
prepared?
Master Budgets
• A master budget is – A comprehensive plan for the upcoming
accounting period.– Usually prepared for a one-year period.– Is based on a series of budget assumptions.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 6
• The master budget consists of several subsidiary budgets, in two categories:– Operating budgets– Financial budgets
Operating Budgets
– Revenue budget– Production budget– Direct materials budget– Direct labour budget– Manufacturing overhead budget– Inventory and cost of goods sold budget– Support department budgets– Budgeted income statement
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 7
• The operating budget is created by preparing the following individual budgets, in this order:
Financial Budgets
– Capital budget– Long-term financing budget– Cash budget– Budgeted balance sheet– Budgeted statement of cash flows
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 8
• The financial budget is created by preparing the following individual budgets, in this order:
Revenue budget
Budgeted sales in units in April
Budgeted selling price per unit
Budgeted revenues
Revenue budget
Budgeted sales in units in April 6,000
Budgeted selling price per unit $68.00
Budgeted revenues $408,000
Operating Budget Example
Stanley J, Inc., makes a tool used by auto mechanics that sells for $68/unit. It expects to sell 6,000 units in April and 7,000 units in May. Stanley J prefers to end each period with a finished goods inventory equal to 10% of the next period’s sales in units and a direct materials inventory equal to 20% of the direct materials required for the next period’s production. The company never has any beginning or ending work-in-process inventories. There were 400 units in finished goods inventory on April 1. Prepare the revenue and production budgets for April.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 9
Production budget
Budgeted sales in units in April
Desired ending FG inventory
Total units required
Less: beginning FG inventory
Required production in units
Production budget
Budgeted sales in units in April 6,000
Desired ending FG inventory 700
Total units required 6,700
Less: beginning FG inventory -400
Required production in units 6,300
Direct materials budget
Required production in units
DM required per unit, in kilograms
Total DM required, in kilograms
Less: Beginning DM inventory
Plus: Desired ending DM inventory
Required DM purchases in kilograms
Budgeted DM cost per kilogram
Budgeted cost of DM
Direct materials budget
Required production in units 6,300
DM required per unit, in kilograms 0.3
Total DM required, in kilograms 1,890
Less: Beginning DM inventory -220
Plus: Desired ending DM inventory 390
Required DM purchases in kilograms 2,060
Budgeted DM cost per kilogram $4.00
Budgeted cost of DM $8,240
Operating Budget Example
Stanley J’s product uses 0.3 kg of direct material per unit, at a cost of $4/kg. There were 220 kg of direct material on hand on April 1. Assume that budgeted production for May is 6,500 units. Prepare the direct materials budget for April.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 10
Operating Budget Example
Stanley J’s product uses 0.2 hours of direct labour at a cost of $12/hr. Prepare the direct labour budget for April.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 11
Direct labour budget
Required production in units
DL required per unit, in hours
Total DL hours required
Budgeted cost per DL hour
Budgeted cost of DL
Direct labour budget
Required production in units 6,300
DL required per unit, in hours 0.2
Total DL hours required 1,260
Budgeted cost per DL hour $12.00
Budgeted cost of DL $15,120
Operating Budget Example
Stanley J’s budgeted fixed manufacturing overhead for April is $167,000, and variable manufacturing overhead is budgeted at $6 per direct labour hour. Prepare the manufacturing overhead budget for April.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 12
Manufacturing overhead budget
Total DL hours required
Budgeted variable overhead per DL hour
Total budgeted variable overhead
Budgeted fixed overhead
Total budgeted overhead
Manufacturing overhead budget
Total DL hours required 1,260
Budgeted variable overhead per DL hour $6.00
Total budgeted variable overhead $7,560
Budgeted fixed overhead $167,000
Total budgeted overhead $174,560
Ending inventories budgets
Budgeted cost of DM purchases
Beginning DM inventory
DM available for use
Budgeted cost of desired ending DM inventory:
Budgeted cost of DM to be used
Ending inventories budgets
Budgeted cost of DM purchases $8,240
Beginning DM inventory $854
DM available for use $9,094
Budgeted cost of desired ending DM inventory:
[6,500 units x 0.3 lbs/unit] x 20% x $4/ lb $1,560
Budgeted cost of DM to be used $7,534
Operating Budget Example
Assume that Stanley J’s April 1 direct materials inventory had a cost of $1,560. Prepare the April ending inventories budget for direct materials.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 13
Budgeted cost of DM to be used
Budgeted cost of DL
Total budgeted overhead
Total budgeted manufacturing costs
Required production in units
Budgeted manufacturing cost per unit
Budgeted ending FG inventory in units
Budgeted cost of ending FG inventory
Budgeted cost of DM to be used $7,534
Budgeted cost of DL $15,120
Total budgeted overhead $174,560
Total budgeted manufacturing costs $197,214
Required production in units 6,300
Budgeted manufacturing cost per unit $31.3037
Budgeted ending FG inventory in units 700Budgeted cost of ending FG inventory $21,913
Operating Budget Example
Prepare the April ending inventories budget for finished goods.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 14
Cost of goods sold budget
Beginning FG inventory
Total budgeted manufacturing costs
Cost of goods available for sale
Less: budgeted ending FG inventory
Budgeted cost of goods sold
Cost of goods sold budget
Beginning FG inventory $12,146
Total budgeted manufacturing costs $197,214
Cost of goods available for sale $209,359
Less: budgeted ending FG inventory $21,913
Budgeted cost of goods sold $187,447
Operating Budget Example
Assume that Stanley J’s April 1 finished goods inventory had a cost of $12,146. Prepare the cost of goods sold budget for April.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 15
Support department budget
Administration
Distribution: Fixed costs
Variable costs
Research & development
Marketing: Fixed costs
Variable costs
Total budgeted support department costs
Support department budget
Administration $22,000
Distribution: Fixed costs $34,000
Variable costs $4,500 $38,500
Research & development $18,000
Marketing: Fixed costs $13,000
Variable costs $16,320 $29,320
Total budgeted support department costs $107,820
Operating Budget Example
Stanley J’s budget for April includes $22,000 for administrative costs, $34,000 for fixed distribution costs, $18,000 for research and development, and $13,000 for fixed marketing costs. Additionally, the budgeted variable costs for distribution are $0.75/unit sold and the budgeted variable costs for marketing are 4% of sales revenue. Prepare the support department budget for April.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 16
Budgeted income statement
Sales revenue
Cost of goods sold
Gross margin
Operating costs:
Administration
Distribution
Research & development
Marketing
Net income before taxes
Income taxes
Net income
Budgeted income statement
Sales revenue $408,000
Cost of goods sold $187,447
Gross margin $220,553
Operating costs:
Administration $22,000
Distribution $38,500
Research & development $18,000
Marketing $29,320 $107,820
Net income before taxes $112,733
Income taxes $31,565
Net income $81,168
Operating Budget Example
Suppose that Stanley J’s income tax rate is 28%. Prepare the budgeted income statement for April.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 17
© John Wiley & Sons, 2009Chapter 10: Static and Flexible Budgets
Cost Management, Cdn Ed, by Eldenburg et alSlide 18
Q3: How is the cash budget developed?
Cash Budgets• Cash budgets are prepared after the
operating budgets.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 19
• The cash budgets include the following individual budgets:– Cash receipts budget– Cash disbursements budget– Short-term borrowings and investments
budget
Cash Budget ExampleBryce Manufacturing is preparing a cash budget for a new division that will begin operations on January 1, 2010. Bryce expects sales to be 40% cash and 60% on account, with 45% of credit sales are collected in the month of the sale. In the month after the sale, 50% of credit sales should be collected, with the remainder collected two months after the sale. Budgeted sales for the first three months are $100,000, $150,000 and $200,000. Prepare a cash receipts budget for the first three months of 2010.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 20
January February March
Cash sales
A/R collections:
From current month's sales
From 1 month ago
From 2 months ago
Total
January February March
Cash sales $40,000 $60,000 $80,000
A/R collections:
From current month's sales $27,000 $40,500 $54,000
From 1 month ago $0 $30,000 $45,000
From 2 months ago $0 $0 $3,000
Total $67,000 $130,500 $182,000
January February March
Direct labour costs
Payments on A/P:
From current month's purchases
From 1 month ago
From 2 months ago
Total
January February March
Direct labour costs $30,000 $45,000 $60,000
Payments on A/P:
From current month's purchases $8,000 $14,000 $18,000
From 1 month ago $0 $10,000 $17,500
From 2 months ago $0 $0 $2,000
Total $38,000 $69,000 $97,500
Cash Budget ExampleBryce Manufacturing budgets direct labour costs to be 30% of sales revenue and expects to pay this in the month the costs are incurred. Direct materials purchases will be on account, and paid as follows: 40% in the month of the purchase, 50% the following month, and 10% in the second month following the purchase. Budgeted direct material purchases for the first 3 months of 2010 are $20,000, $35,000 and $45,000. Compute the budgeted cash disbursements for direct materials and labour for the first 3 months of 2010.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 21
January February March
Direct labour and materials
Other variable costs
Other fixed costs
Total
January February March
Direct labour and materials $38,000 $69,000 $97,500
Other variable costs $4,000 $6,000
Other fixed costs $6,000 $6,000 $6,000
Total $44,000 $79,000 $109,500
Cash Budget ExampleBryce Manufacturing budgets other variable costs at 4% of sales revenue and will be paid in the month after the costs are incurred. Other budgeted fixed costs are $6,000 per month and will be paid in the month incurred. Prepare a cash disbursements budget for all costs, including direct materials and labour.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 22
Cash Budget ExampleUsing the information from the prior slides, prepare a schedule of budgeted cash flows for Bryce Manufacturing’s new division for the first three months of 2010.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 23
January February MarchBeginning cash balanceCash receiptsCash disbursementsEnding cash balance
January February MarchBeginning cash balance $0 $23,000 $74,500Cash receipts $67,000 $130,500 $182,000Cash disbursements ($44,000) ($79,000) ($109,500)Ending cash balance $23,000 $74,500 $147,000
© John Wiley & Sons, 2009Chapter 10: Static and Flexible Budgets
Cost Management, Cdn Ed, by Eldenburg et alSlide 24
Q4: What are budget variances and how are
they calculated?
Budget Variances• Managers compare actual results to
budgeted results in order to– Monitor operations, and – Motivate appropriate performance.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 25
• Differences between budgeted and actual results are called budget variances.– Variances are stated in absolute value
terms, and labeled as Favourable or Unfavourable.
Budget Variances
• Reasons for budget variances are investigated.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 26
• The investigation may find:– Inefficiencies in actual operations that
can be corrected.– Efficiencies in actual operations that can
be replicated in other areas of the organization.
– Uncontrollable outside factors that require changes to the budgeting process.
© John Wiley & Sons, 2009Chapter 10: Static and Flexible Budgets
Cost Management, Cdn Ed, by Eldenburg et alSlide 27
Q5: What are the differences between static
and flexible budgets?
Static Budgets• A budget prepared for a single level of sales
volume is called a static budget.
• Static budgets are prepared at the beginning of the year.
• Differences between actual results and the static budget are called static budget variances.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 28
Flexible Budgets• A budget prepared for a multiple levels of
sales volume is called a flexible budget.
• Flexible budgets are prepared at the beginning of the year for planning purposes and at the end of the year for performance evaluation.
• Differences between actual results and the flexible budget are called flexible budget variances.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 29
Flexible Budget ExampleTina’s Trinkets is preparing a budget for 2010. The budgeted selling price per unit is $10, and total fixed costs for 2010 are estimated to be $5,000. Variable costs are budgeted at $3/unit. Prepare a flexible budget for the volume levels 1,000, 1,100, and 1,200 units.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 30
Sales in units 1,000 1,100 1,200
Revenues
Variable costs
Contribution margin
Fixed costs
Operating income
Volume Levels
Sales in units 1,000 1,100 1,200
Revenues $10,000 $11,000 $12,000
Variable costs $3,000 $3,300 $3,600
Contribution margin $7,000 $7,700 $8,400
Fixed costs $5,000 $5,000 $5,000
Operating income $2,000 $2,700 $3,400
Volume Levels
Static Budget Variances Example
Suppose that Tina’s 2010 static budget was for 1,100 units of sales. The actual results are given below. Compute the static budget variances for each row and discuss.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 31
Static Budget
Actual Results
Static Budget
Variance
Sales in units 1,100 980
Revenues $11,000 $9,604
Variable costs $3,300 $2,989
Contribution margin $7,700 $6,615
Fixed costs $5,000 $4,520
Operating income $2,700 $2,095
Static Budget
Actual Results
Static Budget
Variance
Sales in units 1,100 980
Revenues $11,000 $9,604 $1,396 Unfavourable
Variable costs $3,300 $2,989 $311 Favourable
Contribution margin $7,700 $6,615 $1,085 Unfavourable
Fixed costs $5,000 $4,520 $480 Favourable
Operating income $2,700 $2,095 $605 Unfavourable
Flexible Budget Variances Example
Compute the flexible budget variances for Tina and discuss the results. Compare the flexible budget variances to the static budget variances on the prior page.
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 32
Year-end Flexible Budget
Actual Results
Flexible Budget
Variance
Sales in units 980
Revenues $9,604
Variable costs $2,989
Contribution margin $6,615
Fixed costs $4,520
Operating income $2,095
Year-end Flexible Budget
Actual Results
Flexible Budget
Variance
Sales in units 980 980
Revenues $9,800 $9,604 $196 Unfavourable
Variable costs $2,940 $2,989 $49 Unfavourable
Contribution margin $6,860 $6,615 $245 Unfavourable
Fixed costs $5,000 $4,520 $480 Favourable
Operating income $1,860 $2,095 $235 Unfavourable
© John Wiley & Sons, 2009Chapter 10: Static and Flexible Budgets
Cost Management, Cdn Ed, by Eldenburg et alSlide 33
Q6: How are budgets used to monitor and motivate
performance?
Performance Evaluation• A static budget variance includes effects from
output volume.• A flexible budget variance removes these output
volume effects.• Other adjustments to the year-end flexible
budget may be made for a fair performance evaluation, such as– Input price changes outside the control of the
manager under evaluation– Fixed cost increases outside the control of the
manager under evaluation– Note that it is important that managers have
control over amounts they are held accountable for© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 34
Performance Evaluation• Participative Budgeting– Occurs when managers are responsible for
setting their own budgets which creates “buy-in” in the budgeting process
– Must be careful that budgets are not set unrealistically low as this would offer little motivation to perform well
• Zero-based budgeting– Does not rely on adjusting prior years’
budgets– Managers must be able to justify all budget
amounts– This encourages cost cutting, however is
time-consuming© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 35
© John Wiley & Sons, 2009Chapter 10: Static and Flexible Budgets
Cost Management, Cdn Ed, by Eldenburg et alSlide 36
Q7: What are other approaches to budgeting?
Other Budgeting Approaches
• Rolling budgets are prepared frequently for overlapping time periods and actual results may be used to update the budget for the next period.
• Activity based budgets use more cost pools and cost drivers.
• Kaizen budgets plan cost reductions over time.• Extreme programming can be used to budget
long-term projects that contain a large amount of uncertainty.– Often used for information technology projects– Projects begin with little up-front planning
© John Wiley & Sons, 2009
Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al
Slide # 37
Copyright
Copyright © 2009 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.
© John Wiley & Sons, 2009
Slide 38Chapter 10: Static and Flexible Budgets
Cost Management, Cdn Ed, by Eldenburg et al