Managerial Accounting, Chapter 7 by Crosson, Needles

Chapter 7

The Budgeting Process

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The Budgeting Process

• Objective 1– Define budgeting and explain management’s

role in the budgeting process.


Budgeting

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

goals and intermediate objectives

Process of identifying, gathering, summarizing, and communicating financial

and nonfinancial information about an organization's future activities


Budget

• Synonymous with managing an organization• Essential to accomplishing goals in the strategic

plan• Used to communicate information and evaluate

performance• Aids in coordination of activities and resource

usage • Motivates employees• Helps manage and account for cash

Plan of action based on forecasted transactions, activities, and events


Forms of the 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

Cash Budget Production Budget

• Focuses on nonfinancial information

• Shows planned production in units

• Identifies activities needed to meet certain requirements or standards


Budgeting and Goals

Process by which management establishes an organization’s long-term goals

Strategic planning


Long-Term Goals

Basis for: – Making annual operating plans– Preparing budgets

Define the strategic direction an organization will take over a five- to ten-year period


Long-Term Goals (cont’d)

• 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

When setting long-term goals, the following items should be taken into consideration:


• Must set specific targets and timetables

• Must assign responsibility for achieving the goals to specific personnel

• Should include a range of long-term goals in the organization's strategic plan• Should give direction to efforts to achieve

these goals

Long-Term Goals (cont’d)


Short-Term Goals

• 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

• Involve every part of an enterprise


Short-Term Goals (cont’d)

• 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

Organization’s controller takes charge of coordinating the budgeting process


The Importance of Participation

• Process in which personnel at all levels of an organization actively engage in making decisions about the budget

• Provides a sense of ownership• Helps ensure that departments will attain

targets and stay within the budget

Key to a successful budget


Participative Budgeting

• Controller must be able to communicate and negotiate effectively with people in all levels of an organization– Senior executives

• Formulate organizational long-and short-term goals

– Middle managers– Supervisors

• Responsible for daily operations

Relies on joint decision making


Authoritative Budgeting

• Senior executives allow controller to develop budget without consulting other managers– Managers may feel budgeting is not a top priority

• 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


Budget Implementation

– Oversees each stage in the preparation of the overall budget

– Mediates any departmental disputes that might arise in the process

– Gives final approval to the budget

• Budget committee

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

perspective.


Budget Implementation (cont’d)

– Controller• Has overall responsibility for budget

implementation

– President– Vice presidents

• Budget committee members


• Successful budgets depend on two factors1. Clear communication2. Support of top management

– Middle- and lower-level managers must see that top management supports the budget and encourages its implementation

• A 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

Budget Implementation (cont’d)


Planning

• Helps managers relate the organization’s long-term goals to its short-term activities

• Distributes resources and workloads

• Communicates responsibilities

• Selects performance measures

• Sets goals for bonuses and rewards


Performing

• Communicate expectations• Measure performance and motivate employees• Coordinate activities and allot resources

Budgeting helps managers:


Evaluating

• Evaluate performance• Determine timeliness• Find variances and create solutions• Compare planned performance with actual

performance



Communicating

• Communicate budget information• Provide continuous feedback• Support operating decisions



Stop & Review

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

A. Clear communication and support of top management


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

Stop & Review

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

• 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


The Master Budget (cont’d)

• Financial budgets– Projections of financial results for the accounting

period

– Include:• Budgeted income statement

• Capital expenditures budget

• Cash budget

• Budgeted balance sheet

• Operating budgets– Plans used in daily operations

– Basis for financial budgets


• 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

• No standard format for budget preparation



• 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 in deriving quantitative information

6. Revise the budget until it includes all planning decisions



Preparation of a Master Budget for a Manufacturing Organization


Preparation of a Master Budget for a Retail Organization


Preparation of a Master Budget for a Service Organization


Sales Budget

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

• Prepared first

• Used to estimate sales volume and revenue

• 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


Stop & Review

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 part of the master budget

A set of budgets that are used in planning the daily operations of an organization


Operating Budgets

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

– One comprehensive budget for each product or service

• Procedures for preparing operating budgets include:– Cost behavior analysis

– Cost-volume-profit analysis

– A product costing method


Sales Budget

Detailed plan, expressed in both units and dollars, that identifies the product (or service)

sales expected during an accounting period


Sales Budget (cont’d)

Accountants use budgets 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

Sales managers use budgets to:– Plan sales- and

marketing-related activities

– Determine human, physical, and technical resource needs


• 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

Selecting the best estimates for selling price per unit and the sales demand in units can be difficult



– 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

• Estimated sales volume is very important



• 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



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

Internal factors include:



The Production Budget

Production managers use this information to plan for the materials and human resources that production

activities will require

A detailed plan showing the number of units a company must produce to meet

budgeted sales and inventory levels


What Information Is Needed to Prepare a Production Budget?• 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


• 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

What Information Is Needed to Prepare a Production Budget?


Production Budget


The Direct Materials Purchases Budget

A detailed plan that identifies the quantity of purchases required to meet budgeted

production and inventory needs and the costs associated with those purchases

Purchasing Department

Uses information to plan purchases of direct materials

Accountants

Use information to estimate cash payments to suppliers


What Information Is Needed to Prepare a Purchases Budget?

• Production needs 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.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

3. Calculate the cost of the direct materials purchases.


Direct Materials Purchases Budget


The Direct Labor Budget

A detailed plan that estimates the direct labor hours needed during an accounting period

and the associated costs

Production Managers

Use information to plan how many

employees will be needed during the

period and how many hours they will work

Accountants

Use information to plan cash payments to

workers


The Direct Labor Budget (cont’d)

Human Resource Managers

Use information to:•Decide whether to hire new employees•Reduce the existing work force•Train employees•Prepare schedules of employee fringe benefits


Steps in Preparing a Direct Labor Budget1. 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 Costs

= Estimated Total

Direct Labor Hours x

Estimated Direct Labor Cost per Hour


Direct Labor Budget


The Overhead Budget

A detailed plan of anticipated manufacturing costs, other than direct materials and direct labor costs, that must be incurred to

meet budgeted production needs

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

organizations using activity-based costing


Purposes of the Overhead Budget

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

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


Overhead Budget


The Selling and Administrative Expense Budget

• Accountants use this budget to estimate cash payments for products or services not used in production-related activities

A detailed plan of operating expenses, other than those related to production, that are needed to support sales and overall

operations during an accounting period


Selling and Administrative Expense Budget


The Cost of Goods Manufactured Budget

Sources of informationDirect materials, direct labor, and overhead budgets

A detailed plan that summarizes the estimated costs of production during an

accounting period


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


Stop & Review

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

A. Direct materials budget, direct labor budget, overhead budget


Financial Budgets

• Objective 4– Prepare a budgeted income statement, a cash

budget, and a budgeted balance sheet.


Financial Budgets

• Include– Budgeted income statement– Capital expenditures budget– Cash budget– Budgeted balance sheet

Projections of financial results for the accounting period


The Budgeted Income Statement

Projects an organization’s net income for an accounting period based on the revenues and

expenses estimated for that period


Budgeted Income Statement


The Capital Expenditures Budget

A detailed plan outlining the anticipated amount and timing of capital outlays for long-term assets

during an accounting period

• 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

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

• Enables managers to plan for short-term loans when the cash balance is low or short-term investments when the cash balance is high

A projection of the cash an organization will receive and the cash it will pay out

during an accounting period


Elements of a Cash Budget


Cash Budget Exclusions

• Excludes some planned noncash transactions– Depreciation and amortization expense

– Issuance and receipt of stock dividends

– Uncollectible accounts expense

– Gains and losses on sales of assets

• May also exclude– Deferred taxes

– Accrued interest


Estimating Ending Cash Balance

• To calculate the estimated ending cash balance

Estimated Ending

Cash Balance =

Total Estimated

Cash Receipts –

Total Estimated

Cash Payments +

Estimated Beginning

Cash Balance


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 receipts:


Estimating Cash Payments

• Operating budgets• Budgeted income statement• Capital expenditures budget• Previous year’s financial statements• Loan records

Sources for estimating cash payments:


The Cash Budget (cont’d)

• Supporting schedules– Schedule of expected cash collections

from customers– Schedule of expected cash payments for

direct materials


Schedule of Expected Cash Collections from Customers


Schedule of Expected Cash Payments for Direct Materials


The Cash Budget


The Cash Budget (cont’d)

• 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

• If the ending cash balance on the cash budget is significantly above the minimum level required, the company may invest excess cash in short-term securities to generate additional income


The Budgeted Balance Sheet

• Uses all estimated data compiled in the course of preparing a master budget

• Is the final step in that process

Projects an organization’s financial position at the end of an accounting period


Budgeted Balance Sheet


Budgeted Balance Sheet (cont’d)


Stop & Review

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.


Chapter Review

1. Define budgeting and explain management’s role in the budgeting process.

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.


Chapter Review (cont’d)

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

Managerial Accounting, Chapter 7 by Crosson, Needles

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Transcript of Managerial Accounting, Chapter 7 by Crosson, Needles