Instructions
The Budget Case
This case is designed to evaluate the budget process at a large manufacturing company.
The learning objectives of this case study are as follows:
1. Use the budget to make decisions.
2. Identify how budgeting is used by leadership for planning and control.
3. Discuss ethical considerations in the budget process.
You have just been hired at ABC Manufacturing, and your supervisor has invited you to sit in on
today's budget meeting. You are given a copy of the following proposed budget for next year to
review. The budget is being used by ABC to plan for next year. Your supervisor tells you right
before the meeting, "We always overestimate because the president always makes us cut the
budget by 20%, and besides, I really want to go to that conference in Las Vegas next year.” He
continued,” I have really worked hard this year and put in a lot of overtime so I deserve it."
Prepare a two-page written report by addressing the following tasks:
1. Discuss if you think ABC Manufacturing is properly using the budget process to
plan for next year's expenses.
2. Discuss the comment about the president cutting the budget each year in terms of
proper leadership and control?
3. Discuss the ethical issues related to inflating the budget.
Adhere to APA Style 7th Edition when constructing this assignment, including in-text citations
and references for all sources that are used. Please note that no abstract is needed.
UNIT VI STUDY GUIDE
Capital Budgeting and
Budgetary Planning and Control
Course Learning Outcomes for Unit VI
Upon completion of this unit, students should be able to:
2. Apply accounting concepts and standards to the creation of accounting information and reports.
2.1 Create budgets to make business decisions.
4. Discuss how the application of accounting knowledge is used in a leadership role.
4.1 Identify how budgeting is used by leadership for planning and control.
6. Apply ethical behavior to accounting-related situations.
6.1 Discuss ethical considerations in the budget process.
Course/Unit
Learning Outcomes
2.1
4.1
6.1
Learning Activity
Unit Lesson
Chapter 9
Chapter 10
Unit VI Lab Assignment
Unit VI Case Study
Unit Lesson
Chapter 9
Chapter 10
Unit VI Lab Assignment
Unit VI Case Study
Unit Lesson
Chapter 9
Chapter 10
Unit VI Case Study
Required Unit Resources
Chapter 9: Capital Budgeting and Other Long-Run Decisions
Chapter 10: Budgetary Planning and Control
Unit Lesson
Introduction
Welcome to Unit VI. We will be discussing budgeting in this unit. Budgeting is used by organizations to not
only plan for future expenses but to also control costs. We will be talking about capital or long-term budgets
and operating budgets by looking at how various techniques are used to make business decisions.
Capital Budgeting
When we think about capital budgets, we look at long-term acquisitions or projects such as investing in all
new manufacturing equipment or building a new wing to a hospital. Since these projects typically come with a
very high cost, the organizations needs to decide which projects to consider for adoption and funding. All
organizations have limited resources, so managers need to carefully evaluate each proposed project for
funding consideration. If a project proposal meets the company's initial criteria, it will move to the next level for
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review for possible adoption. If, however, it does not meet the criteria, the project
proposal
willGUIDE
be rejected. To
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assist with determining if a project meets the company's initial criteria, there are
a number of tools that can be
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used to evaluate these types of decisions related to long-term investments. Keep in mind, these long-term
investments are intended to have an impact on multiple years. Since multiple years are involved, we need to
look at how these decisions will affect things like taxes, depreciation, and cash flows in the long term, and we
also need to take into account the time value of money.
The concept of time value of money is basically that a dollar today is not worth that same dollar in the future.
In other words, you may have heard, "When I was young, you could buy a loaf of bread for 79 cents; now it
costs over $3," meaning that over time, prices have increased. What you could buy for a dollar 50 years ago
does not buy the same amount today. This, however, works the same way on your savings or investments.
Let's say you put $100 in your savings account when you were five-years-old and just left it there. Now, at
age 25, you want to withdraw the money. In your savings account, there is a lot more than the $100 you put
into your account due to the interest gained on your account.
Capital budget techniques: The first method we are going to look at to evaluate capital budget projects is
the net present value method. This method looks at time value of money and also relevant cash in and out
flows associated with taking on a new project. For example, going back to our prior example of a computer
manufacturer, let's say the company is thinking about purchasing a new piece of equipment that will
manufacture computers faster. The cost of the equipment is $700,000 and is expected to last five years with a
residual value of $3,000. The new equipment will save the company $200,000 in labor costs each year and
$10,000 in scrap waste costs since it will be more efficient. However, there is an additional maintenance cost
of $12,000 associated with the new machine. In order to make this purchase an option, the company would
like a 12% return on its investment (Jiambalvo, 2019).
Using this technique, let's see if the investment would be considered for possible funding. As you can see
from the example below, if the net present value (NPV) is positive, the purchase of the equipment should be
considered.
The next method we will look at is internal rate of return (IRR). This method is similar in that it also uses the
time value of money in its calculations. However, in this method you are trying to make the NPV equal to zero.
For example, our computer manufacturing company wants to look at a piece of equipment that costs
$100,000 and will have a $60,000 annuity amount yield at the end of each of two years. Our first step is to
solve for the present value factor by dividing the $100,000 and $60,000 to equal 1.6667. Looking up this
factor in the annuity tables, we find a rate of 13% (Jiambalvo, 2019).
The third method we will look at is payback period. This method ignores the time value of money concept and
only looks at the time (amount of years) it takes to pay back the initial investment. Going back to our original
example, if we want to purchase equipment for $700,000 and the estimated cash flows are $198,000 per year
it will take about 3.5 years to payback this initial investment. This is calculated by dividing $700,000 and
$198,000.
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Other considerations: We have looked at a number of calculations that are used
managers
to determine
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if a large capital investment is worth the cost. However, managers must also take
Titleinto consideration nonnumeric aspects when making decisions to purchase large items. For example, some questions asked when
we are talking about new equipment would be, does the company have the personnel in place with the
knowledge to run the new equipment? What will happen to the employees that currently run the old
equipment? What is the impact on the company's reputation? These are just a few considerations the
company may want to consider in addition to the numeric calculations.
Budgetary Control and Planning
Budgets have two main purposes, planning and control. From a planning aspect, budgets are used to
communicate the goals and objectives of the company. A budget provides a way for managers to set the
direction of the company and coordinate activities (Jiambalvo, 2019). For example, one of the objectives of
the company may be to increase sales. The sales department will include an increase in sales in their budget
in order to accomplish this objective. In order to support the increase in sales, the marketing and production
departments will also need to increase their budgets to coordinate their activities to support the increase in
sales.
From a control standpoint, a budget can be used to evaluate performance by comparing the budgeted
numbers to the actual numbers. Then, any variance between budgeted and actual number can be
investigated. One important aspect of budgetary control is to ensure responsibility for budget items is set
appropriately. For instance, it would be appropriate for the production manager to be responsible for the
variance in the wages of production employees. On the other hand, it would not be appropriate for the
production manager to be responsible for the variance in rent on the entire factory.
Developing the budget: Budgets are typically prepared for departments or divisions, and then these budgets
are compiled into a company-wide budget. The oversight of this process is usually handled by a budget
committee. This committee works with all of the departments or divisions to make sure their individual
budgets are consistent with the overall goals and objectives of the company.
As part of the budget process, a time line needs to be set. A typical operating budget is set for one year. This
allows managers to evaluate the company's performance and make any adjustments to operations within the
short-run. However, a more long-term budget may be set, such as three to five years for capital budget
projects. This allows managers, again, to evaluate company performance but in the long-run to ensure the
company is meeting its overall goals and objectives.
The diagram below shows how the budgets within a company are interrelated. As you can see, the starting
point is the sales budget and the other budgets are designed to support the sales budget. For example,
production, selling, administrative, and capital budgets are all related to sales. In other words, if sales are
expected to increase, production would need to increase proportionately to meet the sales increase. In
addition, if sales increases selling, administrative expense would also increase in terms of additional
advertising costs and increase in personnel to ensure the sales budget is met. The same is true for a
decrease in sales. As sales decrease, production would decrease and so would the need for personnel.
Capital acquisition budgets relate the purchase of new equipment that would also support the increase in
sales.
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Control: Once the budgets are set, they need to be monitored to ensure costs are controlled. This is done by
reviewing budget variances. Variances are the differences between budgeted and actual numbers. These
variances or differences help managers to focus in on items that need their attention. Looking at the example
below, we can see that wages has the highest variance. The actual wages were over $600 from what was
budgeted. The manager would need to investigate this variance to see what corrections cold be made to bring
the wages closer to the budgeted amount on the next performance review.
Keep in mind, conditions beyond management's control may be the reason for some of the variances. For
example, equipment may have broken down, which could be causing this variance in wages as well as the
variance in sales. On the other hand, training and education was under budget. This variance shows that no
money was spent in this category even though it was budgeted. This category would be directly under the
control of the manager who would need to provide a reason for the variance. Note that all large variances are
typically investigated regardless if they are over or under budget.
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Ethics in budgeting: As we have learned, budgets are designed to assist managers in planning to meet the
goals and objectives of the company as well as control costs. However, as part of the process, managers may
need to be reminded to accurately budget for expenses. In other words, some managers may want to "pad"
the budget or ask for additional funds for their department or division in order to meet personal performance
goals. In other words, a manager may budget far more than is needed in a certain category so that when the
budget is reviewed at the end of the month, it appears the manager has exceeded expectations, but in reality,
the budget was set too high in the first place. For example, maybe the manger budgeted $1,000 for wages
this month, when in reality, the department has never spent more than $800 in wages. This would look like
the manager saved the company $200, and his or her performance would look outstanding. However, if the
budget was set more accurately at $800, the variance would have been $0, which is more accurate based on
past history.
Conclusion
In this unit, we have looked at both capital and operational budgeting. Budgeting is the key to planning for the
future of the company as well as controlling costs. Capital budgeted is related more to long-term budgeting
and takes into account a number of tools used to evaluate capital budget projects. When looking at capital
budgeting, you need to take into account the time value of money. On the other hand, operational budgets are
related more towards the short-run.
As far as control in budgeting, we looked at the idea of evaluating variances to see how improvements can be
made and at the ethical issues that related preparing budgets.
Reference
Jiambalvo, J. (2019). Managerial accounting (6th ed.). Hoboken, NJ: Wiley.
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Suggested Unit Resources
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View the following videos by accessing the Unit VI Additional Unit Resources folder in the unit.
The video Holland America: Capital Budgeting will discuss the steps in the capital budgeting process.
You can access a transcript for this video by hovering over the PDF button at the bottom of the video and
then clicking on the word “Transcript.” Alternatively, you can click on the “cc” button at the bottom of the video
to turn on closed captions.
The video Tribeca Grand: Budgetary Control and Responsibility Accounting will discuss how to develop a
budget.
You can access a transcript for this video by hovering over the PDF button at the bottom of the video and
then clicking on the word “Transcript.” Alternatively, you can click on the “cc” button at the bottom of the video
to turn on closed captions.
Learning Activities (Nongraded)
Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit
them. If you have questions, contact your instructor for further guidance and information.
After watching both videos in the Suggested Unit Resources, you may want to answer the 11 Unit VI
Questions found in the Additional Unit Resources folder to reinforce the material presented in this unit. Note
that the "View the Video" links referenced in each question are the same two videos linked in Suggested Unit
Resources.
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