Chapter 8 Budgeting Nature and Objectives of Budgeting • Budgets play an important role for organizations of all sizes and forms. o • For example, budgets are used in managing the operations of government agencies, churches, hospitals, and other nonprofit organizations. This chapter describes and illustrates budgeting for a manufacturing company. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Objectives of Budgeting (slide 1 of 2) © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Objectives of Budgeting (slide 2 of 2) • Budgeting affects the following managerial functions: o Planning ▪ Planning involves setting goals to guide decisions and help motivate employees. o Directing ▪ Directing involves decisions and actions to achieve budgeted goals. – A budgetary unit of a company is called a responsibility center. ▪ Each responsibility center is led by a manager who has the authority and responsibility for achieving the center’s budgeted goals. o Controlling ▪ Controlling involves comparing actual performance against the budgeted goals. – Such comparisons provide feedback to managers and employees about their performance. ▪ If necessary, responsibility centers can use such feedback to adjust their activities in the future. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Human Behavior and Budgeting • Human behavior problems can arise in the budgeting process in the following situations: o Budgeted goals are set too tight, which are very hard or impossible to achieve. o Budgeted goals are set too loose, which are very easy to achieve. o Budgeted goals conflict with the objectives of the company and employees. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Human Behavior and Budgeting: Setting Budget Goals Too Tightly • If budgeted goals are viewed as unrealistic or unachievable, the budget may have a negative effect on the ability of the company to achieve its goals. • Attainable goals are more likely to motivate employees and managers. o For this reason, it is important for employees and managers to be involved in the budgeting process. ▪ Involving employees in the budgeting process provides them with a sense of control and, thus, more of a commitment in meeting budgeted goals. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Human Behavior and Budgeting: Setting Budget Goals Too Loosely • Although it is desirable to establish attainable goals, it is undesirable to plan budget goals that are too easy. o Such budget “padding” is called budgetary slack. ▪ Managers may plan slack in their budgets to provide a “cushion” for unexpected events. – However, slack budgets may create inefficiency by reducing the budgetary incentive to trim spending. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Human Behavior and Budgeting: Setting Conflicting Budget Goals © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeting Systems (slide 1 of 4) • The budgetary period for operating activities normally includes the fiscal year of a company. • For control purposes, annual budgets are usually subdivided into shorter time periods, such as quarters of the year, months, or weeks. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeting Systems (slide 2 of 4) • A variation of fiscal-year budgeting, called continuous budgeting, maintains a 12month projection into the future. • The 12-month budget is continually revised by replacing the data for the month just ended with the budget data for the same month in the next year. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Continuous Budgeting © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeting Systems (slide 3 of 4) • Developing an annual budget usually begins several months prior to the end of the current year. • The responsibility of developing an annual budget is normally assigned to a budget committee. o • Such a committee often consists of the budget director, the controller, the treasurer, the production manager, and the sales manager. The budget process is monitored and summarized by the Accounting Department, which reports to the committee. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeting Systems (slide 4 of 4) • There are several methods of developing budget estimates. o One method, called zero-based budgeting, requires managers to estimate sales, production, and other operating data as though operations are being started for the first time. o A more common approach is to start with last year’s budget and revise it for actual results and expected changes for the coming year. ▪ Two major budgets using this approach are the static budget and the flexible budget. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Static Budget (slide 1 of 2) • A static budget shows the expected results of a responsibility center for only one activity level. Once the budget has been determined, it is not changed, even if the activity changes. • Static budgeting is used by many service companies, government entities, and for some functions of manufacturing companies, such as purchasing, engineering, and accounting. • A disadvantage of static budgets is that they do not adjust for changes in activity levels. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Flexible Budget (slide 1 of 3) • Flexible budgets show the expected results of a responsibility center for several activity levels. o A flexible budget is, in effect, a series of static budgets for different levels of activity. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Flexible Budget (slide 2 of 3) • A flexible budget is constructed as follows: o Step 1: Identify the relevant activity levels. ▪ The relevant levels of activity could be expressed in units, machine hours, direct labor hours, or some other activity base. o Step 2: Identify the fixed and variable cost components of the costs being budgeted. o Step 3: Prepare the budget for each activity level by multiplying the variable cost per unit by the activity level and then adding the monthly fixed cost. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Flexible Budget (slide 3 of 3) • Because the flexible budget adjusts for changes in the level of activity, it is much more accurate and useful than the static budget. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Master Budget © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Master Budget for a Manufacturing Company © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Operating Budgets © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sales Budget • The sales budget begins by estimating the quantity of sales. o The prior year’s sales are often used as a starting point. • These sales quantities are then revised for such factors as: o o o Planned advertising and promotions Projected pricing changes Expected industry and general economic conditions • Once sales quantities are estimated, the budgeted sales revenue can be determined as follows: Budgeted revenue = Expected sales volume  Expected unit sales price © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Production Budget • The production budget estimates the number of units to be manufactured to meet budgeted sales and desired inventory levels. • The budgeted units to be produced are determined as follows: Expected units to be sold XXX units Desired units in ending inventory XXX Estimated units in beginning inventory (XXX) Total units to be produced XXX units © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Direct Materials Purchases Budget (slide 1 of 2) • The direct materials purchases budget estimates the quantities of direct materials to be purchased to support budgeted production and desired inventory levels. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Direct Materials Purchases Budget (slide 2 of 2) • The direct materials purchases budget can be developed in three steps: o Step 1: Determine the budgeted direct material required for production, which is computed as follows: Budgeted direct material = Budgeted production volume × Direct material quantity required for production expected per unit o Step 2: The budgeted material required for production is adjusted for beginning and ending inventories to determine the direct materials to be purchased for each material, as follows: Materials required for production (Step 1) XXX Desired ending materials inventory XXX Estimated beginning materials inventory (XXX) Direct material quantity to be purchased o XXX Step 3: The budgeted direct materials to be purchased is computed as follows: Budgeted direct material = Direct material quantity to be purchased × Unit price to be purchased © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Direct Labor Cost Budget (slide 1 of 2) • The direct labor cost budget estimates the direct labor hours and related cost needed to support budgeted production. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Direct Labor Cost Budget (slide 2 of 2) • The direct labor cost budget for each department is determined in two steps, as follows: o Step 1: Determine the budgeted direct labor hours required for production, which is computed as follows: Budgeted labor hours = Budgeted production volume × Direct material quantity required for production expected per unit o Step 2: Determine the total direct labor cost as follows: Direct labor cost = Direct labor required for production (step 1) × Hourly rate © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Factory Overhead Cost Budget • The factory overhead cost budget estimates the cost for each item of factory overhead needed to support budgeted production. • The factory overhead cost budget may be supported by departmental schedules. o Such schedules normally separate factory overhead costs into fixed and variable costs to better enable department managers to monitor and evaluate costs during the year. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Cost of Goods Sold Budget © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Selling and Administrative Expenses Budget • The sales budget is often used as the starting point for the selling and administrative expenses budget. • The selling and administrative expenses budget is normally supported by departmental schedules. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeted Income Statement (slide 1 of 3) © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeted Income Statement (slide 2 of 3) • This budget summarizes the budgeted operating activities of the company. o In doing so, the budgeted income statement allows management to assess the effects of estimated sales, costs, and expenses on profits for the year. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Financial Budgets © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Cash Budgets • The cash budget estimates the expected receipts (inflows) and payments (outflows) of cash for a period of time. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Estimated Cash Receipts • The primary source of estimated cash receipts is from cash sales and collections on account. • In addition, cash receipts may be obtained from plans to issue equity or debt financing as well as other sources such as interest revenue. • To estimate cash receipts from cash sales and collections on account, a schedule of collections from sales is prepared. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Estimated Cash Payments • Estimated cash payments must be budgeted for operating costs and expenses such as manufacturing costs, selling expenses, and administrative expenses. • In addition, estimated cash payments may be planned for capital expenditures, dividends, interest payments, or long-term debt payments. • To estimate cash payments for manufacturing costs, a schedule of payments for manufacturing costs is prepared. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Completing the Cash Budget (slide 1 of 2) • The cash budget is structured for a budget period as follows: © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Capital Expenditures Budget • • The capital expenditures budget summarizes plans for acquiring fixed assets. o Such expenditures are necessary as machinery and other fixed assets wear out or become obsolete. o In addition, purchasing additional fixed assets may be necessary to meet increasing demand for the company’s product. Capital expenditures budgets are often prepared for five to ten years into the future. o This is necessary because fixed assets often must be ordered years in advance. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Budgeted Balance Sheet © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Many researchers praise the benefits of participative budgeting. Is it wise to involve multiple parties at multiple levels in the organization in the budget preparation process? Why or why not? 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