1 Copyright © 2008 Cengage Learning South-Western. Mowen/Hansen Profit Planning Chapter Seven Fundamental Cornerstones of Managerial Accounting

2 Define budgeting and discuss its role in planning, control, and decision making. Objective # 1

3 Planning as it Relates to Budgeting Looking ahead to see what actions should be taken to realize particular goals Planning — Planning and control are tied together

4 Controlling as it Relates to Budgeting Looking backward determining what actually happened and comparing it with the previously planned outcomes Control – Planning and control are tied together

5 Budgets Before a budget is prepared, a strategic plan should be developed. A key component of planning Financial plans for the future Identify the objectives and the actions needed to achieve them

6 Strategic Plan Identifies strategies for future activities and operations. This can be translated into long- and short-term objectives. Objectives form the basis of the budget.

7 Advantages of Budgeting 1.Forces managers to plan 2.Provides information that can be used to improve decision making 3.Provides a standard for performance evaluation 4.Improves communication and coordination

8 Master Budget Comprehensive financial plan for the organization as a whole Can be broken down into quarterly and monthly budgets

9 Continuous Budget A moving 12-month budget. January 2007 February 2007 December 2007 January 2008 …………….

10 Budget Committee Reviews the budget Provides policy guidelines and budgetary goals Resolves differences that arise as the budget is prepared Approves the final budget Monitors the actual performance of the organization as the year unfolds

11 Budget Director Responsible for directing and coordinating the organization’s overall budgeting process Usually the controller

12 Major Components of the Master Budget Operational budgets ◦Describe the income-generating activities of a firm Financial budgets ◦Detail the inflows and outflows of cash and the overall financial position Master budget can be divided into……

13 Define and prepare the operating budget, identify its major components, and explain the interrelationships of it various components. Objective # 2

14 Sales Budget Projection approved by the budget committee that describes expected sales in units and dollars It is the basis for all of the other operating and most of the financial budgets

15 Sales Budget Preparation Steps 1.Develop a sales forecast Usually the responsibility of the marketing department Bottom-up approach ◦Salespeople submit sales projections 2. Forecast is reviewed by the budget committee 3. Budget Committee recommends changes prior to approval

16 Unit selling price 1,000 Quarter Sales Budget Units 1Year 5,700 x $10 Budgeted sales Texas Rex, Inc. For the Year Ended December 31, ,2001,5002,000 x $10 $10,000 $12,000$15,000$20,000 $57,000 Most sales happen in summer and fall.

17 Production Budget Describes how many units must be produced in order to meet sales needs and satisfy ending inventory requirements Formula: Units to be produced = Expected unit sales Units in ending inventory + - Units in beginning inventory

18 Direct Materials Purchases Budget Tells the amount and cost of raw materials to be purchased in each time period. Formula: Direct Materials to be purchased Direct materials needed for production + Desired direct materials in ending inventory - Direct materials in beginning inventory

19 Direct Labor Budget Shows the total direct labor hours needed and the associated cost for the number of units in the production budget

20 Overhead Budget Shows the expected cost of all production costs other than direct materials and direct labor. Overhead costs are separated into fixed and variable costs and a variable rate is calculated

21 Ending Finished Goods Inventory Budget Supplies information needed for the balance sheet Serves as an important input for the preparation of the cost of goods sold budget

22 Cost of Goods Sold Budget Reveals the expected cost of the goods to be sold.

23 Selling and Administrative Expenses Budget Outlines planned expenditures for nonmanufacturing activities Selling and administrative expenses can be broken down into fixed and variable components

24 Define and prepare the financial budget, identify its major components, and explain the interrelationships of its various components. Objective # 3

25 Preparing the Financial Budget The usual financial budgets prepared are: 1.The cash budget 2.The budgeted balance sheet 3.The budget for capital expenditures

26 Describe the behavioral dimension of budgeting. Objective # 4

27 Using Budgets for Performance Evaluation Goal congruence --- Dysfunctional behavior The alignment of managerial and organizational goals. The individual behavior that is in basic conflict with the goals of the organization. ---

28 Using Budgets for Performance Evaluation Managers need frequent timely performance reports to: Know how successful their efforts have been Take corrective action Change plans as necessary

29 Using Budgets for Performance Evaluation Incentives ---The means an organization uses to influence a manager to exert effort to achieve an organization’s goal. Both monetary and nonmonetary incentives are used

30 Participative Budgeting Allows subordinate managers considerable say in how the budgets are established. Advantages: Communicates a sense of responsibility to subordinate managers Fosters creativity Budget goals will more likely become the manager’s personal goals

31 Participative Budgeting Allows subordinate managers considerable say in how the budgets are established. Top management assumes total control of the budgeting process. Disadvantages: Setting standards that are either too high or too low Tempted to build slack in the budget Pseudoparticipation

32 Realistic Standards Budgeted objectives are used to gauge performance. They should be based on realistic conditions and expectations.

33 Controllability of Costs Ideally, managers are held accountable only for costs they can control. Controllable costs – the costs whose level a manger can influence.

34 Multiple Measures of Performance Overemphasis on financial measures can lead to a form of dysfunctional behavior called “milking the firm” or myopia. Myopia – when a manager takes actions that improve budgetary performance in the short run but bring long-run harm to the firm.