The Budgeting Process 7

OBJECTIVE 1: Define budgeting, and explain budget basics.

The Budgeting Process Explain how budgeting helps managers match an organization’s goals with its resources.

The Budgeting Process Advantages of budgeting –Budgets foster organizational communication. –Budgets ensure a focus both on future events and on resolving day-to-day issues.

The Budgeting Process Advantages of budgeting (cont.) –Budgets assign resources and the responsibility to use them wisely to managers who are held accountable for their results. –Budgets can identify potential constraints before they become problems.

The Budgeting Process Advantages of budgeting (cont.) –Budgets facilitate congruence between organizational and personal goals. –Budgets define organizational goals and objectives numerically, against which actual performance results can be evaluated.

The Budgeting Process Budgeting and goals –Strategic planning is the process by which management establishes an organization’s long-term goals. Examples of long-term goals: increase market share by a specific amount An annual operating plan restates long-term goals in terms of what an organization needs to accomplish during the next year.

The Budgeting Process Budgeting and goals (cont.) –The short-term goals identified in an annual operating plan are the basis of an organization’s operating budgets for the year.

The Budgeting Process Budgeting basics –Budget authority Budget and budget line associated with a specific role or job in an organization. Managers must explain or take correction action for any deviations between budget and actual results Concept of responsibility accounting holds managers accountable for only those budget items they actually control.

The Budgeting Process Budgeting basics (cont.) –Participation Participative budgeting is a process in which personnel at all levels of an organization actively engage in making decisions about the budget.

The Budgeting Process Budgeting basics (cont.) –Budget period Static budgets are prepared once a year do not change during the annual budget period. A continuous budget is a 12-month forward rolling budget that summarizes budgets for the next 12 months and is continuously reviews and revised during the year.

The Budgeting Process Budgeting basics (cont.) –Budget approach Traditional budgets requires managers to justify only budget changes over the past year. Zero-based budgeting requires every budget to be justified annually, not just the changes.

The Budgeting Process Budgeting basics (cont.) –Budget implementation A budget committee made up of top management has overall responsibility for budget implementation. Successful budget implementation depends on two factors: –Clear communication of performance expectations and budget targets to all key personnel –The support of top management

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The Master Budget OBJECTIVE 2: Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets.

Figure 1: Preparation of a Master Budget for a Manufacturing Organization

Figure 2: Preparation of a Master Budget for a Retail Organization

Figure 3: Preparation of a Master Budget for a Service Organization

The Master Budget A master budget consists of a set of operating budgets and a set of financial budgets that detail an organization’s financial plans for an accounting period. –Operating budgets are plans used in daily operations and are the basis for preparing the financial budgets.

The Master Budget –Financial budgets are projections of financial results for an accounting period. They include the following: A budgeted income statement A capital expenditures budget A cash budget A budgeted balance sheet

The Master Budget A master budget provides the information needed to match long-term goals to short- term activities and to plan the resources needed to ensure an organization’s profitability and liquidity. –The process of preparing a master budget in manufacturing, retail, and service organizations differs mainly in the kinds of operating budgets that each type of organization prepares.

The Master Budget –Figures 1 through 3 show the different operating budgets of manufacturing, retail, and service organizations.

The Master Budget Guidelines for preparing budgets are –Understand the purpose of the budget. –Identify the user group and its information needs. –Identify sources of accurate, meaningful budget information.

The Master Budget Guidelines for preparing budgets are (cont.) –Establish a clear format for the budget. –Use appropriate formulas and calculations to derive the quantitative information. –Revise the budget until it includes all planning decisions.

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Operating Budgets OBJECTIVE 3: Prepare the operating budgets that support the financial budgets.

Exhibit 1: Sales Budget

Exhibit 2: Production Budget

Exhibit 3: Direct Materials Purchases Budget

Exhibit 4: Direct Labor Budget

Exhibit 5: Overhead Budget

Exhibit 6: Selling and Administrative Expense Budget

Exhibit 7: Cost of Goods Manufactured Budget

Operating Budgets Operating budgets are interrelated and a sales budget is always prepared first. –Sales budget: a detailed plan identifying the sales expected during an accounting period. –Production budget: a detailed pan showing the number of units that a company must produce to meet budgeted sales and inventory needs.

Operating Budgets Operating budgets are interrelated and a sales budget is always prepared first. (cont.) –Direct materials purchase budget: detailed plan that identifies the quantity of purchases required to meet budgeted production and inventory needs and the costs associated with those purchases. Calculate each period’s total production needs in units of direct materials.

Operating Budgets Operating budgets are interrelated and a sales budget is always prepared first. (cont.) –Direct materials purchase budget: detailed plan that identifies the quantity of purchases required to meet budgeted production and inventory needs and the costs associated with those purchases. Determine the quantity of direct materials to be purchased during each accounting period in the budget

Operating Budgets Operating budgets are interrelated and a sales budget is always prepared first. (cont.) –Direct materials purchase budget: detailed plan that identifies the quantity of purchases required to meet budgeted production and inventory needs and the costs associated with those purchases. Calculate the cost of the direct materials purchases by multiplying the total number of unit purchases by the direct materials cost.

Operating Budgets Operating budgets are interrelated and a sales budget is always prepared first. (cont.) –A direct labor budget is a detailed plan that estimates the direct labor hours needed during an accounting period and the associated costs. Estimate the total direct labor hours by multiplying the estimated direct labor hours per unit by the anticipated units of production Calculate the total budgeted direct labor cost by multiplying the estimated total direct labor hours by the estimated direct labor cost per hour.

Operating Budgets Operating budgets are interrelated and a sales budget is always prepared first. (cont.) –An overhead budget is a detailed plan of anticipated manufacturing costs, other than direct materials and direct labor costs, that must be incurred to meet budgeted production needs. –A selling and administrative expense budget is 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.

Operating Budgets Operating budgets are interrelated and a sales budget is always prepared first. (cont.) –A cost of goods manufactured budget is a detailed plan that summarizes the estimated costs of production during an accounting period. Exhibits 1 through 7 show each of the operating budgets is prepared.

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Financial Budgets OBJECTIVE 4: Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet.

Exhibit 8: Budgeted Income Statement

Table 1: Elements of a Cash Budget

Exhibit 9: Schedule of Expected Cash Collections from Customers

Exhibit 10: Schedule of Expected Cash Payments for Direct Materials

Exhibit 11: Cash Budget

Exhibit 12 Budgeted Balance Sheet

Financial Budgets Exhibit 8 illustrates the components of a budgeted income statement and the sources of the data used in preparing the statement.

Financial Budgets A budgeted income statement projects an organization’s net income for an accounting period based on the revenues and expenses estimated for that period.

Financial Budgets A capital expenditures budget is a detailed plan outlining the anticipated amount and timing of capital outlays for long-term assets during an accounting period.

Financial Budgets A cash budget is a projection of beginning cash, cash receipts, cash payments, and ending cash for an accounting period. –The formula used in preparing a cash budget: Estimated ending cash balance = total estimated cash receipts – total estimated cash payments + estimated beginning cash balance

Financial Budgets A cash budget is a projection of beginning cash, cash receipts, cash payments, and ending cash for an accounting period. (cont.) –Exhibits 9 and 10 and the cash budget in Exhibit 11 show which estimates of cash receipts and cash payments are used. –The projected ending cash balance in the cash budget enables managers to plan for short-term investments when the cash balance is high and for short-term loans when the cash balance is low.

Financial Budgets A budgeted balance sheet is a projection of an organization’s financial position at the end of an accounting period. –Exhibit 12 shows how a budgeted balance sheet uses all estimated data compiled in the course of preparing a master budget.

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