5 C H A P T E R Operational Budgets

What are the Purposes of Budgeting ? OVERALL PURPOSE: To quantify a general plan so that performance in relation to a goal can be carefully monitored. TWOFOLD PURPOSE FIRST: To allow individuals or companies to develop a plan to meet a specified goal. SECOND: To allow ongoing comparison between actual results and the plan in order to control operations or activities.

Describe Two Types of Planning Long-run planning includes strategic planning and capital budgeting Short-run planning includes production process prioritizing and operational budgeting or profit planning

List Reasons for Budgeting Planning and setting objectives Communication and coordination Authorization Motivation Conflict resolution Evaluation

Budgeting Process Who or what is the budget committee? A management group responsible for establishing budgeting policy and for coordinating the preparation of budgets. What are two issues of the budgeting process? Behavioral considerations Involvement in preparing the budget

List Behavioral Considerations 1. Top management support 2. Employee participation 3. Addressing budget deviations

Describe the Top-Down Approach to Budgeting Top management prepares the entire budget and distributes it to division managers. Top Management Manager Manager Manager

Describe the Bottom-Up Approach to Budgeting Each manager prepares a budget request, from which management creates an overall budget. Top Management Manager Manager Manager

Master Budget—Manufacturing Planning Process Capital Project Plans Strategic Goals and Plans Short-Term Objectives Operating Budget Production Budget Sales Budget* Direct Materials Budget* Direct Labor Budget* Manufacturing Overhead Budget* Selling/Admin. Expense Budget* * These budgets all flow into the cash budget below. Budgeted Product Sheet Budgeted Income Statement Financial Budgeting * * * * Capital Expenditures Budget Cash Budget Budgeted Balance Sheet Budgeted Cash Flows

Master Budget—Manufacturing Define each budget. Sales Budget A schedule of projected sales over the budget period.

Example: Sales Budget Selling price per bike . . . . . . $ 100 Expected sales (units). . . . . x 100 Expected revenues . . . . . . . $10,000

Master Budget—Manufacturing Define each budget. Sales Budget Production Budget A schedule of production requirements for the budget period.

Example: Production Budget Expected sales. . . . . . . . . . . . . . . 100 Add desired ending inventory. . . . 105 Total number of bikes needed . . 205 Less beginning inventory . . . . . . . 70 Bikes to be produced . . . . . . . . . . 135 Note: Ending inventory is estimated at 80% of the next period’s sales.

Master Budget—Manufacturing Define each budget. Sales Budget Production Budget A schedule of direct materials to be used and purchased during the budget period. Direct Materials Budget

Example: Direct Materials Budget Direct materials usage: Direct Amount Unit Total Materials Required Cost Cost Metal 2,700 lbs. $2.00/ft. $5,400 Plastic 405 lbs. $1.00/ft. $ 405

Example: Direct Materials Budget Direct materials purchases: Metal Plastic Desired ending inventory. . . . . 2,100 315 Needed for production. . . . . . . 2,700 405 Total needed . . . . . . . . . . . . . . 4,800 720 Less beginning inventory. . . . . 2,800 210 Materials to be purchased . . . . 2,000 510 Unit cost. . . . . . . . . . . . . . . . . . x $2 x $1 Total cost . . . . . . . . . . . . . . . . $4,000 $ 510

Master Budget—Manufacturing Define each budget. Sales Budget Production Budget A schedule of direct labor requirements for the budget period. Direct Materials Budget Direct Labor Budget

Example: Direct Labor Budget Number of bikes to produce. . . . 135 Direct labor hours per bike. . . . . x 3 Total hours required. . . . . . . . . 405 Rate per hour. . . . . . . . . . . . . . . .x $5 Total direct labor cost. . . . . . . . $2,025

Master Budget—Manufacturing Define each budget. A schedule of production costs other than those for direct labor and direct materials. Sales Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget

Example: Manufacturing Overhead Budget Variable costs: Indirect materials costs. . . . . . . . . $ 220 Indirect labor costs . . . . . . . . . . . . 600 Total variable costs. . . . . . . . . . . $ 820 Fixed costs: Insurance expense. . . . . . . . . . . . $ 200 Depreciation expense. . . . . . . . . . 600 Total fixed costs . . . . . . . . . . . . . $ 800 Total manufacturing overhead . . . $1,620

Master Budget—Manufacturing Define each budget. Sales Budget A schedule to accumulate all the budgeted production cost to produce each bike Production Budget Selling and Administrative Expense Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Budgeted Product Cost Sheet

Budgeted Product Cost Sheet Input Required Cost Cost Inputs per Bike Metal $2.00/ft. 20 $40.00 Plastic $1.00/ft. 3 3.00 Direct labor $5.00/hr. 3 15.00 Fixed OH $1.98/hr. 3 5.94 Variable OH $2.02/hr. 3 6.06 Total variable cost per bike . . . . . $70.00 Total fixed MOH $1,620 Divide by Production Volume 135 bikes Fixed MOH cost allocated per bike 12.00 Total $82.00

Master Budget—Manufacturing Define each budget. Sales Budget A schedule of all non-production spending expected to occur during the budget period. Production Budget Selling and Administrative Expense Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget

Example: Selling and Administrative Budget Variable expenses: Sales commissions . . . . . . . . . . . . . . $ 400 Total variable expenses. . . . . . . . . . $ 400 Fixed expenses: Salaries expense . . . . . . . . . . . . . . . $1,000 Depreciation . . . . . . . . . . . . . . . . . . . 100 Advertising expense. . . . . . . . . . . . . 200 Total fixed expenses. . . . . . . . . . . . $1,300 Total selling and administrative expenses. . . . . . . . . $1,700

Master Budget—Merchandising Define each budget. Sales Budget Purchases Budget Selling and Administrative Expense Budget A schedule of projected purchases over the budget period. Budgeted Income Statement

Master Budget—Service Define each budget. A service entity’s budget that identifies how much revenue will be generated during a period. Pro-Forma Income Statement Revenue Budget Wages and Salaries Budget Production Budget Cash Budget Pro-Forma Balance Sheet Selling/Admin. Expense Budget Overhead Supplies Pro-Forma Statement of Cash Flows

Master Budget—Manufacturing Define each budget. Sales Budget A schedule of expected cash receipts and disbursements during the budget period. Production Budget Selling and Administrative Expense Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Cash Budget

Example: Cash Budget Cash balance, beginning . . . . . . . . . $ 4,900 Add collections from customers . . . . 10,100 (1)Total cash available. . . . . . . . . . $15,000 Less disbursements for: Direct materials . . . . . . . . . . . . . $ 3,000 Direct labor. . . . . . . . . . . . . . . . . 2,000 Equipment purchase . . . . . . . . . 2,000 (2)Total disbursements. . . . . . . . . . $ 7,000 Minimum cash balance desired. . . . . 6,000 Total cash needed. . . . . . . . . . . . . . . $13,000 Excess (or deficiency) of cash available before financing. . . . . $ 2,000 (3) Financing needed . . . . . . . . . . . 0 Ending cash balance [(1) – (2) + (3)] $ 2,000

Define Static versus Flexible Budgeting Static Budgeting: A quantified plan that projects revenues and costs for only one level of activity. Not useful for controlling costs and measuring performance because the actual level of activity may have differed significantly from the planned level. Flexible Budgeting A quantified plan that projects revenues and costs for varying levels of activity. More useful for control and performance evaluation because it is not confined to one level of activity.