Foundations and Evolutions Cost Accounting Foundations and Evolutions Kinney and Raiborn Seventh Edition Chapter 8 The Master Budget COPYRIGHT © 2009 South-Western, a part of Cengage Learning. South-Western is a trademark used herein under license.

Learning Objectives (1 of 2) Describe how strategic planning is related to budgeting Identify the starting point of a master budget and explain why it is the starting point Identify and prepare the various master budget schedules Explain why the cash budget is important in the master budgeting process

Learning Objectives (2 of 2) Prepare and understand budgeted financial statements prepared at the end of the budgeting process List the benefits provided by a budget (Appendix) Explain how a budget manual facilitates the budgeting process

Terms Budgeting - Formalizes plans and translates qualitative narratives into a documented, quantitative format Budget - Expresses a commitment to planned activities and resource acquisition and use

Strategic Planning Long-term (5 to 10 years) Top-level management Long-range goals, strategies, and policies Foundation for short-term planning Identify and gather information on key variables, both internal and external

Tactical Plans Short-term (1 to 18 months) Top and middle management Planning Tactical Plans Short-term (1 to 18 months) Top and middle management Specific objectives and means to achieve strategic plans Basis against which results can be measured

Budget Budgeting Short-term Top, middle, and operational management involvement Usable guidelines to implement strategic and tactical plans Allocates resources Standard against which performance can be measured

The Master Budget A comprehensive set of budgets, budgetary schedules, and pro forma organizational financial statements For a specific period of time Static – based on a single level of output demand Interactive – departments generate and consume information

The Master Budget Operating Budgets Financial Budgets Budget Sales Budget Cash Budget Production Budget Capital Expenditures Budget Purchases Budget Balance Sheet Direct Labor Budget Income Statement Overhead Budget Statement of Cash Flows Selling & Administrative Budget Statement of Retained Earnings

Selling and Admin Budget The Operating Budget Sales Budget Selling and Admin Budget Production Budget Purchases Budget Overhead Budget Direct Labor Budget

Sales Forecast Ask sales personnel Extrapolate past trends Use market research Employ statistical models and simulation Sales Forecast

Production Budget Production manager combines Sales estimates Beginning inventory targets Ending inventory targets Determines the types, quantities, and timing of products to be manufactured

Direct Labor Budget Total number of people Specific types of workers Production hours needed Costs Union contracts Minimum wage laws Fringe benefit costs Payroll taxes

Overhead Budget Identify activity base Estimate overhead costs Separate costs as fixed or variable Show total costs for operating budgets Show costs without depreciation for cash budgets

Cash Budget Highlights importance of cash for organization’s continued existence Translates accrual-based information into cash flows Indicates effectiveness of credit practices Allows for planned cash borrowing or investing Used to prepare pro forma Cash Flow Statement

Capital Budget Long-term fixed asset needs Plant Equipment Payment points

The Financial Budget Statement of Cash Flows Cash Budget Capital Budget Income Statement/COGMfg Operating Budget Statement of Retained Earnings Balance Sheet

Budgeting Terms Continuous budgeting Budget slack Participatory budget Imposed budgets developed by top management imposed on operating personnel

Activity Budget Connect line items in budget to list of activities Raise awareness of non-value-added activities Question and reduce non-value-added costs Budget

Questions How are strategic and tactical planning related to budgeting? In what order are the master budget schedules prepared? Why is the cash budget important in the master budgeting process?

Potential Ethical Issues Using a single budget system globally that may conflict with national cultures Permitting budget slack Distorting budgeting process by treating short-term conditions as long-term conditions Using fraudulent accounting techniques to meet budget goals

Potential Ethical Issues Ignoring employee input in budgeting Justifying management decisions by using “backwards budgeting” Disregarding contingencies in budgeting Ignoring external performance measures and benchmarks

Potential Ethical Issues Failure to communicate “big picture” assumptions to all managers participating in the budget process Promoting “spend-it-or-lose-it” attitudes to punish cost savings and reward spending Mandating “across-the-board” budget cuts without considering alternative cost reductions