COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license. 1 Chapter 8 Budgeting for Planning and Control

2 1.Define budgeting, and discuss its role in planning, controlling, and decision making. 2.Prepare the operating budget, identify its major components, and explain the interrelationships of the various components. 3.Identify the components of the financial budget, and prepare a cash budget. 4.Define flexible budgeting, and discuss its role in planning, control, and decision making. 5.Define activity-based budgeting, and discuss its role in planning, control, and decision making. 6.Identify and discuss the key features that a budgetary system should have to encourage managers to engage in goal-congruent behavior. Study Objectives

3 The Role of Budgeting in Planning and Control

4 Types of budgets –Master budget Operating budgets Financial budgets Time frame –Annual period –Multi-year rolling budget

5 The Role of Budgeting in Planning and Control Gathering information –Forecasting sales –Forecasting other variables The master budget starts with the sales forecast, which is basis for the sales budget. All other operating and most financial budgets are generated from the sales budget.

6 The Role of Budgeting in Planning and Control

7 The first budget is the sales budget which is based on the sales forecast. Starting point for Production Budget Starting point for Marketing Expense Budget Schedule 1 (in thousands) Goes to Budgeted Income Statement Preparing the Operating Budget

8 Starting point for Direct Materials Purchases Budget Starting point for Direct Labor Budget Schedule 2 (in thousands) Preparing the Operating Budget

9 Goes to Cost of Goods Sold Budget Schedule 3 (in thousands) Preparing the Operating Budget *Follows the inventory policy of having 8 million pounds of materials on hand at the end of the first and second quarters and 5 million pounds on hand at the end of the third and fourth quarters.

10 Goes to Cost of Goods Sold Budget Schedule 4 (in thousands) Starting point for Overhead Budget Preparing the Operating Budget

11 Goes to Cost of Goods Sold Budget Schedule 5 (in thousands) Preparing the Operating Budget *Includes $200,000 of depreciation in each quarter.

12 a Amounts taken from Schedule 3. b Amounts taken from Schedule 4. c Amounts taken from Schedule 5. d Budgeted fixed overhead (Schedule 5)/Budgeted direct labor hours (Schedule 4) = $1,280/240 = $5.33. Goes to Cost of Goods Sold Budget Schedule 6 (in thousands) Preparing the Operating Budget

13 *Production needs  $0.01 = 416,000  $0.01. Goes to Budgeted Income Statement Schedule 7 (in thousands) Preparing the Operating Budget

14 Goes to Budgeted Income Statement Schedule 8 (in thousands) Preparing the Operating Budget

15 Goes to Budgeted Income Statement Schedule 9 (in thousands) Preparing the Operating Budget

16 Goes to Budgeted Income Statement Schedule 10 (in thousands) Preparing the Operating Budget

17 Schedule 11 (in thousands) Preparing the Operating Budget

18 Operating Budgets for Merchandising and Service Firms Merchandising –Merchandise purchases replaces production –Direct materials and direct labor are not required For-profit service: –Sales budget is the production budget –Inventories are nonexistent Not-for-profit service: –Budget for level and types of services provided –Statement of sources and uses replaces income statement

19 Preparing the Financial Budget Cash budget –Break down into short time periods –Forecast need for short-term borrowing –Forecast periods of high cash balances Beginning cash balance +Cash receipts Cash available –Cash disbursements –Minimum cash balance Excess or deficiency of cash –Repayments +Loans +Minimum cash balance Ending cash balance

20 (Continued on next slide) Schedule 12 (in thousands) Preparing the Financial Budget

21 (Continued from previous slide) (Continued on next slide) Schedule 12 (in thousands) Preparing the Financial Budget

22 (Continued from previous slide) Schedule 12 (in thousands) Preparing the Financial Budget

23 Preparing the Financial Budget Budgeted balance sheet –Current (actual) balance sheet –Integrate data from all other budgets

24 Schedule 13 (in thousands) Preparing the Financial Budget a Ending balance from Schedule 12. b 30 percent of fourth-quarter credit sales (0.30 × $800,000); see Schedules 1 and 12. c From Schedule 3 (5,000,000 lbs. × $0.01). d From Schedule 6. e From the December 31, 2009, balance sheet. f December 31, 2009, balance ($9,000,000) plus new equipment acquisition of $600,000; see the 2009 ending balance sheet and Schedule 12. g From the December 31, 2009, balance sheet and Schedules 5, 8, and 10 ($4,500,000 + $800,000 + $20,000 + $40,000). h 20% of fourth-quarter purchases; see Schedules 3 and 12. i From the December 31, 2009, balance sheet. j $6,825,000 + $894,000 (December 31, 2009, balance plus net income from Schedule 11).

25 Shortcomings of the Traditional Master Budget Process Departmental orientation –Plan from resources to outputs –Does not recognize interdependencies among departments Static budgets –Developed for a single level of activity –Based on incremental adjustments Results orientation –Disconnects the process from its output –Cost-cutting accomplished by across-the-board cuts

26 Flexible Budgets for Planning and Control Static budget Vital for planning Less useful for control Master budget Developed around a single level of activity Budgeted activity level rarely equals actual activity

27 Flexible Budgets for Planning and Control

28 Flexible Budgets for Planning and Control Static budgets Master budget Vital for planning Less useful for control Developed around a single level of activity Budgeted activity level rarely equals actual activity Flexible budgets Variable budget Provides expected costs for a range of activity Provides budgeted costs for the actual activity level

29 Flexible Budgets for Planning and Control

30 Flexible Budgets for Planning and Control Flexible budget performance report –Compare budgeted costs given the actual level of activity to the actual costs for the same level –Locate possible problem areas by examining the flexible budget variances –Examines efficiency

31 Flexible Budgets for Planning and Control

32 Flexible Budgets for Planning and Control Flexible budget performance report –Compare budgeted costs given the actual level of activity to the actual costs for the same level –Locate possible problem areas by examining the flexible budget variances –Examines efficiency Managerial performance report –Flexible budget variances –Actual results vs. flexible budget –Examines efficiency –Volume variances –Static budget vs. flexible budget –Examines effectiveness

33 Flexible Budgets for Planning and Control

34 Flexible Budgets for Planning and Control A flexible budget can be built for five overhead activities using three drivers; each is budgeted for two activity levels.

35 Flexible Budgets for Planning and Control The activity-based performance report measures budget variances for each of the overhead activities.

36 Activity-Based Budgets ABB begins with output and then determines the resources necessary to created that output. ABB works backwards from activities and their drivers to the underlying costs –Traditional budgeting relies on functional- based line items (salaries, supplies, etc.) –Flexible budget uses cost behavior to split functional-based line items into fixed and variable

37 Activity-Based Budgets Traditional budgeting relies on functional-based line items.

38 Activity-Based Budgets Flexible budgeting uses cost behavior to split functional-based line items into fixed and variable costs.

39 Activity-Based Budgets Steps to construct an ABB 1.Determine the unit’s output 2.Identify the activities (and related drivers) needed to deliver the output 3.Estimate the demand for each activity 4.Determine the cost of resources required to produce the relevant activities

40 Activity-Based Budgets

41 The Behavioral Dimension of Budgeting Characteristics of a good budgetary system –Frequent feedback on performance –Monetary and nonmonetary incentives –Participative budgeting –Realistic standards –Controllability of costs –Multiple measures of performance

COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning. Cengage Learning and South-Western are trademarks used herein under license. 42 End Chapter 8