Kinney ● Raiborn Cost Accounting: Foundations and Evolutions, 9e © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 8: The Master Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objectives How are strategic planning and tactical planning related to budgeting? What is the starting point of a master budget, and why? What are the various components of a master budget and how are they prepared? Why is the cash budget so important in the master budgeting process? How and why are budgeted financial statements prepared at the end of the budgeting process? What benefits are provided by a budget? (Appendix) How does a budget manual facilitate the budgeting process?

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Management and Planning Planning is the cornerstone of effective management. Budgeting—Formalizes plans and translates qualitative narratives into a documented, quantitative format Budget—Expresses a commitment to planned activities and resource acquisition and use

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. The Planning Process Strategic Planning Tactical Planning Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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 Strategic Planning

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Strategic Planning  Effective strategic planning requires that managers build plans and budgets that integrate external considerations and influences with internal factors  Access to resources  Core competencies  Product development  Product life cycles Strategic Planning

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. External Key Variables Competitor actions Local and global market conditions Political/regulatory climates Current and emerging technology issues Outsourcing opportunities Consumer trends and attitudes Demographics Foreign currency exchange rates Business risk factors Strategic Planning

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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 Tactical Planning

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Budgets Communicate objectives, constraints, and expectations Provide financial predictions Provide nonfinancial performance goals and objectives Identify potential difficulties Determine resource allocation and constraints Permit control through budget-to-actual comparisons Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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 Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Planning Relationships Strategic Planning Tactical Planning Budget Top Management Top, Middle, and Operational Management Top and Middle Management

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. The Control Phase Actual-to-budget comparisons Determining and investigating variances Corrective action Feedback to operating managers Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

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 Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Sales Budget Sales forecast  Ask sales personnel  Extrapolate past trends  Use market research  Employ statistical models and simulation Units to be sold *Selling price per unit =Dollars of sales

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Sales Budget Production Budget Operating Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Production Budget Production manager combines  Sales estimates  Beginning inventory targets  Ending inventory targets Determines the types, quantities, and timing of products to be manufactured

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Ending Inventory Policy Percentage of next period’s projected sales Constant amount Buildup of inventory for high-demand periods Near zero in just-in-time systems Cost of holding inventory includes storage, insurance, obsolescence, shrinkage, damage

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Operating Budget Sales Budget Production Budget Direct Labor Budget Purchases Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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 Units to be produced (or DM components) * Standard time allowed per unit = Standard labor time allowed * Per hour direct labor cost = Total direct labor cost

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Sales Budget Production Budget Overhead Budget Direct Labor Budget Purchases Budget Operating Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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 Predicted activity base * Variable overhead rate per unit of activity =Total variable overhead cost +Fixed overhead cost =Total overhead cost =Total cost without depreciation

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Sales Budget Production Budget Overhead Budget Direct Labor Budget Purchases Budget Selling & Admin Budget Operating Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Selling and Administrative Budget Predicted sales dollars (or other measure) *Variable S&A rate per dollar =Total variable overhead cost + Fixed S&A cost =Total S&A cost = Total cost without depreciation

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Operating Budget Cash Budget The Financial Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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 Beginning cash balance + Cash receipts (collections) =Cash available for disbursements – Cash disbursements =Cash excess or deficiency – Minimum desired cash balance =Cash needed/available for investment or loan repayment +/– Various financing measures =Ending cash balance

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Cash Collections/Disbursements Collections  Sales Cash Accounts Receivable Disbursements  Purchases Cash Accounts Payable

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Receipts/Disbursements FromJanFebMarTotal Nov Dec Jan Feb Mar Total Cash Collections/Disbursements Reduced by discounts and estimated uncollectible accounts Percentage of cash received/paid during the month

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. How to Improve Cash Flow Establish sound credit practices Expedite fulfillment and shipping Bill promptly and accurately Offer discounts for prompt payments Aggressively follow up on past due accounts Deposit payments promptly Seek better payment terms from suppliers/banks Keep tight control of inventory Review and reduce expenses Pay bills on time but never before they are due

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Operating Budget Cash Budget The Financial Budget Capital Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Capital Budget Long-term fixed asset needs  Plant  Equipment Payment points

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. The Financial Budget Income Statement/ Cost of Goods Manufactured Cash Budget Capital Budget Operating Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. The Financial Budget Income Statement/ Cost of Goods Manufactured Cash Budget Capital Budget Operating Budget Statement of Retained Earnings

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Budgets Provide Guide to align activities and resources with organizational goals Vehicle to promote employee participation, cooperation, and departmental coordination Tool to enhance planning, controlling, problem solving, and evaluating Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Budgets Provide Basis to sharpen responsiveness to internal and external factors Model to view future performance and consider alternative measures Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Budgeting Terms Continuous budgeting  12-month rolling budget Budget slack  Intentional underestimation of revenue  Intentional overestimation of expenses Participatory budget  Developed by top management and operating personnel Imposed budgets  Developed by top management  Imposed on operating personnel Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Budget Manual (Appendix) Statements of budgetary purpose and its desired results Listing of specific budgetary activities to be performed Calendar of scheduled budgetary activities Sample of budgetary forms Original, revised, and approved budgets Budget

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. 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?

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Potential Ethical Issues (1 of 2) 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 Ignoring employee input in budgeting Justifying management decisions by using “backwards budgeting”

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part. Potential Ethical Issues (2 of 2) Disregarding contingencies in budgeting Ignoring external performance measures and benchmarks 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