Chapter 20 The Budgeting Process

Planning and the Use of Budgets Companies spend a lot of time on _______ planning, which requires Setting goals and objectives. Long and short term. Developing strategies to achieve those goals. Budgets are a ______ statement of a company’s future plans show how _______ will be used to implement the strategy.

The Budget A budget is a quantified statement of an entity’s _______ plans (typically 1 year). Its components include data that can be financial (budgeted sales activity) or non-financial (budgeted production levels). It allows companies to formally set _____ for _______. The budget provides a means of performance _______.

Advantages of Budgets It requires management to ___ ____ Identify goals and objectives Evaluate risks and opportunities It serves as an early warning system if deviations from the budgets are examined It _______ documents management plans and specific action plans. Informal communication of business plans can create uncertainty and confusion

Advantages of Budgets It _______ employees in a positive way if implemented correctly: Based on realistic level of performance Prepared using participatory budgeting Evaluated carefully and allowing employees to provide explanations for variances Effective Management Tool All departments should contribute to meeting company-wide goals. Budgeting achieves coordination.

Advantages of Budgets Provides performance criteria - __________. Compare actual results to the past results or budget (expected results) and assign responsibility. Assists in identification of problems and corrective actions. Provides _______ for future decisions.

Things to Watch for ____ levels of management should be involved in developing the budget so they buy into the budget. _______ _______ should be tied, in part, to meeting budgetary goals. Conditions are not static, and the company must be able to respond to unforeseen events.

Time Horizon for Budgeting The _______ length of time will depend on the events being budgeted. Single event (party). On-going activities – short-term. Annually, quarterly, monthly. On-going activities – long-term. 5 year business plan. Continuous or Rolling Budgets

Master Budgets A formal, _________ plan for a company’s future. Contains several _______ budgets that are linked to each other. Sequencing of preparation is essential.

Master Budgets Master budgets consist of the following elements: Those supporting budgets which contribute directly to the budgeted income statement _______ _______ Budget Cash budget which leads to Budgeted balance sheet and cash flow statements Budgeted Income Statement

Sales or Revenues Budget This is the _______ of the operating budgets to determine. It is important to set accurate sales estimates because everything else is based on this one . Budgeted revenue = (units sold)*(price). Sales budgeting is complex and depends on many things such as; Economy, competition, competing products, capacity, price of product, new products.

Sales Budget P1 In September 2008, Hockey Den sold 700 hockey sticks at $100 each. Hockey Den prepared the following sales budget for the next four months: To illustrate the budgeting process, we are going to prepare a detailed budget for Hockey Den, a retailer of youth hockey sticks. We will begin with the sales budget.

Sales Budget P1 Exh. 20-6 Hockey Den sold seven hundred hockey sticks at one hundred dollars each in September 2008. Using this pricing information and the forecasted unit sales for the colder months of the fall season, the sales budget for the remaining three months of the year can be prepared. The sales budget includes January 2009 because the purchasing department relies on estimated January sales to plan December 2008 inventory purchases.

Merchandise Purchases Budget Budgeted future sales volume is the primary factor in inventory management decisions Merchandise Purchase Budget (retailer) Production Budget (manufacturer)

Merchandise Purchases Budget Exh. 20-7 Hockey Den buys hockey sticks for $60.00 each and maintains an ending inventory equal to 90 percent of the next month’s budgeted sales. 900 hockey sticks are on hand on September 30. Inventory to be purchased Budgeted ending inventory Budgeted cost of sales for the period Budgeted beginning inventory = + – Once we have completed the sales budget, we can prepare the merchandise purchases budget that will incorporate Hockey Den’s sales demand and inventory policy. To prevent potential stock-outs of inventory items, and to have a good selection of merchandise on hand for customers, Hockey Den always wants its ending inventory for a month to be equal to ninety percent of the next month’s sales. On September 30, nine hundred hockey sticks were on hand, an amount equal to ninety percent of the one thousand hockey sticks budgeted for October sales. Let’s prepare the purchases budget for Hockey Den.

Merchandise Purchases Budget Exh. 20-8 We begin the purchases budget by computing the desired ending inventory for each of the three months. Recall that Hockey Den always wants its ending inventory for a month in units to be equal to ninety percent of the next month’s unit sales. The unit sales figures are from the sales budget.

Merchandise Purchases Budget Exh. 20-8 Next we add the unit sales for each month to the desired ending inventory to get the total needs for each month.

Merchandise Purchases Budget Exh. 20-8 Now, let’s complete the month of October. Total needs for October are one thousand seven hundred and twenty units. Hockey Den can partially meet these needs from the beginning inventory of nine hundred units. Subtracting nine hundred units from one thousand seven hundred and twenty units, we find that Hockey Den must purchase eight hundred twenty units in October. Multiplying the eight hundred twenty units by Hockey Den’s sixty dollars cost per unit converts the purchase amount to forty nine thousand two hundred dollars. Next, we will complete the purchases budget.

Merchandise Purchases Budget Exh. 20-8 Here’s our completed purchases budget. Notice that the ending inventory for each month becomes the beginning inventory for the next month.

Production Budgets (Appendix 20A) What production levels must be achieved to support the sales budget? Production = budgeted sales + desired ending inventory - beginning inventory Production costs include: Materials costs Direct labor Manufacturing overhead We will need budgets for _____ of these

Production Budget: Direct Materials Purchases How much material do we need to support the production level? How much do we need to purchase to maintain desired inventory level? Units purchased = projected material usage + desired ending inventory level – beginning inventory. Calculate in units first, then convert to cost.

Production Budget: Direct Materials Purchases Steps to prepare a direct materials purchasing budget Calculate each period’s total production needs in units of direct materials Determine the total number of units of direct materials to be purchased during each accounting period in the budget Calculate the cost of the direct materials purchases

Production Budget: Direct Labor Direct labor costs will depend on the units to be produced and the time allowed for each unit in the various departments. Figure the time to complete the units and then convert them to costs.

Production Budget: Direct Labor Steps in preparing a direct labor budget Estimate the total direct labor hours Multiply estimated direct labor hours per unit by the anticipated units of production Calculate the total budgeted direct labor cost

Production Budget: Factory Overhead Using the relationships which exist and the estimated cost functions, determine what overhead costs will be incurred in producing the number of units needed. Variable overhead costs per unit. Fixed overhead costs per period. Determine budgeted overhead and divide by the estimated activity level to come up with the overhead application rate.

Other Elements of Operating Budgets Using cost behavior analysis, calculate the budgeted nonmerchandising or nonmanufacturing manufacturing costs Selling Expense Budget General & Administrative Expense Budget

Financial Budget Components Capital Budgeting – budget of capital expenditures needed to support company activity Cash Budget Budgeted Income Statement Information comes from already prepared budgets. Budgeted Balance Sheet & Cash Flow Final step

Cash Budgeting Purpose of the cash budget is to determine whether or not there will be excess cash to invest and/or deficiencies of cash requiring short term borrowing. Beginning balance Plus: Budgeted Receipts Less: Budgeted Disbursements = Estimated ending cash balance. Compare estimated ending balance with the required cash balance. Do we need to borrow money?

Cash Budgeting Information Budgeted Cash Receipts & Expected Collection Point Expected cash sales? Expected collections from credit sales? Budgeted Cash Disbursements & Expected Disbursement Point SG&A Expenses Cash Purchases Cash Payments on Accounts Payable Cash purchases of fixed assets, Payment of interest costs, loan principal and income taxes?

From the Sales Budget P2 Exhibit 20-14 Recall that Hockey Den plans to sell one thousand units in October, eight hundred units in November, and one thousand, four hundred units in December, for a total of three thousand, two hundred units for the quarter. The sales price is one hundred dollars per unit.

From the Merchandise Purchases Budget Exhibit 20-14 Hockey Den pays sixty dollars per unit for its merchandise.

From the Selling Expense Budget Exhibit 20-14 Sales commissions are ten percent of sales revenue. Sales salaries are two thousand dollars per month for the three months. From the Selling Expense Budget

P2 Exhibit 20-14 Administrative salaries are four thousand, five hundred dollars per month and equipment depreciation is one thousand, five hundred dollars per month for the three months. Recall that even though depreciation does not result in a cash disbursement, it is an expense that is included in the income statement. From the General and Administrative Expense Budget Depreciation is a non-cash expense.

From the Cash Budget P2 Exhibit 20-14 Hockey Den paid one hundred dollars in interest in October and two hundred twenty-eight dollars in November. From the Cash Budget

P2 Exhibit 20-14 Hockey Den’s income tax rate is forty percent. $71,672 × .40

Budgeted Balance Sheet The budgeted account balances will depend on previous budget schedules cash balance: cash budget accounts receivable balance: sales budget and pattern of collections inventory amounts: operating budgets borrowing: cash budget retained earnings: effects of income and dividends

Budget Process - Summary Budgeting is a company-wide effort Goals often come from the top Different parts of the organization participate to budget specific activities/units. All this information must be tied together in the master budget. This is where the accountants come in.

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