Managerial Accounting: An Introduction To Concepts, Methods, And Uses Chapter 10 Profit Planning and Budgeting Maher, Stickney and Weil

C Learning Objectives (Slide 1 of 2) Explain the use of a budget as a tool for planning and performance evaluation. Explain how a budget can affect employee motivation. Compare the four types of responsibility centers. Describe the master budget.

C Learning Objectives (Slide 2 of 2) Explain the difference between a flexible budget and master budget. Describe ethical dilemmas in budgeting. List the components of a comprehensive master budget. Describe an incentive model for accurate reporting.

C Organizational Plan Consists of three parts Organization Goals - Broad objectives established by mgmt. that company employees work to achieve Strategic long-range plan - Intermediate and distant future plans stated in broad terms Master Budget - Specific plan for the coming year

C Master Budget Also known as the static budget Indicates sales, production and cost levels, income and cash flows anticipated for the following year Also includes an income statement and balance sheet based on budget data

C Employee Participation in Developing Budgets Participative budgeting - Using input of lower- and middle-management in developing budgets Time-consuming Enhances employee motivation and acceptance of goals Provides info that enables employees to associate rewards and penalties with performance

C Performance Evaluation Budgets provide estimates of expected performance Comparing budgeted with actual results provides a basis for evaluating performance Budgets must be prepared for individual responsibility centers in order to use them to evaluate performance

C Responsibility Centers (Slide 1 of 2) A responsibility center is a division or department responsible for managing a group of activities in the organization Responsibility centers can be classified as follows: Cost centers - mgmt is responsible for managing costs Revenue centers - mgmt is responsible for managing revenues

C Responsibility Centers (Slide 2 of 2) Responsibility centers can be classified as follows (continued): Profit centers - mgmt is responsible for both revenues and costs Investment centers - mgmt is responsible for revenues, costs, and assets

C Flexible Budgets Shows the expected relation between costs and volumes Has two components: Fixed cost - expected to be incurred regardless of the activity level Variable cost - costs change in total as the activity level changes

C Cost Hierarchies When preparing a master budget, it is important to understand how costs are affected by changes in activity levels The following cost hierarchy is helpful in understanding cost behavior: Unit-level activities Batch-level activities Product-level activities Customer-level activities Facility-level activities

C Forecasting Sales Developing the master budget starts with forecasting sales Various methods and sources used to obtain sales forecasts include: Sales staff Market research Delphi technique Trend analysis Econometric Models

C Production Budget (Slide 1 of 2) The production budget is based on the sales budget and estimates of beginning and desired ending inventories Production is calculated as follows: Number of Units to Be Sold +Units in Ending Inventory -Units in Beginning Inventory Units to Be Produced

C Production Budget (Slide 2 of 2) After determining the number of units to be produced, we can budget for the following: Direct materials - traceable to units produced and almost always a variable cost Direct labor - traceable to units produced; usually a variable cost but could be a fixed cost We assume direct labor is a variable cost in this chapter Manufacturing overhead - typically has both variable and fixed components; variable overhead varies with units produced, fixed overhead gives a firm production capacity

C Marketing and Administrative Budgets Budgeted marketing costs might include the following: Facility-level activities - salaries, advertising, sales office costs Unit-level activities - sales commissions, shipping Administrative costs include both fixed and variable costs

C Discretionary Fixed Costs Many “fixed” costs are really discretionary costs They are budgeted as fixed costs but if, for example, the economic conditions look bad, these costs can be reduced Examples: maintenance, advertising Discretionary fixed costs should be distinguished from committed fixed costs, like rent on a factory building, which are required to run the firm

C Budgeted Income Statement Also called the profit plan Prepared using a contribution margin format If management is satisfied with the budget, it is approved If not, management can look for ways to improve budget profits through, for example, sales increases or cost reductions

C Accurate Forecasts An accurate sales forecast is critical to the entire budget process If forecast is too low, sales may be lost because purchasing and production have been planned at too low a level If forecast is too high, excess inventory may result

C Using the Master Budget Master budget includes budgeted financial statements as well as other relevant budgets Once adopted, the master budget becomes a major planning tool Essentially, becomes authorization to produce and sell goods, purchase materials, hire employees

C Comparison of Flexible and Master Budgets The flexible budget is based on actual sales and production volumes Indicates expected revenue and costs at the actual level of activity Comparison of master budget to the flexible budget forms the basis for analyzing differences in planned and actual results

C Example: Flexible and Master Budget Comparison (Slide 1 of 2) Flexible Master Budget(based Budget(based on Sales on actual sales estimated salesVolume of 80,000 units) of 70,000 units)Variance Sales$480,000$420,000$60,000F Less: Var. Man. Costs293,600256,90036,700U Var. Mktg. Costs 11,200 9,800 1,400U Contribution Margin$175,200$153,300$21,900F Less Fixed Costs142,400142,400___-___ Operating Profit$ 32,800$ 10,900$21,900 Exhibit 10.8

C Example: Flexible and Master Budget Comparison (Slide 2 of 2) Observations: Management predicted sales of 70,000 units but 80,000 units were actually sold resulting in a favorable sales volume variance of $21,900 (increased profits) Sales volume variance is the difference in profit caused by the difference in budgeted and actual sales volume The variable cost variances are labeled “unfavorable” but do not necessarily mean “bad” Variable costs are expected to increase due to the increased sales volume

C Budgeting in Nonprofit organizations The master budget is very important in nonprofit organizations Used as a basis for authorizing the expenditure of funds In governmental units, the budget is a legal authorization for expenditure Penalties for exceeding authorized expenditures can be severe

C Ethical Issues in Budgeting Managers and employees not only provide information that will be used in the budget, they may also be evaluated by comparing budget to actual results This can lead to ethical dilemmas Example: Manager may receive a bonus based on exceeding budgeted amounts of sales May be motivated to submit low estimates of sales for the budget to receive a larger bonus

C If you have any comments or suggestions concerning this PowerPoint Presentation for Managerial Accounting, An Introduction To Concepts, Methods, And Uses, please contact: Dr. Donald R. Trippeer, CPA Colorado State University-Pueblo