Managerial Accounting by James Jiambalvo Chapter 8: Budgetary Planning and Control Slides Prepared by: Scott Peterson Northern State University

Chapter 8: Budgetary Planning and Control Chapter Themes:  Budgeting helps management quantify plans and measure performance.  You get what you measure! Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Use of Budgets in Planning and Control The entire planning and control process of many companies is built around budgets. Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Planning Budgets are useful in the planning process because they enhance communication and coordination. The process of developing a formal plan (budget) forces managers to consider carefully their goals and objectives and to specify means of achieving them. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Control Budgets are useful in the control process because they provide a basis for evaluating performance (both management and operations). Often, performance evaluation is carried out by comparing actual performance with planned or budgeted performance. Significant deviations from planned performance are associated with three potential causes… Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Control: Reasons for Deviations From Planned Performance 1. Poorly conceived budgets. 2. Business conditions may have changed. 3. Managers have done a particularly good or bad job managing operations. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Control: Illustration of the Role of Budgets in Planning and Control Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Developing a Budget Budgets are prepared for departments, divisions, and the company as a whole. Often the group that is responsible for approval of the various budgets is the budget committee which includes the senior managers, president, CFO, various vice- presidents and controller. A top- down approach is where goals are pushed down from top management. A bottom-up approach is where lower-level managers are the primary source of information used in setting the budget. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Budget Time Period Before a budget can be prepared, managers must decide on an appropriate budget period. There are a wide variety of budgets ranging from months to several years or more. The key point is that there is an inverse relationship, generally, between the length of the budget period and the detail contained within the budget. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Zero Base Budgeting A common starting point for a budget is a prior period. These amounts are adjusted up or down based on current information and assumptions or estimates of what will happen in the future. On the other hand, Zero Base Budgeting (ZBB) is a method of budget preparation which begins each period with a clean slate. Managers must start from zero and justify budgets every period. Although used in government, ZBB is not commonly used in for-profit organizations. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production direct materials Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production direct materials direct labor Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production direct materials direct labor manufacturing overhead Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production direct materials direct labor manufacturing overhead selling and administrative Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production direct materials direct labor manufacturing overhead selling and administrative capital acquisitions Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production direct materials direct labor manufacturing overhead selling and administrative capital acquisitions cash receipts Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production direct materials direct labor manufacturing overhead selling and administrative capital acquisitions cash receipts cash disbursements Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production direct materials direct labor manufacturing overhead selling and administrative capital acquisitions cash receipts cash disbursements budgeted income statement Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

The Master Budget The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: sales production direct materials direct labor manufacturing overhead selling and administrative capital acquisitions cash receipts cash disbursements budgeted income statement budget balance sheet Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Sales Budget Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets. The sales budget is the first step in the budget process. It comes first because other budgets cannot be prepared without an estimate of sales. For example, production estimates are based on forecast sales. Companies use a variety of methods to estimate sales. These estimates are calculated by various methods including econometric models, previous sales trends, trade journals and magazines, and sales force estimates.

Production Budget Once the sales budget has been prepared, the production budget can be developed. Production forecasts are based on the following relationships: Finished units to be produced = expected sales in units + desired ending inventory of finished units – beginning inventory of finished units. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Direct Material Purchase Budget The amount of direct materials that must be purchased depends on the amount needed for production and the amount need for ending inventory. The amount that must be purchased can be calculated as follows: Required purchases of direct materials = amount required for production + desired ending inventory of direct materials – beginning inventory of direct materials. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Direct Labor Budget The direct labor budget is generally calculated by multiplying the number of units to be produced by the labor hours per unit and the rate per hour. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Manufacturing Overhead Budget Here the cost per unit of production of each variable cost item is multiplied by the quantity of units produced. Fixed costs remain relatively constant. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Selling and Administrative Expense Budget Although we have concentrated on production-related budgets, selling and administrative expense budgets include salaries, advertising, office expenses and other general expenses. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Budgeted Income Statement Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets. Much of the data for the budgeted income statement come from other budgets already prepared. For example, sales figures come from the sales budget. Cost of goods sold is based on unit cost of production (and the direct materials budget). The direct labor budget provides labor cost information. And the manufacturing overhead budget provides overhead cost information.

Capital Acquisition Budget Acquisitions of capital assets such as property plant and equipment must be carefully planned because they consume substantial cash reserves. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Cash Receipts and Disbursements Budget In the cash receipts and disbursements budget, managers plan the amount and timing of cash flows. This is a VERY important budget. And it is a necessary supplement to the budgeted income statement because the timing of cash inflows and outflows may diverge substantially from the recognition of revenues and expenses on an accrual- based income statement. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Budgeted Balance Sheet The last component of the master budget that we consider is the budgeted balance sheet. It is a function of all of the other budgets and is sometimes referred to as a pro-forma balance sheet. It is used to assess the effect of planned decisions on future financial position. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Review of Budget Relationships Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Use of Computers in the Budget Planning Process Computers are very useful in the preparation of budgets. Spreadsheets, like Excel or Lotus 1-2-3, are very effective in modeling budget relationships. Furthermore, spreadsheets allow for “what if” analysis. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Budgetary Control As noted earlier, budgets are used to facilitate control of operations. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Budgets as a Standard for Evaluation Budgets facilitate control by providing a standard for evaluation. The standard is the budgeted amount against which actual results are compared. Differences between budgeted and actual amounts are referred to as budget variances which are reported on performance reports. If material differences between actual costs and budgeted costs emerge, management should investigate. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Static and Flexible Budgets In evaluating performance using budgets, care must be taken to make sure that the level of activity used in the budget is equal to the actual level of activity. As we discussed earlier, production budgets are a function of planned sales. If sales suddenly rise, production must increase to meet demand and in turn total variable production costs will rise. Without considering levels of activity, this increase in cost may be construed as negative when, in fact, it is a necessary cost of production. More…More… Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Static and Flexible Budgets A static budget is not adjusted for the actual level of production and is ill suited for performance measurement. A flexible budget is a set of budget relationships that can be adjusted to various activity levels. And it is more appropriate for use in performance analysis. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Investigating Budget Variances Variances may have three causes: it may be ill conceived conditions have changed job performance Variances should be investigated. And management by exception is an approach that is economical and often used. Under this approach, only exceptional variances are investigated. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Conflict in Planning and Control of Budgets Conflict is inherent in the planning and control uses of budgets. Top management would like managers responsible for carrying out plans also participate in budgeting. However, because the management performance is evaluated in relation to the budget, managers have an incentive to build slack into their budgets. That is, budgets they can easily achieve. Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

Evaluation, Measurement, and Management Behavior Managers pay close attention to those aspects of their jobs that are measured and evaluated. Historically, budgets have measured dollars and cents, but some nonmonetary measures of performance are likely to be advantageous. A certain maximum level of defects, for example. Remember, “You Get What You Measure!” Related Learning Objectives: 1. Discuss the uses of budgets in planning and control. 2. Prepare the budget schedules that make up the master budget. 3. Explain why flexible budgets are needed for performance evaluation. 4. Discuss the conflict between the planning and control sues of budgets.

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