© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 1

CHAPTER 14 Budgeting © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 2

Learning Objectives What are the benefits of budgeting? What types of budgets are used within organizations? What are the main steps in the budgeting process? How does the budgeting process for a manufacturing organization differ from the budgeting process for a service organization or a retail organization? Why is it important to develop a cash budget? What are the challenges faced when budgeting, and how can these challenges be overcome? © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 3

What Is Budgeting? Budgets  A plan  Expressed in monetary terms  Covering a future time period  Based on a defined level of activity Continuous budgets  Always a 12-month budget for the business © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 4

5 What Is Budgeting? Provides ability to:  Implement strategy by allocating resources in line with strategic goals  Co-ordinate activities and assist in communication between different parts of the organization  Motivate managers to achieve targets  Provide a means to control activities  Evaluate managerial performance

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 6 What Is Budgeting? Main methods of budgeting  Incremental budgets  Priority-based budgets  Zero-based budgeting  Activity-based budgeting  Top–down budgets  Bottom–up budgets

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 7 The Budgeting Process

© 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 8 Based on making informed judgments about  How business-wide strategies will affect the responsibility centre  The level of demand placed on the business unit and the expected level of activity to satisfy internal or external customers  The technology and processes used in the business unit to achieve desired productivity levels, based on past experience and anticipated improvements  Any new initiatives or projects that are planned and which require resources  The historic spending patterns by the business unit The Budgeting Process

Depends on a number of factors  Knowledge of past performance  Understanding of market trends, seasonal factors, and competition  Whether the business is a price leader or a price follower  Understanding the drivers of business costs  Knowledge, skills, and time available for budget preparation © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 9 The Budgeting Process

Begin with Forecasted Sales Budget © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch Budgeting for a Manufacturing Company

Then develop a Production Budget © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch Budgeting for a Manufacturing Company

Then a Direct Materials Purchases Budget © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch Budgeting for a Manufacturing Company

Then a Direct Materials Usage Budget © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch Budgeting for a Manufacturing Company

Next develop a Direct Labour Budget © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch Budgeting for a Manufacturing Company

Then a Manufacturing Overhead Budget © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch Budgeting for a Manufacturing Company

Determine manufacturing cost per item © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch Budgeting for a Manufacturing Company

Prepare Cost of Goods Manufactured Statement © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch Budgeting for a Manufacturing Company

A Non-Production Budget is prepared © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 18

Budgeting for a Manufacturing Company A Budgeted Statement of Comprehensive Income is prepared © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 19

Budgeting for a Retail Company Start by defining expected changes for the next year (Year 2) © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 20

Budgeting for a Retail Company Then prepare a budget for the next year © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 21

Budgeting for a Service Industry Prepare Statistics for current year (if available) © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 22

Budgeting for a Service Industry Prepare budget based upon analysis of statistics © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 23

Budgeting for a Service Industry © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 24

Cash Forecasting Purpose of the cash forecast  Ensure that sufficient cash is available to meet the level of activity planned by the sales and production budgets  Meet all of the other cash inflows and outflows of the business There is a difference between the amount a company reports as profit and the amount reported as cash in a given accounting period © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 25

Cash Forecasting Example Based upon the following budget, a cash forecast follows: © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 26

Cash Forecasting Example The company makes half of its sales in cash and half on credit to business customers, who typically pay their accounts in the month following the sales. Credit sales in December to customers who will pay during January amount to $3,500 Sales Receipts Budget © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 27

Cash Forecasting Example Company requires inventory equal to one month’s sales (at cost) at the end of each month. The inventory at the beginning of January is $4,000. The sales and cost of sales estimated for July are $12,000 and $4,800, respectively Purchases Budget Cash Purchases Budget © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 28

Cash Forecasting Example Salaries and wages, selling and distribution costs, and rent are all paid monthly Electricity and telephone are paid twice a year, in March and June Annual insurance premium of $6,000 is paid in January Capital expenditure of $2,500 to be paid in March Income tax of $5,000 due in April $3,000 of dividends due to be paid in June Loan repayment of $1,000 due in February. Opening bank balance is $2,500 © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 29

Cash Forecasting Example Cash Forecast © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 30

Budgeting Challenges Accuracy in Predictions Motivational Problems Limiting Nature of Budgets Negative Reputation of Budgeting © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 31

Conclusion Budgeting Budgeting process Budgeting for Manufacturing Company Budgeting for Retail Company Budgeting for Service Industry Cash forecasting Budgeting Challenges © 2013 John Wiley & Sons, Ltd, Accounting for Managers, 1Ce, Ch 14 32