2. Slide 10-2 CHAPTER 10 Budgetary Planning and Control

3. Learning objective 1: Discuss the use of budgets in planning and control Slide 10-3 BudgetsBudgets  Formal documents that quantify a company’s plans for achieving its goals  For many companies, the entire planning and control process is built around budgets.

4. Slide 10-4 Use of Budgets in Planning  Budgets enhance communication and coordination  Process forces managers to consider their goals and objectives carefully  Managers must specify means of achieving goals and objectives Learning objective 1: Discuss the use of budgets in planning and control

5. Slide 10-5 Use of Budgets in Control Process  Provide a basis for evaluating performance  Essential to assess the performance of managers and their operations  Performance evaluation compares actual with planned or budgeted performance Learning objective 1: Discuss the use of budgets in planning and control

6. Slide 10-6 Use of Budgets in Control Significant deviations from planned performance associated with three potential causes: 1.The budget was poorly conceived 2.Conditions have changed 3.Managers have done a particularly good or poor job managing operations Learning objective 1: Discuss the use of budgets in planning and control

7. Slide 10-7 Which of the following statements regarding budgets is false? a.They are formal documents that quantify a company’s plans. b.They enhance communication and coordination. c.They are useful in planning but not in control. d.They provide a basis for evaluating performance. Answer: c They are useful in planning AND in control Learning objective 1: Discuss the use of budgets in planning and control

8. Slide 10-8 Developing the Budget Budgets are prepared for:  Departments  Divisions of a company  For the entire company Budget Committee  Responsible for approval of various budgets  Made up of senior managers (Presidents, CFO, controller, etc.)  Typically works with departments to develop realistic plans Learning objective 1: Discuss the use of budgets in planning and control

9. Slide 10-9 Developing the Budget Learning objective 1: Discuss the use of budgets in planning and control

10. Slide 10-10 Budget Time Period  Managers must decide on a budget period - Short run budgets prepared for a month, a quarter, or a year -Long run budgets prepared for a three- year or five-year period  Generally, the longer the time frame the less detailed the budget Learning objective 1: Discuss the use of budgets in planning and control

11. Slide 10-11 Five-Year Budgets Learning objective 1: Discuss the use of budgets in planning and control

12. Slide 10-12 Zero Base Budgeting  Common starting point in budgeting is previous period revenues and costs  Zero base requires budgeted amounts to be justified each period - Provides fresh consideration for validity of budgeted amounts - Time consuming and expensive process - Not widely used by business enterprises Learning objective 1: Discuss the use of budgets in planning and control

13. Learning objective 2: Prepare the budget schedules that make up the master budget Slide 10-13 Components of the Master Budget The master budget includes:  Sales budget  Production budget  Direct materials purchases budget  Direct labor budget  Manufacturing overhead budget  Selling and administrative expense budget  Capital acquisitions budget  Cash budget

14. Slide 10-14 Master Budget Learning objective 2: Prepare the budget schedules that make up the master budget

15. Slide 10-15 Sales Budget  First budget prepared since most budgets cannot be prepared without an estimate of sales  A variety of methods are used to estimate sales: - Economic models - Sales trends - Trade journals - Sales force estimates Learning objective 2: Prepare the budget schedules that make up the master budget

16. Slide 10-16 Sales Budget Budgeted sales revenue: Budgeted sales (units) x budgeted sales price Learning objective 2: Prepare the budget schedules that make up the master budget

17. Slide 10-17 Production Budget  Quantity to be produced based on following formula:  Desired ending inventory of finished goods becomes beginning inventory for the next period Learning objective 2: Prepare the budget schedules that make up the master budget

18. Slide 10-18 Production Budget  Preston Joystick budget plan, Quarter 1 - Ending inventory of finished goods = 10% of next quarter’s sales (25,000 X 10% = 2,500) - Budgeted unit sales,Q1 = 21,000 units - Budgeted unit sales, Q2 = 25,000 units - Beginning inventory Q1 = 2,100 units Learning objective 2: Prepare the budget schedules that make up the master budget

19. Slide 10-19  Expected unit sales for VitaPup -Jan 12, 600; Feb 14,500; Mar 19,000  Jan beginning inventory 1,260 units  Desired ending inventory = 15% of next month’s sales Prepare production budget for Jan and Feb Learning objective 2: Prepare the budget schedules that make up the master budget

20. Slide 10-20 Direct Material Purchases Budget  Depends upon amount needed for production and ending inventory  The following formula can be used: Learning objective 2: Prepare the budget schedules that make up the master budget

21. Slide 10-21 Direct Material Purchases Budget Preston Joystick Budgeted production: Q1= 21,400; Q2= 24,800 Parts/unit= 2, cost = $3 per part Ending inventory = 10% of next month’s production Prepare materials purchases budget, Q1 Learning objective 2: Prepare the budget schedules that make up the master budget

22. Slide 10-22 Budgeted production: Q1= 50,000; Q2= 60,000 Parts/unit= 3, cost/part= $5 Ending inventory = 20% of next month’s production Number of parts required for Q1 production is: a.50,000 b.150,000 c.60,000 d.180,000 Answer: b Q1 production 50,000 x 3 parts/unit = 150,000 Learning objective 2: Prepare the budget schedules that make up the master budget

23. Slide 10-23 Budgeted production: Q1= 50,000; Q2= 60,000 Parts/unit= 3, cost/part= $5 Ending inventory = 20% of next month’s required parts Desired ending inventory of parts for Q1 in units is: a.10,000 b.12,000 c.30,000 d.36,000 Answer: d Q2 parts = 60,000 x 3 = 180,000 x 20% = 36,000 Learning objective 2: Prepare the budget schedules that make up the master budget

24. Slide 10-24 Budgeted production: Q1= 50,000; Q2= 60,000 Parts/unit= 3, cost/per part= $5 Ending inventory = 20% of next month’s required part Beginning parts inventory, Q1= 30,000 units Budgeted cost of purchases for Q1 is: a.$750,000 b.$900,000 c.$780,000 d.$1,650,000 Answer: c 150,000 (review 2) + 36,000 (review 3) – 30,000 = 156,000 parts to purchase x $5 cost = $780,000 Learning objective 2: Prepare the budget schedules that make up the master budget

25. Slide 10-25 Direct Labor Budget  Direct labor cost can be budgeted using the following formulas: - Direct labor hours per unit x labor rate per hour = direct labor cost per unit - Direct labor cost per unit x units to be produced = budgeted direct labor cost  Can be used to budget the number of employees needed Learning objective 2: Prepare the budget schedules that make up the master budget

26. Slide 10-26 Direct Labor Budget Learning objective 2: Prepare the budget schedules that make up the master budget

27. Slide 10-27 Manufacturing Overhead Budget Separate costs into fixed and variable:  Variable costs Multiply cost/unit x units produced  Fixed costs - Identical each period except for depreciation - Depreciation may vary due to planned acquisitions or disposals Learning objective 2: Prepare the budget schedules that make up the master budget

28. Slide 10-28 Manufacturing Overhead Budget Learning objective 2: Prepare the budget schedules that make up the master budget

29. Slide 10-29 Selling and Administrative Expense Budget Learning objective 2: Prepare the budget schedules that make up the master budget

30. Slide 10-30 Budgeted Income Statement Compilation of information provided by previously prepared budgets:  Sales from Sales Budget  Cost of goods sold calculated from: - Direct Materials Budget - Direct Labor Budget - Manufacturing Overhead Budget  Other expenses from Selling and Administrative Expense Budget Learning objective 2: Prepare the budget schedules that make up the master budget

31. Slide 10-31 Capital Acquisitions Budget  Decisions with respect to long lived assets - Use net present value or internal rate of return to make capital acquisition decisions  Must be carefully planned since it may substantially reduce cash reserves Learning objective 2: Prepare the budget schedules that make up the master budget

32. Slide 10-32 Cash Receipts and Disbursements Budget  Managers must plan for amount and timing of cash flows  Careful planning of receipts and disbursements necessary to: - Anticipate cash shortages and arrange to borrow funds - Anticipate cash surpluses and seek productive uses Learning objective 2: Prepare the budget schedules that make up the master budget

33. Slide 10-33 Which of the following items does not require a cash outflow? a.Salaries b.Purchase of raw materials c.Advertising d.Depreciation Answer: d Depreciation Learning objective 2: Prepare the budget schedules that make up the master budget

34. Slide 10-34 Estimate Cash Collections and Cash Disbursements  Cash collections -Estimate % of credit sales collected in the period of sale and subsequent periods  Cash disbursements - Estimate % of materials purchases paid in the period of purchase and subsequent periods - Some expenses (depreciation) do not require cash outlays Learning objective 2: Prepare the budget schedules that make up the master budget

35. Slide 10-35 Budgeted credit sales: December =$200,000; January =$150,000; February =$160,000; March =$172,000 Collections: 75% month of sale, 25% following month Budget cash collections for January: Learning objective 2: Prepare the budget schedules that make up the master budget

36. Slide 10-36 Budgeted credit sales: December = $200,000; January= $150,000; February= $160,000; March= $172,000 Collections: 75% month of sale, 25% following month Budget cash collections for February: Learning objective 2: Prepare the budget schedules that make up the master budget

37. Slide 10-37 Budgeted Balance Sheet  Last component of master budget prepared  Sometimes referred to as the pro forma balance sheet  Used to assess the effect of planned decisions on the future financial position of the firm Learning objective 2: Prepare the budget schedules that make up the master budget

38. Slide 10-38 Use of Computers in the Budget Planning Process  Budget committee may review the budget and decide it is inconsistent with company goals  Computers are useful for revisions - Excel or custom program - Allow for changes in items and what-if analysis Learning objective 2: Prepare the budget schedules that make up the master budget

39. Slide 10-39 Budgetary Control Budgets as a Standard for Evaluation -The standard is the budgeted amount -Differences between budgeted and actual amounts are called budget variances -Budget variances should be investigated when they are material Learning objective 2: Prepare the budget schedules that make up the master budget

40. Slide 10-40 Static and Flexible Budgets  Static Budget Not adjusted for the actual level of production  Flexible Budget Can be adjusted for various production levels  Level of activity used in flexible budget is equal to the actual activity level Learning objective 3: Explain why flexible budgets are needed for performance evaluation

41. Slide 10-41 Flexible Budget Learning objective 3: Explain why flexible budgets are needed for performance evaluation

42. Slide 10-42 A ____ budget is not adjusted for the actual level of production. a.Static b.Flexible c.Pro forma d.None of the above Answer: a Static Learning objective 3: Explain why flexible budgets are needed for performance evaluation

43. Slide 10-43 SpreadsheetsSpreadsheets Learning objective 3: Explain why flexible budgets are needed for performance evaluation

44. Slide 10-44 Investigating Budget Variances  Variances are differences between budgeted and actual amounts  Causes of Budget Variances - Budget may not have been well conceived - Conditions may have changed - Managers may have performed particularly well or poorly Learning objective 3: Explain why flexible budgets are needed for performance evaluation

45. Slide 10-45 Differences between budget and actual amounts are referred to as: a.Errors b.Variances c.Flexible budget d.Static budget Answer:b Variances Learning objective 3: Explain why flexible budgets are needed for performance evaluation

46. Slide 10-46 Investigating Budget Variances Management by Exception  Economical approach  Only exceptional variances are investigated, i.e.: - Variances large in absolute dollars -Variances large relative to budgeted amounts  Should investigate both unfavorable and favorable exceptional variances Learning objective 3: Explain why flexible budgets are needed for performance evaluation

47. Slide 10-47 “Unfavorable” Budget Variance Learning objective 3: Explain why flexible budgets are needed for performance evaluation

48. Learning objective 4: Discuss the conflict between the planning and control uses of budgets Slide 10-48 Conflict in Planning and Control Uses of Budgets  Budgets used for planning and control  Management focus on meeting or beating budgeted targets; this affects their compensation  Creates an inherent conflict - Managers may pad budgets - May shift income between periods

49. Slide 10-49 Common Budget-based Compensation Scheme Learning objective 4: Discuss the conflict between the planning and control uses of budgets

50. Slide 10-50 Issues With Budget-based Compensation  Managers have incentive to pad a budget and create budget slack: - by lowering sales forecasts and increasing cost forecasts -to makes budget targets easier to achieve  Managers may shift income from one period to another period once hurdle target for bonus is reached Learning objective 4: Discuss the conflict between the planning and control uses of budgets

51. Slide 10-51 Budget Padding Learning objective 4: Discuss the conflict between the planning and control uses of budgets

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