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Chapter 9 BUDGETING A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms Control Device & Planning Tool
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BUDGETING BASICS Benefits of Budgeting
Requires all levels of management to plan ahead and formalize goals on a recurring basis Provides definite objectives for evaluating performance at each level of responsibility Creates an early warning system for potential problems
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BUDGETING BASICS Benefits of Budgeting
Facilitates coordination of activities within the business Results in greater management awareness of the entity’s overall operations and the impact of external factors Motivates personnel throughout organization to meet planned objectives
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BUDGETING BASICS Length of Budget Period
May be prepared for any period of time Most common - one year Supplement with monthly and quarterly budgets Different budgets may cover different time periods Continuous twelve-month budget Drops the month just ended and adds a future month This keeps management planning a full year ahead
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BUDGETING BASICS Budgeting Process
Base budget goals on past performance Collect data from organizational units Begins several months before the end of the current year Start with the Sales Budget
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BUDGETING BASICS Budgeting Process
Factors considered in Sales Forecasting: General economic conditions Industry trends Market research studies Anticipated advertising and promotion Previous market share Price changes Technological developments
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BUDGETING BASICS Budgeting Process
The budgeting process is usually informal in small companies Assigned to a budget committee in larger companies
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BUDGETING BASICS Budgeting and Human Behavior Participative Budgeting
“bottom-to-top” approach is called Participative Budgeting Advantages: Leads to more accurate budget estimates because lower level managers have more detailed knowledge of their area Employees perceive the process as fair due to involvement of lower level management Overall goal - produce a budget considered fair and achievable by managers while still meeting corporate goals
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BUDGETING BASICS Budgeting and Human Behavior Participative Budgeting
Disadvantages: Can be time consuming and costly Can foster budgetary “gaming” through budgetary slack This is a situation where managers intentionally underestimate budgeted revenues or overestimate budgeted expenses so that budget goals are easier to meet
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BUDGETING BASICS - The Master Budget
A set of interrelated budgets that constitutes a plan of action for a specified time period Contains two classes of budgets: Operating budgets: Individual budgets that result in the preparation of the budgeted income statement Financial budgets: The capital expenditures budget, the cash budget, and the budgeted balance sheet – focus primarily on cash needs to fund operations and capital expenditures
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BUDGETING BASICS - The Master Budget - Components
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OPERATING BUDGETS: Sales Budget
The sales budget is the first budget prepared It is derived from the sales forecast The sales forecast is management’s best estimate of sales revenue for the budget period Every other budget depends on the sales budget
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OPERATING BUDGETS: Sales Budget Example – Hayes Company
Expected sales volume: 3,000 units in the first quarter with 500-unit increment increases for each following quarter Sales price: $60 per unit Hayes Company Sales Budget For the Year Ending December 31, 2005 Expected unit sales Unit selling price Total sales , x $60 $180,000 , x $60 $210,000 , x $60 $240,000 , x $60 $270,000 Year , x $60 $900,000 Quarter
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OPERATING BUDGETS: Production Budget
The production budget shows the units that must be produced to meet anticipated sales It is derived from sales budget plus the desired finished goods Required production in units formula:
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OPERATING BUDGETS: Production Budget Example – Hayes Company
Hayes Co. believes it can meet future sales needs with an ending inventory of 20% of next quarter’s sales
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OPERATING BUDGETS: Direct Materials Budget
The direct materials budget shows both the quantity and cost of direct materials to be purchased It is derived from the direct materials units required for production (from the production budget) and desired ending materials inventory Budgeted cost of direct materials to be purchased = required units of direct materials X anticipated cost per unit
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OPERATING BUDGETS: Direct Materials Budget Example – Hayes Company
Desires an ending inventory of 10% of the next quarter’s production requirements The manufacturing of each unit requires 2 pounds of raw materials at an expected price of $4 per pound
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OPERATING BUDGETS: Direct Materials Budget Example – Hayes Company
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OPERATING BUDGETS: Direct Labor Budget
The direct labor budget shows both the quantity of hours and cost of direct labor necessary to meet production requirements The total direct labor cost formula is:
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OPERATING BUDGETS: Direct Labor Budget Example – Hayes Company
Direct labor hours from the production budget Two hours of direct labor required for each unit Hourly wage rate $10
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OPERATING BUDGETS: Manufacturing Overhead Budget
The manufacturing overhead budget shows the expected manufacturing overhead costs for the budget period It distinguishes between fixed and variable overhead costs Example – Hayes Company Fixed cost amounts are assumed Expected variable costs per direct labor hour: Indirect materials: $1.00 Indirect labor: $1.40 Utilities: $0.40 Maintenance: $0.20
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Hayes Company Manufacturing Budget For the Year Ending December 31, 2005
Quarter 1 $ 6,200 8,680 2, , , ,000 3,800 9, , ,500 $57,100 2 $ 7,200 10,080 2, , , ,000 3,800 9, , ,500 $60,100 3 $ 8,200 11,480 3, , , ,000 3,800 9, , ,500 $63,100 4 $ 9,200 12,880 3, , , ,000 3,800 9, , ,500 $66,100 Year $ 30,800 43,120 12, , , ,000 15,200 36, , ,000 $246,400 Variable Costs Indirect materials ($1.00 per DLH) Indirect labor ($1.40 per DLH) Utilities ($ .40 per DLH) Maintenance ($.20 per DLH) Total variable Fixed costs Supervisory salaries Depreciation Property tax and insurance Maintenance Total fixed Total manufacturing overhead Direct Labor hours 6,200 7,200 8,200 9,200 30,800 Manufacturing overhead rate per direct labor hour ($246,400 30,800) $8.00
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OPERATING BUDGETS: Selling & Administrative Expense Budget
Is a projection of anticipated operating expenses Distinguishes between fixed and variable costs Example – Hayes Company Fixed cost amounts are assumed Expected variable costs per unit sold (from sales budget): Sales commissions: $3.00 Freight-out: $1.00
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Hayes Company Selling & Administrative Budget For the Year Ending December 31, 2005
Quarter Variable Costs Sales commissions ($3 per unit) Freight-out ($1 per unit) Total variable Fixed costs Advertising Sales salaries Office Salaries Depreciation Property taxes and insurance Total Fixed Expenses Total Selling/Admin. Expenses 1 $ 9, , ,000 5,000 15,000 7,500 1, , ,000 $42,000 $ 10, , ,000 5,000 15,000 7,500 1, , ,000 $44,000 $ 12, , ,000 5,000 15,000 7,500 1, , ,000 $46,000 $ 13, , ,000 5,000 15,000 7,500 1, , ,000 $48,000 Year $ 45, , , ,000 60,000 30,000 4, , ,000 $180,000
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OPERATING BUDGETS: Budgeted Income Statement
The budgeted income statement is prepared from the operating budgets Sales Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Selling and Administrative Expense Budget
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FLEXIBLE BUDGETS Projects budget data for various levels of activity Essentially, a series of static budgets at different activity levels The budgetary process is more useful if it is adaptable to changes in operating conditions Flexible budgets can be prepared for each type of budget in the master budget Flexible budgets are static budgets at different activity levels
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DEVELOPING THE FLEXIBLE BUDGET Steps
Identify the activity level and the relevant range of activity Identify the variable costs and determine the budgeted variable cost per unit of activity for each cost Identify the fixed costs and determine the budgeted amount for each cost Prepare the budget for selected increments of the activity level within the relevant range
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FLEXIBLE BUDGET – A CASE STUDY Example – Fox Manufacturing Co.
Monthly comparisons of actual and budgeted manufacturing overhead costs for Finishing Department 2007 master budget Expected annual operating capacity of 120,000 direct labor hours Overhead costs:
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FLEXIBLE BUDGET – A CASE STUDY Example – Fox Manufacturing Co.
Identify the activity level and the relevant range activity level: direct labor hours relevant range: 8,000 – 12,000 direct labor hours per month Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost
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FLEXIBLE BUDGET – A CASE STUDY Example – Fox Manufacturing Co.
Identify the fixed costs and determine the budgeted amount for each cost Three fixed costs per month: depreciation $15,000 property taxes $5,000 supervision $10,000 Prepare the budget for selected increments of activity within the relevant range Prepared in increments of 1,000 direct labor hours
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FLEXIBLE BUDGET – A CASE STUDY Example – Fox Manufacturing Co.
Formula to determine total budgeted costs from the budget at any level of activity: * Total variable cost per unit X activity level Determine total budgeted costs for Fox Manufacturing Company with fixed costs of $30,000 and total variable cost $4 per unit At 9,000 direct labor hours : $30,000 + ($4 X 9,000) = $66,000 At 8,622 direct labor hours: $30,000 + ($4 X 8,622) = $64,488
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