The Budgeting Process Chapter 21

The Budgeting Process Chapter 21
Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University

Learning Objective Define budgeting and explain its role in the management cycle. Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets. Prepare the operating budgets that support the financial budgets. Copyright © Houghton Mifflin Company. All rights reserved.

Learning Objective (cont’d)
Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet. Describe management’s role in budget implementation. Copyright © Houghton Mifflin Company. All rights reserved.

The Budgeting Process Objective 1
Define budgeting and explain its role in the management cycle Copyright © Houghton Mifflin Company. All rights reserved.

Budgeting … is the process of identifying, gathering, summarizing, and communicating financial and nonfinancial information about an organization's future activities Is essential part of the continuous planning for an organization in order to accomplish long-term goals Copyright © Houghton Mifflin Company. All rights reserved.

The Budgeting Process Budgets
Plans of action based on forecasted transactions, activities, and events Are synonymous with managing an organization Essential to accomplishing goals in the strategic plan Copyright © Houghton Mifflin Company. All rights reserved.

The Budgeting Process (cont’d)
Budgets are used to Communicate information Coordinate activities and resource usage Motivate employees Evaluate performance Manage and account for cash Establish minimum levels of cash receipts and expenditures Copyright © Houghton Mifflin Company. All rights reserved.

The Budgeting Process (cont’d)
Many forms of budgets Examples Cash budget Focuses on financial information Shows, among other things, how cash resources will be allotted to operating, investing, and financing activities over a future period Production budget Focuses on nonfinancial information Shows planned production in units Identifies activities needed to meet certain requirements or standards Copyright © Houghton Mifflin Company. All rights reserved.

Budgeting and Goals Strategic planning
Process by which management establishes an organization’s long-term goals Copyright © Houghton Mifflin Company. All rights reserved.

Long-Term Goals … define the strategic direction an organization will take over a five- to ten-year period Are the basis for Making annual operating plans Preparing budgets Copyright © Houghton Mifflin Company. All rights reserved.

Long-Term Goals (cont’d)
Should take into consideration Economic and industry forecasts Employee-management relations Structure and role of management Value chain considerations Organizational capacity Any other operational and tactical issues facing the organization Expected quality of products or services Growth rates Desired market share Copyright © Houghton Mifflin Company. All rights reserved.

Long-Term Goals (cont’d)
Must set specific targets and timetables Must assign responsibility for achieving the goals to specific personnel A range of long-term goals should be included in the organization's strategic plan Should give direction to efforts to achieve these goals Copyright © Houghton Mifflin Company. All rights reserved.

Short-Term Goals Involve every part of an enterprise
Much more detailed than long-term goals To formulate an annual operating plan, long-term goals must be restated in terms of what needs to be accomplished during the next year Short-term goals are the basis of an organization’s operating budgets for the year Copyright © Houghton Mifflin Company. All rights reserved.

Short-Term Goals (cont’d)
Organization’s controller takes charge of coordinating the budget process Designs a complete set of budget-development directions Timetable with deadlines Assigns clearly defined responsibilities for carrying out each part of the budget’s development To specific individuals or management teams The budget may be reviewed and revised during the year Copyright © Houghton Mifflin Company. All rights reserved.

Importance of Participation
The key to a successful budget is participative budgeting Process in which personnel at all levels of an organization actively engage in making decisions about the budget Gives a sense of ownership Helps ensure that departments will attain targets and stay within the budget Copyright © Houghton Mifflin Company. All rights reserved.

Importance of Participation (cont’d)
Participative budgeting depends on joint decision making Controller must be able to communicate and negotiate effectively with people in all levels of an organization Senior managers Formulate organizational long-and short-term goals Middle managers Supervisors Responsible for daily operations Copyright © Houghton Mifflin Company. All rights reserved.

Importance of Participation (cont’d)
Authoritative budgeting Senior executives dictate targets Do not allow middle managers and supervisors a voice in setting them Targets may be unrealistic and impossible to attain Will undermine motivation of managers and supervisors Cooperation is essential for successful budget implementation Senior executives allow controller to develop budget without consulting other managers Managers may feel budgeting is not a top priority Copyright © Houghton Mifflin Company. All rights reserved.

Budgeting and the Management Cycle

Planning Budgeting Originates in this stage Helps managers to Relate the organization’s long-term goals to its short-term activities Distribute resources and workloads Communicate responsibilities Select performance measures Set goals for bonuses and rewards Copyright © Houghton Mifflin Company. All rights reserved.

Executing Budgeting helps managers to Communicate expectations Measure performance and motivate employees Coordinate activities and allot resources Copyright © Houghton Mifflin Company. All rights reserved.

Reviewing Budgeting helps managers to Evaluate performance Determine timeliness Find variances and create solutions Compare planned performance with actual performance Copyright © Houghton Mifflin Company. All rights reserved.

Discussion How are short-term goals related to strategic planning?
Short-term goals define the strategic direction an organization will take over the next year. They are determined to help accomplish the long-term goals that are established during the strategic planning process Copyright © Houghton Mifflin Company. All rights reserved.

The Master Budget Objective 2
Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets Copyright © Houghton Mifflin Company. All rights reserved.

The Master Budget … consists of a set of operating budgets and a set of financial budgets that detail an organization’s financial plans for a specific accounting period, generally a year Copyright © Houghton Mifflin Company. All rights reserved.

The Master Budget (cont’d)
Operating budgets Plans used in daily operations Basis for financial budgets Financial budgets Projections of financial results for the accounting period Include Budgeted income statement Capital expenditures budget Cash budget Budgeted balance sheet Copyright © Houghton Mifflin Company. All rights reserved.

Process of preparing a master budget is similar in all three types of organizations Manufacturing Retail Service The process differs mainly in the kinds of operating budgets each type of organization prepares Copyright © Houghton Mifflin Company. All rights reserved.

Preparation of a Master Budget for a Manufacturing Organization

Preparation of a Master Budget for a Retail Organization

Preparation of a Master Budget for a Service Organization
Copyright © Houghton Mifflin Company. All rights reserved.

Sales budget Is prepared first Used to estimate sales volume and revenues Once developed, other budgets can be developed These other budgets will help manage the organization's resources so that profits can be generated on sales In a service organization, the sales budget is called the service revenue budget Copyright © Houghton Mifflin Company. All rights reserved.

No standard format for budget preparation Procedures vary from organization to organization Only universal requirement is that budgets communicate the appropriate information to the reader in a clear and understandable manner Copyright © Houghton Mifflin Company. All rights reserved.

Managers can improve the quality of budgets by using the following guidelines Know the purpose of the budget Identify the user group and its information needs Identify sources of accurate, meaningful budget information Establish a clear format for the budget Use appropriate formulas and calculations to derive quantitative information Revise the budget until it includes all planning decisions Copyright © Houghton Mifflin Company. All rights reserved.

Discussion Which budget must be prepared first?
The sales budget. This budget is used to estimate sales volume and revenues. Once established, the other budgets can be developed Copyright © Houghton Mifflin Company. All rights reserved.

Operating Budgets Objective 3
Prepare the operating budgets that support the financial budgets Copyright © Houghton Mifflin Company. All rights reserved.

Operating Budgets Procedures for preparing operating budgets include
Cost behavior analysis Cost-volume-profit analysis A product costing method Organizations that manufacture a variety of products or services may prepare Separate operating budgets, or One comprehensive budget for each product or service Copyright © Houghton Mifflin Company. All rights reserved.

Sales Budget … is a detailed plan, expressed in both units and dollars, that identifies the product (or service) sales expected in an accounting period Copyright © Houghton Mifflin Company. All rights reserved.

Sales Budget (cont’d) Sales mangers use the information to
Plan sales- and marketing-related activities Determine human, physical, and technical resource needs Accountants use the information to Determine estimated cash receipts for the cash budget To determine the total budgeted sales Copyright © Houghton Mifflin Company. All rights reserved.

Sales Budget (cont’d) Selecting the best estimates for selling price per unit and the sales demand in units can be difficult If the organization wants to increase its share in the market An estimated selling price below the current selling price may be needed If the organization has improved the product’s quality by using more expensive materials or production processes The estimated selling price may have to be higher than the current price Copyright © Houghton Mifflin Company. All rights reserved.

Sales Budget (cont’d) Estimated sales volume is very important
Will affect the level of operating activities and amount of resources needed for operations Managers may use a sales forecast A projection of sales demand based on an analysis of internal and external factors Copyright © Houghton Mifflin Company. All rights reserved.

Sales Budget (cont’d) External factors taken into consideration in a sales forecast include The state of the local and national economies The state of the industry’s economy The nature of the competition and its sales volume and selling price Copyright © Houghton Mifflin Company. All rights reserved.

Sales Budget (cont’d) Internal factors include
The number of units sold in prior periods The organization’s credit policies The organization’s collection policies The organization’s pricing policies Any new products the organization plans to introduce to the market The capacity of the organization’s manufacturing facilities Copyright © Houghton Mifflin Company. All rights reserved.

The Production Budget … is a detailed plan showing the number of units a company must produce to meet budgeted sales and inventory levels Production managers use this information to plan for the materials and human resources that production activities will require Copyright © Houghton Mifflin Company. All rights reserved.

The Production Budget (cont’d)
To prepare a production budget, managers must know Budgeted number of sales units From the sales budget Desired level of ending finished goods inventory for each period in the budget year Often stated as a percentage of the next period’s budgeted unit sales Copyright © Houghton Mifflin Company. All rights reserved.

The Production Budget (cont’d)
To determine the production needs for an accounting period Copyright © Houghton Mifflin Company. All rights reserved.

The Direct Materials Purchases Budget
… is a detailed plan that identifies the quantity of purchases required to meet budgeted production and inventory needs and the costs associated with those purchases Copyright © Houghton Mifflin Company. All rights reserved.

The Direct Materials Purchases Budget (cont’d)
Purchasing department Uses information to plan purchases of direct materials Accountants Use information to estimate cash payments to suppliers Copyright © Houghton Mifflin Company. All rights reserved.

To prepare a direct materials purchases budget managers must know What production needs will be in the next accounting period Provided in the production budget Desired level of direct materials inventory for each period Per unit cost of direct materials Desired level of ending direct materials inventory Usually stated as a percentage of the next period’s production Copyright © Houghton Mifflin Company. All rights reserved.

Steps to prepare a direct materials purchasing budget Calculate each period’s total production needs in units of direct materials Determine the total number of units of direct materials to be purchased during each accounting period in the budget Calculate the cost of the direct materials purchases Copyright © Houghton Mifflin Company. All rights reserved.

Direct Materials Purchases Budget

The Direct Labor Budget
… is a detailed plan that estimates the direct labor hours needed in an accounting period and the associated costs Copyright © Houghton Mifflin Company. All rights reserved.

The Direct Labor Budget (cont’d)
Production managers use estimated direct labor hours to plan How many employees will be required during the period The hours each employee will work Accountants use estimated direct labor costs to plan For cash payments to workers Human resource managers use information on the direct labor budget to Decide whether to hire new employees Reduce the existing work force Train employees Prepare schedules of employee fringe benefits Copyright © Houghton Mifflin Company. All rights reserved.

The Direct Labor Budget (cont’d)
Steps in preparing a direct labor budget Estimate the total direct labor hours Multiply estimated direct labor hours per unit by the anticipated units of production Calculate the total budgeted direct labor cost Copyright © Houghton Mifflin Company. All rights reserved.

The Manufacturing Overhead Budget
… is a detailed plan of anticipated manufacturing costs, other than direct materials and direct labor costs, that must be incurred to meet budgeted production needs Copyright © Houghton Mifflin Company. All rights reserved.

The Manufacturing Overhead Budget (cont’d)
Two purposes Integrate the overhead cost budgets developed by managers of production and production-related departments Group information for the calculation of manufacturing overhead rates for the forthcoming accounting period Copyright © Houghton Mifflin Company. All rights reserved.

The Manufacturing Overhead Budget (cont’d)
Presentation of information is flexible Grouping by activities is useful for organizations using activity-based costing Copyright © Houghton Mifflin Company. All rights reserved.

Manufacturing Overhead Budget

The Selling and Administrative Expense Budget
… is a detailed plan of operating expenses, other than those related to production, that are needed to support sales and overall operations in an accounting period Accountants use this budget to estimate cash payments for products or services used in nonproduction-related activities Copyright © Houghton Mifflin Company. All rights reserved.

Selling and Administrative Expense Budget

The Cost of Goods Manufactured Budget
… is a detailed plan that summarizes the estimated costs of production in an accounting period Sources of information Direct materials, direct labor, and manufacturing overhead budgets Copyright © Houghton Mifflin Company. All rights reserved.

Cost of Goods Manufactured Budget
Note that most companies anticipate some work in process at the beginning or end of a period covered by the budget Copyright © Houghton Mifflin Company. All rights reserved.

Discussion What are the sources of information for preparing the cost of goods manufactured budget? Direct materials budget Direct labor budget Manufacturing overhead budget Copyright © Houghton Mifflin Company. All rights reserved.

… are projections of financial results for an accounting period
Financial Budgets … are projections of financial results for an accounting period Include Budgeted income statement Capital expenditures budget Cash budget Budgeted balance sheet Copyright © Houghton Mifflin Company. All rights reserved.

The Budgeted Income Statement
… projects an organization’s net income in an accounting period based on revenues and expenses estimated for that period Copyright © Houghton Mifflin Company. All rights reserved.

Budgeted Income Statement

The Capital Expenditures Budget
…. is a detailed plan outlining the anticipated amount and timing of capital outlays for long-term assets in an accounting period Copyright © Houghton Mifflin Company. All rights reserved.

The Capital Expenditures Budget (cont’d)
Managers rely on information in a capital expenditures budget when making decisions about such matters as Buying equipment Building a new plant Purchasing and installing a materials handling system Acquiring another business Copyright © Houghton Mifflin Company. All rights reserved.

The Cash Budget … is a projection of the cash an organization will receive and the cash it will pay out in an accounting period Summarizes the cash flow prospects of all transactions considered in the master budget Copyright © Houghton Mifflin Company. All rights reserved.

The Cash Budget (cont’d)
Information it provides enables managers to plan for Short-term loans when the cash balance is low Short-term investments when the cash balance is high Copyright © Houghton Mifflin Company. All rights reserved.

Excludes some planned noncash transactions Depreciation expense Issuance and receipt of stock dividends Uncollectible accounts expense Gains and losses on sales of assets May also exclude Deferred taxes Accrued interest Copyright © Houghton Mifflin Company. All rights reserved.

Sources for estimating cash receipts Sales budget Budgeted income statement Cash budgets from previous periods Cash collection records and analyses of collection trends Records pertaining to notes, stocks, and bonds Copyright © Houghton Mifflin Company. All rights reserved.

Sources for estimating cash payments Operating budgets Budgeted income statement Capital expenditures budget Previous year’s financial statements Loan records Copyright © Houghton Mifflin Company. All rights reserved.

Schedule of Expected Cash Collections from Customers

Schedule of Expected Cash Payments for Direct Materials

Organizations may maintain a minimum cash balance To cover unusual expenditures If the ending cash balance on the cash budget Falls below the minimum level required Short-term borrowing may be necessary Is significantly larger than the minimum level required May invest excess in short-term securities to generate additional income Copyright © Houghton Mifflin Company. All rights reserved.

The Budgeted Balance Sheet
… projects an organization’s financial position at the end of an accounting period Uses all estimated data compiled in the course of preparing a master budget Is the final step in that process Copyright © Houghton Mifflin Company. All rights reserved.

Budgeted Balance Sheet

Discussion How is the ending cash balance estimated?
Subtract total estimated cash payments from total estimated cash receipts, then, add the estimated beginning cash balance alnce Copyright © Houghton Mifflin Company. All rights reserved.

Budget Implementation
Budget committee Oversees each stage in the master budget preparation Decides any departmental disputes that might arise in the process Gives final approval to the budget Copyright © Houghton Mifflin Company. All rights reserved.

Budget Implementation (cont’d)
Budget committee members Controller Has overall responsibility for budget implementation President Vice presidents The make-up of the committee ensures that the budgeting process has a companywide perspective Copyright © Houghton Mifflin Company. All rights reserved.

A master budget may go through many revisions after approval Budget committee monitors the progress the company is making in attaining budget targets Using periodic reports from department managers Copyright © Houghton Mifflin Company. All rights reserved.

Successful budget implementation depends on two factors Clear communication Support of top management Middle- and lower-level managers must see that top management supports the budget and encourages its implementation Copyright © Houghton Mifflin Company. All rights reserved.

Time for Review Define budgeting and explain its role in the management cycle Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets Prepare the operating budgets that support the financial budgets Copyright © Houghton Mifflin Company. All rights reserved.

And Finally… Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet Describe management’s role in budget implementation Copyright © Houghton Mifflin Company. All rights reserved.

The Budgeting Process Chapter 21

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