1. Copyright © by Houghton Mifflin Company. All rights reserved.1 Financial & Managerial Accounting 2002e Belverd E. Needles, Jr. Marian Powers Susan Crosson - - - - - - - - - - - Multimedia Slides by: Harry Hooper Santa Fe Community College

2. Copyright © by Houghton Mifflin Company. All rights reserved.2 Chapter 21 The Budgeting Process

3. Copyright © by Houghton Mifflin Company. All rights reserved.3 1. Define budgeting and explain its role in the management cycle. 2. Describe the master budget process for different types of organizations, and list the guidelines for preparing budgets. LEARNING OBJECTIVES

4. Copyright © by Houghton Mifflin Company. All rights reserved.4 3. Prepare a budgeted income statement and supporting operating budgets 4. Prepare a cash budget. 5. Prepare a budgeted balance sheet. LEARNING OBJECTIVES

5. Copyright © by Houghton Mifflin Company. All rights reserved.5 The Budgeting Process OBJECTIVE 1 Define budgeting and explain its role in the management cycle.

6. Copyright © by Houghton Mifflin Company. All rights reserved.6 The Budgeting Process u Budgeting is the process of: 4 Identifying 4 Gathering 4 Summarizing 4 Communicating financial and nonfinancial information about an organization’s future activities.

7. Copyright © by Houghton Mifflin Company. All rights reserved.7 u Budget – a plan of action that forecasts future transactions, activities and events in financial or non-financial terms. u Budgets are used in government, not-for-profit and profit-oriented businesses. u Cash Budgets establish target levels of cash receipts and limits on cash spending for particular purposes. u Production Budgets show planned production in units. u JIT and TQM require continuously updated budgets.

8. Copyright © by Houghton Mifflin Company. All rights reserved.8 The Budgeting Process u The budgeting process provides managers with the opportunity to carefully match the goals of the organization with the resources necessary to accomplish those goals.

9. Copyright © by Houghton Mifflin Company. All rights reserved.9 Budgeting and Goals u Long-Term Goals: 5 to 10 year projections, set by top management. 4 Include quality projections, growth rates and desired market share 4 Set specific targets and expected timetables 4 Name the people responsible for achieving the goals 4 Include future profit projections and describe new products and services

10. Copyright © by Houghton Mifflin Company. All rights reserved.10 Budgeting and Goals u Short-Term Goals: 1 year plan, more detailed. 4 Include sales and profit targets by product or service n Define human resource needs n State plans for introducing new products or services n Set a timetable for all parts of the year’s operating plan 4 Name people and their responsibilities, targets and deadlines

11. Copyright © by Houghton Mifflin Company. All rights reserved.11 The Importance of Participation All appropriate people, from top managers to first-line supervisors, who participate in preparing the budget must be identified. Participative Budgeting involves all levels of an organization taking part in creating the budget. Participation results in motivation. Dictated targets de-motivate.

12. Copyright © by Houghton Mifflin Company. All rights reserved.12 Examples of Budgets

13. Copyright © by Houghton Mifflin Company. All rights reserved.13 The Management Cycle u Managers use the budgeting process throughout the management cycle to help: 4 Plan 4 Execute 4 Review 4 Report the organization’s financing, investing, and operating activities.

14. Copyright © by Houghton Mifflin Company. All rights reserved.14 Budgeting and the Management Cycle

15. Copyright © by Houghton Mifflin Company. All rights reserved.15 The Planning Stage u Budgeting pertains especially to the planning stage. 4 Budgets are tied to long-range and short- range plans to meet success factors related to quality, cost, and time. 4 Resources and workloads are distributed to specific products, departments, sales territories and activities.

16. Copyright © by Houghton Mifflin Company. All rights reserved.16 The Planning Stage u Budget information is used to communicate responsibilities to individuals who are accountable for a particular segment of the organization. u Performance measures are carefully selected to motivate individuals or teams to achieve targeted goals.

17. Copyright © by Houghton Mifflin Company. All rights reserved.17 The Executing Stage u During the executing stage, managers use budget information for: Communication Benchmarking Problem recognition

18. Copyright © by Houghton Mifflin Company. All rights reserved.18 The Reviewing Stage u In the reviewing stage, managers: Calculate variances Evaluate performances Review timeliness Create solutions for continuous improvement

19. Copyright © by Houghton Mifflin Company. All rights reserved.19 The Reporting Stage u In the reporting stage, budgets serve as a reference point for many reports, such as performance reports that support bonuses and promotions.

20. Copyright © by Houghton Mifflin Company. All rights reserved.20 A. 1. Calculate variances 2. Evaluate performance 3. Determine timeliness 4. Create solutions for continuous improvementDiscussion Q. Q. What are some examples of ways that budgeting can help managers during the reviewing stage of the management cycle?

21. Copyright © by Houghton Mifflin Company. All rights reserved.21 The Master Budget OBJECTIVE 2 Describe the master budget process for different types of organizations, and list the guidelines for preparing budgets.

22. Copyright © by Houghton Mifflin Company. All rights reserved.22 The Master Budget u The master budget is a set of budgets that consolidates an organization’s financial information into budgeted financial statements for a future period of time. They include: Operating budgets. Budgeted balance sheet. Cash budget. Capital expenditure budget.

23. Copyright © by Houghton Mifflin Company. All rights reserved.23 Preparation of a Master Budget for a Manufacturing Organization

24. Copyright © by Houghton Mifflin Company. All rights reserved.24 The Budgeting Process u Manufacturing, retail, and service organizations’ differ in their preparation. u In all 3 cases, the operating budgets support the budgeted income statement.

25. Copyright © by Houghton Mifflin Company. All rights reserved.25 Manufacturing Organizations u The operating budgets for a manufacturing organization include budgets for: Sales. Production. Direct materials purchases. Direct labor.Manufacturing overhead. Cost of goods manufactured. Selling and administrative expenses.

26. Copyright © by Houghton Mifflin Company. All rights reserved.26 Retail Organizations u Managers of retail organizations must know: What products to sell. Estimated quantities to be sold. The selling price for each.

27. Copyright © by Houghton Mifflin Company. All rights reserved.27 Retail Organizations u The operating budgets for retail organizations include the: Sales budget. Purchases budget. Cost of goods sold budget. Selling and administrative budget.

28. Copyright © by Houghton Mifflin Company. All rights reserved.28 Preparation of a Master Budget for a Retail Organization

29. Copyright © by Houghton Mifflin Company. All rights reserved.29 Service Organizations u Managers of service organizations must know the types and amounts of: Services to perform. Labor hours required. Level of expertise of employees. Labor rates.

30. Copyright © by Houghton Mifflin Company. All rights reserved.30 Service Organizations u The operating budgets for service organizations include: Service revenue. Labor. Services overhead. Selling and administrative budget.

31. Copyright © by Houghton Mifflin Company. All rights reserved.31 Preparation of a Master Budget for a Service Organization

32. Copyright © by Houghton Mifflin Company. All rights reserved.32 Guidelines for Budget Preparation u To improve the quality of the budgets, managers need to know: Why the budget is being prepared. Who will read and use it. How the information will be presented. Where the information can be found. u Several revisions may be required before the final version is ready.

33. Copyright © by Houghton Mifflin Company. All rights reserved.33 A. 1.Budgeted income statement. 2.Budgeted balance sheet. 3.Cash budget.Discussion Q. Q.What three financial statements are included in the preparation of a master budget?

34. Copyright © by Houghton Mifflin Company. All rights reserved.34 The Operating Budgets OBJECTIVE 3 Prepare a budgeted income statement and supporting operating budgets.

35. Copyright © by Houghton Mifflin Company. All rights reserved.35 The Master Budget u A master budget consists of: Detailed operating budgets. Budgeted income statement. Capital expenditures budget. Cash budget. Budgeted balance sheet.

36. Copyright © by Houghton Mifflin Company. All rights reserved.36 The Operating Budgets u Detailed operating budgets include the: Sales budget (in units and dollars). Production budget (in units). Direct materials purchases budget (in units and dollars). Direct labor budget (in hours and dollars). Manufacturing overhead budget. Selling and administrative expense budget. Cost of Goods Manufactured budget.

37. Copyright © by Houghton Mifflin Company. All rights reserved.37 Sales Budget Based on the Sales forecast, influenced by: External 4 The state of the local and national economies. 4 The state of the industry’s economy. 4 The nature of the competition. Internal 4 Number of units sold in prior periods. 4 Credit policies and collection policies. 4 Pricing policies. 4 New product plans. 4 Manufacturing capacity.

38. Copyright © by Houghton Mifflin Company. All rights reserved.38 Sales Budget Hi-Flyer Company Sales Budget For the Year Ended December 31, 20x1 Quarter 1234Year Sales in Units10,00030,00010,00040,00090,000 x Selling Price per Unit$ 5 Total Sales$ 50,000$150,000$ 50,000$200,000$450,000

39. Copyright © by Houghton Mifflin Company. All rights reserved.39 Production Budget u Based on sales and inventory needs. u Used to plan for technical and human resources needed. Total Production Units = Budgeted Sales in Units + Desired Units of Ending Finished Goods Inventory - Desired Units of Beginning Finished Goods Inventory

40. Copyright © by Houghton Mifflin Company. All rights reserved.40 Production Budget Hi-Flyer Company Production Budget For the Year Ended December 31, 20x1 Quarter 1234Year Sales in Units10,00030,00010,00040,00090,000 Add Desired Units of Ending Finished Goods Inventory3,0001,0004,0001,500 Desired Total Units13,00031,00014,00041,50091,500 Less Desired Units of Beginning Finished Goods Inventory1,0003,0001,0004,0001,000 Total Production Units12,00028,00013,00037,50090,500

41. Copyright © by Houghton Mifflin Company. All rights reserved.41 Direct Materials Purchases Budget u Based on production and inventory needs. u Used to plan direct material purchases and to estimate cash payments to suppliers. Total Units of Direct Materials Purchased = Total Production Needs in Units of Direct Materials + Desired Units of Ending Direct Materials Inventory – Desired Units of Beginning Direct Materials Inventory

42. Copyright © by Houghton Mifflin Company. All rights reserved.42 Direct Labor Budget u Based on production needs, labor pay rates, staffing levels, and productivity projections. u Used to schedule (and hire) employees and to estimate cash payments to workers. Total Budgeted Direct Labor Cost = Estimated Total Direct Labor Hours x Estimated Direct Labor Cost per Hour

43. Copyright © by Houghton Mifflin Company. All rights reserved.43 Direct Labor Budget Hi-Flyer Company Direct Labor Budget For the Year Ended December 31, 20x1 Quarter 1234Year Total Production Units12,00028,00013,00037,50090,500 x Direct Labor Hours per Unit.1 Total Direct Labor Hours1,2002,8001,3003,7509,050 x Direct Labor Cost per Hour$ 6 Total Production Units$ 7,200$16,800$ 7,800$22,500$54,300

44. Copyright © by Houghton Mifflin Company. All rights reserved.44 The Manufacturing Overhead Budget u Details manufacturing costs, other than direct materials and labor. u Used to integrate overhead cost budgets and to calculate manufacturing overhead rates. u Categorized by variable and fixed overhead costs. u Frequently broken down by each cost pool.

45. Copyright © by Houghton Mifflin Company. All rights reserved.45 The Selling and Administrative Budget u Details operating expenses, other than production costs, needed to support sales and overall operations u Used to estimate cash payments for non-production-related products and services u Frequently broken into variable and fixed cost groups

46. Copyright © by Houghton Mifflin Company. All rights reserved.46 The Cost of Goods Manufactured Budget u Summarizes production costs, using Direct Materials, Direct Labor and Manufacturing Overhead Budgets

47. Copyright © by Houghton Mifflin Company. All rights reserved.47 Cost of Direct Materials Used = Cost of Total Units of Direct Materials Purchased + Cost of Beginning Direct Materials Inventory - Cost of Ending Direct Materials Inventory The Cost of Goods Manufactured Budget Cost of Goods Manufactured = Total Manufacturing Costs for the Period + Cost of Beginning Work in Process Inventory - Cost of Ending Work in Process Inventory Total Manufacturing Costs for the Period = Manufacturing Overhead Costs + Direct Labor Costs + Cost of Direct Materials Used

48. Copyright © by Houghton Mifflin Company. All rights reserved.48 The Budgeted Income Statement u Prepared after all of the operating budgets u Projects net income based on estimated revenues and expenses

49. Copyright © by Houghton Mifflin Company. All rights reserved.49 The Capital Expenditures Budget u Outlines amount and timing of anticipated capital expenditures. u Examples: 4 Buying equipment 4 Building a new store 4 Purchasing and installing a materials handling system

50. Copyright © by Houghton Mifflin Company. All rights reserved.50 A. 1. Detailed operating budgets. 2. Budgeted income statement. 3. Capital expenditures budget. 4. Budgeted balance sheet.Discussion Q. Q. What are the four major sections of the master budget?

51. Copyright © by Houghton Mifflin Company. All rights reserved.51 Cash Budgeting OBJECTIVE 4 Prepare a cash budget.

52. Copyright © by Houghton Mifflin Company. All rights reserved.52 The Cash Budget u A cash budget is a projection over a period of time of: 4 Beginning cash. 4 Cash receipts. 4 Cash payments. 4 Ending cash.

53. Copyright © by Houghton Mifflin Company. All rights reserved.53 Elements of a Cash Budget ActivitiesCash Receipts FromCash Payments For Operating Cash sales Cash collections on credit sales. Interest income from investments Cash dividends from investments Purchases of direct materials Purchases of operating supplies Direct labor Manufacturing overhead expenses Selling expenses Interest Expense Administrative expenses Investing Sale of investments Sale of long-term assets Purchase of investments Purchase of long-term assets Financing Loan proceeds Proceeds from sale of stock Proceeds from sale of bonds Loan repayment Cash dividends to stockholders

54. Copyright © by Houghton Mifflin Company. All rights reserved.54 The Cash Budget u Excludes planned non-cash transactions and expenses. u Examples: 4 Depreciation expense 4 Amortization expense 4 Issuance and receipt of stock dividends 4 Uncollectable accounts expenses 4 Gains and losses on sales of assets

55. Copyright © by Houghton Mifflin Company. All rights reserved.55 Preparing a Cash Budget u Estimated Ending Cash Balance = Total Estimated Cash Receipts - Total Estimated Cash Payments + Estimated Beginning Cash Balance u Supporting schedules may include: 4 Schedule of Estimated Cash Collections 4 Schedule of Estimated Cash Disbursements for Materials, Labor and Overhead

56. Copyright © by Houghton Mifflin Company. All rights reserved.56 A. 1. Operating activities 2. Investing activities 3. Financing activitiesDiscussion Q. Q.What are the three major activity classifications of a cash budget?

57. Copyright © by Houghton Mifflin Company. All rights reserved.57 Budgeted Balance Sheet OBJECTIVE 5 Prepare a budgeted balance sheet.

58. Copyright © by Houghton Mifflin Company. All rights reserved.58 u Information from all other elements of a master budget is used to prepare a budgeted balance sheet. u A budgeted balance sheet projects the financial position of an organization at the end of a future period. Budgeted Balance Sheet

59. Copyright © by Houghton Mifflin Company. All rights reserved.59 The Cash Budget u Two success factors for implementing a budget are: Communications: Communication of expectations and targets to all key people in the organization. Support: Top management must appear willing to reward people for meeting the organization’s goals that are represented in the budget.

60. Copyright © by Houghton Mifflin Company. All rights reserved.60 A. 1. Communication 2. SupportDiscussion Q. Q.What two factors are needed for the successful implementation of a budget?

61. Copyright © by Houghton Mifflin Company. All rights reserved.61 OK, LET’S REVIEW… 1. Define budgeting and explain its role in the management cycle. 2. Describe the master budget process for different types of organizations, and list the guidelines for preparing budgets. 3. Prepare a budgeted income statement and supporting operating budgets.

62. Copyright © by Houghton Mifflin Company. All rights reserved.62 AND FINALLY… 4. Prepare a cash budget. 5. Prepare a budgeted balance sheet.