1. Prepared by Debby Bloom-Hill CMA, CFM

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 Budgetary Planning and Control  Budgets are the 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 and Control  Planning  Budgets enhance communication and coordination  The process of developing a formal plan forces managers to consider their goals and objectives and to specify means of achieving them  Budgets become the vehicle for communicating information about where the company is heading Learning objective 1: Discuss the use of budgets in planning and control

5. Slide 10-5 Use of Budgets in Planning and Control  Control  Budgets provide a basis for evaluating performance  Control makes sure the company is heading in the proper direction and operating efficiently  To control a company, it is essential to assess the performance of managers and their operations for which they are responsible Learning objective 1: Discuss the use of budgets in planning and control

6. Slide 10-6 Use of Budgets in Control  Often performance evaluation is carried out by comparing actual with planned or budgeted performance  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  Often the group within a company that is responsible for approval of the various budgets is the budget committee Learning objective 1: Discuss the use of budgets in planning and control

9. Slide 10-9 Developing the Budget  The budget committee consists of senior managers  The budget committee works with departments to develop realistic plans that are consistent with overall company goals  In some cases the budget committee may impose a budget without soliciting input from department managers Learning objective 1: Discuss the use of budgets in planning and control

10. Slide 10-10 Developing the Budget  In a top-down approach budgets are developed at higher operational levels without substantial input from lower level managers  In a bottom-up approach, lower level managers are the primary source of information used in setting the budget Learning objective 1: Discuss the use of budgets in planning and control

11. Slide 10-11 Budget Time Period  Managers must decide on an appropriate budget period  Depending on needs, budgets can be prepared for a variety of time periods  Long run budgets are prepared for a three or even a five year period  Short run budgets may cover a month, a quarter, or a year  Generally, the longer the time period, the less detailed the budget Learning objective 1: Discuss the use of budgets in planning and control

12. Slide 10-12 Five-Year Budgets Learning objective 1: Discuss the use of budgets in planning and control

13. Slide 10-13 Zero Base Budgeting  A common starting point in budgeting is previous period revenues and costs  Zero base requires budgeted amounts to be justified by each department at the start of each period  This results in a fresh consideration for the validity of budgeted amounts  It is a time consuming and expensive process  Not widely used by business enterprises Learning objective 1: Discuss the use of budgets in planning and control

14. Learning objective 2: Prepare the budget schedules that make up the master budget Slide 10-14 The Master Budget  The master budget is a comprehensive planning document that incorporates a number of individual budgets  Typically, it includes budgets for sales, production, direct materials, direct labor, manufacturing overhead, selling and administrative expense, capital acquisitions, and cash receipts and disbursements  Also includes budgeted income statement and balance sheet

15. Slide 10-15 Master Budget Learning objective 2: Prepare the budget schedules that make up the master budget

16. Slide 10-16 Sales Budget  The first step involved preparation of sales forecasts and a sales budget  Prepared first because an estimate of sales is needed for other budgets  Companies use numerous methods to estimate sales, including  Economic models  Sales trends  Trade journals, among others Learning objective 2: Prepare the budget schedules that make up the master budget

17. 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 Slide 10-17

18. Production Budget  The production budget can be developed once the sales budget has been prepared  In deciding how much to produce, managers must take into account how much they expect to sell, how much is in beginning inventory, and how much they want in ending inventory Learning objective 2: Prepare the budget schedules that make up the master budget Slide 10-18

19. Production Budget  The quantity that must be produced is calculated using the following formula Learning objective 2: Prepare the budget schedules that make up the master budget Slide 10-19 Finished units to be produced = Expected sales in units + Desired ending inventory of finished goods - Beginning inventory of finished units

20. Slide 10-20 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  Budget finished units to be produced Learning objective 2: Prepare the budget schedules that make up the master budget

21. Slide 10-21 Mason Manufacturing expects to sell 10,000 units in the first quarter and 14,000 in the second quarter. The company desires beginning inventory equal to 20% of sales for the coming quarter. Finished goods on hand at the start of the first quarter equals 2,000 units. How many units should be produced in the first quarter? a.14,000 units b.16,000 units c.10,800 units d.12,000 units Answer: c 10,800 units = 10,000 + 2,800 – 2,000 Learning objective 2: Prepare the budget schedules that make up the master budget

22. Direct Material Purchases Budget  The amount of direct materials that must be purchased depends on  The amount needed for production, and  The amount needed for ending inventory  The amount that must be purchased can be calculated from the following formula Learning objective 2: Prepare the budget schedules that make up the master budget Slide 10-22 Required purchases of direct materials = Amount required for production + Desired ending inventory of direct materials - Beginning inventory of direct materials

23. Slide 10-23 Budgeted production: Q1= 50,000; Q2= 60,000 Parts per unit= 3, cost per 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 per unit = 150,000 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/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

25. Slide 10-25 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 156,000 parts to purchase = 150,000 + 36,000 – 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

26. Slide 10-26 Direct Labor Budget  The direct labor budget presents the direct labor cost by quarter  Direct labor cost is calculated by multiplying the number of units produced each quarter by the labor hours per unit and the rate per hour  The direct labor budget can be used to budget the number of employees needed Learning objective 2: Prepare the budget schedules that make up the master budget

27. Slide 10-27 Direct Labor Budget Learning objective 2: Prepare the budget schedules that make up the master budget

28. Slide 10-28 Manufacturing Overhead Budget  The manufacturing overhead budget separates variable and fixed costs  The cost per unit of production of each variable cost item is multiplied by the quantity produced each quarter  The fixed costs are identical each quarter except for the amount of depreciation  Budget information is also needed for selling and administrative expenses Learning objective 2: Prepare the budget schedules that make up the master budget

29. Slide 10-29 Manufacturing Overhead Budget Learning objective 2: Prepare the budget schedules that make up the master budget

30. Slide 10-30 Selling and Administrative Expense Budget Learning objective 2: Prepare the budget schedules that make up the master budget

31. Slide 10-31 Budgeted Income Statement  Much of the information contained in the budgets already described is utilized in the preparation of a budgeted income statement  The sales figures come directly from the sales budget  Cost of goods sold requires a calculation of the unit cost of production Learning objective 2: Prepare the budget schedules that make up the master budget

32. Slide 10-32 Budgeted Income Statement  Calculation of the unit cost of production  The direct materials budget indicates the materials cost per unit  The direct labor budget indicates the labor cost per unit  The manufacturing overhead budget indicates the overhead cost per unit Learning objective 2: Prepare the budget schedules that make up the master budget

33. Slide 10-33 Capital Acquisitions Budget  For decisions with respect to long-lived assets such as plant and equipment  Incremental cash flows along with net present value and internal rate of return are used for evaluation  The final list of approved projects is documented in the capital acquisitions budget Learning objective 2: Prepare the budget schedules that make up the master budget

34. Slide 10-34 Cash Receipts and Disbursements Budget  Managers must plan for the amount and timing of cash flows  Careful planning of receipts and disbursements is 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

35. Slide 10-35 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

36. Slide 10-36 Estimate Cash Collections  To prepare an estimate of cash collections, management must determine the percent of credit sales revenue that is collected in the period of sale and the percent collected in the subsequent period  The percentage can be estimated based on past collection experience Learning objective 2: Prepare the budget schedules that make up the master budget

37. Slide 10-37 Estimate Cash Disbursements  To prepare an estimate of cash disbursements, management must determine the percent of material purchases that is paid in the period of purchase and the percent that is paid in the subsequent period  The timing of all other cash disbursements must also be considered Learning objective 2: Prepare the budget schedules that make up the master budget

38. Slide 10-38 Estimate Cash Disbursements  In preparing a cash budget, it is important to remember that some expenses do not require cash outlays  For example, depreciation is a part of manufacturing overhead but does not require a current outlay of cash  Another example of a noncash expense is the amortization of prepaid insurance Learning objective 2: Prepare the budget schedules that make up the master budget

39. Slide 10-39 Mason Manufacturing expects sales of $100,000 in the first quarter and $140,000in the second quarter. The company collects 70% of sales in the quarter sold and 30% in the subsequent quarter. What are expected cash collections in the second quarter? a.$128,000 b.$30,000 c.$98,000 d.$142,000 Answer: a $128,000 = (.3 * $100,000) + (.7 * $140,000) Learning objective 2: Prepare the budget schedules that make up the master budget

40. Slide 10-40 Budgeted Balance Sheet  The last component of the master budget is the budgeted balance sheet  This is simply a planned balance sheet  Sometimes called a pro forma balance sheet  Managers can use this budget to assess the effect of their planned decisions on the future financial position of the firm Learning objective 2: Prepare the budget schedules that make up the master budget

41. Slide 10-41 Use of Computers in the Budget Planning Process  Budget committee may review a budget and decide it is inconsistent with company goals  This conclusion may lead managers to explore a variety of actions that affect future costs and revenues  If managers decide to make changes, they must also revise the budget Learning objective 2: Prepare the budget schedules that make up the master budget

42. Slide 10-42 Use of Computers in the Budget Planning Process  Computers are very useful in this situation  Most companies define the budget relationships in a computer model  With computerized budget information, an item can be changed and the computer can recalculate that budget and any other budget affected by the change Learning objective 2: Prepare the budget schedules that make up the master budget

43. Slide 10-43 Budgetary Control  Budgets facilitate control by providing a standard for evaluation  The standard is the budgeted amount, against which actual results are compared  Differences between budgeted and actual amounts are referred to as budget variances Learning objective 2: Prepare the budget schedules that make up the master budget

44. Slide 10-44 Static and Flexible Budgets  In evaluating performance, care must be taken to make sure that the level of activity used in the budget is equal to the actual level of activity  A static budget is not adjusted for the actual level of production  A more appropriate analysis would make use of a flexible budget Learning objective 3: Explain why flexible budgets are needed for performance evaluation

45. Slide 10-45 Flexible Budgets  A flexible budget is a set of budget relationships that can be adjusted to various activity levels  Thus, flexible budgets take into account the fact that when production increases or decreases, variable costs can change  Fixed costs, however, stay the same Learning objective 3: Explain why flexible budgets are needed for performance evaluation

46. Slide 10-46 Flexible Budget Learning objective 3: Explain why flexible budgets are needed for performance evaluation

47. Slide 10-47 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

48. Slide 10-48 SpreadsheetsSpreadsheets Learning objective 3: Explain why flexible budgets are needed for performance evaluation

49. Slide 10-49 Investigating Budget Variances  Significant deviations from the budget, called budget variances, may have three causes 1.The budget may not have been well conceived 2.Conditions may have changed 3.Managers may have performed their jobs particularly well or poorly Learning objective 3: Explain why flexible budgets are needed for performance evaluation

50. Slide 10-50 Investigating Budget Variances  Using a management by exception approach, only exceptional variances are investigated  Generally, variances that are large in absolute dollars or relative to budgeted amounts are considered exceptional  It is important to point out that both exceptional “unfavorable” and exceptional “favorable” variances should be investigated Learning objective 3: Explain why flexible budgets are needed for performance evaluation

51. Slide 10-51 “Unfavorable” Budget Variance Learning objective 3: Explain why flexible budgets are needed for performance evaluation

52. Learning objective 4: Discuss the conflict between the planning and control uses of budgets Slide 10-52 Conflict in Planning and Control Uses of Budgets  Budgets are used for both planning and control  With respect to planning, they communicate company goals and help coordinate various activities  With respect to control, they focus the attention of managers on meeting or beating budget targets  There are inherent conflicts when budgets are used for both planning and control

53. Slide 10-53 Issues With Budget-Based Compensation  The following slide helps understanding of the two related problems  The illustration shows a common budget based compensation scheme in which a manager receives a “hurdle” bonus once a target is hit  Performance better than 80% of budgeted profit results in additional “variable” bonus Learning objective 4: Discuss the conflict between the planning and control uses of budgets

54. Slide 10-54 Common Budget-based Compensation Scheme Learning objective 4: Discuss the conflict between the planning and control uses of budgets

55. Slide 10-55 Issues With Budget-Based Compensation  The first problem is that managers have incentive to pad a budget and create budget slack  Budget slack is a budget with targets that are easy to achieve  The lower the budget target, the more likely it is that managers will receive the hurdle and variable bonus  Managers can create slack by lowering sales and increasing cost forecasts Learning objective 4: Discuss the conflict between the planning and control uses of budgets

56. Slide 10-56 Issues With Budget-Based Compensation  The second problem relates to the fact that managers who are evaluated may have an incentive to shift income from one period to another  Consider a manager who estimates that it is unlikely that the target will be met  The manager has an incentive to shift income from a future period to the current period Learning objective 4: Discuss the conflict between the planning and control uses of budgets

57. Slide 10-57 Issues With Budget-Based Compensation  The best that can be done to mitigate the conflict between the planning and control uses of budgets is to assure managers that their performance in comparison to the budget will be fairly evaluated and compensated  Managers should be confident that they will be allowed to comment on the real causes of budget variances and tell their side of the story Learning objective 4: Discuss the conflict between the planning and control uses of budgets

58. Slide 10-58 Budget Padding Learning objective 4: Discuss the conflict between the planning and control uses of budgets

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