CHAPTER Budgetary Planning ASSIGNMENT CLASSIFICATION TABLE Brief Exercises A Problems B Problems 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11 1A, 2A, 3A 1B, 2B, 3B 11 1A, 2A, 3A, 6A 1B, 2B, 3B 19, 20 12, 13, 14, 15, 16 4A, 6A 4B 21, 22 10 3, 15, 16, 17 5A 5B Study Objectives Questions Indicate the benefits of budgeting 1, 2, State the essentials of effective budgeting 3, 5, 6, 7, Identify the budgets that comprise the master budget 9, 10, 11, 12, 13, 14, 15, 16 1, 2, 3, 4, 5, 6, Describe the sources for preparing the budgeted income statement 17, 18 Explain the principal sections of a cash budget Indicate the applicability of budgeting in nonmanufacturing companies 9-1 Exercises ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Prepare budgeted income statement and supporting budgets Simple 30–40 2A Prepare sales, production, direct materials, direct labor, and income statement budgets Simple 40–50 3A Prepare sales and production budgets and compute cost per unit under two plans Moderate 30–40 4A Prepare cash budget for two months Moderate 30–40 5A Prepare purchases and income statement budgets for a merchandiser Simple 30–40 6A Prepare budgeted income statement and balance sheet Complex 40–50 1B Prepare budgeted income statement and supporting budgets Simple 30–40 2B Prepare sales, production, direct materials, direct labor, and income statement budgets Simple 40–50 3B Prepare sales and production budgets and compute cost per unit under two plans Moderate 30–40 4B Prepare cash budget for two months Moderate 30–40 5B Prepare purchases and income statement budgets for a merchandiser Simple 30–40 9-2 9-3 Q9-21 Q9-22 Broadening Your Perspective Indicate the applicability of budgeting in nonmanufacturing companies Q9-19 Explain the principal sections of a cash budget Identify the budgets that comprise the master budget Describe the sources for preparing the budgeted income statement State the essentials of effective budgeting Q9-7 Q9-8 E9-1 Q9-4 E9-1 BE9-10 E9-3 E9-15 E9-16 Q9-20 BE9-9 E9-12 Q9-17 BE9-8 E9-11 Q9-12 Q9-13 Q9-14 Q9-15 Q9-16 BE9-2 BE9-3 BE9-4 BE9-5 E9-13 E9-14 E9-15 Analysis E9-17 P9-5A P9-5B E9-16 P9-4A P9-4B Manag Analysis Communication Real-World Focus Exploring the Web BE9-1 E9-9 E9-10 E9-11 P9-1A P9-2A P9-1B P9-2B P9-1A P9-1B P9-2A P9-2B P9-6A BE9-6 BE9-7 E9-2 E9-3 E9-4 E9-5 E9-6 E9-7 E9-8 Application Real-World Focus All About You Q9-18 Q9-9 Q9-10 Q9-11 E9-1 Q9-3 Q9-5 Q9-6 Q9-1 Q9-2 Knowledge Comprehension Indicate the benefits of budgeting Study Objective Decision Making Across the Organization Manag Analysis Communication Synthesis Ethics Case Decision Making Across the Organization All About You P9-3A P9-3B P9-3A P9-3B Evaluation Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems BLOOM’S TAXONOMY TABLE STUDY OBJECTIVES INDICATE THE BENEFITS OF BUDGETING STATE THE ESSENTIALS OF EFFECTIVE BUDGETING IDENTIFY THE BUDGETS THAT COMPRISE THE MASTER BUDGET DESCRIBE THE SOURCES FOR PREPARING THE BUDGETED INCOME STATEMENT EXPLAIN THE PRINCIPAL SECTIONS OF A CASH BUDGET INDICATE THE APPLICABILITY OF BUDGETING IN NONMANUFACTURING COMPANIES 9-4 CHAPTER REVIEW Budgeting Basics (S.O 1) A budget is a formal written statement of management’s plans for a specified time period, expressed in financial terms The role of accounting during the budgeting process is to (a) provide historical data on revenues, costs, and expenses, (b) express management’s plans in financial terms, and (c) prepare periodic budget reports Benefits of Budgeting The primary benefits of budgeting are as follows: a It requires all levels of management to plan ahead b It provides definite objectives for evaluating performance c It creates an early warning system for potential problems d It facilitates the coordination of activities within the business e It results in greater management awareness of the entity’s overall operations f It motivates personnel throughout the organization Essentials of Effective Budgeting (S.O 2) In order to be effective management tools, budgets must be based upon a A sound organizational structure in which authority and responsibility are clearly defined b Research and analysis to determine the feasibility of new products, services, and operating techniques c Management acceptance which is enhanced when all levels of management participate in the preparation of the budget, and the budget has the support of top management The most common budget period is one year A continuous twelve-month budget results from dropping the month just ended and adding a future month The annual budget is often supplemented by monthly and quarterly budgets The responsibility for coordinating the preparation of the budget is assigned to a budget committee The budget committee usually includes the president, treasurer, chief accountant (controller), and management personnel from each major area of the company A budget can have a significant impact on human behavior A budget may have a strong positive influence on a manager when a Each level of management is invited and encouraged to participate in developing the budget b Criticism of a manager’s performance is tempered with advice and assistance Long-range planning involves the selection of strategies to achieve long-term goals and the development of policies and plans to implement the strategies Long-range plans contain considerably less detail than budgets The Master Budget (S.O 3) The master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period It is developed within the framework of a sales forecast which shows potential sales for the industry and the company’s expected share of such sales 9-5 10 There are two classes of budgets in the master budget a Operating budgets are the individual budgets that result in the preparation of the budgeted income statement b Financial budgets focus primarily on the cash resources needed to fund expected operations and planned capital expenditures 11 The sales budget is the first budget prepared It is derived from the sales forecast, and it represents management’s best estimate of sales revenue for the budget period It is prepared by multiplying the expected unit sales volume for each product by its anticipated unit selling price 12 The production budget shows the units that must be produced to meet anticipated sales It is derived from the budgeted sales units plus the desired ending finished goods units less the beginning finished goods units 13 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 plus the desired ending direct materials units less the beginning direct materials units 14 The direct labor budget shows the quantity (hours) and cost of direct labor necessary to meet production requirements The direct labor budget is critical in maintaining a labor force that can meet expected levels of production 15 The manufacturing overhead budget shows the expected manufacturing overhead costs The selling and administrative expense budget is a projection of anticipated operating expenses Both budgets distinguish between fixed and variable costs Budgeted Income Statement 16 (S.O 4) The budgeted income statement is the important end-product in preparing operating budgets This budget indicates the expected profitability of operations and it provides a basis for evaluating company performance a The budget is prepared from the budgets described in review points 11-15 b For example, to find cost of goods sold, it is necessary to determine the total unit cost of a finished product using the direct materials, direct labor, and manufacturing overhead budgets Cash Budget 17 (S.O 5) The cash budget shows anticipated cash flows It contains three sections (cash receipts, cash disbursements, and financing) and the beginning and ending cash balances Data for preparing this budget are obtained from the other budgets 18 The budgeted balance sheet is a projection of financial position at the end of the budget period It is developed from the budgeted balance sheet for the preceding year and the budgets for the current year Budgeting in Nonmanufacturing Companies 19 (S.O 6) The major differences in the master budget of a merchandiser and a manufacturing company are that a merchandiser (a) uses a merchandise purchases budget instead of a production budget and (b) does not use the manufacturing budgets (direct materials, direct labor, and manufacturing overhead) 9-6 20 In service enterprises, the critical factor in budgeting is coordinating professional staff needs with anticipated services Budget data for service revenue may be obtained from expected output or expected input 21 In the budget process for not-for-profit organizations, the emphasis is on cash flows rather than on a revenue and expense basis For governmental units, the budget must be strictly followed and overspending is often illegal 9-7 LECTURE OUTLINE A Budgeting Basics Planning is the process of establishing enterprise-wide objectives A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms Accounting information makes major contributions to the budgeting process B The Benefits of Budgeting TEACHING TIP Use ILLUSTRATION 9-1 to discuss the benefits of budgeting Point out that even though the budget process is procedural, it has behavioral implications that could have a positive or negative effect on the accomplishment of company goals It requires all levels of management to plan ahead and to formalize goals on a recurring basis It provides definite objectives for evaluating performance at each level of responsibility It creates an early warning system for potential problems so that management can make changes before things get out of hand It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives 9-8 It results in greater management awareness of the entity’s overall operations and the impact on operations of external factors, such as economic trends It motivates personnel throughout the organization to meet planned objectives C Essentials of Effective Budgeting The essentials of effective budgeting are (a) sound organizational structure, (b) research and analysis, and (c) acceptance by all levels of management D a Effective budgeting depends on a sound organizational structure In such a structure, authority and responsibility for all phases of operations are clearly defined b Budgets based on research and analysis should result in realistic goals that will contribute to the growth and profitability of a company c The effectiveness of a budget program is directly related to its acceptance by all levels of management Length of the Budget Period A budget may be prepared for any period of time Various factors influence the length of the budget period a The type of budget b The nature of the organization c The need for periodic appraisal d Prevailing business conditions 9-9 The budget period should be long enough to provide an attainable goal under normal business conditions and should minimize the impact of seasonal or cyclical fluctuations The most common budget period is one year TEACHING TIP Use ILLUSTRATION 9-2 to give an overview of the budgeting process and identify those who are responsible for coordinating its preparation E The Budgeting Process/Budgeting and Human Behavior The budget is developed within the framework of a sales forecast that shows potential sales for the industry and the company’s expected share of such sales Sales forecasting involves a consideration of various factors: a General economic conditions b Industry trends c Market research studies d Anticipated advertising and promotion e Previous market share f Changes in prices g Technological developments The input of sales personnel and top management is essential to the sales forecast In larger companies, a budget committee has responsibility for coordinating the preparation of the budget 9-10 G The Master Budget The master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period TEACHING TIP Use ILLUSTRATION 9-3 to describe the components of the master budget Point out that the individual budgets making up the master budget are prepared in an ordered sequence The information developed in one individual budget serves as input in preparing other budgets Budgeting is an interrelated process Sales Budget: The sales budget is the starting point in preparing the master budget a Each of the other budgets depends on the sales budget b The sales budget is derived from the sales forecast and it represents management’s best estimate of sales revenue for the budget period Production Budget: The production budget shows the units that must be produced to meet anticipated sales a Production requirements are determined from the following formula: Budgeted Sales Units + Desired Ending Finished Goods Units – Beginning Finished Goods Units = Required Production Units TEACHING TIP ILLUSTRATION 9-4 provides a production requirements formula and illustrates the preparation of a production budget b The production budget provides the basis for the budgeted costs for each manufacturing cost element 9-12 Direct Materials: The direct materials budget shows both the quantity and cost of direct materials to be purchased a The quantities of direct materials are derived from the following formula: Direct Materials Units Required for Production + Desired Ending Direct Materials Units – Beginning Direct Materials Units = Required Direct Materials Units to be Purchased TEACHING TIP ILLUSTRATION 9-5 provides a formula for direct materials quantities and illustrates the preparation of a direct materials budget b The desired ending inventory is a key component in the budgeting process; inadequate inventories could result in temporary shutdowns of production Direct Labor: The direct labor budget contains the quantity (hours) and cost of direct labor necessary to meet production requirements a The direct labor budget is critical in maintaining a labor force that can meet the expected levels of production b The direct labor budget is also used in preparing the budgeted cost of goods sold and the cash budget Manufacturing Overhead: The manufacturing overhead budget shows the expected variable and fixed manufacturing overhead costs for the budget period Selling and Administrative Expense: The selling and administrative expense budget projects anticipated selling and administrative expenses for the budget period This budget classifies expenses as either variable or fixed This budget is also used in preparing the budgeted income statement and the cash budget 9-13 Budgeted Income Statement: The budgeted income statement is the important end-product of the operating budgets a This budget indicates the expected profitability of operations for the budget period b The budgeted income statement provides the basis for evaluating company performance Cash Budget: The cash budget shows anticipated cash flows a Because cash is so vital, this budget is often considered to be the most important financial budget b The cash budget contains three sections: (1) Cash receipts (2) Cash disbursements (3) Financing TEACHING TIP ILLUSTRATION 9-6 provides a format for preparing a cash budget Point out that a cash budget is prepared for a period of time, such as a month, a quarter, a year c Companies obtain data for preparing the cash budget from other budgets and from information provided by management d A cash budget contributes to more effective cash management It shows managers when additional financing is necessary well before the actual need arises and it indicates when excess cash is available for investments or other purposes 10 Budgeted Balance Sheet: The budgeted balance sheet is developed from the budgeted balance sheet for the preceding year and the budgets for the current year 9-14 H Budgeting in Nonmanufacturing Companies Budgets are also used by: a Merchandisers b Service enterprises c Not-for-profit organizations The major differences between the master budgets of a merchandiser and a manufacturer are that a merchandiser: a Uses a merchandise purchases budget instead of a production budget b Does not use the manufacturing budgets (direct materials, direct labor, and manufacturing overhead) In service enterprises, such as a public accounting firm, a law office, or a medical practice, the critical factor in budgeting is coordinating professional staff needs with anticipated services a If a firm is overstaffed, several problems may result: (1) Labor costs will be disproportionately high (2) Profits will be lower because of the additional salaries (3) Staff turnover may increase because of lack of challenging work b If a service enterprise is understaffed, it may loose revenue because existing and prospective client needs for service cannot be met Also, professional staff may seek other jobs because of excessive work loads 9-15 Budgeting is just as important for not-for-profit organizations as for profitoriented enterprises a In most cases, not-for-profit entities budget on the basis of cash flows (expenditures and receipts), rather than on a revenue and expense basis b The starting point in budgeting is usually expenditures, not receipts 9-16 20 MINUTE QUIZ Circle the correct answer True/False Budgeting is the process of establishing enterprise-wide objectives that serve as a deterrent to waste and inefficiency True The effectiveness of the budget program is directly related to its acceptance by all levels of management True False The budgeted income statement indicates the expected profitability of operations for the next year and provides the basis for evaluating company performance True False The manufacturing overhead budget shows only the expected indirect labor costs for the year True False The quantities of direct materials in the direct materials budget are derived from the formula: Desired Ending Direct Materials Units + Direct Materials Units Required for Production – Beginning Direct Materials Units = Required Direct Materials Units to be Purchased True False The sales budget is the first budget prepared and each of the other budgets depends on it True False One disadvantage of budgeting is that it does not facilitate the coordination of activities within a business True False Budgeting always has the effect on human behavior of inspiring managers to higher levels of performance True False False Long-range planning differs from budgeting in the time period involved, emphasis, and the amount of detail presented True False 9-17 10 Budgeting is not used in not-for-profit organizations because it is not necessary for these organizations to engage in profit planning True False Multiple Choice A formal written statement of management’s plans for a specified future time period, expressed in financial terms is a(n) a accounting plan b budget c research analysis d sales budget Which of the following is not a benefit of budgeting? a It reveals the prevailing business conditions b It results in greater management awareness of the entity’s overall operations c It creates an early warning system of potential problems d It provides definite objectives for evaluating performance at each level of responsibility All of the following are financial budgets except the a budgeted balance sheet b budgeted income statement c capital expenditure budget d cash budget The master budget includes all of the following except a Budgeted Income Statement b Capital Expenditure Budget c Cash Budget d Indirect Labor Budget If required production units are 75,000, budgeted sales units are 65,000, required direct materials purchases units are 3,000, and beginning finished goods units are 5,000, then desired ending finished goods units would be a 2,000 b 5,000 c 12,000 d 15,000 9-18 ANSWERS TO QUIZ True/ False False True False False True 10 True False True True False Multiple Choice b a b d d 9-19 ILLUSTRATION 9-1 BENEFITS OF BUDGETING It requires all levels of management to plan ahead and to formalize goals on a recurring basis It provides definite objectives for evaluating performance at each level of responsibility It creates an early warning system for potential problems so that management can make changes before things get out of hand It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives It results in greater management awareness of the entity's overall operations and the impact on operations of external factors It motivates personnel throughout the organization to meet planned objectives 9-20 ILLUSTRATION 9-2 BUDGETING PROCESS BUDGET COMMITTEE MASTER BUDGET OPERATING BUDGETS FINANCIAL BUDGETS DATA FROM ORGANIZATIONAL UNITS 9-21 ILLUSTRATION 9-3 COMPONENTS OF THE MASTER BUDGET Sales Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Operating Budgets Budgeted Balance Sheet Financial Budgets Selling and Administrative Expense Budget Budgeted Income Statement Capital Expenditure Budget Cash Budget 9-22 ILLUSTRATION 9-4 PRODUCTION BUDGET PRODUCTION REQUIREMENTS FORMULA Budgeted Sales Units + Desired Ending Finished Goods Units – Beginning Finished Goods Units Required Production Units = EXAMPLE COMPANY Production Budget For the Quarter Ended March 31, 2008 Expected unit sales Add: Desired ending finished goods units Total units required Less: Beginning finished goods units Required production units 9-23 75,000 5,000 80,000 8,000 72,000 ILLUSTRATION 9-5 DIRECT MATERIALS BUDGET FORMULA FOR DIRECT MATERIALS QUANTITIES Direct Materials Units Required for Production + Desired Ending Direct Materials Units – Beginning Direct Materials Units = Required Direct Materials Units to be Purchased EXAMPLE COMPANY Direct Materials Budget For the Quarter Ended March 31, 2008 Units to be produced Direct materials per unit Total materials needed for production Add: Desired ending direct materials Total materials required Less: Beginning direct materials Direct materials units to be purchased Cost per unit Total cost of direct materials purchased 9-24 72,000 × 216,000 20,000 236,000 18,000 218,000 × $5 $1,090,000 ILLUSTRATION 9-6 CASH BUDGET EXAMPLE COMPANY Cash Budget For the Quarter Ended March 31, 2008 Beginning cash balance $100,000 Add: Cash receipts (Itemized) 250,000 Total available cash 350,000 Less: Cash disbursements (Itemized) 310,000 Excess (deficiency) of available cash over disbursements 40,000 Financing 60,000 Ending cash balance required $100,000 Note: Management requires a minimum cash balance of $100,000 at the end of each quarter 9-25 ... best estimate of sales revenue for the budget period It is prepared by multiplying the expected unit sales volume for each product by its anticipated unit selling price 12 The production budget shows... dropping the month just ended and adding a future month The annual budget is often supplemented by monthly and quarterly budgets The responsibility for coordinating the preparation of the budget... statement of management’s plans for a specified time period, expressed in financial terms The role of accounting during the budgeting process is to (a) provide historical data on revenues, costs, and