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Budgeting for Planning

and Control

Learning Objectives
Define budgeting and discuss its role
in planning, control, and decision
making.
Define and prepare the master
budget, identify its major
components, and explain the
interrelationships of its various
components.

Learning Objectives
(continued)
Describe flexible budgeting and
identify the features that a budgetary
system should have to encourage
managers to engage in goalcongruent behaviour.

Budgets
Budget Financial plan of the resources needed
to carry out activities and meet
financial goals

Ties together:

Goals
Plans
Decision making

Performance
Critical Success evaluations
Strengths
of a company that enable it to
Factors
outperform competitors

Definition and Role of


Budgeting
Planning
Strategic Plan

Control
Monitoring of Actual Activity

Long-Term Objectives
Short-Term Objectives

Budgets are quantitative


expressions of plans

Short-Term Plan
Budgets
Feedback

Comparison of Actual with Planned


Investigation
Corrective action

Purposes of Budgeting

It forces managers to plan.


It provides information that can be used to
improve decision making.
It provides a standard for performance
evaluation.
It improves communication and
coordination.

Two Dimensions of
Budgeting
There are two dimensions to
budgeting:
1. How is the budget prepared?
2. How is the budget used to
implement the organizations
plan?

Human Element in Budgeting

Organizatio
n goals

Goal congruence

Participative Budgeting
Use of input from lowerand middle-management
employees; also called
grass roots budgeting

Individua
l goals

Master Budget
Tactical short range plan that ties the
strategic plan to operating plan
Static Budget
Budget Plan
Planning Budget
Profit Plan
Income statement portion of the master
budget

Master Budget
A master budget can be divided into
operating and financial budgets.
Operating budgets describe the income-generating activities
of a firm: sales, production, and finished goods inventories.
Financial budgets detail the inflows and outflows of cash and
the overall financial position.

The Operating Budget


The operating budget consists of a budgeted
income statement accompanied by the following
support schedules:

Sales budget
Production budget
Direct material purchases budget
Direct labour budget
Overhead budget
Selling and administrative expenses budget
Ending finished goods inventory budget
Cost of goods sold budget

Sales Budget
Sales is the most difficult aspect of
budgeting.

How do we forecast sales?


Sales Staf
Market Research
Delphi Technique
Trend Analysis
Econometric Models

Forecast by Sales Staf

Sales budget consists of:


Number of units

Sales price of a unit

Who knows how many units


will sell and at what price?
Sales personnel have knowledge about customers.

Sales Budget (Schedule 1)


______________Quarter____________
1 2 3 4 Year
Units 2,000 6,000 6,000 2,000 16,000
Unit selling price
x $0.70 x $0.70 x $0.80 x $0.80 x $0.75
$1,400 $4,200 $4,800 $1,600 $12,000
=====
=====
=====
=====
======

Production Budget
Production plan of resources needed to
meet current sales demand and ensure that
inventory levels are sufficient for future
sales

Remember the cost flow model?


BB

TI

TO

E
B

Inventories
Units in
beginning
inventory
(BB)

Required
production
(units)
(TI)

Budgeted sales
(units)
(TO)

Units in
ending
inventory
(EB)

Production Budget
(Schedule 2)
_____________Quarter____________

1 2 3 4 Year
Sales (Schedule 1) 2,000 6,000 6,000 2,000 16,000
Desired ending inventory
500
500
100
100
100
Total needs 2,500 6,500 6,100 2,100 16,100
Less: Beginning inventory (100) (500) (500) (100)
(100)
Units to be produced
2,400 6,000 5,600 2,000 16,000
==== ==== ==== ==== =====

Production Costs

Direct
Materials

Labor
Overhead
santi
ago

Direct Materials Purchases Budget


(Schedule 3)
______________Quarter______________

1 2 3 4 Year
Units to be produced (S.2) 2,400 6,400 5,600 2,000 16,000
Direct materials per unit
x 13
x 13
x 13
x 13
x 13
Production needs 31,200 78,000 72,800 26,000 208,000
Desired ending inventory
4,000
4,000
2,500
2,500
2,500
Total needs 35,200 82,000 75,300 28,500 210,500
Less: Beginning inventory (2,500) (4,000)
(4,000) (2,500)
(2,500)
Direct materials to
be purchased 32,700 78,000 71,300 26,000 208,000
Cost per kilogram x$0.02 x $0.02
x $0.02
x $0.02
x $0.02
Total purchase cost $654 $1,560 $1,426 $520 $4,160
=== =====
=====
==== =====

Direct Labour Budget


(Schedule 4)
________________Quarter____________
1
2
3
4
Year
Units to be produced (Sch. 2) 2,400
6,000
5,600
2,000
16,000
Direct labour time
x 0.015 x 0.015 x 0.015 x 0.015 x 0.015
Total hours needed
36 90 84 30 240
Average wage per hour
x $10
x $10
x $10
x $10
x $10
Total direct labour cost
$360
$900
$840
$300
$2,400

===

===

===

===

====

Overhead Budget (Schedule


5)
_____________Quarter_____________

1 2 3 4 Year
Budgeted DLH ( Sch. 4) 36 90 84 30 240
Variable overhead rate x $8
x $8 x $8
x $8
x $8
Budgeted variable overhead
$288 $720 $672 $240 $1,920
Budgeted fixed overhead*
320
320 320
320
1,280
Total overhead $608 $1,040 $992 $560 $3,200
==== =====
==== ==== =====
*Includes $200,000 of depreciation in each quarter.

Selling and Administrative


Expenses Budget (Schedule 6)
________________Quarter____________
1
2
3
4
Year
Planned sales in units (Sch. 1) 2,000
Variable S & A exp. per unit
x $0.05
Total variable expense$100
$300
Fixed S & A expenses:
Salaries $ 35
$ 35
$ 35
Advertising 10 10 10 10 40
Depreciation 15 15 15 15 60
Insurance
4
4
4
4
16
Travel
5
5
5
Total fixed expenses $ 69
$ 69
Total S & A expenses $169
$369

===

===

===

6,000
6,000
2,000
16,000
x $0.05 x $0.05 x $0.05 x $0.05
$300
$100
$ 800
$ 35

$ 140

5
$ 69
$369

20
$ 69
$169

===

====

$ 276
$1,076

Ending Finished Goods


Inventory Budget (Schedule 7)
Unit-cost computation:
Direct materials (13 kg. @ $0.02)
$0.26
Direct labour (0.015 hr. @ $10)
0.15
Overhead:
Variable (0.015 hr. @ $8)
0.12
Fixed (0.015 hr. @ $5.33*)
0.08
Total unit cost
$0.61
====
*$1,280/240 = $5.33
Units Costs Total
Finished goods: Concrete block
100,000
$0.61

Unit
$61,000

Cost of Goods Sold Budget


(Schedule 8)
Direct materials used (Schedule 3)*
$4,160
Direct labour used (Schedule 4)
2,400
Overhead (Schedule 5)
3,200
Budgeted manufacturing costs
$9,760
Beginning finished goods
55
Goods available for sale
$9,815
Less: Ending finished goods (Schedule 7)
(61)
Budgeted cost of goods sold
$9,754
=====
*Production needs x $0.01 = 416,000 x $0.01

Budgeted Income
Statement
Sales (Schedule 1)
$12,000
Less: Cost of goods sold (Schedule 8)
(9,754)
Gross margin
$ 2,246
Less: Selling and administrative expenses (Schedule 6)
(1,076)
Operating income
$ 1,171
Less: Interest expense (Schedule 10)
(54)
Income before taxes
$ 1,117
Less: Income taxes
(650)
Net income
$
466
======

The Financial Budgets

The usual financial budgets


prepared are:

The cash budget


The budgeted balance sheet
The budget for capital expenditures

Cash Budget
Statement of cash on hand at the start of the budget period,
expected cash receipts, expected cash disbursements, and
the resulting cash balance at the end of the budget period.

Cash receipts
Collections of accounts receivable
Cash sales
Sales of assets
Borrowing
Issuing stock
Other

Cash Budget, Continued. . .

Cash disbursements
Materials purchases
Manufacturing costs
Operating activities
Debt repayment
Acquire new assets
Income taxes
Dividends
Other

The Cash Budget


Beginning cash balance

$x,xxx

Add: Cash receipts

x,xxx

Cash available

$x,xxx

Less: Cash disbursements

x,xxx

Less: Minimum cash balance

x,xxx

Cash surplus (deficiency)

$x,xxx

Add: Cash from loans

x,xxx

Less: Loan repayments

x,xxx

Add: Minimum cash balance


End cash balance

$x,xxx
=====

x,xxx

Cash Budget Example


a. A $100,000 minimum cash balance is required for the end
of each quarter. Money can be borrowed and repaid in
multiples of $100,000. Interest is 12 % per year. Interest
payments are made only for the amount of the principal
being repaid. All borrowing takes place at the beginning of
a quarter and all repayment takes place at the end of a
quarter.
b. Half of all sales are for cash, 70% of credit sales are
collected in the quarter of sale, and the remaining 30% are
collected in the following quarter. The sales for the fourth
quarter of 2000 were $2 million.

Cash Budget Example


(continued)
c. Purchases of raw materials are made on account; 80% of
purchases are paid for in the quarter of purchase. The
remaining 20% are paid for in the following quarter. The
purchases for the fourth quarter of 2000 were $500,000.
d. Budgeted depreciation is $200,000 per quarter for
overhead and $15,000 per quarter for selling and
administrative expenses (see Schedules 5 and 6).

Cash Budget Example


(continued)
e. The capital budget for 2001 revealed plans to purchase
additional equipment to handle increased demand at a
small plant in Nevada. The cash outlay for the equipment,
$600,000, will take place in the first quarter. The company
plans to finance the acquisition of the equipment with
operating cash, supplementing it with short-term loans as
necessary.
f. Corporate income taxes are approximately $650,000 and
will be paid at the end of the fourth quarter (Schedule 9).
g. Beginning cash balance equals $120,000.

Cash Receipts from


Customers
Source Quarter1

Quarter 2

Quarter 3

Quarter 4

Cash sales $ 700,000 $2,100,000 $2,400,000 $ 800,000


Received on
account from:
Quarter 4, 2000300,000
Quarter 1, 2001490,000
Quarter 2, 2001
Quarter 3, 2001

210,000

1,470,000 630,000
1,680,000 720,000

Quarter 4, 2001
560,000
Total cash receipts $1,490,000 $3,780,000 $4,710,000 $2,080,000
======== ======== ======== ========

Cash Disbursements for Raw


Materials
Source Quarter1

Quarter 2

Quarter 3

Quarter 4

Current quarter $523 $1,248 $1,141 $416


Prior quarter
100
131
312 285
Total cash
disbursement
for raw materials $623 $1,379 $1,453 $701
==== =====
=====
====

Cash Disbursements
____________
1
2
3
4
Less cash disbursements:
Raw materials:
Current quarter $523$1,248
$1,141
Prior quarter 100 131 312 285
Direct labour 360 900 840 300
Overhead 408 840 792 360
Selling and adm.
150 350 366 150
Income taxes --- --- --- 650
Equipment
600
----Total disbursements $2,141

====

$3,469

$3,451

______Quarter__________________

$416

--$2,161

====

====

====

Cash Budget (Schedule


10)
_________

______Quarter_______________

1
2
3
4
Year
Beginning cash balance $ 120
$ 169
$ 162
$ 986
$
120
Cash collections (PPT 13-24)
1,490
3,780
4,710
2,080
12,060
Total cash available $1,610
$3,949
$4,872
$3,066
$12,180
Total disbursements (PPT 13-24)
$2,141
$3,469
$3,451
$2,161
Minimum cash balance
100
100
100
100
100
Total cash needs
$2,241
$3,569
$3,551
$2,261
$11,322
Excess (deficiency) of cash
$ (631) $ 380
$1,321
$ 805
Add: Borrowings
700 --- --- --- 700
Less: Repayments --- (300)
(400)
--- (700)
Less: Interest paid
--(18)
( 36)
--(54)
Ending cash balance
$ 169
$ 162
$ 985
$ 904
======
====== ====== ===== ======

$11,222

858

904

Master Budget for a


ManufacturingSales
Firm
Forecast
Marketing and
administrative
cost budget

Production
budget

Required direct
material, direct labor,
and manufacturing
overhead budgets

Budgeted cost
of goods sold

Cash budget
Budgeted
balance sheet

Budgeted
income
statement

Budgeting in Service
Organizations
Sales Forecast
Marketing and
administrative
cost budget

Labor
budget

Budgeted cost of
services

Budgeted income
statement

Cash budget
Budgeted
balance sheet

Budgeting Retail and Wholesale


Organizations
Sales Forecast
Marketing and
administrative
cost budget

Purchases

Budgeted income
statement

Cash budget

Budgeted balance
sheet

Total Assets, Last Year


Assets
Current assets:
Cash
$ 120
Accounts receivable
300
Raw materials inventory
50
Finished goods inventory
55
Total current assets
$ 525
Property, plant, and equipment:
Land
$ 2,500
Building and equipment
9,000
Less: Accumulated depreciation
(4,500)
Total property, plant, and equipment
Total assets
$7,525

7,000
=====

Total Liabilities and


Stockholders Equity, Last Year
Liabilities and Stockholders Equity
Current liabilities:
Accounts payable
$ 100
Stockholders equity:
Common stock, no par
$ 600
Retained earnings
6,825
Total stockholders equity
7,425
Total liabilities and stockholders equity
$7,525

=====

Budgeted Total Assets


Assets
Current assets:
Cash
$
904
Accounts receivable
240
Raw materials inventory
50
Finished goods inventory
61
Total current assets
$1,255
Property, plant, and equipment:
Land
$
2,500
Building and equipment
$ 9,600
Less: Accumulated depreciation
(5,360)
Total property, plant, and equipment
6,740
Total assets
$7,995

=====

Budgeted Total Liabilities and


Stockholders Equity
Liabilities and Stockholders Equity
Current liabilities:
Accounts payable
$ 104
Stockholders equity:
Common stock, no par
$ 600
Retained earnings
7,291
Total stockholders equity
7,891
Total liabilities and stockholders equity
$7,995

=====

Flexible and Static


Budgeting
Static Budgeting is a budget for a
particular level of activity.
Flexible Budgeting is a budget
that provides a firm with the
capability to compute expected
costs (and revenues) for a range
of activities.

The Uses of Flexible Budget

The flexible budget can be used to prepare the budget


before the fact for the expected level of activity.
Flexible budgeting can be used to compare what costs
should have been for the actual level of activity.
Flexible budgeting can help managers deal with uncertainty
by allowing them to see the expected outcomes for a range
of activities.

Performance Report (Exhibit 13-6)

Actual
Budgeted Variance
Units produced
3,000 2,400 600 F
Direct materials cost $ 927.3
$ 624.0
$303.3
Direct labour costs 450.0 360.0 90.0 U
Overhead:
Variable:
Supplies
80.0 72.0 8.0 U
Indirect labour
220.0 168.0 52.0 U
Power
40.0 48.0 (8.0) F
Fixed:
Supervision 90.0 100.0 (10.0)
F
Depreciation
200.0 200.0 0.0
Rent
30.0
20.0
10.0
U
Total $2,037.3
$1,592.0
$445.3
U

====
U

====

===

====== ====== =====

Flexible Production Budget


(Exhibit 13-7)
Variable
Cost

Range of Production
2,400 3,000 3,600

Production Costs
per Unit
Variable:
Direct materials $0.26
$ 624
$ 780
$ 936
Direct labour
0.15
360 450 540
Variable overhead:
Supplies
0.03
72
90
108
Indirect labour
0.07
168 210 252
Power
0.02
48
60
72
Total variable costs
$0.53
$1,272
$1,590
Fixed overhead:
Supervision
$ 100
$ 100
$ 100
Depreciation
200 200 200
Rent
20
20
20
Total fixed costs
$ 320
$ 320
$ 320
Total production costs
$1,592
$1,910
$2,228
=====
=====
=====

$1,908

Actual vs. Flexible Performance


Report (Exhibit 13-8)
Actual Budget
3,000 3,000 -----

Variance

Units produced
Production costs:
Direct materials
$ 927.3
$ 780.0
$ 147.3
Direct labour 450.0 450.0 0.0
Variable overhead:
Supplies
80.0 90.0 (10.0) F
Indirect labour
220.0 210.0 10.0 U
Power
40.0
60.0
(20.0)
F
Total variable costs $1,717.3
$1,590.0
$ 127.3
Fixed overhead:
Supervision $90.0 $100.0 $(10.0)
F
Depreciation 200.0 200.0 0.0
Rent
30.0
20.0
10.0
U
Total fixed costs
$ 320.0
$ 320.0
$0.0
Total production costs
$2,037.3
$1,910.0
$ 127.3
======
=====

==== ==== ====


U

======

Behavioural Dimensions of
Budgeting

Goal Congruence
Dysfunctional Behaviour
Frequent Feedback on Performance
Monetary and Nonmonetary Incentives
Participative Budgeting
Realistic Standards
Controllability of Costs
Multiple Measures of Performance

Static and Flexible Budgets

Static budgets gauge efectiveness


Flexible budgets gauge efficiency
Static and flexible budgets together
gauge both efectiveness and
efficiency

Profit Budgets and Variances


Assume the following budget and actual information

Sales
Variable Costs
Contribution
Margin
Fixed Costs
Operating Income

Master Budget
(1,000 units)
$ 100,000
40,000
60,000

Actual
(800 units)
$ 82,000
39,000
43,000

$ 18,000 U
1,000 F
17,000 U

30,000
30,000

34,000
9,000

4,000 U
21,000 U

Evaluate the above performance report!

Variances

Static and Flexible Profit Budgets

The previous performance report is


misleading, as it
uses a static budget to gauge variable cost
performance
does not attempt to identify variances by causal
factors
mixes the efects of efectiveness and efficiency

It can be improved by comparing


actual to flexible budget to determine the efects of
cost performance and selling prices on profit, and
static and flexible budgets to identify the efects of
volume on profit

Profit Variances
Sales

Master Budget Flexible Budget


(1,000 units)
(800 units)
$ 100,000
$ 80,000

Actual
(800 units)
$ 82,000

Variable Costs

40,000

32,000

39,000

Contribution Margin

60,000

48,000

43,000

Fixed Costs

30,000

30,000

34,000

Operating Income

30,000

18,000

9,000

Comparing the flexible to the static (master) budget isolates the


effects of volume on profits, and comparing actual to flexible budget
isolates the appropriate cost variances as well as the sales price
variance, as follows:
Profit volume variance = 18,000 30,000
Sales price variance = 82,000 80,000
Variable cost variances = 32,000 39,000
Fixed cost variances = 30,000 34,000

=$
=
=
=

- 12,000 (U)
2,000 (F)
- 7,000 (U)
- 4,000 (U)

Total variances

=$

- 21,000 (U)
===========

Thank You