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The Budgeting Process
Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University
Chapter 21
21–2Copyright © Houghton Mifflin Company. All rights reserved.
Learning Objective
1. Define budgeting and explain its role in the management cycle.
2. Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets.
3. Prepare the operating budgets that support the financial budgets.
21–3Copyright © Houghton Mifflin Company. All rights reserved.
Learning Objective (cont’d)
4. Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet.
5. Describe management’s role in budget implementation.
21–4Copyright © Houghton Mifflin Company. All rights reserved.
The Budgeting Process
• Objective 1– Define budgeting and explain its role in the
management cycle
21–5Copyright © 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
21–6Copyright © 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
21–7Copyright © 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
21–8Copyright © 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
21–9Copyright © Houghton Mifflin Company. All rights reserved.
Budgeting and Goals
• Strategic planning– Process by which management establishes
an organization’s long-term goals
21–10Copyright © 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
21–11Copyright © 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
21–12Copyright © 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
21–13Copyright © 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
21–14Copyright © 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
21–15Copyright © 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
21–16Copyright © 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
21–17Copyright © 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
21–18
Budgeting and the
Management Cycle
21–19Copyright © 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
21–20Copyright © Houghton Mifflin Company. All rights reserved.
Budgeting and the Management Cycle
• Executing– Budgeting helps managers to
• Communicate expectations
• Measure performance and motivate employees
• Coordinate activities and allot resources
21–21Copyright © Houghton Mifflin Company. All rights reserved.
Budgeting and the Management Cycle
• Reporting– Budgeting helps managers to
• Communicate budget information
• Provide continuous feedback
• Support operating decisions
21–22Copyright © Houghton Mifflin Company. All rights reserved.
Budgeting and the Management Cycle
• Reviewing– Budgeting helps managers to
• Evaluate performance
• Determine timeliness
• Find variances and create solutions
• Compare planned performance with actual performance
21–23Copyright © Houghton Mifflin Company. All rights reserved.
Discussion
Q. How are short-term goals related to strategic planning?
A. 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
21–24Copyright © 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
21–25Copyright © 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
21–26Copyright © 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
21–27Copyright © Houghton Mifflin Company. All rights reserved.
The Master Budget (cont’d)
• 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
21–28
Preparation of a Master
Budget for a Manufacturing Organization
21–29
Preparation of a Master
Budget for a Retail
Organization
21–30Copyright © Houghton Mifflin Company. All rights reserved.
Preparation of a Master Budget for a Service Organization
21–31Copyright © Houghton Mifflin Company. All rights reserved.
The Master Budget (cont’d)
• 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
21–32Copyright © Houghton Mifflin Company. All rights reserved.
The Master Budget (cont’d)
• 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
21–33Copyright © Houghton Mifflin Company. All rights reserved.
The Master Budget (cont’d)
• Managers can improve the quality of budgets by using the following guidelines
1. Know the purpose of the budget
2. Identify the user group and its information needs
3. Identify sources of accurate, meaningful budget information
4. Establish a clear format for the budget
5. Use appropriate formulas and calculations to derive quantitative information
6. Revise the budget until it includes all planning decisions
21–34Copyright © Houghton Mifflin Company. All rights reserved.
Discussion
Q. Which budget must be prepared first?
A. The sales budget. This budget is used to estimate sales volume and revenues. Once established, the other budgets can be developed
21–35Copyright © Houghton Mifflin Company. All rights reserved.
Operating Budgets
• Objective 3– Prepare the operating budgets that support
the financial budgets
21–36Copyright © Houghton Mifflin Company. All rights reserved.
Operating Budgets
… are a set of budgets that are used in planning the daily operations of an
organization
• Are part of the master budget
21–37Copyright © 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
21–38Copyright © 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
21–39Copyright © 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 Total
Budgeted Sales
= Estimated
Selling Price per Unit
x Estimated Sales in
Units
21–40Copyright © 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
21–41Copyright © 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
21–42Copyright © Houghton Mifflin Company. All rights reserved.
Sales Budget (cont’d)
• External factors taken into consideration in a sales forecast include
1. The state of the local and national economies
2. The state of the industry’s economy
3. The nature of the competition and its sales volume and selling price
21–43Copyright © Houghton Mifflin Company. All rights reserved.
Sales Budget (cont’d)
• Internal factors include
1. The number of units sold in prior periods
2. The organization’s credit policies
3. The organization’s collection policies
4. The organization’s pricing policies
5. Any new products the organization plans to introduce to the market
6. The capacity of the organization’s manufacturing facilities
21–44Copyright © Houghton Mifflin Company. All rights reserved.
Sales Budget (cont’d)
21–45Copyright © 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
21–46Copyright © 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
21–47Copyright © Houghton Mifflin Company. All rights reserved.
The Production Budget (cont’d)
• To determine the production needs for an accounting period
Total Production
Units =
Budgeted Sales in Units
+ Desired Units of Ending Finished Goods Inventory
– Desired Units of
Beginning Finished Goods Inventory
21–48Copyright © Houghton Mifflin Company. All rights reserved.
Production Budget
21–49Copyright © 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
21–50Copyright © 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
21–51Copyright © Houghton Mifflin Company. All rights reserved.
The Direct Materials Purchases Budget (cont’d)
• 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
21–52Copyright © Houghton Mifflin Company. All rights reserved.
The Direct Materials Purchases Budget (cont’d)
• Steps to prepare a direct materials purchasing budget
1. Calculate each period’s total production needs in units of direct materials
2. Determine the total number of units of direct materials to be purchased during each accounting period in the budget
3. Calculate the cost of the direct materials purchases
Total Units of Direct
Materials to Be Purchased
= Total Production Needs in Units of Direct Materials
+
Desired Units of Ending
Direct Materials Inventory
–
Desired Units of Beginning
Direct Materials Inventory
21–53Copyright © Houghton Mifflin Company. All rights reserved.
Direct Materials Purchases Budget
21–54Copyright © Houghton Mifflin Company. All rights reserved.
The Direct Labor Budget
… is a detailed plan that estimates the direct labor hours needed in an accounting period
and the associated costs
21–55Copyright © 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
21–56Copyright © Houghton Mifflin Company. All rights reserved.
The Direct Labor Budget (cont’d)
• Steps in preparing a direct labor budget
1. Estimate the total direct labor hours– Multiply estimated direct labor hours per
unit by the anticipated units of production
2. Calculate the total budgeted direct labor cost
Total Budgeted Direct Labor Cost
= Estimated Total
Direct Labor Hours x Estimated Direct
Labor Cost per Hour
21–57Copyright © Houghton Mifflin Company. All rights reserved.
Direct Labor Budget
21–58Copyright © 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
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The Manufacturing Overhead Budget (cont’d)
• Two purposes
1. Integrate the overhead cost budgets developed by managers of production and production-related departments
2. Group information for the calculation of manufacturing overhead rates for the forthcoming accounting period
21–60Copyright © 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
21–61Copyright © Houghton Mifflin Company. All rights reserved.
Manufacturing Overhead Budget
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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
21–63Copyright © Houghton Mifflin Company. All rights reserved.
Selling and Administrative Expense Budget
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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
21–65Copyright © 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
21–66Copyright © Houghton Mifflin Company. All rights reserved.
Discussion
Q. What are the sources of information for preparing the cost of goods manufactured budget?
A. Direct materials budget
Direct labor budget
Manufacturing overhead budget
21–67Copyright © Houghton Mifflin Company. All rights reserved.
Financial Budgets
• Objective 4– Prepare a budgeted income statement, a
cash budget, and a budgeted balance sheet
21–68Copyright © Houghton Mifflin Company. All rights reserved.
Financial Budgets
… are projections of financial results for an accounting period
• Include– Budgeted income statement
– Capital expenditures budget
– Cash budget
– Budgeted balance sheet
21–69Copyright © 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
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Budgeted Income Statement
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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
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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
21–73Copyright © 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
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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
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The Cash Budget (cont’d)
• 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
21–77Copyright © Houghton Mifflin Company. All rights reserved.
The Cash Budget (cont’d)
• To calculate the estimated ending cash balance
Estimated Ending
Cash Balance =
Total Estimated
Cash Receipts –
Total Estimated
Cash Payments +
Estimated Beginning
Cash Balance
21–78Copyright © Houghton Mifflin Company. All rights reserved.
The Cash Budget (cont’d)
• 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
21–79Copyright © Houghton Mifflin Company. All rights reserved.
The Cash Budget (cont’d)
• Sources for estimating cash payments– Operating budgets
– Budgeted income statement
– Capital expenditures budget
– Previous year’s financial statements
– Loan records
21–80Copyright © Houghton Mifflin Company. All rights reserved.
The Cash Budget (cont’d)
• Supporting schedules– Schedule of expected cash collections
from customers
– Schedule of expected cash payments for direct materials
– Cash budget
21–81Copyright © Houghton Mifflin Company. All rights reserved.
Schedule of Expected Cash Collections from Customers
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Schedule of Expected Cash Payments for Direct Materials
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Cash Budget
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The Cash Budget (cont’d)
• 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
21–85Copyright © 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
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Budgeted Balance Sheet
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Discussion
Q. How is the ending cash balance estimated?
A. Subtract total estimated cash payments from total estimated cash receipts, then, add the estimated beginning cash balance
21–88Copyright © Houghton Mifflin Company. All rights reserved.
Budget Implementation
• Objective 5– Describe management’s role in budget
implementation
21–89Copyright © 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
21–90Copyright © 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
21–91Copyright © Houghton Mifflin Company. All rights reserved.
Budget Implementation (cont’d)
• 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
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Budget Implementation (cont’d)
• Successful budget implementation depends on two factors
1. Clear communication
2. Support of top management– Middle- and lower-level managers must see
that top management supports the budget and encourages its implementation
21–93Copyright © Houghton Mifflin Company. All rights reserved.
Discussion
Q. What two factors are necessary for successful budget implementation?
A. Clear communication and support of top management
21–94Copyright © Houghton Mifflin Company. All rights reserved.
Time for Review
1. Define budgeting and explain its role in the management cycle
2. Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets
3. Prepare the operating budgets that support the financial budgets
21–95Copyright © Houghton Mifflin Company. All rights reserved.
And Finally…
4. Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet
5. Describe management’s role in budget implementation