Chapter 13 Budgeting for Planning and Control

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Chapter 13- Budgeting for Planning and Control
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Learning Objectives
Learning Objectives

• 1. Define budgeting and discuss its role in
  planning, control, and decision making.
• 2. Define and prepare the master budget, identify
  its major components, and explain the
  interrelationships of its various components.
• 3. Identify and discuss the key features that a
  budgetary system should have to encourage
  managers to engage in goal-congruent behaviour.
• 4. Describe budgets for merchandising and service
  firms and zero-base budgeting.

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Definition and Role of Budgeting
Planning
Control
Strategic Plan
Monitoring Actual Performance Long-term
Objectives Short-term Objectives Short-term
Plan Budgets
Comparison of Actual and Planned Feedback
Investigation

Corrective action
Budgets are quantitative expressions of plans
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Planning

• Strategic Plan
• Long-Term Objective
• Short-Term Objective
• Budgets

• To increase market share by increasing product
  quality
• Reduce number of defective units to zero
• Reduce number of defects by 20 for coming year
• Reduce number of defective units expenditures
  for process control will be increased by 25.
  Because of decrease in defects, expenditures for
  rework and repairs will be reduced by 15

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Control

• Actual expenditures for process control was on
  target work repairs higher than planned
  actual defects greater than planned
• Planned increase in expenditure for process
  control was not high enough to produce desired
  increase in quality
• Increase budget for process control by additional
  15 to achieve targeted reduction in defects
• Significant progress was made though planned
  reduction in defects not achieved. Ability to
  attain desired market share within original time
  frame still maintained

• Monitoring and Comparison
• Investigation
• Corrective Action
• Feedback

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Responsibility Centres

• I. Responsibility Accounting Use of accounting
  system to set standards, measure actual outcomes,
  report the performance of responsibility centres.
• II. Responsibility Centre A unit within an
  organization over which a manager is assigned
  responsibility for a specific activity or set of
  activities

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Types of Responsibility Centres

• 1. Cost Centre The manager is responsible only
  for occurrence of cost
• 2. Revenue Centre The manager is responsible
  for revenues and perhaps minimal costs.
• 3. Profit Centre The manager is responsible
  for both revenues and costs
• 4. Investment Centre The manger is responsible
  for revenues, costs, and investments

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Two Dimensions of Budgeting
1. The budget preparation process 2. The
behavioural implications of budgetary control
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Components of the Master Budget

• Operating budgets
• Financial budgets

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Key Features of a Sound Budgetary System

• 1. Frequent feedback on performance
• 2. Flexible budgeting
• 3. Monetary nonmonetary incentives
• 4. Participative budgeting
• 5. Realistic standards
• 6. Controllability
• 7. Multiple measures of performance

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The Operating Budget
Components

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

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Preparing the Sales Forecast
1st Qtr. 2nd Qtr 3rd Qtr. 4th
Qtr. Total
Sales (units) 50,000 75,000
90,000 80,000 295,000 Sales ()
1,500,000 2,250,000 2,700,000 2,400,000
8,850,000 Sales price of 30 per unit
What techniques are used to forecast sales?
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Preparing the Production Budget
1st Qtr. 2nd Qtr 3rd Qtr. 4th
Qtr. Total
Sales (units) 50,000 75,000
90,000 80,000 295,000 Desired EI
15,000 18,000 16,000
12,000 12,000 Total needs
65,000 93,000 106,000 92,000
307,000 Less BI (10,000)
(15,000) (18,000) (16,000)
(10,000) Production 55,000 78,000
88,000 76,000
297,000 Assume company wants to maintain an
inventory level equal to 20 of next quarters
sales. Projected sales for 1st quarter of the
following year are projected to be 60,000
units. Ending inventory for previous year was
10,000 units
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Preparing the Direct Materials Budget
1st Qtr. 2nd Qtr 3rd Qtr. 4th
Qtr. Total
Production 55,000 78,000
88,000 76,000 297,000 Pounds
110,000 156,000 176,000
152,000 594,000 Desired EI 15,600
17,600 15,200 12,000
12,000

Total needs 125,600 173,600
191,200 164,000 606,000 Less BI
(11,000) (15,600) (17,600)
(15,200) (11,000) (kg.)
114,600 158,000 173,600 148,800
595,000 Cost(1.50) 171,900 237,000
260,400 223,200 892,500
2 kg.. of raw materials are needed for each
unit. Production for the 1st quarter of next
year is projected to be 60,000 units. Ending
inventory for the previous year was projected
at 11,000 kg. Ending inventory is estimated at
10 of next quarters production needs.
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Preparing the Direct Labour and Overhead Budgets
1st Qtr. 2nd Qtr 3rd Qtr. 4th
Qtr. Total
Production 55,000 78,000
88,000 76,000 297,000 Direct
labour hours (1/2 hr.) 27,500 39,000
44,000 38,000 148,500
Total(5/hr.)137,500 195,000 220,000
190,000 742,500 Variable
overhead cost(150) 206,250 292,500
330,000 285,000 1,113,750 Fixed overhead
200,000 200,000 200,000
200,000 800,000 Total 406,250
492,500 530,000 485,000
1,913,750
Fixed overhead rate 800,000/742,500 or 107.7
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Preparing the Selling and Administrative Expenses
Budget
1st Qtr. 2nd Qtr 3rd Qtr. 4th
Qtr. Total
Sales (units) 50,000 75,000
90,000 80,000 295,000 Sales ()
1,500,000 2,250,000 2,700,000 2,400,000
8,850,000 Variable Exp. (8) 120,000
180,000 216,000 192,000 708,000
Fixed Expenses Salaries 200,000
200,000 200,000 200,000 800,000
Advertising 50,000 50,000
50,000 50,000 200,000 Other
100,000 100,000 100,000
100,000 400,000 Total
470,000 530,000 566,000 542,000
2,108,000
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Budgeted Cost of Goods Sold and Ending Inventory

Unit cost calculation Direct Materials (2 kg. x
1.50) 3.00 Direct Labour (1/2 hour x
5.00) 2.50 Variable Overhead (2.50 x
1.50) 3.75 Fixed Overhead (5.00 x 1.077)
5.39 Total unit cost
14.64
1st Qtr. 2nd Qtr 3rd Qtr. 4th
Qtr. Total
Sales (units) 50,000 75,000
90,000 80,000 295,000 _at_ 14.64
732,000 1,098,000 1,317,600 1,171,200
4,318,800
Value of Ending Inventory 12,000 units x 14.64
175,680
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Preparing the Budgeted Income Statement
Sales 8,850,000 Cost
of goods sold 4,318,800 Gross Margin
4,531,200 Operating expenses Variable
708,000 Fixed 1,400,000 2,108,000 Net
income before taxes and interest
2,423,200 Interest1
528,060
1,895,140 Taxes _at_ 40
758,056 Net Income 1,137,084
1Interest expense derived from cash budget
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The Financial Budget
Components

• The cash budget
• The budgeted balance sheet
• The budget for capital expenditures

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The Cash Forecast
Data related to preparation of cash budget 1.
The company experiences a 3 month collection
cycle. All sales are for credit with 60
percent collected in the quarter of sale, 30
percent collected in the quarter following the
sale, and 10 percent collected 2 quarters
after the sale. Sales for 3rd and 4th quarters
of last year were 1,750,000 and 2,000,000. 2.
Fifty percent of material purchases are paid in
current quarter 50 percent the following
quarter. 3. Capital expenditures are estimated at
10,000,000 and are to be financed by a
10,000,000 mortgage at 6 interest.
Repayments are made in increments of 1,000. 4. A
50,000 minimum balance of cash is maintained.
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The Cash Forecast (Collections)
1st Qtr. 2nd Qtr 3rd Qtr. 4th
Qtr. Total
Collections 3rd qtr. 175,000
4th qtr. 600,000 1st qtr.
900,000 4th qtr.
200,000 1st qtr.
450,000 2nd qtr.
1,350,000 1st qtr.
150,000
2nd qtr.
675,000 3rd. qtr.
1,620,000
2nd qtr.
225,000 3rd
qtr.
810,000 4th qtr.

1,440,000
1,675,000 2,000,000 2,445,000
2,475,000 7,575,000
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The Cash Forecast (Payments)
1st Qtr. 2nd Qtr. 3rd Qtr.
4th Qtr. Total
Purchases 4th qtr. 70,000

70,000 1st qtr. 85,950
85,950
171,900 2nd qtr.
118,500 118,500
237,000 3rd qtr.
130,200 130,200
260,400 4th qtr.
111,600
111,600 155,950
204,450 248,700 241,800 850,900

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The Cash Forecast (Disbursements)
1st Qtr. 2nd Qtr 3rd Qtr. 4th
Qtr. Total
Payments 155,950 204,450
248,700 241,800 850,900 Direct labour
137,500 195,000 220,000
190,000 742,500 Variable overhead 206,250
292,500 330,000 285,000
1,113,750 Fixed overhead 200,000
200,000 200,000 200,000
800,000 V. sell. admin. 120,000
180,000 216,000 192,000
708,000 Capital outlays 10,000,000 -----
----- -----
10,000,000 Total 10,819,700
1,071,950 1,214,700 1,108,800 14,215,150
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The Cash Forecast
1st Qtr. 2nd Qtr 3rd Qtr. 4th
Qtr. Total
Beginning bal. 50,000 50,700
50,325 50,035 50,000
Collections 1,675,000 2,000,000
2,445,000 2,475,000 8,595,000 Cash
available 1,725,000 2,050,700 2,495,325
2,525,035 8,645,000 Disbursements
10,819,700 1,071,950 1,214,700 1,108,800
14,215,150 Financing Borrowing
10,000,000
10,000,000 Debt
Payment 705,000 789,000
1,103,000 1,255,000 3,852,000 Interest
1150,000 2139,425
3127,590 111,0454 528,060 Ending
balance 50,700 50,325 50,
035 50,190 50,190
110,000,000 x .06 x 3/12 2 (10,000,000 -
705,000) x .06 x 3/12 310,000,000-705,000-789,
000) x .06 x 3/12 4 (10,000,000-705,000-789,000
-1,103,000) X .06 X 3/12)
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The Forecasted Balance Sheet
Assets Cash
50,190 Accounts Receivable1 1,230,000
Inventories2
193,680 Equipment (net)3 16,000,000
Total Assets 17,473,870
Liabilities Accounts Payable4 446,250
Mortgage Payable5 6,148,000
6,595,250
Stockholders Equity Common Stock6
8,000,000 Retained Earnings7 2,878,620
10,638,620
Total Equity 17,473,870
1 (.10 x 2,700,000 .40 x 2,400,000) 2
Includes ending raw materials and finished goods
inventories 3 6,000,000 10,000,000 of new
purchases 4 1/2 of 4th quarter purchases 5
10,000,000 - 3,852,000 6 From ending balance
sheet of previous year 7 Beginning balance of
net income.
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The Flexible Budget
Uses of Flexible Budgets

• The flexible budget can be used to prepare the
  budget before the fact based on expected levels
  of activity.
• The flexible budget is used to compare actual
  costs with flexible budgeted costs at various
  levels of activity and provides a basis for
  performance evaluation.
• Flexible budgets enable managers to deal with
  uncertainty by allowing them to see the expected
  outcomes for a range of activities.

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Preparing the Flexible Budget
_at_ 295, 000 units _at_ 297,000
units _at_ 299,000 units
(Master level)
Direct labour hours (1/2 hr.) 147,500
hr. 148,500 hr. 149,500 hr.
Total(5/hr.) 737,500
742,500 747,500 Variable
overhead 1,106,250 1,113,750
1,121,250 Fixed overhead 800,000
800,000 800,000
Total 2,643,750
2,656,250 2,668,750
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Flexible Budgets and Performance Evaluation
Actual Results Flexible Budget
Flexible Budget _at_ 295,000
units _at_ 295,000 units Variance

Direct labour 741,000
737,500 3,500U
Variable overhead 1,115,000
1,106,250 8,750U
Fixed overhead 815,000
800,000 15,000U
Total
2,671,000 2,643,750
27,250U
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Performance Evaluation (Continued)
Actual Results Master Budget
Static Budget _at_ 295,000
units _at_ 297,000 units Variance

Direct labour 741,000
742,500 1,500F
Variable overhead 1,115,000
1,113,750 1,250U
Fixed overhead 815,000
800,000 15,000U
Total
2,671,000 2,656,250
14,750U
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Behavioural Dimensions of Budgeting

• Goal congruence
• Incentives
• Participation
• Budgetary slack
• Controllable costs

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Operating Budgets for Merchandising and Services

• Merchandising firms
• Service firms
• Government
• Not-for-profit

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Translating the concepts of zero-base budgeting
into practice requires four steps...

• 1. Identifying decision units.
• 2. Creating decision packages for each decision
  unit.
• 3. Ranking decision units in order of priority.
• 4. Preparing the budget.

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Numerical Questions from the Back of Chapters 12
and 13

• E12-3, E12-5, E12-11, P12-3
• E13-1, E13-3, E13-13, E13-19

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Question E12-5

• Please turn to your textbook to read the question.

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Question E12-11

• Please turn to your textbook to read the
  question.

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Question P12-3

• Please turn to your textbook to read the
  question.

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Question E13-1

• Please turn to your textbook to read the
  question.

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Question E13-3

• Please turn to your textbook to read the
  question.

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Question E13-13

• Please turn to your textbook to read the
  question.

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Question E13-19

• Please turn to your textbook to read the
  question.