Analysis and Interpretation of Financial Statements

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CHAPTER 23
BUDGETING FOR PLANNING AND CONTROL
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Budget

• Websters definition ...

• Text def. (p. 827) A plan showing the companys
  objectives and how management intends to acquire
  and use resources to attain those objectives.
• A plan, while necessary, isinsufficient by
  itself control is also needed
  to insure that plans are
  accomplished.

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Why Budget?

• Budgets enable organizations to better deal with
  the uncertainty of the future.
• Without planning, organizations only react to
  future events rather than anticipating them.

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Purposes of Budgets
Formalize in writing managementsplans in
quantitative terms
Express managements plans forcoming periods
Increasemotivation to achievestated goals
Purposes
Cause managers to think ahead,anticipate results
and act tocorrect poor results
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Benefits of Budgets
Produces more cost-conscious employees
Fosters coordination of activities
Communicates plans
Develops a morevisionary management
Facilitates review and revision of plans
Promotes managementby exception
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Considerations inPreparing a Budget

• Management's assumptions re
• State of the economy for the planning period
• Adding, deleting or changing product lines
• Nature and degree of competition
• Effects of government regulation
• Useful accounting data from past periods can be
  adjusted for future expectations.

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General Principles of Good Budgeting

• Coordination of financial and nonfinancial
  planning
• Top management support
• Employee participation ingoal setting
• Communicating results
• Flexibility
• Follow-up

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Behavioral Implications of Budgeting

• Hazards of imposed budgets
• Employee resistance to perceived unfair or
  unrealistic goals
• Does not facilitate free flow of
  management-employee communications
• Participatory budgeting
• All levels of management actively participate in
  the process
• Accountants role
• Should compile the information and coordinate the
  preparation of the budget

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Participatory Budget System
Flow of Budget Data
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Master Budget

• Sets specific targets for
• Sales revenue
• Production costs
• Selling and administrative expenses
• Cash receipts and disbursements
• Culminates in projected financial statements
• Projected Balance Sheet
• A/K/A Financial Budget
• A/K/A Pro Forma Balance Sheet
• Projected Income Statement
• A/K/A Planned Operating Budget
• A/K/A Pro Forma Income Statement

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Master Budget

• Using an electronic spreadsheet to prepare is
  ideal because of
• Considering what if scenarios
• Interlocking relationships between the various
  elements of the budget
• Which is prepared first?
• Projected Income Statement
• Projected Balance Sheet

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Master Budget

• Using an electronic spreadsheet to prepare is
  ideal because of
• Considering what if scenarios
• Interlocking relationships between the various
  elements of the budget
• Which is prepared first?
• Projected Income Statement
• Projected Balance Sheet

a.
b.

• Trivia time! What was the first electronic
  spreadsheet?

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Master Budget
ProjectedIncome Statement and Balance Sheet
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Sales Budget

• Detailed schedule showing expected sales for
  the coming periods expressed in units and dollars.

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Sales Budget

• All items in the budgeting process are dependent
  on a sales forecast.

Informal approach
Formal approach
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Budgets
Thats enough talkingabout budgets, nowshow me
some examples!
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Sales Budget

• Ellis Magnet Co. is preparing budgets for the
  quarter ending June 30. The sales price is 10
  per magnet. Budgeted sales for the next four
  months are
• April 20,000 magnets _at_ 10 200,000 May 50,
  000 magnets _at_ 10 500,000 June 30,000
  magnets _at_ 10 300,000 July 25,000 magnets
  _at_ 10 250,000

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Production Budget
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Production Budget Two Approaches

• Based on sales estimates and level production
  each period
• Ending inventory level is a residual and
  fluctuates
• e.g., ILL. 23.2 (p. 833)
• A/K/A Sales and Production Budget
• Based on sales estimates and desired ending
  inventory level
• Production quantity is a residual and fluctuates
• e.g., Bottom p. 833

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Production Budget

• Ellis wants ending inventoryto be 20 percent
  of the next months budgeted sales in units.
• 4,000 units were on hand March 31.

Lets prepare the production budget using the
second approach.
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Production Budget

• Production must be adequate to meet budgeted
  sales and to provide sufficient ending inventory.

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Production Budget
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Production Budget
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Production Budget
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Production Budget
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Production BudgetMaterial Purchases
The material purchases budget is based on
production quantity and desired material
inventory levels.
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Production BudgetMaterial Purchases

• Five pounds of material are needed for each unit
  produced.
• Ellis wants to have materials on hand at the
  end of each month equal to 10 percent of the
  following months production needs.
• The materials inventory on March 31 is 13,000
  pounds. July production is budgeted for 23,000
  units.

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Production BudgetMaterial Purchases
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Production BudgetMaterial Purchases
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Production BudgetMaterial Purchases
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Production Budget
Production Budget MaterialPurchases
Completed
(Not shown)
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Cash Receipts Budget
O.K., lets do acash receiptsbudget!
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Cash Receipts Budget

• All sales are on account.
• Ellis collection pattern is
• 70 percent collected in month of sale
• 25 percent collected in month after sale
• 5 percent will be uncollectible
• Accounts receivable on March 31 is 30,000, all
  of which is collectible.

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Cash Receipts Budget
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Cash Receipts Budget
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Cash Receipts Budget
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Cash Receipts Budget
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Comprehensive Cash Budget

• We can now prepare a comprehensive cash budget
  which will also include cash disbursements.

.
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Projected Income Statement
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Projected Income Statement
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Projected Income Statement
Computation of unit cost is assumed to shorten
the illustration.
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Projected Income Statement
Assumed
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Projected Balance Sheet
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Text Illustrations
Now, lets look more closely at some of the
illustrations in the chapter
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Leed Company

• ILL. 23.3 (P. 833) - This is the basis for many
  subsequent illustrations.
• ILL. 23.4 (P. 834) - You should have determined
  the source of each number here when you worked
  your way through the chapter.
• Questions?

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Flexible Budget and Budget Variances

• Flexible Budget - one that provides budgeted
  revenues and expenses at various levels of output
  (i.e., production or sales)
• When management uses a flexible budget to
  appraise a departments performance, it bases the
  evaluation on the amounts budgeted for the level
  of activity actually experienced. The difference
  between the actual costs incurred and the
  flexible budget amount for that same level of
  operations is called a budget variance.

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Flexible Budget and Budget Variances

• Referring to ILL. 23.6 (p. 836), the Flexible
  Budget for Manufacturing Overhead, what is the
  relevant range?
• 17,500 to 25,000 units
• Now, if actual power cost 9,600, what is the
  budget variance?

9,600 Actual - 7,000 Budgeted2,600
UNfavorable budget variance
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Illustration 23.7 vs. Illustration 23.8

• 23.7 - Comparison of Planned Operating Budget and
  Actual Results

Used for what? Assessment of overall performance
vs. objectives What were objectives? Sales of
400,000 and profit of 6,000 Why were earnings
better than budget when sales were worse than
budget?
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Illustration 23.7 vs. Illustration 23.8

• 23.8 - Comparison of Flexible Operating Budget
  and Actual Results

Please add to title At the Level of Production
and Sales Attained Used for what? Expense
control purposes
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Additional Budgeting Topic

• Zero-Base Budgeting
• Managers start each year with zero budget
  levels and must justify each dollar appearing in
  the budget instead of just taking the prior
  years budget or actual results as the starting
  point, as is so often done with traditional
  budgeting.

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THE END