The Budgeting Process

1
Chapter 20

• The Budgeting Process

2
The Budgeting Process

• Objective 1
• Define budgeting and explain managements role in
  the budgeting process.

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Budgeting
Process of identifying, gathering, summarizing,
and communicating financial and nonfinancial
information about an organization's future
activities

• Essential part of the continuous planning for an
  organization in order to accomplish long-term
  goals and intermediate objectives

4
Budget
Plan of action based on forecasted transactions,
activities, and events

• Synonymous with managing an organization
• Essential to accomplishing goals in the strategic
  plan
• Used to communicate information and evaluate
  performance
• Aids in coordination of activities and resource
  usage
• Motivates employees
• Helps manage and account for cash

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Forms of the Budget
Cash Budget
Production 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

• Focuses on nonfinancial information
• Shows planned production in units
• Identifies activities needed to meet certain
  requirements or standards

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Budgeting and Goals
Strategic planning

• Process by which management establishes an
  organizations long-term goals

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Long-Term Goals

• Define the strategic direction an organization
  will take over a five- to ten-year period

• Basis for
• Making annual operating plans
• Preparing budgets

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Long-Term Goals (contd)
When setting long-term goals, the following
items should be taken 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

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Long-Term Goals (contd)

• Must set specific targets and timetables
• Must assign responsibility for achieving the
  goals to specific personnel
• Should include a range of long-term goals in the
  organization's strategic plan
• Should give direction to efforts to achieve these
  goals

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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
organizations operating budgets for the year
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Short-Term Goals (contd)
Organizations controller takes charge of
coordinating the budgeting process

• Designs a complete set of budget-development
  directions
• Timetable with deadlines
• Assigns clearly defined responsibilities for
  carrying out each part of the budgets
  development
• To specific individuals or management teams
• The budget may be reviewed and revised during the
  year

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The Importance of Participation
Key to a successful budget

• Process in which personnel at all levels of an
  organization actively engage in making decisions
  about the budget
• Provides a sense of ownership
• Helps ensure that departments will attain targets
  and stay within the budget

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Participative Budgeting
Relies on joint decision making

• Controller must be able to communicate and
  negotiate effectively with people in all levels
  of an organization
• Senior executives
• Formulate organizational long-and short-term
  goals
• Middle managers
• Supervisors
• Responsible for daily operations

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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

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Budget Implementation

• Budget committee

• Oversees each stage in the preparation of the
  overall budget
• Mediates any departmental disputes that might
  arise in the process
• Gives final approval to the budget

The make-up of the committee ensures that the
budgeting process has a companywide perspective.
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Budget Implementation (contd)

• Budget committee members

• Controller
• Has overall responsibility for budget
  implementation
• President
• Vice presidents

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Budget Implementation (contd)

• Successful budgets depend on two factors
• Clear communication
• Support of top management
• Middle- and lower-level managers must see that
  top management supports the budget and encourages
  its implementation

• A 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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Planning

• Helps managers relate the organizations
  long-term goals to its short-term activities

• Distributes resources and workloads
• Communicates responsibilities
• Selects performance measures
• Sets goals for bonuses and rewards

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Performing
Budgeting helps managers

• Communicate expectations
• Measure performance and motivate employees
• Coordinate activities and allot resources

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Evaluating
Budgeting helps managers

• Evaluate performance
• Determine timeliness
• Find variances and create solutions
• Compare planned performance with actual
  performance

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Communicating
Budgeting helps managers

• Communicate budget information
• Provide continuous feedback
• Support operating decisions

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Stop Review

• What two factors are necessary for successful
  budget implementation?

A. Clear communication and support of top
management
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Stop Review

• 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.
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The Master Budget

• Objective 2
• Identify the elements of a master budget in
  different types of organizations and the
  guidelines for preparing budgets.

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The Master Budget

• Consists of a set of operating budgets and a set
  of financial budgets that detail an
  organizations financial plans for
  a specific accounting period, generally a year

• 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

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The Master Budget (contd)

• 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

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The Master Budget (contd)

• 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

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The Master Budget (contd)

• Managers can improve the quality of budgets by
  using the following guidelines
• Know the purpose of the budget
• Identify the user group and its information needs
• Identify sources of accurate, meaningful budget
  information
• Establish a clear format for the budget
• Use appropriate formulas and calculations in
  deriving quantitative information
• Revise the budget until it includes all planning
  decisions

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Preparation of a Master Budget for a
Manufacturing Organization
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Preparation of a Master Budget for a Retail
Organization
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Preparation of a Master Budget for a Service
Organization
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Sales Budget

• Prepared first
• Used to estimate sales volume and revenue
• 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.
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Stop Review

• 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.
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Operating Budgets

• Objective 3
• Prepare the operating budgets that support the
  financial budgets.

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Operating Budgets
A set of budgets that are used in planning the
daily operations of an organization

• Are part of the master budget

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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

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Sales Budget

• Detailed plan, expressed in both units and
  dollars, that identifies the product (or service)
  sales expected during an accounting period

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Sales Budget (contd)

• Accountants use budgets to
• Determine estimated cash receipts for the cash
  budget
• To determine the total budgeted sales

• Sales managers use budgets to
• Plan sales- and marketing-related activities
• Determine human, physical, and technical resource
  needs

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Sales Budget (contd)
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 products
  quality by using more expensive materials or
  production processes
• The estimated selling price may have to be higher
  than the current price

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Sales Budget (contd)

• 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

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Sales Budget (contd)

• External factors taken into consideration in a
  sales forecast include
• The state of the local and national economies
• The state of the industrys economy
• The nature of the competition and its sales
  volume and selling price

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Sales Budget (contd)
Internal factors include

• The number of units sold in prior periods
• The organizations credit policies
• The organizations collection policies
• The organizations pricing policies
• Any new products the organization plans to
  introduce to the market
• The capacity of the organizations manufacturing
  facilities

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Sales Budget (contd)
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The Production Budget
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

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What Information Is Needed to Prepare a
Production Budget?

• 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 periods
  budgeted unit sales

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What Information Is Needed to Prepare a
Production Budget?

• To determine the production needs for an
  accounting period

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Production Budget
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The Direct Materials Purchases Budget

• A detailed plan that identifies the quantity of
  purchases required to meet budgeted production
  and inventory needs and the costs associated with
  those purchases

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What Information Is Needed to Prepare a
Purchases Budget?

• Production needs 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
  periods production

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Steps to Prepare a Direct Materials Purchasing
Budget

• Calculate each periods total production needs in
  units of direct materials.
• 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.
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Direct Materials Purchases Budget
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The Direct Labor Budget

• A detailed plan that estimates the direct labor
  hours needed during an accounting period
  and the associated costs

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The Direct Labor Budget (contd)
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Steps in Preparing a Direct Labor Budget

• Estimate the total direct labor hours
• Multiply estimated direct labor hours per unit by
  the anticipated units of production
• Calculate the total budgeted direct labor cost

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Direct Labor Budget
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The Overhead Budget

• A detailed plan of anticipated manufacturing
  costs, other than direct materials
  and direct labor costs, that must be
  incurred to meet budgeted production needs

• Presentation of information is flexible
• Grouping by activities is useful for
  organizations using activity-based costing

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Purposes of the Overhead Budget

• Integrate the overhead cost budgets developed by
  managers of production and production-related
  departments
• Group information for the calculation of overhead
  rates for the forthcoming accounting period

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Overhead Budget
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The Selling and Administrative Expense Budget
A detailed plan of operating expenses,
other than those related to production,
that are needed to support sales and overall
operations during an accounting period

• Accountants use this budget to estimate cash
  payments for products or services not used in
  production-related activities

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Selling and Administrative Expense Budget
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The Cost of Goods Manufactured Budget
A detailed plan that summarizes the estimated
costs of production during an accounting period

• Sources of information
• Direct materials, direct labor, and overhead
  budgets

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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
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Stop Review

• What are the sources of information for preparing
  the cost of goods manufactured budget?

A. Direct materials budget, direct labor budget,
overhead budget
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Financial Budgets

• Objective 4
• Prepare a budgeted income statement, a cash
  budget, and a budgeted balance sheet.

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Financial Budgets
Projections of financial results for the
accounting period

• Include
• Budgeted income statement
• Capital expenditures budget
• Cash budget
• Budgeted balance sheet

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The Budgeted Income Statement

• Projects an organizations net income for an
  accounting period based on the revenues and
  expenses estimated for that period

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Budgeted Income Statement
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The Capital Expenditures Budget

• A detailed plan outlining the anticipated amount
  and timing of capital outlays for long-term
  assets during an accounting period

• 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

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The Cash Budget
A projection of the cash an organization will
receive and the cash it will pay out
during an accounting period

• Summarizes the cash flow prospects of all
  transactions considered in the master budget
• Enables managers to plan for short-term loans
  when the cash balance is low or short-term
  investments when the cash balance is high

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Elements of a Cash Budget
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Cash Budget Exclusions

• Excludes some planned noncash transactions
• Depreciation and amortization expense
• Issuance and receipt of stock dividends
• Uncollectible accounts expense
• Gains and losses on sales of assets
• May also exclude
• Deferred taxes
• Accrued interest

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Estimating Ending Cash Balance

• To calculate the estimated ending cash balance

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Estimating Cash Receipts
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

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Estimating Cash Payments
Sources for estimating cash payments

• Operating budgets
• Budgeted income statement
• Capital expenditures budget
• Previous years financial statements
• Loan records

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The Cash Budget (contd)

• Supporting schedules
• Schedule of expected cash collections from
  customers
• Schedule of expected cash payments for direct
  materials

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Schedule of Expected Cash Collections from
Customers
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Schedule of Expected Cash Payments for Direct
Materials
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The Cash Budget
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The Cash Budget (contd)

• 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
• If the ending cash balance on the cash budget is
  significantly above the minimum level required,
  the company may invest excess cash in short-term
  securities to generate additional income

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The Budgeted Balance Sheet
Projects an organizations 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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Budgeted Balance Sheet (contd)
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Stop Review

• 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.
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Chapter Review

• Define budgeting and explain managements role in
  the budgeting process.
• Identify the elements of a master budget in
  different types of organizations and the
  guidelines for preparing budgets.
• Prepare the operating budgets that support the
  financial budgets.

85
Chapter Review (contd)

• Prepare a budgeted income statement, a cash
  budget, and a budgeted balance sheet.