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Profit Planning and Budgeting

CHAPTER 9

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PowerPointPowerPoint Presentation by Presentation by

LuAnn BeanLuAnn BeanProfessor of AccountingProfessor of AccountingFlorida Institute of TechnologyFlorida Institute of Technology

Managerial Accounting 11E

Maher/Stickney/Weil

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CHAPTER GOAL

This chapter shows how a short-term operating budget is established and how it fits into the overall plan for achieving organization goals. You will also learn how ethical issues affect the budgeting and performance evaluation process.

☼ ☼

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BUDGET: DefinitionBUDGET: Definition

Is a plan of the resources needed to carry out tasks and

meet financial goals.

LO 1

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STRATEGIC PLANNING

Companies start the strategic planning process by stating their critical success factors, that is the most important things the company must do for success. Companies build on critical success factors to expand operations.

Companies start the strategic planning process by stating their critical success factors, that is the most important things the company must do for success. Companies build on critical success factors to expand operations.

LO 1

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MASTER BUDGET

A master budget is part of the overall organization plan for the next year and includes:Organizational goalsStrategic long-range profit planMaster budget (a tactical short-range profit plan)

LO 1

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ORGANIZATIONAL GOALS: Definition

ORGANIZATIONAL GOALS: Definition

Are broad objectives management establishes and employees work to achieve.

LO 1

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STRATEGIC LONG-RANGE PROFIT PLAN

Any plan that focuses on the intermediate or distant future is stated in broad termsCost control

Optimize contribution from existing product lines by holding product cost increases to less than the general rate of inflation

Market shareMaintain market share by providing a level of service

and quality comparable to top competitors

LO 1

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LO 1

Budgeting is an

information gathering

process where information comes from both internal and external

sources.

Budgeting is an

information gathering

process where information comes from both internal and external

sources.

EXHIBITEXHIBIT 9.19.1

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PARTICIPATIVE BUDGETING: Definition

PARTICIPATIVE BUDGETING: Definition

Is a process of gathering information from lower- and

middle-management employees.

LO 2

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RESPONSIBILITY CENTER: Definition

RESPONSIBILITY CENTER: Definition

Is a division, department responsible for managing a

particular group of activities in the organization.

LO 3

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RESPONSIBILITY CENTERS: Four Types

Cost centersExample: Manufacturing departmentsManagers responsible for managing costs

Engineered cost centers: well-established input/output relationsProduction departments

Discretionary cost centers: input/output relations not well specifiedResearch departments

Revenue centersExample: Marketing departmentsManagers responsible for revenues

LO 3

Continued

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RESPONSIBILITY CENTERS: Four Types

Profit centersManagers responsible for managing costs and

revenues

Investment centersExample: Corporate divisionsManagers responsible for costs, revenues, and

assets

LO 3

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Activity Category

Example

Unit Converts resources into products Direct labor

Batch Batch of same setup, personnel Machine setups

Product Support a particular product line Design work

Customer Meet customer needs Customer service

Facility Support entire organization Human resources

ESTABLISHING BUDGETS: Using Cost Hierarchies

LO 3

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SALES BUDGET

PRODUCTION BUDGET

MARKETING BUDGET

ADMINISTRATIVE BUDGETS

PROFIT PLANNING BUDGET

LO 4BUDGET

PROCESS

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DEVELOPING SALES BUDGET

Forecasting Sales is the heart of the budgeting process and perhaps the most difficult. Information is sought from many sources.

LO 4

Sales staff

Market researchers

Delphi technique

Trend analysis

Econometric models

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EXAMPLE: Victoria’s Gourmet Coffee

Victoria’s Gourmet Coffee is preparing its budget for the year.

LO 4

Continued

VGC

Five departments are involved in budgeting

process.

Five departments are involved in budgeting

process.

EX

HIB

ITE

XH

IBIT

9.29.2

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VICTORIA’S SALES BUDGETVictoria’s Gourmet Coffee forecasts three levels of

sales for budgeting purposes.

LO 4VGC

Ultimately, Victoria’s chose the

expected level of sales,

70,000 units @ $6 each, for

their budgeting process.

Ultimately, Victoria’s chose the

expected level of sales,

70,000 units @ $6 each, for

their budgeting process.

EXHIBITEXHIBIT 9.39.3

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DEVELOPING PRODUCTION BUDGET

Production budgets begin with Beginning Inventory (BI). They combine this with estimate of units to be sold and desired Ending Inventory (EI) to estimate production.

Units Produced =

Units to be sold + Desired EI – Units BI

LO 4

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LO 4VGC

EX

HIB

ITE

XH

IBIT

9.49.4

Production budgets include direct materials, direct labor, and

variable and fixed overhead.

Production budgets include direct materials, direct labor, and

variable and fixed overhead.

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LO 4

Continued

VGC

EX

HIB

ITE

XH

IBIT

9.59.5

Marketing budgets are comprised of

variable (unit) and fixed

(customer and facility) costs.

Marketing budgets are comprised of

variable (unit) and fixed

(customer and facility) costs.

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LO 4

Continued

VGC

EX

HIB

ITE

XH

IBIT

9.69.6

Administrative budgets are comprised of fixed costs,

some of which are

discretionary.

Administrative budgets are comprised of fixed costs,

some of which are

discretionary.

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LO 4VGC

EX

HIB

ITE

XH

IBIT

9.79.7

Budget Profit plans combine

information from all prior

budgets to project an estimate of

profit.

Budget Profit plans combine

information from all prior

budgets to project an estimate of

profit.

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What happens if projected profit is

not the desired profit?

When projected profit does not meet the desired level, managers will seek ways to improve profits.

LO 4MANAGERS WANT TO KNOW!

What happens if actual sales and

production differ from projected levels?

Managers can develop a flexible budget to

compare actual with projected levels.

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LO 5VGC

EX

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9.79.7

Flexible budget based on actual sales volume show higher

profit.

Flexible budget based on actual sales volume show higher

profit.

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What do the terms “favorable” and “unfavorable”

variance mean?

Favorable means the variance will increase profits; unfavorable

means the variance will decrease profits.

LO 5

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IMPORTANCE OF BUDGETS

LO 6

Budgets affect both organizational and individual performance. If sales forecasts are too high, excess inventory arises. Forecasts too low lead to lost sales. Individuals are rewarded when performance measures are met.

Budgets affect both organizational and individual performance. If sales forecasts are too high, excess inventory arises. Forecasts too low lead to lost sales. Individuals are rewarded when performance measures are met.

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SUMMARY OF THE MASTER BUDGET The master budget summarizes management’s plans for the period

covered. Preparing the master budget requires the participation of all managerial groups, from local plant and sales managers to the top executives of the firm and the board of directors.

Once management adopts the budget, it becomes the major planning and control instrument. Master budgets are almost always static budgets; that is, they consider the likely results of the operations at the one level of operations specified in the budget.

Computerizing the process makes it less costly to develop multiple master budgets that take into account various uncertainties facing the firm, such as market conditions, material prices, labor difficulties, and government regulations.

LO 7

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IMPLICATIONS FOR INCENTIVE PLANS

Typical implications for developing good incentive plans include:

developing incentive methods that provide rewards for both accurate forecasts and good performance.

rewards that are positively related to forecasted sales to give incentives to forecast high rather than low.

additional rewards for employees who beat the forecast and penalties for results worse than forecast.

LO 8

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End of CHAPTER 9