6-1

Operational Operational and Financial and Financial

BudgetingBudgetingPrepared by

Douglas Cloud Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

66

6-2

Explain how budgeting relates to the major functions of management.

Describe the components and organization of a comprehensive budget.

Describe several methods managers use to forecast sales and some of the problems of using each method.

Describe two approaches to setting budget allowances for costs and the types of costs for which each is appropriate.

ObjectivesObjectivesObjectivesObjectives

After reading this After reading this chapter, you should chapter, you should

be able to:be able to:

After reading this After reading this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinuedContinuedContinued

6-3

Describe behavioral problems associated with budgeting.

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

Describe the leads and lags that complicate the budgeting of cash receipts and disbursement.

ObjectivesObjectivesObjectivesObjectives

ContinuedContinuedContinuedContinued

6-4

List several ways that managers might resolve cash deficiencies revealed by a cash budget.

Describe similarities and differences between budgeting in for-profit and not-for-profit entities.

State how zero-based-budgeting and program budgeting differ from other budgeting processes.

ObjectivesObjectivesObjectivesObjectives

6-5

Budgets often reveal

incompatibilities and conflicts.

Budgets often reveal

incompatibilities and conflicts.

6-6

Comprehensive BudgetComprehensive BudgetComprehensive BudgetComprehensive Budget

A comprehensive comprehensive budgetbudget or master master budget budget is a set of

financial statements and other schedules

showing the expected, or pro forma, results for a future period.

6-7

Comprehensive BudgetComprehensive BudgetComprehensive BudgetComprehensive Budget

Sales forecastSales forecast Assumptions Assumptions about cost about cost behaviorbehavior

Pro forma Pro forma income income statementstatement

Assumptions about Assumptions about levels of inventory, levels of inventory,

collections of collections of receivables, and receivables, and

payments of payments of expenses and expenses and

liabilitiesliabilities

Balance Balance sheet at sheet at

beginning beginning of budget of budget

periodperiod

Budgets for Budgets for purchases and purchases and

productionproduction

Budgets for cash Budgets for cash and and

requirements for requirements for short-term short-term financingfinancing

Pro forma Pro forma balance balance sheetsheet

++

+Plans for long-term Plans for long-term financing and for financing and for capital spendingcapital spending

+

6-8

20062006

Continuous BudgetsContinuous BudgetsContinuous BudgetsContinuous Budgets

Continuous budgets are maintained by

adding a budget for a month (or quarter) as one of these periods goes by. Thus, a 12-

month budget exists at all times.

6-9

Sales ForecastersSales ForecastersSales ForecastersSales Forecasters

• External Indicators

• Historical Analysis

• Judgment

6-10

Interim Period ForecastsInterim Period ForecastsInterim Period ForecastsInterim Period Forecasts

Three distinct types of sales forecasting methods:

1. Annual forecasts

2. Longer-term forecasts (three to five years)

3. Quarterly or monthly forecasts

Once a forecast for the year has been approved as a basis for planning, it is necessary to break it down into interim periods.

6-11

Expense BudgetExpense BudgetExpense BudgetExpense Budget

Indirect labor $2,400 $0.40

Supplies 200 0.40

Maintenance 1,600 0.20

Depreciation 1,200 0.00

Miscellaneous 700 0.10

Total $6,100 $1.10

CostFixed Amount

per MonthDirect Labor

per Hour

6-12

Expense BudgetExpense BudgetExpense BudgetExpense Budget

Flexible budget

allowance=

fixed cost per month +

direct labor hours

xvariable cost per

hour

Example: Indirect laborExample: Indirect labor

$6,100 + (1,000 x $1.10)

Flexible budget

allowance=$7,200

6-13

Production Performance ReportProduction Performance ReportProduction Performance ReportProduction Performance Report

Direct labor hours 1,000 1,300

Indirect labor $2,800 $2,920 $2,870 $50

Supplies 600 720 705 15

Maintenance 1,800 1,860 1,900 (40 )

Depreciation 1,200 1,200 1,200 0

Miscellaneous 800 830 840 (10 )

Total $7,200 $7,530 $7,515 $15

Month____________________ Department________________Manager__________________

March MixingE. Jones

Budget Allowances

Budgeted Actual Actual Costs Hours Hours Incurred Variance

6-14

Budgeting and BehaviorBudgeting and BehaviorBudgeting and BehaviorBudgeting and Behavior

Conflict

Behavioral problems arise when: When managers’ interests

conflict

When budgets are imposed from above

When stretch goals are used

When budgets are viewed as checkup devices

6-15

Imposed budgets are when senior managers set performance goals (budgets) without consulting the individuals who will be responsible for meeting those goals.

Serious behavioral problems can arise (or be avoided) depending on the attitudes of managers imposing the performance goals.

Imposed BudgetsImposed BudgetsImposed BudgetsImposed Budgets

6-16

S t r e t c h g o a l s are exceptionally

ambitious targets not likely to be achieved

without making fundamental

changes in the way a job is done.

Stretch GoalsStretch GoalsStretch GoalsStretch Goals

6-17

““Checkup” DevicesCheckup” Devices““Checkup” DevicesCheckup” Devices

Behavioral problems arise when managers

compare budgeted and actual results and

subsequently evaluate the performance of their

subordinates.

6-18

““Spend IT or Lose It”Spend IT or Lose It”““Spend IT or Lose It”Spend IT or Lose It”

Expense budgets set limits on levels of costs to be incurred, allowances managers are not

supposed to exceed. If managers view their budget allowances as

strict limits on spending, they may spend either too little or too much.

6-19

Budgeting and EthicsBudgeting and EthicsBudgeting and EthicsBudgeting and Ethics Managers in some areas might consider

preparing—and ask management accountants to help them in doing so—budgets with a great deal of slack so that managers will be able to meet them with minimum effort.

Top-level management impose budgets on subordinates so tight that there is little chance of achieving them.

Ethical issues also arise about the reporting of actual results for a budget period.

6-20

Exhibit 6-3

January $400February 500March 800April 700May 600

Cost of goods sold will be 60% of sales dollars.

Total fixed costs will be $150, of which $15 per month is depreciation expense.

Month Sales Budget

6-21

Budgeted Income Statement

Sales $400 $500 $800 $1,700

Cost of goods sold 240 300 480 1,020

Gross profit andcontribution margin 160 200 320 680

Fixed costs 150 150 150 450

Income $ 10 $ 50 $170 $ 230

Exhibit 6-4

Three-Month January February March Total

6-22

Cost of goods sold $ 240 $ 300 $ 480 $1,020

Budgeted ending inven. 780 900 780 780

Total requirements 1,020 1,200 1,260 1,800

Beginning inventory 540 780 900 540

Purchases $ 480 $ 420 $ 360 $1,260

Purchases BudgetExhibit 6-5

Three-Month January February March Total

6-23

Sales $400 $500 $800 $1,700

Collections:

From prior years, 30% $310 $120 $150 $ 580

From current month, 70% 280 350 560 1,190

Total receipts $590 $470 $710 $1,770

Cash Receipts BudgetExhibit 6-6

Three-Month January February March Total

6-24

From prior month, 40% $195 $192 $168 $ 555

From current month,

60% 288 252 216 756

Total $483 $444 $384 $1,311

Cash Disbursements for PurchasesExhibit 6-7

Three-Month January February March Total

6-25

For merchandise,

see Exhibit 6-7 $483 $444 $384 $1,311

Fixed costs requiring

cash 135 135 135 405

$618 $579 $519 $1,716

Cash Disbursements BudgetExhibit 6-8

Three-Month January February March Total

6-26

Beginning balance,Exhibit 6-3 $ 80 $ 52 $ 50 $ 80

Cash receipts,Exhibit 6-6 590 470 710 1,770

Total available $670 $522 $760 $1,850Cash disbursements,

Exhibit 6-8 618 579 519 1,716Indicated balance $ 52 $(57 ) $241 $ 134Excess (deficiency) 2 (107 ) 191Borrow 107 107Repay 107 107Ending balance $ 52 $ 50 $134 $ 134

Cash BudgetExhibit 6-9

Three-Month January February March Total

6-27

Pro Forma Balance SheetAs of March 31, 20X6

Exhibit 6-10

AssetsCash (Exhibit 6-9) $ 134Accounts receivable (March sales x 30%) 240Inventory (Exhibit 6-5) 780Fixed assets (beginning balance less $45 depreciation for 3 months) 1,535Total assets $2,689 EquitiesAccounts payable (March purchases x 40%) $ 144Stockholders’ equity 2,545Total equities $2,689

6-28

Zero-based budgeting means that managers must justify every dollar they

request in a budget proposal for a given year.

Zero-based budgeting means that managers must justify every dollar they

request in a budget proposal for a given year.

6-29

Program budgeting requires that a budget indicate not only how the requested funds are to be

spent, but also why the funds are to be spent in those ways.

Program budgeting requires that a budget indicate not only how the requested funds are to be

spent, but also why the funds are to be spent in those ways.

6-30

The EndThe End

Chapter 6Chapter 6

6-31