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Budgeting for Planning and ControlLearning ObjectivesDefine budgeting and discuss its role in planning, control, and decision making.Define and prepare the master budget, identify its major components, and explain the interrelationships of its various components.Learning Objectives (continued)Describe flexible budgeting and identify the features that a budgetary system should have to encourage managers to engage in goal-congruent behaviour.BudgetsFinancial plan of the resources needed to carry out activities and meet financial goalsBudgetStrengths of a company that enable it to outperform competitorsCritical Success FactorsGoalsPlansDecision makingPerformance evaluationsTies together:4A budget is a financial plan of the resources needed to carry out activities and meet financial goals. The budget ties together the goals of the organization, the plans for achieving those goals, the decision that are made, and finally, the performance evaluation. By identifying a companys critical success factors, those strengths that enable the company to outperform competitors, and incorporating those factors into the strategic plan, companies are able to improve their overall competitiveness.

Definition and Role of BudgetingStrategic Plan Monitoring of Actual Activity

Long-Term Objectives

Short-Term Objectives

Short-Term Plan

Budgets Comparison of Actual with Planned

Feedback Investigation

Corrective actionPlanningControlBudgets are quantitativeexpressions of plansPurposes of BudgetingIt forces managers to plan.It provides information that can be used to improve decision making.It provides a standard for performance evaluation.It improves communication and coordination.Two Dimensions of Budgeting

There are two dimensions to budgeting:1.How is the budget prepared?2.How is the budget used to implement the organizations plan?Human Element in BudgetingOrganization goalsIndividual goalsGoal congruenceUse of input from lower- and middle-management employees; also called grass roots budgetingParticipative Budgeting

8Using input from lower- and middle management, a participative budget facilitates goal congruence between the organization and individual goals. Master BudgetTactical short range plan that ties the strategic plan to operating planStatic BudgetBudget PlanPlanning BudgetIncome statement portion of the master budgetProfit Plan

9We said the master budget is the financial plan of an organization for the coming year. It is a tactical short-range plan that ties the strategic plan to the operating plan for the year. The income statement portion of the master budget is the profit plan.

Master BudgetA master budget can be divided into operating and financial budgets.Operating budgets describe the income-generating activities of a firm: sales, production, and finished goods inventories.Financial budgets detail the inflows and outflows of cash and the overall financial position.The Operating BudgetSales budgetProduction budgetDirect material purchases budgetDirect labour budgetOverhead budgetSelling and administrative expenses budgetEnding finished goods inventory budgetCost of goods sold budgetThe operating budget consists of a budgeted income statement accompanied by the followingsupport schedules:Sales BudgetHow do we forecast sales?Sales is the most difficult aspect of budgeting.

Sales StaffDelphi TechniqueTrend AnalysisEconometric Models Market Research12Sales is the most difficult aspect of budgeting and the rest of the budget depends on sales. A participative sales budget, including input from staff, along with the use of other techniques and analyses is often used to reduce subjectivity. Forecast by Sales StaffNumber of unitsSales price of a unitSales budget consists of:xWho knows how many unitswill sell and at what price?

Sales personnel have knowledge about customers.13Involving staff just makes sense. Sales personnel have knowledge about customers. Sales Budget (Schedule 1) ______________Quarter____________ 1234YearUnits2,0006,0006,0002,00016,000Unit selling pricex $0.70x $0.70x $0.80x $0.80x $0.75$1,400$4,200$4,800$1,600$12,000==========================Production BudgetProduction plan of resources needed to meet current sales demand and ensure that inventory levels are sufficient for future salesUnits in beginning inventory(BB)Required production (units)(TI)Budgeted sales (units)(TO)Units in ending inventory(EB)=+-Remember the cost flow model?InventoriesBBTITOEB15After completing the sales budget, the production budget can be developed. The production budget plans resources needed to meet current sales demand and ensure that inventory levels are sufficient for future sales. Required production can be computed using the basic cost flow model. The units in beginning inventory (the units already available) plus budgeted units produced minus budgeted units sold equals budgeted units in ending inventory.

Production Budget (Schedule 2) _____________Quarter____________1 2 3 4 Year Sales (Schedule 1)2,000 6,000 6,000 2,000 16,000 Desired ending inventory 500 500 100 100 100 Total needs2,500 6,500 6,100 2,100 16,100 Less: Beginning inventory (100) (500) (500) (100) (100)Units to be produced2,400 6,000 5,600 2,000 16,000 ==== ==== ==== ==== ===== Production CostsLabor

Direct Materials

Overhead

santiago17Once the production budget is developed we can determine production costs. How much direct materials, direct labor, and overhead are required to produce 170,000 units?

Direct Materials Purchases Budget (Schedule 3) ______________Quarter______________1 2 3 4 Year Units to be produced (S.2)2,400 6,400 5,600 2,000 16,000 Direct materials per unit x 13 x 13 x 13 x 13 x 13 Production needs31,200 78,000 72,800 26,000 208,000 Desired ending inventory 4,000 4,000 2,500 2,500 2,500 Total needs35,200 82,000 75,300 28,500 210,500 Less: Beginning inventory (2,500) (4,000) (4,000) (2,500) (2,500)Direct materials tobe purchased32,700 78,000 71,300 26,000 208,000 Cost per kilogramx$0.02 x $0.02 x $0.02 x $0.02 x $0.02 Total purchase cost$654 $1,560 $1,426 $520 $4,160 === ===== ===== ==== ===== Direct Labour Budget (Schedule 4) ________________Quarter____________1234YearUnits to be produced (Sch. 2)2,4006,0005,6002,00016,000Direct labour timex 0.015x 0.015x 0.015x 0.015x 0.015Total hours needed36908430240Average wage per hour x $10 x $10 x $10 x $10 x $10Total direct labour cost$360$900$840$300$2,400================Overhead Budget (Schedule 5) _____________Quarter_____________1234YearBudgeted DLH ( Sch. 4)36908430240Variable overhead rate x $8 x $8 x $8 x $8 x $8Budgeted variable overhead$288$720$672$240$1,920Budgeted fixed overhead* 320 320 320 320 1,280Total overhead$608$1,040$992$560$3,200======================

*Includes $200,000 of depreciation in each quarter.Selling and AdministrativeExpenses Budget (Schedule 6) ________________Quarter____________1234YearPlanned sales in units (Sch. 1)2,0006,0006,0002,00016,000Variable S & A exp. per unitx $0.05x $0.05x $0.05x $0.05x $0.05Total variable expense$100$300$300$100$ 800Fixed S & A expenses:Salaries$ 35$ 35$ 35$ 35$ 140Advertising1010101040Depreciation1515151560Insurance444416Travel 5 5 5 5 20Total fixed expenses$ 69$ 69$ 69$ 69$ 276Total S & A expenses$169$369$369$169$1,076================Ending Finished GoodsInventory Budget (Schedule 7)Unit-cost computation:Direct materials (13 kg. @ $0.02)$0.26Direct labour (0.015 hr. @ $10)0.15Overhead:Variable (0.015 hr. @ $8)0.12Fixed (0.015 hr. @ $5.33*) 0.08Total unit cost$0.61====*$1,280/240 = $5.33UnitUnitsCostsTotalFinished goods: Concrete block100,000$0.61$61,000Cost of Goods Sold Budget (Schedule 8)Direct materials used (Schedule 3)*$4,160 Direct labour used (Schedule 4)2,400 Overhead (Schedule 5) 3,200 Budgeted manufacturing costs$9,760 Beginning finished goods 55 Goods available for sale$9,815 Less: Ending finished goods (Schedule 7) (61) Budgeted cost of goods sold$9,754 ===== *Production needs x $0.01 = 416,000 x $0.01Budgeted Income StatementSales (Schedule 1)$12,000 Less: Cost of goods sold (Schedule 8) (9,754)Gross margin$ 2,246 Less: Selling and administrative expenses (Schedule 6) (1,076)Operating income$ 1,171 Less: Interest expense (Schedule 10) (54)Income before taxes$ 1,117 Less: Income taxes (650)Net income$ 466 ====== The Financial BudgetsThe usual financial budgets prepared are:The cash budgetThe budgeted balance sheetThe budget for capital expendituresCash BudgetStatement of cash on hand at the start of the budget period, expected cash receipts, expected cash disbursements, and the resulting cash balance at the end of the budget period.Cash receiptsCollections of accounts receivableCash salesSales of assetsBorrowingIssuing stockOther

26Regardless of budgeted profits, a company requires cash to operate. Cash budgeting is important to ensure company solvency, maximize interest earned on cash balances, and determine whether the company is generating enough cash for operations. Preparing a cash budget requires that all revenues, costs, and other transactions be examined in terms of their effects on cash. Budgeted cash receipts are computed from collections of accounts receivable, cash sales, sales of assets, borrowing, issuing stock, and other cash-generating activities.

Cash Budget, Continued. . .Acquire new assetsMaterials purchasesManufacturing costsOperating activitiesDebt repaymentIncome taxesDividendsOtherCash disbursements

27Cash disbursements are computed by determining cash required for materials purchases, manufacturing costs, operating activities, debt repayment, acquisition of new assets, income taxes, dividends, and other activities.

The Cash BudgetBeginning cash balance$x,xxxAdd: Cash receipts x,xxxCash available$x,xxxLess: Cash disbursementsx,xxxLess: Minimum cash balance x,xxxCash surplus (deficiency)$x,xxxAdd: Cash from loansx,xxxLess: Loan repaymentsx,xxxAdd: Minimum cash balance x,xxxEnd cash balance$x,xxx=====Cash Budget Examplea.A $100,000 minimum cash balance is required for the end of each quarter. Money can be borrowed and repaid in multiples of $100,000. Interest is 12 % per year. Interest payments are made only for the amount of the principal being repaid. All borrowing takes place at the beginning of a quarter and all repayment takes place at the end of a quarter.b.Half of all sales are for cash, 70% of credit sales are collected in the quarter of sale, and the remaining 30% are collected in the following quarter. The sales for the fourth quarter of 2000 were $2 million. Cash Budget Example (continued)c.Purchases of raw materials are made on account; 80% of purchases are paid for in the quarter of purchase. The remaining 20% are paid for in the following quarter. The purchases for the fourth quarter of 2000 were $500,000.d.Budgeted depreciation is $200,000 per quarter for overhead and $15,000 per quarter for selling and administrative expenses (see Schedules 5 and 6).Cash Budget Example (continued)e.The capital budget for 2001 revealed plans to purchase additional equipment to handle increased demand at a small plant in Nevada. The cash outlay for the equipment, $600,000, will take place in the first quarter. The company plans to finance the acquisition of the equipment with operating cash, supplementing it with short-term loans as necessary.f.Corporate income taxes are approximately $650,000 and will be paid at the end of the fourth quarter (Schedule 9).g.Beginning cash balance equals $120,000.Cash Receipts from CustomersSourceQuarter1Quarter 2Quarter 3Quarter 4Cash sales$ 700,000$2,100,000$2,400,000$ 800,000Received onaccount from:Quarter 4, 2000300,000Quarter 1, 2001490,000210,000Quarter 2, 20011,470,000630,000Quarter 3, 20011,680,000720,000Quarter 4, 2001 560,000Total cash receipts$1,490,000$3,780,000$4,710,000$2,080,000================================Cash Disbursements for Raw MaterialsSourceQuarter1Quarter 2Quarter 3Quarter 4

Current quarter$523$1,248$1,141$416Prior quarter 100 131 312 285Total cash disbursement for raw materials$623$1,379$1,453$701==================Cash Disbursements ____________ ______Quarter__________________1234Less cash disbursements:Raw materials: Current quarter$523$1,248$1,141$416 Prior quarter100131312285Direct labour360900840300Overhead408840792360Selling and adm.150350366150Income taxes---------650Equipment 600 --- --- ---Total disbursements$2,141$3,469$3,451$2,161================Cash Budget (Schedule 10) _________ ______Quarter_______________1 234YearBeginning cash balance$ 120 $ 169$ 162$ 986$ 120Cash collections (PPT 13-24) 1,490 3,780 4,710 2,080 12,060Total cash available$1,610 $3,949$4,872$3,066$12,180

Total disbursements (PPT 13-24)$2,141 $3,469$3,451$2,161$11,222Minimum cash balance 100 100 100 100 100Total cash needs$2,241 $3,569$3,551$2,261$11,322

Excess (deficiency) of cash$ (631)$ 380 $1,321 $ 805$ 858 Add: Borrowings700 --- --- ---700 Less: Repayments--- (300)(400)---(700)Less: Interest paid --- (18) ( 36) --- (54)Ending cash balance $ 169 $ 162 $ 985 $ 904$ 904====== ======================= Master Budget for a Manufacturing FirmSales ForecastProduction budgetMarketing and administrative cost budgetRequired direct material, direct labor, and manufacturing overhead budgetsBudgeted cost of goods soldBudgeted income statementCash budgetBudgeted balance sheet36Lets do a review of the budget process. The budget starts with the sales forecast. From the sales forecast we can budget production, which we use to budget costs of material, labor and overhead, and marketing and administrative costs. After completing the budgeted cost of goods sold and the budgeted income statement we can prepare the cash budget and, finally, the budgeted balance sheet. Budgeting in Service OrganizationsSales ForecastLabor budgetMarketing and administrative cost budgetBudgeted cost of servicesBudgeted income statementCash budgetBudgeted balance sheet

37Budgeting in a service organization follows the same process except that a service organization does not produce products and, therefore, has no production budget. A significant part of the cost budget is the cost of labor. Again, start with the sales forecast and end with the budgeted balance sheet.

Budgeting Retail and Wholesale OrganizationsSales ForecastPurchasesMarketing and administrative cost budgetBudgeted income statementCash budgetBudgeted balance sheet

38Of course, a retail or wholesale organization has a purchase budget rather than a production budget. A retail or wholesale organization will also have a labor budget similar to a service industry. Once again, start with the sales forecast and work through the budgets to a budgeted balance sheet.

Total Assets, Last YearAssetsCurrent assets:Cash$ 120 Accounts receivable 300 Raw materials inventory50 Finished goods inventory 55 Total current assets$ 525Property, plant, and equipment:Land$ 2,500 Building and equipment9,000 Less: Accumulated depreciation (4,500)Total property, plant, and equipment 7,000Total assets$7,525=====39Total Liabilities and Stockholders Equity, Last YearLiabilities and Stockholders EquityCurrent liabilities:Accounts payable$ 100Stockholders equity:Common stock, no par$ 600Retained earnings 6,825Total stockholders equity 7,425Total liabilities and stockholders equity$7,525=====Budgeted Total AssetsAssetsCurrent assets:Cash$ 904Accounts receivable 240Raw materials inventory50Finished goods inventory 61Total current assets$1,255Property, plant, and equipment:Land $2,500Building and equipment$ 9,600Less: Accumulated depreciation (5,360)Total property, plant, and equipment 6,740Total assets$7,995=====Budgeted Total Liabilities and Stockholders EquityLiabilities and Stockholders EquityCurrent liabilities:Accounts payable$ 104Stockholders equity:Common stock, no par$ 600Retained earnings 7,291Total stockholders equity 7,891Total liabilities and stockholders equity$7,995=====Flexible and Static BudgetingStatic Budgeting is a budget for a particular level of activity.Flexible Budgeting is a budget that provides a firm with the capability to compute expected costs (and revenues) for a range of activities.

The Uses of Flexible BudgetThe flexible budget can be used to prepare the budget before the fact for the expected level of activity.Flexible budgeting can be used to compare what costs should have been for the actual level of activity.Flexible budgeting can help managers deal with uncertainty by allowing them to see the expected outcomes for a range of activities.Performance Report (Exhibit 13-6)ActualBudgetedVarianceUnits produced3,0002,400600 F===========Direct materials cost$ 927.3$ 624.0$303.3 UDirect labour costs450.0360.090.0 UOverhead:Variable:Supplies80.072.08.0 UIndirect labour220.0168.052.0 UPower40.048.0(8.0)FFixed:Supervision90.0100.0(10.0)FDepreciation200.0200.00.0 Rent 30.0 20.0 10.0 UTotal$2,037.3$1,592.0$445.3 U=================Flexible Production Budget (Exhibit 13-7) Variable Cost Range of Production Production Costs per Unit2,4003,0003,600Variable:Direct materials$0.26$ 624$ 780$ 936Direct labour0.15360450540Variable overhead:Supplies0.037290108Indirect labour0.07168210252Power 0.02 48 60 72Total variable costs$0.53$1,272$1,590$1,908Fixed overhead:Supervision$ 100$ 100$ 100Depreciation200200200Rent 20 20 20Total fixed costs$ 320$ 320$ 320Total production costs$1,592$1,910$2,228===============Actual vs. Flexible Performance Report (Exhibit 13-8)ActualBudgetVariance Units produced3,0003,000----- ============ Production costs:Direct materials$ 927.3$ 780.0$ 147.3 UDirect labour 450.0450.00.0 Variable overhead:Supplies80.090.0(10.0)FIndirect labour220.0210.010.0 UPower 40.0 60.0 (20.0)FTotal variable costs$1,717.3$1,590.0$ 127.3 UFixed overhead:Supervision$90.0$100.0$(10.0)FDepreciation200.0200.00.0 Rent 30.0 20.0 10.0 UTotal fixed costs$ 320.0$ 320.0 $0.0 Total production costs$2,037.3$1,910.0$ 127.3 U================= Behavioural Dimensions of BudgetingGoal CongruenceDysfunctional BehaviourFrequent Feedback on PerformanceMonetary and Nonmonetary IncentivesParticipative BudgetingRealistic StandardsControllability of CostsMultiple Measures of PerformanceStatic and Flexible Budgets

Static budgets gauge effectivenessFlexible budgets gauge efficiencyStatic and flexible budgets together gauge both effectiveness and efficiency

Profit Budgets and Variances

Assume the following budget and actual informationEvaluate the above performance report!

Static and Flexible Profit Budgets

The previous performance report is misleading, as it uses a static budget to gauge variable cost performance does not attempt to identify variances by causal factorsmixes the effects of effectiveness and efficiencyIt can be improved by comparingactual to flexible budget to determine the effects of cost performance and selling prices on profit, andstatic and flexible budgets to identify the effects of volume on profit

Profit Variances

Thank You

Master Budget

(1,000 units)Actual

(800 units)Variances

Sales$ 100,000$ 82,000 $ 18,000 U

Variable Costs 40,000 39,000 1,000 F

Contribution Margin 60,000 43,000 17,000 U

Fixed Costs 30,000 34,000 4,000 U

Operating Income 30,000 9,000 21,000 U

Master Budget

(1,000 units)Flexible Budget

(800 units)Actual

(800 units)

Sales$ 100,000$ 80,000$ 82,000

Variable Costs 40,000 32,000 39,000

Contribution Margin 60,000 48,000 43,000

Fixed Costs 30,000 30,000 34,000

Operating Income 30,000 18,000 9,000

Comparing the flexible to the static (master) budget isolates the effects of volume on profits, and comparing actual to flexible budget isolates the appropriate cost variances as well as the sales price variance, as follows:

Profit volume variance = 18,000 30,000 = $ - 12,000 (U)

Sales price variance = 82,000 80,000 = 2,000 (F)

Variable cost variances = 32,000 39,000= - 7,000 (U)

Fixed cost variances = 30,000 34,000= - 4,000 (U)

Total variances

= $ - 21,000 (U)

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