CHAPTER 10: STATIC AND FLEXIBLE BUDGETS Cost Management, Canadian Edition © John Wiley & Sons, 2009 Chapter 10: Static and Flexible Budgets Cost Management,

CHAPTER 10: STATIC AND FLEXIBLE BUDGETS

Cost Management, Canadian Edition

© John Wiley & Sons, 2009Chapter 10: Static and Flexible Budgets

Cost Management, Cdn Ed, by Eldenburg et alSlide # 1

Learning Objectives

© John Wiley & Sons, 2009

Chapter 10: Static and Flexible BudgetsCost Management, Cdn Ed, by Eldenburg et al

Slide # 2

• Q1: What are the relationships among budgets, long-term strategies, and short-term operating plans?• Q2: What is a master budget and how is it prepared? How are operating budgets prepared?

• Q3: How is the cash budget developed?

• Q4: What are budget variances and how are they calculated?• Q5: What are the differences between static and flexible budgets?

• Q6: How are budgets used to monitor and motivate performance?

• Q7: What are other approaches to budgeting?


Cost Management, Cdn Ed, by Eldenburg et alSlide 3

Q1: What are the relationships among budgets, long-term

strategies, and short-term operating plans?

Budgets, Strategies, & Operating Plans

• A budget is – A formalized financial plan.– A translation of an organization’s strategies.– A method of communicating.– A way to define areas of responsibility and

decision rights.



Slide # 4

• The budget cycle is the series of sequential steps followed to create and use budgets.



Q2: What is a master budget and how is it prepared? How are operating budgets

prepared?

Master Budgets

• A master budget is – A comprehensive plan for the upcoming

accounting period.– Usually prepared for a one-year period.– Is based on a series of budget assumptions.



Slide # 6

• The master budget consists of several subsidiary budgets, in two categories:– Operating budgets– Financial budgets

Operating Budgets

– Revenue budget– Production budget– Direct materials budget– Direct labour budget– Manufacturing overhead budget– Inventory and cost of goods sold budget– Support department budgets– Budgeted income statement



Slide # 7

• The operating budget is created by preparing the following individual budgets, in this order:

Financial Budgets

– Capital budget– Long-term financing budget– Cash budget– Budgeted balance sheet– Budgeted statement of cash flows



Slide # 8

• The financial budget is created by preparing the following individual budgets, in this order:

Revenue budget

Budgeted sales in units in April

Budgeted selling price per unit

Budgeted revenues

Revenue budget

Budgeted sales in units in April 6,000

Budgeted selling price per unit $68.00

Budgeted revenues $408,000

Operating Budget Example

Stanley J, Inc., makes a tool used by auto mechanics that sells for $68/unit. It expects to sell 6,000 units in April and 7,000 units in May. Stanley J prefers to end each period with a finished goods inventory equal to 10% of the next period’s sales in units and a direct materials inventory equal to 20% of the direct materials required for the next period’s production. The company never has any beginning or ending work-in-process inventories. There were 400 units in finished goods inventory on April 1. Prepare the revenue and production budgets for April.



Slide # 9

Production budget

Budgeted sales in units in April

Desired ending FG inventory

Total units required

Less: beginning FG inventory

Required production in units

Production budget

Budgeted sales in units in April 6,000

Desired ending FG inventory 700

Total units required 6,700

Less: beginning FG inventory -400

Required production in units 6,300

Direct materials budget


DM required per unit, in kilograms

Total DM required, in kilograms

Less: Beginning DM inventory

Plus: Desired ending DM inventory

Required DM purchases in kilograms

Budgeted DM cost per kilogram

Budgeted cost of DM

Direct materials budget


DM required per unit, in kilograms 0.3

Total DM required, in kilograms 1,890

Less: Beginning DM inventory -220

Plus: Desired ending DM inventory 390

Required DM purchases in kilograms 2,060

Budgeted DM cost per kilogram $4.00

Budgeted cost of DM $8,240


Stanley J’s product uses 0.3 kg of direct material per unit, at a cost of $4/kg. There were 220 kg of direct material on hand on April 1. Assume that budgeted production for May is 6,500 units. Prepare the direct materials budget for April.



Slide # 10


Stanley J’s product uses 0.2 hours of direct labour at a cost of $12/hr. Prepare the direct labour budget for April.



Slide # 11

Direct labour budget


DL required per unit, in hours

Total DL hours required

Budgeted cost per DL hour

Budgeted cost of DL

Direct labour budget


DL required per unit, in hours 0.2

Total DL hours required 1,260

Budgeted cost per DL hour $12.00

Budgeted cost of DL $15,120


Stanley J’s budgeted fixed manufacturing overhead for April is $167,000, and variable manufacturing overhead is budgeted at $6 per direct labour hour. Prepare the manufacturing overhead budget for April.



Slide # 12

Manufacturing overhead budget

Total DL hours required

Budgeted variable overhead per DL hour

Total budgeted variable overhead

Budgeted fixed overhead

Total budgeted overhead

Manufacturing overhead budget

Total DL hours required 1,260

Budgeted variable overhead per DL hour $6.00

Total budgeted variable overhead $7,560

Budgeted fixed overhead $167,000

Total budgeted overhead $174,560

Ending inventories budgets

Budgeted cost of DM purchases

Beginning DM inventory

DM available for use

Budgeted cost of desired ending DM inventory:

Budgeted cost of DM to be used

Ending inventories budgets

Budgeted cost of DM purchases $8,240

Beginning DM inventory $854

DM available for use $9,094

Budgeted cost of desired ending DM inventory:

[6,500 units x 0.3 lbs/unit] x 20% x $4/ lb $1,560

Budgeted cost of DM to be used $7,534


Assume that Stanley J’s April 1 direct materials inventory had a cost of $1,560. Prepare the April ending inventories budget for direct materials.



Slide # 13

Budgeted cost of DM to be used

Budgeted cost of DL

Total budgeted overhead

Total budgeted manufacturing costs


Budgeted manufacturing cost per unit

Budgeted ending FG inventory in units

Budgeted cost of ending FG inventory

Budgeted cost of DM to be used $7,534

Budgeted cost of DL $15,120

Total budgeted overhead $174,560

Total budgeted manufacturing costs $197,214


Budgeted manufacturing cost per unit $31.3037

Budgeted ending FG inventory in units 700Budgeted cost of ending FG inventory $21,913


Prepare the April ending inventories budget for finished goods.



Slide # 14

Cost of goods sold budget

Beginning FG inventory

Total budgeted manufacturing costs

Cost of goods available for sale

Less: budgeted ending FG inventory

Budgeted cost of goods sold

Cost of goods sold budget

Beginning FG inventory $12,146

Total budgeted manufacturing costs $197,214

Cost of goods available for sale $209,359

Less: budgeted ending FG inventory $21,913

Budgeted cost of goods sold $187,447


Assume that Stanley J’s April 1 finished goods inventory had a cost of $12,146. Prepare the cost of goods sold budget for April.



Slide # 15

Support department budget

Administration

Distribution: Fixed costs

Variable costs

Research & development

Marketing: Fixed costs

Variable costs

Total budgeted support department costs

Support department budget

Administration $22,000

Distribution: Fixed costs $34,000

Variable costs $4,500 $38,500

Research & development $18,000

Marketing: Fixed costs $13,000


Total budgeted support department costs $107,820


Stanley J’s budget for April includes $22,000 for administrative costs, $34,000 for fixed distribution costs, $18,000 for research and development, and $13,000 for fixed marketing costs. Additionally, the budgeted variable costs for distribution are $0.75/unit sold and the budgeted variable costs for marketing are 4% of sales revenue. Prepare the support department budget for April.



Slide # 16

Budgeted income statement

Sales revenue

Cost of goods sold

Gross margin

Operating costs:

Administration

Distribution

Research & development

Marketing

Net income before taxes

Income taxes

Net income

Budgeted income statement

Sales revenue $408,000

Cost of goods sold $187,447

Gross margin $220,553

Operating costs:

Administration $22,000

Distribution $38,500

Research & development $18,000

Marketing $29,320 $107,820

Net income before taxes $112,733

Income taxes $31,565

Net income $81,168


Suppose that Stanley J’s income tax rate is 28%. Prepare the budgeted income statement for April.



Slide # 17



Q3: How is the cash budget developed?

Cash Budgets• Cash budgets are prepared after the

operating budgets.



Slide # 19

• The cash budgets include the following individual budgets:– Cash receipts budget– Cash disbursements budget– Short-term borrowings and investments

budget

Cash Budget ExampleBryce Manufacturing is preparing a cash budget for a new division that will begin operations on January 1, 2010. Bryce expects sales to be 40% cash and 60% on account, with 45% of credit sales are collected in the month of the sale. In the month after the sale, 50% of credit sales should be collected, with the remainder collected two months after the sale. Budgeted sales for the first three months are $100,000, $150,000 and $200,000. Prepare a cash receipts budget for the first three months of 2010.



Slide # 20

January February March

Cash sales

A/R collections:

From current month's sales

From 1 month ago

From 2 months ago

Total


Cash sales $40,000 $60,000 $80,000

A/R collections:

From current month's sales $27,000 $40,500 $54,000

From 1 month ago $0 $30,000 $45,000

From 2 months ago $0 $0 $3,000

Total $67,000 $130,500 $182,000


Direct labour costs

Payments on A/P:

From current month's purchases

From 1 month ago

From 2 months ago

Total


Direct labour costs $30,000 $45,000 $60,000

Payments on A/P:

From current month's purchases $8,000 $14,000 $18,000

From 1 month ago $0 $10,000 $17,500

From 2 months ago $0 $0 $2,000

Total $38,000 $69,000 $97,500

Cash Budget ExampleBryce Manufacturing budgets direct labour costs to be 30% of sales revenue and expects to pay this in the month the costs are incurred. Direct materials purchases will be on account, and paid as follows: 40% in the month of the purchase, 50% the following month, and 10% in the second month following the purchase. Budgeted direct material purchases for the first 3 months of 2010 are $20,000, $35,000 and $45,000. Compute the budgeted cash disbursements for direct materials and labour for the first 3 months of 2010.



Slide # 21


Direct labour and materials

Other variable costs

Other fixed costs

Total


Direct labour and materials $38,000 $69,000 $97,500

Other variable costs $4,000 $6,000

Other fixed costs $6,000 $6,000 $6,000

Total $44,000 $79,000 $109,500

Cash Budget ExampleBryce Manufacturing budgets other variable costs at 4% of sales revenue and will be paid in the month after the costs are incurred. Other budgeted fixed costs are $6,000 per month and will be paid in the month incurred. Prepare a cash disbursements budget for all costs, including direct materials and labour.



Slide # 22

Cash Budget ExampleUsing the information from the prior slides, prepare a schedule of budgeted cash flows for Bryce Manufacturing’s new division for the first three months of 2010.



Slide # 23

January February MarchBeginning cash balanceCash receiptsCash disbursementsEnding cash balance

January February MarchBeginning cash balance $0 $23,000 $74,500Cash receipts $67,000 $130,500 $182,000Cash disbursements ($44,000) ($79,000) ($109,500)Ending cash balance $23,000 $74,500 $147,000



Q4: What are budget variances and how are

they calculated?

Budget Variances• Managers compare actual results to

budgeted results in order to– Monitor operations, and – Motivate appropriate performance.



Slide # 25

• Differences between budgeted and actual results are called budget variances.– Variances are stated in absolute value

terms, and labeled as Favourable or Unfavourable.

Budget Variances

• Reasons for budget variances are investigated.



Slide # 26

• The investigation may find:– Inefficiencies in actual operations that

can be corrected.– Efficiencies in actual operations that can

be replicated in other areas of the organization.

– Uncontrollable outside factors that require changes to the budgeting process.



Q5: What are the differences between static

and flexible budgets?

Static Budgets• A budget prepared for a single level of sales

volume is called a static budget.

• Static budgets are prepared at the beginning of the year.

• Differences between actual results and the static budget are called static budget variances.



Slide # 28

Flexible Budgets• A budget prepared for a multiple levels of

sales volume is called a flexible budget.

• Flexible budgets are prepared at the beginning of the year for planning purposes and at the end of the year for performance evaluation.

• Differences between actual results and the flexible budget are called flexible budget variances.



Slide # 29

Flexible Budget ExampleTina’s Trinkets is preparing a budget for 2010. The budgeted selling price per unit is $10, and total fixed costs for 2010 are estimated to be $5,000. Variable costs are budgeted at $3/unit. Prepare a flexible budget for the volume levels 1,000, 1,100, and 1,200 units.



Slide # 30

Sales in units 1,000 1,100 1,200

Revenues

Variable costs

Contribution margin

Fixed costs

Operating income

Volume Levels

Sales in units 1,000 1,100 1,200

Revenues $10,000 $11,000 $12,000

Variable costs $3,000 $3,300 $3,600

Contribution margin $7,000 $7,700 $8,400

Fixed costs $5,000 $5,000 $5,000

Operating income $2,000 $2,700 $3,400

Volume Levels

Static Budget Variances Example

Suppose that Tina’s 2010 static budget was for 1,100 units of sales. The actual results are given below. Compute the static budget variances for each row and discuss.



Slide # 31

Static Budget

Actual Results

Static Budget

Variance

Sales in units 1,100 980

Revenues $11,000 $9,604


Contribution margin $7,700 $6,615

Fixed costs $5,000 $4,520

Operating income $2,700 $2,095

Static Budget

Actual Results

Static Budget

Variance

Sales in units 1,100 980

Revenues $11,000 $9,604 $1,396 Unfavourable

Variable costs $3,300 $2,989 $311 Favourable

Contribution margin $7,700 $6,615 $1,085 Unfavourable

Fixed costs $5,000 $4,520 $480 Favourable

Operating income $2,700 $2,095 $605 Unfavourable

Flexible Budget Variances Example

Compute the flexible budget variances for Tina and discuss the results. Compare the flexible budget variances to the static budget variances on the prior page.



Slide # 32

Year-end Flexible Budget

Actual Results

Flexible Budget

Variance

Sales in units 980

Revenues $9,604

Variable costs $2,989

Contribution margin $6,615

Fixed costs $4,520

Operating income $2,095

Year-end Flexible Budget

Actual Results

Flexible Budget

Variance

Sales in units 980 980

Revenues $9,800 $9,604 $196 Unfavourable

Variable costs $2,940 $2,989 $49 Unfavourable

Contribution margin $6,860 $6,615 $245 Unfavourable

Fixed costs $5,000 $4,520 $480 Favourable

Operating income $1,860 $2,095 $235 Unfavourable



Q6: How are budgets used to monitor and motivate

performance?

Performance Evaluation• A static budget variance includes effects from

output volume.• A flexible budget variance removes these output

volume effects.• Other adjustments to the year-end flexible

budget may be made for a fair performance evaluation, such as– Input price changes outside the control of the

manager under evaluation– Fixed cost increases outside the control of the

manager under evaluation– Note that it is important that managers have

control over amounts they are held accountable for© John Wiley & Sons, 2009


Slide # 34

Performance Evaluation• Participative Budgeting– Occurs when managers are responsible for

setting their own budgets which creates “buy-in” in the budgeting process

– Must be careful that budgets are not set unrealistically low as this would offer little motivation to perform well

• Zero-based budgeting– Does not rely on adjusting prior years’

budgets– Managers must be able to justify all budget

amounts– This encourages cost cutting, however is

time-consuming© John Wiley & Sons, 2009


Slide # 35



Q7: What are other approaches to budgeting?

Other Budgeting Approaches

• Rolling budgets are prepared frequently for overlapping time periods and actual results may be used to update the budget for the next period.

• Activity based budgets use more cost pools and cost drivers.

• Kaizen budgets plan cost reductions over time.• Extreme programming can be used to budget

long-term projects that contain a large amount of uncertainty.– Often used for information technology projects– Projects begin with little up-front planning



Slide # 37

Copyright

Copyright © 2009 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.


Slide 38Chapter 10: Static and Flexible Budgets

Cost Management, Cdn Ed, by Eldenburg et al

Documents

CHAPTER 10: STATIC AND FLEXIBLE BUDGETS Cost Management, Canadian Edition © John Wiley & Sons, 2009 Chapter 10: Static and Flexible Budgets Cost Management,