Chapter+10_Budget_new

8/10/2019 Chapter+10_Budget_new

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Profit Planning(Budgeting)

Chapter 10


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After studying Chapter 10, you should be able to:

1. Understand why organizations budget and theprocesses they use to create budgets.2. Understand Basic Budgeting Terms and the

Behavioral Aspects of Budgeting.

3. Understand the Key Components of Master Budget iManufacturing, Merchandising and Service Industrie


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4. Prepare a Master Budget for a ManufacturingCompany.

5. Explain the Costs and Benefits of Budgeting

After studying Chapter 10, you should be able to:


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Learning Objective 1

Understand whyorganizations budget and theprocesses they use to create

budgets.


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The Basic Framework of Budgeting

Abudget is a detailed quantitative plan for acquiring andusing financial and other resources over a specified

forthcoming time period.

1. Theact of preparing a budget is calledbudgeting.2. Theuse of budgets to control an organizations activities is

known asbudgetary control.


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Planning and Control

Planning

involves developingobjectives and preparingvarious budgets toachieve thoseobjectives.

Control

involves the steps taken bymanagement to increase thelikelihood that the objectivesset down while planning areattained and that all parts of theorganization are workingtogether toward that goal.


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Advantages of Budgeting

Advantages

Define goaland objectives

Uncover potentialbottlenecks

Coordinateactivities

Communicateplans

Think about andplan for the future

Means of allocatingresources

Communicate plans throughoutthe organisation.

To avoid managers spendof their time dealing withday-to-day emergencies

Serve as benchmarks forevaluating subsequent performance

To ensure that scarce resourcesare allocated efficiently

To detect potential problembefore it occurs

To ensure that everyone inorganisation has same

objectives


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Responsibility Accounting

Managers should be held responsible for those items - andonly those items - that they can actually control to a significant exten

Responsibility accounting systems enable organizations to reactquickly to deviations from their plans and to learn from feedbacobtained by comparing budgeted goals to actual results

The point is not to penalize individuals for missing targets.


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Choosing the Budget Period

Operating Budget

2008 2009 2010 2011

Operating budgets ordinarilycover a one-year period

corresponding to a companys fiscal year.Many companies divide their annual

budgetinto four quarters.

A continuous budget is aprocess in which there is a rolling

twelve-month budget; a newbudget 12 months into the future) is

added as each current monthexpires.


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Understand Basic BudgetingTerms and the Behavioral

Aspects of Budgeting.


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Bottom-up and Top-down Budgeting

Bottom-up budgeting(Self-imposed budget orParticipative budget)

Top-down budgeting

Top

Management

MiddleManagement

Lower-levelManagement

Top

Management

MiddleManagement

Lower-levelManagement


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Self-Imposed Budgets

Self-imposed budgets should be reviewed by higher leve

of management to prevent budgetary slack(orbudgetpadding).

Most companies issue broad guidelines in terms of overa

profits or sales. Lower level managers are directed toprepare budgets that meet those targets.


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Advantages of the Top-down Budgeting

1. Avoid the potential budgetary slack (budget padding).

2. Provide a clearer performance goals and expectations from the topmanagement.

3. May provide better budget due to top managements access toprivileged/confidential market and organization information .

4. Provide an efficient budgetary process.


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Budget Lapsing

A popular method among government agencies, universities andorganizations relying on allocated funds.

Any unused funding at the end of the financial period cannot be cforward to the following year.

As a result, the following years budget may be cut because of theunder-expenditure in the previous year.


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Budget Lapsingcontinue

Budget lapsing helps ensure that the appropriate level of resourceis utilized in each period. Without budget lapsing, risk-aversemanagers may unnecessarily accumulate funds and this mayadversely affect the performance of the organization.

It helps provide an opportunity for a clean cut-off of expendituresto reallocate any unused resources for other more appropriaterequirements.


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Budget Lapsingcontinue

Budget lapsing can cause undesired behavior effects. For examplmanagers may wastefully spend their entire budget before the endof the period in order to avoid budget cuts.

A system of reviewing the expenditures near end of the period mauncover unnecessary expenditures and discourage managers to

wastefully spend because of budget lapsing.


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Incremental versus Zero-based Budgets Zero-Based Budgets are prepared based on the assumption that

the company has just started. Therefore, resources required haveto be justified from scratch.

For example, when budgeting for staff cost for a restaurant,managers using the zero-based budgeting approach will ignore thexisting staff level and expenses, rather, they will examine factorsuch as opening hours, number of tables, expected patron numbeto work out the number of staff required at each position and levhence the associate costs, to produce a budget.


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Incremental versus Zero-based Budgets

Companies using the zero-based method do not simply ignore prevyears figures. Figures generated by the zero-based method are usuallycompared with previous years figures. Any large differences areinvestigated.

As zero-based budgeting is time consuming and costly, companies to use this method for the relatively large items and the incrementamethod for the rest.


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Top Management Attitude:Human Factors in Budgeting

The success of a budget program depends on three important factor1. Top management must be enthusiastic and

committed to the budget process.2. Top management must not use the budget to

pressure employees or blame them whensomething goes wrong.

3. Budget targets should be challenging but achievable in order to

have good motivational effects.


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The Budget Committee

A standing committee responsible for overall policy matters relating to the budget

coordinating the preparation of the budget resolving disputes related to the budget approving the final budget


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Understand the Key Components ofMaster Budget in Manufacturing,

Merchandising and Service

Industries


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Understand the key components of master budget in Manufacturing,Merchandising, and Service Industries

The first step of budgeting forevery businessis to budget for the revenue,whether it is a sales budget for providing goods or services or a funding budge Although operational budgets are adapted according to the industries, they arevery similar and typically comprise of budgets for

Income statement Cash Balance sheet.

The major differences of different industries include:

Manufacturing: production budget is involved Merchandising: no production budget, only purchase budget of merchandiserequired.

Service Industries: budget for revenue and cost of providing services Not-for-profit: expected funding available and plan usage of funding.


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The Master Budget: An Overview

Production budgetSelling and

administrativebudget

Direct materialsbudget

Manufacturingoverhead budget

Direct laborbudget

Cash Budget

Sales budget

Ending inventorybudget

Budgetedbalance sheet

Budgetedincome

statement


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Learning Objective 4 (a)

Prepare a sales budget,

including a schedule ofexpected cash collections.


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Budgeting Example

Royal Company is preparing budgets for thequarter ending June 30. Budgeted sales for the next five months are:

April 20,000 unitsMay 50,000 unitsJune 30,000 units

July 25,000 unitsAugust 15,000 units.

The selling price is $10 per unit.


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The Sales Budget

The individual months of April, May, and June are summto obtain the total budgeted sales in units and dollars for t

quarter ended June 30th

April May June Quarter(Total)

Budgeted sales in units 20,000 50,000 30,000 100,000

Selling price per unit ____$ 10 ____$ 10 $ 10 $ 10

Total budgeted sales $200,000 $500,000 $300,000 $1,000,000


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Expected Cash Collections

All sales are on account. Royals collection pattern is:

70% collected in the month of sale,25% collected in the month following sale,5% uncollectible.

The March 31 accounts receivable balance of$30,000 will be collected in full.


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Quick Check

What will be the total cash collections for thequarter?

a. $700,000b. $220,000c. $190,000

d. $905,000


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The Production Budget

ProductionBudget

SalesBudget

andExpected

CashCollections

The production budget must be adequate tomeet budgeted sales and to provide for

the desired ending inventory.


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The Production Budget

The management at Royal Company wants ending

inventory to be equal to20% of the following monthsbudgeted sales in units.

On March 31, 4,000 units were on hand.

Lets prepare the production budget.


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Quick Check

What is the required production for May?a. 56,000 unitsb. 46,000 unitsc. 62,000 unitsd. 52,000 units


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Learning Objective 4 (c)

Prepare a direct materials budget,including a schedule of expected

cash disbursements for purchasesof materials.


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The Direct Materials Budget

At Royal Company, five pounds of material are required unit of product.

Management wants materials on hand at the end of eachmonth equal to 10% of the following months production.

On March 31, 13,000 pounds of material are on hand.Material cost is $0.40 per pound.

Lets prepare the direct materials budget.


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Quick Check

How much materials should be purchased in May?a. 221,500 pounds

b. 240,000 poundsc. 230,000 poundsd. 211,500 pounds


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Expected Cash Disbursement forMaterials

Royal pays$0.40 per pound for its materials.

One-halfof a months purchases is paid for in the month ofpurchase; the other half is paid in the following month.

The March 31 accounts payable balance is $12,000.

Lets calculate expected cash disbursements.


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Required Production (units) 26,000 46,000 26,000 101,000

Material per unit (pound) x 5 x 5 x 5 x 5Production needs 130,000 230,000 145,000 505,000

Add: Ending Inventory 23,000 14,500 11,500 11,500

Total Needed 153,000 244,500 156,500 516,000

Less: Beginning Inventory (13,000) (23,000) (14,500) (13,000)

Materials to be purchased in(units) 140,000 221,500 142,000 503,500

Cost of raw material per unit x $ 0.4 x $ 0.4 x $ 0.4 x $ 0.4

Total Cost of Purchase $56,000 $88,600 $56,800 $210,400

The Direct Materials Budget(in $)


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Expected Cash Disbursement forMaterials


Account payable 31/3 $12,000 $12,000

April Purchase:

50% x $56,000 28,000 28,00050% x $56,000 28,000 28,000

May Purchase:

50% x $88,600 44,300 44,300

50% x $88,600 44,300 44,300

June Purchase:

50% x $56,800 ________ ________ 28,400 28,400

Total Cash Disbursement $40,000 $72,300 $72,700 $185,000


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Quick Check

What are the total cash disbursements for the quarter?a. $185,000

b. $ 68,000c. $ 56,000d. $201,400


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The Direct Labor Budget(in Hours & $)


Required Production (units) 26,000 46,000 26,000 101,000

Direct Labour per unit (hour) X 0.05 X 0.05 X 0.05 X 0.05

Labour hours required 1,300 2,300 1,300 5,050

Guaranteed Labour hours(minimum) 1,500 1,500 1,500

Labour hours paid 1,500 2,300 1,500 5,300

Hourly wage rate X $10 X $10 X $10 X $10

Total Direct Labour Costs $15,000 $23,000 $15,000 $53,000

Greater of labor hours requiredor labor hours guaranteed.


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Learning Objective 4 (e)

Prepare amanufacturing

overhead budget.


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Manufacturing Overhead Budget


Budgeted Direct Labour hours 1,300 2,300 1,300 5,050

Variable MOH rate X 20 X 20 X 20 X 20

Variable MOH costs $26,000 $46,000 $29,000 $101,000Fixed MOH costs 50,000 50,000 50,000 150,000

Total MOH costs $76,000 $96,000 $79,000 $251,000

Less: Non Cash Costs * $20,000 $20,000 $20,000 $60,000

Cash disbursement of MOH $56,000 $76,000 $59,000 $191,000

* Depreciation is noncash charge


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Ending Finished Goods InventoryBudget

Production costsper unit

Quantity Cost Total

Direct materials 5 pounds $ 0.40 $2.00

Direct labour 0.05 hours $10.00 0.05

MOH 0.0.5 hours $49.70 2.49

$4.99

Budgeted finished goods inventory

Ending inventory in units 5,000

Unit product costs $ 4.99

Ending finished inventoryin $

$24,950

Total MOH for quarter = $251,000 = $49.70per DLHsTotal Labour hours required 5,050 DLHs

From ProductionBudget


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Explain the Costs and

Benefits of Budgeting


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Costs and Benefits of Budgeting

Budgeting is time-consuming and costly. Budgetary slack or padding is an inherent problem of budgeting.

Despite the drawbacks of budgeting, most companies are still using

budgets to plan, communicate, set objectives and allocate resources etc. Since budgets are still commonly used, benefits of budgeting are high

and drawbacks of budgeting can be minimized by having a goodbudgeting system.

For a good budgeting system, it is critical to have effectivecommunication and mutual trust between the top management and itsstaff.

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Chapter+10_Budget_new