Managerial Accounting – Chapter 9

What is a Budget? A formal written statement of management’s

plans for a specified future time period,

expressed in financial terms

In other words, it’s what we think will happen in

the company, money-wise

Why Budget? Requires all management to plan ahead

Provides definite objectives for performance evaluation

Creates early warning system for potential problems

Facilitates coordination of activities within the business

Greater management awareness of overall operations

Motivates personnel to meet planned objectives

A budget is an aid to management.

A budget is not a substitute for management!

It should go without saying… A budget should be realistic

It should be accepted by management

The people responsible for the budget should have authority to make the budget

The people responsible for implementing budgeted actions should have authority to implement the actions

Budget Time Length Can be for any time – most common is one year

Sometimes supplement with monthly or quarterly budgets (some businesses have cyclical products like winter coats)

Short enough to be reliable, long enough to be attainable

Where do we get budget figures? Past performance data

Collect info from all units

Usually started months before current cycle ends

Industry-wide expectations (sales forecast)

Shows potential industry sales

Shows company’s expected share of industry sales

What do we have to think about?

General economic conditions

Industry trends

Market research studies

Anticipated advertising and promotion

Previous market share

Price changes

Technological developments

Involve all levels of management

Called Participative Budgeting

More accurate – lower level managers have more detailed knowledge of their area

Tend to see process as fair due to involvement

Goal is to produce budget that’s considered fair and achievable by managers; and still meet corporate goals

Participative Budgeting Disadvantages

Time consuming

Costly (time = $$)

Can foster “gaming the system” by building in budgetary slack

Unrealistic budgets can lead to unethical behavior like cutting corners on jobs or distorting internal financial reports

There’s a difference between budgeting and long range planning

Budgeting is short term, usually 1 year

Very detailed

Long range planning is at least 5 years

Not as detailed

Master Budget Complete plan of action for the time period

Contains two interrelated types of budgets: Operating budgets and Financial budgets

What’s the difference? Operating budgets are the individual budgets that

result in preparation of budgeted income statement and establishes goals for sales and production personnel

Financial budgets are the capital expenditures budget; cash budget; budgeted balance sheet

Focus is primarily on cash needs to fund operations and capital expenditures

What order do we go in?

Sales budget is first

Comes from the sales forecast (management’s best estimate of sales revenue for the budget period)

All other budgets depend on sales budget

Multiply expected unit sales volume for each product times anticipated selling price

Next: Production budget Shows units that must be produced to meet

anticipated sales

Derived from sales budget plus desired change in ending finished goods inventory

Direct Materials Budget Shows quantity AND cost of direct materials to be

purchased

Multiply required direct materials units to be purchased by anticipated cost per unit to get budgeted cost of direct materials to be purchased

Mess it up and you run out of inventory and production shuts down.

No cupcakes for you!

Direct Labor Budget Shows quantity of hours, cost of direct labor needed to

meet production requirements

Critical in maintaining a labor force that can meet expected production

Manufacturing Overhead Budget Shows manufacturing overhead costs for budget

period

Distinguishes between fixed and variable over head costs

Selling and Administrative Expense Budget

Projection of anticipated operating expenses

Distinguish between fixed and variable costs

Budgeted Income Statement (Finally, a financial statement!)

Important end result of operating budget

Indicates expected profitability of operations

Provides a basis for evaluating company performance

Prepared from the operating budgets: Sales; Direct Materials; Direct Labor; Manufacturing Overhead; Selling and Administrative Expense

Cash Budget (like a projected Statement of Cash Flows)

Shows anticipated cash flows

Often considered the most important output in preparing financial budgets

Three sections: Cash receipts; Cash disbursements; Financing

Also shows beginning and ending cash balances

Cash Receipts Section

Includes expected receipts from the principle sources of revenue

Expected interest and dividends receipts; proceeds from planned sales of investments, plant assets, company’s capital stock

Cash Disbursements Section Expected cash payments for direct materials, direct

labor, manufacturing overhead, and selling and administrative expenses

Financing Section Expected borrowings and repayments of borrowed

funds, plus interest

Cash Budget Has to be prepared in order

Ending cash balance in one period is the beginning cash balance in the next

Data is obtained from other budgets and from management

Often prepared for one year (individual months shown)

Why prepare a cash budget? Contributes to more effective cash management

Shows managers the need for additional financing before the actual need arises (we can plan ahead)

Indicates when excess cash will be available

Budgeted Balance Sheet Developed from budgeted balance sheet for the prior

year and the budgets for the current year

Let’s look at an example…