SPM Pertemuan 8-UAS

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MANAGEMENT CONTROL SYSTEM

SESSION 8

BUDGET PREPARATIONOCTOBER 15, 2012

JAKARTA, INDONESIA

By Vienda A. Kuntjoro


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Budget

Budget is planning that is stated in quantitative in monetaryunit for one year period.

Characteristic of budget are as following :

1. Estimate potential level of earnings from one business

unit2. Budged is stated in financial (number of unit sales or

produce)

3. Budget is for one year period

4. Proposal of budget agreed by upper level authority

5. Budget that is agreed can be changed only if certaincondition happens

6. Periodically, financial performance compared to budgetthen the variance would be analyzed.


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Budget cycle and Master Budget

Well managed companies usually cycle through the following budgetingsteps during the course of the fiscal year:

1. Working together, managers and management accountants plan theperformance of the company as a whole and the performance of itssubunits (such as departments or divisions). Taking into account pastperformance and anticipated changes in the future, managers at all levelsreach a common understanding on what is expected

2. Senior managers give subordinate managers a frame of reference, a set ofspecific financial or nonfinancial expectations against which actual resultwill be compared.

3. Management accountants help manager investigate variation from plans,such as an unexpected decline in sales. If necessary, corrective action

follows, such as a reduction in price to boost sales or cutting of costs tomaintain profitability

4. Managers and management accountants take into account marketfeedback, changed conditions, and their own experiences as they begin tomake plans for the next period. For example, a decline in sales may causemanagers to make changes in product features for the next period.


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Master Budget

Master budget expresses managements operating

and financial plans for a specified and period(usually a fiscal year), and it includes a set of

budgeted financial statements. The masterbudget is the initial plan of what the companyintends to accomplish in the budget period. Themaster budget evolves from both operating and

financing decision made by managers. Operating decision deal with how to obtain the

funds to acquire those resources.


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Advantages of budgets

Budget are an integral part of management controlsystem. When administered thoughtfully bymanagers, budgets do the following:

Promote coordination and communicationamong subunits within the company

Provide a framework for judging performanceand facilitating learning

Motivate managers and other employees.

Support strategic planning


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Challenges in Administering Budgets

The budgeting process involves all level management.It has been estimated that senior managers spendabout 10% to 20% of their time on budgeting, andfinance planning departments spend as much as 50%

of their time on it. A manager may commit to a budget, but if a situation

arises in which some unplanned repairs or anunplanned advertising program would serve the longrun interests of the company, the manager should

undertake the additional spending. On the flip side,the dramatic decline in consumer demand during therecent recession led designers such as Gucci to slashtheir ad budgets and put on hold planned newboutique.


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Developing an operating budget

Business are increasingly using rolling budgets. (also calledcontinuous budget), is a budget that is always available for aspecified future period.

Steps in preparing an operating budget

1. Identify the problem and uncertainties.

2. Obtain information (discover the direct material have increaseslightly during 2011).

3. Make about the futures (the purchasing manager anticipates thatprice of direct material will be about the same in year 2011. Themanufacturing manager believes that efficiency improvement

would allow costs manufacturing tables to be maintained at 2011cost despite an increase in the price of other inputs.

4. Make decisions by choosing among alternatives

5. Implement the decision, evaluate performance, and learn


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Budgetary slack

At times, subordinates may try to play games and build inbudgetary slack.

Budgetary slack describes the practice of underestimatingbudgeted revenues, or over estimating budgeted costs, to

make budgeted targets more easily achieved. It frequentlyoccurs when budget variances (the difference actual resultand budgeted amounts) are used to evaluate performance.

Budgetary slack provide managers with a hedge againstunexpected adverse circumstances. But budgetary slackalso misleads top management about the true profitpotential of the company, which leads to inefficientresource planning and allocation and poor coordination ofactivities across different parts of the company.


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Human aspects in budgeting?

Why are human factors crucial in budgeting?

The administration of budget requires education,participation, persuasion , and intelligent

interpretation. When wisely administered,budgets create commitment, accountability, andhonest communication, and can be used as thebasis for continuous improvement efforts. When

badly managed, budgeting can lead to gameplaying and budgetary slack the practice ofmaking budget targets more easily


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Prepare Budget

Prepare budget for Stylistic Furniture for 2012. The details are follow:

Stylistic sells two models of granite-top coffee tables: casual and deluxe, Revenueunrelated to sales, such as interest income, is zero

Work in process inventory is negligible and is ignored

Direct materials inventory and finished goods inventory are costed using the firstin, first out (FIFO method). Unit costs of direct material purchased and unit costs

of finished goods sold remain unchanged throughout each budget year but canchange from year to year.

There are two types of direct material : red oak (RO) and granite slabs (GS). Directmaterial costs are variable with respect to units of output coffee tables.

Direct manufacturing labor workers are hired on an hourly basis; no overtime isworked.

There are two cost drivers for manufacturing overhead costs-direct manufacturinglabor hours and setup labor hours

Direct manufacturing labor hours is the cost driver for the variable portion ofmanufacturing operations overhead. The fixed component of manufacturingoperations overhead is tied to the manufacturing capacity of 300,000 directmanufacturing labor hours that Stylistic has planned for 2012.


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Prepare budget (cont.)

Setup labor hours is the cost driver for the variable portion of machine setupoverhead. The fixed component of machine setup overhead is tied to the setupcapacity of 15,000 setup labor hours that Stylistic has planned for 2012.

For computing inventoriable costs, Stylistic allocates all (variable and fixed)manufacturing operations overhead costs using direct manufacturing labor hoursand machine setup overhead costs using setup labor hours.

Nonmanufacturing costs consists of product design, marketing, and distributioncosts. All product design costs are fixed costs for 2012. The variable component ofmarketing costs equals the 6.5% sales commission on revenues paid tosalespeople. The variable portion of distribution costs varies with cubic feet oftables moved.

The following data are available for 2012 budget :

Direct material

Red Oak $7 per board foot (b.f) (same as 2011)Granite $10 per square foot (sqft) (same as 2011)

Direct manufacturing labor $20 per hour


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Prepare budget (cont.1)

PRODUCT

Casual Granit Table Deluxe Granite Table

Red Oak 12 board feet 12 board feet

Granite 6 square feet 8 square feet

Direct manufacturing labor 4 hours 6 hours

PRODUCT

Casual Granit Table Deluxe Granite TableExpected sales in units 50,000 10,000

Selling price $600 $800

Target ending inventory unit 11,000 500

Beginning inventory in units 1,000 500

Beginning inventory in USD $384,000 $262,000

DIRECT MATERIALRed Oak Granite

Beginning inventory 70.000 b.f 60.000 sqft

Target ending inventory 80.000 b.f 20.000 sqft

Note . Maintain Stylistics 12% operating margin.


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Step 1 Prepare the revenue budget

In stylistics case, the revenue budget for 2012 reflectsStylistics strategy to grow revenues by increasing salesdeluxe tables from 8,000 tables in 2011 to 10,000 tables in2012.

Schedule 1 Revenue

For the year ending December 31, 2012

units Selling price Total revenues

Casual 50,000 $600 $30,000,000

Deluxe 10,000 $800 $8,000,000

Total $38,000,000

The $38,000,000 is the amount of revenues in the budgetedincome statement.


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Step 2 Prepare the production budget

in unitsSchedule 2 Production Budget (in units)

For the year ending Dec 31, 2012

Product

Casual Deluxe

Budgeted unit sales (sch. 1) 50,000 10,000

Add target ending finished goods inventory 11,000 500

Total required units 61,000 10,500

Deduct beginning finished goods inventory 1,000 500

Units of finished goods to be produced 60,000 10,000

Note.

For step 3 for example, the bill materials would indicate that 12 bf of red oak and6sqft of granite are needed to produce each casual coffee table and 12 bf ofred oak and 8 sqft of granite to produce each deluxe coffee table. To calculate3A.


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Step 3 Prepare the Direct material usage budget and

direct material purchases budget

Schedule 3A Direct material usage Budget in Quantity and Dollars


Material

Red Oak Granite Total

Physical units budget

Direct material required for casual tables 720,000 b.f 360,000 sqft

(60,000 units*12 b.f and 6 sq.ft)

Direct material required for deluxe tables 120,000 b.f 80,000 sqft

(10,000 units*12 b.f and 8 sqft)

Total quantity of direct materials to be used 840,000 b.f 440,000 sqft

Cost budget

Available from beginning direct materils inventory

(under a FIFO cost flow assumption)

Red Oak 70,000 b.f * $7 per b.f $490,000

Granite 60,000 sqft*$10per sqft $600,000

To be purchased this period

Red Oak (840,000-70,000) bf*$7 per bf $5,390,000

Granite (440,000-60,000) sqft *$10 per sqft $3,800,000

Direct material to be used this period $5,880,000 $4,400,000 $10,280,000


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Step 3 Prepare the Direct material usage budget and direct

material purchases budget (cont.)

Schedule 3B Direct material purchase Budget


Material

Red Oak Granite Total

Physical units budgetTo be used in production (from schedule 3A) 840,000 bf 440,000 sqft

Add target ending inventory 80,000 bf 20,000 sqft

Total requirements 920,000 bf 460,000 sqft

Deduct beginning inventory 70,000 bf 60,000 sqft

Purchase to be made 850,000 bf 400,000 sqft

Cost budget

Red oak : 850,000bf*$7 per bf $5,950,000

Granite 400,000 sqft*$10 per sqft $4,000,000

$5,950,000 $4,000,000 $9,950,000


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Step 4 Prepare the Direct

manufacturing labor costs budget

Schedule 4 : Direct Manufacturing Labor costs budget


Output units produced Direct Mft. Total hours Hourly

(schedule 2) Labor hr per unit wage rate TotalCasual 60,000 4 240,000 $20 $4,800,000

Deluxe 10,000 6 60,000 $20 $1,200,000

Total 300,000 $6,000,000

For 300,000 direct manufacturing labor hours, Stylistics manufacturing managersestimate various line items of overhead costs that constitute manufacturing

operations overhead (that is, all costs for which direct manufacturing labor hours

is the cost drivers).


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Step 5 : Prepare the Manufacturing

Overhead costs budget

Stylistic s managers determine how setups should be

done for the casual and deluxe line of table, taking intoaccount past experience and potential improvementsin setup efficiency.

For example, managers consider the following:

1. Increasing the length of the production run per batchso that fewer batches (and therefore fewer setups)are needed for the budgeted production of tables

2. Decreasing the setup time per batch

3. Reducing the supervisory time needed, for instanceby increasing the skill base of workers.


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Overhead costs budget (cont.)Casual Deluxe tables Total

1.Quantity of tables to be produced 60,000 tables 10,000 tables

2.No. of tables to be produced per batch 59 tables/batch 40 tables/batch

3. No. of batches (1)/(2) 1,200 batches 250 batches

4. Setup time per batch 10 hr/batch 12 hr/batch

5.Total setup hours (3)*(4) 12,000 hours 3,000 hours 15,000 hr6. Setup hours per table (5)/(1) 0.2 hours 0.3 hours

Using an approach similar to the one described for manufacturing operationsoverhead costs, Stylistics managers estimate various line items of costs thatcomprise machine setup overhead costs that is, all costs that are caused by the15,000 setup labor hours (the cost driver). Note how using activity based costdrivers provide additional and detailed information that improves decision makingcompared with budgeting based solely on output based cost drivers. Of course,managers must always evaluate whether the expected benefit of adding more costdrivers exceeds the expected cost.


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Overhead costs budget (cont.1)Schedule 5 : Manufacturing Overhead Costs Budget


manfuacturing Operations Overhead costs

Variables costs

Supplies 1,500,000

Indirect manufacturing labor 1,680,000

Power (support department costs) 2,100,000

Maintenance (support deparment costs) 1,200,000 $6,480,000

Fixed costs (to support department costs)

Depreciation 1,020,000Supervision 390,000

Power (support department costs) 630,000

Maintenance (supportdperatment costs) 480,000 2,520,000

Total manufacturing operationsoverhead costs $9,000,000

Manufacturing Setup Overhead costs

Variables costs

Supplies $390,000

Indirect manufacturing labor 840,000

Power (support department costs) 90,000 $1,320,000

Fixed costs (to support capacity of 15,000 setup labor hours

Depreciation 603,000

Supervision 1,050,000

Power (support department costs) 27,000 1,680,000

Maintenance (supportdperatment costs) $3,000,000

Total manufacturing operationsoverhead costs $12,000,000


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Step 6 : Prepare the ending inventories

Budget

Manufacturing operations overhead costs areallocated to finished goods inventory at thebudgeted rate $30 per direct manufacturing labor

hour (total budgeted manufacturing operationsoverhead, 90,000,000/300,000 budgeted directmanufacturing labor hours). Machine setupoverhead costs are allocated to finished goods

inventory at the budgeted rate $200 per setuphours (total budgeted machine setup overhead,$300,000/15,000 budgeted setup labor hours).


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Step 6 : Prepare the ending inventories

Budget (cont.)Schedule 6A : unit costs of Ending Finished goods inventoryDecember 31, 2012

PRODUCT

Casual Tables Deluxe tables

Cost per unit Input per unit of

output

TOTAL Input per unit of

output

TOTAL

Red Oak $7 12 bf $84 12 bf $84

Granite10 6 sqft 60 8 sqft 80

Direct manufacturing Labor 20 4 hrs 80 6 hrs 120

Manufacturing overhead 30 4 hrs 120 6 hrs 180

Machine setup overhead 200 0.2 hrs 40 0.3 hrs 60

TOTAL $384 $524

Schedule 6B : Endign Inventories budget

December 31, 2012

Quantity Cost per unit TOTALDirect material

Red Oak 80,000 $7 $560,000

Granite 20,000 10 200,000 $760,000

Finished Goods

Casual 11,000 $384 $4,224,000

Deluxe 500 524 262,000 $4,486,000

Total ending inventory $5,246,000


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Step 7 : Prepare the cost of goods sold

budget

Schedule 7 : Cost of goods Sold Budget


From the schedule TOTAL

Beginning finished goods invetory, Jan 01, 2012 Given $646,000

Direct material used 3A $10,280,000

Direct manufacturing labor 4 6,000,000

Manufacturing overhead 5 12,000,000

cost of goods manufactured 28,280,000

cost of goods available for sale 28,926,000

Deduct ending finished goods inventory, Dec 31, 2012 6B 4,486,000

Cost of goods sold $24,440,000


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Step 8 : Prepare the non

manufacturing costs budgetProduct design costs are fixed costs, determined on the basis of the product design

work anticipated for 2012. The variable component of budgeted marketing costs isthe commissions paid to sales people equal to 6.5% of revenues. The fixedcomponent of budged marketing costs equal to $1,330,000 is tied to the marketingcapacity for 2012. The cost driver of the variable component of budgeteddistribution costs is cubic feet of tables moved (Casual : 18 cubic ft * 50,000 tables+ deluxe 35 cubic ft*10,000 tables = 1,440,000 cubic ft). Variable distribution costs

equal $2 per cubic foot. The fixed component of budged distribution costs equals$1,596,000 and is tied to the distribution capacity for 2012. Schedule 8 shows thatthe product design, marketing, and distribution costs budget 2012.

Schedule 8 : Non manufacturing costs budget


Business function Var costs Fixed costs Total cost

Production design $1.024,000 $1,024,000Marketing (var cost :$38,000,000*0.065) $2,470,000 1,330,000 3,800,000

Distribution (var cost : $2*1,140,000 cuft) 2,280,000 1,596,000 3,876,000

$4,750,000 $3,950,000 $8,700,000


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Step 9 : Prepare the budget income

statement Rex Jordan, the CEO of Sytlistic Furniture, is very pleased with the

2012 budget. It call fro a 10% increase in operating incomecompared with 2011. The keys to achieving a higher operatingincome are a significant increase in sales of Deluxe tables, andprocess improvement and efficiency gains throughout the valuechain. As Rex studies the budget more carefully, he is struck by twocomment appended to the budget. First, to achieve the budgednumber of tables sold, Stylistic may need to reduce its selling pricesby 3% to %582 for Casual tables and to $776 for Deluxe tables.Second, a supply shortage in direct materials may result in a 5%increase in the prices of direct materials (red oak and granite)above the material prices anticipated in the 2012 budget. He asksTina Larsen, the management accountant, to use Stylistics financialplanning model to evaluate how those outcomes will affectbudgeted will affect budgeted operating income.


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Step 9 : Prepare the budget income

statement (cont.)Budgeted Income Statement for Stylistic FurnitureFor the year ending December 21, 2012

Revenues Sch. 1 $38,000,000

Costs of goods sold Sch. 7 $24,440,000

Gross margin $13,560,000Operating costs

Product design costs Sch. 8 $1,024,000

Marketing costs Sch.8 $3,800,000

Distribution costs Sch. 8 $3,876,000 $8,700,000Operating income $4,860000


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Sample

Consider the stylistic furniture. Suppose that to maintain itssales quantities, Stylistic needs to decrease selling prices to$582 per Casual table and $776 per Deluxe table, a 3%decrease in the selling price used. All other data isunchanged.

Solution:Schedule 1 & 8 will changes because a change in selling price

affects revenues. Schedule 8 changes because revenuesare a cost driver of marketing costs (sales commissions).The remaining schedules will not change because a changein selling price has no effect on manufacturing costs. Therevised schedules and the new budgeted income statementfollows:


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Sample (cont.)

Schedule 1 : Revenue BudgetFor the year Ending Dec 31, 2012

Selling price Units Total Revenues

Casual tables $582 50,000 $29,100,000

Deluxe tables $776 10,000 $7,760,000

Total $36,860,000

Schedule 8: Nonmanufacturing costs budget

For the year Ending December 31, 2012

Business function Var. Costs Fixed cost Total costs

Product design $1,024,000 $1,024,000

Marketing (Var cost :

$36,860,000*0.065) $2,395,900 $1,330,000 $3,725,900Distribution (Var. cost:

$2*1,140,000cuft) $2,280,000 $1,596,000 $3,876,000$4,675,000 $3,950,000 $8,625,900


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Sample (cont. 1)

Stylistic FurnitureBudget Income Statement

For the year Ending Dec 31, 2012

Revenues Schedule 1 $36,860,000

Cost of goods sold Schedule 7 $24,440,000Gross margin $12,420,000

Operating costs

Product design Schedule 8 $1,024,000

Marketing costs Schedule 8 $3,725,000Distribution Schedule 8 $ 3,876,000 $8,625,000

Operating Income $3,794,100


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Financial Planning models and

sensitivity analysis Sensitivity analysis is a what if technique that examines how a result will change if the original

predicted data are not achieved or if an underlying assumption changes.

To see how sensitivity analysis works, it considers two scenarios identified as possibly affectingStylistic Furnitures budget model for 2012:

1. Scenario 1 : a 3% decrease in the selling price of the casual table and a 3% decrease in the sellingprice of the Deluxe table

2. Scenario 2 : a 5% increase in the price per board foot of red oak and a 5% increase in the priceper square foot of granite.

Key assumption

Units sold Selling price Direct Budgeted

material cost Opr. income

Casual Deluxe Casual Deluxe Red oak Granite Dollars Change from

master budget

What if scenario 50,000 10,000 $600 $800 $7 $10 $ 4,860,000

Scenario1 50,000 10,000 582 776 $7 $10 3,794,100 22% decrease

Scenario2 50,000 10,000 600 800 $7.35 $10.50 4,483,800 8% decrease


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