ACCT 1003

BUDGETARY PLANNING

BUDGETARY PLANNING LESSON OBJECTIVES

1) 2) 3) 4) 5) 6) 7) Discuss the benefits of budgeting. State the essentials of effective budgeting. Understand the importance of people in budgeting Identify the budgets that comprise the master budget Describe the sources for preparing the budgeted income statement. Explain the principal sections of a cash budget. Indicate the applicability of budgeting in non -manufacturing companies.

BUDGETING
What is a Budget A formal statement of managements plans for a specified future time period, expressed in financial terms Formal part of existing organizational processes Managements Plan documents organizational activities Future Time Period not historic key planning tool Financial Terms plan stated in Accounting language

BUDGETING
Key Budgeting Activities Costing the Planning Process Measuring & Reporting Progress towards attaining the plan

BUDGETING
PLANNING CONTROLLING

Budget Financial expression of the plan

BUDGETING

How well resources used variances, test budget assumptions

DIRECTING

DECISION MAKING

Day to day decisions must be made to achieve budget

Must evaluate options, shows effects of decision making

Benefits of Budgeting
1) Requires all levels of management to plan ahead and formalize goals on a recurring basis 2) Measurable targets to assess management performance 3) Ensures co-ordination & communication of business activities Integrated Planning 4) Ensures efficient resource allocation 5) Benchmark to assess performance or plan for future periods 6) Used to motivate staff and improve productivity 7) Creates an early warning system for potential problems 8) Budgeted activity deemed to be sanctioned

Essentials of Effective Budgeting

Supported by Senior Management resourcing, communication, delegated authority, actions etc. Sound organizational structure authority and responsibility for all phases of operations clearly defined Based on research and analysis with realistic goals Accepted by all levels of management

Budgeting Period
May be prepared for any period of time
Most common - one year Supplement with monthly and quarterly budgets Different budgets may cover different time periods

Long enough to provide an attainable goal and minimize seasonal or cyclical fluctuations Short enough for reliable estimates Continuous twelve-month budget
Drop the month just ended and add a future month Keeps management planning a full year ahead

Budgeting Process
Approaches to Budgeting:
1. Top-Down 2. Bottom Up

Determined by the timing and level of staff involvement

Types of Budgets: Distinguished by the level of activity it is built to support

1. Static one level of activity e.g. most likely outcome 2. Flexible a range of outcomes e.gs. worst case, best case & most likely

Budgeting Process
Incremental Budgeting Base budget goals on past performance, use historic data and adjust for changing circumstances
Collect data from organizational units Begins several months before end of current year

Zero-Based Budgeting Build budget as if in operation for the 1 st time e.g. in a manufacturing & sales environment Develop budget within the framework ofa sales forecast

Budgeting Process
Factors considered in Sales Forecasting:
General economic conditions Industry trends Market research studies Anticipated advertising and promotion Previous market share Price changes Technological developments

Budgeting Process
Informal in small companies Budget Committee in larger companies Include the president, treasurer, chief accountant (controller), and management personnel from each major area of the company Review board where managers defend budget goals and requests

Budgeting and Human Behavior

Bottom Up vs. Top Down Approaches Method used can have the following effects: May inspire higher levels of performance or discourage additional effort Depends on how budget developed and administered Invite each level of management to participate This bottom-to-top approach is called Participative Budgeting

Budgeting and Strategic Planning

Three basic differences between the two:
Time period involved Emphasis Detail presented
1. Time period: Budgeting is short-term usually one year Strategic or Long -range planning usually at least five years

2. Emphasis: Budgeting - achievement of specific short-term goals Long-range planning identifies long term goals , selects strategies, develops policies and plans to implement strategies 3. Detail presented: Budgets very detailed Long-range plans - contain less detail r eview of progress toward long term goals

The Master Budget

A set of interrelated budgets that constitutes a plan of action for a specified time period. Main output of the budgetary exercise Contains two classes of budgets:
Operating budgets: Individual budgets that result in the preparation of the budgeted income statement establish goals for sales and production personnel e.g.s Sales Budget, Production Budget, Direct Labour Financial budgets: The capital expenditures budget, the cash budget, and the budgeted balance sheet focus primarily on cash needs to fund operations and capital expenditures

The Master Budget Hierarchy of Preparation

OPERATING BUDGETS: Sales Budget

First budget prepared Derived from the sales forecast Management s best estimate of sales revenue for the budget period Every other budget depends on the sales budget Formula

Expected unit sales volume for each product times Anticipated unit selling price

Sales Budget Example Hayes Company

Expected sales volume : 3,000 units in the first quarter with 500-unit increments for each following quarter Sales price: $60 per unit
Hayes Company Sales Budget For the Year Ending December 31, 2005
Quarter 1 3,000 x $60 2 3,500 x $60 3 4,000 $60 4 4,500 $60 Year 15,000 $60

Expected unit sales Unit selling price Total sales

$180,000 $210,000

$240,000 $270,000

$900,000

OPERATING BUDGETS: Production Budget

Shows the units that must be produced to meet anticipated sales Derived from sales budget plus the desired change in ending finished goods (ending finished goods less the beginning finished goods units) Required production in units formula:

Production Budget Example Hayes Company

Hayes Co. believes it can meet future sales needs with an ending inventory of 20% of next quarters sales
Hayes Company Production Budget For the Year Ending December 31, 2005 Quarter 2 3 3,500 4,000 800 900 4,300 4,900 700 800 3,600 4,100

Expected unit sales Add: Desired ending finished goods u nits* Total required units Less: Beginning finished goods inventory ** Required pro duction units *20% of next quarters sales **20% of estimated first-quarter 2005 sales

1 3,000 700 3,700 600 3,100

4 Year 4,500 1,000 5,500 900 4,600 15,400

OPERATING BUDGETS: Direct Materials Budget

Shows both the quantity and cost of direct materials to be purchased Derived from the direct materials units required for production (from the production budget) plus the desired change in ending direct materials units

Budgeted cost of direct materials to be purchased = required units of direct materials X anticipated cost per unit

OPERATING BUDGETS: Direct Materials Budget Example Hayes Company

1. An ending inventory of 10% of next quarters productionrequirements is sufficient 2. The manufacturing of each unit requires 2 pounds of raw materials at an expected price of $4 per pound

Direct Materials Budget Example Hayes Company

Hayes Company Direct Materials Budget For the Year Ending December 31, 2005 Quarter 1 2 3 3,100 3,600 4,100 x 2 x 2 x 2 6,200 7,200 8,200 720 820 920 6,920 8,020 9,120 620 720 820 6,300 7,300 8,300 x $4 x $4 x $4 $25,200 $29,200 $33,200

Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending di rect materials* Total materials required Less: Beginning direct materials*** Direct materi als purchases Cost per pound Total cost direct materials purchased

4 Year 4,600 x 2 9,200 1,020* * 10,220 920 9,300 x $4 $37,200 $124,800

*10% of next quarters production requirements **Estimated 2006 first- quarter pounds need for production 1 0,200 x 10% ***10% of estimated first-quarter pounds needed for production

OPERATING BUDGETS: Direct Labor Budget

Shows both the quantity of hours and cost of direct labor necessary to meet production requirements Critical in maintaining a labor force that can meet expected production Total direct labor cost formula:

Direct Labor Budget Example Hayes Company

1. Direct labor hours from the production budget 2. Two hours of direct labor required for each unit 3. Hourly wage rate $10
Hayes Company Direct Labor Budget For the Year Ending December 31, 2005 Quarter 1 2 3 Units to be produced 3,100 3,600 4,100 Direct labor hours per unit x 2 x 2 x 2 Total required direct labor hours 6,200 7,200 8,200 Direct labor cost per hour x $10 x $10 x $10 Total direct labor cost $62,000 $72,000 $82,000

4 4,600 x 2 9,200 x $10 $92,000

Year

$308,000

OPERATING BUDGETS: Manufacturing Overhead Budget

Shows the expected manufacturing overhead costs for the budget period Distinguishes between fixed and variable overhead costs Example Hayes Company
Fixed cost amounts are assumed Expected variable costs per direct labor hour: Indirect materials: $1.00 Indirect labor: $1.40 Utilities: $0.40 Maintenance: $0.20

Hayes Company Manufacturing Budget For the Year Ending Dec 31, 2005
Variable Costs Indirect materials ($1.00 per DLH) Indirect labor ($1.40 per DLH) Utilities ($ .40 per DLH) Maintenance ($.20 per DLH) Total variable Fixed costs Supervisory salaries Depreciation Property tax and insurance Maintenance Total fixed Total manufacturing overhead Direct Labor hours 20,000 3,800 9,000 5,700 38,500 $57,100 6,200 20,000 3,800 9,000 5,700 38,500 $60,100 7,200 20,000 3,800 9,000 5,700 38,500 $63,100 8,200 20,000 3,800 9,000 5,700 38,500 80,000 15,200 36,000 22,800 154,000 1 $6,200 8,680 2,480 1,240 18,600 2 $7,200 10,080 2,880 1,440 21,600 3 $8,200 11,480 3,280 1,640 24,600 4 $9,200 12,880 3,680 1,840 27,600 Year $30,800 43,120 12,320 6,160 92,400

$66,100 $246,400 9,200 30,800

Manufacturing overhead rate per direct labor hour ($246,400 30,800) = $8.00

OPERATING BUDGETS: Selling & Administrative Expense Budget

Projection of anticipated operating expenses Distinguishes between fixed and variable costs Example Hayes Company
Fixed cost amounts are assumed Expected variable costs per unit sold (from sales budget): Sales commissions: $3.00 Freight-out: $1.00

Hayes Company Selling & Administrative Budget For the Year Ending December 31, 2005

Quarter Variable Costs Sales commissions ($3 per unit) Freight-out ($1 per unit) Total variable Fixed costs Advertising Sales salaries Office Salaries Depreciation Property taxes and insurance Total Fixed Expenses Total Selling/Admin. Expenses 1 $ 9,000 3,000 12,000 5,000 15,000 7,500 1,000 1,500 30,000 $42,000 2 $ 10,500 3,500 14,000 5,000 15,000 7,500 1,000 1,500 30,000 $44,000 3 $ 12,000 4,000 16,000 5,000 15,000 7,500 1,000 1,500 30,000 $46,000 4 $ 13,500 4,500 18,000 5,000 15,000 7,500 1,000 1,500 30,000 $48,000 Year $ 45,000 15,000 60,000 20,000 60,000 30,000 4,000 6,000 120,000 $180,000

OPERATING BUDGETS: Budgeted Income Statement

Important end-product of the operating budgets Indicates expected profitability of operations Provides a basis for evaluating company performance Prepared from the operating budgets
Sales Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Selling and Administrative Expense Budget

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OPERATING BUDGETS: Budgeted Income Statement Example Hayes Company

To find cost of goods sold:
Determine the unit cost of one Kitchen-mate
COST ELEMENT Direct Materials Direct Labour Manufacturing Overhead Total Unit Cost QUANTITY UNIT COST 2 lbs 2 hrs. 2 hrs. $4.00 $10.00 $8.00 TOTAL $8.00 $20.00 $16.00 $44.00

Cost of Goods Sold = 15,000 units X $44.00 = $660,000.

OPERATING BUDGETS: Budgeted Income Statement

Example Hayes Company
Additional estimated data for budgeted income statement:
Interest expense - $100 Income taxes - $12,000

Sales Cost of Goods Sold Gross Profit Selling & Administrative Costs Income from Operations Interest Expense Income before Tax Income Tax Net Income

$900,000.00 660,000.00 240,000.00 180,000.00 60,000.00 100.00 59,900.00 12,000.00 $47,900.00

FINANCIAL BUDGETS: Cash Budget

Shows anticipated cash flows Often considered to be the most important output in preparing financial budgets Contains three sections:

Cash receipts Cash disbursements Financing

Shows beginning and ending cash balances

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FINANCIAL BUDGETS: Cash Budget

Basic Format

FINANCIAL BUDGETS: Cash Budget

Cash receipts section
Includes expected receipts from the principal sources of revenue - usually cash sales and collections on credit sales Shows expected interest and dividend receipts as well as proceeds from planned sales of investments, plant assets, and capital stock

Cash disbursements section

Includes expected cash payments for direct materials and labor, taxes, dividends, plant assets, etc.

Financing section
Shows expected borrowings and repayments of borrowed funds plus interest

FINANCIAL BUDGETS: Cash Budget

Must prepare in sequence Ending cash balance of one period = beginning cash balance for next Obtain information from other budgets and from management Often prepared for the year on a monthly basis

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FINANCIAL BUDGETS: Cash Budget

Example Hayes Company
Assumptions
January 1, 2005 cash balance: $38,000 Sales: collect 60% in quarter sold; 40% in next quarter Collect $60,000 in Accounts Receivable at December 31, 2004, in Qtr 1 Expected sale of short term investments : $2,000 in Quarter 1 Direct Materials: pay 50% in quarter purchased; 50% in next Pay $10,600 in Accts Payable at December 31, 2004, in Quarter 1 Direct Labor: pay 100% in quarter incurred Manufacturing Overhead and Selling/Administrative Expenses: Pay (except depreciation) in quarter incurred Expected purchase of truck $10,000 cash in Quarter 2 : Estimated annual income taxes: Equal payment each quarter Loans: Pay in earliest quarter with sufficient cash (i.e., cash on hand exceeds the $15,000 minimum required balance)

Cash Budget
Example Hayes Company
Usually prepare schedule of collections from customers:

Cash Budget
Example Hayes Company
Prepare schedule of cash payments for direct materials:

Now prepare the Cash Budget based on the assumptions and the preceding schedules

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FINANCIAL BUDGETS: Cash Budget

Advantages: Contributes to more effective cash management Shows managers need for additional financing before actual need arises Indicates when excess cash will be available

FINANCIAL BUDGETS: Budgeted Balance Sheet

A projection of financial position at the end of the budget period Developed from the budgeted balance sheet for the preceding year and the budgets for the current year

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FINANCIAL BUDGETS: Budgeted Balance Sheet Example Hayes Company Additional data:

BUDGETING - Merchandisers
Sales Budget: starting point and key factor in developing master budget Use a purchases budget instead of a production budget Does not use the manufacturing budgets (direct materials, direct labor, and manufacturing overhead) To determine budgeted merchandise purchases:

BUDGETING - Merchandisers
Example Lima Company
Budgeted sales for July $300,000 and August $320,000 Cost of goods sold: 70% of sales Desired ending inventory: 30% of next month s cost of goods sold

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BUDGETING Not-for-Profit Companies

Important process that differs significantly from that of a profit-oriented company Budget on the basis of cash flows (expenditures and receipts), rather than on a revenue and expense basis The starting point is expenditures, not receipts Funding Budgets Significantly different activity index

BUDGETARY PLANNING LESSON OBJECTIVES

1) 2) 3) 4) 5) 6) 7) Discuss the benefits of budgeting. State the essentials of effective budgeting. Understand the importance of people in budgeting Identify the budgets that comprise the master budget Describe the sources for preparing the budgeted income statement. Explain the principal sections of a cash budget. Indicate the applicability of budgeting in non -manufacturing companies.

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