analysis and interpretation of financial statements
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CHAPTER 23CHAPTER 23
BUDGETING FORPLANNING AND CONTROL
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BudgetBudget Webster’s definition ... Text def. (p. 827): A planplan showing the
company’s objectives and how management intends to acquire and use resources to attain those objectives.
A plan, while necessary, isinsufficient by itself; controlcontrol is also needed to insure that plans are accomplished.
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Budgets enable organizations to better deal with the uncertainty of the future.
Without planning, organizations only react to future events rather than anticipating them.
Why Budget?Why Budget?
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Purposes of BudgetsPurposes of Budgets
Purposes
Express management’s
plans forcoming periods
Increasemotivation to
achievestated goals
Formalize in writing management’splans in quantitative terms
Cause managers to think ahead,anticipate results and act to
correct poor results
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Benefits of BudgetsBenefits of Budgets
Develops a morevisionary management
Facilitates review and revision of plans
Fosters coordinationof activities
Produces more cost-conscious employees
Promotes managementby exception
Communicatesplans
Benefits
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Considerations inConsiderations inPreparing a BudgetPreparing a Budget
Management's assumptions re: State of the economy for the
planning period Adding, deleting or
changing product lines Nature and degree of competition Effects of government regulation
Useful accounting data from past periods can be adjusted for future expectations.
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Coordination of financial and nonfinancial planning
Top management support Employee participation in
goal setting Communicating results Flexibility Follow-up
General Principles of General Principles of Good BudgetingGood Budgeting
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Hazards of imposed budgets Employee resistance to perceived unfair
or unrealistic goals Does not facilitate free flow of
management-employee communications Participatory budgeting
All levels of management actively participate in the process
Accountant’s role Should compilecompile the information and
coordinatecoordinate the preparation of the budget
Behavioral Implications of Behavioral Implications of BudgetingBudgeting
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Participatory Budget SystemParticipatory Budget System
Flow of Budget Data
S upervisor S upervisor
M iddleM anagem ent
S upervisor S upervisor
M iddleM anagem ent
T op Managem ent
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Sets specific targets for Sales revenue Production costs Selling and administrative expenses Cash receipts and disbursements
Culminates in projected financial statements Projected Balance Sheet
• A/K/A Financial Budget• A/K/A Pro Forma Balance Sheet
Projected Income Statement• A/K/A Planned Operating Budget• A/K/A Pro Forma Income Statement
Master BudgetMaster Budget
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Using an electronic spreadsheet to prepare is ideal because of Considering “what if” scenarios Interlocking relationships between
the various elements of the budget Which is prepared first?
Projected Income Statement Projected Balance Sheet
Master BudgetMaster Budget
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Using an electronic spreadsheet to prepare is ideal because of Considering “what if” scenarios Interlocking relationships between
the various elements of the budget Which is prepared first?
Projected Income Statement Projected Balance Sheet
a.b.
Master BudgetMaster Budget
Trivia time! What was the first electronic spreadsheet?
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Master BudgetMaster Budget
DetailBudget
Cash
DetailBudget
Oth
erexp
enses
DetailBudget
Sellin
g an
dad
min
istrativeexp
enses
DetailBudget
Pro
du
ction
costs
ProjectedIncome Statement
andBalance Sheet
DetailBudget
Sales
(Prepared first)(Prepared first)
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Sales BudgetSales Budget
Detailed schedule showing expected sales for the coming periods
expressed in units and dollars.
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All items in the budgeting process are dependent on a sales forecast.
All items in the budgeting process are dependent on a sales forecast.
SalesForecas
t
Compilation of forecasts from sales staff
Economicmodels
Managementintuition
Statisticalforecasts
Sales BudgetSales Budget
Informal approachFormal approach
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That’s enough talkingabout budgets, now
show me some examples!
BudgetsBudgets
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Ellis Magnet Co. is preparing budgets for the quarter ending June 30. The sales price is $10 per magnet.
Budgeted sales for the next four months are:
April 20,000 magnets @ $10 = $200,000May 50,000 magnets @ $10 = $500,000June 30,000 magnets @ $10 = $300,000July 25,000 magnets @ $10 = $250,000
The Sales Budget
July is needed for June ending inventory computations.
Sales BudgetSales Budget
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Production BudgetProduction Budget
ProductionBudget
Sales Budget
Complete
d
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Production BudgetProduction Budget Two ApproachesTwo Approaches
Based on sales estimates and level production each period Ending inventory level is a residual
and fluctuates e.g., ILL. 23.2 (p. 833) A/K/A Sales and Production Budget
Based on sales estimates and desired ending inventory level Production quantity is a
residual and fluctuates e.g., Bottom p. 833
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Production BudgetProduction Budget
Ellis wants ending inventoryto be 20 percent of the next month’s
budgeted sales in units.
4,000 units were on hand March 31.
Let’s prepare the production budget using the
second approach.
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Production BudgetProduction Budget
Production must be adequate to meet budgeted sales and to provide sufficient
ending inventory.
Production must be adequate to meet budgeted sales and to provide sufficient
ending inventory.
Budgeted product sales in units
+ Desired product units in ending inventory
= Total product units needed
– Product units in beginning inventory
= Product units to produce
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Production BudgetProduction Budget
April May JuneBudgeted unit sales 20,000 50,000 30,000Desired ending inventoryTotal units neededLess beginning inventoryUnits to produce
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Production BudgetProduction Budget
April May JuneBudgeted unit sales 20,000 50,000 30,000Desired ending inventory 10,000 6,000 5,000 Total units needed 30,000 56,000 35,000Less beginning inventoryUnits to produce
Ending inventory = 20% of next month's production needsJune ending inventory = .20 × 25,000 July units = 5,000 units
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April May JuneBudgeted unit sales 20,000 50,000 30,000Desired ending inventory 10,000 6,000 5,000 Total units needed 30,000 56,000 35,000Less beginning inventory 4,000 10,000 6,000 Units to produce 26,000 46,000 29,000
Ending inventory = 20% of next month's production needsJune ending inventory = .20 × 25,000 July units = 5,000 unitsBeginning inventory is last month's ending inventory.
Production BudgetProduction Budget
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Production BudgetProduction Budget
ProductionBudgetMaterial
Purchases
Production BudgetUnits
Complete
d
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The material purchases budget is based on production quantity and desired material
inventory levels.
The material purchases budget is based on production quantity and desired material
inventory levels.
Production BudgetProduction BudgetMaterial PurchasesMaterial Purchases
Units to produce × Material needed per unit = Material needed for units to produce+ Desired units of material in ending
inventory= Total units of material needed– Units of material in beginning inventory= Units of material to purchase
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Five pounds of material are needed for each unit produced.
Ellis wants to have materials on hand at the end of each month equal to 10 percent of the following month’s
production needs.
The materials inventory on March 31 is 13,000 pounds. July production is
budgeted for 23,000 units.
Production BudgetProduction BudgetMaterial PurchasesMaterial Purchases
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April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventoryTotal material needs (lbs.)Less beginning inventoryMaterial purchases (lbs.)
Production BudgetProduction BudgetMaterial PurchasesMaterial Purchases
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April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventory 23,000 14,500 11,500 Total material needs (lbs.) 153,000 244,500 156,500Less beginning inventoryMaterial purchases (lbs.)
Ending inventory = 10% of next month's material needsJune Ending inventory = .10 × (23,000 units × 5 lbs. per unit)June Ending inventory = 11,500 lbs.
Production BudgetProduction BudgetMaterial PurchasesMaterial Purchases
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April May JuneUnits to produce 26,000 46,000 29,000 Pounds per unit 5 5 5 Material needs (lbs.) 130,000 230,000 145,000Desired ending inventory 23,000 14,500 11,500 Total material needs (lbs.) 153,000 244,500 156,500Less beginning inventory 13,000 23,000 14,500 Material purchases (lbs.) 140,000 221,500 142,000
Ending inventory = 10% of next month's material needsJune Ending inventory = .10 × (23,000 units × 5 lbs. per unit)June Ending inventory = 11,500 lbs.Beginning inventory is last month's ending inventory.
Production BudgetProduction BudgetMaterial PurchasesMaterial Purchases
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Production BudgetProduction Budget
ProductionBudgetLabor
Production BudgetMaterial
Purchases
Complete
d
(Not shown)(Not shown)
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Cash Receipts BudgetCash Receipts Budget
O.K., let’s do acash receipts
budget!
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Cash Receipts BudgetCash Receipts Budget
All sales are on account.
Ellis’ collection pattern is:
70 percent collected in month of sale
25 percent collected in month after sale
5 percent will be uncollectible
Accounts receivable on March 31 is $30,000, all of which is collectible.
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Cash Receipts BudgetCash Receipts BudgetApril May June
Budgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April salesReceipts from May salesReceipts from June salesTotal cash receipts 170,000$
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Cash Receipts BudgetCash Receipts BudgetApril May June
Budgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000 Receipts from May salesReceipts from June salesTotal cash receipts 170,000$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000
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Cash Receipts BudgetCash Receipts BudgetApril May June
Budgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000 Receipts from May sales 350,000 125,000 Receipts from June salesTotal cash receipts 170,000$ 400,000$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000 May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000
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April May JuneBudgeted unit sales 20,000 50,000 30,000 Price per unit 10$ 10$ 10$ Budgeted sales revenue 200,000$ 500,000$ 300,000$
Receipts from March sales 30,000$ Receipts from April sales 140,000 50,000 Receipts from May sales 350,000 125,000 Receipts from June sales 210,000 Total cash receipts 170,000$ 400,000$ 335,000$
April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000 May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000 June: .70 × $300,000 = $210,000
Cash Receipts BudgetCash Receipts Budget
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.
We can now prepare a comprehensive
cash budget which will also include
cash disbursements.
Comprehensive Cash BudgetComprehensive Cash Budget
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ProjectedIncome
Statement
Cash Budget
Complete
d
(assum
ed)
Projected Income StatementProjected Income Statement
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Ellis Magnet CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$
Projected Income StatementProjected Income Statement
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Ellis Magnet CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000
Computation of unit cost is assumed to shorten the
illustration.
Projected Income StatementProjected Income Statement
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Ellis Magnet CompanyBudgeted Income Statement
For the Three Months Ended June 30
Sales (100,000 units @ $10) 1,000,000$Cost of goods sold (100,000 @ $4.99) 499,000 Gross margin 501,000 Selling and administrative expenses 260,000 Operating income 241,000 Interest expense 2,000 Net income 239,000$
Assumed
Projected Income StatementProjected Income Statement
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Projected Balance SheetProjected Balance Sheet
ProjectedBalance
Sheet
Complete
d
ProjectedIncome
Statement
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Ellis Magnet CompanyProjected Balance Sheet
June 30, 1999Current assets Cash 43,000$ Accounts receivable 75,000 Raw materials inventory 4,600 Finished goods inventory 24,950
Total current assets 147,550 Property and equipment Land 50,000 Building 174,500 Equipment 192,500 Total property and equipment 417,000
Total assets 564,550$
Liabilities and Equities Accounts payable 28,400$ Common stock 200,000 Retained earnings 336,150 Total liabilities and equities 564,550$
25% of Junesales of $300,000
11,500 lbs.at $.40 per lb.5,000 units
at $4.99 each50% of Junepurchases of $56,800
Beginning balance 148,150$Add: net income 239,000 Deduct: dividends (51,000) Ending balance 336,150$
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Text IllustrationsText IllustrationsNow, let’s look more
closely at some of the illustrations in the chapter
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Leed CompanyLeed Company
ILL. 23.3 (P. 833) - This is the basis for many subsequent illustrations.
ILL. 23.4 (P. 834) - You should have determined the source of each number here when you “worked your way through the chapter”. Questions?
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Flexible Budget and Flexible Budget and Budget VariancesBudget Variances
Flexible Budget - one that provides budgeted revenues and expenses at various levels of output (i.e., production or sales)
“When management uses a flexible budget to appraise a department’s performance, it bases the evaluation on the amounts budgeted for the level of activity actually level of activity actually experiencedexperienced. The difference between the actualactual costs incurred and the flexible budget amount for that samesame levellevel of operationsof operations is called a budget variancebudget variance.”
p. 835
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$9,600 Actual
- 7,000 Budgeted2,600 UNfavorable budget variance
Referring to ILL. 23.6 (p. 836), the Flexible Budget for Manufacturing Overhead, what is the relevant range?
17,500 to 25,000 units Now, if actual power cost = $9,600,
what is the budget variance?
Flexible Budget and Flexible Budget and Budget VariancesBudget Variances
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Illustration 23.7 vs.Illustration 23.7 vs. Illustration 23.8 Illustration 23.8
23.7 - Comparison of Planned Operating Budget and Actual Results
Used for what?
Assessment of overall performance vs. objectives
What were objectives?
Sales of $400,000 and profit of $6,000
Why were earnings better than budget when sales were worse than budget?
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Illustration 23.7 vs.Illustration 23.7 vs. Illustration 23.8 Illustration 23.8
23.8 - Comparison of Flexible Operating Budget and Actual Results
PleasePlease addadd to title to title: “At the Level of Production and Sales Attained”
Used for what?
Expense control purposes
p. 837
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Additional Budgeting TopicAdditional Budgeting Topic
Zero-Base Budgeting
Managers start each year with zero budget levels and
must justify each dollar appearing in the budget instead of just taking the
prior year’s budget or actual results as the
starting point, as is so often done with traditional
budgeting.
Zero-Base Budgeting
Managers start each year with zero budget levels and
must justify each dollar appearing in the budget instead of just taking the
prior year’s budget or actual results as the
starting point, as is so often done with traditional
budgeting.
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THE ENDTHE ENDI would be happy to assist you with your cash budget!