21

Chapter 21
The Budgeting Process
Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University
Learning Objective
1. Define budgeting and explain its role in the management cycle. 2. Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets. 3. Prepare the operating budgets that support the financial budgets.
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Learning Objective (contd)

4. Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet. 5. Describe managements role in budget implementation.
Copyright Houghton Mifflin Company. All rights reserved.
213

Objective 1
Define budgeting and explain its role in the management cycle
214
Budgeting
is the process of identifying, gathering, summarizing, and communicating financial and nonfinancial information about an organization's future activities
Is essential part of the continuous planning for an organization in order to accomplish long-term goals
215

Budgets
Plans of action based on forecasted transactions, activities, and events
Are synonymous with managing an organization
Essential to accomplishing goals in the strategic plan
216
The Budgeting Process (contd)

Budgets are used to
Communicate information
Coordinate activities and resource usage Motivate employees Evaluate performance Manage and account for cash
Establish minimum levels of cash receipts and expenditures
217
The Budgeting Process (contd)

Many forms of budgets
Examples
Cash budget
Focuses on financial information Shows, among other things, how cash resources will be allotted to operating, investing, and financing activities over a future period
Production budget
Focuses on nonfinancial information
Shows planned production in units

Identifies activities needed to meet certain requirements or standards
218
Budgeting and Goals

Strategic planning
Process by which management establishes an organizations long-term goals
219
Long-Term Goals
define the strategic direction an organization will take over a five- to ten-year period
Are the basis for

Making annual operating plans
Preparing budgets
Long-Term Goals (contd)

Should take into consideration
Economic and industry forecasts Employee-management relations Structure and role of management Value chain considerations Organizational capacity Any other operational and tactical issues facing the organization
Expected quality of products or services Growth rates Desired market share
Long-Term Goals (contd)

Must set specific targets and timetables
Must assign responsibility for achieving the goals to specific personnel

A range of long-term goals should be included in the organization's strategic plan
Should give direction to efforts to achieve these goals
Short-Term Goals
Involve every part of an enterprise
Much more detailed than long-term goals

To formulate an annual operating plan, long-term goals must be restated in terms of what needs to be accomplished during the next year
Short-term goals are the basis of an organizations operating budgets for the year
Short-Term Goals (contd)

Organizations controller takes charge of coordinating the budget process
Designs a complete set of budget-development directions
Timetable with deadlines
Assigns clearly defined responsibilities for carrying out each part of the budgets development
To specific individuals or management teams
The budget may be reviewed and revised during the year
2114
Importance of Participation
The key to a successful budget is participative budgeting
Process in which personnel at all levels of an organization actively engage in making decisions about the budget
Gives a sense of ownership
Helps ensure that departments will attain targets and stay within the budget
2115
Importance of Participation (contd)

Participative budgeting depends on joint decision making
Controller must be able to communicate and negotiate effectively with people in all levels of an organization
Senior managers
Formulate organizational long-and short-term goals
Middle managers Supervisors

Responsible for daily operations
2116
Importance of Participation (contd)

Authoritative budgeting
Senior executives dictate targets
Do not allow middle managers and supervisors a voice in setting them Targets may be unrealistic and impossible to attain
Will undermine motivation of managers and supervisors
Cooperation is essential for successful budget implementation
Senior executives allow controller to develop budget without consulting other managers
Managers may feel budgeting is not a top priority
2117
Budgeting and the Management Cycle
2118

Planning
Budgeting
Originates in this stage Helps managers to
Relate the organizations long-term goals to its shortterm activities
Distribute resources and workloads Communicate responsibilities Select performance measures Set goals for bonuses and rewards
2119

Executing
Budgeting helps managers to
Communicate expectations Measure performance and motivate employees
Coordinate activities and allot resources
2120

Reporting
Communicate budget information Provide continuous feedback
Support operating decisions
2121

Reviewing
Evaluate performance Determine timeliness
Find variances and create solutions

Compare planned performance with actual performance
2122
Discussion
Q. How are short-term goals related to strategic planning?
A. Short-term goals define the strategic direction an organization will take over the next year. They are determined to help accomplish the long-term goals that are established during the strategic planning process
2123
The Master Budget

Objective 2
Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets
2124
The Master Budget

consists of a set of operating budgets and a set of financial budgets that detail an organizations financial plans for a specific accounting period, generally a year
2125
The Master Budget (contd)

Operating budgets
Plans used in daily operations Basis for financial budgets
Financial budgets
Projections of financial results for the accounting period Include
Budgeted income statement
Capital expenditures budget

Cash budget Budgeted balance sheet

Process of preparing a master budget is similar in all three types of organizations
Manufacturing Retail Service
The process differs mainly in the kinds of operating budgets each type of organization prepares
Preparation of a Master Budget for a Manufacturing Organization
2128
Preparation of a Master Budget for a Retail Organization
2129
Preparation of a Master Budget for a Service Organization
2130

Sales budget
Is prepared first
Used to estimate sales volume and revenues Once developed, other budgets can be developed
These other budgets will help manage the organization's resources so that profits can be generated on sales
In a service organization, the sales budget is called the service revenue budget
2131

No standard format for budget preparation
Procedures vary from organization to organization
Only universal requirement is that budgets communicate the appropriate information to the reader in a clear and understandable manner
2132

Managers can improve the quality of budgets by using the following guidelines
1. Know the purpose of the budget 2. Identify the user group and its information needs 3. Identify sources of accurate, meaningful budget information 4. Establish a clear format for the budget 5. Use appropriate formulas and calculations to derive quantitative information 6. Revise the budget until it includes all planning decisions
Discussion
Q. Which budget must be prepared first?
A. The sales budget. This budget is used to estimate sales volume and revenues. Once established, the other budgets can be developed
2134
Operating Budgets
Objective 3
Prepare the operating budgets that support the financial budgets
2135
Operating Budgets
are a set of budgets that are used in planning the daily operations of an organization
Are part of the master budget
2136
Operating Budgets
Procedures for preparing operating budgets include
Cost behavior analysis Cost-volume-profit analysis A product costing method
Organizations that manufacture a variety of products or services may prepare

Separate operating budgets, or One comprehensive budget for each product or service
2137
Sales Budget
is a detailed plan, expressed in both units and dollars, that identifies the product (or service) sales expected in an accounting period
2138
Sales Budget (contd)

Sales mangers use the information to
Plan sales- and marketing-related activities Determine human, physical, and technical resource needs
Accountants use the information to

Determine estimated cash receipts for the cash budget
To determine the total budgeted sales

Total Budgeted Sales = Estimated Selling Price per Unit x Estimated Sales in Units
2139

Selecting the best estimates for selling price per unit and the sales demand in units can be difficult
If the organization wants to increase its share in the market
An estimated selling price below the current selling price may be needed
If the organization has improved the products quality by using more expensive materials or production processes
The estimated selling price may have to be higher than the current price

Estimated sales volume is very important
Will affect the level of operating activities and amount of resources needed for operations Managers may use a sales forecast
A projection of sales demand based on an analysis of internal and external factors
2141

External factors taken into consideration in a sales forecast include
1. The state of the local and national economies
2. The state of the industrys economy

3. The nature of the competition and its sales volume and selling price
2142

Internal factors include
1. The number of units sold in prior periods
2. The organizations credit policies 3. The organizations collection policies 4. The organizations pricing policies 5. Any new products the organization plans to introduce to the market 6. The capacity of the organizations manufacturing facilities
2144
The Production Budget

is a detailed plan showing the number of units a company must produce to meet budgeted sales and inventory levels
Production managers use this information to plan for the materials and human resources that production activities will require
The Production Budget (contd)

To prepare a production budget, managers must know
Budgeted number of sales units
From the sales budget
Desired level of ending finished goods inventory for each period in the budget year
Often stated as a percentage of the next periods budgeted unit sales
2146
The Production Budget (contd)

To determine the production needs for an accounting period
Total Budgeted Production = Sales in Units Units + Desired Units of Ending Finished Goods Inventory Desired Units of Beginning Finished Goods Inventory
2147
Production Budget
2148
The Direct Materials Purchases Budget

is a detailed plan that identifies the quantity of purchases required to meet budgeted production and inventory needs and the costs associated with those purchases
2149
The Direct Materials Purchases Budget (contd)
Purchasing department
Uses information to plan purchases of direct materials
Accountants
Use information to estimate cash payments to suppliers
2150

To prepare a direct materials purchases budget managers must know
What production needs will be in the next accounting period
Provided in the production budget
Desired level of direct materials inventory for each period Per unit cost of direct materials Desired level of ending direct materials inventory
Usually stated as a percentage of the next periods production
2151

Steps to prepare a direct materials purchasing budget
1. Calculate each periods total production needs in units of direct materials 2. Determine the total number of units of direct materials to be purchased during each accounting period in the budget
Total Units of Direct = Materials to Be Purchased Total Production Needs in Units of Direct Materials Desired Units of Ending + Direct Materials Inventory Desired Units of Beginning Direct Materials Inventory
3. Calculate the cost of the direct materials purchases

Direct Materials Purchases Budget
2153
The Direct Labor Budget

is a detailed plan that estimates the direct labor hours needed in an accounting period and the associated costs
2154
The Direct Labor Budget (contd)

Production managers use estimated direct labor hours to plan
How many employees will be required during the period The hours each employee will work
Accountants use estimated direct labor costs to plan

For cash payments to workers
Human resource managers use information on the direct labor budget to

Decide whether to hire new employees Reduce the existing work force Train employees Prepare schedules of employee fringe benefits
2155
The Direct Labor Budget (contd)

Steps in preparing a direct labor budget
1. Estimate the total direct labor hours
Multiply estimated direct labor hours per unit by the anticipated units of production
2. Calculate the total budgeted direct labor cost

Total Budgeted Direct Labor Cost = Estimated Total Direct Labor Hours x Estimated Direct Labor Cost per Hour
2156
Direct Labor Budget
2157
The Manufacturing Overhead Budget

is a detailed plan of anticipated manufacturing costs, other than direct materials and direct labor costs, that must be incurred to meet budgeted production needs
2158
The Manufacturing Overhead Budget (contd)
Two purposes
1. Integrate the overhead cost budgets developed by managers of production and production-related departments 2. Group information for the calculation of manufacturing overhead rates for the forthcoming accounting period
2159
The Manufacturing Overhead Budget (contd)
Presentation of information is flexible

Grouping by activities is useful for organizations using activity-based costing
2160
Manufacturing Overhead Budget
2161
The Selling and Administrative Expense Budget
is a detailed plan of operating expenses, other than those related to production, that are needed to support sales and overall operations in an accounting period
Accountants use this budget to estimate cash payments for products or services used in nonproduction-related activities
Selling and Administrative Expense Budget
2163
The Cost of Goods Manufactured Budget
is a detailed plan that summarizes the estimated costs of production in an accounting period
Sources of information
Direct materials, direct labor, and manufacturing overhead budgets
2164
Cost of Goods Manufactured Budget
Note that most companies anticipate some work in process at the beginning or end of a period covered by the budget
Discussion
Q. What are the sources of information for preparing the cost of goods manufactured budget?
A. Direct materials budget Direct labor budget Manufacturing overhead budget
2166
Financial Budgets
Objective 4
Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet
2167
Financial Budgets
are projections of financial results for an accounting period Include
Budgeted income statement Capital expenditures budget
Cash budget
Budgeted balance sheet
The Budgeted Income Statement

projects an organizations net income in an accounting period based on revenues and expenses estimated for that period
2169
Budgeted Income Statement
2170
The Capital Expenditures Budget

. is a detailed plan outlining the anticipated amount and timing of capital outlays for long-term assets in an accounting period
2171
The Capital Expenditures Budget (contd)
Managers rely on information in a capital expenditures budget when making decisions about such matters as
Buying equipment Building a new plant Purchasing and installing a materials handling system Acquiring another business
2172
The Cash Budget

is a projection of the cash an organization will receive and the cash it will pay out in an accounting period
Summarizes the cash flow prospects of all transactions considered in the master budget
The Cash Budget (contd)

Information it provides enables managers to plan for
Short-term loans when the cash balance is low
Short-term investments when the cash balance is high
2174
2175

Excludes some planned noncash transactions
Depreciation expense Issuance and receipt of stock dividends
Uncollectible accounts expense

Gains and losses on sales of assets
May also exclude

Deferred taxes
Accrued interest
2176

To calculate the estimated ending cash balance
Estimated Ending = Cash Balance Total Estimated Cash Receipts Total Estimated Cash Payments + Estimated Beginning Cash Balance
2177

Sources for estimating cash receipts
Sales budget
Budgeted income statement Cash budgets from previous periods Cash collection records and analyses of collection trends Records pertaining to notes, stocks, and bonds
2178

Sources for estimating cash payments
Operating budgets
Budgeted income statement Capital expenditures budget Previous years financial statements Loan records
2179

Supporting schedules
Schedule of expected cash collections from customers
Schedule of expected cash payments for direct materials Cash budget
2180
Schedule of Expected Cash Collections from Customers
2181
Schedule of Expected Cash Payments for Direct Materials
2182
Cash Budget
2183

Organizations may maintain a minimum cash balance
To cover unusual expenditures
If the ending cash balance on the cash budget

Falls below the minimum level required
Short-term borrowing may be necessary
Is significantly larger than the minimum level required

May invest excess in short-term securities to generate additional income
2184
The Budgeted Balance Sheet

projects an organizations financial position at the end of an accounting period
Uses all estimated data compiled in the course of preparing a master budget
Is the final step in that process
2185
Budgeted Balance Sheet
2186
Discussion
Q. How is the ending cash balance estimated?
A. Subtract total estimated cash payments from total estimated cash receipts, then, add the estimated beginning cash balance
2187
Budget Implementation
Objective 5
Describe managements role in budget implementation
2188
Budget Implementation
Budget committee
Oversees each stage in the master budget preparation
Decides any departmental disputes that might arise in the process Gives final approval to the budget
2189
Budget Implementation (contd)

Budget committee members
Controller
Has overall responsibility for budget implementation
President
Vice presidents
The make-up of the committee ensures that the budgeting process has a companywide perspective
2190

A master budget may go through many revisions after approval
Budget committee monitors the progress the company is making in attaining budget targets
Using periodic reports from department managers
2191

Successful budget implementation depends on two factors
1. Clear communication 2. Support of top management
Middle- and lower-level managers must see that top management supports the budget and encourages its implementation
2192
Discussion
Q. What two factors are necessary for successful budget implementation?
A. Clear communication and support of top management
2193
Time for Review

1. Define budgeting and explain its role in the management cycle 2. Identify the elements of a master budget in different types of organizations and the guidelines for preparing budgets 3. Prepare the operating budgets that support the financial budgets
And Finally
4. Prepare a budgeted income statement, a cash budget, and a budgeted balance sheet 5. Describe managements role in budget implementation
2195

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Chapter 21

The Budgeting Process

Learning Objective (contd)

Copyright Houghton Mifflin Company. All rights reserved.

The Budgeting Process

Copyright Houghton Mifflin Company. All rights reserved.

Copyright Houghton Mifflin Company. All rights reserved.

The Budgeting Process

Copyright Houghton Mifflin Company. All rights reserved.

The Budgeting Process (contd)

Copyright Houghton Mifflin Company. All rights reserved.

The Budgeting Process (contd)

Shows planned production in units

Copyright Houghton Mifflin Company. All rights reserved.

Budgeting and Goals

Copyright Houghton Mifflin Company. All rights reserved.

Are the basis for

Long-Term Goals (contd)

Long-Term Goals (contd)

Must assign responsibility for achieving the goals to specific personnel

Much more detailed than long-term goals

Short-Term Goals (contd)

The budget may be reviewed and revised during the year

Copyright Houghton Mifflin Company. All rights reserved.

Copyright Houghton Mifflin Company. All rights reserved.

Importance of Participation (contd)

Middle managers Supervisors

Copyright Houghton Mifflin Company. All rights reserved.

Importance of Participation (contd)

Copyright Houghton Mifflin Company. All rights reserved.

Budgeting and the Management Cycle

Budgeting and the Management Cycle

Copyright Houghton Mifflin Company. All rights reserved.

Budgeting and the Management Cycle

Coordinate activities and allot resources

Copyright Houghton Mifflin Company. All rights reserved.

Budgeting and the Management Cycle

Support operating decisions

Copyright Houghton Mifflin Company. All rights reserved.

Budgeting and the Management Cycle

Find variances and create solutions

Copyright Houghton Mifflin Company. All rights reserved.

Copyright Houghton Mifflin Company. All rights reserved.

The Master Budget

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The Master Budget

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The Master Budget (contd)

Capital expenditures budget

The Master Budget (contd)

Preparation of a Master Budget for a Manufacturing Organization

Preparation of a Master Budget for a Retail Organization

Preparation of a Master Budget for a Service Organization

Copyright Houghton Mifflin Company. All rights reserved.

The Master Budget (contd)

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The Master Budget (contd)

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The Master Budget (contd)

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Copyright Houghton Mifflin Company. All rights reserved.

Are part of the master budget