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8/8/2019 7 Budget and Financial Planning
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CHAPTER 7
BUDGETING AND
FINANCIAL PLANNING
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Strategic Planning
Critical success factorsCritical success factors - Strengths ofthe company that enable it to
outperform competitors.
StrategicStrategic
PlanPlan
Critical
Success
Factors
Incorporated IntoIncorporated Into
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Strategic Long-Range Plan
The master budget is part of an overallThe master budget is part of an overallorganizational plan made up of threeorganizational plan made up of three
components . . .components . . .
Organizational goalsOrganizational goals managements broadmanagements broadobjectives that employees work to achieve.objectives that employees work to achieve.
The strategic longThe strategic long--range profit planrange profit plan steps tosteps to
be taken to achieve organizational goals.be taken to achieve organizational goals.The master budgetThe master budget tactical shorttactical short--rangerange
profit plan.profit plan.
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Key Purposes of the Budgeting
SystemThe five primary purposes are:The five primary purposes are:
1.1. Planning.Planning.
2.2. Facilitating Communication andFacilitating Communication andCoordination.Coordination.
3.3.Allocating Resources.Allocating Resources.
4.4. Managing Financial and OperationalManaging Financial and OperationalPerformance.Performance.
5.5. Evaluating Performance and ProvidingEvaluating Performance and Providing
Incentives.Incentives.
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Organizations Use Many Types of
BudgetsOrganization
goals
Individual goals
and values
Long-range
strategic plan
Anticipated
conditions
M
asterM
asterbudgetbudget
Actual period
results
Individual
beliefs
Performance
evaluation
Strategic
evaluation
OrganizationOrganization IndividualIndividual
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The Master Budget as a Planning
ToolAfter organization goals, strategies and long-rangeplans have been developed, work begins on the
master budget.
The master budget is a detailed budget for thecoming fiscal year.
2006
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Sales Budget: The Starting
Point Sales StaffSales Staff close to customer needs. Market ResearchMarket Research can predict long-term
trends in attitudes and the effects of social
and economic changes on the companyssales, potential markets and products.
Sales ForecastingSales Forecasting the process ofpredicting sales of services or goods.
Lets look at some forecasting tools.Lets look at some forecasting tools.
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Forecasting Tools
Delphi TechniqueDelphi Technique individual forecasts ofgroup members are submittedanonymously and evaluated by the group
as a whole. Econometric ModelsEconometric Models statistical method
of forecasting economic data using
regression analysis.
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Operational Budgets Manufacturing firmsManufacturing firms A production budget isdeveloped from budgets for direct materials, direct
labor, and overhead. A budget for selling, general,and administrative (SG&A) expenses is alsoprepared.
Merchandising firmsMerchandising firms Instead of a productionbudget, a budget of merchandise purchased isdeveloped. The SG&A budget is also prepared.
ServiceService--industry firmsindustry firms Based on the salesbudget for its services, a service industry firmdevelops a set of budgets that show how it willmeet the demand.
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Operational Budgets
Every business prepares a . . .
1.1. Cash budgetCash budget
2.2. Capital expenditures budget, and aCapital expenditures budget, and a3.3. Summary of operational budgetsSummary of operational budgets
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International Aspects of Budgeting
Firms with international operations face a variety ofFirms with international operations face a variety ofadditional challenges in preparing their budgets . . .additional challenges in preparing their budgets . . .
1.1. Translation of foreign currencies into localTranslation of foreign currencies into local
currency.currency.2.2. Budget preparation is difficult when inflation (orBudget preparation is difficult when inflation (or
deflation) is high or unpredictable.deflation) is high or unpredictable.
3.3. The economies of all countries fluctuate inThe economies of all countries fluctuate interms of consumer demand, availability ofterms of consumer demand, availability ofskilled labor, and laws affecting commerce.skilled labor, and laws affecting commerce.
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Activity-Based BudgetingActivity-based budgeting (ABB) is the process of
developing a master budget using information obtainedfrom an activity-based costing (ABC) analysis
ResourcesResources
ActivitiesActivities
Forecast of products andForecast of products andservices to be produced,services to be produced,and customers served.and customers served.
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Illustrating the Master BudgetSchedule Title of Schedule
1 Sales Budget
2 Production Budget
3 Direct-Materials Budget
4 Direct-Labor Budget
5 Manufacturing Overhead Budget6 Selling, General, and Administrative Expense Budget (SG&A)
7 Cash Receipts Budget
8 Cash Disbursements Budget
9 Cash Budget
10 Budgeted Schedule of Cost of Goods Manufactured and Sold11 Budgeted Income Statement
12 Budgeted Balance Sheet
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The Sales Budget
Detailed schedule showing expectedsales for the coming periods expressed
in units and dollars.
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Sales Budget of Collegiate
Apparel Collegiate Apparel Company is preparingCollegiate Apparel Company is preparingbudgets for the year ending December31, 20x1.budgets for the year ending December31, 20x1.
Budgeted sales are:Budgeted sales are:
First quarterFirst quarter 15,000 units15,000 unitsSecond quarterSecond quarter 5,000 units5,000 unitsThird quarterThird quarter 10,000 units10,000 unitsFourth quarterFourth quarter 20,000 units20,000 units
The selling price is $12 per unit.The selling price is $12 per unit.
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Sales Budget of Collegiate Apparel
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Production Budget
SalesSalesBudgetBudget
ProductionProduction
BudgetBudget
Planofresourcesneededto meetcurrentPlanofresourcesneededto meetcurrent
salesdemandandensureinventorylevelssalesdemandandensureinventorylevels
aresufficientforfuturesales.aresufficientforfuturesales.
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Forecasting Production
Rearrange the basic inventory formula asfollows . . .
Units in
beginninginventory
Required
productionin units
Sales
inUnits
Units in
endinginventory++ ==
Now,solveforrequired production...
Unitsto be
Produced==
Salesin
Units++
Units inending
inventory
Expectedbeginninginventory
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The Production Budget
Collegiate Apparel wants units in endingfinished goods inventory to be 10% of thenext quarters expected sales in units.
At the beginning of the year, 1,500completed units were on hand.
During the first quarter of 20x2, 15,000 units
are expected to be sold.
Lets prepare the production budget.Lets prepare the production budget.
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The Production Budget
5,0005,000 10% = 500 units10% = 500 units
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Direct-Materials Budget
Direct materials needed for the budgetDirect materials needed for the budgetperiod can be determined as follows . .period can be determined as follows . .
..RequiredRequiredmaterialsmaterials
purchasespurchases==
MaterialsMaterialsused inused in
productionproduction++
EndingEndingmaterialsmaterialsinventoryinventory
BeginningBeginningmaterialsmaterialsinventoryinventory
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Direct-Materials Budget At Collegiate Apparel 1.5 yards of fabric areAt Collegiate Apparel 1.5 yards of fabric are
required per unit of product.required per unit of product.
Management wants fabric on hand at the end ofManagement wants fabric on hand at the end ofeach quarter to be 10% of next quarters raweach quarter to be 10% of next quarters rawmaterials required. On January 1materials required. On January 1stst, 2,100 yards of, 2,100 yards offabric are onfabric are on--hand. During the first quarter of 20x2,hand. During the first quarter of 20x2,Collegiate expects 21,000 yards of fabric to beCollegiate expects 21,000 yards of fabric to berequired.required.
Each yard of fabric cost the company $2.Each yard of fabric cost the company $2.
Lets prepare the direct materials budget.Lets prepare the direct materials budget.
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Direct-Materials Budget
8,2508,250 10% = 825 units10% = 825 units
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Direct-Labor Budget
At Collegiate Apparel, each unit producedrequires 0.20 hour (12 minutes) of directlabor.
Workers earn a wage rate of $10 per hourregardless of the hours worked. CollegiateApparel can hire workers as needed to meetproduction.
Lets prepare the direct labor budget.Lets prepare the direct labor budget.
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Direct-Labor Budget
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Manufacturing-Overhead
BudgetCollegiate Apparel uses activityCollegiate Apparel uses activity--based budgeting.based budgeting.
At the unitAt the unit--level, each unit produced requires $0.25 of indirectlevel, each unit produced requires $0.25 of indirectmaterials and $0.15 of electricity.materials and $0.15 of electricity.
At the batchAt the batch--level, the company expects the followinglevel, the company expects the followingproduction runs:production runs:
11stst quarterquarter 2828 22ndnd quarterquarter 1111
33rdrd quarterquarter 2222
44thth quarterquarter 3939
At the productAt the product--level, the company expects two new stylelevel, the company expects two new styledesigns each quarter with each new Tdesigns each quarter with each new T--shirt design costingshirt design costing$500.$500.
Details of the facilitiesDetails of the facilities--level overhead costs are shown on thelevel overhead costs are shown on the
manufacturingmanufacturing--overhead budget.overhead budget.
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Manufacturing-Overhead
BudgetUnitUnit--, Batch, Batch--, and Product, and Product--level Portions of the Budgetlevel Portions of the Budget
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Manufacturing-Overhead
BudgetProductProduct--, Facilities, Facilities--level and Total Overhead Budgetlevel and Total Overhead Budget
$5,600 + $8,400 + $1,000 + $36,500 = $51,500$5,600 + $8,400 + $1,000 + $36,500 = $51,500
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SG&A Expense Budget
At Collegiate Apparel, salescommissions and freight-out are unit-level SG&A.
Customer-level SG&A expensesinclude licensing fees for use of namesand logos.
Facilities-level SG&A expense includesales salaries, advertising, and clericalwages.
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SG&A Expense Budget
$ $ $ $
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Cash Receipts Budget
At Collegiate Apparel all sales are madeon account.
The company collects 80% of its billings in
the quarter of the sale, 18% in thefollowing quarter. The remaining twopercent of each quarters sales areexpected to be uncollectible.
Sales in the last quarter of 20x0 were$240,000.
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Cash Receipts Budget
$240,000$240,000 18% = $43,20018% = $43,200
$180,000$180,000 2% = $3,6002% = $3,600
$180,000$180,000 18% = $32,40018% = $32,400
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Cash Payments for Direct-
Materials At Collegiate Apparel all purchases of rawmaterials are made on account.
The company pays for60% of its purchases in the
quarter of the purchase and the remaining 40% inthe following quarter.
Purchases in the last quarter of 20x0 were$56,850.
Lets prepare the Cash Receipts Budget.
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Cash Payments for Direct-
Materials
$18,150$18,150 60% = $10,89060% = $10,890
$39,450$39,450 40% = $15,78040% = $15,780
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Other Cash Disbursements
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Cash Budget
Collegiate Apparel started the year with acash balance of $10,000, and borrows$100,000 at the beginning of 20x1 to financeplant expansion.
The loan is repaid in the amount of $25,000at the end of each quarter with interest onthe unpaid balance at 10%.
Payments for the plant expansion were: 1st quarter = $45,000
2nd quarter = $15,000
3rd quarter = $5,000
4th uarter = $35,000
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Cash Budget
$100,000$100,000 10%10% = $2,500 = $2,500
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Calculation of Absorption Unit
Cost
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Cost of Goods Manufactured
and Sold Budget
1,5001,500 $9$9
$13,500$13,500
2,1002,100 $2$2
$4,200$4,200
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Budgeted Income Statement
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Budgeted Balance Sheet The balance in the building account on December31, 20x0
was $400,000, and the balance in the equipment accountwas $320,000. Total accumulated depreciation was$240,000. Depreciation expense is recorded at the rate of$60,000 per year.
At December31, 20x1, the company had a long-term,noninterest-bearing note payable of $200,000. The note isdue on December31, 20x3.
The balance in the owners equity account at December
31, 20x0, was $330,160.
Supplies on hand at December31, 20x1 were $2,000.
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$330,16056,750
$386,910
$240,000$240,000 18%18%
$43,200$43,200
$56,850$56,850 40%40%
$22,740$22,740
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How It All Fits Together
SalesforecastProduction
budget
SG&Abudget
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How It All Fits Together
SalesforecastProduction
budget
SG&Abudget
Requireddirect
materials,labor
and mfg.overhead
budgets
Budgeted
income
statement
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How It All Fits Together
SalesforecastProduction
budget
SG&Abudget
Requireddirect
materials,labor
and mfg.overhead
budgets
Budgetedcost
ofgoods mfg.
andsold
Budgeted
income
statement
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How It All Fits Together
SalesforecastProduction
budget
SG&Abudget
Requireddirect
materials,labor
and mfg.overhead
budgets
Budgetedcost
ofgoods mfg.
andsold
Budgeted
income
statement
Cashbudget
Budgetedbalance
sheet
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Responsibility for BudgetAdministration
Budget CommitteeBudget Committee Consists of key seniorexecutives who may advise the budget director
during the preparation of the budget.
The authority to give final approval to the budgetusually rests with the board of directors.
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Budgetary Slack: Padding theBudget
Padding the budgetPadding the budgetmeans intentionallymeans intentionallyunderestimating revenues or overestimatingunderestimating revenues or overestimatingcosts.costs.
The difference between the revenue or costThe difference between the revenue or costprojection that a person provides and aprojection that a person provides and arealistic estimate of the revenue or cost isrealistic estimate of the revenue or cost is
calledcalled budgetary slackbudgetary slack..
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Participative Budgeting
Participative BudgetingParticipative Budgeting the use ofinput from lower- and middle-
management employees.The process is time consuming but
enhances employee motivation andacceptance of goals.
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Ethical Problemsin Budgeting
Much of the information for the budget isprovided by persons whose performance isthen compared with the budget they help
develop.
I think sales
will increase by
10% next year.
Lets prepare the
sales forecast with a
4% increase, so we
will really look good!
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Zero-Based Budgeting forDiscretionary Costs
A system of establishing financial plansbeginning with an assumption of no activityand justifying each program or activity level.
After some initial success, zero-based budgetingwas found to be impractical.
Massive amounts of timeMassive amounts of time were required toimplement and update the budget.
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Flexible Overhead Budget
A flexible budget is a budget that is valid for aA flexible budget is a budget that is valid for arelevant range of activity. It is not based on onlyrelevant range of activity. It is not based on onlyone level of activity as we have seen with theone level of activity as we have seen with the
static budget.static budget.
St t
t
t ty ( )
t t ty t $ $ $ $
F
t
Includes severalpossible activity
levels.
Based ononly oneactivitylevel.
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Advantages of Flexible Budgets
Actual
Electricity
Cost
Budgeted
Electricity
Cost
Cost
Variance
1,050 1,200 150 Favorable
A manager is faced with the following information from theA manager is faced with the following information from thestatic budget for June when the level of activity was 4,500static budget for June when the level of activity was 4,500machine hours. Was there good control of electric costs?machine hours. Was there good control of electric costs?
Actual
Electricity
Cost
Budgeted
Electricity
Cost
Cost
Variance
1,050 900 150 Unfavorable
After preparing a flexible budget, the managerAfter preparing a flexible budget, the managerobtained the following information about cost controlobtained the following information about cost control
at 4,500 machine hours.at 4,500 machine hours.
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Activity Measure: Based on Input orOutput?
The number of units of output usually is not aThe number of units of output usually is not ameaningful measure in a multiproduct firmmeaningful measure in a multiproduct firm
because it requires the addition of numbers ofbecause it requires the addition of numbers of
dissimilar products. Output should be measureddissimilar products. Output should be measuredin terms of thein terms of the standard inputstandard inputallowed givenallowed given
actual output.actual output.
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Formula Flexible Budget
Total budgetedmonthly
overhead cost
Budgeted variableoverhead cost per
activity unit
Totalactivityunits
Budgeted fixedoverhead cost
per month= +
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Flexible Overhead Budget
Illustrated
$2.15$2.15 6
,000 = $12,9
006
,000 = $12,9
00
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Flexible Overhead Budget
Illustrated
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Flexible Overhead Budget
Illustrated
$24,360 + $16,550 = $40,910$24,360 + $16,550 = $40,910
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Flexible Overhead Budget
IllustratedManufacturing OverheadManufacturing OverheadActual
OverheadAppliedOverhead
ActualActual
activityactivity
PredeterminedPredetermined
overheadrateoverheadrate
Manufacturing OverheadManufacturing Overhead
ActualOverhead
AppliedOverhead
StandardStandard
allowedactivityallowedactivity
PredeterminedPredetermined
overheadrateoverheadrate
The difference lies in the quantity of hours used
Normal costing Standard costing
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Choice of Activity Measure
1.1. The activity measure should be one thatThe activity measure should be one thatvaries in a similar pattern to the way thatvaries in a similar pattern to the way thatvariable overhead varies.variable overhead varies.
2.2. As automation increases, many companiesAs automation increases, many companiesare using measures such as machine hoursare using measures such as machine hoursor process time for their flexible overheador process time for their flexible overheadbudget.budget.
3.3. Dollar measures are subject to priceDollar measures are subject to price--levellevelchanges and fluctuate more than physicalchanges and fluctuate more than physicalmeasures.measures.
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End of Chapter7