Managerial Accounting – Chapter 9
What is a Budget? A formal written statement of management’s
plans for a specified future time period,
expressed in financial terms
In other words, it’s what we think will happen in
the company, money-wise
Why Budget? Requires all management to plan ahead
Provides definite objectives for performance evaluation
Creates early warning system for potential problems
Facilitates coordination of activities within the business
Greater management awareness of overall operations
Motivates personnel to meet planned objectives
A budget is an aid to management.
A budget is not a substitute for management!
It should go without saying… A budget should be realistic
It should be accepted by management
The people responsible for the budget should have authority to make the budget
The people responsible for implementing budgeted actions should have authority to implement the actions
Budget Time Length Can be for any time – most common is one year
Sometimes supplement with monthly or quarterly budgets (some businesses have cyclical products like winter coats)
Short enough to be reliable, long enough to be attainable
Where do we get budget figures? Past performance data
Collect info from all units
Usually started months before current cycle ends
Industry-wide expectations (sales forecast)
Shows potential industry sales
Shows company’s expected share of industry sales
What do we have to think about?
General economic conditions
Industry trends
Market research studies
Anticipated advertising and promotion
Previous market share
Price changes
Technological developments
Involve all levels of management
Called Participative Budgeting
More accurate – lower level managers have more detailed knowledge of their area
Tend to see process as fair due to involvement
Goal is to produce budget that’s considered fair and achievable by managers; and still meet corporate goals
Participative Budgeting Disadvantages
Time consuming
Costly (time = $$)
Can foster “gaming the system” by building in budgetary slack
Unrealistic budgets can lead to unethical behavior like cutting corners on jobs or distorting internal financial reports
There’s a difference between budgeting and long range planning
Budgeting is short term, usually 1 year
Very detailed
Long range planning is at least 5 years
Not as detailed
Master Budget Complete plan of action for the time period
Contains two interrelated types of budgets: Operating budgets and Financial budgets
What’s the difference? Operating budgets are the individual budgets that
result in preparation of budgeted income statement and establishes goals for sales and production personnel
Financial budgets are the capital expenditures budget; cash budget; budgeted balance sheet
Focus is primarily on cash needs to fund operations and capital expenditures
What order do we go in?
Sales budget is first
Comes from the sales forecast (management’s best estimate of sales revenue for the budget period)
All other budgets depend on sales budget
Multiply expected unit sales volume for each product times anticipated selling price
Next: Production budget Shows units that must be produced to meet
anticipated sales
Derived from sales budget plus desired change in ending finished goods inventory
Direct Materials Budget Shows quantity AND cost of direct materials to be
purchased
Multiply required direct materials units to be purchased by anticipated cost per unit to get budgeted cost of direct materials to be purchased
Mess it up and you run out of inventory and production shuts down.
No cupcakes for you!
Direct Labor Budget Shows quantity of hours, cost of direct labor needed to
meet production requirements
Critical in maintaining a labor force that can meet expected production
Manufacturing Overhead Budget Shows manufacturing overhead costs for budget
period
Distinguishes between fixed and variable over head costs
Selling and Administrative Expense Budget
Projection of anticipated operating expenses
Distinguish between fixed and variable costs
Budgeted Income Statement (Finally, a financial statement!)
Important end result of operating budget
Indicates expected profitability of operations
Provides a basis for evaluating company performance
Prepared from the operating budgets: Sales; Direct Materials; Direct Labor; Manufacturing Overhead; Selling and Administrative Expense
Cash Budget (like a projected Statement of Cash Flows)
Shows anticipated cash flows
Often considered the most important output in preparing financial budgets
Three sections: Cash receipts; Cash disbursements; Financing
Also shows beginning and ending cash balances
Cash Receipts Section
Includes expected receipts from the principle sources of revenue
Expected interest and dividends receipts; proceeds from planned sales of investments, plant assets, company’s capital stock
Cash Disbursements Section Expected cash payments for direct materials, direct
labor, manufacturing overhead, and selling and administrative expenses
Financing Section Expected borrowings and repayments of borrowed
funds, plus interest
Cash Budget Has to be prepared in order
Ending cash balance in one period is the beginning cash balance in the next
Data is obtained from other budgets and from management
Often prepared for one year (individual months shown)
Why prepare a cash budget? Contributes to more effective cash management
Shows managers the need for additional financing before the actual need arises (we can plan ahead)
Indicates when excess cash will be available
Budgeted Balance Sheet Developed from budgeted balance sheet for the prior
year and the budgets for the current year
Let’s look at an example…