Overview managerial accounting chapter 09

Prepare a direct materials budget, including a schedule of expected cash disbursements.. The sales budget is a detailed schedule showing the expected sales for the coming period.. The b

LO3 Prepare a production budget

LO4 Prepare a direct materials budget, including a schedule of expected cash disbursements LO5 Prepare a direct labor budget

LO6 Prepare a manufacturing overhead budget

LO7 Prepare a selling and administrative expense budget

LO8 Prepare a cash budget

LO9 Prepare a budgeted income statement

LO10 Prepare a budgeted balance sheet

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Chapter Overview

A The Basic Budgeting Framework. A budget is a detailed plan outlining the acquisition and use of financial and other resources over a specified time period

1 Planning and control A good budgeting system must provide for both planning and

control Planning involves developing objectives and preparing budgets to achieve those objectives Control involves the steps taken by management to ensure that the objectives set down at the planning stage are attained and that all parts of the organization work together towards those objectives

2 Advantages of budgeting Budgeting has many advantages, including:

• Budgeting provides managers with a vehicle for communicating their plans in an orderly way throughout the entire organization

• Budgeting requires managers to plan for the future

• Budgeting provides a means of allocating resources to those parts of the organization where they can be used most effectively

• Budgeting uncovers potential bottlenecks before they occur

• Budgeting coordinates the activities of the entire organization

• Budgets provide benchmarks for evaluating subsequent performance

3 Responsibility accounting A manager should be held responsible for those items of

revenues and costs—and only those items—that the manager can actually control to a

budget specifying a limit on how much can be spent This limit may be adjusted, depending

on the activity during the period This idea will be developed in later chapters

4 Choosing a budget period Budget periods vary in length Some may be as short as a

month, whereas others may cover many years The most common budgeting period, however, is a year

• Operating budgets ordinarily cover a one-year period Additionally, many companies divide their operating budgets into quarterly or monthly periods

• A continuous or perpetual budget covers a 12-month period but adds a new month on the end as the current month is completed This approach stabilizes the planning horizon at one year

5 Self-imposed participative budget The most successful budget programs usually involve

lower-level managers in preparing their own budgets—although this point is in some dispute There are two basic reasons for favoring participative budgets: 1) lower-level managers are more familiar with the details of their own operations than top managers and 2) managers tend to be more committed to budgets that they have been able to influence

6 Human relations Management must keep clearly in mind that budgeting involves

coordinating and motivating people and the human dimension is of primary importance

a Top managers must clearly convey the message in actions as well as in words that budgeting is important If top management appears to be ambivalent about the benefits

of budgeting, others in the organization will be reluctant to commit their own time and energy to the budgeting process

b If there is a preoccupation with getting every dollar and cent right or with placing blame, the budgeting process will be resented and managers will attempt to “game the system.” Budgets should not be used as a club They should be a way of ensuring that everyone understands what is expected Significant deviations from the budget should

be investigated so that managers understand changing conditions and their implications for the organization Managers should not ordinarily be punished for deviations from the budget

B Preparing the Master Budget. (Exercise 9-1 through Exercise 9-7.) The master budget consists of a number of separate, but interrelated budgets The interrelationships among these various budgets are illustrated in Exhibit 9-2 in the text Schedules 1 through 10 in the text present a comprehensive example of a master budget

1 The Sales Budget (Exercise 9-1; Schedule 1 in the text) The sales budget is a detailed

schedule showing the expected sales for the coming period It is typically expressed in both dollars and units of the product The sales budget is usually accompanied by a schedule of expected cash receipts The schedule of expected cash collections should take into account delays in collecting credit sales

2 The Production Budget (Exercise 9-2; Schedule 2 in the text) The budgeted production

for each period can be determined by adding together the budgeted sales and the desired ending inventory and then subtracting the beginning inventory The desired ending inventory in units for each period is usually a predetermined percentage of budgeted unit sales for the following period The production budget is typically expressed in terms of physical units rather than in dollars

In a merchandising company, a merchandise purchases budget would replace the

purchased from suppliers each period This can be determined by adding together the budgeted sales and the desired ending inventory and then subtracting the beginning inventory As in a manufacturing company, the desired ending inventory in units is usually some predetermined percentage of the unit sales for the following period

3 The Direct Materials Budget (Exercise 9-3; Schedule 3 in the text) Once production

needs have been determined, a direct materials budget should be prepared This budget details the materials that will be required to fulfill the production budget and to ensure adequate inventory levels Sufficient amounts of raw material must be acquired to meet both production needs and to provide for desired ending inventories Materials purchases are determined by adding together the materials required for production needs and the desired ending materials inventories, and then subtracting the beginning inventory The desired ending inventory in units is usually a predetermined percentage of the number of units expected to be used in production the following period The direct materials budget is usually accompanied by a schedule of expected cash disbursements for raw materials This schedule should take into account any delays that are anticipated in paying for materials

4 The Direct Labor Budget (Exercise 9-4; Schedule 4 in the text) Once production needs

are known, the direct labor budget must be prepared so that the company will know whether sufficient labor time is available to meet those needs The direct labor budget is typically expressed in both direct labor-hours and in dollars Translating the direct-labor requirements into spending can lead to complications if there is overtime or if there is some sort of guaranteed employment policy

5 The Manufacturing Overhead Budget (Exercise 9-5; Schedule 5 in the text) The

manufacturing overhead budget lists all production costs other than direct materials and direct labor Manufacturing overhead costs should be broken down by cost behavior for budgeting purposes Typically, the variable portion of manufacturing overhead is assumed

to be proportional to budgeted activity and the fixed portion is assumed to be constant in total Under the assumption that depreciation is the only significant non-cash manufacturing overhead expense, the manufacturing overhead expense can be converted to

a cash flow basis by backing out of the total any depreciation charges

6 Ending Finished Goods Inventory Budget (Schedule 6 in the text) This budget details

the amount and value of ending inventory on the budgeted balance sheet The unit product cost from this budget is also used to compute the cost of goods sold for the budgeted income statement The details of the computations will depend on whether variable or absorption costing is used Managers often want budgets on an absorption costing basis since that is the basis that will ordinarily be used to report results to outsiders Data for the computations in this schedule are found in the direct materials, direct labor, and manufacturing overhead budgets

7 The Selling and Administrative Expense Budget (Exercise 9-6; Schedule 7 in the text)

The selling and administrative budget lists the anticipated non-manufacturing expenses for the budget period In practice this budget is usually made up of many smaller individual budgets negotiated with various managers having sales and administrative responsibilities Setting appropriate budget limits for selling and administrative functions is one of the most difficult problems in management accounting and is just beginning to be understood

8 The Cash Budget (Exercise 9-7; Schedule 8 in the text) The cash budget should be broken

that may occur due to fluctuations in cash flows As anyone with a checking account knows, it is quite possible to have a positive overall cash flow during a period and yet be overdrawn at some point during the period The cash budget is composed of four major sections:

a The receipts section

b The disbursements section

c Cash receipts, plus the beginning cash balance, less cash disbursements results in cash excess or deficiency In the case of a deficiency, management must arrange to borrow additional funds In the case of excess cash, management can use the excess funds to repay previous borrowing or to make new investments

d The financing section of the cash budget details the borrowing and repayments projected to take place during the budget period, including any interest payments

9 Budgeted Financial Statements (Schedule 9 in the text) The last components of the

master budget consist of the budgeted income statement and the budgeted statement of financial position The balance sheet is perhaps the most difficult of the statements to construct in the examples we use It requires pulling together data from a variety of schedules and sources

Assignment Materials

Assignment Topic

Level of Difficulty

Suggested Time

Exercise 9-1 Schedule of expected cash collections Basic 20 min Exercise 9-2 Production budget Basic 10 min Exercise 9-3 Materials purchases budget Basic 15 min Exercise 9-4 Direct labor budget Basic 20 min Exercise 9-5 Manufacturing overhead budget Basic 15 min Exercise 9-6 Selling and administrative budget Basic 15 min Exercise 9-7 Cash budget analysis Basic 20 min Problem 9-8 Evaluating a company’s budget procedures Basic 30 min Problem 9-9 Schedule of cash collections; cash budget Basic 45 min Problem 9-10 Behavioral aspects of budgeting; ethics and the manager Basic 45 min Problem 9-11 Production and purchases budgets Basic 45 min Problem 9-12 Direct materials and direct labor budgets Basic 30 min Problem 9-13 Direct labor and manufacturing overhead budgets Basic 30 min Problem 9-14 Schedules of expected cash collections and disbursements Basic 30 min Problem 9-15 Cash budget; income statement; balance sheet Basic 60 min Problem 9-16 Cash budget with supporting schedules Medium 60 min Problem 9-17 Integration of the sales, production, and purchases budgets Medium 60 min Problem 9-18 Cash budget with supporting schedules Medium 60 min Problem 9-19 Completing a master budget Medium 120 min Problem 9-20 Completing a master budget Medium 120 min Problem 9-21 Cash budget for one month Difficult 60 min Problem 9-22 Integrated operating budgets Difficult 90 min Case 9-23 Evaluating a company’s budget procedures Difficult 45 min Case 9-24 Master budget with supporting schedules Difficult 120 min Case 9-25 Cash budget for a growing company Difficult 75 min Essential Problems: Problem 9-11, Problem 9-13, Problem 9-14, Problem 9-15, Problem 9-19 or

Problem 9-20

Supplementary Problems: Problem 8, Problem 9, Problem 10, Problem 12, Problem

9-16 or Problem 9-18, Problem 9-17, Problem 9-21, Problem 9-22, Case 9-23, Case 9-24,

Case 9-25

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Chapter 9 Lecture Notes

Helpful Hint: Before beginning the lecture, show students the ninth segment from the second tape of the McGraw-Hill/Irwin Managerial/Cost Accounting video library This segment introduces students to many of the concepts discussed in chapter 9 The lecture notes reinforce the concepts introduced in the video

Chapter theme: This chapter focuses on the steps taken by businesses to achieve their planned levels of profits – a

process called profit planning Profit planning is

accomplished by preparing numerous budgets, which, when brought together, form an integrated business plan

known as a master budget

I The basic framework of budgeting

A Basic definitions

i A budget is a detailed quantitative plan for

acquiring and using financial and other resources over a specified forthcoming time period

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B Difference between planning and control

i Planning involves developing objectives and

preparing various budgets to achieve those objectives

ii Control involves the steps taken by

management to increase the likelihood that the objectives set down at the planning stage are attained and that all parts of the organization are working together toward that goal

iii To be effective, a good budgeting system must

provide for both planning and control Good

planning without effective control is time wasted

C Advantages of budgeting

i Budgets communicate management’s plans

throughout the organization

ii Budgets force managers to think about and

plan for the future

“In Business Insights”

While our focus in this chapter is on preparing operating budgets for a one-year time frame, longer- term budgets can also be very helpful to organizations from a planning standpoint For example:

“Heading Off a Crisis” (page 380)

• The Repertory Theatre of St Louis is a profit professional theatre that is supported by

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• A five-year budget revealed that within a few years, expenses would exceed revenues and the theatre would be facing a financial crisis

• The solution was to build a second main-stage performing space that would allow the theatre to put on more performances to generate more revenue

• By developing a long-range budget, the management of The Repertory Theatre of St

Louis was able to identify in advance a looming financial crisis and to develop a solution that would avert the crisis in time

iii The budgeting process provides a means of

allocating resources to those parts of the

organization where they can be used most effectively

iv The budgeting process can uncover potential

bottlenecks before they occur

v Budgets coordinate the activities of the entire

organization by integrating the plans of its various parts

vi Budgets define goals and objectives that can

serve as benchmarks for evaluating subsequent performance

Help Hint: Mention to students that budgets are prepared for reasons other than projecting income statement and balance sheet account balances Ask students to think about some other information that might be provided by budgets, such as determining the

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need for short-term borrowing or estimating raw material needs

D Other terminology/concepts related to budgeting

a Responsibility accounting systems

enable organizations to react quickly

to deviations from their plans and to

learn from feedback obtained by

comparing budgeted goals to actual

results The point is not to penalize

individuals for missing targets

ii Choosing a budget period

1 Operating budgets ordinarily cover a one

year period corresponding to a company’s fiscal year Many companies divide their annual budget into four quarters

a In this chapter we focus on one-year operating budgets

2 A continuous or perpetual budget is a

12-month budget that rolls forward one 12-month (or quarter) as the current month (or quarter)

is completed

a This approach keeps managers focused

on the future at least one year ahead

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“In Business Insights”

Some companies are abandoning the traditional budgeting process in favor of alternatives, such as rolling forecasts, that better suit their needs For example:

“Better than Budgets?” (page 385)

• Borealis is a company headquartered in Copenhagen, Denmark, that produces polymers for the plastics industry

• Over a five-year period the company phased out its traditional budgets and replaced them with rolling forecasts and several other management tools

• Instead of holding managers to a budget, targets based on competitors’ performance were set for variable costs, fixed costs, and operating margins

• Since the rolling forecasts of financial results were not used to control spending or to evaluate managers’ performance, managers had little incentive to “game the system” and hence the forecasts were more accurate than those obtained from the traditional budgeting process

iii The self-imposed budget

1 A self-imposed budget or participative

budget is a budget that is prepared with the

full cooperation and participation of managers at all levels It is a particularly useful approach if the budget will be used to evaluate managerial performance

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2 The advantages of self-imposed budgets

include:

a Individuals at all levels of the

organization are viewed as members

of the team whose judgments are

valued by top management

b Budget estimates prepared by line managers (who have intimate knowledge of day-to-day operations)

front-are often more accurate than

estimates prepared by top managers

c Motivation is generally higher when

individuals participate in setting their own goals than when the goals are imposed from above

d A manager who is not able to meet a budget imposed from above can claim

that it was unrealistic Self-imposed

budgets eliminate this excuse

3 Self-imposed budgets should be reviewed by higher levels of management Without such

a review, self-imposed budgets may have

too much “budgetary slack,” or may not be

aligned with overall strategic objectives

“In Business Insights”

Many factors can affect the level of budgetary slack that is built into a budget For example:

“Cutting Slack in Ireland” (page 382)

• A study of four Irish businesses suggests that one

of the best ways for a company to control its budgetary slack is to train its management accountants so that they understand the

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• The study found that budgetary slack was greatest

in an Irish subsidiary of a company headquartered in America whose management accountants least understood the operating side of business

• Midway through the year the management accountants from headquarters insisted that the subsidiary deliver additional cost savings to make

up for poor performance elsewhere in the corporation

• Not surprisingly, the managers of the Irish subsidiary routinely pad their budgets in case this happens again

4 Most companies do not rely exclusively upon self-imposed budgets in the sense that

top managers usually initiate the budget process by issuing broad guidelines in terms

of overall target profits or sales Lower level managers are directed to prepare budgets that meet those targets

Helpful Hint: Ask students if they ever worked in an organization with a management-imposed budget or a participative budget Solicit the reactions of students to these kinds of budgets and the effects they had on

motivation and performance

iv Human factors in budgeting

1 The success of a budget program depends on

three important factors:

a Top management must be enthusiastic

and committed to the budgeting

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process, otherwise nobody will take it seriously

b Top management must not use the

budget to pressure employees or

blame them when something goes

wrong This breeds hostility and mistrust rather than cooperative and coordinated efforts

c Highly achievable budget targets are

usually preferred (rather than “stretch budget” targets) when managers are rewarded based on meeting budget targets

“In Business Insights”

A manager’s compensation is often tied to the budget For example, no bonus may be paid unless 80% of the budget is attained and bonus compensation may be capped at 120% of the budget target This can lead to dysfunctional behavior on the part of managers For example:

“Biasing Forecasts” (page 384)

• A marketing manager for a beverage company intentionally grossly understated demand for the company’s products for an upcoming major holiday so that the budget target for revenues would be easy to beat

• Unfortunately, the company tied production to this biased forecast and ran out of products to sell during the height of the holiday season

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v Zero based budgeting

1 A zero-based budget requires managers to

justify all budgeted expenditures, not just

changes in the budget from the prior year

a Critics argue that zero-based budgeting

is too time consuming and costly to

justify on an annual basis

Nonetheless, occasional zero-based reviews can be very helpful

vi The budget committee

1 A budget committee is usually responsible

for overall policy relating to the budget program, for coordinating the preparation

of the budget, for resolving disputes related

to the budget, and for approving the final

budget

a This committee may consist of the president, vice presidents in charge of various functions such as sales,

production, and purchasing, and the controller

E The master budget: an overview

i The master budget consists of a number of

separate but interdependent budgets

1 The sales budget shows the expected sales

for the budget period expressed in dollars and units It is usually based on a company’s

sales forecast

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a All other parts of the master budget are dependent on the sales budget

“In Business Insights”

Giving employees ownership of the budgeting process can positively impact the results achieved Conversely, imposing unrealistic budget expectations on employees can negatively impact results For example:

“The Importance of Ownership” (page 387)

• Jack Stack, the president and CEO of Springfield Manufacturing, advises managers to accept the sales forecasts made by salespeople While the forecast should be substantiated, it should not be rejected even if the manager disagrees with it

• Stack argues that rejecting or altering the sales forecast removes ownership from the salespeople which in turn takes away their passion for doing what it takes (by legitimate means) to achieve the forecast

• Stack contends that passion is the one thing you must have to achieve a reliable forecast

“Be Realistic” (page 387)

• Gillette, a manufacturer of razors and other consumer products, got into trouble setting unrealistic quarterly sales targets

• To hit these unrealistic targets, Gillette salespersons were willing to do anything – offer cut-rate deals, rearrange product packaging – whatever it took to make the sale

• This resulted in artificially large sales at the end

of each quarter – disrupting production schedules and loading retail stores with excess

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inventory at discounted prices that would have

to be sold off before more inventory would be ordered from Gillette

2 The production budget is prepared after the

sales budget It lists the number of units that must be produced during each budget period

to meet sales needs and to provide for the desired ending inventory The production

budget in turn directly influences the direct

materials, direct labor, and manufacturing overhead budgets, which

in turn enable the preparation of the ending

finished goods inventory budget

a These budgets are then combined with data from the sales budget and the

selling and administrative expense budget to determine the cash budget

3 The cash budget is a detailed plan showing

how cash resources will be acquired and used over a specified time period

a All of the operating budgets have an impact on the cash budget

4 The last step of the process is to prepare a

budgeted income statement and a budgeted balance sheet

Helpful Hint: Budgets – particularly in large organizations – can be very complex To keep the complexity within bounds, we have simplified the budgets Even so, these simplified budgets are intricate, and the level of detail may be overwhelming to some students Emphasize that each step in the process is fairly simple, but the budgets must fit together for the

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plan to be successful Return to Exhibit 9-2 from time to time to review the master budget interrelationships

II Preparing the master budget

A The sales budget

i Assume the facts as shown for the Royal

Company

1 The sales budget multiplies the budgeted sales in units for each month by the selling price per unit

a The total sales budget for the quarter

($1,000,000) is calculated by

multiplying the budgeted sales in units

for the quarter (100,000) by the selling price per unit ($10)

ii Assume the information as shown regarding

Royal’s expected cash collections

1 The first step in calculating Royal’s cash collections is to insert the beginning

accounts receivable balance ($3,000) into

the April column of the cash collections schedule

a This balance will be collected in full in April

2 The second step is to calculate the April

credit sales that will be collected during each month of the quarter

a $140,000 ($200,000 × 70%) will be collected in April and $50,000

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May $10,000 ($200,000 × 5%) will be

uncollectible

3 The third step is to calculate the May credit

sales that will be collected during each month of the quarter

a $350,000 ($500,000 × 70%) will be collected in May and $125,000

($500,000 × 25%) will be collected in

June $25,000 ($500,000 × 5%) will be

uncollectible

Quick Check – calculating cash collections

4 The fourth step is to calculate the June

credit sales that will be collected during the month of June

a $210,000 ($300,000 × 70%) will be

collected in June

5 The fifth step is to calculate the total for

each column in the schedule

B The production budget (must be adequate to meet

budgeted sales and provide for adequate ending

inventory)

i Assume the information as shown to enable the

preparation of Royal’s production budget (If Royal was a merchandising company it would

prepare a merchandise purchases budget

instead of a production budget)

1 The first step in preparing the production

budget is to insert the budgeted sales in units from the sales budget

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2 The second step is to calculate the required production in units for April (26,000 units)

a Notice, the desired ending inventory in

units for April (10,000 units) and the

beginning inventory in units for April

(4,000 units)

Quick Check – Calculating required production

3 The third step is to calculate the required production for May (46,000 units)

a Notice, April’s desired ending

inventory (10,000 units) becomes

May’s beginning inventory

4 The fourth step is to calculate the required production for June (29,000 units)

a Notice, we are assuming a desired ending inventory of 5,000 units

(which implies that projected sales in July are 25,000 units)

5 The fifth step is to complete the “Quarter”

column

a Notice, April’s beginning inventory and June’s ending inventory are carried over to this column

Helpful Hint: Many students have a tendency to add up the inventory amounts instead of using the ending or the beginning figure Pointing this out early might reduce confusion on the part of students

C The direct materials budget

i Assume the information as shown to enable the

preparation of Royal’s direct materials

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budget which quantifies the raw materials that

must be purchased to fulfill the production budget and to provide for adequate inventories (This budget is one step in a company’s overall

material requirements planning (MRP))

1 The first step in preparing the direct

materials budget is to insert the required production in units from the production budget

2 The second step is to calculate the monthly

and quarterly production needs, which in this case are stated in terms of pounds of direct material

3 The third step is to calculate the materials

to be purchased for April (140,000 pounds)

Notice:

a The desired ending inventory of

23,000 pounds is 10% of the

following month’s production

b The beginning inventory of 13,000

pounds is the same as the March 31st

ending inventory

Quick Check – direct material purchases

4 The fourth step is to calculate the materials

to be purchased for May (221,500 pounds)

Notice:

a April’s desired ending inventory becomes May’s beginning inventory

5 The fifth step is to calculate the materials to

be purchased for June ($142,000) and to

calculate the quarterly totals Notice:

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a We are assuming a desired ending inventory for June of 11,500 pounds

b April’s beginning inventory and June’s ending inventory carry over to the

“Quarter” column

Helpful Hint: Tell the students that the inventory purchase budget or the raw materials purchase budget are really just the elements of a cost of goods sold schedule in a different order

ii Assume the information as shown regarding

Royal’s expected cash disbursements for materials

1 The first step in calculating Royal’s cash disbursements is to insert the beginning

accounts payable balance ($12,000) into

the April column of the cash disbursements schedule

a This balance will be paid in full in April

2 The second step is to calculate the April

credit purchases that will be paid during each month of the quarter

a $28,000 ($56,000 × 50%) will be collected in April and $28,000

($56,000 × 50%) will be collected in May

• The $56,000 is derived by multiplying $140,000 pounds

by the $0.40 per pound