Cornerstones of cost management 3rd edition hansen mowen chapter 8

THE ROLE OF BUDGETING IN PLANNING AND CONTROLBudgets • Quantitative plans for the future • Stated in either physical or financial terms or both Control • Process of setting standards, re

CHAPTER 8

BUDGETING FOR PLANNING

AND CONTROL

CHAPTER 8 OBJECTIVES

1 Define budgeting, and discuss its role in

planning, controlling, and decision

making

2 Prepare the operating budget, identify its

major components, and explain the

interrelationships of the various

components

3 Identify the components of the financial

budget, and prepare a cash budget

CHAPTER 8 OBJECTIVES

4 Define flexible budgeting, and discuss its

role in planning, control, and decision

making

5 Define activity-based budgeting, and

discuss its role in planning, control, and

decision making

6 Identify and discuss the key features that a

budgetary system should have to

encourage managers to engage in

goal-congruent behavior.

THE ROLE OF BUDGETING IN PLANNING AND CONTROL

Budgets

• Quantitative plans for the future

• Stated in either physical or financial terms or both

Control

• Process of setting standards, receiving feedback

on actual performance, and taking corrective

action

EXHIBIT 8.1—THE MASTER BUDGET AND

ITS INTERRELATIONSHIPS

THE ROLE OF BUDGETING IN PLANNING AND CONTROL

Purposes of Budgeting

• Forces managers to plan

• Provides resource information to improve decision

making

• Aids in the use of resources and employees that

can be used for evaluation of performance

• Improves communication and coordination

THE ROLE OF BUDGETING IN PLANNING AND CONTROL

The Budgeting Process

• Directing and Coordinating

• Budget director: works under the direction of the

budget committee; usually the controller or

someone who reports to the controller

• Budget committee: responsible for reviewing the

budget, providing policy guidelines and budgetary

goals, resolving differences, approving the final

budget, and monitoring the actual performance

THE ROLE OF BUDGETING IN PLANNING AND CONTROL

The Budgeting Process

• Types of Budgets

• Master budget: financial plan for the year

made up of various individual departmental and

activity budgets

• Operating budgets: concerned with the

income-generating activities

• Financial budgets: concerned with the inflows

and outflows of cash and with financial position

• Continuous (or rolling) budget: a moving

12-month budget

EXHIBIT 8.2—COMPONENTS OF MASTER

BUDGET

PREPARING THE OPERATING BUDGET

• Sales budget: describes expected sales

for each product in units and dollars

• Production budget: describes how many

units must be produced in order to meet

sales needs and satisfy ending inventory

requirements

Units to be produced = Unit sales + Desired units

in ending inventory – Units in

beginning inventory

PREPARING THE OPERATING BUDGET

• Direct materials purchases budget:

based on the amount of materials needed

for production and the inventories of direct materials

Purchases = Expected usage + Desired ending inventory

of direct materials – Beginning

inventory of direct

materials

PREPARING THE OPERATING BUDGET

• Direct labor budget: shows the total

direct labor hours and direct labor cost

needed for the number of units in the

production budget

• Overhead budget: shows the expected

cost of all indirect manufacturing items

PREPARING THE OPERATING BUDGET

• Ending finished goods inventory

budget: supplies information for the

balance sheet and serves as an input for

the cost of goods sold budget

• Cost of goods sold budget: used in

preparing the budgeted income statement

PREPARING THE OPERATING BUDGET

• Marketing expense budget: outlines

planned expenditures for selling and

distribution activities

• Administrative expense budget:

consists of estimated expenditures for the

overall organization and operation of the

company

PREPARING THE OPERATING BUDGET

• Research and development expense

budget: contains planned expenditures

for a separate department devoted to new

product research and development

• Budgeted income statement:

culmination of the operating budget

PREPARING THE FINANCIAL BUDGET

• Capital expenditures budget: financial

plan outlining the expected acquisition of

long-term assets

PREPARING THE FINANCIAL BUDGET

Cash Budget

• Detailed plan that shows all expected sources and

uses of cash

• Five main sections

1 Total cash available

2 Cash disbursements

3 Cash excess or deficiency

4 Financing

5 Cash balance

EXHIBIT 8.4—THE CASH BUDGET

PREPARING THE FINANCIAL BUDGET

Budgeted Balance Sheet

• Represents the culmination of the financial events

of the coming year

• Shows management where the company is

expected to be at the end of the year

EXHIBIT 8.5—BALANCE SHEET FOR ABT,

INC.

EXHIBIT 8.6—BUDGETED BALANCE SHEET

FOR ABT, INC.

PREPARING THE FINANCIAL BUDGET

Shortcomings of the Traditional Master

Budget Process

1 Department oriented and does not recognize the

interdependencies among departments

2 Static, not dynamic

• Static budget: developed for a single level of activity

• Incremental approach: current budget based on last

year’s amounts as adjusted for inflation

• Zero-base budgeting: prior year’s budgeted level is not

taken for granted

PREPARING THE FINANCIAL BUDGET

Shortcomings of the Traditional Master

Budget Process

3 Results, not process, oriented

• Managers concentrate on resources and may fail to

see the link between resources and output

FLEXIBLE BUDGETS FOR PLANNING

AND CONTROL

Static Budgets versus Flexible Budgets

• Static budgets: developed around a single level of

activity

• Flexible budgets: there are two types

• A flexible budget (1) provides expected costs for a

variety of activity levels, or (2) provides budgeted

costs for the actual level of activity

FLEXIBLE BUDGETS FOR PLANNING

AND CONTROL

Flexible Budgets

• Total budgeted production costs increase as output increases

• Sometimes referred to as a variable budget

• Flexible budget variances are generated by

comparing budgeted costs for the actual level of

activity with actual costs for the same level

FLEXIBLE BUDGETS FOR PLANNING

AND CONTROL

• Budgets can be used to examine the

efficiency and effectiveness of a company

• Efficiency is achieved when the business

process is performed in the best possible way,

with little or no waste

• Effectiveness means that a manager achieves

or exceeds the goals described by the static

budget

EXHIBIT 8.7—ABT PERFORMANCE REPORT FOR

QUARTER 1: COMPARISON OF ACTUAL WITH STATIC

(MASTER) BUDGET AMOUNTS

EXHIBIT 8.8—MANAGERIAL PERFORMANCE REPORT:

QUARTERLY PRODUCTION (IN THOUSANDS)

ACTIVITY-BASED BUDGETS

• Flexible budgeting allows creation of

budgets for varying levels of activity

• Begins with output and then determines

the resources necessary to create that

output

• Works backward from activities and their

drivers to the underlying costs

EXHIBIT 8.9—TRADITIONAL BUDGET

FOR THE SECURE-CARE DEPARTMENT

EXHIBIT 8.10—FLEXIBLE BUDGET FOR

THE SECURE-CARE DEPARTMENT

EXHIBIT 8.11—ACTIVITY-BASED BUDGET FOR THE SECURE-CARE

DEPARTMENT

ACTIVITY-BASED BUDGETS

• Feature costing: assigns costs to

activities and products or services based

on the product’s or service’s features

THE BEHAVIORAL DIMENSION OF

BUDGETING

• Budgets are often used to judge the actual

performance of managers

• The alignment of managerial and

organizational goals is often referred to as

goal congruence

• Dysfunctional behavior involves individual

behavior that is in basic conflict with the

goals of the organization

THE BEHAVIORAL DIMENSION OF

BUDGETING

Characteristics of a Good Budgetary

System

• Frequent Feedback on Performance

• Monetary and Nonmonetary Incentives

END OF CHAPTER 8