Lecture Accounting: What the numbers mean (5/e) - Chapter 14: Cost analysis for planning

After reading this chapter, you should be able to answer the following questions: What is the cost terminology that relates to the budgeting process? Why are budgets useful, and how does management philosophy influence the budget process? How are alternative budget time frames used?...

CHAPTER 14

COST ANALYSIS FOR

PLANNING

Learning Objectives

1 What is the cost terminology that

relates to the budgeting process?

2 Why are budgets useful, and how

does management philosophy

influence the budget process?

3 How are alternative budget time

frames used?

4 What is the significance of the sales

forecast (or revenue budget) to the

overall operating budget?

Learning Objectives

5 How is the purchases/production

budget developed?

6 What is the importance of cost

behavior patterns in developing the

operating expense budget?

7 Why are a budgeted income

statement and balance sheet

prepared?

Learning Objectives

9 Why and how are standards useful in

the planning and control process?

10.How is the standard cost of a product

developed?

11.How are standard costs used in the

cost accounting system?

Learning Objective 1

• What is the cost terminology that

relates to the budgeting process?

Planning and Budgeting

• Planning is the initial part of the

planning and control cycle

• A budget is a plan in financial terms

• The results of an organization’s

activities will be reported in terms of

income, cash flow, and financial

position – the financial statements

Strategic, Operational, and Financial Planning

Planning and Control Cycle

Performance

Analysis:

Plans vs

Executing Operational

Usefulness of Budgets

• The preparation of a budget forces

management to plan

• The budget provides a benchmark

against which to compare actual

performance

• The budgeting process requires

communication and coordination

among functional areas of a firm

Standard Costs

• A standard cost is a budget for each

component – materials, labor, and

Cost Classifications

• Classifying costs based on the relationship of total cost to volume of activity results in

categories of variable, fixed, and mixed costs

• Classifying costs according to a time-frame

perspective results in committed and

Learning Objective 2

• Why are budgets useful, and how

does management philosophy

influence the budget process?

The Budgeting Process in

General

• In a highly structured organization, the

budget is seen as carved in stone

• Management philosophy is reflected in

whether the budget is prepared using a

top-down, dictated, approach or a participative,

managers involved, approach

• Most budgets are based on current budgets

with revisions

– the incremental approach

Learning Objective 3

• How are alternative budget time

frames used?

The Budget Time Frame

• Budgets can be prepared for a single period or for several periods

• A single-period budget is prepared in the

months preceding the beginning of the year and

is used the entire year

• A multi-period or rolling budget involves

planning for segments of a year on a repetitive basis

• The advantage of a continuous budget is that it will be more accurate, but it takes more effort

The Budgeting Process

• First, develop and communicate assumptions

about the economy, the industry, and the

– Operating expense budget

– Income statement budget

Learning Objective 4

• What is the significance of the sales

forecast (or revenue budget) to the

overall operating budget?

• Need to consider the past experience of

managers, production capacity, pricing policy, and advertising effectiveness

Learning Objective 5

• How is the purchases/production

budget developed?

Purchases/Production Budget

• By using the cost of goods sold model with units, the quantity of merchandise to be manufactured or purchased can be determined – after the sales

budget

• The firm’s inventory policy determines the amounts

to be used in the computation

• The inventory policy should take into consideration such factors as lead time and forecast errors

Budget Calculations as a Guide

• If a production budget calls for vastly

different quantities to be manufactured each period, the production may be planned at a constant level

• If materials can be purchased in certain

quantities, the purchase quantities nearest to the calculated value will be used

• Budget calculations provide a guide to action – not absolute amounts

Cost of Goods Sold Budget

• Once the sales budget and the

purchases/production budgets have been

prepared, the cost of goods sold budget can

be prepared

• Cost of goods sold consists of:

– Raw materials budget

– Direct labor budget

Learning Objective 6

• What is the importance of cost

behavior patterns in developing

the operating expense budget?

Operating Expense Budget

• Some operating expenses are variable

expenses:

– Sales commissions

• Some operating expenses are fixed:

– Depreciation

• Therefore, operating expenses are budgeted

according to their cost behavior patterns

Learning Objective 7

• Why are a budgeted income

statement and balance sheet prepared?

Budgeted Income Statement

• Use the sales forecast, the cost of

goods sold budget, and the operating

expense budget to prepare budgeted

income statement

• An important step in determining

profitability and overall satisfactory

Budgeted Balance Sheet

• A budgeted balance sheet is prepared

after the impact of all the other budgets has been determined

• Depreciation, amortization, inventory,

cash, liabilities, and owners’ equity are

all affected by the other budgets

Learning Objective 8

• How is the cash budget

developed?

Cash Budget

• Like a budgeted cash flow statement – but with

a short time frame

• Must anticipate short-term borrowing needs

• Must know when excess cash can be invested for interest revenue

• Must make assumptions about collection of

accounts receivable and sales through a cash

receipts budget

• Must make assumptions about cash payments

Learning Objective 9

• Why and how are standards

useful in the planning and control process?

Standard Costs

• Used in:

– Planning and control process of management

– Value inventory for financial reporting

• Has two inputs:

– Quantity of input– Cost per unit of input

• Is a unit budget

Using Standard Costs

costs

• Differences are called variances

• The variances may be due to either differences

in input quantity or differences in cost per input unit

Learning Objective 10

• How is the standard cost of a

product developed?

Developing Standards

will be ideal; maximum efficiency at all times;

usually will have unfavorable variances

some operating inefficiencies; will have both

favorable and unfavorable variances

inefficiencies from past operations; does not

Learning Objective 11

• How are standard costs used in

the cost accounting system?

Costing Products with

Standard Costs

• Must aggregate the individual standard costs

for each of the inputs:

Overhead Standard Costs

• Overhead costs are classified as fixed or variable

• Variable overhead will be expressed in

terms that reflect the causes of overhead expenditures

• Fixed overhead will be expressed as a

total cost per accounting period and

allocated to individual products

Other Uses of Standards

• Can be used for planning and control of

Budgeting for Other Analytical Purposes

• Service firms can use budgeting

techniques for financial and nonfinancial resources such as time budgets

• Can also be used in manufacturing firms

in areas not related to production such as customer service