Budgetary Control

The Budgeting Process

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The Budgeting Process » Budgeting is the process of: • Identifying • Gathering • Summarizing • Communicating financial and nonfinancial information about an organization’s future activities. 24-2 Copyright  Houghton Mifflin Company. All rights reserved.

The Budgeting Process » Budgets are updated to accommodate management’s needs for performance evaluation in some settings such as JIT or TQM environments. budgeting process provides » The managers with the opportunity to carefully match the goals of the organization with the resources necessary to accomplish those goals. 24-3 Copyright  Houghton Mifflin Company. All rights reserved.

Examples of Budgets State University Knights Alumni Club Revenues an Expenditures Budget Homecoming Activities - 20x1 Budgeted Revenues Football Concession Sales Homecoming Dance Tickets (1,200 at $20) Parking Fees Total Budgeted Revenues Budgeted Expenditures Dance Music Group Hall Rental Refreshments Printing Costs Concession Purchases Clean-up Costs Miscellaneous Total Budgeted Expenditures Excess of Revenues Over Expenditures

$32,500 24,000 1,425 $57,925 $7,500 2,000 2,600 1,450 12,200 4,720 800

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31,270 $26,655

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The Management Cycle » Managers use the budgeting process throughout the management cycle to help: • Plan • Execute • Review • Report the organization’s financing, investing, and operating activities. 24-5 Copyright  Houghton Mifflin Company. All rights reserved.

Budgeting and the Management Cycle •Relate the organization’s long-term goals to its short-term activities •Distribute resources and workloads •Communicate responsibilities •Select performance measures •Set goals for bonuses and rewards

• Communicate budget information • Provide continuous feedback

• • • •

• Communicate expectations • Challenge & motivate others • Coordinate activities • Recognize problems

Calculate variances Evaluate performance Determine timeliness Create solutions for continuous improvement

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The Planning Stage » Budgeting pertains especially to the planning stage. • Budgets are tied to long-range and short-range plans to meet success factors related to quality, cost, and time.

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The Planning Stage • Budget information is used to communicate responsibilities to individuals who are accountable for a particular segment of the organization. • Performance measures are carefully selected to motivate individuals or teams to achieve targeted goals.

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The Executing Stage » During the executing stage, managers use budget information for: • Communication. • Benchmarking. • Problem recognition.

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The Reviewing Stage » In the reviewing stage, managers: • Calculate variances. • Evaluate performance. • Review timeliness. • Create solutions for continuous improvement.

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The Reporting Stage » In the reporting stage, budgets serve as a reference point for many reports, such as performance reports that support bonuses and promotions.

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Discussion Q. What are some examples of ways that budgeting can help managers during the reviewing stage of the management cycle? A.

1. Calculate variances. 2. Evaluate performance. 3. Determine timeliness. 4. Create solutions for continuous improvement. 24-12 Copyright  Houghton Mifflin Company. All rights reserved.

Principles of Effective Budgeting » The principles of effective budgeting can be grouped into five categories. 1. Long-range goals. 2. Short-range goals and strategies. 3. Human responsibilities and interaction. 4. Budget housekeeping. 5. Budget follow-up. 24-13 Copyright  Houghton Mifflin Company. All rights reserved.

Discussion Q. What are the five groups of effective budgeting principles? A. 1. 2. 3. 4. 5.

Long-range goals. Short-range goals and strategies. Human responsibilities & interaction. Budget housekeeping. Budget follow-up. 24-14 Copyright  Houghton Mifflin Company. All rights reserved.

Implementation of Budget » Two success factors for implementing a budget are: • Communications: Communication of expectations and targets to all key people in the organization. • Support: Top management must appear willing to reward people for meeting the organization’s goals that are represented in the budget. 24-15 Copyright  Houghton Mifflin Company. All rights reserved.

Discussion Q. What two factors are needed for the successful implementation of a budget? A. 1. Communication. 2. Support. 24-16 Copyright  Houghton Mifflin Company. All rights reserved.

The Quality of Budgets » To improve the quality of the budgets, managers need to know: • Why the budget is being prepared. • Who will read and use it. • How the information will be presented. • Where the information can be found. 24-17 Copyright  Houghton Mifflin Company. All rights reserved.

The Master Budget » The master budget is a set of budgets that consolidate an organization’s financial information into budgeted financial statements for a future period of time. 24-18 Copyright  Houghton Mifflin Company. All rights reserved.

The Master Budget » A master budget consists of the: • Detailed operating budgets. • Cash budget. • Budgeted income statement. • Capital expenditures budget. • Budgeted balance sheet. 24-19 Copyright  Houghton Mifflin Company. All rights reserved.

Discussion Q. What are the four major sections of the master budget? A. 1. Detailed operating budgets. 2. Budgeted income statement. 3. Capital expenditures budget. 4. Budgeted balance sheet. 24-20 Copyright  Houghton Mifflin Company. All rights reserved.

The Operating Budgets » Detailed operating budgets include the: • Sales budget (in units and dollars). • Production budget (in units). • Direct materials purchased budget (in units and dollars). • Direct labor budget (in hours and dollars). • Manufacturing overhead budget. • Cost of goods manufactured. • Selling and administrative expense budget. 24-21 Copyright  Houghton Mifflin Company. All rights reserved.

The Budgeting Process » Because of the different activities and information needs of managers in manufacturing, retail, and service organizations, the master budget process in those settings differs in the preparation of operating budgets. 24-22 Copyright  Houghton Mifflin Company. All rights reserved.

Manufacturing Organizations » The operating budgets for a manufacturing organization include budgets for: • • • • • • •

Sales. Production. Direct materials purchases. Direct labor. Manufacturing overhead. Cost of goods manufactured. Selling and administrative expenses. 24-23 Copyright  Houghton Mifflin Company. All rights reserved.

Retail Organizations » Managers of retail organizations must know: • What products to sell. • Estimated quantities to be sold. • The selling price for each.

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Retail Organizations » The operating budgets for retail organizations include the: • Sales budget. • Purchases budget. • Cost of goods sold budget. • Selling and administrative budget. 24-25 Copyright  Houghton Mifflin Company. All rights reserved.

Preparation of a Master Budget for a Retail Organization Sales Budget

Purchases Budget

Operating Budgets

Cost of Goods Sold Budget

Selling and Administrative Expense Budget

Budgeted Income Statement

Financial Budgets

Cash Budget

Budgeted Balance Sheet

Capital Expenditures Budget 24-26 Copyright  Houghton Mifflin Company. All rights reserved.

Service Organizations » Managers of service organizations must know the types and amounts of: • Services to perform. • Labor hours required. • Level of expertise of employees. • Labor rates. 24-27 Copyright  Houghton Mifflin Company. All rights reserved.

Service Organizations » The operating budgets for service organizations include: • Service revenue. • Labor. • Services overhead. • Selling and administrative budget. 24-28 Copyright  Houghton Mifflin Company. All rights reserved.

Preparation of a Master Budget for a Service Organization Service Revenue

Operating Budgets

Labor Budget

Services Overhead Budget

Selling and Administrative Expense Budget

Budgeted Income Statement

Financial Budgets

Cash Budget

Budgeted Balance Sheet

Capital Expenditures Budget 24-29 Copyright  Houghton Mifflin Company. All rights reserved.

Discussion Q. What three financial statements are included in the preparation of a master budget? A. 1. Budgeted income statement. 2. Budgeted balance sheet. 3. Cash budget. 24-30 Copyright  Houghton Mifflin Company. All rights reserved.

Sales Budget Hi-Flyer Company Sales Budget For the Year Ended December 31, 20x1 Quarter

Sales in Units

1

2

3

4

Year

10,000

30,000

10,000

40,000

90,000

x Selling Price per Unit

$

Total Sales

$ 50,000 $150,000

5

$

5

$

5

$

5

$

5

$ 50,000 $200,000 $450,000

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Production Budget Hi-Flyer Company Production Budget For the Year Ended December 31, 20x1 Quarter 1 Sales in Units

2

3

4

Year

10,000 30,000 10,000 40,000 90,000

Add Desired Units of Ending Finished Goods Inventory

3,000

1,000

4,000

1,500

1,500

Desired Total Units

13,000 31,000 14,000 41,500 91,500

Less Desired Units of Beginning Finished Goods Inventory Total Production Units

1,000 3,000 1,000 4,000 1,000 12,000 28,000 13,000 37,500 90,500 24-32

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Direct Labor Budget Hi-Flyer Company Direct Labor Budget For the Year Ended December 31, 20x1 Quarter 1

2

3

4

Year

Total Production Units

12,000

28,000

13,000

37,500

90,500

x Direct Labor Hours per Unit

.1

.1

.1

.1

.1

1,200

2,800

1,300

3,750

9,050

$

$

$

$

$

Total Direct Labor Hours x Direct Labor Cost per Hour Total Production Units

6

6

6

6

6

$ 7,200 $16,800 $ 7,800 $22,500 $54,300 24-33

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The Cash Budget » A cash budget is a projection over a period of time of: • Beginning cash. • Cash receipts. • Cash payments. • Ending cash. 24-34 Copyright  Houghton Mifflin Company. All rights reserved.

Elements of a Cash Budget Activities

Cash Receipts From

Operating Cash sales Cash collections on credit cards

Investing

Sale of investments Sale of long-term assets Interest income from investments Cash dividends from investments

Financing Loan proceeds Proceeds from sale of stock Proceeds from sale of bonds

Cash Payments For Purchases of direct materials Purchases of operating supplies Direct labor Manufacturing overhead expenses Selling expenses Administrative expenses Purchase of investments Purchase of long-term assets

Loan repayment Interest expense Cash dividends to stockholders 24-35

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Discussion Q. What are the three major activity classifications of a cash budget? A. 1. Operating activities. 2. Investing activities. 3. Financing activities. 24-36 Copyright  Houghton Mifflin Company. All rights reserved.

Budgeted Balance Sheet » Information from all other elements of a master budget is used to prepare a budgeted balance sheet. » A budgeted balance sheet projects the financial position of an organization. 24-37 Copyright  Houghton Mifflin Company. All rights reserved.

OK, LET’S REVIEW . . .

1.Define budgeting and explain its role in the management cycle. 2.Explain the basic principles of budgeting. 3.Describe the master budget process for different types of organizations, and list the guidelines for preparing 24-38 budgets. Copyright  Houghton Mifflin Company. All rights reserved.

AND ALSO . . .

5. 6.

Prepare a cash budget. Prepare a budgeted balance sheet.

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