Analysis and Interpretation of Financial Statements

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Analysis and Interpretation of Financial Statements

  1. 1. CHAPTER 23 B UDGETING FOR P LANNING AND C ONTROL
  2. 2. Budget <ul><li>Webster’s definition ... </li></ul><ul><li>Text def. (p. 827): A plan showing the company’s objectives and how management intends to acquire and use resources to attain those objectives. </li></ul><ul><li>A plan, while necessary, is insufficient by itself; control is also needed to insure that plans are accomplished. </li></ul>
  3. 3. <ul><li>Budgets enable organizations to better deal with the uncertainty of the future. </li></ul><ul><li>Without planning, organizations only react to future events rather than anticipating them. </li></ul>Why Budget?
  4. 4. Purposes of Budgets Purposes Express management’s plans for coming periods Increase motivation to achieve stated goals Formalize in writing management’s plans in quantitative terms Cause managers to think ahead, anticipate results and act to correct poor results
  5. 5. Benefits of Budgets Develops a more visionary management Facilitates review and revision of plans Fosters coordination of activities Produces more cost- conscious employees Promotes management by exception Communicates plans Benefits
  6. 6. Considerations in Preparing a Budget <ul><li>Management's assumptions re: </li></ul><ul><ul><li>State of the economy for the planning period </li></ul></ul><ul><ul><li>Adding, deleting or changing product lines </li></ul></ul><ul><ul><li>Nature and degree of competition </li></ul></ul><ul><ul><li>Effects of government regulation </li></ul></ul><ul><li>Useful accounting data from past periods can be adjusted for future expectations. </li></ul>
  7. 7. <ul><li>Coordination of financial and nonfinancial planning </li></ul><ul><li>Top management support </li></ul><ul><li>Employee participation in goal setting </li></ul><ul><li>Communicating results </li></ul><ul><li>Flexibility </li></ul><ul><li>Follow-up </li></ul>General Principles of Good Budgeting
  8. 8. <ul><li>Hazards of imposed budgets </li></ul><ul><ul><li>Employee resistance to perceived unfair or unrealistic goals </li></ul></ul><ul><ul><li>Does not facilitate free flow of management-employee communications </li></ul></ul><ul><li>Participatory budgeting </li></ul><ul><ul><li>All levels of management actively participate in the process </li></ul></ul><ul><li>Accountant’s role </li></ul><ul><ul><li>Should compile the information and coordinate the preparation of the budget </li></ul></ul>Behavioral Implications of Budgeting
  9. 9. Participatory Budget System Flow of Budget Data
  10. 10. <ul><li>Sets specific targets for </li></ul><ul><ul><li>Sales revenue </li></ul></ul><ul><ul><li>Production costs </li></ul></ul><ul><ul><li>Selling and administrative expenses </li></ul></ul><ul><ul><li>Cash receipts and disbursements </li></ul></ul><ul><li>Culminates in projected financial statements </li></ul><ul><ul><li>Projected Balance Sheet </li></ul></ul><ul><ul><ul><li>A/K/A Financial Budget </li></ul></ul></ul><ul><ul><ul><li>A/K/A Pro Forma Balance Sheet </li></ul></ul></ul><ul><ul><li>Projected Income Statement </li></ul></ul><ul><ul><ul><li>A/K/A Planned Operating Budget </li></ul></ul></ul><ul><ul><ul><li>A/K/A Pro Forma Income Statement </li></ul></ul></ul>Master Budget
  11. 11. <ul><li>Using an electronic spreadsheet to prepare is ideal because of </li></ul><ul><ul><li>Considering “what if” scenarios </li></ul></ul><ul><ul><li>Interlocking relationships between the various elements of the budget </li></ul></ul><ul><li>Which is prepared first? </li></ul><ul><ul><li>Projected Income Statement </li></ul></ul><ul><ul><li>Projected Balance Sheet </li></ul></ul>Master Budget
  12. 12. <ul><li>Using an electronic spreadsheet to prepare is ideal because of </li></ul><ul><ul><li>Considering “what if” scenarios </li></ul></ul><ul><ul><li>Interlocking relationships between the various elements of the budget </li></ul></ul><ul><li>Which is prepared first? </li></ul><ul><ul><li>Projected Income Statement </li></ul></ul><ul><ul><li>Projected Balance Sheet </li></ul></ul>Master Budget a. b. <ul><li>Trivia time! What was the first electronic spreadsheet? </li></ul>
  13. 13. Master Budget Projected Income Statement and Balance Sheet Detail Budget Cash Detail Budget Other expenses Detail Budget Selling and administrative expenses Detail Budget Production costs Detail Budget Sales (Prepared first)
  14. 14. Sales Budget <ul><li>Detailed schedule showing expected sales for the coming periods expressed in units and dollars. </li></ul>
  15. 15. <ul><li>All items in the budgeting process are dependent on a sales forecast. </li></ul>Sales Budget Informal approach Formal approach Sales Forecast Compilation of forecasts from sales staff Economic models Management intuition Statistical forecasts
  16. 16. Budgets That’s enough talking about budgets, now show me some examples!
  17. 17. <ul><li>Ellis Magnet Co. is preparing budgets for the quarter ending June 30. The sales price is $10 per magnet. Budgeted sales for the next four months are: </li></ul><ul><li>April 20,000 magnets @ $10 = $200,000 May 50,000 magnets @ $10 = $500,000 June 30,000 magnets @ $10 = $300,000 July 25,000 magnets @ $10 = $250,000 </li></ul>Sales Budget The Sales Budget July is needed for June ending inventory computations.
  18. 18. Production Budget Production Budget Sales Budget Completed
  19. 19. Production Budget Two Approaches <ul><li>Based on sales estimates and level production each period </li></ul><ul><ul><li>Ending inventory level is a residual and fluctuates </li></ul></ul><ul><ul><li>e.g., ILL. 23.2 (p. 833) </li></ul></ul><ul><ul><li>A/K/A Sales and Production Budget </li></ul></ul><ul><li>Based on sales estimates and desired ending inventory level </li></ul><ul><ul><li>Production quantity is a residual and fluctuates </li></ul></ul><ul><ul><li>e.g., Bottom p. 833 </li></ul></ul>
  20. 20. Production Budget <ul><li>Ellis wants ending inventory to be 20 percent of the next month’s budgeted sales in units. </li></ul><ul><li>4,000 units were on hand March 31. </li></ul>Let’s prepare the production budget using the second approach.
  21. 21. Production Budget <ul><li>Production must be adequate to meet budgeted sales and to provide sufficient ending inventory. </li></ul><ul><ul><li>Budgeted product sales in units </li></ul></ul><ul><ul><li>+ Desired product units in ending inventory </li></ul></ul><ul><ul><li>= Total product units needed </li></ul></ul><ul><ul><li>– Product units in beginning inventory </li></ul></ul><ul><ul><li>= Product units to produce </li></ul></ul>
  22. 22. Production Budget
  23. 23. Production Budget
  24. 24. Production Budget
  25. 25. Production Budget Production Budget Material Purchases Production Budget Units Completed
  26. 26. The material purchases budget is based on production quantity and desired material inventory levels. Production Budget Material Purchases <ul><li>Units to produce </li></ul><ul><li> × Material needed per unit </li></ul><ul><li> = Material needed for units to produce </li></ul><ul><ul><li>+ Desired units of material in ending inventory </li></ul></ul><ul><ul><li>= Total units of material needed </li></ul></ul><ul><ul><li>– Units of material in beginning inventory </li></ul></ul><ul><ul><li>= Units of material to purchase </li></ul></ul>
  27. 27. <ul><li>Five pounds of material are needed for each unit produced. </li></ul><ul><li>Ellis wants to have materials on hand at the end of each month equal to 10 percent of the following month’s production needs. </li></ul><ul><li>The materials inventory on March 31 is 13,000 pounds. July production is budgeted for 23,000 units. </li></ul>Production Budget Material Purchases
  28. 28. Production Budget Material Purchases
  29. 29. Production Budget Material Purchases
  30. 30. Production Budget Material Purchases
  31. 31. Production Budget Production Budget Material Purchases Completed (Not shown) Production Budget Labor
  32. 32. Cash Receipts Budget O.K., let’s do a cash receipts budget!
  33. 33. Cash Receipts Budget <ul><li>All sales are on account. </li></ul><ul><li>Ellis’ collection pattern is: </li></ul><ul><li>70 percent collected in month of sale </li></ul><ul><li>25 percent collected in month after sale </li></ul><ul><li>5 percent will be uncollectible </li></ul><ul><li>Accounts receivable on March 31 is $30,000, all of which is collectible. </li></ul>
  34. 34. Cash Receipts Budget
  35. 35. Cash Receipts Budget
  36. 36. Cash Receipts Budget
  37. 37. Cash Receipts Budget
  38. 38. <ul><li>We can now prepare a comprehensive cash budget which will also include cash disbursements. </li></ul>Comprehensive Cash Budget .
  39. 39. Projected Income Statement Projected Income Statement Cash Budget Completed (assumed)
  40. 40. Projected Income Statement
  41. 41. Projected Income Statement Computation of unit cost is assumed to shorten the illustration.
  42. 42. Projected Income Statement Assumed
  43. 43. Projected Balance Sheet Projected Balance Sheet Completed Projected Income Statement
  44. 44. 25% of June sales of $300,000 11,500 lbs. at $.40 per lb. 5,000 units at $4.99 each 50% of June purchases of $56,800
  45. 45. Text Illustrations Now, let’s look more closely at some of the illustrations in the chapter
  46. 46. Leed Company <ul><li>ILL. 23.3 (P. 833) - This is the basis for many subsequent illustrations. </li></ul><ul><li>ILL. 23.4 (P. 834) - You should have determined the source of each number here when you “worked your way through the chapter”. </li></ul><ul><ul><li>Questions? </li></ul></ul>
  47. 47. Flexible Budget and Budget Variances <ul><li>Flexible Budget - one that provides budgeted revenues and expenses at various levels of output (i.e., production or sales) </li></ul><ul><li>“ When management uses a flexible budget to appraise a department’s performance, it bases the evaluation on the amounts budgeted for the level of activity actually experienced . The difference between the actual costs incurred and the flexible budget amount for that same level of operations is called a budget variance .” </li></ul>p. 835
  48. 48. <ul><li>Referring to ILL. 23.6 (p. 836), the Flexible Budget for Manufacturing Overhead, what is the relevant range? </li></ul><ul><li>17,500 to 25,000 units </li></ul><ul><li>Now, if actual power cost = $9,600, what is the budget variance? </li></ul>Flexible Budget and Budget Variances $9,600 Actual - 7,000 Budgeted 2,600 UN favorable budget variance
  49. 49. Illustration 23.7 vs. Illustration 23.8 <ul><li>23.7 - Comparison of Planned Operating Budget and Actual Results </li></ul>Used for what? Assessment of overall performance vs. objectives What were objectives? Sales of $400,000 and profit of $6,000 Why were earnings better than budget when sales were worse than budget?
  50. 50. Illustration 23.7 vs. Illustration 23.8 <ul><li>23.8 - Comparison of Flexible Operating Budget and Actual Results </li></ul>Please add to title : “At the Level of Production and Sales Attained” Used for what? Expense control purposes p. 837
  51. 51. Additional Budgeting Topic <ul><li>Zero-Base Budgeting </li></ul><ul><li>Managers start each year with zero budget levels and must justify each dollar appearing in the budget instead of just taking the prior year’s budget or actual results as the starting point, as is so often done with traditional budgeting. </li></ul>
  52. 52. THE END I would be happy to assist you with your cash budget!

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