Accounting Principles Chapter 22_Budgeting.pdf

Warren
Reeve
Duchac
Accounting
26e
Budgeting
22
C H A P T E R
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• Budgets play an important role for organizations of
all sizes and forms.
o For example, budgets are used in managing the operations
of government agencies, churches, hospitals, and other
nonprofit organizations.
• This chapter describes and illustrates budgeting for a
manufacturing company.
Nature and Objectives of Budgeting
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• Budgeting affects the following managerial functions:
o Planning
§ Planning involves setting goals to guide decisions and help motivate
employees.
o Directing
§ Directing involves decisions and actions to achieve budgeted goals.
– A budgetary unit of a company is called a responsibility center.
§ Each responsibility center is led by a manager who has the authority and
responsibility for achieving the center’s budgeted goals.
o Controlling
§ Controlling involves comparing actual performance against the budgeted
goals.
Objectives of Budgeting

Human Behavior and Budgeting
• Human behavior problems can arise in the budgeting
process in the following situations:
o Budgeted goals are set too tight, which are very hard or
impossible to achieve.
§ It is important for employees and managers to be involved in the
budgeting process.
o Budgeted goals are set too loose, which are very easy to
achieve.
§ Such budget “padding” is called budgetary slack.
o Budgeted goals conflict with the objectives of the company
and employees.
§ Goal conflict occurs when the employees’ or managers’ self-interest
differs from the company’s objectives or goals.

Human Behavior and Budgeting

• The budgetary period for operating activities
normally includes the fiscal year of a company.
• For control purposes, annual budgets are usually
subdivided into shorter time periods, such as quarters
of the year, months, or weeks.
• A variation of fiscal-year budgeting, called
continuous budgeting, maintains a 12-month
projection into the future.
• The 12-month budget is continually revised by
replacing the data for the month just ended with the
budget data for the same month in the next year.
Budgeting Systems
(slide 1 of 3)

• Developing an annual budget usually begins several
months prior to the end of the current year.
• The responsibility of developing an annual budget is
normally assigned to a budget committee.
• The budget process is monitored and summarized by
the Accounting Department, which reports to the
committee.
Budgeting Systems
(slide 2 of 3)

• There are several methods of developing budget
estimates.
o One method, called zero-based budgeting, requires
managers to estimate sales, production, and other
operating data as though operations are being started for
the first time.
o A more common approach is to start with last year’s budget
and revise it for actual results and expected changes for
the coming year.
§ Two major budgets using this approach are the static budget and
the flexible budget.
Budgeting Systems
(slide 3 of 3)

• A static budget shows the expected results of a
responsibility center for only one activity level. Once
the budget has been determined, it is not changed,
even if the activity changes.
• Static budgeting is used by many service companies,
government entities, and for some functions of
manufacturing companies, such as purchasing,
engineering, and accounting.
• A disadvantage of static budgets is that they do not
adjust for changes in activity levels.
Static Budget

• Flexible budgets show the expected results of a
responsibility center for several activity levels.
• A flexible budget is constructed as follows:
o Step 1: Identify the relevant activity levels.
§ The relevant levels of activity could be expressed in units, machine
hours, direct labor hours, or some other activity base.
o Step 2: Identify the fixed and variable cost components of
the costs being budgeted.
o Step 3: Prepare the budget for each activity level by
multiplying the variable cost per unit by the activity level
and then adding the monthly fixed cost.
Flexible Budget

• The master budget is an integrated set of operating
and financing budgets for a period of time.
o The operating budgets can be used to prepare a budgeted
income statement.
o The financial budgets provide information for a budgeted
balance sheet.
• Most companies prepare a master budget on a
yearly basis.
Master Budget

Master Budget for a Manufacturing Company

Preparation Steps for Master Budget

• The sales budget begins by estimating the quantity of
sales.
o The prior year’s sales are often used as a starting point.
• These sales quantities are then revised for such factors
as:
o Planned advertising and promotions
o Projected pricing changes
o Expected industry and general economic condition.
• Once sales quantities are estimated, the budgeted
sales revenue can be determined as follows:
Sales Budget

• The production budget estimates the number of units
to be manufactured to meet budgeted sales and
desired inventory levels.
• The budgeted units to be produced are determined
as follows:
Production Budget

• The direct materials purchases budget estimates the
quantities of direct materials to be purchased to
support budgeted production and desired inventory
levels.
Direct Materials Purchases Budget
(slide 1 of 2)

Direct Materials Purchases Budget
(slide 2 of 2)
• The direct materials purchases budget can be developed in three steps:
o Step 1. Determine the budgeted direct material required for production, which
is computed as follows:
o Step 2. The budgeted material required for production is adjusted for
beginning and ending inventories to determine the direct materials to be
purchased for each material, as follows:
o Step 3. The budgeted direct materials to be purchased is computed as follows:

Direct Labor Cost Budget
• The direct labor cost budget estimates the direct
labor hours and related cost needed to support
budgeted production.
• The direct labor cost budget for each department is
determined in two steps, as follows:
o Step 1. Determine the budgeted direct labor hours required
for production, which is computed as follows:
o Step 2. Determine the total direct labor cost as follows

• The factory overhead cost budget estimates the cost
for each item of factory overhead needed to support
budgeted production.
• The factory overhead cost budget may be supported
by departmental schedules.
o Such schedules normally separate factory overhead costs
into fixed and variable costs to better enable department
managers to monitor and evaluate costs during the year.
Factory Overhead Cost Budget

• The cost of goods sold budget is prepared by
integrating the following budgets:
o Direct materials purchases budget
o Direct labor cost budget
o Factory overhead cost budget
• The estimated and desired inventories for direct
materials, work in process, and finished goods must be
integrated into the cost of goods sold budget.
Cost of Goods Sold Budget

• The sales budget is often used as the starting point for
the selling and administrative expenses budget.
• The selling and administrative expenses budget is
normally supported by departmental schedules.
Selling and Administrative Expenses Budget

• The budgeted income statement is prepared by
integrating the following budgets:
o Sales budget
o Cost of goods sold budget
o Selling and administrative expenses budget
• In addition, estimates of other income, other expense,
and income tax are also integrated into the budgeted
income statement.
• This budget summarizes the budgeted operating
activities of the company.
Budgeted Income Statement

Budgeted Income Statement

• The cash budget estimates the expected receipts
(inflows) and payments (outflows) of cash for a period
of time.
o The primary source of estimated cash receipts is from cash
sales and collections on account.
o In addition, cash receipts may be obtained from plans to
issue equity or debt financing as well as other sources such
as interest revenue.
o To estimate cash receipts from cash sales and collections on
account, a schedule of collections from sales is prepared.
Cash Budget
(Slide 1 of 2)

o Estimated cash payments must be budgeted for operating
costs and expenses such as manufacturing costs, selling
expenses, and administrative expenses.
o In addition, estimated cash payments may be planned for
capital expenditures, dividends, interest payments, or long-
term debt payments.
o To estimate cash payments for manufacturing costs, a
schedule of payments for manufacturing costs is prepared.
Cash Budget
(Slide 2 of 2)

• The cash budget is structured for a budget period as
follows:
Completing the Cash Budget

• The capital expenditures budget summarizes plans
for acquiring fixed assets.
o Such expenditures are necessary as machinery and other
fixed assets wear out or become obsolete.
o In addition, purchasing additional fixed assets may be
necessary to meet increasing demand for the company’s
product.
• Capital expenditures budgets are often prepared for
five to ten years into the future.
o This is necessary because fixed assets often must be
ordered years in advance.
Capital Expenditures Budget

• The budgeted balance sheet is prepared based on
the operating and financial budgets of the master
budget.
• The budgeted balance sheet is dated as of the end of
the budget period and is similar to a normal balance
sheet except that estimated amounts are used.
Budgeted Balance Sheet

Accounting Principles Chapter 22_Budgeting.pdf

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