Transcript CHAPTER 6
Budgeting Fall 2011 Introduction tool for planning and controlling organizations. A budget is the quantitative expression of a proposed plan of action by management for a future time period and an aid to the coordination and implementation of the plan. Budgeting Mugan 2/? Budgeting Cycle – Planning the performance of the organization – Providing a frame of reference, a set of specific expectations against which actual results can be compared – Investigating variations from plans – Correcting action follows, if necessary – Planning again Budgeting Mugan 3/? Budget Quantitative plans Static –Master Budget For a certain level Flexible Adjusted for different levels and actual level Short term or long term Capital budgets Operational budgets Financial and nonfinancial data Budgeting Mugan 4/? Uses of Budgets Goal congruence Enhance communication and coordination Among different units of the business Among managers, and subunits Performance evaluation Determining possible bottlenecks Budgeting Mugan 5/? Budgets and Feedback Feedback through variance analysis Variance= deviations from the budget; both negative and positive; the amount of deviation is important Variances provide managers with Early warning of problems A basis for performance evaluation-who’s responsible A basis for strategy evaluation Budgeting Mugan 6/? Budgeting and Human Behavior Top-down and bottom-up approach Participative budgeting Superiors may dominate the budget process or hold subordinates accountable for events they have no control over Subordinates may build “budgetary slack” into their budgets By underestimating budgeted revenues, or overestimating budgeted expenses, in an effort to make the resulting budgeted goals (profits) more easily attainable Budgeting Mugan 7/? Comparison Top-down budgets: Top management makes the aggregate forecasts then disaggregates down to lower levels Decision control more important than decision management Bottom-up budgets (participative budgeting): Lower levels know better what they are doing They make initial forecasts therefore can be held responsible Decision management more important than decision control Top executive officers of firms have final decision rights over the entire budget process and resolve disputes After adoption, the budget acts as a set of contracts among the various units of the firm Budgeting Mugan 8/? Responsibility Centers a part, segment, or subunit of an organization whose manager is accountable for a specified set of activities Responsibility Accounting – a system that measures the plans, budgets, actions, and actual results of each Responsibility Center Budgeting Mugan 9/? Types of Responsibility Centers 1. Cost – accountable for costs onlyevaluated based on actual and budgeted costs 2. Revenue – accountable for revenues onlyevaluated based on actual and budgeted revenues 3. Profit – accountable for revenues and costs-evaluated on the profit 4. Investment – accountable for investments, revenues, and costs – return on investment; residual income; EVA Budgeting Mugan 10/? Controllability What items are under the control of the manager? Allocated? Avoidable? Unavoidable? Budgeting Mugan 11/? Budget Process Based on historical data and changing conditions develop estimates Goals and budgets are made known to key personnel Deviations from budgets are investigated and corrective action taken – managers and accountants Budgeting Mugan 12/? Budgeting Mugan 13/? Components of Master Budgets Operating Budget – leads to budgeted income statement Sales budget Production budget Direct Materials budget Direct Labor budget Manufacturing overhead budget Financial Budget – leads to balance sheet and cash flow statement Cash collections Cash payments Purchase of assets Payment of dividends Borrowing and lending Budgeting Mugan 14/? Time Coverage of Budgets Strategic planning requires long-term budgets (2, 5, or 10 years) Many firms require managers to prepare both short-term and long-term budgets as part of the periodic budget review Operating budgets-usually prepared on monthly, quarterly, annually basis Usually the master budget or the static budget is prepared on yearly basis Flexible budgets – rolling budgets Budgeting Mugan 15/? Master Budget Budgeting Mugan 16/? Basic Operating Budget Steps 1. Prepare the Sales Budget 2. Prepare the Production Budget (in Units) 3. Prepare the Direct Materials Usage Budget and Direct Materials Purchases Budget 4. Prepare the Direct Labor Budget Budgeting Mugan 17/? Basic Operating Budget Steps 5. Prepare the Manufacturing Overhead Budget 6. Prepare the Cost of Goods Sold Budget 7. Prepare the Selling and Administrative Expense Budget 8. Prepare the Budgeted Income Statement Budgeting Mugan 18/? Basic Financial Budget Steps Based on the Operating Budgets: 1. Prepare the Cash Budget 2. Prepare the Budgeted Balance Sheet 3. Prepare the Budgeted Statement of Cash Flows Budgeting Mugan 19/? Cash Budget A cash budget shows expected cash receipts and disbursements; it indicates the months having cash shortages and excesses. Budgeting Mugan 20/? Sales Budget First budget prepared since most budgets cannot be prepared without an estimate of sales A variety of methods are used to estimate sales: Budgeting Economic models Sales trends Trade journals Sales force estimates Mugan 21/? Production Budget Quantity to be produced based on following formula: Budgeting Mugan 22/? Example Exercise #1 VitaPup produces a vitamin-enhanced dog food that is sold in Kansas. The company expects sales to be 12,600 bags in January, 14,500 bags in February, and 19,000 bags in March. There are 1,260 bags on hand at the start of January. VitaPup desires to maintain monthly ending inventory equal to 10% of next month’s expected sales. Prepare the production budget for VitaPup for the months of January and February. Budgeting Mugan 23/? Example Exercise #1 Solution Production Budget for January Expected Sales +Desired Ending Inventory - Beginning Inventory Total Production 12,600 1,450 (1,260) 12,790 Production Budget for February Expected Sales + Desired Ending Inventory - Beginning Inventory Total Production Budgeting Mugan 14,500 1,900 (1,450) 14,950 24/? Direct Material Purchase Budget Depends upon the amount needed for production and the amount needed for ending inventory The following formula can be used: Budgeting Mugan 25/? Direct Labor Budget Direct labor can be calculated using the following formula: Number of units produced x Labor hours per unit x Rate per hour Once calculated, can be used to determine the approximate number of employees needed Budgeting Mugan 26/? Manufacturing Overhead Budget Variable Costs Multiply variable cost per unit by quantity produced Fixed Costs Remain relatively constant Depreciation could fluctuate based on planned acquisitions Budgeting Mugan 27/? Selling and Administrative Expense Budget Includes the following: Salaries Advertising Office Expenses Other General Expenses Budgeting Mugan 28/? Budgeted Income Statement Compilation of information provided by previously prepared budgets Budgeting Sales Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Selling and Administrative Expense Budget Mugan 29/? Capital Acquisitions Budget Acquisitions include: Property Plant Equipment Must be carefully planned due to the large amounts of cash that could be used Budgeting Mugan 30/? Cash Receipts and Disbursements Budget Managers must plan for two items: Amount of Cash Flows Timing of Cash Flows Importance Differences between cash flows and income Anticipate cash shortages or surpluses Budgeting Mugan 31/? Example Exercise #2 The Warrenburg Antique Mall budgeted credit sales in the first quarter of 2009 to be as follows: January $150,000 February $160,000 March $172,000 Credit sales in December of 2008 are expected to be $200,000. The company expects to collect 75% of a month’s sales in the month of sale and 25% in the following month. Estimate the cash receipts for January and February. Budgeting Mugan 32/? Example Exercise #2 Solution January Estimated Cash Receipts December (200,000 x 25%) January (150,000 x 75%) Total $50,000 $112,500 $162,500 February Estimated Cash Receipts January (150,000 x 25%) February (160,000 x 75%) Total Budgeting Mugan $37,500 $120,000 $157,500 33/? Budgeted Balance Sheet Last budget prepared Sometimes referred to as the pro forma balance sheet Used to assess the effect of planned decisions on the future financial position of the firm Budgeting Mugan 34/? Budgeting Overview Flowchart Operating Budget Financial Budget Revenues Budget Ending Inventory Budget Production Budget Direct Materials Costs Budget Direct Manufacturing Labor Costs Budget Capital Expenditures Budget Manufacturing Overhead Costs Budget Cost of Goods Sold Budget Cash Budget Budgeted Balance Sheet Operating Expense Budget Budgeted Statement of Cash Flows Budgeted Income Statement Budgeting Mugan 35/? MASTER BUDGET EXAMPLE Newport Stationery Store Balance Sheet as of September 30, 2007 Current Assets Cash $12.000 Accounts Receivable 10.000 Inventory 63.600 Equipment -- net 100.000 Liabilities as of September 30 None Credit sales: Gross margin percentage Salaries and wages (as % of revenues) Rent (as % of revenues) Other operating costs (as % of revenues) Monthly depreciation Minimum inventory level October purchases (light fixtures) November purchases (light fixtures) December purchases Minimum cash balance Annual interest rate on borrowings Budgeting Recent and anticipated sales: September October November December January $40.000 $48.000 $60.000 $80.000 $36.000 75% cash 30% 15% 5% 4% $1.000 $30.000 $600 $400 $0 $8.000 18% Mugan 25% credit 36/? Fill in the schedules Item Total sales Credit sales Cash sales (total sales - credit sales) Schedule A Budgeted Monthly Cash Receipts September October November $ 40.000 $ 48.000 $ 60.000 10.000 12.000 15.000 $ 30.000 $ 36.000 $ 45.000 Receipts: Cash sales Collections on accounts receivable (past month's credit sales) Total Budgeting $ 36.000 $ 10.000 46.000 Mugan $ 45.000 $ 12.000 57.000 December total Q3 $ 80.000 $ 188.000 20.000 $ 47.000 $ 60.000 $ 141.000 $ 60.000 $ 141.000 $ 15.000 75.000 $ 37.000 $ 178.000 37/? Fill in the schedules Schedule B Budgeted Monthly Cash Disbursements for Purchases Item October November December Purchases $ 42.000 $ 56.000 $ 25.200 Deduct 2% cash discount 840 1.120 504 Disbursements $ 41.160 $ 54.880 $ 24.696 Budgeting Mugan 4th Quarter $ 123.200 2.464 $ 120.736 38/? Fill in the schedules Schedule C Budgeted Monthly Cash Disbursements for Operations Item October November December Salaries and wages $ 7.200 $ 9.000 $ 12.000 Rent 2.400 3.000 4.000 Other cash operating costs 1.920 2.400 3.200 Total disbursements for operations $ 11.520 $ 14.400 $ 19.200 Budgeting Mugan 4th Quarter $ 28.200 9.400 7.520 $ 45.120 39/? Fill in the schedules Item S chedule D Budgeted Total Monthly Cash Disbursements October November December Purchases (from Schedule B) $ Cash operating costs (from Schedule C) Light fixtures Total disbursements $ Budgeting 41.160 11.520 600 53.280 Mugan $ $ 54.880 14.400 400 69.680 $ $ 24.696 19.200 0 43.896 4th Quarter $ $ 120.736 45.120 1.000 166.856 40/? Fill in the schedules Schedule E Budgeted Cash Receipts and Disbursements Item October November December Total reciepts (from Schedule A) $ 46.000 $ 57.000 $ 75.000 Total disbursements (from Schedule D) 53.280 69.680 43.896 Net cash increase (decrease) $ (7.280) $ (12.680) $ 31.104 Budgeting Mugan 4th Quarter $ 178.000 166.856 $ 11.144 41/? Fill in the schedules Schedule F Financing Required Item September October November December 4th Quarter Beginning cash balance (prior month's ending cash balance) $ 12.000 $ 8.720 $ 8.040 $ 12.000 Net cash increase (decrease) (from Schedule E) (7.280) (12.680) 31.104 11.144 Cash position before borrowing 4.720 (3.960) 39.144 23.144 Minimum cash balance required 8.000 8.000 8.000 8.000 Cash excess (deficiency) (3.280) (11.960) 31.144 15.144 Borrowing required (multiples of $1,000) 4.000 12.000 0 16.000 Interest payments 540 540 Borrowing repaid 16.000 16.000 Ending cash balance $ 12.000 $ 8.720 $ 8.040 $ 22.604 $ 22.604 Budgeting Mugan 42/? Fill in the schedules Newport Stationery Store Budgeted income Statement for quarter ending December 31, 2007 Revenues (schedule A) Cost of goods sold Gross margin Operating costs Salaries and wages (Schedule C) Rent (Schedule C) Other cash operating costs (Schedule C) Depreciation Operating income Deduct interest expense (Schedule F) Add purchase discounts (Schedule B) Net income before taxes Budgeting $ $ 28.200 9.400 7.520 3.000 $ Mugan 188.000 131.600 56.400 48.120 8.280 (540) 2.464 10.204 43/? Fill in the schedules Newport Stationery Store Balance Sheet as of December 31, 2007 Assets Current assets Cash (Schedule F) Acounts receivable (December credit sales from Schedule A) Inventory (buffer inventory + Dec. inventory purchases from Sch. B) Total current assets Equipment and fixtures Equipment -- net (Sept 30 balance - depreciation for quarter) Fixtures (Schedule D) Total Liabilities and Owner's Equity Liabilities Owners' Equity (Sept. 30 owners' equity + net income for quarter) Budgeting Mugan $ $ 22.604 20.000 $ 55.200 97.804 $ 98.000 195.804 97.000 1.000 None $ $ 195.804 195.804 44/? Use of Computers in the Budget Planning Process Extremely useful in budgeting process Excel Spreadsheet Other specialized program Allows for company to determine effects of a decision on entire budget “What if” Analysis Budgeting Mugan 45/? Budgetary Control Budgets as a Standard for Evaluation Actual amounts are compared with budgeted amounts Differences between actual and budgeted amounts are referred to as budget variances Budget variances should be investigated when they are material Budgeting Mugan 46/? Budgetary Control Management must make sure the level of activity in the budget is equal to the actual level of activity Static Budget Not adjusted for the actual level of production Flexible Budget A set of budget relationships that can be adjusted for various production activity levels Budgeting Mugan 47/? Investigating Budget Variances Causes of Budget Variances Budget may not have been well conceived Conditions may have changed Managers may have performed particularly well or poorly Budgeting Mugan 48/? Investigating Budget Variances Management by Exception Economical approach Only exceptional variances are investigated Must investigate both unfavorable and favorable exceptional variances Budgeting Mugan 49/? Variances If managers learn that specific actions they took helped lower the actual costs, then they can obtain further cost savings by repeating those actions on similar jobs in the future If the factors causing actual costs to be higher than expected can be identified, then actions may be taken to prevent those factors from recurring in the future If cost changes are likely to be permanent, cost information can be updated for future jobs Budgeting Mugan 50/? First-Level Variances The first-level variance for a cost item is the difference between the actual costs and the master budget costs for that cost item Variances are favorable (F) if the actual costs are less than estimated master budget costs Unfavorable (U) variances arise when actual costs exceed estimated master budget costs Budgeting Mugan 51/? Planning Variances A flexible budget adjusts the master budget to reflect the actual volume by using standard costs Standard costs are budgeted unit costs Standards are established per unit of product as well as per unit of input Cost differences between the master and the flexible budget are called planning variances Reflect the difference between planned output and actual output Arise entirely because the planned volume of activity was not realized Budgeting Mugan 52/? Flexible Budget Variances Flexible budget variances are the differences between the flexible budget and the actual results Flexible budget variances reflect: Quantity variances -- the difference between the planned and the actual usage of inputs per unit of output Cost variances -- the difference between the planned and the actual price or cost per unit of the various cost items Budgeting Mugan 53/? Second & Third-Level Variances The second-level variances are the planning variance and the flexible budget variance The direct material flexible budget variances and direct labor flexible budget variances can be decomposed further into third-level variances: Efficiency variances Price variances Budgeting Mugan 54/? Direct Material Variances The material quantity variance is calculated as: Quantity variance = (AQ-SQ) x SP Where: AQ = actual quantity of materials used SQ = standard (estimated) quantity of materials required SP = standard (estimated) price of materials Budgeting Mugan 55/? Direct Material Variances The material price variance is calculated as: Price variance = (AP-SP) x AQ Where: AP = actual price of materials SP = standard (estimated) price of materials AQ = actual quantity of materials used The price variance may, however, be calculated using the quantity purchased rather than the quantity used Budgeting Mugan 56/? Direct Labor Variances Efficiency variance = (AH-SH) x SR Rate variance = (AR-SR) x AH Where: AH = actual number of direct labor hours AR = actual wage rate & SR = standard rate SH = standard (estimated) number of direct labor hours The sum of the rate variance and the efficiency variance equals the total flexible budget direct labor variance Standard hours of DL reflects the total hours allowed for the actual output level given standard direct labor hours per output unit Budgeting Mugan 57/? Overhead Variances Variable Fixed The quantity of capacity-related costs may not change from period to period, but the spending on them may fluctuate Monitoring spending variances on capacity-related resources is possible and desirable Budgeting Mugan 58/? Variable Overhead Cost Variances consist of a quantity component called the efficiency variance and a price component called spending variance Variable overhead cost variances may be analyzed in a manner similar to direct material or direct labor variances when they are assigned to products in the traditional way – by the direct labors Budgeting Mugan 59/? Fixed Overhead variances Since fixed costs are flexed to reflect the actual capacity level; but fixed within a range there is no price variance but a budget variance Actual fixed costs – budgeted fixed costs And Volume variance to reflect the change in capacity Fixed overhead rate per driver unit=(actual driver units – driver units allowed for the actual output level) Budgeting Mugan 60/? Variances Short summary Static Budgets A static budget ( master budget) is prepared for only one level of a given type of activity. All actual results are compared with the original budgeted amounts, even if sales volume is more or less than originally planned. Budgeting Mugan 62/? Master Budget Variance: Sales The variances of actual results from the master budget are called master (static) budget variances. Budgeting Mugan 63/? Master Budget Variance: Expenses Actual expenses that exceed budgeted expenses result in unfavorable expense variances. Actual expenses that are less than budgeted expenses result in favorable expense variances. Budgeting Mugan 64/? Flexible Budget A flexible budget (variable budget) is a budget that adjusts for changes in sales volume and other cost-driver activities. Budgeting Mugan 65/? Flexible Budget Formulas To develop a flexible budget, managers determine revenue and cost behavior (within the relevant range) with respect to cost drivers. Budgeting Mugan 66/? Evaluation of Financial Performance Flexible budget for actual sales activity Units 7,000 Sales $217,000 Variable costs 152,600 Contribution margin $ 64,400 Fixed costs 70,000 Operating income $ (5,600) Budgeting Mugan Master budget Salesactivity variances 9,000 $279,000 196,200 $ 82,800 70,000 $ 12,800 2,000 U $62,000 U 43,600 F $18,400 U – $18,400 U 67/? Isolating the Causes of Variances Effectiveness is the degree to which a goal, objective, or target is met. Efficiency is the degree to which inputs are used in relation to a given level of outputs. Performance may be effective, efficient, both, or neither. Budgeting Mugan 68/? Flexible-Budget Variances Total flexible-budget variance = Total actual results – Total flexible-budget planned results Actual results $(11,570) Flexible budget $(5,600) $5,970 Unfavorable Flexible-budget variances Budgeting Mugan 69/? Sales-Activity Variances Total sales-activity variance = Actual sales unit – Master budgeted sales units × Budgeted contribution margin per unit Budgeting Mugan 70/? Sales price and Sales Volume Variances Sales prices fluctuations cause variance: The sales-price variances arises because a company increased or decreased its sales price when compared with the budgeted sales price. SPV = (Act. Sale Price – Exp. Sale Price) X Act. Sales Volume Volume fluctuations cause variance: The sales-volume variance, which arises from an increase or decrease in units sold. SVV = (Act. Sales Vol. – Bud. Sale Vol.) X Unit Contribution Margin Budgeting Mugan 71/? Variances from Material and Labor Standards Standard Direct-Materials Cost Allowed: Units of good output achieved × Input allowed per unit of output × Standard unit price of input = Flexible budget or total standard cost allowed Budgeting Mugan 72/? Price and Usage Variances (Actual price – Standard Price) × Actual quantity (Actual quantity – Standard quantity) × Standard price Budgeting Mugan 73/? Variable-Overhead Efficiency Variance When actual cost-driver activity differs from the standard amount allowed for the actual output achieved, a variable-overhead efficiency variance will occur. Budgeting Mugan 74/? Variable-Overhead Spending Variance This is the difference between the actual variable overhead and the amount of variable overhead budgeted for the actual level of cost-driver activity. Budgeting Mugan 75/? Variable Overhead Variances Actual Variable Overhead Incurred Flexible Budget for Variable Overhead at Actual Hours Flexible Budget for Variable Overhead at Standard Hours AH × AR AH × SVR SH × SVR Spending Variance Efficiency Variance Spending variance = AH(AR - SVR) Efficiency variance = SVR(AH - SH) Budgeting Mugan 76/? Fixed Overhead Variances Actual Fixed Overhead Incurred Fixed Overhead Budget Fixed Overhead Applied cost driver × predet.overhead rate Budget Variance Volume Variance Predetermined FOVH= Budgeted Fixed OVH/ normal activity level of cost driver Cost driver = units produced, direct labor Budgeting hours, machine hoursMugan etc. 77/? Variance example 1 Requirement 1 Performance Report, April 2004 Actual Budget Units (pounds) 450.000 400.000 Revenues $3.555.000 $3.200.000 Direct materials 865.000 580.000 Direct manufacturing labor 348.000 336.000 Selling price per pound of cookie $7,90 $8,00 Selling-price variance Budgeting Mugan Variance 50.000 F 355.000 F 285.000 U 12.000 U $0,10 U $ 45.000,00 U 78/? Variance example 1 Requirements 2, 3 and 4 Price Actual Costs Incurred Variance (1) (2) = (1) - (3) Direct Materials Cookie mix Milk chocolate Almonds Direct manufacturing labor Mixing Baking Budgeting $93.000 532.000 240.000 $865.000 $0 133.000 0 133.000 $108.000 240.000 $348.000 $0 0 $0 Actual Input Quantity × Efficiency Budgeted Price Variance (3) (4) = (3) - (5) U U $ Mugan $93.000 399.000 240.000 $732.000 $3.000 61.500 15.000 $79.500 $108.000 240.000 $348.000 $0 30.000 $30.000 Flexible Budget (5) U U U U $90.000 337.500 225.000 $652.500 F F $108.000 270.000 $378.000 79/? Variance example 2 Requirement 1 Production and sales in units Machine hours Fixed manuf. Overhead (FMOH) Variable manuf. Overhead (VMOH) VMOH per machine hour FMOH allocated per machine hour Budgeting Actual Flexible Budget Static Budget 110.000 110.000 120.000 30.000 33.000 36.000 $440.000 $450.000 $450.000 $960.000 $990.000 $1.080.000 $32,00 $30,00 $30,00 $12,50 Mugan 80/? Variance example 2 Variable Manufacturing Overhead Actual Costs $960.000 Budgeting Actual Input Qty. × Budgeted Rate Flexible Budget $900.000 $990.000 $60.000 U $90.000 F Spending variance Efficiency variance Mugan 81/? Variance Example 2 Requirement 2 Fixed Manufacturing Overhead Static/Flexible Budget Lump Sum $450.000 Actual Costs $440.000 $10.000 F Spending variance Budgeting Mugan Allocated $375.000 $75.000 U Production volume variance 82/? Variance Example 2 Requirement 3 Production and Sales in Units Machine hours Fixed manuf. Overhead (FMOH) Variable manuf. Overhead (VMOH) VMOH per machine hour FMOH allocated per machine hour Budgeting Actual 110.000 30.000 $440.000 $960.000 $32,00 Mugan Flexible Budget 110.000 33.000 $450.000 $990.000 $30,00 Static Budget 150.000 45.000 $450.000 $1.350.000 $30,00 $10,00 83/? Variance Example 2 Variable Manufacturing Overhead Actual Input Qty. × Budgeted Rate Actual Costs $960.000 $900.000 $60.000 U $990.000 $90.000 Spending variance Budgeting Flexible Budget Mugan F Efficiency variance 84/? Variance Example 2 Fixed Manufacturing Overhead Static/Flexible Budget Lump Sum $450.000 Actual Costs $440.000 $10.000 F Spending variance Budgeting Mugan Allocated $300.000 $150.000 U Production volume variance 85/? THE END Budgeting Mugan 86/?