Transcript CHAPTER 6

Budgeting
EMBA 5412
Fall 2010
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.
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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
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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
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Uses of Budgets
 Goal congruence
 Enhance communication and
coordination
 Among different units of the business
 Among managers, and subunits
 Performance evaluation
 Determining possible bottlenecks
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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
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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
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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
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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
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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
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Controllability
 What items are under the control of
the manager?
 Allocated?
 Avoidable?
 Unavoidable?
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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
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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
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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
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Master Budget
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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
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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
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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
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Cash Budget
 A cash budget shows expected cash
receipts and disbursements; it
indicates the months having cash
shortages and excesses.
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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:




Economic models
Sales trends
Trade journals
Sales force estimates
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Production Budget
Quantity to be produced based on
following formula:
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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.
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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
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14,500
1,900
(1,450)
14,950
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Direct Material Purchase Budget
 Depends upon the amount needed for
production and the amount needed
for ending inventory
 The following formula can be used:
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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
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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
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Selling and Administrative Expense
Budget
Includes the following:
 Salaries
 Advertising
 Office Expenses
 Other General Expenses
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Budgeted Income Statement
Compilation of information provided
by previously prepared budgets

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
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
Sales Budget
Direct Materials Budget
Direct Labor Budget
Manufacturing Overhead Budget
Selling and Administrative Expense
Budget
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Capital Acquisitions Budget
 Acquisitions include:
 Property
 Plant
 Equipment
 Must be carefully planned due to the
large amounts of cash that could be
used
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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
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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.
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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
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$37,500
$120,000
$157,500
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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
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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
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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
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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%
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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
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$
36.000
$
10.000
46.000
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$
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
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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
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4th Quarter
$ 123.200
2.464
$ 120.736
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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
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4th Quarter
$
28.200
9.400
7.520
$
45.120
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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
$
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41.160
11.520
600
53.280
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$
$
54.880
14.400
400
69.680
$
$
24.696
19.200
0
43.896
4th Quarter
$
$
120.736
45.120
1.000
166.856
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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
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4th Quarter
$ 178.000
166.856
$
11.144
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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
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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
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$
$
28.200
9.400
7.520
3.000
$
Mugan
188.000
131.600
56.400
48.120
8.280
(540)
2.464
10.204
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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)
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$
$
22.604
20.000
$
55.200
97.804
$
98.000
195.804
97.000
1.000
None
$
$
195.804
195.804
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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
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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
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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
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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
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Investigating Budget Variances
Management by Exception
 Economical approach
 Only exceptional variances are
investigated
 Must investigate both unfavorable and
favorable exceptional variances
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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)
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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.
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Master Budget Variance: Sales
The variances of actual results
from the master budget are called
master (static) budget variances.
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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.
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Flexible Budget
A flexible budget (variable budget) is a
budget that adjusts for changes in sales
volume and other cost-driver activities.
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Flexible Budget Formulas
To develop a flexible budget, managers
determine revenue and cost behavior
(within the relevant range) with
respect to cost drivers.
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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)
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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
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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.
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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
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Sales-Activity Variances
Total sales-activity variance
=
Actual sales unit – Master budgeted sales units
×
Budgeted contribution margin per unit
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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
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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
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Price and Usage Variances
(Actual price – Standard Price)
× Actual quantity
(Actual quantity – Standard quantity)
× Standard price
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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.
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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.
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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)
EMBA 5403 Fall 2010
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
EMBA 5403 Fall 2010
hours, machine hoursMugan
etc.
77/?
Variance example 1
Requirement 1
Units (pounds)
Performance Report, April 2007
Actual
Budget
450.000
400.000
Revenues
Direct materials
Direct manufacturing labor
Selling price per pound of cookie
Selling-price variance
EMBA 5403 Fall 2010
$3.555.000
865.000
348.000
$7,90
Mugan
$3.200.000
580.000
336.000
$8,00
Variance
50.000 F
355.000
285.000
12.000
$0,10
$ 45.000,00
F
U
U
U
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
EMBA 5403 Fall 2010
$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

The application rates are calculated by dividing the budgeted (or
expected) overhead by the expected usage of labor hours:
Variable overhead application rate = $14,000/7,000 hr. = $2.00/hr.
Fixed overhead application rate = $28,000/7,000 hr. = $4.00/hr.
The applied fixed and variable overhead is calculated by multiplying
the application rates times the standard hours:
Variable overhead applied = (7,850 hr.)($2.00/hr.) = $15,700
Fixed overhead applied = (7,850 hr.)($4.00/hr.) =
EMBA 5403 Fall 2010
Mugan
$31,400
80/?
Variance example 2


The variable overhead variance is the difference between the
actual variable overhead ($12,000) and the applied variable
overhead ($15,700), or $3,700 favorable. The variable overhead
variance can be further decomposed into the variable overhead
spending variance and the variable overhead efficiency variance.
The actual application rate for variable overhead is the actual
variable overhead costs ($12,000) divided by the actual labor
hours (7,800), or $1.5385/hr.
Variable overhead spending variance = Ua(Va - Vs)
= 7,800 hr.($1.5385/hr. - $2.00/hr.) = $3,599.70 favorable
Variable overhead efficiency variance = Vs(Ua - Us)
= $2.0/hr.(7,800 hr. – 7,850 hr.) = $100 favorable
The sum of these two variances equals $3,699.70, which differs
slightly from the variable overhead variance $3,700.00 due to
rounding error.
EMBA 5403 Fall 2010
Mugan
81/?
Variance Example 2
 The fixed overhead variance is the difference between
the actual fixed overhead ($26,000) and the applied
fixed overhead ($31,400), or $5,400 favorable. The
fixed overhead variance can be decomposed into the
fixed overhead budget variance and the fixed
overhead volume variance.
Fixed overhead budget variance = actual - budgeted
fixed overhead
= $26,000 - $28,000 = $2,000 favorable
Fixed overhead volume variance = budgeted - applied
fixed overhead
= $28,000 - $31,400 = $3,400 favorable
 The sum of the fixed overhead budget and volume
variances is equal to the total fixed overhead
variance.
EMBA 5403 Fall 2010
Mugan
82/?
THE END
EMBA 5403 Fall 2010
Mugan
83/?