Post on 13-Jan-2016
Chapter 7
The Budget Process
1. What is the importance of the budgeting process?
2. How do the advantages and disadvantages of
imposed budgets and participatory budgets
compare?
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Learning Objectives
3. Why does a budget manual facilitate the budgeting process?
4. What complicates the budgeting process in a multinational
environment?
5. What is the starting point of a master budget and why is this
item chosen?
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Continuing . . . Learning Objectives
6. How are the various master budget schedules
prepared and how do they relate to one another?
7. Why is the cash budget so important in the master
budgeting process?
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Continuing . . . Learning Objectives
8. How does the statement of cash flows relate to
the income statement and the cash budget?
9. Why does actual revenue from a product differ
from budgeted revenue? (Appendix)
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Continuing . . . Learning Objectives
10. How does traditional budgeting differ from
zero-based budgeting? (Appendix)
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Continuing . . . Learning Objectives
Different Roles of Budgeting
Process and Budgets
• Planning• Motivation• Evaluation• Coordination• Communication• Education• Ritual
Participation
in the Budgeting Process
Imposed budgets
Participatorybudgets
Middle Management
Operational Management
TopManagement
Best Times to Use Imposed Budgets
• In start-up organizations• In extremely small businesses• In times of economic crisis• When operating managers lack budgetary skills or
perspective• When organizational units require precise
coordination of efforts
Advantages of Imposed Budgets
• Increase probability that organization’s strategic plans will be incorporated in planned activities
• Enhance coordination among divisional plans and objectives
• Use top management’s knowledge of overall resource availability
• Reduce the possibility of input from inexperienced or uninformed lower-level employees
• Reduce the time frame for the budgeting process
Disadvantages of Imposed Budgets
• May result in dissatisfaction, defensiveness, and low morale among individuals who must work under the budget
• Reduce the feeling of teamwork• May limit the acceptance of the stated goals and objectives• Limit the communication process among employees and
management• May create a view of the budget as a punitive device• May result in unachievable budgets for international divisions if
local operating and political environments are not adequately considered
• May stifle the initiative of lower-level managers
Best Times to Use
Participatory Budgets
• In well-established organizations• In extremely large businesses• In times of economic affluence• When operating managers have strong budgetary
skills and perspectives• When organizational units are quite autonomous
Advantages of Participatory Budgets
• Provide information from persons most familiar with the needs and constraints of organizational units
• Integrate knowledge that is diffused among various levels of management
• Lead to better morale and higher motivation
• Provide a means to develop fiscal responsibility and budgetary skills of employees
• Develop a high degree of acceptance of and commitment to organizational goals and objectives by operating management
Continuing . . . Advantages of
Participatory Budgets
• Are generally more realistic
• Allow organizational units to coordinate with one another
• Allow subordinate managers to develop operational plans that conform to organizational goals and objectives
• Include specific resource requirements
• Blend overview of top management with operating details
• Provide a social contract that expresses expectations of top management and subordinates
Disadvantages of
Participatory Budgets• Require significantly more time
• Create a level of dissatisfaction with the process approximately equal to that occurring under imposed budgets in cases in which the effects of managerial participation are negated by top-management changes
• Create an unachievable budget in cases in which managers may be ambivalent or unqualified to participate
• May cause managers to introduce slack into the budget
• May support “empire building” by subordinates
• May start the process earlier in the year when there is more uncertainty about the future year
Budget Manual
• Statements of the budgeting purpose and its desired results
• A listing of specific budgetary activities to be performed
• A calendar of scheduled budgetary activities
• Sample budget forms• Original, revised, and approved
budgets
Calendar Budget Period
Year
Quarter 1 Quarter 2 Quarter 3 Quarter 4
October
November
December
January
February
March
April
May
June
July
August
September
The Master Budget
A comprehensive set of an organization’sbudgetary schedules and
pro forma (projected) financial statements
Composition of the Master Budget
Operating Budgets(units & dollars)
Financial Budgets(dollars)
Sales BudgetProduction BudgetPurchases BudgetDirect Labor BudgetOverhead BudgetSelling & Administrative
Budget
Cash BudgetCapital BudgetSchedule of Cost of Goods
ManufacturedIncome StatementStatement of Retained
EarningsBalance SheetStatement of Cash Flows
Budget Example
Sales budgets by month:
January $200
February 300
March 400
Variable cost of goods sold will be 60 percent of sales dollars.
Other variable costs will be 15 percent of sales dollars, paid one month later.
Total fixed costs for the year will be $240, of which $10 per month is depreciation expense.
Balance Sheet, December 31, 19x0
Assets: Liabilities:
Cash 30$ Accts. payable 180$
Accts. receivable 288 Accrued payables 25
Inventory 300 Total liabilities 205$
Plant & equip., net 300 Common stock 500
Retained earnings 213
Total 918$ Total 918$
Budgeted Income Statement for the
Quarter Ending March 31, 19x1
Jan. Feb. Mar. Total
Sales 200$ 300$ 400$ 900$
Variable cost of goods sold 120 180 240 540
Gross margin 80$ 120$ 160$ 360$
Other variable costs 25 30 45 100
Contribution margin 55$ 90$ 115$ 260$
Fixed costs 20 20 20 60
Income 35$ 70$ 95$ 200$
Purchases Budget for the Three
Months Ending March 31, 19x1
Jan. Feb. Mar. Total
Cost of sales 120$ 180$ 240$ 540$
Ending inventory* 420 540 660 660
Total requirements 540$ 720$ 900$ 1,200$
Beginning inventory 300 420 540 300
Purchases required 240$ 300$ 360$ 900$
*Ending inventory is equal to the next two month'sCOGS. April's and May's sales were estimated as $500and $600, respectively.
Cash Collections from Customers
Collections are estimated to be 20 percent in the month of sale, 48 percent the month following, and 32 percent in the second month following. There are no uncollectible accounts.
Cash Receipts
Jan. Feb. Mar. Total
Sales for the month 200$ 300$ 400$ 900$
Collections from sales:
20% of current month's 40$ 60$ 80$ 180$
48% of prior month's* 120 96 144 360
32% of second month's* 88 80 64 232
Total cash collections 248$ 236$ 288$ 772$
*November and December sales were $275 and $250, respectively
Cash Disbursements for Purchases
Jan. Feb. Mar. Total
Budgeted purchases 240$ 300$ 360$ 900$
Payments 180$ 240$ 300$ 720$
Purchases are paid for the month following the purchase.
Cash Disbursements–All Costs
Jan. Feb. Mar. Total
For purchases 180$ 240$ 300$ 720$
Other variable costs 25 30 45 100
Fixed costs 10 10 10 30
Total 215$ 280$ 355$ 850$
Tentative Cash Budget
Jan. Feb. Mar. Total
Beginning balance 30$ 63$ 19$ 30$
Collections 248 236 288 772
Total available 278$ 299$ 307$ 802$
Disbursements 215 280 355 850
Ending balance 63$ 19$ (48)$ (48)$
Minimum Cash Balance Policies
Financial managers devote considerable attention to determining the needed minimum level of cash. As with most decisions, a trade off between two conflicting factors is involved. Too small a minimum balance would lead to a higher probability of running out of cash, while too large a minimum balance would lead to little or no return.
Continuing . . .
Minimum Cash Balance Policies
In this example, the desired minimum cash is $25,000. Cash can be borrowed in $5,000 increments at an interest rate of 12 percent per year.
Revised Cash Budget
Jan. Feb. Mar. Total
Beginning balance 30$ 63$ 29$ 30$
Collections 248 236 288 772
Total available 278$ 299$ 317$ 802$
Disbursements 215 280 355 850
Tentative balance 63$ 19$ (38)$ (48)$
Borrowing 10 65 75
Ending balance 63$ 29$ 27$ 27$
Budgeted Income Statement for the
Quarter Ending March 31, 19x1
Total
Sales $900.00
Variable cost of goods sold 540.00
Gross profit $360.00
Other variable costs 100.00
Contribution margin $260.00
Fixed costs 60.00
Operating income $200.00
Interest expense 0.85
Income $199.15
Balance Sheet, March 31, 19x1
Assets: Liabilities:
Cash $27.00 Accts. payable $360.00
Accts. receivable 416.00 Accrued expenses 60.00
Inventory 660.00 Short-term loan 75.00
Plant & equip., net 270.00 Accrued interest 0.85
Total liabilities $495.85
Common stock 500.00 Retained earnings 377.15
Total $1,373.00 Total $1,373.00
Total Revenue Variance
Actual sales
(ASP x AV)
Budgeted Sales
(BSP x BV)
Total Revenue Variance*
*Favorable or unfavorable
Sales Price Variance
ASP x AV BSP x BVBSP x AV
SalesPrice Variance
AV (ASP - BSP) *
*Favorable or unfavorable
Sales Volume Variance
ASP x AV BSP x BVBSP x AV
BSP (AV - BV) *
*Favorable or unfavorable
Sales Volume
Variance
Example
The Maine Lobsters budget 1999 ticket sales at $70,000 per home game, which represent the sale of an estimated 10,000 tickets at a selling price of $7. At July’s first home game, actual gate ticket revenue was $66,000, creating a total unfavorable revenue variance of $4,000. The actual sales consisted of 12,000 tickets at $5.50.
Revenue Variance Calculations
Total Revenue Variance equals:
70,000 - ($5.50 x 12,000) = $4,000 U
Sales Price Variance equals:
12,000 x ($5.50 - $7.00) = $18,000 U
Sales Volume Variance equals:
$7.00 x (12,000 - 10,000) = $14,000 F
Traditional Budgeting
• Starts with last year’s funding appropriation• Focuses on money• Does not systematically consider alternatives
to current operations• Produces a single level of appropriation for an
activity
Zero-Based Budgeting
• Starts with a minimal (or zero) figure for funding
• Focuses on goals and objectives• Directly examines alternative approaches to
achieving similar results• Produces alternative levels of funding based
on availability of funds and desired results