John Wiley & Sons, Inc. © 2005

Chapter 19Chapter 19

Budgetary Planning

Prepared by Barbara MullerPrepared by Barbara MullerArizona State University WestArizona State University West

Principles of AccountingPrinciples of Accounting

Kimmel Kimmel •• Weygandt Weygandt •• Kieso Kieso

CHAPTER 19BUDGETARY PLANNING

After studying this chapter, you should be able to: Indicate the benefits of budgeting. State the essentials of effective budgeting. Identify the budgets that comprise the

master budget. Describe the sources for preparing the

budgeted income statement. Explain the principal sections of a cash

budget. Indicate the applicability of budgeting in

nonmanufacturing companies.

Budgeting Basics Budget

• formal written statement of management’s plans for a specified future time period, expressed in financial terms

• primary method of communicating agreed-upon objectives throughout the company

• provides historical data on revenues, costs, and expenses

• once adopted, it becomes an important basis for performance evaluation

Benefits of BudgetingSTUDY OBJECTIVE 1

The primary benefits of budgeting include• Requires all levels of management plan ahead

• Provides definite objectives for evaluating performance

• Is an early warning system for potential problems

• Facilitates coordination of activities within the business

• Results in greater management awareness of the entity’s overall operations

• Motivates personnel throughout organization to meet planned objectives

Essentials of Effective BudgetingSTUDY OBJECTIVE 2

Effective budgeting requires• Sound organizational structure where authority and

responsibility for all phases of operations are clearly defined

• Budgets based on research and analysis result in realistic goals

• An effective budget program is accepted by all levels of management

Length of the Budget Period

A budget may be prepared for any period of time Most common budget period is one year Different types of budgets may cover different

time periodso For example, cash may be budgeted monthly, while a plant

expansion budget may cover a 10-year period

A continuous twelve-month budget drops the month just ended and adds a future month

An annual budget may be supplemented by monthly and quarterly budgets

The Budgeting Process

A budget is developed within the framework of a sales forecast

The budgeting process may be informal in small companies; in larger companies a budget committee is often responsible for coordinating the budget process

o Members of the committee often include the president, treasurer, chief accountant (controller), and management personnel from each major area of the company

Flow of Budget Data

Budgeting and Human Behavior

Budgets can be expected to have a strong positive influence on a manager when• Each level of management is invited and encouraged to

participate in developing the budget• Criticism of a manager’s performance is tempered

with advice and assistance• Top management is sensitive to the behavioral

implications of its actions

Budgeting and Long-Range Plans

Budgeting is the achievement of specific short-term goals

Long-range planning identifies and selects strategies to achieve goals and develop policies and plans to implement the strategies

Long-range plans contain less detail than budgets

The Master BudgetSTUDY OBJECTIVE 3

A master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period.

It is developed within the framework of a sales forecast.

Components of the Master Budget

Two Classes of Budgets in the Master Budget

Operating budgets• the individual budgets that result in the preparation of

the budgeted income statement

Financial budgets • focus on the cash resources needed to fund expected

operations and planned capital expenditures

Preparing the Operating Budgets:Sales Budget

The sales budget is prepared from the sales forecast• It represents management’s best estimate of sales

revenue for the budget period• Each of the other budgets depends on the sales

budget

Production Budget

The production budget shows the units that must be produced to meet anticipated sales

It is derived from sales budget plus the desired change in ending finished goods (ending finished goods less the beginning finished goods units)

The required production in units formula is:Desired Ending

Finished Goods Units

Beginning Finished Goods Units

Budgeted Sales Units

Required Production

Units

Direct Materials Budget

Desired Ending Direct

Material Units

Beginning Direct

MaterialsUnits

Direct Materials

Units Required for Production

Required Direct

Materials Purchases

Units

The direct materials budget Shows both the quantity and cost of direct

materials to be purchased It is derived from the direct materials units

required for production (from the production budget) plus the desired change in ending direct materials units

Direct Labor Budget

The direct labor budget •Shows both the quantity of hours and cost of direct labor necessary to meet production requirements•Is critical in maintaining a labor force that can meet expected production

Manufacturing Overhead and Selling and Administrative Budget

Manufacturing overhead budget• Contains expected manufacturing overhead costs

Selling and administrative expense budget• Contains anticipated operating expenses

Both distinguish between fixed and variable costs

Budgeted Income StatementSTUDY OBJECTIVE 4

Budgeted income statement•The important end-product of the operating budgets

•Indicates the expected profitability of operations

•Provides a basis for evaluating company performance

•Prepared from theo Sales budget

o Production budget

o Direct labor budget

o Direct materials purchases budget

o Manufacturing Overhead budget

o Selling and Administrative expense budget

Preparing the Financial BudgetsSTUDY OBJECTIVE 5

Cash budget• Shows anticipated cash flows

• Often considered to be the most important output in preparing financial budgets

• Contains three sectionso Cash receipts

o Cash disbursements

o Financing

Cash Budget

Cash receipts section• Includes expected receipts from the company’s

principal sources of revenue, usually cash sales and collections on credit sales

Cash disbursements section• Includes expected cash payments for direct materials

and labor, taxes, dividends, etc.

Financing section• Shows expected borrowings and repayments of

borrowed funds plus interest

Budgeted Balance Sheet

Budgeted balance sheet A projection of financial position at the end of the

budget period Developed from the budgeted balance sheet for

the preceding year and the budgets for the current year

Budgeting in Non-manufacturing Companies

STUDY OBJECTIVE 6

Budgets are also used by• Merchandisers

• Service enterprises

• Not-for-profit organizations

Desired Ending

Merchandise Inventory

Beginning Merchandise

Inventory

Budgeted Cost of

Goods Sold

Required Merchandise Purchases

Merchandisers Budgets

The major differences between the budgets of a merchandiser and a manufacturer • Merchandisers use a purchases budget instead of a production

budget

• Merchandisers do not use the manufacturing budgets (direct materials, direct labor, and manufacturing overhead)

Service Enterprises

In service enterprises the critical factor in budgeting is coordinating professional staff needs with anticipated services

•If a firm is overstaffed• Labor costs will be disproportionately high

• Profits will be lower because of the additional salaries

• Staff turnover will increase because of lack of challenging work

•If an enterprise is understaffed • Revenue may be lost because existing and prospective client needs for

service cannot be met

• Professional staff may seek other jobs because of excessive work loads

Not-for-Profit Organizations

Budgeting is just as important for not-for-profit organizations as for profit-oriented enterprises• In most cases, not-for-profit entities budget on

the basis of cash flows (expenditures and receipts), rather than on a revenue and expense basis

• The starting point in the budgeting process is usually expenditures, not receipts

Let’s ReviewLet’s Review

A sales budget is:A sales budget is:

a.a. derived from the production budget.derived from the production budget.

d.d. Prepared only for credit sales.Prepared only for credit sales.

c.c. Not the starting point for the master Not the starting point for the master budget.budget.

b.b. management’s estimate of sales revenue for management’s estimate of sales revenue for the year.the year.

Let’s ReviewLet’s Review

A sales budget is:A sales budget is:

a.a. derived from the production budget.derived from the production budget.

d.d. Prepared only for credit sales.Prepared only for credit sales.

c.c. Not the starting point for the master Not the starting point for the master budget.budget.

b.b. management’s estimate of sales revenue for management’s estimate of sales revenue for the year.the year.

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Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.