Budgetary Planning

Chapter 3

23-1
 23 Budgetary Planning

Learning Objectives
State the essentials of effective budgeting and the components of the
1 master budget.

2 Prepare budgets for sales, production, and direct materials.

Prepare budgets for direct labor ,manufacturing overhead, and selling

3 and administrative expenses, and a budgeted income statement.

4 Prepare a cash budget and a budgeted balance sheet.

5 Apply budgeting principles to nonmanufacturing companies.

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 LEARNING State the essentials of effective budgeting and
OBJECTIVE 1 the components of the master budget.

Budget: a 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 organization.

 Promotes efficiency.

 Control device - important basis for performance

evaluation once adopted.

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 Budgeting and Accounting

 Historical accounting data on revenues, costs, and

expenses help in formulating future budgets.
 The budget and its administration are the responsibility
of management.

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 The Benefits of Budgeting

Primary benefits of budgeting:

1. Requires all levels of management to plan ahead.

2. Provides definite objectives for evaluating performance.

3. Creates an early warning system for potential problems.

4. Facilitates coordination of activities within the business.

5. Results in greater management awareness of the entity’s

overall operations.

6. It motivates personnel throughout organization to meet

planned objectives.

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 The Benefits of Budgeting

Question
Which of the following is not a benefit of budgeting?
a. Management can plan ahead.
b. An early warning system is provided for potential
problems.
c. It enables disciplinary action to be taken at every level of
responsibility.
d. The coordination of activities is facilitated.

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 Essentials of Effective Budgeting

 Depends on a sound organizational structure with

authority and responsibility for all phases of operations
clearly defined.
 Based on research and analysis with realistic goals.
 Accepted by all levels of management.

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 Essentials of Effective Budgeting

LENGTH OF THE BUDGET PERIOD

 May be prepared for any period of time.
► Most common - one year.
► Supplement with monthly and quarterly budgets.
► Different budgets may cover different time periods.

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 Essentials of Effective Budgeting

THE BUDGETING PROCESS

 Base budget goals on past performance
► Collect data from organizational units.
► Begin several months before end of current year.
 Develop budget within the framework of a sales
forecast.
► Shows potential industry sales.
► Shows company’s expected share.

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 Essentials of Effective Budgeting

THE BUDGETING PROCESS

 Factors considered in Sales Forecasting:
1. General economic conditions

2. Industry trends

3. Market research studies

4. Anticipated advertising and promotion

5. Previous market share

6. Price changes

7. Technological developments
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 Essentials of Effective Budgeting

BUDGETING AND HUMAN BEHAVIOR

Participative Budgeting:
 Each level of management should be invited to
participate.
 May inspire higher levels of performance or discourage
additional effort.

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 BUDGETING AND HUMAN BEHAVIOR

Participative Budgeting
 Advantages:
► More accurate budget estimates because lower level
managers have more detailed knowledge of their area.
► Tendency to perceive process as fair due to
involvement of lower level management.
 Overall goal - produce budget considered fair and
achievable by managers while still meeting corporate
goals.

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 BUDGETING AND HUMAN BEHAVIOR

Participative Budgeting
 Disadvantages:
► Can be time consuming and costly.
► Can foster budgetary “gaming” or slack

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 BUDGETING AND HUMAN BEHAVIOR

Illustration 23-1
Flow of budget data under
participative budgeting

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 Essentials of Effective Budgeting

BUDGETING AND LONG-RANGE PLANNING

Three basic differences :
Time period:
1. Time period involved
Budgeting is short-term –
2. Emphasis usually one year.
Long range planning – at
3. Detail presented least five years.

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 Essentials of Effective Budgeting

Question
The essentials of effective budgeting do not include:
a. Top-down budgeting.
b. Management acceptance.
c. Research and analysis.
d. Sound organizational structure.

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 The Master Budget

 Set of interrelated budgets that constitutes a plan of

action for a specified time period.

 Contains two classes of budgets:

► Operating budgets. Individual budgets that result

in the preparation of the
► Financial budgets. budgeted income statement
– establish goals for sales
and production personnel.

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 The Master Budget

 Set of interrelated budgets that constitutes a plan of

action for a specified time period.

 Contains two classes of budgets:

► Operating budgets. The capital expenditures

budget, the cash budget,
► Financial budgets. and the budgeted balance
sheet – focus primarily on
cash needs to fund
operations and capital
expenditures.

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 The
Master
Budget

Illustration 23-2
Components of the
master budget

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 DO IT! 1 Budget Terminology

Use this list of terms to complete the sentences that follow.

1. A sales forecast shows potential sales for the industry

and a company’s expected share of such sales.

2. Operating budgets are used as the basis for the

preparation of the budgeted income statement.

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 DO IT! 1 Budget Terminology

Use this list of terms to complete the sentences that follow.

3. The master budget is a set of interrelated budgets that

constitutes a plan of action for a specified time period.
4. Long-range planning identifies long-term goals, selects
strategies to achieve these goals, and develops policies
and plans to implement the strategies.

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 DO IT! 1 Budget Terminology

Use this list of terms to complete the sentences that follow.

5. Lower-level managers are more likely to perceive results

as fair and achievable under a participative budgeting
approach.
6. Financial budgets focus primarily on the cash resources
needed to fund expected operations and planned capital
expenditures.
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 LEARNING Prepare budgets for sales, production, and
OBJECTIVE 2 direct materials.

Sales Budget
 First budget prepared.
 Derived from the sales forecast.
► Management’s best estimate of sales revenue for
the budget period.
 Every other budget depends on the sales budget.
 Prepared by multiplying expected unit sales volume for
each product times anticipated unit selling price.

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 Sales Budget

Illustration – Hayes Company

 Expected sales volume: 3,000 units in the first quarter with
500-unit increases in each succeeding quarter.
 Sales price: $60 per unit. Illustration 23-3
Sales budget

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 Class work
 Goody Company estimates that unit sales will
be 10,000 in quarter 1; 12,000 in quarter 2;
14,000 in quarter 3; and 18,000 in quarter 4.
Using a sales price of $80 per unit, prepare
the sales budget by quarters for the year
ending December 31, 2010.

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 Production Budget

 Shows units that must be produced to meet

anticipated sales.
 Derived from sales budget plus the desired change in
ending finished goods inventory.
 Essential to have a realistic estimate of ending inventory.

Illustration 23-4
Production requirements
formula

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 Production Budget

Hayes Co. believes it can meet future sales needs with an ending
inventory of 20% of next quarter’s budgeted sales volume.

Illustration 23-5
Production budget
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 Direct Materials Budget

 Shows both the quantity and cost of direct materials to be

purchased.
Illustration 23-6
 Formula for direct materials quantities. Formula for direct
materials quantities

Illustration 23-6

 Budgeted cost of direct materials to be purchased = required

units of direct materials x anticipated cost per unit.
 Inadequate inventories could result in temporary shutdowns
of production.

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 Direct Materials Budget

Illustration – Hayes Company

Because of its close proximity to suppliers,

 Hayes Company maintains an ending inventory of raw
materials equal to 10% of the next quarter’s production
requirements.
 The manufacture of each Rightride requires 2 pounds of
raw materials, and the expected cost per pound is $4.
 Assume that the desired ending direct materials amount is
1,020 pounds for the fourth quarter of 2017.
 Prepare a Direct Materials Budget.
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 Direct Materials Budget

Illustration 23-7
Direct materials budget
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 Sales, Production, and Direct
DO IT! 2 Materials Budgets
Soriano Company is preparing its master budget for 2017. Relevant data
pertaining to its sales, production, and direct materials budgets are as
follows:
Sales: Sales for the year are expected to total 1,200,000 units. Quarterly
sales are 20%, 25%, 30%, and 25% respectively. The sales price is
expected to be $50 per unit for the first three quarters and $55 per unit
beginning in the fourth quarter. Sales in the first quarter of 2018 are
expected to be 10% higher than the budgeted sales for the first quarter of
2017.
Production: Management desires to maintain ending finished goods
inventories at 25% of next quarter’s budgeted sales volume.
Direct materials: Each unit requires 3 pounds of raw materials at a cost
of $5 per pound. Management desires to maintain raw materials
inventories at 5% of the next quarter’s production requirements. Assume
the production requirements for the first quarter of 2018 are 810,000
pounds.
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 Sales, Production, and Direct
DO IT! 2 Materials Budgets

Prepare the sales, production, and direct materials budgets by

quarters for 2017.

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 Sales, Production, and Direct
DO IT! 2 Materials Budgets

Prepare the sales, production, and direct materials budgets by

quarters for 2017.

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 Sales, Production, and Direct
DO IT! 2 Materials Budgets
Prepare the sales, production, and direct materials budgets.

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 Prepare budgets for direct labor, manufacturing
LEARNING
OBJECTIVE 3 overhead, and selling and administrative expenses,
and a budgeted income statement.

Direct Labor Budget

 Shows both the quantity of hours and cost of direct labor
necessary to meet production requirements.
 Critical in maintaining a labor force that can meet
expected production.
 Total direct labor cost formula:

Illustration 23-8
Formula for direct labor cost

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 Direct Labor Budget

Illustration: Direct labor hours are determined from the

production budget. At Hayes Company, two hours of direct
labor are required to produce each unit of finished goods. The
anticipated hourly wage rate is $10.

Illustration 23-9
23-36 Direct labor budget LO 3
 Manufacturing Overhead Budget

 Shows the expected manufacturing overhead costs for

the budget period.

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 Manufacturing Overhead Budget

Illustration: Hayes Company expects variable costs to

fluctuate with production volume on the basis of the following
rates per direct labor hour: indirect materials $1.00, indirect
labor $1.40, utilities $0.40, and maintenance $0.20. Thus, for
the 6,200 direct labor hours to produce 3,100 units, budgeted
indirect materials are $6,200 (6,200 x $1), and budgeted
indirect labor is $8,680 (6,200 x $1.40). Hayes also recognizes
that some maintenance is fixed. The amounts reported for fixed
costs are assumed.
Prepare a Manufacturing Overhead Budget.

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 Illustration 23-10

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 Selling and Administrative Expense
Budget

 Projection of anticipated operating expenses.

 Distinguishes between fixed and variable costs.

Illustration: Variable expense rates per unit of sales are sales

commissions $3 and freight-out $1. Variable expenses per
quarter are based on the unit sales from the sales budget
(Illustration 23-3). Hayes expects sales in the first quarter to be
3,000 units. Fixed expenses are based on assumed data.
Prepare a selling and administrative expense budget.

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 Illustration 23-11
Selling and administrative
expense budget

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 Budgeted Income Statement

 Important end-product of the operating budgets.

 Indicates expected profitability of operations.
 Provides a basis for evaluating company performance.
 Prepared from the operating budgets:

► Sales ► Manufacturing Overhead

► Direct Materials ► Selling and Administrative Expense
► Direct Labor

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 Budgeted Income Statement

Illustration: To find the cost of goods sold, it is first necessary

to determine the total unit cost of producing one Rightride, as
follows. Illustration 23-12
Computation of total unit cost

Second, determine Cost of Goods Sold by multiplying units

sold times unit cost: 15,000 units x $44 = $660,000

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 Budgeted Income Statement

Illustration: All data for the income statement come from the
individual operating budgets except the following: (1) interest
expense is expected to be $100, and (2) income taxes are
estimated to be $12,000. Illustration 23-13
Budgeted multiple-step income statement

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 Budgeted Income Statement

Question
Each of the following budgets is used in preparing the budgeted
income statement except the:

a. Sales budget.
b. Selling and administrative budget.
c. Capital expenditure budget.
d. Direct labor budget.

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 DO IT! 3 Budgeted Income Statement

Soriano Company is preparing its budgeted income statement

for 2017. Relevant data pertaining to its sales, production, and
direct materials budgets can be found on the following slide.
Soriano budgets 0.5 hours of direct labor per unit, labor costs at
$15 per hour, and manufacturing overhead at $25 per direct
labor hour. Its budgeted selling and administrative expenses for
2017are $12,000,000. (a) Calculate the budgeted total unit cost.
(b) Prepare the budgeted income statement for 2017.

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 DO IT! 3 Budgeted Income Statement
Soriano Company is preparing its master budget for 2017. Relevant data
pertaining to its sales, production, and direct materials budgets are as
follows:
Sales: Sales for the year are expected to total 1,200,000 units. Quarterly
sales are 20%, 25%, 30%, and 25% respectively. The sales price is
expected to be $50 per unit for the first three quarters and $55 per unit
beginning in the fourth quarter. Sales in the first quarter of 2018 are
expected to be 10% higher than the budgeted sales for the first quarter of
2017.
Production: Management desires to maintain ending finished goods
inventories at 25% of next quarter’s budgeted sales volume.
Direct materials: Each unit requires 3 pounds of raw materials at a cost
of $5 per pound. Management desires to maintain raw materials
inventories at 5% of the next quarter’s production requirements. Assume
the production requirements for the first quarter of 2018 are 810,000
pounds.
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 DO IT! 3 Budgeted Income Statement

Calculate the budgeted total unit cost and prepare the budgeted
income statement for 2017.
(a)

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 DO IT! 3 Budgeted Income Statement

Calculate the budgeted total unit cost and prepare the budgeted
income statement for 2017.
(b)

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 LEARNING Prepare a cash budget and a budgeted
4
OBJECTIVE balance sheet.

Cash Budget
 Shows anticipated cash flows.
 Often considered to be the most important output in
preparing financial budgets.
 Contains three sections:
► Cash Receipts
► Cash Disbursements
► Financing
 Shows beginning and ending cash balances.

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 Cash Budget

Illustration 23-14
Basic form of a cash budget

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 Cash Budget

 Cash Receipts Section

► Expected receipts from the principal sources of revenue.
► Expected interest and dividends receipts, proceeds from
planned sales of investments, plant assets, and the
company’s capital stock.
 Cash Disbursements Section
► Expected cash payments for direct materials, direct labor,
manufacturing overhead, and selling and administrative
expenses.
 Financing Section
► Expected borrowings and repayments of borrowed funds
plus interest.
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 Cash Budget

 Must prepare in sequence.

 Ending cash balance of one period is the beginning cash
balance for the next.
 Data obtained from other budgets and from management.
 Often prepared for the year on a monthly basis.
 Contributes to more effective cash management.
 Shows managers the need for additional financing before
actual need arises.
 Indicates when excess cash will be available.

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 Cash Budget

Illustration – Hayes Company Assumptions

1. The January 1, 2017, cash balance is expected to be $38,000.
Hayes wishes to maintain a balance of at least $15,000.
2. Sales (Illustration 23-3): 60% are collected in the quarter sold
and 40% are collected in the following quarter. Accounts
receivable of $60,000 at December 31, 2016, are expected to
be collected in full in the first quarter of 2017.
3. Short-term investments are expected to be sold for $2,000
cash in the first quarter.
Continued

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 Cash Budget

Illustration – Hayes Company Assumptions

4. Direct materials (Illustration 23-7): 50% are paid in the quarter
purchased and 50% are paid in the following quarter. Accounts
payable of $10,600 at December 31, 2016, are expected to be
paid in full in the first quarter of 2017.
5. Direct labor (Illustration 23-9): 100% is paid in the quarter
incurred.
6. Manufacturing overhead (Illustration 23-10) and selling and
administrative expenses (Illustration 23-11): All items except
depreciation are paid in the quarter incurred.

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 Cash Budget

Illustration – Hayes Company Assumptions

7. Management plans to purchase a truck in the second quarter
for $10,000 cash.
8. Hayes makes equal quarterly payments of its estimated annual
income taxes.
9. Loans are repaid in the earliest quarter in which there is
sufficient cash (that is, when the cash on hand exceeds the
$15,000 minimum required balance).
Prepare a schedule of collections from customers.

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 Cash Budget

Illustration – Prepare a schedule of collections from customers.

Illustration 23-15
Collections from customers

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 Cash Budget

Illustration – Prepare a schedule of cash payments for direct

materials. Illustration 23-16
Payments for direct materials

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23-59 Illustration 23-17 LO 4