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Planning and Budgeting

Chapter 13

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin

Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives
LO 13-1 Understand the role of budgets in overall organization plans.
LO 13-2 Understand the importance of people in the budgeting process.
LO 13-3 Estimate sales.
LO 13-4 Develop production and cost budgets.
LO 13-5 Estimate cash flows.
LO 13-6 Develop budgeted financial statements.
LO 13-7 Explain budgeting in merchandising and service organizations.
LO 13-8 Explain why ethical issues arise in budgeting.
LO 13-9 Explain how to use sensitivity analysis to budget under uncertainty.

13-3

LO
13-1

Budgets

LO 13-1 Understand the role of budgets in overall organization pla

We
We focus
focus on
on the
the planning
planning purpose
purpose of
of the
the budgeting
budgeting
process.
process. For
For our
our purposes
purposes here,
here, a
a budget
budget is
is simply
simply the
the
plan,
plan, stated
stated in
in financial
financial terms,
terms, of
of how
how the
the organization
organization
expects
expects to
to carry
carry out
out its
its activities
activities and
and meet
meet the
the financial
financial
goals
goals established
established in
in the
the planning
planning process.
process.
We show how a master budget is developed and how it
fits into the overall plan for achieving organization goals.
Before we investigate the details of developing a master
budget, we discuss the way that strategic planning can
increase competitiveness and affect global operations.

13-4

LO
13-1

Overall Plan
A master budget is part of an overall organization
plan for the next year made up of three
components:
(1) the organization goals,
(2) the strategic long-range profit plan, and
(3) the tactical short-range profit plan.
Top managers establish broad objectives, which serve as
organization goals that company employees work to achieve.

It is important to detail the specific steps required to achieve the

goals. These steps are expressed in a strategic long-range plan.
The plan for the coming year, which is more specific than longrange plans, is called the master budget, also known as the static
budget, the budget plan, or the planning budget .
13-5

LO
13-1

Organizational and Individual Interaction:

Developing the Master Budget

13-6

LO
13-2

Human Element in Budgeting

LO 13-2 Understand the importance of people in the budgeting pro

Organization
goals

Goal congruence

Individual
goals

Participative Budgeting
Use of input from lower- and middle-management
employees; also called grass roots budgeting

13-7

LO
13-3

Sales Forecasting
LO 13-3

Estimate sales.

Forecasting sales is the most difficult aspect of budgeting.

Sales staff
Market researchers
Delphi technique
Trend analysis
Econometric models
13-8

LO
13-3

Forecasting by Sales Staf

After evaluating the sales forecasts derived
from various sources, the budgeting task force
at Santiago Pants arrived at the following sales
budget for the next budget year:

13-9

LO
13-4

Forecasting Production
LO 13-4

Develop production and cost budgets.

A production budget is a plan of resources needed to meet current

sales demand and ensure that inventory levels are sufficient for future
sales.

Beginning balance
+
BB

Transfers in
TI

Transfers out

= Ending balance
TO

Units in beginning
+
inventory

Required
production

Budgeted
sales

Units in ending
inventory

13-10

LO
13-4

Production Budget
Rearranging for required production:
Budgeted
sales

Units in ending
inventory

Units in beginning

=
inventory

Required
production

Santiago Pants' sales budget is 160,000 units

Management estimates that there will be 5,000 units
in beginning inventory and 15,000 in ending inventory.
160,000
units

15,000
units

5,000
units

170,000
units

13-11

LO
13-4

Production Budget

13-12

LO
13-4

Production Costs
Direct
materials

Direct
labor

Manufacturing
overhead

Indirect Indirect
Other
labor materials

13-13

LO
13-4

Direct Materials Example

13-14

LO
13-4

Direct Materials Example

Santiago Pants
Estimated Production
Materials Data
Yards needed:

13-15

LO
13-4

Direct Materials Example

$
$

13-16

LO
13-4

Direct Labor Example

13-17

LO
13-4

Overhead Example
Santiago Pants
Schedule of Budgeted Manufacturing Overhead
For the Budget Year Ended December 31
Variable overhead needed to product 170,000 units:
Indirect materials and supplies @ $0.30 per unit
Materials handling @ $0.40 per unit
Other indirect labor @ $0.10 per unit
Total variable overhead

$ 51,000
68,000
$ 17,000
$136,000

Fixed manufacturing overhead (supervisory labor $102M,

maintenance and repairs $50M, plant administration $85M,
utilities $55M, depreciation $140M, insurance $30M,
property taxes $60M, and other $22M)
Total manufacturing overhead

$544,000
$680,000
13-18

LO
13-4

Cost of Goods Sold Example

Santiago Pants
Budgeted Statement of Cost of Goods Sold
For the Budget Year Ended December 31
Beginning work-in-process inventory
Manufacturing costs:
Direct materials:
Beginning inventory
Purchases
Materials available for manufacturing
Less: Ending inventory
Total direct materials costs
Direct labor
Manufacturing overhead
Total manufacturing costs
Less: Ending work-in-process
Cost of goods manufactured
Add: Beginning finished goods inventory
Less: Ending finished goods inventory
Cost of goods sold
a

Management estimate

$
35,000
1,715,000
$1,750,000
(50,000)

-0-

$1,700,000
1,870,000
680,000

$4,250,000
-0$4,250,000
120,000aa
(375,000)bb
$3,995,000

Estimate: (15,000 units $25 value of finished goods)

13-19

LO
13-4

Marketing and Administrative

Budget Example

13-20

LO
13-4

Income Statement Example

13-21

LO
13-5

Cash Budget
LO 13-5

Estimate cash flows.

The cash budget is a statement of cash on hand at the

start of the budget period, expected cash receipts,
expected cash disbursements, and the resulting cash
balance at the end of the budget period.
Cash receipts:
Collection of accounts receivable
Cash sales
Sales of assets
Borrowing
Issuing stock
Other
13-22

LO
13-5

Cash Budget
Some cash disbursements:
Materials purchases
Manufacturing costs
Operating activities
Debt repayment
Acquisition of new assets
Income taxes
Dividends
Other activities

13-23

LO
13-5

Cash Budget
Santiago Pants
Cash Budget
For the Budget Year Ended December 31
Cash balance beginning of period
$ 830,000
Receipts:
Collections on accounts
$6,840,000
Collections employee loans
100,000
Total receipts
6,940,000
Less: Disbursements:
Payments for accounts payable
1,694,000
Direct labor
1,870,000
Manufacturing overhead less noncash depreciation charges
540,000
Marketing and administrative costs less noncash charges
1,422,000
Payments for federal income taxes
350,000
Dividends
30,000
Reduction in long-term debt
23,000
Acquisition of new assets
1,470,000
Total disbursements
7,399,000
Budgeted ending cash balance
$ 371,000
13-24

LO
13-5

Cash Collections Example

Santiago Pants
Monthly Collection Experience
Sales on Credit

Expected Sales for Three Months

13-25

LO
13-5

Cash Collections Example

Santiago Pants
Multiperiod Schedule of Cash Collections
For the Quarter Ended March 31
Month
January

February

March

Total for
Quarter

Beginning accounts receivable,

January 1, $540,000
$540,000
$ 540,000
January sales, $500,000aa
100,000 $375,000
475,000
February sales, $450,000bb
90,000 $337,500
427,500
March sales, $600,000cc
120,000
120,000
Total cash collections
$640,000 $465,000 $457,500 $1,562,500
20% collected in January, 75% collected in February, and 5% not collected
20% collected in February, 75% collected in March, and 5% not collected
c
20% collected in March, 75% collected in April, and 5% not collected
a

13-26

LO
13-5

Cash Disbursements Example

Santiago Pants
Monthly Disbursements for Purchases Experience
Cash disbursement for current month's purchases
Cash disbursement for prior month's purchases
Cash discounts taken
Total cash disbursement for purchases

50%
48
2
100%

Expected Purchases for Three Months

January sales
$120,000
February sales
$200,000
March sales
$250,000

13-27

LO
13-5

Cash Disbursements Example

Santiago Pants
Multiperiod Schedule of Cash Disbursements
For the Quarter Ended March 31
Month
January

February

March

Total for
Quarter

Beginning accounts payable,

January 1, $256,000
$256,000
$ 256,000
January purchases, $120,000aa 60,000 $ 57,600
117,600
February purchases, $200,000bb
100,000 $ 96,000
196,000
March purchases, $250,000cc
125,000
125,000
Additional cash payments
250,000 250,000 250,000
750,000
Total cash disbursements $566,000 $407,600 $471,000 $1,444,600
50% paid in January, 48% paid in February, and 2% discounts taken
50% paid in February, 48% paid in March, and 2% discounts taken
c
50% paid in March, 48% paid in April, and 2% discounts taken
a

13-28

LO
13-6

Budgeted Balance Sheet

Example
LO 13-6 Develop budgeted financial statements.
Santiago Pants
Budget Balance Sheet
For the Budget Year Ended December 31 ($000)
Budget Year
Balance
Jan 1

Assets
Current assets:
$ 830
Cash
540
Accounts receivable
155
Inventories
161
Other current assets
$1,686
Total current assets
Long-term assets:
1,866
Property, plant, equipment
(1,246)
Less: Accumulated depreciation
$2,306
Total assets

Additions Subtractions

Balance
Dec 31

$ 6,940 $ 7,399 $ 371

7,200
6,840
900
4,265
3,995
425
-0100
61
$18,405 $18,334 $1,757
1,470
-0(220)
-0$19,651 $18,334

3,336
(1,470)
$3,623
13-29

LO
13-6

Budgeted Balance Sheet

Example
Santiago Pants
Budget Balance Sheet
For the Budget Year Ended December 31 ($000)
Budget Year
Balance
Jan 1

Liabilities and Shareholders Equity

Current liabilities:
Accounts payable
Taxes payable
Current portion of long-term debt
Total current liabilities
Long-term liabilities
Total liabilities
Shareholders' equity
Common stock
Retained earnings
Total shareholders
Total liabilities and shareholders equity

$
$
$

Additions Subtractions

Balance
Dec 31

256 $1,715 $1,694 $

187
550
350
23
23
23
466 $2,288 $2,067 $
258
-023
724 $2,288 $2,090 $

$ 437 $ -0$ -01,145

1,149
30
$1,582 $1,149
30
$2,306 $3,437 $2,120

277
387
23
687
235
922

$ 437
2,264
$2,701
$3,623
13-30

LO
13-6

Assembling the Master Budget

for a Manufacturing Firm

13-31

LO
13-7

Budgeting in Service
Organizations

LO 13-7 Explain budgeting in merchandising and service organizat

Sales forecast

Budgeted cost
of services

Budgeted
income
statement

Cash budget

Marketing and
administrative
cost budget

Budgeted
balance sheets

13-32

LO
13-7

Budgeting Retail and Wholesale

Organizations
Sales forecast
Marketing and
administrative
cost budget

Purchases
Budgeted
income
statement
Cash budget
Budgeted
balance sheets

13-33

LO
13-7

Budgeting Retail and Wholesale

Organizations
Castro Audio & Video, Inc.
Estimated Information for Retail Operations

13-34

LO
13-7

Budgeting Retail and Wholesale

Organizations

13-35

LO
13-8

Ethical Problems in Budgeting

LO 13-8

Explain why ethical issues arise in budgeting.

Budgets can create serious

ethical issues for many people.
The company must recognize
the trade-off between
encouraging unbiased reporting
by managers and the use of
budget information in
performance evaluation and
rewards.
13-36

LO
13-9

Budgeting Under Uncertainty

LO 13-9 Explain how to use sensitivity analysis
to budget under uncertainty.

Budgets allow management to explore many

alternatives.
Spreadsheets are helpful in preparing budgets
and quantifying what-if conditions. Questions
like what if labor costs are 10 percent higher (or
lower) than projected?

13-37

LO
13-9

Alternative Budgeting Scenarios

Santiago Pants Alternative Budget Scenarios

13-38

End of Chapter 13

13-39