CHAPTER

CHAPTER 10
10
Budgetary Planning and Control

Slide 10-2

Budgets
Budgets
Formal documents that quantify a
companys plans for achieving its
goals
For many companies, the entire
planning and control process is built
around budgets.

Slide 10-3

Learning objective 1: Discuss the use of

budgets in planning and control

Use
Use of
of Budgets
Budgets in
in Planning
Planning
Budgets enhance communication
and coordination
Process forces managers to consider
their goals and objectives carefully
Managers must specify means of
achieving goals and objectives

Slide 10-4

Learning objective 1: Discuss the use of

budgets in planning and control

Use
Use of
of Budgets
Budgets in
in Control
Control
Process
Process
Provide a basis for evaluating
performance
Essential to assess the performance of
managers and their operations
Performance evaluation compares
actual with planned or budgeted
performance

Slide 10-5

Learning objective 1: Discuss the use of

budgets in planning and control

Use
Use of
of Budgets
Budgets in
in Control
Control
Significant deviations from planned
performance associated with three
potential causes:
1. The budget was poorly conceived
2. Conditions have changed
3. Managers have done a particularly
good or poor job managing operations

Slide 10-6

Learning objective 1: Discuss the use of

budgets in planning and control

Which of the following statements regarding

budgets is false?
a. They are formal documents that quantify a
companys plans.
b. They enhance communication and
coordination.
c. They are useful in planning but not in
control.
d. They provide a basis for evaluating
performance.

Answer: c
They are useful in planning AND in control
Slide 10-7

Learning objective 1: Discuss the use of

budgets in planning and control

Developing
Developing the
the Budget
Budget
Budgets are prepared for:
Departments
Divisions of a company
For the entire company
Budget Committee
Responsible for approval of various budgets
Made up of senior managers (Presidents, CFO,
controller, etc.)
Typically works with departments to develop
realistic plans
Slide 10-8

Learning objective 1: Discuss the use of

budgets in planning and control

Developing
Developing the
the Budget
Budget

Slide 10-9

Learning objective 1: Discuss the use of

budgets in planning and control

Budget
Budget Time
Time Period
Period
Managers must decide on a budget
period
- Short run budgets prepared for a
month, a quarter, or a year
- Long run budgets prepared for a threeyear or five-year period
Generally, the longer the time frame the
less detailed the budget

Slide 10-10

Learning objective 1: Discuss the use of

budgets in planning and control

Five-Year
Five-Year Budgets
Budgets

Slide 10-11

Learning objective 1: Discuss the use of

budgets in planning and control

Zero
Zero Base
Base Budgeting
Budgeting
Common starting point in budgeting is
previous period revenues and costs
Zero base requires budgeted amounts to
be justified each period
- Provides fresh consideration for validity
of budgeted amounts
- Time consuming and expensive process
- Not widely used by business enterprises

Slide 10-12

Learning objective 1: Discuss the use of

budgets in planning and control

Components
Components of
of the
the Master
Master Budget
Budget
The master budget includes:
Sales budget
Production budget
Direct materials purchases budget
Direct labor budget
Manufacturing overhead budget
Selling and administrative expense
budget
Capital acquisitions budget
Cash budget

Slide 10-13

Learning objective 2: Prepare the budget schedules

that make up the master budget

Master
Master Budget
Budget

Slide 10-14

Learning objective 2: Prepare the budget schedules

that make up the master budget

Sales
Sales Budget
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
Slide 10-15

Learning objective 2: Prepare the budget schedules

that make up the master budget

Sales
Sales Budget
Budget
Budgeted sales revenue:
Budgeted sales (units) x budgeted sales price

Slide 10-16

Learning objective 2: Prepare the budget schedules

that make up the master budget

Production
Production Budget
Budget
Quantity to be produced based on following
formula:

Desired ending inventory of finished goods

becomes beginning inventory for the next
period
Slide 10-17

Learning objective 2: Prepare the budget

schedules that make up the master budget

Production
Production Budget
Budget
Preston Joystick budget plan, Quarter 1
- Ending inventory of finished goods = 10% of
next quarters sales (25,000 X 10% = 2,500)
- Budgeted unit sales,Q1 = 21,000 units
- Budgeted unit sales, Q2 = 25,000 units
- Beginning inventory Q1 = 2,100 units

Slide 10-18

Learning objective 2: Prepare the budget schedules

that make up the master budget

 Expected unit sales for VitaPup

-Jan 12, 600; Feb 14,500; Mar 19,000
Jan beginning inventory 1,260 units
Desired ending inventory = 15% of next months
sales
Prepare production budget for Jan and Feb

Slide 10-19

Learning objective 2: Prepare the budget schedules

that make up the master budget

Direct
Direct Material
Material Purchases
Purchases Budget
Budget
Depends upon amount needed for
production and ending inventory
The following formula can be used:

Slide 10-20

Learning objective 2: Prepare the budget schedules

that make up the master budget

Direct
Direct Material
Material Purchases
Purchases Budget
Budget
Preston Joystick
Budgeted production: Q1= 21,400; Q2= 24,800
Parts/unit= 2, cost = $3 per part
Ending inventory = 10% of next months
production
Prepare materials purchases budget, Q1

Slide 10-21

Learning objective 2: Prepare the budget schedules

that make up the master budget

Budgeted production: Q1= 50,000; Q2= 60,000

Parts/unit= 3 , cost/part= $5
Ending inventory = 20% of next months production
Number of parts required for Q1 production is:
a. 50,000
b. 150,000
c. 60,000
d. 180,000
Answer: b
Q1 production 50,000 x 3 parts/unit = 150,000

Slide 10-22

Learning objective 2: Prepare the budget schedules

that make up the master budget

Budgeted production: Q1= 50,000; Q2= 60,000

Parts/unit= 3, cost/part= $5
Ending inventory = 20% of next months required parts
Desired ending inventory of parts for Q1 in units is:
a. 10,000
b. 12,000
c. 30,000
d. 36,000
Answer: d
Q2 parts = 60,000 x 3 = 180,000 x 20% = 36,000

Slide 10-23

Learning objective 2: Prepare the budget schedules

that make up the master budget

Budgeted production: Q1= 50,000; Q2= 60,000

Parts/unit= 3, cost/per part= $5
Ending inventory = 20% of next months required part
Beginning parts inventory, Q1= 30,000 units

Budgeted cost of purchases for Q1 is:

a. $750,000
b. $900,000
c. $780,000
d. $1,650,000
Answer: c
150,000 (review 2) + 36,000 (review 3) 30,000 =
156,000 parts to purchase x $5 cost = $780,000
Slide 10-24

Learning objective 2: Prepare the budget schedules

that make up the master budget

Direct
Direct Labor
Labor Budget
Budget
Direct labor cost can be budgeted using
the following formulas:
- Direct labor hours per unit x labor rate
per hour = direct labor cost per unit
- Direct labor cost per unit x units to be
produced = budgeted direct labor cost
Can be used to budget the number of
employees needed

Slide 10-25

Learning objective 2: Prepare the budget schedules

that make up the master budget

Direct
Direct Labor
Labor Budget
Budget

Slide 10-26

Learning objective 2: Prepare the budget schedules

that make up the master budget

Manufacturing
Manufacturing Overhead
Overhead Budget
Budget
Separate costs into fixed and variable:
Variable costs
Multiply cost/unit x units produced
Fixed costs
- Identical each period except for
depreciation
- Depreciation may vary due to planned
acquisitions or disposals

Slide 10-27

Learning objective 2: Prepare the budget schedules

that make up the master budget

Manufacturing
Manufacturing Overhead
Overhead Budget
Budget

Slide 10-28

Learning objective 2: Prepare the budget schedules

that make up the master budget

Selling
Selling and
and Administrative
Administrative
Expense
Expense Budget
Budget

Slide 10-29

Learning objective 2: Prepare the budget schedules

that make up the master budget

Budgeted
Budgeted Income
Income Statement
Statement
Compilation of information provided by
previously prepared budgets:
Sales from Sales Budget
Cost of goods sold calculated from:
- Direct Materials Budget
- Direct Labor Budget
- Manufacturing Overhead Budget
Other expenses from Selling and
Administrative Expense Budget

Slide 10-30

Learning objective 2: Prepare the budget schedules

that make up the master budget

Capital
Capital Acquisitions
Acquisitions Budget
Budget
Decisions with respect to long lived assets
- Use net present value or internal rate of
return to make capital acquisition
decisions
Must be carefully planned since it may
substantially reduce cash reserves

Slide 10-31

Learning objective 2: Prepare the budget schedules

that make up the master budget

Cash
Cash Receipts
Receipts and
and Disbursements
Disbursements
Budget
Budget
Managers must plan for amount and
timing of cash flows
Careful planning of receipts and
disbursements necessary to:
- Anticipate cash shortages and arrange
to borrow funds
- Anticipate cash surpluses and seek
productive uses

Slide 10-32

Learning objective 2: Prepare the budget schedules

that make up the master budget

Which of the following items does not

require a cash outflow?
a.
b.
c.
d.

Salaries
Purchase of raw materials
Advertising
Depreciation

Answer: d
Depreciation
Slide 10-33

Learning objective 2: Prepare the budget schedules

that make up the master budget

Estimate
Estimate Cash
Cash Collections
Collections and
and
Cash
Cash Disbursements
Disbursements
Cash collections
- Estimate % of credit sales collected in the
period of sale and subsequent periods

Cash disbursements
- Estimate % of materials purchases paid in
the period of purchase and subsequent
periods
- Some expenses (depreciation) do not
require cash outlays
Slide 10-34

Learning objective 2: Prepare the budget schedules

that make up the master budget

Budgeted credit sales:

December =$200,000; January =$150,000;
February =$160,000; March =$172,000

Collections:
75% month of sale, 25% following month

Budget cash collections for January:

Slide 10-35

Learning objective 2: Prepare the budget schedules

that make up the master budget

Budgeted credit sales:

December = $200,000; January= $150,000;
February= $160,000; March= $172,000

Collections:
75% month of sale, 25% following month

Budget cash collections for February:

Slide 10-36

Learning objective 2: Prepare the budget schedules

that make up the master budget

Budgeted
Budgeted Balance
Balance Sheet
Sheet
Last component of master 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

Slide 10-37

Learning objective 2: Prepare the budget schedules

that make up the master budget

Use
Use of
of Computers
Computers in
in the
the Budget
Budget
Planning
Planning Process
Process
Budget committee may review the budget
and decide it is inconsistent with
company goals
Computers are useful for revisions
- Excel or custom program
- Allow for changes in items and what-if
analysis

Slide 10-38

Learning objective 2: Prepare the budget schedules

that make up the master budget

Budgetary
Budgetary Control
Control
Budgets as a Standard for Evaluation
- The standard is the budgeted amount
- Differences between budgeted and actual
amounts are called budget variances
- Budget variances should be investigated
when they are material

Slide 10-39

Learning objective 2: Prepare the budget schedules

that make up the master budget

Static
Static and
and Flexible
Flexible Budgets
Budgets
Static Budget
Not adjusted for the actual level of production

Flexible Budget
Can be adjusted for various production levels

Level of activity used in flexible budget is

equal to the actual activity level

Slide 10-40

Learning objective 3: Explain why flexible budgets are

needed for performance evaluation

Flexible
Flexible Budget
Budget

Slide 10-41

Learning objective 3: Explain why flexible budgets are

needed for performance evaluation

A ____ budget is not adjusted for the actual

level of production.
a. Static
b. Flexible
c. Pro forma
d. None of the above
Answer: a
Static
Slide 10-42

Learning objective 3: Explain why flexible budgets are

needed for performance evaluation

Spreadsheets
Spreadsheets

Slide 10-43

Learning objective 3: Explain why flexible budgets are

needed for performance evaluation

Investigating
Investigating Budget
Budget Variances
Variances
Variances are differences between
budgeted and actual amounts
Causes of Budget Variances
- Budget may not have been well
conceived
- Conditions may have changed
- Managers may have performed
particularly well or poorly

Slide 10-44

Learning objective 3: Explain why flexible budgets are

needed for performance evaluation

Differences between budget and actual

amounts are referred to as:
a.
b.
c.
d.

Errors
Variances
Flexible budget
Static budget

Answer: b
Variances
Slide 10-45

Learning objective 3: Explain why flexible budgets are

needed for performance evaluation

Investigating
Investigating Budget
Budget Variances
Variances
Management by Exception
Economical approach
Only exceptional variances are
investigated, i.e.:
- Variances large in absolute dollars
-Variances large relative to budgeted amounts

Should investigate both unfavorable and

favorable exceptional variances

Slide 10-46

Learning objective 3: Explain why flexible budgets are

needed for performance evaluation

Unfavorable
Unfavorable Budget
Budget Variance
Variance

Slide 10-47

Learning objective 3: Explain why flexible budgets are

needed for performance evaluation

Conflict
Conflict in
in Planning
Planning and
and Control
Control
Uses
Uses of
of Budgets
Budgets
Budgets used for planning and control
Management focus on meeting or beating
budgeted targets; this affects their
compensation
Creates an inherent conflict
- Managers may pad budgets
- May shift income between periods

Slide 10-48

Learning objective 4: Discuss the conflict between the planning

and control uses of budgets

Common
Common Budget-based
Budget-based
Compensation
Compensation Scheme
Scheme

Slide 10-49

Learning objective 4: Discuss the conflict between the planning

and control uses of budgets

Issues
Issues With
With Budget-based
Budget-based
Compensation
Compensation
Managers have incentive to pad a budget
and create budget slack:
- by lowering sales forecasts and
increasing cost forecasts
-to makes budget targets easier to
achieve
Managers may shift income from one
period to another period once hurdle
target for bonus is reached

Slide 10-50

Learning objective 4: Discuss the conflict between the planning

and control uses of budgets

Budget
Budget Padding
Padding

Slide 10-51

Learning objective 4: Discuss the conflict between the planning

and control uses of budgets

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Slide 10-52