Chapter 9 - Budgeting - 9-1 MGT223 Budgeting Chapter Nine...

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Unformatted text preview: 9-1 MGT223 Budgeting Chapter Nine Learning Objective 1 Explain why organizations budget and the processes they use to create budgets. Advantages of Budgeting Communicate plans Advantages Coordinate activities Means of allocating resources Uncover potential bottlenecks 9-2 Self-Imposed Budget Top Management Middle Management Supervisor Supervisor Middle Management Supervisor Supervisor A budget is prepared with the full cooperation and participation of managers at all levels. A participative budget is also known as a self-imposed budget. selfbudget. Advantages of Self-Imposed Budgets 1. Individuals at all levels of the organization are viewed 1. Individuals at all levels of the organization are viewed as members of the team whose judgments are valued as members of the team whose judgments are valued by top management. by top management. 2. Budget estimates prepared by front-line managers are 2. Budget estimates prepared by frontfront-line managers are often than estimates prepared by often than estimates prepared by top managers. top managers. 3. Motivation is generally when individuals 3. Motivation is generally when individuals participate in setting their own goals than when the participate in setting their own goals than when the goals are imposed from above. goals are imposed from above. 4. A manager who is not able to meet a budget imposed 4. A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Selffrom above can claim that it was unrealistic. SelfSelfimposed budgets eliminate this excuse. imposed budgets eliminate this excuse. Zero Based Budgeting A zero-based budget requires managers to justify all budgeted expenditures, not just changes in the budget from the prior year. Most managers argue that Most managers argue that zero-based budgeting is too zerozero-based budgeting is too time consuming and costly to time consuming and costly to justify on an annual basis. justify on an annual basis. 9-3 Learning Objective 2 Prepare the supporting components of a master budget and the budgeted financial statements. The Master Budget: An Overview Ending Ending Finished Goods Finished Goods Budget Budget Sales Sales Budget Budget Selling and Selling and Administrative Administrative Budget Budget Direct Direct Labour Labour Budget Budget Direct Direct Materials Materials Budget Budget Production Production Budget Budget Manufacturing Manufacturing Overhead Overhead Budget Budget Cash Cash Budget Budget Budgeted Financial Statements Budgeting Example Royal Company is preparing budgets for the Royal quarter ending June 30. Budgeted sales for the next five months are: Budgeted April April May May June June July July August August 20,000 units 50,000 units 30,000 units 25,000 units 15,000 units. The selling price is $10 per unit. The 9-4 The Sales Budget The individual months of April, May, and June are summed to obtain the total projected sales in units and dollars for the quarter ended June 30th Expected Cash Collections • • • • All sales are on account. All sales are on account. Royal’s collection pattern is: Royal’s collection pattern is: 70% collected in the month of sale, 70% collected in the month of sale, 70% 25% collected in the month following sale, 25% collected in the month following sale, 25% 5% uncollectible. 5% uncollectible. 5% • The March 31 accounts receivable balance of • The March 31 accounts receivable balance of $30,000 will be collected in full. $30,000 will be collected in full. Expected Cash Collections 9-5 Expected Cash Collections From the Sales Budget for April. Expected Cash Collections From the Sales Budget for May. The Production Budget Sales Budget and ted e pl Expected om C Cash Collections Production Budget Production must be adequate to meet budgeted sales and provide for sufficient ending inventory. 9-6 The Production Budget • The management at Royal Company wants ending inventory to be equal to 20% of the 20% following month’s budgeted sales in units. • On March 31, 4,000 units were on hand. Let’s prepare the production budget. Let’s The Production Budget The Production Budget March 31 ending inventory Budgeted May sales Desired ending inventory % Desired ending inventory 50,000 20% 10,000 9-7 The Production Budget The Production Budget Assumed ending inventory. The Direct Materials Budget Production Budget d m Co e et pl Direct Materials Budget The direct materials budget details the raw materials that must be purchased to fulfill the production budget and to provide for adequate inventories. 9-8 The Direct Materials Budget • At Royal Company, five pounds of material • At Royal Company, five pounds of material are required per unit of product. are required per unit of product. • Management wants materials on hand at • Management wants materials on hand at the end of each month equal to 10% of the the end of each month equal to 10% of the following month’s production. following month’s production. • On March 31, 13,000 pounds of material • On March 31, 13,000 pounds of material are on hand. Material cost is $0.40 per are on hand. Material cost is $0.40 per pound. pound. Let’s prepare the direct materials budget. Let’s prepare the direct materials budget. The Direct Materials Budget From production budget The Direct Materials Budget 9-9 The Direct Materials Budget March 31 inventory 10% of following month’s production needs. Calculate the materials to be purchased in May. The Direct Materials Budget Assumed ending inventory Expected Cash Disbursement for Materials Royal pays $0.40 per pound for its materials. Royal pays $0.40 per pound for its materials. One-half of a month’s purchases is paid for in OneOne-half of a month’s purchases is paid for in the month of purchase; the other half is paid the month of purchase; the other half is paid in the following month. in the following month. • The March 31 accounts payable balance is • The March 31 accounts payable balance is $12,000. $12,000. • • • • Let’s calculate expected cash disbursements. Let’s calculate expected cash disbursements. 9-10 Expected Cash Disbursement for Materials Expected Cash Disbursement for Materials Compute the expected cash disbursements for materials for the quarter. 140,000 lbs. × $.40/lb. = $56,000 Expected Cash Disbursement for Materials 9-11 Learning Objective 3 Prepare a flexible budget and explain the need for the flexible budget approach. Static Budgets and Performance Reports Static budgets are prepared for a single, of activity. Performance evaluation is difficult when actual activity differs from the planned level of activity. Flexible Budgets May be prepared for any activity level in the relevant range. Show costs that should have been incurred at the actual level of activity, enabling “apples to apples” cost comparisons. Reveal variances related to cost control. Improve performance evaluation. Let’s look at CheeseCo. 9-12 Static Budgets and Performance Reports CheeseCo Static Budget Machine hours Variable costs Indirect labour Indirect materials Power Fixed costs Depreciation Insurance Total overhead costs Actual Results Variance s 10,000 $ 40,000 30,000 5,000 12,000 2,000 $ 89,000 Static Budgets and Performance Reports CheeseCo Static Budget Machine hours Variable costs Indirect labour Indirect materials Power Fixed costs Depreciation Insurance Total overhead costs Actual Results 10,000 $ 40,000 30,000 5,000 $ 34,000 25,500 3,800 12,000 2,000 12,000 2,050 $ 89,000 Variance s 8,000 $ 77,350 Static Budgets and Performance Reports CheeseCo Static Budget Machine hours 10,000 Actual Results Variance s 8,000 2,000 U Variable costs U = Unfavourable variance Indirect labour $ 40,000 $ 34,000 CheeseCo was unable to achieve Indirect materials 30,000 25,500 the budgeted5,000 of activity. level Power 3,800 Fixed costs Depreciation Insurance Total overhead costs $6,000 F 4,500 F 1,200 F 12,000 2,000 12,000 2,050 0 50 U $ 89,000 $ 77,350 $11,650 F 9-13 Static Budgets and Performance Reports CheeseCo Static Budget Machine hours Variable costs Indirect labour Indirect materials Power Actual Results Variance s 10,000 8,000 2,000 U $ 40,000 30,000 5,000 $ 34,000 25,500 3,800 $6,000 F 4,500 F 1,200 F F = Favourable variance that occurs when Fixed costs actual costs are less than budgeted costs. Depreciation 12,000 12,000 Insurance 2,000 2,050 Total overhead costs $ 89,000 $ 77,350 0 50 U $11,650 F Static Budgets and Performance Reports CheeseCo Static Budget Machine hours Variable costs Indirect labour Indirect materials Power Actual Results Variance s 10,000 8,000 2,000 U $ 40,000 30,000 5,000 $ 34,000 25,500 3,800 $6,000 F 4,500 F 1,200 F Since cost Fixed costs variances are favourable, have we done a good job controlling costs? Depreciation 12,000 12,000 Insurance 2,000 2,050 Total overhead costs $ 89,000 $ 77,350 0 50 U $11,650 F Static Budgets and Performance Reports The relevant question is .. .. .. The relevant question is “How much of the favourable cost variance “How much of the favourable cost variance is due to lower activity, and how much is due is due to lower activity, and how much is due to good cost control?” to good cost control?” To answer the question, To answer the question, we must we must the budget to the the budget to the actual level of activity. actual level of activity. 9-14 Preparing a Flexible Budget To a budget we need to know that: Total variable costs change in direct proportion to changes in activity. Total fixed costs remain unchanged within the relevant range. b ria Va le Fixed Learning Objective 4 Prepare a performance report using the flexible budget approach. Flexible Budget Performance Report CheeseCo Flexible budget Cost is prepared for the Formula per Hour same activity level (8,000 hours) as Machine hours actually Variable costs achieved. Indirect labour Indirect material Power Total variable cost Fixed costs Depreciation Insurance Total fixed cost Total overhead costs $ $ Total Fixed Cost Actual Results 8,000 4.00 3.00 0.50 7.50 Flexible Budget 8,000 $ 34,000 25,500 3,800 $ 63,300 $ 12,000 2,000 $ 12,000 2,050 $ 14,050 $ 77,350 Variances 0 9-15 Flexible Budget Performance Report CheeseCo Cost Formula per Hour Total Fixed Cost Flexible Budget Actual Results 8,000 8,000 $ 32,000 $ 34,000 25,500 3,800 $ 63,300 Machine hours Variable costs Indirect labour Indirect material Power Total variable cost $ $ 4.00 3.00 0.50 7.50 Fixed costs Depreciation Insurance Total fixed cost Total overhead costs $ 12,000 2,000 Variances 0 $ 2,000 U $ 12,000 2,050 $ 14,050 $ 77,350 Flexible Budget Performance Report CheeseCo Cost Formula per Hour Total Fixed Cost Variable costs Indirect labour Indirect material Power Total variable cost $ $ Fixed costs Depreciation Insurance Total fixed cost Total overhead costs $ 12,000 2,000 8,000 $ 32,000 24,000 4,000 $ 60,000 4.00 3.00 0.50 7.50 Actual Results 8,000 Machine hours Flexible Budget $ 34,000 25,500 3,800 $ 63,300 $ 2,000 U 1,500 U 200 F $ 3,300 U $ 12,000 2,000 $ 14,000 $ 74,000 $ 12,000 2,050 $ 14,050 $ 77,350 $ Variances 0 0 50 U 50 U $ 3,350 U Static Budgets and Performance How much of the $11,650 favourable variance is due to lower activity and how much is due to cost control? Static Budget Machine hours Variable costs Indirect labor Indirect materials Power Fixed costs Depreciation Insurance Total overhead costs Actual Results Variance s 10,000 8,000 2,000 U $ 40,000 30,000 5,000 $ 34,000 25,500 3,800 $6,000 F 4,500 F 1,200 F 12,000 2,000 12,000 2,050 0 50 U $ 89,000 $ 77,350 $11,650 F 9-16 Flexible Budget Performance Report Overhead Variance Analysis Static Overhead Budget at 10,000 Hours $ 89,000 Let’s place the flexible budget for 8,000 hours here. Actual Overhead at 8,000 Hours $ 77,350 Difference between original static budget and actual overhead = $11,650 F. Flexible Budget Performance Report Overhead Variance Analysis Static Overhead Budget at 10,000 Hours $ 89,000 Flexible Overhead Budget at 8,000 Hours $ Activity This $15,000F variance is . 74,000 Actual Overhead at 8,000 Hours $ 77,350 Cost control This $3,350U variance is . ...
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This note was uploaded on 10/10/2011 for the course ECON 110 taught by Professor Boliy during the Spring '11 term at Aachen University of Applied Sciences.

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