Chapter 23 – Operational Budgeting
Financial and Managerial Accounting, 17/e 23-1
23 OPERATIONAL
BUDGETING
Chapter Summary
The master budget can be a powerful tool for successful planning and control.
Organizations benefit from an effective budgeting process in several ways. First, the budget
assigns responsibility for decision-making to specific managers. Second, it enhances the degree
of planned coordination among organizational units. Third, performance evaluation is improved
since the budget assigns responsibility and allows comparison between actual and expected
outcomes.
The master budget is developed as a set of interrelated plans. These are derived
sequentially beginning with a sales forecast. The sales forecast leads to a production schedule
and an integrated set of manufacturing cost budgets. A plan for ending inventory then leads to a
budget for the cost of goods sold. Budgeting for operating expenses completes the operating
budget. With the operating budget in hand, we next prepare a budgeted income statement. One
of the objectives in so doing is to emphasize that a firm may be profitable but cash poor due to
the length of its operating cycle.
The cash budget is the key to identifying the points in the operating cycle causing the
cash flow problem. Development of the cash budget requires assumptions regarding the timing
of cash receipts and payments. These assumptions combined with the operating budget yield the
cash budget.
The chapter concludes with an illustration of flexible budgeting. This analysis
emphasizes that the flexible budget improves performance evaluation by isolating the effects of
unanticipated volume changes.
Learning Objectives
1. Explain how a company can be “profit rich, yet cash poor.”
2. Discuss the benefits that a company may derive from a formal budgeting process.
3. Explain two philosophies that may be used in setting budgeted amounts.
4. Describe the elements of a master budget.
5. Prepare the budgets and supporting schedules included in a master budget.
6. Prepare a flexible budget and explain its uses.
Chapter 23 – Operational Budgeting
Brief topical outline
A Profit rich, yet cash poor
1 Operating cash flows: the lifeblood of survival
B Budgeting: the basis for planning and control – see Case in Point (page 996)
1 Benefits derived from budgeting
2 Establishing budgeted amounts
a The behavioral approach – see Your Turn (page 997)
b The total quality management approach
c Selecting and using a budgeting approach – see Ethics, Fraud &
Corporate Governance (page 1015)
3 The budget period
4 The master budget: a package of related budgets
5 Steps in preparing a master budget
6 Preparing the master budget: an illustration
7 Operating budget estimates
a Manufacturing cost estimates
b The sales budget
c Production budgets
d Manufacturing cost budgets
e Cost of goods manufactured and sold budget
f Finished goods inventory
g Selling and administrative expense budget
8 Budgeted income statement
9 Cash budget estimates
a Current payables budget
b Prepayments budget
c Debt service budget
d Budgeted income taxes
e Estimated cash receipts from customers – see Your Turn (page 1009)
10 The cash budget
11 Budgeted balance sheets
12 Using budgets effectively
a Advance warning of and responsibility for decision-making
b Coordination of the activities of departments
c A yardstick for evaluating management performance
13 Flexible budgeting
a Computers and flexible budgeting
C Concluding remarks
Chapter 23 – Operational Budgeting
Financial and Managerial Accounting, 17/e 23-3
Topical coverage and suggested assignment
Homework Assignment
(To Be Completed Prior to Class)
Class
Meetings
on Chapter
Topical
Outline
Coverage
Discussion
Questions
Brief
Exercises
Exercises
Problems
Critical
Thinking
Cases
1
A – B
1, 2, 3
1, 2, 9
12
2
B
4, 5, 6
3. 4. 6
1, 3, 5
1
1
3
B – C
9, 13, 14
10
10, 11
2
Comments and observations
Teaching objectives for Chapter 23
The topics presented in Chapter 23 are central to the managerial functions of planning and
control. Our teaching objectives in presenting these topics are to:
1 Discuss the benefits of budgeting to virtually every business organization.
2 Discuss whether budgets should be established at optimal levels or at reasonably
achievable levels.
3 Describe the elements of a master budget, and discuss the logical sequence of their
preparation.
4 Explain the necessity of using a computer in preparing the master budget for a large
organization. Extend this discussion into the preparation of flexible budgets and
budgets reflecting different assumptions.
5 Illustrate several basic computations of budgeted amounts, such as the budgeted level of
production (given a sales forecast and budgeted inventories), and budgeted cash collections
from customers (given a sales forecast and the pattern in which receivables are collected).
6 Explain the limitations of a static budget for conducting performance evaluation.
7 Using the concepts of cost-volume-profit analysis, develop a flexible budget and
demonstrate how it is used to evaluate performance.
Chapter 23 – Operational Budgeting
General comments
In covering budgeting, it is important not to get “bogged down” in the computations of budgeted
amounts. With this in mind, the chapter is focused from the outset on the importance of planning
and controlling cash flows from operations. There are, of course, an unlimited number of
potential computations; it is not possible to illustrate them all. Therefore, we usually illustrate
only one or two of the “basic” types of budgeting computations. Exercises 1 thru 9 are intended
for this purpose. Case 1 provides an opportunity for students to confront the interrelationships
among budgeted financial statements free from an excessive computational burden. We highly
recommend reviewing this case in class.
We also emphasize that in a large organization, the number of specific schedules and
budgets comprising the master budget requires the use of a computer in the budgeting process.
The computer is programmed with the “cost formulas” and the interrelationships among
budgeted amounts. Once this task is completed, the computer can almost instantly develop every
element of the budget from forecast sales data. In addition, the budgeting software can be used
to assess the expected impact of changes in sales, production costs, or any of the other variables
upon which the budget is based. The original development of budgeting software is a formidable
task. Once this software has been developed, however, the time-consuming “number crunching”
aspects of budgeting are eliminated. Also, this software may be used for many years, requiring
only minor adjustments to cost formulas and interrelationships among the budgeted amounts.
An aside There is no more dramatic case of a profit rich – cash poor company than W.T. Grant,
Inc. in the years leading up to its liquidation in 1976. In each of the nine years prior to declaring
bankruptcy, the company reported positive net income. However, it experienced negative cash
flows from operations as it continued to invest in unsalable inventory and uncollectible
receivables. The history of this failed corporation is an object lesson in the importance of
budgeting cash flows.
Supplemental Exercises
Group Exercise
(To complete this exercise, at least one group member must have basic knowledge of the
use of personal computer and spreadsheet software.) Reconsider Problems 23-7 and 23-8. Use
Excel to solve these problems. Your worksheets should be developed so that the flexible budget
can be recomputed for any level of volume within a relevant range. Demonstrate the operation
of the computerized flexible budget to the class.
Chapter 23 – Operational Budgeting
Financial and Managerial Accounting, 17/e 23-5
CHAPTER 23 NAME #
10-MINUTE QUIZ A SECTION
Indicate the best answer for each question in the space provided.
1 Which of the following is not normally a characteristic of a profit rich, cash poor
company?
a Low inventory turnover.
b High accounts receivable turnover.
c High operating income, but low cash flow from operations.
d A long operating cycle.
2 Which of the following is not considered a benefit from budgeting?
a Limited managerial perspectives.
b Advance warning of problems.
c Better coordination among activities.
d A measure of performance evaluation.
3 Which of the following is a characteristic of the behavioral approach to setting budget
targets?
a Complete elimination of inefficiency.
b Complete elimination of non-value-adding activities.
c Constant need for improvement.
d Achievable performance expectations.
4 Which of the following is not normally considered an element of a master budget?
a The production schedule.
b The employee turnover budget.
c The operating expense budget.
d The cash budget.
5 Which budget typically serves as a starting point in developing a master budget?
a The sales budget.
b The cost of goods sold budget.
c The employee turnover budget.
d The manufacturing cost budget.
Chapter 23 – Operational Budgeting
CHAPTER 23 NAME #
10-MINUTE QUIZ B SECTION
Use the following data for questions 1 through 3.
The following budget for the 60,000-unit product level was prepared for the Production
Department for September:
Budgeted
(60,000 Units)
Variable costs:
Direct materials cost ………………………………………………………………. $ 42,000
Direct labor …………………………………………………………………………… 51,000
Variable overhead ………………………………………………………………….. 36,000
Fixed costs:
Manufacturing overhead …………………………………………………………. 66,000
Total manufacturing costs …………………………………………………………. $195,000
During September, the Production Department actually produced 70,000 units at a total
manufacturing cost of $210,000.
1 Refer to the above data. Which of the following is not an accurate amount to be
included in a flexible budget prepared for the 70,000-unit level of production?
a Total overhead cost, $108,000.
b Total manufacturing costs, $210,000.
c Direct materials, $49,000.
d Direct labor, $59,500.
2 Refer to the above data. A performance report prepared for September operations
under a flexible budget approach would show:
a Actual costs under budget by $6,500.
b Total costs per flexible budget of $215,000.
c Actual costs under budget by $21,500.
d Actual costs over budget by $15,000.
3 Refer to the above data. The cost-volume relationship used to prepare the flexible
budget for this department includes:
a Manufacturing overhead cost of $1.00 per unit.
b Fixed cost of $0.83 per unit.
c Total cost of $2.98 per unit.
d Variable costs of $2.15 per unit.
_____ 4 The Company’s actual manufacturing costs for the month of May totaled
$144,000, while the budgeted manufacturing costs were $162,000. Comparison
of the budgeted costs with actual amounts:
a Is not significant unless the budgeted and actual figures are based upon the same
level of production.
b Demonstrates that the Manufacturing Department operated very efficiently during
May.
c Indicates that production cost per unit was 10% below budgeted cost per unit.
d Indicates that the Company produced only 90% of the number of units budgeted for
production in May.