978-1337119207 Chapter 21 Part 1

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385

chapter

21(7)

Budgeting

______________________________________________

OPENING COMMENTS

compared to the budgeted results.

After studying the chapter, your students should be able to:

1. Describe budgeting, its objectives, and its impact on human behavior.

computers in budgeting.

3. Describe the master budget for a manufacturing company.

4. Prepare the basic operating budgets for a manufacturing company.

5. Prepare financial budgets for a manufacturing company.

ADM: Describe and illustrate the use of staffing budgets for nonmanufacturing businesses.

KEY TERMS

budget

budgetary slack

capital expenditures budget

cash budget

continuous budgeting

cost of goods sold budget

direct labor cost budget

direct materials purchases budget

factory overhead cost budget

Chapter 21(7) Budgeting 386

flexible budget

goal conflict

master budget

production budget

responsibility center

sales budget

static budget

zero-based budgeting

STUDENT FAQS

 Since budgets are estimates made before a period begins and may prove wrong, are they worth the

time and effort put into them?

 Why are the cash budget and the capital expenditures budget so important from the balance sheet

budgeting process?

 In a production budget, the volume of production is the first thing to calculate, but deducting the

estimated units in beginning inventory and adding the desired units in ending inventory seems

opposite. Can you explain so I can understand better?

 How do you calculate manufacturing cost?

 The cost of goods sold budget is so long. Why do you expect us to learn to calculate it without the

formula written out?

OBJECTIVE 1

Describe budgeting, its objectives, and its impact on human behavior.

SYNOPSIS

Budgeting plays an important role in aiding managers to plan, direct, and control their business. Planning

involves setting goals, directing helps achieve those goals, and controlling involves comparing the

business’s performance against the budgeted goals that were set. Budgeting can also cause problems in

human behavior. If budgeted goals are set too tightly, and goals are viewed as unachievable, employees

may become discouraged. Reasonable attainable goals motivate employees and managers. Budgeted goals

that are too loose may create inefficiency, by reducing the budgetary incentive to trim spending. Goal

conflict occurs when the employees’ or managers’ self–interest differs from the company’s goals.

Key Terms and Definitions

 Budget—An accounting device used to plan and control resources of operational departments

and divisions.

 Budgetary Slack—Excess resources set within a budget to provide for uncertain events.

 Goal Conflict—A condition that occurs when individual objectives conflict with organizational

objectives.

Chapter 21(7) Budgeting 387

 Responsibility Center—An organizational unit for which a manager is assigned responsibility

over costs, revenues, or assets.

Relevant Check Up Corner and Exhibits

 Exhibit 1—Planning, Directing, and Controlling

 Exhibit 2—Human Behavior Problems in Budgeting

SUGGESTED APPROACH

A budget is used to plan and control operational departments and divisions. Review this explanation and

stress the following points:

1. Budgeting begins with planning, which involves setting specific goals for future operations.

2. Directing involves decisions and actions to achieve the budgeted goals.

3. Controlling is periodically comparing actual results to these goals.

4. Budgets are most effective if:

a. Employees help set goals they are expected to achieve.

b. Budgets are realistic, not too strict.

c. Budgets are not “padded” or too loose.

d. Budgets do not encourage employees to act in ways that conflict with business goals.

An example of goal conflict can be taken from the way many instructors assign course grades. There may

be a conflict if the instructor wants students to participate in class discussions, but bases course grades

strictly on exam scores.

CLASS DISCUSSION—Human Behavior and Budgeting

Ask your students to share examples from their own experiences where budgets caused employees to act

in a manner that hurt the performance or profitability of their organization. After accumulating your

students’ ideas, add observations from your own experience. For example, there is usually no incentive

for managers to spend less than their allowed budget, since it will be difficult to negotiate a higher budget

the next year. As a result, managers frequently “spend the budget” as the fiscal year closes.

WRITING EXERCISE—Evaluating Budgeting Procedures

Ask your students to write an answer to the following question [Transparency Master (TM) 21(7)-1].

Pretorious Manufacturing has just hired a new controller, Diana Metcalf. During her first

week on the job, Diana was asked to establish a budget for operating expenses in 2014.

Since Diana was not yet familiar with the operations of Pretorious Manufacturing, she

decided to budget these expenses using the same procedures as the prior controller.

Therefore, in order to establish a budget for operating expenses, Diana started with actual

operating expenses incurred in 2013 and added 4.3 percent. Diana based this percentage

on inflation as measured by the consumer price index.

Chapter 21(7) Budgeting 388

Possible response: This method of budgeting would be the least desirable method. Although the

previous year’s budget is a starting point, additional input is required to validate that budget to

determine if changes need to be made. Proper budgeting procedures require the input of various

key management employees in order to accurately predict the company’s needs for the

period.

INTERNET ACTIVITY—Personal Budgeting

To spark interest in the topic of budgeting, ask your students to do a Web search using the word

“Budgeting” as the search criteria. This search should find a variety of Web sites with information on

preparing a personal budget. Ask your students to find a couple of tips on developing a personal budget to

share with the class.

OBJECTIVE 2

use of computers in budgeting.

SYNOPSIS

Budgeting systems are varied and differ between companies; however, most companies budget by the

fiscal year. A variation of this is the continuous budget; it maintains a 12-month projection into the future.

As one month drops off, it is replaced by the same month next year. A common approach to budgeting is

Computers are helpful in developing budgets and linking budget and planning information across the

organization.

Key Terms and Definitions

 Continuous Budgeting—A method of budgeting that provides for maintaining a 12-month

projection into the future.

Chapter 21(7) Budgeting 389

 Zero-Based Budgeting—A concept of budgeting that requires all levels of management to start

from zero and estimate budget data as if there had been no previous activities in their units.

Relevant Check Up Corner and Exhibits

 Exhibit 3—Continuous Budgeting

 Exhibit 4—Static Budget

 Exhibit 5—Flexible Budget

 Exhibit 6—Static and Flexible Budgets

 Check Up Corner 21(7)-1 – Flexible Budget

SUGGESTED APPROACH

budgeting.

Follow this introduction with additional material to reinforce the concept of a flexible budget. A thorough

understanding of flexible budgeting is essential to material presented in this chapter and Chapter 22,

which addresses standard costing.

WRITING EXERCISE—Flexible Budgets

[TM 21(7)-3].

Assume that you manage one store in a chain of sporting goods retailers. Each month,

your store is evaluated by comparing actual operating results to budgeted results.

Possible response: Items that would be affected by sales higher than budgeted might include cost

of merchandise sold, sales commissions, and other selling expenses. Flexible budgeting at various

sales levels could address this situation.

Chapter 21(7) Budgeting 390

DEMONSTRATION PROBLEM—Benefits of Flexible Budgeting

As an alternative to the writing exercise above, you may want to capture your students’ attention by

demonstrating the ineffectiveness of a static budget. Relate a static budget to a student’s personal budget.

Assume the student budgets $30 per month for gas. However, during the year, the student gets a job

delivering pizza. As a result, the student spends more than the budget because of increased gas expenses.

TM 21(7)-4 presents information for the Laboratory Services department of Eastgate Hospital. On this

TM, a static budget is compared to actual results. Ask students to comment on how actual results

compared to the hospital’s budget. They will quickly point out that the department was $50,000 over

budget. Next, ask students to evaluate why the variance occurred or to comment on the efficiency of

given.

Next, show TM 21(7)-5, which presents actual results compared against a flexible budget at two activity

levels. Ask students to evaluate the performance of the Laboratory Services department, using this

information. They will be able to see that the department performed quite well, given the increase in

LECTURE AID—Preparing a Flexible Budget

By definition, variable costs increase as sales or production increases. Flexible budgets allow a company

to budget for varying levels of sales and production. The following steps are used in preparing a flexible

budget.

1. Identify the relevant activity levels.

2. Identify the fixed and variable cost components of the costs being budgeted.

3. Prepare the budget for each activity level then add the fixed cost for the period.

GROUP LEARNING ACTIVITY—Flexible Budget

TM 21(7)-6 provides information to be used to complete a flexible budget for a manufacturer. Divide

your class into small groups and ask them to prepare the budget for the indicated levels. Recalculating the

budget for three activity levels will emphasize the usefulness of computers in preparing budgets. You may

want to mention that computer software systems such as spreadsheets and integrated budget and planning

programs ease the budget preparation process as well as serve to provide timely results for analysis. The

correct solution is listed on TM 21(7)-7.

OBJECTIVE 3

Describe the master budget for a manufacturing company.

Chapter 21(7) Budgeting 391

SYNOPSIS

An integrated set of operating and financial budgets for a period of time is called a master budget. Most

are prepared on a yearly basis. Exhibit 7 shows a list of all the individual budgets contained within the

master budget.

Key Terms and Definitions

 Master Budget—The comprehensive budget plan linking all the individual budgets related to

sales, cost of goods sold, operating expenses, projects, capital expenditures, and cash.

Relevant Check Up Corner and Exhibits

 Exhibit 7—Master Budget for a Manufacturing Company

 Exhibit 8—Operating Budgets

SUGGESTED APPROACH

Refer your students to Exhibit 8 in the text. This exhibit diagrams the relationship between the income

statement budgets within the master budget. Use this illustration to emphasize the importance of properly

organizing the budgeting process. Also stress the dramatic affect budgeting errors can have as they “ripple

down” through the organization.

OBJECTIVE 4

Prepare the basic operating budgets for a manufacturing company.

SYNOPSIS

The integrated operating budgets start with preparing a sales budget. The first step in a sales budget is

estimating the quantity of sales for the year. Once sales quantities are estimated, the budgets revenue can

materials purchases budget estimates the quantities of direct materials to be purchased to support

Chapter 21(7) Budgeting 392

budgeted production and desired inventory levels. Also using information from the production budget is

the direct labor budget. The budgeted direct labor hours required for production is computed as: budgeted

direct labor = budgeted production volume × direct labor hours expected. The factory overhead cost

budget estimates the cost for each item of factory overhead needed to support budgeted production. The

cost of goods sold budget uses information from the direct materials purchase budget, the direct labor cost

budget, and the factory overhead cost budget. The cost of goods sold budget is illustrated in Exhibit 14.

The selling and administrative expenses budget shown in Exhibit 15 also starts with the sales budget. The

budgeted income statement is prepared by integrating the sales budget, the cost of goods sold budget, and

the selling and administrative expenses budget. The budgeted income statement allows management to

assess the effects of estimated sales, costs, and expenses on profits for the upcoming year.

Key Terms and Definitions

factory overhead consumed by sold products.

 Direct Labor Cost Budget—Budget that estimates direct labor hours and related costs needed to

support budgeted production.

 Direct Materials Purchases Budget—A budget that uses the production budget as a starting

point to budget materials purchases.

overhead needed to support budgeted production.

 Production Budget—A budget of estimated unit production.

 Sales Budget—One of the major elements of the income statement budget that indicates the

quantity of estimated sales and the expected unit selling price.

Relevant Check Up Corner and Exhibits

 Exhibit 9—Sales Budget

 Exhibit 10—Production Budget

 Exhibit 11—Direct Materials Purchases Budget

 Exhibit 12—Direct Labor Cost Budget

 Exhibit 13—Factory Overhead Cost Budget

 Exhibit 14—Cost of Goods Sold Budget

 Exhibit 15—Selling and Administrative Expenses Budget

 Exhibit 16—Budgeted Income Statement

SUGGESTED APPROACH

The budgets prepared by a manufacturer related to income statement items include:

1. Sales budget

2. Production budget

3. Direct materials purchases budget

4. Direct labor cost budget

5. Factory overhead cost budget

6. Cost of goods sold budget

Chapter 21(7) Budgeting 393

7. Selling and administrative expenses budget

8. Budgeted income statement

It is difficult (if not impossible) to demonstrate all of these budgets in class. Therefore, you may want to

restrict class coverage to the more complicated budgets: production, direct materials purchases, and cost

of goods sold.

DEMONSTRATION PROBLEM—Production Budget

The basic format of a production budget is as follows:

Expected Sales in Units

+ Desired Units in Ending Inventory

= Total Units Needed

– Estimated Units in Beginning Inventory

Total Units to be Produced

Demonstrate this budget using the following information:

Miles Manufacturing has prepared the following sales budget for the first four months of

the year:

January February March April

Sales 20,000 22,000 25,000 21,000

January February March

Expected Sales in Units 20,000 22,000 25,000

Desired Units for Ending Inventory 5,500 6,250 5,250

Total Units Needed 25,500 28,250 30,250

Estimated Units in Beg. Inventory 3,000 5,500 6,250

Total Units to be Produced 22,500 22,750 24,000