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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
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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
