chapter
21(6)
Budgeting
______________________________________________
OPENING COMMENTS
Chapter 21(6) emphasizes accounting activities that help managers plan, direct, and control the operations
of a business. Budgeting is used to establish business goals in the planning function. Budgets help guide
managers’ operational decisions. Budgets are also used to control operations as actual results are
compared to the budgeted results.
After studying the chapter, your students should be able to:
2. Describe the basic elements of the budget process, the two major types of budgeting, and the use of
computers in budgeting.
4. Prepare the basic operating budgets for a manufacturing company.
5. Prepare financial budgets for a manufacturing company.
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
flexible budget
goal conflict
386 Chapter 21(6) Budgeting
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?
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
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.
• Responsibility Center – An organizational unit for which a manager is assigned responsibility
over costs, revenues, or assets.
Chapter 21(6) Budgeting 387
Relevant Example Exercises 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:
2. Directing involves decisions and actions to achieve the budgeted 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
WRITING EXERCISE—Evaluating Budgeting Procedures
Ask your students to write an answer to the following question [Transparency Master (TM) 21(6)-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
388 Chapter 21(6) Budgeting
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
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
Describe the basic elements of the budget process, the two major types of budgeting, and the
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
to start with last year’s budget and adjust for any expected changes for the new year. Another approach,
zero-based budgeting, requires that managers estimate sales, production, and other data as if the
Key Terms and Definitions
• Continuous Budgeting – A method of budgeting that provides for maintaining a 12-month
projection into the future.
• Flexible Budget – A budget that adjusts for varying rates of activity.
• Static Budget – A budget that does not adjust to changes in activity levels.
• 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.
Chapter 21(6) Budgeting 389
Relevant Example Exercises and Exhibits
• Example Exercise 21(6)-1 Flexible Budgeting
• Exhibit 3 – Continuous Budgeting
• Exhibit 4 – Static Budget
• Exhibit 5 – Flexible Budget
• Exhibit 6 – Static and Flexible Budgets
SUGGESTED APPROACH
TM 21(6)-2 describes the two major types of budgets, the static budget and the flexible budget. When
covering zero-based budgeting, point out that it is rare for an organization to require zero-based budgeting
every year. More typically, zero-based budgeting is used as a tool to take a fresh view of operations each
WRITING EXERCISE—Flexible Budgets
As an introduction to flexible budgets, ask your students to write a response to the following question
[TM 21(6)-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.
During December of the current year, your store’s sales were up 25 percent from sales
projected on the budget. As a result of this increase in sales, would you expect any other
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.
Is this really “bad news”? Not if the student’s wages and tips exceed the additional expenses.
390 Chapter 21(6) Budgeting
TM 21(6)-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
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.
3. Prepare the budget for each activity level then add the fixed cost for the period.
GROUP LEARNING ACTIVITY—Flexible Budget
TM 21(6)-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
OBJECTIVE 3
Describe the master budget for a manufacturing company.
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 Example Exercises and Exhibits
• Exhibit 7 – Master Budget for a Manufacturing Company
• Exhibit 8 – Operating Budgets
SUGGESTED APPROACH
The master budget is the comprehensive budget plan that includes the many individual budgets used to
estimate income statement and balance sheet items. These budgets are listed in the text under Objective 3.
The actual preparation of the components of the master budget is covered under Objectives 4 and 5.
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
be determined as follows: budgeted revenue = expected sales volume × expected unit sales price. The
production budget should be integrated with the sales budget to ensure that production and sales are kept
in balance throughout the year. The production budget estimates the number of units to be manufactured
to meet budgeted sales and desired inventory levels. Exhibit 10 illustrates the production budget for the
392 Chapter 21(6) Budgeting
Key Terms and Definitions
• Cost of Goods Sold Budget – A budget of the estimated direct materials, direct labor, and 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.
Relevant Example Exercises and Exhibits
• Example Exercise 21(6)-2 Production Budget
• Example Exercise 21(6)-3 Direct Materials Purchases Budget
• Example Exercise 21(6)-4 Direct Labor Cost Budget
• Example Exercise 21(6)-5 Cost of Goods Sold Budget
• 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
1. Sales budget
3. Direct materials purchases budget
5. Factory overhead cost budget
7. Selling and administrative expenses budget
8. Budgeted income statement
Chapter 21(6) Budgeting 393
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
Explain that the ending inventory provides a cushion in case sales exceed projections or production falls
short of the budget. It also gives the company units to sell at the beginning of the following budget period.
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
Miles estimates that it will begin the year with 3,000 units in inventory. The company
wants to end each month with inventory equal to 25 percent of the next month’s projected
sales. Prepare a production budget for January through March.
Note that the ending inventory of one month becomes the beginning inventory of the following month.
GROUP LEARNING ACTIVITY—Direct Materials Purchases Budget
The direct materials purchases budget follows the same basic format as the production budget. The only
modification is that this budget must be prepared in both units and dollars because the cost of materials
purchased is used in the cost of goods sold budget.
394 Chapter 21(6) Budgeting
The direct materials purchases budget is prepared as follows:
Divide your class into small groups. Ask students to prepare a direct materials purchases budget for Miles
Manufacturing for January and February, using their notes from the preceding demonstration problem and
the following additional information:
2. Materials cost $0.60 per pound.
4. Miles’ desired ending inventory for materials is 5,000 pounds.
The solution to this activity is presented on TM 21(6)-8.
LECTURE AID—Direct Labor and Overhead Budgets
Because the direct labor and overhead budgets are used in the cost of goods sold budget, you may want to
quickly review their format.
The direct labor cost budget is prepared as follows:
A direct labor budget is illustrated in text Exhibit 12. Emphasize that the production and direct labor
budgets must be closely coordinated. If a failure to properly budget labor time results in a labor shortage,
the business may be forced to pay significant amounts of overtime, delay production, or use untrained
workers whose output is poor in quality.
Chapter 21(6) Budgeting 395
GROUP LEARNING ACTIVITY—Cost of Goods Sold Budget
The cost of goods sold budget is complex enough to merit a brief explanation plus an in-class practice
While reviewing TM 21(6)-9, stress the sources for the following information:
Information Source
Beginning Finished Goods Inventory Management’s estimate
Beginning Work in Process Inventory Management’s estimate
Beginning Direct Materials Inventory Direct materials purchases budget
(no. of units unit price)
Direct Materials Purchases Direct materials purchases budget
Ending Direct Materials Inventory Direct materials purchases budget
(no. of units unit price)
OBJECTIVE 5
Prepare financial budgets for a manufacturing company.
SYNOPSIS
Operating budgets reflect the operating activities of the company; the financial budgets reflect the
financing and investing activities. Two of these are the cash budget and the capital expenditures budget.
The cash budget covers both the inflows and outflows of cash. The primary source of cash receipts is
from cash sales and collection on account. Using the sales budget, cash receipts are estimated for each
month. To estimate cash payments, budgeted cash payments for any month are the sum of the cash paid
from the previous month’s manufacturing costs and the cash from the current month’s manufacturing
Relevant Example Exercises and Exhibits
• Example Exercise 21(6)-6 Cash Budget
• Exhibit 17 – Schedule of Collections from Sales
• Exhibit 18 – Schedule of Payments for Manufacturing Costs
• Exhibit 19 – Cash Budget
• Exhibit 20 – Capital Expenditures Budget
SUGGESTED APPROACH
The two balance sheet budgets presented under this objective are the cash budget and the capital
expenditures budget. The capital expenditures budget, which summarizes plans for acquiring fixed assets,
is illustrated in Exhibit 20 in the text. Refer your students to this illustration. Emphasize that most
companies budget capital expenditures for several years into the future, due to the large dollar amounts
associated with these expenditures and the variation in need for capital improvements from year to year.
GROUP LEARNING ACTIVITY—Cash Receipts
The portion of the cash budget that tends to be the most difficult for students is determining the cash
receipts from sales. The difficulty occurs because credit sales are frequently collected over two or more
months.
TM 21(6)-12 presents information for your students to use in preparing the cash receipts portion of a cash
budget. This TM contains data and a basic “shell” format for determining the collections on credit sales.
Divide the class into groups and ask them to complete this exercise. TM 21(6)-13 shows the correct
solution.
GROUP LEARNING ACTIVITY—Cash Payments
TMs 21(6)-14 and 21(6)-15 present an opportunity for your students to practice preparing a schedule of
cash payments. Prior to assigning this activity, remind students that financial accounting recognizes
Chapter 21(6) Budgeting 397
Handout 21(6)-1
Cost of Goods Sold Budget
The following are the direct materials purchases, direct labor cost, and factory overhead
budgets for Bowerman Corporation for the month of August.
Direct Materials Purchases Budget
Material A Material B
Direct Labor Cost Budget Factory Overhead Cost Budget
Hours required for production 5,000 Supervisor salaries $18,000
Hourly rate $10 Utilities 3,500
Total direct labor cost $50,000 Depreciation 7,400
Indirect materials 2,100
Total factory overhead cost $31,000
Bowerman also estimates the following beginning and ending inventory amounts.
Type Item Description LO(s) Difficulty Time Est
BUSPRO
G
AICPA ACBSP – APC Bloom’s EE Excel GL SMH FAI Service Real World Writing Ethics Internet Group
DQ 1 1 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
DQ 2 1 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
DQ 3 1 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
DQ 4 1 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
DQ 5 2 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
DQ 6 2 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
DQ 7 4 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
DQ 8 4 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
DQ 9 5 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
DQ 10 5 Easy 5 min. Analytic Measurement Budgeting and Responsibility Knowledge
PE 1A Flexible budgeting 2 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
PE 1B Flexible budgeting 2 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
PE 2A Production budget 4 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
PE 2B Production budget 4 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
PE 3A Direct materials purchases budget 4 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
PE 3B Direct materials purchases budget 4 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
PE 4A Direct labor cost budget 4 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
PE 4B Direct labor cost budget 4 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
PE 5A Cost of goods sold budget 4 Easy 10 min. Analytic Measurement Budgeting and Responsibility Application x
PE 5B Cost of goods sold budget 4 Easy 10 min. Analytic Measurement Budgeting and Responsibility Application x
PE 6A Cash budget 5 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
PE 6B Cash budget 5 Easy 5 min. Analytic Measurement Budgeting and Responsibility Application x
EX 1 Personal budget 2,5 Easy 15 min. Analytic Measurement Budgeting and Responsibility Application x x x
EX 2 Flexible budget for selling and administrative expenses for a service company 2,4 Easy 20 min. Analytic Measurement Budgeting and Responsibility Application x x x
EX 3 Static budget versus flexible budget 2,4 Easy 20 min. Analytic Measurement Budgeting and Responsibility Application x x x
EX 4 Flexible budget for Assembly Department 2 Easy 15 min. Analytic Measurement Budgeting and Responsibility Application x x x
EX 5 Production budget 4 Easy 15 min. Analytic Measurement Budgeting and Responsibility Application x
EX 6 Sales and production budgets 4 Easy 20 min. Analytic Measurement Budgeting and Responsibility Application x x
EX 7 Professional fees earned budget for a service company 4 Easy 10 min. Analytic Measurement Budgeting and Responsibility Application x
EX 8 Professional labor cost budget for a service company 4 Easy 10 min. Analytic Measurement Budgeting and Responsibility Application x
EX 9 Direct materials purchases budget 4 Moderate 20 min. Analytic Measurement Budgeting and Responsibility Application x x
EX 10 Direct materials purchases budget 4 Moderate 20 min. Analytic Measurement Budgeting and Responsibility Application x
EX 11 Direct materials purchases budget 4 Moderate 20 min. Analytic Measurement Budgeting and Responsibility Application x
EX 12 Direct labor cost budget 4 Moderate 20 min. Analytic Measurement Budgeting and Responsibility Application
EX 13 Direct labor budget for a service business 4 Moderate 20 min. Analytic Measurement Budgeting and Responsibility Application x
EX 14 Production and direct labor cost budgets 4 Moderate 30 min. Analytic Measurement Budgeting and Responsibility Application x x
EX 15 Factory overhead cost budget 4 Moderate 20 min. Analytic Measurement Budgeting and Responsibility Application x
EX 16 Cost of goods sold budget 4 Moderate 20 min. Analytic Measurement Budgeting and Responsibility Application x
EX 17 Cost of goods sold budget 4 Challenging 30 min. Analytic Measurement Budgeting and Responsibility Application
EX 18 Schedule of cash collections of accounts receivable 5 Easy 15 min. Analytic Measurement Budgeting and Responsibility Application x x
EX 19 Schedule of cash collections of accounts receivable 5 Easy 15 min. Analytic Measurement Budgeting and Responsibility Application
EX 20 Schedule of cash payments for a service company 5 Easy 15 min. Analytic Measurement Budgeting and Responsibility Application x
EX 21 Schedule of cash payments for a service company 5 Moderate 20 min. Analytic Measurement Budgeting and Responsibility Application x x
EX 22 Capital expenditures budget 5 Challenging 30 min. Analytic Measurement Budgeting and Responsibility Application x
PR 1A Forecast sales volume and sales budget 4 Moderate 1.5 hours Analytic Measurement Budgeting and Responsibility Application x
PR 2A Sales, production, direct materials purchases, and direct labor cost budgets 4 Moderate 2 hours Analytic Measurement Budgeting and Responsibility Application x
PR 3A Budgeted income statement and supporting budgets 4 Challenging 2.5 hours Analytic Measurement Budgeting and Responsibility Application x
PR 5A Budgeted income statement and balance sheet 4,5 Challenging 2 hours Analytic Measurement Budgeting and Responsibility Application x
PR 2B Sales, production, direct materials purchases, and direct labor cost budgets 4 Moderate 2 hours Analytic Measurement Budgeting and Responsibility Application x
PR 4B Cash budget 5 Challenging 2 hours Analytic Measurement Budgeting and Responsibility Application x x x
PR 5B Budgeted income statement and balance sheet 4,5 Challenging 2 hours Analytic Measurement Budgeting and Responsibility Application x
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