Chapter 23—Operational Budgeting
Financial and Managerial Accounting, 18e 23-11
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
23-2 Instructor’s Resource Manual
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—see Pathways Connection (page 1015)
C. Concluding remarks
Chapter 23—Operational Budgeting
Financial and Managerial Accounting, 18e 23-13
Topical Coverage and Suggested Assignment
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
*Homework assignment (to be completed prior to class)
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
23-4 Instructor’s Resource Manual
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 computerized systemin the budgeting
process. The system is programmed with the “cost formulas” and the interrelationships among
budgeted amounts. Once this task is completed, the system 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.
Many companies now use packaged budgeting software that may be a part of a larger accounting
or enterprise resource planning (ERP) system.
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. This is a great opportunity to emphasize to students the importance of
comparing a company’s reported net income with cash flows in order to better assess financial
health and predict future results.
Supplemental Exercises
Group Exercise
As a group, select an established manufacturing company. Prepare an estimated quarterly
sales forecast for the coming year. Next, prepare a production budget that includes direct
materials, direct labor, and manufacturing overhead. These budgets should be prepared in Excel.
Prepare a summary of your results in a PowerPoint presentation. Explain any assumptions used
in creating the budget and also discuss internal and external factors that may impact the actual
results during the year.
Chapter 23—Operational Budgeting
Financial and Managerial Accounting, 18e 23-15
CHAPTER 23 NAME #
10-MINUTE QUIZ A SECTION
Indicate the best answer for each question.
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
23-6 Instructor’s Resource Manual
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.
Chapter 23—Operational Budgeting
Financial and Managerial Accounting, 18e 23-17
5. A flexible budget is used to evaluate:
a Costs that should have been incurred for a level of output achieved.
b Costs that should have been incurred for a level of output considered to be normal.
c How variable unit costs change as output changes.
d How flexible management was at adapting to changes in business conditions.
Chapter 23—Operational Budgeting
23-8 Instructor’s Resource Manual
CHAPTER 23 NAME #
10-MINUTE QUIZ C SECTION
The cost accountant for Sherman’s Co. prepared the following monthly performance report relating to the
Production Department.
Budgeted Actual
Production Production
(10,000 Units) (11,000 Units)
Direct materials used ……………………………………………………. $240,000 $260,000
Direct labor ……………………………………………………………… $100,000 $101,000
Variable manufacturing overhead………………………………….. $60,000 $65,000
Fixed manufacturing overhead ……………………………………… $160,000 $164,000
1. Refer to the above data. Compute the amounts that should be included for each of the following
in a flexible budget prepared at an 11,000-unit level of production:
a Direct materials: $____________
b Direct labor: $____________
c Fixed manufacturing overhead: $____________
2. Refer to the above data. Assume that a revised performance report is prepared for the 11,000-unit
level of production using a flexible budget approach. Compute the cost variances for each of the
following. Indicate whether each variance is favorable (F) or unfavorable (U).
a Direct materials variance from flexible budget: $____________
b Direct labor variance from flexible budget: $____________
c Total manufacturing overhead variance from flexible budget: $____________
Chapter 23—Operational Budgeting
Financial and Managerial Accounting, 18e 23-19
CHAPTER 23 NAME #
10-MINUTE QUIZ D SECTION
1. Hayden Corporation budgeted its cost of finished goods manufactured at $500,000 for May. Its
May 31 finished goods inventory budgeted to be twice the level of its May 1 finished goods
inventory. The cost of goods sold budget for May has been set at $450,000.
Hayden’s finished goods inventory at May 31 is budgeted at: $____________
2. Suffolk Corporation expects to incur $360,000 in expenses during June (excluding interest and
taxes). Of this amount, depreciation is budgeted at $70,000, and expired prepayments are budgeted
at $35,000. Suffolk’s current payables total $60,000 at June 1 and are budgeted to increase to
$70,000 by June 30.
Payments on current payables budgeted for June total: $____________
3. Weaver Corporation pays its debt service costs in full each month. April debt service costs are
budgeted at $9,000. However, of this amount, only $1,000 represents a reduction of principal. The
company expects to issue no new debt during the month.
What cash disbursement amount will be shown on Weaver’s debt service budget? $____________
4. Bergen Corporation’s accounts receivable remain outstanding approximately 42 days, whereas its
inventory remains in stock approximately 12 days before it is sold. It takes suppliers approximately
7 days to deliver inventory to Bergen once an order is received.
Bergen’s operating cycle is: __________ days
5. As budgeted output per the flexible budget increases, per-unit fixed costs (increase/decrease):
___________
Chapter 23—Operational Budgeting
23-10 Instructor’s Resource Manual
SOLUTIONS TO CHAPTER 23 10-MINUTE QUIZZES
QUIZ A
1 A
QUIZ B
QUIZ C
Learning Objectives: 4, 5, 6
QUIZ D
Learning Objectives: 5,6
Chapter 23—Operational Budgeting
Financial and Managerial Accounting, 18e 23-111
Chapter 23—Operational Budgeting
Financial and Managerial Accounting, 18e 23-11
Assignment Guide to Chapter 23
Brief
Exercises
Exercises
Problems
Cases
Net
Item Number
1 – 10
1 – 15
1
2
3
4
5
6
7
8
1
2
3
5
4
Time estimate (in minutes)
< 15
< 15
25
20
50
40
30
60
50
45
30
20
20
30
30
Difficulty rating
E
E
E
M
S
S
S
S
M
M
M
M
M
M
M
Learning Objectives:
2
√
√
√
√
√
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.
5, 9
12, 14, 15
√
√
√
√
√
√
√
√
√
philosophies that may
be used in setting
5. Prepare the budgets
and supporting
schedules included in
a master budget.
2, 6, 8
√
√
√
√
√
√
√
budget and explain its
√