CHAPTER 23
BUDGETARY PLANNING
Learning Objectives
1. STATE THE ESSENTIALS OF EFFECTIVE
BUDGETING AND THE COMPONENTS OF THE
MASTER BUDGET.
2. PREPARE BUDGETS FOR SALES, PRODUCTION
AND DIRECT MATERIALS.
3. PREPARE BUDGETS FOR DIRECT LABOR,
MANUFACTURING OVERHEAD, AND SELLING
AND ADMINISTRATIVE EXPENSES, AND A
BUDGETED INCOME STATEMENT.
4. PREPARE A CASH BUDGET AND A BUDGETED
BALANCE SHEET.
5. APPLY BUDGETING PRINCIPLES TO
NONMANUFACTURING COMPANIES.
CHAPTER REVIEW
Budgeting Basics
1. A budget is a formal written statement of management’s plans for a specified time period, expressed
in financial terms.
2. The role of accounting during the budgeting process is to (a) provide historical data on revenues,
costs, and expenses, (b) express management’s plans in financial terms, and (c) prepare periodic
budget reports.
Benefits of Budgeting
3. The primary benefits of budgeting are as follows:
a. It requires all levels of management to plan ahead and to formalize goals on a recurring basis.
b. It provides definite objectives for evaluating performance at each level of responsibility.
c. It creates an early warning system for potential problems so that management can make
changes.
d. It facilitates the coordination of activities within the business.
e. It results in greater management awareness of the entity’s overall operations and the impact
on operations of external factors.
f. It motivates personnel throughout the organization to meet planned objectives.
Essentials of Effective Budgeting
4. (L.O. 1) In order to be effective management tools, budgets must be based upon
a. A sound organizational structure in which authority and responsibility are clearly defined.
b. Research and analysis to determine the feasibility of new products, services, and operating
techniques.
c. Management acceptance which is enhanced when all levels of management participate in
the preparation of the budget, and the budget has the support of top management.
5. The most common budget period is one year. A continuous twelve-month budget results from
dropping the month just ended and adding a future month. The annual budget is often supplemented
by monthly and quarterly budgets.
6. The responsibility for coordinating the preparation of the budget is assigned to a budget committee.
The budget committee usually includes the president, treasurer, chief accountant (controller), and
management personnel from each major area of the company.
7. A budget can have a significant impact on human behavior. A budget may have a strong positive
influence on a manager when
a. Each level of management is invited and encouraged to participate in developing the budget.
b. Criticism of a manager’s performance is tempered with advice and assistance.
8. Long-range planning involves the selection of strategies to achieve long-term goals and the
development of policies and plans to implement the strategies. Long–range plans contain considerably
less detail than budgets.
The Master Budget
9. The master budget is a set of interrelated budgets that constitutes a plan of action for a specified
time period. It is developed within the framework of a sales forecast which shows potential sales
for the industry and the company’s expected share of such sales.
10. There are two classes of budgets in the master budget.
a. Operating budgets are the individual budgets that result in the preparation of the budgeted
income statement.
b. Financial budgets focus primarily on the cash resources needed to fund expected operations
and planned capital expenditures.
11. (L. O. 2) The sales budget is the first budget prepared. It is derived from the sales forecast, and it
represents management’s best estimate of sales revenue for the budget period. It is prepared by
multiplying the expected unit sales volume for each product by its anticipated unit selling price.
12. The production budget shows the units to produce to meet anticipated sales. It is derived from
the budgeted sales units plus the desired ending finished goods units less the beginning finished
goods units.
13. The direct materials budget shows both the quantity and cost of direct materials to be purchased.
It is derived from the direct materials units required for production plus the desired ending direct
materials units less the beginning direct materials units.
14. (L. O. 3) The direct labor budget shows the quantity (hours) and cost of direct labor necessary
to meet production requirements. The direct labor budget is critical in maintaining a labor force
that can meet expected levels of production.
15. The manufacturing overhead budget shows the expected manufacturing overhead costs. The
selling and administrative expense budget is a projection of anticipated operating expenses.
Both budgets distinguish between fixed and variable costs.
Budgeted Income Statement
16. The budgeted income statement is the important end-product in preparing operating budgets.
This budget indicates the expected profitability of operations and it provides a basis for evaluating
company performance.
a. The budget is prepared from the budgets described in review points 11-15.
b. For example, to find cost of goods sold, it is necessary to determine the total unit cost of a
finished product using the direct materials, direct labor, and manufacturing overhead budgets.
Cash Budget
17. (L.O. 4) The cash budget shows anticipated cash flows. It contains three sections (cash receipts,
cash disbursements, and financing) and the beginning and ending cash balances. Data for preparing
this budget are obtained from the other budgets.
18. The budgeted balance sheet is a projection of financial position at the end of the budget period.
It is developed from the budgeted balance sheet for the preceding year and the budgets for the
current year.
Budgeting in Nonmanufacturing Companies
19. (L.O. 5) The major differences in the master budget of a merchandiser and a manufacturer are that a
merchandiser (a) uses a merchandise purchases budget instead of a production budget and (b)
does not use the manufacturing budgets (direct materials, direct labor, and manufacturing
overhead).
20. In service enterprises, the critical factor in budgeting is coordinating professional staff needs with
anticipated services. Budget data for service revenue may be obtained from expected output or
expected input.
21. In the budget process for not-for-profit organizations, the emphasis is on cash flows rather than
on a revenue and expense basis. For governmental units, the budget must be strictly followed and
overspending is often illegal.
LECTURE OUTLINE
A. Budgeting Basics.
1. Planning is the process of establishing enterprise-wide objectives.
2. A budget is a formal written statement of management’s plans for a
specified future time period, expressed in financial terms.
3. Accounting information makes major contributions to the budgeting
process.
B. The Benefits of Budgeting.
1. It requires all levels of management to plan ahead and to formalize
goals on a recurring basis.
2. It provides definite objectives for evaluating performance at each level of
responsibility.
3. It creates an early warning system of potential problems so that manage-
ment can make changes before things get out of hand.
4. It facilitates the coordination of activities within the business by correlating
the goals of each segment with overall company objectives.
5. It results in greater management awareness of the entity’s overall opera–
tions and the impact on operations of external factors, such as economic
trends.
6. It motivates personnel throughout the organization to meet planned
objectives.
C. Essentials of Effective Budgeting.
1. The essentials of effective budgeting are (a) sound organizational
structure, (b) research and analysis, and (c) acceptance by all levels of
management.
a. Effective budgeting depends on a sound organizational structure.
In such a structure, authority and responsibility for all phases of
operations are clearly defined.
b. Budgets based on research and analysis should result in realistic
goals that will contribute to the growth and profitability of a company.
2. The effectiveness of a budget program is directly related to its
acceptance by all levels of management.
D. Length of the Budget Period.
1. A budget may be prepared for any period of time. Various factors influence
the length of the budget period.
a. The type of budget.
b. The nature of the organization.
c. The need for periodic appraisal.
d. Prevailing business conditions.
2. The budget period should be long enough to provide an attainable goal
under normal business conditions and should minimize the impact of
seasonal or cyclical fluctuations.
3. The most common budget period is one year.
E. The Budgeting Process/Budgeting and Human Behavior.
1. The budget is developed within the framework of a sales forecast that
shows potential sales for the industry and the company’s expected share
of such sales. Sales forecasting involves a consideration of various factors:
a. General economic conditions.
b. Industry trends.
c. Market research studies.
d. Anticipated advertising and promotion.
e. Previous market share.
f. Changes in prices.
g. Technological developments.
2. The input of sales personnel and top management is essential to the
sales forecast.
3. In larger companies, a budget committee has responsibility for coordi–
nating the preparation of the budget.
ACCOUNTING ACROSS THE ORGANIZATON
A recent study found that fewer than 14% of businesses with fewer than 500
employees prepare an annual budget or have a written business plan. For many
small businesses, the basic assumption is that, “As long as I sell as much as I
can, and keep my employees paid, I’m doing OK”.
Describe a situation in which a business “sells as much as it can” but cannot
“keep its employees paid.”
Answer: If sales are made to customers on credit and collection is slow, the
company may find that it does not have enough cash to pay employees
or suppliers. Without these resources the company will fail to survive.
4. A budget can have a significant impact on human behavior.
c. In developing the budget, each level of management should be
invited to participate. The overall goal is to reach agreement on a
budget that the managers consider fair and achievable, but which
also meets the corporate goals set by top management.
MANAGEMENT INSIGHT
In an effort to revive its plummeting stock, Time Warner’s top management
determined and publicly announced bold new financial goals for the next year.
These goals were unfortunately not reached. The company got a new CEO and
new budgets were developed with each operating unit setting what it considered
optimistic but attainable goals.
What approach did Time Warner use to prepare the old budget? What approach
did it use to prepare the new budget?
Answer: Time Warner used a “top–down” approach to prepare the old budget
since its goals were determined by top management. It used a
F. Budgeting and Long-Range Planning.
1. Budgeting and long-range planning are not the same.
a. One important difference is the time period involved; long-range
planning usually encompasses a period of at least five years.
b. A second significant difference is in emphasis; long-range planning
identifies long-term goals, selects strategies to achieve those goals,
and develops policies and plans to implement the strategies.
Management also considers anticipated trends in the economic and
political environment and how the company should cope with them.
c. The final difference pertains to the amount of detail presented.
Long-range plans contain considerably less detail than budgets
because the data are intended more for a review of progress toward
long-term goals than as a basis of control for achieving specific
results.
2. The primary objective of long-range planning is to develop the best
strategy to maximize the company’s performance over an extended
future period.
G. The Master Budget.
1. The master budget is a set of interrelated budgets that constitutes a plan
of action for a specified time period.
2. Sales Budget: The sales budget is the starting point in preparing the
master budget.
a. Each of the other budgets depends on the sales budget.
b. The sales budget is derived from the sales forecast and it represents
management’s best estimate of sales revenue for the budget period.
3. Production Budget: The production budget shows the units to produce to
meet anticipated sales.
a. Production requirements are determined from the following formula:
Budgeted Sales Units + Desired Ending Finished Goods Units –
Beginning Finished Goods Units = Required Production Units.
b. The production budget provides the basis for the budgeted costs for
each manufacturing cost element.
4. Direct Materials: The direct materials budget shows both the quantity
and cost of direct materials to be purchased.
a. The quantities of direct materials are derived from the following
formula: Direct Materials Units Required for Production + Desired
Ending Direct Materials Units – Beginning Direct Materials Units =
Required Direct Materials Units to be Purchased.
b. The desired ending inventory is a key component in the budgeting
process; inadequate inventories could result in temporary shutdowns
of production.
5. Direct Labor: The direct labor budget contains the quantity (hours) and
cost of direct labor necessary to meet production requirements.
a. The direct labor budget is critical in maintaining a labor force that
can meet the expected levels of production.
b. The direct labor budget is also used in preparing the budgeted cost
of goods sold and the cash budget.
6. Manufacturing Overhead: The manufacturing overhead budget shows
the expected variable and fixed manufacturing overhead costs for the
budget period.
7. Selling and Administrative Expense: The selling and administrative expense
budget projects anticipated selling and administrative expenses for the
budget period. This budget classifies expenses as either variable or fixed.
This budget is also used in preparing the budgeted income statement
and the cash budget.
8. Budgeted Income Statement: The budgeted income statement is the
important end-product of the operating budgets.
a. This budget indicates the expected profitability of operations for the
budget period.
b. The budgeted income statement provides the basis for evaluating
company performance.
9. Cash Budget: The cash budget shows anticipated cash flows.
a. Because cash is so vital, this budget is often considered to be the
most important financial budget.
b. The cash budget contains three sections:
(1) Cash receipts.
(2) Cash disbursements.
(3) Financing.
c. Companies obtain data for preparing the cash budget from other
budgets and from information provided by management.
d. A cash budget contributes to more effective cash management. It
can show managers when additional financing is necessary well
before the actual need arises and it indicates when excess cash is
available for investments or other purposes.
MANAGEMENT INSIGHT
Behind the grandeur of the Olympic Games lies a huge financial challenge—how
to keep budgeted costs in line with revenues. The 2006 Winter Olympics in Italy
narrowly avoided going into bankruptcy before the Games even started;
organizers shifted promotional responsibilities to an Italian state-run agency.
Why does it matter whether the Olympic Games exceed their budget?
Answer: If the Olympic Games exceed their budget, taxpayers of the sponsoring
community and country will end up footing the bill. Depending on the
size of the losses, and the resources of the community, this could
H. Budgeting in Nonmanufacturing Companies.
1. Budgets are also used by:
a. Merchandisers.
b. Service enterprises.
c. Not-for-profit organizations.
2. The major differences between the master budgets of a merchandiser
and a manufacturer are that a merchandiser:
a. Uses a merchandise purchases budget instead of a production
budget.
b. Does not use the manufacturing budgets (direct materials, direct
labor, and manufacturing overhead).
3. In service enterprises, such as a public accounting firm, a law office, or a
medical practice, the critical factor in budgeting is coordinating profes–
sional staff needs with anticipated services.
a. If a firm is overstaffed, several problems may result:
(1) Labor costs are disproportionately high.
b. If a service enterprise is understaffed, it may lose revenue because
existing and prospective client needs for service cannot be met.
Also, professional staff may seek other jobs because of excessive
work loads.
4. Budgeting is just as important for not-for-profit organizations as for profit–
oriented enterprises.
a. In most cases, not-for-profit entities budget on the basis of cash
SERVICE COMPANY INSIGHT
All organizations need to stick to budgets. The most recent recession has
created budgeting challenges for nearly all governmental agencies. Even
Princeton University experienced a 25% drop in the value of its endowment when
the financial markets plunged. When the endowment fell, the university had to
make cuts because the endowment supports 45% of the university’s budget.
Why would a university’s budgeted scholarships fall when the stock market
suffers a serious drop?
Answer: Scholarships typically cannot be paid out of the “principal” portion of
donations made to scholarship endowment funds. Instead, scholar–
ships are usually funded through earnings generated by endowment
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. Budgeting is the process of establishing enterprise-wide objectives that serve as a deter–
rent to waste and inefficiency.
True False
2. The effectiveness of the budget program is directly related to its acceptance by all levels
of management.
True False
3. Budgeting always has the effect on human behavior of inspiring managers to higher
levels of performance.
True False
4. One disadvantage of budgeting is that it does not facilitate the coordination of activities
within a business.
True False
5. The sales budget is the first budget prepared and each of the other budgets depends on it.
True False
6. The quantities of direct materials in the direct materials budget are derived from the
formula: Desired Ending Direct Materials Units + Direct Materials Units Required for
Production – Beginning Direct Materials Units = Required Direct Materials Units to be
Purchased.
True False
7. The manufacturing overhead budget shows only the expected indirect labor costs for
the year.
True False
8. The budgeted income statement indicates the expected profitability of operations for the
next year and provides the basis for evaluating company performance.
True False
9. Long-range planning differs from budgeting in the time period involved, emphasis, and
the amount of detail presented.
True False
10. Budgeting is not used in not-for-profit organizations because it is not necessary for these
organizations to engage in profit planning.
True False
Multiple Choice
1. A formal written statement of management’s plans for a specified future time period,
expressed in financial terms is a(n)
a. accounting plan.
b. budget.
c. research analysis.
d. sales budget.
2. Which of the following is not a benefit of budgeting?
a. It reveals the prevailing business conditions.
b. It results in greater management awareness of the entity’s overall operations.
c. It creates an early warning system of potential problems.
d. It provides definite objectives for evaluating performance at each level of responsibility.
3. All of the following are financial budgets except the
a. budgeted balance sheet.
b. budgeted income statement.
c. capital expenditure budget.
d. cash budget.
4. The master budget includes all of the following except the
a. Budgeted Income Statement.
b. Capital Expenditure Budget.
c. Cash Budget.
d. Indirect Labor Budget.
5. If required production units are 75,000, budgeted sales units are 65,000, required direct
materials purchases units are 3,000, and beginning finished goods units are 5,000, then
desired ending finished goods units would be
a. 2,000.
b. 5,000.
c. 12,000.
d. 15,000.
ANSWERS TO QUIZ
True/ False
1. False 6. True
2. True 7. False
Multiple Choice
1. b.