Chapter 7 Lecture Notes
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Chapter 7
Lecture Notes
Chapter theme: This chapter describes how organizations
define their financial goals by preparing numerous budgets
I. The basic framework of budgeting
Learning Objective 7-1: Understand why organizations
budget and the processes they use to create budgets.
A. Basic definitions
i. A budget is a detailed quantitative plan for
B. Difference between planning and control
i. Planning involves developing objectives and
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at the planning stage are attained and that all parts
C. Advantages of budgeting
i. Budgets communicate management’s plans
throughout the organization.
iv. The budgeting process can uncover potential
bottlenecks before they occur.
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D. Other terminology/concepts related to budgeting
i. Responsibility accounting
1. The premise of responsibility accounting is
that managers should be held responsible
only for those items that they can control to
ii. Choosing a budget period
1. Operating budgets ordinarily cover a one-
year period corresponding to a company’s
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iii. The self-imposed budget
1. A self-imposed budget or participative
budget is a budget that is prepared with the
2. The advantages of self-imposed budgets
include:
a. Individuals at all levels of the
organization are viewed as members
of the team whose judgments are
valued by top management.
b. Budget estimates prepared by front–
line managers (who have intimate
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too much “budgetary slack,” or may not be
aligned with overall strategic objectives.
4. Most companies do not rely exclusively
Helpful Hint: Ask students if they ever worked in an
organization with a management-imposed budget or a
iv. Human factors in budgeting
1. The success of a budget program depends on
three important factors:
a. Top management must be
enthusiastic and committed to the
budgeting process; otherwise nobody
will take it seriously.
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E. The master budget: an overview
i. The master budget consists of a number of separate
but interdependent budgets.
1. The sales budget shows the expected sales
for the budget period expressed in dollars
2. The production budget is prepared after the
sales budget. It lists the number of units that
must be produced during each budget period
to meet sales needs and to provide for the
3. The cash budget is a detailed plan showing
how cash resources will be acquired and
used over a specified time period.
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ii. To help you see the “big picture” keep in mind that
iii. It also bears emphasizing that a master budget is
based on various estimates and assumptions. For
example, the sales budget requires three
estimates/assumptions as follows:
1. What are the budgeted unit sales?
iv. When Microsoft Excel is used to create a master
budget, these types of assumptions can be depicted
in a Budgeting Assumptions tab, thereby enabling
the Excel-based budget to answer “what–if”
questions.
Helpful Hint: Budgets—particularly in large
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II. Preparing the master budget
A. The sales budget
i. Assume the facts as shown for the Royal Company.
1. The sales budget multiplies the budgeted
sales in units for each month by the selling
price per unit.
a. The total sales budget for the quarter
ii. Assume the information as shown regarding
Royal’s expected cash collections.
1. The first step in calculating Royal’s cash
in April.
2. The second step is to calculate the April
credit sales that will be collected during
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in May. $10,000 ($200,000 × 5%)
will be uncollectible.
3. The third step is to calculate the May credit
sales that will be collected during each
4. The fourth step is to calculate the June
credit sales that will be collected during the
month of June.
Learning Objective 7-3: Prepare a production budget.
B. The production budget (must be adequate to meet
budgeted sales and to provide for the desired ending
inventory)
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1. The first step in preparing the production
budget is to insert the budgeted sales in units
from the sales budget.
Quick Check – Calculating required production
3. The third step is to calculate the required
production for May (46,000 units).
July are 25,000 units).
5. The fifth step is to complete the “Quarter”
column.
a. Notice, April’s beginning inventory
and June’s ending inventory are
carried over to this column.
Helpful Hint: Many students have a tendency to add up
reduce confusion on the part of students.
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C. The direct materials budget
i. Assume the information as shown to enable the
preparation of Royal’s direct materials budget
1. The first step in preparing the direct
materials budget is to insert the required
3. The third step is to calculate the materials
to be purchased for April (140,000 pounds).
Notice:
a. The desired ending inventory of
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Quick Check – direct material purchases
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