CHAPTER 9
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. (L.O. 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 present management’s budgeting goals
Benefits of Budgeting
3. The primary benefits of budgeting are as follows:
a. It requires all levels of management to plan ahead.
b. It provides definite objectives for evaluating performance.
Essentials of Effective Budgeting
4. 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 of the budget is directly related to the effectiveness of the budget
program.
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.
Sales, Production, and Direct Materials Budgets
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.
Direct Labor, Manufacturing Overhead, and Selling and Administrative Expense Budgets, and
Budgeted Income Statement
14. 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.
Cash Budget and Budgeted Balance Sheet
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.
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).
LECTURE OUTLINE
A. Budgeting Basics.
1. Planning is the process of establishing company-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 for potential problems so that manage-
ment can make changes before things get out of hand.
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.
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.
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.
MANAGEMENT INSIGHT
A recent study found that fewer than 14% of businesses with fewer than 500
employees do 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
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.
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.
4. A budget can have a significant impact on human behavior.
a. A budget may inspire a manager to higher levels of performance.
b. A budget may discourage additional effort and pull down the morale
of a manager.
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.
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.
SERVICE COMPANY INSIGHT
Governments at all levels must submit budgets; most are required to submit
balanced budgets where revenues cover anticipated expenses. But, estimating
government revenues can be as difficult or even more difficult than estimating
company revenue.
Why is it important that government budgets accurately estimate future
revenues during economic downturns?
Answer: Accuracy of government revenue estimates is especially
important during economic downturns because most
governments must balance their budgets. If anticipated
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 –
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
MANAGEMENT INSIGHT
Some businesses faced a predicament recently due to the skyrocketing cost of
raw materials. Some managers decided to stockpile much larger quantities of
raw materials to avoid paying even higher prices in the future.
What are the potential downsides of stockpiling a huge amount of raw materials?
Answer: If prices continue to go up, these managers will avoid paying higher
prices until their inventory runs out. However, it is a risky strategy.
5. Direct Labor: The direct labor budget contains the quantity (hours) and
cost of direct labor necessary to meet production requirements.
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
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.
d. A cash budget contributes to more effective cash management. It
shows managers when additional financing is necessary well before
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
10. Budgeted Balance Sheet: The budgeted balance sheet is developed
from the budgeted balance sheet for the preceding year and the budgets
for the current year.
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.
(2) Profits are lower because of the additional salaries.
a. In most cases, not-for-profit entities budget on the basis of cash
flows (expenditures and receipts), rather than on a revenue and
expense basis.
b. The starting point in budgeting is usually expenditures, not receipts.
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 probably 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 company-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
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
Multiple Choice
1. b.