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Chapter 8
Lecture Notes
Chapter theme: This chapter focuses on the steps taken by
businesses to achieve their planned levels of profits – a
I. The basic framework of budgeting
Learning Objective 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
acquiring and using financial and other resources
over a specified forthcoming time period.
B. Difference between planning and control
i. Planning involves developing objectives and
preparing various budgets to achieve those
objectives.
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iii. To be effective, a good budgeting system must
provide for both planning and control. Good
planning without effective control is time wasted.
C. Advantages of budgeting
i. Budgets communicate management’s plans
throughout the organization.
iv. The budgeting process can uncover potential
bottlenecks before they occur.
v. Budgets coordinate the activities of the entire
organization by integrating the plans of its various
parts.
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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
a significant extent.
ii. Choosing a budget period
1. Operating budgets ordinarily cover a one-
year period corresponding to a company’s
fiscal year. Many companies divide their
annual budget into four quarters.
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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.
d. A manager who is not able to meet a
budget imposed from above can
claim that it was unrealistic. Self–
imposed budgets eliminate this
excuse.
3. Self-imposed budgets should be reviewed by
higher levels of management. Without such
a review, self-imposed budgets may have
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top managers usually initiate the budget
process by issuing broad guidelines in terms
of overall target profits or sales. Lower level
managers are directed to prepare budgets
that meet those targets.
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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v. The budget committee
1. A budget committee is usually responsible
for overall policy relating to the budget
program, for coordinating the preparation
of the budget, for resolving disputes related
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
and units. It is usually based on a company’s
sales forecast.
a. All other parts of the master budget
are dependent on the sales budget.
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3. The cash budget is a detailed plan showing
how cash resources will be acquired and
used over a specified time period.
a. All of the operating budgets have an
impact on the cash budget.
4. The last step of the process is to prepare a
budgeted income statement and a
budgeted balance sheet.
Helpful Hint: Budgets—particularly in large
organizations—can be very complex. To keep the
II. Preparing the master budget
Learning Objective 2: Prepare a sales budget,
including a schedule of expected cash collections.
A. The sales budget
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1. The sales budget multiplies the budgeted
sales in units for each month by the selling
price per unit.
ii. Assume the information as shown regarding
Royal’s expected cash collections.
1. The first step in calculating Royal’s cash
collections is to insert the beginning
accounts receivable balance ($30,000) into
the April column of the cash collections
schedule.
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will be uncollectible.
3. The third step is to calculate the May credit
sales that will be collected during each
month of the quarter.
a. $350,000 ($500,000 × 70%) will be
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Quick Check – calculating cash collections
4. The fourth step is to calculate the June
5. The fifth step is to calculate the total for
each column in the schedule and the total for
the quarter ($905,000).
Learning Objective 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.
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4. The fourth step is to calculate the required
production for June (29,000 units).
a. Notice, we are assuming a desired
ending inventory of 5,000 units
(which implies that projected sales in
July are 25,000 units).
Helpful Hint: Many students have a tendency to add up
the inventory amounts instead of using the ending or
the beginning figure. Pointing this out early might
reduce confusion on the part of students.
C. The direct materials budget
i. Assume the information as shown to enable the
preparation of Royal’s direct materials budget
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2. The second step is to calculate the monthly
and quarterly production needs, which in
this case are stated in terms of pounds of
direct material.
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Quick Check – direct material purchases
4. The fourth step is to calculate the materials
to be purchased for May (221,500 pounds).
Notice:
a. April’s desired ending inventory
becomes May’s beginning inventory.
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