Expected 2007Change in VolumeCHAPTER 6MASTER BUDGET AND RESPONSIBILITY ACCOUNTING6-1 The budgeting cycle includes the following elements:a. Planning the performance of the company as a whole as well as planning the performanceof its subunits. Management agrees on what is expected.b. Providing a frame of reference, a set of specific expectations against which actual resultscan be compared.c. Investigating variations from plans. If necessary, corrective action follows investigation.d. Planning again, in light of feedback and changed conditions.6-2 The master budget expresses management’s operating and financial plans for a specifiedperiod (usually a fiscal year) and includes a set of budgeted financial statements. It is the initialplan of what the company intends to accomplish in the period.6-3 Strategy, plans, and budgets are interrelated and affect one another. Strategy specifieshow an organization matches its own capabilities with the opportunities in the marketplace toaccomplish its objectives. Strategic analysis underlies both long-run and short-run planning. Inturn, these plans lead to the formulation of budgets. Budgets provide feedback to managers aboutthe likely effects of their strategic plans. Managers use this feedback to revise their strategicplans. 6-4 We agree that budgeted performance is a better criterion than past performance forjudging managers, because inefficiencies included in past results can be detected and eliminatedin budgeting. Also, future conditions may be expected to differ from the past, and these can alsobe factored into budgets.6-5 Production and marketing traditionally have operated as relatively independent businessfunctions. Budgets can assist in reducing conflicts between these two functions in two ways.Consider a beverage company such as Coca-Cola or Pepsi-Cola:- Communication. Marketing could share information about seasonal demand withproduction.- Coordination. Production could ensure that output is sufficient to meet, for example,high seasonal demand in the summer.6-6 In many organizations, budgets impel managers to plan. Without budgets, managers driftfrom crisis to crisis. Research also shows that budgets can motivate managers to meet targets andimprove their performance. Thus, many top managers believe that budgets meet the cost-benefittest.6-7 A rolling budget, also called a continuous budget, is a budget or plan that is alwaysavailable for a specified future period, by continually adding a period (month, quarter, or year) tothe period that just ended. A four-quarter rolling budget for 2007 is superseded by a four-quarterrolling budget for April 2007 to March 2008, and so on.6-16.8 The steps in preparing an operating budget are as follows:1. Prepare the revenues budget2. Prepare the production budget (in units)3. Prepare the direct material usage budget and direct material purchases budget4. Prepare the direct manufacturing labor budget5. Prepare the manufacturing overhead budget6. Prepare the ending inventories budget7. Prepare the cost of goods sold budget8. Prepare the nonmanufacturing costs budget9. Prepare the budgeted income statement6-9 The sales forecast is typically the cornerstone for budgeting, because production (and,hence, costs) and inventory levels generally depend on the forecasted level of sales.6-10 Sensitivity analysis adds an extra dimension to budgeting. It enables managers toexamine how budgeted amounts change with changes in the underlying assumptions. This assistsmanagers in monitoring those assumptions that are most critical to a company in attaining itsbudget and allows them to make timely adjustments to plans when appropriate.6.11 Kaizen budgeting explicitly incorporates continuous improvement anticipated during thebudget period into the budget numbers.6.12 Nonoutput-based cost drivers can be incorporated into budgeting by the use of activity-based budgeting (ABB). ABB focuses on the budgeted cost of activities necessary to produceand sell products and services. Nonoutput-based cost drivers, such as the number of partnumbers, number of batches, and number of new products can be used with ABB.6-13 The choice of the type of responsibility center determines what the manager isaccountable for and thereby affects the manager’s behavior. For example, if a revenue center ischosen, the manager will focus on revenues, not on costs or investments. The choice of aresponsibility center type guides the variables to be included in the budgeting exercise.6-14 Budgeting in multinational companies may involve budgeting in several different foreigncurrencies. Further, management accountants must translate operating performance into a singlecurrency for reporting to shareholders, by budgeting for exchange rates. Managers andaccountants must understand the factors that impact exchange rates, and where possible, planfinancial strategies to limit the downside of unexpected unfavorable moves in currencyvaluations. In developing budgets for operations in different countries, they must also have goodunderstanding of political, legal and economic issues in those countries.6-15 No. Cash budgets and operating income budgets must be prepared simultaneously. Inpreparing their operating income budgets, companies want to avoid unnecessary idle cash andunexpected cash deficiencies. The cash budget, unlike the operating income budget, highlightsperiods of idle cash and periods of cash shortage, and it allows the accountant to plan costeffective ways of either using excess cash or raising cash from outside to achieve the company’soperating income goals.6-26-16 (15 min.) Sales budget, service setting.1.McGrath & Sons2006VolumeAt 2006Selling PricesExpected 2007Change in VolumeExpected 2007VolumeRadon Tests 11,000 $250 +5% 11,550Lead Tests 15,200 $200 -10% 13,680McGrath & Sons Sales BudgetFor the Year Ended December 31, 2007 SellingPriceUnitsSoldTotalRevenuesRadon Tests $250 11,550 $2,887,500Lead Tests $200 13,680 2,736,000 $5,623,5002.McGrath & Sons2006VolumePlanned 2007Selling PricesExpected2007Change inVolumeExpected2007VolumeRadon Tests 11,000 $250 +5% 11,550Lead Tests 15,200 $190 -5% 14,440McGrath & Sons Sales BudgetFor the Year Ended December 31, 2007