Chapter 9 The Master Budget and Responsibility Accounting 1 How and Why do Managers Use Budgets a Strategic Planning Setting long term goals that may extend 5 10 years into the future i Long term loosely detailed budgets are often created to reflect expectations for these ii Once goals are set management designs key strategies for attaining goals iii Strategies are put into place through the use of short term budgets for an entire fiscal long term goals year 1 This is not detailed enough to guide many management decisions 2 Companies usually prepare a budget for every month of the fiscal year b Rolling Budget Budget that is continuously updated so that the next 12 months of operations i Ex As soon as January is over a budget for the next January is prepared c Participative Budgeting Involves the participation of many levels of management in order to 1 Lower level managers are usually closer to the action and therefore have more detailed knowledge for creating realistic budgets 2 Managers are more likely to accept and be motivated by budgets they helped to are always budgeted prepare the budget i Advantages create ii Disadvantages 1 Budget process complex when more people participate 2 Slack Managers may intentionally over budget their expenses and under budget their revenue of their area of operations d Budget Committee Reviews the submitted budgets removes unwarranted slack and revises approves final budget i Includes upper management such as the CEO and CFO as well as managers from every area of the value chain R D Marketing Development etc e Budget Starting Point Many companies use prior year s budgeted figures or actual results as the starting point for creating the budget for the upcoming year i Modified to reflect new products customers or geographical areas changes in marketplace changes in labor contracts raw material and fuel costs general inflation etc f Zero Based Budgeting Prevents perpetual increases in budget by beginning with a budget of zero and justifying every dollar that is put into the budget g Benefits of Budgeting i Planning Forces managers to spend time planning for the future rather than only focusing on daily operations Makes them more likely to achieve goals ii Coordination Communication Coordinates a company s activities forces managers to consider relations among operations across the entire value chain iii Benchmarking Budgets provide a benchmark that motivates employees and helps managers evaluate performance 1 Provides a target that most managers will try to achieve especially if they have participated in the budget making process and budget is set at a realistic level 2 Variance Actual Budget h Master Budget Comprehensive planning document for the entire organization consists of all the supporting budgets needed to create the company s budgeted financial statements i Operating Budgets Budgets needed to run the daily operations of the company culminate in a budgeted income statement 1 Sales Budget Estimates Sales 2 Production Budget Determines how many units need to be produced a DM DL and MOH budgets 3 Operating Expenses Budget Estimates expenses i Financial Budgets Project the collection and payment of cash as well as forecast the company s budgeted balance sheet i Capital Expenditure Budget Company s plan for purchasing property plant and ii Cash Budget Projects the cash that will be available to run the company s operations and determines whether the company will have extra funds to invest or if they will need to borrow cash iii Budgeted Balance Sheet Forecasts the company s position at the end of the budget equipment period 2 How are the Operating Budgets Prepared a Sales Budget of Unit Sales Sales Price Unit Total Sales Revenue i COD Collect on Delivery sales or cash sales 1 Customer is new has poor credit rating has not paid on time in the past b Production Budget Once managers have predicted how many units they expect to sell they can figure out how many units they need to produce i Most manufactures maintain some ending finished goods inventory or safety stock just in case demand is higher than predicted or the problems in the factory slow production 1 Units Needed for Sales Desired End Inventory Total Units Needed Beginning Inventory Units Needed to Produce c Direct Materials Budget i Quantity of DM needed for Production Desired DM Ending Inventory Total Quantity DM Needed DM Beginning Inventory Quantity of DM to Purchase d Direct Labor Budget i Units to Be Produced x DL Hours Unit Total DL Hours Required x DL cost Hour Total DL Cost e MOH Budget Highly dependent on cost behavior Some MOH costs such as indirect materials are variable Costs such as utilities and indirect labor are mixed costs Depreciation insurance property taxes etc are fixed costs i Variable Costs Fixed Costs f Operating Expenses Budget All R D Design Marketing Distribution and Customer Service costs will be shown on the operating expenses budget g Budgeted Income Statement Looks like a regular income statement except for the fact that it uses budgeted data i Sales Rev COGS Gross Profit Operating Expenses Operating Income Interest Expense Income Tax Expense Net Income ii COGS Number of Unit Sales Manufacturing Cost per Unit 1 Manufacturing Cost Unit a DM DL MOH Variable and fixed 3 How are Financial Budgets Prepared a Capital Expenditure Budget Shows the company s intentions to invest in new property plant or equipment capital investments b Cash Collections Budget When does the company expect to receive cash from sales i COD sales will receive cash immediately ii Cash Sales Credit Sales c Cash Payments Budget When will company pay for DL DM MOH i DM DL MOH Operating Expenses Capital Investments Income Taxes ii MOH Total MOH Depreciation Property Tax Insurance Semiannual Payments Dividends for Property Taxes Insurance iii Operating Expenses Operating Expenses Depreciation Expense Bad Debt Expense d Combined Cash Budget Merges the budgeted cash collections and cash payments to project the company s ending cash position i Line of Credit A lending arrangement from a bank in which a company is allowed to borrow money as needed up to a specified maximum amount yet only pay interest on the portion that is actually borrowed until it is repaid 1 Enables company to borrow funds to meet their short term cash deficiencies ii Beginning Balance of Cash Cash Collections Total Cash Available Cash Payments Ending Cash Balance before Financing Financing Ending Cash Balance Borrowing
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