Accounting 2000 Chapter 20 Notes Study Objectives 1 Indicate the benefits of budgeting 2 State the essentials of effective budgeting 3 Identify the budgets that comprise the master budget 4 Describe the sources for preparing the budgeted income statement This includes preparing all of the other operating budgets 5 Explain the principal sections of a cash budget What is a Budget A formal written statement of management s plans for a specified future time period expressed in financial terms Promotes efficiency and is a primary way to communicate agreed Control device upon objectives to all parts of the company adopted important basis for performance evaluation once How is it put together Historical accounting data on revenues costs and expenses help in formulating future budgets Company accounts are normally responsible for presenting management s budgeting goals in financial terms The budget and its administration are however entirely the responsibility of management 1 Accounting 2000 Chapter 20 Notes Requires all levels of management to plan ahead and formalize Provides definite objective for evaluating performance at each Benefits of Budgeting goals on a recurring basis level of responsibility Creates an early warning system for potential problems Facilitates coordination within the business Results in greater management awareness of the entity s overall Motivate personnel operations and the impact of external factors objectives throughout organization to meet planned Principles of Effective Budgeting Depends on a sound organizational structure with authority and responsibility for all phases of operations clearly defined Based on research analysis with realistic goals Should be accepted by all levels of management May inspire higher levels of performance or discourage additional effort Invite each level of management to participate Bottom to top approach is called Participative Budgeting Risk of unreliable budgets greater when they are top down Budgetary Slack refers to managers using the budget to foster gaming by intentionally underestimating budgeted revenues or overestimating budgeted expenses so that budget goals are easier to meet 2 Accounting 2000 Chapter 20 Notes The Budget Period May be prepared for any period of time o Most common one year o Supplement with monthly and quarterly budgets o Different budgets may cover different time periods Long enough to provide an attainable goal and minimize seasonal or cyclical fluctuations Short enough for reliable estimates One option of a budget period is a continuous twelve month budget o Drop the month just ended and add a future month o Keeps management planning a full year ahead Budgeting versus Long Range Planning Three basic differences between Budgeting and Long Range Planning 1 Time period involved 2 Emphasis 3 Detail presented Budgeting is short term usually one year Long range planning at least five years The Budgeting Process Base budget goals on past performance 3 Accounting 2000 Chapter 20 Notes o Collect data from organizational units o Begin several months before end of current year Develop budget within the framework of a sales forecast The Master Budget A set of interrelated budgets that constitutes a plan of action for a specified time period Contains two classes of budgets Operating and Financial Operating budgets o Individual budgets that result in the preparation of the budgeted income statement establish goals for sales and production personnel Financial budgets o The capital expenditures budget the cash budget and the budgeted balance sheet focus primarily on cash needs to fund operations and capital expenditures 4 Accounting 2000 Chapter 20 Notes The Master Budget You are responsible for knowing the names and purpose of all the budgets and how to prepare all of the operating budgets except the budgeted income statement First let s start with the Operating Budgets Remember there are 7 of them 5 Accounting 2000 Chapter 20 Notes Operating Budget 1 The Sales Budget starting point First budget prepared Derived from the sales forecast o Management s best estimate of sales revenue for the budget period o Every other budget depends on the sales budget Prepared by multiplying expected unit sales volume for each product by anticipated unit selling price Hayes Company Example Taken from chapter starting on page 1038 Hayes Company manufactures and sells a single product Kitchen Mate The company prepares budgets by quarter for the year ending December 31 2012 Hayes Company begins its annual budgeting process on September 1st and completes the budget by December 1 of the year prior to the budgeted period Information needed for the Hayes Company Sales Budget Expected sales volume 3 000 units in the first quarter with 500 unit increments for each following quarter Sales price 60 per unit 6 Accounting 2000 Chapter 20 Notes Operating Budget 2 The Production Budget based on sales Shows the units that must be produced to meet anticipated sales THIS BUDGET HAS NO DOLLAR AMOUNTS IN IT Derived from units projected in the sales budget plus the desired change in ending finished goods ending finished goods less the beginning finished goods units Required production in units formula Essential to have a realistic estimate of ending inventory Illustration 20 4 Hayes Company Example Continued Information needed for the Hayes Company Production Budget Hayes Co believes it can meet future sales needs with an ending inventory of 20 of next quarter s sales 7 Accounting 2000 Chapter 20 Notes Operating Budget 3 The Direct Materials Budget Shows both the quantity and cost of direct materials to be purchased Derived from the direct materials units required for production from the production budget plus the desired change in ending direct materials units Budgeted cost of direct materials to be purchased required units of direct materials anticipated cost per unit Illustration 20 6 8 Accounting 2000 Chapter 20 Notes Hayes Company Example Continued Information needed for the Hayes Company Direct Materials Budget An ending inventory of 10 of next quarter s production requirements is sufficient The manufacturing of each unit requires 2 pounds of raw materials at an expected price of 4 per pound 9 Accounting 2000 Chapter 20 Notes Operating Budget 4 Direct Labor Budget Shows both the quantity and cost of labor necessary to meet production requirements Critical in maintaining a labor force that can meet expected production Total direct labor cost