Chapter 8: Profit Planning - BudgetingI. Why organizations budget and the process they use to create budgets● Budget: detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period○ budgetary control: use of budgets to control an organizations activities● Planning: involves developing objectives and preparing various budgets to achieve theseobjectives● Control: involves the steps taken by management to increase the likelihood that the objectives set down while planning are attained and that all parts of the organization are working together toward that goal● Advantages:○ define goals and objectives○ think about plan for the future○ means of allocating resources○ uncover potential bottlenecks○ coordinate activities○ communicate plans● Responsibility accounting: managers should be held responsible for ONLY items that they can actually control● Operating budgets: usually cover a one-year period (fiscal year), many companies dividetheir annual budget into four quarters● Continuous budget: 12-month budget that rolls forward one month (or quarter) as the current month (quarter) is completed● Self-imposed budget (participative budget): a budget that is prepared with the full operation and participation of managers at all levels○ should be reviewed by higher levels of management to prevent “budgetary slack”○ most companies issue broad guidelines in terms of overall profits/sales○ Advantages:■ individuals at all levels of the organization are viewed as members of the team whose judgements are valued by top management■ budget estimates are prepared by the front-line managers are often more accurate than estimates prepared by top managers■ motivations is generally higher when individuals participate in setting theirown goals than when goals are imposed from above■ 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● Human factors in budgeting○ top management must be enthusiastic and committed○ top management must not use the budget to pressure employees or blame them○ highly achievable budget targets are usually preferred when managers are rewarded based on meeting budget targets● Budget Committee○ responsible for overall policy matters relating to the budget, coordinating thepreparation of the budget, resolving disputes related to the budget, approving thefinal budgetII. Prepare a sales budget including a schedule of expected cash collections● Budgeting Example○ # units x $ per unit● Expected Cash CollectionsEx.III. Prepare a Production Budget● Must be adequate to meet budgeted sales and to provide for the desired ending inventoryEx.IV. Prepare a Direct Materials Budget● Schedule of expected cash disbursements for purchases of materialsEx.V. Prepare a Direct Labor Budget● Between labor hours paid vs. guaranteed labor owners, choose higherEx.VI. Prepare a Manufacturing Overhead Budget● Use # of hours worked, not what we paid forEx.VII. Prepare a Selling and Administrative Expense BudgetEx.VIII. Prepare a Cash Budget● Cash receipts section that lists all cash inflows excluding cash received from financing● Cash disbursements section consists of all cash payments excluding repayments of principal and interest● Cash excess or deficiency section determines if the company will need to borrow money or if it will be able to repay funds previously borrowed● Financing section details the borrowings and repayments projected to take place during the budget periodIX. Prepare a Budgeted (Estimated) Income StatementX. Prepare a Budgeted Balance SheetChapter 9 Flexible Budgets and Performance AnalysisI. Prepare a Flexible Budget● Characteristics: planning budgets are prepared for a single, planned level of activity● Performance evaluation is difficult when actual activity differs from the planned level of activity (preventing cost comparisons)● May be prepared for any activity level in the relevant range● Show costs that should have been incurred at the actual level of activity, enabling costcomparisons ● Help managers control costs● Improve performance evaluationsStatic Planning Budget: based off all budgetsFlex Planning Budget: answers how much of the cost variances are due to higher activity and how much are due to cost control (actual quantity, budgeted revenues and expenses)● total variable costs change in direct proportion to changes in activity ● total fixed costs remain unchanged within the relevant rangeII. Prepare a Report Showing Activity Variances and Revenue and Spending VariancesIII. Prepare a Flexible Budget With More Than One Cost Driver● More than one cost driver may be need to adequately explain all of the costs in an organization● Cost formulas used to prepare a flexible budget can be adjusted to recognize multiple cost driversIV. Common Errors in Preparing Performance Reports1. All costs are fixed2. All costs are variableChapter 10 Standard Costs and Variances● Standard Costs: are benchmarks or “norms” for measuring performance○ quantity standards specify how much of an input should be used to make a product or provide a service○ price standards specify how much should be paid for each unit of the input ● Management by exception: deviations from standards deemed significant are brought to the attention of management● Variance Analysis Cycle● Setting Standard Costs○ Direct Materials: Standard price per unit (final, delivered, cost of materials, net of discounts), Standard quantity per unit (summarized in Bill of Materials)○ Direct Labor: Standard rate per hour (single rate to reflect mix of wages earned), Standard hours per unit (use time and motion studies for each labor operation)○ Overhead Standards: Price standard (variable portion of the predetermined overhead rate), quantity standard (the activity in the allocation base for predetermined overhead● Standard costs per unit for direct materials, direct labor, and variable manufacturing overhead can be used to compute activity and spending variance○ Spending variance analysis:● Direct material variances○ 1) purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used ○ 2) the buying and using activities occur at different times: raw material purchasesmay be held in