Accounting26th ch 22

CHAPTER

22

Budgeting

Warren
Reeve
Duchac
©2016

human/iStock/360/Getty Images

Accounting
26e


Nature and Objectives of Budgeting

•

Budgets play an important role for organizations of
all sizes and forms.
o

•

For example, budgets are used in managing the operations
of government agencies, churches, hospitals, and other
nonprofit organizations.

This chapter describes and illustrates budgeting for a
manufacturing company.

©2016


Objectives of Budgeting

•

Budgeting affects the following managerial functions:
o

Planning
 Planning involves setting goals to guide decisions and help motivate
employees.

o

Directing
 Directing involves decisions and actions to achieve budgeted goals.
– A budgetary unit of a company is called a responsibility center.
 Each responsibility center is led by a manager who has the authority and
responsibility for achieving the center’s budgeted goals.

o

Controlling
 Controlling involves comparing actual performance against the budgeted
goals.

©2016


Human Behavior and Budgeting

•

Human behavior problems can arise in the budgeting
process in the following situations:
o

Budgeted goals are set too tight, which are very hard or
impossible to achieve.
 It is important for employees and managers to be involved in the
budgeting process.

o

Budgeted goals are set too loose, which are very easy to
achieve.
 Such budget “padding” is called budgetary slack.

o

Budgeted goals conflict with the objectives of the company
and employees.
 Goal conflict occurs when the employees’ or managers’ self-interest
differs from the company’s objectives or goals.
©2016

Budgeting Systems
(slide 1 of 3)

•
•
•
•

The budgetary period for operating activities
normally includes the fiscal year of a company.
For control purposes, annual budgets are usually
subdivided into shorter time periods, such as quarters
of the year, months, or weeks.
A variation of fiscal-year budgeting, called
continuous budgeting, maintains a 12-month
projection into the future.
The 12-month budget is continually revised by
replacing the data for the month just ended with the
budget data for the same month in the next year.
©2016


Budgeting Systems
(slide 2 of 3)

•
•

•

Developing an annual budget usually begins several
months prior to the end of the current year.
The responsibility of developing an annual budget is
normally assigned to a budget committee.
The budget process is monitored and summarized by
the Accounting Department, which reports to the
committee.

©2016


Budgeting Systems
(slide 3 of 3)

•

There are several methods of developing budget
estimates.
o

o

One method, called zero-based budgeting, requires
managers to estimate sales, production, and other
operating data as though operations are being started for
the first time.
A more common approach is to start with last year’s budget
and revise it for actual results and expected changes for

the coming year.
 Two major budgets using this approach are the static budget and
the flexible budget.

©2016


Static Budget

•

•

•

A static budget shows the expected results of a
responsibility center for only one activity level. Once
the budget has been determined, it is not changed,
even if the activity changes.
Static budgeting is used by many service companies,
government entities, and for some functions of
manufacturing companies, such as purchasing,
engineering, and accounting.
A disadvantage of static budgets is that they do not
adjust for changes in activity levels.

©2016


Flexible Budget

•
•

Flexible budgets show the expected results of a
responsibility center for several activity levels.
A flexible budget is constructed as follows:
o

Step 1: Identify the relevant activity levels.
 The relevant levels of activity could be expressed in units, machine
hours, direct labor hours, or some other activity base.

o
o

Step 2: Identify the fixed and variable cost components of
the costs being budgeted.
Step 3: Prepare the budget for each activity level by
multiplying the variable cost per unit by the activity level
and then adding the monthly fixed cost.

©2016


Master Budget

•

The master budget is an integrated set of operating

and financing budgets for a period of time.
o
o

•

The operating budgets can be used to prepare a budgeted
income statement.
The financial budgets provide information for a budgeted
balance sheet.

Most companies prepare a master budget on a
yearly basis.

©2016


Master Budget for a Manufacturing Company

©2016


Sales Budget

•

The sales budget begins by estimating the quantity of
sales.
o

•

These sales quantities are then revised for such factors
as:
o
o
o

•

The prior year’s sales are often used as a starting point.

Planned advertising and promotions
Projected pricing changes
Expected industry and general economic condition.

Once sales quantities are estimated, the budgeted
sales revenue can be determined as follows:

©2016


Production Budget

•
•

The production budget estimates the number of units
to be manufactured to meet budgeted sales and
desired inventory levels.

The budgeted units to be produced are determined
as follows:

©2016


Direct Materials Purchases Budget
(slide 1 of 2)

•

The direct materials purchases budget estimates the
quantities of direct materials to be purchased to
support budgeted production and desired inventory
levels.

©2016


Direct Materials Purchases Budget
(slide 2 of 2)

• The direct materials purchases budget can be developed in three steps:
o

Step 1. Determine the budgeted direct material required for production, which
is computed as follows:

o

Step 2. The budgeted material required for production is adjusted for
beginning and ending inventories to determine the direct materials to be
purchased for each material, as follows:

o

Step 3. The budgeted direct materials to be purchased is computed as follows:

©2016


Direct Labor Cost Budget

•
•

The direct labor cost budget estimates the direct
labor hours and related cost needed to support
budgeted production.
The direct labor cost budget for each department is
determined in two steps, as follows:
o

Step 1. Determine the budgeted direct labor hours required
for production, which is computed as follows:

o

Step 2. Determine the total direct labor cost as follows

©2016


Factory Overhead Cost Budget

•
•

The factory overhead cost budget estimates the cost
for each item of factory overhead needed to support
budgeted production.
The factory overhead cost budget may be supported
by departmental schedules.
o

Such schedules normally separate factory overhead costs
into fixed and variable costs to better enable department
managers to monitor and evaluate costs during the year.

©2016


Cost of Goods Sold Budget

•

The cost of goods sold budget is prepared by
integrating the following budgets:
o
o

o

•

Direct materials purchases budget
Direct labor cost budget
Factory overhead cost budget

The estimated and desired inventories for direct
materials, work in process, and finished goods must be
integrated into the cost of goods sold budget.

©2016


Selling and Administrative Expenses Budget

•
•

The sales budget is often used as the starting point for
the selling and administrative expenses budget.
The selling and administrative expenses budget is
normally supported by departmental schedules.

©2016


Budgeted Income Statement

•

The budgeted income statement is prepared by
integrating the following budgets:
o
o
o

•
•

Sales budget
Cost of goods sold budget
Selling and administrative expenses budget

In addition, estimates of other income, other expense,
and income tax are also integrated into the budgeted
income statement.
This budget summarizes the budgeted operating
activities of the company.

©2016


Cash Budget
(Slide 1 of 2)

•

The cash budget estimates the expected receipts

(inflows) and payments (outflows) of cash for a period
of time.
o

o

o

The primary source of estimated cash receipts is from cash
sales and collections on account.
In addition, cash receipts may be obtained from plans to
issue equity or debt financing as well as other sources such
as interest revenue.
To estimate cash receipts from cash sales and collections on
account, a schedule of collections from sales is prepared.

©2016


Cash Budget
(Slide 2 of 2)
o

o

o

Estimated cash payments must be budgeted for operating
costs and expenses such as manufacturing costs, selling
expenses, and administrative expenses.

In addition, estimated cash payments may be planned for
capital expenditures, dividends, interest payments, or longterm debt payments.
To estimate cash payments for manufacturing costs, a
schedule of payments for manufacturing costs is prepared.

©2016


Completing the Cash Budget

•

The cash budget is structured for a budget period as
follows:

©2016


Capital Expenditures Budget

•

The capital expenditures budget summarizes plans
for acquiring fixed assets.
o
o

•

Such expenditures are necessary as machinery and other

fixed assets wear out or become obsolete.
In addition, purchasing additional fixed assets may be
necessary to meet increasing demand for the company’s
product.

Capital expenditures budgets are often prepared for
five to ten years into the future.
o

This is necessary because fixed assets often must be
ordered years in advance.

©2016


Budgeted Balance Sheet

•
•

The budgeted balance sheet is prepared based on
the operating and financial budgets of the master
budget.
The budgeted balance sheet is dated as of the end of
the budget period and is similar to a normal balance
sheet except that estimated amounts are used.

©2016