Cornerstones

1. Cornerstones of Managerial Accounting, 5e

2. Chapter 9:Profit Planning Cornerstones of Managerial Accounting, 5e

3. Learning Objectives • Define budgeting and discuss its role in planning, control, and decision making. • Define and prepare the operating budget, identify its major components, and explain the interrelationships of its various components. • Define and prepare the financial budget, identify its major components, and explain the interrelationships of its various components. • Describe the behavioral dimension of budgeting.

4. Description of Budgeting • All businesses should prepare budgets. • Budgets help business owners and managers to plan ahead, and later, exercise control by comparing what actually happened to what was expected in the budget. • Budgets formalize managers’ expectations regarding sales, prices, and costs. • Even small businesses and nonprofit entities can benefit from the planning and control provided by budgets. LO-1

5. Budgeting and Planning and Control • Planning and control are linked. • Planning is looking ahead to see what actions should be taken to realize particular goals. • Control is looking backward, determining what actually happened and comparing it with the previously planned outcomes. • Budgetsare financial plans for the future and are a key component of planning. They identify objectives and the actions needed to achieve them. LO-1

6. Budgeting and Planning and Control (cont.) • Before preparing a budget, an organization should develop a strategic plan. • The strategic planplots a direction for an organization’s future activities and operations; it generally covers at least 5 years. LO-1

7. Planning, Control, and Budgets LO-1

8. Advantages of Budgeting A budgetary system gives an organization several advantages. LO-1

9. The Master Budget • The master budget is the comprehensive financial plan for the organization as a whole. • Typically for a 1-year period, corresponding to the fiscal year of the company. • Yearly budgets are broken down into quarterly and monthly budgets. • The use of smaller time periods allows managers to compare actual data with budgeted data more frequently, so problems may be noticed and resolved sooner. LO-1

10. The Master Budget (cont.) • Some organizations have developed a continuous budgeting philosophy. • A continuous budget is a moving 12-month budget. • As a month expires in the budget, an additional month in the future is added so that the company always has a 12-month plan on hand. • Proponents of continuous budgeting maintain that it forces managers to plan ahead constantly. LO-1

11. Master Budget: Directing and Coordinating • Most organizations prepare the master budget for the coming year during the last 4 or 5 months of the current year. • The budget committee: • reviews the budget • provides policy guidelines and budgetary goals • resolves differences that arise as the budget is prepared • approves the final budget • monitors the actual performance of the organization as the year unfolds. • The controller usually serves as the budget director, the person responsible for directing and coordinating the organization’s overall budgeting process. LO-1

12. Master Budget: Major Components • A master budget can be divided into operating and financial budgets: • Operating budgets describe the income-generating activities of a firm: sales, production, and finished goods inventories. Outcome is a pro forma or budgeted income statement. • Financial budgets detail the inflows and outflows of cash and the overall financial position. • Planned cash inflows and outflows appear in the cash budget. The expected financial position at the end of the budget period is shown in a budgeted, or pro forma, balance sheet. LO-1

13. Master Budget: Major Components (cont.) • Since many of the financing activities are not known until the operating budgets are known, the operating budget is prepared first. LO-1

14. The Master Budget and Its Interrelationships LO-1

15. Preparing the Operating Budget • The operating budget consists of a budgeted income statement accompanied by the following supporting schedules: • sales budget • production budget • direct materials purchases budget • direct labor budget • overhead budget • selling and administrative expenses budget • ending finished goods inventory budget • cost of goods sold budget LO-2

16. Sales Budget • The sales budget is approved by the budget committee and describes expected sales in units and dollars. • The sales budget is the basis for all of the other operating budgets and most of the financial budgets. • It is important that it be as accurate as possible. • The first step in creating a sales budget is to develop the sales forecast. • The sales forecast is just the initial estimate, and it is often adjusted by the budget committee. LO-2

17. Cornerstone 9.1 Preparing a Sales Budget LO-2

18. Budgeting in a Service Industry You are the controller for a large, regional medical center. The chief of cardiology has been pushing to have a free-standing heart hospital built on the medical center campus. However, you are concerned that taking the heart cases away from the main hospital will hurt its bottom line. While the medical center is nonprofit, it does need to cover all of its costs to stay in business. You also wonder whether the heart hospital will break even. What information do you need to forecast revenues and costs of the heart hospital? This is a two part problem. The first question, what impact will the heart hospital have on the main hospital’s revenues, requires knowledge of the number and types of heart cases seen at the main hospital each year. This information could come from the sales revenue budget from the previous year, assuming that the total number of patient days and procedures are broken out by type of case and procedure. Since so many of the costs of a hospital are fixed, there will probably be little decrease in costs as those heart patients leave for the freestanding heart hospital. The second question requires a forecast of the number of patients and probably reimbursement rates expected for procedures to be performed by the heart hospital. This information can be compared with budgeted operating costs to see if the heart hospital’s revenues can cover its costs. Forecasts of sales revenues and costs are dependent on detailed information provided by sources like the marketing or sales department and past accounting information and need to be revised and updates as new information or circumstances dictate. LO-2

19. Production Budget • The production budget tells how many units must be produced to meet sales needs and to satisfy ending inventory requirements. • To compute the units to be produced, both unit sales and units of beginning and ending finished goods inventory are needed: Units to be produced = Expected unit sales + Units in desired ending inventory (EI) – Units in beginning inventory (BI) LO-2

20. Cornerstone 9.2 Preparing a Production Budget LO-2

21. Cornerstone 9.2 Preparing a Production Budget (cont.) LO-2

22. Direct Materials Purchases Budget • After the production budget is completed, the budgets for direct materials, direct labor, and overhead can be prepared. • The direct materials purchases budget tells the amount and cost of raw materials to be purchased in each time period. • The formula used for calculating purchases is as follows: LO-2

23. Cornerstone 9.3 Preparing a Direct Materials Purchases Budget LO-2

24. Cornerstone 9.3 Preparing a Direct Materials Purchases Budget LO-2

25. Cornerstone 9.3 Preparing a Direct Materials Purchases Budget LO-2

26. Direct Labor Budget • The direct labor budget shows the total direct labor hours and the direct labor cost needed for the number of units in the production budget. • The budgeted hours of direct labor are determined by the relationship between labor and output. LO-2

27. Cornerstone 9.4 Preparing a Direct Labor Budget LO-2

28. Overhead Budget • The overhead budget shows the expected cost of all production costs other than direct materials and direct labor. • Many companies use direct labor hours as the driver for overhead. • Then costs that vary with direct labor hours are pooled and called variable overhead. • The remaining overhead items are pooled into fixed overhead. LO-2

29. Cornerstone 9.5 Preparing an Overhead Budget LO-2

30. Ending Finished Goods Inventory Budget • The ending finished goods inventory budget: • Supplies information needed for the balance sheet • Serves as an important input for the preparation of the cost of goods sold budget. • To prepare this budget, the unit cost of producing finished goods must be calculated by using information from the direct materials, direct labor, and overhead budgets. LO-2

31. Cornerstone 9.6 Preparing an Ending Finished Goods Inventory Budget LO-2

32. Cornerstone 9.6 Preparing an Ending Finished Goods Inventory Budget LO-2

33. Cost of Goods Sold Budget • Assuming that the beginning finished goods inventory is valued at $1,251, the budgeted cost of goods sold schedule can be prepared using information from Cornerstones 9.3 to 9.6. • The cost of goods sold budget reveals the expected cost of the goods to be sold. LO-2

34. Cornerstone 9.7 Preparing a Cost of Goods Sold Budget LO-2

35. Selling and Administrative Expenses Budget • The selling and administrative expenses budget outlines planned expenditures for nonmanufacturing activities. • Selling and administrative expenses can be broken down into fixed and variable components. • Items as sales commissions, freight, and supplies vary with sales activity. LO-2

36. Cornerstone 9.8 Preparing a Selling and Administrative Expenses Budget LO-2

37. Cornerstone 9.8 Preparing a Selling and Administrative Expenses Budget (cont.) LO-2

38. Budgeted Income Statement • With the completion of the budgeted cost of goods sold schedule and the budgeted selling and administrative expenses budget, a company has all the operating budgets needed to prepare an estimate of operating income. LO-2

39. Cornerstone 9.9 Preparing a Budgeted Income Statement LO-2

40. Preparing the Financial Budget • The remaining budgets found in the master budget are the financial budgets. • The usual financial budgets prepared are: • cash budget • budgeted balance sheet • budget for capital expenditures LO-3

41. Cash Budget • Understanding cash flows is critical in managing a business. • Often, a business successfully produces and sells products but fails because of timing problems associated with cash inflows and outflows. • Because cash flow is the lifeblood of an organization, the cash budget is one of the most important budgets in the master budget. LO-3

42. Cash Budget (cont.) • The basic structure of a cash budget includes cash receipts, disbursements, any excess or deficiency of cash, and financing as shown below: LO-3

43. Cash Budget: Cash Available • Cash available consists of the beginning cash balance and the expected cash receipts. Expected cash receipts include all sources of cash for the period being considered. • The principal source of cash is from sales. • Since a large proportion of sales is usually on account, a major task of an organization is to determine the pattern of collection for its accounts receivable. LO-3

44. Cash Budget: Cash Available (cont.) • If a company has been in business for a while, it can use past experience to determine what percentage of credit sales are paid in the month of and months following sales. • This is used to create a schedule of cash collections on accounts receivable. LO-3

45. Cornerstone 9.10 Preparing a Schedule for Cash Collections on Accounts Receivable LO-3

46. Cornerstone 9.10 Preparing a Schedule for Cash Collections on Accounts Receivable (cont.) LO-3

47. Cash Budget: Cash Disbursements • The cash disbursements section lists all planned cash outlays for the period. • All expenses that do not require a cash outlay are excluded from the list (e.g., depreciation is never included in the disbursements section). • Just as sources of cash may require a schedule of cash collections on accounts receivable to calculate cash expected from credit sales, the disbursements section may require care in handling payments on account. LO-3

48. Cornerstone 9.11 Determining Cash Payments on Accounts Payable LO-3

49. Cornerstone 9.11 Determining Cash Payments on Accounts Payable (cont.) LO-3

50. Cash Budget: Cash Excess or Deficiency • Some companies expand the basic cash budget format by adding lines to show any borrowing or repayment necessary to achieve a minimum desired cash amount. • When this is done, the preliminary ending cash balance is called cash excess or deficiency. • The cash excess or deficiency line is compared to the minimum cash balance (or lowest amount of cash acceptable as noted by company policy). LO-3