Chapter 8: The Master Budget

1. Chapter 8:The Master Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

2. Learning Objectives • How are strategic planning and tactical planning related to budgeting? • What is the starting point of a master budget and why? • What are the various components of a master budget and how are they prepared? • Why is the cash budget so important in the master budgeting process? • How and why are budgeted financial statements prepared at the end of the budgeting process? • What benefits are provided by a budget? • (Appendix) How does a budget manual facilitate the budgeting process? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

3. Management and Planning • Planning is the cornerstone of effective management. • Budgeting—Formalizes plans and translates qualitative narratives into a documented, quantitative format • Budget—Expresses a commitment to planned activities and resource acquisition and use © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

4. Strategic Planning Tactical Planning The Planning Process Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

5. Strategic Planning Long term (5 to 10 years) Top-level management Long-range goals, strategies, and policies Foundation for short-term planning Identify and gather information on key variables, both internal and external Strategic Planning © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6. Strategic Planning Strategic Planning • Effective strategic planning requires that managers build plans and budgets that integrate external considerations and influences with internal factors • Core competencies • Product development • Product life cycles © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7. External Key Variables Competitor actions Local and global market conditions Political/regulatory climates Current and emerging technology issues Outsourcing opportunities Consumer trends and attitudes Demographics Strategic Planning © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

8. Tactical Plans Short term (1 to 18 months) Top and middle management Specific objectives and means to achieve strategic plans Basis against which results can be measured Tactical Planning © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

9. Budgets Communicate objectives, constraints, and expectations Provide financial predictions Provide nonfinancial performance goals and objectives Identify potential difficulties Determine resource allocation and constraints Permit control through budget-to-actual comparisons Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

10. Budgeting Short term Top, middle, and operational management involvement Usable guidelines to implement strategic and tactical plans Allocates resources Standard against which performance can be measured Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

11. Strategic Planning Tactical Planning Planning Relationships Top Management Top, Middle, and Operational Management Budget Top and Middle Management © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

12. The Control Phase Budget • Actual-to-budget comparisons • Determining and investigating variances • Corrective action • Feedback to operating managers © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

13. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

14. The Master Budget A comprehensive set of budgets, budgetary schedules, and pro forma organizational financial statements For a specific period of time Static—based on a single level of output demand Interactive—departments generate and consume information Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

15. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

16. The Master Budget Budget Operating Budgets Financial Budgets Cash Budget Sales Budget Capital Expenditures Budget Production Budget Purchases Budget Balance Sheet Direct Labor Budget Income Statement Overhead Budget Statement of Cash Flows Selling & Administrative Budget Statement of Retained Earnings © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

17. Sales Budget • Sales forecast • Ask sales personnel • Extrapolate past trends • Use market research • Employ statistical models and simulation Units to be sold * Selling price per unit = Dollars of sales © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

18. Operating Budget Sales Budget Production Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

19. Production Budget Production manager combines Sales estimates Beginning inventory targets Ending inventory targets Determines the types, quantities, and timing of products to be manufactured © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

20. Ending Inventory Policy Percentage of next period’s projected sales Constant amount Buildup of inventory for high-demand periods Near zero in just-in-time systems Cost of holding inventory includes storage, insurance, obsolescence, shrinkage, damage © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

21. Operating Budget Sales Budget Production Budget Purchases Budget Direct Labor Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

22. Direct Labor Budget • Total number of people • Specific types of workers • Production hours needed • Costs • Union contracts • Minimum wage laws • Fringe benefit costs • Payroll taxes Units to be produced (or DM components) * Standard time allowed per unit = Standard labor time allowed * Per hour direct labor cost = Total direct labor cost © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

23. Operating Budget Sales Budget Production Budget Overhead Budget Purchases Budget Direct Labor Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

24. Overhead Budget • Identify activity base • Estimate overhead costs • Separate costs as fixed or variable • Show total costs for operating budgets • Show costs without depreciation for cash budgets Predicted activity base * Variable overhead rate per unit of activity = Total variable overhead cost + Fixed overhead cost = Total overhead cost = Total cost without depreciation © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

25. Operating Budget Sales Budget Selling & Admin Budget Production Budget Purchases Budget Overhead Budget Direct Labor Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

26. Selling and Administrative Budget Predicted sales dollars (or other measure) * Variable S&A rate per dollar = Total variable overhead cost + Fixed S&A cost = Total S&A cost = Total cost without depreciation © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

27. The Financial Budget Cash Budget Operating Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

28. Cash Budget • Highlights importance of cash for organization’s continued existence • Translates accrual-based information into cash flows • Indicates effectiveness of credit practices • Allows for planned cash borrowing or investing • Used to prepare pro forma Cash Flow Statement Beginning cash balance + Cash receipts (collections) = Cash available for disbursements – Cash disbursements = Cash excess or deficiency – Minimum desired cash balance = Cash needed/available for investment or loan repayment +/– Various financing measures = Ending cash balance © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

29. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

30. Cash Collections/Disbursements Collections Sales Cash Accounts Receivable Disbursements Purchases Cash Accounts Payable © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

31. Receipts/Disbursements From Jan Feb Mar Total Nov Dec Jan Feb Mar Total Cash Collections/Disbursements Percentage of cash received/paid during the month Reduced by discounts and estimated uncollectible accounts © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

32. Establish sound credit practices Expedite fulfillment and shipping Bill promptly and accurately Offer discounts for prompt payments Aggressively follow up on past due accounts Deposit payments promptly Seek better payment terms from suppliers/banks Keep tight control of inventory Review and reduce expenses Pay bills on time but never before they are due How to Improve Cash Flow © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

33. The Financial Budget Cash Budget Capital Budget Operating Budget © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

34. Capital Budget • Long-term fixed asset needs • Plant • Equipment • Payment points © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

35. The Financial Budget Cash Budget Capital Budget Operating Budget Income Statement/ Cost of Goods Manufactured © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

36. The Financial Budget Cash Budget Capital Budget Income Statement/ Cost of Goods Manufactured Operating Budget Statement of Retained Earnings © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

37. Budgets Provide Budget • Guide to align activities and resources with organizational goals • Vehicle to promote employee participation, cooperation, and departmental coordination • Tool to enhance planning, controlling, problem solving, and evaluating © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

38. Budgeting Provides Budget • Basis to sharpen responsiveness to internal and external factors • Model to view future performance and consider alternative measures © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

39. Budgeting Terms Budget • Continuous budgeting • 12-month rolling budget • Budget slack • Intentional underestimation of revenue • Intentional overestimation of expenses • Participatory budget • Developed by top management and operating personnel • Imposed budgets • Developed by top management • Imposed on operating personnel © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

40. Activity Budget Budget • Connect line items in budget to list of activities • Raise awareness of non-value-added activities • Question and reduce non-value-added costs © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

41. Budget Manual (Appendix) Budget • Statements of budgetary purpose and its desired results • Listing of specific budgetary activities to be performed • Calendar of scheduled budgetary activities • Sample of budgetary forms • Original, revised, and approved budgets © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

42. Questions How are strategic and tactical planning related to budgeting? In what order are the master budget schedules prepared? Why is the cash budget important in the master budgeting process? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

43. Potential Ethical Issues (1 of 2) Using a single budget system globally that may conflict with national cultures Permitting budget slack Distorting budgeting process by treating short-term conditions as long-term conditions Using fraudulent accounting techniques to meet budget goals Ignoring employee input in budgeting Justifying management decisions by using “backwards budgeting” © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

44. Potential Ethical Issues (2 of 2) Disregarding contingencies in budgeting Ignoring external performance measures and benchmarks Failure to communicate “big picture” assumptions to all managers participating in the budget process Promoting “spend-it-or-lose-it” attitudes to punish cost savings and reward spending Mandating “across-the-board” budget cuts without considering alternative cost reductions © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.