Planning and Budgeting

1. Planning and Budgeting Chapter 13 Edited by Dr. Charles Bailey for ACCT3310

2. Learning Objectives LO 13-1Understand the role of budgets in overall organization plans. LO 13-2Understand the importance of people in the budgeting process. LO 13-3Estimate sales. LO 13-4 Develop production and cost budgets. LO 13-5 Estimate cash flows. LO 13-6 Develop budgeted financial statements. LO 13-7 Explain budgeting in merchandising and service organizations. LO 13-8 Explain why ethical issues arise in budgeting. LO 13-9 Explain how to use sensitivity analysis to budget under uncertainty.

3. LO 13-1 Budgets LO 13-1Understand the role of budgets in overall organization plans. We focus on the planning purpose of the budgeting process. For our purposes here, a budget is simply the plan, stated in financial terms, of how theorganization expects to carry out its activities and meet the financial goals established in the planning process. We show how a master budget is developed and how it fits into the overall plan for achieving organization goals. Before we investigate the details of developing a master budget, we discuss the way that strategic planning can increase competitiveness and affect global operations.

4. LO 13-1 Overall Plan • A master budget is part of an overall organization plan for the next year made up of three components: • the organization goals, • the strategic long-range profit plan, and • (3) the tactical short-range profit plan. Top managers establish broad objectives, which serve as organization goals that company employees work to achieve. It is important to detail the specific steps required to achieve the goals. These steps are expressed in a strategic long-range plan. The plan for the coming year, which is more specific than long-range plans, is called the master budget, also known as the static budget, the budget plan, or the planning budget .

5. LO 13-1 Organizational and Individual Interaction: Developing the Master Budget

6. LO 13-2 Human Element in Budgeting LO 13-2Understand the importance of people in the budgeting process. Organization goals Individual goals Goal congruence Participative Budgeting Use of input from lower- and middle-management employees; also called grass roots budgeting

7. LO 13-3 Sales Forecasting LO 13-3Estimate sales. Forecasting sales is the most difficult aspect of budgeting. How do we forecast sales? Sales staff Market researchers Delphi technique Trend analysis Econometric models

8. LO 13-3 Forecasting by Sales Staff After evaluating the sales forecasts derived from various sources, the budgeting task force at Santiago Pants arrived at the following sales budget for the next budget year:

9. LO 13-4 Forecasting Production LO 13-4Develop production and cost budgets. A production budget is a plan of resources needed to meet current sales demand and ensure that inventory levels are sufficient for future sales. Basic inventory formula: Beginning balance BB + Transfers in TI – Transfers out TO = Ending balance For inventories, production, and sales: Units in beginning inventory + Required production – Budgeted sales = Units in ending inventory

10. LO 13-4 Production Budget Rearranging for required production: • Santiago Pants' sales budget is 160,000 units • Management estimates that there will be 5,000 units • in beginning inventory and 15,000 in ending inventory. Budgeted sales + Units in ending inventory – Units in beginning inventory = Required production 160,000 units + 15,000 units – 5,000 units = 170,000 units

11. LO 13-4 Production Budget

12. LO 13-4 Indirect labor Indirect materials Other Production Costs Direct materials Direct labor Manufacturing overhead

13. LO 13-4 Direct Materials Example

14. LO 13-4 Direct Materials Example Santiago Pants Estimated Production Materials Data Yards needed:

15. LO 13-4 Direct Materials Example $ $

16. LO 13-4 Direct Labor Example

17. LO 13-4 Overhead Example Santiago Pants Schedule of Budgeted Manufacturing Overhead For the Budget Year Ended December 31 Variable overhead needed to product 170,000 units: Indirect materials and supplies @ $0.30 per unit Materials handling @ $0.40 per unit Other indirect labor @ $0.10 per unit Total variable overhead Fixed manufacturing overhead (supervisory labor $102M, maintenance and repairs $50M, plant administration $85M, utilities $55M, depreciation $140M, insurance $30M, property taxes $60M, and other $22M) Total manufacturing overhead $ 51,000 68,000 $ 17,000 $136,000 $544,000 $680,000

18. LO 13-4 Cost of Goods Sold Example Santiago Pants Budgeted Statement of Cost of Goods Sold For the Budget Year Ended December 31 Beginning work-in-process inventory Manufacturing costs: Direct materials: Beginning inventory Purchases Materials available for manufacturing Less: Ending inventory Total direct materials costs Direct labor Manufacturing overhead Total manufacturing costs Less: Ending work-in-process Cost of goods manufactured Add: Beginning finished goods inventory Less: Ending finished goods inventory Cost of goods sold $ 35,000 1,715,000 $1,750,000 (50,000) $1,700,000 1,870,000 680,000 $ -0- $4,250,000 -0- $4,250,000 120,000a (375,000)b $3,995,000 a Management estimate b Estimate: (15,000 units × $25 value of finished goods)

19. LO 13-4 Marketing and AdministrativeBudget Example

20. LO 13-4 Income Statement Example

21. LO 13-5 Cash Budget LO 13-5Estimate cash flows. The cash budget is a statement of cash on hand at the start of the budget period, expected cash receipts, expected cash disbursements, and the resulting cash balance at the end of the budget period. • Cash receipts: • – Collection of accounts receivable • – Cash sales • – Sales of assets • – Borrowing • – Issuing stock • – Other

22. LO 13-5 Cash Budget Some cash disbursements: – Materials purchases – Manufacturing costs – Operating activities – Debt repayment – Acquisition of new assets – Income taxes – Dividends – Other activities

23. LO 13-5 Cash Budget Santiago Pants Cash Budget For the Budget Year Ended December 31 Cash balance beginning of period Receipts: Collections on accounts Collections employee loans Total receipts Less: Disbursements: Payments for accounts payable Direct labor Manufacturing overhead less noncash depreciation charges Marketing and administrative costs less noncash charges Payments for federal income taxes Dividends Reduction in long-term debt Acquisition of new assets Total disbursements Budgeted ending cash balance $6,840,000 100,000 1,694,000 1,870,000 540,000 1,422,000 350,000 30,000 23,000 1,470,000 $ 830,000 6,940,000 7,399,000 $ 371,000

24. LO 13-5 Cash Collections Example Santiago Pants Monthly Collection Experience Sales on Credit Expected Sales for Three Months

25. LO 13-5 Cash Collections Example Santiago Pants Multiperiod Schedule of Cash Collections For the Quarter Ended March 31 Cash disc’t?? Month January February March Total for Quarter Beginning accounts receivable, January 1, $540,000 January sales, $500,000a February sales, $450,000b March sales, $600,000c Total cash collections $540,000 100,000 $640,000 $375,000 90,000 $465,000 $337,500 120,000 $457,500 $ 540,000 475,000 427,500 120,000 $1,562,500 a 20% collected in January, 75% collected in February, and 5% not collected b 20% collected in February, 75% collected in March, and 5% not collected c 20% collected in March, 75% collected in April, and 5% not collected

26. LO 13-5 Cash Disbursements Example Santiago Pants Monthly Disbursements for Purchases Experience Cash disbursement for current month's purchases 50% Cash disbursement for prior month's purchases 48 Cash discounts taken 2 Total cash disbursement for purchases 100% Expected Purchases for Three Months January sales $120,000 February sales $200,000 March sales $250,000

27. LO 13-5 Cash Disbursements Example Santiago Pants Multiperiod Schedule of Cash Disbursements For the Quarter Ended March 31 Month January February March Total for Quarter Beginning accounts payable, January 1, $256,000 January purchases, $120,000a February purchases, $200,000b March purchases, $250,000c Additional cash payments Total cash disbursements $256,000 60,000 250,000 $566,000 $ 57,600 100,000 250,000 $407,600 $ 96,000 125,000 250,000 $471,000 $ 256,000 117,600 196,000 125,000 750,000 $1,444,600 a 50% paid in January, 48% paid in February, and 2% discounts taken b 50% paid in February, 48% paid in March, and 2% discounts taken c 50% paid in March, 48% paid in April, and 2% discounts taken

28. LO 13-6 Budgeted Balance Sheet Example LO 13-6Develop budgeted financial statements. Santiago Pants Budget Balance Sheet For the Budget Year Ended December 31 ($000) Budget Year Balance Jan 1 Additions Subtractions Balance Dec 31 $ 830 540 155 161 $1,686 1,866 (1,246) $2,306 $ 6,940 7,200 4,265 -0- $18,405 1,470 (220) $19,651 $ 7,399 6,840 3,995 100 $18,334 -0- -0- $18,334 $ 371 900 425 61 $1,757 3,336 (1,470) $3,623 Assets Current assets: Cash Accounts receivable Inventories Other current assets Total current assets Long-term assets: Property, plant, equipment Less: Accumulated depreciation Total assets

29. LO 13-6 Budgeted Balance Sheet Example Santiago Pants Budget Balance Sheet For the Budget Year Ended December 31 ($000) Budget Year Balance Jan 1 Additions Subtractions Balance Dec 31 Liabilities and Shareholders Equity Current liabilities: Accounts payable Taxes payable Current portion of long-term debt Total current liabilities Long-term liabilities Total liabilities Shareholders' equity Common stock Retained earnings Total shareholders Total liabilities and shareholders equity $ 256 187 23 $ 466 258 $ 724 $ 437 1,145 $1,582 $2,306 $1,715 550 23 $2,288 -0- $2,288 $ -0- 1,149 $1,149 $3,437 $1,694 350 23 $2,067 23 $2,090 $ -0- 30 30 $2,120 $ 277 387 23 $ 687 235 $ 922 $ 437 2,264 $2,701 $3,623

30. LO 13-6 Assembling the Master Budgetfor a Manufacturing Firm

31. LO 13-7 Budgeting in Service Organizations LO 13-7Explain budgeting in merchandising and service organizations. Sales forecast Budgeted cost of services Budgeted income statement Marketing and administrative cost budget Cash budget Budgeted balance sheets

32. LO 13-7 Budgeting Retail and Wholesale Organizations Sales forecast Purchases Marketing and administrative cost budget Budgeted income statement Cash budget Budgeted balance sheets

33. LO 13-7 Budgeting Retail and Wholesale Organizations Castro Audio & Video, Inc. Estimated Information for Retail Operations

34. LO 13-7 Budgeting Retail and Wholesale Organizations

35. LO 13-8 Ethical Problems in Budgeting LO 13-8Explain why ethical issues arise in budgeting. Budgets can create serious ethical issues for many people. The company must recognize the trade-off between encouraging unbiased reporting by managers and the use of budget information in performance evaluation and rewards.

36. LO 13-9 Budgeting Under Uncertainty LO 13-9Explain how to use sensitivity analysis to budget under uncertainty. Budgets allow management to explore many alternatives. Spreadsheets are helpful in preparing budgets and quantifying “what-if” conditions. Questions like what if labor costs are 10 percent higher (or lower) than projected?

37. LO 13-9 Alternative Budgeting Scenarios Santiago Pants Alternative Budget Scenarios

38. End of Chapter 13