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Chapter 22. Operational Budgeting. Control Steps taken by management to ensure that objectives are attained. Planning Developing objectives for acquisition and use of resources. Budgeting: The Basis for Planning and Control.

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Chapter22

Operational Budgeting


Control

Steps taken by management to ensure that objectives are attained.

Planning

Developing objectives for acquisitionand use of resources.

Budgeting: The Basis forPlanning and Control

A budget is a comprehensive financialplan for achieving the financial andoperational goals of an organization.


Enhanced managerialresponsibility

Coordinationof activities

Performanceevaluation

Benefits

Assignment of decisionmaking responsibilities

Benefits Derived from Budgeting


Budget Problems

Perceived unfair or unrealistic goals.

Poor management-employee communications.

Solution

Reasonable and achievable budgets.

Employee participation in budgeting process.

Establishing Budgeted Amounts: The “Behavioral” Approach


Participation in Budget Process

Flow of Budget Data


2001

2002

2003

2004

C a p i t a l B u d g e t s

The Budget Period

The annual operating budget may be divided into quarterly or monthly budgets.

A continuous budget is usually a twelve-month budget that adds one month as the current month is completed.


Cost of goodssold and endinginventorybudgets

Salesforecast

Productionschedule

  • Budgeted

  • financial budgets:

  • cash

  • income

  • balance sheet

Capitalexpendituresbudget

Operatingexpensebudgets

The Master Budget


Preparing the Master Budget:An Illustration

That’s enough talkingabout budgets, nowshow me an example!


EstimatedUnit Sales

EstimatedUnit Price

Analysis of economic and market conditions+Forecasts of customer needs from marketing personnel

Preparing the Master Budget:An Illustration

SalesBudget


Ellis Magnet Co. is preparing budgets for the quarter ending June 30. The sales price is $10 per magnet. Budgeted sales for the next four months are:

April20,000 magnets @ $10 =$200,000May50,000 magnets @ $10 =$500,000June30,000 magnets @ $10 =$300,000July25,000 magnets @ $10 =$250,000

Preparing the Master Budget:An Illustration

The Sales Budget

July is needed for June ending inventory computations.


Sales

Budget

Production

Budget

Completed

The Production Budget


Ellis wants ending inventoryto be 20 percent of the next month’s budgeted sales in units.

4,000 units were on hand March 31.

Let’s prepare the production budget.

The Production Budget


Production must be adequate to meet budgeted sales and to provide sufficient ending inventory.

  • Budgeted product sales in units

  • +Desired product units in ending inventory

  • =Total product units needed

  • – Product units in beginning inventory

  • =Product units to produce

The Production Budget


The Production Budget


The Production Budget


The Production Budget


Production

Budget

Units

Production

Budget

MaterialPurchases

Completed

The Production Budget


  • Units to produce

  • × Material needed per unit

  • =Material needed for units to produce

    • +Desired units of material in ending inventory

    • =Total units of material needed

    • – Units of material in beginning inventory

    • =Units of material to purchase

The Production BudgetMaterial Purchases

The material purchases budget is based on production quantity and desired material inventory levels.


Five pounds of material are needed for each unit produced.

Ellis wants to have materials on hand at the end of each month equal to 10 percent of the following month’s production needs.

The materials inventory on March 31 is 13,000 pounds. July production is budgeted for 23,000 units.

The Production BudgetMaterial Purchases


The Production BudgetMaterial Purchases


The Production BudgetMaterial Purchases


The Production BudgetMaterial Purchases


Materials used in production cost $.40per pound. One-half of a month’s purchases are paid for in the month of purchase; the other half is paid for in the following month.

No discount terms are available.

The accounts payable balance onMarch 31 is $12,000.

Cash Payments forMaterial Purchases


Cash Payments forMaterial Purchases


Cash Payments forMaterial Purchases


Cash Payments forMaterial Purchases


Cash Payments forMaterial Purchases


Production

Budget

UnitsMaterial

Production

Budget

Labor

Completed

The Production Budget


Each unit produced requires 3 minutes (.05 hours) of direct labor. Ellis employs 30 persons for 40 hours each week at a rate of $10 per hour. Any extra hours needed are obtained by hiring temporary workers also at $10 per hour.

The Production BudgetDirect Labor


Cash Payments forDirect Labor


Cash Payments forDirect Labor


Production

Budget

UnitsMaterialLabor

Production

Budget

ManufacturingOverhead

Completed

The Production Budget


Variable manufacturing overhead is $1 per unit produced and fixed manufacturing overhead is $50,000 per month.

Fixed manufacturing overhead includes $20,000 indepreciation which does not require a cash outflow.

The Production BudgetManufacturing Overhead


Cash Payments forManufacturing Overhead


Cash Payments forManufacturing Overhead


Cash Payments forManufacturing Overhead


Production

Budget

SellingandAdministrativeExpenseBudget

Completed

Selling and Administrative(S&A) Expense Budget


Selling expense budgets contain both variable and fixed items.

Variable items: shipping costs and sales commissions.

Fixed items: advertising and sales salaries.

Administrative expense budgets contain mostly fixed items.

Executive salaries and depreciation on company offices.

Selling and Administrative(S&A) Expense Budget


Variable selling and administrative expenses are $.50 per unitsoldand fixed selling and administrative expenses are $70,000 per month.

Fixed selling and administrative expenses include $10,000 in depreciation which does not require a cash outflow.

Cash Payments for(S&A) Expenses


Cash Payments for(S&A) Expenses


Cash Payments for(S&A) Expenses


I have seen a lot of cashpayments but no cashreceipts. Show me somecash receipts!

Cash Receipts Budget


All sales are on account.

Ellis’s collection pattern is:

70 percent collected in month of sale

25 percent collected in month after sale

5 percent will be uncollectible

Accounts receivable on March 31 is $30,000, all of which is collectible.

Cash Receipts Budget


Cash Receipts Budget


Cash Receipts Budget


Cash Receipts Budget


Cash Receipts Budget


With just a little more information we will be able to prepare a comprehensive cash budget.

Comprehensive Cash Budget


Comprehensive Cash BudgetAdditional Information

  • Ellis Magnet Company:

    • Has a $100,000 line of credit at its bank, with a zero balance on April 1.

    • Maintains a $30,000 minimum cash balance.

    • Borrows at the beginning of a month and repays at the end of a month.

    • Pays interest at 16 percent when a principal payment is made.

    • Pays a $51,000 cash dividend in April.

    • Purchases equipment costing $143,700 in May and $48,800 in June.

    • Has a $40,000 cash balance on April 1.


$50,000 × .16 × 3/12 = $2,000


Cash

Budget

Budgeted

Income

Statement

Completed

The BudgetedIncome Statement


The BudgetedIncome Statement


Computation of unit cost follows

The BudgetedIncome Statement


The BudgetedIncome Statement

Total mfg. OH for quarter $251,000

Total labor hours required 5,050 hrs.

= $49.70 per hr.

Manufacturingoverhead is appliedbased ondirect labor hours.


The BudgetedIncome Statement


The BudgetedIncome Statement


Budgeted

Income

Statement

Budgeted

BalanceSheet

Completed

The BudgetedBalance Sheet


Ellis reports the following account balances on June 30, prior to preparing its budgeted financial statements:

Land - $50,000

Building (net) - $174,500

Common stock - $200,000

Equipment (net) - $192,500

Retained earnings - $148,150

The BudgetedBalance Sheet


25% of June

sales of

$300,000

11,500 lbs. @ $.40 per lb.

5,000 units

@ $4.99 each

50% of June

purchases

of $56,800


Let’s change topics.

Flexible Budgeting


Performance evaluation is difficult when actual activitydiffersfrom the activity originally budgeted.

Hmm! Comparingcosts at differentlevels of activity is like comparingapples with oranges.

Flexible Budgeting

Consider the followingcondensed examplefrom the CheeseCompany . . .


Flexible Budgeting


Flexible Budgeting

U = Unfavorable variance – Cheese Company was unable to achieve the budgeted level of activity.


Flexible Budgeting

F = Favorable variance: actual costs are less than budgeted costs.


Flexible Budgeting

Since cost variances are favorable, havewe done a good job controlling costs?


Flexible Budgeting

  • How much ofthe favorable costvariance is due to loweractivity, and how much is dueto good cost control?

I don’t think I can answer the question using the originalbudget.


To answer the question, we must

the budget to the actual level of activity.

Flexible Budgeting

  • How much ofthe favorable costvariance is due to loweractivity, and how much is dueto good cost control?

I don’t think I can answer the question using the originalbudget.


Central Concept

If you can tell me what your activity wasfor the period, I will tell you what your costs and revenue should have been.

Flexible Budgeting


Flexible Budgeting

Show expenses that should haveoccurred at the actual level ofactivity.

May be prepared for any activity level in the relevant range.

Reveal variances due to good cost

control or lack of cost control.

Improve performance evaluation.


Toa budget for different activity levels, we must know how costs behave with changes in activity levels.

Total variable costschangein direct proportion to changes in activity.

Total fixed costs remainunchangedwithin therelevant range.

Flexible Budgeting

Variable

Fixed


Flexible Budgeting

Let’s prepare budgets for the Cheese Company.


Flexible Budgeting

Variable costs are expressed as a constant amount per hour.

In the original budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of $4.00 per hour.


Flexible Budgeting


Total variable cost = $7.50 per unit × budget level in units

Flexible Budgeting


Fixed costs are expressed as a total amount that does not change within the relevant range of activity.

Flexible Budgeting


Flexible BudgetingPerformance Report

Now let’s prepare a budget performance report at 8,000 actual machine hours for the Cheese Co.


Flexible BudgetingPerformance Report


Indirect labor and indirect material have unfavorablevariances because actual costs are more than the flexible budget costs.

Flexible BudgetingPerformance Report


Power has a favorable variance because the actual cost is less than the flexible budget cost.

Flexible BudgetingPerformance Report


End of Chapter 22

I would be happy to assist you with your cash budget!


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