COST MANAGEMENT Accounting Control HansenMowenGuan Chapter 8 Budgeting

COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan • Chapter 8 • Budgeting for Planning and Control COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning and South-Western are trademarks used herein under license. 1

Study Objectives 1. Define budgeting, and discuss its role in planning, controlling, and decision making. 2. Prepare the operating budget, identify its major components, and explain the interrelationships of the various components. 3. Identify the components of the financial budget, and prepare a cash budget. 4. Define flexible budgeting, and discuss its role in planning, control, and decision making. 5. Define activity-based budgeting, and discuss its role in planning, control, and decision making. 6. Identify and discuss the key features that a budgetary system should have to encourage managers to engage in goal-congruent behavior. 2

The Role of Budgeting in Planning and Control 3

The Role of Budgeting in Planning and Control • Types of budgets – Master budget • Operating budgets • Financial budgets • Time frame – Annual period – Multi-year rolling budget 4

The Role of Budgeting in Planning and Control • Gathering information – Forecasting sales – Forecasting other variables The master budget starts with the sales forecast, which is basis for the sales budget. All other operating and most financial budgets are generated from the sales budget. 5

The Role of Budgeting in Planning and Control 6

Preparing the Operating Budget The first budget is the sales budget which is based on the sales forecast. Schedule 1 (in thousands) Starting point for Production Budget Starting point for Marketing Expense Budget Goes to Budgeted Income Statement 7

Preparing the Operating Budget Schedule 2 (in thousands) Starting point for Direct Materials Purchases Budget Starting point for Direct Labor Budget 8

Preparing the Operating Budget Schedule 3 (in thousands) * Follows the inventory policy of having 8 million pounds of materials on hand at the end of the first and second quarters and 5 million pounds on hand at the end of the third and fourth quarters. Goes to Cost of Goods Sold Budget 9

Preparing the Operating Budget Schedule 4 (in thousands) Starting point for Overhead Budget Goes to Cost of Goods Sold Budget 10

Preparing the Operating Budget Schedule 5 (in thousands) *Includes $200, 000 of depreciation in each quarter. Goes to Cost of Goods Sold Budget 11

Preparing the Operating Budget Schedule 6 (in thousands) a. Amounts taken from Schedule 3. b. Amounts taken from Schedule 4. c. Amounts taken from Schedule 5. d. Budgeted fixed overhead (Schedule 5)/Budgeted direct labor hours (Schedule 4) = $1, 280/240 = $5. 33. Goes to Cost of Goods Sold Budget 12

Preparing the Operating Budget Schedule 7 (in thousands) *Production needs $0. 01 = 416, 000 $0. 01. Goes to Budgeted Income Statement 13

Preparing the Operating Budget Schedule 8 (in thousands) Goes to Budgeted Income Statement 14

Preparing the Operating Budget Schedule 9 (in thousands) Goes to Budgeted Income Statement 15

Preparing the Operating Budget Schedule 10 (in thousands) Goes to Budgeted Income Statement 16

Preparing the Operating Budget Schedule 11 (in thousands) 17

Operating Budgets for Merchandising and Service Firms • Merchandising – Merchandise purchases replaces production – Direct materials and direct labor are not required • For-profit service: – Sales budget is the production budget – Inventories are nonexistent • Not-for-profit service: – Budget for level and types of services provided – Statement of sources and uses replaces income statement 18

Preparing the Financial Budget Cash budget – Break down into short time periods – Forecast need for short-term borrowing – Forecast periods of high cash balances + – – – + + Beginning cash balance Cash receipts Cash available Cash disbursements Minimum cash balance Excess or deficiency of cash Repayments Loans Minimum cash balance Ending cash balance 19

Preparing the Financial Budget Schedule 12 (in thousands) (Continued on next slide) 20

Preparing the Financial Budget Schedule 12 (in thousands) (Continued from previous slide) (Continued on next slide) 21

Preparing the Financial Budget Schedule 12 (in thousands) (Continued from previous slide) 22

Preparing the Financial Budget • Budgeted balance sheet – Current (actual) balance sheet – Integrate data from all other budgets 23

Preparing the Financial Budget Schedule 13 (in thousands) a Ending balance from Schedule 12. b 30 percent of fourth-quarter credit sales (0. 30 × $800, 000); see Schedules 1 and 12. c From Schedule 3 (5, 000 lbs. × $0. 01). d From Schedule 6. e From the December 31, 2009, balance sheet. f December 31, 2009, balance ($9, 000) plus new equipment acquisition of $600, 000; see the 2009 ending balance sheet and Schedule 12. g From the December 31, 2009, balance sheet and Schedules 5, 8, and 10 ($4, 500, 000 + $800, 000 + $20, 000 + $40, 000). h 20% of fourth-quarter purchases; see Schedules 3 and 12. i From the December 31, 2009, balance sheet. j $6, 825, 000 + $894, 000 (December 31, 2009, balance plus net income from Schedule 11). 24

Shortcomings of the Traditional Master Budget Process • Departmental orientation – Plan from resources to outputs – Does not recognize interdependencies among departments • Static budgets – Developed for a single level of activity – Based on incremental adjustments • Results orientation – Disconnects the process from its output – Cost-cutting accomplished by across-the-board cuts 25

Flexible Budgets for Planning and Control Static budget • Vital for planning • Less useful for control • Master budget • Developed around a single level of activity • Budgeted activity level rarely equals actual activity 26

Flexible Budgets for Planning and Control 27

Flexible Budgets for Planning and Control Static budgets • Master budget • Vital for planning • Less useful for control • Developed around a single level of activity • Budgeted activity level rarely equals actual activity Flexible budgets • Variable budget • Provides expected costs for a range of activity • Provides budgeted costs for the actual activity level 28

Flexible Budgets for Planning and Control 29

Flexible Budgets for Planning and Control • Flexible budget performance report – Compare budgeted costs given the actual level of activity to the actual costs for the same level – Locate possible problem areas by examining the flexible budget variances – Examines efficiency 30

Flexible Budgets for Planning and Control 31

Flexible Budgets for Planning and Control • Flexible budget performance report – Compare budgeted costs given the actual level of activity to the actual costs for the same level – Locate possible problem areas by examining the flexible budget variances – Examines efficiency • Managerial performance report – Flexible budget variances – Actual results vs. flexible budget – Examines efficiency – Volume variances – Static budget vs. flexible budget – Examines effectiveness 32

Flexible Budgets for Planning and Control 33

Flexible Budgets for Planning and Control A flexible budget can be built for five overhead activities using three drivers; each is budgeted for two activity levels. 34

Flexible Budgets for Planning and Control The activity-based performance report measures budget variances for each of the overhead activities. 35

Activity-Based Budgets • ABB begins with output and then determines the resources necessary to created that output. • ABB works backwards from activities and their drivers to the underlying costs – Traditional budgeting relies on functionalbased line items (salaries, supplies, etc. ) – Flexible budget uses cost behavior to split functional-based line items into fixed and variable 36

Activity-Based Budgets Traditional budgeting relies on functional-based line items. 37

Activity-Based Budgets Flexible budgeting uses cost behavior to split functional-based line items into fixed and variable costs. 38

Activity-Based Budgets Steps to construct an ABB 1. Determine the unit’s output 2. Identify the activities (and related drivers) needed to deliver the output 3. Estimate the demand for each activity 4. Determine the cost of resources required to produce the relevant activities 39

Activity-Based Budgets 40

The Behavioral Dimension of Budgeting • Characteristics of a good budgetary system – Frequent feedback on performance – Monetary and nonmonetary incentives – Participative budgeting – Realistic standards – Controllability of costs – Multiple measures of performance 41

COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan • End Chapter 8 COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning and South-Western are trademarks used herein under license. 42