© pearson education limited 2008 1 © prentice hall 2008 management accounting cheryl s. mcwatters,...

1© Prentice Hall 2008

© Pearson Education Limited 2008

MANAGEMENT ACCOUNTINGMANAGEMENT ACCOUNTING

Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. MorseCheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse


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Management Accounting McWatters, Zimmerman, Morse

Management Accounting Management Accounting

Budgeting Budgeting(Planning and control)(Planning and control)

Chapter 8


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ObjectivesObjectives

• Use budgeting for planning purposes• Use budgeting for control purposes• Identify the conflicts that exist between planning and control

in the budgeting process• Describe the benefits of having both short-term and long-term

budgets• Explain the responsibility implications of a line-item budget• Identify the costs and benefits of budget lapsing• Develop flexible budgets and identify when flexible budgeting

should be used instead of static budgeting• Explain the costs and benefits of using zero-based budgeting• Create a master budget for an organisation• Create pro-forma financial statements based on data provided


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The Purpose of BudgetsThe Purpose of Budgets

Budgets are a key component of the organization’s planning and control system

Budgets are a key component of the organization’s planning and control system

Budgeting is the process of gathering information to assist in making forecasts Budgeting is the process of gathering information to assist in making forecasts

Budgets are forecasts of future revenues and expenses

Budgets are forecasts of future revenues and expenses


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Budgeting for Planning DecisionsBudgeting for Planning Decisions

Budgets are a used to transfer information to individual decision makers in the

organization

Budgets are a used to transfer information to individual decision makers in the

organization

Budgets play an integral role in making planning decisions

Budgets play an integral role in making planning decisions


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Budgeting for Planning DecisionsBudgeting for Planning Decisions

Encourage bottom-up flow of information

Encourage bottom-up flow of information

Encourage top-down flow of information and

plans

Encourage top-down flow of information and

plans

Budgets

attempt to

Budgets

attempt to


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Budgeting for ControlBudgeting for Control

Budgets are often used to assign responsibilities by allocating resources to managers

Budgets are often used to assign responsibilities by allocating resources to managers

Budgeted amounts can be used as targets by which performance is evaluated and rewarded

Budgeted amounts can be used as targets by which performance is evaluated and rewarded

Budgeted amounts can be used as goals to motivateBudgeted amounts can be used as goals to motivate


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VariancesVariances

The difference between budgeted performance and actual performance is called the variance

The difference between budgeted performance and actual performance is called the variance

An adverse variance occurs when Actual costs > Budgeted costs or Actual revenues < Budgeted revenues

An adverse variance occurs when Actual costs > Budgeted costs or Actual revenues < Budgeted revenues

A favorable variance occurs when Actual costs < Budgeted costs or Actual revenues > Budgeted revenues

A favorable variance occurs when Actual costs < Budgeted costs or Actual revenues > Budgeted revenues

Variances are commonly calculated on a monthly basis to identify how successfully an organization is meeting its goalsVariances are commonly calculated on a monthly basis to identify how successfully an organization is meeting its goals


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VariancesVariancesNumerical ExampleNumerical Example

Budgeted (£) Actual (£) Variance (£)

Revenues 450,000 453,000 3,000 F

Cost of goods sold (235,000) (248,000) 13,000 A

General administration (80,000) (132,000) 52,000 A

Selling expenses (100,000) (90,000) 10,000 F

Profit 35,000 (17,000) 52,000 A

Administration Costs differ greatly from those expected and would be investigated

Administration Costs differ greatly from those expected and would be investigated


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Conflict between PlanningConflict between Planningand Controland Control

For control, budgets serve as the benchmark for performance measurement

For control, budgets serve as the benchmark for performance measurement

Over reliance on performance measurement will lead to a reduction in knowledge transfer

Over reliance on performance measurement will lead to a reduction in knowledge transfer

For planning, budgets communicate specialized knowledge from one area to another

For planning, budgets communicate specialized knowledge from one area to another


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Conflict between PlanningConflict between Planningand Controland Control

The budget is an informal set of contracts between the units of the organization

The budget is an informal set of contracts between the units of the organization

Most budgets are set in a negotiation processMost budgets are set in a negotiation process

To manage the conflict between planning and control many organizations put the Chief

Executive in change of the budgeting process and the chief financial officer in charge of the

collection and preparation of data

To manage the conflict between planning and control many organizations put the Chief

Executive in change of the budgeting process and the chief financial officer in charge of the

collection and preparation of data


8-12


Participative BudgetingParticipative Budgeting

With Participative Budgeting the person ultimately being held responsible for meeting the target makes the initial budget forecast

With Participative Budgeting the person ultimately being held responsible for meeting the target makes the initial budget forecast

Motivation to achieve the target is higherMotivation to achieve the target is higher

Participative Budgeting is a bottom-up processParticipative Budgeting is a bottom-up process


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How Budgeting Helps Resolve How Budgeting Helps Resolve Organizational ProblemsOrganizational Problems

Budgeting Systems Budgeting Systems

Links knowledge with responsibility to make

planning decisions

Links knowledge with responsibility to make

planning decisions

Measures and rewards performance for controlMeasures and rewards

performance for control

Distributes Responsibilities

Distributes Responsibilities

An administrative device to resolve organizational

problems

An administrative device to resolve organizational

problems


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Short-Term versus Long-Term Short-Term versus Long-Term BudgetsBudgets

1. Selecting overall objectives2. Choosing markets3. Selecting products to produce4. Determining price/quality mix5. Choosing technologies

Strategic Planning

Forecasts of large asset acquisitionsFinancing plans

Research and development plans

Long-term Budgets (more than one year)

Short-term Budgets (1 year or less)

Quantities to produceQuantities to sell

Supplies acquisitions


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Line-Item BudgetsLine-Item Budgets

• Budgets that authorize the manager to spend only up to the specified amount on each line item

• Managers cannot spend savings from one line item on another line item

• The manager does not have the responsibility to substitute resources among line items as circumstances change

• Impose more control on Managers

• Prevalent in government organizations


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Line-Item BudgetsLine-Item BudgetsNumerical ExampleNumerical Example

Line item budgets reduce management incentives to search for cost savings and reduce the organisation flexibility

Line item budgets reduce management incentives to search for cost savings and reduce the organisation flexibility

Line item Amount (£)

Salaries 185,000

Office supplies 12,000

Office equipment 3,000

Postage 1,900

Maintenance 350

Utilities 1,200

Rent 900

Total 204,350


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Budget LapsingBudget Lapsing

• Funds that have not been spent at year-end do not carry over to the next year

• Managers have incentive to spend at the end of each year

• Operating efficiency is reduced

• Managers have less discretion in the timing of expenditures


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Static budgets do not vary with volume and are used when a manager has control over volume or the

consequences thereof

Static budgets do not vary with volume and are used when a manager has control over volume or the

consequences thereof

Static versus Flexible BudgetsStatic versus Flexible Budgets

Flexible budgets are adjusted for changes in volume and are used mainly in manufacturing where the

manager does not have control over volume

Flexible budgets are adjusted for changes in volume and are used mainly in manufacturing where the

manager does not have control over volume


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Static versus Flexible BudgetsStatic versus Flexible BudgetsNumerical ExampleNumerical Example

Ticket Sales (€)

(Formula) 3,000 4,000 5,000

Revenues €18N* 54,000 72,000 90,000

Band €20,000 + 0.15N (28,100) (30,800) (33,500)

Auditorium €5,000 + 0.05N (7,700) (8,600) (9,500)

Security €80(N/200) (1,200) (1,600) (2,000)

Other costs €28,000 (28,000) (28,000) (28,000)

Profit/Loss (11,000) 3,000 17,000*N is the number of tickets sold

Each line item in the budget varies with volume. Then a budget is prepared at different volume levels Each line item in the budget varies with volume.

Then a budget is prepared at different volume levels


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Improve performance evaluationImprove performance evaluation

May be prepared for any activity level in the relevant range

May be prepared for any activity level in the relevant range

Show revenues and expensesthat should have occurred at the

actual level of activity

Show revenues and expensesthat should have occurred at the

actual level of activity

Reveal variances due to good cost control or lack of cost control

Reveal variances due to good cost control or lack of cost control

Flexible BudgetsFlexible Budgets



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Central Concept

If you can tell me what your activity was for the period, I will tell you what your

costs and revenue should have been

Central Concept

If you can tell me what your activity was for the period, I will tell you what your

costs and revenue should have been



8-22


Incremental versusIncremental versusZero-Base BudgetsZero-Base Budgets

Base budget is the

previous budget Only incremental

changes from the previous budget are examined in detail

Base budget is the

previous budget Only incremental

changes from the previous budget are examined in detail

Incremental Budgets

Each line item is set at

zero each year Every line item must be

justified and renewed each year

Each line item is set at

zero each year Every line item must be

justified and renewed each year

Zero-Base Budgets


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Zero-Base BudgetsZero-Base Budgets

• ZBB Motivates managers to maximize firm value by identifying and eliminating those expenditures whose total costs exceed total benefits

• Incremental expenditures are deleted when their costs exceed their incremental benefits

• Inefficient base budgets are not eliminated• In practice ZBB is used infrequently• Most useful when new top-level management come

from outside the firm• Costly to conduct


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The Master BudgetThe Master Budget

Integrates the estimates from each department to predict production requirements, financing, cash flows

and financial statements at the end of the period.

Integrates the estimates from each department to predict production requirements, financing, cash flows

and financial statements at the end of the period.

Serves as a guide and benchmark for the entire organization

Serves as a guide and benchmark for the entire organization


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Comprehensive Master Budget Comprehensive Master Budget IllustrationIllustration

The following slides provide an illustration of the Master Budget

The following slides provide an illustration of the Master Budget

The Master Budget is prepared for a simple firm NaturApples (an apple processor)

The Master Budget is prepared for a simple firm NaturApples (an apple processor)


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Budgeted profit and loss

Statement

Budgeted profit and loss

Statement

Master Budget IllustrationMaster Budget IllustrationBudgeting process - NaturApplesBudgeting process - NaturApples

Beginning balance sheetBeginning

balance sheetBudgeted cash

flowsBudgeted cash

flowsBudgeted

Balance SheetBudgeted

Balance Sheet

Financial BudgetFinancial Budget

Sales budgetSales budgetProduction

budgetProduction

budget

Selling and administrative budget

Selling and administrative budget

Capital investment budget

Capital investment budget

Factory overhead

budget

Factory overhead

budget

Direct labour budget

Direct labour budget

Direct materials

budget

Direct materials

budget

Apple procurement

Apple procurement


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Master BudgetMaster Budget Numerical ExampleNumerical Example

Expected beginning Balance SheetExpected beginning Balance Sheet

Assets £ £

Cash 100,000

Accounts receivable 200,000

Inventory

Sauce (13,500 cases x £58/case) 783,000

Pie Filling (2,500 cases x £48/case)

120,000 903,000

Property, plant and equipment (net) 2,300,000

3,503,000

Liabilities and shareholders equity

Accounts payable 100,000

Long-term debt 1,000,000

Shareholders equity 2,403,00

3,503,000


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Sales BudgetSales Budget

Budgeted cases Budgeted price/case (£) Budgeted revenue (£)

Sauce 140,000 68 9,520,000

Pie Filling 60,000 53 3,180,000

Total 12,700,000


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Production Budget – Production volumeProduction Budget – Production volume

Product Sales Ending inventory

Beginning inventory

Production

Sauce 140,000 5,000 13,500 131,500

Pie Filling 60,000 1,000 2,500 58,500

Beginning inventory + Production = Sales + Desired ending inventory

or

Production = Sales + Desired ending inventory – beginning inventory

Beginning inventory + Production = Sales + Desired ending inventory

or

Production = Sales + Desired ending inventory – beginning inventory


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Production BudgetProduction BudgetRaw Materials

Product Kilograms per case x Cases = Kilograms x Cost Per Kilogram (£) = Cost (£)

Sauce 25 131,500 3,287,500 0.80 2,630,000

Pie Filling 20 58,500 1,170,000 0.80 936,000

Total 4,457,500 3,566,000

Direct Labour

Product Hours per case x Cases = Hours x Cost Per hour (£) = Cost (£)

Sauce 0.60 131,500 78,900 10 789,000

Pie Filling 0.50 58,500 29,250 10 292,500

Total 108,150 1,081,500


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Overhead

Product Direct labour cost x Overhead per £ of direct labour = Cost (£)

Sauce £789,000 2 1,578,000

Pie Filling £292,500 2 585,000

Total 2,163,000

Product Costs

Product Total product cost (£)

Materials + Labour + Overhead /

Cases = Cost per case (£)

Sauce 4,997,000 131,500 38

Pie Filling 1,813,500 58,500 31

Total 6,810,500

Master Budget Master Budget Numerical ExampleNumerical Example

Production BudgetProduction Budget


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Production BudgetProduction Budget

Raw Materials

Product Kilograms per case x Cases = Kilograms x Cost Per Kilogram (£) = Cost (£)

Sauce 25 131,500 3,287,500 0.80 2,630,000

Pie Filling 20 58,500 1,170,000 0.80 936,000

Total 4,457,500 3,566,000

Direct Labour

Product Hours per case x Cases = Hours x Cost Per hour (£) = Cost (£)

Sauce 0.60 131,500 78,900 10 789,000

Pie Filling 0.50 58,500 29,250 10 292,500

Total 108,150 1,081,500

Overhead

Product Direct labour cost x Overhead per £ of direct labour = Cost (£)

Sauce £789,000 2 1,578,000

Pie Filling £292,500 2 585,000

Total 2,163,000

Product Costs

Product Total product cost (£)

Materials + Labour + Overhead /

Cases = Cost per case (£)

Sauce 4,997,000 131,500 38

Pie Filling 1,813,500 58,500 31

Total 6,810,500


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Selling and Administration BudgetSelling and Administration Budget

Selling and administrative areas £

Marketing 470,000

Finance 160,000

Shipping 380,000

Chairman's office 180,000

Total selling and administration 1,190,000


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Capital Investment BudgetCapital Investment Budget

Capital investment project Purchase date Cost (£)

Coring machine 05/10/2008 40,000

Dicing machine 05/10/2008 80,000

Total 120,000


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Financial BudgetFinancial Budget

Financial transactions Date Amount (£)

Loan from bank 05/10/2008 100,000

Repayment of bank loan 05/04/2009 (100,000)

Retirement of long-term debt 01/06/2009 (200,000)

Payment of interest 31/12/2009 (50,000)

Payment of interest 30/06/2009 (50,000)

Payment of dividends 30/09/2009 (2,000,000)

Net cash flow from financial transactions (2,300,000)


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Master BudgetMaster Budget - -Numerical ExampleNumerical ExampleBudgeted profit and loss statementBudgeted profit and loss statement

Revenues (Sales budget) £ £ £

Cost of goods sold 12,700,000

Beginning inventory (Beg, balance sheet) 903,000

+ Production costs (production budget) 6,810,500

- Ending inventory (Production budget)

Sauce (£38/case x 5,000 cases) 190,000

Pie Filling (£31/case x 1,000 cases) 31,000 (221,000) (7,492,500)

Gross Margin 5,207,500

Selling and administrative expenses (Selling and admin. budget) (1,190,000)

Interest expense (Financial budget) (100,000)

Net profit before taxes 3,917,500

Taxes (£3,917,500 x 0.40) 1,567,000

Net Profit 2,350,500

Beginning shareholders’ equity (Beg Balance sheet) 2,403,000

+ Net Profit 2,350,500

-Dividends 2,000,000

Ending shareholders equity 2,753,500


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Master BudgetMaster Budget - -Numerical ExampleNumerical Example

Cash Flow from Operations £ £

Net Income (Income Statement) 2,350,500

Add: Depreciation 400,000

Inventory Decrease 682,000

Accounts Payable Increase 50,000

Less: Accounts Receivable Increase (100,000)

Total Cash Flow from Operations 3,382,500

Cash Flow from Investments

Coring Machine Purchase (Capital Investment Budget) (40,000)

Dicing Machine Purchase (Capital Investment Budget) (80,000) (120,000)

Cash Flow from Financial Transactions

Bank Loan (Financial Budget) 100,000

Bank Loan Repayment (Financial Budget) (100,000)

Long-term Debt Retirement (Financial Budget) (200,000)

Dividend Payment (Financial Budget) (2,000,000) (2,200,000)

Change in Cash Balance 1,062,500

Beginning Cash Balance (Beginning Balance Sheet) 100,000

Ending Cash Balance 1,162,500

Budgeted cash flow statementBudgeted cash flow statement


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Master Budget - Master Budget - Numerical ExampleNumerical ExampleAssets £ £

Cash (Cash Flow Statement) 1,162,500

Accounts Receivable (Predicted) 300,000

Inventory: Applesauce 5,000 cases @ £38 190,000

Apple Pie filling 1,000 cases @ £31 31,000 221,000

Property, Plant and Equipment (net)

Beginning Balance (Beginning Balance Sheet) 2,300,000

Capital Investments (Capital Investment Budget) 120,000

Depreciation for the Year (400,000) 2,020,000

Total Assets 3,703,500

Liabilities and Stockholders' Equity

Accounts Payable (Predicted) 150,000

Long-Term Debt

Beginning Balance (Beginning Balance Sheet) 1,000,000

Retirement (Financial Budget) (200,000) 800,000

Total Liabilities 950,000

Stockholders' Equity (Income Statement) 2,753,500

Total Liabilities and Stockholders' Equity 3,703,500

Budgeted Balance SheetBudgeted Balance Sheet


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Management Accounting Management Accounting

Budgeting Budgeting(Planning and controlling)(Planning and controlling)

End of Chapter 8

© pearson education limited 2008 1 © prentice hall 2008 management accounting cheryl s. mcwatters,...

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