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MANAGEMENT CONTROL SYSTEM
SESSION 8
BUDGET PREPARATIONOCTOBER 15, 2012
JAKARTA, INDONESIA
By Vienda A. Kuntjoro
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Budget
Budget is planning that is stated in quantitative in monetaryunit for one year period.
Characteristic of budget are as following :
1. Estimate potential level of earnings from one business
unit2. Budged is stated in financial (number of unit sales or
produce)
3. Budget is for one year period
4. Proposal of budget agreed by upper level authority
5. Budget that is agreed can be changed only if certaincondition happens
6. Periodically, financial performance compared to budgetthen the variance would be analyzed.
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Budget cycle and Master Budget
Well managed companies usually cycle through the following budgetingsteps during the course of the fiscal year:
1. Working together, managers and management accountants plan theperformance of the company as a whole and the performance of itssubunits (such as departments or divisions). Taking into account pastperformance and anticipated changes in the future, managers at all levelsreach a common understanding on what is expected
2. Senior managers give subordinate managers a frame of reference, a set ofspecific financial or nonfinancial expectations against which actual resultwill be compared.
3. Management accountants help manager investigate variation from plans,such as an unexpected decline in sales. If necessary, corrective action
follows, such as a reduction in price to boost sales or cutting of costs tomaintain profitability
4. Managers and management accountants take into account marketfeedback, changed conditions, and their own experiences as they begin tomake plans for the next period. For example, a decline in sales may causemanagers to make changes in product features for the next period.
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Master Budget
Master budget expresses managements operating
and financial plans for a specified and period(usually a fiscal year), and it includes a set of
budgeted financial statements. The masterbudget is the initial plan of what the companyintends to accomplish in the budget period. Themaster budget evolves from both operating and
financing decision made by managers. Operating decision deal with how to obtain the
funds to acquire those resources.
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Advantages of budgets
Budget are an integral part of management controlsystem. When administered thoughtfully bymanagers, budgets do the following:
Promote coordination and communicationamong subunits within the company
Provide a framework for judging performanceand facilitating learning
Motivate managers and other employees.
Support strategic planning
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Challenges in Administering Budgets
The budgeting process involves all level management.It has been estimated that senior managers spendabout 10% to 20% of their time on budgeting, andfinance planning departments spend as much as 50%
of their time on it. A manager may commit to a budget, but if a situation
arises in which some unplanned repairs or anunplanned advertising program would serve the longrun interests of the company, the manager should
undertake the additional spending. On the flip side,the dramatic decline in consumer demand during therecent recession led designers such as Gucci to slashtheir ad budgets and put on hold planned newboutique.
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Developing an operating budget
Business are increasingly using rolling budgets. (also calledcontinuous budget), is a budget that is always available for aspecified future period.
Steps in preparing an operating budget
1. Identify the problem and uncertainties.
2. Obtain information (discover the direct material have increaseslightly during 2011).
3. Make about the futures (the purchasing manager anticipates thatprice of direct material will be about the same in year 2011. Themanufacturing manager believes that efficiency improvement
would allow costs manufacturing tables to be maintained at 2011cost despite an increase in the price of other inputs.
4. Make decisions by choosing among alternatives
5. Implement the decision, evaluate performance, and learn
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Budgetary slack
At times, subordinates may try to play games and build inbudgetary slack.
Budgetary slack describes the practice of underestimatingbudgeted revenues, or over estimating budgeted costs, to
make budgeted targets more easily achieved. It frequentlyoccurs when budget variances (the difference actual resultand budgeted amounts) are used to evaluate performance.
Budgetary slack provide managers with a hedge againstunexpected adverse circumstances. But budgetary slackalso misleads top management about the true profitpotential of the company, which leads to inefficientresource planning and allocation and poor coordination ofactivities across different parts of the company.
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Human aspects in budgeting?
Why are human factors crucial in budgeting?
The administration of budget requires education,participation, persuasion , and intelligent
interpretation. When wisely administered,budgets create commitment, accountability, andhonest communication, and can be used as thebasis for continuous improvement efforts. When
badly managed, budgeting can lead to gameplaying and budgetary slack the practice ofmaking budget targets more easily
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Prepare Budget
Prepare budget for Stylistic Furniture for 2012. The details are follow:
Stylistic sells two models of granite-top coffee tables: casual and deluxe, Revenueunrelated to sales, such as interest income, is zero
Work in process inventory is negligible and is ignored
Direct materials inventory and finished goods inventory are costed using the firstin, first out (FIFO method). Unit costs of direct material purchased and unit costs
of finished goods sold remain unchanged throughout each budget year but canchange from year to year.
There are two types of direct material : red oak (RO) and granite slabs (GS). Directmaterial costs are variable with respect to units of output coffee tables.
Direct manufacturing labor workers are hired on an hourly basis; no overtime isworked.
There are two cost drivers for manufacturing overhead costs-direct manufacturinglabor hours and setup labor hours
Direct manufacturing labor hours is the cost driver for the variable portion ofmanufacturing operations overhead. The fixed component of manufacturingoperations overhead is tied to the manufacturing capacity of 300,000 directmanufacturing labor hours that Stylistic has planned for 2012.
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Prepare budget (cont.)
Setup labor hours is the cost driver for the variable portion of machine setupoverhead. The fixed component of machine setup overhead is tied to the setupcapacity of 15,000 setup labor hours that Stylistic has planned for 2012.
For computing inventoriable costs, Stylistic allocates all (variable and fixed)manufacturing operations overhead costs using direct manufacturing labor hoursand machine setup overhead costs using setup labor hours.
Nonmanufacturing costs consists of product design, marketing, and distributioncosts. All product design costs are fixed costs for 2012. The variable component ofmarketing costs equals the 6.5% sales commission on revenues paid tosalespeople. The variable portion of distribution costs varies with cubic feet oftables moved.
The following data are available for 2012 budget :
Direct material
Red Oak $7 per board foot (b.f) (same as 2011)Granite $10 per square foot (sqft) (same as 2011)
Direct manufacturing labor $20 per hour
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Prepare budget (cont.1)
PRODUCT
Casual Granit Table Deluxe Granite Table
Red Oak 12 board feet 12 board feet
Granite 6 square feet 8 square feet
Direct manufacturing labor 4 hours 6 hours
PRODUCT
Casual Granit Table Deluxe Granite TableExpected sales in units 50,000 10,000
Selling price $600 $800
Target ending inventory unit 11,000 500
Beginning inventory in units 1,000 500
Beginning inventory in USD $384,000 $262,000
DIRECT MATERIALRed Oak Granite
Beginning inventory 70.000 b.f 60.000 sqft
Target ending inventory 80.000 b.f 20.000 sqft
Note . Maintain Stylistics 12% operating margin.
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Step 1 Prepare the revenue budget
In stylistics case, the revenue budget for 2012 reflectsStylistics strategy to grow revenues by increasing salesdeluxe tables from 8,000 tables in 2011 to 10,000 tables in2012.
Schedule 1 Revenue
For the year ending December 31, 2012
units Selling price Total revenues
Casual 50,000 $600 $30,000,000
Deluxe 10,000 $800 $8,000,000
Total $38,000,000
The $38,000,000 is the amount of revenues in the budgetedincome statement.
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Step 2 Prepare the production budget
in unitsSchedule 2 Production Budget (in units)
For the year ending Dec 31, 2012
Product
Casual Deluxe
Budgeted unit sales (sch. 1) 50,000 10,000
Add target ending finished goods inventory 11,000 500
Total required units 61,000 10,500
Deduct beginning finished goods inventory 1,000 500
Units of finished goods to be produced 60,000 10,000
Note.
For step 3 for example, the bill materials would indicate that 12 bf of red oak and6sqft of granite are needed to produce each casual coffee table and 12 bf ofred oak and 8 sqft of granite to produce each deluxe coffee table. To calculate3A.
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Step 3 Prepare the Direct material usage budget and
direct material purchases budget
Schedule 3A Direct material usage Budget in Quantity and Dollars
For the year ending December 31, 2012
Material
Red Oak Granite Total
Physical units budget
Direct material required for casual tables 720,000 b.f 360,000 sqft
(60,000 units*12 b.f and 6 sq.ft)
Direct material required for deluxe tables 120,000 b.f 80,000 sqft
(10,000 units*12 b.f and 8 sqft)
Total quantity of direct materials to be used 840,000 b.f 440,000 sqft
Cost budget
Available from beginning direct materils inventory
(under a FIFO cost flow assumption)
Red Oak 70,000 b.f * $7 per b.f $490,000
Granite 60,000 sqft*$10per sqft $600,000
To be purchased this period
Red Oak (840,000-70,000) bf*$7 per bf $5,390,000
Granite (440,000-60,000) sqft *$10 per sqft $3,800,000
Direct material to be used this period $5,880,000 $4,400,000 $10,280,000
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Step 3 Prepare the Direct material usage budget and direct
material purchases budget (cont.)
Schedule 3B Direct material purchase Budget
For the year ending December 31, 2012
Material
Red Oak Granite Total
Physical units budgetTo be used in production (from schedule 3A) 840,000 bf 440,000 sqft
Add target ending inventory 80,000 bf 20,000 sqft
Total requirements 920,000 bf 460,000 sqft
Deduct beginning inventory 70,000 bf 60,000 sqft
Purchase to be made 850,000 bf 400,000 sqft
Cost budget
Red oak : 850,000bf*$7 per bf $5,950,000
Granite 400,000 sqft*$10 per sqft $4,000,000
$5,950,000 $4,000,000 $9,950,000
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Step 4 Prepare the Direct
manufacturing labor costs budget
Schedule 4 : Direct Manufacturing Labor costs budget
For the year ending Dec 31, 2012
Output units produced Direct Mft. Total hours Hourly
(schedule 2) Labor hr per unit wage rate TotalCasual 60,000 4 240,000 $20 $4,800,000
Deluxe 10,000 6 60,000 $20 $1,200,000
Total 300,000 $6,000,000
For 300,000 direct manufacturing labor hours, Stylistics manufacturing managersestimate various line items of overhead costs that constitute manufacturing
operations overhead (that is, all costs for which direct manufacturing labor hours
is the cost drivers).
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Step 5 : Prepare the Manufacturing
Overhead costs budget
Stylistic s managers determine how setups should be
done for the casual and deluxe line of table, taking intoaccount past experience and potential improvementsin setup efficiency.
For example, managers consider the following:
1. Increasing the length of the production run per batchso that fewer batches (and therefore fewer setups)are needed for the budgeted production of tables
2. Decreasing the setup time per batch
3. Reducing the supervisory time needed, for instanceby increasing the skill base of workers.
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Step 5 : Prepare the Manufacturing
Overhead costs budget (cont.)Casual Deluxe tables Total
1.Quantity of tables to be produced 60,000 tables 10,000 tables
2.No. of tables to be produced per batch 59 tables/batch 40 tables/batch
3. No. of batches (1)/(2) 1,200 batches 250 batches
4. Setup time per batch 10 hr/batch 12 hr/batch
5.Total setup hours (3)*(4) 12,000 hours 3,000 hours 15,000 hr6. Setup hours per table (5)/(1) 0.2 hours 0.3 hours
Using an approach similar to the one described for manufacturing operationsoverhead costs, Stylistics managers estimate various line items of costs thatcomprise machine setup overhead costs that is, all costs that are caused by the15,000 setup labor hours (the cost driver). Note how using activity based costdrivers provide additional and detailed information that improves decision makingcompared with budgeting based solely on output based cost drivers. Of course,managers must always evaluate whether the expected benefit of adding more costdrivers exceeds the expected cost.
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Step 5 : Prepare the Manufacturing
Overhead costs budget (cont.1)Schedule 5 : Manufacturing Overhead Costs Budget
For the year ending Dec 31, 2012
manfuacturing Operations Overhead costs
Variables costs
Supplies 1,500,000
Indirect manufacturing labor 1,680,000
Power (support department costs) 2,100,000
Maintenance (support deparment costs) 1,200,000 $6,480,000
Fixed costs (to support department costs)
Depreciation 1,020,000Supervision 390,000
Power (support department costs) 630,000
Maintenance (supportdperatment costs) 480,000 2,520,000
Total manufacturing operationsoverhead costs $9,000,000
Manufacturing Setup Overhead costs
Variables costs
Supplies $390,000
Indirect manufacturing labor 840,000
Power (support department costs) 90,000 $1,320,000
Fixed costs (to support capacity of 15,000 setup labor hours
Depreciation 603,000
Supervision 1,050,000
Power (support department costs) 27,000 1,680,000
Maintenance (supportdperatment costs) $3,000,000
Total manufacturing operationsoverhead costs $12,000,000
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Step 6 : Prepare the ending inventories
Budget
Manufacturing operations overhead costs areallocated to finished goods inventory at thebudgeted rate $30 per direct manufacturing labor
hour (total budgeted manufacturing operationsoverhead, 90,000,000/300,000 budgeted directmanufacturing labor hours). Machine setupoverhead costs are allocated to finished goods
inventory at the budgeted rate $200 per setuphours (total budgeted machine setup overhead,$300,000/15,000 budgeted setup labor hours).
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Step 6 : Prepare the ending inventories
Budget (cont.)Schedule 6A : unit costs of Ending Finished goods inventoryDecember 31, 2012
PRODUCT
Casual Tables Deluxe tables
Cost per unit Input per unit of
output
TOTAL Input per unit of
output
TOTAL
Red Oak $7 12 bf $84 12 bf $84
Granite10 6 sqft 60 8 sqft 80
Direct manufacturing Labor 20 4 hrs 80 6 hrs 120
Manufacturing overhead 30 4 hrs 120 6 hrs 180
Machine setup overhead 200 0.2 hrs 40 0.3 hrs 60
TOTAL $384 $524
Schedule 6B : Endign Inventories budget
December 31, 2012
Quantity Cost per unit TOTALDirect material
Red Oak 80,000 $7 $560,000
Granite 20,000 10 200,000 $760,000
Finished Goods
Casual 11,000 $384 $4,224,000
Deluxe 500 524 262,000 $4,486,000
Total ending inventory $5,246,000
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Step 7 : Prepare the cost of goods sold
budget
Schedule 7 : Cost of goods Sold Budget
For the year ending Dec 31, 2012
From the schedule TOTAL
Beginning finished goods invetory, Jan 01, 2012 Given $646,000
Direct material used 3A $10,280,000
Direct manufacturing labor 4 6,000,000
Manufacturing overhead 5 12,000,000
cost of goods manufactured 28,280,000
cost of goods available for sale 28,926,000
Deduct ending finished goods inventory, Dec 31, 2012 6B 4,486,000
Cost of goods sold $24,440,000
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Step 8 : Prepare the non
manufacturing costs budgetProduct design costs are fixed costs, determined on the basis of the product design
work anticipated for 2012. The variable component of budgeted marketing costs isthe commissions paid to sales people equal to 6.5% of revenues. The fixedcomponent of budged marketing costs equal to $1,330,000 is tied to the marketingcapacity for 2012. The cost driver of the variable component of budgeteddistribution costs is cubic feet of tables moved (Casual : 18 cubic ft * 50,000 tables+ deluxe 35 cubic ft*10,000 tables = 1,440,000 cubic ft). Variable distribution costs
equal $2 per cubic foot. The fixed component of budged distribution costs equals$1,596,000 and is tied to the distribution capacity for 2012. Schedule 8 shows thatthe product design, marketing, and distribution costs budget 2012.
Schedule 8 : Non manufacturing costs budget
For the year ending December 31, 2012
Business function Var costs Fixed costs Total cost
Production design $1.024,000 $1,024,000Marketing (var cost :$38,000,000*0.065) $2,470,000 1,330,000 3,800,000
Distribution (var cost : $2*1,140,000 cuft) 2,280,000 1,596,000 3,876,000
$4,750,000 $3,950,000 $8,700,000
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Step 9 : Prepare the budget income
statement Rex Jordan, the CEO of Sytlistic Furniture, is very pleased with the
2012 budget. It call fro a 10% increase in operating incomecompared with 2011. The keys to achieving a higher operatingincome are a significant increase in sales of Deluxe tables, andprocess improvement and efficiency gains throughout the valuechain. As Rex studies the budget more carefully, he is struck by twocomment appended to the budget. First, to achieve the budgednumber of tables sold, Stylistic may need to reduce its selling pricesby 3% to %582 for Casual tables and to $776 for Deluxe tables.Second, a supply shortage in direct materials may result in a 5%increase in the prices of direct materials (red oak and granite)above the material prices anticipated in the 2012 budget. He asksTina Larsen, the management accountant, to use Stylistics financialplanning model to evaluate how those outcomes will affectbudgeted will affect budgeted operating income.
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Step 9 : Prepare the budget income
statement (cont.)Budgeted Income Statement for Stylistic FurnitureFor the year ending December 21, 2012
Revenues Sch. 1 $38,000,000
Costs of goods sold Sch. 7 $24,440,000
Gross margin $13,560,000Operating costs
Product design costs Sch. 8 $1,024,000
Marketing costs Sch.8 $3,800,000
Distribution costs Sch. 8 $3,876,000 $8,700,000Operating income $4,860000
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Sample
Consider the stylistic furniture. Suppose that to maintain itssales quantities, Stylistic needs to decrease selling prices to$582 per Casual table and $776 per Deluxe table, a 3%decrease in the selling price used. All other data isunchanged.
Solution:Schedule 1 & 8 will changes because a change in selling price
affects revenues. Schedule 8 changes because revenuesare a cost driver of marketing costs (sales commissions).The remaining schedules will not change because a changein selling price has no effect on manufacturing costs. Therevised schedules and the new budgeted income statementfollows:
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Sample (cont.)
Schedule 1 : Revenue BudgetFor the year Ending Dec 31, 2012
Selling price Units Total Revenues
Casual tables $582 50,000 $29,100,000
Deluxe tables $776 10,000 $7,760,000
Total $36,860,000
Schedule 8: Nonmanufacturing costs budget
For the year Ending December 31, 2012
Business function Var. Costs Fixed cost Total costs
Product design $1,024,000 $1,024,000
Marketing (Var cost :
$36,860,000*0.065) $2,395,900 $1,330,000 $3,725,900Distribution (Var. cost:
$2*1,140,000cuft) $2,280,000 $1,596,000 $3,876,000$4,675,000 $3,950,000 $8,625,900
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Sample (cont. 1)
Stylistic FurnitureBudget Income Statement
For the year Ending Dec 31, 2012
Revenues Schedule 1 $36,860,000
Cost of goods sold Schedule 7 $24,440,000Gross margin $12,420,000
Operating costs
Product design Schedule 8 $1,024,000
Marketing costs Schedule 8 $3,725,000Distribution Schedule 8 $ 3,876,000 $8,625,000
Operating Income $3,794,100
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Financial Planning models and
sensitivity analysis Sensitivity analysis is a what if technique that examines how a result will change if the original
predicted data are not achieved or if an underlying assumption changes.
To see how sensitivity analysis works, it considers two scenarios identified as possibly affectingStylistic Furnitures budget model for 2012:
1. Scenario 1 : a 3% decrease in the selling price of the casual table and a 3% decrease in the sellingprice of the Deluxe table
2. Scenario 2 : a 5% increase in the price per board foot of red oak and a 5% increase in the priceper square foot of granite.
Key assumption
Units sold Selling price Direct Budgeted
material cost Opr. income
Casual Deluxe Casual Deluxe Red oak Granite Dollars Change from
master budget
What if scenario 50,000 10,000 $600 $800 $7 $10 $ 4,860,000
Scenario1 50,000 10,000 582 776 $7 $10 3,794,100 22% decrease
Scenario2 50,000 10,000 600 800 $7.35 $10.50 4,483,800 8% decrease
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THANK YOU