Horngrenima14e ch07 2

©2008 Prentice Hall Business Publishing, ©2008 Prentice Hall Business Publishing, Introduction to Management AccountingIntroduction to Management Accounting 14/e,14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 7 Horngren/Sundem/Stratton/Schatzberg/Burgstahler 7 - - 11

Introduction to Management Introduction to Management AccountingAccounting

Introduction to Budgets Introduction to Budgets and Preparing the Master and Preparing the Master

BudgetBudget

Chapter 7Chapter 7


Budgets and the OrganizationBudgets and the Organization

BudgetsBudgets Goals and Goals and objectivesobjectives

A budget provides a comprehensive financial A budget provides a comprehensive financial overview of planned company operations.overview of planned company operations.

LearningLearningObjective 1Objective 1


Benefits of BudgetsBenefits of Budgets

Provide an opportunity to Provide an opportunity to reevaluate existing activitiesreevaluate existing activities

and evaluate new ones.and evaluate new ones.

Aid managers in communicating Aid managers in communicating objectives and coordinating actions objectives and coordinating actions

across the organization. across the organization.

CompelCompelmanagersmanagers

to thinkto thinkaheadahead


Human Relations ProblemsHuman Relations Problems

1. Low levels of participation in the 1. Low levels of participation in the budget process andbudget process and

Lack of acceptance of responsibility Lack of acceptance of responsibility for the final budget.for the final budget.

2. Incentives to lie and cheat in the 2. Incentives to lie and cheat in the budget process.budget process.

3. Difficulties in obtaining accurate 3. Difficulties in obtaining accurate sales forecasts.sales forecasts.

1. Low levels of participation in the 1. Low levels of participation in the budget process andbudget process and

Lack of acceptance of responsibility Lack of acceptance of responsibility for the final budget.for the final budget.

2. Incentives to lie and cheat in the 2. Incentives to lie and cheat in the budget process.budget process.

3. Difficulties in obtaining accurate 3. Difficulties in obtaining accurate sales forecasts.sales forecasts.


Management should seek Management should seek to create an environment to create an environment where there is a true where there is a true two-way flow of two-way flow of information.information.

Management should seek Management should seek to create an environment to create an environment where there is a true where there is a true two-way flow of two-way flow of information.information.


Potential Problems in Implementing Potential Problems in Implementing BudgetsBudgets

Participative budgets are Participative budgets are formulated with the formulated with the active participation of all active participation of all affected employees.affected employees.

Participative budgets are Participative budgets are formulated with the formulated with the active participation of all active participation of all affected employees.affected employees.

Message Message conveyed by the conveyed by the budget system budget system may be may be misaligned with misaligned with incentives incentives provided by the provided by the compensation compensation system.system.

Message Message conveyed by the conveyed by the budget system budget system may be may be misaligned with misaligned with incentives incentives provided by the provided by the compensation compensation system.system.


Incentives to Lie and CheatIncentives to Lie and Cheat

Dysfunctional Dysfunctional incentives lead incentives lead managers to make managers to make poor decisions. poor decisions.

Lying can arise if the Lying can arise if the budget process budget process creates incentives to creates incentives to bias the budget bias the budget information.information.Budgetary Slack (budget padding) is Budgetary Slack (budget padding) is

the overstatement or understatement the overstatement or understatement of budgeted revenue to create a goal of budgeted revenue to create a goal that is easier to achieve.that is easier to achieve.



Sales ForecastingSales Forecasting

A sales forecast is a prediction of salesA sales forecast is a prediction of salesunder a given set of conditions.under a given set of conditions.

Sales forecasts are usually prepared underSales forecasts are usually prepared underthe direction of the top sales executive.the direction of the top sales executive.


The sales budget is the result of decisions to create The sales budget is the result of decisions to create Conditions that will generate a desired level of sales.Conditions that will generate a desired level of sales.


Competitors’

Competitors’

actionsactions

Past patterns

Past patterns

of sales

of sales

Estimates made

Estimates made

By sales force

By sales forceGen

eral

Gener

al

econ

omic

econ

omic

conditi

ons

conditi

ons

Factors to Consider When Forecasting Factors to Consider When Forecasting SalesSales

Changes in the

Changes in the

firm’s prices

firm’s pricesChanges in

Changes in

product mix

product mix

Market Market

research research

studiesstudies

Advertisin

g

Advertisin

g

and sales

and sales

promotion plans

promotion plans


Types of BudgetsTypes of Budgets

Strategic planStrategic plan Long-range planningLong-range planning

Capital budgetCapital budget

Master budgetMaster budget

Continuous budget Continuous budget



Strategic PlanStrategic Plan

The most forward-looking budget is theThe most forward-looking budget is thestrategic plan, which sets the overallstrategic plan, which sets the overall

goals and objectives of the organization.goals and objectives of the organization.

The strategic plan leads to long-rangeThe strategic plan leads to long-rangeplanning, which producesplanning, which produces

forecasted financial statementsforecasted financial statementsfor five- to ten-year periods.for five- to ten-year periods.


Long-range plans…Long-range plans…

are coordinated with capital budgets,are coordinated with capital budgets,which detail the planned expenditureswhich detail the planned expendituresfor facilities, equipment, new products,for facilities, equipment, new products,

and other long-term investments.and other long-term investments.

Long-range PlansLong-range Plans

Master budgets link to both long-range Master budgets link to both long-range plans and short-term budgets.plans and short-term budgets.


Master BudgetMaster Budget

SalesSales

ProductionProduction

DistributionDistribution

FinanceFinance

The master budgetThe master budget

is a detailed and is a detailed and

comprehensive analysis comprehensive analysis

of the first year of theof the first year of the

long-range plan. long-range plan.

It summarizes theIt summarizes the

planned activitiesplanned activities

of all subunits ofof all subunits of

an organization.an organization.


Continuous BudgetContinuous Budget

Rolling budgets...Rolling budgets...are a common form ofare a common form ofmaster budgets that master budgets that add a month in the add a month in the future as the month future as the month

just ended is dropped.just ended is dropped.


Operating budgetOperating budget(Profit plan). . .(Profit plan). . .

Financial budget. . .Financial budget. . .

Master BudgetMaster Budget

Focuses on the Focuses on the Income Statement Income Statement

and supporting and supporting schedules or schedules or

budgeted budgeted expenses.expenses.

Focuses on the Focuses on the effects that the effects that the

operating budget operating budget and other plans will and other plans will

have on cash have on cash balances.balances.


Steps in Preparing the Master Steps in Preparing the Master BudgetBudget

1. Basic data1. Basic data

2. Operating budget2. Operating budget

3. Financial budget3. Financial budget



Steps in Preparing the Master BudgetSteps in Preparing the Master Budget

1. Basic data1. Basic dataa.a. Sales budgetSales budgetb.b. Cash collections from customersCash collections from customersc.c. Purchases and cost-of-goods sold budgetPurchases and cost-of-goods sold budgetd.d. Cash disbursements for purchasesCash disbursements for purchasese.e. Operating expense budgetOperating expense budgetf.f. Cash disbursements for operating expensesCash disbursements for operating expenses

The principal steps in preparingThe principal steps in preparingthe master budget:the master budget:


Steps in Preparing the Master BudgetSteps in Preparing the Master Budget

Financial BudgetFinancial Budget3.3. Prepare forecasted financial statements:Prepare forecasted financial statements:

b.b. Capital budgetCapital budgetc.c. Cash budgetCash budgetd.d. Budgeted Balance sheetBudgeted Balance sheet

Operating BudgetOperating Budget2. Prepare budgeted income statement using basic data in step 1.2. Prepare budgeted income statement using basic data in step 1.


Operating BudgetOperating Budget

SalesSalesbudgetbudget

Cash collectionsCash collectionsfrom customersfrom customers

DisbursementsDisbursementsfor purchasesfor purchases

Disbursements forDisbursements foroperating expensesoperating expenses

PurchasesPurchasesbudgetbudget

Operating expensesOperating expensesbudgetbudget



Cash CollectionsCash Collections

It is easiest to prepare budgetedIt is easiest to prepare budgetedcash collections at the samecash collections at the same

time as the sales budget.time as the sales budget.

Cash collections include the currentCash collections include the currentmonth’s cash sales plus themonth’s cash sales plus the

previous month’s credit sales.previous month’s credit sales.


Purchases Budget and Cash Purchases Budget and Cash DisbursementsDisbursements

Budgeted purchasesBudgeted purchases= Desired ending inventory= Desired ending inventory

+ Cost of goods sold+ Cost of goods sold– – Beginning inventoryBeginning inventory

Disbursements could include 50% of the current month’s Disbursements could include 50% of the current month’s purchases and 50% of the Previous month’s purchases.purchases and 50% of the Previous month’s purchases.


Operating Expense BudgetOperating Expense Budget

The budgeting of operating expenses depends on several factors.The budgeting of operating expenses depends on several factors.

Month-to-month changes in sales volume and other cost-driver Month-to-month changes in sales volume and other cost-driver activities directly influence many operating expenses.activities directly influence many operating expenses.

Expenses driven by Expenses driven by sales volume include sales volume include

sales commissions andsales commissions and many delivery expenses.many delivery expenses.


Other expenses are not influenced by salesOther expenses are not influenced by salesor other cost-driver activity and are regardedor other cost-driver activity and are regardedas fixed, within appropriate relevant ranges.as fixed, within appropriate relevant ranges.

RentRent

InsuranceInsurance

DepreciationDepreciation

SalariesSalaries

Operating Expense BudgetOperating Expense Budget


Operating Expense DisbursementsOperating Expense Disbursements

Disbursements for operating expenses areDisbursements for operating expenses arebased on the operating expense budget.based on the operating expense budget.

Disbursements may include 50% of last month’s and this month’s Disbursements may include 50% of last month’s and this month’s wages and commissions plus miscellaneous and rent expenses.wages and commissions plus miscellaneous and rent expenses.

The total of these disbursements is thenThe total of these disbursements is thenused in preparing the cash budget.used in preparing the cash budget.


Budgeted Income StatementBudgeted Income Statement

The income statement will be completeThe income statement will be completeafter addition of the interest expense,after addition of the interest expense,

which is computed after the cashwhich is computed after the cashbudget has been prepared.budget has been prepared.

Budgeted income from operationsBudgeted income from operationsis often a benchmark for judgingis often a benchmark for judging

management performance.management performance.


Financial BudgetFinancial Budget

The Cash budget contains these major sections:The Cash budget contains these major sections: available cash balanceavailable cash balance net cash receipts and disbursementsnet cash receipts and disbursementsfinancingfinancing


The cash budget is a The cash budget is a statement of planned statement of planned

cash receipts and cash receipts and disbursements. disbursements.


Cash BudgetCash Budget

Available cash balanceAvailable cash balance= Beginning cash balance= Beginning cash balance

– – Minimum cash balance desired.Minimum cash balance desired.

Cash receipts depend on collections fromCash receipts depend on collections fromcustomers’ accounts receivable, cash sales,customers’ accounts receivable, cash sales,

and on other operating income sources.and on other operating income sources.



Cash disbursements for purchases dependCash disbursements for purchases dependon the credit terms extended by supplierson the credit terms extended by suppliers

and the bill-paying habits of the buyer.and the bill-paying habits of the buyer.

Payroll depends on wage, salary, and Payroll depends on wage, salary, and commission terms and on payroll dates.commission terms and on payroll dates.



Other disbursements include outlays forOther disbursements include outlays forfixed assets, long-term investments,fixed assets, long-term investments,

dividends, and the like.dividends, and the like.

Disbursements for some costs and expensesDisbursements for some costs and expensesdepend on contractual terms for installmentdepend on contractual terms for installment

payments, mortgage payments, rents,payments, mortgage payments, rents,leases, and miscellaneous items.leases, and miscellaneous items.



Management determines the minimumManagement determines the minimumcash balance desired dependingcash balance desired depending

on the nature of the businesson the nature of the businessand credit arrangements.and credit arrangements.



Financing requirements depend on howFinancing requirements depend on howthe total cash available comparesthe total cash available compares

with the total cash needed.with the total cash needed.

Needs include the disbursements plusNeeds include the disbursements plusthe desired ending cash balance.the desired ending cash balance.



Ending cash balanceEnding cash balance= Beginning cash balance= Beginning cash balance

+ Receipts – Disbursements+ Receipts – Disbursements+ Cash from financing+ Cash from financing

The cash from financing can beThe cash from financing can beeither positive (borrowing)either positive (borrowing)or negative (repayment).or negative (repayment).


Budgeted Balance SheetBudgeted Balance Sheet

The final step in preparing the master budgetThe final step in preparing the master budgetis to construct the budgeted balance sheetis to construct the budgeted balance sheet

that projects each balance sheet item inthat projects each balance sheet item inaccordance with the business plan.accordance with the business plan.

Management then considers all Management then considers all the major financial statements as the major financial statements as a basis for changing the course of a basis for changing the course of events.events.


Activity-Based Master BudgetsActivity-Based Master Budgets

An activity-based budgetary system An activity-based budgetary system emphasizes the planning and control emphasizes the planning and control

purpose of cost management.purpose of cost management.

Functional budgeting focuses on Functional budgeting focuses on preparing budgets for various preparing budgets for various functions such as production, functions such as production,

selling, and administrative support.selling, and administrative support.


Financial Planning ModelsFinancial Planning Models

Financial models are only as good as the assumptions Financial models are only as good as the assumptions and the inputs used to build and manipulate them.and the inputs used to build and manipulate them.

Financial planning models are mathematical models Financial planning models are mathematical models that can incorporate the effects of alternative that can incorporate the effects of alternative

assumptions about sales, costs, or product mix.assumptions about sales, costs, or product mix.


Spreadsheets for BudgetingSpreadsheets for Budgeting

Arithmetic errors are virtually nonexistent.Arithmetic errors are virtually nonexistent.

Spreadsheet software for personal computers is Spreadsheet software for personal computers is a powerful and flexible tool for budgeting thata powerful and flexible tool for budgeting thatcan be used to prepare mathematical models.can be used to prepare mathematical models.

Financial planning models are mathematical models Financial planning models are mathematical models that can incorporate the effects of alternative that can incorporate the effects of alternative

assumptions about sales, costs, or product mix.assumptions about sales, costs, or product mix.



End of Chapter 7End of Chapter 7

The EndThe End