College of Accounting Education

3F, Business & Engineering Building

Matina, Davao City
Phone No.: (082)300-5456 Local 137

MAS 1: SHORT-TERM BUDGETING, FORECASTING AND CONTROL Jade D. Solaña, CPA, MBA
Management Advisory Services August 24, 2021

APPETIZER QUESTIONS:

Activity 1. True or False. Determine the following statements whether true or false.

1. If a monthly cash budget is prepared properly, there will never be a cash deficiency at the end of
any month.
2. The budgeted balance sheet is prepared entirely from the budgets for the current year.
3. The starting point when budgeting for a not-for-profit organization is generally to budget
expenditures first.
4. A merchandiser has a merchandise purchases budget rather than a production budget.
5. A critical factor in budgeting for a service firm is to determine the amount of products to
purchase.
6. The budget itself and the administration of the budget are entirely accounting responsibilities.
7. Financial planning models and statistical and mathematical techniques may be used in
forecasting sales.
8. The direct materials budget is derived from the direct materials units required for production
plus desired ending direct materials units less beginning direct materials units.
9. The manufacturing overhead budget shows the expected manufacturing overhead costs.
10. In order to develop a budgeted balance sheet, the previous year's balance sheet is needed.
11. In service enterprises, the critical factor in budgeting is coordinating materials and equipment
with anticipated services.
12. Budget reports comparing actual results with planned objectives should be prepared only once a
year.
13. If actual results are different from planned results, the difference must always be investigated
by management to achieve effective budgetary control.
14. Certain budget reports are prepared monthly, whereas others are prepared more frequently
depending on the activities being monitored.
15. The master budget is not used in the budgetary control process.
16. A master budget is most useful in evaluating a manager's performance in controlling costs.
17. A static budget is one that is geared to one level of activity.
18. A static budget is changed only when actual activity is different from the level of activity
expected.
19. A static budget is most useful for evaluating a manager's performance in controlling variable
costs.
20. A flexible budget can be prepared for each of the types of budgets included in the master
budget.
21. A flexible budget is a series of static budgets at different levels of activities.
22. Flexible budgeting relies on the assumption that unit variable costs will remain constant within
the relevant range of activity.

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23. Total budgeted fixed costs appearing on a flexible budget will be the same amount as total fixed
costs on the master budget.
24. A flexible budget is prepared before the master budget.
25. The activity index used in preparing a flexible budget should not influence the variable costs that
are being budgeted.

Activity 2. Multiple Choice. Choose the correct answer from the given choices.

1. The budget committee would not normally include the

a. research director.
b. treasurer.
c. sales manager.
d. external auditor.

2. The budget committee in a company is often headed by the

a. president.
b. controller.
c. treasurer.
d. budget director.

3. Long-range planning
a. generally presents more detailed information than an annual budget.
b. generally encompasses a longer period of time than an annual budget.
c. is usually more accurate than an annual budget.
d. is prepared on a quarterly basis if the budget is prepared on a quarterly basis.

4. Long-range planning usually encompasses a period of at least

a. six months.
b. 1 year.
c. 5 years.
d. 10 years.

5. Which of the following is not a proper match-up?

a. Long range planning = Strategies
b. Budgeting = Short-term goals
c. Long-range planning = 5 years
d. Budgeting = Long-term goals

6. Which is the last step in developing the master budget?

a. Preparing the budgeted balance sheet
b. Preparing the cost of goods manufactured budget
c. Preparing the budgeted income statement
d. Preparing the cash budget

7. The total direct labor hours required in preparing a direct labor budget are calculated using the

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a. sales forecast.
b. production budget.
c. direct materials budget.
d. sales budget.

8. The direct materials and direct labor budgets provide information for preparing the
a. sales budget.
b. production budget.
c. manufacturing overhead budget.
d. cash budget.

9. A sales forecast
a. shows a forecast for the firm only.
b. shows a forecast for the industry only.
c. shows forecasts for the industry and for the firm.
d. plays a minor role in the development of the master budget.

10. Which of the following is not an operating budget?

a. Direct labor budget
b. Sales budget
c. Production budget
d. Cash budget

11. Which of the following is not a financial budget?

a. Capital expenditure budget
b. Cash budget
c. Manufacturing overhead budget
d. Budgeted balance sheet

12. Which of the following is done to improve the reliability of the sales forecast?
a. Employ financial planning models
b. Lengthen the planning horizon to more than a year
c. Rely solely on outside consultants
d. Use the sales forecasts from the previous year

13. The financial budgets include the

a. cash budget and the selling and administrative expense budget.
b. cash budget and the budgeted balance sheet.
c. budgeted balance sheet and the budgeted income statement.
d. cash budget and the production budget.

14. The culmination of preparing operating budgets is the

a. budgeted balance sheet.
b. production budget.
c. cash budget.

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d. budgeted income statement.

15. An overly optimistic sales budget may result in

a. increases in selling prices late in the year.
b. insufficient inventories.
c. increased sales during the year.
d. excessive inventories.

16. In a production budget, total required units are the budgeted sales units plus
a. beginning finished goods units.
b. desired ending finished goods units.
c. desired ending finished goods units plus beginning finished goods units.
d. desired ending finished goods units minus beginning finished goods units.

17. The direct materials budget details

1. the quantity of direct materials to be purchased.
2. the cost of direct materials to be purchased.
a. 1
b. 2
c. both 1 and 2
d. neither 1 nor 2

18. Which one of the following budgets would be prepared for a manufacturer but not for a
merchandiser?
a. Direct labor budget
b. Cash budget
c. Sales budget
d. Budgeted income statement

19. The formula for determining budgeted merchandise purchases is budgeted

a. production + desired ending inventory – beginning inventory.
b. sales + beginning inventory – desired ending inventory.
c. cost of goods sold + desired ending inventory – beginning inventory.
d. cost of goods sold + beginning inventory – desired ending inventory.

20. Which one of the following is a problem resulting from a service company being overstaffed?
a. Labor costs will be disproportionately low.
b. Profits will be higher because of the additional salaries.
c. Staff turnover may increase.
d. Revenue may be lost.

Financial forecasting, an essential element of planning, is the basis for budgeting activities and estimating
future financing needs. Financial forecasts begin with forecasting sales and their related expenses. This
ends up with financial statement budgets.

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Budget – a budget is a detailed plan outlining the acquisition and use of financial and other resources over
some given time period. As such, it represents a plan for the future expressed in formal quantitative terms.

Major benefits to be gained from budgeting

1. Budgets provide a means of communicating management’s plans throughout the organization

2. Budgets force managers to think about and plan for the future
3. The budgeting process provides a means of allocating resources to those parts of the organization where
they can be most effectively used
4. The budgeting process can uncover potential bottlenecks before they occur
5. Budgets coordinate the activities of the entire organization by integrating the plans of the various parts.
Budgeting helps to ensure that everyone in the organization is pulling in the same direction
6. Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance

Budgeting forces managers to plan, provides resource information for decision making, sets benchmarks for
control and evaluation, and improves the functions of communication and coordination.

Budgeting Models
• Continuous budgeting – a time frame is maintained and when a segment in a budgeted time frame
expires and is dropped, a new segment is to be added to maintain the same time frame.
• Flexible budgeting – costs and expenses are segregated to fixed and variable components giving way
to the determination of estimated costs based on actual capacity.
• Static budgeting – costs and expenses are not segregated to fixed and variable components and the
budgeted costs, without adjustments to actual capacity, serve as the basis in evaluating actual
performance.
• Imposed budgeting – budgets are prepared by top management with little or no inputs from operating
personnel
• Participatory budgeting – budgets are developed through joint decision making by top management
and operating personnel.
• Program budgeting – an approach that relates resource inputs to service outputs; it generally starts by
defining the objectives by output results rather than in terms of quantity of input activities.
• Zero-based budgeting – activities to be incurred are to be prioritized based on its order of relevance
in line with a defined goal in the coming period without regard to part experiences or present
condition.
• Life-cycle budgeting – costing is done over the entire life span of a product starting from its period of
conception, to infancy, growth, expansion, up to maturity; it includes all costs expected to be incurred
in the research and development, design, commercial production, marketing, channels of distribution,
customer services, and post-sales services of a product to determine the most strategic price for
market dominance, saturation or influence.

Differences of the Master Budget among manufacturing, merchandising, and service organizations

For a merchandising firm, the production budget is replaced by a merchandise purchases budget.
Merchandising firms also lack direct materials and direct labor budgets. All other budgets are essentially the
same. For a service firm (for profit), the sales budget doubles as the production budget, and there is no finished
goods inventory budget. The rest of the budgets have counterparts.

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Importance of Goal Congruence – goal congruence is important because it means that the employees of an
organization are working toward the goals of the organization.

The role of the top management in participative budgeting – top management should provide guidelines and
statistical input (e.g.. industrial forecasts), and should review the budgets to minimize the possibility of
budgetary slack and ensure that the budget is compatible with the strategic objectives of the firm. Top
managements should also provide the incentive and reward system associated with the budgetary system.

Pro-forma schedules

1. Sales Budget: Units to be sold XX

X Unit selling price XX
Sales revenue XX

2. Production Budget: Units to be sold XX

Add: Desired Ending finished goods inventory XX
Total needs XX
Less: Beginning finished goods inventory XX
Units to be produced XX

3. Direct Materials Budget: Units to be produced XX

Multiply by: Direct materials per unit XX
Production needs XX
Add: Desired RM inventory XX
Total needs XX
Less: Beginning RM inventory XX
Raw Materials to be purchased XX
Multiplied by: Unit Price XX
Total purchase cost XX

4. Direct Labor Budget: Units to be produced XX

Multiplied by: Direct labor time per unit XX
Total hours needed XX
Multiplied by: Rate per hour XX
Total direct labor cost XX

5. Overhead Budget: Budgeted direct labor hours XX

Multiplied by: Variable overhead rate XX
Budgeted variable overhead XX
Add: Budgeted fixed overhead XX
Total Overhead XX

6. Cost of Goods Sold: Direct Materials XX

Direct Labor XX
Overhead XX
Budgeted Manufacturing Costs XX
Add: Beginning Finished Goods Inventory XX
Goods Available for Sale XX

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Less: Ending Finished Goods Inventory XX

Budgeted Cost of Goods Sold XX

7. Budgeted Income Statement Sales XX

Less: Cost of Goods Sold XX
Gross Margin XX
Less: Selling and administrative expenses XX
Operating Income XX
Less: Interest expense XX
Income before taxes XX
Less: Income taxes XX
Net Income XX

8. Cash Budget Beginning cash balance XX

Add: Collections XX
Total cash available XX
Less: Disbursements XX
Cash balance end, before additional financing XX
Financing:
Borrowings XX
Repayments (XX)
Interest (XX)
Ending cash balance XX

STATIC BUDGET

A static budget is planned ahead of time based upon your best educated guess about future
actual activity. Static budgets are usually planned a year in advance, broken out into smaller reporting
periods such as months and quarters.

A big disadvantage for new businesses is the lack of actual data upon which to build a budget.
If actual data differ significantly from the static budget, there's no way to change the budget or to
determine if the costs to produce the revenue were properly controlled. Instead, you must produce a
forecast. The forecast is a new document that predicts the remainder of the reporting period's activity
and compares it to the static budget and the actuals.

Why Static Budgets Work

The best reason to use a static budget is the variance analysis. The variance analysis tells you
how much your budget is over or under the original projections, via percentage and pesos. Even for
new businesses, it may be easier to plan for future years when you know you have a comparison
between what was expected and what actually occurred. In future years, you can adjust the budget up
or down depending upon the variance percentages. Static budgets work best when you have a

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reasonable amount of certainty gauging what revenues and costs will be, barring extraordinary
circumstances.

FLEXIBLE BUDGET
A flexible budget calculates budgeted revenues and budgeted costs based on the actual output in
the budget period. The flexible budget is prepared at the end of the period. For example, Webb Co.
has an actual output of 10,000 jackets at the end of the reporting period – April 2011. The flexible budget
is the hypothetical budget that Webb would have prepared at the start of the budget period if it had
correctly forecast the actual output of 10,000 jackets. In other words, the flexible budget is not the plan
Webb initially had in mind for April 2011 (remember Webb planned for an output of 12,000 jackets
instead). Rather, it is the budget Webb would have put together for April if it knew in advance that the
output for the month would be 10,000 jackets. In preparing the flexible budget, note that:
■ The budgeted selling price is the same P120 per jacket used in preparing the static budget.
■ The budgeted unit variable cost is the same P88 per jacket used in the static budget.
■ The budgeted total fixed costs are the same static-budget amount of P276,000. Why? Because the
10,000 jackets produced falls within the relevant range of 0 to 12,000 jackets. Therefore, Webb
would have budgeted the same amount of fixed costs, P276,000, whether it anticipated making
10,000 or 12,000 jackets.
The only difference between the static budget and the flexible budget is that the static budget is prepared
for the planned output of 12,000 jackets, whereas the flexible budget is based on the actual output of
10,000 jackets. The static budget is being “flexed,” or adjusted, from 12,000 jackets to 10,000 jackets. The
flexible budget for 10,000 jackets assumes that all costs are either completely variable or completely fixed
with respect to the number of jackets produced. Webb develops its flexible budget in three steps.

Step 1: Identify the Actual Quantity of Output.

In April 2011, Webb produced and sold 10,000 jackets.

Step 2: Calculate the flexible budget for revenues based on budgeting selling price and actual quantity of
output.

Flexible-budget revenues = P120 per jacket x 10,000 jackets = P1,200,000

Step 3: Calculate the flexible budget for costs based on budgeted variable cost per unit output unit, actual
quantity of output and budgeted fixed costs.

Flexible-budget variable costs

Direct materials, P60 per jacket x 10,000 jackets 600,000
Direct manufacturing labor, P16 per jacket x 10,000 jackets 160,000
Variable manufacturing overhead, P12 per jacket x 10,000 120,000
Total flexible-budget variable costs 880,000
Flexible-budget fixed costs 276,000
Flexible-budget total costs 1,156,000

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The flexible budget allows for a more detailed analysis of the P93,100 unfavorable static-budget
variance for operating income.

Characteristics of a Flexible Budget

The budgets that we explored in the last chapter were planning budgets. A planning budget is
prepared before the period begins and is valid for only the planned level of activity. A static planning
budget is suitable for planning but is inappropriate for evaluating how well costs are controlled. If the
actual level of activity differs from what was planned, it would be misleading to compare actual costs to
the static, unchanged planning budget. If activity is higher than expected, variable costs should be higher
than expected; and if activity is lower than expected, variable costs should be lower than expected.
Flexible budgets take into account how changes in activity affect costs. A flexible budget is an
estimate of what revenues and costs should have been, given the actual level of activity for the period.
When a flexible budget is used in performance evaluation, actual costs are compared to what the costs
should have been for the actual level of activity during the period rather than to the static planning
budget. This is a very important distinction. If adjustments for the level of activity are not made, it is very
difficult to interpret discrepancies between budgeted and actual costs.

The Minuses of the Flexible Budget Approach

Flexible budgeting is a more sophisticated method because you can make changes to the budget
in the middle of the reporting period. However, you may not have the time, experience or inclination
to adjust the budget frequently. Also, there may be unexpected effects from an unexpected change in
volume, for which you won't know to plan. Flexible budgets require knowing in advance which costs are
fixed or variable, and how expenses are affected by changes in revenue.

Why Flexible Budgets Work

Because the flexible budget changes based upon volume, it provides a greater level of control.
New businesses need to keep a tight lid on costs; capping certain flexible expenses to a percentage of
volume helps accomplish this. A new business could vary a great deal from what was originally planned,
and flexible budgets offer a real-time view of a business's expenses and revenues.

PRACTICE PROBLEMS

1. Hease Company is preparing its master budget for 2008. Relevant data pertaining to its sales budget
are as follows:

Sales for the year are expected to total 6,000,000 units. Quarterly sales are 25%, 30%, 15%, and 30%,
respectively. The sales price is expected to be P2.00 per unit for the first quarter and then be increased
to P2.30 per unit in the second quarter.

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Instructions
Prepare a sales budget for 2008 for Hease Company.

2. Neeley Company combines its operating expenses for budget purposes in a selling and administrative
expense budget. For the first quarter of 2008, the following data are developed:
1. Sales: 20,000 units; unit selling price: P35
2. Variable costs per peso of sales:
Sales commissions 6%
Delivery expense 2%
Advertising 4%
3. Fixed costs per quarter:
Sales salaries P24,000
Office salaries 17,000
Depreciation 6,000
Insurance 2,000
Property taxes 1,000

Instructions
Prepare a selling and administrative expense budget for the first quarter of 2008.

3. The Northeast Regional Division of Hight Wholesale Corporation has been requested to prepare a
quarterly budgeted income statement for 2009. The regional manager expects that sales in the first
quarter of 2009 will increase by 10% over the same quarter of the preceding year and will then increase
by 5% for each succeeding quarter in 2009.
The corporate head office has requested that the regional manager maintain an inventory in pesos
equal to 25% of the next quarter's sales. Quarterly purchases average 55% of quarterly sales. Budgeted
ending inventory on December 31, 2008 is P132,000. Quarterly salaries are P15,000 plus 5% of sales.
All salaries are classified as sales salaries. Other quarterly expenses are estimated to be as follows:
Rent expense P18,000
Depreciation on office equipment P9,000
Utilities expense P2,700
Miscellaneous expenses 2% of sales
The income statement for the first quarter of 2008 was as follows:
Income Statement
For the Quarter Ended March 31, 2008
Sales .............................................................................................................. P480,000
Cost of goods sold......................................................................................... 264,000
Gross profit ................................................................................................... 216,000
Operating expenses
Sales salaries .............................................................................................. P39,000
Rent expense ............................................................................................. 18,000
Depreciation .............................................................................................. 9,000
Utilities ....................................................................................................... 2,700

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Miscellaneous ............................................................................................ 9,600

Total operating expenses .................................................................. 78,300
Net income ................................................................................................... P137,700
Instructions
Prepare a budgeted quarterly income statement in tabular form for the first quarter of 2009.

4. The company wishes to maintain a minimum cash balance of P50,000 at the end of each month. The
company borrows money from the bank at 8% interest if necessary to maintain the minimum cash
balance. Borrowed money is repaid in months when there is an excess cash balance. The beginning
cash balance on July 1 was P50,000. Assume that borrowed money in this case is for one month.

Instructions
Prepare a cash budget for the months of July and August. Prepare separate schedules for expected
collections from customers and expected payments for purchases of inventory.

5. Farris Co.’s projected sales are as follows:

August P240,000
September P270,000
October P330,000
Farris estimates that it will collect 30% in the month of sale, 50% in the month after the sale, and
18% in the second month following the sale. Two percent of all sales are estimated to be bad
debts.

Instructions
How much are Farris Co.'s budgeted cash receipts for October?

6. Shirk Productions makes a single product. Expected manufacturing costs are as follows:
Variable costs
Direct materials P6.50 per unit
Direct labor 2.40 per unit
Manufacturing overhead 1.10 per unit
Fixed costs per month
Supervisory salaries P12,600
Depreciation 3,500
Other fixed costs 2,200

Instructions
Determine the amount of manufacturing costs for a flexible budget level of 3,200 units per month.

7. Sekine Company uses flexible budgets. Items from the budget for March in which 2,000 units were
produced and sold appear below:
Direct materials P18,000
Indirect materials - variable 2,000

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Supervisor salaries 15,000

Depreciation on factory equipment 4,000
Direct labor 10,000
Property taxes on factory 1,000
Instructions
If Sekine prepares a flexible budget at 3,000 units, compute its total variable cost.

8. Doonan Company's master budget reflects budgeted sales information for the month of June, 2008,
as follows:
Budgeted Quantity Budgeted Unit Sales Price
Product A 20,000 P7
Product B 24,000 P9
During June, the company actually sold 19,500 units of Product A at an average unit price of P7.10
and 24,800 units of Product B at an average unit price of P8.90.

Instructions
Prepare a Sales Budget Report for the month of June for Doonan Company which shows whether
the company achieved its planned objectives.

9. Bay City estimates production overhead costs equal to P200,000 + P4X + P7Y, where X is the number
of direct labor hours used and Y is the number of machine hours used. Bay City budgeted 20,000 direct
labor hours and 50,000 machine hours for 20X2. Bay City produced 30,000 units in 20X2, each requiring
1 direct labor hour and 2.5 machine hours. Actual production costs were P890,000.

a. Calculate the flexible budget allowance for production overhead costs for 20X2.
b. Find the amount and direction of the budget variance for 20X2 for production overhead.

10. Webster Company has the following sales budget.

January P200,000
February P240,000
March P300,000
April P360,000

Cost of sales is 70% of sales. Sales are collected 40% in the month of sale and 60% in the following
month. Webster keeps inventory equal to double the coming month's budgeted sales requirements.
It pays for purchases 80% in the month of purchase and 20% in the month after purchase. Inventory
at the beginning of January is P190,000. Webster has monthly fixed costs of P30,000 including P6,000
depreciation. Fixed costs requiring cash are paid as incurred.

a. Compute budgeted cash receipts in March.

b. Compute budgeted accounts receivable at the end of March.
c. Compute budgeted inventory at the end of February.
d. Compute budgeted purchases in February.
e. March purchases are P290,000. Compute budgeted cash payments in March to suppliers of goods.

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f. Compute budgeted accounts payable for goods at the end of February.

g. Cash at the end of February is P45,000. Cash disbursements are not required for anything other
than payments to suppliers and fixed costs. Compute the budgeted cash balance at the end of
March.

“Someone's sitting in the shade today because someone planted a

tree a long time ago.”

― Warren Buffett

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