ACA 212 Strategic Cost Management

Lesson 7: Budgeting Lecture Notes

Learning Outcomes:
a. Discuss the importance of budgeting.
b. Relate how strategic planning relate to budgeting.
c. Determine and explain the starting point of a master budget.
d. Discuss how are the various components in a master budget prepared.
e. Explain how do the components relate to one another?
f. Explain why the cash budget is so important in the master budgeting process.
g. Discuss the benefits provided by a budget.

I. Terminology
Budget a financial plan for the future based on a single level of activity; the quantitative expression of a
company’s commitment to planned activities and resource acquisition and use

Budgeting the process of formalizing plans and translating qualitative narratives into a documented
quantitative format

Budget manual a detailed set of documents that provides information and guidelines about the budgetary
process

Budget slack an intentional underestimation of revenues and/or overestimation of expenses in a budgeting

process

Continuous budgeting a process in which there is a 12-month budget; a new budget month (12 months into
the future) is added as each current month expires

Financial budget a plan that combines the monetary details from the operating budgets; includes the cash and
capital budgets of a company as well as the pro forma financial statements

Imposed budget a budget developed by top management with little or no input from operating personnel;
operating personnel are then informed of the budget goals and constraints

Master budget the comprehensive set of budgets, budgetary schedules, and pro forma organizational
financial statements

Operating budget a budget expressed in both units and dollars

Participatory budget a budget that has been developed through a process of joint decision making by top
management and operating personnel
II. LECTURE NOTES

A. The Budgeting Process

1. Budgeting is the process of formalizing plans and committing them to written, financial terms.
a. A budget is a financial plan for the future based on a single level of activity; the quantitative
expression of a company’s commitment to planned activities and resource acquisition and use.
b. The master budget is the comprehensive set of all budgetary schedules and the pro forma financial
statements of an organization.
c. Budgeting helps provide a focused direction or a path chosen from many alternatives.

2. Strategic Planning
a. Budgets must begin with nonquantitative elements though they are typically expressed in financial
terms.
b. Strategic planning is the process of developing a statement of long-range (5–10 years) goals for the
organization and defining the strategies and policies that will help the organization achieve these
goals.
c. About half of all planning time is spent on analyzing critical external factors

3. Tactical Planning
a. Tactical planning is the process of determining the specific means or objectives by which the
strategic plans of the organization will be achieved; it is short range in nature (usually 1–18
months).
a. Such short-term tactical plans are considered “single use” plans and have been developed to
address a given set of circumstances or a specific time frame.
b. The annual budget is an example of a single use tactical plan.
b. Planning is the cornerstone of effective management and effective planning requires that
managers must predict, with reasonable precision, the key variables that affect company
performance and conditions.
a. Financial planning is important even when future conditions will be approximately the same as
current conditions, but it is critical when conditions are expected to change.
b. Planning should include qualitative descriptions of goals, objectives, and means of
accomplishment.
c. A well-prepared budget can effectively communicate objectives, constraints, and expectations to
personnel throughout an organization.
d. Employee participation is needed in the budget process
e. A well-prepared budget translates a company’s strategic and tactical plans into usable guidelines
for company activities.
f. Strategic and tactical planning both require the incorporation of information concerning the
economy, environment, technological developments, and available resources into the setting of
goals and objectives.
g. Management must review the budget prior to its approval and implementation in order to
determine if the forecasted results are acceptable.
h. A budget, having been accepted, is then implemented and is adopted as a standard against which
performance can be measured.
i. The budget becomes the basis for controlling activities and resource usage by indicating the
resource constraints under which managers must operate for the upcoming budget period.
j. The control phase begins, once the budget has been implemented, and includes making actual-to-
budget comparisons, determining variances, investigating variance causes, taking necessary
corrective action, and providing feedback to operating managers.
B. The Master Budget
1. The master budget includes both the operating and financial budgets.
2. An operating budget is a budget that is expressed in both units and dollars. It includes components of
the various pro forma financial statements.
a. Sales budget.
b. Purchases budget.
c. Production budget.
d. Purchases budget.
e. Direct labor budget.
f. Overhead budget.
g. Selling and administrative expenses budget.
h. A financial budget is a budget that aggregates monetary details from the operating budgets; it
includes the cash and capital budgets of a company as well as the pro forma financial statements.
a. Cash budget.
b. Capital expenditures budget.
c. Pro forma balance sheet.
d. Pro forma income statement
e. Pro forma statement of cash flows.
f. Pro forma statement of retained earnings.
i. The master budget is prepared for a specific time period and is static rather than flexible.
j. The output level of sales or service quantities that are selected for use in the master budget
preparation affects all other organizational components; it is essential that all the components
interact in a coordinated manner.
k. The budgetary process begins with the Sales Department’s estimates of the types, quantities, and
timing of demand for the company’s products.

C. The Master Budget Illustrated

1. The sales budget is prepared in both units and sales dollars; peso sales figures are calculated by
multiplying sales quantities by product selling prices.
2. The production budget follows naturally from the sales budget and uses information regarding the
type, quantity, and timing of units to be sold.
a. Sales information is combined with information on beginning and ending inventories so that
managers can schedule the necessary production.
b. Ending inventory policy is generally specified by company management, and desired ending
inventory is usually a function of the quantity and timing of demand in the upcoming period as
related to the capacity and speed of the firm to produce particular units.
3. The purchases budget for direct and indirect materials is first stated in whole units of finished
products.
a. The budget is subsequently converted to individual direct material component requirements.
b. The direct material component requirements are finally converted to cost of purchases figures.
4. The personnel budget con
a. People
b. Number of worker types
c. Number of hours
5. The direct labor budget consists of direct labor cost estimates that are based on the standard hours
of production needed to produce the number of units shown in the production budget.

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 a. Labor requirements are stated in total number of people, specific number of types of people,
and production hours needed for factory employees.
b. Labor costs are calculated from such items as union or other labor contracts, minimum wage
laws, fringe benefit costs, payroll taxes, and bonus arrangements.

6. The overhead budget shows the estimated cost of each overhead item for the period(s).
a. Overhead is another production cost that management must estimate.
b. All fixed and variable overhead costs must be specified, and mixed costs must be separated into
their fixed and variable components.
7. The selling and administrative (S&A) budget includes the estimated selling and administrative expenses
for the period(s).
a. The operating expenses for each month can be predicted in the same fashion as overhead costs.
b. Sales figures rather than production levels are used as the measure of activity in preparing this
budget.

8. The Capital Budget

a. The capital budget is prepared separately from the master budget, but capital budgeting does
affect the master budgeting process since expenditures are involved. Capital budgeting is a process
of assessing an economic entity’s long-term needs in the area of plant and equipment purchases
and budgeting for those expenditures.

9. The Cash Budget

a. A cash budget can be constructed after all the preceding budgets have been developed.
b. Cash budgets can be used to: predict seasonal fluctuations in any potential cash flow, indicating a
need for short-term borrowing and a potential schedule of repayments; show the possibility of
surplus cash that could be used for investment; and measure the performance of the accounts
receivable and accounts payable departments by comparing actual to scheduled collections,
payments, and discounts taken.
c. Managers translate sales revenue information into actual cash receipts through the use of an
expected collection pattern; the balances of the Accounts Receivable and Allowance for
Uncollectibles accounts can be projected once such a schedule of cash collections has been
prepared.
d. Management can prepare an estimated cash disbursements schedule for accounts payable using
the purchases information.
e. The cash receipts and disbursements information is used to prepare the cash budget.

10. Budgeted Financial Statements.

a. Budgeted financial statements are prepared by the Accounting Department for the period(s) and
reflect the results that will be achieved if the estimates and assumptions used for all previous
budgets actually occur.
b. The statements allow management to determine if the predicted results are acceptable for the
period; management then has the opportunity to change and adjust items before beginning the
new period if the predicted results are not acceptable.
c. Management must prepare a schedule of cost of goods manufactured, which is necessary to
determine cost of goods sold, before an income statement can be drafted.
d. The projected income statement uses much of the information previously developed in
determining the revenues and expenses for the period.
e. A balance sheet can be prepared upon completion of the income statement.
 f. The information found in the income statement, balance sheet, and cash budget is used in
preparing a statement of cash flows (SCF). The statement explains the change in the cash balance
by reflecting the company’s sources and uses of cash.

D. Concluding Comments
1. Benefits of a well-prepared budget.
a. a guide to help managers align resource activities and resource allocations with organizational
goals;
b. a vehicle to promote employee participation, cooperation, and departmental coordination;
c. a tool to enhance conduct of managerial functions of planning, controlling, problem solving, and
performance evaluating;
d. a basis on which to sharpen management’s responsiveness to changes in both internal and external
factors; and
e. a model that provides a rigorous view of future performance of a business in time to consider
alternative measures.

2. Demand must be predicted as accurately and with as many details as is possible because of its
fundamental nature in the budgeting process.
a. Sales forecasts should indicate type and quantity of products to be sold, geographic locations of the
sales, types of buyers, and times when the sales are to be made.
b. Such detail is necessary because different products require different production and distribution
facilities; different customers have different credit terms and payment schedules; and different
seasons or months may require different shipping schedules or methods.

3. Estimated sales demand has a pervasive impact on the master budget.

a. Managers use as much information as is available and may combine several estimation approaches
in arriving at a valid prediction.
b. The combining of prediction methods provides managers with a technique to confirm estimates
and reduce uncertainty.

4. Ways of estimating future demand are:

a. canvassing sales personnel for a subjective consensus;
b. making simple extrapolations of past trends;
c. using market research; and
d. employing statistical and other mathematical models.

5. Continuous budgeting is a process in which there is an ongoing 12-month budget at all points in time
during a budget period; a new budget month (12 months into the future) is added as each current
month expires.
a. Management must find the causes of the differences if actual results are different from plans.
b. The budget may or may not be revised if actual performance is substantially less than what was
expected, depending on the causes of the variances.
c. Alterations may be made to the budget if actual performance is substantially better than expected,
although management might decide not to alter the budget so that the positive performance is
highlighted.

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 6. Budget slack is the intentional underestimation of revenues and/or overestimation of expenses in a
budgeting process for the purpose of including deviations that are likely to occur so that results will
occur within budget limits.
a. The presence of slack in the budget allows subordinate managers to achieve their objectives with
less effort than would be necessary if there were no slack.
b. Slack creates problems due to the considerable interaction of the budget factors.

7. An imposed budget is a budget that top management develops with little or no input from operating
personnel; operating personnel are then informed of the budget objectives and constraints.

8. A participatory budget is a budget that has been developed through a process of joint decision making
by top management and operating personnel.

9. Managers might want to contemplate extending their budgeting process to recognize the concepts of
activities and cost drivers. The budgeting aspect of activity-based costing (ABC) is attribute-based
costing (ABC II).

E. The Budget Manual

1. The budget manual is a detailed set of documents that provide information and guidelines about the
budgetary process, and should include the following:
a. statements of the budgetary purpose and its desired results;
b. a listing of specific budgetary activities to be performed;
c. a calendar of scheduled budgetary activities;
d. sample budgetary forms; and
e. original, revised, and approved budgets.
2. The statements of budgetary purpose should flow from general to specific.
3. The budgetary activities should be listed by position, not by person.
4. The budget calendar should indicate a timetable for all budget activities and should be keyed directly
to the activities list.
5. The sample forms should be easy to understand and may include standardized worksheets
6. The final section includes the budgets generated by the budgeting process.