DISCUSSION: Financial Planning and Budgeting

The Basic Budgeting Framework. A budget is a detailed plan outlining the acquisition and use of
financial and other resources over a specified time period.

1. Planning and control. A good budgeting system must provide for both planning and control.
Planning involves developing objectives and preparing budgets to achieve those objectives.
Control involves the steps taken by management to ensure that the objectives set down at the
planning stage are attained and that all parts of the organization work together towards those
objectives.

2. Advantages of budgeting. Budgeting has many advantages, including:

 Budgeting provides managers with a vehicle for communicating their plans in an orderly way
throughout the entire organization.

 Budgeting requires managers to plan for the future.

 Budgeting provides a means of allocating resources to those parts of the organization where
they can be used most effectively.

 Budgeting uncovers potential bottlenecks before they occur.

 Budgeting coordinates the activities of the entire organization.

 Budgets provide benchmarks for evaluating subsequent performance.

3. Responsibility accounting. A manager should be held responsible for those items of revenues
and costs—and only those items—that the manager can actually control to a significant extent.
The manager who is held responsible for a specific cost should have a budget specifying a limit
on how much can be spent. This limit may be adjusted, depending on the activity during the
period. This idea will be developed in later chapters.

4. Choosing a budget period. Budget periods vary in length. Some may be as short as a month,
whereas others may cover many years. The most common budgeting period, however, is a year.

 Operating budgets ordinarily cover a one-year period. Additionally, many companies divide their
operating budgets into quarterly or monthly periods.

 A continuous or perpetual budget covers a 12-month period but adds a new month on the end
as the current month is completed. This approach stabilizes the planning horizon at one year.

5. Self-imposed participative budget. The most successful budget programs usually involve lower-
level managers in preparing their own budgets—although this point is in some dispute. There
 are two basic reasons for favoring participative budgets: 1) lower-level managers are more
familiar with the details of their own operations than top managers and 2) managers tend to be
more committed to budgets that they have been able to influence.

6. Human relations. Management must keep clearly in mind that budgeting involves coordinating
and motivating people and the human dimension is of primary importance.

7. Top managers must clearly convey the message in actions as well as in words that budgeting is
important. If top management appears to be ambivalent about the benefits of budgeting, others
in the organization will be reluctant to commit their own time and energy to the budgeting
process.

8. If there is a preoccupation with getting every dollar and cent right or with placing blame, the
budgeting process will be resented and managers will attempt to “game the system.” Budgets
should not be used as a club. They should be a way of ensuring that everyone understands what
is expected. Significant deviations from the budget should be investigated so that managers
understand changing conditions and their implications for the organization. Managers should
not ordinarily be punished for deviations from the budget.

1. Preparing the Master Budget. The master budget consists of a number of separate, but
interrelated budgets. The interrelationships among these various budgets are illustrated in
Exhibit 9-2 in the text. Schedules 1 through 10 in the text present a comprehensive example of a
master budget.

The Master BudgetLinks to an external site.

1. The Sales Budget The sales budget is a detailed schedule showing the expected sales for the
coming period. It is typically expressed in both dollars and units of the product. The sales budget
is usually accompanied by a schedule of expected cash receipts. The schedule of expected cash
collections should take into account delays in collecting credit sales.

The Sales BudgetLinks to an external site.

2. The Production Budget (Schedule 2 in the text). The budgeted production for each period can
be determined by adding together the budgeted sales and the desired ending inventory and
then subtracting the beginning inventory. The desired ending inventory in units for each period
is usually a predetermined percentage of budgeted unit sales for the following period. The
production budget is typically expressed in terms of physical units rather than in dollars.

In a merchandising company, a merchandise purchases budget would replace the production

budget. The merchandise purchases budget shows the amount of goods to be purchased from suppliers
each period. This can be determined by adding together the budgeted sales and the desired ending
inventory and then subtracting the beginning inventory. As in a manufacturing company, the desired
ending inventory in units is usually some predetermined percentage of the unit sales for the following
period.
The Production BudgetLinks to an external site.

3. The Direct Materials Budget (Schedule 3 in the text). Once production needs have been
determined, a direct materials budget should be prepared. This budget details the materials that
will be required to fulfill the production budget and to ensure adequate inventory levels.
Sufficient amounts of raw material must be acquired to meet both production needs and to
provide for desired ending inventories. Materials purchases are determined by adding together
the materials required for production needs and the desired ending materials inventories, and
then subtracting the beginning inventory. The desired ending inventory in units is usually a
predetermined percentage of the number of units expected to be used in production the
following period. The direct materials budget is usually accompanied by a schedule of expected
cash disbursements for raw materials. This schedule should take into account any delays that
are anticipated in paying for materials.

Direct Materials BudgetLinks to an external site.

4. The Direct Labor Budget (Schedule 4 in the text). Once production needs are known, the direct
labor budget must be prepared so that the company will know whether sufficient labor time is
available to meet those needs. The direct labor budget is typically expressed in both direct
labor-hours and in dollars. Translating the direct-labor requirements into spending can lead to
complications if there is overtime or if there is some sort of guaranteed employment policy.

Direct Labor BudgetLinks to an external site.

5. The Manufacturing Overhead Budget (Schedule 5 in the text). The manufacturing overhead
budget lists all production costs other than direct materials and direct labor. Manufacturing
overhead costs should be broken down by cost behavior for budgeting purposes. Typically, the
variable portion of manufacturing overhead is assumed to be proportional to budgeted activity
and the fixed portion is assumed to be constant in total. Under the assumption that depreciation
is the only significant non-cash manufacturing overhead expense, the manufacturing overhead
expense can be converted to a cash flow basis by backing out of the total any depreciation
charges.

Manufacturing Overhead BudgetLinks to an external site.

6. Ending Finished Goods Inventory Budget (Schedule 6 in the text). This budget details the
amount and value of ending inventory on the budgeted balance sheet. The unit product cost
from this budget is also used to compute the cost of goods sold for the budgeted income
statement. The details of the computations will depend on whether variable or absorption
costing is used. Managers often want budgets on an absorption costing basis since that is the
basis that will ordinarily be used to report results to outsiders. Data for the computations in this
schedule are found in the direct materials, direct labor, and manufacturing overhead budgets.

Ending Inventory BudgetLinks to an external site.

7. The Selling and Administrative Expense Budget (Schedule 7 in the text). The selling and
administrative budget lists the anticipated non-manufacturing expenses for the budget period.
In practice this budget is usually made up of many smaller individual budgets negotiated with
 various managers having sales and administrative responsibilities. Setting appropriate budget
limits for selling and administrative functions is one of the most difficult problems in
management accounting and is just beginning to be understood.

Selling, General, and Administrative Expense BudgetLinks to an external site.

8. The Cash Budget (Schedule 8 in the text). The cash budget should be broken down into time
periods that are as short as feasible so as to alert management to problems that may occur due
to fluctuations in cash flows. As anyone with a checking account knows, it is quite possible to
have a positive overall cash flow during a period and yet be overdrawn at some point during the
period. The cash budget is composed of four major sections:

9. The receipts section.

10. The disbursements section.

11. Cash receipts, plus the beginning cash balance, less cash disbursements results in cash excess or
deficiency. In the case of a deficiency, management must arrange to borrow additional funds. In
the case of excess cash, management can use the excess funds to repay previous borrowing or
to make new investments.

12. The financing section of the cash budget details the borrowing and repayments projected to
take place during the budget period, including any interest payments.

The Cash BudgetLinks to an external site.

9. Budgeted Financial Statements (Schedule 9 in the text). The last components of the master
budget consist of the budgeted income statement and the budgeted statement of financial
position. The balance sheet is perhaps the most difficult of the statements to construct in the
examples we use. It requires pulling together data from a variety of schedules and sources.

Preparing a Budgeted Income StatementLinks to an external site.

https://www.youtube.com/watch?v=-_Q733bUC20Links to an external site.