CHAPTER 10

Budgetary Planning and Control

 Budgets

• Formal documents that quantify a company’s

plans for achieving its goals
• For many companies, the entire planning and
control process is built around budgets.
 Use of Budgets in Planning

• Budgets enhance communication

and coordination
• Process forces managers to consider
their goals and objectives carefully
• Managers must specify means of achieving
goals and objectives
 Use of Budgets in
Control Process
• Provide a basis for evaluating performance
• Essential to assess the performance of
managers and their operations
• Performance evaluation compares actual with
planned or budgeted performance
 Use of Budgets in Control
Significant deviations from planned performance
associated with three potential causes:
1. The budget was poorly conceived
2. Conditions have changed
3. Managers have done a particularly good or poor
job managing operations
 Developing the Budget
Budgets are prepared for:
– Departments
– Divisions of a company
– For the entire company

Budget Committee
– Responsible for approval of various budgets
– Made up of senior managers (Presidents, CFO, controller,
etc.)
– Typically works with departments to develop realistic
plans
 Budget Time Period
• Managers must decide on a budget period
- Short run budgets prepared for a month, a
quarter, or a year
- Long run budgets prepared for a three-year or
five-year period
• Generally, the longer the time frame the less
detailed the budget
 Zero Base Budgeting
• Common starting point in budgeting is previous
period revenues and costs
• Zero base requires budgeted amounts to be justified
each period
- Provides fresh consideration for validity of
budgeted amounts
- Time consuming and expensive process
- Not widely used by business enterprises
 Components of the Master
Budget
The master budget includes:
– Sales budget
– Production budget
– Direct materials purchases budget
– Direct labor budget
– Manufacturing overhead budget
– Selling and administrative expense budget
– Capital acquisitions budget
– Cash budget
Master Budget
 Sales Budget
• First budget prepared since most budgets cannot
be prepared without an estimate of sales
• A variety of methods are used to estimate sales:
- Economic models
- Sales trends
- Trade journals
- Sales force estimates
 Sales Budget
Budgeted sales revenue:
Budgeted sales (units) x budgeted sales price
 Production Budget
• Quantity to be produced based on following formula:

Expected sales in units

Add: Desired ending inventory of finished goods
Subtract: Beginning inventory of finished units
Equals Finished units to be produced

 Desired ending inventory of finished goods

becomes beginning inventory for the next
period
 Production Budget
• Preston Joystick budget plan, Quarter 1
- Ending inventory of finished goods = 10% of next quarter’s
sales (25,000 X 10% = 2,500)
- Budgeted unit sales,Q1 = 21,000 units
- Budgeted unit sales, Q2 = 25,000 units
- Beginning inventory Q1 = 2,100 units
Expected sales in units 21,000
Add: Desired ending inventory of finished goods 2,500
Subtract: Beginning inventory of finished units (2,100)
Finished units to be produced 21,400
• Expected unit sales for VitaPup
-Jan 12, 600; Feb 14,500; Mar 19,000
• Jan beginning inventory 1,260 units
• Desired ending inventory = 15% of next month’s sales
Prepare production budget for Jan and Feb
January February
Expected sales in units 12,600 14,500
Add: Desired ending inventory * 2,175 2,850
Subtract: Beginning inventory (1,260) (2,175)
Equals Finished units to be produced 13,515 15,175

* Jan:14,500 X 15% = 2,175

* Feb: 19,000 X 15% = 2,850
 Direct Material Purchases Budget
• Depends upon amount needed for production and
ending inventory
• The following formula can be used:

Materials required for production

Add: Desired ending inventory of direct materials
Subtract: Beginning inventory of direct materials
= Required purchases of direct materials
 Direct Material Purchases Budget
Preston Joystick
Budgeted production: Q1= 21,400; Q2= 24,800
Parts/unit= 2, cost = $3 per part
Ending inventory = 10% of next month’s production
Prepare materials purchases budget, Q1
Units to be produced 21,400
Parts per unit 2
Number of parts required for production 42,800
Plus desired ending inventory of parts* 4,960 *(10% X 24,800 X 2)
Total parts needed 47,760
Less beginning inventory of parts (4,280)
Number of parts to be purchased 43,480
Purchase price per part $3
Cost of purchases $130,440
 Direct Labor Budget
• Direct labor cost can be budgeted using the following
formulas:
- Direct labor hours per unit x labor rate per hour =
direct labor cost per unit
- Direct labor cost per unit x units to be produced =
budgeted direct labor cost
• Can be used to budget the number of employees
needed
Direct Labor Budget
 Manufacturing Overhead Budget
Separate costs into fixed and variable:
– Variable costs
Multiply cost/unit x units produced
– Fixed costs
- Identical each period except for depreciation
- Depreciation may vary due to planned
acquisitions or disposals
Manufacturing Overhead Budget
Selling and Administrative
Expense Budget
 Budgeted Income
Statement
Compilation of information provided by previously
prepared budgets:
– Sales from Sales Budget
– Cost of goods sold calculated from:
- Direct Materials Budget
- Direct Labor Budget
- Manufacturing Overhead Budget
– Other expenses from Selling and Administrative Expense
Budget
 Capital Acquisitions
Budget
• Decisions with respect to long lived assets
- Use net present value or internal rate of return to
make capital acquisition decisions
• Must be carefully planned since it may substantially
reduce cash reserves
 Cash Receipts and Disbursements
Budget

• Managers must plan for amount and timing of cash

flows
• Careful planning of receipts and disbursements
necessary to:
- Anticipate cash shortages and arrange to borrow
funds
- Anticipate cash surpluses and seek productive uses
 Estimate Cash Collections and
Cash Disbursements
• Cash collections
- Estimate % of credit sales collected in the period of
sale and subsequent periods
• Cash disbursements
- Estimate % of materials purchases paid in the period of
purchase and subsequent periods
- Some expenses (depreciation) do not require cash
outlays
 Budgeted credit sales:
December =$200,000; January =$150,000; February =$160,000;
March =$172,000
Collections:
75% month of sale, 25% following month

Budget cash collections for January:

Cash collections from December sales $200,000 X 25% $50,000
Cash collections from January sales $150,000 X 75% 112,500
Budgeted January cash collections $162,500
 Budgeted credit sales:
December = $200,000; January= $150,000; February= $160,000;
March= $172,000
Collections:
75% month of sale, 25% following month

Budget cash collections for February:

Cash collections from January sales $150,000 X 25% $37,500
Cash collections from February sales $160,000 X 75% 120,000
Budgeted February cash collections $157,500
 Budgeted Balance Sheet
• Last component of master budget prepared
• Sometimes referred to as the pro forma balance
sheet
• Used to assess the effect of planned decisions on the
future financial position of the firm
 Budgetary Control
Budgets as a Standard for Evaluation
- The standard is the budgeted amount
- Differences between budgeted and actual amounts
are called budget variances
- Budget variances should be investigated when they
are material
 Static and Flexible Budgets
• Static Budget
Not adjusted for the actual level of production
• Flexible Budget
Can be adjusted for various production levels
• Level of activity used in flexible budget is equal to the
actual activity level
• A flexible budget is a budget that adjusts or flexes for
changes in the volume of activity.
Flexible Budget