CHAPTER 9

Budgetary Planning
ASSIGNMENT CLASSIFICATION TABLE
Brief
Exercises

A
Problems

B
Problems

1, 2, 3, 4,
5, 6, 7, 8,
9, 10, 11

1A, 2A, 3A

1B, 2B, 3B

11

1A, 2A, 3A,

6A

1B, 2B, 3B

19, 20

12, 13, 14,

15, 16

4A, 6A

4B

21, 22

10

3, 15, 16,
17

5A

5B

Study Objectives

Questions

1.

Indicate the benefits of

budgeting.

1, 2, 4

2.

State the essentials of

effective budgeting.

3, 5, 6,
7, 8

3.

Identify the budgets

that comprise the
master budget.

9, 10, 11,
12, 13, 14,
15, 16

1, 2, 3, 4,
5, 6, 7

4.

Describe the sources for

preparing the budgeted
income statement.

17, 18

5.

Explain the principal sections of

a cash budget.

6.

Indicate the applicability of

budgeting in nonmanufacturing
companies.

9-1

Exercises

ASSIGNMENT CHARACTERISTICS TABLE

Problem
Number

Description

Difficulty
Level

Time
Allotted (min.)

1A

Prepare budgeted income statement and supporting

budgets.

Simple

3040

2A

Prepare sales, production, direct materials, direct labor,

and income statement budgets.

Simple

4050

3A

Prepare sales and production budgets and compute cost

per unit under two plans.

Moderate

3040

4A

Prepare cash budget for two months.

Moderate

3040

5A

Prepare purchases and income statement budgets for a

merchandiser.

Simple

3040

6A

Prepare budgeted income statement and balance sheet.

Complex

4050

1B

Prepare budgeted income statement and supporting

budgets.

Simple

3040

2B

Prepare sales, production, direct materials, direct labor,

and income statement budgets.

Simple

4050

3B

Prepare sales and production budgets and compute cost

per unit under two plans.

Moderate

3040

4B

Prepare cash budget for two months.

Moderate

3040

5B

Prepare purchases and income statement budgets for a

merchandiser.

Simple

3040

9-2

9-3
Q9-21
Q9-22

6.

Broadening Your Perspective

Indicate the applicability

of budgeting in
nonmanufacturing
companies.

Q9-19
Explain the principal
sections of a cash budget.

5.

Identify the budgets

that comprise the
master budget.

3.

Describe the sources for

preparing the budgeted
income statement.

State the essentials of

effective budgeting.

2.

Q9-7
Q9-8
E9-1

Q9-4
E9-1

BE9-10
E9-3
E9-15
E9-16

Q9-20
BE9-9
E9-12

Q9-17
BE9-8
E9-11

Q9-12
Q9-13
Q9-14
Q9-15
Q9-16
BE9-2
BE9-3
BE9-4
BE9-5

E9-13
E9-14
E9-15

Analysis

E9-17
P9-5A
P9-5B

E9-16
P9-4A
P9-4B

Manag. Analysis
Communication
Real-World Focus
Exploring the Web

BE9-1
E9-9
E9-10
E9-11
P9-1A
P9-2A
P9-1B
P9-2B

P9-1A P9-1B
P9-2A P9-2B
P9-6A

BE9-6
BE9-7
E9-2
E9-3
E9-4
E9-5
E9-6
E9-7
E9-8

Application

Real-World Focus All About You

Q9-18

Q9-9
Q9-10
Q9-11
E9-1

Q9-3
Q9-5
Q9-6

Q9-1
Q9-2

Knowledge Comprehension

4.

Indicate the benefits of

budgeting.

1.

Study Objective

Decision Making
Across the
Organization
Manag. Analysis
Communication

Synthesis

Ethics Case
Decision Making
Across the
Organization
All About You

P9-3A
P9-3B

P9-3A
P9-3B

Evaluation

Correlation Chart between Blooms Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems

BLOOMS TAXONOMY TABLE

STUDY OBJECTIVES
1. INDICATE THE BENEFITS OF BUDGETING.
2. STATE THE ESSENTIALS OF EFFECTIVE BUDGETING.
3. IDENTIFY THE BUDGETS THAT COMPRISE THE
MASTER BUDGET.
4. DESCRIBE THE SOURCES FOR PREPARING THE
BUDGETED INCOME STATEMENT.
5. EXPLAIN THE PRINCIPAL SECTIONS OF A CASH
BUDGET.
6. INDICATE THE APPLICABILITY OF BUDGETING IN
NONMANUFACTURING COMPANIES.

9-4

CHAPTER REVIEW
Budgeting Basics
1.

(S.O. 1) A budget is a formal written statement of managements plans for a specified time
period, expressed in financial terms.

2.

The role of accounting during the budgeting process is to (a) provide historical data on revenues,
costs, and expenses, (b) express managements plans in financial terms, and (c) prepare periodic
budget reports.

Benefits of Budgeting
3.

The primary benefits of budgeting are as follows:

a. It requires all levels of management to plan ahead.
b. It provides definite objectives for evaluating performance.
c. It creates an early warning system for potential problems.
d. It facilitates the coordination of activities within the business.
e. It results in greater management awareness of the entitys overall operations.
f.
It motivates personnel throughout the organization.

Essentials of Effective Budgeting

4.

(S.O. 2) In order to be effective management tools, budgets must be based upon

a. A sound organizational structure in which authority and responsibility are clearly defined.
b. Research and analysis to determine the feasibility of new products, services, and operating
techniques.
c. Management acceptance which is enhanced when all levels of management participate in
the preparation of the budget, and the budget has the support of top management.

5.

The most common budget period is one year. A continuous twelve-month budget results from
dropping the month just ended and adding a future month. The annual budget is often
supplemented by monthly and quarterly budgets.

6.

The responsibility for coordinating the preparation of the budget is assigned to a budget
committee. The budget committee usually includes the president, treasurer, chief accountant
(controller), and management personnel from each major area of the company.

7.

A budget can have a significant impact on human behavior. A budget may have a strong positive
influence on a manager when
a. Each level of management is invited and encouraged to participate in developing the budget.
b. Criticism of a managers performance is tempered with advice and assistance.

8.

Long-range planning involves the selection of strategies to achieve long-term goals and the
development of policies and plans to implement the strategies. Long-range plans contain considerably
less detail than budgets.

The Master Budget

9.

(S.O. 3) The master budget is a set of interrelated budgets that constitutes a plan of action for a
specified time period. It is developed within the framework of a sales forecast which shows
potential sales for the industry and the companys expected share of such sales.

9-5

10.

There are two classes of budgets in the master budget.

a. Operating budgets are the individual budgets that result in the preparation of the budgeted
income statement.
b. Financial budgets focus primarily on the cash resources needed to fund expected
operations and planned capital expenditures.

11.

The sales budget is the first budget prepared. It is derived from the sales forecast, and it
represents managements best estimate of sales revenue for the budget period. It is prepared by
multiplying the expected unit sales volume for each product by its anticipated unit selling price.

12.

The production budget shows the units that must be produced to meet anticipated sales. It is
derived from the budgeted sales units plus the desired ending finished goods units less the
beginning finished goods units.

13.

The direct materials budget shows both the quantity and cost of direct materials to be
purchased. It is derived from the direct materials units required for production plus the desired
ending direct materials units less the beginning direct materials units.

14.

The direct labor budget shows the quantity (hours) and cost of direct labor necessary to meet
production requirements. The direct labor budget is critical in maintaining a labor force that can
meet expected levels of production.

15.

The manufacturing overhead budget shows the expected manufacturing overhead costs. The
selling and administrative expense budget is a projection of anticipated operating expenses.
Both budgets distinguish between fixed and variable costs.

Budgeted Income Statement

16.

(S.O. 4) The budgeted income statement is the important end-product in preparing operating
budgets. This budget indicates the expected profitability of operations and it provides a basis for
evaluating company performance.
a. The budget is prepared from the budgets described in review points 11-15.
b. For example, to find cost of goods sold, it is necessary to determine the total unit cost of a
finished product using the direct materials, direct labor, and manufacturing overhead
budgets.

Cash Budget
17.

(S.O. 5) The cash budget shows anticipated cash flows. It contains three sections (cash
receipts, cash disbursements, and financing) and the beginning and ending cash balances. Data
for preparing this budget are obtained from the other budgets.

18.

The budgeted balance sheet is a projection of financial position at the end of the budget period.
It is developed from the budgeted balance sheet for the preceding year and the budgets for the
current year.

Budgeting in Nonmanufacturing Companies

19.

(S.O. 6) The major differences in the master budget of a merchandiser and a manufacturing
company are that a merchandiser (a) uses a merchandise purchases budget instead of a
production budget and (b) does not use the manufacturing budgets (direct materials, direct labor,
and manufacturing overhead).

9-6

20.

In service enterprises, the critical factor in budgeting is coordinating professional staff needs with
anticipated services. Budget data for service revenue may be obtained from expected output or
expected input.

21.

In the budget process for not-for-profit organizations, the emphasis is on cash flows rather than
on a revenue and expense basis. For governmental units, the budget must be strictly followed and
overspending is often illegal.

9-7

LECTURE OUTLINE
A.

Budgeting Basics.
1. Planning is the process of establishing enterprise-wide objectives.
2. A budget is a formal written statement of managements plans for a
specified future time period, expressed in financial terms.
3. Accounting information makes major contributions to the budgeting
process.

B.

The Benefits of Budgeting.

TEACHING TIP

Use ILLUSTRATION 9-1 to discuss the benefits of budgeting. Point out that even
though the budget process is procedural, it has behavioral implications that could
have a positive or negative effect on the accomplishment of company goals.
1. It requires all levels of management to plan ahead and to formalize goals
on a recurring basis.
2. It provides definite objectives for evaluating performance at each level of
responsibility.
3. It creates an early warning system for potential problems so that management can make changes before things get out of hand.
4. It facilitates the coordination of activities within the business by correlating
the goals of each segment with overall company objectives.

9-8

5. It results in greater management awareness of the entitys overall operations and the impact on operations of external factors, such as economic
trends.
6. It motivates personnel throughout the organization to meet planned
objectives.

C.

Essentials of Effective Budgeting.

1. The essentials of effective budgeting are (a) sound organizational
structure, (b) research and analysis, and (c) acceptance by all levels of
management.

D.

a.

Effective budgeting depends on a sound organizational structure.

In such a structure, authority and responsibility for all phases of
operations are clearly defined.

b.

Budgets based on research and analysis should result in realistic

goals that will contribute to the growth and profitability of a company.

c.

The effectiveness of a budget program is directly related to its

acceptance by all levels of management.

Length of the Budget Period.

1. A budget may be prepared for any period of time. Various factors influence
the length of the budget period.
a.

The type of budget.

b.

The nature of the organization.

c.

The need for periodic appraisal.

d.

Prevailing business conditions.

9-9

2. The budget period should be long enough to provide an attainable goal

under normal business conditions and should minimize the impact of
seasonal or cyclical fluctuations.
3. The most common budget period is one year.

TEACHING TIP

Use ILLUSTRATION 9-2 to give an overview of the budgeting process and

identify those who are responsible for coordinating its preparation.
E.

The Budgeting Process/Budgeting and Human Behavior.

1. The budget is developed within the framework of a sales forecast that
shows potential sales for the industry and the companys expected share
of such sales. Sales forecasting involves a consideration of various factors:
a.

General economic conditions.

b.

Industry trends.

c.

Market research studies.

d.

Anticipated advertising and promotion.

e.

Previous market share.

f.

Changes in prices.

g.

Technological developments.

2. The input of sales personnel and top management is essential to the

sales forecast.
3. In larger companies, a budget committee has responsibility for coordinating the preparation of the budget.

9-10

4. A budget can have a significant impact on human behavior.

F.

a.

A budget may inspire a manager to higher levels of performance.

b.

A budget may discourage additional effort and pull down the morale
of a manager.

c.

In developing the budget, each level of management should be

invited to participate. The overall goal is to reach agreement on a
budget that the managers consider fair and achievable, but which
also meets the corporate goals set by top management.

Budgeting and Long-Range Planning.

1. Budgeting and long-range planning are not the same.
a.

One important difference is the time period involved; long-range

planning usually encompasses a period of at least five years.

b.

A second significant difference is in emphasis; long-range planning

identifies long-term goals, selects strategies to achieve those goals,
and develops policies and plans to implement the strategies. Management also considers anticipated trends in the economic and political
environment and how the company should cope with them.

c.

The final difference pertains to the amount of detail presented.

Long-range plans contain considerably less detail than budgets
because the data in long-range plans are intended more for a review
of progress toward long-term goals than as a basis of control for
achieving specific results.

2. The primary objective of long-range planning is to develop the best

strategy to maximize the companys performance over an extended
future period.

9-11

G.

The Master Budget.

1. The master budget is a set of interrelated budgets that constitutes a plan
of action for a specified time period.

TEACHING TIP

Use ILLUSTRATION 9-3 to describe the components of the master budget. Point
out that the individual budgets making up the master budget are prepared in an
ordered sequence. The information developed in one individual budget serves as
input in preparing other budgets. Budgeting is an interrelated process.

2. Sales Budget: The sales budget is the starting point in preparing the
master budget.
a.

Each of the other budgets depends on the sales budget.

b.

The sales budget is derived from the sales forecast and it represents
managements best estimate of sales revenue for the budget period.

3. Production Budget: The production budget shows the units that must be
produced to meet anticipated sales.
a.

Production requirements are determined from the following formula:

Budgeted Sales Units + Desired Ending Finished Goods Units
Beginning Finished Goods Units = Required Production Units.

TEACHING TIP

ILLUSTRATION 9-4 provides a production requirements formula and illustrates

the preparation of a production budget.
b.

The production budget provides the basis for the budgeted costs for
each manufacturing cost element.
9-12

4. Direct Materials: The direct materials budget shows both the quantity
and cost of direct materials to be purchased.
a.

The quantities of direct materials are derived from the following

formula: Direct Materials Units Required for Production + Desired
Ending Direct Materials Units Beginning Direct Materials Units =
Required Direct Materials Units to be Purchased.

TEACHING TIP

ILLUSTRATION 9-5 provides a formula for direct materials quantities and

illustrates the preparation of a direct materials budget.
b.

The desired ending inventory is a key component in the budgeting

process; inadequate inventories could result in temporary shutdowns
of production.

5. Direct Labor: The direct labor budget contains the quantity (hours) and
cost of direct labor necessary to meet production requirements.
a.

The direct labor budget is critical in maintaining a labor force that

can meet the expected levels of production.

b.

The direct labor budget is also used in preparing the budgeted cost
of goods sold and the cash budget.

6. Manufacturing Overhead: The manufacturing overhead budget shows

the expected variable and fixed manufacturing overhead costs for the
budget period.
7. Selling and Administrative Expense: The selling and administrative expense
budget projects anticipated selling and administrative expenses for the
budget period. This budget classifies expenses as either variable or fixed.
This budget is also used in preparing the budgeted income statement
and the cash budget.

9-13

8. Budgeted Income Statement: The budgeted income statement is the

important end-product of the operating budgets.
a.

This budget indicates the expected profitability of operations for the

budget period.

b.

The budgeted income statement provides the basis for evaluating

company performance.

9. Cash Budget: The cash budget shows anticipated cash flows.

a.

Because cash is so vital, this budget is often considered to be the

most important financial budget.

b.

The cash budget contains three sections:

(1) Cash receipts.
(2) Cash disbursements.
(3) Financing.

TEACHING TIP

ILLUSTRATION 9-6 provides a format for preparing a cash budget. Point out that a
cash budget is prepared for a period of time, such as a month, a quarter, a year.
c.

Companies obtain data for preparing the cash budget from other
budgets and from information provided by management.

d.

A cash budget contributes to more effective cash management. It

shows managers when additional financing is necessary well before
the actual need arises and it indicates when excess cash is available
for investments or other purposes.

10. Budgeted Balance Sheet: The budgeted balance sheet is developed

from the budgeted balance sheet for the preceding year and the budgets
for the current year.
9-14

H.

Budgeting in Nonmanufacturing Companies.

1. Budgets are also used by:
a.

Merchandisers.

b.

Service enterprises.

c.

Not-for-profit organizations.

2. The major differences between the master budgets of a merchandiser

and a manufacturer are that a merchandiser:
a.

Uses a merchandise purchases budget instead of a production

budget.

b.

Does not use the manufacturing budgets (direct materials, direct

labor, and manufacturing overhead).

3. In service enterprises, such as a public accounting firm, a law office, or a

medical practice, the critical factor in budgeting is coordinating professional staff needs with anticipated services.
a.

If a firm is overstaffed, several problems may result:

(1) Labor costs will be disproportionately high.
(2) Profits will be lower because of the additional salaries.
(3) Staff turnover may increase because of lack of challenging
work.

b.

If a service enterprise is understaffed, it may loose revenue because

existing and prospective client needs for service cannot be met.
Also, professional staff may seek other jobs because of excessive
work loads.

9-15

4. Budgeting is just as important for not-for-profit organizations as for profitoriented enterprises.

a.

In most cases, not-for-profit entities budget on the basis of cash

flows (expenditures and receipts), rather than on a revenue and
expense basis.

b.

The starting point in budgeting is usually expenditures, not receipts.

9-16

20 MINUTE QUIZ
Circle the correct answer.
True/False
1.

Budgeting is the process of establishing enterprise-wide objectives that serve as a deterrent to waste and inefficiency.
True

2.

The effectiveness of the budget program is directly related to its acceptance by all levels
of management.
True

3.

False

The budgeted income statement indicates the expected profitability of operations for the
next year and provides the basis for evaluating company performance.
True

9.

False

The manufacturing overhead budget shows only the expected indirect labor costs for
the year.
True

8.

False

The quantities of direct materials in the direct materials budget are derived from the
formula: Desired Ending Direct Materials Units + Direct Materials Units Required for
Production Beginning Direct Materials Units = Required Direct Materials Units to be
Purchased.
True

7.

False

The sales budget is the first budget prepared and each of the other budgets depends on it.
True

6.

False

One disadvantage of budgeting is that it does not facilitate the coordination of activities
within a business.
True

5.

False

Budgeting always has the effect on human behavior of inspiring managers to higher
levels of performance.
True

4.

False

False

Long-range planning differs from budgeting in the time period involved, emphasis, and
the amount of detail presented.
True

False

9-17

10.

Budgeting is not used in not-for-profit organizations because it is not necessary for these
organizations to engage in profit planning.
True

False

Multiple Choice
1.

A formal written statement of managements plans for a specified future time period,
expressed in financial terms is a(n)
a. accounting plan.
b. budget.
c. research analysis.
d. sales budget.

2.

Which of the following is not a benefit of budgeting?

a. It reveals the prevailing business conditions.
b. It results in greater management awareness of the entitys overall operations.
c. It creates an early warning system of potential problems.
d. It provides definite objectives for evaluating performance at each level of responsibility.

3.

All of the following are financial budgets except the

a. budgeted balance sheet.
b. budgeted income statement.
c. capital expenditure budget.
d. cash budget.

4.

The master budget includes all of the following except

a. Budgeted Income Statement.
b. Capital Expenditure Budget.
c. Cash Budget.
d. Indirect Labor Budget.

5.

If required production units are 75,000, budgeted sales units are 65,000, required direct
materials purchases units are 3,000, and beginning finished goods units are 5,000, then
desired ending finished goods units would be
a.
2,000.
b.
5,000.
c. 12,000.
d. 15,000.

9-18

ANSWERS TO QUIZ
True/ False
1.
2.
3.
4.
5.

False
True
False
False
True

6.
7.
8.
9.
10.

True
False
True
True
False

Multiple Choice
1.
2.
3.
4.
5.

b.
a.
b.
d.
d.

9-19

ILLUSTRATION 9-1
BENEFITS OF BUDGETING
1. It requires all levels of management to plan ahead and to formalize
goals on a recurring basis.
2. It provides definite objectives for evaluating performance at each
level of responsibility.
3. It creates an early warning system for potential problems so that
management can make changes before things get out of hand.
4. It facilitates the coordination of activities within the business by
correlating the goals of each segment with overall company objectives.
5. It results in greater management awareness of the entity's
overall operations and the impact on operations of external factors.
6. It motivates personnel throughout the organization to meet
planned objectives.

9-20

ILLUSTRATION 9-2
BUDGETING PROCESS

BUDGET COMMITTEE

MASTER BUDGET

OPERATING BUDGETS

FINANCIAL BUDGETS

DATA FROM ORGANIZATIONAL UNITS

9-21

ILLUSTRATION 9-3
COMPONENTS OF THE MASTER BUDGET

Sales
Budget

Production
Budget

Direct
Materials
Budget

Direct
Labor
Budget

Manufacturing
Overhead
Budget

Operating Budgets

Budgeted
Balance
Sheet

Financial Budgets

Selling and
Administrative
Expense Budget

Budgeted
Income
Statement

Capital
Expenditure
Budget

Cash
Budget

9-22

ILLUSTRATION 9-4
PRODUCTION BUDGET

PRODUCTION REQUIREMENTS FORMULA

Budgeted
Sales
Units

Desired
Ending
Finished
Goods Units

Beginning
Finished
Goods
Units

Required
Production
Units

EXAMPLE COMPANY
Production Budget
For the Quarter Ended March 31, 2008
Expected unit sales
Add: Desired ending finished goods units
Total units required
Less: Beginning finished goods units
Required production units

9-23

75,000
5,000
80,000
8,000
72,000

ILLUSTRATION 9-5
DIRECT MATERIALS BUDGET

FORMULA FOR DIRECT MATERIALS QUANTITIES

Direct
Materials
Units
Required for
Production

Desired
Ending
Direct
Materials
Units

Beginning
Direct
Materials
Units

Required
Direct
Materials
Units to be
Purchased

EXAMPLE COMPANY
Direct Materials Budget
For the Quarter Ended March 31, 2008
Units to be produced
Direct materials per unit
Total materials needed for production
Add: Desired ending direct materials
Total materials required
Less: Beginning direct materials
Direct materials units to be purchased
Cost per unit
Total cost of direct materials purchased

9-24

72,000
3
216,000
20,000
236,000
18,000
218,000
$5
$1,090,000

ILLUSTRATION 9-6
CASH BUDGET

EXAMPLE COMPANY
Cash Budget
For the Quarter Ended March 31, 2008
Beginning cash balance

$100,000

Add: Cash receipts (Itemized)

250,000

Total available cash

350,000

Less: Cash disbursements (Itemized)

310,000

Excess (deficiency) of available cash

over disbursements

40,000

Financing

60,000

Ending cash balance required

$100,000

Note: Management requires a minimum cash balance of

$100,000 at the end of each quarter.

9-25