Budgets

& the Budgeting Cycle

Budget
(a) Quantitative expression of a plan of action by management
for a specified period; and
(b) Aid to coordinate what needs to be implemented
Ø Includes both financial & nonfinancial aspects of the plan
Ø Serves as a blueprint for the firm to follow
Ø Targets, Profit Plans, Budgeted Financial Statements: Pro forma
Statements, Goals: Commitments
Financial Budget – quantifies management’s expectations
regarding income, cash flows & financial position
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Budgets & the Budgeting Cycle
Strategic Plans
To accomplish the OBJECTIVES, specifies how an organization
matches: CAPABILITIES OPPORTUNITIES
Questions:
1. What are our OBJECTIVES?
2. How do we CREATE VALUE for customers while
DIFFERENTIATING ourselves from competitors?
3. MARKETS: local, regional, national, global? Trends? Economy?
Industry? Competitors?
4. Organizational & Financial structures?
5. Risk & Opportunities?
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Budgets & the Budgeting Cycle
4 Step Budget Process:
Working document: Master Budget
1. PERFORMANCE TARGETS as a whole & its subunits
Who: Managers, Management Accountants
Consider: Past performances & anticipated changes
2. FRAME of REFERENCE – financial & non financial
expectations
Who: Senior Managers to Subordinate Managers
3. BUDGET VARIANCES INVESTIGATION: Corrective actions
4. Planning again, in light of feedback and changed conditions

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Budgets & the Budgeting Cycle
Master Budget
Expresses:
*Operating plans: how to best use the limited resources
*Financing plans: how to obtain funds to acquire the
resources
Advantages of Budgets:
ü Promote coordination & control among subunits
ü Provide a framework for judging performance and facilitating
learning
ü Motivate managers & other employees

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Budgets & the Budgeting Cycle
Master Budget
Financial Budget: How to obtain funds to acquire
resources
*Capital Expenditures Budget
*Cash Budget
*Budgeted Balance Sheet
*Budgeted Statement of Cash Flows

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Budgets & the Budgeting Cycle
Master Budget
Operating Budget: How to best use the limited resources
* Revenue Budget
* Ending Inventory Budget
* Production Budget
* Direct Materials, Direct Labor, Direct Overhead Costs
Budget
* Cost of Goods Sold Budget
* R & D/ Design Costs Budget
* Marketing Costs Budget
* Distribution Costs Budget
* Budgeted Income Statement
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Developing an Operating Budget
Time Coverage
Typically developed for a set of periods: Month, Quarter, Year.
The set period can then be broken down into subperiods. For
example 12-month cash budget broken into 12 monthly periods.
Purpose: BETTER COORDINATION
1 Year – most frequently used; often subdivided into quarters &
months. Budgeted data are revised as the year goes on. e.g. at
2nd quarter-end, management may change the budget for the
next 2 quarters in light of new info obtained for the 1st 6 months

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Developing an Operating Budget
Time Coverage
Rolling Budget/ Continuous Budget
Budget that is always available for a specified future period.
Created by continually adding a month, quarter or a year to the
period just ended.
E.g. 4-Quarter Rolling Budget: April 2011 to March 2012
- superseded in the next quarter, in June 2011 by the
4-Quarter Rolling Budget: July 2011 to June 2012
- There is always a 12-month budget in place
Adjusted for changing market conditions.

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Developing an Operating Budget
Steps in Preparing an Operating Budget
1. Identify the Problems & Uncertainties.
2. Obtain information.
3. Make predictions about the future.
4. Make decisions by Choosing among
Alternatives.
5. Implement the Decision, Evaluate
Performance & Learn.
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Developing an Operating Budget
Steps in Preparing an Operating Budget
1. Identify the Problems & Uncertainties
þ Strategy: Price Increase? Keeping up demand?
þ Build budget to achieve growth – cost control thru
efficiency improvements
2. Obtain information
þ Past experiences – effects of increases in selling price
þ Market information:
§ Market prices of Direct Materials
§ Industry Trends
§ Competitors
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Developing an Operating Budget
Steps in Preparing an Operating Budget
3. Make predictions about the future
þ Judgment & elimination of biased thinking
þ Reading of circumstances based on available info
þ Retest assumptions
4. Make decisions by Choosing among Alternatives
þ Strategy as guidepost
þ Consistency binds individuals & timelines together and
provides a COMMON PURPOSE for disparate decisions

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Developing an Operating Budget
Steps in Preparing an Operating Budget
5. Implement the Decision, Evaluate Performance & Learn
þ Management Accountants: collect info & follow through on
actual performance. Scorekeeping: Budget vs. Actual
þ Control or post-decision role of info: Taking action to
implement planning decisions.
þ Decide how to evaluate performance
þ Provide feedback & learning for future decision making
þ Motivation: Link rewards to performance, i.e. bonus &
promotions

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Step 1: Prepare the Revenues Budget
- The starting point for the Operating Budget
- The result of elaborate info gathering based on discussions on
customer needs, market potential & competitors; info
gathering through Customer Response Management (CRM) or
sales management system.
The following depends on forecasted level of unit sales or
revenues (usually based on expected demand):
Ø Production level
Ø Inventory level
Ø Manufacturing Costs
Ø Nonmanufacturing Costs
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Step 2: Prepare the Production Budget

Budget Budget Target ending Beginning

Finished Finished
Production = Sales + Goods Invty - Goods Invty
(units) (units) (units) (units)

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Step 3A: Direct Materials Usage Budget
Bill of Materials – document specifying materials for finished goods
Physical Units Budget
Direct Materials required for material A xxx,xxx
Direct Materials required for material B xxx,xxx
Total quantity of direct materials to be used xxx,xxx
Cost Budget
Available from beginning materials inventory xxx,xxx
To be purchased this period xxx,xxx
Direct Materials to be used this period xxx,xxx

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Step 3B: Direct Materials Purchases Budget
Physical Units Budget
To be used in production (Sch A) xxx,xxx
Add: Target ending inventory xxx,xxx
Total requirements xxx,xxx
Less: Beginning inventory xxx,xxx
Purchases to be made xxx,xxx
Cost Budget
Total Units xxx,xxx
* Cost per unit x,xxx
Direct Materials to be used this period xxx,xxx

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Step 4: Direct Manufacturing Labor Costs Budget

Output Units produced (Sch 2) xxx,xxx

* Direct Manufacturing Labor-Hrs per unit x,xxx
Total Hours xxx,xxx
* Hourly Wage Rate x,xxx
Direct Manufacturing Labor Costs xxx,xxx

Managers use LABOR STANDARDS, the time allowed per unit of

output.
These costs depend on wage rates, production methods, process
& efficiency improvements, and hiring plans.
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Step 5: Manufacturing Overhead Costs Budget
Activity-based Budgeting (ABB) – budget cost for activities to
produce & sell the products & services.
Variable costs
Supplies
Indirect manufacturing labor
Power (support department cost)
Maintenance
Fixed Costs
Depreciation
Supervision
Power
Maintenance
Total manufacturingoperations overhead costs
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Step 6: Ending Inventories Budget

Step 7: Cost of Goods Sold Budget

Step 8: Nonmanufacturing Cost Budget

Step 9: Budgeted Income Statement

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Budgeting & Responsibility Accounting
Organization Structure – arrangement of lines of responsibility
within the organization
Responsibility Center – a part, segment, or subunit of an
organization whose manager is accountable for a specified set of
activities
Responsibility accounting – a system that measures the plans,
budgets, actions, and actual results of each responsibility center.
4 Responsibility Centers:
1. Cost center
2. Revenue Center
3. Profit Center – revenues & costs
4. Investment Center – investments, revenues & costs
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Budgeting & Responsibility Accounting
Feedback – performance relative to budget
Variances – differences between actual results & budget
1. Early Warning – variances alert managers; for corrective
action or exploitation of available opportunities
2. Performance Evaluation – variances prompt managers to
probe: Materials & labor usage efficiency? R&D spending?
Other deviations from plan?
3. Evaluating strategy – revenues & costs

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