Profit Planning

Prof. Pamela Gonzalez

Source: Cornerstones of Managerial Accounting, 5e

Budgets help business owners and

managers to plan ahead, and later, exercise
control by comparing what actually
happened to what was expected in the
budget.

Budgets are financial plans

for the future and are a key
component of planning.

Budgets formalize managers expectations

regarding sales, prices, and costs.
Planning is looking ahead to see what
actions should be taken to realize
particular goals.
Control is looking backward, determining
what actually happened and comparing it
with the previously planned outcomes.
Before preparing a budget, an organization should develop a strategic plan.
Strategic plan plots a direction for an organizations future activities and
operations; it generally covers at least 5 years.

Budgeting
Planning

Information
for Decision
Making

The master budget is the

comprehensive financial plan for the
organization as a whole.

Standards
for
Performanc
e
Evaluation

Improved
Communica
tion &
Coordinatio
n

A continuous budget is a moving 12month budget.

Most organizations prepare the master budget for the coming year during the last 4 or 5
months of the current year.
The budget committee:

reviews the budget

provides policy guidelines and
budgetary goals
resolves differences that arise as the
budget is prepared
approves the final budget
monitors the actual performance of the
organization as the year unfolds.

Operating
Budgets

Describe the incomegenerating activities of a

firm: sales, production,
and finished goods
inventories.

Financial
Budgets

Detail the inflows and

outflows of cash and the
overall financial position.

Operating Budgets
The sales budget is approved by the
budget committee and describes expected
sales in units and dollars.
The sales budget is the basis for all of the other operating
budgets and most of the financial budgets.

Operating Budgets
Units to be produced = Expected unit sales
+ Units in desired ending inventory (EI)
Units in beginning inventory (BI)

The production budget tells how many

units must be produced to meet sales
needs and to satisfy ending inventory
requirements.

Operating Budgets
The direct materials purchases budget
tells the amount and cost of raw materials
to be purchased in each time period.

Operating Budgets
The direct labor budget
shows the total direct labor
hours and the direct labor cost
needed for the number of
units in the production
budget.

Operating Budgets
The overhead budget shows the expected
cost of all production costs other than
direct materials and direct labor.

Operating Budgets
The ending finished goods inventory budget:
Supplies information needed for the balance sheet
Serves as an important input for the preparation of the cost of goods
sold budget.

Operating Budgets
The cost of goods sold budget reveals the
expected cost of the goods to be sold.

Operating Budgets
The selling and administrative expenses
budget outlines planned expenditures for
nonmanufacturing activities.

Budgeted Income Statement

Financial Budgets
The usual financial budgets prepared are:
cash budget
budgeted balance sheet
budget for capital expenditures
The basic structure of a cash budget includes cash receipts,
disbursements, any excess or deficiency of cash, and financing
as shown below:

Cash available consists of the beginning cash balance and the expected cash
receipts. Expected cash receipts include all sources of cash for the period
being considered.

Financial Budgets

Financial Budgets
The cash disbursements section lists all planned cash outlays for the
period.
All expenses that do not require a cash outlay are excluded from the
list (e.g., depreciation is never included in the disbursements section).

Financial Budgets
Some companies expand the basic cash budget format
by adding lines to show any borrowing or repayment
necessary to achieve a minimum desired cash
amount.
When this is done, the preliminary ending cash
balance is called cash excess or deficiency.
Borrowings and Repayments: If a company converts its
preliminary cash balance line to a cash excess (deficiency) line,
it may be borrowing or repaying money. If there is a deficiency,
this section shows the necessary amount to be borrowed. When
excess cash is available, this section shows planned
repayments, including interest expense.
Ending Cash Balance: The last line of the
cash budget is the ending cash balance.

Budgeted Balance Sheet

The budgeted balance sheet depends on
information contained in the current
balance sheet and in the other budgets in
the master budget.
Explanations for the budgeted figures are
typically provided in the footnotes

Using Budgets for

Performance Evaluation

Budgets are often used to judge the performance of

managers.
Bonuses, salary increases, and promotions are all affected
by a managers ability to achieve or beat budgeted goals.
Positive behavior occurs when the goals of each manager
are aligned with the goals of the organization and each
manager has the drive to achieve them.
The alignment of managerial and organizational goals is
often referred to as goal congruence.
If the budget is improperly administered, subordinate
managers may subvert the organizations goals.
Dysfunctional behavior is individual behavior that is in
basic conflict with the goals of the organization.

Positive Behavior
Key features that promote a reasonable degree of
positive behavior include:
o
o
o
o
o
o

frequent feedback on performance

monetary and nonmonetary incentives
participative budgeting
realistic standards
controllability of costs
multiple measures of performance

Frequent Feedback

Monetary and
Nonmonetary
Incentives

Frequent, timely performance reports

allow managers to know how successful
their efforts have been, to take corrective
actions, and to change plans as necessary.
Monetary incentives are used to control a
managers tendency to shirk and waste
resources by relating budgetary
performance to salary increases, bonuses,
and promotions.
Nonmonetary incentives, including job
enrichment, increased responsibility and
autonomy, and recognition programs can
be used to enhance a budgetary control
system.

Participative
Budgeting

Realistic Standards

Participative budgeting allows

subordinate managers considerable say in
how the budgets are established.
problems:
setting standards that are either too
high or too low
building slack into the budget
(often referred to as padding the
budget)
pseudoparticipation
Budgets should reflect operating realities,
including the following,
Actual Levels of Activity: Flexible
budgets are used to ensure that
budgeted costs can be realistically
compared with costs for actual levels
of activity.
Seasonal Variations: Interim budgets
should reflect seasonal effects.

Realistic Standards

Controllability of
Costs

Efficiencies: Budgetary cuts should be

based on planned increases in
efficiency and not simply arbitrary
across-the-board reductions.
General Economic Trends: General
economic conditions also need to be
considered.

Controllable costs are costs whose level a

manager can influence.

Multiple Measures
of Performance

Often, organizations make the mistake of

using budgets as their only measure of
managerial performance.
While financial measures of performance
are important, overemphasis can lead to a
form of dysfunctional behavior called
milking the firm or myopia.

Myopic behavior occurs when a manager takes actions that improve

budgetary performance in the short run but bring long-run harm to the
firm.

Exercises
P 9-47
P 9-48
Case 9-55