Chapter 9

Profit Planning,
Activity-Based
Budgeting and e-
Budgeting

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 Learning
Objective
1

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 Budget defined
The quantitative expression of a proposed
plan of action by management for a
specified period, and
An aid to coordinating what needs to be
done to implement that plan
A budget generally includes both the
plans financial and nonfinancial aspects
and serves as a blueprint for the company
to follow in an upcoming period.
 Budgets help managers.
Communicate directions and goals to
different departments of a company to help
them coordinate the actions they must
pursue to satisfy customers and succeed in
the marketplace.
Judge performance by measuring financial
results against planned objectives,
activities, and timelines to learn about
potential problems.
Motivate employees to achieve their goals.
6-4
 Budgeting cycle:
1. Before the start of a fiscal year, managers
at all levels take into account past
performance, market feedback, anticipated
future changes and other indicators to
initiate plans for the next period.
2. Senior managers give subordinate
managers a frame of reference against
which they will compare actual results.
3. Managers and management accountants
investigate any deviations from the plan.
6-5
 Working document:
Master Budget
The master budget is at the core of the
budgeting process. It expresses
managements operating and financial plans
for a specified period:
Operating decisions deal with how to best use
the limited resources of an organization. (the
operating budget)
Financial decisions deal with how to obtain the
funds to acquire those resources. (the financial
budget)
6-6
The Ongoing Budget
Process:
1. Managers and accountants plan the
performance of the company, taking into
account past performance and anticipated
future changes
2. Senior managers distribute a set of goals
against which actual results will be
compared

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The Ongoing Budget
Process:
3. Accountants help managers investigate deviations
from budget. Corrective action occurs at this
point
4. Managers and accountants assess market
feedback, changed conditions, and their own
experiences as plans are laid for the next budget
period
Effective budgeting integrates the companys strategy
into the budget process. Strategy specifies how an
organization matches its own capabilities with the
opportunities in the marketplace to accomplish its
objectives.
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 Effective Strategies
What are our objectives?
How do we create value for the customer while
distinguishing ourselves from our competitors?
Are the markets for our products local, regional,
national, or global? What are our market
trends? How are we affected by the economy,
our industry, and our competitors?
What organizational and financial structures
serve us best?
What are the risks and opportunities of
alternative strategies, and what are our
contingency plans if our preferred plan fails?
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Strategy, Planning and
Budgets, Illustrated

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Budgeting Cycle and Master
Budget
Plan the performance of the company as a
whole and of the subunits within the company.
Senior managers communicate to subordinates
a set of expectations against which
performance will be measured.
Management accountants investigate variations
from plans, and corrective action may be taken.
Managerial accountants and managers take into
account market feedback, changed conditions,
and their own experiences in making plans for
the upcoming period.

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 Advantages of Budgets
1. Promote coordination and communication.
Coordination is the meshing and balancing of
all aspects of production in a company in the
best way for the company to meet its
objectives.
Communication is making sure those goals are
understood by all employees.

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 Advantages of Budgets
2. Budgets serve as a framework for judging
performance and facilitating learning. Budgeting
helps overcome two limitations of using past
performance.
Past results often incorporate past mistakes and
substandard performance.
Future conditions can be expected to differ from the
past, budgets account for these changed conditions.
3. Budgets can be used to motivate managers and
other employees. Studies have shown that
challenging budgets improve employee
performance.

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Challenges in Administering
Budgets
It is a time consuming process that involves
all levels of management.
Management at all levels should understand
and support the budget. If top management
support is lacking, the budget effort will be
lackluster and halfhearted.
Budgets should not be administered rigidly.
Changing conditions may call for changes in
plans.

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 Time Coverage of Budgets
Budgets typically cover a set time period
including a full business cycle. Normally an
annual budget would be prepared, but broken
down into subperiods such as a month or
quarter.
Some companies utilize rolling budgets or
continuous budgeting. This type of budget is
created by continually adding a month or
quarter to the existing budget, so that the
company always has a 12-month budget in
place
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Purposes of Budgeting Systems

Budget
Budget Planning
a detailed plan, Facilitating
expressed in Communication and
quantitative terms, Coordination
that specifies how Allocating Resources
resources will be Controlling Profit and
acquired and used Operations
during a specified Evaluating Performance
period of time. and Providing Incentives
 Types of Budgets
Income
Statement

Budgeted
Financial
Statements

Balance Statement of
Sheet Cash Flows
 Types of Budgets
Detail
Budget
Detail

Materials
Budget
Detail

Production
Budget
Master
Budget
Covering all Sales
phases of
a companys
operations.
Components of Master
Budgets
Operating Budget building blocks leading to
the creation of the Budgeted Income
Statement
Financial Budget building blocks based on
the Operating Budget that lead to the creation
of the Budgeted Balance Sheet and the
Budgeted Statement of Cash Flows

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Basic Financial Budget Steps
Based on the Operating Budgets:
1. Prepare the Capital Expenditures Budget
2. Prepare the Cash Budget
3. Prepare the Budgeted Balance Sheet
4. Prepare the Budgeted Statement of Cash
Flows

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Sample
Master
Budget,
Illustrated

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Other Budgeting Issues
Financial-planning software may be
employed to conduct sensitivity (what-if)
analysis to assist in the budgetary process
Kaizen Budgeting incorporating
continuous improvement factors in the
budgeting process
Activity-Based Budgeting incorporating
Activity-Based Costing in the budgetary
process

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Budgets and Feedback
Budgets offer feedback in the form of
variances: actual results deviate from
budgeted targets
Variances provide managers with
Early warning of problems
A basis for performance evaluation
A basis for strategy evaluation

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 Types of Budgets
Capital
Capital budgets
budgets with
with acquisitions
acquisitions
that
that normally
normally cover
cover several
several years.
years.
Financial
Financial budgets
budgets with
with financial
financial
resource
resource acquisitions.
acquisitions.
Long Range Budgets

Continuous or
1999Rolling Budget2000 2001 2002

This
This budget
budget is
is usually
usually aa twelve-month
twelve-month
budget
budget that
that rolls
rolls forward
forward one
one month
month
as
as the
the current
current month
month is
is completed.
completed.
 Learning
Objective
2

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 Sales of Services or Goods

Ending
Inventory Production
Budget Budget
Work in Process
and Finished
Goods

Ending Direct Direct Selling and

Overhead
Inventory Materials Labor Administrative
Budget Budget Budget Budget
Budget
Direct Materials

Cash Budget
Budgeted Income
Statement
Budgeted Balance
Sheet
Budgeted Statement
of Cash Flows
 Learning
Objective
3

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 Activity-Based Costing versus
Activity-Based Budgeting
Resources
Resources Resources
Resources
Activity-Based
Activity-Based
Costing
Costing (ABC)
(ABC)
Activities
Activities Activities
Activities

Activity-Based
Activity-Based
Cost Budgeting
Budgeting (ABB)
(ABB)
Cost objects:
objects: Forecast
Forecast of
of products
products
products
products and
and services
services and
and services
services to
to be
be
produced,
produced, and
and produced
produced andand
customers
customers served.
served. customers
customers served.
served.
 Learning
Objective
4

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Basic Operating Budget
Steps
1. Prepare the Revenues Budget
2. Prepare the Production Budget (in Units)
3. Prepare the Direct Materials Usage Budget
and Direct Materials Purchases Budget
4. Prepare the Direct Manufacturing Labor
Budget

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Basic Operating Budget
Steps
5. Prepare the Manufacturing Overhead Costs
Budget
6. Prepare the Ending Inventories Budget
7. Prepare the Cost of Goods Sold Budget
8. Prepare the Operating Expense (Period Cost)
Budget
9. Prepare the Budgeted Income Statement

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 Sales Budget
Breakers,
Breakers, Inc.
Inc. is
is preparing
preparing budgets
budgets for
for the
the quarter
quarter
ending
ending June
June 30.
30.
Budgeted
Budgeted sales
sales forfor the
the next
next five
five months
months are:
are:
April
April 20,000
20,000 units
units
May
May 50,000
50,000 units
units
June
June 30,000
30,000 units
units
July
July 25,000
25,000 units
units
August
August 15,000
15,000 units.
units.
The
The selling
selling price
price isis $10
$10 per
per unit.
unit.
Sales Budget
 Production Budget

Sales Production
Budget Budget
t ed
e
pl
om
C

Production must be adequate to meet budgeted

sales and provide for sufficient ending inventory.
 Production Budget

The
The management
management of of Breakers,
Breakers, Inc.
Inc. wants
wants
ending
ending inventory
inventory to
to be
be equal
equal to
to 20%
20% ofof the
the
following
following months
months budgeted
budgeted sales
sales inin units.
units.

On
On March
March 31,
31, 4,000
4,000 units
units were
were on
on hand.
hand.

Lets
Lets prepare
prepare the
the production
production budget.
budget.
 Production Budget

From sales
budget
Production Budget
Production Budget

March 31
ending inventory
Production Budget
Production Budget
 Direct-Material Budget
At
At Breakers,
Breakers, five
five pounds
pounds of of material
material areare required
required
per
per unit
unit of
of product.
product.
Management
Management wants wants materials
materials onon hand
hand at at the
the end
end
of
of each
each month
month equal
equal to
to 10%
10% ofof the
the following
following
months
months production.
production.
On
On March
March 31,
31, 13,000
13,000 pounds
pounds ofof material
material areare on
on
hand.
hand. Material
Material cost
cost $.40
$.40 per
per pound.
pound.

Lets
Lets prepare
prepare the
the direct
direct materials
materials budget.
budget.
Direct-Material Budget

From our
production
budget
 Direct-Material Budget

10% of the following

months production
 Direct-Material Budget

March 31
inventory
Direct-Material Budget
 Direct-Material Budget

June Ending Inventory

July production in units 23,000
Materials per unit 5
Total units needed 115,000
Inventory percentage 10%
June desired ending inventory 11,500
 Direct-Labor Budget
At Breakers, each unit of product requires 0.1 hours
of direct labor.
The Company has a no layoff policy so all
employees will be paid for 40 hours of work each
week.
In exchange for the no layoff policy, workers agreed
to a wage rate of $8 per hour regardless of the hours
worked (No overtime pay).
For the next three months, the direct labor workforce
will be paid for a minimum of 3,000 hours per month.
Lets prepare the direct labor budget.
Direct-Labor Budget

From our
production
budget
Direct-Labor Budget
Direct-Labor Budget

This is the greater of

labor hours required or
labor hours guaranteed.
Direct-Labor Budget
 Overhead Budget
Here is Breakers Overhead Budget for the quarter.
 Selling and Administrative
Expense Budget

At
At Breakers,
Breakers, variable
variable selling
selling and
and administrative
administrative
expenses
expenses areare $0.50
$0.50 per
per unit
unit sold.
sold.
Fixed
Fixed selling
selling and
and administrative
administrative expenses
expenses are
are
$70,000
$70,000 per
per month.
month.
The
The $70,000
$70,000 fixed
fixed expenses
expenses include
include $10,000
$10,000 in in
depreciation
depreciation expense
expense that
that does
does not
not require
require aa cash
cash
outflows
outflows for
for the
the month.
month.
Selling and Administrative
Expense Budget

From our
Sales budget
Selling and Administrative
Expense Budget
Selling and Administrative
Expense Budget
 Cash Receipts Budget
At
At Breakers,
Breakers, all
all sales
sales are
are on
on account.
account.
The
The companys
companys collection
collection pattern
pattern is:is:
70%
70% collected
collected in in the
the month
month of of sale,
sale,
25%
25% collected
collected in in the
the month
month following
following sale,
sale,
5%
5% is
is uncollected.
uncollected.
The
The March
March 3131 accounts
accounts receivable
receivable balance
balance of
of
$30,000
$30,000 will
will be
be collected
collected inin full.
full.
Cash Receipts Budget
Cash Receipts Budget
 Cash Disbursement Budget

Breakers
Breakers pays
pays $0.40
$0.40 per
per pound
pound for
for its
its materials.
materials.
One-half
One-half ofof aa months
months purchases
purchases areare paid
paid for
for in
in the
the
month
month ofof purchase;
purchase; the
the other
other half
half is
is paid
paid in
in the
the
following
following month.
month.
No
No discounts
discounts areare available.
available.
The
The March
March 31 31 accounts
accounts payable
payable balance
balance is is
$12,000.
$12,000.
 Cash Disbursement Budget

140,000 lbs. $.40/lb. = $56,000

Cash Disbursement Budget
 Cash Disbursement Budget
Breakers:
Breakers:
Maintains
Maintains aa 12%
12% open
open line
line of
of credit
credit for
for $75,000.
$75,000.
Maintains
Maintains aa minimum
minimum cashcash balance
balance of of $30,000.
$30,000.
Borrows
Borrows and
and repays
repays loans
loans on
on the
the last
last day
day of
of the
the
month.
month.
Pays
Pays aa cash
cash dividend
dividend ofof $25,000
$25,000 inin April.
April.
Purchases
Purchases $143,700
$143,700 ofof equipment
equipment inin May
May and
and
$48,300
$48,300 in
in June
June paid
paid in
in cash.
cash.
Has
Has an
an April
April 11 cash
cash balance
balance of of $40,000.
$40,000.
 Cash Budget
(Collections and Disbursements)

From our Cash

Receipts Budget
 Cash Budget
(Collections and Disbursements)

From our Cash

Disbursements
Budget
 Cash Budget
(Collections and Disbursements)

From our Direct

Labor Budget
 Cash Budget
(Collections and Disbursements)

From our
Overhead Budget
 Cash Budget
(Collections and Disbursements)

From our
Selling and Administrative
Expense Budget
 Cash Budget
(Collections and Disbursements)

To maintain a cash
balance of $30,000,
Breakers must borrow
$35,000 on its line of credit.
 Cash Budget
(Financing and Repayment)

Ending cash balance for April

is the beginning May balance.
 Cash Budget
(Collections and Disbursements)

Breakers must
borrow an
addition $13,800
to maintain a
cash balance
of $30,000.
 Cash Budget
(Financing and Repayment)
 Cash Budget
(Collections and Disbursements)

At the end of June, Breakers

has enough cash to repay
the $48,800 loan plus interest
at 12%.
 Cash Budget
(Financing and Repayment)
 Cash Budget
(Collections and Disbursements)
 Cash Budget
(Financing and Repayment)
Cost of Goods Manufactured
Cost of Goods Sold
 Budgeted Income Statement

Cost of Budgeted
Goods Income
Manufact- Statement
t ed
l e
uredm
p and
CoSold

After we complete the cost of goods manufactured

and sold schedules, we can prepare
the budgeted income statement for Breakers.
Budgeted Income Statement
Budgeted Statement of Cash Flows
 Budgeted Balance Sheet
Breakers
Breakers reports
reports thethe following
following account
account balances
balances
on
on June
June 3030 prior
prior toto preparing
preparing its
its budgeted
budgeted
financial
financial statements:
statements:
Land
Land -- $50,000
$50,000
Building
Building (net)
(net) -- $148,000
$148,000
Common
Common stock
stock -- $217,000
$217,000
Retained
Retained earnings
earnings -- $46,400
$46,400
 25%of June
sales of
$300,000

11,500 lbs. at
$.40 per lb.

5,000 units at
$4.60 per unit.
50% of June
purchases
of $56,800
 Learning
Objective
5

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 Sales of Services or Goods

Ending
Inventory Production
Budget Budget
Work in Process
and Finished
Goods
When the interactions of the elements
of the master
Ending Direct budget
Directare Overhead
expressedSelling
as and
Inventory Materials Labor Administrative
Budget a set of mathematical
Budget Budget relations,
Budget it Budget
becomes a financial planning model
Direct Materials

that can be used to answer what if

Cash Budget
questions about unknown variables. Budgeted Income
Statement
Budgeted Balance
Sheet
Budgeted Statement
of Cash Flows
 Learning
Objective
6

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 Budget Administration

The Budget Committee is a standing

committee responsible for . . .

overall
overall policy
policy matters
matters relating
relating to
to the
the budget.
budget.
coordinating

coordinating the
the preparation
preparation of
of the
the budget.
budget.
 E-Budgeting

Employees throughout an organization

can submit and retrieve budget
information electronically. This tends to
streamline the entire budgeting process.
 Firewalls and Information
Security
Budget information is extremely sensitive and
confidential. A firewall is a computer or
router placed between a companys internal
network and the internet to control all
information between the outside world and
the companys local network.
Kaizen Budgeting, Illustrated

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Budgeting and the Organization:
Responsibility Accounting
Responsibility Center a part, segment, or
subunit of a 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

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Types of Responsibility
Centers
1. Cost accountable for costs only
2. Revenue accountable for revenues only
3. Profit accountable for revenues & costs
4. Investment accountable for investments,
revenues, and costs

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Controllability
Controllability is the degree of influence that a
manager has over costs, revenues, or related
items for which he is being held responsible
Responsibility Accounting focuses on
information sharing, not in laying blame on a
particular manager

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 Zero-Base Budgeting
To receive funding during the budgeting
process, each activity must be justified in
terms of its continued usefulness.
International Aspects of Budgeting

Firms
Firms with
with international
international operations
operations face
face special
special
problems
problems when
when preparing
preparing aa budget.
budget.
Fluctuations
Fluctuations in
in foreign
foreign currency
currency exchange
exchange rates.
rates.
High
High inflation
inflation rates
rates in
in some
some foreign
foreign countries.
countries.
Differences
Differences in
in local
local economic
economic conditions.
conditions.
 Learning
Objective
7

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 Budgeting Product Life-Cycle
Costs
Product
Product planning
planning
and
and concept
concept
Design.
Design.

Distribution
Distribution Preliminary
Preliminary
and
and customer
customer design.
design.
service.
service.

Detailed
Detailed design
design
Production.
Production. and
and testing.
testing.
 Learning
Objective
8

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Behavioral Impact of Budgets
Budgetary Slack: Padding the Budget
People often perceive that their performance will
look better in their superiors eyes if they can
beat the budget.
Budgetary Slack
The practice of underestimating budgeted
revenues, or overestimating budgeted
expenses, in an effort to make the resulting
budgeted goals (profits) more easily
attainable

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Budgeting and Human
Behavior
The budgeting process may be abused both
by superiors and subordinates, leading to
negative outcomes
Superiors may dominate the budget process
or hold subordinates accountable for events
they have no control over
Subordinates may build budgetary slack
into their budgets

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 Participative Budgeting

Top M anagem ent

M id d le M id d le
M anagem ent M anagem ent

S u p e rv is o r S u p e rv is o r S u p e rv is o r S u p e rv is o r

Flow of Budget Data

End of Chapter 9