The Budgeting Process: Multimedia Slides By: Gail A. Mestas, Macc, New Mexico State University

The Budgeting
Process
Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University
Learning Objective
1. Define budgeting and explain its role

in the management cycle.
2. Identify the elements of a master
budget in different types of
organizations and the guidelines for
preparing budgets.
3. Prepare the operating budgets that
support the financial budgets.
Copyright © Houghton Mifflin Company. All rights reserved. 21–2

Learning Objective (cont’d)
4. Prepare a budgeted income

statement, a cash budget, and a
budgeted balance sheet.
5. Describe management’s role in budget
implementation.

The Budgeting Process
• Objective 1
– Define budgeting and explain its role in the
management cycle

Budgeting
… is the process of identifying, gathering,

summarizing, and communicating
financial and nonfinancial information
about an organization's future activities
• Is essential part of the continuous planning

for an organization in order to accomplish
long-term goals

The Budgeting Process
• Budgets
– Plans of action based on forecasted
transactions, activities, and events
– Are synonymous with managing an
organization
• Essential to accomplishing goals in the
strategic plan

The Budgeting Process (cont’d)
• Budgets are used to

– Communicate information
– Coordinate activities and resource usage
– Motivate employees
– Evaluate performance
– Manage and account for cash
• Establish minimum levels of cash receipts and
expenditures

The Budgeting Process (cont’d)
• Many forms of budgets

– Examples
• Cash budget
– Focuses on financial information
» Shows, among other things, how cash resources will
be allotted to operating, investing, and financing
activities over a future period
• Production budget
– Focuses on nonfinancial information
» Shows planned production in units
» Identifies activities needed to meet certain
requirements or standards

Budgeting and Goals
• Strategic planning
– Process by which management establishes
an organization’s long-term goals

Long-Term Goals
… define the strategic direction an

organization will take over
a five- to ten-year period
• Are the basis for

– Making annual operating plans
– Preparing budgets

Long-Term Goals (cont’d)
• Should take into consideration

– Economic and industry forecasts
– Employee-management relations
– Structure and role of management
– Value chain considerations
– Organizational capacity
– Any other operational and tactical issues facing
the organization
• Expected quality of products or services
• Growth rates
• Desired market share

Long-Term Goals (cont’d)
• Must set specific targets and timetables

• Must assign responsibility for achieving
the goals to specific personnel
• A range of long-term goals should be
included in the organization's strategic
plan
– Should give direction to efforts to achieve
these goals

Short-Term Goals
• Involve every part of an enterprise

• Much more detailed than long-term
goals
• To formulate an annual operating plan,
long-term goals must be restated in
terms of what needs to be
accomplished during the next year
Short-term goals are the basis of an
organization’s operating budgets for the year

Short-Term Goals (cont’d)
• Organization’s controller takes charge of

coordinating the budget process
– Designs a complete set of budget-development
directions
• Timetable with deadlines
– Assigns clearly defined responsibilities for carrying
out each part of the budget’s development
• To specific individuals or management teams
– The budget may be reviewed and revised during
the year

Importance of Participation
• The key to a successful budget is

participative budgeting
– Process in which personnel at all levels of
an organization actively engage in making
decisions about the budget
• Gives a sense of ownership
– Helps ensure that departments will attain targets and
stay within the budget

Importance of Participation (cont’d)
• Participative budgeting depends on joint

decision making
– Controller must be able to communicate
and negotiate effectively with people in all
levels of an organization
• Senior managers
– Formulate organizational long-and short-term goals
• Middle managers
• Supervisors
– Responsible for daily operations

Importance of Participation (cont’d)
• Authoritative budgeting
– Senior executives dictate targets
• Do not allow middle managers and supervisors a voice in
setting them
• Targets may be unrealistic and impossible to attain
– Will undermine motivation of managers and supervisors
» Cooperation is essential for successful budget
implementation
– Senior executives allow controller to develop

budget without consulting other managers
• Managers may feel budgeting is not a top priority

Budgeting
and the
Management
Cycle
21–18
Budgeting and the Management Cycle
• Planning
– Budgeting
• Originates in this stage
• Helps managers to
– Relate the organization’s long-term goals to its short-
term activities
– Distribute resources and workloads
– Communicate responsibilities
– Select performance measures
– Set goals for bonuses and rewards

• Executing
– Budgeting helps managers to
• Communicate expectations
• Measure performance and motivate employees
• Coordinate activities and allot resources

• Reporting
• Communicate budget information
• Provide continuous feedback
• Support operating decisions

• Reviewing
• Evaluate performance
• Determine timeliness
• Find variances and create solutions
• Compare planned performance with actual
performance

Discussion
Q. How are short-term goals related to

strategic planning?
A. Short-term goals define the strategic
direction an organization will take over
the next year. They are determined to
help accomplish the long-term goals that
are established during the strategic
planning process

The Master Budget
• Objective 2
– Identify the elements of a master budget in
different types of organizations and the
guidelines for preparing budgets

The Master Budget
… consists of a set of operating budgets

and a set of financial budgets
that detail an
organization’s financial plans
for a specific accounting period,
generally a year

The Master Budget (cont’d)
• Operating budgets
– Plans used in daily operations
– Basis for financial budgets
• Financial budgets
– Projections of financial results for the accounting
period
– Include
• Budgeted income statement
• Capital expenditures budget
• Cash budget
• Budgeted balance sheet

• Process of preparing a master budget is

similar in all three types of organizations
– Manufacturing
– Retail
– Service
• The process differs mainly in the kinds
of operating budgets each type of
organization prepares

Preparation of
a Master
Budget for a
Manufacturing
Organization
21–28
Preparation
of a Master
Budget for a
Retail
Organization
21–29
Preparation of a Master Budget for a Service
Organization

• Sales budget
– Is prepared first
• Used to estimate sales volume and revenues
• Once developed, other budgets can be
developed
– These other budgets will help manage the
organization's resources so that profits can be
generated on sales
In a service organization, the sales budget

is called the service revenue budget

• No standard format for budget

preparation
– Procedures vary from organization to
organization
– Only universal requirement is that budgets
communicate the appropriate information
to the reader in a clear and understandable
manner

• Managers can improve the quality of budgets

by using the following guidelines
1. Know the purpose of the budget
2. Identify the user group and its information needs
3. Identify sources of accurate, meaningful budget
information
4. Establish a clear format for the budget
5. Use appropriate formulas and calculations to
derive quantitative information
6. Revise the budget until it includes all planning
decisions

Discussion
Q. Which budget must be prepared first?

A. The sales budget. This budget is used to
estimate sales volume and revenues.
Once established, the other budgets can
be developed

Operating Budgets
• Objective 3
– Prepare the operating budgets that support
the financial budgets

Operating Budgets
… are a set of budgets that are used in

planning the daily operations of an
organization
• Are part of the master budget

Operating Budgets
• Procedures for preparing operating budgets

include
– Cost behavior analysis
– Cost-volume-profit analysis
– A product costing method
• Organizations that manufacture a variety of
products or services may prepare
– Separate operating budgets, or
– One comprehensive budget for each product or
service

Sales Budget
… is a detailed plan,
expressed in both units and dollars,
that identifies
the product (or service) sales
expected in an accounting period

Sales Budget (cont’d)
• Sales mangers use the information to

– Plan sales- and marketing-related activities
– Determine human, physical, and technical
resource needs
• Accountants use the information to
– Determine estimated cash receipts for the cash
budget
• To determine the total budgeted sales

Total Estimated Estimated
Budgeted = Selling Price x Sales in
Sales per Unit Units
• Selecting the best estimates for selling price

per unit and the sales demand in units can be
difficult
– If the organization wants to increase its share in
the market
• An estimated selling price below the current selling price
may be needed
– If the organization has improved the product’s
quality by using more expensive materials or
production processes
• The estimated selling price may have to be higher than
the current price
• Estimated sales volume is very

important
– Will affect the level of operating activities
and amount of resources needed for
operations
– Managers may use a sales forecast
• A projection of sales demand based on an
analysis of internal and external factors

• External factors taken into consideration

in a sales forecast include
1. The state of the local and national
economies
2. The state of the industry’s economy
3. The nature of the competition and its
sales volume and selling price

• Internal factors include

1. The number of units sold in prior periods
2. The organization’s credit policies
3. The organization’s collection policies
4. The organization’s pricing policies
5. Any new products the organization plans
to introduce to the market
6. The capacity of the organization’s
manufacturing facilities

The Production Budget
… is a detailed plan
showing the number of units
a company must produce
to meet budgeted sales
and inventory levels
• Production managers use this information to

plan for the materials and human resources
that production activities will require

The Production Budget (cont’d)
• To prepare a production budget,

managers must know
– Budgeted number of sales units
• From the sales budget
– Desired level of ending finished goods
inventory for each period in the budget
year
• Often stated as a percentage of the next
period’s budgeted unit sales

The Production Budget (cont’d)
• To determine the production needs for

an accounting period
Total Budgeted Desired Units of Desired Units of
Production = Sales in + Ending Finished – Beginning Finished
Units Units Goods Inventory Goods Inventory

Production Budget

The Direct Materials Purchases Budget
… is a detailed plan that identifies

the quantity of purchases required
to meet budgeted production
and inventory needs and the costs
associated with those purchases

(cont’d)
• Purchasing department
– Uses information to plan purchases of
direct materials
• Accountants
– Use information to estimate cash payments
to suppliers

(cont’d)
• To prepare a direct materials purchases

budget managers must know
– What production needs will be in the next
accounting period
• Provided in the production budget
– Desired level of direct materials inventory for each
period
– Per unit cost of direct materials
– Desired level of ending direct materials inventory
• Usually stated as a percentage of the next period’s
production

(cont’d)
• Steps to prepare a direct materials
purchasing budget
1. Calculate each period’s total production needs in
units of direct materials
2. Determine the total number of units of direct
materials to be purchased during each
accounting period in the budget
Total Units Desired Units Desired Units
Total Production
of Direct of Ending of Beginning
= Needs in Units of + –
Materials to Direct Materials Direct Materials
Direct Materials
Be Purchased Inventory Inventory
3. Calculate the cost of the direct materials

purchases
Direct Materials Purchases Budget

The Direct Labor Budget
… is a detailed plan that estimates

the direct labor hours needed
in an accounting period
and the associated costs

The Direct Labor Budget (cont’d)
• Production managers use estimated direct labor

hours to plan
– How many employees will be required during the period
– The hours each employee will work
• Accountants use estimated direct labor costs to plan
– For cash payments to workers
• Human resource managers use information on the
direct labor budget to
– Decide whether to hire new employees
– Reduce the existing work force
– Train employees
– Prepare schedules of employee fringe benefits

The Direct Labor Budget (cont’d)
• Steps in preparing a direct labor budget

1. Estimate the total direct labor hours
– Multiply estimated direct labor hours per
unit by the anticipated units of production
2. Calculate the total budgeted direct labor
cost
Total Budgeted Estimated Total Estimated Direct
= x
Direct Labor Cost Direct Labor Hours Labor Cost per Hour

Direct Labor Budget

The Manufacturing Overhead Budget
of anticipated manufacturing costs,
other than direct materials
and direct labor costs,
that must be incurred to
meet budgeted production needs

The Manufacturing Overhead Budget (cont’d)
• Two purposes
1. Integrate the overhead cost budgets
developed by managers of production
and production-related departments
2. Group information for the calculation of
manufacturing overhead rates for the
forthcoming accounting period

The Manufacturing Overhead Budget (cont’d)
• Presentation of information is flexible

– Grouping by activities is useful for
organizations using activity-based
costing

Manufacturing Overhead Budget

The Selling and Administrative Expense
Budget
of operating expenses,
other than those related to production,
that are needed to support sales
and overall operations
• Accountants use this budget to estimate cash

payments for products or services used in
nonproduction-related activities

Selling and Administrative Expense Budget

The Cost of Goods Manufactured Budget
… is a detailed plan that summarizes the

estimated costs of production in an
accounting period
• Sources of information
– Direct materials, direct labor, and manufacturing
overhead budgets

Cost of Goods Manufactured Budget
Note that most companies anticipate some work in process

at the beginning or end of a period covered by the budget
Discussion
Q. What are the sources of information

for preparing the cost of goods
manufactured budget?
A. Direct materials budget
Direct labor budget
Manufacturing overhead budget

Financial Budgets
• Objective 4
– Prepare a budgeted income statement, a
cash budget, and a budgeted balance
sheet

Financial Budgets
… are projections of financial results

for an accounting period
• Include
– Budgeted income statement
– Capital expenditures budget
– Cash budget
– Budgeted balance sheet

The Budgeted Income Statement
… projects an organization’s net income

based on revenues and expenses
estimated for that period

Budgeted Income Statement

The Capital Expenditures Budget
…. is a detailed plan outlining the

anticipated amount and timing of
capital outlays for long-term assets

The Capital Expenditures Budget (cont’d)
• Managers rely on information in a

capital expenditures budget when
making decisions about such matters as
– Buying equipment
– Building a new plant
– Purchasing and installing a materials
handling system
– Acquiring another business

The Cash Budget
… is a projection of the cash

an organization will receive
and the cash it will pay out
• Summarizes the cash flow prospects of all

transactions considered in the master budget

The Cash Budget (cont’d)
• Information it provides enables

managers to plan for
– Short-term loans when the cash balance is
low
– Short-term investments when the cash
balance is high

• Excludes some planned noncash

transactions
– Depreciation expense
– Issuance and receipt of stock dividends
– Uncollectible accounts expense
– Gains and losses on sales of assets
• May also exclude
– Deferred taxes
– Accrued interest

• To calculate the estimated ending cash

balance
Estimated Total Total Estimated
Ending = Estimated – Estimated + Beginning
Cash Balance Cash Receipts Cash Payments Cash Balance

• Sources for estimating cash receipts

– Sales budget
– Cash budgets from previous periods
– Cash collection records and analyses of
collection trends
– Records pertaining to notes, stocks, and
bonds

• Sources for estimating cash payments

– Operating budgets
– Capital expenditures budget
– Previous year’s financial statements
– Loan records

• Supporting schedules
– Schedule of expected cash collections
from customers
– Schedule of expected cash payments for
direct materials
– Cash budget

Schedule of Expected Cash Collections from
Customers

Schedule of Expected Cash Payments for
Direct Materials

Cash Budget

• Organizations may maintain a minimum cash

balance
– To cover unusual expenditures
• If the ending cash balance on the cash
budget
– Falls below the minimum level required
• Short-term borrowing may be necessary
– Is significantly larger than the minimum level
required
• May invest excess in short-term securities to generate
additional income

The Budgeted Balance Sheet
… projects an organization’s
financial position
at the end of an accounting period
• Uses all estimated data compiled in the

course of preparing a master budget
– Is the final step in that process

Budgeted Balance Sheet

Discussion
Q. How is the ending cash balance

estimated?
A. Subtract total estimated cash payments
from total estimated cash receipts, then,
add the estimated beginning cash
balance

Budget Implementation
• Objective 5
– Describe management’s role in budget
implementation

Budget Implementation
• Budget committee
– Oversees each stage in the master budget
preparation
– Decides any departmental disputes that
might arise in the process
– Gives final approval to the budget

Budget Implementation (cont’d)
• Budget committee members

– Controller
• Has overall responsibility for budget
implementation
– President
– Vice presidents
The make-up of the committee ensures that the

budgeting process has a companywide perspective

• A master budget may go through many

revisions after approval
– Budget committee monitors the progress
the company is making in attaining budget
targets
• Using periodic reports from department
managers

• Successful budget implementation

depends on two factors
1. Clear communication
2. Support of top management
– Middle- and lower-level managers must see
that top management supports the budget
and encourages its implementation

Discussion
Q. What two factors are necessary for

successful budget implementation?
A. Clear communication and support of top
management

Time for Review
1. Define budgeting and explain its role

in the management cycle
2. Identify the elements of a master
budget in different types of
organizations and the guidelines for
preparing budgets
3. Prepare the operating budgets that
support the financial budgets

And Finally…
4. Prepare a budgeted income

statement, a cash budget, and a
budgeted balance sheet
5. Describe management’s role in budget
implementation

The Budgeting Process: Multimedia Slides By: Gail A. Mestas, Macc, New Mexico State University

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The Budgeting

1. Define budgeting and explain its role

Copyright © Houghton Mifflin Company. All rights reserved. 21–2

4. Prepare a budgeted income

Copyright © Houghton Mifflin Company. All rights reserved. 21–3

Copyright © Houghton Mifflin Company. All rights reserved. 21–4

… is the process of identifying, gathering,

• Is essential part of the continuous planning

Copyright © Houghton Mifflin Company. All rights reserved. 21–5

Copyright © Houghton Mifflin Company. All rights reserved. 21–6

• Budgets are used to

Copyright © Houghton Mifflin Company. All rights reserved. 21–7

• Many forms of budgets

Copyright © Houghton Mifflin Company. All rights reserved. 21–8

Copyright © Houghton Mifflin Company. All rights reserved. 21–9

… define the strategic direction an

• Are the basis for

Copyright © Houghton Mifflin Company. All rights reserved. 21–10

• Should take into consideration

Copyright © Houghton Mifflin Company. All rights reserved. 21–11

• Must set specific targets and timetables

Copyright © Houghton Mifflin Company. All rights reserved. 21–12

• Involve every part of an enterprise

Copyright © Houghton Mifflin Company. All rights reserved. 21–13

• Organization’s controller takes charge of

Copyright © Houghton Mifflin Company. All rights reserved. 21–14

• The key to a successful budget is

Copyright © Houghton Mifflin Company. All rights reserved. 21–15

• Participative budgeting depends on joint

Copyright © Houghton Mifflin Company. All rights reserved. 21–16

– Senior executives allow controller to develop

Copyright © Houghton Mifflin Company. All rights reserved. 21–17

Copyright © Houghton Mifflin Company. All rights reserved. 21–19

Copyright © Houghton Mifflin Company. All rights reserved. 21–20

Copyright © Houghton Mifflin Company. All rights reserved. 21–21

Copyright © Houghton Mifflin Company. All rights reserved. 21–22

Q. How are short-term goals related to

Copyright © Houghton Mifflin Company. All rights reserved. 21–23

Copyright © Houghton Mifflin Company. All rights reserved. 21–24

… consists of a set of operating budgets

Copyright © Houghton Mifflin Company. All rights reserved. 21–25

Copyright © Houghton Mifflin Company. All rights reserved. 21–26

• Process of preparing a master budget is

Copyright © Houghton Mifflin Company. All rights reserved. 21–27

Copyright © Houghton Mifflin Company. All rights reserved. 21–30

In a service organization, the sales budget

Copyright © Houghton Mifflin Company. All rights reserved. 21–31

• No standard format for budget

Copyright © Houghton Mifflin Company. All rights reserved. 21–32

• Managers can improve the quality of budgets

Copyright © Houghton Mifflin Company. All rights reserved. 21–33

Q. Which budget must be prepared first?

Copyright © Houghton Mifflin Company. All rights reserved. 21–34

Copyright © Houghton Mifflin Company. All rights reserved. 21–35

… are a set of budgets that are used in

• Are part of the master budget

Copyright © Houghton Mifflin Company. All rights reserved. 21–36

• Procedures for preparing operating budgets

Copyright © Houghton Mifflin Company. All rights reserved. 21–37

Copyright © Houghton Mifflin Company. All rights reserved. 21–38

• Sales mangers use the information to

• To determine the total budgeted sales

• Selecting the best estimates for selling price