Budgeting: Process, Benefits, and Human Behavior

Budgeting Process

• Budgeting is the process of planning future business actions and expressing them as formal plans.
• A budget is a formal statement of a company's plans, expressed in dollars.
• Budgetary control process is managements utilization of budgets to ensure planned objectives are achieved.

Benefits of Budgeting

• Planning focuses on future opportunities and threats.
• Control provides a benchmark for evaluating performance.
• Motivation establishes performance goals for employees to strive for.
• Communication conveys management's specific action plans to all employees.
• Coordination aligns the activities of all employees and departments toward the company's overall goals.

Budgeting and Human Behavior

• Budgets are a positive motivating force when the goals are challenging but attainable, employees help in preparation, and evaluations provide opportunities to explain differences between budgeted and actual amounts.
• Potential negative outcomes include employees engaging in unethical behavior or fraud to meet results, understating sales and overstating expense budgets to create a cushion, or spending budgets on unnecessary items to prevent budget reductions in the next period.

Budget Reporting and Timing

• Continuous budgeting is applied by preparing rolling budgets.
• Budgets are revised continually as time passes.
• A rolling budget involves the company revising the entire set of budgets by adding a new quarterly budget to replace the quarter that has just elapsed.

Master Budget Components

• The master budget includes the following components in sequential order: Sales Budget, Production Budget, Direct Materials Budget, Direct Labor Budget, Factory Overhead Budget, Capital Expenditures Budget, Cash Budget, and Budgeted Financial Statements.

Sales Budget

• In September, Toronto Sticks Company sold 700 hockey sticks at $60 each.
• Toronto Sticks prepared a sales budget for the next three months

Computing Production Requirements

• A production budget is prepared by a manufacturer and shows the number of units that should be produced during a period.
• The production budget is based on unit sales projected in the sales budget, along with inventory considerations.
• The formula to calculate production requirements is: Units to Produce = Budgeted Ending Inventory Units + Budgeted Sales Units - Beginning Finished Goods Inventory Units.
• It is always expressed in units of product, not costs.

Production Budget

• The production budget starts with the budgeted sales units.
• Desired ending inventory is added to the budgeted sales units.
• Beginning inventory units is subtracted to calculate the units to produce.

Computing Materials to be Purchased

• The direct materials budget is based on the production budget and is expressed in costs.
• The formula to calculate is as follows: Materials to be purchased = Units to produce X Materials required per unit + Desired ending materials inventory - Beginning materials inventory

Direct Materials Budget

• The direct materials budget shows the budgeted costs for the direct materials that will need to be purchased to satisfy the estimated production for the period.

Computing Cost of Direct Labor

• The direct labor budget is based on the production budget and expressed in costs.
• The formula to calculate the cost of direct labor is as follows: Cost of direct labor = Units to produce X Direct labor hours required per unit X Direct labor cost per hour

Direct Labor Budget

• The direct labor budget shows the budgeted costs for the direct labor that will be needed to satisfy the estimated production for the period.

Factory Overhead Budget

• The factory overhead budget shows the budgeted costs for factory overhead that are needed to complete the estimated production for the period.
• The variable portion of factory overhead is assigned at a rate of $2.50 per unit of production, and fixed overhead is $1,500 per month.

Product Cost Per Unit

• TSC's can compute product cost per unit from the three manufacturing budgets: direct materials, direct labor, and factory overhead.
• For budgeting purposes, TSC assumes it will normally produce 3,000 units of product each quarter, yielding fixed overhead of $1.50 per unit, other product costs are all variable.

Cost of Goods Sold Budget

• The product cost per unit is used to prepare the cost of goods sold budget and budgeted income statement.

Selling Expense Budget

• TSC pays sales commissions equal to 10 percent of total sales.
• TSC pays a monthly salary of $2,000 to its sales manager.

General and Administrative Expense Budget

• Toronto Sticks Company has general and administrative salaries of $54,000 per year or $4,500 per month.

Capital Expenditures Budget

• The capital expenditures budget reports expected cash receipts and cash payments related to the sale and purchase of plant assets.

Cash Budget

• The next step is to prepare the cash budget, which shows budged cash receipts and cash payments during the budget period.
• The general formula for a cash budget is: Beginning Cash Balance + Budgeted Cash Receipts - Budgeted Cash Payments = Preliminary Cash Balance
• If Above minimum -> Repay loans, Ending cash balance will increase
• If Below minimum -> Increase Loans, Ending cash balance will be at minimum

Budgeted Cash Receipts from Sales

• Cash sales are 40% of each month's sales.
• Accounts receivable balance at the end of each month is 60% of that month's budgeted sales.

Preparing Cash Budget

• This is to prepare the cash budget by subtracting the cash payments from total avaliable cash to caluclate Preliminary cash balance.

Preparing the Cash Budget - Loan Activity

• Formula: Cash paid for interest = Interest rate (%) × Beginning loan balance

Budgeted Income Statement

• All information in the budgeted income statement is taken from component budgets examined on previous slides.
• The predicted amount of income tax expense for the quarter, computed as 40% of the budgeted pretax income, is included.

Budgeting for Service Companies

• Service providers also use master budgets, but typically need less operating budgets than manufacturers.
• Important budgets for a service company include: Sales, direct labor, capital expenditures, cash, selling expenses, general and admin expenses and financial statements

Direct Labor Budget

• Direct labor cost = budgeted direct labor hours X Direct labor cost per hour

Revenue Per Employee

• Revenue per employee

Master Budget Process for a Merchandiser

• A merchandiser must prepare a merchandise purchases budget rather than a production budget, unlike a manufacturing company.

Preparing the Merchandise Purchases Budget

• Layout shows this equation: Units to purchase = Budgeted sales units + desired merchandise inventory units

Merchandise Purchases Budget

• Ending inventory for a month in units should equal 90% of next month's unit sales.

Schedule of Cash Payments for Merchandise Purchases

• Subtract beginning inventory to determine the budgeted number of units to be purchased.