Short-Term Budgeting Lecture Notes 3 PDF

# Short-Term Budgeting - Lecture notes 3 ## BS Accountancy (ACC 102) ### Module 3 ### Short-Term Budgeting ## Introduction Repeated references to budget allowances have been made throughout previous chapters and we have seen how closely accounting and budgeting are related and how one depends on the...

# Short-Term Budgeting - Lecture notes 3 ## BS Accountancy (ACC 102) ### Module 3 ### Short-Term Budgeting ## Introduction Repeated references to budget allowances have been made throughout previous chapters and we have seen how closely accounting and budgeting are related and how one depends on the other. Accounting draws some of its data from planned performances established in the budget; in turn, recorded historical data provide a basis for determining budget estimates. ## Intended Learning Outcomes After studying this chapter, students should be able to: 1. Define budgeting and other related terminologies 2. Understand the uses of the process of budgeting 3. Understand the functions and composition of budget committee 4. Determine the relationships between operating and financial budgets 5. Identify the different types of budgets or the major composition of the master budget 6. Prepare a master budget and its supporting schedules 7. Prepare operating and financial budgets using the flexible budget model 8. Describe the different models of budgeting 9. Relate budgeting to standards-setting, planning and controlling functions of management ## Budget defined A budget is a financial plan of the resources needed to carry out tasks and meet financial goals. It is also a quantitative expression of the goals the organization wishes to achieve and the cost of attaining these goals. The act of preparing a budget is called budgeting. The use of budgets to control a firm's activities is known as budgetary control. The overall or master budget (also known as planning budget or budget plan) indicates the sales level, production and cost levels, income and cash flows that are anticipated for the coming year. The master budget is a summary of all phases of a company's plans and goals for the future. In short, it represents a comprehensive expression of management's plan for the future and how these plans are to be accomplished. ## The Budgetary System The CEO has a mission to accomplish and objective to achieve. Otherwise, he has no business keeping his job. To achieve the objectives, he has to devise strategies to win people and optimize other resources in the organization. The key paradigm is “winning people". To do this and to unleash power of organizational oneness, the CEO must encourage employee participation and involvement and enlist their commitment towards the organizational objectives. These could be done through the process of budgeting, which has the following uses: 1. **Communication.** The most important process of management is communication. Vision, mission, goals, objectives, plans, standards, and performance evaluation measures must be clearly articulated and understood among officers and personnel. More than understanding, man in the organization must believe, get involved and work with commitment in achieving organizational goals. This could be done by clearly delineating the lines of communications, i.e., an organizational structure should clearly define lines of authority and responsibility. 2. **Motivation** As communication lines are cleared and made more transparent, people will understand the end-results of organizational plans and ask. As they are made part in conceptualizing the plans, they get involved and become more committed in attaining plans. This process moves people to act in accordance with organizational goals. 3. **Standards.** After the actions, results should be summarized and evaluated. At the very onset, the measurement to be used in evaluating performance must be established. These measures of performance are called “standards”. They must be clearly defined and agreed-upon between the person, whose performance is evaluated, and the evaluator. If standards are too high or improbable to achieve, people get demoralized as there is no fair chance of getting a high performance rating. If standards are too low, people are not motivated to exert their best effort, thereby encouraging mediocre results. Standards are set to motivate. They are also an important basis for planning and controlling. Standards to be objective, are normally expressed in quantitative form, e.g., amount, units, hours, thirst, kilograms, number of invoices processed, etc. Still, the most objective mode of expressing standards is in terms of money. 4. **Planning** As standards are set, plans could be done better. A good plan must be S.M.A.R.T. (i.e., specific, measurable, attainable, realistic, and time-bounded). Plans must be specific to be clear, measurable to be fair in the evaluation process, attainable to elicit outstanding performance, realistic to allow people to relate to, and time-bounded to impress urgency and deadlines. The design and development of a plan must be participated in by people in the organization. This means an effective appetizer to increase one's desire in achieving an objective. As plans are developed, men must start developing a “sense of ownership", and eventually, commitment. Questions such as, “what resources are needed?”, “How do we do it?", "When do we do it?", "Who will do it?", And "where do we do it?" need to be resolved with acceptable certainty. Planning is an act of approximating the future and preparing resources, systems, strategies, structures and methods that could best seize the opportunities in a given condition to increase the equity or wealth of an organization. 5. **Organizing and Directing** As plans are framed, resources are organized accordingly. Policies, systems, operational strategies, methods and means are devised as activities are mapped-out and lined-up to execute plans. People are trained, machines brought in, materials outsourced, systems and standards strictly implemented, and offline and online performances monitored. Revisions of plans may be done in-progress and remedial actions are devised and executed when necessary. All along, acts are done in accordance with organizational plans, goals and objectives. In this context, the importance of operational management cannot be undermined. The effectiveness and fitness of managerial judgment are tested. Resources are not only marshaled but are organized and operationally managed. Actions, processes, and transformations are done to meet the objectives of the organization. 6. **Controlling and Performance Evaluation** Controls are to be devised and installed prior to business and operational processes. Controls are also done during the process. Controls are classified as feedback controls, concurrent controls, and feedforward controls. Feedback controls pertain to completed activities, concurrent controls refer to ongoing processes, feedforward controls anticipate and prevent problems. Questions such as, “what structures are best for our operation?", "what systems and policies are best applicable under the circumstances?”, “why are we not meeting our targets or why are we extending our targets?“, “why are machines and men not performing as expected?”, what methods are applicable under the circumstances?", "why is the market behaving differently?", And "why do our financial results differ from our estimates?" need answers. ## The Budget Committee Top executives should primarily subscribe to organizational objectives. The CEO must therefore exercise competence in leading and managing his top executives. Top executives must not only be capable and competent but must have "ownership" of organizational goals. There must be trust and openness in communication. One way to achieve this is through the creation of a Budget Committee. A budget committee is normally composed of top executives in the administrative, operational and financial areas of business such as the Vice Presidents for Sales, Production, Purchasing, Human Resources, Information Technology, Engineering and Quality, Administration, and, most especially, Finance. The Budget Committee is also known in practice as the management committee (i.e., MANCOM) or executive committee (i.e., EXECOM). The Budget Committee, which is normally headed by a Budget Director, administers the budgetary process. It is concerned at developing the budget manual that includes a budget planning calendar and distribution instructions for all budget schedules. A budget planning calendar is the schedule of activities for the development and production of the budget. It includes a list of dates indicating when the specific information is needed to be provided to other departments or units until the entire budgetary process is completed. A budget manual includes distribution instructions for all budget schedules to show that a segment's budget is an input to another department or business unit in the preparation of their own budget. Without distribution instructions, someone who needs a particular schedule might be overlooked, and delays may occur. A planning calendar integrates the entire budgetary activities. Along the way, men should be educated about the purpose, forms, and processes of the budgetary system. They should be taught how to make their own budget using the standard chart of accounts and the standardized budget schedules, know the relevance of their schedule to another schedule, and the model of performance evaluation. The bottom-line is, everybody should be made aware of and be involved. ## The Master Budgets ... a financial process model! Budgets are plans expressed a quantitative form, primarily in financial expression. When plans are expressed quantitatively, they are more objective, understandable, and measurable. The budgetary process is dependent on the organizational structure and purposes. As such, the budget normally stay in answering the basic question, “Is there a market for the business?" This question directs the master budgeting process to start in the sales budget. The normal budgetary sequence is shown in figure 5.1. [Description of figure 5.1 is missing, but it might include a simple diagram explaining the steps of the Master Budget, starting from the Sales Budget, and moving down to the Production, Operating expenses, Cost of Goods Sold, Profit or Loss, and Financial Budget] Normally, the development of business is driven by its demand. In this perspective, the budgeting process starts from the sales budget. Once it is projected, the production budgets, operating expenses budgets, and the budgeted statement of profit or loss follow (i.e., operating budgets). Then, the financial budgets leading to the budgeted statement of financial position and the budgeted statement of cash flows with supporting schedules on collections from customers and payments to suppliers (i.e., financial budgets). The entirety of the operating and financial budgets comprise the master budgets of the enterprise at a given level of activity in a given business period. If there is a limitation on organizations resources such as materials and parts, direct labor hours, machine hours, financial, cultural, and regulatory aspects, the starting point in preparing the master budget shall be defined by such limitation. ## Types of Budget The types of budgets or the major composition of the master budget are: 1. The Operating budget 2. The Financial budget 3. The Capital budget The following is a simplified subclasfficiation of the above-mentioned types of budget for a manufacturing firm: ### A. Operating Budget 1. Budgeted Income Statement a. Sales budget b. Production budget 1. Materials cost budget 2. Direct labor cost budget 3. Factory overhead budget 4. Inventory levels 2. Cost of Sales Budget 3. Selling and Administrative expenses budget 4. Financial Expense budget ### B. Financial Budget 1. Budgeted Statement of Financial Position 2. Cash Budget ### C. Capital Investment ## Budget Budgeting ## Terminologies Defined ### Budgeted Income Statement Refers to projection of revenue, expenses, and results of operations for a definite period of time. ### Cash budget A period-by-period statement of cash at the start of a budget period, expected cash receipts classified by source; expected cash disbursements, classified by function, responsibility, and form; and the resulting cash balance at the end of the budget period. ### Financial Budget Refers to the budget of the financial resources as reflected in the budget statement of financial position and cash budget. ### Fixed Budget Projection of cost at a particular or one level of production (usually at normal capacity) for a definite time period. ### Flexible (variable) budget Projection of cost at different levels of production for a definite period of time ### Participative budget Budget prepared using employees at all levels in the organization ### Physical budget Budget that is expressed in units of materials, number of employees or number of man-hours or service units rather than in pesos ### Planning budget (static budget) Another term for master budget ### Production budget Production plan of resources needed to meet current sales demand and ensure adequate inventory levels ### Program budget Budget for the major programs or projects that the company plans to undertake ### Operating budget Refers to the plans for the conduct of business for the planning period; it includes the budgeted income statement and all its supporting budgets. ### Responsibility budget Budget for a responsibility center ### Rolling (continuous, progressive) budget Budget which is prepared throughout the year, that is, as one month elapses, a budget is prepared for one more month in the future ### Sales budget Budget that shows the quantity of each product and the revenue expected to be sold ### Traditional budgeting A system of budgeting which concentrates on the incremental change from the previous year assuming that the previous year's activities are essential and must be continued. ### Zero-based budgeting A system establishing financial plans beginning with an assumption of no-activity and justifying each program or activity level ## The Sales Budget Sales indicate meeting customers' wants, demands, needs, and desires. It fundamentally drives the creation of business activities. It is the initiating motive of business organization and the genesis of normal business planning. Mathematically, the sales are affected by the unit sales price and quantity sold. The unit sales price is affected by cost, competition, product substitutes, market trends, regulations, demand and supply behavior, and estimated profit, among other things. The number of units sold is affected by the unit sales price. Other factors influencing sales forecast include the past sales volume, general economic and industry conditions, relationship of sales to economic indicators, (such as gross domestic product, gross national product, personal income, employment, prices in industrial production), relative product profitability, market research studies, advertising and other promotions, quality of salesforce, seasonal variations, production capacity, and long-run sales trends for various products. In forecasting sales, factors that have strong correlation with sales pattern are identified and used. Basically, there are three ways of making escalates for the sales budget: 1. **statistical forecasting** based on analysis of general business conditions, market conditions, product growth curves, etc. 2. **Make an internal estimate** by collecting the opinions of executives and sales staff. 3. **Analyze the various factors** that affect sales revenue and then predict the future behavior of each of these factors. The estimated number of units sold could be estimated per product line, department, geographical area, model, and market classification. In projecting units to be sold, several forecasting techniques are employed which normally apply the concept of probability and best estimates models, statistics, and simulation analysis. The study of probability and other forecasting techniques are reserved in the chapter for quantitative techniques applied in business. ## Sample Problem 3.1. Estimated Sales in Units and Pesos The management of New corporation is considering three state economic conditions: strong, fair, and weak. Based on some macro studies, it has been agreed that the economy in the coming year may be 40% strong, 50% fair and 10% weak. The projected number of units are 120,000 units, 90,000 units, and 50,000 units for strong, fair, and weak economic conditions, respectively. The budgeted unit sales price given the estimates in units sold is P 120. Five percent (5%) of the gross sales are estimated to be uncollectible. ### Required: 1. Budgeted units to be sold in the coming year 2. Budgeted amount of sales, net of doubtful accounts. ### Solutions/ Discussions: 1. The budgeted sales in units shall be determined as follows: | Economy | Projected Sales Units | Probability | Budgeted Unit Sales | |---|---|---|---| | A | 120,000 | 40% | 48,000 | | B | 90,000 | 50% | 45,000 | | C | 50,000 | 10% | 5,000 | | Total | | | 93,000 | 2. The budgeted net sales in pesos shall be: - Budgeted sales in units: 93,000 - x Unit sales price: P 120 - Budgeted gross sales in pesos: P 11,160,000 - Less: Allowance for doubtful accounts: (P 11,160,000 x 5%) = 558,000 - Budgeted net sales in pesos: P 10,602,000 Once the sales units are projected and the sales amount already budgeted, the budgeted costs and expenses would now be estimated, then the financial budgets all in connection with the strategic plan of the business. In the following discussions, the unit sales price and projected sales in units are normally given. ## The Production Budget Budgeted production is based on budgeted sales and inventory policies. An inventory policy is normally based on the number of units to be sold in the following period. The formula for the budgeted production could be derived from the traditional method of determining number of units sold which states that finished goods inventory-beginning plus production less finished goods inventory-ending equal budgeted sales. You tweak the formula and the computation for the budgeted production is as follows: ### Table 3.1. Pro-Forma Budgeted Production - Projected sales: x - Add: Finished goods invty - end: x - Total Goods Available for Sale: x - Less: Finished Goods Inventory - Beg: x - Budgeted Production: x Once the budgeted production is set, the budgeted materials, direct labor, and variable overhead may now be prepared. The budgeted fixed overhead is based on normal capacity (e.g., normal production) which is considered flat or constant over the periods (e.g., months) covered by the budget. It differs from the master budget where its level of capacity varies from one month to another. An illustration of Budgeted Production Schedule is presented on schedule 3 of Sample Problem 3.3. ## The Direct Materials Budget The raw materials budget is based on budgeted production. There are two (2) materials budgets to be estimated; 1. Budgeted direct materials used 2. Budgeted direct materials purchases ### Budgeted direct materials used budget Multiply the budgeted production by the standard materials per unit of finished goods and you get the budgeted direct materials to be used, or the budgeted direct materials requirements. This makes the standard costing system a “sine qua non" in the budgetary process. The standard cost is used in the preparation of the direct materials budgets, direct labor, variable overhead, fixed overhead, selling expenses, and administrative expenses budgets as well. ### Budgeted direct materials purchases budget Direct material purchases is direct materials used add the materials inventory ending, then deduct the materials inventory beginning. This procedure is derived from the traditional computation of raw materials used which is raw materials inventory-beginning plus materials purchases less raw materials inventory-ending. From this standpoint, the raw materials purchases budgets are derived, as follows. ### Table 3.2. Pro-Forma Budgeted Direct Materials Used and Purchases - Budgeted direct materials used: x (Budgeted production x Std. materials per unit) - Add: Materials Inventory End: x - Total Materials for Use: x - Less: Materials Inventory - Beg: x - Budgeted direct mat. Purchases in units: x - x Materials cost per unit: x - Budgeted materials purchases in pesos: P x An illustration of Budgeted Direct Materials Used and Purchases is presented in Sample Problem 3.4, Schedule 4. ## The Direct Labor Budget Let us assume a labor intensive operation where workers are paid by the hour. On this premise, the budgeted direct labor hours is budgeted production times the standard direct labor hour per unit produced. The standard direct labor rate per hour is multiplied to budgeted direct labor hours to get the budgeted direct labor cost. The standard direct labor hours per unit and the standard rate per hour are to be provided by the standard cost sheet. The pro-forma computation of the budgeted direct labor cost is as follows: ### Table 3.3. Pro-Forma Budgeted Direct Labor - Budgeted Direct Labor hours: x (Budgeted production x Std. DLH per unit) x DL Rate per hour - Budgeted DL cost: Px Px The budgeted direct labor hours would determine the number of production personnel needed to be employed for a given budgetary period. An illustration of Budgeted Direct Labor is presented in Sample Problem 6.5, Schedule 6. ## The Factory Overhead Budget The factory overhead should be budgeted separately for the fixed overhead in the variable overhead components. Fixed overhead is constant in total while the standard fixed overhead rate is computed based on the normal capacity. In short-term budgeting the standard fixed overhead rate is considered constant. Total variable overhead costs change in relation to the level of production while unit variable cost is constant. The computational guideline for the factory overhead is as follows: ### Table 3.4. Budgeted Factory Overhead Computations - Budgeted variable overhead: x (Budgeted production x Std. Var OH per unit) - Budgeted fixed overhead: P x (Normal capacity x Std. Fx OH rate/unit) - Budgeted total overhead: Px The standard hours per unit and standard overhead rates per hour are to be based on the standard cost sheet developed by the business. An illustration of Budgeted Factory Overhead is presented in Sample Problem 6.5, Schedule 7. ## The Budgeted Statement of Cash Flows Cash may be considered as the alpha and omega of the business process. Investors interest would boil down to the ability of the business to return their money and how much more could be given to them as premium for accepting the risk of investing in the business. Managers are also interested in the daily and regular cash position of the business to effectively monitor operating activities. An analysis of cash inflows and outflows would provide management vita information on the liquidity needs of the business. Several models of cash management, presentation and analyses have been developed for management use, as follows: 1. **Cash budget model** 2. **Economic cash flow model** 3. **Accounting statement of cash flow model** The presentation formats of these cash report presentation models are presented in each of the boxes in the following page. [Description of Figure 6.2 is missing, but it might include three different tables explaining how to present Cash Reports using the Cash Budget model, Economic Cash Flow model, and the Statement of Cash Flow model.] The cash management model separates the operating and investing cash performance before the financing activities. This gives the management a vital perspective on the ability of the business activities, (i.e., operating and investing) to generate cash. The financing section includes the receipts from short-term financing and long-term financing as well. However, the short-term financing is always prioritized for operating cash management purposes. The financing section also includes the payments to interest, principal, and return of equity. Cash flows are classified as financing, investing, and operating activities. This classification may be traced from understanding the general contents of the Statement of Financial Position and Statement of Profit or Loss. ### Statement of Financial Position [Description of the simplified Statement of Financial Position is missing, but it might include a table showing the core components of the statement, such as Current Assets, Non-Current Assets, Equity, Liabilities, etc.] ### INVESTING ACTIVITIES | Inflows | |---| | Sale of Noncurrent assets | ☑ | | Acquisition of | ☑ | ### FINANCING ACTIVITIES | Inflows | |---| | Long-term borrowing | ☑ | | Payment of long-term | ☑ | | Issuance of shares of stock | ☑ | | Retirement of shares of stock | ☑ | | Purchase of teasurey stock | ☑ | | Re-issuance of treasury stock | ☑ | | Dividends paid | ☑ | ### OPERATING | Inflows | Outflows | |---|---| | Cash sales | | ☑ | | Collections from credit customers | ☑ | | | Receipts from other revenue | ☑ | | | Cash purchases | | ☑ | | Payments to merchandise suppliers | | ☑ | | Payments to operating expenses | | ☑ | | Payments to other expenses | | ☑ | Operating activities employ current assets and current liabilities. The difference of current assets and current liabilities is called the working capital. It is the fundamental resource used by the management in managing revenues, costs, and profit. As such, current items pertain to operating activities and are excluded from financing and investing activities. Investing activities basically refer to those of noncurrent assets and marketable securities. Financing activities essentially relate to long-term debt and equity transactions. Under the International Financial Reporting Standards, specifically in International Accounting Standard No, 7, interest expense may be classified as operating or investing activities depending on the reason of its incurrence. Accordingly, if interest expense is incurred to sustain the operating activities of the business, such interest is classified as an operating item. If an interest is incurred arising from the raising of financing money, such interest is classified as a financing item. Dividend income may be classified as either operating or investing activity depending on the nature the investment from which the dividend is derived and the purpose of dividend distribution. An illustration for Cash Budget is presented in Sample Problem 3.7, Schedule 13. ## Schedule of Accounts Receivable Collections Credit sales are collected over a period of time. Collection patterns are to be established to more accurately estimate the inflows of cash from operations. A schedule of Accounts Receivable collections from credit sales is to be done. Total collections from receivables include those from credit customers and cash sales. ## Schedule Accounts Payable Payments Credit purchases are not usually paid in the period of purchase. Normally, payments are spread over a number of months. Schedule of account payables payments is to be made to more accurately determine timing of cash outflows to merchandise suppliers. ## Accruals and Prepayments There are also accrued and prepaid (deferred or unearned) income and expenses. In the budgeted statement of cash flows, only the cash portion of the accrued and prepaid items are considered. Let us revisit the contents of the accrued and prepaid expenses accounts to determine the amount of expenses paid, as shown below: | | Accrued | Prepaid | |---|---|---|---| | PAID | x | Beg Bal | + | Beg Bal | + | INCURRED | x | | End Bal | x | INCURRED | x | PAID | x | Beg Bal | x | Using the T-account analysis, the “expenses-paid” would be computed as: - Operating expenses incurred: Px - Add: Accrued expenses, beg.: Px - Prepaid expenses, end: x - Total: x - Less: Accrued expenses, end: x - Prepaid expenses, beg.: x - Operating expenses paid: Px In determining the amount of income received, let us also revisit the contents of accrued and | | Accrued | Deferred | |---|---|---| | Beg. Bal + | x | RECEIVED | x | EARNED | x | Beg Bal + | x | | EARNED | x | End Bal | x | End Bal | x | RECEIVED | x | Using the T-account analysis, the “income received” is computed - Add: Accrued income, beg.: Px - Deferred income, end: x - Total: x - Less: Accrued income, end: x - Deferred income, beg.: x - Income received.: Px ## Operating Expenses Operating expenses budget should also be estimated in details in accordance with the principles of accrual accounting. There shall be separate budget schedules each for marketing, selling, and administrative expenses. It would be truly of great value if the expenses are further classified as direct to the segment or otherwise, and controllable or noncontrollable as to the authority of the segment manager. Operating expenses could also be classified based on the new model of business functions such as: research and development expenses, design engineering expenses, marketing expenses, distribution expenses, and customer services expenses. The production costs are assembled, grouped and reported as part of the cost of goods manufactured and sold. ## Research and Development Leading companies in their industry or line of business, or companies that operate in a technology- based business environment, need to allocate resources for research and development to stay competitive and relevant in the upcoming period. Detailed research and development budget would provide important information to managers in their strategic and tactical decisions. Research has, at least, three phases: basic research, applied research, and developmental research. These researches are focused towards cost reduction, product improvements and development of new products. Distribution as to the overall budget allotment to these research phases and focuses should be clearly projected, summarized and presented. ## Budgeting Models There are several budgeting models used by organizations. Some examples are flexible budgeting, fixed (or static) budgeting, continuous budgeting, zero-based budgeting, life-cycle budgeting, activity-based budgeting, kaizen budgeting, and government budgeting. ### Flexible budgeting Flexible budgeting separates costs as to either variable or fixed. In this model, budgeted costs are determined at any level of business activity. Flexible budgeting uses standard costs to prepare budgets for multiple activity levels. Total fixed costs remain constant while total variable costs increase as production increases. The budgeted costs based on actual level of production become the standard costs and are compared with the actual costs to get and analyze cost variances. An illustration of flexible budgets follows: ### Sample Problem 3.2. Flexible Budgeting The Luzon Corporation has a unit direct materials cost of P 10, unit direct labor cost of P 5, unit variable overhead cost of P 4, factory rent paid of P 200,000, factory depreciation of P 400,000, and miscellaneous fixed overhead of P 100,000. The company's normal capacity which is also its maximum capacity is 20,000 units. The budgeted costs at 70%, 80%, 90%, and 100% capacity are as follows: Fixed or static budgeting does not segregate cost into fixed and variable components. Costs are estimated only at a single level of activity. Actual cost are compared with the budgeted cost regardless of the actual level of production and cost variances are obtained and analyzed accordingly. ### Continuous or rolling budgeting Continuous or rolling budgeting maintains a particular time frame (or period) covered in budgeting (say 12 months). When a time segment (e.g., month) had passed, it is dropped from the budget frame and a new month is added to maintain the same period of time covered by the budget. ### Zero-based budgeting (ZBB) Zero-based budgeting (ZBB) does not consider past performances in anticipating the future. Budgeted cost should be classified and packaged based on activities which must be prioritized and justified as to their incurrence. The aim is to encourage objective examination of all costs in the hope that cost could be better controlled. ZBB starts from the lowest budgetary units of the organization. It needs determination of objectives, operations, and costs for each activity and the alternative means of carrying out that activity. Different levels of service or work effort are evaluated for each activity, measurements and performance standards are established, and activities are ranked according to their importance to the activity. A decision package is prepared that describes various levels of service that may be provided, including at least one level lower than the current one. Each expenditure is justified for each budget period and costs are reviewed from a cost-benefit perspective. ### Life-cycle budgeting Life-cycle budgeting intends to account for all costs incurred in the stages of the "value chain", from research and development to design, production, marketing, distribution, up to customer services. Costing in this model is important for pricing decisions. Revenues generated from the product should cover not only the costs of production but the entire business costs incurred. It is also analyzed in line with the product life-cycle concept where products have four life stages such as infancy (or start-up stage), growth stage, expansion stage, and maturity (or decline) stage. It is estimated that about 80% of all costs are already committed (may not yet be incurred) before the business begins. Life-cycle budgeting emphasizes the potential for locking in (designing in) future costs since the opportunity of reducing costs is great before production begins. In the whole-life cost concept, the budget includes the "after-purchase costs" closely associated with the life-cycle cost. After-purchase costs include the costs of operating, support, repair, and disposal incurred by customers. Whole-life cost equals the life-cycle cost plus the after-purchase costs. Life-cycle costing is related to target costing and target pricing. A target price is determined in a given market condition and costs and profit margin are adjusted accordingly. ### Activity-based budgeting Activity-based budgeting is applied when the activity-based management system is used. It breaks down processes into activities and permits the identification of value-adding activities and their cost drivers. Activities are grouped according to their homogeneity and costs drivers are established per homogeneous pool. It tracks down cost incurrence based on the behavior of its cost driver such as number of set-ups, downtime, number of units produced, machine hours, number of employees square footage, number of kilowatt used, number of customer complaints, and many more. ### Kaizen (continuous improvements) budgeting Kaizen (continuous improvements) budgeting assumes the continuous improvement of products or processes by way of small innovations rather than major changes. Budgets are normally not reached unless innovative improvements occur. Kaizen budgeting is based on learning curve theory where cost decreases as time passes by and experiences are gained. Kaizen is also related to product life-cycle costing. ### Governmental budgeting Governmental budgeting is not only a financial plan but is also an expression of public policy and a form of control having the force of the law. A government budget is a legal document, a law enacted by the congress, which must be complied with by heads and personnel of various government agencies. Since government budgeting is not profit-centered, the use of budgets in the appropriation process is of major importance. One budgeting concept in government budgeting is “line budgeting" where the emphasis is more on the control of expenditures. Each line expense should be disbursed according to the limits of the approved appropriations. ## APPENDIX 3.1 MASTER BUDGET SCHEDULES This section illustrates the computations, mechanics and interrelationships in a master budget. Although the illustrative data are presented separately per sample problem, they are however interrelated. The concept is to individually show budgetary computations per major account and later will be consolidated in budgeted financial statements. The data pertain to Charmaine Corporation. ### Sample Problem 3.3. Projected Sales and Estimated Collections from Customers Charmaine Corporation made the following projections on its sales in the coming year, 2020: | Econom | Q1 | Q2 | Q3 | Q4 | Probabilit | |---|---|---|---|---|---| | y | | | | | y | | Good | 74,000 | 92,000 | 80,000 | 102,000 | 50% | | Fair | 50,000 | 80,000 | 70,000 | 90,000 | 30% | | Bad | 40,000 | 50,000 | 45,000 | 60,000 | 20% | The unit sales price is expected to be constant at P 20. All sales are made on credit. Receivables from customers are collected 60% in the quarter of sales, 30% in the quarter following sales, and 8% in the second quarter following sale. The remaining 2% is considered uncollectibles. The account receivables balance on December 31, 2019 is estimated to be P 640,000; 25% of which is coming from the 3rd quarter sales of 2019. ### Required: 1. **Schedule 1:** Projected sales in units and in pesos per quarter and for the year 2020. 2. **Schedule 2:** Estimated collections from customers per quarter and for the year 2020. ### Solutions/ Discussions: The projected sales in units are computed by considering the probability of occurrence. | | Expected units sold | |---|---| | Q1 | Q2 | Q3 | Q4 | | Good (projected sales x 50%) | 37,000 | 46,000 | 40,000 | 51,000 | | Fair (projected sales x 30%) | 15,000 | 24,000 | 21,000 | 27,000 | | Bad (projected sales x 20%) | 8,000 | 10,000 | 9,000 | 12,000 | | | 60,000 | 80,000 | 70,000 | 90,000 | - (*) For example: (74,000 units x 50%) = 37,000 units - (50,000 units x 30%) = 15,000 - (40,000 units x 20%) = 8,000 - Expected sales in = 60,000 units ### Schedule 1. Budgeted units | | Q1 | Q2 | Q3 | Q4 | Total | |---|---|---|---|---|---| | Budgeted sales in units | 60,000 | 80,000 | 70,000 | 90,000 | 300,000 | | x Unit sales price | P 20 | P 20 | P 20 | P 20 | P 20 | | Budgeted sales in | P 1,200,000 P 1,600,000 P 1,400,