AC222 Chapter 23 Budgetary Planning Professor Outline As you read this chapter, pay particular attention to terms and illustrations presented to you in the text. From your study of this chapter, you should be able to 1. Indicate the benefits of budgeting 2. State the essentials of effective budgeting 3. Identify the budgets that comprise the master budget 4. Describe the sources for preparing the budgeted income statement 5. Explain the principal sections of a cash budget 6. Indicate the applicability of budgeting in non-manufacturing companies Budgeting Basics A budget is a formal written statement of management's plans for a specified time period, expressed in financial terms. The role of accounting during the budgeting process is to (a) provide historical data on revenues, costs, and expenses, (b) express management's plans in financial terms, and (c) prepare periodic budget reports. Budgets are an important tool in strategic planning, control, and evaluation. Benefits of Budgeting The primary benefits of budgeting are as follows: a. It requires all levels of management to plan ahead. b. It provides definite objectives for evaluating performance. c. It creates an early warning system for potential problems. d. It facilitates the coordination of activities within the business. e. It results in greater management awareness of the entity's overall operations. f. It motivates personnel throughout the organization. Essentials of Effective Budgeting In order to be effective management tools, budgets must be based upon: a. A sound organizational structure in which authority and responsibility are clearly defined. b. Research and analysis to determine the feasibility of new products, services, and operating techniques. c. Management acceptance which is enhanced when all levels of management participate in the preparation of the budget, and the budget has the support of top management. The most common budget period is one year. A continuous twelve- month budget results from dropping the month just ended and adding a future month. The annual budget is often supplemented by monthly and quarterly budgets. The responsibility for coordinating the preparation of the budget is assigned to a budget committee. The budget committee usually includes the president, treasurer, chief accountant (controller), and management personnel from each major area of the company. A budget can have a significant effect on human behavior. A budget may have a strong positive influence on a manager when: a. Each level of management is invited and encouraged to participate in developing the budget. b. Criticism of a manager's performance is tempered with advice and assistance. c. Top management is sensitive to the behavioral implications of its actions. Long-range planning involves the selection of strategies to achieve long-term goals and the development of policies and plans to implement the strategies. Long-range plans contain considerably less detail than budgets. The Master Budget The master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period. It is developed within the framework of a sales forecast which shows potential sales for the industry and the company's expected share of such sales. There are two classes of budgets in the master budget. a. Operating budgets include the individual budgets that result in the preparation of the budgeted income statement. b. Financial budgets focus primarily on the cash resources needed to fund expected operations and planned capital expenditures. The sales budget is the first budget prepared. It is derived from the sales forecast, and it represents management's best estimate of sales revenue for the budget period. It is prepared by multiplying the expected unit sales volume for each product by its anticipated unit selling price. The production budget shows the units that must be produced to meet anticipated sales. It is derived from the budgeted sales units plus the desired ending finished goods units less the beginning finished goods units. The direct materials budget contains both the quantity and cost of direct materials to be purchased. It is derived from the direct materials units required for production plus the desired ending direct materials units less the beginning direct materials units. The direct labor budget contains the quantity (hours) and cost of direct labor necessary to meet production requirements. The direct labor budget is critical in maintaining a labor force that can meet expected levels of production. The manufacturing overhead budget shows the expected manufacturing overhead costs. The selling and administrative expense budget projects anticipated operating expenses. Both budgets distinguish between fixed and variable costs. Budgeted Income Statement The budgeted income statement is the important end-product of the operating budgets. This budget indicates the expected profitability of operations and it provides a basis for evaluating company performance. a. The budget is prepared from the budgets described earlier b. For example, to find cost of goods sold, it is necessary to determine the total unit cost of a finished product using the direct materials, direct labor, and manufacturing overhead budgets. Cash Budget The cash budget shows anticipated cash flows. It contains three sections (cash receipts, cash disbursements, and financing) and the beginning and ending cash balances. Data for preparing this budget are obtained from the other budgets. Budgeted Balance Sheet The budgeted balance sheet is a projection of financial position at the end of the budget period. It is developed from the budgeted balance sheet for the preceding year and the budgets for the current year. Budgeting in Nonmanufacturing Companies The major differences in the master budget of a merchandiser and a manufacturer are that a merchandiser (a) uses a merchandise purchases budget instead of a production budget and (b) does not use the manufacturing budgets (direct materials, direct labor, and manufacturing overhead). In service enterprises, the critical factor in budgeting is coordinating professional staff needs with anticipated services. Budget data for service revenue may be obtained from expected output or expected input. In the budget process for non-profit organizations, the emphasis is on cash flows rather than on a revenue and expense basis. For governmental units, the budget must be strictly followed and overspending is often illegal.
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