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Budgeting for Planning and Control Topic 1 by Dr. Ong Tze San tzesan@econ.upm.my

Budgeting for Planning and Control Topic 1 by Dr. Ong Tze San tzesan@econ.upm.edu.my. Budget. The quantitative expression of a proposed plan of action by management for a specified period An aid to coordinating what needs to be done to implement that plan

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Budgeting for Planning and Control Topic 1 by Dr. Ong Tze San tzesan@econ.upm.my

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  1. Budgeting for Planning and Control Topic 1 by Dr. Ong Tze San tzesan@econ.upm.edu.my

  2. Budget • The quantitative expression of a proposed plan of action by management for a specified period • An aid to coordinating what needs to be done to implement that plan • Budgets can be used to compare actual outcomes with planned outcomes

  3. Planning: Strategic Plan Long-Term Objectives F e edba ck Control: Short-Term Objectives Compare actual results with planned amounts Budgets Operations Production, Service, and Sales The Master Budget and Its Interrelationships

  4. Purposes of Budgeting 1. It forces managers to plan. 2. It provides resource information that can be used to improve decision making. 3. It provides a standard for performance evaluation. 4. It improves communication and coordination.

  5. Budget Director: works under the direction of the budget committee; usually the controller or someone who reports to the controller. Budget Committee: responsible for reviewing the budget, providing policy guidelines and budgetary goals, resolving differences that may arise as the budget is prepared, approving the final budget, and monitoring the actual performance of the organization. Directing and Coordinating the Budgets Objective 1 8-5

  6. 1. How is the budget prepared? 2. How is the budget used to implement the organization’s plan? Two Dimensions of Budgeting

  7. Master Budget • A comprehensive financial plan made up of various individual departmental and activity budgets for the year. • Components of master budget: • Operating budgets are concerned with income generating activities • Financial budgets are concerned with inflows and outflows of cash and with financial position

  8. The Role of Budgeting in Planning and Control • The data used to create the budget come from many sources. • The sales forecast is the basis for the sales budget – which is the basis for all of the other operating budgets and most of the financial budgets. • A continuous or rolling budget is a moving twelve month budget.

  9. Preparing the Operating Budget 1. Sales budget 2. Production budget 3. Direct materials purchases budget 4. Direct labor budget 5. Overhead budget 6. Ending finished goods inventory budget 7. Cost of goods sold budget 8. Marketing expense budget 9. Research and development budget 10. Administrative expense budget 11. Budgeted income statement

  10. Schedule 1 (in thousands) ABT, Inc. Sales Budget For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Units 2,000 6,000 6,000 2,000 16,000 Unit selling price x $0.70x $0.70x $0.80x $0.80 x $0.75 Sales $ 1,400 $ 4,200 $ 4,800 $ 1,600 $12,000 The sales forecast is the basis for the sales budget. The accuracy of the sales forecast strongly affects the soundness of the entire master budget.

  11. Computing Units to be Produced Expected unit sales + Units, ending inventory – Units, beginning inventory Units to be produced =

  12. Schedule 2 (in thousands) ABT, Inc. Production Budget For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Sales (Schedule 1) 2,000 6,000 6,000 2,000 16,000 Desired ending inventory 500 500 100 100 100 Total needs 2,500 6,500 6,100 2,100 16,100 Less: Beginning inventory 100 500 500 100 100 Units to be produced 2,400 6,000 5,600 2,000 16,000

  13. Schedule 3 (in thousands) ABT, Inc. Direct Materials Purchases Budget For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Units to be produced (Schedule 2) 2,400 6,000 5,600 2,000 16,000 Direct materials per unit (lbs.) x 26 x 26 x 26 x 26 x 26 Production needs 62,400 156,000 145,600 52,000 416,000 Desired ending inventory (lbs.) 8,000 8,0005,000 5,000 5,000 Total needs 70,400 164,000 150,600 57,000 421,000 Continued

  14. Quarter 1 2 3 4 Year Total needs 70,400 164,000 150,600 57,000 421,000 Less beginning inventory 5,000 8,000 8,000 5,000 5,000 Direct materials to be purchased (lbs.) 65,400 156,000 142,600 52,000 416,000 Cost per pound x $0.01x $0.01x $0.01x $0.01 x $0.01 Total purchase cost $ 654 $ 1,560 $ 1,426 $ 520 $ 4,160

  15. Schedule 4 (in thousands) ABT, Inc. Direct Labor Budget For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Units to be produced (Schedule 2) 2,400 6,000 5,600 2,000 16,000 Direct labor time per unit (hrs.) x 0.015x 0.015x 0.015x 0.015x 0.015 Total hours needed 36 90 84 30 240 Wage per hour x $8 x $8 x $8 x $8 x $8 Total direct labor cost $ 288 $ 720 $ 672 $ 240 $ 1,920

  16. Schedule 5 (in thousands) ABT, Inc. Overhead Budget For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Budgeted direct labor hours (Schedule 4) 36 90 84 30 240 Variable overhead rate x $8 x $8 x $8 x $8 x $8 Budgeted variable overhead $288 $ 720 $672 $240 $1,920 Budgeted fixed overhead 320 320320 320 1,280 Total overhead $608 $1,040 $992 $560 $3,200

  17. Schedule 6 (in thousands) ABT, Inc. Ending Finished Goods Inventory Budget For the Year Ended December 31, 2012 Unit-cost computation: Direct materials (26 lbs. @ $0.01) $0.26 Direct labor (0.015 hr. @ $8) 0.12 Overhead: Variable (0.015 hr. @ $8) 0.12 Fixed (0.015 hr. @ $5.33) 0.08 Total unit cost $0.58 Units Unit Cost Total Finished goods: Concrete blocks 100 $0.58 $58

  18. Schedule 7 (in thousands) ABT, Inc. Cost of Goods Sold Budget For the Year Ended December 31, 2012 Direct materials used (Schedule 3) $4,160 Direct labor used (Schedule 4) 1,920 Overhead (Schedule 5) 3,200 Budgeted manufacturing costs $9,280 Beginning finished goods 55 Goods available for sale $9,335 Less: Ending finished goods (Schedule 6) 58 Budgeted cost of goods sold $9,277

  19. Schedule 8 (in thousands) ABT, Inc. Marketing Expense Budget For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Planned sales in units (Schedule 1) 2,000 6,000 6,000 2,000 16,000 Variable marketing expenses per unit x$0.05x$0.05x$0.05x$0.05x$0.05 Total variable expenses $ 100$ 300$ 300$ 100$ 800 Continued

  20. Quarter 1 2 3 4 Year Fixed marketing expenses: Salaries $ 10 $ 10 $ 10 $ 10 $ 40 Advertising 10 10 10 10 40 Depreciation 5 5 5 5 20 Travel 3 3 3 3 12 Total fixed expenses $ 28$ 28$ 28$ 28$112 Total marketing expenses $128 $328 $328 $128 $912

  21. Schedule 9 (in thousands) ABT, Inc. Research and Development Expenses Budget For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Sales $18 $18 $18 $18 $ 72 Prototype design and development 10 10 10 10 40 Total R & D expenses $28 $28 $28 $28 $112

  22. Schedule 10 (in thousands) ABT, Inc. Administrative Expense Budget For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Salaries $25 $25 $25 $25 $100 Insurance --- --- 15 --- 15 Depreciation 10 10 10 10 40 Travel 2 2 2 2 8 Total administrative expenses $37 $37 $52 $37 $163

  23. Schedule 11 (in thousands) ABT, Inc. Cost of Goods Sold Budget For the Year Ended December 31, 2012 Sales (Schedule 1) $12,000 Less: Cost of goods sold (Schedule 7) 9,277 Gross margin $ 2,723 Less: Marketing expenses (Schedule 8) -912 R & D expenses (Schedule 9) -112 Administrative expenses (Schedule 10) -163 Operating income $ 1,536 Less: Interest expense (Schedule 12) 42 Income before taxes $ 1,494 Less: Income taxes 600 Net income $ 894

  24. Schedule 11 (in thousands) ABT, Inc. Cost of Goods Sold Budget For the Year Ended December 31, 2012 Sales (Schedule 1) $12,000 Less: Cost of goods sold (Schedule 7) 9,277 Gross margin $ 2,723 Less: Marketing expenses (Schedule 8) -912 R & D expenses (Schedule 9) -112 Administrative expenses (Schedule 10) -163 Operating income $ 1,536 Less: Interest expense (Schedule 12) 42 Income before taxes $ 1,494 Less: Income taxes 600 Net income $ 894

  25. The Financial Budgets • Capital expenditures budget – financial plan outlining the expected acquisition of long term assets. • Cash Budget – detailed plan that shows all expected sources and uses of cash • Budgeted balance sheet – represents the culmination of the financial events of the coming year and shows management where the company is expected to be at the end of the year • Budgeted statement of cash flows

  26. The Cash Budget Beginning cash balance + Cash receipts Cash available - Cash disbursements - Minimum cash balance Excess or deficiency of cash - Repayments + Loans + Minimum cash balance Ending cash balance

  27. Additional Information Min cash balance = $100,000 for the end of each Q. Beginning cash balance = $120,000 Money can be borrowed & repaid in multiples of $100,000. Interest = 12% per year. Interest payment are made only for the amount of the principal being repaid. All borrowing takes place at the beginning of a Q & repayment takes place at the end of a Q. ½ of all sales = cash, ½ are on credit; 70% are collected in the Q of sales & 30% are collected in the following Q. Sales for last year (4th Q) = $2million. Purchases of materials = on account; 80% are paid for in the Q, 20% in the following Q. Last year purchases = $500,000 Budgeted depreciation = $200,000 per Q for OH. Buying new equipment $600,000 in 1st Q for OH & 10% depreciation rate per year. Income taxes = $600,000 & will be paid at the end of 4th Q.

  28. Schedule 12 (in thousands) ABT, Inc. Cash Budget For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Beginning cash balance $ 120 $ 113 $ 152 $1,334 $ 120 Cash collections 1,490 3,780 4,710 2,080 12,060 Total cash available $1,610$3,893$4,862$3,414$12,180 Total disbursements $2,097 $3,317 $3,310 $2,079 $10,803 Minimum cash balance 100 100 100 100 100 Total cash needs $2,197$3,417$3,410$2,179$10,903 Excess (deficiency) of cash -$ 587 $ 476 $1,452 $1,235 $ 1,277 Add: Borrowings 600 --- --- --- 600 Less: Repayments --- 400 200 --- 600 Less: Interest paid --- 24 18 --- 42 Ending cash balance $ 13 $ 52 $1,234 $1,235 $ 1,235 Plus: Minimum cash balance 100 100 100 100 100 Ending cash balance $ 113 $ 152 $1,334 $1,335 $ 1,335

  29. Total Disbursements ABT, Inc. For the Year Ended December 31, 2012 Quarter 1 2 3 4 Year Material: current $ 523 $ 1248 $ 1141 $416 $ 3328 Prior 100 131 312 285 828 Direct labor 288 720 672 240 1920 Overhead 408 840 792 360 2400 Marketing 123 323 323 123 892 R & D 28 28 28 28 112 Admin 27 27 42 27 123 Income taxes - - - 600 600 Equipment 600 - - - 600 Total 2097 3317 3310 2079 10803

  30. ABT, Inc. Schedule of Cash Receipts (in thousands) Source Quarter 1 Quarter 2 Quarter 3 Quarter 4 Cash sales $ 700 $2,100 $2,400 $ 800 Received on account from sales in: Quarter 4, 2011 300 Quarter 1, 2012 490 210 Quarter 2, 2012 1,470 630 Quarter 3, 2012 1,680 720 Quarter 4, 2012 560 Total cash receipts $1,490 $3,780 $4,710 $2,080

  31. ABT, Inc. Balance Sheet (in thousands) December 31, 2011 Note that this is the actual balance sheet for 2011 Assets Current assets: Cash $ 120 Accounts receivable 300 Material inventory 50 Finished goods inventory 55 Total current assets $ 525 Property, plant, and equipment: Land $2,500 Building and equipment 9,000 Accumulated depreciation -4,500 Total property, plant, and equipment 7,000 Total assets $7,525 Continued

  32. Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 100 Stockholders’ equity: Common stock, no par $ 600 Retained earnings 6,825 Total stockholders’ equity 7,425 Total liabilities and stockholders’ equity $7,525

  33. Schedule 13 (in thousands) ABT, Inc. Budgeted Balance Sheet December 31, 2012 Assets Current assets: Cash $1,335 Accounts receivable 240 Material inventory 50 Finished goods inventory 58 Total current assets $1,683 Property, plant, and equipment: Land $2,500 Building and equipment 9,600 Accumulated depreciation -5,360 Total property, plant, and equipment 6,740 Total assets $8,423 Continued

  34. Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 104 Stockholders’ equity: Common stock, no par $ 600 Retained earnings 7,719 Total stockholders’ equity 8,319 Total liabilities and stockholders’ equity $8,423

  35. Static Budgets versus Flexible Budgets • A static budget is a budget for a particular level of activity. • A flexible budgetis a budget that provides a firm with the capability to compute expected costs for a range of activity.

  36. The Uses of Flexible Budget • The flexible budget can be used to prepare the budget before the fact for the expected level of activity. • Flexible budgeting can be used to compute what costs should have been for the actual level of activity. • Flexible budgeting can help managers deal with uncertainty by allowing them to see the expected outcomes for a range of activities.

  37. Flexible Production Budget Range of Production (units) Production Costs 1,000 1,200 1,400 Variable Cost per Unit Variable overhead: Direct materials $4.00 $4,000 $4,800 $5,600 Direct labor 1.20 1,200 1,440 1,680 Variable overhead: Supplies 0.45 450 540 630 Power 0.15 150 180 210 Total variable costs $5.80 $5,800$6,960$8,120 Fixed overhead: Supervision $1,105 $1,105 $1,105 Depreciation 540 540 540 Total fixed costs $1,645$1,645$1,645 Total production costs $7,445 $8,605 $9,765

  38. Performance Report Quarterly Production Costs Actual Budget Variance Units produced1,200 1, 200 ---- Direct materials $4,830 $4,800 $30 U Direct labor 1,440 1, 440 ---- Variable overhead: Supplies 535 540 -5 F Power 170 180-10 F Total variable costs $6,975$6,960$15 F Continued

  39. Performance Report Quarterly Production Costs Actual Budget Variance Units produced1,200 1, 200 ---- Fixed overhead: Supervision 1,055 1,105 -50 F Depreciation 540 540 --- Total fixed costs $1,595 $1,645-$50 F Total production costs $8,570 $8,605 $35 U

  40. Behavior Dimensions of Budgeting • Goal congruence • Dysfunctional behavior • Frequent feedback on performance • Monetary and nonmonetary incentives • Participative budgeting • Realistic standards • Controllability of costs • Multiple measures of performance

  41. Participative budgeting has three potential problems: • Setting standards that are either too high or too low. • Building slack into the budget. • Pseudoparticipation.

  42. Incremental vs. Zero-based Budgeting • Incremental Budgeting : -- the budget process is concerned with the increment in operations or expenditure for the coming budget period • Zero-based Budgeting --requires that all activities are justified and prioritized before decisions are taken relating to amount of resources allocated to each activity --the projected expenditure for existing programs should start from base zero

  43. Activity-Based Budgeting • Activity flexible budgeting is the prediction of what activity costs will be as activity output changes.

  44. Flexible Budget: Direct Labor Hours Cost Formula Direct Labor Hours Direct materials --- $10 $100,000 $200,000 Direct labor --- 8 80,000 160,000 Maintenance $ 20,000 3 50,000 80,000 Machining 15,000 1 25,000 35,000 Inspections 120,000 --- 120,000 120,000 Setups 50,000 --- 50,000 50,000 Purchasing 220,000 --- 220,000 220,000 Total $425,000 $22 $645,000 $865,000 Fixed Variable 10,000 20,000

  45. Activity Flexible Budget Driver: Direct Labor Hours Formula Level of Activity Direct materials --- $10 $100,000 $200,000 Direct labor --- 8 80,000 160,000 Subtotal $0$18$180,000$360,000 Driver: Machine Hours Maintenance $20,000 $5.50 $64,000 $108,000 Machining 15,000 2.00 31,000 47,000 Subtotal $35,000$7.50$95,000$155,000 Fixed Variable 10,000 20,000 Fixed Variable 8,000 16,000 Continued

  46. Activity Flexible Budget Driver: Number of Setups Fixed Variable 25 30 Inspections $80,000 $2,100 $132,500 $143,000 Setups --- 1,800 45,000 54,000 Subtotal $80,000$3,900$177,500$197,000 Driver: Number of Orders Fixed Variable 15,000 25,000 Purchasing $211,000$ 1$226,000$236,000 Total $678,500 $948,000

  47. Activity-Based Performance Report Actual CostsBudgeted CostsBudget Variance Direct materials $101,000 $100,000 $ 1,000 U Direct labor 80,000 80,000 --- Maintenance 55,000 64,000 9,000 F Machining 29,000 31,000 2,000 F Inspections 125,500 132,500 7,000 F Setups 46,500 45,000 1,500 U Purchasing 220,000226,000 6,000 F Total $657,000 $678,500 $21,500 F

  48. Variances for the Inspection Activity Activity Actual Cost Budgeted Cost Variance Inspection: Fixed $ 82,000 $ 80,000 $2,000 U Variable 43,500 52,500 9,000 F Total $125,500 $132,500 $7,000 F

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