Report on the different types of budgets that provide management accounting info
ID: 2580342 • Letter: R
Question
Report on the different types of budgets that provide management accounting
information that might be used by organisations.
Prepare a list under the headings:
1. Title of report/budget.
2. Department/area to which the budget is applicable.
3. Primary function of the budget.
4. Supported by data from which departments/area.
5. Users including those outside of management.
Identify and collect 10 samples of reports and budgets. Make a list of these
reports/budgets, their primary function and the person or department for whom
they are prepared.
Explanation / Answer
Four Types of Budgets
Budget Types and Characteristics
Type of Budget
Caracteristics of the Technique
Type of cost or Expenditure
Examples
Appropriation Budget
A maximum amount is established for certain expenditures based on management judgment.
Discretionary costs.
Employee training, advertising, sales promotion and research and development.
Flexible Budget
A static amount (a) is established for fixed costs and a variable rate (b) is determined per activity measure for variable costs, i.e., Y = a + bX
The static amount (a) includes both discretionary and committed costs while the flexible part (b) includes engineered costs per X value.
The static part: salaries, depreciation, property taxes and planned maintenance. The flexible part: direct material, direct labor and variable overhead. Also, some costs related to sales reps such as sales commissions and travel.
Capital Budget
Decisions concerning potential investments are made using discounted cash flow techniques.
Committed costs.
New plant and equipment.
Master
Budget
A comprehensive plan is developed for all revenue and expenditures.
Discretionary, engineered and committed costs.
All revenue and expenditures for any company.
PREPARING A MASTER BUDGET
THE OPERATING BUDGET
Preparing an Operating Budget is a sequential process of developing nine sub-budgets. Except for one or two exceptions the sub-budgets must be prepared in the following order: sales, production, direct materials, direct labor, factory overhead, ending inventory, cost of goods sold, selling & administrative and income statement (see Exhibit 9-4). Each part is described below.
1. SALES BUDGET
Developing a sales budget involves the following calculations:
Budgeted Sales $ = (Budgeted Unit Sales)(Budgeted Sales Prices)
Current Period Cash Collections = Current Period Cash Sales + Current Period Credit Sales Collected in Current Period + Prior Period Credit Sales Collected in Current Period
These calculations are relatively simple, but where does the budget director obtain this information? Well, sales forecasting is a marketing function. Sales estimates are frequently generated by the company's sales representatives who discuss future needs with customers (wholesalers and retailers). Statistical forecasting techniques can also be used to make estimates of expected future sales, considering the company's previous sales performance and various assumptions about the future economic climate, and the actions of competitors and consumers. Pricing is also a marketing function, but many prices are based on costs plus a markup (the supply function) and consideration of what consumers are willing and able to pay for the product (the demand function). Thus, the budgeted sales price is usually determined after the budgeted unit cost has been calculated (see 6b. below).
The information needed to develop an equation for collections is provided by the finance department and is normally based on past experience. These calculations are somewhat more involved than they appear to be in the equation above because of the effects of cash discounts and the time lags between credit sales and collections. Cash discounts are frequently used to speed up cash inflows. This puts the funds back to work sooner and reduces the need for short term loans. However, even with a generous cash discount for prompt payment, collections for credit sales are typically spread out over several months. The examples illustrated below provide some of the possibilities.
2. PRODUCTION BUDGET
Preparing a production budget includes consideration of the desired inventory change as follows:
Units To Be Produced = Budgeted Unit Sales (from 1) + Desired Ending Finished Goods - Beginning Finished Goods
The desired ending inventory is usually based on the next periods sales budget. Considerations involve the time required to produce the product, (i.e., cycle time or lead time) as well as setup costs and carrying costs. In a just-in-time environment the desired ending inventory is relatively small, or theoretically zero in a perfect situation. In the examples and problems in this chapter, the ending finished goods inventory is stated as a percentage of the next period's (month's) unit sales.
3. DIRECT MATERIAL BUDGET
The direct materials budget includes five separate calculations.
a. Quantity of Material Needed for Production = (Units to be Produced)(Quantity of Material Budgeted per Unit)
The quantity of material required per unit of product is determined by the industrial engineers who designed the product. Materials requirements are frequently described in an engineering document referred to as a "bill of materials".
b. Quantity of Material to be Purchased = Quantity of Material Needed for Production + Desired Ending Material - Beginning Material
This calculation is more involved than equation 3b appears to indicate because it includes information for two future periods. The desired ending materials quantity is normally based on the next period's (month's) materials needed for production and this amount depends on the third period's budgeted unit sales. Of course inventories of raw materials (just like finished goods) are kept to a minimum in a JIT environment. Factors that influence the desired inventory levels include the reliability of the company's suppliers, as well as ordering and carrying costs.
c. Budgeted Cost of Material Purchases = (Quantity of Material to be Purchased)(Budgeted Material Prices)
This amount is needed to determine cash payments. Once the quantity to be purchased has been determined, the cost of purchases is easily calculated. Budgeted material prices are provided by the purchasing department.
d. Cost of Material Used = (Quantity needed for Production)(Budgeted Material Prices)
The cost of materials used is needed in the cost of goods sold budget below.
e. Cash Payments for Direct Material Purchases = Current Period Purchases Paid in Current Period + Prior Period Purchases Paid in Current Period
The information needed to determine budgeted cash payments is provided by accounting, (accounts payable) and is usually based on past experience. Normally the budget should reflect a situation where the company pays promptly to take advantage of all cash discounts allowed, thus 3e may be equal to 3c.
4. DIRECT LABOR BUDGET
Fewer calculations are needed for direct labor than for direct materials because labor hours cannot be stored in the inventory for future use. Time can be wasted, but not postponed.
a. Direct Labor Hours Needed For Production = (Units to be Produced)(D.L. Hours Budgeted per Unit)
The amount of direct labor time needed per unit of product is determined by industrial engineers. Estimates are frequently made using a technique referred to as motion and time study. This involves measuring each movement required to perform a task and then assigning a precise amount of time allowed for these movements. The cumulative time measurements for the various tasks required to produce a product provide the estimate of a standard time per unit. There are alternative techniques that are less expensive, but motion and time study provides estimates that are very precise. Learning curves provide another quantitative technique that is helpful in establishing labor standards.
b. Budgeted Direct Labor Cost = (D.L. Hours needed for Production)(Budgeted Rates Per Hour)
The budgeted rates per hour for direct labor are provided by the human resource department. Frequently the labor (union) contract provides the source for this information. Many different types of labor may be required with different levels of expertise and experience. Thus, Equations 4a and 4b may include several calculations.
5. THE FACTORY OVERHEAD BUDGET
The factory overhead budget is based on a flexible budget calculation as described in Exhibit 9-3. More specifically, the calculation is as follows:
a. Budgeted Factory Overhead Costs = Budgeted Fixed Overhead + (Budgeted Variable Overhead Rate)(D.L. Hours needed for Production from 4a)
This is a cumulative equation that combines the equations for the company's various types of indirect resources. This same idea was illustrated in Chapter 4 when introducing predetermined overhead rates. The predetermined overhead rates developed in Chapter 4 and the budgeted overhead rates discussed in this chapter are conceptually the same.
A plant wide rate based on direct labor hours is used as the overhead allocation basis in this chapter and subsequent chapters mainly to simplify the illustrations. Keep in mind however, that although many companies are still using a single production volume based measurement for overhead allocations, most companies use departmental rates and many companies are now using activity based rates.
The calculation for cash payments reflects one of the differences between cash flows and accrual accounting. Since some costs, like depreciation, do not involve cash payments in the current period, these costs must be subtracted from the total overhead costs to determine the appropriate amount.
b. Cash Payments for Overhead = Budgeted Factory Overhead Cost - Depreciation and other costs that do not require cash payments
Alternative Calculation for Budgeted Factory Overhead Costs
Although budgeted factory overhead costs can be calculated in the manner presented above, there is an alternative approach that illustrates the difference between budgeted and standard costs. Budgeted factory overhead costs can be calculated by determining the standard factory overhead costs and then adjusting for the planned production volume variance. The planned production volume variance is similar to the capacity (or idle capacity) variance illustrated in Chapter 4. It is the difference between the denominator inputs used to calculate the overhead rates, i.e., direct labor hours in our example, and the budgeted direct labor hours needed for production, multiplied by the budgeted fixed overhead rate.
The alternative calculation for factory overhead costs is:
Budgeted factory overhead costs = (Total budgeted overhead rate per hour)(D.L. hours needed for production from 4a)
+ Unfavorable planned production volume variance or - Favorable planned production volume variance
Multiplying the total overhead rate by the number of direct labor hours needed for production provides the standard or applied overhead costs. However, if the number of direct labor hours needed for planned production (i.e., budgeted hours) is not equal to the number of hours used to calculate the overhead rates (i.e., denominator hours), then standard fixed overhead costs will not be equal to budgeted fixed overhead costs. The difference is the planned production volume variance.
6. ENDING INVENTORY BUDGET
The dollar amount for the ending inventory of finished goods is needed below to determine cost of goods sold. The dollar amounts for ending direct materials and finished goods are needed for the balance sheet.
a. Ending Direct Materials = (Desired Ending Materials from 3b)(Budgeted Prices)
b. Budgeted or Standard Unit Cost = (Quantity of D.M. required per Unit)(Budgeted Prices) + (D.L. Hours required per Unit)(Budgeted Rate)
+ (Total Overhead Rate)(D.L. Hours required per Unit)
The budgeted or standard unit cost can be calculated at any time after the budgeted quantities per unit and input prices are obtained. The calculation is placed here because it is needed for 6c.
c. Ending Finished Goods = (Desired Ending Finished Goods from 2)(Budgeted Unit Cost)
7. COST OF GOODS SOLD BUDGET
Cost of goods sold is needed for the income statement. One method of determining budgeted COGS involves accumulating the amounts from the previous sub-budgets as follows.
a. Budgeted Total Manufacturing Cost = Cost of Direct Material Used (from 3d.) + Cost of Direct Labor Used (from 4b.)
+ Total Factory Overhead Costs (from 5a.)
b. Budgeted Cost of Goods Sold = Budgeted Total Manufacturing Cost (from 7a.) + Beginning Finished Goods (from previous ending or calculate from 2 and 6b) - Ending Finished Goods (from 6c or calculate from 2 and 6b)
This is the same approach used in Chapter 2 to determine cost of goods sold, but when developing a budget we typically assume no change in Work in Process. Therefore, budgeted cost of goods manufactured is equal to budgeted cost of goods sold.
Alternative Calculation for Budgeted Cost of Goods Sold
Budgeted cost of goods sold can also be calculated by determining standard cost of goods sold, and then adjusting for the planned production volume variance. The alternative calculation for cost of goods sold is:
Budgeted Cost of Goods Sold = (Budgeted unit sales)(Budgeted unit cost)
+ Unfavorable planned production volume variance
or - Favorable planned production volume variance
Although budgeted unit cost equals standard unit cost, budgeted cost of goods sold is not equal to standard cost of goods sold. Again, the difference between standard and budgeted costs is the production volume variance. There are two reasons to become familiar with this alternative. First, it helps strengthen your understanding an important concept that appears again in subsequent chapters, e.g., Chapters 10 and 12. A second reason is that the alternative approach provides a much faster way to calculate budgeted cost of goods sold. Therefore it can be used as a stand alone method, or as a way to check the accuracy of your calculations in 7a and b.
You may wonder why a company would plan a production volume variance in the budget. This occurs because the denominator activity for a particular month is normally the average monthly production based on one twelfth of the planned production for the entire year. The denominator may also be an average based on normal, practical, or theoretical maximum capacity for the year. When the planned production for a particular month is higher or lower than the monthly average, a planned production volume variance results.
8. SELLING & ADMINISTRATIVE EXPENSE BUDGET
The preparation of the selling and administrative expense budgets is very similar to the approach used for factory overhead.
a. Budgeted Selling and Administrative Expenses = Budgeted Fixed Selling & Administrative Expenses + (Bud Variable Rate as a Proportion of Sales $)(Budgeted Sales $)
b. Cash Payments for Selling & Administrative Expenses = Budgeted Selling & Administrative Expenses - Depreciation and other cost which do not require cash payments
Although we will place less emphasis on this part of the master budget, (mainly to simplify the illustrations) these costs are usually significant. Also remember that many appropriation budgets (treated as fixed costs) may be included, particularly for certain administrative costs. In addition, as pointed out earlier in the text, a more precise traceable costing approach might be used for management purposes where some selling and administrative costs are allocated (i.e., traced to products) in determining a more precise product cost. Remember however, that selling and administrative costs are treated as expenses (period costs) in the conventional inventory valuation methods.
9. BUDGETED INCOME STATEMENT
Preparing the budgeted income statement involves combining the relevant amounts from the sales, cost of goods sold and selling & administrative expense budgets and then subtracting interest, bad debts and income taxes to obtain budgeted net income. These amounts are provided by the finance department. In a comprehensive practice problem, the applicable amount for interest expense may need to be calculated from information associated with the cash budget. Bad debt expense is based on the expected proportion of un collectibles stated in the information related to cash collections.
a. Budgeted Sales $ - Budgeted Cost of Goods Sold = Budgeted Gross Profit
b. Budgeted Gross Profit - Budgeted Selling & Administrative Expenses = Operating Income
c. Operating Income - Interest Expense - Bad Debts Expense = Net Income Before Taxes
d. Net Income Before Taxes - Income Taxes = Net Income After Taxes
THE FINANCIAL BUDGET
The financial budget includes the cash budget, the capital budget and the budgeted balance sheet.
10. CASH BUDGET
a. Budgeted Cash Available = Beginning Cash Balance + Budgeted Cash Collections from 1
b. Budgeted Cash Excess or Deficiency = Budgeted Cash Available - Budgeted Cash Payments from 3e, 4b, 5b and 8b
c. Ending Cash Balance = Cash Excess or Deficiency + Borrowings - Repayments including Interest
11. BUDGETED BALANCE SHEET
Preparing the budgeted balance sheet involves accumulating information from the previous period’s balance sheet, the various operating sub-budgets, the cash budget and other accounting records.
ASSETS
a. Current Assets:
Cash (from the cash budget 10c)
Accounts Receivable (from the sales budget and previous balance sheet)
Direct materials (from the ending inventory budget 6a)
Finished goods (from the ending inventory budget 6c)
b. Long Term Assets:
Land (from previous balance sheet and budgeted activity)
Buildings (from previous balance sheet and budgeted activity)
Equipment (from previous balance sheet and budgeted activity)
Accumulated depreciation (from the accounting records)
Total Assets
LIABILITIES
c. Current Liabilities:
Accounts Payable (from various operating sub-budgets)
Taxes Payable (from income statement)
d. Long term Liabilities
Total Liabilities
SHAREHOLDERS EQUITY
e. Common Stock (from previous balance sheet and budgeted activity)
f. Retained Earnings (from previous balance sheet and income statement)
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
Budget Types and Characteristics
Type of Budget
Caracteristics of the Technique
Type of cost or Expenditure
Examples
Appropriation Budget
A maximum amount is established for certain expenditures based on management judgment.
Discretionary costs.
Employee training, advertising, sales promotion and research and development.
Flexible Budget
A static amount (a) is established for fixed costs and a variable rate (b) is determined per activity measure for variable costs, i.e., Y = a + bX
The static amount (a) includes both discretionary and committed costs while the flexible part (b) includes engineered costs per X value.
The static part: salaries, depreciation, property taxes and planned maintenance. The flexible part: direct material, direct labor and variable overhead. Also, some costs related to sales reps such as sales commissions and travel.
Capital Budget
Decisions concerning potential investments are made using discounted cash flow techniques.
Committed costs.
New plant and equipment.
Master
Budget
A comprehensive plan is developed for all revenue and expenditures.
Discretionary, engineered and committed costs.
All revenue and expenditures for any company.