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Using Budgets to Achieve Organizational ObjectivesChapter 11Learning Objective 1Identify the primary role of budgets and budgeting in organizations.Capacity-Related and Flexible ResourcesuWhat are flexible costs?uThey are costs that vary with the activity level in the organization.uWhat are committed costs?uThey are costs that do not change with changes in activity level.uThe budgetary process determines the level of most committed costs.Planning and Control and the Role of BudgetsuWhat is a budget?uIt is a quantitative expression of the money inflows and outflows that reveals whether a financial plan will meet organizational objectives.uWhat is budgeting?uIt is the process of preparing budgets.Planning and Control and the Role of BudgetsuBudgets are a central part of the design and operation of management accounting systems.uBudgets also provide a way to communicate the organizations short-term goals to its members.uBudgeting serves to coordinate the organizations activities.Planning and Control and the Role of BudgetsuBudgeting is a tool that forces coordination of the organizations activities and helps identify coordination problems.uBudgets are prepared for specific time periods.uDifferences between actual results and the budget plan are called variances.Planning and Control and the Role of BudgetsIdentify Organization Objectives and Short-Term GoalsDevelop Long-Term Strategy and Short-Term PlansDevelop MasterBudgetMeasure and AssessPerformanceReevaluate Objectives,Goals,Strategy,and PlansPlanningControlPlanning and Control and the Role of BudgetsuBudgeting involves forecasting the demand for three types of resources.uFlexible resources that give rise to variable costsuIntermediate-term capacity resources that give rise to capacity-related costsuLong-term capacity resources that give rise to capacity-related costsLearning Objective 2Demonstrate the importance of each element of the budgeting process.Budgeting uThe budgeting process describes the broad activities performed during the budget period.uPlanners can select any budget period,but usually choose one year.Elements of Budgeting1.Organization Goals3.Capital Spending Plan2.Sales Plan5.Production Plan8.Labor Hiring and Training Plan10.Expected Financial Results4.Inventory Policy6.Productive Capacity7.Materials Purchasing Plan9.Administrative and Discretionary Spending Plan 11.Statement of Expected Cash Flows12.Projected Financial StatementsLearning Objective 3Explain the different types of operating budgets and financial budgets and their interrelationships.Master Budget OutputsuThe master budget includes two sets of outputs:The expected or projectedfinancial resultsThe plans or operating budgetsOperating BudgetsuOperating budgets typically consist of six operating plans:uThe sales plan identifies the planned level of sales for each product.uThe capital spending plan specifies the long-term capital investments.uThe production plan schedules all required purchasing activities.Operating Budgets4The materials purchasing plan schedules all required purchasing activities.5The labor hiring and training plan specifies the number of people the organization must hire or release.6The administrative and discretionary spending plan includes administration,staffing,research and development,and advertising.Financial BudgetsuPlanners usually present the projected financial results,or financial budgets,in three forms:uA statement of expected cash flowsuThe projected(pro forma)balance sheetuThe projected(pro forma)income statementFinancial BudgetsuFinancial analysts use the statement of projected cash flows in two ways:uTo plan when excess cash will be generated so that they can undertake short-term investmentsuTo organize how to meet any cash shortagesLearning Objective 4Describe the way that organizations effectively use and interpret budgets.The Budgeting ProcessuWhat is a demand forecast?uIt is the estimate of the market demand,or sales potential,for a product given the specific product price.uThis forecast drives the budgeting process.uWhat is the production plan?uIt identifies the intended production during each sub-period of the annual budget.The Budgeting ProcessuHow frequent can budget sub-periods be?udailyuweeklyumonthlyuPlanners use the inventory policy along with the sales plan to develop the production plan.The Budgeting ProcessuWhat is aggregate planning?uIt is an approximated determination of whether the organization has the capacity to undertake a proposed production plan.uWhat are spending plans?uThey are tentative resource commitments.The Budgeting ProcessuWhat are examples of spending plans?Materials purchasingplansLabor hiring andtraining planAdministrative anddiscretionaryspending planCapital spendingplanThe Budgeting ProcessuWhat resources determine capacity levels?uFlexible resources that the organization can acquire in the short termuCommitted resources that the organization must acquire for the intermediate termuCommitted resources that the organization must acquire for the long termCapacity Types and Commitment TimeTermFlexible resources required in short term(less than several weeks)Type of Capacity AcquiredProvides the ability to useexisting capacityExamplesRaw materials,supplies,casual laborCapacity Types and Commitment TimeTermCommitted resources acquired for theintermediate term(up to six months)Type of Capacity AcquiredGeneral purpose capacity that istransferable between organizationsExamplesPeople,general purpose equipment,specialty raw materialsCapacity Types and Commitment TimeTermCommitted resources acquired for thelong-term(more than six months)Type of Capacity AcquiredSpecial purpose capacity that is customizedfor the organizations useExamplesBuildings,special purpose equipmentInterpreting the Production PlanuProduction is the minimum of demand and capacity.Production=Minimum(production capacity,total demand)The Financial PlansuOnce planners have developed the production,staffing,and capacity plans,they can prepare a financial summary of the tentative operating plans.uWhat is a line of credit?uIt is a short-term financing arrangement,with a pre-specified limit,between an organization and a financial institution.The Cash Flow Statement Projected Cash Flow StatementCash inflows from sales and collectionsof receivablesCash outflows for:Short-term flexible resources Intermediate-term committed resources Long-term committed resourcesResults of financing operationsThe Cash Flow StatementFormat of Cash Flow StatementCash inflows Cash outflows=Net cash flowThe Cash Flow StatementFormat of Financing Section of Cash Flow StatementNet cash flow from operations+Opening cash Cash invested or withdrawn Cash provided or used in issuing or retiring stock or debt=Cash available before short-tem financing Cash used or provided by short-term financing=Ending cashUsing the Projected ResultsuPlanners use budget information to.uidentify broad resources requirements.uidentify potential problems.ucompare projected operating and financial results.Cost-Volume-Profit AnalysisuConventional cost-volume-profit analysis rests on several assumptions.uWhat are some of these assumptions?uAll of an organizations costs are either flexible or capacity related.uUnits made equals units sold.uRevenue per unit does not change as volume changes.Cost-Volume-Profit AnalysisuWhat is the contribution margin?uIt is the selling price less all flexible costs.uWhat is the break-even point in units?Capacity-Related CostsContribution Margin Per UnitCost-Volume-Profit AnalysisuAssume Princeton Company manufactures three products:Plastic valves,metal valves,and specialty valves.uCapacity related costs are$20,400,000.Plastic Metal Specialty Unit Sales 500,000 425,000 400,000 Contribution Margin$14$15$13Cost-Volume-Profit AnalysisuWhat is the weighted average contribution margin?uPlastic valves:$14 500,000 1,325,000uMetal valves:$15 425,000 1,325,00uSpecialty valves:$13 400,000 1,325,00u$14.0189Cost-Volume-Profit AnalysisuWhat is the breakeven in units?u$20,400,000$14.0189=1,455,178 uHow many plastic valves?u1,455,178 500,000 1,325,000=549,124uHow many metal valves?u1,455,178 425,000 1,325,000=466,755Learning Objective 5Undertake what-if and sensitivity analysis two important budgeting tools used by budget planners.What-If AnalysisuWhat is“what-if”analysis?uIt is a strategy that uses a model to predict the results of varying key parameters or estimates.Sensitivity AnalysisuWhat is sensitivity analysis?uIt is the process of selectively varying a plans or a budgets key estimates.uIf small changes in parameters produce large changes in decisions or results,the plan is said to be sensitive to the estimates.Learning Objective 6Identify the role of budgets in service and not-for-profit organizations.The Role of Budgeting in Service and Not-For-Profit OrganizationsuThe role for budgeting in planning and control is as important in not-for-profit and government organizations as it is in profit seeking organizations.The Role of Budgeting in Service and Not-For-Profit OrganizationsOrganization Focus of Budgeting Type ProcessManufacturing Sales and manufacturing activities Natural resources Sales,resource availability,and acquisitionService Sales activities,and staffing requirementsNonprofit Raising revenues and controlling expendituresThe Role of Budgeting in Service and Not-For-Profit OrganizationsuWhat is an appropriation?uIt is an authorized spending limit in a governmental department.uWhat is a periodic budget?uIt is a budget prepared for a specified period of time.uusually one yearThe Role of Budgeting in Service and Not-For-Profit OrganizationsuWhat is continuous budgeting?uIt is the process that organizes the budget into subintervals.uAs each budget subinterval ends,the organization drops the completed subinterval from the budget and adds the next budget subinterval.Controlling Discretionary ExpendituresuOrganizations use three general approaches to budget discretionary expenditures.Incremental BudgetingZero-Based BudgetingProject FundingControlling Discretionary ExpendituresuWhat is incremental budgeting?uIt is an approach to developing appropriations for discretionary expenditures that assumes that the starting point for each discretionary expenditure item is the amount spent on it in the previous budget.Controlling Discretionary ExpendituresuWhat is zero-based budgeting?uIt is an approach to developing appropriations for discretionary expenditures that assumes that the starting point for each discretionary expenditure item is zero.Controlling Discretionary ExpendituresuWhat is project funding?uIt is an approach to developing appropriations for discretionary expenditures that organizes appropriations into a package that focuses on achieving some defined output.Controlling Discretionary ExpendituresuA recent phenomenon has been the rise of activity based budgeting.uActivity based budgeting uses knowledge about the relationship between production units and the activities required to produce those units to develop detailed estimates of activity requirements.Learning Objective 7Recognize the behavioral effects of budgeting on an organizations employees.Managing the Budget ProcessuWho should manage and oversee the budgeting process?uMany organizations use a budget team.uThe budget team usually reports to a budget committee which generally includes the chief executive officer.Behavioral Aspects of BudgetinguThere are two interrelated behavioral issues in budgeting:uDesigning the budget processuInfluencing the budget processDesigning the Budget ProcessuWhat is authoritative budgeting?uIt is a budget in which superiors tell subordinates what their budget will be.uWhat are stretch targets?uThey are targets that exceed previous targets by a significant amount and usually require an enormous increase in a goal over the next budgeting period.Designing the Budget ProcessuWhat is participative budgeting?uIt is a method of budget setting that involves a joint decision making process in which all parties agree about setting the budget targets.Designing the Budget ProcessuWhat is consultative budgeting?uIt is a budgeting method whereby managers ask subordinates to discuss their ideas about the budget,but no joint decision making occurs.Influencing the Budget ProcessuWhat is influencing the budget process?uIt is when people try to influence or manipulate the budget to their own ends.uManagers have been known to play budgeting games in which they attempt to manipulate information and targets to achieve as high a bonus as possible.End of Chapter 11
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