Unit Il STRATEGIC COST MANAGEMENT CONCEPTS AND TECHNIQUES FOR PLANNING AND CONTROL Chapter 5 Strategy and the Master Budget 6 Organizational Innovations: Total Quality Management; Just-in-Time Production System 7 The Balanced Scorecard: A Tool to Implement Strategy 8 Cost Planning for Product Life Cycle: Life-Cycle Costing and Long-Term Pricing; Target Costing and Theory of Constraints 9 Decentralized Operations and Segment Reporting 10 Variable Costing: A Tool for Evaluating Management Performance Scanned with CamScannerCHAPTER. STRATEGY AND THE MASTER BUDGET EXPECTED LEARNING OUTCOMES After studying this chapter, you should be able fo... 1. 2. Explain what a budget is and its role in the management process Describe the importance of strategy in budgeting and its relationship to the strategic long-term and short-term goals of the firm Explain the management process of preparing the master budget Prepare a sales budget including a computation of expected cash receipts Prepare a production budget, direct materials budget, direct labor budget including the computation of expected cash disbursements for purchases of material and payment of direct labor Prepare a manufacturing overhead budget and a selling and administrative expense budget and expected cash disbursements relative thereto Prepare a cash budget Prepare a budgeted income stafement and a budgeted statement of financial position Describe the alternative approach in budgeting such as zero-base budgeting, activity-baséd budgeting and Kaizen (Continuous improvement) budgeting 10. Explain the ethical issues in budgeting. ooo Scanned with CamScannerCHAPTER 5 STRATEGY AND THE MASTER BUDGET 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. i ROLE OF A BUDGET 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. Budgets and the budgeting process are intertwined with all aspects of management. In addition to being a plan of operations, a budget plays an important role in allocating resources, coordinating operations, identifying constraints and limitations, and communicating expected actions and results, authorizing activities, motivating and guiding implementation, providing guidelines for control of operations, managing cash flows, and serving as criteria in performance evaluations. In the process of preparing a firm’s budget, managers need to be forward-looking, in evaluating upcoming events and situations as they relate to the firm’s strategic goals, Budget preparation allows management the opportunity and time to work Out any potential problems that the company might meet in the coming periods. The firm is able to minimize if not totally avoid the adverse effects that anticipated Problem could have on operation. Budgeting can also help managers identify Current and potential bottleneck in operation. Critical resources can then be Mustered to ease any bottleneck in operations and prevent them from becoming Obstacles to attaining budgeting goals. Scanned with CamScannerChapter 5 a cae n also mandates coordinating the operating activities of er operations and achieve is of an organizatio its and synchronizing firms to run smooth Completion ofa budget for all units operations among all budgeted uni various department. Budgets help better results, i t | drift that Properly conceived, budgeting can mean the di fference between a general may or may not lead to a desired goal and a carefully plotted aera predetermined objective that holds drift to a minimum. Budget eae decision-making process more effective by helping managers meet unc a . The objective of budgeting is to substitute deliberate, well-conceived business judgment for accidental success in enterprise management. Budgets should not be expressions of wishful thinking but rather descriptions of attainable objectives. IMPORTANCE OF STRATEGY IN BUDGETING As discussed in the earlier chapters, a firm’s strategy is the path it chooses for attaining its long-term goals and mission. It is the starting point in preparing its plans and budgets. For example, a very large and successfull Retail Department Store in the Philippines considers itself the leader of top-of-the-line consumer goods (wardrobe, designer bags and shoes, accessories, housewares, and so forth. One of its departments is the Supermarket and Grocery Department, selling food items, fresh and processed and other household needs. Even though this department is a little bit profitable, for competitive reasons, the firm made a strategic decision to leave this line of business. Subsequent budgets of this firm reflect this strategic decision, Formulation of Strategy The process of determining @ company’s strategy starts with the assessment of external factors that affect operation and evaluating internal factors th be it strength and weakness, See External factors typically include © Competition * Technical, economic politi al, ical, regula é 7 factors Pt regulatory, social and environmental A careful examination of such i iti limitations and threaty. | Sw“ eters can help the firm identify opportunites, Scanned with CamScanner: Strategy and Master Budget _101 Internal factors on the other hand, include operating characteristics such as Financial strength «Managerial talent and expertise e Functional structure, and © Organizational culture Matching the firm’s strengths with its identified opportunities, resources and threats enables it to form its strategy. Having analyzed external factors surrounding the organization and assessed the internal situations it is in, management can match opportunities with strength and competitive advantages of the firm and determine its strategies and long-term opportunities. Figure 5-1 summarizes the activities involved in the development of a firm’s product strategy. Figure 5-1: Development of a Firm’s Product Strategy [Analyze External Factors ‘Assess Internal Conditions Economy Finance Politics Management Technology Structure Regulation Morale Society, Environment ' Culture Competition = Identify Opportunities, Recognize Strengths, Limitations and Threats Weaknesses and Competitive Advantages Match Opportunities with "Strengths and Competitive Advantages of the Firm Finalize Strategic Goals and Long-Term Objectives Scanned with CamScanner102 Chapter 5 Strategic Goals and Long-Term Objectives i =f jectives throu; An organization presents its strategic goals and long-term objecti igh capital budget and master budgets. Strategy provides the framework or parameters within which a ion ae ee = developed. A firm’s long-range plan identifies required actions over a 5-y‘ 10-year period to attain the goals set forth in their strategies. Long Range Planning Long range planning often entails capital budgeting, which is a process of evaluating proposed major projects such as purchases of new equipment, construction of a new factory, and addition of new products and planning for resource requirements. Capital budgets are prepared to bring an organization’s capabilities into line with the needs of its long-rang plan and long-term forecast. An organization's capacity is a result of capital investments made in prior budgeting periods. Capital budgeting is discussed in more details in Chapter 13. Short-Term Objectives and The Master Budget Short-term objectives are goals for the coming period, which can be a month, a quarter, a year, or any length of time desited by the organization for planning Purposes. A firm determines short-term objectives for the budget period based on strategic goals, long-term objectives and plans, operating results of past periods, and expected future operating and environmental factors including economic, industry and marketing conditions, ; Figure 5-1 presents the relationship between Strategic goals, long-term objectives and plan, short-term goals, budget, operations and control. Scanned with CamScannerStrategy and Master Budget 103 Figure 5-2: The Relationship between Strategic Goals, Long-Term Objectives aad Plans, Short-Term Goals, Budget, Operations and Control r Strategic Goals Capital Budget FEEDBACK Controls Scanned with CamScanner104 Chapter 5 TER BUDGET ‘THE MANAGEMENT PROCESS OF PREPARING THE MAS' Top Management Involvement 1s to be involved and show strong. may make the budget od balance of top For a budget to be effective, top management need a interest in budget results. Too much involvement, howev 5 and alienate lower managers. The right answer is a g0 management involvement with lower-level managers. Top management ensures that budget guidelines are being followed through the budget review and approval process. Active involvement by top managem reviewing and approving the proposed budget is an effective way to discourage lower-level managers from playing budget games (¢.g., budgets with easy, target and adding stock to a budget). Budgeting processes usually include formation of a budget committee; determination of the budget guidelines; preparation of the initial budget proposal; budget negotiation, review and approval; and budget revision. Organization for Budget Preparation It is essential that the manager of an entity assigns the most qualified personnel to the preparation of the budget. A budget committee with representation from the different functional areas (marketing, production, finance, and administration) is generally considered an effective body to oversee preparation and administration of the budget. The controller may be selected to serve as head of the committee for two major reasons: (1) Controller's position is independent from the operating parts of the organization, (2) He has the skills and experiences in coping with the intricacies of setting up a budget The controller acts as a coordinator in the budgeting operation, He recommends how budgets should be prepared, assembles the budgets, Prepares periodic reports showing variances of the actual results from the budgeted results, interprets variances and offers suggestions for improvement whenever possible. The budget committee decides how budgets shall be Prepared, passes on the final budget, and settles disputes in one segment of the business and another when differences of opinion arise. The committee also receives budget reports and makes policy decisions with respect to budget revisions and other problems of budget administration, Scanned with CamScannerStrategy and Master Budget _105 Budget Guidelines one of the responsibilities of the budget committee is to provide initial budget ndefines that set the tone for the budget and govern budget preparation. All esponsibility centers (or budget units follow the initial budget guidelines in preparing their budgets. The starting point in developing budget guidelines is the firm’s strategy. In developing the initial budget guidelines, the budget committee also needs to consider development that have occurred since the adoption of the strategic plan; the general outlook of the economy and the market; the goal of the organization for the budgeting period; specific corporate policies such as mandates for downsizing, reengineering, and the operating results of the year to date. The Budget Period Asa general rule, the period covered by a budget should be long enough to show the effect of managerial policies but short enough so that estimates can be made with reasonable accuracy. This suggests that different types of budgets should be made for different time spans. ‘A master budget is an overall financial and operating plan for a coming fiscal period and the coordinated program for achieving the plan. It is usually prepared on a quarterly or an annual basis. Long range budgets called capital budgets, which incorporate plans for major expenditures for plant and equipment or the addition of product lines, might be prepared to cover plans for as long as 5 to 10 years. Responsibility budgets which are segments of the master budget relating to the aspect of the business that is the responsibility of a particular manager are often prepared monthly. Cash budgets may be prepared on a day-to-day or monthly basis. Some companies follow a continuous budgeting plan whereby budgets are constantly reviewed and updated. ‘The updating is accomplished, for example, by extending the annual budget one additional month at the end of each month. A review of the budget may also suggest that the budget be changed as a result of changing business and operating conditions. Scanned with CamScanner106 Chapter 5 The Initial Budget Proposal He let Based on the initial budget guidelines, each responsibility i: preps Seta factors budget proposal. In preparing an initial budget proposa', should be considered by a budget unit. Internal factors: * Introduction of new products. Adoption of new manufacturing processes. Changes in availability of equipment or facilities. Changes in product design or product mix. : Changes in caphetations or operating processes of other budget units that the budget unit relies on for its input materials or other operating factors. * Changes in other operating factors or in the ‘expectations or operating processes in those other budget units that rely on the budget unit to supply them components. External factors: Competitor's actions. © Changes in the labor market. * Availability of raw materials or components and their prices. ¢ — Industry’s outlook for the near term. Budget Negotiation, Review and Approval, Revision The head of the budget units examines the initial budget proposal to determine whether the proposal is within the budget guidelines. The head also checks to see if the budget goals can be reasonably attained and in line with the goals of the budget units at the next level up, and the budgeted operations are consistent with the budgeted activities of another budget unit. Negotiation occur at all levels of the organization. As budget units approve their budgets, the budgets go through the successive levels of the organization until they reach the final level, when the combined unit budgets become the budget of the organization. The budget committee reviews and gives final approval to the budget. The chief executive officer then approves the entire budget and submits the budget to the board of directors. Systematic, periodic revision of the approved budget or the use of a continuous budget can be an advantage in dynamic operations because the updated budget provides better operating guidelines. Regular budget revision, however, may encourage responsibility centers not to prepare their budgets with due diligence. Organizations with systematic budget revisions need to ensure that revisions are allowed only if circumstances have changed significantly. Scanned with CamScannerStrategy and Master Budget _107 ‘The Master Budget er budget is'a comprehensive budget for a specific period. it consists of terrelated operating and financial budgets. Some firms refer to the process as profit planning or targeting. A mast many in of preparing a master budget Figure 5-3 delineates the relationships among components of a master budget. Figure 5-3: The Master Budget 1 Strategie Goals, Long-Term Objectives, ‘and Long-Range Plan 7 i __ [Capital Short-Term Objectives bac [Sales Budget Production Operating Budget Budget Selling and ‘ Administrative Direct Direct Factory Expense Materials | | Labor | | Overhead | Budget__| Budget Budget Budget Cash Budget Pro Forma Financial Statements Financial > Projected Income Statement Budget Projected Balance Sheet \* Projected Cash Flow Statement Scanned with CamScanner108 spter 5 Steps in Developing a Master Budget 7 itlined as follows: ‘The major steps in developing a Master Budget may be ou paiy, Tse will 1. Establish basic goals and long-range plans for oie serve as guidelines in the preparation of budgs 2. Prepare a sales forecast for the budget period. 3. Estimate the cost of sales and operating expenses. aoe 4. Determine the effect of budgeted operating results on assets, bey Pal 7 ep ownership equity accounts. The cash budget is the largest Pe ee since changes in many asset and liability accounts will depend upon flow forecast. 5. Summarize the estimated data in the form of a projected income statement for the budget period, the projected statement of financial position as of the end of the budget period and the projected cash flow statement. Preparation of Comprehensive Master Budget Illustrated Gilbert Manufacturing Company manufactures a special line of tools. As of December 31, 20X 1, the Statement of Financial Position of the firm is as follows: Gilbert Company Statement of Financial Position December 31, 20X1 Assels Equities Current assets Current liabilities Cash P 150,000 Accounts payable P_ 140,000 Accounts receivable 220,000 Taxes payable 156,000 Inventories 592,000 Current portion of Other current assets — 23,000 long-term debt 83,000 Total current assets P 985,000 Total current liabilities P 379,000 Long-term liabilities 576,000 Total liabilities 955,000 Long-term assets = Equity Property, plant and Share capital P. 350,000 equipment 2,475,000 Retained earings 4,305,000 Less: Accumulated Total t 1,655,000 depreciation 850,000 Net P4,625,000 Total Equities 2,610,000 Total assets 2,610,000 as 7 Scanned with CamScannerStrategy and Master Budget _109 following information is available for the development of its Master Budget for 20X2: Estimated sales: Units Price per unit Finished goods inventory: Beginning Ending Work in process inventory: NONE Raw materials: Materials required per unit of finished product Beginning inventory Ending inventory Unit Cost Direct labor Overhead is estimated as follows: Variable: Indirect materials and supplies Materials handling Other indirect labor Fixed: Supervisor labor Maintenance & repair Plant administration Utilities Depreciation Insurance Property taxes Other 6,400 P800 900 units @ P500 1,000 Material 3 units 5 units 2,200 4,000 1,300 4,600 P10 P30 P146 per unit produced P5.85 per unit produced 9.07 per unit 5.07 per unit P175,000 85,000 173,000 87,000 280,000 43,000 117,000 41,000 Scanned with CamScanner110 Chapter 5 ted as follows: Marketing and Administrative expenses are bude Variable Marketing Costs: 40.625 per unt sold Sales commissions 16.250 per unit sold Other marketing costs : Fixed Marketing Costs: 100,000 Sales salaries 493,000 oe 78,000 Administrative costs (all fixed): Administrative salaries eo Data processing services 103, Legal and other professional fees 180,000 Depreciation - building, fumiture and equipment 94,000 Taxes - other than income 160,000 Other 26,000 Additional information: The treasurer's office also provided the following information and estimates: 1) All sales are on account and collections from customers are expected to amount to PS,185,000. 2) Equipment costing P300,000 with accumulated depreciation of P275,000 will be sold at its net book value. New equipment costing P320,000 will be purchased during the year. 3 Accounts payable will increase by P15,000 and assumed to be for materials purchases only. 4) Income taxes will be provided at an average rate of 35% of income before taxes while P252,000 will be paid during the year. 5) Dividends amounting to P140,000 will be Paid during the year and the current portion of the long-term debt shall also be settled at the end of the year. Interest rate is 8% Per annum. REQUIRED: Prepare the Master Budget for Gilbert Ci it December 31, 20X2, eee Based on the above Preliminary data, each of Gilber : os ; : be discussed and illustrated, Company's budgets will now Scanned with CamScannerStrategy and Master Budget eee gece eee ee ERERE eee Cee-eeeerrE aoeereeecere sales Budget e sales budget showing what products will be sold in what quantities at what ices, 1S the foundation on which all other short-term budgets are built. The sales budget triggers a chain reaction that leads to the development of many other budget fguresinan organization. The sales budget provides the revenue predictions from which cash receipts from customers can be estimated and supplies the basic data for constructing budgets for production costs and selling and administrative expenses. In short, the sales forecast is the keystone of the budget structure. The accuracy and reasonableness of the sales data will affect the whole budget. The ais forecast is made after consideration of the following factors. 1. Past sales volume 2, General economic and industry conditions 3, Relationship of sales to economic indicators 41 Relative product profitability 5, Market research studies and competition 6. Pricing, advertising and other promotion policies 7, Production capacity . 8. Quality of sales force 9. Seasonal variations 10. Long-term sales trends for various products For Gilbert Company, the Sales Budget is presented as follows: Schedule 1 Sales Budget For 20X2 Price Total Sales Units Per Unit Revenue Estimated sales 6,400 800 5,120,000 Production Budget After the sales budget has been set, a decision can be made on the level of Production that will be needed for the period to support sales and the production "dget can be set as well. The production budget becomes a key factor in the lane mination of other budgets, including the direct materials budget, the direct budget and the manufacturing overhead budget. These budgets in turn are ‘o assist in formulating a cash budget. Scanned with CamScanner112__ Chapter 5 iously prepared sales budget as well as the inventory Using the data from the prev! ‘on budget is developed. summary information, the following producti oon Production Budget For 20X2 6400 Units to be sold 4000 Add: Desired ending inventory 1 Total 900 Less: Beginning inventory 900 Units to be produced $500 Raw Materials Budget After determining the number of units to be produced, the Raw Materials Purchases can now be prepared, as follows: Schedule 3 Raw Materials Purchases For 20X2 Materials R s Units required for production R (6500 x 3) 19,500 ‘S (6500 x 5) 32,500 Add: Desired ending inventory 4,300 4,600 Total units required 20,800 37,100 Less: Beginning inventory 2,200 4,000 Units to be purchased 18,600 33,100 Unit price xP10 xP30 Total purchases 186,000 993,000 Direct Labor Budget 7 ‘The preliminary data show that the budgeted direct labor cost per unit produced is P146. This must have been arrived at after considering such factors as skills level of the workers, labor rate per hour, time requirement, conditions of union contracts, etc. The direct labor is therefore budgeted as follows: Schedule 4 Number of units to be produced 6,500 Multiply by: Direct labor cost per unit P146 Total budgeted direct labor costs ‘949,000 Scanned with CamScannerStrategy and Master Budget 113 Overhead Costs Budget study of past records will show how the cost reaets to changes in volume or in relation to other factors. Some overhead items may be projected on the basis of direct labor hours or on materials costs or on machine hours. The overhead costs budget for 20X2 is illustrated below using the basic information from the preliminary data previously established. Schedule $ Budgeted Manufacturing Overhead For 20X2 Variable overhead: units needed to produce 6500 units Indirect materials and supplies (@P5.85) P 38,000 Materials handling (@ P9.07) 59,000 Other indirect labor (@P5.07) 33,000 Total 430,000 Fixed manufacturing overhead Supervisor labor 175,000 Maintenance & repairs 85,000 Plant administration 473,000 Uslities 87,000 Depreciation 280,000 Insurance 43,000 Property taxes 117,000 Others __41,000 Total 1,001,000 Total manufacturing overhead 1,131,000 Budgeted Cost of Sales “The Budgeted Cost of Sales Statement can now be developed using the data from the following: Production Budget Schedule 2 Raw Materials Budget Schedule 3 Direct Labor Budget Schedule 4 Overhead Cost Budget Schedule 5 Budgeted Statement of Cost of Sales Schedule 6 Scanned with CamScanner114 Chapter 5 Schedule 6 Budgeted Statement of Cost of Sales For 20X2 Beginning work in process inventory P Manufacturing costs Direct materials Beginning inventory {(2200 R @ P10) + (4000 S @P30) F acon Purchases (Schedule 3) 1.179.000 Total P1,321,000 Less: Ending inventory {(1300 R @ P10) + (1600 $ @ P30) — 151,000 Total direct materials cost P1,170,000 Direct labor (8500 @ P146) 949,000 Manufacturing overhead (Schedule 5) 1,131,000 Total manufacturing cost P3,250,000 Less: Ending work in process inventory - Cost of goods manufactured P3,250,000 Add: Beginning finished goods inventory (900 @ P500) 450,000 Total available for sale P3,700,000 Less: Ending finished goods . E inventory (1000 @ P500) 500,000 Cost of sales 3,200,000 Scanned with CamScannerStrategy and Master Budget 115 Marketing and Administrative Expense Budget As with overhead costs, marketing and administrative expenses are also made up of fixed and marketing variable components. The marketing and administrative expense budget for 20X2 is shown on the next page. Previously provided data are used. : Schedule 7 Budgeted Marketing and Administrative Costs For 20X2 Variable marketing costs Sales commission (6400 @ P40.625) - P 260,000 Others (6400 @ P16.25) 404,000 Total P_ 364,000 Fixed marketing costs Sales salaries P 100,000 Advertising 493,000 Others. 78,000 Total P 371,000 Total marketing costs P._ 735,000 Administrative costs (all fixed) Administrative salaries P 254,000 Data processing services 103,000 Legal and other professional fees 180,000 Depreciation - building, furniture and equipment 94,000 Taxes - other than income 108,000 Others 26,000 Total 765,000 Total marketing and administrative costs P1,500,000 Scanned with CamScanner116 Chapter 5 Cash Budget Cash Receipts He i rs. The possibili Normally, the bulk of a firm’s cash receipts comes from brat aia ine of cash from other sources (such as additional investn : ts ting budget borrowings) should likewise be considered when cash receip' . Cash Disbursements . Data converted from individual budgets previously illustrated supply the basic information for the cash disbursements budget. However, various adjustments and additions will have to be made when preparing the budget for prepayments, accruals as well extraneous items (such as the purchase of new equipment, dividend payment) that do not show up in any of the individual budgets already prepared. If the financial policy of the company requires that a minimum cash balance be maintained at all times, the cash budget must be altered to accommodate bank loans and their repayment. Using the data collected in the various budgets and the information that has been Previously provided, the following Cash Budget Statement is developed. Schedule 8 Gilbert Manufacturing Company Cash Budget For the Budget Year Ending December 34, 20X2 Cash balance, January 1, 20X1 P_ 150,000 Add: Estimated receipts Collections from customers P5,185,000 Sale of assets 25,000 Total 5,210,000 Total cash available 5,360,000 Less: Estimated disbursements Payments for material purchases P4,164,000 Direct labor 949,000 Manufacturing overhead 851,000 Marketing & Administrative expenses 4,458,000 Payments for income tax 252,000 Dividends 140,000 Reduction in long-term debt 83,000 Acquisition of new assets 320,000 Total disbursements 5,217,000 Cash balance, December 31 . P_143,000 + Scanned with CamScannerStrategy and Master Budget 117 Budgeted Income Statement After the cash budget has been completed, Gilbert Company prepares the budgeted income statement showing the net income that is to be expected during the budget period. The information needed to prepare the budgeted income statement comes from the previously provided preliminary data as well as from the company’s other budgets. Schedule 9. Gilbert Manufacturing Company Budgeted Income Statement For the Budget Year Ending December 34, 20X2 Sales (Schedule 1) 5,120,000 Less: Cost of sales (Schedule 6) 3,200,000 Gross profit 1,920,000 Less: Marketing and administrative costs (Schedule 7) 4,500,000 Net operating profit P 420,000 Less: Interest expense * __52,000 * Net income before taxes P 368,000 Less: Provision for income taxes (35%) 128,000 * Net income after taxes 240,000 * * Rounded off. Budgeted Statement of Financial Position The budgeted statement of financial position is developed by beginning with the current statement of financial position and adjusting it for the data contained in the other budgets. Gilbert Company’s budgeted statement of financial position is presented below: Schedule 10 ; Gilbert Manufacturing Company Budgeted Statement of Financial Position December 31, 20X2 Assets Current assets ; Cash (Schedule 8) P 143,000 Accounts receivable 155,000 Inventories 651.000 Other current assets 372000 Total current assets Scanned with CamScanner118 Chapter 5 Long-term assets 7 P2,495,000 net plant and equipment 949,000 Less: Accumulated depreciation 1,546,000 Net 2,518,000 Total assets Equities Current liabilities P 155,000 Accounts payable 32,000 Taxes payable 7 7 Current portion of long-term debt —. Total current liabilities P ce Long-term liabilities et Total liabilities P_ 763,000 Equity Share capital P 350,000 Retained earnings 41,405,000 Total Equities 2,518,000 Budgeting in Service Industries A service organization achieves its budgeted goals and fulfills its mission through providing services. Budgeting for service firms, similar to budgeting for manufacturing’ or merchandising firms, plans for the resources available from operation and the required resources in opérations to fulfill budgeted goals. The difference is in the absence of products or merchandise purchase budget and their ancillary budget. ‘An important focal point in its budgeting is personal planning, A service ftim must ensure that it has personnel with the appropriate skills and competence to perform the services required for the budgeted sales revenue, Budgeting in Not-For-Profit Organization A not-for-profit organization's objective is to provide services efficiently and effectively as mandated in its charter, while not i ww re i arter, not sper ve Domeeeer pending more than the allowed The objecti izati aan of not-for-profit organizations such as governments, state univer or colleges, secondary and primary schools, charity organizations, » and foundations are different from those of for-profit organizations. Scanned with CamScannerStrategy and Master Budget 119 With no clear standard by which to measure performance in delivering services, and with a clear mandate not to exeeed budgeted expenditures, the master budget of a not-for-profit organization often becomes an authorization document for allowable expenditures and activities. In effect, the budget for a not-for-profit organization often becomes the source of both the power and limitations of the budgeted unit. Budgeting in International Setting Subsidiaries or subdivisions of a multinational firm often have their own budgets. They must follow the firm’s budget procedure and coordinate their budgets with other divisions of the firm. A Philippine subsidiary of an international firm in Belgium, for example, must negotiate its budget with the European headquarters or the business unit to which the subsidiary belongs. The superior divisions then approve the budget in sequence until the final approval by the corporate budget committee. Alternative Approaches in Budgeting Zero-Base Budgeting Zero-base budgeting is a budgeting process that requires managers to prepare budgets from a zero base. A typical and traditional budgeting process is an incremental process that starts with the current budget. The process assumes that most, if not all, current activities and functions will continue into the budget period. the primary focus in a typical budgeting process is on changes+to the current operating budget. A zero-base budgeting process on the other hand allows no activities or functions to be included in the budget unless managers can justify their needs. Zero-base budgeting requires managers or budgeting teams to perform in-depth reviews and analyses of all budget items. Such a budgeting process encourages managers to be aware of activities or functions that have outlived their usefulness or have been a waste of resources. A tight, efficient budget often results from zero-base budgeting. Activity-Based Budgeting Activity-based budgeting (ABB) is a budgeting process based on activities and cost drivers of operations. ABB starts with the budgeted output and segregates costs required for the budgeted output into homogenous activity cost pools such as unit, batch, product-sustaining activity cost pools based on similarity of their resource and activity consumption cost drivers. Scanned with CamScanner120 _ Chapter 5 Activity-based budgeting can be a simple extension of a firm’s ee costing systems that has grouped its costs into activity cost pools. The firm needs to review the appropriates of its activity cost pools and accuracy of its activity costs for the budget period, however, before employing them in budgeting. Either internal or external relevant operating factors may have changed and rendered the data from thé current activity-based costing inaccurate or irrelevant, especially when a firm has experienced inexplicable variances. Kaizen (Continuous Improvement) Budgeting Kaizen budgeting is a budgeting approach that explicitly demands continuous improvement in operation processes and incorporates the improvements in the budget. A firm using kaizen budgeting prepares budgets based on the desired future operating processes for the budget period. This is an improvement over the current operating processes, rather than the continuation of the current practices as is often the case in traditional budgeting. It will be noted that continuous improvement (Kaizen) has become a common practice for firms operating in today’s globally competitive environment. Kaizen budgeting begins by analyzing practices to identify areas for improvement and determine expected changes needed to attain the desired improvements. Budgets are prepared based on improved practices or produces. As a result budgeted cost often is lower than those in the preceding period, and the firm expects to be able to manufacture products or render services at a lower cost. ETHICAL ISSUES IN BUDGETING Ethical issues in budgeting include preventit : : avoidance of having a higher budget aol, inclusion ef badgne ae een the budget to avoid having it cut back. Behavioral issues in budgeti and abe ne the difficulty level of budget targets, the drawbacks and advantages of authoritative and participate budgeting processes, the extent of involvem: ert Se in budgeting, and the role of the budget department or controller os ba eet sii geting. Ethical issues permeate all as E q rT | aspects of budgeting. A signi o et : budgeting is provided by people Significant portion of deliberately Ainidh dat fl Employees breach the ede oF cts et : c for budgeting pu of ethics if they performance expectations. Purposes that would lead to lower Scanned with CamScannerStrategy and Master Budget 121 Including budget slack, or padding the budget, is the practice of knowingly including a higher amount of expenditure in the budget than managers truly feel is needed. Managers often justify such practices as insurance against uncertain future events. spending the budget is another serious ethical issue in budgeting. Managers may believe that if they do not use up all the budgeted amounts, future budgets will be reduced. To avoid cuts in their budgets, managers may resort to wasteful spending to exhaust the remaining budgeted amount before the end of the period. As a result, precious resources are wasted on activities that yield little or no benefit to the firm. Or necessary assets are acquired to use up remaining funds. Furthermore, time is wasted on unproductive efforts in trying to use up the budget. Goal Congruence Goal congruence is consistency between the goals of the firm and the goals of its employees. A perfect goal congruence is the ideal for which many firms strive. Realistically, perfect goal congruence almost never exists because resources for satisfying short-term goals of individuals are often in conflict with those of the firm. For example, employees desire to earn a high salary with minimum effort, whereas a firm seeks to pay employees the lower possible compensation while receiving maximum efforts from them. A budget that aligns the goals of the firm with those of its employees has much better chance of leading to successful operations. One approach that encourages goal congruence is avoiding authoritative budgeting and using participative budgeting as much as possible. An employee identifies a budget as their own in participative budgeting, the goals of the firm and those of its employees become the same. Authoritative or Participative Budgeting Budgeting processes are either top down or bottom up. Authoritative budgeting in a top-down budgeting process top management prepares budgets for the entire organization, including those for lower-level operations. A participative budgeting Process, is a bottom-up approach that involves the people affected. by the budget, including lower-level employees, in preparing the budget. Scanned with CamScanner122 Chapter 5 aking control than participative Is for the budget period and An authoritative budget, lower-level managers and etter decision-m: the overall goal attain the goals. art of the f the budget. Authoritative budgeting provides b budgeting. Top management sets prepare a budget for operations to however, often lacks commitment on the pé workers responsible for the implementation 0 levice. The process of preparing icipativ get isa \d communication d A participative budget is a good com evi or gasp of the problems a participative budget often gives top managemen! . their peaple face and enables employees to gain a better understanding of the quandaries top management deals with. A participative budget is more likely to gain the employees’ commitment to fulfill the budgetary goals. Unless properly controlled, however, a participative budget may lead to easy budget targets or targets not in compliance with the organization’s strategy or budget targets. An effective budgeting process therefore usually combines both top-down and bottom-up budgeting approaches. Divisions prepare their initial budgets based on the budget guidelines issued by the firm’s budget committee. Senior managers review and make suggestions to the proposed budget before sending it back to the divisions for revisions. The final budget usually from more participation, not enforced negotiations. Scanned with CamScannerStrategy and The Master Budget _123 REVIEW QUESTIONS, EXERCISES AND PROBLEMS Questions What is a budget? What is budgetary control? Discuss some of the major benefits to be gained from budgeting. What is a master budget? Briefly describe its contents. Describe the flow of budget data in an organization. Who are the participants in the budgeting process, and how do they participate? 5. How can budgeting assist a company in planning its workforce staffing levels? 6. “Asa practical matter, planning and control mean exactly the same thing.” Do you agree? Explain. 7. Budgets are half-used if they serve only as a planning device? Explain. §, What are the two major features of a budgetary program? Which feature is more important? Why? 9. Explain briefly how a budget can be used in costing products. 10, Why must sales and production be coordinated? 11. How can a labor hour budget be translated into a labor cost budget? 12. How are long-range plans for the acquisition of plant assets included in current budgets? Ben 13. What is the budget period? Is a budget prepared for a month, for a year, or for some other interval of time? Explain. 14, What is a rolling, continuous, or progressive budget? 15, Explain how a comparison of actual results with a budget can be applied in the control of operations. 16. Can a comparison of actual results with a budget lead to better future budgets? Explain. 17. What is a self-imposed budget? What are the major advantages of self- imposed budgets? What caution must be exercised in their use? 18. “The principal purpose of the cash budget is to see how much cash the company will have in the bank at the end of the year.” Do you agree? Explain. 19. How does zero-based budgeting differ from traditional budgeting? Scanned with CamScanner124 Chapter 5 a the right column with the i ol Matching Type. Match the definitions enumerated terms on the left column. He 7 AA quantitative benchmark for 1. Sales forecast inensuring company achievement. ing long-range i A budget reflecting Ub eet hi decisions of the company. C. The most important input for budget preparation. All estimates of activity depend upon this information. 3. Responsibility accounting 4. Statement of financial position D. An integrated plan of action for the firm as a whole, expressed in financial term. 5. Performance budget E. A system that relates costs to organizational structure. 6. Objective F. An integrated statement of resource levels and their sources. 7. Capital expenditures budget G. A set of statements providing broad direction for the firm. 8. Profit plan H. The practice of focusing attention on those activities where the actual performance differs significantly from planned performance, 9. Master budget |. A budget prepared after the fact, phowing what costs should have een at the actual level of activity. 10. Goals 1 An operating budget for a specific future period of time. Scanned with CamScannerStrategy and The Master Budget 128 Exercises Exercise 1 (Schedule of Expected Cash Collections) Peak sales for Mideast Products, Inc., occur in August. The company’s sales budget for the third quarter showing these peak sales is given below: duly August September Total Budgeted sales 600,000 900,000 2,000,000 2,000,000 From past experience, the company has learned that 20% of a month’s sales are collected in the month of sale, that another 70% is collected in the month following and that the remaining 10% is collected in the second month following sale. Bad debts are negligible and can be ignored. May sales totaled P430,000 and June sales totaled P540,000. Required: 1. Prepare a schedule of expected cash collections from sales, by month and in total, for the third quarter. 2. Assume that the company will prepare a budgeted statement of financial position as of September 30. Compute the accounts receivable as of that date. Exercise 2 (Production Budget) Rock Telecom has budgeted the sales of its innovative mobile phone over the next four months as follows: Sales in Units July 30,000 August 45,000 September 60,000 October 50,000 The company is now in the process of preparing a production budget for the third quarter. Past experience has shown that end-of-month inventories of finished goods must equal 10% of the next month’s sales. The inventory at the end of June was 3,000 units. Required: Prepare a production budget for the third quarter showing the number of units to be produced each month and for the quarter in total. Scanned with CamScanner126 _ Chapter 5 Exercise 3 (Materials Purchase Budget) ic calculator. Each Mini Products, Inc., has developed a very powerful aan eae calculator requires three small “chips” that cost P2 ction budget from an overseas supplier. Mini Products has prepared abet Vea 3 as for the calculator by quarters for Year 2 and for the first q! shown below. Year 3 Year 2 a First Second Third Fourth First Budgeted Production in. 60,000 90,000 -—‘150,000 calculators 100,000 80,000 The-chip used in production of the calculator is sometimes hard to get, so it is necessary to carry large inventories as a precaution against stockouts. For this reason, the inventory of chips at the end of the quarter must be equal to 20% of the following quarter’s production needs. Some 36,000 chips will be on hand to start the first quarter of Year 2. Required: Prepare a material purchases budget for chips, by quarter and in total, for Year 2. At the bottom of your budget, show the peso amount of purchases for each quarter and for the year in total, Exercise 4 (Direct Labor Budget) The Production Department of the Laguna Plant of JC Corporation has submitted the following forecast of units to be produced at the plant for each quarter of the upcoming fiscal year. The plant produces high-end outdoor barbeque grills. quarter 2" quarter 3" quarter 4 quarter Units to be produced 5,000 4,400 4,500 4,900 Each unit requires 0.40 direct labor-hours and direct labor-hour workers paid PII per hour. Required: 1. Construct the company’s direct labor budget for the upcoming fiscal year, assuming that the direct labor work force is adjusted each quarter to match the number of hours required to produce the forecasted number of units produced. 2. Construct the company’s direct labor budget for the upcoming fiscal year, assuming that the direct labor work force is not adjusted each quarter. Scanned with CamScannerStrategy and The Master Budget 127 Instead, assume that the company’s direct labor work force consists of permanent employees who are guaranteed to be paid for at least 1,800 hours of work each quarter. If the number of required direct labor-hours is less than this number, the workers are paid for 1,800 hours anyway. Any hours worked in excess of 1,800 hours in a quarter are paid at the rate of 1.5 times the normal hourly rate for direct labor. Exerei 5 (Manufact ing Overhead Budget) The direct-labor budget of Kiko Corporation for the upcoming fiscal year contains the following details concerning budgeted direct labor-hours. 1 quarter 2" quarter 3" quarter 4" quarter Budgeted direct labor- hours 5,000 4,800 5,200 5,400 The company’s variable manufacturing overhead rate is P1.75 per direct labor- hour and the company’s fixed manufacturing overhead is P35,000 per quarter. The only noncash item included in the fixed manufacturing overhead is depreciation, which is P15,000 per quarter. Required: 1. Construct the company’s manufacturing overhead budget for the upcoming fiscal year. 2. Compute the company’s manufacturin; overhead rate (including both variable and fixed manufacturing overhead) for the upcoming fiscal year. Round off to the nearest whole centavos. Exercise 6 (Selling and Administrative Budget) The budgeted unit sales of Helene Company for the upcoming fiscal year are provided below: quarter 2" quarter 3" quarter 4" quarter Budgeted unit sales 12,000 14,000 11,000 10,000 ‘The company’s variable selling and administrative expenses per unit are P2.75. Fixed selling and administrative expenses include advertising expenses of P12,000 per quarter, executive salaries of P40,000 per quarter, and depreciation of P16,000 per quarter, In addition, the company will make insurance payments of P6,000 in the 2" Quarter and P6,000 in the 4" Quarter. Finally, property taxes of P6,000 will be paid in the 3% Quarter. Scanned with CamScanner128 _ Chapter 5 owe ae company’s selling and administrative expense budget for the upcoming fiscal year. Exercise 7 (Cash Budget Analysis) w for a retail company (000 omitted). is given belo Giana eeaeint alance of P5,000 to start each quarter. The company requires a minimum cash b Quarter T 2 cy 4 Year Cash balance, beginning POP?) P2+ PP? PP? Add collections from customers eee a5 aor Total cash available BSS Hoe eteeke, 2 2 Less disbursements: Purchase of inventory 40 58 2 32 2 Operating expenses ae ao 54 2 Equipment purchases 10 8 8 2 Dividends BDigraot Deiat Der aD) Total disbursements —2 lo _2 _2 Excess (deficiency) of cash available over disbursements, oa 2 Financing: OO Borrowings 2 20 : 7 2 Repayments (including interest)* = = © oO Total financing 222 59. gy Cash balance, ending P2 p2 pe * Interest will total P4,000 for the year, Required: Fill in the missing amounts in the table above. Scanned with CamScanneregy and The Master Budget 129 Problems Problem 1 (Schedule of Expected Cash Collections and Disbursements) Cookie Products, a distributor of organi fs, a distr rganic beverages, needs a cash September. The following information is available: es a, The cash balance at the beginning of September is P9,000. b. Actual sales for July and August and expected for September as are follows: July August September Cash sales P 6,500 P 5,250 P 7,400 Sales on account 0,000 40,000 Total sales P47,400 Sales on account are collected over a three-month period in the following ratio: 10% collected in the month of sale, 70% collected in the month following sale, and 18%collected in the second month following sale. The remaining 2% is uncollectible. c. Purchases of inventory will total P25,000 for September. Twenty percent of a month’s inventory purchases are paid for during the month of purchase. The accounts payable remaining from August's inventory purchases total P16,000, all of which will be paid in September. 4. Selling and administrative expenses are budgeted at P13,000. for September. Of this amount, P4,000 is for depreciation. e. Equipment costing P18,000 will be purchased for cash during September, and dividends totaling P3,000 will be paid during the month. aintain a minimum cash balance of PS,000. An open f. The company must m able from the company’s bank to bolster the cash line of credit is avail position as needed. Required: 1. Prepare a schedule of expected cash col 2. Prepare a schedule of expected cash dis! inventory purchases. ae , 3. Prepare a cash budget for September. Indicate in the financin; borrowing that will be needed during September. lections for September. bursements during September for g section any Scanned with CamScanner130 Chapter 5 Problem 2 (Production and Purchases Budgets) tailers. One Tiny Toys manufactures and distributes a number of products val P214 in the of these products, Toyclay, requires three pounds of m aehats Heme manufacture of each unit. The company is now planning a ee of Toyelay for the third quarter — July, August, and September. Peak si Slimane occur in the third quarter of each year: To keep. production an ee moving smoothly, the company has the following inventory require! : a. The finished goods inventory on hand at the end of each month must = equal to 5,000 units plus 30% of the next month’s sales. The finishe goods inventory on June 30 is budgeted to be 17,000 units. b. The raw materials inventory on hand at the end of each month must be equal to one-half of the following month’s production needs for raw materials. The raw materials inventory on June 30 for material P214 is budgeted to be 64,500 pounds. c. The company maintains no work in process inventories. A sales budget for Toyclay for the last six months of the year follows: Budgeted Sales in Units July 40,000 Augus 50,000 September 70,000 October.. 35,000 November. 20,000 December 10,000 Required: 1. Prepare a production budget for Toyclay for the months July, August, September, and October. 2. Examine the production budget that you prepared. Why will the company Produce more units than it sells in July and August and less units than it sells in September and October? 3. Prepare a budget showing the quantity of material P214 to be purchased for July, August and September and for the quarter in total. Scanned with CamScannerStrategy and The Master Budget 131 Problem 3 (Cash Budget; I rie get; Income Statement; Statement of Financial The statement of financial position of Picture Thi \ financia This, Inc., a distri photographie supplies, as of May 31 is given below: Pee PICTURE THIS, INC. Statement of Financial Position May 31 Assets Cash. P 8,000 Accounts receivable. 72,000 Inventory..... 30,000 Buildings and equipment, net of depreciation ..... 500,000 Total assets.. 610,000 Liabilities and Equity ‘Accounts payable, suppliers ...... P 90,000 Note payable 15,000 Share capital, no par... 420,000 Retained eamings....... _85,000 Total liabilities and equity.. 610,000 Picture This, Inc., has not budgeted previously, and for this reason itis limiting ite master budget planning horizon to just one month ahead = namely, June. ‘The company has assembled the following budgeted data relating to June: a. Sales are budgeted at P250,000. Of these sales, P60,000 will be for cash; the remainder will be credit sales. One-half of a month's credit sales are collected in the month the sales are made, and the remainder is collected in the month following. All of the May 31 accounts receivable will be collected in June. b. Purchases of inventory are expected to total 200,000 during June. These purchases will all be on account. Forty percent of all inventory purchases are paid for in the month of purchases the remainder is paid in the following month. All of the May 31 accounts payable to suppliers will be paid during June. c. The June 30 inventory balance is budgeted at 40,000. Scanned with CamScannerChapter 5 1,000, exclusive of at PS budgeted Depreciation is 4. Operating expenses for June are, Nee cash, depreciation. These expenses will budgeted at P2,000 for the month. : 7 / - tatement of financial position will be The note payable on the May 31 state! paid gurtg, June: ‘The company’s interest expense for June (on all borrowing) will be P500, which will be paid in cash. f New warehouse equipment costing P9,000 will be purchased for cash during June will borrow P18,000 from its bank by giving a . During June, the company y arenes he b The new note will be due new note payable to the bank for that amount. in one year Required: 1. Prepare a cash budget for June. Support your budget with schedules showing budgeted cash receipts from sales and budgeted cash payments for inventory purchases. Prepare a budgeted income statement for June. Prepare a budgeted statement of financial position as June 30. wr Problem 4 (Sales, Production and Materials Purchases Budget) The following information is made available to you by the management of Nikko Manufacturing Company for the year 20X3: Sales forecast: 80,000 units of its only product at P30 per unit The seasonal variations index based on prior years Operation is as follows: Ist quarter 80 3rd quarter 110 2nd quarter 100 4th quarter 110 A unit of product requires 3 units of raw materials which are purchased at P5.00 per unit. Inventories at the beginning and end of the year are: 7 Beginning End Finished goods 3,000 units 5 000 units Raw materials 12,500 units 15,000 units which are to be maintained at 20% of the succeeding quarter’s éstimated sales and production requirements. Purchases of raw materials are to be made to correspond with budgeted monthly production. Scanned with CamScannerStrategy and The Master Budget _133 Required: 1) Budget of anticipated sales 2) Statement of production required 3) Statement of raw materials purchase requirements. Problem 5 (Schedule of Expected Cash Collections; Cash Budget) Jo Tan, president of JTC Products, has just approached the company’ with a request for a P30,000, 90-day loan. "The purpose ofthe loan is assist the company in acquiring inventories in support of peak April sales. Since the company has had some difficulty in paying off its loans in the past, the loan officer has asked for a cash budget to help determine whether the loan should be made. The following data are available for the months April - June, during which the loan will be used: a. On April 1, the start of the loan period, the cash balance will be P26,000, Accounts receivable on April 1 will total P151,500, of which P141,000 ‘will be collected during April and P7,200 will be collected during May. The remainder will be uncollectible. b. Past experience shows that 20% of a month’s sales are collected in the month of sale, 75% in the month following sale, and 4% in the second venth following sale. The other 1% represents bad debts that are never Collected. Budgeted sales and expenses for the period follow: April May June Sales . ae 200,000 300,000 -—-—P2S0,000 Merchandise purchase: 120,000 180,000, 150,000 Payroll 9,000 9,000 8,000 Lease payments .. 15,000 15,000 15,000 Advertising 70,000 80,000 60,000 ipment purchases. 8,000 - - pe eeitien os 10,000 10,000 10,000 ¢. Merchandise purchases are paid in full during the month following purchase. vAceounts payable for merchandise purchases on March 31, which will be paid during April, total P108,000. d._ In preparing the cash budget, assume that in April and repaid in June. Interest on th t the P30,000 loan will be made ¢ Joan will total P1,200. Scanned with CamScanner134 Chapter 5 topes a schedule of expected cash collections for April, May, and June and for the three months in here and in total, for the ee 2. Prepare a cash budget, by mont! 3. itthe company needs a minimum cash balance of P20,000 to start each month, can the loan be repaid as planned? Explain. Problem 6 (Flexible Budget) Factory Overhead Flexible Budget Preparation Summary flexible overhead budgets are to be prepared for two departments of Summer Machine Company. Budget data follows: Department I Manufacturing overhead varies at the rate of P6.50 for each machine hour, and the fixed manufacturing overhead is budgeted for the year at P300,000. At normal capacity, the department should operate at 200,000 machine hours. Department 2 ¢ Manufacturing overhead varies at the rate of P7.00 for each direct labor hour, and the fixed manufacturing overhead is budgeted for the year at P500,000. At normal capacity, the department should operate at 400,000 machine hours. One direct labor is equal to two machine hours. Required: Prepare in summary form a flexible budget for each department showing costs at normal capacity, at 90, 80, 70, and 60 percent of normal capacity. Scanned with CamScannerStrategy and The Master Budget 135 Problem 7 (Cash Budget with Supporting Schedules) Ju Products, Inc., is a merchandisin, it Ine. is am 1g Company that sells binders, other school supplies. ‘The company is planning its cash needs for the it quarter. In the past, Ju Products has had to borrow money during the third quarter to support peak sles of back-to-school materials, which oseur during ugust. The following information has been assembled to assist i i a cash budget for the quarter: pete a. Budgeted monthly absorption costing income statements for July-October are as follows: July August September October Sales 40,000 P70,000 50,000 Pas Cost of goods sold 24,000 _42,000 300m) "ara Gross margin 16,000 "28,000 “20000 “18,000 Selling and administrative expenses: Seling expense 7,200 11,700 8.500 7,300 Administrative expense* 5600 _7,200 8,100 5.900 Total expenses 12,800 “18,900 14600 13.200 ‘Net operating income 3200 pein ps4 p4,800 * Includes P2,000 depreciation each month. Sales are 20% for cash and 80% on credit. > c. Credit sales are collected over a three-month period with 10% collected in the month of sale, 70% in the month following sale, and 20% in the second month following sale. May sales totaled P30,000, and June sales totaled P36,000. d. Inventory purchases are paid for within 15 days. Therefore, 50% of a month’s inventory purchases are paid for in the month of purchase. The remaining 50% is paid in the following month. Accounts payable for inventory purchases at June 30 total P11,700. ° e. The company maintains its ending inventory levels at 75% of the cost of the merchandise to be sold in the following month. The merchandise inventory at June 30 is P18,000. f. Land costing P4,500 will be purchased in July. g. Dividends of P1,000 will b declared and paid in September. h. The cash balance on June 30 is P8,000; the company must maintain a cash balance of at least this amount at the end of each month. Scanned with CamScanner