Topic 4 - Budgetary-MaiNguyen

Accounting Principles, Sunderland Program, 12/10/2021
Banking Academy
T1
Topic 4:
Budgeting
&
Budgetary control
Learning Outcome 4:
Prepare budgets for planning, control and decision making
using speadsheet
01 Nature & Purpose of budgeting
02 Budget preparation
Contents
03 Budgetary control
Standard cost system & variance

04 analysis
Practical example
05
Nguyen Thi Thanh Mai 1

Slide 1
T1 Test, 10/09/2021
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Introduction: Hillerich & Bradsby Co.

The family-owned company that makes the famous Louisville Slugger®
baseball bat, Hillerich & Bradsby Co., began as a woodworking shop
in 1856, making everything from balustrades to bedposts. By 1875, the
little company was employing 20 people.
In 1919, the company launched its first national advertising campaign.
Just four years later, the company was producing one million bats a
year.
In 1954, Hillerich & Bradsby purchased a Pennsylvania timber company
to ensure an adequate supply of high-quality white ash for their bats. In
1970, the company began making aluminum baseball bats and, in 1975,
they began selling baseball and softball gloves. In 2019, Hillerich &
Bradsby marked their 135th anniversary of the Louisville Slugger®.
Introduction: Budgeting
Companies such as Hillerich & Bradsby use
budgeting in the following ways:
1. To assign decision-making authority
over the company’s resources.
2. To coordinate and implement plans.
3. To hold employees accountable for the
results of their decision making.

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Illustration: Network Technologies, Inc.

In January 2020, Nancy Conrad founded Network
Technologies, Inc. (NTI). NTI manufactures a screening
device designed to safeguard personal computers
against viruses transmitted through networks.
Operating from a small manufacturing facility in
Baltimore, NTI struggled through its first nine months of
operations. However, the company experienced a very
strong fourth quarter and managed to finish the year with
total sales of $900,000 and a net income of $144,000.
Profit Rich, Yet Cash Poor

Conditions leading to cash
shortages when profits are high.
Large investments
Long operating cycles
in assets to support
(cash-to-cash cycles).
rapid revenue growth.
Consider the following cash-to-cash cycle.

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Profit Rich, Yet Cash Poor
The following profitability measures were taken from

NTI’s financial report for the year ended December 31,
2020.
Profit Rich, Yet Cash Poor (cont.)

Even though NTI appears to be profitable relative to industry
averages, it is plagued by severe cash flow problems. The
liquidity measures presented as follows were also taken from
NTI’s December 31, 2020, financial report. Unlike the
profitability measures, these measures are all well below
industry averages.

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Operating Cash Flows: The Lifeblood of Survival
● In response to a surge in demand experienced in the

fourth quarter of 2020, NTI disbursed large sums of
cash to manufacture goods available for sale.
● NTI’s cash was literally tied up in direct materials, work
in process, and finished goods inventories as units
were produced.
● Furthermore, as these goods were sold, cash
remained tied up in accounts receivable.
NTI’s Operating Cycle

As shown, NTI’s operating cycle during
2020 averaged 247 days. In other words,
cash was tied up in inventory and
receivables for 247 days before converting
back into cash. Throughout its operating
cycle, however, payrolls, materials
purchases, debt service, and overhead
costs all required disbursements of cash
on a timely basis (for example, 30 days).
No wonder NTI’s 2020 statement of cash
flows reported a $250,000 negative cash
flow from operations!

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Budgeting: The Basis for Planning and Control

● A budget is a comprehensive financial plan setting forth the
expected route for achieving the financial and operational
goals of an organization.
● Even the smallest business will benefit from preparing a
formal written plan for its future operations, including the
expected levels of sales, expenses, net income, cash
receipts, and cash outlays.
● Virtually all economic entities—businesses, governmental
agencies, universities, churches, and individuals—engage in
some form of budgeting.
○ The extent to which plans are formalized in written budgets varies.
International Case in Point: Yahoo

Operational budgeting for multinational companies can
be very complex. For example, Yahoo! has global
operations in more than 25 worldwide locations and
offerings are available in more than 30 languages.
Because Yahoo! collects revenue and pays expenses in
foreign currencies, Yahoo! experiences foreign exchange
rate fluctuation risks. Managers try to forecast exchange
rates during the budgeting period and undertake
measures that manage the impact of the exchange rate
changes on the revenue, assets, liabilities, and expenses
incurred in these foreign currencies.

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Benefits Derived from Budgeting

Careful planning and preparation of a formal budget
benefits a company in many ways including:
1. Enhanced management responsibility.
2. Assignment of decision-making
responsibilities.
3. Coordination of activities.
4. Performance evaluation.
Benefits Derived from Budgeting

Enhanced management
responsibility
Coordination Performance
of activities Benefits evaluation
Assignment of decision-
making responsibilities

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Budgeting: The Basis for Planning and Control
A budget is a comprehensive financial

plan for achieving the financial and
operational goals of an organization.
Planning Control
Developing Steps taken by
objectives for management to
acquisition ensure that
and use of objectives are
resources. attained.
Establishing Budgeted Amounts

● Comparisons of actual performance with budgeted amounts are
widely used in evaluating the performance of departments and
department managers.
● Two basic philosophies prevail today that dictate the levels at
which budgeted amounts should be set. We identify these
philosophies as:
1. The behavioral approach.
2. The total quality management approach.
● We first discuss the behavioral approach, which currently is the
more widely used budgeting philosophy.

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The Behavioral Approach

● The assumption underlying the behavioral approach is that
managers will be most highly motivated if they view the budget
as a fair basis for evaluating a responsibility center’s
performance.
● Budgeted amounts are set at reasonable and achievable
levels.
○ A department that operates in a highly efficient manner
should be able to exceed the budgeted level of
performance.
○ Failure to stay within the budget, in contrast, is viewed as
an unacceptable level of performance.
Your Turn: VP of Production and Sales

Assume that you are vice president for production and sales at NTI. Your
department is a profit center and is evaluated on profits. Profit goals are
set for each quarter during the year. You, your sales manager, Bob Poole,
and your production manager, Joe Reco, share a $1,500 bonus each
quarter you are able to meet your profit goal. Halfway through the second
quarter of 2021, it becomes clear that the department will not be able to
meet its profit goal for the second quarter. Bob suggests that he could
“move” the booking of some sales from quarter two to quarter three to
increase the likelihood of earning the quarter-three bonus. Joe also
suggests using some additional resources during the second quarter to get
a head start on meeting the third-quarter profit goals. Joe states, “If we use
overtime labor during the second quarter to increase inventory of finished
goods, then our costs in quarter three will be lower and we will be more
likely to meet our profit goal and earn the quarter-three bonus.” What will
you say to Joe and Bob?

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Total Quality Management Approach
● Every individual and segment of the organization

should strive for improvement constantly.
● The entire organization is committed to the goal of
completely eliminating inefficiency and non-value-
added activities.
● In short, the organization strives to achieve
perfection across its entire value chain.
Selecting and Using a Budgeting Approach
Managers should participate actively in the budgeting

process.
Department managers generally are the best source of
information about the levels of performance that can
be achieved within their departments.
These managers also should understand both the
intended purpose of the budget and the philosophy
underlying the development of budgeted amounts.

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Selecting and Using a Budgeting

Approach (cont.)
● In comparing actual performance with budgeted
amounts, top management should consider the
philosophy used in developing the budgeted amounts.
○ If a behavioral approach is employed, a highly
efficient unit may exceed the budgeted level of
performance.
○ If a total quality management approach is used, a
highly efficient unit should fall slightly short of the
budget standards.
The Budget Period
“ ● The period covered by a budget should be long

enough to show the effect of management
policies but short enough so that estimates can
be made with reasonable accuracy.
● Most operating budgets and financial budgets
cover a period of one fiscal year.
○ Companies often divide these annual
budgets into four quarters, with budgeted
figures for each quarter.

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Rolling Budgeting
● An increasing number of companies use rolling
budgeting, whereby a new quarter or month is added to
the end of the budget as the current quarter or month
draws to a close.
○ Thus, the budget always covers the upcoming 12
months.
○ One advantage of rolling budgeting is that it
stabilizes the planning horizon at one year ahead.
○ Rolling budgeting forces managers into a
continuous review and reassessment of the budget
estimates and the company’s current progress.
The Master Budget
“
A typical master budget for a manufacturing company
would include the following:
1. Operating budgets
a. Sales budget
b. Production budgets including
■ Units to produce
■ Direct materials
■ Direct labor
■ Overhead
c. Cost of goods manufactured and sold budget

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The Master Budget (cont.)

d. Selling and administrative expense budget
■ Marketing
■ Administrative expenses
■ Research and development
e. Cash budget
2. Financial budgets
a. Budgeted income statement
b. Budgeted balance sheet
c. Budgeted cash flows statement
d. Capital expenditures budget
Organizational Budgeting

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Steps in Preparing a Master Budget

The following is the logical sequence of steps for preparing the
annual elements of the master budget.
1. Prepare a sales forecast.
2. Prepare budgets for production, manufacturing costs, and
operating expenses.
3. Prepare a budgeted income statement.
4. Prepare a cash budget.
5. Prepare a budgeted balance sheet.
Preparing the Master Budget: An Illustration
We will now develop NTI’s master budget for 2021.

• A primary objective of this process is to help NTI avoid the
cash flow problems experienced during 2020.
• Sales of NTI’s product are expected to increase throughout
2021. However, the company will drastically cut back
production during the first quarter to liquidate some of the
finished goods inventory currently on hand.
• As of January 1, there is no work in process inventory.
• No capital expenditures are planned for 2021.

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NTI’s Beginning Balance Sheet
Manufacturing Cost Estimates

In preparation for the budget process, Lisa Scott, NTI’s cost
accountant, has thoroughly analyzed the company’s variable and
fixed manufacturing costs.
• Direct materials consist of two specially coated disks that
cost $7.50 each.
• Direct labor is one-eighth hour per disk or one-quarter
hour per finished unit.
• She is confident that variable manufacturing costs per unit
will not increase during 2021.
• She also believes that fixed manufacturing overhead will
hold steady at approximately $15,000 per quarter.

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Manufacturing Cost Estimates (cont.)

On the basis of her analysis, she compiled the following
manufacturing cost estimates.
The Sales Budget

Bob Poole, NTI’s marketing director, is optimistic
that demand for the company’s product will
continue to grow in 2021.
• He estimates that sales will reach 8,000
units in the first quarter and 10,000 units in
the second quarter.
• Sales estimates for the third and fourth
quarters are 30,000 units and 40,000
units, respectively.
• To keep its product affordable to a wide
range of users, NTI is committed to
holding its selling price per unit at $75
throughout the year.

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The Sales Budget (cont.)

Bob Poole, NTI’s marketing director, is optimistic
that demand for the company’s product will continue
to grow in 2021. He estimates that sales will reach
8,000 units in the first quarter and 10,000 units in
the second quarter. Sales estimates for the third
and fourth quarters are 30,000 units and 40,000
units, respectively.
Establishing Budgeted Amounts:

Behavioral Approach
Budget Problems Solution
 Perceived unfair or  Reasonable and
unrealistic goals. achievable budgets.
 Poor management-  Employee
employee participation in
communications. budgeting process.

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Establishing Budgeted Amounts:

Total Quality Management Approach
A commitment to the Budgeted amounts set
goal of completely at levels representing
eliminating inefficiency. absolute efficiency.
Small failures to
achieve budgeted
amounts direct
management to
areas where
improvement is
possible.
Selecting and Using a Budgeting Approach:

Managers Should Participate Actively
Top Management
Middle Middle
Management Management
Supervisor Supervisor Supervisor Supervisor
Flow of Budget Data

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Figure 15.1
Budgetary control: features
Figure 15.2
Budget procedure

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Figure 15.3
Functional budgets
Source: Adapted from Chartered Institute of Management Accountants (2005). CIMA Official Terminology, Oxford: CIMA Publishers.
Figure 15.4
Flexing the budget

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Figure 15.5
Budgeting: behavioural elements
The Budget Period

The annual operating budget may be
divided into quarterly or monthly budgets.
2012 2013 2014 2015
Capital Budgets are for longer periods of time.
A rolling budget is usually a twelve-month budget

that adds one month as the current month
is completed.

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The Master Budget
NTI’s Beginning Balance Sheet

Based on significant
cash flow problems
that NTI experienced
in the 4th Quarter, the
company has no
work-in-process
inventories as of
January 1, plans to
liquidate quite a bit of
finished goods, and
plans no capital
expenditures for
2015, despite
increasing sales that
are anticipated.

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Steps in Preparing a Master Budget
Sales
Budget
Estimated Estimated
Unit Sales Unit Price
Analysis of economic and market conditions

+
Forecasts of customer needs from
marketing personnel
Preparing the Master Budget:

Manufacturing Cost Estimates

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The Sales Budget

Bob Poole, NTI’s marketing director, is optimistic that
demand for the company’s product will continue to grow in
2015. He estimates that sales will reach 8,000 units in the
first quarter and 10,000 units in the second quarter. Sales
estimates for the third and fourth quarters are 30,000 units
and 40,000 units, respectively.
8,000 units to
Production
Budget
The Production Budget: Units

Production must be adequate to meet budgeted
sales and to provide sufficient ending inventory.
Budgeted product sales in units
+ Desired product units in ending inventory
= Total product units needed
– Product units in beginning inventory
= Product units to produce

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Production Budget: Units

Upon examining performance reports for 2014, Joe Reco, NTI’s
production manager, concluded that he had overreacted to the
rapid sales growth experienced in the fourth quarter. Based on
new inventory policies and estimates, the unit production budget
was created.
8,000 units
From Sales
Budget
The Production Budget: Material Purchases
The material purchases budget is based

on production quantity and desired
material inventory levels.
Units to produce
× Material needed per unit
= Material needed for units to produce
+ Desired units of material in ending inventory
= Total units of material needed
– Units of material in beginning inventory
= Units of material to purchase

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The Production Budget:

Direct Labor & Overhead
Budgeted Production Direct Labor Budget

× Labor Hours per unit
= Total Hours needed for units to produce
X Cost per Labor Hour
= Budgeted Direct Labor Cost
Overhead Budget
Budgeted Production
× Variable overhead cost
= Budgeted Variable Overhead cost
+ Budgeted Fixed Overhead cost
= Total Budgeted Overhead
The Production Budget: Cost Budgets

From NTI 2015 Units of Production Budget

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Cost of Goods Manufactured and Sold Budget

The budget estimates for cost of goods
sold are computed using the beginning
finished goods inventory figure from the
beginning balance sheet and information
from the production budgets.
Beginning Production
Balance Budget
Sheet Information
Cost of Goods
Manufactured and Sold
Budget
Cost of Goods Manufactured and Sold Budget

A manufacturing company’s cost of goods sold is equal to its
beginning finished goods inventory, plus the cost of goods
manufactured during the period, less its ending finished goods
inventory.

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Selling and Administrative

(S&A) Expense Budget
 Selling expense budgets contain both variable and
fixed items.
 Variable items: shipping costs and sales commissions.
 Fixed items: advertising and sales salaries.
 Administrative expense budgets contain mostly
fixed items.
 Executive salaries and depreciation on company offices.
The Budgeted Income Statement

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Cash Budget Estimates

The estimates and data necessary to prepare
the cash budget and budgeted balance
sheets are called cash budget estimates.
These include budgeted disbursements for
payables, prepayments, debt service, and
taxes. In addition, NTI must budget cash
receipts from collection of receivables.
The Cash Budget
There is an improved cash position from 2014 to

2015 due to:
• A new policy of controlling inventory and
production schedules; and
• Goals to tighten credit policies.

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The Budgeted Balance Sheet
Benefits of Budgeting
Advance warning and
assignment of responsibility
for conditions that require
corrective actions.
BUDGETS
Coordination of activities among
all departments within the
organization.
The creation of standards for

evaluating performance.

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Flexible Budgeting
Hmm! Comparing
costs at different
levels of activity
is like comparing
apples with oranges.
Performance evaluation is
difficult when actual activity
differs from the activity
originally budgeted.
Flexible Budgeting

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How can we
evaluate Joe
using the original
budget?
Flexible Budgeting
To answer the question, we must

the budget to the actual level of activity.
Central Concept: If you can tell me what your
activity was for the period, I will tell you what
your costs and revenue should have been.
Flexible Budgeting
Show expenses that should
have occurred at the actual
level of activity.
May be prepared for any activity

level in the relevant range.
Reveal variances due to cost

control or lack of cost control.
Improve performance
evaluation.

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Flexible Budgeting
To a budget for different activity

levels, we must know how costs behave
with changes in activity levels.
 Total variable costs change
in direct proportion to
changes in activity.
 Total fixed costs remain Fixed
unchanged within the
relevant range.
Flexible Budgeting

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Flexible Budgeting
Performance Report
Ethics, Fraud, and Corporate Governance

There is a growing concern in many states that
judicial budgetary requests have been denied
by governors and state legislatures in order to
free up resources for more politically popular
priorities.
Diverting financial resources for alternative

purposes results in shortfalls that jeopardize a
state’s ability to defend the indigent and
provide other services. Budgetary integrity,
political neutrality, and the prudent oversight
of resource allocations are as important in the
public sector as they are in the private sector.

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Thanks!
Any questions?
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Accounting Principles, Sunderland Program, 12/10/2021

01 Nature & Purpose of budgeting

Standard cost system & variance

Nguyen Thi Thanh Mai 1

Introduction: Hillerich & Bradsby Co.

Nguyen Thi Thanh Mai 2

Illustration: Network Technologies, Inc.

Profit Rich, Yet Cash Poor

Consider the following cash-to-cash cycle.

Nguyen Thi Thanh Mai 3

Profit Rich, Yet Cash Poor

The following profitability measures were taken from

Profit Rich, Yet Cash Poor (cont.)

Nguyen Thi Thanh Mai 4

Operating Cash Flows: The Lifeblood of Survival

● In response to a surge in demand experienced in the

NTI’s Operating Cycle

Nguyen Thi Thanh Mai 5

Budgeting: The Basis for Planning and Control

International Case in Point: Yahoo

Nguyen Thi Thanh Mai 6

Benefits Derived from Budgeting

Benefits Derived from Budgeting

Nguyen Thi Thanh Mai 7

Budgeting: The Basis for Planning and Control

A budget is a comprehensive financial

Establishing Budgeted Amounts

Nguyen Thi Thanh Mai 8

The Behavioral Approach

Your Turn: VP of Production and Sales

Nguyen Thi Thanh Mai 9

Total Quality Management Approach

● Every individual and segment of the organization

Selecting and Using a Budgeting Approach

Managers should participate actively in the budgeting

Nguyen Thi Thanh Mai 10

Selecting and Using a Budgeting

The Budget Period

“ ● The period covered by a budget should be long

Nguyen Thi Thanh Mai 11

The Master Budget

Nguyen Thi Thanh Mai 12

The Master Budget (cont.)

Nguyen Thi Thanh Mai 13

Steps in Preparing a Master Budget

Preparing the Master Budget: An Illustration

We will now develop NTI’s master budget for 2021.

Nguyen Thi Thanh Mai 14

NTI’s Beginning Balance Sheet

Manufacturing Cost Estimates

Nguyen Thi Thanh Mai 15

Manufacturing Cost Estimates (cont.)

The Sales Budget

Nguyen Thi Thanh Mai 16

The Sales Budget (cont.)

Establishing Budgeted Amounts:

Nguyen Thi Thanh Mai 17

Establishing Budgeted Amounts:

Selecting and Using a Budgeting Approach:

Supervisor Supervisor Supervisor Supervisor

Flow of Budget Data

Nguyen Thi Thanh Mai 18

Nguyen Thi Thanh Mai 19

Nguyen Thi Thanh Mai 20