Budgeting: Accounting 26e

CHAPTER
22 Budgeting
Accounting
26e
human/iStock/360/Getty Images
Warren
Reeve
Duchac
Learning Objectives
• LO1: Describe budgeting, its objectives,

and its impact on human behavior.
• LO2: Describe the basic elements of the
budget process, the two major types of
budgeting, and the use of computers in
budgeting.
• LO3: Describe the master budget for a
manufacturing company.
• LO4: Prepare the basic operating budgets
for a manufacturing company.
• LO5: Prepare financial budgets for a
manufacturing company.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Nature and Objectives of Budgeting
• Budgets play an important role for

organizations of all sizes and forms.
o For example, budgets are used in managing
the operations of government agencies,
churches, hospitals, and other nonprofit
organizations.
• This chapter describes and illustrates
budgeting for a manufacturing company.
Objectives of Budgeting
(slide 1 of 2)
• Budgeting involves:
o Establishing specific goals.
o Executing plans to achieve the goals.
o Periodically comparing actual results with the
goals.
Objectives of Budgeting
(slide 2 of 2)
• Budgeting affects the following managerial

functions:
o Planning
 Planning involves setting goals to guide decisions and help
motivate employees.
o Directing
 Directing involves decisions and actions to achieve
budgeted goals.
– A budgetary unit of a company is called a responsibility
center.
 Each responsibility center is led by a manager who has the
authority and responsibility for achieving the center’s budgeted
goals.
o Controlling
 Controlling involves comparing actual performance against
the budgeted goals.
– Such comparisons provide feedback to managers and
employees about their performance.
 If necessary, responsibility centers can use such feedback to
Planning, Directing, and Controlling
Human Behavior and Budgeting
• Human behavior problems can arise in the

budgeting process in the following
situations:
o Budgeted goals are set too tight, which are
very hard or impossible to achieve.
o Budgeted goals are set too loose, which are
very easy to achieve.
o Budgeted goals conflict with the objectives of
the company and employees.
Human Behavior Problems in Budgeting
Human Behavior and Budgeting:
Setting Budget Goals Too Tightly
• If budgeted goals are viewed as unrealistic

or unachievable, the budget may have a
negative effect on the ability of the
company to achieve its goals.
• Attainable goals are more likely to
motivate employees and managers.
o For this reason, it is important for employees
and managers to be involved in the budgeting
process.
 Involving employees in the budgeting process
provides them with a sense of control and, thus, more
of a commitment in meeting budgeted goals.
Setting Budget Goals Too Loosely
• Although it is desirable to establish

attainable goals, it is undesirable to plan
budget goals that are too easy.
o Such budget “padding” is called budgetary
slack.
 Managers may plan slack in their budgets to provide
a “cushion” for unexpected events.
– However, slack budgets may create inefficiency by
reducing the budgetary incentive to trim spending.
Setting Conflicting Budget Goals
• Goal conflict occurs when the employees’

or managers’ self-interest differs from the
company’s objectives or goals.
Budgeting Systems
(slide 1 of 4)
• The budgetary period for operating

activities normally includes the fiscal year
of a company.
• For control purposes, annual budgets are
usually subdivided into shorter time
periods, such as quarters of the year,
months, or weeks.
Budgeting Systems
(slide 2 of 4)
• A variation of fiscal-year budgeting, called

continuous budgeting, maintains a 12-
month projection into the future.
• The 12-month budget is continually
revised by replacing the data for the
month just ended with the budget data for
the same month in the next year.
Continuous Budgeting
Budgeting Systems
(slide 3 of 4)
• Developing an annual budget usually

begins several months prior to the end of
the current year.
• The responsibility of developing an annual
budget is normally assigned to a budget
committee.
o Such a committee often consists of the budget
director, the controller, the treasurer, the
production manager, and the sales manager.
• The budget process is monitored and
summarized by the Accounting
Department, which reports to the
committee.
Budgeting Systems
(slide 4 of 4)
• There are several methods of developing

budget estimates.
o One method, called zero-based budgeting,
requires managers to estimate sales,
production, and other operating data as though
operations are being started for the first time.
o A more common approach is to start with last
year’s budget and revise it for actual results
and expected changes for the coming year.
 Two major budgets using this approach are the static
budget and the flexible budget.
Static Budget
• A static budget shows the expected

results of a responsibility center for only
one activity level. Once the budget has
been determined, it is not changed, even if
the activity changes.
• Static budgeting is used by many service
companies, government entities, and for
some functions of manufacturing
companies, such as purchasing,
engineering, and accounting.
• A disadvantage of static budgets is that
they do not adjust for changes in activity
levels.
Static Budget
Flexible Budget
(slide 1 of 3)
• Flexible budgets show the expected

results of a responsibility center for
several activity levels.
o A flexible budget is, in effect, a series of static
budgets for different levels of activity.
Flexible Budget
(slide 2 of 3)
• A flexible budget is constructed as follows:

o Step 1: Identify the relevant activity levels.
 The relevant levels of activity could be expressed in
units, machine hours, direct labor hours, or some
other activity base.
o Step 2: Identify the fixed and variable cost
components of the costs being budgeted.
o Step 3: Prepare the budget for each activity
level by multiplying the variable cost per unit
by the activity level and then adding the
monthly fixed cost.
Flexible Budget
Flexible Budget
(slide 3 of 3)
• Because the flexible budget adjusts for

changes in the level of activity, it is much
more accurate and useful than the static
budget.
Static and Flexible Budgets
Example Exercise Flexible Budgeting
At the beginning of the period, the Assembly

Department budgeted direct labor of $45,000 and
supervisor salaries of $30,000 for 5,000 hours of
production. The department actually completed 6,000
hours of production. Determine the budget for the
department, assuming that it uses flexible budgeting.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
Master Budget
• The master budget is an integrated set

of operating and financing budgets for a
period of time.
o The operating budgets can be used to prepare
a budgeted income statement.
o The financial budgets provide information for a
budgeted balance sheet.
• Most companies prepare a master budget
on a yearly basis.
Master Budget for a Manufacturing Company
Operating Budgets
Sales Budget
(slide 1 of 2)
• The sales budget begins by estimating

the quantity of sales.
o The prior year’s sales are often used as a
starting point.
• These sales quantities are then revised for
such factors as:
o Planned advertising and promotions
o Projected pricing changes
o Expected industry and general economic
condition.
• Once sales quantities are estimated, the
budgeted sales revenue can be
determined as follows:
Sales Budget
(slide 2 of 2)
• Elite Accessories Inc. manufactures wallets

and handbags that are sold in two regions,
the East and West regions. Elite
Accessories estimates the following sales
volumes and prices for 2016:
Sales Budget
Production Budget
(slide 1 of 2)
• The production budget estimates the

number of units to be manufactured to
meet budgeted sales and desired
inventory levels.
• The budgeted units to be produced are
determined as follows:
Production Budget
(slide 2 of 2)
• Elite Accessories Inc. expects the following

inventories of wallets and handbags:
Production Budget
Landon Awards Co. projected sales of 45,000 brass
plaques for 2016. The estimated January 1, 2016,
inventory is 3,000 units, and the desired December 31,
2016, inventory is 5,000 units. What is the budgeted
production (in units) for 2016?
Example Exercise Production Budget
Landon Awards Co. projected sales of 45,000 brass

plaques for 2016. The estimated January 1, 2016,
inventory is 3,000 units, and the desired December 31,
2016, inventory is 5,000 units. What is the budgeted
production (in units) for 2016?
part.
Direct Materials Purchases Budget
(slide 1 of 3)
• The direct materials purchases budget

estimates the quantities of direct materials
to be purchased to support budgeted
production and desired inventory levels.
(slide 2 of 3)
• The direct materials purchases budget can be developed in

three steps:
o Step 1. Determine the budgeted direct material required for
production, which is computed as follows:
o Step 2. The budgeted material required for production is

adjusted for beginning and ending inventories to determine the
direct materials to be purchased for each material, as follows:
o Step 3. The budgeted direct materials to be purchased is

computed as follows:
(slide 3 of 3)
• Elite Accessories Inc. uses leather and lining in producing wallets

and handbags. The quantity of direct materials expected to be
used for each unit of product is as follows:
• The following inventory and unit price information is expected:
• The estimated price per square yard of leather and lining during
2016 follows:
• Landon Awards Co. budgeted production of
47,000 brass plaques in 2016. Brass sheet
is required to produce a brass plaque.
Assume 96 square inches of brass sheet are
required for each brass plaque. The
estimated January 1, 2016, brass sheet
inventory is 240,000 square inches. The
desired December 31, 2016, brass sheet
inventory is 200,000 square inches. If brass
sheet costs $0.12 per square inch,
determine the direct materials purchases
budget for 2016.
Example Exercise Direct Materials Purchases Budget
Landon Awards Co. budgeted production of 47,000 brass plaques

in 2016. Brass sheet is required to produce a brass plaque.
Assume 96 square inches of brass sheet are required for each
brass plaque. The estimated January 1, 2016, brass sheet
inventory is 240,000 square inches. The desired December 31,
2016, brass sheet inventory is 200,000 square inches. If brass
sheet costs $0.12 per square inch, determine the direct materials
purchases budget for 2016.
Direct Labor Cost Budget
(slide 1 of 3)
• The direct labor cost budget estimates

the direct labor hours and related cost
needed to support budgeted production.
(slide 2 of 3)
• The direct labor cost budget for each

department is determined in two steps, as
follows:
o Step 1. Determine the budgeted direct labor
hours required for production, which is
computed as follows:
o Step 2. Determine the total direct labor cost as

follows
(slide 3 of 3)
• Elite Accessories Inc.’s production

managers estimate the following direct
labor hours are needed to produce a wallet
and handbag:
• The estimated direct labor hourly rates for

the Cutting and Sewing departments for
Elite Accessories Inc. during 2016 follow:
• Landon Awards Co. budgeted production of
47,000 brass plaques in 2016. Each plaque
requires engraving. Assume that 12 minutes
are required to engrave each plaque. If
engraving labor costs $11.00 per hour,
determine the direct labor cost budget for
2016.
Example Exercise Direct Labor Cost Budget
Landon Awards Co. budgeted production of 47,000

brass plaques in 2016. Each plaque requires engraving.
Assume that 12 minutes are required to engrave each
plaque. If engraving labor costs $11.00 per hour,
determine the direct labor cost budget for 2016.
part.
Factory Overhead Cost Budget
• The factory overhead cost budget

estimates the cost for each item of factory
overhead needed to support budgeted
production.
• The factory overhead cost budget may be
supported by departmental schedules.
o Such schedules normally separate factory
overhead costs into fixed and variable costs to
better enable department managers to monitor
and evaluate costs during the year.
Factory Overhead Cost Budget
Cost of Goods Sold Budget
(slide 1 of 2)
• The cost of goods sold budget is

prepared by integrating the following
budgets:
o Direct materials purchases budget
o Direct labor cost budget
o Factory overhead cost budget
• The estimated and desired inventories for
direct materials, work in process, and
finished goods must be integrated into the
cost of goods sold budget.
(slide 2 of 2)
• Elite Accessories Inc. expects the following

direct materials, work in process, and
finished goods inventories:
Example Exercise Cost of Goods Sold Budget
(slide 1 of 2)
Prepare a cost of goods sold budget for Landon Awards Co.

Landon Awards Co. budgeted production of 47,000 brass plaques in 2016.
Brass sheet is required to produce a brass plaque. Assume 96 square inches
of brass sheet are required for each brass plaque. The estimated January 1,
2016, brass sheet inventory is 240,000 square inches. The desired December
31, 2016, brass sheet inventory is 200,000 square inches. Brass sheet costs
$0.12 per square inch which means the direct materials purchases budget for
2016 is $536,640.
Each plaque requires engraving. Assume that 12 minutes are required to
engrave each plaque. Engraving labor costs $11.00 per hour which means the
direct labor cost budget for 2016 is $103,400.
Assume the estimated inventories on January 1, 2016, for finished goods and
work in process were $54,000 and $47,000, respectively. Also assume the
desired inventories on December 31, 2016, for finished goods and work in
process were $50,000 and $49,000, respectively. Factory overhead was
budgeted for $126,000.
Example Exercise Cost of Goods Sold Budget
(slide 2 of 2)
Selling and Administrative Expenses Budget
• The sales budget is often used as the

starting point for the selling and
administrative expenses budget.
• The selling and administrative expenses
budget is normally supported by
departmental schedules.
Selling and Administrative Expenses Budget
Budgeted Income Statement
(slide 1 of 2)
• The budgeted income statement is

prepared by integrating the following
budgets:
o Sales budget
o Cost of goods sold budget
o Selling and administrative expenses budget
• In addition, estimates of other income,
other expense, and income tax are also
integrated into the budgeted income
statement.
(slide 2 of 2)
• This budget summarizes the budgeted

operating activities of the company.
o In doing so, the budgeted income statement
allows management to assess the effects of
estimated sales, costs, and expenses on profits
for the year.
Financial Budgets
• The financial budgets reflect the financing

and investing activities of the company.
• Two financial budgets are the:
o Cash budget
o Capital expenditures budget
Cash Budget
• The cash budget estimates the expected

receipts (inflows) and payments (outflows)
of cash for a period of time.
Estimated Cash Receipts
(slide 1 of 3)
• The primary source of estimated cash

receipts is from cash sales and collections
on account.
• In addition, cash receipts may be obtained
from plans to issue equity or debt
financing as well as other sources such as
interest revenue.
• To estimate cash receipts from cash sales
and collections on account, a schedule of
collections from sales is prepared.
(slide 2 of 3)
• The following data for Elite Accessories

Inc. are used:
(slide 3 of 3)
• The budgeted cash collected for any

month is the sum of the cash collected
from previous month’s sales and the cash
collected from current month’s sales.
o For Elite Accessories Inc., the cash collected in
February is 40% of cash collected on sales in
January ($1,080,000 × 40%) added to 60% of
cash collected on sales in February
($1,240,000 × 60%), shown as follows:
Schedule of Collections from Sales
Estimated Cash Payments
(slide 1 of 3)
• Estimated cash payments must be

budgeted for operating costs and
expenses such as manufacturing costs,
selling expenses, and administrative
expenses.
• In addition, estimated cash payments may
be planned for capital expenditures,
dividends, interest payments, or long-term
debt payments.
• To estimate cash payments for
manufacturing costs, a schedule of
payments for manufacturing costs is
prepared.
(slide 2 of 3)
• The following data for Elite Accessories

Inc. are used:
(slide 3 of 3)
• The budgeted cash payments for any month are the sum of
the cash paid from previous month’s manufacturing costs
(less depreciation) and the cash paid from current month’s
manufacturing costs (less depreciation).
o For Elite Accessories Inc., the cash paid in February is 25% of
manufacturing costs (less depreciation) in January [($840,000 –
$24,000) × 40%) added to 75% of cash paid on manufacturing
costs (less depreciation) in February [($780,000 – $24,000) ×
75%), computed as follows:
Schedule of Payments for Manufacturing Costs
Completing the Cash Budget
(slide 1 of 2)
• The cash budget is structured for a budget

period as follows:
Completing the Cash Budget
(slide 2 of 2)
• Assume the following data for Elite

Accessories Inc.:
Cash Budget
Example Exercise Cash Budget
Landon Awards Co. collects 25% of its sales on account

in the month of the sale and 75% in the month
following the sale. If sales on account are budgeted to
be $100,000 for March and $126,000 for April, what are
the budgeted cash receipts from sales on account for
April?
part.
Capital Expenditures Budget
• The capital expenditures budget

summarizes plans for acquiring fixed
assets.
o Such expenditures are necessary as machinery
and other fixed assets wear out or become
obsolete.
o In addition, purchasing additional fixed assets
may be necessary to meet increasing demand
for the company’s product.
• Capital expenditures budgets are often
prepared for five to ten years into the
future.
o This is necessary because fixed assets often
Capital Expenditures Budget
Budgeted Balance Sheet
• The budgeted balance sheet is prepared

based on the operating and financial
budgets of the master budget.
• The budgeted balance sheet is dated as of
the end of the budget period and is similar
to a normal balance sheet except that
estimated amounts are used.

Budgeting: Accounting 26e

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CHAPTER

• LO1: Describe budgeting, its objectives,

• Budgets play an important role for

• Budgeting affects the following managerial

• Human behavior problems can arise in the

• If budgeted goals are viewed as unrealistic

• Although it is desirable to establish

• Goal conflict occurs when the employees’

• The budgetary period for operating

• A variation of fiscal-year budgeting, called

• Developing an annual budget usually

• There are several methods of developing

• A static budget shows the expected

• Flexible budgets show the expected

• A flexible budget is constructed as follows:

• Because the flexible budget adjusts for

At the beginning of the period, the Assembly

• The master budget is an integrated set

• The sales budget begins by estimating

• Elite Accessories Inc. manufactures wallets

• The production budget estimates the

• Elite Accessories Inc. expects the following

Landon Awards Co. projected sales of 45,000 brass

• The direct materials purchases budget

• The direct materials purchases budget can be developed in

o Step 2. The budgeted material required for production is

o Step 3. The budgeted direct materials to be purchased is

• Elite Accessories Inc. uses leather and lining in producing wallets

• The following inventory and unit price information is expected:

Landon Awards Co. budgeted production of 47,000 brass plaques

• The direct labor cost budget estimates

• The direct labor cost budget for each

o Step 2. Determine the total direct labor cost as

• Elite Accessories Inc.’s production

• The estimated direct labor hourly rates for

Landon Awards Co. budgeted production of 47,000

• The factory overhead cost budget

• The cost of goods sold budget is

• Elite Accessories Inc. expects the following

Prepare a cost of goods sold budget for Landon Awards Co.

• The sales budget is often used as the

• The budgeted income statement is

• This budget summarizes the budgeted

• The financial budgets reflect the financing

• The cash budget estimates the expected

• The primary source of estimated cash

• The following data for Elite Accessories

• The budgeted cash collected for any

• Estimated cash payments must be

• The following data for Elite Accessories

• The cash budget is structured for a budget

• Assume the following data for Elite

Landon Awards Co. collects 25% of its sales on account

• The capital expenditures budget

• The budgeted balance sheet is prepared

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