Budgeting and Standard Cost Systems

1. Budgeting and Standard Cost Systems Chapter 13

2. Learning Objectives After studying this chapter, you should be able to: • Describe budgeting, its objectives, its impact on human behavior, and types of budget systems. • Describe the master budget for a manufacturing company. • Describe the types of standards and how they are established. • Describe and illustrate how standards are used in budgeting. • Compute and interpret direct materials and direct labor variances. • Describe and provide examples of nonfinancial performance measures.

3. Learning Objective 1 Describe budgeting, its objectives, its impact on human behavior, and types of budget systems

4. Budgeting • A budget is a financial plan for a business. • Objectives of budgeting: • Establishing specific goals • Executing plans to achieve those goals • And, periodically comparing actual results to the goals

5. Managerial Functions Affected by Budgets Exhibit 1: Planning, Directing, and Controlling

6. Human Behavior and Budgeting • Importance of setting a reasonable budget: • Budgets set too tightly discourage employees when expectations are too high. • Budgets set too loosely lead to budgetary slack – called “padding” the budget. Employees may develop a “spend it or lose it” mentality. • Goal conflict occurs when the employees’ or managers’ self-interest differs from the company’s objectives or goals.

7. Continuous Budgeting Systems • Continuous budgets maintain a 12-month projection into the future. Exhibit 3: Continuous Budgeting

8. Developing Budget Estimates • Zero-based budgeting requires managers to estimate sales, production, and other data as though operations are being started for the first time. • More common methods involve revising last year’s budget: • Static budgeting • Flexible budgeting

9. Static Budget: It is based on one activity level and does not change if circumstances change. Flexible Budget: It shows expected results at various activity levels. Static and Flexible Budgets Exhibit 4: Static Budget Exhibit 5: Flexible Budget

10. Flexible budgeting adjustments produce lower actual-to-budget differences. Static and Flexible Budgets Exhibit 6: Static and Flexible Budgets No. of units Produced

11. Computerized Budgeting Systems • Speeds up and reduces the cost of preparing the budget. • Allow for various operating alternatives to be easily assessed. • Enables the company to tie all budgets together.

12. Learning Objective 2 Describe the master budget for a manufacturing company

13. Master Budget • A master budget is a series of budgets that are linked together. • Major parts of a master budget include:

14. Relationship of the Various Income Statement Budgets Exhibit 7: Income Statement Budgets

15. Sales Budget • Indicates the quantity of estimated sales and the selling price per unit. Exhibit 8: Sales Budget

16. Production Budget • Indicates the number of units to be manufactured to meet budgeted sales and inventory level. • Feeds the following budgets: • Direct materials purchases budget – quantity of direct materials needed. • Direct labor cost budget – labor required for each unit of product. • Factory overhead cost budget – estimated factory overhead costs necessary for production. Exhibit 9: Production Budget

17. Direct Materials Purchases Budget Exhibit 10: Direct Materials Purchases Budget

18. Direct Labor Cost Budget Exhibit 11: Direct Labor Cost Budget

19. Factory Overhead Cost Budget Exhibit 11: Factory Overhead Cost Budget

20. Cost of Goods Sold Budget • Derived from the sales and production budgets. • Needs the following information: • Direct materials purchases budget • Direct labor cost budget • Factory overhead cost budget • Desired ending inventory • Estimated beginning inventory Exhibit 13: Cost of Goods Sold Budget

21. Selling and Administrative Expenses Budget Exhibit 14: Selling and Administrative Expenses Budget

22. Budgeted Income Statement • Derived from the following: • Sales budget • Cost of goods sold budget • Selling and administrative expenses budget • Other income/expense data Exhibit 15: Budgeted Income Statement

23. Combines the following: Schedule of cash collections – projects cash inflows from sales. Schedule of cash payments – projects cash outflows for manufacturing costs. Projects capital spending needs over the next five years. Budgeted Balance Sheet Capital Expenditure Budget (summarizes plans for acquiring fixed assets) Cash Budget (expected cash inflows and outflows during a period)

24. Capital Expenditures Budget Exhibit 19: Capital Expenditures Budget

25. Cash Collections from Sales Exhibit 16: Schedule of Collections from Sales

26. Cash Payments for Manufacturing Costs Exhibit 16: Schedule of Collections from Sales

27. Cash Budget Exhibit 18: Cash Budget

28. Budgeted Balance Sheet • Estimates financial condition at the end of a budget period. • Assumes all other budgets are met. • Similar to a balance sheet based on actual data.

29. Learning Objective 3 Describe the types of standards and how they are established

30. Standards • Standards are performance goals. • Standard costs systems: • Provide a measure for performance. • Allow measurement of variances from performance goals. • Standard setting involves the joint efforts of accountants, engineers, and other management personnel.

31. Types of Standards • Ideal – Standards that can be achieved only under perfect operating conditions. • Currently attainable – Standards that can be attained with reasonable effort.

32. Other Issues with Standards • Reviewing and Revising Standards • Ensure current operating conditions are reflected • Support of Standards • Value inventory and plan/control costs • Criticism of Standards • Use in performance evaluations

33. Learning Objective 4 Describe and illustrate how standards are used in budgeting

34. Budgetary Performance Evaluation • Standards are separated into: • Standard Price • Standard Quantity • Standard cost per unit • Standard cost Standard Standard per unit Price Quantity = ×

35. Using Standards • We’ll illustrate the use of standards in budgeting by examining Cowpoke Inc., a manufacturer of blue jeans. The standard cost of size XL jeans is below. Exhibit 20: Standards Cost for XL Jeans

36. Budget Performance Report • Assume the actual jeans sold were 5,000 pairs compared to the original budget of 6,000 pairs. Exhibit 21: Budget Performance Report

37. Budget Performance Report • Variance: • Actual Cost < Standard Cost = Favorable • Actual Cost > Standard Cost = Unfavorable Exhibit 21: Budget Performance Report

38. Learning Objective 5 Compute and interpret direct materials and direct labor variances

39. Summary of Manufacturing Cost Variances Exhibit 22: Manufacturing Cost Variances

40. Direct Materials Variances • Direct Materials Price Variance • Difference between the actual price per unit and the standard price per unit multiplied by the actual quantity used. • Direct Materials Quantity Variance • Difference between the actual quantity used and the standard quantity allowed (based on the actual production level) multiplied by the standard price per unit.

41. Direct Materials Variances for Cowpoke Inc. Standard Price = $5 per yard Actual Price = $5.50 per yard Standard Quantity = 7,500 yards Actual Quantity = 7,300 yards (5,000 pairs * 1.5 yards/pair of jeans) Total Direct Materials Cost Variance = $2,650 Unfavorable

42. Direct Materials Variances for Cowpoke Inc. Exhibit 23: Direct Materials Variance Relationships

43. Direct Labor Variances • Direct Labor Rate Variance • Difference between the actual rate per hour and the standard rate per hour multiplied by the actual hours worked. • Direct Labor Time Variance • Difference between the actual hours worked and the standard hours allowed (based on the actual production level) multiplied by the standard rate per hour.

44. Direct Labor Variances for Cowpoke Inc. Standard Rate = $9 per hour Actual Price = $10 per hour Standard Hours = 4,000 hours Actual Hours = 3,850 (5,000 pairs at .80 hours per pair) Total Direct Labor Cost Variance = $2,500 Unfavorable

45. Direct Labor Variances for Cowpoke Inc. Exhibit 24: Direct Labor Variance Relationships

46. Learning Objective 6 Describe and provide examples of nonfinancial performance measures

47. Nonfinancial Performance Measures

48. Nonfinancial Performance Measures • Nonfinancial performance measures should be used in conjunction with financial measures to avoid goal conflicts. • Common examples:

49. End of Chapter 13