MANAGEMENT ACCOUNTING

1. MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse

2. Management Accounting Budgeting(Planning and control) Chapter 8

3. Objectives • Use budgeting for planning purposes • Use budgeting for control purposes • Identify the conflicts that exist between planning and control in the budgeting process • Describe the benefits of having both short-term and long-term budgets • Explain the responsibility implications of a line-item budget • Identify the costs and benefits of budget lapsing • Develop flexible budgets and identify when flexible budgeting should be used instead of static budgeting • Explain the costs and benefits of using zero-based budgeting • Create a master budget for an organisation • Create pro-forma financial statements based on data provided

4. The Purpose of Budgets Budgets are a key component of the organization’s planning and control system Budgets are forecasts of future revenues and expenses Budgeting is the process of gathering information to assist in making forecasts

5. Budgeting for Planning Decisions Budgets are a used to transfer information to individual decision makers in the organization Budgets play an integral role in making planning decisions

6. Budgeting for Planning Decisions Encourage top-down flow of information and plans Budgets attempt to Encourage bottom-up flow of information

7. Budgeting for Control Budgets are often used to assign responsibilities by allocating resources to managers Budgeted amounts can be used as goals to motivate Budgeted amounts can be used as targets by which performance is evaluated and rewarded

8. Variances The difference between budgeted performance and actual performance is called the variance An adverse varianceoccurs when Actual costs > Budgeted costs or Actual revenues < Budgeted revenues A favorable varianceoccurs when Actual costs < Budgeted costs or Actual revenues > Budgeted revenues Variances are commonly calculated on a monthly basis to identify how successfully an organization is meeting its goals

9. VariancesNumerical Example Administration Costs differ greatly from those expected and would be investigated

10. Conflict between Planningand Control For control, budgets serve as the benchmark for performance measurement For planning, budgets communicate specialized knowledge from one area to another Over reliance on performance measurement will lead to a reduction in knowledge transfer

11. Conflict between Planningand Control To manage the conflict between planning and control many organizations put the Chief Executive in change of the budgeting process and the chief financial officer in charge of the collection and preparation of data The budget is an informal set of contracts between the units of the organization Most budgets are set in a negotiation process

12. Participative Budgeting With Participative Budgeting the person ultimately being held responsible for meeting the target makes the initial budget forecast Participative Budgeting is a bottom-up process Motivation to achieve the target is higher

13. How Budgeting Helps Resolve Organizational Problems Links knowledge with responsibility to make planning decisions Budgeting Systems Measures and rewards performance for control An administrative device to resolve organizational problems Distributes Responsibilities

14. Forecasts of large asset acquisitions Financing plans Research and development plans Long-term Budgets (more than one year) Short-Term versus Long-Term Budgets 1. Selecting overall objectives 2. Choosing markets Selecting products to produce Determining price/quality mix Choosing technologies Strategic Planning Short-term Budgets (1 year or less) Quantities to produce Quantities to sell Supplies acquisitions

15. Line-Item Budgets • Budgets that authorize the manager to spend only up to the specified amount on each line item • Managers cannot spend savings from one line item on another line item • The manager does not have the responsibility to substitute resources among line items as circumstances change • Impose more control on Managers • Prevalent in government organizations

16. Line-Item BudgetsNumerical Example Line item budgets reduce management incentives to search for cost savings and reduce the organisation flexibility

17. Budget Lapsing • Funds that have not been spent at year-end do not carry over to the next year • Managers have incentive to spend at the end of each year • Operating efficiency is reduced • Managers have less discretion in the timing of expenditures

18. Static budgets do not vary with volume and are used when a manager has control over volume or the consequences thereof Static versus Flexible Budgets Flexible budgets are adjusted for changes in volume and are used mainly in manufacturing where the manager does not have control over volume

19. Static versus Flexible BudgetsNumerical Example Each line item in the budget varies with volume. Then a budget is prepared at different volume levels

20. Static versus Flexible Budgets Show revenues and expensesthat should have occurred at the actual level of activity Flexible Budgets May be prepared for any activity level in the relevant range Reveal variances due to good cost control or lack of cost control Improve performance evaluation

21. Static versus Flexible Budgets 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

22. Incremental versusZero-Base Budgets • Base budget is the previous budget • Only incremental changes from the previous budget are examined in detail • Each line item is set at zero each year • Every line item must be justified and renewed each year Incremental Budgets Zero-Base Budgets

23. Zero-Base Budgets • ZBB Motivates managers to maximize firm value by identifying and eliminating those expenditures whose total costs exceed total benefits • Incremental expenditures are deleted when their costs exceed their incremental benefits • Inefficient base budgets are not eliminated • In practice ZBB is used infrequently • Most useful when new top-level management come from outside the firm • Costly to conduct

24. The Master Budget Integrates the estimates from each department to predict production requirements, financing, cash flows and financial statements at the end of the period. Serves as a guide and benchmark for the entire organization

25. Comprehensive Master Budget Illustration The following slides provide an illustration of the Master Budget The Master Budget is prepared for a simple firm NaturApples (an apple processor)

26. Master Budget IllustrationBudgeting process - NaturApples Sales budget Production budget Apple procurement Factory overhead budget Direct labour budget Direct materials budget Selling and administrative budget Capital investment budget Financial Budget Beginning balance sheet Budgeted profit and loss Statement Budgeted cash flows Budgeted Balance Sheet

27. Master BudgetNumerical Example Expected beginning Balance Sheet

28. Master BudgetNumerical Example Sales Budget

29. Master BudgetNumerical Example Production Budget – Production volume Beginning inventory + Production = Sales + Desired ending inventory or Production = Sales + Desired ending inventory – beginning inventory

30. Master BudgetNumerical Example Production Budget

31. Master Budget Numerical Example Production Budget

32. Production Budget

33. Master BudgetNumerical Example Selling and Administration Budget

34. Master BudgetNumerical Example Capital Investment Budget

35. Master BudgetNumerical Example Financial Budget

36. Master Budget -Numerical Example Budgeted profit and loss statement

37. Master Budget -Numerical Example Budgeted cash flow statement

38. Budgeted Balance Sheet Master Budget - Numerical Example

39. Management Accounting Budgeting(Planning and controlling) End of Chapter 8