9. Budgeting (Concepts, Methodology ..) Flashcards
1
Q
Roles Of Budgets and The Budgeting Process
A
- A budget is a realistic plan for the future that is expressed in quantitative terms
- The major objective of any budget system are to foster planning of operations, provide a framework for performance evaluation and promote communication among organization
- A budget as a tool is used for:
1) Planning tool - A budget is a written plan for the future that forces management to evaluate the assumptions and the objectives identified during budget process. Companies prepare budget to anticipate problems BEFORE they occur.
2) Control tool - Help firms to control costs by setting cost guidance (it DOESN’T improve cost control) and reveal the efficient or inefficient use of company resources (it DOESN’T prevent inefficiencies). For budget process to serve effectively it MUST be integrated with accounting system and organizational structure.
3) Motivational tool - Employees are more apt to have a positive feeling toward a budget if some degree of flexibility is allowed
4) Communication tool - Senior management must be involved in the process but they lack detailed knowledge of daily operation
5) Goal congruence - Everyone is working towards the same end objective - Budget PLANNING steps are:
1) Start with MISSION STATEMENT formulated by BOD and Senior Management
2) Strategic Plan which is made of long term objectives
3) Priorities to allocate limited resources
4) Short term objectives - To evaluate progress toward success is EACH OF THE PREVIOUS STAGES:
1) Not all quantification is in monetary terms, sometimes units sold are count
2) Compare actual results to the budget - considered advantage to judge performance by allowing the management to measure actual performance against predicted performance at organizational or individual level - Who participates in budget process:
1) BOD - starts with mission statement
2) Senior management - translate statement into strategic plan
3) Budget committee composed of TOP MANAGEMENT to draft budget calendar and budget manual. It also reviews and approves budgets submitted by departments
4) Middle lower management - Receives budget instructions and draw their budget departments - Two types of budget methods:
1) Top down (authoritative) - imposed by upper management, has less chance of acceptance, consists accuracy across all departments, less complex. It also facilitates implementations of strategic plans and coordination of divisions
2) Bottom up (participative) - greater chance of acceptance, provide a broader information base. It is higher in cost and time, create budget slack which is known as padding. - Budgetary slack is the excess of resources budgeted over the resources necessary to achieve organization goals - overstating expenses and under estimating revenues. Firm may reduce slack by reviewing budget during development and allowing for greater flexibility in making additional budget changes
- A budget CAN’T be a lump sum of total year, it must be divided per month per department ..
- Budget planning calendar is a schedule of activities for the development and adoption of the budget, it includes list of dates.
- Budget manual - everyone involved in budget preparation MUST be educated on the procedures for planning and submitting.
- Budget department is responsible for compiling the budget, they are NOT responsible for developing the estimates
- Best practice guidance for the budget process: ACUS
1) Automating the process
2) Setting realistic goals
3) Considering what if scenarios
4) Updating budgets regularly to reflect current condition - External factors on the budgeting process:
1) General economic conditions
2) Industry situation includes company market share, governmental, regulatory, labor market and competitors - To revise a budget a POLICY must be in place.
- Steps to revise a budget:
1) Establishing budget
2) Measure actual performance
3) Analyze and compare actual to budget
4) Implement corrective actions
5) Review and revise budget
2
Q
Budgeting and Standard Costs
A
- Standard costs are predetermined expectations about how much a unit of input, unit of output or a given activity should cost.
- Standard costs are usually set for one year, can be measured in TOTAL cost or PER UNIT. Also can be used in costing for inventory
- Standard cost becomes more challenging as time process in an environment where continuous improvement exists, they become out dated.
- Standard prices are designed for INTERNAL performance measurement.
- Standard cost IS NOT an average of past cost. They maybe based on accounting, engineering or statistical quality control studies.
- Because of the impact of fixed costs, standard costs system is usually NOT effective unless it has flexible budgeting.
- Activity analysis identifies, describes and evaluates the activities that go into producing a particular output
- Historical data may be used to set standards by firms that lack the resources to engage in the complex task of activity analysis.
- Direct material have DIRECT relationship between unit price and quality.
- For direct labors, the complexity of the production process and the restrictions on pays scales imposed by union agreements have the most impact on formulating cost standards.
- Theoretical and Practical standards:
1) Theoretical (Ideal) standards are based on MOST skilled workers with NO allowance for waste, spoilage. Adopted by come companies that apply continuous improvement and other total quality management principles.
2) Practical (Attainable) requires WELL trained workers (avg workers) with an allowance for normal spoilage, waste. More appropriate for developing budgets
3
Q
The Master Budget
A
- Is a series of budget to achieve entity goals and DOESN’T contain actual results. It is also called comprehensive budget, annual profit plan.
- The use of master budget throughout the year as a constant comparison with actual results signifies that the master budget is also a STATIC BUDGET.
- Capital budget is completed before operating budget is begun (NOT part of operating budget) - also considered to be independent item in the preparation of master budget , it is outside operating cycle and approved by BOD. Prepared more than 1 year in advance and it have DIRECT impact on cash budget and pro forma FS
- Sales budget (revenue budget) is the first budget prepared (fundamental budget) - it is the MOST DIFFICULT to forecast. Must be in units and dollars
- Production budget is based on units ONLY. It starts with sales budget. When moving from sales budget to production budget we should consider the change of finished goods ad WIP.
- Purchase budget follow AFTER PROJECTED SALES have been set, prepared monthly, or even weekly.
- Expense budget is prepared using sales budget as a basis. It is build based on prior years costs and adjusted for anticipated change in price, wages and sales volume
- Cash budget is usually the LAST to be prepared and considered the MOST important part of a company budget program. Almost ALL organizations regardless of size prepares it.
4
Q
Budget Methodologies
A
- Flexible budget is used at the END of a period to compare ACTUAL results with budget. It calculates quantity and costs of inputs that should have been consumed given the achieved production
- NO budget methodology can REDUCE planning UNCERTAINTY.
- Better identification of resources needed is an advantage of any kind of budgeting
- A PROJECT budget consists of all the costs expected to attach to a particular project. Requires commitment and large sum of funds and appropriate time frame over the project life cycle
- Activity based budgeting looks at a desired outcomes and work from there to determine needed resources. A traditional budgeting involves lumping all indirect costs into a single cost pool - Under traditional budget if a unit or division is under budget one year, the following year they may have budget cuts, unlike ABB.
- Activity based budgeting defines activity level then cost pool then cost driver
- Zero based budgeting is a planning process in which each manager MUST justify his or her departments entire budget EVERY BUDGET CYCLE. A manager must build the budget every year from Zero, the objective is to encourage periodic examination of all costs in the hope that some can be reduced or eliminated
- Zero based budget divides the activities of individual responsibility center into a series of packages that are prioritized. It provides more efficient allocation of resources available.
- Incremental budgeting in which the CURRENT years budget is simply ADJUSTED to allow for changes planned for the coming year.
- Continuous (rolling) budgeting is one that is revised on a regular (continuous) basis. A principle advantage that manager is always thinking ahead. Disadvantage is the time spend on preparation.
5
Q
Operating Budget / other budget
A
- DM budget follows directly from production department, it is concerned with both UNITS and INPUT PRICES
- DL budget depends on wages rate, amount and types of production, numbers and skill levels of employees to be hired.
- Employee fringe benefits MUST include company paid benefits and company paid payroll tax. They can be derived once cost of wages has been determined.Fringe MUST be allocated to MOH
- Ending finished goods inventory budget have a direct impact on the pro forma BS
- COGS combines the results of the projections for DM, DL and OH - the end result have direct ompct on pro forma IS
- Break even analysis is also called cost volume profit analysis.
- If VS increases, contribution margin decreases
6
Q
Projected Cash Collection / Cash Budget
A
- Cash collection schedules is used to estimate the inflows of cash from customer payments
- Cash budget is affected by sales credit policy, purchasing terms and planned capital acquisition. Prepared annually, quarterly, monthly or even weekly - Non-routine property sales could result in large fluctuations of cash and should be considered for medium and long term forecasts.
- When preparing cash disbursement schedules we ALWAYS EXCLUDE depreciation
- Firms develop cash budgets to avoid opportunity costs of non invested cash and minimize the cost of interim financing
- Cash budgets starts with cash collection and ends with pro forma statement of cash flow
- The completed cash budget can be used to plan outside financing activities. Dividend policy can also be planned using the cash budget
7
Q
Sales Forecast and Pro Forma FS
A
- Sales forecast start by looking back at historical trend to determine next years sales pattern. One of the most effective ways is regression analysis.
- Sales forecast is LEAST influenced by seasonal patterns to which demand for its products is subject
- The FIRST pro forma FS to be forecasted is IS
- Pro forma is a Latin phrase means According To Form, translated to AS IF. It is used to decide whether the budgeted activities will result in an acceptable level of income
- Pro forma BS is prepared using Cash budget, Capital budget and Pro forma IS
- Pro forma statement of cash flow is the LAST statement prepared. It evaluates a firm liquidity, solvency and financial flexibility.
- Pro forma FS are of interest to parties OUTSIDE the organization as well as INSIDE
- EPS is probably the MOST heavily relied upon performance measure used by investors. It is only calculated for COMMON STOCKS because common shareholders are the residual owners of a corporation
8
Q
Rules for Calculations
A
* For any budget we can follow BASE formula: Beginning \+ Additions - Subtract = Ending
- Sales budget =units sales* Selling price
- Production budget =
Projected sales in units
+ Desired ending inventory (% of next month sales)
= total needed - beg inventory ( for 1st month it equals sales projected units * % of desired inventory)
= Units to be produced - If company wants to produce 1000 units and 10% wont pass inspection, how much units the company should produce = 1000 / 90%
* DM budget = Units to be produced * raw material per finished product = total units needed for production * raw material cost per unit = cost of units used in production \+ desired units in ending inventory = Total needs - beg inventory = Raw materials to be purchased * raw material cost per unit = Cost of raw material to be purchased
* DL budget = Units to be produced * DL hours per units - If question says 15 mins per unit, we divide by 60 to reach in hours) = Projected total direct labor hours * DL cost per hour = Total DL cost
* Unit DL cost= Weekly wages cost \+ Fringe benefits = Weekly total compensation / weekly hours available = Cost per DL hour * DL hours per unit
- Exam tip : If the question says that OH equals DL times 2 then we need to Multiply DL * 3
- Finished goods inventory units budget =
Beg inventory balance (units will be from the question but we need to calculate its cost)
+ Production (from production budget)
= Goods available for sale - COGS - from units sold
= ending inventory (ending units * cost per unit of production) - For example if target inventory is 10 days of sales (based upon 360 days),first quarter sales is 67,500 how much is ending inventory for the first quarter = 67,500 /90 = 750 units then multiply by 10 days to each quarter ending stock = 7,500
- One half equals 50%
- Purchases = COGS - Decrease in inventory
OR
COGS + Increase in inventory
OR
Desired ending inventory at cost + Current moth sales at cost - Beg inventory at cost - If a company prices its products by adding 30% to its cost and sales was 700 then cost = 700 / 1.3
- Break even point units = Total fixed costs / contribution margin per unit
- Contribution margin per units = Total fixed costs / break even point in units
- Cash paid to suppliers = Purchases - Increase in AP
- Cash collection from credit sales =
Beg AR
+ Credit sales - Ending AR
* Increase in Cash = Net income \+ Depreciation expense - Increase in working capital OR + decrease in working capital - Capital expenditures
* Change in Cash = Collections on sales - Disbursements for inventory - Disbursements for other expenses \+ Beginning accounts receivable - Beginning accounts payable
- When preparing cash budget , net book value + gain received of sale of assets are cash if questions mentions it is cash sale transaction
- In calculating minimum cash balance we DISREGARD line of credit amount - NOT PART OF CALCULATION
- Estimated cash disbursements =
COGS - decrease in inventory
+ decrease in AP - Review idea of questions 29, 31 in subunit 7
- AP balance is the purchases on CREDIT during a period
- Interest expense is EXCLUDED in calculating operating income
- In calculating pro forma Income statement, we MUST check if there is any uncollectable sales amount to be treated as BDR
- In calculating pro forma Income statement, if the question says to increase sales price by 5%, COGS MUST not be changed
- Review question of subunit 9
- Growth rate (GR) = (ending value - beginning value) / beginning value
- Average annual growth rate = (GR1 + GR2 + GR3 ..) / number of periods
- EPS = (Net income - preferred dividend) / number of common shares outstanding
* CUSTOMER operating profit= Sales per customer - COGS per customer - Delivery cost per customer - Order taking cost per customer
