Master Budget and Responsibility Accounting

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Erick McCormick
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1 Master Budget and Responsibility Accounting 1

2 Budgeting Cycle Performance planning Providing a frame of reference Investigating variations Corrective action Planning again 2

3 The Master Budget Master Budget based on one expected scenario Operating Decisions Financial Decisions 3

4 Why Budgets? Conveys strategy to employees and managers Provides a framework for judging performance Motivates employees and managers Promotes coordination and communication 4

5 Strategy, Planning, and Budgets Strategy Analysis Long-run Planning Short-run Planning Long-run Budgets Short-run Budgets 5

6 Time Coverage of Budgets Budgets typically have a set time period (month, quarter, year). This time period can itself be broken into subperiods. The most frequently used budget period is one year. Businesses are increasingly using rolling budgets. 6

Requirements Budget: - Materials - Labor - Capacity

7 Operating Budget Materials Inventory B. Procurement B. Sales Budget Production B. Finished Goods Inventory B. Requirements Budget: - Materials - Labor - Capacity Revenue B. Non-Production Cost B. Production Cost B. -direct - overhead 7

Operating Budget Example Hawaii Diving expects 1,100 units to be sold during the month of August 2013.

8 Operating Budget Example Hawaii Diving expects 1,100 units to be sold during the month of August Selling price is expected to be $240 per unit. How much are budgeted revenues for the month? 1,100 $240 = $264,000 8

9 Operating Budget Example Two pounds of direct materials are budgeted per unit at a cost of $2.00 per pound, $4.00 per unit. Three direct labor-hours are budgeted per unit at $7.00 per hour, $21.00 per unit. Variable overhead is budgeted at $8.00 per direct laborhour, $24.00 per unit. Fixed overhead is budgeted at $5,400 per month. Variable nonmanufacturing costs are expected to be $0.14 per revenue dollar. Fixed nonmanufacturing costs are $7,800 per month. 9

10 Production Budget Example Budgeted sales (units) + = Target ending finished goods inventory (units) Beginning finished goods inventory (units) Budgeted production (units) 10

11 Production Budget Example Assume that target ending finished goods inventory is 80 units. Beginning finished goods inventory is 100 units. How many units need to be produced? Units required for sales 1,100 Add ending inv. of finished units 80 Total finished units required 1,180 Less beg. inv. of finished units 100 Units to be produced 1,080 11

12 Direct Materials Usage Budget Each finished unit requires 2 pounds of direct materials at a cost of $2.00 per pound. Desired ending inventory equals 15% of the materials required to produce next month s sales. September sales are forecasted to be 1,600 units. What is the ending inventory in August? 480 pounds 12

13 Direct Materials Usage Budget September sales: 1,600 2 pounds per unit = 3,200 pounds 3,200 15% = 480 pounds (the desired ending inventory) What is the beginning inventory in August? 1,100 units 2 15% = 330 units How many pounds are needed to produce 1,080 units in August? 1,080 2 = 2,160 pounds 13

14 Material Purchases Budget Hawaii Diving Direct Material Purchases Budget for the Month of August 2013 Units needed for production 2,160 Target ending inventory 480 Total material to provide for 2,640 Less beginning inventory 330 Units to be purchased 2,310 Unit purchase price $ 2.00 Total purchase cost $4,620 14

15 Direct Manufacturing Labor Budget Each unit requires 3 direct labor-hours at $7.00 per hour. Hawaii Diving Direct Labor Budget for the Month of August 2013 Units produced: 1,080 Direct labor-hours/unit 3 Total direct labor-hours: 3,240 Total budget at $7.00/hour: $22,680 15

16 Manufacturing Overhead Budget Variable overhead is budgeted at $8.00 per direct laborhour. Fixed overhead is budgeted at $5,400 per month. Hawaii Diving Manufacturing Overhead Budget for the Month of August 2013: Variable Overhead: (3,240 $8.00) $25,920 Fixed Overhead 5,400 Total $31,320 16

17 Ending Inventory Budget Cost per finished unit: Materials $ 4 Labor 21 Variable manufacturing overhead 24 Fixed manufacturing overhead 5* Total $54» *$5,400 1,080 = $5 What is the cost of the target ending inventory for materials? 480 $2 = $960 What is the cost of the target finished goods inventory? 80 $54 = $4,320 17

18 Cost of Goods Sold Budget Direct materials used 2,160 $2.00 4,320 Direct labor 22,680 Total overhead 31,320 Cost of goods manufactured $58,320 Assume that the beginning finished goods inventory is $5,400. Ending finished goods inventory is $4,320. What is the cost of goods sold? 18

19 Cost of Goods Sold Budget Beginning finished goods inventory $ 5,400 + Cost of goods manufactured $58,320 = Goods available for sale $63,720 Ending finished goods inventory $ 4,320 = Cost of goods sold $59,400 19

20 Nonmanufacturing Costs Budget Hawaii Diving Other Expenses Budget for the Month of August 2013 Variable Expenses: ($0.14 $264,000) $36,960 Fixed expenses 7,800 Total $44,760 20

21 Cost of Goods Sold Budget Hawaii Diving has budgeted sales of $264,000 for the month of August. Cost of goods sold are budgeted at $59,400. What is the budgeted gross margin? Hawaii Diving Budgeted Income Statement for the Month ending August 31, 2013 Sales $264, % Less cost of sales 59,400 22% Gross margin $204,600 78% Other expenses 44,760 17% Operating income $159,840 61% 21

22 Financial Planning Models Financial planning models are mathematical representations of the interrelationships among operating activities, financial activities, and other factors that affect the master budget. 22

23 Example: Cash Budget Depends on collection pattern: In the month of sale: 50% In the month following sale: 27% In the second month following sale: 20% Uncollectible: 3% 23

24 Cash Budget Budgeted charge sales are as follows: June $200,000 July $250,000 August $264,000 September $260,000 What are the expected cash collections in August? 24

25 Cash Budget Budgeted Cash Receipts for the Month Ending August 31, 2013 August sales: $264,000 50% $132,000 July sales: $250,000 27% $67,500 June sales: $200,000 20% $40,000 Total $239,500 25

26 Cash Budget Budgeted Cash Disbursements for the Month Ending August 31, 2013 August purchases $ 4,620 Direct labor $22,680 Total overhead $31,320 Other expenses $9,760* Total $68,380 *Other expenses exclude depreciation 26

27 Cash Budget Cash Budget for the Month Ending August 31, 2013 Budgeted receipts $239,500 Budgeted disbursements 68,380 Net increase in cash $171,120 27

28 Exercise: Prepare a purchases budget in pounds for July, August, and September, and give total purchases in both pounds and dollars for each month. Lubriderm Corporation has the following budgeted sales for the next six-month period: Month Unit Sales June 90,000 July 120,000 August 210,000 September 150,000 October 180,000 November 120,000 There were 30,000 units of finished goods in inventory at the beginning of June. Plans are to have an inventory of finished products that equal 20% of the unit sales for the next month. Five pounds of materials are required for each unit produced. Each pound of material costs $8. Inventory levels for materials are equal to 30% of the needs for the next month. Materials inventory on June 1 was 15,000 pounds 28

29 What is Kaizen? The Japanese use the term kaizen for continuous improvement. Kaizen budgeting is an approach that explicitly incorporates continuous improvement during the budget period into the budget numbers. 29

30 Kaizen Budgeting A kaizen budgeting approach would incorporate future improvements. Budgeted Hours/Item January March April June July September October December

31 Activity-Based Budgeting Activity-based costing reports and analyzes past and current costs. Activity-based budgeting (ABB) focuses on the budgeted cost of activities necessary to produce and sell products and services. 31

32 Activity-Based Budgeting Product A Product B Units produced: Labor-hours per unit: 3 3 Budgeted setup-hours: 5 5 Total budgeted machine setup related cost is $25,920 per month. Total budgeted labor-hours are: Product A: ,640 Product B: Total 3,240 What is the allocation rate per labor-hour? $25,920 3,240 = $

33 Activity-Based Budgeting Total cost allocated to each product line: Product A: $8.00 2,640 = $21,120 Product B: $ = $ 4,800 Under ABB, the number of setups is the cost driver. $25,920 budgeted machine setup cost 10 budgeted machine setup-hours = $2,592 allocation rate per machine setup-hour. How much machine setup related costs are allocated to each product line? 33

34 Activity-Based Budgeting Product A Product B $12,960 $12,960 $2,592 5 $2,592 5 Setup-related cost per unit: Product A: $12, $14.73 Product B: $12, $

35 What is a Responsibility Center? It is any part, segment, or subunit of a business that needs control. production service 35

36 Types of Responsibility Centers Cost Center Profit Center Investment Center 36

37 What is Controllability? It is the degree of influence that a specific manager has over costs, revenues, or other items in question. A controllable cost is any cost that is primarily subject to the influence of a given responsibility center manager for a given time period. 37

38 Controllability Responsibility accounting focuses on information and knowledge, not control. A responsibility accounting system could exclude all uncontrollable costs from a manager s performance report. In practice, controllability is difficult to pinpoint. 38

39 Human aspects of Budgeting Budgeting should not be considered as a mechanical tool Quality of the budget depends on the information that is fed into the process There are incentives for dishonest reports Budgetary slack Empire building Management aims to ensure honest reporting by lower level management Via appropriate performance measures Monitoring 39

40 True or False??? A budget that covers the financial aspects is a qualitative expression of a proposed plan of action by management for a specified period. The master budget reflects the impact of only operating decisions. Feedback in the budgeting process may cause a firm to alter its strategies and plans. Statistical analysis should be the only input used to forecast sales. Sensitivity analysis allows managers to see how results will change if predicted data are not achieved or an underlying assumption changes. 40

41 Pick your Choice I: When a budget is administered wisely, it will discourage strategic planning. provide a framework for performance evaluation. discourage managers and employees. eliminate coordination and communication between subunits. If a firm is using activity-based budgeting, the firm would use this in place of which of the following budgets? Direct materials budget Revenue budget Direct labor budget Manufacturing overhead budget 41

42 Pick your Choice II: BDH Corporation, which makes only one product, Kisty, has the following information available for the coming year. BDH expects sales to be 30,000 units at $50 per unit. The current inventory of Kisty is 3,000 units. BDH wants an ending inventory of 3,500 units. Each unit of Kisty takes two units of component L. Component L is budgeted to cost $12 per unit. Current inventory of L is 4,000 units. BDH wants 6,000 units of L on hand at the end of the next year. How much will the direct materials budget show as the cost of materials to be purchased? $330,000 $390,000 $684,000 $756,000 42

43 Who Gets the Money? New York Post, April 29, 2001 In the above-cited article, ABC and its parent company, Walt Disney Company, say that the show "Who Wants to be a Millionaire," is the most profitable television show ever - generating almost $1 billion in revenue in a little less than two years on the air. Each individual show costs about $700,000 to produce, including prize money and host Regis Philbin's salary. Each show earns $2 million in advertising revenue. The rights to air Millionaire are also sold to Canada for $250,000 per episode. The Millionaire show also sells a CD-ROM game for $20. About 4 million of these games have been sold. There is also an on-line version of the game that Millionaire fans can play. Users of the game don't pay, but each "hit" is noted when advertising space is sold for the site. The article also points out that Disney also sells hats and t-shirts of the game, and markets a special version of "Millionaire" to corporations that can be played at conventions by employees and clients. 43

44 Who Gets the Money? - Questions 1. The Millionaire show itself generates about $1.3 million per episode in net income ($2 million in revenue, $700,000 in expenses.) Give a reason why this should be considered a profit center for evaluating a manager's performance. 2. Do you think that one manager has responsibility for the Millionaire show, as a profit center, or is it divided as a cost center and as a revenue center? 3. Should the ancillaries of the show (the t-shirts, CD-ROM, etc.) be evaluated as a profit center, cost center or revenue center? Why? 44

THE MASTER BUDGET ET R BUDGE VERVIEW OV. Horngren 13e

THE MASTER BUDGET ET R BUDGE VERVIEW OV. Horngren 13e Chapter 6: THE MASTER BUDGET Horngren 13e 1 ET R BUDGE W OF THE MASTER VERVIEW OV 2 3 Learning Objective 1: Describe the master budget... The master budget is the initial budget prepared p before the start