Budgeting affects the following managerial functions: o
Planning Planning involves setting goals to guide decisions and help motivate employees.
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.
Controlling Controlling involves comparing actual performance against the budgeted goals.
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. The budget process is monitored and summarized by the Accounting Department, which reports to the committee.
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. 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.
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.
Flexible budgets show the expected results of a responsibility center for several activity levels. 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.
Step 2: Identify the fixed and variable cost components of the costs being budgeted. 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.
The direct labor cost budget estimates the direct labor hours and related cost needed to support budgeted production. 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:
Step 2. Determine the total direct labor cost as follows
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.
The cash budget estimates the expected receipts (inflows) and payments (outflows) of cash for a period of time. o
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.
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 longterm debt payments. To estimate cash payments for manufacturing costs, a schedule of payments for manufacturing costs is prepared.
The capital expenditures budget summarizes plans for acquiring fixed assets. o o
Such expenditures are necessary as machinery and other fixed assets wear out or become obsolete. 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 must be ordered years in advance.
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.