Operating Budget

BUDGETING FOR PLANNING
AND CONTROL
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Learning Objectives
1. Define budgeting and discuss its role in
planning, control, and decision making.
2. Define and prepare the operating budget,
identify its major components, and explain the
interrelationships of its various components.
3. Define and prepare the financial budget,
identify its major components, and explain the
interrelationships of its various components.
4. Describe the behavioral dimension of
budgeting.
Description of Budgeting
 All businesses should prepare budgets.
 Budgets help business owners and managers to
plan ahead, and later, exercise control by
comparing what actually happened to what was
expected in the budget.
 Budgets formalize managers’ expectations
regarding sales, prices, and costs.
 Even small businesses and nonprofit entities can
benefit from the planning and control provided by
budgets.
LO-1
Budgeting and Planning
and Control
 Planning and control are linked.
 Planning is looking ahead to see what actions
should be taken to realize particular goals.
 Control is looking backward, determining what
actually happened and comparing it with the
previously planned outcomes.
 Budgets are financial plans for the future and are
a key component of planning. They identify
objectives and the actions needed to achieve
them.
LO-1
Budgeting and Planning
and Control (cont.)
 Before preparing a budget, an organization
should develop a strategic plan.
 The strategic plan plots a direction for an
organization’s future activities and operations; it
generally covers at least 5 years.
LO-1
Planning, Control, and Budgets
LO-1
Advantages of Budgeting
A budgetary system gives an organization
several advantages.
Information for
Planning Decision
Making
Standards for Improved

Performance Communication
Evaluation & Coordination
LO-1
The Master Budget
 The master budget is the comprehensive
financial plan for the organization as a whole.
 Typically for a 1-year period, corresponding to the
fiscal year of the company.
 Yearly budgets are broken down into quarterly
and monthly budgets.
 The use of smaller time periods allows managers
to compare actual data with budgeted data more
frequently, so problems may be noticed and
resolved sooner.
LO-1
The Master Budget (cont.)
 Some organizations have developed a
continuous budgeting philosophy.
 A continuous budget is a moving 12-month
budget.
 As a month expires in the budget, an additional
month in the future is added so that the company
always has a 12-month plan on hand.
 Proponents of continuous budgeting maintain that
it forces managers to plan ahead constantly.
LO-1
Master Budget:
Directing and Coordinating
 Most organizations prepare the master budget for the
coming year during the last 4 or 5 months of the
current year.
 The budget committee:
 reviews the budget
 provides policy guidelines and budgetary goals
 resolves differences that arise as the budget is prepared
 approves the final budget
 monitors the actual performance of the organization as the year
unfolds.
 The controller usually serves as the budget director,
the person responsible for directing and coordinating
the organization’s overall budgeting process.
LO-1
Master Budget:
Major Components
 A master budget can be divided into operating and
financial budgets:
 Operating budgets describe the income-generating
activities of a firm: sales, production, and finished goods
inventories. Outcome is a pro forma or budgeted
income statement.
 Financial budgets detail the inflows and outflows of
cash and the overall financial position.
 Planned cash inflows and outflows appear in the cash
budget. The expected financial position at the end of
the budget period is shown in a budgeted, or pro forma,
balance sheet. LO-1
Master Budget:
Major Components (cont.)
 Since many of the financing activities are not
known until the operating budgets are known, the
operating budget is prepared first.
LO-1
The Master Budget and
Its Interrelationships
LO-1
Preparing the Operating Budget
 The operating budget consists of a budgeted
income statement accompanied by the following
supporting schedules:
 sales budget
 production budget
 direct materials purchases budget
 direct labor budget
 overhead budget
 selling and administrative expenses budget
 ending finished goods inventory budget
 cost of goods sold budget
LO-2
Sales Budget
 The sales budget is approved by the budget
committee and describes expected sales in units
and dollars.
 The sales budget is the basis for all of the other
operating budgets and most of the financial budgets.
 It is important that it be as accurate as possible.
 The first step in creating a sales budget is to develop
the sales forecast.
 The sales forecast is just the initial estimate, and it is
often adjusted by the budget committee.
LO-2
Cornerstone 9.1
Preparing a Sales Budget
LO-2
Budgeting in a Service Industry
You are the controller for a large, regional medical center. The chief of cardiology has been pushing
to have a free-standing heart hospital built on the medical center campus. However, you are
concerned that taking the heart cases away from the main hospital will hurt its bottom line. While the
medical center is nonprofit, it does need to cover all of its costs to stay in business. You also wonder
whether the heart hospital will break even.
What information do you need to forecast revenues and costs of the heart
hospital?
This is a two part problem. The first question, what impact will the heart hospital have on the main
hospital’s revenues, requires knowledge of the number and types of heart cases seen at the main
hospital each year. This information could come from the sales revenue budget from the previous
year, assuming that the total number of patient days and procedures are broken out by type of case
and procedure. Since so many of the costs of a hospital are fixed, there will probably be little
decrease in costs as those heart patients leave for the freestanding heart hospital. The second
question requires a forecast of the number of patients and probably reimbursement rates expected
for procedures to be performed by the heart hospital. This information can be compared with
budgeted operating costs to see if the heart hospital’s revenues can cover its costs.
Forecasts of sales revenues and costs are dependent on detailed information provided by
sources like the marketing or sales department and past accounting information and need to
be revised and updates as new information or circumstances dictate. LO-2
Production Budget
 The production budget tells how many units
must be produced to meet sales needs and to
satisfy ending inventory requirements.
 To compute the units to be produced, both unit
sales and units of beginning and ending finished
goods inventory are needed:
Units to be produced = Expected unit sales
+ Units in desired ending inventory (EI)
– Units in beginning inventory (BI)
LO-2
Cornerstone 9.2
Preparing a Production Budget
LO-2
Cornerstone 9.2
Preparing a Production Budget (cont.)
LO-2
Direct Materials Purchases Budget
 After the production budget is completed, the
budgets for direct materials, direct labor, and
overhead can be prepared.
 The direct materials purchases budget tells the
amount and cost of raw materials to be
purchased in each time period.
 The formula used for calculating purchases is as
follows:
LO-2
Cornerstone 9.3
Preparing a Direct Materials Purchases
Budget
LO-2
Cornerstone 9.3
Budget
LO-2
Cornerstone 9.3
Budget
LO-2
Direct Labor Budget
 The direct labor budget shows the total direct
labor hours and the direct labor cost needed for
the number of units in the production budget.
 The budgeted hours of direct labor are
determined by the relationship between labor and
output.
LO-2
Cornerstone 9.4
Preparing a Direct Labor Budget
LO-2
Overhead Budget
 The overhead budget shows the expected cost
of all production costs other than direct materials
and direct labor.
 Many companies use direct labor hours as the
driver for overhead.
 Then costs that vary with direct labor hours are
pooled and called variable overhead.
 The remaining overhead items are pooled into
fixed overhead.
LO-2
Cornerstone 9.5
Preparing an Overhead Budget
LO-2
Ending Finished Goods Inventory
Budget
 The ending finished goods inventory budget:
 Supplies information needed for the balance sheet
 Serves as an important input for the preparation of the
cost of goods sold budget.
 To prepare this budget, the unit cost of producing
finished goods must be calculated by using
information from the direct materials, direct labor,
and overhead budgets.
LO-2
Cornerstone 9.6
Preparing an Ending
Finished Goods Inventory Budget
LO-2
Cornerstone 9.6
Preparing an Ending
Finished Goods Inventory Budget
LO-2
Cost of Goods Sold Budget
 Assuming that the beginning finished goods
inventory is valued at $1,251, the budgeted cost
of goods sold schedule can be prepared using
information from Cornerstones 9.3 to 9.6.
 The cost of goods sold budget reveals the
expected cost of the goods to be sold.
LO-2
Cornerstone 9.7
Preparing a Cost of Goods Sold Budget
LO-2
Selling and Administrative
Expenses Budget
 The selling and administrative expenses
budget outlines planned expenditures for
nonmanufacturing activities.
 Selling and administrative expenses can be
broken down into fixed and variable components.
 Items as sales commissions, freight, and supplies
vary with sales activity.
LO-2
Cornerstone 9.8
Preparing a Selling and Administrative
Expenses Budget
LO-2
Cornerstone 9.8
Preparing a Selling and
Administrative Expenses Budget (cont.)
LO-2
Budgeted Income Statement
 With the completion of the budgeted cost of
goods sold schedule and the budgeted selling
and administrative expenses budget, a company
has all the operating budgets needed to prepare
an estimate of operating income.
LO-2
Cornerstone 9.9
Preparing a Budgeted
Income Statement
LO-2

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BUDGETING FOR PLANNING

Standards for Improved

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