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Managerial Accounting:
An Introduction To Concepts, Methods, And Uses
Chapter 10
Profit Planning and Budgeting
Maher, Stickney and Weil
Learning Objectives
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(Slide 1 of 2)
Explain the use of a budget as a tool for
planning and performance evaluation.
Explain how a budget can affect
employee motivation.
Compare the four types of responsibility
centers.
Describe the master budget.
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Learning Objectives
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(Slide 2 of 2)
Explain the difference between a
flexible budget and master budget.
Describe ethical dilemmas in budgeting.
List the components of a
comprehensive master budget.
Describe an incentive model for
accurate reporting.
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Organizational Plan
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Consists of three parts
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Organization Goals - Broad objectives
established by mgmt. that company
employees work to achieve
Strategic long-range plan - Intermediate
and distant future plans stated in broad
terms
Master Budget - Specific plan for the
coming year
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Master Budget
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Also known as the static budget
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Indicates sales, production and cost levels,
income and cash flows anticipated for the
following year
Also includes an income statement and
balance sheet based on budget data
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Employee Participation
in Developing Budgets
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Participative budgeting - Using input of
lower- and middle-management in
developing budgets
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Time-consuming
Enhances employee motivation and
acceptance of goals
Provides info that enables employees to
associate rewards and penalties with
performance
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Performance Evaluation
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Budgets provide estimates of expected
performance
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Comparing budgeted with actual results
provides a basis for evaluating
performance
Budgets must be prepared for individual
responsibility centers in order to use them
to evaluate performance
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Responsibility Centers
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(Slide 1 of 2)
A responsibility center is a division or
department responsible for managing a group
of activities in the organization
Responsibility centers can be classified as
follows:
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Cost centers - mgmt is responsible for managing
costs
Revenue centers - mgmt is responsible for
managing revenues
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Responsibility Centers
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(Slide 2 of 2)
Responsibility centers can be classified as
follows (continued):
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Profit centers - mgmt is responsible for both
revenues and costs
Investment centers - mgmt is responsible for
revenues, costs, and assets
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Flexible Budgets
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Shows the expected relation between
costs and volumes
Has two components:
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Fixed cost - expected to be incurred
regardless of the activity level
Variable cost - costs change in total as the
activity level changes
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Cost Hierarchies
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When preparing a master budget, it is
important to understand how costs are
affected by changes in activity levels
The following cost hierarchy is helpful in
understanding cost behavior:
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Unit-level activities
Batch-level activities
Product-level activities
Customer-level activities
Facility-level activities
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Forecasting Sales
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Developing the master budget starts with
forecasting sales
Various methods and sources used to obtain
sales forecasts include:
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Sales staff
Market research
Delphi technique
Trend analysis
Econometric Models
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Production Budget
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(Slide 1 of 2)
The production budget is based on the sales
budget and estimates of beginning and
desired ending inventories
Production is calculated as follows:
Number of Units to Be Sold
+Units in Ending Inventory
-Units in Beginning Inventory
Units to Be Produced
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Production Budget
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(Slide 2 of 2)
After determining the number of units to be
produced, we can budget for the following:
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Direct materials - traceable to units produced and
almost always a variable cost
Direct labor - traceable to units produced; usually
a variable cost but could be a fixed cost
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We assume direct labor is a variable cost in this chapter
Manufacturing overhead - typically has both
variable and fixed components; variable overhead
varies with units produced, fixed overhead gives a
firm production capacity
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Marketing and
Administrative Budgets
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Budgeted marketing costs might include
the following:
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Facility-level activities - salaries,
advertising, sales office costs
Unit-level activities - sales commissions,
shipping
Administrative costs include both fixed
and variable costs
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Discretionary Fixed Costs
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Many “fixed” costs are really
discretionary costs
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They are budgeted as fixed costs but if, for
example, the economic conditions look
bad, these costs can be reduced
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Examples: maintenance, advertising
Discretionary fixed costs should be
distinguished from committed fixed costs, like
rent on a factory building, which are required to
run the firm
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Budgeted Income Statement
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Also called the profit plan
Prepared using a contribution margin
format
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If management is satisfied with the
budget, it is approved
If not, management can look for ways to
improve budget profits through, for
example, sales increases or cost reductions
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Accurate Forecasts
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An accurate sales forecast is critical to
the entire budget process
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If forecast is too low, sales may be lost
because purchasing and production have
been planned at too low a level
If forecast is too high, excess inventory
may result
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Using the Master Budget
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Master budget includes budgeted
financial statements as well as other
relevant budgets
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Once adopted, the master budget becomes
a major planning tool
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Essentially, becomes authorization to produce
and sell goods, purchase materials, hire
employees
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Comparison of Flexible
and Master Budgets
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The flexible budget is based on actual
sales and production volumes
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Indicates expected revenue and costs at
the actual level of activity
Comparison of master budget to the
flexible budget forms the basis for
analyzing differences in planned and
actual results
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Example: Flexible and Master
Budget Comparison (Slide 1 of 2)
Flexible
Master
Budget(based
Budget(based on Sales
on actual sales
estimated sales Volume
of 80,000 units) of 70,000 units) Variance
$480,000
$420,000
$60,000F
Sales
Less:
Var. Man. Costs
293,600
Var. Mktg. Costs
11,200
Contribution Margin $175,200
Less Fixed Costs
142,400
Operating Profit
$ 32,800
Exhibit 10.8
256,900
9,800
$153,300
142,400
$ 10,900
36,700U
1,400U
$21,900F
___-___
$21,900
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Example: Flexible and Master
Budget Comparison (Slide 2 of 2)
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Observations:
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Management predicted sales of 70,000 units but
80,000 units were actually sold resulting in a
favorable sales volume variance of $21,900
(increased profits)
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Sales volume variance is the difference in profit caused
by the difference in budgeted and actual sales volume
The variable cost variances are labeled
“unfavorable” but do not necessarily mean “bad”
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Variable costs are expected to increase due to the
increased sales volume
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Budgeting in
Nonprofit organizations
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The master budget is very important in
nonprofit organizations
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Used as a basis for authorizing the
expenditure of funds
In governmental units, the budget is a
legal authorization for expenditure
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Penalties for exceeding authorized
expenditures can be severe
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Ethical Issues in Budgeting
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Managers and employees not only provide
information that will be used in the budget,
they may also be evaluated by comparing
budget to actual results
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This can lead to ethical dilemmas
Example: Manager may receive a bonus
based on exceeding budgeted amounts of
sales
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May be motivated to submit low estimates of sales
for the budget to receive a larger bonus
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If you have any comments or suggestions concerning this
PowerPoint Presentation for Managerial Accounting, An
Introduction To Concepts, Methods, And Uses, please contact:
Dr. Donald R. Trippeer, CPA
[email protected]
Colorado State University-Pueblo
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