EXAM 2 REVIEW

Calculating Target Profit

(Fixed expenses + Target profit)/Unit contribution margin = Number of sales units required to earn target profit (Fixed expenses + Target profit)/Contribution-margin ratio = Dollar sales required to earn target profit [(Unit Sales Price) X (Sales Volume Required to Earn Target Profit)] - [(Unit Variable Expense) X (Sales Volume Required to Earn Target Profit)] - (Fixed Expenses) = Target Profit

Unit Contribution Margin

Amount that remains of each product's price after variable expenses are covered

Two Factors That Create Difference in Expected Profit at Two Sales Prices

1. Different unit contribution margin 2. Different sales volume

Changes in Fixed Expenses

1. Estimate of fixed expenses increases EX: increase of 2.5% = (Fixed expenses x 1.025)/Unit contribution margin = Break-even point (units) or → break-even point x 1.025 2. Nonprofit organizations often receive cash donations from people or organizations desiring to support a worthy cause -- donation is equivalent to a reduction of fixed expenses and reduces organization's break-even point (Fixed expenses - Donations)/Unit contribution margin = Break-even point (units)

3 Primary Reasons (Budgetary Slack)

1. People often perceive their performance will look better in superior's eyes if they can "beat the budget" 2. Used to cope with uncertainty -- departmental supervisor may feel confident in cost projections but also feel some unforeseen events during budgetary period could result in unanticipated costs If nothing goes wrong, supervisor can beat cost budget; if something does, supervisor can use slack to absorb impact and still meet cost budget 3. Budget cuts are often required when early drafts of the budget show that resources are not adequate to cover all planned spending → vicious cycle Padded because likely be cut and cut because likely to have been padded

3 Basic Parts of a Control System

1. Predetermined or standard performance level 2. Measure of actual performance 3. Comparison between standard and actual performance

Order of Budgeting

1. Sales planning process and sales budget -- need for products and services to fill sales orders is what drives company's production plans + production budget 2. Production budget -- tells company how much of each input and conversion resource is needed 3. Combining this with company's input and resource cost estimates yields appropriate budgets

Behavioral Impact of Budgets

A budget affects virtually everyone in an organization -- those who prepare it, those who use it to facilitate decision making, and those who are evaluated using it

After-Tax Net Income

A firm's after-tax net income, the amount of income remaining after subtracting the firm's income tax expense, is less than its before-tax income

Operational Budget: Manufacturing Firms

A manufacturing firm company develops a production budget that shows number of units of each product to be manufactured Coupled with production budget are ending-inventory budgets for raw material, work in process, and finished goods Ending-inventory budgets reflect manufacturer's plan to have some level of inventory on hand at all times to meet peak demand while keeping production at a stable level From production budget, a manufacturer develops budgets for direct materials, direct labor, and overhead required in the production process A budget for selling and administrative expenses also is prepared

Operational Budget: Merchandising Firms

A merchandising firm purchases products manufactured by others and sells them to the end users, adding value through a combination of distribution and retail operations Operational portion of master budget is similar to manufacturing firm, but instead of a production budget for goods, a merchandiser develops a budget for merchandise purchase No budget for direct material, because it does not engage in production but will develop budgets for labor (or personnel), overhead, and selling and administrative expenses

International Aspects of Budgeting

A multinational firm's budget must reflect translation of foreign currencies into official corporate currency, usually determined by location of corporate headquarters or stock exchange on which company has its primary listing Almost all currencies fluctuate in values relative to dollar, makes budgeting for those translations difficult -- multinationals have sophisticated financial ways of hedging against such currency fluctuations, but still more challenging Difficult to prepare difficult budgets when inflation is high or unpredictable -- most countries occasionally experience periods of high inflation, and some experience hyperinflation, sometimes with annual inflation rates >100% Economies of all countries fluctuate in terms of consumer demand, availability of skilled labor, laws affecting commerce, etc. -- companies with offshore operations have to anticipate changing conditions in budgeting processes

Task Analysis

Analyze process of manufacturing a product to determine what it should cost Manager or accountant typically works with engineers intimately familiar with production process -- together they conduct studies to determine exactly how much direct material should be required and how machinery should be used in production process Time and motion studies are conducted to determine how long each step performed by direct-labor production workers should take

Cost Variance

Any difference between actual cost and budgeted or standard cost May lead company to look for an explanation for the incorrect prediction Manager compares actual cost of item with standard cost

Activity-Based Budgeting (ABB)

Applying ABC concepts to the budgeting process 1. Specify the products or services to be produced and the customers served 2. Activities necessary to produce these products and services are determined 3. Resources necessary to perform the specified activities are quantified ABC assigns resource costs to activities, then assigns activity costs to products and services produced and customers served ABB begins by forecasting demand for products and services as well as customers to be served → forecasts are used to plan activities for budget period and budget resources necessary to carry out activities

Solving Problem of Budgetary Slack

Avoid relying on budget as a negative evaluation tool If supervisor is allowed some managerial discretion to exceed budget when necessary, there will be less tendency toward budgetary padding Managers can be given incentives to achieve budgetary projections and to provide accurate projections -- ask managers to justify all or some projections and reward managers who consistently provide accurate estimates Across-the-board budget cuts during budgeting process should be avoided in favor of more targeted approaches that are based on spending justifications

Operational Budget: Service-Industry Firms

Based on sales budget for its services, a service-industry firm develops a set of budgets that show how the demand for those services will be met Prepares a production budget (for production of its services) and the related operational budgets, but precise nature of these budgets depends on industry

For any CVP analysis to be valid, the following important assumptions must be reasonably satisfied within the relevant range:

Behavior of total revenue is linear (straight-line) -- implies price of product or service won't change as sales volume varies within relevant range Behavior of total expenses is linear (straight-line) over relevant range Expenses can be categorized as fixed, variable, or semivariable -- total fixed expenses remain constant as activity changes and unit variable expense remains unchanged as activity varies Efficiency and productivity of production process and workers remain constant In multiproduct organizations, sales mix remains constant over relevant range In manufacturing firms, inventory levels at beginning and end of period are the same -- implies number of units produced during period = number of units sold

Interpreting the CVP Graph

Break-even point -- determined by the intersection of the total-revenue line and total-expense line Position of the break-even point within an organization's relevant range of activity provides important information to management EX: if organization's break-even point is close to max possible sales volume, could be cause for concern in nonprofit organization operating on limited resources Profit and Loss Areas -- CVP graph discloses more information than the break-even calculation Manager can see the effects on profit of changes in volume Vertical distance between lines on graph represents profit or loss at a particular sales volume Does not resolve potential problems but directs management's attention to the situation Alternative format for CVP graph is preferred by some managers -- fixed expenses are graphed above variable expenses (vice versa displayed in typical CVP graphs)

Perfection (Ideal) Standard

Can be attained only under nearly perfect operating conditions Assume peak efficiency, lowest possible input prices, best-quality materials obtainable, and no disruptions in production Some managers believe they help achieve lowest production cost by motivating employees to achieve lowest cost possible -- standard is theoretically attainable so employees have incentive to come as close as possible to achieving it Other managers and many behavioral scientists disagree -- feel that perfection standards discourage employees, since they are so unlikely to be attained Setting unrealistically difficult standards may encourage employees to sacrifice product quality to achieve lower costs By skimping on raw-material quality or attention given to manual production tasks, employees may lower the production cost but may come at expense of a higher rate of defective units → firm may incur higher costs than necessary as defective products are returned by customers or scrapped upon inspection

Direct-Labor Budget

Captures costs of labor directly traceable to the product/service/event Understand what drives the need for different kinds of labor and build budget on that basis

Cost-Volume-Profit Graph

Commonly used to capture relationship between profit and volume of activity Step 1: Label vertical axis in dollars and horizontal axis in units of sales Step 2: Draw the fixed-expense line -- parallel to horizontal axis, since fixed expenses do not change with activity Step 3: Compute total expense at any convenient volume and plot point Step 4: Draw the total-expense line -- passes through point plotted in Step 3 and the intercept of fixed-expense line on vertical axis Step 5: Compute total sales revenue at any convenient volume and plot point Step 6: Draw the total revenue line -- passes through point plotted in Step 5

Predetermined (Standard) Cost

Company's best estimate of the average cost to produce a single unit of product or service -- serves as starting point for creating the relevant budgets When firm plans to produce multiple units, managers use standard unit cost to determine total standard or budgeted cost of production

The Master Budget

Comprehensive set of budgets covering all phases of an organization's operations for a specified period of time By formalizing communication and coordination of operating and financial plans, the master budget makes sure everyone's plans are consistent and that the total output of all those plans yields a result that makes sense for the organization Collects all operating plans and translates them into a financial picture of results of planned operations while identifying resources required to accomplish those plans and their costs Collectively, interdependent budgets comprise the master budget

Key Features of a Master Budget

Consists of a series of budget schedules that are heavily interdependent, with outputs of one schedule serving as inputs to another Budget schedules follow a logical sequence, beginning with the sales budget and building to the budgeted financial statements Operational assumptions are specifically identified and incorporated into budget Activity-based budgeting logic is incorporated All the key types of master budget schedules are present: sales, operational, financing, and financial statements Every master budget will be different but will have all above features

Budget Committee

Consists of key senior executives and is often appointed to advise budget director during preparation of budget Authority to give final approval to master budget usually belongs to board of directors, or a board of trustees in many nonprofit organizations Usually has a subcommittee whose task is to examine proposed budget carefully and recommend approval or changes By exercising authority to make changes and grant final approval, board of directors can wield considerable influence on overall direction organization takes

Rolling Budgets (Revolving or Continuous Budgets)

Continually updated by periodically adding a new incremental time period, such as a quarter, and dropping the period just completed Usually a 12 month budget that rolls forward one month as the current month is completed

Traditional Income Statement

Cost of goods sold includes both variable and fixed manufacturing costs, as measured by product-costing system Gross margin = Sales - COGS Selling and admin expenses are then subtracted; each expense includes both variable and fixed costs Does not disclose breakdown of each expense into variable and fixed components

Conversion Costs

Costs of the resources needed to convert purchased inputs into a marketable product or service Usually direct labor and various kinds of production overhead, and companies must plan for their availability, use, and cost

Short-Range Budget

Cover a year, a quarter, or a month

Long-Range Budget

Cover periods longer than a year Capital budgets with acquisitions that normally cover several years, financial budgets with financial resource acquisitions, etc.

Sales Forecasting

Critical step in budgeting process -- accuracy of entire budgeting process depends first on getting the sales budget right Various procedures are used in sales forecasting and final forecast usually combines information from many different sources Many firms have a top-management-level market research staff whose job is to coordinate company's sales forecasting efforts Typically, everyone from key executives to firm's sales personnel will be asked to contribute sales projections Slightly inaccurate sales forecast, coming at very beginning of budgeting process, will throw off all other schedules comprising the master budget

Cash Disbursements Budget

Depends on spending plans reflected in several operational budgets -- shows timing of cash flowing out the company Timing of cash flows out of company does not precisely align with expenditures reflected in the operational budgets Often purchases are made on account -- means that payment is not made in cash at time of purchase, instead payment is made later under terms that are negotiated, often 30-60 days after delivery of product or service Cash for purchases does not necessarily flow out of company at exact time purchase is made Payment policies will differ between vendors and types of payments, and any significant differences need to be anticipated in the budget

Budget

Detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time Developing a budget is a critical step in planning any economic activity Businesses of all types and governmental units at every level must take financial plans to carry out routine operations, to plan for major expenditures, and to help in making financial decisions

Budget Manual

Developed and disseminated by budget director to communicate budget procedures and deadlines to employees throughout organization States who is responsible for providing various types of information, when the information is required, and what form the information is to take and who should receive each schedule when the master budget is complete

Safety Margin

Difference between budgeted sales revenue and break-even sales revenue -- gives management a feel for how close projected operations are to break-even point

Budgetary Slack

Difference between revenue or cost projection that a person provides and a realistic estimate of revenue

Purchases Budget

Documents plans for acquiring goods and services from outside the organization in order to create its product Based on goods and services the company plans to sell, as documented in the sales budget Other common purchases budgets are for the direct materials needed in manufacturing and the goods needed for retail and distribution

Operating Leverage

Extent to which an organization uses fixed costs in its cost structure Greatest in firms with a large proportion of fixed costs, low proportion of variable costs, and the resulting high contribution-margin ratio Refers to ability of the firm to generate an increase in net income when sales revenue increases A firm's operating leverage affects its break-even point -- relatively high operating leverage has proportionally high fixed expenses, break-even point will be relatively high Safety margin is affected by a firm's operating leverage -- high fixed expenses result in high break-even point and low safety margin Labor-intensive production processes vs. advanced manufacturing systems: A movement toward an advanced manufacturing environment often results in higher break-even point, lower safety margin, and higher operating leverage High-tech manufacturing systems generally have greater throughput, allowing greater potential profitability In an economic recession, a highly automated company with high fixed costs will be less able to adapt to lower consumer demand than will a firm with a more labor-intensive production process

Cost Structure and Operating Leverage: A Cost-Benefit Issue

Firm's cost structure plays important role in determining CVP relationships Proportionately high fixed costs = relatively high operating leverage → high operating leverage allows firm to generate a large percentage increase in net income from a relatively small percentage increase in sales revenue High operating leverage = relatively high break-even point -- entails some risk to firm Optimal cost structure for organization involves a trade-off -- management must weigh benefits of high operating leverage against risks of large committed fixed costs and associated high break-even point

A Move Toward JIT and Flexible Manufacturing

Flexible manufacturing system uses highly automated material-handling and production equipment to manufacture a variety of similar products Setups would be quicker and more frequent, production runs would be smaller Fewer inspections would be required, due to the total quality control (TQC) philosophy that often accompanies JIT Variable manufacturing costs would be lower, due to savings in direct labor General factory overhead costs would increase, due to greater depreciation charges on new production equipment Setup, inspection, and material handling are largely fixed with respect to sales volume but not with respect to cost drivers, such as number of setups, inspections, and hours of material handling

Traditional CVP Analysis

Focuses on number of units sold as only cost and revenue driver Sales revenue is assumed to be linear in units sold Costs are categorized as fixed or variable, with respect to number of units sold, within relevant range Approach is consistent with traditional product-costing systems, in which cost assignment is based on a single, volume-related cost driver Can be misleading or provide less than adequate information for various management purposes An ABC system can provide a much more complete picture of CVP relationships and thus provide better information to managers

Operational Budget: Nonprofit Organizations

Fundamental goal of a nonprofit organization is not to sell products or services (although some do as a way of raising funds) but rather to complete programs in support of their mission Instead of a sales budget, nonprofits generally begin budgeting process with a programs budget that shows the level of services to be provided Then operational budgets can be developed to identify resources necessary for producing the programs Prepare budgets showing anticipated funding

Contribution Income Statement

Highlights distinction between variable and fixed expenses All variable expenses are subtracted from sales to obtain contribution margin and all fixed costs are subtracted from contribution margin to obtain net income

Profit-Volume Graph

Highlights the amount of profit or loss Graph intercepts vertical axis at amount equal to fixed expenses at 0 activity level Graph crosses horizontal axis at break-even point Vertical distance between horizontal axis and profit line, at a particular level of sales volume, is the profit or loss at that volume

Analysis of Historical Data

In a mature production process, where firm has a lot of production experience, historical costs can provide a good basis for predicting future costs -- often will need to adjust predictions to reflect movements in price levels or tech changes in production process Despite relevance of historical cost data in setting cost standards, managers must guard against relying on them blindly Understanding how standards were derived can provide important insights into their reliability For new products, such as genetically engineered medicines, there are no historical cost data upon which to base standards -- manager should turn to another approach

Budget Administration

In small organizations, the procedures used to gather information and construct a master budget are usually informal Larger organizations use a formal process to collect data and prepare the master budget

Selling, General and Administrative Expense (SG&A) Budget

Includes sales and marketing costs of company Can be divided between direct costs and shared marketing costs General administrative costs include depreciation costs of headquarters building and various other fixed assets owned by company Depreciation cost included in "Total SG&A expenses" line will become part of budgeted income statement but at bottom line of SG&A budget, depreciation is deducted as a noncash cost so cash portion of SG&A spending can be separated out for inclusion in cash disbursements budget Similar adjustment would be made for noncash costs included in any other budget schedule

Increase in Net Income

Increase in Sales Revenue x Contribution Margin Ratio = Increase in Net Income Percentage Increase in Net Income = Contribution Margin Ratio x [(Increase in Net Income/Increase in Sales Revenue)]

E-Budgeting

Increasingly popular, Internet based budgeting tool that can help streamline and speed up budgeting process -- e = electronic and enterprisewide Employees throughout organization can submit and retrieve budget information electronically Often part of a larger FP&A system, can occur in two different ways 1. Company runs central FP&A software on its own computers and employees company wide use Internet to access centralized app (enterprise-hosted model) 2. Popular alternative -- FP&A software provider hosts app on its website and the company's employees use the Internet to access it and record data there Provider-hosted approach (cloud or SaaS (software-as-a-service)) solution -- frequent, centralized updating of e-budgeting software by software vendor with outsourcing of tech issues associated with hosting and running software Disadvantage -- company's proprietary financial data resides outside company walls; serious data security risk, but software providers are increasingly mitigating to satisfaction of clients via extensive security procedures

Participative Budgeting

Involve employees throughout an organization in budgetary process so they feel the budget is theirs and not imposed on them Too much participation and discussion can lead to vacillation and delay When those involved in budgeting process disagree in significant and irreconcilable ways, process of participation can accentuate those differences Problem of budget padding can be severe unless incentives for accurate projections are involved

Assumptions and Predictions Underlying the Master Budget

Making predictions and agreeing on assumptions are valuable parts of the budgeting process Managers are forced to identify and agree on the assumptions that will be part of the year's financial plan → after making the predictions, the risk of being wrong can sometimes be mitigated by managers' actions

Combined Approach (Historical and Task Analysis)

Managerial accountants often apply both historical cost analysis and task analysis in setting cost standards. EX: technology has changed for only one step in the production process → managerial accountant would work with engineers to set cost standards for the technologically changed part of the production process but accountant would likely rely on less time-consuming method of analyzing historical cost data to update cost standards for remainder of production process

Management by Exception

Managers do not have time to look into causes of every variance between actual and standard costs but take time to investigate causes of significant cost variances When operations are going along as planned, actual costs and profit will typically be close to the budgeted amounts -- if there are significant departures from planned operations, such effects will show up as significant cost variances Managers investigate these variances to determine causes, if possible, and take corrective action when indicated

Extending the Master Budget for a Manufacturing Firm

Manufacturing firms have many features that complicate budgeting process Have inventories -- add several additional steps in order to adjust for planned changes in inventory levels Both inventories of finished products and inventories of raw materials and components require additional budgeting steps In many cases, have more complex cash flows because of many transactions involved in conversion processes and many different ways they sell products Frequently, manufacturers also have large investments in property, plant and equipment that require periodic reinvestment

Use of Standards by Service Organizations

Many service industry firms, nonprofit organizations, and governmental units make use of standards Use standards in budgeting and cost control in much the same way that manufacturers use standards

Cost Control System

Measures the actual cost incurred in the production process

Standard Direct-Labor Quantity

Number of labor hours normally needed to manufacture one unit of product

Budget Director (Chief Budget Officer)

Often the organization's controller -- specifies process by which budget data will be gathered, collects information, and prepares master budget

Traditional v Contribution Income Statements

Operating managers frequently prefer contribution because of its separation of fixed and variable expenses highlights CVP relationships It is readily apparent from the contribution format statement how income will be affected when sales volume changes

Changes in the Unit Contribution Margin

Organizations' variable expenses increase → not possible to break even Change in unit sales price will alter unit contribution margin → raising sales price will raise unit contribution margin and lower break-even point Lower break-even point decreases risk of operating but more likely to break even with lower sales price

Budgetary Slack: Padding the Budget

Padding the budget = intentionally underestimating revenue or overestimating costs If a sales manager's performance is evaluated on basis of whether the sales budget is exceeded -- incentive is to give a conservative, or cautiously low, sales estimate -- sales manager's performance will look much better in eyes of top management when a conservative estimate is exceeded than when an ambitious estimate is not met When a supervisor provides a departmental cost projection for budgetary purposes, there is an incentive to overestimate costs -- that way, throughout the year there is always enough money left in the budget to pay for what the department needs When actual cost incurred in department proves to be less than inflated cost projection, the supervisor appears to have managed in a cost-effective way

Major factors considered when forecasting sales

Past sales levels and trends for firm developing forecast and for entire industry General economic trends (economy growing? how fast? recession or economic slowdown expected?) Economic trends in company's industry Other factors expected to affect sales in the industry (weather) Political and legal events (legislation pending) Intended pricing policy of company Planned advertising and product promotion Expected actions of competitors New products or processes contemplated by company or other firms (new tech) Market research studies

Capital Budget

Plan for the acquisition of capital assets, such as buildings and equipment

Financing Budget

Plan that shows how organization will acquire its financial resources, such as through issuance of stock or incurrence of debt; project cash flow and identify likely cash shortfalls and surpluses

5 Primary Purposes of Budgeting

Planning -- quantifying a plan of action (staffing, supplies, etc.) Facilitating communications and coordination -- for any organization to be effective, each manager throughout the organization must be aware of plans made by other managers Allocating resources -- organization's resources have limited capacity, and budgets provide one means of allocating resources among competing services Controlling profit and operations -- a budget is a plan and plans are subject to change, budget serves as a useful benchmark with which actual results can be compared (help managers evaluate the firm's effectiveness) Evaluating performance and incentives -- comparing actual results with budgeted results helps managers evaluate performance of individuals, departments, divisions, or entire companies and can be used to provide incentives

Cash Budget

Plays critical role in planning the firm's cash needs Summarizes the various cash inflows and outflows from operations, as represented in cash receipts and cash disbursement budgets, and also incorporates non operational cash flows and addresses financing issues Non-operational cash flows may include purchase and sale of fixed assets from capital budgets, payments to or from investors, plans to purchase other companies, and short-term borrowings By predicting company's net cash position at frequent points during planning period, firm can plan ahead Can arrange sources of short-term borrowing for times when cash outflows exceed inflows, and can plan to pay off those borrowings and make short-term investments when cash flow reverses Can signal cash flow trends and events that will require long-term capital acquisition via debt or equity financing

Target Profit (Target Income)

Problem of computing the volume of sales required to earn a particular target profit is very similar to the problem of finding the break-even point Break-even point is the number of units of sales required to earn a target profit of 0

Financing Budgets

Project cash flow and identify likely cash shortfalls and surpluses

Cash Receipts Budget

Provides information about the cash flows into the company based on sales of its services or products (or from cash contributions and grants, for nonprofits) These inflows will not precisely match budgeted sales, reasons include: Timing of sales and collections can differ customer-to-customer -- between businesses, it is common to have payment terms specifying that cash will not change hands until 30 days or more after sale date Different payment methods convert to cash at different speeds -- cash payments can usually be deposited to bank same day as sale but proceeds from credit cards can take several days to be received, and check payments may take longer Some sales are never collected -- uncollectible accounts receivable due to bounced checks, counterfeit money, credit and debit card fraud, and customers who default on their obligations

Sensitivity Analysis

Provides the analyst with a feel for how sensitive the analysis is to the estimates upon which it is based The widespread availability of personal computers and spreadsheet software has made sensitivity analysis relatively easy to do

Sales Mix

Relative proportion of each type of product sold for any organization selling multiple products

Cost Structure

Relative proportion of its fixed and variable costs Differ widely among industries and among firms within an industry A company using a computer-integrated manufacturing system has a large investment in plant equipment, which results in a cost structure dominated by fixed costs A home building contractor's cost structure has a much higher proportion of variable costs The highly automated manufacturing firm is capital-intensive, whereas the home building contractor is labor-intensive An organization's cost structure has a significant effect on the sensitivity of its profit to changes in volume

Profit

Sales Revenue - Variable Expenses - Fixed Expenses [(Unit Sales Price) X (Sales Volume in Units)] - [(Unit Variable Expense) X (Sales Volume in Units)] - (Fixed Expenses) = Profit

Operational Budget

Set of budgets based on the sales budget that specify how its operations will be carried out to meet the demand for its goods or services All organizations begin budgeting process with plans for goods or services to be provided and revenue to be available from sales or other funding sources

Financial Planning Model

Set of mathematical relationships that express interactions among the various operational, financial, and environmental events that determine the overall results of an organization's activities In a fully developed financial planning model, all key estimates and assumptions are expressed as general mathematical relationships → model is run on a computer many times to determine impact of different combinations of these unknown variables "What if" questions can be answered about such unknown variables as inflation, interest rates, value of the dollar, demand, competitors' actions, union demands in forthcoming wage negotiations, etc. Widespread availability of economical spreadsheet tools and cloud-based FP&A solutions has made financial planning models more common

Budgeted Financial Statements (Pro Forma Financial Statements)

Show how organization's financial statements will appear at a specified time if operations proceed according to plan -- make up final portion of master budget Budgeted income statement, budgeted balance sheet, and budgeted statement of cash flows

Budgeted Balance Sheet

Shows expected end-of-period balances for company's assets, liabilities, and owner's equity, assuming planned operations are carried out To construct, we start with firm's balance sheet projected for beginning of budget year and adjust each account balance for changes expected during following year

Budgeted Income Statement

Shows expected revenues and expenses Assumes built-in expectations are met Arriving at net income requires an estimate of the appropriate tax rate

Production Budget

Shows number of units to be produced during a budget period Resources for manufacturing, such as raw materials, production workers, and machines, are needed when products are produced, not sold -- why is there difference in timing between units sold and units produced? Sales are sometimes hard to predict Often a logistical lag exists between when a product is made and when it can be sold (think of China-to-U.S. supply chain) Companies build products for inventory as a way to smooth production levels so they don't have to lay off workers or buy as many machines Serves as bridge between sales budget and operational budgets that plan for spending on production Production budget can be found by: Sales in units + desired ending inventory of finished goods = total units required Total units required - expected beginning inventory of finished goods = units to be produced

Budgeted Schedule of Cost of Goods Manufactured and Sold

Shows production costs expected to flow through inventory accounts, and identifies portion of production costs expected to be in WIP, FGI and COGS at end of period 1. Summarizes various costs of production from other budget schedules to compute period's total manufacturing costs 2. Adjusts for beginning and ending cost of WIP to compute COGM 3. COGM represents total cost of products completed and transferred to FGI 4. COGM is adjusted by beginning and ending balances in FGI to compute COGS

Sales Budget

Shows projected sales in units and then multiples the unit sales by the sales price to determine sales revenue

Direct-Material Budget

Shows the number of units and the cost of material to be purchased and used during a budget period in the master budget of a manufacturing company Can be found by: Raw material required for production + desired ending inventory of raw material = total raw material required Total raw material required - expected beginning inventory of raw material = raw material to be purchased Important link between planned production and purchases of raw materials Particularly critical linkage in manufacturing firms -- considerable effort is devoted to careful inventory planning and management

Unfavorable Variance

Spending is higher than expected (U)

Favorable Variance

Spending is less than expected (F) The fact that a significant variance has occurred indicates that something has not gone as planned, which warrants attention even if it is favorable EX: favorable direct-labor efficiency variance may indicate development of a more efficient way of performing their duties → by investigating the variance, management will become aware of the improved method and may be able to implement it elsewhere Favorable variances can sometimes indicate a problem EX: favorable direct-labor efficiency variance might be because of pressure to perform faster and to do so they are taking shortcuts that result in more errors → errors could lead to higher customer dissatisfaction and additional cost and effort by the company to correct them after the fact

Participation in Setting Standards

Standards should not be determined by managerial accountant alone -- managers generally will be more committed to meeting standards if they participate in setting them EX: production supervisors should have role in setting production cost standards, and sales managers should be involved in setting targets for sales prices and volume Knowledgeable staff personnel should participate in the standard-setting process EX: task analysis should be carried out by a team consisting of production engineers, production supervisors, and managerial accountants

Practical (Attainable) Standards

Standards that are perhaps challenging but still able to be regularly attained Assume a production process as efficient as practical under normal operating conditions Allow for such occurrences as occasional machine breakdowns and normal amounts of raw-material waste Keeps employees on their toes without demanding miracles Most behavioral theorists believe practical standards encourage more positive and productive employee attitudes than perfection standards

Starting a Sales Forecast

Starting point is generally sales level of prior year → market research staff considers input from key executives and sales personnel In many firms, elaborate econometric (economic measurement) models are built to incorporate all the available information systematically Statistical methods, such as regression analysis and probability distribution for sales, are often used

Production Overhead Budget

Summarizes the costs of production other than purchases and direct labor

Financial Planning and Analysis (FP&A) Systems

System that helps managers assess company's future and know if they are reaching their performance goals -- complete system includes subsystems for planning, measuring and recording results, and evaluating performance Forces different parts of organization to communicate with one another to create performance targets and set expectations about financial and nonfinancial results of operations

Cost-Volume-Profit Analysis

Technique summarizes effects of changes in an organization's volume of activity on its costs, revenue, and profit Can be extended to cover effects on profit of changes in selling prices, service fees, costs, income-tax rates, and the organization's mix of products Not necessarily valid to compare operating statistics across organizations of different or same industry but it is worthwhile to track a particular organization's activity across time periods

Developing the Master Budget

The master budget is our formal plan for each event and the overall company -- it helps achieve our FP&A goals Documenting our plan for financial results Communicating our plans for, and assumptions about the various [festivals] Deciding how to share resources Controlling operations by developing benchmarks for the financial and operational results of the [festival] Evaluating performance of managers against those benchmarks, providing a baseline for incentive compensation

Standard Direct-Material Quantity

Total amount of direct material normally required to produce one unit of finished product, including allowances for normal waste or inefficiency

Standard Direct-Material Price

Total delivered cost, after subtracting any purchase discounts, of one direct-material unit -- expressed in same units used to describe standard quantity

Standard Direct-Labor Rate

Total hourly cost of compensation, including fringe benefits

Total Contribution Margin

Total sales revenue - total variable expenses Amount of revenue available to contribute to covering fixed expenses after all variable expenses have been covered

Operating Leverage Factor

Used by managerial accountant to measure a firm's operating leverage at a particular sales volume Operating leverage factor = Contribution margin/Net income It is a measure, at a particular level of sales, of the percentage impact on net income of a given percentage change in sales revenue (% change in sales revenue)(operating leverage factor) = % change in net income

Weighted-Average Unit Contribution Margin

Uses sales mix to find the average of the several products' unit contribution margins, weighted by the relative sales proportion of each product Break-even point = Fixed expenses/Weighted-average unit contribution margin

Break-Even Point

Volume of activity where revenues = expenses -- organization has no profit or loss in units = fixed expenses/unit contribution margin in sales dollars = fixed expenses/contribution-margin ratio

Contribution-Margin Ratio

unit contribution margin/unit sales price