Chapter 5

Disadvantages of Practical Standards

There are none!

The Cash Payments for Materials Budget

-A budget that calculates each period's cash payments for material purchases based on production schedules and payment practices. -Shows when payments for materials purchases will be made -Requires knowledge of past accounts payable payment patterns -Calculates ending accounts payable balance for the budgeted balance sheet 1. Apply the established disbursements pattern to existing accounts payable. 2. Apply the established disbursements pattern to budgeted materials purchases.

Direct Labor Budget

-A budget that calculates the number of direct labor hours and the total direct labor cost required to meet the budgeted level of production. -Shows when and how much of each direct labor category to employ in order to meet the production budget -May use average standard wage rates for each class of direct laborer rather than actual wage rates for each employee

Selling and Administrative Expense Budget

-A budget that estimates when and how much selling and administrative expense will be incurred. -Shows expenses to be incurred to support the budgeted level of sales -Includes variable and fixed expenses -Pay special attention to non-cash expenses such as bad debt expense and depreciation expense. -These expenses *do not flow to the cash budget.*

Sales Budget

-A budget that forecasts the number of units expected to be sold multiplied by the prices expected to be charged, resulting in the revenue expected to be earned. -Shows budgeted sales revenue for the period, which flows to the budgeted income statement for the period -Begins with the sales forecast, which typically will be prepared by the sales and marketing departments -Requires a forecasted sales price in addition to the sales volume forecast -Is prepared for *each product*

Direct Materials Purchases Budget

-A budget that itemizes the amount and cost of materials that must be purchased to meet budgeted production. -Shows when and how much of each direct material to purchase in order to meet the production budget -Includes budgeted ending inventory of direct materials to provide a cushion for production errors or supply shortfalls -Is prepared for each direct material input used in the production process

Cash Receipts Budget

-A budget that shows when and how much cash is expected to be collected from the sale of products or services. -Based on sales budget -Requires knowledge of historical accounts receivable collection patterns -Distinguishes between cash sales and credit sales -Provides ending accounts receivable balance for the budgeted balance sheet 1. Apply the established collections pattern to the existing accounts receivable. 2. Apply the established collections pattern to budgeted sales.-The total of each month's cash collections flows to the cash budget -Total bad debts flows to the selling and administrative expense budget. -Any extra balances of sales left over that will not be collected until the following year will be reported as the accounts receivable balance on the Pro-forma balance sheet

Bottom-Up Budget

-A budgeting process that begins at the lowest levels of management and filters up through the organization. -At each higher level of management, the budget is reviewed and may be altered to satisfy the competing needs of various units within the organization. -As changes are made to the budget, the best practice is for management to communicate the rationale behind those changes to the affected units. -Also referred to as *participative budgeting* because those employees who will be held accountable for meeting the budget participate in its creation.

Budgetary Slack

-Also called *budgetary padding* -The process of over- or understating budget items to make actual results look favorable when compared to the budget.

What is a Budget?

-An operating plan expressed in dollars -Shows how resources will be committed during the coming period -Helps plan for the future -Communicates corporate direction and coordinates corporate efforts -In other words, you can think of a budget as "putting your money where your mouth is."

Disadvantages of Ideal Standards

-De-motivating because you know you can never achieve the standard -Employees may take shortcuts and reduce effectiveness -Poor planning tool

What is a standard?

-Expectations that specify the characteristics, rules, or guidelines that define a particular level of performance or quality. -Benchmark for measuring performance -An expectation -In accounting, you can think of it as a budget of a single unit of output

Advantages of Bottom-Up Budgets

-Gathers information from persons most familiar with the needs and constraints of organizational units -Allow organizational units to coordinate with one another -Lead to better morale and higher motivation -Develop a high degree of acceptance of and commitment to organizational goals and objectives by operating management

Advantages of Top-Down Budgets

-Increase probability that the organization's strategic plans will be incorporated in planned activities -Enhance coordination among divisional plans and objectives -Use top management's knowledge of overall resource availability -Reduce the time frame for the budgeting process

Disadvantages of Top-Down Budgets

-May result in dissatisfaction, defensiveness, and low morale among individuals who must work under the budget -Reduces the feeling of teamwork -May limit the acceptance of the stated goals and objectives -May create a view of the budget as a punitive device

Advantages of Practical Standards

-Motivate employees to perform -Good planning tool

Advantages of Ideal Standards

-Motivational tool (yes & no) -Constant reminder to workers of need for increased efficiency

Standard Manufacturing Overhead

-Multiply the overhead rate by the appropriate standard activity base—in C&C's case, direct labor cost. -A company that applies overhead based on direct labor hours would multiply the overhead rate by the number of direct labor hours required to make unit of product.

Cash Excess (Cash Needed)

-Once managers know the total cash available to spend and the total cash disbursements for the period, they can calculate whether the company will have enough cash on hand to make the budgeted disbursements on time. -That is what the cash excess (cash needed) section of the cash budget is all about. It can be completed using the following steps: 1. Subtract the total cash disbursements from the total cash available to spend to determine whether the cash available to spend is adequate to cover the budgeted cash disbursements for the period. 2. Subtract the minimum desired cash balance from the result in Step 1 to determine the cash excess or cash needed. -If the difference between the total cash available to spend and the budgeted cash disbursements in Step 1 is positive, more cash is available than is required to make budgeted disbursements in the period. -If the difference is negative, not enough cash is available to make budgeted disbursements.

Pro Forma Financial Statements

-Reports "as-if" results rather than actual results -Shows the financial position of the company assuming the budget is achieved -Financial statements that report the organization's financial position if all the components of a budget or other estimations are achieved as planned.

Disadvantages of Bottom-Up Budgets

-Require significantly more time -Effects of managerial participation may be negated by top-management changes -Managers may be ambivalent or unqualified to participate, creating an unachievable budget -May cause managers to introduce slack into the budget

Setting standards

-Standards are set for *both quantity and price of each input* (materials, labor, and overhead) -There must be an *estimated cost* to manufacture a single unit of product or perform a single service (standard cost) in order to meet that certain standard -Essentially, there must be a budget for a single unit of output

Practical Standard

-Standards that represent a level of performance that can be attained with reasonable effort. -A practical standard is not set at a level so low that it is always reached or can be reached with no effort at all. -In an academic context, a 3.0 GPA might be considered a practical standard. -In a manufacturing setting, practical standards allow for machine breakdowns, employee fatigue, and other normal operating glitches.

Cash Available to Spend

-The beginning cash balance plus cash payments collected from customers during the period. -The beginning cash balance is taken from the beginning balance sheet or from the prior period's ending cash balance. Beginning Cash Balance + Collections from Sales = Total Cash Available

Production Budget

-The budget that calculates the level of production required to meet budgeted sales and maintain desired ending levels of finished goods inventory. -Shows when and how many units to produce in order to meet budgeted sales volume -Includes budgeted ending inventory of finished goods to provide a cushion for unexpected sales -A retail establishment will have a purchases budget rather than a production budget Budgeted Sales + Budgeted Ending Inventory - Budgeted Beginning Inventory = *Budgeted Production*

Cash Disbursements

-The cash disbursements section of the cash budget lists each type of cash disbursement that is expected to occur during the period. -You will find much of this information in the operating budgets you have already prepared Material Purchases + Direct Labor + Manufacturing Overhead + Selling & Administrative Expenses + Equipment Purchases = Total Cash Disbursments

Manufacturing Overhead Budget

-The component of the operating budget that shows the expected overhead costs for the period. -Is based on budgeted production levels of the overhead application base -Uses the predetermined overhead rate for variable overhead -Assumes budgeted fixed overhead cost is incurred evenly throughout the budget period -Pay special attention to non-cash expenses such as depreciation expense that do not flow to the cash budget

Minimum Cash Balance

-The minimum amount of cash a firm wants to have on hand to meet unexpected cash needs, shifts in demand patterns, or certain debt requirements.

Ideal Standards

-The performance standard that implies perfection. -Think about academic performance, in which the 4.0 GPA represents the ideal standard. -In a manufacturing environment, the ideal standard is a kind of "factory heaven": machines never break down; workers always operate at 110 percent efficiency, never needing breaks; and materials always arrive on time, in the quantity and quality ordered. -Unfortunately, this scenario never occurs in manufacturing.

Standard Cost of Direct Labor

-The standard cost of one single unit of direct labor Standard Wage Rate Per Direct Labor Hour x Standard Quantity of Direct Labor Hours = *Standard Direct Labor Cost* EXAMPLE: ($9.60 per direct labor hour) x (0.25 direct labor hours) = $2.40 per unit -Standard wage may equal base hourly rate, payroll taxes, and fringe benefits -Standard quantity may equal how much time it takes to cut, sew, machine downtime, and rest period

Standard Costs of Direct Materials

-The standard cost of one single unit of direct material Standard Price of Direct Material Input x Standard Quantity of Direct Material Input *Standard Cost of Direct Materials* EXAMPLE: Yarn ($3.50 per yard) x (1.1 yards) = $3.85 per unit -Standard price may equal list price, quantity discount, and freight -Standard quantity may equal required fabric, waste, and spoilage

Direct Labor Quantity Standard

-The time needed to produce one unit of product

Short-Term Financing

-This section is only prepared if there is a need to borrow money or repay previously borrowed money -Shows principal and interest amounts -Provides the ending cash balance for the budgeted balance sheet and interest expense for the budgeted income statement

Steps to calculate a Direct Materials Purchases Budget

1. Enter budgeted production from the production budget 2. Calculate the direct materials production needs by multiplying the number of units to be produced during the period by the direct materials standard quantity for one unit. 3. Calculate the desired budgeted ending inventory of direct materials. 4. Calculate the total direct materials required for the period by adding the budgeted ending inventory to the direct materials production needs. 5. Calculate the required purchases of direct materials by subtracting the beginning direct materials balance from the total direct materials required for the period. 6. Calculate the budgeted dollar amount of direct materials purchases by multiplying the required purchases of direct materials by the standard price per unit

Steps to calculating Direct Labor Budget

1. Enter budgeted production from the production budget. 2. Calculate the number of direct labor hours needed to meet the production schedule by multiplying the number of units to be produced during the period by the standard number of direct labor hours for one unit. 3. Calculate the total budgeted direct labor payroll by multiplying the total required direct labor hours by the standard average wage rate for the period. If the company pays a wide range of direct labor wage rates, the direct labor budget will be more accurate if direct labor hours are calculated separately for each pay level

Steps to calculate a Production Budget

1. Enter budgeted sales units from the sales budget (already given) 2. Calculate budgeted ending inventory units for the period using the given percentage 3. Add budgeted ending inventory units to budgeted sales units to determine the number of units required during the period. 4. Subtract beginning inventory units from required units to determine the budgeted production

Steps to calculate Cost of Goods Sold Budget

1. Enter the Beginning Work in Process Inventory balance (from the beginning balance sheet). 2. Add the budgeted direct materials, budgeted direct labor, and budgeted manufacturing overhead used in production. 3. Subtract the budgeted ending Work in Process Inventory balance to determine the budgeted cost of goods manufactured. 4. Add the beginning Finished Goods Inventory balance (from the beginning balance sheet). 5. Subtract the budgeted ending Finished Goods Inventory balance.

Steps to calculate Ending Raw Materials Budget

1. Enter the beginning Raw Materials Inventory balance. It will be the same amount as the ending Raw Materials Inventory balance on the previous period's balance sheet. 2. Add budgeted purchases from the direct materials purchases budget. 3. Subtract the direct materials used in the production of new units started during the period.

Steps to calculating Manufacturing Overhead Budget

1. Enter the budgeted activity base from the appropriate budget. 2. Calculate the variable overhead cost per period using the variable rate and the budgeted activity base. 3. Calculate the fixed overhead cost per period assuming that costs are incurred evenly throughout the period. 4. Calculate the total overhead cost for the period by adding the fixed and variable overhead costs. 5. Subtract the noncash overhead items from the total overhead cost to determine the cash payments for overhead

Steps to calculate Finished Goods Inventory Budget

1. Enter the standard cost of each product. 2. Calculate the ending Finished Goods Inventory balance by multiplying the total standard cost per unit by the budgeted number of units in the ending Finished Goods Inventory shown in the production budget.

Master Budget

A collection of operational budgets that are used to develop pro-forma. (budgeted) financial statements -All areas must work together to achieve the organization's goals. -Not only do information and decisions in one area of the organization affect other areas, but information from each of the operating budgets flows to one or more of the pro-forma financial statements.

Operating Budget

A component of the master budget that provides a financial plan for operations during the budget period.

Ending inventory and cost of goods sold budget

A component of the operating budget that calculates Raw Materials, Work in Process, and Finished Goods Inventory balances and Cost of Goods Sold for the budget period based on budgeted production and sales.

Top-Down Budget

A process by which executive managers create the budget, and that budget is then pushed down through the rest of the organization -This approach is sometimes called an *imposed budget* because those who must implement the budget have no input into it. -A top-down budget approach is the most efficient method of budget preparation, since it involves the fewest people.

The Cash Budget

Cash Available to Spend - Cash Disbursements = Cash excess or Cash Needed + Short Term Financing = Ending Cash Balance

Standard Costs

The expected cost to produce one unit of product.

Ending Cash Balance

Total Cash Available To Spend - Total Cash Disbursments + Total Short-Term Financing = Ending Cash Balance