BUDGETING BASICS AND

BEYOND
(4th Edition)
Jae K. Shim
Joel G. Siegel
Allison I. Shim
 CHAPTER 1
THE WHAT AND WHY OF BUDGETING: AN
INTRODUCTION
 Budget?

 A budget is defined as the formal expression

of plans, goals, and objectives of
management that covers all aspects of
operations for a designated time period
 A budget is a financial plan to control future
operations and results
 Effective Budgeting

Effective budgeting requires the existence of the

following:
 Predictive ability
 Clear channels of communication, authority, and
responsibility
 Accounting-generated accurate, reliable, and timely
information
 Compatibility and understandability of information
 Support at all levels of the organization from upper,
middle, and lower
 Types of Budgets

 Master Budget  Rolling Budget

 Static (Fixed) Budget  Add-On Budget
 Flexible (Expense)  Supplemental Budget
Budget  Bracket Budget
 Operating and Financial  Stretch Budget
Budgets  Strategic Budget
 Cash Budget  Activity-Based Budget
 Capital Expenditure (ABB)
Budget  Target Budget
 Program Budget  Probabilistic Budget
 Life-cycle budget
 Incremental Budget
 The Budgetary Process

 Setting objectives.
 Analyzing available resources.
 Negotiating to estimate budget
components.
 Coordinating and reviewing components.
 Obtaining final approval.
 Distributing the approved budget.
Actual Costs vs. Budget Costs

 At the beginning of the period, the budget is

a plan. At the end of the period, the budget is
a control instrument to assist management in
measuring its performance against plan so as
to improve future performance. Budgeted
revenue and costs are compared to actual
revenue and costs to determine variances
 Budget Issues

 Bottom-up (Participative) versus Top-down

 Advantages and Disadvantages of Budgets
 Budgetary Slack: Padding the Budget
 CHAPTER 2
STRATEGIC PLANNING AND BUDGETING: PROCESS,
PREPARATION, AND CONTROL
 Planning and Budgeting?

 Planning should link short-term, intermediate-

term, and long-term goals. The objective is to
make the best use of the companies’ available
resources over the long term. Budgeting is
simply one portion of the plan.
 The plan is the set of details implementing the
strategy. The plan of ex­ecution is typically
explained in sequential steps including costs
and timing for each step. Deadlines are set.
 Strategic Planning

 Strategic plans are long-term, broad plans

ranging from 2 to 30 years, with 5 to 10 years
being most typical
 The strategic plan is the mission of the
company and looks to existing and
prospective products and markets. Strategic
plans are designed to direct the company’s
activities, priorities, and goals.
Short-term and Long-term Plans

 Short-range plans are typically for one year (although

some plans are for two years). The plans examine
expected earnings, cash flow, and capital expenditures

 Long-term planning is usually of a broad, strategic

(tactical) nature to accomplish objectives. A long-term
plan is typically 5-10 years (or more) and looks at the
future direction of the company. It also considers
economic, po­litical, and industry conditions
 Budget Accuracy

The accuracy of budget preparation may be

determined by comparing actual numbers to budget
numbers in terms of dollars and units. Budget
accuracy is higher when the two figures are closer to
each other. Ratios showing budget accuracy include:
 Sales Accuracy = Actual Sales/Budgeted Sales
 Cost Accuracy = Actual Cost/Budgeted Cost
 Profit Accuracy = Actual Profit/Budgeted Profit
 CHAPTER 3
ADMINISTERING THE BUDGET: REPORTS, ANALYSES,
AND EVALUATIONS
 Types of Reports

 Planning reports may be short term, looking at

the company as a whole, each division, each
department, and each responsibility center
within the department
 Control reports concentrate on performance
effectiveness and areas needing improvement.
 Information reports assist in planning and
policy formulation. The re­ports show areas of
growth or contraction
 More on Reports

Budget reports should contain the following

data:
 Trends over the years
 Comparison to industry norms
 Comparison of actual to budget with
explanation and responsible party for
variances. Follow-up procedures are needed
for control.
 More Report Types

 Periodic Reports. These are reports prepared

at regular intervals
 Advance Reports. Important partial
information may be reported before all
information is available for a periodic report
 Special Studies. Special reports are issued for
a specific, nonroutine purpose
 The Budget Manual

 A budget manual describes how a budget is

to be prepared.
The manual includes:
 Standardized forms, lists, and reports
 Instructions
 Format and coverage of performance reports
 Administrative details
 Follow-up procedures
 The Budget Sheet

A budget sheet should be designed to record the

information used by the op­erating manager
and budget preparer. The budgeting sheet
should include the following information:
 Historical cost records used
 Cost formulas
 Changes in operating conditions
 Foreseeable conditions
 The Budget Committee

 A standing budget committee is usually responsible

for overall policy relating to the budget program and
for coordinating the preparation of the budget itself.
This committee may consist of the president; vice
presidents in charge of various functions such as
sales, production, purchasing, CFO, and the
controller.
 Budget Calendar

 The budget planning calendar is the schedule of

activities for the development and adoption of the
budget. It should include a list of dates indicating
when specific information is to be provided by each
information source to others.
 CHAPTER 4
BREAK-EVEN AND CONTRIBUTION MARGIN ANALYSIS:
PROFIT, COST, AND VOLUME CHANGES
Questions Answered by Break-even and
Contribution Margin Analysis

 What sales volume is required to break even?

 What sales volume is necessary to earn a desired profit?
 What profit can be expected on a given sales volume?
 How would changes in selling price, variable costs, fixed
costs, and output affect profits?
 How would a change in the mix of products sold affect
the break-even and target income volume and profit
potential?
Applications of the CVP Model

 Economic analysis of new product.

 Labor contract negotiations.
 Choice of production process.
 Pricing policy.
 Location selection.
 Financing decisions.
 Make or buy decision
 Capital budgeting analysis.
 Some Applications of
Contribution Margin Analysis
and “What-If” Analysis

 Sales Mix Analysis

 Contribution Margin Analysis and
Nonprofit Organizations
 CVP Analysis with Step-function Costs
 CVP-based Strategies
 CVP Analysis under Uncertainty
 Assumptions Underlying
Break-even and Contribution Margin Analysis

 The selling price per unit is constant throughout the

entire relevant range of activity.
 All costs are classified as fixed or variable.
 The variable cost per unit is constant.
 There is only one product or a constant sales mix.
 Inventories do not change significantly from period
to period.
 Volume is the only factor affecting variable costs.
 CHAPTER 5
PROFIT PLANNING: TARGETING AND REACHING
ACHIEVABLE GOALS
 Profit Planning

 Profits are planned, they just do not happen.

Profit planning involves setting realistic and
attainable profit objectives and targets, and
then accomplishing them
 Objectives in the Profit Plan

 The objective must be definite and specific

 An objective states what is going to be done.
The objective must be clear, quantifiable,
compatible, practical, strong, realistic, and
attainable (not too easy or too difficult). A
general and vague objective is of little value.
The objective should be in writing
 CHAPTER 6
MASTER BUDGET: GENESIS OF FORECASTING AND
PROFIT PLANNING
Master Budget Flowchart Structure
Master (Comprehensive) Budgeting

 Obviously these budgets cannot be prepared

independently. Production is scheduled to meet
the sales demand. Materials, labor, and factory
overhead costs are related to production. Selling
and administrative ex­penses are based on sales.
Cash receipts and disbursements can be esti­
mated only after sales revenue and costs are
known. It is obvious that all of these separate
budgets must be closely coordinated.
 Sales Planning Compared with
Forecasting

 Sales planning and forecasting often are confused. Although

related, they have distinctly different purposes.
 A forecast is not a plan; rather it is a statement and/or a
quantified assessment of future conditions about a particular
subject (e.g., sales revenue) based on one or more explicit
assumptions.
 A sales plan incorporates management decisions that are based
on the forecast, other inputs, and management judgments
about such related items as sales volume, prices, sales effects,
production, and financing.
 Types of Budgets

 Sales budget  Selling and

 Production budget administrative
 Materials requirement expenses budget
budget  Cash budget
 Materials purchases  Budgeted income
budget statement
 Direct labor budget
 Budgeted balance
 Factory overhead costs sheet
budget
The Production Budget

Expected Desired
Production = Planned sales + Ending — Beginning inventory
Volume Inventory
 CHAPTER 7
COST BEHAVIOR:
EMPHASIS ON FLEXIBLE BUDGETS
An understanding of cost -behavior is
helpful to managers for four reasons:

An understanding of cost -behavior is helpful to

managers for four reasons:
Flexible budgeting
Break-even and contribution margin analysis
Appraisal of divisional performance
Short-term choice decisions
 Costs by Behavior

 VARIABLE COSTS. Variable costs, also known as

engineered costs, vary in total with changes in
volume or level of activity
 FIXED COSTS. Fixed costs do not change in total
regardless of the volume or level of activity
 MIXED (SEMI-VARIABLE) COSTS. As previously
discussed, mixed costs contain both a fixed
element and a variable one.
 Analysis of Mixed
(Semi-variable) Costs

Since the mixed costs contain both fixed and variable

elements, the analysis takes the following mathematical
form, which is called a flexible budget formula:
Y = a + bX
where Y = the mixed cost to be broken up (dependent
variable).
X = any given measure of activity (cost driver)
such as direct labor hours, machine hours, or production
volume (independent variable).
a = the fixed cost component (constant).
b = the variable rate per unit of X (slope).
The Contribution Income Statement

 An alternative format of income statement,

known as the contribution income statement,
organizes the costs by behavior rather than
by function. It shows the relationship of
variable costs and fixed costs a given cost
item is associated with, regardless of the
functions.
More on Contribution Income

 Contribution margin is available to cover

fixed costs.
 The statement highlights the concept of
contribution margin, which is the difference
between sales and variable costs. The
traditional format, on the other hand,
emphasizes the concept of gross margin,
which is the difference between sales and
cost of goods sold.
 CHAPTER 8
EVALUATING PERFORMANCES: THE USE OF VARIANCE
ANALYSIS
 Variances

 Variance analysis compares standard to

actual costs or performances
 There are two types of variances: material
and immaterial
 Defining a Standard Cost

 Standard cost, which is the predetermined

cost of manufacturing, servicing, or
marketing an item during a given future
period. It is based on current and projected
conditions. This norm is also dependent
upon quantita­tive and qualitative
measurements (e.g., working conditions).
 Setting Standards

There are four types of standards

 Basic. These are not changed from period to period
 Maximum efficiency. These are perfect standards,
which assume ideal, optimal conditions
 Currently attainable. These are based on efficient
activity
 Expected. These are expected figures, which should
come very close to actual figures
 Cost Variances

Three cost measures:

 Quantity per unit of work times actual units of
work produced
 Standard cost equals standard price times
standard quantity, where standard quantity
equals standard quantity per unit of work
times actual units of work produced.
 Total cost variance equals actual cost less
standard cost
 Flexible Budgets

 The flexible budget is geared toward a range

of activities rather than a single level of
activity. A flexible budget employs budgeted
figures at different capacity levels. It allows
you to choose the best expected (normal)
capacity level (100%) and to assign pessimistic
(80%), optimistic (110%), and full (150%)
capacity levels
 CHAPTER 9
MANUFACTURING COSTS: SALES FORECASTS AND
REALISTIC BUDGETS
 Manufacturing Cost Budgets

 In order to budget for manufacturing costs, a

production budget needs to be established, which in
turn requires a sales budget.
 Manufacturing costs are subdivided into direct
materials, direct labor, and factory overhead.
Planning and Control of Material
Purchases and Usage

After determining the number of units to be produced,

the company prepares the materials requirement
budget and the materials purchase budget. Purchase of
materials depends on production requirements and
inventories. The direct materials budget involves a
balancing of raw material needed for production, the
raw material inventory balances, and the purchase of
raw materials. The budget may provide for allowances
for waste and spoilage.
 CHAPTER 10
MARKETING: BUDGETING SALES, ADVERTISING, AND
DISTRIBUTION
 Sales Budget

 The sales budget is the starting point in

preparing the master budget, since estimated
sales volume influences nearly all other items
appearing in the master budget. The sales
budget, which ordinarily indicates the
quantity of each product expected to be sold,
allows all departments to plan their needs.
 Sales Forecasts

 Sales forecasts are especially crucial aspects

of many financial management activities,
including budgets, profit planning, capital
expenditure analysis, and acquisition and
merger analysis. It is the key to other
forecasts and plans.
 Budgeting Advertising

Percentage of sales or profit

Unit sales method
Objective-task method
 Measures of Advertising

 Trend in advertising cost to sales

 Advertising cost per unit sold
 Advertising cost per sales dollars
 Advertising cost per customer
 Advertising cost per transaction
 Advertising cost by product, media, and territory
 CHAPTER 11
RESEARCH AND DEVELOPMENT: BUDGETS FOR A
LONG-TERM PLAN
Research and Development (R&D)

 Research and development (R&D) is needed

to develop new products and services or to
significantly improve existing ones in order
to remain competitive and grow
 The R&D Budget
The R&D budget may be based on:
Estimated cost of specific projects
A percentage of expected sales
A percentage of current year and/or prior year sales
A percentage of profit
A percentage of operating income
A percentage of investment in capital assets
A percentage of cash flow
R&D per unit
 Costs and Planning

 There are direct and indirect costs

associated with R&D projects
 Any project limitations have to be noted
 In R&D, individual projects have to be
planned, appraised, and controlled
 CHAPTER 12
GENERAL AND ADMINISTRATIVE COSTS: BUDGETS FOR
MAXIMUM PRODUCTIVITY
 General and Administrative
Expenses

 Administrative departments include general

administration, personnel, accounting, legal,
insurance, computer services, and treasury.
Administration is personnel existing because
of the organization structure. Examples are
office managers and staff.
 Headcount Forecasting

 In the nonmanufacturing functions of a

business (such as general administration,
R&D, marketing, and product engineering),
the most significant expense usually is
salaries. Some companies have developed
formal procedures for projecting and
controlling such expenses. These methods
are known as headcount forecast algorithms.
 CHAPTER 13
CAPITAL EXPENDITURES: ASSETS TO BE BOUGHT,
SOLD, AND DISCARDED
 Capital Expenditures

 Capital expenditures include replacing

machinery to economize on costs, expanding
production to increase volume, marketing of
a new product, improving the quality of
products or services, and manufacturing under
proposed contracts. Capital expenditures
should take into account current and needed
facilities. Commitments must also be
considered.
 Capital Budget Process

The four steps in the capital expenditure

budgetary process are:
Approving the project
Approving the estimate
Authorizing the project
Follow-up
 CHAPTER 14
FORECASTING AND PLANNING: REDUCING RISK IN
DECISION MAKING
 Who Uses Forecasts?

 Forecasts are needed for marketing, production,

purchasing, manpower, and financial planning.
Further, top management needs forecasts for
planning and implementing long-term strategic
objectives and planning for capital expenditures.
More specifically, marketing managers use sales
forecasts to determine optimal sales force
allocations, set sales goals, and plan promotions and
advertising. Market share, prices, and trends in new
product development are also required.
Sales Forecasts and Managerial
Functions
Qualitative Forecasting Methods

Qualitative approach—forecasts based

on judgment and opinion
Expert opinions
Delphi technique
Sales force polling
Consumer surveys
Quantitative Forecasting Methods
a. Forecasts based on historical data
Naive methods
Moving average
Exponential smoothing
Trend analysis
Classical decomposition
b. Associative (causal) forecasts
Simple regression
Multiple regression
Econometric modeling
 CHAPTER 15
MOVING AVERAGES AND SMOOTHING TECHNIQUES:
QUANTITATIVE FORECASTING
 Quantitative Forecasting

Naive models
Moving averages
Exponential smoothing
 Exponential Smoothing

 Exponential smoothing is a popular technique for short-run

forecasting by managers. It uses a weighted average of past
data as the basis for a forecast. The procedure gives heaviest
weight to more recent information and smaller weight to
observations in the more distant past. The reason is that the
future is more dependent on the recent past than on the
distant past.
 The method is known to be effective when there is randomness
and no seasonal fluctuations in the data. One disadvantage of
the method, however, is that it does not include industrial or
economic factors such as market conditions, prices, or the
effects of competitors’ actions.
 CHAPTER 16
REGRESSION ANALYSIS: POPULAR SALES FORECAST
SYSTEM
 Least-Squares Method

 The least-squares method is widely used in

regression analysis for estimating the parameter
values in a regression equation. The regression
method includes all the -observed data and attempts
to find a line of best fit. To find this line, a technique
called the least-squares method is used.
 Regression Statistics

 Correlation coefficient (r) and coefficient of

determination (R2)
 Standard error of the estimate (Se) and prediction
confidence interval
 Standard error of the regression coefficient (Sb) and
t-statistic
 Using Regression on Excel

Excel has an easy-to-use regression routine.

To utilize Excel 2010, for example, for
regression analysis, three steps need to be
followed:
Click the Data menu.
Click Data Analysis.
Click Regression.
Excel on Regression
 Regression Output

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.7800
R Square 0.6084
Adjusted R 0.5692
Square
Standard 2.3436
Error
Observations 12

Coefficien Standard t Stat P- Lower 95% Upper

ts Error value* 95%
Intercept 10.583643 2.1796 4.8558 0.0007 5.7272 15.4401
DLH 0.563197 0.1429 3.9414 0.0028 0.2448 0.8816
*The P-value for X Variable = .0028 indicates that we have a 0.28% chance that the true
value of the variable coefficient is equal to 0, implying a high level of accuracy about the
estimated value of 0.563197.
 CHAPTER 17
CASH BUDGETING AND FORECASTING CASH FLOW:
TWO PRAGMATIC METHODS
 Cash Flow Forecasting

 A forecast of cash collections and potential

write-offs of accounts receivable is essential
in cash budgeting and in judging the
appropriateness of current credit and
discount policies. The critical step in making
such a forecast is estimating the cash
collection and bad debt percentages to be
applied to sales or accounts receivable
balances.
 The Cash Budget

 The cash budget presents the amount and

timing of the expected cash inflow and
outflow for a designated time period. It is a
tool for cash planning and control and should
be detailed so that your know how much is
needed to run your business
 Cash Budget Components

 The cash receipts section, which is cash collections

from customers and other cash receipts such as royalty
income and investment income.
 cash disbursements section, which comprises all cash
payments made by purpose.
 cash surplus or deficit section, which simply shows the
difference between the total cash available and the
total cash needed including a minimum cash balance if
required
 financing section, which provides a detailed account of
the borrowings, repayments , and interest payments
 CHAPTER 18
FINANCIAL MODELING: TOOLS FOR BUDGETING AND
PROFIT PLANNING
 A Financial Model

A financial model is one in which:

One or more financial variables appears (expenses,
revenues, investment, cash flow, taxes, and earnings).
The model user can manipulate (set and alter) the
value of one or more financial variables.
The purpose of the model is to influence strategic
decisions by revealing to the decision maker the
implications of alternative values of these financial -
variables.
Use of Financial Modeling in Practice

 The use of financial modeling, especially a

computer-based financial modeling system, is
in wide use. The simple reason is the growing
need for improved and quicker support as a
decision support system (DSS) and enterprise
resource planning (ERP) and wide and easy
availability of computer software.
 CHAPTER 19
USING SOFTWARE PACKAGES AND E-BUDGETING:
COMPUTER-BASED MODELS, AND SPREADSHEETS,
AND WEB-BASED SYSTEM SOFTWARE
 Use of a Spreadsheet Program for
Financial Modeling and Budgeting

 Spreadsheet programs such as Excel and a stand-

alone package such as Up Your Cash Flow can be used
to develop a financial model. These packages are an
effective tool for sensitivity analysis. Sensitivity
analysis is a "what-if" technique that examines how a
result will change if the original predicted data are
not achieved or if an underlying assumption changes.
to For illustrative purposes, we present some
examples of projecting an income statement.
Construction of a Rolling Budget

 A Rolling budget, often called continuous or perpetual budget is

a 12-month (four-quarter) budget that rolls forward one month
(or quarter) as the current month (or quarter) is completed. In
other words, one month (or quarter) is added to the end of the
budget as each month (or quarter) comes to a close. This
approach keeps managers focused at least one year ahead so
that they do not become too narrowly focused on short-term
results. Also, markets are changing so fast that the traditional
budget is quickly out of date within weeks of its publication.
Many companies adopt a rolling-forecast process so that
budget allocations can be constantly adjusted to meet changing
market conditions.
Rolling Budget Example 1

Six-Month Budget (March through August)

March April May June July August Total
Sales $210,000 $216,000 $224,000 $208,000 $190,000 $180,000 $1,228,000
Cost of goods sold 84,000 86,400 89,600 83,200 76,000 72,000 $491,200
Gross margin 126,000 129,600 134,400 124,800 114,000 108,000 $736,800
Selling expenses 52,000 53,000 55,000 51,000 49,000 47,000 307,000
G&A expenses 26,000 27,000 27,000 25,000 24,000 24,000 153,000
Operating income 48,000 49,600 52,400 48,800 41,000 37,000 276,800
Interest expenses 1,000 1,000 1,200 1,200 900 900 6,200
Income (before taxes) 47,000 48,600 51,200 47,600 40,100 36,100 270,600
Income taxes (40%)
18,800 19,440 20,480 19,040 16,040 14,440 108,240

Net income $28,200 $29,160 $30,720 $28,560 $24,060 $21,660 $162,360

Rolling Budget Example 2

Revised Six-Month rolling Budget (April through September)

April May June July August September Total

Sales $220,000 $225,000 $210,000 $192,000 $182,000 $195,000 $1,224,000
Cost of goods sold 88,000 90,000 84,000 76,800 72,800 78,000 $489,600
Gross margin 132,000 135,000 126,000 115,200 109,200 117,000 $734,400
Selling expenses 53,000 55,000 51,000 49,000 47,000 50,100 305,100
G&A expenses 27,000 27,000 25,000 24,000 24,000 25,000 152,000
Operating income 52,000 53,000 50,000 42,200 38,200 41,900 277,300
Interest expenses 1,000 1,000 1,200 1,100 1,100 1,100 6,500
Income (before
51,000 52,000 48,800 41,100 37,100 40,800 270,800
taxes)
Income taxes (40%)
20,400 20,800 19,520 16,440 14,840 16,320 108,320
Net income $30,600 $31,200 $29,280 $24,660 $22,260 $24,480 $162,480
 E-budgeting

 The e in e-budgeting stands for both electronic and

enterprisewide; employees throughout an
organization, at all levels and around the globe, can
submit and retrieve budget information
electronically via the Internet.
 Budgeting software is utilized and made available on
the Web (in a cloud computing environment), so that
budget information electronically submitted from
any location is in a consistent companywide format.
 E-budgeting Software

 There are much user-oriented software

specifically designed for corporate planners,
treasurers, budget preparers, managerial
accountants, CFOs, and business analysts.
 Web-based (Web-enabled)
 Intranet or Internet
 Cloud computing
 Enterprise Resource Management (ERM)
 CHAPTER 20
CAPITAL BUDGETING: SELECTING THE OPTIMUM LONG-
TERM INVESTMENT AND REAL OPTIONS
 Factors to Consider in Determining
Capital Expenditures

 Rate of return
 Budget ceiling
 Probability of success
 Competition
 Tax rate
 Dollar amounts
 Time value of money
 Risk
 Liquidity
 Long-term business strategy
 Forecasting errors
 Evaluation Methods

 Accounting Rate of Return (ARR)

 Payback Period
 Payback Reciprocal
 Net Present Value (NPV)
 Internal Rate of return (IRR)
 Probability Index
 Real Options

 Almost all capital budgeting proposals can be

viewed as real options. Also, projects and
operations contain implicit options, such as
the option as to when to take a project, the
option to expand, the option to abandon, and
the option to suspend or contract operations.
Deciding when to take a project is called the
investment timing option.
 Capital Budgeting under Risk

Several methods to incorporate risk into capital budgeting are

Simulation
Sensitivity analysis
Decision (probability) trees

Other means of adjusting for uncertainty include

Decreasing the expected life of an investment
Use of pessimistic estimates of cash flow
Comparison of the results of optimistic, pessimistic, and best-
guess estimates of cash flows
 CHAPTER 21
BUDGETING FOR COST MANAGEMENT: ACTIVITY-
BASED BUDGETING AND LIFE-CYCLE BUDGETING
 Activity-Based Budgeting

 In contrast to functional budgeting, Activity-

based Budgeting (ABB) is activity-oriented.
Activity-based budgets focus on the
budgeted cost of activities required to
produce and sell products and services. An
activity-based budgetary system emphasizes
the planning and control purpose of cost
management.
 ABB Example
Quarter
Year
1st 2nd 3rd 4th
Unit-Level Costs
Units 18,000 9,600 13,800 21,600 63,000
Indirect material ($.20 per unit) $3,600 $1,920 $2,760 $4,320 $12,600
Electricity ($.18 per unit) 3,240 1,728 2,484 3,888 11,340
Total unit-level costs $6,840 $3,648 $5,244 $8,208 $23,940
Batch-Level Costs
Production runs 30 16 23 36 105
Setup ($110 per run) $3,300 $1,760 $2,530 $3,960 $11,550
Purchasing and material handling ($125 per
3,750 2,000 2,875 4,500 13,125
unit)
Inspection ($75 per run) 2,250 1,200 1,725 2,700 7,875
Total batch-level costs $9,300 $4,960 $7,130 $11,160 $32,550
Product-Level Costs+A42
Engineering designs 3 3 3 3 12
Design ($600 per design) $1,800 $1,800 $1,800 $1,800 $7,200
Total product-level costs $1,800 $1,800 $1,800 $1,800 $7,200
Facility-Level Costs
Supervisory salaries $14,000 $14,000 $14,000 $14,000 $56,000
Insurance 1,400 1,400 1,400 1,400 5,600
Property taxes 1,000 1,000 1,000 1,000 4,000
Maintenance 2,600 2,600 2,600 2,600 10,400
Utilities 2,500 2,500 2,500 2,500 10,000
Depreciation 15,000 15,000 15,000 15,000 60,000
Total facility‑level costs $36,500 $36,500 $36,500 $36,500 $146,000
Total Factory Overhead $54,440 $46,908 $50,674 $57,668 $209,690
 Life-cycle Budgeting

A relatively recent focus of the budgeting process is to plan

for all of the costs that will be incurred throughout a
product's life cycle, before a commitment is made to the
product. Product life-cycle costs encompass the following
three phases in a product's life cycle.
Development (product planning, concept design
preliminary design. detailed design, and testing)
Manufacturing (conversion activities)
Logistics (distribution and customer service)
 Life-cycle Budget Example

Budgeted Costs
Item
Item 2X12 2X13 2X14 Total
Units produced 40,000 60,000
Development costs $195,000 $195,000
Manufacturing costs 240,000 360,000 600,000
Logistics costs 80,000 120,000 200,000
Annual subtotal $195,000 $320,000 $480,000 $995,000
After-purchase costs 80,000 120,000 200,000
Annual total $195,000 $400,000 $600,000 $1,195,000
 Kaizen Budgeting

 Kaizen budgeting incorporates expectations

for continuous improvement into budgetary
estimates. Kaizen costing determines target
cost reductions for a period, such as a month.
Thus, variances are the differences between
actual and targeted cost reduction. The
objective is to reduce actual costs below
standard costs.
 CHAPTER 22
ZERO-BASE BUDGETING: PRIORITY BUDGETING FOR
BEST RESOURCE ALLOCATION
 Zero-base Budgeting

ZBB begins with a zero balance and formulates

objectives to be achieved. All activities are
analyzed for the current year. The manager may
decide to fund an existing project as last year
after his or her yearly review. However, it is
most likely that funding will be increased or
decreased based on new information. It is also
possible that an alternative way may be used for
that project based on current cost or time
considerations
 ZBB Process

 Developing assumptions
 Ranking proposals
 Appraising and controlling
 Preparing the budget
 Identifying and evaluating decision
units
 CHAPTER 23
MANAGERS’ PERFORMANCE AND BALANCED
SCORECARD: EVALUATION ON THE DIVISION LEVEL
 Responsibility

 With responsibility must come authority to

carry out decisions. Profit planning requires
that managers be held accountable for their
results as long as they have authority over
the items in question. If responsibility is
assigned without authority, the profit
planning system fails and manager
frustration occurs.
 Responsibility Accounting

 Responsibility accounting is the system for

collecting and reporting revenue and cost
information by areas of responsibility.
 It operates on the premise that managers
should be held responsible for their
performance, the performance of their
subordinates, and all activities within their
responsibility center.
 Responsibility Centers

Responsibility centers can be one of the following types:

 Cost center. A cost center is the unit within the
organization which is responsible only for costs
 Investment center. An investment center is the unit
within the organization which is held responsible for the
costs, revenues, and related investments made in that
center
 Profit center. A profit center is the unit which is held
responsible for the revenues earned and costs incurred in
that center
 The Balanced Scorecard

A Balanced Scorecard (BSC) is a set of performance

measures --constructed for four dimensions of
performance.
Financial
Customer
Internal processes
Learning and growth.
Balanced Scorecard Dimensions

Description Measures

Financial Operating income

Is the company achieving its Return on assets
financial goals? Sales growth
Cash flow from operations
Reduction of administrative expense

Customer Is the company meeting Customer satisfaction

customer expectations? Customer retention
New customer acquisition
Market share
On-time delivery
Time to fill orders

Internal Processes Is the company improving critical Defect rate

internal processes? Lead time
Number of suppliers
Material turnover
Percent of practical capacity

Learning and Growth Is the company improving its Amount spent on employee training
ability to innovate? Employee satisfaction
Employee retention
Number of new products
New product sales as a percent of total sales
Number of patents
Balanced Scorecard –Web Resources

Web resources that you can log on to learn more about

industry “best practices” or examples of successful
implementations at other firms when developing
measurement program
The Balanced Scorecard Institute (www.balancedscorecard.org).
American Productivity and Quality Center (www.apqc.org).
Management Help (www.managementhelp.org).
Performance Measurement Association (PMA)
(www.performanceportal.org).
 CHAPTER 24
BUDGETING FOR SERVICE ORGANIZATIONS: SPECIAL
FEATURES
 Why Service industries?

There are two reasons why special attention should be

devoted to budgetary planning and control
techniques in the service industry
 First, planning and control are critical functions in all
business, whether they produce and sell goods or
provide services. Many service businesses have
become more competitive in recent years
 Second, the practice of budgeting is probably not as
well developed in service companies as it is in
manufacturing firms
 Common Six-step Pattern

• A profit or target for the company is established.

• An annual plan is developed that indicates expected
revenues and expenses by the organizational segments
and in total, by month.
• The cash budget is established.
• A planned statement of financial position is developed
and tested against selected standards.
• Actual performance is measured against plan by specific
levels of management position.
• Corrective action is taken as deemed necessary.
 CHAPTER 25
BUDGETING FOR NONPROFIT ORGANIZATIONS:
DIVERSE TYPES
 Nonprofit Organizations

Nonprofit organizations can be broken down into three major

types
 The first is comprised of voluntarily supported organizations,
such as hospi­tals, churches, colleges, foundations, health and
welfare agencies, and privately funded schools
 The second type includes organizations supported through tax
assessments, such as government units and state-supported
schools
 The third type operates primarily for the benefit of its
supporters, such as cooperatives, country clubs, and other
community-based organizations.
Objective Of Financial Reporting

 The objective of financial reporting is

accountability to the public rather than to
investors. There is no profit distribution. The
accounting equation associated with fund
accounting is: Assets = Restrictions on Assets.
A nonprofit entity may have a surplus or
deficit depending on whether revenues
exceed expenditures
 CHAPTER 26
USING MANAGEMENT GAMES FOR
EXECUTIVE TRAINING
 Some Goals of
Management Games

 Improve decision making and analytical skills

 Facilitate participants’ understanding of the external environment
simulated
 Interactively apply the knowledge, concepts, and skills acquired in various
business courses
 Develop awareness of the need to make decisions without complete -
information
 Improvise appropriately and adapt constructively from previously learned
concepts, theories, and techniques
 Develop ability to recognize the need for additional factual material
 Develop an understanding of the interrelationships of the various
functions within the firm and how these interactions affect overall
performance
The Capstone Business Simulation

Students use a Capstone spreadsheet, called capstone.xls, to create and analyze decision
tactics in each round. Capstone.xls provides the capability to evaluate alternate worst-
case/best-case scenarios, to help students optimize planning.
The Strategy menu in the capstone.xls spreadsheet is organized around
several primary functional areas:
Research and Development (R&D)
Marketing
Production
Finance
Several additional optional modules include:
Total Quality Management
Human Resources
Labor Contract Negotiation
Advanced Marketing
Sample Individual Participant Results
Report
END OF PRESENTATION