Cost Exam 3

Budget Process overview

• Budget commitee

• Budget Period

• Budget Guidelines

• Negotioation, Reveiw, Approval

• Revision

Long range plan

• First point of budget prep process

• 5-7 year peiod of stratigic goals

• expressesd in master budget and capital budgeting

Master budget short term objective

Operating budgets:

Finacial budgets:

Operating budgets

Plans for all parts of operation like production, purchasing, personnel, marketing budgets

Financial budgets

Find sources and use of funds

Master Budget

• Gand Plan of action

• translates short term goals into steps

• communicates to managers and employee’s expectations of top management

• helps coordinates subunit activates

• Performance evaluations

Master budget comprises a set of _____ and _____ Budgets

Operating budgets form in a budgeted income statement

Financial budgets form in Balance sheet

Budgets Graph

operating budgets at middle/top, financial budgets at bottom

Sales budget

• Prepared first

• shoes est. sales = two components

  • Forecasted sales volume (harder in real world)

  • Budgeted selling price

Production budget

Sales + EI - BI = Production

DM usage budget

• Last line of production budget = First line of DM usage budget

• Shows amount and budgeted cost of DM required for budgeted production

DM purchases budget

• Budgeted purchases of DM

• needed to complete DM usage budget

• 
  

DL budget

• enables personnel dept to plan hiring and repostioning of employees beased on production needs

• prepared for each type of labor

• fuction of

  • budget output (production budget)

  • standard DL hours (budgeted)

  • standard DL rate (budgeted)

Overhead budget

includes all production costs other than DM and DL. Some separate into Variables and Fixed

COGM and COGS budget

• prepared after OH buget

• Budgeted income statment and balance sheet use info from this

Cash budget

• Cash flow from operating, investing, financing

The budgeted Income statment and Balance sheet

• can be prepared using all budgets

• describes expected NI

• budgeted balance sheet is last budget in process

Uncertainty and budget process

• what if anyalsis

• sensitivity anyalsis

• scenerio anyalsis

  • best case

  • worst case

  • most likley

Budgeting in service companies

focus must be on personnel planning

Zero bases budgeting

• Start from zero no activities or fuctions unless mangers say

• hilights activities and fuctions that have outlived usefulness

• difficult/time consuming

activity bases budgeting

• starts with budgeted output and costs

• simplified extensition of ABC system

Kaisen

• budget that incorprates countinies improvment expectation

• can be a complement to ABB and TDABB

budgeting issues

• budgetary slack: cushion mangers implment to ensure sucess

• spending the budget: mangers feel need to spend budget so its not cut

• Goal congruence: consistency between goals of firm, units, and employees

• authortive or patricptive budgeting

  • top down = authortive

  • bottom up = participtive

• Difficulty of budget: easy budget may not be as productive, difficult can discourage

• Compensation issues

Control

procedures, tools, systems to monitor and reach goals

management accounting and control systems

organizations core performance measurement system

operational control

• control system that focuses on short term operations performance

• control of basic business processes

short term financial control

• comparison between actual and budget results

• creates flex budget

actual results of financial short-term control

• prepared at end of period after actual activity is known

• All actual measurements used

Master (static) budget

• prepared before start of period

• contains all budgeted measurements

Static budget variances

static - actual

Flex budget

• Prepared at end of period

• actual sales volume with budgeted SP, VC, and Fixed costs

Master - Flex

Sales volume variance (difference in volume)

Flex - actual

Flex budget variance (difference in Selling price)

Common causes of DM variances

• Price Variance

  • Purchase of materials at different grade

  • quantity discounts

  • delivery expedite cost (rush orders)

• Usage Variance

  • Purchase of nonstandard quality

  • Poorly trained/supervised workers

  • poorly maintained machines

Common causes of DL variances

• Rate variance

  • Labor substitution

  • out of date standards

• Efficiency variances

  • Poorly trained workers

  • Poor quality raw materials

  • Porr maintained equipment

  • poor supervision

  • out of date standards

Standard costs

costs that should incurred under normal efficient operations

standard cost systems

accounting system which standard costs flow through formal accounting records (regardless standard costs can still be useful at end of period)

standard types

• ideal (perfect)

• continuous improvement

• currently attainable

standard setting procedures

• authortive

• participative

Capital Budgeting

• Process of identifying, evaluating, selecting, controlling capital investments

capital budget

• part of organization master budget that deals with current periods planned capital investments

capital investments

projects that involve large expenditure of funds and expected future benefits over number of years

post audit

• in depth review of completed capital investments projects for purpose of comparing realized costs and benefits with pre inv est.

Discounted Cash flows

Capital budgeting decisions that model and incorporate PV of future cash flow

Capital structure

means by which a company is financed: mix of debt and equity

Relevant after tax cash flows: Project initiation

• required investments outlays, including installation costs

• includes incremental net working capital commitments

• cash inflow associated with investment tax credit

Relevant after-tax cash flows: Project operation

• Cash operating expenses, net

• additional networking capital; requirements

• operating cash inflows, net

Relevant after-tax cash flows: Project disposal

• net tax, proceeds from disposal of investments

• recapture of investment in net working capital

WACC (weighted avg cost of capital)

• used in capital budgeting to discount future after tax cash flows back to present

• single Rate of return on combined components of capital, based on target capital structure

• Min rate of return

CAPM time value component

is the risk free rate (Rf) the return on safest investment

CAPM Risk component

• Market risk premium (Rm-Rf) the return provided by the market over risk rate

• Measure of security’s risk (beta)effect of individuals security on validity of a portfolio

• Security risk premium (B(Rm-Re)) RRR of the security is risk free rate of return plus security risk premium

RRR

Risk Free rate (Rf) + Measure of risk(B) x Market return (RM)

4 capital budgeting methods

1. NPV = discounted cash flows

2. IRR = discounted cash flows

3. payback

4. AARR

NPV method

• Calculates expected gain/loss by discounting future cash flows back to present using WACC (RRR)

• only projects with zero or positive NPV are accepted

Internal rate of return

• Nothing to do with opinions or requirements

• represents est. of true rate of return

• RRR that = 0 NPV

• In practice

  • General = excel or calc

  • when cash flows are equal: annuity PV factor = inv/annual net cash inflows

  • future cash flows are uneven: use trial and error

Modified IRR

• adjusted to account to assumed RRR associated with interim inflows

• assumes all positive cash flows are reinvested at WACC remaining life

• more conserve est of RRR

sensitivity analysis

• what if: changing one variable

• Scenario: how investment would do under different combination of variables

• Monte Carlo: computer provides distribution of possible scenarios

Real option

growth opportunities in capital