Chapter 20 ACG notes
Master Budgets and Performance Planning
Chapter 20 by Wild and Shaw - Financial and Managerial Accounting 2025 Release
Learning Objectives
CONCEPTUAL C1: Describe the benefits of budgeting.
ANALYTICAL A1: Prepare a direct labor budget for a service firm and analyze revenue per employee.
PROCEDURAL P1: Prepare the operating budgets of a master budget for a manufacturing company.
P2: Prepare a cash budget for a manufacturing company.
P3: Prepare budgeted financial statements.
P4: Prepare each component of a master budget for a merchandising company. (Appendix 20A)
Benefits of Budgeting (Learning Objective C1)
Definition and Key Concepts
Budgeting: The process of planning future business actions and expressing them as formal plans.
Budget: A formal statement of a company’s plans expressed in dollars.
Budgetary control process: The management's use of budgets to ensure that planned objectives are met.
Importance of Budgeting
Plan: Focuses on future opportunities and threats.
Control: Provides benchmarks for evaluating performance.
Coordinate: Aligns activities of all employees and departments toward the company’s overall goals.
Communicate: Management’s specific action plans are communicated to all employees.
Motivate: Budgeting performance levels set goals for employees to attain or exceed.
Motivating Forces and Challenges
Positive Motivating Force When:
Goals reflected in the budget are challenging but attainable.
Employees involved in preparing the budget.
Evaluations provide opportunities to explain discrepancies between actual and budgeted amounts.
Potential Negative Outcomes:
Pressure on employees may lead to unethical behavior or fraud.
Employees might understate sales and overstate expenses to create a cushion.
They may spend budgets on unnecessary items to avoid reductions in future periods.
Budget Reporting and Timing
Continuous Budgeting
Implemented through the preparation of rolling budgets which are continually revised over time.
A rolling budget involves updating the entire set of budgets by adding a new quarterly budget to replace the quarter just completed.
Operating Budgets for Manufacturing Companies (Learning Objective P1)
Components of the Master Budget
Master Budget Components: Include critical financial statements and projections over a specific period.
Example: Toronto Sticks Company’s balance sheet at the start of the budgeting period.
Sales Budget Example
Toronto Sticks sold 700 hockey sticks at a price of $60 each. Future sales projections have been prepared for the next three months.
Production Requirements
The Production Budget does not show costs but is expressed in units.
It is derived from the unit sales projected in the sales budget and takes inventory considerations into account.
Direct Materials and Direct Labor Budgets
Direct Materials Budget: Indicates the budgeted costs of direct materials necessary to meet production needs. This is derived from production requirements.
Direct Labor Budget: Provides budgeted costs for direct labor necessary for estimated production, also derived from production requirements.
Factory Overhead Budget
Shows budgeted costs needed to complete production for the period:
Variable factory overhead assigned at a rate of $2.50 per unit produced.
Fixed overhead budgeted at $1,500 per month.
Product Cost Calculation
Product cost per unit combines the costs from direct materials, direct labor, and factory overhead:
TSC assumes production of 3,000 units each quarter, resulting in a fixed overhead cost of $1.50 per unit for the quarter.
Cost Budgets
Cost of Goods Sold Budget
The calculated product cost per unit will be used to prepare:
Cost of Goods Sold Budget
Budgeted Income Statement
Selling Expense Budget
TSC sales commissions are 10% of total sales (variable).
A fixed monthly salary of $2,000 for the sales manager.
General and Administrative Expense Budget
Includes annual salaries of $54,000 or $4,500 monthly, and other general expenses.
Common expenses: property taxes, office expenses, insurance, and depreciation on non-manufacturing assets.
Cash Budget Preparation (Learning Objective P2)
Capital Expenditures Budget
Reports expected cash receipts and payments for the purchase/sale of plant assets, generally prepared after operating budgets.
Cash Budget Structure
Displays budgeted cash receipts and cash payments for the budget period.
General formula: Add budgeted cash receipts to the beginning cash balance and subtract budgeted cash payments.
Cash Receipts and Payments
Budgeted Cash Receipts for Sales: Accounts receivable at month-end is 60% of current month’s budgeted sales, while cash sales are 40% of total monthly sales.
Cash Payments for Direct Materials: Reflect costs based on direct materials needs and timing of cash outflows.
Budgeted Financial Statements (Learning Objective P3)
Budgeted Income Statement
Synthesizes all information from previous component budgets. Includes an estimated income tax expense, set at 40% of the pretax income.
Budgeted Balance Sheet Example
Provided for Toronto Sticks Company as of December 31:
Assets:
Cash: $44,706
Accounts Receivable: $50,400
Raw Materials Inventory: $9,700
Finished Goods Inventory: $13,770
Equipment: $225,000, Less Accumulated Depreciation: $40,500.
Liabilities and Equity:
Accounts Payable: $4,950
Income Taxes Payable: $39,502
Equity breakdown.
Total Assets and Total Liabilities equals: $298,326.
Budgeting for Service Companies (Learning Objective P4)
Differences in Budgeting for Service Firms
Service providers prepare master budgets but typically require fewer operating budgets than manufacturers.
Key budgets: Direct labor budgets which are crucial for profitability as they can significantly impact price bids and income.
Direct Labor Budget Importance
An example involving direct labor budgeting in service firms, emphasizing the impact of accurate estimates on pricing and income outcomes.
Appendix A: Preparing Master Budget Components for a Merchandising Company
Merchandise Purchases Budget vs. Manufacturing Budget
Unlike manufacturers, merchandisers need to create a merchandise purchases budget instead of a production budget.
Examples of preparing purchases budget layouts and cash payments schedules for handling merchandise purchases are provided.