Chapter Eight

Functional and
Activity-Based Budgeting

PPT 8 -1
 Learning Objectives

 Define budgeting and discuss its role in planning,

control, and decision making.
 Define and prepare the master budget, identify its
major components, and explain the
interrelationships of its various components.

PPT 8 -2
 Learning Objectives (continued)

 Describe flexible budgeting and identify the

features that a budgetary system should have to
encourage managers to engage in goal-congruent
behavior.
 Describe activity-based budgeting.

PPT 8 -3
Definition and Role of Budgeting
Planning Control
Strategic Plan Monitoring of Actual Activity

Long-Term Objectives
Budgets are quantitative
Short-Term Objectives expressions of plans

Short-Term Plan

Budgets Comparison of Actual with Planned

Feedback Investigation

Corrective action
PPT 8 -4
 Purposes of Budgeting

 It forces managers to plan.

 It provides information that can be used to improve
decision making.
 It provides a standard for performance evaluation.
 It improves communication and coordination.

PPT 8 -5
 Two Dimensions of Budgeting

There are two dimensions to budgeting:

1. How is the budget prepared?
2. How is the budget used to implement the
organization’s plan?

PPT 8 -6
 Master Budget

A master budget can be divided into operating and

financial budgets.
Operating budgets describe the income-generating
activities of a firm: sales, production, and finished goods
inventories.
Financial budgets detail the inflows and outflows of cash
and the overall financial position.

PPT 8 -7
 The Operating Budget
The operating budget consists of a budgeted
income statement accompanied by the following
support schedules:
 Sales budget

 Production budget

 Direct material purchases budget

 Direct labor budget

 Overhead budget

 Selling and administrative expenses budget

 Ending finished goods inventory budget

 Cost of goods sold budget

PPT 8 -8
 Sales Budget (Schedule 1)

______________Quarter____________
1 2 3 4 Year
Units 2,000 6,000 6,000 2,000 16,000
Unit selling price x $0.70 x $0.70 x $0.80 x $0.80 x $0.75
$1,400 $4,200 $4,800 $1,600 $12,000
===== ===== ===== ===== ======

PPT 8 -9
 Production Budget (Schedule 2)

_____________Quarter____________

1 2 3 4 Year
Sales (Schedule 1) 2,000 6,000 6,000 2,000 16,000
Desired ending inventory 500 500 100 100 100
Total needs 2,500 6,500 6,100 2,100 16,100
Less: Beginning inventory (100) (500) (500) (100) (100)
Units to be produced 2,400 6,000 5,600 2,000 16,000
==== ==== ==== ==== =====

PPT 8 -10
Direct Materials Budget (Schedule 3)
______________Quarter______________
1 2 3 4 Year
Units to be produced (2) 2,400 6,400 5,600 2,000 16,000
Direct materials per unit x 26 x 26 x 26 x 26 x 26
Production needs 62,400 156,000 145,600 52,000 416,000
Desired ending inventory 8,000 8,000 5,000 5,000 5,000
Total needs 70,400 164,000 150,600 57,000 421,000
Less: Beginning inventory (5,000) (8,000) (8,000) (5,000) (5,000)
Direct materials to
be purchased 65,400 156,000 142,600 52,000 416,000
Cost per pound x$0.01 x $0.01 x $0.01 x $0.01 x $0.01
Total purchase cost $654 $1,560 $1,426 $520 $4,160
PPT 8 -11
 Direct Labor Budget (Schedule 4)

________________Quarter____________
1 2 3 4 Year
Units to be produced (Sch. 2) 2,400 6,000 5,600 2,000 16,000
Direct labor time x 0.015 x 0.015 x 0.015 x 0.015 x 0.015
Total hours needed 36 90 84 30 240
Average wage per hour x $10 x $10 x $10 x $10 x $10
Total direct labor cost $360 $900 $840 $300 $2,400

PPT 8 -12
 Overhead Budget (Schedule 5)

_____________Quarter_____________

1 2 3 4 Year
Budgeted DLH ( Sch. 4) 36 90 84 30 240
Variable overhead rate x $8 x $8 x $8 x $8 x $8
Budgeted variable overhead $288 $720 $672 $240 $1,920
Budgeted fixed overhead* 320 320 320 320 1,280
Total overhead $608 $1,040 $992 $560 $3,200

*Includes $200,000 of depreciation in each quarter.

PPT 8 -13
 Selling and Administrative
Expenses Budget (Schedule 6)
________________Quarter____________
1 23 4Year
Planned sales in units (Sch. 1) 2,0006,000 6,0002,00016,000
Variable S & A exp. per unit x $0.05x $0.05x $0.05 x $0.05x $0.05
Total variable expense $100$300 $300$100$ 800
Fixed S & A expenses:
Salaries $ 35$ 35 $ 35$ 35$ 140
Advertising 1010 1010 40
Depreciation 1515 1515 60
Insurance ---- 15-- 15
Travel 5 5 5 5 20
Total fixed expenses $ 65$ 65 $ 80$ 65$ 275
Total S & A expenses $165$365 $380$165$1,075

PPT 8 -14
 Ending Finished Goods
Inventory Budget (Schedule 7)
Unit-cost computation:
Direct materials (26 lb.. @ $0.01) $0.26
Direct labor (0.015 hr. @ $10) 0.15
Overhead:
Variable (0.015 hr. @ $8) 0.12
Fixed (0.015 hr. @ $5.33*) 0.08
Total unit cost $0.61

*$1,280/240 = $5.33 Unit

Units CostsTotal
Finished goods: Concrete block 100,000$0.61$61,000

PPT 8 -15
Cost of Goods Sold Budget (Schedule 8)

Direct materials used (Schedule 3)* $4,160

Direct labor used (Schedule 4) 2,400
Overhead (Schedule 5) 3,200
Budgeted manufacturing costs $9,760
Beginning finished goods 55
Goods available for sale $9,815
Less: Ending finished goods (Schedule 7) (61)
Budgeted cost of goods sold $9,754

*Production needs x $0.01 = 416,000 x $0.01

PPT 8 -16
 The Financial Budgets

The usual financial budgets prepared are:

 The cash budget

 The budgeted balance sheet

 The budget for capital expenditures

PPT 8 -17
 The Cash Budget

Beginning cash balance $x,xxx

Add: Cash receipts x,xxx
Cash available $x,xxx
Less: Cash disbursements x,xxx
Less: Minimum cash balance x,xxx
Cash surplus (deficiency) $x,xxx
Add: Cash from loans x,xxx
Less: Loan repayments x,xxx
Add: Minimum cash balance x,xxx
End cash balance $x,xxx
=====

PPT 8 -18
 Cash Budget Example

a. A $100,000 minimum cash balance is required for the end of

each quarter. Money can be borrowed and repaid in multiples
of $100,000. Interest is 12 % per year. Interest payments are
made only for the amount of the principal being repaid. All
borrowing takes place at the beginning of a quarter and all
repayment takes place at the end of a quarter.
b. Half of all sales are for cash, 70% of credit sales are collected
in the quarter of sale, and the remaining 30% are collected in
the following quarter. The sales for the fourth quarter of 2000
were $2 million.

PPT 8 -19
 Cash Budget Example (continued)

c. Purchases of raw materials are made on account; 80% of

purchases are paid for in the quarter of purchase. The
remaining 20% are paid for in the following quarter. The
purchases for the fourth quarter of 2000 were $500,000.
d. Budgeted depreciation is $200,000 per quarter for overhead
and $15,000 per quarter for selling and administrative
expenses (see Schedules 5 and 6).

PPT 8 -20
 Cash Budget Example (continued)

e. The capital budget for 2001 revealed plans to purchase

additional equipment to handle increased demand at a small
plant in Nevada. The cash outlay for the equipment,
$600,000, will take place in the first quarter. The company
plans to finance the acquisition of the equipment with
operating cash, supplementing it with short-term loans as
necessary.
f. Corporate income taxes are approximately $650,000 and will
be paid at the end of the fourth quarter (Schedule 9).
g. Beginning cash balance equals $120,000.

PPT 8 -21
 Cash Receipts from Customers

Source Quarter1Quarter 2Quarter 3Quarter 4

Cash sales $ 700,000$2,100,000$2,400,000$ 800,000
Received on
account from:
Quarter 4, 2000 300,000
Quarter 1, 2001 490,000210,000
Quarter 2, 2001 1,470,000630,000
Quarter 3, 2001 1,680,000720,000
Quarter 4, 2001 560,000
Total cash receipts $1,490,000$3,780,000$4,710,000$2,080,000

PPT 8 -22
Cash Disbursements for Raw Materials

Source Quarter1 Quarter 2 Quarter 3 Quarter 4

Current quarter $523 $1,248 $1,141 $416
Prior quarter 100 131 312 285
Total cash
disbursement
for raw materials $623 $1,379 $1,453 $701

PPT 8 -23
 Cash Disbursements
____________ ______Quarter__________________
1 23 4
Less cash disbursements:
Raw materials:
Current quarter $523$1,248 $1,141$416
Prior quarter 100131 312285
Direct labor 360900 840300
Overhead 408840 792360
Selling and adm. 150350 365150
Income taxes ------ ---650
Equipment 600 --- --- ---

Total disbursements $2,141$3,469 $3,450$2,161 ======== ========

PPT 8 -24
 Cash Budget (Schedule 10)
_________ ______Quarter_______________
1 23 4Year
Beginning cash balance $ 120 $ 169$ 162$ 986$ 120
Cash collections (PPT 8-23) 1,490 3,780 4,710 2,080 12,060
Total cash available $1,610 $3,949$4,872$3,066$12,180

Total disbursements (PPT 8-25) $2,141 $3,469$3,450$2,161$11,221

Minimum cash balance 100 100 100 100 100
Total cash needs $2,241 $3,569$3,550$2,261$11,321

Excess (deficiency) of cash $ (631)$ 380 $1,322 $ 805$ 859

Add: Borrowings 700 --- --- --- 700
Less: Repayments --- (300) (400)--- (700)
Less: Interest paid --- (18) ( 36) --- (54)
Ending cash balance $ 169 $ 162 $ 986 $ 905$ 905
====== ================= ======

PPT 8 -25
 Budgeted Income Statement

Sales (Schedule 1) $12,000

Less: Cost of goods sold (Schedule 8) (9,754)
Gross margin $ 2,246
Less: Selling and administrative expenses (Schedule 6) (1,075)
Operating income $ 1,171
Less: Interest expense (Schedule 10) (54)
Income before taxes $ 1,117
Less: Income taxes (PPT 8-25) (650)
Net income $ 467
======

PPT 8 -26
 Total Assets, Last Year
Assets
Current assets:
Cash $ 120
Accounts receivable 300
Raw materials inventory 50
Finished goods inventory 55
Total current assets $ 525
Property, plant, and equipment:
Land $ 2,500
Building and equipment 9,000
Less: Accumulated depreciation (4,500)
Total property, plant, and equipment 7,000
Total assets $7,525 =====

PPT 8 -27
 Total Liabilities and Stockholders’
Equity, Last Year
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable $ 100
Stockholders’ equity:
Common stock, no par $ 600
Retained earnings 6,825
Total stockholders’ equity 7,425
Total liabilities and stockholders’ equity $7,525
=====

PPT 8 -28
 Budgeted Total Assets
Assets
Current assets:
Cash $ 905
Accounts receivable 240
Raw materials inventory 50
Finished goods inventory 61
Total current assets $1,256
Property, plant, and equipment:
Land $2,500
Building and equipment $ 9,600
Less: Accumulated depreciation (5,360)
Total property, plant, and equipment 6,740
Total assets $7,996 =====

PPT 8 -29
 Budgeted Total Liabilities and
Stockholders’ Equity
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable $ 104
Stockholders’ equity:
Common stock, no par $ 600
Retained earnings 7,292
Total stockholders’ equity 7,892
Total liabilities and stockholders’ equity $7,996
=====

PPT 8 -30
 Flexible and Static Budgeting

Static Budgeting is a budget for a particular level of

activity.
Flexible Budgeting is a budget that provides a firm
with the capability to compute expected costs for a
range of activity.

PPT 8 -31
 The Uses of Flexible Budget

 The flexible budget can be used to prepare the budget

before the fact for the expected level of activity.
 Flexible budgeting can be used to compare what costs
should have been for the actual level of activity.
 Flexible budgeting can help managers deal with
uncertainty by allowing them to see the expected outcomes
for a range of activities.

PPT 8 -32
 Performance Report (Exhibit 8-6)
Actual BudgetedVariance
Units produced 3,0002,400 600 F ==== ====
===
Direct materials cost $ 927.3$ 624.0 $303.3 U
Direct labor costs 450.0360.0 90.0 U
Overhead:
Variable:
Supplies 80.072.0 8.0 U
Indirect labor 220.0168.0 52.0 U
Power 40.048.0 (8.0)F
Fixed:
Supervision 90.0100.0 (10.0)F
Depreciation 200.0200.0 0.0
Rent 30.0 20.0 10.0 U
Total $2,037.3$1,592.0 $445.3 U ======
====== =====

PPT 8 -33
Flexible Production Budget (Exhibit 8-7)
Variable Cost
Range of Production
Production Costs per Unit2,400 3,0003,600
Variable:
Direct materials $0.26$ 624 $ 780$ 936
Direct labor 0.15360 450540
Variable overhead:
Supplies 0.0372 90108
Indirect labor 0.07168 210252
Power 0.02 48 60 72
Total variable costs $0.53$1,272 $1,590$1,908
Fixed overhead:
Supervision $ 100 $ 100$ 100
Depreciation 200 200200
Rent 20 20 20
Total fixed costs $ 320 $ 320$ 320
Total production costs $1,592 $1,910$2,228
===== ===== =====

PPT 8 -34
Actual vs. Flexible Performance Report
(Exhibit 8-8)
Actual Budget Variance
Units produced 3,0003,000 ----- ==== ========
Production costs:
Direct materials $ 927.3$ 780.0 $ 147.3 U
Direct labor 450.0450.0 0.0
Variable overhead:
Supplies 80.090.0 (10.0)F
Indirect labor 220.0210.0 10.0 U
Power 40.0 60.0 (20.0) F
Total variable costs $1,717.3$1,590.0 $ 127.3 U
Fixed overhead:
Supervision $90.0$100.0 $(10.0)F
Depreciation 200.0200.0 0.0
Rent 30.0 20.0 10.0 U
Total fixed costs $ 320.0$ 320.0 $0.0
Total production costs $2,037.3$1,910.0 $ 127.3 U ======
====== =====

PPT 8 -35
Behavior Dimensions of Budgeting

 Goal Congruence
 Dysfunctional Behavior
 Frequent Feedback on Performance
 Monetary and Nonmonetary Incentives
 Participative Budgeting
 Realistic Standards
 Controllability of Costs
 Multiple Measures of Performance
PPT 8 -36
Activity-Based Budgeting

Activity flexible
budgeting is the
prediction of what
activity costs will be as
activity output changes.

PPT 8 -37
Flexible Budget: Direct Labor Hours

Cost Formula Direct Labor Hours

Fixed Variable10,00020,000
Direct materials ---$10 $100,000$200,000
Direct labor ---8 80,000160,000
Maintenance $ 20,0003 50,00080,000
Machining 15,0001 25,00035,000
Inspections 120,000--- 120,000120,000
Setups 50,000--- 50,00050,000
Purchasing 220,000 --- 220,000 220,000
Total $425,000$22 $645,000$865,000 ======= ==========
=======

PPT 8 -38
 Activity Flexible Budget
Driver: Direct Labor Hours
Formula Level of Activity
Fixed Variable10,00020,000
Direct materials ---$10 $100,000$200,000
Direct labor --- 8 80,000 160,000
Subtotal $0$18 $180,000$360,000
== ===

Driver: Machine Hours

Fixed Variable8,000 16,000
Maintenance $20,000$5.50$64,000 $108,000
Machining 15,000 2.00 31,000 47,000
Subtotal $35,000$7.50$95,000 $155,000
====== ====

PPT 8 -39
Activity Flexible Budget (continued)
Driver: Number of Setups
Fixed Variable25 30
Inspections $80,000$2,100$132,500 $143,000
Setups --- 1,800 45,000 54,000
Subtotal $80,000$3,900$177,500 $197,000====== =====

Driver: Number of Orders

Fixed Variable 15,000 25,000
Purchasing $211,000$1 $226,000$236,000 ======= ==
Total $678,000$948,000
======= =======

PPT 8 -40
Activity-Based Performance Report

Actual Costs Budgeted Costs Budget Variance

Direct materials $101,000 $100,000 $1,000 U
Direct labor 80,000 80,000 ---
Maintenance 55,000 64,000 9,000 F
Machining 29,000 31,000 2,000 F
Inspections 125,500 132,500 7,000 F
Setups 46,500 45,000 1,500 U
Purchasing 220,000 226,000 6,000 F
Total $657,000 $678,500 $21,500 F
======= ======= ======

PPT 8 -41
Variances for the Inspection Activity

Activity Actual Cost Budgeted Cost Variance

Inspection:
Fixed $ 82,000 $ 80,000 $2,000 U
Variable 43,500 52,500 9,000 F
Total $125,500 $132,500 $7,000 F
======= ======= =====

PPT 8 -42
End of Chapter 8

PPT 8 -43