ACC 3301 D

ACC 3301, Managerial Accounting 1

Course Learning Outcomes for Unit V Upon completion of this unit, students should be able to:

2. Assess various budgets within an organization. 2.1 Identify the essentials of effective budgeting. 2.2 Differentiate between the various types of budgeting.

Required Unit Resources Chapter 9: Budgetary Planning—Read the following sections:

• Effective Budgeting and the Master Budget • Sales, Production, and Direct Materials Budgets • Direct Labor, Manufacturing Overhead, and S&A Expense Budgets • Cash Budget and Budgeted Balance Sheet • Budgeting in Nonmanufacturing Companies

Chapter 10: Budgetary Control and Responsibility Accounting—Read the following sections:

• Budgetary and Static Budget Reports • Flexible Budget Reports • Responsibility Accounting and Responsibility Centers • Investment Centers

In order to access the following resources, click the links below. Chapter 9 PowerPoint Presentation PDF of Chapter 9 Presentation Chapter 10 PowerPoint Presentation PDF of Chapter 10 Presentation Unit Lesson

Introduction Benjamin Franklin and Winston Churchill both highlighted that if you want an endeavor to succeed, the most important thing you can do is make plans and prepare for any circumstances that might arise. They both indicate that failing to plan means one had better be ready to fail. As individuals, it is important to plan. If you plan to buy a house, then you must make plans to set aside enough money for a down payment. In addition, just like with individuals, corporations must plan for the future and attempt to control costs and set revenue goals. The management tool both corporations and individuals will use for this plan is called a budget. In the simplest terms, a budget is a list of expected revenues and expenses over a period of time. A budget is a plan developed by upper management that gives guidance regarding the direction a company is heading, the anticipated generated revenue, and the expected incurred costs to lead the company toward success.

UNIT V STUDY GUIDE Budgetary Planning and Budgetary Control

ACC 3301, Managerial Accounting 2

UNIT x STUDY GUIDE Title

Managers are then able to compare actual revenue and expenses against budgeted amounts to take corrective action or devise a plan to keep the company on track.

The Budget Process Most companies have learned that the best approach to developing a budget is a bottom-up approach as opposed to a top-down approach. In other words, lower-level managers will create detailed budgets for their departments usually based on past performance. This is generally known as participative budgeting. It allows for all levels of managers to participate in the budget process. This will also generate support from lower managers because they will feel that they had some help in creating the budget. The general starting point for developing budgets is the previous year’s actual results. From this, the following amounts must be adjusted: (1) new products, customers, or regions; (2) competitive advantages or disadvantages; (3) changes in labor and material costs; (4) changes in the economy; and (5) any new strategies or direction for the company. If managers are not careful, this plan can cause expenses to grow from year to year. Therefore, a plan to help counteract this is to have managers justify each dollar for their departments. This will keep the managers mindful of the costs and help hold them accountable for the performance of their departments. The master budget is the comprehensive planning document that houses all the various budgets of a company. The master budget consists of an operating budget and financial budgets. The operating budget consists of (1) sales budget, (2) production budget, (3) operating expenses budget, and (4) budgeted income statement. The financial budget consists of the capital expenditure budget, cash budgets, and the budgeted balance sheet. The budget process begins with the sales departments. The correct question to ask is how many units do you think we will sell next year? If you owned a motorcycle dealership and asked your sales department this question, you need to remember that because they are in sales and marketing, they are usually optimistic about their numbers. Okay, so let’s say we asked the question, and their answer is shown in the table below:

Projected Number of Units to be Sold Motorcycle Types Sold

1st QTR 2nd QTR 3rd QTR 4th QTR Totals Average Sales Price

Total Budgeted Sales

Sports 200 300 200 150 850 $10,000 $8,500,000 Cruisers 300 350 400 250 1300 $17,500 $22,750,000 Touring 150 225 250 100 725 $25,000 $18,125,000

Totals 650 875 850 500 2,875 $52,500 $49,375,000 As you can see, you would start with monthly projections. The quarterly figures shown above were reduced to fit on one page. Then, you come up with annual units and multiply by the average sales price to arrive at a total budgeted sales amount. It is important that this number is fairly accurate because it will drive all of the other operating budgets. In this example, we do not have a production budget because we are not manufacturing these motorcycles but selling them as a dealership. Therefore, we must arrive at our cost for these bikes so we can budget a gross profit. If our gross profit margin has been 20%, and we have good reason to believe it will stay the same, then we know that our cost for these 2,875 motorcycles will be $39,500,000 (80% of $49,375,000). The operating expenses budget is usually based on previous year’s numbers with modifications for sales volume, marketing changes, or any known competitive advantages or disadvantages (e.g., did a local motorcycle dealership move or go out of business). After the operating expenses budget has been prepared, the company now has an idea as to the expected net income for the budgeted period. This allows management to move to financial budgets and consider capital budget amounts (e.g., building or renovating a new building) and plan for cash budgets to see if there will be any months in which the company may need to consider a line of credit. View the following video by accessing the Unit V Additional Unit Resources folder in the unit.

ACC 3301, Managerial Accounting 3

UNIT x STUDY GUIDE Title

For more information about budgetary planning, check out the Real World Video: Budgetary Planning (BabyCakes NYC) video. Once you click on the link, closed captioning can be accessed by clicking the “CC” button on the bottom right of the video window, and a transcript can be accessed by clicking the “T” button next to the “CC” button.

Performance Evaluation Let’s say the company is big and has several different divisions. How would you know in which company to invest additional capital? The return on investment (ROI) is an excellent measure of performance and measures the amount of net income generated relative to the size of the assets invested. The formula for computing the ROI is shown below:

Let’s view some numbers for Pizza Hut and Kentucky Fried Chicken:

This means for every dollar invested in KFC, the return on the investment is $0.08; however, Pizza Hut has a return on each dollar invested of $0.24. Therefore, all things being equal, the company would want to invest more money in Pizza Hut because every dollar invested will return $0.16 more than KFC. (Note: these amounts are inaccurate and for illustration purposes only). This calculation looks simple and straightforward; however, management must decide how to measure the assets. For example, should the company use end-of-year asset totals, beginning-of-year asset totals, or the average (beginning of year + end of year) divided by 2? The company must also decide what assets are included; most managers agree that only productive assets should be used in the calculation. Should the company use the gross book value of the assets (historical cost method) or the net book value (gross less accumulated depreciation)? There are many decisions that need to be made, and the same measurement method must be used consistently.

Evaluating Budget Performance A budget is a guide or plan and should be used to gauge actual performance. Recall that the variance is the difference between budgeted amounts and actual amounts. When comparing budgeted revenue to actual revenue, any time actual revenue exceeds budgeted revenue, it is a favorable variance; however, when reviewing expenses, it is an unfavorable variance for actual expenses to exceed budgeted expenses. Let’s consider the following results in the image below:

Budget Items Actual Budgeted Variance F/U Sales $3,250,000 $2,950,000 $300,000 F Cost of Goods Sold $2,437,500 $2,360,000 $77,500 U Gross Profit $812,500 $590,000 $222,500 F Operating Expenses $325,000 $375,000 $50,000 F Net Income $487,500 $215,000 $272,500 F

The sales were $300,000 more than budgeted, and this is a favorable variance (F). For the cost of goods sold, the variance is $77,500, and this is an unfavorable variance (U). However, the numbers do not tell the entire story. The actual cost of goods sold is only 75% of actual sales, and the budgeted amount for cost of goods sold is 80%. Therefore, the actual result is better by an increase in 5% gross profit. Also, please

Operating Income Total Assets

Return on Investment (ROI) =

ACC 3301, Managerial Accounting 4

UNIT x STUDY GUIDE Title

observe that actual operating expenses were below budgeted expenses by $50,000. All these factors led to a very favorable variance in budgeted net income by $272,500. It is always good to review the numbers; however, management should also try to understand the numbers. Why are sales greater than budget? Did we do a poor job of budgeting our projected sales? Did a competitor move away or go out of business unexpectedly? Did a particular product exceed expectations? All of these questions are important to better plan and budget for following years. It is important to look at all aspects of the budget to understand why our gross profit margin was actually 25% instead of 20%; moreover, how were we able to reduce expenses by $50,000?

Conclusion As you can see, budgets are extremely important to the overall success of a company. For publicly held companies, meeting or exceeding the budget can affect stock price. Analysts’ forecasts are often based on information provided by the executives of the company. When the company does not meet or exceed those expectations, then the stock price will usually suffer. We can end this unit in the way we started. For companies that do not prepare a budget to help them succeed, they are actually planning to fail. Suggested Unit Resources View the following video by accessing the Unit V Additional Unit Resources folder in the unit. Check out the Real World Video: Budgetary Control and Responsibility Accounting (Tribeca Grand Hotel) video to see how budgetary planning is used in the running of a New York hotel. Once you click on the link, closed captioning can be accessed by clicking the “CC” button on the bottom right of the video window, and a transcript can be accessed by clicking the “T” button next to the “CC” button.

ACC 3301, Managerial Accounting 1

Course Learning Outcomes for Unit V Upon completion of this unit, students should be able to:

2. Assess various budgets within an organization. 2.1 Identify the essentials of effective budgeting. 2.2 Differentiate between the various types of budgeting.

Required Unit Resources Chapter 9: Budgetary Planning—Read the following sections:

• Effective Budgeting and the Master Budget • Sales, Production, and Direct Materials Budgets • Direct Labor, Manufacturing Overhead, and S&A Expense Budgets • Cash Budget and Budgeted Balance Sheet • Budgeting in Nonmanufacturing Companies

Chapter 10: Budgetary Control and Responsibility Accounting—Read the following sections:

• Budgetary and Static Budget Reports • Flexible Budget Reports • Responsibility Accounting and Responsibility Centers • Investment Centers

In order to access the following resources, click the links below. Chapter 9 PowerPoint Presentation PDF of Chapter 9 Presentation Chapter 10 PowerPoint Presentation PDF of Chapter 10 Presentation Unit Lesson

Introduction Benjamin Franklin and Winston Churchill both highlighted that if you want an endeavor to succeed, the most important thing you can do is make plans and prepare for any circumstances that might arise. They both indicate that failing to plan means one had better be ready to fail. As individuals, it is important to plan. If you plan to buy a house, then you must make plans to set aside enough money for a down payment. In addition, just like with individuals, corporations must plan for the future and attempt to control costs and set revenue goals. The management tool both corporations and individuals will use for this plan is called a budget. In the simplest terms, a budget is a list of expected revenues and expenses over a period of time. A budget is a plan developed by upper management that gives guidance regarding the direction a company is heading, the anticipated generated revenue, and the expected incurred costs to lead the company toward success.

UNIT V STUDY GUIDE Budgetary Planning and Budgetary Control

ACC 3301, Managerial Accounting 2

UNIT x STUDY GUIDE Title

Managers are then able to compare actual revenue and expenses against budgeted amounts to take corrective action or devise a plan to keep the company on track.

The Budget Process Most companies have learned that the best approach to developing a budget is a bottom-up approach as opposed to a top-down approach. In other words, lower-level managers will create detailed budgets for their departments usually based on past performance. This is generally known as participative budgeting. It allows for all levels of managers to participate in the budget process. This will also generate support from lower managers because they will feel that they had some help in creating the budget. The general starting point for developing budgets is the previous year’s actual results. From this, the following amounts must be adjusted: (1) new products, customers, or regions; (2) competitive advantages or disadvantages; (3) changes in labor and material costs; (4) changes in the economy; and (5) any new strategies or direction for the company. If managers are not careful, this plan can cause expenses to grow from year to year. Therefore, a plan to help counteract this is to have managers justify each dollar for their departments. This will keep the managers mindful of the costs and help hold them accountable for the performance of their departments. The master budget is the comprehensive planning document that houses all the various budgets of a company. The master budget consists of an operating budget and financial budgets. The operating budget consists of (1) sales budget, (2) production budget, (3) operating expenses budget, and (4) budgeted income statement. The financial budget consists of the capital expenditure budget, cash budgets, and the budgeted balance sheet. The budget process begins with the sales departments. The correct question to ask is how many units do you think we will sell next year? If you owned a motorcycle dealership and asked your sales department this question, you need to remember that because they are in sales and marketing, they are usually optimistic about their numbers. Okay, so let’s say we asked the question, and their answer is shown in the table below:

Projected Number of Units to be Sold Motorcycle Types Sold

1st QTR 2nd QTR 3rd QTR 4th QTR Totals Average Sales Price

Total Budgeted Sales

Sports 200 300 200 150 850 $10,000 $8,500,000 Cruisers 300 350 400 250 1300 $17,500 $22,750,000 Touring 150 225 250 100 725 $25,000 $18,125,000

Totals 650 875 850 500 2,875 $52,500 $49,375,000 As you can see, you would start with monthly projections. The quarterly figures shown above were reduced to fit on one page. Then, you come up with annual units and multiply by the average sales price to arrive at a total budgeted sales amount. It is important that this number is fairly accurate because it will drive all of the other operating budgets. In this example, we do not have a production budget because we are not manufacturing these motorcycles but selling them as a dealership. Therefore, we must arrive at our cost for these bikes so we can budget a gross profit. If our gross profit margin has been 20%, and we have good reason to believe it will stay the same, then we know that our cost for these 2,875 motorcycles will be $39,500,000 (80% of $49,375,000). The operating expenses budget is usually based on previous year’s numbers with modifications for sales volume, marketing changes, or any known competitive advantages or disadvantages (e.g., did a local motorcycle dealership move or go out of business). After the operating expenses budget has been prepared, the company now has an idea as to the expected net income for the budgeted period. This allows management to move to financial budgets and consider capital budget amounts (e.g., building or renovating a new building) and plan for cash budgets to see if there will be any months in which the company may need to consider a line of credit. View the following video by accessing the Unit V Additional Unit Resources folder in the unit.

ACC 3301, Managerial Accounting 3

UNIT x STUDY GUIDE Title

For more information about budgetary planning, check out the Real World Video: Budgetary Planning (BabyCakes NYC) video. Once you click on the link, closed captioning can be accessed by clicking the “CC” button on the bottom right of the video window, and a transcript can be accessed by clicking the “T” button next to the “CC” button.

Performance Evaluation Let’s say the company is big and has several different divisions. How would you know in which company to invest additional capital? The return on investment (ROI) is an excellent measure of performance and measures the amount of net income generated relative to the size of the assets invested. The formula for computing the ROI is shown below:

Let’s view some numbers for Pizza Hut and Kentucky Fried Chicken:

This means for every dollar invested in KFC, the return on the investment is $0.08; however, Pizza Hut has a return on each dollar invested of $0.24. Therefore, all things being equal, the company would want to invest more money in Pizza Hut because every dollar invested will return $0.16 more than KFC. (Note: these amounts are inaccurate and for illustration purposes only). This calculation looks simple and straightforward; however, management must decide how to measure the assets. For example, should the company use end-of-year asset totals, beginning-of-year asset totals, or the average (beginning of year + end of year) divided by 2? The company must also decide what assets are included; most managers agree that only productive assets should be used in the calculation. Should the company use the gross book value of the assets (historical cost method) or the net book value (gross less accumulated depreciation)? There are many decisions that need to be made, and the same measurement method must be used consistently.

Evaluating Budget Performance A budget is a guide or plan and should be used to gauge actual performance. Recall that the variance is the difference between budgeted amounts and actual amounts. When comparing budgeted revenue to actual revenue, any time actual revenue exceeds budgeted revenue, it is a favorable variance; however, when reviewing expenses, it is an unfavorable variance for actual expenses to exceed budgeted expenses. Let’s consider the following results in the image below:

Budget Items Actual Budgeted Variance F/U Sales $3,250,000 $2,950,000 $300,000 F Cost of Goods Sold $2,437,500 $2,360,000 $77,500 U Gross Profit $812,500 $590,000 $222,500 F Operating Expenses $325,000 $375,000 $50,000 F Net Income $487,500 $215,000 $272,500 F

The sales were $300,000 more than budgeted, and this is a favorable variance (F). For the cost of goods sold, the variance is $77,500, and this is an unfavorable variance (U). However, the numbers do not tell the entire story. The actual cost of goods sold is only 75% of actual sales, and the budgeted amount for cost of goods sold is 80%. Therefore, the actual result is better by an increase in 5% gross profit. Also, please

Operating Income Total Assets

Return on Investment (ROI) =

ACC 3301, Managerial Accounting 4

UNIT x STUDY GUIDE Title

observe that actual operating expenses were below budgeted expenses by $50,000. All these factors led to a very favorable variance in budgeted net income by $272,500. It is always good to review the numbers; however, management should also try to understand the numbers. Why are sales greater than budget? Did we do a poor job of budgeting our projected sales? Did a competitor move away or go out of business unexpectedly? Did a particular product exceed expectations? All of these questions are important to better plan and budget for following years. It is important to look at all aspects of the budget to understand why our gross profit margin was actually 25% instead of 20%; moreover, how were we able to reduce expenses by $50,000?

Conclusion As you can see, budgets are extremely important to the overall success of a company. For publicly held companies, meeting or exceeding the budget can affect stock price. Analysts’ forecasts are often based on information provided by the executives of the company. When the company does not meet or exceed those expectations, then the stock price will usually suffer. We can end this unit in the way we started. For companies that do not prepare a budget to help them succeed, they are actually planning to fail. Suggested Unit Resources View the following video by accessing the Unit V Additional Unit Resources folder in the unit. Check out the Real World Video: Budgetary Control and Responsibility Accounting (Tribeca Grand Hotel) video to see how budgetary planning is used in the running of a New York hotel. Once you click on the link, closed captioning can be accessed by clicking the “CC” button on the bottom right of the video window, and a transcript can be accessed by clicking the “T” button next to the “CC” button.