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    Prepare Operating Budgets – Principles of Accounting, Volume 2: Managerial Accounting

    40 PREPARE OPERATING BUDGETS

    Operating budgets are a primary component of the master budget and involve examining the expectations for the primary operations of the business. Assumptions such as sales in units, sales price, manufacturing costs per unit, and direct material needed per unit involve a significant amount of time and input from various parts of the organization. It is important to obtain all of the information, however, because the more accurate the information, the more accurate the resulting budget, and the more likely management is to effectively monitor and achieve its budget goals.

    Individual Operating Budgets

    In order for an organization to align the budget with the strategic plan, it must budget for the day-to-day operations of the business. This means the company must understand when and how many sales will occur, as well as what expenses are required to generate those sales. In short, each component—sales, production, and other expenses—must be properly budgeted to generate the operating budget components and the resulting pro-forma budgeted income statement.

    The budgeting process begins with the estimate of sales. When management has a solid estimate of sales for each quarter, month, week, or other relevant time period, they can determine how many units must be produced. From there, they determine the expenditures, such as direct materials necessary to produce the units. It is critical for the sales estimate to be accurate so that management knows how many units to produce. If the estimate is understated, the company will not have enough inventory to satisfy customers, and they will not have ordered enough material or scheduled enough direct labor to manufacture more units. Customers may then shop somewhere else to meet their needs. Likewise, if sales are overestimated, management will have purchased more material than necessary and have a larger labor force than needed. This overestimate will cause management to have spent more cash than was necessary.

    Sales Budget

    The sales budget details the expected sales in units and the sales price for the budget period. The information from the sales budget is carried to several places in the master budget. It is used to determine how many units must be produced as well as when and how much cash will be collected from those sales.

    For example, Big Bad Bikes used information from competitor sales, its marketing department, and industry trends to estimate the number of units that will be sold in each quarter of the coming year. The number of units is multiplied by the sales price to determine the sales by quarter as shown in (Figure).

    Sales Budget for Big Bad Bikes. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)

    The sales budget leads into the production budget to determine how many units must be produced each week, month, quarter, or year. It also leads into the cash receipts budget, which will be discussed in Prepare Financial Budgets.

    Production Budget

    Estimating sales leads to identifying the desired quantity of inventory to meet the demand. Management wants to have enough inventory to meet production, but they do not want too much in the ending inventory to avoid paying for unnecessary storage. Management often uses a formula to estimate how much should remain in ending inventory. Management wants to be flexible with its budgeting, wants to create budgets that can grow or shrink as needed, and needs to have inventory on hand. So the amount of ending inventory often is a percentage of the next week’s, month’s, or quarter’s sales.

    In creating the production budget, a major issue is how much inventory should be on hand. Having inventory on hand helps the company avoid losing a customer because the product isn’t available. However, there are storage costs associated with holding inventory as well as having a lag time between paying to manufacture a product and receiving cash from selling that product. Management must balance the two issues and determine the amount of inventory that should be available.

    When determining the number of units needed to be produced, start with the estimated sales plus the desired ending inventory to derive the maximum number of units that must be available during the period. Since the number of units in beginning inventory are already produced, subtracting the beginning inventory from the goods available results in the number of units that need to be produced.

    After management has estimated how many units will sell and how many units need to be in ending inventory, it develops the production budget to compute the number of units that need to be produced during each quarter. The formula is the reverse of the formula for the cost of goods sold.

    The number of units expected to be sold plus the desired ending inventory equals the number of units that are available. When the beginning inventory is subtracted from the number of units available, management knows how many units must be produced during that quarter to meet sales.

    Source : opentextbc.ca

    ACCT 3220

    Study with Quizlet and memorize flashcards terms like What are the four elements of the budgeting​ cycle?, What is the definition of a master​ budget?, ​"Strategy, plans, and budgets are unrelated to one​ another." Do you​ agree? Why? and more.

    ACCT 3220 - Cost Accounting Chapter 6 Theory Practice

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    What are the four elements of the budgeting​ cycle?

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    1. Planning the performance of the company as a whole and of its subunits

    2. Providing subordinate managers with a frame of reference

    3. Investigation into variations from the plan

    4. Use of​ feedback, new conditions and experience to develop a plan for the next period

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    What is the definition of a master​ budget?

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    A master budget is a budget that expresses​ management's operating and financial plans for a specified period and includes a set of budgeted financial statements.

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    Terms in this set (13)

    What are the four elements of the budgeting​ cycle?

    1. Planning the performance of the company as a whole and of its subunits

    2. Providing subordinate managers with a frame of reference

    3. Investigation into variations from the plan

    4. Use of​ feedback, new conditions and experience to develop a plan for the next period

    What is the definition of a master​ budget?

    A master budget is a budget that expresses​ management's operating and financial plans for a specified period and includes a set of budgeted financial statements.

    ​"Strategy, plans, and budgets are unrelated to one​ another." Do you​ agree? Why?

    Strategy, plans, and budgets are interrelated and affect one another. Strategic analysis underlies both​ long-run and​ short-run planning. In​ turn, these plans lead to the formulation of budgets. Budgets provide feedback to managers about the likely effects of their strategic plans. Managers use this feedback to revise their strategic plans.

    ​"Budgeted performance is a better criterion than past performance for judging​ managers." Do you​ agree? Why?

    Agree—because inefficiencies included in past results can be detected and eliminated in budgeting.​ Also, future conditions may be expected to differ from the​ past, and these can also be factored into budgets.

    ​"Production managers and marketing managers are like oil and water. They just​ don't mix." How can a budget assist in reducing battles between these two​ areas?

    Budgets can assist in reducing conflicts between these two functions by using good communication. The marketing department could share information about seasonal demand with the production department.

    ​"Budgets meet the​ cost-benefit test. They force managers to act​ differently." Do you​ agree? Explain.

    ​Yes, because research shows that budgets can motivate managers to meet targets and improve their performance. Without​ budgets, managers are more apt to drift from crisis to crisis.

    Choose the definition and example for a rolling budget.

    A rolling budget is a budget or plan that is always available for a specified future​ period, by continually adding a period​ (month, quarter, or​ year) to the period that just ended. A​ four-quarter rolling budget for 2007 is superseded by a​ four-quarter rolling budget for April 2007 to March​ 2008, and so on.

    Select the steps in preparing an operating budget in the proper order.

    1. Prepare the revenues budget

    2. Prepare the production budget (in units)

    3. Prepare the direct material usage budget and direct material purchases budget

    4. Prepare the direct manufacturing labor budget

    5. Prepare the manufacturing overhead budget

    6. Prepare the ending inventories budget

    7. Prepare the cost of goods sold budget

    8. Prepare the nonmanufacturing costs budget

    9. Prepare the budgeted income statement

    ​"The sales forecast is the cornerstone for​ budgeting." Why?

    Because production and inventory levels generally depend on the forecasted level of sales.

    Choose the definition for kaizen budgeting.

    Explicitly incorporates continuous improvement anticipated during the budget period into the budget numbers.

    Choose the description that tells how​ nonoutput-based cost drivers can be incorporated into budgeting.

    ​Activity-based budgeting​ (ABB) focuses on the budgeted cost of activities necessary to produce and sell products and services.​ Nonoutput-based cost​ drivers, such as the number of part​ numbers, number of​ batches, and number of new products can be used with ABB.

    Choose the explanation that tells how the choice of the type of responsibility center​ (cost, revenue,​ profit, or​ investment) affects behavior.

    The type of responsibility center determines what the manager is accountable for and thereby affects the​ manager's behavior. The choice of a responsibility center type guides the variables to be included in the budgeting exercise.

    ​"Cash budgets must be prepared before the operating income​ budget." Do you​ agree? Why?

    No. Cash budgets and operating income budgets must be prepared simultaneously. In preparing their operating income​ budgets, companies want to avoid unnecessary idle cash and unexpected cash deficiencies. The cash budget allows the accountant to plan cost effective ways to achieve the​ company's operating income goals.

    Source : quizlet.com

    The steps in preparing a budget — AccountingTools

    The process of preparing a budget should be highly regimented and follow a set schedule, so that the completed budget is ready for use by the beginning of the next fiscal year.

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    AccountingTools The steps in preparing a budget

    September 30, 2021

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    Budgeting Capital Budgeting

    Many organizations prepare budgets that they use as a method of comparison when evaluating their actual results over the next year. The process of preparing a budget should be highly regimented and follow a set schedule, so that the completed budget is ready for use by the beginning of the next fiscal year. Here are the basic steps to follow when preparing a budget:

    Step 1. Update Budget Assumptions

    Review the assumptions about the company's business environment that were used as the basis for the last budget, and update as necessary.

    Step 2. Review Bottlenecks

    Determine the capacity level of the primary bottleneck that is constraining the company from generating further sales, and define how this will impact any additional company revenue growth.

    Step 3. Available Funding

    Determine the most likely amount of funding that will be available during the budget period, which may limit growth plans.

    Step 4. Step Costing Points

    Determine whether any step costs will be incurred during the likely range of business activity in the upcoming budget period, and define the amount of these costs and at what activity levels they will be incurred.

    Step 5. Create Budget Package

    Copy forward the basic budgeting instructions from the instruction packet used in the preceding year. Update it by including the year-to-date actual expenses incurred in the current year, and also annualize this information for the full current year. Add a commentary to the packet, stating step costing information, bottlenecks, and expected funding limitations for the upcoming budget year.

    Step 6. Issue Budget Package

    Issue the budget package personally, where possible, and answer any questions from recipients. Also state the due date for the first draft of the budget package.

    Step 7. Obtain Revenue Forecast

    Obtain the revenue forecast from the sales manager, validate it with the CEO, and then distribute it to the other department managers. They use the revenue information as the basis for developing their own budgets.

    Step 8. Obtain Department Budgets

    Obtain the budgets from all departments, check for errors, and compare to the bottleneck, funding, and step costing constraints. Adjust the budgets as necessary.

    Step 9. Obtain Capital Budget Requests

    Validate all capital budget requests and forward them to the senior management team with comments and recommendations.

    Step 10. Update the Budget Model

    Input all budget information into the master budget model.

    Step 11. Review the Budget

    Meet with the senior management team to review the budget. Highlight possible constraint issues, and any limitations caused by funding problems. Note all comments made by the management team, and forward this information back to the budget originators, with requests to modify their budgets.

    Step 12. Process Budget Iterations

    Track outstanding budget change requests, and update the budget model with new iterations as they arrive.

    Step 13. Issue the Budget

    Create a bound version of the budget and distribute it to all authorized recipients.

    Step 14. Load the Budget

    Load the budget information into the financial software, so that you can generate budget versus actual reports.

    The number of steps noted here may be excessive for a smaller business, where perhaps just one person is involved in the process. If so, the number of steps can be greatly compressed, to the point where a preliminary budget can possibly be prepared in a day or two.

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