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33 Cards in this Set
- Front
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Purposes of a Budget (forced planning) |
1. Planning Tool: forces management to evaluate assumptions used & objectives identified.
2. Control Tool: sets guidelines for costs & provides framework for performance evaluations
3. Motivational Tool: employees are motivated if help prepare
4. Means of Communication & Coordination: states entity's objectives in numerical terms. Requires segments to cooperate |
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Master Budget (also called Comprehensive Budget or Annual Profit Plan) |
Consists of org's operating & financial plans for a specified period (year or operating cycle). Consists of:
1. Operating Budget: emphasis on obtaining & using current resources. It contains the following budgets: sales, production, DM, DL, MOH, CGS, Non-MFG (R&D, S&A), and Pro-forms Income Statement.
2. Financial Budget: emphasis on obtaining the funds needed to purchase operating assets. It includes the following budgets: *Capital budget (completed befitting operating is begun); *Cash budget (projected cash payment/collection schedule); *Proforma statement of financial position; *Proforma statement of cash flows |
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Sales (Revenue)Budget |
Starting point for the cycle that produces the annual profit plan (master budget).
*Based on sales forecast, which reflects trends, economic & industry conditions, market research, competitors' activities, & credit/pricing policies.
*Must specify both projected unit sales and dollar revenues |
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Production Budget |
Follows directly from the sales budget and is concerned with units only.
*Product pricing is ignored bc the purpose is only to plan output & inventory levels and the necessary mfg activity.
*Levels of production limited to sales budget to minimize carrying costs and obsolescence. |
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Purchases Budget |
Prepared after projected sales are estimated: *Monthly / weekly basis *Plan purchases, avoid stockouts *Inventory should be at level to avoid unnecessary carrying costs *Similar to production budget; however, units are purchased rather than produced |
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Manufacturing budgets |
1. Direct Materials Budget: concerned w units & input prices
2. Direct Labor Budget: depends on wage rates, amounts & types of production, #'s & skill levels of employees to be hired
3. MFG Overhead Budget: reflects nature of OH as mixed cost (variable & fixed component)
4. CGS Budget: combines the projections for the 3 major inputs (materials, labor, OH); result directly affects pro forms income statement. |
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Non-Manufacturing Budget |
Consists of individual budgets for R&D, design, marketing, distribution, customer service, and admin costs; development of all these budgets reflects value chain approach.
*The variable & fixed portions of selling & admin costs must be treated separately. |
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Non-Manufacturing Budget |
Consists of individual budgets for R&D, design, marketing, distribution, customer service, and admin costs; development of all these budgets reflects value chain approach.
*The variable & fixed portions of selling & admin costs must be treated separately. |
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Pro-forma Income Statement |
Used to decide whether the budgeted activities will result in an acceptable level of income. If the initial projection is a loss or unacceptable, adjustments can be made to components of master budget.
End of budgeting process; financial statements are pro-forms if they reflect projected rather than actual results. |
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Project Budgets |
Consist of all costs attached to a particular project; significant enough to be tracked separately
*Resources used must align with master budget |
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Activity Based Budgeting (ABB) |
Applies ABB cost principles to budgeting; focuses on the numerous activities necessary to produce & market goods and services; requires cost driver analysis. *Budget line items are related to activities performed; *ABB contrasts with traditional on functions/spending categories; non value added activities are quantified.
ABB provides greater detail regarding indirect costs bc it permits isolation of numerous cost drivers: 1. Cost pool established for each activity & cost driver identifies for each pool; 2. Budgeted cost for each pool is determined by: demand x estimated cost of unit of activity |
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Zero-based Budgeting |
Each manager must justify department's budget every cycle.
Every year starts at zero. All expenditures must be justified regardless of variance from previous years.
Pro: encourage periodic re-examination of all costs to possibly reduce or eliminate
Con: more time & effort |
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Continuous (Rolling) Budgeting |
Revised on a regular basis; continuously extended for additional month or quarter in accordance with new data.
Pro: requires managers to always be thinking ahead
Con: amount of time spent on budget preparation |
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Kaizen (continuous improvement) Budgeting |
Assumes continuous improvement; requires estimates of the effects or improvements & costs of their implementation.
*Not based on existing system, but on changes to be made
*Targets cannot be reached unless improvements occur |
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Static and Flexible Budgeting |
Static (master) budget: prepared before period begins & cannot be changed. Based on standard costs (per unit x price)
Flexible budget: prepared using same drivers (i.e. DL cost per hr) that were used to prepare static budget but for different levels of production |
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Variance Analysis using Flexible Budgeting |
Common use of flexible budgets is variance analysis; helps mgmt in monitoring & measuring company performance.
Variance: difference in actual results and budgeted amounts 1. Favorable: occurs when actual revenues are greater or costs lower; 2. Unfavorable when opposite |
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Cost-Volume Profit Analysis (CVP) / Breakeven Analysis |
Tool for understanding interactions of revenues with fixed & variable costs; allows mgmt to determine the probable effects of changes in sales volume, price, product mix, etc
Simplifying Assumptions: 1. Cost & revenue relationships are predictable & linear over the range of activity & timespan.
2. Unit selling prices & market conditions are constant.
3. Changes in inventory are insignificant; production = sales.
4. Total VC change proportionally with volume, but unit VC are constant over relevant range.
5. FC remain constant, but unit FC vary indirectly with volume. |
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Breakeven Point |
Level of output at which all FC & cumulative VC have been covered; output that operating income = zero; each additional unit above generates profit.
Simple Calculation: FC / unit contribution margin
Breakeven Point in Dollars: FC / contribution margin ratio
*B/E point in sales dollars also = [B/E point in units x selling price] |
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Margin of Safety |
The excess of sales over B/E sales; amount which sales can decline before losses occur.
Margin of Safety in dollars = [Total Sales $ - B/E point dollars]
Margin of Safety % = [Margin of Safety in Dollars] / [Total Sales in Dollars]
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Target Operating Income |
By treating target income as FC, CVP analysis can be applied.
Target unit volume = [FC + Target Operating Income] / Unit Contribution Margin (UCM)
Target sales in dollars = [FC + Target Operating Income] / Contribution Margin Ratio
Standard Operating Income = [Sales - VC - FC] |
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Target Net Income |
Net Income (After tax amount) = Operating income - [Operating Income x Tax Rate]
Target Unit Volume = [FC + (Target Net Income / Tax %] / Unit Contribution Margin (UCM) |
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Relevant Costs |
To be relevant, costs must be:
1. Be received or incurred in the future: sunk costs have no bearing on future decisions
2. Differ among the possible courses of action
3. Be avoidable: be saved by not taking a particular action |
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Divestment Decision |
Decision to terminate an operation, product line, business segment, branch, or major customer. If marginal cost, exceeds marginal revenue, firm should divest.
4 steps in divestment decision: 1. Identify FC that will be eliminated (i.e. Insurance);
2. Determine revenue to justify continuing operations;
3. Establish opportunity cost of funds that will be received through divestment;
4. Determine whether carrying amount of assets is equal to economic value. If not, reevaluate decision using current FMV instead of carrying amount.
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Special Orders when Excess Capacity Exists |
When a manufacturer has excess production capacity, no opportunity cost is incurred by accepting a special order.
Opportunity cost: the maximum benefit foregone by not choosing the best alternative use of scarce resources.
*Should accept if the minimum price for product = VC |
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Special Orders in Absence of Excess Capacity |
When manufacturer lacks excess production capacity, the differential (marginal/incremental) costs of accepting must be considered.
*Besides the VC of the production run, firm must consider opportunity cost of redirecting productive capacity away from other products. |
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Outsourcing Decisions |
Entity should use available resources as efficiently as possible before outsourcing.
*If not enough capacity is available, products that are produced least efficiently should be outsourced.
*Support services (legal, IT, training, accounting)
*Managers only considers costs relevant to investment decision. If total relevant costs of production are less than cost to buy the item, it should be unsourced. |
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Sell or Further Process |
In determining whether to sell a product at the split off point or process the item further at additional cost, the joint cost of the product is irrelevant bc it is a sink cost.
Sell or process further decision should be based on relationship betw incremental costs (additional processing) and the incremental revenues (benefits). |
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Responsibility Centers |
Well-designed accounting system establishes responsibility centers (SBUs); decentralize and facilitate local decision making. Purposes:
1. Encourage managerial effort to achieve org objectives;
2. Motivate managers to make decisions consistent with those objectives;
3. Provide a basis for managerial compensation
*Each center is structured under direction of 1 manager; measures are designed for every center to monitor performance.
1. Controllable factors: those factors mgr can influence in a given time period; some costs cannot be traced (admin); not synonymous with VC
2. Goal congruence: performance measures must be designed so that mgr's pursuit ties directly with org goals; sub-optimization occurs when segment pursues goals in its best interests |
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Types of Responsibility Centers |
1. Cost center (i.e. maintenance dept): responsible for costs only; cost drivers are the relevant performance measures; disadvantages include: a) potential for cost shifting b) disregard long term issues c) allocation of service dep. costs *Performance Measures (PM): VC, Total Cost, Variance Analysis
2. Revenue center (i.e. Sales dep): responsible for revenues only, which are drivers for performance measures, factors that influence unit sales *PM: Gross Sales, Net Sales
3. Profit center (appliance department): responsible for revenues & expenses *PM: Sales, Gross Margin, Operating Income
4. Investment Center (branch office): responsible for revenues, expenses, and invested capital. *PM: Return on investment, Residual Income, ROA, ROE, Economic Rate of Return, Economic Value Added |
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Common Costs |
Costs of products, activities, facilities, services, or operations shared by 2 or more cost objects.
Joint costs: common costs of single process that yields 2 or more joint products.
*Bc common costs are indirect costs, identification of a direct cause-and-effect relationship betw common cost and the actions of the cost object to which its allocated, can be difficult. - promotes acceptance by mgrs who perceive fairness of procedure |
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Transfer Pricing |
Prices charged by one segment of an organization for goods & services it provides to another segment; used by profit & investment centers
Transfer Pricing Basic Methods 1. Cost plus pricing sets price at the selling segment's full cost of production plus a reasonable markup.
2. Market pricing uses the price the selling segment could obtain on the open market.
3. Negotiated pricing gives the segments the freedom to bargain among themselves to agree on a price.
*Limitation of transfer prices based on actual cost rather than selling gives little incentive to control costs |
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Minimum Transfer Price |
Minimum price that the seller is willing to accept. Calculation:
[Incremental Cost to Date + Opportunity cost of selling internally]
*Opportunity cost varies depending on 1) the existence of an external market and 2) whether the seller has excess capacity. |
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Transfer Prices Multinational Considerations |
When segments are located in different countries, taxes and tariffs may override any other considerations when setting transfer prices.
*Additional concerns: exchange rate fluctuations, threats of expropriation, and limits on transfers of profits outside the host country |
