INFO 7225

MODULE 2
Managerial Accounting
Topics 7, 8, and 9
Professor Shiaoming Shi
College of Engineering
Northeastern University
7. Budgeting

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LEARNING OBJECTIVES
After completing this session, you should be able to
• Describe how and why managers prepare and use budgets;
• Understand the basic process companies use to create budgets and the
general composition of basic budgets that are summed up in a master
budget;
• Prepare operating budgets;
• Prepare financial budgets;
• Develop a standard cost;
• Compute and evaluate materials variances.

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Reading Assignments
Read chapter 7, sections 1, 2, and 5
Think about the following questions as you read chapter 7:
➢ What are the advantages to budgeting?
➢ What are the differences between top-down and bottom-up approach to
budgeting?
➢ What are the differences between traditional budgeting process and zero-based
budgeting process?
➢ What are the differences between a static budget and a flexible budget?
➢ How are operating budgets and financial budgets related within a master budget?

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INTRODUCTION
• The master budget has two major categories:
1) The operating budget assists in planning and monitoring the
day-to-day activities of the organization by informing
management of
✓ How many units need to be produced
✓ When and how much material needs to be ordered
✓ How many labor hours need to be scheduled, and
✓ The amount of overhead expected to be incurred
2) The financial budget assists with planning and monitoring the
financing requirements of the organization

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INTRODUCTION
• The operating budget helps plan future revenue and
expenses and results in a projected _______________.
- The operating budget has several subsidiary budgets that all
begin with _______________.
• The financial budget plans the use of assets and liabilities
and results in a projected _______________.

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Operating Budgets, Financial Budgets, and the Relationship between Budgets

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Prepare Operating Budgets
(Pound)
Manufacturing Overhead

• Costs that support production but are not direct materials or direct labor are
considered overhead.
• Manufacturing overhead has three components:
1) Indirect materials (materials used in production but not traced to specific
products because the net informational value from the time and effort to trace the
cost to each individual product produced is impossible or inefficient)
2) Indirect labor (labor costs of those employees associated with the
manufacturing process, but whose contributions are not directly traceable to the
final product), and
3) Overhead (costs that are necessary for production but not efficient to assign to
individual product production. Examples of typical overhead costs are production
facility electricity, warehouse rent, and depreciation of equipment.)
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Prepare Operating Budgets:
Manufacturing overhead Budget
For Big Bad Bikes to create their MOH budget,
they first determine that the appropriate
driver for assigning overhead costs to
products is direct labor hours (DLH). The
overhead allocation rates for the variable
overhead costs are:
• Indirect material of $1.00 per
DLH
• Indirect labor of $1.25 per DLH
• Maintenance of $0.25 per DLH,
and
• Utilities of $0.50 per DLH

The fixed overhead costs per

quarter are:
• Supervisor salaries of $15,000
• Fixed maintenance salaries of
$4,000
• Insurance of $7,000, and
• Depreciation expenses of
$3,000.
Prepare Budgeted Income Statement

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Total MFG OH cost = $131,863

# units produced = 7,050
MFG OH per unit = $18.70
# of units sold = 6,000
MFG OH = $112,224 (expensed
as part of COGS)
# of units unsold (remaining in EI) = 6,000
MFG OH for EI = $112_____________,224 20
Prepare Financial Budgets

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Relationship between Budgets
Review/Summary
Prepare Operating Budgets Prepare Financial Budgets
• The _____ budget is the first budget developed, • The financial budget include the ____________
and the estimated sales in turn guide the budget and the _____ budget.
___________ budget. • The cash ________ schedule and cash _______
• The production budget shows the quantity of schedule are computed and combined with
goods produced for each time period and leads other budgets to develop the cash budget.
to computing when and how much _______ • Information from financial budgets and the
___________ needs to be ordered, when and budgeted income statement are used to develop
how much ______ needs to be scheduled, and the budgeted _____________.
when and how much manufacturing overhead
needs to be planned.
Budgets Are Used to Evaluate Goals
• The sales and administrative budget plans for
the _________________ expenses. • Management’s evaluations of ________ results
versus the estimated __________results help
• All operating budgets combine to develop the assess performance and plan for the future.
budgeted ___________ statement.

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8. Standard Costs and Variance
Analysis

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Reading Assignments
Read chapter 8, sections 1, 2 and 5
Think about the following questions as you read chapter 8:
➢ What two components are needed to determine a standard for materials?
➢ What two components are needed to determine a standard for labor?
➢ What elements require consideration before establishing an overhead standard?
➢ What causes a favorable variance and an unfavorable variance?
➢ When might a favorable variance not be a good outcome?
➢ When might an unfavorable variance be a good outcome?

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What is the difference between a budget and a standard?
A budget usually refers to a company’s _____________ for costs, revenues, and
cash flows associated with the overall operations of the organization, or a
subsection of the corporation such as a division.
A standard usually refers to a company’s projected costs for ____________ of a
product or service and includes the expected (or standard) cost for the various
cost components of each unit, such as materials, labor, and overhead.
Standard costs provide information that is useful in _______________________.
Standard costs are compared to actual costs, and ___________ between the two
are termed variances. Favorable variances result when actual costs are _______
than standard costs, and vice versa.
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 Favorable and Unfavorable Variances

Actual Standard Standard

Actual Cost
Cost Cost Cost
(AQ X AP)
(AQ X AP) (SQ X SP) (SQ X SP)

• AQ, “actual quantity” of input used to produce the output

• AP, “actual price” of the input used to produce the output
• SQ and SP refer to the “standard” quantity and price
Example 1. Developing a Standard Cost Card
Use the information provided to create a standard cost card for production of one deluxe bicycle from Bicycles Unlimited.
To make one bicycle it takes four pounds of material. The material can usually be purchased for $5.25 per pound. The
labor necessary to build a bicycle consists of two types. The first type of labor is assembly, which takes 2.75 hours. These
workers are paid $11.00 per hour. The second type of labor is finishing, which takes 4 hours. These workers are paid
$15.00 per hour. Overhead is applied using labor hours. The variable overhead rate is $5.00 per labor hour. The fixed
overhead rate is $3.00 per hour.
STANDARD COST CARD
Product:
Manufacturing Information Standard Quantity Standard Price Cost Summary
Direct Materials (per unit)

Direct Labor (per unit)

Manufacturing Overhead
Variable Overhead
Fixed Overhead

Standard Cost per Bicycle

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Variance Analysis
Direct Materials Variances
Total Variance =

Direct Labor Variances

Total Variance =
Example 2. Compute Materials Variances
Biglow Company makes a hair shampoo called Sweet and Fresh. Each bottle has a standard
material cost of 8 ounces at $0.85 per ounce. During May, Biglow manufactured 11,000 bottles.
They bought 89,000 ounces of material at a cost of $74,760. All 89,000 ounces were used to
make the 11,000 bottles. Calculate the total variance, material price variance, and the material
quantity variance.

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Example 3a.
Actual Material Cost

Actual quantity of input 4,100

Actual price per unit of input x $90
Actual cost of direct materials $369,000
Example 3b.
Actual Labor Cost

Actual hours of labor 12,500

Actual rate per hour x $14
Actual cost of direct labor $175,000
Factory (Manufacturing) Overhead Variances

• Overhead has both variable and fixed components (unlike direct labor
and direct material that are exclusively variable in nature).
➢ The variable components may consist of items like indirect material, indirect
labor, and factory supplies.
➢ Fixed factory overhead might include rent, depreciation, insurance, maintenance,
and so forth.
• Because variable and fixed costs behave in a completely different
manner, it stands to reason that proper evaluation of variances between
expected and actual overhead costs must take into account the intrinsic
cost behavior.
• As a result, variance analysis for overhead is split between variances
related to variable overhead and variances related to fixed overhead.
 Compute Total Variable Overhead (VOH) Cost Variance

Budgeted data: Actual output information:

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 Compute Total Variable Overhead (VOH) Cost Variance

Budgeted data: Actual output information:

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Summary/Review
Standard Costs and Variances Direct Labor Variances
• Standards are budgeted unit amounts for ______ • Two components: direct labor ______ variance and
paid and _________ used. direct labor _________________________ variance.
• Variances are the difference between _________ ➢ Actual rate paid vs. standard rate
and _________ amounts. ➢ Actual hours vs. standard/budgeted hours
• Variance can be favorable or unfavorable.
Factory VOH Variances
Direct Materials Variances • The variable overhead rate variance is the
difference between the actual variable
• Two components: direct materials _________
manufacturing overhead and the variable
variance and direct materials _________ variance.
overhead that was expected given the number of
• The direct materials price variance is caused by hours worked.
_________ too much or too little for material.
• The variable overhead efficiency variance is
• The direct materials quantity variance is caused driven by the difference between the actual hours
by _________ too much or too little material.
worked and the standard hours expected for the
units produced.
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9. Capital Budgeting Decisions

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OUTLINE
• Payback period
- Simple payback period
- Time value of money
- Discounted payback period
• Discounted cash flow models
- Capital recovery cost
- Net present value (NPV)
- Internal rate of return (IRR)
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 EXAMPLE 1 (Chapter 11, Problem Set A, Problem 2)
Jasmine Manufacturing is considering a project that will require an initial
investment of $52,000 and is expected to generate future cash flows of $10,000
for years 1 through 3, $8,000 for years 4 and 5, and $2,000 for years 6 through
10. What is the payback period for this project?

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Time Value of Money
Present Value and Future Value
Capital Recovery Cost
Net Present Value (NPV)
Internal Rate of Return (IRR)
 EXAMPLE 2 (Chapter 11, Problem Set A, Problem 9)

Pitt Company is considering two alternative investments. The company requires a

12% return from its investments. Neither option has a salvage value.
Compute the (NPV and) IRR for both projects and recommend one of them.
 Internal Rate of Return (IRR)
EOY Project X CF Project Y CF

0 -$180,000 -$118,000

1 82,000 35,000

2 59,000 55,000

3 92,000 72,000

4 81,000 68,000

5 76,000 27,000
SUMMARY
Use Discounted Cash Flow Models to Make Capital Investment Decisions:
• A dollar is worth more today than it will be in the future. This is due to
______________________.
• For a capital asset investment to be economically justified, its net revenue
(or cost savings) must exceed its ________________________.
• The discounted cash flow model assigns values to a project’s alternatives.
Two measurement tools are used in discounted cash flows: ___________.
• NPV considers ______________, converts future cash flows into ___, and
compares that to the _______________. If _________, the company would
look to invest in the project.
• IRR shows the profitability of an investment, where ____ equals zero. If
__________________________, the company would invest in the project.
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Thank you!
Questions?

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