Chapter Summary

Chapter 22 - Summary

Companies must often tie up large sums of cash in direct materials, work in process, and finished goods inventories. As finished goods are sold, cash continues to remain tied up in accounts receivable. Thus, a company may be reporting record profits, yet still experience cash flow problems.

The benefits of budgeting are the benefits that come from thinking ahead. Budgeting helps to coordinate the activities of the different departments, provides a basis for evaluating department performance, and provides managers with responsibility for future decision making. In addition, budgeting forces management to estimate future economic conditions, including costs of materials, demand for the company's products, and interest rates.

The most widely used approach is to set budgeted amounts at levels that are reasonably achievable under normal operating conditions. The goal in this case is to make the budget a fair and reasonable basis for evaluating performance.

An alternative is to budget an ideal level of performance. Under this approach, departments normally fall somewhat short of budgeted performance, but the variations may identify areas in which improvement is possible.

A "master budget" is a group of related budgets and forecasts that together summarize all the planned activities of the business. A master budget usually includes a sales forecast, production schedule, manufacturing costs budget, operating expense budget, cash budget, capital expenditures budget, and projected financial statements. The number and type of individual budgets and schedules that make up the master budget depend on the size and nature of the business.

A logical sequence of steps in preparing a master budget is discussed on pages 937--938. The operating budget estimates are used primarily in preparing a budgeted income statement, whereas the financial estimates are used in preparing the cash budget and budgeted balance sheets.

A flexible budget shows budgeted revenue, costs, and profits for different levels of business activity. Thus a flexible budget can be used to evaluate the efficiency of departments throughout the business even if the actual level of business activity differs from management's original estimates. The amounts included in a flexible budget at any given level of activity are based on cost-volume-profit relationships.

Chapter 22 serves as something of a link between the preceding several chapters and the next two chapters. The preparation of a master budget closely relates to the use of standard costs, covered in the next chapter, and draws heavily on concepts regarding cost flows, product costing, cost-volume-profit analysis, and responsibility accounting. In our next and final chapters, we will see how managers select and utilize budget information for controlling operations and when making decisions pertaining to investments in long-term assets.