Accounting, Financial, Taxation

To you, who responsible for budgeting, “annual budget” process is one of your most important agenda in November. As a controller, budgeting is one of my main responsibilities. If you are somewhat new about budgeting while company put such big trust and assign you to conduct budgeting process (which is great!), budgeting manual procedure I am going to post may helps. Creating the annual budget, loading budget into financials, creating budget variance report and conduct quarterly budget review will be presented in a clear step—by—step procedure sets that you can follow.

Creating the Annual Budget

Annual Budget procedure is used by the controller to guide the process of updating the annual budget.

Step-1: Update Budget Assumptions

1. Review the assumptions listed on the assumptions page of the budget with senior management, and revise as necessary.
2. Define the capacity levels of all bottleneck operations in the company, as well as the maximum capacity of key production lines and facilities. If capacity levels are expected
   to be significantly altered due to known downtime during the budget period, note the estimated downtime in the assumptions section of the budget.
3. Verify that the criteria used for ranking capital budget proposals remain the same, and adjust as necessary. This should include an adjustment of the corporate and incremental cost of capital to reflect current funding conditions.
4. Discuss with the CFO the maximum amount of funding that is likely to be available for both working capital and capital budgeting purposes during the budget period, and enter these amounts in the assumptions section of the budget.
5. Review with senior management the step costing points at which significant new investments must be made in the company’s capacity structure in all departmental areas.
   Note in the assumptions section the capacity levels at which these step costs will be triggered (e.g., reaching 85% production capacity on the ABC production line will require an additional $2.8 million for a supplemental production line).

Step-2: Updating Expenses

As of mid-November, issue to each department of listing of its expenses that are annualized based on actual expenses through October of the current year. The listing should include the personnel in each department and their current pay levels. Request a return date of 10 days in the future for this information, which should include estimated changes in expenses.

Step-3: Update Revenue

As of mid-November, issue to the sales manager a listing of revenue by month by business unit, through October of the current year. Request a return date of 10 days in the future for this information, which should include estimated changes in revenues.

Step-4: Update Capital Expenditures

As of mid-November, issue a form to all department heads, requesting information about the cost and timing of capital expenditures for the upcoming year. Request a return date of 10 days in the future for this information.

Step-5: Update Automation

As of mid-November, issue a form to the manager of automation, requesting estimates of the timing and size of reductions in headcount in the upcoming year that are due to automation efforts. Request a return date of 10 days in the future for this information. Be sure to compare scheduled headcount reductions to the timing of capital expenditures, as they should track closely.

Step-6: Update the Budget Model

This task should be completed by the end of November.

1. Update the numbers already listed in the budget with information as it is received from the various managers. This may involve changing “hard-coded” dollar amounts or flex budget percentages. Be sure to keep a checklist of who has returned information so you can follow up with those who have not.
2. Update the “Last Year” cells on the right side of the budget model, using annualized figures.
3. Verify that the indirect overhead allocation percentages shown on the budgeted factory overhead page are accurate.
4. Verify that all employee related tax, medical, and workers’ compensation amounts listed at the top of the staffing budget page are still accurate.
5. Add job titles and staffing levels to the staffing page as needed, along with new average pay rates based on projected pay levels made by department managers.
6. Run a depreciation report for the upcoming year, add the expected depreciation for new capital expenditures, and add this amount to the budget.
7. Revise the loan detail budget based on projected borrowings through the end of the year.
8. Verify that the groups of staff positions used to summarize payroll expenses continue to reflect the pay structure of the company. If not, create new groupings or alter existing ones to more accurately summarize payroll expenses.
9. Review the summarized budget model with attached dashboard that is used by senior management. Adjust the model as necessary to reflect the needs of the senior management team.
10. Meet with the human resources (HR) manager to determine how the budget model is to be incorporated into the company’s system of performance measurements and rewards, and determine what data feeds are needed from the budget model by the HR manager to accomplish this.
11. Review the general ledger accounts referenced in the budget. Eliminate any accounts for which the budgeted amounts are likely to be excessively small, merge related accounts together, add accounts for new operations, and delete accounts for operations that have been eliminated.
12. Conduct a general review of the budget model to see if it can be simplified in any way, both in terms of a reduction in the information presented and the complexity of the underlying model.

Step-7: Review the Budget

Print out the budget and circle any budgeted expenses or revenues that are significantly different from the annualized amounts for the current year. Go over the questionable items with the managers who are responsible for those items.

Step-8: Revise the Budget

Revise the budget, print it again, and review it with senior management. Incorporate any additional changes.

Step-9: Issue the Budget

Bind the budget and issue it to the management team.

Loading Budget into Financial Statement Database

This procedure is used by the controller to enter all data from the budget model into the financial statement database in the computer system. There are several steps to follow:

Step-1: Locate Budget Model

1. Call up the completed budget model.
2. Print the budget.
3. Verify that there is a valid account number for every budget line item in the budget model.
4. Highlight the budget numbers that must be input into the financial statement database.

Step-2: Access Computer Input Screen

1. Call up the accounting software package, and access the BUDGET menu. Then access the INPUT BUDGET screen from that menu.
2. Enter the appropriate budget year to be entered, as well as the budget version.

Step-3: Enter Budget Information

1. Enter the account number for each budget line item.
2. Enter the budget in each month on the screen for that account number.
3. Verify that the months entered and the amounts are correct, and then press ENTER.
4. Repeat for all account numbers.

Step-4: Verify Entered Information

1. Go to the BUDGET menu and access the REPORTS screen.
2. Select the BUDGET report and enter the correct budget year and version. Print the report.
3. Compare the entered amounts to the amounts listed on the budget model. Go back to step 3 to correct any incorrectly entered budget numbers.

Creating Budget Variance Report

This procedure is used by the financial analyst to calculate and report on the extent of actual financial results from budgeted expectations.

Step-1: Locate Budget Variance Spreadsheet

Call up the budget variance spreadsheet.

Step-2: Enter New Year Budget

1. Enter all expense line items from the budget model into the variance model.
2. Verify that the same managers listed in the variance report from last year are still responsible for expense line items this year.
3. Send the preliminary variance report to the controller to verify the accuracy of the format and numbers.

Step-3: Enter Year-to-Date Actual Amounts

1. Enter both year-to-date and last month actual expenses in the report.
2. Verify that the expense totals match the numbers in the financial statements.
3. Sort the report by responsible manager and subdivide the report so that each manager only receives the listing of accounts for which they are responsible.

Step-4: Issue Variance Report

1. Schedule meetings with all department managers who are receiving the report.
2. Go over all negative variance items, and record their responses regarding actions to take to correct problems.
3. Include manager comments in the final variance report, and issue it to senior management.

Conducting Quarterly Budget Review

This procedure is used by the controller to review with other department managers the comparison of actual to budgeted financial results for their departments for the last quarter.

Step-1: Prepare Quarterly Budget Report

1. Extract the most recent budget variance report.
2. Print copies of the report and issue it to those managers who are listed as being responsible for expense line items.

Step-2: Conduct Manager Interviews

1. Meet with managers to verify their intentions regarding currently negative variances.
2. Record these comments on the report.
3. Supply managers with any additional requested information, such as added detail regarding expenses, or copies of actual supplier invoices.

Step-3: Report Results to General Manager

1. Highlight all negative variances on the budget report, and sort it by the names of responsible managers.
2. Issue the completed budget variance report to the general manager.

The budget of finished goods inventory (or merchandise in the case of trading concerns) must be based on the sales budget. If, for example, it is expected that 500 units of item A will be sold during the budget period, it must be ascertained what number of units must be kept in stock to support such a sales program. It is seldom possible to predetermine the exact quantity that will be demanded by customers day by day. Some margin of safety must be maintained by means of the finished goods inventory so that satisfactory deliveries can be made. With this margin established, it is possible to develop a program of production or purchases whereby the stock will be replenished as needed.

Budgeting Finished Goods by Individual Items

Two general methods may be employed in budgeting the finished goods inventory:

Method-1: A budget is established for each item separately.

This is done by studying the past sales record and the sales program of each item and determining the quantity that should be on hand at various dates (usually, the close of each month) throughout the budget period. The detailed production or purchasing plan can then be developed to provide such quantities over and above current sales requirements. The total budget is merely the sum of the budgets of individual items. This total budget can then be tested by the rate of turnover desired as proof that a satisfactory relationship will be maintained between inventory and sales and that it harmonizes with the general finance plan. If it fails in either respect, revision must be made in the plans of sales, production, or finance until a proper coordination is effected.

Under this plan, control over the inventory is effected by means of enforcement of the sales and production plans. If either varies to any important degree from the budget, the other must be revised to a compensating degree and the inventory budget revised accordingly.

Method-2: Sales and Production Plans can be enforced with reasonable certainty.

Where the sales and production plans can be enforced with reasonable certainty, this is the preferable method. It is particularly suitable for those concerns that manufacture a comparatively small number of items in large quantities. The application is similar in principle to that illustrated in connection with raw materials controlled budget-wise by minimums and maximums.

Budgeting Total Finished Quantities and Values

Where the sales of individual items fluctuate considerably and where such fluctuations must be watched for hundreds or even thousands of items, a second plan is preferable.

Here basic policies are adopted relative to the relationship that must be maintained between finished goods and sales. This may be done by establishing standard rates of turnover for the inventory as a whole or for different sections of the inventory. For example: it may be decided that a unit turnover rate of three times per year should be maintained for a certain class of goods or that the dollar inventory or another class must not average more than one-fourth of the annual dollar cost of sales. The budget is then based on such relationships, and the proper executives are charged with the responsibility of controlling the quantities of individual items in such a manner that the resulting total inventories will conform to the basic standards of inventory.

With such standard turnover rates as basic guides, those in charge of inventory control must then examine each item in the inventory; collect information about its past rate of movement, irregularity of demand, expected future demand, and economical production quantity; and establish maximum and minimum quantities, and quantities to order. Once the governing quantities are established, they must be closely watched and frequently revised if the inventory is to be properly controlled.

The establishment and use of maximum, minimum, and order quantities can never be resolved into a purely clerical routine if it is to be effective as an inventory control device. A certain element of executive judgment is necessary in the application of the plan. If, for example, the quantities are based on past sales, they must be revised as the current sales trend indicates a change in sales demand. Moreover, allowance must be made for seasonal demands. This is sometimes accomplished by setting different limits for different seasons.

The most frequent cause of the failure of such inventory control plans is the assignment of unqualified personnel to the task of operating the plan and the failure to maintain a continuous review of sales experience relative to individual items. The tendency in far too many cases is to resolve the matter into a purely clerical routine and assign it to clerks who are capable only of routine execution. The danger is particularly great in companies carrying thousands of items in finished stock, with the result that many quantities are excessive, and many obsolete and slow-moving items accumulate in stock. The successful execution of an inventory control plan requires continuous study and research, meticulous records of individual items and their movement, and a considerable amount of individual judgment.

The plan, once in operation, should be continually tested by comparing the actual rates of turnover with those prescribed by the general budget program. If this test is applied to individual sections of the finished inventory, it will reveal the particular divisions that fail to meet the prescribed rates of movement. The work of correction can then be localized to these divisions.

Whenever possible, the plan of finished inventory control should be exercised in terms of units. When this is not practicable, it may be based on dollar amounts.

In the context of preparing the annual business plan in monetary terms, and based on the quantities of finished goods (furnished by the cognizant executive) deemed necessary for an adequate inventory, the inventory accountant can develop the budget for the finished goods inventory, much as is shown in condensed form as below:

When the total of the inventory segments is known, the total inventory budget for the company can be summarized as in shown below:

Such a summary can be useful in discussing inventory levels with management. Any pertinent ratios can be included.

Again, in testing the reasonableness of the annual business plan, the inventory—by segments, or perhaps in total—should be tested by turnover rate or another device suggested for control (or planning) purposes.

On the previous post we have discussed Budgeting for Raw Materials Inventory, now let’s go on for Work-In-Process (WIP) Inventory. The inventory of goods actually in process of production between stocking points can be best estimated by applying standard turnover rates to budgeted production. This may be expressed either in units of production or dollars and may be calculated for individual processes and departments or for the factory as a whole. The former is more accurate. To illustrate this procedure, assume the following inventory and production data for a particular process or department:

Process inventory estimated for January = 1 500 units (a)
Production budgeted for month of January = 1,200 units (b)
Standard rate of turnover (per month) = 4 times (c)
Average value per unit of goods in this process = $10

With a standard turnover rate of four times per month: the average inventory should be 300 units (1,200 ( 4). To produce an average inventory of 300 units, the ending inventory should be 100 units:

500 + 100
———–— = 300
2

Using the symbol X to denote the quantity to be budgeted as ending inventory, the following formula can be applied:

           2b                2(1200)
X = (–) –––—– x a = —————- (–) 500 = 100 units
           c                  4

Value of ending inventory is $1,000 (100 × $10)

Where the formula produces a minus quantity (as it will if beginning inventory is excessive), the case should be studied as an individual problem, and a specific estimate should be made for the process or department in question.

Control over the work-in-process inventories can be exercised by a continuous check of turnover rates. Where the individual processes, departments, or plants are revealed to be excessive, they should then be subjected to individual investigation.

The control of work-in-process inventories has been sorely neglected in many concerns. The time between which material enters the factory and emerges as the finished product is often much longer than necessary for efficient production. An extensive study of the automobile tire industry revealed an amazing spread of time among five leading manufacturers, one company having an inventory float six times that of another. This study also indicated, by an analysis of the causes of the float time that substantial reductions could be made in all five of the companies without interfering with production efficiency. Thus, budgeting for work-in-process inventory is an excellent area in which to incorporate an active program of inventory reduction activities, usually through a program of incorporating just-in-time concepts into the production process.

Although it is desirable to reduce the investment in goods actually being processed to a minimum consistent with efficient production, it is often desirable to maintain substantial inventories of parts and partially finished goods as a means of reducing finished inventories.

Parts, partial assemblies, processed stock, or any type of work-in-process that is stocked at certain points should be budgeted and controlled in the same manner as materials. That is, inventory quantities should be set for each individual item, based on the production plan; or inventory limits should be set that will conform to standard rates of turnover. In the former case, control must be exercised through the enforcement of the production plan; in the latter case, maximum and minimum quantities must be established and enforced for each individual item.

With the planned cost input to work-in-process known from the materials usage budget, the direct labor budget, and the manufacturing expense budget, and the quantities of planned completed goods furnished by manufacturing, the inventory accountant may develop the planned work-in-process time-phased (condensed) budge. The reasonableness of the budgeted inventory level should be tested by comparing it to historical inventory turnover levels.