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6.7. Preparing operational budget (2)

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Core Concepts of Accounting – Numbers and People

Moscow Institute of Physics and Technology

4.9 (15 ratings) | 1.3K Students Enrolled

Course 3 of 5 in the Understanding Modern Finance Specialization

Whenever the word “accounting” is pronounced, it is immediately associated with the need to memorize endless boring numbers. However, it is the common financial statements that contain important information that provides inputs for valuation of investment projects. The only challenge is how to properly extract them. Accounting and finance are indeed intertwined. Sometimes people that are not experienced in the area even mix them up. But most often emphasis in accounting is on numbers. Still, the deep understanding of key accounting concepts helps reveal the interests and actions of people behind these numbers. And the human dimension of accounting adds invaluable insight in the potential of successful project implementation. This Course discusses core ideas and concepts of both financial and managerial accounting. It by no means pretends to be comprehensive to any extent. But, being rather an accounting overview, it focuses on the issues that are most relevant and important for effective valuation of investment projects. The learners will gain insight into the essence of accounting. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. To pursue a career in accounting, a more detailed study is strongly recommended.

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From the lesson

Budgets and Responsibility Accounting. Accounting and Valuation – Final Conclusions

Week 6, the final week of the Course, is devoted to the discussion of budgets and responsibility accounting as powerful tools of improving efficiency and quality of managerial decision making. A comprehensive example of preparing the operational budget will help reveal the interdependence of different areas of management in the budgeting process. We will also discuss responsibility accounting in some more detail to follow relationships between decision makers, processes, and results – or, as we call it, numbers and people. We will comment on some major trends in approaching budgeting in the fast changing, uncertain, and complex world. Finally, we summarize the contribution of accounting to the valuation of investment projects. As a result, you will be able to successfully apply the obtained knowledge and skills well beyond accounting, but in any financial and managerial area.

6.1. Budgets – an overview. The budgeting cycle11:23

6.2. Budgets, planning and project management13:20

6.3. The master budget – an idea6:23

6.4. Operational budget – the data (1)13:09

6.5. Operational budget – the data (2)5:22

6.6. Preparing operational budget (1)3:16

6.7. Preparing operational budget (2)6:58

6.8. Preparing operational budget (3)6:40

6.9. Preparing operational budget (final steps)7:44

6.10. Budgeting and responsibility accounting16:57

6.11. Changes in budgeting – major trends8:01

6.12. Accounting and valuation – final conclusions7:13

Taught By

Konstantin Kontor
Director and Professor of Finance and Strategy

Transcript

Now we proceed with the preparation of supporting schedules for our operating budget. In this episode, we will study direct materials usage and purchases. So this is our goal. Now, we start with direct material usage. So, I created this table for you. So we here, have materials one and two, and a total that goes for dollar amounts. And how do we proceed here? So, direct materials are used to produce R and HD, two kinds of spare parts. So we start with direct materials used in the production of R. So first of all from the previous schedule, from a previous episode, we know that we have to produce 7,000 pieces of R. And for each piece we know that we use 11 kilograms of material one, and 5 kilograms of material two. So, that results in these numbers 77 tons of material one and 35 tons of material two. Now by the same token when we take the production of HD, we remember that the amount will be 1,200 and that uses 12 kilos of the first material and eight of the second one. And the resulting numbers are 14,400 kilograms of material one and 9,600 of material two. We add this up. And these numbers, 91,400 and 44,600, these are the amount in kilograms of these materials that we will use in production. Now where will we take these materials from? From two sources, the first source is the beginning inventory and the second source is purchases. So beginning with inventory. Why is it beginning? Because we use FIFO. So we first take everything from the beginning inventory and then what is lacking, we purchase. So we take this number, subtract this number. So we have to overall purchase 83,400 kilograms of material one. Before we arrive at this line here, just, we make a first contribution in terms of dollars. So if we take eight tons of material one from the beginning inventory, its cost is 8,000 times $8 per kilo which is $64,000. Here we have the same for material two and the total amount as $124,000. Now, we said that we have to purchase 83,400 kilos of material one and 38,600 kilos of material two, that is what we lack for production needs. And here, we also multiply by unit costs. And here, like I said, we made the simplifying assumptions up there, that the unit cost stays constant over the forecast period. So for example, if we would like to take into account the changing costs of purchases, we will change these numbers, that is done in a straightforward way. But here, we ignore that just not to make these calculations way too cumbersome. Although, again, I am emphasizing it's pretty straightforward. There are other things in these calculations that are not so straightforward and you change some numbers, but these are not so. Again, we multiply this by that and the pre last line gives you the cost of purchases $667,200, $386,000 and $1,053,200. And in blue here, there are a total costs of direct material used $73,200, $446,000 and then $1,177,200. So, that was the schedule for direct material usage. But we have to remember, that we used that in production but maybe, if the ending balance of direct materials in inventory changes, then we have to purchase more. And the next schedule, that is schedule 3B, purchase of direct materials, that shows how logic proceeds here. Again, we have materials one, two, and total. Now direct materials for use in production, we take from the previous schedule, that's 91,400. Now to that we have to add the target and direct materials inventory, which is 9,000 kilos, and the total is 100,400. But then, we subtract the beginning inventory of direct materials that we used in the previous schedule. And then, we see that we have to purchase 92,400. So in the previous schedule, we said that we have to put this in production, but part of that arrives from our beginning of inventory. Great. And that was 83,400. But on top of that we have to purchase this to make sure that we have the ending inventory of direct materials. So exactly the same logic goes here, and we arrive at the final numbers of purchases 92,400, 41,600. Again, unit costs stay the same. And therefore, we arrive at the final blue line that says that total direct material purchase cost is $739,200, $416,000, and then $1,155,200. Now, you can say, well, that sounds kind of redundant. So it's almost close to what we did before. But the story is remember, this concept of numbers versus people. Now in purchases we have the people who are in charge of purchases, in production there are other people who are in charge of production. So to properly provide these people with information, we have to give this table to the purchasing people, and the previous table to the production people. So although they are close, and when we put them together in these calculations they seem to be very, almost doubling our efforts. But their recipients are different people and that's very important. Well, so far so good. In what follows we proceed with other supporting schedules.

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