Chapter 9 Financial Planning and Analysis: The Master Budget 377 378 Chapter 9 Anancial Planning and Analysis. The Master Budget Activity Based Costing (ABC) Activity-Based Budgeting (ABB) the capital budget, payments to or from investors, plans to purchase other companies, and short-term borrowings. By predicting the company's net cash position at frequent points during the planning period, the firm can plan ahead. It can arrange sources of short-term borrowing for times when cash outflows exceed inflows, and it can plan to pay off those borrowings and make short-term investments when the cash flow reverses. It can also signal cash flow trends and events that will require long-term capital acquisition via debt or equity financing. This ability to foresee and avoid cash emergencies makes the cash budget a very important and powerful tool. Budgeted Financial Statements The final portion of the master budget, depicted in Exhibit 9-1, includes a budgeted income statement, a budgeted balance sheet, and a budgeted statement of cash flows. These budgeted financial statements show the overall financial results of the organiza- tion's planned operations for the budget period. Notice that they are not the beginning of the master budgeting process, they are the end result! Activity-Based Budgeting The concepts that underlic activity-based costing (ABC) can be used to better understand the budgeting process." Activity-based costing uses a two-stage cost-assignment process. In Stage I, overhead costs are assigned to cost pools that represent the most significant activities constituting the production process. The activities identified vary across com- panies, but such activities as order processing, material handling, machine setup, labor scheduling, quality control, and purchasing provide examples. After assigning costs to the activity cost pools in Stage I, cost drivers appropriate for cach cost pool are identified. Then, in Stage II, the overhead costs are allocated from cach activity cost pool to cost objects (e.g., products, services, and customers) in proportion to the amount of activity consumed. Exhibit 9-2 portrays the two-stage allocation process used in activity-based costing systems. STAGE I Resource costs are assigned to activity cost pools associated with significant activities. Learning Objective 9-4 Explain the concept of actity- hased budgeting and the ingle hrings to the budgeting process. Exhibit 9-2 Activity-Based Costing System Exhibit 9-3 Activity Based Budgeting Reverses Activity Besed Costing Commenting on how the company's ABC and ABM ooves led to act based bungeeg "We are using ABM as a means to execute our strategic management process") Corporation Resources Resources Activities Activities Cost objects products and services produced. and customers served Forecast of products and services to be produced, and customers served Applying ABC concepts to the budgeting process helps to explain the logic of bud- geting. Sometimes the process is even referred to as activity-based budgeting (ABB). < Conceptually, ABB takes the ABC model and reverses the flow of the analysis, as depicted in Exhibit 9-3. The first step is to specify the products or services to be pro- duced and the customers to be served. Then the activities that are necessary to produce these products and services are determined. Finally, the resources necessary to perform the specified activities are quantified. As portrayed in the diagram, ABC assigns resource costs to activities, and then it assigns activity costs to products and services produced and customers served. ABB, on the other hand, begins by forecasting the demand for products and services as well as the customers to be served. These forecasts then are used to plan the activities for the budget period and budget the resources necessary to carry out the activities. In the next section of the chapter, we will illustrate the process of constructing a mas- ter budget. As we do so, notice how the conceptual activity-based budgeting model helps explain the steps in the budgeting process. Resource costs are assigned to activities. Order Processing Quality Control Material Handling Machine Setup Labor Scheduling Purchasing Costs are assigned from each activity cost pool to each cost object in proportion to its consumption of the activity. Each activity has its own cost driver. STAGE II Overhead costs are assigned to cost objects. Cost objects (o... products or services produced, or customers served). Activity-based costing (ABC) is covered in Chapter 5. Leaming Objective 9-5 Prepare each of the budget schedules that make up the master bucget in a nonmanufacturing firm, and that exist in manufacturing budgets as wel. Developing the Master Budget To illustrate the steps in developing a master budget, we begin with this chapter's focus company, Snowcap Music Festivals. Snowcap is a producer and event manager of des- tination music events worldwide. The company prides itself on attracting leading musi- cal talent to its events, known as SMurFests, while also exposing festival guests to the "next big thing" by identifying and promoting new talent. The Snowcap brand enjoys exceptional consumer loyalty: frequent festivalgoers call themselves, naturally, Smurfs and SMurFettes. This translates into profits through repeat business, strong festival atten- dance, and significant merchandise sales. The company works hard to create a stimulat- ing and creative but safe environment. "Helpful references include Stephen C. Hansen and Robert G. Tonk, ralities, The Clevved Loop: Implementing Activity-Based Planning and Budgeting, Bookman Publishing and Marketing, 2004, and James A. Brimson and John Antos, Driving Value Using Activity-Based Budgeting (New York: John Wiley & Sons, 1999).