part 3 of 6 excel-based budgeting for indirect...
TRANSCRIPT
Budgeting. Sometimes the more effort we put
into it, the less people appreciate our efforts! But there’s a
way to make a budget that can be used and appreciated.
This is the third in a series of six articles describing how
to use Excel to create such a budget. Although it will take
a bit of effort to put together your first Excel-based Mas-
ter Budget, making this type of budget will provide you
with a powerful tool that you can quickly and easily
update in future years. Not only that, but we plan to show
you how to use this spreadsheet tool to see how small
changes in your business will make big changes to your
bottom line, something all the managers and supervisors
in your company should appreciate. First, though, we
need to continue creating the budget.
In Part 1, we started our Excel-based Master Budget
with the Data Input Sheet, the foundation of the rest of
the budget. We also discussed the creation of the Sales
Budget and the Cash Collections Schedule. Part 2 took us
through the first part of the production process: the Pro-
duction Budget, the Direct Materials Budget, the Sched-
ule of Cash Payments, and the Direct Labor Budget. Part
3 will take us through the rest of the production process
by creating a Manufacturing Overhead Budget and an
Ending Finished Goods Inventory Budget. We will then
wrap up the foundation by creating the Selling and
Administrative Budget.
Is your computer ready? Here we go.
Creating the ManufacturingOverhead BudgetAs in the previous budgets we’ve discussed, all the infor-
mation for the Manufacturing Overhead Budget is drawn
34 S T R AT E G IC F I N A N C E I A p r i l 2 0 1 0
BUDGETING
Excel-Based Budgeting for Indirect Costs
Creating Linked Budgets for Overhead and S&AExpenses
By Jason Porter and Teresa Stephenson, CMA
Part 3 of 6
from the Data Input Sheet or previous budgets. This
process is the true magic of the spreadsheet-based budget
process. Gathering all of your estimates and assumptions
in one place lets you quickly and easily update and
change your budget with just a few keystrokes. If you
decide to switch to a Just-in-Time (JIT) inventory system,
a quick adjustment to your desired ending inventory per-
centage (say from 10% to 2%) will automatically change
your Production Budget, Direct Materials Budget, Direct
Labor Budget, and so on, all the way through your Pro
Forma Financial Statements, without requiring any addi-
tional work on your part. It’s awesome!
Take a look at the Manufacturing Overhead Budget
shown in Figure 1. The first row of numbers contains the
direct labor hours for each quarter, which are the compa-
ny’s chosen overhead cost drivers. Since the company has
decided to use total direct labor hours as its cost driver,
the numbers are carried forward from the Direct Labor
Budget (Figure 9 in Part 2 of this series, March 2010),
where they were calculated using assumptions from the
Data Input Sheet (Figure 1 in Part 1 of this series, Febru-
ary 2010). Of course, different companies will want to use
different cost drivers based on their own analyses. The
Manufacturing Overhead Budget can easily be adjusted to
suit the needs of your company. The only rule is to make
sure the information for the driver you choose is on the
Data Input Sheet. For example, if you were to use
machine hours, you would need a place to put budgeted
machine hours on the Data Input Sheet. Then, when cre-
ating your Manufacturing Overhead Budget, you would
pull machine hours forward as the first line instead of
labor hours. The rest of the Overhead Budget would then
follow the format shown in Figure 1.
The variable overhead rate and fixed overhead
amounts also are found on the Data Input Sheet. Again,
we reiterate the importance of pulling them from that
sheet and not typing them in. Once you start typing num-
bers into the budgets instead of using formulas that pull
information from the Data Input Sheet, you lose all the
power this budget provides. Multiplying the total estimat-
ed cost drivers (direct labor hours in this case) by the
variable overhead rate gives you the total variable over-
A p r i l 2 0 1 0 I S T R AT E G IC F I N A N C E 35
Figure 1: Manufacturing Overhead Budget and Schedule of Cash Payments for Overhead
head for each quarter. Add to that the quarterly fixed
overhead estimate, and you get total overhead cost for
each quarter. When you’ve finished these basic calcula-
tions, you can easily calculate the predetermined over-
head rate by dividing the final total overhead estimate for
the year by the total estimated cost drivers for the period.
This predetermined overhead rate, the standard direct
material costs, and the direct labor costs are used to cal-
culate the total unit cost when you create the Ending Fin-
ished Goods Inventory Budget. If your company uses
departmental overhead rates, we suggest a separate Over-
head Budget for each department. Likewise, if you use
activity-based costing (ABC), a new budget for each
activity or group of related activities would make keeping
track of the process much easier.
The final step when estimating overhead is creating the
Schedule of Cash Payments for Overhead. Since one of
the primary goals of a Master Budget is to provide esti-
mates of cash needs, you have to separate depreciation
and other noncash overhead from the total. This process
is much easier to do when estimating overhead than it is
in the middle of the Cash Budget (as we’ll discuss in Part
4). To create the Schedule of Cash Payments for Over-
head, simply take the total manufacturing overhead
reported at the top of the worksheet and deduct the non-
cash items. We chose to use a percentage estimate of 25%
of the total in our example, as reported in the Data Input
Sheet. In your company it might be best to use a set
amount, a separate schedule of noncash items, values
from your depreciation schedule, or a percentage of some
other value. Regardless of which method you choose, be
sure to set up the formula using numbers from the Data
Input Sheet. Figure 2 shows the formulas for both the
Overhead Budget and the Schedule of Cash Payments for
Overhead. The columns for Q2 and Q4 are hidden so that
you can see the formulas better, but they would be similar
to the formulas shown for Q1 and Q3.
By using cell references instead of typing numbers into
Excel, you can make budgets look attractive without los-
ing any information. For example, notice that in Figure 1
the predetermined overhead rate is displayed as $5.03, a
nice, neat number. In reality, the rate is a little more than
$5.02612, not a fun number to use when doing manual
calculations. Of course, the alternative leads to the round-
ing effects everyone is familiar with (troubles balancing,
high estimates, low estimates, etc.). But using an Excel-
based budget gives you the best of both worlds. You can
easily set your formatting option to round your overhead
rate to two or three decimal places without changing the
true value. As long as you reference the cell that contains
the initial equation in future budgets, such as the Ending
Finished Goods Inventory Budget, Excel will use the full,
unrounded number, and your calculations won’t have
rounding errors. This way you get both the accuracy and
the clarity that often compete in manual budgets.
Creating the Ending Finished GoodsInventory BudgetAlthough you can easily put the various budgets together
on the same Excel worksheet, we feel that placing each of
36 S T R AT E G IC F I N A N C E I A p r i l 2 0 1 0
BUDGETING
Figure 2: Formulas for the Manufacturing Overhead Budget
the subsidiary budgets on a different worksheet (or tab)
makes the budget easier to read and follow, especially for
the nonaccounting managers and supervisors who we
hope will use the information. In this case, we’ve started
a new tab called the “Ending Inv Budget.”
Many of the numbers in our Ending Finished Goods
Inventory Budget (Figure 3) will come from the Data
Input Sheet, but some of the information will also need
to be gathered from the production cost budgets. Re-
member, in a budget we use standard amounts instead of
actual, even when estimating ending inventory. For exam-
ple, the number of units in ending finished goods inven-
tory comes from the Production Budget (Figure 2 in Part
2), the cost per direct labor hour comes from the Direct
Labor Budget (Figure 9, Part 2), and the predetermined
overhead rate comes from the Manufacturing Overhead
Budget (Figure 1 here). In reality, this particular budget
isn’t strictly necessary. We could easily incorporate all the
calculations in other budgets. But as we mentioned previ-
ously, the overall goal of our Master Budget is ease of use
and understanding. For that reason, we prefer to have our
calculations separated into worksheets that are easy to
read and understand.
Back to Figure 3. First we created columns that label
our data clearly. For example, Column E describes the
units associated with each number. As always, the terms
and quantities have been carried forward from the Data
Input Sheet so that any changes will flow through auto-
matically. For example, right now a basic bike costs $116
to produce. Suppose that the sales department decided
A p r i l 2 0 1 0 I S T R AT E G IC F I N A N C E 37
Figure 3: Ending Finished Goods Inventory Budget
that each basic bike should include a spare tire. Go back
to the Data Input Sheet and enter 3 for the standard
quantity of tires under the basic bike. The change “flows”
forward. The first place the change occurs is in the Direct
Materials Budget (see Part 2 for examples of this budget).
Originally, the company was supposed to purchase 51,139
tires for the year. Now that each basic bike needs three
tires, that has updated to 68,336. The cost of a basic bike
has increased to $126, which makes sense because a single
tire costs $10. The value of the total ending inventory has
increased as well. All of those changes happened as soon
as we typed in the number and hit Enter. Isn’t that cool?
Okay, go back and change the tire value back to 2; we’ll
wait here for you.
Once you’ve gathered the per-unit direct materials
costs, you can get the total direct labor hours per bike
and calculate applied overhead per bike. In our example,
this information is found on the Data Input Sheet. But
depending on the calculations required and the driver
chosen, you might have to get the data from one of the
production budgets. Just remember that those budgets
gathered the data from the Data Input Sheet. The cost per
direct labor hour comes from the Direct Labor Budget,
and the variable overhead rate comes from the Manufac-
turing Overhead Budget. After gathering the cost per unit
of materials and labor and the cost driver for each unit,
you can calculate the total standard cost per bicycle. The
final step for each product is to get the total units in end-
ing inventory from the Production Budget and multiply
the ending units by the cost per unit to get an estimated
ending inventory value. For basic bikes, we show an end-
ing inventory value of $100,495. The final result of the
Ending Finished Goods Inventory Budget is the sum of
all ending inventory values for all products.
Creating a Selling andAdministrative BudgetThe final budget we’ll discuss in this article is the Selling
and Administrative Budget, which is much less complicat-
ed than the production budgets. One important thing to
remember, though, is that where variable costs in produc-
tion are based on how many units are produced, variable
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BUDGETING
Figure 4: Selling and Administrative Budget
A p r i l 2 0 1 0 I S T R AT E G IC F I N A N C E 39
costs in selling and administration are usually based on
how many units are sold. The logic of that takes only a
minute to understand. When you produce goods, your
variable costs tend to be materials and labor—things that
increase as you make more and decrease as you make less.
For example, one variable cost for the bike manufacturer
could be tires. More bikes made means more tires used. Yet
regardless of how many bikes Bob’s makes, commissions—
the quintessential variable selling expense—are paid on
bikes sold. If Bob’s made a million bikes but didn’t sell any,
the selling commission would still be zero!
Figure 4 shows the Selling and Administrative Budget
for Bob’s Bicycles. Our first step was to bring forward the
estimated sales of each type of bike. Then we brought
forward the variable selling cost rates. It’s a simple matter
to multiply those quantities to show the total estimated
variable costs. Next, we brought forward the fixed costs,
dividing them by four to show the quarterly amounts
instead of the annual amounts reported in the Data Input
Sheet.
Our example budget is fairly simple, but endless varia-
tions are possible in practice. For instance, suppose you
anticipated that your office rent would increase 10% each
quarter. Your Data Input Sheet would then show a base
amount and the estimated amount of the increase. Take a
look at Figure 5, where we’ve shown how to do this, but
remember this isn’t part of our example bike company
budget.
Once the information is in the Data Input Sheet, using
that data in the actual budget tab is fairly straightforward.
Notice that we used three cells for the statement: “with a
10% increase each qtr.” The words to the left and the
right of the 10% were isolated so that the increase per-
centage is in its own box and can be used in a formula.
The Selling and Administrative Budget for the first quar-
ter would use the $3,000 from the cost cell. The second
quarter would pick up the quantity on the Selling
and Administrative Budget for the first quarter
and multiply it by one plus the percentage from
the Data Input Sheet. By making that a perma-
nent reference (using F4), you can copy the equa-
tion to the third and fourth quarters. When this is
done correctly, the amounts for Q1 through Q4,
respectively, will be $3,000, $3,300, $3,630, and
$3,993. You can also estimate specific dollar
amounts per quarter or specific dollar increases
per quarter, whatever best fits your company’s
business model.
Moving OnThe first article in this series discussed the importance of
budgets, the usefulness of an Excel-based budget, the
Data Input Sheet, and the Sales Budget. The second arti-
cle showed how to create the Production, Direct Materi-
als, and Direct Labor budgets. This article continued the
series by discussing the creation of the Manufacturing
Overhead Budget, the Ending Finished Goods Inventory
Budget, and the Selling and Administrative Budget. This
completes all of the foundation budgets involved in the
Master Budget.
We encourage you to take these basic tools and apply
them to your business. A good way to start is to recreate
our example step by step, check your flow through, then
save your work as a basic template. You can then use a
copy of your template as the starting point to create a
Master Budget for your company, one budget at a time.
Now that we’ve finished the basic budgets, we can
move on to discuss the Cash Budget and Pro Forma
Financial Statements. These final segments of the Master
Budget gather the information from the basic budgets to
provide decision-making estimates. And that’s the process
we’ll start in Part 4. Until then, happy budgeting! SF
Jason Porter, Ph.D., is assistant professor of accounting at
the University of Idaho and is a member of IMA’s Washing-
ton Tri-Cities Chapter. You can reach him at (208) 885-
7153 or [email protected].
Teresa Stephenson, CMA, Ph.D., is assistant professor of
accounting at the University of Wyoming and is a member
of IMA’s Denver-Centennial Chapter. You can reach her at
(307) 766-3836 or [email protected].
Note: A copy of the example spreadsheet, including all the
formulas, is available from either author.
Figure 5: Example of a Possible Refinement