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A lecture delivered my Managing Partner Mr. Y. O.

Olajide on the occasion of the 10 year anniversary of Olajide And Associates (Chartered Accountants) Costing can be categorized into 1. Costing principles 2. accounting for decision making 3. costing techniques which deals with planning and evaluation, containing 1. budgeting control 2. standard costing 4. costing methods .i.e. 1. Process costing 2. Job costing, etc. What is Budgeting? A budget is a statement of action expressed in monetary terms. It must have a period of time and the actual situation recorded and compared with the budget. It helps to plan ahead, and enable us to know where we are. There must be a corporate plan and a tool is used in the short run to achieve it .i.e. the budget. There is the need to identify the SWOT of the firm and the resources. Budget preparation is difficult in practice since all resources must be well co-ordinated in other to eliminate sub-optimization and actualize the corporate goal of profit maximization. However the aim may be to satisfy rather than maximizing. INTRODUCTION Budgeting is one of the managerial tools that forces managers to perform according to a given level of expectations. The process of preparing the budget forces executives to become better administrators. Budgeting puts planning to where it belongs in the fore front of the managers mind (Horngreen). Budgeting is primarily attention directive because it helps managers to focus on operating or financial problems early enough for effective planning or action. DEFINITION OF A BUDGET A plan quantified in monetary terms, prepared and approved prior to a defined period of time, usually showing planned income to be generated and or expenditure to be incurred during that period and the capital to employed to attain the given objective CIMA ADVANTAGES/BENEFITS OF BUDGETS Budgets are designed to carry out a variety of functions: 1. 2. 3. 4. 5. Planning Evaluating performance Evaluating activities Implementing plans communicating Motivating and authorizing actions. (matching)

These are the summary of benefits of budgets. PLANNING 1. It aids the planning of annual operations budgets forces managers to think ahead to anticipate and prepare for changing conditions. 2. It puts planning to achieve it belongs i.e. it has the explicit responsibility of the management. 3. It helps in formulating the business objectives. 4. Budgeting is primarily attention directing i.e. where attention must be focused on Management By Exception (MBE). Management By Objective (MBO) enables all managers to know the level of achievement required and set plans to meet it. While MBE is where top management are notified of variations in budget above the tolerant limit, both favorable and unfavorable. In MBO, the manager is consulted of the managers. It helps managers to focus on operating or financial problems early enough for effective planning or action. 5. The process of preparing budget forces executives to become a better administrator. CO-ORDINATION 1. With the aid of budgets, the goals of individual managers are harmonized with the organizations goals as a whole. 2. The budgetary process enables the managers to futurise the relationship of their departments to other departments and in the process to identify and resolve conflicts. COMMUNICATION 1. It helps in communicating the objective of the organizations to the managers thereby facilitating the principle of MBO. 2. Budgeting help[s in the integration of various plans and providing feedback for the actual result. PERFORMANCE EVALUATION 1. Budgeted goals or expectations are more appropriate in appraising managers than past performance. The historical data is not good in judging performance because it conceals inefficiencies. 2. It provides a useful means of informing managers of well they are performing in meeting targets through variance accounting. CONTROL OF ACTIVITIES 1. It is useful for cost control i.e. concerted efforts at keeping costs to specified limit. (Cost control). 2. Investigation of variances may lead to identification of inefficiencies which will be corrected or noted in the subsequent periods.

3. It facilitates management by exception which means that managers attention and effort can be concentrated on significant variations and as deviations from the expected results. MOTIVATION 1. A manager can be rewarded for performing up to expectations i.e. for achieving targets. 2. Managers may also be motivated to perform in line with the organizations objective participating when he is involved in setting the standard. In conclusion, it should also be noted that budgets may also demotivate managers where it is dictated from the above and the manager sees it as a threat rather than a challenge. In this situation it may be resisted and more harm will be done than good. This is the major problem of budget in practice. SHORT TERM BUDGETING AND LONG TERM PLANNING The short term is a subset of the long term plan. The corporate plan is the whole organization. Strategic plan is part of corporate plan and is for each department for a long term. Tactical plan is a plan for short period time say 12 months. It is the responsibility of management to ensure that all various functions of the organization are co-ordinated by preparing plans of actions for future periods. These detailed plans are usually referred to as budgets. A budget is a short term plan (usually extending over a year) developed within the frame work of the medium to the long term corporate plans. The budgetary process is the means by which the long range plan is implemented. The long range plan is strategic plan or when applied to the organization as a whole. Corporate plan is defined as The formulation, evaluation and selection of strategies involving a review of the objectives of an organization, the environment in which it is to operate and assessment of its strengths, weaknesses, opportunities, and threats (SWOT) for the purpose of preparing a long term strategic plan of action which will attain the objective set CIMA. Corporate plan usually extends over a long period of time, i.e. from 2 years to 10 or often 15 years, or 50 years. Whereas short term planning or budgeting must accept the environment of today, and the physical, human, and financial resources at present available to the firm. In most cases, the budget is more realistic than the corporate plan. However, with the introduction of computer the corporate plan is adjusted with current conditions. ROLE OF LONG TERM AND SHORT TERM PLANNING WITHIN THE PLANNING, DECISION MAKING AND CONTROL 1) Identifying objectives 2) Search for alternative Courses of action 3) Collect data about alternatives 4) Select the alternative causes of action most suitable 5) Implement long term plan in the form annual budgets 6) Monitor/Record actual results 7) Make provision for unexpected Deviations/response to Deviations from plan.

The above is how to prepare a budget for function of an organization. SUMMARY From the above diagram it can be seen that budgeting is concerned with the implementation of the approval program with the long range. The budget translates the long range plans and the capital budget into an operating plan. A budget is usually developed yearly based on existing long term decision. The budgeting process is not however one where the programmes for individual years included in the long term plans are merely added together. The long term programs must be reviewed and revised in the light of more recent information. The budgeting process can not therefore be viewed as being purely concerned with the current year; it must be considered as an integrated part of the long term planning process in other to realize long term objectives. It is influenced by decisions which have being taken in the past and it has implications for programs which will continue in future periods. Budgeting now, and budgeting for future i.e. corporate plan and budgeting.

THE DOCUMENTATION OF THE ANNUAL BUDGET BUDGET PERIOD This is the period in which the budget covers, usually 12 months. PERIOD BUDGETED Division of budget period for the purpose of control and review i.e. monthly. For effecting of the actual situation, it is a subset of the period, i.e. 1 month, or every 3 months. BUDGET COMMITTEE Responsible for the preparation of the budget. The secretary is the budget officer usually the Management Accountant. BUDGET OFFICER Responsible for the tactical aspect of preparing the budget. Co-ordinate report and present it at in a way understandable by the manager. BUDGET MANUAL Contains procedures, appeal, roles of individual, each department, expectation of the organization, organization chart, etc. BUDGET CENTER Division of organization into sections for the purpose of budget preparation, and used for control. It is a cost centre and relevant in responsibility accounting. PRINCIPAL BUDGET FACTOR This is that resource that is limited in supply. This must first be considered - raw material. All other budget i.e. production will be based on this factor. In most cases, sales are used as the Principal Limiting Factor. Nowadays raw material is the most. PERIOD BUDGET This is the period in which the annual budget (or budget period) is divided into. It is usually 12 months or 13 four-weekly period or 52 weeks in a year. The objective is for reporting control.

BUDGET COMMITTEE The committee is usually made up of heads of departments or senior managers. It is usually chaired by the chief executive of the organization. While the budget office serves as the secretary. The responsibilities of the budget committee are: 1. To educate the managers and ensure their co-operation and to act as a forum where differences of opinion can be argued out and reconciled. 2. To ensure that managers in their organization understand what other departments are trying to do. 3. To establish long term plans around which the budget to be built and then to identify budget objectives. 4. To review departmental budgets. 5. To examine reports showing actual performance compared with budget target and expectations. BUDGET OFFICER He is usually the organizations management accountant where there is no budget accountant. His functions are: 1. He composes the budget on a day to day basis. 2. He reports to the budget committee and ensures that his decisions are transmitted to the appropriate managers. 3. He will translate most of the budget policies into financial figures and prepare the master budget for the consideration of the budget committee. THE BUDGET MANUAL It is a procedure or rule book which spells out standing instruction governing the responsibilities of persons and the procedures, forms and records relating to the preparation and use of budgets. (CIMA) CONTENTS OF THE BUDGET MANUAL 1. Introduction - stating the purpose of the budget (preface, forward) which is preferably written e.g. the chief executive. 2. Objective/ explanation of the budgetary process. 3. Organization structure4s and responsibilities. 4. Functional budgets and their relationship with the master budget. 5. Capital expenditure budget details. 6. Explanations on budget preparations and the various assumptions/ policies that have being made. 7. Budget development and administration procedures. E.g. 1. Budget committee membership and terms of reference. 2. Sequence of budget preparation 3. Time table for budget preparation/publications. viii) Accounting Procedures:

1. 2. 3. 4.

Name and terms of reference of the budget office (usually) the management accountants Coding list Sample forms Time table for accounting reports production of reports, closing dates etc.

BUDGET CENTRES A section of an organization for which separate budgets can be prepared and controls exercised e.g. sales budget, production budget, administrative budget, etc. PRINCIPAL BUDGET FACTOR This is a factor which at a particular time, or over a particular time, or over a period will limit the activities of an undertaking and which is therefore taken into account in preparing budgets. The first task in budgeting is to identify the factor which imposes a limitation or ceiling on the level of activity. It may be sales, demand or it may be materials due to lack of forest. CONDITIONS FOR SUCCESSFUL BUDGETING/ESSENTIAL FEATURES OF A BUDGETARY CONTROL SYSTEM 1. Identify the objective where we are going 2. Sell the budget to all employees 3. Let them realize that the budget is not an instrument of threat. Use management by objective. 4. Perfect Management Information System (MIS) for feedback, proper accounting system. 5. Clearly defined organization chart - blame and reward appropriately apportioned. Later dependent of variance analysis. The essential requirements for effective budgetary control are as follows: 1. The establishment of clear objectives. 2. The employees must be thoroughly educated on the need for the budgetary control system. They must be assumed that budgeting is a positive vehicle for realizing the employees individual aspirations and that of the organization as a whole. 3. Top management support for the operation of the system is imperative for its success. 4. The actual available technique such as Operation Research, Computer Science, social science etc to ensure that the budget is as realistic as possible. 5. The correct choice of the budget period and the recognition of the most appropriate period budget for the purpose of control and reviewing. 6. The assessment of the budgeted level of attainment to ensure that it is realistic and achievable, taking into account. The various changes in the operating conditions. 7. The use of a realistic preparation time table which must be circulated to all departments taking into account the complexity of each of the functions. 8. The reorganization of responsibility for control in the establishment of budget centers taking into account the managers level of authority and span of control. 9. Clear instructions or guidelines to executives so as to assist them in executing the policies formulated in the budget during the period.

10. The detailed scrutiny of actual result against the plan and establishment of an effective control system that ensures that where an action is necessary managers are advised accordingly. 11. All factors that might impede the attainment of the corporate objectives must be highlighted and resolved in the best interest of the organization as a whole. This will ensure that the budget guarantees goal congruence. STAGES IN THE BUDGETING PROCESS 1. Communicating details of budget policies and guide lines to those people responsible for the preparation of budgets. 2. Determining the factor which restricts output, sales, and raw materials. 3. Preparation of the sales budget (raw material budget). 4. Initial preparation of various budgets (functional budgets) 5. Negotiation of budget with superiors agreeing on the output level to achieve. For fear of increasing the target, the manager will consciously build in slacks .i.e. say he can achieve however, if the budget is not negotiated, if because that of the accountant or superiors budget. It can never be achieved. This area can be asked in many ways budget is a tool to help managers, if is a threat, if is a target, if is a negative instrument of operation, if demotivation. 1. Co-ordination and review of the budget which is usually performed by the budget committee to ensure goal congruence. 2. Final acceptance of the budget in motivating the employees. 3. Ongoing review of budget .i.e. continuous review of the budget e.g. changes in the rate of force. For budget to be realistic, actual performance must be compared with budget. Question is more of application than computation i.e. theoretical for the past year. TYPES OF BUDGET 1. 2. 3. 4. 5. 6. 7. 8. Functional/activity or operating budget. Financial or master budget. The process/ method include The fixed or rigid or static The flexible budget The continuous or rolling budget Zero base budgeting Incremental budgeting Program planning and budgeting system (PPBS).

FUNCTIONAL BUDGET (ACTIVITY, OPERATING) It is the budget for each budget. It is related to a particular function, hence the name i.e. sales, production etc. This budget will be summarized into the financial/master budget. This will be made up of

1. 2. 3. 4.

Cash budget Budgeted Profit and Loss SSAF Balance sheet hence, the name financial budget.

Factor Budget - is a budget of income and expenditure applicable to a particular function. A function may refer to a department or a process. Functional budget frequently include: 1. 2. 3. 4. Production cost budget Sales budget Marketing cost budget R & D budget etc

The reason why it is so called is that the budget are related to the functions or activities of a given budget center. MASTER BUDGET This is a budget which is prepared from the summaries of the functional budgets. It is the summary of the goals or targets of all sub-units of an organization. It must contain the following statements. 1. 2. 3. 4. Budgeted profit and loss a/c, or statement of expected future income Cash flow or forecast statements, (receipts & payments) Budgeted balance sheet Statement of changes in financial position to be prepared if required only. Prepare cash budget, profit and loss and balance sheet of master budget is required. 5. The supporting schedules of the functional budgets i.e. details of the sales of production budgets. These statements are the results of various planning decisions and policies to be adopted for the period after detailed and vigorous appraisal of the organizations future and its environment. BASIC STEPS IN PREPARING OPERATING / MASTER BUDGETS Step I - preparation of the sales budget (raw material budget) assuming it is the budget principal limiting factor. N.VB the inventory levels, the purchase, operating expenses are usually geared with the sales achieved. Step II the decision about the company inventory level which will also affect the production budget, affect product, the master budget, number of machine due to budget, and the number of employees required. Step III prepare production budget specify the quantity of each productto be made on each production unit Step IV Preparing production resources budget raw material usage budget specify type and quantity, machine utilization budget, overhead cost budget etc. STEP V material purchasing budget specifying quantity and total amount. Ensure stock holding policy for raw material is taken into account. Step VI prepare the capital expenditure budget. Step VII prepare the working capital budget formulating debtors policies, credit facilities to be

employee, changes in the stock levels anticipated etc. ratios should be calculated and effects any decisions taken on discounts or any period allowances considered. Step VIII prepare the cash budget to in corporate all the functional budgets and the capital expenditure budget. Step IX prepare the amalgamated or summarized budgeted profit and loss, statements for the budget period and for the period budget - total and individually. Step X prepare the projected balance sheet Step XI pass the prepared master budget to the budget committee or the m/d or board of directors for approval. Once approved this budget becomes the master budget for the coming year. SALES FORECASTING Sales forecasting is a difficult task in practice. The following factors must be based on historical record and taken into account in sales forecasting. 1. Past sales value this will be based on historical record. 2. General economic and industrial condition favorable or adverse. 3. Relationship of sales to economic indicators such as disposable income, employment, and price levels, etc. 4. Relative product profitability need to adjust price. 5. Result of market research studies. 6. Cost of production for price. 7. Pricing policies market leaders, penetrating price, skimming, and listing. 8. Advertising and other promotional strategies this will affect the sales value. 9. Method of production and the level of sophistication of production technology. 10. The quality of sales force 11. The level of competition 12. Seasonal variations e.g. sales of ice cream, Christmas cards. 13. Production capacity which affects the level of supply. 14. Long term sales trend for various products. 15. Various product life cycles 16. Type of market aimed at i.e. exportation, dumping, culture of the people, government policies, and the stability of the government. METHODS OF SALES FORECASTING Any of these method or consideration of them can be used in sales forecasting. 1. Sales staff procedures i.e. they should report of what they can sell, they know the behavior of the customer. The information will be collected at various at various stages in the organization. 2. Statistical methods which include the trend cycle projection and correlation analysis, time series etc, realize that the result will depend on data collected. The result will be made unless the sales staff is relied upon. 3. Group executive judgment. It is a brain storming exercise. The executives are gathered and they all make contribution to the computation of the sales figures. The method is very quick and cheap.

However, it suffers the fact that responsibility for sales forecasting may be mixed up, i.e. no one can be responsible for not achieving the budget. It also ignores the need for a tough minded approach to produce important facts. PROBLEMS OF BUDGETING Disadvantages why budgets do not succeed in practice 1. Employee may regard it as a pressure or negative instrument rather than a procedure to assist the executives to do a better job. 2. Budgeting techniques is closely identified with the management control process, it might be incorrectly perceived that it can replace management, whereas there is no substitute for good management. After preparing the budgets management may not monitor staffs. Staffs need to be told of what to do. 3. If care is not taken, motivation may be misplaced. It may demotivate where the target is not attainable, or is not achieved; no reward, etc become frustrated. 4. The setting of realistic estimates may be difficult particularly the level of attainment. How can all the goals be achieved. How do we solve the problem of slack? The budget must be reviewed rather than make it rigid. 5. The required degree of management co-operation may not be obtained and top management support may be inadequate. Although in most cases, because of the awareness of budgets by top executives, this profit is less prominent. 6. The job problem of concealing efficiency level by incorporating efficiency level by incorporating slacks into the budget when they realize that the figures submitted for budgeting will subsequently be used to increase their efficiency. 7. The supporting accounting system may be inadequate. 8. Deficient organizational structure may impair the success of a budget no proper responsibility accounting. 9. The rate of inflation is usually unknown particularly in Nigeria and therefore budgeting for price trends/levels will be principally a guess work. 10. Forecasting may be carried too far into the future and this may reduce its level of accuracy. 11. Usually in practice not enough time is allowed for budget preparation particularly in small organizations, usually carried out as a crash program PREPARED BY Y.O.OLAJIDE (FCA, FCTI) MANAGING PARTNER Olajide and Assoicates Nig. www.olajideassociates.com