Budget & Budgetary

Control

2
2-1

Role of Budgeting in Planning and Control

Looking ahead to
see what actions
should be taken to
realize particular
goals
Identifies
strategies
for
future activities
and operations.

Objectives
form
the
basis of the
budget.

Tied Together
Looking backward
determining what
actually happened
and comparing it
with the previously
planned outcomes

What is a Budget
Detailed plan expressed in quantitative terms, that

specifies how resources will be acquired and used

during a specific period of time.

A key component of planning

Identifies the objectives & actions needed to achieve
them

Budgeting system the set of procedures used to

develop a budget.

DG
BU ET

ST FIN
AT AN
EM C I
EN AL
TS

What is a Budgetary Control

Allocating Resources

Forces managers to
plan

Compare actual results

with planned objectives

Purposes of Budgeting Systems

1.

Planning

2.

Facilitating Communication and Coordination

3.

Allocating Resources

4.

Controlling Profit & Operations

5.

Evaluating Performance & Providing Incentives

The
The Concept
Concept of
of Budgetary
Budgetary Control
Control
Schedule below illustrates a partial budgetary control
system for a manufacturing company
Note the frequency of reports and their emphasis on
control

Master Budget
The master budget is the comprehensive financial
plan for the organization as a whole.
Typically, the master budget is for a one-year period
corresponding to the fiscal year.

A master budget can be divided into operating and

financial budgets.
Operating budgets describe the incomegenerating activities of a firm: sales, production,
and finished goods inventories.
Financial budgets detail the inflows and outflows
of cash and the overall financial position.

The Master Budget: Graphic

Operating
Budgets

Financial
Budgets

Preparing the Operating Budget

The first budget is the sales budget which is
based on the sales forecast.
Other budgets cant be prepared without sales budget
Schedule 1 (in thousands)

Starting point for Production Budget

Starting point for Marketing Expense Budget
Many methods used to forecast sales
Econometric methods
Previous sales trends
Trade journals & magazines
Sales force estimates

Goes to Budgeted
Income Statement

Preparing the Operating Budget

Schedule 2 (in thousands)

Starting point for Direct Materials Purchases Budget

Starting point for Direct Labor Budget

Finished units
to be produced

Expected
Sales in Units

Desired ending
inventory of
finished units

Beginning
inventory of
finished units

Preparing the Operating Budget

Schedule 3 (in thousands)

From production budget

Goes to Cost of
Goods Sold Budget

Reqd purchase
of direct material

Amt reqd for

production

Desired ending
inventory of
Direct material

Beginning
inventory of
Direct material

Preparing the Operating Budget

Schedule 4 (in thousands)

From production budget

Starting point for Overhead Budget

Goes to Cost of Goods Sold Budget

No. of units be
produced

Labour hrs
per unit

Rate per hr

Preparing the Operating Budget

Schedule 5 (in thousands)

Goes to Cost of Goods Sold Budget

Preparing the Operating Budget

Schedule 6 (in thousands)

Amounts taken from Schedule 3.

Amounts taken from Schedule 4.
c
Amounts taken from Schedule 5.
d
Budgeted fixed overhead (Schedule 5)/Budgeted direct labor hours (Schedule 4) = $1,280/240 = $5.33.
a
b

Goes to Cost of Goods Sold Budget

Preparing the Operating Budget

Schedule 7 (in thousands)

*Production needs $0.01 = 416,000 $0.01.

Goes to Budgeted Income Statement

Preparing the Operating Budget

Schedule 8 (in thousands)

Goes to Budgeted Income Statement

Preparing the Operating Budget

Schedule 9 (in thousands)

Goes to Budgeted Income Statement

Preparing the Operating Budget

Schedule 10 (in thousands)

Goes to Budgeted Income Statement

Preparing the Operating Budget

Schedule 11 (in thousands)

Preparing the Financial Budget

Schedule 12 (in thousands)

(Continued on next slide)

8-20

Preparing the Financial Budget

Schedule 13 (in thousands)

a
Ending balance from Schedule 12.
30 percent of fourth-quarter credit sales
(0.30 $800,000)see Schedules 1 and 12.
c
From Schedule 3 (5,000,000 lbs. $0.01).
d
From Schedule 6.
e
From the December 31, 2006, balance sheet.
f
December 31, 2006, balance ($9,000,000) plus
new equipment acquisition of $600,000 (see
the 2006 ending balance sheet and Schedule
12).
g
From the December 31, 2006, balance sheet and
Schedules 5, 8, and 10
($4,500,000 + $800,000 +$20,000 + $40,000).
h
20 percent of fourth-quarter purchases
(0.20 $520,000)see Schedules 3 and 12.
i
From the December 31, 2006, balance sheet.
j
$6,825,000 + $894,000 (December 31, 2006,
balance plus net income from Schedule 11).
b

8-21

Master Budget Retail Organisation

Budgeting in Service Companies

These firms have different operating characteristics,

operating environments, and considerations than those of

manufacturing and merchandising firms
Service firms are different due to the absence of production

or merchandise purchase budgets and their ancillary

budgetsthe focus of the budgeting process must be
personnel planning:

Does the firm have sufficient staff and resources to provide

the expected level of service output in the upcoming period?
Do staff members have the appropriate skills?
23

Master BudgetService

Traditional Master Budget Process-Shortcomings

Departmental orientation
Plan from resources to outputs
Does not recognize interdependencies among
departments
Static budgets

Developed for a single level of activity

Based on incremental adjustments
Does not reflect changes in revenue & expenses
with reference to volume change

Results orientation
Disconnects the process from its output
Cost-cutting accomplished by across-the-board cuts

25

Traditional Master Budget Process-Shortcomings

Master budgets are static budgets that are developed around a
particular level of activity
Performance
PerformanceReport:
Report:Quarterly
QuarterlyProduction
ProductionCosts
Costs
(in
(inthousands)
thousands)

Flexible Budgets for Planning and

Control

Flexible budgets
Static budgets
Variable budget
Master budget
Provides expected costs
Vital for planning
Less useful for control for a range of activity
Provides budgeted
Developed around a
costs for the actual
single level of activity
activity level
Budgeted activity
Locate possible
level rarely equals
problem areas by
actual activity
examining flexible
budget variances
27

Flexible Budgets for Planning and

Control
Flexible budgets provide expected costs for a range of activity
or the actual level of activity.
Flexible
FlexibleProduction
ProductionBudget
Budget (in
(inthousands)
thousands)

8-28

Flexible Budgets for Planning and

Control

Actual
Actualversus
versusFlexible
FlexiblePerformance
PerformanceReport:
Report:
Quarterly
QuarterlyProduction
ProductionCosts
Costs (in
(inthousands)
thousands)

8-29

Static Vs Flexible Budgets

Managerial
ManagerialPerformance
PerformanceReport:
Report:
Quarterly
QuarterlyProduction
Production (in
(inthousands)
thousands)

8-30

Flexible Budgets for Planning and

Control

A flexible budget can be built for five overhead activities using

three drivers; each is budgeted for two activity levels.
Activity
ActivityFlexible
FlexibleBudget
Budget

Flexible Budgets for Planning and

Control
Activity-Based
Activity-BasedPerformance
PerformanceReport
Report

The activity-based performance report compares

the budgeted costs for actual activity usage with
the actual costs.

Flexible Budget at 10,000 and 12,000 Levels

Incremental Budget
Description: A budget that is prepared by increasing
last years budget by a fixed amount or a
percentage
Strength: Simple to prepare; management focuses
on new programs and business changes
Weakness: Little emphasis on analyzing last years
budgetinefficiencies are passed on to
the current year
Government, not-for-profit organizations
Typical Usage:

Alternative Budgeting Approaches

Zero Based Budgeting (ZBB)

The baseline is zero rather than last years budget.
Description:A budget that requires management to start
at zero and estimate all expenses as a new
operation

Strength: Forces a comprehensive analysis of

business priorities and needs for resources

Difficult and time-consuming to prepare

Weakness:
Typical Usage:

Organizations focusing on cost reduction

and evaluating efficiency

Alternative Budgeting Approaches (continued)

Activity-based budgeting (ABB) is a budgeting process

based on activities and cost drivers of operations:

Starts with the budgeted output and segregates costs required for
the budgeted output into homogeneous cost pools

Can be a simple extension of a firms ABC system

Four Key Steps

1.

Determine budgeted costs for each activity

2.

Determine demand for each activity

3.

Compute the cost of each activity

4.

Describe budget in terms of costs of performing these activities

36

Alternative Budgeting Approaches (continued)

Kaizen (Continuous improvement) budgeting:

Promotes active engagement in reforming and altering

business practices and processes
The Japanese use the term kaizen
for continuous improvement.
Kaizen budgeting is an approach that
explicitly incorporates continuous
improvement during the budget
period into the budget numbers.

Alternative Budgeting Approaches (continued)

Kaizen (Continuous improvement) budgeting:
Example : Budgeted labour hours for Regular and Heavy-Duty Units
produced during the year
Regular Heavy-Duty
January-March
April-June
3.90
July-September
October-December

4.00
5.85
3.80
3.70

6.00
5.70
5.55

Behavior Dimensions of Budgeting

Goal congruence
Dysfunctional behavior
Frequent feedback on performance
Monetary and nonmonetary incentives
Participative budgeting
Realistic standards
Controllability of costs
Multiple measures of performance

Human Behavior & Budgeting

The success of budgeting depends upon:

The degree to which top management accepts the
budget program as a vital part of the companys
activities.
The way in which top management uses budgeted data.

Human Behavior & Budgeting

Managers
Managers should
should be
be held
held responsible
responsible for
for those
those
items
items
and
and only
only those
those items
items
that
that
the
the manager
manager can
can actually
actually control
control
to
to aa significant
significant extent.
extent.

Behavior Dimensions of Budgeting

Difficulty level of the budget target?

An easy budget may

fail to encourage
employees to give
their best efforts

a very difficult target

can be discourage
managers from even
trying

A highly achievable
target is suggested
with incentives for
exceeding
the
budgeted figures

Behavior Dimensions of Budgeting

Authoritative or participative budgeting?

Top-down budgeting is referred to as authoritative budgeting

Bottom-up budgeting is referred to as participative budgeting
Effective budgeting processes often combine the two types
T op M anagem ent

M id d le
M anagem ent

S u p e rv is o r

S u p e rv is o r

M id d le
M anagem ent

S u p e rv is o r

Flow of Budget Data

S u p e r v is o r

International Aspects of Budgeting

Multinational companies face special problems
when preparing a budget.

Fluctuations in foreign currency exchange rates.

High inflation rates in some foreign countries.
Differences in local economic conditions.
Local governmental policies.