Chapter 9

BUDGET
PREPARATION

Formal Control Process

Goals
Goals
and
andstrategies
strategies
(Chp
(Chp22&&13)
13)

Rules
Rules
(Chp
(Chp3)3)

Other
Other
information
information
Reward (feedback)

Strategic
Strategic
Planning
Planning
(Chp
(Chp8)8)
Revise

Budgeting
Budgeting
(Chp
(Chp9)9)

Revise

Responsibility
Responsibility
center
center
Performance
Performance
(Chp
(Chp10
10&&11)
11)
Corrective
action

Report
Report
actual
actualvsvsplan
plan
Measurement
Feedback
Communication

Was
Was
performance
performance
satisfactory?
satisfactory?
(Chp
(Chp11
11&&12)
12)

Yes
No

Nature of a Budget
Budget are important tool for effective short-term
planning & control in organization.

An operating budget usually covers one year

& states the revenues & expenses planned for
that year.

Characteristics of Budget

Estimate the profit potential of the business unit.

Stated in monetary terms, although it may be backed
up by nonmonetary amounts.
Generally covers a period of one year.
It is a management commitment.
The budget proposal is reviewed & approved by an
authority higher than the budgetee.
Once approved, the budget can be changed only under
specified conditions.
Periodically, actual financial performance is compared
to budget, & variances are analyzed & explained.

Continued

The process of preparing a budget

should be distinguished from:
a. Strategic

planning
b. Forecasting

Contrast with Forecasting

A

budget is a management plan, with the

positive assumption that positive steps
will be taken by the budgetee to make
actual events correspond to the plan.
A forecast is merely a prediction of what
will most likely happen, carrying no
implication that the forecaster will
attempt to so shape events that the
forecast will be realized.

Use of a Budget
1.
2.
3.

4.

To fine-tune the strategic plan.

To help coordinate the activities of the several
parts of the organization
To assign responsibility to managers, to
authorized the amounts they are permitted to
spend, & to inform them of the performance
that is expected of them.
To obtain a commitment that is a basis for
evaluating a managers actual performance

Content of
an Operating Budget
Strategic Plan
Revenue & expense for each major
program

Operating Budget
For organization as a whole & for each
business unit

Not necessarily by responsibility

centers

Classified by responsibility centers

More expenses are variable

Expenses may be:

Flexible
Discretionary
Committed

For several years

Total reconciles to operating
budget

Total reconciles to operating budget

Capital Budget
Each major capital project listed
separately

Typically includes:
Revenues
Production cost & cost of sales
Marketing expense
Logistic expense (sometimes)
General & administrative
R&D
Income taxes (sometimes)
Net Income

Total reconciles to strategic plan (unless

revised)

Total project expenditures by

quarters

Other Budgets

Capital Budget

Budgeted Balance Sheet

Showing the balance sheet implications of decisions included in

the operating budget & the capital budget

Budgeted Cash Flow Statement

The approved capital projects, plus a lump-sum amount for

small projects that do not require high-level approval.
Part of strategic planning process.

Showing how much of the cash needs during the year will be
supplied by retained earnings.

Management by Objectives

The process of putting specific objectives to managers.

Budget Preparation Process

Organization

Budget Department

Normally reports to the corporate controller,

administers the information flow of the budgetary
control system.

The Budget Committee

Consist of members of senior management (CEO,

COO, CFO).
Reviewing & either approving or adjusting each of
the budgets.

Continued

Issuance of Guidelines

Based on strategic planning

To govern the preparation of the budget, for
dissemination to all managers.
Ex: assumed inflation, corporate policies,
compensation & benefit.

Initial Budget Proposal

Responsibility center manager & their staffs develop

a budget request.
Based on the existing levels, which are then
modified in accordance with the guidelines.

Continued

Negotiation

The budgetee discusses the proposed budget with his

or her superior.
The heart of budget preparation process.
Slack: the different between the budget amount &
the best estimate.

Review & Approval

Analyst put the pieces together & examine the total.

Final approval is recommended by the budget
committee to the CEO, CEO to the Board of Directors.

Continued
Budget Revisions
There are two general type of budget revisions:
1. Procedures that provide for a systematic updating of
the budgets.
2. Procedures that allow revisions under special
circumstances.
Budget revisions must be justified on the basis of
significantly changed conditions from those existing when
the original budget was approved
Contingency Budgets

Provides a way of quickly adjusting to changed condition if

the situation arises.

Behavioral Aspects

Participation in the Budgetary Process

Top-down & bottom-up budgeting.

Research: the budget participation has
positive effects on managerial motivation for
because:
1. There is likely to be greater acceptance of budget
goals if they are perceived a being under managers
personal control, rather than being imposed externally.
2. Participative budgeting results an effective information
exchange.

Continued

Degree of Budget Target Difficulty

The ideal
challenging but attainable.
Why attainable???
If budget too difficult, managers are motivated to take shortterm action that may not be in the long-term interest of the
company.
Reduce the motivation for managers to engage in data
manipulation to meet the budget.
Difficult to attain budget may lead to over commitment of
resources.
If managers able to meet & exceed their target, there is a
winning atmosphere.

Continued

Senior Management Involvement

To motivate budgetee.
There should be active participation in the
approval process.
Follow up on budget results.

The budget department

It has difficult behavioral problem, they must walk

the fine line between helping the line manager &
ensuring the integrity of the system.

Quantitative Techniques

Simulation

A method that constructs a model of a real

situation & then manipulates this model in
such a way as to draw some conclusion to
the real situation.

Probability Estimates
Point estimates
Probability distribution