Budget and Budgetary 0control

8/2/2019 Budget and Budgetary 0control

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BUDGET AND BUDGETARYCONTROL

Definition of Budget Purpose of Budgeting

Budget Administration

Stages and Process of Budgeting Master Budget and its Preparation

Static Budgets vs Flexible Budgets

Incremental Budgeting Zero-based Budgeting

Behavioral Dimensions of Budgeting


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Definitions of Budget

A detailed plan, expressed inquantitative terms that specifies how

resources will be acquired and usedduring a specified period of time

Budgets are the quantitative expressionofplansthat identify an organisations

objectives and actions needed toachieve them. They form the basis foroperations


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BUDGET

A BUDGET IS (A) THEQUANTITATIVE EXPRESSION OF A

PROPOSED PLAN OF ACTION BYMANAGEMENT FOR ASPECIFIEDPERIOD AND (B) AN AID TO

COORDINATING WHAT NEEDS TOBE DONE TO IMPLEMENT THAT PLAN


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Purpose of Budgeting

Planning annual operations Budgeting forces management to plan for

the future to develop an overall

direction for the organisation, foreseeproblems and develop future policies

Communicating plans to the variousresponsibility centre managers

Communicating is getting the goals to beunderstood and accepted by theemployees


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Coordinating the activities of thevarious parts of the organisation andensuring that the parts are in

harmony with each other Coordination is meshing and balancing

all factors of production and alldepartments and business functions inthe best way for the company to meetits goals


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Controlling activities and evaluatingthe performance of managers A companys performance can be

measured against the budgetsestablished for those plans

Motivating managers

Budget that are challenging improveperformance

Set challenging but achievable targets


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m n s ra on o u ge ngProcess

Budget committee

Consists of high level executivesrepresenting the major segments of thebusiness

Responsibility: to ensure that budgets arerealistically established and coordinatedsatisfactorily

Appointment of budget officer (usually

accountant) to coordinate the individualbudgets into a comprehensive budget.


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Administration of BudgetingProcess (cont.)

Accounting staff

Assist managers in the preparation of

their budgets Provide past information that may be

useful for budget preparation

Provide a valuable advisory and clericalservice for line managers


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Administration of BudgetingProcess (cont.)

Budget manual

Describe the objectives and procedures

involved in the budgeting process Useful reference source for managers

responsible for budget preparation

Circulated to those responsible forbudget preparation


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Stages in the Budgeting

Communicating details of budgetpolicy and guidelines to those peopleresponsible

Determining the factor that restrictsoutput

Preparation of sales budget

Initial preparation of various budgets


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Stages in the Budgeting(cont.)

Negotiation of budgets withsuperiors

Coordination and review of budgets Final acceptance of budgets

Ongoing review of budgets


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Master Budget

A comprehensive financial plan madeup of various individual departmentaland activity budgets for the year

A set of budgeted financial statementsthat summarize managementsoperating and financial plans for a

future time period


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Master Budget

Components of Master budget: Operating Budget

Concerned with income generatingactivities

Financial Budget

Concern with future inflow and outflows ofcash and with financial position


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The Role of Budgeting inPlanning and Control

Components ofthe MasterBudget


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8-

The Role of Budgeting inPlanning and Control

The Master Budget and Its Interrelationships


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Operating Budgets Operating Budget components:

Sales budget

Production budget

Direct material purchase budget

Direct labour budget Overhead budget

Ending finished goods inventory budget

Cost of goods sold budget

Marketing expense budget

Administrative expense budget

Research and development expense budget

Budgeted Income statement


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Financial Budget

Capital Expenditure Budget

Cash Budget

Budgeted Balance Sheet and

Budgeted Cash Flows Statement


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Cash Budget

A detailed plan that shows all expectedsources and uses of cash

Consists of 5 main sections: Total cash available

Total cash disbursement

The cash excess or deficiency The Financing Section


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Cash Budget (cont.)

Total cash available=Beginning Bal. + Cash receipts

Cash receipts include mainly:

Cash sales Collection from credit sales

The collection pattern of credit sales can bedetermined from past experience using anaccounts receivable aging schedule


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Cash Budget

Cash disbursement section includes allplanned cash outlays for the periodincluding purchase of materials,

payment of wages and payment ofother expenses

Does not include:

Interest payment on short term loan (willappear in the financing section)

Non cash expenses (e.g depreciation)


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Cash Budget

Compares cash available and cashneeded

Total cash needed = Total cashdisbursements + Min. Cash bal

Minimum cash balance is the lowest

amount of cash on hand that a firmfinds acceptable


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Cash Budget

Financing section consists of:

Borrowings

Planned repayments, including interest

Planned ending cash balance reflects

the minimum cash balance


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Static Budget

Static Budgets prepared for asingle level of activity

Master Budget is a Static Budget

Fl ibl B d ti


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Flexible Budgeting

Flexible Budgets prepared for several

levels of activity within relevant range Flexible Budget also known as

Variable Budget

Flexible Budgets provides (1)expected costs for a range of activityor (2) provides budgeted costs for

the actual level of activity


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Flexible Budgeting (cont.)

Can be used to examine theefficiency and effectiveness of afirm

Efficiency is achieved when thebusiness process is performed in thebest possible way with little or nowaste

Effectiveness means that a managerachieves or exceeds the goalsdescribed by the static budget


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Incremental Budgeting

Existing operations and the currentbudgeted allowance for existingactivities are taken as starting point for

the next annual budget. Indirect costs and support activities are

prepared on an incremental basis

Adjust the base for changes( changesin product mix, volume and price)


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Incremental Budgeting

Disadvantages: majority ofexpenditure associated with the base

level of activity remains unchanged,cost of non- unit level activitiesbecomes fixed and waste inherent in

the current way of doing things will beperpetuated


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Zero Based Budgeting

A budgeting approach in which the initialbudget for each activity in an organisation isset to zero

An attempt overcome the limitations of

incremental budgets To be allocated resources, an activitys

continuing existence must be justified by theappropriate management personnel

Focuses on programmes/activities instead offunctional department based on line items


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Zero-based budgeting

Benefits:

Traditional budgeting tend to extrapolate thepast by adding a percentage increase to thecurrent year. ZBB avoids the deficiencies ofincremental budgeting and represents a

move towards the allocation of resources byneed or benefit.The level of funding is nottaken for granted

ZBB create a questioning attitude rather than

assumes that current practice representsvalue for money

ZBB focuses on outputs in relation value formoney


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Activity Based Budgeting

Incorporates a broader set of costdrivers into the budget

Requires more detail information

(extends ABC into budgetingprocess)

Leads to more insights about ways

firms can better manage futurecosts


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Behavioral Dimensions ofBudgeting

Budgets often used to judge theperformance of managers

Promotion/salary increases are affected

by the managers abilities to achieve orbeat the budgeted goals

Hence budgets can have significant

behavioral effect Positive behaviour occurs when the

individual goals are aligned with the

organisational goals (goal congruence)


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Behavioral Dimensions ofBudgeting (cont.)

If budget improperly administered,negative behaviour occurs

Dysfunctional behaviour : individual

behaviour in conflict with the goals oforganisation

Key features that a budgetary system

should have to encourage managers toengage in goal congruent behaviour


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Key features of a good Budgetarysystem

Frequent feedback on Performance

Managers need to know how well they aredoing

Provision of frequent and timely reportsallows them to know how successful theirefforts have been and gives managers timeto take corrective actions

Can help reinforce positive behaviour andgives managers time to adapt to changingconditions


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Key features of a good budgetarysystem

Monetary incentives and non monetaryincentives Incentives are the means that are used to

encourage managers to work toward

achieving the organisational goals incentives should be tied to the budgetary

system

Realistic standards Budgeted objectives are used to gauge

performance, hence they should be based onrealistic conditions and expectations


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Key features of a good Budgetarysystem

Controllability of costs Managers should be held accountable only

for costs over which they have control

Controllable costs are costs whose level amanager can influence

Participative Budgeting


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Participative Budgeting

Allows subordinate managersconsiderable say in how the budgetsare established

Emphasise on the accomplishment ofbroad objectives not on individualbudget items


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Participative Budgeting (cont..)

Advantages:

communicates a sense of responsibility tosubordinate managers,

foster creativity, more likely that budget will beaccepted and becomes the personal goals ofmanagers

increased responsibility and challenge inherent

in the process provide non-monetary incentivesthat lead to a higher level of performance

Involvement of individual whose knowledge oflocal conditions may enhance the planning

process


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Participative Budgeting (cont.)

Potential problems: Setting standards that are either too high

or too low. Making mistakes in setting thebudget can result in decreased

performance levels.Setting easilyachievable targets may cause themanager to loose interest and performancemay drop. Setting too tight budgetsensures failures to achieve the targets andfrustrates the manager.


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Building slack into the budget Budgetary slack exists when the manager

deliberately underestimates revenuesor/and overestimates costs.

Either approach increase the likelihood that themanager will achieve the budget andconsequently reduce the risk that the managerfaces

Padding the budget also ties up resources that

might be used more productively elsewhere Can be eliminated if the top management dictates

lower expense budget. Also review budgetscarefully and provide input where needed


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Psuedo participation

Management assumes total control of thebudgeting process, seeking onlysuperficial participation from lower levelmanagers

Top management way of obtaining formal

acceptance of the budget not seeking realinput.


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Key features of a goodbudgetary system

Realistic standards

- Should be based on realistic conditions

and expectations- Should reflect operating realities suchas actual level of activity, seasonalvariations and general economic trends


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Key features of a goodbudgetary system

Controllability of cost

- managers are held accountable for costs

that they can control.- controllable costs are costs whose levela manager can influence.


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Key features of a good Budgetary system

Multiple measures of performance Do not use budget as the only measure of

managerial performance

overemphasis on this measure can lead to a formof dysfunctional behavior (myopic behaviour occurs

when a manager tale actions that improvebudgetary performance in the short run but bringlong run harm to the firm

Eg to meet the cost or profit objectives, managerscan reduce expenditures for preventive

maintenance, advertising and new productdevelopment. May also fail to promote deservingemployees to keep the cost of labour low andchoose low quality materials to reduce cost ocmaterials

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