Chapter 7

The Budget Process

1. What is the importance of the budgeting process?

2. How do the advantages and disadvantages of

imposed budgets and participatory budgets

compare?

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Learning Objectives

3. Why does a budget manual facilitate the budgeting process?

4. What complicates the budgeting process in a multinational

environment?

5. What is the starting point of a master budget and why is this

item chosen?

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Continuing . . . Learning Objectives

6. How are the various master budget schedules

prepared and how do they relate to one another?

7. Why is the cash budget so important in the master

budgeting process?

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Continuing . . . Learning Objectives

8. How does the statement of cash flows relate to

the income statement and the cash budget?

9. Why does actual revenue from a product differ

from budgeted revenue? (Appendix)

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Continuing . . . Learning Objectives

10. How does traditional budgeting differ from

zero-based budgeting? (Appendix)

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Continuing . . . Learning Objectives

Different Roles of Budgeting

Process and Budgets

• Planning• Motivation• Evaluation• Coordination• Communication• Education• Ritual

Participation

in the Budgeting Process

Imposed budgets

Participatorybudgets

Middle Management

Operational Management

TopManagement

Best Times to Use Imposed Budgets

• In start-up organizations• In extremely small businesses• In times of economic crisis• When operating managers lack budgetary skills or

perspective• When organizational units require precise

coordination of efforts

Advantages of Imposed Budgets

• Increase probability that organization’s strategic plans will be incorporated in planned activities

• Enhance coordination among divisional plans and objectives

• Use top management’s knowledge of overall resource availability

• Reduce the possibility of input from inexperienced or uninformed lower-level employees

• Reduce the time frame for the budgeting process

Disadvantages of Imposed Budgets

• May result in dissatisfaction, defensiveness, and low morale among individuals who must work under the budget

• Reduce the feeling of teamwork• May limit the acceptance of the stated goals and objectives• Limit the communication process among employees and

management• May create a view of the budget as a punitive device• May result in unachievable budgets for international divisions if

local operating and political environments are not adequately considered

• May stifle the initiative of lower-level managers

Best Times to Use

Participatory Budgets

• In well-established organizations• In extremely large businesses• In times of economic affluence• When operating managers have strong budgetary

skills and perspectives• When organizational units are quite autonomous

Advantages of Participatory Budgets

• Provide information from persons most familiar with the needs and constraints of organizational units

• Integrate knowledge that is diffused among various levels of management

• Lead to better morale and higher motivation

• Provide a means to develop fiscal responsibility and budgetary skills of employees

• Develop a high degree of acceptance of and commitment to organizational goals and objectives by operating management

Continuing . . . Advantages of

Participatory Budgets

• Are generally more realistic

• Allow organizational units to coordinate with one another

• Allow subordinate managers to develop operational plans that conform to organizational goals and objectives

• Include specific resource requirements

• Blend overview of top management with operating details

• Provide a social contract that expresses expectations of top management and subordinates

Disadvantages of

Participatory Budgets• Require significantly more time

• Create a level of dissatisfaction with the process approximately equal to that occurring under imposed budgets in cases in which the effects of managerial participation are negated by top-management changes

• Create an unachievable budget in cases in which managers may be ambivalent or unqualified to participate

• May cause managers to introduce slack into the budget

• May support “empire building” by subordinates

• May start the process earlier in the year when there is more uncertainty about the future year

Budget Manual

• Statements of the budgeting purpose and its desired results

• A listing of specific budgetary activities to be performed

• A calendar of scheduled budgetary activities

• Sample budget forms• Original, revised, and approved

budgets

Calendar Budget Period

Year

Quarter 1 Quarter 2 Quarter 3 Quarter 4

October

November

December

January

February

March

April

May

June

July

August

September

The Master Budget

A comprehensive set of an organization’sbudgetary schedules and

pro forma (projected) financial statements

Composition of the Master Budget

Operating Budgets(units & dollars)

Financial Budgets(dollars)

Sales BudgetProduction BudgetPurchases BudgetDirect Labor BudgetOverhead BudgetSelling & Administrative

Budget

Cash BudgetCapital BudgetSchedule of Cost of Goods

ManufacturedIncome StatementStatement of Retained

EarningsBalance SheetStatement of Cash Flows

Budget Example

Sales budgets by month:

January $200

February 300

March 400

Variable cost of goods sold will be 60 percent of sales dollars.

Other variable costs will be 15 percent of sales dollars, paid one month later.

Total fixed costs for the year will be $240, of which $10 per month is depreciation expense.

Balance Sheet, December 31, 19x0

Assets: Liabilities:

Cash 30$ Accts. payable 180$

Accts. receivable 288 Accrued payables 25

Inventory 300 Total liabilities 205$

Plant & equip., net 300 Common stock 500

Retained earnings 213

Total 918$ Total 918$

Budgeted Income Statement for the

Quarter Ending March 31, 19x1

Jan. Feb. Mar. Total

Sales 200$ 300$ 400$ 900$

Variable cost of goods sold 120 180 240 540

Gross margin 80$ 120$ 160$ 360$

Other variable costs 25 30 45 100

Contribution margin 55$ 90$ 115$ 260$

Fixed costs 20 20 20 60

Income 35$ 70$ 95$ 200$

Purchases Budget for the Three

Months Ending March 31, 19x1

Jan. Feb. Mar. Total

Cost of sales 120$ 180$ 240$ 540$

Ending inventory* 420 540 660 660

Total requirements 540$ 720$ 900$ 1,200$

Beginning inventory 300 420 540 300

Purchases required 240$ 300$ 360$ 900$

*Ending inventory is equal to the next two month'sCOGS. April's and May's sales were estimated as $500and $600, respectively.

Cash Collections from Customers

Collections are estimated to be 20 percent in the month of sale, 48 percent the month following, and 32 percent in the second month following. There are no uncollectible accounts.

Cash Receipts

Jan. Feb. Mar. Total

Sales for the month 200$ 300$ 400$ 900$

Collections from sales:

20% of current month's 40$ 60$ 80$ 180$

48% of prior month's* 120 96 144 360

32% of second month's* 88 80 64 232

Total cash collections 248$ 236$ 288$ 772$

*November and December sales were $275 and $250, respectively

Cash Disbursements for Purchases

Jan. Feb. Mar. Total

Budgeted purchases 240$ 300$ 360$ 900$

Payments 180$ 240$ 300$ 720$

Purchases are paid for the month following the purchase.

Cash Disbursements–All Costs

Jan. Feb. Mar. Total

For purchases 180$ 240$ 300$ 720$

Other variable costs 25 30 45 100

Fixed costs 10 10 10 30

Total 215$ 280$ 355$ 850$

Tentative Cash Budget

Jan. Feb. Mar. Total

Beginning balance 30$ 63$ 19$ 30$

Collections 248 236 288 772

Total available 278$ 299$ 307$ 802$

Disbursements 215 280 355 850

Ending balance 63$ 19$ (48)$ (48)$

Minimum Cash Balance Policies

Financial managers devote considerable attention to determining the needed minimum level of cash. As with most decisions, a trade off between two conflicting factors is involved. Too small a minimum balance would lead to a higher probability of running out of cash, while too large a minimum balance would lead to little or no return.

Continuing . . .

Minimum Cash Balance Policies

In this example, the desired minimum cash is $25,000. Cash can be borrowed in $5,000 increments at an interest rate of 12 percent per year.

Revised Cash Budget

Jan. Feb. Mar. Total

Beginning balance 30$ 63$ 29$ 30$

Collections 248 236 288 772

Total available 278$ 299$ 317$ 802$

Disbursements 215 280 355 850

Tentative balance 63$ 19$ (38)$ (48)$

Borrowing 10 65 75

Ending balance 63$ 29$ 27$ 27$

Budgeted Income Statement for the

Quarter Ending March 31, 19x1

Total

Sales $900.00

Variable cost of goods sold 540.00

Gross profit $360.00

Other variable costs 100.00

Contribution margin $260.00

Fixed costs 60.00

Operating income $200.00

Interest expense 0.85

Income $199.15

Balance Sheet, March 31, 19x1

Assets: Liabilities:

Cash $27.00 Accts. payable $360.00

Accts. receivable 416.00 Accrued expenses 60.00

Inventory 660.00 Short-term loan 75.00

Plant & equip., net 270.00 Accrued interest 0.85

Total liabilities $495.85

Common stock 500.00 Retained earnings 377.15

Total $1,373.00 Total $1,373.00

Total Revenue Variance

Actual sales

(ASP x AV)

Budgeted Sales

(BSP x BV)

Total Revenue Variance*

*Favorable or unfavorable

Sales Price Variance

ASP x AV BSP x BVBSP x AV

SalesPrice Variance

AV (ASP - BSP) *

*Favorable or unfavorable

Sales Volume Variance

ASP x AV BSP x BVBSP x AV

BSP (AV - BV) *

*Favorable or unfavorable

Sales Volume

Variance

Example

The Maine Lobsters budget 1999 ticket sales at $70,000 per home game, which represent the sale of an estimated 10,000 tickets at a selling price of $7. At July’s first home game, actual gate ticket revenue was $66,000, creating a total unfavorable revenue variance of $4,000. The actual sales consisted of 12,000 tickets at $5.50.

Revenue Variance Calculations

Total Revenue Variance equals:

70,000 - ($5.50 x 12,000) = $4,000 U

Sales Price Variance equals:

12,000 x ($5.50 - $7.00) = $18,000 U

Sales Volume Variance equals:

$7.00 x (12,000 - 10,000) = $14,000 F

Traditional Budgeting

• Starts with last year’s funding appropriation• Focuses on money• Does not systematically consider alternatives

to current operations• Produces a single level of appropriation for an

activity

Zero-Based Budgeting

• Starts with a minimal (or zero) figure for funding

• Focuses on goals and objectives• Directly examines alternative approaches to

achieving similar results• Produces alternative levels of funding based

on availability of funds and desired results