•

Budgets
The various activities within a company should be coordinated
• by the preparation of plans of actions for future periods → These detailed plans are referred to
as budgets.

Conceptual questions-effect on human behaviour

– What you measure is what you get

– Motivation and Challenge factor

– Participation vs. Threat

Link to standard costing

1. Budgeted (total) vs. standard(per unit)

2. Flexed budget (std cost for actual production)

Link to absorption costing

1. Determination of overhead recovery rate (Budgeted

cost/Budgeted production)

Link to: Financial statement analysis, valuations.

Cash budgets: read and apply.

Background
Operations are the detailed activities of an organization.
- A budget is a plan of operations expressed in monetary terms.

The budget director organizes the budget process.

- This person suggests basic approaches, sets a timetable, provides computer support, and
interacts with managers.
- The result of the budget director’s efforts is a master budget, which is the planned income
statement and balance sheet.

There are various approaches to budgeting including annual, rolling, fixed, flexible, incremental, and
zero based.
Budgets occur in levels of summarization including account level, functional, project or program, and
total operations.
The normal order of preparation of operations budgets for a manufacturer is (1) sales, (2) production, (3)
purchases, labour, and overhead, (4) general and administrative expenses and (5) statement of
operations.

The process of developing a budget helps communicate goals and objectives from top management to
lower levels. If lower levels of management are expected to communicate back to top management,
there is participation in the process.
The budget provides part of the basis for performance evaluation. Budgeting often results in operations
that are better coordinated, more efficient, and more effective.

There are challenges associated with budgeting.

- Although some budgetary slack (padding) is useful for responding to changes in demands,
excessive slack is sometimes a symptom of rigid and bureaucratic budget approaches.
- During lean times, top managers tend to make counterproductive budget cuts. They reduce
budgets for departments in spite of needs.
- Sometimes, top managers are arbitrary in their allocations, which results in a lack of confidence
by lower-level managers. Budgets should not be rigid or fixed and participation should not be
faked.

Purpose of budgets

Planning

Goal
Coordination
congruence

WHY
PRODUCE
BUDGET?
Performance
Communication
management

Control Motivation
Conflicting roles of budgets

Bottom up vs Top Down

Bottom up: try to determine underlying costs of each department and then add up per level to get to the
top (total budget for organisation).

Top down: Senior management develops high-level budget for company which is then allocated to
various departments downwards.

Budget process
Types of budgets

Things to consider when preparing sales forecast

• Historical performance
• Expansion into international markets
• Impact of new legislation
• Impact of competition
• State of economy
• Seasonal fluctuations- nature of product
• Stability of suppliers
• Advertising and promotional campaigns

Disadvantages of budgeting
• Doesn’t take into account unforeseen events- budgets are static- comparing actual to ‘past’
• Time consuming exercise
• Conflicting roles in the budget- goal setting vs. motivation
• Restrictive – 12-month limit
• Top-down approach
• Must “spend” the budget
Zero-based budgeting
• What?
1. Zero base – each year’s budgets being compiled as if the projects are launched for the
first time
2. Question each line item on the income & expenses
• Benefits
1. Creates a questioning attitude
2. Aims for effective use of resources - achieving output in the best possible way
3. Eliminates past efficiencies/arbitrary extrapolations
4. Works best for discretionary costs e.g. Advertising
• Problems
1. People resistant to change- scared to be “challenged”
2. Time consuming
3. Costly to implement

Activity-based budgeting
• Conventional Approach
– Costs are allocated as a % of sales (Increase in sales = Increase in costs)
– Costs are then adjusted for changes in product mix, price, volume etc
• Activity-Based Budgeting
– Not all costs vary with the final output of products
– ABC: resources  activity  cost object
– ABB: cost object demand  activities required  resources required

Stages in the planning process

1. Identify the objectives of the organization
2. Identify potential strategies
3. Evaluate the alternative strategic options
4. Select a course of action
5. Implement the long-term plan in the form of the annual budget
6. Monitor actual process
7. Respond to divergence from plan

1. Identify the objectives of the organisation.

What is the organisation trying to achieve?
Attainment of objectives should be measurable
Should motivate people
Objectives that form the hierarchy:
1. Mission = broad purpose & reason for an organisation’s existence, nature of the business &
customers it seeks to serve.
2. Corporate objectives = relate to organisation as a whole. Measurable & expressed in
financial terms (ie: desired profits, sales levels, market share, growth rates).
3. Overall objectives are then broken down into subsidiary objectives → product range, market
segmentation, customer service
4. Unit objectives = specific objectives of individual units within the organisation → targets for
individual units.

2. Identify potential strategies:

Identify range of possible courses of action that might enable the company’s objectives to be achieved
Undertake a strategic analysis – to understand the company’s present position, strengths, weaknesses,
opportunities, threats
Determine the basis on which it will compete (select one as a company can’t be all things to all people):
 Cost leadership (lowest cost producer)
 Differentiation (unique to others)
 Focus (strategy on parts of the market)

Determine the directions it wishes to take –

 Doing nothing
 Withdrawing from some markets
 Selling existing products more effectively in existing markets
 Selling existing products in new markets
 Developing new products for sale in existing markets (product development)
 Developing new products for sale in new markets (diversification)

3. Evaluate alternative strategic options.

Alternative strategies should be examined based on the following criteria:
 Suitability – does the proposed strategies fit the situation identified in the strategic analysis?
 Feasibility – can the strategy be implemented in resource terms?
 Acceptability – will it be sufficiently profitable? Is the level of risk acceptable?

4. Select course of action.

Long-term plans should be created to implement the strategies.
A long-term plan = a statement of the preliminary targets and activities required to achieve strategic
plans together with a broad estimate for each year of the resources required.
5.Implement the long-term plan in the form of the annual budget:
Budgets are a clear indication of what is expected to be achieved during the budget period whereas long-
term plans represent the broad directions that top management intend to follow.
Budget is developed within the context of ongoing business and is ruled by previous decisions that have
been taken within the long-term planning process.

6.Monitor actual results.

Monitor

7.Respond to divergences from plan.

Control process of budgeting

The budget period

 Preparation of budgets on an annual basis is too rigid and ties a company to a twelve month
commitment, which can be risky because the budget is based on uncertain forecasts.
 An alternative approach is for the annual budget to be broken down by months for the first three
months, and by quarters for the remaining nine months (continuous or rolling budget).
 The quarterly budgets are then developed on a monthly basis as the year proceeds
Continuous / rolling budgeting:
 Ensures that a 12 month budget is always available by adding a quarter in the future as the
quarter just ended is dropped.
 Ensures that planning is not something that takes place once a year when the budget is being
formulated, instead budgeting is a continuous process, and managers are encouraged to
constantly look ahead and review future plans.
 Actual performance will be compared with a more realistic target, because budgets are
constantly reviewed and updated.
 Disadvantage = can create uncertainty for managers because the budget is constantly being
changed.

Administration of budgets
Budgeting committee
 Appoints budget officer who will coordinate individual budgets into a budget for the whole
organisation.
 Functional heads will present their budget to the committee for approval.
Accounting staff
 Assist managers in the preparation of their budgets.
 Do not determine the content of budgets, but provide advisory & clerical service.
Budget manual
 Describes the objectives and procedures involved in the budgeting process.
 Includes a timetable and dates when budgets should be presented to the budgeting committee.
Budgeting process

Sets of budgets
- Sales budget
- Production budget
- Direct materials budget
- Direct labour budget
- Factory overhead budget
- Selling and administration budget
- Departmental budgets
- Master budgets
- Cash budget

- See page 381 in drury for illustrated examples

Computerised budgeting
• Computer-based financial models are mathematical statements of the inputs and output
relationships that affect the budget.
• These models allow management to conduct sensitivity analysis to ascertain the effects on the
master budget of changes in the original predicted data or changes in the assumptions that were
used to prepare the budgets.
Line item budgets
• Expenditures are expressed in considerable detail, but the activities being undertaken are given
little attention.
• Shows the nature of the spending but not the purpose

Activity-based budgeting
- Conventional budgeting = budgeted expenses for forthcoming budget for support activities are
normally based on the previous year’s budget plus an adjustment for inflation.
- Support costs are considered to be fixed in relation to activity volume.
- Activity-based budgeting (ABB) aims to manage costs more effectively by authorizing the supply
of only those resources that are needed to perform activities required to meet the budgeted
production & sales volume.
- ABC assigns resource expenses to activities and then uses activity costs to cost objects (such as
products, services or customers) ABB is the reverse of this process.
- Cost objects are the starting point.
- Budgeted output determines the necessary activities which are then used to estimate the
resources that are required for budget period.
ABB involves the following stages:
- estimate the production & sales volume by individual products and customers;
- estimate the demand for organizational activities;
- determine the resources that are required to perform organizational activities;
- estimate for each resource the quantity that must be supplied to meet the demand ; and
- take action to adjust the capacity of resources to match the projected supply.

Planning, programming budgeting systems

- Non-profit organisations the annual budgeting process compares budgeted and actual inputs,
but does not provide information on the efficiency with which activities have been performed, or
the effectiveness in achieving objectives.
- Aim of PPBS is to enable the management of a non-profit organisation to make more informed
decisions about the allocation of resources to meet the objectives of the organisation.

PPBS involves the following stages:

- establishing the overall objectives;
- identifying the programmes to achieve these objectives; and
- determining the costs & benefits of the programmes so that budget allocations can be made on
the basis of cost-benefits of the different programmes.

Zero based budgeting

- ZBB is a method of budgeting that is mainly used in non-profit organisations but it can also be
applied to discretionary costs and support activities in profit organisations.
- Based on programmes (ie: health care) and not departments
- It seeks to overcome the deficiencies of incremental budgeting.
- ZBB works from the premise that projected expenditure for existing programmes should start
from base zero, with each year’s budgets being compiled as if the programmes were being
launched for the first time.