Chapter 9

Budgeting systems

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 Outline
• Strategic planning and budgeting
systems
• Purposes of budgeting
• Responsibility accounting
• The annual budget: a planning tool
• Budget processes
• Behavioural consequences of budgeting
• Zero-base budgeting and program
budgeting
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 Strategic planning and
budgeting systems
• A budget is
– A detailed plan of future operating activities
– A financial model of future operations
– A core component of an organisation’s
planning and control system
– A critical way of providing information to
managers
– Regarded as short-term planning, typically
for one year (cont.)

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 Strategic planning and
budgeting systems (cont.)
• Strategic planning is long-term
planning usually undertaken by senior
managers
– Decisions about corporate strategy
– Decisions about business strategy
– A time horizon of three or more years
– Formulated in broad terms
– Directly influences the formulation of
budgets
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 Purposes of budgeting
• Planning
– Expresses a plan of action in financial
terms
• Facilitating communication and
coordination
– Provides a formal mechanism to enable
communication and coordination
• Allocating resources
– Provides a way of allocating limited
resources among competing users (cont.)

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 Purposes of budgeting (cont.)
• Controlling profit and operations
– The budget can serve as a benchmark
• Evaluating performance and
providing incentives
– Comparing actual results with a budget
helps managers evaluate performance
– Achievement of budget targets may be
linked to the payment of cash rewards or
profit sharing

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 Responsibility accounting
• Budgets usually reflect managers’
areas of responsibility
• Responsibility accounting
– Managers are responsible for their area
of the business
• Managers of various departments
– Develop budget estimates for their area
of responsibility
– They are then held responsible for
meeting those budget targets (cont.)

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Responsibility accounting (cont.)
• Responsibility centres
– A unit of the organisation whose manager is held
accountable for the unit’s activities and performance
– Cost centre, revenue centre, profit centre and
investment centre
– The type of responsibility centre determines the type
of financial results for which a manager is held
accountable

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The annual budget: a planning tool
• The annual budget (or master budget) is
a comprehensive set of budgets that
covers all aspects of a firm’s activities
– Consists of several interdependent budgets
– Financial budgets
– Operating budgets
– Large organisations: comprehensive formal
processes
– Smaller organisations: less formal processes
(cont.)

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 Components of the annual budget

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 The annual budget:
a planning tool (cont.)
• Operating budgets
– Sales budget
– Various cost budgets
• Financial budgets
– Budgeted income statement
– Budgeted balance sheet
– Cash budgets
– Capital expenditure budget
(cont.)

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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 9-11
 The annual budget:
a planning tool (cont.)
• Budgets are developed for specific time
periods
• Rolling budgets are continually updated
by adding a new time period and
dropping the period just completed
• Budgets vary in their level of detail,
often dependent on the size and
complexity of the organisation

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 Strategic plans and budget
assumptions
• Budgets commence with an
understanding of the strategy of the
organisation
• The budget should support the
organisation’s strategic plans
• The budget is based on assumptions
about the competitive and economic
environment
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Langfield-Smith, Thorne, Smith, Hilton Management Accounting, 7e 9-13
 Operating budgets:
the sales budget
• A detailed summary of estimated sales
units and revenues
• Sales volume is based on the sales
forecast
• Sales forecasting is a critical early
stage of the budgeting process
• Market research may be used to
estimate sales volume, selling price,
etc. (cont.)

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 Operating budgets:
the sales budget (cont.)
• Relevant factors depend on the type of
industry and nature of the organisation
• Internal factors: past sales levels, new
products planned, intended pricing policy,
and planned advertising and promotions
• External factors: general economic trends,
specific industry trends, political and legal
events, expected activities of competitors
and customers

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 Operating budgets:
the cost budget
• Manufacturing firms
− Production budget of direct materials, direct
labour and overheads
− Budgets for selling and administrative
expenses
• Retailers and wholesalers
− Purchasing budget of goods purchased for
resale
• Service firms
− Costs incurred to provide services
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 Detail of operating budgets for a
manufacturing business

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 Financial budgets
• The cash budget
– Expected cash receipts and planned cash
payments for the budget period
– Timing of all cash movements
– Allows the business to plan its financial
resources
• Capital expenditure budget
– A plan for the acquisition of long-term
assets, such as buildings
– May involve cash flows over many years
(cont.)
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 Financial budgets (cont.)
• Budgeted income statement
– Shows expected revenues and planned expenses for the
budget period
• Budgeted balance sheet
– Shows expected assets and liabilities at the end of the
budget period
• Both statements may be broken down by quarter or
month of the year

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 Budgets in not-for-profit
organisations and
government agencies
• Annual budget has many of same
components as for-profit organisation
• No sales budget if services provided for no
charge
• Service levels may drive the resources that
are needed and hence the cost budgets
• Other revenue budgets may be estimated
– Government grants, donations, sponsorships
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 Budgeting processes
• In large organisations, formal processes are
often used to collect data
• Budget administration often responsibility of
senior management
• A budget manual communicates:
− who is responsible for providing information
− when the information is required
− what form it will take
• A budget committee may be appointed
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 Behavioural consequences
of budgeting
• A budget affects virtually all staff in an
organisation
• Individuals’ reactions to the budgeting
process may affect an organisation’s
effectiveness
• Three main issues to consider
– Participative budgeting
– Budgetary slack
– Budget difficulty
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 Participative budgeting
• Where managers develop their own
initial budget estimates for their own
area of operations
– Top-down budgeting is where senior
managers impose budget targets
– Bottom-up budgeting is where lower
managerial and operations levels are active
in setting their own budgets
(cont.)

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 Participative budgeting (cont.)
• Participative budgeting benefits
– Encourages coordination and
communication between managers and
the wider organisation
– Leads to more accurate budget
estimates
– Leads to individuals identifying more
closely with the budget targets
(cont.)

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Participative budgeting (cont.)
• Participative budgeting costs
– Expensive and time-consuming
– Can cause delays and indecisiveness
– May aggravate differences and
disagreements
– Provides opportunities for padding the
budgets
• Employee empowerment is a wider
concept than budgetary participation
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 Padding the budget
• Managers intentionally underestimate
revenues or overestimate costs
• Budgetary slack
– Difference between the (padded) estimated revenue
or cost projection and a realistic estimate of revenue
or cost
• Reasons for padding the budget
– Manager’s performance looks better when they
exceed their budget
– A way of coping with uncertainty
– To guard against initial budget requests being cut
back by senior management
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 Budget difficulty
• Ensuring employees are motivated to
achieve the budget targets as their own
• Achieving goal congruence
− when the organisation’s goals coincide with
the individual’s goals
• Budgets should be set at a level that
provides challenge and stretch, but are
not unachievable
(cont.)

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 Budget difficulty (cont.)
• Budget acceptance occurs when
− Targets are developed with employees’
participation
− Targets are considered achievable
− There is frequent feedback on performance
− Individuals are held responsible for
activities that are within their control
− Achievement of targets is accompanied by
rewards that are valued

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 The effect of budget difficulty on
employee performance

Source: Emmanuel, Olley & Merchant (1990, p. 173)

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 Zero-base budgeting (ZBB)
• Managers must justify each activity in
order to receive an allocation of
resources
• Time-consuming and expensive to
implement
• Not useful in identifying areas of
waste, redundant activities or ways to
improve performance
• Can be too introspective
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 Program budgeting
• Budgets prepared for individual
programs and program objectives
• Control is achieved through
quantitative and qualitative
performance measures
• Often associated with budgeting in
government departments
• Focus is on outputs not inputs

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 Summary
• Budgeting is a detailed plan summarising the organisation’s financial
activities
• Five major purposes of a budgeting system are
− planning
− communication and coordination
− allocating resources
− controlling profit and operations
− evaluating performance and providing incentives
• Budgets are developed along responsibility lines
• Various formal budgeting systems
• Budgeting can have behavioural implications

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