Accounting 6310

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Accounting 6310

• Chapter 6 Budgeting

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Definition

• Budget
• Managements formal quantification of the
  operations of an organization for a future
  period.
• It is an aggregate forecast of all transactions
  expected to occur.

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Functions of Budgets
There is a trade-off between these two functions.
It helps to have different people in charge of
each of the two functions.
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Nature of Budget

• Generally covers one year
• Often broken down into monthly or quarterly
  budgets
• Sometimes have revolving or continuous budgets
  one quarter ends and another quarter is added
• Can prepare longer term budgets (3-5 years) to
  avoid short-term focus

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Relation to Strategic Planning

• Strategic planning
• Precedes budgeting
• Provides the framework for the annual budget
• Budget is a slice of the strategic planning pie
• Budget focuses on individual responsibility
  centers not whole company like strategic plan

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Purposes of Budgeting

• To fine-tune the strategic plan
• To help coordinate the activities of the several
  parts of the organization
• To assign responsibility to managers, to
  authorize the amounts they are permitted to
  spend, and 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

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Advantages of Budgeting
Advantages
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Questions for Managers

• Does the organizations strategy create economic
  value?
• Does the organization have enough cash to fund
  the strategy and remain solvent?
• Does the organization create enough value to
  attract the financial resources that it needs to
  fund long-term investment in new assets?
• Is there sufficient resources to implement the
  intended strategy?

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Issues in Budgeting

• Budgetary Slack
• Budgeting Revisions
• Participation in the Budgeting Process
• Human Factors in Budgeting
• Difficulty in Meeting Budget
• New Approaches to Budgeting

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Budgetary Slack

• Budgeting revenues lower than expected
• Budgeting expenses or costs higher than expected
• Represent easier targets to achieve
• Budgeting superiors must attempt to find this
  slack and eliminate it

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Budgetary Slack

• Some companies
• Reward managers for meeting exact budgets
• Automatically decrease expense figures and
  increase revenue figures for slack
• Penalize managers more for large unjustified
  increases in actual income than for decreases in
  actual income
• Ratchet effect
• Basing next years standard of performance on
  this years actual performance
• Causes employees to underperform

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Budgeting Revisions

• Too many changes in the budget renders it a
  useless control tool
• Must establish procedures for changing the budget
  during the period
• Some companies use sensitivity analysis with
  best, worst, and most likely cases. Managers are
  expected to discuss what decisions they would
  make in the best and worst cases.

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Participation in the Budgeting Process

• Top down
• Top management determines the budget and passes
  it down throughout the organization
• Bottom up
• Lower level management formulates the budget and
  top management makes changes if necessary
• More successful than top down

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Participative Budget System Bottom Up
Flow of Budget Data
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Participation in the Budgeting Process

• Bottom up
• Must make sure budgets meet the companys
  strategy
• Must make sure slack is limited
• Participative budgeting is especially helpful for
  responsibility centers that operate in dynamic
  environments since lower level managers have more
  information about their operations.

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Human Factors in Budgeting

• The success of budgeting depends upon
• The degree to which top management accepts the
  budget program as a vital part of the companys
  activities.
• The way in which top management uses budgeted
  data.
• When rewarded for meeting/not meeting the budget,
  employees may take risky actions.

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Degree of Budget Target Difficulty

• Budget should be challenging but attainable.
• Achievable budgets reduce data manipulation.
• Achievable budgets create positive attitudes
  among workers.
• If too difficult, budgets are often ignored.
• Overly difficult budgets may cause over
  commitment of resources.
• If too easy, managers may coast when budget is
  met.

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New Approaches to Budgeting

• Line-item budgets
• Managers can spend only up to the specified
  amount on each line item (no borrowing from other
  areas).
• Budget lapsing
• No carryover of unused amounts to future years
• Zero-based Budgets
• Every line item must be justified

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New Approaches to Budgeting

• Beyond Budgeting (Break the annual performance
  trap!)
• Do not use budgets in performance evaluation or
  reward systems use them only for PLANNING
  purposes.
• Evaluate employees on other measures, including
  benchmarking or nonfinancial factors

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Examples of Budgets

• Revenues
• Production costs and cost of goods sold
• Variable and fixed costs
• Other budgets

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Revenue Budgets

• Estimate level of sales
• First and most important budget
• Drives all other budgets
• If sales are too low, inventory may build up
• Can start with past sales and adjust for economic
  and other factors
• Often very uncertain

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Cost Budgets

• Budgeted production cost and cost of sales
• Often represent the standard cost of items
  produced or acquired
• Includes budgets for the necessary production
  materials, labor and overhead
• Includes inventory assumptions

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Cost Budgets

• Variable costs
• Often vary by sales
• Delivery costs, commissions, order taking
• Nonvariable costs
• Committed costs - costs already determined by
  previous decisions in the short-run salaries,
  rent, depreciation, past advertising commitments

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Cost Budgets

• Nonvariable costs
• Discretionary costs - costs that can be incurred
  or not depending on available resources
  training, advertising, travel, research and
  development
• Activity-based indirect costs - costs that vary
  with some other cost driver than sales or
  production volume

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Other Budgets

• Capital Budget
• Planned spending on capital projects
• Budgeted Balance Sheet contains revised
  balances after previous budgets prepared
• Budgeted Cash flow Statement shows how much
  cash will be needed and whether outside financing
  sources will be needed
• Management by Objective management objectives
  are quantified and managers are held accountable
  for them.

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Homework

• Computer Budget Project 1 50 points
• DUE WEDNESDAY, APRIL 8
• Computer Budget Project 2 50 points
• DUE WEDNESDAY, APRIL 15