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Nama : Erlinda Katlanis NIM : 1081002089 Summary of Chapter 9 Budget Preparation Nature of a budget Budget has some characteristics,

such as: 1. 2. 3. 4. 5. 6. 7. A budget estimates the profit potential of the business unit. It is stated in monetary terms, although the monetary amounts may be backed up by nonmonetary amounts (e.g., units sold or produced). It generally covers a period of one year. It is a management commitment. The budget proposal is reviewed and approved by an authority higher than the budegetee. Once approved, the budget can be changed only under specified conditions. Periodically, actual financial performance is compared to budget, and variances are analyzed and explained. The process of preparing a budget should be distinguished from: a. b. Strategic planning Forecasting

Relation to Strategic Planning Strategic planning and budger preparation involve planning, but the types of planning activities are different in the two processes. The budgeting process focuses on a single year, whereas strategic planning focuses on activities that extend over a period of several years. Strategic planning precedes budgeting and provides the framework within which the annual budget is developed. A budget is a one-year slice of the organizations strategic plan. Another difference between a strategic plan and a budget is that the former is essentially sturctured by product lines or other programs, while the latter is structured by responsibility centers. Contrast with Forecasting

A budget is a management plan, with the implicit assumption that positive steps will be taken by the budgeteethe manager who prepares the budgetto make actual events correspond to the plan. A forecast is merely a prediction of what will most likely happen, carrying no implication that the forecaster will attempt to so shape events that the forecast will be realized. Characteristics of a forecast: 1. 2. 3. 4. 5. 6. A forecast may or may not be stated in monetary terms. It can be for any time period. The forecaster does not accept responsibility for meeting the forecasted results. Forecasts are not usually approved by higher authority. A forecast is updated as soon as new information indicates there is a change in conditions. Variances from forecast are not analyzed formally or periodically.

Use of a budget 1. Fine-tuning the strategic plan The budget, which is completed just prior to the beginning of the budget year, provides an opportunity to use the latest available information and is based on the judgement of managers at all levels throughout the orgnization. 2. Coordination Example, line organizations may be assuming a higher level of service from support organizations than those organizations plan to provide. During the budget preparation process, these inconsistencies are identified and resolved. 3. Assigning responsibility The approved budget should make clear what each manager is responsible for and also authorizes responsibility center managers to spend specified amounts of money for certain designated purposes without seeking the approval of higher authority. 4. Basis for performance evaluation The budget represents a commitment by the budgetee to his or her superior. The commitment is subject to change if the assumptions on which it is based change, but the budget nevertheless is an excellent starting point for performance appraisal. The budget assigns responsibility to each responsibility center in the organizations.

Types of Plans and Their Contents Strategic Plan Operating Budget Revenue and expense for For organization each major program Not necessarily business unit by Classified by responsibilty centers Revenues Production cost of sales Marketing expense Logistics (sometimes) General administrative Research development Incomes (sometimes) Net income More variable expenses are Expenses may be: Flexible Discretionary Commited For several years Total reconciles For one year divided into monts or quarters to Total reconciles to Total project expenditures by quarters operating budget strategic plan (unless revised) taxes and and expense cost and responsibility operating budget as Capital budget a Each major capital project listed separately

whole and for each

Not as much detail as Typically includes:

Cash Forecast Budgeted Balance Sheet

Operating Budget Categories 1. Revenue budgets A revenue budget consists of unit sales projection multiplied by expected selling prices. The revenue budget is the most critical elemnt in a profit budget, but it is also subject to the greatest uncertainty element. It is usually based on forecasts of some conditions for which the sales manager cannot be held responsible. 2. Budgeted production cost and cost of sales Production managers make plans for obtaining quantities of material and labor, and may prepare procurement budgets for long-lead-time items. They also develop production schedules to ensure that resources needed to produce the budgeted quantities will be available. The budgeted cost developed by the production managers may not be for the same quantities of products as those shown in the sales budget; the difference represents additions to or substractions from finished goods inventory. The cost of sales reported in the summery budget is the standard cost of the products budgeted to be sold. 3. Marketing expenses Marketing expenses are expenses incurred to obtain sales. Advertising must be prepared months in advance of its release, and contracts with media also are placed months in advance. Logisctics expenses usually are reported separately from order getting expenses. They include order entry, warehousing and order picking, transportation to the customer, and collection of accounts receivable. 4. General and administrative expenses These are G&A expenses of staff units, both at headquarters and at business unit. Overall, they are discretionary expenses, although some components are engineered expenses. 5. Research and development expenses The R&D budget uses either of two approaches, or a combination of them. In one approach, total amount is the focus. The alternative approach is aggregating the palnned spending on each approved project, plus an allowance for work that is likely to be undertaken even though it is not currently identified. 6. Income taxes

Although the bottom line is income after income taxes, some companies do not take income taxes into account in preparing the budgets for business units and the policies of income taxes are determined at corporate headquarters. Other Budgets 1. Capital budget The capital budget states the approved capital projects, plus a lump-sum amount for small projects that do not require high-level approval. It is usually prepared separately from the oprating budget and by different people. 2. Budgeted balance sheet The budgeted balance sheet shows the balance sheet implications of decisions included in the operating budget and the capital budget. 3. Budgeted cash flow statement The budgeted cash flow statement shows how much of the cash needs during the year will be supplied by retained earnings and how much, if any, must be obtained by borrowing or from other outside sources. 4. Management by objectives The objective of each responsibility center are set forth in quantitative terms wherever possible, and, as in the case with the budgeted amounts, are accepted by the responsible manager. Unfortunately, some management by objectives (MBO) systems are separated from the budget preparation process. This is beacuse MBO was initially advocated by authors of personnel texts and articles, whereas the financial budget is the province of management accounting texts. Budget Preparation Process Organization Budget Department The budget department has some functions, such as: 1. 2. 3. Publishes procedures and forms for the preparation of the budget. Coordinates and publishes each year the basic corporatewide assumptions that are to be the basis for the budgets. Makes sure that information is properly communicated between interrelated organization units.

4. 5. 6. 7. 8.

Provides assistance to budgetees in the preparation of their budgets. Analyzes proposed budgets and makes recommendations, first to the budgetee and subsequently to senior management. Administers the process of making budget revisions during the year. Coordinates the work of budget departments in lower echelons. Analyzes reported performance against budget, interprets the result, and prepares summery reports for senior management.

The Budget Committee The budget committe consists of members of senior management, such as the chief executive officer, chief operating officer, and the chief financial officer. The budget committe reviews and either approves or adjusts each of the budgets. Issuance of Guidelines The first step in the budget preparation process is to develop guidelines that govern the preparation of the budget, for dissemination to all managers. These guidelines are implicit in the strategic plan. Staff also develops a timetable for the steps in the budget preparation process. Initial Budget Proposal Changes from the current level of performance can be classified as: 1. Changes in external forces a. Changes in the genral level of economic activity as it affects the volume of sales. b. Expected changes in the price of purchased materials and services. c. Expected changes in labor rates. d. Expected changes in the cost of discretionary activities. e. Changes in selling prices. 2. Changes in internal policies and practices a. Changes in production costs, reflecting new equipment and methods. b. Changes in discretionary costs, based on anticipated changes in workload. c. Changes in market share and product mix.

Negotiation The budgetee discusses the proposed budget with his or her superior. The superior attempts to judge the validity of each of the adjustments. The superior must be prepared to defend the budget that is finally agreed to. Slack Slack is the difference between the budget amount and the best estimate. Review and Approval The proposed budgets go up through succesive levels in the organization. When they reach the top of a business unit, analysts put the pieces together and examine the total. Final approval is recommended by the budget committee to the chief executive officer. The CEO also submits the approved budget to the board of directors for ratification. Budget Revisions There are two general types of budget revisions: 1. 2. Procedures that provide for a systematic updating of the budgets. Procedures that allow revisions under special circumstances.

Budget revisions must be justified on the basis of significantly changed conditions from those existing when the original budget was approved. Contingency Budgets Contingency budget is identify management actions to be taken if there is a signifiacnt decrease in the sales volume from what was anticipated at the time of developing the budget. It provides a way of quickly adjusting to changed conditions if the situation arises. Behavioral Aspects There are some motivational considerations in the preparation of operating budgets, such as: 1. Participation in the budgetary process There are two reasons that budget participation has positive effects on managerial motivation:

a. There is likely to be greater acceptance of budget goals if they are perceived as being under managers personal control, rather than being imposed externally. b. Participative budgeting results in effective information changes. 2. Degree of budget target difficulty There are several reasons senior management approves achievable budgets for business units: a. If the budgeted target is too difficult, managers are motivated to take the shortterm actions that may not be in the long-term interests of the company. b. Achievable budget targets reduce the motivation for managers to engage in data manipulation to meet the budget. c. If business unit profit budgets represent achievable targets, senior management can, in turn, divulge a profit target to security analysts, shareholders, and other external constituencies with a reasonable expectation of being correct. d. A profit budget that is very difficult to attain usually implies an overly optimistic sales target. e. When business unit managers are able to meet and exceed their targets, there is a winning atmosphere and positive attitude within the company. 3. Senior management involvement Management must participate in the review and approval of the budgets and the approval should not be a rubber stamp. Management also must follow up on budget results. 4. The budget department The budget department must analyze the budgets in detail, and it must be certain that budgets are prepared properly and that the information is accurate. To perform their function effectively, the members of the budget department must have a reputation for impartiality and fairness. Quantitative Techniques Simulation Simulation is a method that constructs a model of a real situation and then manipulates this model in such a way as to draw some conclusions about the real situation. The preparation and review of a budget is a simulation process.

Probability Estimates Each number in abudget is a point estimatethat is, it is the single most likely amount. Some authors have proposed that budgets be prepared initially using probability distributions instead of point estimates.