BUDGET AND BUDGETARY CONTROL

Definition of Budget Purpose of Budgeting Budget Administration Stages and Process of Budgeting Master Budget and its Preparation Static Budgets vs Flexible Budgets Incremental Budgeting Zero-based Budgeting Behavioral Dimensions of Budgeting

Definitions of Budget

A detailed plan, expressed in quantitative terms that specifies how resources will be acquired and used during a specified period of time Budgets are the quantitative expression of plans that identify an organisations objectives and actions needed to achieve them. They form the basis for operations

BUDGET

A BUDGET IS (A) THE QUANTITATIVE EXPRESSION OF A PROPOSED PLAN OF ACTION BY MANAGEMENT FOR ASPECIFIED PERIOD AND (B) AN AID TO COORDINATING WHAT NEEDS TO BE DONE TO IMPLEMENT THAT PLAN

Purpose of Budgeting

Planning annual operations

Budgeting forces management to plan for the future to develop an overall direction for the organisation, foresee problems and develop future policies

Communicating plans to the various responsibility centre managers

Communicating is getting the goals to be understood and accepted by the employees

Purpose of Budgeting

Coordinating the activities of the various parts of the organisation and ensuring that the parts are in harmony with each other

Coordination is meshing and balancing all factors of production and all departments and business functions in the best way for the company to meet its goals

Purpose of Budgeting

Controlling activities and evaluating the performance of managers

A companys performance can be measured against the budgets established for those plans

Motivating managers
Budget that are challenging improve performance Set challenging but achievable targets

Administration of Budgeting Process

Budget committee
Consists of high level executives representing the major segments of the business Responsibility: to ensure that budgets are realistically established and coordinated satisfactorily Appointment of budget officer (usually accountant) to coordinate the individual budgets into a comprehensive budget.

Administration of Budgeting Process (cont.)

Accounting staff
Assist managers in the preparation of their budgets Provide past information that may be useful for budget preparation Provide a valuable advisory and clerical service for line managers

Administration of Budgeting Process (cont.)

Budget manual
Describe the objectives and procedures involved in the budgeting process Useful reference source for managers responsible for budget preparation Circulated to those responsible for budget preparation

Stages in the Budgeting

Communicating details of budget policy and guidelines to those people responsible Determining the factor that restricts output Preparation of sales budget Initial preparation of various budgets

Stages in the Budgeting(cont.)

Negotiation of budgets with superiors Coordination and review of budgets Final acceptance of budgets Ongoing review of budgets

Master Budget

A comprehensive financial plan made up of various individual departmental and activity budgets for the year
A set of budgeted financial statements that summarize managements operating and financial plans for a future time period

Master Budget

Components of Master budget:

Operating Budget
Concerned with income generating activities

Financial Budget
Concern with future inflow and outflows of cash and with financial position

The Role of Budgeting in Planning and Control

Components of the Master Budget

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The Role of Budgeting in Planning and Control

The Master Budget and Its Interrelationships

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Operating Budgets

Operating Budget components: Sales budget Production budget Direct material purchase budget Direct labour budget Overhead budget Ending finished goods inventory budget Cost of goods sold budget Marketing expense budget Administrative expense budget Research and development expense budget Budgeted Income statement

Financial Budget
Capital

Expenditure Budget Cash Budget Budgeted Balance Sheet and Budgeted Cash Flows Statement

Cash Budget
A detailed plan that shows all expected sources and uses of cash Consists of 5 main sections:

Total cash available Total cash disbursement The cash excess or deficiency The Financing Section

Cash Budget (cont.)

Total cash available =Beginning Bal. + Cash receipts Cash receipts include mainly:

Cash sales Collection from credit sales

The collection pattern of credit sales can be determined from past experience using an accounts receivable aging schedule

Cash Budget
Cash disbursement section includes all planned cash outlays for the period including purchase of materials, payment of wages and payment of other expenses Does not include:

Interest payment on short term loan (will appear in the financing section) Non cash expenses (e.g depreciation)

Cash Budget
Compares cash available and cash needed Total cash needed = Total cash disbursements + Min. Cash bal Minimum cash balance is the lowest amount of cash on hand that a firm finds acceptable

Cash Budget

Financing section consists of:

Borrowings Planned repayments, including interest

Planned ending cash balance reflects the minimum cash balance

Static Budget

Static Budgets prepared for a single level of activity Master Budget is a Static Budget

Flexible Budgeting
Flexible Budgets prepared for several levels of activity within relevant range Flexible Budget also known as Variable Budget Flexible Budgets provides (1) expected costs for a range of activity or (2) provides budgeted costs for the actual level of activity

Flexible Budgeting (cont.)

Can be used to examine the efficiency and effectiveness of a firm Efficiency is achieved when the business process is performed in the best possible way with little or no waste Effectiveness means that a manager achieves or exceeds the goals described by the static budget

Incremental Budgeting
Existing operations and the current budgeted allowance for existing activities are taken as starting point for the next annual budget. Indirect costs and support activities are prepared on an incremental basis Adjust the base for changes( changes in product mix, volume and price)

Incremental Budgeting

Disadvantages: majority of expenditure associated with the base level of activity remains unchanged, cost of non- unit level activities becomes fixed and waste inherent in the current way of doing things will be perpetuated

Zero Based Budgeting

A budgeting approach in which the initial budget for each activity in an organisation is set to zero An attempt overcome the limitations of incremental budgets To be allocated resources, an activitys continuing existence must be justified by the appropriate management personnel Focuses on programmes/activities instead of functional department based on line items

Zero-based budgeting

Benefits:

Traditional budgeting tend to extrapolate the past by adding a percentage increase to the current year. ZBB avoids the deficiencies of incremental budgeting and represents a move towards the allocation of resources by need or benefit.The level of funding is not taken for granted ZBB create a questioning attitude rather than assumes that current practice represents value for money ZBB focuses on outputs in relation value for money

Activity Based Budgeting

Incorporates a broader set of cost drivers into the budget Requires more detail information (extends ABC into budgeting process) Leads to more insights about ways firms can better manage future costs

Behavioral Dimensions of Budgeting

Budgets often used to judge the performance of managers Promotion/salary increases are affected by the managers abilities to achieve or beat the budgeted goals Hence budgets can have significant behavioral effect Positive behaviour occurs when the individual goals are aligned with the organisational goals (goal congruence)

Behavioral Dimensions of Budgeting (cont.)

If budget improperly administered, negative behaviour occurs Dysfunctional behaviour : individual behaviour in conflict with the goals of organisation Key features that a budgetary system should have to encourage managers to engage in goal congruent behaviour

Key features of a good Budgetary system

Frequent feedback on Performance

Managers need to know how well they are doing Provision of frequent and timely reports allows them to know how successful their efforts have been and gives managers time to take corrective actions Can help reinforce positive behaviour and gives managers time to adapt to changing conditions

Key features of a good budgetary system

Monetary incentives and non monetary incentives

Incentives are the means that are used to encourage managers to work toward achieving the organisational goals incentives should be tied to the budgetary system

Realistic standards

Budgeted objectives are used to gauge performance, hence they should be based on realistic conditions and expectations

Key features of a good Budgetary system

Controllability of costs
Managers should be held accountable only for costs over which they have control Controllable costs are costs whose level a manager can influence

Participative Budgeting

Participative Budgeting
Allows subordinate managers considerable say in how the budgets are established Emphasise on the accomplishment of broad objectives not on individual budget items

Participative Budgeting (cont..)

Advantages:

communicates a sense of responsibility to subordinate managers, foster creativity, more likely that budget will be accepted and becomes the personal goals of managers increased responsibility and challenge inherent in the process provide non-monetary incentives that lead to a higher level of performance Involvement of individual whose knowledge of local conditions may enhance the planning process

Participative Budgeting (cont.)

Potential problems:

Setting standards that are either too high or too low. Making mistakes in setting the budget can result in decreased performance levels.Setting easily achievable targets may cause the manager to loose interest and performance may drop. Setting too tight budgets ensures failures to achieve the targets and frustrates the manager.

Participative Budgeting (cont.)

Building slack into the budget

Budgetary slack exists when the manager deliberately underestimates revenues or/and overestimates costs. Either approach increase the likelihood that the manager will achieve the budget and consequently reduce the risk that the manager faces Padding the budget also ties up resources that might be used more productively elsewhere Can be eliminated if the top management dictates lower expense budget. Also review budgets carefully and provide input where needed

Participative Budgeting (cont.)

Psuedo participation
Management assumes total control of the budgeting process, seeking only superficial participation from lower level managers Top management way of obtaining formal acceptance of the budget not seeking real input.

Key features of a good budgetary system

Realistic standards
- Should be based on realistic conditions and expectations - Should reflect operating realities such as actual level of activity, seasonal variations and general economic trends

Key features of a good budgetary system

Controllability of cost
- managers are held accountable for costs that they can control. - controllable costs are costs whose level a manager can influence.

Key features of a good Budgetary system

Multiple measures of performance

Do not use budget as the only measure of managerial performance overemphasis on this measure can lead to a form of dysfunctional behavior (myopic behaviour occurs when a manager tale actions that improve budgetary performance in the short run but bring long run harm to the firm Eg to meet the cost or profit objectives, managers can reduce expenditures for preventive maintenance, advertising and new product development. May also fail to promote deserving employees to keep the cost of labour low and choose low quality materials to reduce cost oc materials