ACCT2102 Lecture 9: Budgeting (master budget components)
L9: Planning & Control 1: Master Budget
1. Define budgeting and discuss its role in planning, control and decision making
2. Describe the benefits (advantages) of budgeting
3. Describe the purpose of responsibility centres, responsibility accounting and the concept of controllability
4. Recognise the alternative (structural) approaches to budget development and the behavioural aspects of budgeting
5. Define and prepare the Master Budget – particularly the operating budget and its supporting schedules, and the
financial budget including the cash budget
6. Be able to explain the interrelationships of the Master Budget’s various components
7. Describe the limitations of budgeting !
8. Be aware of alternative budgeting approaches !
1. Define budgeting and discuss its role in planning, control and decision-making.
Budget is the financial picture of the proposed plan of the business (prepared by management for a specified
future time period), including actions needed to implement the plan.
Budgeting is a circular/continual movement. Budgets are the way firms transform strategic objectives into
operational goals.
Useful when integrated with the organisation’s strategy (own capabilities —> market opportunities)
Most widely used accounting tool in PLANNING and CONTROLLING.
The plan (in quantitative and financial terms) that specifies how an organisation will acquire and use
resources during a particular period of time (the next year) to achieve strategy.
- !The financial expression of goals for the coming period. !
- Allocates scarce resources among competing uses !
-Allows managers to plan for the future therefore reduces ‘uncertainty’. !
- Facilitates co-ordination and communication. !
- Control profit and operations !
- A guide for performance and a framework for evaluating performance and motivating employees !
- Useful for influencing management behaviour and motivating 7 managers in line with
organisational objectives
!
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2. Describe the benefits (advantages) of budgeting (D,F,A,B,C,C)
1. Defines goals and objectives
2. Forces management to think and plan for the future
3. A means of allocating resources, measuring performance, and rewarding employees.
4. Uncovers potential bottlenecks, cash shortfalls, etc
5. Coordinates activities
6. Communicates plans
Time Coverage of budgets
• Budgets typically have a set time period (a month, quarter or year).
Usually a rolling budget is preferred: a budget that is continually updated by adding a new time period (such
as a month) and dropping the period just completed. !
Result? Always have a budget that covers a specified future time period (e.g. a year). !
3. Describe the purpose of responsibility centres, responsibility accounting and the concept of
controllability
Responsibility Accounting: an underlying concept of accounting performance measurement systems.!
Why? Large diversified organisations are difficult to manage as a single segment – they must be
separated into manageable parts (responsibility centres)
It is a system for evaluating the performance of managers of responsibility centres based on activities under
their supervision.
- requires plans, budgets, actions and results of each responsibility centre
- It is about the degree of influence (rather than control)
- Focuses on information sharing–not in laying blame
- Its purpose is to ensure that each manager (and each employee) in the organisation is striving
towards the overall goals set by top management.
Responsibility accounting focuses on information and knowledge, not control !
• A responsibility accounting system could exclude all uncontrollable costs from a manager’s
performance report. !
• Consider a Division of a company–where the manager is ‘responsible’ as a profit centre manager.... !
Responsibility centre: A segment, or subunit of an organisation whose manager is responsible for specified
financial and non-finanical results of the subunit’s activities.
- A functional approach.
- Examples of responsibility centres: cost centres, revenue centres, profit centres, investment centres.
There will be a few departments under each centre. For example, the sales department of a particular product
line would be a revenue centre. If you are a salesman in charge of the sales of a product, then you are a
manager of the revenue centre. Your job is to bring in revenue for the company. So your budget/targets/
goals is all about revenue.
The next level (higher level of manager): There will be a manager responsible for the sales department
(revenue centre) AND the factory that is producing the product. He is called ‘product manager’. He would be
called ‘profit centre’ manager because his role is to maximise budget.
Even higher up. “Investment centre manager” would be assessed by Return On Investment (ROI). He is not
only controlling costs and revenues, but also the assets that he’s using the generate those profits. He’s
focused on maximising profit on every dollar of asset that he wants to use.
The choice of the type of responsibility center determines what the manager is accountable for and thereby
affects the manager’s behavior. For example, if a revenue center is chosen, the manager will focus on
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revenues, not on costs or investments. The choice of a responsibility center type guides the variables to be
included in the budgeting exercise.
BUDGET matches RESPONSIBILITY.
E.g. Cost manager will have a cost budget. Investment centre manager will have included in his budget the
profit that he’s going to make next year and the assets he’s going to use. He will have a target ROI.
Controllability: It is the degree of influence that a specific manager has over costs, revenues, or other items in
question. !
A controllable cost is any cost that is primarily subject to the influence of a given responsibility centre
manager for a given time period.
!
4. Recognise the alternative (structural) approaches to budget development and the behavioural
aspects of budgeting
Alternative (structural) approaches to budget development: information flows
Top-down budgeting: CEO —> Middle Management —> Operational Management
“we set it, you do it”
lack of ownersip/control felt by the personnel by having budget imposed on them.
Bottom-up budgeting: Operational Management —> Middle Management —> CEO
gets the finishing, assembly division, supervising division, to participate in preparing.
gives the lower level of managers feelings of responsibility/contributing/ownership for their budgets.
If you prepare your own budgets, you feel more motivated to achieve it.
Behavioural Implications of Budgeting: A budget affects virtually everyone in an organisation: those who
prepare it, those who use it to facilitate decision-making, and those who are evaluated using the budget.
Participative Budgeting —> People perform better and make greater attempts to achieve a goal if they have
been consulted in setting the goals.
But it can cause us to end up with inaccurate data, example is budgetary slack.
Budgetary Slack—> Results from PADDING THE BUDGET. Intentionally underestimating revenue or
overestimating costs in order to make the goals more achievable and enhance the person’s performance
evaluation.
“You are the revenue centre manager. You will be evaluated on the basis of the achievement of your revenue
budget.” You are likely to set a lower revenue goal. If you are a cost centre manager, you’re going to budget
for a higher lower of cost than what you think you’re going to achieve in order to achieve a positive
performance evaluation. This is not in the best interests of the company.
Q: How might a company reward employees for meeting or exceeding budget, yet discourage them
from creating budgetary slack?
A: Could set a higher target. Could make the reward attach to a reasonable achievement. E.g. Revenue
manager. They need to meet a *certain sales*. Could use market based data (need to increase 10%) to
compare against what was forecasted for market increases.
You don’t get the bonus if you’re more than a certain % away. !
Q: In a bottom-up environment, is it possible to completely eliminate budgetary slack? Why or why
not?
A: No, it cannot completely be eliminated. !
Features of an ideal budgetary system used to evaluate performance (identified from research and practice)
» Frequent feedback on performance!
» Monetary and non-monetary incentives
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