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chap 10

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Ryerson University
ACC 406
George Gekas

1 BUDGETING Dr. George Andrew Gekas These notes are posted on blackboard to high light and complement certain aspects of the topic, facilitate those students who may have missed my lecture, balance traditional with internet based learning and overall enhance student=s learning. The notes are not meant to suggest what may be in the exams, replace textbook studying and/or problem solving. A budget is a detailed outline of how resources will be acquired and used over a specific period of time. It is an orderly, quantitative plan of action for a future period of time. Every organization small, big, in the private or public sector needs a budget. Reasons for preparing a budget 1. It compels right planning. 2. It formalizes the planning process. 3. It communicates the set objectives to others and promotes co-ordination among the organizations sub-units. 4. It provides criteria for evaluation performance. 5. It uncovers potential troubles. Types of Budgets A budget period is important as it establishes different types of budgets. A. Capital budget It is usually a long-term budget of expenditures for fixed assets. Capital budgets are focused on the Balance Sheet and the Statement of Changes in Financial Position. B. Operating budget It is for the short term, usually an annual budget. Operating budgets are focusing on Income Statement items. C. Perpetual budget It is a continuous 12-month budget whereby each month a month is added in place of the month that has expired. A few other types of budgets may include: 1. self-imposed budget 1 2 It is a process of budgeting whereby each responsibility center submits to the immediate superior level (bottom-up approach) a budget. Following the chain of command, organization wide, an overall company budget is developed. Self-imposed budgets have some distinct advantages: A. All involved feel part of the team through their participation. B. The persons preparing the budgets are in the best position to forecast their own operations and needs. C. People who make their own budgets tend to live within their own budgets. D. The authors of the budget are responsible for potential deviations from it. However, employee freedom to make their own budget sometimes may promote inefficiency and waste. 2. zero based budgeting It is a budgeting process whereby all proposed costs and expenditures must be justified as if the proposed functions or programs were initiated for the very first time. Previous allocation of resources, past practices and customs are irrelevant. Everything is planned and budgeted for as if it was a completely new operation. Fresh start leads to questioning and rationalization of existing budgets instead of adding to and subtracting from recent budgets. 3. project budgeting A Project budget is associated with the completion of a given project. Costs and time constraints are considered. Time is relevant only as to the level of completion and completion date. For example, 20% completion within the first quarter of the year means that the project will be 20% complete by March 31. 4. Master budget The master budget comprises from a series of sub budgets summarizing all planned activities of all sub-units. It normally consists of the following sub budgets: A. Sales budget It is based on a sales forecast. A sales forecast can be affected by: Past experience (sales volume) General economic conditions Industry conditions Companys market share (existing and target share) 2 3 Overall promotion strategy which may assist or hamper sales Methods of forecasting Methods of forecasting may include the following: Quantitative Models Naive Models: Average absolute or percentage change Weighted average absolute or percentage change Moving average absolute or percentage change Trend analysis Curve fitting Note: Naive Models (A under quantitative models above) are based on the idea that history usually repeats itself. Simple forecasting rules are devised, such as the forecast equals the current year plus five percent. Casual Models: Regression Input - output Time Series Models Econometrics Decomposition Simulation Note: Casual models attempt to identify relationships between variables that have held in the past. For example, Sales volume for a given brand and that product's relative price are related the relationship of sales volume fluctuations and price is then assumed to hold into the future Barometric Models Indicators Ratios and spread Learned Behaviour Models Product life cycle Note: Extrapolative forecasts for particular variables are made on the basis of that variable's history. The patterns identified in the past are assumed to hold into the future. Qualitative Models Judgement from the ex experts 3
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