Chapter 9 Budgeting.docx

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Accounting & Financial Management
AFM 102
Tom Vance

09 – budgeting Chapter 9: Budgeting The Basic Framework of Budgeting Definition Of Budgeting  budget: a detailed plan for the acquisition and use of financial and other resources over a specified time peri- od  represents a plan for the future expressed in formal quantitative terms  master budget: a summary of a company’s plans in which specific targets are set for sales, production, distri- bution, and financing activities; generally culminates in a cash budget, budgeted income statement, and budgeted balance sheet BudgetsDual Role: Planning and Control  planning: developing objectives and preparing budgets to achieve these objectives  develop objectives  prepare various budgets  control: those steps taken by management that attempt to increase the likelihood that the objectives devel- oped at the planning stage are attained and to ensure that all parts of the organization function in a manner consistent with organizational policies  the steps taken by management to increase likelihood of success Advantagesof Budgeting  provide a means of communicating management’s plans throughout the organization  force managers to think about a plan for the future (instead of spending a lot of time dealing with emergen- cies)  provide a means of allocating resources to those parts of the organization where they can be used most effec- tively  can uncover potential bottlenecks before they occur  bottlenecks: a machine, activity or process that limits total output because it is operating at capacity  coordinate activities of the entire organization by integrating the plans of the various parts (helps ensure that everyone in the organization is pulling in the same direction)  define goals and objectives that can serve as benchmarks for evaluating subsequent performance Responsibility Accounting  responsibility accounting: a system of accountability in which managers are held responsible for those items of revenue and cost and only those items over which the manager can exert significant influence. The man- agers are held responsible for differences between budgeted and actual results  this concept is central to any effective profit planning and control system  the manager:  should take the initiative to correct any unfavourable discrepancies  should understand the source of significant favourable or unfavourable discrepancies  would be prepared to explain the reasons for discrepancies to higher management Choosing a Budget Period  operating budgets normally cover a one-year budget which corresponds to the company’s fiscal year  continuous or perpetual budget: a 12-month budget that rolls forward one month as the current month is completed  makes sure managers are focused at least one year ahead The Participative Budget  success of a budget program depends on how the budget is developed page 1 of 5 09 – budgeting  budgets involving managers with cost control responsibilities in preparing their own budget estimates are more successful  participative or self-imposed budget: a method of preparing budgets in which managers prepare their own budgets. These budgets are then reviewed by the manager’s supervisor, and any issues are resolved by mu- tual agreement  advantages:  all individuals of the organization are recognized as members of the team, and their views and judge- ments are valued by top management  budget estimates prepared by front-line managers are more accurate and reliable than those prepared by top managers  creates commitment to attaining the goal because individuals participate in setting their own goals  managers can’t say that the budget was unrealistic and impossible if the budget was self-imposed  self-imposed budgets may be too loose and allow to much ‘budgetary slack’ so budgets must be reviewed before being accepted  budget committee: a group of key management personnel responsible for  overall policy matters related to the budget program  coordinating the preparation of the budget  handling disputes related to the budget  approving the final budget  a participative approach to setting budgets requires all managers to understand and agree with the organiza- tion’s strategy  top managers start the budget process by issuing broad guidelines in terms of overall target profits/sales  lower-level managers prepare budgets that meet those targets The Matter of Human Relations  whether are not the budget is accepted depends on ...  if top management accepts the budget program as a vital part of the company’s activities  the way in which top management uses budgeted data  top management should not use the budget as a means of pressuring employees or as a way to find someone to blame  management should remember that the purposes of the budget are to motivate employees and to coordi- nate their efforts  being focused only mostly cost reduction creates a rigid and inflexible budget which is usually counterproduc- tive and can lead to budget games  budget games is used to describe when managers skilfully time revenues, expenditure, and investments in the short-run  bonuses based on meeting and exceeding budgets are often an element of management compensation Zero-Based Budgeting  incremental approach: start with last year’s budget and add/subtract according to anticipated needs  zero-base budget: a method of budgeting in which managers are required to justify all costs as if the pro- grams involved were being proposed for the first time  used particularly in the gov’t and not-for-profit sectors  requires considerable documentation  the manage must prepare a series of ‘decision packages’ where all activities are ranked according to relative important and the cost of each activity is identified  key issues: too time consuming and costly, annual reviews become mechanical and limits the benefits The Master Budget:An Overview  sales budget: a detailed schedule showing the expected sales for coming periods; these sales are typically expressed in both dollars and units  key to the entire budgeting process page 2 of 5 09 – budgeting  how determine how many units will have to be produced (and the production budget is used to determine the budgets for manufacturing costs, DM budget, DL budget and manuf. o’head budget)  cash budget: a detailed plan showing how cash resources will be acquired and used over some specific time period Sales Forecasting – A Critical Step  sales budget is based on the sales forecast  based on sales from prior years, unfilled back orders, pricing policy and marketing plans, trends in the indus- try and general economic conditions Preparing the Master Budget  sales budget (includes a schedule of expected cash collections)  all other items on the master budget depends on the sales budget  constructed by multiplying the budgeted sales in units by the selling price  a schedule of expected cash collections is prepared after (needed later for the cash budget)  production budget (manuf. firm) inventory purchases budget (merch. firm)  production budget: a detailed plan showing the number of units that must be produced during a period in order to meet both sales and inventory needs  production requirements are influenced by the desired level of ending inventory  insufficient inventories can lead to lost sales/crash production efforts in the next period  inventory purchases shows the amount of goods to be purchased from its suppliers budgeted sales in units add: desired ending inventory
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