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Chapter 8

BUS 215 Chapter 8: Master Budgeting

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BUS 215
Trisha Anderson

• The master budget is an essential management tool that communicates management’s plans throughout the organization, allocates resources, and coordinates activities. What is a budget? • A budget is a detailed plan for the future that is usually expressed in formal quantitative terms • Budgets are used for two distinct purposes o Planning involves developing goals and preparing various budgets to achieve those goals. o Control involves gathering feedback to ensure that the plan is being properly executed or modified as circumstances change • Advantages of Budgeting o Organizations realize many benefits from budgeting, including: • Budgets communicate management’s plans throughout the organization. • Budgets force managers to think about and plan for the future. In the absence of the necessity to prepare a budget, many managers would spend all of their time dealing with day-to-day emergencies. • The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively. • The budgeting process can uncover potential bottlenecks before they occur. • Budgets coordinate the activities of the entire organization by integrating the plans of its various parts. Budgeting helps to ensure that everyone in the organization is pulling in the same direction. • Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance. • Responsibility Accounting o The basic idea underlying responsibility accounting is that a manager should be held responsible for those items—and only those items—that the manager can actually control to a significant extent. • personalizes accounting information by holding individuals responsible for revenues and costs. o The point of an effective responsibility accounting system is to make sure that nothing “falls through the cracks,” that the organization reacts quickly and appropriately to deviations from its plans, and that the organization learns from the feedback it gets by comparing budgeted goals to actual results. • Choosing a Budget Period o Operating budgets ordinarily cover a one-year period corresponding to the company’s fiscal year o A continuous or perpetual budget is a 12-month budget that rolls forward one month (or quarter) as the current month (or quarter) is completed. • The Self-Imposed Budget o A self-imposed budget or participative budget is a budget that is prepared with the full cooperation and participation of managers at all levels. o Self-imposed budgets have a number of advantages: • Individuals at all levels of the organization are recognized as members of the team whose views and judgments are valued by top management. • Budget estimates prepared by front-line managers are often more accurate and reliable than estimates prepared by top managers who have less intimate knowledge of markets and day-to-day operations. • Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. Self-imposed budgets create commitment. • A manager who is not able to meet a budget that has been imposed from above can always say that the budget was unrealistic and impossible to meet. With a self-imposed budget, this claim cannot be made. o Two important limitations • lower-level managers may make suboptimal budgeting recommendations if they lack the broad strategic perspective possessed by top managers • self-imposed budgeting may allow lower-level managers to create too much budgetary slack. • Human Factors In Budgeting o the budget should be used as a positive instrument to assist in establishing goals, measuring operating results, and isolating areas that need attention. The Master Budget: An Overview • The master budget consists of a number of separate but interdependent budgets that formally lay out the company’s sales, production, and financial goals. • The first step in the budgeting process is the preparation of the sales budget, which is a detailed schedule showing the expected sales for the budget period. • A cash budget is a detailed plan showing how cash resources will be acquired and used. o The budgeted income statement provides an estimate of net income for the budget period and it relies on information from the sales budget, ending finished goods inventory budget, selling and administrative expense budget, and the cash budget • Seeing the Big Picture o a master budget for a manufacturing company is designed to answer 10 key questions as follows: • How much sales revenue will we earn? • How much cash will we collect from customers?
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