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The Ongoing Budget Process: 1. Managers and accountants plan the performance of the company, taking into account past performance and anticipated future changes 2. Senior managers distribute a set of goals against which actual results will be compared
The Ongoing Budget Process: 3. Accountants help managers investigate deviations from budget. Corrective action occurs at this point 3. Managers and accountants assess market feedback, changed conditions, and their own experiences as plans are laid for the next budget period
Strategy, Planning and Budgets, Illustrated
Advantages of Budgets
Components of Master Budgets
Relationship between Budgets Company objectives and policies Current year’s figures Business conditions and outlook for the industry Sales Forecast (s) Production Forecast (s) Sales Budget Sell. & Dis. Bud Production Budget Materials Budget Labour Budget Admin. Budget If the limiting factor is on the production side, these are reversed Res. & Dev. Budget Cap. Exp. Budget Expense Budget Master Operating Budget Stocks Budget Debtors’ Budget Creditors’ Budget Cash Budget
Preparation of Budgets 1. Sales Budget The sales budget is a detailed schedule showing the expected sales for a specific future period. It is typically expressed in both rupees and units of the product.
Preparation of Budgets 2. Production Budget Sales Budget Production Budget The production budget is a schedule, which shows the expected number of units to be produced within a specific future period.
Preparation of Budgets 3. Direct Materials Budget Sales Budget Direct Materials Budget details the materials required to fulfill the production budget and to ensure adequate inventory levels Production Budget Direct Materials Budget
Preparation of Budgets 3. Direct Materials Budget Direct Materials Usage Budget Purpose of preparing materials usage budget is to identify the required units of each material to produce the required production Direct Materials Purchases Budget Purpose of preparing direct materials purchase budget is to determine the required number of units of each material to purchase during a given period
Preparation of Budgets 3. Direct Materials Budget Direct Materials Usage Budget Direct Materials Purchases Budget
Product Budgeted Sales A 6000 units B 9000 units Opening Stock of FG 2100 units 2400 units *Target closing stocks 30 days sales 40 days sales Budgeted material consumption per unit 12 kg 4 kg
• At the beginning Raw material stocks will be 34800 kg. • Raw material closing stock = 20 days consumption • Budgeted material cost is Rs 20 per Kg • There are 12 five day weeks in the budget period. • Prepare production budget and material purchase budget
Preparation of Budgets 4. Direct Labour Budget & Other overhead Budgets Sales Budget The direct labour budget is typically expressed in both direct labour-hours and in rupees. Selling & Administrative Expenses Budget Production Budget Direct Materials Budget Direct Labor Budget Production Overhead Budget
Preparation of Budgets 5. Cash Budget Cash budget is a schedule, which shows cash receipts, cash payments, cash increase or decrease during the period and opening & closing balances for a specific future period The cash budget should be broken down into time periods that are as short as feasible in order to alert management to problems that may occur due to fluctuations in cash flows
Sample Format for a Cash Budget X Company Limited Cash Budget For the Three Months Ending March 31, 2004 (In Rs. ) • Estimated cash receipts: • Cash sales • Accounts receivable • Interest Revenue 24, 500 • Total cash receipts 1, 091, 700 • Estimated cash payments: • Manufacturing costs • Selling & administrative exp. • Capital additions — • Interest expense • Income taxes 150, 000 • Total cash payments 1, 075, 000 Example 14. 5: 108, 000 953, 200 1, 061, 200 802, 000 160, 000 22, 500 984, 500 124, 000 97, 000 1, 058, 400 970, 200 — — 1, 182, 400 771, 000 165, 000 — — — 1, 210, 000 780, 000 145, 000 274, 000 — —
Preparation of Budgets 5. Master Budget The master budget is a summary budget, which consists ……. . …………………………. . A master budget involves the development of complete set of financial statements for the budget period with supporting schedules. Essentially, it is a consolidated summary of all the detailed budgets showing their outcomes to overall results
Different Approaches to Budgeting Ø Real-world scenarios of budgeting differ from the ideal model. Ø Instead, the ideal model of budgetary planning is modified in various ways to suit various real-world contingencies. Ø Systems of budgetary planning would be different from organization to organization depending on;
Incremental Budgeting Ø Incremental budgeting implies a simple budgeting exercise where the future activity levels and budget targets are set by ……………………………………. Ø ‘percentage of progress’ can be estimated by considering; ……………………………………………………………
Ø Therefore, Incremental budgeting Øexemplifies a system where the future is seen as the mere projection of the past. Øexemplifies an internal-looking paradigm, which ignores the competitive forces and conditions outside the organization. ØThe most notable weakness ………………………………………………. ØIB is mostly applied in public sector organizations. Budgeting in public sector organizations is mostly exercised as a mode of justifying resource allocation from central funding institutions, and previous year figures are often used.
Zero-based budgeting Ø Evolved especially in the public sector, as a solution to the problem of IB. Ø When a ZBB system is in place, managers are required to justify all budgeted expenditure in terms of programmed service levels, activities and operations. Ø Therefore, the baseline is zero rather than the last year’s budgets. Ø This type of budgeting compels managers to assess periodically whether services and activities that are being financed are still necessary, and whether they are carried out in the most efficient and effective manner.
Programme budgeting Ø Organizations which deal with project-based activities, use programme budgeting techniques. Ø Rather than budgeting for recurring budgeting periods, PB considers a given programme (e. g. construction project) as the planning frame for budgeting. Ø Using various project planning techniques like network and critical path analysis, programme activities are identified, sequentially arranged according to the precedence of activities, and resource and time consumptions are estimated. Ø The result is a PB which details the timing and resource requirements for the successful completion of the project.
Activity-based budgeting • Activity-based budgeting (ABB) focuses on the budgeted cost of activities necessary to produce and sell products and services. Ø It first forecasts and estimates the level of ‘activities’ during the forthcoming budget period. Ø Then, on the basis of activity-cost drivers and resource cost drivers, it estimates the amount of resources that those activities would consume, and thereby the cost of activities. Ø In this sense, budgets are prepared for each activity category.
The ABB process is the reverse of the ABC process: • Budgeted output of cost objects Determine the necessary activities Determine the resources required for the budget period
• ABB aims to eliminate wasted resources • The ABB process is the reverse of the ABC process • ABB is end product driven ABC Costs (Resources) Allocated to Activities Allocated to Cost objects e. g. products ABB Product demand Activities Required Resources (costs) required
Kaizen Budgeting • The Japanese use the term “kaizen” for continuous improvement. • Kaizen budgeting is an approach that explicitly incorporates …………………………………….
EXAMPLE: • It was previously estimated that it should take 3 labor-hours for Hawaii Diving to manufacture its product. • A kaizen budgeting approach would incorporate future improvements. • Budgeted Hours/Item January – March 2011 3. 00 April – June 2011 2. 95 July – September 2011 2. 90 October – December 2011 2. 85
Budgets and Feedback • Budgets offer feedback in the form of variances: actual results deviate from budgeted targets • Variances provide managers with – Early warning of problems – A basis for performance evaluation – A basis for strategy evaluation
Budgeting and Human Behavior Setting budget goals too tightly Setting budget goals too loosely Setting conflicting budget goals
Budgeting and Human Behavior • The budgeting process may be abused both by superiors and subordinates, leading to negative outcomes • Superiors may dominate the budget process or hold subordinates accountable for events they have no control over • Subordinates may build “budgetary slack” into their budgets
Conclusion • Budgeting, is a well-known control system, but the practices of budgeting will be different across different companies and contexts.