1. Accounting 6310
Chapter 6 – Budgeting

2. Definition
Budget –
Management’s formal quantification of the operations of an organization for a future period.
It is an aggregate forecast of all transactions expected to occur.

3. Functions of Budgets
There is a trade-off between these two functions. It helps to have different people in charge of each of the two functions.

4. Nature of Budget Generally covers one year
Often broken down into monthly or quarterly budgets
Sometimes have revolving or continuous budgets; one quarter ends and another quarter is added
Can prepare longer term budgets (3-5 years) to avoid short-term focus

5. Relation to Strategic Planning
Precedes budgeting
Provides the framework for the annual budget
Budget is a “slice” of the strategic planning pie
Budget focuses on individual responsibility centers; not whole company like strategic plan

6. Purposes of Budgeting To fine-tune the strategic plan
To help coordinate the activities of the several parts of the organization
To assign responsibility to managers, to authorize the amounts they are permitted to spend, and to inform them of the performance that is expected of them
To obtain a commitment that is a basis for evaluating a manager’s actual performance

7. Advantages of Budgeting
Translate strategy into a detailed plan
Communicate plans
throughout organization
Think about and
plan for the future
Advantages
Coordinate
activities
Serves as a means of
allocating resources
Uncover potential
bottlenecks

8. Questions for Managers
Does the organization’s strategy create economic value?
Does the organization have enough cash to fund the strategy and remain solvent?
Does the organization create enough value to attract the financial resources that it needs to fund long-term investment in new assets?
Is there sufficient resources to implement the intended strategy?

9. Issues in Budgeting Budgetary Slack Budgeting Revisions
Participation in the Budgeting Process
Human Factors in Budgeting
Difficulty in Meeting Budget
New Approaches to Budgeting

10. Budgetary Slack Budgeting revenues lower than expected
Budgeting expenses or costs higher than expected
Represent easier targets to achieve
Budgeting superiors must attempt to find this slack and eliminate it

11. Budgetary Slack Some companies: Ratchet effect
Reward managers for meeting exact budgets
Automatically decrease expense figures and increase revenue figures for slack
Penalize managers more for large unjustified increases in actual income than for decreases in actual income
Ratchet effect
Basing next year’s standard of performance on this year’s actual performance
Causes employees to underperform

12. Budgeting Revisions
Too many changes in the budget renders it a useless control tool
Must establish procedures for changing the budget during the period
Some companies use sensitivity analysis with best, worst, and most likely cases. Managers are expected to discuss what decisions they would make in the best and worst cases.

13. Participation in the Budgeting Process
Top down
Top management determines the budget and passes it down throughout the organization
Bottom up
Lower level management formulates the budget and top management makes changes if necessary
More successful than top down

14. Participative Budget System – Bottom Up
Flow of Budget Data

15. Participation in the Budgeting Process
Bottom up
Must make sure budgets meet the company’s strategy
Must make sure slack is limited
Participative budgeting is especially helpful for responsibility centers that operate in dynamic environments since lower level managers have more information about their operations.

16. Human Factors in Budgeting
The success of budgeting depends upon:
The degree to which top management accepts the budget program as a vital part of the company’s activities.
The way in which top management uses budgeted data.
When rewarded for meeting/not meeting the budget, employees may take risky actions.

17. Degree of Budget Target Difficulty
Budget should be challenging but attainable.
Achievable budgets reduce data manipulation.
Achievable budgets create positive attitudes among workers.
If too difficult, budgets are often ignored.
Overly difficult budgets may cause over commitment of resources.
If too easy, managers may coast when budget is met.

18. New Approaches to Budgeting
Line-item budgets
Managers can spend only up to the specified amount on each line item (no borrowing from other areas).
Budget lapsing
No carryover of unused amounts to future years
Zero-based Budgets
Every line item must be justified

19. New Approaches to Budgeting
Beyond Budgeting (Break the annual performance trap!)
Do not use budgets in performance evaluation or reward systems; use them only for PLANNING purposes.
Evaluate employees on other measures, including benchmarking or nonfinancial factors

20. Examples of Budgets Revenues Production costs and cost of goods sold
Variable and fixed costs
Other budgets

21. Revenue Budgets Estimate level of sales
First and most important budget
Drives all other budgets
If sales are too low, inventory may build up
Can start with past sales and adjust for economic and other factors
Often very uncertain

22. Cost Budgets Budgeted production cost and cost of sales
Often represent the standard cost of items produced or acquired
Includes budgets for the necessary production materials, labor and overhead
Includes inventory assumptions

23. Cost Budgets Variable costs Nonvariable costs Often vary by sales
Delivery costs, commissions, order taking
Nonvariable costs
Committed costs - costs already determined by previous decisions in the short-run; salaries, rent, depreciation, past advertising commitments

24. Cost Budgets Nonvariable costs
Discretionary costs - costs that can be incurred or not depending on available resources; training, advertising, travel, research and development
Activity-based indirect costs - costs that vary with some other cost driver than sales or production volume

25. Other Budgets Capital Budget
Planned spending on capital projects
Budgeted Balance Sheet – contains revised balances after previous budgets prepared
Budgeted Cash flow Statement – shows how much cash will be needed and whether outside financing sources will be needed
Management by Objective – management objectives are quantified and managers are held accountable for them.

26. Homework Computer Budget Project #1 – 50 points DUE WEDNESDAY, APRIL 8