1. 1 Nature of a Budget An operating budget usually covers one year and states the revenue and expenses planned for that year Budgets are an important tool for effective short term planning and control in organizations

2. 2 Nature of a Budget Budget has these characteristics : Estimates the profit potential of the business unitEstimates the profit potential of the business unit It is stated in monetary termsIt is stated in monetary terms It generally covers a period of one yearIt generally covers a period of one year It is a management commitmentIt is a management commitment The budget proposal is reviewed and approved by an authority higher than the budgeteeThe budget proposal is reviewed and approved by an authority higher than the budgetee Once approved, the budget can be changed only under specified conditionsOnce approved, the budget can be changed only under specified conditions Periodically, actual financial performance is compared to budget, and variances are analyzed and explainedPeriodically, actual financial performance is compared to budget, and variances are analyzed and explained Budget has these characteristics : Estimates the profit potential of the business unitEstimates the profit potential of the business unit It is stated in monetary termsIt is stated in monetary terms It generally covers a period of one yearIt generally covers a period of one year It is a management commitmentIt is a management commitment The budget proposal is reviewed and approved by an authority higher than the budgeteeThe budget proposal is reviewed and approved by an authority higher than the budgetee Once approved, the budget can be changed only under specified conditionsOnce approved, the budget can be changed only under specified conditions Periodically, actual financial performance is compared to budget, and variances are analyzed and explainedPeriodically, actual financial performance is compared to budget, and variances are analyzed and explained

3. 3 Nature of a Budget Relation to Strategic Planning The budgeting process focuses on a single year whereas strategic planning focuses on activities that extend over a period of several years.The budgeting process focuses on a single year whereas strategic planning focuses on activities that extend over a period of several years. Strategic plan is essentially structured by product lines or other programs, while budgeting is structured by responsibility centers.Strategic plan is essentially structured by product lines or other programs, while budgeting is structured by responsibility centers. Relation to Strategic Planning The budgeting process focuses on a single year whereas strategic planning focuses on activities that extend over a period of several years.The budgeting process focuses on a single year whereas strategic planning focuses on activities that extend over a period of several years. Strategic plan is essentially structured by product lines or other programs, while budgeting is structured by responsibility centers.Strategic plan is essentially structured by product lines or other programs, while budgeting is structured by responsibility centers.

4. 4 Nature of a Budget Contrast with Forecasting As contrasted with a budget, a forecast has the following characteristic :As contrasted with a budget, a forecast has the following characteristic : A forecast may or may not be stated in monetary unitsA forecast may or may not be stated in monetary units It can be for any time periodIt can be for any time period The forecaster does not accept responsibility for meeting the forecasted resultsThe forecaster does not accept responsibility for meeting the forecasted results Forecasts are not usually approved by higher authorityForecasts are not usually approved by higher authority A forecast is updated as soon as new information indicates there is a change in conditionsA forecast is updated as soon as new information indicates there is a change in conditions Variances from forecast are not analyzed formally or periodically.Variances from forecast are not analyzed formally or periodically. Contrast with Forecasting As contrasted with a budget, a forecast has the following characteristic :As contrasted with a budget, a forecast has the following characteristic : A forecast may or may not be stated in monetary unitsA forecast may or may not be stated in monetary units It can be for any time periodIt can be for any time period The forecaster does not accept responsibility for meeting the forecasted resultsThe forecaster does not accept responsibility for meeting the forecasted results Forecasts are not usually approved by higher authorityForecasts are not usually approved by higher authority A forecast is updated as soon as new information indicates there is a change in conditionsA forecast is updated as soon as new information indicates there is a change in conditions Variances from forecast are not analyzed formally or periodically.Variances from forecast are not analyzed formally or periodically.

5. 5 Nature of a Budget Use of a Budget : Preparation of an operating budget has four principal purposes : 1.To fine tune the strategic plan 2.To help coordinate the activities of the several parts of the organization. 3.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 4.To obtain a commitment that is a basis for evaluating a manager’s actual performance. Use of a Budget : Preparation of an operating budget has four principal purposes : 1.To fine tune the strategic plan 2.To help coordinate the activities of the several parts of the organization. 3.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 4.To obtain a commitment that is a basis for evaluating a manager’s actual performance.

6. 6 Nature of a Budget Content of an Operating Budget : Next slide shows the content of a typical operating budget and contrasts the operating budget with other types of planning documents, the strategic plan and the capital budget, the cash budget, and the budgeted balance sheet.Next slide shows the content of a typical operating budget and contrasts the operating budget with other types of planning documents, the strategic plan and the capital budget, the cash budget, and the budgeted balance sheet. Content of an Operating Budget : Next slide shows the content of a typical operating budget and contrasts the operating budget with other types of planning documents, the strategic plan and the capital budget, the cash budget, and the budgeted balance sheet.Next slide shows the content of a typical operating budget and contrasts the operating budget with other types of planning documents, the strategic plan and the capital budget, the cash budget, and the budgeted balance sheet.

7. 7 Nature of a Budget Strategic Plan Revenue and expense for each major programRevenue and expense for each major program Not necessarily by responsibility centersNot necessarily by responsibility centers Not as much detail as operating budgetNot as much detail as operating budget More expenses are variableMore expenses are variable For several yearsFor several years Total reconciles to operating budgetTotal reconciles to operating budget Strategic Plan Revenue and expense for each major programRevenue and expense for each major program Not necessarily by responsibility centersNot necessarily by responsibility centers Not as much detail as operating budgetNot as much detail as operating budget More expenses are variableMore expenses are variable For several yearsFor several years Total reconciles to operating budgetTotal reconciles to operating budget Operating Budget For organization as a whole and for each business unit Classified by responsibility centers Typically includes : Revenues, Production cost and cost of sales, Marketing expense, Logistics expense, General & administrative, Research&development Income taxes, Net income Expenses may be Flexible,Discretionary, Committed, For one year divided into months or quarters Total reconciles to strategic plan Operating Budget For organization as a whole and for each business unit Classified by responsibility centers Typically includes : Revenues, Production cost and cost of sales, Marketing expense, Logistics expense, General & administrative, Research&development Income taxes, Net income Expenses may be Flexible,Discretionary, Committed, For one year divided into months or quarters Total reconciles to strategic plan Types of Plans and Their Contents Capital Budget Each major capital project listed separately Total project expenditures by quarters Capital Budget Each major capital project listed separately Total project expenditures by quarters

8. 8 Nature of a Budget Operating Budget Categories Revenue Budgets A revenue budget consist of unit sales projection multiplied by expected selling pricesA revenue budget consist of unit sales projection multiplied by expected selling prices The revenue budget is the most criticalThe revenue budget is the most critical The element of budget revenue is subject to the greatest uncertaintyThe element of budget revenue is subject to the greatest uncertainty The revenue budget usually is based on forecasts of some conditions for which the sales manager cannot be held responsible.The revenue budget usually is based on forecasts of some conditions for which the sales manager cannot be held responsible. Operating Budget Categories Revenue Budgets A revenue budget consist of unit sales projection multiplied by expected selling pricesA revenue budget consist of unit sales projection multiplied by expected selling prices The revenue budget is the most criticalThe revenue budget is the most critical The element of budget revenue is subject to the greatest uncertaintyThe element of budget revenue is subject to the greatest uncertainty The revenue budget usually is based on forecasts of some conditions for which the sales manager cannot be held responsible.The revenue budget usually is based on forecasts of some conditions for which the sales manager cannot be held responsible.

9. 9 Nature of a Budget Operating Budget Categories Budgeted Production Cost and Cost of Sales Production managers make plans for obtaining quantities of material and labor, and they may prepare procurement budgets for long lead timesProduction managers make plans for obtaining quantities of material and labor, and they may prepare procurement budgets for long lead times Production managers also develop production schedules to ensure that resources needed to produce the budgeted quantities will be availableProduction managers also develop production schedules to ensure that resources needed to produce the budgeted quantities will be available The cost of sales reported in the summary budget is the standard cost of the products budgeted to be sold.The cost of sales reported in the summary budget is the standard cost of the products budgeted to be sold. Operating Budget Categories Budgeted Production Cost and Cost of Sales Production managers make plans for obtaining quantities of material and labor, and they may prepare procurement budgets for long lead timesProduction managers make plans for obtaining quantities of material and labor, and they may prepare procurement budgets for long lead times Production managers also develop production schedules to ensure that resources needed to produce the budgeted quantities will be availableProduction managers also develop production schedules to ensure that resources needed to produce the budgeted quantities will be available The cost of sales reported in the summary budget is the standard cost of the products budgeted to be sold.The cost of sales reported in the summary budget is the standard cost of the products budgeted to be sold.

10. 10 Nature of a Budget Operating Budget Categories Marketing Expenses Marketing expenses are expenses incurred to obtain salesMarketing expenses are expenses incurred to obtain sales Logistic expenses usually are reported separately from order getting expensesLogistic expenses usually are reported separately from order getting expenses Many companies include logistic expenses in the marketing budget, because they tend to be the responsibility of the marketing organizationMany companies include logistic expenses in the marketing budget, because they tend to be the responsibility of the marketing organization Operating Budget Categories Marketing Expenses Marketing expenses are expenses incurred to obtain salesMarketing expenses are expenses incurred to obtain sales Logistic expenses usually are reported separately from order getting expensesLogistic expenses usually are reported separately from order getting expenses Many companies include logistic expenses in the marketing budget, because they tend to be the responsibility of the marketing organizationMany companies include logistic expenses in the marketing budget, because they tend to be the responsibility of the marketing organization

11. 11 Nature of a Budget Operating Budget Categories General and Administrative Expenses These are G&A expenses of staff units, both at headquarters and at business units.These are G&A expenses of staff units, both at headquarters and at business units. Overall, they are discretionary expenses, although some components are engineered expenses.Overall, they are discretionary expenses, although some components are engineered expenses. Operating Budget Categories General and Administrative Expenses These are G&A expenses of staff units, both at headquarters and at business units.These are G&A expenses of staff units, both at headquarters and at business units. Overall, they are discretionary expenses, although some components are engineered expenses.Overall, they are discretionary expenses, although some components are engineered expenses.

12. 12 Nature of a Budget Operating Budget Categories Research and Development Expenses The R&D budget uses two approachesThe R&D budget uses two approaches In one approach, total amount is the focus. This may be the current level of spending, or it may be a larger amountIn one approach, total amount is the focus. This may be the current level of spending, or it may be a larger amount The alternative approach is aggregating the planned spending on each approved projectThe alternative approach is aggregating the planned spending on each approved project Operating Budget Categories Research and Development Expenses The R&D budget uses two approachesThe R&D budget uses two approaches In one approach, total amount is the focus. This may be the current level of spending, or it may be a larger amountIn one approach, total amount is the focus. This may be the current level of spending, or it may be a larger amount The alternative approach is aggregating the planned spending on each approved projectThe alternative approach is aggregating the planned spending on each approved project

13. 13 Nature of a Budget Operating Budget Categories Income Taxes Some companies do not take income taxes into account in preparing the budgets for business units, because income tax policies are determined at corporate headquarters.Some companies do not take income taxes into account in preparing the budgets for business units, because income tax policies are determined at corporate headquarters. Operating Budget Categories Income Taxes Some companies do not take income taxes into account in preparing the budgets for business units, because income tax policies are determined at corporate headquarters.Some companies do not take income taxes into account in preparing the budgets for business units, because income tax policies are determined at corporate headquarters.

14. 14 Other Budgets Capital Budget The capital budget states the approved capital projects, plus a lump sum amount for small projects that do not require high level approvalThe capital budget states the approved capital projects, plus a lump sum amount for small projects that do not require high level approval For the projects that remain, an estimate of the cash that will be spent each quarter is prepared. This is necessary in order to prepare the cash flow statement.For the projects that remain, an estimate of the cash that will be spent each quarter is prepared. This is necessary in order to prepare the cash flow statement. Capital Budget The capital budget states the approved capital projects, plus a lump sum amount for small projects that do not require high level approvalThe capital budget states the approved capital projects, plus a lump sum amount for small projects that do not require high level approval For the projects that remain, an estimate of the cash that will be spent each quarter is prepared. This is necessary in order to prepare the cash flow statement.For the projects that remain, an estimate of the cash that will be spent each quarter is prepared. This is necessary in order to prepare the cash flow statement.

15. 15 Other Budgets Budgeted Balance Sheet The budgeted balance sheet shows the balance sheet implications of decisions included in the operating budget and the capital budget.The budgeted balance sheet shows the balance sheet implications of decisions included in the operating budget and the capital budget. Budgeted Balance Sheet The budgeted balance sheet shows the balance sheet implications of decisions included in the operating budget and the capital budget.The budgeted balance sheet shows the balance sheet implications of decisions included in the operating budget and the capital budget.

16. 16 Other Budgets Budgeted Cash Flow Statement The budgeted cash flow statement shows how much of the cash needs during the year will be supplied by retained earnings and how much, if any, must be obtained by borrowing or from other outside sources.The budgeted cash flow statement shows how much of the cash needs during the year will be supplied by retained earnings and how much, if any, must be obtained by borrowing or from other outside sources. It is, of course, important for financial planningIt is, of course, important for financial planning Budgeted Cash Flow Statement The budgeted cash flow statement shows how much of the cash needs during the year will be supplied by retained earnings and how much, if any, must be obtained by borrowing or from other outside sources.The budgeted cash flow statement shows how much of the cash needs during the year will be supplied by retained earnings and how much, if any, must be obtained by borrowing or from other outside sources. It is, of course, important for financial planningIt is, of course, important for financial planning

17. 17 Other Budgets Management by Objectives Some companies make their objectives explicitSome companies make their objectives explicit The process is doing so is called management by objectives in the literatureThe process is doing so is called management by objectives in the literature Unfortunately, some management by objectives (MBO) systems are separated from the budget preparation process. MBO and budgeting should be two parts of the same planning process.Unfortunately, some management by objectives (MBO) systems are separated from the budget preparation process. MBO and budgeting should be two parts of the same planning process. Management by Objectives Some companies make their objectives explicitSome companies make their objectives explicit The process is doing so is called management by objectives in the literatureThe process is doing so is called management by objectives in the literature Unfortunately, some management by objectives (MBO) systems are separated from the budget preparation process. MBO and budgeting should be two parts of the same planning process.Unfortunately, some management by objectives (MBO) systems are separated from the budget preparation process. MBO and budgeting should be two parts of the same planning process.

18. 18 Budget Preparation Process Organization Budget Department The budget department, which normally, reports to the corporate controller, administers the information flow of the budgetary control system. The budget department performs the following function :The budget department, which normally, reports to the corporate controller, administers the information flow of the budgetary control system. The budget department performs the following function : - Publishes procedures and forms - Publishes procedures and forms - Coordinates and publishes the basic corporate - Coordinates and publishes the basic corporate wide assumption wide assumption - Make sure that information is properly - Make sure that information is properly communicated between organization units communicated between organization units Organization Budget Department The budget department, which normally, reports to the corporate controller, administers the information flow of the budgetary control system. The budget department performs the following function :The budget department, which normally, reports to the corporate controller, administers the information flow of the budgetary control system. The budget department performs the following function : - Publishes procedures and forms - Publishes procedures and forms - Coordinates and publishes the basic corporate - Coordinates and publishes the basic corporate wide assumption wide assumption - Make sure that information is properly - Make sure that information is properly communicated between organization units communicated between organization units

19. 19 Budget Preparation Process Organization Budget Department - Provides assistance to budgetees in the preparation of their budgets - Analyzes proposed budgets and make recommendation to the budgetee - Administers the process of making budget revisions during the year - Coordinates the work of budget departments in lower echelons - Analyzes reported performance against budget, interprets the results and prepare summary reports for senior management Organization Budget Department - Provides assistance to budgetees in the preparation of their budgets - Analyzes proposed budgets and make recommendation to the budgetee - Administers the process of making budget revisions during the year - Coordinates the work of budget departments in lower echelons - Analyzes reported performance against budget, interprets the results and prepare summary reports for senior management

20. 20 Budget Preparation Process Organization The Budget Committee The budget committee consists of members of senior managementThe budget committee consists of members of senior management The budget committee reviews and either approves or adjusts each of the budgets.The budget committee reviews and either approves or adjusts each of the budgets. Organization The Budget Committee The budget committee consists of members of senior managementThe budget committee consists of members of senior management The budget committee reviews and either approves or adjusts each of the budgets.The budget committee reviews and either approves or adjusts each of the budgets.

21. 21 Budget Preparation Process Issuance of Guidelines The first step in budget preparation process is to develop guidelines that govern the preparation of the budget, for dissemination for all managersThe first step in budget preparation process is to develop guidelines that govern the preparation of the budget, for dissemination for all managers All responsibility centers must follow some of these guidelines, such as inflation, etcAll responsibility centers must follow some of these guidelines, such as inflation, etc Other guidelines are specific to certain responsibility centersOther guidelines are specific to certain responsibility centers The budget staff develops the guidelines and senior management approves them.The budget staff develops the guidelines and senior management approves them. Issuance of Guidelines The first step in budget preparation process is to develop guidelines that govern the preparation of the budget, for dissemination for all managersThe first step in budget preparation process is to develop guidelines that govern the preparation of the budget, for dissemination for all managers All responsibility centers must follow some of these guidelines, such as inflation, etcAll responsibility centers must follow some of these guidelines, such as inflation, etc Other guidelines are specific to certain responsibility centersOther guidelines are specific to certain responsibility centers The budget staff develops the guidelines and senior management approves them.The budget staff develops the guidelines and senior management approves them.

22. 22 Budget Preparation Process Initial Budget Proposal Budget is based on the existing levels, which are then modified in accordance with the guidelines.Budget is based on the existing levels, which are then modified in accordance with the guidelines. Changes from the current level of performance can be classified as :Changes from the current level of performance can be classified as : a. Changes in external forces b. Changes in internal policies and practices Initial Budget Proposal Budget is based on the existing levels, which are then modified in accordance with the guidelines.Budget is based on the existing levels, which are then modified in accordance with the guidelines. Changes from the current level of performance can be classified as :Changes from the current level of performance can be classified as : a. Changes in external forces b. Changes in internal policies and practices

23. 23 Budget Preparation Process Initial Budget Proposal a.Changes in external forces Changes in general level of economic activity as it affects the volume of salesChanges in general level of economic activity as it affects the volume of sales Expected changes in the price purchased of materials and servicesExpected changes in the price purchased of materials and services Expected changes in labor ratesExpected changes in labor rates Expected changes in the cost of discretionary activitiesExpected changes in the cost of discretionary activities Changes in selling pricesChanges in selling prices Initial Budget Proposal a.Changes in external forces Changes in general level of economic activity as it affects the volume of salesChanges in general level of economic activity as it affects the volume of sales Expected changes in the price purchased of materials and servicesExpected changes in the price purchased of materials and services Expected changes in labor ratesExpected changes in labor rates Expected changes in the cost of discretionary activitiesExpected changes in the cost of discretionary activities Changes in selling pricesChanges in selling prices

24. 24 Budget Preparation Process Initial Budget Proposal b. Changes in internal policies and practices Changes in production costs, reflecting new equipment and methodsChanges in production costs, reflecting new equipment and methods Changes in discretionary costsChanges in discretionary costs Changes in market share and product mixChanges in market share and product mix Initial Budget Proposal b. Changes in internal policies and practices Changes in production costs, reflecting new equipment and methodsChanges in production costs, reflecting new equipment and methods Changes in discretionary costsChanges in discretionary costs Changes in market share and product mixChanges in market share and product mix

25. 25 Budget Preparation Process Negotiation The budgetee discusses the proposed budget with his or her superior.The budgetee discusses the proposed budget with his or her superior. This is the heart of the processThis is the heart of the process Negotiation The budgetee discusses the proposed budget with his or her superior.The budgetee discusses the proposed budget with his or her superior. This is the heart of the processThis is the heart of the process

26. 26 Budget Preparation Process Review and Approval The proposed budgets go up through successive levels in the organizationThe proposed budgets go up through successive levels in the organization In part, the analyst studies consistencyIn part, the analyst studies consistency In part, the examination asks whether the budget will produce satisfactory profitIn part, the examination asks whether the budget will produce satisfactory profit Final approval is recommended by the budget committee to the CEOFinal approval is recommended by the budget committee to the CEO Review and Approval The proposed budgets go up through successive levels in the organizationThe proposed budgets go up through successive levels in the organization In part, the analyst studies consistencyIn part, the analyst studies consistency In part, the examination asks whether the budget will produce satisfactory profitIn part, the examination asks whether the budget will produce satisfactory profit Final approval is recommended by the budget committee to the CEOFinal approval is recommended by the budget committee to the CEO

27. 27 Budget Preparation Process Budgets Revision One of the principal considerations in budget administration is the procedure for revising a budget after it has been approved.One of the principal considerations in budget administration is the procedure for revising a budget after it has been approved. There two general types of budget revisions :There two general types of budget revisions : 1. Procedures that provide for a systematic updating the budgets 2. Procedures that allow revisions under special circumstances Budget revisions must be justified on the basis of significantly changed conditions from those existing when the original budget was approvedBudget revisions must be justified on the basis of significantly changed conditions from those existing when the original budget was approved Budgets Revision One of the principal considerations in budget administration is the procedure for revising a budget after it has been approved.One of the principal considerations in budget administration is the procedure for revising a budget after it has been approved. There two general types of budget revisions :There two general types of budget revisions : 1. Procedures that provide for a systematic updating the budgets 2. Procedures that allow revisions under special circumstances Budget revisions must be justified on the basis of significantly changed conditions from those existing when the original budget was approvedBudget revisions must be justified on the basis of significantly changed conditions from those existing when the original budget was approved

28. 28 Budget Preparation Process Contingency Budgets Some companies routinely prepare contingency budgets that identify management actions to be taken if there is a significant decrease in the sales volume from what was anticipated at the time of developing the budget.Some companies routinely prepare contingency budgets that identify management actions to be taken if there is a significant decrease in the sales volume from what was anticipated at the time of developing the budget. The contingency budget provides a way of quickly adjusting to changed conditions if the situation arises.The contingency budget provides a way of quickly adjusting to changed conditions if the situation arises. Contingency Budgets Some companies routinely prepare contingency budgets that identify management actions to be taken if there is a significant decrease in the sales volume from what was anticipated at the time of developing the budget.Some companies routinely prepare contingency budgets that identify management actions to be taken if there is a significant decrease in the sales volume from what was anticipated at the time of developing the budget. The contingency budget provides a way of quickly adjusting to changed conditions if the situation arises.The contingency budget provides a way of quickly adjusting to changed conditions if the situation arises.

29. 29 Behavioral Aspects Participation in the Budgetary Process A budget process is either “ top down “. The top down approach rarely works, howeverA budget process is either “ top down “. The top down approach rarely works, however Actually, an effective budget preparation process blends the “ bottom up “Actually, an effective budget preparation process blends the “ bottom up “ Research has shown that budget participation has positive effects on managerial motivation for two reasons :Research has shown that budget participation has positive effects on managerial motivation for two reasons : a. There is likely to be greater acceptance of budget goals if they are perceived as being under manager’s personal control. b. Participative budgeting results in effective information exchanges. Participation in the Budgetary Process A budget process is either “ top down “. The top down approach rarely works, howeverA budget process is either “ top down “. The top down approach rarely works, however Actually, an effective budget preparation process blends the “ bottom up “Actually, an effective budget preparation process blends the “ bottom up “ Research has shown that budget participation has positive effects on managerial motivation for two reasons :Research has shown that budget participation has positive effects on managerial motivation for two reasons : a. There is likely to be greater acceptance of budget goals if they are perceived as being under manager’s personal control. b. Participative budgeting results in effective information exchanges.

30. 30 Behavioral Aspects Degree of Budget Target Difficulty There are several reasons why senior management approves achievable budgets for business units a. If the budgeted target is too difficult, managers are motivated to take short term actions that may not be in the long term interests of the company b. Achievable budget targets reduce the motivation for managers to engage in data manipulation c. If business unit profit budgets represent achievable targets, senior management can, in turn, divulge a profit target to security analyst Degree of Budget Target Difficulty There are several reasons why senior management approves achievable budgets for business units a. If the budgeted target is too difficult, managers are motivated to take short term actions that may not be in the long term interests of the company b. Achievable budget targets reduce the motivation for managers to engage in data manipulation c. If business unit profit budgets represent achievable targets, senior management can, in turn, divulge a profit target to security analyst

31. 31 Behavioral Aspects Degree of Budget Target Difficulty There are several reasons why senior management approves achievable budgets for business units d. A profit budget that is very difficult to attain usually implies an overly optimistic sales target e. When business unit managers are able to meet and exceed their targets, there is a “winning” atmosphere and positive attitude within the company Degree of Budget Target Difficulty There are several reasons why senior management approves achievable budgets for business units d. A profit budget that is very difficult to attain usually implies an overly optimistic sales target e. When business unit managers are able to meet and exceed their targets, there is a “winning” atmosphere and positive attitude within the company

32. 32 Behavioral Aspects Senior Management Involvement Senior management involvement is necessary for any budget system to be effective in motivating budgeteesSenior management involvement is necessary for any budget system to be effective in motivating budgetees Management must participate in the review and approval of the budgets, and the the approval should not be a rubber stampManagement must participate in the review and approval of the budgets, and the the approval should not be a rubber stamp Senior Management Involvement Senior management involvement is necessary for any budget system to be effective in motivating budgeteesSenior management involvement is necessary for any budget system to be effective in motivating budgetees Management must participate in the review and approval of the budgets, and the the approval should not be a rubber stampManagement must participate in the review and approval of the budgets, and the the approval should not be a rubber stamp

33. 33 Behavioral Aspects The Budget Department The budget department has a particularly difficult behavioral problemThe budget department has a particularly difficult behavioral problem To perform their function effectively, the members of the budget department must have a reputation for impartiality and fairnessTo perform their function effectively, the members of the budget department must have a reputation for impartiality and fairness The Budget Department The budget department has a particularly difficult behavioral problemThe budget department has a particularly difficult behavioral problem To perform their function effectively, the members of the budget department must have a reputation for impartiality and fairnessTo perform their function effectively, the members of the budget department must have a reputation for impartiality and fairness

34. 34 Quantitative Techniques Simulation Simulation is a method that constructs a model of a real situation and then manipulates this model in such a way as to draw some conclusions about the real situation.Simulation is a method that constructs a model of a real situation and then manipulates this model in such a way as to draw some conclusions about the real situation. With a computer simulation, senior management can ask what the effect of different types of changes would be and receive almost instantaneous answersWith a computer simulation, senior management can ask what the effect of different types of changes would be and receive almost instantaneous answers Simulation Simulation is a method that constructs a model of a real situation and then manipulates this model in such a way as to draw some conclusions about the real situation.Simulation is a method that constructs a model of a real situation and then manipulates this model in such a way as to draw some conclusions about the real situation. With a computer simulation, senior management can ask what the effect of different types of changes would be and receive almost instantaneous answersWith a computer simulation, senior management can ask what the effect of different types of changes would be and receive almost instantaneous answers

35. 35 Quantitative Techniques Probability Estimates Some authors have proposed budgets be prepared initially using probability distributions instead of point estimates, that is, the budget committee would approve a number of probability distributions, rather than specific amounts.Some authors have proposed budgets be prepared initially using probability distributions instead of point estimates, that is, the budget committee would approve a number of probability distributions, rather than specific amounts. Probability Estimates Some authors have proposed budgets be prepared initially using probability distributions instead of point estimates, that is, the budget committee would approve a number of probability distributions, rather than specific amounts.Some authors have proposed budgets be prepared initially using probability distributions instead of point estimates, that is, the budget committee would approve a number of probability distributions, rather than specific amounts.

36. 36 Financial Service Organizations Financial service organizations include commercial bank and thrift institutions, insurance companies and securities firms

37. 37 Service Organizations in General Characteristics : Absence of inventory bufferAbsence of inventory buffer Difficulty in controlling qualityDifficulty in controlling quality Labor intensiveLabor intensive Multi unit organizationsMulti unit organizations Characteristics : Absence of inventory bufferAbsence of inventory buffer Difficulty in controlling qualityDifficulty in controlling quality Labor intensiveLabor intensive Multi unit organizationsMulti unit organizations

38. 38 Service Organizations in General a.Absence of inventory buffer Goods can be held in inventory but services cannot be storedGoods can be held in inventory but services cannot be stored Although a manufacturing company can earn revenue in the future from products that are on hand today, a service company cannot do so. A service company must try to minimize its unused capacityAlthough a manufacturing company can earn revenue in the future from products that are on hand today, a service company cannot do so. A service company must try to minimize its unused capacity The cost of service organizations are essentially fixed in the short runThe cost of service organizations are essentially fixed in the short run A key variable in most service organizations, therefore, is the extent to which current capacity is matched with demand.A key variable in most service organizations, therefore, is the extent to which current capacity is matched with demand. a.Absence of inventory buffer Goods can be held in inventory but services cannot be storedGoods can be held in inventory but services cannot be stored Although a manufacturing company can earn revenue in the future from products that are on hand today, a service company cannot do so. A service company must try to minimize its unused capacityAlthough a manufacturing company can earn revenue in the future from products that are on hand today, a service company cannot do so. A service company must try to minimize its unused capacity The cost of service organizations are essentially fixed in the short runThe cost of service organizations are essentially fixed in the short run A key variable in most service organizations, therefore, is the extent to which current capacity is matched with demand.A key variable in most service organizations, therefore, is the extent to which current capacity is matched with demand.

39. 39 Service Organizations in General b. Difficulty in Controlling Quality A manufacturing company can inspect its products before they are shipped to the customer, and their quality can be measured visually or with instrumentsA manufacturing company can inspect its products before they are shipped to the customer, and their quality can be measured visually or with instruments A service company cannot judge product quality until the moment the service is rendered, and then judgments are often subjectiveA service company cannot judge product quality until the moment the service is rendered, and then judgments are often subjective b. Difficulty in Controlling Quality A manufacturing company can inspect its products before they are shipped to the customer, and their quality can be measured visually or with instrumentsA manufacturing company can inspect its products before they are shipped to the customer, and their quality can be measured visually or with instruments A service company cannot judge product quality until the moment the service is rendered, and then judgments are often subjectiveA service company cannot judge product quality until the moment the service is rendered, and then judgments are often subjective

40. 40 Service Organizations in General c. Labor Intensive Manufacturing companies add equipment and automate production lines, thereby replacing labor and reducing costs.Manufacturing companies add equipment and automate production lines, thereby replacing labor and reducing costs. Most service companies are labor intensive and cannot do thisMost service companies are labor intensive and cannot do this d. Multi Unit Organizations Some service organizations operate many units in various locations, each unit relatively small.Some service organizations operate many units in various locations, each unit relatively small. c. Labor Intensive Manufacturing companies add equipment and automate production lines, thereby replacing labor and reducing costs.Manufacturing companies add equipment and automate production lines, thereby replacing labor and reducing costs. Most service companies are labor intensive and cannot do thisMost service companies are labor intensive and cannot do this d. Multi Unit Organizations Some service organizations operate many units in various locations, each unit relatively small.Some service organizations operate many units in various locations, each unit relatively small.

41. 41 Financial Service Organizations Special Characteristics : While the general principles and concepts of management control systems apply, they need to be adapted to the following special characteristics of the financial services industry : a. Monetary Assets b. Time Period for Transactions c. Risk and Reward d. Technology Special Characteristics : While the general principles and concepts of management control systems apply, they need to be adapted to the following special characteristics of the financial services industry : a. Monetary Assets b. Time Period for Transactions c. Risk and Reward d. Technology

42. 42 Financial Service Organizations The Financial Service Sector General observations can be made about the financial sector : a.Financial services are very important in the overall performance of economy b.30 years ago, financial services, existed as distinct and separate industries. c.Financial services firms have used the IT revolution to innovate new products and discover new methods of trading d.The need for controls in the financial services sector has become paramount. e.During the 1990s, new form of financial instruments (such as derivatives) designed by financial service firms sometimes resulted in millions of dollars of losses for their clients. The Financial Service Sector General observations can be made about the financial sector : a.Financial services are very important in the overall performance of economy b.30 years ago, financial services, existed as distinct and separate industries. c.Financial services firms have used the IT revolution to innovate new products and discover new methods of trading d.The need for controls in the financial services sector has become paramount. e.During the 1990s, new form of financial instruments (such as derivatives) designed by financial service firms sometimes resulted in millions of dollars of losses for their clients.

43. 43 Financial Service Organizations The Financial Service Sector The corporate scandals during 2000 have created a huge push for investment banks to spin off their Research Department. The arguments for spin off are many : a.This separation will ensure objective research data. b.At present, cost of research is being subsidized by investment banks c.Investor confidence will improve if they are convinced that research is unbiased. On the other hand, arguments against such a spin off, are a.The cost of research will go up if they are set up as separate firms b.To keep costs down, research departments may issue short reports instead of a rich. The Financial Service Sector The corporate scandals during 2000 have created a huge push for investment banks to spin off their Research Department. The arguments for spin off are many : a.This separation will ensure objective research data. b.At present, cost of research is being subsidized by investment banks c.Investor confidence will improve if they are convinced that research is unbiased. On the other hand, arguments against such a spin off, are a.The cost of research will go up if they are set up as separate firms b.To keep costs down, research departments may issue short reports instead of a rich.

44. 44 Financial Service Organizations Special Characteristics : While the general principles and concepts of management control systems apply, they need to be adapted to the following special characteristics of the financial services industry : a. Monetary Assets b. Time Period for Transactions c. Risk and Reward d. Technology Special Characteristics : While the general principles and concepts of management control systems apply, they need to be adapted to the following special characteristics of the financial services industry : a. Monetary Assets b. Time Period for Transactions c. Risk and Reward d. Technology

45. 45 Corporate Strategy Implications for Management Control Strategic planning Conglomerates tend to use vertical strategic planning systems Related diversified firms tend to be both vertical and horizontal Single industry firms tend to be both vertical and horizontal Implications for Management Control Strategic planning Conglomerates tend to use vertical strategic planning systems Related diversified firms tend to be both vertical and horizontal Single industry firms tend to be both vertical and horizontal

46. 46 Business Unit Strategy Mission The mission of existing business should “pure build” at one end and “pure harvest” at the other hand. To implement the strategy effectively, there should be congruence between the mission chosen and the types of controls used. Mission The mission of existing business should “pure build” at one end and “pure harvest” at the other hand. To implement the strategy effectively, there should be congruence between the mission chosen and the types of controls used.

47. 47 Business Unit Strategy Competitive Advantage A business unit can choose to compete either as a differentiated player or as a low cost player. Competitive Advantage A business unit can choose to compete either as a differentiated player or as a low cost player.

48. 48 Top Management Style Implications for Management Control The various dimensions of management style significantly influence the operations of control systems Style affect the management control process Implications for Management Control The various dimensions of management style significantly influence the operations of control systems Style affect the management control process

49. 49 Top Management Style Implications for Management Control Personal versus Impersonal Controls Some managers are “number oriented”, and they deriving tentative conclusions from it. Other managers are “people oriented”, they usually arrive at their decision by talking with people Implications for Management Control Personal versus Impersonal Controls Some managers are “number oriented”, and they deriving tentative conclusions from it. Other managers are “people oriented”, they usually arrive at their decision by talking with people

50. 50 Top Management Style Implications for Management Control Tight versus Loose Controls A manager’s style affects the degree of tight versus loose control in any situation. The manager of a routine production responsibility center can be controlled relatively tightly or loosely. The actual control reflects the style of the manager’s superior Implications for Management Control Tight versus Loose Controls A manager’s style affects the degree of tight versus loose control in any situation. The manager of a routine production responsibility center can be controlled relatively tightly or loosely. The actual control reflects the style of the manager’s superior