Session 10

Accounting - 1

Accounting – Budget

Definitions
 Budget is a detailed plan for theacquisition and use of resources over a
specified time period. It represents a plan for the future expressed in
formal quantitative terms.
o Budgeting: The act of preparing a budget
o Budgetary Control: Use of budgets to control a firms activities.
 Padding means making the budget proposal larger than the actual
estimates.

Concepts
Why do we budget?
 Planning
o Communication
 Management by objectives
o Co-ordination
 Goal Congruence
o Control
 Management by exception
 Responsibility accounting: who is responsible for what?
 Advantages
o Define goal and objectives
o Communicating plans
o Coordinate activities
o Think about and plan for the future
o Means of allocating resources
o uncover potential bottlenecks
Budgeting Process
 Budget controller and/or committee are responsible for
o Overall policy metters relating to the budget
o Coordinating the preparation of the budget.
 Budget manual
 Principle budget factor is the factor that will limit the activities of an
undertaking, e.g. sales, material or labour.
o Sales: Involves a realistic sales forecast.
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Accounting - 2

 Master budget (Final Blueprint)

o Profit and Loss Account
o Balance Sheet

Sales Budget
 Detailed schedule showing expected sales for the coming periods
expressed in units and pounds.

Production Budget
 After the sales budget has been completed, the production budget to
reach this amount of sales can be created.
o Production must be adequate to meet budgeted sales and provide
for sufficient ending stock.
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Accounting - 3

Expected cash collections

 Scenario: Some or all sales are on account
 Example:Royal’s collection pattern si:
o 70% collected in the month of sale
o 25% collected in the month following sale
o 5% is uncollectible

Cash budget
 Cash budget is an attempt to identify the timing of cash receipts and
payments in a future period.
 It exists to make sure that there is always enough money in the business
o “Cash requirements may be forecasted through a cash budget.”
 How to overcome a cash deficit
o Give less credit to customers
o Take more credit from suppliers
o Spread the cost of fixed asset purchase or lease
o Negotiate an overdraft with the bank
o Use positive measures e.g. an advertising campaign.
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Accounting - 4

How do we budget
 Which approach?
o Imposed budgets/top-down budgeting
 If this style of budgeting is used, budgets are prepared from
top-down direction, i.e. senior management sets the high-
level budget (often just basic numbers) without collecting
detailed information from operating staff. This total general
target is then broken down into detailed budget.
o Participative approach/bottom-up budgeting
 If this style of budgeting is used, budgets are prepared from
bottom-up, i.e. operating staff collects the detailed
information from various departments/functions/other
sources.
 Which method
o Incremental budgeting
o Zero based budgeting
o Activity based budgeting

Incremental budgeting
 To budget for year 5, use year 4 figures as a base.
 This assumes that year 4s figures represent
o Fully justified activities
o Best working practices
o Acceptable cost efficiency
 If a participative system is applied, budget padding is protected
Zero-Base Budgeting
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Accounting - 5

 Managers are required to justify all budgeted expenditures, not just

changes in the budget from the previous year. The baseline is zero rather
than last year’s budget (zero assumption)
 All activities are re-evaluated.
 Identify and rank decision packages.
o Cost benefit approach is taken to evaluate each package
o These packages compete for available resources and selection.
 What is a decision package?
o A document that identifies and describes a specific activity in such
a manner that senior management can:
 evaluate and rank it against other activities competing for
limited resources, and
 decide whether to approve or disapprove it.
Advantages Disadvantages
Involves line managers Zero assumption threatening for
managers
Promotes search for a better way Benefits difficult to quantify
Costs must be matched to benefits Time consuming and costly

Activity-based budgeting
 planning is linked to strategic objectives
 based on activity analysis (from activity based costing – ABC)
Budgetary Control
 Four stages:
o 1. Establish budgets to reflect responsibility and achieve objectives
(prepare the master plan).
o 2. Compare actual versus expected results.
 Were the costs of the actual output / service what we
expected given what we know about the type of costs
concerned?
 The key issue: we must know the types of costs we are
dealing with.
 3. Examine feedback variances (i.e. those cases where actual costs differ
from what we would have expected).
 4. Only take corrective action if variances occur.
o (Recall ‘Management by Exception’.)
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Accounting - 6

Variance Analysis
 Variances may be changes to volume, price or both (many causes)
 Adverse/Unfavourable Variance (increased costs, less income) = A/U
 Favourable Variance (reduce costs, more income) = F

Activity-
Static Budgets and Performance Reports
 Static Budgets are prepared for a single planned level of activity.
Performance evaluation is difficult when actual activity differs from the
planned level of activity.
 The relevant question is
o How much of the favourable cost variance is due to lower activity
and how much is due to good cost control?”
o To answer the question, we must flex the budget to the actual
level of activity.
Flexible Budgets
 Show revenues and expenses that should have occurred at the actual
level of activity.
 May be prepared for any activity level in the relevant range.
 Reveal variances due to good cost control or lack of cost control.
 Improve performance evaluation
 Tp flex the budget, we have to apply correctly the High-Low-Method.