COURSE OBJECTIVE D: Prepare a master budget and use the information in it to analyze the results of operations.
This chapter will examine in detail the preparation of a master budget, including schedules for sales, collections, cost of sales, payments, operating expenses, a cash budget, and budgeted income statement and balance sheet. It will discuss the purposes and uses of budgets for managers.
Profit planning involves the preparation of a number of budgets, integrated as the master budget, that outline what will be necessary for the organization to achieve its profit goals.
A budget is a quantitative plan to acquire and use resources in a specific time period.
Planning: develop goals and prepare budgets.
Control: managers ensure that the goals are achieved in a cost efficient manner.
See Chapter 2: planning and control cycle – particularly Exhibit 2-1.
Why should an organization prepare a budget?
1. Communication: everyone in the organization will be aware of the goals and plans, and their part in them.
2. Planning: avoid “putting out fires,” that is, crises caused by no foresight. Managers must think and plan ahead formally.
3. Resource allocation: Resources are always limited. Which projects will be funded? Where can the organization’s limited resources be used most effectively?
4. Constraints: (Bottlenecks) identify these before they become a reason for goals to be missed. (See Chapters 2, 12)
5. Coordination of activities: Actions throughout the organization must be integrated into an overall plan, so that everyone is working toward the same goals.
6. Benchmarking: the budget serves as the guide to what performance should be, so that as the actual period unfolds, it can be used to compare actual results and evaluate performance.
Responsibility accounting holds that a manager should be held responsible for those items – and only those items – that (s) he can control. This personalizes the budget, gives goals to individuals. The point is not to punish, but to monitor and correct.
HOWEVER: Ask yourself this question: How is “control” over a cost item defined? Must it be absolute? Is it more a question of information rather than absolute control?
In general, the budget year is the organization’s fiscal year.
Continuous (also called perpetual) budget is rolled forward constantly. As one month (or in some cases one quarter) ends, another month (quarter) is added to the budget. Encourages constant re-evaluation and adjustment of goals and budgets.
Participative or self-imposed budgets ask managers with cost responsibility to prepare budgets for their own area of responsibility, and submit them to the manager above them for review and consolidation.
Signals value for each manager’s abilities, knowledge, opinion.
“On the spot” knowledge of the manager’s area of responsibility.
Manager is motivated to achieve self-set goals – referred to as “commitment” or “buy-in.”
The manager has less excuse for missing goals – not achieving the budget set – if the manager was the one who devised the goals.
Downside: lower level managers may set goals that are too easily achieved – called budgetary slack – in order to be sure of achieving what is expected of them. This makes it necessary for higher-level managers to review budget information carefully, and offer corrections or feedback.
“Top down” budget imposed primarily by upper management. Reality: most budgets are a hybrid of the two, with, often, top management “guidelines” for profit expectations and lower-level-management preparation of details.
What makes a budget successful?
Unqualified support of the process by top management.
Positive rather than negative approach to achievement of goals: pressure or blame are counterproductive and lead to dysfunctional behavior (e.g. see above “downside”).
Compensation tied to real goals that the company wants to achieve, not just budget targets. Too much emphasis on meeting specific…