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ACC3602

Managerial Planning and Control


Semester II, AY 2014/15
Instructor:Dr.ZhuZinan
Email:bizzz@nus.edu.sg
Office:BIZ1#724

Lecture 5
Planning and Budgeting
RelevantChapters:

MerchantandVanderStede,ManagementControlSystems:
PerformanceMeasurement,Evaluation,andIncentives,
Chapter8
LearningObjectives:
1.
Budgetingbasics
2.
Budgetingprocess
3.
Budgetingapproaches
4.
Financialperformancetargets
5.
Behavioralissuesinbudgeting

1. Budgeting basics

Budgetreferstoadetailedplan,expressedin
quantitativeterms,thatspecifieshowresourceswill
beacquiredandusedduringaspecifiedperiodof
time.
Budgetsareusedfortwodistinctpurposes
planningandcontrolling.
Planninginvolvesdevelopingobjectivesand
preparingvariousbudgetstoachievethese
objectives.
Controlinvolvesstepstakenbymanagementthat
attempttoensuretheobjectivesareattained.

1. Budgeting basics
Planning

Control

StrategicPlanMonitoringofActualActivity
LongTermObjectives

Budgetsarequantitative
expressionsofplans

ShortTermObjectives
ShortTermPlans

BudgetsComparisonofActualwithPlanned
FeedbackInvestigation
Correctiveaction

1. Budgeting basics

Budgetsofferfeedbackintheformof
variances:actualresultsdeviatefrom
budgetedtargets.
Variancesprovidemanagerswith:
Earlywarningofproblems
Abasisforperformanceevaluation
Abasisforstrategyevaluation

1. Budgeting basics

Budgetingandmanagementcontrol:
Budgetinginvolvessettingtargetsthatare
commonlyusedasstandardsagainstwhichto
evaluateperformance
Planningandbudgetingprocessesinvolveformal
reviewsofplansandincludetheactionsthatare
felttobegoodfortheorganizationtotake
Planningandbudgetingprocessesprovidethe
neededinformationfordecisionmakingtothe
relevantmanagers

2. Budgeting Process

Formbudgetcommittee
UsuallyincludestheCEOoroneormorevicepresidents,
headsofstrategicbusinessunits,andtheCFO
Setsandapprovestheoverallbudgetgoalsforallmajor
businessunits
Coordinatesbudgetpreparation
Resolvesconflictsanddifferencesthatariseduringbudgeting
Approvesthefinalbudget
Monitorsoperationsastheyearunfolds
Reviewstheoperatingresultsattheendoftheperiod

2. Budgeting Process
Determinebudgetperiod
L o n g

R a n g e

B u d g e t s

Short Range Budgets

2011

2012

e.g.,Operatingbudgetsordinarilycovers
Aoneyearperiodcorrespondingtoa
Companysfiscalyear.Manycompanies
Dividedtheirannualbudgetintofour
Quarters.

2013

Rolling Budget

2014

e.g.,a12monthbudgetthatrolls
forwardonemonth(orquarter)as
thecurrentmonth(orquarter)is
completed.

2. Budgeting Process
Issuebudgetguidelines
Thebudgetcommitteeisresponsibleforprovidinginitial
budgetguidelinesthatsetthetoneforthebudgetand
governitspreparation.
Aftercarefulconsiderationof:
Generaloutlookofeconomyandmarket,organizations
strategicgoals,longtermplan,expectedoperatingresultsof
thecurrentperiod,specificcorporatedecisions(e.g.,
downsizing,pollutioncontrol,specialpromotions,etc.)

Eachresponsibilitycenterpreparesitsbudgetproposal
basedonguidelines

2. Budgeting Process
Negotiation,review,andapproval
Executivesofbudgetunitsexamineinitialbudget
proposals.
Budgetsgothroughsuccessivelyhigherlevelsofthe
organizationuntiltheyreachthetoplevel,atwhichpoint
thecombinedunitbudgetsbecometheorganizations
budget.
Afterafinalreview,thebudgetcommitteegivesits
approval.TheCEOthenapprovestheentirebudget.

2. Budgeting Process
Revision
Proceduresforbudgetrevisionvaryamongorganizations.
Fororganizationsthatallowbudgetrevisionsonlyunder
specialcircumstances,obtainingapprovaltomodifya
budgetcanbedifficult.

3. Budgeting Approaches
Sales budget
Ending inventory
budget

Direct materials
budget

Production budget

Direct labor
budget

Selling and
administrative
budget

Manufacturing
overhead budget

Cash Budget

Budgeted
income
statement

Budgeted
balance sheet

An example
Papst Companyispreparingitscashbudgetforthemonth
ofMay.Thefollowinginformationisavailableconcerningits
accountsreceivable:
ActualcreditsalesforMarch
ActualcreditsalesforApril
EstimatedcreditsalesforMay
Estimatedcollectionsinthemonthofsale
Estimatedcollectionsinthefirstmonthafterthemonthofsale
Estimatedcollectionsinthesecondmonthafterthemonthofsale
Estimatedprovisionforbaddebts(madeinthemonthofsale)

$130,000
$160,000
$210,000
25%
60%
10%
5%

Thefirmwritesoffalluncollectibleaccountsattheendof
thesecondmonthafterthemonthofsale.

3. Budgeting Approaches
Zerobasebudgeting(ZZB) isabudgetingprocessthat
requiresmanagerstopreparebudgetsfromazerobase
Thistypeofbudgetingallowsnoactivitiesorfunctionstobe
includedinthebudgetunlessmanagerscanjustifytheirneeds
Indepthreviewsandanalysesofallbudgetitemsmake
managersawareofactivitiesandfunctionsthathaveoutlived
theirusefulness
Canbeadifficultandtimeconsumingprocess

3. Budgeting Approaches

Activitybasedbudgeting(ABB) isabudgeting
processbasedonactivitiesandcostdriversof
operations:
Startswiththebudgetedoutputandsegregates
costsrequiredforthebudgetedoutputinto
homogeneouscostpools
CanbeasimpleextensionofafirmsABCsystem

3. Budgeting Approaches

Resources

Resources
ActivityBased
Costing(ABC)

Activities

Cost objects:
products and services
produced, and
customers served.

Activities

ActivityBased
Budgeting(ABB)

Forecast of products
and services to be
produced and
customers served.

3. Budgeting Approaches
Example:
ManufacturingOverheadcostsatCozycamp:
Unitlevel: indirectmaterial,electricityformachinery
Batchlevel: (productionrun;500unitsperrun):setup
($400/setup),materialhandling($600/handling),
inspection($500/inspection)
Productlevel: designengineering($1,200perdesign)
Facilitylevel: managersalary,insuranceandtaxes,
maintenance,utilities,depreciation

Schedule

5 Overhead Budget - ABB


COZYCAMP CO.
Manufacturing Overhead Budget
For the Year Ending December 31, 2002
Quarter

FromProductionBudget

Cost
Driver

1st

2nd

3rd

4th

Unit-level costs:
Units
Indirect material
Electricity (machinery)
Total unit-level costs

6,000
$ 18,000
6,000
$ 24,000

15,500
$ 46,500
15,500
$ 62,000

19,000
$ 57,000
19,000
$ 76,000

9,500
$ 28,500
9,500
$ 38,000

50,000
$150,000
50,000
$200,000

Batch-level costs:
Production runs
Setup
Material Handling
Quality inspection
Total batch-level costs

12
4,800
7,200
6,000
$ 18,000

31
$ 12,400
18,600
15,500
$ 46,500

38
$ 15,200
22,800
19,000
$ 57,000

19
7,600
11,400
9,500
$ 28,500

100
$40,000
60,000
50,000
$150,000

Product-level costs
New tent designs
Design engineering
Total product-level costs

$
$

1
1,200
1,200

4
$4,800
$4,800

Facility-level costs
Supervisory salaries
Insurance and property taxes
Maintenance
Utilities
Depreciation
Total facility-level costs

$ 52,500
11,300
47,500
40,000
110,000
$ 261,300

$ 52,500
11,300
47,500
40,000
110,000
$ 261,300

$ 52,500
11,300
47,500
40,000
110,000
$ 261,300

$ 52,500
11,300
47,500
40,000
110,000
$ 261,300

$210,000
45,200
190,000
160,000
440,000
$1,045,200

$ 304,500
110,000

$ 371,000
110,000

$ 395,500
110,000

$ 329,000
110,000

$1,400,000
440,000

$ 194,500

$ 261,000

$ 285,500

$ 219,000

Total overhead
Less depreciation
Total cash disbursements
for overhead

1
1,200
1,200

$
$

1
1,200
1,200

$
$

1
1,200
1,200

$
$

Year

$960,000

3. Budgeting Approaches

Kaizen(Continuousimprovement)budgeting:
Incorporatescontinuousimprovementexpectationsinto
thebudgetsandadjustsrequiredresourcedemandsbased
ontargetedefficiencyandproductivitygains
Adecreaseincostisaresultofperformingthesame
activitymoreefficientlyandwithhigherquality;nota
resultofarbitraryeliminationofactivitiesorcomponents
Notlimitedtointernalimprovements.Somefirmsexpect
anddemandcontinuousimprovementsfromthesuppliers
andexplicitlyincorporateconsequenteffectsinbudgeted
productioncostandmanufacturingschedules.
E.g.,CitizenWatch

3. Budgeting Approaches
Budgeting Product Life-Cycle Costs
Product planning
and
concept design
Distribution
and customer
service

Preliminary
design

Production

Detailed design
and testing

4. Financial Performance Targets


Plansandbudgetsbecometargetsthataffectmanagers
motivation becausethetargetsarelinkedto
performanceevaluations and,often,variousincentives.
Themostcommonlyusedperformancetargetsat
managementlevelsinforprofitorganizationsarise
duringthebudgetingprocess:thelaststageofthefull
threecycleplanningsystem.
Typicallyfinancialinnature,expressedonafiscalyearorannual
basis,matchresponsibilitystructure,tieintoannual
performancereviewandincentivecontracts

4. Financial Performance Targets

Budgetsmatchtheorganizationsfinancial
responsibilitystructure.
Responsibilityaccountingisasystemthatmeasures
theplans,budgets,actions,andactualresultsof
eachresponsibilitycenter.
Abudgetcontainsanelementofmanagement
commitment,thatis,themanagersagreetoaccept
theresponsibilityforattainingthebudgeted
objectives.

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4. Financial Performance Targets

Typesoffinancialperformancetargets
Modelbased(engineered)/historical/negotiated
Internally/externallyfocuses
Benchmarking

Information asymmetry

Fixed/Flexible
Shouldmanagersbeheldaccountableforachievingtheirplans
regardlessofthebusinessconditionstheyface?

4. Financial Performance Targets

Motivation / Performance

Budgettargetdifficulty

Easy

Goal Difficulty

Impossible

4. Financial Performance Targets

Budgettargetdifficulty
In theory (lab experiments):

Probability

Good targets are about 2540% achievable

Target

Performance

4. Financial Performance Targets

Budgettargetdifficulty
In practice (field research)

Probability

Targets are about 8090% achievable

Target

Performance

4. Financial Performance Targets

Budgettargetdifficulty

Probability

Effective vs. ineffective management teams

Target

Performance

4. Financial Performance Targets

Challengingbutachievable...

Toincreasemanagerscommitmenttoachievethetargets
Tominimizedysfunctionalmanagementactions
Myopicbehavior,datamanipulation

Toreducethecostoforganizationalinterventions
Managementbyexception

Toprotectagainstthecostofoptimisticrevenueprojections
Overcommitmentofresources

Tocreateawinningatmosphereandpositiveattitude

4. Financial Performance Targets

Howmuchinfluenceshouldsubordinateshavein
settingtheirtargets?
Topdown/bottomupbudgeting

Leadstobetteracceptanceofbudgettargets,andhence,
commitmenttoachievethem
Isaneffectivewayofinformationsharingbringingtogether
corporateprioritiesandconstraintswithlowerlevelinsightsabout
businesspotentialsandrisks
Requiresignificantlymoretime
Maymotivatemanagerstointroduceslackintothebudget
Maysupportempirebuildingbysubordinates

5. Behavioral Issues in Budgeting

Wheneverbudgetsareusedtoevaluatemanagers
performanceandthentocompensatethembased
ontheirperformancerelativetothebudgettarget,
strongincentivesarecreatedforthesemanagersto
gamethesystem.
Gamingoccursinboththebudgetsettingprocess,and
Intheactionsmanagerstakeduringtheyeartoachieve
thebudgetedtargets.

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5. Behavioral Issues in Budgeting

PaddingtheBudget
Thedifferencebetweentherevenueorcost
projectionthatapersonprovidesandarealistic
estimateoftherevenueorcostiscalledbudgetary
slack.
Peopleoftenperceivethattheirperformancewilllook
betterintheirsuperiorseyesiftheycanbeatthebudget.
Todealwithuncertainty
Budgetedcostareoftencutbyseniormanagementwhen
allocatingresources.

5. Behavioral Issues in Budgeting

Budgetratcheting
Usinghistoricaldataonpastperformanceisacommon
mechanismforsettingnextyearsbudget.Unfortunately,
itoftenleadstoaperverseincentivecalledtheratchet
effect.
Referstobasingnextyearsbudgetonthisyearsactual
performance.However,performancetargetsareusually
adjustedinonlyonedirectionupward.
Causesemployeestotemperthisyearsbetterthan
budgetedperformancetoavoidbeingheldtoahigher
standardinfutureperiods.

5. Behavioral Issues in Budgeting

Spendingthebudget
Budgetlapsing:unspentfundsdonotcarryovertothe
nextyear.
Managersoftenfeeliftheydonotusealltheresources
theyreceive,nextyearsbudgetmaybecut
Budgetsthatlapseprovidetightercontrolsonmanagers.
Buyingitemsthathavelowervalue
Reducemanagersflexibilitytoadjusttochanging
operatingconditions.

5. Behavioral Issues in Budgeting


Budgetingistimeconsumingandcostly.
Budgetaryslackorpaddingisaninherentproblemof
budgeting.
Despitethedrawbacksofbudgeting,mostcompaniesarestill
usingbudgetstoplan,communicate,setobjectivesand
allocateresourcesetc.
Sincebudgetsarestillcommonlyused,benefitsofbudgeting
arehighanddrawbacksofbudgetingcanbeminimizedby
havingagoodbudgetingsystem.
Foragoodbudgetingsystem,itiscriticaltohaveeffective
communicationandmutualtrustbetweenthetop
managementanditsstaff.

EndofLecture5

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