Ch 9 Profit Planning and Activity-Based Budgeting

Purposes of Budgeting Systems

A budget is a detailed plan, expressed in quantitative terms, that specifies how resources
will be acquired and used during a specified period of time.

Budgeting systems have five primary purposes:

1. Planning

The most obvious purpose of a budget is to quantify a plan of action. The budgeting
process forces the individuals who make up an organization to plan ahead.

2. Facilitating Communication and Coordination

For any organization to be effective, each manager throughout the organization must be
aware of the plans made by other managers. The budgeting process pulls together the
plans of each manager in an organization.

3. Allocating Resources

Generally, an organization’s resources are limited, and budgets provide one means of
allocating resources among competing uses.

4. Controlling Profit and Operations

A budget is a plan, and plans are subject to change. Nevertheless, a budget serves as a
useful benchmark with which actual results can be compared. Such a comparison can
help managers evaluate the firm’s effectiveness in selling insurance.

5. Evaluating Performance and Providing Incentives

Comparing actual results with budgeted results also helps managers evaluate the
performance of individuals, departments, divisions, or entire companies. Since budgets
are used to evaluate performance, they also can be used to provide incentives for people
to perform well.
 Types of Budgets

Different types of budgets serve different purposes.

A master budget, or profit plan, is a comprehensive set of budgets covering all phases of
an organization’s operations for a specified period of time.

Budgeted financial statements, often called pro forma financial statements, show how
the organization’s financial statements will appear at a specified time if operations
proceed according to plan.

Budgeted financial statements include a budgeted income statement, a budgeted balance

sheet, and a budgeted statement of cash flows.

A financial budget is a plan that shows how the organization will acquire its financial
resources, such as through the issuance of stock or incurrence of debt.

A capital budget is a plan for the acquisition of capital assets, such as buildings and
equipment.

Budgets are developed for specific time periods. Short-range budgets cover a year, a
quarter, or a month, whereas long-range budgets cover periods longer than a year.

Rolling budgets are continually updated by periodically adding a new incremental time
period, such as a quarter, and dropping the period just completed. Rolling budgets are
also called revolving budgets or continuous budgets.

The Master Budget: A Planning Tool

The master budget comprises many separate budgets, or schedules, that are
interdependent.

1. Sales of Services or Goods

The starting point for any master budget is a sales revenue budget based on a sales
forecast for services or goods. Airlines forecast the number of passengers on each of their
routes.

2. Sales Forecasting
All companies have two things in common when it comes to forecasting sales of services
or goods. Sales forecasting is a critical step in the budgeting process, and it is very
difficult to do accurately

various procedures are used in sales forecasting, and the final forecast usually combines
information from many different sources.

Major factors considered when forecasting sales include the following:

1. Past sales levels and trends 2. General economic trends. 3. Economic trends in the
company’s industry. 4. Political and legal events.5. The intended pricing policy of the
company. 6. Planned advertising and product promotion. 7. Expected actions of
competitors. 8. New products contemplated by the company or other firms.9. Market
research studies.

3. Operational Budgets

Based on the sales budget, a company develops a set of operational budgets that specify
how its operations will be carried out to meet the demand for its goods or services.

Manufacturing Firms

A manufacturing company develops a production budget, which shows the number of

product units to be manufactured.

-Coupled with the production budget are ending-inventory budgets for raw material, work
in process, and finished goods.

-Manufacturers plan to have some inventory on hand at all times to meet peak demand
while keeping production at a stable level.

-From the production budget, a manufacturer develops budgets for the direct materials,
direct labor, and overhead that will be required in the production process.

-A budget for selling and administrative expenses also is prepared.

Merchandising Firms

The operational portion of the master budget is similar in a merchandising firm, but
instead of a production budget for goods, a merchandiser develops a budget for
merchandise purchases.
-A merchandising firm will not have a budget for direct material, because it does not
engage in production.

-However, the merchandiser will develop budgets for labor (or personnel), overhead, and
selling and administrative expenses.

Service-Industry Firms

Based on the sales budget for its services, a service industry firm develops a set of
budgets that show how the demand for those services will be met.

Cash Budget

Every business prepares a cash budget. This budget shows expected cash receipts, as a
result of selling goods or services, and planned cash disbursements, to pay the bills
incurred by the firm.

Summary of Operational Budgets

-Operational budgets differ since they are adapted to the operations of individual
companies in various industries.

-However, operational budgets are also similar in important ways. In each firm, they
encompass a detailed plan for using the basic factors of production—material, labor, and
overhead—to produce a product or provide a service.

4. Budgeted Financial Statements

The final portion of the master budget includes a budgeted income statement, a budgeted
balance sheet, and a budgeted statement of cash flows.

These budgeted financial statements show the overall financial results of the
organization’s planned operations for the budget period.

5. Nonprofit Organizations

The master budget for a nonprofit organization includes many of the components.

-Many nonprofit organizations provide services free of charge. Hence, there is no sales
budget.

-However, such organizations do begin their budgeting process with a budget that shows
the level of services to be provided.
-Nonprofit organizations also prepare budgets showing their anticipated funding.

-In summary, all organizations begin the budgeting process with plans for (1) the goods
or services to be provided and (2) the revenue to be available, whether from sales or from
other funding sources.

Activity-Based Budgeting

The process of constructing a master budget can be significantly enhanced if the concepts
of activity-based costing are applied. Activity-based costing uses a two-stage cost-
assignment process. ‫معرروفين‬

Applying ABC concepts to the budgeting process yields activity-based budgeting

(ABB).

Under ABB, the first step is to specify the products or services to be produced and the
customers to be served.

Then the activities that are necessary to produce these products and services are
determined.

Finally, the resources necessary to perform the specified activities are quantified.
Conceptually, ABB takes the ABC model and reverses the flow of the analysis.

ABC assigns resource costs to activities, and then it assigns activity costs toproducts and
services produced and customers served.

ABB, on the other hand, begins by forecasting the demand for products and services as
well as the customers to be served.

These forecasts then are used to plan the activities for the budget period and budget the
resources necessary to carry out the activities.

Benefits of ABB
Proponents of ABB believe that real, sustainable payoffs from activity-based costing and
activity-based management will not be forthcoming until an organization’s budgeting
process embraces the ABM approach.

-Utilizing ABC information in the budgeting process provides solid reasoning for
budgeting costs at particular levels, since the underlying ABC information is based
explicitly on the relationships among cost drivers, activities, and resources consumed.

-Moreover, the resulting budget is more useful to management, because it reveals how
cost levels will change if the predicted quantities of the cost drivers change.

-Traditional budgeting processes, which do not embrace the ABB approach, often
classify such costs as setup, purchasing and material handling, quality control and
inspection, or design engineering as fixed costs, since they do not vary with the number
of units produced.

-The ABB approach, however, recognizes that these costs are really variable if the budget
analyst is careful to identify the appropriate cost driver with which each of these costs
varies.

Master Budget include:

1. Sales Budget: This budget displays the projected sales in units for each quarter and
then multiplies the unit sales by the sales price to determine sales revenue.
2. Production Budget: shows the number of units of services or goods that are to be
produced during a budget period
3. Direct-Material Budget: shows the number of units and the cost of material to be
purchased and used during a budget period.
4. Direct-Labor Budget:shows the number of hours and the cost of the direct labor to
be used during the budget period.
5. Manufacturing-Overhead Budget:shows the cost of overhead expected to be
incurred in the production process during the budget period.
6. Selling, General, and Administrative Expense Budget: shows the planned amounts
of expenditures for selling, general, and administrative expenses during the budget
period.
7. Cash Receipts Budget: details the expected cash collections during a budget period.
8. Cash Disbursements Budget: details the expected cash payments during a budget
period.
9. Cash Budget: details the expected cash receipts and disbursements during a budget
period.
10. Budgeted Schedule of Cost of Goods Manufactured and Sold: details the direct
material, direct-labor, and manufacturing-overhead costs to be incurred, and shows
the cost of the goods to be sold during the budget period.
11. Budgeted Income Statement: shows the expected revenue and expenses for the
budget period, assuming that planned operations are carried out.
12. Budgeted Statement of Cash Flows: provides information about the expected
sources and uses of cash for operating activities, investing activities, and financing
activities during a particular period of time.
13. Budgeted Balance Sheet: shows the expected end-of-period balances for the
company’s assets, liabilities, and owner’s equity, assuming that planned operations
are carried out.
Assumptions and Predictions Underlying the Master Budget

A master budget is based on many assumptions and estimates of unknown

parameters.Some estimates tend to be quite accurate, while other predictions are much
more difficult to make accurately.

Financial Planning Models

Managers must make assumptions and predictions in preparing budgets because

organizations operate in a world of uncertainty. A financial planning model is a set of
mathematical relationships that express the interactions among the various operational,
financial, and environmental events that determine the overall results of an organization’s
activities.

Budget Administration

In small organizations, the procedures used to gather information and construct a master
budget are usually informal.

In contrast, larger organizations use a formal process to collect data and prepare the
master budget.

Such organizations usually designate a budget director or chief budget officer. This is
often the organization’s controller.

The budget director specifies the process by which budget data will be gathered, collects
the information, and prepares the master budget.

To communicate budget procedures and deadlines to employees throughout the

organization, the budget director often develops and disseminates a budget manual.

A budget committee, consisting of key senior executives, often is appointed to advise

the budget director during the preparation of the budget. The authority to give final
approval to the master budget usually belongs to the board of directors, or a board of
trustees in many nonprofit organizations.

E-budgeting is an increasingly popular, Internet-based budgeting tool that can help

streamline and speed up an organization’s budgeting process.

International Aspects of Budgeting

As the economies and cultures of countries throughout the world become intertwined,
more and more companies are becoming multinational in their operations. Firms with
international operations face a variety of additional challenges in preparing their
budgets.

First, a multinational firm’s budget must reflect the translation of foreign currencies into
U.S. dollars. Since almost all the world’s currencies fluctuate in their values relative to
the dollar, this makes budgeting for those translations difficult.

Second, it is difficult to prepare budgets when inflation is high or unpredictable.

Predicting such high inflation rates is difficult and further complicates a multinational’s
budgeting process.

Finally, the economies of all countries fluctuate in terms of consumer demand,

availability of skilled labor, laws affecting commerce, and so forth.

Budgeting Product Life-Cycle Costs

A relatively recent focus of the budgeting process is to plan for all of the costs that will
be incurred throughout a product’s life cycle, before a commitment is made to the
product.

Product life-cycle costs encompass the following five phases in a product’s life cycle

• Product planning and concept design. • Preliminary design. • Detailed design and
testing. • Production. • Distribution and customer service.
In order to justify a product’s introduction, the sales revenues it will generate over its life
must be sufficient to cover all of these costs.

Thus, planning these life-cycle costs is a crucial step in making a decision about the
introduction of a new product. This is particularly true for firms with very short product
life cycles.

When product life cycles are as short as a year or two, the firm does not have time to
adjust its pricing strategy or production methods to ensure that the product turns a profit.

-Management must be fairly certain before a commitment is made to the product that its
life-cycle costs will be covered.

-By the time the planning, design, and testing phases are complete, roughly 85 percent of
this product’s life-cycle costs have been committed, while only about 5 percent actually
have been incurred.

Given the early commitment that must be made to significant downstream costs in a
product’s life cycle, it is crucial to budget these costs as early as possible.

Behavioral Impact of Budgets

One of the underlying themes stressed in this text is the behavioral impact of managerial
accounting practices.

A budget affects virtually everyone in an organization: those who prepare the budget,
those who use the budget to facilitate decision making, and those who are evaluated using
the budget.

-The human reactions to the budgeting process can have considerable influence on an
organization’s overall effectiveness.

1. Budgetary Slack: Padding the Budget

Budget padding means underestimating revenue or overestimating costs.

budgetary slack. The difference between the revenue or cost projection that a person
provides and a realistic estimate of the revenue or cost

Why do people pad budgets with budgetary slack? There are three primary reasons.
First, people often perceive that their performance will look better in their superiors’
eyes if they can “beat the budget.”

Second, budgetary slack often is used to cope with uncertainty. the supervisor may feel
that some unforeseen event during the budgetary period could result in unanticipated
costs. One way of dealing with that unforeseen event is to pad the budget.

-If nothing goes wrong, the supervisor can beat the cost budget. If some negative event
does occur, the supervisor can use the budgetary slack to absorb the impact of the event
and still meet the cost budget.

The third reason why cost budgets are padded is that budgetary cost projections are
often cut in the resource-allocation process.

How does an organization solve the problem of budgetary slack?

First, it can avoid relying on the budget as a negative evaluation tool. If the supervisor is
allowed some managerial discretion to exceed the budget when necessary, there will be
less tendency toward budgetary padding.

Second, managers can be given incentives not only to achieve budgetary projections but
also to provide accurate projections. This can be accomplished by asking managers to
justify all or some of their projections and by rewarding managers who consistently
provide accurate estimates.

2. Participative Budgeting

The idea of participative budgeting is to involve employees throughout an organization in

the budgetary process. -Such participation can give employees the feeling that “this is our
budget,” rather than “this is the budget you imposed on us.”

-While participative budgeting can be very effective, it also can have shortcomings.
-Too much participation and discussion can lead to vacillation and delay.

-Also, when those involved in the budgeting process disagree in significant and
irreconcilable ways, the process of participation can accentuate those differences.
-Finally, the problem of budget padding can be severe unless incentives for accurate
projections are provided.
82. Virginia State University (VSU) is preparing its master budget for the upcoming
academic year (an academic year consists of two semesters). Currently, 12,000 students
are enrolled on campus; however, the admissions office is forecasting a 5% growth in the
student body despite a tuition hike to $80 per credit hour. The following additional
information has been gathered from an examination of university records and
conversations with university officials:
· VSU is planning to award 150 tuition-free scholarships.
· The average class has 30 students, and the typical student takes 15 credit hours each
semester.
· Each class is three credit hours.
· Each faculty member teaches five classes during the academic year.
Required:
A. Compute the budgeted tuition revenue for the upcoming academic year.
B. Determine the number of faculty members needed to cover classes.
C. In preparing the university's master budget, should the administration begin with a
forecast of students or a forecast of faculty members? Briefly explain. 

A. Total student body: 12,000 + (12,000  5%) = 12,600;

Tuition-paying students: 12,600 - 150 = 12,450;
Forecasted tuition revenue: 12,450 students  30 credit hours  $80 = $29,880,000
B. Each student generates 10 "enrollments" per year (15 credit hours  2 semesters  3
credit hours per class). Thus, 126,000 "enrollments" (12,600 students  10) must be
covered.
Classes to be taught: 126,000  30 students per class = 4,200 classes;
Faculty needed: 4,200 classes  5 classes per professor = 840 faculty
C. The university should begin with a forecast of the number of students. While the
number of faculty may be a key driver for a variety of expenditures, the number of
faculty is highly dependent on the number of students. Students (and tuition revenue) are
akin to sales—the starting point in the budgeting process.
86. Atlantis Corporation assembles bicycles by purchasing frames, wheels, and other parts from
various suppliers. Consider the following data:
· The company plans to sell 25,000 bicycles during each month of the year's first quarter.
· A review of the accounting records disclosed a finished-goods inventory of 1,400 bicycles on
January 1 and an expected finished-goods inventory of 1,850 bicycles on January 31.
· Atlantis has 4,300 wheels in inventory on January 1, a level that is expected to drop by 5% at
month-end.
· Assembly time totals 30 minutes per bicycle, and workers are paid $14 per hour.
· Atlantis accounts for employee benefits as a component of direct labor cost. Pension and
insurance costs average $2 per hour (total); additionally, the company pays Social Security taxes
that amount to 8% of gross wages earned.
Required:
A. How many bicycles does Atlantis expect to produce (i.e., assemble) in January?
B. How many wheels are budgeted to be purchased in January?
C. Compute Atlantis's total direct labor cost for January.
D. Briefly explain how the company's purchasing activity would affect the end-of-period balance
sheet. 

A. Finished-goods inventory is expected to increase by 450 units (1,850 - 1,400). Thus, the
company will assemble 25,450 bicycles (25,000 + 450).
B. Atlantis's production will require 50,900 wheels (25,450  2). Given that inventory will drop
by 215 units (4,300  5%), the company must purchase 50,685 wheels (50,900 - 215).
C. Assembly time: 25,450 bicycles  30/60 = 12,725 hours

   

D. Purchasing activity would likely affect the balance sheet in several ways. Atlantis's Cash
account would decrease and any end-of-period obligations to suppliers would be disclosed as
accounts payable. In addition, the wheels on hand at the end of the period would affect raw-
material inventories, and the cost of wheels acquired and used would influence the ending
inventory of bicycles.
89. The accounting records of Backspace, Inc., revealed an accounts receivable balance of
$195,000 on January 1, 20x6. Forty percent of the company's sales are for cash, and the
remaining 60% are on account. Of the credit sales, 30% are collected in the month of sale and
70% are collected in the following month. Total sales in January and February are expected to
amount to $500,000 and $530,000, respectively.
Assume that in the latter half of 20x6, Backspace hired a new sales manager who aggressively
tried to maximize the company's market share. She implemented a compensation system for the
sales force that was 100% commission based, with the commission calculated on the basis of
gross sales dollars. Sales volume increased dramatically in a very short period of time, and the
sales and collection patterns changed, as follows:

   

Required:
A. Compute the company's cash inflows for January and February, 20x6.
B. Determine the outstanding receivables balance at the end of February.
C. Compare the sales and collection patterns before and after the arrival of the new sales
manager. Have things improved or deteriorated? Explain.
D. On the basis of the information presented, determine what likely caused the improvement or
deterioration in collection patterns. 

A. January: Accounts receivable ($195,000) + January cash sales ($500,000  40%)

+ January credit sales collected in January ($500,000  60%  30%) = $485,000
February: January credit sales collected in February ($500,000  60%  70%) +
February cash sales ($530,000  40%) + February credit sales collected in February ($530,000 
60%  30%) = $517,400
B. Since credit sales are collected over two months, 70% of February's credit sales are still
outstanding: $530,000  60%  70% = $222,600
C. Although sales have increased, the credit and collection patterns have deteriorated. One of the
company's likely objectives is to accelerate cash inflows. Notice that in percentage terms, cash
sales have declined (40% vs. 20%); credit customers now take longer to pay as judged by
collections in the month of sale (30% vs. 15%); and high levels of uncollectibles have arisen (0%
vs. 10%).
D. The data reveal that total sales increased as did the percentage of sales made on credit. It
appears that the sales manager's emphasis on market share may have led to sales being made to
poor credit risks [as judged by the high rate of uncollectibles and reduced percentages of sales
being settled in the month of sale (both cash and credit)]. These actions may have been triggered
by a commission system based on gross sales, thus "encouraging" employees to increase sales
despite the credit worthiness and profitability of the customer.
95. Discuss the importance of budgeting and identify five purposes of budgeting systems. 

Budgets aid in determining how to acquire resources, and when and how these resources should
be used. In simple terms, a formal budgeting program is a key ingredient to effective
management. The five purposes of budgeting are to:
1. develop a plan of action.
2. facilitate communication of the plan and coordinate various views within an organization.
3. allocate limited resources effectively and efficiently.
4. serve as a benchmark to control profit and operations.
5. evaluate performance and provide incentives to managers.

97. Terry Pineno, new-accounts manager at East Bank of Clarion, has been asked to project how
many new accounts she will open during 20x2. The local economy has been growing, and the
bank has experienced a 10% increase in the number of new accounts over each of the past five
years. In 20x1, the bank had 10,000 accounts.
Pineno is paid a salary, plus a bonus of $20 for every new account above the budgeted amount.
Thus, if the annual budget calls for 1,000 new accounts, and 1,080 new accounts are obtained, her
bonus will be $1,600 (80  $20).
Pineno believes that the local economy will continue to grow at the same rate in 20x2 as it has in
recent years. She decided to submit a projection of 700 new accounts for 20x2.
Required:
Your consulting firm has been hired by the bank president to make recommendations for
improving the bank's operation. Write a memorandum to the president defining and explaining
the negative consequences of budgetary slack. Also discuss the bank's bonus system for the new-
accounts manager and how the bonus program tends to encourage budgetary slack. 

Memorandum
Date: Today
To: President, East Bank of Clarion
From: I.M. Student and Associates
Subject: Budgetary slack
Budgetary slack is the difference between a budget estimate that a person provides and a realistic
determination of the amount. The practice of creating budgetary slack is called padding the
budget. The primary negative consequence of slack is that it undermines the credibility and
usefulness of the budget as a planning and control tool. When a budget includes slack, the
amounts in the budget no longer portray a realistic view of future operations.
The bank's bonus system for the new-accounts manager tends to encourage budgetary slack.
Since the manager's bonus is determined by the number of new accounts opened in excess of the
budgeted number, there is an incentive for the manager to understate her activity projections.
There is evidence of this behavior, as a 10% increase over the bank's current 10,000 accounts
would be 1,000 new accounts in 20x2. Pineno's projection, however, is only 700.
98. James Corporation, headquartered in Chicago, has a manufacturing plant in Dallas. Plant
managers desire to participate in the company's budget efforts, which, for the past 10 years, have
been handled solely by top executives in Chicago. Dallas managers feel that by becoming
involved, they can make great strides in terms of improving operating performance of their aging
facility.
Required:
Briefly discuss this situation, focusing on the benefits and problems of letting Dallas managers
participate in the company's budgetary efforts. 

Participative budgets will make the plant managers feel that their opinions are valued by top
management and, generally speaking, the plant managers will have a better attitude about trying
to achieve the budget. Additionally, it is possible in this case that the participative approach will
result in a more realistic budget document. Chicago personnel may be too far removed from daily
activities in Dallas to get an accurate picture of on-going operations.
On the negative side, a participative budget may take longer to prepare and may lead to some
local in-fighting when compared with one that is imposed from corporate headquarters. Also,
participative budgets may have some padding or slack, as the Dallas managers are faced with an
aging facility. This facility may be inefficient and, with their participation, managers may bend
the numbers a bit to improve appearance.

MATCHING

163. Match each of the following terms with the phrase that most closely describes it. Each
answer may be used only once.

_____ 1. Budgeted income statement

_____ 2. Budgets

_____ 3. Budget variances

_____ 4. Capital acquisitions budget

_____ 5. Flexible budget

_____ 6. Budget slack

_____ 7. Master budget

_____ 8. Sales budget

_____ 9. Static budget

_____ 10. Income shifting

_____ 11. Management by exception

_____ 12. Zero-based budgeting

A. Differences between actual and budgeted amounts

B. A comprehensive planning document that incorporates a number of individual budgets

C. Approach in which managers only investigate exceptional variances

D. Set of budget relationships that can be adjusted to various activity levels

E. Setting budget targets that are easy to achieve

F. Moving income from one period to another to achieve budget targets

G. Method of budget preparation that requires each amount to be justified, even if it was
supported in previous periods

H. Budget showing plans to purchase property, plant, and equipment

I. Formal documents that quantify a company’s plans for achieving its goals
J. A budget that is only valid for a single level of activity

K. Summarizes sales, cost of goods sold, and other expenses to project net income

L. First budget that is prepared since other budgets depend upon it

Answers
1 K 5 D 9 J

2 I 6 E 10 F

3 A 7 B 11 C

4 H 8 L 12 G

21) Describe the benefits to an organization of preparing an operating budget.

Answer: A well-prepared operating budget should serve as a guide for a company to

follow during the budgeted period. It is not "set in stone." If new information or
opportunities arise, the budget should be adjusted.

A well-prepared operating budget assists management with the allocation of scarce

resources. It can help management see trouble spots in advance, and then management
can decide where to allocate its limited resources.

A well-prepared operating budget fosters communication and coordination among

various segments of the company. The process of preparing a budget requires managers
from different functional areas to work together and communicate performance levels
they both want and can attain.

A well-prepared operating budget can become the performance standard against which
firms can compare the actual results.

22) Bob and Dale have just purchased a small honey manufacturing company that was
having financial difficulties. After a brief operating period, they decided that the
company's main problem was the lack of any financial planning. The company made a
good product and market potential was great.

Required:
Explain why a company needs a good budgeting plan. Specifically address the need for a
master budget.
Answer: The master budget is a series of interrelated budgets that quantify management's
expectations about a company's revenues, expenses, net income, cash flows, and financial
position. When administered wisely, a budget:
1. provides a framework for judging performance,
2. motivates managers and employees, and
3. promotes coordination and communication among subunits within the company.

29) Describe some of the drawbacks of using the operating budget as a control device.
Answer: When the operating budget is used as a control device it can lead to behavior
that is actually detrimental to the organization.

The major problem with the budget performance report is not the report itself, but rather
the way it is used. In general, managers are rewarded for favorable variances, and
disciplined for unfavorable variances. This encourages managers to set lax standards for
both sales and costs so favorable variances result. It can also lead to "budget games."

Another drawback is that once the budget is established, if there is any variance between
budget and actual, it is assumed to be because of actual. However, as we know, the
budget will never be totally accurate due to the uncertainties of predicting the future.

If used properly, however, the operating budget can be a tremendous benefit to any
company.
Diff: 2

30) What is budget slack? What are the pros and cons of building slack into the budget
from the point of view of (a) an employee and (b) a senior manager?
Answer: Budget slack occurs when subordinates (a) ask for excess resources above and
beyond what they need to accomplish budget objectives and (b) distort information by
claiming they are not as efficient or effective at what they do, thus lowering
management's performance expectations of them.

Employee's point of view: There are two benefits from this point of view. First, the
subordinate may be able to obtain excess resources to achieve desired goals. This may
take a lot of pressure off the subordinate and reduce job anxiety. Second, the subordinate
may be able to convince senior management to lower their work expectations of him or
her. This may also lead to lower pressure on the subordinate to perform. Both of these
types of slack building are designed to reduce job stress for the subordinate. However, if
incentives are graduated in such a way that achieving higher and higher goals provides
the subordinate with more and more compensation in the form of bonuses, then the
subordinate may lose income by selecting lower goals.
Senior management's point of view: When subordinates build in slack, they are either
using unnecessary resources to achieve a goal that they should have been able to achieve
with fewer resources, or they are understating their performance capabilities. Thus, the
organization is either not running as efficiently as it can, or is losing potential
productivity from employees who are not working as hard as they can. In some cases,
senior management may believe that subordinates build in slack to relieve job pressure. If
burnout of employees has been happening in the organization, then perhaps senior
management may be more forgiving and view some slack building as necessary to keep
their employees from quitting.

31) How is budgeting for a multinational corporation different than budgeting for a
corporation that is strictly domestic?
Answer: Budgeting for a multinational corporation is made far more complex than
budgeting for a domestic corporation because the multinational corporation often has
subunits operating in many different countries, resulting in less familiar business
environments and many different currencies.

Multinational corporations need to understand many different business environments

with significant political, legal, and economic environments.

Multinational companies earn their revenues and incur their expenses in many different
currencies, and must report their results a single currency. Additionally, management
accountants in different countries need to budget for foreign exchange rates and
anticipate changes that might take place during the year in the face of constantly
fluctuating exchange rates.

10) Roger Moon has just purchased the film studio of a movie company that specializes
in comedies. He found that the company did not try to estimate the cost of making a
movie. Instead, it just gave the producer a budget and told him/her to make a movie
within budget. Mr. Moon does not like the former movie-budget concept and desires to
establish a formal cost estimation system.

Required:
What are some of the potential problems that may be encountered in changing from a
budget to a cost estimation movie making system?
Answer: One of the first problems will be the timing of matching the cost drivers with
the actual movie production process. Under the former budget system, the relationships
with many of the cost drivers were probably forced to meet budget, or else poorly kept
because they were substantially under budget and control over them was weak.

Next will be the problem of determining which costs are fixed and which are variable
under the budget system. It may be difficult to determine those that are truly variable.

Timing problems will also have to be reconciled. Some costs may be incurred monthly
rather than by movie, and some type of accrual will have to be made to keep the costs
allocated to the proper cost driver.

Finally, there may be gaps in the historical data because only total costs had to be
maintained within the budget. There was probably little attention paid to cost categories,
thereby causing reliable cost data to be scarce.