Motivation, budgets ans

Responsibility accounting

Major Features of Budgets

Definition and Role of Budgets
Budget: a quantitative expression of a proposed plan of action by management for future time
period and is an aid to the coordination and implementation of the plan.

Adopted budgeting cycle of many companies:

1. Planning the performance of the organization as a whole as well as its subunits. The
entire management team agrees upon what is expected.
2. Providing a frame of reference, a set of specific expectations against which actual
results can be compared.
3. Investigating variations from plans. If necessary, corrective action follows
investigations.
4. Planning again, considering and changed conditions.

Master budget: coordinates all the financial projections in the organisation's individual budgets
in a single organization-wide set of budgets for a given time period. It embraces it the impact
of both operating and financing decisions.
Operating decisions: are about the acquisition and use of scarce resources.
Financing decisions: center on how to obtain the funds to acquire resources.

Roles of Budgets
Strategy and Plans
Budgeting is most useful when done as an integral part of an organisation's strategic analysis.

Strategy: can be viewed as describing how an organization matches its own capabilities with
the opportunities in the marketplace to accomplish its overall objectives.

Strategic analysis underlies both long-run and short-run planning.

Long-nm planning Long-nm budgets

strategy analysis

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Short-nm budgets

A Framework for Judging Performance

Budgeted performance measures can overcome two key limitation s of using past performance
as a basis for judging actual results:
• Past results incorporate past miscues and substandard performance.
• The future may be expected to be very di2erent from past.

Coordination and Communication

Coordination: the meshing and balancing of all factors of production or service and of all the
departments and business functions so that the company can met is objectives.
Communication: is ge4ng those objectives understood and accepted by all departments and
functions.

Motivation and Wider Organisational Issues

The manner in which a budget is administered can adversely impact on the managers'
behavior. Budgets should not be administered rigidly.

Types of Budget
Time Coverage
The most frequently used budget period is one year. The annual budget is often subdivided by
months for the first quarter and by quarters for the remainder of the year.

Rolling budget: a budget or plan that is always available for a specified future period by adding
a month, quarter or year in the future as the month quarter or year just ended is dropped.

An Illustration of a Master Budget

Operating budget: the budgeted profit statement and its supporting budget schedules.
Financial budget: part of the master budget that comprises the capital budget, cash budget,
budgeted balance sheet and budgeted statement of cash flows.

Budgeted financial statement are sometimes called proforma statements.

Basic Data and the Requirements

Steps in Preparing an Operating Budget

• Step 1: Revenue budget. The revenue budget is the usual starting point for budgeting,
because production (and hence costs) and stock levels generally depend on the forecast
level of revenue.
Padding the budget or introducing budgetary slack refers to the practice of
underestimating budgeted revenues (or overestimating budgeting costs) in order to
make budgeted targets more achievable.

• Step 2: Production budget (in units). After revenues are budgeted, the production
budget can be prepared. The total finished goods units to be produced depends on
planned sales and expected changes in stock levels.
When unit sales are not stable throughout the year, managers must decide whether to
adjust production levels periodically to minimize stock held or to maintain constant
production levels and let stock rise and fall.
 • Step 3: Direct materials usage budget and direct materials purchases budget. The
decisions on the number of units to be produced is the key to computing the usage of
direct materials in quantities and in euros.

• Step 4: Direct manufacturing labor budget. These costs depend on wage rates,
production methods and hiring plans.

• Step 5: Manufacturing overhead budget. The total of these costs depends on how
individual overhead cost very with assumed cost driver, direct manufacturing labor
hours. The specific variable- and fixed-cost categories may be obtained, following
discussions with company personnel in di2erent areas.

• Step 6: Closing stock budget. These unit costs are used to calculate the cost of target
closing stocks of direct materials and finished goods.

• Step 7: Cost of goods sold budget.

• Step 8: Other (non-production) costs budget. For brevity, other areas of the value
chain are combined into a single schedule.

• Step 9: Budgeted operating pro3t statement. Top management's strategies for

achieving revenue and operating profit goals influence the costs planned for the
di2erent business functions of the value chain.

As strategies change, the budget allocations for di2erent elements of the value chain will also
change.

Computer-Based Financial Planning Model

Financial planning models: are mathematical representations of the relationships across
activities, financial activities and financial statements.

Kaizen Budgeting
Kaizen budgeting: is a budgetary approach that explicitly incorporates continuous
improvement during the budget period into the resultant budget numbers.

Activity-BasedBudgeting
Activity-based budgeting: focuses on the cost of activities necessary to produce and sell
products and services. It separates indirect costs into separate homogeneous activity cost
pools.
Management uses the cause-and-e2ect criterion to identify the cost drivers for each of these
indirect-cost pools.

Four key steps inactivity-based budgeting are:

1. Determine the budgeted cost of performing each unit of activity at each activity area.
2. Determine the demand for ach individual activity based on budgeted, production, new
product development and so.
 3. Calculate the cost of performing each activity.
4. Describe the budget as cost or performing various activities (rather than budgeted cost
of functional or conventional value-chain spending categories).

Budgeting and Responsibility Accounting

Organizational Structure and Responsibility
Organizational structure: an arrangement of line or responsibility within the entity.
Coordinating the organization's e2orts means assigning responsibility to managers who are
accountable for their actions in planning and controlling human and physical resources.

Responsibility center: a part, segment or subunit of an organization whose manager is

accountable for a specified set of activities.
Responsibility accounting: a system that measures the plans (by budgets) and actions (by
actual results) of each responsibility center.

Four major types of responsibility center are:

1. Cost center: manager accountable for cost only.
2. Revenue center: manager accountable for revenues only.
3. Profit center: manager accountable for revenues and costs.
4. Investment center: manager accountable for investments, revenue and costs.

The responsibility accounting approach costs to either the individual who has the best
knowledge about why the costs arose or the activity that caused the costs.

Feedback
Variances, properly used can be helpful in four ways:
1. Early warning
2. Performance valuation
3. Evaluating strategy
4. Communicating the goals of the organization.

Responsibility and Controllability

Controllability: the degree of influence that a specific manager has over costs, revenue or other
items in question.
Controllable cost: is any cost that is primarily subject to the influence of a given manager of a
given responsibility center for a given time span.

In practice, controllability is di8cult to pinpoint:

• Few costs are clearly under the sole influence of one manager.
• With a long enough time span, all costs will come under somebody's control.
Emphasis on Information and Behavior
Managers should avoid overemphasising controllability. Responsibility account is more far
reaching. It focuses on information and knowledge, not control.

Performance report for responsibility centers may also include uncontrollable items because
this approach could change behavior in the directions top management desires.
Budgeting: a Discipline in Transition
Criticism of traditional budgeting
Excessive reliance on extrapolating past
trends
MAKE ACROSS-THE-BOARD FIXED
PERCENTAGE CUTS WHEN EARLY
ITERATIONS OF A BUDGET PROVIDE'
UNACCEPTABLE RESULTS'
Budget examines individual functional areas
as if they are independent (so-called silos)
BUDGET MYOPICALLY OVEREMPHASIZES A
FIXED TIME HORIZON SUCH AS A YEAR.
MEETING ANNUAL COST TARGETS VIEWED
AS KEY TASK TO BE ACCOMPLISHED
Budget is preoccupied with financial aspects
of events in the budget period
Budgets are not used until end of budget
period to evaluate performance
PROPOSAL FOR CHANGE
Link budgeting explicitly to strategy
Use activity based budgeting to guide areas
for cost reduction
Explicitly adopt a cross functional approach
where interdependencies across business
function areas of the value chain are
recognized
Tailor the budget cycle to the purpose of
budgeting. Events beyond current period
are recognized as important when
evaluating current actions. Value creations
is given paramount importance.
Balance financial aspect with both non
financial (such as quality and time) aspects
Signals to all employees the need for
continuous improvement of performance
(such as revenue enhancement and cost
reduction) within the budget period.