MANAGEMENT ACCOUNTING AND CONTROL

(MNAC)

Session 25

Budgeting

Chapter 6 of Prescribed Text-Book : Horngren

Learning Objectives (1,2,3 & 5 of Chapter 6)

1. Describe the Budget and the advantages of budgets

2. Describe the master budget and explain its benefits
3. Prepare the operating budget and its supporting schedules
5. Describe responsibility centers and responsibility accounting
 Budget

• A budget is the quantitative expression of a proposed plan of

action by management for a specified/upcoming period.
• A budget is an aid to coordinate what needs to be done to
implement that plan.

A budget generally includes the plan’s both financial and

nonfinancial aspects and serves as a road map for the
company to follow in an upcoming period.
 Budgets Help Managers….
• Budgets are an integral part of management control systems.

When administered thoughtfully by managers, budgets do the

following:
1. Promote coordination and communication among subunits within
the company : Communicate directions and goals to different
departments of a company to help them coordinate the actions they
must pursue to satisfy customers and succeed in the marketplace.

2. Provide a framework for judging performance and facilitating

learning: judge performance by measuring financial results against
planned objectives, activities, and timelines to learn about potential
problems.
3. Motivate managers and other employees
 Challenges in Administering a Budget

There are several challenges in administering a budget:

The budgeting process is time-consuming that involves all levels of

management : Estimates suggest that senior managers spend about 10–20%
of their time on budgeting and financial planning departments spend as much
as 50% of their time on it.

For most organizations, the annual budget process is a months-long

exercise that consumes a tremendous amount of resources.
Budgets today involve employees throughout the company and the
accountant is a budget coordinator and not a budget preparer.
Management at all levels should understand and support the budget. If
top management support is lacking, the budget effort will be a lackluster.
 Time Coverage of Budgets

The timeline for a budget is dependent on the motive for creating the
budget.
• The motive for creating a budget should guide a manager in
choosing the period for the budget.
• As an example, if the purpose for the budget is cash-flow, you may
look at a 6-month horizon whereas if you are looking at profitability
of a new product line, you may need to look 3-years into the future.

The most frequently used budget period is 1 year (one full

business cycle) : Normally an annual budget would be prepared but
broken down into subperiods such as a month or quarter.
Businesses may also use a rolling budget or continuous budget :
This budget is always available for a specified future period, by
continually adding a month, quarter, or year to the period just ended.
 Strategic Plans and Operating Plans

Budgeting is most useful when it is integrated with a

company’s strategy.

Strategy specifies how an organization matches its capabilities

with the opportunities in the marketplace to accomplish its
objectives.

A company can have :

a strategy of providing quality products or services at a low
price, or
a strategy of providing a unique product or service that is
priced higher than the products or services of competitors.
 Strategic Plans and Operating Plans

To develop successful strategies, managers must consider

questions such as the following:

1. What are our objectives?

2. How do we create value for our customers while distinguishing
ourselves from our competitors?
3. Are the markets for our products local, regional, national, or global?

4. What trends affect our markets?

5. How do the economy, our industry, and our competitors affect
us?
6. What organizational and financial structures serve us best?
7. What are risks and opportunities of alternative strategies and
what are our contingency plans if our preferred plan fails?
 Budgeting Cycle

These three steps describe the ongoing budget-related

processes:

1. Before the start of a fiscal year, managers at all levels take

into account past performance, market feedback, and
anticipated future changes to initiate plans for the next period.
2. Senior managers give subordinate managers a frame of
reference, a set of specific financial or nonfinancial
expectations, against which they will compare actual results.
3. Managers and management accountants investigate any
deviations from the plan.
 Master Budget (Pro-Forma Statements)

The master budget is the initial plan of what the company

intends to accomplish in the period and evolves from both the
operating and financing decisions managers make as they
prepare the budget.

The master budget is at the core of the budgeting process. It

expresses management’s operating and financial plans for a
specified period (usually a fiscal year):
– Operating decisions deal with how to best use the limited
resources of an organization (the operating budget).
– Financial decisions deal with how to obtain the funds to
acquire those resources (the financial budget).
Operating Budget and Financial Budget

The operating budget :

Begins with the Revenues budget,
Includes multiple schedules and
Concludes with the Budgeted Income Statement.

The financial budget is made up of the :

Capital Expenditure budget,
Cash budget,
Budgeted Balance Sheet, and
Budgeted Statement of Cash Flows.
 Basic Operating Budget Steps

1. Prepare the revenues budget (the starting point).

2. Prepare the production budget (in units).
3. Prepare the direct materials usage budget and direct
materials purchases budget
4. Prepare the direct manufacturing labor costs budget
5. Prepare the manufacturing overhead costs budget
6. Prepare the ending inventories budget
7. Prepare the cost of goods sold budget
8. Prepare the non- manufacturing costs budget
9. Prepare the budgeted income statement.
 Basic Financial Budget Steps

Based on the operating budgets:

1. Prepare the capital expenditures budget.
2. Prepare the cash budget.
3. Prepare the budgeted balance sheet.
4. Prepare the budgeted statement of cash flows.
Overview of the Master Budget

Copyright © 2018, 2016, 2015 Pearson Education, Inc. All Rights Reserved.
 Problem 6.18 – Master Budget Preparation
Woolworth Manufacturing company manufactures blue rugs, using wool and dye as
direct materials.

One rug is budgeted to use 36 skeins of wool at a cost of Rs 20 per skein and 0.8 gallons
of dye at a cost of Rs.60 per gallon.

All other materials are indirect.

At the beginning of the year, Woolworth has an inventory of 4,58,000 skeins of wool at
a cost of Rs. 96,18,000 and 4000 gallons of dye at a cost of Rs. 2,36,800. Target
ending inventory of wool and dye is zero. Woolworth uses the FIFO inventory cost flow
method.

Woolworth blue rugs are very popular, and demand is high, but because of capacity
constraints the firm will produce only 2,00,000 blue rugs per year. The Budgeted selling
price is Rs. 20,000 each. There are no rugs in beginning inventory. Target ending
inventory of rugs is also zero.

Woolworth makes rugs by hand but uses a machine to dye the wool. Thus, overhead
costs are accumulated in two cost pools – one for weaving and the other for dyeing.

Weaving overhead is allocated to products based on direct manufacturing labor-

hours(DMLH). Dyeing overhead is allocated to products based on machine-hours(MH).
There is no direct manufacturing labor cost for dyeing. Woolworth budgets 62
DMHL to weave a rug at a budgeted rate of Rs.130 per hour. It budgets 0.2 MH to dye
each skein in the dyeing process.

The following table presents the budgeted overhead costs for the dyeing and weaving
cost pools:

Q1 : Prepare the Master Budget – Operating Budget

Q2. What actions might you take as a manager to improve profitability if sales drop to
1,85,000 of blue rugs ?
 Solution 6.18 – Master Budget Preparation
Answer 1. Master Budget – Operating Budget

1. Step 1 : Prepare the revenues budget

2. Prepare the production budget

3. Prepare the direct materials usage budget
4. Prepare the direct manufacturing labor costs budget
5. Prepare the manufacturing overhead costs budget
5. Prepare the ending inventories budget
7. Prepare the cost of goods sold budget
8. Prepare the non-manufacturing costs budget

No Non-manufacturing costs in this example

9. Prepare the budgeted income statement

A2 What actions might you take as a manager to improve profitability if sales drop to 1,85,000
of blue rugs ? Woolworth should look to reduce Fixed costs and produce less to reduce
Variable costs and Inventory costs.
Budgeting and Responsibility Accounting

To attain the goals described in the master budget, top managers

must coordinate the efforts of all the firm’s employees.
Organization structure is an arrangement of lines of responsibility
within an organization.
How each company structures its organization significantly shapes
how it coordinates its actions.
Functional organizations develop strong competencies within each
function but are generally less focused on particular markets or
customers.
Firms that are organized by product line or brand are more
focused on particular markets or customers.
Budgeting and Responsibility Accounting
Each manager, regardless of level, is in charge of a responsibility
center.
A responsibility center is a part, segment, or sub-unit of an
organization whose manager is accountable for a specified set of
activities.
Responsibility accounting is a system that measures the plans,
budgets, actions, and actual results of each responsibility center.

There are four types of responsibility centers.

Cost—accountable for costs only
Revenue—accountable for revenues only
Profit—accountable for revenues and costs
Investment—accountable for investments, revenues, and costs
 Budgets and Feedback

Budgets, coupled with responsibility accounting, provide

feedback to top managers about the performance relative to
the budget of different responsibility center managers.
Budgets offer feedback in the form of variances: actual
results deviate from budgeted targets.
Variances provide managers with:
Early warning of problems
A basis for performance evaluation
A basis for strategy evaluation
 Assignment

Ch 6 : Problem 6.19 and 6.25

Copyright © 2018, 2016, 2015 Pearson Education, Inc. All Rights Reserved.