Budget processes

Budget processes (cont.)
•
Behavioural consequences of budgeting
•
Participative budgeting
•
Zero base budgeting and program budgeting
•
Flexible budgets
Budgeting Example: Selling and Administrative
Budgeting Example: Selling and Administrative ExpensesExpenses
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•At Rex, variable selling and administrative At Rex, variable selling and administrative expenses are $0.50 per unit soldexpenses are $0.50 per unit sold
•
•Fixed selling and administrative expenses are Fixed selling and administrative expenses are $70,000 per month$70,000 per month
•
•The fixed selling and administrative expenses The fixed selling and administrative expenses include $10,000 in costs (primarily depreciation) include $10,000 in costs (primarily depreciation) that are not cash outflows of the current monththat are not cash outflows of the current month
Budgeting Example: Selling and
Budgeting Example: Selling and Administrative Expenses BudgetAdministrative Expenses Budget

Budgeting Example: Cash Collection
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•All sales are on account (meaning on credit)All sales are on account (meaning on credit)
•
•Rex’s sales collection patternRex’s sales collection pattern
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•70% collected in the month of the sale70% collected in the month of the sale
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•25% collected in the month following the sale25% collected in the month following the sale
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•5% is uncollectible (bad debt)5% is uncollectible (bad debt)
•
•The March 31 accounts receivable balance The March 31 accounts receivable balance of $30,000 will be collected in full in Aprilof $30,000 will be collected in full in April
Budgeting Example: Schedule of Expected Cash
Budgeting Example: Schedule of Expected Cash CollectionCollection
Budgeting Example: Cash Disbursements for
Budgeting Example: Cash Disbursements for MaterialsMaterials
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•Rex pays $0.40 per kg of its materialsRex pays $0.40 per kg of its materials
•
•OneOne–half of a month’s purchases are paid for half of a month’s purchases are paid for in the month of purchase; the other half is in the month of purchase; the other half is paid in the following monthpaid in the following month
•
•The accounts payable balance at 31 March is The accounts payable balance at 31 March is $12,000$12,000
Budgeting Example: Cash Disbursements
Budgeting Example: Cash Disbursements for Materialsfor Materials
April
April
May
May
June
June
Quarter
Quarter
Accounts
Accounts PayablesPayables
12,000
12,000
12,000
12,000
April purchases
April purchases
(140,000 Kgs)
(140,000 Kgs)
28,000
28,000
28,000
28,000
56,000
56,000
May purchases
May purchases
(221,500 Kgs)
(221,500 Kgs)
44,300
44,300
44,300
44,300
88,600
88,600
June purchases
June purchases
(142,000 Kgs)
(142,000 Kgs)
28,400
28,400
28,400
28,400
Total cash
Total cash disbursementdisbursement
$
$40,00040,000
$
$72,30072,300
$
$72,70072,700
$
$185,000185,000
Budgeting Example: Additional Cash Information
Budgeting Example: Additional Cash Information
Rex Limited
Rex Limited
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•Maintains a 16% open line of credit for Maintains a 16% open line of credit for $75,000$75,000
•
•Maintains a minimum cash balance of $30,000Maintains a minimum cash balance of $30,000
•
•Borrows on the first day of the month and Borrows on the first day of the month and repays loans on the last day of the monthrepays loans on the last day of the month
•
•Pays a cash dividend of $49,000 in AprilPays a cash dividend of $49,000 in April
•
•Purchases equipment for $143,700 in May Purchases equipment for $143,700 in May and $48,300 in June (paid in cash)and $48,300 in June (paid in cash)
•
•Has a cash balance of $40,000 at 1 AprilHas a cash balance of $40,000 at 1 April
Budgeting Example: Cash Budget
Budgeting Example: Cash Budget
Budgeting Example: Cash Budget (cont.)
Budgeting Example: Cash Budget (cont.)
Budgeting Example: Cash Budget
Budgeting Example: Cash Budget
Budgeting Example: Cash Budget (cont.)
Budgeting Example: Cash Budget (cont.)
Budgeting Example: Budgeted Income
Budgeting Example: Budgeted Income StatementStatement
Budgeting Example: Information for Budgeted Balance
Budgeting Example: Information for Budgeted Balance SheetSheet
•
•Rex reported the following account Rex reported the following account balances on 30 June prior to preparing its balances on 30 June prior to preparing its budgeted financial statementsbudgeted financial statements
Land
Land$50,000$50,000
Building (net)
Building (net)$175,000$175,000
Share Capital
Share Capital$200,000$200,000
Retained earnings
Retained earnings$146,150$146,150
Budgeting Example: Budgeted Balance Sheet
Budgeting Example: Budgeted Balance Sheet
Rex Limited
Rex Limited
Budgeted Balance Sheet as at 30 June
Budgeted Balance Sheet as at 30 June
Current assets
Current assets
Cash
Cash
43,000
43,000
Accounts receivable
Accounts receivable
75,000
75,000
Raw material inventory
Raw material inventory
4,600
4,600
Finished goods inventory
Finished goods inventory
24,950
24,950
Non
Non–current assetscurrent assets
Land
Land
50,000
50,000
Building
Building
175,000
175,000
Equipment
Equipment
192,000
192,000
Total assets
Total assets
$564,550
$564,550
Accounts payable
Accounts payable
28,400
28,400
Contributed equity
Contributed equity
200,000
200,000
Retained earnings
Retained earnings
336,150
336,150
Total
Total
$
$564,550564,550
Budgets in Not
Budgets in Not–forfor–profit Organisations and profit Organisations and Government AgenciesGovernment Agencies
•
•Annual budget has many of same components Annual budget has many of same components as foras for–profit organisationprofit organisation
•
•No sales budget if services provided for no No sales budget if services provided for no chargecharge
•

•Other revenue sources may be estimatedOther revenue sources may be estimated

-Government grants, donations, sponsorshipsGovernment grants, donations, sponsorships
•
•Service levels drive the resources that are Service levels drive the resources that are needed and inform the cost budgetsneeded and inform the cost budgets
Behavioural Consequences of Budgeting
Behavioural Consequences of Budgeting
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•A budget affects virtually all staff in an A budget affects virtually all staff in an organisationorganisation
•
•Individuals’ reactions to the budgeting Individuals’ reactions to the budgeting process may affect an organisation’s process may affect an organisation’s effectivenesseffectiveness
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•Three main issues to considerThree main issues to consider
1.
1.Participative budgetingParticipative budgeting
2.
2.Budgetary slack Budgetary slack
3.
3.Budget difficultyBudget difficulty
Participative Budgeting
Participative Budgeting
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•Where managers develop their own initial Where managers develop their own initial budget estimates for their own area of budget estimates for their own area of operationsoperations

-Negotiation and revisions of budget estimatesNegotiation and revisions of budget estimates

-Allows managers at all levels to have inputAllows managers at all levels to have input
Participative Budgeting (cont.)
Participative Budgeting (cont.)
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•TopTop–down budgeting is where senior down budgeting is where senior managers impose budget targetsmanagers impose budget targets
•
•BottomBottom–up budgeting is where lower up budgeting is where lower managerial and operations levels are active managerial and operations levels are active in setting their own budgetsin setting their own budgets
Employee Empowerment
Employee Empowerment
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•Based on the belief that employees will Based on the belief that employees will experience greater motivation when they experience greater motivation when they have higher degrees of authority and have higher degrees of authority and independenceindependence
•
•More broad concept than budgetary More broad concept than budgetary participationparticipation
Pros and Cons of Participative Budgeting
Pros and Cons of Participative Budgeting
•

•BenefitsBenefits

-Encourages coordination and communication Encourages coordination and communication between managers and the wider organisationbetween managers and the wider organisation

-More accurate budget estimatesMore accurate budget estimates

-Individuals identify more closely with the budget Individuals identify more closely with the budget targetstargets
•

•CostsCosts

-Expensive and timeExpensive and time–consumingconsuming

-Can cause delays and indecisiveness Can cause delays and indecisiveness

-May instigate differences and disagreementsMay instigate differences and disagreements

-Provides opportunities for padding the budgetsProvides opportunities for padding the budgets
Budgetary Slack
Budgetary Slack
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•Managers may intentionally underestimate Managers may intentionally underestimate revenues or overestimate costs revenues or overestimate costs
•

•Budgetary slackBudgetary slack

-Difference between the estimated revenue or cost Difference between the estimated revenue or cost projection and a realistic estimate of revenue or projection and a realistic estimate of revenue or costcost
•

•Reasons for padding the budgetReasons for padding the budget

-Manager’s performance looks better when they Manager’s performance looks better when they exceed their budgetexceed their budget

-A way of coping with uncertaintyA way of coping with uncertainty

-To guard against initial budget requests being cut To guard against initial budget requests being cut back by senior managementback by senior management
Budget Difficulty
Budget Difficulty
•

•Goal congruenceGoal congruence

-When the organisation’s goals coincide with When the organisation’s goals coincide with individuals’ goalsindividuals’ goals
•

•Budget acceptance is more likely when:Budget acceptance is more likely when:

-Targets are developed with employees’ participationTargets are developed with employees’ participation

-Targets are considered achievableTargets are considered achievable

-Frequent feedback on performanceFrequent feedback on performance

-Employees have control over activitiesEmployees have control over activities

-Achievement accompanied by rewardsAchievement accompanied by rewards
The Effect of Budget Difficulty on Employee
The Effect of Budget Difficulty on Employee PerformancePerformance
Source
Source: : From From Accounting for Management Control, Accounting for Management Control, 2nd 2nd ednedn, Emmanuel, C., , Emmanuel, C., OtleyOtley, D. & Merchant, K., 1990. Reproduced by , D. & Merchant, K., 1990. Reproduced by permission of permission of CengageCengageLearning EMEA Ltd.Learning EMEA Ltd.))
Zero
Zero–Base Budgeting Base Budgeting
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•All expenses are initially set as 0 at the All expenses are initially set as 0 at the beginning of the budgeting processbeginning of the budgeting process
•
•Managers must justify each activity in order to Managers must justify each activity in order to receive an allocation of resourcesreceive an allocation of resources
•
•TimeTime–consuming and expensive to implementconsuming and expensive to implement
•
•Not useful in identifying areas of waste, Not useful in identifying areas of waste, redundant activities or ways to improve redundant activities or ways to improve performanceperformance
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•Can be too introspectiveCan be too introspective
Program Budgeting
Program Budgeting
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•Budgets prepared for individual programs and Budgets prepared for individual programs and program objectives as opposed to line item program objectives as opposed to line item budgetingbudgeting
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•Control is achieved through quantitative and Control is achieved through quantitative and qualitative performance measures qualitative performance measures
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•Often associated with budgeting in Often associated with budgeting in government departmentsgovernment departments
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•Focus is on outputs and outcomesFocus is on outputs and outcomes
Flexible Budgets
Flexible Budgets
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•A budget prepared for a range of activity A budget prepared for a range of activity levelslevels
•
•Static budgets are prepared for one specific Static budgets are prepared for one specific activity levelactivity level
•
•Flexible budgets provide valid basis for Flexible budgets provide valid basis for comparing actual and expected costs to comparing actual and expected costs to budget, because they are updated for the budget, because they are updated for the actual level of activityactual level of activity
Static and Flexible Budgets for Moleskins, R.M.
Static and Flexible Budgets for Moleskins, R.M. WilliamsWilliams
Summary
Summary
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•Budgeting is a detailed plan summarising the Budgeting is a detailed plan summarising the organisation’s financial activitiesorganisation’s financial activities
•

•Budgeting systems have multiple purposesBudgeting systems have multiple purposes

-Planning Planning

-Communication and coordinationCommunication and coordination

-Allocating resourcesAllocating resources

-Controlling profit and operationsControlling profit and operations

-Evaluating performance and providing incentivesEvaluating performance and providing incentives
Summary (cont.)
Summary (cont.)
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•Annual budget: set of interdependent budgets Annual budget: set of interdependent budgets
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•Budgeting has significant behavioural Budgeting has significant behavioural implicationsimplications