CHAPTER 13 BUDGETING Flashcards
(43 cards)
what is a budget and what types are commonly prepared
A budget is a quantitative expression of a plan of action prepared in advance of the period to which it relates.
Budgets set out the costs and revenues that are expected to be incurred or earned in future periods.
Most organisations prepare budgets for the business as a whole. The following budgets may also be prepared by organisations:
Departmental budgets.
Functional budgets for sales, production, expenditure and so on.
Statements of profit or loss and Statements of financial position in order to determine the expected future profits.
Cash budgets in order to determine future cash flows.
what are the main purposes of budgeting
The main aims of budgeting are:
Planning for the future – in line with the objectives of the organisation.
Controlling costs – by comparing the plan or the budget with the actual results and investigating significant differences between the two.
Co-ordination of the different activities of the business by ensuring that managers are working towards the same common goal (as stated in the budget).
Communication – budgets communicate the targets of the organisation to individual managers.
Motivation – budgets can motivate managers by encouraging them to beat targets or budgets set at the beginning of the budget period. Bonuses are often based on ‘beating budgets’. Budgets, if badly set, can also demotivate employees.
Evaluation – the performance of managers is often judged by looking at how well the manager has performed ‘against budget’.
Authorisation – budgets act as a form of authorisation of expenditure.
In a management accounting context, the budgeting process is part of the overall planning process.
what are the behavioural aspects of budgeting
If budgets are to be effective, attention must be paid to the behavioural aspects i.e. the effect of the system on people in the organisation and vice versa.
Senior management need to be fully committed to the budgeting system and it is equally important that lower levels of management and operational staff in the organisation should be similarly committed and motivated.
if managers and employees have no confidence in the budgetary processes in operation, it is unlikely that they will operate as an effective control
what is a top down approach to budgeting
The top down approach is where budgets are set by higher levels of management and then communicated to the lower levels of management to whose areas of responsibility they relate. This is also known as an imposed budget.
what are the strengths and drawbacks of a top down approach to budgeting
The main problem with this approach is that those responsible for operating the budget will see it as something in which they have had no say. They lack ownership of the budget and as such they will be reluctant to take responsibility for it. It is unlikely to motivate the employees to achieve the budgetary targets set for them.
However, it can be argued that this top down approach may be the only approach to budgeting which is feasible if:
lower level employees have no interest in participating in the process
they are not technically capable of participating in budget setting
only top level management have access to information which is necessary for budgeting purposes – perhaps information which is commercially sensitive.
wha is the bottom up approach to budgeting
The bottom up approach to budgeting is where lower level managers are involved in setting budget targets. This is known as a participative budget.
If individual managers are involved in setting budget targets, it is likely that they will accept those targets and strive actively towards the attainment of them.
In this way actual performances should be improved by the motivational impact of budgets.
The main problem is if budgets are used both in a motivational role and for the evaluation of managerial performance, then the problem of budgetary bias may arise.
what is budgetary bias
Budgetary bias is where a manager deliberately sets a lower revenue target or a higher cost target.
The effects of this sort of bias can be minimised by careful control at the budget setting stage and by monitoring the budget from one year to the next.
An extension of the bottom up approach is the concept of budget challenging – employees are given the chance to question a budget presented to them (in a positive way) before it is finalised.
what is motivation in a business context
Motivation is the drive or urge to achieve an end result. An individual is motivated if they are moving forward to achieving goals or objectives.
in what ways can management accounting planning and control influence motivation
There is evidence which suggests that management accounting planning and control systems can have a significant effect on manager and employee motivation.
These include:
the level at which budgets and performance targets are set
manager and employee reward systems
the extent to which employees participate in the budget setting process.
what is the aim of setting budgets and targets
The aim of setting budgets is to provide a challenge for employees and managers that is achievable with an appropriate level of effort.
If a budget target is set that is too easy, then actual performance will appear to be better than the budget but it will not have challenged the employees. Human behaviour will tend to lead to individuals putting in the minimum possible effort to achieve a set target.
If the budget is too difficult, managers become discouraged at what they regard as unattainable. This may de-motivate and as a result, actual performance falls short of what might reasonably have been expected.
what are incentive schemes
Budgets by themselves have a limited motivational effect. It is the reward structure that is linked to achieving the budget requirements, or lack of reward for non-achievement, which provides the real underlying motivational potential of budgets.
Managers may receive financial rewards (for example, bonuses) and non-financial rewards (for example, promotion or greater responsibility) based on their ability to meet budget targets. The reward will need to be seen as worthwhile if it is to motivate a manager to achieve the budget.
It is usual to assess the performance of a manager by a comparison of budgeted and actual results for his/her area of responsibility in the organisation.
what are the characteristics of a good employee reward system
Fairness – the system should reward effort which helps the organisation achieve its objectives.
Motivational – it should motivate the managers and employees to behave congruently i.e. in a way which assists the organisation to achieve its objectives.
Understandability – the system should be such that it is clear to managers what they need to do to achieve the rewards. Unduly complex reward systems, perhaps based on complex bonus formulae are unlikely to be effective in generating improved performance.
Consistently applied – the system should operate in the same way for all employees or, if not possible, for all employees at a given level in the organisation.
Objective – the system should be based on measurable criteria with a minimum of subjectivity. It should also be such that it is not open to manipulation by managers in their own interests.
Universal – all employees and managers at all levels in the organisation should be subject to an appraisal and reward system.
what are 3 types of incentive schemes
There are three main types of incentive schemes
Performance related pay (PRP)
Piecework – reward related to the pace of work or effort. The faster the employee works, the higher the output and the greater the reward.
Management by objectives (MBO) – key results are identified for which rewards will be paid on top of salary.
Points system – this is an extension to MBO reward systems where a range of rewards is available based on a point system derived from the scale of improvement made such as the amount of cost reduction achieved.
Commission – paid on the performance of an individual typically paid to salaried staff in sales functions, where the commission earned is a proportion of total sales.
Bonus schemes– usually a one off as oppose to PRP schemes which are usually a continual management policy.
Profit sharing
Usually available to a wide group of employees (often companywide) where payments are made in the light of the overall profitability of the company.
Share issues may be part of the scheme.
what are the 8 stages of the planning and control cycle
The eight stages are explained below:
1 Set mission
This involves establishing the broad overall aims and goals of the organisation – these may be both economic and social.
2 Identify objectives
This requires the company to specify objectives towards which it is working. These objectives may be in terms of:
economic targets
type of business
goods/services to be sold
markets to be served
market share
profit objectives
required growth rates of sales, profits, assets.
3 Search for alternative courses of action
A series of specific strategies should be developed dealing particularly with:
developing new markets for existing products
developing new products for existing markets
developing new products for new markets.
4 Gathering data about alternatives
This is an information-gathering stage.
This stage in budget preparation is where data is sourced both internally and externally, for example costs, revenues, possible competition and legislation changes.
The management accountants will use this information to start producing forecasts of possible production levels, sales levels and planned costs and revenues
To be able to produce forecasts, cost behaviours and items that affect cost such as inflation will need to be established and a standard cost will need to be calculated for each unit of product
5 Select course of action
Having made decisions, long-term plans based on those decisions are created.
6 Implement short-term plan in the form of annual budgets
This stage signals the move from long-term planning to short-term plans in the form of annual budgeting. The budget provides the link between the strategic plans and their implementation in management decisions
7 Monitor actual outcomes
This is the particular role of the cost accountant, keeping detailed financial and other records of actual performance compared with budget targets
8 Respond to divergences from plan
This is the control process in budgeting, responding to divergences from plan either through budget modifications or through identifying new courses of action.
how are budgets prepared in the context of the business
Budget committee is formed – a typical budget committee is made up of the chief executive, budget officer (management accountant) and departmental or functional heads (sales manager, purchasing manager, production manager and so on). The budget committee is responsible for communicating policy guidelines to the people who prepare the budgets and for setting and approving budgets.
Budget manual is produced – an organisation’s budget manual sets out instructions relating to the preparation and use of budgets. It also gives details of the responsibilities of those involved in the budgeting process, including an organisation chart and a list of budget holders.
Limiting factor is identified – in budgeting, the limiting factor is known as the principal budget factor. Generally there will be one factor that will limit the activity of an organisation in a given period. It is usually sales that limit an organisation’s performance, but it could be anything else, for example, the availability of special labour skills.
what are the final steps in the budget process
once the budget relating to the limiting factor has been produced then the managers responsible for the other budgets can produce them. The entire budget preparation process may take several weeks or months to complete. The final stages are as follows.
1Initial budgets are prepared.
2Initial budgets are reviewed and integrated into the complete budget system.
3After any necessary adjustments are made to initial budgets, they are accepted and the master budget is prepared (budgeted statement of profit or loss, statement of financial position and cash flow). This master budget is then shown to higher management for final approval.
4Budgets are reviewed regularly. Comparisons between budgets and actual results are carried out and any differences arising are known as variances.
what are continuous budgets
A Continuous budget is prepared a year (or budget period) ahead and is updated regularly by adding a further accounting period (month, quarter) when the first accounting period has expired. If the budget period is a year, then it will always reflect the budget for a year in advance. Continuous budgets are also known as rolling budgets.
what is ‘what-if’ analysis
‘What-if’ analysis is a form of sensitivity analysis, which allows the effects of changes in one or more data value to be quickly recalculated.
What-if analysis is a technique whereby each of the inputs can be changed both individually and in combination to see the effects on the final results.
An example of basic what-if analysis would be flexing a fixed budget to see how changes in activity levels affect the costs and revenues and therefore the profit of the business.
what is scenario planning
Scenario planning is a strategic planning tool used to make flexible long-term plans. It aims to define critical uncertainties and develop possible scenarios in order to identify the impacts and the responses to give for each one uncertainty.
what are the steps involved in scenario planning
Scenario planning involves the following steps:
1 Identify high impact, high uncertainty factors in the environment.
Once identified, factors need to be ranked according to importance and uncertainty.
2 For each factor, identify different possible futures.
Precision is not possible but developing a view of the future against which to evaluate and evolve strategies is important.
3 Cluster together different factors to identify various consistent future scenarios.
This process usually results in between seven and nine mini scenarios.
4 ‘Writing the scenario’ – for the most important scenarios (usually limited to three), build a detailed analysis to identify and assess future implications.
should include financial implications, strategic implications, the probability of occurence
5 For each scenario, identify and assess possible courses of action for the firm. For each scenario, identify and assess possible courses of action for the firm.
6 Monitor reality to see which scenario is unfolding.
7 Revise scenarios and strategic options as appropriate.
what are the pros and cons of scenario planning
pros
focuses management attention on the future and possiblities
encourages creative thinking
can be used to justify a decision
encourages communication via the participation process
can identify the sources of uncertainty
encourages companies to consider fundamental changes in the external environment
cons
costly and inaccurate - uses resources and time
tendency for cultural distortion and for people to get carried away
risk of self fulfilling prophecy ie thinking about the scenario may be the cause of it
many scenarios considered will not actually occur
what are functional budgets
A functional budget is a budget of income and/or expenditure which applies to a particular function of the business. The main functional budgets that you need to be able to prepare are:
sales budget
production budget
raw material usage budget
raw material purchases budget
labour budget
overheads budget.
what are sales budgets
sales for product = units x selling price
what are production budgets
(forecast sales - opening inv + closing inv)/budgeted production
(all in units)
