Chapter one
Introduction to Budgeting Processes
The budget—For planning and control
A budget is a detailed quantitative plan for acquiring and using financial
and other resources over a specified coming time period.
The act of preparing a budget is called budgeting.
The use of budgets to control an organization’s activities is known as
budgetary control.
Difference Between Planning and Control
Planning – involves developing objectives and preparing
various budgets to achieve those objectives.
Control – involves the steps taken by management to
increase the likelihood that the objectives set down while
planning are attained and that all parts of the organization are
working together toward that goal.
What is the advantages and disadvantages of budgeting?
- Budgeting helps you plan ahead of time.
- It gives an understanding of the expenses that are necessary and
unnecessary.
- It gives you a control over your money and gives awareness about what
happens with the money.
- It helps us organize savings and spending.
. Some disadvantages include that it can be time-consuming, difficult to
stick to, and may not work for everyone.
1
Imposed Budget versus Participatory (Self-Imposed Budget)
Imposed Budget imposed from the top management without
considering the opinions and feelings of the personnel affected. Such a
dictatorial process may result in resistance to the budget. Employees may
believe that the performance evaluation method is unfair or that the goals
are unrealistic and unattainable.
Problems encountered with such imposed budgets have led accountants
and management to adopt participatory budgeting.
Participatory budgeting means that all levels of management
responsible for actual performance actively participate in setting operating
goals for the coming period. Managers and other employees are more likely
to understand and accept goals when they are involved in formulating
them.
Although many companies have used participatory budgeting
successfully, it does not always work.
Whether or not participation works depends on management’s
leadership style, the attitudes of employees, and the organization’s size and
structure.
Participation is not the answer to all the problems of budget preparation.
However, it is one way to achieve better results in organizations that are
receptive to the philosophy of participation.
2
Types of budgeting methods
There are 4 types of budgeting methods:
1- Incremental - Incremental budgeting takes last year’s actual figures
and adds or subtracts a percentage to obtain the current year’s
budget. It is the most common method of budgeting because it is
simple and easy to understand. Incremental budgeting is appropriate
to use if the primary cost drivers do not change from year to year
2- Activity based - Activity-based budgeting is a top-down budgeting
approach that determines the amount of inputs required to support
the targets or outputs set by the company. For example, a company
sets an output target of $100 million in revenues. The company will
need to first determine the activities that need to be undertaken to
meet the sales target, and then find out the costs of carrying out these
activities.
3- Value proposition - Value proposition budgeting is about making
sure that everything that is included in the budget delivers value for
the business. Value proposition budgeting aims to avoid unnecessary
expenditures
4- Zero based - Zero-based budgeting (ZBB) is a budgeting technique
that allocates funding based on efficiency and necessity rather than
on budget history. Management starts from scratch and develops a
budget that only includes operations and expenses essential to
running the business; there are no expenses that are automatically
added to the budget.
3
4
The ten schedules in the master budget are designed to answer
ten questions:
1. How much sales revenue will we earn?
2. How much cash will we collect from customers?
3. How much raw material will we need to purchase?
4. How much manufacturing costs will we incur?
5. How much cash will we pay to our suppliers and our direct
laborers, and how much cash will we pay for manufacturing
overhead resources?
6. What is the total cost that will be transferred from finished
goods inventory to cost of goods sold?
7. How much selling and administrative expense will we incur
and how much cash will be pay related to those expenses?
8. How much money will we borrow from or repay to lenders –
including interest?
9. How much operating income will we earn?
10. What will our balance sheet look like at the end of the
budget period?
The budget is classified broadly into two categories:
1. Operating budget; summarize the level of activities such as sales,
purchasing, and production.
The Operating Budget consists of:
• Sales budget
• Production budget
• Direct materials budget
• Direct labor budget
• Factory overhead budget
• Selling and administrative expense budget
• Income statement
2. Financial budget; such as balance sheets, income statements, and
cash flow statements, identify the expected financial consequences
of the activities summarized in the operating budgets
The Financial Budget consists of:
• Cash budget
• Balance sheet
