Lecture 9 Budget

Budgeting
Prepared by
Erfan Ovee Nomaan
• Identify objectives
• Identify potential strategies
• Evaluate each strategy
Planning • Choose alternative courses of action

• Implement the long term plan in the form of the
and control annual budget
• Measure actual results and compare with the plan
• Respond to divergences from the plan
Long term plan
Yr 0 Yr 1 Yr2 Yr3 Yr4

Yr5
Annual budget
J F M A M J J A S O N D
Objectives of the budgetary process
Ensure achievement Communicate ideas

Compel planning
of objectives and plans
Provide a framework
Establish a system of
Coordinate activities for responsibility
control
accounting
Motivate employees
to improve their
performance
Preparation
of the annual
budget
• Identify the principal budget
factor
• Prepare sales budget
• Prepare functional budgets
• Prepare material budget
• Communicate
• Monitor performance
Behavioural considerations
SETTING BUDGETS IMPLEMENTING CONTROL

BUDGETS
Budgeting Types
Master Functional Static Incremental

Budget Budgets Budget budgeting
Zero-based Rolling Flexible

Budgeting Budgets Budgets
A master budget is the central planning tool
that a management team uses to direct the
activities of a corporation, as well as to judge
the performance of its various
responsibility centers. It is customary for the
senior management team to review a number
Master of iterations of the master budget and
Budget incorporate modifications until it arrives at a
budget that allocates funds to achieve the
desired results. Hopefully, a company uses
participative budgeting to arrive at this final
budget, but it may also be imposed on the
organization by senior management, with
little input from other employees.
Functiona
l
Budgets
A static budget is fixed for the entire period
covered by the budget, with no changes
based on actual activity. Thus, even if actual
sales volume changes significantly from the
expectations documented in the static
budget, the amounts listed in
Static The static budget is used as the basis from
Budget which actual results are compared. The
resulting variance is called a static budget
variance. Static budgets are commonly used
as the basis for evaluating sales performance.
However, they are not effective for evaluating
the performance of cost centers. the budget
are not changed.
• “A method of setting budgets in which the
prior period budget is used as a base for the
current budget, which is set by adjusting
the prior period budget to take account of
any anticipated changes.”
Incremental • Last period +- any changes expected
Budgets • Inflation
• Special Projects
• Downsizing
• Cost
effective
• Quick – Less
Incrementa management
l Budgeting time lost
Advantage preparing
s them
• Easy to
understand –
based on
prior periods
Incremental Budgeting
Disadvantages
•Inaccuracies magnified
•Inefficiencies
perpetuated
•Waste encouraged
Zero-Based
Budgeting
• Uses
• Useful in Non-profit
organisations
• Non-volume based
departments
• Termination or re-
design (re-
engineering)
situations
ZBB Justification
• Does the activity need to be

carried out?
• What are the consequences of
not carrying out the activity?
• Are there alternative ways of
doing it?
• What does it currently cost
and how much should it cost?
• Do the benefits exceed the
costs?
Implementation of ZBB
Identify decision packages.

• Identify the different activities the business
is involved in.
• Evaluate and rank each activity (decision
package) on the basis of its benefit to the
organisation.
• Allocate resources in the budget according
to available funds, and the evaluation and
ranking of the decision packages.
Advantages:
• Removes inefficient or obsolete
operations
• Avoids wasteful expenditure
Advantage
• Staff learn from the appraisals of
s of ZBB activities
• Results in a more efficient allocation
of resources
Disadvantages:
• Extra paperwork
• Ranking process is
difficult
Disadvantage
s of ZBB • Takes
management time
• Costly
A rolling budget is continually
updated to add a new budget
period as the most recent
budget period is completed.
Rolling Thus, the rolling budget involves
Budget the incremental extension of the
existing budget model. By doing
so, a business always has a
budget that extends one year
into the future.
Reflects the Dynamic Business Environment
The economy, the industry, and the competition are
constantly changing, impacting the company’s
operating results. An advantage of the rolling budget
philosophy is that it recognizes the difficulty of
Rolling anticipating what the business environment will be one
budget’s year from now. The small business owner adjusts his
forecast during the year in response to changes in the
advantage business environment.
and More Logical Spending Decisions
Managers with money left in their budgets toward the
disadvantag end of the year tend to spend the money just because it
e is there, not because the expenditures are necessary.
Quicker Response Time
For example, a small business owner may learn that one
of his competitors is interested in selling the company.
The rolling forecast allows him to quickly see whether
he can afford to make the acquisition or make
adjustments in spending going forward to ensure he
can.
Covers Up Budgeting Inefficiencies
Time-Consuming
A flexible budget adjusts or flexes
for changes in the volume of
Flexible activity. It is more sophisticated
Budget and useful than a static budget,
which remains at one amount
regardless of the volume of
activity.
Advantages of flexible budget
•Adjustment for
Predictions
•Adapting Change
•Control and Evaluation
•Inflation and Variance
• Continuous Monitoring
• Inaccurate Adjustments
Disadvantage
• Lack of Information
s of Flexible • Complexity
Budget
Note: A practical problem
will be solved in tomorrows
lecture.
Jan Jan Variance
Actual Budget (000)
(000) (000) FAV/(UNF)
Monitoring
performanc Sales 500
e Cost of (400)
sales
Gross 100
profit
Jan Jan Variance
Actual Budget (000)
(000) (000) FAV/(UNF)
Monitoring
performanc Sales 400 500
e Cost of (320) (400)
sales
Gross 80 100
profit
Jan Jan Variance
Actual Budget (000)
(000) (000) FAV/(UNF)
Monitoring
performanc Sales 400 500 (100)
e Cost of (320) (400) 80
sales
Gross 80 100 (20)
profit
Jan Jan Variance Actual
Actual Budget (000) YTD
(000) (000) FAV/(UNF) (000)
Monitoring
performanc Sales 400 500 (100) 400
e Cost of (320) (400) 80 (320)
sales
Gross 80 100 (20) 80
profit
Flexed Budget
If P=10, CoGS = 8 Jan Jan Flexed Variance
Actual Budget 0
Flexible 40 40 FAV/(UNF)
Budget £ £ £
Variance Sales 400 40 x 10 = 400 0
Cost of sales -320 40 x -8 = -320 0
Gross profit 80 80 0
Week 9 Seminar question:
Woodo and Thames
seminars Valley

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Budgeting

Planning • Choose alternative courses of action

Yr 0 Yr 1 Yr2 Yr3 Yr4

Ensure achievement Communicate ideas

SETTING BUDGETS IMPLEMENTING CONTROL

Master Functional Static Incremental

Zero-based Rolling Flexible

• Does the activity need to be

Identify decision packages.

Variance Sales 400 40 x 10 = 400 0

Cost of sales -320 40 x -8 = -320 0

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