Chapter 15 The budgeting process

Budgets = a financial plan for implementing management decisions.

Control process = the process of comparing actual and planned outcomes, and responding
to any deviations form the plan.

Long-term plan/ strategic plan = a top-level plan that sets out the objectives that an
organization’s future activities will be directed towards.

Vision statement = a statement that clarifies the beliefs and governing principles of an
organization, what it wants to be in the future or how it wants the world in which it
operates to be.

Mission statement = a statement that provides in very general terms what the organization
does to achieve its vision, its broad purpose and reason, its existence, the nature of the
business it is in and the customers it seeks to serve and satisfy

Corporate objectives = specific, measurable statements, often expressed in financial terms,

of what the organization as a whole wish to achieve.

Unit objectives = specific, measurable statements, often expressed in financial terms, of

what individual units within an organization wish to achieve.

Strategy = the courses of action that must be taken to achieve an organization’s overall
objectives
Budgeting = the implementation of the long-term plan for the year ahead through the
development of detailed financial plans

Budgetary control process = the process of comparing actual and planned outcomes, and
responding to any deviations from the plan

Feedback lopes = parts of a control system that allow for review and corrective action to
ensure that actual outcomes conform with planned outcomes.

Budgets serve a number of useful purposes:

1. Planning annual operations
2. Coordinating the activities of the various parts of the organization and ensuring that
the parts are in harmony with each other
3. Communicating plans to the various responsibility centre managers
4. Motivating managers to strive to achieve the organizational goals
5. Controlling activities
6. Evaluating the performance of managers and business units

Management by exception = a system in which a manager’s attention and effort can be

concentrated on significant deviations from the expected results.

Continuous/ rolling budgeting = an approach to budgeting in which the annual is broken

down into months for the first three months and into quarters for the rest of the year, with
a new quarter being added as each quarter ends.

Stages in the budgeting process:

1. Communicating details of budget policy and guidelines to those people responsible
for the preparation of budgets
2. Determining the factor that restricts output
3. Preparation of the sales budget
4. Initial preparation of various budgets
5. Negotiation of budgets with superiors
6. Coordination and review of budgets
7. Final acceptance of budgets
8. Ongoing review of budgets

Master budget = a document that brings together and summarizes all lower level budgets
and which consists of a budgeted profit and loss account, a balance sheet and cash flow
statement.
1. Sales budget
- Shows the quantities of each product that the company plans to sell and the
intended selling price.
- It provides the predictions of total revenue from which cash receipts from customers
will be estimated and it also supplies the basic data for constructing budgets for
production costs and for selling, distribution and administrative expenses.
- Foundation for all other budgets.
2. Production budget
- First the sales budget must be made.
- Quantities only
- Responsibility of the production manager
- The objective is to ensure that production is sufficient to meet sales demand and
that economic inventory levels are maintained.
3. Direct materials usage budget
- The supervisor will prepare estimates of the materials that are required to meet the
production budget.
4. Direct materials purchase budget
- Responsibility of the purchasing manager
- The planned quantities of raw materials to meet the production requirements.
- The objective is to purchase these materials at the right time at the planned
purchase price.
- Necessary to take in to account the planned raw materials inventory levels.
5. Direct labor budget
- Responsibility of the respective manager of the departments.
- They will prepare estimates of their departments’ labor hours required to meet the
planned production.
6. Production overhead budget
- Responsibility of the respective production department managers.
- The total of the overhead budget will depend on the behavior of the costs of the
individual overhead items in relation to the anticipated level of production.
- The overheads must also be analyzed according to whether they are controllable or
non-controllable for the purpose of cost control.
- The budgeted expenditure for the variable overhead items is determined by
multiplying the budgeted direct labor hours for each department by the budgeted
variable overhead rate per hour.
- It is assumed that all variable overheads vary in relation to direct labor hours.
7. Selling and administration budget
- The sales manager will be responsible for the selling budget, the distribution
manager will be responsible for the distribution expenses and the chief
administrative officer will be responsible for the administration budget.
8. Departmental budgets
- For cost control, the direct labor budget, materials usage budget and production
overhead budget are combined into separate departmental budgets known as
responsibility centres.
- These budgets are normally broken down into 12 separate monthly budgets, and the
actual monthly expenditure is compared with the budgeted amounts for each of the
items concerned.
- This comparison is used for judging how effective managers are in controlling the
expenditure for which they are responsible.
9. Master budget
- When all the budgets have been prepared, the budgeted profit and loss account and
balance sheet provide the overall picture of the planned performance for the budget
period.
10. Cash budget
 - A budget that aims to ensure that sufficient cash is available at all times to meet the
level of operations that are outlined in all other budgets.

The budgetary process does not end for the current year once the budget has begun;
budgeting should be seen as a continuous and dynamic process.

With conventional budgeting, indirect costs and support activities are often prepared on an
incremental basis  existing operations and the current budgeted allowance for existing
activities are taken as the starting point for preparing the next annual budget.

Incremental budgeting = an approach to budgeting in which existing operations and the

current budgeted allowance for existing activities are taken as the starting point for
preparing the next annual budget and are then adjusted for anticipated changes.

Activity-based budgeting (ABB) = an approach to budgeting that takes cost objects as the
starting point, determines the necessary activities and then estimates the resources that are
required for the budget period.
1. Estimate the production and sales volume by individual products or customers
2. Estimate the demand for organizational activities, especially indirect cost and
support activities
3. Determine the resources that are required to perform organizational activities
4. Estimate for each resource the quantity that must be supplied to meet the demand
5. Take action to adjust the capacity of resources to match the projected supply

Line item budgets = the traditional format for budgets in nonprofit organizations, in which
expenditures are expressed in considerable detail, but the activities being undertaken are
given little attention.

Zero-based budgeting (priority-based budgeting) = an approach to budgeting in which

projected expenditure for existing activities starts from base zero rather than last year’s
budget, forcing managers to justify all budget expenditure.
- Mainly used in non-profit organizations, but it can also be applied to discretionary
costs and support activities in profit organizations.
1. A description of each organizational activity in a decision package
2. The evaluation and ranking of decision packages in order of priority
3. Allocation of resources based on order of priority up to the spending cut-off level

Traditional budgeting tends to extrapolate the past by adding a percentage increase to the
current year. ZBB avoids the deficiencies of incremental budgeting and represents a move
towards the allocation of resources by need or benefit. Thus, unlike traditional budgeting
the level of previous funding is not taken for granted.

ZBB creates a questioning attitude rather than one that assumes that current practice
represents value for money.

ZBB focuses attention on outputs in relation to value for money. That is, it requires
managers to ‘make the case’ for all the spending, outputs of which are often intangible.
Incremental budgets = budgets where expenses for an item within the budget are based on
the previous budgeted allowance plus an increase to cover higher prices caused by inflation.

Discretionary costs = costs such as advertising and research where management has some
discretion as to the amount it will budget.

Decision packages = a decision package represents the incremental packages reflecting

different levels of effort that may be expended to undertake a specific group of activities
within an organization.

Priority-based incremental budgets = budgets in which managers specify what incremental

activities or changes would occur if their budgets were increased or decreased by a specified
percentage, leading to budget allocations being made by comparing the change in costs
with the change in benefits.

Beyond budgeting = a term used to describe alternative approaches, such as rolling

forecasts, that can be used instead of annual budgeting.