Accounting Chapter 9 Budgeting - PDF

PowerPoint to accompany Chapter Budgeting  Learning Objectives Define a budget Explain how budgets, corporate objectives and long-term plans are related Set out the main components of the budget-setting process and explain how the vari...

PowerPoint to accompany Chapter Budgeting  Learning Objectives Define a budget Explain how budgets, corporate objectives and long-term plans are related Set out the main components of the budget-setting process and explain how the various budgets interlink Identify the main uses of budgeting Construct various budgets, including the cash budget, from relevant data Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia  Learning Objectives cont’d Use a budget as a means of exercising control over the business Explain and apply flexible budgeting Calculate a series of variances between budget and actual to help control activity Identify the limitations and the behavioural implications of the traditional approach to control through budgets and standards Assess the contribution and importance of budgeting in practice Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Budgets, Long-term Plans and Corporate Objectives Corporate objectives - identify the broader goals of the business Long-term plan - defines the general direction of the business over next (e.g.) five years, covers matters like: Market(s) the business aims to serve Production / service methods Levels of profit sought Financial / financing requirements and methods Personnel and other requirements Budget - essentially a financial plan for a future time Expressed in financial terms Converts the long-term plan into an actionable blueprint for the future Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia The Planning Process Identify business objectives Consider options Evaluate options and make a selection Prepare long-term plans (long-term budgets) Prepare budgets (short-term) Figure 9.1 Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia  Time Horizons of Plans and Budgets Long-term plans are typically 5 years and budgets typically set for 12 months Not set in concrete - management has discretion Depends on industry e.g. 5 years in an I.T. business would be too long due to rate of change Budgets may also be done on a ‘rolling’ monthly basis Limiting factors - aspects of a business that stop it from achieving objectives and which must be factored in to the budget Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia  Budgets and Forecasts Budgets and forecasts are distinctly different: A budget is a plan for a future time, expressed mainly in financial terms Forecasts tend to be predictions of the future state of the environment Forecasts are useful to the planner / budget setter Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia  The Interrelationship of Various Budgets In a business, there is not one budget, but several - each relating to a specific aspect of the business Ideally, there should be a separate budget for each person in a managerial position Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia The Interrelationship of Various Budgets Trade Cash Trade receivables budget payables budget budget Capital Direct Raw Sales Overheads expenditure labour materials budget budget budget budget purchases budget Finished Production Raw materials inventories budget inventories budget budget Figure 9.2 Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia The Budget Setting Process 1. Establish who will take 6. responsibility Review and 7. for the co-ordinate Prepare the budget-setting the budgets master budgets process 2. Communicate 5. budget Prepare draft 8. guidelines to budgets Review and relevant for all other co-ordinate managers areas the budgets 3. 4. 9. Identify the key Prepare the Monitor or budget for performance limiting factor the area of the relative to the limiting factor budgets Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia The Budget Setting Process cont’d Budget committee - a group of managers formed to supervise and take responsibility for the budget-setting process Budget officer - an individual, often an accountant, appointed to carry out or take responsibility for having carried out the tasks of the budget committee Top-down - an approach to budgeting where senior management originates the budget targets Bottom-up - most of the budget input comes from lower level staff such as sales representatives Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia The Uses of Budgets There are five main uses of budgets: 1. Promote forward thinking and the possible identification of short-term problems; 2. Help co-ordinate various sections of the business; 3. Motivate managers to achieve better performance; 4. Provide a basis for a system of control; 5. Provide a system of authorisation for managers to spend up to a limit Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia The Uses of Budgets cont’d Promote forward Help co-ordinate thinking and Budgets the various sections identification of of the business short-term problems Motivate managers Provide a basis Provide a system to achieve better for a system of authorisation performance of control Figure 9.3 Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Preparing the Cash Budget The cash budget is a key budget - all aspects of a business are eventually reflected in cash The cash budget reflects the whole business more than any other single budget Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Preparing the Cash Budget cont’d Most cash budgets feature the following: - Broken down into sub-periods, usually months - In columnar form, one month per column - Cash receipts and payments identified under headings and a total for each month is shown - The surplus or deficit of cash is identified for each month - The running cash balance is identified Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Preparing Other Budgets Other budgets are mostly prepared in the same format as the cash budget and may include: - The debtors budget - The creditors budget - The inventories budget Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia  Using Budgets for Control Control is usually seen as making events conform to a plan Budgets represent the plan and therefore provide the basis for exercising control over the business The planning and control process usually follows a sequence which is illustrated on the following slide Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia The Planning and Control Process Evaluate options Identify objectives Consider options and make a selection Perform and collect Prepare long-term information on Prepare budgets plans (long-term actual performance (short term) budgets) Identify and analyse differences between Respond to Revise plans plans and actuals variances and (and budgets) (variations) exercise control if necessary Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Using Budgets for Control cont’d Comparing actual performance with the budget The most important budget target to meet is the profit target Draw a comparison between actual costs incurred and budgeted costs for the level of production achieved Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Using Budgets for Control cont’d Flexing the budget Flexed Budget - a budget revised to reflect costs that would have been expected for the actual activity Identify which items are fixed and which are variable relative to the level of output Prepare the revised (flexed) budget, then do the operating profit comparison with actual figures The flexed budget makes a more accurate comparison between budget and actual possible The difference between original and flexed budget profit figures is called sales volume variance Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Variances Key variances: Sales volume (quantity) variance Sales price variance Materials variances: - Total direct materials variance - Direct materials usage variance - Direct materials price variance Labour variances: - Total direct labour variance - Direct labour efficiency variance - Direct labour rate variance Fixed overhead spending (expenditure) variance Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Standard Quantities and Costs Standards are planned quantities and costs (or revenues) for units of input or output Form the ‘building blocks’ of the budget Represent targets and therefore benchmarks by which actual performance is measured Are the basis of calculation for most variances Should be reviewed regularly and revised if necessary Also have uses beyond the context of budgetary control Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia  Investigating Variances Can be both time-consuming and expensive Only useful if management gains the means to regain control so future targets can be met Significant adverse variances represent a potentially very costly fault and should be investigated Significant favourable variances represent things not going to plan and may mean targets are too low Insignificant variances should be kept under review in case they are not the result of chance factors Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia  Necessary Conditions for Budgetary Control A serious attitude from all levels of management Clearly defined areas of managerial responsibility Reasonable budget targets (focus on achievability) Established data collection, analysis and distribution Specific rather than general-purpose reporting Fairly short reporting periods (e.g. monthly) Timely variance reports made available to managers Action taken to regain control Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Limitations of Control Through Variances and Standards Budgetary control, while useful and valuable also has limitations including: Not all expenses can be directly linked to productive activity Standards can rapidly become obsolete due to technological and price change factors Factors outside of management control can impact Delineating management responsibility may prove difficult in practice Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Behavioural Aspects of Budgetary Control Research indicates that: Existence of budgets tends to improve performance Demanding but achievable targets seem to motivate more than easy targets Unrealistic targets adversely affect performance Allowing managers to set their own targets improves motivation, commitment and performance Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Criticisms of Budgetary Control Time consuming Budgets are rarely Budgets can stifle the and strategically focused costly to put entrepreneurial spirit together Different budgets needed to create value needed for planning, control Budgets are out of touch and motivation Budgets can be with the needs of seen modern business as a bureaucratic Budgets dealing with exercise in cost- Increases in technology cutting Behavioural aspects are may lead to more often misunderstood, centralisation at the cost leading to perverse of greater involvement Budgets may make behaviour people feel under-valued A system of Budgets can stifle accountability projects may create a counter- because resources are productive atmosphere already allocated of blame and mistrust When managers are in a position to influence Often associated with budget Budgets may lead to an overly inward department figures, the danger of focus cetredness bias exists Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Review Any budgetary control system set up must ensure that: The environment the business operates in is fully understood; The business develops an appropriate culture; The role of the budget in terms of its fit with the strategic plan is clearly understood; A culture of value-adding is developed Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia