Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 1 Accounting for Management Decisions WEEK 10 BUDGETING READING: TEXT CH 9, pp. 438 453 only Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 2 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 3 Budgets, Long-term Plans and Corporate Objectives goals Corporate objectives - identify the broader goals of the business direction Long-term plan - defines the general direction of the business over next (eg) 5 years, covers matters like: Markets Markets the business aims to serve Production Production/service methods profit Levels of profit sought Financing requirements and methods Personnel and other requirements Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 4 Budgets, Long-term Plans and Corporate Objectives Budgetfinancial Budget - essentially a financial plan for a future time financial Expressed in financial terms long-term future Converts the long-term plan into an actionable blueprint for the future Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 5 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 6 Time Horizons of Plans and Budgets Long-term 5 Long-term plans are typically 5 years, and Budgets1 Budgets are typically set for 1 year discretion Not set in concrete - management has discretion too longchange Depends on industry eg 5 years in an IT business would be too long due to rate of change rolling Budgets may also be done on a rolling monthly basis Limiting 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 7 Budgets and Forecasts Budgetsforecasts Budgets and forecasts are distinctly different: plan A budget is a plan for a future time, expressed mainly in financial terms Forecastspredictions 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 8 The Interrelationship of Various Budgets severalspecific In a business, there is not one budget, but several - each relating to a specific aspect of the business separate Ideally, there should be a separate budget for each person in a managerial position Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 9 The Interrelationship of Various Budgets contd Productionbudget DirectlabourbudgetTradereceivablesbudgetCashbudgetTradepayablesbudgetFinishedinventoriesbudget Raw materials inventoriesbudget SalesbudgetOverheadsbudgetCapitalexpenditurebudgetRawmaterialspurchasesbudget Figure 9.2 START Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 10 The Budget Setting Process 1. Establish who will take responsibility for the budget-settingprocess 2. Communicate budget guidelines to relevant managers 3. Identify the key or limiting factor 7. Prepare the master budgets 5. Prepare draft budgets for all other areas 4. Prepare the budget for the area of the limiting factor 6. Review and co-ordinate the budgets 8. Review and co-ordinate the budgets 9. Monitor performance relative to the budgets Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 11 The Budget Setting Process contd committee Budget committee - a group of managers formed to supervise and take responsibility for the budget-setting process officer 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 Top-down - an approach to budgeting where senior management originates the budget targets Bottom-up 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 12 The Uses of Budgets 5 main There are 5 main uses of budgets: problems 1.Promote forward thinking and the possible identification of short-term problems; co-ordinate 2.Help co-ordinate various sections of the business; 3.Motivate 3.Motivate managers to achieve better performance; control 4.Provide a basis for a system of control; authorisation 5.Provide a system of authorisation for managers to spend up to a limit Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 13 The Uses of Budgets contd Promote forward thinking and identification of short-term problems Budgets Help co-ordinate the various sections of the business Motivate managers to achieve better performance Provide a basis for a system of control Provide a system of authorisation Figure 9.3 Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 14 Preparing the Cash Budget cashkey The cash budget is a key budget - all aspects of a business are eventually reflected in cash whole single The cash budget reflects the whole business more than any other single budget Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 15 Cash Preparing the Cash Budget contd Most cash budgets feature the following: months Broken down into sub-periods, usually months In columnar form, one month per column receiptspayments Cash receipts and payments identified under headings and a total for each month is shown surplusdeficit The surplus or deficit of cash is identified for each month running The running cash balance is identified Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 16 Cash Budget Example 9.1: Suppliers Ltd is a wholesale business. The budgeted income statement for the next 6 months is as follows: JanFebMarchAprilMayJune Sales COGS Wages10 Electricity Depreciation Other overheads Total expenses Net profit245763 Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 17 Cash budget contd The business allows all of its customers one months credit. Sales during Dec were $60,000. (see slide #24) The business plans to maintain inventory at its existing level of $30,000 until Mar, when it is to be reduced by $5,000. Inventory will remain at this lower level indefinitely (see slide #24). Inventory purchases are made on one months credit. December purchases were $30,000. Wages and other overheads are paid in the month concerned. Electricity is paid quarterly in arrears in March and June. $4,000 The business plans to buy and pay for a new delivery van in Mar that will cost $15,000 but an existing van will be traded in for $4,000 as part of the deal. The business expects to start Jan with $12,000 in cash. Prepare the cash budget for the 6 months ending in June Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 18 Cash budget contd JanFebMarAprMayJune Receipts $000s Debtors (Note 1) Payments Creditors (Note 2) Wages10 Electricity Other overheads Van purchase Total payments Cash surplus1810(13)17133 Opening balance Cash balance (3) Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 19 Cash budget contd Notes: behind The cash receipts lag a month behind sales. equal constant reduce lower that In most months the purchases of inventory will be equal to COGS because the business maintains a constant level of inventory. During March however the business plans to reduce its inventory by $5,000. This means that inventory purchases will be lower than the COGS in that month. The payments for inventory purchases lag a month behind purchases. Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 20 Cash budget contd previous 3.Each months cash balance is the previous months figure plus the cash surplus for the current month. The balance at the start of Jan is $12,000 4.Depreciationnot 4.Depreciation does not give rise to a cash payment. Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 21 Preparing Other Budgets Other budgets are mostly prepared in the same format as the cash budget and may include: debtors - The debtors budget creditors - The creditors budget inventories - The inventories budget Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 22 Other budgets Example 9.2: Same as 9.1 plus Inventory at 1 Jan $30,000 Debtors Budget JanFebMarAprMayJun Opening bal sales cash receipts Closing bal Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 23 Other budgets Creditors budget JanFebMarAprMayJune Opening balance Purchases Cash payments Closing balance Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 24 Other budgets Inventories budget (Note the opening bal is $30,000 while closing inventory is $30,000 until Mar when it becomes $25,000 and remains at this level. COS is shown and represents inventory used. Purchases can be deduced as a residual figure JanFebMarAprMayJun Opening balance Purchases Inventories used Closing bal Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 25 Using Budgets for Control Control plan Control is usually seen as making events conform to a plan exercising Budgets represent the plan and therefore provide the basis for exercising control over the business sequence/process The planning and control process usually follows a sequence/process which is illustrated on the following slide Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 26 The Planning and Control Process Identify objectives Consider options Evaluate options and make a selection Prepare long-term plans (long-term budgets) Prepare budgets (short term) Perform and collect information on actual performance Identify and analyse differences between plans and actuals (variations) Respond to variances and exercise control Revise plans (and budgets) if necessary Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 27 Using Budgets for Control contd Comparing actual performance with the budget target The most important budget target to meet is the profit target comparison 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 28 Necessary conditions for Budgetary control management A serious attitude from all levels of management Clearly Clearly defined areas of managerial responsibility Reasonable Reasonable budget targets (focus on achievability) data Established data collection, analysis and distribution Specific Specific rather than general-purpose reporting short Fairly short reporting periods (eg monthly) variance Timely variance reports made available to managers Action Action taken to regain control Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 29 Limitations of Control Through Variances and Standards limitations Budgetary control, while useful and valuable also has limitations including: directly Not all expenses can be directly linked to productive activity obsolete Standards can rapidly become obsolete due to technological and price change factors outside Factors outside of management control can impact difficult Delineating management responsibility may prove difficult in practice Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 30 Behavioural Aspects of Budgetary Control Research indicates that: improve Existence of budgets tends to improve performance achievable Demanding but achievable targets seem to motivate more than easy targets adversely Unrealistic targets adversely affect performance own Allowing managers to set their own targets improves motivation, commitment and performance Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 31 Criticisms of Budgetary Control Time consuming and costly to put together Time consuming and costly to put together Different budgets needed for planning, control and motivation Different budgets needed for planning, control and motivation Budgets are rarely strategically focused Budgets are rarely strategically focused Budgets dealing with Increases in technology may lead to more centralisation at the cost of greater involvement Budgets dealing with Increases in technology may lead to more centralisation at the cost of greater involvement Often associated with an overly inward focus Often associated with an overly inward focus Behavioural aspects are often misunderstood, leading to perverse behaviour Behavioural aspects are often misunderstood, leading to perverse behaviour A system of accountability may create a counter- productive atmosphere of blame and mistrust A system of accountability may create a counter- productive atmosphere of blame and mistrust Budgets can be seen as a bureaucratic exercise in cost- cutting Budgets can be seen as a bureaucratic exercise in cost- cutting Budgets may lead to department cetredness Budgets may lead to department cetredness Budgets are out of touch with the needs of modern business Budgets are out of touch with the needs of modern business Budgets may make people feel under-valued Budgets may make people feel under-valued Budgets can stifle projects because resources are already allocated Budgets can stifle projects because resources are already allocated Budgets can stifle the entrepreneurial spirit needed to create value Budgets can stifle the entrepreneurial spirit needed to create value When managers are in a position to influence budget figures, the danger of bias exists When managers are in a position to influence budget figures, the danger of bias exists Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia 32 Review must Any budgetary control system set up must ensure that: understood The environment the business operates in is fully understood; appropriate The business develops an appropriate culture; rolefit The role of the budget in terms of its fit with the strategic plan is clearly understood; value-adding A culture of value-adding is developed