2Lecture ObjectivesExplain how budgeting fits into the overall framework of decision-making, planning and controlDescribe the purposes and uses of budgets in organisationsIdentify the various stages in the “traditional” budgeting processDescribe some of the benefits of effective budgeting and assess some of the limitations of budgetingConstruct cash budgets from relevant data
3Overview of the planning process Identify the objectives of the organization.Identify potential strategies.Evaluate alternative strategic options.Select course of action.Implement the long-term plan in the form of the annual budget.Monitor actual results.Respond to divergencies from plan.
5Why do we produce budgets? To aid the planning of actual operations:by forcing managers to consider how conditions might change and what steps should be taken now.by encouraging managers to consider problems before they arise.To co-ordinate the activities of the organization:by compelling managers to examine relationships between their own operation and those of other departments.To communicate plans to various responsibility centre managers:everyone in the organization should have a clear understanding of the part they are expected to play in achieving the annual budget.by ensuring appropriate individuals are made accountable for implementing the budget.
6Why do we produce budgets? To motivate managers to strive to achieve the budget goals:by focusing on participationby providing a challenge/target.To control activities:by comparison of actual with budget (attention directing/management by exception).To evaluate the performance of managers:by providing a means of informing managers of how well they are performing in meeting targets they have previously set.
7Stages in the budgeting process Communicate details of budget policy and guidelines to those people responsible for preparing the budget.Determine the factor that restricts output.Preparation of the sales budget.Initial preparation of budgets.Negotiation of budgets with higher management.Co-ordination and review of budgets.Final acceptance of budgets.Ongoing review of the budgets.
9The Integrated Process Primary budget drives all othersPlanned increase in sales affectsproductionpurchaseslabourcost of overheadsfinancing/cash
10An Example - ScenarioMarsupial Ltd manufactures 2 products - the Echidna and the Platypus.The Echidna is manufactured in Department 1 and the Platypus in DepartmentThe products consume 2 materials - A and B, and also direct labourDetails of standard costs and usage are given below:Standard costs per unitMaterial A - £5.20 per kiloMaterial B - £8.80 per kiloDirect labour - £10.00 per hourOverhead recovery is on the basis of direct labour hours.Standard usage of materials and labour per unit of productEchidna PlatypusMaterial A 5 kilos 8 kilosMaterial B 3 kilos 4 kilosLabour 6 hours 10 hours
11An Example - Scenario Other data: Echidna Platypus Forecast sales 9, ,000Selling price per unit £ £400Budgeted closing inventory 1,Budgeted opening inventoryDirect Materials InventoriesMaterial A Material BBudgeted opening inventory (kgs)Budgeted closing inventory (kgs) 1,300 1,000Budgeted OverheadsDept 1 Dept 2Variable (controllable) £Fixed (non-controllable) £ 290, ,000
12Required Draw up the following budgets… Sales Budget Production Budget Direct Materials Usage BudgetDirect Materials Purchases BudgetDirect Labour BudgetFactory Overhead Budget
13Sales Budget Product Units sold Unit selling price Total Revenue (£) Echidna 9, ,150,000Platypus 6, ,400,0005,550,000
14Production Budget Dept 1 (Echidna) Dept 2 (Platypus) Units to be sold 9,000 6,000Planned closing inv. 1,Total units required 10,500 6,700Less opening inventoryUnits to produce 9,700 6,400
15Direct Materials Usage Budget Dept 1 Dept 2 TotalsUnits Unit Price Total Units Unit Price Total Total Units Cost48,500 £ ,200 51,200 £ ,240 99, ,440 (A)29,100 £ ,080 25,600 £ ,280 54, ,360 (B)508, , ,800Material A is firstMaterial B is secondTotal Units calculated as:Production budget X Kilos per unit = 9,700 X 5 = 48,500
16Direct Materials Purchases Budget Material A Material BProduction requirement (DM usage) 99, ,700Planned closing inventory 1, ,000101, ,700Less opening inventory100, ,100Planned purchase price £ £8.80Budgeted Purchases £521,560 £484,880
17Direct Labour Budget Dept 1 Dept 2 Budgeted production (units) 9,700 6,400Hours per unitTotal budgeted hours 58,200 64,000Budgeted wage rate £10.00 £10.00Total wages £582, £640,000
19The Cash Budget Will Deal with Cash Budget as separate entity See Drury for cash budget link to integrated exampleIllustration – Alf Smith Example
20Does Budgeting work?Bourne et al. (“Lore Reform” – 2002) suggest some main criticisms of planning and budgeting.Among these such criticisms asmajor barrier to responsivenessrarely strategically focussedencourage “gaming”based on unsupported assumptionsmake people feel undervaluedPoint to the “theory” of the budget being lost in practice
21The impact of incremental budgeting Early (& simplistic) principle that saysBudget concerned with increment in operations in coming budget periodTherefore adjust/inflate previous budget in line with known/anticipated price risesBut much “base-level” activity does not changePerpetuates past inefficiencies/errors
22Activity-based budgeting (ABB) Conventional budgeting is inappropriate for those activities where the consumption of resources does not vary proportionately with the volume of the final output of products or services.For support activities conventional incremental budgets merely serve as authorization levels for certain levels of spending.Incremental budgeting results in the cost of non-unit levelactivities becoming fixed.ABB aims to authorize only the supply of those resources that are needed to perform activities required to meet budgeted production and sales volumes.The ABB process is the reverse of the ABC process:Budgeted output of cost objects…Determine the necessary activities…Determine the resources required for the budget period
23Stages in Activity Based Budgeting Estimate the production and sales volume by individual products and customersEstimate the demand for organizational activitiesDetermine the resources that are required to perform organizational activitiesEstimate for each resource the quantity that must be supplied to meet the demandTake action to adjust the capacity of resources to match the projected supplyPeriodically actual results should be compared with an adjusted (flexible) budget
24Zero Based Budgeting (ZBB) Zero Based Budgeting (ZBB) is an approach to budgeting that starts from the premise that no costs or activities should be factored into the plans for the coming budget period, just because they figured in the costs or activities for the current or previous periods.Rather, everything that is to be included in the budget must be considered and justified.
25Stages in ZBB Developing Decision Packages Rank the Decision Packages The “decision package” is a term associated with ZBB, and refers to an analysis of each discrete activity, according to cost and purpose.The analysis should also extend to considering the benefits of the activity, alternative courses of action, how to measure performance, and the consequences of not performing the activity.Rank the Decision PackagesAllocate ResourcesRank of DPs feed into prioritisation of Resource allocation
26Pros & Cons of ZBB Pros Questions accepted beliefs Focuses on value for moneyClear links between budgets and objectivesInvolves operational managers actively, and can lead to better communication and consensusIs an adaptive approach to changing circumstancesCan lead to better resource allocationConsAdds to the time and effort involved in budgetingMay be difficulties in identifying suitable performance measures and decision criteriaQuestioning current practice can be seen as threatening – careful management of the “people” element is essentialMay be uncertainty about costs and resources of options other than current practice