1. The Budgeting Process Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 37

2. 2 Budgets  What is a budget?  A projection of future operations (costs, revenues, and cash) and the resulting financial position of a company  Three basic types  Capital budgets  Proposed expenditures for long-term capital expenditures  Operating budgets  Costs, revenues, and cash flows relating to operations  Financial budgets  Proforma financial statements 2

3. 3 Budget Characteristics  Are prepared in advance and pertain to future periods  Are derived from a company’s long-term strategy  Quantified in physical or monetary units  Serve as a benchmark of expected performance  Must be realistic  Should be flexible  Should be evaluated regularly  Must be clearly communicated 3

4. 4 Budgeting helps managers  Communicate plans to other levels of management and employees  Quantify targets  Determine directions in order to allocate resources  Promote forward thinking  Turn strategic objectives into reality  Specify a means of achieving goals Planning Aspects of Budgeting 4

5. 5 Controlling Aspects of Budgeting Budgeting helps managers….  Aid in measuring performance  Provide direction and co-ordination  Assign responsibilities  Motivate managers to achieve goals  Improve efficiency  Establish targets and standards 5

6. 6 What Can We Budget?  Monetary and nonmonetary amounts can be budgeted  Budgets can be in terms of:  Financial amounts  Time  Acquisition and use of materials  Manufacturing of products  Attendance at a football game  Number of points earned for class participation 6

7. 7 Budget Committee  Responsible for approval of the various budgets  Includes the senior managers, president, CFO, various vice-presidents and controller 7 Budget committees do not prepare the budgets.

8. 8 Budget Approaches Top-down Approach Goals are pushed down from top management Bottom-up approach Lower-level managers are the primary source of information used in setting the budget 8

9. Budget Time Periods  Range from months to several years  Inverse relationship between the length of the budget period and the detail contained within the budget Short Budget Period Short Budget Period Long Budget Period Long Budget Period Much Detail Much Detail Less Specific Less Specific 9

10. Specialized Budgeting  Zero-based budgeting  A method of budget preparation which starts from zero each budget period  Managers must justify budgets every period  Used primarily in government  Kaizen budgeting  A Japanese model of budgeting  Incorporates continuous improvement into each subsequent budget period  Assumes costs can be reduced somewhat as time goes by because the company becomes more efficient 10

11. 11 Are Budgets Successful? Depends on 1.Degree of support that top management gives the budget 2.How top management uses budget information 3.Timeliness of budget follow up Depends on 1.Degree of support that top management gives the budget 2.How top management uses budget information 3.Timeliness of budget follow up 11

12. Problems as a Result of Budgeting  Goal incongruence  Occurs when upper-level management and lower- level managers focus on different goals  Arises from  Managers’ desires to make their annual performance evaluations look good and  Upper-level management wanting to maximum profits or ROI 12

13. Problems as a Result of Budgeting  Budget slack  Also known as padding the budget  Only occurs when bottom-up budgeting is employed  Bottom-up budgeting allows lower-level managers to provide input into budgeted amounts  To avoid the possibility of not meeting the budget target, managers tend to  Overstate budget expenses  Understate revenue 13

14. Problems as a Result of Budgeting  Income shifting  Occurs when a manager’s bonus is tied to meeting or beating budget targets  Causes managers to shift income between periods to increase their performance evaluations 14

15. 15 Budget Variances Managers may have done a ‘very good’ or ‘very bad’ job Managers may have done a ‘very good’ or ‘very bad’ job Business or economic conditions may have changed Business or economic conditions may have changed Weak development of budget Weak development of budget 15 Exist when actual results differ from budgeted amounts Causes of variances

16. 16 The End