U U N IT
4
Budget and Budgetary Planning
Unit Overview
The task of developing a budget brings into focus two of the core functions of
management accounting, namely planning and control. Planning involves the
development of future objectives and the preparation of budgets to achieve those
objectives (Horngren et al., 2012). Control involves the steps taken by management to
ensure that the objectives set down at the planning stage are attained and that all parts
of the organization function in a manner consistent with organizational policies. This
unit focuses on the budget as a planning tool; the control dimension will be addressed
in Unit 5.
Organizations would usually engage in long-term planning to determine their
objectives. The long-term plan provides the framework within which budgets are
prepared for a specific period of time, usually one year. The budget is the expression
of the plan in financial terms, taking current conditions into consideration.
Responsibility accounting is based on the principle that control of the organization
must, to some extent, be placed in the hands of those who hold management positions
in the organization. It suggests that management should be held accountable for the
performance of the segments or divisions under their control.
This unit looks at both these aspects in which management implements its core
functions of planning and control
Unit 4 Learning Objectives
By the end of this Unit, you will be able to:
1. Define the term budget and describe its use in the organization;
2. Prepare the various schedules of a master budget;
3. Explain the concept of responsibility accounting;
4. Describe the process of responsibility accounting using responsibility centers.
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This Unit is divided into two sessions as follows:
Session 4.1: Budgetary Planning
Session 4.2: Responsibility Accounting
READING
Required Readings and Resources
Horngren, C., Datar, S. M. & Rajan, M. V. (2012). Cost Accounting:
A Managerial Emphasis (14th ed.). New Jersey: Pearson.
Chapter 6
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SSession 4.1
Budgetary Planning
Opening Case
Having spent most of his early life in Trinidad, Jake migrated to Canada in 1989. He has
worked in a West Indian bakery in Scarborough, Ontario, since then. With his years of
experience of interacting with his customers, he identified the need to introduce more
West Indian products. Having done some preliminary market surveys, he decided
to produce and sell a line of tamarind balls. He obtained the necessary regulatory
approvals and sourced the major equipment that he needed. While he knew that there
was a strong market for the product, he still felt a bit unsure as he was not seeing the
whole picture with respect to his revenue and cost. He decided to call his brother in
Trinidad whom he knew had some experience in the accounting field. The following
conversation ensued:
Brother (answers Hello
phone):
Jake: It’s me, your brother Jake, how are you doing?
Brother: Nice to hear from you. How are things up north? I hear
you’re selling tamarind balls.
Jake: That is the reason why I called you. All those years we
sent you to school, I hope you can help me now with this
tamarind ball business. I am not feeling comfortable with
all the costs and I am not sure how this thing will play out.
Brother: Man! You need to do a budget.
Jake: Budget! That is like what the Prime Minister reads in the
Parliament every year?
Brother: Well it is the same concept. What the Prime Minister does
is give his costs and revenue for the upcoming financial
year. You would look at three months, six months or the
next year and what costs you would incur with those sales
levels.
Jake: Why do I need to do a budget?
Brother: I will send you an email giving you all the virtues of
budgeting but you should remember Dad saying, “Before
you start, know how you finishing”, and budgeting would
help you to do that.
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Jake: But I don’t know how to do a budget and it’s sounding like
“real” work
Brother: It could be, but I am doing a course in this area and if you
send me the figures I can help you prepare the budget.
Jake: I would be happy to. You just need to let me know which
figures you need. Now I am feeling that this could turn out
to be a “sweet” business.
Brother: It sure could be.
Reflect on the following:-
1. What are some of the advantages of budgeting?
2. What figures would Jake need to get for his brother to prepare the budgets?
3. Do you feel that having a budget would help Jake to see the whole picture?
Introduction
All organizations must make financial plans to implement day-to-day operations,
plan for major expenditure and provide themselves with a tool for making financial
decisions. Many organizations do not always see the benefits of budgeting and
therefore, do not devote time and effort into its preparation. There are good reasons
for building budgets and implementing its use in organizations. This session seeks to
explore the role of budgets and to define the benefits to be derived from budgeting.
The Concept of Budgeting
A budget is a detailed plan for proposed future action that is intended to be implemented
within a set period of time (Horngren et al., 2012). It is expressed in quantitative terms
and can cover both the financial and nonfinancial aspects of the plan. Some analysts
in the field emphasize that the budget must be taken as a guide for action rather than
as a rigid blue print that must be adhered to, notwithstanding changing conditions.
The usefulness of budgeting is clearly seen when a budget is incorporated into the
organizations’ strategic planning process. Please read pages 184 - 185 of Chapter 6 of
Cost Accounting –A Managerial Emphasis for a greater insight into this.
Budget Preparation
Budget preparation can be either top-down or bottom-up. With top-down budgeting
virtually all budget development takes place at the upper echelons of management. The
budget is thus imposed on lower-level personnel, who rarely become involved in the
development process. The bottom-up approach emphasizes lower-level participation
in the process. This latter approach is implemented through a budget committee which
coordinates the entire exercise. Data is collected from divisional managers, who in turn
collect estimates from departmental managers. These departmental managers may
then seek input from employees within their respective departments. This approach
usually begins with the setting and issuance of general budget guidelines.
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Notwithstanding its stated advantage over the top-down approach, there is the
possibility that managers may use the bottom-up approach to build slack or padding
into their estimates. Budgetary slack refers to the practice of either underestimating
revenues or overestimating costs. We will return to this concept later in this unit.
Purposes of Budgets and its Challenges
Budgets can be an effective tool in the organization to assist in coordination and
communication, performance appraisal and to motivate employees. At the same time
it is not without its challenges. Budgets can be time consuming and can be a liability,
as the essence of budgeting is not given precedence over attaining the numbers
especially when conditions change rapidly. Please read pages 185 - 187 of the core text
for a detailed discourse about the Benefits and Challenges of Budgeting
LEARNING ACTIVITY 4.1
Benefits of Budgeting
Write an e-mail to Jake explaining, in simple language, the benefits to
be derived from budgeting.
Be sure to explain how budgeting would help him in seeing the
whole picture. Post your email to the discussion forum and respond
to at least one of your peers.
Purposes of Budgets and its Challenges
The individual budgets in the master budget are usually grouped into two or sometimes
three subcategories within the broader budget. In our study we will use the two-part
classification, which subdivides the master budget into the operating budget and the
financial budget.
The operating budget comprises the budgeted income statement and it’s supporting
budget schedules. These supporting schedules normally include the following:
• Revenue (sales) budget,
• Production budget (in units),
• Direct materials usage budget,
• Direct materials purchases budget,
• Manufacturing overhead budget,
• Ending inventory budget,
• Cost of goods sold budget,
• Other (nonproduction) costs budget.
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In some instances the revenue or sales budget is considered in a separate category,
hence the three-part classification. Whether in a two-part or three-part classification,
the sales budget is always the starting point of the budgeting process. It is generated
from forecasts that the organization makes about future sales of goods and services.
The nonproduction costs budget can be further differentiated into its various facets,
namely,
• Research and development costs budget
• Marketing costs budget
• Distribution costs budget
• Customer-service budget
The operating budget is geared towards planning for the acquisition and use of scarce
resources and the individual budgets are for making financial projections for the
respective business functions of the organization’s value chain. All of the budgets
listed above ultimately feed into the budgeted income statement.
The second subcategory, the financial budget, comprises the capital budget, cash
budget, budgeted balance sheet and the budgeted statement of cash flows. Together
these present the projected financial results of the operations planned for the budget
period.
While the description above was done in relation to the manufacturing sector, with
appropriate adjustments it can also apply to the merchandising and services sectors. In
addition, an individual company will prepare the budgets necessary for its operations
which may or may not include all of those listed above.
Pages 187 – 198 of Chapter 6 of the core text give a detailed illustration on the
preparation of the operating budgets. Pages 188 – 190 provides a description of the
steps in the budgetary process and pages 191 – 198 offers a detailed example of the
developing the Operating Budget. You should read and study the example provided.
Video/Slideshow
For greater insight into the budget process and master budget
please view the following videos:
Introduction to Budgeting (Managerial Accounting),
available at: https://www.youtube.com/
watch?v=pCwLhz0ltlE&index=1&list=PL_KGEFWqEaTDsCvEOXpJs4JlpHAzD6ob
The Master Budget, available at: https://www.youtube.com/
watch?v=Wy9MGFjS7ZA&list=PL_KGEFWqEaTDsCvEOXpJs4JlpHAzD6ob&index=2
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Session 4.1 Summary
The master budget coordinates all the financial projects in the organization’s individual
budgets in a single organization-wide set of budgets for a set period of time. In this
session, we discussed the major components of a master budget and prepared the
budgeted income statement and its supporting budget schedules. In the next session,
we will take a closer look at Responsibility Accounting.
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SSession 4.2
Responsibility Accounting
Introduction
In the overview to this unit, we introduced our discussion on the budget, noting that
it was a key planning and control tool. Session 1 focused on the planning aspect,
based on the principle that the budget gave concrete expression to the overall goals
and objectives of the organization. The organization must ensure that all its subunits
are functioning in a manner that is consistent with the overall goals embodied in its
master budget. Organizations seek to attain this coordination by formally assigning
responsibility for the attainment of its goals to the managers of the respective subunits.
This session describes the mechanisms used to make subunits responsible for achieving
the goals of the organization.
Responsibility Accounting
Responsibility accounting is the overall term used to describe the reporting system
that an organization uses to measure the performance of personnel and departments
in order to determine the extent to which their performances are meeting overall
goals (Horngren et al., 2012). This system is operationalized through responsibility
centres. Responsibility centre is the designation used to describe the respective parts,
subunits or segments of an organization and in particular to highlight the fact that the
respective managers are accountable for the activities within the centre.
At regular intervals the performance of each centre is summarized in a performance
report. This report, which normally covers a time span of a year or less, compares
budgetary projections with actual operations and provides feedback on the management
of the activities that the centre is responsible for. Basically, the performance report is
used for both evaluation and control purposes.
Video/Slideshow
For greater insight into responsibility centers please review the
following video:
Cost Accounting 16: Responsibility Centers, available at: https://
www.youtube.com/watch?v=CtEGlp8ARrE
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Benefits of Responsibility Accounting
The key point to be made about responsibility accounting is that it emphasizes the
provision of information rather than the apportioning of blame. It seeks to identify the
individual in the organization best positioned to manage a particular event or financial
operation and to ensure that the individual has access to the type of information which
would facilitate efficient management of the event/operation. When performance falls
below expectations within a center, the focus is on using information to understand
root causes and, by extension, to improve performance, rather than to apportion blame.
Responsibility accounting also highlights controllability. In Unit 1 we talked about
controllable and uncontrollable costs. In the context of responsibility accounting, a
controllable cost is any cost that falls under the influence of the manager of a given
responsibility centre. One of the intentions of responsibility accounting is to ensure
that managers only have responsibility for those costs that fall within their centre.
However, this clear demarcation is not always possible since few costs are clearly
under the influence of any single manager. In addition, there may be some costs that
are difficult to allocate to any centre. Further, given the relatively short time-span
of a performance report, and given the fact that managers may change, it may be
the case that the assessment of controllability within a center may not always be the
responsibility of the current manager. Please read pages 199 – 201 for a discussion on
Controllability and Budgetary Responsibility.
On the whole, responsibility accounting and the use of performance reports are seen
as key in facilitating the smooth running of an organization, helping it to achieve higher
levels of performance.
Human Aspects of Budgeting
While budgeting is essentially a mechanical exercise, as demonstrated above, one
cannot ignore the fact that the human aspect has an impact on that exercise. While the
techniques of budgeting are free of emotions, its administration requires education,
administration and intelligent interpretation.
Earlier, we talked about the possibility of managers building slack into the budgeting
exercise. We defined budgetary slack as the practice of either underestimating revenues
or overestimating costs. Two such situations are, for example, marketing managers
may build in budgetary slack by underestimating revenues. Thus, when actual sales
are ultimately recorded, if these exceed the budgeted estimates, the manager would
be favorably assessed by top management. For the same reason, a departmental head
may overestimate costs, with the intention that if actual costs are less, the relevant
managers can be viewed as having efficiently managed their operations. Please read
pages 201 – 203 for more details on the Human Aspects of Budgeting.
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LEARNING ACTIVITY 4.2
1. Study the Appendix – The Cash Budget on page 206 of Cost
Accounting – A Managerial Emphasis and attempt questions 6.35
and 6.36 on pages 219 – 220.
2. Attempt question 6.26 - Responsibility and Controllability - on page
214 of Cost Accounting – A Managerial Emphasis. Share your
answers in the discussion forum.
Round up Self-assessment Quiz
•
A budget is a detailed plan for proposed future action that is not time
bound. [T]
[F]
•
The advantages of budgeting include facilitating planning, coordination,
communication, resource allocation and performance evaluation in the
organization [T]
[F]
•
The master budget is usually grouped into two subcategories, namely
operating budget and financial budget [T]
[F]
•
Budgeting is a process that is free of human emotions. [T]
•
Responsibility accounting describes the reporting system that an
organization uses to measure the performance of personnel and
departments in order to determine the extent to which their performances
are meeting overall goals. [T]
[F]
•
The four major responsibility centres are sales, human resources, profit
and investment centres. [T]
[F]
[F]
Session 4.2 Summary
This session examined the concept of responsibility accounting which is a system that
measures the plans (by budgets) and actions (by actual results) of each responsibility
centre of an organization. Responsibility centres are respective subunits of an
organization.
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Unit 4 Summary
This unit was dedicated to two concepts related to planning and control in an
organization, namely budgeting, and planning and responsibility accounting. In our
discussion of budgets, we examined the purposes of budgets and the various schedules
involved in the preparation of a master budget.
In the second session of the unit, we discussed responsibility accounting, which
is the term used to describe the reporting system an organization uses to measure
the performance of departments. In looking at this concept we described various
responsibility centres through which responsibility accounting is operational, various
performance reports and the benefits of responsibility accounting.
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References
Cost Accounting 16 – Responsibility Centers [Video File]. Retrieved from https://
www.youtube.com/watch?v=CtEGlp8ARrE
Introduction to Budgeting [Video File]. Retrieved from https://www.youtube.
com/watch?v=pCwLhz0ltlE&index=1&list=PL_KGEFWqEaTDsCvEOXpJs4JlpHAzD6ob
The Master Budget [Video File] Retrieved from https://www.youtube.
com/watch?v=Wy9MGFjS7ZA&list=PL_KGEFWqEaTDsCvEOXpJs4JlpHAzD6ob&index=2
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