Unit 8
Budgetary Planning - The
Budget Process
A budget is
‘quantitative expression of a plan for a
defined period of time’.
A budget as defined by CIMA Official Terminology.
The role of Budgeting
The main objective of budgeting is to provide a formal
quantitative and authoritative statement of the firms
plans expressed in monetary terms.
It acts as a blueprint for a business to follow in future
periods.
The master budget
The plan of action selected is termed the master
budget for the period.
A projected profit and loss account.
A projected balance sheet.
A projected cash budget.
Budgetary planning
‘ the establishment of objectives, and the
formulation, evaluation and selection of the
policies, strategies, tactics and action
required to achieve them'.
Planning as defined by CIMA Official Terminology
In general, budgetary planning is divided into:
Strategic planning
Short-term planning.
Control Process
Long Term
Planning Process
Framework for planning, decisionmaking and control
 Set business objectives
Decision
 Identify potential strategies
 Evaluate and select strategies
 Implement strategies
 Compare actual results with plan
 Investigate variances and take corrective action
Decision
The budgetary process
1.
2.
3.
4.
5.
6.
7.
Communicate details of budget policy and guidelines
Identify limiting factors
Preparation of sales budget
First draft preparation of department budgets
Budget negotiation
Co-ordination and review of budgets
Final acceptance of budget
Administration of the budget
process
Any budget process should have the following
administrative supports
A budget committee
A budget manual
Accounting staff for support
A budget committee
A budget committee should consist of senior management who
are responsible for the major functions of the organisation.
Generally the committee will appoint a budget officer (normally
an accountant) who co-ordinates the individual budgets into the
master budget.
Each business segment submits a budget and each member of
the budget committee see the other budgets submitted and the
overall effect in the master budget.
The final budgets are agreed.
The budget committee also sets the guidelines for the
preparation of individual budgets and the procedures for
negotiating and agreeing budgets.
A budget manual
A budget manual outlines the objectives, rules,
regulations and procedures involved in the
budgetary process. It is generally prepared by
the company accountant and could include
timetables regarding the process, highlighting
important dates as well as the persons
responsible for the various budgets to be
submitted.
Advantages
A budget gives a firm direction. It forces management to set and
prioritise goals which act as a blueprint for the future.
Budgeting compels management to plan and focus on the future.
Budgets provide management with a basis on which to measure
subsequent performance.
The budgeting process encourages communication within the
organisation.
The budgetary process plays a strong role in the co-ordination of
activities and goal congruence.
The budgetary process provides a basis for responsibility
accounting..
Control within an organisation is facilitated by the regular,
systematic monitoring and reporting of activities and comparing
with the budget.
The preparation of a master budget facilitates better cash and
working capital management.
Because of the ‘exception principle’, managers time can be
saved and attention directed to areas of most concern.
Problems or difficulties
Some organisations may find it difficult to forecast sales with any
degree of accuracy.
It may be difficult for management to estimate the availability of
resources for the year ahead.
Currency fluctuations and inflation may make it difficult to
estimate future price levels for materials, expenses and wages.
Badly handled budgetary systems that fail to consider the human
aspects involved may dilute the morale of a workforce.
Managers are often made accountable for budget variances that
may be caused by factors outside their control.
Budget slack, the intentional overstating of expenses, may
prevent an organisation from producing accurate budgets and
can affect the overall cost competitiveness of an organisation.
For many organisations, budgets are developed around existing
organisational structures which may be inappropriate for current
conditions and organisational development.
A budget and planning process that is too rigid may hinder the
creativity and flexibility in an organisation.
Approaches to budget
implementation
There are two main approaches to budget
implementation
A top-down (imposed) approach
A bottom-up (participative) approach
Top-down approach
‘a budgeting process where budget
allowances are set without permitting
ultimate budget holders the opportunity to
participate in the process’.
Top-down approach to budgeting as defined by CIMA Official Terminology.
Top-down approach
When a top-down (imposed) approach is
adopted, senior management prepare a budget
with little or no input from operating personnel.
The budget is then imposed on employees who
have to work to the budget figures. This
imposed approach can be effective in newly
formed or small organisations during economic
hardship when precise co-ordination is required,
or when operational managers lack budgeting
skills.
Top-down approach
Advantages
Senior managers should be aware
of the total resources of the
organisation.
Budgets should be in line with
strategic plans.
Co-ordination should be enhanced.
The approach is quicker and less
costly in the short-term..
Disadvantages
Imposed approach may result in
staff dissatisfaction and poor
morale.
Can contribute to a lack of team
spirit.
Limited acceptance of budget by
staff which can contribute to poor
performance.
Budget process may be seen as a
punitive device.
Unachievable budgets may be set.
Lower-level management initiative
is stifled.
Bottom-up approach
‘a budgeting process where all budget
holders have the opportunity to participate in
setting their own budgets’.
Bottom-up approach to budgeting as defined by CIMA Official Terminology.
Bottom-up approach
Where a bottom-up (participative) approach is
adopted, budgets are developed by lower-level
managers who then submit and agree their
budgets with their superiors. This approach can
be effective in very large organisations or where
operational managers have strong budgeting
skills.
Bottom-up approach
Advantages
Budget information comes from
those who know at an operational
level.
Knowledge used in the process is
spread throughout the
organisation and should improve
the quality and accuracy of
budget data.
Morale and motivation may be
improved as participation levels
increase.
In general, the likelihood of
acceptance of the budget is
increased.
Generally budgets can be more
realistic.
Disadvantages
The approach is more time
consuming.
Changes often made by senior
managers can cause motivation
issues.
Lower level managers may be
unqualified to participate.
Budgetary slack may be introduced.
The budget process may be forced
to start earlier, therefore more
uncertainty exists regarding budget
forecasts.
Motivational aspects of budgets
Performance and motivation may be improved:
When the process involves a bottom-up approach to target
setting, management at all levels are involved or have their say
in the target setting process.
Where targets are set that are demanding but achievable.
Where the work environment is more relaxed and factors such
as staff motivation are considered to be as important as
achieving set targets.
Where targets are not achieved, a caring non-personal and noncritical approach is taken.
Where managers are not held responsible for costs and
revenues that they are not in a position to control. Thus the
existence of responsibility accounting, where departmental
managers are only responsible for costs and revenues
generated within their control.
Motivational aspects of budgets
Performance and motivation may be hindered:
Where the process of target setting is a top-down approach with
management deciding targets for their subordinates.
Where unrealistic targets are set resulting in an idealistic budget
rather than an attainable or realistic budget.
Where the expectation in the work environment is that targets
must be met above all other things. In this instance managers
will introduce 'slack' into the target setting process to ensure the
target is achieved.
Where a critical approach is taken when targets are not
achieved.
Budgeting and Responsibility
Accounting
Budgeting works best where a clear organisation
structure exists. This occurs where an organisations
structure is an arrangement of lines of responsibility
where each manager within the organisation is
responsible for a part or segment of the organisation
There are four major types of responsibility centres:
Cost centres
Revenue centres
Profit centres
Investment centres
A cost centre
This is where the manager is responsible for
costs only. An example would include the
maintenance or cleaning department of a hotel
which only deals with costs and expenditure and
thus would be a cost centre.
A revenue centre
This is where managers are only responsible for
the revenues earned. An example would include
the sales reservations of a hotel or leisure
centre.
A profit centre
This is where the manager is responsible for
both the revenues and costs of a section or
segment of the organisation. An example would
include a leisure centre as part of a chain or a
retail outlet as part of a chain of outlets or a
restaurant within a hotel. Here the budget
represents both revenues and costs.
An investment centre
This is where a manager is responsible for
investments as well as revenues and costs. The
regional manager of a retail chain would for
example, be responsible for not just how each of
the outlets have performed from a profit
(revenues less costs) perspective, but for the
level and quality of the investment and the level
of return on investment achieved within the
region.
Responsibility accounting
Responsibility accounting measures actual results with
budgeted for every responsibility centre and ultimately
helps to trace costs and revenues to the person who has
the most knowledge of, and who is responsible for, those
costs and revenues. Budgets coupled with responsibility
accounting, provide a focus for managers when
interpreting variances. Variances, whether positive or
negative, should prompt questions and subsequent
investigation, not blame. Thus responsibility accounting
identifies a person who can properly explain a variance.