Chapter 7
The Budget Process
Learning
Objectives
1. What is the importance of the budgeting
process?
2. How do the advantages and disadvantages of
imposed budgets and participatory budgets
compare?
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Continuing . . . Learning
Objectives
3. Why does a budget manual facilitate the budgeting
process?
4. What complicates the budgeting process in a
multinational environment?
5. What is the starting point of a master budget and
why is this item chosen?
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Continuing . . . Learning
Objectives
6. How are the various master budget schedules
prepared and how do they relate to one another?
7. Why is the cash budget so important in the master
budgeting process?
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Continuing . . . Learning
Objectives
8. How does the statement of cash flows relate to
the income statement and the cash budget?
9. Why does actual revenue from a product differ
from budgeted revenue? (Appendix)
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Continuing . . . Learning
Objectives
10. How does traditional budgeting differ from
zero-based budgeting? (Appendix)
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Different Roles of Budgeting
Process and Budgets
•
•
•
•
•
•
•
Planning
Motivation
Evaluation
Coordination
Communication
Education
Ritual
Participation
in the Budgeting Process
Imposed budgets
Top
Management
Middle Management
Operational Management
Participatory
budgets
Best Times to Use Imposed Budgets
•
•
•
•
In start-up organizations
In extremely small businesses
In times of economic crisis
When operating managers lack budgetary skills or
perspective
• When organizational units require precise
coordination of efforts
Advantages of Imposed Budgets
• Increase probability that organization’s strategic plans
will be incorporated in planned activities
• Enhance coordination among divisional plans and
objectives
• Use top management’s knowledge of overall resource
availability
• Reduce the possibility of input from inexperienced or
uninformed lower-level employees
• Reduce the time frame for the budgeting process
Disadvantages of Imposed Budgets
• May result in dissatisfaction, defensiveness, and low morale
among individuals who must work under the budget
• Reduce the feeling of teamwork
• May limit the acceptance of the stated goals and objectives
• Limit the communication process among employees and
management
• May create a view of the budget as a punitive device
• May result in unachievable budgets for international
divisions if local operating and political environments are
not adequately considered
• May stifle the initiative of lower-level managers
Best Times to Use
Participatory Budgets
•
•
•
•
In well-established organizations
In extremely large businesses
In times of economic affluence
When operating managers have strong budgetary
skills and perspectives
• When organizational units are quite autonomous
Advantages of Participatory Budgets
• Provide information from persons most familiar with the
needs and constraints of organizational units
• Integrate knowledge that is diffused among various levels
of management
• Lead to better morale and higher motivation
• Provide a means to develop fiscal responsibility and
budgetary skills of employees
• Develop a high degree of acceptance of and commitment
to organizational goals and objectives by operating
management
Continuing . . . Advantages of
Participatory Budgets
• Are generally more realistic
• Allow organizational units to coordinate with one another
• Allow subordinate managers to develop operational plans
that conform to organizational goals and objectives
• Include specific resource requirements
• Blend overview of top management with operating details
• Provide a social contract that expresses expectations of top
management and subordinates
Disadvantages of
Participatory Budgets
• Require significantly more time
• Create a level of dissatisfaction with the process
approximately equal to that occurring under imposed
budgets in cases in which the effects of managerial
participation are negated by top-management changes
• Create an unachievable budget in cases in which managers
may be ambivalent or unqualified to participate
• May cause managers to introduce slack into the budget
• May support “empire building” by subordinates
• May start the process earlier in the year when there is more
uncertainty about the future year
Budget Manual
• Statements of the budgeting
purpose and its desired results
• A listing of specific budgetary
activities to be performed
• A calendar of scheduled budgetary
activities
• Sample budget forms
• Original, revised, and approved
budgets
Calendar Budget Period
Year
Quarter 1
Quarter 2
Quarter 3
Quarter 4
January
April
July
October
February
May
August
November
March
June
September
December
The Master Budget
A comprehensive set of an organization’s
budgetary schedules and
pro forma (projected) financial statements
Composition of the Master Budget
Operating Budgets
Financial Budgets
(units & dollars)
(dollars)
Sales Budget
Production Budget
Purchases Budget
Direct Labor Budget
Overhead Budget
Selling & Administrative
Budget
Cash Budget
Capital Budget
Schedule of Cost of Goods
Manufactured
Income Statement
Statement of Retained
Earnings
Balance Sheet
Statement of Cash Flows
Budget Example
Sales budgets by month:
January
February
March
$200
300
400
Variable cost of goods sold will be 60 percent of sales
dollars.
Other variable costs will be 15 percent of sales dollars,
paid one month later.
Total fixed costs for the year will be $240, of which $10
per month is depreciation expense.
Balance Sheet, December 31, 19x0
Assets:
Cash
Liabilities:
$ 30
Accts. payable
Accts. receivable
288
Accrued payables
Inventory
300
Total liabilities
Plant & equip., net
300
Total
$ 918
$ 180
25
$ 205
Common stock
500
Retained earnings
213
Total
$ 918
Budgeted Income Statement for the
Quarter Ending March 31, 19x1
Jan.
Feb.
Mar.
Total
$ 200
$ 300
$ 400
$ 900
120
180
240
540
$ 80
$ 120
$ 160
$ 360
Other variable costs
25
30
45
100
Contribution margin
$ 55
$ 90
$ 115
$ 260
20
20
20
60
$ 35
$ 70
$ 95
$ 200
Sales
Variable cost of goods sold
Gross margin
Fixed costs
Income
Purchases Budget for the Three
Months Ending March 31, 19x1
Jan.
Cost of sales
$
Ending inventory*
Total requirements
$
420
$
Beginning inventory
Purchases required
120
Feb.
540
240
$
540
$
300
$
180
Mar.
720
$
420
$
300
$
*Ending inventory is equal to the next two month's
COGS. April's and May's sales were estimated as $500
and $600, respectively.
240
Total
$
540
660
660
900
$ 1,200
540
300
360
$
900
Cash Collections from Customers
Collections are estimated to be 20 percent in
the month of sale, 48 percent the month
following, and 32 percent in the second
month following. There are no
uncollectible accounts.
Cash Receipts
Jan.
Sales for the month
Feb.
Mar.
Total
$
200
$
300
$
400
$
900
$
40
$
60
$
80
$
180
Collections from sales:
20% of current month's
48% of prior month's*
32% of second month's*
Total cash collections
$
120
96
144
360
88
80
64
232
248
$
236
$
288
*November and December sales were $275 and $250, respectively
$
772
Cash Disbursements for Purchases
Jan.
Feb.
Mar.
Total
Budgeted purchases
$
240 $
300 $
360 $
900
Payments
$
180 $
240 $
300 $
720
Purchases are paid for the month following the purchase.
Cash Disbursements–All Costs
Jan.
For purchases
$
180
Feb.
$
240
Mar.
$
300
Total
$
720
Other variable costs
25
30
45
100
Fixed costs
10
10
10
30
Total
$
215
$
280
$
355
$
850
Tentative Cash Budget
Jan.
Beginning balance
$
Collections
Total available
$
248
$
Disbursements
Ending balance
30
Feb.
278
63
$
236
$
215
$
63
Mar.
299
19
$
288
$
280
$
19
Total
$
307
30
772
$
802
355
850
(48) $
(48)
Minimum Cash Balance Policies
Financial managers devote considerable
attention to determining the needed
minimum level of cash. As with most
decisions, a trade off between two
conflicting factors is involved. Too small
a minimum balance would lead to a
higher probability of running out of cash,
while too large a minimum balance would
lead to little or no return.
Continuing . . .
Minimum Cash Balance Policies
In this example, the desired minimum
cash is $25,000. Cash can be borrowed
in $5,000 increments at an interest rate
of 12 percent per year.
Revised Cash Budget
Jan.
Beginning balance
$
Collections
Total available
$
248
$
Disbursements
Tentative balance
30
Feb.
278
63
$
299
$
19
$
$
10
$
63
$
29
29
Total
$
288
280
Borrowing
Ending balance
$
236
215
$
63
Mar.
317
772
$
802
355
850
(38) $
(48)
65
$
30
27
75
$
27
Budgeted Income Statement for the
Quarter Ending March 31, 19x1
Total
Sales
Variable cost of goods sold
Gross profit
$900.00
540.00
$360.00
Other variable costs
100.00
Contribution margin
$260.00
Fixed costs
Operating income
Interest expense
Income
60.00
$200.00
0.85
$199.15
Balance Sheet, March 31, 19x1
Assets:
Liabilities:
Cash
$27.00
Accts. payable
Accts. receivable
416.00
Accrued expenses
60.00
Inventory
660.00
Short-term loan
75.00
Plant & equip., net
270.00
Accrued interest
0.85
Total liabilities
$495.85
Total
$1,373.00
Common stock
Retained earnings
Total
$360.00
500.00
377.15
$1,373.00
Total Revenue Variance
Budgeted
Sales
Actual sales
(ASP x AV)
(BSP x BV)
Total Revenue Variance*
*Favorable
or unfavorable
Sales Price Variance
ASP x AV
BSP x AV
BSP x BV
Sales
Price Variance
AV (ASP - BSP) *
*Favorable
or unfavorable
Sales Volume Variance
ASP x AV
BSP x AV
BSP x BV
Sales Volume
Variance
BSP (AV - BV) *
*Favorable
or unfavorable
Example
The Maine Lobsters budget 1999 ticket sales at
$70,000 per home game, which represent the sale of
an estimated 10,000 tickets at a selling price of $7.
At July’s first home game, actual gate ticket revenue
was $66,000, creating a total unfavorable revenue
variance of $4,000. The actual sales consisted of
12,000 tickets at $5.50.
Revenue Variance Calculations
Total Revenue Variance equals:
70,000 - ($5.50 x 12,000) = $4,000 U
Sales Price Variance equals:
12,000 x ($5.50 - $7.00) = $18,000 U
Sales Volume Variance equals:
$7.00 x (12,000 - 10,000) = $14,000 F
Traditional Budgeting
• Starts with last year’s funding appropriation
• Focuses on money
• Does not systematically consider alternatives
to current operations
• Produces a single level of appropriation for an
activity
Zero-Based Budgeting
• Starts with a minimal (or zero) figure for
funding
• Focuses on goals and objectives
• Directly examines alternative approaches to
achieving similar results
• Produces alternative levels of funding based
on availability of funds and desired results