Management Accounting - Assigment 2

Definition A budget is “A quantitative statement, for a defined period of time, which may include planned revenues, expense, asset, liabilities and cash flows” (BPP Professional Education, 2004: 155) The purpose and benefits of a budget There are seven main purposes and benefit of using a budget is: a To ensure the achievement of the organization’s objective Using the budget system requires the managers have to set consistent objectives in the future instead of changing every day It also means that different parts of the business have to think of an agreed objective at the budget planning b To compel planning Planning is the key in the whole process of budget planning, planning force management to look ahead and systematically anticipate the future, to set out detailed plans for achieving the targets for each department, operation and each manager and to anticipate problems If a formal plan of attack is created, it allows managers (or individuals) to focus on problems before they actually occur c To communicate ideas and plans A formal system is necessary to ensure that each person, affected by the plans is aware of that he or she is supposed to be doing Budget planning will promote the exchange of management with each of the policies and objectives of the business d Co-ordinate activities The activities of different departments need to be co-ordinated to ensure maximum integration of effort towards common goals If everyone concerned sticks to the formal plan adopted by a budget, everyone knows where the enterprise is heading and ensures that it stays on track In a large company, operations are generally divided into different departments and under the responsibility of different managers To achieve overall objectives, close coordination of activities is a necessity e To provide a framework for responsibility accounting Budgets require that managers of budget centres are made responsible for the achievement of budget targets for the operations under their personal control f To establish a system of control Control through the budget is a list of fiduciary responsibility The overall lookshows that, the budget will affect a firm's strategy Control over actual performance is provided by the comparisons of actual results against the budget plan If the two results not match, the intervention must be to devise appropriate measures Without planning, there is no standard to evaluate what is happening and so any management always indicative random and arbitrary g Motivate employees to improve their performance If people at every level in the business participate more in the planning and budgetary control, they understand and support the operational objectives of the business Being involved in the planning and control is an important motivation for everyone Steps in the preparation of a budget a) Budget committee The co-ordination and administration of budget is usually the responsibility of a budget committee The budget committee is assisted by a budget officer who is usually an accountant Functions of the budget committee include the following: • • • • b) Timetabling Co-ordination and allocation of responsibility Communication of final budgets to the appropriate managers Issuing of the budget manual Responsibility for budgets The responsibility for preparing the budgets should, ideally, lie with the managers who are responsible for implementing them c) The budget manual The budget manual is a collection of instruction governing the responsibilities of persons and the procedures, forms and records relating to the preparation and use of budgetary data d) Steps in budget preparation The procedures for preparing a budget will differ from organization to organization but the steps described below will be indicative of the steps followed by many organizations The preparation of a budget may take weeks or months and the budget committee may meet several times before the master budget is finally agreed e) Identifying the principal budget factor The principal budget factor is the factor which limits the activities of an organization 3 Preparing functional budgets By functional budgets, mean that budgets relate to an area of an organization that produces, or does, something This is not necessarily to say that we are talking about manufacturing alone We can have functional budgets in manufacturing, in commerce, in government We can have functional budgeting in nonprofit making organizations too Functional budget preparation is not a difficult affair: work through the above example a couple of times and you should agree The key principles of functional budget preparation are: • • • • • Understand the function, process or system you are budgeting Find all of the data you need Separate the values from the volumes Check for interrelationships, understand and use them Check your arithmetic once you have prepared each budget http://business.fortunecity.com/discount/29/prepfuncbud.htm Cash budgets A cash budget is a statement in which estimated future cash receipts and payments are tabulated in such a way as to show the forecast cash balance of a business at defined intervals (BPP Professional Education, 2004:162) The usefulness of cash budget The cash budget is one of the most important planning tools that an organization can use Its shows the cash effect of all plans made within the budgetary process and hence its preparation can lead to a modification of budgets if it shows that there are insufficient cash resources to finance the planned operation It can also give them management an indication of potential problems that could arise and allows hem the management the opportunity to take action to avoid such problem A cash budget can allow four positions Management will need to take appropriate action depending on the potential position This is part of the process of management of working capital (BPP Professional Education, 2004:164) For example, without setting a cash budget, spending a dollar a day on a newspaper seems fairly unimpressive However, upon setting a cash budget to account for regular annual cash expenditures, this seemingly small daily expenditure comes out to an annual total of $365, which may be better spent on other things If you frequently buy specialty newspaper, your annual expenditure will be substantially more Budgeted profit and loss account and balance sheet As well as wishing to forecast its cash position, a business might want to estimate its profitability and its financial position for a corning period This would involve the preparation of a budgeted profit and loss account and balance sheet, both of which form the master budget Flexible budgets A flexible budget is a budget that is a function of one or more levels of activity Thus, the budget depends on one or more measures of activity volume rather than being fixed in amount • • A fixed budget is a budget which is set for a single activity level A flexible budget is “A budget which, by recognizing different cost behavior patterns, is designed to change as volume of activity changes” A flexible budget has some advantages: Actual costs are compared to budget activities costs are equivalent in the flexibility budget Provideexactlybasisforthe analysis offluctuations At planning stage, it may be helpful to know what the effects would be if the actual outcome differs from the prediction Budgetary control • • A control technique whereby actual results are compared with budgets Any differences (variances) are made the responsibility of key individuals who can either exercise control action or revise the original budgets The most important method of budgetary control, for the purpose of your examination, is variance analysis, which involves the comparison of actual result achieved during a control period with a flexible budget The differences between actual results and expected results are called variances and these are used to provide a guideline for control action by individual managers We will be looking at variances in some detail later in this Unit The correct approach to budgetary control is as follow: Identify fixed and variable costs Produce a flexible budget using marginal costing techniques Cost estimation Cost estimating is a well-formulated prediction of the probable construction cost of a specific building project A cost estimate can be an important management tool to library planners during the design phases of a project providing information about the facility and the project budget It should be obvious that the production of a budget calls for the preparation of cost estimates and forecasts In this section we will consider various cost estimation techniques a) Cost estimate methods Cost estimation involves the measurement of historical cost to predict future costs Some estimate techniques are more sophisticated than other and are therefore likely to be more reliable but, in practice, the simple techniques are more commonly found and should give estimates that are sufficiently accurate for the their purpose It is these simple techniques which we will be examining here b) Account-classification method or engineering method By this method, the manager responsible for estimating cost will go through a list of the individual expenditure items which make up the total costs Each item will be classified as fixed, variable or semi-variable, and values will be assigned to these, probably by reference to the historical cost account with an adjustment for estimated cost inflation c) High/low method Records of costs in precious previous periods are reviewed and the costs of the following two periods selected • • The period with the highest volume of activity The period with the lowest volume of activity The variable cost per unit may be calculated from this (difference in total costs + difference in activity levels), and the fixed cost may then be determined by substitution d) The scattergraph method The advantage of the scattergraph over the high/low method is that a greater quantity of historical data is used in the estimation, but its disadvantage is that the cost line is drawn by visual judgment and so is a subjective approximation Computers and budgeting Using Microsoft Excel to track your spending and build a budget It's good stuff; it's easy enough to follow while helping to create a comprehensive spreadsheet to set a budget and track its effectiveness a) Advantages of computer Computers, however, can take hard work out of budgeting: a computerized system will have four basic advantages over a manual system: • • • • b) A computer has the ability to process a larger volume of data A computerized system can process data more rapidly than a manual system Computerized systems tend to be more accurate than manual systems Computers have the ability to store large volumes of data in a readily accessible form Methods Budgeting is usually computerized using either a computer program written specifically for the organization or by a commercial spreadsheet package Both method of computerization of the budgeting process will involve a mathematical model which represents the real world in terms of financial values The model will consist of several, or many, interrelated variables, a variable being an item in the model which has a value For example a cash budgeting model would include variables for sales, credit periods, purchases, wages and salaries and so on c) Spreadsheets Spreadsheet as the term commonly used to describe many of the modeling packages available for microcomputers, being loosely derived from the likeness to a “spreadsheet of paper” divided in to rows and columns Access the use of spreadsheets in budgeting let us consider a cash budget A cash budget needs frequent updating to reflect current and forecast conditions, changes in credit behavior and so on Incremental and zero based budgeting system a) Incremental budgeting Incremental budgeting is a reasonable procedure if current operations are as effective efficient and economical as they can be, and the organization and the environment are largely unchanged b) The principles of zero based budgeting Zero based budgeting involves preparing a budget for each cost centre from a zero base Every item of expenditure has then to be justified in its entirety in order to be included in the year’s budget c) Implementing zero based budgeting The implementing of ZZB involves a number of steps but of greater importance is the development of a question attitude by all those involved in the budgetary process Existing practices and expenditures must be challenged and searching questions, such as the following must be asked • • • • Does the activity need to be carried out? What would be the consequences if the activity was not carried out? Does the activity benefit the organization? Is the current level of provision current? The basic approach of ZZB has three steps: Step 1: Define decision packages Step 2: Evaluate and rank packages Step 3:Allocate resources d) The advantages of implementing ZZB • Cost reductions are possible • Useful for service departments where the output is difficult to identify • It force employees to avoid wasteful expenditure • It challenges the status quo and forces an organization to examine alternative • activities and existing expenditure levels Increases staff motivation by providing greater initiative and responsibility in decision-making • Efficient allocation of resources, as it is based on needs and benefits e) The disadvantages of implementing ZZB • The organization’s information systems may not be cable of providing suitable incremental cost and incremental benefit analysis • Difficult to define decision units and decision packages, as it is time-consuming • • and exhaustive Short-term benefit might be emphasized to the detriment of long-term benefit Difficult to administer and communicate the budgeting because more managers • are involved in the process It may be difficult to sell ZBB to managers as a useful technique for the following reason  Incremental costs and benefit of alternative courses of action are hard to quantify accurately  Employees or trade union representatives may resist management ideas for changing the ways in which work is done f) Using zero based budgeting ZBB can be used by bothprofit-makingand non-profit-making organization It is popular in the US and Canada but its adoption has been slow in the UK The procedure of zero base budgeting not lend themselves easily to direct manufacturing costs where standard costing, work study and techniques of management planning and control have long, been established as a means of budgeting expenditure 10 Budgeting performance and motivation a) Budgets and motivation Much has been written about the motivational effect of the budgeting process on managers in a business and there are many conflicting views However it is well recognized that the budgetary process has the potential to be a powerful motivating tool, but conversely can also quite easily have a de-motivating effect on managers b) Budgets and standards as target The quantity of material and labour time included in the budget will depend on the level of performance required by management Four types of performance standard might be set: Ideal standards, Attainable standards, Current standard, and Basic standards Similar comments apply to budgets The various research projects into the behavioural effects of budgeting have given conflicting views on certain points However, there appears to be general agreement that a target must fulfill certain conditions if it is to motivate employees to work towards it: • • • c) It must be sufficiently difficult to be a challenging target It must not be so difficult that it is not achievable It must not be accepted by the employees as their personal goal Participation There are basically two ways in which a budget can be set: from the top down (imposed budget) or from the bottom up d) Imposed style of budget In this approach to budgeting, top management prepare a budget with little or no input form operating personnel This budget is then imposed upon the employees who have to work to the budgeted figures The times when imposed budgets are effective are as follows: • • • When operational manager lack budgeting skills In newly-formed organization, because of employees’ lack of knowledge In very small businesses, because the owner/manager has a complete overview of the business There are advantages and disadvantages of this style of setting budgets: Advantages • • The use senior management’soverall awareness of the organization The aims of long-term plans are more likely to be incorporated into short-term • plans Budget can be drawn up in a shorter period of time because a consultation process is not required Disadvantages • If consideration is not given to local operating and political environments, • • unachievable budgets for overseas divisionscould be produced The felling of team spirit may disappear Employees might see the budget as part of a system of trying to find fault with their work: if they cannot achieve a target that has been imposed on them they will be punished e) Participative style of budgeting Participative budgeting is a good motivational tool because the people participating may work harder to accomplish the budgeting goals, cooperation is facilitated, and more realistic budgeting figures are obtained The advantages of participative budgets are: • Co-ordination and cooperation between those involved in budget preparation should • improve Managers should feel that that they own the budget and will therefore be more • committed to the targets and more motivated to achieve them Knowledge spread among several levels of management is pulled together, again producing more realistic budgets And there are a number of disadvantages of participative budgets: • • • • f) • Managers may not co-ordinate their own plan with those of other departments An earlier start to the budgeting process could be required Budget may be unachievable if managers are not qualified to participate They consume more time Negotiated style of budgeting In the imposed budget approach, operational managers will try to negotiate with senior managers the budget targets which they consider to be unreasonable or • unrealistic Likewise senior management usually reviews and reviews and revises budgets presented to them under a participative approach through a process of negotiation • with lower level manager Final budgets are therefore most likely to lie between what top management would really like and what junior managers believe is feasible g) Creative budgets In the process of preparing budgets, managers might deliberately overestimate costs and underestimate sales, so that they will not be blamed in the future for overspending and poor results In controlling actual operations, managers must then ensure that their spending rises to meet their budget, otherwise they will be blamed for careless budgeting h) Goal congruence and dysfunction decision making It is therefore importance that some of desires, interests and goals motivating employees correspond with the goals of the organization as a whole On the other hand, dysfunctional behavior can occur if a manager’s goals are not in line with those of the organization as a whole Attempts enhance his or her own situation or performance will be at the expense of the best interests of the organization as a whole Participation is not necessarily the answer Goal congruence does not necessarily result from allowing managers to develop their own budgets