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Budgeting

CHAPTER 9

Budgeting

A budget is a detailed plan, expressed in quantitative

terms, that specifies how resources will be acquired


and used during a given period of time.
It is a quantified plan of action.

Nature of a Budget
15-3

Estimates profit potential


Monetary terms
A period of one year
A management commitment
Can be changed under specified conditions
Compared with actual financial performance

Key Purposes of the Budgeting System

The five primary purposes are:


1.
2.
3.
4.
5.

Planning.
Facilitating Communication and Coordination.
Allocating Resources.
Managing Financial and Operational Performance.
Evaluating Performance and Providing Incentives.

Organizations Use Many Types of Budgets


Organization
Organization
goals

Individual
Long-range
strategic plan

Individual goals
and values

Anticipated
conditions

Individual
beliefs

Master
budget
Strategic
evaluation

Actual period
results

Performance
evaluation

Types of Budgets
Master budget (profit plan)
a comprehensive profit plan that covers all phases of an
organizations operation.
Pro-forma (projected) financial statements
similar to historical statements, except that they project the
future.
Capital budget
Focuses on the acquisition of long-term assets

Sales
Sales of
of Services
Services or Goods
Goods
Ending
Ending
Inventory
Inventory
Budget
Budget

Production
Production
Budget
Budget

Work
Work in
in Process
Process
and
and Finished
Finished
Goods
Goods

Ending
Ending
Inventory
Inventory
Budget
Budget

Direct
Direct Materials
Materials

Direct
Direct
Materials
Materials
Budget
Budget

Direct
Direct
Labor
Labor
Budget
Budget

Overhead
Overhead
Budget
Budget

Cash
Cash Budget
Budget
Budgeted Balance
Sheet
Budgeted Statement
of Cash Flows

Selling
Selling and
and
Administrative
Budget

Budgeted Income
Statement

Illustrating the Master Budget

Sales Forecast
Sales Forecasting the process of predicting sales of

services or goods.
The master budget begins with a sales forecast.
Items to consider in sales forecasts:

Past sales levels and trends


General economic conditions
Industry trends
Company pricing policies
Action of competitors
New products

Sales Budget of Collegiate Apparel


Collegiate Apparel Company is preparing budgets for

the year ending December 31, 20x1.


Budgeted sales are:
First quarter 15,000 units
Second quarter
5,000 units
Third quarter 10,000 units
Fourth quarter 20,000 units
The selling price is $12 per unit.

Sales Budget of Collegiate Apparel

Production Budget
Sales
Budget
m
o
C

pl

ed
t
e

Production
Budget

Plan of resources needed to meet current


sales demand and ensure inventory levels
are sufficient for future sales.

Forecasting Production
Rearrange the basic inventory formula as follows . . .
Units in
Required
beginning + production
inventory
in units

Sales
in
Units

Units in
ending
=
inventory

Now, solve for required production . . .


Units
to be
Produced

Sales
in
Units

Units in
ending
inventory

Expected
beginning
inventory

The Production Budget


Collegiate Apparel wants units in ending finished

goods inventory to be 10% of the next quarters


expected sales in units.
At the beginning of the year, 1,500 completed units
were on hand.
During the first quarter of 20x2, 15,000 units are
expected to be sold.

Lets prepare the production budget.

The Production Budget

5,000 10% = 500 units

Direct-Materials Budget
Direct materials needed for the budget period can be
determined as follows . . .
Required
materials
purchases

Materials
used in
=
+
production

Ending
materials
inventory

Beginning
materials
inventory

Direct-Materials Budget
At Collegiate Apparel 1.5 yards of fabric are required per

unit of product.
Management wants fabric on hand at the end of each
quarter to be 10% of next quarters raw materials
required. On January 1stst, 2,100 yards of fabric are onhand. During the first quarter of 20x2, Collegiate
expects 21,000 yards of fabric to be required.
Each yard of fabric cost the company $2.
Lets prepare the direct materials budget.

Direct-Materials Budget

8,250 10% = 825 units

Responsibility for Budget Administration


Budget Committee Consists of key senior executives
who may advise the budget director during the
preparation of the budget.
The authority to give final approval to the budget
usually rests with the board of directors.

Budget Department
15-20

Publishes procedures and forms for budget

preparation.
Publishes assumptions for the basis of budgets.
Facilitate communications among departments.
Makes analyses and budget recommendations.
Administers budget revisions.
Analyzes performance against budget.

Participative Budgeting
Participative Budgeting the use of input from lowerand middle-management employees.

The process is time consuming but enhances employee


motivation and acceptance of goals.
Budget negotiation is the heart of budgeting process.

Advantages of Participative Budgeting


1.
1. Individuals
Individuals at
at all
all levels
levels of
of the
the organization
organization are
are viewed
viewed
as
as members
members of
of the
the team
team whose
whose judgments
judgments are
are valued
valued
by
by top
top management.
management.
2.
2. Budget
Budget estimates
estimates prepared
prepared by
by front-line
front-line managers
managers are
are
often
often more
more accurate
accurate than
than estimates
estimates prepared
prepared by
by top
top
managers.
managers.
3.
3. Motivation
Motivation is
is generally
generally higher
higher when
when individuals
individuals
participate
participate in
in setting
setting their
their own
own goals
goals than
than when
when the
the
goals
goals are
are imposed
imposed from
from above.
above.
4.
4. A
A manager
manager who
who is
is not
not able
able to
to meet
meet aa budget
budget imposed
imposed
from
from above
above can
can claim
claim that
that it
it was
was unrealistic.
unrealistic. SelfSelfimposed
imposed budgets
budgets eliminate
eliminate this
this excuse.
excuse.

Budgets and Feedback


Budgets offer feedback in the form of variances:

actual results deviate from budgeted targets


Variances provide managers with

Early warning of problems


A basis for performance evaluation
A basis for strategy evaluation

Budgeting and Human Behavior


The budgeting process may be abused both by

superiors and subordinates, leading to negative


outcomes
Superiors may dominate the budget process or hold
subordinates accountable for events they have no
control over
Subordinates may build budgetary slack into their
budgets

Ethical Problems in Budgeting


Much of the information for the budget is provided by persons
whose performance is then compared with the budget they help
develop.
Lets prepare the
sales forecast with a
4% increase, so we
will really look good!

I think sales
will increase by
10% next year.

Critics of Budgeting
15-26

Budgeting process is inefficient

Senior managers spend 10% to 20% of their time on budgeting.


Yet, most suggest that budgeting is not a valuable use of their
time.

It becomes obsolete rapidly.


It does not motivate the right behavior.
It is out of sync with the strategic planning.

Budgetary Slack: Padding the Budget


Padding
Padding the
the budget
budget means
means intentionally
intentionally underestimating
underestimating
revenues
revenues or
or overestimating
overestimating costs.
costs.
The
The difference
difference between
between the
the revenue
revenue or
or cost
cost projection
projection that
that
aa person
person provides
provides and
and aa realistic
realistic estimate
estimate of
of the
the revenue
revenue or
or
cost
cost is
is called
called budgetary
budgetary slack.
slack.
A
A solution:
solution: reward
reward managers
managers for
for making
making accurate
accurate
estimates.
estimates.

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