Budgeting for Planning and Controlling

Putu Agus ArdianaFaculty of Economics and Business

Udayana University, Indonesia

Description of Budgeting

• Goal congruence• While short-term plans must address short-

term needs, they must also include actions that contribute to longer-term success

• Fail in planning means planning a failure

Budgeting, Planning, and Controlling (1)

• Planning and controlling are inextricably linked

• Planning is looking ahead to see what action should be taken to realize particular goals

• Control is looking backwards, determining what actually happened and comparing it with the previously planned outcomes

• The comparison can then be used to adjust the budget, looking ahead once more

Budgeting, Planning, and Controlling (2)

• Budgets are financial plans for the future identifying objectives and the action required to achieve them

• Before a budget is prepared, an organization should develop a strategic plan

• Strategic plan identifies strategies for future activities and operations, generally covering at least five years

Strategic Plan

Budgets

Long-Term Objectives

Investigation

Monitoring of Actual Activity

Comparison of Actual with Planned

Feedback

Short-Term Objectives

Short-Term Plan

Corrective Action

Planning Controlling

Budgeting, Planning, and Controlling (3)

The Advantages of Budgeting

• It forces managers to plan• It provides information that can be used to

improve decision making• It provides a standard for performance

evaluation• It improves communication and coordination

Preparing the Master Budget (1)• Master budget is the comprehensive financial

plan for the organization as a whole• Typically, the master budget is for a one-year

period corresponding to the financial year of the company

• Yearly budgets are broken down into quarterly and monthly budgets

• The use of smaller time periods allows managers to compare actual data with budgeted data more frequently, so problems may be noticed and solved sooner

Preparing the Master Budget (2)

• Some organizations have developed a continuous budgeting philosophy

• A continuous budget is a moving 12-month budget. As a month expires in the budget, an additional month in the future is added so that the company always has a 12-month plan on hand

• Proponents of continuous budgeting maintain that it forces managers to plan ahead constantly

Major Components of Master Budget (1)

• Operating budget describes the income-generating activities of a firm: sales, production, and finished goods inventories

• The ultimate outcome of the operating budget is a pro-forma or budgeted income statement

• Financial budget details the inflows and outflows of cash and the overall financial position

• Planned cash inflows and outflows appear in the cash budget

• The expected financial position at the end of the budget period is shown in a budgeted or pro-forma balance sheet

• Operating budget is prepared first then financial budget

Major Components of Master Budget (2)

• The operating budget consists of a budgeted income statement accompanied by the following supporting schedules:– The sales budget– The production budget– The direct materials purchases budget– The direct labor budget– The overheads budget– The ending finished goods inventory budget– The cost of goods sold budget– The selling and administrative expenses budget

Major Components of Master Budget (3)

• The remaining budgets found in the master budget are the financial budgets. They are:– The cash budget– The budgeted balance sheet– The budgeted for capital expenditures

Sales Budget

Long-Term Sales Forecast

Direct Materials Purchases Budget

Production Budget

OverheadsBudget

Direct LaborBudget

Selling and Administrative

Expenses Budget

Ending Finished Goods Inventory Budget

Cost of Goods Sold Budget

Budgeted Income Statement

Cash Budget

Budgeted Balance Sheet

Budgeted Statement of Cash Flows

Capital Budget

(Unit Cost)

The Master Budget and Its Relationship

Using Budgets for Performance Evaluation: Static Budgets Vs Flexible Budgets

• Budgets are useful control measures• To be used in performance evaluation, however,

two major considerations must be addressed:– How budgeted amounts should be compared with

actual results– The impact of budgets on human behavior

• Static budget is a budget for a particular level of activity

• Flexible budget is a budget that enables a firm to calculate expected costs for a range of activity levels

Actual Budgeted Variance

Units produced 1,300 1,220 80 F

Direct materials cost $9,105 $8,601 $(504) U

Direct labor cost $3,120 $2,928 $(192) U

Overheads:

Variable:

Supplies $580 $549 $(31) U

Power $184 $183 $(1) U

Fixed:

Supervision $1,055 $1,105 50 F

Depreciation $540 $540 0

TOTAL $14,584 $13,906 $(678) U

Using Budgets for Performance Evaluation: A Static Budget

A Flexible Budget (1)

Production CostsVariable Cost

per UnitRange of Production (Units)

1,000 1,200 1,300

Variable:

Direct materials $7.05 $7,050 $8,460 $9,165

Direct labor $2.40 $2,400 $2,880 $3,120

Variable overheads:

Supplies $0.45 $450 $540 $585

Power $0.15 $150 $180 $195

Total variable costs $10.05 $10,050 $12,060 $13,065

Fixed overheads:

Supervision $1,105 $1,105 $1,105

Depreciation $540 $540 $540

Total fixed costs $1,645 $1,645 $1,645

Total production costs $11,695 $13,705 $14,710

A Flexible Budget (2)

Actual Budgeted Variance

Units produced 1,300 1,300 0

Direct materials cost $9,105 $9,165 $60 F

Direct labor cost $3,120 $3,120 0

Variable Overheads:

Supplies $580 $585 $5 F

Power $184 $195 $11 F

Total variable costs $12,989 $13,065 $76 F

Fixed Overheads:

Supervision $1,055 $1,105 $50 F

Depreciation $540 $540 0

Total fixed costs $1,595 $1,645 $50 F

TOTAL PRODUCTION COSTS $14,584 $14,710 $126 F

The Behavioral Dimension of Budgeting (1)

• Since a manager’s financial status and career can be affected, budgets can have a significant behavioral effect

• The alignment of managerial and organizational goals is often referred to as goal congruence

• Dysfunctional behavior is individual behavior that is in basic conflict with the goals of the organization

The Behavioral Dimension of Budgeting (2)

• An ideal budgetary system is one that simultaneously drives managers to achieve the organization’s goals in an ethical manner

• The ideal system probably doesn’t exist but research and practices have identified some key features that promote a reasonable degree of positive behavior including frequent feedback on performance, monetary and non-monetary incentives, participating budgeting, realistic standards, and controllability of costs and multiple measures of performance

Participative Budgeting

• Participative budgeting allows subordinate managers considerably say in how the budgets are established

• However, participative budgeting has three potential problems:– Setting standards that are either too high or too low– Building slack into the budget (padding the budget) by

underestimating revenue or overestimating expenses– Incurring pseudo-participation

Thank You