CMA - Budgeting Methodolgies

7/24/2019 CMA - Budgeting Methodolgies

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Certified

Management

Accountant

Certified

Management

Accountant



Part 1 : Financial Planning,

Performance and Control

Topic 4 : Budgeting Methodologies

Section B : Planning, Budgeting,and Forecasting



• Annual / Master Budget

– To use its budget as an effective planning and management tool, a company must

choose a budget methodology that supports and reinforces its managementapproach.

– An organization’s master budget, also known as an annual business plan or profit

plan, is a comprehensive budget for a year or less.

– Every aspect of the company’s revenue and cost flows is projected, starting with

the sales budget, based on its forecasted sales for the upcoming periods, and

ending with a set of pro forma financial statements, which include the income

statement and balance sheet.

– The benefits of having a master budget are numerous and the drawbacks are few.

Virtually every company needs some form of master budget.

– Depending on the types of business, organizational structure, complexity of

operations, and management philosophy, a company can choose differentapproaches in formulating its master budget.

– The company can even adopt different approaches for different pieces of its master

budget.

– Six different budgeting systems that a company can use to create its budgets are:

Project budgeting - Activity-based budgeting - Incremental budgeting - Zero-based budgeting - Continuous (or rolling) budgeting – Flexible budget 3

Budgeting Methodologies



• Project Budgeting

– Project budgets are used when a project is completely separate from other elements of a

company or is the only element of the company.

– The time frame for a project budget is simply the duration of the project, but a multiyearproject could be broken down by year.

– Successful past project budgets for similar projects should be used as benchmarks when

developing project budgets.

– Project budgets are developed using the same techniques and components as shown for

master budgeting, except that the focus will be solely on costs related to the project instead

of the com pany as a whole. – The overhead budget is simplified because the company will allocate certain portions of the

company’s fixed and variable overhead to the project, and all remaining overhead for the

company is excluded from the project budget.

– Project budget advantages include the ability to contain all of a project’s costs so that its

individual impact can be easily measured.

– Project budgets work well on both large and small scales, and project management softwarecan facilitate developing and tracking these budgets.

– A potential limitation of project budgets occurs when projects use resources and staff that are

committed to the entire organization rather than dedicated to the project.

– In such situations, the budget will contain links to these resource centers, and affected

individuals may be reporting to two or more supervisors.

– Care must be taken in dividing costs and lines of authority. 4




• Activity-Based Budgeting

– An activity-based budget (ABB) focuses on activities instead of departments or

products.

– Each activity is matched with the most appropriate cost driver, which is any

volume-based) or activity-based unit of measurement of the cost of a job or

activity needed to sustain operations.

– Costs are divided into cost pools, such as unit, batch, product, and facility.

– Cost pools include homogeneous costs that all vary in the same proportion to the

rise and fall of production. – Fixed costs are in one pool, and different levels of variable costs are in their own

pools.

– The accuracy of these groupings should be evaluated each time a master budget is

prepared.

–Whereas traditional budgeting focuses on input resources and expresses budgetingunits in terms of functional areas, ABB focuses on value-added activities and

expresses budgeting units in terms of activity costs.

– Traditional budgeting places emphasis on increasing management performance;

ABB places emphasis on team- work, synchronized activity, and customer

satisfaction.

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• Activity-Based Budgeting

• ABB proponents believe that traditional costing obscures the relationships between

costs and outputs by oversimplifying the measurements into such categories as labor

hours, machine hours, or output units for an entire process or department.

• ABB uses activity-based cost drivers, such as number of setups, to make a clearconnection between resource consumption and output.

• ABB will also use volume-based drivers if they are the most appropriate measurement

unit for a particular activity.

• IF the relationships are made clear, managers can see how resource demands are

affected by changes in products offered, product designs, manufacturing techniques,

customer base, and market share.

• Each planned activity will have its cost implications highlighted. Because of this,

companies using ABB will be able to continuously improve their budgeting.

• Conversely, traditional budgets focus on past (historical) budgets and often continue

funding items that would be cut if their cost-effectiveness were better known.

• ABB can be used as the foundation of a master budgeting process. The resulting sub-

budgets would be based on different ways of measuring the costs, so the resulting

proportions of costs would be weighted differently.

For instance, some portion of the indirect materials or labor that would be part of

overhead could be tracked more carefully and included in direct materials and

direct labor amounts. 6





• Incremental Budgeting :

– An incremental budget is a general type of budget that starts with the prior year’s

budget and uses projected changes in sales and the operating environment to

adjust individual items in the budget upward or downward.

– It is the opposite of a zero- based budget.

– The main drawback to using this type of budget (and the reason that some

companies use zero-based budgets) is that the budgets tend to only increase in size

over the years.

– A sense of entitlement may also arise with the use of an incremental budget.

• Zero-Based Budgeting :

– In order to avoid situations in which ineffective elements of a business continue to exist

simply because they were on the prior budget, some companies use zero-based budgets,

which, as the name implies, start with zero dollars allocated.

– While the traditional budget focuses on changes to the past budget, the zero-based budget

focuses on constant cost justification of each and every item in a budget.

– Managers must conduct in-depth reviews of each area under their control to provide such

justification.

– The strength of the zero-based budget is that it forces review of all elements of a business.

– Zero-based budgets can create efficient, lean organizations and therefore are popular with

government and nonprofit organizations.

– A zero-based budget is a way of taking a new look at an old problem. 8




• The first step in developing a zero-based budget is to have each department manager rank all

department activities from most to least important and assign a cost to each activity.

• Upper management reviews these lists, called “decision packages,” and cuts items that lack

justification or are less critical.

• Upper management asks questions, such as “Should the activity be performed and if it is not, what

will happen?” or “Are there substitute methods of providing this function such as outsourcing or

customer self-service?”

• Managers may also use benchmark figures and cost-benefit analysis to help decide what to cut.

• Only those items approved appear in the budget.

• The cost of the accepted items may be arrived at thorough discussion and negotiation with the

department managers.

• Once the budget figures are determined, the zero-based budget becomes the basis for a master

budget.

• Theoretically, zero-based budgets have the advantage of focusing on every line item instead of just

the exceptions.

• They should motivate managers to identify and remove items that are more costly than the

benefits provided.

• These budgets are especially useful when new management is hired.

• Zero-based budgets have a major drawback in that they encourage managers to exhaust all of their

resources during a budget period for fear that they will be allocated less during the next budget

cycle.

• IF a manager has incorporated budget slack into the budget, a zero-based budget can encourage a

significant amount of waste and unnecessary purchasing.

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• One issue with zero-based budgeting is the time-consuming and expensive annual review process.

As a result, the review often may be less thorough than it is intended to be.

• In addition, by not using prior budgets, the firm may be ignoring lessons learned from prior years.

• IF used every year, a zero-based budget actually may become little more than an incremental

budget with a little extra processing. Managers simply remember their old justifications and figures

and use them the following year.• The time and expense of a zero-based budget often is mitigated by performing zero-based budgets

only on a periodic basis, such as once every five years, and applying a different budget method in

the other years. Or the firm might rotate the use of zero-based budgeting for a different division

each year.

• Continuous (Rolling) Budgets :

– A continuous budget, or rolling budget, adds a new period onto the budget at the end of eachperiod so there are always several periods planned for the future and the budgets remain up-

to-date with the operating environment.

– As with the other budget types, this budget becomes the master budget for an entity.

– However, while other budgets will expire at the end of the budgeted time period, the time

frame for this budget always remains the same—for example, one year, no matter if it is

viewed in January or July. – Therefore, if the period is a month, each month a new set of monthly financial statements is

issued to each person responsible for preparing the budget.

– In a monthly budget meeting, managers report on the variances from the past month’s

budget and make projections for the next month.

– After review, a budget coordinator updates the master budget, performing the calculations

not performed by line managers, such as depreciation or inventory valuation. 10



– A continuous budget will be more relevant than a budget prepared once a year.

– IT can reflect current events and changes in its estimates, and it has the advantage of breaking

down a large process into manageable steps.

– Because managers always have a full period of budgeted data, they tend to view decisions in a

longer-term perspective than with a one-year budget, which will cover a shorter and shorter

period of time as the year progresses. – Potential disadvantages of continuous budgets include the need to have a budget coordinator

and/or the opportunity cost of having managers use part of each month working on the next

month’s budget.

– Continuous budgets are appropriate for firms that cannot devote a large block of time to a

once-a-year budget process. These types of budgets are also useful for companies that want

their managers to have a longer-term view of the firm.

• Flexible Budgeting :-

• Flexible budgeting establishes a base cost budget for a particular level of output (a cost-volume

relationship), plus an incremental cost-volume amount that shows the behavior of costs at various

volumes.

• Only the variable costs are adjusted; fixed costs remain unchanged. The most common use of aflexible budget is to show the budget that would have been made if the organization had exactly

matched its sales forecast.

• While flexible budgets from prior periods can be helpful in determining how to modify the next

budget, a flexible budget that applies actual production output cannot be used as a type of master

budget because the actual production output is not known until the period is complete.

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Original versus actual budget

Flexible budget



End of TopicMr. Tamer Bedir

[email protected]

00966541553318

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CMA - Budgeting Methodolgies