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Chapter 9 Outline

Budgeting: Profit Planning and Control Systems


  1. Overview of Budgeting
    1. Detailed plan in quantitative terms: A budget is a detailed plan, expressed in quantitative terms, that specifics how resources will be acquired and used during a given period of time.
    2. Serves as a benchmark: A budget is a tool used in planning, communicating and coordinating the plans and views of various managers within an organization, allocating limited resources among various programs and projects, controlling operations by serving as a standard against which actual results can be compared and evaluating performance.
    3. Types: The types of budgets include master budgets (a comprehensive profit plan that covers all phases of an organizationís operations), pro-forma (budgeted) financial statements, a capital budget for the acquisition of long-term assets, and rolling budgets, which are continuously updated by adding a new time period (e.g., a month) and dropping the period just completed.
II.      The Master Budget
    1. Comprehensive planning tool: The master budget is a comprehensive planning tool for an organizationís operations during a specific time period (usually a year). It is based on a sales forecast of goods or services.
    2. Begins with sales forecast and considers many items: The master budget begins with a sales forecast.   
    1. Items considered in making a sales forecast include:
    1. past sales levels and trends;
    2. general economic conditions;
    3. industry trends;
    4. Other facts affecting industry sales(e.g. technological change);
    5. political and legal events;
    6. company pricing policies;
    7. advertising and product promotions;
    8. actions of competitors;
    9. new products;
    10. market research studies;
    1. Focus industry dependent: Operational budgets vary from firm to firm. Manufacturersí budgets focus heavily on production activities, merchandising firms prepare budgets for purchasing activities, service firms prepare budgets showing how demand for their services will be met, and so forth.
    2. Variety of items: Manufacturing budgets are prepared for a host of different items including production, materials acquisitions, labor use, overhead incurrence, selling and administrative expenses, cash flows, and projected financial statement. See e.g., Text at 340.


III.      Budget Administration and Base Budgeting
    1. Key executives make up budget committee: Many companies use a budget committee, which consist of key executive who advise the budget director.
    1. Director directly responsible: The budget director, often the controller, has direct responsibility for preparation of the budget document or manual.
    2. Board ultimately responsible: The board of directors is responsible for deciding whether to approve the budget.
    3. Zero-based starts fresh: Some companies use a zero-based budgeting approach, which is essentially a start-from-scratch method. To receive funding for an upcoming period, each activity must be justified in terms of its continued usefulness to the organization.
    4. Base-budgeting incremental: Other organizations use a base-budgeting approach whereby an initial base package is given to a unit. This package would include minimal funding, below which the unit would not be a viable entity. Then, managers may request excess funding (i.e., an incremental package) for those activities where benefits exceed the costs.
IV.      Budgeting Product Life-Cycle Costs
    1. Product life-cycle phases: The product life-cycle cost include: (1) product planning and concept design; (2) preliminary design; (3) detailed design and testing; (4) production; and (5) distribution and customer service.
    2. Most costs committed: In many cases, most of a productís costs are committed rather early in the itemís life cycle. It is therefore essential to budget total costs as early as possibleómost definitely, prior to the product being introduced to the marketplace.
V.      Behavioral Impact on Business
    1. Participative budgeting empowers: Participative budgeting involves employee participation in the budget-preparation process at various levels of the organizational hierarchy. Although final decision-making responsibility remains at the top of an organization, the inclusion of more employees (and their input) increases the sense of ownership over the budget document and the motivation to meet it. Too much participation, though, can delay the process and raise costs.
    2. Tendency to pad: When budget information comes from many employees, upper management should be aware of the tendency to "pad the budget." For example if asked to submit a sales budget, the sales manager may give a lower figure than he or she really expects. This "padding" is done so if sales come in higher than the given number, the sales force will look especially productive. Underestimating sales and overestimating expenses are examples of padding, and the difference between the padded amount and the realistic amount is called budgetary slack.
    3. Decreasing uncertainty reduces padding: To avoid padding, upper management should educate employees to the fact that budgets will not be used for "witch hunts" when figures are not met. Decreasing employee uncertainty over how budgets will be used decreases the tendency to build in a buffer or pad. Also, employees should be rewarded for accurate budgets, not just meeting the budgets, for predicting sale too low may result in high-cost production to meet the "surprise" increase in orders.
    4. Participative budgeting can create ethical conflicts: Participative budgeting can give rise to ethical considerations, especially when padding has been built in and a manager receives a bonus for "beating the budget."

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