AC 202: MANAGERIAL ACCOUNTING II

Topic
BUDGETING

Mr. Mshana: MFA-OG, B.com

Accounting Hons, CPA (T), ATEC (II)

To be covered
ü Introduction
ü Objectives of budgeting
ü Conflicting Budgetary objectives
ü How to resolve the conflicts
ü Goal Congruence vs Goal Incongruence
ü How to solve goal incongruence problem
ü Pre-requisites of budgeting
ü Steps in preparing a budget
ü Budget Administration
ü Contents of a master budget
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
 Introduction
Management team of an organization is vested with
powers to execute five key roles/functions which are
planning, organizing, leading, staffing and controlling.

Budgeting emanates from planning function of

management.

Planning refers to the process of choosing appropriate

goals and actions to pursue and then determining
what strategies to use, what actions to take, and
deciding what resources are needed to achieve the
goals.
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)

Introduction
A budget therefore refers to a quantitative statement
for a defined future period which may include
planned revenue, Expenses, Assets, Liabilities, Cash-
flows etc.
A budget is simply a plan that is expressed in
monetary value.
A budgetary control system is a means of monitoring
revenue and costs, and thereby exercising control in an
entity by devising budgets and comparing budgeted
figures with the actual results, to find discrepancies, if
any, and to take corrective actions.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
 Budgetary control system
• A budgetary planning and control system is essentially a
system for ensuring communication, coordination and control
within an organisation.
• The function of controlling is done by Budgetary Control system.
• Budgetary Control System - is a means of monitoring revenue
and costs, and thereby exercising control in an entity by
devising budgets and comparing budgeted figures with the
actual results, to find discrepancies, if any, and to take
corrective actions.

Budgetary control activities

Budget
Setting

Comparing
Revision of of Budget
Budget with Actual
Data

Corrective Analysis of
Action differences

Reviewing
and
Reporting

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 Objectives of Budgeting
ü Planning

ü Controlling

ü Communication

ü Co-ordination

ü Motivation

ü Performance evaluation

ü Optimal utilization of resources

ü Identification of areas of in-efficiencies

Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)

Objectives of budget
• Planning – Budget compel management to look forward.
– Prevents managers from relying on ad hoc or uncoordinated
planning.
• Co-ordination – meshing and balancing all departments
appropriately for company to meets its goals.
– Goal congruence.
• Communication – making sure goals are understood by all
employees.
– Vertical and Horizontal Communication.

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 Objectives of budget
• Controlling – budget is a yardstick against which actual
performance is measured & assessed.
– Management by exception.
• Performance Evaluation – basis for evaluation of the
performance of a division or a manager.
– Comparing Actual vs Predicted Performance.
• Motivating – budget provides targets which are linked
with rewards, in turn it motivate employees to give their
best.
Note: There is sometimes a tradeoff between the objectives.

Conflicting budgetary objectives

At times the objectives above may come into conflict to
one another.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
 Examples of Conflicting budgetary
objectives
Planning vs Performance evaluation
Budgets are prepared in advance of the budget period.
For planning, it is essential, but for performance
evaluation, the preparation of budgets ahead of the
budget period may not be suitable. The circumstances
and environment at the time when the budgets are set
may differ drastically from those at the time of actual
performance. Therefore, performance should be
measured by comparing the actual performance with
the adjusted budgeted performance, in order to avoid /
resolve the conflicts.
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)

Examples of Conflicting budgetary

objectives
Planning vs motivation
In order to motivate the personnel of the organization,
budgets are usually set high. However, such budgets
may not be suitable for planning, as planning requires
that the target set should be achievable.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
 Examples of Conflicting budgetary
objectives
Motivation vs performance evaluation
In order to motivate the personnel in an organisation,
goals are usually set high. This practice sometimes acts
as undue pressure on the personnel, and instead of
motivating, de-motivates them. This ultimately affects
their performance and consequently the objective to
motivate fails.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

Techniques to resolve the conflicts above

ü Use of Rolling Budget
ü Contingency planning
ü Updating through revised forecasts
ü Performance evaluation on the basis of revised
budgets
ü Judgment of the general manager
ü Tight-ship policy-following up organization
procedures closely
ü Combining bottom-up and top-up approach-seniors
check whether proposed objectives are in line with
organization’s objectives
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)
 Goal Congruence vs Goal incongruence
Goal Congruence refers to the agreement between
corporate objectives and individual goals of managers
in charge and/or specific departmental goals.

Goal In-congruence therefore is a situation where the

corporate goals do not align with individual goals of
management in charge and/or specific departmental
goals.
This happens when managers tend to prioritize their
own goals over corporate goals.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

Reasons for goal incongruence

The following may contribute to conflicting objectives
between an organization and managers or its
departments:
ü Reward system
ü Objectives not clearly defined
ü Imperfect information
ü Departmental rivalry

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
 Reconciliation
For a budgetary control system to be successful, the
objectives of the individuals and departmental
budgets need to be reconciled with the objectives of
the organization as a whole. This also helps to facilitate
goal congruence. Reconciliation of budgets involves:

ü Participation of all levels of management

ü Co-ordination of budget
ü Transparency in the budgeting process
ü Flexible pay system i.e. inclusion of bonus pay
system
Mr. Mshana: MFA-OG, Bcom Accounting
Hons, CPA (T), ATEC (II)

Budgeting approaches
• “Success of a budget is • Incremental Budgeting
often determined by the • Zero Based Budgeting (ZBB)
way the budget is • Rolling Budgeting
prepared” (Unknown
Author). • Fixed Budgeting
• Budget Approach involves • Flexible Budgeting
ways, philosophy, policies, • Activity Based Budgeting
procedures of preparing (ABB)
budget. This includes:-
– Top Down Budget
– Bottom Up Budget

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Top-down & bottom-Up budgeting

Top

Medium Managers

Lower Level Managers

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Top down budgeting

• In this approach, top management prepare a budget and
then impose it downwards to lower level managers for
implementation.
– It is also called Imposed budgeting.
• It is effective when the firm is new, small, lower level
managers lack budgeting skills etc.
• + It is simple and use less time, achieve coordination,
cheap, and enable a strategic focus organization.
• - It reduce motivation, unrealistic budget, it create boss
environment, and dependence culture.

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 BOTTOM UP BUDGETING
• Budget is prepared by lower – level managers and then are
sent upward for synchronization and review.
– Budget holders are given the opportunity to participate and
preparing their own budget.
• It is also called self-imposed budgeting , or participatory
budgeting.
• + It is more realistic, increase motivation of employees,
develop management skills, and more effective to large
firms.
• - It can produce uncoordinated budget, time user approach,
and create a room for budgetary slack.

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Criticisms of budgeting
• Budgets are time consuming and expensive.
• Budget provide poor value to users.
• Budget fail to focus on shareholder value (maximizing).
• Budget are too rigid and prevent fast response.
• Budget protect rather than reduce costs.
• Budget stifle (hinders) product and strategy innovation.
• Budget focus on sales targets rather than customer
satisfaction.
• Budget reinforce a dependency culture.
• Budget lead to unethical behaviour.

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 CLASS QUIZ
• Which of the following in not one of the main purpose of
budget?
A. Planning and Control
B. The alignment of individual and corporate goals
C. To enable a flexibility of approach to company policies
D. To optimize the use of scarce resources

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Class quiz
• A budget is not
A. A forecast
B. A qualitative statement
C. A plan
D. A part of the strategic management process

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 Class quiz
• Which of the following is not a function of budgeting?
A. Controlling
B. Decision making
C. Planning
D. Motivating

25

Class quiz
• The term ‘budgetary period’ relates to:
A. A specific year for which the budget has been prepared
B. The period in which the budget is finalized
C. The period for which the budget is prepared
D. The subdivisions of the main budget

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 Pre-requisites of Budget
ü Top management Support

ü Effective communication

ü Effective Participation/team-work

ü Clear and realistic objectives

ü Flexibility

ü Efficient Data gathering mechanisms

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

Steps in Budget Preparations

ü Communicate details of budget policy and budget guidelines
to those responsible
ü Determine factor Limiting output (Principle budgetary factor)
ü Prepare sales budget (Assuming sales demand is the limiting
factor)
ü Initial preparation of various budgets (by departmental
managers)
ü Negotiation of budget with superiors
ü Co-ordination of various budgets into a master budget
ü Approval of budget by committee
ü Implementation and on-going review

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
 Budget Administration
ü Budget Committee
ü Budget Officer
ü Accounting and Finance staff
ü Budget Manual

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

Master Budget
A master budget is a projected financial plan. It
displays a consolidation of the functional budgets to
present the overall impact of the projected operational
activities on the profitability of the organization as a
whole. It is a statement showing the estimation of
revenue, costs and profit (loss) for the organization
during the budget period.
A master budget normally contains all functional
budgets, capital expenditure budget, budgeted SOPL
(statement of profit or loss) and budgeted SOFP
(statement of financial position) of the budget period.

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
 Contents of a Master Budget
1. Budgetary objective for period under review
2. Operating Budget/functional budgets
i. Sales Budget

ii. Production Budget

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

Contents of a Master Budget

iii. Direct material Usage Budget

iii. Direct material Purchase Budget

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)
 Contents of a Master Budget
v. Direct Labor Cost Budget

v. Other Budget i.e. Variable overhead cost Budget, Fixed

overhead cost Budget etc.

3. Financial Budget/expenditure Budget etc.

4. Cash-Flow statement Budget

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

Incremental budgeting
• Budgeting approach in which next year budget is prepared
by using current year results, and then adjusting for;-
– Sales changes, general increase in prices and any known
changes.
• + It is simple, use less time, and good for recurring
expenditure such as salaries etc.
• - It carries over previous problems and inefficiencies, it is not
good in controlling cost, lack of innovation and it can lead to
budgetary slack.

34
 Example of incremental budgeting
• Overhead costs are budgeted on an incremental basis.
Prepare Overhead Budget for the next year, 20X2, by using
the details below:
Overheads category 20X1 ($) Known changes Inflation adjustments between 20X1 and 20X2

Property cots 120,000 None +5%

Central wages 150,000 Note 1 below +3%

Stationery 25,000 Note 2 below 0%

• Note 1: One member employed and will be paid

$ 12,000 in 2012.
• Note II: Stationery Cost will fall by 40% due to
movement to paperless economy.

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ZERO BASED BUDGETING

• ZBB was developed to solve the weakness for incremental
budgeting.
• The budget is prepared on zero base or from scratch, and
every item included in the next year`s budget has to be
discussed thoroughly. (Cost and Benefit analysis).
• It is also called priority based budgeting.
• ZBB was first used by public sector organization and it is more
effective in budgeting discretionary cost (R&D, Advertising
etc.).

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 Zero based budgeting
• There are three common steps of preparing ZBB
1. Identify Activities in an organization.
2. Evaluate and Rank the Activities, on the basis of benefit
and cost analysis.
3. Allocate resources according to the ranking.

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Zero based budgeting

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 Rolling budget
• Budgets which are continuously updated throughout a
financial year, by adding a further period (say a month or a
quarter) and removing the corresponding period that has just
ended.
• Also they are called Continuous Budget.
• All the changes occurred in lapsing period will be incorporated
in the next (full) year budget.
• Good in Dynamic Environment.

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ROLLING BUDGET

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 Rolling budget

Advantages Disadvantages
• It is good in dynamic environment • Time consuming process
• Budget are up to date. • It is expensive (large budgeting
• It is more realistic team)
• It removes uncertainty in • It tiresome and boredom activity
budgeting. – Lose interest in budgeting
• It increases motivation as
managers are evaluated on
realistic budget.

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Fixed and flexible budget

Fixed Budget Flexible Budget

• A static budget that is • Recognises cost behaviour and
prepared for a specific period changes as the actual volume
and it is not expected to of activity changes.
change. • It is used for control purposes
– Regardless of changes in level • It is prepared for actual level
of activity. of activity or for different level
• It is used for planning of activity.
purposes.

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 Other approaches to budgeting
• Activity Based Budgeting (ABB) – budget is prepared basing
on the activity to be performed by an entity in the next year.
– Make use of Activity Based Costing (ABC)
• Keizen Budgeting – a budget that allows continuous
improvement

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Class quiz
• A flexible budget is
A. A budget that will be changed at the end of every month in
order to reflect the actual costs of a department.
B. A budget that is constantly being changed.
C. A budget that comprises variable costs only
D. A budget that is adjusted to reflect different costs at different
activity levels

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 Class quiz

• A fixed budget is:

A. A budget that ignores inflation
B. A budget that never changes
C. A budget that itemizes the fixed costs of a department
D. A budget that is set for a specified level of activity

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Class quiz

• What is meant by an incremental budget?

A. A budget prepared from first principles
B. The variable elements of a budget, excluding fixed costs
C. A budget that is based on previous year, adjusted for known
changes.
D. A budget that breaks even

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 Class quiz
• Which of the following statements can be considered to be an
advantage of bottom-up budget?
A. Uses the knowledge of all staff to build a fair budget
B. The cheapest method of producing a budget
C. Reduces the level of budget negotiation between staff
D. Prevents slack being built into budgets

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Class quiz
• A firm has produced the following budget for an activity level
of 200,000 units:
– Materials TZS 15,000
– Direct labour 40,000
– Fixed expenses 77,000
• What would be the total cost for a level of activity of 225,000
units?
• A: 133,875 B: 148,500 C: 125,889 D:
138,875

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 Beyond budgeting (BB)
• BB –‘An idea that companies need to move beyond budgeting
because of the inherent flaws in budgeting.
– A term used to describe alternative approaches, such as rolling
forecasts, that can be used instead of annual budgeting.
• It was developed by a Research Institute known as BBRT since
1998.
• BBRT list several criticism of Traditional budgeting process:-

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CASH BUDGET
• Cash budgets show the expected receipts and payments
during a budget period and are a vital management planning
and control tool.
• 'Detailed budget of estimated cash inflows and outflows
incorporating both revenue and capital items.‘ (CIMA Official
terminologies)
• One of the important tool in working capital management
and financial management.
• It is mostly a monthly report for a quarter, semi-annual etc.

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 Sources of cash receipts
• Cash Sales
• Payment by customers for credit sales
– Cash received from debtors
• The sale of property, plant and equipment
• Issue of share or capital introduced.
• Loan received or grant received
• Receipt from interest or dividends from investments outside
the business.

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Reasons for cash payments

• Payment to suppliers (raw material or finished goods)
• Payroll expenses and other operating expenses
• Repayment of loans
• Purchase of capital items (fixed assets)
• Payments of interest, dividends and taxation.

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 BENEFITS OF CASH BUDGET
• It shows the cash effect of all plans made within the
budgetary process.
• It gives indication of the potential cash problems.
• Help management to prepare for any cash shortage or
surplus.
– Avoids surprises.
• Help the company to manage any seasonal fluctuation of the
business.
• It is used in acquiring loans from banks.
– As supporting document. Etc.

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Sections of the cash budget

• Receipts Section
• Disbursements Section
• Cash Surplus or Deficit
• Financing Section

54
 QUESTIONS AND ANSWERS
Ac 202_class illustrations for budgeting topic.pdf

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)

THE END

BE EVER BLESSED BEYOND MEASURES!!

Mr. Mshana: MFA-OG, Bcom Accounting

Hons, CPA (T), ATEC (II)