Budgeting and budgeting control

8,383 views

Published on

Published in: Education
0 Comments
9 Likes
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total views
8,383
On SlideShare
0
From Embeds
0
Number of Embeds
7
Actions
Shares
0
Downloads
784
Comments
0
Likes
9
Embeds 0
No embeds

No notes for slide

Budgeting and budgeting control

  1. 1. BudgetaryControlStatic Budgets Budgeting and Budgetary ControlFlexible BudgetsResponsibilityAccountingResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide S EL End Show 7-1
  2. 2. Budgetary Control andBudgetaryControl Responsibility AccountingStatic BudgetsFlexible BudgetsResponsibilityAccountingResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7-2
  3. 3. Budgetary Management FunctionsControlStatic Budgets • PlanningFlexible BudgetsResponsibilityAccounting • Directing and MotivatingResponsibilityReports/CostResponsibility • ControllingReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7-3
  4. 4. Budgetary ControlBudgetaryControl • One of the three mainStatic BudgetsFlexible Budgets functions of managementResponsibilityAccounting is to control.ResponsibilityReports/Cost • Budgets are useful inResponsibilityReports -ProfitInvestment controlling operations.CentersPrevious Next Slide Slide End Show 7-4
  5. 5. Budgetary ControlBudgetaryControlStatic Budgets The use of budgets toFlexible Budgets control operations.ResponsibilityAccounting Compare actual resultsResponsibilityReports/Cost with planned objectives.Responsibility TSReports -Profit EN L EMCIA BU AT N ST INA DGInvestment F TECentersPrevious Next Slide Slide End Show 7-5
  6. 6. Illustration 7-1 Budgetary ControlBudgetaryControlStatic BudgetsFlexible BudgetsResponsibilityAccountingResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7-6
  7. 7. Illustration 7-2Budgetary Control Reporting System
  8. 8. Illustration 7-6 Static BudgetBudgetaryControlStatic Budgets A projection of budget dataFlexible Budgets at one level of activity.ResponsibilityAccounting Barton Steel (Forging Department) Manufacturing Overhead Budget (Static)Responsibility For the Year Ended December 31, 2002Reports/CostResponsibility Budgeted Production in units (steel ingots) Budgeted Production in units (steel ingots) 10,000 10,000Reports -Profit Budgeted Costs Budgeted Costs Indirect materials Indirect materials $$250,000 250,000Investment Indirect labor 260,000 Indirect labor 260,000Centers Utilities 190,000 Utilities 190,000 Depreciation Depreciation 280,000 280,000 Property taxes Property taxes 70,000 70,000 Supervision Supervision 50,000 50,000Previous Next $1,100,000 $1,100,000 Slide Slide End Show 7-8
  9. 9. Static BudgetBudgetaryControlStatic BudgetsFlexible BudgetsResponsibilityAccountingResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7-9
  10. 10. Flexible BudgetBudgetaryControlStatic Budgets A projectionFlexible Budgets of budgetResponsibilityAccounting data forResponsibilityReports/Cost variousResponsibilityReports -Profit levels ofInvestment activity.CentersPrevious Next Slide Slide End Show 7 - 10
  11. 11. Illustration 7-13 Flexible Budget Fox Manufacturing Company (Finishing Department) Flexible Monthly Manufacturing Overhead Budget For the Month Ended January 31, 2002Activity level Activity level Direct labor hours Direct labor hours 8,000 8,000 9,000 9,000 10,000 10,000 11,000 11,000 12,000 12,000Variable costs Variable costs Indirect materials ($1.50) Indirect materials ($1.50) $12,000 $12,000 $13,500 $13,500 $15,000 $15,000 $16,500 $16,500 $18,000 $18,000 Indirect labor ($2.00) Indirect labor ($2.00) 16,000 16,000 18,000 18,000 20,000 20,000 22,000 22,000 24,000 24,000 Utilities ($.50) Utilities ($.50) 4,000 4,000 4,500 4,500 5,000 5,000 5,500 5,500 6,000 6,000 Total variable Total variable 32,000 32,000 36,000 36,000 40,000 40,000 44,000 44,000 48,000 48,000Fixed costs Fixed costs Depreciation Depreciation 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 Supervision Supervision 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 Property taxes Property taxes 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 Total fixed Total fixed 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000Total costs Total costs $62,000 $62,000 $66,000 $66,000 $70,000 $70,000 $74,000 $74,000 $78,000 $78,000
  12. 12. Illustration 7-15Flexible Budget at 10,000 and 12,000 Levels
  13. 13. Management by ExceptionBudgetaryControlStatic Budgets The review of budget reportsFlexible Budgets by management focusedResponsibilityAccounting entirely or primarily onResponsibilityReports/Cost differences between actualResponsibilityReports -Profit results and plannedInvestmentCenters objectives.Previous Next Slide Slide End Show 7 - 13
  14. 14. Illustration 7-17 Responsibility Reporting SystemBudgetaryControl The preparation of reportsStatic Budgets for each level ofFlexible BudgetsResponsibility responsibility in theAccounting company’s organizationResponsibilityReports/Cost chart.ResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 14
  15. 15. Controllable CostsBudgetaryControlStatic Budgets Costs that a manager has theFlexible Budgets authority to incur within aResponsibilityAccounting given period of time.ResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 15
  16. 16. Illustration 7-17 Responsibility for Controlling CostsBudgetaryControlStatic BudgetsFlexible BudgetsResponsibilityAccountingResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 16
  17. 17. DecentralizationBudgetaryControlStatic Budgets Control of operations isFlexible Budgets delegated to many managersResponsibilityAccounting throughout the organization.ResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 17
  18. 18. SegmentBudgetaryControlStatic Budgets An area of responsibility inFlexible Budgets decentralized operations.ResponsibilityAccountingResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 18
  19. 19. Responsibility AccountingBudgetaryControlStatic Budgets A part of managementFlexible Budgets accounting that involvesResponsibilityAccounting accumulating and reportingResponsibilityReports/Cost revenues and costs on theResponsibilityReports -Profit basis of the manager whoInvestmentCenters has the authority to make the day-to-day decisionsPrevious Slide Next Slide about the items. End Show 7 - 19
  20. 20. Illustration 7-20
  21. 21. Direct Fixed CostsBudgetaryControlStatic Budgets Costs that relate specificallyFlexible Budgets to a responsibility centerResponsibilityAccounting and are incurred for theResponsibilityReports/Cost sole benefit of the center.ResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 21
  22. 22. Indirect Fixed CostsBudgetaryControlStatic Budgets Costs that are incurred forFlexible Budgets the benefit of more than oneResponsibilityAccounting profit center.ResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 22
  23. 23. Cost CenterBudgetaryControlStatic Budgets A responsibility center thatFlexible Budgets incurs costs but does notResponsibilityAccounting directly generate revenues.ResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show Warranty Dept 7 - 23
  24. 24. Profit CenterBudgetaryControlStatic Budgets A responsibility center thatFlexible Budgets incurs costs but alsoResponsibilityAccounting generates revenue.ResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 24
  25. 25. Investment CenterBudgetaryControlStatic Budgets A responsibility center thatFlexible Budgets incurs costs, generatesResponsibilityAccounting revenues, and has controlResponsibilityReports/Cost over the investment fundsResponsibilityReports -Profit available for use.InvestmentCentersPrevious Next Slide Slide End Show 7 - 25
  26. 26. Illustration 7-18BudgetaryControlStatic BudgetsFlexible BudgetsResponsibilityAccountingResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 26
  27. 27. Illustration 7-22 Responsibility ReportBudgetaryControl Contribution margin less controllableStatic Budgets fixed costs=Controllable Margin.Flexible BudgetsResponsibility Mantel Manufacturing Company (Marine Division)Accounting Responsibility ReportResponsibility For the Year Ended December 31, 2002Reports/Cost Difference DifferenceResponsibility Favorable F Favorable FReports -Profit Budget Actual Unfavorable U Budget Actual Unfavorable UInvestment Sales Sales $1,200,000 $1,150,000 $1,200,000 $1,150,000 $50,000 U $50,000 UCenters Variable Costs Variable Costs Cost of goods sold Cost of goods sold 500,000 500,000 490,000 490,000 10,000 F 10,000 F Selling & administrative Selling & administrative 160,000 160,000 156,000 156,000 4,000 F 4,000 F Total Total 660,000 660,000 646,000 646,000 14,000 F 14,000 F Contribution margin Contribution margin 540,000 540,000 504,000 504,000 36,000 U 36,000 UPrevious Next Controllable fixed costs Slide Slide Controllable fixed costs Cost of goods sold Cost of goods sold 100,000 100,000 100,000 100,000 -0- -0- End Selling & administrative Selling & administrative 80,000 80,000 80,000 80,000 -0- -0- Show Total Total 180,000 180,000 180,000 180,000 -0- -0- 7 - 27 Controllable margin Controllable margin $$360,000 $$324,000 360,000 324,000 $36,000 U $36,000 U
  28. 28. Residual IncomeBudgetaryControl The income that remains afterStatic BudgetsFlexible Budgets subtracting from theResponsibility controllable margin theAccountingResponsibility minimum rate of return on aReports/Cost company’s operating assets.ResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 28
  29. 29. Return on Investment (ROI)BudgetaryControl A measure of management’sStatic Budgets effectiveness in utilizing assetsFlexible Budgets at its disposal in an investmentResponsibilityAccounting center.ResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 29
  30. 30. Principles of Performance EvaluationBudgetary • Managers of responsibility centersControl should have direct input into theStatic Budgets process of establishing budget goals ofFlexible Budgets their area of responsibility.ResponsibilityAccounting • The evaluation of performance shouldResponsibility be based entirely on matters that areReports/Cost controllable by the manager beingResponsibility evaluated.Reports -Profit • Top management should support theInvestmentCenters evaluation process. • The evaluation process must allow managers to respond to theirPrevious Next evaluations. Slide Slide • The evaluation should identify both End Show good and poor performance. 7 - 30
  31. 31. BudgetaryControlStatic BudgetsFlexible BudgetsResponsibility • Capital Budgeting AnalysisAccountingResponsibilityReports/CostResponsibilityReports -ProfitInvestmentCentersPrevious Next Slide Slide End Show 7 - 31
  32. 32. • OutlineBudgetaryControlStatic BudgetsFlexible BudgetsResponsibility • Traditional Capital Budgeting TechniquesAccountingResponsibilityReports/Cost – Payback Period ApproachResponsibility – Discounted Payback Period ApproachReports -Profit – Discounted Cash Flow TechniquesInvestment • Net Present ValueCenters • Internal Rate of Return • Profitability Index • Net Present Value versus Internal Rate of ReturnPrevious Next Slide Slide End Show 7 - 32
  33. 33. • Meaning of Capital BudgetingBudgetaryControlStatic Budgets • Capital budgeting addresses the issue ofFlexible BudgetsResponsibility strategic long-term investment decisions.Accounting • Capital budgeting can be defined as theResponsibilityReports/Cost process of analyzing, evaluating, andResponsibility deciding whether resources should beReports -Profit allocated to a project or not.Investment • Process of capital budgeting ensureCenters optimal allocation of resources and helps management work towards the goal ofPrevious Next shareholder wealth maximization. Slide Slide End Show 7 - 33
  34. 34. • Significance of Capital BudgetingBudgetaryControlStatic BudgetsFlexible Budgets • Considered to be the most importantResponsibility decision that a corporate treasurerAccountingResponsibility has to make.Reports/CostResponsibility • So much is the significance of capitalReports -Profit budgeting that many businessInvestmentCenters schools offer a separate course on capital budgetingPrevious Next Slide Slide End Show 7 - 34
  35. 35. • Why Capital Budgeting is soBudgetary Important?ControlStatic BudgetsFlexible Budgets • Involve massive investment ofResponsibilityAccounting resourcesResponsibility • Are not easily reversibleReports/CostResponsibility • Have long-term implications forReports -ProfitInvestment the firmCenters • Involve uncertainty and risk for the firmPrevious Next Slide Slide End Show 7 - 35
  36. 36. Why Capital Budgeting is so Important?BudgetaryControl • Due to the above factors, capital budgeting decisions become critical and must be evaluatedStatic Budgets very carefully.Flexible BudgetsResponsibility • Any firm that does not follow the capitalAccounting budgeting process will not be maximizingResponsibility shareholder wealth andReports/CostResponsibility • Management will not be acting in the bestReports -Profit interests of shareholders.InvestmentCenters • RJR Nabisco’s smokeless cigarette project example – Project initiated in 1989Previous Next – More than $300 million was invested Slide Slide – Had 2 flaws- required special lighter & was tasteless for smoker End Show – Within 2 years the project failed to deliver 7 - 36
  37. 37. Why Capital Budgeting is so Important?Budgetary • Similarly:Control • Euro-Disney, – Failed miserably because of following factors :Static Budgets – Cultural gap’s – French felt that their children might looseFlexible Budgets french culture as it had more of English culture – Europeans love travelling and not interested in 1 dayResponsibility vaccationAccounting – All Investments were Bad (Lost everything) . 1st year $900mResponsibility loss.Reports/Cost • Concorde Plane, – Too noisyResponsibility – Too expensiveReports -Profit – Plane crash in 2000- killed 113 passengersInvestment • Saturn of GMCenters – Best selling model to kill competition from Japan cars – For 5 years GM did not make any other model – After 5 years brought various models killing the Saturn modelPrevious Next Slide Slide All faced problems due to bad capital budgeting, while End Intel became global leader due to sound capital Show budgeting decisions in 1990s. 7 - 37
  38. 38. • Techniques of Capital BudgetingBudgetary AnalysisControlStatic Budgets • Payback Period ApproachFlexible BudgetsResponsibility • Discounted Payback PeriodAccountingResponsibility ApproachReports/Cost • Net Present Value ApproachResponsibilityReports -Profit • Internal Rate of ReturnInvestmentCenters • Profitability IndexPrevious Next Slide Slide End Show 7 - 38
  39. 39. • Which Technique should we follow?BudgetaryControlStatic BudgetsFlexible Budgets • A technique that helps us in selectingResponsibility projects that are consistent with theAccounting principle of shareholder wealthResponsibilityReports/Cost maximization.Responsibility • A technique is considered consistent withReports -ProfitInvestment wealth maximization ifCenters – It is based on cash flows – Considers all the cash flowsPrevious – Considers time value of money Next Slide Slide – Is unbiased in selecting projects End Show 7 - 39
  40. 40. • Payback Period ApproachBudgetaryControlStatic BudgetsFlexible Budgets • The amount of time needed to recover theResponsibility initial investmentAccounting • The number of years it takes including aResponsibilityReports/Cost fraction of the year to recover initial investment is called payback periodResponsibilityReports -Profit • To compute payback period, keep adding theInvestment cash flows till the sum equals initialCenters investment • Simplicity is the main benefit, but suffers from drawbacksPrevious Next • Technique is not consistent with wealth Slide Slide maximization—Why? End Show 7 - 40
  41. 41. • Discounted Payback PeriodBudgetaryControlStatic Budgets • Similar to payback period approach withFlexible BudgetsResponsibility one difference that it considers time valueAccounting of moneyResponsibilityReports/Cost • The amount of time needed to recoverResponsibility initial investment given the present value ofReports -Profit cash inflowsInvestmentCenters • Keep adding the discounted cash flows till the sum equals initial investment • All other drawbacks of the payback periodPrevious Next remains in this approach Slide Slide End • Not consistent with wealth maximization Show 7 - 41
  42. 42. • Net Present Value ApproachBudgetaryControlStatic BudgetsFlexible Budgets • Based on the Rupees amount of cash flowsResponsibility • The Rupee amount of value added by aAccounting projectResponsibilityReports/Cost • NPV equals the present value of cashResponsibilityReports -Profit inflows minus initial investmentInvestment • Technique is consistent with the principleCenters of wealth maximization—Why? • Accept a project if NPV ≥ 0Previous Next Slide Slide End Show 7 - 42
  43. 43. • Internal Rate of ReturnBudgetaryControlStatic BudgetsFlexible Budgets • The rate at which the net presentResponsibility value of cash flows of a project isAccounting zero, I.e., the rate at which theResponsibilityReports/Cost present value of cash inflows equalsResponsibility initial investmentReports -ProfitInvestment • Project’s promised rate of returnCenters given initial investment and cash flowsPrevious Next • Consistent with wealth maximization Slide Slide End • Accept a project if IRR ≥ Cost of Show 7 - 43 Capital
  44. 44. • NPV versus IRRBudgetaryControlStatic Budgets • Usually, NPV and IRR are consistent withFlexible BudgetsResponsibility each other. If IRR says accept the project,Accounting NPV will also say accept the projectResponsibility • IRR can be in conflict with NPV ifReports/CostResponsibility – Investing or Financing DecisionsReports -Profit – Projects are mutually exclusiveInvestment • Projects differ in scale of investmentCenters • Cash flow patterns of projects is different – If cash flows alternate in sign—problem of multiple IRRPrevious Next Slide Slide • If IRR and NPV conflict, use NPV End approach Show 7 - 44
  45. 45. • Profitability Index (PI)BudgetaryControlStatic Budgets • A part of discounted cash flow familyFlexible BudgetsResponsibility • PI = PV of Cash Inflows/initial investmentAccounting • Accept a project if PI ≥ 1.0, which meansResponsibilityReports/Cost positive NPVResponsibility • Usually, PI consistent with NPVReports -ProfitInvestment • PI may be in conflict with NPV ifCenters – Projects are mutually exclusive • Scale of projects differ • Pattern of cash flows of projects is differentPrevious Slide Next Slide • When in conflict with NPV, use NPV End Show 7 - 45
  46. 46. • Evaluating Projects with UnequalBudgetary LivesControlStatic BudgetsFlexible Budgets • Replacement Chain AnalysisResponsibilityAccounting • Equivalent Annual Cost MethodResponsibilityReports/Cost • If two machines are unequal in life,Responsibility we need to make adjustment beforeReports -ProfitInvestment computing NPV.CentersPrevious Next Slide Slide End Show 7 - 46
  47. 47. • Which technique is superior?BudgetaryControlStatic Budgets • Although our decision should be based onFlexible Budgets NPV, but each technique contributes inResponsibility its own way.Accounting • Payback period is a rough measure ofResponsibility riskiness. The longer the payback period,Reports/Cost more risky a project isResponsibilityReports -Profit • IRR is a measure of safety margin in aInvestment project. Higher IRR means more safetyCenters margin in the project’s estimated cash flows • PI is a measure of cost-benefit analysis.Previous Slide Next How much NPV for every dollar of initial Slide investment End Show 7 - 47

×