2. The purpose of a budget as a controlling instrument
Distinguishing a budget from a strategic plan and from a forecast
Several types of budget
Typical operating budget
This presentation is focus
on the management control of operations
in the current year.
It starts by describing
Budget Preparation presented by Hermawan Wicaksono
3. Nature of Budget
Budgets are an important tool for effective short-term planning and control in organizations.
A budget is a management plan, with the implicit assumption that the positive steps will be
taken by the budgetee to make actual events correspond to the plan. An operating budget
usually covers one year and states the revenues and expenses planned for that year. It has
these characteristics:
1. A budget estimates the profit potential of the business unit.
2. It is stated in the monetary terns.
3. It generally covers a period of one year.
4. It is a management commitment.
5. It reviewed and approved by an authority higher than the budgetee.
6. One approved it can be changed only under specified conditions.
7. Periodically, actual financial performance is compared to budget.
Nature of Budget
Budgets are an important tool for effective short-term planning and control in organizations.
A budget is a management plan, with the implicit assumption that the positive steps will be
taken by the budgetee to make actual events correspond to the plan. An operating budget
usually covers one year and states the revenues and expenses planned for that year. It has
these characteristics:
1. A budget estimates the profit potential of the business unit.
2. It is stated in the monetary terns.
3. It generally covers a period of one year.
4. It is a management commitment.
5. It reviewed and approved by an authority higher than the budgetee.
6. One approved it can be changed only under specified conditions.
7. Periodically, actual financial performance is compared to budget.
Budget Preparation presented by Hermawan Wicaksono
4. The process of preparing a budget should be distinguished from
1. Strategic planning
2. Forecasting
Strategic planning is the process of deciding on the nature and size of the several programs
that are to be undertaken in implementing an organization’s strategies. The budgeting process
focuses on a single year, whereas the strategic planning focuses on activities that extend over
a period of several years.
The budget will be used to influence a manager’s performance before the fact and to appraise
performance after the fact.
A forecast is merely prediction of what will most likely happen, it has the following
characteristics:
1. It may not be stated in monetary terms.
2. It can be for any period.
3. It doesn’t accept responsibility for meeting the forecasted result.
4. It is not usually approved by higher authority.
5. It is updated as soon as new information indicates there is a change in conditions.
6. Variances of a forecast are not analyzed formally or periodically.
A budget is a both planning and controlling tool. All budgets include elements of
forecasting.
Budget Preparation presented by Hermawan Wicaksono
5. Use of a Budget
Preparation of an operating budget has four principal purposes
1. To fine-tune the strategic plan
2. To help coordinate the activities of the several parts of the organization
3. To assign responsibility to managers
4. To obtain a commitment that is a basis for evaluating
Fine-tuning the strategic plan
The budget which is completed just prior to the beginning of the budget year, provides an
opportunity to use the latest available information and is based on the judgment of
managers of all levels throughout the organizations
Coordination
Every responsibility enter manager in e organization participates of the budget. There will
be inconsistencies in the organization, but during the budget preparation process, these
inconsistencies are identified and resolved.
Assigning responsibility
The approval budget should make clear what each manager is responsible for. The budget
also authorizes responsibility center managers to spend specified amounts of money for
certain designated purposes without seeking the approval of higher authority.
Basis for performance evaluation
The commitment is subject to change if the assumptions on which it is based change, but
the budget nevertheless is an excellent starting point for performance appraisal. The
budget assigns responsibility to each responsibility center in organization.
Budget Preparation presented by Hermawan Wicaksono
6. Cash Forecast
Budgeted Balance Sheet
Revenue and expense for
each major program
Not necessarily by
responsibility centers
Not as much detail as
operating budget
More expenses are
available
For several years
Total reconciles to
operating budget
For organization as whole
and for each business unit
Classified by
responsibility centers
Typically includes:
1. Revenue
2. Production cost and cost of sales
3. Marketing expense
4. Logistic expense (sometimes)
5. General & Administrative
6. Research & Development
7. Income Taxes
8. Net income
Expenses may be
1. Flexible
2. Discretionary
3. Committed
For one year divided into
months or quarters
Total reconciles to
strategic plan
(unless revised)
Total project expenditure
by quarters
Each major capital project
listed separately
Capital Budget
Types of Plans and Their Contents
Operating BudgetStrategic Plan
Budget Preparation presented by Hermawan Wicaksono
7. Operating Budget Categories
It categorized into:
1. Revenue Budgets
The revenue item is listed first because the amount of the budgeted revenues influences the
amount of many of the other items. A revenue budget consists of unit sales projection
multiplied by expected selling prices. The revenue budget is the most critical, but it is also
the element that is subject to the greatest uncertainty. The revenue budget usually is based
on forecasts for some conditions for which the sales manager cannot be held responsible.
2. Budgeted production cost and cost sales
Production managers make plans for obtaining quantities of material and labor , they also
develop production schedules to ensure that resources needed to produce the budgeted
quantities will be available. The difference between purchases and sales represents
additions to or decreases in inventory.
3. Marketing expenses
Marketing expenses are expenses incurred to obtain sales.
4. General and administrative expenses
In budget preparation, much attention is given to these categories; because they are
discretionary, the appropriate amount to authorize is subject to much debate.
5. Research and development expenses
Many companies decide to spend a specified percentage of sales revenue on R&D, but this
percentage is based on a long-run average.
6. Income taxes
Some companies do not take income taxes into account in preparing the budgets for
business units, it is because income tax policies are determined at corporate headquarters.
Budget Preparation presented by Hermawan Wicaksono
8. Other Bugdets
Capital budget. The capital budget states the approved capital projects, plus a lump-sum
amount for small projects that do not required high-level approval.
Budgeted balance sheet. It shows the balance sheet implications of decisions included in the
operating budget and the capital budget.
Budgeted cash flow statement. It shows how much of the cash needs during the year will be
supplied by retained earnings and how much, if any must be obtained by borrowing or form
other outside sources.
Management by objectives. The objectives of each responsibility center are set forth in
quantitative terms wherever the possible, and, as in the case with the budgeted amounts, are
accepted by the responsible manager.
Budget Preparation presented by Hermawan Wicaksono
9. Budget Preparation Process
Budget Department
The budget department, which normally reports to the corporate controller, administers the
information flow of the budgetary control system. The budget department performs the
following functions:
1. Publishes procedures and forms the preparation of the budget.
2. Coordinates and publish each year the basic cooperatewide assumptions that are to be
the basis for the budgets.
3. Make sure that the information is properly communicated between interrelated
organization units.
4. Provides assistance to budgetees in the preparation of their budgets.
5. Analyzed proposed budgets and makes recommendations, first to the budgetee and
subsequently to senior management.
6. Administers the process of making budget revisions during the year.
7. Coordinates the work of budget departments in lower echelons.
8. Analyzed reported performance against budget, interprets the result, and prepares
summary reports for senior management.
The Budget Committee
The budget committee consists of members of senior management. The budget committee
performs a vital role. It reviews and either approves and adjusts each of budgets.
Budget Preparation presented by Hermawan Wicaksono
10. Changes in Budgetting
The budget may be changed. Changes from the current level of performance can be classified
as internal and external changes.
Changes in internal policies and practices are
1. Changes in production cost
2. Changes in discretionary cost
3. Changes in the market share
Changes in external forces are:
1. Changes in the general level economic activity as it affects the volume of sales.
2. Expected changes in the price of purchased materials and service.
3. Expected changes in labor rates.
Budget Preparation presented by Hermawan Wicaksono
11. Participation in the Budgetary Process
An effective budget preparation process blends the two approaches, top-down budgeting and
bottom-up budgeting. Budgetees prepare the first draft of the budget of their area
responsibility, which is “bottom-up”, but they do so within guidelines established at higher
levels, which is “top-down”. Senior managers review and critique these proposed budget to
ensure that budgetees do not “play games” with the budgeting system.
Budget participation has positive effects on managerial motivation for two reasons:
1. There is likely to be greater acceptance of budget goals if they are perceived as being
under managers’ personal control, rather than being imposed externally. This leads to
higher personal commitment to achieve the goals.
2. Participative budgeting results in effective information changes. The approved budget
amounts benefit from the expertise and personal knowledge of the budgetees, who are
closest to the product/market environment. Further, the budgetees have a clearer
understanding of their jobs through interactions with superiors during the review and
approval phase.
Budget Preparation presented by Hermawan Wicaksono
12. The ideal budget is one that challenging but attainable. Statically, this may be interpreted as
meaning that a manager who performs reasonably well has at least a 50 chance of achieving
the budget amount. There are several reasons senior management approves achievable
budgets for business units:
1. If the budgeted target is too difficult, managers are motivated to take short-term that
may not be in the long-term interests of the company. It usually implies an overly
optimistic sales target.
2. Achievable budget targets reduce the motivation for managers to engage in data
manipulation.
3. When business unit managers are able to meet and exceed their targets, there is a
“winning” atmosphere and positive attitude within the company.
Budget Preparation presented by Hermawan Wicaksono
13. To perform their function effectively, the members of the budget department must have a
reputation for impartiality and fairness and also have the personal skills required to deal
effectively with people.
Budget Preparation presented by Hermawan Wicaksono
