Langfield Smith 8e IRM Ch09 PDF

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Copyright © 2017 McGraw-Hill Education (Australia) Pty Ltd IRM Langfield-Smith, Smith, Andon, Hilton, Thorne Management Accounting 8eCHAPTER 9BUDGETING SYSTEMSANSWERS TO QUESTIONS9 Strategic plans are concerned with long-term planning, whereas budgeting is usually related to planning for a short-ter...

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CHAPTER 9

BUDGETING SYSTEMS ANSWERS TO QUESTIONS 9.1

Strategic plans are concerned with long-term planning, whereas budgeting is usually related to planning for a short-term period. As strategic plans may relate to a ten- or even 20-year horizon, those plans may include the acquisition of new businesses, development of new product lines, expansion of the business, the refinancing of new operations and restructuring of the business. The budget must be formed by taking into account the details of the strategic plan. The budget will tend to be formulated in greater detail than the strategic plan and may relate to one year or even a shorter time period.

9.2

A budget may facilitate communication and coordination by creating a forum in which the competing uses of resources can be debated and evaluated and different scenarios can be modelled. The manager of each division may present a case to the senior management team for changes in the allocation of resources for his or her division. This could be for the development of new products or other value-enhancing activities or projects. These cases will be carefully evaluated by senior management to ensure the best outcomes for the company as a whole.

9.3

A budget can be used to evaluate performance by comparing the actual results to the budget. This can be used to assess the performance of individuals, departments, divisions and the overall company. Managers may be held accountable for the performance of their organisational unit, and financial or other incentives may be provided to encourage managers to meet or exceed the budgeted goals.

9.4

Proponents of Beyond Budgeting criticise traditional budgeting as a method of steering senior managers toward particular decisions. Terms that students will find on their websites include ‘stifling bureaucracy’ and ‘suffocating control systems’. These advocates of ‘BB’ believe that more responsive frontline managers should receive information that enables them to make informed decisions, using initiative and acquiring personal improvement that enhances future decisions. Classroom discussions regarding the use of or abandonment of budgets could encompass whether it is traditional budgeting per se that is stifling initiative, or if it is the ways in which senior personnel used budgets and design budgeting systems.

9.5

Managers are responsible and accountable for the operations and outcomes of one part of the organisation. The budgeting process (i) communicates to managers what they are expected to achieve and, sometimes in broad terms, how to achieve those objectives (ii) identifies the resources expected to be consumed in achieving those objectives (iii) can provide periodic information that assists managers to monitor their progress toward the objectives and take corrective action (iv) can evaluate the performance of the managers and provide them with incentives to achieve outcomes that are in the best interests of the organisation as a whole. Within a responsibility accounting framework the budget is therefore used: to identify what the manager is accountable for (their area of responsibility and its expected outcomes); in the measurement of how well the manager conformed to expectations; and to provide input to an analysis of results that explains the causes and effects of good and bad performance.

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9.6

The flow chart below depicts the components of the annual budget for a fashion retailer. Strategic planning

Budget assumptions

Sales budget: Stock and inventory control

Material budget: inventory

Inventory: clothes

Overhead budget

Labour budget:shop assistants

Selling and administrative budget

Cash budget

Balance sheet

9.7

Income statement

Cash budgets record the amount and expected timing of the receipt and payment of cash. They forecast possible cash shortages and cash surpluses. Plans can then be made for borrowings and short-term investments at appropriate times. While not taking advantage of investing surplus cash is a missed opportunity, an inability to settle debts as they fall due is a very serious matter leading to lost credibility and reputation, loss of suppliers or even legal action threatening the existence of the business. The cash budget is therefore an important tool for managing cash receipts and disbursements. It is important for any company to make sure that it has enough cash on hand to meet its cash needs. Where the cash budgeting forecasts cash shortages, this can then be managed to ensure that the amount borrowed is at the best rate and that it is borrowed to cover only that period where there is a shortage. In many large organisations, weekly or even daily cash budgeting takes place. Not only are cash shortages managed; cash surpluses are also anticipated and invested, sometimes overnight, to get the best return.

9.8

General economic trends and changing consumer preferences are important when forecasting sales of tickets to the Australian Ballet. The state of the economy affects the consumption pattern of households. For example, an increase in the level of disposable household income may lead to an increased demand for entertainment, and it could lead to an increase in demand for tickets to see the ballet. Increased disposable income can also lead to an increase in demand by audiences to see more shows, rather than just a one-off show (return sales). Naturally we would expect demand to decrease if the amount of disposable income decreases. Demand is also affected by consumer preferences that are not driven by the economy. For example, the type of show the Australian Ballet puts on: a ballet designed for children, such as Beauty and the Beast, being performed in school holidays would be more popular than a ballet written for adults. Relevant consumer preferences can also be affected by geographic location, for example the different locations that the Australian Ballet performs, such as Sydney or Brisbane. Over time a change in demographics could further change these consumer preferences.

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9.9

General economic trends and competitor behaviour are important when forecasting sales in the media industry. The state of the economy affects the consumption pattern of households. For example, an increase in the level of disposable household income may lead to an increased demand for newspapers and magazines, or an increased demand for other media, such as Foxtel or Netflix. Hence increased disposable income can lead to an increase in both the quality and quantity of media consumption. Conversely, decreased disposable income is likely to lead to a decrease in the quality and quantity of newspapers and other media. The activities of competitors will also affect which newspapers and media consumers are likely to use. As an example, the introduction of on-line newspapers and mail order options would be expected to have an impact on shopping mall outlet sales of newspapers and media.

9.10 Other major events students may research include the Football World Cup, the Australian Open (both golf and tennis), Federal and State elections, New Year's Eve firework displays, food festivals and religious festivals in various cities. Some insight into the complexities of budgeting for a major event can be obtained from a New York Times article on the Venice Biennale. Descriptions of the locations used and the exhibits to be transported and housed can be found at: www.nytimes.com/2013/05/26/arts/design/massimiliano-gioni-of-venice-biennale.html?_r=0. (Accessed 13 January 2014.) If discussing this question in class it is suggested that contributions be obtained from various students and then common themes explored.

9.11 Operating budgets include the sales budget and a series of cost budgets that specify how an organisation’s operations will be carried out to meet the budgeted demand for its goods and services. The operating budgets prepared at a university would include: 

a budget for projected revenue, based on forecast demand for various courses offered by the university



a labour budget showing the number of professional and academic staff required to provide the courses offered



an overhead budget listing planned expenditures for costs such as utilities and maintenance.

Financial budgets summarise the financial impact of operating budgets. For a university these would include: 

a cash budget showing planned cash receipts and disbursements



a budgeted income statement



a budgeted balance sheet.

A capital expenditure budget, detailing projected items of building and equipment over the next 5–10 years, would also be prepared.

9.12 A university student club could use budgeting for planning purposes in many ways. For example, there is a need to balance the membership fee with the forecast number of members. A slight increase in fees could significantly decrease the number of members. The resultant revenue from membership subscriptions would then guide what activities and facilities can be acquired and maintained. Some clubs need to employ staff (often a student or two for a few hours per week) and the number and cost needs to be provided for in the budget. The capital budget would be used to plan for the purchase of equipment, such as computers and items related to the special interests of the club. If club windcheaters are to be made available for sale it will be necessary to budget for the demand and acquire the goods for sale. The cash budget would be important in planning for cash receipts, including membership fees, sales, planned activities (such as ski club trips to the snow) and disbursements. It is important for any organisation to make sure that it has sufficient cash on hand to meet its needs, and to anticipate any cash shortages.

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9.13 Some managers may see budgeting as a constraint on creativity. However, in large organisations in particular, budgeting provides an important communication and coordinating tool, and is essential for forecasting cash position, evaluating performance and controlling excessive expenditure. The budget can therefore be a useful tool in improving the business rather than an impediment to improving business. A budget is not intended to stifle innovation and development but provides the means of evaluating proposed projects both before and after implementation (feed-forward and feedback). Whereas proposals have a heavy focus on planned activity, budgets provide the financial focus of the plans, to ensure that necessary funds and other resources are available as and when they are needed and improve the efficient and effective delivery of the projects.

9.14 The accountant often specifies the process by which budget data will be gathered, collects the information and prepares the final budget. To communicate budget procedures and deadlines to employees throughout the organisation, the accountant often develops and disseminates a budget manual.

9.15 Top-down budgeting describes the system where senior managers impose budget targets on more junior managers. There is little participation or consultation in the budget setting process. Budgets may be set at the corporate level and then cascaded down to the various responsibility centres—profit centres and cost centres—throughout the organisation. However, bottom-up budgeting is used to describe the participative process in which people at the lower managerial and operational levels play an active role in setting their own budget. Budgets are collected at the lowest responsibility centres of the business and are consolidated and fed up to senior management. Both practices can be used in the one budgeting system, as some operational budgets may be set by local responsibility centres while other corporate spending (such as advertising) may be set by senior management. In these situations there may need to be some negotiation between various levels of management to ensure consistency between the various final budgets.

9.16 Participative budgeting allows managers at all levels to develop their own initial estimates for budgeted sales, costs and so on. The positive outcomes of participative budgeting are improvements in coordination and communication between managers and incentives for the managers to work within the budgets. It is generally believed that most people will perform better and try harder to achieve a budget goal if they have been consulted in setting that budget; they often feel a responsibility to achieve targets that they helped set. However, the negative outcomes of participative budgeting are that the process of participation can be costly to administer and too time-consuming. Also, too much participation and discussion can lead to indecisiveness and delay. In addition, when those involved in the budgeting process disagree in significant and irreconcilable ways, the process of participation may aggravate those differences. Finally, participative budgeting could lead to budget padding and cause budgetary slack that undermines the accuracy and integrity of the budget.

9.17 Budgetary slack describes the difference between the revenue or cost projection that a person provides in the budgeting process and a realistic estimate of the revenue or cost. It involves the underestimation of revenue and the overestimation of costs such that it is easier to achieve budget targets. Building budgetary slack into the budget is called padding the budget. A significant problem caused by budgetary slack is that the budget ceases to be an accurate portrayal of likely future events. As cost estimates are often inflated and revenue estimates are often understated, the budget loses its effectiveness as a planning tool. An organisation can reduce the problems of budgetary slack in several ways. First, it can avoid relying on the budget as a negative, evaluative tool. Second, managers can be given incentives not only to achieve budgetary projections but also to provide accurate projections.

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9.18 Setting more challenging targets will not always result in improved performance. Setting targets at unachievable levels may demotivate managers. If a manager does not feel that their efforts can lead to achieving the targets they may not try as hard as possible for higher results and may achieve far less than if they were targeting achievable outcomes. The guidelines provided in the chapter suggest that for budgets to be motivational, employees must accept the budget targets as their own targets. Students should understand the term and meaning of goal congruence, the situation in which the organisation’s goals coincide with an individual’s goals. This should happen by design, not serendipitously. Achieving goal congruence is often considered one of the greatest challenges in managing large organisations. Budget acceptance is more likely when: 

targets are developed with the participation of employees



targets are considered achievable



there is frequent feedback on performance



employees are held responsible for activities that they believe are within their control



achievement of targets is accompanied by rewards that are valued.

9.19 Under zero-base budgeting, the budget for virtually every activity in the organisation is initially set to zero. To receive funding during the budgeting process, each activity must be justified in terms of its continued usefulness. The zero-base budgeting approach forces management to rethink each phase of an organisation’s operations before allocating resources.

9.20 Program budgeting involves identifying the various programs undertaken by the business, and developing objectives and budgets for each program. Program budgeting differs from line item budgeting as resources are no longer allocated to line items (salaries, rent, electricity etc.) or expenditure controlled by line items. The advantage of program budgeting is that the ‘program’ is the focus for control, and performance is evaluated against both financial and non-financial objectives and performance measures for each specific program. This gives better information to allow managers to make clearer decisions based on programs rather than overall budgets for the business.

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SOLUTIONS TO EXERCISES EXERCISE 9.21 (20 minutes) Cash budgeting 1 Pascoe Ltd Cash receipts August Month

Sales

Per cent

Expected collections

June

$ 300 000

8%

$24 000

July

390 000

30%

117 000

August

660 000

60%

396 000

Total

$537 700

2 Pascoe Ltd Expected cash payments August July purchases to be paid in August

$270 000

Less 2% cash discount

5 400

Net purchases cost

$264 600

Cash disbursements for expenses

144 000

Total payments

$408 600

3 Pascoe Ltd Cash Budget 31 August Balance, 1 August

$220 000

Add Expected receipts

431 700

Cash available

$651 700

Less Expected payments

408 600

Expected balance, 31 August

$243 100

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EXERCISE 9.22 (25 minutes) Cash receipts: retailer 1

Calculate estimated cash receipts in October using an Excel ® spreadsheet:

Month

Credit sales

Percentage collected

Collected in October

October

$450 000

70%

$315 000

September

$400 000

15%

60 000

August

$350 000

10%

35 000

July

$300 000

4%

12 000

Total

2

$422 000

Calculate estimated cash receipts in fourth quarter from credit sales in fourth quarter. Credit sales

Collected in October

Collected in November

Collected in December

October

$450 000

$315 000

$ 67 500

$ 45 000

November

$500 000

350 000

75 000

December

$425 000

Month

297 500

Total

$315 000

$417 500

$417 500

Total estimated cash receipts in fourth quarter The spreadsheet might look like this: Same month

Collection month

next month

70%

15%

2nd month 10%

$1 150 000

3rd m...