Budgeting

The Planning Process

All organisations have their objectives. Some of the objectives may not be expressed in accounting terms for example objectives to improve the welfare of the staff or to improve the impact on the local environment. However, in this chapter the emphasis is on objectives usually expressed in quantitative terms eg. increase in market share, profit growth, increase in the asset value etc which they wish to achieve. There are three levels of planning - corporate long term planning, medium term planning and annual planning or budgeting. The annual budgets are steps along the way to achieve the long-range plan of the organisation.

To ensure that the objectives are achieved plans or budgets must be prepared.

Definition: A budget is a financial or quantitative interpretation prior to a defined period of time, of a policy to be pursued for that period, to attain a given objective.

Budgets are part of the planning and control process. They help to define the objectives of the organisation. Budgeting is probably the most important contribution that the accounting department makes to the role of management.

The accountant draws up a plan which integrates the various functional areas of the business. Control is exercised by firstly, delegating responsibility to departmental managers for the attainment of the budgets and then the regular comparison of the actual results with the planned outcomes.

Budgets assists an organisation

• to plan and control profitability

• to plan and control production resources

• to plan and control capital expenditure

• to plan and control finance

An organisation which engages in budgeting can obtain the benefits of

• better planning and awareness of what has to be achieved

• greater coordination of the different functional areas

• better communication with staff contributing to the targets to tbe set

• motivation of the staff with staff assigned their responsibilities

• efficient and effective use of scarce resources and an awareness of cost-consciousness

Administration of the budget.

The administration of the budget is the responsibility of the budget officer who is usually the accountant . The accountant works in conjunction with the budget committee comprised of the departmental management. Senior management

outline the broad strategic objectives of the organisation and communicate these to the functional managers. The budget committee identifies the key budget factor which determines what acts as a constraint on the organisation’s activities. This key budget factor decides the key budget ie. the one which sets the objectives for the subordinate budget. The subordinate budgets are constructed by asking the questions - when are the goods to be sold, where are the goods to be sold and how are the goods to be produced.It may be the sales volume which drives the other subsidiary budgets. For instance, if the sales department forecasts the annual sales at 20,000 units then the production budget must be integrated with this figure. Alternatively, productive capacity may be the key budget factor . The company may have the capacity to produce only 18,000 units a year so this figure sets the objectives for the other budgets.

The accountant helps the managers to set the budgets by providing information as required. Sales forecasting may proceed by means of statistical methods which are based on economic indicators or by carrying out an internal forecast by canvassing the sales staff. The current sales level, past trends, market research can provide useful information.

On receipt of the various budgets the accountant notifies managers of revisions to their budget. Once the accountant and the committee agree the master budget which is a forecasted profit and loss account and balance sheet can be drawn up.

In terms of control the accountant is responsible for the regular monitoring of the budgets, for reporting back to the budget committee regularly( daily,weekly or monthly basis) through variance reports and for revising the budgets if necessary.

Preparing budgets

Example

The budgeted sales of Magee Engineering Lt. for 19x0 is as follows:

Product	Sales units	Unit selling price
Dag	20,000	£25
Mag	18,000	£20
Pag	15,000	£22

The opening stocks at the beginning of the year 19x0

Product	Product units	Component	Part units
Dag	3,000	A	40,000
Mag	3,000	B	50,000
Pag	2,000	C	60,000
		D	40,000
		E	10,000

The marketing director intends to run a marketing campaign towards the end of 19x0 and has requested that product unit stocks should be increased at the end of 19x0 above the commencement stocks by the following

Dag increased by 20%

Mag increased by 50%

Pag increased by 20%

The purchasing director has requested that all components part stocks be reduced by 20% at the end of 19x0 because of improved delivery times from suppliers.

The product material specification and component cost for each of the products are as follows:

	Component part	A	B	C	D	E
	Part cost (each)	50p	35p	60p	55p	£1.0
Product	Component parts
	per product
Dag		3	4	6	2	1
Mag		2	3	4	2	1
Pag		5	2	3	3	1

The newly appointed managing director asks you to prepare the following budgets and to explain the linkage between them.

1. Sales budget in product units and value

2. Production budget in product units

3. Material usage budget in component parts.

4. Materials purchase budget in component parts and value.