Budget in Accouting

A budget can be interpreted as a detailed plan that emphasizes the procurement of a company’s financial and other resources for a specific period of time in the future. Budgets are either flexible or fixed. Flexible budgets are usually designed to change according to the level of activity achieved, whereas fixed budgets are prepared for a specific level of performance (Wyatt, 2012). A budget serves as a forecasting and management tool for evaluating company performance. They can be created by department, function, or the entire organization. Budgeting is the process of quantifying an organization’s plans to assist in the attainment of objectives within the stipulated time (Whitecotton, Libby & Phillips, 2013). Strategic planning entails preparing long term plans that are consistent with the company’s policy. Budgeting allows the plans of the company to be put into action.

Steps in Budgeting

The first step in budgetary control involves the creation of budget centers. A budget centers is a section created within an organization to facilitate budgetary control. The budget centers should be clearly defined. The second step involves introducing of adequate accounting records (Wyatt, 2012). A sound accounting system should be put in place for efficient budgetary control. Budgets should adopt the same accounting standards such as classification and recognition of revenue as well as expenses to allow comparison. The third step in budgetary control involves preparing of the organizational structure. An organizational structure defines the hierarchy as well as the responsibility of every employee in the company (Wyatt, 2012). Finally, a budget committee needs to be established for the purpose of overseeing the entire budgeting process.

Stages in Budgeting

Communicating the details of the company’s budget policy and procedures to the people charged with the responsibility of preparing budgets is the first stage in budgeting. The policies to be communicated may include changes in the sales mix and expansion or contraction of business operations. On the other hand, crucial procedures or guidelines that should be communicated to people in charge of preparing the budget to include any salary allowance and wage increment, expected changes in the company’s level of productivity and the possible changes in the market demand and output (Weygandt, Kimmel & Kieso, 2015). The second stage in budgeting involves the determination of the limiting factor. The limiting factor refers to the factor of production that restricts the company from producing at its full capacity. The limiting factor usually gives the starting point of the budgeting process. Preparation of the revenue budget is the third stage in budgeting. Revenue budget is the most difficult to prepare since it is influenced by external factors that are beyond the control of a company. Such external factors include consumer tastes and preferences, competition and availability of substitutes as well as the economic status of a county in which the business operates (Weygandt, Kimmel & Kieso, 2015). In most cases, the sales demand is the limiting factor meaning that the revenue budget becomes a basis for preparation of other budgets.

The fourth stage involves preparation of other budgets. Each manager prepares a budget for his or her department which are later coordinated and refined at the top most levels of management. It is important to include the managers in different6 departments since it motivates them in working hard to achieve goals that they set themselves. After the managers at the lower levels have submitted their departmental budgets, the budgeting process enters the negotiating stage. During this stage, each budget is analyzed and consolidated into one (Whitecotton, Libby & Phillips, 2013). Each manager should prove that the objectivity of his or her budget. After negotiations, the budget enters coordination and reviewing stage in which every budget is modified to strike a balance among all budgets and ensure compatibility. The seventh phase in preparation of budget involves acceptance of all budgets that are modified and compatible. It is at this stage in which all budgets are consolidated into a master budget (Whitecotton, Libby & Phillips, 2013). When the master budget is approved, the managers in various departments are given the authority to carry out their activities as planned. The final stage involves a control process in which adherence of different departments to the budgets. A periodic comparison of the actual and budgeted results is made to ensure that each department is on the right track towards achieving its goal as well as the overall objective of the company.

Master Budget

A master budget involves the entire quantification of the budgeting plan. It entails all the functional budgets of the organization. In other words, a master budget is a combination of all departmental functional budgets within an organization. It is essential since it ensures that all individual budgets align with each other (Bogsnes, 2016). That way, a master budget presents a picture of the overall organization. It has the production budgets, factory overhead budgets, and non-production budgets.

Production budgets

Production budgets can be divided as sales, production, direct labor and direct material budgets. A revenue budget represents a detailed schedule showing the expected sales for the forthcoming financial period. It forecasts what the company expects to sell to the customers in the financial period under consideration (Weygandt, Kimmel & Kieso, 2015). Therefore, it is expressed in terms of units and dollars. Since a revenue budget is significant to the preparation of other budgets, it should be prepared with accuracy. In other words, all the constitutes of master budget depend on the revenue budget. For example, the budgeted production is usually based on the quantity demanded in the market and the available inventory. Therefore, if the revenue budget has some flaws, the production budget will be flawed as well (Whitecotton, Libby & Phillips, 2013). The actual revenue in the previous periods, a report from the sales representatives, information from a market research or survey and level of orders placed in advance are some of the factors that should be considered while preparing a revenue budget.

A sample format of the revenue budget is:

No of Units

Cost per Unit

Revenue

Product A

xx

xx

xx

Product B

xx

xx

xx

Product C

xx

xx

xx

On the other hand, a production budget summarizes the requirements for the forthcoming financial period. It matches the revenue budget. The end of period inventory needs to be valued accurately to ensure that economic inventory levels are maintained (Weygandt, Kimmel & Kieso, 2015). There should be no excess levels of inventory to avoid holding costs, and it should be adequate to avoid shortages and ordering costs that are unnecessary. The revenue forecast, the available level of production capacity and the company’s policy concerning the levels of units completed are some of the factors that should be considered while preparing a production budget (Bhimani et al. 2013). The budget committee determines the cycle in which the production budget should be prepared. A general format of a production budget is as follow;

Product A (units)

Product B(Units)

Product C (Units)

required closing inventory

xx

xx

xx

Add forecasted revenue

xx

xx

xx

Total requirement

xx

xx

xx

Less estimated opening inventory

xx

xx

xx

Production requirement in units

xx

xx

xx

The direct material budget shows the estimated quantity and cost of all the raw materials and components required to meet the demand of the production budget. It is usually expressed in units and consists of a direct material usage and direct material purchases budgets. The usage budget shows the estimated units of raw materials required for the budgeted production while the purchase budget ensures that adequate levels of raw materials are maintained (Bhimani et al. 2013). The format for the two direct material budgets are as follows:

Raw Material Usage

units of X per unit of production

Units of Y per unit of production

material X (total units)

Material Y (Total Units)

No of Units

Product A

xx

b

xx

b

xx

Product B

xx

b

xx

b

xx

Product C

xx

b

xx

b

xx

Total direct materials

XX

XX

Raw material Purchase Budget

Material X (units)

Material Y (units)

Required closing inventory

xx

xx

Add Current usage

xx

xx

Total material required

xx

xx

cost per unit

xx

xx

the total cost of material required

xx

xx

Finally, the direct labor budget estimates the number of labor hours required to meet the budgeted production. It is based on the level of budgeted production. The format of a direct labor budget is as follows:

Units

Hrs. Needed/unit

total number of hrs.

Product A

xx

a

xx

Product B

xx

a

xx

Product c

xx

a

xx

standard wage per hr.

xx

Direct labor cost

XX

Factory Overhead Budget and Non-Production Budget

The factory overhead budget shows the estimate for fixed, variable, semi-variable and production overheads. They are usually prepared per department. On the other hand, non-production budgets comprise of budgets for selling and distribution costs, administration costs, research and development costs, capital expenditure and the cash budget (Bogsnes, 2016). The selling and distribution cost budget represent the estimated costs that the company will incur while distributing and selling its products during the forthcoming financial period. Such expenses include salaries to the sales representative, selling office cost and advertising expenses.

A budget for administration costs represents the administration expenses that the company is likely to incur during the period under consideration. It covers the salaries and wages of the members of staff in the department such as accounting, human resource, and, information technology. In other words, expenses in other departments except production and selling and distribution are budgeted under the administration cost (Bogsnes, 2016). The budget is usually incremental since the salaries and compensation of the employees increase every year. The research costs relate to the cost incurred while performing a scientific investigation in which the company improves its operations or products. On the other hand, development cost consists of the expenses incurred by the company while implementing the results and recommendations made by the research (Bogsnes, 2016). The capital expenditure budget shows the estimate of the non-current assets that the company will purchase during the period under consideration. Finally, a cash budget shows the cash inflows and outflows expected to take place in respect to the functional budget. It may be prepared for a span of one week, month or quarter of the budget.

Advantages of Budgeting

Aside from allowing implementation of the company’s plans, budgetary planning oversees several functions. Foremost, budgetary planning allows coordination of activities within departments as well as function. Secondly, it acts as a communication tool in the organization since it involves liaison and discussions among different levels of management in the company. Vertical and horizontal communication is essential for efficiency as well as coordination of activities within an organization (Hope & Fraser, 2013). Budgetary planning facilitates communication in which all levels of management and all department are aware of what is expected of them. The third point is that budgeting allows comparison of the actual and budgeted results as well as reporting on the variances. The same acts as a control gauge which enables the organization to accomplish the objectives set within the expenditure limits.

The control process in budgeting involves five simple steps. Firstly, the budget is prepared based on the predetermined data on the company’s performance and prices. Secondly, a measurement of the actual performance is well as the recording of the data is done (Hope & Fraser, 2013). Thirdly, comparison of the actual and budgeted data is made recording the variance. Fourth, a variance analysis is conducted to determine what could have caused the differences between the actual and budgeted data. Finally, corrective actions are undertaken through the administering of proper strategies and measures.

Budget acts as a motivational tool to the employees of the company. Since resources available to the company are always scares and managers are competing over the resources, budgets act as a target which needs to be achieved. In the process, some employees are positively motivated towards the achievement of the goals they have set (Hope & Fraser, 2013). Otherwise, imposing a budget to the management may discourage them because they were not a party to its preparation. Finally, budgeting and planning clarify responsibilities and authorities. In other words, it sets clear lines of the responsibility of every manager in the organization.

Limitations of Budgeting

The first disadvantage of budgeting is that budgets are based on estimates. Forecasting has never been accurate since it is vulnerable to both external and internal factors that may be favorable or adverse. The strength or weakness of a budgeting system is dependent on the extent of accuracy the company makes its estimates (Bhimani et al. 2013). Secondly, a budget is usually faced with the risk of rigidity (Hope & Fraser, 2013). A budget program needs to be dynamic and subject to continuous adjustments to align to the changes in the economic and social changes. Many are the times in which budgets adopt the state of rigidity since they are not revised with the changes in the business environment. Such a budget loses its usefulness. For instance, a company may have budgeted to produce a certain level of production. However, the market demand increases and calls for a need to adjust the number of units produced (Hope & Fraser, 2013). If the company does not adjust the budget, then it is said to be a rigid budget which is limiting the company from exploiting available opportunities and increase profitability. The third limitation is that budgeting is only a tool of management and can never replace the management. It cannot be executed automatically, and the entire organization should participate in the preparation of the budget. Besides, budgeting is an expensive technique (Hope & Fraser, 2013). It requires the employment of specialist in the field of budgeting thus adds salary expenses to the company. Finally, the process of setting levels that should be achieved is quite difficult. Higher levels may discourage employees while lower levels cause them to relax. Antagonism may arise if the budgets exert undue pressure to the employees.

References

Bhimani, A., Horngren, C. T., Sundem, G. L., Stratton, W. O., & Schatzberg, J. (2013). Introduction to Management Accounting. Pearson Higher Ed.

Bogsnes, B. (2016). Implementing beyond budgeting: unlocking the performance potential. John Wiley & Sons.

Hope, J., & Fraser, R. (2013). Beyond budgeting: how managers can break free from the annual performance trap. Harvard Business Press.

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & Managerial Accounting. John Wiley & Sons.

Whitecotton, S., Libby, R., & Phillips, F. (2013). Managerial accounting. McGraw-Hill Higher Education.

Wyatt, N. (2012). The Financial Times Essential Guide to Budgeting and Forecasting: How to Deliver Accurate Numbers (pp. 3-21, 98, 154-155, 167-174).