BUDGETING

By Ejaz Khan
CMA, ACMA,MIPA,AFA & APFA
 Learning outcomes
C. BUDGETING
1. Nature and purpose of budgeting
a) Explain why organisations use budgeting.
b) Describe the planning and control cycle in an organisation.
2. Statistical techniques
a) Explain the advantages and disadvantages of using high low method to estimate the fixed and variable
element of costing.
b) Construct scatter diagrams and lines of best fit.
c) Analysis of cost data.
(i) Explain the concept of correlation coefficient and coefficient of Determination.
(ii) Calculate and interpret correlation coefficient and coefficient of determination.
(iii) Establish a linear function using regression analysis and interpret the results.

By Ejaz Khan
Learning outcomes
d) Use linear regression coefficients to make forecasts of costs and revenues.
e) Adjust historical and forecast data for price movements.
f) Explain the advantages and disadvantages of linear regression analysis.
g) Describe the product life cycle and explain its importance in forecasting.
h) Explain the principles of time series analysis (cyclical, trend, seasonal variation and
random elements).
i) Calculate moving averages.
j) calculation of trend, including the use of regression coefficients.
k) Use trend and seasonal variation (additive and multiplicative) to make budget forecasts.
l) Explain the advantages and disadvantages of time series analysis.
m) Explain the purpose of index numbers.
n) Calculate simple index numbers for one or more variables.
o) Explain the role and features of a computer spreadsheet system.

By Ejaz Khan
 Learning outcomes
p) Identify applications for computer spreadsheets and their use in cost and management
accounting.
3. Budget preparation
a) Explain the importance of principal budget factor in constructing the budget’.
b) Prepare sales budgets.
c) Prepare functional budgets (production, raw materials usage and purchases, labour, variable and
fixed overheads)
d) Prepare cash budgets.
e) Prepare master budgets (statement of profit or loss and statement of financial position)
f) Explain and illustrate ‘what if’ analysis and scenario planning.
4. Flexible budgets
a) Explain the importance of flexible budgets in control
b) Explain the disadvantages of fixed budgets in control
By Ejaz Khan
 Learning outcomes
c) Identify situations where fixed or flexible budgetary control would be appropriate
d) Flex a budget to a given level of volume
5. Capital budgeting and discounted cash flows
a) Discuss the importance of capital investment planning and control
b) Define and distinguish between capital and revenue expenditure
c) Outline the issues to consider and the steps involved in the preparation of a capital
expenditure budget
d) Explain and illustrate the difference between simple and compound interest, and between nominal and
effective interest rates
e) Explain and illustrate compounding and discounting
f) Explain the distinction between cash flow and profit and the relevance of cash flow to capital
investment appraisal
g) Identify and evaluate relevant cash flows for individual investment decisions.
By Ejaz Khan
Learning outcomes
h) Explain and illustrate the net present value (NPV) and internal rate of return (IRR) methods of
discounted cash flow.
i) Calculate present value using annuity and perpetuity formulae
j) Calculate NPV, IRR and payback (discounted and non-discounted) [s]© ACCA 2016–2017 All rights
reserved.
k) Interpret the results of NPV, IRR and payback calculations of investment viability[s]
6. Budgetary control and reporting
a) Calculate simple variances between flexed budget, fixed budget and actual sales, costs
and profits.
b) Discuss the relative significance of variances.
c) Explain potential action to eliminate variances.
d) Define the concept of responsibility accounting and its significance in control.
e) Explain the concept of controllable and uncontrollable costs.
By Ejaz Khan
Learning outcomes

f) Prepare control reports suitable for presentation to management. (to include recommendation of
appropriate control action.
7. Behavioural aspects of budgeting
a) Explain the importance of motivation in performance management.
b) Identify factors in a budgetary planning and control system that influence motivation.
c) Explain the impact of targets upon motivation.
d) Discuss managerial incentive schemes.
e) Discuss the advantages and disadvantages of a participative approach to budgeting.
f) Explain top down, bottom up approaches to budgeting.

By Ejaz Khan
 The Planning & Control Cycle:

Planning:
It is a management process, concerned with defining
goals for company's future direction and determining
on the missions and resources to achieve those
targets.

Control:
Controlling is the measurement and correction of
performance in order to make sure that enterprise
objectives and the plans devised to attain them are
accomplished.

By Ejaz Khan
 The Planning & Control Cycle:

Seven Steps in the Planning and Control Cycle:

Step 1 Identify objectives

Step 2 Identify potential strategies

Step 3 Evaluate strategies Planning Process

Step 4 Choose alternative courses of action

Step 5 Implement the long-term plan

Step 6 Measure actual results and compare with plan

Control Process
Step 7 Respond to divergences from plan

By Ejaz Khan
 Budgetary Planning & Control Systems:
Budget:
The budget is a quantitative statement for a defined period of time, which may include
planned revenues, expenses, assets liabilities and cash flows. A budget facilitates planning.

Objectives:
➢ To ensure the achievement of the organisation’s objectives
➢ To compel planning
➢ To communicate ideas and plans
➢ To co-ordinate activities
➢ To provide a framework for responsibility accounting
➢ To establish a system of control
➢ To motivate employees to improve their performance

By Ejaz Khan
 Responsibility Centres:
Responsibility Accounting:
An accounting system which tracks and reports costs, expenses, revenues, and operational
statistics by area of responsibility or organizational unit.

Responsibility Centre:
A responsibility center is an organizational unit headed by a manager, who is responsible for its
activities and results. In responsibility accounting, revenues and cost information are collected
and reported on by responsibility centers.
Types of Responsibility centres:
➢ Cost centres
➢ Profit centres
➢ Investment centres
By Ejaz Khan
 Responsibility Centres:

Traceable & Controllable Costs:

A traceable cost is a cost for which there is a direct, cause-and-
effect relationship with a process, product, customer, geographical
area, or other cost object. If the cost object goes away, then the
traceable cost associated with it should also disappear.
Whereas, controllable costs are variable costs such as raw
materials, labour, and other overheads deemed controllable by
management. A certain portion of fixed costs can also be
considered controllable.

By Ejaz Khan
 Controllable Costs:

Controllable Cost:
It is a cost that can be controlled, typically by a cost, profit or investment centre manager.

Uncontrollable Costs:
Uncontrollable costs are business expenses that the manager doesn't have direct power over. In
other words, the business manager doesn't have control over how these costs are incurred. A good
example of an uncontrollable cost is insurance.

A cost which is not controllable by a junior manager or supervisor might be controllable by a senior
manager. Similarly, a cost which is not controllable by a manager in one department may be
controllable by a manager in another department.

By Ejaz Khan
 Controllable Costs:

The Controllability of Fixed Costs:

The notion that the fixed costs are always non-controllable is false.
a) Committed fixed costs_ non-controllable in short-term
b) Discretionary fixed costs_ raised or lowered at fairly short notice

Controllability & Apportioned Costs:

➢ Managers are accountable only for the costs over which they have some influence.
➢ In the case of apportioned overhead costs, the managers are not responsible for the
apportioned costs from other departments over which they have no control.
➢ But if the manager of department A have an influence over the apportioned costs from
department B, he is accountable.

By Ejaz Khan
 Fixed & Flexible Budgets:

Fixed Budgets:
A fixed budget is a budget that does not change or flex when sales or
some other activity increases or decreases. A fixed budget is also
referred to as a static budget.

Flexible Budget:
A flexible budget is a budget that adjusts or flexes for changes in the
volume of activity. The flexible budget is more sophisticated and useful
than a static budget.

By Ejaz Khan
 Flexible Budgets & Budgetary Control:

Budget Variance:
It is the difference between the components of fixed budget and the
actual results.

Budgetary Control:
Budgetary control refers to how well managers utilize budgets to
monitor and control costs and operations in a given accounting
period. In other words, budgetary control is a process for managers
to set financial and performance goals with budgets, compare the
actual results, and adjust performance, as it is needed.

By Ejaz Khan
 Features & Functions of Spreadsheet:
Spreadsheet:
An electronic document in which data is arranged in the rows and
columns of a grid and can be manipulated and used in
calculations.

Advantages of Spreadsheet:
➢ Easy to learn & use.
➢ Makes the calculations & manipulation of data convenient and
quicker.
➢ Enables the analysis, reporting and sharing of financial
information.
➢ Enables ‘what if’ analysis.

By Ejaz Khan
 Spreadsheets

Disadvantages:
➢ It may make reports appear infallible.
➢ High proportion of large models contain critical errors.
➢ A database may be more suitable to use with large volumes of data.
➢ It is not good at word processing.
➢ It is not suitable for constructing an entire accounting system.
➢ It is only as good as its original design, garbage in = garbage out.
➢ Formulae are hidden from sight so the underlying logic of a set of calculations may not be
obvious.

By Ejaz Khan
 Behavioral Implications of Budgeting:

Behavioral Problems in Making Budgets:

➢ Managers who set the budget are often not the managers who are
responsible to achieve its targets.
➢ Failure in achieving goal congruence.
➢ Control is applied at different stages by different people.

Motivation:
It is the process of stimulating people to actions to accomplish the goals.
It should be ensured that the employees have positive attitudes towards:
➢ Setting budgets
➢ Implementing budgets
➢ Feedback of results

By Ejaz Khan
 Behavioral Implications of Budgeting:

Goal Congruence:
It is the consistency or agreement of individual goals with
company goals.

Dysfunctional Decision Making:

Managers and others take decisions that promote their self-
interest at the expense of the interest of the organisation as a
whole

Dysfunctional decision making occurs when goal congruence

does not exist.

By Ejaz Khan
 Behavioral Implications of Budgeting:

Behavioral Problems in Making Budgets:

➢ Poor attitudes while setting budgets
➢ Poor attitude when putting plans into action
➢ Poor attitudes and use of control information
➢ Flawed reward and evaluation systems can
encourage dysfunctional behaviours
➢ Pay can be a demotivator as well as motivator

By Ejaz Khan
 Participation & Performance Evaluation
Participation:
Participation is joint consultation in decision making, goal setting, profit sharing, teamwork, and other
such measures through which a firm attempts to foster or increase its employees' commitment to
collective objectives.
Participation in the budgeting process improves the level of motivation and thus, improves the quality of
budget decisions and the efforts of individuals to achieve their budget targets.

Imposed Style of Budgeting: (top-down budget)

A budget allowance which is set without permitting the ultimate
budget holder to have the opportunity to participate in the
budgeting process.

By Ejaz Khan
 Participation & Performance Evaluation
When Imposed Budgets are effective?
➢ When the organization is newly formed
➢ When it’s a very small business
➢ During periods of economic hardships
➢ When operational managers lack budgeting skills
➢ When precise co-ordination is required among different units of the organisation

Imposed Style of Budgeting:

Advantages:
➢ Enhanced co-ordination between the plans and the divisional objectives.
➢ They use senior management consciousness of net resource availability.
➢ They decrease the possibility of inputs from inexperience or uniformed lower level employees.

By Ejaz Khan
 Participation & Performance Evaluation

➢ They reduce the period of time taken to draw up the budget.

➢ Strategic plans are likely to be incorporated into planned activities.

Disadvantages:
➢ It may result in dissatisfaction, defensiveness and low morale among employees, who must
implement the budget.
➢ The feeling of team spirit might vanish.
➢ The acceptance of organizations goals and objectives could be limited.
➢ The sense of the budget as a punitive tool could arise.
➢ Unachievable budget for overseas divisions may be imposed on local divisions if consideration is
not given to the local operating and political environment.

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 Participation & Performance Evaluation

Participative Style of Budgeting: (Bottom-up Budgeting)

A budgeting system in which all budget holders are given the opportunity to participate in
setting their own budgets.
Advantages:
➢ Familiarity and better knowledge
➢ Higher motivation and morale
➢ Combined knowledge and efforts
➢ Increased commitment
➢ More realistic and specific
➢ Better co-ordination

By Ejaz Khan
 Participation & Performance Evaluation

Disadvantages:
➢ Time consuming
➢ Dissatisfaction might be caused by the alterations made by senior managers
➢ Incompetent managers’ participation
➢ Budgetary slack and budget bias
➢ Easy budget targets
➢ Empire building by subordinates

By Ejaz Khan
 Participation & Performance Evaluation
Negotiated Style of Budgeting:
A budget in which budget allowances are set largely on the basis
of negotiations between budget holders and those to whom
they report.
It combines top-down and bottom-up budgeting approaches.
Negotiated budgeting can start by setting the general figures by
top management. But compared to top-down budgeting,
operational managers are given an opportunity to negotiate
these figures. But it can also work vice versa – i.e. senior
managements challenges or possibly adjusts the figures arrived
through bottom-up budgeting.

By Ejaz Khan
 Participation & Performance Evaluation

Performance Evaluation:
Performance Evaluation is a constructive process to
acknowledge the performance of a non-probationary career
employee. An employee's evaluation shall be sufficiently specific
to inform and guide the employee in the performance of her/his
duties.
Individuals should not be kept in dark about their performance.
Performance evaluation is one of the important sources of
motivation.
The information feedback regarding actual results should
possess the qualities of good information

By Ejaz Khan
 Participation & Performance Evaluation
The Qualities of Good Information:

➢ Relevance
➢ Accuracy
➢ Inspires confidence
➢ Timely
➢ Cost effective
➢ Completeness
➢ Clarity
➢ Appropriately communicated
➢ Manageable volume

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 Participation & Performance Evaluation

Features of Feedback:
➢ Clear and comprehensive
➢ Exceptional reporting principle
➢ Controllable items should be reported
➢ Timely
➢ Accurate
➢ Communicated to the manager having responsibility along with the authority

Styles of Performance Evaluation:

➢ Budget constraint
➢ Profit conscious
➢ Non-accounting

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 Participation & Performance Evaluation

Budgetary Slack:
Budgetary slack is the deliberate under-estimation
of budgeted revenue or over-estimation of
budgeted expenses. This allows managers a much
better chance of "making their numbers," which is
particularly important for them if performance
appraisals and bonuses are tied to the
achievement of budgeted numbers.

By Ejaz Khan
 The Use of Budget Targets
Difficulty-level of the Targets:
➢ Ideal standards could result in demotivation
➢ A low standard of efficiency is also motivating
➢ The normal level is the same that has been achieved in the
past, thus, it might encourage budgetary slack.
➢ For the manager whose tendency to achieve success is
greater than that of avoiding failure, targets of intermediate
levels are the most motivating and likely to be achieved.
➢ For the manager whose tendency to avoid failure is
stronger than the tendency to achieve success, targets of
intermediate level are worse than the easy or difficult
targets.

By Ejaz Khan
 The Use of Budget Targets

Solution_ The Expectation & The Aspiration Budget:

The solution might be to have two budget:
a. A budget based on reasonable expectations
b. A second budget for motivational purposes, with difficult (intermediary level) targets

By Ejaz Khan
 The Management Accountant & Motivation

Difficulties Arising as a Result of Participating Budgeting:

➢ Pseudo-participation
➢ Co-ordination
➢ Training
➢ Slack

Profit Sharing Schemes:

Profit sharing refers to various incentive plans introduced by businesses that provide direct or
indirect payments to employees that depend on company's profitability in addition to employees'
regular salary and bonuses. In publicly traded companies these plans typically amount to
allocation of shares to employees.

By Ejaz Khan
 The Management Accountant & Motivation

Advantages of Profit Sharing Schemes:

➢ Brings employees together to work towards a common goal. Their sole aim will be the success of the
company.
➢ Motivation levels will be high.
➢ The employee focus will be on profitability.
➢ Increases commitment to the organization among the employees.
➢ Employee can identify with the company. He or she will feel part of it.
➢ Bridges the gap between the employee and employer.
➢ Promotes the well-being of the employee.

By Ejaz Khan
 The Management Accountant & Motivation

Disadvantages of Profit Sharing Schemes:

➢ Employees wait until the year end for bonuses

➢ Factors affecting the profit may be beyond the control of employees
➢ Too many employees are engaged in a single scheme

Incentive Schemes Involving Shares:

➢ Share option scheme

➢ Employee share ownership plan

By Ejaz Khan
 The Management Accountant & Motivation

Value Added Incentive Schemes:

It is an alternative to profit as a business performance measure and it can be used as the basis of
an incentive scheme.

Value added = Sales – Cost of brought-in materials and services

The advantage of this scheme is that, it excludes any brought-in costs, and is affected only by the
costs incurred internally, such as labour.

By Ejaz Khan
THE END

By Ejaz Khan