ADVANCED MANAGEMENT ACCOUNTING Dr. Ronny Andesto, S.E., M.M Program Magister Akuntansi Universitas Mercu Buana 2018

COURSE # 11 BUDGETING

AGENDA  The Background ;  The Meaning and Objectives of Budgeting ;  Disadvantages of Budget ;  Budgeting Methods ;  Using Three Wheel of Profit Plan Concept to Budgeting ;  Master Budget ;  Activity Based Budgeting ;  Beyond Budgeting.

THE BACKROUND  Firm’s resources are limited.  To provide optimal results, companies must plan, coordinate and control their use of resources properly.  The tool that can be used to plan, coordinate and control the use of resource is Budget and the process to creation the budget called the Budgeting.

BUDGETING Meaning, Advantages and Disadvantages  Meaning :  Budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms.  Budgeting is the creation of a plan of action expressed in financial terms.  Objectives / Advantages :  Its forces management to “think about” and “plan” the future.  Its provides a means for allocating resources.  Its creates an early warning systems for potential problems so that management can make changes before things get out of hand.  Its facilitates coordination of activities in organization.  It results in greater management awareness of the entity’s overall operations and the impact on operations of external factors, such as economic trends.  Its sets standards/definite objectives for evaluating performance.  Its communicates the plans of the organization to each employee.  Its provides information for decision making.

BUDGETING Meaning, Advantages and Disadvantages  Disadvantages :  Its time consuming & costly process.  Its difficult to adjust in rapidly changing environment.  Its creates opportunity for “budgetary slack”.  Its creates opportunity for “budgetary gaming”.

METHODS FOR SETTING BUDGETS METHODS FOR SETTING BUDGET PARTICIPATIVE BUDGETING AUTHORITATIVE BUDGETING CONSULTATIVE BUDGETING

METHODS FOR SETTING BUDGET Authoritative Budgeting  Meaning : A budgeting process that occurs when a superior informs subordinates what their budget will be without requesting input.  Advantages :  The process is straightforward & efficient – it allows superiors to assign budgets and promotes overall coordination among subunits in the organization because it is done from a single perspective.  Eliminates the opportunity for “budgetary slack”.  Eliminates the opportunity for “budgetary gaming”.  Creates new ideas in achieving targets.  Disadvantage :  Superiors usually have less information about the process being budgeted than the subordinate. The superior indicates the goals to the subordinates. This creates opportunity for employee to be frustrated and debilitated.  The lack of motivation and commitment to the budgeted goals because of the lack of employee participation in establishing the budget.

METHODS FOR SETTING BUDGET Participative Budgeting  Meaning : A method of budget setting that uses a joint decision-making process in which all relevant parties agree about setting the budget targets.  Advantages :  Provides an opportunity for employee to use information that they develop through their training or experience on the job to jointly set their goals and negotiate the level of their budgets.  Induces subordinates to reveal their private information, reveals data about how well they can perform their jobs, or allows the introduction of new ideas that may help improve existing processes.  Disadvantage :  Time consuming and thus more costly.  Creates opportunity for “budgetary slack”.  Creates opportunity for “budgetary gaming”.

METHODS FOR SETTING BUDGET Consultative Budgeting  Meaning : A method of budget setting that occurs when managers ask subordinates to discuss their ideas about the budget but no joint decision making occurs.  Advantages :  Provides an opportunity for employee to introduce their aspiration (ideas and information) in the process of setting budget.  Eliminates the opportunity for “budgetary slack”.  Eliminates the opportunity for “budgetary gaming”.  Disadvantage :  Creates opportunity for employee to be frustrated and debilitated.  The lack of motivation and commitment to the budgeted goals because of the lack of employee participation in establishing the budget.

USING THREE WHEELS OF PROFIT PLANNING FOR SETTING BUDGET Shareholders Equity Assets Utilities Return on Equity Profits Sales Operating Cash Investment in Assets Inventory Operating Expenses Account Receivable CASH WHEEL PROFITS WHEEL ROE WHEEL

 STAGE I : PROFIT WHEEL The purpose of Profit Wheel is to set a budget that produces a level of profit that meets the company's ROE target. Steps in Profit Wheel are : 1.Prepares a sales budget and other budgets that allow to calculate profit target. 2.Prepares a budget for assets that will generate profit target. 3.Calculates Return on Equity (ROE) based on profit target above. 4.Compares ROE above with targeted ROE.  STAGE II: ROE WHEEL The purpose of the ROE Wheel is to ensure that the profit target meets the ROE target. Steps in Profit Wheel are : 1.Repeat the Profit Wheel ; 2.Increase the asset utilities. 3.Change the capital structure USING THREE WHEELS OF PROFIT PLANNING FOR SETTING BUDGET Cont

 STAGE III: CASH WHEEL The purpose of the Cash Wheel is to ensure that the company has a positive cash flow to fund all budgeted activities. Cash flow can be improve in 3 ways : 1.Decrease level of account receivable. 2.Decrease level of inventory. 3.Reconsider investment in assets. USING THREE WHEELS OF PROFIT PLANNING FOR SETTING BUDGET End

 The Master Budget is the comprehensive financial plan for the organization as a whole.  Sometimes, the Master Budget also called Comprehensive Budgets.  The Master Budget consist of Operating Budget and Financial Budget.  The Operating budgets describe the income-generating activities of a firm. The ultimate outcome of the operating budgets is a Pro forma or Budgeted Income Statement.  The Financial budgets detail the inflows and outflows of cash and the overall financial position. Planned cash inflows and outflows appear in the Cash Budget. The expected Financial Position at the end of the budget period is shown in a Pro forma or Budgeted Balance Sheet.  Typically, the master budget is for a One-Year Period corresponding to the fiscal year of the company. Yearly budgets are broken down into Quarterly and Monthly budgets. The use of smaller time periods allows managers to compare actual data with budgeted data more frequently, so problems may be noticed and solved sooner. MASTER BUDGETS Basic Concepts

MASTER BUDGETS Major Components

The sales budget is the projection that describes expected sales for each product in units and dollars. PREPARING THE OPERATING BUDGET Sales Budget Schedule 1

The production budget describes how many units must be produced in order to meet sales needs and satisfy ending inventory requirements. PREPARING THE OPERATING BUDGET Production Budget Schedule 2

The direct material purchasing budget describes how many units of direct material must be purchased in order to meet production nd inventory need PREPARING THE OPERATING BUDGET Direct Material Purchase Budget Schedule 3

The direct labor budget shows the total direct labor hours needed and the associated cost for the number of units in the production budget. PREPARING THE OPERATING BUDGET Direct Labor Budget Schedule 4

The overhead budget shows the expected cost of all indirect manufacturing items. PREPARING THE OPERATING BUDGET Direct Labor Budget Schedule 5

The ending finished goods inventory budget supplies information needed for the balance sheet and also serves as an important input for the preparation of the cost of goods sold budget.. PREPARING THE OPERATING BUDGET Ending Finished Goods Inventory Budget Schedule 6

Budget of cost of goods sold describes the units and costs for goods sold. PREPARING THE OPERATING BUDGET Cost of Good Sold Budget Schedule 7

The marketing expense budget outlines planned expenditures for selling and distribution activities. PREPARING THE OPERATING BUDGET Marketing Expenses Budget Schedule 8

The research and development expense budget outlines planned expenditures for research and development activities. PREPARING THE OPERATING BUDGET Research and Development Expense Budget Schedule 9

The administrative expense budget consists of estimated expenditures for the overall organization and operation of the company. PREPARING THE OPERATING BUDGET Administrative Expense Budget Schedule 10

PREPARING THE OPERATING BUDGET Budgeted Income Statement Schedule 11

PREPARING THE FINANCIAL BUDGET Cash Budget Schedule 12

PREPARING THE FINANCIAL BUDGET Budgeted Balance Sheet Schedule 13

 Activity-Based Budgeting (ABB) identifies activities, demands for activity output, and the cost of resources needed to support the activity output demanded.  The principal difference in an activity-based approach is a detailed listing of activities and their expected costs within the overhead, selling, and administrative categories.  Activity-based budgeting has the potential of being more accurate than traditional budgeting because it focuses on output measures for each activity and thus allows a manager to understand cost behavior at a much more detailed level.  Activity-based budgeting is also more accurate because it uses cost formulas that depend on each activity’s output measures.  The activity-based budget begins with output and then determines the resources necessary to create that output. ACTIVITY-BASED BUDGETING Basic Concepts

 In environments that have a high of uncertainty, the traditional budgeting approach is deemed no longer relevant.  In this condition, many companies assume that the traditional budget is more constraining than encouraging the implementation of organizational activities.  As an alternative, Jeremy Hope & Robin Fraser (2003) have proposed a “Beyond Budgeting” approach.  Basic Assumptions :  The targets more flexible to reviewed and modified if necessary and managers are more motivated to achieve these goals since the goals represent measures that link directly to the competition rather than an internal artificial goal.  The beyond budgeting model provides a more decentralized way of managing. Rather than relying on traditional hierarchical and centralized management, managers are much more accountable to their teams and work groups since the targets directly pertain to what they are doing. BEYOND BUDGETING Basic Concepts

 For more detail about Master Budget, see Hansen, Mowen & Guan (2008), Cost Management : Accounting & Control, Chapter 8. Note