Description

A budget serves many purposes for organizations; it translates strategic and tactical
goals into financial terms, providing managers with an action plan for the future, and
allowing management to monitor performance. In this brief course you will learn about
the basics of budgeting, including the varying types of budgets, and you will explore the
benefits of budgeting.

Learning Outcomes

After completing this course, you'll be able to:

1. Recognize the uses and functions of budgeting

2. Recognize the key activities, considerations, and benefits of strategic

organizational planning

3. Recognize the purpose and make-up of a master budget

4. Identify the components and calculations used to create a master budget and
recognize uses for this information

5. Identify the components and purpose of an operating budget

6. Recognize how sales, production, and cost of goods sold budgets are created and
perform related calculations

7. Recognize the purpose of cash budgets and how they are prepared

8. Identify ways the budget process can be managed for optimal results and
recognize the benefits and limitations of the management-by-objective system
Budget Basics

A budget expresses, in numbers, management's plan of action for a future period of

time. A budget is a blueprint for the company to follow. It covers both financial and non-
financial objectives - that is, the numbers may be dollar amounts or they may be other
numerical goals, such as the number of units sold. Budgets typically provide forecasts of
sales, production, purchases, revenues and expenses, cash flows, and financial position.

Budgets can cover different time periods. For example, if a project will take three years
to complete, a budget that covers three years would be appropriate. A budget will
typically be subdivided into shorter periods, such as months or quarters. The most
commonly used period for a budget is one year. In a rolling budget, also called a
continuous budget, as each time period ends, another equivalent time period is added to
the budget.

Budgeting can be employed by an organization to accomplish many goals, as can be seen

in the following summary.

Click on each term below to read more.

Uses of Budgets

Planning making and coordinating short-term plans

Communication informing managers of the firm's plans

Motivation motivating managers to achieve budget goals

Control assuring that desired budgeted results are achieved

Evaluation evaluating performance of units and managers

Education educating managers about their unit and interrelationship with firm

Source: Anthony and Reece, Accounting Principles (Irwin)

Organizational Planning Issues

There are different objectives and goals at every different level of an organization.

Goals at the top of the organization--company-wide or corporate objectives--are

generally strategic in nature and are set with the notion of forwarding the strategy of the
organization. Budgets are a way of translating these strategic goals into concrete plans.

Most organizations want these objectives reflected in the activities of the next level of
responsibility--at the business unit or divisional level. Business unit or divisional
objectives are meant to sync-up with the overall objectives for the organization and are a
way to execute the corporate strategy.

This translates into much more specific objectives at the operational level: goals for sales
and marketing, goals for customer service, and other tactical efforts by the organization.

What is important to remember is that at every level these objectives are meant to act in
harmony with the corporate objectives.

How Planning is Impacted

What do all these goals and objectives mean in more specific planning terms?

It means that any manager in an organization must be aware of all of the demands he or
she faces when planning for the future.

Click through the interactive image below using the black arrows in the lower right
corner.
Planning must take into account all of these objectives, which, at times, can conflict.
That's why a written plan of action is so helpful; it is a way of thinking through priorities
for the future.

Questions

To test your understanding of the content presented in this assignment, please click on
the Questions icon below. If you have trouble answering any of the questions presented
here, you are always free to return to this or any assignment to re-read the material.
Strategic Budgeting

In the strategic planning process, strategy implementation follows strategy formulation.

Strategy implementation consists of carefully laying out the activities and decisions
necessary to execute the formulated strategy. To implement strategy, managers decide
upon tactics, or specific actions, to achieve the strategic goals and implement the
strategic plans. It is important that tactical plans specify responsibilities and timelines.
Managers should also ensure that strategy implementation includes methods to monitor
and evaluate the company's success in implementation.

Click through the interactive image below to see the planning process in action. Use the
black arrows in the lower right corner to navigate.

When most people think of the word budget, they think in terms of money or dollars.
However, budgets can also be developed to plan for other important resources. One such
resource is time. Consider some of the jobs you've had and ask yourself these questions:

1. How was your time on the job allocated each day?

 2. How was your time budget developed?

3. How much pressure did you feel to meet the time budget?

4. Why would a service organization have a detailed time budget?

Managers can plan meticulously, but they must also be prepared to handle incorrect
estimates. Sensitivity analysis allows managers to prepare for potential changes to what's
expected.

Practical Budgeting Issues

Successful budgeting should provide goals not just for the company as a whole, but also
for subunits, such as departments or divisions. Variations in performance from the
budgeted amounts should be investigated, and corrective action should be taken, if
necessary. Further planning should take into account such variations, as well as changed
conditions. A budget should facilitate judging performance and motivating managers and
other employees.

Responsibility accounting is a means of coordinating the efforts of all employees to attain

budgeted goals.

Responsibility accounting is an accounting management system that specifies the

boundaries of a manager's responsibility and duties and allows significant autonomy. (A
responsibility center, sometimes called a strategic business unit (SBU), is an
organizational unit where a manager is assigned responsibility for its performance.)

People have become more important in the budgeting process, in part, because of the
influence of computer technology. Computers can now handle the "number crunching"
side of budgeting, and managers can begin to concentrate on the human element.

Questions

To test your understanding of the content presented in this assignment, please click on
the Questions icon below. If you have trouble answering any of the questions presented
here, you are always free to return to this or any assignment to re-read the material.
The Master (or Static) Budget

A master budget is a comprehensive budget plan which includes all the individual
budgets related to sales, cost of goods sold, operating expenses, capital expenditures,
and cash.

A master budget is designed to be the major planning device for an organization: it

integrates and coordinates the activities of the various functional areas within the
organization.

A master budget should place emphasis on the performance of the total system
(organization) rather than the various subsystems or functional areas.

In practice this means the master budget is comprehensive enough to ensure that all the
resources (equipment, materials, labor, supplies, etc.) needed by the organization will be
at the right place at the right time. It also is designed to insure the same mix of products
produced is the mix of products that sales/marketing is planning to sell (based on the
sales budget).

A master budget is a set of interrelated budgets which together provide a complete

picture of the business. A model of a simple master budget is shown below. You can roll
your cursor over each box for more information.
 Source: International Accounting Network/Rutgers Accounting Web.

Complex Master Budget

This is a more complex, detailed model of the master budget. You can roll your cursor
over the areas highlighted in orange for further information.
 Source: International Accounting Network/Rutgers Accounting Web

There are a number of assumptions budgeters generally make when creating a master
budget. To remove some of the external complexities, the following are held constant
during the budget period:

1. sales prices

2. variable costs per unit of output

3. fixed costs (total)

4. sales mix (in a multi-product company)

This leads to a more linear budget, but it makes the master budget more understandable.
Within the master budget individual business units may look at more non-linear models
for sales and production, but the more comprehensive budget usually offers one set of
numbers.

Calculating the Master (or Static) Budget

The master budget also provides goals against which the performance of employees and
segments of the company can be measured, in order to permit an informed evaluation of
employees or business segments and hopefully to motivate employees and business
segments to improve their performance.

The master budget is best used to measure the performance of those managers who are
responsible for the overall performance of the company or a business segment, or the
performance of those managers who are responsible for generating the sales, or
revenues, of a company or business segment. Managers who are only responsible for
controlling costs should more appropriately be measured against a flexible budget, which
is based on actual sales, not planned or expected sales. The master budget typically
covers a one year period, but other time periods can be used.

Example

A purchasing manager's performance should more appropriately be compared to a

flexible budget than a master budget, since this manager would only be responsible for
controlling costs.

Master Budget Components

The master budget consists of an operating budget and a financial budget. The
operating budget contains several component budgets. First, the sales or revenues
budget and the ending inventory budget must be created. Based on these budgets a
production budget can be created. Based on the production budget the budgets for direct
materials, direct labor, and manufacturing overhead can be produced. The cost of goods
sold budget can be created based on these last three budgets plus the ending inventory
budget. After additional budgets are created for various operating expenses such as
research and development, marketing costs, and administrative costs, the budgeted
income statement can be produced.

The financial budget consists, in order of their preparation, of a capital expenditures

budget, a cash budget, a budgeted balance sheet, and a budgeted statement of
cash flows.
Components of a master (static) budget can be calculated as follows. Click on the equal
sign to see the full equation.

How to calculate

Budgeted sales (revenues) = (budgeted units sold) x (budgeted sale price per unit)

Budgeted variable costs = (budgeted units sold) x (budgeted variable cost per
unit)

Budgeted contribution margin (budgeted sales) - (budgeted variable costs)

=

Budgeted operating income = (budgeted contribution margin) - (budgeted fixed

costs)

Example

The Green Company plans to sell 20,000 units of its product at a price of $30 per unit. Its
variable costs per unit are expected to be $5 for direct materials, $3 for direct labor, and
$2 for manufacturing overhead. Its fixed costs are expected to be $50,000. Its master
(static) budget would be:

The Green Company

Master Budget

Units sold = 20,000

Sales = $600,000 (20,000 x $30)

Variable Costs

Direct materials = $100,000 (20,000 x $5)

Direct labor = $60,000 (20,000 x $3)

Manufacturing overhead = $40,000 (20,000 x $2)

Total variable costs = $200,000

Contribution margin = $400,000 (600,000 - $200,000)

Fixed costs = $50,000

Operating income = $350,000 ($400,000 - $50,000)

Problem

Bobble Inc. manufactures wobbly-headed dolls for dashboards. They plan to sell 75,000
wobbly-headed donkeys to global vendors at a price of $3 per unit. The variable costs per
wobbly-headed donkey are expected to be $0.75 for direct materials, $0.50 for direct
labor, and $0.20 for manufacturing overhead. Fixed costs are expected to be $30,000.
What does the master (static) budget look like? (remember: do not include any commas
in your answers)

Bobble, Inc.
Master Budget

Units sold =

Sales = $

Variable costs:

Direct materials = $

Direct labor = $
Manufacturing overhead = $

Total variable costs = $

Contribution margin = $

Fixed costs = $

Operating income = $

Analyzing with the Master Budget

Suppose that the Green Company needs to evaluate the performance of its employees in
achieving budgeted goals, and then determine why some goals were not met. It needs to
compare its actual results with its budgeted goals, and then calculate the variances from
the master (static) budget.

How to calculate

Master (static) Actual Result - Budgeted Goal

Budget Variance =

Please note: For units sold, sales, contribution margin, and operating income a
positive variance is favorable, indicating that the company's goals
were exceeded.

For any costs a negative variance is favorable, indicating that the

company spent less than it was expecting.

Example

Shown below are the master (static) budget variances that would be calculated based on
the budgeted amounts and actual results given below for the Green Company.
Type either a U or an F into each text box, depending on whether the variance should be
considered Favorable or Unfavorable. Click the "Check" button below to see if your
answers are correct.

Static Budget
Static Budget Actual Results U/F
Variance

Units sold 20,000 18,000 -2,000

Sales $600,000 $630,000 $30,000

Variable Costs:

Direct Materials 100,000 140,000 40,000

Direct Labor 60,000 50,000 -10,000

Manufacturing 40,000 35,000 -5,000

Overhead

Total Variable Costs 200,000 225,000 25,000

Contribution Margin 400,000 405,000 5,000

Fixed Costs 50,000 70,000 20,000

Operating Income 350,000 335,000 -15,000

The Master Budget Process

The process of developing the master budget is generally overseen by a budget
committee. The manager of each responsibility center should prepare a budget for his or
her own department, which is then negotiated with the budget committee before it is
finalized. The budget committee should provide guidelines that all responsibility centers
should follow in preparing their budgets. These guidelines should outline short-term goals
for the company that will set the tone for and govern the preparation of the budget. The
committee should also consider the company's long-term goals, its corporate strategy,
current operating results, financial resources, the outlook for the economy and the
marketplace, and any company policies that are being implemented.

The benefits of a master budget are that it motivates employees to improve their
performance, provides standards against which to judge employee performance, and
improves coordination as all departments are working toward the same numerical goals.
It also focuses attention on the goals that the company wants to achieve.

The limitations of a master budget are that the achievement of short-term targets may
diminish the focus on long-term objectives, that managers may focus more on achieving
their own goals than on the larger objective of improving the performance of the
company as a whole, and that the focus on quantitative goals may diminish the attention
to qualitative measures of performance such as providing good customer service or
maintaining standards of ethical behavior.

Questions

To test your understanding of the content presented in this assignment, please click on
the Questions icon below. If you have trouble answering any of the questions presented
here, you are always free to return to this or any assignment to re-read the material.

Operating Budgets

After additional budgets are created for various operating expenses such as research and
development (R&D), marketing costs, and administrative costs, the budgeted income
statement can be produced.

Other Budget Systems

Management turns to different budget systems when it feels that they are better suited
to achieving given goals, such as an organization-wide focus on continuous improvement
or on adapting to changing market conditions (a reason for introducing a rolling budget).

Here are some of the major alternative budget systems in use in the United States and
globally. Click on each term in the table below to read more about each.

Other Budget Systems

Activity-based A budget system that uses activity based cost measures to better
budgeting (ABB) estimate requirements for new and existing programs

Zero-based A budget system where managers start from zero and all
budgeting (ZBB) expenditures must be justified each new period

A budget system which uses marginal costing principles and is

Flexible budgeting
designed to change as volume of output changes

A budget system based on kaizen, the Japanese process of

Kaizen budgeting
continuous improvement

When a firm is looking to assess the performance of a stand-alone project, it will often
turn to a project budget system, which is designed for a project separate from the
other operations of the organization.

Questions

To test your understanding of the content presented in this assignment, please click on
the Questions icon below. If you have trouble answering any of the questions presented
here, you are always free to return to this or any assignment to re-read the material.

Calculating Operational Budgets

The sales budget, the production budget and the cost of goods sold budget are the
operating budgets most widely used within organizations.
The sales budget is important in developing the annual profit plan because it tells you
how much revenue you plan to earn. It is also important because all, or almost all, of the
other budgets in the annual profit plan are influenced by the sales budget, since the level
of sales affects the cost of goods sold as well as many other expenses.

The sales budget affects the production budget, since you generally need to make more
units if you plan to sell more units.

The sales budget is based on the number of units that can be sold and the price that can
be charged per unit. Both of these amounts will be affected by customer needs, recent
sales volume, advertising and promotional activity, competition, economic conditions, and
the regulatory environment. Many companies perform or obtain market research to
better understand some of these factors. Also, keep in mind that the number of units sold
may be limited by the productive capacity of the company.

Preparing a Sales Budget

To produce a sales budget, you need to determine the number of units that can be sold
and the price that can be charged per unit. You can then compute the total amount of sales
in dollars. This must be done for each time period covered by the sales budget.

How to calculate

Total Sales = (number of units sold) x (price per unit)

Example

Suppose the number of units that can be sold in January is 1,400 and the price that can
be charged per unit sold is $50, then the budget for January would be:

Units sold =

Sales price = $

Total sales = $

If inventory levels are held constant from the beginning of the period to the end of the
period, the number of units produced would equal the number of units sold. Because
inventory levels usually do change from the beginning of the period to the end of the
period, the number of units produced usually does not equal the number of units sold,
but a higher level of units sold does tend to increase the number of units produced.
A higher ending inventory of finished goods will require a higher level of production, since
the additional goods will need to be produced. Likewise, a lower ending inventory will
require a lower level of production. A higher beginning inventory of finished goods will
require a lower level of production, since more of the goods required can come from that
beginning inventory. Likewise, a lower beginning inventory will require a higher level of
production.

In determining the desired level of the inventory of finished goods, there is a trade-off,
because a shortage of inventory can lose sales, while excessive inventory is costly to
maintain. Other factors to consider in preparing a production budget are a company's
production yields and quality, the availability of the resources of production, and the
question of stable production, which causes inventory to build up when sales are slow,
versus a flexible production schedule, which may require overtime pay when sales are
strong.

Preparing a Production Budget

The planned level of production depends upon the planned level of sales and the planned
levels of inventory. Keep in mind that since the current period's ending inventory will
become the next period's beginning inventory, the desired level of the current period's
ending inventory will normally be based on the planned level of sales for the next period.

How to calculate

Assuming the following:

PC = budgeted number of units to produce in the current period

EIC = desired level of ending inventory for the current period
BIC = expected level of beginning inventory for the current period
SC = planned number of units to be sold in the current period
SN = planned number of units to be sold in the next period

EIC = SN x (desired % of next period's sales to be in this period's ending inventory)

PC = SC + EIC - BIC

Example
Assume that a company plans to sell 400 units of its product in January and 500 units in
February. Assume that the company desires its inventory at the end of each month to be
15% of the planned sales for the next month, and that it expects to begin January with 60
units in its inventory. We can calculate the desired level of ending inventory for January
and the budgeted number of units to produce in January as follows:

EIC = 15% x 500 = 75 units

PC = 400 + 75 - 60 = 415 units

Problem

Frankfort Inc. plans to sell 200 canisters of chemicals in July and 350 canisters in August.
They desire their inventory at the end of each month to be 20% of the planned sales for
the next month, and they expect to begin July with 45 canisters in their inventory.
Calculate the desired level of ending inventory for July and the budgeted number of units
to produce in July.

EIC = canisters

PC = canisters

All other things being equal, the higher the level of production called for in the production
budget, the greater will be the purchases of direct materials and direct labor. However,
the level of purchases of direct materials will also be affected by the levels of inventories
of direct materials.

Preparing a Cost of Goods Sold Budget

The components of the cost of goods sold budget are the three manufacturing costs -
direct materials, direct labor, and manufacturing overhead - and the finished goods
inventories at the beginning and end of the period. When products are sold, the cost of
those goods, which is the cost of goods sold, comes out of the inventory asset and
becomes an expense. Therefore, the higher the cost of goods sold, the lower the amount
of inventory on the balance sheet, and the lower the net income on the income statement
(since the additional expense reduces net income.)

(NOTE: all figures in the calculations below would be budgeted, or expected, figures, not
actual figures, except for the finished goods beginning inventory, which may be an actual
or a budgeted figure).
 How to calculate

direct materials cost

Total cost of goods manufactured = + direct labor cost
+ manufacturing overhead cost

total cost of goods manufactured

Total cost of goods available for sale =
+ finished goods beginning inventory

total cost of goods available for sale

Budgeted cost of goods sold =
- finished goods ending inventory

Example

A company expects direct materials cost of $30,000, direct labor cost of $70,000, and
manufacturing overhead cost of $50,000. Its finished goods beginning inventory was
$10,000 and its finished goods ending inventory is expected to be $25,000.

Total cost of goods manufactured

= 30,000 + 70,000 + 50,000
= $150,000

Total cost of goods available for sale

= 150,000 + 10,000
= $160,000

Budgeted cost of goods sold

= 160,000 - 25,000
= $135,000

Problem

What is the budgeted cost of goods sold for this company if the direct materials cost is
$40,000 and its finished goods ending inventory is expected to be $30,000?

Budgeted cost of goods sold:

Summary of Budget Systems

Management turns to different budget systems when it feels that they are better suited
to achieving given goals, such as an organization-wide focus on continuous improvement
or on adapting to changing market conditions (a reason for introducing a rolling budget).

Here are some of the major alternative budget systems in use in the United States and
globally.

Web Resources

These websites offer additional information on:

 Master budgets

 Activity-based budgeting (ABB)

 Zero-based budgeting (ZBB)

Advanced Topics: Cash Budgeting

The purpose of the cash budget is to estimate how much cash is being received and
spent in each time period, so that a company can make sure that it has enough cash at
all times to meet its needs. If the cash budget indicates a shortage of cash in any time
period, the company can arrange to borrow enough money to cover the shortage. The
cash budget can also help identify when the company will have enough cash to repay
such borrowings.

The cash budget is related to the other budgets because it takes the projected results from
other budgets and shows how they would affect the company's cash. For example, it uses
the sales shown on the sales budget to estimate how much cash will be collected from
customers in each time period.

Example

The cash budget uses the purchases shown on the direct materials purchases budget to
estimate how much cash will be spent on direct materials in each time period.

The elements of the cash budget are the cash balance at the beginning of the period, cash
collections, cash disbursements, cash balance before financing, the effects of financing
transactions (borrowings or repayments of principal or interest), and the cash balance at
the end of the period. The cash budget is affected by the company's policies on collection
of receivables and payment of payables because these policies influence the timing of the
collections and payments.

Example

If a company pays its payables in 30 days, a one month delay, then any purchases on
credit that it makes in May will not be paid until June.

Preparing a cash budget

When preparing a cash budget, any depreciation expense or bad debt expense should be
not be included as cash disbursements, because depreciation is an expense that does not
directly affect cash and bad debts are reflected in the cash collections section as a
reduction in the collections. The formulas below will aid in the preparation of the cash
budget.

In order to prevent the cash budget from being too cluttered, it may be a good idea to
prepare a schedule of cash receipts and a schedule of cash payments for direct material
purchases prior to the preparing the cash budget, which would then incorporate the
figures from those two schedules.

How to calculate

Cash collected from sales on

(amount of sales) x (% collected)
credit =

Cash paid for purchases on

(amount of purchases) x (% paid)
credit =

(minimum balance required)

Amount borrowed = - (cash balance before financing)
* ignore if result is less than zero

(cash balance before financing)

Amount repaid of principal and - (minimum balance required)
interest = * ignore if result is less than zero, and limit repayment to total of
principal and interest owed

Example

A landscaping company that also produces and sells flower pots has the following
budgeted figures from its various budgets for a 3 month period:

April May June

Service Revenue

Sales of flower pots $180,000 $210,000 $240,000

 Purchase of direct materials $12,000 $14,000 $16,000

Direct labor $24,000 $28,000 $32,000

Manufacturing overhead $36,000 $42,000 $48,000

Purchase of office equipment $60,000 $10,000

Selling expenses

Salaries of salespeople $85,000 $85,000 $85,000

Bad debt expense $5,000 $6,000

Administrative expenses

Salaries of office personnel $105,000 $105,000 $105,000

Depreciation $8,000 $8,000 $9,000

The sales of flower pots are on a cash basis. The services are billed at the beginning of
each month with term 2/10, n/30. Customers pay 60% of the bills within 10 days (to get
the 2% discount), 20% of the bills in 30 days, and 15% in 60 days. The other 5% are
never paid. Purchases of direct materials are made on credit; 70% of them are paid in the
month of the purchase and 30% in the month following the purchase. The company has a
cash balance of $25,000 at the beginning of May. It wants a minimum balance of
$20,000, and has a line of credit on which it can borrow, and interest of 1% per month is
paid when the principal is repaid. Borrowings are assumed to be made at the beginning of
the month and repayments are assumed to be made at the end of the month. No money
is owed on line of credit on May 1.

May

MAY - Schedule of Cash Collections

Cash collected from cash sales $210,000

 Cash collected from payments within 10 days 70,560 120,000 x .60 (1-.02)

Cash collected from payments within 30 days 24,000 120,000 x .20

Cash collected from payments within 60 days 15,000 100,000 x .15

$319,56
Total cash collected
0

MAY - Schedule of cash payments on direct materials purchases

Cash payments on current month purchases $98,000 14,000 x .70

Cash payments on last month's purchases 3,600 12,000 x .30

$13,40
Total cash payments on direct material purchases
0

MAY - Cash Budget

Beginning cash balance $25,000

Total cash collected 319,560

344,56
Cash available
0

Total cash payments on direct material purchases 13,400

Direct labor 28,000

Manufacturing overhead 42,000

 Purchase of office equipment 60,000

Salaries of sales team 85,000

Salaries of office personnel 105,000

333,40
Total cash disbursements
0

Cash balance before financing 11,160

Borrowing 8,840 20,000 - 11,160

Repayment of principal 0

Interest paid 0

$20,00
Ending cash balance
0

June

JUNE - Schedule of Cash Collections

Cash collected from cash sales $240,000

Cash collected from payments within 10 days 82,320 140,000 x .60 (1-.02)

Cash collected from payments within 30 days 28,000 140,000 x .20

Cash collected from payments within 60 days 18,000 120,000 x .15

 $368,32
Total cash collected
0

JUNE - Schedule of cash payments on direct materials purchases

Cash payments on current month purchases $11,200 16,000 x .70

Cash payments on last month's purchases 4,200 14,000 x .30

$15,40
Total cash payments on direct material purchases
0

JUNE - Cash Budget

Beginning cash balance $20,000 May ending balance

Total cash collected 368,320

388,32
Cash available
0

Total cash payments on direct material purchases 15,400

Direct labor 32,000

Manufacturing overhead 48,000

Purchase of office equipment 10,000

Salaries of sales team 85,000

Salaries of office personnel 105,000

 295,40
Total cash disbursements
0

Cash balance before financing 92,920

Borrowing 0

Repayment of principal -8,840

Interest paid -177

$83,90
Ending cash balance
3

Repayment of principal is 92,920 - 20,000 = 72,920 (but limited to 8,840)

Interest = 8,840 x 1% x 2 months = 177

What would interest equal if the cash balance before financing for May was $12,000?

Interest: $

Managing the budget process

The budget process is generally overseen by a budget committee. A typical budget

committee includes the chief executive officer, some vice presidents or the heads of
strategic business units, and the chief financial officer. The manager of each responsibility
center should prepare a budget for his or her own department, which is then negotiated
with the budget committee before it is finalized.
For example, the sales manager would produce a budget for the sales department, which
would then be negotiated with the budget committee.

The budget committee should provide guidelines that all responsibility centers should
follow in preparing their budgets. The budget guidelines should outline short-term goals
for the company that will set the tone for and govern the preparation of the budget. The
committee should consider many factors in providing these guidelines, including:

 the company's long-term goals

 its corporate strategy

 current operating results

 financial resources

 the outlook for the economy and the marketplace

 any company policies that are being implemented

For example, if the firm is expanding into new markets and will be hiring additional
employees, that should be reflected in the budget guidelines.

Management-by-Objective (MBO)

Management-by-objective (MBO) is a management system in which subordinates and

their superiors jointly determine specific performance objectives (MBOs).

In management-by-objective, a manager or other worker, in agreement with his or her

supervisor, sets goals as to the results that will be achieved during a particular time
period. Performance in achieving these goals is recorded, and the supervisor provides
counseling in how to achieve the goals and reviews the final results versus the stated
goals in evaluating the employee's performance.

Click on the links below to read more about the benefits and limitations of Management-
by-0bjective.

Benefits

Limitations

Questions

To test your understanding of the content presented in this assignment, please click on
the Questions icon below. If you have trouble answering any of the questions presented
here, you are always free to return to this or any assignment to re-read the material.
Self-Assessment

Question 1

Budgeting should provide goals for:

A. the company as a whole

B. divisions

C. departments

D. all of the above

Question 2

A budget improves:

A. Communication

B. Coordination

C. Both A and B

D. Neither A nor B

Question 3

The last step of the development of the operating budget is the creation of the:

A. direct materials budget

B. direct labor budget

C. manufacturing overhead budget

D. budgeted income statement

Question 4

In management-by-objective, the employee's supervisor

 A. agrees to the goals set by the employee

B. provides counseling in how to achieve the goals

C. reviews the final results versus the stated goals

D. all of the above

Question 5

The limitations of management-by-objective include

A. The achievement of short-term targets may diminish the focus on long-term objectives

B. the agreed upon goals may become obsolete in the face of changes in corporate objectives or
changes in the competitive environment

C. Both A and B

D. Neither A nor B

Question 6

The most common time period for a budget is

A. 10 months

B. 8 weeks

C. 1 year

D. None of the above

Question 7

If as each time period ends, another equivalent time period is added to the budget, such a budget is called a

A. perpetual budget

B. rolling budget

C. continuous budget

D. Either B or C

Question 8

The budget committee should include

 A. the chief executive officer

B. the chief financial officer

C. some vice-presidents or the heads of strategic business units

D. All of the above

Question 9

The budget guidelines should be influenced by

A. the company's long-term goals

B. the company's current operating results

C. the outlook for the economy and the marketplace

D. All of the above

Question 10

Which of the following is the most important benefit of a master budget?

A. It interrelates all budgets in a firm.

B. It gives management a complete picture of the firm.

C. It can offer different levels of budgeting complexity.

D. It provides internal controls.

Question 11

Which of the following is not a component of the Operating Budget?

A. Sales Budget

B. Master Budget

C. Production Budget

D. Ending Inventory Budget

Question 12

In the strategic planning process, ________________ follows ________________.

A. strategy implementation/strategy formulation

B. strategy formulation/strategy implementation

C. planning/communication

D. strategy formulation/strategic planning