The Basic Framework of Budgeting
A budget is a formal
quantitative plan outlining future financial expectations, often used by
individuals and organizations to manage income and expenditures effectively.
While households use budgets to allocate resources for essentials and savings,
companies adopt more complex budgeting systems to guide operations and
decision-making (Garrison, Noreen, & Brewer, 2018).
Budgeting serves two primary
purposes: planning—the process of setting goals and formulating
strategies to achieve them—and control—monitoring outcomes to ensure
adherence to plans or making necessary adjustments based on feedback. A sound
budgeting system must incorporate both to be effective (Garrison et al., 2018).
Organizations benefit from budgeting
in several ways: it promotes communication of managerial plans, compels
proactive thinking, supports optimal resource allocation, identifies potential
bottlenecks, fosters organizational coordination, and establishes
performance benchmarks (Garrison et al., 2018).
Reference:
Garrison, R. H., Noreen, E. W.,
& Brewer, P. C. (2018). Managerial Accounting (16th ed.).
McGraw-Hill Education.
Responsibility Accounting
Responsibility accounting is a foundational concept in profit planning and control
systems. It emphasizes that managers should be held accountable only for
those costs and revenues they can significantly control. Each budget line
item is assigned to a specific manager who is then responsible for any
variances between the budgeted and actual results. This approach personalizes
accounting information by assigning ownership of financial outcomes,
thereby promoting accountability and control over costs (Garrison, Noreen,
& Brewer, 2018).
Responsibility accounting does not
aim to penalize managers for discrepancies. Instead, it encourages them to
identify, understand, and address unfavorable variances and learn from both
favorable and unfavorable outcomes. The goal is to ensure that performance
issues are not overlooked and that the organization responds promptly and
learns from financial feedback. This fosters continuous improvement and
enhances the effectiveness of the organization’s budgeting and control systems
(Garrison et al., 2018).
Reference:
Garrison, R. H., Noreen, E. W.,
& Brewer, P. C. (2018). Managerial Accounting (16th ed.).
McGraw-Hill Education.
Choosing a Budget Period
Operating budgets typically span a
one-year period aligned with the company’s fiscal year. Many firms
divide this annual budget into quarters, with the first quarter further
broken down into monthly budgets, while subsequent quarters may
initially remain as quarterly aggregates. As the year progresses, these are
further detailed, promoting periodic review and reassessment of
financial plans (Garrison, Noreen, & Brewer, 2018).
Some organizations adopt a continuous
(or perpetual) budgeting approach, where the budget continuously extends by
adding one month or quarter as each period ends. This ensures that managers
maintain a forward-looking perspective and do not become overly fixated
on short-term outcomes. While this chapter focuses on one-year budgets, the
same principles can be applied to multi-year planning, even if precise
forecasting becomes more difficult. Longer-term budgets, despite potential
inaccuracies, can help identify future opportunities and risks (Garrison
et al., 2018).
Reference:
Garrison, R. H., Noreen, E. W.,
& Brewer, P. C. (2018). Managerial Accounting (16th ed.).
McGraw-Hill Education.
The Self-Imposed Budget
A self-imposed budget, also
known as a participative budget, is created with the active involvement
of managers at all organizational levels. This participatory approach fosters ownership,
motivation, and realistic budgeting, as lower-level managers often
have more accurate knowledge of operational conditions compared to top
executives (Garrison, Noreen, & Brewer, 2018). The self-imposed budgeting
process begins at the supervisory level, with each manager preparing their own
budget, which is then reviewed and consolidated at higher levels.
Key advantages of
self-imposed budgeting include:
- Recognizing the value and input of managers at all
levels.
- Producing more realistic and accurate estimates
from front-line managers.
- Enhancing motivation and commitment through
goal-setting involvement.
- Eliminating the excuse of unattainable goals when
budgets are self-prepared.
However, this method is not without
its limitations. A common issue is budgetary slack, where
managers may deliberately underestimate performance expectations to ensure easy
targets. Thus, self-imposed budgets require careful review by higher
management to maintain efficiency and strategic alignment.
Although ideal, many companies do
not adopt this participatory model. Instead, top-down budgeting—where
senior management dictates profit targets—often prevails. Such targets may
either be unrealistically high (demotivating employees) or excessively
lenient (encouraging inefficiency). For optimal results, organizations
should blend strategic direction from top management with operational
insights from lower levels, ensuring both alignment and motivation
(Garrison et al., 2018).
Reference:
Garrison, R. H., Noreen, E. W.,
& Brewer, P. C. (2018). Managerial Accounting (16th ed.).
McGraw-Hill Education.
The effectiveness of a budgeting system is not determined solely by its
technical precision but is deeply influenced by human factors,
particularly the attitudes and behaviors of managers
throughout the organization. For a budget program to be successful, top
management’s commitment and active support are crucial. When senior
leaders treat the budget as a core managerial tool rather than a bureaucratic
obligation, their enthusiasm encourages middle and lower-level managers
to take the process seriously (Garrison, Noreen, & Brewer, 2018).
However, the misuse of budgets—especially as instruments of pressure or
punishment—can create hostility and distrust. Budgeting should
serve as a positive, motivational tool, not a mechanism for
placing blame. It is essential that managers perceive budgeting as a process
for goal-setting, performance evaluation, and organizational alignment,
rather than as an inflexible constraint.
The challenge level of budget targets also affects human
behavior. While some argue for “stretch budgets” to drive peak
performance, most organizations favor highly achievable budgets—challenging
yet attainable with reasonable effort. These targets are generally more
acceptable to managers, especially when bonus incentives are
tied to budget achievements. Such budgets not only foster greater confidence
and commitment, but also help minimize unethical practices aimed at
manipulating results to earn bonuses.
Ultimately, budgeting should be a collaborative and motivational
tool that balances technical rigor with an understanding of human
psychology. Overemphasis on rigid enforcement or unrealistic targets can
backfire, undermining both morale and performance (Garrison et al., 2018).
Reference:
Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial
Accounting (16th ed.). McGraw-Hill Education.
The budget committee plays a central role in the
development and administration of an organization’s budgeting process. This standing
committee, typically composed of the president, key vice presidents
(e.g., sales, production, and purchasing), and the controller, is responsible
for formulating overall budgetary policy, coordinating departmental
contributions, resolving disputes, and approving the final budget (Garrison,
Noreen, & Brewer, 2018).
Budgeting is inherently political because it involves resource
allocation and sets performance benchmarks that
directly influence departmental evaluations. As such, it can trigger conflicts
among managers, each striving to secure favorable terms for their
departments. These tensions can undermine organizational cohesion and shift
focus away from shared objectives.
To mitigate such risks, strong interpersonal skills are
essential for navigating the complexities of budgeting discussions. However,
even excellent communication and negotiation capabilities may be insufficient
if top management misuses the budget—for instance, by
employing it as a tool for exerting undue pressure or assigning blame. A
healthy budget culture thus requires a balanced approach that combines technical
competence, emotional intelligence, and a
supportive leadership philosophy.
Reference:
Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial
Accounting (16th ed.). McGraw-Hill Education.
The master budget is a comprehensive set of interrelated
budgets that outline an organization’s operational and financial plans for a
specific period. It culminates in three key financial documents: the cash
budget, the budgeted income statement, and the budgeted
balance sheet (Garrison, Noreen, & Brewer, 2018).
The budgeting process begins with the sales budget, which
forecasts expected sales and serves as the foundation for all subsequent
budgets. Since every component of the master budget depends on the accuracy of
the sales forecast, it is critical to develop it using reliable forecasting
techniques, often involving advanced statistical or marketing methods.
Following the sales budget, the production budget is
formulated to determine the required production volume. This leads to the
creation of the direct materials, direct labor,
and manufacturing overhead budgets, which together form the manufacturing
cost budget. These operational budgets, alongside the selling
and administrative expense budget, feed into the cash budget,
a detailed projection of expected cash inflows and outflows.
Once the cash budget is finalized, it becomes the basis for preparing the budgeted
income statement and budgeted balance sheet, ensuring
consistency across all financial planning documents. The interdependence
of these components reflects the integrated nature of effective budgetary
control.
Reference:
Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial
Accounting (16th ed.). McGraw-Hill Education.
Sure! Here's a clear and structured explanation of the Master
Budget, suitable for students, professionals, or academic contexts:
What is a Master Budget?
A Master Budget is a comprehensive financial planning
document that brings together all of the individual budgets related to a
company’s sales, operations, and finances. It provides a complete overview of
what a business expects to achieve financially over a specific period—usually
one year.
Purpose of the Master Budget:
·
To plan business activities in
advance.
·
To coordinate operations across
departments.
·
To serve as a benchmark for
performance evaluation.
·
To ensure that resources are
allocated efficiently.
·
To assist in forecasting
profit, cash flows, and financial position.
Main Components of the Master Budget:
The master budget consists of two broad categories:
1. Operating Budgets
These are related to the day-to-day operations of the business:
·
Sales Budget: Forecast of
expected sales in units and dollars.
·
Production Budget: Determines
how many units need to be produced based on sales forecasts and inventory
policies.
·
Direct Materials Budget:
Estimates raw materials required for production.
·
Direct Labor Budget: Projects
the labor hours and cost needed.
·
Manufacturing Overhead Budget:
Estimates all production costs other than direct materials and direct labor.
·
Selling and Administrative Expense
Budget: Forecasts all non-production expenses.
2. Financial Budgets
These focus on the company’s financial health:
·
Cash Budget: Projects cash
inflows and outflows; helps manage liquidity.
·
Budgeted Income Statement:
Estimates profitability based on revenues and expenses.
·
Budgeted Balance Sheet:
Predicts the financial position (assets, liabilities, and equity) at the end of
the budget period.
How Does It Work?
1. It
starts with the sales budget, which drives most other
components.
2. Based
on expected sales, the company determines production needs.
3. Production
needs then drive material, labor, and overhead budgets.
4. These
operational budgets, along with other expense forecasts, feed into the cash
budget.
5. Finally,
the company prepares the budgeted financial statements.
Why is the Master Budget Important?
·
It provides a roadmap for the
business.
·
Encourages goal setting and
strategic alignment.
·
Allows for performance monitoring
and corrective action.
·
Enhances communication and coordination
between departments.
Conclusion:
The master budget is the backbone of a company's financial
planning and control system. It brings all parts of the organization together
toward common financial and operational goals.
What is a Sales Budget?
A Sales Budget is the starting point of the master
budgeting process. It is a detailed projection of a company’s expected sales
revenue for a specific period, usually broken down by product, region, or time
(monthly or quarterly).
It estimates:
·
Number of units to be sold
·
Selling price per unit
·
Total sales revenue
Purpose of the Sales Budget:
·
Provides the basis for
production and purchasing budgets.
·
Helps plan for cash inflows.
·
Aids in setting targets for the
sales team.
·
Helps identify seasonal trends
and manage inventory.
Sales Budget Formula:
Sales Revenue=Expected Units to be Sold×Selling Price per Unit\text{Sales
Revenue} = \text{Expected Units to be Sold} \times \text{Selling Price per
Unit}
✅ Numerical Example:
Company: ABC Electronics
Product: Smart Speakers
Budget Period: First Quarter (3 months)
Forecasted Sales:
|
Month |
Expected Sales
(Units) |
Selling
Price/Unit |
Total Sales
Revenue |
|
January |
2,000 units |
$50 |
2,000 × $50 = $100,000 |
|
February |
2,500 units |
$50 |
2,500 × $50 = $125,000 |
|
March |
3,000 units |
$50 |
3,000 × $50 = $150,000 |
|
Total Q1 |
7,500 units |
$375,000 |
📊 Sales Budget (Q1) for ABC
Electronics:
|
Month |
Units to be
Sold |
Selling Price
per Unit |
Total Sales |
|
January |
2,000 |
$50 |
$100,000 |
|
February |
2,500 |
$50 |
$125,000 |
|
March |
3,000 |
$50 |
$150,000 |
|
Total |
7,500 |
$375,000 |
💡 Additional Insights:
·
If ABC Electronics also sells in two different regions,
you can break the sales budget by region.
·
You can also include cash vs. credit
sales if relevant, which is useful for preparing the cash
budget.
🧊
Example: Sales Budget for Hampton Freeze (Popsicle Company)
Product: Popsicles
Year: 2012
All sales are on credit
Collection Pattern:
- 70% collected in the quarter of the sale
- 30% collected in the following quarter
📈 Schedule 1 – Quarterly Sales Budget for 2012
|
Quarter |
Budgeted
Sales (Units) |
Selling
Price per Unit |
Total
Sales Revenue |
|
Q1 |
25,000 |
$8 |
$200,000 |
|
Q2 |
20,000 |
$8 |
$160,000 |
|
Q3 |
35,000 |
$8 |
$280,000 |
|
Q4 |
20,000 |
$8 |
$160,000 |
|
Total |
100,000 units |
$800,000 |
💵 Schedule of Expected Cash Collections
|
Quarter |
From
Current Quarter Sales (70%) |
From
Previous Quarter Sales (30%) |
Total
Collections |
|
Q1 |
70% of $200,000 = $140,000 |
— |
$140,000 |
|
Q2 |
70% of $160,000 = $112,000 |
30% of Q1 = $60,000 |
$172,000 |
|
Q3 |
70% of $280,000 = $196,000 |
30% of Q2 = $48,000 |
$244,000 |
|
Q4 |
70% of $160,000 = $112,000 |
30% of Q3 = $84,000 |
$196,000 |
|
Q1 of Next Year |
— |
30% of Q4 = $48,000 |
$48,000 |
✅
Total Cash Collections Over Time
- In 2012: $752,000
- In Q1 of 2013: $48,000
- Total for 2012 sales: $800,000, confirming full
collection over time.
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