#17130 - Profit Planning & Budgeting Theory - Irish Management Accounting Theory

Budgeting is future orientated plan, a plan is a means to an end. There are generally standing budget committees whom operate and convert strategic budgets into operational ones to meet goals of the company and to keep the company profitable in the long run. Generally, these committees are only found in larger organisations.

Objectives of Budgeting:

• Compel planning, so firms need to plan for the future and anticipate any foreseeable problems which might arise.

• Benchmark performance, responsibility accounting for management.

• Motivational impetus, setting targets is a form of motivating, giving bonuses also can be motivational.

• Medium of communication, where employees are aware as to what is required of them in the position they hold.

• Enhance co-ordination, between different units of the company, to work more efficiently as a full team orientated business.

• Promote goal congruence, so need for clear goals and then individuals acting to meet these goals.

• Instil financial awareness, management can realise the financial reprecusions for certain things and can become more aware of how to manage to reduce costs.

Master Budget:

• This budget is a summary of the information contained in the functional budgets (sales production), it is precise and determines a firms structure by the nature of its output.

• It contains three main elements; cash budget, budgeted profit and loss and the budgeted balance sheet.

The Cash Budget:

• This budget ensures that sufficient cash is available to meet payments and commitments and is an effective use of surplus cash.

• Non cash items (depreciation/bad debts) do not get entered into this budget and as result it is reliable from a cash only point of view.

• All cash flows are recorded in this budget, however, you only record a sale in this budget when you know you are receiving the cash, so this budget can be seen to be one of real timing.

Budgeted Profit & Loss Account:

• It is what it says the budgeted profit or loss expected for next year, it considers received payments and payments from the company.

• It also contains certain non-cash items such as depreciation as it is an expense of running the business along with some provision for bad debts.

• A distinction here from the cash budget is that statements based on accruals are included are you are expected to receive these payments in the course of business.

Budgeted Balance Sheet:

• This budget can be best seen as an amalagamation of the data compromised in the previous two mentioned budgets along with information from functional budgets which concern purchases, sales and labour etc.

• Details of fixed assets gets included here also.

• It is important because it is generally a contrast from the current balance sheet when doing out a budgeted balance sheet and thus, the expected retained profit will be compromised of last year’s actual retained profit plus an estimated retained profit for the year coming.

A number of different approaches can be taken however, when it comes to budgeting;

• Incremental Budgets;

  • These are the most popular budgets used by businesses, it begins with a current budget and is revised to cater for events which occur throughout the year along with the inclusion of anticipated date for the next budget period such as inflation rates and the volumes of activity.

  • It is quite straightforward, in the sense that it just compares changes from last years budget with this years one.

  • However, despite being overly straightforward, the problem which may arise is that past information may become too prevalient, and inefficiencies which occurred in the past will be brought into the present and future.

• Zero based Budgeting;

  • This is the opposite to incremental budgeting, here every year you reset the figure to zero and start from scratch, new year new budget, no retrospective looking feature.

  • This is based on consideration of alternative ways to achieve certain objectives.

  • Every figure within this budget is one which needs to be justified.

  • Because some expenditure is necessary however, maybe it is more relevant to look at things which are expected to change as opposed to starting from scratch each year.

• Rolling Budgets:

  • These forms of budgets involve normally prepared functional and master budgets the budget period isn’t generally, done on a yearly basis, instead these budgets are sub-divided into a number of shorter periods such as monthly or quarterly.

  • This ultimately, keeps the business in focus from period to period and the future.

  • However, this is quite a costly method due to the continuous assessments and updates, yet it can be seen as quite worthwhile when conditions are constantly changing and subject to uncertainty.

• Activity Based Budgeting;

  • This relates to overheads and is quite similar to activity based costing. The budget is formulated on the total budgeted cost for each cost driver,...