CHAPTER STRATEGY AND THE MASTER BUDGET EXPECTED LEARNING OUTCOMES After studying this chapter, you should be able to... 1. Explain what a budget is and its role in the management process 2. Describe the importance of strategy in budgeting and its relationship to the strategic long-term and short-term goals of the firm 3. Explain the management process of preparing the master budget 4, Prepare a sales budget including a computation of expected cash receipts 5. Prepare a production budget, direct materials budget, direct labor budget including the computation of expected cash disbursements for purchases of material and payment of direct labor 6. Prepare a manufacturing overhead budget and a selling and administrative expense budget and expected cash disbursements relative thereto 7. Prepare a cash budget Prepare a budgeted income stafement and a budgeted statement of financial position 9. Describe the alternative approach in budgeting such as zero-base budgeting, activity-based budgeting and Kaizen (Continuous improvement) budgeting 10. Explain the ethical issues in budgeting oresCHAPTER 5 STRATEGY AND THE MASTER BUDGET Repeated references to budget allowances have been made throughout previous chapters and we have seen how closely accounting and budgeting are related and how one depends on the other. Accounting draws some of its data from planned performances established in the budget; in turn, recorded historical data provide a basis for determining budget estimates. ROLE OF A BUDGET A budget is a financial plan of the resources needed to carry out tasks and meet financial goals. It is also a quantitative expression of the goals the organization wishes to achieve and the cost of attaining these goals. The act of preparing a budget is called budgeting. The use of budgets to control a firm's activities is known as budgetary control. Budgets and the budgeting process are intertwined with all aspects of management. In addition, to being a plan of operations, a budget plays an important role in allocating resources, coordinating operations, identifying constraints and limitations, and communicating expected actions and results, authorizing activities, motivating and guiding implementation, providing guidelines for control of operations, managing cash flows, and serving as criteria in performance evaluations. In the process of preparing a firm’s budget, managers need to be forward-looking in evaluating upcoming events and situations as they relate to the firm’s strategic goals. Budget preparation allows management the opportunity and time to work out any potential problems that the company might meet in the coming periods. The firm is able to minimize if not totally avoid the adverse effects that anticipated problem could have on operation. Budgeting can also help managers identify current and potential bottleneck in operation. Critical resources can then be mustered to ease any bottleneck in operations-and prevent them from becoming obstacles to attaining budgeting goals.100 Chapter 5 Completion of a budget for all units of an organization also mandates coordinating operations among all budgeted units and synchronizing the operating activities of various department. Budgets'help firms to run smoother operations and achieve better results. Properly conceived, budgeting can mean the difference between a general drift that may or may not lead to a desired goal and a carefully plotted course toward a predetermined objective that holds drift to a minimum. Budgets make the decision-making process more effective by helping managers meet uncertainties. The objective of budgeting is to substitute deliberate, well-conceived business judgment for accidental success in enterprise management. Budgets should not be expressions of wishful thinking but rather descriptions of attainable objectives. IMPORTANCE OF STRATEGY IN BUDGETING As discussed in the earlier chapters, a firm’s strategy is the path it chooses for attaining its long-term goals and mission, It is the starting point in preparing its plans and budgets. For example, a very large and successful Retail Department Store in the Philippines considers itself the leader of top-of-the-line consumer goods (wardrobe, designer bags and shoes, accessories, housewares, and so forth. One of its departments is the Supermarket and Grocery Department, selling food items, fresh and processed and other household needs. Even though this department is a little bit profitable, for competitive reasons, the firm made a strategic decision to leave this line of business. Subsequent budgets of this firm reflect this strategic decision. Formulation of Strategy The process of determining a company’s strategy starts with the assessment of external factors that affect operation and evaluating internal factors than can be its strength and weakness. External factors typically include * Competition * Technical, economic political, regulatory, social and environmental factors A careful examination of such factors can help the firm identify opportunities, limitations and threats.Strategy and Master Budget 101 Internal factors on the other hand, include operating characteristics such as Financial strength Managerial talent and expertise Functional structure, and Organizational culture Matching the firm’s strengths with its identified opportunities, resources and threats enables it to form its strategy. Having analyzed external factors surrounding the organization and assessed the internal situations it is in, management can match opportunities with strength and competitive advantages of the firm and determine its strategies and long-term opportunities. Figure 5-1 summarizes the activities involved in the development of a firm’s product strategy. Figure 5-1: Development of a Firm’s Product Strategy Analyze External Factors Assess Internal Conditions Economy Finance Politics Management Technology Structure Regulation Morale Society, Environment Culture Competition Identify Opportunities, Recognize Strengths, Limitations and Threats Weaknesses and Competitive Advantages Match Opportunities with ————_ Strengths and Competitive Finalize Strategic Goals and Long-Term ObjectivesCHAPTER 5 STRATEGY AND THE MASTER BUDGET Repeated references to budget allowances have been made throughout previous chapters and we have seen how closely accounting and budgeting are related and how one depends on the other. Accounting draws some of its data from planned performances established in the budget; in turn, recorded historical data provide a basis for determining budget estimates. ROLE OF A BUDGET A budget is a financial plan of the resources needed to carry out tasks and meet financial goals. It is also'a quantitative expression of the goals the organization wishes to achieve and the cost of attaining these goals. The act of preparing a budget is called budgeting. The use of budgets to control a firm's activities is known as budgetary control. Budgets and the budgeting process are intertwined with all aspects of management. In addition, to being a plan of operations, a budget plays an important role in allocating resources, coordinating operations, identifying constraints and limitations, and communicating expected actions and results, authorizing activities, motivating and guiding implementation, providing guidelines for control of operations, managing cash flows, and serving as criteria in performance evaluations. In the process of preparing a firm’s budget, managers need to be forward-looking in evaluating upcoming events and situations as they relate to the firm’s strategic goals. Budget preparation allows management the opportunity and time to work out any potential problems that the company might meet in the coming periods. The firm is able to minimize if not totally avoid the adverse effects that anticipated problem could have on operation. Budgeting can also help managers identify current and potential bottleneck in operation. Critical resources can then be mustered to ease any bottleneck in operations and prevent them from becoming obstacles to attaining budgeting goals.100__Chapter 5 Completion of a budget for all units of an organization also mandates coordinating operations among all budgeted units and synchronizing the operating activities of various department. Budgets help firms to run smoother operations and achieve better results, Properly conceived, budgeting can mean the difference between a general drift that may or may’ not lead to a desired goal and a carefully plotted course toward a predetermined objective that holds drift to a minimum. Budgets make the decision-making process more effective by helping managers meet uncertainties. The objective of budgeting is to substitute deliberate, well-conceived business judgment for accidental success in enterprise management. Budgets should not be expressions of wishful thinking but rather descriptions of attainable objectives. IMPORTANCE OF STRATEGY IN BUDGETING As discussed in the earlier chapters, a firm’s strategy is the path it chooses for attaining its long-term goals and mission. It is the starting point in preparing its plans and budgets. For example, a very large and successful Retail Department Store in the Philippines considers itself the leader of top-of-the-line consumer goods (wardrobe, designer bags and shoes, accessories, housewares, and so forth. One of its departments is the Supermarket and Grocery Department, selling food items, fresh and processed and other household needs. Even though this department is a little bit profitable, for competitive reasons, the firm made a strategic decision to leave this line of business. Subsequent budgets of this firm reflect this strategic decision. Formulation of Strategy The process of determining a company’s strategy starts with the assessment of external factors that affect operation and evaluating internal factors than can be its strength and weakness. External factors typically include © Competition © Technical, economic political, regulatory, social and environmental factors A careful examination of such factors can help the firm identify opportunities, limitations and threats.Strategy and Master Budget 101 Internal factors on the other hand, include operating characteristics such as e Financial strength ¢ Managerial talent and expertise e Functional structure, and e Organizational culture Matching the firm’s strengths with its identified opportunities, resources and threats enables it to form: its strategy. Having analyzed external factors surrounding the organization and assessed the internal situations it is in, management can match opportunities with strength and competitive advantages of the firm and determine its strategies and long-term opportunities. Figure 5-1 summarizes the activities involved in the development of a firm’s product strategy. Figure 5-1: Development of a Firm’s Product Strategy Analyze External Factors Economy Finance Politics Management Technology Structure Regulation Morale Society, Environment Culture Competition Identify Opportunities, Recognize Strengths, Limitations and Threats Weaknesses and : Competitive Advantages Match Opportu wi >} Strengths and Competitive Advantages of the Firm Assess Internal Conditions Finalize Strategic Goals and Long-Term Objectives102 Chapter 5 Strategic Goals and Long-Term Objectives An organization presents its strategic goals and long-term objectives through capital budget and master budgets. Strategy provides the framework or parameters within which a long-range plan is developed. A firm’s long-range plan identifies required actions over a 5-year to 10-year period to attain the goals set forth in their strategies. Long Range Planning Long-range planning often entails capital budgeting, which is a process of evaluating proposed major projects such as purchases of new equipment, construction of a new factory, and addition of new products and planning for resource requirements. Capital budgets are prepared to bring an organization’s capabilities into line with the needs of its long-rang plan and long-term forecast. An organization’s capacity is a result of capital investments made in prior budgeting periods. Capital budgeting is discussed in more details in Chapter 13. Short-Term Objectives and The Master Budget Short-term objectives are goals for the coming period, which can be a month, a quarter, a year, or any length of time desired by the organization ‘for planning purposes. A firm determines short-term objectives for the budget period based on strategic goals, long-term objectives and plans, operating results of past periods, and expected future operating and environmental factors including economic, industry and marketing conditions. Figure 5-1 presents the relationship between strategic goals, long-term objectives and plan, short-term goals, budget, operations and control.Strategy and Master Budget _103 Figure 5-2: The Relationship between Strategic Goals, Long-Term Objectives and Plans, Short-Term Goals, Budget, Operations and Control i Strategic Goals x | a Ss of Long-term Plans au ¥ wt Capital Budget 7 Short-Term Objectives |¢« Master Budget Controls104 Chapter 5 THE MANAGEMENT PROCESS OF PREPARING THE MASTER BUDGE} ‘Top Management Involvement For a budget to be effective, top management needs to be involved and show strong interest in budget results. Too much involvement, however, may make the budget and alienate lower managers. The right answer is a good balance of top management involvement with lower-level managers. Top management ensures that budget guidelines are being followed through the budget review and approval process. Active involvement by top management in reviewing and approving the proposed budget is an effective way to discourage lower-level managers from playing budget games (e.g., budgets with easy, target and adding stock to a budget). Budgeting processes usually include formation of a budget committee; determination of the budget guidelines; preparation of the initial budget proposal; budget negotiation, review and approval; and budget revision. Organization for Budget Preparation It is essential that the manager of an entity assigns the most qualified personnel to the preparation of the budget. A budget committee with representation from the different functional areas (marketing, production, finance, and administration) is generally considered an effective body to oversee preparation and administration of the budget. The controller may be selected to serve as head of the committee for two major reasons: (1) Controller’s position is independent from the operating parts of the organization. (2) He has the skills and experiences in coping with the intricacies of setting up a budget. The controller acts as a coordinator in the budgeting operation. He recommends how budgets should be prepared, assembles the budgets, prepares periodic reports showing variances of the actual results from the budgeted results, interprets variances and offers suggestions for improvement whenever possible. The budget committee decides how budgets shall be prepared, passes on the final budget, and settles disputes in one segment of the business and another when differences of opinion arise. The committee also receives budget reports and makes policy decisions with respect to budget revisions and other problems of budget administration.Strategy and Master Budget _105 Budget Guidelines One of the responsibilities of the budget committee is to provide initial budget guidelines that set the tone for the budget and govern budget preparation. All responsibility centers (or budget units follow ‘the initial budget guidelines in preparing their budgets The starting point in developing budget guidelines is the firm’s strategy. In developing the initial budget guidelines, the budget committee also needs to consider development that have occurred since the adoption of the strategic plan; the general outlook of the economy and the market; the goal of the organization for the budgeting period; specific corporate policies such as mandates for downsizing, reengineering, and the operating results of the year to date. The Budget Period As a general rule, the period covered by a budget should be long enough to show the effect of managerial policies but short enough so that estimates can be made with reasonable accuracy. This suggests that different types of budgets should be made for different time spans. A master budget is an overall financial and operating plan for a coming fiscal period and the coordinated program for achieving the plan. It is usually prepared on a quarterly or an annual basis. Long range budgets called capital budgets, which incorporate plans for major expenditures for plant and equipment or the addition of product lines, might be prepared to cover plans for as long as 5 to 10 years. Responsibility budgets which are segments of the master budget relating to the aspect of the business that is the responsibility of a particular manager are often prepared monthly. Cash budgets may be prepared on a day-to-day or monthly basis. Some companies follow a continuous budgeting plan whereby budgets are constantly reviewed and updated. The updating is accomplished, for example, by extending the annual budget one additional month at the end of each month. A review of the budget may also suggest that the budget be changed as a result of changing business and operating conditions.106 Chapter 5 The Initial Budget Proposal Based on the initial budget guidelines, each responsibility center prepares its initial budget proposal. In preparing an initial budget proposal, the following’ factors should be considered by a budget unit. Internal factors: * «Introduction of new products. Adoption of new manufacturing processes. Changes in availability of equipment or facilities. Changes in product design or product mix. Changes in expectations or operating processes of other budget units that the budget unit relies on for its input materials or other operating factors. «Changes in other operating factors or in the expectations or operating processes in those other budget units that rely on the budget unit to supply them components. External factors: * Competitor’s actions. © Changes in the labor market. * Availability of raw materials or components and their prices. * — Industry’s outlook for the near term. Budget Negotiation, Review and Approval, Revision The head of the budget units examines the initial budget proposal to determine whether the proposal is within the budget guidelines. The head also checks to see if the budget goals can be reasonably attained. and in line with the goals of the budget units at the next level up, and the budgeted operations are consistent with the budgeted activities of another budget unit. Negotiation occur at all levels of the organization. As budget units approve their budgets, the budgets go through the successive levels of the organization until they reach the final level, when the combined unit budgets become the budget of the‘organization. The budget committee reviews and gives final approval to the budget. The chief executive officer then approves the éntire budget and submits the budget to the board of directors. Systematic, periodic revision of the approved budget or the use of a continuous budget can be an advantage in dynamic operations because the updated budget provides better operating guidelines. Regular budget revision, however, may encourage responsibility centers not to prepare their budgets with due diligence. Organizations with systematic budget revisions need to ensure that revisions are allowed only if circumstances have changed significantly.Strategy and Master Budget _107 The Master Budget ‘A master biidget is a comprehensive budget for a specific period. it consists of many interrelated operating and financial budgets. Some firms refer to the process of preparing a master budget as profit planning or targeting. Figure 5-3 delineates the relationships among components of a master budget. Figure 5-3: The Master Budget Strategic Goals, Long-Term Objectives, and Long-Range Plan Short-Term Objectives }e——| Capital Budget i > Sales Budget Production Operating Budget ¢ Budget Selling and Administrative Direct Direct Factory Expense Materials Labor | | Overhead Budget Budget Budget Budget ° Cash Budget "Prjected come Sttomart | Frandal Projected Balance Sheet le Budget _| Projected Cash Flow Statement108 Chapter 5 Steps in Developing a Master Budget The major steps in developing a Master Budget may be outlined as follows: 1. Establish basic goals and long-range plans for the company. These will serve as guidelines in the preparation of budget estimates. 2. Prepare a sales forecast for the budget period. Estimate the cost of sales and operating expenses. 4. Determine the effect of budgeted operating results on assets, liabilities and ownership equity accounts. The cash budget is the largest part of this step, since changes in-many asset and liability accounts will depend upon the cash flow forecast. 5. Summarize the estimated data in the form of a projected income statement for the budget period, the projected statement of financial position as of the end of the budget period and the projected cash flow statement. Preparation of Comprehensive Master Budget Illustrated Gilbert Manufacturing Company manufactures a special line of tools. As of December 31, 20X1, the Statement of Financial Position of the firm is as follows: Gilbert Company Statement of Financial Position December 31, 20X1 Assets Equities Current assets Current liabilities Cash P 150,000 Accounts payable P 140,000 Accounts receivable 220,000 Taxes payable 156,000 Inventories $92,000 Current portion of Other current assets 23,000 long-term debt 83,000 Total current assets P_ 985,000 Total current liabilities P 379,000 Long-term liabilities 576,000 Total liabilities P 955,000 Long-term assets Equity Property, plant and Share capital P 360,000 equipment 2,475,000 Retained earnings 4,305,000 Less: Accumulated Total P1,655,000 depreciation 850,000 Net 1,625,000 Total Equities 2,610,000 Total assets 2,610,000 qStrategy and Master Budget _109 The following information is available for the development of its Master Budget for 20X2: Estimated sales: Units Price per unit Finished goods inventory: Beginning Ending Work in process inventory: Raw materials: Materials required per unit of finished product. Beginning inventory Ending inventory Unit Cost Direct labor Overhead is estimated as follows: Variable: Indirect materials and supplies Materials handling Other indirect labor Fixed: Supervisor labor Maintenance & repair Plant administration Utilities Depreciation Insurance Property taxes Other 6,400 P800 900 units @ P500 1,000 Material R 3 units Sunits 2,200 4,000 4,300 4,600 P10 P30 P4146 per unit produced P5.85 per unit produced 9.07 per unit 5.07 per unit 175,000 85,000 173,000 87,000 280,000 43,000 117,000 44,000110 Chapter 5 Marketing and Administrative expenses are budgeted as follows: Variable Marketing Costs: Sales commissions P40.625 per unit sold Other marketing costs P16.250 per unit sold Fixed Marketing Costs: Sales salaries P100,000 Advertising 493,000 Other 78,000 Administrative costs (all fixed): Administrative salaries 254,000 Data processing services 103,000 Legal and other professional fees 180,000 Depreciation - building, furniture . and equipment 94,000 Taxes - other than income 160,000 Other 26,000 Additional information: The -treasurer’s office also provided the following information and estimates: 1) All sales are on account and collections from customers are expected to amount to P5,185,000_, Equipment costing P300,000 with accumulated depreciation of P275,000 will be sold at its net book value. New equipment costing P320,000 will be purchased during the year. Accounts payable will increase by P15,000 and assumed to be for materials purchases only. 4) Income taxes will be provided at an average rate.of 35% of income before taxes while P252,000 will be paid during the year. Dividends amounting to P 140,000 will be paid during the year and the current portion of the long-term debt shall also be settled at the end of the year. Interest rate is 8% per annum. 2 3 5 REQUIRED: Prepare the Master Budget for Gilbert Company for the year ending December 31, 20X2. Based on the above preliminary data, each of Gilbert Company’s budgets will now be discussed and illustrated.Strategy and Master Budget 11 Sales Budget The sales budget showing what products will be sold in what quantities at what prices, is the foundation on which all other short-term budgets are built. The sales budget triggers a chain reaction that leads to the development of many other budget figures in.an organization. The sales budget provides the revenue predictions from which cash receipts from customers can be estimated and supplies the basic data for constructing budgets for production costs and selling and administrative expenses. In short, the sales forecast is the keystone of the budget structure. The accuracy and reasonableness of the sales data will affect the whole budget. The sales forecast is made aftér consideration of the following factors. 1. Past sales volume 2. General economic and industry conditions 3. Relationship of sales to economic indicators 4, Relative product profitability 5. Market research studies and competition 6. Pricing, advertising and other promotion policies 7. Production capacity 8. Quality of sales force 9. Seasonal variations 10. Long-term sales trends for various products For Gilbert Company, the Sales Budget is presented as follows: Schedule I Sales Budget For 20X2 Price Total Sales Units Per Unit Revenue Estimated sales 6,400 800 5.120.000 Production Budget After the sales budget has been set, a decision can be made on the level of production that will be needed for the period to support sales and the production budget can be set as well. The production budget becomes a key factor in the determination of other budgets, including the direct materials budget, the direct labor budget and the manufacturing overhead budget. These budgets in tum are needed to assist in formulating a cash budget.U2 Chapter 5 Using the data from the previously prepared sales budget as well as the inventory summary information, the following production budget is developed. Schedule 2 Production Budget For 20X2 Units to be sold 6400 Add: Desired ending inventory 41000 Total 7400 Less: Beginning inventory 900 Units to be produced 6500 Raw Materials Budget After determining the number of units to be produced, the Raw Materials Purchases can now be prepared, as follows: Schedule 3 Raw Materials Purchases For 20X2 Materials Units required for production R (6500 x 3) 19,500 $ (6500 x 5) 32,500 Add: Desired ending inventory 1,300 4,600 Total units required 20,800 37,100 Less: Beginning inventory 2,200 4,000 Units to be purchased 18,600 33,100, Unit price xP10 x P30 Total purchases 186,000 993.000 Direct Labor Budget The preliminary data show that the budgeted direct labor cost per unit produced is P146. This must have been arrived at after considering such factors as skills level of the workers, labor rate per hour, time requirement, conditions of union contracts, etc, The direct labor is therefore budgeted as follows: Schedule 4 Number of units to be produced 6,500 Multiply by: Direct labor cost per unit P146 Total budgeted direct labor costs 949,000Strategy and Master Budget 113 Overhead Costs Budget Study of past records will show how the cost reacts to changes in volume or in relation to other factors. Some overhead items may be projected on the basis of direct labor hours or on materials costs or on machine hours. The overhead costs budget for 20X2 is illustrated below using the basic information from the preliminary data previously established. Schedule 5 Budgeted Manufacturing Overhead For 20X2 Variable overhead: units needed to produce ‘$500 units Indirect materials and supplies (@P5.85) P 38,000 Materials handling (@ P9.07) 59,000 Other indirect labor (@P5.07) 33,000 Total 430,000 Fixed manufacturing overhead Supervisor labor 475,000 Maintenance & repairs 85,000 Plant administration 173,000 Utilities 87,000 Depreciation 280,000 Insurance 43,000 Property taxes 417,000 Others 44,000 Total 4,001,000 Total manufacturing overhead P4.134,000 Budgeted Cost of Sales The Budgeted Cost of Sales Statement can now be developed using the data from the following: Production Budget Schedule 2 Raw Materials Budget Schedule 3 Direct Labor Budget Schedule 4 Overhead Cost Budget Schedule 5 Budgeted Statement of Cost of Sales Schedule 6114__ Chapter 5 Schedule 6 Budgeted Statement of Cost of Sales For 20X2 Beginning work in process inventory Manufacturing costs Direct materials Beginning inventory [(2200 R @ P10) + (4000 S @P30)) Purchases (Schedule 3) Total Less: Ending inventory [(1300 R @ P10) + (1600 S @ P30) Total direct materials cost Direct labor (6500 @ P146) Manufacturing overhead (Schedule 5) Total manufacturing cost Less: Ending work in process inventory Cost of goods manufactured ‘Add: Beginning finished goods inventory (900 @ P500) Total available for sale Less: Ending finished goods inventory (1000 @-P500) Cost of sales P 142,000 4,479,000 P1,321,000 151,000 P4,170,000 949,000 1,131,000 P3,250,000 "3,250,000 450,000 P3,700,000 500,000 P3,200,000Strategy and Master Budget 115 Marketing and Administrative! Expense Budget As with overhead costs, marketing and administrative expenses are also made up of fixed and marketing variable components. The marketing and administrative expense budget for 20X2 is shown on the next page. Previously provided data are used. Schedule 7 Budgeted Marketing and Administrative Costs For 20X2 Variable marketing costs Sales commission (6400 @ P40.625) P 260,000 Others (6400 @ P16.25) 104,000 Total P_ 364,000 Fixed marketing costs Sales salaries P 100,000 Advertising 193,000 Others 78,000 Total P 374,000 Total marketing costs P_ 735,000 Administrative costs (all fixed) . Administrative salaries P 254,000 Data processing services 103,000 Legal and other professional fees 180,000 Depreciation - building, furniture and equipment 94,000 Taxes - other than income 108,000 Others 26,000 Total 765,000 Total marketing and administrative costs P1,500,000116 Chapter § Cash Budget Cash Receipts Normally, the bulk of a firm’s cash receipts comes from customers. The possibility of cash from other sources (such as additional investments, sales of assets, borrowings) should likewise be considered when cash receipts are being budgeted. Cash Disbursements Data converted from individual budgets previously illustrated supply the basic information for the cash disbursements budget. However, various adjustments and additions will have to be made when preparing the budget for prepayments, accruals as well extraneous items (such as the purchase of new equipment, dividend payment) that do not show up in any of the individual budgets already prepared. If the financial policy of the company requires that a minimum cash balance “be maintained at all times, the cash budget must be altered to accommodate bank loans and their repayment. Using the data collected in the various budgets and the information that has been previously provided, the following Cash Budget Statement is developed. Schedule 8 Gilbert Manufacturing Company Cash Budget For the Budget Year Ending December 31, 20X2 Cash balance, Jénuary 1, 20X1 P_ 150,000 Add: Estimated receipts Collections from customers 5,185,000 Sale of assets 25.000 Total 5,210,000 Total cash available 5,360,000 Less’ Estimated disbursements Payments for material purchases P1,164,000 Direc labor “349,000 Manufacturing overhead 851,000 Marketing & Administrative expenses, Interest 4,458,000 Payments for income tax "952,000 Dividends 440,000 Reduction infong term debt 83,000 \cquisition of new assets 0, Total disbursements 5 7 oo Cash balance, December 31 ‘000Strategy and Master Budget 117 Budgeted Income Statement After the cash budget has been completed, Gilbert Company prepares the budgeted income statement showing the net income that is to be expected during the budget period. The information needed to prepare the budgeted income statement comes from the previously provided preliminary data as'well as from the company’s other budgets. Schedule 9 Gilbert Manufacturing Company Budgeted Income Statement For the Budget Year Ending December 34, 20X2 Sales (Schedule 4) P5,120,000 Less: Cost of sales (Schedule 6) 3,200,000 Gross profit 1,920,000 Less: Marketing and administrative costs (Schedule 7) 4,500,000 Net operating profit P 420,000 Less: Interest expense 52,000 * Net income before taxes P_ 368,000 Less: Provision for income taxes (35%) 428,000 * Net income after taxes 240,000 * * Rounded off. Budgeted Statement of Financial Position The budgeted statement of financial position is developed by beginning with the current statement of financial position and adjusting it for the data contained in the other budgets. Gilbert Company’s budgeted statement of financial position is presented below: Schedule 10 Gilbert Manufacturing Company Budgeted Statement of Financial Position December 31, 20X2 Assets Current assets Cash (Schedule 8) P 143,000 Accounts receivable 455,000 Inventories 661,000 Other current assets 23,000 Total current assets 2 972,000118 _ Chapter 5 Long-term assets Property, plant and equipment 2,495,000 Less: Accumulated depreciation 949,000 Net 1,546,000 Total assets Equities Current liabilities Accounts payable P. 155,000 Taxes payable 32,000 Current portion of long-term debt Total current liabilities P 187,000- Long-term liabilities 576,000, Total liabilities 763,000 Equity Share’ capital P 350,000 Retained earnings 4,405,000 Total Equities : 2,518,000 Budgeting in Service Industries A service organization achieves its budgeted goals and fulfills its mission through providing services. Budgeting for service firms, similar to budgeting for manufacturing or merchandising firms, plans for the resources available from operation and the required resources in operations to fulfill budgeted goals. The difference is in the absence of products or merchandise purchase budget and their ancillary budget. An important focal point in its budgeting is personal planning. A service frim must ensure that. it has personnel with the appropriate skills and competence to perform the services required for the budgeted sales revenue. Budgeting in Not-For-Profit Organization A not-for-profit organization’s objective is to provide services efficiently and efféctively as mandated in its charter, while not spending more than the allowed expenditure level. The objectives of not-for-profit organizations such as governments, , state universities or colleges, secondary and primary schools,. charity organizations, museums, and foundations are different froin those of for-profit organizations.Strategy and Master Budget_119 With no clear standard by which to measure performance in delivering services, and with a clear mandate not to exceed budgeted expenditures, the master budget of a not-for-profit organization often becomes an authorization document for allowable expenditures and activities. In effect, the budget for a not-for-profit organization often becomes the source of both the power and limitations of the budgeted unit. Budgeting in International Setting Subsidiaries or subdivisions of a multinational firm often have their own budgets. They must follow the firm’s budget procedure and coordinate their budgets with other divisions of the firm. A Philippine subsidiary of an international firm in Belgium, for example, must negotiate its budget with the European headquarters or the business unit to which the subsidiary belongs. The superior divisions then approve the budget in sequence until the final approval by the corporate budget committee. Alternative Approaches in Budgeting Zero-Base Budgeting Zero-base budgeting is a budgeting process that requires managers to prepare budgets from a zero base. A typical and traditional budgeting process is an incremental process that starts with the current budget. The process assumes that most, if not all, current activities and functions will continue into the budget period. the primary focus in a typical budgeting: process is on changes to the current operating budget. A zero-base budgeting process on the other hand allows no activities or functions to be included in the budget unless managers can justify their needs. Zero-base budgeting requires managers or budgeting teams to perform in-depth reviews and analyses of all budget items. Such a budgeting process encourages managers to be aware of activities or functions that have outlived their usefulness or have been a waste of resources. A tight, efficient budget often results from zero-base budgeting. Activity-Based Budgeting Activity-based budgeting (ABB) is a budgetirig process based on activities and cost drivers of operations. ABB starts with the budgeted output and segregates costs required for the budgeted output into homogenous activity cost pools such as unit, batch, product-sustaining activity cost pools based on similarity of their resource and activity consumption cost drivers.120 Chapter 5 Activity-based budgeting can be a simple extension of a firm’s activity-based costing systems that has grouped its costs into activity cost pools. The firm needs to review the appropriates of its activity cost pools and accuracy of its activity costs for the budget period, however, before employing them in budgeting. Either internal or external relevant operating factors may have changed and rendered the data from the current activity-based costing inaccurate or irrelevant, especially when a firm has experienced inexplicable variances. Kaizen (Continuous Improvement) Budgeting Kaizen budgeting is a budgeting approach that explicitly demands continuous improvement in operation processes and incorporates the improvements in the budget. A firm using kaizen budgeting prepares budgets based on the desired future operating processes for the budget period. This is an improvement over the current operating processes, rather than the continuation of the current practices as is often the case in traditional budgeting. It will be noted that continuous improvement (kaizen) has become a common practice for firms operating in today’s globally competitive environment. Kaizen budgeting begins by analyzing practices to identify areas for improvement and determine expected changes needed to attain the desired improvements. Budgets are prepared based on improved practices or produces. As a result, budgeted cost often is lower than those in the preceding period, and the firm expects to be able to manufacture products or render services at a lower cost. ETHICAL ISSUES IN BUDGETING Ethical issues in budgeting include preventing concealment of information, avoidance of having a higher budget goal, inclusion of budget slack, and spending the budget to avoid having it cut back. Behavioral issues in budgeting encompass the difficulty level of budget targets, the drawbacks and advantages of authoritative and participate budgeting processes, the extent of involvement of top management in budgeting, and the role of the budget department or controller on budgeting. Ethical issues permeate all aspects of budgeting. A significant portion of information used in budgeting is provided by people whose performance is evaluated against the budget. Employees breach the code of ethics if they deliberately furnish data for budgeting purposes that would lead to lower performance expectations.Strategy and Master Budget 124 Including budget slack, or padding the budget, is the practice of knowingly including a higher amount of expenditure in the budget than managers truly feel is needed. Managers often justify such practices as insurance against uncertain future events, Spending the budget is another serious ethical issue in-budgeting. Managers may believe that if they do not use up all the budgeted amounts, future budgets will be reduced. To avoid cuis in their budgets, managers may resort to wasteful spending to exhaust the remaining budgeted amount before the end of the period. As a result, precious resources are wasted on activities that yield little or no benefit to the firm. Or necessary assets are acquired to use up remaining funds. Furthermore, time is wasted oh unproductive efforts in trying to use up the budget. Goal Congruence Goal congruence ‘is consistency between the goals of the firm and the goals of its employees. A perfect goal congruence is the ideal for which many firms strive. Realistically, perfect goal congruence almost never exists because resources for satisfying short-term goals of individuals are often in conflict with those of the firm. For example, employees desire to earn a high salary with minimum effort, whereas a firm seeks to pay employées the lower possible compensation while receiving maximum efforts from them. A budget that aligns the goals of the firm with those of its employees has much better chance of leading to successful operations. One approach that encourages goal congruence is avoiding authoritative budgeting and using participative budgeting as much as possible. An employee identifies a budget as their own in participative budgeting, the-goals of the firm and those of its employees become the same. Authoritative or Participative Budgeting Budgeting processes are either top down or bottom up. Authoritative budgeting in a top-down budgeting process top management prepares budgets for the entire organization, including those for lower-level operations. A participative budgeting process, is a bottom-up approach that involves the people affected by the budget, including lower-level employees, in preparing the budget.122 Chapter 5 Authoritative budgeting provides better decision-making control than participative budgeting. Top management sets the overall goals for the budget period and prepare a budget for operations to attain the goals. An authoritative budget, however, often lacks commitment on the part of the lower-level managers and workers responsible for the implementation of the budget. A participative budget is a good communication device. The process of preparing a participative budget often gives top management a better grasp of the problems their people face and enables employees to gain a better understanding of the quandarigs top management deals with. A participative budget is more likely to gain the employees’ commitment to fulfill the budgetary goals. Unless properly controlled, however, a participative budget may lead to easy budget targets or targets not in compliance with the organization’s strategy or budget targets. An effective budgeting process therefore usually combines both top-down and bottom-up budgeting approaches. Divisions prepare -their initial budgets based on the budget guidelines issued by the firm’s budget committee. Senior managers review: and make suggestions to the proposed budget before sending it back to the divisions for revisions. The final budget usually from more participation, not enforced negotiations.