CHAPTER 10 Budgetary Planning and Control Slide 10-2 Budgetary Planning and Control  Budgets are the formal documents that quantify a company’s plans for achieving its goals  For many companies, the entire planning and control process is built around budgets Slide 10-3 Learning objective 1: Discuss the use of budgets in planning and control Use of Budgets in Planning and Control  Planning  Budgets enhance communication and coordination  The process of developing a formal plan forces managers to consider their goals and objectives and to specify means of achieving them  Budgets become the vehicle for communicating information about where the company is heading Slide 10-4 Learning objective 1: Discuss the use of budgets in planning and control Use of Budgets in Planning and Control  Control  Budgets provide a basis for evaluating performance  Control makes sure the company is heading in the proper direction and operating efficiently  To control a company, it is essential to assess the performance of managers and their operations for which they are responsible Slide 10-5 Learning objective 1: Discuss the use of budgets in planning and control Use of Budgets in Control  Often performance evaluation is carried out by comparing actual with planned or budgeted performance  Significant deviations from planned performance associated with three potential causes: The budget was poorly conceived Conditions have changed Slide 10-6 Managers have done a particularly good or poor job managing operations Learning objective 1: Discuss the use of budgets in planning and control Test Your Knowledge Which of the following statements regarding budgets is false? a They are formal documents that quantify a company’s plans b They enhance communication and coordination c They are useful in planning but not in control d They provide a basis for evaluating performance Answer: c They are useful in planning AND in control Slide 10-7 Learning objective 1: Discuss the use of budgets in planning and control Developing the Budget  Budgets are prepared for:  Departments  Divisions of a company  For the entire company  Often the group within a company that is responsible for approval of the various budgets is the budget committee Slide 10-8 Learning objective 1: Discuss the use of budgets in planning and control Developing the Budget  The budget committee consists of senior managers  The budget committee works with departments to develop realistic plans that are consistent with overall company goals  In some cases the budget committee may impose a budget without soliciting input from department managers Slide 10-9 Learning objective 1: Discuss the use of budgets in planning and control Developing the Budget  In a top-down approach budgets are developed at higher operational levels without substantial input from lower level managers  In a bottom-up approach, lower level managers are the primary source of information used in setting the budget Slide 10-10 Learning objective 1: Discuss the use of budgets in planning and control Static and Flexible Budgets  In evaluating performance, care must be taken to make sure that the level of activity used in the budget is equal to the actual level of activity  A static budget is not adjusted for the actual level of production  A more appropriate analysis would make use of a flexible budget Slide 10-51 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Flexible Budgets  A flexible budget is a set of budget relationships that can be adjusted to various activity levels  Thus, flexible budgets take into account the fact that when production increases or decreases, variable costs can change  Fixed costs, however, stay the same Slide 10-52 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Flexible Budget Slide 10-53 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Test Your Knowledge A budget is not adjusted for the actual level of production a b c d Static Flexible Pro forma None of the above Answer: a Static Slide 10-54 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Investigating Budget Variances  Significant deviations from the budget, called budget variances, may have three causes The budget may not have been well conceived Conditions may have changed Managers may have performed their jobs particularly well or poorly Slide 10-55 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Investigating Budget Variances  Using a management by exception approach, only exceptional variances are investigated  Generally, variances that are large in absolute dollars or relative to budgeted amounts are considered exceptional  It is important to point out that both exceptional “unfavorable” and exceptional “favorable” variances should be investigated Slide 10-56 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets “Unfavorable” Budget Variance Slide 10-57 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Conflict in Planning and Control Uses of Budgets  Budgets are used for both planning and control  With respect to planning, they communicate company goals and help coordinate various activities  With respect to control, they focus the attention of managers on meeting or beating budget targets  There are inherent conflicts when budgets are used for both planning and control Slide 10-58 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Issues With Budget-Based Compensation  The following slide helps understanding of the two related problems  The illustration shows a common budget based compensation scheme in which a manager receives a “hurdle” bonus once a target is hit  Performance better than 80% of budgeted profit results in additional “variable” bonus Slide 10-59 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Common Budget-based Compensation Scheme Slide 10-60 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Issues With Budget-Based Compensation  The first problem is that managers have incentive to pad a budget and create budget slack  Budget slack is a budget with targets that are easy to achieve  The lower the budget target, the more likely it is that managers will receive the hurdle and variable bonus  Managers can create slack by lowering sales and increasing cost forecasts Slide 10-61 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Issues With Budget-Based Compensation  The second problem relates to the fact that managers who are evaluated may have an incentive to shift income from one period to another  Consider a manager who estimates that it is unlikely that the target will be met  The manager has an incentive to shift income from a future period to the current period Slide 10-62 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Issues With Budget-Based Compensation  The best that can be done to mitigate the conflict between the planning and control uses of budgets is to assure managers that their performance in comparison to the budget will be fairly evaluated and compensated  Managers should be confident that they will be allowed to comment on the real causes of budget variances and tell their side of the story Slide 10-63 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Budget Padding Slide 10-64 Learning objective 3: Explain why flexible budgets are needed for performance evaluation, and discuss the conflict between the planning and control uses of budgets Copyright © 2016 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Slide 10-65 ... in the first quarter? a 14,000 units b 16,000 units c 10, 800 units d 12,000 units Answer: c 10, 800 units = 10, 000 + 2,800 – 2,000 Slide 10- 22 Learning objective 2: Prepare the budget schedules... finished goods = 10% of next quarter’s sales (25,000 X 10% = 2,500)  Budgeted unit sales,Q1 = 21,000 units  Budgeted unit sales, Q2 = 25,000 units  Beginning inventory Q1 = 2 ,100 units  Budget.. .CHAPTER 10 Budgetary Planning and Control Slide 10- 2 Budgetary Planning and Control  Budgets are the formal documents that