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PART 1: FINANCIAL REPORTING, PLANNING,

PERFORMANCE, AND CONTROL

STUDY UNIT EIGHT

B. Planning, Budgeting and Forecasting
(30% - Levels A, B, and C)

PREPARED BY
sameh Y. El lithy, CMA, CIA.

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© Sameh . Y.El lithy, CMA, CIA. Forecasting
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Budgeting Concepts

a. Operations and performance goals

b. Characteristics of a successful budget process
c. Resource allocation
d. Other budgeting concepts

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Budget
 A schedule of planned or expected revenues, expenses, assets, and
liabilities. A budget provides guidelines for future operations and
appraisal of performance. (Also called Profit Plan.) ICMA

Budget Process
The process used by an organization to
prepare a plan for a future period, allocate
resources, determine revenues and
expenditures, and compile reports pertaining
to that plan.

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Advantages of Budget
A budget provides the foundation for
planning, because a successful budget is
created by a process of aligning the
company’s resources with its strategy.
Budgets are a big part of most
management control systems. When
administered wisely, a budget becomes a
planning tool, a control tool, a
motivational tool, and a communication
tool.
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Sec.B. Planning, Budgeting and

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Characteristics that define Successful
Budgeting Processes
Budget period
Management must consider what the most
suitable length of time would be to suit the
needs of the organization.
Participants in the budget process
three groups make or break a budget:
the board of directors, top management, and the budget
committee.
Middle and lower management also play a significant role,
because they create detailed budgets based on upper
management’s plan.
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Characteristics that define Successful
Budgeting Processes
Basic steps in budgeting
the steps that responsibility centers take in
preparing their budgets include the initial
budget proposal, budget negotiation, review
and approval, and revision.
Use of cost standards
Organizations set different types of standards
that they strive to achieve in order to meet
their goals.

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Three interrelated environments affect
management's planning and budgeting
 The Industry in which the company operates includes the
company's current market share,
 The country or the national environment, in which the
company operates: includes governmental regulatory
measures, the labor market, and the activities of competitors.
 For instance, if input costs are rising in a firm's industry, the budget must
reflect that reality; profit margins and cash flows will not be the same as
in prior years. Also, a company in, or near, bankruptcy will face a different
financial situation than would the market leader.
 And the wider macro environment in which the company
operates:
 For instance, if the economy is entering a period of lower demand, a
manufacturer will not project increased sales. If costs are not changeable,
the company may budget losses for the short-term to hold on to market
share.
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Methods of budget preparation -

Authoritative or Participative
Budgeting?

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Authoritative or Participative
Authoritative (top-
down) Budgeting
A budgeting process where
all budgets for the
organization are prepared
by top management,
including budgets for
lower-level operations.
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Participative Budgeting
A type of budgeting that
allows managers to
participate in the
preparation of budgets.
(Also called Bottom-Up.)
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Authoritative or Participative

The ideal process combines the features of each

and falls somewhere between these methods.
 The five steps in a combined approach include:
 Budget participants are identified, including representatives of all levels
of management as well as key employees with expertise in particular
areas.
 Top management communicates the strategic direction to budget
participants.
 Budget participants create the first draft of their budget.
 Lower levels submit budgets to the next higher level for review in an
iterative process stressing communication in both directions.
 Rigorous but fair review and budget approval by top management sets the
final budget.

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Advantages and Disadvantages of Participative

Budget Development

A good communication Budget targets that are

device.
A budget is potentially a
good motivational tool.
A participative budget is
more likely to be
achievable.
Greater accuracy of
budget estimates.
Extensive coordination
between departments.
© Sameh . Y.El lithy, CMA, CIA.
too easy to achieve.
Participative budget can
lead to targets not in
compliance with the
organization's strategy.
Time-Consuming.
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Advantages and Disadvantages of Authoritative

Budget Development

Better control. Lacks commitment (“buy-

Facilitates the
implementation of
strategic plans.
 Reduces the time
required for budgeting.
Increases coordination of
divisional objectives.
Budgetary slack is not a
problem.
© Sameh . Y.El lithy, CMA, CIA.
in”) of lower-Level
managers,
May result in a budget
that is not possible to
achieve, May limit the
acceptance of proposed
goals and objectives,
Reduces the
communication between
employees and
management..
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The Role of Top Management in Successful Budgeting

Top management is ultimately responsible for the

budgets.
The primary means top managers have of exercising
this responsibility is to ensure that all levels of
management understand and support the budget
and the overall budget control process.
Senior management must still participate in the budget
process to ensure that the combined objectives of the
various departments are consistent with profitability
objectives of the company and managers pursue
objectives consistent with those set by top
management.
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The Right Approach is a Good Balance

Top managers Lower-level managers

 should have a more are more familiar with
strategic perspective day-to-day operations than
than lower level managers. top managers.
 The single most important
factor in assuring its success
is for upper management to
demonstrate that they take the
project seriously and consider
it vital to the organization’s
future.
 Greatest amount of positive motivation and goal congruence can be achieved
if the firm have the divisional and senior management jointly develop goals
and the divisional manager develop the implementation plan.
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Behavioral Issues in Budgeting

Budgetary Slack
Intentional underestimation of revenues and/or
overestimation of expenses.
Adverse effects of Budgetary Slack
Budgetary slack misleads top management,
which leads to inefficient resource planning and allocation and poor
coordination .
wastes resources and could lead employees to make half-
hearted efforts.
result in a very inaccurate master budget.
misrepresent the true profit potential of the company.

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How companies avoid problems of budgetary slack?

Using multiple indicators when evaluate

managerial performance
Reward managers based on the subsequent
accuracy of the forecasts used in preparing
budgets.
Holding in-depth reviews
Use the budget/profit plan as a planning and
control tool but not for managerial performance
evaluation.

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Budgeting Process

The process usually includes

the formation of a budget committee;
 determination of the budget period;
specification of budget guidelines;
preparation of the initial budget proposal;
budget negotiation, review, and approval;
and budget revision.
 Top management provides final budget approval.

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Budgeting and Responsibility Accounting

Responsibility accounting is a system that measures

the plans, budgets, actions, and actual results of each
responsibility center.
A responsibility accounting system could either
exclude all uncontrollable costs from a manager’s
performance report or segregate
Cost Standards such costs from the
in Budgeting
controllable costs.
A manager should not be evaluated on costs that are out of
his or her control.
It is also important to recognize that
 fixed costs and indirect costs are not always uncontrollable,
 and variable costs and direct costs are not always controllable.

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Cost Standards in Budgeting

Standards are any carefully determined

price, quantity, service level, or cost.
Used in the budgeting process to align costs that an
entity expects to incur with the final budget.
Assists in performance evaluation.
Allows employees to better understand what is
expected of them.
Permits development of flexible budgeting.

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Steps to be taken in Developing Standards for DM

Direct materials standards are determined by quality,

quantity, and price objectives.
Quality is determined first to align with the company’s
strategy (price leader, innovator, etc.).
Once the quality is determined and standards have allowed
for losses, spoilage, scrap, and waste, the quantity can be
determined to align with management’s estimates of
demand.
After quantity is determined, a price is set by selecting
vendors in the supply chain that align with the company
strategy

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Steps to be taken in Developing Standards for DL

The quality of the workforce should be determined

based on the strategic goals of the company.
Based on the quality of the workforce, the organization
can align the amount and price that the labor will
cost.
Direct labor standards are adjusted for expected
breaks, downtime, and spoilage.
 Productivity/Learning should be factored into standard setting and
variance analysis

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Ideal/theoretical or Currently attainable (practical)
Standards
Theoretical (Forward-looking
goals)
 currently attainable only if
all circumstances result in
the best possible outcome.
Work into a continuous
improvement strategy and
total quality management
philosophies.
allow for no work delays,
interruptions, waste, or
machine breakdowns.
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Practical/Currently
attainable (Closer to
historical standards)
attainable by properly
trained individuals.
can be attained by efficient
efforts.
allow for normal work
delays, spoilage, waste,
employee rest periods, and
machine downtime.
better motivating target for
manufacturing personnel.
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Authoritative or Participative

A firm can use either an authoritative or a participative

procedure in setting standards.
An authoritative standard is determined solely or
primarily by management.
In contrast, a participative standard calls, throughout
the standard-setting process, for active participation of
employees affected by the standard.

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Advantages and Disadvantages of Participative

Standard-Setting

Encourages employees to May not support

have a sense of achievement of the firm's
ownership. strategic goals.
Result is an acceptance Costly in terms of time
of, and commitment to, and money.
the goals expressed in
the budget.

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Advantages and Disadvantages of Authoritative

Standard-Setting

Proper consideration of be less likely to be

all operating factors. accepted.
Ensuring total Reduce motivation
consistency across all
functional areas.
less complex and time-
consuming

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Sources for Standards Setting

 Standard costs are derived from general standards for operations. Several
resources are used in determining standards for operations. These are;
 Activity analysis,
 Identifies, codifies, and analyzes the activities needed to finish a job or operation.
 most accurate way of determining standard costs
 Activity analyses in activity-based costing are the most thorough costing method—and are
the most expensive to implement.
 Historical data,
 may perpetuate past Inefficiencies, does not incorporate continuous
Improvements
 is relatively inexpensive but is less reliable than activity analysis
 Benchmarking
 help a firm maintain its competitive edge

Last updated 24/Apr./17

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End

Sec.B. Planning, Budgeting and

© Sameh . Y.El lithy, CMA, CIA. Forecasting