Managerial Accounting
Class Notes and Lecture Outline
Operations Budgeting 
What is Budgeting?
  • budgeting defines the planning and forecasting of future business operations in quantitative terms
  • establishes objectives for revenue inflows and cost outflows
  • provides guidelines for future operations
  • serves as a basis for performance appraisal
The 3 Goals of Budgeting
  1. provide organizational estimates of revenues, expenses, human resource needs, and equipment requirements
  2. provides the basis to develop coordinated management procedures and policies for both the short term and the long term
  3. provides methods of control for comparison and evaluation of actual operating results
Types of Budgets
  1. Capital Budget
    • this budget considers balance sheet items and long-range expenditures projected to improve operating capacity and efficiency
  2. Operating Budget
    • projects sales revenues and operating costs over a specified operating period
    • note:  this results in a projected income statement also called pro forma income statement
  3. Departmental Budget
    • forecasts revenues and operating expenses for a specific profit center
  4. Master Budget
    • comprehensive budget that includes all of the operating departments or division of the organization
  5. Fixed Budget
    • forecasts 1 level of activity and shows a static projection of estimates forecasted
    • main disadvantage of a fixed budget -- there is no plan in place if actual revenues and costs differ from the forecast
  6. Flexible Budget
    • forecasts several levels of operating activity for the coming period
  7. Short Term Budget
    • 1 year or less
  8. Long Term Budget
    • greater than 1 year
    • considers the major future plans of the organization
Advantages and Disadvantages of Budgeting
  • advantages
    1. encourages participation and enhances communication among management, employees, and customers
    2. encourages the development of potential courses of action for evaluation and consideration
    3. allows comparison between the standards developed and actual results
    4. may provide a variety of different operating scenarios
    5. forces the organization to look into the future
    6. requires those involved to be aware of the internal and external factors affecting the organization
  • disadvantages
    1. the time and resulting costs in preparing the budget may be considerable
    2. based largely on "unknown" information -- our best "guesstimates"
    3. may require the use of confidential information
    4. there could be a tendency to "spend to the budget"
The Budgeting Cycle
  1. establish attainable and reasonable goals and objectives
  2. create a plan to reach those goals and objectives
  3. compare the actual results to the budgeted results 
  4. identify problems areas and analyze the variances
  5. take action to correct unfavorable variances
  6. always seek new techniques and procedures that will improve the effectiveness of the budgeting process (this creates a dynamic process)
Limitations to Budget Forecasting Techniques
  1. the results are only as good as the forecasted data used
  2. mathematical approaches cannot substitute for individual judgment and experience
  3. mathematical approaches may not consider certain variables controllable by management
  4. the longer the time horizon budgeted the greater is the chance for forecasting error
  5. historical data may not be a good predictor of future activity levels
Developing The Pro Forma Income Statement
  • estimate revenue levels by department
    • past revenue figures; anticipated trends; competitive factors
    • economic factors; limiting factors
  • deduct direct operating expenses for each department
    • usually based on historical %
    • with labor, develop staffing schedules
  • combine departmental operating incomes and deduct undistributable expenses to arrive at net income
    • many of these fixed costs are called discretionary expenses
    • distribute unallocated expenses as a ratio of revenues
Zero Based Budgeting  (ZBB)
  • technique used to control undistributed expenses
  • ZBB requires that each budgeted amount be justified
  • key element is the decision unit process:
    • establish decision unit
    • determine unit’s objectives
    • justification of the unit’s continuation
    • list alternative ways to achieve goals
    • recommend one alternative
    • develop budget for different levels
    • rank the different decision units
  • advantages of ZBB
    • concentrates on the $ cost and not broad %
    • can reallocate funds to areas providing the greatest benefit
    • provides quality information to the operation
    • obliges management to identify inefficient functions
    • reduce areas of duplication or overlap
  • disadvantages of ZBB
    • implies that the traditional budgeting process is not adequate
    • time, effort, paperwork, and cost
    • may be unfair to some department heads who are not as capable as others in defending their budgets
Variance Analysis
  • process of analyzing variances in order to give management more information about the causes of the variance
  • a variance is the difference between budgeted and actual results
  • we can classify this difference as:
    • favorable
    • unfavorable
  • the variance usually made up of 2 components
    • price (or cost) variance
    • quantity variance
  • can be used for revenues and expenses
  • variance analysis provides additional information that is of help identifying causes of these differences
  • 3 major types
    1. revenue variance analysis
      revenue variance graph

    2. cost of goods sold variance analysis
      cost variance graph

    3. variable labor variance analysis
      labor variance graph

  • Moving Averages
    • attempt to remove random variations
    • gives equal weight to each of the periods
    • a large number of periods (n) results in a forecast that reacts slowly
    • current forecast is based on past information
  • Regression Analysis
    • assumes a linear relationship between 2 variables
    • Y = mX + b
    • Y is called the dependent variable
    • X is called the independent variable
    • we use this relationship to forecast the value of the Y variable

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this page is maintained by Reed Fisher
last updated January 15, 2011