CHAPTER TWO

Master Budget and responsibility

of accounting
 2.1.INTRODUCTION
• Budgets play a crucial role in businesses.
• Without budgets, it’s difficult for managers and their
employees to know whether they’re on target for their
growth and spending goals.
2.2.THE FUNDAMENTALS OF BUDGETING
 Budget –is defined & expressed in different ways for
example:
• It is a pre plan of action for a definite period of time.
• According to CIMA (Chartered Institute Management
Accountant); budgeting –is a plan quantified in monetary
terms prepared & approved prior to a definite period of
time, usually showing planned income to be generated
or/and expenditures to be incurred during the period &
capital to be employed to attain objectives.
 From this definition we can understand that budget is
characterized as follows:
• It is a primary for planning & controlling device.
• It is prepared in monetary terms.
• It is prepared for a definite period of time.
• It shows planned income & expenditures.
• It is used to implement policy of management.
• A budget is a comprehensive formal management
plans expressed in quantitative terms, describing the
expected operations of an organization over some
future time period.
• Therefore, budget deals with a specific entity, covers a
specific future time period and is expressed in
quantitative terms.
• Budget entity - A specific budget must apply to a clearly
defined accounting entity.
• For budgeting purpose the entity may consist of a small
part of a business, a single activity, or a specific project.
• The concept of a budget entity applies to individuals as
well.
• Future time period –Many financial figures are meaningless
unless they are couched in some time references.
• For example, income statements are annual, quarterly, or
monthly.
• A job offer of Br. 40,000 is of little value without knowing if
the figure represents pay for a month, a year, a lifetime, or
some other time period.
• We might assume the Br. 40,000 is annual salary.
• In accounting, however, time reference should be clearly
stated.
• Budgets should express the expected financial
consequences of programs and activities
planned for a specific period of time.
• Annual budget are widespread.
• In addition to annual budgets, budgets for
many other time periods are prepared.
• The planning horizon for budgeting may vary
from one day to many years.
• For example, master budget usually cover 1
month to 1year where as long-range plan are
prepared for 2 to 10 years.
 2.3. STRATEGIC PLANS AND OPERATING PLANS
•

• Budgeting is most useful when it is integrated with a company’s

strategy. Strategy specifies how an organization matches its own
capabilities with the opportunities in the marketplace to accomplish
its objectives.
 In developing successful strategies, managers consider questions
such as the following:
• What are our objectives?
• How do we create value for our customers while distinguishing
ourselves from our competitors?
• Are the markets for our products local, regional, national, or global?
What trends affect our markets? How are we affected by the
economy, our industry, and our competitors?
• What organizational and financial structures serve us best?
• What are the risks and opportunities of alternative strategies, and
what are our contingency plans if our preferred plan fails?
• A company, such as company “A”, can have a
strategy of providing quality products or
services at a low price.
• Another company, such as company “B”, can
have a strategy of providing a unique product
or service that is priced higher than the
products or services of competitors.
• strategic plans are expressed through long-
run budgets and operating plans are
expressed via short-run budgets.
• Short-term planning –is the process of deciding what
objectives to pursue during a short, near-future period,
usually one year, and what to do to achieve those
objectives. The typical short-term budget covers one
year and is broken down into monthly or quarterly
units.
• Another method frequently used to prepare a short-
term budget is the continuous budget. This kind of
budget starts with an annual budget broken down into
12 monthly units. As each month arrives, it is dropped
from the plan and replaced by a new month so that at
any given time, the next 12 months are always shown.
Using this technique, a firm always has guidance for
the full following year. When a continuous budget is
not used, a firm will have guidance for only a month or
two as it approaches the end of its budgetary period.
• Long-term planning –also known as strategic planning
is the process of setting long-term goals and
determining the means to attain them.
• Short-term planning is concerned with operating
details for the next accounting period, but long-term
planning addresses broad issues, such as new product
development, plant and equipment replacement, and
other matters that require years of advance planning.
• For example, short-term planning in the automotive
industry would be concerned with which and how
many of the current year’s models to manufacture,
while long-range planning would focus on new model
development and major changes, as well as equipment
replacements and modifications.
• The time frame for long-range planning may
extend as far as 20 years in the future, but its
usual range is from 2 to 10 years.
• An important part of long-term planning is the
preparation of the capital budget, which
details plans for the acquisition and
replacement of major portions of property,
plant, and equipment
• Quantitative plan –Often budgets contain materials
describing the various programs and activities planned
by the company.
• All planned projects or activities for the organization
are reduced to the common denominator of money
and other quantitative measures, such as units of input
or output.
2.4. PRINCIPAL ADVANTAGES OF BUDGETING
•

• As noted earlier, a budget is a detailed plan expressed

in quantitative terms that specifies how resources will
be acquired and used during a specific period of time.
• The act of preparing a budget is known as budgeting.
The use of budgets to control a firm’s activities is called
budgetary control.
•
• Companies realize many benefits from a budgeting
program.
• Among these benefits are the following:
• Requires periodic planning.
• Fosters coordination, cooperation, and communication.
• Provides a framework for performance evaluation.
• Means of allocating resources.
• Satisfies legal and contractual requirements.
• Created an awareness of business costs.
• Periodic Planning (Formalization of Planning) –The most
obvious purpose of a budget is to quantify a plan of action.
• Coordination, Cooperation and Communication –Planning
by individual managers does not ensure an optimum plan
for the entire organization.
• Performance Evaluation or Framework for Judging
Performance –Budgets are estimates of future events, and
as such they serve as estimates of acceptable performance.
• Comparing actual result against budgeted results helps
managers to evaluate the performance of individuals,
departments, or entire companies.
• Means of Allocating Resources –Because we live in a world
of limited resources, virtually all individuals and
organizations must ration their resources.
• Legal and Contractual Requirements –Some organizations are
required to budget because of legal requirements.
• Others commit themselves to budgeting requirement when signing
loan agreements or other operating agreements
• Cost Awareness –Accountants and financial managers are
concerned daily about the cost implications of decisions and
activities, but many other managers are not.
• Production managers focus on input, marketing manager’s focuses
on sales, and so forth.
• It is easy for people to overlook costs and cost-benefit relationships.
• At budgeting time, however, all managers with budget responsibility
must convert their plans for projects and activities to costs and
benefits. This cost awareness provides a common ground for
communication among the various functional areas of the
organization.
 2.5.TYPES OF BUDGET
• Budgets are classified in different ways:
•

 Based on capacity
• Fixed budget –is a budget that remains unchanged wit
level of activity.
• Flexible budget –it is the budget that will fluctuate
•
with the level of output.
 Based on time
• Long-rang budget –a budget that may cover long
periods.
• Short-rang budget –a budget that covers less than one
year.
•
 Based on coverage
 Functional budget –budgets related to the various functions of a
business.
• Functional budget includes:
• Physical budget –budgets of quantity of sales & productions.
• Profit budget –budgets that ascertains the profit; like sales budget,
profit & sales budget, etc.
• Cost budget –these provide information on costs like manufacturing
cost, selling & administration costs etc.
• Financial budgets –these provide information on the financial
position of the firm. e.g.; cash budget, capital expenditure budget
etc.
 Master budget – is a consolidated summary of the various
operation & financial budgets. Or
• - It is a set of budgets prepared collectively for all activities of a
company.