Chapter 8: Strategy and the Master Budget

Summary

An organization’s budget is a quantitative plan that identifies the resources required and commitments to fulfill its goal for the budget period. Budgeting allows management to plan ahead, communicate the plan and goals for the budget period to all divisions and employees, and motivate employees. A budget also serves as a blueprint for operations, a guideline for controlling operations, and a basis for performance evaluation.

Strategy helps a firm to be more focused in its operations and to take advantage of its strengths and opportunities. A firm carries out its strategy through long-range plans and master budgets. Strategy provides a framework within which the organization develops its long-range plan. An annual master budget is an extension of the organization’s long-range plan to fulfill organization goals and objectives. A successful budget is accepted and supported by the key management, becomes a personalized budget for the people responsible for implementing it, and is perceived by all personnel as a tool to help them to do a better job, not as a pressure device. A successful budget is also a motivating device and must be technically accurate.

Budgeting processes include 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 revisions. A budget committee oversees all budget matters and usually consists of at least one key senior manager. The committee issues budget guidelines based on plans emanating from reviews of the firm’s strategy, external and internal factors, goals and objectives of the budget period, and experience gained from implementing the current budget. Based on the budget guidelines, managers prepare initial budgets and discuss and negotiate their budget proposals with superiors. The budget committee or the chief executive officer gives final approval of the budget.

The master budget includes sales, production, direct materials, direct labor, factory overhead, selling, and administration expense budgets, and the budget cash statement, income statement, and balance sheet.

A service firm prepares a budget following set procedures just as a manufacturing or merchandising firm does. A major difference between budgets for service firms and those for manufacturing or merchandising firms is the absence of a production budget or merchandise purchase budget and its ancillary budgets for service firms. The budgeting procedures and all other budget items are the same for both service and manufacturing or merchandising firms. A service firm must carefully plan its activities for securing the required resources, frequently focusing on the labor force to render the planned services to fulfill the budgeted activities. A budget for a not-for-profit organization reflects its authorized activities.

A multinational company should carefully consider in its budget such issues as cultural and language differences, dissimilar political and legal environments, fluctuating monetary exchange rates, and discrepancies in inflation rates of different countries.

Zero-base budgeting differs from traditional budgeting in that it is not an incremental budget of the current budget. Zero-base budgeting requires managers to evaluate and justify all activities included in the budget. Activity-based budgeting focuses on the activities and cost drivers in preparing budgets. Kaizen budgeting integrates expected improvements into budgets.

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 participative budgeting processes, the extent of involvement of top management in budgeting, and the role of the budget department or controller in budgeting.