M5A1: Discussion—Working with Budgets

Budgets are the driving force behind all organizations. Whether a manufacturing organization, or a service organization such as a medical or public accounting firm, budgets are used not only for planning purposes but also for performance monitoring and evaluation of areas within an organization.

More than likely, you are often required to work with budgets within your organization. Using the module reading and the Argosy University online library resources, research budgets including multiple budgets.Respond to the following:

• Describe in detail the budgets that you work with.
• In your description, what was the objective of the budget i.e., to motivate employees or control costs? (A budget could have more than one objective.) Was the use of the budget successful in achieving the objective?
• Based on the effectiveness of the budget, what recommendations would you suggest to improve the communication and/or utilization of the budget(s)?
• Assume your organization has multiple budgets and you are to work with these. Explain how these budgets should be linked together.

Give reasons and examples in support of your responses.

Write your initial response in 4–5 paragraphs. Apply APA standards to citation of sources.

 

• Read all posts from your peers.
• Explain how their experiences differ from yours.
• Provide substantive comments by contributing new, relevant information or quotes from course readings, Web sites, or other sources; building on the remarks or questions of others; or sharing practical examples of key concepts from your experiences, professional or personal.

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Assignment 1 Grading Criteria	Maximum Points
Initial response: Was insightful, original, accurate, and timely.Was substantive and demonstrated advanced understanding of concepts.Compiled/synthesized theories and concepts drawn from a variety of sources to support statements and conclusions.
Discussion response and participation: Responded to a minimum of two peers in a timely manner.Offered points of view supported by research.Asked challenging questions that promoted the discussion.Drew relationships between one or more points in the discussion.
Writing: Wrote in a clear, concise, formal, and organized manner.Responses were error free.Information from sources, where applicable, was paraphrased appropriately and accurately cited.
Total:

 

Budgeting is extremely important, whether for personal or business reasons. Budgets are of many types and are the main tools used for planning, control, and decision making in almost every organization. These can also be used to force organizations to plan for future communication, coordination, resource allocation, profit control, and performance evaluation.

Many professional service firms rely heavily on the use of time budgets. For example, architect firms know on average how long it takes to work with commercial clients on the design of a building or with individuals for a house. Based on these estimates, management assigns clients to architects within the firm and estimates the fees that will be charged. If one architect has five clients assigned to him or her and each design is budgeted to be completed in ten hours, this means that fifty hours of work have been delegated for completion by that architect. Additional work will not be assigned to this architect until all other architects are equally assigned the same number of hours. Additionally, if it takes this architect ninety hours to complete the designs, as against the assigned fifty hours, this may be a sign there are issues with the productivity of this architect that need to be examined.

In the assignments you will get an opportunity to examine how budgets are used to analyze performance and set incentives for employees and management within an organization. You will also make recommendations for improving the effectiveness of such systems.

A flexible budget shows what the costs should be for various levels of activity. The flexible budget amount for a specific level of activity is determined differently depending on whether a cost is variable or fixed. If a cost is variable, the flexible budget amount is determined by multiplying the cost per unit of activity by the level of activity specified for the flexible budget. If a cost is fixed, the original budgeted fixed cost is used as the flexible budget amount. With a flexible budget, production is examined at various levels within the relevant range of production.

Flexible budgets are analyzed using budget variances. As covered previously, the two variances for variable overhead are variable overhead spending and variable overhead efficiency variances. In addition to these variances, when analyzing fixed overhead, two additional variances need to be examined. One is the budget variance, which is simply the difference between the actual total fixed overhead and budgeted fixed overhead. The other, more complex variance is volume variance, which is the difference between the amount of fixed overhead applied to inventory and the total amount of fixed overhead cost that was originally budgeted. The budget variance is a straightforward measure of the degree to which fixed overhead spending was under control. The volume variance is the consequence of treating a fixed cost as if it was variable, and its meaningful application is limited.

When analyzing overhead costs, it is essential to distinguish between variable and fixed:

· Total variable overhead costs vary in proportion to total changes in activity.

· Total fixed costs do not change within the relevant range.

This distinction is important when constructing flexible budgets and when computing overhead variances.

It is also important to understand the relevant range. Imagine a sports stadium that has a seating capacity of 55,000 fans. If the team playing in the facility is not winning games, ticket sales will be low. Therefore, it is likely that selling the capacity of 55,000 seats will be difficult. When a game is played, certain costs will be incurred regardless of the number of fans in the facility. These costs are known as fixed overhead costs and are incurred for aspects such as general lighting, property taxes on the building, insurance, and heating. In many cases, the stadium management would be willing to do whatever possible to fill up the stadium and get 55,000 fans into the seats, even if it means giving away free or very low cost tickets. This is because the relative cost of letting one more fan into the arena is low, so any revenue generated from the low cost ticket will help cover the fixed utility costs. At the same time, once the fans are in the arena, they often spend money on food and other souvenirs within the facility. Such spending generates substantial revenue that covers the fixed overhead costs. This revenue would not have been generated if the seats had been empty.

On the other hand, if the team is playing really well, there will be a strong demand for all 55,000 seats. In this case, tickets will not be given away, and in fact, fans would be willing to pay a premium cost to get in. Suppose the team plays well over a number of seasons and the demand for seats is consistently more than the capacity. Stadium management would need to make significant renovations of the arena to accommodate these fans. This would increase the fixed costs. In this scenario, the relevant range is the capacity of the facility. Fixed costs would not change if the number of fans seated in the stadium were between 0 and 55,000. However, above 55,000 fans, the relevant range is exceeded and the capacity would need to be increased, which in turn would increase the fixed cost. This is the only way in which the fixed cost can increase.

The complete set of budgets that covers all aspects of the operations of an organization is referred to as the master budget. Preparing a master budget can be difficult, as there are so many variables at play. The first step is developing a sales forecast. Once a company has a sales estimate for the year, operational budgets can be prepared based on the estimated production needs. After this, the individual budgets can be prepared for each department.

The first budget prepared is the production budget, which shows the number of goods or services that will need to be produced during the period. Next, thedirect material budget is created to show the number of units and the total cost of all the necessary materials to be purchased during the period. Then, thedirect labor budget is prepared to show the total number of direct labor hours needed and the cost during the period. The manufacturing overhead budget is developed next to show the cost of all overhead expenses that will be incurred during the period. The selling, general, and administrative expense budget is then prepared, and this shows the total amount of selling, general, and administrative expenses for the period. Next, the cash receipts budget is prepared to show the entire expected cash inflows for the period. This is followed by the cash disbursement budget, which shows all expected cash payments for the year. Once this set of budgets is completed, budgeted financial statements are prepared. These statements provide a forecast of the overall financial performance of the organization, if everything goes as planned.

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A standard costing system is the traditionally used costing system. It has two main purposes: cost control and product costing. Standard costs are determined by accountants working together with other employees of the organization. Such costs are created for direct material, direct labor, and manufacturing overhead. A cost manager would use these standard cost figures as a benchmark with which to compare actual costs. This allows managers to determine if there are any substantial cost variances.

The variances that management will compute to monitor performance include the following:

· Direct material price is the difference between the actual and standard price

· Direct material quantity is the difference between the actual quantity and the standard quantity

· Direct labor rate is the difference between the actual and standard hour rate

· Direct labor efficiency is the difference between the actual hours and the standard hours

There is no set rule to indicate when a variance is considered too high. Managers must use their own judgment and business sense to make this determination.

Overhead is one of the most difficult costs to account for because it is a large pool of all the different indirect costs. Tracing the overhead costs to each individual product or service is laborious, which is why a flexible budget is created. In a flexible budget, overhead costs are specified for various activity levels. There are two types of flexible budgets that can be used. The first, thecolumnar flexible budget, is based on several different activity levels. The other type, the formula flexible budget, is used for a continuous range of activity.

Once the flexible budget is created, variances can also be examined to find out how well the company is performing.

These variances include the following:

· Variable overhead spending is the product of the difference between the actual and standard overhead rates and actual quantity [(Actual overhead rate – Standard overhead rate) × Actual quantity].

· Variable overhead efficiency is the difference between the actual and standard quantity (Budget allowance on actual quantity – Budget allowance on standard quantity).

· Fixed overhead budget is the difference between actual and fixed overhead (Actual overhead – Fixed overhead).

· Fixed overhead volume is the difference between budgeted fixed overhead and applied fixed overhead (Budgeted fixed overhead – Applied fixed overhead).

When analyzing variances it is important to understand whether the variance is favorable or unfavorable. A favorable variance indicates that the company has benefited from the variance, for example, when actual costs are less than budgeted. An example of an unfavorable variance would be that actual costs were greater than budgeted.

The analysis of variance can be a difficult task, but it is important to spend the time necessary to do this because variances tell a lot about the overall performance of a company. Knowing how well a company is performing is necessary for maintaining long-term success.

Budgets affect just about every department and every person within an organization. This tremendous impact causes people to act differently to make sure the budgets are met. One common way of doing this is to pad budgets. However, this makes the prepared budget less useful, as it is not an accurate representation of the company. A company can ensure the accuracy of budgets by involving employees throughout the organization in creating the budgets. This process, referred to as participative budgeting, makes employees feel more involved, and they are likely to be more willing to stick to and follow the budget.
 
Budgeting can be a very time-consuming task, but it is necessary if a company is to maintain business for the long term. Most companies have a budget director who is in charge of budgeting to keep everything organized. Organizations will also have a budget committee made up of senior executives who help advise the budget director. It helps to have people who are familiar with budgeting involved, as this makes the process run smoother.