Principles of Accounting: Chapter Twenty-One

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Chapter Summary

Chapter 21 is about budgeting. The chapter begins with an examination of the importance of budgets to planning and shaping an organization's activities. Budgets also provide a communication and feedback tool. Not to be overlooked are the human dimensions of budgeting. Budgets can be mandated or developed by participative processes. They require estimations and are subject to failings, such as deliberate introduction of slack. Budgeting is sometimes done on an incremental basis by beginning with a prior period plan, but an alternative is zero-based budgeting that requires justification of all expenditures each period.

A comprehensive budget will include many components, but generally begins with planned sales. Sales drive production budgeting, including materials, labor, and overhead. The production budget must interface with the cash budget. The entire process can culminate in budgeted financial statements. Carefully linked electronic spreadsheets prove quite helpful in budgeting, and a comprehensive illustration is shown.

The chapter concludes by discussing budget periods and cycles. Businesses might utilize a continuously updating (perpetual) budget, in lieu of a single static budget that is intended to span well into the future.

Exercises

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Key Terms

Key Terms: Chapter Twenty-One

bottom-up participative budget

A budget approach driven by the direct participation of lower-level employees

budget committee

A group of senior managers from each business unit charged with leading the budget preparation and review process

budget slack

The influence of behavior to "pad" a budget via misstating expected revenues and/or expenses; to create more favorable budget vs. actual performance appraisals

cash budget

An essential budget component detailing planned cash receipts, disbursements, and financing actions

continuous budget

A budget that is constantly updated; as one month/quarter is completed another is added to the set the projections

direct labor budget

A budget that details expected direct labor needs, along with the related costs of labor

direct material purchases budget

A budget that details expected direct material purchases, along with the related cash payments

encumbrance

A budgetary restriction occurring in advance of a related expenditure

factory overhead budget

A budget that details the anticipated factory overhead, including calculations related to the allocation of such amounts

flexible budget

A budget that covers a range of potential outcomes by relating expense levels to the potential revenues

incremental budgeting

A budgeting approach where the prior year experience sets a base line for a new budget; changes are made based on new information but the base need not be rejustified in detail

master budget

Also known as the comprehensive budget; an integrated set of articulated budgets relating to numerous operational subcomponents (labor, material, overhead, SG&A, etc.)

pro forma financial statements

"As if" budgeted financial statements

production budget

A budget that details planned levels of production; takes into account sales and inventory build/decline

sales budget

A budget that details anticipated sales levels

SG&A budget

A budget that details anticipated selling, general, and administrative costs

static budget

A budget that does not anticipate alternative outcomes; estimated sales and expenses are fixed and establish the relevant benchmarks

top-down mandated budget

A budget approach where upper level management establishes parameters under which the budget is to be prepared

zero-based budgeting

A budget approach where each expenditure item must be justified for each new budget period