5.

Financial results controls

n Three core elements:
– Financial responsibility centers
§ The apportioning of accountability for financial results
within the organization

– Formal management processes

§ Planning & budgeting to define performance expectations
and standards for evaluating performance

– Motivational contracts
§ To define the links between results and various
organizational incentives

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 Planning and budgeting
Example:
To become the worldwide
Vision Desired future
leader in retailing state

To give ordinary people the

chance to buy the same Mission How to achieve
thing as rich people the desired
future state
Cost leadership: “Everyday
low prices” Strategy
Long term and
short term
Financial and non-financial objectives
objectives Budgets

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 Planning and budgeting
n Produce written plans that specify:
– Where the organization wishes to go.
– How it intends to get there.
– What results should be expected.

n Purposes of the planning and budgeting process?

– To engage in longer-term thinking.
– To achieve coordination (top-down, bottom-up, sideways).
– To enhance management control.
– To arrive at challenging but realistic performance targets.

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 Advantages of budgeting
n Communicate management’s plans throughout
the organization
n Planning as top priority
n Resource allocation
n Uncover potential bottlenecks
n Coordinates activities of the entire organization
n Benchmarks for evaluating subsequent
performance

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Increasingly specific, detailed, short-term, and
Planning cycle
• Relatively broad processes of thinking
Strategic about the missions, goals and strategies.
dispersed at all organizational levels

Planning • Normally a top-management process.

• Specification of specific action programs

Programming to be implemented over the next few years
and specification of the resources each
Capital will consume.
Budgeting • It involves many more people at different
organizational levels (top-down/bottom-up).

• Short-term financial planning.

Operational • Budgets match the organization’s
Budgeting responsibility structure.
• Emphasis on quantitative data.

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 Characteristics of a budget
n It is usually stated in monetary terms.
n It generally covers a period of one year.
n It contains an element of management commitment,
i.e., the managers agree to accept the responsibility
for attaining the budgeted objectives.
n The budget is approved by an authority higher than
the budgetee.
n Once approved, the budget can be changed only
under specified conditions.
n Periodically, actual financial performance is compared
to budget and variances are analyzed and explained.

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 Budgeting and management
control
n Budgeting involves setting targets which are often used later as
standards against which to evaluate performance — results controls

n Planning and budgeting processes involve formal reviews of plans and

include the actions that are felt to be good for the organization to take
— action controls

n Planning and budgeting processes serve to get information needed for

decision making to the right managers — personnel controls

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 The budget preparation process
Budget Committee
Top-Down

1.
3. Negotiation

I
ss
2.

ua
I
nit

nc
ial

e
Budget

of
Bu

Department

G
dg

uid
et

eli
Pr

ne
op

4. Approval

s
os
al

Bottom-Up
Business Managers

The budgeting process takes about four months in most firms.

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 Types of financial performance
targets
How to prepare the budget:
n Model-based (engineered)/historical/negotiated

n Internally/externally-derived Information asymmetry

– Target costing
– Benchmarking

How to use the budgets:

n Fixed/Flexible
– Should managers be held accountable for achieving their plans
regardless of the business conditions they face?
– Relative performance targets.

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How to prepare the budgets: Example

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Key Income Statement Most Likely Optimistic Pessimistic
Account (10% Growth) (15% Growth) (0% Growth)
Sales 10, 120 10,580 9,200
COGS 5,258 5,497 4,780
Gross Margin 4,862 5,083 4,420
Wages and Salaries 1,591 1.591 1,591
Rent and facilities 882 882 882
Advertising 644 673 685
Administrative expenses 478 500 435
Interest 65 65 65
Depreciation 109 109 109
Training 40 40 40
Other 56 56 56
Profit before tax 997 1,167 657
Income tax 349 408 230
Net profit 648 759 427

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Key Balanced Sheet Most Likely Optimistic Pessimistic
Account (10% Growth) (15% Growth) (0% Growth)
Assets:

Cash 302 361 184

Accounts Receivable 281 293 255
Inventory 1.083 1,133 985
Property, Plant and Equipment 2,005 2,005 2,005
Other Assets 325 325 325
Total Assets 3,996 4,117 3,754
Liabilities:

Account Payable 230 240 209

Bank loan 880 880 880
Stockholders’ Equity 2,886 2,997 2,665
Total liabilities and shareholders’ 3,996 4,117 3754
equity

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 Target Costing System
•Target Costing: Strategic cost
management system that support the
following objectives: product
functionality, quality, and cost during the
planning and design stages of a new
product

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Japanese Target Costing System
Cust. Target
Value Price

Value Target
Cost
SH Target
Value Profit
Competency
Gap

Current
Competence

Estimated
Resources
Cost
Future
Competence
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 Budget participation
n Top-down/bottom-up budgeting

§ The budgetee is both involved in and has influence

over setting the budget.

§ Leads to better acceptance of budget targets, and hence,

commitment to achieve them.

§ Is an effective way of information sharing:

– Corporate priorities and constraints
– lower-level insights about business potentials and risks.

§ But, slack, bias, conservatism, lack of budgeting

experience.

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 Budget target difficulty
Motivation/Performance

Easy Impossible
Goal Difficulty

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 Challenging but achievable
n To minimize dysfunctional management actions.
§ Myopic behavior, data manipulation

n To increase manager’s commitment to budget targets.

n To reduce the cost of organizational interventions.

§ Management-by-exception

n To protect against the cost of optimistic revenue projections.

§ Over-commitment of resources

n To create a “winning” atmosphere and positive attitude.

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Budgeting
3. Operating cash

2. A/R Cash Cycle 4. Inventory

1. Sales

2. Op. Expenses Profit Cycle 4. Investment

3. Profits

6. Asset Utilization 4. S/E

ROE Cycle

5. ROE

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 Types of budgets
n Master Budget: formal summary of the company’s plan
– sets specific targets for sales, production, material, purchases,
and financing activities
– culminates in projected statement of net income, financial
position, and cash flow.
– Can be divided into: capital budgets and operating budgets
n Capital budgets:
– cover acquisition of land, buildings, and other items of capital
equipment and have time horizon >1 year
n Operating budgets
– Cover sales, production, material purchases, cash and related
items
– One year period and can be a continuous (= perpetual basis)

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 The Master Budget

The master budget:

– Represents the “grand plan of action” for an upcoming

period

– Translates the organization’s short-term objectives into

action steps

– Culminates in the preparation of a set of pro-forma financial

statements
– Communicates to employees and managers alike the
expectations of top management
– Helps coordinate subunit activities
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 Master Budget
Sales Budget Long range sales
forecast

Production Budget
S&A expense
budget

DM budget DL budget FOH budget

Capital Budget

Cash budget

Budgeted I/S Budgeted B/S Budgeted CFS

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 Alternative Budgeting
Approaches

Zero-base budgeting (ZBB) is a

budgeting process that requires
managers to prepare budgets from a
zero base

– Justify every activities/functions in the budget

– Make managers aware of cost/benefits of each
activity
– Can be a difficult and time-consuming process

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 Alternative Budgeting Approaches
(continued)
n Activity-based budgeting (ABB)

n Kaizen (Continuous improvement)

budgeting

n Rolling (Perpetual) budget

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 Behavioral Issues in Budgeting

• Budgetary slack, or padding the budget

• Spending the budget

• Goal congruence between divisional and

company

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Budgeting Example: Accounting Firm (2nd quarter)*:
Balance Sheet as of March 31 (Given),
Current Assets
Cash $600,000
A/R 2,500,000
$ 3,100,000
Plant & Equipment:
Land 400,000
Buildings & Equipment 1,610,000
Accumulated depreciation (750,000) $1,260,000
Total Assets $4,360,000
Liabilities: Account payable $ 2,312,000
Shareholders Equity:
Common shares $ 930,000
R/E 1,118,000 $2,048,000
Total Liability & Shareholders Equity $4,360,000
* Horngren et al, 2019, Cost Accounting: A managerial emphasis, 8th Canadian edition, chapter 6.
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Budgeting example:
•An accounting firm has prepared the following sales budget:
March 100 clients June 300 clients
April 200 clients July 250 clients
May 500 clients August 150 clients
•Each client is charged $100,000 per audit engagement
•Collection pattern:
•70% in the month of audit
• 25% in the month following audit
• 5% is uncollectible.
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Budgeting example (Continued):
•Each client requires 500 working hour. Auditors are paid
$50 per hour.
•Overhead costs: Variable: $5 per working hour. Fixed:
$5,000,000 per month (include $100,000 depreciation).
•S&A expenses: Variable: $2 per working hour. Fixed:
$7,000,000 per month (include $50,000 depreciation).
•Open line of credit with CIBC (monthly interest: 2%) .
Excess cash to be used for debt payment (if applicable).
Minimum cash balance: $500,000
•Overhead costs are applied on the basis of auditor’s
working hour
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 Sales Budget:
March April May June Quarter
Budgeted sales (units)
Audit fee per clients
Budgeted sales (dollars)
Scheduled of Expected Cash Collection
March Sales (25%)
April Sales (70% and 25%)
May Sales (70% and 25%)
June Sales (70% and 25%)
Total cash collection
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 Auditor Cost Budget:
April May June Quarter
Total number of client
Working hours per client
Working hours required
Auditor cost per hour
Total auditor cost

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 Overhead Budget:
April May June Quarter
Total working hours
Variable overhead rate
Variable overhead cost
Fixed overhead costs
Total overhead costs
Less: Depreciation
Cash disbursement for OH costs

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 Selling and Administrative Expense Budget:
April May June Quarter
Total working hours
Variable S&A rate
Variable S&A expense
Fixed S&A expense
Total S&A expenses
Less: Depreciation
Cash disbursement for S&A

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 Cash Budget (000):
April May June Quarter
Cash balance: Beginning
Add: Cash collections
Total cash available
Less: Disbursement
Auditor cost
Overhead costs
S&A
Total Disbursements
Excess (deficiency)
Financing:
Borrowing
Repayments
Interest
Total financing
Cash balance, ending

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 Budgeted I/S and B/S
Budgeted I/S for the Quarter ending June 30 (000)
Net sales
Less: Auditor costs
Overhead costs
Gross margin
Less: S&A expenses
Net Operating Income
Less: Interest expense
Net Income

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 Balance Sheet as of June 30 (000)
Current Assets
Cash
A/R
Allowance for doubtful accounts
Plant & Equipment:
Land
Buildings & Equipment
Accumulated depreciation
Total Assets
Liabilities:
Account payable
Shareholders Equity:
Common shares
R/E (Beginning R/E+NI)
Total Liability & Shareholders Equity
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 Group exercise:

Complete the second quarter budgets:

May, June, Quarter, for Sales, Auditor Cost,
Overhead, Selling and Administrative, and Cash
budgets

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