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The document outlines the roles and responsibilities of management accountants in cost management, strategic planning, and operational control within organizations. It emphasizes the importance of cost management information for decision-making, compliance with legal requirements, and the development of competitive strategies such as cost leadership and product differentiation. Additionally, it discusses various management accounting techniques, including Total Quality Management (TQM) and Just-In-Time (JIT) production systems, aimed at improving efficiency and reducing costs.
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0% found this document useful (0 votes)
8 views

AECOST_REVIEWER-1

The document outlines the roles and responsibilities of management accountants in cost management, strategic planning, and operational control within organizations. It emphasizes the importance of cost management information for decision-making, compliance with legal requirements, and the development of competitive strategies such as cost leadership and product differentiation. Additionally, it discusses various management accounting techniques, including Total Quality Management (TQM) and Just-In-Time (JIT) production systems, aimed at improving efficiency and reducing costs.
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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AECOST REVIEWER assist management in establishing plans for reasonable

economic objectives and in the making of rational decisions


with a view toward achieving these objectives. It is the process
of identification, measurement, accumulation, analysis,
STRATEGY is a set of policies, procedures and approaches preparation, interpretation, and communication of financial
to business that produce long terms success information, which is used by management to plan, evaluate
and control activities within an organization. It also comprises
COST MANAGEMENT is the practice of accounting in which
the preparation of financial reports for non-management
the accountant develops and uses cost management
groups such as shareholders, creditors, regulatory agencies
information
and tax authorities.
COST MANAGEMENT INFORMATION is the information that
3. Management Accountants - (including cost accountants)
manager needs to, it includes both financial information about
Management accountants provide information to managers,
cost and revenues as well as relevant nonfinancial information
providing reports on performance, key indicators, business
about productivity, quality, and other key success factors for
situation analysis, and problem investigation. They actively
the firm
participate in managing the entity, making strategic, tactical,
and operational decisions, and coordinating efforts. They
ensure the organization operates unified in its long-term,
Uses of Cost Management Information intermediate, and short-term best interests.

1. Strategic Management – involves the development of a Information about Management Accountants:


sustainable competitive position in which the firm’s
competitive advantage spells continues success, involves Management accounting is concerned primarily with providing
identifying and implementing these goals and action plans. information to internal managers who are charged with
planning and controlling the operations of the firm and making
2. Planning and Decision-Making – outlines the importance a variety of management decisions. Generally, management
of financial management in supporting recurring decisions like accountants do the following tasks:
equipment maintenance and cash flow management,
budgeting, profit planning, and making strategic decisions (a) Scorekeeping is a process of collecting and analyzing data
related to a firm's operations. to evaluate organizational performance, identify issues,
opportunities, and inefficiencies, and inform management
3. Management and Operational Cost - Cost management actions based on routine accounting reports.
information is needed to provide a fair and effective basis for
identifying inefficient operations and to reward and motivate (b) Problem-solving or quantification of the relative merits of
the most effective manages. possible courses of action as well as recommendations as to
the best procedure. This is commonly associated with non-
Operational Control takes place when mid-level manages recurring decisions.
(e.g, product managers, regional managers) monitors the
activities of operating-level managers and employers (e.g, Three important guidelines help management accountants
production supervisions, department heads). Management provide the most value when scorekeeping provide the most
control on the other hand, is the evaluation of mid-level value when scorekeeping, problem-solving and attention
manager by upper-level manager (e.g., Controller or the Chief directing (interpreting and reporting). These are
Financial Officer (CFO)).
1. Employ a cost-benefit approach
4. Reportorial and Compliance to Legal Requirements -
2. Recognize behavioral as well as technical considerations
responsibilities require management to comply with the
financial reporting requirements to regulatory agencies such and
as the Securities and Exchange Commission (SEC) Bureau
3. Use appropriate cost concepts for different purpose
of Internal revenue (BIR), and other relevant government
authorities and agencies. the management accountant provides a system which allows
management to receive the necessary information used in
performing its administrative functions of:
Management Accountants Role in Strategic Cost • planning which involves setting of goals for the firm,
Management evaluating the various ways to meet the goals and picking out
1. Cost Management - is the practice of accounting in which what appears to be the best way to meet the goals;
the accountant develops and uses cost management • controlling which involves the evaluation of whether actual
information. This area of accountancy practice is performed
performance conforms with planned goals; and
by management accountants. Management accountants are
the accounting professionals who develop and analyze cost • decision making which involves determination of predictive
management information and other accounting information. information (e.g. relevant costs) for making important
business decisions.
2. Management Accounting - involves the application of
appropriate techniques and concepts to economic data so as
to
Organization Structure and the Management Accountant equivalent rank to the CFO - called the chief information
officer - is responsible for information systems.
A major function of the management accountant is that of
tailoring the application of the process to the organization so
that the organization's objectives, short-term and long-term,
are achieved effectively.

Management accounting is intended to include persons


involved in such functions as controllership, treasury, financial
analysis, planning, and budgeting, cost accounting, internal
audit, systems, and general accounting. Management
accountants thus may have titles as controller, treasurer,
budget analyst, cost analyst, and accountant, among others.

Line authority is the authority to command action or give


orders to subordinates. Line managers are directly
responsible for attaining the objectives of the business firm as
efficiently as possible. Sales and production managers
typically have line authority.

Staff authority is the authority to advise but not command


others; it is exercised laterally or upward. Staff managers give
support, advice and service to line departments. Examples of
staff authority are found in personnel, purchasing, engineering The Controller as the Top Management Accountant
and accounting.
Controllership is the practice of the established science of
Chief Accounting Officer's Role and Function: control which is the process by which management assures
• The controller typically fills the staff role in a company, unlike itself that the resources are procured and utilized according to
sales and production executives. plans in order to achieve the company's objectives.
• The controller transmits best accounting procedures to the
President via a manual of instructions. In most organizations, the top managerial accounting position
• In practice, the controller holds functional authority from top is held by the controller. The controller provides reports for
line management to direct line people on applying these planning and evaluating company activities (e.g., budgets and
procedures. performance reports) and provides the information needed to
make management decisions (e.g.,decisions related to
construction of a new factory or decisions related to adding or
dropping a product). The controller also has responsibility for
Difference between CFO and Controller
all financial accounting reports and tax filings with the Bureau
chief financial officer (CFO) - also called the finance director of Internal Revenue and other taxing agencies, as well as
in many countries - is the executive responsible for overseeing coordinating the activities of the firm's external auditors.
the financial operations of an organization. The
The controller is an integral part of the top management team.
responsibilities of the CFO vary among organizations, but they
If one wants a high level career in management accounting,
usually include the following areas:
he/she will need not only strong accounting skills but also
• Controllership - includes providing financial information for skills required of all high-level executives.
reports to managers and reports to shareholders
These skills include excellent written and oral communication
andoverseeing the overall operations of the accounting
skills, solid interpersonal skills and a deep knowledge of the
system.
industry in which the firm competes.
• Treasury - includes banking and short- and long-term
The controller's authority is basically staff authority in that the
financing, investments, and management of cash.
controller's office gives advice and service to other
• Risk management - includes managing the financial risk of departments. However, in his own department, he has line
interest-rate and exchange-rate changes and derivatives authority. In the modern concept of controllership, it is
maintained that the controller does control in a special sense.
management.
That is, by reporting and interpreting relevant data, the
• Taxation - includes income taxes, sales taxes, and controller exerts a force or influence that impels management
international tax planning. toward logical decisions consistent with objectives.

• Internal audit - includes reviewing and analyzing financial


and other records to attest to the integrity of the organization's
financial reports and to adherence to its policies and
procedures.

In some organizations, the CFO is also responsible for


information systems. In other organizations, an officer of
reliability of the information contain in the firm's financial
statements.

Certificate in Internal Auditing (CIA) - Since one of the


management control responsibilities of the management
accountant is to develop effective systems to detect and
prevent errors and fraud in the accounting records, it is
common for the management accountant to have strong ties
to the control-oriented organization such as the Institute of
Internal Auditors (IA) granting Certification in Internal Auditing
(CIA). To attain the status of Certified Internal Auditor an
individual must pass a comprehensive examination designed
to ensure technical competence and have the required
number of years of work experience.
Functions of Controllership

1. Planning. Establish and maintain an integrated plan of


Business Environment
operation consistent with the company's goals and objectives,
both short and long term, analyzed and revised, as required, Contemporary Business Environment:
communicated to all levels of management, with appropriate
systems and procedures installed.  Global competition and continuous improvement
drive.
2. Control. Develop and revise standards against which to  Advancements in manufacturing, information, and
measure performance and provide guidance and assistance e-commerce technologies.
to other members of management in insuring conformance of  Greater customer focus.
actual results to standards.
 New forms of management organization.
3. Reporting. Prepare, analyze, and interpret financial results  Changes in social, political, and cultural business
for utilization by management in the decision- making environment.
process, evaluate the data with reference to company and unit  Complex operations necessitate separate
objectives; prepare and file external reports as required to management-oriented and financial-oriented data.
satisfy government regulatory bodies, shareholders, financial
Global Business Environment:
institution, customers, and the general public.

4. Accounting. Design, establish, and maintain general and  Rapid growth of international markets and trade
drives significant changes in the contemporary
cost accounting systems at all company levels, including
business environment.
corporate, divisional, plant, and unit to properly record all
financial transactions in the books of accounts and records in  Economic independence and increased
accordance with sound accounting principles with adequate competition significantly affect profit-oriented
internal control. businesses, not-for-profit organizations,
consumers, and regulators.
5. Other Primary Responsibilities. Manage and supervise  Large multinational alliances and increasing trade
such functions as taxes, including interface with the respective agreements highlight growth opportunities in global
taxing authorities and agents; maintain appropriate markets.
relationships with internal and external auditors; develop and  Global trade benefits consumers, managers,
maintain systems and procedures; develop record retention business owners, and investors by offering low-
programs; supervise assigned treasury functions; institute cost, high-quality goods.
investor and financial public relations programs; office  Firms need cost management and financial and
management; and direct other assigned functions. non-financial information to sustain
competitiveness in the competitive global business
environment.

International Certifications
Cost Leadership and Product Differentiation
Certified Management Accountant (CMA) - is one who has
passed the rigorous qualifying examination, has met an Cost Leadership is a competitive strategy in which a firm
experience requirement, and participates in continuing succeeds in producing products or services at the lowest cost
educations. The CMA Certificate is granted by the Institute in the industry. A firm that is a cost leader makes sustainable
Management Accountants (IMA). profits at lower prices, thereby limiting the growth of
competitions in the industry through its success in price wars
Certified Public Accountant (CPA) - is one who has met the and undermining the profitability of competitors which must
pre-qualification educational requirements, passed the CPA
meet the firm's low price.
licensure examinations given by the Professional Regulatory
Board of Accountancy and has satisfied all other legal and Product Differentiation is implemented by creating a
regulatory requirements of a public accountant. The CPAs perception among consumers that the product or service is
main responsibility is to provide assurance concerning the unique in some important way, usually by being of higher
quality, features or innovation. This perception allows the firm  Reductions in paperwork
to charge higher prices and outperform the competition in
profits without reducing cost significantly. Most industries, There are five main features in a JIT production system:
including automobile, consumer electronics, and industrial
equipment, have differentiated firms. The appeal of 1. Production is organized in manufacturing cells, a
differentiation is especially strong for product lines which the grouping of all the different types of equipment used
perception of quality and image is important, as in cosmetics, to manufacture a given product
jewelry and automobiles. Tiffany, Rolex, Ferrari and BMW are 2. Workers are trained to be multiskilled so that they
good examples of firms that emphasize differentiation. are capable of performing a variety of operations
and tasks.
3. Total quality management is aggressively pursued
to eliminate defects.
Cost Management Techniques 4. Emphasis is placed on reducing setup time, which
is the time required to get equipment, tools and
a. Total Quality Management (TQM) - is a technique in which materials ready to start the production of a
management develops policies and practices to ensure that component or product, and manufacturing lead
the firm's products and services exceed customers' time, which is the time from when an order is ready
expectations. two major characteristics of TQM are a focus on to start on the production line to when it becomes a
serving customers, and systematic problem-solving using finished good.
teams made up of front-line workers. 5. Suppliers are carefully selected to obtain delivery of
quality-tested parts in a timely manner.
TQM. develop a company that stresses listening to the needs
of customers, making products right the first time, reducing c. Process Reengineering
defective products that must be reworked, and encouraging
workers to continuously improve their production process. Reengineering is a process for creating competitive
advantage in which a firm reorganizes its operating and
TQM affects product costing by reducing the need to track the management functions, often with the result that jobs are
cost of scrap and rework related to each job. If TQM is able to modified, combined, or eliminated. It has been defined as the
reduce these costs to a very low level, the benefit of tracking "fundamental rethinking and radical redesign of business
the costs is unlikely to exceed the cost to the accounting processes to achieve dramatic improvements in critical,
system. contemporary measures of performance, such as cost,
quality, service, and speed.
b. Just In Time (JIT) - is a production system also known as
pul-it-through approach, in which materials are purchased and Process reengineering, a more radical approach to
units are produced only as needed to meet actual customer improvement than TQM, is an approach where a business
demand. In a JIT system, inventories are reduced to the process is diagrammed in detail, questioned and then
minimum and in some cases, zero. completely redesigned in order to eliminate unnecessary
steps, to reduce opportunities for errors and to reduce costs.
JIT is the philosophy that activities are undertaken only as
A business process is any series of steps that are followed in
reeded or demanded.
order to carry out some task in a business.
Just-in-Time (JIT) production is a system in which each
The main objective of this approach is the simplification and
component on a production line is produced immediately as
elimination of wasted effort and the central idea is that all
needed by the next step in the production line.
activities that do not add value to product or service should be
The demand-pull feature of JIT production systems achieves eliminated. In its most simplified version, the steps used in
close coordination among work centers. It smoothes the flow process reengineering are:
of goods, despite low quantities of inventory.
1. A business process is diagrammed in detail.
Financial Benefits of MT
2. Every step in the business process must be analyzed and
JIT tends to focus broadly on the control of total manufacturing justified.
costs instead of individual costs such as direct manufacturing
3. The process is redesigned to include only those steps that
labor. JIT can provide many financial benefits, including:
make the product or service more valuable.
 Lower investment in inventories.
 Reductions in carrying and handling costs of
inventories. This process can yield the following anticipated results:
 Reductions in risk of obsolescence of inventories.
 Lower investment in plant space for inventories 1. Process is simplified
and production.
2. Process is completed in less time
 Reductions in setup costs and total manufacturing
costs.
3. Costs are reduced, and
 Reduction in costs of waste and spoilage as a
result improves quality. 4. Opportunities for errors are reduced.
 Higher revenues as a result of responding faster to
customer
Process reengineering has one basic recurrent problem, that analysis to improve operational control and management
is - employee resistance. As with other improvement projects, control. ABC and ABM are key strategic tools for many firms,
employees fear loss of jobs which may lead to lost morale and especially those with complex operations, or great diversity of
failure to improve the bottom line i.e.,profits). For the process products.
to prosper and succeed, employees must be convinced that
the end result of the improvement will be more secure, rather h. Theory of Constraints (TOC)
than less secure jobs. They can be made to understand that
The Theory of Constraints is a sequential process of
improving the processes, the company can generate more
business, produce a better product at lower cost and will have identifying and removing constraints in a system. The Theory
of Constraints emphasizes the importance of managing the
the competitive strength to prosper.
organization's constraints or barriers that hinder or impede
d. Benchmarking progress toward an objective. Since the constraint is whatever
is holding back the organization, improvement efforts usually
 determines its critical success factors must be focused on the constraint to be really effective.
 studies the best practices of other firms (or other
units within a firm) for achieving these critical The basic sequential steps followed in applying TOC are:
success factors, and
1. Analyze all the factors of production (materials, labor,
 then implements improvements in the firm's
facilities, methods, etc.) required in the production chain.
processes to match or beat the performance of
those competitors. 2. Identify the weakest link, which is the constraint.
 Today benchmarking efforts are facilitated by
cooperative networks of noncompeting firms that 3. Focus improvement efforts on strengthening the weakest
exchange benchmarking information. link.

e. Mass Customization 4. If improvement efforts are successful, eventually the


weakest link will improve to the point where it is no longer the
a management technique in which marketing and production weakest link.
processes are designed to handle the increased variety that
results from delivering customized products and services to 5. At this point, a new weakest link (new constraint) must be
customers. The growth of mass customization is in effect identified and improvement efforts must be shifted over that
another indication of the increased attention given to link.
satisfying the customer.
The Theory of Constraints approach is a perfect complement
f. Balanced Scorecard to Total Quality Management and Process Reengineering - it
focuses improvement efforts where they are likely to be most
The balanced scorecard is an accounting report that includes effective.
the firm's critical success factors in four areas
i. Life Cycle Costing
• financial performance,
Life-cycle costing is a management technique to identify and
• customer satisfaction, monitor the costs of a product throughout its lifecycle. It
consists of all steps from product design and purchase of raw
• internal business process, and material to delivery of andservice of the finished product.
• innovation and learning. The steps include:
The concept of balance captions the intent of broad coverage,
1. research and development
financial and nonfinancial of all the factors that contribute to
the success of the firm in achieving its strategic goals. The 2. product design, including prototyping, target costing and
use of the balanced scorecard is thus a critical ingredient of testing
the overall approach that firms take to become and remain
competitive. 3. manufacturing, inspecting, packaging and warehousing

g. Activity-based Costing and Management 4. marketing, promotion and distribution

Activity analysis is used to develop a detailed description of 5. sales and service.


the specific activities performed in the operation of the firm.
Many firms have found that they can improve planning, Cost management traditionally has focused only on costs
product costing, operational control, and management control incurred up to the third step manufacturing.
by using activity analysis to develop a detailed description of
the specific activities performed in the firm's operations. Management accountants now strategically manage the
product's full life cycle of costs, including upstream and
The activity analysis provides the basis for activity-based downstream costs as well as manufacturing costs.
costing and activity-based management. Activity-based
costing (ABC) is used to improve the accuracy of cost analysis
by improving the tracing of costs to products or to individual
customers. Activity-based management (ABM) uses activity
j. Target Costing m. E-Commerce

Target costing involves the determination of the desired cost This E-Commerce business model adopted by Amazon.com
for a product or the basis of a given competitive price so that and eBay has also attracted many investors to pursue the use
the product will earn a desired profit. The basic relationship of Internet in conducting business. Established companies will
that is observed in this approach is undoubtedly continue to expand into cyberspace - both for
business-to-business transactions and for retailing. The
Target cost = Market determined price - Desired profit Internet has important advantages over more conventional
marketplaces for some kinds of transaction such as mortgage
The entity using target costing must often adopt strict cost- banking. It is also very likely that a blockbuster business may
reduction measures to meet the market price and remain be built around the concept of selling low-value, low-margin
profitable. This is a common strategic approach used by
and bulky items like groceries over the Internet.
intensely competitive industries where even small price
differences attract consumers to the lower-priced product. n. The Value Chain

k. Computer-Aided Design and Manufacturing Value chain refers to the sequence of business functions in
which usefulness is added to the products or services of a
More companies are using computer-aided design (CAD) and company. The term value refers to the increase in the
computer-aided manufacturing (CAM) to respond to changing usefulness of the product or service and a result its value to
consumer tastes more quickly. These innovations allow
the customer.
companies to significantly reduce the time necessary to bring
their products from the design process to the distribution The value chain is an analysis tool that firms use to identify
stage. the specific steps required to provide a product or service to
the customer. The key idea of this concept is that the firm
Computer-aided design (CAD) is the use of computers in studies each step in its operation to determine how each
product development, analysis, and design modification to
activity contributes to the firm's competitiveness and profits.
improve the quality and performance of the product.
Analyzing the firm's value chain helps management discover:
Computer-aided manufacturing (CAM) is the use of
• which steps or activities are not competitive
computers to plan, implement, and control production.
• where costs can be reduced, or
l. Automation
• which activity should be outsourced, and
Automation involves and requires a relatively large investment
in computers, computer programming, machines, and • how to increase value for the customer at one or more of the
equipment. Many firms add automation gradually, one steps of the value chain.
process at a time. To improve efficiency and effectiveness
continuously, firms must integrate people and equipment into When properly implemented, these approaches can
the smoothly operating teams that have become a vital part of
manufacturing strategy. Flexible manufacturing systems (a) enhance quality
(FMS) and computer-integrated manufacturing (CIM) are
two integration approaches. (b) reduce cost

A flexible manufacturing system (FMS) is a computerized (c) increase output


network of automated equipment that produces one or more
(d) eliminate delays in responding to customers.
groups of parts or variations of a product in a flexible manner.
It uses robots and computer-controlled materials-handling These techniques are introduced here and most are covered
systems to link several stand-alone, computer-controlled more fully in later Chapters.
machines in switching from one production run to another.
Internal value chain is the set of activities required to design,
Computer-integrated manufacturing (CIM) is a manufacturing develop, produce, market and deliver products or services to
system that totally integrates all office and factory functions customers. If customer values are emphasized, managers are
within a company via a computer-based information network forced to determine which activities in the value chain are
to allow hour-by-hour manufacturing management. important to customers. A management accounting system
should track information about a wide variety of activities than
The major characteristics of modern manufacturing
span the internal value chain.
companies that are adopting FMS and CIM are production of
high-quality products and services, low inventories, high
degrees of automation, quick cycle time, increased flexibility,
and advanced information technology. These innovations shift
the focus from large production volumes necessary to absorb
fixed overhead to a new emphasis on marketing efforts,
engineering, and product design.
Importance of Strategy in Budgeting Short-Term Objectives and The Master Budget

a firm's strategy is the path it chooses for attaining its long- Short-term objectives are goals for the coming period, which
term goals and mission. It is the starting point in preparing its can be a month, a quarter, a year, or any length of time
plans and budgets. For example, a very large and successful desired by the organization for planning purposes. A firm
Retail Department Store in the Philippines considers itself the determines short-term objectives for the budget period based
leader of top-of-the-line consumer goods (wardrobe, designer on strategic goals, long-term objectives and plans, operating
bags and shoes, accessories, housewares, and so forth. results of past periods, and expected future operating and
environmental factors including economic, industry and
One of its departments is the Supermarket and Grocery marketing conditions.
Department, selling food items, fresh and processed and
other household needs. Even though this department is a little
bit profitable, for competitive reasons, the firm made a
strategic decision to leave this line of business. Subsequent The Management Process of Preparing the Master Budget
budgets of this firm reflect this strategic decision.
Top Management Involvement
Formulation of Strategy
For a budget to be effective, top management needs to be
The process of determining a company's strategy starts with involved and show strong interest in budget results. Too much
the assessment of external factors that affect operation and involvement, however, may make the budget and alienate
evaluating internal factors than can be its strength and lower managers. The right answer is a good balance of top
weakness. management involvement with lower-level managers.

External factors Top management ensures that budget guidelines are being
followed through the - budget review and approval process.
• Competition Active involvement by top management in reviewing and
approving the proposed budget is an effective way to
• Technical, economic political, regulatory, social and discourage lower-level managers from playing budget games
environmental (e.g., budgets with easy, target and adding stock to a budget).

Internal factors Budgeting processes usually include formation of a budget


committee; determination of the budget guidelines;
• Financial strength preparation of the initial budget proposal; budget negotiation,
review and approval; and budget revision
• Managerial talent and expertise
Organization for Budget Preparation
• Functional structure, and
It is essential that the manager of an entity assigns the most
• Organizational culture
qualified personnel to the preparation of the budget. A. budget
committee with representation from the different functional
areas (marketing, production, finance, and administration) is
Strategic Goals and Long Term Objectives generally considered an effective body to oversee preparation
and administration of the budget.
An organization presents its strategic goals and long-term
objectives through capital budget and master budgets. The controller may be selected to serve as head of the
Strategy provides the framework or parameters within which committee for two major reasons:
a long-range plan is developed.
 Controller's position is independent from the
A firm's long-range plan identifies required actions over a 5- operating parts of the organization.
year to 10-year period to attain the goals set forth in their  He has the skills and experiences in coping with the
strategies. intricacies of setting up a budget.

Long Range Planning The controller acts as a coordinator in the budgeting


operation. He recommends how budgets should be prepared,
Long range planning often entails capital budgeting, which is assembles the budgets, prepares periodic reports showing
a process of evaluating proposed major such as purchases of variances of the actual results from the budgeted results,
new equipment, construction of a new factory, and addition of interprets variances and offers suggestions for improvement
new products and planning for resource requirements. Capital whenever possible.
budgets are prepared to bring an organization's capabilities
into line with the needs of its long-rang plan and long-term The budget committee decides how budgets shall be
forecast. prepared, passes on the final budget, and settles disputes in
one segment of the business and another when differences of
An organization's capacity is a result of capital investments opinion arise. The committee also receives budget reports
made in prior budgeting periods. and makes policy decisions with respect to budget revisions
and other problems of budget administration.
Budget Guidelines budget committee reviews and approves. The chief executive
officer then submits the budget to the board of directors.
One of the responsibilities of the budget committee is to Systematic budget revisions can improve dynamic operations
provide initial budget guidelines that set the tone for the but may discourage due diligence.
budget and govern budget preparation. All responsibility
centers (or budget units follow the initial budget guidelines in The Master Budget
preparing their budgets).
A master budget is a comprehensive budget for a specific
The starting point in developing budget guidelines is the firm's period. it consists of many interrelated operating and financial
strategy. In developing the initial budget guidelines, the budgets. Some firms refer to the process of preparing a
budget committee also needs to consider development that master budget as profit planning or targeting.
have occurred since the adoption of the strategic plan; the
general outlook of the economy and the market; the goal of Steps in Developing a Master Budget
the organization for the budgeting period; specific corporate
policies such as mandates for downsizing, reengineering, and The major steps in developing a Master Budget may be
the operating results of the year to date. outlined as follows:

1. Establish basic goals and long-range plans for the


The Budget Period
company. These will serve as guidelines in the preparation of
Budgets should be long enough to show managerial policies' budget estimates.
effects but short enough for accurate estimates. Different
types of budgets should be prepared for different time spans. 2. Prepare a sales forecast for the budget period.
Master budgets are financial and operating plans for a fiscal
3. Estimate the cost of sales and operating expenses.
period, while capital budgets cover 5-10 years. Responsibility
and cash budgets are prepared monthly or daily. Some 4. Determine the effect of budgeted operating results on
companies follow a continuous budgeting plan, updating the assets, liabilities and ownership equity accounts. The cash
budget as needed due to changing business conditions. budget is the largest part of this step, since changes in many
asset and liability accounts will depend upon the cash flow
The Initial Budget Proposal
forecast.
Based on the initial budget guidelines, each responsibility
5. Summarize the estimated data in the form of a projected
center prepares its initial budget proposal. The following
income statement for the budget period, the projected
factors should be considered by a budget unit.
statement of financial position as of the end of the budget
Internal factors: period and the projected cash flow statement.

• Introduction of new products. Sales Budget

The sales budget showing what products will be sold in what


• Adoption of new manufacturing processes.
quantities at what prices, is the foundation on which all other
• Changes in availability of equipment or facilities. short-term budgets are built. The sales budget triggers a chain
reaction that leads to the development of many other budget
• Changes in product design or product mix. figures in an organization. The sales budget provides the
revenue predictions from which cash receipts from customers
• Changes in expectations or operating processes of other can be estimated and supplies the basic data for constructing
budget units that the budget unit relies on for its input budgets for production costs and selling and administrative
materials or other operating factors. expenses. In short, the sales forecast is the keystone of the
budget structure. The accuracy and reasonableness of the
• Changes in other operating factors or in the expectations or
sales data will affect the whole budget.
operating processes in those other
The sales forecast is made after consideration of the following
budget units that rely on the budget unit to supply them
factors.
components.
 Past sales volume
External factors:
 General economic and industry conditions
 Competitor's actions.  Relationship of sales to economic indicators
 Changes in the labor market.  Relative product profitability
 Availability of raw materials or components and  Market research studies and competition
their prices.  Pricing, advertising and other promotion policies
 Industry's outlook for the near term.  Production capacity
 Quality of sales force
Budget Negotiation, Review and Approval, Revision  Seasonal variations
 Long-term sales trends for various products
The head of budget units reviews initial budget proposals to
ensure they align with budget guidelines and goals.
Negotiations occur at all levels of the organization. Budgets
go through successive levels until the final level, where the

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