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Unit 3 Section 2

The document discusses using budgets for performance evaluation. It outlines the stages of budgeting as communicating budget aims, determining the principal budget factor, preparing the sales budget and other functional budgets, negotiating budgets, reviewing the budgets, and accepting the finalized master budget. It also describes the key functions of budgets as coordination, assigning responsibility, utilizing scarce resources, motivation, planning, evaluation, communication, and control. Finally, it explains that budgets form the baseline for future company performance and are used to evaluate departmental performance by comparing actual expenses to budgeted amounts.

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Babamu Kalmoni Jaato
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78 views4 pages

Unit 3 Section 2

The document discusses using budgets for performance evaluation. It outlines the stages of budgeting as communicating budget aims, determining the principal budget factor, preparing the sales budget and other functional budgets, negotiating budgets, reviewing the budgets, and accepting the finalized master budget. It also describes the key functions of budgets as coordination, assigning responsibility, utilizing scarce resources, motivation, planning, evaluation, communication, and control. Finally, it explains that budgets form the baseline for future company performance and are used to evaluate departmental performance by comparing actual expenses to budgeted amounts.

Uploaded by

Babamu Kalmoni Jaato
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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USING BUDGETS FOR PERFORMANCE EVALUATION

COST AND MANAGEMENT


UNIT 3 SECTION
ACCOUNTING 2
Unit 3, section 2: Using budget for performance evaluation

You are welcome once again to the session 2 of Unit 4 of this module. I
hope you enjoyed reading the first session. Pause a moment and in your own
words explain to a friend, the terms budget, budgetary control and cash
budget. In this session, we will concentrate on stages of budgeting, some of
the essential functions of a budget and it use for performance evaluation.

By the end of this session you should be able to:


 outline three stages in budgeting
 state and explain three functions of a budget;
 explain the use of a budget for performance evaluation; and

Now read on…

Stages in budgeting
The main stages in budgeting are as follows:
 Communicating Budget Aims: the budget committee establishes the
aims, policy administration and underlying assumptions that can affect
the budget. The aims will be general targets such as profit or market
share linked to the longer term strategic plan. Such aims are
communicated to the various functions for the preparation of the
functional budgets.

 Determining the Principal Budget Factor This factor limits the level
activity at which the organisation can operate. It could be a factor of
production such as restricted machine capacity or labour hours. The
limiting factor is most likely to emanate from magnitude of sales
demand since there is no point in producing more than what customers
are willing to buy; except for non-profit making establishments where it
is often cash resources. Prior to the preparation of the budgets it is
necessary for top management to identify the factor which restricts
performance as this factor becomes the pivot upon which the annual
budgeting process rotates.

 Prepare Sales Budget: After determining the principal budget factor,


the next stage is to prepare the most difficult budget since it involves the
relationship between price and demand. Every effort must be made to
ensure this is as accurate as possible as all other budgets will be affected
by management decisions at this point.

 Prepare all Other Functional Budgets: After preparing the sales


budget. Functional or departmental managers will prepare their own
budgets. The preparation of the budget should be a ‘bottom-up’ process.
This means that the budget should originate at the lower levels of
management and be refined and co-ordinated at higher levels. This
approach will encourage managers to participate in the preparation of

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Unit 3, section 2: Using budget for performance evaluation ACCOUNTING

their budgets and thereby increase the probability that they will accept
the budget and also strive to achieve the budget targets.

 Negotiation of Budgets: At this stage, the functional managers will


meet with the senior management to refine the budget prepared. The
senior management will then co-ordinate each budget with other linked
budgets. In attempt to do this, excess cost will be eliminated from the
budget, to make their targets achievable.

 Review: The functional budgets are brought together at this stage, to


form a whole. The whole budget is then assessed and reviewed. This is
usually a management accounting function. It must be assessed initially
for feasibility and then reviewed for acceptability.

 Acceptance: The budget is summarised for the business as a whole in


the master budget and accepted by the budget committee as the target for
the coming year. It is expressed as budgeted financial statement and is
also used to prepare cash budgets and more detailed production and
sales plan.

Functions or Purpose of Budgets


A budget provides a direction for an organization, aids coordination of
activities and facilitates control. Usually budgets quantify management’s
expectations regarding future income, cash flows, and financial standing of
the organization. Therefore, the functions or purposes of a good budget can
be identified in the following ways:

 Co-ordination: the existence of a budget ensures that different


departments’ actions are co-ordinated to a common goal and will avoid
dysfunctional behaviour. For instance production department budgets
will be linked directly to sales department targets. Thus, budgets help to
maintain harmony within an organization.

 Responsibility: different staff can be made responsible for their own


areas of the budget, which will encourage maximum participation.

 Utilisation of Scarce Resources: If sales demand is not the limiting


factor it may be that other factors of production such as labour hours
may constrain a specific production budget or plan. In such a case, tools
like key factor analysis or linear programming can be employed to
appropriate resources into the most profitable production mix or plan.

 Motivation: Corporate plans are more likely to be achieved if they are


broken down and expressed as quantified targets, often in the form of
budgets. If a budget is set as a target, we may need to motivate our staff
towards achieving it either through positive or negative means.

UEW/IEDE 93
COST AND MANAGEMENT
ACCOUNTING Unit 3, section 2: Using budget for performance evaluation

 Planning: Budgets compel managers to consider the future rather than


reacting to crisis spontaneously as they occur. A plan will definitely
provide for alternative course of action should such crises arise.

 Evaluation: Budget is often used as a yard stick for evaluating how well
(or poor) responsible officers or managers are actually doing. Put
differently, budget may be used to evaluate the results of a department
or function of an organization such as a cost centre, where a manager is
held responsible for the control of expenditure. It may further be used to
evaluate the actions of a manager within the organization and therefore
ensures effective and efficient performance.

 Telling (i.e. Communication): a budget will set out lines of


communication and responsibility within an organisation. In large
organizations, particularly if they are organized along divisional lines, it
is often difficult to communicate to people the broad objectives and
plans of the entire organization. The budget is a plan of action
expressed in quantitative terms. Staff will therefore be better informed
and will feel highly motivated as being part of a team.

 Control: Once a period has elapsed, the actual results of an organization


for a period can be compared with budgeted results to see how close it
came to achieving the plan. This will enable the company to potentially
bring about improvements for the future. The budget therefore acts as a
comparator against which the actual results may be compared.

Budgeting and Performance Evaluation


Budgeting forms the baseline for a company's future performance.
Managers create the budget anticipating financial conditions and market
expectations for future periods. These managers calculate revenues and
expenses for the period being budgeted. When the period reflected in the
budget arrives, the managers compare actual expenses to the budget
numbers and evaluate the department's performance

Creating a company budget involves every department within the


organization. The sales department anticipates market conditions and
estimates future revenues to create a sales budget. The production
department uses this information to create a production budget anticipating
material, labour and overhead costs. Administrative and selling managers
anticipate their expenses for the upcoming year. A budget manager
coordinates the communication between each department and compiles each
section into a master budget and creates budgeted financial reports.

The accounting department records monthly transactions in the general


ledger. The accountant creates regular financial statements to communicate
the financial results for the company. The accountant also creates financial

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Unit 3, section 2: Using budget for performance evaluation ACCOUNTING

reports which communicate sales activity and department expenses for


individual departments. The accountant distributes the department reports to
the appropriate department managers and the complete set to the budget
manager.

The budget manager compares the actual sales sand expenses to the
budgeted sales and expenses. The difference between the actual and
budgeted amounts equals the budget variance. The budget manager
combines the actual numbers, the budget numbers and the budget variance
numbers on one report for each department. The budget manager distributes
this report to the department managers and their superiors.

Budget variances are used to evaluate the performance of individual


department managers. The larger the variance, the more questions superiors
ask regarding the amounts. The department managers must explain the
reason for the budget variance. If the budget manager has a reasonable
explanation or the situation was out of their control, their performance is not
adversely affected. If the budget variance exists due to mismanagement by
the department manager, the manager's evaluation will be negative

Exercises
 Discuss the stages of budgeting
 Explain five (5) functions of a budget
 Explain how budget is used as a tool for performance evaluation

UEW/IEDE 95

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