CHAPTER 8 BUDGETING The Master Budget - operating and

financial budgets compose the master

Planning is the cornerstone of effective budget. An operating budget is a budget
management, and, in the complex that is expressed in both units and
business environment, successful dollars.
planning requires that managers predict,
with reasonable precision, the key The master budget is prepared for a
variables that affect company specific period and is static in the sense
performance. Such predictions provide that it is based on a single level of
managers with the foundation for output demand.
effective problem solving, control, and
Production Budget - Production budget
resource allocation. Planning (especially
in financial terms) is important even if follows from the sales budget and is
future conditions are expected to based on information about the type,
approximate current ones, and it is quantity, and timing of units to be sold.
critical when future conditions are Purchases Budget - A purchases
expected to change. budget contains the amount of
Budgeting - The process of formalizing inventory that a company must
and translating qualitative narratives into purchase during each budget period.
a documented, quantitative format. Personnel Budget – A personal budget
Budgeting indicates a direction or path is a finance plan which allocates future
choses from many alternatives inclusion income towards expenses, savings and
of quantifiable amounts provides specific debt repayment
criteria against which future
preformance (also recorded in Direct Labor Budget – used to
accounting terms) can be compare. calculate the number of labor hours
that will be needed to produce the
Strategic Planning - The strategic plan units itemized in the production
should identify key variables that will be budget.
the a long range basis (5–10 years) are
engaged in strategic planning. The Overhead Budget – contains all
strategic plan should identify key manufacturing costs other than direct
variables that will be the direct causes of materials and direct labor. The
the achievement (or nonachievement) of information in this budget becomes
organizational goals and objectives. Key part of the cost of goods sold line item
variables be internal (under the control in the master budget.
of management) or external (normally
Selling and Administrative Budget -
noncontrollable by management)
expenses can be predicted in the same
Tactical planning determines how the manner as overheadcosts.
strategic plans will be achieved.
Capital Budget – focuses on the short- the key management control tool in a
term or upcoming fiscal period. decentralized organization.

Capital budgeting is the process that a A responsibility accounting system

business uses to determine which produces responsibility reports that
proposed fixed asset purchases it assist each successively higher level of
should accept, and which should be management in evaluating the
declined.. performances of subordinate
managersand their respective
Cash Budget – A cash budget
organizational units.
itemizes the projected sources and
uses of cash in a future period. This A responsibility accounting system helps
budget is used to ascertain whether organizational unit managers to conduct
company operations and other the five basic control functions:
activities will provide a sufficient
• Prepare a plan (e.g., using budgets
amount of cash to meet projected cash
requirements. and standards) and use it to
communicate output expectations and
Income Statement - statement uses delegate authority.
much of the information previously
• Gather actual data classified in
developed in determining the revenues
and expenses for the period. accordance with the activities and
categories specified in the plan.
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• Monitor the differences between
Internal Performance Measures - planned and actual data at scheduled
provide a focus on the efficiency and intervals. Responsibility reports for
effectiveness of production processes subordinate managers and their
must be developed by management. immediate supervisors normally include
comparisons of actual results with
External Performance Measures - flexible budget figures.
must signal an organization’s ability to
satisfy its customers. The quality and • Exert managerial influence in
quantity of firms competing in the global response to significant differences.
market have placed consumers at the Because of day-to- day contact with
center of attention.
• Continue comparing data and
Responsibility accounting system responding; then, at the appropriate
facilitates decentralization by providing time, the process will begin again.
information about the performance,
Types of Responsibility Centers
efficiency, and effectiveness of
organizational subunits and their Cost Center - an organizational unit
managers. Responsibility accounting is whose manager has the authority only to
incur costs and is specifically evaluated Standard cost systems require less
on the basis of how well costs are clerical time and effort than are
controlled. necessary in an actual cost system. A
standard cost system assigns costs to
Revenue Center - strictly defined as an inventory and Cost of Goods Sold
organizational unit that is responsible for accounts at predetermined amounts per
the generation of revenues and has no unit regardless of actual conditions.. A
control over setting selling prices or standard cost system holds unit costs
budgeting costs. constant for some period.However,more
Profit Center - organizational unit importantly than the clerical efficiency
whose manager is responsible for provided, standard cost systems are
generating revenues and managing designed to provide information for
expenses related to current activity. managers to use in performing their
various functions.
Investment Center - an organizational
unit whose manager is responsible for - Motivating
managing revenues and current - Planning
expenses. - Controlling
- Decision Making
Short-Term Financial Performance - Performance Evaluation
Measures for Management
CONSIDERATIONS IN
Return on Investment - a ratio relating ESTABLISHING STANDARDS
income generated by an investment
Center to the resources (or asset base) Appropriatness - developed from past
used to produce that income. and current information, standards must
evolve to reflect relevant future technical
ROI = Income / Assets Invested and environmental factors.
Residual Income - An investment Attainability - standards provide a
center’s residual income (RI) is the profit target level of performance and can be
earned that exceeds an amount set at various levels of rigor that can
“charged” for funds committed to the affect employee motivation.
center.
PRACTICAL STANDARD - Standards
Residual Income = Income - (Target that can be reached or slightly exceeded
Rate x Asset Base) approximately 60–70 percent of the time
with reasonable effort . These
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standards allow for normal,unavoidable
WHY STANDARD COST SYSTEMS delays such as those caused by
ARE USED machine downtime and worker breaks.
Practical standards represent an
attainable challenge and traditionally performed by workers (such as bending,
havebeen thought to be the most reaching, lifting,moving material, and
effective in motivating workers and packing) or by machinery (such as
determining their performance levels. drilling, cooking, and assembling)should
be identified. In specifying operations
IDEAL (THEORETICAL) STANDARDS
and movements, activities such as
- Standards that provide for no cleanup,setup, and rework are
inefficiency of any type. These considered.
standards are the most rigorous and do
not allow for normal operating delaysor Overhead Standards reflect the
human limitations such as fatigue, company’s predetermined
boredom, or misunderstanding. ideal manufacturing overhead rate(s).
standardsare impossible to attain.
General Variance Analysis Model - A
Material Standards - The first step in total variance is the difference between
developing material standards is to the total actual cost for the production
identify and list the specific direct inputs and the total standard cost
material(s) needed to manufacture the applied to the production output.
product. THis list is generally available
Using a Balanced Scorecard for
on product specification documents prior
Measuring Performance
to initial production. Without such
documentation, material specifications provides a set of measurementsthat
can be determined by observing the “complements financial measures of
production area, questioning past performance with measures of the
productionpersonnel, inspecting material drivers of future performance.” The
requisitions, and reviewing the product- scorecard should reflect an
related cost accounts. organization’s mission andstrategy and
Four things must be known about typically includes performance
material inputs: measures from four perspectives:

• financial,
• type of material needed,
• internal business,
• quality (grade) of material needed,

• quantity of material needed, and • customer, and

• price per unit of material (must be • learning and growth.

based on level of quality specified). Using the Balanced Scorecard to
Labor Standards - requires the same Drive Strategy
basic procedures as those used for Companies adapt the balanced
material. Each production operation scorecard to fit their own structures and
environments. Financial measures of the PI = Present Value of Net Cash Inflows /
BSC should reflect stakeholder-relevant Net Investment
issues of profitability,organizational
Internal rate of return (IRR)- the
growth, and market price of stock.
discount rate that causes the present
CHAPTER 11 : value ofthe net cash inflows to equal the
present value of the net cash outflows.
WHAT IS CAPITAL BUDGETING?
Capital budgeting involves evaluating Postinvestment Audit –information on
and ranking alternative future actual project results is gathered and
investments to effectively and efficiently compared to expected results. This
allocate limited capital. process provides a feedback or control
feature to both the persons who
Financing decision involves choices
submitted the original project information
regarding the method o fraising capital
and those who approved it.
to fund an investment. Financing is
based on an entity’s ability to issue and Module 12 : STATEMENT OF CASH
service debt and equity securities. FLOWS

Investment decision is a judgment IAS 7 issued - IAS 7 was revised and

about which assets to acquire to renamed again in 2008 by the IASB to
accomplish an entity’s mission. require companies to issue a statement
of cash flows. Its objective was to
Payback Period - This method require companies to provide
measures the time required for a standardized reports on their cash
project’s cash inflows to equal the generation and cash absorption for a
original investment. The payback for a period. Its principal feature wasthe
project is complete when the analysis of cash flows under three
organization has recouped its standard headings of ‘operating
investment. activities’, ‘investingactivities’ and
Payback Period = Investment / Annuity ‘financing activities’.
Amount METHODS OF PRESENTING CASH
Net present value method - FLOWS FROM OPERATING
determines whether a project’s rate of ACTIVITIES
return is equal to, higherthan, or lower ● The direct method reports cash
than the desired rate of return. inflows and outflows directly, starting
Profitability Index - a ratio of a with the major categories of gross cash
project’s net cash inflows to the project’s receipts and payments. This means that
net investment. cash flows such a receipts from
customers and payments to suppliers
are stated separately within the used to understand the operational
operating activities. performances of each and every
department and unit of the business
● The indirect method starts with the concern. Internal analysis helps to take
profit before tax and then adjusts this decisions regarding achieving the goals
figure for non-cash items such as of the business concern.
depreciation and changes in working
capital. 2. Based on Method of Operation -
financial statement analysis may be
Module 13: FINANCIAL STATEMENT
classified into two major types such as
ANALYSIS
horizontal analysis and vertical analysis.
A financial statement is an official A. Horizontal Analysis - Under the
document of the firm, which explores the horizontal analysis, financial statements
entire financial information of the firm.
are compared with several years and
The main aim of the financial statement based on that, a firm may take
is to provide information and understand decisions. Normally, the currentyear’s
the financial aspects of the firm. figures are compared with the base year
Types of Financial Statement (base year is consider as 100) and how
Analysis the financial information are changed
from one year to another.This analysis is
1. Based on Material Used - financial also called as dynamic analysis.
statement analysis may be classified
into two major types such as External B. Vertical Analysis Under the vertical
analysis and internal analysis. analysis, financial statements measure
the quantities relationship of the various
A. External Analysis - Outsiders of the items in the financial statement on a
business concern do normally external particular period.It is also called as static
analyses but they are indirectly involved analysis, because, this analysis helps to
in the business concern such as determine the relationship with various
investors, creditors,government items appeared in the financial
organizations and other credit agencies. statement.
External analysis isvery much useful to
understand the financial and operational TECHNIQUES OF FINANCIAL
position of the business concern. This STATEMENT ANALYSIS
analysis provides only limited - Ratio Analaysis
information about the business concern. - Comparative Statement
B. Internal Analysis - The company - Trend Analysis
itself does disclose some of the valuable - Common Size Analysis
informations to the business concern in - Funds Flow Statement
this type of analysis. This analysis is - Cash Flow Statements
Comparative statement analysis is an Liquidity Ratio - It is also called as
analysis of financial statement at short-term ratio. This ratio helps to
different period of time. This statement understand the liquidity in a business
helps to understand the comparative which is the potential ability to meet
position of financial and operational current obligations. This ratio expresses
performance at different period of time. the relationship between current assets
and current assets of the business
Comparative financial statements again concern during a particular period.
classified into two major parts such as :
comparative balance sheet analysis - Current Ratio
and comparative profit and loss - Quick Ratio
account analysis.
Activity Ratio It is also called as
Comparative balance sheet analysis turnover ratio. This ratio measures the
concentrates only the balance sheet of efficiency of the current assets and
the concern at different period of time. liabilities in the business concern during
Under this analysis the balance sheets a particular period. This ratio is helpful to
are compared with previous year’s understand the performance of the
figures or one-year balance sheet business concern.
figures are compared with other years.
Comparative balance sheet analysis - Stuck Turnover
may be horizontal or vertical basis. This - Debtors Turnover
type of analysis helps you understand - Credit Turnover
the real financial position of the concern - Working Capital Turnover
as well as how the assets, liabilities and Solvency Ratio It is also called as
capitals are placed during a particular leverage ratio, which measures the long-
period. term obligation of the business concern.
Ratio analysis is a commonly used tool This ratio helps to understand, how the
of financial statement analysis. Ratio is long-term funds are used in the
a mathematical relationship between business concern.
one number to another number. Ratio is - Debt- Equity
used as an index for evaluating the - Proprietary Ratio
financial performance of the business - Interest Coverage
concern.
Profitability Ratio helps to measure the
Ratio can be classified into various profitability position of the business
types. Classification from the point of concern.
viewof financial management is as
follows: - Gross Profit
- Net Profit
- Operating Profit
 - Return in Investment 9. payment for employees

– Outflow

1. Collection from customer - Operating

– Inflow
10. Increase in expense
- Operating
-
2. Additional cast investment
-
– Inflow
Format of Cash Flows Statement:
- Financing

3. Cash withdrawal Name of the company

STATEMENT OF CASH FLOWS
– Outflow Date and Year
- Financing

4. D. Payment of interest

– Outflow

- Operating

5. Increase in inventory

– Non cash

- Non cash

6. Payment income taxes

– Outflow

- Operating

7. Depreciation expense

-Non cash

-Non cash

8. Proceeds of sales from land

- Inflows

- Investing