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Chapter 10 - Strategy and the Master Budget
Chapter 10
Strategy and the Master Budget
Learning Objectives (LOs)
1. Describe the role of budgets in the overall management process.
2. Discuss the importance of strategy and its role in the master budgeting process.
3. Outline the budgeting process.
4. Prepare a master budget and explain the interrelationships among its supporting schedules.
5. Deal with uncertainty in the budgeting process
6. Identify unique characteristics of budgeting for service companies
7. Understand alternative approaches to budgeting (zero-base, activity-based, time-driven activity-
based, and kaizen budgeting)
8. Discuss various behavioral considerations in budgeting
New in this Edition
One updated Real-World Focus (RWF) item (Contemporary Refinements to Traditional
Budgeting)
Four totally new RWF items (Importance of Budgeting and Planning; Budgeting and Sensitivity
Analysis; Negative Behavioral Consequences of Traditional Budgeting; and, Rolling Financial
Forecasts)
Three revised end-of-chapter problems
Reduction in length of the chapter, with shorter, crisper explanations of the budgeting process
Teaching Suggestions
This chapter introduces one of the most strategic topics of the book—the master budget and the master
budgeting process. The master budget has a critical role in planning, coordinating, and controlling
activities within the organization. In particular, the master budget can provide the basis for a plan to
manage cash flows, especially for a firm with complex or seasonal operations. A unique aspect of this
chapter is the full development of the budgeting process, including the formation of the budget committee
through to the review and approval of the final budget, and the ethical and behavioral issues that arise in
the budget process. End-of-chapter material has been expanded to cover sensitivity analysis, ethical
considerations, and budgeting for not-for-profit and other non-manufacturing contexts.
I usually teach this topic in two class meetings (one week, 150 minutes). In the first meeting I cover the
objectives and strategic role of the master budget, and follow that with a walk-through of a few short
problems on sales, production, and materials budgets. I make sure there is a good mix of problems,
including some dealing with production planning and others dealing with cash flow management. On
each of these problems I make sure we cover the strategic role of the master budget application in that
problem. For example, I will use a cash budget problem to illustrate the important role of the cash budget
in cash management and feasibility of funding for strategic capital investments, and in turn, the important
role of cash management to the success of the firm. As we point out in some of the end-of-chapter
assignments, cash management is particularly important to small and medium-size organizations. On the
second meeting I make sure that the class has no questions on the assigned homework and then I usually
cover a few of the longer problems.
10-1
Education.
Chapter 10 - Strategy and the Master Budget
Assignment Matrix
End-of-Chapter Exercises & Problems Chapter Learning Objectives Text Features
7th ed. 6th ed.
Transition
6e to 7e
X = included in Connect
Est.
Time
1. Roles of budgets/budgeting
2. Importance of strategy
3. Outline the budgeting process
4. Prepare a master budget
5. Dealing with uncertainty
6. Budgets for service orgs.
7. Alternative budgeting approaches
8. Behavioral considerations
Strategy
Service
International
Ethics
Sustainability
Brief Exercises
X
10-14
10-14
Revised
X
10 min
X
10-15
10-15
Revised
X
10 min
X
10-16
10-16
-
X
10 min
X
10-17
10-17
-
X
10 min
X
10-18
10-18
-
X
10 min
X
10-19
10-19
Revised
X
10 min
X
10-20
10-20
-
X
10 min
X
10-21
10-21
-
X
10 min
X
10-22
10-22
-
X
10 min
X
10-23
10-23
-
X
10 min
X
Exercises
10-24
10-31
-
X
25 min
X
10-25
10-24
-
X
25 min
X
10-26
10-25
-
X
35 min
X
10-27
10-26
-
X
35 min
X
10-28
10-27
-
X
30 min
X
10-29
10-28
Revised
X
20 min
X
10-30
10-29
-
X
45 min
X
10-31
10-30
Revised
X
35 min
X
10-32
10-51
-
X
50 min
X
10-33
10-32
-
X
50 min.
X
X
10-34
10-52
-
X
50 min
X
X
X
X
10-35
10-33
Revised
X
25 min
X
10-36
10-34
-
X
45 min
X
10-37
10-35
-
X
50 min
X
10-38
10-36
Revised
X
45 min
X
X
10-39
10-37
-
-
30 min
X
X
10-40
10-38
-
X
75 min
X
X
10-41
10-40
Revised
X
30 min
X
X
X
10-42
10-41
Revised
X
40 min
X
X
X
10-43
10-42
-
X
60 min
X
10-44
10-43
-
X
25 min
X
10-45
10-45
-
X
25 min
X
X
X
10-46
10-44
-
-
50 min
X
X
X
10-47
10-39
-
-
30 min
X
X
X
10-48
10-46
Revised
-
30 min
X
X
Continued on next page…
Chapter 10 Assignment Matrix—Continued
10-2
Education.
Chapter 10 - Strategy and the Master Budget
End-of-Chapter Exercises & Problems Chapter Learning Objectives Text Features
7th ed. 6th ed.
Transition
6e to 7e
X = included in Connect
Est.
Time
1. Roles of budgets/budgeting
2. Importance of strategy
3. Outline the budgeting process
4. Prepare a master budget
5. Dealing with uncertainty
6. Budgets for service orgs.
7. Alternative budgeting approaches
8. Behavioral considerations
Strategy
Service
International
Ethics
Sustainability
Problems
10-49
10-50
Revised
X
50 min
X
10-50
10-47
Revised
X
90 min
X
10-51
10-48
Revised
X
90 min*
X
X
10-52
10-49
Revised
X
90 min*
X
X
X
10-53
10-54
Revised
-
60 min
X
X
10-54
10-53
Revised
-
60 min
X
10-55
10-55
-
-
75-90 min
X
X
X
X
10-56
10-56
-
-
75-90 min
X
X
10-57
10-57
Revised
-
45-60 min
X
X
10-58
10-58
-
-
75 min
X
X
X
X
X
X
10-59
10-59
Revised
-
40 min
X
X
10-60
10-60
-
-
45 min
X
X
X
*Much less time if assigned in conjunction with Problem 10-50 and solved using an Excel spreadsheet.
Lecture Notes
This chapter explains the role of strategic position in budgeting and the key roles budgets play in the
planning and control of operations. The chapter has four major themes: (1) the role of a firm's strategy in
guiding the budgeting process, (2) how to prepare the master budget for an organization, (3) ethical and
behavioral considerations in the budgeting process, and (4) current controversies regarding the role of the
traditional budgeting process.
A budget is an organization's quantified plan-of-action for an upcoming period; it identifies the resources
and commitments required to fulfill the organization's goals for the budget period. Preparing a budget
compels planning and promotes coordination and communication within the organization. Budgets serve
as blueprints for the organization in the upcoming period and guidelines for operating activities, provide
performance criteria, and facilitate implementation of plans. The master budgeting process culminates in
the development of pro-forma financial statements.
Budgeting is most useful when linked to the strategy of the organization. Strategy describes how an
organization matches its own capabilities with the opportunities in the marketplace in order to accomplish
its overall objectives (Exhibit 10.1). Strategic analysis starts with analyzing external factors to identify
opportunities, limitations, and threats and assessing internal situations to recognize the organization's
strengths, weaknesses, and competitive advantages. These analyses lead to strategic goals. Exhibit 10.2
shows the relationships between strategic goals, long-run objectives, and an organization’s budgeting
process.
A typical budgeting process consists of the following components/tasks:
10-3
Education.
a. Forming the budget committee,
b. Determining the budget period,
c. Specifying budget guidelines,
d. Preparing the initial budget proposal,
e. Negotiating the final budget,
f. Reviewing and approving the budget, and
g. Revising budget.
Management at all levels of the organization should participate in budget preparation and understand and
support the budgets. Top management support is critical for the budgets. In any event, budgets should not
be administered rigidly because changing conditions may call for changes in plans.
The most frequently used budget period is one year that coincides with the organization's fiscal year. The
annual budget is often subdivided by quarters and by months. Some organizations use “continuous”
(rolling) budgets in which a month, quarter, or year is added as the month, quarter, or year is ended.
The master budget is a comprehensive expression of management's plan-of-action for a future time
period (usually a year); the master budget includes both operating and financial budgets. Preparation of a
master budget starts with a review and analysis of the organization's strategic goal(s) and long-term
objectives; the master budgeting process concludes with a set of budgeted financial statements including
the budgeted income statement (and supporting schedules), budgeted balance sheet, and budgeted
statement of cash flows. Exhibit 10.2 provides an overview of the master budget.
Preparation of a master budget for a manufacturing company usually includes ten steps:
Step 1: Prepare the sales (revenues) budget (Exhibit 10.3)
Step 2: Prepare the production budget (in units) (Exhibit 10.4)
Step 3: Prepare the direct materials usage budget (Exhibit 10.5)
Step 4: Prepare the direct materials purchases budget (Exhibit 10.6)
Step 5: Prepare the direct labor budget (Exhibit 10.7)
Step 6: Prepare the manufacturing (factory) overhead budget (Exhibit 10.8)
Step 7: Prepare the cost of goods manufactured/cost of goods sold budget (Exhibit 10.9)
Step 8: Prepare the selling and administrative expense budget (Exhibit 10.10)
Step 9: Prepare the cash receipts budget—operating activities (Exhibit 10.11) and the Cash Budget
(Exhibit 10.12)
Step 10: Prepare the budgeted financial statements:
a. Budgeted Income Statement (Exhibit 10.13)
b. Budgeted Balance Sheet (Exhibit 10.15)
Included in this chapter of the IRG is an Excel spreadsheet that we used as the basis for the
comprehensive budgeting example presented in Chapter 10. Please see the end of this document for
the embedded file.
Although the budgeting procedures for different types of organizations are primarily the same as the
processes for manufacturing or merchandising firms, the procedures can involve considerations of
different factors. The focal point of a service organization's budget is personnel planning. With a clear
mandate not to exceed the budgeted revenues and expenditures for not-for-profit organizations, the master
budget of a not-for-profit organization often becomes the means to plan and document authorization for
expenditures. A multinational company faces unique budgeting issues that arise because of, among others,
cultural and language differences, dissimilar political and legal environments, fluctuating monetary
exchange rates, and discrepancies in the inflation rates of different countries.
10-4
Chapter 10 - Strategy and the Master Budget
Over the years alternative budgeting approaches have been proposed to improve budget effectiveness.
Among them are zero-base budgeting (ZBB), activity-based budgeting (ABB), time-driven activity-based
budgeting (TDABB), and Kaizen budgeting.
A typical budgeting process starts with the current budget and assumes that most of the current
activities and functions will continue into the budget period. In contrast, a zero-base budgeting
(ZBB) approach allows no activity or function to be included in the budget period unless it can be
justified.
Activity-based budgeting (ABB) and time-driven activity-based budgeting (TDABB) focus on
the budgeted costs of activities necessary to produce and sell products and services. ABB entails
formulating budgets for each activity area and links resource consumption and output. The more
detailed information available from ABB/TDABB provides managers with additional insight into
opportunities for cost reduction and elimination of non-value-added activities. Of particular
interest is a discussion regarding the use of ABB/TDABB for resource capacity planning (in
conjunction with the use of practical capacity to estimate cost-driver rates under ABC).
Kaizen (continuous improvement) budgeting explicitly incorporates continuous improvement
during the budget period into the budget numbers. Budgeted costs are based on future improve-
ments that are yet to be implemented rather than on current practices and methods.
Various financial software packages can be used to facilitate the budgeting process. As such, these
packages can reduce the computational burden and time required to prepare budgets. These software
packages, either as a stand-alone module or part of the enterprise software, enable managers to prepare
budgets and conduct sensitivity ("what if") analysis of the effects on budgets of changes in the original
predicted data or in the underlying assumptions. The 7th edition of the text includes a section titled
“Uncertainty and the Budgeting Process.” In this section, we discuss each of the following approaches to
dealing with uncertainty, as follows: (a) what-if analysis; (b) sensitivity analysis; and (c) scenario
analysis.
The 7th edition has an expanded discussion of behavioral considerations in the budgeting process.
Included in the new edition is a discussion of the “beyond budgeting” controversy as well as pitfalls
associated with the use of fixed performance plans, including an associated problem of gaming the
performance indicator. We introduce, as part of this discussion, the notion of linear compensation plans,
rolling financial forecasts, and relative performance results.
Below is an Excel spreadsheet that is embedded in this Word file. The Excel file contains the
comprehensive budgeting example used throughout Chapter 10. To access the Excel file, double-click on
the icon.
The following assignments contain links to on-line Excel 2010 support resources (“what-if” analysis,
scenario analysis, Data Tables, Goal Seek, and Solver) for handling uncertainty in the master budgeting
process:
1. Ex. 10-34
10-5
Chapter
10--Comprehensive Budgeting Example.xlsx
Chapter 10 - Strategy and the Master Budget
2. Ex. 10-37
3. Pr. 10-53
4. Pr. 10-54
5. Pr. 10-55
Finally, at the discretion of the instructor, the following behavioral issues associated with the budgeting
process can be covered:
1. Budgetary slack
2. Goal congruence (i.e., extent of consistency between the goals of the firm, its subunits, and
employees)
3. The use of authoritative or participative budgeting?
4. Level of difficulty embodied in budgets (in particular, the value of setting budgetary goals on
the basis of “highly achievable targets”)
5. Linkage of compensation and budgeted performance:
a. Gaming the performance indicator
b. Use of so-called linear compensation plans
c. Use of rolling financial forecasts and relative performance (or, relative improvement)
contracts
10-6
Education.
