Bernardus Alan Handoko

11/311392/EK/18212
IUP Accounting 2011

CHAPTER 10
USING BUDGET FOR PLANNING AND
COORDINATION
Summary:

Resource Flexibility
For decisions affecting the short-term, the firms capacity-related costs are
considered as given and fixed. The supply of capacity resources is based on the
amount needed to produce the projected volume of product. The budgeting process
makes clear that some resources, once acquired, cannot be disposed of easily if
demand is less than expected.
The Budgeting Process
The process that determines the planned level of the most flexible costs. Budgeting
also includes discretionary spending such as for R&D, advertising, and employee
training.
o Role of Budgeting:
Budgets serve as a control for managers within the business units of an
organization.
Budgets play a central role in the relationship between planning and
control.
Budgets reflect in quantitative terms how to allocate financial
resources to each part of an organization.
o Elements of Budgeting
Flexible resources that create variable costsFlexible resources
are those that can be acquired or disposed of in the short term, such as
the lumber, glue, and varnish used in a furniture factory.
Intermediate-term capacity resources that create fixed costs
An example is forecasting the need for rental storage space that might
be contracted on a quarterly, semiannual, or annual basis.
Resources that, in the intermediate run and long run, enhance
the potential of the organizations strategyThese are
discretionary expenditures, which include research and development,
employee training, the maintenance of capacity resources, advertising,
and promotion.
Long-term capacity resources that create fixed costsAn
example is a new fabrication facility for a computer chip manufacturer,
which might take several years to plan and build and might be used for
10 years.
o Two major types of budgets comprise the master budget:
Operating budgetssummarize the level of activities such as sales,
purchasing, and production
Financial budgetsidentify the expected financial consequences of the
activities summarized in the operating budgets
Demand Forecast
An organizations goals provide the starting point and the framework for evaluating
the budgeting process. Comparison of the tentative operating plans projected
financial results with the organizations financial goals.
Organizations develop demand forecasts in many ways:
o Market surveys

Bernardus Alan Handoko

11/311392/EK/18212
IUP Accounting 2011
o
o
o

Statistical models
Assume that demand will either grow or decline by some estimated rate over
previous demand levels
Require a sales plan for each key line of goods and services

The Production Plan

Planners determine a production plan by matching the completed sales plan with the
organizations inventory policy and capacity level. The plan identifies the intended
production during each of the interim periods comprising the annual budget period.
The inventory policy is critical and has a unique role in shaping the production plan.
One policy is to produce goods for inventory and attempt to keep a target number of
units in inventory at all times.
Inventory Policy: Just-in-time (JIT) inventory policy: Demand directly drives the
production plan. Production in each interim period equals the next interim periods
planned sales. JIT requires: Flexibility among employees, equipment, and suppliers; a
production process with little potential for failure.
Developing the Spending Plan
Once planners identify a feasible production plan, they may make tentative resource
commitments. The purchasing group prepares a plan to acquire the required raw
materials and supplies. Because sales and production plans change, the organization
and its suppliers must be able to adjust their plans quickly based on new information.
The personnel and production groups prepare the labor hiring and training plans.
When an organization is contracting, it will:
o Use retraining plans to redeploy employees to other parts of the organization,
or
o Develop plans to discharge employees
The Capacity Level
Three types of resources determine capacity:
o Flexible resources that the organization can acquire in the short term.
o Capacity resources that the organization must acquire for the intermediate
term.
o Capacity resources that the organization must acquire for the long term.
The resource-consuming activity:
o Activities that create the need for resources (and resource expenditures) in
the short-term.
o Activities undertaken to acquire capacity for the intermediate-term.
o Activities undertaken to acquire capacity needed for the long-term.
The Financial Plan
Financial summary of the tentative operating plans:
o The projected balance sheet serves as an overall evaluation of the net effect
of operating and financing decisions during the budget period.
o The projected income statement serves as an overall test of the profitability of
the proposed activities.
o The projected cash flow forecast helps an organization identify if and when it
will require external financing.
What-If Analysis
Explore the effects of alternative marketing, production, and selling strategies.
Alternative proposals like these can be evaluated in a what-if analysis. The structure
and information required to prepare the master budget can be used easily to provide
the basis.
Sensitivity Analysis

Bernardus Alan Handoko

11/311392/EK/18212
IUP Accounting 2011
Sensitivity analysis is the process of selectively varying a plans or a budgets key
estimates for the purpose of identifying over what range a decision option is
preferred.
Variance Analysis
Comparison of planned (or budgeted) results with actual results.