Master Budget

1 Introduction

The purpose of this chapter is to introduce the master budget or financial plan. This topic includes an important set of concepts and techniques that represent the major planning device for an organization, as well as the foundation for a traditional standard cost performance evaluation and control system. The chapter includes six sections. The first section provides a discussion of the underlying concepts of financial planning and budgeting including the various types of budgets. This section also includes a diagram of the master budget that provides an overview of the overall budgeting process. Sections two and three include short, but important discussions of the purposes and benefits of budgeting and the limitations and problems involved in budgeting. The assumptions upon which the budget is based are briefly described in section four. The techniques used to prepare a master budget are discussed and illustrated in section five. This is the longest section and includes a discussion of where the budget director obtains the budget information as well as how the information is used to complete the various schedules and sub-budgets involved. The last section includes a simplified, but fairly comprehensive example.

 

Budgeting involves planning for the various revenue producing and cost generating activities of an organization. The importance of budgeting is emphasized by an old saying, "Failing to plan, is like planning to fail." Budgeting is essentially financial planning, or planning for financial performance. Financial performance depends on revenue and cost. Revenue is provided from sales of merchandise by retailers, sales of products, harvested, mined, constructed, formed, processed or assembled by farms, mining companies, construction companies and manufacturers and from sales of various services by firms involved in activities such as banking, insurance, accounting, law, medical care, food distribution, repair and entertainment. In addition to producing revenue, all of these companies generate three types of costs including discretionary, engineered and committed costs. Various costs fall into one of these three categories based on the cause and effect relationships involved. Although there are a variety of ways to define costs, categorizing costs in terms of the cause and effect relationships is a prerequisite for understanding the different types of budgets that are introduced in this chapter. These three cost concepts are summarized and discussed in more detail below.    

   1.2.1. Discretionary Costs

Many activities are viewed as beneficial to an organization, even thought the benefits obtained, or value added by performing the activities cannot be defined precisely, either before or after the activity is completed. The costs of the inputs, or resources required to perform such activities are referred to as discretionary costs. These costs are discretionary in the sense that management must choose the desired level of the activity based on intuition or experience because there is no well-defined cause and effect relationship between cost and benefits. Discretionary costs are usually generated by service or support activities. Examples include employee training, advertising, sales promotion, legal advice, preventive maintenance, and research and development. The value added by each of these activities is intangible and difficult, if not impossible to measure, where value added refers to the benefits obtained by either internal or external customers. In terms of cost behavior, discretionary costs may be fixed, variable or mixed.

   1.2.2. Engineered Costs

Engineered costs result from activities with reasonably well defined cause and effect relationships between inputs and outputs and costs and benefits. Direct material costs provide a good example. Engineers can specify precisely how many parts (inputs) are required to generate a specific output such as a microcomputer, a coffee maker, an automobile, or a television set. Direct labor also falls into the engineered cost category as well as indirect resources that vary with product specifications and production volume. Although the cause and effect relationships are not as precise for indirect resources, these relationships can be established using statistical techniques such as regression and correlation analysis. A key difference between discretionary costs and engineered costs is that the value added by the activities associated with engineered costs is relatively easy to measure. Engineered costs are variable in terms of cost behavior.

   1.2.3. Committed Costs

Committed costs refer to the costs associated with establishing and maintaining the readiness to conduct business. The benefits obtained from these expenditures are represented by the company's infrastructure. For example, the costs associated with the purchase of a franchise, a patent, drilling rights and plant and equipment create long-term obligations that fall into the committed cost category. These costs are mainly fixed in terms of cost behavior and expire to become expenses in the form of amortization and depreciation.

Four types of budgets are used for planning and controlling the various types of costs discussed above. These four techniques are summarized in 

BUDGET TYPES AND CHARACTERISTICS
.

   1.3.1. Appropriation Budgets

The oldest type of budget is referred to as an appropriation budget. Appropriation budgets place a maximum limit on certain discretionary expenditures and may be either incremental, priority incremental, or zero based. Incremental budgets are essentially last year's budget amount plus an increment, i.e., small increase. Priority incremental budgets also involve an increase, but require managers to prioritize, or rank discretionary activities in terms of their importance to the organization. The idea is for the manager to indicate which activities would be changed if the budget were increased or decreased. The technique is expensive to use because zero based budgets theoretically require justification for the entire budget amount. When it was popular, a more typical approach was to justify the last twenty percent of the budget, i.e., use eighty percent based budgeting.

From a control perspective, appropriation budgets are effective in limiting the amount of expenditure, but create a behavioral bias to spend to the limit. Establishing a maximum amount for expenditure encourages spending to the limit because spending below the limit implies that something less than the maximum appropriation was needed. Spending below the limit might result in a budget cut in future periods. Since nearly every manager views a budget reduction in their discretionary costs as undesirable, there are frequently crash efforts at the end of a budget period to spend up to the limit.

   1.3.2. Flexible Budgets

Flexible budgets are based on a cost function such as Y = a + bX, where Y represents the budgeted cost, or dependent variable. The constant "a" represents a static amount for fixed costs and the constant "b" represents the rate of change in Y expected for a unit change in the independent variable X. The expression " bX" is the flexible part of the budget cost function. The flexible budget technique is used for planning and monitoring all types of costs. The static amount "a" includes both discretionary and committed costs, while the flexible part "bX" includes various types of engineered costs. The flexible characteristic of the technique enables the flexible budget to play a key role in both financial planning and performance evaluation.

   1.3.3. Capital Budgets

Capital budgets represent the major planning device for new investments. Discounted cash flow techniques such as net present value and the internal rate of return are used to evaluate potential investments. Capital budgets are part of a somewhat more encapsulating concept referred to as investment management. Investment management involves the planning and decision process for the acquisition and utilization of all of the organization's resources, including human resources as well as technology, equipment and facilities. The concept of investment management includes the discounted cash flow methods, but is more comprehensive in that the organization's portfolio of interrelated investments is considered as well as the projected effects of not investing.

   1.3.4. Master Budgets

The fourth type of budget is referred to as the master budget or financial plan. The master budget is the primary financial planning mechanism for an organization and also provides the foundation for a traditional financial control system. More specifically, it is a comprehensive integrated financial plan developed for a specific period of time, e.g., for a month, quarter, or year. This is a much broader concept than the first three types of budgeting. The master budget includes many appropriation budgets (typically in the administrative and service areas) as well as flexible budgets, a capital budget and much more. A diagram illustrating the various parts of a master budget is presented in ----------

The master budget has two major parts including the operating budget and the financial budget. The operating budget begins with the sales budget and ends with the budgeted income statement. The financial budget includes the capital budget as well as a cash budget, and a budgeted balance sheet. The main focus of this chapter is on the various parts of the operating budget and the cash budget. The budgeted balance sheet is covered briefly, but not emphasized. In the next section, we consider the purposes, benefits, limitations and assumptions of the master budget.

There are a variety of purposes and benefits obtained from budgeting. Consider the following:

a. Periodic Planning (Formalization of Planning).

The most obvious purpose of a budget is to quantify a plan of action. The development of a quarterly budget for a Sheraton Hotel, for example, forces the hotel manager, the reservation manager, and the food and beverage manager to plan for the staffing and supplies needed to meet anticipated demand for the hotel’s services. Thus, budgets forces managers to think a head to anticipate and prepare for the changing conditions. The budgeting process makes planning an explicit management responsibility.

b. Integrates and Coordinates

The master budget is the major planning device for an organization. Thus, it is used to integrate and coordinate the activities of the various functional areas within the organization. For example, a comprehensive plan helps ensure that all the needed inputs (equipment, materials, labor, supplies, etc.) will be at the right place at the right time when needed, just-in-time if possible. It also helps insure that manufacturing is planning to produce the same mix of products that marketing is planning to sell.

c. Communicates and Motivates

Another purpose and benefit of the master budget is to provide a communication device through which the company’s employees in each functional area can see how their efforts contribute to the overall goals of the organization. This communication tends to be good for morale and enhance jobs satisfaction. People need to know how their efforts add value to the organization and its' products and services. The behavioral aspects of budgeting are extremely important.

c. Promotes Continuous Improvement

The planning process encourages management to consider alternatives that might improve customer value and reduce costs.. The financial plan and subsequent financial performance measurements reflect the financial expectations and consequences of those efforts.

d. Guides Performance

The master budget also provides a guide for accomplishing the objectives included in the plan. The budget becomes the basis for the acquisition and utilization of the various resources needed to implement the plan. Perfection of the guidance aspect of budgeting can significantly reduce the amount of uncertainty and variability in the company’s operations.

e. Facilitates Evaluation and Control

The master budget provides a method for evaluating and subsequently controlling performance. We will develop this idea in considerable detail in the following chapter. Performance evaluation and control is a very powerful and very controversial aspect of budgeting.

f. Cost Awareness.

Accountants and financial managers are concerned daily about the cost implications of decisions and activities, but many other managers are not. Production managers focus on input, marketing manager’s focuses on sales, and so forth. It is easy for people to overlook costs and cost-benefit relationships. At budgeting time, however, all managers with budget responsibility must convert their plans for projects and activities to costs and benefits. This cost awareness provides a common ground for communication among the various functional areas of the organization.

 

There are several limitations and problems associated with the master budget that need to be considered by management. These problems involve uncertainty, behavioral bias and costs.

a. Uncertainty

Budgeting includes a considerable amount of forecasting and this activity involves a considerable amount of uncertainty. Uncertainty affects both sides of the financial performance dichotomy, but uncertainty on the revenue side presents a more serious limitation for planning. The sales budget is frequently based on a forecast supported by a variety of assumptions about the economy, and the actions of competitors, suppliers, and customers. The uncertainty associated with sales forecasting creates a greater problem than uncertainty on the cost side because the other parts of the budget are derived from the sales forecast.

b. Costs

A third problem or limitation is that budgeting requires a considerable amount of time and effort. Many companies maintain a twelve-month budget on a continuous basis by adding a future month as the current month expires. While this does not create a major expenditure for large or medium sized organizations, smaller companies may find it difficult to justify the costs involved. Many small, potentially profitable firms, do not plan effectively and eventually fail as a result. Cash flow problems are common, e.g., not having enough cash available (or accessible through a line of credit with a bank) to pay for merchandise or raw materials or to meet the payroll. Many of these problems can be avoided by preparing a cash budget on a regular basis.

c. Budgeting And Human Behavior

Budgets can have a significant behavioral effect. Whether that effect is positive or negative depends to large extent on how budgets are used.   Positive behavior occurs when the goals of individual managers and employees are aligned with the goal of the organization and the manager has the drive to achieve them. The alignment of managerial and organizational goals is often referred to as goal congruence.

If budgets is improperly administered, the may result in dysfunctional behaviour, a behavior that is in basic conflict with the goals of the organization. If budgets are to benefit an organization, they need the support all the firm’s employees.  The behavioral problems include the following: conflicting views, imposed budgets, budgets as checkup devices, and unwise adherence to budgets.

Conflicts. The problem of conflicts in budgeting can be illustrated by considering a matter of importance to almost any firm-inventory policy. The sales manager of a retail firm wants inventory to be as high as possible because it is easier to make sales if the goods are available to the customer immediately. For the same reason, the sales manager in a manufacturing firm also wants inventory immediately ready for delivery. A financial manager wants low inventories because of the costs associated with having inventory (storage, insurance, taxes, interest, and so on). In a manufacturing firm, the production manager is not interested in inventory per se, but in steady production, no interruptions for rush orders, no unplanned overtime, and other conditions that minimize production costs. Thus, three managers have different view on the desirable level of inventory. They will be evaluated by reference to how well they do their job, so each has an interest in the firm’s inventory policy. In a conventional manufacturing environment, the conflict is resolved with great difficulty, if at all and the managerial accountant might be called in to help determine the best inventory level for the firm.

Imposed Budgets. Significant problems can result from the imposition of unachievable budgets. Managers can become discouraged and feel no commitment to meeting budgeted goals. Or perhaps they will take actions that seem to help achieve goals (such as scrimping on preventive maintenance to achieve lower costs in the short run) but are really harmful in the long run (when machinery breaks down and production must be halted altogether).

Budgets as “Checkup” Devices. Behavioral problems do not arise solely because of the procedure followed for developing budget allowances. Comparisons of budgeted and actual result and subsequent evaluation of performance also introduce difficulties. In ideal circumstances managers use actual results to evaluate their own performance, to evaluate the performance of other, and to correct elements of operations that seem to be out of control. The budget serves as a feedback device; it lets managers know the result of their actions. Having seen that something is wrong, they can take steps to correct it.

Unfortunately, budgets are often used more for checking up on manager; that is, the feedback function is ignored. Where this is the case, managers are constantly looking over their shoulders and trying to think of ways to explain unfavorable results. The time spent on thinking of ways to defend the results could be more profitably used to plan and control operations. Some evaluation of performance is necessary, but the budget ought not to be perceived as a club to be held over the heads of managers.

Unwise Adherence to Budgets. As noted earlier, the budgets set limits on cost incurrence, allowances beyond which managers are not expected to go. However, if managers’ view budgeted amounts as strict limits on spending, they may spend either too little or too much. For example, there are times when exceeding the budget benefits the firm. Suppose a sales manager believes that a visit to several important customers or potential customers will result in greatly increased sales. The sales manager will be reluctant to authorize the visit if it will result in exceeding the travel budget.

At the other extreme, a manager who has kept costs well under budget might be tempted to spend frivolously so that expenditures will reach the budgeted level. The manager may fear that the budget for the following year will be cut because of the lower costs for the current year, the manager might take an undesirable action-authorize an unnecessary trip-in order to protect personal interests.

Typically, the following simplifying assumptions are made when preparing a master budget:

1. Sales prices are constant during the budget period,

2. Variable costs per unit of output are constant during the budget period,

3. Fixed costs are constant in total and

4. Sales mix is constant when the company sells more than one product.

These assumptions facilitate the planning process by removing many of the economic complexities.

 

1.7 Preparing a Master Budget

 The master budget is the comprehensive financial plan for the organization as a whole; it is made up of a various individual budgets for each part of the organization aggregated into one overall budget for the entire organization.

The two major components of master budget are the operating budget and the financial budget.

   1.7.1. The Operating Budget

Preparing an Operating Budget is a sequential process of developing nine sub-budgets. Except for one or two exceptions the sub-budgets must be prepared in the following order: sales, production, direct materials, direct labor, factory overhead, ending inventory, cost of goods sold, selling & administrative and income statement Each part is described below.

    1.7.1.1. Sales Budget

The Sales budget is the starting point in preparing the master budget. As shown earlier, all other items in the master budget, including production, purchase, inventories, and expenses, depend on it in some way. Manufacturing and merchandising companies forecast sales of their goods. Service giving companies, like, hotels forecast the number of rooms that will be occupied during various seasons.

Sales forecasting All companies have two things in common when it comes to forecasting sales of services or goods: Sales forecasting is a critical step in the budgeting process, and it is very difficult to do it accurately. Sales forecasting is the process of predicting sales of services or goods. Various procedures are used in sales forecasting, and the final forecast usually combines information from many different sources. Many firms have a top management level market research staff whose job is to coordinate the company’s sales forecasting efforts. Among the major factors considered when forecasting sales are:

1. Past sales levels and trends

2. General economic trends.

3. Economic trends in the company’s industry.

4. Other factors expected to affect sales in the industry.

5. Political and legal events.

6. The intended pricing policy of the company.

7. Planned advertising and product promotion.

8. Expected actions of competitors.

Developing a sales budget involves the following calculations

Budgeted Sales $ = (Budgeted Unit Sales)(Budgeted Sales Prices)

Current Period Cash Collections = Current Period Cash Sales + Current Period Credit Sales Collected in Current Period + Prior Period Credit Sales Collected in Current Period

These calculations are relatively simple, but where does the budget director obtain this information? Well, sales forecasting is a marketing function. Sales estimates are frequently generated by the company's sales representatives who discuss future needs with customers (wholesalers and retailers). Statistical forecasting techniques can also be used to make estimates of expected future sales, considering the company's previous sales performance and various assumptions about the future economic climate, and the actions of competitors and consumers. Pricing is also a marketing function, but many prices are based on costs plus a markup (the supply function) and consideration of what consumers are willing and able to pay for the product (the demand function).

The information needed to develop an equation for collections is provided by the finance department and is normally based on past experience. These calculations are somewhat more involved than they appear to be in the equation above because of the effects of cash discounts and the time lags between credit sales and collections. Cash discounts are frequently used to speed up cash inflows. This puts the funds back to work sooner and reduces the need for short term loans. However, even with a generous cash discount for prompt payment, collections for credit sales are typically spread out over several months.

     1.7.1.2.  Production Budget

Preparing a production budget includes consideration of the desired inventory change as follows:

Units To Be Produced = Budgeted Unit Sales + Desired Ending Finished Goods - Beginning Finished Goods

The desired ending inventory is usually based on the next period’s sales budget. Considerations involve the time required to produce the product, (i.e., cycle time or lead time) as well as setup costs and carrying costs. In a just-in-time environment the desired ending inventory is relatively small, or theoretically zero in a perfect situation. In the examples and problems in this chapter, the ending finished goods inventory is stated as a percentage of the next period's (month's) unit sales.

     1.7.1.3.  Direct Material Budget

The direct materials budget includes five separate calculations.

a. Quantity of Material Needed for Production
   = (Units to be Produced)(Quantity of Material Budgeted per Unit)

The quantity of material required per unit of product is determined by the industrial engineers who designed the product. Materials requirements are frequently described in an engineering document referred to as a "bill of materials".

b. Quantity of Material to be purchased

     = Quantity of Material Needed for Production + Desired Ending Material - Beginning Material

This calculation is more involved than equation 3b appears to indicate because it includes information for two future periods. The desired ending materials quantity is normally based on the next period's (month's) materials needed for production and this amount depends on the third period's budgeted unit sales. Of course inventories of raw materials (just like finished goods) are kept to a minimum in a JIT environment. Factors that influence the desired inventory levels include the reliability of the company's suppliers, as well as ordering and carrying costs.

c. Budgeted Cost of Material Purchases
   = (Quantity of Material to be Purchased)(Budgeted Material Prices)

This amount is needed to determine cash payments. Once the quantity to be purchased has been determined, the cost of purchases is easily calculated. Budgeted material prices are provided by the purchasing department.

d. Cost of Material Used
   = (Quantity needed for Production)(Budgeted Material Prices)

The cost of materials used is needed in the cost of goods sold budget below.

e. Cash Payments for Direct Material Purchases

= Current Period Purchases Paid in Current Period + Prior Period Purchases Paid in Current Period

The information needed to determine budgeted cash payments is provided by accounting, (accounts payable) and is usually based on past experience. Normally the budget should reflect a situation where the company pays promptly to take advantage of all cash discounts allowed, thus 3e may be equal to 3c.

     1.7.1.4.  Direct Labor Budget

Fewer calculations are needed for direct labor than for direct materials because labor hours cannot be stored in the inventory for future use. Time can be wasted, but not postponed.

a. Direct Labor Hours Needed For Production
         = (Units to be Produced)(D.L. Hours Budgeted per Unit)

The amount of direct labor time needed per unit of product is determined by industrial engineers. Estimates are frequently made using a technique referred to as motion and time study. This involves measuring each movement required to perform a task and then assigning a precise amount of time allowed for these movements. The cumulative time measurements for the various tasks required to produce a product provide the estimate of a standard time per unit.

b. Budgeted Direct Labor Cost

= (D.L. Hours needed for Production)(Budgeted Rates Per Hour)

The budgeted rates per hour for direct labor are provided by the human resource department. Frequently the labor (union) contract provides the source for this information.

     1.7.1.5. Factory Overhead Budget

The factory overhead budget is based on a flexible budget calculation. More specifically, the calculation is as follows:

1. Budgeted Factory Overhead Costs 
   = Budgeted Fixed Overhead  + (Budgeted Variable Overhead Rate)(D.L. Hours needed for Production from 4a)
   The calculation for cash payments reflects one of the differences between cash flows and accrual accounting. Since some costs, like depreciation, do not involve cash payments in the current period, these costs must be subtracted from the total overhead costs to determine the appropriate amount.
2. Cash Payments for Overhead
   = Budgeted Factory Overhead Cost  - Depreciation and other costs that do not require cash payments

   Multiplying the total overhead rate by the number of direct labor hours needed for production provides the standard or applied overhead costs.    

     1.7.1.6. Ending Inventory Budget

The dollar amount for the ending inventory of finished goods is needed below to determine cost of goods sold. The dollar amounts for ending direct materials and finished goods are needed for the balance sheet.

a.      Ending Direct Materials

       = (Desired Ending Materials from 3b)(Budgeted Prices)

b.      Ending Finished Goods

= (Desired Ending Finished Goods)(Budgeted Unit Cost)

     1.7.1.7. Cost Of Goods Sold Budget

Cost of goods sold is needed for the income statement. One method of determining budgeted COGS involves accumulating the amounts from the previous sub-budgets as follows.

a. Budgeted Total Manufacturing Cost
   = Cost of Direct Material Used (from 3d.)  + Cost of Direct Labor Used (from 4b.)
   + Total Factory Overhead Costs (from 5a.)

b. Budgeted Cost of Goods Sold
   = Budgeted Total Manufacturing Cost (from 7a.)
   + Beginning Finished Goods (from previous ending or calculate from 2 and 6b)
   - Ending Finished Goods (from 6c or calculate from 2 and 6b)

This is the same approach used in Chapter 2 to determine cost of goods sold, but when developing a budget we typically assume no change in Work in Process. Therefore, budgeted cost of goods manufactured is equal to budgeted cost of goods sold.

     1.7.1.8.  Selling & Administrative Expense Budget

The preparation of the selling and administrative expense budgets is very similar to the approach used for factory overhead.

a. Budgeted Selling and Administrative Expenses
   = Budgeted Fixed Selling & Administrative Expenses  + (Budgeted Variable Rate as a Proportion of Sales $)(Budgeted Sales $)

a. Cash Payments for Selling & Administrative Expenses

 = Budgeted Selling & Administrative Expenses  - Depreciation and other cost which do not require cash payments

     1.7.1.9. Budgeted Income Statement

Preparing the budgeted income statement involves combining the relevant amounts from the sales, cost of goods sold and selling & administrative expense budgets and then subtracting interest, bad debts and income taxes to obtain budgeted net income. In a comprehensive practice problem, the applicable amount for interest expense may need to be calculated from information associated with the cash budget. Bad debt expense is based on the expected proportion of uncollectible stated in the information related to cash collections.

a. Budgeted Sales $ - Budgeted Cost of Goods Sold
   = Budgeted Gross Profit

b. Budgeted Gross Profit - Budgeted Selling & Administrative Expenses
   = Operating Income

c. Operating Income - Interest Expense - Bad Debts Expense
   = Net Income Before Taxes

d. Net Income Before Taxes - Income Taxes
   = Net Income After Taxes

 

   1.7.2. The Financial Budget

The financial budget includes the cash budget, the capital budget and the budgeted balance sheet. The cash budget and budgeted balance sheet are discussed below.  

      1.7.2.1. Cash Budget

a. Budgeted Cash Available
   = Beginning Cash Balance + Budgeted Cash Collections from 1

b. Budgeted Cash Excess or Deficiency
   = Budgeted Cash Available - Budgeted Cash Payments 

c. Ending Cash Balance
   = Cash Excess or Deficiency + Borrowings - Repayments including Interest

 

     1.7.2.2. Budgeted Balance Sheet

Preparing the budgeted balance sheet involves accumulating information from the previous period’s balance sheet, the various operating sub-budgets, the cash budget and other accounting records.

ASSETS

a. Current Assets:
 Cash (from the cash budget - c)
 Accounts Receivable (from the sales budget and previous balance sheet)
 Direct materials (from the ending inventory budget-a)
 Finished goods (from the ending inventory budget -c)

b. Long Term Assets:
 Land (from previous balance sheet and budgeted activity)
 Buildings (from previous balance sheet and budgeted activity)
 Equipment (from previous balance sheet and budgeted activity)
 Accumulated depreciation (from the accounting records)

  Total Assets

LIABILITIES

c. Current Liabilities:
 Accounts Payable (from various operating sub-budgets)
 Taxes Payable (from income statement)

d. Long term Liabilities

    Total Liabilities

SHAREHOLDERS EQUITY

e. Common Stock (from previous balance sheet and budgeted activity)

f. Retained Earnings (from previous balance sheet and income statement)

    Total Shareholders’ Equity

    Total Liabilities and Shareholders’ Equity

 

1.8  Summary

Budgeting is the creation of plan of action expressed in financial terms. Budgeting plays a key role in planning, control, and decision-making. Budgets, among other things, force planning, serve to improve communication and coordination, allocates scarce recourses and used to evaluate performance. 

The comprehensive set of budgets that covers all phases of an organization’s operations is called a master budget. The first step in preparing a master budget is to forecast sales of the organization’s services or goods. Based on the sales forecast, operational budgets are prepared to plan production of services or goods and to outline the acquisition and use of material, labor and other resources. Finally, a set of budget financial statements are prepared to show what the organization’s overall financial condition will be if planned operations are carried out.

The success of a budgetary system depends on how seriously human factors are considered. To discourage dysfunctional behaviour, organizations should avoid overemphasizing budgets as a control mechanism and use a participative budgeting process.

Participative budgeting is the process of allowing employees throughout the organization to have a significant role in developing the budget.  Participative budgeting can result in greater commitment to meet the budget by those who participated in the process.

Budgeting systems ate costly. They are needed because it is believed and assured that the systems will help organizations make better collective operating and financial decisions.