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Book: Charles T. Horngren - Introduction to management accounting, summary Y2Q2 $4.83
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Book: Charles T. Horngren - Introduction to management accounting, summary Y2Q2

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  • Course
  • Financial and Management Decisions
  • Institution
  • Avans Hogeschool (Avans)
  • Book
  • Introduction to Management Accounting Global Edition

A summary of the course 'Financial and Management Decisions' in Year 2, quarter 2 of the study programme 'International Business and Management Studies' at Avans Hogeschool. The used book is 'Charles T. Horngren - Introduction to management accounting'.

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Document information

  • No
  • H7, h8, h3, h10
  • December 27, 2017
  • 14
  • 2017/2018
  • Summary

Subjects

  • ibms
  • internationalbusiness
  • fma
  • financial
  • avans

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  • Avans Hogeschool (Avans)
  • Bedrijfseconomie / Finance & control
  • Financial and Management Decisions
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FMA Y2Q2


CHAPTER 7
When you have finished studying this chapter, you should be able to: 7-28, 7-33, 7-38, 7-40
1. Explain how budgets facilitate planning and coordination.
2. Anticipate possible human relations problems caused by budgets.
3. Explain potentially dysfunctional incentives in the budget process.
4. Explain the difficulties of sales forecasting.
5. Explain the major features and advantages of a master budget.
6. Follow the principal steps in preparing a master budget.
7. Prepare the operating budget and the supporting schedules.
8. Prepare the financial budget.
9. Use a spreadsheet to develop a budget (Appendix 7).

A budget is a quantitative expression of a plan of action that imposes the formal structure of an
organization. Managers use budgeting as an effective cost-management tool. Budgets facilitate
planning and coordination. Benefits of budgets:
1. Budgeting compels managers to think ahead by formalizing their responsibilities for planning.
2. Budgeting provides an opportunity for managers to reevaluate existing activities and evaluate
possible new activities.
3. Budgeting aids managers in communicating objectives and coordinating actions across the
organization.
4. Budgeting provides benchmarks to evaluate subsequent performance.

Three problems that can limit, in some cases severely, the advantages of budgeting:
1. Low levels of participation in the budget process and lack of acceptance of responsibility for the
final budget
2. Incentives to lie and cheat in the budget process
3. Difficulties in obtaining accurate sales forecasts

The main factors affecting budget acceptance are the perceived attitude of top management, the
level of participation in the budget process, and the degree of alignment between the budget and
other performance goals. An environment where there is a two-way flow of information reduces
negative attitudes. Budgets created with the active participation of all affected employees—called
participative budgeting—are generally more effective than budgets imposed on subordinates.

Message conveyed by the budget system may be misaligned with incentives provided by the
compensation system. Misalignment between the performance goals stressed in budgets versus the
performance measures the company uses to reward employees and managers can also limit the
advantages of budgeting.

Effective budgets provide targets for managers and motivate them to achieve the organization’s
objectives. However, misuse of budgets can lead to undesirable incentives— incentives to lie and
cheat. Not only do such incentives lead managers to make poor decisions, they undercut attempts to
maintain high ethical standards in the organization. What incentives might cause managers to create
biased budgets—essentially to lie about their plans? Managers may want to increase the resources
allocated to their department—resources such as space, equipment, and personnel—and larger
budgets may justify such allocations. Why do managers want more resources? Day-to-day managing
is easier when the department has more resources to achieve its output targets. Further, it is
common for managers of larger units with more resources to have higher pay, higher status, and
greater prospects for promotion. Recognizing these incentives allows organizations to implement
budgets in a way that minimizes bias. For example, when employees understand, accept, and
participate in the budget process, they are less likely to introduce biased information. Also, decision

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Charles T. Horngren - Introduction to management accounting

, FMA Y2Q2


makers can be aware of expected bias when they make decisions based on budget information. When
organizations use budgets as a target for performance evaluations, managers have additional
incentives to lie. Managers have incentives to create budgetary slack or budget padding— that is,
overstate their budgeted costs or understate their budgeted revenues to create a budget target that
is easier to achieve. Budgetary slack also helps buffer managers from budget cuts imposed by higher-
level management and provides protection against cost increases or revenue shortfalls due to
unforeseen events. And one more complication—managerial bonuses based on making budget.

A sales forecast is a prediction of sales under a given set of conditions. The sales budget is the
specific sales forecast that is the result of decisions to create the conditions that will generate a
desired level of sales. Factors to consider when forecasting sales:
1. Past patterns of sales: Past experience combined with detailed past sales by product line,
geographic region, and type of customer can help predict future sales.
2. Estimates made by the sales force: A company’s sales force is often the best source of information
about the desires and plans of customers.
3. General economic conditions: The financial press regularly publishes predictions for many
economic indicators, such as gross domestic product and industrial production indexes (local and
foreign). Knowledge of how sales relate to these indicators can aid sales forecasting.
4. Competitors’ actions: Sales depend on the strength and actions of competitors. To forecast sales, a
company should consider the likely strategies and reactions of competitors, such as changes in their
prices, product quality, or services.
5. Changes in the firm’s prices: A company should consider the effects of planned price changes on
customer demand (see Chapter 5). Normally, lower prices increase unit sales while higher prices
decrease unit sales.
6. Changes in product mix: Changing the mix of products often can affect not only sales levels but also
overall contribution margin. Identifying the most profitable products and devising methods to
increase their sales is a key part of successful management.
7. Market research studies: Some companies hire marketing experts to gather information about
market conditions and customer preferences. Such information is useful to managers making sales
forecasts and product-mix decisions.
8. Advertising and sales promotion plans: Advertising and other promotional costs affect sales levels.
A sales forecast should be based on anticipated effects of promotional activities.

The master budget is a detailed and comprehensive analysis of the first year of the long-range plan. It
quantifies targets for sales, purchases, production, distribution, and financing in the form of
forecasted financial statements and supporting operating schedules.

Continuous budgets or rolling budgets are master budgets that simply add a month (or quarter) in
the future as they drop the month (or quarter) just ended. In this way, budgeting becomes an
ongoing process instead of an annual exercise. Continuous budgets force managers to always think
about the next full year, not just the remainder of the current fiscal year.

The sales budget is the starting point for budgeting because planned inventory levels, purchases, and
operating expenses all depend on the expected level of sales. Schedule b uses the sales budget to
plan when CHC will collect cash. In turn, we will use Schedule b to prepare the cash budget in Step 3.
Cash collections from customers include the current month’s cash sales plus collection of the previous
month’s credit sales.

The elements of the purchases budget are tied together by a simple intuitive identity that ignores
minor complications such as returns and defects but relates the fundamental uses of inventory to the
sources: Inventory is either sold or else carried over to the next period as ending inventory. Inventory
comes from either beginning inventory or purchases. Month-to-month changes in sales volume and

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Charles T. Horngren - Introduction to management accounting

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