Skills to Develop
- Understand the process used to establish budgets.
Question: Some companies prefer to take a “top-down” approach to budgeting, in which upper management establishes the budget with little input from other employees. These budgets are imposed on the organization and do little to motivate employees or to gain acceptance by employees. What method of budgeting is more effective than the top-down approach?
Successful companies approach budgeting from the bottom up. This requires the involvement of various employees within the organization, not just upper management. Lower-level employees often know more about their functional areas than upper management, and they can be an excellent source of information for budgeting purposes. Although getting input from employees throughout the organization can be time consuming, this approach tends to increase employee motivation and acceptance of the budget.
Most organizations have a budget committee that supervises the budgeting process. A budget committee3 is a group within the organization responsible for overseeing and approving the master budget. A master budget4 is a series of budget schedules outlining the organization’s plans for the upcoming period (typically for a year and presented in monthly or quarterly time periods). The master budget can take many different forms but often includes schedules that provide planning for sales, production, selling and administrative expenses, and capital expenditures. These schedules lead to the budgeted income statement, cash flows, and balance sheet (also part of the master budget).
Figure 9.1 shows the components of the master budget with references to the figure in which we present each component for Jerry’s Ice Cream.
Figure 9.1 - Master Budget Schedules
a See Figure 9.3 for the sales budget.
b See Figure 9.8 for the selling and administrative budget.
c See Figure 9.4 for the production budget.
d See Figure 9.5 for the direct materials purchases budget.
e See Figure 9.6 for the direct labor budget.
f See Figure 9.7 for the manufacturing overhead budget.
g See Figure 9.10 for the capital expenditures budget.
h See Figure 9.9 for the budgeted income statement.
i See Figure 9.11 for the cash budget.
j See Figure 9.12 for the budgeted balance sheet.
Some companies take a top-down approach to budgeting (upper management establishes the budget with little input from others), while other companies take a bottom-up approach (lower level employees are involved in the budgeting process). The bottom-up approach tends to be more effective as employees are more inclined to accept the budget. Regardless of the approach used, the budget committee (made up of a group within the organization) is responsible for overseeing and approving the master budget.
REVIEW PROBLEM 9.2
- What is a master budget?
- Why do successful companies tend to use the bottom-up approach to establish a master budget?
- A master budget is a series of budget schedules outlining the organization’s plans for the upcoming period, typically prepared monthly, quarterly, or annually. The master budget includes budgets for sales, production, operating expenses, and capital expenditures. Managers use this information to create budgeted financial statements (income statement, cash flows, and balance sheet).
- The bottom-up approach requires involvement of employees throughout the organization, not just upper management, to create the operating budget. Successful companies use this approach because lower-level employees tend to know more about their functional areas than upper management, providing for more accurate budget information. Also, employee involvement in the budget process increases the likelihood employees will accept the budget.
- A group within the organization responsible for overseeing and approving the master budget.
- A series of budget schedules outlining the organization’s plans for the upcoming period.