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7.8: Other Budgeting Methods

  • Page ID
    10638
  • Budgeting in service companies

    The concepts discussed in this chapter are equally applicable to service companies. Service firms have service revenues and operating expenses that must be budgeted. Projected income statements and balance sheets can be prepared for service companies and are typically based on past performance.

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    To illustrate, assume Windy Weather Company wants to make the following changes this year to last year’s results:

    1. Sales will increase 5%
    2. Sales commissions will remain the same at 10% of sales
    3. Sales and administrative salaries will increase 3%
    4. Supplies, rent and miscellaneous expenses will remain the same.
    5. Income taxes will be 30% of net income.

    The budgeted income statement for this year would be:

    Windy Weather Company    
    Budgeted Income Statement   
      Last Year
    BUDGET
    Calculation
    Sales $450,000 $472,500 450,000 + (450,000 x 5%)
    Less Expenses: heading only – no entry
       Sales Commissions $45,000 $49,500 472,500 x 10%
       Sales Salaries $50,000 $51,500 $50,000 + (50,000 x 3%)
       Administrative Salaries $75,000 $77,250 $75,000 + (75,000 x 3%)
       Supplies Expense $5,000 $5,000 no change
       Rent Expense $120,000 $120,000 no change
       Miscellaneous Expense $15,000 $15,000 no change
    Total Expenses $310,000 $318,250 sum of all expenses
    Income from operations $140,000 $154,250 Sales 450,000 – Expenses 318,250
    Less: Income Tax (30%) ($42,000) ($46,275) Inc. from operations x 30%
    Net Income $98,000 $107,975 Inc. from operations – income tax

    Zero-Based Budgeting

    An alternative to the traditional budget is zero-based budgeting.

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    Zero-base budgeting became popular in the 1970s, particularly when President Jimmy Carter supported it for state and federal governmental units. It has received less attention since then.

    Under zero-base budgeting, managers in a company start each year with zero budget levels and must justify every dollar that appears in the budget. Managers do not assume any costs incurred in previous years should be incurred this year. Each manager prepares decision packages that describe the nature and cost of tasks that can be performed by that unit and the consequences of not performing each task. Top organization officials rank the decision packages and approve those that they believe are most worthy. A major drawback to the use of this concept is the massive amounts of paperwork and time needed to prepare and rank decision packages, especially in large organizations.

    Accounting in the Headlines

    Why is Campbell Soup Company using zero-based budgeting?

    In addition to expanding its healthier and more natural product lines, Campbell’s has also announced it will be implementing zero-based budgeting.  It expects to save $200 million off its expected annual costs of close to $7 billion.

    Questions

    1. What is “zero-based budgeting”?
    2. How does Campbell’s expect that it will save $200 million by using zero-based budgeting?
    3. What are some potential drawbacks to Campbell’s from its use of zero-based budgeting?

    Final Thoughts

    For the final thoughts on budgeting, it might be helpful to rethink about how we create budgets, who creates them and what motivation the person might have for the budget figures.  This video discusses the difference between participating and traditional budgeting.

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