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            A Budget charts a course for a business by outlining the plans of the business in financial terms. Like a road map, the budget can help a company navigate through the year and reduce negative outcomes. Budgeting involves 1) establishing specific goals, 2) executing plans to achieve goals, and 3) periodically comparing actual results with the goals. These goals include both the overall business goals as well as the specific goals for the individual units within the business. Establishing specific goals for future operations is part of the planning function of the management, while executing actions to meet the goals is the directing function of the management. Periodically comparing actual results with these goals and taking appropriate action is the control function of management.


            Planning not only motivates employees to attain goals, but also improves overall decision making. During the planning phase of the budget process, all viewpoints are considered, options identified, and cost reduction opportunities assessed. This effort leads to better decision making for the organization. As a result, the budget process may reveal opportunities or threats that were not known prior to the budget planning process.


            Once the budget plans are in place, they can be used to direct and coordinate operations in order to achieve the stated goals. The budgetary units of an organization are called responsibility centers. Each responsibility center is led by a manager who has authority over and responsibility for the unit's performance. If there is a change in the external environment, the budget process can also be used by unit managers to readjust the operations.


            As time passes, the current performance of an operation can be compared against the planned gaols. This provides prompt feedback to employees about their performance. If necessary, employees can use such feedback to adjust their activities in the future. Comparing the actual results against the plan also helps prevent unplanned expenditures. The budget encourages employees to establish their spending priorities.


            Budgeting systems vary among businesses because of such factors as organizational structure, complexity of operations, and management philosophy. The budgetary period for operating activities normally includes the fiscal year of a company. However, to achieve effective control, the annual budgets are usually subdivided into shorter time periods, such as quarters of the year, months or weeks. Developing budgets for the next fiscal year usually begins several months prior to the end of the year. This responsibility is normally assigned to a budget committe. Such committee normally consists of the budget director and such high-level executives as the controller, the treasurer, the production manager, and the sales manager. Once the budget has been approved, the budget process is monitored and summarized by the Accounting Department, which reports to the committe.
            There are several methods to develop the a budget estimate. One method, called zero-base budget, requires managers to estimate sales, production, and other operational information, as if operations were to be started for the first time. This method has the advantage of taking a fresh view of the operations each year. A more common approach is to start with last year's budget and revise it for actual results and expected changes for next year. Two types of budget using this method are the static budget and budget flexibility.


            A static budget shows the expected results of a responsibility center for only one activity level. Once the budget has been determined, it is not changed, even if the activity is changing. The static budget is used in many service companies and for some administrative functions of manufacturing companies, such as purchasing, engineering and accounting. For example, the Assembly Department manager for Colt Manufacturing Company prepared the static budget for the upcoming year, shown in the table below:

    Colt Manufacturing Company, Inc.
    Assembly Department Budget
    For the Year Ending July 31, 2008
    Direct labor
    Supervisor salaries
    Total department costs

            A disadvantage of static budgets is that these do not adjust for changes in activity levels. For example, assume that the actual amounts spent by the Assembly department of the company Colt Manufacturing, Inc. totaled $72,000, which is $12,000 or 20% ($12,000 / $60,000) more than what was budgeted. Are these good or bad news? At first you might think that this is a bad result, but this conclusion may not be valid because the static budget may be difficult to interpret. To illustrate, assume that the assembly manager constructed the budget based on plans to assemble 8,000 units during the year. However, 10,000 units were actually produced, representing a 25% (2000 / 8000) more than expected. Then, should the additional $12,000 in spending in excess of the budget be considered bad news? Maybe not, because the Assembly department provided 25% more production with only 20% additional cost.


            Unlike static budgets,   flexible budgets show the expected results of a responsibility center for several levels of activity. You can think of a flexible budget as a series of static budget for different levels of activity. Such budgets are particularly useful in estimating and controlling factory costs and operating expenses.
    The following table shows the flexible budget annual manufacturing expense in the assembly department of the company Colt Manufacturing, Inc.

    Colt Manufacturing Company, Inc.
    Assembly Department Budget
    For the Year to Finish July 31, 2008
    Units of Production
    Variable cost:

    Direct labor ($5 per unit)
    Electric Power ($0.50 per unit)
    Total variable cost
    Fixed Cost:

    Electric Power
    Supervisor salaries
    Total fixed cost
    Total department costs

            When constructing a flexible budget, we first identify the relevant activity levels. In the above example there are 8,000, 9,000, and 10,000 units of production. Alternative activity bases, such as machine hours or direct labor hours, may be used in measuring the volume of activity. Second, we identify the fixed and variable cost components of the costs being budgeted. For example, in the table, the cost of electricity is separated into its fixed cost ($1,000 per month) and variable cost ($0.50 per unit). Finally, we prepare the budget for each activity level by multiplying the variable cost per unit by the activity level and then adding the monthly fixed cost.
    With a flexible budget, the department manager can be evaluated by comparing actual expenses to the budgeted amount for actual activity. For example, if the Assembly department of the company Colt Manufacturing, Inc. actually spent $72,000 to produce 10,000 units, the manager would be considered above its budget by $1,000 ($ 72000 - $ 71000). Under the static budget in the first table, the department was above the budget by $12,000.
    In conclusion,  the flexible budget for the Assembly department is much more accurate than the static budget, because budget amounts adjust for changes in activity.


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