UNIVERSITY of SAN CARLOS TECHNOLOGICAL CENTER

Nasipit, Talamban, 6000 Cebu City, Philippines

A Research Paper on:

Budgeting in Cost Accounting

Submitted By:
Submitted By:
Vasnani, Neelesh Naresh
BSIE 3rd year student

Submitted to:
Mrs. Lorafe Lozano
IE 324 Managerial Accounting Instructor
Department of Industrial Engineering

Submitted On:
March 26, 2015

I. Introduction

Budgeting is something most of us have heard of, in fact, it can be safely said that most of
us have tried budgeting or making budgets at some point in our lives, whether it is to manage
household expenses, to manage a family business, or to tackle even the most miniscule of
monetary situations. This is so because of the very nature of how our world works, it is because
our world works on money, a driver of life that has to be limited, inconsistent, and unpredictable
for our world to run. Since money is not infinite, wherever there is money, there should be
budgeting involved. Sadly, most of us find it a pain to follow budgets and see these as hard goals
to meet.

It is an entirely stricter component when we deal with big organizations and companies. It
is mandatory for organizations to follow financial plans or budgets to achieve financial success
the main reason companies are set up for. Most companies today follow various budgeting
methods to achieve financial success, or should I say, to prevent financial failure. Budgeting does
not guarantee success, but it prevents the contrary, and that is why it is very important for
budgeting to be practiced in the economic world, where it matters.

II. Theory

In Cost accounting, a budget is often defined as a financial plan that can contain both
financial and non-financial information. According to Wild et al. (2011), a budget is a formal
statement of a companys future plans. Moreover, all managers must participate in budgeting
decisions. The primary focus of budgeting is on the future, consequently, budgets commonly

cover and look into a period of one year. Although the focus is on the future, these budgets are
usually made from past information and data.

Before the budgets are made, it is first decided as to which part of the organization will
form the budgeting committee to take part in the budgeting process. There are ethical challenges
that companies experience since employees can falsely state the budgets for their convenience.
This is a very delicate step and requires a systematic approach to deal with. Companies usually
choose from two different approaches namely, top-down budgets and bottom-up budgets.

In the top-down budget approach, the top management sets the parameters for the budget,
based on the companys objectives and goals. These parameters can include sales, production and
expenditure goals to name a few. Once the parameters are set, the lower-level employees do the
basic calculations for the budget, and are limited to that. This limitation can be a disadvantage of
this approach since employees might view the goals as if they were dictated over them, which
can cause resentment. However, this can be a good thing also since the top management can use
this budget as a mode of communication to tell the employees to perform based on the
companys goals and financial targets.

As far as the bottom-up approach is concerned, the lower-level employees are more
involved in the budgeting process. They develop the budget plan and send it upward to the midlevel people who add their own inputs until it reaches the top. The budget committee then
reviews the budget and sends it back down for revisions. This can be a tedious approach but it
makes sure that the work is done by specialized teams this also promotes teamwork and allows

for a more accurate budget. This involvement also makes the employees feel confident that they
can achieve the budget, which isnt the case for the former approach. This confidence can
actually better the performance, thats why good managers are alert to this. As mentioned, this
approach can also be tedious due to its repetitive nature, which causes it to be more expensive to
develop. Ultimately, the bottom-up approach is widely used in modern companies due it its
prevailing advantages, however, a company can opt for any approach to match its objectives.

After the approach (bottom-up or top-down) has been decided, it is time to create the
budget. Companies usually create master budgets which include all the necessary sub-budgets.
According to Wild et al. (2011), a master budget would include individual budgets for sales,
purchases, production, expenses, capital expenditures and cash. Which of these budgets to
include in a master budget would depend on the companys size and complexity. There are
however basic components that that a master budget should have. Master budgets usually begin
with operating budgets, which include sales budget, production budget, and general expenses
budget. Next comes the capital expenditure budget, which relates to plant asset expenses. Lastly,
the master budget should include financial budgets like the estimated cash budget, income
statement and balance sheet. After this master budget is prepared, the whole company adheres to
it until the next period arrives. Some studies show that it is better to adhere to your master budget
completely while Atkinson et al. (2012) suggests that the master budget should be used only as a
rough guideline. According to Wild et al (2011), the following diagram summarizes how a
master budget is made.

III.

Applications
Many modern companies have benefited by applying budgeting in their business plans.
The IMA (Institute of Management Accountants) revealed that the use of master budgets has
increased considerably in businesses due to its noticeable improvements. This section of the
paper will highlight cases where budgeting is applied for the better.

A case study by Taylor and Rafai (2003) revealed that a manager at an automotive company
in Detroit was able to reduce costs by 37.6% through budgeting. This was achieved by
minimizing overestimation by gradually decreasing budgets to reach optimum accuracy. All of
this was possible after immense data gathering from historical statements.

Sticking to the automotive industry, another company that benefited from budgeting
decisions is Ferrari S.p.A. We all know that manufacturing cars takes a lot of perfection and
expertise, and at Ferraris level, there are many costs involved while making luxury cars. They
were able to increase revenues by 5.4% from 2012 to 2013, and the main reason cited by their
operations manager in a news interview was that they were able to forecast their demand
accurately, because of which their budgets were spot on.

Another case study by the Leoisaac website (see references) showed how a football club
escaped bankruptcy by fixing their budgeting. The so called grassroots football club relied on
the lower-level management too much for their budgeting, this caused improper estimates since
the employees were altering the budgets for their convenience. The management then
implemented the bottom-up budget approach through a new budget committee that would review

the budgets, and within 18 months, the company was back up and running, and it was all thanks
to the budgeting success.

The Principles of Accounting website showcased a situation where the importance of

budgeting is highlighted. A manager is appointed at a power plant, and the managers job will
determine the success of the plant. This manager then has to deal with several unknown aspects
like number of customers served, amount of fuel to satisfy demand, inventory and reordering of
fuel, etc. To deal with this, a plan is made from data that determines production levels based on
demand. The amount of fuel is determined by that and supplier contracts are adjusted
accordingly. From this data, the budget plan is made and the capacity is reverse engineered.
Fortunately, the whole plant now has numerical outcomes to achieve hand in hand with the new
manager.

All of these applications and studies show how important budgeting is. They also conform
to the theory discussed earlier. We can see how from the two approaches, the bottom-up
approach was utilized in real life too. It can also be noted that both service and manufacturing
types of companies use budgeting. The use of master budgets and its components can also be
observed in these applications. Overall, it is amusing to see that budgeting is becoming more
popular in practice, not just in theory. New firms will only benefit as budgeting becomes more
widespread.

IV.

References

Wild J., Shaw K., Chiappetta B. (2011). Fundamental Accounting Principles: McGraw-Hill Education
Atkinson A., Kaplan R., Young S., Matsumura E. (2012). Management Accounting: Pearson Education
http://www.motorauthority.com/news/1090430_ferrari-achieves-record-profit-in-2013-with-fewer-sales

http://www.leoisaac.com/budget/index.htm
http://www.imanet.org/docs/default-source/maq/2003maq_fall-pdf.pdf?sfvrsn=0
http://www.dummies.com/how-to/content/cost-accounting-budgeting-basics.html

http://www.principlesofaccounting.com/chapter21/chapter21.html