Accountants have traditionally concentrated on recording what has happened financially in the past; however, in managerial accounting, accountants are increasingly involved in helping to formulate policy for business organizations, providing information for decision-makers and frameworks for making those decisions. Managerial accountants use financial accounts in the process of decision0making within a business organization. Examples of this process would include determining which business activities were least profitable and then making a decision about whether or not to continue with these business activities, or estimating future revenues in order to aid decision-making today.
According to Needles and Powers, in order for any organization to succeed in accomplishing its goals, it must be able to control expenses and operate efficiently." One of the more effective ways of controlling expenses," they say, "is to use operating budgets. An operating budget reflect management’s operating plans and consists of detailed listings of projected selling and general and administrative expenses for a company" (Needles & Powers, 1998, p. 119). The participants in the budget process will be concerned with carrying out the plan, or in other quantitative terms such as units of product or service.
Some of the traditional benefits associated with the budgeting process include:
- communicating company-wide goals to subunits,
- fostering cooperation between departments,
- maintaining control by evaluating actual figures to budget figures, and
- revealing the interrelationship of one function to another.
While the financial statements which are published as a result of the budgeting process are the most widely visible product (and the ones with which the public is most concerned), these financial statements only represent a small part of the budgeting process. Generally speaking, the accounting data and most accounting reports which make up the budgeting process are generated solely or primarily for a company’s managers. These management reports may consist of summaries of past events, forecasts of the future, or a combination of the two. Preparation of these data and reports is the focus of managerial accounting, which consists mainly of four broad functions:
- budgetary planning,
- cost finding,
- cost and profit analysis, and
- performance reporting.
The first major component of internal accounting systems for management’s use is the company’s system for establishing budgetary plans and setting performance standards. The establishment of these performance standards also requires a company to develop a system for measuring actual results and reporting the differences between actual performance and the established standards. This budgeting process leads to the establishment of specific organizationalplans which are then translated into action with varying degrees of efficiency. Statistical analysis, quality controls, and trended data are typically provided to management for assessment and determination of need for corrective action, or by preparing revised plans. While these plans can be either broad, strategic outlines of the company’s future or specific and detailed schedules of the inputs and outputs associated with specific independent programs, most business plans are periodic plans; in other words, these plans refer to company operations for a specified period of time. It is these periodic plans which are summarized in a series of projected financial statements, or budgets.
The two principal budget statements are the profit plan and the cash forecast. The profit plan is an estimated income statement for the budget period. It summarizes the planned level of selling effort, shown as selling expense, and the results of that effort, shown as sales revenue and the accompanying cost of goods sold.Separate profit plans are ordinarily prepared for each major segment of the company’s operations.
The details underlying the profit plan are contained in departmental sales and cost budgets, each part identified with the executive or group responsible for carrying out that part.In addition, a number of business also prepare alternative budgets for operating volumes other than the volume anticipated for the period. These contingency sets of such alternative budgets are known as the flexible budgets.
According to Shillinglaw, the practice of flexible budgeting has been adopted widely by factory management to facilitate evaluation of cost performance at different volume levels and has also been extended to other elements of the profit plan. The second major component of the annual budgetary plan, the cash forecast or cash budget, summarizes the anticipated effects on cash of all the company’s activities. Other elements of the budgetary plan besides the profit plan and the cash forecast, include capital expenditure budgets, personnel budgets, production budgets, and budgeted balance sheets. All of these elements can help management make better decisions on how to allocate scarce resources and provide a benchmark against which to measure subsequent performance.
Today, budgeting is essentially a top down process. This method requires budget packets to be sent out from the corporate office to various divisions and then operating units with forms to be filled in and sales and operational forecasts completed and returned. Many organizations are now describing this process as "bottom up," because the next step is to roll up the completed business unit forms to calculate total corporate budgets.
The bottom-up terminology could be acceptable if that was really the end of the process; however, few organizations stop at this point.The more likely reality is that the process is iterative, with budgets being "adjusted" by the corporate office and returned to the operating units. "The resulting budget, often several months after the initial distribution of the budget forms, then becomes law even though many of the assumptions on which the budget is based no longer apply" (emphasis added) (Babbini, 1999, p. 52). As a result, Babbini says that monthly variance reports are produced and discussed but these generally provide "little truth or wisdom."
In the final analysis, budgets which are created this way fail to measure those things that create shareholder value and which are critical to the success of modern organizations including:
- customer loyalty,
- development of intellectual properties,
- speed to meet customer expectations,
- employee development, and
- product/service quality.