Chapter 10: Static and Flexible Budgets 10-3
Chapter 10
Static and Flexible Budgets
BUILD YOUR PROFESSIONAL COMPETENCIES
10.29 Focus on Professional Competency: Resource Management
A.
1. The budget includes anticipated spending on various activities within an organization. Through the process of creating budgets, managers are forced to make decisions about the amount of resources to allocate to different activities. The budget communicates the results of those decisions.
2. Budgets are typically prepared at the department level and proceed through a process of negotiations between the department managers and head office. Thus, the budget communicates the resources that can be used for individual departments.
B.
1. Prices for most resources are uncertain because they may change and decisions about how to spend resources may change. Prices for resources are subject to economic supply and demand as well as firm-specific arrangements. For example, companies that pay lower than market wages are likely to lose employees. To become more competitive in hiring employees, a company may need to increase pay levels or benefits, modify work hours, or make other concessions that increase resource costs. Raw material prices also fluctuate with market prices and with alternative contractual arrangements that are available to suppliers.
2. Large increases in the cost of an individual resource are likely to cause managers to seek ways to reduce use of that resource. For example, as labor costs increase managers may reduce labor time by increasing the quality of raw materials or by modifying production processes to use greater automation. Managers may also outsource work to countries having lower labor costs. Decreases in resource costs have the opposite effect; managers are likely to seek ways to increase the use of the resource. For example, managers have increased their use of automated production equipment as the cost automation has declined.
3. Fluctuations in the costs and use of resources are likely to lead to budget variances because specific fluctuations cannot be foreseen when the budget is created. Although managers know that prices will fluctuate, they cannot perfectly estimate future prices. They also cannot perfectly anticipate modifications in their use of resources until future market conditions occur.
C.
1. One way to measure organizational performance is to compare actual results to budgeted results. This comparison provides information about how well the organization met its goals.
2.
a. Using flexible budgets to adjust for actual volumes: When an individual manager is not responsible for differences between budgeted and actual volumes, a flexible budget does a better job of measuring the level of expected costs that are under the manager’s control. Thus, variances calculated using a flexible budget provide better measures of the manager’s performance. When a flexible budget is not used, the manager may be inappropriately rewarded when actual volume is less than budgeted, and inappropriately penalized when actual volume exceeds the budget.
b. Removing allocated costs: When allocated costs cannot be controlled by the manager, they provide no information about the manager’s performance. Therefore, variances related to these costs also provide no information about the manager’s performance. To avoid inappropriately rewarding or penalizing managers for variances in allocated costs, these costs should be removed from the performance evaluation.
c. Updating costs for anticipated price changes: managers should be held responsible for their use of resources at the expected price. As discussed in Part B above, managers are likely to change their use of resources based on changes in price. To encourage managers to make the best use of resources, they should be held accountable for their decisions based on the expected prices.
3. Continuous improvement is the process of constantly making small changes to enhance organizational performance. The analysis of budget variances helps managers identify areas where organizational performance is different than expected, leading to recommendations for ways to improve future planning and operations. For example, a favorable variance can focus manager attention on ways to achieve similar favorable results in the future. An unfavorable cost variance can help managers identify and eliminate waste or inefficiencies.
D. If students have difficulty locating a citizen’s budget guide, refer them to guidance available for this problem on the web site for the textbook (available at www.wiley.com/college/eldenburg).
1. Following are possible reasons why a government might publish a citizen’s guide to the budget; students may think of others:
· Legal requirement; laws may exist to require the government to publish a citizen’s guide
· Provide an overview of the budget and budgeting process for citizens, government managers and staff, legislative bodies, and other interest parties
· Improve communication with the general public
· Demonstrate fiduciary responsibility
2. This answer depends on the governmental entity chosen by the student. The purpose of this question is to help students recognize that different organizations use different terminology and slightly different processes, but that the general underlying budgeting cycle is the same for all types of organizations. The purpose is also to encourage student interest in governmental budgeting and accounting.
3. Citizens could analyze the budget to study the relative amount of resources assigned to different types of activities. They could also analyze the budgeting process for the degree and type of citizen input. When financial statements are released after the end of the budget period, citizens could determine whether the original budget was met or whether it was necessary to modify the budget to avoid exceeding the legally-adopted budget.