Department of Construction

CONS7820 Professional Business Management

Describe and apply Budget and Management Accounting Systems

Define accounting

Define the accounting entity

Performance measurement

Reporting on the performance of an entity

Financial Position The Balance Sheet

Financial Performance The Income Statement

The Concept of Asset and Expense

The Budget Process

Presented by:
Bill Oldfield
Lecturer in Accounting
Business Practice Pathway
Room: 115-3045. Ext. 8822
Email: woldfield@unitec.ac.nz

The Budget and Management Accounting Systems

Page 1
ACCOUNTING

The process of identifying, measuring and communicating economic

information to permit informed judgements and decisions by users of the
information.

THE ACCOUNTING ENTITY

An area of economic interest to a particular individual or group

PERFORMANCE MEASUREMENT

The measurement of performance is an essential prerequisite to the

communication of information to interested parties. The parties that are likely to
be interested in the financial health and performance of an entity include:

The Owners of the Entity

The owners wish to ensure that:
the entity is able to cover the cost of operations and thus maintain the
resources originally provided by the owners, and
the objectives of the entity are being achieved. In the case of a commercial
business the primary objective is usually to provide the owners with a return
on their investment

The Managers of the Entitys Resources

The owners of the entity may employ staff to manage all or part of the entity for
them. In this situation it is important that information is available to the
managers indicating the extent to which they have achieved the objectives set
by the owners and themselves. Accounting can be used to provide a measure
of performance of individuals as well as the entity as a whole.

The Lenders of Resources to an Entity

It is not uncommon for entities to use more resources than are provided by the
owners. In this situation it is possible for an entity to borrow funds from external
third parties for both the establishment and operation of the entity. The entity
has to produce information for the lenders of resources which indicate the
likelihood of the entity being able to cover its costs of operations and hence be
able to repay the amounts lent to it when they fall due.

Government
Governments levy income tax on entities on the basis of the actual profit
earned (profit being the extent to which income from operations exceeds the
cost of operations). Therefore entities have to provide information to the
government that indicates the level of taxable profit earned and hence the basis
on which taxation should be levied.

The Budget and Management Accounting Systems - Page 2

REPORTING on the PERFORMANCE of ENTITIES

The purpose of measuring the performance of an entity is to determine its financial

fitness and to ascertain the extent to which it is achieving its purpose or objectives.

Financial Fitness
To measure the financial fitness you need to provide a uniform basis for
measuring economic activity money or the monetary unit (the monetary
convention). Measuring transaction data in monetary units enables a value to
be attached to all transactions which affect the entity and permits the recording
of the transaction in a consistent form. However, not everything can be
measured and recorded in monetary terms (intellectual capital and human
resources). The indicators used to measure the financial fitness of an entity
are financial position and financial performance.

Financial Position
The primary indication of an entitys financial position is its ability to continue in
operation by being able to pay debts as they fall due. This is ascertained by
identifying the assets, liabilities and owners equity of the entity.
Assets may be defined as the economic resources of an entity.
Liabilities may be defined as claims on the assets of an entity by people
other than the owners of the entity
Owners Equity may be defined as the net worth or the owners financial
interest in the entity

The Accounting Equation:

Assets = Liabilities + Owners Equity

The Balance Sheet indicates the entitys financial stability.

Financial Performance
An indication of the entitys financial performance is the extent to which
revenues exceed operating costs and hence increase owners equity. Where
an entity is unable to earn sufficient operating income to cover its operating
costs, the loss will result in a reduction of the owners equity in the entity. In its
simplest form, the financial performance of an entity is reflected in a change in
the owners equity in the entity. In representing the net assets (assets less
liabilities), owners equity is comprised of two essential elements:

1. Capital funds or resources contributed to the entity by the owner(s)

2. Retained accumulated profits accumulated surpluses or profits; that is the
excess of revenues over costs that have not been distributed to the owners.

Owners Equity = Capital + Accumulated retained profits - Distributions

The Income Statement (Profit and Loss Statement) indicates the extent to
which the entity is able to preserve or increase the owners equity in the entity.

The Budget and Management Accounting Systems - Page 3

ELEMENTS OF ACCOUNTING

ASSETS anything of monetary value that a business owns or has control of.

Among the more common assets of any business are

Cash at bank
Inventories (goods unsold at balance day) not applicable to a
service business as services cannot be inventoried.
Equipment
Vehicles (cars, trucks, vans all forms of transport owned by the
business)

Not all assets are items of a tangible nature. e.g. when a business sells
services or goods on credit, any amounts owing by customers on balance day
(the last day of the accounting period) will be included as assets because the
customers/clients are legally liable for those sums of money. Also goodwill is
not represented by something tangible.

Assets in the Balance Sheet are usually divided into two sections:

Current Assets are assets that can be readily turned into cash. Examples
are accounts receivable (debtors, inventories and cash deposits)

Non-Current Assets are assets of a more permanent nature such as

plant, machinery, land, buildings and vehicles. These are shown in the
financial statement at historical (cost) price less an annual amount
charged to recognise wear, tear and obsolescence.

LIABILITIES amounts owed by the business to outsiders

If the business requires additional finance and negotiates an overdraft with their
bank, they will be liable for the amount of the overdraft taken up. Also included
as a liability will be any amounts owing to suppliers for goods and services
bought on credit but not yet paid for. The person or business to which the
money is owed is known as an account payable or a creditor. A debtor owes
money to a creditor.

Liabilities in the Balance Sheet (aka Statement of Financial Position) are also
divided into two sections:

Current Liabilities are liabilities that are expected to be paid within one
year. A bank overdraft will be included as a current liability as a bank
manager has the right to withdraw the facility at any time.

Non-Current Liabilities are liabilities that are not expected to be met within
the next 12 months. Examples are debentures and mortgages.

The Budget and Management Accounting Systems - Page 4

OWNERS EQUITY (CAPITAL OR PROPRIETORSHIP) is the amount that a
business owes to its owner/s.

The heading and layout of this section will depend on the type of business
ownership.

There are two types of owners equity

Investment by the owner

Profits arising from the everyday operations of the business.

REVENUE (INCOME) the cash or accounts receivable arising from the sale
of goods and services.

EXPENSES (COSTS) the amounts paid out or incurred by the business in

order to generate revenue.

Examples are rent, wages, salaries, electricity, rates and repairs and
maintenance. It can sometimes be difficult to decide whether an item is an
expense or an asset.

If the item will benefit the business (i.e. generate income) over more than one
accounting period, part of it will be written off against the income for each
period. This is the case with plant and equipment which will benefit the
business (generate income) over many years. Hence, it will be depreciated
over the life of the asset (the period the benefit will be received).

Where an item will benefit the business only in the current accounting period it
is an expense and will be written off against the revenue earned in that period
(e.g. rent, stationery)

REVENUE MINUS EXPENSES = PROFIT

The Budget and Management Accounting Systems - Page 5

THE CONCEPT OF ASSET AND EXPENSE

The method of calculating profit is by charging expenses against revenue for

the period. All resources that are consumed in the process of earning revenue
for the current period must be charged against that revenue in order to
establish the profit.

Revenue recognition is concerned with timing when should revenue from a

transaction be included in the financial statements and thus when should the
net profit be reported as earned profit for the period? It is important that
revenue is not recognised before it has been earned - do not count your
chickens before they have hatched.

Cash Vs Accrual Accounting Cash accounting systems are based on

payments actually made during the period and receipts which have actually
been received during the period. Such a system is unlikely to provide the entity
with a good matching of costs and revenues as most items of revenue and
expenditure do not have cash consequences in the current accounting period.
Accrual accounting aims to ensure in a mechanistic fashion that a proper
matching takes place by accruing both revenue earned and expenses incurred
for the period but for which there has been no cash received or paid.

The Budget and Management Accounting Systems - Page 6

CLASS EXERCISES CLASSIFICATION OF ITEMS

Question One.

By writing A (asset), L (liabilities) or O (owners equity), indicate what you think

is the correct grouping for each of the items listed below.

A, L, O
1 Amount owing for materials
2 Digging machine
3 Inventory of tools owned on balance date
4 Mortgage taken out by the business
5 Owners investment in the business
6 Fixtures and fittings
7 Bank overdraft
8 Fees owed to the business
9 Land & buildings owned by the business
10 Loan to the business
11 Loan to another business
12 Cash at bank

Question Two.

By writing A (asset), L (liabilities) OEq (owners equity/capital), R (revenue), E

(expense), indicate what you think is the correct grouping for each of the items
listed below

A, L, OEq, R, E
1 Rent paid
2 Account receivable (debtors)
3 Van repairs
4 Advertising
5 Cost of contract labour
6 Purchase of shares in the business
7 Debentures/Finance company loan
8 Fees received
9 Fees receivable
10 Motor vehicle
11 Bank fees/charges
12 Interest on mortgage paid
13 Bad debts
14 Insurance premium paid
15 Wages
16 Accounts payable (creditors)
17 Goodwill
18 Drawing board
19 Computer
20 Stationery
21 Rent and rates

The Budget and Management Accounting Systems - Page 7

SOURCES OF FINANCE

First Principle NEVER BORROW SHORT TERM TO INVEST LONG TERM

There are two sources of finance

Internal investment by the owner/s

External outsiders. This can be short term (to finance working capital) or
long term (to finance fixed assets)

By writing S (short term), L (long term), indicate what you think is the correct
grouping for each of the sources listed below

S, L
1 Mortgage
2 Bank overdraft
3 Trade credit
4 Hire purchase
5 Factoring of debtors
6 Commercial bills
7 Bank loans
8 Credit control
9 Sale and lease back
10 Share capital
11 Retained earnings
12 Debentures
13 Government grants
14 Inventory control

List other sources of finance you can think of and indicate whether they are
short or long term.

S, L
15
16
17
18
19
20
21

The Budget and Management Accounting Systems - Page 8

BUDGETS

A budget is a quantitative summary of the expected consequences of the

organisations activities.

PROFIT PLANNING
Detailed Plan:
- acquisition and use
- financial and other resources
- some time period
- turns perspective forward.

EVOLUTION
- Personal Observations
small organisation
personally oversees operations

- Add Historical Data

why ?????
period comparisons

- Add Future Plans

why ????
actual Vs plan (measure of performance)

Method of altering behavior and decisions (by senior management)

PLANNING
development of FUTURE objectives

CONTROL
ensuring that objectives are attained
ensuring that all the organisation functions in a manner consistent with
policies
evaluates performance / feedback

EFFECTIVE budgeting
must provide BOTH - Planning and control - interdependent

ADVANTAGES

- compels planning (formalise)

- provides performance benchmarks
- co-ordinates the organisation
- integrates plans and objectives
- part of strategy and tactics

STRATEGY - objectives

TACTICS - means for attaining strategic goals

The Budget and Management Accounting Systems - Page 9

IMPOSED vs PARTICIPATIVE

Managers prepare own budgets

- team membership (views, judgements valued)
- accuracy / reliability
- motivation
- no buckpassing

Review
- to ensure validity

CLASSIFICATIONS
- performance reports
- long term (capital, facilities, project)
- flexible
- life-cycle
- operating
- the sales plan
- the production plan
- the capital spending plan (to provide the capacity to produce)
- the materials requirements / purchasing plan
- the labour plan
- the administrative and discretionary spending plan
- financial
- cash
- zero based

THE MASTER BUDGET

- a network of interrelationships
WHERE DO YOU START ??????

INCOME FORECASTING
- historical
- economic / industry conditions
- product profitability
- market research
- pricing
- advertising/ promotion
- quality (product / sales force)
- competition
- seasonal variation
- production capacity
- long term sales trend

The Budget and Management Accounting Systems - Page 10

Background

Definition - a plan expressed in money. It is prepared and approved prior to

the budget period and may show income, expenditure, and the capital to be
employed. It may be drawn up showing incremental effects on previous budgeted
or actual figures, or be compiled by zero-based budgeting.

a plan expressed in money... - Budgets have traditionally been the preserve

of financial specialists. An underlying assumption is that financial measures
provide the only meaningful assessment of organisational performance. Based
on this assumption, it makes perfect sense for qualified accountants to use
budgets for setting financial targets. The task of other functions is then to
organise production, sales etc. so as to achieve these targets.

Finance is only one of the resources employed in an organisation. The

key task of management is to deploy all the resources available so as
to achieve objectives in the most effective manner. It is true that a
monetary plan is necessary to convert the cost of resources consumed
to a common measure. But to give priority to the financial targets over
strategic objectives is to distort the overall operations of the
organisation.

The emphasis on a financial plan can give undue attention to aspects

that can easily be measured in monetary terms. This can mean
neglect of other aspects less easily measured. It is relatively simple to
estimate what it costs to produce Product X, or provide Service Y - just
focus on the input resources (materials and labour) and work out the
cost of each. But how can we measure the customers satisfaction or
dissatisfaction when Product X or Service Y is purchased? Ultimately,
this factor is more important to organisational success than
product/service costings contained in the budget.

It is prepared and approved... - The process of preparing and eventually

adopting a budget has traditionally been a lengthy and bureaucratic procedure.
A manager responsible for a particular functional area will make a first attempt
to forecast the year ahead. When all the functional budgets are prepared a
consolidation process follows to produce an overall budget. Senior managers
review the outcomes and (typically) proclaim that its not good enough - costs
are too high and revenue targets are inadequate. The functional budgets are
referred back to the managers who prepared them and the process is repeated.
It can take many resubmissions before the budget is adopted - often in a form
to which functional managers can give only their assent not their conviction.
The very foundations of this procedure are questionable, because the
emphasis on the individual functional areas downgrades the importance of the
business processes that cut across functional boundaries.

The Budget and Management Accounting Systems - Page 11

 Workshop

BUDGETS - A Tool for Planning and Performing

Directions:

Use this worksheet to prepare a normal weekly time budget. List the assumptions
you have made in preparing your estimates and answer the questions.

Activity Normal Week - Hours

Work
Scheduled Classes
Scheduled Tutorials
Scheduled Computer Laboratories
Personal Study Time
Travel Time
Sleeping / Eating
Family Responsibilities
Leisure
Other -
Other -
Total Hours 168

Assumptions :
List below all the assumptions that you used to estimate your budgeted hours in each
activity category:

QUESTIONS:

Does your budget help you plan and control your resources? How or how not?

The Budget and Management Accounting Systems - Page 12

Which of your activities are fixed uses of your time?

Which of your activities are variable uses of your time?

How did you derive your budget estimates?

To make more time available in your day, would a 10% reduction in time spent in ALL
your activities make sense? Is this a good approach to budgeting? Why or why not?

The Budget and Management Accounting Systems - Page 13

CASE STUDY

Wells Consultants will commence business on 1 July 200A. The total capital
contributed by the two directors/owners will be $300,000 in cash.

Anticipated billings for the year ended 30 June 200B are $484,000. The monthly
breakdown has been estimated as follows.

July 200A $10,000

August 17,000
September 22,000
October 27,000
November 33,000
December 40,000
January 200B 47,000
February 52,000
March 54,000
April 57,000
May 60,000
June 65,000

The planned expenditure for the year is as follows:

Directors salaries (2x $96,000) $192,000

Other salaries 60,000
Contract staff 96,000
Office rental 15,000
Office equipment rental 3,000

Motor vehicles (2) (purchased 1/7/200A)

Cost $90,000, Depreciation @ 20% 18,000

Motor vehicle running expenses 12,000

Equipment (purchased 1/7/200A)

Cost $50,000, Depreciation @ 25% 12,500

Equipment lease 12,000

Operating costs (5% of fees) 24,200

Salaries and contract staff are paid each month. All other costs are incurred evenly
throughout the year and paid in the month incurred except for Operating costs that
are paid the following month.

All fees are on credit and are due on the 20 th of the month following billing. The
collection of debt is 80% when due and 20% the following month.

Required:
On the basis of this data, and using the attached worksheet, prepare the following
budgets for each of the first three months and for the quarter in total

1. Budgeted Income Statement

2. Budgeted Balance Sheet
3. Cash budget for each month

The Budget and Management Accounting Systems - Page 14

Budget Worksheets

1. Revenue Budget
Fees July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June Total
200A 200B

2. Inwards Cash Budget

Fees July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June Total
% 200A 200B

Total

Debtors
Fees July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June
% 200A 200B

Total

The Budget and Management Accounting Systems

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3. Expenses Budget
Expenses July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June Total
200A 200B

Total

The Budget and Management Accounting Systems - Page 16

4. Outwards Cash Budget
July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June Total
Expenses 200A 200B

Capital

Total

The Budget and Management Accounting Systems - Page 17

5. Cash Budget
July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June Total
200A 200B
Opening
Balance

Inwards

Total

Outwards

Closing

The Budget and Management Accounting Systems - Page 18

6. Budgeted Income Statement for the period ended
July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June Total
200A 200B
Income

Fees

Total Income

Expenses

Expenses

Total Expenses

PROFIT

The Budget and Management Accounting Systems - Page 19

7. Budgeted Balance Sheet as at the end of:
July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June
200A 200B
Owners Equity
Capital
Profit (Cumulative)
Total

Current Liabilities
Creditors

TOTAL 274,958 256,416 242,524 233,382 229,990 233,298 243,256 257,864 274,222 293,480 315,590 342,550

Current Assets
Cash
Debtors
Total Current Assets

Non-Current Assets
Motor Vehicle
Accum Dep.

Equip
Accum Dep.

Total Non-Current
Assets

TOTAL Assets 274,958 256,416 242,524 233,382 229,990 233,298 243,256 257,864 274,222 293,480 315,590 342,550

The Budget and Management Accounting Systems - Page 20