7.8 Other Budgeting Methods

Budgeting in service companies

The concepts discussed in this chapter are equally applicable to service companies. Service firms have service revenues and operating expenses that must be budgeted. Projected income statements and balance sheets can be prepared for service companies and are typically based on past performance.

To illustrate, assume Windy Weather Company wants to make the following changes this year to last year’s results:

  1. Sales will increase 5%
  2. Sales commissions will remain the same at 10% of sales
  3. Sales and administrative salaries will increase 3%
  4. Supplies, rent and miscellaneous expenses will remain the same.
  5. Income taxes will be 30% of net income.

The budgeted income statement for this year would be:

Windy Weather Company    
Budgeted Income Statement   
  Last Year
 BUDGET
 Calculation
Sales $450,000 $472,500 450,000 + (450,000 x 5%)
Less Expenses: heading only – no entry
   Sales Commissions $45,000 $49,500 472,500 x 10%
   Sales Salaries $50,000 $51,500 $50,000 + (50,000 x 3%)
   Administrative Salaries $75,000 $77,250 $75,000 + (75,000 x 3%)
   Supplies Expense $5,000 $5,000 no change
   Rent Expense $120,000 $120,000 no change
   Miscellaneous Expense $15,000 $15,000 no change
Total Expenses $310,000 $318,250 sum of all expenses
Income from operations $140,000 $154,250 Sales 450,000 – Expenses 318,250
Less: Income Tax (30%) ($42,000) ($46,275) Inc. from operations x 30%
Net Income $98,000 $107,975 Inc. from operations – income tax

Zero-Based Budgeting

An alternative to the traditional budget is zero-based budgeting.

Zero-base budgeting became popular in the 1970s, particularly when President Jimmy Carter supported it for state and federal governmental units. It has received less attention since then.

Under zero-base budgeting, managers in a company start each year with zero budget levels and must justify every dollar that appears in the budget. Managers do not assume any costs incurred in previous years should be incurred this year. Each manager prepares decision packages that describe the nature and cost of tasks that can be performed by that unit and the consequences of not performing each task. Top organization officials rank the decision packages and approve those that they believe are most worthy. A major drawback to the use of this concept is the massive amounts of paperwork and time needed to prepare and rank decision packages, especially in large organizations.

Accounting in the Headlines

Why is Campbell Soup Company using zero-based budgeting?

photo of campbell soup in grocery storeConsumers are increasingly distrusting “Big Food,” and Campbell Soup Company (CPB) is working to counter the effects of that trend by offering more healthy or natural alternatives.  For example, Campbell’s recently introduced a new line of organic soups, Campbell’s® Organics, and acquired both Bolthouse Farms juices and Plum Organics baby food.

In addition to expanding its healthier and more natural product lines, Campbell’s has also announced it will be implementing zero-based budgeting.  It expects to save $200 million off its expected annual costs of close to $7 billion.

Questions

  1. What is “zero-based budgeting”?
  2. How does Campbell’s expect that it will save $200 million by using zero-based budgeting?
  3. What are some potential drawbacks to Campbell’s from its use of zero-based budgeting?

Final Thoughts

For the final thoughts on budgeting, it might be helpful to rethink about how we create budgets, who creates them and what motivation the person might have for the budget figures.  This video discusses the difference between participating and traditional budgeting.