Budgeting,

Performance
Evaluation,
Pricing
Decisions
VA L U AT I O N C O N C E P T S A N D
METHODS
BUDGETING
◦ Budgeting Process
◦ Types of Budget
◦ Budget Methodologies
◦ Master Budget
BUDGETING PROCESS
◦ It is related into all functions of management.
◦ Composed of several steps:
1. Budget Preparation – Top-Down Approach and Bottom-Up Approach
2. Budget Communication
3. Budget Approval – Under Budget Committee (Executive Committee)
4. Budget Implementation – Provides incentives
5. Budget Monitoring – Creation of Budget Report (Maintain or Revise
Budget)
TYPES OF BUDGET
◦ STATIC / FIXED BUDGET
- Budget is fixed even if there’s a different activity level.
- Good for checking Fixed Cost
◦ FLEXIBLE BUDGET
- Adjustable according to different scenarios with different
activity level.
BUDGET METHODOLOGIES
◦ ROLLING BUDGET – Maintains the coverage of budget, if the
coverage is 12 months, it will be rolled out to another 12
months.
◦ INCREMENTAL BUDGET – Adjust prior year to management’s
expectation next year (% increase / decrease from prior year)
◦ ACTIVITY-BASED BUDGET – Supports the activity-based
costing which has a budget per activity.
◦ KAIZEN – Continuous improvement in the budget (more
specific than Incremental.
BUDGET METHODOLOGIES
◦ LIFE CYCLE BUDGETING – Most tedious budget. Covers the
Introduction, Growth & Expansion, Maturity, Decline.
◦ ZERO-BASED BUDGETING – As if it is the 1st Time Budgeting
(Zero Knowledge of prior year), no reference from previous
year, future-oriented, and all are justified
MASTER BUDGET
BASIC TEMPLATE
◦ BPSE TEMPLATE

B- Beginning Inventory
P- Production (+)
S- Sales (-)
E- Ending Inventory
EXERCISE:
◦ Bella Inc. has the following information:
MONTH BUDGETED SALES
MARCH P50,000
APRIL 53,000
MAY 51,000
JUNE 54,500
JULY 52,500

In addition, the gross profit rate is 40% and the desired inventory level is
30% of next month’s cost of sales.
REQUIREMENT: Prepare a purchases budget for April through June.
EXERCISE:
◦ Luna Inc. has the following budgeted sales for the next six-month period:
JUNE 90,000 AUGUST 210,000 OCTOBER 180,000
JULY 120,000 SEPTEMBER 150,000 NOVEMBER 120,000
There were 30,000 units of finished goods in inventory at the beginning of
June. Plans are to have an inventory of finished products that equal 20% of
the unit sales for the next month.
Five pounds of materials are required for each unit produced. Each pound
of material costs P8. Inventory levels for materials are equal to 30% of
needs for the next month. Materials inventory on June 1 was 15,000
pounds. Each unit requires 0.50 DLH at a rate of P5 per hour. Overhead is
applied on the basis of P2 per direct labor hour.
EXERCISE:
◦ REQUIREMENTS:
A. Prepare production budgets in units for July, August, and September.
B. Prepare a purchases budget in pounds for July, August, and September,
and give total purchases in both pounds and dollars for each month.
PERFORMANCE EVALUATION
◦ Performance evaluation is the basis of a management control
system. Periodic comparisons of the actual costs, revenues and
investments with the budgeted costs, revenues and investments
can help management in taking decisions about future
allocations.
◦ RESPONSIBILITY ACCOUNTING – is an internal reporting
system that supports decentralization of decision-making and
generation of information specific to the center.
DECENTRALIZATION vs CENTRALIZATION
◦ Decentralization is the delegation of authority and
responsibility to supervisors or mid-level management. It refers
to the creation of divisions or segments of an organization to
become more manageable sub-units in the organization.
◦ Centralization decision-making leaves decision-making to few
top-level managements. Decisions is cascaded to lower-level
management for implementation.
SEGMENT REPORTING
◦ Business segment reporting breaks out a company’s financial
data by company divisions, subsidiaries, or other kinds of
business segments.
GOAL CONGRUENCE AND MOTIVATION
◦ Goal Congruence is a situation in which people in multiple
level of an organization share the same goal. A well thought out
organization design causes goal congruence and results in an
organization being able to work together to accomplish a
strategy.
◦ Consequently, both morale and performance will tend to be
low and organizational accomplishment will be negligible. In
some cases, the organizational goals can be so opposed that
no positive progress is obtained.
OTHER TERMINOLOGIES
◦ Controllable Cost – costs which may be directly regulated at a
given level of managerial activity and time-frame.
◦ Non-controllable Cost – cost that cannot be altered based on
a personal business decision or need.
◦ Direct/Traceable Fixed Cost – fixed cost that is avoidable if a
segment or division is discontinued.
◦ Common Fixed Cost – Also known as Unavoidable Fixed Cost
or Allocated Fixed), fixed cost necessary to sustain operations
of multiple segments.
 RESPONSIBILITY CENTERS
COST PROFIT REVENUE INVESTMENT
Investment,
Cost and Revenues, Cost,
ACCOUNTABILITY Revenues Revenues, Cost,
Expenses and Expenses
and Expenses
Contribution
Standard Cost Margin, Revenue
EVALUATION ROI, RI, EVA
Variances Segment Variances
Income
Investment in
Production Marketing Branch,
EXAMPLE Sales Division
Department Department Investment in
Subsidiary
RESPONSIBILITY CENTERS
1. COST CENTER – Standard cost variance analysis is used in
evaluating cost center.
2. PROFIT CENTER -
A. Segment Contribution Margin
= Total Revenue – Total Variable Cost
B. Segment Income or Segment Margin
SI = Segment Contribution Margin – Avoidable FC
OR SI = Net Operating Income + Common Fixed Cost
RESPONSIBILITY CENTERS
3. REVENUE CENTER – Revenue variance analysis is used.
4. INVESTMENT CENTER
A. Return On Investment (ROI)
ROI = Ope. Inc. / Ave. Investment or Assets
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒 𝑆𝑎𝑙𝑒𝑠
OR ROI = 𝑥
𝑆𝑎𝑙𝑒𝑠 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑜𝑟 𝐴𝑠𝑠𝑒𝑡𝑠
B. Residual Income (RI)
RI = Ope. Income – (min. ROR x Ave. Investment Asset)
RESPONSIBILITY CENTERS
4. INVESTMENT CENTER
C. Economic Value Added (EVA)
= EBIAT – (WACC x Total Long-term Sources of Financing)
OR = NOPAT – (Total Assets – Current Assets) x WACC

EBIAT – Earnings Before Interest but After Tax

NOPAT – Net Operating Profit After Tax
WACC – Weighted Average Cost of Capital
TRANSFER PRICING
TRANSFER PRICE is the price charged by one segment of an
organization for a product or service that it supplies to another
segment of an organization. A transfer price is used to determine
the cost to charge another division, subsidiary, or holding
company for service rendered.
TRANSFER PRICE RANGE
The highest price the buying division would be willing to pay is
the external price it pays from an outside supplier. The variable
cost is the lowest price provided there is no opportunity cost and
fixed cost remain unaffected.

𝑇𝑜𝑡𝑎𝑙 𝐶𝑀 𝑜𝑓 𝐿𝑜𝑠𝑡 𝑆𝑎𝑙𝑒𝑠

LOWEST / MINIMUM PRICE = VC/Unit +
𝑇𝑜𝑡𝑎𝑙 𝑈𝑛𝑖𝑡𝑠 𝑇𝑟𝑎𝑛𝑠𝑓𝑒𝑟𝑟𝑒𝑑
ALTERNATIVE TRANSFER PRICES
1. Negotiated transfer price
2. Cost-based transfer price
3. Market-based transfer price
4. Dual transfer price
BALANCED SCORECARD
A balanced scorecard consists of an integrated set of
performance measures that are derived from and support the
company’s strategy throughout the organization.

TWO BASIC STRATEGIES:

1. Product Differentiation – Superior and Unique Product
2. Cost Leadership – High quality & Affordable
BALANCED SCORECARD
FOUR PERSPECTIVES
1. Financial Perspective
- LT & ST financial performance objectives and cost
2. Customer Perspective
- Customer satisfaction, qualitative measure
3. Internal Business Perspective
- Internal processes to provide value
4. Learning & Growth
- Capabilities to create LT growth
NON-FINANCIAL MEASURES
PRODUCTIVITY
- Concerned with the efficient production of output. It
specially addresses the relationship between inputs and outputs.
It is the ratio of output to input = output/input.

NON-FINANCIAL MEASURES
- Not stated in pesos and is considered as leading
indicators.
Internal Business Process Performance Measures
A. Delivery Cycle Time – from the time order placed to be
shipped to customers (it includes WAIT TIME or LEAD TIME)
B. Throughput Time (Manufacturing Cycle) – Conversion of
RM to FG.
C. Manufacturing Cycle Efficiency (MCE) – Ratio of Value-
Added time to Total Throughput Time
D. Velocity (Yield or Quota) – Number of units per time
 Internal Business Process Performance Measures

Order Received Production Started Goods Shipped

WAIT TIME PROCESS TIME + INSPECTION TIME + MOVE TIME

+ QUEUE TIME

THROUGHPUT (MANUFACTURING CYCLE)

DELIVERY CYCLE TIME

Internal Business Process Performance Measures
VALUE-ADDED TIME
- It creates customer satisfaction.
- There is an actual changes in the product that provides
values.

VALUE-ADDED TIME NON-VALUE-ADDED TIME

PROCESS TIME WAIT TIME
INSPECTION TIME
MOVE TIME
QUEUE TIME
Internal Business Process Performance Measures
MANUFACTURING CYCLE EFFICIENCY
𝑉𝑎𝑙𝑢𝑒−𝐴𝑑𝑑𝑒𝑑 𝑇𝑖𝑚𝑒 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝑇𝑖𝑚𝑒
= OR
𝑇ℎ𝑟𝑜𝑢𝑔ℎ𝑝𝑢𝑡 𝑇𝑖𝑚𝑒 𝑇ℎ𝑟𝑜𝑢𝑔ℎ𝑝𝑢𝑡 𝑇𝑖𝑚𝑒

Note: If the result is < 1, it means it contains non-value-added

time and this should be removed to improve MCE.