Page 103 - Accounting Best Practices

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Budgeting Best Practices
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The only issue with this approach is that some managers like to produce bud-
gets that represent flights of fancy and do not appreciate having the extra infor-
mation regarding funding, since it brings them back to reality rather abruptly.
When these unique personalities are in management, it is best to use a great deal
of tact when presenting funding information. A good variation that works in this
situation is to present a range of funding amounts, along with the percentage
chance of having each amount available, plus the likely interest rate that the com-
pany will have to pay in order to obtain the funds. By showing a probable interest
rate, management will then understand that extra tiers of funding will only be
available at a greater cost, since the company’s credit risk rises as it borrows more
money. This form of presentation is an effective way to increase management’s
understanding of funding availability.

Cost: Installation time:

5–5 IDENTIFY STEP-COSTING CHANGE POINTS
A typical problem for anyone constructing a budget is to determine when step-
costing points occur. A step-cost is a block of additional expenses that must be
added when a certain level of activity is reached. For example, machinery can only
operate at a reasonable capacity level, perhaps 75 percent, before another machine
must be added to cope with more work, even if that workload will only fill the
machine at a very low level of capacity. The same principle applies to adding per-
sonnel or building space. In all cases, there is a considerable added expense that
must be incurred in one large block. If the expense is sufficiently large, it can play
havoc with the total level of expenses. Or, in the case of a really large capital pur-
chase, it may leave no room for other capital purchases for the next year. Accord-
ingly, it is necessary to keep close track of step-cost change points.
The best way to determine when an increase in step-costs will occur is to
create a table of activity measures that directly relates to each step-cost. For
example, a new shipping person is needed for every 135 pallets of product
shipped per day. By relating sales for the next year to the number of pallet loads
of shipments, one can reasonably predict when an additional shipper is needed.
Similarly, if a piece of production machinery will support $1 million of sales, it is
an easy matter to extrapolate this relationship based on expected sales to deter-
mine when additional machine purchases must be made. However, keep in mind
that step-costs can be delayed by using new work methods, which can alter these
relationships. For example, an automated shrink-wrapping machine can substan-
tially increase the number of pallets that a single shipper can handle in a day,
while a good preventive maintenance routine can reduce the amount of machine
downtime, thereby increasing utilization rates and delaying the need for more
production equipment. When these changes are added to the budget, it becomes
necessary to change the relationship between the activity levels and step-costs,