Budgets - An Overview

Budgeting involves setting out a plan of action which serves as a yardstick to measure the future performance of a business. Secondly it also helps motivate the staff by setting some targets for them, so they strive harder and the organization benefits from it. The outcome of the entire budgeting exercise depends on how it is implemented within the organization.

A Top-down approach is one where the top-management of the company create the budget and impose it on the lower managers and staff. Such a budget might not have the desired effect. On the contrary a Participative Budget approach involves the managers of all different functions to actively participate and provide their input into the budgeting process. Because of their participation they naturally own the budget and are motivated to achieve the targets set.

However, some times the managers involved in the budget preparation process intentionally set mediocre targets. This is called Padding the Budget. The managers in such a situation set only what can be achieved with an average performance.

Budgets should be ideally challenging but still realistic so that the organization can grow larger and at the same time the managers remain motivated to work towards the organizational objectives.

FOH Applied Rate and Cost Drivers

One of the tools used for controlling FOH costs is the use of an FOH applied rate. Now how do we calculate this applied rate and what is its purpose? I'll start with the purpose. This is a budgeted rate based on the expected working conditions of the company, which is used to budget for the coming period.

The formula of FOH rate is = Total Budgeted Indirect Expenses/Expected capacity

The expected capacity could be expected hours of labour for the company's budgeted target of production, hours of machine running for the production of units expected, etc. Whatever it may be it is up to the management but it is better that the denominator chosen be the cost driver of that product.

Cost Driver is any activity in the production process that is primarily and largely responsible for the costs incurred. The higher the quality of the cost driver chosen the better the calculated applied rate.