9 Kaizen Budgeting

The Theory

Firms prepare budgets in numerous ways. We will introduce a few different budgeting techniques, then learn the method for Kaizen budgeting.

Activity-Based Budgeting

Activity-based budgeting is a popular technique, focusing on the different activities involved in producing and marketing the product and what drives costs for each activity. In activity-based budgeting, firms first examine the activities involved in manufacturing their products and determine whether any activities should be eliminated or streamlined. Then, they estimate the amount of cost driver used for each activity, as well as the cost of the activity per unit of cost driver. The final budgeted amount for each activity would be the budgeted amount of the cost driver multiplied by the budgeted cost per unit of cost driver.

Zero-Based Budgeting

Some firms use zero-based budgeting, which initially sets every budget in the organization to zero, requiring managers to justify every budgeted cost in terms of its future usefulness to the organization.

Rolling Budgets

Rolling budgets are continually updated by adding a new time period (month, quarter, etc.) to the end of the budget as the last time period expires. Thus, a budget is always prepared for a set future time horizon.

Kaizen Budgeting

The concept of Kaizen, or continuous improvement, is one of the main theories underlying the Toyota Production System.^[1] In this chapter, we will explore the concept of continuous improvement by learning the method for Kaizen budgeting.

The operating budget and cash budgeting processes we looked at in the previous chapters were based on budget standards that stayed constant from period to period. A Kaizen budget, on the other hand, incorporates continuous improvement into the budgeting process. Firms that wish to gradually, continuously reduce costs or make process improvements can use Kaizen budgeting to incorporate those changes into their budgets.

The Method

In Kaizen budgeting, the items targeted for improvement change by a gradual amount each period. For example, if direct labor cost is targeted for continuous improvement, the per-unit direct labor cost should be reduced gradually each period, usually by a set percentage.

If the item targeted for continuous improvement is variable—revenue or a variable cost—take both the improvement and sales volume into consideration, because variable items are affected by sales volume. Firms can apply continuous improvement to the per-unit cost or selling price, then multiply that per-unit amount by the volume in units to arrive at the total amount. If sales change at a constant rate, firms can start with the total amount of revenue or variable cost and apply factors for both the improvement and the change in volume.

On the other hand, if the item targeted for continuous improvement is a fixed cost, the improvement should be applied to the total amount of the fixed cost, without considering sales volume. Unlike variable costs, fixed costs do not change in proportion to sales volume, so volume should not be included in a Kaizen budget for fixed costs.

To account for continuous improvement each period, use a factor of one plus the improvement percentage if the improvement is for a revenue (which improves as it increases) and one minus the improvement percentage if the improvement is for a cost (which improves as it decreases).

Illustrative Example

Zimbabwe, Inc. has budgeted $1,125,000 for direct materials usage and $250,000 for fixed factory overhead for January of next year. Sales for the next 12 months are planned as follows:

Zimbabwe has a goal of decreasing both their direct materials cost per unit and their fixed factory overhead cost, continuously reducing each cost by 1% each month.

Prepare a Kaizen budget for direct materials and fixed factory overhead for each month of the year.

Direct materials cost per unit is $1,125,000 / 75,000 = $15 per unit. Zimbabwe wants to decrease this cost by 1% each month, so the per-unit cost each month would be 99% of the previous month’s per-unit cost. Direct materials cost would be:

Total fixed factory overhead cost is $250,000. Zimbabwe wants to decrease this cost by 1% each month, so the total cost each month would be 99% of the previous month’s total cost. Fixed factory overhead cost would be:

Lecture Examples

1. The following information is from your firm’s budget for February:

Sales for the next three months are expected to be as follows:

Your firm hopes to continuously improve selling price by 2% per month, direct materials cost by 1% per month, and fixed overhead cost by 1.5% per month.

Prepare a Kaizen budget for March through May.

 

2. Direct labor costs are $300,000 in February for unit sales of 10,000. Sales are expected to increase by 5% each month, and we want to improve direct labor costs by 3% each month.

Prepare a Kaizen budget for March.