- Budget administration: Administering the budget. Usually a senior accounting manager who devises the process by which budget data will be gathered, collects the information and prepares the final budget.
- Budget manual: identifies who is responsible for providing various types of information, when the information is required and what form that information is to take. To communicate budget procedures and deadlines to employees throughout the organisation.
- Budget committee: consisting of key senior executives is often
- appointed to advise the accountant during the preparation of the budget
- Continually updated
- Add a new time period
- Drop the period just completed
- Under zero-base budgeting, the budget for virtually every activity in the organisation is initially set to zero. To receive an allocation of resources during the budgeting process, managers must justify each activity in terms of its continued usefulness to the business.
- This approach forces managers to rethink each phase of a firm’s operations before requesting resources.
- Zero-base budgeting is designed to restrict the very common practice of projecting next year’s budgeted costs by adding a percentage increase to the current year’s costs.
- –Managers must justify each activity
- –Forces managers to rethink
- Not very common
- –Time-consuming and expensive as it requires extensive in-depth
- analysis of expenditures, and so may be used only every three or four years or for certain parts of the business.
- –Not useful in identifying areas of waste, redundant activities or ways to improve performance
- –Can be too introspective; missing the big picture. When managers
- focus on their own part of the business, they can overlook the interactions with other departments and the relevance of their operations to overall business objectives and strategies.
Budgets in not-for-profit organisations and government agencies
- Somewhat similar to profit-seeking organisations
- However often there is no sales budget
- Service levels are still considered
- –Resource allocation decisions
- Other revenue budgets may be estimated
- –Government grants, donations, sponsorships
- Responsibility centre: a part, segment or subunit of an organisation whose manager is accountable for a specified set of activities
- Arises from decentralisation: the restructuring of the organisation into smaller sub-units, each with specific operations and decision-making responsibilities
- Responsibility accounting: a system that measures the plans, budgets, actions and actual results of each responsibility centre
- Budgets are prepared along responsibility accounting lines
Tunnel vision- only think about themselves
Types of responsibility centres
- Cost: accountable for costs only (common)
- Revenue: accountable for revenues only
- Profit: accountable for revenues & costs (common)
- Investment: accountable for investments, revenues and costs
- Controllability is the degree of influence that a manager has over costs, revenues or related items for which he is being held responsible
- Controllable versus uncontrollable costs
- Uncontrollable costs can be excluded or segregated in reports
- Responsibility accounting focuses on information sharing not in laying blame on a particular manager
- Controllability is difficult to enforce:
- –Few costs are clearly under the influence of a single manager (e.g. teamwork)
- –Performance report typically focus on a period of a year or less, yet many decisions have long term repercussion
- –In the long run, all costs become controllable by someone
- In large organisations, formal processes are typically used to collect data
- Budget administration is often the responsibility of senior management
- A budget manual communicates:
- –who is responsible for providing information
- –when the information is required
- –what form it will take
- –budget committee
- Three main behavioural issues
- –Participative budgeting
- –Budgetary slack
- –Budget difficulty
- Allows managers at all levels of the firm to develop their own initial estimates for budgeted sales, costs, etc.
- Bottom-up as opposed to top-down
- May encourage coordination and communication
- May lead to more accurate budget estimates
- May lead to individuals identifying more closely with the budget targets
- Can be expensive and time-consuming,
- Too much participation and discussion can lead to indecisiveness and delay.
- When those involved in the budgeting process disagree in significant and irreconcilable ways, the process of participation may aggravate differences and disagreements
- Provides opportunities for padding the budgets unless there are incentives to encourage people to provide accurate budget estimates.
- Top-down budgeting is where senior managers impose budget targets on more junior managers—there is little participation or consultation in the
- budget-setting process.
- This may be a cost-effective and timely way of setting budgets
- Two major disadvantages. First, senior managers may have less
- knowledge of the local business environment than do those managers working directly in the particular responsibility centres. Budget targets may not embody this knowledge and may be unrealistic.
- Second, limited involvement in setting budget targets can result in a lack of commitment of middle and junior managers to achieving the budget
- Bottom-up budgeting is the participative process in which people at the lower managerial and operational levels play an active role in setting their own budgets.
- Budgets are collected at the lowest responsibility centres of the business and are consolidated and fed up to senior management.
- Under this approach, we would still expect a certain amount of review and negotiation to take place before budgets are approved by senior managers.
- Participative budgeting can encourage coordination and communication between managers and a greater understanding and appreciation of the objectives and strategy of the wider organisation.
- Accuracy of the budget estimates may be enhanced because those people close to operations have the best knowledge of the likely sales in their region or the likely costs of running their responsibility centre.
- It is generally believed that most people will perform better and try harder to achieve a budget goal if they have been consulted in setting that budget.
- Enables employees to develop greater levels of independence, allowing them to make day-to-day decisions and solve work-related problems.
- It is based on the idea that employees will experience greater motivation and improve their performance through this increased authority and responsibility.
- –Based on the belief that employees will experience greater motivation when they have higher degrees of authority and independence
- Employee empowerment is a wider concept than budgetary participation, but it would imply that employees at all levels of the organisation would be given the authority to develop their own budgets and targets and to manage their own work areas.
Budgetary slack (padding the budget)
- Underestimating revenue or overestimating costs
- The difference between the estimated revenue or cost projection and a realistic estimate of the revenue or cost
- Reasons for budgetary slack
- –Performance can look better if you can ‘beat the budget’- may be motivated if reward is based on exceeding budget expectations.
- –A way of coping with uncertainty (allowing for an unforeseen event. If it happens budgetary slack will absorb the cost and will still be on budget)
- –To insulate against initial budget requests being cut back by management (Thus we have a vicious circle- budgetary projections are padded because they are likely to be cut, and they are cut because they are likely to be padded)
Strategies to reduce opportunities for budgetary slack
- Avoid relying on the budget as a negative evaluative tool. If a departmental supervisor is criticised every time a budgeted cost projection, or a sales projection, is not achieved the likely response will be to pad the budget. In contrast, if the supervisor is allowed some discretion to exceed the budgeted costs when necessary, there will be less of a tendency to pad the budget.
- Use benchmarking
- Senior managers regularly involve themselves in the tasks of subordinates;
- Promoting and fostering values and norms unfavourable to budgetary slack;
- Linking rewards to predictive accuracy
- Using stretch targets (attach bonus to achieving stretch target)
- It seems that for budgets to be motivational, employees must accept the budget targets as their own targets.
- Goal congruence: The situation in which the organisation’s goals coincide with an individual’s goals
- Budget acceptance is more likely when:
- –Targets are developed with employee participation
- –Targets are considered achievable
- –There is frequent feedback on performance
- –employees are held responsible for activities that they believe are within their control
- –Achievement of targets is accompanied by valued rewards
- Set to provide challenge and stretch, but is not too difficult to achieve
Budgeting in multinational companies
- Multinational firms face additional difficulties in budgeting
- -Cost and revenues in multiple currencies
- -Need to forecast exchange rates
- -Different political, legal, and economic conditions
Budgeting provides a means to identify issues and learn and adapt to changing conditions
Common criticism of traditional budgeting
- Too time consuming
- Becomes out of date very quickly
- May create a set frame of mind for the managers and hinder innovations
- Solutions? Rolling budgets, Flexible budgets, Beyond budgeting.