FLEXIBLE BUDGET – CONT… - Advantages of Flexible budgets:
- Do not require frequent revision.
- Geared towards a range of activity rather than towards a single level of activity.
- More accurately reflect changes in direct costs resulting from variations in production mix or rate.
- Provide a firmer basis for distributing the overhead costs at different level.
- Comparison between actual results and budgets will become more meaningful.
- If the actual direct labor is 10,000 with the actual costs listed, then the budget should be flexed too, as shown in table, in order to compare with actual performance at that particular level.
- The difference, if any will show variance which can be expressed as either favorable if actual is less than budget, whilst adverse if the actual is more than budget.
USES OF FLEXIBLE BUDGET - For planning purposes - 'contingency flexible budgets‘.
- To find out in advance the costs it would have to bear if output falls short of budget
- To decide whether it is possible to find alternatives for spare capacity if output more than budgeted
- To estimate costs of overtime or extra machine hire if output is more than budgeted
- For budgetary control purposes - Fairer and more meaningful comparisons.
- A budget affects everyone in an organisation.
- Preparer and users
- Performance evaluation
- The arguments against involving managers in the preparation of their budgets include:
- Most managers will recognize that a budget will be used as a target against which their performance will be measures. This may tempt them to set an easier target by including some budgetary slack.
- The managers may have little knowledge of budgeting and be unprepared for such a task.
- BEHAVIOURAL CONSEQUENCES OF BUDGETING- CONT…
- The arguments for involving managers in the preparation of their budgets:
- Most managers seek involvement in the planning of their organizations so that they can enhance their sense of belonging to the organization, and this motivate them.
- If managers set their own targets, they can consider the circumstances of their own division and make the target attainable.
- 2 issues:
- Participative budgeting
- Budgetary slack
- Budgets can be used as a performance measure to decide on bonus and promotions - conflicts arise due differences in opinion because of the budgets set.
- This will have consequences on management and employee behavior.
- A sound budgetary system will promote desirable behavior and the right attitude
- BEHAVIOURAL CONSEQUENCES OF BUDGETING- CONT…
1) PARTICIPATIVE BUDGETING - A process where managers who are held accountable for budget performance help to develop their own budget estimates.
- The process of gaining acceptance of the budget involved a lot of negotiation and subsequent revisions of budget estimates.
- Lengthy and time consuming.
TOP DOWN (IMPOSED APPROACH) - Systems where senior managers impose budget targets on more junior manager with little or not consultation.
- Set at corporate level and cascaded down throughout the organisation.
- Advantages:
- Timely and cost effective
- Disadvantages:
- Senior managers may have less knowledge of the local business environment – unrealistic
- Limited involvement in setting budget targets can result in a lack of commitment of middle and junior managers.
BOTTOM UP (PARTICIPATIVE APPROACH) - The participative process in which people at the lower managerial and operational levels play an active role in setting their own budget.
- Budgets:
- collected at the lowest managerial levels and
- consolidated and fed up to senior management
- enhanced accuracy of estimates
- Advantages:
- Encourage coordination and communication between managers
- Greater understanding and appreciation of the objectives and strategy of the wider organisation.
- Disadvantages:
- Expensive
- Time consuming
- Opportunities of padding the budget
2) BUDGETARY SLACK - Padding the Budget - The practice of underestimating revenues or overestimating costs so that budget targets are easier to achieve
- Budgetary Slack – the difference between the revenue or cost projections that a person provides and a realistic estimates of that revenue and cost
- E.g. Annual utilities cost of RM18 000 but estimated RM20 000 – has built RM2 000 slack.
2) BUDGETARY SLACK- CONT.. - Reasons for creating budgetary slack:
- People believe that their performance will look better if they can “beat the budget”
- Budget is used to cope with uncertainty
- If nothing goes wrong, supervisor can beat the budget
- If unfortunate event occur, budgetary slack will absorb
- Managers are competing for limited resources – common for their initial budget requests to be cut by their manager or the budget review committee
- Budgetary projections are padded because they are likely to be cut, and they are cut because they are likely to be padded.
2) BUDGETARY SLACK- CONT.. - How to solve?
- Avoid relying on the budget as a negative evaluation tool.
- Allow some discretion to exceed the budgeted costs when necessary
- Managers can give incentives not only to achieve budgetary projections but also to provide accurate budget estimates.
MOTIVATION & ETHICAL ISSUES OF BUDGETING - Motivation is the drive in the employees’ attitude needed to expedite operations based on budget.
- Ethical issues involve honesty and trust of the employees when exercising their responsibilities to execute those operations based on budgets.
- Any action which goes against this will cause dysfunctional behaviour and upsets plans and implementation.
- Dysfuntional behaviour – employees who does not carry out duties morally as expected
LIMITATION OF BUDGETING BEYOND BUDGETING (BB) - “A set of guiding principles that, if followed, will enable an organization to manage its performance and decentralize its decision making process without the need for traditional budgets. Its purpose is to enable the organization to meet the success factors of the information economy (e.g. being adaptive in unpredictable conditions).”
- Beyond budgeting, p.212
- Not only a new approach to budgeting, resource allocation and operational planning, but also a more holistic approach in strategy and corporate performance management to overcome criticisms to traditional budgeting
- Prevent rapid response
- Detailed and expensive
- Out-of-date within a few months
- Enforce control and command
- Encourage unethical behaviour
- Empowered and adaptive organisation
IMPORTANCE OF BB - Response rapidly to threats and opportunities
- Attracts and keeps the best people
- Enable and encourages continuous innovation
- Leads to loyal and profitable customers
- Support good governance and ethical behaviur
BEYOND BUDGETING (BB)- CONT… 12 PRINCIPLES OF BB - Values
- Governance
- Transparency
- Teams
- Trust
- Accountability
- Goals
- Rewards
- Planning
- Coordination
- Resources
- Control
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