Sunday, 29 March 2015

BUDGETING SUMMARY NOTES



BUDGETING 1

A budget is a quantified plan of action for a forthcoming accounting period.
It is prepared for a specific time period. It is normally expressed in financial terms and prepared for one year.

Aims of budgeting
  1. Planning- look to the future
  2. Control- actual results are compared against the budget and action is taken as appropriate
  3. Communication- forms the basis of reporting by junior and senior managers
  4. Co-ordination- allows the business to co-ordinate all diverse actions towards a common corporate goal
  5. Evaluation- evaluate the financial results and actions of managers within the business
  6. Motivation- rewards should be given for operating within or under budgeted levels of expenditure
  7. Authorisation and delegation.

Performance hierarchy
  1. Strategic planning is long term, looks at the whole organisation and defines resource requirements.
  2. Tactical planning is medium term, looks at the department/divisional level and specifies how to use resources
  3. Operational planning is very short term, very detailed and is mainly concerned with control. Most budgeting activities fall within operational planning to include advertising spend, sales forecasts, inventory policies etc.

Budgets and Performance Management
The budget is the target against which the performance of the budget centre or the manager is measured. The advantages of this approach are that:
  1. Clear target known throughout organisation
  2. Managers are involved in setting the targets make it them more realistic
  3. Budget target can be linked to individual rewards, which may provide motivation to improve performance.

The Disadvantage of the approach
      1.  Managers may work towards specific short-term budget and not long-term organisational goals
  1. Managers may distort results to try to exceed targets and gain rewards.
 Behavioural aspects of budgeting



Budgets and Behaviour
Individuals react to the demands of budgeting and budgetary control in different ways and their behaviour can damage the budgeting process.
  1. Dysfunctional behaviour- individual managers seek to achieve their own objectives at the expense of the objectives of the organisation
  2. Budget slack (or bias)- a deliberate over-estimate of expenditure and / or under-estimation of revenues in the budgeting process i.e. to make life easy, targets are exceeded and bonuses won.
Management Styles (Hopwood)
He described three management styles that can be applied to budgets and performance management.
  1. Budget-constrained style
The performance evaluation is the managers’ success in meeting budget targets in the short term, with no consideration for other aspects of performance that are not targeted in the budget
  1. Profit- conscious style
The performance of a manager is measured in terms of his ability to increase the overall effectives of his area of responsibility, in relation to meeting the longer-term objectives of the organisation
  1. Non- accounting style
Performance evaluation is not based on budgetary information, and accounting information plays a relatively unimportant role. Other, non- accounting performance indicators, such as quality, are as important as the budget targets.

Participation in setting targets
Managers may be involved in setting targets or senior management without consultation may impose these.




Advantages of participation
  1. Increased motivation
  2. Better understanding of an individual managers’ aspiration
  3. Improve co-ordination within units
  4. Specific resource needs are included
  5. Based on information from employees
 Disadvantages of participation
  1. Time consuming
  2. May result in a wide range of targets which are seen as unfair
  3. Managers may understate targets to make them easier to achieve (i.e. incorporate budgetary slack)
  4. Negotiation may become a political process
  5. Unachievable and may cause dissatisfaction
The planning and control cycle
Planning and control occurs at all levels of the performance hierarchy to different degrees.

The planning and control has seven steps.
Step1. Identify objectives
Step2. Identify potential strategies
Step3. Evaluate strategies
Step4. Choose alternative courses of action
Step5. Implement the long-term plan
Step6. Measure actual results and compare with the plan
Step7 Respond in the three main ways:
 i). Take control action
ii). Decide to do nothing
iii). Alter the plan or target if actual results are different from the plan or target.
 Corporate Objective include:

Profitability                                 Customer satisfaction
Market share                             Quality
Growth                                       Industrial relations
Cash flow                                   Added value
Return on capital employed      Earning per share
Risk

Objectives of budgetary systems
  1. Ensure the achievement of the organisations’ objections
  2. Compel planning
  3. Co-ordinate activities –maximum integration
  4. Communicate ideas and plans
  5. Provide a framework for responsibility accounting
  6. Establish a system of control
  7. Motivate employees to improve their performance

Conflicting objectives
The implications of resolution will often be specific to the organisation and will depend on:
  1. The specific purpose for which the budget is to be used
  2. The management style and culture of the organisation
  3. The knowledge and experience of the managers preparing budgets
 Resolution
  1. Preparation of cash based targets
  2. Give managers share options so they focus on shareholder wealth
  3. Negotiation and compromise
  4. Give priority
  5. Ensuring each manager gets a satisfactory result, thought not as much as they want
  6. Use more non-financial indicates that focus on key long term issues such as quality, productivity etc
  7. Link bonuses to longer time periods later than short time
  8. Greater scrutiny of budgets
  9. Better training of managers
Propellerads