MANAGEMENT ACCOUNTING

LECTURE 1

BUDGET AND BUDGETARY CONTROL

DAVID ABBAM ADJEI
 Lecture Learning objectives
1. To Define and identify the features of a Budget.
2. To understand the Budgetary control and Budgetary control system
and how to make it effective
3. To list and explain the stages in the Budgeting Process
4. To identify the key Administrative requirements for the Budgeting
process
5. To explain the Objectives or purposes of Budgetary Control system
6. To identify the Types of Budgets and how to prepare functional
budgets and master budgets
7. To explain the Behavioural Implications of Budgets
8. To list and explain the various Criticisms of budget preparation
 Definition And Features Of Budget
What Is A Budget?
A budget is a quantitative expression of a plan of action prepared
in advance of the period to which it relates and an aid to the
coordination and implementation of this plan.

The budget quantifies management’s expectations regarding future

income, cash flows, and financial position.
The Essentials/Features Of Budgets Are:
1. It is a future plan.
2. It is prepared in advance of the period that it relates.
3. It is a written document.
4. It is more of quantitative in nature than qualitative.
5. It is a means to achieve an objective and not an end in itself.
What is Budgetary Control/Budgeting?
This is the process of establishing budgets and comparing the
budgeted figures with the actual performance.
Budgetary control is a system which uses budgets as a means of
planning, coordination and controlling.
Budgetary Control System Involves The Following:
1. Establishment of Objectives
2. Establishment of budgets
3. Comparison of actual performance with budgets
4. Ascertain the causes of deviations
5. Take corrective actions if necessary
Stages In The Budgeting Process
1. Communicating details of the Budget policy.
Many decisions affecting the budget year would have been taken by
management as part of the long-term planning process.
It means that the starting point for every budget is the long-range
plan.
Top management strategies and policies in the long-range plan must
be communicated to those responsible for the preparation of the
current year’s budgets.
2. Determining the limiting factor.
In every organization there is a factor that is capable of restricting
performance for a given period.
This is `Limiting factor`, `Principal Budget factor` or `Key budget
factor`
Any of the following could be a limiting factor:
a. Sales demand,
b. Cash availability,
c. Machine capacity available,
d. Labour hours available,
e. Power (electricity), and
f. Availability of raw materials
3. Preparation of the sales or revenue budget.
This is the sales demand and the selling price estimated for the
budget period. All other budgets are going to depend on the Sales
budget.
This budget is also the most difficult plan to produce, because total
sales revenue depends on the actions of customers.
In addition, sales demand may be influenced by the state of the
economy or the actions of competitors.
4. Initial Preparation Of Various Budgets.
The managers who are responsible for meeting the budgeted
performance should prepare the budget for those areas for which
they are responsible.
The preparation of the budget should be a ‘bottom-up’ process. This
means that the budget should originate at the lowest levels of
management and be refined and coordinated at higher levels.
5. Negotiations of Budgets.
At this stage all units, sections and departments of the firm will
justify the estimates for inclusion in the budget to their superiors.
Budgets normally originates from the lower level of management
to the top level.
As the budgets go up, they must be justified by the person or
department submitting them.
6. Coordination and review of budgets
As the individual budgets move up the organizational hierarchy in
the negotiation process, they must be examined in relation to each
other.
This examination may indicate that some budgets are out of balance
with other budgets and need modifying so that they will be
compatible with other conditions, constraints and plans that are
beyond a manager’s knowledge or control
7. Final acceptance of budgets
When all the budgets are in harmony with each other, they are
summarized into a master budget consisting of a budgeted profit
and loss account, a balance sheet and a cash flow statement.
After the master budget has been approved, the budgets are then
passed down through the organization to the appropriate
responsibility centers.
The approval of the master budget is the authority for the manager
of each responsibility center to carry out the plans contained in each
budget.
8. Ongoing review of budgets
The budget process should not stop when the budgets have been
agreed.
Periodically, the actual results should be compared with the
budgeted results.
This will enable management to identify the items that are not
preceding according plan and to investigate the reasons for the
differences.
The Administration Of The Budgeting Process
The following issues must be established for the proper
administration of the budget:
1. The Budget Period
2. The Budget Committee
3. The Budget Officer
4. The Budget Manual
The Budget Period
1. The Budget Period
This is the period for which a budget is prepared and used, which
may then be subdivided into control periods.
The Control periods are the regular intervals for which monitoring
and evaluation are to be done on the budgets.
The length of the budget period will depend on various factors
such as:
1. The nature of the business
2. The part of the business being budgeted for
3. The basis of control
4. The type of budget being prepared
5. The resources required to prepare the budget.
 The Budget Committee
The coordination and administration of budgets is usually the
responsibility of a budget committee.
The membership of the budget committee varies according to the
size
of the organization and the nature of the business.
It normally includes:
1. Executive management/Managing Director
2. Senior Budget Holders/Functional Heads.
3. Budget Officer/accounting staff whose task it is to integrate the
budgets
The budget committee performs the following functions/roles:
1. It recommends the general guidelines that the organization
should follow in preparing budgets
2. It coordinates the separate budgets
3. It submits the final budget to the Board of Directors for approval.
4. It ensures the successful implementation of the budget
programme.
5. It examines comparisons of budgeted and actual results and
recommends corrective action
6. Issuing of the budget manual
7. Provision of information to assist in the preparation of budgets
The Budget Officer
The following are the functions of the budget officer:
The budget committee normally appoints a budget officer. The
budget officer is the secretary to the budget committee.
1. To disseminate instructions about the preparation of the budget
2. To provide to those responsible for preparing the budgets
whatever information is available to help them in producing the
eventual budgets
3. To set deadlines for the submission of the various components of
the budget
4. To collate the budgets and produce draft master budgets
The Budget Manual
This is a document that sets out instructions on the responsibilities
and procedures of budget preparation.
The budget manual normally includes the following information:
1. The objectives and description of the budgeting process
2. The definition of responsibilities and the authority of the
participants in the budgeting process.
3. Procedures to be followed together with specimen forms and
statements to be completed.
4. If budgeting is done with spreadsheets, layouts and
computations may be pre-programmed, requiring only the
entry of the figures.
5. It may include a flow diagram showing how individual
budgets are interlinked and specify deadlines by which first
drafts must be prepared.
6. A time table for the preparation of the budget statements
showing the stages in the preparation of the master budget and
the deadlines for the completion of the various stages.
Objectives/Purposes Of Budgeting Or Budgetary Control
1. Ensure the achievement of the organisation's objectives
Objectives are set for the organisation as a whole, and for
individual departments and operations within the organisation.
Quantified expressions of these objectives are then drawn up as
targets to be achieved within the timescale of the budget plan.
2. Compel Planning
This is probably the most important feature of a budgetary planning
and control system.
Planning forces management to look ahead, to set out detailed
plans for achieving the targets for each department, operation and
(ideally) each manager and to anticipate problems.
It thus prevents management from relying on ad hoc or
uncoordinated planning which may be detrimental to the
performance of the organisation.
3. Communicate ideas and plans
A formal system is necessary to ensure that each person affected by
the plans is aware of what he or she is supposed to be doing.
Communication might be one-way, with managers giving orders to
subordinates, or there might be a two-way dialogue and exchange
of ideas.
4. Coordinate activities
The activities of different departments or sub-units of the
organisation need to be coordinated to ensure maximum integration
of effort towards common goals.
This concept of coordination implies, for example, that the
purchasing department should base its budget on production
requirements and that the production budget should in turn be based
on sales expectations.
5. Provide a framework for responsibility accounting
Budgetary planning and control systems require that managers of
budget centres are made responsible for the achievement of budget
targets for the operations under their personal control.
6. Establish a system of control
A budget is a yardstick against which actual performance is
measured and assessed.
Control over actual performance is provided by the comparisons of
actual results against the budget plan. Departures from budget can
then be investigated and the reasons for the departures can be
divided into controllable and uncontrollable factors.
7. Motivate employees to improve their performance
The interest and commitment of employees can be retained via a
system of feedback of actual results, which lets them know how
well or badly they are performing.
The identification of controllable reasons for departures from budget
with managers responsible provides an incentive for improving
future performance.
Budgetary Control And Decision Making
A strong system of budgetary control provides an invaluable source of
information that can be used to aid management in making decisions
surrounding the future direction of the business.
The various areas of decision making are:
1. Availability of funds. A key source of information that budgets and
budgetary control provide to decision makers relates to the amount of
funds that are available to an organisation in total and where these funds
are to be used.
2. Project costing and management. Budgetary control system helps
decision makers to determine what projects it would be feasible for the
organisation to take on, and can also highlight areas where spending
could be reduced in order to be redeployed somewhere else.
3. Operational control and continuity. Budgetary control is important
for ensuring resources are focused on the key areas required for the
continuation of business operations. Funds are allocated where they
are needed.
4. Variance Analyses. Analyses of actual income and expenditures
against budgets on a regular basis can help to identify issues early.
Understanding the reasons for variances early is highly beneficial
to decision makers as it allows for remedial action to be taken.
5. Cash flow and funding. A good system of budgetary control will
provide decision makers with a much stronger understanding of the
cash flow situation of the organisation, which in turn inform
decision as to the best way to fund both current and future projects.
Approaches To Budget Preparation
Setting up a budget can be challenging, and so is choosing the right
budgeting method that best fits the business’ model and needs.
There are five common types of budgets that companies use:
1. Incremental Budgeting,
2. Zero-based budgeting,
3. Activity-based budgeting,
4. Rolling Budgets, and
5. Fixed and Flexible Budgeting.
Incremental Budgeting
It bases the budget on the current year’s result plus an extra amount
for estimated growth and/or inflation next year.
Incremental budgeting is a reasonable procedure if current
operations are as effective, efficient and economical as they can be.
It is also appropriate for budgeting for costs such as staff salaries,
which may be estimated on the basis of current salaries plus an
increment for inflation and are hence administratively fairly easy to
prepare.
Benefits of incremental budgeting
1. It is easy to prepare and is therefore quick. Since it is easy to
prepare, it is also easily allocated to more junior members of
staff
2. It is easy to understand.
3. Less preparation time leads to lower preparation costs
4. Prevents conflict between departmental managers since a
consistent approach is adopted throughout the organisation
5. The impact of change can be seen quickly
6. Line items can easily be monitored and controlled
Drawbacks of incremental budgeting
1. It assumes that all current activities and costs are still needed,
without examining them in detail
2. With incremental budgeting, the Spending Officer does not have to
justify the existing costs at all.
3. There is no incentive for departmental managers to try and reduce
costs and in fact, they may end up spending money just for the sake
of it, knowing that if they don't spend it this year they won't be
allocated the cash next year, since they will be deemed not to need it.
4. Performance targets are often unchallenging, since they are largely
based on past performance with some kind of token increase
5. Budgetary slack. This can take one of two forms: It can either be
underestimating the amount of income that will come in over a
given amount of time, or overestimating the expenses that are to be
paid out over the same time period.
6. Traditional budgets emphasis financial performance instead of
pursuing corporate strategy.
7. Cannot deal with a fast-changing environment, and are often out of
date before the start of the budget period;
8. Encourage incremental thinking by employing a ‘last year plus x
per cent’ approach to planning. This can inhibit the development of
‘break-out’ strategies that may be necessary in a fast-changing
environment;
Zero Base Budgeting
Introductory ideas and principles behind ZBB
1. ZBB involves the preparation of operating budgets on the
assumption that the organization is starting out afresh in the new
planning period.
2. ZBB is based on the idea that cost should not be added to budget
just because they were there in the previous budget.
3. According to ZBB, uncritical acceptance of past strategies,
policies, procedures is hostile to growth.
4. ZBB says it is not the expenditure that should justify the output.
It should be the output that must justify the expenditure.
5. The principle behind ZBB is that the budget for each cost centre
should be made from scratch or zero. Every item of expenditure
must be justified in its entirety in order to be included in the next
year’s budget.
Implementation Of ZBB
The following stages are used
a. Developing Decision Packages
A decision package is a document, which identifies a distinct or
separate activity, function or operation in a conclusive manner for
management evaluation and comparison with other activities.
The decision packages are developed by the Decision units headed by
divisional Managers.
A Decision Unit represent separate program or groups of activities
that an organisation Undertakes.
A decision package as a document contains:
1. A description of the activity
2. A statement of the targets or objectives of the activity
3. Alternative methods and cost of achieving the objectives
4. Establish the performance measures of the various activities
5. The consequences of not undertaking the activities
There are two types of decision packages
a. Mutually exclusive decision packages.
This contains alternative methods of getting the same job done. The
best option among the packages must be selected by comparing costs
and benefits and the other packages are then discarded.
b. Incremental packages
Incremental packages divide one aspect of an activity into different
levels of effort. The 'base' package will describe the minimum
amount of work that must be done to carry out the activity and the
other packages describe what additional work could be done, at what
cost and for what benefits.
b. Ranking The Decision Packages
Evaluate and rank each activity (decision package) on the basis of
its benefit to the organisation.
This can be a lengthy process. Minimum work requirements (those
that are essential to get a job done) will be given high priority and
so too will work which meets legal obligations.
Existing practices and expenditures must be challenged and
searching questions asked:
1. Are these activities really necessary?
2. Can some of these activities be combined?
3. Can these activities be performed in a different way?
4. Can an activity be discontinued?
5. What is the minimum required level for each activity?
6. What is the best way of providing the function?
c. Resource Allocation
Allocate resources in the budget according to the funds available
and the evaluation and ranking of the competing packages. For
example, a car manufacturer may choose to allocate significantly
more funds to production processes than service and admin
functions, based on the ranking of each activity in step 2.
Advantages Of ZBB
1. It is possible to identify and remove inefficient or obsolete operations
2. It adds a psychological impetus to employees to avoid wasteful
expenditure
3. It obliges a company to look very closely into costs behaviour patterns.
4. It focuses on value for money.
5. Allocation of resources linked to results and needs. This leads to better
allocation of resources.
6. It develops a questioning attitude to everything done in the company.
7. There is increased staff involvement and motivation
8. It responds to changes in the environment
Disadvantages Of ZBB
1. Requires monstrous initial investment in time and cost
2. Comparing small increments is difficult and results in subjective
and arbitrary decisions being taken
3. Short term benefits may be emphasized to the detriment of long
term planning
4. It encourages the false idea that all decisions have to be made in the
budget
5. It calls for management skills in decision analysis which may be
lacking in the organisation
6. Intangible transactions may be ignored because it will be difficult to
justify
8. The ranking process can be difficult. Managers face three
common problems.
i. A large number of packages may have to be ranked.
ii. It can be difficult to rank packages which appear to be
equally vital, for legal or operational reasons.
iii. It is difficult to rank activities which have qualitative rather
than quantitative benefits – such as spending on staff
welfare and working conditions.
Activity Based Budgeting
Activity based budgeting involves defining the activities that underlie
the financial figures in each function and using the level of activity to
decide how much resource should be allocated, how well it is being
managed and to explain variances from budget.
ABB is therefore based on the following principles.
1. It is activities which drive costs and the aim is to control the causes
(drivers) of costs rather than the costs themselves, with the result
that in the long term, costs will be better managed and better
understood.
2. Not all activities are value adding and so activities must be
examined and split up according to their ability to add value.
3. Most departmental activities are driven by demands and
decisions beyond the immediate control of the manager
responsible for the department's budget.
4. Traditional financial measures of performance are unable to
fulfil the objective of continuous improvement. Additional
measures which focus on drivers of costs, the quality of activities
undertaken, the responsiveness to change and so on are needed.
Benefits of ABB
1.Different activity levels will provide a foundation for the 'base' package
and incremental packages of ZBB.
2.It will ensure that the organisation's overall strategy and any actual or
likely changes in that strategy will be taken into account, because it
attempts to manage the business as the sum of its interrelated parts.
3.Critical success factors will be identified and performance measures
devised to monitor progress towards them.
4.Because concentration is focused on the whole of an activity, not just its
separate parts, there is more likelihood of getting it right first time.
ROLLING BUDGETS
Rolling budgets are budgets which are continuously updated by
adding a further period (say a month or a quarter) and deducting the
earliest period. 
Instead of preparing a periodic budget annually for the full budget
period, there would be budgets every one, two, three or four months
(three to six, or even twelve budgets each year).
Each of these budgets would plan for the next twelve months so that
the current budget is extended by an extra period as the current
period ends: hence the name rolling budgets.
Advantages of rolling budgets
1.They reduce the element of uncertainty in budgeting because they
concentrate detailed planning and control on short-term prospects
where there is certainty.
2.They force managers to reassess the budget regularly, and to
produce budgets which are up to date in the light of current events
and expectations.
3.Planning and control will be based on a recent plan which is likely
to be far more realistic than a fixed annual budget made many
months ago
4.Realistic budgets are likely to have a better motivational influence
on managers.
Disadvantages of rolling budgets
1.They involve more time, effort and money in budget preparation.
2.Frequent budgeting might have an off-putting effect on managers
who doubt the value of preparing one budget after another at
regular intervals
3.Revisions to the budget might involve revisions to standard costs
too, which in turn would involve revisions to stock valuations.
This could replace a large administrative effort from the accounts
department every time a rolling budget is prepared.
BEHAVIOURAL ASPECTS OF BUDGETING
The effectiveness of budgeting and budgetary control depends largely
on the behaviour and attitudes of managers and employees.
Budgets provide performance targets for individual managers. If
managers are rewarded for achieving or exceeding their target, budgets
could provide them with an incentive and motivation to perform well.
It has also been suggested that budgets can motivate individuals if they
are able to participate in the planning process. By identifying with the
targets, they might have a powerful motivation to succeed in achieving
them.
When budgeting helps to create motivation in individuals, the human
aspect of budgeting is positive and good for the organisation.
Unfortunately, in practice human behaviour in the budgeting process
often has a negative effect. There are several possible reasons why
behavioural factors can be harmful:
1. Misunderstanding and worries about cost-cutting
2. Opposition to unfair targets set by senior management
3. Blame Cultures
4. Sub-optimisation
5. Budget slack or budget bias
1. Misunderstanding and worries about cost-cutting.
Budgeting is often considered by the managers affected to be an
excuse for cutting back on expenditure and finding ways to reduce
costs. Individuals often resent having to reduce their spending, and so
have a hostile attitude to the entire budgeting process.
2. Opposition to unfair targets set by senior management.
When senior managers use the budgeting process to set unrealistic and
unfair targets for the year, their subordinates may unite in opposition
to what the senior managers are trying to achieve. Ideally budgets
might be set with realistic targets that provide for some improvements
in performance.
A distinction can be made between:
Aspirational budgets, which are budgets based on performance levels
and targets that senior managers would like to achieve, and
Expectational budgets, which are budgets based on performance levels
and targets that senior managers would realistically expect to achieve.
3. Blame Cultures.
Performance of operational managers may be measured by comparing
actual performance with the budget. The manager might be rewarded
for achieving budget targets but criticised for failing to meet the budget.
This tendency to blame managers for failing to meet the budget targets
will have an adverse effect on the motivation and attitude of the
operational managers in the following circumstances:
a. The budget might not make any distinction between costs that are
controllable and costs outside the managers control. The manager
may be criticised for excess spending on items over which he has no
control.
b. Circumstances might change and events might occur that make the
original budget realistic, yet the Manage may be criticised.
4. Sub-optimisation
There may be a risk that the planning targets for individual managers are
not in the best interests of the organisation as a whole. For example, a
production manager might try to budget for production targets that fully
utilise production capacity. However, working at full capacity is not in
the best interests of the company as a whole if sales demand is lower. It
would result in a build-up of unwanted finished goods inventories.
5. Budget Slack (Budget Bias).
Budget slack has been defined as ‘the intentional overestimation of
expenses and/or underestimation of revenue in the budgeting
process’. Managers who prepare budgets may try to overestimate
costs so that it will be much easier to keep actual spending within
the budget limit. Similarly, managers may try to underestimate
revenue in their budget so that it will be easier for them to achieve
their budget revenue targets. As a result of slack, budget targets are
lower than they should be.
Other Behavioural Implications Of Budgeting
Human behaviour may also be seen in the following areas:
1. The effect of budget levels on performance
2. Budget and staff motivation.
3. Staff participation in the budgeting process
4. Management use of budget information
A. Budget Levels on Performance
How difficult should a target be? It has been argued that as the level
of budget targets or difficulty is increased both the budgeteer's
aspirations and performance increases.
However, there becomes a point where the budget is perceived as
impossible to achieve, the aspiration level and performance decline
dramatically.
Clearly defined targets can improve motivation and thus produce
better performance than if no targets exist.
B. Budgets and motivation
There must be a goal congruence between the individuals and the
organisation
Therefore, motivation here is the need to achieve a selected targets or
objective and the resulting drive and determination that influence
actions directed towards the selected target.
Budget can produce motivational effects and sometimes it can also
produce undesirable negative reactions.
There are poor attitudes of managers at the Budget planning
stage. This may include:
1. May build in slack and bias
2. Complain of lack of time for budgeting
3. Complain that a formal budget is restrictive
4.They may set budgets for their budget centre and not coordinate
their own plans with those of other budget centres.
5.They may base future plans on past results, instead of using the
opportunity for formalized planning to look at alternative
options and new ideas.
There are also poor attitude of managers at the Budget
implementation. Such attitude may include:
1. They may put in enough effort and nothing more
2. They may complain that formal budget may encourage rigidity
and discourage flexibility
3. They may complain that short term plans may draw attention
away from long term plans
4. There may be minimal cooperation and communication
between managers
5. They may seek to blame the budgeting systems for any
problems
There are also poor attitude in the use of budget as a control
information. Such attitudes may include:
1. They may not prepare control reports at all
2. Managers may resent control information. May see it as trying to
find fault
3. Managers may not understand the control report
4. Managers may have false sense of what the objectives of the firm
should be
5. If there are flaws in the systems of recording, managers may
dismiss control information as unreliable
6. Control information may be recorded weeks after the action and
managers may regard them not useful
C. Participation in Budgeting
A budget can be prepared or set from:
1. Top-down (imposed budget)
2. Bottom-up (participatory budget)
3. Negotiated Budget
Whatever method used depends on:
4. The managers involves
5. The subordinates available
3. The tasks or jobs involves
4. The Business environment
Top-down Style of Budgeting
This involves preparation of budgets by senior managers without
giving the ultimate budget holder an opportunity to participate in
the budgeting process.
The times when imposed budgets are effective are:
1. Newly formed organisations
2. Very small business
3. Period of economic hardships
4. Where operational managers lack the skills to prepare budgets
5. Where there is the need for precise coordination
Advantages of top-down budgeting style
1. Strategic plans are likely to be incorporated into planned
activities
2. They enhance the coordination between the plans and objectives
of divisions
3. They use senior management’s awareness of total resources
availability
4. They decrease the period of the time taken to draw up the budget
5. It gives senior managers better control of the business
6. It reduces the opportunity for operational staff to build slack or
padding into the budgeting process
Disadvantages of top-down budgeting style
1. Imposed targets are likely to make managers feel demotivated
and alienated and result in poor performance
2. Senior management are not involved in the day to day operation
of the business and may not come out with a good budget
3. This budgeting approach will result in the absence of
communication between managers at all levels throughout the
organisation.
Bottom-up budgeting style (Participatory style)
This approach gives all budget holders an opportunity to participate
in setting their budgets. There is some level of involvement of
subordinates within the organisation for setting budgets.
Participative budgets are effective in the ff circumstances:
1. Well-established firms
2. Very large businesses
3. During periods of economic boom and affluence
4. Where operational managers have budgeting skills
5. Where different parts of the organisation act autonomously
Advantages of bottom-up style
1. There is improved communication
2. There is greater understanding of the factors involved in preparing
budgets
3. There is the opportunity to thrash out problems at budget meetings
before the budget is set
4. Increased acceptance of the budget
5. There is improved commitment from the staff in the budget
implementation
6. There is a real likelihood of an improvement in the quality of the
budget because the manager’s expertise is used.
7. This style of budgeting is more realistic
8. Coordination between units are likely to be improved
Disadvantages of bottom-up style
1. The participative process can be very time consuming, thus
delaying the availability of the budget for the forthcoming year.
2. Staff may underestimate the expected revenue in order to make
their final target more achievable.
3. Staff may agree among themselves to include unnecessary
expenditure (budgetary slack) so that it is easier for them to
achieve the cost targets they have set.
4. Staff may spend a great deal of time arguing with each other (and
with the college director) as to how to measure the benefits of a
particular course and how the cost / benefit analysis of each course
should be compared.
5. Staff may be excellent academically but could lack the
knowledge and skills required to formulate their budget and to
work together to form the budget for the college overall.
6. Changes implemented by senior management may cause
dissatisfaction
7. They can support 'empire building' by subordinates
Negotiated Budget
At the two extremes, budgets can be dictated from above or simply emerge
from below but, in practice, different levels of management often agree
budgets by a process of negotiation. In the imposed budget approach,
operational managers will try to negotiate with senior managers the budget
targets which they consider to be unreasonable or unrealistic.
Likewise senior management usually review and revise budgets presented
to them under a participative approach through a process of negotiation with
lower level managers.
Final budgets are therefore most likely to lie between what top
management would really like and what junior managers believe is
feasible.
Criticisms Of Budgeting/Budgetary Control System
In our discussion of the budgetary planning and control process we have
come across many difficulties with budgets and criticisms of how they
are used in organisations.
Some have even advocated that the preparation and use of budgets
should be abandoned totally.
The following general criticisms have been levelled against budget
preparation and use:
1. Budgets are time consuming and expensive. Even with the support
of computer models it is estimated that the budgeting process uses
up to 20 to 30 per cent of senior executives’ and financial managers’
time.
2. Budgets are divorced from strategy. Most organisations monitor the
monthly results against the short term budget for the month. What is needed
instead is a system of monitoring the longer term progress against the
organisation’s strategy.
3. Budgets provide poor value to users. Although surveys have shown that
some managers feel that budgets give them control, a large majority of
financial directors wish to reform the budgetary process because they feel
that finance staff spend too much time on 'lower value added activities’.
4. Budgets fail to focus on shareholder value. Most budgets are set on an
incremental basis as an acceptable target agreed between the manager and the
manager’s superior. Managers may be rewarded for achieving their short
term budgets and will not look to the longer term or take risks, for fear of
affecting their own short term results.
5. Budgets are too rigid and prevent fast response. Although most
organisations do update and revise their budgets at regular
intervals as the budget period proceeds the process is often too
slow compared with the pace at which the external environment is
changing.
6. Budgets protect rather than reduce costs. Once a manager has
an authorised budget he can spend that amount of resource
without further authorisation. A ‘use it or lose it’ mentality often
develops so that managers will incur cost unnecessarily. This
happens especially towards the end of the budget period in the
expectation that managers will not be permitted to carry forward
any unused resource into the budget for next period.
7. Budgets stifle product and strategy innovation. The focus on
achieving the budget discourages managers from taking risks in case
this has adverse effects on their short term performance. Managers do
not have the freedom to respond to changing customer needs in a fast
changing market because the activity they would need to undertake is
not authorised in their budget.
8. Budgets focus on sales targets rather than customer satisfaction.
The achievement of short term sales forecasts becomes the focus of
most organisations. However this does not necessarily result in
customer satisfaction. Alternatively if a manager has already met the
sales target for a particular period they might try to delay sales to the
next period, in order to give themselves a ‘head start’ towards
achieving the target for the next period.
9. Budgets reinforce a dependency culture. The process of
planning and budgeting within a framework devolved from
senior management perpetuates a culture of dependency.
Traditional budgeting systems, operated on a centralised basis,
do not encourage a culture of personal responsibility.
10.Budgets lead to unethical behaviour. For example building
slack into the budget in order to create an easier target for
achievement.