The Budgeting Process and the use of Budgetary Information - Free Essay Example

Sample details Pages: 8 Words: 2363 Downloads: 6 Date added: 2017/06/26 Category Economics Essay Level High school Tags: Budget Essay Did you like this example? Planning, Control Budgeting CIMA Official Terminology (2005) defines planning as: The establishment of objectives, and the formulation, evaluation and selection of the policies, strategies, tactics and action required to achieve them. Planning comprises long term/strategic planning and short term/operational planning. The latter is usually for a period of up to one year. It further defines a budget as: A quantitative expression of a plan for a defined period of time. Don’t waste time! Our writers will create an original "The Budgeting Process and the use of Budgetary Information" essay for you Create order It may include planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows. The above 2 definitions make the relationship between planning and budgeting relatively clear. A budget provides a numerical analysis of a plan. Planning can be both long and short term and budgets can cover the same timescales as the plan. However, longer term planning is generally both more aspirational and more uncertain as it requires significant assumptions to be made and this is equally reflected in longer term budgets. CIMA also defined budgetary control as The establishment of budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy, or to provide a basis for its revision.In other words, budgetary control provides a measure by which objectives and assumptions can be verified and amended in order to improve business performance. The validity of the measure will only be appropriate if the budget setting process is appropriate and leads to a realistic budget given factors known at the time of preparation. Gowthorpe (2011 p.359) recognised that budgeting, for most organizations, is an important dimension of the processes of planning, controlling and evaluating outcomes. To summarise, planning is the establishment of objectives, strategies and tactics to meet the desired performance of the business. A budget is a financial translation of the plan. Plans will generally involve improvements to the business either in sales, growth, diversity or other business developments over the planning cycle and as such the budget shows what this will mean for the business after taking account of the costs involved in achieving the performance. Budgetary control allows a business to track its progress against its plan by comparing the budget to the actual finances. Budgets can b e established via a top down or a bottom up approach. Top down budgets are imposed from above by senior management/the board whereas bottom up are participative and involve managers in the budget setting process (Gowthorpe 2011).Further to the overall top down or bottom up approach there are numerous methods for establishing the budget. Gowthorpe (2011) and Siyanbola (2013) both reviewed the variety of approaches to budgeting. These consisted of incremental budgeting, zero based budgeting (ZBB), base budgeting (BB) activity based budgeting (ABB). Many business adopt incremental budgeting which uses the previous budget as the base from which to begin the new budget. This type of approach may be as straightforward as determining an inflationary factor to all cost lines. It tends to be relatively simple and cuts down the time spent on budgeting however, the key disadvantage is that this approach may under or overestimate the required budget. This means that individual department s may be disadvantaged compared to others or if this approach is applied over more than one year, budgets may become misaligned with the real world conditions. It can further lead to inefficiencies being perpetuated year after year. A second method is ZBB. This ignores any previous budgets and starts the process from the very beginning. In this approach each department is required to justify their budget. This is obviously time consuming but can be very useful in raising financial awareness across the business and will tend to mean that inefficiencies are not perpetuated. BB is a method that has 2 phases to it. In phase 1 the business calculates what resources would be needed to keep going and then any additional spend needs to be justified on a cost/benefit basis. This is less time consuming than ZBB but can still lead to problems in both determining what level of resource may be considered just enough and it doesnt account well for volume shifts in revenue or product mix. ABB could also be adopted. This calculates the cost of producing each unit of activity. This type of budgeting tends to lead to better cost focus but it does require a lot of effort to measure and it assumes a linear relationship of costs to activities which may not apply in all cases. Finally there is Kaizen budgeting which assumes anticipated cost improvements in the budget. In reality, all budgets in business today tend to have an element of Kaizen budgeting. Incremental budgeting may have inflationary increases which will often be overlaid with efficiency challenges. A department may find themselves justifying their case for an increase in budget for a new activity using ZBB and will then still be passed an efficiency challenge to achieve. Process for Preparation of an Annual Master Budget The process for preparation will differ depending upon the organisation but will normally incorporate the following: Budget responsibilities à ¢Ã¢â€š ¬Ã¢â‚¬Å" it will be necessary to determine the budget leader in an organisation. This is normally the Financial Controller or Corporate Finance Team but some organisations have a specific budget and planning team who coordinate all the budget activities. Budget timescales à ¢Ã¢â€š ¬Ã¢â‚¬Å" the entire timetable needs to be set out and published to all those people who have input to the budget setting process. The timetable will cover everything from the date that templates are expected to be published through to submission dates, review periods and re submission deadlines. Budget assumptions à ¢Ã¢â€š ¬Ã¢â‚¬Å" all budgets will generally require some key assumptions to be made at an overall company level in relation to items such as inflation, cost of capital, exchange rates if relevant, productive hours growth. Some of these may be assumptions in individual budgets such as sales budgets but it is essential that the master budget process consolidates all the assumptions made. This is to ensure that budgets are aligned across the business. For example, if the sales department budgets for a 10% increase in sales based on assuming excellent marketing of the new product that is being launched in the middle of the year, then it is important that the business understands if marketing have budgeted for the campaign and if production are planning to launch on time and have the relevant production quantities planned. If this is not the case then the budgets are misaligned and potentially unrealistic. Budget instructions / manual à ¢Ã¢â€š ¬Ã¢â‚¬Å" instructions need to be compiled for use alongside any assumptions /pre-set criteria that people need to incorporate. Budget templates à ¢Ã¢â€š ¬Ã¢â‚¬Å" templates need to be designed and prepared. These are often locked spreadsheets with only certain fields being available for entry. Standard templates are critical for consolidation purposes and avoidance of errors in consolidation. Review process (often 2 stages) à ¢Ã¢â€š ¬Ã¢â‚¬Å" this can differ widely across organisations but is often in the form of a submission and first presentation to senior management and/or the FD followed by rework to incorporate requested changes which will then be consolidated into the master budget for presentation to the board of directors. Further to the steps above the annual master budget is compiled by consolidating all the departmental and or functional budgets into one overall budget. Walther (2014) noted that the budget construction process will normally follow the organizational chart. Each component of the entity will be involved in preparing budget information relative to its unit. Depending upon the business this could include, production budgets, sales budgets, overhead department budgets, investment budgets but will also include the cash budget. The order in which the budgets are prepared is important however, as the outputs of each budget will make the inputs for the next budget. Below is a simple graphical representation of the order of completion of a master budget. Potential Behavioural Issues Arising from the Budgeting Process and the use of Budgetary Information Bruns (1975 p.178) stated that budgets are potential means of influencing behaviour and that control is the successful exercise of power to influence, hence there are many potential behavioural problems that can emerge from the budgeting process. There has been significant research exploring the effects of type of approach on the behaviours. Merchant (1981) studied how the size, diversity and degree of decentralisation affected the choice of approach which in turn affected the behaviours. Banks and Giliberti (2008) considered that top down budgets generally have less ownership within a business since those responsible for delivering have had little or no say in the setting process and as such may be more difficult to deliver. This will depend on how challenging the budget is of course. Conversely bottom up budgets tend to have more buy in from managers but this still doesnt necessarily mean they will be achieved and nor does it necessarily mean the budget is more accurate. Furth ermore, budgets that engage the management in their development may still not have ownership if managers dont believe that the engagement is genuine. If the budget being set is deemed to be unachievable by those expected to deliver it, then this can become demotivating. Setting a stretch target can be motivating for people but too much stretch and they will feel as though it is not worth any effort as they cannot achieve it even if they try. Budget owners may try to build in budgetary slack in order to make it more likely they can achieve or outperform their budget. No matter the environment, it can be very difficult to avoid budgetary slack being built into the numbers as it can be very difficult to assess or prove the level of slack built in by an astute manager. Camman (1976) and Merchant (1985) found that a managers propensity to create slack is affected by the system adopted but that this propensity is generally lower in a more participative approach whereas Antle and Epp en (1985) and Lukka (1988) argued that high participation created slack. However, Onsi (1973) suggested that slack was not necessarily always a bad thing. It could provide funds to be able to undertake valuable activities that would not necessarily be approved by stakeholders if more transparent due to requirements for returns from the business. He also found that slack was more likely in successful firms in good markets thereby making it possible to achieve efficiencies and continue to meet expectations of shareholders in more difficult times. If incremental budgeting is used in a business, managers may either deliberately spend up to their budgets or in some cases overspend so they can get a bigger base to start from the following year. Clearly this is not necessarily optimising for a business and this is where good budgetary control can help. Analysis of variances should be against budget at the lowest level practicable so that it is clear whether the result is due to accur ate budgeting or other factors that were not budgeted originally. The temptation to spend up to budget will almost certainly happen if an organisation adopts a use it or lose it approach to budgeting. In todays world, there is increasing pressure in many businesses to drive down costs as a result of decreasing margins. As such, if a budget has not been used, it can be tempting to assume it is not needed and as such reduce the following years start baseline. If the manager has made a great effort to gain efficiencies during the year, then this does not necessarily feel like a suitable reward as it is simply likely to make it harder to achieve the following year. If the efficiencies are sustainable then this may be realistic but if they were one-off opportunities that the manager took advantage off, then they will not necessarily be repeatable. The budget setting process must include a certain amount of flexibility or the budget is likely to be either unrepresentative of the actual picture or it may cause inflexibility within the business in its ability to react apropriately to short term events and changes. Sudden market changes could lead to a need to increase production of one product at the expense of another and it may be that the margin on the increased product is not as profitable. However, the process must allow for a view of the bigger picture. It may well be that the margin per product is lower but the market change means that far more product can be sold thereby increasing profits overall. The budget process should not stop the right decision being made. The above discussion highlights the importance of a company adopting a genuine and appropriate approach to their budget setting process as it is a time-consuming and as such an expensive exercise. It would be a shame if this time consuming and expensive exercise simply produced a document that no one felt ownership for and that was in reality neither achievable for the business nor representativ e of the best outcome that could actually be achieved. References Antle, R. Eppen, G. D., 1985. Capital Rationing Organizational Slack in Capital Budgeting. Management Science, 31(2), pp. 163-174. Banks, A. Giliberti, J., 2008. Behavioural Aspects of Budgeting. In: McGraw-Hill, ed. Budgeting. s.l.:McGraw-Hill, pp. 217-215. Bruns, W. J. Waterhouse, J. H., 1975. Budgetary Control Organization Structure. Journal of Accounting Research, 13(2), pp. 177-203. Cammann, C., 1976. Effects of the use of Control Systems. Accounting, Organizations Society, 1(4), pp. 301-313. CIMA, 2005. CIMA Official Terminology. 2nd ed. Oxford: CIMA Publishing. Gowthorpe, C., 2011. Business Accounting Finance. Third ed. Andover: Brendan George. Lukka, K., 1988. Budgetary Biasing in Organizations. Accounting, Organizations Society, 13(3), pp. 281-301. Merchant, K. A., 1981. The Design of the Corporate Budgeting System: Influences on Managerial Behaviour and Performance. Accounting Review, 56(4), pp. 813-829. Merchant, K. A., 1985. Budgeting the Propensity to create Budgetary Slack. Accounting, Organizations Society, 10(2), pp. 201-210. Onsi, M., 1973. Factor Analysis of Behavioural Variables Affecting Budgetary Slack. Accounting Review, 48(3), pp. 535-548. Siyanbola, T. T., 2013. The Impact Of Budgeting And Budgetary Control On The Performance of Manufacturing Company in Nigeria. Journal of Business Management Social Sciences Research (JBMSSR) , 2(12), pp. 8-16. Walther, D. L., 2014. Chapter Twenty-One: Budgeting: Planning for Success. Available at: https://www.principlesofaccounting.com/chapter21/chapter21.html