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Ac211 Module 2 Planning And Control (Course Notes) Notes

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Lecture 1: Budgeting 08 November 2010

Topics

* Budgets

* Responsibility Accounting

* Biased Budgets

Reading

Key Points

* 4 roles of budgets

* Budgets

* Responsibility accounting

Budgets Roles of budgets: a. Communication and coordination b. Motivation c. Strategic planning d. Performance measurement Types of budgets:
* Master Budget: Provides financial-projected framework for other budgets in the organisation
* Operating Budgets (Revenue Budgets): Predict income and costs
* Capital Budgets: Used for planning investments to aid financing decisions
* Activity-Based Budgeting: Cost of activities that make up a project What are budgets?
* Budgets set out amounts of resources and outputs that are expected to be consumed and produced
* Targets to be achieved
* Key component of the organization's planning and control system
* In planning decisions, budgets communicate specialized knowledge from one part of the organization to another
* For control, budgets serve as benchmarks for performance measurement systems
* Require a trade-off between the two
* It is an informal set of contracts between the different units of the organization
* They encourage a 'bottom-up' flow of information
* i.e. head office requesting budgeting information from departments
* Participative budgeting = A bottom-up budget process, in which the person ultimately held responsible for meeting the target makes the initial budget forecast
* Enhances motivation for lower-level workers to accept the targets
* Used more frequently when lower-level managers had specialized knowledge
* Budgets also play an important role in control
* Used to assign responsibilities by allocating resources to different managers
* Some experts argue that the budget should be 'tight' but achievable
* Sometimes annual budgets do not provide meaningful goals because of a fast-changing industry
* In such a case, rolling forecasts can be used to update the budget each month etc.
* e.g. Avon Automotive (a global automotive component designer and manufacturer) How do responsibilities relate to budgets?
* They set out areas of responsibility
* i.e. what and how much of a resource to use to achieve a set result How do budgets affect the behaviour of managers?
* Would setting demanding performance targets push managers to perform better?
* Managers often spend up to 20 per cent of their time on budgeting Questions to ask when budgeting
* How achievable are the cost/revenue figures?
* What are the implications of not achieving the goals?
* What are the implications of achieving the goals?
How do budgets relate to goals?
* Budgets tell managers what goals are expected to be achieved
* They don't say how to achieve them
* Translates organizational goals into financial terms

Conflict between planning and control
* Conflict between planning decisions and control is particularly severe in marketing
* To manage conflict, many organizations put the CEO in charge of the budgeting process
* Signals the important of the budgeting process
* Resolving disagreements among departments requires making trade-offs and the CEO, who has an overall view of the entire firm, is best able to make these trade-offs
* Firms also use budget committees Responsibility Accounting Responsibility Accounting
* Responsibility Accounting = comparing budgets to actual results to account for how well managers perform
* Identifies different responsibility centres through the type of data compiled in the budget:
* Cost centre
* Revenue centre
* Profit centre
* Investment centre Controllability of Costs
* Responsibility accounting traces costs to activities that caused the cost
* This implies that costs are controllable because this relates the cost to the people most knowledgeable about the cost
* Responsibility for costs tends to cut across domains and across time
* Responsibility accounting is aimed at tracing costs
* Controllability cannot always be achieved on time or allocated unambiguously
* The person made responsible for the costs may not control them
* They do however have the best knowledge of how they were accrued
* Cross-Domain Responsibility: Sometimes one department may control the costs of another department by enforcing that a sale goes through for example Departments can charge the accounts of the department responsible for executing the cost

Course Notes Page 1

* Cross-domain responsibility

* Biased budgets

* Budgetary slack Definitions

* Activity-Based Budgeting: Cost of activities that make up a project

* Budgetary Slack = The intentional underestimation of revenues and productive capabilities and/or overestimation of costs and resources required to complete a budgeted task

* Capital Budgets: Used for planning investments to aid financing decisions

* Cross-Domain Responsibility: Sometimes one department may control the costs of another department by enforcing that a sale goes through for example

* Master Budget: Provides financial-projected framework for other budgets in the organisation

* Operating Budgets (Revenue Budgets): Predict income and costs

* Responsibility Accounting = comparing budgets to actual results to account for how well managers perform

* Departments can charge the accounts of the department responsible for executing the cost General Practices of Responsibility Accounting
* The person responsible are asked by responsibility accounting to be sources of expert information
? Questions that may be asked include:
* Why are budgeted revenues lower or higher than actual ones?
* What factors affect costs?
* This information is collected and will affect future budgets Biased Budgets Biased Budgets
* Budgetary Slack = The intentional underestimation of revenues and productive capabilities and/or overestimation of costs and resources required to complete a budgeted task
* Dunk and Nouri (1998) said that subordinates may use budgetary slack to "ease their work or obtain personal rents" What are the reasons for biased budgets?
* The more bonuses and promotion rely on the budget, the more incentive there is to introduce bias
* Participation is an opportunity to manipulate the budget
* There are informational advantages associated with biased budgets (subordinates know more than managers)
* Because of uncertainty about information, there is more place for interpretation
* Biased budgets may be functional for the organisation:
* The slack can serve as a buffer
* Can help to improve managerial performance when budgets are significant and there is uncertainty
* Isolates risk-averse subordinates from excessive risk
* Increases job satisfaction by protecting from the consequences of budget targets

How do organisations create budgetary slack?
* Labelling a cost as variable when it is only semi variable
* They may include a fixed element What are the benefits of budgetary slack?
* May help to put budgets in perspective
* Reduce budget emphasis and allow subordinates to allocate attention to goals other than meeting the budget
* i.e. quality or customer service
* May help to allocate resources more efficiently

Course Notes Page 2

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