Ac211 Module 2 Planning And Control (Course Notes) Notes

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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