Chapter 08 (Cont.) - Budgetary system

  1. Incremental budget

A method of budgeting which next year budget is prepared by using current year's actual result as a starting point

Advantages:

  • Quickest and easiest budgeting method
  • Suitable for business in stable environment

Disadvantages:

  • Build in previous problems and inefficiencies
  • Managers may spend all their allowances
  • Uneconomic activities may be continue
  1. Fixed and Flex Budget

Fixed budget:

  • Prepare on the estimation of production and sale
  • Budget is not revised to new level of activities

Flex budget:

  • Can be adjusted based on the actual results
  • Retrospectively
  1. Zero based budgeting

Implementing ZBB: 1. Define decision packages (items and activities about which a decision will be made). Two types of decision package: Mutually exclusive packages (Alternative methods of getting the same job done) and Incremental packages (start with minimum and then add up) 2. Evaluate and rank each activity 3. Allocate resources

Involves preparing a budget for a cost center from a zero base

Advantages:

  • Remove inefficient or obsolete operations
  • Avoid wasteful expenditure
  • Increase motivation of staff
  • Respond to changes
  • Provides in-depth assessment of a business operation
  • Challenges the status quo
  • More efficient allocation of resources

Disadvantages:

  • Enormous extra volume of paperwork
  • Short-term benefits may be emphasized more than long-term
  • All decisions have to be made in the budget
  • Call for management skills, and managers have to be trained for ZBB
  • Org's info system may not be capable to provide suitable info
  • Ranking process may be difficult

Using ZBB in practice:

  • Not suitable for direct manufacturing costs
  • Best applied to support expenses (eg. marketing, finance, accounting, sales, distribution, etc.)
  • Can be applied to non-profit organizations and service industries
  1. Activities Based Budgeting

Involves defining the activities that underlie financial figures to decide the allocation of resources

Principles of ABB:

  • Activities which drives costs -> Aim is to plan and control the causes of costs
  • Not all activities add value
  • Decisions beyond immediate control
  • Traditional methods unable to continuous ỉmprovement
  1. Beyond Budgeting
  1. Rolling budget: is a budget that continuously updated by adding a further accounting period to the end of the budget when the corresponding budget period ends.

Criticism:

  • Budgets are time-consuming and expensive
  • Budgets provides poor value to users
  • Budgets fail to focus on shareholder's value
  • Budgets are too rigid and prevent fast response
  • Budgets protect than reduce costs
  • Budg-ets prevent product and innovation
  • Budget focus on sales rather than customer satisfaction
  • Budgets are divorced from strategy
  • Budgets reinforce a dependency culture
  • Budgets leads to unethical behavior (eg. slack)

Concepts

Use adaptive process for making decision rather than tie decision making to conformity with rigid budget

Move towards devolved networks rather than centralized hierarchy