Please enable JavaScript.
Coggle requires JavaScript to display documents.
Chapter 16 introduction to budgeting, Disadvantages of ZBB - Coggle Diagram
Chapter 16 introduction to budgeting
CIMA`S official terminology of management accounting divides a budget as a quantitative statement for a defined period of time which may include planned revenues, asset, liabilities, and cash flows. A budget provides a focus for the organization, aids the co-ordination of activities and facilities control
Form a budget committee
The committee will be composed of senior executives representing the major segments of the business. This committee will be responsible for
Setting and approving overall budget objectives
Directing and coordinating budgeted preparation
Arbitrating conflicts and differences
Approving the final budget
Monitoring operational activity and reviewing operating results
Approving revisions to the budget
Establish A budgeted administration system
In addition to the budget committee, a budget officer will be appointed to coordinate individual department budgets to ensure consistency. The budget officer will prepare a budget manual which acts as a preference point for the budgeting process. This manual will detail the procedure to be followed on a timetable for completion
Set the budget period
A budget is set for a particular period of time usually one year broken down by quarters or months, it is quite common for businesses to prepare continuous budgets
Set budget guidelines
The budget committee provides initial guidelines which settled the adjective of budget and provided framework for its preparation. The guidelines consider general economic and market expectations, strategic objectives and expected operating results. All areas preparing the budget work within these guidelines. The most important of these guidelines is the determination of the factors which restrict performance. All organizations have some factor which restricts performance usually sales demand or production capacity it is important to identify this factor often known as a limiting factor or a principal budget factor in order to ensure that the budget properly reflects the business environment. Once the principal budget factors identified in this budget must be prepared first as overall budgets will be driven by this factor.
For example, if there is a shortage of a particular raw material this will dictate how much material can be purchased and this will subsequently affect how much material can be used in production and finished production made. Therefore, the material partial budget must be prepared first.
Prepare initial budgets
Initial operating budgets are prepared for each major business segment based on the budget guidelines
Negotiate review and approve
An effective budgeting process encourages participation from all levels of management. Starting at the lowest management level, managers submit an initial budget for approval to their superiors. These senior managers then incorporate the individual budgets into the overall budget for that business area. Following successful layers of approval and negation, the final approved budgets are combined into a master budget. The budget committee then reviews the budget to ensure that there has been consistency in the component parts and that it has been prepared according to the predetermined guidelines before finally improving the budget and placing it before the board of directors for authorization
Budget revision
No budget should ever be so rigid that it cannot be changed. Such rigidity would be harmful for the business. Internal or external factors may make it appropriate to revisit the budget and revise it to incorporate such factors. Procedures for revising the budget variance. Some businesses constantly revise budgets by adopting continuous or rolling budgeting systems.
Some benefits of budgeting
Planning - a formal budgeting process requires a formal planning exercise. In order to prepare a budget, managers are compelled to identify their operational plans in response to consideration of potential future conditions. This allows managers to foresee potential problems
Communication - budgets are a means of communicating information about the future direction of the business
Coordination - the master budget coordinates the activities of the business as it integrates the plans of the various segments of the business into one document. This ensures all parts of the businesses are headed in the same direction
Control - by highlighting refences between actual and expected performance, budgets help managers to exercise control over the activities within their area of responsibility and take proactive action when required
Performance evaluation - budgets help define targets and objectives can be used to evaluate managerial performance
Motivation - by setting targets and objectives, a budget can be a motivational aid. Its motivation effectiveness is however reliant on the level of participation which employees have in setting these targets
Approaches to budgeting
Incremental budgeting
This is the least effect but the quickest method of budgeting. Involves taking the budget for the previous year and adjusting it for inflation and any new projects
Disadvantage of incremental budgeting
Any inefficiency in the previous year budget will be increased by the adjustment for inflation
No consideration is given to the justification for each activity. They will be undertaken merely because there we were undertaken in the previous year
Different ways of achieving the objectives of the company will not be identified or examined
Managers are aware that if they fail to spend their budget then it's likely they will receive a reduced budget for the next period. This could encourage unnecessary spending or waste
Continuous budgeting
A continuous budget is prepared for a set number of months, quarters, or years. as each month or quarter ends the original budget is updated to reflect current and future operational conditions and the budget for a new month or quarter is added
Benefits of a continuous budgeting system include
Constant budget period is available at all times
Encourages managers to consistently review budgeted operations for the remainder of the budget period and examine operations beyond the immediate future
Budgeting and planning became more up to date
Disadvantage of continuous budgeting
Management would spend a large amount of time updating budgets instead of managing all areas of the business
Zero based budgeting
Incremental budgeting approaches are not always clearly linked to strategy and are focused on financial aspects only. In contrast zero-based budgeting support is a more innovative approach requiring managers to justify all costs as if the proposals were being considered for the first time. this approach is focused on opportunity costing and can eliminate in efficiencies
Under a zero-based budget all budgeted expenditure must be justified each year. The starting point for the budget is 0 rather than last year's budget. Zero waste budgeting is a complex detailed process. The activities of a department or unit are ranked with their associated costs according to their relative importance. Senior managers review the activities and allocate resources according to the criteria based on assignments of priority
There are 4 distinct stages in the implementation of zero- based budgeting
Managers identify the activities undertaken in the area of responsibility
Each of the individual activities is then identified in a decision package. A decision package identifies the related costs and benefits of each activity
A ranking system is developed which allows each decision package to base assessed in terms of a cost benefit analysis
Resources are then allocated to the various packages based on the relative ranking of each package
Advantages of ZBB
Budget starts from zero - all spelling is justified
All activities and cost behaviors examined in detailed
Attempts to eliminate inefficiencies or slack
Time consuming and ignores previous year's effort
Focuses on short term benefits
Requires management skills - alternatives are too difficult to cost
Activity based budgeting
Organizations that use activity-based costing may extend the system to incorporate activity-based budgeting. ABB priorities funding for those resources needed to perform activities required to meet the production and sales volume budget. It works in a reverse process to the ABC process; ABC examines cost activities and then uses overhead cost drivers to assign cost to cost objects. ABB starts with the cost object. Budgeted output for each course object determines the necessary activities which will be consumed for the budget. These are used to eliminate and stimulate the resources required for budgeting.
Behavioral implications of budgets
Budgeting and budgetary control systems have an impact on people. Depending on how your budget is compiled it may be viewed favorably, unfavorably or with indifference. Their approach to preparing the budget should focus on motivating employees. In general, budgeting is a consultative process, it is more likely to be views favorable however the following negative aspects may still arise
Over emphasis on short term budget targets may lead to decisions which while increasing short term profit may have a negative implication for business in the medium term or long term
A focus on financial aspects may result in important qualitative factors being neglected examples include customer complaints
Spend it or lose it. Fear that expenditure below budget will negatively impact future allocations, encourages spending for the sake of spending. This has implications for cost control
Managers may be tempted to build in slack or padding. If managers have a role or on the development of their own budgets, they may understate expected revenues and overstate expected costs
If bonuses are based on budget, sales targets and sales managers may be tempted to engage in risky sales practice
“It is not in the budget period” inflexible budget processes may hinder opportunity. Intuitive ideas and opportunities not foreseen at the time of the budget was prepared may be passed or postponed
Budgeting depends on negation and approval. This can lead to intense internal business politics
Problems with budgeting
An incremental approach to budgeting or promoting an inherent assumption that ongoing activities are essential is being carried out efficiently and will continue to be necessary in the future. Problem with this approach include
Inefficiencies are carried forward with little emphasis placed on examining more efficient ways of performing activities
New activities may have difficulty attracting funding as existing activities or deemed necessary. This problem can be partially evaluated using zero based budgeting
The budget preparation process is time-consuming, costly and a bureaucratic process. The budget itself could be rendered out of date very quickly as external conditions change
Businesses usually plan on having a long-term future. Budgets have a short-term focus. It can be difficult to build long term strategy and vision into this short-term tool
A single budget is used for multiple purposes leading to the danger of conflict. planning and motivation aim may conflict – demanding, reasonably unattainable budget targets may be appropriate to motivate maximum performance but are not very suitable for planning purposes
Disadvantages of ZBB