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  • University : Holmes Institutes
  • Subject Name : Accounting and Finance

Managerial Accounting

Abstract

Budgeting refers to these plans which are prepared by an organization in relation to its financial operations which is prepared for a particular period of time. Budgeting has served a number of purposes within an organization. It has facilitated communication between those in senior positions and their juniors as the subordinates provide a justification of the resources that they will require so as to achieve their targets. Budgeting has acted as a tool that is used by a number of organizations for various purposes that include planning and control. Budgeting has significantly helped the management of the organization in their decision making process. However, the traditional budgeting methods have become outdated now and advanced methods of budgeting have now replaced the traditional budgeting methods . This assessment aims at providing a critical evaluation of traditional methods of budgeting.

Contents

Abstract

Introduction

Purpose of budgeting

Real-life examples of use of budgeting as a tool for planning, control and performance evaluation

Budgeting practice used in selected article and its behavioral implications

Pros and Cons of Traditional Budgeting practices

Recommendation on use of Budgeting for contemporary organizations

References

Introduction

This report involves a critical evaluation of the Journal article “Designing zero-based budgeting for public organizations” by Mukdad Ibrahim in the context of use of budgeting as a management tool for managing the resources of the business organization. The report explains about the purpose and role of the budgeting process, provides some real life examples of organizations from journal articles where budgeting was used as tool for planning budgeting and performance evaluation. The report also identifies the budgeting practice that has been used by organizations that have been included in the selected journal article and explains behavioral implications of that budgeting practice. It further provides a critical evaluation of the traditional budgeting methods and provides recommendations on use of budgeting by contemporary organizations as a tool for planning and controlling.

Purpose of Budgeting

Budgets are used as a tool to predict the profitability and are used to make decisions in relation to allocation of resources. The decisions taken by the managers of various departments have an impact on the profitability of the business. It is important for a business organization to have a plan for its operations and departments so as to be able to make proper decisions and coordinate the activities of different departments that are part of the business (Ibrahim 2019). It also facilitates communication between various departments which leads to co-ordination between different departments (Bufan 2013). Budgets play an important role in the decision making process by providing the useful information on the basis of which important business decisions can be taken.

As budget is a plan that has been prepared by the organization for a particular period of time, it acts as the basis for taking various important decisions related to the business (Bufan 2013). It provides insight for important decisions such as whether a particular business activity should be continued or not. It also helps in estimation of the quantity of resources that will be required for operating at different levels of activity (Bufan 2013). Budgeting exercise also helps the management of the organization in its controlling activities as managers are required to achieve the targets decided for them and to use the funds and resources as per the budgets assigned to them.

Also, a comparison of the budgeted and actual figures helps to identify the variances that exist and the reason for variances between budget and actual. The budgeting exercise also enables an organization to evaluate the performance of its managers by checking that whether the managers achieved the targets set for them and whether the spending made by them was in accordance with the budgets assigned to them (Bufan 2013).

Real-Life Examples of Use of Budgeting as A Tool for Planning, Control and Performance Evaluation

There are different types of budges that are prepared by the organization for the purposes of its planning, controlling, performance evaluation and decision making. The types of budgets have been broadly divided into four categories – incremental budgets, activity based budgets, value proposition budgets and zero based budgets (Corporate Finance Institute n.d.). Incremental budgets are prepared on the basis of figures related to previous years by adding or subtracting certain percentages of amount so as to arrive at the budget for current year.

Activity based budgets are based on the top down approach of preparing budgets in which the goals or targets are decided by the top level management and the middle and lower level management prepares budgets so as to reach those goals (Corporate Finance Institute n.d.). Value proposition budgets are based on the principle or belief that all information that is included in the budgets will add value to the business organization (Corporate Finance Institute n.d.). Zero based budgeting is styles of budgeting in which budgets are prepared by taking zero as the base i.e. the budgets are prepared from the start.

Some real – life examples where zero based budgeting was used as a tool for planning and controlling the activities of the business as well as for evaluating the performance of the managers of business are given below:

Case of Georgia State Government

The use of zero based budgeting for planning and controlling was demonstrated in the case of Georgia State Government. In this case, various questionnaires were distributed to heads of different departments to share their experiences related to use of zero based budgeting in the finance department of the central government. There were several interviews held wherever it was feasible to do so. It was complained by a large number of departmental heads that the zero based budgeting was introduced without asking their opinion on same before implementing it. Around 52 percent of the people who were included in the survey were proactively involved in the budgeting process (Ibrahim 2019).

Further, nearly 68 percent of total number of people who were involved in the survey reported that a major Improvement can be made in the quality of information that is made available to the management for their decision making process (Ibrahim 2019). It was observed that implementation of zero based budgeting provided several advantages over the traditional method of budgeting. The first significant improvement that was brought by zero based budgeting was the creation of financial planning process in such a way that the scarce financial resources of the state were recognized and it was to be made sure that those limited resources are to be used in the best possible manner (Ibrahim 2019).

This shows how the budgeting exercise was use in this case for planning related to business. The second main improvement that was brought by zero based budgeting over the traditional approach of budgeting was that there was a major improvement in the quality of information that was available to the managers for their decision making process mainly due to the use of zero based budgeting (Ibrahim 2019). The level of information that is provided by zero based budgeting is quite clear and detailed and is capable of providing much greater insight regarding the efficiency and effectiveness of the tasks being carried out by the state government (Ibrahim 2019).

This shows how the budgeting exercise was use in this case for controlling the activities of the business and for evaluating the performance of managers (here government). The last improvement that has been contributed by zero based budgeting over traditional budgeting processes is that it has made the managers adopt a more proactive approach towards the budgeting process. This is due to the high level of responsibility placed by zero based budgeting on managers.

Case of Public Agencies of Texas

The impact of implementation of zero based budgeting was studied in the case of public agencies of Texas that had implemented zero based budgeting (Ibrahim 2019). The questionnaires were sent to various budget actors of public agencies of Texas after one year of implementation of Zero Based Budgeting. The main purpose behind this survey was to find out differences that existed between opinion provided by budget directors and analysts. The directors were of the opinion that large budgets should be maintained whereas the analysts were of the opinion that the budget amount should be reduced (Ibrahim 2019). There were differences in the opinion of budget advocates and legislators/ analysts in relation to the benefits that were expected to be offered by Zero Based Budgeting (Ibrahim 2019).

It was seen that Zero Based Budgeting led to increased involvement of managers in the process of budgeting but it was also observed that a large proportion of their time was spent in this. The increased involvement of managers led to better coordination among departments and better planning (Ibrahim 2019). The views offered by the legislators were that zero based budgeting provided for proper circulation of information between different departments of the organization who are involved in the preparation of the budget (Ibrahim 2019).

It was also observed in this case that zero based budgeting lead to a greater feeling of unity among different departmental heads and helped in better controlling of the activities of the organization by minimizing waste, elimination of duplicate responsibilities of duties and optimum utilization of resources (Ibrahim 2019) its activities in an effective manner and also evaluate the performance of its personnel by checking the extent to which the targets se by the budget were followed by its personnel and managers.

Budgeting Practice Used in Selected Article and Its Behavioral Implications

The budgeting practice that has been selected by the organization in the selected journal article is zero based budgeting. As the name suggests, the process of zero based budgeting begins with a zero balance and various items of expenses are added to the budget when they are considered essential and are justified. A zero based budget does not depend on the results of prior years instead the entire budget is prepared right from the scratch. One of the important behavioral implications of this type of budgeting technique is that it encourages the managers to think for short term only by moving resources towards those areas that will generate revenue only in the short term (Hilton & Platt 2005).

Hence, it gives rise to short term thinking amongst employees which is not advantageous for the organization in the long run. Another major behavioral implication of this type of budgeting method is that it can give an opportunity to managers to involve in manipulation (Hilton & Platt 2005). Further, this technique of budgeting could lead to dysfunctional behavior in juniors even if the budgeting system has been set up in an organized manner. It could also give rise to a job related tension in employees and have negative effect on relationship between subordinates and seniors (Hilton & Platt 2005).

Pros and Cons of Traditional Budgeting Practices

Budgeting is regarded as one of the most important tool that is used in managerial accounting. Almost every organization relies upon the process of budgeting so as to achieve its long term and short term goals. A traditional budget involves expressing the plan to be followed by the management for a particular period of time and provides additional information on what needs to be done so as to achieve those plans. The main purpose of traditional budget is to achieve the goals and to supervise and direct the actions of managers by proper planning, co-ordination, measurement and reward system. A traditional budget is basically a plan for achievement of a particular target. It also involves setting goals and preparation of forecasts in relation to items of revenue, costs, production and cash flows.

The traditional budgeting methods have certain advantages as well as disadvantages. The most important benefit of traditional budgeting methods is that they help in planning, controlling and measurement of performance of managers (Good Fellow Publishers n.d.). Traditional budgeting which are based on top down approach strengthen the role and importance of top level management and restrict the independence and decision making of middle level managers. It is not possible for the management of any organization to manage the operations of the business without the help of budgets. It is not possible for the managers to effectively control the activities of the organization without budgeting exercise (Réka, Ştefan, and Daniel n.d.).

The budgetary control provides them with a tool to control the activities of its employees and staff by providing a comparison of budgeted amounts with the actual amounts. The reasons for differences between budgeted figures and actual figures can be analyzed by performing variance analysis of the differences. The variance analysis enables the managers to gain an understanding of the present situation and to take decisions for the future- whether to follow the same strategy or introduce certain changes.

Traditional budgeting keeps the managers informed about the important issue that relate to the actions for the company. Another important benefit of traditional budgeting practices is that it is used to measure and evaluate the performance of its managers. If a budget has been prepared in a proper way, it provides comprehensive information to the management regarding the next year. It helps to decide objectives in a proper manner and acts as a useful tool for decision making process (Réka, Ştefan, and Daniel n.d.).

The traditional budgeting methods have suffered a lot of criticism in the recent years. The main criticism of the traditional budgeting methods is that they are not able to keep up according to the changed requirements of the today’s dynamic business environment and thus is not much useful nowadays. Another criticism of traditional budgeting techniques is that they do not change according to changes taking place in the market. Further, traditional budgeting methods consume a large amount of time and are costly to prepare and implement. Moreover, the budgets prepared based on traditional budgeting methods only focus on reduction of cost but do not focus on creation of value.

Traditional budgets are generally prepared and updated on an annual basis and are based on a number of assumptions and guess work (Réka, et al. n.d.). The top down approach of budgeting often leads to decline in the motivation of managers as they are not involved in the decision making process. Apart from these problems associated with traditional budgeting techniques they are quite slow in identification of issues and become out of date very quickly. As such do not provide benefit in accordance with their cost and are quite time consuming. Also, traditional budgeting methods may not provide proper and correct performance measurement.

Even though the tradition methods of budgeting have become outdated and do not provide much value now, the processing of budgeting in it has not become outdated. The modern and advanced techniques of budgeting are being increasingly used by various organizations as a replacement of traditional budgeting methods. These advanced and new budgeting techniques are less time consuming, involve lower costs and are capable of adapting to current business environment (Réka et al. n.d.).

They are capable of serving the needs of the business of the modern world. One of such new budgeting techniques is balanced scorecard which not only focuses on financial aspects of performance of a business but also focuses on non- financial aspects – sustainability, environmental performance and employee’s satisfaction (Cieslak & Kalling, 2007). Some of the alternative and modern methods of budgeting that have been developed are – better budgeting, beyond budgeting, activity based budgeting and the rolling forecasts.

The concept of beyond budgeting enables the organizations to implement best practices in relation to planning and controlling from companies all over the world. The “beyond budgeting” does not focus on discontinuation of budgets but adds certain elements to the budgeting process so as to it is able to add value to the business (Réka, Ştefan, & Daniel n.d.). Beyond budgeting techniques enable an organization to perform its performance management activities and to achieve decentralization of its decision making process without depending upon the traditional budgets which are costly as well as time consuming.

Beyond budgeting techniques provide useful insight to the management of organizations on how they can be managed in a better manner (Réka, Ştefan, & Daniel n.d.). There are two broad differences between traditional budgeting methods and beyond budgeting methods. Beyond budgeting methods are more flexible methods of budgeting, are reviewed on a regular basis and can be adopted based on requirements (Réka, et al. n.d.) .However, traditional budgets are not capable of being reviewed and modified on a frequent basis and are usually prepared o an annual basis only (Réka, et al. n.d.) .

Therefore, in view of the above discussions the comment that ‘traditional budgeting practices are constraint on creativity, and the time and energy spent on budget formulation is better spent elsewhere’ is correct to a large extent as the traditional budgeting methods are no longer relevant in the current business environment. Traditional budgeting techniques were considered as highly useful in the past. These were used as an effective tool for planning, controlling and performance measurement. However, they have lost their importance with the passage of time and with changes in the business environment. There is requirement for alternative techniques that can adapt to the new business environment and market conditions.

Recommendation on Use of Budgeting for Contemporary Organizations

On the basis of these discussions and explanations in relation to the new methods of budgeting and modern approaches to the budgeting process, we would recommend the use of budgeting process to the contemporary organizations. However, it would be feasible for the contemporary organizations to not merely rely on the traditional budgeting process for use in the planning and controlling activities for the business but make a move towards implementing modern budgeting techniques such as beyond budgeting, activity based costing, balance score card etc. which are more suitable for modern business world.

Beyond budgeting techniques provide for a decentralized way of managing the activities and decision making wherein the most of the decision making power as well as the accountability is passed on to the line managers. Beyond budgeting creates an environment of self management for the managers and employees because everyone has the authority to take the relevant decisions at their level and at the same time be accountable for their decisions (Réka, et al. n.d.). This adds to the motivation of managers and staff members and leads to high levels of productivity and higher customer satisfaction.

References

Bufan, I.D. 2013. The Role of The Budgeting In The Management Process: Planning and Control. SEA–Practical Application of Science, 1(01), pp.16-37.

Cieslak, K. and Kalling, T. 2007. Reasons behind contemporary use of budgets. Lund, Sweden.

Corporate Finance Institute. n.d. Types of Budgets. [Online]. Available at https://corporatefinanceinstitute.com/resources/knowledge/accounting/types-of-budgets-budgeting-methods/

Good Fellow Publishers. n.d. The Use of Budgets In Organizations. [Online]. Available at https://www.goodfellowpublishers.com/free_files/Chapter%209-5c9efebc0f326dd1ec3a768c5217d595.pdf

Hilton, R.W. and Platt, D.E. 2005. Managerial Accounting: Creating Value In a Dynamic Business Environment. New York: McGraw-Hill/Irwin.

Ibrahim M .2019. Designing Zero-based Budgeting For Public Organizations. Problems and Perspectives in Management 17(2). 323-333. doi:10.21511/ppm.17(2).2019.2

Réka, C.I., Ştefan, P. and Daniel, C.V. Traditional Budgeting Versus Beyond Budgeting: A Literature Review. Annals of Faculty of Economics, University of Oradea. Faculty of Economics, vol. 1(1), pages 573-581, July.

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