Accounting for Managers - Budgetary Control – Week 7 PDF

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Accounting for Managers - Budgetary Control – Week 7...

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Accounting for Managers - Budgetary Control – Week 7 Budget Setting Process Step 1 – Establish who will take responsibility (lead the process). Step 2 – Communicate budget guidance to managers. Step 3 – Identify the key/limiting factor. Step 4 – Prepare budget for the key factor (usually sales). Step 5 – Prepare draft budgets for all areas. Step 6 – Review and co-ordinate budgets. Step 7 – Prepare the master budget. Step 8 – Communicate budgets. Step 9 - Monitor and Control. -

In practice most are annual budgets.

Types of Budgets -

Incremental budgets •

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Zero based budgets •

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Start with a blank piece of paper.

Flexible budgets •

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Take last years figures and update them for changes.

Budget can be flexed to give a better working comparison.

Discretionary budgets •

These budgets do not directly link to the key budget e.g. Marketing.

Multiple Functions of Budgets -

Promote forward thinking •

Forecasting

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Planning

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Communication

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Evaluation and control

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Motivate performance

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Provide a system of authorisation

One budget may not be sufficient to satisfy all these functions.

Financial Control Structures -

Responsibility accounting is based on the recognition of individual areas of responsibility. There are three main types of responsibility centres:

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Cost or revenue centres

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Profit centres

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Investment centres

Cost or revenue centres •

Where managers are simply responsible for the costs or revenues relating to their centres (a cost centre could be a production department, a revenue centre could be a sales department).

Profit centres •

Where the manager has responsibility for both the centre’s costs and revenues (i.e. profit). A profit centre manager has little control over the purchase of fixed assets.

Investment centres •

These are similar to profit centres, but the difference being that the manager is also responsible for fixed asset purchases.

Control and Responsibility •

Managers should have control over the costs for which they are being held responsible. In responsibility accounting these costs are termed controllable costs (e.g. a production department’s direct materials and direct labour costs). In responsibility accounting a non-controllable cost would be one that was simply allocated to the department, over which the manager had no say (e.g. allocated electricity costs).

Assessing Performance Basic concepts (the 3 Es): •

Economy – trying to carry out activities as economically (cheaply) as possible.

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Efficiency – the ratio of input to outputs (e.g. relating actual costs to some standard).

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Effectiveness – the relationship between a responsibility centre’s outputs and its objective. This may be difficult to quantify.

Flexible Budgeting •

When holding managers accountable, it is important to remember that some costs will vary with changes in levels of production. When preparing performance reports it is necessary to take account of the variability of costs. If the actual level of activity is greater than the budgeted level, variable costs will be greater than that was budgeted for simply because of the changes in the level of activity.

Discretionary Costs -

These are costs which can be varied at the discretion of management (e.g. marketing expenditure, research and development costs, etc.). Here, it is not possible to relate financial inputs with outputs).

Discretionary Costs – various methods 1. Cash limits – often the implicit assumption is that there is scope for improved efficiency. 2. Zero Base Budgeting – rather than looking at what was spent last year, this approach requires the spender to justify the cost which are to be incurred. So, there is no “base”, everything has to be justified. This is time consuming and consequently this approach would not be adopted every year. 3. Program Planning Budgeting Systems (PPBS) – this is used where there is a specific “program” (e.g. developing a new product, moving to a new factory, etc). •

The objective needs to be defined.

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There should be a measurable outcome.

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This can be difficult.

4. Management by objective – e.g. agreeing the activities and performance for individuals over a specified time period. 5. Value for money audits. 

Simple model – the evaluation of economy and efficiency without a judgement about effectiveness.

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Comprehensive model – an objective, professional and systematic assessment of: -

The nature and functioning of an organisation’s managerial system and procedures.

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The economy and efficiency with which its services are provided, and

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The effectiveness of its performance and achieving its objectives.

Budgets as Targets Targets are likely to motivate, but need: •

Specific objectives.

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Specified time period.

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Results.

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Agreement.

Effect of Budgets on Performance •

Based on Stedry’s work (1960), the implications of his findings are: -

Budgets do not always lead to improved performance.

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Failure to achieve a budget target is likely to lead to a lowering of aspiration levels.

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The budget level which motivated the best performance is unlikely to be achieved much of the time! Therefore small adverse variances can be a healthy sign.

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So, one budget may be needed by senior management for planning purposes, and another budget may be needed for motivational purposes.

Participation in the Budget Process •

It is argued that participation gives a greater sense of responsibility. Therefore, people should be more inclined to accept the results.

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Pseudo-participation – acceptance of the target under pressure.

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Bias – people may introduce slack into the budget – thus meaning that it is easier to achieve the target (and maybe achieve a bonus).

What’s Wrong with Budgetary Control? •

May suppress creativity

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May cause waste – protects rather than reduce costs

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Emphasis on mistakes – concentrate on under performance

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Difficult to set standards – often last year plus.

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Consistent failure may cause apathy

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Undue emphasis on the past

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Excuses/blame culture.

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Where do the numbers come from? – management imposed

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Cost and time of the budgetary process....