Introduction Why budgeting? It is common sense that we budget for the next action. Company is in the same case and budgeting in the company is more important as they are dealing with significant amount of resources. Objectives of budgetary control system The objectives of budgetary control system are essentially the benefits of it, there are many: 1. Planning – budgeting starts at planning stage, this will force management to look ahead, detailed budgets will be set. 2. Control – budget provides a yardstick for actual results to be compared, then the variances could be investigated and controlled, evaluation of performance can be done too. 3. Coordination – it is important to ensure maximum integration of effort from every department towards common goals, budget will facilitate this. All departments in the organization should be coordinated and be in line with the objectives and limiting factor (principal budget factor). 4. Communication – the budget is an effective way of informing departments and people what is expected of them. 5. Motivation – rewards can be given to employees who achieved the expected performance set in the budget. Corporate and divisional objectives Corporate objectives concern the firm as a whole, they should relate to the key factors for business success (known as critical success factors). Examples of corporate objectives include: 1. Maximizing shareholders wealth. 2. Improve market share. 3. Growth and sustainable. 4. Continuous improvement in quality (for company which has total quality management system). 5. Ensure customer satisfactions. Divisional objectives are set by divisional managers. These objectives are more related to how to improve the division performance. There is a danger element because sometime managers make decisions that are of self-interest, the objectives set could conflict with other divisions’ objectives and also the corporate objectives. This type of decision making is called dysfunctional decision making whereby the decisions taken by divisional manager are in the best interests of his own part of the business, but possibly against the interests of the organization as a whole. Conflicting objectives may be resolved by: 1. Prioritization – certain goals get priority over others. Senior managers will rank goals and strategies according to certain criteria. 2. Negotiation – allows full participation of all people who prepare the budgets and have bargaining process for each stage of budgeting process. 3. Compromise – when there is disagreement in negotiation, the parties should compromise, if it is positive then both parties win something, if it is negative then both parties lose something. Win-lose situation will cause damage to relationship. 4. Satisfying – This occurs when a satisfactory rather than optimal solution is found. Organization may not aim to maximize performance in one area if this leads to poor performance elsewhere, so accept satisfactory solution. Every organization should try to ensure goal congruence exists in order to avoid conflicting objectives. Goal congruence is the state which leads individuals or groups to take actions that are in their self-interest and also the best interest of the organization. (ie. manager goals = organization goals) This is not easy to achieve, budgetary control system needs to be well designed which should encourage continuous feedback from employees. In conclusion, budgets serve as an essential element of planning and control. You should have heard about planning and control cycle in the earlier studies, company starts from identifying objectives, then the best strategy is set based on the objectives and control takes place after the actual results of implementing the strategy are compared to the budgeted results. Many of these are common sense and you should be able to understand them well by relating it to your experience.

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Further incremental packages may then be prepared to reflect a higher level of service or support. production budget. Zero-based budgeting (ZBB) – as the name suggested. 3. (b) Very large business. It is more on theory side of budgeting. I discuss about the traditional and modern budget systems. a car manufacturer may choose to allocate more funds to production processes than service and admin functions. a new Q1 will be added. (b) Ranking of decision packages – management will evaluate and rank each activity (incremental decision package) on the basis of its benefit to the organization. when Q1 is over. budgeting occurs at short-term planning which is for less than one year. management will collect all the feedback after the comparison of actual and budgeted results. (d) When operational managers have strong budgeting skills. There are three types of planning: long-term. 4. and take action based on it. For example. Bottom-up budgeting (participative) – this is the opposite of top-down budgeting. both positive and negative. this involves preparing the budget from zero base. This will help management decide what to spend and where to spend it. at the end of Q1. (c) During period of recession. company will also update Q2 budget and make it more detailed. 2. and these are all covered in earlier studies. and material purchase budget and so on. For example. in paper F5. This is suitable in the following situation: (a) Organization is well-established. Every item of expenditure has to be justified before it is included in the budget. Different types of budgetary systems You must be able to select appropriate budgetary systems for different organization and discuss their usefulness and problems. Planning is deemed as more significant at the higher levels of performance hierarchy while budgetary control occurs at the lower levels of the performance hierarchy. representing the minimum level of service or support needed to achieve the organization’s objectives. operational managers are brought together to discuss and make the budgets. (c) During period of good economic environment. (c) Allocate resource – the resources are then allocated based on the order of priority up to the spending level. medium-term and short-term. Top-down budgeting (imposed) – top management prepares the budget and then imposes to the employees. Rolling budget – rolling budgets are budgets which are continuously updated by adding a further accounting period when the earlier accounting period has expired. This may also improve the quality of budget decisions as the skills of the managers are pooled. let say a budget is for four quarters (Q). At the control stage. (b) Very small business.BUDGETORY SYSTEM Introduction In this article. (d) Operational managers lack budgeting skills. you will not be required to prepare sales budget. material usage budget. This is suitable in the following situation: (a) New organization. There are three steps of ZBB: (a) Define decision packages – decision package (description of activity) is prepared at the base level (base package). Budgetary systems fit into the planning and control stage. W r i t t e n b y : S e a h C h o o i K h e n g E d i t e d b y : M u s t a f a K h u w a j a Page 2 . Planning and control in the performance hierarchy Planning and control occurs at all level of the performance hierarchy to different degrees. It takes into account the latest information. This could improve motivation as the budget is not one-sided. you must be familiar with the following: 1. based on the ranking of each activity.

Advantages of ZBB 1. Prevent budgetary slack. Disadvantages of bottom-up budgeting 1. Advantages of top-down budgeting 1. 2. Can improve motivation. Budget is set by experienced top management instead of some inexperienced employees. Activity based budgeting (ABB) – ABB involves defining the activities that caused the costs and using the level of activity to decide how much resource should be allocated. Remove inefficient or obsolete operations. It is known for encouraging slack and wasteful spending. Disadvantages of ZBB 1. If employees feel the budget is unachievable. It responds to changes in the business environment. 3. at the time of preparing annual budget. 3. 4. Disadvantages of top-down budgeting 1. More efficient allocation of resources. non-profit-making organizations and support expenses (expenses to support the essential production function). Reduce the time of preparing annual budget because for example. May not be agreed by the employees. In general they are more realistic. Frequent budgeting could have a demotivating effect on managers. Up-to-date budgets are always available. Disadvantages of rolling budgets 1. Managers may not be experienced enough and so the quality of budget can be affected. Take up a lot of time and costs may be more than benefits. Enhance the coordination between the plans and objectives of divisions. service industries. Advantages of bottom-up budgeting 1. effort and money. 3. 4. 2. The lower-level managers now may still be inexperienced when they had become top management. Feedforward control is control based on forecast results. They are based on information from employees most familiar with the department. Reduce uncertainty because they concentrate detailed planning and control on short-term prospects. control action will be taken in advance if the forecast is bad. hence it is particularly unsuitable for public sector organisations which are aiming to achieve desired results with the minimum use of resources. Feed-forward control – this is different from feedback and business organization uses feedback for control. 5. 7. Budgeting time is reduced. Need more time? 2. so motivation may be affected. 2. 2. 6. training costs. three quarters budget could have been done. Managers may introduce budgetary slack (deliberate overestimation of costs and/or underestimation of revenues in the budget). 2. Advantages of rolling budgets 1. 4. Budget is prepared using a previous period’s budget or actual performance as a base. Incremental budgeting – this is the traditional approach to budgeting. Strategic plans are more likely to be incorporated into budget as top management understands better the strategic plan which is set by them. research and development costs). The budget will be more realistic and this would have a better motivational influence on managers. W r i t t e n b y : S e a h C h o o i K h e n g E d i t e d b y : M u s t a f a K h u w a j a Page 3 . it will cause great demonization. 3. ABB involves the use of costs determined using activity based costing (ABC) as a basis of preparing budgets. 2. Knowledge of several levels of management is pooled. 4. with incremental amounts then being added for the new budget period. how well it is being managed and to explain variances from budget. Need more time. 3. 3.ZBB is useful for budgeting for discretionary costs (egg.

Costs are analyzed into activities. 3. the information needed would be the past sales patterns and also the forecast of future sales patterns. Costs of preparing ABB could be higher than benefits from it 3. Disadvantages of ABB 1. In case of production budget. Require more time and costs. Build from the readily available figures from last year. Uncertainty can be allowed in flexible budgeting. 2. it will be complicated to prepare ABB. 3. Lack of accounting information. 5. the sources of information include labor costs. Ranking of decision packages can be difficult. 3. Budgets provide poor value to users. In case of sales budget. economic environment. Training – everyone needed to be fully trained if new budget system is to be introduced. 4. Beyond Budgeting is a model that proposes that traditional budgeting should be abandoned. but it is useful to understand it now as you will see it in P5. W r i t t e n b y : S e a h C h o o i K h e n g E d i t e d b y : M u s t a f a K h u w a j a Page 4 . Therefore. installation costs etc). pricing policies and discounts offered legislation and so on. raw material costs and machine hours. you have to think where to get the information for preparing a realistic budget. Advantages of incremental budgeting 1. this is an important role of management accountant. The sources of information include the results of market research. These methods are suitable when the degree of uncertainty is quantifiable.2. Can increase management commitment to the budget process. Loss of control – senior management may take time to be familiar with new system and understand the implications of results. 3. 3. 4. Disadvantages of incremental budgeting 1. Different activity levels will provide a foundation for the base package and incremental package of ZBB. A more accurate budget is available. It criticizes budgeting that: 1. Costs of implementation may be high (include training costs. 2. Managers may have to be trained in ZBB techniques as it requires skills in constructing decision packages. Quickest and easiest method of budgeting. 2. Encourage budgetary slack. Uneconomic activities may be continued. therefore it is easier to identify what because more costs. we have to be forward-looking. Advantages of ABB 1. Suitable for organizations that operate in a stable environment. Flexible budget is a budget which recognizes cost behavior and is designed to change as volume of activity changes. Beyond Budgeting This may not be important for F5 (in fact not stated in study guide). Budgets are time consuming and expensive. Probabilistic budgeting (probabilities are assigned to different conditions) and sensitivity analysis are also useful. How budget systems can deal with uncertainty in the environment Rolling budgets are a way of trying to reduce uncertainty by continuously updating budget. 2. Difficulties of changing a budgetary system 1. Can lead to misallocation of resources. 2. 2. Information used in budget systems and sources of information needed Past data may be used as a starting point for the preparation of budgets but other information from a wide range of sources will also be used because in budgeting. When there are a lot of activities involved. Resistance by employees – employees who had familiar with the current system may be unwilling to go for new control system.

There is nothing difficult here and nothing for you to memorize. 6. Budgets stifle product and strategy innovation. 9. just get the idea and describe with your own words in exam. Budgets lead to unethical behavior. Two fundamental concepts of Beyond Budgeting are: 1. Budgets are too rigid and prevent fast response. Budgets fail to focus on shareholder value. Use adaptive management processes rather than the more rigid annual budget – managers should be planning on a more rolling basis but with the focus on cash forecasting rather than purely on cost control. Budgets protect rather than reduce costs. 5. Budgets reinforce a dependency culture. 4. 8. Move towards devolved networks rather than centralized hierarchies – it encourages a culture of personal responsibility by delegating decision making and performance accountability to line managers. 2. In conclusion. Budgets are divorced from strategy. 7. W r i t t e n b y : S e a h C h o o i K h e n g E d i t e d b y : M u s t a f a K h u w a j a Page 5 . then you should be able to give the advantages and disadvantages.3. 10. if you are able to explain the different types of budgetary systems. Budgets focus on sales targets rather than customer satisfaction.

also known as least squares technique. I am unable to provide it in this article. Linear relationship is expressed as y = a + bx. the more realistic the budget. total costs of 1800 units = 9250 + 12.5 x 1800 = $31750. Budget is based on forecast. (b) Prepare a budget for total costs if output is 22000 units. Month Output (‘ooo units) (x) Costs ($000) (y) 1 20 82 2 16 70 3 24 90 4 22 85 5 18 73 (a) Derive an equation to determine the expected cost level. look at the formula sheet when reading the following example: You are given the following data for output at a factory and costs of production over the past five months. you should use the activity level and total costs that are not affected by step-fixed cost. y = 11250 + 12. eg. is a statistical method of estimating costs using historical data from a number of previous accounting period. Step 2: Calculate fixed cost by fixed cost = total cost – (variable cost per unit x units) Step 3: Summarise the relationship by making an equation. Linear regression analysis. Fixed cost = $600.QUNATATIVE ANALYSIS OF BUDGETING Introduction This topic is actually about the techniques to forecast costs and revenues. However it is based on historical information and the cost estimates may not be accurate. so y = 600+ 0.5 Fixed cost = $28000 – ($12.5 x 1500) = $9250 y = 9250 + 12. Step 1: (Total costs at highest activity level – total costs at lowest activity) ÷ (total units at highest activity level – total units at lowest activity level). variable cost per unit = $0. Below example is when there is step-fixed cost: Company A produces product G. Solution: (a) For your workings. there will be an increase in fixed costs of $2000. The following information related to G: Total costs ($) Activity level (units) 40000 2300 28000 1500 After 2000 units of G are produced. Therefore. total cost equation is y = a+ bx. you don’t have to memorise the formula as they are given in exam.2. Variable cost per unit = (40000 – 2000 – 28000) ÷ 2300 – 1500 = $12. There are formula to calculate a and b. High-low method is used to identify fixed and variable costs from semi-variable cost.5x when activity level is less than 2000 units. Most of the calculations are simple except learning curves which you will need some time to understand. however you should be able to use them quickly in exam.2x. the more accurate the forecast. Solution: You have to exclude step-fixed cost when you calculate variable cost per unit. High-low method is simple and easy to use. When you calculate fixed cost.5x when activity level is 2000 units or more. you should prepare to calculate the following amount (note that sum of y^2 is used to calculate correlation coefficient which will be used later): x y xy x^2 y^2 20 82 1640 400 6724 W r i t t e n b y : S e a h C h o o i K h e n g E d i t e d b y : M u s t a f a K h u w a j a Page 6 . High-low method and linear regression analysis Both of these methods can be used to analyse fixed and variable cost elements from total cost data. calculate the total costs of 1800 units.

but you can ignore C and R. Time series – this is a series of figures or values recorded over time.100^2)(5 x 32278 . Solution: shows the same workings excluding because you don’t need to calculate correlation coefficient. Correlation coefficient is a measure of how linear the relationship between variables is. 2. you could be asked to do this in exam. Coefficient of determination is a measure of how much the change in the dependent variable (y) is explained by the change in the independent variable (x). 3.99.100 x 400 )/square root of [(5 x 2040 .2 = $85200 When we use linear regression analysis.6 x 100)/5 = 28 y = 28 + 2. if not then there must be mistake. total costs = y = 28 + 2. again refer to formula sheet: Using the above example. 4. Trend (T) – the general direction which sales follow. Coefficient of determination = r^2 and this is not given in exam. Trend Trend line can be determined by regression analysis. It should be within 0 and 1. Seasonal variations (S) – the short-term fluctuations in recorded values.6 x 22 = 85. It is still based on past data and it is not reliable if we don’t know the correlation coefficient.400^2)] = 0. Judgement and experience – sales personnel can be asked to provide estimates. Random variations (R) – fluctuations caused by unforeseen events. actual time series (A) = T + S + C + R. Simulation. cost function is assumed to be linear. Therefore.6 a = 400/5 – (2. 2. Forecasting techniques Management can use a number of forecasting methods such as: 1. Market research can be used (especially for new products or services). For example. A correlation coefficient of +1 indicates perfect positive linear correlation. can be estimated by looking at the sales revenue of past few years.100^2) = 2. whereas -1 indicates perfect negative linear correlation. 4. An example is needed here: Sales of product B over the seven year period from 20X1 to 20X7 were as follows. Year x y xy x^2 20X1 0 22 0 0 W r i t t e n b y : S e a h C h o o i K h e n g E d i t e d b y : M u s t a f a K h u w a j a Page 7 . the variables are considered linear and so the linear regression analysis is quite reliable. it must be within this range. it is unpredictable. sales of ice cream will be higher in summer than in winter. you have to find the y = a + bx and y will be the trend. the r = (5 x 8104 . main focus is on this method. these are the longerterm version of seasonal variations. The formula of it is given in exam. Cyclical variations (C) – medium-term changes in results caused by events which repeat in cycles. Year 20X1 20X2 20X3 20X4 20X5 20X6 20X7 Sales of B (‘000 units) 22 25 24 26 29 28 30 Calculate the trend line of sales and forecast sales in 20X8. Time series analysis A time series has four components: 1. 5. start the x by numbering from 0 upwards.100 x 400)/(5 x 2040 . Simple average growth model – growth rate of sales for example.16 70 1120 256 4900 24 90 2160 576 8100 22 85 1870 484 7225 18 73 1314 324 5329 sum x= 100 ∑y = 400 ∑xy = 8104 sum x^2 = 2040 ∑y^2 = 32278 n = 5 (There are five pairs of data for x and y values) b = (5 x 8104 . 3. you can be given sales of the product for a number of years.6x (b) When output is 22000 units.

forecast sales for 2011 for the company. It is more suitable when the trend is increasing or decreasing over time. first check whether the adding up of four seasonal variations will be equal to 0. the figures left out will represent trend. Multiplicative model. this is based on A = T x S x R.5 Trend line. Trend for Q1 of 2011 = 21 + 5 (12) = 81. This method attempts to remove seasonal variations from a time series by a process of averaging. x = 12 at 2011 quarter 1. Have a look at an example: Company A wishes to forecast sales for Q1 of 2011.25 x 21)/7 = 22. forecast sales for Q1 of 2011 = 81 + (-70) = $11.(1. There is something to check here.21^2) = 1. Sales in 20X8 (year 7) will be 22. when using additive model. When the seasonal variations given are with ‘+’ or ‘-‘. Good news here is that you can ignore the adjustment of seasonal variations in exam (unless examiner specifically requires it). if you are required to use multiplicative model. so for example the trend of Q1 adds seasonal variation of Q1 = actual time series/forecast sales. Solution: Q1 Q2 Q3 Q4 Total Seasonal variations -50 150 -70 50 80 Adjustment -20 -20 -20 -20 -80 Adjusted seasonal variations -70 130 -90 30 0 x = 0 at 2008 quarter 1. Then multiply trend with seasonal variation to get forecast sales.21 x 184)/(7 x 91 . so for example the trend of Q1 multiplies seasonal variation of Q1 = forecast sales. 2. then it is understood that additive model is used. so x = 1 at 2008 quarter 2. A moving average is an average of the results of a fixed number of periods and since it is an average of several time periods. however you can refer to the textbook to get more idea of it. Seasonal variations There are two types of models to estimate seasonal variations: 1. it is related to the mid-point of the overall period. when using multiplicative model. adding all four seasonal variations should equal to 4.20X2 20X3 20X4 20X5 20X6 20X7 1 2 3 4 5 6 ∑x = 21 25 24 26 29 28 30 ∑y = 184 25 1 48 4 78 9 116 16 140 25 180 36 ∑xy = 587 sum of x^2 = 91 n=7 b = (7 x 587 .5 + 1. It is more suitable when the trend is constant. this is based on A = T + S + R (you can ignore R). Trend values can also be determined by using moving averages. if not you should make adjustment to the seasonal variations. The seasonal variations for four quarters are estimated as follow: Q1 Q2 Q3 Q4 Total Seasonal variations -$50 $150 -$70 $50 $80 Using additive model. There is nothing difficult here. y = 22.25 = 31250 units. W r i t t e n b y : S e a h C h o o i K h e n g E d i t e d b y : M u s t a f a K h u w a j a Page 8 . It is not mentioned in study guide to learn moving average and so you will not be required to do moving average in exam.5 + 1. this becomes simple. adding all four seasonal variations should equal to 0. Normally you could be given seasonal variations for 4 quarters and told to use either model to forecast sales. x = 0 at 2008 quarter 1.25 a = (184/7) . Additive model. if not then make it 0 by adjustment.25x.25 x 7 = 31. x = 4 at 2009 quarter 1. Trend line determined using linear regression analysis is y = 21 + 5x. if not then multiplicative model. After you got the concept.

4. 3. User-friendly. production units in production budget (which is linked to sales budget) will also change accordingly. As you know. for example when you change the sales amount of the sales budget. W r i t t e n b y : S e a h C h o o i K h e n g E d i t e d b y : M u s t a f a K h u w a j a Page 9 . 2. 3. It is vulnerable and people can easily corrupt or manipulate the data. Allow data to be displayed graphically. It is difficult to trace errors. Minor error in design can affect the validity of data. Disadvantages 1. Save time for planning and decision making. Can manipulate information very fast. With this. Advantages 1. 4. it facilitates ‘what if’ analysis. Cannot take account of qualitative factors.Using spreadsheets in budgeting Spreadsheet packages can be used to build business models to assist the forecasting and planning process. spreadsheet is particularly useful for ‘what if’ analysis or sensitivity analysis and also simulation. 2.

There are four types of standards and each having impact on employee motivation: 1. The budgets will therefore be more realistic to the employees and they will have the motive to achieve their suggested targets. If they are too difficult then they will demotivate (ideal standard). employees are very likely to leave the job immediately. budgetary systems and quantitative analysis of budgeting. manager can show the employees the targets set under aspirations budgets but when doing standard costing. We must remember that employees are the one that are going to do help in achieving the target. this last article about budgeting is about dealing with people. this is used in expectations budget. It would be better to have a higher level person to negotiate the targets with the employees so that guidance is provided and avoid budgetary slack. Ideal standard – standard that is based on perfect working conditions. this is known as aspirations budgets. Many researchers also agree that pay can be an important motivator. Ideally budget should be slightly higher than expected performance level. some allowance is made for wastage and inefficiencies. This could be used for long-term targets.BEHAVIOURAL ASPECTS OF BUDGETING Introduction This is the last section of budgeting. Setting difficulty level for a budget Targets can assist motivation if they are set at the right level: 1. Budget targets are normally set with pay as a reward of achieving it. Attainable standard – standard that can be attained if the work is carried out efficiency. Therefore. budgets cannot be useful without correctly dealt with the employees in the organisation. manager should compare the actual results with the expectations budget. In this topic we discuss the effects of budgeting on people (employees). Participation of employees in the negotiation of targets This is already discussed in budgetary systems article. 2. if without it. In conclusion. W r i t t e n b y : S e a h C h o o i K h e n g E d i t e d b y : M u s t a f a K h u w a j a Page 10 . Basic standard – standard that is unchanged over the years and is used to show changes in efficiency or performance. However do not forget that employees have lesser experience and they might build budgetary slack to the budget. This is likely to motivate higher levels of performance. management accountant must also remember that budgeting deals with people. 3. Although Frederick Herzberg classified salary as hygiene factor (do not have motivating effect) in two-factor theory. This has motivating effect and aspirations budgets use it. After knowing the objectives of budgeting. Current standard – standard that is based on current working conditions. Factors influencing behaviour In other words. 2. 4. However the budget for planning and decision making should be based on reasonable expectations (expectations budget). It comes from attitudes. If they are too easy then managers are less likely to put in maximum effort as there is no sense of achievement. their consideration must be taken into account. it should not be used as a target because it is too easy for managers. a summary is that this can have motivating effect as the employees have chance to voice out what they think the targets should be. what influences motivation? Motivation is what makes people behave in the way that they do. this has a demotivating effect as it is unattainable. it does not have motivation effect. Individuals will be motivated by personal desires and interests.

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