ABO

Lecture 5: Behavioural Approaches to

Budgeting
Budgeting approaches
1. Incremental budgeting can assist planning process:
– Involves making an alteration to expenditure budget for cost centre from
previous year
– This traditional method suits production and cost centres where output is
easily measurable and standardised (largely what we have learnt thus far)
2. Other contemporary approaches to cost centre budgeting include:
• Program budgeting
• Zero-based budgeting
• Activity-based budgeting
• Rolling budgeting
• Kaizen budgeting
– These approaches can be useful for all organisation including
‘discretionary’ cost centres
• Beyond budgeting
– Replaces budgeting altogether to avoid the behavioural impacts of
traditional budgeting
Program budgeting

• Program budgeting requires the cost centre to plan

its expenditure specifically around the programs or
projects conducted by the cost centre
–i.e. HR want to run specialised staff training sessions
• Advantages of this approach
–Focuses on expenditure relating to specific programs
–Requires justification for expenditure to be linked with
objectives of program

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Zero-based budgeting

• Zero-based budgeting requires managers to justify

budget amounts as if there was no available
information about budgets or costs from prior
periods
–i.e. government departments were typically asked to budget
using this method which would then be submitted for
approval and funds
• Advantages of this approach
–Encourages managers to cut costs and focus on desired
outcomes
–Often results in reduced wastage, more value-adding
activities and quality improvement
• Major disadvantage is that it is time consuming
Activity-based budgeting

• Activity-based budgeting (ABB) uses activity cost

pools and their related cost drivers to anticipate
costs for individual activities
• Advantages of this approach
–Budgeted structured around activities
–Allows for identification of resource consumption for
each activity
–Can be used for engineered cost centres as well as in
discretionary cost centres

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Rolling budgeting
• A rolling budget is a budget that is prepared monthly
or quarterly and reflects planning changes, often
through next 12 to 18 months
• Rolling budgets
–Reflect the most recent results
–Incorporate significant changes in business strategy,
operating plans and the economy
• Advantages of this approach
–Useful for companies operating in volatile environments
–Rapid increases or decreases in costs and inventory
levels during economic upturns or downturns
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Kaizen budgeting

• Kaizen budgeting sets targeted cost reductions across

time, anticipating market price reductions across the
life of a product
–Used widely in the car market (comes from the
Japanese concept of lean manufacturing)
• Advantages of this approach
–Cost reductions and quality improvements are explicitly
embedded in the budget

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Beyond Budgeting

• An alternative to budgeting? Has been used in

‘service sector industries’ such as banking.
• The beyond budgeting approach is based on a
employee empowerment model
• Core focus includes
–Extreme decentralisation of decision making
–‘Relative’ performance evaluation based on
benchmarking
–Replacing annual planning with adaptive and evolved
orientation using rolling forecasts

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Beyond budgeting

Radical decentralisation and accountability

–Gives individuals autonomy
–Allows for quick customer response
–Small devolved work teams
– contribute to strategic operational planning
– given profit responsibility
–Employees only held accountable for items and costs
under direct/indirect influence

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Beyond budgeting

Accounting and reward systems

–Timely reporting of information
–Performance reports that only measure what people
can influence
–Information that reflects critical performance variables
linked to strategy (goal congruence)
–Reporting of trends (to highlight impending problems)
–Information about charges from services utilised (no
arbitrary allocations)

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Beyond budgeting

Relative performance evaluation

–Performance measurement relies on direct
comparison with peers at varying layers
–Based on level of employee’s commitment towards
customers
–Reinforced by encouraging employees to be actively
involved in
– setting their own targets or goals
– continuously improving

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Comparing ‘Beyond Budgeting’ with traditional
incremental approaches
Principles Beyond Budgeting
Target setting Set aspirational goals for
continuous relative improvement
Rewards Reward shared success based on
relative improvement
Planning Make planning a continuous and
inclusive process
Controls Base controls on relative
performance indicators & trends
Resources Make resources available as
needed
Coordination Coordinate cross company
interactions dynamically
Traditional
Use fixed annual
targets
Reward based on
meeting fixed targets
Make planning a top-
down, annual event
Measure variances
against a fixed plan
Use annual budget
allocations
Use annual planning
cycles

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Comparing ‘Beyond Budgeting’ with traditional
incremental approaches
Principles Beyond Budgeting Traditional
Customer Focus everyone on improving Achieve vertically
focus customer outcomes negotiated targets
Accountability Create a network of teams Use centralised
accountable for results hierarchies
Work Champion success as winning in Take a contractual
environment the marketplace approach
Performance Give teams freedom & capability Adhere to fixed plans
to act
Governance Base governance on clear goals, Base governance on
values and boundaries detailed rules & budgets
Transparency Promote open and shared Restrict access to ‘need
environment to know’

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Budgeting - the ‘reality’ and the problems
A ‘fixed contract’ that leads to politics, game-playing,
empire-building
• Budgetary slack Distortion of inputs for establishment of achievable targets
• Budgetary mismanagement Not achieving above budget if only meeting
budget is rewarded

• Budget as a weapon Blame shifting to others if budget not achieved

• Make budget at any cost Don’t care about long-term goals; Don’t care
about the impact on other subunits

• Incremental approaches Need more revenue, less cost, more profit;

Focus on financial constraints (cost reduction) rather than managing towards goals
(value creation)

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Budget manipulation

• Incentives to manipulate budgets increase in larger

entities where managers tend to focus only on
resources and performance of their own
departments, rather than considering the entity as a
whole
• This can lead to submission of biased budget
requests which in turn results in misallocations of
resources among competing departments or projects

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The behavioural implications of budgeting

Excessive reliance on budgets

–Budget achievement does not necessarily mean goal
achievement
–Tendency towards meeting budget at any cost with little
consideration of long-term goals
–Minimal consideration of impacts on other parts of the
organisation
–Excessive focus on cost reduction rather than value
creation
–Compromise of quality, customer service, profitability
and long-run performance

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