BUDGETARY

CONTROL

MAF 551 MANAGEMENT ACCOUNTING AND CONTROL

 LEARNING OBJECTIVE
1. Distinguish between feed forward and
feedback control systems
2. Prepare fixed and flexible budgets
3. Prepare performance report
4. Discuss motivational, behavioral and
ethical issues of budgeting
5. Explain the limitations of budgeting
6. Describe the practice of Beyond
Budgeting
 INTRODUCTION
 The use of budgets in controlling
operations is known as budgetary control
and the centrepiece of budgetary control is
the use of budget reports.
Management needs to compare actual
results and planned activities, to monitor if
the business is spending according to
budget.
 FEATURES OF BUDGETARY CONTROL
Name of Primary
Report Frequency Purpose Recipient(s)
Sales Weekly Determine whether sales Top management and
goals are being met sales manager
Labor Weekly Control direct and indirect VP of production and
labor costs production department
managers
Scrap Daily Determine efficient use of Production manager
materials
Departmental Monthly Control overhead costs Department manager
overhead
costs
Selling Monthly Control selling expenses Sales manager
expenses
Income Monthly and Determine whether Top management
statement quarterly income objectives are
being met
FEEDBACK & FEED-FORWARD
CONTROL
 BUDGETARY CONTROL REPORT
Performance report or budgetary
control statement.
Compare actual results with the
budget.
Differences identified as variances.
Management role – investigate and
correct the variances if necessary.
 FIXED BUDGET
A fixed budget or static budget is a projection of budget data at
one level of activity.
Data for different levels of activity are ignored and actual results
are compared with budget data at the activity level used in
developing the master budget.
Used for planning purpose.
Fixed budget is not appropriate to assess a manager’s
performance in where he or she has control over variable costs.
Disadvantages:
It ignores the possibility that there can be variations in the
expected level of activity.
The analysis of the variances may be meaningless - not
being compared on a common basis.
 FIXED BUDGET – CONT…
Time / Costs Budgeted Actual Variance

1st Quarter RM180,000 RM179,000 RM1,000 (F)

2nd Quarter RM210,000 RM199,500 RM10,500 (F)

Total RM390,000 RM387,500 RM11,500 (F)

1) The comparison shows favourable variance in both the quarters

with a net effect of RM11,500 favourable variance, as a whole.

2) It can also be seen from the above that the activity levels are not
defined and the comparison between actual and budgeted
performance are based on purely monetary figures only.
 FLEXIBLE BUDGET
Designed to projects budget data for various level of activity
and it is a series of static budget at different level of activity.
Assist in decision-making where it facilitates the
management to predict its performance against levels of
activity through the impact of changes in variable costs and
sales value.
Used high and low method to differentiate the elements of
costs.
Will be used in performance reports to determine the
performance of the company.
 FLEXIBLE BUDGET – CONT…
Advantages of Flexible budgets:
Do not require frequent revision.
Geared towards a range of activity rather than
towards a single level of activity.
More accurately reflect changes in direct costs
resulting from variations in production mix or rate.
Provide a firmer basis for distributing the overhead
costs at different level.
Comparison between actual results and budgets
will become more meaningful.
 FLEXIBLE BUDGET – CONT…
Activity level
Direct labor hours 8,000 9,000 10,000 11,000 12,000
Variable costs RM RM RM RM RM
Indirect materials 12,000 13,500 15,000 16,500 18,000
Indirect labor 16,000 18,000 20,000 22,000 24,000
Utilities 4,000 4,500 5,000 5,500 6,000
Total variable costs 32,000 36,000 40,000 44,000 48,000
Fixed costs
Depreciation 15,000 15,000 15,000 15,000 15,000
Supervision 10,000 10,000 10,000 10,000 10,000
Property taxes 30,000 30,000 30,000 30,000 30,000
Total fixed costs 62,000 66,000 70,000 74,000 78,000
 FLEXIBLE BUDGET – CONT…
 If the actual direct labor is 10,000 with the actual costs listed, then the budget should be flexed too, as
shown in table, in order to compare with actual performance at that particular level.
 The difference, if any will show variance which can be expressed as either favorable if actual is less
than budget, whilst adverse if the actual is more than budget.

Flexed Actual Variance

Direct labor hours 10,000 10,000 0
Variable costs RM RM RM
Indirect materials 15,000 15,500 500 (A)
Indirect labor 20,000 21,000 1,000 (A)
Utilities 5,000 4,700 300 (F)
Total variable costs 40,000 41,200 1,200 (A)
Fixed costs
Depreciation 15,000 13,000 2,000 (F)
Supervision 10,000 9,000 1,000 (F)
Property taxes 30,000 34,000 4,000 (A)
Total fixed costs 55,000 56,000 1,000 (A)
 USES OF FLEXIBLE BUDGET
For planning purposes - 'contingency flexible
budgets‘.
 To find out in advance the costs it would have to
bear if output falls short of budget
 To decide whether it is possible to find
alternatives for spare capacity if output more
than budgeted
 To estimate costs of overtime or extra machine
hire if output is more than budgeted
For budgetary control purposes - Fairer and more
meaningful comparisons.
 BEHAVIOURAL CONSEQUENCES OF
BUDGETING
A budget affects everyone in an organisation.
 Preparer and users
 Performance evaluation

The arguments against involving managers in the preparation of

their budgets include:
1)Most managers will recognize that a budget will be used as a
target against which their performance will be measures. This
may tempt them to set an easier target by including some
budgetary slack.

2)The managers may have little knowledge of budgeting and be

unprepared for such a task.
 BEHAVIOURAL CONSEQUENCES OF
BUDGETING- CONT…

The arguments for involving managers in the preparation

of their budgets:
1)Most managers seek involvement in the planning of
their organizations so that they can enhance their sense
of belonging to the organization, and this motivate them.

2)If managers set their own targets, they can consider the
circumstances of their own division and make the target
attainable.
 BEHAVIOURAL CONSEQUENCES OF
BUDGETING- CONT…
 2 issues:
 Participative budgeting
 Budgetary slack
Budgets can be used as a performance measure
to decide on bonus and promotions - conflicts
arise due differences in opinion because of the
budgets set.
This will have consequences on management and
employee behavior.
A sound budgetary system will promote desirable
behavior and the right attitude
 1) PARTICIPATIVE BUDGETING
A process where managers who are held
accountable for budget performance help to
develop their own budget estimates.
The process of gaining acceptance of the
budget involved a lot of negotiation and
subsequent revisions of budget estimates.
Lengthy and time consuming.
 TOP DOWN (IMPOSED APPROACH)

Systems where senior managers impose budget

targets on more junior manager with little or not
consultation.
Set at corporate level and cascaded down
throughout the organisation.
Advantages:
 Timely and cost effective
Disadvantages:
 Senior managers may have less knowledge of the local
business environment – unrealistic
 Limited involvement in setting budget targets can result
in a lack of commitment of middle and junior managers.
 BOTTOM UP
(PARTICIPATIVE APPROACH)
 The participative process in which people at the lower managerial and
operational levels play an active role in setting their own budget.
 Budgets:
 collected at the lowest managerial levels and
 consolidated and fed up to senior management
 enhanced accuracy of estimates
 Advantages:
 Encourage coordination and communication between managers
 Greater understanding and appreciation of the objectives and
strategy of the wider organisation.
 Disadvantages:
 Expensive
 Time consuming
 Opportunities of padding the budget
 2) BUDGETARY SLACK

Padding the Budget - The practice of

underestimating revenues or overestimating
costs so that budget targets are easier to
achieve
Budgetary Slack – the difference between the
revenue or cost projections that a person
provides and a realistic estimates of that
revenue and cost
E.g. Annual utilities cost of RM18,000 but
estimated RM20,000 – has built RM2,000
slack.
 2) BUDGETARY SLACK- CONT..
Reasons for creating budgetary slack:
 People believe that their performance will look better if they
can “beat the budget”
 Budget is used to cope with uncertainty
 If nothing goes wrong, supervisor can beat the budget
 If unfortunate event occur, budgetary slack will absorb
 Managers are competing for limited resources – common for
their initial budget requests to be cut by their manager or the
budget review committee
 Budgetary projections are padded because they are likely to
be cut, and they are cut because they are likely to be padded.
 2) BUDGETARY SLACK- CONT..
How to solve?
Avoid relying on the budget as a negative
evaluation tool.
Allow some discretion to exceed the
budgeted costs when necessary
Managers can give incentives not only to
achieve budgetary projections but also to
provide accurate budget estimates.
 MOTIVATION & ETHICAL ISSUES OF
BUDGETING
Motivation is the drive in the employees’ attitude
needed to expedite operations based on budget.
Ethical issues involve honesty and trust of the
employees when exercising their responsibilities to
execute those operations based on budgets.
Any action which goes against this will cause
dysfunctional behaviour and upsets plans and
implementation.
 Dysfuntional behaviour – employees who does not
carry out duties morally as expected
LIMITATION OF BUDGETING
 BEYOND BUDGETING (BB)
 “A set of guiding principles that, if followed, will enable an organization to
manage its performance and decentralize its decision making process without
the need for traditional budgets. Its purpose is to enable the organization to
meet the success factors of the information economy (e.g. being adaptive in
unpredictable conditions).”
Beyond budgeting, p.212
 Not only a new approach to budgeting, resource allocation and operational
planning, but also a more holistic approach in strategy and corporate
performance management to overcome criticisms to traditional budgeting
 Prevent rapid response
 Detailed and expensive
 Out-of-date within a few months
 Enforce control and command
 Encourage unethical behaviour
 Empowered and adaptive organisation
 IMPORTANCE OF BB
Response rapidly to threats and
opportunities
Attracts and keeps the best people
Enable and encourages continuous
innovation
Leads to loyal and profitable customers
Support good governance and ethical
behaviur
BEYOND BUDGETING (BB)- CONT…
 12 PRINCIPLES OF BB
Values
Governance
Transparency
Teams
Trust
Accountability
Goals
Rewards
Planning
Coordination
Resources
Control