1

FINANCIAL PLANNING
AND ANALYSIS: THE
MASTER BUDGET
(PART II)

WEEK 3

Chapter 9
BY:
PROF DR RUZITA JUSOH
McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
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Learning Outcomes
After learning this topic, you should be able to:
❑ Alternative techniques of budgeting.
❑ Limitations of budgeting
❑ Feedback vs feedforward controls
❑ Describe the difference between participative and
authoritative budgeting approaches.
❑ Explain how budget difficulty influences managers’
behavior.
❑ Explain the budgetary slack concept.
Alternative Budgeting 3

Approaches
►Activity-based budgeting
►Zero-based budgeting
►Incremental budgeting
►Rolling budget
 Activity-Based Costing versus Activity
4
Based Budgeting (ABB)
Resources Resources
Activity-Based
Costing (ABC)

Activities Activities

Activity-Based
Cost objects: Budgeting (ABB)
Forecast of products
products and services and services to be
produced, and produced and
customers served. customers served.
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 5

https://hbr.org/1998/07/the-promise-and-peril-of-integrated-cost-systems
 Activity-Based Budgeting 6

►Activity-based budgeting is a budgeting

process based on activities and cost drivers of
operations
►It starts with the budgeted output and
segregates costs required for the budgeted
output into homogeneous activity cost pools
(such as unit, batch, product-sustaining, and
facility-sustaining activity cost pools)
 Zero-based Budgeting (ZBB) 7
►Zero-based budgeting (ZBB) is a budgeting process that
requires managers to prepare budgets from a zero base.
►resources are allocated to each activity without considering
the past budgets or achievements.
►A zero-base budgeting process allows no activities or functions
to be included in the budget unless managers can justify their
need
►Zero-based budgeting requires managers or budgeting teams
to perform in-depth reviews and analyses of all budget items
►Eliminates all sorts of inefficiencies and avoids any wasteful
expense.
►More time consuming
Incremental budgeting 8

► Incremental budgeting is a budgeting method where current year’s budget

is prepared by making changes in the past year’s budget.
► The changes are in the form of addition or reduction of expenses to last
year’s budget.
► Inefficiencies/wasteful expenses present in the activities are mostly
ignored.
► Less time consuming
► Easy to prepare
► do not require any specialized knowledge or training to prepare the
budget, not like zero-based budgeting
Limitations of Budgeting 9

Class exercise
 Feedback vs feedforward control systems
10

► Feedback control
► Aim to ensure that specific outcomes will be achieved
► Involve monitoring, measuring, investigating, taking
corrective actions, and providing rewards.
► Focus on cost control or cost containment.
► Cost as an ex-post (based on actual results rather than
forecasts)
Feedback control 11

► Focus on financially oriented information

► e g. Standard costing system
► Implications on managers:
► It can be very useful for detecting some kinds of
problems, but at the same time, it can also induce
employees and even managers to behave
unethically or dysfunctionally in order to meet the
preset goals.
Budgets and Feedback Control

► Budgets offer feedback in the form of variances: actual

results deviate from budgeted targets
► Variances provide managers with
► Early warning of problems
► A basis for performance evaluation
► A basis for strategy evaluation
Feedforward control 13

► cost as an ex ante (based on forecasts rather than

actual results)
► Feedforward control is done via plans, budgets,
standards and targets

► Refer to Feedforward/feedback control model by

Fitzgerald et al. (1991).
 Feed-forward control systems

Feed-forward approach:

• Monitoring is done at an early stage of a process where

prediction being made of anticipated future outputs.

• If the expected outputs differ from what outputs are desired,

control actions are implemented to minimise these
differences.
• Expected outcomes are compared with desired outcomes.
• These are revised in successive iterations until a desired
outcome is identified.

•Feed-forward control loops react to forthcoming dangers.

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
 Feedforward Control

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Feedback Control Report - Example

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

 Feedforward Control Report -
Example

McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.

Behavioral aspects of
budgeting

1. Participation in the budgetary

process (i.e goal/target setting)
►- Authoritative
►- Participative

►2. Degree of budget target

difficulty
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 Authoritative Budgeting

▪ Budgeting processes are either top down or bottom

up
▪ In a top-down budgeting process, top management
prepares budgets for the entire organization
(including those for lower-level operations)
▪ This process is often referred to as authoritative
budgeting.
▪ Leads to a lack of commitment/motivation on the
part of budgetees.

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 Participative Budgeting

•- In a bottom-up budgeting process, the people

affected by the budget, including lower-level
employees, are involved in the budget
preparation process
- This process is often referred
to as participative budgeting
►Generate commitment/motivation
to meeting the targets/objectives
- However, can lead to budget slack

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Participative Budgeting

Flow of
Budget Data
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Budgetary Slack
• Budgetary slack is a cushion created in a budget by
management to increase the chances of actual
performance beating the budget…easier to achieve

• It is like padding the budget.

• It is the difference between the budget amount and the
budget estimate.
• It is the deliberate under-estimation of budgeted
revenue or over-estimation of budgeted expenses- an
effort to make the resulting budgeted goals (profits) more
easily attainable.

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Behavioral Impact of Budgets

Budgetary Slack: Padding the Budget

People often perceive that their
performance will look better in
their superiors’ eyes if they can
“beat the budget.”

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 Difficulty Level of the Budget Target
• An easy budget target may fail to
encourage the employees to give their
best efforts
• A budget target that is very difficult to
achieve can, however, discourage
managers from even trying to attain it
• Ideally, budget targets
should be challenging
yet attainable (realistic target)

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 Budget Difficulty and Effort
High

Effort
Low
Easy Difficult
Budget
Difficulty

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The End

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