Budgeting thesis

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Titleof Dissertation
ASSESSMENTOFTHERELATIVEIMPORTANCEOFHAVINGTHEOLDTRADITIONAL
BUDGETINGTECHNIQUEASA PLANNINGANDMANAGEMENT CONTROLTOOL
AND ITSCRICITISMS.
Author
[FredM’mbololo
Supervisor
[ StefanoAttici]
Purpose of the thesis:
To contribute tothe budgeting theory ingeneral andmake recommendations
on how to improve on the oldtraditional budgeting technique.
Academic Year
[2013-2014]

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Acknowledgement
Thisthesisiswritten aspart of furtherresearchonbudgetingbut notforsubmittingforanyparticular
degree course. Thisresearchstudyprovidesme withdeeperunderstandingof how oldtraditional
budgetingactsas a planningand managementcontrol tool whilecriticallyassessingitscriticismsand
consideringthe alternativesmethodsof budgetingsuchasBeyondbudgetingandthe restas outlinedin
thisresearchstudy.
Firstof all,Ithank my HeavenlyFatherforthe Grace and Healthhe has grantedme
Secondly,Iappreciate Stefano Atticci forall hissupportand deepguidance duringthisresearchstudy.I
alsothank the facultymembersof LSBFfor theirendlesssupport.
Of course,itisneedlesstoshowmygratitude tomycolleagueshere inKenyawho participatedinthe
interviewsand helped me incollectingthe relevantdatathrough qualitativemethodapproach.
Finally,Ithankmyfamilyandfriendswhoprovidedme withapeace of mindandencouragedme to
complete this researchstudy.
FredM’mbololo
23, January,2014

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Abstract
Purpose – Traditional budgetsare seenbypractitionersasbeingincapableof meetingthe demands
of the competitiveenvironmentandare criticizedforimpedingefficientresource allocationand
encouragingdysfunctional behaviorsuchasmyopicdecisionmakingandbudgetgames.However,
budgetingisstill regardedasanorganizational imperative managementtool andthere islittle empirical
evidence thatorganizationsaltertheirexistingbudgetingpractices.Iintendtoassessthe relative
importance of havinga propertool forbudgetingversusthe abilityof whoever“owns”the budgeting
processto criticallyassessthe indicationsthatthe tool isgenerating.
Design/methodology/approach –A case studyA was chosenandthe use of budgetsas a management
control tool was assessedindetails,the budgetingprocesswasalsoreviewed,alternative methodsto
budgetingwere alsoconsidered.
Findings–The researchresultsconfirmthere isa contradiction of a highdegree of criticismon
traditional Budgetingasmanagementcontrol tool butveryfew organizationshave adoptedthe
alternative methodsof budgeting.Itseemsthatthere needs tobe acertainlevel of dissatisfaction
withinanorganizationintermsof dysfunctionalbehavior,gamingandgoal incongruency before itstarts
to examine itscurrent situationandsearchforalternatives.Assuch,itseemsthatsome momentumfor
change needstoexist before changesare considered,ratherthanthatorganizationsare continuously
lookingforthe best possible alternative totheirbudgetingprocess.A lackof a needforchange –
because the processis consideredsatisfactorilyefficient –is the mostimportantfactor why
organizationsare not consideringchangestotheirbudgetingprocess,followedbycognitiveand
preconsciousconstraints.
Originality/value –The papercontributestothe accountingliterature asitprovidesevidence onthe
factors thatcouldinfluence the acceptance of changes inthe budgetingprocess.Knowingthesefactors
will increase the chance thatmanagerscan successfullyintroduceandimplementanadjusted
budgetingprocessandhence criticallyevaluatebudgetingasanappropriate managementtool.
Keywords:Budgeting,Budgets, managementtool
Papertype Researchpaper

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Acronyms and Abbreviations
ABC ActivitybasedCosting
ABB Activitybasedbudgeting
ABM Activitybasedmanagement
BB Beyondbudgeting
BBRT Beyond budgetingroundtable
BSC Balance Score Card
CRM Customerrelationshipmanagement
EVA Economicvalue added
KPIs Keyperformance indicators
MCS Managementcontrol systems
RB Rollingbudgeting
RAPM Reliance onaccountingperformance measures
VBM Value basedmanagement
ZBB Zerobasedbudgeting

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Content of table
TITLE PAGE..................................................................................................................................................i
ACKNOWLEDGEMENTS............................................................................................................................ ii
ABSTRACT..................................................................................................................................................iii
ACRONYMS& ABBREVIATIONS................................................................................................................ iv
TABLE OF CONTENTS................................................................................................................................v
LIST OF TABLES..........................................................................................................................................xi
LIST OF FIGURES........................................................................................................................................xii
CHAPTER ONE: INTRODUCTIONTO THERESEARCH STUDY
1.0 Introduction............................................................................................................................1
1.1 ResearchBackground.................................................................................................2
1.2 Statementof the problem..........................................................................................3.
1.3 Purpose of the study...................................................................................................4.
1.4 Objectivesof the study...............................................................................................4
1.5 Research questions.....................................................................................................4
1.6 Significance of the study.............................................................................................5
1.7 Scope of the study......................................................................................................5
1.8 Assumptionsof the study...........................................................................................5
1.9 Limitationsof the study...............................................................................................6
1.10 Mitigatingfactorsto the study....................................................................................7

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1.11 Delimitationstothe study..................................................................................7
1.12 Definitionsof terms............................................................................................7
1.13 Structure of the study........................................................................................8
CHAPTER TWO: LITERATUREREVIEW ONBUDGETING
2.0 Introduction..........................................................................................11
2.1 Theory and Evolution of budgeting.............................................11.
2.1.1 The theory of budgeting...................................................11
2.1.2 Evolution of budgeting in France......................................12
2.1.3 Evolution of budgeting in Great Britain............................13.
2.1.4 Evolution of budgeting in United States............................13
2.1.5 Dramatic changes in budgeting.........................................15
2.1.6 Evolution of budgeting within the three waves of economic
change................................................................................16
2.2 Other descriptions of a budget and budgeting............................16
2.2.1 Uses of budgets..................................................................16
2.3 The process of budgeting.............................................................20
2.3.1 Budgeting process at Case study A......................................22
2.4 Classification of budgets...............................................................25
2.5 Problems with traditional budgeting in practice..........................26
2.5.1 Additional problems with traditional budgeting...............28
2.5.2 Other benefits of throwing out the budget process and its
associated annual performancetrap. ...............................32

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2.6 The role of budgetary data in performanceevaluation...............33
2.6.1 Budget constrained style....................................................33
2.6.2 A profit conscious style.......................................................33
2.6.3 A non-accounting style.......................................................33
2.7 Overview of activity-based budgeting...........................................36
2.7.1 The role of budgeting in planning and control....................36
2.7.2 Activity-based budgeting.....................................................37
2.7.3 The two main benefits of ABB.............................................38
2.7.4 Using ABM for operational improvements and strategic
Decisions...............................................................................40
2.7.5 A model of activity-based budgeting....................................44
2.8 Alternatives to traditional budgeting..............................................47
2.8.1 Rolling budget.......................................................................47
2.8.2 Activity-based budgeting...................................................... 48
2.8.3 ZBB beginnings.......................................................................50
2.8.3.1 What ZBB does...................................................51
2.8.3.2 ZBB basics...........................................................52
2.8.3.3 Identifications of organizational decision units..54
2.8.3.4 Construction of decision packages.....................54
2.8.3.5 Ranking of decision packages and allocation of
Resources.............................................................55
2.8.3.6 Applicability.........................................................59
2.8.3.7 What can we expect of ZBB.................................61
2.8.4 Beyond budgeting....................................................................62
2.8.4.1 The ‘beyond budgeting’ model-private sector....66

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2.8.4.2 The public sector..........................................68
2.9 Conclusion.........................................................................69
2.10 The beyond budgeting round table (BBRT).......................72
2.10.1 The beyond budgeting or coherent model...74
2.11 Balance Scorecard.............................................................78
2.12 Balance Scorecard as a management control tool............79
2.12.1 Strategy focused organization.......................81
2.12.2 Summary of literature review........................84
CHAPTER THREE: RESEARCH METHODOLOGY
3.0 Introduction............................................................................................87
3.1 Criticism of prior research methods.............................................87
3.2 Research philosophy.....................................................................90
3.2.1 Quantitative research.........................................................90
3.2.2 Qualitative research............................................................91
3.3 Validity, reliability and generalization............................................92
3.3.1 Data quality issues associated with semi-structured and in-
depth interviews..................................................................91
3.3.2 Reliability..............................................................................93
3.3.3 Validity..................................................................................94
3.3.4 Generalizability.....................................................................95
3.4 Secondary data................................................................................96
3.5 Primary data....................................................................................97
3.6 Data analysis....................................................................................97
3.7 Ethical considerations in the research study...................................98

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CHAPTER FOUR: FINDINGS, ANALYSISAND DISCUSSIONS
4.0 Introduction.....................................................................................102
4.1 Strategic planning..................................................................103
4.1.1 Operational Integration...............................................103
4.1.2 Performancemeasures................................................103
4.1.3 Progress evaluation.....................................................104
4.1.4 Reporting.....................................................................104
4.1.5 Analysis and continuous improvements......................104
4.2 Top down approach budgeting practices...............................106
4.2.1 Advantages of top-down approach of budgeting........106
4.2.2 Disadvantages of top-down approach of budgeting...106
4.3 Budget performance................................................................107
4.3.1 Budget as a fixed contract.............................................109
4.3.2 Performanceevaluation................................................109
4.3.2.1 Time consuming........................................110
4.3.2.2 Planning and forecasting...........................110
4.4 Uncertain and competitive environment.................................111
4.4.1 Budgets are rarely strategically focused and often
contradictory..................................................................111
CHAPTER FIVE: CONCLUSIONS, RECOMMENDATIONS AND FURTHERRESEARCH
5.0 Introduction.........................................................................................112
5.1 Some criticisms of the current budgeting systemas a management
control tool................................................................................113

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5.2 Budgeting at Borealis company........................................................115
5.3 Recommendations...........................................................................116
5.4 The ‘beyond budgeting’ journey towards adaptivemanagement...122
5.5 Areas for further research study......................................................127
6.0 References.......................................................................................128

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List of tables:
1. How the budget underminesthe various budgetingmodels............................................32
2. Comparingtraditional andbeyondbudgetingprocesses.................................................71
3. The principlesof the coherentmodel...............................................................................74
4. How leadersneedtochange tomeettoday’scompetitive successfactors...................75
5. The three conditionsrelatedtofive majorresearchstrategies.......................................92

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List of figures:
1. Structure of the researchstudy..............................................................................................10
2. Evolution.................................................................................................................................15
3. Outline of the budgetaryprocess...........................................................................................19
4. Budgetaryprocess...................................................................................................................22
5. Illustrationof masterbudget....................................................................................................24
6. Pitfallsof conventional budgeting.............................................................................................29
7. Purposesof budgeting...............................................................................................................36
8. ABCand ABB compared.............................................................................................................39
9. UsingABM foroperational improvementsandstrategicdecisions...........................................40
10.. Outputsof the ABMmodel......................................................................................................42
11. A model of ABB..........................................................................................................................43
12 Overview of the ABBapproach...................................................................................................46
13. Summaryof the rollingbudget..................................................................................................48
14. Summaryof ABB........................................................................................................................49
15. A brief historyof zero-base budgeting......................................................................................50
16. Decisionpackage form...............................................................................................................53
17. Formulationof decisionpackages..............................................................................................55
18. Summaryof ZBB.........................................................................................................................58
19. Management’sinvolvementinthe zero-basedbudgeting........................................................60
20. Advantagesof beyondbudgeting..............................................................................................62
21. Summaryof beyondbudgetingmodel-private sector...............................................................67
22. Summaryof beyondbudgetingmodel-publicsector.................................................................70
23 Traditional budgetingmodel versusthe beyondbudgetingmodel............................................72
24. Managementtoolsandtheirrelationshipwithbudgeting........................................................77
25. Using BSC as a strategicmanagementsystem..........................................................................79

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26. Linkingstrategytobudgetsina step-downprocedure................................................................81
27. Balance Scorecardstrategymap..................................................................................................82
28. The principlesof astrategyfocusedorganization........................................................................83
29. Impactof advancedbudgetingtechniqueson oldtraditional budgeting.....................................86
30. The budgetperformance cycle....................................................................................................105
31. Breakingthe budgetatBorealis-the fourpillarsof the budget-lessorganization.......................115
32. Separatingperformance managementfromfinancialreporting.................................................116
33. The beyondbudgetingidea;the continuousadaptive process....................................................121

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Chapter 1-Introductiontothe ResearchStudy
1.0 Introduction
Budgetingis“still regardedasanorganizational imperative if costsare to be controlled andfinancial performanceto
be achieved”(Frow,Marginson, Ogden.,2010). However,traditional budgetsare seenbypractitionersof being
incapable of meeting the demands of the competitive environment(Ekhol andWallin,2000, p. 1; Østergren and
Stensaker,2011, p. 150) and are heavilycriticizedforimpedingefficientresource allocation,encouragingmyopic
decisionmakingandencouragingbudgetgames
(Otley,2003; Hansen et al.,2003; Hope and Fraser,2003). At the same time there seemstobe little empirical
evidence of organizationsadoptingneworadjusted budgetingpractices (EkholmandWallin, 2000).
Beyondbudgetingis:
‘An idea thatcompaniesneed to movebeyond budgeting becauseof theinherentflawsin budgeting
especially when used to set contracts.Itis argued thata rangeof techniques,such asrolling forecastsand
marketrelated targets,can takethe place of traditionalbudgeting.’
CIMA OfficialTerminology,2005
BeyondBudgetinghasbeenproposedasan influentialideathatwill reinvigorate managementaccounting
contributioninbusiness operationandperformance.Itisclaimedthatthe traditional system
has lostrelevance withthe modernbusinessenvironmentandisno longersatisfyingthe needsof managers.
Budgetshave beeningrained inthe culture of businesssince theirinceptioninthe 1920s and
managerswill finditextremelydifficulttoradicallyshifttoasystemwithoutbudgets.The implicationsof aBeyond
Budgetingsystemare; performance measuresrelative tocompetitorsanda decentralized
organization structure.
Alternativessuchasthe rollingbudgetingandactivitybasedbudgeting techniquesmaybe more favorable to
managementwhodesiresaformal planningandcontrol system butthe problemisthattheyare evenmore time
consumingthanthe traditional budgetingtechniqueshence maynotbe consideredasanappropriate substitute
managementcontrol tool.The BeyondBudgetingconceptis still initsinfancyandrequiresfurtherdevelopmentand
practical implementation.
Hope and Fraser(2003) contendedthatthe budgetingsystem, asimplementedbymostbusinesses,
shouldbe eradicated.The budgetingdebate hasarisendue toamovementintothe informationage (Drury,2008).

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Thisthesis discusseshowbudgetinghasevolvedintoits currentstate,before examiningwhythisuniversal
technique hascome undersuchheavy criticismof late.The limitationsandweaknessesof usingthe traditional
budgetingsystem asamanagementtool will be assesseddoingthe appropriate literaturereview..Atthe core of this
researchstudy isthe evaluation whetherthe BeyondBudgetingmodel ismore relevantintoday’s business
environmentandif itcan be a prominent managementtool inthe future practicesof managementaccounting
1.1 Research Background
I choose a qualitative studyinordertoanswerthe researchquestions. The directorsof this chosen company
wantedthe name of the companyto remainanonymoushence Iwill onlyrefertoitas Case studyA.
Gerring,(2004:341) suggeststhatregretfully,the term“case study”isa definitional morass. Toreferto a work as a
case studymightmean(a) that itsmethodisqualitative, small-N (Yin1994);(b) that the researchis ethnographic,
clinical,participant-observation,orotherwise“inthe field”(Yin1994); (c) thatthe researchischaracterizedby
process-tracing(George andBennett2004);(d) that the researchinvestigatesthe propertiesof asingle case
(Campbell andStanley1963, ; Eckstein[1975] 1992); or (e) thatthe researchinvestigatesasingle phenomenon,
instance,orexample (the mostcommonusage).
Case StudyA isa local medium-sizedcompanybasedinKenyaandwasestablishedinthe 1990’s; itoperatesina
competitivemarketwithshiftingconditions. Ithasa few directorswhoare at the same time shareholders. I had an
opportunitytoworkinthat companyand realizedthatthe budgetingprocesswasnotalwaystakenseriouslyby
boththe executive managementandthe subordinate staff. Inthe past capital assetshave beenboughtwithoutany
formal analysisdone andoutside the budgetedfiguresconsequentlythe companyincurredabig bankloanand has
beenrunningona bankoverdraftto finance itsworkingcapital.
The banks have of late compelledthe companytocarry outbudgetingastheyneedtosee the companyvari ous
budgets tosee whetherthe companywill defaultonthe interestpaymentsandloanpayments. The budgetsare
usedinthe companyas a performance evaluator forall itsstaff and alsousedas the ultimate managementplanning
and control tool.
The budgetingprocessusedisthe oldtraditional budgetingprocess,financial indicatorsare the onlyKey
performance indicatorswhile the non-financial indicatorsare largelyignored,itisatop downapproach budgeting
approach andbudgetstargetsare imposedonthe lowermanagementlevels. The managementstyle isautocratic,
goodachieverswhomeetthe budgetedtargetsare rewardedwithadditional bonuswhilenon-achieversare
severely punishedand insome casesactuallydismissed fromwork thusthere isahighturnoverof staff. There is

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hardlyany participative budgetingstyleadoptedinthe company,communicationandco-ordinationof activitiesis
usuallypoor. The variance analysis isusually done atthe year-endbythe accountantbutisrarely givenback as
feedbacktothe subordinate staff toenable themimprove orcorrecttheirprocesses.
1.2 Problemstatement
Case studyA for manyyearshas usedthe traditional budgetingasa managementtool,theyhave notalways
preparedthe annual budgets some years back,the annual budgetwasnot preparednot because the companywas
practicingbeyondbudgetingbutthe mainreasonwasthe accountant’slack of knowledge onthe budgetingprocess
or importance of budgets. Thusthe company is notable to complywiththe annual budget. The problemsthatface
case studyA are numerous,tostart with,the budgetaryprocessis usuallyatopbottommanagementandis not
punctual and the budgetworkscounterproductive due tothe unrealistictargets.
Secondly,the performanceculture isunsatisfactory. AtCase StudyA, the participantsof the budgetaryprocessdo
not always workas a team,there isa lot of gaming,dysfunctional behaviorandincongruence inthe company inthat
certainindividuals only strivetoattaintheirowngoals while overlookingthe importance of the overall
organizational objectivesandgoalsandonlya few individualstrytorealistic achieve the companybudgetswhichare
useful andveryhighbutat leastattainable. Therefore,synergiesfromrunningefficientprocessesand
accountabilityare fullymissed,andthe budgetmissesitspurpose asa planningand control managementtool for
the organizationdue lackof communicationandco-ordinationof activities
And thirdly,the companyhasnumerousbankoverdraftsandloanstherefore the topmanagementis always
compelledtoprepare budgetsforthemmainlythe cashbudgetandthe budgetedincomesstatementandbalance
sheetforthe nextfive yearstosatisfythe bankconditions
Therefore,itisnecessaryto critical assess traditionalbudgetingasamanagementplanningand control tool andalso
lookat the criticismof thistool and the personincharge of the budgetingprocess.The availableliterature and
analysisshouldshowwhetherthe traditional budgetingprocessis still avalidmanagementcontrol tool or
alternative budgetingtechniquesare bettertools.

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1.3 Purpose of the study
Many organizationsmainly use the traditional budgetingprocessasa managementtool toplanandcontrol the
businessoperationsandinordertoassessthe relative importance of havingapropertool forbudgetingand
criticismof usingthattool at organization- Case studyA. The traditional budgetingprocessisdiscussedindepthis
compared to the alternative budgetingtechniquesthathave beendevelopedrecently.
The thesiswill contributetoa betterunderstandingof the traditional budgetingprocessinaholisticwayandto
explainthe weaknessesof budgetarycontrol thathave beenfoundinthe literature.A goodunderstandingof the
budgetingprocessisanecessityforelaboratingonthe alternative budgetingtechniquesthathave beendeveloped
to overcome those weaknesses.
1.4 Objectivesofthe Study
To fulfil the purpose of the Research,the followingobjectiveswillbe addressed.
(i) To describe and examinethe budgetingprocessat Case StudyA and make recommendationsonhowto
improve it
(ii) To contribute tothe available literature byexploringthe traditionalbudgetingasamanagement
planningandcontrol tool and consideringthe alternative methodsof budgeting.
(iii) To describe and examinethe budgetperformance of Case StudyA andmake recommendationonhow
to improve whileconsideringthe alternativestothe oldtraditional budgeting andhow theycanbe
implementedinthe company
(iv) To describe andestablishthe relationshipbetweenthe budgetingprocessandbudgetperformance and
make suggestionsonhowtoimprove it.
(v) Criticallyevaluate the importance of the oldtraditional budgetingasamanagementplanningand
control tool at Case studyA.
1.5 Research Questions
(i) What isthe budgetingprocessat Case StudyA
(ii) Whatisthe budgetperformance of Case StudyA
(iii) Whatisthe relationshipbetweenthe budgetingprocessandperformance in Case StudyA
(iv) ShouldCase StudyA Ltd abandonthe traditional budgetingpracticesandadoptotheralternative
budgetingtechniqueslike beyondbudgetingapproach.

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1.6 Significance of the Study
(i) The studywill benefitthe Shareholders,directorsandthe managementteamof Case StudyA by helpingthem
finda solutiontothe problemof poorbudgetperformance.
(ii) The studywill be usedbyacademiciansandotherresearchersfor furtherresearchwork.
(iii) Make suggestionsandrecommendations thatwill goalong wayinimprovingthe qualityof the budgeting
processthat will improve budgetperformance at Case StudyA
(iv) The study will be usedtoassessthe linkage andrelationshipbetweenbudgetingprocessand
performance.
1.7 Scope of the Study
(i) The studywas focusedonthe budgetingprocessintermsof level of participation,degreeof feedbackandcontrol
and overall budgetperformance.
(ii) Generallyassessthe importanceof havingbudgetingasa managementtool andcriticizingthe importance of that
tool.
1.8 Assumptionsof the Study
The researcher made the following assumptions regarding this study:
i. Participantsansweredthe interviewandsurveyquestionsabout budgets and budgeting process within the
organization truthfully.
ii. Participants were familiar enough with the budgeting process to answer the survey questions.
iii. The researcherexpectedthe entire exercise to move on smoothly relying on the maximum cooperation of
all those who were involved. That the case study was ideal to examine the traditional budgeting as a
management tool and also assess the alternative methods of traditional budgeting, the data collection
instruments had validity and measured the desired parameters and that the participants truthfully and
correctly answered the questions.

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1.9 Limitationsof the Study
Limitationsare potentialweaknessesorproblemswiththe studyidentifiedby the researcher. The limitations often
relate toinadequate measures of variables,lossor lack of participants, small sample sizes, errors in measurement,
and other factors typically related to data collection and analysis. These limitations are useful to other potential
researchers who may choose to conduct a similar or replication study (Creswell, 2005).
The limitations of this qualitative case study include;
i. The study involved the perception of participants of a budgeting process but was only within one
organization-Case Study A.
ii. Perceptions of those who participated are not factual information and are biased based on the
participant’s own experiences and attitudes.
iii. The expanse of the study area, inadequate financial resources and time constraints also reduced the
chances of interviewing more participants and reviewing in details the budgeting process over a given
period of time.
iv. Concern that case studies lack rigor: Case studies have been viewed in the evaluation and
research fields as less rigorous than surveys or other methods. Reasons for this include the
fact that qualitative research in general is still considered unscientific by some and in many
cases, case study researchers have not been systematic in their data collection or have
allowed bias in their findings.
v. Not generalizable: A common complaint about case studies is that it is difficult to generalize
fromone case to another.Butcase studieshave alsobeenprone toovergeneralization, which comes from
selecting a few examples and assuming without evidence that they are typical or representative of the
population.

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1.10 Mitigation factors to the study
These limitations were mitigated by making sure that;
i. The data was collected from individuals who were closely involved or participated in the budgeting
process and knowledgeable enough for this study.
ii. In writingthe case study,care was takento provide the richinformationinadigestible manner by using
a lot of diagrams and simple illustrations.
iii. In conductingandwritingthe case study, care has been used in being systematic in the data collection
and take steps to ensure validity and reliability in the study and bias findings was also avoided.
iv. Yin,a prominentresearcher,advisescase studyanalyststogeneralizefindings to theories, as a scientist
generalizes from experimental results to theories
, iv The case studyshownwasappropriate throughpilotingandcareful scrutinyof the perceivedparameters
involved in the budgeting process.
1.11 Delimitationstothe Study
Delimitation narrows the scope of the study. The follow were delimitations of this study:
i. Participation in this study was voluntary.
ii. The case study only covered the budgeting process in details in one organization.
1.12 Definitionofterms
Budget:
Bhimani,Horngren,Datar& Foster,(2008) define abudgetasa quantitative future plancreatedbymanagersto
assistthe implementationof thisplan. A budgetisan agreeduponplan,expressedinfinancial terms,againstwhich
performance tobe realizedinthe future ismeasuredandcompared(de Waal etal.,2004).
Shimand Siegel,(2009) gave the mostcomprehensivedefinitionof abudgetas a follows;
“A budgetis defined asthe formalexpression of plans,goals,and objectivesof management
thatcoversall aspectsof operationsfora designated timeperiod.The budgetis a tool
providing targetsand direction.Budgetsprovidecontroloverthe immediate environment,help

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to masterthe financialaspectsof the job and department,and solveproblemsbeforethey
occur.Budgetsfocuson the importanceof evaluating alternativeactionsbeforedecisions
actually are implemented.
A budgetis a financial plan to controlfutureoperationsand results.Itis needed to operate
effectively and efficiently.Budgeting,when used effectively,is a techniqueresulting in
systematic,productivemanagement.Budgeting facilitatescontroland communication andalso
providesmotivation to employees.”
As such,the budgetisa financial reflectionof the organization’sannual operatingplan,whichinturnisa translation
of the long-termstrategicobjectivesintoshort-termactions.
Budgetingprocess
The budgetingprocessisthe iterative processinwhichthe budgetisdeterminedinseveral roundsof dialogue
betweenhigherandlowermanagementlevels.Thisdialogue resultsinaperformance contractbetweenlowerand
highermanagement,stipulatingthe targetstobe achieved.Throughoutthe year, the organizationchecks regularly
(oftenmonthly)whetheritisstill ontrackto reach itstargets.Thus, the budget isoftenusedforcontrol purposes
withinthe organization.
1.13 Structure of the study:
Chapter1: Thisresearch studyaimsto 1) assesscriticallythe oldtraditional budgetingprocessasaplanningand
managementcontrol tool,itscriticismsandatthe same time evaluate the otheralternative budgetingtechniques,2)
discussthe budgetingprocessandperformance andsuggestsolutionsand3) To describe andestablishthe
relationshipbetweenthe budgetingprocessandbudgetperformance andmake suggestionsonhow toimprove it.
Chapter2 will focusonthe literature review of budgeting. Itsstartswithdiscussing the theoryand evolutionof
budgeting,thenotherdescriptionsof budgeting,the usesandtypesof budgets,criticismsof the oldtraditional
budgeting,the commonbudgetingstylesusedbycompanies andotheralternativesof budgetingare alsodiscussed
indetails

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Chapter3 It does discussthe researchmethodologyusedinthisstudy. Itelaboratesonthe criticismsof the prior
researchmethods. Italsoexplainsthe reasonwhythe qualitativemethodof datacollectionwaspreferredoverthe
quantitative one,the rationale of the researchapproachusedandalsoethical considerationsare explainedindepth.
Chapter4 The chapterfocuses mainlyonthe findings,analysisanddiscussionof the researchresults. The chapter
explainsthe currentproblemsfoundin Case StudyA,budgetary processbasedon itsweaknesses. The use of the
budgetsasa performance evaluatorandasa managementcontrol tool isevaluated. The oldtraditional budgeting
process isbenchmarkedagainstthe otheralternativebudgetingtechniques like activity-basedbudgeting(ABB),
Zero-basedbudgeting,beyondbudgetingtechniquesandthe like thathave been developedrecently decadesto
overcome those weaknesses.
Chapter5 will summarizethe main conclusions fromthis researchstudy.Itwill alsodiscussthe recommendations
and implications forundertakingfurtherresearchinthisfield.
Basedon the outcome,anoverviewof the actionsandcontrolswill be giventoensure the bestviablebudgeting
solutionforCase studyA.

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Figure1: Structure of the Researchstudy
Chapter 1: Introduction of the Research study
Problemdefinition, research purpose andobjectives, andstructure ofthe thesis
Chapter 2: Literature Review on budgeting ingeneral
TheoryandEvolutionof budgeting, Usesand types ofbudgets, budgetingtechniques
Chapter 5: Conclusions
Conclusions, recommendations andfurther researchwork
Chapter 3: Research Methodology
Criticisms of priormethods, rationale forthe qualitative approach andethical considerations
Chapter 4: Findings/Analysis and Discussions of the results
Budgetaryprocess andproblems, alternative budgeting techniques reviewed

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Chapter 2: LITERATURE REVIEW ON BUDGETING
2.0 Introduction:
Thischapter mainly focusesonthe literaturereview of budgeting ingeneral.Itsstartswithdiscussingthe theoryand
evolutionof budgeting inthe developednationslikeFrance,GreatBritain,the UnitedStates,the evolutionof
budgetinginthree economicwave is alsodiscussed. The otherdescriptionsof budgeting are given,the usesand
typesof budgets are explained,the criticismsof the oldtraditional budgeting asa planningandmanagementcontrol
tool is discussed,the commonbudgetingstylesusedbycompaniesandotheralternativesof budgeting processes
are elaboratedonandtheirsuitabilityincomparisontothe oldtraditional budgetingtechnique isalsocritically
assessed
2.1 Theory and Evolution ofBudgeting
2.1.1 The Theory of budgeting
In social sciencesatheoryisa testable model of humaninteractionscapable of predictingfuture occurrencesor
eventsof the same kindas well ascapable of beingtestedthroughexperimentorotherwise verifiedthrough
observation.Budgetingdoesnothave atheoryinthe classical sense of providinganorientationtothe field,stating
assumptionsandpointingtosome hypothesesaboutwhatcauseswhat(Rubin1997).
Accordingto Rubin,budgettheory“isfragmentedandincomplete…[it] isinthe process of beinginvented”(Rubin
1997: 185). Inother words,the theoryof effectivebudgeting iscontinuallyevolving.Scholarssee “the studyof
budgetingaspart of a largerresearch agendawhichwouldultimatelyenable prediction of consequencesandthe
comparative analysisof governmentalpolicy”(Caiden1994: 44).
Many budgetpolicies,procedures,andtechnical practicesthatwe currentlyassociate withmodernbudgetingwere
developedduringthe nineteenthcenturywhenmajorchangesinbudgetpracticesoccurredinFrance.Atthe time
Napoleon’sprimaryconcernwaswithmasteringthe militarybudget.Toobtainbetterinformationandcontrol on
militaryspending,Napoleon establishedthe CoursdesComptes(WebberandWildavsky 1986).

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2.1.2 Evolution of budgetinginFrance
Early 19th centuryFrance sawthe establishmentof the wordsbudgetandbudgetaryprocedures.Bythe 1860s,
France had developedauniformaccountingsystemthatitappliedtoall departmentsandunitswithindepartments,
a standard fiscal year,conventionsonhowlongencumbrancescanbe heldopenafterthe close of the fiscal year,
and a requirementthatall departmentsexplainprogrammaticallyandaccountfiscallyforall fundswhichtheywere
allocated.The budgetwasconsideredtobe one of the government’sprimarypolicydocuments.Indeed,the control
of governmentexpenditureswasassuredthroughthe schedulingof expendituresbydifferentdepartments.
Expenditure claimsthatexceededabudgetcategory wouldnotbe honoredforpayment.
2.1.3 Evolution of budgetingin Great Britain
Britishbudgetarypracticesof the mid-19thcenturylackednotonlymanyof the technical featuresof the French
budgetarysystem,buthadnotadoptedthe emphasisonconsistencyanduniversalityof applicationthatwascentral
to the underlyingpublicsectorbudgetprocess.Forexample,althoughmostfundsunderthe mid-19thcentury
Britishsystemwere appropriatedbyParliament,there wasnosingulardocumentreflectingall government
expenditures,nocomparisonsbetweenbudgetedexpendituresversusactual expenditures,anddifferentaccounting
mechanismswhere usedbyvariousdepartments.Lumpsumappropriationswere widelyused.Duringthe period
whenWilliamGladstonewas Chancellorof the ExchequerandlaterPrime Minister,he andotherreformers
integratedmanyof the more advancedfeaturesof Frenchbudgetarytechniquesasa wayof controllinggovernment
finances.
For example,in1861 the PublicAccountsCommittee wascreatedinEngland.
In 1866, the officesof the Comptrollerand AuditorGeneral were created.
Gladstone emphasizedthe notionof balancingthe budget.
Thisprincipal became atechnical feature of hisbudgets(WebberandWildavsky1986).
Thus bythe endof the 19th centurythe frameworkformoderngovernmentbudgeting
(unity,balance,comprehensiveness,andcontrol) hademergedinEurope.

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2.1.4 Evolution of budgetingin the UnitedStates
In contrastto Europe,budgetreforminthe UnitedStateswas initiallyestablished atthe local notnational
governmentlevels.Thiswasinpartdue to the fact that the public hadmore directcontrol overlocal activities.Mass
immigration,coupledwithincreasing industrializationandurbanization,createdlarge demandsuponlocal
governmentsforhousing,education,healthcare andtransportation(Rabin1997; WebberandWildavsky 1986).
To more efficientlymanage theseincreasingdemandsongovernmentservices, Standardized accounting,reporting,
and auditingpracticeswere introduced.
The budgetingprocessinthe UnitedStateswaslargelyimpactedbytwocompetingcoalitions:
(1) The Federalists(Whigs) whosupportedanactive governmenttopromote commerce,buildinfrastructure
necessaryforeconomicactivity, anddevelopthe financial institutionsnecessarytosupporteconomicgrowth;and,
(2) The Republicans(DemocraticRepublicans,thenlaterDemocrats) whobelievedthattaxesshouldbe keptlow
and governmentkeptata minimumsothatsmall farmersandtradesmancouldfreelypursue theirtrade without
governmenthindrance (Rabin1997).
Competingcoalitionswere keptinequilibriumthroughthe normof abalancedbudget.The normof a balanced
budgetsolidifiedintoapractical limitationongovernmentactivity.Ratherthandevelopingthe technical capabilities
to control spendingaswasoccurring inEurope,the UnitedStatescontrolledbudgetaryoutlayssimplybykeeping
the governmentsmall (WebberandWildavsky1986).
Congressitself hadnomechanismtoensure thatappropriate spendingwasbeingimplementedwithout
modifications.
To addressthe problemsof mountingdebt,the fragmentationof powerandthe absence of publicaccountability
and control incombatingcorruption19th and 20th
century budgetreformersinthe U.S.proposedanarray of
improvementsincludinguniformaccountingandauditingpractices,andaseriesof practicesforfinancial planning
and administrationthatcame to be knownas the executive budgetmovement.Central tothe reformsinthe U.S.of
thisera wasthe conceptof the responsible executive (i.e.,astrongmayor).Ineffect,reformerswere adoptingmany
of the businesspracticesof the daywithstrongexecutiveauthority(i.e.astrongbusinessexecutive).The first

14
principal of thismovementbecamethatbudgetsshouldbe developedandproposedbythe executivetoaccomplish
statedobjectivesforwhichthe executive wouldlaterbe held accountable tothe voters.
For fiscal clarity,budgetswouldbe unifiedandencompassnot onlyexpendituresbutalsorevenues.Publicsector
budgetingwouldessentiallyfollowthe practice of Americancorporationsbybeingcomprehensive,balancedand
annual (Taylor1911).
A uniformaccountingsystem, the establishmentof acomptroller,andprotocols forbothreportingandauditing
wouldaidthe developmentandimplementationof the budget.
A keydevelopmentinbudgettheoryhasbeenthe differentiationbetweenmicrobudgeting andmacro-budgeting
and the inherenttensionbetweenthem(LeLoup,1988).
Macro-budgetingiswhere highlevel decisionsonspending,revenue anddeficit aggregatesandrelative budget
share are oftenmade fromthe top down.Micro-budgetingiswhere intermediatelevel decisionsonagencies,
programs,and line-itemsare usually made fromthe bottomup.Bothlevelsof budgetinganalysisare interestedin
howpowerisstructuredinbudgetaryprocessesaswell ashow it isexercisedandexpressedthrough budgetary
choices.These techniqueshelpedtolinkbudgetingtoalarger agendaof improvingpublicsectorperformance.
The evolutionof budgettheoryandpolicy-makingpracticesillustratesthat undeniable progresshasbeenachieved,
oftenonmodestfrontsandwithreasonably simpletechniques.Budgetpracticesacrossthe globe have been
graduallyevolvinginto becomingmore uniformwithrespecttoaccountingandauditingpractices,balance,and
control.Lost inthe evolutionof effective budgetingpracticesisthe identificationof demandside (social
accountabilitytothe local community) issuesof identificationof
needs(budgetplanning),managerial efficiency(budgetexecution),andeffectivenessof implementation(budget
execution).

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2.1.5 Dramatic changesin budgeting
In the 1980s and 1990s, bothnational andsubnational governmentshave witnesseddramaticchangesinbudgeting.
Alongthe way,decentralizationbecameanimportantcomponentof publicsectorreformeffortseliminatingthe
planningbureaucracy’smonopolyoverthe budget.Inmanycountries“[w]idespreadinterestindemocratization
encourageddevolutionof authoritytoautonomousmunicipal governmentsascounterweightstothe centralized
governmentsof the past,andinholdingregularlyscheduledelectionstotransferpowerfromtraditionalnational
level rulingelitestoaccountable electedofficials”(Guess1997:248).
In these countries,transitionfromcentrallyplannedsystemstodemocraciesledtoa demandforgreater
accountability,whichinreturnrequiredatransparentfinancialmanagementsystem.
An ongoingchallengeforcountriesinimplementingdecentralizationprogramsistodevelopcoordinatedbudgetary
and financial managementreformpoliciesacrosslevelsof governmenttoensure correspondence withnational
macroeconomicobjectivesforinflation,growth,fiscal andmonetary stabilization (Ter-Minassian,1997) and linking
betterbudgetformulationandexpenditure processestoproactive civilinvolvementand oversight.
Figure 2: Evolutionof budgetingwithinthe three waves of economicchange:

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2.1.6 Evolution of budgetingwithinthe three wavesof economicchange:
In the informationanddigital erawithinwhichcompaniesoperate today,the keycompetitiveconstraintisnolonger
land,laboror capital. It is knowledge orintellectual capital,competentmanagers,skilledworkers,effectivesystems,
loyal customersandstrongbrands (Hope andFraser,1997:20).
Thisis the periodtheycall “informationwave”,inwhichthe waya successful companyoperatesisshiftingfroma
“make-and-sell”toa “sense-andrespond”approach.
“Make-and-sell”isanindustrial-age model basedontransactions,capital assets,massproduction,economiesof
scale and productmargins,while “sense-andrespond”isaninformationandservice age model whichemphasizes
clientrelationships,intellectual assets,masscustomization,economiesof scope andvalue creation(Fraser,2001,24)
If we closelylookatthe timeframe inthe above figure,itcanbe notedthat advancedbudgetingmodelshave been
developedonlyrecently. Inmy ownopinion,these modelsportrayanatural response fromcompaniesthathave
had to slowlyevolve inordertoavoidextinctionandcontinue survivinginthe currentmarket.
2.2 Other descriptionsof a budget and budgeting
A budgetis a periodicquantitative andfinancial expressionof future plansof action. Budgetingisthe processby
whichthe plansof action are chosen,coordinated,communicatedandevaluatedinthe organization.Thismeans
that budgetingconsistsof bothaplanninganddecisionmakingex ante aswell asmonitoringandperformance
measurementex post.Itmustlikewisebe noticedthatbudgetingischaracterizedbybeingperiodiceconomic
managementthathasto be coordinatedwiththe strategicobjectivesanddecisionslike choice of placement,
technology,markets,customersetc.onthe one handand the operational daytoday decisionsonthe other.There
are several factorsthatmake budgetingimportantfordecisionmakingandmanagementcontrol tool.
2.21 Uses of budgets
Firstly,budgetingplaysacrucial role inthe goal setting (targetsetting) procedure inmanyorganizationsasitsets
the standard forthe performance inthe comingperiod.Asmentionedearlierresearchfromdifferenttheoretical
standpointshasovertime paida lotof attentiontothe effectsbudgetparticipationintargetsettinghason
organizational performance.Likewisethe relationshipbetweenbudgettargetachievability(budgetdifficulty) and

17
performance hasgainedinterestasa researchobject.While there are anagreementinthe literature onthateasy
achievable targetsleadstopoorperformance there maystillexistsdifferencesinthe perceptionof how stretched
the targetsshouldbe to optimize the performance.While manyargue thatthe probabilitytoachieve budgettargets
islessthan 50 percenta classical studycarriedoutby Merchant& Manzoni (1989) findthattargets can be
challengingfororganizationsevenif theyare likelytobe achieved.
Secondly,budgetingopensupforthe possibilitytoefficientlyorganize the decision making and planningprocess in
the company.The circumstance that the companybecomesable toseparate the decisionpointsfromthe time of
executionof actionsleadstoareductionof the time pressure onthe organization.Thathappenswhenthe company
inits budgetdocumentsitsplannedactions,includingdate of executionandwhichpersonsandorganizational units
that will participate.If the companyplansa salescampaign,salesmaterialisfirstdesignedandproducedtoensure
that brochures,TV-commercialsetc.are readywhenthe salesseasonstarts.Butitalsohappenswhenthe decisions
requiresasignificantlyamountof analytical work.Thatistypical forstrategicdecisionslike marketdevelopment,
productdevelopmentorimplementationof new technology.These typesof decisionsrequiresaconscious
managementof the analytical andideageneratingworkthatprecede the choice of a new strategy.Inthat
connectionthe strengthof budgetingis,thatthe companyforeachbudgetperiodcandecide,whichdevelopment
tasksthat shall be carriedout, whoshall be involvedandwhenthe tasksshall be carriedout.
Thirdly,budgetingopensuptoa higherdegree of decentralization incertainphasesof the decisionmakingprocess.
It is,thus,possible toletdifferentpersonsinthe decisionmakingprocessthanthe onesthatwill have toexecute the
decision.Thiscanbe personswithknowledge withinmarketanalysis,advertising,planningasalespromotion,after
whichthisisprimarilycarriedoutby the company’ssalespeople.Anotherexamplecouldbe toinclude accountants
and productengineersinpreparationof the companysalesplanwiththe purpose of controllingsaleswithfocusof
profitabilityandthe utilizationof scarce productioncapacity.
Fourthly,control of a company’seconomyassumesthatthe company’s resources can,as far as possible,be adjusted
to the expectedlevel of activity.The opportunityforacquiringanddisposingof resourcesisnaturally controlledby
the opportunitytoadjustresourcestoactivitywhichisconditionedbyresourcesvariabilityandreversibility.
Resource adjustmentalsoappliesinsituationswhere the companyisateitherfull capacityorat capacitydeficiency
and where the capacityistherefore actingasa capacity constraint.Insuch situationsperiodicplanningwith
budgetingisone wayof ensuringthatthe scarce capacityis usedinthe besteconomicwaypossible.
Fifthly,budgetinggivesthe opportunitytoensure coordination of activitycreationacrossbusinessfunctions.By
coordinationisinthiscontextunderstoodas thecoordination of decisions inseveral instances.The needfor
coordinationariseswhenmore functionsororganizational departmentstogetherhave toparticipate inthe business
activity. Intradingcompaniesitcouldbe purchasingandsale,inmanufacturingcompaniesthisalsoincludes

18
productionandinservice companiesitcanbe the differentspecialistfunctionsthatworktogether.Butthe need for
coordinationalsomayexistwhenitcomestothe company’sotherfunctionssuchasHR, finance andresearchand
development.A numberof the tasksperformedbya HR departmentlike hiringandfiringof employees,employee
trainingandthe development of employee policiesare largelycontrolledbythe “demand”fromthe other
departmentsof the company.Thisrequirescoordinationandconcerningthe periodicfinancialcontrol,the budget
acts as a central coordinationmanagementtool.

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Figure 3 Outline of the budgetary process.
Source:Adaptedfrom Lucey (1993) pp332

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2.3 The process of budgeting
The budget traditionally flows out of the mission statement and organization strategy. The mission statement is
worked out into a strategy which will be the main goal for the organization for the upcoming years. A concrete
financial plan is composed from the strategy containing the financial consequences for the upcoming year. This is
the budget.The management communicates the budget through the top-down method. The top-down method is
one of the maincharacteristicsof the budget,andmeansthat the informationcomesfromabove;the management,
and movesdowntowardsthe line management.The linemanagersthenformulate theirownbudgetand year-goals
and sendtheirplansback(bottomup) to the management.The managersandthe line managers then discuss pl ans
inorder to reacha final budgetandyeargoal.Next,the budgetisusedtocontrol whether or not the organization is
still ontrack e.g.controllingwhetherthe goals,setinthe strategy,are beingreached. If necessary, the organization
takescorrective measures.Atthe endof the year the evaluation and rewarding takes place. A comparison is made
betweenthe goalssetinthe budget,andthe goalsreachedbythe staff.The diagram below givesaclearoverviewof
the above mentioned process.
At Case studyA thisalternative budgetingprocessisimplementedratherthanthe priorbudgetingprocessasthe
operationsforthe companyare local and not complex.

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Figure 4: An Alternative budgetingprocess
2.3.1 Budgeting process at Case Study A
In orderfor the budgettobe inuse from the start of the nextfinancial year,budgetingprocessstarts
three to five monthsbefore the fiscal yearchange.
The budgetcan is dividedintothree parts:
1. Revenue turnover,
2. Direct costsand
3. Indirectexpenses.
Directexpensesrelate directlytorevenueasthey,ina service company,containsalarycosts.Theyare quite easyto
justifyastheycan be linkedtorevenue levels.Indirectorsupportingexpensesare hardertojustifyandtheir
allocationwithinthe organizationcanbe complex asthe companydoesnotuse the ABC costingmethod.
In myopinion,budgetingisaback-and-forthmovementbetweenthe topandlowermanagement.
In a top-downapproach like inthisCase StudyA scenario,detail-level plansare givenfromthe executive
managementforwhichthe sub-unitbudgetsare basedon. Thismeansthat the uppermanagementfirstgivesout
broad overall objectivesandthe constraintsof the company.Thenthe lower-levelmanagers work tomeetthe
budgettargets basedon theirownexpectationsandknowledge.

23
However, if the lower-level managersare notactivelytakingpartintothe process,theywill notcommitthemselves
to the setobjectives.
Commitmentisvital asthe effectiveness of budgetingprocess dependsonit.
Whenmanagerstake part insettingtheirownunit’sobjectives,theyare more likelytotake responsibilityforthose
objectivesandcanbe held accountable. Astheytake the settargetsas their own,theywill strive toachieve them.
While creatingthe budget,the corporate level goalsmust be takenintoaccount,butin orderto make the budget
realistic,itsgoalsandfigurescannot simplybe dictatedfromabove,since the lower-levelmanagersusuallyhave a
deeperunderstandingontheirunit’sbusinessthanthe finance orthe uppermanagement .

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Classificationof budgets
Figure 5:Illustrationof Master budget
Source: Adapted from Horngrenand Foster (1991) pp177

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2.4 Classificationof budgets
Horngrenand Foster(1991) suggestthe followingasclassificationof budgets:
There are countlessformsof budgets. Manyspecial budgetsandrelatedreportsare preparedincluding:
-Comparisonsof budgetswithactual performance (performancereports)
-Reportsforspecificmanagerial needs- forexample,cost-volumeprofitprojections
-Longterm budgetsoftencalled‘capital’or“facilities”or“project”budgets.
-Flexiblebudgets
-Life-cyclebudgets
Figure 2 showsa simplifieddiagramof the variouspartsof the masterbudget,the comprehensiveplan,a
coordinatedsetof detailedfinancialstatementsforshortperiods,usuallyayear. Asthe diagramindicates,many
supportingbudgetsare necessaryinactual practice. The bulkof the diagrampresentsvariouselementsthat
togetherare oftencalledthe operatingbudgetwhichisthe income statementanditssupportingbudgets.
In contrast,the financial budgetisthatpart of the masterbudgetthatcomprisesthe capital budget,cashbudget,
budgetedbalance sheetandbudgetedstatementof cashflows. Itfocusesonthe impacton cash of operationsand
otherfactors suchas plannedcapital outlaysforequipment.
For simplicity,figure5doesnot showall functions (forexample,research) andthe interrelationshipsamongthe
variousbudgets. Forinstance the amountof interestexpense onthe budgetedincomestatementisaffectedbythe
cash budget. Moreover,toavoidclutterthe figure doesnotemphasize thatonce the salesbudgetiscompleted,
purchasing,production,marketingandadministrativedepartmentscanoftenbe workingontheirbudgets
simultaneously. Similarly,the variousingredientsof the financial budgetare oftenpreparedsimultaneously.

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2.5 Problems withtraditional budgeting inpractice
A recentreportby Neely,Sutcliff,Heyns, (2001),drawnprimarilyfromthe practitionerliterature,
liststhe 12 mostcitedweaknessesof budgetarycontrol as:
1. Budgetsare time-consumingtoputtogether;
2. Budgetsconstrainresponsivenessandare oftenabarrierto change;
3. Budgetsare rarelystrategicallyfocusedandoftencontradictory;
4. Budgetsadd little value,especiallygiventhe time requiredtoprepare them;
5. Budgetsconcentrate oncost reductionandnot value creation;
6. Budgetsstrengthenvertical command-and-control;
7. Budgetsdo notreflectthe emergingnetworkstructuresthatorganizationsare adopting;
8. Budgetsencourage gamingandperverse behaviors;
9. Budgetsare developedandupdatedtooinfrequently,usuallyannually;
10. Budgetsare basedon unsupportedassumptionsandguesswork;
11. Budgetsreinforce departmentalbarriersratherthanencourage knowledge sharing;
and
12. Budgetsmake people feel undervalued.
While notall wouldagree withthese criticisms,otherrecent critiques(e.g.,Schmidt1992;
Hope and Fraser1997, 2000, 2003; EkholmandWallin2000; Marcino 2000; Jensen2001)
alsosupportthe perceptionof widespreaddissatisfactionwithbudgetinginpractice.We
synthesize the sourcesof dissatisfactionasfollows.
Claims1, 4, 9, and10 relate tothe recurringcriticismthatby the time budgetsare used,theirassumptionsare
typicallyoutdated,reducingthe value of the budgetingprocess.
A more radical versionof thiscriticismisthatconventional budgetscan neverbe valid because theycannotcapture
the uncertaintyinvolvedinrapidlychangingenvironments (Wallender1999).
In more conceptual terms,the operationof auseful budgetarycontrol systemrequirestworelatedelements.First,
there mustbe a high degree of operational stabilitysothatthe budgetprovidesavalidplanfora reasonable period

27
of time (typically the nextyear).Second,managersmusthave goodpredictive modelssothatthe budget providesa
reasonable performance standardagainstwhichtoholdmanagersaccountable (BerryandOtley1980).
Where these criteriahold,budgetarycontrol isauseful control mechanism, butfororganizationsthatoperate in
more turbulentenvironments,itbecomes lessuseful (Samuelson2000).
Claims2, 3, 5, 6, and 8 relate toanothercommoncriticismthatbudgetarycontrolsimpose avertical command-and-
control structure,centralize decisionmaking,stifle initiative,andfocusoncostreductionsratherthanvalue
creation.Assuch,budgetarycontrolsoften impedethe pursuitof strategicgoalsbysupportingsuchmechanical
practicesas lastyear-plusbudgetsettingand across-the-boardcuts.
Moreover,the budget’sexclusive focus onannual financialperformance causesamismatchwithoperationaland
strategicdecisions thatemphasize nonfinancial goalsandcutacross the annual planningcycle,leadingto budget
gamesinvolvingskillful timingof revenues,expenditures,andinvestments
(Merchant1985a).
Finally,claims7,11, and 12 reflectorganizationalandpeople-relatedbudgetingissues.
The critics argue that vertical,command-and-control,responsibilitycenter-focusedbudgetary controlsare
incompatiblewithflat,network,orvalue chain-basedorganizational designs andimpede empoweredemployees
frommakingthe bestdecisions(Hope andFraser 2003).
Givensucha longlistof problemsandmanycallsforimprovement,itseemsoddthat the vast majorityof U.S.firms
retaina formal budgetingprocess(97percentof the respondents inUmapathy[1987]).
One reasonthat budgetsmaybe retainedinmostfirms isbecause theyare so deeplyingrainedinanorganization’s
fabric(ScapensandRoberts1993). ‘‘Theyremainacentrallycoordinatedactivity(oftenthe onlyone) withinthe
business’’(Neelyetal.2001, 9) and constitute ‘‘the onlyprocessthatcoversall areasof organizational activity’’

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2.5.1 Additional Problems withtraditional budgeting
In the ACCA studytextof AdvancedPerformance management(2012:37), the Get through guide,postulates the
followingaspitfallsof traditional budgeting.
Advocatesof beyondbudgetinghave criticizedconventional budgetingprocessesonseveral counts. Itisclaimed
that budgets:
 Cannotcope witha fast-changingenvironmentandtheyare oftenout-of-datebeforethe startof the budget
period.
 Focustoo much managementattentiononthe achievementof short-termfinancial targets. Instead,
managersshouldfocusonthe thingsthat create value forthe business(e.g.innovation,buildingbrand
loyalty,respondingquicklytocompetitivethreatsandsoon).
 Reinforce a‘commandandcontrol’structure that preventsjuniormanagersfromexercisingautonomy. This
may be particularlytrue where a top-down approach,thatallocatesbudgetstomanagers,isbeingused.
Where managersfeel constrained,attemptstoretainandrecruitable managerscan be difficult.
 Take up an enormousamountof managementtime thatcouldbe betterused. Inpractice,budgetingcanbe
a lengthyprocessthatmay involve muchnegotiation, reworkingandupdating. However,thismayaddlittle
to the achievementof businessobjectives.
 Are basedaroundbusinessfunctions(e.gsales,marketing,productionandsoon). However,toachieve the
business’sobjectives,the focusshouldbe onbusinessprocessesthatcutacross functional boundariesand
reflectthe needsof the customer.
 Encourage incremental thinkingbyemployinga‘lastyearfigure plusa certainpercent’approachto
planning. Thiscaninhibitthe developmentof ‘breakout’strategiesthatmaybe necessaryina fast-changing
environment.
 Can protectcosts ratherthan lowercosts. In some cases,a fixedbudgetforanactivity,suchasresearchand
development,isallocatedtoamanager. If the amountis notspent,the budgetmaybe takenaway and in
future periods,the budgetforthisactivitymaybe eitherreducedoreliminated. Sucha response tounused
budgetallocationscanencourage managerstospendthe whole of the budget,irrespective of need,inorder
to protectthe allocationstheyreceive.
 Promote a negative mentalityamongstmanagers. Inordertomeetbudgettargets,managersaytry to
negotiate lowersalestargetsorhighercostallocationsthantheyfeel isreallynecessary. Thishelpsthemto
buildsome ‘slack’intothe budgetsandsomeetingthe budgetbecomeseasier.

29
 Moreover,one of the biggestproblemswithbudgetsisthattheytendtopromote an inward-looking,short-
termculture that focusesonachievingbudgetfigure,ratherthanonimplementingbusinessstrategyand
creatingshareholdervalueoverthe mediumtolongterm.
Figure 6: Pitfallsof conventional budgeting,Source:Adaptedfrom ACCA study text,(2012:37)
Otley(2003) believesbudgetsystemhasthe potential tocreate dysfunctionalbehaviour anddiscusseshis
experience of acoal mine thatheld backstock to meetweeklyquotas,anexampleof ‘Cookingthe Books’.

30
Wallander,formerexecutive forHandelsbanken inSweden,criticizedandabandonedthe budgetinthe 1970’s. He
statesinhiswork “Budget-anunnecessaryevil”,thatorganizationcoulddobetterwithoutbudgeting. First,
Wallanderclaimsthatthe budgetisbasedonthe principle “same weathertomorrow astoday”(Wallander,1999)
The budgetindicatesanongoingnormal andcontinuoustrend,thusthe budgethasnoeffectasa managementtool
for forecasting. Secondly,if somethingunexpectedoccursthe budgetwouldbe atno helpeither(Wallander,1995).
The budgetrather stopspeople fromtakingactions. AccordingtoWallander,budgetsare summariesbasedon
guessesandassumptionsaboutthe future andexcludeunpredictable events. Inbestcase scenariosbudgetsare
onlya waste of resourcesandin worstscenariostheyare dangerousbecause theygive deceitful informationabout
where firmsare heading.
The majorityof criticismof traditional budgetingmethodshasbeenpublishedby the proponentsbehindthe Beyond
Budgetingmovement,Hope &Fraser. Theirinitial criticismswereusedasa spearheadtocreate a better
managementtool.
Traditional methodsrelyonpastinformationwhichcanhave negative knockoneffects.Anexample
isthe incremental budgetingtool,wherethe previousyear’sbudgetis slightlyadjusted forthe new yearwithoutany
analysisintoareaswhichare over/underperforming.
The performance evaluationisgenerallycarriedoutatthe end of the budgetperiod;thiscan be toolate to remedy
deficiencies.Leadingonfromthis,the commonpractice isto carry outfixedpercentage cutswhenearlyresults
appearunacceptable (Hope &Fraser,2003).
Libby& Lindsay(2007) feel thatthe problemsare originatingfromhow budgetsare implementedandusedwithin
business,if usedcorrectlytheystill canbe a veryeffective tool.
Ekholm& Wallin(2010) agree withLibbyand Lindsay,andadd thatif properly usedtraditional budgetsare astrong
frameworktoplanand measure acompany’s operations.Therefore itcanbe suggestedthatmany of the
inadequaciesof traditional budgetscouldbe downtothe implementationandnotthe tool itself.
Despite the reasoningbehindthese limitations,Hope andFraser(1997) report that 99% of Europeancompaniesuse
formal budgetingprocedures,thisfigure islikelytoremainhigheventoday.Inaddition,asurveyof US organizations
by Libby& Lindsay (2007) revealedthatover50% of seniormanagersfeltbusinessescouldnotcope without budgets
and that theywere imperative tosuccess.Managersalsobelievedthatdespite the associatedtime andcosts,
budgetswere addingvalue toacompany.

31
Ekholm& Wallin (2010) feel the annual budgetisnotdeadyet,butit ispast itspeakand has lostusefulness and
become outdated.
The existingbudgetmodel cannotpossiblybe of anyuse forthe followingreasons:
 Budgetsdonot helpcompaniesfocusonthe performance driversof today’sorganizationse.g.innovation
rates,service levels,quality,andknowledge sharingetc.(these are clearlyshowninabalancedscorecard)
 Budgetshave beenturnedintofixedperformance contractsandhave ledtodysfunctional behaviorwithdire
circumstances - managersina studywere foundtobe inclinedtoeithertryandbeatthe systemorfelt
pressuredtoachieve targetsat any cost (the same behaviorthatgeneratedmanyof the recent“managed
earnings”scandals)
 Budgetstreatall employeesascosts;whereasateam’stalent,innovationandcommitmentare more
importantindeterminingperformance thanthe “personnelcosts”of the teamthe budgetprocessbuilds
silos,effectivelycompartmentalizingacompanyintosmall units.
Hope and Fraser(2003a) were the firstto pointoutthat the budgetprocesslimitsthe abilityof organizationsto
make full use of newmanagementphilosophiessuchaseconomicvalue added(EVA),BalancedScorecard,activity
basedmanagement(ABM),customerrelationshipmanagement(CRM) androllingforecasts
Hope and Fraser(2003b), the managementgurusbehindthe “Beyondbudgetingmovement”have statedthatnot
onlyisthe budgetprocessa time consuming,costlyexercise generatinglittle value,butalso,andmore importantly,
a major limitingfactoronhowyourorganizationcanperform.Theyhave manyexamplesof companies,following
the philosophiestheyhave expounded,whichhave brokenfree andachievedsuccesswell beyondtheir
expectations.Here are three quoteswhichchallengethe veryconceptof budgeting.
“So long as thebudgetdominatesbusinessplanning a self-motivated workforceisa fantasy,howevermany cutting-
edgetechniquesa company embraces”
“Modern companiesrejectcentralization,inflexibleplanning,and command and control.So why do they cling to a
processthatreinforcesthosethings?”
“The samecompaniesthatvowto respond quickly to marketshiftscling to budgeting – a processthat slowsthe
responseto marketdevelopmentsuntilit is too late.”

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2.5.2 Other benefitsofthrowing out the budgetprocess and its associatedannual performance trap
Many readerswill have wonderedwhythe introductionof soundnew managementtoolshasnotworkedintheir
organization.Hope andFraserhave foundthe culprit;the budgetprocess asexplainedinthe below drawntable:
Model How the budget undermines the model
Economic
Value added
(EVA)
The “silo based” budgeting approach is not compatible with a
process view of the organization which is required for EVA.
Benchmarking The extent of under performanceagainst best-in-class standards
loses its visibility as the shortterm budget (fixed performance
contract) dominates thought and action
Balance
Scorecard
(BSC)
Itis easy to turn the BSC with its financial and non-financial
measures into yet another fixed performancecontract with the
same dysfunctionalbehavior. The silo approach to budgets again
wins over the strategic and cross functionalfocus that a BSC needs
Activity based
management
(ABM)
The budget process does not focus on costdrivers or critical success
factors but instead forces management to sail a coursethat was set
many months earlier which may haveno relevance to the prevailing
conditions
Customer
relationship
management
(CRM)
The inside-out budget process is at odds with the outside-in CRM
strategies. Sales staffs aretoo frequently hell bent on meeting
internal goals rather than customer satisfaction and customer
profitability.
Table 1: How the budgetunderminesvariousbudgetingmodels
(Otley1999). However,amore recentsurveyof Finnishfirmsfound thatalthough25 percentare retainingtheir
traditional budgetingsystem,61percenta reactivelyupgradingtheirsystem, and14 percentare eitherabandoning
budgetsorat leastconsideringit(EkholmandWallin2000). We discusstwopractice-leddevelopmentsthat
illustrate proposalsto improve budgetingorto abandon it.
Althoughthe twodevelopmentsreachdifferentconclusions,bothoriginatedinthe same organization,the
ConsortiumforAdvancedManufacturing-International(CAM-I);one in the U.S.and the otherin Europe.The U.S.-
basedCAM-IActivity-BasedBudgeting(ABB)

33
groupadvocatesimprovingthe budgetingsystembymarryingamore complete, activitybased operational model
witha detailedfinancial model.
Its focusison improving budgeting’ssupport of operationalplanning.The European-basedCAM-IBeyond Budgeting
(BB) group takesa more radical viewandrecommendsatwo-stage approach.
The firststage addressesthe problemswithbudgetingwhentheyare usedforperformance evaluation.
It suggeststhattraditional budgetarycontrolsthatcombine planningandperformance evaluationleadtobothpoor
planninganddysfunctionalbehavior.
Therefore,the BB-grouprecommendseitherradicallychangingtraditional budget-basedperformance evaluationsor
completelyeliminatingthe budgetprocess.The secondstage of the BB-approachisto radicallydecentralizethe
organizationandempowerlower-level managersandemployees. Althoughthe ABB-grouphasmore of a planning
focusand the BB-groupmore of a performance evaluationfocus,theyshare acommonbeliefthattraditional
budgetingisfundamentally mismatchedtotoday’srapidlychanginganduncertainenvironments.
2.6 The Role of Budgetary Datain Performance Evaluation
It isimportantto recognize thatevenstandardaccounting reportswhichshow the actual andbudgetedcostsforan
organizational costcentre canbe usedinmanydifferent waysinperformance evaluation.Inastudyconductedin
one divisionof alarge Chicago-basedcompany,21three stylesof evaluationwhichmake distinctlydifferentusesof
the monthlyaccountingdatawere isolatedandoperationally defined:
2.6.1 Budget ConstrainedStyle.
Despite the manyproblemsin usingaccountingdataascomprehensive measuresof managerialperformance,the
evaluationisprimarilybased uponthe costcentre head'sabilitycontinuallytomeetthe budgetona short-term
basis.Thiscriterionof performance isstressedatthe expense of othervaluedcriteria.
2.6.2 A Profit ConsciousStyle.
The performance of the cost centre headisevaluatedonthe basisof hisabilityto increase the long-term
effectivenessof hisunitinrelation tothe purposesof the enterprise,one importantaspect
beinghisconcernwith the minimizationof long-runcosts. Forthispurpose,the accountingdata have tobe used
withsome care ina flexible manner,andwhere necessary, supplementedbyalternativesourcesof information.

34
2.6.3 A Non-accountingStyle.
Accountingdataplaya relatively unimportantpartinthe supervisor'sevaluationof his subordinates'performance.
The stylesof evaluationwere operationallydefinedonthe basisof costcentre headrankingsof the three most
importantcriteriaintheirevaluationoutof a listof eightpossible items;abudgetconstrainedorientationbeing
representedby'meetingthe budget'anda profitconscious
orientationby'concernwithcosts.
These phraseswere selectedonthe basisof observationsmade duringan exploratoryseries of interviews,whenit
was foundthattheywere usedbymembersof the companyto referto
distinctpatternsof evaluativebehaviorwhichwerein agreementwiththose describedabove.The research
instrumentswere pre-testedandattemptsweremade to collectevidence tofurtherestablishtheirconstruct
validity.
Empirical evidence indicatedthatboththe budgetconstrained andprofitconsciousstylesresultedinahigher
degree of involvementwithcoststhanthe non-accountingstyle.
Onlythe profitconsciousstyle,however,succeeded inattainingthisinvolvementwithoutincurringeither emotional
costs forthe costcentre headsor defensive behaviorwhichwasdysfunctional forthe enterprise.The budget
constrainedstyle resultedinabelief thatthe evaluationwasunjust,widespreadtensionandworryon the job,and
feelingsof distrustanddissatisfactionwiththe supervisor.
It is hardlysurprisingthatthese costcentre headswere foundtomanipulatethe accountingdataand
make decisionswhichresultedinlessinnovative behaviorand,attimes,highertotal processingcostsforthe
enterprise asawhole.Inaddition,the conflictandrivalrybetween fellow costcentre headsinsuchdepartments
impededthe co-operationwhichwassoessential forcontrollingtheirinter-dependentactivities.
In contrast,the profitconscious style,while seenasa verydemandingstyle,wasaccepted andrespected,and
resultedinsimilarlevelsof job-relatedtension,supervisorsatisfactionandpeersupportivenessand those prevailing
witha non-accountingevaluation.
The study clearlydemonstratedthatthe final effectiveness withwhichabudgetarysysteminfluencesthe overall
efficiencyof anenterprise,aswellasitsownmore limited purposes,isdependentnotonlyuponthe designand
technical characteristics,butalsouponthe precise manner inwhichthe dataare usedby line managers.

35
Accountingdatado not inand of themselvespose athreatto members of anenterprise,andtheirimperfections
neednotnecessarily be seenasunjustwhentheyare usedinperformance evaluation.
A manageris notfacedwitha simple choice betweenusingandnotusingthe data in evaluation.Instead, he can
reapmany of the benefitsof the systembystressing factorswhichitattemptstomeasure withoutthisresulting in
dysfunctional consequences.
To do so,however,consideration hastobe giventothe widerorganizational contextwithinwhichtheyare used.
While arigiduse of the data is difficulttoresist,passing down ahierarchyonce ithas beenestablishedatone level,
the studyshowedthatthe way inwhichthe data are used isassociatedwithmuchmore general differencesin
supervisorystyle.
Both the budgetconstrainedandprofit conscioussupervisors,unlike those usinganon-accounting
style,were seenastryingtocreate a structured job environmentwhichwasdemandinganddifficulttosatisfy.
The profitconscioussupervisors,however,werealsoseen asmaintainingawarmand friendlyatmospherewhich
was supportive andconduciveformutual trustandrespect.
Withoutthe moderatingeffectof thisconsiderate attitude towardsthe costcentre heads,the concernforthe
accountingdata wasseenas threateningandstressful,servingasa triggerfordefensive and oftendysfunctional
behavior.
The profitconsciousstyle appearstobe one aspectof a general problem-solvingapproachto management,as
distinctfroman approachwhichattemptsto impose afalse measure of cognitivesimplicityontoacomplex and
interdependentseriesof activities.
The evaluationof performance isof primaryimportance initself withthe budgetconstrained style,influencingall
aspectsof the supervisor'sandthe cost centre head's behavior.Inthiscontext,evaluationisnot viewedas an
ongoingpartof the managerial process, interrelatedwithotherimportantaspectsof the job,and justone part of
the processof influence.Rather,itisseen asa distinctanddominantactivity,andthe primarysource of influence
and control,overshadowingothervital elements of the process.The budgetbecomesnotanaidto management but
a constrainton it.
While cautionneedstobe exercisedin generalizingthe findings,thisstudyof the role anduse of important aspects
of a formal informationandcontrol systemhighlights the crucial inter-dependencyof specialistmanagement
functionswhenthese are viewedaspartof a widersocial system.The veryeffectivenessof the budgetarysystem

36
was bothdependentupon,aswell asreinforcing,the characteristicsof the widerorganizationalclimatewithin
whichitsuse occurred.
2.7 Overview of Activity-BasedBudgeting
2.7.1 The Role of BudgetingIn Planningand Control
Budgetingplaysacrucial role in planningandcontrol. Plansidentifyobjectivesand the actionsneededtoachieve
them.Budgetsare the quantitative expressionsof these plans,statedineitherphysical orfinancial termsorboth.
Whenusedfor planningabudgetisa methodfor translatingthe goalsandstrategiesof an organizationinto
operational terms.Budgetscanalsobe usedincontrol. Control isthe processof settingstandards,receiving
feedbackonactual performance,andtakingcorrective actionwheneveractual performance deviatessignificantly
fromplannedperformance.Thus,budgetscanbe usedto compare actual outcomeswithplannedoutcomes,and
they can steeroperationsbackoncourse,if necessary.The
illustrationof the relationshipof budgetstoplanning, operating,andcontrol showedasbelow.Budgetsevolve from
the long-runobjectivesof the firm;theyformthe basisforoperations.Actual resultsare comparedwith budgeted
amountsthroughcontrol.Thiscomparison providesfeedbacksbothforoperationsandforfuture budgets(Hansen
and Mowen,2003).
Figure7: Purposesof budgeting

37
2.7.2 Activity-BasedBudgeting
Horngren,SundemandStratton (2007 sayin essence that:
Mostbusinessorganizationsusebudgetto focusattention on company operation and finances,notjustlimit
to spending.Budgetshighlight potentialproblemsand advantagesearly,allowing managersto takestepsto
avoid theseproblemsor usethe advantageswisely.A budgetisa tool thathelpsmanagersboth their
planning and controlfunctions.Budgetshelp managersplan forthefuture.However,managersalso use
themto evaluatewhathappened in thepast.Study afterstudy hasshown thatthebudgetto be oneof the
mostwidely used and highestrate cost-managementtoolsforcostreduction and control.Advocatesof
budgeting go so faras to claim thatthe processof budgeting forcesa managerto becomea better
administratorand putsplanning in theforefrontof themanager’smind.Actually,many seemingly healthy
businesseshavedied becausemanagersfailed to draw up,monitor,and adjustbudgetsto changing
conditions.Themajorbenefitsof budgeting can summary asfollow:
(1) budgeting compelsmanagersto thinkahead by formalizing theirresponsibilitiesforplanning,
(2) budgeting providesexpectationsthatarethebest frameworkforjudging subsequentperformance,and
(3) budgeting aidsmanagersin coordinating theirefforts,so thattheplan of an organization’ssubmitsmeet
the objectiveof the organization asa whole”.
However,intoday’sbusinessenvironment,a numberof organizationsandpeople have beenverycritical of the
traditional budgetingprocess.
These criticsargue that the traditional budgetingprocessdoes the following:
(1) reflectatop-downapproachto organizingthatisinconsistentwith the needtobe flexible and adapttochanging
organization circumstance,
(2) focusesoncontrolsratherthan focusing onhelpingthe organizationachieve itsstrategicobjectives,
and
(3) causesresource allocationstobe drivenbypolitics ratherthanstrategy.Thatis, political powerinthe

38
organizationdrivesresourceallocationsratherthanthe strategicneedsthatdrive traditional budgeting(Kaplan
1998)
A recentapproachto budgetisactivity-basedbudgetingthatisbasedonABC. Activity-basedbudgetinguses
knowledge aboutthe relationshipsbetweenthe quantityof productionunitsandthe activitiesrequiredtoproduce
those unitstodevelopdetailedestimateof activityrequirements underlyingthe proposedproductionplan.
2.7.3 The two main benefits of ABB are:
(1) It identifiessituationswhen productionplanrequire newcapacity –both physical capacityandcapacityin people
resources – to delivermuch of supportandservice activitiesinorganizations.
(2) It providesamore accurate wayto projectfuture costs (Kaplan:2008)
Hansenand Mowen(2003) presented thatthe ABBbeginswithoutputandthendeterminesthe resources
necessarytocreate that output.Ideally,the organizationtranslatesitsvisionintoastrategywith definable
objectivesinordertocreate value.
Ways of creatingvalue include growingmarketshare,improving salesrates,reducingexpenses,increasingprofit
margins, increasingproductivity,andreducingthe costof capital.
We can lookat a budgetfromthree perspectives:a traditional functional-basedapproach,aflexible budgeting
approach,and an activity-basedapproach.
Traditional budgetingreliesonthe use of functional-basedlineitems, suchassalaries,supplies,depreciationon
equipment,and soon.The flexiblebudgetusesknowledgeof costbehavior
to splitthe functional-basedlineitemsintofixedand variable components.
The ABB worksbackward from activitiesandtheirdriverstothe underlyingcosts.
Traditional budgetingfocusesonthe result,notthe processorroot cause. ABB,by focusingonthe process, give
managersguidance inthe wayto achieve the desired results.Whenactivity-basedbudgetingisused,the root causes
can be identified,andthisknowledgecanbe usedto effectprocessandcost efficiencies(HansenandMowen, 2003).

39
A comparisonof ABC and ABB is shownin figure as follow:
Figure 8: ABC and ABBcompared
Source: Adaptedfrom Horngren, Sundemand Stratton, (2007)
Activity-basedcosting(ABC) is definedasamethodologythatmeasuresthe cost andperformance of activities,
resources,andcost objects.Specifically, resourcesare assignedtoactivities,thenactivitiesare assignedtocost
objectsbasedontheiruse.ABCrecognizesthe causal relationshipsof costdriversto
activities(Instituteof ManagementAccountants,1998).

40
Figure 9: Using ABM for operational improvements andstrategic decisions
2.7.4 Using ABM for operational improvements andstrategic decisions
Operational ABM – worksto enhance efficiency,lowercostsandasset utilization.Itcanincrease the capacityof
resourcesbyreducingmachine downtime,improvingoreliminatingentirelyfaultyactivitiesandprocessesand
increasingthe efficiencyof the organization’s resources.The benefitsfrom
operational ABMcan be measuredbyreducedcosts,higherrevenuesthrough betterresource utilizationandcost
avoidance.
Strategic ABM – exploresvariouswaysacompanycan create andsustaina competitive advantageinthe
marketplace. ABMattemptsto alterthe demandfor activitiestoincrease profitability,encompassesdecisions
aboutproduct design anddevelopmentwhere the biggestopportunityforcostreductionexists, improves

41
relationshipswithsuppliersandcustomers. Some of the specificusesof ABMin organizationstodayinclude
attribute analysis,strategicdecisionmaking,benchmarking,operationsanalysis, profitability/pricinganalysis,and
processimprovement.ABC/ABMsystemscan
use (IMA,1998) manydifferentattributesor“datatags” for a specificcost. Data attributesallow acompanyto
performanalysisonmanydifferentdimensionsof a managementproblemusingthe same basicstore of data.
Organizationsthatare designingandimplementingABMwill findthere are five basicinformationoutputs:
• relevantinformationaboutthe costof activitiesandbusinessprocesses;
• the cost of non-value-addedactivities –inorderto identifyactivitiesthatdonotcontribute tocustomer
value or the organization’sneedand make improvementefforts;
• activity-basedperformance measures –to provide scorecards,toreporthow well improvementeffortsare
working;
• accurate product/service cost(costobjects) information –thisisvital forselectingthe segmentedmarkets
where anorganizationcompetes;
• cost drivers – inorder toidentifyfactorsthatcan cause changesin the cost of an activity.

42
Figure10: Outputs of the ABM model
The shiftfromABC (forproduct profitabilityassessment) toABM(formore general managerial control anddecision
support) hasbeensupplementedbythe broadeningof ABC/Mapplicationtodifferenttypesof business,todifferent
functional specializationswithinbusinessandtothe complementaritiesof ABC/M to othernew high-profile
managementandaccountingtechniques(Bjornenak& Falconer,2002: 504).
Together,ABCandABM methodologiesprovidethe toolsandthe knowledge base formakinginformeddecisions -
decisionsthatrelate tothe pricing, management,andimprovementof productsandservices.Theyare utilizedto
gainfullerunderstandingof the real costdynamicsandcost structuresinvolved inbusinessoperations.
ABMtogetherwithABCprinciplescanenable managers tobetterunderstand(a) bothproductandcustomer
profitability,(b) the costof businessprocesses,and(c) how to improve them.
ABC andABM are a continuumof value.ABMisthe applicationof ABCdatato manage product portfoliosand
businessprocessesbetter.
ABB processisa reverse processof ABCapproach. The above figure highlightsthe mainconceptsanddifferences
betweenABCallocationof resource coststoactivitiesand products,andABBdoes.ABB beginswiththe forecasted
demandforgoods(salesbudget).Itfocusesonestimating the demandforeachactivity’soutputasmeasure byits
cost driver.Thenusingthe rate at whichactivitiesconsume resourcestoestimate orbudgetthe resource needed.
ABB emphasisonactivitiesandtheirconsumptionof resources, some managersbelieve thatitismore useful for
controllingwaste andimprovingefficiency.

43
ActivityBasedBudgetinghasitsideological basisof the workonActivityBasedCostingasRobinCooperandRobert
S. Kaplanstarteddevelopinginthe mid-1980s.But incontrast to ActivityBasedCosting, thatviaresource drivers
traces resourcestoactivitiesandhence viaactivitycostdriverstracesthe consumptionof activitiestoproducts,
customersandothers,and thenthe processisreversedinActivityBasedBudgeting.Ifigure 4.9a model of Acti vity
BasedBudgetingisshown.
Figure 11: A model ofActivity based budgeting;
Source: Adaptedfrom Kaplan & Cooper (1998) ,pp116

44
2.7.5 A model of Activity basedbudgeting;
Kaplan& Cooper(1998) opine thatActivityBasedBudgetingconsistsof the following5sequences:
1. Estimate nextperiod´sexpectedproductionandsalesvolumesbythe individual productsandcustomers
2. Forecast the demandfororganizational activities
3. Calculate the resource demands toperformthe organizationalactivities
4. Determine the actual resource supplytomeetthe demands
5. Determine the activitycapacity
The startingpointfor budgetingisasalesforecastof salesvolume andmix of productsto customersperperiod.This
formsthe basisfor a calculationof production,stocks,purchasesof materialsandcapacityrequirementsand
capacityusage equivalenttohowitwouldbe done withintraditionalbudgeting.Butthe specificityof ActivityBased
Budgetingisthatthe sales forecastat the same time isusedto estimate the needforindirectandsupportactivities.
Thiscan be activitiesinthe formof,forexample ordering,receivingandhandlingmaterials,schedulingandsetting
up productionruns,andpack and shiporders. Butit can, inprinciple be all activitiesthatisshowninthe activity
catalog of the company.The linkbetweenproductsalesforecastandthe needforactivitieswill be done through
selectionof appropriate activity-costdriversandknowledge of how manyactivity-costdriverunitsagivenquantity
of productsor customersdemand.
The nextstepinthis processisto translate the demandforactivitiestoaresource demand.Thismeansthatitmust
be determinedhowmanyunitsof activityaresource unitcanperform.Activitiescaninprinciple be estimatedin
numberof activityunits(transactions) ortime (duration).The choice betweenthe 2typesof driversisguidedbythe
homogeneityinthe activities.Byhomogeneousactivities,characterizedbyavery uniformtime peractivity,the
numberof unitsof activityrelativelyeasilyandunambiguouslyistranslatedintoause onresourcesintime.
Alternatively,activitiescanbe measuredintime.Totranslate the numberof expectedactivitiesintoaneedfor
resourcesthe companymustdefine the capacityperresource unit.There are fourcapacityconceptsthat are
importantto be aware of:
1. Theoretical capacity
2. Practical capacity
3. Normal capacity utilization
4. Used capacity

45
Theoretical capacity expressedthe maximumcapacityavailableforagivenresource.Anemployee,hiredfor40
hoursper weekandwhoispaidfor 52 weeksayear has a maximumtheoretical capacityof 2080 hours.From this
processeslike vacation,sickleave,breaksandeducationis subtractedsothe real time atdisposal totask performing
for the companymightonlybe 1600 hours.Thisis the practicalcapacity that expressesthe time anemployeehasat
disposal fordoingthe jobshe or she isintendedtodoin the company. Finallyworkplanningormissingtaskscan
meanthat youmightonlybe able to use the employee 80% of the time at disposal.The real used capacity isthus
only1280 hours.In some instancesthere isaneedfordefiningthe normalcapacity utilization whichisthe average
level of utilizationof the capacityovera periodof time,typically2-3years.
Whencapacity iscalculated,the startingpointwouldbe the practical capacitysince itexpressesthe reel capacity
available fortaskperforminginthe company.But the difference betweenthe theoretical capacityandthe practical
capacitydependsona numberof conditionsthatisdeterminedandagreeduponinthe individual companysuchas
lengthof breaks,extentof trainingetc.Itisthusa managementissuetoagree uponthe expectationsbetweenthe
companyand the employeesregardingwhichconditionsthere shouldbe betweentheoretical andpractical capacity.
Similarly,itisimportanttoplanworkinsuch a way thatthe practical capacityis usedsince a large difference
betweenpractical andusedcapacityindicatesinefficientresource utilization.Atthe same time,the above means
that the chosenlevel of service andqualityisdefiningforhow manyresourcesisneededtoperformagivennumber
of tasks.
Accordingto Hansenand Mowen (2007), in orderto buildanABB fourstepsare needed.
Step1: The outputof the departmentmustbe determined;
Step2: The activitiesneededtodeliverthe output,along withtheirrelateddrivers,mustbe identified;
Step3: The demandforeach activitymustbe estimated;
Step4: The cost of resourcesrequiredtoproduce the relevantactivitiesmustbe determined.
It iscriticallyimportanttosee thatABB is basedon expectedoutput.Traditional budgetoftenplansforward from
lastyears’experience,whileABBplansbackward fromnextyear’soutput.The differencesbetweenthe two
approachesare more thansemantic.Inaddition,the ABB approach,usingresourcesandactivitiestocreate output,

46
givesthe managersmuchmore informationaswell as abilitytoconsidereliminatingnon-value-addedactivities.
(HansenandMowen,2003)
Figure 12: Overviewof the ABB-Approach
Source:Adaptedfrom Hansen, Otley, Vander Stede, 2003, pp100

47
2.80 Alternativestotraditional budgeting
2.8.1 Rolling budget
In the ACCA studytextof AdvancedPerformance management(2012:30), the Get throughguide,itdefinesrolling
budgetas a budgetthatneedsto be continuouslyupdatedbydeductingthe earliestperiodandtakinginto
considerationthe future period. Thisapproachto budgetinghelpstoeliminate the adverse impactof environmental
uncertaintiesonsettinggoalsbyupdatingthe budgetin quicksuccession. Thisbudgetencouragesaforward-looking
attitude.
Strengths
1. As rollingbudgetsare preparedonthe basisof recentexperience bytakingintoconsiderationthe current
period,theyare updatedwiththe currentchanges. Rollingbudgetsare continuouslyupdatedwithcurrent
information. Thishelpstominimizethe operational variances.
2. Rollingbudgetsare the mostsuitable formof budgetfororganizationsworkinginanuncertainenvironment,
where future costsand/oractivitiescannotbe foreseenreliably.
3. A rollingbudgetmakesthe budgetingprocessresponsivetoplansinfluencedbychangesinstrategyandthe
market.
Weaknesses
1. A rollingbudgetincreasesbudgetaryworkandaccordinglymayface criticismonthe groundsthat exceptin
a veryuncertainenvironment,itisnotuseful toupdate the budgetsofrequently.
2. There isthe possibilitythatmanagerswillassignlessimportance toit.

48
Figure 13: Summary of rollingbudget
Source:Adapted from ACCAstudy text of AdvancedPerformance management (P5) 2012:31
2.8.2 Activity-basedbudget (ABB):
In the ACCA studytextof AdvancedPerformance management(2012:31), the Get throughguide,itdefinesactivity-
basedbudgetingasanapproach to budgetinginwhich,insteadof evaluatingthe costelements,activitiescausing
costs are evaluatedinordertoascertainwhethertheyare essentialforthe budgetedproductionandsalesvolume.
The endeavorof an activity-basedbudgetistoensure the supplyof onlythose resourcesthatare neededtoperform
activitiesrequiredtomeetthe budgetedproductionandsales. Like all otherapproachestobudgeting,itisalsoa
feedbackactivity.
Whereasactivity-basedcostingassignsresourcescoststoactivitiesandthenusesactivitycostdrivers toassign
activitycoststo cost objects(suchas products,servicesorcustomers),anactivity-basedbudgetfollowsthe reverse
process. Costobjectsare the startingpoint. Theirbudgetedoutputdeterminesthe necessaryactivitieswhichare
thenusedto estimate the resourcesthatare requiredforthe budgetperiod.
Strengths
An activity-basedbudgetisone of the mostuseful formsof budgetasit identifiesthe cause andeffectrelationship
betweenthe activityandthe costas well asbetweenthe activityandthe product.

49
1. An activity-basedbudgetcanprovide more detailedinformationthatcanimprove decision-making
comparedto a budgetbasedsolelyonoutput-basedcostdrivers.
Weaknesses
1. ABB are onlysuitable fororganizationswhere the activity-basedcostingsystem(ABCsystem) hasbeen
adopted. Thisisbecause,insuchorganizations,activitycentershave beenidentified. The ABCsystem
calculatesthe costsof individual activitiesandassignsthe activitycoststoproductsor services(i.e.the cost
objects) onthe basisof the activitiesneededtoproduce aproduct or a service. Without thisinformation,it
isimpossible toevaluate the activities. Therefore ABBcannotbe usedinan organizationwhere the ABC
systemhasnot beenadopted.
2. An ABBis time-consuminganditrequiresalotof efforttoimplementanABBin an organization.
Accordingly,large organizationswhichhave multiple costdriverscanonlyaffordtoprepare anactivity-
basedbudget.
Figure 14: Summary of Activity-basedbudgeting
Source: Adaptedfrom ACCA study text ofAdvanced Performance management(P5) 2012:32

50
Zero-basedbudget (ZBB):
Beginnings:
Figure 15: A briefhistoryof Zero-basedbudgeting
2.8.3 ZBB BEGINNINGS
Althoughzero-basebudgeting(ZBB) became popular inthe 1970s, the concepthas beenaroundmuchlonger. As
earlyas 1924 Britishbudget authorityE.HiltonYoung advocatedcomplete justificationof everyitem requested ina
budget(Wildavsky1975).

51
In 1962 the U.S. Department of Agriculture adoptedaground-upsystemof budgeting whichisconsideredtobe the
firstformal use of ZBB in the U.S. government.
However,the "Fatherof ZBB" (Crowe 1982) is withoutquestionPeterPyhrr,whocreated
and developedaZBBsystemforTexasInstruments aspart of hisresponsibilitiesascontrol administratorin the
1960s. The ideabeganin1962 when TexasInstruments startedusinganobjectives-strategies-tactics(OST) system
for evaluatingresearchanddevelopmentprojects (Chen1980).
Thisprocessfinallyevolvedintothe current ZBBconcept,whichwaspopularizedbyPyhrrin1970 in
an article inthe Harvard BusinessReview. JimmyCarter,thenGovernorof Georgia,readhisarticle,
was impressedwithit,andinvitedPyhrrtojoinhim inadaptingZBBfor Georgia's1972/1973 budget.Carter was so
enthusiasticaboutthe systemthat,whenhe became President,he orderedall federal agenciestoimplementa ZBB
systemby1979.
The concept of ZBB soon spread throughoutboththe publicandprivate sectorswithmixed
resultsandwas the subjectof manyarticlesinthe 1970s. AlthoughRonaldReagan droppedZBBduringhistenure as
President,andmuchof the enthusiasmhasnow disappeared (Koenig1985), a critical lookat how ZBB works, its
advantages,andpossible benefits,mayprovide some insightasto how thissystemmightbe adoptedoradapted by
organizationstoday.
2.8.3.1 WHATZBB DOES
ZBB is an operating,planning,andbudgetingprocess thatrequireseachmanagertojustifyhisentire budgetrequest
indetail.The burdenof proof shiftstoeach manager whomustjustifywhyshe shouldspendanymoneyatall (Pyhrr
1977).
It isdesignedtorequire the participationof managersatall levelsbecausetheyare indailycontact
withthe servicesof the organizationandare the experts inthe activitiesintheirdepartments.ZBBprovidesa
consistentframeworkwithinwhichall managersanalyzeall of theiroperationsintermsof objectives,alternatives,
performance measurements,andcost/benefits(Chen1980).
Theoretically,eachprogrammustbe analyzed,presented, andapprovedatthe beginningof eachbudgetcycle with
each organizational unitstartingfromabase of zero,hence the name (Koenig1985).
In practice,mostmanagersassume thatbasic functionscurrentlyinpositionare important andneedtobe
continued.

52
2.8.3.2 ZBB BASICS
Althoughopinionvariesonhowmanybasicstepsare necessarytoimplementZBB,the consensusshowsthree:
• identificationof organizational decisionunits,
• constructionof decisionpackages,and
• rankingof decisionpackagesandallocationof resources

53
Figure16: Decisionpackage form

54
2.8.3.3 Identificationof Organizational DecisionUnits
ZBB beginswiththe identificationof the organizational decisionunits,whichprepare the firstpartof the budget
(Hammond1980).
These unitsstartat the lowestlevel forwhichbudgetscanbe preparedandmaybe definedby
cost center,function,programoractivities,ororganizational unit(Taylor1977).
In libraries,decisionunitsmay fall alongdepartmentlines,suchasreference,technical services,children's,etc.Each
unit,whichmayvary insize, musthave an identifiable managerwiththe authorityto establishprioritiesandprepare
budgets.Italsomust comprise agroup of activitieswhichcanbe meaningfullyanalyzed andinfluencedby
managerial decisions.
In developingdecisionunitsitisnecessarytodetermine if the unitisessentialtothe organizationandif its activities
and operationsare inaccord withthe organization's goalsandobjectives.If itisnot,thenthismustbe remedied
before proceeding.Once these unitsare determined, itisnotnecessarytoredothisstepfor eachbudget unless
there are changesmade in the unit.
2.8.3.4 Constructionof DecisionPackages
The keyto the successof ZBB is the preparationof meaningful decisionpackages. A decisionpackage isabrief
justificationandrequestdocumentthatincludesthe critical informationnecessaryformanagerstomake judgments
on programdirectionandresource requirements (Sarant1978).
These packagesare createdat the departmentlevel andinvolvedescribingandanalyzingthe activities
of thatunit.The packagesshouldinclude different waysof performingthe same function,alternative methods that
have beenidentified,andthe reasonforthe final choice.
They shouldalsoindicate differentlevelsof effortnecessary toperformthe function,includingminimum,current,
and incremental levelsof fundingandperformance.The minimumlevel isthatfundingorperformance levelbelow
whichitis not feasible tocontinue aprogrambecause it and performance level of "proposed"budgetactivitiesat the
currentfundinglevel.
Andthe incremental levels are the proposedactivitiespossible withadditional funding.

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