Management Accounting Beyond Budgeting

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Beyond
Traditional
Budgeting
Chapter 10
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• LO1 Critically analyse the use of traditional
budgets
• LO2 Appreciate the role of alternative budgets
in different industries and sectors
• LO3 Illustrate the differences in the process of
preparing rolling forecasts, kaizen budgets,
zero-based budgets and activity-based budgets
• LO4 Prepare a sales-based budget using
activity-based budgeting
• LO5 Discuss the nature of beyond budgeting
Learning Outcomes
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• Traditional budgeting uses a detailed line approach
which is subject to an incremental change in
forthcoming years.
• There are alternative systems which can be used
within the budgeting process.
• There are also management philosophies that argue
budgeting should not be used in any form.
Introduction
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• The CIMA 2009 survey clearly demonstrates that
traditional budgeting is still the most popular form of
budgeting.
• However, traditional budgeting is renowned for its
limitations.
• The biggest concern with traditional budgeting is the
inability to respond to a fast-changing environment.
Traditional budgeting
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• Reeves and Deimler (2011) argue that:
–Traditional budgeting assumes the world is
predictable and relatively stable!
–In order to remain competitive, companies
need to be able to respond and learn fast,
which will impact the budget.
Traditional budgeting
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• Frow et al (2010) argue that:
–Organizations are facing economic
uncertainty through new technologies,
business models and shorter product life
cycles
–All of which need to be constantly updated
within the budgets.
Traditional budgeting
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• Other general concerns regarding traditional
budgeting include:
–Game playing
–Time consuming
–Resource intensive
–Out of date
Traditional budgeting
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• There are many alternative budgeting
systems, today we will examine the following:
–Rolling forecasts
–Zero-based budgeting
–Kaizen budgeting
–Activity-based budgeting
Alternative budgeting systems
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Rolling Forecasts
• An approach to budgeting that uses a
continuous updating approach to forecasting,
the time period of the budget remains
constant
• In the majority of cases they will have 6-8
rolling quarterly forecasts
Alternative budgeting systems
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Rolling Forecasts
Alternative budgeting systems
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Zero-based budgeting
• An approach to budgeting that starts with a
blank piece of paper every accounting period.
Resources are allocated on needs rather than
past budgeted information.
Alternative budgeting systems
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Zero based budgeting
The process:
1. All activities within the organization need to be
identified. For each activity a report needs to be
generated to analyse the costs, justify the reason
for the activity to go ahead and to present all
alternatives. Targets should be identified as a
performance tool. These activity reports are
commonly referred to as ‘decision packages’.
Alternative budgeting systems
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Zero based budgeting
The process:
2) Every activity report will then be given due
consideration and they will be ranked in order of
what is required for that up and coming budget
period.
3) The final stage is the allocation of resources which is
determined by the ranking performed in stage two.
Alternative budgeting systems
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Zero based budgeting
Alternative budgeting systems
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Kaizen budgeting
• Budgeting based on a continuous
improvement philosophy. Seeking small
improvements in the operating processes
which are recorded within the budget
statement.
• Although it is about cost reduction it is a
cultural mindset.
Alternative budgeting systems
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Kaizen budgeting
Alternative budgeting systems
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Activity-based budgeting
• Budgeting based on activities rather than
units, products, or departments. An extension
of ABC.
• CIMA (2009) reports that nearly 50% of the
respondents used ABB.
Alternative budgeting systems
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Activity-based budgeting
Process:
1. Analyse products and customers to be able to
predict the production and sales demand.
1. Use the information from the ABC system to
estimate the resources required to perform
organizational activities.
Alternative budgeting systems
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Activity-based budgeting
Process:
3) With demand predicted, estimate the quantity of
each resource that will be needed to meet the
demand.
4) Allocate resources based on these predictions for
each activity.
Alternative budgeting systems
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Activity-based budgeting
Alternative budgeting systems
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Preparing a sales budget using ABB
Twilight Inc. is an electronic component
manufacturer. Based on predicted figures the
forecast sales for the forthcoming year will be
£10,000,000. The company is expecting to
maintain the current customer base with
current customers placing an expected 50,000
orders. For the existing customers the value
per sales order is expected to be 5% higher
than the previous year.
Alternative budgeting systems
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Preparing a sales budget using ABB
A new base of potential customers has been
identified and including these new customers
the budgeting sales forecast equals
£10,785,000. The new customers are expected
to produce an average sales value of £190.
Alternative budgeting systems
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Preparing a sales budget using ABB
Inflation is expected to be 3% in the
forthcoming budget period. The current sales
manager suggests that the current year would
produce costs of £250,000.
–We are going to calculate the Sales office
budget for the forthcoming period.
Alternative budgeting systems
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Preparing a sales budget using ABB
There are several steps required to calculate this sales
office budget.
– Calculate the current budget cost per order
– Calculate the existing customers’ sales budget
– Calculate the budgeted sales order for new customers
– Calculate the total sales orders – existing and new
customers
– Calculate the new budget cost for the sales office
Alternative budgeting systems
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Preparing a sales budget using ABB
Step one - Calculate the current budget cost
per order
Cost per sales order:
(£250,000 / 50,000) x 1.03 = £5.15 per sales
order
Alternative budgeting systems
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Preparing a sales budget using ABB
Step two - Calculate the existing customers’
sales budget – based on predicted increased
sales of existing customer
£10,000,000 x 1.05 = £10,500,000
Alternative budgeting systems
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Preparing a sales budget using ABB
Step three - Calculate the budgeted sales order for
new customers
Student task: consider the information in the
question and calculate this.
(£10,785,000 - £10,500,000) / £190 = 1,500 orders
Alternative budgeting systems
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Preparing a sales budget using ABB
Step four - Calculate the total sales orders –
existing and new customers
50,000 + 1,500 = 51,500 orders
Alternative budgeting systems
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Preparing a sales budget using ABB
Step five - Calculate the new budget cost for
the sales office
Student task: Calculate this
£5.15 x 51,500 orders = £265,225
Alternative budgeting systems
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• A philosophy which seeks the abandonment of budgets.
Using relative target measure this approach seeks
innovation and value added activities to measure the
success of a department, under a devolved process.
• Traditional budgeting was deemed to have many
problems, see slide 8.
• Hope and Fraser (2003) brought the discussion of the
beyond budgeting philosophy to the wider audience.
Beyond budgeting
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• The arguments towards using this philosophy
are as follows:
1. Using fixed budgets to set targets will only
ever achieve small improvements.
2. Setting incentives based on fixed targets can
create fear, rather than encouraging
innovation.
Beyond budgeting
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32. © McGraw-Hill Education (UK) Limited 2013
3) Fixed targets create a sense of compliance rather
than adding value.
4) Allocating resources through traditional budgeting
encourages managers to hoard resources rather than
use them where they are needed.
5) Centralization ignores market reactions.
Source: Adapted from Hope and Fraser, 2003
Beyond budgeting
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Beyond budgeting
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Beyond budgeting
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Using the beyond budgeting philosophy it is
argued that:
– Moving away from fixed targets, by using relative
targets through bench marking, will encourage
employees to improve their own performance.
– Using relative targets will encourage employees to
be innovative and provide the confidence to take
(positive) risks they would not have done before.
Beyond budgeting
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36. © McGraw-Hill Education (UK) Limited 2013
– By continuously readdressing plans employees
are encouraged to think about value creation
rather than achieving set numbers within the
budget.
– By using on demand allocation of resources rather
than allocating for the year ahead reduces costs.
– Using decentralization and passing the decision
making to small local teams means market
feedback is used within the process.
Beyond budgeting
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37. © McGraw-Hill Education (UK) Limited 2013
• So why isn’t everyone using this philosophy?
–It is very difficult to move away from the
traditional budgeting process, cultural
mindset.
–It is difficult to generate relative
benchmarks for lower level managers
–Some of the principles need more detailed
explanation
Beyond budgeting
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38. © McGraw-Hill Education (UK) Limited 2013
• There are many systems available for
companies to use, traditional budgeting,
alternative budgeting and alternative
philosophies.
• The management accountant has to find a
system that suits the company’s individual
needs.
Summary
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39. © McGraw-Hill Education (UK) Limited 2013
• CIMA (2009) Management Accounting tools for today and tomorrow.
www.cimaglobal.com
• Frow, N., Marginson, D. Ogden, S. (2010) “Continuous” budgeting:
Reconciling budget flexibility with budgetary control. Accounting,
Organisations and Society. 35, 444-461
• Hope, J., Fraser, R (2003) Who needs budgets? Harvard Business Review.
81 (2) 108-115
• Reeves, M. & Deimler, M. (2011) Adaptability: The New Competitive
Advantage. Harvard Business Review. 89, (7/8), 134-141
References
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