T Y P E S O F B U D G E T The budget for the period is prepared by adjusting the previous period‟s budget (or actual results if available). ZBB aims to eliminate non-value adding activities by evaluating the costs and benefits of each decision package. ABB is a technique used to budget that focuses on the cost of activities rather than assuming that costs increase in direct proportion to output.
Beyond Budgeting <ul><li>Beyond budgeting advocates argue that management is motivated only to meet the budget and may do things that are not in the long term interest of the business. </li></ul><ul><li>What is it? </li></ul><ul><ul><li>The general principle is that an organization should not program its activities in the form of a rigid plan locked into an annual cycle. </li></ul></ul><ul><ul><li>In place of fixed annual plans and budgets that tie managers to predetermined actions, targets are reviewed regularly and based on stretch goals linked to performance against world-class benchmarks, peers, competitors and prior periods. </li></ul></ul>
Questions (September 2010) <ul><li>A college is preparing its budget for 2012. In previous years the director of the college has prepared the college budget without the participation of senior staff and presented it to the college board for approval. </li></ul><ul><li>Last year the college board criticised the director over the lack of participation of his senior staff in the preparation of the budget for 2011 and requested that for the 2012 budget the senior staff were to be involved. </li></ul>Required: Discuss the potential advantages and disadvantages to the college of involving the senior staff in the budget preparation process. (Total for Question Three = 10 marks)
<ul><li>Answer to (a) </li></ul><ul><li>If the store managers overstate their budgeted costs and resource requirements then the following planning and decision making problems could arise within CW: </li></ul><ul><li>• It may cause CW to order excess items which would result in higher inventory holding costs as the items remain unused, or result in inefficient handling / theft of items as the store managers try to prove that their budget was correct and not draw attention to themselves by having favourable variances in their performance reports. </li></ul><ul><li> </li></ul><ul><li>• It may cause CW to recruit and train additional employees in order to meet the budgeted resource requirements. This will lead to higher than necessary staff levels, higher payroll and employee costs and may lead to future redundancies or inefficient operations as the store managers try to prove that their budget was correct and not draw attention to themselves by having favourable variances in their performance reports. </li></ul><ul><li> </li></ul><ul><li>• It may cause CW to invest in new additional equipment which is not really needed and which would therefore be a drain on the cash resources of CW. This could prevent them from investing in other areas of the business that would represent a more profitable use of the money available. </li></ul>• It may cause CW to borrow funds in order to fund the new capital investment or the additional working capital in the business. This funding would not really be required but if taken would cause CW to incur additional financing costs.
<ul><li>Answer to (b) </li></ul><ul><li>Behavioural problems could arise from the removal of the excess costs and resources from the managers’ budgets if it is removed without agreement from the managers. There are two main difficulties here: </li></ul><ul><li>• If the manager agrees that the excess can be removed this is an admission that their original budget was wrong and as a result their integrity as a manager is questioned. They are vulnerable to the accusation that they do not understand their own store and as a result their ability to be a manager is also questioned. </li></ul><ul><li> </li></ul><ul><li>• If the excesses are removed without the manager’s agreement then there is the risk that the manager will disown their budget and as a result they will not be motivated towards achieving it. They may even take operational decisions that lead to adverse variances when measured against the amended budget to try to ensure that the performance reports show that their original budget was correct. </li></ul>
Question ( May 2010) <ul><li>A firm of solicitors is using budgetary control during 2010. The senior partner estimated the demand for the year for each of the firm’s four divisions: Civil, Criminal, Corporate, and Property. A separate partner is responsible for each division. </li></ul><ul><li>Each divisional partner then prepared a cost budget based on the senior partner’s demand estimate for the division. These budgets were then submitted to the senior partner for his approval. He then amended them as he thought appropriate before issuing each divisional partner with the final budget for the division. He did not discuss these amendments with the respective divisional partners. Actual performance is then measured against the final budgets for each month and each divisional partner’s performance is appraised by asking the divisional partner to explain the reasons for any variances that occur. </li></ul><ul><li>The Corporate partner has been asked to explain why her staff costs exceeded the budgeted costs for last month while the chargeable time was less than budgeted. Her reply is below: </li></ul><ul><li>“ My own original estimate of staff costs was higher than the final budgeted costs shown on my divisional performance report. In my own cost budget I allowed for time to be spent developing new services for the firm’s corporate clients and improving the clients’ access to their own case files. This would improve the quality of our services to clients and therefore increase client satisfaction. The trouble with our present system is that it focuses on financial performance and ignores the other performance indicators found in modern performance management systems.” </li></ul>Required: (a) Discuss the present budgeting system and its likely effect on divisional partner motivation. (b) Explain two non-financial performance indicators (other than client satisfaction and service quality) that could be used by the firm.
<ul><li>Answer to (a) </li></ul><ul><li> The senior partner seems to want to involve the divisional partners in the budgeting </li></ul><ul><li>process by inviting them to prepare cost budgets for their respective divisions. </li></ul><ul><li>However, since they are then amended without any consultation it is clear that the </li></ul><ul><li>divisional partners do not have any real involvement as they are not able to influence </li></ul><ul><li>their final cost budgets. </li></ul><ul><li>From a motivational point of view this approach is probably worse than not involving the </li></ul><ul><li>divisional partners at all. They will feel that they have wasted their time in preparing a </li></ul><ul><li>budget which is then effectively ignored. </li></ul><ul><li>The benefit of involvement leading to ownership of the budget and thus feeling </li></ul><ul><li>personally responsible for achieving the target costs is therefore lost. Divisional </li></ul><ul><li>partners will not be motivated to achieve the budgeted cost. Indeed they may be </li></ul><ul><li>motivated to deliberately fail to achieve the budgeted costs in order to prove that their </li></ul><ul><li>own budget was correct and that the changes imposed by the senior partner were </li></ul><ul><li>wrong. </li></ul>Answer to (b) A number of non-financial performance indicators could be used by the firm. These include: • Number of training days for staff and partners – which is used to measure the investment by the firm in its people and the firm’s commitment to providing up to date and current information to its clients. • Response time between the enquiry and the first meeting with a client – which is used to measure the efficiency and flexibility of the firm to meet client demand.