ABSTRACT
Budgeting in a management accounting organisation is not merely a practice to allocate resources into different departments under a specified limit to save cost; it is rather the practice that would shape the whole organisation’s overall performance and profit. From a management accounting’s viewpoint, budgets are essential to be used in an organisation as it affects the organisation greatly. Thus, this paper will analyse the important points of a budgeting system which includes, the various roles and objectives a budget has within an organisation, and the criticism and assumptions of budgeting – that is, the benefits and drawbacks of using budgets such as behavioural and environmental issues, in which are linked towards the conflicting issues of planning and evaluation of a budget. The article, Using Negotiated Budgets for Planning and Performance Evaluation: An Experimental Study by Markus C. Arnold and Robert M. Gillenkirch accentuates how budgets can be used single handily or separately for different purposes or tasks which is yet another conflict arising between planning and evaluation performance.
INTRODUCTION
In the last decade, it was founded by Briers and Chua (2001, p. 238) that organisations have developed a substantial amount of management accounting tools, which includes balanced scorecards, target costing, activity-based costing (ABC), and enterprise resource planning systems. These technologies however, require the use of budgets, which is broadly used by companies since the beginning of the 19th century (Cazaux 1965). In other words, organisations have been using budgets for hundreds of years now and budgets have become a standard accounting tool used by numerous companies. Raghunandan et al. (2012, p. 110) emphasised that no matter how large or complex the business is; it requires the need of budgetary systems to accomplish its goals, in which it may garner substantial rewards once it is implemented and used properly. Henceforward, budgets are regarded as one of the most valuable and effective management accounting tool in an organisation. Horngren et al. (2014, p. 12) defines budgets as a proposal made by the management based on quantitative factors. In a management accounting standpoint, budgets can be projected by a variety of methods and each contains unique purposes that is used in an organisation. The three main budgets used by an organisation include operational budgeting, financial budgeting, and capital budgeting. This paper will analyse on the objectives of a budget, which influences the development and implementation of a budget. Next, the critique of budgeting will be examined by looking though the benefits and challenges of using a budgeting system within an organisation as well as the conflicting issues between planning and evaluation.
ROLES & OBJECTIVES OF A BUDGET
Budgets are often described as operational planning and coordination, motivation and performance evaluation, and goal communication and strategy formulation (Atkinson et al. 2011). It assists organisations to make decisions on how much money to spend by forecasting income and expenditure, and how to control plus monitor its performances under the influence of management accounting information. As stated by Gorshkova et al. (2015, p. 413), developing a budgeting system in an organisation may generate an assurance of financial growth in its business. Thus, budgets contain four important objectives that would influence the development and implementation of a budget.
Planning
Primarily, a company’s budget needs to have a strategic plan. It does not matter whether it is a small not-for-profit organisation or a big profit organisation, all organisations needs to have a budget plan set out. This plan is linked to the organisations budget and would assist the organisation to achieve its goals. Rouse (n.d.) indicates that with a strategic plan in hand; it will outline the company’s financial direction and expectations throughout the next three to five years. The purpose of planning aims to observe the ongoing decisions in the management and intervene whenever the activities are out of scope. For instance, if the company seems to be working towards a different objective, the management will intervene indicating that objectives made are not in line with the company’s plan. This interference delivers a chance for the managers to revise the budgets plan and go over its procedures made by the workforce (Simons 1990, p. 136). With planning, it enables the company to forecast future business conditions as well as avoiding unexpected problems that may occur out of the blue. The company will have to stick to its plan and follow the strategies set out. Such activity is closely linked to the Principle of Efficient Body of manoeuvre whereby it involves an individual’s body such as managers or employees to link with the company’s plans to carryout the activity. This is similar to the case of Wedgwood where Etruria implemented potter’s instruction’s book, which serves as a manoeuvre by clearly identifying how each task should be performed in the production (Macintosh 2002, p. 94).
Controlling
Subsequently, control will be able to measure the performance that is set out in the company’s plan. In order to take control and make adjustments in its performances, the company will need to compare against the actual and budgeted results to seek the corrective actions that needs to be taken into account. Such evaluation is significant as it is able to identity the budgets variances which will then be analysed and investigated in the company (Raghunandan et al. 2012, p. 111). From there, the company will make appropriate actions such as increasing the labour hours or decreasing raw materials to achieve the targets in the budgeting plan. Efficient resources will also be allocated across the company into different departments and it will be controlled as to how much should be given in each department and how much should be kept in the case of unpredicted issues such as natural disasters. If such an event occurs, the company would have a ‘backup’ to purchase more inventory.
Communication
Besides that, budgets have a role in emboldening communication between managers and employees in different departments. A manager will have to communicate to its employees regarding its work process so that it will be in line with the company’s budget. Not only will this enhance manager and employee relationship, but it also assists in coordination with the company’s activities. It is necessary for managers to inform its employees of the rationales underlying the budgeting process and the organisational roles they are to serve (Samuelson 1986, p. 36). Without communication, employees could be under- or over-budgeting the company’s expense and this in turn would impact the company’s goals. Ueno and Sekaran (1992, p. 659) accentuates that communication and coordination play a big role in a company’s budget. Hence, communication is vital to ensure that the coordination of the company’s activities is in the right place. It is also important to communicate budgets through a quantitative and qualitative approach. Most of the time, organisations tend to focus on quantitative factors. As an example, a budget might state that 2,000 units should be made during a specific period, however it does not state what kind of quality should it be made. Same goes to labour, a budget might state the amount to be paid for every labour rate per hour, nonetheless it does not specify the skills that employees should have (ACCA Global 2010). Parker (2012, pp. 54 – 55) claims that most organisations tend to focus more on its quantitative factors, whilst ignoring its qualitative factors and thus, risking a failure to comprehend that important elements do not always lie in measurable values and in fact it could be in a more subjective approach.
Motivation
Ultimately, a budget represents a target, and an aim towards a target can be a power motivator for the management and employees. However, it is important to understand that whether a targeted budget will actually motivate the managers and employees depends on how difficult the targeted budget is perceived to be (ACCA Global 2010). An imperative aspect of motivation is its direction and commitment. When a budget plan is set and approved, it provides the management a specific direction to work towards the company’s objectives. With a direction, it would motivate the managers to work hard as opposed to a budget without a direction in which would provide no pathway for managers to work on. Mia (1988, p. 465) intensifies that there is a striking improved performance in a company’s budget whenever managers possess a more positive and motivational attitude. As for commitment, when a manager’s performance is linked towards the company’s incentive system, the managers are more likely committed to their work. For example, a manager would receive a 20% bonus salary if the manager manages to achieve the targeted sales budget that is set out by the company’s financial plan. Such incentives will motivate the manager to work hard and commit to the job. This incentive system is closely interconnected to normalizing sanctions under the Principle of Discipline Mind whereby individuals would receive a reward for outstanding performances (Macintosh 2002, p. 87).
BENEFITS & DRAWBACKS OF A BUDGET
There are benefits as well as drawbacks in operating budgets within the organisation. According to Vitez (n.d.), most organisations regularly use budgets to construct a financial road map to plan its future business expenditures. With a planned budget in hand, companies will be able to estimate and allocate costs appropriately. As cash used to invest on fixed assets and working capital are limited, the budgeting system will be able to assist in managements decisions regarding which assets are worth to invest in and in turn, this would reserve additional cash for the company’s future business. For instance, with a budgeting system, the manager will be able to identify to spend less than $200,000 on marketing cost for the next two months, as the company would need the additional cash for future purposes such as expansion, endorsement, etc. plus the company does not need to spend much on its marketing as the budget has projected its strong marketing plan from the previous months. Besides that, a budgeting system also allows companies to uncover bottleneck issues. Bottlenecks may occur at different phases of a process and it may concern issues such as limited capacity and interference or prioritization that does not follow the standard procedure of the company (Gargasson et al. 2014, p. 1037). Thus, with a budgeting system, companies will be able to identify what can be performed to expand the capacity of the bottleneck issue or possibly workaround to shift the bottleneck. For example, companies may identity valued and non-valued activities, and they could eliminate the non-valued activities to relieve bottleneck issues.
In contrast, there are some drawbacks in using a budgeting system. An important downside of budgets is its timing. Budgeting process requires heaps amounts of time to establish. It usually takes up a few months to strategize a budget and it will require the management to take part of it as well and thus, taking up the management’s time (Australian National Audit Office 2008, p. 30). This can be further illustrated when companies have to first gather a good amount of information followed by constructing its budgeting process. Once that is done, the budgets have to be sent to the top management for approval. This whole process takes up a lot of time. In addition, Hope and Fraser (2003) suggests that companies should eliminate the use of a budgeting system. This is because companies tend to focus mainly on its budgets to achieve its goals whilst investing huge sums in IT networks, process engineering and a range of management accounting tools such as Economic Value Added (EVA), balanced scorecards, etc. However, these tools are unable to establish new orders due to the constant emphasis on budgeting processes.
CHALLENGES & CONFLICTING PLANNING AND EVALUATION ISSUES
As reported by Barrett and Fraser (1977), a budgeting system comprises of three major conflicting roles, which includes planning and motivation, motivation and evaluation, and planning and evaluation. Planning and evaluation, however, is merely a minor conflict, which often occurs through the challenges of behavioural and environmental issues.
Behavioural implications of managers and employees may affect the planning and evaluation of a budget system. For managers, an unrealistic budgeting plan could conceivably lead managers to make decisions and evaluations that are prejudicial to the company. A manager will do whatever it takes to keep the company within the planned budget but this could in turn harm the company indirectly. As a case in point, if the company has exceeded its planned capital budget in the previous month, the manager might make evaluations to cut down on raw materials and packaging to reduce its budget. Although the company could possibly keep its costs within the budget, the product might not be sufficient and it could lead to customer unsatisfactory. In addition, a budget plan may as well have an impact on employee behaviour. At times, budgets are evaluated at high levels or unrealistic budgeting figures. When this happens, employees will be de-motivated to work, as it will be hard to achieve such high expectations. The employees will eventually give up and company performance will be reduced. Besides that, Riley (2014) specifies that setting a budget at a level too low would result in employee slacking. This is because with such a low target, both the managers and employees are not inspired to work hard to achieve organisational goals. Hence, the aim is to plan and evaluate budgets that are perceived as being possible to accomplish, but at the same time will entice the employees to work harder (ACCA Global 2010).
Other than that, environmental issues within the company is yet another conflict that arises between planning and evaluation. Juozapavičiūė and Stončiuvienė (2008) found that the main problem with budgeting is due to the difficulty to adapt to the ever-changing business environment. At times there will be unexpected circumstances, which would cause the company to make additional plans and alter its budgeting processes. Flexible budget may be deemed as an appropriate budget that organisations should use. This is because a flexible budget is variable; a change in sales volume would change the company’s budget to suit the markets needs and thus, less environmental issues within the company. Holtzman (n.d.) provides a great example of a flexible budget; an organisation produced 3,200 units although its master budget indicated that it was only supposed to produce 3,000 units. Due to such unpredicted change in the business environment, the flexible budget will rearrange its master budget by making appropriate amendments in its sales and expenses to reflect the new figure. A flexible budget also provides a greater level of control because it allows companies to rearrange its allocation of costs and funds based on the changing events in the market. Unfortunately, according to Vaznonienė and Stončiuvienė (2012, p. 159), it was found most organisations turn down flexible budgeting, as it is time-consuming to constantly plan and make adjustments of the budget. Ultimately, it will be difficult for companies with fixed budgets to familiarise itself with the ever-changing business environment and hence, this would cause companies to evaluate its performances based on unrealistic information. Jehle (1999, p. 55) highlights that as the market environment is continuously moving, the companies are shifting as well and thus, managements have to constantly alter its budgeting plans. Consequently, it is critical for companies to frequently alter its budgets as the business environment fluctuates. To resolve such an issue, organisations should undertake a flexible budget as opposed to a static budget even though it may be time consuming to continuously plan and adjust the budget, however it will be easier to evaluate the company’s budget. Nonetheless, such actions could ease the conflict between planning and evaluation.
Furthermore, another conflicting issue involves how Arnold and Gillenkirch (2015, p. 2) stresses that planning and evaluation are often in conflict with one another due to the need to provide managers with adequate financial incentives in which will strife with the accurate planning of the budgeting system. Due to this, budgets have to be set at different levels. Conventionally, Merchant and Manzoni (1989, p. 541) affirmed that companies hardly use different budgets for different purposes. Instead they would use a single budget for multiple purposes. However, Churchill (1984, p. 152) emphasised that a single budget may not be recommended for the use of multiple task and managers are better off using separate budgets for multiple task in its place.
CONCLUSION
Nowadays, with modern companies and the growing demands in the market, the use of management accounting tools such as ABC, target costing, benchmarking, and total quality management (TQM) are seen as tools that are not sufficient enough to meet the today’s demands (Newing 1994, p. 1). This goes to show how organisations have been using budgets to the point where there is a need to create a more enhanced and superior budgeting system. Budgets are taken seriously in a management accounting standard and it proves how budgets are effective in saving organisational costs. The objectives of a budgeting system are important as it outlines the various roles a budget plays in the company which is a crucial aspect to develop and implement a budget. Although there may be several benefits in using a budget, a benefit is not a benefit without its drawbacks. Hence, there are disadvantages as well as challenges in operating a budgeting system along with its conflicting planning and evaluation issues. Nevertheless, budgets have been long considered as a necessary universal tool in managing a company (Jensen 2003, p. 380).
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