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BUDGETARY CONTROL MAF 551 MANAGEMENT ACCOUNTING AND CONTROL

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Page 1: BUDGETARY CONTROL.ppt

BUDGETARY CONTROL

MAF 551 MANAGEMENT ACCOUNTING AND CONTROL

Page 2: BUDGETARY CONTROL.ppt

1. Distinguish between feed forward and feedback control systems

2. Prepare fixed and flexible budgets

3. Prepare performance report

4. Discuss motivational, behavioral and ethical issues of budgeting

5. Explain the limitations of budgeting

6. Describe the practice of Beyond Budgeting

LEARNING OBJECTIVE

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The use of budgets in controlling operations is known as budgetary control and the centrepiece of budgetary control is the use of budget reports.

Management needs to compare actual results and planned activities, to monitor if the business is spending according to budget.

INTRODUCTION

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Name of Report Frequenc

yPurpose

Primary Recipient(s)

Sales Weekly Determine whether sales goals are being met

Top management and sales manager

Labor Weekly Control direct and indirect labor costs

VP of production and production department managers

Scrap Daily Determine efficient use of materials

Production manager

Departmental overhead costs

Monthly Control overhead costs

Department manager

Selling expenses

Monthly Control selling expenses

Sales manager

Income statement

Monthly and quarterly

Determine whether income objectives are being met

Top management

FEATURES OF BUDGETARY CONTROL

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FEEDBACK & FEED-FORWARD CONTROL

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Performance report or budgetary control statement.

Compare actual results with the budget.

Differences identified as variances.

Management role – investigate and correct the variances if necessary.

BUDGETARY CONTROL REPORT

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A fixed budget or static budget is a projection of budget data at one level of activity.

Data for different levels of activity are ignored and actual results are compared with budget data at the activity level used in developing the master budget.

Used for planning purpose.Fixed budget is not appropriate to assess a manager’s

performance in where he or she has control over variable costs.Disadvantages:

It ignores the possibility that there can be variations in the expected level of activity.

The analysis of the variances may be meaningless - not being compared on a common basis.

FIXED BUDGET

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Time / Costs Budgeted Actual Variance

1st Quarter RM180,000 RM179,000 RM1,000 (F)

2nd Quarter RM210,000 RM199,500 RM10,500 (F)

Total RM390,000 RM387,500 RM11,500 (F)

FIXED BUDGET – CONT…

1) The comparison shows favourable variance in both the quarters with a net effect of RM11,500 favourable variance, as a whole.

2) It can also be seen from the above that the activity levels are not defined and the comparison between actual and budgeted performance are based on purely monetary figures only.

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Designed to projects budget data for various level of activity and it is a series of static budget at different level of activity.

Assist in decision-making where it facilitates the management to predict its performance against levels of activity through the impact of changes in variable costs and sales value.

Used high and low method to differentiate the elements of costs.

Will be used in performance reports to determine the performance of the company.

FLEXIBLE BUDGET

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Advantages of Flexible budgets:

Do not require frequent revision.Geared towards a range of activity rather than

towards a single level of activity.More accurately reflect changes in direct costs

resulting from variations in production mix or rate.Provide a firmer basis for distributing the overhead

costs at different level.Comparison between actual results and budgets

will become more meaningful.

FLEXIBLE BUDGET – CONT…

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Activity level

Direct labor hours 8,000 9,000 10,000 11,000 12,000

Variable costs RM RM RM RM RM

Indirect materials 12,000 13,500 15,000 16,500 18,000

Indirect labor 16,000 18,000 20,000 22,000 24,000

Utilities 4,000 4,500 5,000 5,500 6,000

Total variable costs 32,000 36,000 40,000 44,000 48,000

Fixed costs

Depreciation 15,000 15,000 15,000 15,000 15,000

Supervision 10,000 10,000 10,000 10,000 10,000

Property taxes 30,000 30,000 30,000 30,000 30,000

Total fixed costs 62,000 66,000 70,000 74,000 78,000

FLEXIBLE BUDGET – CONT…

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If the actual direct labor is 10,000 with the actual costs listed, then the budget should be flexed too, as shown in table, in order to compare with actual performance at that particular level.

The difference, if any will show variance which can be expressed as either favorable if actual is less than budget, whilst adverse if the actual is more than budget.

FLEXIBLE BUDGET – CONT…

Flexed Actual Variance

Direct labor hours 10,000 10,000 0

Variable costs RM RM RM

Indirect materials 15,000 15,500 500 (A)

Indirect labor 20,000 21,000 1,000 (A)

Utilities 5,000 4,700 300 (F)

Total variable costs 40,000 41,200 1,200 (A)

Fixed costs

Depreciation 15,000 13,000 2,000 (F)

Supervision 10,000 9,000 1,000 (F)

Property taxes 30,000 34,000 4,000 (A)

Total fixed costs 55,000 56,000 1,000 (A)

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For planning purposes - 'contingency flexible budgets‘.To find out in advance the costs it would have to

bear if output falls short of budgetTo decide whether it is possible to find alternatives

for spare capacity if output more than budgetedTo estimate costs of overtime or extra machine hire

if output is more than budgeted

For budgetary control purposes - Fairer and more meaningful comparisons.

USES OF FLEXIBLE BUDGET

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A budget affects everyone in an organisation. Preparer and users Performance evaluation

The arguments against involving managers in the preparation of their budgets include:

1)Most managers will recognize that a budget will be used as a target against which their performance will be measures. This may tempt them to set an easier target by including some budgetary slack.

2)The managers may have little knowledge of budgeting and be unprepared for such a task.

BEHAVIOURAL CONSEQUENCES OF BUDGETING

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BEHAVIOURAL CONSEQUENCES OF BUDGETING- CONT…

The arguments for involving managers in the preparation of their budgets:

1)Most managers seek involvement in the planning of their organizations so that they can enhance their sense of belonging to the organization, and this motivate them.

2)If managers set their own targets, they can consider the circumstances of their own division and make the target attainable.

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2 issues:Participative budgetingBudgetary slack

Budgets can be used as a performance measure to decide on bonus and promotions - conflicts arise due differences in opinion because of the budgets set.

This will have consequences on management and employee behavior.

A sound budgetary system will promote desirable behavior and the right attitude

BEHAVIOURAL CONSEQUENCES OF BUDGETING- CONT…

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A process where managers who are held accountable for budget performance help to develop their own budget estimates.

The process of gaining acceptance of the budget involved a lot of negotiation and subsequent revisions of budget estimates.

Lengthy and time consuming.

1) PARTICIPATIVE BUDGETING

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Systems where senior managers impose budget targets on more junior manager with little or not consultation.

Set at corporate level and cascaded down throughout the organisation.

Advantages:Timely and cost effective

Disadvantages:Senior managers may have less knowledge of the local

business environment – unrealisticLimited involvement in setting budget targets can result

in a lack of commitment of middle and junior managers.

TOP DOWN (IMPOSED APPROACH)

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The participative process in which people at the lower managerial and operational levels play an active role in setting their own budget.

Budgets: collected at the lowest managerial levels and consolidated and fed up to senior management enhanced accuracy of estimates

Advantages: Encourage coordination and communication between managers Greater understanding and appreciation of the objectives and

strategy of the wider organisation.Disadvantages:

Expensive Time consuming Opportunities of padding the budget

BOTTOM UP (PARTICIPATIVE APPROACH)

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Padding the Budget - The practice of underestimating revenues or overestimating costs so that budget targets are easier to achieve

Budgetary Slack – the difference between the revenue or cost projections that a person provides and a realistic estimates of that revenue and cost

E.g. Annual utilities cost of RM18 000 but estimated RM20 000 – has built RM2 000 slack.

2) BUDGETARY SLACK

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Reasons for creating budgetary slack: People believe that their performance will look better if they

can “beat the budget” Budget is used to cope with uncertainty

If nothing goes wrong, supervisor can beat the budget If unfortunate event occur, budgetary slack will absorb

Managers are competing for limited resources – common for their initial budget requests to be cut by their manager or the budget review committee

Budgetary projections are padded because they are likely to be cut, and they are cut because they are likely to be padded.

2) BUDGETARY SLACK- CONT..

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How to solve?

Avoid relying on the budget as a negative evaluation tool.Allow some discretion to exceed the budgeted costs when necessary

Managers can give incentives not only to achieve budgetary projections but also to provide accurate budget estimates.

2) BUDGETARY SLACK- CONT..

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Motivation is the drive in the employees’ attitude needed to expedite operations based on budget.

Ethical issues involve honesty and trust of the employees when exercising their responsibilities to execute those operations based on budgets.

Any action which goes against this will cause dysfunctional behaviour and upsets plans and implementation.Dysfuntional behaviour – employees who does not carry

out duties morally as expected

MOTIVATION & ETHICAL ISSUES OF BUDGETING

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LIMITATION OF BUDGETING

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“A set of guiding principles that, if followed, will enable an organization to manage its performance and decentralize its decision making process without the need for traditional budgets. Its purpose is to enable the organization to meet the success factors of the information economy (e.g. being adaptive in unpredictable conditions).”

Beyond budgeting, p.212

Not only a new approach to budgeting, resource allocation and operational planning, but also a more holistic approach in strategy and corporate performance management to overcome criticisms to traditional budgeting Prevent rapid response Detailed and expensive Out-of-date within a few months Enforce control and command Encourage unethical behaviour

Empowered and adaptive organisation

BEYOND BUDGETING (BB)

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Response rapidly to threats and opportunities

Attracts and keeps the best peopleEnable and encourages continuous

innovationLeads to loyal and profitable customersSupport good governance and ethical

behaviur

IMPORTANCE OF BB

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BEYOND BUDGETING (BB)- CONT…

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ValuesGovernanceTransparencyTeamsTrustAccountabilityGoalsRewardsPlanningCoordinationResourcesControl

12 PRINCIPLES OF BB