1

Module 3:
Budgets: Control purpose

CRICOS Provider Code 00301J

 2

Phases of Management
Control
Modules 1 and 2
Strategies

Strategic Planning
Modules 6, 8, 9 and 10 Module 3

Evaluation Revise Budgeting

Budget

Measurement and
Reporting

Modules 4, 5, 6, 7 and 8

CRICOS Provider Code 00301J

 3

Lecture Outline
What is budgeting?

Responsibility Accounting

Strategy in Budgeting

Functions of budgets

Managerial use of budgetary information

Behavioural Issues in Budgeting

CRICOS Provider Code 00301J

 4

What is Budgeting?
Process of planning the activities of the organization’s
responsibility centers for the next period, usually the
next year.
 Budget = profit plan = a detailed plan expressed in
quantitative, usually/mostly in monetary terms, covering
a specified period of time, usually one year.

 Budgets are prepared along responsibility accounting

lines

CRICOS Provider Code 00301J

 5

Responsibility Accounting
A responsibility centre is a sub-unit of the
organisation whose manager is held accountable for
the sub-units’ activities and performance.
 Types of Responsibility Centres:
◦ Cost centres
◦ Revenue centres
◦ Profit centres
◦ Investment centres

 Managers of departments develop their own budget

estimates for cost, revenue or profits for their areas
and are then held responsible for meeting those
budget targets.

CRICOS Provider Code 00301J

 6

Strategy in Budgeting
 Strategy is the means by which an organisation
plans to achieve its objectives.

 A budget should help the organisation achieve its

strategic goals and objectives by:
◦ Utilizing the organisation’s strengths and taking full
advantage of its opportunities.
◦ Ensuring that projects and initiatives that are crucial to
achieving results are adequately funded.

CRICOS Provider Code 00301J

 7

Strategic Goals and Long Term Objectives and

Budgets
Strategy

Long term plan

Capital Budgeting
Short term plan

Master Budget

Operating Budgets
Financial Budgets

CRICOS Provider Code 00301J

 8

Strategic Use of Budgets

 Depends on the strategic position of the
responsibility centre.
 Less reliance on meeting the budget in
responsibility centres in build strategic position.
 Knowledge of managers in responsibility centres in
harvest strategic position less important.

CRICOS Provider Code 00301J

 9

Functions of Budgets
 Planning.
◦ Forecasts
 Facilitating communication and coordination across the organisation.
 Allocating resources.
◦ Consider alternative uses of limited resources
 Controlling profit and operations
◦ Comparison of budget and actual financial results
 Evaluating performance and providing incentives
◦ Motivational tool

CRICOS Provider Code 00301J

 10

Managerial Use of Budgetary

Information
Budgets serve multiple and conflicting purposes.
 Problems arise because of:
◦ how managers use the information provided by the budget
system and
◦ how the effects of such use feedback on the information that is
entered into the budget.

 Commonly, conflict arises when budgets are used as:

◦ Forecasts;
◦ Targets; and
◦ Standards for performance evaluation.

CRICOS Provider Code 00301J

 11

Managerial use of budgetary

information
Budgets as forecast
◦ Predicting most likely outcome rather than expected outcome
◦ Past performance used as a basis of setting future targets
◦ Issue of budgetary slack
◦ Optimistic targets to motivate but need accurate estimates for
planning

Need to ensure budget process fits different situations.

E.g., corporate planning should use forecasting models unrelated
to budgets.

CRICOS Provider Code 00301J

 12

Managerial use of budgetary

information
 Budgets as targets
◦ Budget standard is the target to aim for.
◦ Defined, quantitative targets lead to better performance than no
target or “do your best”.
◦ Needs to be challenging – attainable vs. unattainable goals.
◦ Managers need to be involved in setting the targets (goal
acceptance)
◦ Senior managers’ attitudes towards adverse variance is important.
◦ Motivating budgets are no good for planning!

CRICOS Provider Code 00301J

 13

Managerial use of budgetary

information
Budgets as standards for performance evaluation
◦ Rewards linked directly with budget achievement
◦ Getting managers to achieve targets is not difficult – getting
managers to achieve it the right way is!
◦ Behaviour is difficult to specify and reward

◦ Therefore, reward performance. If rewarding performance, then

◦ Budget standard comes under pressure (slack)
◦ Accounting information may be manipulated (fraud)
◦ Actual performance may be manipulated (undesirable methods)

CRICOS Provider Code 00301J

 14

Behavioural Issues in
Budgeting
A budget affects virtually all staff in an
organisation
◦ those who prepare the budget,
◦ those who use the budget for decision making and
◦ those whose performance is evaluated using the budget

 Three main behavioural issues are:

◦ budget participation,
◦ budgetary slack and
◦ budget difficulty.

CRICOS Provider Code 00301J

 15

Participative Budgeting
 Top-down/authoritative budgeting - where senior
managers impose budget targets on more junior managers.
 Bottom-up/participative budgeting - where people at the
lower managerial and operations levels play an active part
in setting their own budgets.

 Participative budgeting may…

◦ Encourage coordination and communication between managers
and a greater understanding and appreciation of the wider
organisation
◦ Lead to more accurate budget estimates as those close to the
operations have the best knowledge of the likely sales or costs in
their area
◦ Can lead to individuals identifying more closely with the budget
targets

CRICOS Provider Code 00301J

 16

Participative Budgeting
 Can be expensive and time-consuming
 Can lead to delays
 May aggravate differences and disagreements
 Provides opportunities for padding the budgets
(budget slack)

CRICOS Provider Code 00301J

 17

Budget slack
What is it?
◦ The difference between the estimated revenue or cost
projection, and a realistic estimate of the revenue or
cost
◦ Underestimating revenue or overestimating costs –
“Padding the budget”

CRICOS Provider Code 00301J

 18

Budget Slack
 Reasons for budgetary slack
◦ Performance can look better if you can ‘beat the
budget’
◦ A way of coping with uncertainty
◦ To insulate against initial budget requests being cut
back by management

 Undesirable results
◦ Waste of resources
◦ Employees do not try as hard to meet or exceed the
budget

CRICOS Provider Code 00301J

 19

Budget Difficulty
 Budget difficulty
◦ Budget acceptance is more likely when
Targets are developed with employee participation
Targets are considered achievable
There is frequent feedback on performance
Employees are held responsible for activities that are
within their control
Achievement of targets is accompanied by rewards that are
valued

◦ Budgets must be set at a level that provides challenge

and stretch, but not unattainable

CRICOS Provider Code 00301J

 20

Next Week:
Variances

CRICOS Provider Code 00301J