Behavioural Issues in Budgeting

To The Chief Executive From prudence Accountant regard 19th January, 2012 To The Chief Executive From caution Accountant Date 19th January, 2012 Behavioural issues which may nail down the usefulness of budgeting Management accountancy Behavioural issues which may limit the usefulness of budgeting Management Accounting The university of northampton By Matthew Matemba 10347139 The university of northampton By Matthew Matemba 10347139 Table of Contents 1 diverge A2 1. 1Executive Summary2 1. Background2 1. 3Definition2 2Purposes of work out2 3Budgetary Biasing Framework3 3. 1Budget Slack (Bias)4 3. 2Seat of Power4 3. 3Budget swordplay4 3. 4Gatekeepers5 3. 5Beating the System5 3. 6The Know-All5 4Effects of Budgeting Slack (Bias)5 5Causes of Budget Slack6 6Conclusion6 7Part B8 7. 1Cash Budget8 7. 2Interpretaion of Cash Budget9 8References9 9Bibliography11 10Appendices12 Part A Executive Summary This report demonstrates behavioural issues which may limit the usefulness of b udgeting in Langdale Ltd.Including in the report are origin, definition, purposes and types of budgeting. Prior to the above, the report intends incompatible form of budgeting padding causes of budgeting slow up , researches and above all the control of aforesaid(prenominal) behaviours in organisations and three months funds budget for Duncan Distilleries plc. Background According to Dugdale and Lyne, the emergence of Scientific Management in the 1920s, standard costing and public sector budgeting was launch by the development of business organisations (2010, P. xi).Quickly, this development became budgetary control with a budget designed to compare estimated planning with actual result of performance in aid to identify any variance either favourable or adverse. Keuning (1997) suggested that, budgeting is associated with higher managers assigning t bespeak to different de touch offments. Definition Chartered Institute of Management Accountants (CIMA) in the UK defines a budget as A plan expressed in money. It is prepared and approved prior to the budget period and may show income, outgo and capital to be employed. May be drawn up showing incremental effects on former budgeted or ctual figures or be compiled by Zero-based budgeting (Hannagan, 2008, p. 560). There are various types of budgets namely, Zero-Based, Incremental, Rolling and Activity Based budget. Purposes of Budget The purposes of budget are planning of annual operations, co-ordinating the activities of various parts of the organisation, communicating plans to the various responsible centre managers, motivating managers to strive to achieve the organisation goals by meeting set targets. Finally, controlling activities and evaluating the performance of managers.Undoubtedly, budget plays major part in managing organisations because norms are set to compare budgeted and actual performances financially. However, research has showed that with new realities of global competition, rapid change and m odern technology the Beyond Budgeting movement has criticized the handed-down budgeting that, it was not meeting the advance challenges in terms of technology. Therefore, Bunce and Fraser formed the Beyond Budgeting Round Table in the UK in 1998 and inspired by the Swedish bank, Svenska Handelsbanken (Michael, 2007).Contrary to main purpose of budgeting individuals actions demonstrates about behavioural issue which may limit the usefulness of budgeting and this might not different from employees of Langdale Ltd. The draw 1 below illustrates the relationship amid objectives of budgeting contrary to behavioural issues of employees. Budgetary Biasing Framework Walker (2004) Budget Slack (Bias) As illustrated above, personal goals are a behaviour which may limit the usefulness of budgeting. It is a deliberate over-estimating of expenditure and/or under-estimate of revenues when setting budget in order to achieve easy targets.These actions from managers nullify the ability of manage ment to control variances. Research has revealed that, the inclusion of budget Slack or Padding is common in various companies. For example, Dugdale & Lyne (2010 cited in Onsi 1973 p. 26) found that 80% of managers interviewed were preparing to admit they bargained for Slack. Though, budget slack are seen as unfortunate and dysfunctional, there are some indications that some slack can be desirable providing some flexibility to operating managers Dugdale & Lyne (2010).This is known as manipulating of figures. However, reports show that due to complex inter-relationships between the various departments degree of manipulating of budgeting is difficult. Contemporary literature has reinforced the idea that slack can be desirable as well as dysfunctional. For example, Nohria and Gulati (1996) noted that slack could act as a buffer that was necessary for organisation accommodation Tan, J. and Peng, M. W. (2003) See Appendix B. Dugdale & Lyne (2010 cited in Van der Stede 2002 p. 6) found t hat slack could facilitate strategy in business units pursuing differentiation in such circumstance ends up with surplus assets such as plant, equipment and buildings. Seat of Power Additionally, from draw 1 shows a power factor which is another behavioural issue which is a limitation to budgeting. This affects budgeting process when individual managers have influence over the outcome of proposed capital expenditure. Consequently, this could divert the company direction which is contrary to its corporate objectives.Performance measure therefore, should establish to encourage the aim of the company and not individual or departmental goal. (Hannagan, 2008, p. 569) Budget Gaming Moreover, another limitation of useful budgeting is budget playing period which is an attempt by managers to practice bias in advance. A study shows managers also tend to game the budget after it has been implemented by fashioning accounting entries to portray their operation in a light that are driven by desire to report better result. Hopwood in his study showed that such behaviour is more likely if managers are evaluated Hopwood (1972) See Appendix C.For example, cost centre managers attempted to charge items of cost to other cost centres and tended to time the expenditure in light of their effects on the short-term variance but such manipulation was available to relatively few people. Gatekeepers These are employees in high position who delay in passing on vital teachings to heads of departments. Such personnel have authority to regulate the flow of information also in a position to determine various levels of management decisions. Beating the SystemIndividuals or groups may be able to beat the brass and they are even proud of behaving in such a manner. For example, a company set a budget of ? 15,000 for capital equipment. Above this limit redundant authority is required before any extra be are incurred. However, the managers beating the placement simply acquire a machine at a cost of ? 18,000 by ordering the capital equipment separately for instance, ? 14,000 and ? 4,000 per machine respectively. Surprisingly this behaviour happens in the real world and efficient internal control system and audit controls are called for further investigation. The Know-AllThere are certain managers who think they will take decisions without consulting their subordinates not realising that, the said capital equipment will scarcely work with certain additional equipment. In one case, although the subordinates were not consulted, yet they knew the know-all manager was buying a fixed asset they remained silent wise to(p) this machine might need additional parts to operate. Eventually, there was a job and the subordinates were very pleased when things went wrong. To conclude, this highlights the importance of participation and meeting to discuss on capital investment in non-current assets. Hannagan, 2008, p. 569). Effects of Budgeting Slack (Bias) Budgeting slack creates an environment where budgeting goals are not met or exceeded. Employees therefore fail to maximise sales and minimising costs and actually rather providing incentives to overspending as managers fear losing money in subsequent years and above all, budget slack encourage waste. Causes of Budget Slack The problem of budget slacks is inevitable when the previous years budgeting is used as a basis for preparing the current budget as shown on diagram 1. This address is known as Incremental Budgeting being used by Langdale Ltd.Though, provisions are made for inflation, increased activities and easily to use and understand by managers and above all less costly to operate, incremental budgets have some draw-backs such as not considering operation priorities, not objective orientated wherefore leading to manipulation of budget figures and encourages Spend it or Lose mentality. Consequently, BPP (2005, p. 303) has recommended that, to eliminate budget slack, the alternative budget to adopt is Zero-Based budgeting. Nevertheless, zero-based budgeting is mostly use in operate companies such as Governmental organisations and non-governmental organisations.Conclusion Debatably, Langdale Ltd being a publishing company, an alternative budgeting to improve incremental budgeting is Activity-based budgeting (ABB). ABB is contemporary approach to financial planning. It establishes the relationship between cost and activities. Resources are allocated to each activity which provides in-depth details especially regarding overheads because ABB permits the identification of adding a value to activities and the cost drivers of such operations. It minimising the utilisation of resources by focusing on how to increase productivity.Furthermore, ABB will provide the company opportunity of focusing on why you need to undertake certain activities, how often to perform them and their relative cost. Certainly, this approach of budgeting will enhance on processing information and products of wasteful activities that may reduce and re-deploy the companys resources for potential alternatives. Finally, in manufacturing sector being the range of mountains of Langdale Ltd ABB can enable the company to quantify decisions as follows * Reduction in Set-up and machine repairs. * Facilitates detailed analysis of cost consequently, lead to avoid certain cost.Part B Cash Budget Duncan Distilleries Plc. Cash Budget for July to September 2011. July August September ? 000 ? 000 ? 000 Sales (50% IN 30 Days) Note 6 clxxx 180 375 (50% in 60 Days) 180 345 345 imprecate Loan Given 100 100 Total inflows 360 625 820 Outflows Fixed cost Note 1. 1 32 32 32 Material 194 312 349 inconstant cost Note 2. 1 208 233 235 Fixed Selling and Distribution Note 3. 3 3 3 3 Variable Selling and distribution Note 3. 1 14 15 18 Administration Given 18 18 18 Finance Costs Bank interest Note 4 - 1 2 Financing Costs (repayment) 0 0 0 Total Outflows 469 614 657 Net Cash flow -109 11 163 Opening proportionateness 25 -84 -73 Closing Balance -84 -73 90 Interpretaion of Cash Budget The cash budget alerts Duncans management the company run into deficit in July and August. Although, the cash inflow in September will show surplus yet the financial position of the company is not strong since the first repayment of ? 50,000 loan will be due in 1st October. As a result, management has to negotiate with their bankers to extend the repayment to November. The company could also use different method of sales such as online in order to reduce variable selling and distribution cost. Finally, since the cost of material is quiet high, management could ask for more flexible terms of payment to their suppliers in percentage terms Scarlett (2009). References BPP Learning Media, 2007. emanation Performance Management. 1st ed. London BPP Learning Media Ltd. BPP, 2005.Management Accounting Performance Evaluatio n. 2nd ed. London BPP Professional Education. Dugdale,D. & Lyne, S. , 2010. Budgeting Practice and Organisation structure, Oxford s. n. Hannagan, T. , 2008. Management Concept & Practices. In 5, ed. Management Concept & Practices. Harlow. Essex Pearson Education Limited, p. 560. Hopwood, A. , 1972. An Empirical Study of the map of Accounting Data in Performance Evaluation. Online, vol. 10, pp. 156-182. obtainable from http/www. jstor. org/stable/248970 Accessed 10 December 2011. Keuning, D. , 1997.Management A Contemporary Approach. London Pitman Publishing. Michael, A. , 2007. Beyound Budgeting. Online . Available from www. cimaglobal. com Accessed 10 November 2011. Tan, J. & Peng, M. , 2003. The Role of Organizational Slack Theory and Evidence. Online, vol. 24, pp. 1251-1252. Available from http//www. utdallas. edu Accessed 10 December 2011. Walker, J. , 2004. Home. Online . Available from http//maaw. info/ArticleSummaries/ArtSumWalkerJohnson99. htm Accessed 27 November 2011. Wa lther, L. , n. d. Home. Online. Available from http//www. rinciplesofaccounting. com/chapter21/chapter21. html Accessed 26 November 2011. Bibliography BPP Learning Media, 2007. Advance Performance Management. 1st ed. London BPP Learning Media Ltd. BPP, 2005. Management Accounting Performance Evaluation. 2nd ed. London BPP Professional Education. Dugdale , D. & Lyne, S. , 2010. Budgeting Practice and Organisation structure, Oxford s. n. Hannagan, T. , 2008. Management Concept & Practices. In 5, ed. Management Concept & Practices. Harlow. Essex Pearson Education Limited, p. 560. Hopwood, A. , 1972.An Empirical Study of the Role of Accounting Data in Performance Evaluation. Online Available from http/www. jstor. org/stable/248970 Accessed 10 December 2011. Keuning, D. , 1997. Management A Contemporary Approach. London Pitman Publishing. MAAW, 2004. Home. Online Available from http//maaw. info/ArticleSummaries/ArtSumVanderStede2000. htm Accessed 27 November 2011. Michael, A. , 2007. Be yound Budgeting. Online Available from www. cimaglobal. com Accessed 10 November 2011. Scarlett, R. , 2009. Performance Operations. Oxford Cima Publishing. Tan, J. & Peng, M. , 2003.The Role of Organizational Slack Theory and Evidence. Online Available from http//www. utdallas. edu Accessed 10 December 2011. Walker, J. , 2004. Home. Online Available from http//maaw. info/ArticleSummaries/ArtSumWalkerJohnson99. htm Accessed 27 November 2011. Walther, L. , n. d. Home. Online Available from http//www. principlesofaccounting. com/chapter21/chapter21. html Accessed 26 November 2011. Appendices A. Calculations Cash Budget B. ledger The Role of Organization Slack C. Journal An Empirical Study of the Role of Accounting Data in Performance Evaluation