Planning And Control Of Budgets - Essay Example

Some management accountants argue that budgets are great for planning, but not for control. What do you think they mean? Do you agree with the ment? Explain why? Every organisation, company, governmental organisations have budgeting process that determines expenses and revenues, sales and savings and sets financial goals for the future. Budgeting forecasts potential earnings, helps to anticipate problems and compares the expected performance with actual performance. Thus, some management accountants argue that budgets are great for planning, but not for controlling. I think this statement has several meanings. First of all, control can mean making sure that the real numbers match the ones that were set out in the budgeting plan. It can mean ensuring the goals are met by controlling the expenditure, controlling the employees’ actions and controlling the outcome. Additionally, the use of planning cannot be underestimated. It is identified as an activity to plan a particular set of activities in order to serve a number of objectives. On the basis of objectives, the process of planning is identified and carried out. And, with the help of budgets, the process of planning is determined, discussed, highlighted and finally implemented. Without the use of budgets, the planning becomes ineffective and meaningless. On the other hand, controlling is a subsequent process, which can be achieved when an organization becomes in a position to compare the budgeted figures with the actual results. On the basis of such comparison, the organization is enabled to control the excessive costs or costs that can be reduced. On the basis of this understanding, planning serves different objectives with the use of budgets in comparison with the control that is there to bring different aspects of the management results. Although both are significant to the entire process of budgeting, yet they cannot be underestimated at the cost of each other. Thereby, it is hard to agree with the statement that the budgets are great for planning not for control. In the subsequent parts of this paper, first, budget and its objectives are provided, it is followed by different types of budgets and there uses are critically highlighted, then, it is followed by the discussion over budgeting and planning and budgeting and controlling. In this essay, the above statement will be discussed in more detail and conclusion will be made whether I agree with the statement or not. Budgeting and its objectives Budgeting is a significant control system in almost all organizations (Armstrong et al., 1996; Ekholm and Wallin, 2000; Merchant and Van der Stede, 2003). A budget is defined as a quantitative statement, which comprises for a defined period of time. In which, planned revenue, assets, expenses, cash flows and liabilities may be included. And, it can be used for multiple purposes (Garrison and Noreen, 2003; Horngren et al., 2003).Additionally, a budget helps organization to concentrate its current availability of resources; ensure an appropriate level of coordination has been put in place to ensuring budgetary objectives. In which, costs are highlighted to be controlled; and control is achieved when different types of budgets, such as master budgets, sales budgets, purchase budgets, production budgets are compared with the actual costs. On the other hand, planning comes after the step of determining budgets. Planning is strategy how to serve the budgetary objectives. Budgetary objectives are achieved with the implementation of budgets. And, the prior study suggests that organizations use budgets for attainment of their identical objectives and they are not determined in isolation (Moores and Yeun, 2001). Consequently, the reasons to budget are going to be correlated (Shields and Shields, 1998). First, budgets are devised to be used as a means of communication horizontally and vertically. Horizontally, budgets can be used for the purpose of discussion among or between different departmental managers. This communication greatly helps them to coordinate their inter-departmental activities. Sometimes, purchase manager may be wishing to purchase raw material in a bulk quantity; however, if the sales manager suggests that the demand of the produced items is less; in that case, the purchase manager may defer the purchase. Vertically, a department manager may discuss the some budget related issues with the senior management of the organization; in which the department manager may highlight some of the practical issues being faced by the department manager. Second, budgets can be used for coordination in the organization. For example, the production manager plans to produce a sum of goods in two days. But, the store manager suggests that the currently available raw material may be insufficient to produce the suggested number of goods in two days. This requires an active coordination between not only the production and store manager, but also among the managers of other departments. Third, budgets can be used to evaluate performance of the departmental managers. Performance evaluation of managers is carried out when the budget figures are compared with the actual figures in a given period of time. If the departmental manager has been successful in attaining the budget figures in that period, this would enable the strategic management of the organization to determine the performance awards and rewards, subsequently. Fourth, budgets can be an attractive source of motivation. In most organizations, the departmental managers are provided with reward based targets in the budgets. In which, if they become successful in achieving a particular level of budget target, they would be rewarded with certain attractive benefits and packages. As a result, this reward based budgeting motivates departmental managers to adopt such operational strategies that facilitate them in achieving such budgetary targets. There is a long going debate over the role of the budgeting within an organisation. Hope and Fraser (2000) state that in the last couple of decades, budgeting became a tool for ‘controlling the business, driving management behaviour and rewarding performance’. This shows that budgeting can be used for control as well as planning. This statement was proved right with the study conducted by Drtina et al (1996) with the largest office furniture supplier in the US, The HON Company and their budgeting process. This company uses budgeting to control their business performance, as it is very difficult to be successful in very volatile furniture industry. Particularly office furniture industry is full of uncertainties and fluctuating demand, which causes problems even in short term planning. Thus The HON Company found a solution for their planning problem in the face of budgeting. The budgeting became a solution to the problems associated with constant changes in their volatile business environment. They use budgeting to plan and control the development of new products, services, stay competitive and to ensure everybody in the company is aware of the changes. Managers use quarterly budgeting systems, which means they prepare updated four-quarter budget at the beginning of each quarter. This is done to communicate and cooperate operating plans among all departments and to be prepared to deal with any changes within the industry. By preparing budgeting plan every three-month, managers and employees can set realistic goals and stay informed of any rapid changes. Thus HON Company shows that budgeting can be used to plan and to control the company operations. They believe that changes in budgets does not simply involve changes in numbers, but means company’s plan need to be changed accordingly. Nevertheless, if managers in HON Company considered budgeting as very useful planning and control tool, then Bart (1988) considers budgeting as a game that managers do play for self-benefit. The term ‘budgeting gamesmanship’ was defined as ‘deliberate and premeditated manipulation of current year sales, cost and profit forecasts by product managers to project an overly conservative image into their product budgets’. The author believes that budgeting in some large companies does not represent realistic image of the situation. Therefore, it is difficult to project realistic goals and standards within such organisation, particularly at a time of high uncertainty in the business environment. Bart (1988) concluded that almost all product managers that were interviewed played ‘budgeting games’. Mostly, this involved understating or overstating some expenses, prices and volumes. Underestimating or overestimating in budgeting is very risky, as it affects the whole company operations. If every manager from all departments reported false projections, then the overall estimates for the whole organisation would not forecast realistic future. Thus making precise predictions about the firm’s performance and position in the competition can be problematic. Budgeting is one of the most important management tools that help leading the organisation towards its goals. Therefore based on the study conducted by Bart (1988), it is clear that some firms cannot use their budgeting system even for planning, yet to control, as it is not based on the realistic information. The author identified several situations that motivate gamesmanship. Performance rewards was found to be the most common driver for budgeting games, as underestimating future targets ensures bonus pay for the managers when they exceed their target. However, interestingly it was discovered that the firms where senior managers were against of budget gamesmanship, product managers were more determined to play ‘games’. Also, other companies that did tolerate gamesmanship outperformed in profit margins those companies that opposed budgeting games. This once again demonstrates that budgeting cannot be used for controlling the organisation’s performance. Moreover, Jensen (2001) has also criticised traditional budgeting for not being suitable for planning and controlling due to distorted information provided by managers. He criticises that budgeting provides incentives to lie, to set low easily achievable targets for the sake of bonuses, even if the company will bear the negative consequences as a result of their decisions. He exemplifies a manager who set a low target to secure the bonuses, making the company to set its demand level correspondingly low, and as a result the company run out of the product at the highest selling season, which led to poor profit margins. This demonstrates again that budgeting is not suitable for controlling the employees’ performance, which in this case makes it even difficult to use for planning and forecasting. Nevertheless, the author believes all these distortions are caused by pay for performance reward scheme. Therefore, replacing this reward, which is based on managers having to exceed their set targets to receive bonus to the one that rewards for their actions no matter if they exceeded, achieved the set target or reached below estimated target. Thus, senior executes will be able to receive realistic numbers, which in turn can be used for planning as well as controlling. Furthermore, Steele and Albright (2004) have also demonstrated several techniques, so called ‘games’ that managers use during budgeting. These methods include ‘sandbagging’, ‘the magician’, ‘the lone agent’, ‘the visionary’ and ‘the hostage taker’. All these games negatively affect the company and their budgeting system… Nevertheless, despite the problems encountered by traditional budgeting, there are new technologies, Internet and new programmes make budgeting an easy and very useful process. Hornyak (1998) has praised e-budgeting tool, which helps managers with the budgeting process. This new e-budgeting tool overcomes all the negative points of traditional budgeting that made it difficult for planning and controlling. It allows users to access their budgeting plan from anywhere in the world at any time. Financial managers are able to develop strategic plans based on ‘what if’ scenarios and demonstrate how various changes will affect other departments and activities within organisation. Moreover, this tool helps managers who have a little knowledge in finance to control and assess employees’ performance and decide who will receive bonuses, salary increase or other benefit packages. This e-budgeting tool has a number of advantages. For example, it reduces administrative costs and tasks, increases overall employee participation and allows concentrating on strategic plans more effectively. Budgeting and planning Planning is developed on the basis of budgets. After receiving budget approval, the departmental managers are encouraged to develop and implement planning strategy to achieve the targets set in the budget. For managers, planning possesses a considerable significance as it is the only way to attend the budgetary objectives. These budgetary objectives are provided in the budgets and will be entertained when the budgetary targets are met in the given period of time. For example, a purchase manager has been given a budget of purchasing 1,000 units in a year with a particular budgeted cost price. In order to purchase these units, the purchase manager is required to develop a plan, enumerating the further break-up of 1,000 units on per month, per week and per day basis along with the cost price. Additionally, the purchase manager cannot ignore the availability of other factors such as, availability of funds, availability of storage facility with its current minimum and maximum capacity, the current production schedule along with the demand of the finished units in the market. These factors always find their presence whenever the purchase manager intends to implement the planning strategy into action. Budgeting and controlling Control comes with the comparison of the budgeted figures with the actual figures. And, the control highlights variances, discrepancies between the budgeted and actual results along with the causes leading to those discrepancies. As a result, when the strategic management of the organization is provided with the causes leading to variances or responsible for increasing the costs or expenses, they direct the related department manager to take necessary steps to avoid the re-occurrence of such variances or discrepancies. Additionally, if the highlighted causes suggest that the departmental manger was responsible and did not take any concrete steps to avoid the occurrence; the management of the organization would be enabled to take necessary actions against the related department manager. Furthermore, if the highlighted variances suggest that the budgets were excessively and un-realistically developed, in that situation, the strategic management may find it reasonable to learn from such mistake; and avoid making such budgets. However, some authors suggest that it would not be possible to use budgets to control costs and other expenditures as the department managers are allowed to devise budgets along with authority to implement them; and they are only allowed to obtain budget approval from the senior management of the organization. As a result, this leaves little room to control additional costs as the departmental managers are considerably authorized to develop and implement the budget. On the face of it, it looks realistic; however, the closer understanding of the argument does suggest that at the time of approval or any other meeting with the strategic management, the departmental managers are expected to provide a detailed description about why the actual results did not meet the budgeted figures. Under such conditions, the departmental managers are under a considerable pressure to perform well, particularly in these days where cost of doing business is hugely rising globally and many businesses are putting more pressure on their departmental managers not only to ensure achieving the budgetary targets but also to minimise costs as much as they can. Furthermore, performance evaluation of the departmental managers may not bring positive results for the departmental managers if they have provided additional costs to the organization along with the statement showing the absence of the fulfilment of budgetary targets. Without any doubt, there exists a plausible link with the performance evaluation and the budgetary targets; and this link does not allow departmental managers not to control costs and plan their strategy to minimise costs and attend the budgetary objectives and targets. Additionally, this fact is also authenticated by works of Hope and Fraser (2000) in their article called-Beyond budgeting. In which, they greatly emphasize on the implementation of Svenska Handelsbanken model, empowering managers to make decisions and fix their problems along with enjoying the freedom with responsibility. Clearly, this empowerment cannot be availed and continued if the managers do not perform in a way to serve the organizational and departmental objectives such as controlling costs and increasing the output. Within this context, the process of controlling may face some tough time when the managers are pushing to put forward their favourite budgets on table in order to get them approved from the senior management. However, Steele and Albright (2004) in their article-Games Managers Play at Budget Time- clearly mention some ways to handle this problem: They contend that adopting a frank and open behaviour, accommodating and ready to listen attitude towards managers, and putting an eye on the numbers and the psychology of managers; are those ways that can be used to tackle the different types of managers. All in all, these factors clearly authenticate that the budgets can be used for the purpose of control at the strategic management level, which is fully authorized to ask reasons from departmental managers for both cost controlling and obtaining the budgetary objectives. Conclusion A budget is a statement of planned revenues, cash flows, liabilities, assets, and expenses for a particular period of time. The budget enables organizations to attend their budgetary objectives along with the use of performance evaluation. The departmental managers are given budgetary objectives, which are incorporated in the budgets. And, they are authorized to determine and implement their planning strategy in a way to achieve the budgetary objectives. For that purpose, they bring the annual budget figure at the monthly and daily level. In this way, they become in a position to determine and implement their planning strategy in the most effective way. After implementation of the planning, performance evaluation of the departmental managers is carried out. In which, the budgeted figures are compared with the actual ones. If any discrepancies are highlighted by that comparison, the departmental managers are required to explain the causes. In this way, with the help of performance evaluation, causes of discrepancies and budgetary variances are highlighted. This enables the strategic management and the departmental managers to control the causes of such discrepancies and ensure the attainment of budgetary objectives. References Armstrong, P., Marginson, P., Edwards, P., Purcell, J., 1996. Budgetary control and the labor force: findings from a survey of large British companies. Manage. Acc. Res. 7, 1–23. Ekholm, B., Wallin, J., 2000. Is the annual budget really dead? Eur. Acc. Rev. 9, 519–539 Merchant, K.A., Van der Stede, W.A., 2003. Management Control Systems: Performance Measurement, Evaluation, and Incentives. Pearson/Prentice Hall, London. Moores, K., Yuen, S., 2001. Management accounting systems and organizational configuration: a life-cycle perspective. Acc. Organ. Soc. 26, 351–389. Garrison, R.H., Noreen, E.W., 2003. Managerial Accounting. McGraw-Hill/Irwin, New York. Horngren, C.T., Datar, S.M., Foster, G., 2003. Cost Accounting: a Managerial Emphasis. Prentice Hall, Upper Saddle River Hope, J. & Fraser, R (2000) “ Beyond Budgeting”, Strategic Finance, 30-35. Shields, J.F., Shields, M.D., 1998. Antecedents of participative budgeting. Acc. Organ. Soc. 23, 49–76. Steele, R. & Albright, C (2004) “Games Managers Play at Budget Time,” MIT Sloan Management Review: 81-84 Read More