Managerial Accounting of an Organization - Essay Example

Managerial Accounting Introduction: The budget of the organization is an integral financial plan that incorporates a systematic and organized analysis and interpretation of the company’s financial forecast in respect to the products, services, markets and its application of resources. It involves the process of planning by the managers; with that, it requires financial and operational information of resources for the decision making. With that it sets a predetermined benchmark and standard for the measurement of the subsequent performance of the company. The budgeting has been practicing for quite a long time but with the passage of time the traditional techniques of budgeting are not much productive. The reasons that back the statement include the increasing pressure of capital market, rapidly changing business environment and an escalating competitive environment. In the context of that, the below presented paper has discussed the different aspect of traditional budgeting followed with the criticism over the traditional approach of budgeting. With that, the paper has discussed the recent external pressures from the capital market. Approaches towards Budgeting: According to the Kaplan, there are three approaches towards budgeting i. Activity Based Budgets Activity based budgets are the flexible budgets that are based on the different cost drivers. In activity based budgets, multiple cost drivers are used for the different activities of the business. The activity based budgeting is more precise as compared to the conventional budgeting. ii. Incremental Budgets The incremental approach towards budgeting initiates with the previous budgeting period which are also term as the actual results. It adds and subtracts the incremental amount to overcome with the inflation and other obvious changes. iii. Zero Based Budgets Zero based budgeting is that approach for budgeting that necessitates each element of cost to be particularly justified, as the activities related with the budget are taken into the considerations for the first time. In zero based budgeting, the allowance for budget is zero without any prior approval (Kaplan Financial Limited, 2012). Traditional Budget: The traditional budget of an organization designates the amount and quantity of money the management of the company allocated for a predetermined period in order to meet the financial obligations of the company. These includes allocation of funds for the operations of the business, the liabilities and other expenses incurred by the organization. The aim of the budget is to facilitate the organization to spend the revenues and income generated by an organization in accordance with the plan. The traditional budget is based on reviewing the historical performance of the company followed with the projections in relation with the findings for future modifications (Inc, 2014). Hence, the traditional budgeting employs the incremental approach. It starts with the budget of the previous year and regulates up or down according to need from the budget in order to reflect and follow the changing assumptions for the upcoming budgeting period. The justification and reasoning for the increase in expenditure are related with an increase in the costs of inputs like material, labor and several forms of overheads. It has been observed that the incremental approach adopted and followed in preparing the budgets may not integrate a proper evaluation and estimation of the level and extent of the services being offered (Cheong, n.d.). Measures Management Model - Traditional Budgeting Targets and Rewards Incremental targets with predetermined fixed incentives Planning and Control Fixed plans on an annual basis with Variance control Resource and Coordination Pre-assigned resources with central coordination Organizational Culture Centrally controlled with the focus on organizing numbers (Kaplan Financial Limited, 2012) Criticism on Traditional Budgeting: It has been thoroughly discussed that the traditional budgeting approach is based on the fixed periods, annually. In relation with that, the traditional budgeting approach persuades rigid and stiff planning without any flexibility. Moreover, in fast moving business, when the business operations and activities are rapidly evolving it is often turn out to be inappropriate. The traditional budgeting approach is time and energy consuming for the management of the organizations. Further, by adopting and practicing the traditional approach of budgeting the managers and employees of the organization tend to achieve the lowest target set in the budget rather than putting their efforts to meet the set target in the budget. This leads the business operations and activities inconsistent with the Total Quality Management approach. It compels managers and employees to meet the requirements of the budget even of it leads towards the outcome of undesirable and unwanted actions. The traditional approach of budget encourages the managers and the employee to spend in the pattern that has been mentioned in the budget despite of the fact that it might be unnecessary for the business. This is back by the fact of guarding several elements of against the budget of next year. It facilitates the barriers and obstructions among several different departments of the company rather than facilitating the sharing of knowledge among them. The traditional budgeting approach is perceived as a mechanism for the top down control practice by the senior management. This budgeting approach focuses on the short term financial performance of the company and overlooks the key drivers of the shareholder value. In accordance with the traditional approach, the variance reports produced by the organizations are inadequate and insufficient with many significant justifications unanswered. Recent external pressures from the Capital Market: Jack Welch, the chairperson of the General electric, does not think of budgets much. He stated the proc3ess of budgeting in his bestselling book “Winning”, the most ineffective and unproductive practice in the management of the organizations. It takes much time, energy, fun factor and big dreams out of the company. Moreover, according to him most of the time the company wins despite their budgets and not following their budgets. Many European CEOs have been sharing the distaste and aversion of Mr. Welch for the traditional budgeting approach. That is the reason that supported the implication of rolling forecast and other methods and techniques of continuous planning in many European countries over the traditional budgeting approach. With the passage of time, the trend is slowly and gradually changing and making its way transversely. Now more American organizations realize that the frequent adaptation of the planning approach is the most excellent way to set the future course of their organizations (Wolf, 2014). In reference with the above stated viewpoint of the chairperson of the General Electric, it has been also observed that any approach in the budgeting has a direct relation with the management of the company. The budget control is the most important feature of the management control of the organization. With that, it has been observed that the capital market pressure have also impacted the budgeting of the corporations. This is in the form of emerging expectations of the capital market focusing on the growth and performance of the company. In the past few years, the shortening of product lifecycle and increased in the competition at global level made it difficult for the organizations to maintain the sales and growth of the profits. Resultantly, there is a variance between the actual results and the forecasted results (Ryan, 2007). The institutional investors are gradually and progressively more willing to intervene and get involved in the organizational affairs, in this way these investors influence the managers way of performing their duties and responsibilities. These influences are in the form of expectations to the constitution in the fair returns on the invested funds and the expected time frame (Berle & Means, 1968; Froud et al., 2006). The spirit of control budget: The term budget controlling is defined as the consistency of planning, controlling, coordinating and motivating with the help of monetary values and different departments in the organization (Buckley and McKenna, 1972). The main gist of the entire process of budgeting revolves around influencing and persuading the behavior of management by determining and setting the established standards of performance and controlling the achievement and accomplishments of those set standards (Ryan, 2007). With that, it has been observed that the measures taken for the budgetary control is the fraction of a complex and intricate organizational reality. It tends to work reasonably well and satisfactorily in the comparatively stable environment (Otley, 2001). The Otley (2001) also observed that the assumption made for the budgetary control is the main incorporated method of controlling for most of the business entities. This explains that the budget of the organization is a financial representation of its business plan. Hence, budget can be used as a tool to monitor and control the complex and complicated issues in the business plan of the organization. This reflects that the budget of the organization is linked with overall attainment and accomplishment of its performance targets. However, the implementation of the planning and control of the budget can turn to be problematic and challenging in obtaining the predetermined set objectives (Hopwood, 1972; Lowe & Shaw, 1968; Llewellyn, 1998). The use of the budget is an integral of the managerial accounting and according to Otley (2001) the practices of managerial accounting have been changed quite fundamentally and drastically in the past fifteen years and more. The change in the practices of managerial accounting practices appears to be more in practice as compared to the tradition methods of accounting this also involve the managerial approach towards traditional budgeting. With the rapid development in the domain of managerial accounting, the activity-based budgeting emerged as the accurate method of developing the costing of any product, and it has turned out to be far reaching the outcomes. This is because the activity based budgeting has involved the better knowledge and information of the product cost and the overhead cost; it also provides an overall improvement in the business processes. In reference to that the traditional budgetary system would be unable to maintain the good performance of the company. The predetermined standards might have the potential to limit the prospect performance of the company. This will reduce the competitive advantage of the company, which is quite essential in sustaining and progressive in today’s business and corporate scenario. Further, the increasing pressure from the capital making it difficult for the organizations to perform at optimum level. Now the business environment is emerging in the form where the individual and the intellectual capital are essential for the success (Ryan, 2007). In due course the prevailing uncertainty in the environment is related in terms of risk in budgeting (Collier and Berry, 2002). Now for the organizations it is equally important and a growing concern to interact and intermingle with the capital market as it was with the product market (Froud et al., 2006). The increasing and intensified competition prevailing in the business environment is continuously going through the rapid advancement in the technology and the processes (Teece, 2000). This escorted the state of diminishing profit margins for many companies. Thus, the requirement of credibility and reliability for the accomplishment of the budgeted results is directed by the shareholders who do not have loyalty for the organization on long term basis (Rappaport, 1986; Handy, 1995; Drucker, 1999; Froud et al., 2006). Now, this evolving change in the pattern of loyalty of shareholders of the organization, along with increasing intensity of competition and declining profits margins, has put the increasing pressure on the organizations to obtain the operating results that were planned by the management of the organizations. This issue is significantly related with the time horizon, where the success of the organization is essential in longer innovation in the company and contemplating a situational relationship with the shareholders of the company and the expectations they have on short term level (Ryan, 2007). In this way, there is a possibility that there could be conflict and disagreement between relationship of the organization and the capital market in terms of prioritizing of the expectations. The capital markets and the shareholders are gradually and progressively focusing on the developments on short term level which have the potential to negatively affect the efforts of the organization for the long term developments. Here, it is observed that the control of the organization is one approach for managing the dilemma of short term and long term expectations of the capital markets and shareholder in relation with the performance of the company. In this way, the organizations respond internally and counter the external drivers of the emerging context of the expectations. Now as stated above the traditional budgeting techniques are not efficient and with the increasing pressure from the capital market it is getting difficult for the organizations to maintain the growth and performance of the company. In order to overcome the dilemma, the BBRT (Beyond Budgeting Rounding Table) has splurge quite a lot time in examining and assessing the performance management of several large organizations. The studies concluded that the budgeting culture prevailing in the organizations is among the greatest obstacles that lead towards change. The Hackett Group in the year 2003 has figured out that an average billion dollar organization exhausted around 25,000 person days in generating the billion dollar revenue for formulating the annual budget. The extensive use of budgetary systems consumed a long time of the organizations like six to eight months for the entire process. With that, some budgets are detailed and involved in the input of many operations and hence cost a lot to the companies and consumed the resources of the company immensely. In has been observed, in the discussion presented above, that the rapidly emerging competitive business environment in the world and increasing pressure of the capital market demand the company to become more vigilant and flexible. Whereas, the traditional budgeting provides the approach that is fixed and inflexible in nature. The approach lead towards the fixed goals and objectives set by the management of the organization irrespective of the realistic nature of the goals. Now once the budget is locked it does not facilitate the change irrespective of the change in the industry and/or market conditions. This hurdles the emergence and implementation of new concepts, innovations in the business, new partnerships and other financial repercussions encounter by the company. The traditional budgeting can be curative rolling forecast which is the rational adaptation of the budget or by taking into account the issues that are expected to rise in the process of planning (Wolf, 2014). Conclusion: The need of the organizations in today’s business environment is to become more flexible towards the rapid change in the environment. In doing so, the organizations have to be more focused on their growth and development, and have to improve the profit margins on a regular basis. In relation to that the capital market is also influencing the organization at an increased level. The pressure has been exerted by the shareholders in terms of knowing the returns on the investment. The traditional budgeting techniques and approach provide the company with the fixed and inflexible initiatives and measures but, on the contrary, the capital market is more interested in the short term performance and returns of the organization. Hence, it has been concluded that the traditional technique of budgeting shall be eradicated. However, it is suggested that it can be replaced by the rolling forecast technique in the organizations. References Berle, A., & Means, G. (1968). The modern corporation and private property, 1932. McMillan, New York, NY Buckley, A., & McKenna, E. (1972). Budgetary control and business behaviour. Accounting and business research, vol. 2, no. 6, pp, 137-150. Cheong, F. (n.d.). From traditional budget planning to zero-based budgeting. Available from http://www.hkiaat.org/images/uploads/articles/PBE%20PII%20Steve%20Fong_apr12.pdf [Accessed 3 December 2014] Collier, P. M., & Berry, A. J. (2002). Risk in the process of budgeting.Management accounting research, vol. 13, no. 3, pp. 273-297. Drucker, P. F. (1999). Knowledge-worker productivity: The biggest challenge. The knowledge management yearbook 2000-2001 Froud, J., Johal, S., Leaver, A., & Williams, K. 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American Management Association, Available from http://www.amanet.org/training/articles/Why-Its-Time-to-Say-Goodbye-to-Traditional-Budgeting.aspx [Accessed 3 December 2014] Read More