The Process of Budgeting - Term Paper Example

Participatory Budgeting Table of Contents Background study 3 Budget participation 3 Impact of participatory budgeting upon organizational activities 6 Negative impacts of participatory budgeting and budgetary slack 7 Reference list 9 Background study Budgeting is a crucial organizational process which facilitates the allocation of an organizations financial resource on the basis of predicted expenses and gains. The process of budgeting includes reviewing the profits attained in the past periods and making projection in relation to the current periods sales and production. The process also includes predicting fixed, variable and semi variable incomes and expenses. The purpose of budget preparation is meeting the organizations prime profit objectives. Budgeting is often used as a tool for measuring the efficiency existing in an organization and to appraise managers and employees. It is most essentially a system which facilitates the proper allocation of finances. Financial budgeting helps controlling the expenses of a firm thereby optimizing the manner in which production activities are carried out. Budgeting also facilitates an organization to estimate the necessary fund required to meet production expenses. This makes it simpler to undertake financing decisions. Budgeting also facilitates an organization to estimate the level of liquidity to be maintained (Lau and Lim, 2002). On the basis of the established budgets, production department’s activities are required to control their activities so that the cost of production does not cross the estimated levels. Budgets are often used for communicating organizational activities and future operations to investors and shareholders. Budgeting is viewed as a useful process in allocating rare resources. Budget participation is a process by which all important stakeholders of an organization jointly participate in the budget formulation process. Budget participation is a useful technique for encouraging subordinates to participate in the management related processes. It is a common practice in most organizations at present so that participatory management can be facilitated. However, large scale organizations often find it difficult to implement budget participation as it becomes inconvenient to include members of all departments. The ability of subordinates to participate in the budget formulation process is also an important factor to consider. Considering such aspects, the following theoretical review has been constructed for vividly analysing the usefulness of participatory budgeting and the issues induced by the same (Leach-López, Stammerjohan and McNair, 2007). Budget participation The participatory budgeting technique is seen to gain much importance in the current business environment. The system allows subordinates to influence the manner in which targets are set. The increasing complexities of the business environment have made it necessary for organizations to undertake the participatory budgeting technique so that interest of subordinates can be considered while developing future plans of action such as budgets. The main objective that budgets aims to fulfil is the proper allocation of resources amongst employees. Kilfoyle and Richardson (2011) have viewed participatory budgeting as a suitable technique for developing harmony between superiors and subordinates. Contribution of employees in the budget development process is considered to be effective for proper distribution of resources. Employees are individuals who are directly related to production and therefore possess high knowledge regarding resources and their utilizations. Hence, they are in a position to give adequate and correct feedback in respect of how organizational resources are to be utilized and the manner in which they must be allocated. Gonçalves (2013), in his work “The Effects of Participatory Budgeting on Municipal Expenditures and Infant Mortality in Brazil’ has provided similar views as Kilfoyle and Richardson. In his work the author sates that the interests of subordinates gets protected when they are involved in the budget formulation process. Such participatory techniques are seen to strengthen the flow of information between mangers and subordinates. When facts and figures are strategically analysed and discussed, managers are able to gain a clear picture in respect of the manner of functioning of the firm. Managers are able to recognize the shortcomings faced in the grass root operations and device strategies for improving the same. Nouri and Parker (1998) on the basis of the evidences collected from different institution have gained the understanding that since budget are a tool for directing future courses of action, employee participation in the process enhances its affectivity to a large extend. The opinions of Nouri and Parker were seen to be much similar to the views expressed by both Gonçalves and Kilfoyle. Business organizations are seen to operate in complex work conditions. Information dissemination and viewing all functions carried out within the organization therefore becomes difficult. Participatory budgeting process provides adequate scope by which mangers are able to discuss important matters with subordinates and develop measures that are more profitable. When managers prepare budgets without corresponding with lower level employees, it is often seen that wrong measures gets implemented and resources do not get allocated as per the requirements of production. Due to mismatch of the actual requirements of the organization and the plans formulated, wastage of resources gets affected. When subordinates are included in the plan formulation processes, they develop a larger sense of belongingness with the firm. Employees are made to feel important and their understanding of the management is also seen to improve. Employees develop a sense of commitment and are seen to understand the roles which their superiors are required to fulfil (Lau and Buckland, 2001). Management objectives are seen to be more clearly understood by lower level employees. Friction between managers and employees are often seen to arise out of misinterpretation of the objectives of the two groups. When they work together and communicate freely with each other, such misinterpretations can be reduced to a large extend. Employees are provided with the facility to assess whether superiors are taking fair and just decisions. Transparency needs of the organization also get fulfilled as greater employee contribution in management decision is encouraged. It is also observed that when participatory management is implemented within the organization, negotiation processes between employees and managers for acquiring resources gets reduced. Since managers allocate resources based on the consent provided by the employees, their resistance towards the same is minimized. Employees are enabled to provide direct information regarding their resource requirements. Therefore, accurate allocation of resources gets facilitated. In order to improve the accuracy of work, participatory budgeting is seen to be a suitable method (Derfuss, 2009). The participation of subordinates in the process of preparation of final budgets is seen to impact the overall system of working greatly. Budgets can be prepared by an organization in respect of different types of activities such as production, revenue and expense estimation. It may also be prepared for allocating personnel, machines and other valuable resources to different activities of an organization. Since budgets are directly or indirectly related to the basic operations of a firm, subordinate participation in the process makes budget formulation more achievable and realistic in nature. Subordinates are able to recognize the goals and objectives of managers and administrators and what they expect from them. While developing budgets using the participatory technique, it becomes essential for both mangers and subordinates to place their interests in front of each other. As a result, both interests groups are able to vividly determine how to align different activities so that the needs of the organization, managers and employees can be met effectively. Impact of participatory budgeting upon organizational activities The empirical studies conducted by Nouri and Kyj (2008) have developed the understanding that budget participation influences performance through different variables or functions. The direct impacts of budget participation upon organizational performance are not clearly visible. One of the critical roles played by participatory budgets is regarding the manner in which it facilitates information dissemination. When managers and employees directly communicate with each others, it becomes possible to transmit information directly without depending on any other individual or intermediary for passing on the information. The direct interaction facilitates managers and employees to clarify different elements present in the financial statements. Hence there is little or no room for misapprehension of the statements. The direct interaction between employees and mangers leads to the development of more reliable budgets which receives greater acceptance from stakeholders and employees. Participatory budgeting facilitates reduction in role ambiguity and thereby provides adequate direction to employees in respect of the manner in which they are expected to perform. The understanding of organizational goals becomes clearer when employees directly interact with their superiors (Yuen, 2007). The participation of subordinates in management decision and planning processes enhances their confidence. Subordinates develop a sense of belongingness in the organization and begin to associate themselves more deeply with the objectives of the organization. Employee empowerment is seen to be met to a certain degree through the participatory budgeting technique. In order to achieve organizational success, it is essential that subordinates remain motivated and contribute positively towards the goals of the firm. In the report ‘The moderating effects of hierarchy and control systems on the relationship between budgetary participation and performance’ written by Jermias and Setiawan (2008), the implications of budget participation upon the organization has been vividly discussed. As per the report, task uncertainty is greatly reduced when employees are encouraged to participate in managerial decision making process. Budget development is an important component of long term managerial planning process and therefore must be prepared in the most accurate manner. Work tasks are more complex in the upper hierarchical levels of an organization. As a result, obtaining clear information becomes a necessity for taking the right decisions. Since subordinates are directly handling resources and operating at the grass root level, their knowledge in respect of customer needs, product quality and demand are considerably high. Subordinate participation provides the management with more updated information regarding the conditions existing in the markets. This facilitates more accurate decision making and budgetary planning. While constructing budgets, managers are required to know about the various types of contingent expenses which may arise in the course of doing business. Subordinate knowledge in respect of such factors is high. Subordinates have greater knowledge in respect of business risks arising in the normal course of business and how cost of production can be minimized. Agbejule and Saarikoski (2006) have supported this opinion by stating in their research work that management knowledge regarding cost of operations can be strengthened by allowing subordinates to contribute towards the production process. Negative impacts of participatory budgeting and budgetary slack Although budgets are seen to largely have a positive impact upon the manner in which business activities are carried out in an organization, there are certain potential drawbacks to the system as well. Such drawbacks have been identified in the paper ‘Impact of reputation and variance investigations on the creation of budget slack’ which has been written by Webb, 2002. Management and subordinate interests differ in a number of ways. While employees focus upon earnings profits and increasing returns for the business, management is seen to remain keener on growth and reputation. Often meeting the interest of both the parties becomes mutually exclusive, thereby increasing the conflicts existing amongst them. Much time gets wasted in negotiation of interests. Additionally, developing straight and direct communication between employees and management is difficult if they are separated by geographical distance. A similar situation is seen to exist in multinational companies. In order to conduct participatory budgeting, it becomes essential to bring employees and managers together which may be a cost inducing process. Fisher, Frederickson and Peffer (2000), as per their studies have found out that budgetary slacks often get created when mangers find it risky to reveal important information to employees. As a result, employees remain unable to understand different aspects of the budget and are not able to contribute in its development effectively. Information discretion leads to the development of resistance, leaving employees feeling discriminated. In the opinion of Reid (2002), for developing a successful budget participation process, it is essential for both managers and employees to possess an open attitude and be cooperative towards the needs of each other. This is not the case however in most organizations, due to their rigid organizational systems and culture. Many at times mangers exclude employees from contributing in the budget formulation as they believe that employees may indulge in manipulating the allocation of resources. Employees may consider only their needs and neglect the requirements of other interest groups associated with the business. Therefore, a slack in proper budgeting becomes evident. Many at times the suggestions provided by employees cannot be included in the final budgets due to a number of factors such as existence of more important factors. Under such circumstances, managers are required to provide explanation to the employees so as why their suggestions were not accepted by the management (Leone and Rock, 2002). Much time and efforts are wasted in the process. In order to avoid such situations, managers may consider not including subordinates in the process of budgeting. Budget formulation requires high knowledge and understanding of the different functions performed by the organization. Employees may often not be in a position of having such high knowledge, due to which they are unable to contribute towards the formulation of such large budgets. As per the studies conducted by V. K. Chong and K. M. Chong (2002), since budget participation is not a necessary role of employees, they often view such tasks as a chore and do not take them seriously. Moreover involving employees in the budgeting process leads to delay in a number of production related activities. Hence, meeting deadlines becomes difficult. To avoid delays in the manufacturing system, employee participation in management processes are often avoided. Mutual trust between employees and managers is also an essential factor which is absent in many organization due to differences in the nature of work. When employee interests are given more importance, higher strategic needs of the organization cannot be fulfilled leading to immense slack in meeting organizational objectives. Likewise, when the number of individuals involved in the budgeting process increases, more time is required to formulate them (Libby and Lindsay, 2010). Reference list Agbejule, A. and Saarikoski, L., 2006. The effect of cost management knowledge on the relationship between budgetary participation and managerial performance. The British Accounting Review, 38(4), pp. 427-440. Chong, V. K. and Chong, K. M., 2002. Budget goal commitment and informational effects of budget participation on performance: A structural equation modelling approach. Behavioural Research in Accounting, 14(1), pp. 65-86. Derfuss, K., 2009. The relationship of budgetary participation and reliance on accounting performance measures with individual-level consequent variables: a meta-analysis. European Accounting Review, 18(2), pp. 203-239. Fisher, J. G., Frederickson, J. R., & Peffer, S. A. (2000). Budgeting: An experimental investigation of the effects of negotiation. The Accounting Review, 75(1), 93-114. Gonçalves, S., 2014. The effects of participatory budgeting on municipal expenditures and infant mortality in Brazil. World Development, 53(1), pp. 94-110. Jermias, J. and Setiawan, T., 2008. The moderating effects of hierarchy and control systems on the relationship between budgetary participation and performance. The International Journal of Accounting, 43(3), pp. 268-292. Kilfoyle, E. and Richardson, A. J., 2011. Agency and structure in budgeting: thesis, antithesis and synthesis. Critical Perspectives on Accounting, 22(2), pp. 183-199. Lau, C. M. and Buckland, C., 2001. Budgeting—the Role of Trust and Participation: A Research Note. Abacus, 37(3), pp. 369-388. Lau, C. M. and Lim, E. W., 2002. The intervening effects of participation on the relationship between procedural justice and managerial performance. The British Accounting Review, 34(1), pp. 55-78. Leach-López, M. A., Stammerjohan, W. W. and McNair, F. M., 2007. Differences in the role of job-relevant information in the budget participation-performance relationship among US and Mexican managers: a question of culture or communication. Journal of Management Accounting Research, 19(1), pp. 105-136. Leone, A. J. and Rock, S., 2002. Empirical tests of budget ratcheting and its effect on managers’ discretionary accrual choices. Journal of Accounting and Economics, 33(1), pp. 43-67. Libby, T. and Lindsay, R. M., 2010. Beyond budgeting or budgeting reconsidered? A survey of North-American budgeting practice. Management Accounting Research, 21(1), pp. 56-75. Nouri, H. and Kyj, L., 2008. The effect of performance feedback on prior budgetary participative research using survey methodology: An empirical study. Critical Perspectives on Accounting, 19(8), pp. 1431-1453. Nouri, H. and Parker, R. J., 1998. The relationship between budget participation and job performance: The roles of budget adequacy and organizational commitment. Accounting, Organizations and Society, 23(5), pp. 467-483. Reid, P. (2002). A critical evaluation of the effect of participation in budget target setting on motivation. Managerial Auditing Journal, 17(3), 122-129. Webb, R. A. (2002). The impact of reputation and variance investigations on the creation of budget slack. Accounting, Organizations and Society, 27(4), 361-378. Yuen, D., 2007. Antecedents of budgetary participation: enhancing employees job performance. Managerial Auditing Journal, 22(5), pp. 533-548. Read More