Why Most Companies Choose to Use a Single Budget for the Many Purposes of Budget - Literature review Example

Introduction According to Gond, Grubnic, Herzig, and Moon (2012), modern business enterprise is facing serious challenges due to the dynamics of the contemporary markets. Modern organizations must be highly integrated if they are to face the dynamics and budgeting not only helps when it comes to planning but it equally provides an array of measures in the management accounting. Some of these measures provided by budgeting are helpful, in ensuring that managers are held accountable for the performance of the firm. Budget is commonly defined as the projected quantitative plans by the management for the forthcoming period. Others define budget as a set of projected consequences that result from planned activity (Moynihan, & Lavertu, 2012). Organizations commonly use budget with an aim of facilitating the communication of specific information within the firm to ensure that consistent plan on production can be arrived. Most of the transactions are recorded according to the budgeted numbers. Accounting record is then expected to contain the differences that exist between actual and budget performance. The records that appear in the accounting records are expected to be those that can be analyzed and help evaluate the firm’s performance. Budgets are in most case simultaneously for purposes that are always seen to be conflict when it comes to planning and performance evaluations. There are those suggestions given by economy theory that separate budgets should be used for conflicting purposes something that is highly contradicting some of the evidences that organization do not do that (Moynihan, & Lavertu 2012). There are instances where planning task conflicts with performance evaluation task and as such would significantly affect the way budget negotiation behaves and the outcome. It would be highly important to find out whether it will be possible to use a single budget for both planning task and performance evaluation tasks or there is the need to come up with budget that addresses planning task different and doing the same with performance evaluation (Zheng, & Sakellariou 2013). This paper therefore illustrates the understanding behind interdependencies of the conflicting purposes of budgeting and further explains why most companies choose to use a single budget for the many purposes of budget. Budgeting The budgeting process interacts with operations research process through two major ways. The first way is that the transfer of the information that are accounting based and those that are not to those that are involved in the operations is achieved through the budget process. The transferred information helps in formulating production plan of the firm (de Azevedo, de Oliveira, Ensslin, Jungles, & Ensslin 2012). The second way is that budget helps in reflecting the production plan and as such being used to serve as a benchmark for subsequent performance evaluation. Additional information is got from the analysis of the deviations and it can be useful in formulating the subsequent production plan (Schick 2014). Budgets are commonly prepared at each level of the organization with the master budget, which is defined as the overall financial plan for the specified period, reflecting the goals and objectives of a given organization. Within the master budget, there is the operating and financial budgets with the operating budget showing planned sales of the company along with its operating expenses whereas financial budgeting showing financial plans that involve leasing, borrowing and cash management (Arnold, 2014). When budgeting is properly done, it can competently work as planning and controlling system for management accountant and the firm as a whole. The object and goals of the or5gansiation are usually documented in the financial terms and these plans are usually used for the entire year if they are properly formulated. Performance report of the firm in every month is usually compared with the actual result in the respective month. To be able to control the firms operations, management accountant are expected to examine the performance report and necessary actions initiated. Budgeting and cost management The role that is being played by the effective budgeting in the management of any organization can be best understood when it is connected to the fundamentals of cost management. The fundamentals of cost management are to ensure that resources are optimally allocated and that the organization is positioned such that it can remain profitable (Hope, & Fraser 2013). Organizations are known to be buying and using flexible resources, which include but not limited to supplies and materials in a given quantity that is required by the firm. The costs at which flexible resources are obtained highly depend on the extent at which it is used. Some of these resources are highly variable in the short run while others such as machinery and skilled employees do not have variable costs. To be able to ensure that proper allocation for both short and long run resources are achieved by the firm, a more comprehensive budget is required. Large and medium organizations benefit from the use of budget as it helps them in accomplishing various objectives. Some of these objectives include but not limited to planning, resources allocation, coordination, motivation, and evaluation of performance. Planning as a budgeting Role Budgeting is always done and made to take the organizational plan, which include goal and objectives that are then quantified into a more tangible thing. Through the budget, organization is capable of designing ways through which resources will be acquired or utilized with an aim of meeting cost management objectives (Stergren & Stensaker 2011). In most cases, budgeting has been seen as a tool for performance evaluation only but that is not true as budget is also essential in determining future financial plan by evaluating future expectations as regards to revenue and costs (Mertens, & Wilson 2012). Management accountant are very much concerned with the level at which company costs are management. They will always want to come up with a comprehensive plan on how to obtain required resources for production and how products are to be produced at much more controlled cost. The only way that can be done is by way of developing a budget that captures the resources required to meet the company’s objective and goals along with possible costs. Planning is known to involve making forecast of both financial and nonfinancial environmental factors that the business may not have the power to control. In management accounting, the main concern is to ensure that performance objectives are realized (DRURY 2013). Performance objective is commonly referred to as targets, which remains an excellent way of implementing sub goals. Budgeting ensures that broad performance objectives are broken down into a more specific and action oriented targets. Example of a much broader performance objective is when an o5rgansisation is intending to earn $300,000 in the second quarter of this year. This performance objective still remains too broad and can better of broken-down by management accountant by setting the minimum labor cost to being $2 per unit in the second quarter. The other way in which a more specific budget can be done with an aim of coming up with a clear performance of objective plan is setting a minimum of three defective units that can be produced for every a thousand units for the second quarter. When a company, say TT is producing two toy cars, a flexible budget is developed for the machinery department with an aim of predicting expenses of the department within the accounting as a function of the firm’s activity level. Management accountants then analyses the prior results that help the department to forecast the relationship that exists between activity and costs (Bedford 2015). Activity that is fund to be highly correlated with costs is always considered a cost driver. Management is capable of using a budget to formally state its performance objective and goals in financial terms within a given period. It is always require that management to use a common denominator to communicate its plan, which is always in dollars. Marketing department is expected to come up with plans that are reduced to sales budget and budgets on marketing expenses that are simultaneously developed. Each department in an organization is equally expected to come up with their plans done in financial terms (Arnold, & Gillenkirch 2015). Coordination of all the activities of an organizational is very instrumental for the preparation of the master budget. Financial needs, revenue plans, asset requirements, and planned expenditures are properly integrated by the master budget. All the activities that managers of the organization are expected to are equally integrated in this budget. With a very effective coordination, manager’s plans are brought into correspondence with the set firms objectives. Budgets are capable of giving managers much more analytical task of always wanting to stick to the budgetary dictates on a daily basis. This should not be considered unnecessary burden because in the event that this is not done then the company’s corporate existence may be under a threat over the increasing costs that can possibly result to loss of jobs and managers being laid off. Budgeting therefore becomes the most useful tool that a business can use to provide a game plan. Budgeting offers a game plan that is useful in the long-term operations of the business as well as daily operations. A properly organized budget by the firm can be helpful to the business when it comes to meeting its goals and as such become more profitable and survive throughout the financial times. When developing a budget, planning is one of the very first things that come into mind as such should be highly taken seriously. Performance Evaluation as a Budgeting role The performance of any manager is most cases evaluated through measuring the success in meeting the budgets. Most organizations award bonuses as regards to the ability of an employee to meet the target as defined in the periodic budgets but sometimes it may partly depend on the manager’s performance. Budgets has been considered to be a very useful way through which managers are informed on how best they are doing as related to meeting the own previously set targets. In the operational budget, the data works as a standard for which manager’s or organizational actual unit’s results are compared. When such as standard misses, senior managers of the origination would have nothing but the past for which they measure the present results. There is very little meaningful evaluation of the company or manager’s performance when present to past comparisons are used in as much as it is very interesting. In the event that performance evaluation is done to measure operating abilities of a manager and not their forecasting skills, unforeseeable or uncontrollable effects that are desirable that takes place during the budget period need to be removed (Frezatti, Aguiar, Guerreiro, & Gouvea, 2011). Some of the uncontrollable environment variables include changes that take place in the government regulations, shortages, labor unrest or just increase in raw materials cost that are not expected. In the role of evaluation budget there is the support that budget receive from other management control elements. As such, budget works as a very crucial standard used in measurement but falls to the system of reporting in providing data on the exact results that need to be measured over the standard. The work of budget as a way of carrying out performance evaluation equally influences the behavior of human. Budget can therefore be seen to be very effective when it comes to carrying out the work of performance evaluation of the organization or manager’s performance (Arnold, & Gillenkirch 2015). It would be very crucial that when drawing the organizational budget, the performance evaluation be taken into account. Conflicting roles of budgets Since in most case there is only a single budget that is used to serve multiple objectives, there is always a danger that a conflict may arise. There is the case where budgets that are not capable of achieving appropriate performance evaluation are demanded but the same budget is not the right budget for realizing planning purposes. In the case of planning purposes, budgets are prepared in advance before the actual budget period by basing it on various forecasted circumstances or environment. When it comes to performance evaluation, it needs to be based on the comparing actual performance with budgets that are adjusted to show circumstances that mangers operated in an actual sense. Most of the companies in practice compare their actual performance with very original. The adjusted is done to the exact level of the activity of the firm, which means that it is flexible. However, in the event that circumstances predicted changes due to from the original budget then there will be a conflict in the evaluation and planning. When there is a conflict between performance evaluation and planning tasks, the behavior of the budget negotiations as well as its outcomes will be affected. Management accountants find it very difficult whether to decide on using a single budget for both planning tasks and evaluation performance or just prepare different budgets for planning and performance evaluation tasks. A number of studies have however shown that superior restrictions to a single budget for performance evaluation and planning tasks leads to an increase in the corporation of the subordinates even more than when two separate budgets are used. Besides the increased corporation in the subordinates due to the use of a single budget, there is also the aspect of saving costs. Coming up with two sets of budget will translate to additional costs unlike when a single budget is used. The value of increased cooperation and the costs saved offsets the loss that comes by the flexibility in the restriction. The trade off largely depends on the environment of the firm, cost of poor planning and low performance. Most of the existing empirical however shows that less conflict when it comes to negotiation can be attributed to better outcomes of planning tasks and performance evaluations. Summary and conclusion Modern organizations must be highly integrated if they are to face the dynamics and budgeting not only helps when it comes to planning but it equally provides an array of measures in the management accounting. Some of these measures provided by budgeting are helpful, in ensuring that managers are held accountable for the performance of the firm. There are two major ways through which budget interact with operation. The first way is that the transfer of the information that are accounting based and those that are not to those that are involved in the operations is achieved through the budget process. The transferred information helps in formulating production plan of the firm. This paper has given explicit conflict between budgeting and operation of an organization. The conflict therefore exists when budget is used for multiple purposes but there is need for further consideration before going for the option of drawing two budgets for performance evaluation and that of planning tasks. References Arnold, M C 2014, ‘The Effect of Superiors' Exogenous Constraints on Budget Negotiations. The Accounting Review, 90(1), 31-57. Arnold, MC & Gillenkirch, RM 2015, 'Using negotiated budgets for planning and performance evaluation: An experimental study', Accounting, Organizations and Society, vol. 43, pp. 1-16. Bedford, D S, 2015, ‘Management control systems across different modes of innovation: Implications for firm performance,’ Management Accounting Research. de Azevedo, RC de Oliveira Lacerda, R T, Ensslin, L, Jungles, AE & Ensslin, S R, 2012, ‘Performance measurement to aid decision making in the budgeting process for apartment-building construction: case study using MCDA-C,’ Journal of Construction Engineering and Management, 139(2), 225-235. 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