Components of the Budget - Essay Example

Introduction A budget is basically a summary ment of plans that are expressed in quantitative terms or a comprehensive financial plan that helpsthe managers to identify and evaluate their resources in order to obtain optimum profit for their organization (Meigs, 1982). The chartered institute of management Accountants of England defines a budget as follows, “ a financial and or quantity statement, prepared and approved prior to a defined period of time , of the policy to be pursued during that period for the purpose of attaining a given objective” (Narangs 1995, p.5.156) Stages of Preparation of Budgets According to Martz (1980, p.448), the following are the stages involved in the preparation of budgets, Establishing General Policies ,Requesting, receiving and reviewing individual budget estimates, Suggesting revisions in individual budget estimates ,Approval of budget and later revisions., Receiving and analyzing budget reports, recommendations of actions needed and designed to improve efficiency where necessary. Assumptions Used To Create Budget Estimates. Budgets hold too high a level in the organizational hierarchy. (Llewellyn, 1998) The budgeting process is directed by a budget committee that usually includes the sales manager, the production manager, the chief engineer, the treasurer and the controller (Martz, 1980, p.448) Budgets are not owned by individuals. (Llewellyn, 1998) Cumulative efforts are made at all levels , at the decision making process for establishing targets and making estimates and at the implementation phase also when the budgeted target has to be achieved. Budgets are usually much aggregated (Llewellyn, 1998) It is assumed that adequate guidance has been given at all levels of middle and lower levels of operation. Martz (1980, p.448) The Role of the Budget As An Analytic Tool To Evaluate Organizational Performance Lucey (1992, p. 321), identifies the budget as an analytical tool for evaluation of organizational performance. 1. It helps in planning and co ordination of activities among the departments and individuals as well. 2. It Clarifies the of authority given and responsibility taken by the employees 3. It increases the Communication at all levels of management. 4. It enhances the overall control. The process of comparing actual results with the budgeted one highlights the inefficiencies and the limitations as well. 5. It increases motivation amongst the employees and they strive harder to gain the competitive advantage over others. The Budget Eliminates Inefficiencies in an Organization’s Performance. Otley (1999) suggests that the budgetary control process provides an encompassing framework through which all aspects of an organization’s activity are summed up into a single set of financial statements but at the same time It acts as a valuable source of monitoring the actual outcomes with the budgeted and also helps to identify and eliminate the inefficiencies in an organization performance, for example. It focuses only on the financial results and sufficient importance and attention is not given to the means or ways through which they are achieved. In some type of businesses where there is rapid change in current environment conditions because of any economic or social factors, frequent budget changes are avoided because budget revision are considered as time consuming and loss in budgetary control. It’s difficult to avoid the inevitable distorting effects arisen when managers are rewarded for achieving the budget targets. This can be reduced by giving some proper and justified incentive schemes like bonuses or overtime premium or any other reward system to the subordinates. It should be kept in mind that it is the overall collective team effort and the usually the pressure is usually taken by the middle and lower level management to meet the targeted goals. Usually the variances are used for the apportionment of blame rather than in the process of learning and adaptation. Role of Budget In The Business Control Cycle Narangs (1995) budgets considered budgets as an effective tool of planning and control. They play an important role in the overall business cycle because of the following reasons: It increases the co- ordination among various activities For example preparation of purchase budget can never be made without the production budget in any manufacturing concern. The purchase department must know the targeted production in order to estimate the amount and qty of raw material required for the finished goods. Similarly, the sales budget is a prerequisite of making a production budget because the production department must be aware of the targeted sales of the period and then they add the desired closing and deducting the expected closing stock in order to get the estimated units of sales. Budgets are means of communication Effective, realistic and achievable budget acts as a strong means of communication between the top, middle and lower level or organization. It is the ideas and the planning of the top management that are transformed and applied in the form of a budget and the responsibility is shifted towards the subordinates to meet the targeted goals set by them .but at the same time it is very important that the targeted sets and the budgets designed should be with accordance to the capabilities and limitations of the employees i.e. it should be a realistic one. It is a Means of Controlling Performance The targets set and the planning made in the form of budget will not only enhance the co- ordination between the various departments but it will also play a very important role in controlling and improving an individual’s performance and of the department as a whole. The departments will strive harder and stronger to get the competitive advantage over others to get the incentives in the form of bonuses and any other reward system. Internal And External Control Mechanisms To Monitor And Evaluate the Budget. Martz (1980, p.448) proposes the following internal and external control mechanism should be adopted in order to evaluate and monitor the budget. 1. Adequate guidance should be provided to ensure that all the management levels are working on the same assumptions and they are well aware of the targeted goals and objectives and the agenda given to achieve them. 2. Participation in the budgeting process should be encouraged at each level. 3. Individuals must be given the freedom to participate and have the authority to influence and accept their own performance level and thereby meeting the challenges arises as a result. 4. The preparation of budget should be structured such that there is a reasonably high probability of success in attaining the targeted objectives Use of Budgets in the Performance Accountability Information distortion Otley (1978) identifies that information distortion usually occurs when an individual focuses more to present his favorable contribution for the organization rather than the overall organization performance .The appropriateness of the technical characteristics in a particular environmental and organizational structure can become ineffective if the information gathered through, research and investigation for budgeting is not used efficiently because of the following reasons: 1. When any information is ignored during investigation or planning phase. 2. Manipulation of the information for personal gains or rewards. 3. Providing falsified information. Budgetary slack Problems of budgetary slack is very common , this refers to an attempt made by mostly at the managerial level of obtaining a budget larger than strictly necessary so as to spend more liberally or to make a wrong representation of beating the budget (Lucey, 1992, p. 328). Use of Budget in the Reward Process. According to Martz Proper budget implementation becomes difficult to be achieved if the organization lacks reward system. The reward system must be based on the following principles: 1. Establish sufficient reward and reward contingencies; 2. Focus on rewarding achievement rather than punishing failures , it’s a fact that encouragement and support always helps the employees and motivate them to work harder for achieving the targeted goals. 3. Rapid feedback should be provided on the performance of each work team and on individuals. The frequent usage of reports gives them an opportunity to understand the evaluation criterion of the management and to point out their weaknesses. Major Business Initiative taken in the Organization as a Result Of the Budget Process Recently a new department ‘Marketing’ has been opened to cater the needs of advertising and sales promotion of our organization. The detailed investigation and selection of relevant data collected last year through market research, questionnaires and interviews of the existing customers for the prediction of the sales demand signifies this need and this new initiative will surely help the sales department to achieve their targeted sales. References. Jain Narangs (1995),13th ed. India Llewellyn Sue , (1998)Pushing budgets down the line: ascribing financial responsibility in the social services , Accounting, Auditing & Accountability Journal,pp.292-308 Martz .Usry(1980),7th ed. New York Otley David,(1999), Performance management: a framework for management control systems research, Management Accounting Research, 1999, 10 Otley David, (1999), budget use and managerial performance, Journal of Accounting Research, vol.16, p.122 T Lucey ,(1992), Costing 3rd ed. Great Britain Walter B Meigs ( 1982) ,Accounting the basis for organization, , 4rd ed. London Read More