The Budget Usage to Determine the Resource to Be Allocated to Discretionary Spending - Term Paper Example

A Report to the Managing Director - THEORY, THE STRATEGY FOR THE PLANNING AND CONTROL OF THE RESEARCH AND DEVELOPMENT DEPARTMENT Table of Contents Introduction A well drawn up budget matches the revenue with the costs and helps in the optimum allocation of the resources. It has to be revised on a regular basis to make a note of the emerging requirements. Budget is often referred to as spending plan and it acts as a financial tool for controlling money. This revolves around developing objectives and devising the budgets to realize the objectives through effective planning (Barbee, n.d.). Budget is a realistically drawn up plan for a time period that directs the efforts in the framing of realistic goals and sets the guidelines for the accomplishment of the goals. Budgeting is effective in dealing with unanticipated expenses and emergencies. Once a plan is in place it can be used for measuring the progress of goal achievement (Freedom Debt Management, n.d.; College of Business Administration, 2008). Use of budgets for discretionary costs Budgets are important for the financial well-being of the business (Ward & Ward, n.d.). At the time of preparing the budgets it is important to categorize the expenses such as fixed expenses, variable expenses and discretionary expenses. The discretionary expenses are not absolutely necessary for business survival. Necessary adjustments are done in these form of expenses i.e. they are reduced to honour the other types of expenditures. In any business there are two types of costs discretionary costs and non-discretionary costs. It is easy to understand the discretionary costs like payment of rent or electric bill but the discretionary costs are less clear. The discretionary costs include the alteration, construction, research and development etc. Besides the discretionary and non-discretionary costs there are other types of costs such as controllable and uncontrollable costs. So a budget comprises of costs that are discretionary, non-discretionary, controllable and uncontrollable (Cotts & Rondeau, 2004, pp. 59). Budget conveys the authority of the manager to allocate a specified amount on the items that are enlisted in the budget. The appropriations in the budget act as the benchmark for a comparison with the costs that are actually incurred. Expenditures of a budgeted category are matched with the pre-set amounts in deciding any over or under spending of funds and if needed corrective action are initiated (KU School of Social Welfare, n.d.). For the control of discretionary costs the top management must translate the policies and objectives that it considers vital for the organizational success. The management then must make a plan of the spending relating to the discretionary activities that will help in achieving the defined business objectives. There can be various forms of discretionary spending such as construction, buying of new equipments, training, research and development etc. If the business decides to expand in the near future then this will require additional space. For this the business can plan for constructing new building. Similarly if the business wants to introduce a new technology it must impart the necessary training to the employees who are the ones to make use of the new software. This will require an additional spending in the form of training expenses. Again if the management wishes to enhance its scale of production then it has to make renewed investment in plant and machinery. It can either procure them or hire them. Irrespective of this the management will have to incur an amount on this. Once the management is able to prioritize its discretionary costs and after a review of the income expectations and cash flow of the year the level of funds for this category of expense can be set. In case of strong economic outlook the management allocates a significant proportion of the costs to this category. This is obvious as the plans of expansion yield any result only in the case of a positive economic scenario. The budgeting of the discretionary costs is based on three factors- significance of the activity in the accomplishment of the business objectives and goals, anticipated operational level in the coming period and negotiating ability of the managers during the process of budgeting. For some types of discretionary costs the managers have to spend the entire amount of appropriations within a stipulated frame of time whereas for others the policy of limited spending is justified. The cost of maintenance is one area where limited spending cannot be justified. A reduction in this kind of costs can result in inferior quality of output or production breakdowns. For this reason the managers are not in favour of lowering the actual maintenance costs as compared to the budgeted and do not consider it as an effective cost reduction tool. In certain cases the managers recommend spending more than the budgeted amount on maintenance. This is done to bring about a fall in the defective production of the output. Lesser amount of defective goods means that the business has higher output at its disposal for sale thereby increasing the revenue. Moreover this also leads to control of resource wastage besides raising the business income. But this kind of spending is not allowed for other forms of discretionary costs such as entertainment and travel. A specific appropriation to this category of expenditure is satisfactory. It is said to improve the efficiency of the employees which is essential for increasing business revenues. However care must be taken to ensure that no excess amount of appropriations is made to this category of expenses. Overspending on this expenditure is considered to be irresponsible. In the event of strong cash flows and positive business environment the business may not face any difficulty in allocating a certain portion of its cash flows to this category of spending. But spending in this particular category will require special consideration in the event of reduced business operations. A business evaluates the priority of the activities in such situations. However in these situations the management can raise some discretionary costs while eliminating the unnecessary discretionary spending. Like in the case of an economic downturn a business reduces its advertising budget. This is not desirable as it is during these times that the revenue of the business passes through serious lows and spending on the marketing of the product is an efficient way of boosting the sales of the company. During these situations the management can curtail the travelling allowances of the executives in order to provide for the advertising expenses. While it is possible to quantify the benefits derived from the use of committed funds the same is not true for the discretionary funds. Like in the case of fund allocation to a project of five years duration. The benefits that are derived from this can be measured both on before as well as after basis through audit and capital budgeting. The returns generated on the project serve as a measure for evaluating the worth of the investment. But this is not possible for the discretionary funds as the benefits derived from them cannot be measured and often may not be even identified. Like the case of research and development expense which is a type of discretionary cost. The amount spent on the research of a new or improved technology may not always materialise i.e. the research may not always be successful. Planning and control of discretionary costs The discretionary spending budget is critical as it is difficult to assess whether a particular spending is justified or not. At times the decision-maker may become subjective allocating the budgeted amount of discretionary spending. Therefore a budget drawn in this regard may lack any logical justification or may be misunderstood. For this reason an approach that is articulative in nature is adopted by the management in drawing up these budgets. The department that gets a higher percentage of budget allocation is elated whereas a department that faces budget cuts is disappointed. For making the budget process more fair the management bases the costs on certain parameters. Like in the case of advertising the amount budgeted is based as a percentage of sales. The entertainment expenses are similar to the previous year with some adjustments relating to inflation. The amount allocated to the research and development must be a certain percentage of the sales as well as capital budget. Training costs are the same as the last year with additions relating to a percentage of amounts spent on the new projects. This percentage of budget allocation can be made better if it can be linked with the causes on which it depends. Like the amount spent on research is based on the technological advancement desired by the firms and the general level of technological progress in the industry. The amount spent on advertising would depend on the position of its product in the market and market forces. Controlling the discretionary costs is not easy as the variance analysis is not effective in pinpointing the areas of improving the efficiency. Therefore what can be done is to delegate the powers to the managers who are better equipped to analyse the need of the expenditure. This requires the appointment of the authority that sanctions the budgets and is placed at a higher level of organizational hierarchy, framing of rules relating to when, how much, where and who can spend this money. Besides all the expenses made must be closely monitored. Rules, procedures will ensure stricter control and better co-ordination. Large sized organizations can maintain an internal audit department that takes care to prevent any procedural lapses (Patel, 1997). Setting the budget for the research development department The amount allocated as research and development is based on the technological advancement that is desired by the firm. Usually the firm that wishes to become a market leader spends heavily on research and development. A certain percentage of sales are allocated as research expense. The amount of capital budget demarcated by the business is also one of the factors influencing this type of costs. A business that faces intense competition must continuously upgrade itself if it wants to survive the fierce competition. This demands that the business allocate a fixed amount for this form of discretional spending. This will ensure that the business is able to produce sophisticated goods and services that are in line with the market expectations. Besides this another factor on which the budget on this category of expense is based is the technological advancement n the industry. If the industry to which the business belongs is technologically sound then this necessitates that the business matches the requisites of the industry. Apart from all this the amount spent on research is also based on the fund availability. If the business expects strong cash flows from certain inventions then it may spend heavily on the creation of this kind of technology. Measurement and control of discretionary spending As the benefits derived from the discretionary spending cannot be always measured the management often assumes theses activities to be unimportant. But certain discretionary activities like maintenance & repairs, training of employees and research and development are important for business survival in today’s highly competitive environment. These activities are crucial for the long term success of the business. An appropriation towards the research and development expenditure improves the quality of the business output which is important for the long term business survival. With the advancement in technology the customers demand for sophisticated products and services. Therefore it is important for the business to match up to the expectations of the customers if it wants to retain its customers. For this reason the management assign a considerable portion of the funds to research and development so as to provide the sophisticated goods and services. The immediate result of this form of expenditure may not be seen in the near term but it will surely boost the future business output. The efficiency of an activity is measured by comparing the actual and budgeted figures. Efficiency is measured as a ratio of input to output. For instance the efficiency of an automobile is measured in terms of miles travelled per gallon of fuel consumption. The more the number of miles travelled the higher the efficiency of the vehicle. An appropriate measure of efficiency is possible only when the inputs and outputs can be related to the same period. This requirement makes the measurement of discretionary costs difficult. As it has been seen, that for several years there is no commendable output from this kind of spending. Like the case of research and development expenditure where there may be significant differences in the time period in which the results from these expenditures are actually reflected (Kinney & Raiborn, 2008. pp. 599). Effectiveness of the operations is measured by comparing the achieved results with the desired results. The effectiveness of an activity is not affected by whether it is expressed in monetary terms or non-monetary terms. For measuring effectiveness the inputs may not be considered however this is required in measuring efficiency. The effectiveness of the discretionary costs can be understood from the match between the actual and desired result. As most of the discretionary costs give benefits that are measured on non-definitive or non-monetary basis keeping a control of all these costs is difficult. This makes it mandatory to develop a plan for such costs. Control is limited to the monitoring of these costs to ensure that it conforms to the budgeted figures. The discretionary costs give rise to linkage benefits that accrue to the departments in the line function and accrue at a future date. For this reason there is no general acceptable criterion for the measurement of the performance. Overspending is considered to be ineffective and under spending as inefficient. Due to this the budget mangers sometimes spend funds even when not required and at times do not spend funds even when it is required. Therefore a strategic approach of setting the performance target is required than merely comparing the actual budgets with the actual expenses. Like the performance of the maintenance department can be assessed in terms of availability of plant, personnel department’s performance can be assessed in terms of quick availability of employee data and data quality. Conclusion The above discussion shows how the budgets can be used in the determination of the resource that is to be allocated to discretionary spending (Scarlett & Scarlettt, 2007, pp. 248). For being meaningful the budgets must be checked periodically (Prieskorn & Farms, n.d.). The benefits derived from such costs usually span across a length of time making it difficult to match the actual and the budgeted expenses. An effective control mechanism must be in place to direct and allocate the spending in these areas. It is difficult to quantify the performance efficiency relating to these kinds of costs therefore a careful monitoring and planning system must be in place for controlling the discretionary costs in an organization. Reference Freedom Debt Management. No Date. Spending Plans. Available at: http://www.freedomdm.org/spending_plans.html [Accessed on March 16, 2010]. Cotts, G.D. Rondeau, P.E. 2004. The facility manager's guide to finance and budgeting. AMACOM Div American Mgmt Assn. Patel, B. 1997. Cost Accounting for Management Decisions. Allied Publishers. Scarlett, C.R. Scarlett, B. 2007. Cima Management Accounting-Performance Evaluation. Butterworth-Heinemann. Kinney, R.M. Raiborn, A.C. 2008. Cost Accounting: Foundations and Evolutions. Cengage Learning. Barbee, F. No Date. The work of management. Profit Planning. Available at: http://www.cbpp.uaa.alaska.edu/afrfb/acct202/Chpt_09_HO.ppt#4 [Accessed on March 16, 2010]. Ward, R.D. Ward, P.S. No Date. Budgetary Planning. Accounting Principles. Available at: http://www1.broward.edu/~aappleba/a2071/ch23.ppt#4 [Accessed on March 16, 2010]. KU School of Social Welfare. No Date. Control. COMMON PURPOSES/FUNCTIONS BEHIND BUDGET ACTIVITY. Available at: http://www.socwel.ku.edu/marke/PDF%20Files/COMMON%20PURPOSES.pdf [Accessed on March 16, 2010]. Prieskorn, G. Farms, B. No Date. THE IMPORTANCE OF BUDGETING. 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