MAKING BUDGETS WORK FM A – M ANAG EM ENT AC C OUNTI NG
LEARNING OUTCOMES 1. Explain the management
importance
of
motivation
in
performance
2. Discuss the issues in setting difficulty level of budgeting 3. Discuss the advantages and disadvantages of a participative approach to budgeting
4. Explain top down, bottom up approaches to budgeting
BEHAVIORAL IMPLICATION OF BUDGETING • Effectiveness of a budgetary system is dependent on the attitude of those who are responsible for implementing it. • A budget influences behaviour of managers in the following ways: One of the objectives of a budget is to motivate. It motivates the people in the company to produce high levels of output. Higher but achievable targets motivate the staff, however unachievable targets demotivate them.
Participation from lower level management while devising the budget & transparency in the budgetary system helps lower level management to be motivated. 3
FACTORS INFLUENCING BEHAVIOR OF EMPLOYEES 1. Misunderstanding about objectives of senior management • Due to fear of cost cutting by upper level management, lower managers prepare budgets with slack 2. Targets set by senior managers • Subordinates resist unachievable targets • They will not be motivated if targets are easily achievable 3. Sub-optimal planning • Due to conflicts between organisational & divisional objectives, the targets will need to be changed • This may demotivate the manager 4. Participation of lower level management • If targets are changed without any explanation employees will be demotivated
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ISSUES IN SETTING DIFFICULTY LEVEL OF BUDGETING • There is likely to be demotivating effect where an ideal standard of performance is set • A low standard is demotivating because there is no sense of achievement in attaining the required standard • A budgeted level of attainment that is same as level achieved in the past might encourage budgetary slack • Individual aspirations might be much higher or lower than organisation’s aspirations • To make the budget successful, the target level should be set by ensuring the participation of all levels of management in the budget prepartion process & making the process transparent 5
ISSUES IN SETTING DIFFICULTY LEVEL OF BUDGETING 1. Non-participation of lower level management • Top management prepares budgets for entire organisation, including those for lower level operations • Employees may not give full commitment to achieve targets 2. Non-participation of top level management • Less involvement of top management demotivates lower managers to believe in the budget 3. Role of budget department or controller in budgeting • Budget department or controller is responsible for checking accuracy & appropriateness of budgets • Many of the tasks are perceived as negative eg point out slack, excessive inventory, inefficient operation 6
BENEFITS AND IMPLICATIONS OF PARTICIPATION OF EMPLOYEES IN SETTING TARGETS • Functional budgets are reviewed by budget committee /department so that they are in line with corporate objectives & co-ordinated with other departments’ objectives • If there is no goal congruence between individual objectives & corporate objectives, need to modify the budgets to achieve goal congruence. • Conflicts between organisational & divisional objectives need to resolve through a negotiation process • Participation of all individuals involved in the process of setting the budgets will eliminate doubts or suspicion about the objectives of the budget
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BENEFITS OF PARTICIPATION OF EMPLOYEES IN NEGOTIATING TAREGTS 1. Employees commit to achieving the target as they heave agreed to it 2. Effective communication is possible & result in realistic targets 3. Employees will know reasons for cost-cutting DIFFICULTIES IN EMPLOYEES’ PARTICIPATION IN THE NEGOTIATION OF TARGETS 1. Some employees may not be able to communicate well in front of top management & may agree with top management’s proposals This defeat the objective of negotiation 1. In highly programmable processes ie input-output relationship is clear, negotiation wastes time 2. Attitude of the employees affects the negotiation 8
BUDGETING ISSUES Sources of budget information • Past data • Sales forecasts • Production department costing information Criticisms of budgeting • Time-consuming and expensive • Fail to focus on shareholder value • Too rigid and prevent fast response • Protect rather than reduce costs • Stifle product and strategy innovation • Focus on sales targets rather than customer satisfaction • Lead to unethical behaviour
BUDGETING ISSUES Changing a budgetary system A change in the budgetary system could bring about improved planning, control and decision making. However, before a change is made the following issues should be considered: • Are suitably trained staff available to implement the change successfully? • Will changing the system take up management time which should be used to focus on strategy? • All staff involved in the budgetary process will need to be trained in the new system and understand the procedure to be followed in changing to the new approach. A lack of participation and understanding builds resistance to change. • All costs of the systems change, e.g. new system costs, training costs, should be evaluated against the perceived benefits. Benefits may be difficult to quantify and therefore a rigorous investment appraisal of the project may be difficult to prepare.
BUDGETING ISSUES Difficulties of changing budgetary practices
• Resistance by employees • Loss of control
• Time consuming and expensive training • Cost of implementation • Lack of accounting information and systems in place
SETTING THE DIFFICULTY Budgets as targets • Can budgets, as targets, motivate managers to achieve a high level of performance?
• Ideal standards are demotivating because adverse efficiency variances are always reported • Low standards are demotivating because there is no sense of achievement in attainment, no impetus to try harder • Normal levels of attainment can encourage budgetary slack
BUDGETARY SLACK Budgetary slack
• Difference between the minimum necessary costs and the costs built into the budget or actually incurred • Managers might deliberately overestimate costs and underestimate sales • In this case they hope that they will not be blamed for overspending and poor results
SETTING THE DIFFICULTY LEVEL To ensure managers are properly motivated, two budgets can be used • One for planning and decision-making, based on reasonable expectations (expectations budget) • One for motivational purposes, with more difficult targets (aspirations budget)
SETTING THE DIFFICULTY LEVEL Consider control culture • 'Blame culture' – managers will be blamed for adverse variances and accused of poor performance. This is likely to provoke a defensive reaction, with the manager trying to justify what has gone wrong. • 'Improvement culture' – Variances are considered as useful indicators for control action and improving performance. Managers are not blamed for adverse variances, but encouraged to look for suitable control measures whenever significant adverse variances occur.
EFFECT OF REPORTED VARIANCES ON STAFF ACTIONS • (a) The manager who is considered responsible for the variance should agree and accept that the cause of the variance is his responsibility. Variances should be reported to the appropriate manager. • (b) The manager should consider the reported variance to be ‘fair’. Variances should be a realistic measure. This is a reason why it is advisable to separate planning variances from operational variances when a budget or standard needs revision. It is also a reason why variances reported using ideal standards may be de-motivating.
• (c) The manager should want to do something to deal with the causes of the variance. Incentives and motivation are important factors.
EFFECT OF REPORTED VARIANCES ON STAFF ACTIONS • (d) Variance should be reported in a timely manner, as soon as reasonably practical. If a reported variance relates to events that occurred a long time ago, managers will be reluctant to investigate them ‘now’ because the variance will seem out-of-date. • (e) The manager must believe that the cause of the variance is something that he is in a position to control. If a manager considers the cause of a variance to be outside his sphere of authority, or to be due to a factor that he cannot do anything to change, he will not be motivated to look for control measures.
PARTICIPATION A budget can be set from: 1. the top down (imposed budget) or 2. from the bottom up (participatory budget) It has been argued that participation in the budgeting process will improve motivation and so will improve the quality of budget decisions and the efforts of individuals to achieve their budget target
TOP DOWN BUDGETS Imposed style of budgeting (Top-down budgets) may be effective: • In newly formed organisations • In very small businesses • During periods of economic hardship
• When operational managers lack budgeting skills • When the organisation's different units require precise coordination
TOP DOWN BUDGETS Advantages – Strategic plans are likely to be incorporated into planned activities – They enhance the coordination between the plans and objectives of divisions
– They use senior management's awareness of total resource availability – They decrease the input from inexperienced or uninformed lowerlevel employees
– They decrease the period of time taken to draw up the budgets
TOP DOWN BUDGETS Disadvantages • Dissatisfaction, defensiveness and low morale amongst employees • The feeling of team spirit may disappear
• The acceptance of organisational goals and objectives could be limited • The feeling of the budget as a punitive device could arise • Unachievable budgets for overseas divisions could result if consideration is not given to local operating and political environments • Lower-level management initiative may be stifled
BOTTOM UP BUDGETING • Budgets are developed by lower-level managers who the submit the budgets to their superiors. The budgets are based on the lower-level managers' perceptions of what is achievable and the associated necessary resources
Participative style of budgeting (Bottom-up budgets) may be effective: • In well established organisations • In very large businesses • During periods of economic affluence • When operational managers have strong budgeting skills
• When the organisation's different units act autonomously
BOTTOM UP BUDGETING Advantages of participative approach • More realistic budgets • Coordination, morale and motivation improved • Increased management commitment to objectives Disadvantages of participative approach • More time-consuming • Budgetary slack may be introduced • Does not suit some employees – may fear budget will be used against them or adds to work pressures