Management Accounting and Budgeting Issues Essay

Exclusively available on Available only on IvyPanda® Written by Human No AI

Y-Budget Limited

Production Budget in Units

MonthOpening stock
Units
Production for the month – Units
(75% of Current Month Sales + 25% of Next Month Sales)
September125450
October75275
November50200
December50150

Raw materials Purchase Budget in Kilos and Value

MonthUnits producedMaterial AMaterial B
Per Unit
Kg
Total KgPrice Per kg £Total Value £Per Unit
Kg
Total KgPrice Per kg £Total Value
£
September45031350567504180035400
October2753825541254110033300
November200360053000480032400
December150345052250460031800

Introduction

Budgeting has certain definite objectives to achieve, as it represents a blueprint of the anticipated plan of action or operation. Budgets express plans covering the entire organization and all its functions like purchase, production, marketing and the like. Budget is considered as an official declaration of the organizational policies defining the organizational objectives for the understanding of the organizational members at all levels. Ensuring coordination of the business as a whole is another objective of budgeting. The process of budgeting takes into account factors like probable production capacities and marketing potential and coordinates them towards achieving the overall organizational objectives. In such coordination, it becomes important that budgeting considers the availability of all other resources like materials and labor so that it can balance the objectives and make them achievable. Budgeting encourages team spirit and it involves different people to solve a common problem. Budgeting is to be regarded as a better means of communication, as it is expected to pass on complex plans laid down by the top management through various functional departments to ensure prompt action.

Benefits of Budgets

The budgetary control is defined to include the processes of planning, controlling, coordinating, and motivation through monetary expression of organizational objectives communicated to different departments within the organization. Budgeting usually takes the form of quantitative and monetary plans drafted for a period of one year. The budgetary control is the organizational planning process translated into monetary objectives. The essence of the budgetary control process is the influencing of the management behavior by establishing set performance standards and monitoring the achievement of the standards established.

For most of the organizations, the budgetary control process is considered as the main integrative control tool from the overall control perspectives of the organization (Otley, 2001). The assumption behind such a view can be seen from the fact that the budget is the easiest and effective way of representing the organization’s overall business plan and in addition, the budget can be used as the controlling and monitoring tool for mitigating the complex issues of the business plan. From this viewpoint, budgeting can be seen as the link for the overall attainment of the organizational performance standards. As Campbell (1985) states, it is essential that every budgeting system is customized and the success of such budgeting is measured by the extent to which it can motivate the individuals to offer their maximum contribution in achieving the organizational objectives. Past research has focused on the shortcomings and challenges of using budgeting as a process for management control (Hansen et al., 2003; Lukka, 1988)

Traditionally, centralized control has been identified to be one of the important objectives of budgeting. Budgeting is expected to exercise centralized control through delegated authority and responsibility. Since budgets are drawn and grouped based on the responsibilities of different functional departmental and divisional heads, they are expected to aid decentralization. Budgets are considered as the means of exercising managerial control and enable the management to measure performance of every business unit or division of organization. The managers can take corrective action, as and when they observe any deviation in the actual performance as compared to budgets.

Institute of Cost and Management Accountants defines budgetary control as “the establishment of budgets relating the responsibilities of executives to the requirements of a policy and the continuous comparison of actual with budget results, either to secure by individual action the objective of that policy or to provide a basis for its revision.” (FAO Corporate Documentary Depository, 2001) When the contributions from budgeting process to the organizational performance are considered budgets represent the control mechanism in most firms. Therefore, it can be argued that eliminating budgeting process would mean loosening the control on business processes. In the traditional budgeting process, a top-down (hierarchical) approach is used for where the principle of “command and control” takes the central focus. In this process, decisions, resources, and rewards flow down. On the other hand, information, which is mostly exceptions, flows upwards. “The role of line management is simply to operate the established facilities, systems, and personnel according to senior management’s rules, regulations and pre-determined targets. Valued rewards then follow from doing so,” (Murray, 2003). According to Wallander, (1999), budgets that create vertical command-and-control and responsibility centre-focused budgetary controls are incompatible with organizational designs, which are flat or value chain-based. Such controls act against empowering the employees from making the decisions.

Profit planning and controlling are the two important objectives of the traditional budgeting system. Achievement of these objectives results in certain distinct advantages. By effective planning and controlling of the revenues and expenditure, budgetary control focuses on the maximization of the earnings of the organization. Budgeting ensures that capital and resources are allocated to the best and most profitable opportunities. Budgeting enables employees at all levels to understand the objectives and policies of the company and acts as a tool for evaluating the effectiveness of these policies on a periodic basis. By adopting well-designed budgets, the companies are able to plan their expenditure and financing of the business. This ensures better and economical utilization of the funds at the disposal of the company. Budgeting apart from functioning as a control measure enables the organization to coordinate the functions and performance of various branches and divisions of the organization closely. This enhances the cooperation among the organizational members.

Problems with budgets

Budgets can be considered as a ‘fixed performance contract’. Committing to and meeting the budget targets by supervisors and employees represents accepting a “performance contract” entered into between an employee and a manager. Budgeting by the very nature implies that there will be reward and recognition for the employee for his/her performance, only when the budgeted targets are met. Either this implication is made in an implicit way or it is made explicit. Those employees who perform to meet the targets can expect a better evaluation of their performance and rewards and recognition in return from the organization. Employees can also feel motivated intrinsically with the sense of satisfaction of having achieved the set targets.

However, the use of budgeting as fixed performance contract results in certain deficiencies in the functioning at the organizational level. This can make the organization inherit certain disadvantages of budgetary gaming. The sales manager may deliberately make a lower estimate for the sales and with a view to meet, the sales budget may overstate or understate sales towards the end of the budget period by manipulating the delivery of orders. In order to meet the expense budget target, the divisional managers may present a fat budget for expenses. There may also be a tendency to spend the total budgeted amount within the budget period, so that they may be able to get the same budget allotment of expenses for the next period. In their pressure to meet the budget targets, the managers may lose focus of organizational goals. For instance, the divisional manager may decide to spend more on revenue items like traveling at the cost of research and development, which is detrimental to the progress and growth of the organization. There may be undue influences on the distributors and dealers to order and take delivery of merchandise before the current budget period expires and they may be offered large discounts so that the sales budget can be met. The divisional or functional managers tend to manipulate the profits for the period by booking next year’s expenses within the current budget period when the divisional head is not confident of meeting the next year’s budgeted profits. Divisional managers may also defer the next year’s revenue by requesting customers to delay delivery. The divisional manager may hold back the profits when he/she does not anticipate meeting the target for the year so that he/she can get reduced targets for the next budget period.

Jensen (2001, 2003) offers an explanation that the managers resort to budgeting games because of the traditional link between the budgets and the performance bonuses. Normally in a pay-for performance bonus system the managers will be rewarded only for attaining the minimum targets. This also will be capped after reaching the maximum levels fixed. Hence the managers in this case would involve themselves in budget gaming and diversions to maximize their performance incentive. Therefore, in this system the managers will be motivated to reach the minimum budgetary standards by adopting any necessary means and would try to keep their performance under the maximum levels as far as possible (Jensen, 2001). The solution to mitigate this problem is to follow a linear pay-for-performance system in which the managers are rewarded based on actual performance instead of the considering the budget targets (Jensen, 2003).

“The problems with fixed budget targets at the individual level seem to translate to the organizational level as well.” (Murray, 2003) With the result that the organizational efficiency is diminished over time as the performance is mostly stuck to meeting the budgeted targets. The approved budget targets become the foundation on which the divisional managers commit to perform. “With the penalty for falling to meet the numbers playing out in the newspapers almost every day, and generous incentive compensation to fuel the fire, all too often these ambitious goals lead to corporations “managing” earnings in ways that destroy long term corporate value,” (Murray, 2003). This behavior among the managers would probably lead to outright accounting and financial frauds as were witnessed in the case of Enron and WorldCom debacles. The temperament of senior management is transferred down the line with the subordinates picking up the culture of making the numbers. The budgeting game thus becomes the usual practice and accepted as the norm as the way of doing the business.

Behavioral Aspects of Budgeting

When the individuals and their behavior have started increasingly affecting the budgetary control process, there are circumstances in which the changing budgetary control and performance expectations affect the employee behaviors (Simons, 1995). However, it so happens that many organizations adopt somewhat a mechanistic approach to the budgetary control process without the requisite consideration of the behavioral aspects of the human beings involved in the whole process. It is often forgotten that the goals and objectives of the organization have to be accomplished with the help and support of the human beings associated with the organization concerned. Therefore, it becomes vitally important that the effect of individual behavior on budget and the effect of budgets on the individuals’ course of action have to be perceived carefully to attain the objectives of the organization without much pressure on employees and executives at any level of the organization. However, the pressure on individuals that is being exerted by the budgetary process for meeting the performance standards affect the performance of the individual employees, which is one of the major limitation of the traditional budgeting. Such pressure itself becomes detrimental in maximizing the contribution by the individual employees. The norms and standards of performance are fixed at a level that the employees find it difficult to attain them without extra efforts. Any unattainable standards fixed by the budgetary process will lead only to frustration among the employees.

In the early research by Lowe and Shaw (1968), the process of budgetary control was considered as elements of behavioral theory in which the budgets pose as enablers executing the resolutions of the coalitions and conflicts of the management. Because of the fact that there are certain human factors involved in the budgetary control process, the budgets are often developed in many organizations through a complicated and complex process. The social scientists have made an extensive study into the behavioral aspects involved in budgeting. Based on these studies budgeting has been construed as a method of communicating the goals of the organization to the employees at the appropriate levels. The objective of such communication is to achieve the desired goals of the organization by facilitating, coordinating, and controlling the different sections of the organization. In order to carry out this process effectively it is vitally important for managers to develop suitable attitudes and ideal strategies, which will have the effect of cultivating and maintaining supportive and cooperative relationships with the employees at all levels of the organization. It is important that the budgets be not considered mere computational tools for effectively controlling the expenses of an organization. However, in practice this has been the case in that budgeting has been considered more as a ritual than a control mechanism for improving the organizational performance.

Conclusion

Despite the criticisms leveled against budgeting, there are tangible advantages resulting from a budgeting exercise. The discussion contained in the preceding paragraphs of this note more than evidences this. This makes budgeting an important issue in the area of management accounting. In the absence of a performance and control measure, organizations may find it difficult to assess the contribution of the managers in achieving the desired organizational performance levels.

Reference List

Campbell, I.J., 1985. Budgeting : is it a Technical or Behavioural process. Management Accounting, pp.66 – 70.

FAOCorporateDocumentaryDepository, 2001. Web.

Hansen, S.C., Otely, D.T. & VanderStede, W.A., 2003. Practice Developments in Budgeting: An Overview and Research Perspective.. Journal of Management Accounting Research, 15, pp.95-116.

Jensen, C.M., 2001. Corporae budgeting is broken-let’s Fix it’. Havard Business review Boston, 79(10), pp.94 – 101.

Jensen, C.M., 2003. Paying People to Lie: The Truth about Budgeting Process. European Financial Management, 9(3), pp.379-466.

Lowe, E.A. & Shaw, R.W., 1968. An analysis of managerial biasing: evidence from a Company’s Budgeting Process. Journal of Management Studies, pp.304-15.

Lukka, K., 1988. Budgetary Biasing in Organizatios: Theoretical Framework and Empirical Evidence. Accounting Organisations and Society, 13(3), pp.281-301.

Murray, L.R., 2003. Budgeting–an action unnecessary evil. Web.

Otley, D., 2001. Extending the boundaries of management accounting research. Developing systems for performance management British accounting research.

Simons, R., 1995. Control in sge of empowerment. Havard Business Review.

Wallander, J., 1999. Budgeting – an unnecessary evil.. Scandinavian Journal of Management, 15, pp.405-21.

More related papers Related Essay Examples
Cite This paper
You're welcome to use this sample in your assignment. Be sure to cite it correctly

Reference

IvyPanda. (2022, March 22). Management Accounting and Budgeting Issues. https://ivypanda.com/essays/management-accounting-and-budgeting-issues/

Work Cited

"Management Accounting and Budgeting Issues." IvyPanda, 22 Mar. 2022, ivypanda.com/essays/management-accounting-and-budgeting-issues/.

References

IvyPanda. (2022) 'Management Accounting and Budgeting Issues'. 22 March.

References

IvyPanda. 2022. "Management Accounting and Budgeting Issues." March 22, 2022. https://ivypanda.com/essays/management-accounting-and-budgeting-issues/.

1. IvyPanda. "Management Accounting and Budgeting Issues." March 22, 2022. https://ivypanda.com/essays/management-accounting-and-budgeting-issues/.


Bibliography


IvyPanda. "Management Accounting and Budgeting Issues." March 22, 2022. https://ivypanda.com/essays/management-accounting-and-budgeting-issues/.

If, for any reason, you believe that this content should not be published on our website, please request its removal.
Updated:
This academic paper example has been carefully picked, checked and refined by our editorial team.
No AI was involved: only quilified experts contributed.
You are free to use it for the following purposes:
  • To find inspiration for your paper and overcome writer’s block
  • As a source of information (ensure proper referencing)
  • As a template for you assignment
1 / 1