Week 4

• What is a budget?

  A detailed, short-term plan in quantitative, financial form that details the acquisition and deployment of resources and sets appropriate targets and constraints
• What are budgets for?

  Planning

  Co-ordination

  Communication

  Control: variances

  Motivation

  Performance evaluation
• Incremental budgeting

  Take last year’s budget

  Add on inflation

  Add new spending/income areas

  Remove redundant spending/income areas

  Adjust for one-off items

  Negotiate and revise budgets

  Agree budgets
• Zero-based budgeting

  Starts from scratch

  Organisational objectives are set

  Every organisational unit has to justify their budget based on cost-benefit analysis

  Decision packages developed for alternatives

  Packages ranked against criteria

  Highest ranked packages form the budget

  Often applied to programmes or activities
• ZBB cont’d

  •Started late 60s Texas Instruments•

  •Idea is all activities justified and prioritized before deciding how much you spend on each•

  •Focus is on programmes or activities rather than functional departments
• ●Examples of functional dep’t – a production department, or accounts dep’t, or canteen – a department that performs some function.  Traditionally it has a budget saying how much it can spend on eg salaries, electricity, materials,
• Incremental

  •Easy (and therefore cheap!)

  •Focuses on change

  •Requires minimal communication

  •Stability

  •Minimises conflict
• ZBB

  •Linked to objectives

  •Involves managers

  •More flexible
• Incremental

  No link with objectives

  Builds in errors

  Inflexible
• ZBB

  Time consuming and expensive

  Increased conflict

  Requires clear organisational objectives
• Activity-based Budgeting (ABB)

  Useful for organisations who have adopted activity-based costing; budgets based on activities identified
• Stages of ABB:

  1.Estimate the production and sales volume by individual products and customers

  ●2.Estimate the demand for organisational activities (incl support activities), i.e. quantity of activity cost drivers required

  ●3.Determine the resources required to perform activities, e.g. labour hours, machine hours

  ●4.Estimate for each resource the quantity that must be supplied to meet the demand

  ●5.Take action to adjust the capacity of resources to match projected supply, i.e. redeploy unneeded resources or authorise additional spending
• ABB advantages

  Makes relationship between outcomes (cost drivers) and expenditure visible à better planning

  Particularly important for support activities which are treated as fixed cost under incremental budgeting

  More flexible than incremental budgetingqSupports continuous improvement
• ABB disadvantages

  Can only be used if ABC implemented

  More complex than incremental budgetingq

  Requires more negotiation (increased conflict?)
• Budgets and behaviour

  •Dysfunctional behaviour (particularly with incremental budgets)

  ·Intentional slack·

  Hiding expected advantages

  ·Accounting manipulation·‘

  Spend it or lose it’ mentality

  ·De-motivating
• ‘Goal congruence’ is helped by participation in the budget setting process
• “Subordinates should be given an opportunity to participate in the various decisions which affect them directly or indirectly”
• Participation has the strongest effect on motivation
• Whether participation in budget setting helps avoid dysfunctional behaviours  depends on

  Organisational culture and structure (being participative seems to help if groups at work are cohesive
• Whether participation in budget setting helps avoid dysfunctional behaviours  depends on

  ·Nature of the task (makes more difference where flexibility and innovation are important, rather than just routine tasks  (Hopwood 1976))·
• Whether participation in budget setting helps avoid dysfunctional behaviours  depends on

  ·Personality considerations (eg highly authoritarian people with a low need for independence are unaffected by participative approaches (Vroom 1960).)
• Hofstede – social psychologist who studied IBM in lots of countries around the world

  He argued that people from different countries had different average scores on four different  cultural dimensions (in later work he increased this to six) (Hofstede 1980)
• •Power distance (the extent to which less powerful members of a society accept and expect that power is distributed unequally)
• •Uncertainty avoidance (the degree to which members of a society feel uncomfortable with uncertainty and ambiguity)
• •Individualism-collectivism (individualism is the preference for a loosely-knit social framework in which individuals are expected to take care only of themselves and their immediate families)
• •Masculinity-femininity (preference in society for achievement, heroism, assertiveness rather than co-operation, modesty, caring for the weak..)
• §US companies have a greater tendency to resort to more   extensive formal communication and coordination in the budget planning process
• §US firms build more slack into their budgets
• §Stronger reliance on short-term performance evaluation (employees move company much more often in US)
• •We have discussed three budgetary systems: incremental, zero-based and activity-based budgeting
• •All have advantages and disadvantages and organisations need to decide which approach is most suited to their needs and resources
• •Behavioural (and cultural) aspects should be considered; in particular when budgeting is used for performance management purposes