ACCA F5 Chapter 8 - Budgeting Flashcards

1 Approaches to budgeting - Top down vs bottom up budgeting- Incremental budgeting- Zero-based budgeting (ZBB)- Rolling budgets- Activity-based budgeting- Feed-forward control

1 Approaches to budgeting - A top down budget is a budget that is set without allowing the ultimate budget holder to have the opportunity to participate in the budgeting process. - A bottom up budget is a system of budgeting in which budget holders have the opportunity to participate in setting their own budgets. Also called participative budgeting.

1 Approaches to budgeting 1) Increased motivation due to ownership of the budget 2) Should contain better information since employees most familiar with the department set the budget 3) Increases manager's understanding and commitment 4) Better communication between departments 5) Senior managers can concentrate on strategy

1 Approaches to budgeting 1) Senior managers may resent loss of control 2) Dysfunctional behaviour: budgets may not be in line with corporate objectives as managers lack a strategic perspective and will focus on divisional concerns 3) Bad decisions from inexperienced managers 4) Budget preparation is slow and disputes can arise 5) Budgetary slack: managers set targets that are too easy to achieve.

1 Approaches to budgeting An incremental budget starts with the previous period’s budget or actual results and adds (or subtracts) an incremental amount to cover inflation and other known changes. It is suitable for stable businesses, where costs are not expected to change significantly. There should be good cost control and limited discretionary costs.

1 Approaches to budgeting 1) Quickest and easiest method 2) Suitable if the organisation is stable and historic figures are acceptable since only the increment needs to be justified

1 Approaches to budgeting 1) Builds in previous problems and inefficiencies 2) Uneconomic activities may be continued. E.g. the firm may continue to make a component in-house when it might be cheaper to outsource. 3) Managers may spend unnecessarily to use up their budgeted expenditure allowance this year, thus ensuring they get the same (or a larger) budget next year.

1 Approaches to budgeting 1) A ‘method of budgeting that requires each cost element to be specifically justified, as though the activities to which the budget relates were being undertaken for the first time. Without approval, the budget allowance is zero’ 2) - allocating resources in areas were spend is discretionary, i.e. non-essential. For example, research and development, advertising and training.- public sector organisations such as local authorities

1 Approaches to budgeting 1) Managers should specify, for their responsibility centres, those activities that can be individually evaluated 2) Each of the individual activities is then described in a decision package. The decision package should state the costs and revenues expected from the given activity. It should be drawn up in such a way that the package can be evaluated and ranked against other packages. 3) Each decision package is evaluated and ranked usually using cost/benefit analysis. 4) The resources are then allocated to the various packages

1 Approaches to budgeting 1) Inefficient or obsolete operations can be identified and discontinued 2) ZBB leads to increased staff involvement at all levels since a lot more information and work is required to complete the budget 3) It responds to changes in the business environment 4) Knowledge and understanding of the cost behaviour patterns of the organisation will be enhanced 5) Resources should be allocated efficiently and economically

1 Approaches to budgeting 1) It emphasises short-term benefits to the detriment of long-term goals. 2) The budgeting process may become too rigid and the organisation may not be able to react to unforeseen opportunities or threats 3) The management skills required may not be present 4) Managers may feel demotivated due to the large amount of time spent on the budgeting process 5) Ranking can be difficult for different types of activities or where the benefits are qualitative in nature