Budgetary System
Budget is a quantitate detailed plan prepared for a specific time period it is normally prepared in financial terms
and prepare for one year.
Example past year questions:
Learning outcomes Examiner report
Explain how budgetary system fit within the
performance hierarchy
Select and explain appropriate budgetary systems
for an organization
Describe the information used in budget systems
and the source of the information needed
Indicate the usefulness and problems with different
budget types
Explain the difficulties of changing the type of
budget used
Prepare flexed budgets, rolling budgets and activity Q1 - Section A - SD 2020
based budgets Section C - MJ 2022
Explain the beyond budgeting mofer, including the
benefits and problems
Explain how budget systems can deal with
uncertainty in the environment
1. Objectives of budgeting systems (top down/bottom up):
a) Ensure the achievement of the organisation’s objective
b) Compel planning
c) Communicate the ideas and plans
d) Co-ordinate activities
e) Provide a framework for responsibility accounting
f) Establish control system
g) Motivates employees
Planning: One of the key purpose of the budgeting is to require planning to occur so that organization achieve its
objective to set an achievable target
Communication: help to communicate between the organization both vertically for example between senior and
junior managers and horizontally for example different organization functions
Co ordination: Budgeting is the method of bringing together the method of activities of all the different departments
into one plan.
Control: control the performance through the budgeted cost and actual cost. Variances between budgeted and actual
cost can be investigated in order to determine the reason why actual performance has differed from the plan
Motivation: influence the behavior of managers and employees, and may motivate them to improve the
performance if the target represented by the budget is reality based.
Appraisal: Managerial performance is evaluated by the budgetary targets for which individual managers are
responsible have been achieved. Managerial rewards such as bonuses or performance related pay can also be linked
to achievement of budgetary targets.
2. Feedback as control:
- Negative feedback: deviate from plan / must be brought back on course
- Positive feedback: according to plan / control action continuing the current course
- Feedforward control: control based on forecasts
3. Type of feedback:
Single loop
It is a control which regulates the control of a system for example if sales budget is not reached control action will be
taken to ensure target will be reached soon.
Double loop
It is a information to change for example if target not reach the company would change the plan it self.
Types of budgets:
4. Incremental budgeting
Definition Budget next year is prepared by using current year’s actual result
Make adjustment (expected inflation, sales growth & etc)
Advantages:
1. The impact of change can be seen quickly
2. Prevents conflict between departmental managers since a consistent approach is adapted throughout the
operation
3. It is easy and quicker to make. Since it is easy to make it can be allocated to junior staff
4. Less preparation leads to lower preparation cost
5. It is easy to understand.
Disadvantages:
1. It is not appropriate in rapidly changing environment
2. Assessing the amount of increment can be difficult to assess
3. It builds on wasteful spending. If the actual figures for this year include overspends caused by some form of error
then the budget for next year would potentially include this overspend again.
4. It encourages organizations to spend up to the maximum allowed/encourage slack in the knowledge if they don’t
do this then they will not have as much to spend in the following year’s budget.
5. It can ignore the true activity based drivers of a cost leading to poor budgeting.
5. ZBB
Definition Budget should be made from scratch/zero
Every item must be justified in its entirety in order to be included in the next year budget
Approach: 1) Define item/activities “decision packages”
2) Evaluate and rank based on priority
3) Allocate resources
Advantages:
1. It eliminates the inefficiencies that can arise with incremental budgeting
2. It raise a questioning attitude towards current activities rather then just accepting the status quo
3. It leads to more efficient allocation of resources
4. It focusses attention on the need to obtain value for money from the consumption of organizational resources
5. All of the organization activities and operations are reviewed in depth.
Disadvantages:
1. In large organizations there are large number of activities, in these circumstances lot of paper work could be
unmanageable
2. Since decisions are made at the budget time, managers may feel unable to react to changes that occur during the
year. This could have a detrimental effect on the business if it fails to react to emerging opportunities and threats.
3. The process of identifying decision packages determine their purpose costs and benefits is time consuming and
costly
6. ABB (ABC)
Definition Use ABC methods as a basis of preparing budgets
Based on activities and cost driver
Advantages:
1. It provides useful basis for monitoring and controlling overhead costs by drawing management attention
the activities and comparing actual costs with what the activities were expected to cost
2. It avoid slack that is often linked to incremental budgeting due to its details assessment of the activities and
needed to support planed sales and production.
3. In ABB cost of support activities are not seen as fixed to be increased by annual increments but as depending
extent on the planned level of activity.
4. Organizational resources are allocated more efficiently due to the detailed cost and the activity information
implementing an ABB system.
Disadvantages:
1. ABB might not be appropriate for the organization and its activities and cost structures
2. A budget should be prepared on the basis of responsibility centers, with identifiable budget holders made
responsible for the performance of their budget center. A problem with ABB could be to identify clear individual
responsibilities for activities.
3. A considerable amount of time and effort might be needed to establish an ABB system, for example to identify the
key activities and their cost drivers.
4. It could be argued that in the short term many overhead costs are not controllable and do not vary directly with
changes in the volume of activity for the cost driver. The only cost variance to report would be fixed overhead
expenditure
7. Rolling budgets
Definition Known as continuous budgets
Adding a further period and removing the corresponding period that has just end
Advantages:
1. Realistic budgets are likely to have better motivational influence on managers
2. Planning and control are based on recent plans which is likely to be far more realistic than a fixed annual budget
made many months ago.
3. There is always a budget which extends for several months ahead. For example if rolling budgets are prepared
quarterly there will budget extending for next 9 to 12 months. This is not the case when fixed annual budgets are
4. They force managers to assess budgets regularly and to produce budgets which are uptodate in the light of current
events and expectations.
5. It reduce the element of uncertainty in budgeting because they concentrate detailed planning and control on short
term prospects where the degree of uncertainty is much smaller.
Disadvantages:
1. They involve more time, effort and money in budget preparation
2. Revisions in budgets might include revision in standard cost too which in turn would involve revisions to stock
valuations. This could replace a large administrative effort from the accounts department every time a rolling budget
is prepared.
3. Frequent budget preparation might have an off putting effect on managers who doubt the value of preparing one
budget after another at regular intervals.
8. Beyond budgeting concept
Definition New budgeting model that proposes traditional budgeting should be abandoned.
Adaptive management process should be used rather than fixed annual budget
Advantages:
1. It empowers manager to act by removing resource constraints, key ratios are set, rather than detailed line by line
budgets.
2.It motivates people by giving them challenges. Responsibilities and clear value as guidelines. Rewards are team
based this uses the know-how of individual and teams interfering the customer, which in turn enables a far more
3. It establishes customer oriented teams that are accountable for profitable customer outcomes.
4. Goals are agreed via reference to external benchmarks as opposed to internally negotiated fixed targets.
Managerial focus shift from beating managers for a slice of resources beating the competition.
Problems of adapting beyond budgeting:
1. Managers should be clear what the expectations are and what they have to do they will need to be challenged and
motivated
2. There is no simple method of beyond budgeting it will depend on each company’s culture , structure, IT
Infrastructure etc.
9. Changing budgetary systems
Normally business will face some difficulties
a) Resistance by employees
b) Loss of control
c) Cost of implementation
d) Training
e) Lack of a/c information
10. Uncertainty in budgeting
Causes of uncertainty:
a) Customers
b) Products/services
c) Inflation
d) Materials
e) Competitors
f) Employees
g) Machines
h) Disaster
Budgetary system Questions
Q1: The finance function of Bagnall Co has been asked to oversee the production of the company's budgets for the
forthcoming year. In its initial instructions to the company's various divisions, the finance function has stressed
that once budgets for the next year have been formally agreed, steps will be taken to maintain their ongoing
relevance by undertaking a monthly review of budgets for forthcoming months in the light of performance in
earlier months.
Which of the following best describes this approach to budgeting?
A Flexible budgeting
B Incremental budgeting
C Zero-based budgeting
D Rolling budgeting
Q2:
Q3:
Q4:
Q5:
Q6:
DESIGNIT (DEC 2012 EXAM)
Designit is a small company providing design consultancy to a limited number of large clients. The business is mature
and fairly stable year on year. It has 30 employees and is privately owned by its founder. Designit prepares an annual
fixed budget. The company’s accounts department consists of one part-qualified accountant who has a heavy
workload. He prepares the budget using spreadsheets. The company has a November year end.
Designit is now considering replacing the fixed budget with a monthly rolling budget, which Designit believes will make
the budgeting process more relevant and timely and encourage managers to focus on the future rather than the past.
Required:
(a) Explain what a monthly rolling budget is and how it would operate at Designit.
(4 marks)
(b) Discuss the problems that may be encountered if Designit decides to introduce monthly rolling budgets.
(6 marks)
a) -Monthly rolling budget is a continuous style of budgeting. It eliminate one part of budget period either(Total: 10 marks)
monthly or quarterly that has just ended, and then adding a new period afterwards.
-For Designit co, they may use it by monthly period. Which is, after the december budget has end, they will remove that
month. Then, they will use that actual information and reflect that changes in the budget system. Lastly, they will add another
new december month in the budgetary system.
b) -One of the problems might be that the employees is going to be resistance towards the new budgetary system. Since the
business has been stable before, implementing the changes might require the employee to implement a new way of budgeting
process which they didn't familiar to what they usually done before.
-Next, the employee might also be required to attend a few training on how to implement the budgeting process. This will take
their time away from their current work. Since the accountant is now on a heavy workload, he is likely to reject the idea of
attending the training.
-Then, some of the managers might also loss their control in the budgetary system. Since it is a new system, it may require a
different coordination of resources in the company. Then, it may be possible that some managers will lose their control, hence
their motivation will be affected.
a) Rolling Budget.
-Rolling budget is a continuous budget which will be updated regularly. It is done by removing a recently ended period and
adding a new period in the budget.
-It is good for a fast changing environment & it will reduce the uncertainty to make the budget become more realistic.
-If Designit implement a twelve month rolling budget, the budget will start at december until november next year. When
december has passed, Designit will then need to update or roll forward the budget one month ahead to december next year.
Then, the budget will now be from January to December of subsequent year.
-Plus, any figure in the budget need to be revised to reflect any changes that happen during December this year.
b) Problems.
-One of the problems is the one part-qualified accountant. This is because the accountant is just part-qualified and may not be competent enough
to implement the new budget system.
-The accountant may not have the experience or expertise to prepare the budget and may create a lot of errors during the budgetary process and
this might lead to wrong decision making by the top management.
-Plus, this is the only accountant in the company. This will cause the accountant have an extra overload work to prepare the budget.
- Since the rolling budget need to be revised regularly, the accountant may not have enough time to adequately prepare the budget.
