The basic framework of budgeting Essay

Custom Student Mr. Teacher ENG 1001-04 18 April 2016

The basic framework of budgeting

Basic definations

i. A budget is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period.

1. The act of preparing a budget is called budgeting.
2. The use of budgets to control an organization’s activities is known as budgetary control.

Difference between planning and control

i. Planning involves developing objectives and preparing various budgets to achieve those objectives. ii. Control involves the steps taken by management to increase the likelihood that the objectives set down at the planning stage are attained and that all parts of the organization are working together toward that goal. iii. To be effective, a good budgeting system must provide for both planning and control. Good planning without effective control is time wasted.

Advantages of budgeting

i. Budgets communicate management’s plans throughout the organization. ii. Budgets force managers to think about and plan for the future. iii. The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively. iv. The budgeting process can uncover potential bottlenecks before they occur. v. Budgets coordinate the activities of the entire organization by integrating the plans of its various parts. vi. Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance.

The bottom-up/self-imposed budget

1. A self-imposed budget or participative budget is a budget that is prepared with the full cooperation and participation of managers at all levels. It is a particularly useful approach if the budget will be used to evaluate managerial performance. 2. The advantages of self-imposed budgets include:

a. Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management. b. Budget estimates prepared by front-line managers (who have intimate knowledge of day-to-day operations) are often more accurate than estimates prepared by top managers. c. Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. d. A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse.

3. Self-imposed budgets should be reviewed by higher levels of management. Without such a review, self-imposed budgets may have too much “budgetary slack,” or may not be aligned with overall strategic objectives. 4. Most companies do not rely exclusively upon self-imposed budgets in the sense that top managers usually initiate the budget process by issuing broad guidelines in terms of overall target profits or sales. Lower level managers are directed to prepare budgets that meet those targets.

The top-down/mandated budgeted

Top-down budget can be known as mandated budget. This budget prepared by the top management and imposed on the lower layers of the organization. The top down budgets clearly express the performance goals and expectations of top management but can be unrealistic because input from the lower-level staff is not obtained. Using a top-down method often saves time overall. Nowdays most of the companies are using top-down only because the top management can save their time on taking decision upon their targets.

Budgetary Slack

a. The difference between the minimum necessary costs and the costs built into the budget or actually incurred. b. Managers might deliberately overestimate costs and underestimate sales, so that they will not blamed in the future for overspending and poor results. c. In controlling actual operations, managers must then ensure that their spending rises to meet their budget, otherwise they will be ‘blamed’ for careless budgeting. d. This is referred to as building slack into the budget or padding the budget and can result when revenues are set too low or expenses are set rather high by lower level managers. e. This allows managers a much better chance of “making their numbers,” which is particularly important for them if performance appraisals and bonuses are tied to the achievement of budgeted numbers.

Human factors in budgeting

1. The success of a budget program depends on three important factors: a. Top management must be enthusiastic and committed to the budgeting process, otherwise nobody will take it seriously. b. Top management must not use the budget to pressure employees or blame them when something goes wrong. This breeds hostility and mistrust rather than cooperative and coordinated efforts. c. Highly achievable budget targets are usually preferred (rather than “stretch budget” targets) when managers are rewarded based on meeting budget targets.

Incremental budget

1. This is a budget prepared using a previous period’s budget or actual performance as a basis with incremental amounts added for the new budget period. 2. The allocation of resources is based upon allocations from the previous period. 3. The advantage of incremental budgeting is that it is an easy, quick and cheap method of preparing budgets for what may be many cost centres in a large organisation. 4. Disadvantages of incremental budgeting:

a. Consideration will not be given to the justification for each activity. They will be undertaken merely because they were undertaken the previous year. b. Different ways of achieving the objective will not be examined, and so past inefficiencies will be continued. c. Managers know that if they fail to spend their budget, it is likely to be reduced next period. They therefore try to spend the whole budget, regardless of whether or not the expenditure is justified. 5. Example: If wages and salaries were budgeted based on the previous year’s plus percentage of pay adjustment, the budget would potentially be allowing an overstaffing situation to continue from the previous year.

Zero based budgeting

1. A zero-based budget requires managers to justify all budgeted expenditures, not just changes in the budget from the prior year.

a. Critics argue that zero-based budgeting is too time consuming and costly to justify on an annual basis. Nonetheless, occasional zero-based reviews can be very helpful.

2. The advantages of zero-base budgeting are as follows:

a. It provides a systematic approach for the evaluation of different activities and rank them in order of preference for the allocation of scarce resources. b. It ensures that the various functions undertaken by the organization are critical for the achievement of its objectives and are being performed in the best possible way. c. It provides an opportunity to the management to allocate resources for various activities only after having a thorough cost-benefit-analysis. The chances of arbitrary cuts and enhancement are thus avoided. d. The areas of wasteful expenditure can be easily identified and eliminated. e. The technique can also be used for the introduction and implementation of the system of ‘management by objective.’ Thus, it cannot only be used for fulfillment of the objectives of traditional budgeting but it can also be used for a variety of other purposes.

3. Disadvantage of ZBB:

a. The work involves in the creation of decision-making and their subsequent ranking has to be made on the basis of new data. This process is very tedious to management. b. The activity selected for the purpose of ZBB are on the basis of the traditional functional departments. So the consideration scheme may not be implemented properly. 4. Example: When budgeting staff cost for a restaurant, the manager using the zero-based budgeting approach would ignore the existing staff level and expenses. Instead, he would examine factors such as the opening hours, number of tables, and expected patron numbers to work out the number of staff required at each position and level, and the resultant associate costs. The zero-based method’s figures would then be compared with the previous year’s figures to check if they are reasonable.

Case studies

E corporation is the one most important instituitions owed by the Ministry of Petroleum(2008), Egypt. Governmental instituition reponsible for supervision & control of the petroleum in Egypt. C company is one of the marketing subsidiaries, established in 1934. C company is one of pioneer companies in marketing various petroleum, oil, chemicals & petrochemicals products. Profit before tax of 183 million Egyptian pounds from a turnover of 10 billion in 2008. Sales specialists who work with sales department manager to submit the budget to the director sales manager & then submits it to the company’s general manager who express his opinion about it & then submits it to Chairman of BOD of C. Budget moves to the budget general manager in the parent company E. In this case study, they are using bottom-up budget.


The main contribution of this paper is that it proposes that what was originally described as a negative behavioural phenomenon be rethought as a positive risk management strategy.We reposition budget slack in terms of budget risk management and suggest this is consistent with risk management thinking.Though one or two authors have viewed budgetary slack more positively, none has made the explicit link to risk management.Also further research may explore the ethical dimension of behaviour and its possible foundation in religious values and beliefs to see if this influences how building “contingencies” into budgets is perceived.This is needed more than ever in the conditions of environmental uncertainty we find ourselves in currently, especially in the region in which the study took place.The evidence from this small study in a single organisation obviously cannot be generalised to the whole population.


1. In Malaysia, studies on budgetary slack still in initial stage. A few researches do studies on the effect of religion, organisational and cultural on budgetary slack among Malaysian organisation. By the research in Malaysian organisation, there is no effect of religion and cultural. To do budgetary slack is high for companies in Malaysia compare to companies in the United Kingdom (UK) and New Zealand.

2. Only management style has a significant negative relationship with budgetary slack. More autocratic management style will decrease the budgetary slack. Practically, for management to control budgetary slack, management has to control the level of participation and emphasize on budget and information asymmetry simultaneously. Thus, management needs to choose the right combination of organisational factors to control the budgetary slack in order to gain effective management. Management can also increase autocratic management style to reduce budgetary slack.

Example question

Reference :

McGraw-Hill Education(Asia). Managerial Accounting: An Asian Perspective 13th Edition by Ray H.Garrison, Eric W.Noreen, and Peter C. Brewer.

SOUTH-WESTERN CENGAGE Learning. Management and Cost Accounting, 7th Edition by Colin Dury.

BPP Learning Media. FIA FMA Management Accounting and ACCA Paper 2 Management Accounting 1st Edition March 2011 .

BPP Learning Media. ACCA for Paper P5 Advanced Performance Management, 5th Edition October 2011.

McGraw-Hill Education. Irwin Managerial & Cost Accounting 2006.

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