Second Year Management Accounting

Lecture 1

BUDGETS AND CONTROL

1. Introduction and the Concept of Control

CONTROL as defined by Webster's dictionary

"Application of policies and procedures

for directing, regulating, and co-ordinating,

production, administration and other business activities

in a manner to achieve the objectives of the enterprise.”

FOUR NECESSARY CONDITIONS FOR CONTROL

• OBJECTIVES must exist• OUTPUT must be MEASURABLE• PREDICTIVE MODEL of the process is

required• TAKING ACTION must be possible

Systems Approach to Control:Boulding’s hierarchy of systems

1. Static structures, e.g. a bridge or table

2. Simple mechanical systems, e.g. a clock

3. Cybernetic or closed loop systems, e.g. a themostat

4. Open, self-maintaining systems, e.g. a cell

5. Plant or society of cells

6. Animal, characterised by brain

7. Human, characterised by language and conciousness

8. Social systems

9. Trancendental systems

FEEDBACK CONTROL

& FEEDFORWARD CONTROL

Backward looking or not?

Reactive or proactive?

Decisions and Control

PROGRAMMED DECISIONS,

"where the decision situation is sufficiently well understood for a reliable prediction of the outcome to be made"

NON-PROGRAMMED DECISIONS

"where the judgement of the managers involved is most important because there is no formal method of predicting likely outcomes”

TWO IMPORTANT FEATURES OF ORGANISATIONAL CONTROL

1.Organisational control is a process, not a single event

2.Organisational control is only defined in terms of objectives

THREE TYPES OF ORGANISATIONS

1.Normative Organisations

2.Coercive Organisations

3.Utilitarian Organisations

Control and Controls

Adminis-trative

Controls

Social Controls

Self Controls

Control of the

Organisa-tion

AN ALTERNATIVE DEFINITION OF CONTROL

"Control is the directing or influencing of behaviour, so that an individual is working towards the objectives of the organisation"

Key implications of the definition

· Objectives

· Implication of size

· Formal control systems

BUDGETARY CONTROL

1. A PLAN What ought to happen

2. EVENTS OCCUR What actually happens

3. COMPARISON What differences are

OF 1. AND 2. there

4. EXPLANATION Why are there

OF 3. differences

5. APPROPRIATE ACTION TO BE TAKEN

BUDGETARY CONTROL MODEL

BUDGET

ACTIVITY

BUDGETREVISION

EXPLAN-ATION

EITHER/OR

CORRECTIVEACTION

COMPARISON

RESPONSIBILITY CENTRE

"A part, segment or sub-unit of an organisation whose manager is accountable

for a specified set of activities"

RESPONSIBILITY ACCOUNTING:

"A system that measures the plans (by budgets) and actions (by actual results) of each responsibility centre”

RESPONSIBILITY CENTRES

Type of Centre Focus of Attention

Investment Centre Profits and level of capital employed in division

Profit Centre Profits i.e. revenue and costs

Cost Centre Costs only

Budgets

• Definition:– A comprehensive quantitative plan for utilising the

resources of an organisation for a given time period.

• More simply:– A budget is the financial expression of a plan.

Purposes of Budgeting

• Plan• Communicate• Co-ordinate• Motivate• Control• Evaluate• Authorise

Planning

• Corporate and Strategic Planning– time-scale: 3 - 5 years

• Budgets– usually for one year– first year of budget should be congruent with the

corporate plan

• Budget “phasing”– usually month by month– what factors would be considered in “calendarising” the

budget?

Preparation of the Budget

• Responsibility centres– Managers have clearly designated areas of

responsibility

– All costs can be assigned as responsibilities of specific managers

• “Bottom-up” Budgeting– Allow managers to develop individual budgets

– Aggregate into a company budget

• “Top-down” Budgeting– Set out top-level results

– Break down to individual responsibility centres

Co-ordinating the Budget

• Where do we start?• The role of forecasting• Importance of limiting factors• The usual sequence:

– Sales budget– Production budget– Purchases budget– Overhead budgets

Budgets for Motivation

• Budgets and behaviour:– Encourage participation or not?– Tight or realistic budgets?

• Hopwood’s analysis of management styles:– Budget constrained– Profit-conscious– Non-accounting

Budgeting for Expenses

Types of Expense:• committed expense• discretionary expense• variable expense• service expense

Committed Expense

Some costs cannot be avoided:• rent, rates on buildings• contracted lease charges• salary costs for executives under

contract

These are easy to budget• make sure they are right!• remember that renegotiation may be

possible

Discretionary Expenses

Not related to short-run activity but may be necessary, for example:• to build staff skills for the future• to ensure up-to-date systems• to maintain infrastructure

No easy way to say what these expenses “should” be:• external benchmarks?• importance of the activities supported?

Variable Expense

• Vary with activity• Identify inputs and outputs• Establish relationship between

inputs and outputs• Look for improvements and savings• Establish budget output• Establish budget resources

Service Expenses

• Provided by other departments

• Sometimes treated as uncontrollable

• But this is not very sensible:the user department should control the use of the service even if it cannot control the price paid for the service

‘Strategies’ for Budgeting

When people try to influence or manipulate the budget to their own ends

The Gardener The Duck Hunter

The Entrepreneur The Gambler

The Surgeon The Good Soldier

The Saviour The Honest Guy

The Drowning Man

Negotiating Budgets: Games People Play, INC., September 1981, pp89-91. Reproduced in Management Accounting, 2nd ed., (1996), Atkinson, Banker, Kaplan, and Young

The next slides are light-hearted and not too serious!!

The Gardener

• ‘Waters’ the budget growing many new shoots

• By budget time the garden has grown into a jungle

• Slick presentation makes cutting the budget difficult and exhausting

The Duck Hunter

• Knows how to use decoys• Peppers her budget with

complex presentations of expensive decoys

• Aims to focus attention on the details of her decoy and hide her real project

The Entrepreneur

• Flamboyant, Gutsy and innovative• Needs ‘the right kind of investment and

support’ for his new idea• Uses graphs and charts to illustrate how

he will make the company a fortune• But the ideas are untested and

implementation is a high risk strategy

$

The Gambler

• Has a perfect ‘poker face’• Needs his budget to achieve a

‘big score’• Willing to take enormous risks to

win• Threatens to resign if his budget

is cut

The Surgeon

• Has just performed a major ‘operation’ on her budget

• Claims the ‘patient’ cannot take any more

The Good Soldier

• A true company person, believes in all company objectives

• Claims to have adhered strictly to company policy and produced a ‘bare bones’ budget

• Unusually adept at successfully padding her budget

The Saviour

• Offers his department as the firms salvation

• Requires a great deal of money to carry the entire company

• Implies that failure to fund him places the firm in doubt

The Drowning Man

• Makes his budget presentation as if it were his last

• Requests more money to keep his department above water

• Claims to have been under funded in the past

The Honest Guy

• Someone who really means what he says

• His budget is accurate and realistic

• A rare animal who guarantees there is no ‘fat’ left in his budget to cut