Q # 1. Explain How Budgetary Systems Fit Within the Performance Hierarchy?

A budget is a “quantified plan of action for a forthcoming accounting period” that can be set
from the top down or from the bottom up. Its objectives are to:

 ensure that the organization achieves its objectives

 Encourage planning for the short and long term
 Communicate ideas and plans for the employee and the organisation
 Coordinate activities that work towards the common goal
 Provide a framework for responsibility accounting
 Establish a system of control for measuring performance
 Motivate employees to improve their performance

Budgetary systems which are tools of planning and control occur at various levels in the
performance hierarchy and to different degrees. Plans made at the higher level provide a guideline
for the plans at the lower levels. Plans made at the lower level essentially carry out the plans made
at the higher level.

Strategic Level (Corporate Plans/ Strategic Plans)

 Focus on the overall performance

 Sets plans and targets for each department
 Can be qualitative

Lower Management Level (Tactical Plans)

 Less than 12 months

 Individual departmental plans with guidelines set by senior management
 Many include non-financial budgets
 Overall budget is expressed in financial terms with accompanying financial statements
 Links strategic plans at senior level and operational level
 Budget target should be in line with strategic objectives
 Approved by senior management

Junior Level (Operational Plans)

 Based on objectives about what to achieve

 Specific
 Targets are listed quantitatively
 Detailed specs of targets and standards
 Short term
 Operational plans are prepared with goal of reaching budget targets

LOTS OF INFORMATION FROM A VARIETY OF SOURCES IS USED WHEN

PREPARING BUDGETS. HISTORICAL DATA IS VERY VALUABLE BECAUSE IT
CAN PROVIDE USEFUL INSIGHTS AND ASSIST IN TREND ANALYSIS.
For sales budgets, useful information includes:

 Past sales patterns

 The economic environment
 Results of market research
 Anticipated advertising
 Competition
 Changing consumer tastes
 Legislation
 Distribution
 Pricing policies and discounts
 Environmental factors

For production budgets, useful information includes:

 Labour costs
 Raw material costs
 Machine hours
Q # 2. Discuss the issues surrounding setting the difficulty level for a budget?
There are a number of serious problems associated with budgeting, which include gamesmanship,
excessive time required to create budgets, and budgeting inaccuracy. In more detail, the problems with
budgeting include:

 Inaccuracy. A budget is based on a set of assumptions that are generally not too far distant from
the operating conditions under which it was formulated. If the business environment changes to
any significant degree, the company’s revenues or cost structure may change so radically that actual
results will rapidly depart from the expectations delineated in the budget. This condition is a
particular problem when there is a sudden economic downturn, since the budget authorizes a certain
level of spending that is no longer supportable under a suddenly reduced revenue level. Unless
management acts quickly to override the budget, managers will continue to spend under their
original budgetary authorizations, thereby rupturing any possibility of earning a profit. Other
conditions that can also cause results to vary suddenly from budgeted expectations include changes
in interest rates, currency exchange rates, and commodity prices.
 Rigid decision making. The budgeting process only focuses the attention of the management
team on strategy during the budget formulation period near the end of the fiscal year. For the rest
of the year, there is no procedural commitment to revisit strategy. Thus, if there is a fundamental
shift in the market just after a budget has been completed, there is no system in place to formally
review the situation and make changes, thereby placing a company at a considerable disadvantage
to its more nimble competitors.
 Time required. It can be very time-consuming to create a budget, especially in a poorly-
organized environment where many iterations of the budget may be required. The time involved is
lower if there is a well-designed budgeting procedure in place, employees are accustomed to the
process, and the company uses budgeting software. The work required can be more extensive if
business conditions are constantly changing, which calls for repeated iterations of the budget
model.
 Gaming the system. An experienced manager may attempt to introduce budgetary slack, which
involves deliberately reducing revenue estimates and increasing expense estimates, so that he can
easily achieve favorable variances against the budget. This can be a serious problem and requires
considerable oversight to spot and eliminate. Further, anyone who uses gaming is essentially being
encouraged to engage in unethical behavior, which can lead to further difficulties related to fraud
 Blame for outcomes. If a department does not achieve its budgeted results, the department
manager may blame any other departments that provide services to it for not having adequately
supported his department.
 Expense allocations. The budget may prescribe that certain amounts of overhead costs be
allocated to various departments, and the managers of those departments may take issue with the
allocation methods used. This is a particular problem when departments are not allowed to
substitute services provided from within the company for lower-cost services that are available
elsewhere.
 Use it or lose it. If a department is allowed a certain amount of expenditures and it does not
appear that the department will spend all of the funds during the budget period, the department
manager may authorize excessive expenditures at the last minute, on the grounds that his budget
will be reduced in the next period unless he spends all of the authorized amounts. Thus, a budget
tends to make managers believe that they are entitled to a certain amount of funding each year,
irrespective of their actual need for the funds.
 Only considers financial outcomes. The nature of the budget is numeric, so it tends to focus
management attention on the quantitative aspects of a business; this usually means an intent focus
on improving or maintaining profitability. In reality, customers do not care about the profits of a
business – they will only buy from the company as long as they are receiving good service and
well-constructed products at a fair price. Unfortunately, it is quite difficult to build these concepts
into a budget, since they are qualitative in nature. Thus, the budgeting concept does not necessarily
support the needs of customers.
Q # 3 Explain and evaluate ‘Top Down’ and Bottom Up’ budgetary systems;
‘Rolling’, ‘Activity Based’, 'Incremental' and 'Zero-based' budgetary systems?

Different types of budgetary systems that are appropriate for certain situations:

 Top Down – Set by senior management

 Bottom Up – Set by lower management for approval by senior management
 Rolling – Are continuously updated throughout the year
 Zero-Based – The budget for each cost center must be made from scratch and has to be
justified
 Activity Based – Budgets are prepared using activity-based costing methods
 Incremental – Next year’s budget is prepared using this year’s results with adjustments for
inflation, sales growth or decline etc.
 Feed-Forward Control – Predictions are made and compared to desired outputs