• Planning and control
Chapter 1 • Budgetary control
• Budget setting styles
Budgetary • Budget systems
• Incremental budgets
systems • Fixed budgets
• Flexible/flexed budgets
• Zero based budgets
• Activity based budgets
• Rolling budgets
• Budgeting issues
Syllabus learning outcomes
• Explain how budgetary systems fit within the performance
hierarchy.
• Select and explain appropriate budgetary systems for an
organisation, including top-down, bottom-up, rolling, zero-
base, activity-base, incremental and feed-forward control.
• Describe the information used in budget systems and the
sources of the information needed.
• Explain the difficulties of changing a budgetary system.
Syllabus learning outcomes
• Explain how budget systems can deal with uncertainty in the
environment.
• Prepare rolling budgets and activity based budgets.
• Indicate the usefulness and problems with different budget
types (including fixed, flexible, zero-based, activity-based,
incremental, rolling, top-down, bottom-up, master,
functional).
• Explain the difficulties of changing the type of budget used.
Chapter overview
• This chapter serves as an introduction to Part C of the
syllabus and looks at budgetary control. We begin by looking
at the objectives of budgetary systems, which should be
familiar to you from previous studies.
• We then look at the various stages in the planning process,
and where the annual budget fits in to this.
• We also see how the budget is used in the control process.
• We then move onto methods of preparing budgets.
Chapter overview
Budget methods:
• Incremental budgeting bases next year’s budget on this
year's, with increases for inflation and changes in activity
levels. However, this may not always be appropriate for
certain organisations or for certain types of cost and
revenue.
• Zero based budgeting and rolling budgets are alternative
budget systems which can be applied in certain
circumstances and situations.
Chapter overview
Budget methods:
• Activity based budgets may use bases other than volume of
output for flexing budgets.
• Rolling budgets are budgets which are continuously
updated throughout a financial year by adding a further
period and removing the period just ended.
Summary
Fixed, flexible, Changing
flexed budgetary system
Incremental
Budgetary
Budgetary system
control
Zero based
Budgeting and
Activity based Rolling
uncertainty
Tackling the exam
• Discussion questions are likely to involve a comparison of
two or three approaches to budgeting.
• Questions involving rolling budgets/activity based budgets
are likely to involve calculations requiring knowledge of cost
behaviours and the use of the high-low method.
Objectives of budgeting systems
Objectives of a budgetary planning and control system
• Ensure the organisation's objectives are achieved
• Compel planning
• Communicate ideas and plans
• Coordinate activities
• Provide a framework for responsibility accounting
• Establish a system of control
• Motivate employees to improve their performance
Planning and control 1
• Purpose of budgetary control:
P – Planning
R – Responsibility
I – Integration and co-ordination
M – Motivation
E – Evaluation and control
Planning and control 2
Planning and control cycle
1 Identify objectives
2 Identify alternative courses of action (strategies) which
might contribute towards achieving the objectives
3 Evaluate each strategy
4 Choose alternative courses of action
5 Implement the long-term plan in the form of the annual
budget
6 Measure actual results and compare with plan
7 Respond to divergences from the plan
Planning and control 3
Planning and control occurs at all levels of the performance
hierarchy to different degrees.
The performance hierarchy refers to the system by which
performance is measured and controlled at different levels
of management within the organisation.
Corporate level – strategic plans
Management control level – tactical plans
Operational level – operational plans
Budgetary control 1
• Controllable vs uncontrollable costs
• Feedback control
• Feedforward control
Budgetary control 2
• Managers should be evaluated only on those items within
their control.
Budgetary control 3
• Feedback control involves taking action after the event.
• Feedforward involves taking action during the event.
Budgetary control 4
Single or double feedback loop elements of system include:
• Target
• Sensor
• Comparator
• Effector
Budgetary control 5
High level
controller Double
feedback
loop
Effector Comparator Single
feedback
loop
Input Process Sensor Output
Budget setting styles
Participation
Budget setting styles
• Imposed (from the top down)
• Participative (from the bottom up)
• Negotiated
• Final budgets are likely to lie between what top management
would really like and what junior managers believe is feasible
Budget systems
• Incremental budgeting
• Fixed budgets
• Flexible budgets
• Flexed budgets
• Zero base budgeting (ZBB)
• Activity-based budgeting (ABB)
• Rolling budgets
Incremental budgets 1
• Based on current year
• Builds in slack and inefficiencies
• Relatively straightforward
Incremental budgets 2
Incremental budgeting
• This involves adding a certain percentage to last year's
budget to allow for growth and inflation
• It allows slack and wasteful spending to creep into budgets
Fixed budgets 1
• Budget set in advance
• Does not change
Fixed budgets 2
Fixed budgets
• Prepared on the basis of an estimated volume of production
and an estimated volume of sales
• No variants of the budget are made to cover the event that
actual and budgeted activity levels differ
• They are not adjusted (in retrospect) to reflect actual
activity levels
Flexible/flexed budgets 1
Flexible budgets
• Budget set for several activity levels
• Good planning tool enabling ‘what if’ scenarios
Flexed budgets
• Restate budget based on actual volumes
• Useful for control
• Like for like comparison and meaningful variances
Flexible budgets 2
Flexible budgets
• Budgets which, by recognising different cost behaviour
patterns, change as activity levels change
• Flexible budgets can be drawn up to show the effect of
actual volumes of output and sales differing from budgeted
volumes
• At the end of a period, actual results can be compared to a
flexed budget
• A flexed budget is what results should have been at actual
output and sales volumes as a control procedure
Question: Flexible budget
Tianjin Beer has a bottling plant for its beer and has prepared flexible
budgets:
Flexible budgets
Bottles: 10,000 12,000 14,000
Production costs: $ $ $
Materials 30,000 36,000 42,000
Labour 27,000 31,000 35,000
Overhead 20,000 20,000 20,000
Required
If actual production was 12,350 bottles and the production costs incurred
totalled $90,000, what is the meaningful total variance for performance
evaluation purposes?
Answer: Flexible budget
Materials:
Variable cost = $3/unit
Overhead:
Fixed cost = $20,000
Labour: Output Cost
14,000 35,000
(High-low method) 10,000 27,000
4,000 8,000
∴VC/unit = $2
Answer: Flexible budget cont'd
By substitution into high output:
Total VC = $28,000
∴ Total FC = $35,000 – $28,000
= $7,000
∴ Flexed budgeted cost: $
Materials (12,350 ´ 3) 37,050
Labour (7,000 + 2 ´ 12,350) 31,700
Overhead 20,000
88,750
Actual costs – Flexed budgeted cost ∴ $1,250 (A)
Zero based budgets 1
• Build up budgets from scratch
• Allocates resources effectively
• Suitable for discretionary spend
Zero based budgets 2
• This approach treats the preparation of the budget for each
period as an independent planning exercise
• The initial budget is zero and every item of expenditure has
to be justified in its entirety to be included
Step 1
• Define decision packages – a specific activity so that it can
be evaluated and ranked
• Can be mutually exclusive packages or incremental
packages
Zero based budgets 3
Step 2
• Evaluate and rank packages on the basis of their benefit to
the organisation
Step 3
• Allocate resources according to the funds available and the
ranking of packages
Zero based budgets 4
Advantages of ZBB
• Identifies and removes inefficient and/or obsolete
operations
• Provides a psychological impetus to employees to avoid
wasteful expenditure
• Leads to a more efficient allocation of resources
Zero based budgets 5
Disadvantages of ZBB
• Involves time and effort
• Can cause suspicion when introduced
• Costs and benefits of different alternative courses of action
can be difficult to quantity
• Ranking can prove problematic
Activity based budgets 1
• Build up budgets by activity rather than by department
Activity based budgets 2
Activity based budgeting (ABB)
• ABB involves the use of costs determined using Activity
Based Costing (ABC) in budgets
• It involves defining the activities that underlie the figures in
each function
• Uses the level of activity to decide how much resource
should be allocated, how well it is being managed and to
explain variances from budget
Rolling budgets 1
• Always look at 12 months of budget
• Complete 1st period (say a month or a quarter), remove from
budget and add another month or quarter on the end
• Useful in times of uncertainty
Rolling budgets 2
Continuous/rolling budgets
• Continuously updated by adding a further accounting period
when the earlier accounting period has expired
Dynamic conditions making original budget inappropriate
• Organisational changes
• Environmental considerations
• New technology
• Inflation
Rolling budgets 3
Advantages of rolling budgets
• Reduce uncertainty
• Up-to-date budget always available
• Realistic budgets are better motivators
Disadvantages of rolling budgets
• Involve more time, effort and money
Question: Rolling budget
Bay Co uses a system of rolling budgets. The sales budget for the year to 31
Dec 2X13 is as follows:
Q1 Q2 Q3 Q4 Total
$ $ $ $ $
Sales 122,000 131,760 142,301 153,685 549,746
Actual sales for Q1 were 117,879. The adverse variance is explained by
growth being lower than anticipated and the market being more competitive
that predicted.
Senior management has proposed that the revised assumption for sales
growth should be 5% per quarter.
Required
Update the budget from Q2 based on the above information.
Answer: Rolling budget
2X13 Q2 Q3 04 2X14 Q1 Total
$ $ $ $ $
Sales 123,773 129,962 136,460 143,283 533,478
The revised budget should incorporate 5% growth, starting from Q1's actual
figure.
Q2 $117,879 ´ 1.05 = $123,773
Q3 $123,773 ´ 1.05 = $129,962
Q4 $129,962 ´ 1.05 = $136,460
Q1 $136,460 ´ 1.05 = $143,283
Budgeting issues 1
Sources of budget information
• Past data
• Sales forecasts
• Production department costing information
Allowing for uncertainty
• Flexible budgeting
• Rolling budgets
• Probabilistic budgeting
• Sensitivity analysis
Budgeting issues 2
Criticisms of budgeting
• Time-consuming and expensive
• Fail to focus on shareholder value
• Too rigid and prevent fast response
• Protect rather than reduce costs
• Stifle product and strategy innovation
• Focus on sales targets rather than customer satisfaction
• Lead to unethical behaviour
Budgeting issues 3
Difficulties of changing budgetary practices
• Resistance by employees
• Loss of control
• Time consuming and expensive training
• Cost of implementation
• Lack of accounting information and systems in place
Question: December 2011 question
3a
Required
Identify and explain SIX objectives of a budgetary control
system. (9 marks)
Approach: December 2011
question 3a
• It is worth nine marks so you would have 16.2 minutes to
answer it. Your answer needs to be succinct and to the point.
• Ensure that you clearly separate each point that you make in
order to make it easy for the marker to identify them.
• The following are suggested headings that you may have
used in your answer. You may have come up with others.
Answer: December 2011 question
3a
Objectives of a budgetary control system:
• To compel planning
• To communicate ideas and plans
• To coordinate activities
• To provide a framework for responsibility accounting
• To establish a system of control
• To motivate employees to improve their performance
• To ensure the achievement of the organisation's objectives
• To evaluate performance
Question: Specimen exam
The following statements have been made about zero
based budgeting:
(1) Employees will focus on eliminating wasteful
expenditure.
(2) Short-term benefits could be emphasised over long-
term benefits.
Which of the above statements is/are true?
A 1 only C Neither 1 nor 2
B 2 only D Both 1 and 2
Answer: Specimen exam
D
Zero based budgeting begins by looking at the minimum
budgeted expenditure, and building a budget from this zero
base. This encourages employees to focus on wasteful and
unnecessary spending. However the focus is on short-term
savings and may give insufficient consideration to longer-
term benefits of current spending.
Question: Specimen exam
The following statements have been made about changing
budgetary systems:
(1) The costs of implementation may outweigh the
benefits.
(2) Employees will always welcome any new system
which improves planning and control within the
organisation.
Which of the above statements is/are true?
A 1 only C Neither 1 nor 2
B 2 only D Both 1 and 2
Answer: Specimen exam
A
The costs of introducing a new system may exceed the
benefits. Employees are often inclined to resist change, even
though the planned changes may improve planning and
control within the organisation.
Summary
1 Objectives
§ Ensure the organisation's objectives are achieved
§ Compel planning
§ Communicate ideas and plans
§ Coordinate activities
§ Provide a framework for responsibility accounting
§ Establish a system of control
§ Motivate employees to improve their performance
Summary
2 Planning and control
§ Purpose of budgetary control is:
P – Planning
R – Responsibility
I – Integration and co-ordination
M – Motivation
E – Evaluation
Summary
3 Budgetary control
§ Managers should only be assessed on those items within their control.
§ Control can be feedback or feedforward – comparison of past results or
forecast results to plan.
Summary
4 Budget systems
§ Incremental budgeting
§ Fixed budgets
§ Flexible budgets
§ Flexed budgets
§ Zero base budgeting (ZBB)
§ Activity-based budgeting (ABB)
§ Rolling budgets
Summary
5 Incremental budgets
§ Incremental budgets tend to build in slack and efficiency
Summary
6 Fixed budgets
§ Fixed budgets are set in advance and do not change
Summary
7 Flexible/flexed budgets
§ Flexible budgets are ideal for planning
§ Flexed budgets are the best budget for control as they allow you to
compare like for like.
Summary
8 Zero based budgets
§ ZBB results in efficient resource allocation and is suitable for
discretionary spend
Summary
9 Activity based budgets
§ ABB ensures that causes of cost are managed.
Summary
10 Rolling budgets
§ Rolling budgets are useful in times of uncertainty.
Summary
11 Budgeting issues
§ Time-consuming and expensive
§ Fail to focus on shareholder value
§ Too rigid and prevent fast response
§ Protect rather than reduce costs
§ Stifle product and strategy innovation
§ Focus on sales targets rather than customer satisfaction
§ Lead to unethical behaviour
