C1- Budgetary Systems and Types of Budgets

C1: Budgeting and Control | Budgetary Systems and Types of Budgets (ACCA F5)

Budgetary Systems and Types of Budgets looks at budgetary systems within the performance hierarchy; the different types of budgeting systems; the information contained in a budget and the sources of information; the usefulness and problems with different types of budgets; the beyond budgeting model; issues in setting the difficulty level for a budget; benefits and difficulties of employees participating in negotiating targets; difficulties in changing a budgetary system or budgets and how budget systems can deal with uncertainty in the environment.

Budgetary Systems and Types of Budgets

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

a) Explain how budgetary systems fit within the performance hierarchy.

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

b) Select and explain appropriate budgetary systems for an organization, including topdown, bottom-up, rolling, zero-base, activity base, incremental and feed-forward control.

There are 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 centre 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

c) Describe the information used in budget systems and the sources of the information needed.

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

d) Indicate the usefulness and problems with different budget types (including fixed, flexible, zero-based, activity- based, incremental, rolling, top-down, bottom up, master,
functional).

For the advantages and disadvantages of the different budget types, please refer to BPP’s ACCA F5 Performance Management Study Text.

e) Prepare rolling budgets and activity based budgets.

The rolling budget is continuously updated throughout the financial year.

Example:

Company X uses a rolling budget system. Their sales budget is as follows:

  • Jan – Mar: 34,000
  • Apr – Jun: 22,000
  • Jul – Sep: 45,000
  • Oct- Dec: 56,000
  • TOTAL: 157,000

Actual sales for January to March were 26,000. Senior Management has proposed that the revised assumption for sales growth should by 3% per quarter. Update the budget.

The actual sales figures for Jan-Mar are:

  • Jan – Mar: 34,000 x 1.030 = 35,020

Based on management’s assumption, the revised budget is as follows:

  • Apr – Jun: 35,020 x 1.030 = 37,153
  • Jul – Sep: 37,153 x 1.030 = 38,268
  • Oct – Dec: 38,268 x 1.030 = 39,416
  • Jan – Mar: 39,416 x 1.030 = 40,598.48
  • TOTAL: 155,435.48

f) Explain the beyond budgeting model, including the benefits and problems that may be faced if it is adopted in an organization.

Beyond budgeting is a budgeting model which proposes that traditional budgeting should be abandoned and replaced with “adaptive management processes.”

 Note: The Beyond Budgeting model was put forward by Hope and Fraser (2003). 

Benefits of beyond budgeting are:

  • Decision making processes are adaptive
  • There is more focus on personal responsibility
  • Focuses on improving future performance

g) Discuss the issues surrounding setting the difficulty level for a budget.

There is a strong relationship between the difficulty level of a budget and performance. Targets and goals set at the right level, will motivate employees. A budget set at current achievable levels (expectations budget). A budget set at a level higher than the achievable level (aspirations budget) will motivate.

h) Explain the benefits and difficulties of the participation of employees in the negotiation of targets.

When employees participate in the negotiation of targets, it makes them more motivated. The organization will benefit from better decision making because it involves the people doing the work. The employees will also be more enthusiastic about working towards their own targets. However it could be a time consuming exercise and several targets may be identified which could be an impossible task.

i) Explain the difficulties of changing a budgetary system or type of budget used.

If an organization wants to change its budgetary system, it may encounter a number of problems including:

  • Resistance by employees
  • Loss of control
  • Costs of implementation
  • Training
  • Lack of accurate information

j) Explain how budget systems can deal with uncertainty in the environment.

Some budgetary systems like flexible budgeting, rolling budgets, probabilistic budgeting and sensitivity analysis allow an organization to deal with uncertainty.

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