Addis Ababa University College of Commerce

Department of Business Administration and Information Systems

Name :Mahlet Wondimu

Date : June 22, 2010

Module: Budgeting and Control

Part 1

Essay type Questions

1. Briefly discuss the major purpose and limitation of budgeting

PURPOSES of BUDGET

Integrates and Coordinates

The master budget is the major planning device for an organization. Thus, it is used to integrate
and coordinate the activities of the various functional areas within the organization. A
comprehensive plan helps ensure that all the needed inputs will be at the right place at the right
time when needed, just-in-time if possible. It also helps insure that manufacturing is planning to
produce the same mix of products that marketing is planning to sell. The idea is that the products
should be pulled through the system on the basis of the sales budget, rather than produced
speculatively and pushed on the sales force. Excess inventory and other resources hide problems
and add unnecessary costs. The integrative nature of the budget provides a way to implement the
lean enterprise concepts of just-in-time and the theory of constraints where the emphasis is
placed on the performance of the total system (organization) rather than the various subsystems
or functional areas.
 Communicates and Motivates

Another purpose budget is to provide a communication device through which the company’s
employees in each functional area can see how their efforts contribute to the overall goals of the
organization. This communication tends to be good for morale and enhance jobs satisfaction.
People need to know how their efforts add value to the organization and its' products and
services. The behavioral aspects of budgeting are extremely important.

Promotes Continuous Improvement

The planning process encourages management to consider alternatives that might improve
customer value and reduce costs. The PDCA cycle supports specific improvements in the
company’s processes. The financial plan and subsequent financial performance measurements
reflect the financial expectations and consequences of those efforts.

Guides Performance

The budget also provides a guide for accomplishing the objectives included in the plan. The
budget becomes the basis for the acquisition and utilization of the various resources needed to
implement the plan. Perfection of the guidance aspect of budgeting can significantly reduce the
amount of uncertainty and variability in the company’s operations. In a JIT environment, the
budget can also serve as a guide to vendors.

Facilitates Evaluation and Control

The budget provides a method for evaluating and subsequently controlling performance. .
Performance evaluation and control is a very powerful and very controversial aspect of
budgeting.

The budget also helps

 As an aid in making and coordinating short range plans

 As a device for communicating these plans to various responsibility center managers
 As a away to motivate mangers to achieve their responsibility center goals
 As a benchmark for controlling ongoing activities
 As a basis for evaluating the performance of responsibility centers and their managers
 As a means of educating managers
 Budgets communicate managers plan throughout the organization
 Budgeting forces managers to give planning top priority
 Budgets provide a means of allocating resources to their most effective uses
 Budgeting uncovers potential bottlenecks
 Budgeting coordinates the activities of the entire organization
 Budgeting provides goals that serve as a benchmark for evaluating subsequent performance

LIMITATION of BUDGETING

There are several limitations and problems associated with the budget that need to be considered
by management. These problems involve uncertainty, behavioral bias and costs.

Uncertainty
Budgeting includes a considerable amount of forecasting and this activity involves a
considerable amount of uncertainty. Uncertainty affects both sides of the financial performance
dichotomy, but uncertainty on the revenue side presents a more serious limitation for planning.
The uncertainty associated with sales forecasting creates a greater problem than uncertainty on
the cost side because the other parts of the budget From a performance evaluation and control
perspective, uncertainty on both sides of the financial performance dichotomy is not as much of a
problem because flexible budgets are used to fine tune the original budget to reflect expectations
at the current level of activity.

Behavioral Bias
A second problem involves a variety of behavioral conflicts that are created when the budget is
used as a control device. To be effective, the budget must be used by the managers it is designed
to help. Thus, it must be acceptable to all levels of management. The behavioral literature on
budgeting supports the view that the budget should reflect what is most likely to occur under
efficient operating conditions. If a budget is to be used as an effective planning and monitoring
device, it should encourage a high level of performance and efficiency, but at the same time, it
should be fair and obtainable. If the budget is viewed by managers as unfair, it may intimidate
rather than motivate. One way to gain acceptance is referred to as participative budgeting. The
idea is to include all levels of management in the budget preparation process. Of course this
process must be coordinated by a budget director to ensure that a fair budget is obtained that will
help achieve the goals of the total organization.
Another way to reduce the behavioral bias against budgeting is to recognize the concepts of
variation and interdependence when using the budget to evaluate performance. The concept of
interdependence refers to the fact that the various segments of a company are part of a system.
Inevitably, these segments, or subsystems influence each other. Failure to adequately recognize
the interdependencies within an organization tends to cause behavioral conflicts and motivate
participants to optimize the performance of the various segments rather than to optimize the
performance of the overall system.
Finally, the behavioral conflicts associated with budgeting are reduced by using flexible budgets
when evaluating performance.

Costs
A third problem or limitation is that budgeting requires a considerable amount of time and effort.
Many companies maintain a twelve month budget on a continuous basis by adding a future
month as the current month expires. While this does not create a major expenditure for large or
medium sized organizations, smaller companies may find it difficult to justify the costs involved.
Many small, potentially profitable firms do not plan effectively and eventually fail as a result.
Cash flow problems are common, to pay for merchandise or raw materials or to meet the payroll.
Many of these problems can be avoided by preparing a cash budget on a regular basis.

In short a budget can have the following limitations

 Imposed budgets usually cause frustration and resentment.

 It should only include controllable items.
 Budget plans can become cumbersome/meaningless and/or inflexible when external
factors change and internal decisions get modified.
 Development of a new budge should include re-examination of standards.
 Budgeting is based on forecast not on exact outcomes, its success hinges up to the
precision of estimates
 The installation of a perfect system of budgeting is not possible in short periods. Business
condition changes rapidly therefore budgeting program should be continuously adopt to changes
trying various techniques and procedures in developing and using the budgeting system
 Sound budgeting system will not in itself improve and management of an enterprise
unless it is properly implemented. Understood by all and concerted effort is made for its
implementation
 Budgeting is an aid to management, it is not management or replace management
 Budgeting may hide inefficiency instead of revealing them if a proper evaluation system
lacks
 Budgeting will lower moral and productivity if unrealistic target is set and it is used as a
pressure tactic.

2. Discuss the basic types of management control system

a. Bureaucratic control system
 It is a top down control
 It uses reward and punishment to influence employee behavior
 It uses policies and rules to control behavior
 Bureaucratically controlled companies are resistant to change and slow to respond to
customer
 Use bureaucratic control system when
 Standard operating procedure are needed
 Necessary to establish limits

b. Objective Control
 use of observable methods
Behavioral control-
 Regulates action and behaviors of employees

Output control-
Measure employee output
Coupled with use of reward and incentives
 Use behavioral control system when
 It is easier to measure activities than outputs
 “cause and effect relationships are available”
 Good measure of behavior are available

 Use output control system when

 It is easier to measure output than behavior
 “cause and effect relationships are unclear
 Good measure of output are available
 Clear goals and standards are available

c. Normative Control

When Company believes and values guide employee behavior and decision

Created by: Careful selection of employees

Role modeling and retailing of stories

 Use normative control system when

 Culture is strong
 Difficult to create behavior measure
 Difficult to create output measure

d. Concertive Control System

 Employees are guided by belief that are shaped and negotiated by work groups
 Autonomous work groups
- operate without managers
- Members are responsible for controlling work group process, output and behavior

 Use concertive control system when

 Group responsibility for task accomplishment
 Workers take ownership of behavior and output
 Strong work based control needed

e. Self Control System

 Employees control their own behavior
 Employees make decisions within clear boundaries
 Managers and employees set goals and monitor their own progress

 Use self control system when

 Workers are intrinsically motivated
 Difficult to create behavior measure
 Difficult to create output measure
 Workers have self control and self leadership
Part II

Gitma is a whole seller of cricate and equipment: he trades in cricate bats, pads, gloves, sweaters
and so on. Girma’s territory covers much of the southern and eastern part of Ethiopia and his
business sufficiently large that he needs to consider each product line as it s own revenue center.
To this end, he prepares detailed budgets line by line. Consider the following details for his
purchase and sales of cricate bats.

Girmas assessment of the coming season is that the weather will be hot and dry. And the demand
for cricate bats will be high fromm june and for the rest of the season ( until early September).
After September, girma will concentrate on his overseas business

Girmas 2011

Sales (unit )

June July August September October November December

950 950 750 600 600 500 600

Stocks at the end of any month is to be set at the level of 100 bats plus 20% of the number of
bats scheduled to be sold in the following month.

Required

For the seven months period June to December 2011, prepare the stock and purchase budget and
the sales budget: the selling price per bat is $20 and the purchase price per bat is $15
 Sales Budget
Girma Co
monthly sales budget
June 2011-dec2011

  Budgeted unit sales Budgeted unit price budgeted totals sales

June 950 $20 $19,000
July 950 $20 $19,000
august 750 $20 $15,000
September 600 $20 $12,000
October 600 $20 $12,000
November 500 $20 $10,000
December 600 $20 $12,000
total 4950 $20 $99,000

Stock
purchase(End inv+ Ending bud
  CGS-Beg inv) Inv(100+20%*Sales) CGS Beg Inv
may   290 Co
Girma    
June 950 290
Merchandise Purchase Budget 950 290
July 910 250
June 2011-dec2011 950 290
august 720 220
Augus 750 Novembe
Octobe 250 Decembe
September 600 220 600 220
  June July t September r r r
October 580 200 600 220
Net months unit sale 950 750 600 600 500 600 100
November 520 220 500 200
Bud end inv
December 600 100 600 100
100+20%*X 290 250 22 v0 220 200 220 120
Plus: current month sale 950 950 750 600 600 500 600
total unit needed 1240 1200 970 820 800 720 720
Less: beginning
inventory 290 290 250 220 220 200 100
no to be purchase 950 910 720 600 580 520 620
Budgeted cost per unit x 15 x 15 x 15 x 15 x 15 x 15 x 15
Budgeted cost of 1425 1365
purchase 0 0 10800 9000 8700 7800 9300