CHAPTER 4: Visual Overview

Objective: To appraise alternative methods of budgeting for control.

1.1 Top-Down v Bottom-Up Budgeting
Top-down budgeting is where budgets are prepared centrally, usually by senior management. These
are then imposed on more junior managers.

Bottom-up budgeting means that junior managers prepare their own budgets initially. These are
then reviewed by the finance department and/or senior management – some negotiation may take
place before the final budget is achieved.

Activity 1 Top-Down and Bottom-Up Budgeting

State the advantages of top-down budgeting and the advantages of bottom-up budgeting.
*Please use the notes feature in the toolbar to help formulate your answer.

1.2 McGregor's Theories of Human Behaviour

McGregor suggests that the circumstances in which top-down or bottom-up budgeting would be
more appropriate depends on the nature of the employees.

The two types of employees are the Theory X and Theory Y employees:

1. Theory X

 People dislike work.

 People dislike responsibility.

 They are only motivated by money.

 They must be told what to do.

2. Theory Y

 People seek responsibility.

 They want to participate in decision making.

The type of employee working for an organisation therefore has implications for the budgetary
process.
Features

Employee Y
Employee X
 Junior management prepare budgets;
 Senior management prepare budgets;
 Senior management review to ensure consi
 Imposed on junior management; with organisation objectives;

 Quicker than bottom-up approach.  Risk of budget bias/slack.

1.3 Fixed v Flexible Budgets

At the end of the period, actual results are compared to the budget, and action taken to remedy any
deviations from the budget in future periods. However, a problem arises if the budget is prepared at
one activity level and the actual activity is very different; comparison is less meaningful, as it is
difficult to differentiate between deviations due to the different level of activity and those due to
other factors. The following three types of budget are defined by how they deal with variances
between actual levels of activity and budgeted, if at all.

1.3.1 Fixed Budgets

A fixed budget is prepared at the beginning of the period based on the expected activity level (sales
units, production units, etc). No adjustment is made to this budget at the end of the year when
comparing actual performance against the budget. This means that the budgeted activity levels may
be very different from the actual activity levels, making comparison meaningless, as different levels
of activity would incur different levels of cost.
 1.3.2 Flexible Budgets

When the budget is prepared, several versions of the budget are prepared. So a budget may be
prepared, for example, for 12,000, 14,000 and 16,000 units. At the end of the year the budget that is
closest to the actual activity level is used for the comparison of actual results against the budget.

This provides a range of possible outcomes across a variety of scenarios, for better understand on
how costs and revenues would behave at different activity levels, and allow for evaluation of
performance that is more fair.

Such an approach requires knowledge of cost behaviour – which costs are fixed, so they will not vary
with output, and which are variable.

1.3.3 Flexed Budgets

At the end of the year, prior to comparing the actual figures against the budget, the budget is
recalculated (flexed) using the original budget assumptions, but the actual activity levels. This means
that the comparison is more valid.

Example 1 Flexed Budget

Original budget

$000

Sales (50,000 items @ $100)

Production (55,000 units)

Materials (55,000 × 40) 2,200

Labour (55,000 × 3) 165

Variable overheads (55,000 × 9) 495

Fixed overheads (55,000 × 15) 825

Budgeted cost of production 3,685

Less: Closing inventory (5,000 @ $67) (335)

Standard cost of goods sold

Budgeted profit (50,000 @ $33)

Example 1 Flexed Budget

Actual sales were 53,000 units and production was 56,000 units. The flexed budget would be
calculated as follows:

Flexed budget

$000 $000

Sales 53,000 × $100 5,300

Production costs

Materials 56,000 × $40 2,240

Labour 56,000 × $3 168

Variable overheads 56,000 × $9 504

Fixed overheads 56,000 × $15 840

Less: Closing inventory (201)

Cost of goods sold (3,551)

Profit 1,749

Note: the above budgets have been prepared using absorption costing, as the fixed overheads
absorbed into cost of sales and closing inventory has been flexed.

1.3.5 Disadvantages of Flexed and

1.3.4 Advantages of Flexed and Flexible Budgets Flexible Budgets

 Easier comparison of actual results against

the budget since like is being compared with  In the modern business world,
like. many costs are fixed – so flexible
and flexed budgets may add
 During the planning stage, management has
little value.
better knowledge of cost behaviour, and
therefore what impact changes in output will  Difficulty of identifying variable
have on total costs. and fixed costs.

Activity 2 Fixed v Flexible Budgeting

 Good Trip is a travel agency. It employs a team of five staff – an accountant, three sales staff and a
manager. The agency does not organise holidays directly, but acts as an agent for big package
holiday companies. The company receives a commission on each booking that is made.

Required:

Discuss whether fixed or flexible budgeting would be more appropriate for Good Trip.

*Please use the notes feature in the toolbar to help formulate your answer.

4.1.4 Rolling Budgets (Rolling Forecasts)

1.4 Rolling Budgets (Rolling Forecasts)

1.4.1 Weaknesses of Traditional Periodic Budgeting

 Traditional periodic budgets are prepared in advance for the full budget period (typically one
year). The problem with this approach is that the budget itself may become outdated very
quickly due to changes in the external environment.

In response to this weakness, many organisations prefer to use rolling budgets.

Definition

Rolling budget – a system of budgeting where the budget is continuously updated. The budget horizon (typically one year) is
kept constant by adding another month (or quarter) to the end of the budgeted period as each month (or quarter) expires.

Example 2 Rolling Budget

A budget is prepared for the year 20X0.

At the end of January 20X0, the actual performance for the month of January is compared against
the budget. Based on this comparison, it may be decided that the budgets for the period 1
February to 31 December 20X0 should be changed to reflect changes in external factors. Once this
has been done, a budget is also prepared for January 20X1. The new budget therefore covers the
period from 1 February 20X0 to 31 January 20X1.

1.4.2 Advantages and Disadvantages of Rolling Budgets

 There will always be a budget for the next 12  Time consuming.

months. This can be useful for planning things such
 Budgets may be changed to hide operationa
as cash flows.
inefficiencies.
 Managers will be more motivated as the budget is
 Not necessary in a stable environment.
more realistic, since it will be updated to take
account of changes that occur that are outside of
 their control.

 The budget is always updated to reflect external

changes. It is therefore more relevant and more valid
for comparison against actual performance.

Activity 3 Use of Rolling Budgets

Betterbuys is a food retailer that runs a supermarket in northern England.

Pear develops portable communication devices and music players for the top end of the market.
Pear’s products have short life cycles due to the competitive nature of the market.

Required:

Discuss whether rolling budgets would be appropriate for each of the two organisations.

*Please use the notes feature in the toolbar to help formulate your answer.

1.5 Incremental Budgeting

In incremental budgeting:

 The process starts with the previous period’s budget or actual results.

 Incremental amounts are added/subtracted to cover:

o Any known changes to the business;

o Inflation.

This approach may be appropriate for a stable business with good cost control.

1.5.1 Advantages of Incremental Budgeting

 Only the increment needs to be justified.

 Easy and quick to prepare the budgets.

1.5.2 Disadvantages of Incremental Budgeting

 Unnecessary costs will remain in the budget because they were in the previous year’s
budget. Inefficiencies will therefore be compounded.

 Does not encourage a detailed examination of where improvements could be made to

increase efficiency.

 Budgeted expenditure is not related to the activities that the organisation wishes to
perform.

4.1.6 Zero-Based Budgeting (ZBB)

1.6 Zero-Based Budgeting (ZBB)

1.6.1 Basic Features

Zero-based budgeting attempts to overcome the weaknesses in incremental budgeting – in

particular, the criticism that costs will be included in a budget because they were in previous year’s
budgets. It requires managers to plan what projects they wish to do, and base the budget around
these.

 The process starts with the assumption that the budget for next period is zero.

 Budget holders identify what programmes their department wishes to perform in the next
year.

 Budget holders prepare a “decision package” for each programme which includes:

o Goal of the programme;

o Level of funding required and benefits;

o Consequences to the company of the department not performing its function.

 Senior management (usually a budget committee) decide which decision packages to accept
based on predetermined criteria. Decision packages are ranked in terms of priority for
allocation of funds, based on their importance and fulfilment of the criteria set.

 Resources are allocated to departments according to ranking of decision packages accepted

and approved for disbursement.

1.6.2 Advantages of ZBB 1.6.3 Disadvantages of ZBB

 Too costly and time consuming – th

it has never achieved the popularit
proponents expected.

 Should reduce budgetary slack as costs must be justified based  Not appropriate for non-discretion
on the activities they relate to. expenditure such as costs of produ
these depend on quantities of outp
 Useful for discretionary spending and support activities such
as advertising and research and development where  Budget holders, staff and trade uni
management can choose how much to spend on a particular feel threatened – that they have to
item. their existence.

 Resources will be allocated to the programmes that best  The ranking and selection of packa
achieve the objectives of the organisation. be subjective.

1.6.4 Use of ZBB

Many organisations have used a partial version of ZBB – applying it to some departments that
undertake discretionary-type activities, such as marketing.

Other organisations have used ZBB as a “one-off” exercise to identify potential cost savings before
returning to more traditional incremental types of budgeting in future periods.
 Example 3 Use of ZBB in Large Global Companies

An Accenture plc study released in February 2018 provided the following insights on ZBB:

 Historically ZBB has been used in the consumer goods sector but has gained popularity
among a broader range of organisations looking to cut costs, with approximately 300
large global companies currently using the technique. Kraft, Heinz, Unilever, Tesco and
Diageo are among the organisations that use ZBB, as well as others in consumer goods,
life sciences, chemicals, automotive and retail sectors.

 The organisations surveyed by Accenture saved on average $280 million per year with the
help of ZBB.

 Organisations also make the budgeting technique applicable to a wider number of tasks.
More than 90% of surveyed firms used it to reduce their spend on travel, facilities, legal
and professional services.

 Over half of organisations cut their sales and marketing budget applying ZBB, and more
than 40% reduced their headcount (by 43%) and their cost of goods sold (by 42%).

 More savings are possible by combining ZBB with big data analysis and artificial
intelligence.

 Half of the organisations surveyed did not pursue a staged approach when introducing
ZBB but launched it simultaneously across all of their markets.

4.1.7 Activity-Based Budgeting (ABB)

1.7 Activity-Based Budgeting (ABB)

1.7.1 Principles of Activity-Based Budgeting

Activity-based budgeting follows the principles of activity-based costing (ABC) “in reverse”. (ABC is
assumed knowledge from the Performance Management exam.) Having decided how many units to
produce and sell, the organisation then needs to define the cost of the activities required to produce
them. These depend on the drivers identified for each activity. A typical ABB exercise may follow the
following steps:

1. Estimate the expected output (units) for each product.

2. Identify the number of units of each activity that will be required to produce the output. This
is based on knowledge of the relationships between the output and the activities that are
required to be performed to produce the output.

3. Determine the resources needed to perform the activities required. This is based on
knowledge of the drivers – the factors that influence the price of the activities.

4. If the current commitment of resources is such that too many or too few resources exist to
perform the activities required in Step 2, adjust accordingly.
 Example 4 Activity-Based Budgeting

Alex uses activity-based costing, and wishes to adopt an activity-based approach to budgeting.

Having estimated the total budgeted sales for the next financial year (Step 1 above), Alex has
identified that one of the activities needed to support the budgeted sales is “Processing sales
orders”. Alex has identified that 2,800 orders will be received next year based on the budgeted
sales level (Step 2).

One of the resources needed for processing orders is staff. Each member of staff in the Sales
Order department can handle 60 orders per month, or 720 order per year. Since Alex expects
2,800 orders next year, the company will need 3.9 (i.e. four) members of staff (Step 3).

Currently Alex employs six members of staff in the Sales Order Processing department. Alex
should consider relocating two members of staff to other departments.

4.2.1 Variance Investigation

2.1 Variance Investigation

Definitions

Variances – differences between actual prices and standard prices and actual quantities and
standard quantities.

Variance analysis – the process of calculating and interpreting variances.

The main purpose of variance investigation is to improve operations.

 Actual cost and performance is compared with the standard cost of actual performance.

 The differences between actual results and what should have happened according to the
standards are variances.

 Management should consider both the nature (“why did it arise?”) and magnitude (“by how
much has it increased/decreased”?) of any variance.

 A corrective action could include re-calibrating/re-setting the specifications of an item of

equipment or changing a supplier.

 An amended standard cost may be prepared for the next period.

2.2 Controllability

The controllability principle is that managers should be judged only on things within their control.

In a system of responsibility accounting, managers are given responsibility for particular areas of the
organisation. At the end of the period, the performance of managers may be judged at least in part
by variances:

 which are attributed to their department;

 between actual and budgeted revenues, costs and profits.

Managers' remuneration may also be linked to this (e.g. bonuses could be paid if managers achieve
their budgeted profit figures). It is clearly important therefore that the performance management
system is fair.

Activity 6 Controllability

Rehan is the production manager of a factory making ball bearings. His performance is judged using
variance analysis. The variance analysis for the last month has just been performed and includes the
following:

 An adverse materials price variance due to a change in the supplier. The supplier was
changed because Rehan complained that the quality of the products sold by the previous
supplier was substandard.
  A labour idle time variance caused by two factors:

1. A strike lasting two days over pay.

2. A machine breakdown, meaning staff could not work until the machine was fixed.

 A fixed overhead variance caused by an increase in factory rent. All rental contracts are dealt
with by the company's legal department.

Required:

Discuss which of the events above (if any) are outside of Rehan's control and should, therefore, be
ignored when assessing his performance.

*Please use the notes feature in the toolbar to help formulate your answer.

4.2.3 Revision of Budgets and Standards

2.3 Revision of Budgets and Standards

At the end of a budget period, prior to comparing the actual performance of an organisation against
the budget, budgets may be revised to take account of changes within the environment which were
not anticipated when the budget was prepared.

The reason for such revision is that because managers are judged on how they performed relative to
the budget, it is unfair to use a budget that turns out to be incorrect.

The principles that should be applied when revising budgets are as follows:

 If something occurred during the budget period that was outside the control of the manager
and meant that the budget was not achieved, it should be revised.

 If, in retrospect, it appears that the original budget was unrealistic, the budget may also be
revised.

 Management should not revise budgets to hide inefficiencies.

 Senior management should approve only appropriate revisions.

Activity 7 Budget Revisions

The budget for an airline for the year ended 31 December 20X1 was prepared in October 20X0. Since
the budget was prepared, the following events occurred:

 The price of oil increased 25% on world markets. This caused airline fuel prices to increase.
Fuel accounts for 50% of the airline's costs.

 Due to a strike, the airline could not operate for four weeks of the year. There was no
revenue during this period.

 The airline lost an additional two weeks of revenue due to the eruption of a volcano and the
associated ash cloud.
Required:

For each of the events above, discuss which should result in budget revisions and which should
not.

*Please use the notes feature in the toolbar to help formulate your answer

2.4 Planning and Operational Variances

Traditional variance analysis compares:

If the actual environment differs from what was anticipated when the original standard was set,
management should consider revising the standard (revised standard).

Even if the environment has not changed, hindsight might show that an unrealistic standard was
used (e.g. ideal standard). Again, management should consider revising the standard.

The factors to consider in deciding whether to revise a standard are essentially the same as whether
to revise a budget (as above).

The variances calculated by comparing actual performance against the revised standard
are operational variances (or operating variances). The calculation of these is exactly the same as
the method used to calculate “traditional” variances in your ACCA studies to date; the only
difference is that a revised standard is used.

The difference between the revised standard and original standard is the planning variance
(or budget revision variance). These variances can relate to any element of the standard product
specification or indeed to sales or production volumes.

Definitions

Planning variance – arises when an original budget is revised with the benefit of hindsight ("after the fact").

Operational variance – arises when actual performance differs from a revised standard.

4.2.5 Planning Cost Variances

2.5 Planning Cost Variances

There are various methods of calculating planning variances. The following approach starts with the
traditional variance (e.g. a material price variance), which is then analysed into planning and
operational variances.

2.5.1 Materials Price and Labour Rate

The approach to calculating the materials price and labour rate variances is the same, so these two
variances are dealt with together here.

 For materials, the references to quantity are to quantities of materials;

 For labour, the quantities are labour hours.

Traditional Price/Rate Variance

Actual quantity x Actual price x

Actual quantity x Standard price x

Price variance x

If the standard price is subsequently revised, the traditional variance can be analysed into planning
and operational variances, as follows:

Planning Price Variance

This shows the effect of revising the standard cost by comparing the standard cost of actual
materials using the old and new standard cost:

Actual quantity x Original standard price x

Actual quantity x Revised standard price x

Planning price variance x

 This is adverse if the revised standard price is higher than the original standard price.

Operational Price Variance

The calculation of the operational price variance is very similar to the calculation of the traditional
price variance. The only difference is that the actual price is compared with the revised standard
instead of the original standard:

Actual quantity x Actual price x

 $

Actual quantity x Revised standard price x

Operational price variance x

 This is favourable if the actual cost is less than the revised standard cost.

2.5.2 Materials Usage and Labour Efficiency

The approach to calculating the materials usage and labour efficiency variances is the same, so these
two variances are dealt with together here.

Traditional Usage/Efficiency Variance

Kilos/Hours, etc

Actual quantity used x

Standard quantity for actual output x

Difference x

At standard price/rate per unit/hour $x

Materials usage/labour efficiency variance $x

Planning Usage/Efficiency Variance

Kilos/Hours, etc

Original standard quantity for actual output x

Revised standard quantity for actual output x

Difference x

At standard price/rate per unit/hour $x

Materials usage/labour efficiency planning variance $x

 This is adverse if the revised standard quantity is greater than the original standard quantity.

Operational Usage/Efficiency Variance

 Kilos/Hours, etc

Actual quantity used x

Revised standard quantity for actual output x

Difference x

At standard price/rate per unit/hour $x

Materials usage/labour efficiency operational variance $x

2.6 Market Size and Market Share Variances

2.6.1 The Concept

A traditional sales volume variance may result from:

 a market size variance, which arises because the size of the market was different from
expected due to a change in the external environment (e.g. economic growth); or

 a market share variance, which arises because the share of that market was different from
budget (e.g. due to effective advertising).

If the actual market size for a product is known, the sales volume variance can therefore be split:
 Key Point

Sales managers can control the market share variance, but not the market size variance.

2.6.2 Market Size Variance

Kilos/Hours, etc

Budgeted sales quantity x

Revised budgeted quantity

(Actual market size × Budgeted market share) x

Difference x

× Standard contribution/profit per unit x

Market size variance $x

Key Point

If marginal costing is used, multiply the variances by standard contribution per unit.
 Key Point

If absorption costing is used, multiply the variances by the standard profit per unit.

2.6.3 Market Share Variance

Units

Actual sales quantity x

Revised budgeted quantity x

Difference x

× Standard contribution/Profit per unit x

Market share variance $x

4.2.7 Evaluation of Revision of Standards

2.7 Evaluation of Revision of Standards

Advantages Disadvantages

 Distinguishes between those variances

caused by bad planning or unavoidable
factors and those which are the result
of operating factors.

 Adverse operating variances provide

feedback control on processes which
need correcting.
 Extra data requirements (e.g. market size).
 Planning variances can be used to
update standards to current conditions.  More time consuming.

 Motivation may improve if managers  Managers may claim that all adverse
know they will only be assessed on variances have external causes and all
variances under their control (i.e. favourable variances have internal causes
operational variances). (i.e. manipulation of revised standards).

2.8 Manipulation
From the previous discussion, it should be apparent that budgets and standards prepared at the
start of the year may need revision at the end of the year if they are inappropriate because of
factors which occurred outside of the control of the organisation.

Care clearly must be taken to ensure that budget revisions are only made when appropriate.
Managers who have not achieved their budget targets, or who experience adverse variances, may
try to hide these by revising the budgets and standards.

In practice, there may be some debate about whether an organisation should revise a standard or a
budget.

4.3.1 Criticisms of Traditional Budgeting

3.1 Criticisms of Traditional Budgeting

For many years there has been much criticism of the traditional budgetary processes. Hope and
Fraser detail these criticisms in their book Beyond Budgeting. This looks at the problems inherent in
the traditional budgeting process, and suggests an alternative approach to performance
management, the "Beyond Budgeting" model.

In discussing budgets, Hope and Fraser use a broader definition of budgeting than simply producing
a financial plan. They mean the whole performance measurement process of agreeing on the
targets, setting reward schemes based on achieving those targets, using budgets to allocate
resources, and controlling performance based on this process. They refer to this as the "fixed
performance contract".

The main criticisms of this budgeting model as described by Hope and Fraser are as follows:

3.1.1 Budgets Take Up Too Much Time

The budgeting process takes up too much of the time of senior management, and does not add
sufficient value to the organisation to justify this.

3.1.2 Budgeting Is Out of Kilter with the Modern Business Environment

In the more competitive environments that have existed since the 1980s, businesses must react
quickly to customer needs. This requires transferring power from the centre to managers who are
closer to the customers. The old "command and control" structure of organisations represented by
traditional budgeting process has become outdated.

The primary drivers of shareholder value in the modern business world are intellectual capital such
as brands, loyal customers and proven management teams. These are outside of the orbit of the
budgetary control system.

3.1.3 The Extent of Gaming

Budgets were initially introduced as a planning tool for managing costs and cash flows. However,
over time budgets also came to be used as performance management tools for managing the
business. The "fixed performance contract" was introduced, as follows:

 A fixed target – usually expressed in terms of budgeted sales, costs, profits and ratios such as
return on capital employed.
  Incentives were introduced based on achieving these targets, such as bonuses and
promotions for achieving the budgets.

 Resources are allocated to departments based on the budget.

This system sounds good in theory, but in practice it can lead to an annual "performance trap"
whereby the actions of all managers are focused on meeting the performance targets of the current
year.

This may lead to dysfunctional behaviour, or gaming. Gaming means manipulating a system to
achieve some advantage (e.g. building slack into budgets).

During their research, Hope and Fraser encountered the following examples of gaming:

 Managers negotiate the lowest targets and the highest rewards.

 Always make the bonus whatever it takes (e.g. by "window dressing"). For example, ensuring
that sales targets are met by making sales on a "sale or return" basis at the end of the
financial year to a friend. The following year the goods are returned.

 Never put the customer above the sales targets.

 Never share knowledge or resources with other teams.

 Ask for more resources than you need. You will be cut back to what you actually need.

 Always spend what's in the budget or you will lose it.

 Always be able to explain adverse variances on causes beyond your control.

 Never provide accurate forecasts – hide bad news or you will be expected to compensate.

 Always meet the numbers, never beat them.

 Never take risks.

3.2 Beyond Budgeting Model

Definition

Beyond Budgeting – a set of guiding principles to enable an organisation to manage its performance and decentralis
decision-making process without the need for traditional budgets.

Hope and Fraser suggest that the traditional budgetary control process should be replaced by the
following system:

 Replace financial targets with targets based on key performance indicators (KPIs) and use
"stretch goals" for planning that are not linked to reward schemes.

 Appraise managers using comparisons with peers and benchmarks and reward them
accordingly.

 Devolve responsibility for planning away from the centre.

  Manage resources to be available for worthwhile opportunities.

 Use rolling forecasts, performance league tables and other KPIs to measure and control
performance rather than just relying on comparison of actual performance against the
budget.

3.2.1 Setting Targets

Definition

Stretch goal – a goal that requires an organisation or person to push themselves to their limits.

Where managers rewards are linked to achieving fixed financial targets, managers negotiate the
lowest targets. This means that the organisation does not achieve its potential. Beyond budgeting
encourages managers to set challenging targets or "stretch goals" that cannot be achieved by
making small improvements to existing performance.

 Managers are asked what their department could achieve if it aimed to maximise
performance over the short to medium term.

 Since their rewards will not depend on achieving these targets, managers will not have an
incentive to simply negotiate easy targets. Raising targets encourages maximum profit
potential.

 Setting targets based on KPIs is quicker than setting detailed financial budgets, therefore
reducing the time spent on budgeting.

 Targets set are more aligned with the strategy of the organisation than financial targets.

3.2.2 Rewarding People

In traditional budgeting, fixed targets are set at the start of the year and managers are rewarded if
they achieve those targets, regardless of any external changes in the environment. This leads to
manipulation of data and gaming – an attitude of "make the target whatever it takes".

 Beyond budgeting uses relative targets (e.g. how managers perform compared to peers) or
benchmarks (e.g. profits compared to competitors or market share)..

 Targets are therefore more relevant and realistic, unlike internally set targets.

 Targets are also fairer, as they take into account changes in the external environment
automatically; if the economy is not doing well in a particular year, the competitor's profits
will also be lower. This helps to eliminate gaming as managers now see that the targets are
fair.

3.2.3 Action Planning

In traditional budgeting, budgets are often prepared at the start of the year using top-down
methods. These fix the behaviour that is expected of the managers. The problem is that in a dynamic
business environment, organisations need to be able to react quickly to changes (e.g. to customer
demand). The traditional budget limits such reaction.

 In the beyond budgeting model, business unit managers and front-line staff develop their
own plans for maximising customer satisfaction and shareholder wealth.
  The role of senior management is to provide higher-level targets and to challenge the plans
produced by business unit managers.

 Unit managers will typically prepare medium-term goals on an annual basis and short-term
goals on a quarterly basis. They can therefore respond to changing demand and anticipate
business threats and opportunities. This continuous and open process allows teams to
create value.

3.2.4 Managing Resources

In traditional budgeting, budgets are used as the basis for deciding how resources should be
allocated to each department. If new projects become available that were not envisaged when the
budget was prepared, funds may not be made available for them. This may lead to good business
opportunities being missed.

 In the beyond budgeting model, resource decisions are devolved to front-line teams, making
them more responsive. Managers are more accountable; there is greater ownership and less
waste.

 Funds are allocated to projects based on a "fast track" review process (i.e. if front-line teams
need additional resources, they will be approved if they meet agreed criteria).

3.2.5 Coordinating Actions

In traditional budgeting, the budgets of all departments are coordinated. According to Hope and
Fraser, although the departments may be coordinated with each other, they are not aligned with the
strategy of the organisation. An additional problem is that it is not enough to perform this
coordination once every year.

 In beyond budgeting, coordination occurs through cross-company interaction.

 Service level agreements between the different departments are used to coordinate their
activities. Under such agreements one department commits to providing goods or services
to another, based on expected demand, covering an appropriate time frame.

 Operating capacity rises and falls according to demand, rather than to meet a
predetermined budget. Production is more flexible and there is less waste as fewer items are
made for inventory.

3.2.6 Controlling Performance

In traditional budgeting systems, control is exercised by comparing actual performance against

budget and asking managers to explain any variances. Corrective action is then taken to bring actual
performance back into line with the budget. This leads to too much focus on the short term,
according to Hope and Fraser. Few organisations focus beyond the end of the current financial year.

 Beyond budgeting model uses a more diverse range of forward-looking indicators to manage
performance. There is a greater focus on trends and forecasts.

 Extensive use of rolling forecasts and leading indicators provide managers with a view of
what will happen in the future.
  There is also greater use of comparison of KPIs achieved against benchmarks and the use of
league tables. This provides managers with a more sophisticated view of performance and
should eliminate manipulation of data.

4.3.3 Evaluation of Beyond Budgeting

3.3 Evaluation of Beyond Budgeting

3.3.1 Advantages

 Divisional managers will be more motivated as they will be given autonomy to plan for their
own business units.

 Creates a climate based on competitive success. Using relative performance measures and
comparing performance with external benchmarks encourages managers to focus on
beating competitors rather than other managers.

 Faster response to changes in customer needs as managers can react quickly to new threats
and opportunities rather than adhere to an outdated budget. Resources will also be made
available for new projects if they are worthwhile even if not originally in the budget.

 Performance is not only focused on financial numbers but on KPIs, which reflect more
faithfully the overall objectives of the organisation (see Chapter 15 for examples).

 More customer-focused attitude of departments that supply other internal departments.

3.3.2 Disadvantages

 The organisational culture may not support this approach (e.g. where senior managers are
accustomed to a command-and-control style of management).

 May not be appropriate in organisations in which financial control is crucial to success (e.g.
in public sector organisations where funds are limited).

4 Summary and Quiz

Summary and Quiz

 Various budgetary systems exist for comparing budgeted performance
against actual including fixed, flexible, flexed, periodic and rolling.
 Incremental budgeting is a traditional approach to budgeting which takes
the current year's budget as a starting point in preparing the next year's
budget.
 Zero-based budgeting tries to improve on this by starting the budgeting
process with a zero base, and basing the budget on the activities that the
organisation wishes to perform.
 The main purpose of analysing variances is to improve operations by
taking action when variances are identified.
 Prior to performing variance analysis, budgets and standards may be
revised to take into account unexpected changes in the environment or
correct standards that are found to be unrealistic. Comparing actual
performance against a revised standard may lead to a fairer evaluation.
Operational variances compare actual performance with a revised budget or
standard;
Planning variances compare the original standard with the revised standard
for actual output.
The Beyond Budgeting model aims to replace traditional budgetary control systems
with a more modern approach which replaces financial targets with key performance
indicators.