Question

A Budget is a quantitative plan prepared for a specific time period. It is normally expressed in financial terms and prepared for one year. The Chartered Institute of Management Accountants (CIMA) also defined a budget as “a plan quantified in monetary terms, prepared prior to a defined period of time to attain a given objective”. Several objectives exist for the preparation of a budget. Notable among them include assisting in Planning, Control, Communication, Co-ordination, Evaluation, Motivation, Authorization and Delegation. Individuals react to demands of budgets and budgetary controls in different ways. Their behavior can damage the budgeting process. Behavioral problems are often linked to management styles. Required: Based on your knowledge of Budgeting; (a) Discuss the following behavioral problems of budgeting which are linked to management styles: i. Dysfunctional behaviour ii. Budget slack (b) State and discuss four (4) approaches to budgeting (c) State and discuss the following types of budgets: i. Fixed Budget 5 ii. Flexed Budget iii. Flexible Budget

Answer 1

A Budget is a quantitative plan prepared for a specific time period. It is normally expressed in financial terms and prepared for one year.

a) Dysfunctional Behaviour:
Budgets can bring positive behaviour among the people when the goals of individual managers are found in conformity with the goals of the organisation. The perfect matching (or near perfect matching) between the organisational and managerial goals is often referred to as goal congruence. The managers who participate in the budget making process may feel happy in producing a fair budget in terms of organisational goals and objectives. Such a budget may induce and motivate others to bring excellence in their performance. But sometimes, due to improper implementation of the budget and unrealistic management expectations, the reaction of subordinate managers are found to be negative, which in turn has adverse impact on achieving the organisational goals. Such a negative behaviour is known as dysfunctional behaviour which is de­fined as an individual behaviour that is in basic conflict with the goals of the organisation.

Budget slack:
Budget slack is the practice of overestimating the expenses and/or underestimating the projected revenues when preparing a budget statement for the next financial period. It is a cushion created by management or lower-level managers to prepare budget estimates that will not be hard to achieve.

b) Four approaches to Budgeting:
There are four common types of budgets that companies use: (1) incremental, (2) activity-based, (3) value proposition, and (4) zero-based.

1. Incremental budgeting:
Incremental budgeting takes last year’s actual figures and adds or subtracts a percentage to obtain the current year’s budget. It is the most common method of budgeting because it is simple and easy to understand.
2. Activity-based budgeting:
Activity-based budgeting is a top-down budgeting approach that determines the amount of inputs required to support the targets or outputs set by the company.
3. Value proposition budgeting:
Value proposition budgeting is really a mindset about making sure that everything that is included in the budget delivers value for the business. Value proposition budgeting aims to avoid unnecessary expenditures.
4. Zero-based budgeting:
As one of the most commonly used budgeting methods, zero-based budgeting starts with the assumption that all department budgets are zero and must be rebuilt from scratch.

c) Types of Budgets:
Fixed Budget
Flexed Budget
Flexible Budget

Fixed Budget - Budget prepared for defined activity level / (output) is fixed budget. Fixed budget presents figures as if production level, price and all costs are static in nature but in real only fixed costs remain unchanged.

Flexed Budget - Flexible budget revised at actual activity level is flexed budget. Flexed budget identifies the (variable, fixed, semi-variable and step fixed) nature of costs with the change in volume. Original budget is revised to reflect the effect of variable elements, and step fixed costs at actual output.

Flexible Budget - Budget that recognises changing nature of costs with changes in output level is flexible budget. For comparison of corresponding flexible budget is revised to give a flexed budget.