• TOPIC 3

• PLANNING AND
BUDGETING

Chapter 8 Planning and Budgeting

Chapter 21 Capital Budgeting

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Financial results controls
• Three core elements
– Financial responsibility centers
 The apportioning of accountability for financial
results within the organization
– Formal management processes
 Planning and budgeting to define performance
expectations and standards for evaluating
performance

– Motivational contracts
 To define the links between results and various
organizational incentives
Planning and Budgeting
• Planning…is basically the process of deciding
about the goals of an organization (and/or its
members) as well as the means to attain those
goals” (Flamholtz, 1983, p.155)

• “Planning involves the setting of work goals for

each key functional area and the establishment of
standards for each goal” (Flamholtz, 1985, p.39)

• “ “…Planning is decision-making in advance”

(Merchant & Van Der Stede, 2003, p.302)
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Planning and Budgeting
• What are budgets?
• Budgets are detailed written plans, in quantitative
terms, that specify how resources will be acquired
and used during a forthcoming period of time –
usually one year
• Budgets translate strategies and plans into
operational terms
• - Where the organization wishes to go; （ GOAL,
Objective)
• - How it intends to get there;(strategies)
• - What results should be expected.(performance
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target)
An important aspect of budgeting is the assignment of
accountability. Budgets usually reflect managers’ areas of
responsibility.
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 Planning and Budgeting
Formulation
of
organizational Mission
Vision objectives statement

Plans
(E.g. Yearly Formulation
Revisions of plans
budgets) of strategies
Control
Managers
Managers
Planning evaluate
implement Managers
plans and performance
prepare plans to
design support against plans
Control strategies and take
systems corrective
• Performance Reports actions

Management activities Information flows in a management accounting system

 • Relatively broad processes of thinking
Strategic about the missions, goals, and strategies
Incrementally specific, detailed, short-term,

Planning • Normally a top-management process

and involving all organizational levels

• Specification of specific action programs

Programming to be implemented over the next few years
and specification of the resources each
Capital will consume
Budgeting • It involves managers at different levels
(top-down/bottom-up)

• Short-term financial planning

Operational • Budgets match the organization’s
Budgeting responsibility structure
• Emphasis on quantitative data
The budget preparation process

Budget Committee
Top-Down

1.
3. Negotiation

I
ss
2.

ua
I
nit

nc
ial

e
Budget

of
Bu

Department

Gu
dg

id e
et
Pr

l in
op

es
4. Approval
os
al

Bottom-Up
Business Managers

The budgeting process takes about 4 months in most firms

 The budget preparation process
Budget guidelines

• Senior management issues policies and guidelines that are to

govern the budget preparation.

• Generally detailed guidelines are given that take into account

projected economic conditions,
allowance made for price increases and wage increases,
changes in product line,
changes in the scale of operations,
allowable number of promotions,
anticipated productivity gains.
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Operating Budget
CHARACTERISTICS
 It is usually stated in monetary terms
 It generally covers a period of one year
 It contains an element of management commitment,
that is, the managers agree to accept the responsibility
for attaining the budgeted objectives
 The budget is approved by an authority higher than the
budgetee
 Once approved, the budget can be changed only under
specified conditions
 Periodically, actual financial performance is compared to
budget and variances are analyzed and explained
 Operating Budget
Operational budgets are plans; They provide details
of what management hopes to accomplish and how.
Their value in the planning process comes from the
fact that budgeting forces management to
examine in detail both the general economic
situation of which the company is a part and the
economic interrelationships among all the company's
various activities.
Budgeting allows managers to explore how costs
and revenues will behave under specific sets of
operating assumptions.
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Operating Budget
The process often points out conflicts between
top management's objectives and the realities of the
company's capabilities.
Through budgeting, management can both identify
resources that will be necessary to achieve
objectives and learn how those resources must be
applied. If present resources cannot meet planned
objectives, the process of operational budgeting
may bring about an examination of the financial
implications of additional asset procurement (capital
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Operating Budget
• There are variations in presentation, some
organisations prepare the first three months in
detail, and the rest of year by quarters and before
each new quarter a detailed budget is prepared for
the next quarter.

• Some organisations prepare a rolling budget, with

this approach before the end of each quarter or
month, the next period is completed so that there is
a continual plan for the next twelve months.

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 Purposes of Planning and Budgeting
 (A) To enhance management control

 (B) To engage in long(er)-term thinking (Forecasting &

 Planning)

 (C) To achieve coordination

 (D) Motivation : “challenging-but-achievable”

Performance targets

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(A) To enhance management control
 Budgeting involves setting targets that are
commonly used as standards against which to
evaluate performance – results controls
 Planning and budgeting processes involve formal
reviews of plans and include the actions that are
felt to be good for the organization to take –
action controls ( pre-action review )
 Planning and budgeting processes provide the
needed information for decision making to the
relevant managers – personnel controls
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(B) To engage in long-term thinking
 Forcasting

 The prediction of events over which the

organization has little or no control

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 (B) To engage in long-term thinking
 Planning
 The attempt to shape an optimizing future by
altering those factors that are controllable in the
light of available forecasts
 Forces manager to think ahead
-- develop a Strengths, Weaknesses, Opportunities
and Threats – SWOT analysis – understand the
company
 Anticipate possible problems and their solutions
( strategic and operational decisions).
 Also enables prediction of work impact and profits,
cash flows and asset structure
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(B) To engage in long-term thinking
 Forecasting dangers :
 Bias : distortion or manipulation of budget
estimates by managers to achieve certain goals.
 Forms :
 a. build slack into estimates by underestimating

revenue and / or overestimating cost

estimates
 b. store slack for bad years
 c. set unattainable targets in tough environment

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 (B) To engage in long-term thinking
 Bias may be caused by :
1. The reward system in an organization
-- linking rewards to budget performance
-- slack are built in to make budgets easier to achieve
2. Past company history
-- higher expectation from top management
-- managers prepare optimistic budgets to gain
approval at the risk of disappointment
3. Manager’s insecurity
-- managers whose past performance have been
below expectation may also prepare optimistic
budgets to gain approval at the risk of disappointment

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(B) To engage in long-term thinking
-- Consequences of forecasting bias:
-- over- optimistic or pessimistic budgets are not
useful for planning and control, particular at
higher levels of aggregation
-- poor provision and coordination of resources

-- Bias may be detected by:

-- improved prediction models
-- better statistical forecasting techniques

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(C) To achieve coordination
Coordination Force the sharing of information
across the organization
1. top-down – communication of the organizational
goals
2. bottom-up – communication of opportunities,
resources needs, constraints and

risks
3. sideways -- enhances the abilities of the
organization entities ( divisions,
subunits) working together towards
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(C) To achieve coordination
Coordination
 Enables managers in different parts of the
organization to coordinate their activities more
efficiently
 Bring actions of the various segments of an
organization together and reconciled into a
common plan
-- make people aware of what is expected of them
-- vertical （ bottom-up-top) and lateral
communication of opportunites,
resource needs, constraints and risk
-- instil financial awareness
-- promotes goal congruence
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(D) Motivation : Establish “challenging-
but-achievable” performance targets
 Target must be related to corporate objective
-- should translate strategies into operation
Motivation through target setting
 A target is a commitment to achieve a specific
objective – the level of achievement believed
possible given specific strategies
 Target setting processes generally used to

-- enable employees to be focused and

measured
-- for motivation
-- as the basis for performance evaluation
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(D) To establish “challenging-but-
achievable” performance targets
Motivation through target setting
 To have motivational impact, targets must
be acceptable
-- specific and formal
-- improve communication
-- challenging-but-achievable targets
-- allow for participation in target setting

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 Financial Performance Targets ( TYPES)
• Model-based (engineered)

-- derived from a quantitative model of what

performance should be ( standard units sold x

standard price)
• Historical
• -- based on historical performance in prior period
• Negotiated
• -- derived from a process of negotiation between
lower and higher-level managers.
Information asymmetry
Financial Performance Targets ( TYPES)
Internally / externally-derived
– Target costing – with continuous impovement
– Benchmarking – compare the performance with
competitors
Fixed / Flexible
– Fixed targets do not vary over a given time
– Flexible targets are charged according to te conditions
faced during the period. ( eg. Changes in volume of
activity, price of input , prediction …)
– Should managers be held accountable for achieving their
plans regardless of the business conditions they face?
– Relative performance targets
(D) Motivation : Establish “challenging-but-
achievable” performance targets
Advantages
 To minimize dysfunctional management actions
» Myopic behavior, data manipulation
 To increase manager’s commitment to budget targets
 To reduce the cost of organizational interventions
» Management-by-exception
 To protect against the cost of optimistic revenue
projections
» Over-commitment of resources
 To create a “winning” atmosphere and positive attitude
(D) Motivation : Establish “challenging-
but-achievable” performance targets

Easy target
Okay performance Impossible target
Terrible
performance
Challenging target
Great performance

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Budget target difficulty
Motivation / Performance

Easy Goal Difficulty Impossible

Budget target difficulty (continued)
In theory (lab experiments):
“Good targets” are about 25–40% achievable
Probability

Target Performance
Budget target difficulty (continued)
In practice (field research)
Targets are about 80–90% achievable
Probability

Target Performance
Budget participation
Refers to the extent that subordinates are involved
in determining the budget targets that they will be
held accountable for.

• Top-down budgeting is where senior managers

impose budget targets

• Bottom-up budgeting is where lower managerial

and operations levels are active in setting their
own budgets
Budget participation
 Top-down / bottom-up budgeting
» The budgetee is both involved and has
influence over setting the budget

» Leads to better acceptance of budget targets,

and hence, commitment to achieve them

» Is an effective way of information sharing

bringing together corporate priorities and
constraints with lower-level insights about
business potentials and risks

» But, potential for slack, bias, conservatism, …

 Budget participation
• Should employees participate in setting the
budget or should it be produced by top
management ?
• Bottom-up vs top-down
• Better planning and information
• Information at the top or at the bottom
• Participation in budget setting will affect
motivation

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Budget participation
Target setting dangers
• Unacceptable ( and unattainable) targets
may lead to
-- Undue pressure
-- Conflict between managers
-- Manipulation of accounting data

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Budget participation
• Evaluating performance relative to budget is
usually a dominant measure of performance
• Extracting and analyzing variances
• Link reward system to performance

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 Budget participation
Benefits of budget participation:
• Increased likelihood of target acceptance and
higher budget commitment
• Encourages coordination and communication
between managers
–Clarifies objectives, reduces “sub-goal”
pursuit
–Opportunity for top managers to access
private information of subordinates
Management Planning and Control 22705
 Budget participation
Disadvantages of Budget Participation

• Can be expensive and time-consuming

• May aggravate differences and disagreements

• Provides opportunities for distorting or biasing

budget targets (e.g. creating budgetary slack)

Management Planning and Control 22705

Beyond Budgeting
• Criticisms of companies’ Planning and Budgeting
processes
• 1. are rife with politics and gameplaying
• 2. centralize power in the organization and stifle initiative
• 3. focus on cost reductions rather than value creation or
• addition
• 4. separate planning(thinkers) from execution(doers)
• 5. cause too many costs for far few benefits
• 6. the process can take too long
• 7. are just a snap shot in time
• 8. hard to achieve goal congruence
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Beyond Budgeting
• Companies are now increasing using
the concept of “ beyond budgeting” as it
confers some advantages :
-- It is a more adaptive process compared
to traditional budgeting
-- It is a decentralized process

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Beyond Budgeting
• A range of tools and techniques to
replace traditional budgets, including:
1. Rolling forecast
2. Flexible operational plans
3. Balanced scorecard
4. Continuous performance monitoring
5. Rewards are based on relative
performance
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Beyond Budgeting

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 “Beyond Budgeting”?
 Some “principles”
– Goals
» Set relative goals for continuous improvement; not fixed
performance contracts
– Rewards
» Reward success based on relative performance; not on meeting
fixed targets
– Planning
» Make planning a continuous and inclusive process; not a top-down
annual event
– Coordination
» Coordinate interactions dynamically; not through annual planning
cycles
– Resources
» Make resources available as needed; not through annual budget
allocations
– Controls
» Base controls on relative indicators and trends; not on variances
against plan
END OF PPT NOTES

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