Strategic Management Accounting and Performance Measurement Lecture Notes PDF

STRATEGIC MANAGEMENT ACCOUNTING AND PERFORMANCE MEASUREMENT FINANCE DEPARTMENT SMAPM 2024-2025  LECTURE 4 FINANCE DEPARTMENT SMAPM 2024-2025  WHAT IS A BUDGET? A budget is a quantitative detailed plan prepared for a specif...

STRATEGIC MANAGEMENT ACCOUNTING AND PERFORMANCE MEASUREMENT FINANCE DEPARTMENT SMAPM 2024-2025  LECTURE 4 FINANCE DEPARTMENT SMAPM 2024-2025  WHAT IS A BUDGET? A budget is a quantitative detailed plan prepared for a specific time period. It is normally expressed in financial terms and prepared for one year. Forecasting is a technique used to arrive at estimates based on judgment and experience. FINANCE DEPARTMENT SMAPM 2024-2025  PURPOSE OF BUDGETING  Planning  Evaluation  Control  Motivation  Communications  Authorisation  Coordination  Delegation FINANCE DEPARTMENT SMAPM 2024-2025  PERFORMANCE HIERARCHY FINANCE DEPARTMENT SMAPM 2024-2025  BUDGETING APPROACHES Top-down and bottom-up budgeting Flexible budget Incremental budgeting Zero-based budgeting Rolling budgets Activity-based budgeting Beyond budgeting Feedback and feedforward control FINANCE DEPARTMENT SMAPM 2024-2025  BUDGETING AND PARTICIPATION Imposed (top-down) An imposed/top-down budget is a budget allowance which is set without permitting the ultimate budget holder to have the opportunity to participate in the budgeting process Participatory (bottom-up) Participative/bottom-up budgeting is a budgeting system in which all budget holders are given the opportunity to participate in setting their own budgets FINANCE DEPARTMENT SMAPM 2024-2025  IMPOSED BUDGETS 1. Time-Consuming: Involving managers in budgeting takes more time than having senior managers impose budgets. 2. Skills and Motivation: Managers may lack the skills or motivation to contribute effectively to budgeting. 3. Senior Manager’s View: Senior managers have a better overall view of the company and its resources, making them better at creating budgets that maximize scares resources. 4. Alignment with Strategy: Senior managers are aware of the organisation’s long-term goals and can create budgets that align with the strategy. 5. Dissatisfaction and Demotivation: If participation is token, and senior management frequently makes drastic changes to budgets, it can lead to dissatisfaction and demotivation among staff. FINANCE DEPARTMENT SMAPM 2024-2025  PARTICIPATORY BUDGETS 1. Boosted Morale: Managers feel like their opinion is listened to, that their opinion is valuable. 2. Ownership: When managers help set the budget, they are more motivated to achieve the targets they themselves set, leading to a sense of personal responsibility. 3. Detailed insight: Lower-level managers possess in-depth knowledge of their specific areas, enabling them to create more realistic budgets. 4. Enhanced Creativity: Participatory budgeting encourages creative problem-solving and innovative ideas from various perspectives. 5. Fosters Accountability: Managers are more accountable for budget outcomes when they have a hand in its creation. FINANCE DEPARTMENT SMAPM 2024-2025  Flexible budget A flexible budget is a budget which, by recognizing different cost behavior patterns, is changed as the volume of output and sales changes. It recognizes cost behavior patterns such as changes in sales revenue and variable costs as sales volumes change, and step changes in fixed costs as activity levels rise or fall by more than a certain amount. Flexible budgets are prepared under marginal costing principles, and so mixed costs are split into their fixed and variable components. This is useful at the control stage: it is necessary to compare actual results to the actual level of activity achieved against the results that should have been expected at this level of activity. FINANCE DEPARTMENT SMAPM 2024-2025  INCREMENTAL BUDGETING An incremental budget starts with the previous period’s budget or actual results and adds (or subtracts) an incremental amount to cover inflation and other known changes. It is suitable for stable businesses, where costs are not expected to change significantly. There should be good cost control and limited discretionary costs. FINANCE DEPARTMENT SMAPM 2024-2025  INCREMENTAL BUDGETING FINANCE DEPARTMENT SMAPM 2023-2024  ZERO-BASED BUDGETING The principle behind zero based budgeting (ZBB) is that the budget for each cost center should be made from 'scratch' or zero. Every item of expenditure must be justified in its entirety in order to be included in the next year's budget. ZBB rejects the assumption inherent in incremental budgeting that next year's budget should be based on the current financial year results (or the current year budget) FINANCE DEPARTMENT SMAPM 2024-2025  3 STEPS OF ZERO-BASED BUDGETING There is a three-step approach to ZBB. Define items or activities for which costs should be budgeted, and spending decisions should be planned: these are 'decision packages'. Evaluate and rank the packages in order of priority: eliminate packages whose costs exceed their value. Allocate resources to the decision packages according to their ranking. Where resources such as money are in short supply, they are allocated to the most valuable activities. FINANCE DEPARTMENT SMAPM 2024-2025  WHAT IS A DECISION PACKAGE? Decision packages are activities or items in the budget about which a decision should be made. Decision package: Analyses the cost of the activity States the purpose of the activity Identifies alternative methods of achieving the same purpose Assesses the consequence of not doing the activity at all Establishes measures of performance for the activity. FINANCE DEPARTMENT SMAPM 2024-2025  ADVANTAGES OF ZERO-BASED BUDGETING 1. Cutting Unproductive Work: We can find and stop work that is not working well or is no longer needed. 2. More Staff Involvement: ZBB makes everyone work together more because we need lots of information and effort to finish the budget. 3. Adapts to Changes: It changes when the business changes. 4. Better Cost Understanding: It allows us to understand how costs work in the organisation better. 5. Efficient Resource Use: It allows to use the resources wisely and cost-effectively. FINANCE DEPARTMENT SMAPM 2024-2025  DISADVANTAGES OF ZERO-BASED BUDGETING 1. Short-Term Focus: Prioritizing short-term gains can harm long-term objectives. 2. Rigidity: A rigid budgeting process can hinder responses to unexpected opportunities or risks. 3. Skills Gap: Lacking the necessary management skills can be an issue. 4. Demotivation: Extensive time spent on budgeting can demotivate managers. 5. Challenge in Ranking: Ranking is challenging for diverse activities or when benefits are qualitative. FINANCE DEPARTMENT SMAPM 2024-2025  ROLLING BUDGETS A rolling budget is a budget (usually annual) that is kept continuously up to date by adding another accounting period (e.g. month or quarter) when the earliest accounting period has expired. Suitable if: Accurate forecasts cannot be made. For example, in a fast-moving environment or for any area of business that needs tight control. FINANCE DEPARTMENT SMAPM 2024-2025  ROLLING BUDGETS FINANCE DEPARTMENT SMAPM 2024-2025  A TYPICAL ROLLING BUDGET 1. A budget is prepared for the coming year and broken down into suitable control periods, e.g., quarterly 2. At the end of the first control period, a comparison is made of that period’s results against the budget. The conclusions drawn from this analysis are used to update the budgets and add a further budget so that the company once again has budgets available for the coming year and control periods 3. The planning process is repeated at the end of each control period (three- months) FINANCE DEPARTMENT SMAPM 2024-2025  ADVANTAGES OF ROLLING BUDGETS 1. Enhanced Budget Utilization: Planning and control will rely on a more precise budget. 2. Minimized Uncertainty: Rolling budgets decrease the level of uncertainty in budgeting by focusing on the short-term when uncertainty is lower. 3. Continuous Future Planning: A budget for the future is always in place, typically covering the next 12 months. 4. Ongoing Budget Review: It compels management to regularly review and create more current budgets. FINANCE DEPARTMENT SMAPM 2024-2025  DISADVANTAGES OF ROLLING BUDGETS 1.Cost and Time: Rolling budgets are more expensive and time-consuming than incremental budgets. 2.Employee Demotivation: They can demotivate employees if they spend too much time budgeting or if targets keep changing. 3.Static Budget Risk: There's a risk that the budget simply becomes the last budget with minor adjustments. 4.Reduced Control: More budgeting work may result in less control over actual results. 5.Meeting Confusion: Meetings can become confusing as managers debate which numbers to pursue, diverting attention from key issues. FINANCE DEPARTMENT SMAPM 2024-2025  ACTIVITY-BASED BUDGETING Activity-based budgeting is a method of budgeting based on an activity framework utilising cost driver data in the budget setting and variance feedback processes It is simply about preparing the budgets using the budgeted overhead costing using ABC costing methodology. FINANCE DEPARTMENT SMAPM 2024-2025  ADVANTAGES OF ABB 1. It highlights the expenses associated with overhead activities, which can make up a significant part of the overall operational expenses. 2. It acknowledges that these expenses are linked to specific activities. By controlling the factors that lead to these expenses, we can improve cost management and comprehension. 3. It can offer valuable insights by showing how the cost of an activity relates to the level of service it delivers. FINANCE DEPARTMENT SMAPM 2024-2025  DISADVANTAGES OF ABB 1. It can take a lot of time and work to figure out the main tasks and what makes them cost more. 2. It might be hard to assign specific people to these tasks. 3. Some costs are not easy to control in the short run and do not directly change how much work is being done. The only cost changes to report would be fixed overhead expenses for each task. FINANCE DEPARTMENT SMAPM 2024-2025  BEYOND BUDGETING Beyond budgeting (BB) is the generic name given to a body of practices intended to replace budgeting as a management model. The core concept is the need to move from a business model based on centralized organisational hierarchies to one based on devolved networks. Replaces budgeting altogether to avoid the behavioral impacts of traditional budgeting FINANCE DEPARTMENT SMAPM 2024-2025  BEYOND BUDGETING Has been used in ‘service sector industries’ such as banking. The beyond budgeting approach is based on an employee empowerment model Core focus includes Extreme decentralization of decision-making Relative performance evaluation based on benchmarking Replacing annual planning with adaptive and evolved orientation using rolling forecasts FINANCE DEPARTMENT SMAPM 2024-2025  BEYOND BUDGETING FINANCE DEPARTMENT SMAPM 2024-2025  BEYOND BUDGETING FINANCE DEPARTMENT SMAPM 2024-2025  ADVANTAGES OF BEYOND BUDGETING 1.Quicker Response Time: Being part of a flexible organization and having an adaptable strategy helps managers respond promptly to customer requests. 2.Enhanced Innovation: Managers in an environment that values team and business unit performance tend to embrace new ideas. 3.Cost Efficiency: Within this framework, managers are more inclined to see costs as limited resources to be used wisely, rather than as a guaranteed budget. 4.Stronger Customer and Supplier Loyalty: Front-line teams' prominent role in interactions with customers and suppliers tends to strengthen these important relationships. FINANCE DEPARTMENT SMAPM 2024-2025  DISADVANTAGES OF BEYOND BUDGETING 1.Lack of Control: Beyond Budgeting can lead to a perception of reduced control over financial matters, potentially affecting fiscal discipline. 2.Difficulty in Measurement: Measuring performance in a Beyond Budgeting environment can be challenging, as it relies on more flexible performance indicators, which may be less precise. 3.Change Resistance: Transitioning to Beyond Budgeting may face resistance from employees accustomed to traditional budgeting practices, requiring time for full adaptation. 4.Resource Allocation: Without fixed budgets, resource allocation decisions can become less transparent and may not align effectively with strategic priorities. FINANCE DEPARTMENT SMAPM 2024-2025  FEEDBACK CONTROL Feedback control is defined as 'the measurement of differences between planned outputs and actual outputs achieved, and the modification of subsequent action and/or plans to achieve future required results'. This is the most common type of control system. Positive feedback is feedback taken to reinforce a deviation from the standard. The inputs or processes would not be altered. Negative feedback is feedback taken to reverse a deviation from the standard. This could be by amending the inputs or process so that the system reverts to a steady state. For example, a machine may need to be reset over time to its original settings. FINANCE DEPARTMENT SMAPM 2024-2025  FEEDFORWARD CONTROL Feedforward control system operates by comparing budgeted results against a forecast. Control action is triggered by differences between budgeted and forecast results. Feedforward control is control based on forecast results. In other words, if forecast is bad, control action is taken before the actual results come through. FINANCE DEPARTMENT SMAPM 2024-2025  THANK YOU! FINANCE DEPARTMENT SMAPM 2024-2025