BUDGETING
Budgeting techniques
A budget is a formal written statement of management’s plans for a specified period of time, expressed in financial terms. It charts the course for future action. Budgeting embraces both accounting and management functions. It is a management function because it is a plan, which will be used to assist in managing the operation. Budgeting requires management to plan for decision making, establishing objectives, and setting priorities. Budgeting is also an accounting function because the plans are translated into financial terms. Probably no other instrument contributes more directly to effective management than a budget.
However, budget preparation requires substantial time and effort on the part of the school personnel involved in the process. Because of the time involvement, it is important for the school foodservice administrator to understand the managerial uses of the budget as well as the specific procedures and techniques for the successful preparation of a budget. To develop a workable and accurate budget, the school foodservice administrator must understand (a) the benefits of preparing a budget, (b) the factors that influence budgeting, (c) the methods of budgeting, (d) the budgeting process, and (e) how to analyze and adjust the budget.
Incremental budgeting is a traditional method, widely used in commercial organizations and in the public sector. Incremental budgeting means basing the budget for a department or function on that of the previous period, usually adjusting for inflation by a percentage increase. Specific changes, such as a planned expansion or reduction in activities, would also be allowed for. In some cases the previous year’s actual costs may be used as a starting point, rather than the budget, particularly if the actual costs were lower.
Incremental budgeting technique takes advantage that the budget is stable and change is gradual and planned managers can operate their departments on a consistent basis, also the system is relatively simple to operate and easy to understand and most importantly coordination between budgets is easier to achieve, the impact of change can be seen quickly.
On the other hand however incremental budgeting assumes that activities and methods of working will continue in the same way giving no incentive for developing new ideas and there is no incentive to try to reduce costs on the contrary, spending up to the budget is encouraged by this method, so that next year the level of budget is maintained and the budgets may become out of date, and no longer relate to the level of activity or the type of work being carried out. To this, the priority for resources may have changed since the budgets were set originally, there may be ‘budgetary slack’ built in to the budgets, which is never reviewed, this means that managers have overestimated their requirements in the past, in order to obtain a budget which is easier to work to, and which will allow them to achieve favourable results budgeting would continue to budget at the same level, increased for inflation, for hospitality and catering relating to meetings, visitors and so on. This would encourage staff to spend up to the budget, even if the number and timing of meetings or visits changed. There would be no incentive to review catering provision or to look for more cost-effective ways of providing suitable hospitality.
Because of these problems, which can occur in a similar way throughout an organization, the incremental approach may not lead to the best use of its resources. A department which has had a large share of the total funds available over a number of years may no longer be as important to the organization, whereas newer departments which are gradually increasing in importance will need a greater share.
Zero base budgeting is a method, which was developed in the 1970s with a view to eliminating some of the problems of incremental budgeting. It takes the opposite view: instead of assuming everything will continue as before, the focus is on achieving the organization’s objectives in the most efficient way. Zero Base Budgeting means that the budget for each budget center starts from a base of zero for each period. Budgets for proposed activities are then put forward, assessed and prioritized (in relation to the organization’s objectives) and allocated funds in order of priority. Therefore the functions of the organization are analyzed to identify the structure of departments to be used as budget centers, the work of each department (budget centre) is then analyzed to identify the activities actually carried out, starting from a base of zero, budgets are prepared in each budget center, showing the costs and benefits of the work of the department; these budgets show the expected results at several different levels of activity and are called ‘decision packages’, the decision packages must then be judged by managers and put in order according to how efficiently they contribute towards the organization’s objectives, the total funds available are allocated to decision packages in order of priority, thus deciding which activities are to be carried out and at what level if a particular activity is obsolete or contributing nothing, it will receive no funds and will be discontinued.
Therefore the technique carry the advantages that; this system focuses the use of resources on achieving the organization’s objectives also budget center managers have to re evaluate in detail the cost effectiveness of the working methods and results achieved in their departments, new projects are compared with existing work, so that innovation is encouraged, rather than assuming existing activities must continue, allocation of resources is linked to the achievement of results, wastage and budgetary slack should be eliminated, because budgets which are not cost-effective will not be given funds, planning and budgeting is combined into a single process when the decision packages to be funded are chosen.
Despite these accreditations of zero base budgeting is also criticized, since the process itself is very complex and therefore costly to operate, by separating different activities, links between them may not be allowed for, leading to an uncoordinated approach, short-term benefits may be emphasized in the decision packages, to the detriment of long-term planning, the process of judging and prioritizing the decision packages may be extremely difficult and it may be affected by the internal politics of the organization, so that it is not really objective Zero base budgeting can only be applied where different levels of a particular type of work are possible and where the costs and benefits can be identified.
Therefore it is more likely to be appropriate for service departments or service organizations and for non-profit-making organizations than for direct cost budgets in manufacturing. Direct cost budgets are more dependent on forecasts of demand for products and can be justified on that basis. Priorities may change, however, between service departments, making a review starting from a base of zero a useful tool. For example, maintenance of machinery will need a greater share of funds when an organization is highly automated, and if there is a corresponding reduction in the workforce, it will reduce the necessity for a large personnel department.
Zero base budgeting can be applied to ‘discretionary’ costs, where the level of expenditure and the methods to be used can be decided by managers. For example in the case of training costs, decisions can be made between ‘packages’ detailing the costs and benefits of in-house training, computer-based training, day release and block release, at different levels. Also in another aspect of advertising, decisions can be made between ‘packages’ detailing the expected benefits from different levels of expenditure, using various methods of advertising, particularly where new opportunities such as websites become available and older methods may become less effective. More still with credit control, decisions can be made between ‘packages’ detailing the costs of different levels of activity increasing the activity would mean more frequent checks and chasing of debtors and hence better control for each control level, the financial benefits in terms of reducing finance costs and avoiding bad debts would be estimated and compared with the cost.
Programme based budgeting is a technique which is applicable to non-profit making organizations. Programme based budgeting means breaking down the work of the organization into ‘programmes’ designed towards achieving its various objectives. Several departments within the organization may contribute towards a single programme. The total funds available are shared between the programmes, rather than being split into budgets for departments.
It is usually the case that insufficient funds are available to achieve all the desired objectives, and decisions have to be made as to which programmes are to be carried out and what level of work can be supported. The choice of programmes should ensure that cost-effective methods are used, to achieve as much as possible (in terms of the organization’s objectives) with the total funds available.
For example a local authority in a local government may decide to allocate funds to a programme designed to improve services to elderly people. This may include work from the housing department on security and insulation, an allocation of funding towards increased transport subsidies, input from the social services department to improve day care, and so on. It would be necessary to prepare a budget for the programme as a whole, broken down into budgets for costs of each aspect of the programme. Also a charity may have money donated to help alleviate famine in a particular area. Decisions may be made between immediate relief programmes and longer-term programmes to provide clean water, support for agriculture and education.
The internal rate of return (IRR) and the net present value (NPV) have long been the accepted capital budgeting measures preferred by corporate management and financial theorists, respectively. While corporate management prefers the relevancy of a yield-based capital budgeting method, such as the IRR, financial theorists, based on orthodox economic theory, endorse the NPV method. The debate between NPV and IRR methods dates from the inception of modern interest theory. The IRR was first proposed by Boehm-Bawerk’s Positive Theorie des Kapitals and later supported by Keynes (Keynes, J.M, 1936). However, both methods suffer from inconsistencies when ranking potential investment projects based on the Fisherian assumption of wealth maximization. This study develops a capital budgeting method, the Rate of Return on Invested Assets (RRIA), that corrects the inconsistencies of both the IRR and NPV, is based on the assumption of wealth maximization, therefore pedagogically sound, and appeals to the relevancy of a yield-based capital budgeting method valued by corporate management.
When setting budgets it is essential to take into account how costs behave in relation to the amount of work, which is to be carried out. It is impossible to prepare a realistic budget for a particular amount of work unless it is known whether, for example, costs remain fixed, increase steadily or go up in steps as the amount of work increases. The measurement of an amount of work is usually referred to as the ‘level of activity’ and it must be measured in appropriate cost units for the type of work involved. In manufacturing, numbers of units produced can be used as a measure of level of activity. In other types of organization, the cost units used must relate to the work being done, for example miles traveled in a transport business, or occupied roomdays in a hotel.
Fixed and flexed budgets
When the level of activity changes, it is expected that the total of all costs (and the total income) will change. Information about how each type of cost behaves will enable budgets to be adjusted for different levels of activity. A budget for one specific level of activity is referred to as ‘fixed’. A budget adjusted for a change in level of activity is called a ‘flexed’ or ‘flexible’ budget. If actual results are to be compared with budgets for the purposes of performance measurement, such adjustments would be necessary to ensure that the comparison is of ‘like with like’.
Study
Institutions apply activity based budgeting means that budgets are prepared using the principles of Activity Based Costing. It involves identifying activities, which are being carried out in the organization, and, for each activity, the cost driver. If Activity Based Budgeting is to be used, decisions need to be made, as part of the planning process, as to the amount of each activity that will be required, and the funds to be allocated to it.
The analysis of cost behaviour here is just as important as in marginal and absorption costing. In Activity Based Budgeting and Costing, the behaviour of costs is defined in terms of the cost drivers, because these are the factors, which cause costs to change.
A budget is a formal written statement of management’s plans for a specified period of time, expressed in financial terms. It charts the course for future action. Budgeting embraces both accounting and management functions. It is a management function because it is a plan, which will be used to assist in managing the operation. Budgeting requires management to plan for decision making, establishing objectives, and setting priorities. Budgeting is also an accounting function because the plans are translated into financial terms. Probably no other instrument contributes more directly to effective management than a budget.
However, budget preparation requires substantial time and effort on the part of the school personnel involved in the process. Because of the time involvement, it is important for the school foodservice administrator to understand the managerial uses of the budget as well as the specific procedures and techniques for the successful preparation of a budget. To develop a workable and accurate budget, the school foodservice administrator must understand (a) the benefits of preparing a budget, (b) the factors that influence budgeting, (c) the methods of budgeting, (d) the budgeting process, and (e) how to analyze and adjust the budget.
Incremental budgeting is a traditional method, widely used in commercial organizations and in the public sector. Incremental budgeting means basing the budget for a department or function on that of the previous period, usually adjusting for inflation by a percentage increase. Specific changes, such as a planned expansion or reduction in activities, would also be allowed for. In some cases the previous year’s actual costs may be used as a starting point, rather than the budget, particularly if the actual costs were lower.
Incremental budgeting technique takes advantage that the budget is stable and change is gradual and planned managers can operate their departments on a consistent basis, also the system is relatively simple to operate and easy to understand and most importantly coordination between budgets is easier to achieve, the impact of change can be seen quickly.
On the other hand however incremental budgeting assumes that activities and methods of working will continue in the same way giving no incentive for developing new ideas and there is no incentive to try to reduce costs on the contrary, spending up to the budget is encouraged by this method, so that next year the level of budget is maintained and the budgets may become out of date, and no longer relate to the level of activity or the type of work being carried out. To this, the priority for resources may have changed since the budgets were set originally, there may be ‘budgetary slack’ built in to the budgets, which is never reviewed, this means that managers have overestimated their requirements in the past, in order to obtain a budget which is easier to work to, and which will allow them to achieve favourable results budgeting would continue to budget at the same level, increased for inflation, for hospitality and catering relating to meetings, visitors and so on. This would encourage staff to spend up to the budget, even if the number and timing of meetings or visits changed. There would be no incentive to review catering provision or to look for more cost-effective ways of providing suitable hospitality.
Because of these problems, which can occur in a similar way throughout an organization, the incremental approach may not lead to the best use of its resources. A department which has had a large share of the total funds available over a number of years may no longer be as important to the organization, whereas newer departments which are gradually increasing in importance will need a greater share.
Zero base budgeting is a method, which was developed in the 1970s with a view to eliminating some of the problems of incremental budgeting. It takes the opposite view: instead of assuming everything will continue as before, the focus is on achieving the organization’s objectives in the most efficient way. Zero Base Budgeting means that the budget for each budget center starts from a base of zero for each period. Budgets for proposed activities are then put forward, assessed and prioritized (in relation to the organization’s objectives) and allocated funds in order of priority. Therefore the functions of the organization are analyzed to identify the structure of departments to be used as budget centers, the work of each department (budget centre) is then analyzed to identify the activities actually carried out, starting from a base of zero, budgets are prepared in each budget center, showing the costs and benefits of the work of the department; these budgets show the expected results at several different levels of activity and are called ‘decision packages’, the decision packages must then be judged by managers and put in order according to how efficiently they contribute towards the organization’s objectives, the total funds available are allocated to decision packages in order of priority, thus deciding which activities are to be carried out and at what level if a particular activity is obsolete or contributing nothing, it will receive no funds and will be discontinued.
Therefore the technique carry the advantages that; this system focuses the use of resources on achieving the organization’s objectives also budget center managers have to re evaluate in detail the cost effectiveness of the working methods and results achieved in their departments, new projects are compared with existing work, so that innovation is encouraged, rather than assuming existing activities must continue, allocation of resources is linked to the achievement of results, wastage and budgetary slack should be eliminated, because budgets which are not cost-effective will not be given funds, planning and budgeting is combined into a single process when the decision packages to be funded are chosen.
Despite these accreditations of zero base budgeting is also criticized, since the process itself is very complex and therefore costly to operate, by separating different activities, links between them may not be allowed for, leading to an uncoordinated approach, short-term benefits may be emphasized in the decision packages, to the detriment of long-term planning, the process of judging and prioritizing the decision packages may be extremely difficult and it may be affected by the internal politics of the organization, so that it is not really objective Zero base budgeting can only be applied where different levels of a particular type of work are possible and where the costs and benefits can be identified.
Therefore it is more likely to be appropriate for service departments or service organizations and for non-profit-making organizations than for direct cost budgets in manufacturing. Direct cost budgets are more dependent on forecasts of demand for products and can be justified on that basis. Priorities may change, however, between service departments, making a review starting from a base of zero a useful tool. For example, maintenance of machinery will need a greater share of funds when an organization is highly automated, and if there is a corresponding reduction in the workforce, it will reduce the necessity for a large personnel department.
Zero base budgeting can be applied to ‘discretionary’ costs, where the level of expenditure and the methods to be used can be decided by managers. For example in the case of training costs, decisions can be made between ‘packages’ detailing the costs and benefits of in-house training, computer-based training, day release and block release, at different levels. Also in another aspect of advertising, decisions can be made between ‘packages’ detailing the expected benefits from different levels of expenditure, using various methods of advertising, particularly where new opportunities such as websites become available and older methods may become less effective. More still with credit control, decisions can be made between ‘packages’ detailing the costs of different levels of activity increasing the activity would mean more frequent checks and chasing of debtors and hence better control for each control level, the financial benefits in terms of reducing finance costs and avoiding bad debts would be estimated and compared with the cost.
Programme based budgeting is a technique which is applicable to non-profit making organizations. Programme based budgeting means breaking down the work of the organization into ‘programmes’ designed towards achieving its various objectives. Several departments within the organization may contribute towards a single programme. The total funds available are shared between the programmes, rather than being split into budgets for departments.
It is usually the case that insufficient funds are available to achieve all the desired objectives, and decisions have to be made as to which programmes are to be carried out and what level of work can be supported. The choice of programmes should ensure that cost-effective methods are used, to achieve as much as possible (in terms of the organization’s objectives) with the total funds available.
For example a local authority in a local government may decide to allocate funds to a programme designed to improve services to elderly people. This may include work from the housing department on security and insulation, an allocation of funding towards increased transport subsidies, input from the social services department to improve day care, and so on. It would be necessary to prepare a budget for the programme as a whole, broken down into budgets for costs of each aspect of the programme. Also a charity may have money donated to help alleviate famine in a particular area. Decisions may be made between immediate relief programmes and longer-term programmes to provide clean water, support for agriculture and education.
The internal rate of return (IRR) and the net present value (NPV) have long been the accepted capital budgeting measures preferred by corporate management and financial theorists, respectively. While corporate management prefers the relevancy of a yield-based capital budgeting method, such as the IRR, financial theorists, based on orthodox economic theory, endorse the NPV method. The debate between NPV and IRR methods dates from the inception of modern interest theory. The IRR was first proposed by Boehm-Bawerk’s Positive Theorie des Kapitals and later supported by Keynes (Keynes, J.M, 1936). However, both methods suffer from inconsistencies when ranking potential investment projects based on the Fisherian assumption of wealth maximization. This study develops a capital budgeting method, the Rate of Return on Invested Assets (RRIA), that corrects the inconsistencies of both the IRR and NPV, is based on the assumption of wealth maximization, therefore pedagogically sound, and appeals to the relevancy of a yield-based capital budgeting method valued by corporate management.
When setting budgets it is essential to take into account how costs behave in relation to the amount of work, which is to be carried out. It is impossible to prepare a realistic budget for a particular amount of work unless it is known whether, for example, costs remain fixed, increase steadily or go up in steps as the amount of work increases. The measurement of an amount of work is usually referred to as the ‘level of activity’ and it must be measured in appropriate cost units for the type of work involved. In manufacturing, numbers of units produced can be used as a measure of level of activity. In other types of organization, the cost units used must relate to the work being done, for example miles traveled in a transport business, or occupied roomdays in a hotel.
Fixed and flexed budgets
When the level of activity changes, it is expected that the total of all costs (and the total income) will change. Information about how each type of cost behaves will enable budgets to be adjusted for different levels of activity. A budget for one specific level of activity is referred to as ‘fixed’. A budget adjusted for a change in level of activity is called a ‘flexed’ or ‘flexible’ budget. If actual results are to be compared with budgets for the purposes of performance measurement, such adjustments would be necessary to ensure that the comparison is of ‘like with like’.
Study
Institutions apply activity based budgeting means that budgets are prepared using the principles of Activity Based Costing. It involves identifying activities, which are being carried out in the organization, and, for each activity, the cost driver. If Activity Based Budgeting is to be used, decisions need to be made, as part of the planning process, as to the amount of each activity that will be required, and the funds to be allocated to it.
The analysis of cost behaviour here is just as important as in marginal and absorption costing. In Activity Based Budgeting and Costing, the behaviour of costs is defined in terms of the cost drivers, because these are the factors, which cause costs to change.
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