Should Traditional Budgetary Control Be Abandoned - Essay Example

……………………………………………………………………..xxxxxxx ………………………………………………………………….xxxxxxx ……………………………………………………………………..xxxxxx ………………………………………………………………………xxxxxx @2014 Introduction Budgets form an important part of the business environment as they are regarded as key evaluators and drivers of the performance of managers as well as they key element of planning and control. They are the most powerful tools for management control since they play an essential role in the power politics of the organization as they can increase the authority and power of top management and can also limit the autonomy of lower level managers. The purpose of budgeting is to give financial values to company targets and plans and this makes the company progress easily measurable and the company is also able to transform their strategic ideas into operative actions that are understandable. Traditional budgetary model has received criticism in the recent years, which is based on the fact that traditional budgeting is a relic of the past and normally prevent reactions to the market changes, cannot also keep up with the requirements and changes in the business world today and it is not useful for business management (Ostergren & Stensaker 2011). Traditional budgetary model is also costly and time consuming and it rarely focuses on strategy and is often contradictory. The traditional budgetary model also adds very little value, focuses on cost reduction instead of value creation and strengthens vertical control and command. Even though traditional budgets have evolved over the years, the budgets have not faced the changes in the business and economic environment and hence they should be abandoned and alternative budgeting methods created. Background of traditional budgeting Every organization relies on budget and budgetary systems in the achievement of strategic goals- organizations reap huge benefits if they properly understand the budgets and how to implement them. The traditional budget serves as a financial plan that is used to support the specified targets of an organization. The process of traditional budgeting involves the setting of strategic objectives and goals as well as the development of forecasts for costs, revenues, cash flow, production and other important factors. The development of traditional budgets was aimed at serving three purposes which include the communication of financial expectations, coordinating the financial activities of an organization and to motivate managers for them to act in accordance with the interests of the company. The approaches used in traditional budgeting are numerous and this is because it lacks regulations that stipulate how and which form of budget should be applied. It also takes into consideration some factors such as the nature and complexity of organizations internal operations, organizational structure as well as the management philosophy. Abandonment of traditional budgetary model in light of the recent external pressures from the capital market for timely and accurate information Budgetary control has undergone major shifts with the significant influence on the change of the budgeting practices being the growth and the capital market increased influence (Wim 2000). The recent external pressures from the capital market requiring timely and accurate information has the led to a proposed approach that will address the shortcomings of traditional budgeting process, which may lead to the abandonment of the traditional budgetary model. The current pressures require organizations to find a new budgeting and budgetary model that will empower the front managers to make decisions faster. In the business context, the influence of the capital markets has highly impacted on budget and other control practices that are found in organizations (Bill 2007). The constant pressure from capital markets on share prices also requires organizations to change their use of budgetary control system. There is the need for organizations to adopt a budgeting model that will acknowledge the internal importance of the members of the organization and externally the growing shareholder influence on business operations. The traditional methods are not open and speedy and do not therefore match the today’s economy, which is fast moving. The fact that organizations are rapidly changing requires a budgeting model that will accommodate this changes for fast and accurate budget information. A budgeting approach that is speedy and open will help organizations in integrating their control systems to form more holistic systems that have all elements being fully supported in a consistent manner by the management philosophy (Callahan, Stetz &Brooks 2011). This integration is important in recognizing the internal importance of all members of the organization as well as the external shareholder influences on the organization. Resource dependency theory suggests that organizations normally depend on external environment for the provision of resources. Divisions within a firm also depend on corporate environment for their resources. The traditional budgeting method, which is a tool for resource allocation has enabled some managers to become experts when it comes to securing the resources of their divisions by playing a budgetary game (a dysfunctional behavior where managers are always under pressure of meeting targets), which leads to the provision of inaccurate information. Traditional budgets are heavily focused on resource allocation instead of empowering its employees to act through the provision of resource capabilities. This is because it is a must for the company resources to be committed to the budgeting period. That is, the use of budgets has made the company more planning-oriented instead of more market-oriented, which is not good for the rapidly changing market and economy (Ekholm & Wallin 2000). Abandoning the traditional budgeting method would enable the company to move from prior resource allocation to dynamic resource allocation, which is highly flexible in terms of creative solutions and action plans and it is more relevant in terms of decision making and timing as compared to budgets. The capital markets believe that the traditional budgeting method is not fit for purpose. This method of budgeting tends to highly focus on those targets that are based on incremental changes from the previous accounting period (Bill, 2007). This results into targets that are inwardly comfortable for the accountant and outwardly difficult for the superiors. Traditional budgeting methods rely on past information and this has negative knock on effects. For example, the traditional budgeting method uses the previous year’s budget, which is then slightly adjusted for the New Year without any proper analysis on the areas that underperformed. This performance evaluation is then carried up to end of a budget period hence becoming too late for the organization to remedy deficiencies hence inaccurate information. This clearly shows how the traditional budgeting method does not focus on the maximization of shareholder value. This method of budgeting normally ignores key drivers of shareholder value as it only focuses on short term financial performance (David, 2001). The traditional budgeting method is incapable of supporting sound financial decision making as it does not accurately reflect the full cost of individual services and projects; hence the reason as to why it should be abandoned for a performance based budgeting method. It is estimated that creation of a budget using traditional methods consumes close to 20% of the management time and this means that organizations take a long time (six to eight months) in organizing their budgets. This is considerable time that an organization spends on an activity that does not add value to the organization (Hansen, Otley and Van Der Stede 2003). This results into the provision of untimely information (since annual budgeting using traditional budgeting method is too infrequent) and this is one of the reasons as to why the capital market is putting pressures on organizations to abandon the traditional budgeting methods. The traditional budgeting methods are also inflexible and fixed and they quickly become irrelevant. The preparation of budgets using traditional methods starts top down and then becomes a detailed bottom up building process that is aimed at meeting the managements fixed goals, whether they are realistic or not. Once the budget is done, it is locked down with no changes being done to it. Economy, industry, market conditions may change yet budgets created do not change rather remain as they were prepared. According to the agency theory, the principal (top management) using traditional budgeting method sets goals, which are rigid as they are based on external factors such as benchmarking. This method also leads into limited flexibility and freedom for the agent (each division management). Therefore, the traditional budgeting method does not give the principal control over the behaviour of the agent and this becomes quite difficult for the principal to have access to a more timely and relevant information. As a result, traditional budgeting method leads to the production of budgets that are quite distinct from the actual results leading to the presentation of inaccurate information (Ostergren & Stensaker 2011). That is, traditional budgeting method leads to the production of inadequate variance reports that leaves the questions of ‘what’ and ‘how’ unanswered; hence the need to abandon the traditional budgeting methods for performance based budgeting methods. It is important for the management to re-think on the way it controls its systems based on traditional budgeting and adopt an alternative budgeting approach to management control. Traditional budgeting approach has been too rigid to reflect a fast moving economy that is evident in the market today, lacks strategic focus and only focuses on cost reduction instead of focusing on value creation (Hansen & Mouritsen 2007). The bureaucratic style evident in this method of budgeting normally restricts flexibility which has impacts on the creative instincts of an organization. Therefore traditional budgeting method is not efficient as it hinders proper allocation of resources in companies and also encourages myopic decision making as well as other dysfunctional budget games (a dysfunctional behavior where managers are always under pressure of meeting targets) leading to inaccurate information (Jensen 2003). The future of the company using traditional budgets may manageable, but it may be false perception and this is because of the gap that the budgets created between target and plan. Abandoning the traditional method will help in the reduction of the gap that between target and plan, created by budgeting, hence leading to realistic forecasts and accurate information. Traditional budgets are based on fixed annual periods and do encourage managers to work towards the achievement of the budget even if it results into undesirable actions, encourage employees and managers to meet the lowest target instead of trying to beat the target that has already been set. The function and the design of traditional budgets are also quite inefficient in the market today as it does not provide organizations connection with corporate strategy hence the need to abandon the traditional budgeting method for new model of budgeting. Conclusion In conclusion, it is quite evident that traditional budgeting method does not match the current rapid changes in economics and market today and should therefore be abandoned for a performance based budgeting. Budgeting is a major activity of the management with its major objective being to support strategy implementation by management. The recent economic and market changes have led to the need to evolve budgeting. Based on the above analysis, it is evident that the limitations of traditional budgeting method (Wallander 1999). This means that traditional budgets are outdates and are not appropriate for the current business environment. Therefore, better budgeting techniques should be exercised in order to update the already failing traditional budgeting approach. Traditional budgeting leads to budget games and it has increased vertical integration, which can only be dealt with if the traditional method of budgeting is revised or abandoned (Pilkington & Crowther 2007). Furthermore, the rigidity of the traditional budgets makes them capable of destroying shareholder value within a firm and it is therefore important to develop new budgeting systems. It is therefore my view that the traditional budgeting method is in dire need of revitalizing and refreshing otherwise it should be totally abandoned for a better budgeting technique and especially that focuses on performance. References Bill R, 2007. Budgeting, the individual and the capital market: a case of fiscal stress. Accounting Forum, 31, (2007), pp. 384-397 Burns J & Bldvinsdottir G, 2007. The changing role of management accountant, in: T.Hopper, D. Northcott and R. Scapens (Eds) Issues in management accounting (Edinburgh: Prentice Hall). Callahan K. R, Stetz G &Brooks L.M, 2011. Project Management Accounting: Budgeting, Tracking, and Reporting Costs and Profitability. John Wiley & Sons Coulter M, 2005. Strategic management in action. Upper Saddle River, NJ: Person Prentice Hall David. O, 2001. Extending the boundaries of management accounting research, British Accounting Review, 33, (2001), pp. 243-261. Drury C, 2008. Management and cost accounting. 7th edition. 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