Management Accounting and Control - Essay Example

Management accounting and control Budgeting systems are a part of the management functions of most organizations. It is a long established faith thateffective budgeting processes enhance the performances at different levels in the organization and serves as its planning system. The budgeting system primarily deals with the controlling functions in the organization; since the management does not have the facility to deal with the external factors that affect its performance it confines its planning route to the factors that are controllable internally. The budget, in simple words, can be described as the forecast developed for the organization for the next year or a consecutive number of years. It acts as a plan developed by experts from within the organization or belonging to external agencies, private or governmental. These professionals make forecasts based on assumptions related to the prices of goods produced, costs of production, wages of labour, level of demand in the market and several other variables. These assumptions are then distributed in the form of a budget to the various departments from the head office. The employees in these departments then infer the status of their respective departments and figure out the ways of action depending on their level of knowledge about the market. Therefore in effect the budget comes true only to the extent up to which the specific departments make accurate assumptions regarding their own operations and also the condition of the market. The moral of this entire process lies in the advice lent out to the different departments that they must try and act in a little more efficient way and that they should be selling more amounts of the products in the coming years (Wallander, 1999). This context is good enough to prove redundancy of the intricate system of budgeting in organizations. The management can also do it without taking refuge under complicated assumptions but rather check at regular intervals that the departments are following the advice. In this paper we shall look into the issue that the process of budgeting is no longer a relevant system for running an organization successfully and that it has been termed by a most well known Swedish author as “an unnecessary evil” (Chapman, Hopwood and Shields, 2009). Considerable amount of debate has arisen regarding the necessity of budgets in business organizations. The process of preparing an annual budget embodies a lengthy process incurring huge expenses. Thus as Hope and Fraser calls it, the system of budgeting is quite cumbersome and is expensive too. The benefits promised by this practice are not certain. The bottom line of this process for the entire business unit is summed up to the forecast of cash flow for the coming year. Once prepared, the budget is subjected to review and it passes through multiple iterations as negotiations take place at each level throughout the organization. The ultimate outcome is reached when the entire budget is settled at an agreement. This is then sent to the corporate centre so as to allow the senior executives to keep a tab on the performances by the different departments (Hope and Fraser, 2003). A deficit in the feeling of need to change and inability to recognize the lags in the old budgeting processes is the most important reason why many organizations are yet holding on to traditional budgeting practices (Waal, Hermkens-Janssen and Ven, 2011). Conventional system of budget approval is considered needless as well as dysfunctional under the evolution of new governance theory (Carver, 1991). According to this theory, the boards should focus on larger issues facing the business and should allow the managers to adjust the policy boundaries to meet the goals of the departments. This calls for decentralization within the firms in the private sector (Bowhill, 2008). Under this system, departmental managers are provided with authority to the maximum possible extent for the completion of their tasks with success. In other words, they are subjected to minimal constraints. Decentralization is one of the most effective alternatives to the traditional budgetary system of planning. It inspires employees and subordinates to put in their maximum contribution for the betterment of the performance of the entire organization as a single unit. If an organization follows this process it should maintain an operating budget containing a single performance target set for every administrative team. Capital budgeting is considered distinct from operating budgeting in effective decentralized organizations. Operating budgets in such organizations are framed to meet the minimum level required for proper functioning of each of its department (Jones and Thompson, 2007). Inappropriate utilization of budgeting tool: a problem The budgeting tool had come into use in the business organizations in the early phase of the 1990s. At that point of time it acted as a tool for managing cash flows and for the maintenance of costs. The budgeting system was in use during this period in the big industrial organizations such as General Motors, Seimens, ICI and Du Pont. The basis for setting the targets to evaluate and reward performance is the “fixed performance contract” (Hope and Fraser, 2003). These contracts cascade down the various levels of the organization and appear in the final step as the budget contract. Although such contracts are a good platform to build a transparent understanding between different divisions and facilitate the executives at the senior levels to preserve control over these divisions, if landed into wrong hands, such contracts make way for undesirable outcomes. It gives rise to dysfunctional behaviour within the organization. Not only has the budget become “a thing of the past” (Gurton, 1999), it is also found to entail several evils. The budget is a controlling system which checks whether the financial outcomes with regard to performance by the organization are varying positively or negatively on behalf of the company. Therefore the managers are tempted to fiddle with the budget in order to make it fit the actual outcomes. This process, if remains in practice for a long time, might block the chances of investing in new projects in the future (Hm and Röhm, 2007). It hampers the performance of the organizations in the future and reduces scope for further innovation. Slack budgets occur when the actual amount of spending sums up to an amount less than that estimated in the budget. This allows spending of the remaining amount of budget on purchase of unnecessary things or on areas that do not require immediate attention. This is done in order to prevent the amount of the budget from getting reduced in the upcoming year (Warren, Reeve and Duchac, 2008). Budgeting, thus, does not fit the shoe of a rational process through which performance can be monitored and resources be allocated efficiently (Huang and Chen, 2010). The changing business environment of the 1980s has set the alarm to the utility of the budgetary processes. Technological advances had increased pressure on performances by the corporate firms. Competition rose in terms of costs and the big players were faced with the responsibility to make tough decisions in the chase for survival. Intellectual capital The existing budgeting process had already fallen weak on the rise of evolving business environment in the 1980s. Intellectual capital, like brand value, proven track record of management teams and customer loyalty, had become primary driver behind share values of firms. These factors were not accounted for by the traditional system of budgeting in which goals were focused internally and all measures taken were in support of these goals. The “command and control” (Hope and Fraser, 2003) style of management followed under the traditional budgeting regime had become outdated in the 1980s. Budgetary slack Performance objectives are set by the experts at the time of preparing the budget. The entire process of preparation of an annual budget consumes around twelve to eighteen months. Therefore these objectives are not always in line with the immediate requirements faced by the departments. Besides, personal goals of the managers often conflict with the pre-fixed goals set by the budget. Managers’ personal goals generally pertain to their personal income and career. In some organizations, the incentive system is linked to the formulation of the budget. The budgeting process is allowed to be modified such as to forecast such figures that are readily achievable. Divisional managers in this regard often overstate the costs and understate the revenues (Belkaoui, 1994). While successful in meeting the expectations of the top management, such a budgeting process leads to an output that is less than optimal. In order to prevent a failure of the budget or to perk up the appearances of the operations in their respective departments, and in turn to win the favour of the top management, divisional managers intentionally build a slack in the budget (Warren, Reeve and Duchac, 2008). Sometimes the budget process causes unintended dysfunctional behaviour. The annual budget focuses on a single financial year. This creates problem in a multi-year investment pattern adopted by the big organizations. The projects under yearly budget are left underdeveloped so as not to drag them into next year’s budget. Multi-year projects face acceleration or deceleration based on the demand to remain within the approved budget. Criticism over budget: Corporate ethics The proposal about eliminating budgetary control has been criticised on the ground that it might lead executives to do anything they think is appropriate to meet the expectations of the analyst, thereby paving way for unethical behaviour (Carreras, Mujtaba and Cavico, 2011). However, in some cases the budget is used to bring forced improvements in performance. In this scenario the employees are supposed to operate under a strict and rigid guideline which is aimed at bringing a certain yield. But, the organization stands high risk of running into issues regarding corporate ethics under such austerity (Institute of Management and Administration (IOMA), 2012). Such restrictive budgetary policy has been a culprit behind many cases of corporate scandal in the twenty-first century. A blatant example is the case with WorldComm. One of the largest companies in the world in the market for internet data and communication, WorldComm, has been plagued by accounting scandal and has finally become bankrupt due to the strict budgeting regime maintained by the CEO of the organization. A budget had been framed for the organization and Bernard Ebbers, former CEO of WorldComm, had mandated that the employees had to uphold their performance so as to strictly adhere the outcome to the level of “2% under budget” (Crosson and Needles, 2010). This led to the breakdown of smooth system of operations in the organization and created rapid erosion in the profits earned by the organization. Overstatement of assets in this condition pushed the company into an accounting scandal (University of New Mexico, n.d.). A situation of asymmetric information was deliberately created that supplemented the tight budgeting system and fuelled incidences of violation of corporate ethics (Institute of Management and Administration (IOMA), 2012). Another incidence in which the budgetary framework has been unethically utilized for the profit of the managers is the case of General Electric (GE). One of the missile projects undertaken by GE incurred costs greater than that amount agreed to be paid by the US air force. In this situation middle managers shifted the extra figures covertly to other projects that were running within the budget. However, this incidence was uncovered and one of the most reputed companies in the U.S. industry was blotted with scandal (Chryssides and Kaler, 1993). From this perspective, budgeting system in the organizations are not utilized for maintaining better control over the organizations’ performance, but is exploited for making individualistic departmental gains and making departmental activities to look good to the top management. The case of Handelsbanken It is a truth that one makes forecasts about the future drawing knowledge from her past experiences. There are two strong reasons put by Wallander behind abandoning the process of budgeting. According to Wallander, no matter how many critical assumptions one makes and intricate mathematical exercises one attempts to solve, one cannot foresee beyond her previous experience. Anything that has not at all occurred in the past or something that had occurred long back would be buried in one’s memory and shall not be seen even if it develops in front of one’s eyes. Sometimes psychological obstacles prevent the individuals from realizing such developments; they do so in order to avoid the reality about the changes that would be necessary in their plans thereafter. Hence a strictly structured budget does not always represent the real costs and gains. Besides, assumptions are made upon the underlying belief that the next day would be similar to the present day. Hence there is no justification behind spending time on making a budget for the upcoming year almost one year back (Bogsnes, 2008). When Wallander became the executive director of Handelsbanken, the biggest Swedish bank in 1970s, he had one notion in his mind; the organization should abandon budgeting. At that time the bank was going through financial crisis and Wallander was able to stabilize its condition by decentralizing its operations and changing the aim of the organization. From being the largest bank in Sweden the focus of the organization was changed to being the most profitable bank in the country. This aim was achieved by bringing down costs to a level lower than the cost incurred by all other players in the industry. In this process Handelsbanken abandoned budgeting process and achieved its objective without sensing the lack of a budget. The bank also grew in size and in a period of twenty three years once again regained its position as the largest bank in the country (Wallander, 1999). Conclusion The traditional budgeting system is undoubtedly an outdated technique of steering an organization. The process of budgeting only highlights the outcomes that are either naturally apparent or are not correct (Collier and Agyei-Ampomah, 2006). In most organizations, for a very long period, the assumptions underlying the budget structures have not been revised. The budgeting system has become complex with passage of time and working with such a model requires lots of time and effort, the outcome of which is of minimal use to actual business operations (Christopher, 1977). Over-optimistic forecasts reflected in budgets sometimes give rise to unethical behaviour. They affect the financial targets of the organization indirectly and allow them to be adjusted surreptitiously by the managers. Rapid changes in business environment have made the budgetary control outmoded (Abdel-Kader, 2011). Rather, building an accountability process to elucidate the departure of actual performance from planned performance would be more effective (John and Ngoasong, 2008). This demands a framework of immediate information reporting. Dissimilar interpretation of the budgets also leads inefficiency and uncertain outcomes (Kihn, 2011). The budget decisions are influenced by uncertainty due to the complex business environment (Ibrahim, 1993). Now, if the budget does not produce the desired meaning to all the employees uniformly, the outcome might be far from desired. In the face of environmental uncertainty Sandalgaard suggests that companies should adopt rolling forecasts in order to keep their budgets updated (Sandalgaard, 2012), but we have already discussed that the entire process of forecasting becomes redundant since it does not forecast anything new that can move beyond past experiences. However, the concept of planning is not rejected altogether. Organizations are no longer in need of a budget. Wallander had emphasised upon the importance of having an economic model that would establish the relationship between essential variables for the running of business, such as production and sales. This sort of planning takes place throughout the year. It is more efficient for making plans about a company’s course of action than the budgetary control system. References Abdel-Kader, M. G., 2011. 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