FIXED BUDGETS

BUDGETING AND BUDGETARY CONTROL Notes

Activity Based Budgeting

In ordinary/conventional budgeting, budget expenses for the current activities are normally based on previous year budget adjusted for price changes and anticipated future changes. Such costs are considered to be fixed in relation to the activity level. Activity based budgeting manages costs more effectively by authorizing the supply of only those resources required to perform activities directed towards meeting the budget. Activity-based costing is the reverse of Activity based costing in that it starts with the output to determine the level of activity, which in turn is used to estimate the resources required to meet the output. The following steps are followed in coming up with an activity-based budget

• Estimation of production and sales volume by individual products and customers.
• Estimation of demand for organizational activities
• Determination of the resources required to perform organizational activities (iv) Estimation of quantity for each resource that must be supplied to meet the demand (v) Taking appropriate action to adjust capacity of resources.

It is also referred to as Priority based budgeting. It is a cost benefit approach budgeting where it assumes that the cost allowance is Zero for any item until the manager responsible justifies its existence in terms of costs and benefits. It ignores all previous budgets and assumes that items in the budget are no longer required

CIMA definition: A method of budgeting whereby all activities are re-evaluated each time the budget is set.

It takes away the implied right of existing activities to continue receiving resources unless they can be shown to be the best use of such resources.

It is concerned with alternative means that established activities have been compared with alternative uses of the same resources. It works from the premise that projected expenditure for existing programmes should start from base zero with each year’s budget being compiled as if the programmes were being launched for the first time. It seeks to overcome the deficiencies of incremental budgeting, which include perpetuation of past inefficiencies and waste inherent in the past way of doing things.

Perpetuation of inefficiencies arise because indirect costs and support activities are prepared on an incremental basis i.e. the budget for the current period is prepared based on the previous period’s operations but adjusted for changes expected to occur in the current period. In this way, majority of expenditure associated with the base level of activity remain unchanged.

• Definition of decision package: This is the comprehensive description of the organization’s functions or activities.
• Evaluation and ranking of packages: This is on benefit basis.
• Resource allocation according to priorities

Advantages

• More efficient allocation of resources
• Focus attention on values for money and makes clear relationship between input and output.
• Develops a questioning attitude and makes it easier to identify obsolete, inefficient and less cost effective operations.
• Leads to greater staff and management knowledge of operations

Disadvantages

1. Time consuming.
2. High skills required.
3. May encourage wrong impression that all decisions must be made through budgets.
4. Short-term benefits may be emphasized to the detriment of long-term benefits.

Incremental or traditional budgeting: this involves taking the previous period’s budget as the starting point and adjusting it for any changes. This may result in efficiency and ineffective use of resources.

Rolling budgeting: this is an approach to budgeting where a whole year’s budget is considered, then divided into quarters. After every quarter, the budget is reviewed and another quarter budgeted for i.e. there is always a full years budget.

Program planning budget system: it is applied in the budgeting for non-profit organizations which have no profit objective and in most cases have difficulties in measuring their performance. Budgeting is done on the basis of the programs going on and those anticipated.

CHAPTER SUMMARY

Objectives of budgeting

• Coordination
• Communication
• Control Motivation
• Clarification of Responsibility and Authority
• Planning

Steps followed in the planning process

• Identify the objectives
• Identifying the alternative strategies available
• Evaluation of strategies available
• Selection of the best course of action
• Implementation of the selected course of action
• Control

Stages in budgeting process

Preparation of the sales budget

• Initial preparation of other budgets
• Negotiation of budgets
• Coordination and review of the budget
• Final acceptance of the budget
• Budget review

Limitations of budgeting

• Budgets are based on estimate
• Danger of rigidity
• Budgeting is only a tool of management
• It is an expensive technique
• Difficult to set levels of attainment
• Budgeting control is a terminate exercise and therefore variances may be of little use to the current operations.

Organization of budgetary control

• The creation of budget centres
• The introduction of adequate accounting records
• The preparation of organization charts
• The establishment of a budget committee