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Benefits and problems concerning traditional approach to budgeting

In order to advise two different businesses about the benefits and problems associated with traditional approach to budgeting and budgetary control, i have collected and compiled the information regarding budgeting and divided it into different parts so that the reader may easily understand .


A budget is a planning and controlling tool for an oraganisation.This tool can work effectively only when it is used with due care.It is not only the a cost monitoring mechanism but also an integral part of an organisation’s planning and control activities.It aims at achieving organisational objectives and motivating the personnel concerned.For the success of budgetary system gathering the essential informationand choosing an appropriate budgetary system etc.are necessary.

The ideal budegting system is one that encourages goal congruence(i.e. a situation where the personal goals of the employees match the oraganisational goals).Ensuring the greater participation of the supervisory level in the management process can ensure goal congruence.

Budgets may be of different types to suit the different practices followed by different organisations.An organisation using a conventional systemof budgeting may somtimes need to switch over to another to suit its requirements.Changing a budegtary system is not a simple task.An oraganisation has to face certain difficultiesin the form of resistance to change by the personnel of the organisation,changes required in the existing support systems etc., inorder to change its budgetary system.The Success of a budget is also largely dependant on the level of accuracy in estimating the revenues and costs for the budget period.There are several statistical techniques which may prove useful in forecasting the figures to be incorporated in budgets.


2.1. Introduction:

First of all we begin this topic with the simple definition of budget.In short budget can be defined as Quantitative economic plan made with regard to time. Therefore, for something to be characterised as a budget it must comprise the quantities of economic resources to be allocated and used, it has to be expressed in economic i.e. monetary terms, it has to be a plan – not a hope or a forecast but an authoritative intention, and it must be made within a certain period of time (Harper, 1995, p. 318). Only a plan that has such characteristics can be called a budget.

However, if a budget is looked upon in its wider context, it can be defined as a management tool that puts executives in control of the financial health of their company. It is an objective measure of the financial structure of company’s operation and a tool that forces management to be accountable in a structured and objective way. Budgets as management tools by themselves are neither good nor bad. How managers administer budgets is the key to their value. When administered wisely, budgets facilitate planning and resource allocation and help to enumerate, itemize, dissect and examine all of the products and services that a company offers to customers (Seer, 2000, p. 187). In short and taken at its simplest level, a budget is a mathematical exercise, but in reality it is much, much more than numbers on spreadsheets, which is what following text will definitely show.

The purpose of budgeting is that it gives management an idea of how well a company is meeting their income goals, whether or not expenses are in line with predicted levels, and how well controls are working. Properly used, budgeting can and should increase profits, reduce unnecessary spending, and clearly define how immediate steps can be taken to expand markets (Thomsett, 1988, p. 5). In order to achieve this, management needs to build a budgeting system, the major objectives of which are to (Viscione, 1984, p. 42):

Set acceptable targets for revenues and expenses.

Increase the likelihood that targets will be reached.

Provide time and opportunity to formulate and evaluate options should obstacles arise.

Since budgeting as a process is very complex, it comes as no surprise that budgets are trying to fulfil numerous functions such as (Harper, 1995, p. 321, and Churchill, 1984, p. 162):

Planning – a budget establishes a plan of action that enables management to know in advance the amounts and timing of the production factors required to meet desired level of sales.

Controlling – a budget can be used to help an organization reach its objectives by ensuring that each of the individual steps are taken as planned.

Coordinating – a budget is where all the financial components of an organization Individual units, divisions, and departments – are assembled into a coherent master picture that expresses the organization’s overall operational objectives and strategic goals.

Communicating – by publishing the budget, management explicitly informs its subordinates as to what exactly they must be doing and what other parts of the organization will be doing. A budget is designed to give managers a clear understanding of the company’s financial goals, from expected cost savings to targeted revenues.

Instructing – a budget is often as much an executive order as an organizational plan since it lays down what must be done. It may, therefore, be regarded by subordinates as a management instruction.

Authorising – if a budget is a management instruction then conversely it is an authorisation to take budgeted action.

Motivating – in that a budget sets a target for the different members of the organization so that it can act to motivate them to try and attain their budgeted targets.

Performance measuring – by providing a benchmark against which actual performance can be measured, a budget clearly plays a crucial role in the important task of performance measurement.

Decision-making – it should never be assumed that a budget is set in concrete and when changing course a well-designed budget is a very useful tool in evaluating the consequences of a proposed alternative since the effect of any change can be traced throughout the entire organization.

Delegating – budgets delegate responsibility to the managers who assume authority for a specified set of resources and activities. In this way budgets emphasise even more the existing organizational structure within the company.

Educating – the educating effect of a budget is perhaps most evident when the process is introduced in a company. Operating managers learn not only the technical aspects of budgeting but also how the company functions and how their business units interact with others.

Better management of subordinates – a budget enhances the skills of operating managers not only by educating them about how the company functions, but also by giving them the opportunity to manage their subordinates in a more professional manner.

The requirements that all these functions impose upon a budget make it difficult for one system to meet them all. It is precisely because these requirements differ, that role conflicts in budgeting system arise. These need to be appropriately dealt with so that dysfunctional behaviour like budget padding or other damaging budget games for the company do not appear. Since there are three major roles for any budgeting system, at least three conflicts may arise (Barrett, Fraser, 1977, p. 141):

Planning versus motivation

For a budget to be most effective in the planning role, it should be based on a realistic assessment of the company’s operating capabilities and on management’s judgment about what is most likely to happen in the future. Yet this kind of budget runs the risk of setting targets so low that motivation is adversely affected since to motivate properly, budget objectives should be set higher than those for planning and be difficult yet attainable. On the other hand, these difficult yet attainable objectives lead to an overly optimistic budget and run the risk of falling short and under using company resources.

Motivation versus evaluation

There is a widely held belief that budget objectives should be set as fixed standards against which performance can be judged. Managers are also likely to be more committed to achieving this kind of objective since they know that the performance standards by which they are evaluated are not constantly changing. On the other hand, managers’ motivation can be impaired by rigid application of a “fixed standard” philosophy which doesn’t consider the impacts of uncontrollable or unforeseeable events and doesn’t allow for their removal from budget standards.

Planning versus evaluation

The planning role’s requirement of providing realistic assessment of future prospects can conflict with the need to eliminate the effects of uncontrollable or unforeseeable environmental variables from the budget used for evaluation purposes. Yet, because they are separated in time, the conflict between these requirements is considered a minor one since it can be considerably reduced if appropriate adjustments are done at the end of the budget period.

As can be seen in the previous paragraph, functions that typical budgets want to cover are very wide. It comes then as no surprise that those budgets are being used today in practice for many purposes. Bunce, Fraser and Woodcock’s (1995) survey showed that general uses of budgets can be divided into financial and operational type of uses. Figure 2 clearly indicates that, of the various uses of budgeting for management, the most important are those financially oriented like the use of budgets for financial forecast, cost control, cash flow management, and capital expenditure supervision. The operational management uses of budgeting have been less common but the interviewed companies have concluded that, in today’s business environment, they are of growing importance. The need to improve performance is intensifying to the point that it is no longer enough just to control costs, but

That company must also pay attention to things like strategy, communication, and employee evaluation. These are purposes for which budgets have not been used so much in the past.

As stated in the opening definition, budgets are plans set for a certain period of time, such as a month, quarter, and year and so on. This time period is then usually broken into smaller sub periods. The most frequently used budgets are annual budgets that are subdivided by months for the first quarter and by quarters for the remainder of the year. Of course, actual time periods for which budgets are made depend mostly on their purpose and use, and it is solely the decision of individual companies as to what time periods will be utilized for their budgeting process.

2.2. History of budgets:

The English word “budget” stems from the French word “bougette” and the Latin word “bulga” which was a leather bag or a large-sized purse which travellers in medieval times hung on the saddle of their horse. The treasurer’s “bougette” was the predecessor to the small leather case from which finance ministries even today in countries like Great Britain and Holland present their yearly financial plan for the state. So after being used to describe the word wallet and then state finances, the meaning of the word “budget” in 19th century slowly shifted to the financial plan itself, initially only for governments and then later for private and legal entities (Hofstede, 1968, p. 19). It was only then that budgets started to be considered as financial plans and not just as money bags.

The use of budgets as financial planning and control tools for business enterprises is historically a rather young phenomenon. In the US, early budgetary principles in companies were mostly derived from the budget techniques in government. The other source of budgetary principles for business in the US was the Scientific Management Movement, which in the years between 1911 and 1935 conquered the US industry. Many historians agree that early budgeting systems can be seen as a logical extension of Taylor’s Scientific Management from the shop floor to the total enterprise. However, it was not until the depression years after 1930 that budget control in US companies started to be implemented on a large-scale.Budgets with their focus on cost control simply became a perfect management tool for that period of time (ibid., p. 20). In Europe the idea of using budgets for business was firstly formulated by the French organization pioneer Henri Fayol (1841-1925). There was, however, little application in practice. Another practical stimulus came from the ideas of the Czech

entrepreneur Thomas Bata (1876-1925) who introduced the so-called departmental profit-and-loss-control as a tool for decentralizing his international shoe company into a federation of independently run small businesses. Nevertheless, the main inducement for the development of budgets and their implementation in European companies came from across the Atlantic in the years following the Second World War (ibid., p. 21).

Companies like Du Pont and General Motors in the U.S., Siemens in Germany, and Saint Gobain and Eléctricité de France in France, which pioneered the M-form (multidivisional) organizational structure in the 1920’s, first started to use budgets to support their rapid growth as they expanded into new products and markets. This was to help them to reduce the complexity of managing multiple strategies (Hope, Fraser, 1997, p. 20). The enormous diversity in the product markets served by these vertically integrated corporations required new systems and measures to coordinate dispersed and decentralized activities. In this kind of environment, budgets and ROI measure rightly played a key role in permitting central management to coordinate, motivate and evaluate the performance of their divisional managers, and perform a proper allocation of internal capital and resources (Johnson, Kaplan,1991, p. 11). However, it is was only in the 1960’s that accountants started adding to budgets

other functions (like management performance evaluation and motivation) in addition to those functions for which they had originally been devised – planning and control (Hope, Fraser,1999b, p. 50). In that period, budgets became the central and most important activity within management accounting or in the words of Horngren, Foster and Datar: “the most widely used accounting tool for planning and controlling organizations” (2000, p. 178). This is exactly how budgets have remained to this day. The only thing that has changed in the meantime is the competitive environment in which today’s companies operate and which has provoked many discussions about budgets’ disadvantages and their alternatives, some of which will be presented in later parts of this assessment.

2.3. Budgeting Process:

The process of budgeting generally involves an iterative cycle which moves between targets of desirable performance and estimates of feasible performance until there is, hopefully, convergence to a plan which is both feasible and acceptable (Emmanuel, Otley, Merchant,1990, p. 31). Alternatively, if we look beyond many details and iterations of the usual budgeting process we can see that there is a simple universally applicable budgeting process, the phases of which can be described in the following manner (Finney, 1994, p. 16):

Budget forms and instructions are distributed to all managers.

The budget forms are filled out and submitted.

The individual budgets are transformed into appropriate budgeting/accounting terms and consolidated into one overall company budget.

The budget is reviewed, modified as necessary, and approved.

The final budget is then used throughout the year to control and measure the organization.

The inevitable dependence of individual budgets on one another requires that budgets be prepared in a hierarchical manner. Figure 3 indicates a common hierarchical form of the budgeting process together with the necessary data flow between particular budgets and phases of their making. This picture shows that despite having only a few general phases, the budgeting process, due to its linearity and iteration loop, is in fact a very complex and time consuming process.

Since it is so complex and important, the budgeting process requires lots of decision making on the particular choices that developers of budgets have at their disposal. Churchill (1984, p.151) has provided a list of eight budget choices that managers have to be concerned with when setting up the budgeting system. Thereby, these concerns vary according to whether the company intends to use its budgets primarily for planning or for control. These budget choices are:

Whether it is to be prepared from the bottom-up or top-down,

How it is to be implemented,

How the budget process is linked to the strategic planning process,

Whether it should be a rolling budget and how often it should be revised,

Whether performance should be evaluated against the original budget or the one relating to the actual activity level of the organization,

Whether compensation/bonuses should be based on budgeted performance,

What budget evaluation criteria should be used, and

What degree of ”stretch” should be incorporated into the budget.

In general, accounting theory suggests that large companies should be concerned more with operational efficiency and emphasize coordination and control aspects of budgets, while smaller innovative firms should concentrate more on the planning aspects of their budgets.

2.4. Types Of Budgets:

A budget is not a unitary concept but varies from organization to organization. The basic concept of budgeting involves estimating future performance, comparing actual results with the estimate, and analyzing the differences between them. Factors that are relevant in determining the type or style of an organization’s budget and its effects include: the type of organization, the leadership style, personalities of people affected by the budget, the method of preparation, and the desired results of the budgeting process (Cherrington, Cherrington, 1973, p. 226).

In general, budgets can be classified into two primary categories (Cohen, Robbins, Young,1994, p. 171):

Operating budgets:

Operating budgets consist of plans for all those activities that make up the normal operations of the firm. The main components of the firm’s operating budget include sales, production, inventory, materials, labour, overheads and R&D budgets.

Financial budgets:

Financial budgets are used to control the financial aspects of the business. In effect, these budgets reveal the influence of the operating budgets on the firm’s financial position and earnings potential. They include a cash budget, capital expenditures budget and pro forma balance sheet and income statement.

In figure 4, all major budgets that can be used in a typical company and how they are linked and interconnected within the larger system of the master budget can be seen. This confirms what has already been said about the budgeting process – that individual budgets are dependent on one another which requires that they be prepared in a hierarchical manner.

Except for the usual division of companies’ budgets into operational and financial, budgets can also be differentiated based on expenditure authority. Using this approach, two major groups of budgets can be defined (Kemp, Dunbar, 2003, p. 3):

Line-item budgets

These are budgets where the name of each line is set, as is the amount of money that can be spent on each item. If one works within a line-item budget, one can not overspend a specific line item and then compensate this with savings on other line (or vice versa). The authority to move money from one line item to another must be granted at a higher level.

Block budgets

These are the opposites of line-item budgets. Here a block of money is given. The details of the budget are presented but, later on, if one wants to spend more money on one item and less on another, one is free to do so. As long as the block of money is not overspent before the end of the year, the budget remains under control.

2.5. Budgets as planning tools:

Welsch, Hilton, Gordon (1988, p. 73) have defined the budgeting process as a profit planning and control process and in that way not only have identified the two most important functions of budgets in organizations, but have also presented budgeting process in a wider context than it is usually depicted. Figure 5 clearly shows that the budgeting process is more than just a process of combining quantitative financial plans. It is a tool with which top management cascades strategy goals to operating levels. Budgets are ideal for this purpose since they are in essence the detailed quantification of targets for short-term choices of actions. Before continuing, it must be emphasised here that budgeting is not planning – it is just the quantification of planning.

Since the budget is fundamentally a plan, planning is the first important element of budgeting work. Planning is one of the elementary functions of management. It is the process of developing enterprise objectives and selecting a future course of action to accomplish them. It includes establishing enterprise objectives, developing premises about the environment in which they are to be accomplished, selecting a course of action for accomplishing the objectives, initiating activities necessary to translate plans into action and current replanning to correct deficiencies (Welsch, Hilton, Gordon, 1988, p. 3). It is a phase that involves the interpretation of the broader strategic policies derived during the formulation of strategy and their translation into more specific shorter-range plans. Once these short-term plans are quantified, they become budgets. That is why in many instances short-term planning and budgetary planning are used as synonyms. However, as figure 6 will show, connection between planning and budgeting is not isolated from influences of other elements that constitute corporate planning system and it is precisely the coherent functioning of the complete system that allows corporate planning to be implemented, period by period, through the budgetary process and its two elementary phases – budgetary planning and budgetary

Control (Lucey, 1996, p. 104).

Apart from the purposes of setting desired objectives and goals and linking them with strategic long-range and tactical short-range plans, the fundamental objective of management planning within budgeting system is to provide a feedforward process for operations and control. It is this feedforward process that renders the planning phase of the budgeting system vitally important since it allows control and corrections of plans before they are even implemented. The difference between feedback and feedforward concepts is that feedback monitors past results to detect and correct disturbances to the plan, while feedforward reacts to immediate or forthcoming dangers by making adjustments to the system in advance in order to cope with the problem on time, i.e. feedback monitors, feedforward warns (Lucey,1996, p. 144). Since in any organizations it is unlikely that pure feedforward or pure feedback control could operate in isolation because feedback control is too slow, while feedforward

control is too risky, these two concepts usually function within a single budgeting system as can be seen in figure 7.

2.6. Budgets as control devices :

At the beginning of the period, the budget is a plan. At the end of the period, the budget is a control device to measure performance against expectations so that future performance may be improved. Control is achieved through continuous reporting of actual progress and expenditures relative to plans i.e. budgets (Shim, Siegel, 1994, p. 15). The aim of budgetary control is to provide a formal basis for monitoring the progress of the organization as a whole and of its component parts towards achievement of the objectives specified in budgets (Lucey, 1996, p. 147). Budgetary control process usually functions in a closed loop. This loop, which is illustrated in figure 8, starts with the planning phase, then records actual transactions, and finally reports against the plan and generates management response.

In accounting literature, budgeting is also known as responsibility accounting. This means that plans and the resulting information on the performance of the plans are expressed in terms of human responsibilities because it is people, not reports that control operations. We can define responsibility accounting as a system of accounting in which costs and revenues are analysed in accordance with areas of personal responsibilities so that the performance of the budget holders can be monitored in financial terms (Lucey, 1996, p. 147). So the crucial thing for profit control is the division of authority and responsibility to managers. This means that managers should accept responsibility only over those figures that they have control. However, in practice, controllability1 is difficult to pinpoint for at least two reasons (Horngren, Foster, Datar, 2000, p. 195):

Few costs are clearly under the sole influence of one manager.

Over a long enough time span, all costs will come under somebody’s control.

For this reason, companies, alongside traditional responsibility centres2, also usually set up budget centres. These can be defined as a part of an organization for which a given manager has responsibility and authority and to which profit control data can be assigned (Harper,1995, p. 320).

For budgeting control purposes, a special type of budget is prepared called the flexible budget. In order to understand why only those budgets can be used for the accurate measurement of performance, firstly the difference between them and fixed budgets must be explained. The fixed budget is based on the level of output planned at the start of the budget period. On the other hand, the flexible budget is developed using budgeted revenues or cost amounts based on the level of output actually achieved in the budget period (Horngren, Foster, Datar, 2000, p. 220). For this reason, from a control viewpoint, the fixed budget is likely to be inappropriate (unless by pure chance the actual level of activity turns out to be the same as the planned level – which is highly unlikely) and should not be used for control purposes. It is with respect to this sort of budget that the old saying “the budget is out of date before the budget period even begins” is often a correct one (Harper, 1995, p. 336).

2.7. Benefits and problems associated with traditional budgeting:

It is claimed that today as many as 99 percent of European and US companies are using budgets and have no intention of abandoning them (Better Budgeting: A report, 2004, p. 2). However, on the same page, it is stated that as many as 60 percent of those companies claim that they are not completely satisfied with their current budgeting systems and are continuously trying to improve them (ibid., p. 3). From this evidence, it is obvious that budgets carry with them many benefits and problems.

Here is a list of some of the benefits that traditional budgeting can bring into organization if

properly implemented and administered (Lucey, 1996, p. 161):

It is a major formal way by which the organizational objectives are translated into specific plans, tasks and objectives related to individual managers and supervisors.

It is an important medium for communication of organizational plans and objectives and of the progress made towards meeting those objectives.

The development of budgets helps achieve coordination between the various departments and functions of the organization.

The involvement of all levels of management in setting budgets, the acceptance of defined targets, the two way flow of information and other features of a properly organized budgeting system all help to promote a coalition of interest and to increase motivation.

Management’s time can be saved and attention directed to areas of greatest concern by the exception principle which is at the heart of budgetary control.

Performance at all levels is systematically reported and monitored thus aiding the control of current activities.

The investigation of operations and procedures, which is part of budgetary planning and the subsequent monitoring of expenditure, may lead to reduced costs and greater efficiency.

The regular systematic monitoring of results compared to the plan (i.e. the budget) provides information upon which current operations are adjusted to bring them into line with the previous plan or, adjustments are made to the plan itself where this becomes necessary.

The integration of budgets makes it possible to better manage cash and working capital and makes stock and buying policies more realistic.

Nobody has better summarized in one sentence all the advantages of traditional budgeting as did Umapathy in his major work on budgeting practices in U.S. industry from 1987.Umapathy stated: “There is no other managerial process that translates qualitative mission statements and corporate strategies into action plans, links the short-term with the long-term, brings together managers from different hierarchical levels and from different functional areas, and at the same time provides continuity by the sheer regularity of the process” (Umapathy, 1987, p. xxii). It is exactly because of this that budgets will soon celebrate their century long existence.

Since budgets encompass so many different functions and are used for so many things in organizations, it is obvious to expect them to have certain weaknesses. A group of authors at the Cranfield School of Management made an extensive review of budgeting literature. As part of their research, they identified 12 significant weaknesses of traditional planning and budgeting practices. These factors fall into three principal categories and can be listed as follows (Neely, Bourne, Adams, 2003, p. 23):

Competitive strategy

Budgets are rarely strategically focused and are often contradictory.

Budgets concentrate on cost reduction and not value creation.

Budgets constrain responsiveness and flexibility, and are often a barrier to change.

Budgets add little value since they tend to be bureaucratic and discourage creative thinking.

Business process

Budgets are time consuming and costly to put together.

Budgets are developed and updated too infrequently, usually annually.

Budgets are based on unsupported assumptions and guesswork.

Budgets encourage gaming and dysfunctional behaviour.

Organizational capacity

Budgets strengthen vertical command and control.

Budgets do not re¬‚ect the emerging network structures that organizations are adopting.

Budgets reinforce departmental barriers rather than encourage knowledge sharing.

Budgets make people feel undervalued.

Furthermore, one of the biggest problems with budgets is that they tend to promote an inward-looking, short-term culture that focuses on achieving a budget figure, rather than on implementing business strategy and creating shareholder value over the medium to long term. For all these reasons, it is believed that these weaknesses lead collectively towards business underperformance and should therefore be dealt with (ibid).

The above listed benefits and disadvantages of budgeting system have been present since the first day of their implementation in large multidivisional US companies at the beginning of last century. It was the job of managerial accountants in those and all other organizations to devise systems that would maximize utilization of budgets’ benefits and minimize their negative influences. A subsequent review of budgeting theory shows that academicians have been identifying budgeting problems and suggesting solutions for them since the 1950’s and that new budgeting techniques developed in 1980’s and 1990’s can be viewed as practitioners’ attempt to incorporate some of their advice into business practice.


There are certain alternative approaches which a management accountant may use are s follows:

3.1. Top-down approach

Under this system, the budgets are prepared in line with the strategic objectives of an organization.Top management specifies their expectations and objectives and ,accordingly, the overall organizational budget and the divisional budgets are prepared.The divisional budgets are therefore components of the overall budget.

This approach enables comunication beetween the top level of management and the other management may set high targets in order to motivate the employees to chase the targets.

Appropriateness of this method

It brings synergy in the working of an organization. This approach is most suitable to small organizations where superiors have overall knowledge of the working of the organization. It is also suitable in situations where the organization cannot allow much time or cost for planning.

3.2 Bottom-up approach

The bottom-up approach is a budgeting system in which all budgets holders are given the opportunity to participate in setting their own budgets. The opposite of the top-down approach, the bottom-up approach starts with the targets set by lower level management, which are then rolled over to successive stages for review. Once all divisional budgets have been collected, an overall budget for the organization is prepared. This achieves the co-ordination that is essential for the success of a budgetary system.

Appropriateness of this method

This approach makes it possible to involve all levels of management in the budgeting process. Since

under this approach, the targets are set by lower level of management(who are aware of actual working conditions),the budgets is more realistic than one which is prepared by top management(who are not aware of problems at grassroots level).Conflicts between the objectives of the budget can be avoided by adopting the bottom-up approach.

3.3. Zero Base Budgeting

Zero-based budgeting is a technique of planning and decision-making which reverses the working process of traditional budgeting. In traditional incremental budgeting, departmental managers justify only increases over the previous year budget and what has been already spent is automatically sanctioned. No reference is made to the previous level of expenditure. By contrast, in zero-based budgeting, every department function is reviewed comprehensively and all expenditures must be approved, rather than only increases. Zero-based budgeting requires the budget request be justified in complete detail by each division manager starting from the zero-base. The zero-base is indifferent to whether the total budget is increasing or decreasing.

Advantages of Zero-Based Budgeting

Efficient allocation of resources, as it is based on needs and benefits.

Drives managers to find cost effective ways to improve operations.

Detects inflated budgets.

Municipal planning departments are exempt from this budgeting practice.

Useful for service departments where the output is difficult to identify.

Increases staff motivation by providing greater initiative and responsibility in decision-making.

Increases communication and coordination within the organization.

Identifies and eliminates wasteful and obsolete operations.

Identifies opportunities for outsourcing.

Forces cost centres to identify their mission and their relationship to overall goals.

Disadvantages of Zero-Based Budgeting:

Difficult to define decision units and decision packages, as it is time-consuming and exhaustive.

Forced to justify every detail related to expenditure. The R&D department is threatened whereas the production department benefits.

Necessary to train managers. Zero-based budgeting must be clearly understood by managers at various levels to be successfully implemented. Difficult to administer and communicate the budgeting because more managers are involved in the process.

In a large organization, the volume of forms may be so large that no one person could read it all. Compressing the information down to a usable size might remove critically important details.

Honesty of the managers must be reliable and uniform. Any manager that exaggerates skews the results.

Appropriateness of this method:

A zero based budget aims to curtail unnecessary costs , it is suitable for both profit-seeking as well as not for profit organizationto adopt this kind of budget . It is best suited to the service industries and to not for profit organizations where for each activity,alternative courses of action are possible.In such organizations ZBB helps in deciding the best suitable way of performing the activity.

3.4. Rolling budgets and forecasts:

A rolling budget (or continuous budget) is a plan that is continually updated so that the time frame remains stable while the actual period covered by the budget changes. For example, as each month passes, the one-year rolling budget is extended by one month, so that there is always a one-year budget in place. Due to the rolling budget, managers have to rethink the process and make changes each month or each period. The result of this is usually a more accurate, up-to-date budget incorporating the most current information (Horngren, Foster,Datar, 2000, p. 182).

Advantages of Rolling Budget and forecast:

Encourages managers to think about planning as an ongoing process, rather than as a static event.

An opportunity to provide more “real time” response to rapidly changing environment.

In theory, the annual planning process is eliminated; the projection for next year is simply the first rolling forecast.

Planning is not dictated by the calendar, but can be triggered by important events and changes.

Disadvantages of Rolling Budget and forecast:

Like a budgeting process, managers and employees must forecast responsibly and not regard it as a routine task.

Rolling budgets and forecasts have to be completed every month or quarter, instead of annually as before, which increases work and costs related to budgeting.

Constantly changing assumptions and the financial implications of those assumptions tends to invalidate targets, along with the commitment to achieve them.

The planning process can become too time-consuming.

Appropriateness of this method:

As rolling budgets are prepared on the bases of the near experience by taking into consideration the current period , they are updated with the current changes.Rolling budgets are continously updated with the current information, this helps in minimisingthe operational variances.Rolling budgets are the most suitable form of budget for organzations working in an uncertain environment, where future costs and /activities cannot be foreseen reliably.

3.5. Incremental budgeting

An incremental budget is a way of preparing budgets , where budgets are prepared on the basis of the previous year’s budget with some additions and deletions for the forthcoming budget period.

Appropriateness of this method:

Incremental budgeting are suitable for all kinds of organizations, but they are critisized for not justifing the cost elements for inclusion in the budgets.Nevertheless they are widely used by organizations since they are easy to prepare.

3.6. Activity based budgeting:

ABB is the method of budgeting based on an activity framework and utilising cost driver data in the budget setting and variance feedback process. In this approach the budget is based on activities that drive the costs. Like all other approaches to budgeting it is also a feedback activity. ABB allows supply of only those resources that are needed to carry out the activities required to meet the budgets.

Appropriateness of this method:

An activity based budget is one the most appropriate forms of budget as it identifies the cause and effect relationship between the activity and the cost as well as between the activity and the product.

ABBs are most suitable to only those organizations where activity-based costing system is adopted . This is because , in such organizations, activity centres are identified.

3.7. Feed forward control:

An organization may have two kinds of control mechanism -feed back control that scans past performance to detect and correct distubancesto the planand feed forward control that responds to immediate or forthcoming dangers by making adjusments to the systems in advance in order to cope with the problem.

Appropriateness of this method:

Feed forward control is the most suited to those organzation working in a highly volatile environment.this control predicts future bottlenecks and takes actionto restrain those bottlenecks from affecting production and thereby allow the organizationt to chase its objectives.the ability to sense impending problems and to take prior corrective actions, which are the essence of feed forward control, is the hallmark of successful organisations.


Despite the many criticisms that have come from practitioners, budgeting theory has been very useful in pinpointing specific problems and providing adequate solutions related to budgeting systems. Sometimes, the findings of budgeting studies have been contradictory and vague, but in general most recommendations have been tested and verified in real situations. What I personally have found rather strange is that some basic pieces of advice like the use of flexible budgets and responsibility accounting are not actually being implemented in practice. Very few companies even today use flexible budgets and make a clear distinction between controllable and non-controllable costs when evaluating their managers. It comes then as no surprise to see that many advanced models that were subsequently developed to improve traditional budgeting, actually carried with themselves lots of the findings and recommendations developed by budgeting theory over the last 50 years. Presumably, only the environmental changes that came after the 1970’s with the appearance of the so-called information wave, created conditions where the disadvantages of traditional budgeting for the first time since budgets’ initial use outweighed its advantages and forced managerial accountants to start thinking about how to deal with them. Nevertheless, as can be seen in figure 12, although traditional budgeting has changed over the last 30 years, this change has been neither dramatic nor radical. Instead, incremental improvements have been witnessed, with traditional budgets being supplemented by new tools and techniques. Budgeting is therefore evolving, rather than becoming obsolete.

What can freely be said is that traditional budgeting is not dead or totally obsolete yet, since it is still being used in the majority of companies around the world. However, many of them are starting to realize that exactly the same budgeting model as was used in the 1920’s can not be used now in the 21st century. Business environment conditions are no longer the same and budgeting systems need to become more responsive to the needs of customers and requirements set by competition. How exactly this change in budgeting system will evolve, is something that each individual company needs to discover for itself. The point is to customize internal systems, including planning and control, to requirements, needs and abilities that each company faces, i.e. to achieve adequate fit between external environment and internal systems as contingency theory suggests. Whether that will be achieved by the installation of rolling budgets and forecasts or of the Balanced Scorecard or any other method of better budgeting techniques, only depends on the dimension of traditional budgeting that managements want to target and change. Those companies that are bold enough and that have corporate culture that thrives on constant improvement can even go so far as to implement one of the Beyond Budgeting models, which have no budgets at the core of their approach. Well, there are no longer budgets in traditional meaning of this word, but financial plans and forecasts are still there.

What one must realise is that the need for planning, forecasting, coordinating and controlling activities within business entities will never go away. What will, in my opinion, hopefully change is the way these quantitative economic plans are actually used in everyday life. By this is meant the following: instead of being incremental exercises done only once in a year for the whole business year in advance and then rigidly used to evaluate employees, budgets should be flexible and done continuously, updated possibly every quarter, where their financial targets are linked with long-term strategy. If done so, the several times afore mentioned dysfunctional behaviours like budget padding and budgeting games will be reduced to at least an acceptable level. As people are not perfect and they are the ones who make and use budgets, it is unrealistic to expect that these behaviours will ever be completely eliminated. Budgets should also cease being used for control and employee evaluation purposes. This process should be completely separated and implemented so that the key performance

indicators, made out of a joint set of financial and non-financial indicators, are used for evaluation and progress control. The key performance indicators must be based on benchmarked results of major competitors and expectations of owners and investment community, and not on the assumptions and wishes that management thought of some 18 months before the real numbers are actually evaluated.

If changes like these are implemented and if each individual function of budgeting system is taken out of the system and replaced with some modern management tool like the Balanced Scorecard or activity based costing, then it is very easy to understand the main premise of the Beyond Budgeting model. Namely, the Beyond Budgeting model claims that this kind of planning and control system is very much different to the traditional budgeting system and as such should not longer be named so and therefore should abandon its budgeting name. However, in my opinion, the most important conclusion of this thesis is that it is really not important whether financial plans are called budgets or by any other name, whether they are used for control and evaluation or not, or whether they are done in the traditional or in some more modern way. My comment is that “budgets are nothing, but budgeting is everything”. I have come to conclusion that the process itself is more relevant than the actual numbers, since budgeting is the only process within a company that forces everyone to think and talk about the factors influencing the future performance of a business. It is also the only process that quantifies management’s vision and strategy making them operational and therefore realistic and attainable. Only when managers and other participants in the budgeting process realize that the thinking process is more important than the figures themselves, will budgets and all their benefits be fully utilised. Until then, simple changes in the methods and techniques of how budget figures are compiled will simply not be enough.

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