9.1 Budgetary control Flashcards
The meaning of budgetary control
- It is about assessing actual performance against budgeted performance and taking corrective action when necessary
- The control system is a systematic approach which tells managers whether or not they are achieving what they planned to achieve
- It focuses on total costs for a department or business unit and responsibility for these total costs is allocated to an individual (aka responsibility accounting)
- If there are any differences (variance) the responsible person can act to either take action to bring cost back under control or correct budget
Two main types of control system
- Feedback control
- Feedforward control
Feedback control system
- The aim is to correct problems that have been discovered at the period end, when actual results are compared with budget
- If there is a significant different then it is investigated and if possible and desirable it is corrected
- They are therefore reactive - feedback happens after the event
Feedback results are either
- Negative feedback - Is corrective action intended to bring actual performance closer to the target (to reverse a deviation from std)
- Positive feedback - Is corrective action intended to increase the difference between actual performance and the target
How feedback control systems work
- An org prepares a budget and commits resources to achieving the budgeted targets
- The bus uses its resources to make products / provide services and sell their output (private sector)
- Outputs from the system are measured (units made, costs incurred, revenue earned)
- The measurements provide feedback info to management who compare actual results with budget
- Where a need for control action is identified the manager takes suitable control action to stop problem recurring in future
Feedforward control system
- The aim is to anticipate problems with the aim of preventing them from occurring (more proactive)
- It operates by comparing results that are currently expected in light of latest info (actual results forecast) and the desired results (budget)
- If there is a difference it is investigated and corrected
- Feedforward control should be used in conjunction with feedback control
Advantage of feedforward control
- It is forward looking, it informs management what is likely to happen unless control measures are taken.
- Whereas feedback control is backward looking, and historical variances are not necessarily a guide to what will happen
Problem with feedforward control
- Control reports should be produced regularly, which means that forecasts must be updated regularly, therefore an efficient forecasting system is needed.
- Forecasts might be prepared using computer models with revisions each month based on updated info and where appropriate making alterations to basic assumptions of the model
Feedback and feedforward control reports
These might be presented at the same time but they will have a different layout, present different info and have different uses
- Feedback - will look back and consider differences from planned performance
- Feedforward - will look forward and create expectations about expected future performance and try identify potential future issues
A fixed budget is
- A budget set prior to the control period and not subsequently changed in response to changes in activity costs or revenues (prepared for a single level of activity)
- Can serve as a benchmark in performance evaluation
A flexible budget is
- A budget which is also prepared at beginning of budget period and recognises different cost behaviour patterns and are designed to change as the volume of activity changes (prepared for a number of levels of activity)
- It is an example of what if analysis
A flexed budget involves
- Flexing variable costs from original budgeted levels to the allowances permitted for actual volume achieved while maintaining fixed cost at original budget levels
- It is prepared at the end of the budget period
- It provides a more meaningful estimate of costs and revenues and is based on actual level of output
- In budgetary control systems managers should always compare performance against flexed budget
Preparing a flexed budget
- First managers must identify the cost behaviour, ie which are fixed, variable and semi-variable
- The allowed expenditure on variable costs can then be increased or decreased as the level of activity changes
- Allowance for fixed costs will remain constant
- Semi variable can be split using high low method
- Budget cost allowance (flexed budget) calculation = Budgeted fixed cost + (number of units produced x variable cost per unit)
Responsibility accounting is
- A key aspect of budgetary control that makes managers account for the costs and revenues for which they are responsible
- They should only be appraised on the costs they can control (success depends on ability of org to correctly identify these)
Controllable costs are
Costs which can be influenced by the budget holder and are generally considered to be those which are:
- Variable - Most variable costs are thought to be controllable in the short term because managers can influence the efficiency with which resources are used (eg: direct labour and material costs)
- Directly attributable fixed costs - Although fixed in short term within relevant range of output, a drastic reduction in output would reduce these costs (rent etc)
