Lecture 7 Flashcards
Budget definition
The quantitiative expression of a companys action plan
E.g. planned production levels and targets, planned resource use
A tool for planning, coordinating, controlling, motivating and communicating
Summarized in a set of budgeted financial statements
Typically for a period of one year
Functions of budgeting
Planning and coordination
Motivation and performance measurement
Communication of goals and strategy
Planning and coordinating
Quantify and operationalize strategic goals
Ensures resource availability
Overcome past issues and incorporate future changes
Coordinate: balancing of all factors of all the departments to meet strategic objectives
Motivation and performance measurement
Clear indicators and milestones
Compensation can depend on budget achievements
Communication of goals and strategy
Communicate: getting objective understood and accepted by employees
Close the gap between “status quo” and vision
Planning and coordination (modern company)
Quantify and operationalize
Overcome past misallocation and sub-standard performance
Incorporate future changes
Communication (modern company)
Bridge the gap between “status QUo” (small-scale production c ulture) and new vision
Prommote coordination and communication to align goals
Motivation (modern company)
Measure and evaluate performance on the dimensions that metter to the new strategy
Master budget
A comprehensive set of budgets that includes operating and financial planning
Operating planning
How to use (scarce) resources
Financial planning
How to get funds to acquire resource
Capital budget
Which long term projects to finance
Identify investments
Choose investment
Liquidity planning
Available cash = beginning cash balance less minimal cash balance
Criticisms of budgeting practices
Time consuming (managers, management accountants)
Impedes adaptability
(how to deal with unforseen opportunities or challenges)
(should budgets be revised during the budget period)
(period effects and rolling forecasts)
Leads to fixed performance contracts
(should targets be (subjectively) adjusted ex post/at the end of the period)
Disconnected from firm strategy
Computer based models
Financial planning models: what if analysis
E.g. what if selling price dops to
What if material costs increase to
Models interrelationships among depts
Kaizen budgeting
Incorporates continuous improvement into the budget numbers during the budget period
Activity-based budgeting (ABB)
Focuses on the budgeted cost of activities
Forecat production volume -> activities -> costs
Budgeting and participation
Top-down approach
Central determination of budgets based on data from strategic planning
Only fine-tuning on lower, decentralized levels
Budgeting and participation
Mixed approach
Interaction and iterations between headquarter and decentral units
Budgeting and participation
Bottoms up approach
Composing of budgets on lower, decentralized levels
Compiling on central headquarter level
In the mixed and bottom-up approach:
Active participation of lower-level managers
Participative budgeting can be costly due to negative consequences of manager involvement
Poor planning and coordination
Higher management compensation (due to slack)
Information asymmetry
One side with more/better/superior information and the opportunity to exploit this information advantage
After contracting asymmetry
Hidden action
Moral hazard
Before contracting information asymmetry
E.g. hidden characteristics:
Adverse selection
Information asymmetry: so now what
Management accounting is often about understanding these problems and designing a control system to minimize negative effects of information asymmetry
E.g. in the design of
A costing system
A performance measurement system
Budget reporting system
Information asymmetry: countermeasures (signaling)
Costly signals attractive for good participants and unattractive for bad ones
E.g. certificates or diplomas
Information asymmetry: countermeasures (screening)
Learn more about the relevant characteristics
E.g. Health checks
Pay experts to check used cars
Information asymmetry: countermeasures (monitoring)
Make the agents actions “observable”
E.g. Surveillance
Spot checks
Information asymmetry: countermeasures (contracts)
Design contracts/incentives to align interests
E.g. performance-driven compensation
Clawbacks (i.e. ask to pay back bonus)
Relevant field of management accounting research
Managers not often completely honest, but rarely lie to the extreme
Managers trade off financial gains with self-image of being moral
Managers distort reports to implement CSR projects
Managers are rather willing to lie when another person profits
