Lecture 7 Flashcards
Budgeting & Participation : Top-down approach
Central determination of
budgets based on data
from strategic planning
Only fine-tuning on lower,
decentralised levels
Budgeting & Participation : Mixed approach
Interaction and iterations
between headquarter and
decentral units
Budgeting & Participation :Bottom-up approach
Composing of budgets on
lower, decentralised levels
Compiling on central
headquarter level
Budgeting & Participation : Participative budgeting
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)
Budget definition
The quantitative expression of a company’s action plan
Essentially,
A tool for planning, coordinating, controlling, motivating and communicating
- Summarised in a set of budgeted
financial statements
Typically for a period of one year
- Sub-periods (month, quarter)
- Rolling budgets: always available for a
specified period by adding a
month/quarter/year (continuous
updating)
The 3 Functions of Budgeting
1) Planning and coordination
- Quantify and operationalise 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
2) Motivation and performance measurement
- Clear indicators and milestones
- Compensation can depend on budget achievements
3) Communication of goals and strategy
- Communicate: Getting objectives understood and accepted by employees
- Close the gap between “Status Quo” and vision
Master Budget: definition and basic concept
A comprehensive set of budgets that includes operating and financial planning
concept :
a master budget is split between operating planning and financial planning
Operating planning: how to use (scarce) resources
Financial planning: how to get funds to acquire resources
What are the elements of the operating budgets
- Revenue budget
- Production budget in units
- Direct materials purchase budget
- Direct labour budget
- Cost of goods sold budget
- Supporting budget schedules
- Non-manufacturing costs budget
- Budgeted P&L statement
What are the elements of the Financial budgets
- Capital budget
- Cash budget
- Budgeted balance sheet
- Budgeted statement of cash flow
What are the criticisms of the Budgeting practices :
i) Time consuming
Managers
Management Accountants
ii) Impedes adaptability
How to deal with unforeseen opportunities or challenges
Should budgets be revised during the budget period?
Period effects and rolling forecasts
iii) Leads to fixed performance contracts
Should targets be (subjectively) adjusted ex post/at the end of the period?
iv) Disconnected from firm strategy
Modern Budget Approaches
1) Computer-based
models:
Financial planning:
What-if…
* selling price drops
* material costs
Inter-relationships among units
2) Kaizen’ budgeting
Incorporates continuous improvement into the budget numbers during the budget period
3) Activity-based budgeting
- Focuses on the budgeted cost of activities
- Forecast production volume → activities → costs
What Are Agency Conflicts?
Def : The principal–agent problem refers to the conflict in interests and priorities that arises when one person or entity takes actions on behalf of another person or entity
i) Honesty in reporting
ii) Messing with measurements
What Is Information Asymmetry?
Def : an information asymmetry is a situation where one party has more or better information than the other
can be split into
after contracting (Moral Hazard, Hidden action)
Before contracting (Hidden characteristics: Adverse selection)
Information Asymmetry : Moral Hazard;
What is it ?
Behaviour by the agent considered inappropriate by the principal after a contract has been made.
Information Asymmetry: (Adverse) Selection ;
Adverse selection occurs when one party in a negotiation has relevant information the other party lacks. The asymmetry of information often leads to poor decisions
Agents might self-select based on incentive contracts
Application: health care insurance
Mandatory, universal: no self-selection
Voluntary: self-selection
i) Potential problem here: “adverse selection”
ii) Not a “naïve” population, but self-selected based on preferences or characteristics
iii) Self-enforcing dynamic of increasing premia and increasing rate of bad risks (in the population)
iv) Remedies: health checks (prohibited access or limited coverage), deductibles
Selection can be unexpected or expected
