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Lecture

Lecture Notes 5

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Department
Accountancy
Course
AYB321
Professor
All Professors
Semester
Spring

Description
AYB321 – STRATEGIC MANAGEMENT ACCOUNTING Lecture 5: Budgeting Systems (Part 2) Budgeting  The goal is an ‘accurate’ budget.  If the budget is inaccurate: o Targets are too easy (or hard) o Firms have too much (or little) capacity o Value is destroyed. Behavioural Issues in Budgeting Participative budgeting  Refers to the level of involvement lower level managers have in setting their own budget.  Two extremes: o ‘Top-down’ budgeting o ‘Bottom-up budgeting  Advantages of budget participation:  Disadvantages: o Uses managers’ specific knowledge o Slow o Encourages communication and o Opens the firm up to influence costs, coordination between managers especially when budget performance is o Creates ‘ownership’ of the final budget tied to the reward system. targets. o Budgetary slack Budgetary Slack  Difference between the projection a person provides and a realistic estimate.  Three main reasons for budget padding by BU managers: o Seen to be performing better if they ‘beat the budget’. o Provides a shield against unanticipated negative impacts (reduces risk). o Expectation of arbitrary budget cuts by the budget committee.  Tying rewards to the budget increases the perverse incentive, impacts budget integrity.  Overcoming this problem is not easy. Four possible solutions: o De-emphasise the importance of meeting budget. o Wider range of objective indicators (the ‘informativeness principle’). o Design an incentive scheme that rewards not only the achievement of the budget, but also for providing accurate budget projections. o Get rid of budgets Budgetary Difficulty  Budget difficulty refers to how difficult it is expected to be to achieve the budget.  Setting the budget at the right level of difficulty is challenging: o Too easy = little incentive to improve productivity o Too difficult = BU manager is likely to just ‘give up’.  Problem exacerbated by information asymmetry.  Targets that are challenging but achievable are often referred to as ‘stretch targets’.  Characteristics of effective target setting include: o Targets are set participatively; o Targets are seen to be achievable; o Frequent performance feedback is provided; o Employees are only held responsible for activities they control; and o Achievement of the target is tied to the reward system. Criticisms of Budgeting and ‘Beyond Budgeting’  These behavioural issues lead to many criticisms of traditional budgeting approaches: o Encourages politics and game-playing (influence costs). o Incremental thinking, thus stifling creativity and transformational change. o Approval process is too centralised, thus ignoring dispersed specific knowledge. o Budget ‘cuts’ focus on cost reduction at the expense of growth and value creation. o Tends to separate planning from execution.  Generally,
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