Accounting Principles - Assignment Example

Accounting Principles Answer (A) Budget in any corporate entity serves several purposes and those can be described as per the following. a) It is an instrument to plan and deploy the resources to achieve the short-term and long-term goals of any organization. b) It is a tool to control the activities of different subunits within the organisation. c) Budget exercise is used as a tool for forecasting and it can be used to motivate employees towards the set goals. Budgetary activity facilitates the planning process of the firm in a systematised manner keeping in view the organizational goals. Budget not only helps allocate resources and set the direction of the firm but also helps determine priorities to act in a manner that can bring results. Since budget sets targets in numbers, monitoring becomes easy and effective; it helps guide and coordinate activities of different functional units within the organisation. For startup businesses, a budget acts like a roadmap that helps them formulate goals and assess their functioning. For established businesses, a budget helps them see their performance through the years and likely future growth prospects to justify their capital investments. By comparing actual and budgeted figures, management can see how well or bad their organisation is sailing through in the marketplace. Budgets help forecast the need of cash flow without which any business is likely to strangle and suffer immensely. Budget brings efficiency in the operation by providing a framework for performance evaluation of different unit heads and the whole organisation. Budget is the best way of controlling expenses and to take remedial measures as and when becomes necessary ((Budgets and Budgeting, 2012). Answer (B) Conventional budgeting works best when conditions are relatively stable and market is continuously growing. In a downturn, the approach has several fallacies. There is no doubt that conventional budgeting system has contributed a lot ever since corporations began working in a more systematized way yet it is a fact that conventional budgeting system has its own strengths and weaknesses. Conventional budgeting exercise looks at the numbers of the previous year and then depending on the targeted growth decides for expense and revenue figures. Traditional budget is also known as incremental budgeting. Some of the advantages of the conventional budget are: a) It is more stable and brings gradual change. b) It is more simple and easy to work on it. c) Any changes can be observed easily. d) It is easy for managers to run their department on traditional budget formulations. e) The impact of change is visible clearly. Following disadvantages are observed in the conventional budgeting (Stokdyk, 2007). f) There is not enough space for new ideas. g) Cost reduction is not provided with suitable incentives; spending up to budgeted figure gets natural encouragement so that next year’s budget do not get converted to a reduced amount. h) It is likely that priority may have changed after budgets are set; and budgeted figure may have gone out of date due to inflation or extraneous factor that has now no connection to the level of activity and type of work being performed. Budgetary Control through Variance Measurement Variance analysis sets the process for budgetary control. Any change from the budgeted figure is known as variance and variance can be either favorable or adverse. When revenue is higher or expense is less than expected, a favorable variance occurs. An adverse variance is said to have occurred when revenues are lower or expenditures are higher than forecast. Budget needs to be monitored for variance for a suitable time period so that timely remedial action can be taken. A following illustration speaks about favorable and adverse variance with respect to expense and revenue generated in a typical organization. Adverse/Favourable Variance Yearly Budget Pro rata monthly Budget Monthly Actual Variance Labour Charges £360,000 £30,000 £31,500 £1,500 (adverse) Raw Materials £ 720,000 £ 60,000 £62,500 £2,500 (adverse) Revenue Gen. £1,440,000 £120,000 £127,000 £7,000 (favourable) It is apparent from the above cited monthly variance analysis that adverse variance is likely to affect the monthly cash flow and to maintain the normal operations and production, the corrective action is necessary. This establishes that budgets are always flexible and depending upon market forces the company needs to make necessary changes. For example, during sudden spurt in product demand, the company would always like to take advantage and accordingly, production manager will be asked to step up the production. Expenses on procurement of raw materials, fuel charges and labour will go up. Finance manager will have to arrange additional finances needed to boost the production. Thus, variance analysis helps management to take corrective action in all related activities to respond extraneous conditions appropriately (Budgeting and Variance Analysis, 2000). Answer C There are some modern strategic budgeting methods and they can be listed as per the following Zero-Base Budgeting Zero-base budgeting (ZBB) approach asks managers to build a budget from the base, zero level. As per the survey done by Government Finance Officers Association (GFOA), post 2008 financial crisis the use of ZBB has increased in some areas. ZBB takes the firm away from incremental budgeting which starts with the last years budget. Here the starting point is zero with no connection to the past spending patterns whatsoever. The organization is segmented into "decision units" at the lowest level. Managers then list on all activities and the corresponding spending. Each decision-unit can have many decision-packages. At least three decision packages are necessary, for example, base package, current service package and enhanced package (Zero-Base Budgeting, 2011). Target-based Budgeting Target-based Budgeting came into being in the 1980s to simplify the complexity of Zero-base budgeting. In TBB approach, each department is provided with a target spending allocation and department submits a budget for that amount and targeted amount is always less than affordable amount. The difference between the two, targeted and affordable amount for additional activities is funded through decision-packages. Department submit requests for decision packages which are not covered in target spending. It is the top management that examines the decision-packages and decides about its funding. Programme review provides a good alternative to ZBB where far-reaching changes are needed to provide a given service. Program review can identify many opportunities for improvement and has been found to be a good alternative to ZBB for corporations where more insight is needed to the planning questions (Zero-Base Budgeting, 2011). Answer D Beyond budgeting means freeing the capable people of the organisation from the set guidelines and allowing them to satisfy the customers needs in a novel way so as to beat competition consistently (BBRT, 2012). Humans constitute major assets in the modern organisation and their energy and talent, in the conventional budgeting system, is wasted in meeting guidelines of the budgeting instead of creating value for customers. Conservative budgeting, in the current times, consumes too much time and resources of the company and that can better be harnessed for more creative contributions (Hope and Fraser, 2001). Going beyond budget is essentially a change programme that has three drivers. It starts with a visionary leader who sees beyond budgeting to bring about a change through their vision. Sponsor, mostly the CEO or the CFO, works as a second driver mobilising the people and resources to bring about the change. The third driver is the change agent who sells the ideas to sponsors, who in turn will motivate key members of the organisation for a change (Hope and Fraser, 2001). Beyond budgeting revolves around some key leadership principles and those can be described as per the following (Hope and Fraser, 2001). a. Creating a common purpose with clear values coupled with shared rewards are in the basis to develop the commitment of teams. b. Creating a performance climate so as to have a sustained competitive edge over competition. c. Front line teams are given freedom and support to perform as per the strategy derived. d. An open and supportive transparent information system is put in place to build the confidence of all members of the organisation. e. Frugality is encouraged challenging the value-addition of all resources at all times. Answer (E) Budgeting process results into a stereotype behavior in managers because they must meet certain business goals such as growth in revenue and contribution. Management measures performance of the division based on the criteria such as revenue, profits or returns garnered; manager of the unit tends to project these figures at the lowest possible levels. In the similar way, where cost is an important consideration for the divisions such as production units, manager tends to project the cost and capital expenses on the highest possible levels. In doing so, managers want to meet the budgetary estimates without much of the hassles. Underestimation of profits, revenue and overestimation of costs, depending upon its applicability, is a common tendency among managers while reporting the budgetary estimation by them. Hope and Fraser (2003) argue that most managers go budget-bound keeping eye on numbers at every quarter and year-end. In the process, innovative behaviour and novel ideas from the managers do not get any place or boost in the organisation. Budgets are fixed performance contracts that reduce flexibility of the managers and for their safety they prefer working on the proven path and guidelines. References Budgets and Budgeting (2012). Inc.com. [Online] Available from http://www.inc.com/encyclopedia/budgetsandbudgeting.html [Accessed 8 January 2013] BBRT (2012). Beyond Budgeting Round Table. [Online] Available from http://www.bbrt.org/beyond-budgeting/beybud.html [Accessed 8 January 2013] Budgeting and Variance Analysis (2000). A Level of Achievement. [Online] Available from http://www.ngfl-cymru.org.uk/vtc/bus_studs/members/downloads/budgeting.pdf [Accessed 8 January 2013] Hope J. & Fraser, R. (2003). Beyond Budgeting. Harvard Business School Publishing Corporation. Also [Online] Available from http://www.hpartner.com/pdf/Beyond_Budgeting.pdf [Accessed 8 January 2013] Stokdyk, J. (2007). Traditional budgeting under the microscope. [Online] Available from http://www.accountingweb.co.uk/topic/financial-reporting/traditional-budgeting- under-microscope-john-stokdyk [Accessed 8 January 2013] Zero-base budgeting (2011). Modern Experiences and Current Perspectives. [Online] Available from http://www.gfoa.org/downloads/GFOAZeroBasedBudgeting.pdf [Accessed 8 January 2013] Read More