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Managerial accounting

Managerial accounting sample essay

Many companies use the traditional budgeting techniques. Drury (2009) defines traditional budgeting as the one where the central managers are required to prepare detailed annual budgets of organisations that they serve (Drury 2009). Traditional annual budgets can be rigid and risky, since they deal with estimates which are uncertain. As budgetary control focuses mainly on internal processes, organisations must seek to balance between the changing patterns from both the internal and external business environments. One of the major external contexts is the capital market (Röhm, 2004). Timely and full disclosure of information forms an essential component of a well-functioning capital market. Investors may be disadvantaged if such important aspect is not present. The traditional system of budgeting has been criticised on several grounds. Firstly, it is time-consuming. It is also costly and unable to meet the demands of the highly dynamic current society (Power 2007). A concept referred to as beyond the budgeting is adopted by the opponents of the traditional budgeting system and those who appraise systems that do not lean on traditional budgeting systems as performance indicators. Current paper will assess the statement that, “The traditional budget is a rigid tool and should therefore be discarded in practice” in light of the external pressures from the capital market for both accurate and timely information. Statistical comparison between the opponents and proponents of the approach will be highlighted to assist in drawing of the conclusion.

Lyne and Dugdale carried out a survey study in 40 companies. They found out that budgeting helped companies in planning, communication, controlling and coordination of activities.  According to the research, the budgets were found to be one of the key components of control systems, especially when used as a planning tool (Dugdale & Lyne 2006). Libby and Lindsay (2007) note that depending on the way the traditional budgeting is used, it can be an effective tool in the management of resources of any given organisation. A survey conducted by Libby and Lindsay proved that more than 50% of the senior managers believed that organisations could not be managed without the traditionally designed budgets (Libby & Lindsay 2007). Although such budgets are costly and time demanding, they have previously shown that they can add value in an organisation. Ekholm & Wallin (2000) claim that traditional budgets are strong tools to assess the operations of a company when they are properly implemented. The problem might be in the implementation and not in the tool itself (Ekholm & Wallin 2000).

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Horngren et.al (2008) survey study proved that 92% of the 150 companies that were interviewed in North America see budgets as important management tools to reduce and control costs. Budgets normally help managers become great administrators so that they put planning first in their minds. Most of the respondents interviewed asserted that 99% of the European-based companies can not operate without traditional budgeting techniques (Horngren et.al 2008).

Businesses have a major aim of meeting their competitive success. Competitive success is achieved through myriads of ways which may include, but not limited to, low cost, best management team, loyal customers, consistent innovation, high standards of company control and governance (Epstein & Birchard 2000). Business planning incorporates efficient operation and better use of resources among others. The resources of a company may never be sufficient and therefore, it requires that they are allocated to the most appropriate areas for maximum output. The management team is required to conduct an appraisal that will determine the areas that may bring maximum returns. Quantified projection of the allocation of such resources can effectively be done by the use of a budget. Sometimes enormous resources are required to drive projects and it means that capital budgeting will be required. Project failure means that companies incur many losses. Most of the decisions that people make are irreversible and have long-term implications on the operations of the organisation. Investing in specific areas involve many risks and uncertainties (Epstein & Birchard 2000). It demands the company to carry out an analysis on the suitability of such investments to the firm through capital budgeting.

Criticism from the beyond budgeting suggests that budgeting may not be suitable for modern businesses, since competitiveness and innovation are the essential components of modern companies. Traditional budgeting, especially in Sweden, has been dismissed by many companies claiming that it does not meet the demands of the dynamic environment (Agyemang & Ryan 2013). Beyond budgeting techniques used as monitoring systems, such as balance scorecards and rolling forecasts, are intensely utilized alongside with the annual budgets. Rolling forecast done either on monthly or quarterly basis has been an efficient substitute of annual budgets which have been deemed inflexible. It is a quick comparison with the competitors and it is advantageous in that it saves time. However, it is likely to portray a sense of uncertainty among the managers due to the different changes that arise (McSweeney 2006).

Neely, Heyns and Bourne did a research which showed that 80% of companies were dissatisfied with the traditional budgeting system. They suggested that the budgeting system has had its fair share. The survey carried out proved that traditional budgeting system had lost its value and was incompatible with the modern business organisations (Bourne, Neely & Heyns 2000). There are different control and planning mechanisms that companies use. For instance, companies like Electrolux and credit Lyonnais uses rolling forecast, producing quarterly and monthly budgets. Others, such as Svenska handelsbanken, work without budgets. BP and Volvo companies focus on future and neglect the past performance. Modern companies operate in dynamic environment and use diversified techniques to prevail in the highly competitive environment (Hilton 2005). As a result, the companies have been speedy, precise and economical through forecasting using explicit forecasting processes. Such techniques are based on the fact that when situations change, the assumptions made can be changed to suit the planned activities to aim at better results. Modern companies have also made serious strides while investing in modern IT software programmes that tend to limit the cost of budgeting. From the investments made, companies are able to forecast variances even before they occur and make the necessary amendments. One of the greatest philosophies that companies work with is that better day-to-day organisation, planning and management lead to greater financial performance than better financial management (Bourne, Neely & Heyns 2000).

Fanning (2000) carried out a research and found out that traditional budgets had manifested disadvantages of being highly inefficient in terms of cost of budgeting and reduction of its effectiveness. However, heavy investment in information technology can be employed to reduce such shortcoming. Spreadsheets are mostly used and are quite elastic and cheap tools. In addition, there are new web-based tools that have appeared and that tend to increase the effectiveness of modern budgeting by a great percentage as compared to the traditional budgeting (Fanning, 2000). Some of the Scandinavian companies have opted to deal with other control methods, such as balanced scorecards. A research study carried out by Frazer and Hope (2003) found out that more than 80% of the organisations do not change their budgets within the fiscal year which further affirms the contention of reduced usage of the traditional budgets (Frazer & Hope 2003). The fast changing competitive economy brings more complexity to the use of the traditional budgets (Bogsnes 2009).

In environments where changes are prominent, decisions require to be constantly reviewed, re-examined and improved. Budgeting can be one of the methods that aid an organisation’s planning and controlling mechanisms. However, the traditional budgeting process impedes growth or acts as an obstacle towards the achievement of the desired aims (Libby & Lindsay 2010). It occurs due to the fact that the traditional methods do not allow the subordinates to contribute to the budgeting process although they are the ones who are aware of their local environments. On another point of view, traditional budgeting does not take into account of the fact that resources, such as capital, are volatile. In addition, some unplanned things may arise and influence the prevalence of economic, political and social changes. Budgeting helps in the achievement of the desired goals but traditional budgeting does not give the organisations the required flexibility to handle changes as they occur.

In the beyond the budgeting approach, the manager will be required to rationalize the predicted expenditure and it is always assumed that the spending base line is zero. With such kind of approach, a complete overhaul of the organisation’s activities can be done. Managers might find that there are some activities within the system that do not coincide with the organisation’s desired goals or objectives. Such activities can be excluded in the planning process to minimise wastage of both time and other resources. With the zero-based budgeting, an organisation can allocate financial resources to the immediate feasible projects which can give an organisation maximum benefit. ‘Dysfunctional budget games’ can also be avoided with the adoption of the beyond the budgeting approach (Wallander, 1999). Since the traditional budgets do not put performance measurement in mind, there is a tendency of the managers to exaggerate expenditures in anticipation that they will reap the benefits of the surplus forecasts.

On another insightful perspective, the subordinates may try to underestimate the resource allocation in the budgets in fear that their forecasts in their remuneration will be reduced. On the one hand, the traditional budgeting provides an avenue where the employees of a company strive to work considering the fixed budget put in place. On the other hand, beyond the budgeting approach invites an action-oriented approach and high degree of flexibility which gives rise to accountability and a greater sense of responsibility to the ever-changing environment. Through focussing actions away from the fixed budgets, the employees can be able to implement activities that are geared towards attaining the objectives of an organisation within a specific period of time.

According to Otley (2001), most of the management activities in many organisations are of non-financial nature, since the ordinary budgetary systems offer insufficient techniques of evaluating performances of companies. Accounting systems provide a vehicle for promoting certain changes. However, they may also act to impede changes functioning as potential barriers in certain circumstances. Performance measurement entails wide-ranging avenues and most of the companies are realising the potential areas that need to be kept in check to reach holistic success (Otley, 2001).

Rigid budgets tend to limit the managers as they only concentrate on short-term plans. Van (2000) research study found out that businesses that have recorded massive profits tend to have flexible budgets that minimise pressure for the short-term outcomes. Most of the people advocate for less rigid budgetary systems that allows them to adjust effectively to the demands of the changing environment (Van 2000). He carried out a study among 153 company managers to determine the effectiveness of rigid budgetary systems in assessing the performance of companies. According to the study, short-term managerial orientation is linked to rigid budgetary approaches. It can be considered to be dysfunctional from the long-term point of view. However, the short-term measures can be used to adjust to immediate challenges causing poor performance. Another insightful discovery offered by the study was that containing the managers to deliver based on rigid budgets affects other areas of the organisation which are deemed important when checking the performance level of the company (Van 2000). From the study, the large profit making businesses preferably work with less rigid budgets which encourages managers to look at the long-term goals.

The capital market tends to focus more on growth and performance. Institutional shareholders demand much credibility in organisations, while at the same time companies struggle to balance between the expected and the actual end results (Mouritsen 2005). Failure to deliver results may cause the situation when shareholders will not show loyalty to organisations they invest in. However, sales and ultimately profits are difficult to maintain, especially in the ever-changing environment (Ryan 2007). There are many changes that have been manifested with the moving from individual to larger management groups. Therefore, shareholders look for short-term institutional benefits as compared to long-term benefits.

Otley (2001) notes that the traditional budgetary system only works rationally in a relatively stable institution. The current business environment, though stable, can only support short-term perspectives. It in real sense aims at maximising the certainty of results that are short-term planned. Otley (2001) argues that the budgetary control has been treated as the main planning and performance measuring tool in most business enterprises. The level of performance is linked to the attainment of the objectives set out in the budgets. Both external and internal factors of the business environment may never be considered. For example, social, economic and political factors bring changes that will require the company to adapt to. Budgets may never offer an avenue for such changes as resources, such as intellectual capital, would do (Ryan 2007).

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The current business trend requires that business practitioners consider not only the product market but also the capital market (Ryan 2007). According to Ryan (2007), companies, such as Eurel, suffers from decline in their profit margins. It can be attributed to a number of challenges in such situations. For example, some of the modern investments aim at achieving credible results as opposed to just increasing the shareholders’ dividends every fiscal period. Current business environment requires maximizing on the individual member’s capability. The collective efforts applied by all the members aid in contributing to the overall progress of the company (Teece 2000). Ryan (2000) carried out a study on employees of Eurel on the changes that took place when Continuous Improvement Plan (CIP) replaced the budget system. The conclusion made from the most of the interviewees proved that the Continuous Improvement Plan brought many positive changes to the company. First, the company aligned itself with the demands of the capital market. Secondly, the method acted as a collective tool that improved all areas of performances within the company. For example, the method acted to convene all the members for frequent communication which is an integral part of success in any company (Ryan, 2000). Conclusions made in meetings can be communicated to the shareholders and in this way the system acted to link the company and the shareholders on frequent basis. Then the company can assure them of its commitment to deliver the required results. Frequent assessment programmes also act to provide transparency and accountability (Hansen, Otley & Van der Stede 2003). The effectiveness of the Continuous Improvement Plan was partly attributed to its bottom-up approach.

According to the traditional budgeting system, the top management is fully engaged in the process of decision making process. It is, therefore, a centralized budgetary system that does not let the managers of the specific decision making units to be involved (Hope & Fraser 2003). It is contrary to the zero-based budgeting which appraises the unit managers to make decisions regarding the budgeting process. It emphasises the evaluation of the existing budgetary expenditure. Therefore, it can give the managers a possibility to inflate the expenditure to gain surplus from it. Zero-based budgeting is very rational and scrutinized to fit the current conditions. It gives minimal allowances for inflation of the expected expenditure. Unethical managers are likely to be exposed in a zero-based budgeting than in the traditional budgeting (Hansen 2011).

The traditional budgeting method will require renewal but it should not be completely removed. Although the zero-based budgeting technique provides an alternative to the management concept, it does not provide a convincing method capable of overhauling the budgeting technique (Bunce 2007). Current paper supports the course that traditional budgeting techniques are disused and seem inapplicable in the dynamic environment. Beyond budgeting proponents view the technique as a more effective method of planning and control which can be used to overcome the limitations of the traditional budgeting technique (Ekholm & Wallin 2000). Hope and Frazer see the technique as becoming the most popular method of management for the future (Daum & Frazer 2003). After the evaluation of various academic journals and articles, current paper affirms that beyond budgeting technique will surpass the traditional budgeting technique in the near future. On the one hand, it might be very hard for organisation to refuse from the concept of budgeting as it is strongly embedded in business culture. What is supposed to be done is to invent better budgeting techniques which will help in overcoming the problems created by the traditional budgeting technique (Ahrens & Chapman 2004).

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