Budgeting and Budgetary Control
44 Pages Posted: 2 Jun 2003 Last revised: 6 Mar 2018
Date Written: April 29, 2003
Operational management needs to know the causes of off-standard performance in order to improve operations. The knowledge of variances (real result versus budget) will aid control, at least if and when these variances are understood well enough. The only criterion for the calculation of a variance is its usefulness. Of course variances must be calculated immediately after the event and one should act upon them adequately.
Budget processes in many cases actually exemplify what is harming companies instead of helping them. Jensen, 2001, describes what is happening in practice (http://ssrn.com/abstract=267651). Measuring performance, by whether or not achieving set targets for the period or missing them, is ridiculous. Budgets and targets mean nothing without thorough detailed budgetary control; how should it be conducted?
Variance analysis, the way it is taught at many schools and universities, in accordance with a wide variety of textbooks, is put to the test. This paper presents a few examples, with quotes from various textbooks and examinations. Problem definitions are quoted literally. Working-outs as explained by famous writers/lecturers/consultants are given where necessary and otherwise they are available at the quoted places in literature. The author's opinion is that these working-outs cannot stand the test. Anyway my opinion is not important, the reader decides. I give my elaboration in full detail, in reaction to the corresponding working-out published in well-known textbooks/examination papers, and may the best one prevail. Of course the elaborations of others and myself have a lot in common, but the discrepancies are at stake. Wrong, incomplete, unclear analyses will lead to mismanagement. In literature a so-called Dutch method is advocated versus what is supposed to be the American way to handle variance analysis i.e. solving the problem of budgeting and budgetary control. The author's opinion is that only one calculating method can be the right one. Only the best integral working-out is the essential base to better (operational) management.
Of course variance analysis is but a means to an end. A deeper understanding of the state of the company is the ultimate goal of all representations in budgeting and budgetary control. Management's task is to find the reasons for the variances and to take proper action to bring operations into line with the budget. Maybe the variances and trends indicate that the standards need amendment.
A strategic investment proposal is also a budget. The realised results ex post (not just future cash flows resulting out of an investment today), should be analysed in full detail (http://ssrn.com/abstract=366561).
Keywords: Budgeting, Budgets, Control Systems, Performance Measurement, Monitoring, Evaluating, Motivation, Productivity, Accounting Irregularities, Cooking the Books, Managing the Numbers, Strategic Investments, Accounting Systems, the New IASB Rules
JEL Classification: M40, M46, G31
Suggested Citation: Suggested Citation