How budgeting works in business


According to Kaplan and Norton budgeting is a process run by the finance staff, to set financial targets for revenue, expense, profits and investments for the next financial year. This study is set to have a comprehensive and detailed analysis of the HK Corporation budgeting process. In the process of this analysis, this study will answer the question how the budgeting process as employed by HK Corporation contributes to the failure to achieve the managing director's sales and profit targets. The study also will recommend ways in which the budgeting process can be revised to correct this problem.

When a company fails to meet its targets, the managers are tempted to reduce cost of the functional areas so as to make the company to seen to be making profits. This study will analyze the long run impact this action to the corporation. In addition, the study will point out the ways that the company uses to motivate its employees. Finally, the study will analyze the benefits of a well implemented standard cost system and how the company should improve standard cost and variance reporting system so as to increase employees' motivation.

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The following are key features that HK Corporation lacks and therefore contributes greatly to the corporation failure to meet sales and profits targets placed by the managing director.

A. Absence of flexible budget.

HK Corporation does not use flexible budget and therefore the management lacks time to see if actual cost and revenues are in accord with budgeted amounts. If the budget was flexible, it could allow selective investigation of significant variances and therefore help managers to focus only in areas that need attention. This process is called management by exception and could help the HK corporation production process not come to a halt because of lack of specific raw materials. (Riahi-Belkaoui, A, 2004pp276-279)

B. Relay on subordinates.

The managing director of HK Corporation imposes the budget on the subordinate managers. This eliminates participative budgeting process and therefore the subordinate managers do not feel to have a considerable say on how the budget are established. In this company, overall objectives are communicated to the manager, who helps develop a budget that will accomplish the objectives. (Horton, W, 2001p3)

C. How to improve the performance.

To improve its performance (for sales and profit targets), HK Corporation should emphasize accomplishment of broad objectives, but not few individual budget items. Budgeted objectives are usually used to measure performance; accordingly, they should always be based on realistic conditions and expectations. Flexible budgets are used to ensure that the budgeted costs provide standard provides standards that are compatible with actual level. HK corporation in real sense does a not use any measures to make sure that budgeted costs provides standards that are compatible with actual activity levels. (Piotrowski, C. M, 1992pp49-53)

Conventionally, managers should be held accountable on costs that they have control over them. Controllable costs are costs whose lever of manager can control. Therefore, I as a manager who has no responsibility on a cost should not be held accountable of it. HK Corporation puts non controllable costs in the budgets of subordinate managers. (Broadbent M and Cullen J, 2003pp90-91) According to Smith, if these costs must be included in the budget they should be separated from controllable costs and labeled as non-controllable. HK Corporation does not do this and therefore managers are charged for costs that they do not have control over. (Smith G. S, 2002pp19)

HK Corporation uses budgets as the only measure of managerial performance. This over emphasis on this measure has led to the dysfunctional behavior called myopia. Myopia occurs when a manger takes actions that improve performance in the short run but bring a long-run harm to the firm. The best way to prevent myopic behavior is to measure the performance of managers in several dimensions that have long-run attributes. They Include; productivity, quality and personnel development. (Hansen, D.R. et al, 2007pp176-178)

I as a manager would adopt following Ways in which HK Corporation's budgeting process could be revised to correct the problems discussed above.

D. Participative budgeting process

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HK Corporation should allow subordinate managers to have a say on how the budgets are established. Participative budgeting communicates a sense of responsibility to subordinate managers and fosters creativity. Since subordinate managers create the budget, it is more likely that the budget goals will become their personal goals, resulting to greater goal congruence. Moreover, participative budgeting process has the advantage of involving individual knowledge of local conditions that may enhance the entire planning process. (Bryans, W, 2004p89)

E. Use realistic standards.

Budgeted objectives are used to measure performance and therefore, they should be based on realistic conditions and expectations. HK Corporation sets the budgeted objectives so high and therefore, actual costs and revenues are not compatible with the budgeted costs and revenues. To eliminate this problem the company should use flexible budgets so as to ensure that the budgeted costs provide standards that are compatible with actual activity level. (Bagad, V.S, 2009pp11-15)

F. Use of multiple measures of performance

To overcome the dysfunctional behavior called myopia, the company should use a multiple measures to gauge performance. HK Corporation should use other measures of performance that have long-run attributes. Other areas that performance could be evaluated included; productivity, quality, and personnel development. (Naseem, A, 2005pp245-247)

G. when sales volume falls below budget.

The functional areas should not cut their costs when the sales volume falls below the target. This is because, reduction of costs will lead to a dysfunctional behavior called "milking the firm or myopia." Myopic behavior comes about when managers undertake operations that perk up budgetary performance in the short-run, but bring long-run harm to the firm. To meet the cost reduction HK Corporation must reduce expenditures for preventive maintenance, advertising, and new product development. The management also will have cut the cost used to promote deserving employees to keep the cost of labor low and finally, use poor quality materials to reduce the cost of materials. (Wintrobe, R, 2000p29)

Reduction of costs by functional areas will make the company to meets its budgeted cost objectives and profits. In the short- run, this action will lead to improved budgetary performance, but in the long run productivity will fall, market share will decline, and capable employees will leave for more attractive opportunities. (Lorange, P, 2005pp173-175) Motivation and behavior is very epic part of the organization which being address below.

H. Motivation and Behavior

To encourage both managers and the workforce to work towards achieving the company's goals, the company should provide both monetary and non-monetary incentives to them. Conventionally, incentives encourages goal congruent behavior and therefore, motivating the management and the staff. HK Corporation uses negative incentives to motivate it managers. Negative incentives use fear of punishment to motivate, whereas positive incentives use rewards to motivate. This can be clearly seen when Adam says that it was really frustrating to see charges for things he did not have control over. (Sundara, R.S and Ahmed N.M, 2009pp316-320) I as a manager After providing motivation would know the benefit of standard cost and analyze the variances to help in succeeding the objectives.

I. Benefits from standard cost and variance reporting system.

A well established standard cost has many benefits to the company that uses this type of cost system.

Comparison of actual costs with standard costs enables the management to evaluate performance of various cost centers. This therefore, helps to measure the efficiency of the firm.(Clive, R.E and Merchant, K.A,1990p166)

Performance variances are determined by comparing actual costs with standard costs. Variances enable the management to spot out the place of inefficiencies. This helps the management to fix responsibility for deviation in performance and more significantly, take corrective measures at the earliest stage possible.(,2009)

According to Bhattacharyya, in a standard cost system, targets of different people are fixed in according to predetermined standards. The attention of the management is drawn only when actual performance is less than the budgeted performance. This aspect is known as "management by exception", where everyone is given a target to be achieved in a given period of time.(Bhattacharyya,A.K,2005pp869-870)

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The main rationale of each costing system is to control costs and cost reduction. In this system, standards are constantly analyzed and an effort is made to improve efficiency. (Pizzey, A 1989pp267). According to Lucey, whenever a variance occurs, the values are meticulously studied and immediate corrective measures undertaken. This helps to single out weak points enabling cost control system.(Lucey, T,2003p267)

J. How to improve standard cost and variance reporting system

HK Corporation should set standards based on realistic estimates that allow for material spoilage, idle time and other normal production interferences. These standards provide motivation for workers to achieve favorable results because they are reasonable. (Lewis, J. R, 1995p34)

Variances should be clearly noted and further analysis, investigation and appropriate action taken. Variances permit the supervisory personnel to defend themselves and their employees against failures that were not under their control. According to Marshal and others, variances provide the yard stick to measure the fairness of the standards, allowing management to redirect its efforts and to make reasonable adjustments. (Marshal, D.H, et al, 2003) HK corporation top management should try to eliminate undesirable variances and reward desired performance from the subordinate managers and the workforce in general. This helps to motivate employees to meet their targets and therefore, improving the performance of the company. (, 2009)


While concluding, HK Corporation should revise its budgetary system so as to motivate it managers and employees. More significantly, managing director should not impose the budget to the managers, instead he should give them a say in the creation of the budgets. This will go a step ahead to in making them to work hard to meet the targets in sales and profits.