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The report will provide a detailed evaluation of two methods used in modern day accounting strategy (the Incremental System and Beyond Budgeting) the short comings of the Incremental system while also providing advantages and disadvantages of some of the methods that are classed under the Beyond Budgeting term in comparison to the Incremental System. To conclude a recommendation of which of the budgeting systems proves more effective after having compared and contrasted the findings.
To evaluate and contrast between the two budgeting systems (Incremental and Beyond Budgeting)
Provide the flaws of the currently used Incremental system
Give evidence for and against the two strategies under the beyond budgeting heading given.
A recommendation on which strategy for the company to use.
This report will evaluate and contrast between two of the currently used strategies in budget preparation of a business (Incremental Budgeting and Beyond Budgeting) for a small company that manufactures small electrical goods. The Beyond Budgeting strategies have become more and more popular with companies over the recent years for more beneficial reasons that the commonly used incremental budgeting system. With relevant advantages and disadvantages of the 'Beyond Budgeting' system while showing the flaws of using the 'Incremental' system in today's ever-changing financial environment. Then finishing with a recommendation and a conclusion to the findings that have been included in this report the most popular strategies being used in today's budgeting (Incremental) and the proposed (Beyond Budgeting) that should be optimal for the electrical goods company.
Incremental Budgeting System
Definition of Incremental System
'A budgeting approach where the prior year experience sets a base line for a new budget; changes are made based on new information but the base need not be re-justified in detail' (principlesofaccounting.com, 2010)
The Disadvantages of the Incremental system
One of the flaws that's encountered in the Incremental strategy is that the time consumed by the members of staff preparing budgets. Budget preparation time can vary between 4 to 6 weeks and some companies can even take up to 16 weeks to complete their annual budgets. Even when the budgeting process is complete there's no telling that the possible 16 week preparation will even have been worthwhile to the company on completion.
Another common flaw of the Incremental system is the lack of adaptability the budget provides on the company's strategy and growth as a whole. The budget does not allow room for adjustments in any sort of changes to the company policies this not letting the budget adapt to constantly changing prices in an ever-changing financial climate.
The Incremental Budget doesn't encourage any sort of cost saving when in production. The managers when preparing the budgets for the next periods may come across a certain sector not using their budget fully and the manager may assume that they do not need the fully budget for the next period and the budget may be cut. Or on the other side the sector might be aware that the manager may cut the budget if they don't use it and so the rest of the budget will be used on non-productive items when the remaining funds could have been carried on to the next period and reduced some costs for the company.
The last disadvantage of Incremental Budgeting is that the budget will assume the annual production process in the company stays the same as previous years set of accounts and will not be accurately adjusted to suit the current year's projections and possible changes that the company may/may not adjust to.
Beyond Budgeting What Is It?
Beyond Budgeting isn't a specific budgeting strategy it is used when a company that's using their current Incremental Budgeting System and would like a new, improved, efficient strategy such as: Zero Based Budgeting, Activity Based Budgeting, Score Card Budgeting, etc. The company will have to evaluate their current production stages and adopt a suitable system that provides the best results to adhere to the company's targets and goals.
Zero Based Budgeting (ZBB)
'A method of budgeting in which all expenses must be justified for each new period.Â Zero-based budgeting starts from a "zero base" and every function within an organization is analysed for its needs and costs.' (Investopaedia).
Advantages of Zero Based Budgeting
Every aspect of the budget is examined and adjusted to an accurate figure that will be used in the company's production. It will question each figure in the final budget if the company needs the quantity proposed, if there is a possible alternative component that could be purchased at cheaper price, better quality or larger quantity of same materials elsewhere for cheaper.
It encourages managers to find out or create more cost efficient ways for the company to save money, and it will bring more 'front line' employees that are working to create the figures that are used to create the budgets. With the Incremental budget the 'agency problem' may occur where a manager or managers are expected to assist in the company's growth and sales although the managers will fail to try other possible cost reducing methods to keep their position at the company. It also will cause an increase of communication between the 'front line' and managerial sections of the business and giving the managers improved and accurate information on how to proceed in the production. With this being said the 'front line' morale may increase due to the responsibility and in initiative being used by them to directly affect the company's approach to reducing the cost of production.
Disadvantages of Zero Based Budgeting
The advantages of zero based budgeting may come across as more worthwhile although it can have its downsides for instance, compared to the Incremental Budgeting System Zero Based Budgeting can be even more time consuming as each cost centre and aspect of production will be looked over and re-evaluated to try and reduce any cost. Also when providing evidence to the managers on why each action has been/ has to be taken can take a while and become strenuous. When looking over the costs and processes in the production there can be grey areas where Zero Based Budgeting is involved as certain process that can't consistently produce the same output can also prove using this strategy difficult.
Balanced Score Card (BSC)
'A strategic planning and management system used extensively in business and by organizations worldwide. Benefits of the system include increasing focus on results, aligning business activities with organization strategy and improving performance and communications.
The balanced score card proposes that the organization should be viewed from four perspectives, with metrics developed; data collected and analysed for each of them. These four perspectives are: Financial, Customer, Internal Business Processes and Learning and Growth. ' (investopaedia)
Advantages of Balanced Score Card
With the Balanced Score Card strategy the measurement of output is more accurately recorded as the production is underway. It will give the managers a better outlook on the quantity of materials being used at which stages of production and overall quantity of material to achieve the production's goal.
The efficiency of the overall production can be monitored throughout each of the stages of production with the current process in the place and the data acquired from the Balanced Score Card strategy can be used to construct a possible new, more cost efficient strategy for the company to gain or increase their current output. With a strategy that the information is so freely available to most members of the production staff their initiative and opinion can be used to receive feedback on if the production as a whole or certain aspects of the production can be improved in any way to either improve production or reduce specific cost that may not be needed anymore in the production.
Disadvantages of Balanced Score Card
A short coming of the Balanced Score Card Budgeting strategy can only be as accurate as the employees that provide the information that is used for the Balance Score Card. Members of staff might finish their production stage and hour early and decide to lie about to cover up the fact that they might not have been doing their work for the last hour of work because they would maybe get sent home early without pay for that final hour.
The Balance Score Card strategy will be filled with data only relevant to the time of production but with today's current economic state materials can be cheaper today and by tomorrow it can be considerably more expensive, it also doesn't include any room for assessment of risk or opportunity.
The evidence shown of the flaws of the Incremental System how it's time consuming, inadaptable, it does not promote cost saving, possible honest cost expenditure and it does not take into account current economic prices. Beyond Budgeting is an umbrella term that offers types of budgeting strategies, Zero Based Budgets, Balanced Score Card were only two that were covered.
Zero Based Budgeting is effective for accurate data gained from the production process as they all begin from zero, encourages managers and employees to come with/implement more cost efficient processes. Like the Incremental System this strategy can be time consuming as all process has to be monitored and calculated. This budgeting strategy is most effective only in larger companies that have several processes that would have to have to be monitored.
Balanced Score Card can provide management with accurate day to day uses of materials and equipment and with this data they are able to work on more cost efficient ways to improve production output. Like the Zero Based Budgeting strategy it allows employees from managers to production workers to give recommendations on how to improve production output, also increasing communication between 'front line' employees and the managerial department. The flaws of Balanced Score Card is the possibility of having unreliable employees and the strategy doesn't consider any changes of price that frequently vary in the modern day economy.
Using the information given in this report the company should choose either of the Beyond Budgeting approaches depending on which suits the specifications, production and processes used within the company.