Budgeting: a survey set out to find why a process that is viewed so negatively continues to be widely embraced, write Dr Prabhu Sivabalan and Dr David Brown of the University of Technology, Sydney.
Budgeting remains one of the most critiqued accounting practices in business. Some practitioners swear by budgets, and operate in organisations that are wholly governed and evaluated through budget reporting systems. Others find the budgeting process fraught with politicisation and game playing, viewing budget systems with much cynicism.
Perhaps the greatest irony of budgeting is this: almost every practitioner has something negative to say about its practice in organisations, yet anecdotal evidence shows budgeting to be widely prevalent. As far back as 1987, survey studies showed that 97 per cent of US organisations surveyed used budgets.
In 2000, a study in Europe found that no less than 92 per cent of organisations continued to use budgets, with many planning on increasing their investment in their budgeting process. How does a practice that is almost universally decried by accounting practitioners continue to be so prevalently used in practice?
In collaboration with CPA Australia, a team of accounting academics from the University of Technology, Sydney sought to investigate this apparent paradox by studying the operating budgets' characteristics of 335 medium / large Australian organisations. The data was obtained through surveys. The results analysed from practitioner responses highlighted a range of interesting perspectives concerning budgeting.
Why do organisations budget?
In practice, it is generally assumed organisations prepare budgets before a period commences (pre-period planning), in order to manage performance during a period (intra-period control), and evaluate performance at the end of a period (post-period evaluation). This three-pronged approach aims to manage an organisation's ability to attain its financial goals. Budgets are used to help plan, control and evaluate organisational operations. In order to investigate the reasons for budgeting among Australian organisations, the 335 survey respondents were asked to identify the extent to which they regarded 10 budget reasons as being important and beneficial to their organisation. Results are outlined in the table on page 66.
Findings from the survey responses of the 335 organisations show that organisations primarily budget for reasons relating to operational planning / control and not performance evaluation (see table). The most important reasons to budget among the cross-section of organisations is 'control costs', followed by 'board of director monitoring', 'formulate action plans', and 'coordinate resources'. These reasons relate to the planning and control function, and are explained in the following points:
1. Control costs (control) Budgets remain most popular among Australian organisations in their use for cost control. Budgets cause managers to reflect on future expenditures, helping them to decide on appropriate spending levels. Subsequently, in many organisations budgets are used to monitor actual spending within a period.
2. Board of director monitoring (control) An interesting finding from this study is the very high benefit ranking of the use of budgets as a monitoring device by the board of directors. This reason ranked second highest of the 10 budget reasons. This is quite significant, as it is a reminder that budgets remain one of the few formal aggregated financial documents that very senior agents of an organisation may use to enforce control. Also, if things should go awry in an organisation, directors may always use the formal budget as a justification for their initial financial expectations. For the above reasons, budgets are regarded with great importance by directors (irrespective of line manager budget perceptions).
3. Formulate action plans (planning) Organisations regard the use of budgets as being a control that facilitates their consideration of future activity planning. In asking departments to prepare budgets, departments are forced to reflect on the types of activities / projects they may wish to embark upon in a future period, and to cost these activities.
4. Coordinate resources (planning) Budgets are seen as being important in their pre-period use for apportioning organisational funds across departments. The budget preparation system intrinsically requires departments to outline their spending requirements. Once approved, departments are expected to adhere to budget numbers. Thus, budgets facilitate the apportioning of resources across different areas of an organisation.
If budgets are used for evaluation, they are used more for business unit evaluation than staff evaluation. This difference is important to acknowledge, because it highlights that many organisations continue to evaluate based on a budget, but not in a direct manner that impacts staff.
5. Business unit evaluation (evaluation) Budgets may be used to reflect on the performance of business units, and not specifically the staff within business units. This is a more general means for using budgets as an evaluation device. In this study, 'Business unit evaluation' was ranked fifth of the 10 reasons to budget, and falls below the top four planning- and control-related reasons explained previously.
6. Staff evaluation (evaluation) The staff evaluation reason ranked seventh. Staff evaluation appears to provide significantly lower budget benefits than business unit evaluation.
Organisations do not appear to be placing importance on the budget's use for evaluating staff, relative to many other budget reasons. Why? This was thought to be a surprising finding, as it is often simply assumed that budgets are prepared in order to be compared to actuals, thereby used as a mechanism for evaluation (staff or business units). Budgets are compared to actual values, and deviations are considered when judging staff performance.
However, 335 medium / large Australian organisations responding to this survey say otherwise. They derive greater benefits from budgeting for other reasons relating to controlling costs, director monitoring, formulating action plans and coordinating resources.
How is it that the use of budgets for evaluation has fallen below these four in importance?
An analysis of budget problem types and game playing helps to better understand the problems associated with using budgets for performance evaluation.
Using budgets for evaluation
An investigation of budget criticisms reveals that most budget-based problems relate to the use of budgets for evaluation, not planning and control. Organisations rarely say that they are unhappy with budgets because they force them to plan and control their operations.
These two activities are quite positively regarded by business managers. Instead, organisations are concerned with the game playing undertaken by employees who know they are being evaluated on budget numbers, and hence seek to opportunistically manage budget estimates. If a budget is used for evaluation, it brings with it a set of political game-playing problems, which ultimately affect planning, control and evaluation activities.
Many practitioners argue that the source of most budget problems and resulting challenges arise from the use of budgets for performance evaluation, especially that of staff.
When staff members are judged using a budget, they experience a degree of concern or uncertainty regarding the budget number. As early as 1952 this uncertainty was acknowledged and labelled job-related tension (JRT) in a Harvard Business Review article.
When employees experiene budget-related tension, they seek to alleviate tension by engaging in game playing. Game playing may manifest in two ways: employees build slack into budget numbers (budget gaming); or employees suboptimally alter their real-world activities to meet budget numbers (operational gaming).
The first type of game playing involves employees negotiating looser budget numbers (overstating costs, understating revenues) during the budget-setting process in order to make it easier for them to meet targets. This is problematic, as many companies simultaneously request budget numbers from staff and negotiate targets with staff. Therefore, staff naturally build in unrealistically conservative numbers during the budget-setting process.
The second involves staff manipulating the way in which they work to reduce budget stress. For example, departmental managers evaluated on budget adherence may intentionally under-invest in critical capacity-building or operational expenditures in order to be sure of staying within budget.
The effects
It is important to note that budget problems arising from performance evaluation also bear ramifications for plan-ning and control. If employees game play with budgets and build in budgetary slack, organisations find it harder to coordinate resources across departments (planning), and decide on the approval of future action plans within departments. Organisations also struggle to monitor staff during a period using budget numbers (control), because the numbers themselves are not appropriately indicative of expected organisational activity.
Because budgets are so problematic for evaluation, it is not surprising to observe that employees are moving away from using budgets to evaluate staff. If budgets are used to evaluate, it is used more for business unit evaluation, without direct bearing on employee performance evaluation.
Do organisations regard budgets as beneficial?
The general level of satisfaction with budgets is reasonably high. Respondents were asked to complete their bene-fits ratings for the different reasons to budget, using a scale of one (no benefit) to seven (very high benefit).
The first five benefits all scored greater than five, revealing a reasonably strong satisfaction with budgets in organisations. The scores of the bottom five benefits were all around four, revealing them to be moderately beneficial.
Organisations are therefore generally satisfied with their budgets, and especially so when using budgets for planning and control reasons.
This finding is not emphasised often enough in practice, as the majority of budget discussions focus on budget negatives, without acknowledging their positive impacts to organisations.
The findings from this study indicate that organisations that use budgets more for planning and control, and less for evaluation, ultimately source greater benefits.
Dr Prabhu Sivabalan is a lecturer in management accounting at the University of Technology, Sydney (UTS). Dr David Brown is a senior lecturer in the UTS school of accounting.
