Budgeting
What this domain tests
Budgeting links plans to control. The exam tests budget purposes, alternative budgeting approaches, the behavioural consequences of budgets, and your ability to flex a budget to the actual activity level.
Core rules
- Purposes: planning, coordination, communication, motivation, control and performance evaluation. These can conflict - a control-focused budget invites slack.
- Incremental budgeting starts from last year's figure; cheap but it perpetuates inefficiency. Zero-based budgeting re-justifies every cost from a zero base in decision packages; useful for discretionary costs but time-consuming and prone to short-termism.
- Rolling budgets are continuously updated, typically quarterly, improving accuracy in uncertain environments.
- Activity-based budgeting costs the activities needed to deliver the expected output.
- A flexible budget is set at the actual activity level; the static budget is not, so comparing actual with static mixes volume and efficiency effects.
- Beyond Budgeting advocates devolved decision-making, relative targets and rolling forecasts instead of annual fixed performance contracts.
Worked example
Static budget: 10,000 units at Rs. 30 variable cost plus Rs. 200,000 fixed cost = Rs. 500,000. Actual: 12,000 units, total cost Rs. 570,000. Flexed budget = (12,000 × 30) + 200,000 = Rs. 560,000. The variance is Rs. 10,000 adverse - a genuine overspend. Comparing actual Rs. 570,000 with the static Rs. 500,000 would show Rs. 70,000 adverse, but Rs. 60,000 of that is simply extra volume, not poor control.
Traps
Reporting the static-budget variance as a performance measure; ignoring the behavioural effect of using budgets as fixed contracts; confusing a rolling budget with a forecast; forgetting that participation reduces resistance to targets but can increase slack creation.