Project Finance, Accounting and Control

Introduction
Every organization targets to achieve the best performance in the lowest budget and still aims to have the full control of the system of the organization Practically the above statement is too true to be real. Every organization has certain flaws existing even with all necessary precautions taken to avoid failure. Budgets are an important tool for management planning and control (Atrill & McLaney, 2005). In order to achieve strategic objectives all managers need to manage performance and control of budget is essential to achieve this. Some industries use budgeting as a control of expenditures, where other businesses use budget functions as a tool for planning, a means of communication, or as a goal to measure performance. Budgeting system is recommended by certain authors of organizational structure where relevant and timely information can be provided, minimal number of rules and regulations as control system, through participation or through a process of social integration (Ashton et al, 1995). In the past, budgets has been considered as an integral part of management control system, however over the past few years which is been criticized as management control technique.

Performance Measurement
Performance is measured against some clearly defined target or standard, often determined by senior managers in the organizational hierarchy and communicated downwards through the budgeting process (Ashton et al, 1995). The purpose of performance measure is to set direction and to motivate managers (Horngren et al, 1998). Shank et al. (1995) describe performance measurement as one of four broad design tests for an effective management system. Stretch targets must be set that are achievable and fair and that reward good decision-making. Managers must use the targets as drivers of behavior and not just look at results. Barsky and Bremser (1999) conclude that for management to better align actions with strategic goals, it is important to use the budget to emphasize core beliefs and

critical interactive controls and then to develop an integrated set of financial and non-financial measures to evaluate progress. Measurement of performance is an essential tool whenever a process is changed or adopted. It can give feedback on the effectiveness of the plans and their implementation (Chow et al., 1998). There is a slight change in focus of performance measurement from financial measures to over-reliance of financial measures in performance evaluation (Chan, 2004).

Budget planning and Control System

A budgetary planning and control system is essentially a system for ensuring communication, coordination and control within the organization (Management Accounting, F2). Short term plans are usually called budgets and typically cover a one year period which mainly expressed in financial terms, and Budgetary Control referrers to managements use of budget to monitor and control the companies operations (Larson et al, 2005). Budgets are intended to encourage managers to work towards the business objectives and to do this in a coordinated manner. A management control system is a logical integration of techniques to gather and use information to make planning and control decisions, to motivate employee behavior, and to evaluate performance (Horngren et al, 1998) Non-financial measures have an important role to play in assessing performance in key areas such as customer/supplier delivery times, set-up times, defect levels and customer satisfaction levels it can also be used as the basis for targets and can be incorporated into the budgeting process and reported alongside the financial targets for the business (Atrill & McLaney, 2005). According to Atrill & McLaney (2005) budget will define precise target such as Cash receipts and targets Sales, broken down into amounts and prices for each of the products or services provided by the business Detailed stock requirement Detailed labor requirement Specific production requirement.

Types of Budgeting
Budgeting was initially looked as financial base of decision making which has changed over period of time and different types of budgeting system were 3

introduced to suit the organizational requirement. The initial stage was the traditional approach to budgeting which also known as incremental budgeting that bases next years budget on current years with increases for inflation and changes in the activity level. It encourages slack and wasteful spending to slip into budgeting (Performance Management, F5). However, this may not always be appropriate for certain organizations or for certain types of cost and revenue. Flexible and fixed budgets are used where budget planning is done based on activity. Fixed budget remains unchanged regardless of activity and flexible budget are designed to flex with activity. In terms of control budget is usually flexed to reflect the volume that actually occurred which differs from the original plan. It enables to make more valid comparison between budgets estimated and the actual occurred. To be able to do flexing budget items which fixed and variable relative to the volume of outputs needs to be identified (Atrill & McLaney, 2005). Zero based budgeting and rolling budgeting are alternative budget systems which can be applied in certain circumstances and situations. Activity based budgets may use bases other than volume of output for flexing budgets (Performance Management, F5)

Advantages of Budgeting
The advantages of budgeting include: Coordination of sales and production; Formulation of a profitable sales and production program; Coordination of sales and production with finances; Proper control of expenditures; Formulation of investment and financing programs; and Coordination of all operations within the business (Zimmerman, 2003). Budgeting compels managers to think by formalizing their responsibilities for planning Budgeting provides definite expectations that are best framework for judging performance It aids in coordinating the efforts of the managers and their objectives with that of the organization as a whole (Horngren et al, 1998).

Disadvantages of Budgeting
Budgets cannot deal with a fast changing environment and they are often out of date before the start of the budget period Budgets are set based on the past performance and inefficiencies of the past may be concealed. 4

 Budgeting is a lengthy process involving negotiation, reworking and updating which may take enormous amount of management time which can be more productive otherwise It can protect cost but not lower cost, the budget may be taken away if it is not been used or it may be eliminated

Issues faced when setting budgeting / Behavioral implication of budgeting

A budgetary control system can motivate but it can also produce undesirable reactions, it is therefore the reason why management accountant should try to ensure employees have positive attitude towards setting budget, implementing budget and feedback of results (Performance Management, F5). Budgetary slack is defined as the amount by which managers intentionally build excess requirement for resources into a budget, or knowingly understate productive capability (Young, 1985). Usually the objective of creating budget slack is to gain higher rewards for less effort and to reduce pressure on managers. High job commitment and involvement will also decrease the managerial desire to create budgetary slack (Nouri, 1994; Nouri and Parker, 1998). To avoid budgetary slack the organizational goals should be outstanding from the personal goals and more importantly the employers should set optimistic and achievable targets Managers may complain of being too busy to spend time on budgeting, may also be discouraged with a formal budget as it is rigid and inflexible. Managers may not accept the system in case of discrepancies as they are unfamiliar with accounting terminology or principles

Management Control System

Control is a process of monitoring, planning decisions and evaluating an organizations activities and employees (Larson et al, 2005). A well-designed management control system aids and coordinates the process of making decisions and motivates individuals throughout the organization to act in concert. It also

facilitates forecasting revenue and cost-driver levels, budgeting, measuring and evaluating performance (Horngren et al, 1998). By following the system of budgetary control, a scope of delegating responsibility and decision making authority to the junior managers can be created yet the senior manager can still retain control as senior managers can ascertain targets for junior managers to attain and therefore working towards achievement of organizational objectives (Atrill & McLaney, 2005). There are two types of control known as feedback and feed-forward controls. Both the methods are used while budgeting where feedback method is comparing actual results and feed-forward is preparing a budget. Feed-forward control is more favorable as it allows the managers to look ahead and bring out innovation and creativity as it tries to anticipate future problems Every organization needs to maintain a control system in order to run the business successfully. It provides a direct control mechanism between expected and action; it also helps maintain profitability and liquidity for survival. Control provides autonomy to managers in measuring results as it is financial terms which also provides means of aggregating monetary results Control can also be risky to an organization when employees are work under pressure and are de-motivated, they will not be working towards the achieve of organizational objectives, employees and managers may be discouraged to express creative ideas and this can lead to negative attitude towards the control system

Arguments on using budgeting management control system

as

In the past, budgets has been considered as an integral part of management control system, however over the past few years which is been criticized as management control technique. For many decades empirical research has documented extensive use of budgeting system in various organizations as key element of management control system. However, in the current economy there appear to be a paradigm shift in the management accounting literature (Ahmed el at, 2003) critics argue that with the change in the technology and rapidly changing business environment following the traditional budget is no longer appropriate (Kaplan, 1988, 1990; Johnson and Kaplan, 1987) Blocher el at (2002) argued that budgets helped to allocate resources, coordinate operations and provide a means for performance measurement which Hilton el at 6

(2000) also agrees and claims that budget is widely used technique for planning and control process. Clarke and Taol (1999) also supports that budgets are essential as it can be incorporated as part of the financial component of the Balanced Scorecard (Ahmed el at, 2003). On the other hand critics on budgets consider budgets are fundamentally flawed as planning and control mechanism. According to Stewart (1990) experts says budgets controls the wrong things, like head count and miss the right one like such as quality, customer service and even profits. A number of problems were listed in an article by Prendergast (2000) like firstly, a lot guess work is involved in budgeting; secondly, due to shorter product life cycle and rapid changing environment budgets are inaccurate and finally, he argues that over years budgets have resulted in conflict between top management and their subordinates. McNally (2002) criticizes that budgeting process consumes too much time and incur very high costs and consequently once the budget is approved, it may no longer be accurate and this may cause problems to business. Some of the criticisms put forward by Hope and Fraser (2003) in Beyond Budgeting are: Budget fails to focus on shareholders value since most budgets are set on incremental basis the managers overlook the long term budget and focus on short term from fear that they will not be able to achieve the target and will not be rewarded. Budget stifle product and strategy innovation as Managers worry that taking risk may effect adversely on their short term performance which hinders to fulfill the customer needs in a fast changing environment Budget reinforces a dependency culture where the process of planning and budgeting within a framework developed from senior management enable a culture of dependency. The essence of the beyond-budgeting model is that organizations must change their focus from top-down control to bottom-up empowerment, because this seems to be the best way to adjust to the fast changing world of the information age (Hope and Fraser, 2003).

Budgeting as Measurement tool

Performance

Collier and Gregory (1995) identified budget to actual performance as the key management performance indicator used in their case study organizations. Feedback plays an important role in planning, control and leadership development (Joshi et al, 7

2003). According to Cook (1968) feedback positively associates with budget performance. Variances are of vital importance in judging managerial performance. Based on the survey conducted by Weisenfeld and Tyson (1990), found that budgeting and variance analysis can be positive tools if accounting information and communication process is utilized appropriately. Companies use budget variance to evaluate the ability of the managers to in running the departments and improve in next period budget Many firms use accounting techniques as major part of their performance evaluation. Argyris (1952) documented few consequences such as: lack of concentration in the unit, blaming others is done rather than accepting responsibility which is more time consuming, creation of small group loyalties and creation of budget slack. The participation of managers in setting their goals tends to improve motivation and performance; this is probably because managers feel a sense of commitment to the targets and a moral obligation to achieve them Performance measures tied to strategic plans aid an organization in a variety of ways, including developing the strategic plan, and analyzing the achievement of departmental and corporate objectives, monitoring operations by red flagging daily operations that have gone outside acceptable parameters, charting progress towards goals, and evaluating employees and suppliers (Hass el at, 2005)

Conclusion
Budgetary planning and control system can either positively or negatively impact the performance of the managers and divisional members. For example, if the budget if the annual budget set for a division is low compared to other divisions of the organization the performance of the low budget division will low and team member will be de-motivated, therefore it is essential to be make careful decision of budget planning and control system on measuring performance Managers set and communicate targets, or standards, and evaluate performance, and prescribe corrective actions if actual performance deviates from the planned. Many organizations have used budgeting as the base of their decision making. It is important to note that there is a clear role for accounting measures in motivation and performance appraisal. Motivation is based on non-accounting and non-monetary features due to which to be justifiable performance also needs to be evaluated against objectives that cannot be measured in accounting terms (Ashton et al, 1995).

Organizations need to be very stringent in making decision making for the choice of performance measure in terms of budget planning and control system. Choice of budget approach can make a difference in success of the business like top down approach of performance measure to control budget can be discouraging and could lead to motivational and morale problems, on the other hand may be use of flexible budgeting proof to be favorable for the business as opposed to the static budgets, in performance measurement will result in fairer evaluation system

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Larson, K D, Wild, J. J and Chiappetta, B (2005), Fundamental Accounting Principles, 7th edition, McGraw Hill/Irwin McNally, R (2002), the Annual Budgeting Process, Accountancy Ireland, Vol. 34 No. 1, pp. 10-12 Nouri, H. (1994), Using organizational commitment and job involvement to predict budgetary slack: a research note, Accounting, Organizations and Society, Vol. 19 No. 3, pp. 289-95. Nouri, H. and Parker, R.J. (1998), the relationship between budget participation and job performance: the roles of budget adequacy and organizational commitment, Accounting, Organizations and Society, Vol. 23 No. 5/6, pp. 467-83. Prendergast, P (2000), Budgets hit back, Management Accounting, pp. 14-16 Shank, J.K., Jewett, W.G. J and Branstad, P.A. (1995), the perform system: turning strategies into results, Journal of Strategy Management: Competition, 4th quarter, p. S22. Stewart, T A (1990), Why Budgets are bad for business, Fortune, 4th June, pp. 179-90 Weisenfeld, L and Tyson T (1990), How to make Accounting a positive tool in managements hand, Management Accounting (UK), November-December, pp. 1920 Young, S.M. (1985), Participative budgeting: the effects of risk aversion and asymmetric information on budgetary slack, Journal of Accounting Research, Vol. 23, pp. 829-42. Zimmerman, J L (2003), Accounting for Decision Making and Control, 4th edition, McGraw-Hill, New York, NY. Learning materials Project Finance, Accounting and Control Module C11CR; Heriot-Watt University Dubai Campus, March/April 2009.

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