Performance Management and Control of the Organisation

7 Behavioural aspects

7.1 Participation

If the budget process is not handled properly, it can easily cause dysfunctional activity. It is therefore necessary to give thought to the behavioural aspects.

Budget calculations required for APM

The September 2026 to June 2027 syllabus requires candidates not only to discuss budgeting methods, but also to calculate fixed and flexible, rolling, activity-based, zero-based and incremental budgets. The calculations will normally be straightforward. The important APM skill is to interpret the result and recommend a budgeting method that fits the organisation and its environment.

7.2 Incremental budget calculation

An incremental budget starts with the current cost and adjusts it for expected changes. For example, a department currently costs $240,000. Prices are expected to rise by 4% and activity by 3%.

Incremental budget = $240,000 × 1.04 × 1.03 = $257,088.

This calculation assumes that the existing activities and cost relationships are appropriate. It can therefore preserve waste, budgetary slack and obsolete working practices.

7.3 Rolling budget calculation

Suppose that at 31 March an organisation has budgets for the remaining three quarters of $520,000, $540,000 and $560,000. Management revises these to $525,000, $535,000 and $570,000 and adds a new budget of $590,000 for the following first quarter.

The new rolling twelve-month budget is $525,000 + $535,000 + $570,000 + $590,000 = $2,220,000.

The process is repeated at the end of the next quarter. Rolling budgets are particularly useful where prices, demand or technology change quickly, but continual revision uses management time and can create uncertainty for managers.

7.4 Activity-based budget calculation

An activity-based budget begins with the expected demand for activities and then applies the cost-driver rate.

Activity-based budgeting makes the cause of overheads more visible. Management can challenge the number of activities as well as the cost of each activity.

7.5 Zero-based budget calculation

Under zero-based budgeting, activities are organised into decision packages. Each package states the service level, cost and expected benefit. Assume that a public body has $600,000 available:

The statutory service must be funded. Of the remaining packages, the preventative programme ranks higher. The selected budget is therefore $400,000 + $180,000 = $580,000, leaving $20,000 unused or available for a reduced package.

The apparent numerical ranking must not replace judgement. Benefits may be qualitative, long term or difficult to measure.

8 Planning and operational variances

A conventional variance compares actual performance with the original budget or standard. This can give a misleading impression where the original standard has become unrealistic because conditions changed.

• Planning variance: the part caused by an inaccurate original standard or by a change in conditions outside the operational manager's control.

• Operational variance: the part caused by actual performance compared with the revised, realistic standard. This is normally more relevant when assessing the manager's performance.

The revised standard should be based on information that was not reasonably available when the original standard was set. Managers must not be allowed to revise standards merely to disguise poor performance.

8.1 Material price example

A company originally budgeted a material price of $10 per kg. Before purchasing, an unexpected market shortage increased the general market price to $11.50 per kg. The purchasing manager bought 20,000 kg for $11.20 per kg.

The two detailed variances reconcile to the original $24,000 adverse variance. The planning variance indicates that the original standard became unrealistic. The operational variance shows that the purchasing manager performed well by paying $0.30 per kg below the revised market price.

8.2 Using the variances

• Investigate why the original standard was wrong and improve the planning process.

• Assess operational managers using factors they could reasonably control.

• Consider interactions with quality, delivery reliability, inventory and customer service. A favourable price variance may have been achieved by buying inferior material.

• Avoid automatically treating every planning variance as uncontrollable. Poor forecasting or failure to update known information may itself indicate weak management.

• Use a range of financial and non-financial measures rather than judging performance from a single variance.

Exam focus: At APM level, calculation is only the starting point. Explain what the variance reveals, question the assumptions behind the revised standard and recommend appropriate management action.Top-down budgeting

This is where budgets are imposed by top management without the participation of the people who will actually be involved in implementing it.

• Bottom-up budgeting
  

Here the budget-holders do participate in the setting of their own budgets.

8.3 Target setting and motivation

Targets can assist motivation and appraisal if they are set at the right level.

• if they are too difficult then they will demotivate
  

• if they are too easy then managers are less likely to strive for optimal performance
  

• ideally they should be slightly above the anticipated performance level
  

Good targets should be:

• agreed in advance
  

• dependent on factors controllable by the individual
  

• measurable
  

• linked to appropriate rewards and penalties
  

• chosen carefully to ensure goal congruence

8.4 Budgets and evaluation

Budgets are often used for the evaluation of performance: hit a budget and you’ve done well, miss it and you could be in trouble. However, proper evaluation requires care as performance might not be controllable and, indeed the budget could have been or could become incorrect.

Hopwood identified three approaches to the use of budget information by managers in performance evaluation:

Budget constrained style:   A cost overrun or a revenue shortfall is always bad and is always the subordinate’s fault. Even if the subordinate had spent more for a good reason (for example to appease a very important customer who had had poor service), that expenditure would be criticized - even though it might have led to the customer being retained. This approach leads to very bad relations between superior and subordinate; it can also lead to misreporting.

Profit conscious style:   Long–term profitability and long term performance are the important measures. Cost overruns will be looked at, but will usually be tolerated for the sake of long-term success. This is probably how most of us would like to be managed.

Non-accounting style:   Here, the manager is not particularly interested in accounting and budgets. At one stage this approach would have been found in many hospitals in the UK. Treatments were relatively basic and cheap and expenditure didn’t have to be watched. Now with more expensive treatments and an aging population, financial budgets have become much more important.

8.5 Responsibility accounting

A system of accounting that separates revenues and costs into areas of separate responsibility, which can then be assigned to specific managers. This can improve performance provided there is no doubt about who is in charge of achieving results and provided that person can influence the results.

8.6 Management by objectives

A system of management incorporating clearly established objectives at every level of the organisation. Here there is less emphasis on monetary budgets and more emphasis on taking action which helps the business to achieve its objectives.

Employees are given objectives then it is substantially left up to them to decide how to achieve those objectives. It can be very motivating because employees are given the responsibility to choose how best to meet their objectives.

9 Budgeting in not-for-profit organisations

Issues that tend to arise in budgeting that are specific to not-for-profit organisations include the following:

• There might be little control over revenue. For example, it might arise from an allocation of government money.
  

• There might be no revenue because goods and services are provided free. Therefore, how is success to be identified?
  

• The organisation may be prevented from borrowing funds or from budgeting for a deficit.
  

• The organisation may not be allowed to transfer funds from one budget head to another.
  

• The budgeting tends to be just for one financial year (i.e. short-term rather than long-term) incremental budgeting is the method most widely used.