What Is Budgeting Methods in ACCA Performance Management?

When you're a professional accountant, the ACCA Performance Management (PM) syllabus teaches you that mastering all the content is necessary to get the best results when taking the PM examination. You will discover that one of the most vital areas of your studies includes different budgeting methods to plan, control, and evaluate an organization's performance.

For all students who will take part in the PM examination, or for any individual looking to advance their management accounting skills, you must learn how to use the correct budgeting method in the most effective manner. This guide discusses the key budgeting techniques that are most utilized, as well as the behavioral aspects of each technique, and how to differentiate them from each other to succeed on your examinations.

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The Purpose of Budgeting (The "CRIC" Acronym)

Before we delve into the individual budgeting methods, we should understand why organizations implement a budgeting methodology in the first place. Within the ACCA PM syllabus, we refer to the CRIC acronym for the four main objectives of budgeting:

• Coordination: This means that all departments (e.g., sales, production, finance) are "pulling together" towards the same objective.

• Responsibility: This is the level of accountability assigned to managers for their specific areas of responsibility.

• Incentivisation: This is where you create incentives for employees to achieve their targets (and often includes bonuses).

• Control: This involves comparing actual results to the budget to highlight variances.

  
  

By understanding the links between these four areas of goal setting, you can analyse a company’s balance sheet and income statements effectively because you can see where actual results deviated from the plan.

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Top 5 Budgeting Methods in ACCA PM

The exam will expect you to be aware of the four budget types and the definitions for ACCA PM Budget Types, and the level at which to use each budget type.

1. Incremental Budgeting

This budget type is a traditional method that takes the previous year’s results as the baseline and applies an increase for inflation or estimated activity increases, and is best suited for a stable company that has year after year consistency.

• Best for: Stable businesses with consistent year-on-year operations.

• Risk: It often leads to budgetary slack, where managers add "padding" to ensure they hit their targets.

2. Zero-Based Budgeting (ZBB)

Unlike incremental budgeting, ZBB begins from a "zero base," where each activity is justified from first principles for each upcoming period.

• Best for: ZBB is best for Public Sector companies and for companies wishing to cut costs drastically.

• Benefit: It provides a means to identify wasted resources and includes consideration of "decision packages" in order to make more informed decisions about how best to use limited resources.

3. Rolling Budgets (Continuous Budgets)

Rolling budgets are updated to reflect the latest (monthly/quarterly) accounting periods. Rolling budgets should be used by organizations that operate in dynamic business environments where they cannot rely on a fixed annual budget due to the speed of change in their markets and operations.

4. Activity-Based Budgeting (ABB)

Activity-based budgeting utilizes the same concepts and principles as Activity-Based Costing methods to determine the required resources necessary to produce finished products/services according to established production targets.

5. Beyond Budgeting

Beyond budgeting is a relatively new management philosophy that argues that the rigid nature of traditional annual budgets prevents organisations from effectively adapting to rapidly rising/rapid-falling business conditions. The beyond-budgeting model encourages greater levels of decentralised, participatory leadership and empowers managers to respond to market changes immediately.

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Fixed vs. Flexible vs. Flexed Budgets

Students often find it difficult to identify the differences between these three terms. Understanding how to distinguish between Fixed Budgets, Flexible Budgets, and Flexed Budgets is essential for any student striving for success in their studies, as well as for traders trying to develop successful trading strategies using Technical Analysis Tools.

• Fixed Budget - A Fixed Budget is a budget developed for a particular activity level (for example, producing 10,000 units).

• Flexible Budget - A Flexible Budget is a set of budgets created for various levels of activity (for example, 8,000, 10,000, or 12,000 units).

• Flexed Budget - A Flexed Budget is created after the end of a reporting period, and it is simply the original budget that has been adjusted to reflect the actual level of activity experienced. This allows for a true apples-to-apples comparison of budget vs actuals in the calculation of variances.

Behavioral Aspects

The human factors involved in budgeting methods should not be overlooked. The way in which a budget is created affects the overall morale and productivity of employees involved with budgets.

• Management leads/Imposes Budgeting - In this scenario, management sets the targets to be achieved. This may allow for quick goal alignment, but it can lose momentum among managers at lower levels.

• Manager Leads/Participates in Budgeting - In this instance, managers have input into setting their targets. This leads to higher levels of commitment and motivation among managers, but some managers may create excessive slack in the budget to secure bonuses by establishing less difficult targets.

  
  

Balancing the competing interests of both approaches, effectively managing risk within your budget, will allow you to set targets that are both challenging and achievable.

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Conclusion

The right method for budgeting will depend on your organisation's culture, environment, and goals. Incremental is simple, but the accuracy offered by ZBB and Rolling Budgets provides an advantage in today's fast-paced and constantly changing business world. As an ACCA student, you will need to consider these budgeting methods critically when judging your exam scenario.