Utilization Of Budgeting And Standard Costing System As Planning And Performance Measurement Tools In Essay.

Explain the utilization of two tools named as budgeting and standard costing system that are applied by managers as planning and performance measurement tool.

Budgeting as a Planning and Performance Measurement Tool

Performance management is a procedure though which the managers and employees of the organization plan and work together in order to measure and review the entire performance of the organization. There are several tools and techniques of the performance management that are employed by the companies in their businesses so that correct evaluation of their activities can be done and managers can take appropriate decisions regarding the same (Bhattacharyya, 2011). The report discusses about the utilization of two tools named as budgeting and standard costing system that are applied by managers as planning and performance measurement tool. These tools help the management in taking better decisions by allowing them to compare the actual results with the standard or set targets.

The procedure of creating plans and preparing budgets for the function of different departments of the organization is called budgeting. The term budgets mean quantitative statements that represent the estimated expenditure and income of the company for a specific period of time. It communicates the strategy, policies, plans, goals and objectives decided by the management to the employees and other executives for a specified period of time. Budgeting involves preparation of different type of budgets such as cash budget, sales budget, material purchase budget and others in accordance with the requirements of the department.  It is considered as the most important function of management and is carried out at all the level of organization. All the private and public companies undertake budgeting for the purpose of predicting the future income and expenditure for a particular period. For the organizations working at large scale, budgeting is considered as the collective process as it involves each and every department or division to prepare their own budget and plan their own objectives that completely align to the ultimate goal of the company. Budgeting system helps the management to carry out its function of planning easily and also contributes in the measurement of organization’s performance (Baiocchi and Ganuza, 2014).

The main objective of budgeting is to create a balance between the available resources of the company and the money invested in it. This will eventually help in facilitating the smooth functioning of the operations. In order to create such balance, organizations are required to plan, control and prepare budgets according to their set and predetermined target. Another objective of applying budgeting in the business is to help the management in making appropriate and suitable decisions (Bogsnes, 2016). By knowing in advance the expenses and income, managers can take correct actions in order to fulfil the same. The budgets prepare provides a financial framework that help the management in following a proper decision making process for its organization. The budgets created help the managers in formulating correct and suitable strategies which can be applied in order to curb expenses to the maximum extent. Furthermore, the process helps in deciding what and how much money is to be spent and how to eliminate the unnecessary expenses so that more revenue can be made (Gallani, Krishnan, Marinich and Shields, 2018).

Objectives of Budgeting

Considering the planning function of management, budgeting is of great use as it allows them to forecast the future income, expenses, profits and losses. It provides a Performa in financial aspect which outlines all the expenditures that are to be incurred in future in relation to the respective incomes. Estimation of such amounts are of great help for the organization as they can plan their operations accordingly and can decide what to produce and how much to produce. Deciding everything in advance will eventually help the company to improve its performance and position over the years. Budgets also play a role in establishing control in the organization and therefore it is said that it is a performance measurement tool. It is used to measure the actual performance of the company against the set or predetermined targets (Lalli, 2012). Although there are various other tools and techniques which are used for the purpose of measuring the performance but budgeting is considered to be the mainstay of performance measurement in many companies or organizations. Large number of entities relies mainly on their budgets in order to measure their actual achievement with the set targets. The performance of the company is monitored against the budget and all the departments are required to function in accordance with the budgets so that the operations can be carried out at ease and in alignment with the main motives of the firm (Miller, 2018). 

Being a performance measurement tool, the budgets eventually stimulates the control process in an organization. It is used for comparing the actual results with the set ones and the deviations or variations are identified. Once the gap between actual and budgeted result is identified, the management then take corrective measures to resolve the issue and make sure that the same would not occur in future. Such comparison brings control in the business as employees are motivated to perform according to the planning done and within the budget (Rubin, 2016). Measurement of actual results help the managers in their decision making process. Identification of the deviations will eventually force the managers to take suitable steps in accordance to it. So, on a whole it can be said that applying budgeting system in the business will facilitate the planning function of the management and is also used as a performance measurement tool in order to stimulate the better decision making process.

Apart from this, budgeting also has some advantages that it helps in predicting the profitability of the company by making estimates of all the income and expenses for a particular financial year.  The system allows the managers to think for a long run by considering its competitive and financial position for the year. Other benefits include allocation of cash, planning for raising funds, conducting a bottleneck analysis and others.  However, apart from having such benefits, the system of budgeting has its own limitations also. One of them is that the creation of budgets is very costly and time consuming process. It requires more expertise and more knowledge and become more complex when performed in an organization operating at large scale. Moreover, some of the budgets prepared are rigid in nature as such their facts and figures cannot be easily modified according to the changes in the organization. Any fluctuation in the market cannot be properly addressed by the company if the budgets are not flexible. In addition to that the system of budgeting can be manipulated by the senior executives for the purpose of meeting their own individual goals. The officers can reduce the revenue or increase the expenses according to them for the purpose of taking benefits (Kelly and Rivenbark, 2014).

Advantages and Limitations of Budgeting

Nevertheless, despite having some limitations budgeting is that key system or function on which the whole management is relied upon for the purpose of performance evaluation. Keeping aside its weaknesses, it helps the firm to evaluate and measure its actual performance against the budgeted targets. Also, it results in enhancing the planning function of the managers as preparation of budgets requires them to think and plan in advance about the income and expenditure of the company for a particular year. So, on a whole it is interpreted that budgeting system serve as planning and performance measurement tool with an objective to assist the management in making suitable decisions (Barr and McClellan, 2018). 

It is known as a method of costing through which standard costs are employed in the business. According to ICMA, standard costing is a procedure of preparing and applying standard costs, comparing them with the actual costs, identifying the variances and analysing the same for finding out the causes of the differences. The system of standard costing showcases the cost of deviations from standards and determines their causes in order to make the management aware about the same immediately so that proper action can be taken within the time frame. The process involve ascertainment and application of standard costs, reporting of actual costs, comparison of both the elements, analysis of variances and after that implementation of appropriate course of action for the purpose of addressing the variance. The standard costs are used as target costs and are formulated on the basis of historical data. They are always different from actual costs because of the uncertainties prevail in the organization’s environment (CIMA 2008).

The main objective of this system is to implement budgetary control system in the business and evaluate the performance of the company. Furthermore, the standard costing helps in motivating the employees to perform their best by setting up standards for themselves. It acts as a control device for the management by properly reviewing organization’s actual performance with the standard one. Standard costing helps in the planning function of the management in a way that managers are required to set out some standards in advance so as to measure the actual performance of the company. This requires them to make certain assumptions such as no machinery or worker problems. However, standards form on this premise is ideal and unrealistic in nature (Kaplan and Atkinson, 2015). They can only be achieved in the situation where the company has highly skilled workers who are giving their best to the organization. On the other side, practical standards are strict but attainable as the companies can accomplish them if workers perform efficiently. These practical benchmarks are used in planning function of the management as they are comparatively more realistic, allows machinery repairs and rest periods for the workers. Furthermore, at time of developing budgets, organizations use standard costs to evaluate the worker’s performance, management’s performance and setting suitable selling prices. The costs set under standard costing system are very much useful in setting the selling prices as the budgets prepared shows the estimated expenditure which are used to determine the amount to be charged for a product so that a desired net income can be earned on sale of the same (DRURY, 2013). 

Standard Costing System as a Planning and Performance Measurement Tool

Being used as a performance measurement tool, standard costing technique help in comparing the actual cost of the business with the standard cost identified earlier. Such evaluation or comparison provide insights to the management about the variances identified and help it to conduct a proper analysis of the same. Variance analysis will eventually lead to the better performance of the company as the managers are aware about the gaps that occurred between the actual and standard results. Also, implementation of correct course of action within the suitable time frame will result in the removal of variances and improvement in the performance of the business. Along with the regular analysis of the variances, standard costing allows the managers to compare the actual results with the expectations so that the causes of deviations can be identified. By then addressing those causes, organization can sustain uncertainties (Berger, 2011).

The utility of standard costing system aids management to make correct predictions and provides a framework for judging the business performance. The utility of the system is as follows:

• It is considered to be a valuable guide for the management as it helps in formulating polices related to price and production of the product and services. For instance, it is used in profit planning, inventory pricing and others.
• The concept provides a stable basis of comparing the actual and standard costs in accordance with the different element of costs. It also provides insights about remedial actions and probability of improvement in the long run (Rajasekaran, 2010). 
• The utilization of standard costing creates an environment of cost consciousness at the workplace and also provides incentives to the individuals working at different level of organization.
• It helps the management to create a more effective and efficient budget for the year. Also the concept of management by exception can be exercised properly by applying the standard costing system in the business.

Apart from these utilities, the system has several advantages which are been taken by the companies who are applying this concept in their operations. One of the benefits is that compilation of standard cost eliminates the weakness of traditional costing system. The costs set as standard are used as a yardstick for the purpose of comparison. In addition to that, variance analysis helps the managers to have proper and regular checks on the costs that are incurred. By doing this, managers can concentrate solely on the variances only and rest aspects of cost control can be look after at lower level. The application of standard costing makes the reporting of operations more meaningful and relevant. Also it assists the management in interpreting the reports easily. Overall, it helps in making efficient utilization of the resources and human capital available with the company (Course, 2015). However, like every technique has some advantages and disadvantages, standard costing also has its own limitations. One of them is setting of a standard which is a very difficult task for the managers as it requires a lot of expertise and knowledge such as understanding of time study, fatigue study and others. Also, because of this it proves to be very costly for the firms operating at small scale. Furthermore, standards are rigid and once set cannot be changed for a considerable amount of time. This makes them highly unrealistic for some industries where fluctuations or movements in the prices of product are regular thing. Moreover, revising the standards is also not easy as the cost would be high in doing the same. The variance analysis is also depending upon the standards set and the loose and high standards can create several problems in the organization (Panchenko, 2017).

Objectives of Standard Costing System

Overall, it can be said that the standard costing system can be applied by any type of industries or companies in order to make their planning and performance efficient. It is used as a management tool by most of the managers as it helps them in performing their functions effectively and assists them in taking important decisions in the best interest of the organization. Comparing the performance with the set benchmarks provide great insights to the management as it allows them to overlook the factors which have affected the performance. In addition, it also make them aware about the costs which have incurred more than the standard one. This will eventually lead them towards a correct decision making process in respect of the costing of the operations. So on a whole, standard costing is an effective tool of management that improvise the entire performance and functions of the companies (Horngren, Bhimani, Datar, Foster and Horngren, 2002). 

Conclusion

The report concludes that it is very important for the management of an organization to employ such measurement tools as it will eventually results in improved functions of the managers and employees. Budgeting and standard costing helps in making appropriate planning regarding the expenses, incomes, costs, profits and losses of the business for a particular financial year. Also they provide set targets and standards, against which managers can measure the actual performance of the company and figure out the variances and their causes. This ultimately results in appropriate decision making on part of management which eventually improvise the position and performance of the company.

References

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Barr, M.J. and McClellan, G.S. (2018). Budgets and financial management in higher education. New Jersey: John Wiley & Sons

Berger, A. (2011). Standard Costing, Variance Analysis and Decision-Making. Germany: GRIN Verlag.

Bhattacharyya, D.K. (2011). Performance management systems and strategies. India: Pearson Education.

Bogsnes, B., (2016) Implementing beyond budgeting: Unlocking the performance potential. United States: John Wiley & Sons.

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Course, U.G. (2015). Department of Commerce. Computer, 6, pp.7-7.

DRURY, C.M. (2013). Management and cost accounting. USA: Springer.

Gallani, S., Krishnan, R., Marinich, E. and Shields, M.D.,(2018). Budgeting, Psychological Contracts, and Budgetary Misreporting. United States: John Wiley & Sons.

Horngren, C.T., Bhimani, A., Datar, S.M., Foster, G. and Horngren, C.T. (2002). Management and cost accounting. Harlow: Financial Times/Prentice Hall.

Kaplan, R.S. and Atkinson, A.A. (2015). Advanced management accounting. New Delhi: PHI Learning.

Kelly, J.M. and Rivenbark, W.C., (2014) Performance budgeting for state and local government. California: Routledge.

Lalli, W.R., (2012). Handbook of budgeting (Vol. 562). New Jersey: John Wiley & Sons.

Miller, G. (2018). Performance based budgeting. United Kingdom: Routledge

Panchenko, A. (2017). Standard Costing: Advantages and Disadvantages. Available at: https://eztuir.ztu.edu.ua/jspui/bitstream/123456789/6503/1/193.pdf

Rajasekaran, V. (2010). Cost accounting. India: Pearson Education India.

Rubin, I.S., (2016) The politics of public budgeting: Getting and spending, borrowing and balancing. Chicago: CQ Press.

Wildavsky, A., (2017) Budgeting and governing. California: Routledge.