Free Custom «Flexible Budgeting (Advanced Managerial Accounting)» Essay Paper

Introduction

Budgeting is often carried by most firms because it serves as a framework for measuring performance, planning and control. Whereas the budget process results in the development of a single budget, several draft budgets are usually sketched in the process (Bhimani, Horngren, Datar, & Foster, 2008). This draft budgets take into consideration uncertainties that may emerge after business operations commence; for instance, it is relatively difficult to approximate the future market demand; therefore, producing the draft budgets for the various demand levels requires one to have knowledge of how revenues and cost behave with respect to the various levels of activity (Villiers, 2007). This information can play an integral role in ensuring that there is better control. Bragg, (2001) points out that the concept of flexible budgeting is not a new methodology. Firms such Gillette and General Motors have been using this technique since their establishment. According to Drucker (2002), flexible budgets can be adjusts to address the changes in the volume of activity. In addition, flexible budgets can also be used as a performance evaluation tools when used together with the static budget. A fundamental rule of thumb regarding the use of flexible budgets is that they act as a business cycle analysis tool; therefore, they cannot be drafted prior to the end of the business cycle. Evaluating the flexible budget during the end of the trading period plays an integral role in helping the management to fine-tune the static budget forecasts of the next trading cycle so as to match the dynamic nature of the operational costs. In this regard, Drury (2008) perceives a flexible budget as an end of trading cycle actual accounting for the expense, which can be used to compare with the initial static budget. This paper discusses how flexible budgeting can be applied in performance and evaluation, particularly with regard to the physical measures of sustainability performance in order to have a more precise picture of performance. The paper first provides an overview of flexible budgeting, after which it analyzes how flexible budgeting can be applied in measuring sustainability performance. A case study of Bacardi Limited is used to facilitate this discussion.

 

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Overview of Flexible Budgeting

Grahame (2012) points out that, planning budgets are usually intended for a single, planned volume of activity and that evaluating performance is relatively difficult in cases whereby the actual activity is different from the planned volume of operational activities. Flexible budgets can be prepared to meet the needs of any activity volume within the reasonable range; it indicates the costs that the firm should have incurred if the predictions could have been accurate, which facilitates apples to apples comparisons. Horngren (2003) argues that flexible accounting is an important tool that managers can use to control operational costs and enhance performance evaluation.           

Flexible budgeting is a core requirement for businesses; this is because firms that fail to accurately monitor their shifting expenses in comparison with the initial static budget have difficulties in reporting their actual earnings accurately. According to Juan (2007), flexible budgeting helps businesses in four ways: helps firms to adjust for predictions, adapt to change, control and evaluation, and variance and inflation. During the preparation of fixed budgets, it is assumed that one can predetermine the volume of activities such as production and sales quantities. However, there are factors that the business cannot control, which increases the likelihood that the estimates may not turn out as approximated in the budget. This poses the need to adopt a flexible budget, which is adjustable according to the volume of activity within a reasonable range. In this regard, Kinney & Raiborn (2008) asserts that a flexible budget can help the firm make adjustments in case the activities are not as forecasted.

With regard to adapting change, it is apparent that the business environment is increasingly becoming dynamic; as a result, businesses have the need to adapt to these changes if they are to be successful. A flexible budget comes in handy as one of the methods to adapt to these changes, initiate operational adjustments on a timely manner, and exploit the opportunities arising from the changes in the external environment. With regard to the role of control and evaluation, Maher (2005) points out flexible budgeting enables the business to control the costs; this is because it shows the deviation from the actual performance and planned performance. The flexible budget variance points out the difference between the actual costs and the budgeted costs. According to McLaney & Atrill (2007), flexible budgeting plays an instrumental role in helping businesses to trace the variances between the planned estimated and the actual estimates. Drafting a static budget entails making assumptions and predictions regarding the sales, the economic and market variables and other factors that are likely to affect the business prior to the commencement of business operations; however, there is a likelihood that these assumptions are likely to be false (Siciliano, 2003). However, information used in drafting the flexible budget is derived from actual results, which allows firms to make adjustments on the static budget for precision and compare the outcomes with the planned forecasts. The firm can compare the actual profits and line-by-line operational costs outlined in the flexible budget with the approximations outlined in the static budget. According to Mocciaro, Picone & Minà (2012), variance information can help the firm to improve its operational efficiency and trace problem areas. Having provided an overview of how flexible budgets work, the following section discusses how flexible budgeting can be applied in sustainability performance.

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Flexible Budgets and Sustainability Performance: The Case for Bacardi Limited

From the above discussion, it is apparent that flexible budgeting is best suited to address the financial changes that a firm may experience in the course of its operation when compared to a static budget having the same figures regardless of the changes. As a result,  Bartley et al. (2012) considers a flexible budget as the most ideal budget that can be used in determining and evaluating how a firm is performing; this is because it offers specific figures for various groups relating to the business. Flexible budget reports can be used in the evaluation of various types of performances such as marketing, sales, employees as well as sustainability performances. According to Bartley et al (2012), one of the most ground-breaking applications of flexible budgets relates to performance indicators of sustainability, which is important in helping businesses that are aiming to adopt strategies to be environment friendly. Just like other operational aspects of the business, flexible budgeting can be used to evaluate how the firm is performing with regard to sustainability key performance indicators (KPI). In this regard, Bartley et al (2012) suggests that managers can incorporate flexible budgeting principles on sustainability processes, which the authors refer to as activity-based flexible budgeting approach (Saudagaran, 2009).

Bartley et al (2012) asserts that the activity-based flexible budgeting serves to address the concerns raised regarding the view that aggregate measures fail to capture the actual improvement rates. For instance, for the case of Bacardi, a change in production mix from Scotch Whiskey to rum could result in increases in green house gas emissions even in cases whereby the emissions per unit of both rum and Scotch Whiskey are lessened (Proctor, 2006). This budgeting approach facilitates the computation of efficiency of sustainability KPIs, which are not unclear when the productions mix changes. Furthermore, these metrics can be in the form of aggregated cross product lines in order to offer efficiency improvement measures that are company-wide and are not distorted when the company changes its production mix. For the case of Bacardi, the efficiency metrics are used internally to support decision-making, control and planning. The resulting efficiency improvement measures (aggregate performance indices) can be compared with the absolute sustainability performance measures in order gauge the firm’s performance as regards sustainability. This is a hypothetical picture of how Bacardi applied flexible budgeting with regard to sustainability measures.

It is evident that the activity-based flexible budget model used by Bacardi makes use of flexible budget variance analysis to evaluate its sustainability performance improvement. Warren & Reeve (2011) defines flexible budget variance as the difference existing between the amount the firm intends to spend and the amount that it actually spends during a given trading cycle. In this regard, the variance could be either positive, which implies that the costs exceeded the budget, or negative, which implies that the actual costs were relatively lower when compared to the planned costs. According to Juan (2007), the concept of flexible budget analysis can help firms to measure the performance of various aspects. When the firm’s actual performance is different from what was planned for a given trading cycle, the flexible budget variance analysis plays an integral role in cost control and performance evaluation. In order to use flexible budget variance analysis, a firm must have a static budget, which spells the costs for a given trading cycle for the various forms of business operations such as sales, marketing, and advertising among others (Velmurugan, 2010). The variations in the actual costs with the projected values offer valuable information regarding the firm’s performance. With regard to performance measurement, Velmurugan (2010) highlights two significant attributes of performance that are often evaluated using flexible budget variance analysis, which include efficiency and effectiveness. Effectiveness refers to the measure to which the predetermined objective is achieved whereas efficiency refers to the amount of input that firm uses to achieve a given level of output.

The performance evaluation tool used by Bacardi Limited (the activity-based flexible accounting) is a replica of the flexible budget variance analysis. For instance, the firm commences by determining the relationship existing between the amounts of a particular sustainability KPI with regard to the activity level of a selected base year (Bartley et al. 2012). In this regard, Bacardi measures the carbon dioxide emissions levels of a Scotch whiskey distillery for a given base year, say 2010, which it produced about 10,000 liters of alcohol and emitted about 20,000 units of carbon dioxide. As a result, for the year 2010, the rate of carbon dioxide emissions is calculated to be 2 units of carbon dioxide emissions per 1000 liters of alcohol. At the end of 2011 trading year, Bacardi multiplies the actual activity level of 2011 (say 12,600 liters of pure alcohol) with the rate from the base year, which results in the flexible budget of 2011, which is 25200 units of carbon dioxide (obtained by 2 units x 12,600 liters). This draws on the assumption there are no changes regarding the efficiency. After this, the firm compares the actual amount of carbon dioxide emissions during 2011 (say 20,300 units) with the amount in the flexible budget of 25,200 units. From an accounting perspective, the flexible budget variance is given by 4900 carbon dioxide units. However, Bacardi Limited converts the variance to an index number; for instance, the index for 2011 is computed by (100 X 20300 units)/ 25200 units, which is equal to 81. This analysis points out that efficiency of carbon dioxide emissions at the distillery has improved by 19 percent (Bartley et al. 2012).

From the method adopted by Bacardi Limited (activity-based flexible budgeting), similarities between the process and the preparation of a flexible budget for performance evaluation can be deduced. For instance, Bacardi Limited Methodology entails the use of per unit values, which is similar to costs per unit for the case flexible budgeting. In flexible budgeting, price variance is computed by this formula: (actual price of input – planned price of input) X the actual quantity of input. The efficiency variance is computed by: (actual quantity of input utilized – planned quantity of input for the actual output) x the budgeted price of input. From these, it is apparent that efficiency variance in flexible budgeting is similar to the index number adopted in Bacardi Limited’s methodology Smith (2007).

Conclusion

This paper has discussed the concept of flexible budgeting and how it can be adapted to the performance measures of sustainability using the activity-based flexible budgeting. It is evident that evaluating the flexible budget during the end of the trading period plays an integral role in helping the management to fine-tune the static budget forecasts of the next trading cycle so as to match the dynamic nature of the operational costs. Flexible budgeting helps businesses in four ways: helps firms to adjust for predictions, adapt to change, control and evaluation, and variance and inflation. With regard to the adaption of flexible budgeting in measures of sustainability, the concept of variance analysis comes in handy for firms seeking to adapt flexible budgeting concepts in sustainability performance. In order to use flexible budget variance analysis, a firm must have a static budget, which spells the costs for a given trading cycle for the various forms of business operations such as sales, marketing, and advertising among others. The variations in the actual costs with the projected values offer valuable information regarding the firm’s performance.