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Budgetary Control: Advantages and Disadvantages

Budget and budgetary control are the two most important aspects of any business. The budgetary control acts as a complimentary aspect to budget and works and in hand. Budget can e termed as an accounting concept, whereby, an organization and its members, try to define the trend of activities of an organization during a course of time, depending on the past experience. Budgets, comes up various figures relating to sales, purchase etc. and puts forward a frame of reference in front of its employees and other members. Thus, it helps an organization to keep a check on its present activities in relation to budget thus provided, and this check in words can be termed as budgetary control.
Budgets, by definition, have to be prepared in advance; and as a result, often referred to as the feed forward system. Feed forward incorporates the most important aspect of budgeting: looking at situations in advance, thinking about the impact and implications of things in advance and attempting to take control of situations in advance. Budget and budgetary control seems to stream line the activities of organizations and provides a disciplinary outlook. Budgets are often termed as integral part of any business and thus, play a vital role in a organizational success. In the following report, an attempt has been made to put across a brief overview in regard to the same.
A budget can be described as a plan expressed in quantitative and money terms. Budgets are usually prepared and approved in advance and take into consideration the period it needs to be used and the similar period on the previous years.
Budgets are prepared to put across a picture whereby, an organization tries to implement different actions and planning to attain the budgetary figures. Budgets are prepared on a department wise as well as a whole. The budgetary figures put across helps an organization to gear up its activities and often act in boosting up the employee motivation. However, since budget and budgetary facts and figures relates to future, the forecasting and its preparation should be taken care off.
BUDGETORY CONTROL As already mentioned, budget and budgetary control works hand in hand. A budget puts forward the financial data representation of certain facts and figures depending on the past, which needs to be fulfilled in the near future. However, budgetary control ensures the fact that the budget is properly followed and an organization attains the predetermined growth. In other words, the concept of budgetary control can be described as an action relating to the usage on the budget to attain pre-determined organizational success. The whole phenomenon can be described as a chain of activities whereby, budgets are prepared to attain an organizational goal and then, the successful implementation and following those figures in different sphere of activities can be described as budgetary control.
In simple words, budgetary control relates to the establishment of budgets relating the responsibilities of budget holders the needs of a policy. Budgetary control also relates to the continuous comparison of actual with budgeted results to ensure that the objectives of the same are properly achieved; or to provide a basis for the change of those objectives.
In summary, a budget is a statement setting out the monetary, numerical or non quantitative aspects of an organisation’s plans for the coming week or month or year. Budgetary control is the analysis of what happened when those plans came to be put into practice, and what the organisation did or did not do to correct for any variations from these plans.
BENEFITS OF BUDGET AND BUDGETARY CONTROL Budgets provide benefits both for the business, and also for its managers and other staffs:
The budget assists planning – A budget is prepared for the future in order ensures proper allocation of resources among all the departments and so that the organization attains the predetermined success. A budget thus assists a business to plan its future course of action.
The budget communicates and co-ordinates – A budget once prepared and accepted by the authority is usually communicated to all the departments and other members so that all the work can be properly co-ordinated. The budget helps in controlling over-utilisation of resources or increase in cost/expenses and a decrease in incomes/sales.
The budget helps in decision-making process – A budget is designed kept in mind the future course of action and thus, helps in the decision-making activities of the future.
The budget can be used to monitor and control – A budget helps in keeping a control on the overall activities of a business organization.
The budget can be used to motivate and control – A budget puts forward certain monthly and quarterly figures which different departments needs to attain during that specific. Often on attaining such figures, the employees are rewarded with bonus or increments.
The budget maintains a discipline – A budget helps an organization to maintain a discipline over its expenditure trends and thus, keeps a maintains an organizational discipline.

Analysis of Conceptual Frameworks in Accounting

Introduction International Accounting Standards Board (IASB) has begun a mutual project with US Financial Accounting Standards Board (FASB) to rebuild the existing frameworks and converge them into a common framework. First, some background. The US Securities and Exchange Commission (SEC) has proposed that companies required to file financial statements with the SEC begin replacing U.S General Accepted Accounting Principles (US GAAP) with International Financial Reporting Standards (IFRS) beginning in 2014. For all practical purposes this means the eventual adoption of IFRS (principles-based) for all companies in the United States (U.S. accounting standards are considered to be rule-based model). The shift aims to harmonize US accounting standards to an international one in tandem with the globalization of capital markets.’Norwalk’ agreement between the FASB and the IASB was signed paving the way for the creation of more principles-based accounting standards for global financial reporting (Wikipedia, 2010).
What is a Conceptual Framework? International Conceptual Framework of Financial Reporting is a system of interactive objectives and fundamentals which lays out a set of consistent standards in preparing financial reports.A conceptual framework is akin to a constitution that prescribes the nature, function and limits of financial accounting and financial statements.
Why is a conceptual framework necessary? First, to be useful, standard setting shouldbuild on and relate to an established body of concepts and objectives. A soundly developed conceptual framework should enable the IASB or FASB to issue more useful and consistent standards over time. A coherent set of standards and rules should be theresult, because they would be built upon the same foundation. The framework should increase financial statement users’ understanding of and confidence in financial reporting, and it should enhance comparability among companies’ financial statements. Second, new and emerging practical problems should be more quickly solved byreference to an existing framework of basic theory. For example, PandaCorporation sold two issues of bonds that it would redeem either with $1,000 in cash or with 50 ounces of silver, whichever was worth more at maturity. Both bond issues had a stated interest rate of 9 percent. At what amounts should the bondshave been recorded by Panda or the buyers of the bonds? What is the amount ofpremium or discount on the bonds and how should it be amortized, if the bond redemptionpayments are to be made in silver (the future value of which was unknownat the date of issuance)?It is difficult, if not impossible, for the FASB or IASB to prescribe the proper accountingtreatment quickly for situations like this. Practising accountants, however, must resolvesuch problems on a day-to-day basis. Through the exercise of good judgment and withthe help of a universally-accepted conceptual framework, practitioners can dismiss certainalternatives quickly and then focus on an acceptable treatment.
Harmonization of accounting standards is very important. For instance, Multinational companies doing business in more than one country will find that it is difficult to comply with more than one set of accounting standards established by authorities in different nations.
Harmonization of accounting standards will help the world economy in the following ways: by facilitating international transactions and minimizing exchange costs by providing increasingly “perfect” information; by standardizing information to world-wide economic policy-makers; by improving financial markets information; and by improving government accountability. International investment decisions and financial-based management decisions are then made with less risk.
Furthermore, harmonization of accounting policy would help provide a “level playing field” globally. Regulators and auditors will be receiving the same information, facilitating the evaluation process.
In today’s accounting environment, there are two formats of accounting systems, namely principles-based system and rules-based system.Almost all companies are required to prepare their financial statements according to one of the two standards. Recently, there has been much debate on whether principle-based accounting would be more efficient than the popular rules-based accounting, in the wake of accounting scandals, such as Enron. As a result of the Enron saga, the current way of accounting has been come under a great deal of scrutiny.
Rules-based Accounting Rules-based accounting such as US GAAP is basically a list of detailed rules that must be followed when preparing financial statements. Many accountants favor the prospect of using rules-based standards, because in the absence of rules they could be brought to court if their judgments of the financial statements were incorrect. When there are strict rules that need to be adhered to, the possibility of lawsuits is diminished (Investopedia, 2009). Having a set of rules can increase accuracy and reduce the ambiguity that can trigger aggressive reporting decisions by management. The matrix of rules, however, can cause unnecessary complexity in the preparation of financial statement
Principles-based Accounting Principles-based accounting such asIFRS is adopted as a conceptual basis for accountants. A simple set of key objectives are set out to ensure good reporting, e.g. qualitative characteristics, faithful representation. Common examples are provided as guidelines and explain the objectives. Although some rules are unavoidable, the guidelines are not meant to be used for every situation (Investopedia, 2009). Precise requirements can sometimes compel managers to manipulate the statements to fit what is compulsory. The problem with principles-based accounting is that lack of guidelines can yield unreliable and inconsistent information that makes it difficult to compare one organization with another.
When contemplating which accounting method is best, it must be made certain that the information provided in the financial statements is relevant, reliable and comparable across reporting periods and entities. Increased discussion has pushed accountants towards principle-based accounting, but it is recognized that the method needs to be modified to make it more effective and efficient.
To illustrate thecomparison, for example, depreciation expense for all fixed assets is to be set at 10 percent per annum of the original cost of the asset until the asset is fully depreciated.Such a rule leaves no room for judgment or argument about the amount of depreciation expense to be recognized. Comparability and consistency across firms and through time is virtually assured under such a rule. This is a rules-based system.In contrast, under the principles-based system, depreciation expense for the reporting period should reflect the decline in the economic value of the asset over the period. Such a standard requires the application of judgment and evaluation by both managers and auditors. The goal is to register the realistic value of the asset according to “as is” basis.
Differences between IFRS and U.S. GAAP Statement of Income – Under IFRS, extraordinary items are not segregated in the income statement, while, under US GAAP, they are shown below the net income.
Consolidation – IFRS favors a control model whereas U.S. GAAP prefers a risks-and-rewards model. Some entities consolidated in accordance with FIN 46(R) may have to be shown separately under IFRS.
Inventory – Under IFRS, LIFO (Last In, First out) cannot be used while under U.S. GAAP,companies have the choice between LIFO and FIFO (First In, First Out). Using the LIFO method results in lower gross profit, which allows a company tobe taxed less.
Earning-per-Share – Under IFRS, the earning-per-share calculation does not average the individual interim period calculations, whereas under U.S. GAAP the computation averages the individual interim period incremental shares.
Development Costs – These costs can be capitalized under IFRS if certain criteria are met, while it is considered as “expenses” under U.S. GAAP(Remi Forgeas, 2008).
Advantages Rules-based System
Increased accuracy, reduced ambiguity and a diminished possibility of lawsuits.
Rule-based standards are generally considered easier to audit for compliance purposes, and may produce more consistent and comparable financial reports across entities.
Auditor display higher confident in decision making because they have a bright-light guidelines.
Principles-based System
The fundamental advantage of principles-based accounting is that its broad guidelines can be practical for a variety of circumstances
Potentially very flexible with regard to new and changing products and environments. As such, they should also require less maintenance.
Another advantage of a principles-based system is that it would result in simpler standards. Principles-based system would lead to standards that would be less than 12 pages long, instead of over 100 pages.
Accountants are afforded the flexibility to input their expertise and judgment more freely in line with the professional code in producing the financial statements. Such deployment of their skills and experience will enhance their professionalism.
Disadvantages Rules-based System
Lack of transparency of disclosure. In the wake of recent accounting scandals, such as Enron and Worldcom, investors are becominghypersensitive to the reliability of published accounts and suspicious of the possibility of inflated earnings.
The major drawback to a rules-based system is the complexity in the preparation of financial statements
May include a lack of flexibility with regard to changing conditions and new products, hence requiring almost continual maintenance at times.
Frequently subjectto manipulation as entities may search for loopholes that meet the literal wording of the standard but violate the intent of the standard.
Principles-based System
Critics of a principles-based approach argue that financial statements are more difficult to audit andwould likely lose their comparability and consistency across industries and issues regarding income measurement and recognition would remain controversial. For example, how much income will General Electric actually recognize on a multi-year defense contract under the percentage of completion method of accounting? Will this be comparable to the income reported by its competitors?
To the extent that they rely on individual judgment to interpret and implement the standards, there is a danger that they can be used to manipulate financial results. For example, what ifthe auditors behaving badly? Abuse their trust and fail to apply the principles in “good faith consistent with the intent and spirit of the standards.”
Auditors display less confidence in their decisions.
Between the rules-based and principles-based modules, it is felt that the latter will be more practical and preferred by the global community, given its universal appeal based on ethics, sound judgment, transparency, credibility and even downright common sense factors. Moreover, in the globalised business arena, this system would be easier to adopt, comprehend
and acceptable as against rigid rules that may be interpreted differently from one country to another.
Example Cases Enron Case
U.S. accounting standards are considered to be rule-based model. For example, we look at the Enron scandal, which broke in October 2001 and eventually led to the collapse of the Enron Corporation. Through the use of accounting loopholes, special purpose entities (SPE), and poor financial reporting, Enron was able to cover up billions of dollars in debt from failed deals and projects.In the U.S, Accounting law allows a company to exclude a SPE from its own financial statements if an independent party has control of the SPE, and if this independent party owns at least 3 percent of the SPE.
Enron needed to find a way to hide the debt since high debt levels would lower the investment grade and trigger banks to recall lendings. Using the Enron’s stock as collateral, the SPE, which was headed by the CFO Fastow, borrowed large sums of money. And this money wasused to balance Enron’s overvalued contracts. Thus, the SPE enabled Enron to convert loans and assets burdened with debt obligations into income. In addition, the taking over by the SPE made Enron transfer more stock to SPE. However, the debt and assets purchased by the SPE, which was actually burdened with large amount of debts, were not reported on Enron’s financial accounts.
Enron was also guilty of using a dubious mark-to-market accounting system in its forward gas contract sales whereby income was estimated as the present value of net future cashflows to indicate “true economic value”. When these projects faltered, income was still recorded based on the initial value which of course was incorrect. As a result more projects had to be “created” to sustain a steady income inflow to appease the shareholders.
Shareholders lost nearly $11 billion when Enron’s stock price, which hit a high of US$90 per share in mid 2000, plummeted to less than $1 by the end of November 2001.
Transmile case
A special audit carried out by Moores Rowland Risk Management Sdn. Bhd, showed that Transmile made pre-tax losses of RM126 million and RM77 million for 2006 and 2005, respectively, instead of pre-tax profits of RM207 million and RM120 million as originally reported – a total of RM530 million in overstatement. Their auditors Deloitte