In association with
Study notes
Notes
Study
Paper P2
Performance
Management
Too many students go into the exam without a firm
grasp of the syllabus and how topics will be examined.
This leads them to give unfocused answers when
they need to show their knowledge of specific areas
By Norwood Whittle, FCMA, CGMA
CIMA course leader at the University of Northampton
and lead marker for P2
O
ver the many years I have delivered
CIMA courses, I’ve noticed that
few candidates seem to examine the
syllabus in detail. Students might
be aware of the broad headings but
not of all the items under them.
Unfortunately, this will reduce their chances of
success. They will tend to prepare a set of generic
answers that could be roughly adapted to any
question in one particular area of the syllabus. Such
answers rarely gain high marks.
This article will focus on one of the main parts
of the P2 syllabus – topic C, “Budgeting and
management control” – and examine some of the
important components relating to budgeting.
I won’t cover every item in this area, nor will I
discuss generating a budget or the characteristics
of the various types of budgets, because the study
text does that. What I will do is describe the angles
from which it may be examined so that we can see
what the examiner is actually testing.
Management accounting is built on the three
pillars of planning, control and decision-making.
It’s essential to distinguish among the three
different types of planning: strategic, budgetary
‘Students might
be aware of the
syllabus’s broad
headings, but not
of all the items
under them’
39
Paper P3
Performance Strategy p44
Paper F3
Financial Strategy p47
and operational. These three are related, the main
difference being the length of time they cover.
Strategic planning focuses on achieving the
organisation’s long-term objectives; budgetary
planning covers the short to medium term; and
operational planning refers to short-term or dayto-day processes.
Candidates must be able to:
l Describe the three types of planning.
l Distinguish among them.
l Explain how a budget is carried out within the
framework of the strategic plan.
The two most important control tools are
standard costing and variances, and budgets. This
key area of the syllabus will be examined regularly
and you must be able to apply your knowledge to
questions about specific aspects of budgets and
budgeting control, instead of writing generic
answers. You must also be able to suggest the most
appropriate budget technique for the scenario
given, so you’ll need to be familiar with the main
features of the different types of budgets.
Remember that the syllabuses under the
Performance pillar are progressive, which means
that aspects covered in both the P1 and C01 papers
can be examined in the P2 paper.
When preparing for the P2 exam, review these
two syllabuses and confirm your understanding
of how to:
l Form a budget committee.
l Identify any principal budgeting factor.
l Review and co-ordinate action of the budget.
l Agree the budget period.
l Prepare functional budgets.
l Prepare a master budget.
Let’s consider some of the main items in this
part of the syllabus.
Budget v budgetary control
Candidates need to be able to do the following:
l Define a budget.
l Define budgetary control and describe the steps
of producing a budget. Judging from many
41
Study notes
Paper P2
Performance Management
answers in past exams, it’s clear that many candidates don’t appreciate that budgetary control is
the process that an organisation completes in preparing a budget. Budgetary control is the practice
of systematically comparing the results actually
achieved with those budgeted for.
l Understand the principles of standard costing
and variance analysis, and how this technique
dovetails with the preparation of a budget.
l Relate the theory to any scenario.
approaches, appreciating in particular that the
bottom-up approach allows less senior managers
to get more involved in setting budgets. It also
allows the business to take full advantage of its
managers’ local knowledge and expertise. The
main drawbacks of this approach are that it can
be time-consuming and lead to the introduction
of “slack” to allow the budget to be achieved easily.
Candidates need to be able to:
l Understand the circumstances under which each
technique is appropriate.
l Discuss the advantages and disadvantages of
each technique.
l Appreciate the behavioural implications of
adopting either approach.
The theory of systems
You need to be aware of the basic control system
theory and how this applies in budgetary control.
Candidates need to be able to:
l Describe how a system is a set of related parts
co-ordinated to accomplish a set of goals.
l Describe the key characteristics and components
of a system – inputs, process, outputs, environment
and boundary – and relate these to any scenario.
Incremental v zero-based budgets
It’s quite common, particularly in the public sector,
to fix a budget on the basis of what happened the
year before, perhaps with some adjustments for
changes that are nearly certain to occur – e.g. an
agreed pay rise. This is known as incremental
budgeting and it’s often used for functions such
as R&D, advertising and training. Budgets relating
to this type of expenditure are known as dis­
cretionary budgets.
In contrast, zero-based budgets (ZBBs) are based
on the principle that all expenditure must be
justified. Hence, it is not assumed that an activity
will automatically be financed in the forthcoming
year just because it was financed the year before.
Candidates need to be able to:
l Describe incremental budgeting.
l Understand the nature of discretionary costs
and discretionary budgets.
l Understand the circumstances under which an
incremental budget is more appropriate and those
under which a ZBB is more appropriate.
l Describe the main characteristics of a ZBB – e.g.
decision packages.
l Discuss the pros and cons of ZBBs.
Feedback v feed-forward control systems
Most budgetary control systems work on the
feedback principle. Information on actual results
are compared against control data – in this case,
the budget – and any variances from the control
data will normally prompt immediate action
(feedback) to bring future results back in line with
the budget. Feedback control involves acting after
the event, but in some situations it may be more
appropriate to adopt a feed-forward approach.
This is where there is monitoring at an early stage
of a process, which may show that an adjustment
should be made at a later stage before the final
output. Feed-forward control loops react to
forthcoming dangers.
Candidates need to be able to:
l Explain the concepts of feedback and feedforward control systems.
l Compare and contrast the two systems.
l Explain the difference between negative and
positive feedback.
l Describe how a feedback control loop might work
in the context of a budgetary control system.
l Describe the components of the control system
(sensor, comparator and effector).
Top-down v bottom-up (participative)
You need to be able to discuss the advantages and
disadvantages of the top-down and bottom-up
‘Zero-based
budgets are
based on the
principle that
all expenditure
must be
justified’
Rolling (continual) budgets
Most budgets are prepared periodically, usually
for the next financial year. This is appropriate in
most cases. But when it’s hard to predict events
accurately for the next 12 months – owing to a high
level of inflation, say – it may be more appropriate
to adopt a rolling approach in which a detailed
budget is produced for the first three months
42
Study notes
Paper P2
Performance Management
and a less detailed macro budget is produced to
cover the subsequent nine months.
Candidates need to be able to:
l Describe the main characteristic of a rolling
budget, especially any disadvantages – e.g. the
fact that they are extremely time-consuming.
l Understand the circumstances under which a
rolling budget approach would be beneficial.
l Discuss whether the traditional budget or the
rolling budget is likely to be more beneficial for
planning purposes.
When managers compare actual results against
the budget, the comparison needs to be meaningful
– otherwise, it won’t be valid. For many businesses,
revenues and costs in a period are fairly predictable
and the budget could be prepared for one level
of activity. But this wouldn’t be suitable for
enterprises where the level of activity could vary
widely – e.g. ice cream sales in a cold, wet summer.
In such circumstances a flexible budget would be
more appropriate and a budget would be prepared
for different levels of activity.
Candidates need to be able to:
l Describe the main characteristics of fixed
budgets and flexible budgets.
l Understand the circumstances that would favour
one approach over the other.
l Generate a flexible budget having been given
the necessary data – e.g. costs that are fixed and
those that vary with output.
l Apply the high-low technique to establish the
fixed cost and variable cost per unit of output.
l Present the flexible budget so that a nonfinancial person can understand it.
Activity-based budgeting (ABB)
Candidates need to appreciate that ABB extends
the principles of activity-based costing. With the
ABB approach, budgets are prepared according to
activity rather than function, as is normally the
case with a traditional budget. ABB starts with
output (the sales budget) and then works through
to find the activity costs, whereas activity-based
costing is the other way around. It starts by
establishing activity costs and then attaches these
costs to units of output. If an activity-based budget
is put in place, it should give a better understanding
of the effect on budget costs of changes in the
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Fixed v flexible budgets
‘Preparing the
budget for one
level of activity
wouldn’t be
suitable for
enterprises
where the level
of activity could
vary widely –
e.g. ice cream
sales in a cold,
wet summer’
usage of the cost driver because of how cost
drivers, activities and costs are explicitly related.
Candidates need to be able to:
l Describe the main characteristics of activitybased budgets.
l Discuss how activity-based budgets compare
with traditional budgets.
l Describe how control should be improved in an
ABB environment.
l Discuss the advantages of ABB.
Beyond budgeting
It is important for candidates to be able to question
the continued use of traditional budgets. Most
businesses fully accept the need for planning well
ahead, but it’s often suggested that the budget
systems adopted should reflect a broader, more
intelligent approach. The beyond budgeting model
promotes a more decentralised, participative
approach to managing a business and is based on
the use of “stretch targets” that can be adapted.
Candidates need to be able to:
l Describe the main principles associated with
beyond budgeting.
l Compare beyond budgeting with the traditional
approach, particularly highlighting the disad­
vantages of the latter.
l Explain how beyond budgeting allows greater
adaptability to changing business conditions.
l Explain how beyond budgeting can increase motivation among staff – i.e. the behavioural aspect.
Further reading CIMA Official Study Text – P2 Performance Management (2012-13 edition), CIMA Publishing, 2012.