Summary: Chapter 6: Budgeting

Read the summary and the most important questions on Chapter 6: Budgeting

• 1 Chapter 6: What is budget?

  This is a preview. There are 17 more flashcards available for chapter 1
  Show more cards here

• In which way is a budget part of the firm's organizational architecture?

  -> partition decision rights
  -> control behavior
  
  It's an integral part of decision making. 
  Besides that the budget is developed by using key planning assuptions like product prices. 

• Why do organizations need budget?

  1. To communicate and coordinate information both vertically and horziontally in the organization. Between different divisions. 
  2. Assign decision rights.
  3. Set goals through negotiation and internal contracting -> tanslate strategy into plans. 
  4. Measure performance

• Trade off 1: What is participative budgeting?

  Optimal decision making requires mangers to fully reveal private knowledge about production and market conditions during budget negotiations.

• Trade off 1: What is sandbagging (negotiate easier targets)/slack/underforcasting?

  When budgets are also used for performance evaluation, managers have an incentive to make biased budget forecasts so that theire actual performance will look good relative to budgets. So they will give a lower budget forcast to make sure they will reach it. 

• Trade off 2: Budget ratcheting: What is the ratchet effect?

  Bases next year's standard of performance on this year's actual performance

• Trade off 2: What are the disadvantages of budget ratchet?

  1. Performance targets usually adjusted upward 
  2. Sandbagging: employees will reduce there output.

• Trade off 2: What are the sulutions of the disadvantages of budget ratchet?

  1. Eliminate budget targets
  2. Estimate next year's sales
  3. More frequent job rotation
  
  => Ratchet effect creates dysfunctional behavior. However alternatives might prove more costly! 

• What is the difference in the effect of short term (1 year) Vs. long term (2,5,10 years) budgets?

  Firms that only use short term budgets do not create adequate incentives for long term maintenance and responding to new opportunities. This can effect the frims value. 
  But there is no link with decision control. 

• What are line item budgets?

  Line item budgets authorize managers to spend only up to the specified amount on each line item. 

• Advantages of line item budgets?

  Tight control educes oportunities for managers to take actions inconsistent with the firm goals.
  
  Example: when he has a amount for office supplies of 12.000 the manager can't save the remaining part of that year to the nex year or an other line item.