Responsibility BudgetingResponsibility Budgeting

Responsibility Centered BudgetingResponsibility Centered BudgetingCreating an internal free market economy Creating an internal free market economy (“Each tub on its own bottom”)(“Each tub on its own bottom”)

The gist of 20th century thinking management control is The gist of 20th century thinking management control is expressed by the mantra: expressed by the mantra:

let the managers manage;let the managers manage;make the managers manage.make the managers manage.

Responsibility budgeting is the stock answer to the Responsibility budgeting is the stock answer to the question of how to empower managers to manage and, at question of how to empower managers to manage and, at the same time, motivate them to use their collective the same time, motivate them to use their collective intelligence to create value through exchange in product intelligence to create value through exchange in product and financial markets and by establishing and sustaining and financial markets and by establishing and sustaining mutually beneficial relationships with customers, suppliers, mutually beneficial relationships with customers, suppliers, and especially other members of their organizations. and especially other members of their organizations.

Principles of Responsibility Budget Principles of Responsibility Budget ManagementManagement

Best operating decisions are made closest to point of Best operating decisions are made closest to point of

implementationimplementation

Degree of decentralization positively related to the size and Degree of decentralization positively related to the size and complexity of the organizationcomplexity of the organization

Correct decisions are more likely in an information-rich Correct decisions are more likely in an information-rich environmentenvironment

Authority should be commensurate with responsibility, and vice Authority should be commensurate with responsibility, and vice versaversa

Responsibility and authority require clear rewards and Responsibility and authority require clear rewards and sanctionssanctions

Good planning and performance are facilitated by stable Good planning and performance are facilitated by stable environmentsenvironments

The relationship of the parts to the whole should be reflected in the The relationship of the parts to the whole should be reflected in the assignment of responsibilityassignment of responsibility

The legitimacy of institutional and local responsibility has to be The legitimacy of institutional and local responsibility has to be recognizedrecognized

The existence of a mutually supportive academic and administrative The existence of a mutually supportive academic and administrative plan is assumedplan is assumed

Recommendation: Budget Recommendation: Budget Hearings/DiscussionsHearings/Discussions

What they can achieveWhat they can achieve

– Openness among decision-makers helps clarify common Openness among decision-makers helps clarify common valuesvalues

– Accountability of the leadership is reinforced, building trustAccountability of the leadership is reinforced, building trust– Group problem-solving enhances a sense of empathy and Group problem-solving enhances a sense of empathy and

communitycommunity– Cross-fertilization between units - spreading good ideasCross-fertilization between units - spreading good ideas– Positive motivation for leadershipPositive motivation for leadership– Propagation of accurate information, dispelling rumors and Propagation of accurate information, dispelling rumors and

misunderstandingsmisunderstandings

Budget Construction Under Responsibility Budget Construction Under Responsibility Center ManagementCenter Management

Current year’s approved based budgetCurrent year’s approved based budgetBudget adjustmentsBudget adjustmentsAdjusted (Planning) based budgetAdjusted (Planning) based budgetNext year’s income estimatesNext year’s income estimatesAllocations to unitsAllocations to unitsDevelopment of detailDevelopment of detailSummarization and reviewSummarization and reviewApproval of next year’s budgetApproval of next year’s budgetDisseminationDissemination

Responsibility BudgetingResponsibility Budgeting

The most common remote control system used by large-scale organizations in the private The most common remote control system used by large-scale organizations in the private sector. sector.

(a) units and managers are evaluated relative to the targets they accept, (a) units and managers are evaluated relative to the targets they accept,

(b) only financial measures are used to measure and reward accomplishment or punish failure, (b) only financial measures are used to measure and reward accomplishment or punish failure, and and

(c) financial success or failure is attributed entirely to managerial decisions and/or employee (c) financial success or failure is attributed entirely to managerial decisions and/or employee performance. performance.

Types of Responsibility Centers

Discretionary & Engineered expense centersRevenue centers Cost centers

Standard cost centersQuasi-profit centers

Profit centersInvestment Centers

Responsibility budgets IResponsibility budgets I For expense centers the budget is a spending planFor expense centers the budget is a spending plan

For discretionary expense centers, fixed spending targetsFor discretionary expense centers, fixed spending targets

For engineered expense centers, flexible spending targets (i.e., the budget has two For engineered expense centers, flexible spending targets (i.e., the budget has two components, a discretionary component and a component that varies directly with components, a discretionary component and a component that varies directly with volume)volume)

For a cost or profit centers the budget is a performance target or goalFor cost centers, the target is a unit-cost standardFor quasi-profit centers, the target is a quasi-profit measure: (Standard Cost [units delivered] – Actual Unit Cost [units delivered]).

For profit centers, the budget is a profit target [revenue – cost of goods sold.]The budget of an investment center is also a target or goal – usually return on assets [ROA or ROI] or residual income [EVA or RI]The main difference between investment centers and all other responsibility centers is that the former approve their own capital budgets

Responsibility Budgeting vs. Budgetary Responsibility Budgeting vs. Budgetary ControlControl

Responsibility budgeting differs from budgeting in two respects:Responsibility budgeting differs from budgeting in two respects:

Distinction between controllable and no controllable itemsDistinction between controllable and no controllable items

Performance reportsPerformance reports

Either emphasize or include only items controllable by the individual Either emphasize or include only items controllable by the individual managermanager

Responsibility Reporting System

Involves preparation of a report for each level of responsibility in the company's organization chart.

Permits management by exception at each level of responsibility.

Responsibility Centered BudgetingResponsibility Centered Budgeting

StrengthsStrengths– Dynamic responsiveness when funding sources are Dynamic responsiveness when funding sources are

connected to the generating activitiesconnected to the generating activities– Decreases tendency for artificial salesmanshipDecreases tendency for artificial salesmanship– Development of more responsible local leadershipDevelopment of more responsible local leadership

VulnerabilitiesVulnerabilities– Can promote harmful internal competitionCan promote harmful internal competition– May create barriers for cross-center cooperationMay create barriers for cross-center cooperation– Undermines sense of communityUndermines sense of community– Can leave vital but “not profitable” university functions Can leave vital but “not profitable” university functions

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