The Use of a Single Budget or Separate Budgets for Planning and Performance Evaluation

Abstract

Budgeting has different functions in the firm that are not necessarily congruent with each other but conflict. Specifically, in many firms, budgets are simultaneously set and used for both operative planning and performance evaluation. Although prior literature recommends using different budget levels for different purposes to resolve potential conflicts between these functions, empirical evidence indicates that the majority of firms use a single budget level for planning and performance evaluation. To examine the questions of whether and why firms do so, we identify economic and behavioral costs of using separate budget levels. We then test our hypotheses using survey data from management accounting executives in German speaking countries responsible for planning and budgeting in their companies. We find that when deciding about the use of a single versus separate budget levels, firms trade off the costs of incurring higher variances against the costs of preparing a separate budget and reduced credibility of the performance evaluation system. Moreover, we find that using a single budget level for both purposes at the beginning of the year does not signify using a single budget level at the end of the year. Firms seem to respond to the various economic and behavioral costs either at the beginning of the year or, alternatively, in the course of the year and adjust budget levels for planning, performance evaluation, or both accordingly. Our study contributes to the literature by reconciling discrepancies between descriptive empirical practice and recommendations from prior literature about the use of a single versus separate budgets for multiple purposes.