Chapter Four

Budgetary Control
1.
Budget
Definition : Any financial plan serving as an estimate of and a control over future operations. Any estimate of future costs. Any systematic plan for the utilization of manpower, material or other resources.
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1. Budget Essential features : Statement prepared in monetary terms for implementation of a policy formulated by management. Laid down before the budget period during which it is followed. Prepared for a definite future period. The policy to be followed to attain objectives is laid down before preparation of the budget.
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2. Budgetary Control
A budgetary control system secures control over performance and costs in different parts of a business. i] ii] by establishing budgets by comparing actual attainments against budgets ; and iii] by taking corrective action and remedial measures or revision of budgets, if necessary.
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2. Budgetary Control
It is an excellent system for decentralization of authority without losing control over the operations of the firm. It is analogous to a course ahead worked out by a navigation officer for the captain of the ship to follow. Every time the ship is off the course, the captain gets the signals from navigation officer, so that he can bring her back on course.
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3. Forecast and Budget A forecast is an assessment of probable future events. A budget is an operating and financial plan of a business enterprise. A forecast is merely a statement does not convey any sense of control. A budget is a tool of control and represents actions that can achieve objectives of the firm.
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3. Forecast and Budget A forecast is a preliminary step for budgeting. A budget starts when forecasts are over. Forecasts have wider scope are prepared for any type of data.. A budget can be prepared if it can be expressed in quantitative terms.
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4. Objectives of budgetary control. 1. To use different levels of management in a cooperative endeavour for achievement of the objectives of the firm. 2. To facilitate centralized controls with delegated authority and responsibility. 3. To achieve maximum profitability by planning income and expenditure through optimum use of available resources. 4. To reduce losses and wastes to the minimum.
Budgetary Control
4. Objectives of budgetary control. 5. To bring out clearly where effort is needed to remedy the situation. 6. To see that the firm is not deflected from marching towards its long term objectives without being overwhelmed by emergencies. 7. To coordinate various activities like production, sales, purchase etc with the help of budgetary control.
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5. Advantages of budgetary control. 1. Maximization of profits through effective planning and control of income and expenditure. 2. Planned approach to expenditure and financing of the business that ensures optimum utilization of funds for the business. 3. Clear definition and periodic examination of the objectives and policies of the firm.
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5. Advantages of budgetary control. 4. Managerial coordination is facilitated. 5. Maximum & effective utilization of men, materials, resources since the task and ways to achieve it are spelled for each level of management. 6. Generation of reports under principles of management by exception. 7. Managers are forced to think ahead and solve problems. .
Budgetary Control
5. Advantages of budgetary control. 8. Delegation of authority is assisted and a powerful tool offered for responsibility accounting. 9. Conditions created for successful introduction of standard costing. 10. Basis provided for establishing incentive scheme for remuneration of managers. 11. Since difficulties are foreseen, they are warded off.
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6. Limitations of budgetary control. 1. Efficacy of budgets is dependent on adequacy or otherwise of initial estimates. 2. Budgets carry a degree of rigidity which reduces their usefulness in business environment which is full of dynamism. 3. Control is based only on quantitative data turning the exercise impersonal.
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6. Limitations of budgetary control. 4. systems under budgetary control become top heavy and cannot be managed by small concerns, 5. Budgets are seen as panacea for all problems. This over reliance results in the failure of the system. 6. Resented by employees as restrictions are imposed on their authority & style of working.
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6. Limitations of budgetary control.
Limitations call for maintaining realistic and dynamic approach to budgetary control.
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7. Preliminaries for the adoption of a system of budgetary control. Pre-requisites for Budgetary Control. Organization chart with duties & responsibilities of each executive in clear cut terms. Unambiguous objectives, plans and policies of the business. Listing of key budget factors. Budget Committee to oversee formulation & execution.
Budgetary Control
7. Preliminaries for the adoption of a system of

budgetary control. Pre-requisites for Budgetary Control. contd.
Primary responsibility for preparation of budgets with those who are responsible for its performance. Comprehensive, complete & continuous budgets that are capable of attainment. Top management support. Organization headed by a director for budget preparation, maintenance & administration
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7. Preliminaries for the adoption of a system of budgetary control. Pre-requisites for Budgetary Control. contd. Efficient system of accounting to provide data required by the system. Proper system for communication and reporting among many levels of management. Detailed user friendly Budget Manual to provide plan, procedure and budget period.
Budgetary Control
8. Installation of budgetary control system. i] Organization Chart An organization chart, defining functional representatives of executives, responsible for accomplishment of organizational objectives, needs to be prepared first. A typical chart for Budgetary Control follows
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i] Organization Chart
Budget Officer
Purchase Manager
Production Manager
Personnel Manager
Sales Manager
Accountant
Purchase Budget Production & Materials Budget Plant Utilization Budget
Labour Budget
Sales Budget Cost Budget Advt. Budget Master Budget Selling & Distri Budget
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8. Installation of budgetary control system. ii] Budget Center Sections of the organization of the undertaking have to be defined for the purpose of budget control. Budgets are to be set for each budget center with the assistance of its departmental head.
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8. Installation of budgetary control system. iii] Budget Manual A budget manual sets instructions governing the responsibilities of persons and the procedures, forms and records relating to the preparation and use of budgets. It is a booklet containing instructions for procedures and time schedules.
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8. Installation of budgetary control system. iii] Budget Manual The main idea behind the manual is to present complete picture of budget exercise and avoid issue of instructions on day to day basis. This allows managers to work independently and be ready to act on variations from budgets.
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8. Installation of budgetary control system. iv] Budget Controller The Budget Controller is appointed to coordinate activities of the Budget Committee. Her duties include Preparation of various budgets & their consolidation into a single master budget.
Compiling data on actual performance versus budgets, ascertaining causes of deviations and reporting to executives.
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8. Installation of budgetary control system. iv] Budget Controller Reporting cases to management where revision to budgets necessary. Preparation of various documents for successful operation of the budgets. Budget Controller does not control, but advises executives on their performance against budgets.
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8. Installation of budgetary control system. v] Budget Committee Is the group of managers that discusses a mutually agreed program to meet their targets. Its duties and responsibilities are described in the Budget manual; which include Receive , review estimates from members and make recommendations. When there is a conflict between departments review & recommend decisions.
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8. Installation of budgetary control system. v] Budget Committee Recommend changes and approval of revisions to budgets. Receive, study and analyze periodic reports and budget variations. If conditions warrant recommend budget revisions. Recommend revision to budget policies and procedures. Recommend changes to the Budget manual.
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8. Installation of budgetary control system. vi] Budget Period is the period for which a budget is prepared and used which may be sub divided into control periods. Factors to be considered in deciding the period : Long enough to complete production of all products.
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8. Installation of budgetary control system. vi] Budget Period contd. Should cover one entire seasonal cycle; in case of business with seasonal nature. Long enough to allow financing of production in time. Major operations like plant re layout must be planned well in advance.
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8. Installation of budgetary control system. vi] Budget Period contd. Should coincide with financial period so that actual results correspond with budget numbers.
Budget period is not to be confused with Control period. Control period indicates frequency at which reports under budgetary control system are to be distributed to managers.
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8. Installation of budgetary control system. vii] Budget Key Factor.

is factor which will limit the activities of the undertaking and which is taken into account in preparing budgets. It usually is the demand for product or service. But could be anyone from : a] customer demand, b] plant capacity, c] availability of raw materials, skilled labour or capital, d] accommodation for plant, raw & finished materials.
Budgetary Control
8. Installation of budgetary control system. vii] Budget Key Factor contd.

Managers identify the key factor and take a decision to get over the limiting factor. Else the framework of budgets has to be within the limits of the key factor.
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8. Installation of budgetary control system. viii] Budget Reports

Performance evaluation and reporting of variance is an integral part of all control systems. Hence effective budget reports be simple and intelligible should bear a heading & indicate period covered. be issued regularly and promptly. should contain essential data.
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8. Installation of budgetary control system. viii] Budget Reports contd.

be expressed indirect figures. correlated to money value. free from any personal bias. dated and signed by persons who prepare & check.
Reports need to be followed up until action is taken to avoid further variances or to revise budget if deficiency is noticed.
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9. Classification of Budgets.
Budgets are normally classified based on : Scope of activities covered Master Budget Functional Budget Efficiency of activities Fixed Budget Flexible Budget
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Budgets are normally classified based on: contd. Conditions of activities Basic Budget Current Budget Period Short Term Budget Long Term Budget.
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Budgets are normally classified based on : Scope of activities covered Functional Budget is sub-divided into Production Production Cost Overheads Research & Development and Financial - budgets.
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Budgets are normally classified based on : Scope of activities covered Production Cost Budget is further classified into: Material Labor Plant Budgets.
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Budgets are normally classified based on : Scope of activities covered Overheads Budget is further classified into: Factory Selling & distribution Overheads Budgets.
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Approved targets for individual functions are known as functional budgets and consolidation of all budgets constitutes Master Budget.
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9. Classification of Budgets. Sales Budget :A forecast of total sales In rupees as well as in quantities. Considers both external( economy, markets, regulations) & internal (funds, products) factors. Is considered as a key stone of budgeting.
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9. Classification of Budgets. Production Budget :A forecast of total production Production value part indicates quantity of products to be manufactured. Production cost part details manufacturing costs for the period. Aims at optimum use of resources. Assists scheduling of factors of production & preparation of delivery schedules.
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9. Classification of Budgets. Materials Budget :A forecast of total material requirements for production Acts as guide for Purchase department to plan purchases. Determines various levels of inventory. Assists Finance to arrange necessary funds.
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9. Classification of Budgets. Direct Labour Budget :A forecast of total labour requirements for production is calculated from data of time & grades of workers needed to manufacture each item, operation, job of budgeted production. Using rates of pay, allowances, bonus etc Labour cost budget is computed.
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9. Classification of Budgets. Administrative Cost Budget :Since most of administration expenses are period costs and fixed in nature, this budget is prepared with fewer difficulties. Once management decisions are finalized these costs get frozen.
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9. Classification of Budgets. Selling Expenses Budget :Includes all expenses on promotion, maintenance and distribution of finished products. Separate budgets normally prepared for fixed and variable parts of expenses.
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9. Classification of Budgets. Research & Development Budget :Includes all expenses on projects on hand & new projects approved by the management. Expenses planned for the budget period are included.
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9. Classification of Budgets. Cash Budget :A cash forecast is an estimate showing the amount of cash which would available in future period. One pert contains cash receipts and other disbursements. Budget is normally prepared on monthly basis.
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9. Classification of Budgets. Cash Budget :- objectives1.Arrange for finances or investments as per shortage or excess cash balances indicated at end of each month. 2. Coordinate in relation to total working capital, investments, debts etc. 3. Establish sound credit basis for banks, financial institutes& creditors. 4. Focus on sudden, seasonal requirements, over stocking or delays in collections etc.
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Budgetary Control
9. Classification of Budgets. Master Budget :A consolidated summary of all functional budgets. Its approval signifies approval of all budgets which then can be employed. In a sense it is a budgeted profit & loss account and balance sheet of a firm.
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9. Classification of Budgets. Master Budget :- contd. Prepared by the budget committee. Provides a scientific base to compute effect of any change in operations like sales volume, product mix, prices, labour costs, material costs, or change in facilities.
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9. Classification of Budgets. Fixed Budget :This budget remains unchanged irrespective of the level of activity actually attained. Useful for a short period where volumes remain unchanged or for expenses of fixed nature. Have limited application and cannot be used as a toll for cost control.
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9. Classification of Budgets. Flexible Budgets :This budget recognizes different cost behaviour patterns, is designed to change as volume of output changes. Budgeted costs are available for any level of activity and hence has wide application.
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9. Classification of Budgets. Flexible Budgets :Are desirable When the level of activity changes during a year. Business is new & demand is difficult to predict. Where there is a shortage of materials, labour or plant capacity.
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9. Classification of Budgets. Flexible Budgets :Features Prepared for a range of activity rather than a single level. Provide a very dynamic basis for comparison with actuals. Tailor made budget available for volume achieved. Are based on full knowledge of cost behavior
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9. Classification of Budgets. Flexible Budgets :Methods of preparation Tubular method or multi-activity method. Formula or ratio method. Graphic Method
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9. Classification of Budgets. Various Types of Budgets :-
Basic Budget : a budget prepared for use without any change for a long period of time. Current Budget : a budget related to the current conditions and for use over a short period.
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9. Classification of Budgets. Various Types of Budgets :- contd. Long-Term Budget : a budget prepared for a period exceeding one year. Useful for forward planning & capital expenditures. Short-Term Budget : a budget prepared for a period less than a year. Useful for junior levels of management for control purposes.
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10. Control ratios. Following ratios are used by managers to find out favorable or unfavourable variations from budgets.
Standard Hours for Actual Production Activity Ratio
:
Budgeted Hours
x 100
Indicates a measure of activity achieved during the period.
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Actual Hours Worked
Capacity Ratio :
Budgeted Hours
x 100
Indicates whether & to what extent budgeted hours of activity were actually used during the period.
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Standard Hours for Actual Production Efficiency Ratio : x 100
Actual Hours
Indicates the degree of efficiency attained in production during the period.

Budgetary Control
11. Zero base budgeting A method of budgeting whereby all activities are re-evaluated each time a budget set. Discrete levels of each activity are valued and a combination chosen to match funds available. In this exercise managers have to defend their budget from scratch and justification based on past budgets or actuals is not accepted.
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11. Zero base budgeting

Steps involved: Analyze all current or proposed programs /expenses. Evaluate in terms of purpose, consequence, performance measures, alternatives, causes and benefits. These are called decision packages. Rank the packages with supporting documents. Allocate resources per ranking.
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Important Features: Concentration on why and not how much a unit spends. Choices are made based on what a unit can offer against a specific cost. Individual unit objects are linked to corporate targets. Quick budget adjustments are possible to maintain expenditure level. Alternatives are considered and best one selected. All levels of management are involved.
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Points of difference between traditional & zero based budgeting: Traditional budgeting is accounting oriented; zero based budget has decision oriented approach. Traditional budget starts with last budget and proposes additions / subtractions. In zero base budgeting decision packages are ranked for resource allocation.
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Points of difference between traditional & zero based budgeting:- contd. Under traditional budgeting managers tend to inflate budgets. In zero based budgeting rational analysis of expense is mandatory. The decision why a particular amount be spent, is to be justified by managers under zero based budgeting, while in traditional budgeting it is top management responsibility.
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Points of difference between traditional & zero based budgeting:- contd. Traditional budget is not as clear & responsive zero based budget. Zero based budgeting has a direct approach as decision packages enjoying priority over others are spotlighted. Approach under traditional budgeting is circuitous.
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Advantages of zero based budgeting:-
Promotes operational efficiency as it is not based on incremental approach and requires managers to review & justify their activities for funds. Participation of all levels of management in preparation of budgets assures its successful implementation.
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Advantages of zero based budgeting:- contd.
The technique is elastic & forces managers to develop financial planning and management information system (MIS). Evaluation of every budget proposal weeds out inefficiency and reduces costs of production.
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Criticism against zero based budgeting:-
Defining the decision units and decision packages is difficult. Managers view it as a threat as managers are not allowed to take anything as granted. Requires immense training to managers in technique of justifying their expenditures from a scratch.
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12. Performance budgeting

Performance budgeting is looked upon as a budget based on functions, activities and projects. It is linked to the budgetary system based on objective classification of expenditure. This technique is a process of analyzing, identifying, simplifying and crystallizing specific performance objectives of a job to be achieved over a period in the framework of organizational objectives.
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Objectives : Measure progress towards short term and long term objectives of a firm through reviews at every stage and at every level. Inter-relate physical and financial aspects of every program, project or activity.
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Objectives :- contd. Facilitate effective performance audit.
Assess the effects of the decision making of supervisor to the middle and top management. To bring annual plans & budgets in line with short and long term plan objectives. Present a comprehensive operational document.
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Limitations :-
Difficulties in classifying programs and activities. Problems of evaluation of various schemes. Relegation of important programs to background. Only quantitative evaluation is carried and sometimes needed results cannot be measured.
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13. Responsibility accounting A method of accounting in which costs are identified with persons assigned to their control rather than with products or functions is known as responsibility accounting. Units under specified authority in the organization are developed as responsibility centers. These are individually evaluated for their performance.
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13. Responsibility accounting Transfer pricing system to determine performance and results of each center is essential for success of responsibility accounting.
Costs are classified by responsibility centers, within center whether controllable or non-controllable. And controllable costs by elements in sufficient details to provide basis for useful analysis.
Budgetary Control
13. Responsibility accounting

Guidelines for assigning costs :i] If a person has authority over both acquisition and the use of the service, he should be charged with the cost of such service. ii] If the person significantly influences the cost through his own action, he may be charged with such costs. iii] Even if he does not significantly influence the cost through his own action, he may be charged with those costs if management desires him to control those costs.
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Allocation of overheads :-
i] under product costing arbitrary bases have to be used for apportioning overheads to products rendering cost control difficult. ii] the situation becomes acute in case of distribution of service department costs to products. iii] Under responsibility accounting transfer of overheads to responsibility centers is direct.
Budgetary Control

Principles :i] A plan of objectives is set up in terms of a target, budget, standard or estimate This plan is broken over individual responsibility centers. ii] The results of actual operation by each center are ascertained. iii] Variances are determined and reported to higher management. iv] Corrective action is taken and communicated to individual responsible.
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To sum up :-
Responsibility accounting lays stress on planning and cost control rather than cost ascertainment and its advantage lies in the prompt reporting of performance of executives at various levels in management.
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14. Social reporting The concept is gaining importance as the society is getting conscious about cost benefit of corporate activity. Several benefits accrue to the firm at the cost to the society. Hence corporations are expected to take care of the society as a whole and of the varied groups therein as are affected by the corporation.
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14. Social reporting The concept is gaining importance because : increasing awareness about the corporate social contribution. identification and rewards to business for its social contribution. identification of adverse effects on the environment.
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14. Social reporting The concept is gaining importance because :- contd. improving credibility and reputation of business. transferring cost of social activities to other segments of the society.
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14. Social reporting Objectives: Identify and measure the net social contribution of an individual firm . Determine whether individual firms strategies and practices are consistent with widely shred social principles. Provide complete data on firms goals, policies, performance etc. as it affects scarce resources.
Budgetary Control
14. Social reporting
Social reporting is being included in the Annual Accounts & Reports of responsible companies.
Next Chapter Cost Volume Relations & Break Even Analysis Bye . . . . .
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Cost Accounting
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Chapter Four

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Budgetary Control

6. Limitations of budgetary control.

7. Preliminaries for the adoption of a system of

Purchase Budget Production & Materials Budget Plant Utilization Budget

8. Installation of budgetary control system. vii] Budget Key Factor.

8. Installation of budgetary control system. vii] Budget Key Factor contd.

8. Installation of budgetary control system. viii] Budget Reports

8. Installation of budgetary control system. viii] Budget Reports contd.

9. Classification of Budgets. Various Types of Budgets :-

Indicates a measure of activity achieved during the period.

Indicates the degree of efficiency attained in production during the period.

11. Zero base budgeting

11. Zero base budgeting

11. Zero base budgeting

11. Zero base budgeting

11. Zero base budgeting

11. Zero base budgeting

11. Zero base budgeting

11. Zero base budgeting

12. Performance budgeting

12. Performance budgeting

12. Performance budgeting

12. Performance budgeting

13. Responsibility accounting

13. Responsibility accounting

13. Responsibility accounting

13. Responsibility accounting

14. Social reporting

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