Module - V

Budgetary Control

Budget:

Meaning - A budget is the monetary or/and quantitative expansion of business plans and policies to be
pursued in the future period of time. The term budgeting is used for preparing budgets and other
procedures for planning, co-ordination and control of business enterprise.
Definition - According to I.C.W.A., London “A budget is a financial and/or quantitative statement
prepared prior to a defined period of time, of the policy to be pursued during that period for the
purpose of attaining a given objective”

In the words of Crown and Howard, “A budget is a pre-determined statement of management policy
during a given period which provides a standard for comparison with the results actually achieved.”

G.A.Welshstates, “A budget is a written plan covering projected activities of a firm for adefinite time
period.”

Budgeting:

Meaning - Budgeting is a managerial tool and is used for the purpose of short-term planning and control.
It denotes the complete cycle of designing, implementing and operating budgets. The main purpose of
short-term budgets is to ensure that the plans are provided with adequate resources.

Definition:

According to Shillonglow, "Budgeting is the preparation of comprehensive operating and financial plans
for specific intervals of time".

According to William J. Vatter, "Budgeting is a kind of 'future tense' accounting in which the problems of
future are met on paper before the transactions actually occur".

Budgetory Control:

Meaning - Budgetary Control is a method of managing costs through preparation of budgets. Budgeting
is thus only a part of the budgetary control.

Definition:

According to CIMA, “Budgetary control is the establishment of budgets relating to the responsibilities of
executives of a policy and the continuous comparison of the actual with the budgeted results, either to
secure by individual action, the objective of the policy or to provide a basis for its revision.”

Objectives of Budgetary Control:

1) Planning:Planning has been defined as the design of a desired future position for an entity and it rests
on the belief that the future position can be attained by uninterrupted management action. Detailed
plans relating to production, sales, raw‐material requirements, labour needs, capital additions, etc. are
drawn out.

2) Co‐ordination: Budgeting plays a significant role in establishing and maintaining coordination.

Budgeting assists managers in coordinating their efforts so that problems of the business are solved in
harmony with the objectives of its divisions. Efficient planning and business contribute a lot in achieving
the targets.

3) Measurement of Success:Budgets present a useful means of informing managers how well they are
performing in meeting targets they have previously helped to set. In many companies, there is a practice
of rewarding employees on the basis of their accomplished low budget targets or promotion of a
manager is linked to his budget success record.

4) Motivation: Budget is always considereda useful tool for encouraging managers to complete things in
line with the business objectives. If individuals have intensely participated in the preparation of budgets,
it acts as a strong motivating force to achieve the goals.

5) Communication: A budget serves as a means of communicating information within a firm. The

standard budget copies are distributed to all management people that provides not only sufficient
understanding and knowledge of the programmes and guidelines to be followed but also gives
knowledge about the restrictions to be adhered to.

6) Control: Control is essential to make sure that plans and objectives laid down in the budget are being
achieved. Control, when applied to budgeting, as asystematized effort is to keep the management
informed of whether planned performance is being achieved or not.

Advantages of Budgetary Control :

1. The budgetary control aims at the maximisation of profits of the enterprise. To achieve this aim, a
proper planning and co-ordination of different, proper control over various capital and revenue
expenditures. The resources are put to the best possible use.
2. The working of different departments and sectors is properly coordinated. The budgets of different
departments have a bearing on one another. The co-operation of various executives and subordinates is
necessary for achieving budgeted targets.
3. The plans, policies and goals are decided by the top management. All efforts are put together to reach
the common goal of the organisation. Every department is given a target to be achieved. The efforts are
directed towards achieving some specific aims. If there is no definite aim then the efforts will be wasted
in pursuing different aims.

4. By providing targets to various departments, budgetary control provides a tool for measuring
managerial performance. The budgeted targets are compared to actual results and deviations are
determined. The performance of each department is reported to the top management. This system
enables the introduction of management by exception.
5. The planning of expenditure will be systematic and there will be an economy in spending. The
finances will be put to optimum use. The benefits derived for the concern will ultimately extend to
industry and then to national economy. The national resources will be used economically and wastage
will be eliminated.
6. The deviations in budgeted and actual performance will enable the determination of weak spots.
Efforts are concentrated on those aspects where performance is less than stipulated.
7. The management will be able to take corrective measures whenever there is a discrepancy in
performance. The deviations will be regularly reported so that necessary action is taken at the earliest.
In the absence of a budgetary control system, the deviations can be determined only at the end of the
financial period.
8. It creates budget consciousness among the employees. By fixing targets for the employees, they are
made conscious of their responsibility. Everybody knows what he is expected to do and he continues
with his work uninterrupted.
9. In the present day competitive world budgetary control has Significant role to play. Every
businessman tries to reduce the cost of production for increasing sales. He tries to have those
combinations of products where profitability is more.
10. Budgetary control system also enables the introduction of incentive schemes of remuneration. The
comparison of budgeted and actual performance will enable the use of such schemes.

Limitations of Budgetary Control:

1. It tends to bring about rigidity in operation, which is harmful. As budget estimates are quantitative
expression of all relevant data, there is a tendency to attach some sort of rigidity or finality to them.
2. It being expensive is beyond the capacity of small undertakings. The mechanism of budgeting system
is a detailed process involving too much time and costs.
3. Budgeting cannot take the position of management but it is only an instrument of management. ‘The
budget should be considered not as a master, but as a servant.’ It is totally misconception to think that
the introduction of budgeting alone is enough to ensure success and to security of future profits.
4. It sometimes leads to produce conflicts among the managers as each of them tries to take credit to
achieve the budget targets.
5. Simple preparation of budget will not ensure its proper implementation. If it is not implemented
properly, it may lower morale.
6. The installation and function of a budgetary control system is a costly affair as it requires employing
the specialized staff and involves other expenditure which small companies may find difficult to incur.

Essentials of effective budgeting:

1. Support of top management: When the budget system is to be effective, it must be totally supported
by each member of the management and the impetus and direction should come from thetop
management. No Control system may be effective unless the company is convinced how the top
management considers the system to be essential.
2. Participation by responsible executives: Those entrusted with the efficiency of the budgets need to
participate in the procedure of setting the budget figures. This will make sure proper implementation of
budget programmes.

3. Reasonable goals: The budget figures needs to be realistic and represent reasonably achievablegoals.
The responsible executives must agree that the budget targets are attainable and reasonable.

4. Clearly defined organization: In order to derive highest benefits from the budget system,
nicelydefined responsibility centers ought to be built up within the company. The controllable costs
forevery responsibility centers should be individually shown.

5. Continuous budget education: The easiest way to make sure the active interest of the responsible
supervisors is constant budget education in respect of goals, techniques and potentials of budgeting.This
might be accomplished through written manuals, meetings and so on. actual results achievedetc.
whereby preparation of budgets. may be discussed.

6. Adequate accounting system: There is close relationship between budgeting and accounting. Forthe
preparation of budgets, one has to depend on the accounting department for reliable historical data
which primarily forms the basis .for many estimates. The accounting system should be so designed so as
to set up accounts in terms of areas of managerial responsibility. In other words,responsibility
accounting is essential for successful budgetary control.

7. Constant vigilance: Reports comparing budget and actual results should be promptly preparedand
special attention focused on significant exceptions i.e. figures that are significantly different from those
expected.

8. Maximum profits: The ultimate object of realising the maximum profit should always be
keptuppermost.

9. Cost of the system: The budget system must not cost more than it is worth. Since it is actually not
practicable to calculate just what a budget system is worth, it simply implies a caution against including
expensive refinements unless their worth clearly justifies them.

10. Integration with standard costing system: Where standard costing system can be used, it shouldbe
totally integrated with the budget programme, in regard of both variance analysis and budget
preparation.

Classification and Types of budget:

The budgets are usually classified according to their nature. The following are the types of budgets
which are commonly used.
(A) Classification according to Time
1. Long-term budgets.

2. Short-term budgets.
3. Current budgets.
(B) Classification on the Basis of Functions/ functional budget ;
1. Functional or Subsidiary Budgetary.

2. Master Budget.
(C) Classification on the Basis of Flexibility
1. Fixed budget,

2. Flexible budget
(A) Classification According to Time
1. Long Term Budgets. The budgets are prepared to depict long term planning of the business, The
period of long term budgets varies between five to ten years, The long term planning is done by the top
level Management ; it is not generally known to lower levels of management. These budgets are useful
for those industries where gestation period is long i.e. machinery, electricity, engineering, etc.
2. Short-term Budgets. These budgets are generally for one or two years and are in the form of
monetary terms. The consumer’s goods industries like sugar, cotton, textile, etc. use short-term budgets.
3. Current Budgets. The period of current budgets is generally of months and weeks. These budgets
relate to the current activities of the business.

(B) Classification on the Basis of Functions

1. Functional Budgets: These budgets relate to different functions, the number of these budgets
depends upon the size and nature of the business. The commonly used functional budgets are :
(a) Sales Budget

(b) Production budget including (i) Raw material budget (ii) Labour Budget (iii) Plant utilisation Budget (c)
Purchase Budget (d) Cash Budget (e) Finance Budget.
2. Master Budget: Various functional budgets are integrated into master budget. This budget is
prepared by the ultimate integration of separate functional budgets. Master budget is prepared by the
budget officer and it remains with the top level management.
This budget is used to co-ordinate the activities of various functional departments and is also helping as
a control device.

(C) Classification on the basis of flexibility:

1. Static or fixed budget: The static budgets are designed for a particular level of activity. It is prepared
before the beginning of the financial year.

2. Flexible budgets: A flexible budget involves a series of budgets dealings with different levels of
activities. As a name suggests, the budget varies according to the level of activities.

Functional Budgets:

The following are the types of functional budgets;

a) Sales Budget
b) Production Budget
c) Raw Materials Budget
d) Purchase Budget
e) Labour Budget
f) Production Overhead Budget
g) Selling & Distribution Budget
h) Administration Cost Budget
i) Capital Expenditure Budget

j) Cash Budget

a) Sales Budget: :
The sales budget is an estimate of total sales which may be articulated in financial or quantitative terms.
It is normally forms the fundamental basis on which all other budgets are constructed. In practice,
quantitative budget is prepared first then it is translated into economic terms. While preparing the Sales
Budget, the Quantitative Budget is generally the starting point in the operation of budgetary control
because sales become, more often than not, the principal budget factor. The factor to be consider in
forecasting sales are as follows:

Study of past sales to determine trends in the market.

Estimates made by salesman various markets of company products.

Changes of business policy and method.

Government policy, controls, rules and Guidelines etc.

Potential market and availability of material and supply.

b. Production Budget ::
The production budget is prepared on the basis of estimated production for budget period. Usually, the
production budget is based on the sales budget. At the time of preparing the budget, the production
manager will consider the physical facilities like plant, power, factory space, materials and labour,
available for the period. Production budget envisages the production program for achieving the sales
target. The budget may be expressed in terms of quantities or money or both. Production may be
computed as follows:
Units to be produced = Desired closing stock of finished goods + Budgeted sales – Beginning stock of
finished goods.
PRODUCTION COST BUDGET: This budget shows the estimated cost of production. The production
budget demonstrates thecapacity of production. These capacities of production are expressed in terms
of cost in production cost budget. The cost of production is shown in detail in respect of material cost,
labour cost and factory overhead. Thus production cost budget is based upon Production Budget,
Material Cost Budget, Labour Cost Budget and Factory overhead.

c. Raw-material budget:
Direct Materials budget is prepared with an intention to determine standard material cost per unit and
consequently it involves quantities to be used and the rate per unit. This budget shows the estimated
quantity of all the raw materials and components needed for production demanded by the production
budget. Raw material serves the following purposes:

It supports the purchasing department in scheduling the purchases.

Requirement of raw‐materials is decided on the basis of production budget.

It provides data for raw material control.

Helps in deciding terms and conditions of purchase like credit purchase, cash purchase, payment
period etc.
It should be noted that raw material budget generally deals with only the direct materials whereas
indirect materials and supplies are included in the overhead cost budget.
d. Purchase budget:
Strategic planning of purchases offers one of the most importantareas of reduction cost in many
concerns. This will consist of direct and indirect material and services. The purchasing budget may be
expressed in terms of quantity or money.
The main purposes of this budget are:

It designates cash requirement in respect of purchase to be made during budget period; and
It is facilitates the purchasing department to plan its operations in time in respect of purchases so that
long term forward contract may be organized.

e. Labour budget :
Human resourcesare highly expensive item in the operation of an enterprise. Hence, likeother factors of
production, the management should find out in advance personnel requirements for various jobs in the
enterprise. This budget may be classified into labour requirement budget and labour recruitment budget.
The labour necessities in the various job categories such as unskilled, semi‐skilled and supervisory are
determined with the help of all the head of the departments. The labour employment is made keeping
in view the requirement of the job and its qualifications, the degree of skill and experience required and
the rate of pay.
f. Production OverheadBudget :
The manufacturing overhead budget includes direct material, direct labour and indirect expenses. The
production overhead budget represents the estimate of all the production overhead i.e. fixed, variable,
and semi‐variable to be incurred during the budget period. The reality that overheads include many
different types of expenses creates considerable problems in:
1) Fixed overheads i.e., that which is to remain stable irrespective of vary in the volume of output,
2) Apportion of manufacturing overheads to products manufactured, semi variable cost i.e., thosewhich
are partly variable and partly fixed.
3) Control of production overheads.
4) Variable overheads i.e., that which is likely to vary with the output.
The production overhead budget engages the preparation of overheads budget for each division of the
factory as it is desirableto have estimates of manufacturing overheads prepared by those overheads to
have the responsibility for incurring them. Service departments cost are projected and allocated to the
production departments in the proportion of the services received by each department.
g. Selling and Distribution budget:
The Selling and Distribution Cost budget is estimating of the cost of selling, advertising, delivery of goods
to customers etc. throughout the budget period. This budget is closely associated to sales budget in the
logic that sales forecasts significantly influence the forecasts of these expenses. Nevertheless, all other
linked information should also be taken into consideration in the preparation of selling and distribution
budget. The sales manager is responsible for selling and distribution cost budget. Naturally, he prepares
this budget with the help of managers of sub‐divisions of the sales department. The preparation of this
budget would be based on the analysis of the market condition by the management, advertising policies,
research programs and many other factors. Some companies prepare aseparate advertising budget,
particularly when spending on advertisements are quite high.
h. Administration cost budget:
This budget includes the administrative costs for non‐manufacturing business activities like director’s
fees, managing directors’ salaries, office lightings, heating and air condition etc. Most of these expenses
are fixed so they should not be too difficult to forecast. There are semi‐variable expenses which get
affected by the expected rise or fall in cost which should be taken into account. Generally, this budget is
prepared in the form of fixed budget.
i. Capital expenditure budget :
This budget stands for the expenditure on all fixed assets for the duration of the budget period. This
budget is normally prepared for a longer period than the other functional budgets. It includes such items
as new buildings, land, machinery and intangible items like patents, etc. This budget is designed under
the observation of the accountant which is supported by the plant engineer and other functional
managers. At the time of preparation of the budget some important information should be observed:
Overfilling on the production facilities of certain departments as revealed by the plant utilization
budget.

Long‐term business policy with regard to technical developments.

Potential demand for certain products.

j. Cash budget :
The cash budget is a sketch of the business estimated cash inflows and outflows over a specific period of
time. Cash budget is one of the most important and one of the last to be prepared. It is a detailed
projection of cash receipts from all sources and cash payments for all purposes and the resultants cash
balance during the budget. It is a mechanism for controlling and coordinating the fiscal side of business
to ensure solvency and provides the basis for forecasting and financing required to cover up any
deficiency in cash. Cash budget thus plays avital role in the financing management of a business
undertaken. Cash budget assists the management in determining the future liquidity requirements of
the firm, forecasting for business of those needs, exercising control over cash. So, cash budget thus plays
a vital role in the financial management of a business enterprise.

Function of Cash Budget:

It makes sure that enough cash is available when it is required.

It designates cash excesses and shortages so that steps may be taken in time to invest any excess cash
or to borrow funds to meet any shortages.

It shows whether capital expenditure could be financed internally.

It provides funds for standard growth.

It provides a sound basis to manage cash position.

2. Classification on Flexibility
a) Fixed budget
b) Flexible budget
1. Fixed budget :
A fixed budget is prepared for one level of output and one set of condition. This is a budget in which
targets are tightly fixed. It is known as a static budget. According to CIMA,''A budget which is designed to
remain unchanged irrespective of the level of the activity attained''. It is firm and prepared with the
assumption that there will be no change in the budgeted level of motion. Thus, it does not provide room
for any modification in expenditure due to the change in the projected conditions and activity. Fixed
budgets are prepared well in advance.
This budget is not useful because the conditions go on the changing and cannot be expected to be firm.
The management will not be in a position to assess, the performance of different heads on the basis of
budgets prepared by them because to the budgeted level of activity. It is hardly of any use as a
mechanism of budgetary control because it does not make any difference between fixed, semi‐variable
and variable costs and does not provide any space for alteration in the budgeted figures as a result of
change in cost due to change in the level of activity. Fixed budget can be revised in the light of changing
situations, yet the rigidity and control over costs and expenses would be lost in such cases. Fixed
budgets should be prepared only where sales, production and costs can be accurately estimated.
2. Flexible budget:
This is a dynamic budget. In comparison with a fixed budget, a flexible budget is one “which is designed
to change in relation to the level of activity attained.” The underlying principle of flexibility is that a
budget is of little use unless cost and revenue are related to the actual volume of production. The
statistics range from the lowest to the highest probable percentages of operating activity in relation to
the standard operating performance. Flexible budgets are a part of the feed advance process and as
such are a useful part of planning. An equally accurate use of the flexible budgets is for the purposes of
control.
Flexible budgeting has been developed with the objective of changing the budget figures so that they
may correspond with the actual output achieved. It is more sensible and practical, because changes
expected at different levels of activity are given due consideration. Thus a budget might be prepared for
various levels of activity in accord with capacity utilization.

Flexible budget may prove more useful in the following conditions:

Where the level of activity varies from period to period.

Where the business is new and as such it is difficult to forecast the demand.

Where the organization is suffering from the shortage of any factor of production. For example,
material, labour, etc. as the level of activity depends upon the availability of such a factor.

Where the nature of business is such that sales go on changing.

Where the changes in fashion or trend affects the production and sales.

Where the organization introduces the new products or changes the patterns and designs of its
products frequently. Where a large part of output is intended for the export.
3. Classification on Time Budget / period :
With regard to time, budgets may be classified into four categories:
(a) Long‐term Budget: These budgets are prepared on the basis of long‐term projection and portray a
long‐range planning. These budgets generally cover plans for three to ten years. In this regard it is
mostly prepared in terms of physical quantities rather than in monetary values.

(b) Short‐term Budget: In this budget forecasts and plans are given in respect of its operations for a
period of about one to five years. They are generally prepared in monetary units and are more specific
than long‐term budgets.
(c) Current Budgets: These budgets cover a very short period, may be a month or a quarter or maximum
one year. The preparation of these budgets requires adjustments in short‐term budgets to current
conditions.
(d) Rolling Budgets: A few companies follow the practice of preparing a rolling or progressive budget. In
this case companies prepare the budget for a year in advance. A new budget is prepared after the end of
each month or quarter for a full year in advance. The figures for the month or quarter which has rolled
down are dropped and the statistics for the next month or quarter are added.

4. Classification on other basis

a) Zero base budgeting: Zero-based budgeting is a budgeting method that requires all expenses to be
justified and approved in each new budget period, typically each year.
b) Performance Budgeting (PB): The term performance implies results or outputs. ‘ A performance
budget is one which presents the purposes and objectives for which funds are required, the costs of the