UNIT-I: BUDGETARY CONTROL

MEANING AND OBJECTIVES OF BUDGET, BUDGETING AND

BUDGETARY CONTROL; REQUISITES OF BUDGETING
PROCESS- BUDGET PERIOD, BUDGET COMMITTEE AND
BUDGET FACTS CLASSIFICATION AND PREPARATION OF
FUNCTIONAL AND MASTER BUDGETS; CASH BUDGET;
FIXED AND FLEXIBLE BUDGETING PROCESS;
PERFORMANCE, PROGRAMME AND ZERO-BASE
BUDGETING METHODS; ADVANTAGES AND LIMITATIONS
OF BUDGETING. (THEORY AND PROBLEMS)

Mr. Vishwanath Bhanuse

Full-Time Guest Faculty
Dept. of Studies and Research in Commerce,
Rani Channamma University, PG Centre, Jamkhandi
 WHAT IS THE MEANING OF COST?
 The term cost has several meanings. In accounting, retail,
research and production, it is the value of money that we
used up to create something. That money is therefore not
available for use anymore.
 The term, in business, may refer to the amount of
money spent to acquire something. In such cases, it is
the input that has gone into acquiring the thing
 Put simply; ‘cost’ is the amount that we must give up or pay
to get something.
 From a seller’s point of view, cost is the amount of
money that is spent to produce a good or product. If a
producer were to sell his products at the production price.
 From a buyer’s point of view the cost of a product is also
known as the price. This is the amount that the seller
charges for a product, and it includes both the production
cost and the mark-up, which is added by the seller in order
to make a profit.
`
 WHAT IS COST IN A BUSINESS FIRM?
 In managerial accounting, and in a real-world
business firm, one of the most important concepts is
that of cost. Cost in a business firm can be thought
of as an investment in the business, but it's a
specific kind of investment that goes toward efforts
to sell a product or service.
 Since there are many different ways that a company

may try to sell its unique goods or services,

concepts of cost are similarly varied. There are
many types of costs, such as
direct and indirect costs, that a manager must
understand to effectively manage a business.
 CLASSIFICATIONS OF COST
Classification of Costs essentially means the grouping of
costs according to their similar characteristics. Now, in
costing there are a dozen ways to classify costs as per
their nature, functions, traceability etc. Here we will be
focusing on five such classifications. Let us learn this in
detail.
 Fixed Cost: Fixed cost refers to the cost of a business

expense that doesn’t change even with an increase or

decrease in the number of goods and services produced
or sold. Fixed costs are commonly related to recurring
expenses not directly related to production, such as rent,
interest payments, and insurance.
Since fixed costs are not related to a company’s
production of any goods or services, they are generally
indirect. Shutdown points tend to be applied to reduce
fixed costs.
 Variable Cost: A variable cost is a corporate expense that
changes in proportion to how much a company produces or
sells. Variable costs increase or decrease depending on a
company's production or sales volume they rise as production
increases and fall as production decreases.
Examples of variable costs include a manufacturing
company's costs of raw materials and packaging or a retail
company's credit card transaction fees or shipping expenses,
which rise or fall with sales. A variable cost can be
contrasted(go against) with a fixed cost.
Total Variable Cost = Total Quantity of Output X
Variable Cost Per Unit of Output
 Semi-Variable Cost: A semi-variable cost, also known as a
semi-fixed cost or a mixed cost, is a cost composed of a
mixture of both fixed and variable components. Costs are
fixed for a set level of production or consumption, and they
become variable after this production level is exceeded. If no
production occurs, a fixed cost is often still incurred.
 Examples of semi variable costs : Telephone bills and vehicle
expenses, internet fees.
 MARGINAL COSTING
 In economics, the marginal cost is the change in total production cost
that comes from making or producing one additional unit. To calculate
marginal cost, divide the change in production costs by the change in
quantity. The purpose of analyzing marginal cost is to determine at
what point an organization can achieve economies of scale to optimize
production and overall operations. If the marginal cost of producing one
additional unit is lower than the per-unit price, the producer has the
potential to gain a profit.
Marginal Cost = Change in Total Expenses / Change in Quantity
of Units Produced
 Definition of Marginal Costing
The Institute of Cost and Management Accountants, London,
has defined Marginal Costing as :
"The ascertainment of variable costs and of the effect on profit of
changes in volume or type of output by differentiating between fixed
costs and variable costs".
 'Variable Costing' is another term used for Marginal Costing. It denotes
the amount by which total cost change when there is an increase or
decrease in the production volume by one unit. It equates to the total
variable cost of a unit.
 CHARACTERISTICS OF MARGINAL COSTING
The following are the characteristics of marginal costing:
(1) Classification of costs: All costs are classified as fixed and
variable costs.
(2) Focus on variable costs: Fixed costs are constant. They do not
fluctuate with output. By contrast, variable costs always go up or
down with the output, while the per unit cost remains the same.
(3) Treatment of finished and semi-finished goods: The value
of finished goods and work-in-progress is included in the
marginal cost.
(4) Treatment of fixed costs: Fixed expenses are shown on
the debit side of the profit and loss account for the period in
which they are incurred.
(5) Basis of pricing: Prices are based on marginal cost plus
contribution. Thus, the contribution is the excess of the selling
price over the marginal cost of sales.
(6) Determination of profitability: The profitability of a product
is determined after a close study of the contribution made
available by each unit of output.
 WHAT IS ABSORPTION COSTING?
Absorption costing also known as 'full costing' is the
total cost technique. It is the conventional and most
widely used technique of ascertaining cost. CIMA,
(Chartered Institute of Management Accountants)
London, defines absorption costing as "the practice
of charging all costs both variable and fixed to
operations, processes or products." Under this
technique, product cost is made up of all direct costs
(i.e. direct material, direct labour, direct expenses
and variable factory overheads) plus fixed factory
overheads absorbed at a predetermined rate on the
basis of normal capacity. The administration, selling
and distribution overheads are treated as period
costs, and hence, are written off against the income
for the period in which they are incurred.
 FEATURES OF ABSORPTION COSTING
Following are some of the features of the Absorption
Costing: –
 Overhead Absorption Rate (OAR): This technique uses
Overhead Absorption Rate to allocate overhead costs to
cost units.
 Closing Inventories: The closing stock of inventory is
valued under Absorption Costing. In addition, the valuation
includes Fixed and Variable costs.
 Effects on Profit: The profit is affected by the increase or
decrease in the output levels.
 Profit as Production Function: The profit calculation is
dependent on production rather than sales.
 Cost Allocation: During cost allocation, both fixed and
variable costs are taken into consideration.
 Decision Making: It is not helpful to the managers for
effective decision-making.
ABSORPTION COSTING INCOME STATEMENT
 POINTS TO REMEMBER
 The variable costs are directly charged in this
costing method. In contrast, fixed costs are
apportioned(distribute) over different products
manufactured over time.
 The per-unit cost remains constant when the output

level remains constant from time to time. However,

the output level cannot remain stable over time, and
so the per-unit cost.
 With the changes in the output level, the per-unit

cost also changes because of the portion of fixed

costs in the unit cost. But, the fixed cost remains the
same even when the output level changes.
PART-II BUDGETARY CONTROL
What is Budget?
 Budget Means:
It refer to a plan relating to a definite future period of time
expressed in monetary/quantitative terms.
A budget is a formal expression of the expected
incomes and expenditure for a definite future period.
 To manage your monthly expenses, prepare for life's
unpredictable events, and be able to afford big-ticket items
without going into debt, budgeting is important.
 Definition of Budget: According to CIMA (Chartered
Institute of Management Accountants) UK, a budget is “A plan
quantified in monetary terms prepared and approved prior to
a defined period of time, usually showing planned income to
be generated and, expenditure to be incurred during the
period and the capital to be employed to attain a given
objective.”
 In a view of Keller & Ferrara, “a budget is a plan of action to
achieve stated objectives based on predetermined series of
related assumptions.”
 G.A.Welsh states, “A budget is a written plan covering
projected activities of a firm for a definite time period.”
 HOW TO CREATE A BUDGET?
1. Examine Your Revenue: Look back and examine your previous and
current revenues. Compare any similarities and differences in their
output and discover income sources that may benefit your company
plan on a monthly and annual basis. Examine how many changes
occurred during these periods and prepare for any seasonal changes.
Include factors such as your taxes, policies, and your personnel's
travel and operating expenses in your monitoring your budget
calculations.
2. Subtract Fixed Costs: Fixed costs commonly apply to your
recurring operations in the business. They may occur on a daily,
weekly, monthly, or yearly basis, so take note on these fixed costs
that might be associated with your business. Once you identified
everything, try to minimize these costs from your income.
3. Determine Your Variable Expenses : Along with your fixed costs,
determine your variable expenses as well. Variable expenses change
how much you use a service. Some examples are your utilities and
equipment, office supplies, marketing costs, and other professional
development for your employees. Identify necessary variable
expenses form your business and reduce them during lean months.
At the same time, you increase them during profitable months when
you have extra income. What matters most is to have a good
judgment on when to make changes.
4. Prepare a Contingency Fund: Anything can happen in
business and you may never expect them to come. Prepare
a contingency fund to give yourself extra cash when
emergencies and unwanted events may occur. At least you
will be ready to quickly respond to damages on your
inventory and management.
5. Make a Profit and Loss Statement: Once you have
collected every important information for your corporate
budget, it is time for you to create your profit and loss
statement. Add all your income for the month, do this as
well with your expenses for the month. You subtract your
expenses from your income and hope to get a good profit.
6. Create Your Projections: May you be a newcomer in
business or an old-timer, you still need to create your
projections for your corporate budget. Have a plan outline
of your budget, refer to your profit and loss statement, and
understand the seasonal ups and downs of your business.
Check for good investments for your company and avoid
things that may deplete your profit in the future.
 CHARACTERISTICS OF BUDGET
The main characteristics of budget are as
follows:
1. A budget is concerned for a definite future period.

2. A budget is a written document.

3. A budget is a detailed plan of all the economic

activities of a business.
4. Budget is a mean to achieve business and it is not
an end in itself.
5. Budget needs to be updated, corrected and
controlled every time when circumstances change.
Therefore, it is a continuous process.
6. Budget helps in planning, coordination and control.

7. A budget acts as a business barometer.

8. Budget is usually prepared in the light of past

experiences.
 WHAT IS BUDGETING?
 Budgeting is a strategic planning process that
businesses use to plan how they will spend their
money in the future. To make a budget, businesses
look at how much money they made (revenue) and
spent (expenses) in the past and use that
information to predict how much money they will
make and spend in the future.
 For example, a software company might make a

budget to plan how much money they will spend on

developing new products, advertising their products,
and running their business. A resulting budget is a
tool that helps management make informed
decisions, avoid overspending, achieve financial
goals, and more.
 In Simple/other words The budget is a formal

quantitative expression of the goals of management.

 BUDGETARY CONTROL:
 Budgetary control is a system of controlling cost which includes
preparation of Budgets coordinating the departments and
establishing responsibilities comparing performance with
budgeted and acting upon results to achieve the maximum
profitable.
 Budgetary control is known as setting up a particular budget by
management to know the variation between the company’s
actual performance and budgeted performance. It also helps
managers utilize these budgets to monitor and control various
costs within a particular accounting period.
 It is a process of planning and controlling all the functions of an
organization through comparison and analysis of budgeted
numbers to actual results. Comparing the budgeted numbers
with actual results identifies the areas that need improvement
and where cost reduction is feasible or budgeted numbers need
to be revised.
 In simple Budgetary Control is a method of managing costs
through preparation of budgets. Budgeting is thus only a part of
the budgetary control.
Definitions:
 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.”
 Brown and Howard: "The budget is a predetermined statement of

management policy during a given period which provides a

standard for comparison with the results actually achieved."
 George R. Terry: "A budget is an estimate of future needs

arranged according to an orderly basis covering some or all the

activities of an enterprise for a definite period of time."
 Harry L. Wyllie: "Budgets are finished products...They are formal

programs of future operations and expected results. Budgets result

from forward thinking and planning."
 Sanders: "The essence of a budget is a detailed plan of operations

for some specific future period, followed by a system of records

which serves as a check upon plan."
 H. J. Weldon: "A budget is thus a standard with which to measure

the actual achievement of people, departments, etc."

WHAT IS THE DIFFERENCE BETWEEN BUDGET AND
BUDGETARY CONTROL?
Budget Budgetary Control
Budget is an estimation of revenues Budgetary control is the process where
and costs for a period. budgets are prepared at the beginning of
the accounting period to compare and
analyze the actual results at the end of the
accounting period.
Time Period
Preparation of the budget occurs prior Decisions relating to budgetary control will
to the beginning of the accounting be taken at the end of the accounting
period. period.
Inclusion of Revenues and Costs
Estimations of revenues and costs will Both estimations and actual revenues and
be included in budgets. costs will be included in budgetary control.
Nature
Budgeting is the formulation of the Budgetary control refers to the control of
plan of the organization. business activities.
Dependency
Budget can be set without follow up But budgetary control is not possible
action i.e., without budgetary control. without a budget. However budget without
the budgetary control will not be of much
STEPS IN THE BUDGETARY CONTROL PROCESS
1. Setting Financial Objectives: The first step in the budgetary control
process is determining the organization’s financial objectives. This
might include increasing revenue, reducing costs, improving cash flow,
or increasing profit margins.
2. Developing the Budget: The next step is to develop a comprehensive
budget that outlines expected income and expenditures for a specific
period. This might include creating separate budgets for different
departments, products, or projects.
3. Implementing the Budget: Once the budget has been developed, it
must be implemented within the organization. This might involve
communicating the budget to employees, creating systems to monitor
and control expenditures, and making necessary changes based on
employee feedback.
4. Monitoring Performance Against the Budget: The final step in the
budgetary control process is monitoring performance against the
budget. This might involve comparing actual expenditures and
revenues to budgeted amounts, tracking cash flow, and reviewing
financial reports.
5. Taking Corrective Action: If the organization is not meeting its
budgeted targets, it may be necessary to take corrective action. This
might involve reducing expenditures, increasing revenue, or changing
the budget itself.
 OBJECTIVES OF BUDGETARY CONTROL:
Budgeting is a forward planning. It serves basically as a tool for
management control; it is rather a pivot of any effective scheme of control.
The objectives of budgeting may be summarized as follows:
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. By planning many problems estimated long
before they arise and solution can be thought of through careful study. In
short, budgeting forces the management to think ahead, to fore see and
prepare for the anticipated conditions. Planning is a constant process since
it requires constant revision with changing conditions.
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. Lack of co‐ordination in an organization is observed
when a department head is permitted to enlarge the department on the
specific needs of that department only, although such development may
negatively affect other departments and alter their performances. Thus, co‐
ordination is required at all vertical as well as horizontal levels.
3. Motivation: Budget is always considered a 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.
4. Communication: A budget serves as a means of
communicating information within a firm. The
standard budget copies are distributed to all
management people provide not only sufficient
understanding and knowledge of the programmes and
guidelines to be followed but also give knowledge
about the restrictions to be adhered to.
5. 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 a
systematized effort is to keep the management
informed of whether planned performance is being
achieved or not.
 ESSENTIALS/ REQUISITES OF A GOOD BUDGETARY CONTROL
SYSTEM
1. Support from top management: The effective implementation of the budgetary
control system depends upon the attitude and perception of management towards
it. If the top executive takes the budgeting as a mere routine job and does not take
any interest in its implementation, it will be a incapable exercise.
2. Quantification of organizational goal: The goal of the organization should be
clearly expressed and quantified. There should not be any misconception and
confusion in the minds of employees regarding goals to be attained.
3. Creation of responsibility center: The entire organization should be divided
into sections and sub­section with clear assignment of duties and responsibilities
for each of them.
4. The split of organizations’ goals: The goals of each department or
responsibility center should be spelled out towards the attainment of the overall
goals of the organization. The functional goals should be compatible with the
organizational goal.
5. Realistic: The target to be set in the budget should be fairly attainable. If it is set
at a level beyond the capacity of employees, they will lose their interest in its
implementation, on the other hand, if it is set at a very low level, it will be
meaningless as the job, in any case, will be done.
6. Participation: All the key employees should be made involved in the preparation
of the budget. Participation brings in commitment. Commitment enhances the
efficiency and productivity of employees.
7. Good accounting system: There is close relationship between budgeting and
accounting. One has to depend on accounting department for reliable historical
data. Responsibility accounting is essential for successful budgetary control.
8. Coordination: Co-ordination is an important requirement” of budgetary
control. It brings in common thinking, mutual trust, and confidence amongst
various departments.
9. Flexibility: A budget should be enable to change if the changing situation so
warrants.
10. Reporting system: The success of budgetary control depends upon a good
reporting system. The actual performance vis-a-vis the target should be
continuously reported to the management to enable them to take corrective
action in the areas which are not performing well.

 Other Requisites of Budgetary Control:

1) Clear cut objectives and goals should be well defined.
2) The ultimate objective of realising maximum benefits should always be kept
uppermost..
3) Budget committee should be set up for budget preparation and efficient
execution of the plan.
4) A budget should always be related to a specified time period.
5) Support of top management is necessary in order to get the full support and
co- operation of the system of budgetary control.
(6) To make budgetary control successful, there should be a proper delegation of
authority and responsibility.
(7) Adequate accounting system is essential to make the budgeting successful.
(8) The employees should be properly educated about the benefits of budgeting
system.
 TYPES OF BUDGETARY CONTROL
1 Operational Control
It covers the revenue and operating expenses,
which are essential to running a day-to-day business. The
actual numbers to a budget are compared monthly in most
cases. It helps achieve control over EBITDA – Earnings
before interest, taxes, depreciation, and amortization.
2 Cash Flow Control
This is an important budget that controls the working
capital requirement and cash management. Therefore,
cash crunches could be detrimental to everyday
functioning, which is an important aspect.
3 Capex Control
It covers capital expenditures, like buying
machinery or constructing a building. Because it involves a
huge amount of money, the control here helps eliminate
waste and reduce costs.
 ADVANTAGES OF BUDGETARY CONTROL
1. Participation: Budgetary control allows the employees of the organization
to participate in the process and contribute their maximum effort towards
achieving the goal.
2. Top management support: Budgetary control is a process that works
mainly with the assistance of the top management like the directors,
managers, etc. Therefore, if the management is supportive and cooperative,
this system of budget control becomes easier and more efficient.
3. Reduce cost: It manages the cost of production of the company by effective
planning of financial activities and ensures that the resources are being
utilized properly so that there is minimum wastage. This brings down the cost
of operation to the organization.
4. Maximization of profit: Through planned goals and proper coordination,
the organization functions efficiently as all the activities are adequately
performed and the expenditures and capital are put to use correctly with the
help of the process of budgetary control.
5. Specific aims: The process of budgetary control makes the goal of the
organization clearer and easier to accomplish. The expenses and resources
are well allocated into areas required and help avoid unnecessary wastage in
terms of time and money. Therefore, the improved control over activities and
finance makes the goal more definite for the organization.
6. Tool for measuring performance: The budgetary control acts as a tool for
measuring performance. It helps compare the result achieved by the
organization and the objectives that were set earlier while planning. It
detects the areas that need attention and provides assistance or solutions.
 LIMITATIONS OF BUDGETARY CONTROL
1. Limited to the financial aspect: The concept or process of budgetary
control sole focuses on only the financial outlook of the organization. The
other issues like customer satisfaction, employee benefit, safety issues, etc.
are disregarded.
2. No stability: It is almost impossible to have a stable business environment.
Considering that the business condition remains constant, the process of
budgetary control may not be accurate for a lot of the financial decisions. The
organization can find it difficult to work or adjust according to the changes it
faces.
3. Inflexibility: Budgetary control depends on specific capital and limited time.
However, this can create inflexibility in the organization as the employees
might not be ready for a change and keep new ideas and projects to
themselves, which would have benefited the organization.
4. Dependent on assumptions: Budgets are often dependent on financial
aspects like expenses, revenue, and future profits. Since these data are
mostly based on previous years’ performances, they might not be helpful or
accurate for future reference. If any of those assumptions turn out to be
wrong, the organization can suffer some kind of loss or damage.
5. Time-consuming: Making a detailed budget report can take up a lot of time
and effort that otherwise would have been used for other important activities
such as strategic planning, customer service, and product development.
Though budgeting helps reduce the wastage of resources, a long process of
monitoring, planning, and adjusting can exhaust a lot of resources too.
 ORGANIZATION FOR BUDGETARY CONTROL

There are certain steps which are necessary for the successful
implementation of a budgetary control system. They are as follows:

1. Organization for budgetary control.

2. Budget centers.

3. Budget officer.

4. Budget manual

5. Budget committee.

6. Budget period.

7. Determination of key factor.

1. Organization for Budgetary Control: The proper organization is essential for
the successful preparation, maintenance and administration of budgets. A
Budgetary Committee is formed which comprises the departmental heads of
various departments. All the functional heads are entrusted with the responsibility
of ensuring proper implementation of their respective departmental budgets.
An organization chart for budgetary control is give below:

The Chief Executive is the overall incharge of budgetary system. He constitutes a

budget committee for preparing realistic budgets. A budget officer is the gonvener of
the budget committee who co- ordinates the budgets of different departments. The
managers of different departments are made responsible for their departmental
budgets.
2. Budget Centres: A budget centre is that part of the organisation for
which the budget is prepared. A budget centre may be a department,
section of a department or any other part of the department. The
establishment of budget centres is essential for covering all parts of the
organisation. The budget centres are also necessary for cost control
purposes. The appraisal of performance of different parts of the
organisation becomes easy when different centres are established.
3. Budget Manual: A budget manual is a document which spells out the
duties and the also the responsibilities of the various executives concerned
with the budgets. It specifies the relations among various functionaries.
A budget manual covers the following matters:
(i) A budget manual clearly defines the objectives of budgetary control
system. It also gives the benefits and principles of this system.
(ii) The duties and responsibilities of various persons dealing with
preparation and execution of budgets are also given in a budget manual.
It enables the management to know of persons dealing with various
aspects of budgets and clarify their duties and responsibilities.
(iii) It gives information about the sanctioning authorities of various budgets.
The financial powers of different managers are given in the manual for
enabling the spending of amount on various expenses.
(iv) A proper table for budgets including the sending of performance reports
is drawn so that every work starts in time and a systematic control is
exercised.
(v) The length of various budget periods and control points be clearly
given.
(vi) The procedure to be followed in the entire system should be clearly
stated.
(vii) A method of accounting to be used for various expenditures should
also be stated in the manual.
A budget manual helps in knowing in writing the role of
every employee, his duties, responsibilities, the ways of
undertaking various tasks etc. it also helps in avoiding ambiguity
of any time.

4. Budget Officer: The Chief Executive who is at the top of the

organisation, appoints some person as Budget Officer. The budget
officer is empowered to scrutinize the budgets prepared by different
functional heads and to make changes in them, if the situation so
demands. The actual performance of different departments is
communicated to the Budget Officer. He determines the deviations
in the budgets and takes necessary steps to rectify the deficiencies,
if any. He works as a co-ordinator among different departments and
monitors the relevant information. He also informs the top-
management about the performance of different departments. The
budget officer will be able to carry out his work fully well only if he is
conversant with the working of all the departments.
5. Budget Committee: In small scale concerns, the accountant
is made responsible for preparation and implementation of
budgets. In large scale concerns a committee known as Budget
Committee is formed. The heads of all the important
departments are made members of this committee. The
committee is responsible for preparation and execution of
budgets. The members of this committee put up the case of
their respective departments and help the committee to take
collective decisions, if necessary. The Budget Officer acts as
co-ordinator of this committee.
The function of the budget committee……
 Issuing guidelines to various department for the preparation of

the budget
 Developing the time-table for budget preparation.

 Receiving and evaluating the budget estimates to ensure that

the organization long-term objectives are achieved

 Consulting deferent managers for solving their problems.

 Establishing the roles and responsibilities of all the participants

in the budgeting process.

6. Budget Period: A budget period is the length of time for
which a budget is prepared . The budget period depends
upon a number of factors. It may be different for different
industries or even it may be different in the same industry or
business.
The budget period depends upon the following
considerations:
(a) The type of budget i.e., sales budget, production budget,
raw materials purchase budget, capital expenditure budget.
A capital expenditure budget may be for a longer period ie,
3 to 5 years; purchase, sale budgets may be for one year.
(b) The nature of demand for the products,

(c) The timings for the availability of the finances.

(d) The economic situation of the cycles.

(e) The length of trade cycles.

All the above mentioned factors are taken into

account while fixing the period of budgets.
7. Determination of key factor: Key Factor is also
called as "Limiting Factor" or Governing Factor. While
preparing the budget, it is necessary to consider key
factor for successful budgetary control. The influence of
the Key Factor which dominates the business operations in
order to ensure that the functional budgets are reasonably
capable of fulfillment. The Key Factors include.
(1) Raw materials may be in. short supply.

(2) Non-availability of skilled labours.

(3) Government restrictions.

(4) Limited sales due to insufficient sales promotion.

(5) Shortage of power.

(6) Underutilization of plant capacity.

(7) Shortage of efficient executives.

(8) Management policies regarding lack of capital.

(9) Insufficient research into new product development.

(10) Insufficiency due to shortage of space.

 CLASSIFICATION AND TYPES OF BUDGET

Classification and Types of Budget

(A) On the Basis of (B) On the Basis of (C) On the Basis of

Time Function Flexibility

1. Long – term 1. Operating

1. Fixed budgets
budgets budgets

2. Short- term
2. Financial budgets 2. Flexible budgets
budgets

3. Current budgets 3. Master budgets

 A. CLASSIFICATION ON TIME BUDGET
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.
(B) CLASSIFICATION ON THE BASIS OF
FUNCTION
1. Operating/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
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 the
capacity 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 important areas 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 resources are highly expensive
item in the operation of an enterprise. Hence, like other 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.
 g. SELLING AND DISTRIBUTION COST 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 a
separate 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.
 2. FINANCIAL BUDGETS
 Financial budgets are concerned with cash receipts
and disbursements, working capital, capital
expenditure, financial position and results of
business operations. The commonly used financial
budgets are:
a) Cash Budget

b) Working Capital Budget

c) Capital Expenditure Budget

d) Income Statement Budget

e) Statement of Retained Earnings Budget Budgeted

Balance Sheet or Position Statement Budget.
 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.
 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 a vital 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.

 Advantages of Cash Budget:
1. Usage of Cash: Management can plan out the use of cash in accord
with the changes of receipt and payment. Payments can be planned
when sufficient cash is available and continue the business activity
with the minimum amount of working capital.
2. Allocation for Capital Investment: It is dual benefits such as
capital expenditure projects can be financed internally and can get an
idea for cash availability of capital investment.
3. Provision of Excess Funds: It reveals the availability of excess cash.
In this regard management can decide to invest excess funds for short
term or long term according to the requirements in the business.
4. Pay‐out Policy: This budgetary system may help the management
for future pay‐out policy in the form of dividend. In case the cash
budget liquid position is not favourable, the management may reduce
the rate of dividend or maintain dividend amount or skip dividend for
the year.
5. Provision for acquiring Funds: It gives the top level management
ideas for acquiring funds for particular time duration and sources to
be explored.
6. Profitable Use of Cash: Business person can take decision for the
best use of liquidity to make more profitable transaction. It can be
used at the time of bulk purchase payments and one get the benefit
of discount.
 Limitation of Cash Budget:
1. Complex Assumption: Business is full of uncertainties,
so it is very difficult to have near perfect estimates of
cash receipts and payments, especially for a longer
duration. It can be predicted for short duration such as of
three to four months.
2. Inflexibility: If the finance manager fails to show
flexibility in implementing the cash budget, it will incur
adverse effects. If the manager follows strictly adheres to
the estimates of cash inflow it may negatively result in
losing customers. Likewise, loyalty in payments may lead
to deterioration of liquid position.
3. Costly: Application of this technique necessitates
collecting of statistical information from various sources
and expert personnel in operation research would be the
costliest deal. It becomes expensive which may not be
affordable to small business houses. In addition, finding
out experts is not always possible. In this situation the
long term predictions do not prove correct.
 3. MASTER BUDGETS
 Master Budget is Various functional budgets are
integrated into master budget. This budget is
prepared by the ultimate integration of separate
functional budgets. According to I.C.W.A. London,
"The Master Budget is the summary budget
incorporating its 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 also to help as a control device.
(C) CLASSIFICATION ON THE BASIS OF FLEXIBILITY
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. 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
 It 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.
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.” 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.
 ZERO BASE BUDGETING:
 The ‘Zero‐Base’ refers to a ‘nil‐budget’ as the starting point. It starts with a
presumption that the budget for the next period is ‘zero’ until the demand
for a function, process, or project is not justified for single penny. The
assumption is that without such justification, no expenditure will be allowed.
In effect, each manager or functional head is required to carry out cost‐
benefit analysis of each of the activities, etc. under his control and for which
he is responsible.
The method of ZBB suggests that the business should not only make
decision about the proposed new programmes but it should also, regularly,
review the suitability of the existing programmes. This approach of preparing
a budget is called incremental budgeting since the budget process is
concerned mainly with the increases or changes in operations that are likely
to occur during the budget period.
This method for the first time was used by the Department of
Agriculture, U.S.A. in the 19th century. Other State Governments of the
U.S.A. found this method helpful and so almost all the states took deep
interest in the ZBB method. A number of states of America use this
technique even today. The ICAI has brought out a research in the form of a
monograph showing the application of the ZBB method that worries in
tandem with the concerns for national environment and its requirements. In
India, however, the ZBB approach has not been fully accepted and
actualized.
 "ZBB is a management tool, which provides a
systematic method for evaluating all operations and
programmes, current or new, allows for budget
reductions and expansions in a rational manner and
allows re‐allocation of sources from low to high
priority programmes.“
‐ David
Lieninger
 PROCEDURE OF ZERO‐BASE BUDGETING:
(1) Determination of the objective: This is an initial step for
determining the objective to introduce ZBB. It may result into
the decreased cost in personnel overheads or debunk the
projects which do not fit in the business structure or which are
not likely to help accomplish the business objectives.
(2) Degree at the ZBB is to be introduced: It is not possible
every time to evaluate every activity of the whole business.
After studying the business structure, the management can
decide whether ZBB is to be introduced in all areas of business
activities or only in a few selected areas on the trial basis.
(3) Growth of Decision units: Decision units submit their data
as to which cost benefit analysis should be done in order to
arrive at a decision that helps them decide to continue or
abandon. It could be a functional department, a programme, a
product‐line or a sub‐line. Here the decision unit sexist
independent of all the other units so that when the cost
analysis turns unfavourable that particular unit could be
closed down.
(4) Growth of Decision packages: Decision units are to be identified for
preparing data relating to the proposals to be included in the budget,
concerned manager analyzes the activities of his or her own decision
units. His job is to consider possible different ways to fulfill objectives.
The size of the business unit and the volume of goods it deals with
determine the number of decision units and packages. The decision
package has to contain all the information which helps the management
in deciding whether the information is necessary for the business, what
would be the estimated costs and benefits expected from it.
(5) Assessment and Grading of decision packages: These packages
invented and formulated are submitted to the next level of responsibility
within the organization for ranking purposes. Ranking basically decides as
to whether or not to include the proposals in the budget. The
management ranks the different decision packages in the order from
decreasing benefit or importance to the organization. Preliminary ranking
is done by the unit manager himself and for the further review it is sent to
the superior officers who consider overall objectives of the organization.
(6) Allotment of money through Budgets: It is the last step engaged in
the ZBB process. According to the cost benefit analysis and availability of
the funds management has ranks and thereby a cut‐off point is
established. Keeping in view reasonable standards, the approved
designed packages are accepted and others are rejected. The funds are
then allotted to different decision units and budgets relating to each unit
are prepared.
 Advantages:
 ZBB rejects the attitude of accepting the current position in support of an
attitude of inquiring and testing each item of budget.
 It helps improve financial planning and management information system
through various techniques.
 It is an educational process and can promote a management team of talented
and skillful people who tend to promptly respond to changes in the business
environment.
 It facilities recognition of inefficient and unnecessary activities and avoid
wasteful expenditure.
 Cost behavior patterns are more closely examined.
 Management has better elasticity in reallocating funds for optimum utilization
of the funds.
 Disadvantages:
 It is an expensive method as ZBB incurs a huge cost every in its preparation.
 It also requires high volume of paper work; hence sometimes it becomes a
tedious job.
 In ZBB there is a danger of emphasizing short‐term benefits at the expenses of
long term ones.
 This is not a new method for evaluating various alternatives, and cost‐benefit
analysis.
 The psychological effects can also not be ignored. It holds out high hopes as a
modern technique, claiming to raise the profitability and efficiency of the
business.
 ADVANTAGES OF BUDGETING
1. Developmental Orientation: Developing a budget compels
management to shift its focus from short-term, ongoing
management of the company to longer-term planning. This is the
main objective of budgeting; even if management is unsuccessful
in achieving its objectives as specified in the budget, at least it is
considering how to enhance the company's competitive and
financial position.
2. Analysis of Bottlenecks: Every organization has a bottleneck
someplace. The budgeting process may be utilized to focus on
what can be done to either increase the capacity of that
bottleneck or move work around it. It also aids management in
reviving or revamping the company before it's too late.
3. Planning For Funds: The quantity of money that will be spun
off or required to fund operations should be derived from a
properly established budget. The treasurer uses this data to
forecast the financing requirements for the business. The
treasurer can determine whether to invest extra funds in short-
term or long-term investment instruments using this information
for investment planning. The budgets' justifications or underlying
presumptions can also be understood by management. The
fundamental presumptions that underlie the budgeted statistics
4. Review of Profitability: This is one of the most
advantageous features of budgeting during the flurry of
daily management. It is simple to lose track of where a
firm makes its revenue. A correctly constructed budget
identifies which portions of the company generate
revenue and which ones consume it, forcing
management to decide whether to scale down or expand
in some areas. Management can also take remedial
measures for the departments that are not assisting the
organization's overall objective.
5. Sound Financial Management: Budgets can serve as
a motivating tool to help you manage your money.
Budgeting may help you reach your financial objectives,
which can spur you on to do more budgeting and gain
financial control. The budgets' justifications or underlying
presumptions can be understood by management in
businesses. The fundamental presumptions that underlie
the budgeted statistics can then be improved.
 DISADVANTAGES OF BUDGETING
1. Delayed Results: Budgeting requires time and work, as you
are aware, and for some individuals, the rewards don't show up
quickly enough. The issue with this is that some people may
lose interest in adhering to a budget. Since most individuals
concentrate on the long-term objective, it might be
challenging to keep to the budget since they are process-
oriented. Remember that you will ultimately achieve your
goals if you stick to your budget since it is effective.
2. Inaccuracy: This could be the main reason why most
individuals stop using budgets. Budgeting is erroneous
sometimes, or even always, if you are not very practical. When
creating a budget, you must remember that you are predicting
and estimating how much you will spend based on your
current information. Rent is ₹8000, but if the spread rises, rent
will be more. Or if you regularly fill your car up with ₹2000
worth of petrol each month, but if fuel prices rise, you'll have
to pump in more, costing you more money than you
anticipated. Since you may never be certain of your revenue
for a given month, budgeting can be particularly difficult for
freelancers.
3. Budgeting is Rigid, And Mechanical: Many people think
creating a budget is a mechanical, inflexible process limiting
your flexibility. You must follow a rigorous budget that limits
where and how much money you may spend while you go about
your daily life. For example, what if you wanted to visit your
favorite restaurant, but your budget indicated that you had
already used all your monthly allowance for dining out that
month? This is very rigid.
4. Budgeting Results Take Time to Appear: Budgeting
requires time and work, as you are aware, and for some
individuals, the rewards don't show up quickly enough. The
issue with this is that some people may lose interest in adhering
to a budget. Since most individuals concentrate on the long-
term objective, it might be challenging to keep to the budget
since they are process-oriented. Remember that you will
ultimately achieve your goals if you stick to your budget since it
is effective.
5. Excessive Work and Time: Budgeting will almost certainly go
wrong since you will neglect certain costs. When creating a
budget for the first time, some people are not practical. You
must realize that this will need time and effort.
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 http://umeschandracollege.ac.in/pdf/study-m
aterial/accountancy/Budget-Budgetary-Contr
ol-Sem-IV.pdf
 https://www.studocu.com/in/document/mahat
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