Management Accounting

FINC001
BUDGETING AND BUDGETARY
CONTROL
Unit 13
TOPICS TO BE COVERED
Introduction
• Concept of Budget
• Concept of Budgetary Control
• Comparison between Budget, Budgeting and Budgetary Control
Objectives
• Precautions in Budgetary Control
• Merits and Demerits of Budgetary Control
Classification of Budgets
• Concept of Performance Budgeting
• Process of Performance Budgeting
• Concept of Zero-Based Budgeting
• Merits of Zero-Base Budgeting
INTRODUCTION
In this unit we will discuss the importance of understanding the concept of
budgeting and budgetary control for cost control.

Budgeting is the broadly used and best rated tool of planning and controlling
the activities in the business.
Planning implies where we are and where we want to go. Planning is the key to
look and forecast future. Business Budgets help the management in developing
financial blueprint of procuring resources and its effective utilization.
Then control is the process of measuring, comparing and correcting actual
performance to ensure that activities should be carried out properly. Therefore,
understanding concept of Budgeting, its types, budgetary control and their
scope in business is important.
CONCEPT OF BUDGET AND BUDGETARY
CONTROL
Budgetary Control is a pivotal device used by top-level management to draw the
minimum usage of scarce corporate capitals and to make best use of the resources
in enterprise. For the increment in profits, cost control is must.

To achieve this objective, management must make the plans in advance for
different types of business activities such as logistics, sales, production and
overheads etc. Planning should be like where we are and where we want to go
further.

A budget is a pre-determined tool of management during a specified time period

which gives a blueprint for comparison with the outcomes actually attained.
CONCEPT OF BUDGET
According to Institute of Cost and Management Accountants, I.C.M.A., London
“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 of the purpose of
attaining a given objective.”
A budget is a proper declaration of projected income and expenses based on
future tactics and purposes. It is an estimate made for a certain future period
on the basis of monetary and non-monetary information. These are to be made
and approved in advance, before they are implemented.
In other words, a budget is like a blueprint that management makes to
estimate the incomes and expenses for a forthcoming period.
FEATURES OF BUDGET
The features of budget are as follows:
• Budgets is made for certain period.
• It is an estimation based on financial/non-financial units.
• It is an essential tool to regulate costs.
• It should be flexible.
• It should be fusion of past, present and future.
• It should be the joint effort of department heads at various levels and
executives involved.
• It should be the outcome of forward thinking and forecasting.
• It should include comprehensive plan of action.
• It should have support of top-level management for its implementation.
CONCEPT OF BUDGETARY CONTROL
• Budgetary control comprises of two procedures i.e. groundwork of the budget
and controlling the costing
• It is the procedure of comparing the actual outcomes with the planned
budgets for the manufacturing/non-manufacturing firm for the upcoming
year.
• Top level management set the benchmarks i.e. standards for the various
departments. So that they compare the budgeted numbers with the real
performance for the calculations of deviations/ discrepancies, if any.
• Initially, budgets are made and then achieved outcomes are documented.
This comparison of budgeted and achieved outcomes will permit the top-level
management to detect the deviations and take corrective course of actions at
an appropriate period.
CONCEPT OF BUDGETARY CONTROL
According to Institute of Cost and Management Accountants, I.C.M.A.,
London

“Budgetary Control is the establishment of budgets relating to the

responsibilities of executives to the requirements of a policy and continuous
comparison of actual with budget results either to secure by individual action of
objectives of that policy or to provide a solid basis for its revision.”

According to Brown and Howard

“Budgetary control is a system of controlling costs which includes the

preparation of budgets, coordinating the departments and establishing
responsibilities, comparing actual performance with the budgeted and acting
upon results to achieve maximum profitability.”
COMPARISON BETWEEN BUDGET,
BUDGETING AND BUDGETARY CONTROL
Budget is an estimation made on the basis of monetary and non-monetary data
which is made in advance for the accomplishment of goals. Budgeting must
start with the formulation of budgets.

Budgetary control is a way of controlling all aspects of producing/selling costs

comprises of making budgets, cohesiveness among departments, comparing
real statistics with budgeted and acting with corrective action, if deviation
arises.

According to Rowland and William,

“Budgets are the individual objectives of a department, etc., whereas Budgeting

may be said to be act of building budgets. Budgetary control embraces all and
in addition includes the science of planning the budgets to effect an overall
management tool for the business planning and control”.
OBJECTIVES OF BUDGETARY CONTROL
Budgetary control works as a tool to make best use of scarce resources for
higher profits. The objectives are as follows:
• To help top-level management in monitoring cost of various departments.
• To surge the efficiency of manufacturing process.
• To increase profits due to wastage control.
• To co-ordinate the actions of various responsibility centers.
• To consolidate the control system.
• To regulate the total capital prerequisite.
• To regulate research and development process.
• To anticipate capital outflows for upcoming events.
ESSENTIALS (PROCESS) OF BUDGETARY
CONTROL
There are certain phases which are required for the successful execution of a
budgetary control system. The budgetary officer has to be more cautions with
the following essentials:
Goals and Strategy of Business:
Every business has its goal to be achieve on time. While preparing the budget,
the short term and long-term objectives should be considered. Therefore, the
goals should be clear, so that the strategy is made to achieve those goals.
Fixation of Budget Period:
A budget is prepared and employed for a specified time. No defined rules being
followed by business units while choosing a time frame for budgets. But few
important factors must be considered for the length of budget period i.e. type of
business, demand and supply of goods and services, requirements of finance,
shipping, transportation and need for control of operation.
ESSENTIALS OF BUDGETARY CONTROL
Establishment of budget centers:
Budgets centers are established with the aim of budgetary control. It is the part
of the organization which keeps checks on various departments such as sales
department, purchase department, production department, etc. These budget
centers help in cost controlling and appraising the performance of each
department in the organization.
Establishment of adequate accounting records:
Proper recording of all the accounting transactions is very vital. The
transactions should be analyzed on timely basis, so that proper actions should
be taken on time. A chart of accounts should be prepared corresponds with
budget center.
Preparation of an organization chart:
The organization chart helps in the proper functioning of the organization at
times. The success of the budgets depends upon the coordination among all the
departments. Therefore, an organization chart is prepared comprising of the
employees from top to bottom i.e., chief executive then budget officer then
budget committee followed by all department heads as production manager,
sales manager, finance manager, accounting manager, personnel manager and
ESSENTIALS OF BUDGETARY CONTROL
Establishment of budget centers:
Budgets centers are established with the aim of budgetary control. It is the part of the
organization which keeps checks on various departments such as sales department,
purchase department, production department, etc. These budget centers help in cost
controlling and appraising the performance of each department in the organization.

Establishment of adequate accounting records:

Proper recording of all the accounting transactions is very vital. The transactions should
be analyzed on timely basis, so that proper actions should be taken on time. A chart of
accounts should be prepared corresponds with budget center.

Preparation of an organization chart:

The organization chart helps in the proper functioning of the organization at times. The
success of the budgets depends upon the coordination among all the departments.
Therefore, an organization chart is prepared comprising of the employees from top to
bottom i.e., chief executive then budget officer then budget committee followed by all
department heads as production manager, sales manager, finance manager, accounting
manager, personnel manager and research & development manager etc.
ESSENTIALS OF BUDGETARY CONTROL
Establishment of Budget Committee:
A budget committee is not an executive committee. Its decisions become
binding only with the authority of the chief executive who is the chairman of
this committee. The budget officer, whether he is called budget director or
controller, should be responsible direct to the chief executive and acts as a
secretary to the budget committee.

The main functions of a budget committee are:

• to receive and scrutinize all budgets
• to adopt detailed policy to be tracked
• to recommend amendment of all budgets; where requires
• to support on re viewed budget
• to accept and contract with the budget and comparison statements
• to endorse act to be occupied beneath the circumstances.
MERITS OF BUDGETRY CONTROL
Extension of Income (profit):
Every organization object at extending the income by utilizing its limited
resources in the best manner. Therefore, a proper planning should be done
before hand to get best results in future. There should be proper control on
various capital and revenue expenditures.
Co-ordination among Departments:
All the departments work in coordination. Master budget helps in achieving the
feature of effective cooperation and coordination among various departments as
finance, HR, marketing, R & D and Logistics etc.
Optimization of Recourses:
Budgetary control guides each activity towards optimization of resources
efficiently and effectively. Predetermined objectives are defined, and each
activity performs accordingly.
MERITS OF BUDGETRY CONTROL
Measuring Performance:
Under Budgetary Control, actual performance can be easily linked with targets.
Deviations are determined. Measurement of the actual performance must be
recorded and reported on time to management
Determining Weaknesses:
After measuring the performance, the management could easily find the
variations/deviations from the actual budget compared with budgeted one.
Timely, the management tries to take corrective actions for the improvement of
deviations occurred.
Effective Control:
When actual performance is compared with budgeted; the deviations could be
checked and effective steps are taken immediately. Controlling becomes an
effective tool in Budgetary Control.
Decreases Expenses:
Now a days, budgetary control plays an important role. Every entrepreneur tries
to decrease expenses (cost) of operations for maximum sales. Budgeting is a
tool which makes permutations and combinations for the minimum costs.
DEMERITS OF BUDGETARY CONTROL
Uncertain Future:
Budget is a tool prepared by organization for saving the cost in future.
Predictions sometimes may not come true despite best estimates made for
future. Future is undefined. Budgets were just the forecasts based on
assumptions and sometimes shows the wrong picture in future after matching
with the actual one. So wrong assumptions reduce the utility of budgets.
Lack of cohesiveness among departments:
There should be proper cohesiveness among departments, so that the task of
budgetary control should become a success. Each department is inter-related to
other in terms of performance. It affects the outcomes of other departments.
Budgetary officer bridges the gap between the departments. But appointment
of budgetary officer is a costly affair.
.
DEMERITS OF BUDGETARY CONTROL
Opposition of Budgets:
Employees opposes the budgets as these budgets shows their efficiency and
inefficiency at different levels. Due to the fear of poor performance and
inefficiency they oppose the application of Budgetary Control System.
Required Budget Revisions:
Budgets are made on the basis of hypothesis that certain conditions will prevail.
Due to future uncertainties, revision of budgets is required time to time.
Frequent changes in the targets will diminish the value of budgets and
modifications in budgets involve vast expenses
CLASSIFICATION OF BUDGETS
CLASSIFICATION OF BUDGETS
ACCORDING TO FUNCTIONS
Budgets can be classified as follows:
Sales Budget:
A sales budget is just like nerve center or backbone of the firm. It is based on the
forecasting of future sales that will work as a benchmarking for the sales department. First
of all, the sales department is going to make the budget and accordingly the other
departments adjust their budgets. A sales manager is made obligatory for a future
estimation of sales. Thus, the sale budget helps in finding the future sale target, how mush
sales could be achieved in other areas, how to increase sales and how much capital is
required for marketing and advertising for more sales. The sale budgets show the total sales
proceeds.
Production Budget:
The production budget is an estimation of production i.e. how much to produce at which
cost. Production manager is accountable for the preparation of budget under the set cost of
production. This budget is made on the basis of sales budget.
Firstly, the demand has to be forecasted in sales budget and then accordingly the production
manager has to make acceptable provisions for the accomplishment of the above demand.
The main aim of production budget is to produce the goods at minimum cost. In order to
achieve the goods on time, an appropriate production planning required in advance.
CLASSIFICATION OF BUDGETS
Cash Budget:
The cash budget can be made for any time frame. It is a planning in advance about the
earnings and expenditures of cash for a specified period. It is a statement which shows
the cash situation. Cash budget is viable tool of planning and control of finance needs of
the enterprise. Cash budget guarantees that cash should be available, when required. In
case of any scarcity of cash, the manager will arrange funds for proper allocation and its
utilization in business. In short, cash budget is an advance planning of cash earnings and
expenses at the time of its preparation. Normally cash budget is made for six months.
etc.
Materials/Purchase Budget:
Raw materials is a significant factor in manufacturing unit. The materials/purchase
budget is worried with the requirements of raw materials necessary in manufacturing
unit. The purchasing of raw materials depends upon the production budget. The purchase
department will plan the purchase of raw materials at different times. The department
will adjust the maximum stock level, minimum stock level and re-ordering level
accordingly. The budgeted cost of raw materials will be determined and raw materials will
be purchased as per the needs of production department.
CLASSIFICATION OF BUDGETS
Manufacturing Overheads Cost Budget:
It is the part of works cost which comes from indirect labour, indirect raw
materials, expenses and other factory expenses. These overheads cost be
divided into fixed cost, variable cost and semi-variable cost. The direct raw
materials and direct labour are not the part of manufacturing overheads cost
budget. The fixed works overheads costs remain same irrespective of output
whereas the variable works costs is calculated by multiplying the rate per unit
by the budgeted units.

Capital Expenditure Budget:

At times, the production unit needs capital for purchasing fixed assets for
producing more units. The budget committee has to make a capital expenditure
budget which gives an approx. idea of the total funds required once, as these
fixed assets are going to give the benefit for many years depending on the life
of the asset. This budget helps the management that which new fixed assets
are required with the details of cost and the return on them.
CLASSIFICATION OF BUDGETS
ACCORDING TO FLEXIBILITY Budgets can be classified as follows:

Fixed Budget: According to Institute of Cost and Management

Accountants, I.C.M.A., London,
“Fixed budget is a budget which is designed to remain unchanged
irrespective of the level of activity attained.”
As its name fixed, it does not modify with the modification in level of activity essentially
achieved. It is made for a given level of activity and doesn’t reflect the changes in the
conditions.
Flexible Budget: According to Institute of Cost and Management
Accountants, I.C.M.A., London
“A flexible budget is a budget designed to change in accordance with
the level of activity actually attained.”
This budget comprises of sequence of budgets for changed level of activity. It
changes with the level of the activity achieved. It is made after considering unexpected
alterations in the circumstances of the business.
CLASSIFICATION OF BUDGETS
ACCORDING TO PERIODS Budgets can be classified as follows:

Long Term Budgets:

The main objective of making the long-term budget is to represent the long-
standing forecasting of the enterprise. The time period of long-term budgets
differs from four to ten years. It is made by top level management and followed
by lower level management. Few sectors such as R & D, long-term finances,
capital budgeting required to make such long-term budgets as they have longer
gestation period.

Short Term Budgets:

The motive of making short-term budget, as the name suggests is planning for
short gestation period. It is generally made for one or two years. Few examples
of the firms making short-term budgets are sugar, cotton and textiles etc. The
main aim of short-term budget is to have the enough liquidity for the day today
activities. It is a tool used by many enterprises for existence and saving the
future risk of losing the business in case of shortage of funds.
CLASSIFICATION OF BUDGETS
ACCORDING TO CONDITION Budgets can be classified as follows:

Basic Budget:
Basic budget is an elementary budget made by any department for distinct
period comprises of 12 months. Every enterprise generally prepares basic
budgets for planned production/sales dimensions, costs, assets, liabilities and
cash flows.

Current Budget:
These budgets are made with the objective of handling the current condition of
the business. Nothing is fixed in this budget. These budgets are generally for
months and weeks and relates with handling of present situations arises in the
business.
According to Institute of Cost and Works Accountants of India, I.C.W.A.
London,
“Current Budget is a budget which is established for use over a short period of
time and is related to current conditions.”
CONCEPT OF PERFORMANCE
BUDGETING
Performance budget is based on functions, activities and projects which focuses
attention on the accomplishment, the general and relative importance of the
work to be done and services to be rendered rather than upon the means of
accomplishments such as service, supplies, equipment, etc.

In this budgeting system, all the functions of various departments would be

divided into programmes of activities, sub- programmes and component
scheme and approximations would be presented for each. Performance
budgeting seeks to build a relationship between inputs (costs) and their direct
outputs.

According to National Institute of Bank Management,

“Performance budgeting is, the process of analyzing, identifying, simplifying,
and crystallizing specific performances objectives of job to be achieved over a
period, in the framework of the organizational objectives, the purposes and
objectives of the job. The technique is characterized by its specific direction
towards the business objectives of the organization.”
PROCESS OF PERFORMANCE BUDGETING
Formation of responsibility center (departments):
Each department will be called as responsibility center where a specific manager is held
responsible for the performance of their section.
Formation of performance targets:
Targets of each department are established against the physical performance. For
example, number of units to be sold must be established in advance and conveyed to
sales responsibility center. Similarly, in case of production responsibility center, the
number of units to be produced must be set in advance.
Calculating financial requirements:
While setting the physical targets, the need of finance arises. It means the funds which
are required by all the departments are forecasted in advance without delay.
Comparison of actual with targeted (budgeted) performance:
The most usual step is comparing the actual results with targeted performances for
finding the deviations.
Reporting and action:
Deviations are thus analyzed for corrective action, if required.
CONCEPT OF ZERO-BASED BUDGETING
According to Peter Phyrr,
ZBB is defined as “a planning and budgeting process which requires each
manager to justify his entire budget request in detail from scratch (hence zero
base). Each manager states why he should spend any money at all. This
approach requires that all activities be identified as decision packages which will
be evaluated by systematic analysis ranked in order of importance.”
According to Institute of Cost and Management Accountants, I.C.M.A.,
London,
ZBB is defined as “a method of budgeting where all activities are revaluated
each time a budget is set. Discrete levels of each activity are valued and a
combination chosen to match funds available.”
It is the different method of budgeting for all the events of an enterprise as if
each activity were being performed for the very first time, i.e., from a scratch
having zero base. The process starts with zero with all expenses justified. ZBB
is a recent development and becomes very popular these days.
 Budgets are
tied to specific
activities and
level of
services

Spending Zero Based Budgeting

increases or process allocates Budgets are not
cuts funding based on connected to
are not simply program efficiency prior year
spread evenly and necessity rather spending
across budgets than budget history.

Funding is
targeted more
to activities
that align with
the startegy
MERITS OF ZERO-BASE BUDGETING
• Helps in identifying exaggerated budgets.
• Effective allocation of resources.
• Removes the attitude of accepting the current position.
• Psychological push to employees for avoidance of wasteful expenditure.
Promotes talented people to respond promptly.
• Enables the top-level management to get cost effective ways for betterment.
SUMMARY
• Budgets refers to the plans which are prepared by budget officers for helping
Top-Level management in cost controlling and maximum revenue generation.
• Budgets is an official appearance of expected receipts and overheads for a
particular time zone. Business is full of uncertainty. So budgeting and
budgetary control plays a pivotal role in managing cost with good profits.
Both forecasting and controlling becomes possible in different budgets.
• Sales budgets helps in setting the sales targets in future to earn more profits
then previous years. Same with production department sets the target of
units to be produced according to the sales target given by sales manager.
• Budgetary Control is like an instrument which uses various budgets as a
means of planning and controlling all activities of production and sales of
goods and services.
• Cash Budget is very important budget estimating cash receipts from all
sources and cash payments for all requirements during the budget time
period. It is the last budget to be made to control the liquidity position in
business.