BUDGETARY CONTROL SYSTEMS

Budget, budgeting and budgetary control

Budget: a budget is a plan and blueprint for future management action. It is expressed in
monetary terms. The statement shows the planned level of income which the firm is expected to
generate and the expenditure that is expected to be incurred. It also lays down the capital that is
to be employed for the purpose.

The terminology of CIMA defines a budget as under:

“A plan quantified in monetary terms prepared and approved prior to a defined period of time
usually showing planned income to be generated and/or expenditure to be incurred during that
period and the capital to be employed to attain objective.”

A budget is a plan which helps an organization to answer such questions as:

1. What to achieve?
2. How to achieve it?
3. In the process of answering such question, management systematically analyses the
likely changes in the internal as well as the external environment and their probabilities.
4. It is also used for control

In order to run an organization in a professional manner, it is necessary to plan for the future.
A budget is a plan for future action. We know that the future is uncertain. However, one can
surely plan over a short term horizon namely a year and quantify as much as possible.

The budget is prepared for a defined period of time and approved prior to the commencement
of the specified period namely budget year. It defines the objectives of the firm and each
responsibility centre in concrete and quantitative terms and prescribes guidelines for the
accomplishments of said objectives.

Budgeting: the process of preparation, implementation and the operation of budgets is

known as budgeting. Budgeting is the formulation of plans for a given future period in
numerical terms. It is method of looking ahead and attempting to solve problems before they
arise. It requires that a business study and evaluate its role in the economic environment with
the object of establishing and achieving stated goals for all levels of the organization.
Business transactions essential for the attainment of these goals are forecast and summarized
in the form of projected financial statements. If statements indicate satisfactory achievement,
budgets are accepted; if unsatisfactory, an attempt is made to modify them to secure desired
aims.

in essence, budgeting is a process of resource allocation. The process may be applied within
any revenue generating entity whether it is proprietorship or a company, profit or non-profit,
manufacturing or service. It can even be used by the head of the family unit.

Budgetary control: budgetary control is a systematic and formalized approach for

accomplishing the planning, coordination and control responsibilities of management.

As defined by the terminology of CIMA” budgetary control is the establishment of budgets

relating the responsibilities of executives to the requirements of a policy and the continuous
comparison of actual with budgeted results either to secure by individual action the objective
of the policy, or to provide a basis for its revision.” Budgetary control is in essence a system
which uses budgets as a mean of planning and controlling all aspects of production and sale
of all goods or services. The system works as follows:

1) Establishment of budgets
2) comparisons on a continuous basis of actual results with budgets
3) ascertainment of variances by responsibility centre’s
4) investigation of variances to highlight causes
5) corrective action to remedy the causes in order to ensure the defined objectives are
attained

Budgetary control can be exercised either financially or physically or in both ways. Usually
budgets incorporate both financial and physical commitments and targets.

Features of a budget

A budget is a blueprint for management action. It is a vital tool for carrying out effective
short-term planning and control in firms. The following are the features of a budget:
 1) One year duration- generally budgets are prepared for one year. However, in the case of
seasonal business like fruit canning, ice cream, apparels etc., there may be two budgets
for each year –a slack season budget and peak season budget.
2) Estimation of business units profit potential - it shows how much profit or loss a business
unit is expected to make and thereby reveals its profit potential.
3) Appraisal of performance- at the end of a specified period, actual performance is
compared with the budget and deviations are ascertained. These deviations which are
known as variances are analyzed by causes and responsibility centre’s.
4) Monetary terms- the figures in the budget are expressed in monetary terms. However, the
monetary figures are supported by non-monetary information namely units purchased,
units manufactured, units sold etc.
5) Alteration of approved budget under specified conditions- after the budget has been
approved by the top management, the same cannot be altered expect under specified
conditions.
6) Review and approval by a higher authority- the budget proposal which is prepared by the
budgetee is reviewed and approved by an authority higher than the budgetee.
7) Managerial commitment- the budget is essentially a commitment made by the mangers of
responsibility centers. They agree to shoulder responsibility for the purpose of achieving
the budget objectives.

Objectives and Functions of Budgeting

An effective budgeting system is vital to the success of any firm. Budgeting is needed in
an organization to perform the functions of (i) Planning, (ii) Coordination, (iii) Communication,
(iv) Control & Performance Evaluation.

1. Planning-

Almost all business activities require some amount of planning to ensure efficient and
maximum use of scarce resources. The budget is a formal framework that provides specific
deadlines to achieve departmental objectives and contributes towards the overall objectives of an
organization. A budget incorporates expected performance and present managerial targets. These
targets guide the business operations and help in overcoming problems and analyzing the future.
Budgeting influences the formulation of all business strategies and subsequently assists
managers in executing such strategies.

2. Coordination-

Coordination is a managerial function under which all factors of production and all
departmental activities are balanced and integrated to achieve the objectives of the organization.
The budgeting process provides the basis for individuals in all parts of the organization to
exchange ideas on how best to achieve these objectives.

3. Communication-

It’s necessary in an efficient organization that all people be informed about the
objectives, policies, programmes and performances. This is made possible through their
participation in the budgeting process. Budgets inform each manager of what others have agreed
to do. They also inform managers of the resources available to achieve the objectives and targets.

4. Control & Performance Evaluation-

Budgeting enters into control at 3 points:

1. When a budget is being formulated, departments analyse their plans for the future and
submit estimates as per their requirements, justifying each of their demands by
demonstrating a need.

2. After budgets of different departments have been reviewed and approved, they become
targets that set desirable limits in spending.

3. At the end of the budget period, a comparison of actual expenditures with budget
expenditure is made as a means of judging performance and fixing responsibility for
deviations.

Budgets are the basis of performance evaluation in an organization as they reflect

realistic estimates od acceptable and expected performance. It’s more accurate, reliable and
reasonable to measure current performance against a budget rather than against a vague
expectation or against results of previous years when conditions may have changed.

Difference between Budget and Forecast

A budget is a plan for management action. It is prepared based on the implied assumptions that
the budgetee will take positive steps to make actual events conform to plans. A prediction of
what is most likely to happen is known as a forecast. There is no implication in the document
that the person who is responsible for making the forecast will attempt to so shape events that the
forecast will be met.

A budget happens to be a tool for planning and control whereas a forecast is a planning device.
Elements of forecasting are included in all budgets. The budgetees cannot be made to bear
responsibility for certain outcomes that have an effect on their ability to meet budgeted
objectives.

A budget is prepared for a defined period of time while a forecast can be for any time period. A
budget is usually expressed in monetary terms whereas a forecast may or may not be stated in
monetary terms.

An updation of a forecast is carried out as soon as new information gives the indication that there
is a change in conditions. This is not the case with a budget.

Prerequisites of Budgetary Control System:

Budgetary Control System must posses the undernoted features in order to be successful:

(i) Top Management Support- The top management of a firm must be convinced about
the benefits of budgeting, participate in its implementation, issue guidelines as and
when necessary and devote time and resources for the preparation. It should also
shoulder the responsibility for coordination of budgets of various departments and
their final approval. Last but not the least, it has to resolve conflicts of different
departments regarding resource allocation and take follow up procedure in order to
secure that budgets are effectively implemented.
(ii) Proper Organizational Structure- A sound organizational structure should be there
in the firm and the authorities and responsibilities of each manager should be clearly
defined. Based on this, the budgetary control system should be established. In the
absence of this demarcation of authorities and responsibilities, managers can’t be held
responsible. This is because they would be unaware of their responsibilities and at the
same time held responsible for activities over which they have no responsibility.
(iii) Clear and Realistic Nature of Goals- Every organization has its own goals and
objectives and budgeting is a tool for achieving them. The goals must be clear and
should preferably be in writing. This would provide proper direction to the employees
and save management’s time. The goals should also be reasonable, appear realistic
and capable of being attained. Goals should not be set at a very low level as the same
can be easily attained without providing any motivation. On the other hand, goals set
at an extremely high level appear unrealistic and unattainable to the employees,
creates a scene of demoralization and as a result they do not make serious efforts to
attain them.
(iv) Flexibility – One of the essential requirements of an effective budgetary control
system is flexibility. Whenever the situation so requires, a manager should be able to
take action which is considered prudent. Apart from this, the system should have a
bulletin flexibility so that the impact of changes in activity levels on costs, revenues
and profits are easily known.
(v) Participative Process- People at all levels should participate in the preparation of
budgets. A combination of top down and bottom up process is desirable. It has been
proved that if employees participate in developing budgets, they will make efforts to
ensure the success of the budgeting system. Budgets are prepared by line managers
with the assistance and under the supervision of the Controller’s/ Financial
Controller’s Department. This provides them motivation during the implementation
process.
(vi) Conductive Environment- In order to enable the budgetary control system to
function effectively a conductive environment should be created. This can only be
done by educating employees so that they regard the system as a positive tool for
achieving performance rather than a negative device for pressuring, finding fault and
 punishment. Similarly, the dysfunctional aspects of budgeting must be clear to the
management. They must take care to avoid or at least minimize them.

Advantages of budgeting:

 Budgeting helps in solving problems in a disciplined manner.

 It helps the organization to plan well in advance for mobilizing resources needed for achieving its
goal.
 The nature of evaluation criteria is more objective.
 Forward planning gets encouragement where there is a system of budgeting.
 As the performance of managers are measured against budgets, they are motivated to accomplish
high performance
 Budgeting enables the organization to review and restate its fundamental goals, policies and
procedures

LIMITATIONS OF BUDGETING

(i)Conflict of Goals:
The goals of budgeting must match with the objectives of the enterprise. However, it does
happen that budget goals are set without considering the aims and objectives of the
enterprise. This gives rise to confusion and defeats the purpose of budgeting.
(ii) Judgment of Management :
Budgeting is both an art as well as a science. As a result, managerial judgment plays an
equally important role. There is an element of bias and subjectivity in managerial
judgment . This can create problems while preparing estimates for budgets.
(iii) Establishment of unattainable targets:
One must be careful in setting targets for budgeting . Unattainable targets will lead to
lower morale and as a result productivity would fall.
(iv) Improper Implementation:
The success of budgeting depends upon its implementation. If the same is not properly
implemented , the system would not be understood by all the people in the organization.
The subordinates and the managers would not put in the desired effort for achieving the
goals laid in the budget.
(v) Undesirable Complications:
A budget should not have more details than is necessary as it leads to complications. It is,
however, found that many a time it is too detailed and rigid.
(vi) Failure to continuously adapt:
Budgeting is an exercise in dynamics. Business conditions change continuously and the
organization must adapt the budgeting system to it.
(vii) High cost of operating System:
The cost of operating the system is quite high. It is possible that the benefits arising from
it may not be commensurate with the cost . Hence before installing a budgeting system
the firm has to study its information needs so that a proper system which can be utilized
fully and effectively.