CHAPTER XxXil Budgetary Control Definition—Forecast and Budget— Objectives — Budgeting— Objectives —Budgeté Control—Characteristics — Advantages — Essentials of — Budgetary Cae Limitations—Organisation—Classifications—Fixed and Florio Preparation of Flexible Budgets—Control Ratios—Sales Budget—Production Budget—Cash Budget—Zero Base budget — Theoretical Questions—Practical Problems. Modern business world is full of competition, uncertainty and exposed to different types of risks. This complexity of managerial problems has led to the development of various fanagerial tools, techniques and procedures useful for the management in managing the posness successfully. Budgeting is the most common, useful and widely used standard device {planing and coitrol. The budgetary control has now become an essential tool of the tnanagement for controlling costs and maximising profit. Costs can be reduced, wastage can teptevented and proper relationship between costs and incomes can be established only thtn the various factors of production are combined in profitable way. The resources of a fosines can be effectively utilised by efficient conduct of its operations. This requires careful wrking out of proper plans in advance, co-ordination and control of activities on the part of management. A proper planning and control are essential for an efficient management. A good number stools and devices are available. Of all these, the most important device used is budget. Cost accounting aims not only at cost ascertainment, but also greatly at cost control and cost eduction, Thus the management aims at the proper and maximum utilisation of resources amilable. It is possible when there is a pre-planning. Modern management aims that all types of operations should be predetermined in advance, so that the cost can be controlled atevery step. The more important point is that the actual programme compared with the Be Prosamme and the variances are analysed and investigated: All are familiar vith the idea of budget, at every walk of life—state, firm, business ete. Definition Abuiiget isa detailed plan of operations for some specific future period. Many of us are familiar with the term ‘Budget’. For instance, if we want to have a holiday trip to Kashmir, We are to estimate the cost of travelling, boarding, lodging etc. so as to have sufficient Amount for the trip. On return from the trip, we may like to compare the actual amount Be rtrosted or budgeted figures. Similarly we can, mow. the importance of eee rouschold management, The word ‘budget’ ia derived from a French tem "Bogeee atta iesotesa leather pouch in which funds ate appropriated for meeting Mliipated expenses, The same meaning applies to the business management. ‘A budget is a ‘Numerical statement expressing the plans, policies and goals of the enterprise for a definite Petiod in the future. It is a plan laying down the targets to be achieved within a specified Period. It is a final and approved share of a forecast. When forecasts are approved by the teneement as a tentative plan for the future they become budget. The following are some t Important definitions: L “Bulger iy an estimate of future needs arranged according to an orderly basis, covering Some or all of the activities of an enterprise for definite period of time”. e —George R. Terry 665666 Cost Accounting 2. “A Budget is a comprehensive and co-ordinated plan, expressed in financial terms, for the operations and resources of an enterprise for some specific period in the future, ~—James 3. “A budget is a predetermined statement of management policy suneaaae period f f arison with the results actually which provides a standard for comp: aly sc ae 4. “A financial and/or quantitative statement, prepared prior to a scioet ra et time, y during that period for the purpose of a gi ive of the policy to be pursued during that ps oT Ciel eae A study of the above definitions reveals the following basic elements ofa bua’ 1. Budget is a comprehensive plan of what the enterprise endeavours to achieve. 2. It is a statement in terms of money or quantity or both. 3. It is prepared for a definite future period. 4. It is prepared prior to the defined period. é 5. It provides yardsticks and measures for the purpose of comparison. 6. It is prepared in advance and refers to the future course of action. 4 7. It indicates the business policy which has to be followed so as to achieve a given objective. Forecast and Budget Forecast is mainly concerned with probable events; but budget is concerned with planned events Forecast may be done for longer time; but budget is prepared for shorter periods. Forecast is only a tentative estimate and can be revised; but budget remains unchanged for the budget period. Forecast results in planning and the planning results in budgeting. Forecast is a prediction or an estimate of changes, if any, in characteristics, economic phenomena which may affect one’s business plans. It is a study into the future, when the forecasts are given a shape and approved by the management as a commitment, they become budgets. For example, sales forecast is an estimate for future sales, while a sales budget is a commitment with an objective to reach certain sales figures. Forecast is the base while a budget is the structure built on the base. Forecast is not used for evaluating the efficiency of performance while a budget is always used for this purpose. Forecast refers to the events over which there is no control, (for example, forecast of restricted import) while a budget is an endeavour to control the events. Objectives of a Budget 1. It directs the attention of all concerned to the attainment of a common goal. 2. It leads to the disclosure of organisational weakness. The budgets are compared with actual performance; and variances, if any, are investigated. This step helps in taking corrective and remedial measures. 3. It aims at careful control over the performance and cost of every function. e 4, It contributes to co-ordinated efforts of all departments in order to achieve an inte grated goal. Budgets grow from bottom and are controlled from top-level. Budgeting ‘A budget is essentially @ statement of the intention of management. Budgeting refers to the management action of formulating bud, lgets. Preparation of budgets involves study, ini esata667 aor oi ity of vas situations and understanding of m ‘ecei ved inate, open gos g of management objectives as in aration of rise. It includes the entire processing of maki i ee cessing of making the budget plans- aa eT pudgeting is @ planning function, and their application oF implementation is & was the basis for yn. When plans are embodied in a budget and the same is used functio jst foperations, we have budgetary control. Budgetary control starts with budgeting aids with control. Budgeting is defined as ws 5 1, ‘The entire process of preparing the budgets is known as budgeting”. Batty 4, «Budgeting may be said to be the act of building budgets”. _ Rowland and Harr onjectives of Budgeting ‘The main objectives of budgeting are: Jo obtain more economical use of capital ‘To prevent waste and reduce expenses. Jo facilitate various departments to operate efficiently and economically. ‘To plan and control the income and expenditure of the firm To create a good business practice by planning for future. To fix responsibilities on different departments or heads. To co-ordinate the activities of various departments. Jo ensure the availability of working capital. Jo smooth out seasonal variations, by developing new products. 1 a 3 4 5 6 1 8 a 9, To ensure the matching of sales with productions. What is a Budget? Budgets are blueprint of the desired plan of action. They are means of communications. They indicate the business policies. They serve as declaration of policies. They provide a means of coordination of the business as a whole. ‘They are instruments of managerial control, They are controlling tools. ‘They provide yardsticks for comparison. They set definite goals. They fix responsibilities an .d direct to profitable direction. Seer essen l Budgetary Control g Budsetary control means the establishment of budgets relating to the responsibilities executives to the requirement of a policy, and continuous comparison of actuals with results either to secure by individual action the objective of that policy or to basis for its revision.” gale budgeting and budgetary control, according to Rowland and William H. Harr _ Budgets are the individual objectives of a department etc., whereas budgeting may bi ‘of building budgets. Budgetary control embraces all this, And in addition of planning the budgets themselves and the utilisation of such budgets management for the business planning and control.” rical statement expressing the plans, ici a , policies and goals for a defi- Sudgeting means the process of preparing budgets. Budgetary control668 Cost Accounting is a system of controlling costs which includes the preparation of ae co-ordinating the departments and establishing responsibilities, comparing actual performance with the budgeted; and acting upon results to achieve maximum profitability. Characteristics 1. Establishment. Budgets are prepared for each department and then the plans ang objectives are presented before the management, 2. Co-ordination. The budgetary control co-ordinates the plans of various departments and the master budget is prepared. 3. Continuous comparison. The essential feature of budgetary control is to conduct con. tinuous comparison of actual performance with budgeted figures, revealing the varia. tions. 4. Revision. Budgets are revised, if necessary, according to changed conditions Advantages The advantages and benefits of budgetary control are summarised next - Budgets fix the goals and targets, without which operation lacks direction. . Reduction in cost and elimination of inefficiency is achieved automatically. . The budget facilitates to maintain ordered effort and brings about efficiency in results, . An effective system of budgetary control results in co-ordinated effort of all persons involved. 5. Budgetary control enables the management to decentralise responsibility without los- ing control of the business since it pin-points inefficiency. 6. The budgetary control and standard costing go hand in hand and the combination of the two gives the most effective results. It promotes mutual co-operation and team spirits among the persons involved. 7. Budgetary control ensures that the capital employed at a particular level is kept at a minimum level. 8. It facilitates an intelligent and planned forecast for future. 9. It is a good guide to the management for making future plans. It is on the basis of budgetary control, realistic budgets can be drawn. 10. It aims at maximisation of profit through cost control and proper utilisation of re- sources. 11. It brings to light the inefficiencies and weaknesses on comparing actual performance with budget. Thus management can take remedial measures. 12. It is a guide to the management in the field of research and development in future 13. It evaluates the performance. 14. Since budget provides advance information, financial crises can be avoided 15. It acts as a safety signal for the management. It prevents wastages of all types. Essentials of a Successful Budgetary Control A budget is both a plan as well as a control tool. A bi all phases of operations for a definite period in future. It plans, objectives and goals laid down in advance by the top management for the concer as a whole and for every sub-division thereof. For an effective system of budgetary control certain pre-requisites must be present. These essentials are: 1, The budgetary control system should have full support of top management. 2. There should be well-planned organisational set-up, clearly demarcated. aeye usiness budget is a plan covering is a formal expression of policies, with responsibility and authorityudgetary Control 4, The accounting system sh, 4, Variations should be re, agement: Budgets have no meanj back provided ‘ould provide Ported Prompel accurate and timely information. ¥ and clearly to the appropriate levels of man- Ng unless ¢] hey lead to control action as a consequence of feed- 6. ly an 4 Spas prope Motivated towards the system. §. It is most desirable that ie e ane which are realistic and attainable. ; i and meaningful participation of all concerned. ). Budgets should actually aim as a ¢, 10. The budgets should be ice See device rather than control device. changed operational circumstances v8" '© Permit the adjustments in the light of The budget should |, Limitations of Budgetary Control Budgetary control is a sound techni the appreciation, it has its own limitati 1, Budgets deal with future. Forec: of accuracy of the estimates. 2. Budgeting is time-consuming process. Durin, conditions may change and estimates may go 3. The successful operation and execution of bu executive personnel. 4. Budgetary control is essentially a tool of decision-making and it helps the management in taking sound decisions. But it cannot replace the management. 5. Budgeting necessitates the employment of specialised staff and this involves expendi- ture which small concerns may not afford. 6. A budget programme should be dynamic, capable of being adapted to changing con- ditions. But when budgets are prepared with pre-determined targets, there is a feeling that the budgeted figures are final. Thus budgetary programme is bound to become rigid. 7. The success of the budgetary control largely depends upon willing co-operation or team-work of all concerned. If there is no co-operation, the whole system collapses. 1g the preparation period, the business wrong by that time. idgets depends upon the efficiency of the Organisation The following are the essentials for a sound system of budgetay 1. Chart. There must be an organisational chart to show the authority and responsi- bility of each executive of the firm. This will enable him to know his relationship with other ®ecutives. The budget director derives power from the chief executive, helps in co-ordination and drawing up of all budgets and suggests changes, if necessary. The sales manager, pro- (ction manager, purchasing manager, personne! manager and accountant will prepare their . pose of effective budgetary control, budget centres are : ment cs Te repartment or a section of the undertaking. Separate tndgets are prepared for each department and the departmental head is responsible for Sing out Pagets Departmental heads should have effective control over the execution Fhe badge, to prevent unfavourable variation. | In small firms, the chief accountant prepares the budgets and co-ordinates ities, In big concerns, a committee is appointed for this task. The committee control:670 Cost Accounting cons ts of various section heads, the chief executive and the budget controller. The budgets are prepared by section heads and submitted to the committee for approval; changes are made, if necessary, and approved. a 4. Budget Manual. It is a document which sets out the responsibilities of ersons engaged in the routine work. Budget manual lays down the objectives of the organisation, responsibilities of all executives and the procedure to be followed for budgetary control. Duties, authorities, powers of each official of the different departments are clearly defined, 50 as to avoid conflicts among the personnel. It also specifies different forms and records to be used for the purpose of budgetary control. 5. Budget Period. This is the period or time for wi remains in operation. The length of period depends on the nature of business, the production period, the control aspect etc. There is no definite rule as regards the duration of a budget period. Generally, the budget is prepared for a year, which is preferred by most concerns. For example manufacturers of consumer goods may prepare budgets for a year, whereas in industries like ship-building the period of the budget may be 5 to 10 years. 6. Key-Factor. Key-factor is also known as ‘limiting factor’ or ‘governing factor’ which means this is the factor, the extent of whose influence must first be assessed, in order to ensure that the functional budgets are reasonably capable of fulfilment. The key factor may be, shortage of raw materials, non-availability of labour, limited sales, government restrictions etc. The key-factor is a limitation on production or sales. First locate the key- factor, before preparing the budget, as it influences all other budgets. For example, shortage of power supply leads to under-utilisation of plant capacity. Therefore, the concern will have to first prepare a budget for plant utilisation and later the other budgets say sales will be prepared. Master Budget. A master budget is the summary budget for the entire enterprise and embodies the summarised figures for various activities. This is also known as summary budget or finalised profit plan. This budget includes the budgeted position of the profit and loss as well as balance sheet. Master budget is prepared by the committee and becomes a target for the company. hich the budget is prepared and Classification of Budgets On the basis of time On the basis of Flexibility On the basis of Functions 1. Long Term 1. Fixed 2. Short Term 2. Flexible 3. Current Sales Production Materials Labour Overheads Plant Utilisation Cash Capital expenditure. exouseye There are various types of budgets. Some of the important budgets are discussed below: Fixed and Flexible Budgets Fixed Budget. This is a budget which is designed to remain unchanged irrespective of the level of activity actually attained. This is prepared for definite production and capacity level. It is not adjusted according to activity level attained. The fixed budgets are not effective tools of cost control. These types of budgets have limited use. ‘A fixed budget has been defined by ICMA, England as “A budget which is designed t@ | remain unchanged irrespective of the level of activity actually attained.” 4control rs pual ower i practical life, conditions do not remain static. The main reason ® a in ewifuen different from the budgeted output. In such a case the budget cann is - oe ©. purpose of cost control. There may be internal or external factors which force y to change. jdget. This is a dynamic budget: I is a budget which is designed > ee ‘e with the level of activity. Actual output may differ from the budgeted outpy' : pater its necessary to modify the budget on the basis of hanged output. The Budge waepased in such a way as to present the budgeted cost for different levels of activity, it i #7 istic and practical, because changes expected at different levels of activity are give? gst Fea eration. It is also called variable budget or sliding scale budget. The expenses are {nto three catagories—fixed, variable and semivariable. It is an important tool of rol, as it facilitates comparison of actual results with the budgeted figures: scwA, UK defines flexible budget as “a budget which, by recognising the difference seven fixed, semi-fixed and variable costs, is designed to change in relation to the level of sepity Ascertainment of costs at various levels of ‘activity becomes possible. Price fixation, Ming quotations and tenders and finding out profit at changed capacities are facilitated. preparation of Flexible Budget ‘A budget prepared in a manner so as to give the budgeted cost for any level of activity jzknown as flexible budget. A flexible budget is the opposite of static budget. It is prepared fea range of activity instead of a single level. Fixed costs are related mostly to the period iftime and are not concerned with the level of production or volume of sales. Variable ‘cts vary directly and proportionately with the volume of activity. ‘At zero level activity, the variable costs will not be in existence. The semi-variable costs occupy 5 “in-between” sion between the fixed and variable costs. A part of these costs is variable and the rest Mixed, They are fixed to a certain level of activity and then rise with increase in the level ‘factivity but not in the same proportion as the activity increases. As a matter of fact budget for each department can be prepared on the lines of flexible budget by classifying tess into ‘fixed’ and ‘variable’. In order to appropriately fix up the costs for different. Inlumes, the degree of variability for each item cost at various levels of output could be Trolved on the basis of past experience. This requires a close study of the individual items ofexpenditure, their nature and variability. 1. Decide the range of activity to develop a flexible budget. 2 Determine the cost behaviour —fixed, variable and semi-variable to each element of cost. 3. Select the activity level (generally in terms of output) 4. Prepare the budget at each activity level. Uustration 1. The budgeted output of a factory specialising in the production of single product at the ‘otimam capacity of 6,400 units per annum amounts to Rs. 1,76,048 as detailed below: ™ syexible Bu cost cont ua. Rs. Fized cost , Beeriale costs: 20,688 1,440 Repairs etc. 1700 Miscellaneous ee Direct materials ee a7 ed 1,55,360 1,76,048