The Hong Kong Management Association

HK Hong Kong Polytechnic Joint Diploma Ail

MA in Management Studies tt:l:I

l,ECTURE - 11112 - BUDGETS AND BUDGETARY CONTROL

1. NATURE OF BUDGETS

A BUDGET is defined as a quantitative expression of a plan of action for an ensuing

period, either for the business as a whole or for any sub-unit.

It is a plan quantilied in monetary terms, prepared and approved prior for 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 a given objective.

(CIMA)

BUDGETS can be classified into either

1. Short-term or

2. Long-term budgets.

Short-term budget
Is one which is related to current conditions. Many firms prepare such budgets on an
annual basis with detailed breakdowns of quarterly or monthly periods.

Long-term budget
ls one which is established as a plan for the long-term development of the business, such as
the five-years plan.
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2. USES OF BUDGETS

Budgets are a major feature of most control systems.

When the budgets are administered intelligently and properly, they may serve the
following purposes:-

1. Compel planning
Budgets formulate expected performance and express managerial targets.
Managers are forced to look ahead and will be ready for changes.

2. Control
Budgets serve as a blueprint for the implementation of the plans. Any deviations from
the blueprint should be investigated, and corrective action would be taken if necessary.

3. Communication of plans
The budgets provide a channel for the communication of the plans to all levels of
people who are responsible for their implementation.

4. Co-ordination of activities
For the purposes of preparation of the budgets, managers are forced to think of the inter-
relationships among individual operations, and the company as a whole.

5. Authorisation
The approved budgets can be used !o authorise !he routine expenditures contained in them.

6. Evaluation of performance
The budget helps to let employees know what is expected of them by their superior.
Such a budgeted performance would be used as the yardstick for assessing the performance
of the staff.

7. Motivation
Staff will be motivated to achieve the budget if they are evaluated on the basis of their
success of achieving the budget targets.

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3. PREPARATION OF BUDGETS

The preparation of budgets is a management as well as an accounting task.

The line managers will have the ultimate responsibility for the preparation of individual
budgets. However, the accountant will be responsible for the provision of necessary
technical assistance and for the organisation of the budgetary process.

BUDGETARY PROCESS
is a means of translating the objectives of the business into such detailed plans of action.

THE PREPARATION OF A MASTER BUDGET

will summarize the objectives of all sub-units of an organization - i.e.

sales, prodnction, distribntion and finance.

It quantifies the expectations regarding future income, cash flows, financial position and
supporting plans. In order to compile the master budget of a business, we need to
complete the preparation of the following component budgets as sequenced below:-

- Sales Budget;

- Production Budget

Raw Materials Budget

Labour Budget

Factory Expenses Budget

Equipment Budget

- Selling and Administration Expenses Budget

Inventory Budget

Research and Development Budget

- Capital Expenditure Budget.

The whole process of preparation of a master budget is illustrated in Example 2.

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4. PREPARATION OF CASH BUDGET

CASH BUDGET
indicates the effect of the budgeted activities on the flow of liquid resources. Thus, cash
budget assists the financial manager to ensure that sufficient, but not too much, cash is
available for the budgeted level of activity.

The proforma of a typical cash budget is shown as Appendix 1

The preparation of a cash budget is illustrated in Example 1.

5. BUDGET ADMINISTRATION

The following terms may be encountered in connection with the preparation of budgets:

- BUDGET DIRECTOR
This is sometimes called BUDGET CONTROLLER. This may be the Chier Accountant
or one of his subordinates. The budget director is to organize the various budget activities.

• BUDGET COMMITTEE
In large organizations, budget committee will consist of several members of the top
management from the functional divisions. The committee's job is to oversee the work of
preparing the budget. The budget committee will be responsible for setting general
guidelines to be followed by the line managers in building up their budgets, resolving
differences amongst them, and submitting the final budget to the Chief Executive.

- BUDGET MANUAL
Budget manual is a written set of instructions and relevant information that serves as a
reference book for the implementation of the budgeting process. It should contain details
of the responsibilities of individuals engaged in the preparation of budgets, the basis on
which each of them should prepare their functional or departmental budget, and the forms
and records to be used for reporting the actual results.

- BUDGET CENTRE
Budget centre is a section of the business for which an individual is responsible for the
preparation of a separate budget.

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6. BUDGETARY CONTROL

BUDGETARY CONTROL

ls defined as the establishment of budgets relating ro rhe responsibilities of executives ro the

requirements of a policy, and the continuous comparison 1?{ actual with budgeted results,
either to secure by individual action the objective <?f tha! policy or ro provide a basis for irs
revision. ( CIMA )

The budgetary control process can be explained by using the diagram in Appendbi: 2.

The use of budgets in the control process formalises the plans and provides the basis for a
comparison of actual and expected performance.

VARIANCE ANALYSIS

Is the commonly used technique in the budgetary control process.

VARIANCE
Actually is the difference between actual performance and budgeted performance.
The technique of variance analysis involves ascertaining the causes of variances and
providing feedback to management for their correction of the plans.

7. USEFULNESS OF BUDGETARY CONTROL

The main uses of budgetary control are as follows:-

I. Variances calculated at intervals within the budget period will give warning signals
of divergences, and appropriate action may be taken before it is too late.

2. Variances calculated at the end of a period may indicate that the plans were
inappropriate in some way.
This information may be useful in the formulation of plans for future periods.

3. Variances may be used to evaluate the performance of individuals and to determine

individual rewards ( or punishment), e.g. payment of bonus, promotion or firing.

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