Dr Ajay Chhabria’s - Notes

BUDGETING AND BUDGETARY CONTROL

Meaning 
Budget: CIMA Official Terminology has defined the terms ‘budget’ as
“Quantitative expression of a plan for a defined period of time. It may
include planned sales volumes and revenues; resource quantities, costs and
expenses; assets, liabilities and cash flows.”

Budgeting: It is a means of coordinating the combined intelligence of an

entire organisation into a plan of action based on past performance and governed
by rational judgment of factors that will influence the course of business in the
future.

Budgetary control : Budgetary Control is a method of managing costs through

preparation of budgets. Budgeting is thus only a part of the budgetary control.
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.”

Objectives 
Planning:
The process of budgeting begins with the establishment of specific targets of performance and is
followed by executing plans to achieve such desired goals and from time to time comparing actual
results with the target goals. These targets include both the overall business targets as well as the
specific targets for the individual units within the business. Establishing specific targets for future
operations is part of the planning function of management, while executing actions to meet the goals is
the directing function of management. It may be explained as
1) Budget plans are made in synchronisation with the overall objectives of the organisation,
keeping mission and corporate strategy into account. Individual plans at unit level should be in
consonance with organisational plan.
2) Budgets reflect plans and that planning should have taken place before budgets are prepared.
3) Budgets plans are quantified and responsibility is assigned to the persons who are responsible
for execution of plan.
4) Using the budget to communicate these expectations throughout the organisation has helped
many a companies to reduce expenses during a severe business recession.
5) Planning not only motivates employees to attain goals but also improves overall decision
making. During the planning phase of the budget process, all viewpoints are considered,
options identified, and cost reduction opportunities assessed. This process may reveal
opportunities or threats that were not known prior to the budget planning process.

Directing and Coordinating:

1) Once the budget plans are in place, they can be used to direct and coordinate operations in order
to achieve the stated targets.
2) A business, however, is much more complex and requires more formal direction and
coordination.
3) The budget is one way to direct and coordinate business activities and units to achieve stated

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targets of performance.
4) The budgetary units of an organisation are called responsibility centers. Each responsibility
center is led by a manager who has the authority over and responsibility for the unit’s
performance.
5) Objectives and degree of performance expected from a responsibility centres are communicated
rapidly.

Controlling:
1) As time passes, the actual performance of an operation can be compared against the planned
targets. This provides prompt feedback to employees about their performance. If necessary,
employees can use such feedback to adjust their activities in the future.
2) Feedback received in the form of budget report from the responsibility centre. This report is
helpful to know the performance of the concerned unit.
3) Any unexpected changes into the conditions which were prevailing at the time of preparing
budget are taken into account and budgets are revised to show true performance yardstick.
4) Comparing actual results to the plan also helps prevent unplanned expenditures. The budget
encourages employees to establish their spending priorities.

The main objective of Budgeting is to help in achieving the overall objective of the organization.

Advantages 
1) Efficiency: The use of budgetary control system enables the management of a business concern
to conduct its business activities in the efficient manner.
2) Control on expenditure: It is a powerful instrument used by business houses for the control of
their expenditure. It in fact provides a yardstick for measuring and evaluating the performance
of individuals and their departments.
3) Finding deviations: It reveals the deviations to management, from the budgeted figures after
making a comparison with actual figures.
4) Effective utilisation of resources: Effective utilisation of various resources like— men,
material, machinery and money—is made possible, as the production is planned after taking
them into account.
5) Revision of plans: It helps in the review of current trends and framing of future policies.
6) Implementation of Standard Costing system: It creates suitable conditions for the
implementation of standard costing system in a business organisation.
7) Cost Consciousness: Budgets are studied by outside fund providers also such as banking and
financial institutions, realising that management encourages cost consciousness and maximum
utilisation of available resources.
8) Credit Rating: Management which have developed a well ordered budget plans and which
operate accordingly, receive greater favour from credit agencies.

Limitations 

1) Based on Estimates: Budgets are based on series of estimates which are based on the
conditions prevailed or expected at the time budget is established. It requires revision in plan if
conditions change.
2) Time factor: Budgets cannot be executed automatically. Some preliminary steps are required
to be accomplishedbefore budgets are implemented. It requires proper attention and time of
management. Management must not expect too much during the development period.

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3) Co-operation Required: Staff co-operation is usually not available during budgetary control
exercise. In a decentralised organisation each unit has its own objective and these units enjoy
some degree of discretion. In this type of organisation structure, coordination among different
units are required. The success of the budgetary control depends upon willing co- operation and
teamwork,
4) Expensive: Its implementation is quite expensive. For successful implementation of the
budgetary control, proper organisation structure with responsibility is prerequisite. Budgeting
process start from the collection of requirements to budget and performance analysis. It
consumes valuable resources for these purpose, hence, it is an expensive process.
5) Not a substitute for management: Budget is only a managerial tool and must be applied
correctly for management to get benefited. Budgets are not a substitute for management.
6) Rigid document: Budgets are considered as rigid document. But in reality, an organisation is
exposed to various uncertain internal and external factors. Budget should be flexible enough to
incorporate ongoing developments in the internal and external factors affecting the very
purpose of the budget.

Essentials of successful budgetary control 

Essential elements of a budget are as follows:
1) Organisational structure must be clearly defined and responsibility should be assigned to
identifiable units within the organisation.
2) Setting of clear objectives and reasonable targets. Objectives should be in consonance with the
long term plan of the organisation.
3) Objectives and degree of responsibility should be clearly stated and communicated to the
management or person responsible for.
4) Budgets are prepared for the future periods based on expected course of actions.
5) Budgets are updated for the events that were not kept into the mind while establishing budgets.
Hence, budgets should flexible enough for mid- term revision.
6) The entire organisation must be committed to budgeting.
7) Budgets should be quantifiable and master budget should be broken down into various
functional budgets.
8) Budgets should be monitored periodically. Variances from the set yardsticks (standards)
should be analysed and responsibility should be fixed.
9) Budgetary performance needs to be linked effectively to the reward system.

classification of budgets 

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) All the departments of a business unit co-operate for the preparation of a business
budget.
5) Budget is a mean to achieve business and it is not an end in itself.
6) Budget needs to be updated, corrected and controlled every time when circumstances
change. Therefore, it is a continuous process.
7) Budget helps in planning, coordination and control.

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8) Different types of budgets are prepared by industries according to business

requirements.
9) A budget acts as a business barometer.
10) Budget is usually prepared in the light of past experiences.
11) Budget is a constant endeavour of the Management.

Responsibility accounting 
Responsibility accounting is a kind of management accounting that is accountable for all the
management, budgeting, and internal accounting of a company. The primary objective of this accounting
is to support all the Planning, costing, and responsibility centres of a company.

The accounting generally includes the preparation of a monthly and annual budget for an individual
responsibility centre. It also accounts for the cost and revenue of a company, where reports are
accumulated monthly or annually and reported to the concerned manager for the feedback.
Responsibility accounting mainly focuses on responsibilities centres.

For instance, if Mr X, the manager of a unit, plans the budget of his department, he is responsible for
keeping the budget under control. Mr X will have all the required information about the cost of his
department. In case, if the expenditure is more than the allocated budget than Mr X will try to find the
error and take necessary action and measures to correct it. Mr X will be personally accountable for the
performance of his unit.

Advantages of Responsibility Accounting:

a) It urges the management to acknowledge the company structure and checks who is accountable
for what and fix the problems.
b) It enhances attention and awareness of the managers as they have to explain the variations for
which they are responsible.
c) It helps to compare the achievements between the pre-planned goals and actual results.
d) It creates a sense of efficiency within individual employees as their work and achievements will
be reviewed.
e) It guides the management to plan and structure the future expenditure and revenue of a
company.
f) Being a cost control tool, it creates ‘cost consciousness’ among workers.
g) Individual and company goals are established and communicated in the best way.
h) It improves and controls the company’s operating activities for an effective and efficient
outcome.
i) Simplifies the report structure and guides to prompt reporting.

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Assignment Q1) What is Budgeting and Budgetary Control? Explain Budgetary Control Process, Types
of Budget Control, Advantages & disadvantages of Budgetary Control.

BUDGETING AND BUDGETARY CONTROL

Meaning 
Budget: CIMA Official Terminology has defined the terms ‘budget’ as
“Quantitative expression of a plan for a defined period of time. It may
include planned sales volumes and revenues; resource quantities, costs and
expenses; assets, liabilities and cash flows.”

Budgeting: It is a means of coordinating the combined intelligence of an

entire organisation into a plan of action based on past performance and governed
by rational judgment of factors that will influence the course of business in the
future.

Budgetary control : Budgetary Control is a method of managing costs through

preparation of budgets. Budgeting is thus only a part of the budgetary control.
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.”

Budgetary Control Process Steps

Typically, there are 3 steps in a budget control process. These are as follows:

Prepare Budgets : First, the budget needs to be prepared. This budget is simply a set of financial goals
that the management wants to achieve. E.g. the goal may be to increase sales by 12% this year. Or the
goal may be to cut down the labor costs by 5% this year.

Compare with Actuals: Second, when a company gets the actual performance results, the management
compares it with the performance/standards set in the budget. The goal is to find out to what extent the
actual performance is in line with the budgeted performance and to what extent is the performance off-
track. E.g., the company may find out that the budget goal was to increase the sales by 12%, but the
sales increased by only 7%.

Corrective Actions: Third, the company analyses the reasons for the deviation in the actual performance
and takes corrective actions. E.g., the company may find out that the sales didn’t increase by 12%
because of the shortage of workforce faced by the sales team. So, the company takes corrective action

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in order to improve the performance of underperforming operations. Thus, the company may decide to
increase its workforce by a certain percentage so as to achieve the desired increase in sales.

Types of Budget Control

There are various types of budget controls that an organization can implement.

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Operation Budget Control

Operating budget control covers the revenues and operating expenses of the firm. This budget control is
important for running the day-to-day operations of the firm smoothly. Usually, firms compare the
performance of this budget with the actual performance on a monthly basis since a monthly comparison
enables the organization to take corrective actions in a more timely manner. This budget control helps in
achieving a desired level of EBITDA – Earnings before Interest, Tax, Depreciation, and Amortization.

Cash Flow Budget Control

This budget control compares the forecasted cash inflows and cash outflows from various sources to the
actual inflows and outflows of cash. This provides an important control in the organization since it
ensures that the organization has enough cash to meet its requirements and obligations. Cash budget
control also involves investing the excess cash available, thereby making profits out of idle cash.

This budget control covers capital expenditures like buying a plant or machinery. This budget control
helps the organization to plan and manage its capital expenditure. Capital expenditures involve huge
sums of money. So, it becomes very important to take steps that ensure that the firm makes only
profitable investments and takes decisions at the right time.

Advantages of Budgetary Control

a) In a budget control system, a firm assigns targets to each department, individual, etc. It then
compares the budgeted performance with the actual one. The firm then reports the
performance of each department to the top management. Hence, budget control serves as an
effective tool for measuring the performance of departments, individuals, and cost centers.
b) The difference between budgeted performance and actual performance helps the management
to identify its weak areas. The firm gives special attention to such areas.
c) Budget control helps the management to identify what improvement measures can be taken.
E.g., an actual performance of 6% growth in sales instead of the budgeted 12% may help the
management to take corrective actions such as an increase in workforce, increase in
advertisement expenses, etc. If there were no budget, the corrective action would not have
been taken.
d) It brings efficiency (each department does its best to achieve the budgeted performance) and
cost reduction by proper planning, which ultimately results in profit maximization.
e) Budgetary control brings discipline to the organization. The managers perform better because
they know that their performance will be measured.

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f) It improves coordination between different departments since the performance and results of
one department are often dependent on another department. E.g., the sales department may
have the target of increasing sales, and the production department may have the target of
increasing production this year. Since the goal of one depends on another, this improves
coordination between the two departments.
g) Budget control helps the organization to understand its strengths and weaknesses simply by
measuring the performance of departments, cost centers, etc., over a period of time.
h) It helps the organization keep its performance on track (by comparing actual performance
against budgeted ones regularly or several times a year and taking corrective actions) and
achieving its long-term goals.

Disadvantages of Budgetary Control

a) Organizations prepare budgets for the future period. However, the predictions of the budget
may not come true. This is because the future is uncertain and the conditions which are
presumed to prevail in the future may change. These change in conditions upsets the budget
which is prepared on the basis of some assumptions about the future. Hence, future uncertainty
reduces the value of budget control.
b) Under a budgetary control system, targets are given to every person. The common tendency of
people is to achieve only the targets and work nothing more. Some employees or managers may
exceed the budget performance, but they feel satisfied with achieving only the targets given to
them. Hence, budgetary targets may lead to under realization of employee’s potential. It makes
talented employees complacent and overburdens the less talented ones.
c) A budget control system may create added conflict between the departments. Every
department has its own budgetary goal to achieve. The goal of one department may conflict
with the goal of another department. For e.g., it may happen that the production department
decides to reduce the quality of the product in order to achieve its target of cutting down
production costs. But, the marketing department wants the same quality product to be
manufactured. Hence, budget control may create conflict between the two departments.
d) The coordination which is required between different departments is both an advantage as well
as a disadvantage. It may happen that two departments may not go well with each other despite
being interdependent on each other. This lack of coordination may lead to poor performance
from both the departments who could have performed better individually.

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