Budgeting and

UNIT 10 BUDGETINGAND BUDGETARY Budgetary Control

CONTROL

Objectives
The objectives of this unit are to familiarise you with:

 the basic aspects of financial planning and the role of budgeting

 various types of budgets
 some new ideas and development in the area of budgeting.

Structure
10.1 Introduction
10.2 Financial Planning
10.3 What is a Budget?
10.4 Budgetary Control
10.5 Classification of Budgets
10.6 Control Ratios
10.7 Performance Budgeting
10.8 Zero base Budgeting
10.9 Summary
10.10 Keywords
10.11 Self-assessment Questions/Exercises
10.12 Further Readings

10.1 INTRODUCTION
At the beginning of the course, we have emphasised the need for managers
to be forward-looking. For you, therefore, reviewing the past information
alone is not enough since your job involves predicting and shaping the future
of your enterprises. This requires proper planning about all activities of the
business. Finance being the lifeblood of a business, financial planning is of
utmost significance to a businessman. A budget is an essential tool for
financial planning and control.

However, before we come to the intricacies of budgeting, it will be useful for

you to understand the meaning and implications of financial planning.

10.2 FINANCIAL PLANNING

Financial planning is concerned with the raising of funds and their effective
utilisation to maximise the company’s wealth. It includes the determination
of: 253
Application of  the amount of funds needed for implementing various business plans
Cost  the pattern of financing, i.e. the form and proportion of various corporate
Accounting securities, such as shares, debentures, bonds, bank loans to be issued or
raised
 the timing of floatation of various corporate securities

Despite a sound financial plan, the desired results may not be achieved if
there is no effective control to ensure its implementation. The budget
represents a set of yardsticks or guidelines for use in controlling an
organisation’s internal operations. The management, through budget, can
evaluate the performance of every level of the organisation. The discrepancy
between plan performance and actual performance is highlighted through
budgets. The organisation may have to change the course of its operations in
a particular area or revise its plans keeping in view the changing conditions.

It will, therefore, be useful for you to understand the complete budgeting

process. In this unit, we shall explain what budget is and what budgetary
control means. Besides the importance of budgeting as a management tool,
the techniques of preparing various types of budgets will also be discussed.

10.3 WHAT IS ABUDGET?

A budget is a plan expressed in quantitative, usually monetary terms,
covering a specific period of time, usually one year. In other words, a budget
is a systematic plan for the utilisation of workforce and material resources. In
a business organisation, a budget represents an estimate of future costs and
revenues. Budgets may be divided into two basic classes: Capital Budgets
and Operating Budgets. Capital budgets are directed towards proposed
expenditures for new projects and often require special financing. The
operating budgets are directed towards achieving short term operational goals
of the organisation, for instance, production or profit goals in a business firm.
Operating budgets may be sub-divided into various departmental or
functional budgets. The main characteristics of a budget are:

 It is prepared in advance and is derived from the long term strategy of

the organisation
 It relates to the future period for which objectives or goals have already
been laid down
 It is expressed in quantitative form, physical or monetary units, or both.

Different types of budgets are prepared for different purposes,e.g. Sales

Budget, Production Budget, Administrative Expense Budgets, Raw-material
Budget, etc. All these sectional budgets are afterwards integrated into a
master budget that represents the organisation’s overall plan. A budget is
useful in the following ways:
 It brings about efficiency and improvement in the working of the
organisation.
 It is a way of communicating the plans to various units of the
254
 organisation. By establishing the divisional, departmental, sectional Budgeting and
budgets, exact responsibilities are assigned. It thus minimises the Budgetary Control

possibilities of buck-passing if the budget figures are not met.

 It is a way of motivating managers to achieve the goals set for the units.
 It serves as a benchmark for controlling ongoing operations.
 It helps in developing a team spirit where participation in budgeting is
encouraged.
 It helps in reducing wastage and losses by revealing them in time for
corrective action.
 It serves as a basis for evaluating the performance of managers.
 It serves as a means of educating the managers.

10.4 BUDGETARYCONTROL
No system of planning can be successful without having an effective and
efficient system of control. Budgeting is closely connected with control. The
exercise of control in the organisation with the help of budgets is known as
budgetary control.

The process of budgetary control includes

1. preparation of various budgets

2. continuous comparison of actual performance with budgetary
performance and
3. revision of budgets in the light of changed circumstances.

A system of budgetary control should not become rigid. There should be

enough scope for flexibility to provide for individual initiative and drive.
Budgetary control is an important device for making the organisation more
efficient on all fronts. It is an essential tool for controlling costs and
achieving the overall objectives.

Installing A Budgetary Control System

Having understood the meaning and significance of budgetary control in an
organisation, it will be useful to know how a budgetary control system can be
installed. This requires, first of all, finding answers to the following questions
in the context of an organisation:

1) What is likely to happen?

2) What can be made to happen?
3) What are the objectives to be achieved?
4) What are the constraints, and to what extent their effects can be
minimised?
Having found answers to the above questions, the following steps may be
taken to install an effective budgetary control system in an organisation.
255
Application of Organisation for Budgeting
Cost
Setting up a definite plan of organisation is the first step towards installing a
Accounting
budgetary control system in an organisation. A Budget Manual should be
prepared giving details of the powers, duties, responsibilities and areas of
operation of each executive in the organisation.

Responsibility for Budgeting

The responsibility for preparation and implementation of the budgets may be
fixed as under:

Budget Controller
Although the Chief Executive is finally responsible for the budget
programme, it is better to delegate a large part of the supervisory
responsibility to an official designated as Budget Controller or Budget
Director. Such a person should have knowledge of the technical details of the
business and should report directly to the President of the Chief Executive of
the organisation.

Budget Committee
The Budget Controller is assisted in his work by the Budget Committee. The
Committee may consist of Heads of various departments, viz., Production,
Sales Finance, Personnel, Purchase, etc., with the Budget Controller as its
Chairman. It is generally the responsibility of the Budget Committee to
submit, discuss and finally approve the budget figures. Each head of the
department should have his own Sub-committee with executives working
under him as its members.

Fixation of the Budget Period

‘Budget period’ means the period for which a budget is prepared and
employed. The budget period depends upon the nature of the business and the
control techniques. For example, a seasonal industry will budget for each
season, while an industry requiring long periods to complete work will
budget for four, five or even larger number of years. However, control
purposes must prepare budgets both for long as well as short periods.

Budget Procedures
After establishing the budget organisation and fixing the budget period, the
actual work or budgetary control can be taken upon the following pattern:

Key Factor
It is also termed as limiting factor. The extent of influence of this factor must
first be assessed in order to ensure that the budget targets are met. It would be
desirable first to prepare the budget relating to this particular factor and then
prepare the other budgets. We are giving below an illustrative list of key
factors in certain industries.

256
 Industry Key factor Budgeting and
Budgetary Control
Motor Car Sales demand

Aluminium Power

Petroleum Refinery Supply of crude oil

Electro-optics Skilled technicians

Hydel power generation Monsoon

The key factors should be correctly identified and examined. The key factors
need not be of a permanent nature. In the long run, the management may
overcome the key factors by introducing new products, changing material
mix, working overtime or extra shifts ,etc.

Making a Forecast
A forecast is an estimate of the future financial conditions or operating
results. Any estimation is based on the consideration of probabilities. An
estimate differs from a budget in that the latter embodies an operating plan of
an organisation.

A budget envisages a commitment to certain objectives or targets, which the

management seeks to attain on the basis of the forecasts prepared. A forecast,
on the other hand, is an estimate based on the probabilities of an event. A
forecast may be prepared in financial or physical terms for sales, production
cost, or other resources required for business. Instead of just one forecast, a
number of alternative forecasts may be considered to obtain the most
realistic, overall plan.

Preparing Budgets
After the forecasts have been finalised, the preparation of budgets follows.
The budget activity starts with the preparation of the sales budget. Then
production budget is prepared based on the sales budget and the production
capacity available. The financial budget (i.e. cash or working capital budget)
will be prepared on the basis of sales forecast and production budget. All
these budgets are combined and coordinated into a master budget. The
budgets may be revised in the course of the financial period if it becomes
necessary to do so, in view of the unexpected developments, which have
already taken place or are likely to take place.

Choice Between Fixed and Flexible Budgets

A budget may be fixed or flexible. A fixed budget is based on a fixed volume
of activity. It may lose its effectiveness in planning and controlling if the
actual capacity utilisation is different from what was planned for any
particular unit or time e.g. a month or a quarter. The flexible budget is more
useful for changing levels of activity as it considers fixed and variable costs
separately. Fixed costs, as you are aware, remain unchanged over a certain
range of output. Such costs change when there is a change in capacity level.
The variable costs change in direct proportion to output. If ‘flexible
257
Application of budgeting approach is adopted, the budget controller can analyse the variance
Cost between actual costs and budgeted costs depending upon the actual level of
Accounting activity attained during a period of time. This will be explained in detail a
little later.

Activity 10.1
Arrange a meeting with one of the officials concerned with budgetary control
and administration in your organisation and discuss the following points:
a) The nature and the exact nomenclature of the budgetary control system.
b) The time for which the system has been in operation.
c) The objectives and scope activities) of the system.
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10.5 CLASSIFICATION OFBUDGETS

Budgets can be classified into different categories on the basis of Time,
Function, or Flexibility. The different budgets covered under each category
are shown in the following chart:

Chart 10.1: Classification of Budgets

Let us discuss some of the budgets covered in the above classification.

Rolling Budget
Some organisations follow the practice of preparing a rolling or progressive
258 budget. In such organisations, a budget for a year in advance will always be
there immediately after a month, or a quarter, passes, as the case may be, a Budgeting and
new budget is prepared for twelve months. The figures for the month/quarter, Budgetary Control

which have rolled down, are dropped, and the next month/quarter figures are
added. For example, suppose a budget has been prepared for the year 2020,
after the expiry of the first quarter ending 31st March 2020, a new budget for
the full year ending 31st March. In that case, 2021 will be prepared by
dropping the figures for the quarter which has rolled (i.e. quarter ending 31st
March 2020) and adding the figures for the new quarter ending 31st March
2021. The figures for the remaining three quarters ending 31st December
2020 may also be revised, if necessary. This process will continue whenever
a quarter ends and a new quarter begins.

Sales Budget
Sales Budget generally forms the fundamental basis on which all other
budgets are built. The budget is based on projected sales to be achieved in a
budget period. The Sales Manager is directly responsible for the preparation
and execution of this budget. He usually takes into consideration the
following organisational and environmental factors while preparing the sales
budget:

Organisational factors Environmental Factors

Past sales figures and trends Salesmen’s General trade prospects Seasonal
estimates fluctuations Potential market
Plant capacity Orders on hand Degree of competition
Proposed expansion or discontinuation Government controls, rules and
of products Availability of material or regulations relating to the industry
supplies Financial aspect Political situation and its impact on
Cost of distribution of goods t h e market

It is desirable to break up the entire sales budget on the basis of different

products, time periods and sales areas or territories.

Illustration 10.1
Andhra Vinyl Ltd. has three sales divisions at Madras, Bangalore and
Hyderabad. It sells two products - I and II. The budgeted sales for the year
ending 31st December 2002 at each place are given below:

Madras Product I 50,000 units @ Rs. 16 each

Product II 35,000 units @, Rs. 10 each
Bangalore Product II 55,000 units @ Rs. 10 each
Hyderabad Product I 75,000 units @ Rs. 16 each
The actual sales during the same period were:
Madras Product I 62,500 units @ Rs.16 each
Product II 37,500 units @ Rs. 10 each
259
Application of Bangalore Product II 62,500 baits @ Rs. 10 each
Cost
Accounting
Hyderabad Product I 77,500 units @ Rs. 16 each

From the reports of the sales department it was estimated that the sales
budget for the year ending 31st December 2003 would be higher than 2002,
budget in the following respects:

Madras Product I 4,000 units

Product II 2,500 units
Bangalore Product II 6,500 units
Hyderabad Product I 5,000 units

Intensive sales campaign in Bangalore and Hyderabad is likely to result in

additional sales of 12,500 units of products I in Bangalore and 9,000 units of
Products II in Hyderabad. Let us prepare a sales budget for the period ending
31st December, 2003.

Production Budget
This budget provides an estimate of the total volume of production
distributed product-wise with the scheduling of operations by days, weeks
and months, and a forecast of the inventory of finished products. Generally,
the production budget is based on the sales budget. The responsibility for the
overall production budget lies with the Works Manager and that of
departmental production budgets with departmental works managers.

Production budget may be expressed in physical or financial terms or both in

relation to production. The production budgets attempt to answer questions
like: (i) What is to be produced? (ii) When it is to be produced? (iii) How it is
to be produced? (iv) Where it is to be produced? The production budget
260
envisages the production programme for achieving the sales target. It serves Budgeting and
as a basis for preparing related cost budgets, e.g., materials cost budget, Budgetary Control

labour cost budget, etc. It also facilitates the preparation of a cash budget.
The production budget is prepared after taking into consideration several
factors like (I) Inventory policies, (ii) Sales requirements, (iii) Production
stability, (iv) Plant capacity, (v) Availability of materials and labour, (iv)
Time taken in the production process, etc.

Activity 10.2
From the following details of Mysore Cement Works Limited, complete the
production budget for the three-month period ending March 31, 2003
(Production budget for product P has already been worked (out).

Type of Estimated stock Estimated sales Desired closing

Product on Jan 1, 2003 during Jan-March stock on
2003 March 31, 2003
(Units) (Units) (Units)
P 1,000 5,000 1,500
Q 1,500 7500 2,500
R 2.000 6.500 1,500
S 1,500 6.000 1,000

261
Application of Production Costs Budgets
Cost
There are three elements of costs, namely direct material, direct labour and
Accounting
overheads. Separate budgets for each of these elements have to be prepared.

The direct materials’ budget has two components, (i) materials requirement,
budget, and (ii) materials procurement or purchase budget. The former deals
with the total quantity of materials required during the budget period, while
the latter deals with the materials to be acquired from the market, during the
budget period. Materials to be acquired are estimated after considering the
closing and the opening inventories and the materials for which orders have
already been placed.

Illustration 10.2
The Sales Director of Andhra Paraffin Company expects to sell 25,000 units
of a particular product next year. The Production director consulted the store-
keeper who gave the necessary details as follows:

Two kinds of raw materials, P and Q, are required for manufacturing the
product. Each unit of the product requires 2 units of P and 3 units of Q. The
estimated opening balances at the commencement of the next year are:

Finished products : 5,000 units

Raw material P : 6,000 units
Raw material Q : 7,500 units

The desirable closing balances at the end of the next year are:

Finished : 7,000 units

Raw material P : 6,500 units
Raw material Q : 8,000 Units

Let us prepare a statement showing material purchase budget for the next
year. units to be produced = Sales + Desired closing Stock - Opening
Stock

= 25,000 + 7,000 - 5000 = 27,000 units.

Materials Purchase or Procurement Budget

Finished productMaterials in units

units
P Q
Production budget 27,000 54,000 81,000
Estimated Opening Balance +5,000 -6,000 -7,500
32,000 48,000 73,500

262 Estimated Closing Balance -7,000 +6,500 +8,000

 Estimated Sales of Product 25,500 Budgeting and
Budgetary Control
Estimated Purchase of Materials 54,500 81,500

Direct Labour Budget: Direct labour budget, like direct materials budget,
may be divided into two categories, (i) direct labour requirement budget and
(ii) direct labour procurement budget. The former deals with the total direct
labour requirement in terms of quantity or/and value, while the latter states
the additional direct workers to be recruited.

Activity 10.3
The production budget of a factory shows that 1,000 units of a product are to
be manufactured during the next month consisting of 25 working days. Each
unit is expected to take two hours, and each worker is required to work for 8
hours a day. Calculate (a) the number of workers required to complete the
job, (b) the number of additional workers to be recruited in case the factory
has already 8 workers and likes to keep two workers in reserve for possible
absenteeism, and (c) the Labour Budget if the wages of existing and the new
workers are Rs. 500 and Rs. 600 p.m. respectively. Part (a) has already been
worked out.

Overhead Budget The overheads may relate to the factory, general

administration selling and distribution function. Therefore, separate budgets
may be prepared for factory overheads, administrative overheads, and selling
and distribution overheads.

Factory Overheads Budget: Factory or manufacturing overheads include

the cost of indirect material, indirect labour and indirect expenses.
Manufacturing overheads may be classified into in the volume of output, (ii)
Variable Overheads, i.e. which tend to vary with the output; and (iii) Semi-
variable Overheads, i.e. which are partly variable and partly fixed. The
manufacturing overheads budget will provide an estimate of these overheads 263
Application of to be incurred during the budget period.
Cost
Fixed manufacturing overheads can be estimated based on past information
Accounting
and knowledge of any changes which may occur during the ensuing budget
period. Variable overheads are estimated after considering the scheduled
production and operating conditions in the budget period.

Illustration 10.3
From the following average figures of previous quarters, let us prepare
manufacturing overhead budget for the quarter ending March 31, 2003. The
budgeted output during this quarter is 8,000 units.

The figures for the previous quarter are:

Fixed overheads Rs. 40,000

Variable overheads 20,000 (@ Rs. 5 per unit)

Semi-variable 20,000 (40% fixed and 60% varying @ Rs. 3 per

unit)

Manufacturing Overheads Budget for the Quarter ending 31st March

2003
(Output 8,000 units)

Fixed overheads 40,000

Variable overheads @ Rs. 5 per unit 40,000

Semi-variable overheads 8,000
Fixed
Variable (@Rs. 3 per unit) 24,000 32,000
Total Overheads 1,12,000

Administrative Overheads Budget: This budget covers the administrative

expenses, including the salaries of administrative and managerial staff. A
careful analysis of the needs of all administrative departments of the
enterprise is necessary. The minimum requirements for the efficient operation
of each department can be estimated on the basis of costs for the previous
years and after a study of the plans and responsibilities of each administrative
department for the budget period. The budget for the entire administrative
function is obtained by integrating the separate budgets of all administrative
departments.

Selling and Distribution Overheads Budget: This budget includes all

expenses relating to selling, advertising delivery of goods to customers, etc.
It is better to analyse such costs according to products, types of customers,
territories, and the sales departments. The responsibility for the preparation of
this budget rests with the executives of the sales department. There must be a
264 relationship of selling expenses with the volume of sales expected, and an
effort should be made to control the costs of distribution. The preparation of Budgeting and
the budget would depend on analysis of the market situation by the Budgetary Control

management, advertising policies, research programmers, and the fixed and

variable elements.

Illustration 10.4
Let us prepare a Sales Overheads Budget for the quarter ending 31st March,
2021 from the estimates given below:

Rs.
Advertisement 12,500
Salaries of the sales department 25,000
Expenses of the sales department 7,500
Counter salesmen salaries and allowances 30,000

Commission to counter salesmen is payable at 1% of sales executed by them.

Travelling salesmen are entitled to a commission at 10% on sales affected

through them and a further 5% towards expenses.

Sales Sales at Sales by Traveling Total estimated

Territories Counters salesmen sales

A 4,00,000 50,000 4,50,000
B 6 00 000 75 000 6 75 000
C 7,00,000 1,00,000 8,00,000

Cash Budget
Planning cash and controlling its use are essential tasks. If the future cash
265
Application of flows are not properly anticipated, it is likely that idle cash balances may be
Cost created, resulting in unnecessary losses. It may also result in cash deficits and
Accounting consequent problems. The financial manager should, therefore, plan the
needs and uses. Budget is a useful device for this purpose.

The cash budget is a summary of the firm’s expected cash inflows and
outflows over a particular period of time. In other words, cash budget
involves a projection of future cash receipts and cash disbursements over
various time intervals.

A cash budget helps the management in:

a) determining the future cash needs of the firm
b) planning for financing of those needs
c) exercising control over cash and liquidity of the firm

The overall objective of a cash budget is to enable the firm to meet all its
commitments in time and at the same time prevent accumulation at any time
of unnecessary large cash balances with it.

There are two types of flows in both these components, viz. operating cash
flows and financial cash flows. Some common elements of each are as
follows:

Cash Inflows - a) Operating: cash sales, receivable collections.

b) Financial: interest receipts, sale of marketable

securities, issue of new securities.

Cash Outflow- a) Operating: wage payments, payments of bills

and accounts payable, and capital expenditure
Payable.
b) Financial: dividend payments, interest
payments, redemption of securities, loan
repayments, purchase of marketable securities,
tax payments.

Sales Work Sheet

Sales bring in a major part of cash inflows. All sales may not be against cash;
credit sales are pretty common. Each business establishment has its own
credit policy for promoting sales. Even when care is taken to ensure that
credit sales do not exceed the permitted percentage of total sales and that
debtors do not default in paying bills in time, it is a common experience that
the total amount of sales is recovered over a period of time.

Let us take an example. In a business, 10 per cent of the sales value in a

month is realised in cash during the same month; 50 per cent is received in
the next month; and the remaining 40 per cent in the month after that. We can
find out the estimated cash inflow due to sales for every month with the help
of the data on past and future sales.
266
Sales Work Sheet January to March 2021 Budgeting and
Budgetary Control
Nov. Dec. Jan. Feb. March
2020 2020 2021 2021 2021
Past Sales 960 900
Estimated future sales - - 900 1,000 1,000
Estimated Cash Receipts from sales:
10% of current month's sales 90 100 100
50% of last month’s sales 450 450 500
40% of previous to last Month’s sale 384 360 360
Total Cash Collections from receivables 924 910 960

The total cash collections from receivables will be transferred to the cash
budget Proforma.

Similarly, a Purchase Work Sheet can also be prepared to find out the
estimated total cash disbursements for purchases. For example, 50 per cent of
current month’s purchases may be paid for in the current month, 40 per cent
in the next month and the remaining 10 per cent in the month after that.

A Proforma Cash Budget with hypothetical figures in presented below

Proforma for Cash Budget

(In
Rs.)
Month
s
Estimated Cash Inflows: Jan. Feb. March
Cash Sales 9.60
(including collections of current
and previous month's sales)
Others 1.90
Total 11.50
Cash Outflow
Bills for Purchases 6.83
Factory Expenses 3.49
Head Office Expenses 1.54
Interest 1.21
Others 0.40
Total 13.47
Excess Inflow during the-month (1-2) 1.97
Opening Cash Balance 2.32
Closing Cash Balance (4+3) 0.35
Minimum Cash Balance Needed 2.00
Estimated Cash Surplus (5-6) - or Deficit (6-5) 1.65

Illustration 10.5
267
Application of You are appointed as the Finance Manager of Bihar Polymers Limited.
Cost Prepare a cash budget for six months of 2020 with the help of the following
Accounting information:

a) Sales on credit cost of material and wages are budgeted as follows

(figures for November and December of the previous year are the actual
figures for those months).

Months Credit sales Cost of material Wages

Nov. 30,000 5,000 10,000
Dec. 32,000 6,000 12,000
Jan. 28,000 5,000 10,000
Feb. 31,000 7,000 11,000
March 34,000 8,000 12,000
April 29,000 5,000 9,000
May 30,000 6,000 11,000
June 36,000 7,000 12,000

b) Fixed overheads amount to Rs. 10,000 per month.

c) Preference dividend of Rs. 8,000 for the half-year will be due in June.

d) Income tax amount of Rs. 10,000 is payable in January.

e) Progress payments under a building contract are due as follows:

March31 Rs. 12,000

May31 Rs. 15,000

f) Goods are sold on terms: Net cash in the following month. Experience
indicates that 80% of debtors pay within the period of credit and the
remainder do not pay until the following month.

g) Cost of material is payable in the month following the month in which

the cost is incurred. Half of the purchases are subjected to a 2% discount
and the remaining is payable net.

h) The company pays all its accounts promptly.

268
 Budgeting and
Budgetary Control

Purchase Budget

January February March

Desired ending inventory (at cost price) 90,000 97,500 1,12,500

Add Cost of goods (Current Month) 37,500 45,000 45,000

Total requirement 1,27,500 1,42,500 1.57,500

Less beginning inventory (60.000) (90,000) (97,500)

Purchases 67,500 52,500 60,000

It will be seen that deficiency of cash occurs in the months of January,

March, May and June, mainly because some unusual payments like
preference dividend, advance income tax and progress payments under
building contract are to be made in those months. With the help of the cash
budget, the company will be able to plan its short-term financing. One of the
courses is to obtain overdraft facilities from its bankers.

The net cash position in a particular period may show a deficit. Hence,
arrangements should be made in advance to fill this gap by borrowing or by
other means. In case there is a surplus balance, the desirability of investing it
in government or other short-term securities should be examined. Any
surplus should be invested in safe securities, provided the surplus is
reasonably considerable and the investment period is short of ensuring quick
conversion of securities in cash without loss of value.

Activity 10.4
Arrange a meeting with an accounting executive of any organisation and
ascertain if cash budgeting is being practiced? Obtain a Proforma of cash
budget for your record. What are the major sources of cash inflows and the
main uses of cash outflows? In what way our organisation manages any
deficit or surplus of cash revealed by the cash budget?
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Application of ............................................................................................................................
Cost ............................................................................................................................
Accounting
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Master Budget
The Master or final budget is a summary budget, which incorporates all
functional budgets in a capsule form. It sets out the plan of operations for all
departments in considerable detail for the budget period. The budget may
take the form of a Profit and Loss Account and a Balance Sheet as at the end
of the budget period.

The Master budget requires the approval of the Budget Committee before it is
put into operation. Sometimes, a number of master budgets may have to be
prepared before the final one is agreed upon. The budget generally contains
details regarding sales (net), production costs, cash position, and key account
balances (e.g. debtors, fixed assets, bills payable, etc.). It also shows the
gross and net profits and the important accounting ratios.

Fixed and Flexible Budgets

Fixed Budget:
A fixed budget is designed to remain unchanged irrespective of the level of
activity. This budget is prepared on the basis of a standard or fixed level of
activity. Since the budget does not change with the change of level of
activity, it becomes an unrealistic yardstick in case the level of activity
(volume of production or sales) actually attained does not conform to the one
assumed for budgeting purposes. The management will not be able to assess
the performance of different heads on the basis of budgets prepared by them
because they can serve as yardsticks only when the actual level of activity
corresponds to the budgeted level of activity. On account of the limitations of
fixed budgeting and its inability to provide for automatic adjustments when
the volume changes. Firms whose sales and production cannot be accurately
estimated have given up the practice of fixed budgeting

The Master Budget may have the following format:

270
Exhibit 10.1: Budget Format Budgeting and
Budgetary Control

Flexible Budget: The Flexible Budget is designed to change in accordance

with the level of activity attained. Thus, when a budget is prepared in such a
manner that the budgeted cost for any level of activity is available, it is
termed as flexible budget. Such a budget is prepared after considering the
fixed and variable elements of cost and the changes that may be expected for
each item at various levels of operations. Flexible budgeting is desirable in
the following cases:

a) Where because of the nature of business, sales are unpredictable, e.g. in

luxury or semi-luxury trades.
b) Where the venture is new and, therefore, it is difficult to foresee the
demand e.g., novelties and fashion products.
c) Where business is subject to the vagaries of nature, such as soft drinks.
d) Where progress depends on an adequate supply of labour and the
business is in an area suffering from a shortage of labour.

10.6 CONTROL RATIOS

The budget is a part of the planning process. After the various budgets,
including the master budget, have been prepared, you may like to compare
actual performance with the budgeted performance. This can be done by
using three important ratios as shown below:

271
Application of
Cost
Accounting

The above ratios are expressed in terms of percentages. If the ratio works out
to 100 per cent or more, the trend is taken as favourable. If the ratio is less
than 100 per cent, the indication is taken as unfavorable. We shall discuss
these ratios in some detail.

Activity Ratio: Activity Ratio is a measure of the level of activity attained

over a period of time. It is obtained by expressing the number of standard
hour’s equivalent to the work produced as a percentage of the budgeted
hours.

Activity Ratio = X 100

Capacity Ratio: This ratio indicates whether and to what extent budgeted
hours of activity are actually utilized. It shows the relationship between the
actual number of working hours and the maximum possible number of
working hours in a budgeted period.

Capacity Ratio =

Efficiency Ratio: This ratio indicates the degree of efficiency attained in

production. It is obtained by expressing the standard hour’s equivalent to the
work produced as a percentage of the actual hours spent in producing that
work

Efficiency Ratio =

Activity 10.5
Calculate: Efficiency, Activity and Capacity ratios and comment on the
results obtained for a factory that produces two units of a commodity in one
standard hour. Actual production during a particular year is 34,000 units and
the budgeted production for the year is 40,000 units. Actual hours operated
are 16,000 (Some clueshave been provided).

Two units are produced in one standard hour. Hence, for the actual
production of 34,000 units, the standard hours required will be 17,000 (i.e
34,000/2).

For budgeted production of 40,000 units, budgeted hours will be 20,000 (i.e.
40,000/2)

Efficiency Ratio:
............................................................................................................................
............................................................................................................................
272
............................................................................................................................ Budgeting and
Budgetary Control
Activity Ratio:

............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................

Capacity Ratio:
............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................

Activity 10.6
In Activity 10.1, you had described the system of budgetary control in your
organisation. Keeping in view the objectives of the system, you now
critically evaluate the system in terms of its achievements and/or failures.
What do you think are the causes for failure (total or partial)? Reflect on
improving the system.

Achievements:
............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................

Failures:
............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................

Causes for failure:

............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................ 273
Application of ............................................................................................................................
Cost
Ideas for improvement:
Accounting
............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................
............................................................................................................................

10.7 PERFORMANCE BUDGETING

As explained in the preceding pages, budgeting is nothing but the technique
of expressing, largely in financial terms, the management’s plans for
operating and financing the enterprise during specific periods of time. Any
system of budgeting must provide for performance appraisal, as well as
follow up measures in order to be successful.

The traditional (also known as line-item or object-account) budget in

government enumerates estimated expenditures by type (and quantity) for a
specified period of time, usually one year. The expenditure is classified by
the object; the personnel are listed by type of position; the budget is divided
into sections according to organisational units, department sections; and the
types of expenditure are listed by category. The primary purpose of
traditional budget, particularly in government administration, is to ensure
financial control and meet the requirements of legal accountability, that is, to
ensure that appropriation, sanction or allotment limits for different items are
not related to the intended or planned outputs (or achievements). The
necessity for linking the expenditures (or inputs in financial terms) to outputs
(in physical terms), facilitating the evaluation of outcomes (or result of
activities) cannot be over emphasised.

Performance budgeting (or programme budgeting) has been designed to

correct the shortcomings of traditional budgeting by emphasising
management’s considerations/ approaches. Both the financial and physical
aspects are incorporated into the budget. A performance budget presents the
operations of an organisation in terms of functions, programmes, activities,
and projects.

In performance budgeting (PB), precise detainment of job to be performed or

services to be rendered is done. Secondly, the budget is prepared in terms of
functional categories and their sub-division into programmes, activities, and
projects. Thirdly, the budget becomes a comprehensive document. Since the
financial and physical results are interwoven, it facilitates management
control.

The main objectives of PB are:

i) to coordinate the physical and financial aspects;
ii) to improve the budget formulation, review and decision-making at all
274
 levels of management Budgeting and
Budgetary Control
iii) to facilitate better appreciation and review by controlling authorities
(legislature, Board of Trustees or Governors, etc) as the presentation is
more purposeful and intelligible;
iv) to make more effective performance audit possible; and
v) to measure progress towards long-term objectives which are envisaged in
a development plan.

Performance budgeting involves the evaluation of the performance of the

organisation in the context of both specific, as well as, overall objectives of
the organisation. It presupposes a crystal clear perception of organisational
objectives in general and short-term business objectives as stipulated in the
budget, in particular by each employee of the organisation, irrespective of his
level. It thus, provides a definite direction to each employee and also a
control mechanism to higher management.

Performance budgeting requires the preparation of periodic performance

reports. Such reports compare budget and actual data, and show variances.
Their preparation is greatly facilitated if the authority and responsibility for
the incurrence of each cost element is clearly defined within the firm’s
organisational structure. In addition, the accounting system should be
sufficiently detailed and coordinated to provide necessary data for reports
designed for the particular use of the individuals or cost centers having
primary responsibility for a specific cost.

The responsibility for preparing the performance budget of each department

lies on the respective Department Head. Each Department Head will be
supplied with a copy of the section of the master budget appropriate to his
sphere. For example, the chief buyer will be supplied with a copy of the
materials purchase budget to arrange forth purchase of necessary materials.
Periodic reports from various sections of a department will be received by the
departmental head that will submit a summary report about his department to
the budget committee. The report may be daily, weekly or monthly,
depending upon the size of the business and the budget period. These reports
will be in the form of comparison of budgeted and actual figures, both
periodic and cumulative. The purpose of preparing these reports is to
promptly inform about the deviations in actual and budgeted activity to the
person who has the necessary authority and responsibility to take necessary
action to correct the deviations from the budget.

10.8 ZERO BASEBUDGETING

Earlier, we have explained the formulation of different types of budgets.
Suppose the approach adopted in the formulation and preparation of budgets
is based on current level of operations or activities, including current level of
expenditure and revenue. In that case, such budgeting is known as traditional
budgeting. This type of budgeting process generally assumes that the
allocation of financial resources in the past was correct and will continue to
hold good for the future. In most cases, an addition is made to the current
275
Application of figures of cost to allow for expected (or even unexpected) increases.
Cost Consequently, the budget generally takes an upward direction year after year,
Accounting in spite of generally declining efficiency. Such a system of budgeting cannot
be expected to promote operational efficiency. It may, on the other hand,
create several problems for top management. Some of these problems are:
 Programmes and activities involving wasteful expenditure are not
identified, resulting in avoidable financial and other costs.
 Inefficiencies of a prior year are carried forward in determining
subsequent years’ levels of performance.
 Managers are not encouraged to identify and evaluate alternative means
of accomplishing the same objective.
 Decision-making is irrational in the absence of rigorous analysis of all
proposed costs and benefits.
 Managers tend to inflate their budget requests resulting in more demand
for funds than their availability. This results in recycling the entire
budgeting process.

Thus, the traditional budgeting technique may be quite meaningless in the

present context when management must review or re-evaluate every task to
utilize the scarce resources in a better manner or improve performance. The
technique of zero-base budgeting provides a solution for overcoming the
limitations of traditional budgeting by enabling top management to focus on
priorities, key areas and alternatives of action throughout the organisation.

The technique of zero base budgeting suggests that an organisation should

not only make decisions about the proposed new programmes, but should
also review the appropriateness of the existing programmes from time to
time. Such a review should particularly be done of such responsibility centers
where there are a relatively high proportion of discretionary costs. Costs of
this type depend on the discretion or policies of the responsibility centre or
top managers. These costs have no direct relation to the volume of activity.
Hence, management discretion typically determines the amount budgeted.
Some examples are expenditure on research and development, personnel
administration, legal advisory services.

Zero base budgeting, as the term suggests, examines or reviews a programme

or function or responsibility from ‘scratch’. The reviewer proceeds on the
assumption that nothing is to be allowed. Therefore, the manager proposing
the activity has to justify that the activity is essential and the various amounts
asked for are reasonable considering the outputs or results or volume of
activity envisaged. No activity or expense is allowed simply because it was
being allowed or done in the past. Thus, according to this technique, each
new or existing programme must be justified in its entirety each time a new
budget is formulated. It involves:
 dealing with particularly all elements of mangers’ budget requests
 critical examination of ongoing activities along with the newly proposed
activities
276
 providing each manager a range of choices in setting priorities in respect Budgeting and
of different activities and in allocating resources. Budgetary Control

Process of Zero Base Budgeting

The following steps are involved in Zero base budgeting:

Determining the objectives of budgeting: The objective may be ‘to effect

cost reduction in staff overheads, or it may be to drop, after careful analysis,
projects which do not fit into the achievement of the organisation's objectives
etc.

Deciding on scope of application: The extent to which zero-base budgeting

must be introduced has to be decided, i.e. whether it will be introduced in all
areas of the organisation’s activities or only in a few selected areas on a trial
basis.

Developing decision units: Decision units for which cost-benefit analysis is

proposed have to be developed so as to arrive at decisions whether they
should be allowed to continue or to be dropped. Each decision unit, as far as
possible, should be independent of other units so that it can be dropped if the
cost analysis proves to be unfavourable for it.

Developing decision packages: A decision package for each unit should be

developed. While developing a decision package, answers to the following
questions would be desirable:

 Is it necessary to perform a particular activity at all? If the answer is in

negative, there is no need to proceed further.
 How much has been the actual cost of the activity and what has been the
actual benefit of both tangible as well as intangible forms?
 What should be the estimated cost of the level of activity and the
estimated benefit from such activity?
 Should the activity be performed in the way it is being performed, and
what should be the cost?

If the project or activity is dropped, can the unit be replaced by an outside

agency Financial and Investment Analysis

After completing decision packages for each unit, the units are ranked
according to the findings of cost-benefit analysis. Essential projects are
identified and given the highest ranks. The last stage is that of implementing
the decision taken in the light of the study made. It involves the selection and
acceptance of those projects that have a positive cost-benefit analysis or are
capable of meeting the organisation's objectives.

The above analysis shows that zero-base budgeting is in a way an extension

of the method of cost-benefit analysis to the area of corporate budgeting.
Advantages of Zero Base Budgeting

Let us summarise the advantages of zero-base budgeting:

277
Application of  It provides the organisation with a systematic way to evaluate different
Cost operations and programmes undertaken. It enables management to
Accounting allocate resources according to the priority of the programmes.
 It ensures that every programme undertaken by managers is essential for
the organisation and is being performed in the best possible way.
 It enables the management to approve departmental budgets based on
cost-benefit analysis. No arbitrary cuts or increase in budget estimates
are made.
 It links budgets with corporate objectives. Nothing will be allowed
simply because it was being done in the past. An activity may be shelved
if it does not help in achieving the goals of the enterprise.
 It helps identify areas of wasteful expenditure and, if desired, it can also
be used to suggest alternative courses of action.
 It facilitates the introduction and implementation of the system of
‘management by objectives’. Thus it can be used not only for the
fulfillment of the objectives of traditional budgeting but also for a variety
of other purposes.

It is contended that zero-base budgeting is time-consuming. Of course, it is

true, but it happens only in the initial stages when decision units have to be
identified and decision packages have to be developed or completed. Once
this is done and the methodology is clear, zero base budgeting is likely to
take less time than traditional budgeting. In any case, until the organisation is
properly acclimatised to the technique of zero base budgeting, it may be done
so that all responsibility centers are covered at least once in three or four
years.

Zero-base budgeting as a concept has become quite popular these days. The
technique was first used by the U.S. Department of Agriculture in 1962.
Texas Instruments, a multinational company, pioneered its use in the private
sector. Today, a number of major companies such as Xerox, BASF,
International Harvester and Easter Airlines in the United State are using the
system.

Some departments of the Government of India have recently introduced zero-

base budgeting intending to make the system of budgetary control more
effective.

Activity 10.7
Discuss again with an official concerned with the budgetary control system in
your organisation in the light of new developments that have taken place in
the field of budgeting. Has your organisation adopted any of the features of
the new developments of innovations, such as Performance Budgeting, Zero
Base Budgeting, etc.? List some of the important steps taken in the recent
past.
............................................................................................................................
............................................................................................................................
278
............................................................................................................................ Budgeting and
Budgetary Control
............................................................................................................................
............................................................................................................................

10.9 SUMMARY
Financial planning is of utmost significance to management since finance is
regarded as the lifeblood of business. A budget is a quantitative expression,
usually in financial terms, of the future plans of an organisation. It includes
projections regarding the levels of activity, expenses and revenues. A budget
is an essential tool of financial planning. It helps in uncovering inefficiencies
in operations, in minimising wasteful expenditure and in bringing out
weaknesses in the organisation structure.

The responsibility for preparing the budget rests on the Budget Controller,
who is assisted in his work by a Budget Committee. The Budget Committee
may consist of heads of various departments, viz., Sales, Production,
Personnel, Purchase, and Finance etc. Each head of the department is made
responsible for preparing and executing the budget of his department. In a
business organisation, the preparation of any budget is preceded by a sales
forecast. A production budget is prepared after considering the forecasts
embodied in the sales budget and the available productive capacity etc. The
production budget includes the preparation of various cost budgets associated
with the production process. Budgets pertaining to different functions or units
are then combined and coordinated into one Master Budget.

The budget may be revised from time to time if the changed conditions or
new developments so warrant. A budget may be fixed or flexible. A fixed
budget is based on fixed volume of activity. If actual capacity utilisation is
likely to vary from period to period, flexible budgets are more desirable. A
flexible budget is thus prepared for changing levels of activity. It considers
fixed and variable costs separately and is therefore more useful to a business
where the level of activity cannot be exactly predicted.

In a budgetary control system, control ratios may be computed and used to

compare the actual performance with the budgeted performance. These ratios
are activity ratio, capacity ratio and efficiency ratio. In case the ratio is a
hundred percent or more, it is considered favourable. If it is less than a
hundred percent, it is taken as unfavourable.

The traditional budgeting technique takes the current level of operations as

the basis for estimating the future level of operations slowly going out of
date. It is increasingly realised that the traditional technique has serious
shortcomings in view of the constantly changing conditions of today. The
management is expected to review and re-evaluate the tasks because of the
increasing pressures of the environment. The concept of `zero base
budgeting’ is considered a suitable alternative to replacing the traditional
method.’ ‘Zero-base Budgeting’ technique suggests that an organisation
should not only make decisions about the proposed new programmes but
should also, from time to time, review the appropriateness of the existing 279
Application of programmes. Nothing is allowed simply because it was being allowed in the
Cost past. Each programme, whether new or existing, has to be justified in its
Accounting entirety each time a new budget is formulated.

The concept of ‘Zero base Budgeting’ has been accepted for adoption in the
departments of the Central Government and some State Governments.

10.10 KEYWORDS
Budget: A statement in financial terms, prepared prior to a defined period of
time, showing the strategy to be pursued during that period to attain a given
objective.

Budgeting: Art of building budgets.

Budgetary Control: The establishment of budgets relating to 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 that policy or to provide a basis for its
revision.

Budget Manual: A document that sets out, inter alia, the responsibilities of
the persons engaged in the routine and the forms and records required for
budgetary control.

Master Budget: Summary budget, incorporating all component functional

budgets, which are finally approved, adopted and employed.

Fixed Budget: A budget designed to remain unchanged irrespective of the

level of activity attained.

Flexible Budget: A budget designed to change in accordance with the level

of activity attained.

Performance Budget: A budget, which specifies the outputs or results to be

achieved along with the inputs or expenditure to be incurred during the
budget period.

Zero Based Budgeting: An operating planning and budgeting process which

required each manager to justify his entire budget in detail from scratch.

Decision Unit: A significant programme, individual department or unit or

level of an organisation that can be analysed from the stand point of decisions
and funding.

Decision Package: A programme with goals, activities, and resources along

with a document that identifies and describes the programme in terms of its
(i) goals, (ii) activities by means of which goals are to be achieved, (iii)
benefits to be expected (iv) alternatives to the programme, (v) consequences of
not approving the programme and, (vi) financial and workforce resources required.

280
10.11 SELF-ASSESSMENT QUESTIONS Budgeting and
Budgetary Control
/EXERCISES
a) What do you understand by ‘Budgeting’? Mention the types of budgets
that the management of a big industrial concern would typically prepare.
b) What is Budget? What is sought to be achieved by Budgetary Control?
c) What is the significance of ‘Budgetary Control’ in modern business?
d) Outline a plan for Sales Budget and Purchase Budget. What
considerations are necessary in the preparation of such budgets?
e) Distinguish between Master Budget and Financial Budget. How does
management make use of Master Budget
f) What is a `Flexible Budget’ and how it is different from ‘Fixed Budget’?
g) Explain the methods of forecasting cash requirements.
h) State whether each of the following statements is True or False

i) Fill in the blanks:

a) A system by which budgets are used as a means of planning and

controlling all aspects of a business…………..
b) Is a budget designed to furnish budgeted costs for any level of
activity actually attained?
c) Is a summary of all functional budgets in a capsule form?
d) Budgetary control helps management to............................................
e) Budget is an expression of a business plan in financial terms
…………
f) …………… shows the anticipated sources and utilisation of cash.
g) …………. determines the priorities of functional budgets.
h) A document that sets out the responsibilities of the persons engaged
in
theroutineofandtheformsandrecordsrequiredforbudgetarycontroliscal
led……………………..
i) Cash budget is a ……….. Budget. 281
Application of j) …………isabudgetwhichstatesthe‘additionalworkerstobeengaged in
Cost the factory.
Accounting k) A budget which consolidates the organisation's overall plan is
called…………..
l) Capacity Ratio x Efficiency Rate=………………………..
m) It is essential to determine the proper ……… and to have well
defined ……………

j) Choose the correct answer:

i. Sales budget is a:

(a) functional budget, (b) master budget, (c) expenditure budget.

ii. In the case of plants the limiting factor may be :

(a) insufficient capacity, (b) shortage of experienced salesmen, (c)

general shortage of power.

iii. The difference between fixed and variable cost has a special
significance in the preparations of:

(a) flexible budget, (b) master budget, (c) cash budget.

iv. The budget that is prepared first of all is:

(a) cash budget, (b) master budget, and (c) budget for the key
factor.

v. In the case of materials, the key factor may be:

(a) insufficient advertising, (b) restrictions imposed by quota, (c)

low market demand

vi. The budget, which commonly takes the form of budgeted Profit and
Loss Account and Balance Sheet, is:

a) cash budget, (b) master budget, and (c) flexible budget.

k) Prepare a materials budget of Bihar Udyog Ltd, based on the

following information. The production orders of the products show
the following consumption

i) Consumption for a batch of 1,000 units of

Material No. Rate per kg. Product Pkg Product Qkg

1 Rs.60 50 80

2 60 10 5

3 10 - 30
4 50 6 10

5 25 4 4
282
 Total 70 129 Budgeting and
Budgetary Control
ii) Production (units)

Product P 12,000units

ProductQ 11,000units
l) Draw a Material Procurement Budget (Quantitative) from the
following information:
The estimated sale of a product is 20,000 units. Each unit of the product
requires 3 units of material X and 5 units of Material Y.

Estimated opening balance at the commencement of the next year:

Finished Product 2,500 kgs.

Material X 6,000 units
Material Y 10,000 units
Material on order:
Material X 3,500 units
Material Y 5,500 units
The desirable closing balances at the end of the
next year:
Finished Product 3,500 units
Material X 7,500 units
Material Y 12,500 units
Material on order:
Material X 4,000 units
Material Y 5,000 units

Q13. Kashmir Valley Ltd. has submitted the following information:

2002 Sales Purchase Wages Other

Expenses

January 40,000 20,000 7,500 2,000

February 50,000 30,000 10,000 2,500
March 60,000 40,000 12,000 3,0'00
April 70,000 40,000 12,500 2,000
May 50,000 30,000 12,000 2,500
June 30,000 20,000 7,500 2,250
July 35,000 15,000 9,000 2,750
August 40,000 15,000 9,000 2,500
September 30,000 20,000 8,000 2,000
October 50,000 25,000 11,000 3,000
November 60,000 30,000 12,000 3,500 283
Application of December 65,000 35,000 12,500 4,250
Cost
Accounting The company is engaged in the manufacture of furniture. It recently
purchased machinery worth Rs. 50,000 on 1st April, 2003 on deferred
payment basis with interest at 12% per annum with the stipulation that the
principal is repayable in four equal quarterly installments beginning from
April, 2003 and thereafter interest to be paid as at the end of each quarter, i.e.
in July, October and January. The company has been carrying deposits of Rs.
50,000 at 16% interest, payable on the last day of June every year.

About 40% sales are made on cash basis. A credit period of two months is
allowed for sales on credit. Closing cash balance as on 31st March 2003 is
projected at Rs. 5,250.

A cash discount of 5 % is available if creditors are paid within one month,

but not later. The company has been advised by its consultant to maintain a
minimum cash balance of Rs. 2,500 for day-to-day cash requirements.

As the Financial Controller of Kashmir Valley Ltd., please prepare a cash

budget for the quarter from April to June 2003.

a) Production cost of a factory for a year is as follows:

Direct Wages Rs. 80,000

Direct Materials 1,20,000

Production overheads, fixed 40,000

Production overheads, variable 60,000

During the forthcoming year, it is anticipated that:

1) AverageratefordirectlabourremunerationwillfallfromRs.3perhourtoRs.2.5
0 per hour;
2) Production efficiency will remain unchanged; and
3) Direct labour hours will increase by 33 1/3%

The purchase price per unit of direct materials and of the other materials and
services which comprise overheads will remain unchanged.

Draw up a budget and compute a factory overhead rate, the overheads being
absorbed on a direct wage basis.

b) ABC Co. wishes to arrange overdraft facilities with its bankers during
the period April to June when it will be manufacturing mostly for stock.
Prepare a Cash Budget including the extent of bank facilities the
company will require at the end of each month for the above period from
the following data.

a) Sales Purchases Wages

284
 February 1,80,000 1,24,800 12,000 Budgeting and
Budgetary Control

March 1,92,000 1,44,000 14,000

April 1,08,000 2,43,000 11,000
May 1,74,000 2,46,000 10,000
June 1,25,000 2,68,000 15,000
15. 50 per cent of credit sales is realised in the month following the sale
and the remaining 50 per cent in the following second month. Creditors
are paid in the month following the month of purchase.

c) Cash at bank on the 1st April (estimated) is Rs.25,000.

16) Jammu Manufacturing Company Ltd. is to start production on 1st

January 2004. The Prime cost of a unit is expected to be Rs. 400 out of
which Rs. 160 is for materials and Rs.240 for labour. In addition,
variable expenses per unit are expected to be Rs. 80 and fixed expenses
per month Rs.3,00,000. Payment for materials is to be made in the month
following the purchase. One third of sales will be for cash and the rest on
credit for settlement in the following month. Expenses are payable in the
month in which they are incurred. The selling price is fixed at Rs.800 per
unit. The number of units manufactured and sold are expected to be
asunder:
January 9,000 April 20,000
February 12,000 May 21,000
March 18,000 June 24,000

Draw a cash budget showing requirements of cash from month to month.

17) The Sudershan Chemicals Ltd., operates a system of flexible budgetary

control. A flexible budget is required to show levels of activity at 70%,
80% and 90% the following is a summary of the relevant information:

 Sales based on normal level of activity of 70 % (3,50,000) units at

Rs. 200 each. If output is increased to 80% and 90% , selling prices
are to be reduced by 2.5 % and 5 % of the original selling price,
respectively, to reach a wider market.
 Variable costs are Rs. 100 per unit (70 % is the cost of raw
material). In case output reaches 80 % level of activity or above the
effective purchase of raw material will be reduced by 5%
 Variable overheads: Salesman’s commission is 2 % of sale value.
 Semi-variable overheads (total) at 3,50,000 units are Rs.
1,20,00,000. They are expected to increase by 5 % if output reaches
a level of activity of 80 % and by a further 10% if it reaches the 90
% level.
 Total fixed overheads are Rs. 2,00,000 which is likely to remain
unchanged up to 100%capacity.

18) Calculate: (a) Efficiency Ratio (b) Activity Ratio (c) Capacity Ratio from 285
Application of the following figures:
Cost
Budgeted production 880 units
Accounting
Standard hours per unit10
Actual production 750 units
Actual working hours 6,000

Answers to Self-assessment Exercises

8 (a) F, (b) F, (c) T, (d) F, (e) T, (f) F, (g) T, (h) F, (i)F.

9. a) is called budgetary control

a) Flexible Budget

b) Master Budget

c) plan and control

d) for some specific future period

e) Cash budget

f) Principal budget factor

g) is termed Budget Manual

h) Short-term

i) Labour Procurement Budget

j) Master Budget

k) Activity Ratio

m) Budget Period, Responsibility Centre.

10. (i) a; (ii) a; (iii) a; (iv)c; (v) b; (vi) b;

Material No 1 2 3 4 5
Qty. (Kg.) 1,480 175 330 182 92

Amount 88,800 10,500 3,300 9,100 2,300

(Rs.)

12) Units to be procured X: 65,000; Y:1,07,000

13) Closing balance April May June

Rs.2,250 Rs. 2,500 Rs. 2,500

14) Cost of production Rs. 3,08,889, Production overhead rate 112.5 %.

15) Closing balance April May June

(Overdraft) (Rs.56,000) (47,000) (1,67,000)

286 17) Budgeted Profit: 70 % :Rs. 214 lakhs. 80 % :Rs. 250.4 lakhs, 90 % :
 Rs.269.65 lakhs. Budgeting and
Budgetary Control
18) (a) 125%; (b) 85.23%; (c) 68.18%.

10.12 FURTHERREADINGS
Arthus, J. Keown, .1. William Petty, John D. Martin, David, F. Scott, 10-10-
2002, Foundation of Finance: The Logic and Practice of Financial
Management, Prentice Hall : New Delhi (Chapter 10)
Horngren Charles T. Sundem Gary L. Stratton William, O. Introduction to
Management Accounting, 11 thed (Part 2); Prentice Hall of India: New Delhi
McAlpine, T.S. 1976. The Basic Arts of Budgeting, Business Books (Chapter
2, 6, 7, and 9).
Moor, Carl L. and Robert K. Jaedicke. 1976. Managerial Accounting, South
Western Publishing Co., (Chapter 17 and 18).
Chandra,Prasanna,1985. . Managers’ Guide to Finance and
Accounting, Tata McGraw-Hill: Delhi (Chapter 8 &24).
Prem Chand. 1969. Perjbrniance Budgeting, Academic Books: New Delhi.
Pyhrr, Peter A 1973. Zero Base Budgeting, John Wiley & Sons: New York.
Maheshwari, S.N. 1987. Management Accounting and Financial Control,
Sultan Chand: New Delhi.(Section C, Chapter 1).

AUDIO/VIDEO PROGRAMME
Audio
Emerging Horizons in Accounting & Finance - Part I: Zero Base Budgeting
Video
Management Control Systems: Part I & II

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