Module 3:

Budgetary Control
Meaning:
A budget is a detailed plan of operations for some specific future period. The word 'budget' is derived
from a French term "Bougette" which denotes a leather pouch in which funds are appropriated for
meeting anticipated expenses. The same meaning applies to the business management.

A budget is a numerical statement expressing the plans, policies and goals of the enterprise for a
definite period in the future.

According to George R. Terry, “Budget is an estimate of future needs arranged according to an orderly
basis, covering me or all of the activities of an enterprise for definite period of time".

“A Budget is a comprehensive and co-ordinated plan, expressed in financial terms, for the operations
and resources of an enterprise for some specific period in the future."
—James

“A budget is a pre-determined statement of management policy during a given period which provides a
standard for comparison with the results actually achieved."
—Brown and Howard

“A financial and/or quantitative statement, prepared prior to a defined period of time, of the policy to
be pursued during that period for the purpose of a given objective."
—ICMA, England

Basic Features:
• Budget is a comprehensive plan of what the enterprise endeavours to achieve.
• It is a statement in terms of money or quantity or both.
• It is prepared for a definite future period.
• It is prepared prior to the defined period.
• It provides yardsticks and measures for the purpose of comparison.
• It is prepared in advance and refers to the future course of action.
• It indicates the business policy which has to be followed so as to achieve a given objective.

BUDGETING:
A budget is essentially a statement of the intention of management. Budgeting refers to the management
action of formulating budgets. Preparation of budgets or budgeting is a planning function, and their
application or implementation is a control function. Budgetary control starts with budgeting and ends
with control. Budgeting is defined as:

"The entire process of preparing the budgets is known as budgeting" —Batty

"Budgeting may be said to be the act of building budgets". —Rowland and Harr
Objectives of Budgeting
The main objectives of budgeting are:
• To obtain more economical use of capital.
• To prevent Waste and reduce expenses.
• To facilitate various departments to operate efficiently and economically.
• To plan and control the income and expenditure of the firm.
• To create a good business practice by planning for future.
• To fix responsibilities on different departments or heads.
• To co-ordinate the activities of various departments.
• To ensure the availability of working capital.
• To smooth out seasonal variations, by developing new products.
• To ensure the matching of sales with productions.

Budgetary Control:
"Budgetary control means the establishment of budgets relating to the responsibilities of executives to
the requirement of a policy, and continuous comparison of actuals with budgeted results either to secure
by individual action the objective of that policy or to provide basis for its revision.”

Advantages of Budgetary Control:

The advantages and benefits of budgetary control are summarised next:
• Budgets fix the goals and targets, without which operation lacks direction.
• Reduction in cost and elimination of inefficiency is achieved automatically.
• The budget facilitates to maintain ordered effort and brings about efficiency in results.
• An effective system of budgetary control results in co-ordinated effort of all persons involved.
• Budgetary control enables the management to decentralise responsibility without losing control
of the business since it pin-points inefficiency.
• The budgetary control and standard costing go hand in hand and the combination of the two
gives the most effective results. It promotes mutual co-operation and team spirits among the
persons involved.
• Budgetary control ensures that the capital employed at a particular level is kept at a minimum
level.
• It facilitates an intelligent and planned forecast for future.
• It is a good guide to the management for making future plans. It is on the basis of budgetary
control, realistic budgets can be drawn.
• It aims at maximisation of profit through cost control and proper utilisation of re- sources.
• It brings to light the inefficiencies and weaknesses on comparing actual performance with
budget. Thus, management can take remedial measures.
• It is a guide to the management in the field of research and development in future.
• It evaluates the performance.
• Since budget provides advance information, financial crises can be avoided.
• It acts as a safety signal for the management. It prevents wastages of all types.

Limitations of Budgetary Control:

Budgetary control is a sound technique of control. But it is not a perfect tool. Despite he appreciation,
it has its own limitations which are as follows:
 • Budgets deal with future. Forecasting is necessary for budgeting. Forecasts and estimates are
rarely cent per cent accurate. The success largely depends upon the degree of accuracy of the
estimates.
• Budgeting is time-consuming process. During the preparation period, the business conditions
may change and estimates may go wrong by that time.
• The successful operation and execution of budgets depends upon the efficiency of the executive
personnel.
• Budgetary control is essentially a tool of decision-making and it helps the management in taking
sound decisions. But it cannot replace the management.
• Budgeting necessitates the employment of specialised staff and this involves expenditure which
small concerns may not afford.
• A budget programme should be dynamic, capable of being adapted to changing conditions. But
when budgets are prepared with pre-determined targets, there is a feeling that the budgeted
figures are final. Thus, budgetary programme is bound to become rigid.
• The success of the budgetary control largely depends upon willing co-operation or team-work
of all concerned. If there is no co-operation, the whole system collapses.

TYPES OF BUDGETS:
Fixed Budgets
On the Basis of Capacity
Flexible Budgets

Functional Budgets
On the Basis of Coverage
Budgets

Master Budget

Long-term Budget
On the Basis of Period
Short-term Budget

Basic Budget
On the Basis of
Conditions
Current Budget

On the Basis of Capacity:

1. Fixed Budget:
The budget which is designed to remain unchanged irrespective of the level of activity actually attained
is called Fixed Budget. Fixed Budget is based on a single level of activity. It is used as an effective tool
of cost control. It does not change with the change in the level of activity. In case of fixed budget,
expenses are not classified into fixed, variable and semi-variable.
2. Flexible Budget:
A budget which is designed to change in relation to the level of activity attained by recognising the
difference between fixed, semi-fixed and variable costs is called Flexible Budget. Flexible budget is
also known by other names, such as variable budget, dynamic budget, sliding scale budget, step budget,
expenses formula budget and expenses control budget. It is prepared for different levels of activity.
Expenses are classified into fixed, variable and semi-variable expenses. Further, semi-variable expenses
are segregated into fixed and variable expense.

The underlying principle of a flexible budget is that every business is dynamic, ever-changing, and never
static. Thus, a flexible budget might be developed that would apply to a 'relevant range' of production,
say 8,000 units to 12,000 units. Under this approach, if actual production slips to 9,000 units from a
projected 10,000 units, the manager has a specific tool (i.e., the flexible budget) that can be used to
determine budgeted cost at 9,000 units of output.

Note:
Refer Illustration 6 and 7 for detailed understanding. (M N Arora Book)

Basis of Distinction Fixed Budget Flexible Budget

1. Change with It does not change with actual volume of It can be recasted on the basis
Activity activity achieved. Thus, it is known of activity level to be
as rigid or inflexible budget. achieved. Thus, it is not rigid.
2. One Level or It operates on one level of activity and It consists of various budgets
different levels of under one set of conditions. It assumes that for different levels of activity.
activity there will be no change in the prevailing
conditions, which is unrealistic.
3. Utility of Variance Since all costs like-fixed, variable and
Here analysis of variance
Analysis semi-variable are related to only one level
provides useful information as
of activity, variance analysis does not give
each cost is analysed
useful information. according to its behaviour.
4. Decision Making If the budgeted and actual activity levels
Flexible budgeting at different
differ significantly, then the aspects like
levels of activity, facilitates
cost ascertainment and price fixation do
the ascertainment of cost,
not give a correct picture. fixation of selling price and
tendering of quotations.
5. Basis of Comparison Comparison of actual performance with It provides a meaningful basis
Fixed Budget budgeted targets will be meaningless of comparison of the actual
specially when there is a difference performance with the
between the two activity levels. budgeted targets.

On the Basis of Coverage:

1. Functional Budgets:
The budget which is related to a particular function of the business is called Functional Budget. The
various types of functional budgets are:
Sales Budget
Production Budget
Production Cost Budget
 Raw Materials Budget
Purchases Budget
Labour Budget
Production Overheads Budget
Selling and Distribution Cost Budget
Administration Cost Budget
Capital Expenditure Budget
Cash Budget.

(a) Sales Budget:

A statement that shows planned sales in terms of quantity and value is called sales budget. It forecasts
what the company can reasonably expect to sell to its customers during the budget period. The sales
budget can be prepared to show sales classified according to products, salesmen, customers, territories
and periods. The factors to be considered in forecasting sales are past sales, reports by salesmen,
company conditions, business conditions, special conditions, and market analysis.

(b) Production Budget

The production budget is a plan of production for the budget period. It is first drawn up in quantities of
each product and when the remaining budgets have been compiled and cost of production calculated,
then the quantities of production cost are translated into money terms, what in effect becomes a
production cost budget. The production budget is the initial step in budgeting manufacturing operations.

(c) Production Cost Budget:

The budget that shows the estimated cost of production is called Production Cost Budget. The cost of
production is shown in detail in respect of material cost, labour cost, and factory overheads. Therefore,
Production Cost Budget is based upon Production Budget, Material Cost Budget, Labour Cost Budget
and Factory Overhead Budget.

(d) Raw Material Budget:

The budget which shows the estimated quantities of all the raw materials and components needed for
production demanded by the production budget is called Raw Materials Budget. Raw material budget
serves the following purposes:
It assists purchasing department in planning the purchases
It helps in the preparation of purchase budget
It provides data for raw material control.
It should be noted that raw material budget generally deals with only the direct materials. Indirect
materials and supplies are included in the overhead cost budget.

(e) Purchase Budget:

The budget that provides details of the purchases which are planned to be made during the period to
meet the needs of the business is called purchase budget. It indicates:
The quantities of each type of raw material and other items to be purchased;
The timing of purchases;
The estimated cost of material purchases.
(f) Labour Budget:
The budget which shows the forecast of labour requirements to meet the demands of the company during
the budget period is called labour budget. This budget must be linked with production budget and
production cost budget.

Labour cost is classified into direct and indirect. Some companies prepare a labour budget that includes
both direct and indirect labour, while others include only direct labour cost and include the indirect
labour in the overhead cost budget.

(g) Production Overheads Budget:

The budget which shows the forecast of all the production overheads (fixed, variable and semi-variable)
to be incurred during the budget period is called production overheads budget.

The production overheads budget involves the preparation of overheads budgets for each department of
the factory as it is desirable to have estimates of manufacturing overheads prepared by those individuals
who have the responsibility for incurring them.

(h) Selling and Distribution Cost Budget:

The budget which represents the forecast of all cost incurred in selling and distributing the company’s
products during the budget period is called Selling and Distribution Cost Budget. Generally, the sales
budget and selling and distribution cost budgets are prepared simultaneously since each has a definite
impact on the other.

(i) Administration Cost Budget:

The budget that represents the forecast of all administration expenses, like directors’ fees, managing
director’s salary, office lighting, heating and air conditioning, etc. is called Administration Cost Budget.

(j) Capital Expenditure Budget:

The budget that represents the expenditure on all fixed assets during the budget period is called Capital
Expenditure Budget. It includes items like new buildings, machinery, land and intangible items like
patents, etc.

(k) Cash Budget:

The budget that shows the detailed estimate of cash receipts from all sources, cash payments for all
purposes and the remaining cash balances during the budget period is called Cash Budget. The cash
budget is one of the most important and one of the last to be prepared. The cash budget is usually
prepared using the Receipts and Payment Method.

2. Master Budget:
When all the functional budgets have been prepared, these are summarized into what is known as a
master budget. Thus, a master budget is a consolidated summary of all the functional budgets. In other
words, a summary budget which incorporates all functional budgets is called Master Budget.

According to CIMA, London, 'master budget is a summary budget incorporating its component
functional budgets and which is finally approved, adopted and employed."
A master budget has two parts;
(i) operating budget, i.e., budgeted profit and loss account, and
(ii) financial budget, i.e., budgeted balance sheet.
Thus, a projected profit and loss account and a balance sheet together constitute a master budget.

Note:
Problems may come from Master Budget, Flexible Budget and Cash Budget.
Refer book and go through illustrations.

ZERO BASE BUDGETING

PERFORMANCE BUDGETING