BUDGETS AND BUDGETORY CONTROL
Budgeting is an integral part of management to achieve organizational
objectives.. A budget is a plan of action and is prepared to facilitate
the planning and control process.
Definition of Budget:
‘A budget is a financial
and/or quantitative statement, prepared prior to a defined period of time, of
the policy to be pursued during the period for the purpose of attaining a given
objective’. (The Chartered Institute
of Management Accountants, London
Elements of Budget:
The basic elements of a budget are as follows:-
1. It is a comprehensive and coordinated plan of action.
2. It is a plan for the firm’s operations and resources.
3. It is based on objectives to be attained.
4. It is related to specific future period.
5. It is expressed in financial and/or physical units.
Budgetary Control:
CIMA, London defines budgetary control as, “the
establishment of the budgets relating to the responsibility of executives to
the requirements of a policy and the continuous comparison of actual with
budgeted result either to secure by individual action the objectives of that
policy or to provide a firm basis for its revision”
‘Budgetary Control is a planning in advance of the various
functions of a business so that the business as a whole is controlled’. (Wheldon)
Elements of budgetary control:
1. Establishment of budgets for each function and division
of the organization.
2. Regular comparison of the actual performance with the
budget to know the variations from budget and placing the responsibility of
executives to achieve the desire result as estimated in the budget.
3. Taking necessary remedial action to achieve the desired
objectives, if there is a variation of the actual performance from the budgeted
performance.
4. Revision of budgets when the circumstances change.
5. Elimination of wastes and increasing the profitability.
Objectives of Budgetary Control
Budgetary Control assists the management in the allocation
of responsibilities and is a useful device to estimate and plan the future
course of action. The general objectives of budgetary control are as follows:
1. Planning:
(a) A budget is an action plan as it is prepared after a
careful study and research.
(b) A budget operates as a mechanism through which
objectives and policies are carried out.
(c) It is a communication channel among various levels of
management.
(d) It is helpful in selecting a most profitable
alternative.
(e) It is a complete formulation of the policy of the
concern to be pursued for attaining given objectives.
2. Co-ordination:
It coordinates various activities of the business to
achieve its common objectives. It induces the executives to think and operate
as a group.
3. Control:
Control is necessary to judge that the performance of the
organization confirms to the plans of business. It compares the actual
performance with that of the budgeted performance, ascertains the deviations,
if any, and takes corrective action at once.
Installation of Budgetary Control:
There are certain steps necessary to install a good
budgetary control system in an organization. They are as follows:
1. Determination of the Objectives
2. Organization for Budgeting
3. Budget Centre
4. Budget Officer
5. Budget Manual
6. Budget Committee
7. Budget Period
8. Determination of Key Factor
1. Determination of Objectives:
It is very clear that the installation of a budgetary
control system presupposes the determination of objectives sought to be
achieved by the organization in clear terms.
2. Organization for Budgeting:
Having determined the objectives clearly, proper
organization is essential for the successful preparation, maintenance and
administration of budgets. The responsibility of each executive must be clearly
defined. There should be no uncertainty regarding the jurisdiction of executives.
3. Budget Centre:
It is that part of the organization for which the budget is
prepared. It may be a department or any other part of the department. It is
essential for the appraisal of performance of different departments so as to
make them responsible for their budgets.
4. Budget Officer:
A Budget Officer is a convener of the budget committee. He
coordinates the budgets of various departments. The managers of different
departments are made responsible for their department’s performance.
5. Budget Manual:
It is a document which defines the objectives of budgetary
control system. It spells out the duties and responsibilities of budget
officers regarding the preparation and execution of budgets. It also specifies
the relations among various functionaries.
6. Budget Committee:
The heads of all important departments are made members of
this committee. It is responsible for preparation and execution of budgets. The
members of this committee may sometimes take collective decisions, if
necessary. In small concerns, the accountant is made responsible for the same
work.
7. Budget Period:
It is the period for which a budget is prepared. It depends
upon a number of factors. It may be different for different concerns/functions.
The following are the factors that may be taken into consideration while
determining budget period:
a. The type of budget,
b. The nature of demand for the products,
c. The availability of finance,
d. The economic situation of the cycle and
e. The length of trade cycle
8. Determination of Key Factor:
Generally, the budgets are prepared for all functional
areas of the business. They are inter related and inter dependent. Therefore, a
proper coordination is necessary. There may be many factors that influence the
preparation of a budget. For example, plant capacity, demand position,
availability of raw materials, etc. Some factors may have an impact on other
budgets also. A factor which influences all other budgets is known as Key
factor. The key factor may not remain the same. Therefore, the organization
must pay due attention on the key factor in the preparation and execution of
budgets.
Types of Budgeting:
Budget can be classified into three categories from
different points of view. They are:
1. According to Function
2. According to Flexibility
(a) Sales Budget:
The budget which estimates total sales in terms of items,
quantity, value, periods, areas, etc is called Sales Budget.
(b) Production Budget:
It estimates quantity of production in terms of items,
periods, areas, etc. It is prepared on the basis of Sales Budget.
(c) Cost of Production Budget:
This budget forecasts the cost of production. Separate
budgets may also be prepared for each element of costs such as direct materials
budgets, direct labour budget, factory materials budgets, office overheads
budget, selling and distribution overheads budget, etc.
(d) Purchase Budget:
This budget forecasts the quantity and value of purchase
required for production. It gives quantity wise, money wise and period wise
particulars about the materials to be purchased.
(e) Personnel Budget:
The budget that anticipates the quantity of personnel
required during a period for production activity is known as Personnel Budget.
(f) Research Budget:
The budget relates to the research work to be done for
improvement in quality of the products or research for new products.
(g) Capital Expenditure Budget:
The budget provides a guidance regarding the amount of
capital that may be required for procurement of capital assets during the
budget period.
(h) Cash Budget:
This budget is a forecast of the cash position by time
period for a specific duration of time. It states the estimated amount of cash
receipts and estimation of cash payments and the likely balance of cash in hand
at the end of different periods.
(i) Master Budget:
It is a summary budget incorporating all functional budgets.
It also includes the preparation of a Projected Income Statement and a Projected Balance Sheet. Sometimes control
ratios like projected Net Profi ratio, Earnings Per Share, Return on Investment
II. According to Flexibility:
On the basis of flexibility, budgets can be divided into
two categories:
1. Fixed Budget
2. Flexible Budget
1. Fixed Budget:
Fixed Budget is one which is prepared on the basis of a
standard or a fixed level of activity. It does not change with the change in
the level of activity.
2. Flexible Budget:
A budget prepared to give the budgeted cost of any level of
activity is termed as a flexible budget. According to CIMA, London
PREPARATION OF BUDGETS:
I. SALES BUDGET:
Sales budget is the basis for the preparation of all other
budgets. It is the forecast of sales to be achieved in a budget period. The
sales manager is directly responsible for the preparation of this budget. Sales
budget is prepared after considering a number of factors such as past sales
figures and trend, Market demand, . Nature of competition, Plant capacity, Seasonal
fluctuations etc.
II. PRODUCTION BUDGET:
Production = Sales + Closing Stock – Opening Stock
Example:
3. The sales of a concern for the next year are estimated
at 50,000 units. Each unit of the product requires 2 units of Material ‘A’ and
3 units of Material ‘B’. The estimated opening balances at the commencement of
the next year are:
Finished Product : 10,000 units
Raw Material ‘A’ : 12,000 units
Raw Material ‘B’ : 15,000 units
The desirable closing balances at the end of the next year
are:
Finished Product : 14,000 units
Raw Material ‘A’ : 13,000 units
Raw Material ‘B’ : 16,000 units
Prepare the materials purchase budget for the next year.
Answer:
Production Budget
Estimated Sales 50,000 units
Add: Estimated Closing Finished Goods 14,000 ,,
64,000 ,,
Less: Estimated Opening Finished Goods 10,000 ,,
Production 54,000
Materials Purchase Budget
Material ‘A’ Material ‘B’
Material Consumption 1,08,000
units 1,62,000 units
Add: Closing stock of materials 13,000 ,, 16,000 ,,
1,21,000 ,, 1,78,000
,,
Less: Opening stock of materials 12,000 ,, 15,000 ,,
Materials to be purchased 1,09,000
,, 1,63,000 ,,
Workings:
Materials consumption: Material ‘A’ Material ‘B’
Material required per unit of production 2 units 3 units
For production of 54,000 units 1,08,000 1,62,000
III. CASH BUDGET:
It is an estimate of cash receipts and disbursements during
a specified future period of time. “The Cash Budget is an analysis of flow of
cash in a business over a future, short or long period of time. It is a
forecast of expected cash intake and outlay” (Soleman, Ezra – Handbook of
Business administration).
Procedure for preparation of Cash Budget:
1. First take into account the opening cash balance, if
any, for the beginning of the period for which the cash budget is to be
prepared.
2. Then Cash receipts from various sources are estimated.
It may be from cash sales, cash collections from debtors/bills receivables,
dividends, interest on investments, sale of assets, etc.
3. The Cash payments for various disbursements are also
estimated. It may be for cash purchases, payment to creditors/bills payables,
payment to revenue and capital expenditure, creditors for expenses, etc.
4. The estimated cash receipts are added to the opening
cash balance, if any.
5. The estimated cash payments are deducted from the above
proceeds.
6. The balance, if any, is the closing cash balance of the
month concerned.
7. The closing cash balance is taken as the opening cash
balance of the following month.
8. Then the process is repeatedly performed.
9. If the closing balance of any month is negative i.e the
estimated cash payments exceed estimated cash receipts, then overdraft facility
may also be arranged suitably.
FIXED AND FLEXIBLE BUDGETS:
Fixed Budget
A Fixed Budget is defined as a
budget which is designed to remain constant at all levels of activities. The
level of activity is anticipated first,
and only a single budget is
prepared at this level. Actual performance is measured and compared with the
budget.
Flexible Budget
A Flexible Budget is defined as, ‘a budget designed to change
in accordance with level of activity attained’, CIMA, London
Under flexible budgeting a series of budgets are prepared
at different levels of activities. Therefore, it facilitates meaningful
comparison of actual performance with appropriate budget figures.
It is prepared according to marginal costing principles:
1. Cost can be classified into fixed and variable cost. Semi-variable
cost is to be segregated fixed and variable elements.
2. Total fixed cost remains constant at all levels of activities.
3. Total Variable cost varies in the same proportion withy the level of activity actually achieved.
It is based on the
following equation:
Total Cost = Fixed Cost + (output x Varaible Cost per unit)
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