10 BUDGET AND BUDGETARY CONTROL CONTENTS 10.0 Aims and Objectives 10.1 Introduction 10.2 Functions of a Budget 10.3 Essentials of Effective Budgeting 10.3.1 Research and Analysis 10.3.2
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BUDGET AND BUDGETARY CONTROL
CONTENTS
10.0 Aims and Objectives
10.1 Introduction
10.2 Functions of a Budget
10.3 Essentials of Effective Budgeting
10.3.1 Research and Analysis
10.3.2 Sound Organisational Structure
10.3.3 Comparison with the Actual
10.3.4 Length of the Budget Period
10.3.5 The Budget Preparation
10.4 Budgetary Controls
10.4.1 Budgetary Control and Responsibility Centres 10.4.2 Advantages of Budgeting and Budgetary Control 10.5 Problems in Budgeting
10.6 Characteristics of a Budget
10.7 Budget Organisation and Administration
10.7.1 Budget Centres
10.7.2 Budget Committee
10.7.3 Budget Officer
10.7.4 Budget Manual
10.8 The Budgetary Process
10.9 Types of Budget
10.9.1 Master Budget
10.9.2 Functional Budgets
10.10 Let us Sum up
10.11 Lesson End Activity
10.12 Keywords
10.13 Questions for Discussion
10.14 Suggested Readings
10.0 AIMS AND OBJECTIVES
After studying this lesson, you will be able to:
Understand meaning and functions of budget
Describe the concept of budgetary control
Discuss budgeting process
Explain various types of budget
Trang 3We are quite familiar with the word 'budget' in relation to economic policies of a national government Moreover, whenever we plan any activity, we generally make a 'budget' Similar is the case with any business activity A budget is a plan expressed in monetary terms covering a future time period Budgets are an important tool for management planning and control and are an integral part of a well-run business Budgets are based
on a defined level of activity They are normally produced for a year which is divided into months/quarters, and are generally expressed either on the basis of expected sales revenue or capacity as the case may be
Budgets may be recast anytime during a year, e.g., quarterly or six-monthly, usually to accommodate any changes/adjustments anticipated during a year At times confused with forecast, there is a distinction between the two A forecast usually refers to a prediction of economic activity based on data/information available, whereas a revised or budgetary update refers to revision of planned economic activity vis-à-vis resources available, typically covering a 12-month period Budget should not be confused with business targets, which are typically solely focused on achieving certain levels of activity, e.g., sales–budgets are primarily projection covering a gamut of activities linked to availability of external factors and internal inputs such as men, materials, machinery and money
10.2 FUNCTIONS OF A BUDGET
Helps in allocation of resources for the implementation of the strategy
Act as a tool to evaluate managerial performance
Acts as a means to control activities
Co-ordinate activities between different parts of the organisation
10.3 ESSENTIALS OF EFFECTIVE BUDGETING
10.3.1 Research and Analysis
Budgets should be prepared keeping in view organisational goals Thorough research and analysis should be done of the various aspects related to growth and profitability of the organisation before forming budgets Properly conducted research helps in setting realistic goals for the budget which are in co-ordination with the overall organisational objectives
10.3.2 Sound Organisational Structure
Well established authority–responsibility relationship at all levels for all phases of operation
is important to build up a sound organisational structure Since a budget will be effective only if it is unanimously approved at all the levels of the organization, many organisations believe in a budget settlement process as a pre-requisite for getting overall approval/ acceptability Thus, while targets may be fixed arbitrarily, sound budgetary practices involve overall organisational consensus/commitment as a pre-requisite for successful implementation
10.3.3 Comparison with the Actual
For the success of the budget it is important to systematically and periodically review the actual and expected results for any variations Reasons for the variations should be
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studied and analysised In this way budget become an important tool for evaluating
performance Care should be taken that responsibility should be held only for variations
which are controllable
10.3.4 Length of the Budget Period
Factors influencing the length of the budget period are: the nature of the organisation,
business conditions currently prevailing, the need for periodic appraisal etc A budget
may be prepared for any period of time depending upon the requirement While setting
budget period, due consideration should be given to minimise the impact of seasonal or
cyclical fluctuations For example, cash budget is prepared monthly, whereas budget to
buy a machinery worth Rs 10 crores may cover a six to eight year period In case of a
long budget period it is difficult to determine reliable estimates, in view of various
imponderables that will inevitably be encountered along the way For example, if global
prices of oil shoot up by over 100%, entire national budgets/BOP positions will need
recasting, what to speak of individual organisational budgets
10.3.5 The Budget Preparation
The preparation of the budget is a lengthy process It begins with the collection of data
several months before the end of the current year from within the organisation covering
its various units Even the data related to the previous year's performance can be taken
as a base for formulating future budgetary goals Other factors to be kept in mind are
sales forecast, (the input of sales personnel and top management support are essential to
the sales forecast), market research studies, changes in prices, general economic
conditions, industry trends, technological developments etc
In larger companies, budget committee is set up which is responsible for coordinating the
preparation of the budget The budget committee includes management personnel looking
after operation of major areas of, the company, such as sales, production, and research
In small companies, the budgeting process is often informal
10.4 BUDGETARY CONTROLS
A control technique whereby actual results are compared with budgets
Any differences (variances) are made the responsibility of key individuals who can
either exercise control action or revise the original budgets
10.4.1 Budgetary Control and Responsibility Centres
These enable managers to monitor organisational functions
A responsibility centre can be defined as any functional unit headed by a manager who
is responsible for the activities of that unit
There are four types of responsibility centres:
a) Revenue centres: Organisational units in which outputs are measured in monetary
terms but are not directly compared to input costs
b) Expense centres: Units where inputs are measured in monetary terms but outputs
are not
c) Profit centres: Where performance is measured by the difference between
revenues (outputs) and expenditure (inputs) Inter-departmental sales are often
made using "transfer prices"
Trang 510.4.2 Advantages of Budgeting and Budgetary Control
There are a number of advantages to budgeting and budgetary control:
Compels management to think about the future, which is probably the most important feature of a budgetary planning and control system Forces management to look ahead, to set out detailed plans for achieving the targets for each department, operation and (ideally) each manager, to anticipate and give the organisation purpose and direction
Promotes coordination and communication
Clearly defines areas of responsibility Requires managers of budget centres to be made responsible for the achievement of budget targets for the operations under their personal control
Provides a basis for performance appraisal (variance analysis) A budget is basically
a yardstick against which actual performance is measured and assessed Control
is provided by comparisons of actual results against budget plan Departures from budget can then be investigated and the reasons for the differences can be divided into controllable and non-controllable factors
Enables remedial action to be taken as variances emerge
Motivates employees by participating in the setting of budgets
Improves the allocation of scarce resources
Economises management time by using the management by exception principle
10.5 PROBLEMS IN BUDGETING
Whilst budgets may be an essential part of any marketing activity they do have a number
of disadvantages, particularly in perception terms
Budgets can be seen as pressure devices imposed by management, thus resulting in:
a) bad labour relations b) inaccurate record-keeping
Departmental conflict arises due to:
a) disputes over resource allocation b) departments blaming each other if targets are not attained
It is difficult to reconcile personal/individual and corporate goals
Waste may arise as managers adopt the view, "we had better spend it or we will lose it" This is often coupled with "empire building" in order to enhance the prestige
of a department
Responsibility versus controlling, i.e some costs are under the influence of more than one person, e.g power costs
Managers may overestimate costs so that they will not be blamed in the future should they overspend
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10.6 CHARACTERISTICS OF A BUDGET
A good budget is characterised by the following:
Participation: involve as many people as possible in drawing up a budget.
Comprehensiveness: embrace the whole organisation.
Standards: base it on established standards of performance.
Flexibility: allow for changing circumstances.
Feedback: constantly monitor performance.
Analysis of costs and revenues: this can be done on the basis of product lines,
departments or cost centres
10.7 BUDGET ORGANISATION AND ADMINISTRATION
In organising and administering a budget system the following characteristics may apply:
10.7.1 Budget Centres
Units responsible for the preparation of budgets A budget centre may encompass several
cost centres
10.7.2 Budget Committee
This may consist of senior members of the organisation, e.g departmental heads and
executives (with the managing director as chairman) Every part of the organisation
should be represented on the committee, so there should be a representative from sales,
production, marketing and so on Functions of the budget committee include:
Coordination of the preparation of budgets, including the issue of a manual
Issuing of timetables for preparation of budgets
Provision of information to assist budget preparations
Comparison of actual results with budget and investigation of variances
10.7.3 Budget Officer
Controls the budget administration The job involves:
liaising between the budget committee and managers responsible for budget
preparation
dealing with budgetary control problems
ensuring that deadlines are met
educating people about budgetary control
10.7.4 Budget Manual
This document:
charts the organisation
details the budget procedures
contains account codes for items of expenditure and revenue
Trang 710.8 THE BUDGETARY PROCESS
Budgets are based on standard costs for a defined level of sales demand or production activity for a defined period Generally, the budgeting process is as under:
1 To identify business objectives and budget goals
2 To forecast general business environment including economic and industry environment and the state of competition
3 To develop detailed sales budgets by market sectors, geographic territories, major customers and product groups
4 To prepare production budgets in respect of materials, labour and overhead by responsibility centre managers so that goods or services can be produced accordingly
so as to satisfy the demand as per the sales forecast
5 Preparation of non-production budgets by cost centres
6 To prepare capital expenditure budgets
7 To identify financing requirements by preparing cash forecasts
8 To prepare master budget (profit and loss, balance sheet and cash flow/funds flow)
9 To get approval of the board in respect of profitability and financing targets
It is important to carry out a thorough investigation of current performance while preparing budget Besides this there are various factors which make the process of preparing budget complex Some of them are as follows:
complete knowledge of past performance, i.e., a statistical and narratory database
thorough knowledge and understanding of seasonal factors, market trends, competition etc in respect of the industry/business
understanding the costs drivers
whether or not the business is a price leader
whether expenses are controllable or not
It is imperative that a budget have subjective judgments of likely future events, customer demand and also assumptions about product/service mix, average prices, cost inflation etc Once the budget is approved in toto, the budget needs to be allocated, i.e., spread over each month This process of spreading the budget over a period of time is known as 'profiling' Profiling is either based on the number of working days, seasonal fluctuation
or any other basis It helps in accurate estimation of the time period about the incurrence
of the costs and the earning of the revenue as enshrined in the budgetary data
The Budgetary Control Process
The use of a budget to control a firm's activities is known as budgetary control The steps in budgetary control are as under:
The establishment of budgets for each department
Continuous monitoring of actual performance with the budgeted figures and fixing responsibilities
Assessment / revision / corrective action in the light of changed circumstances or deviation in actual performance
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10.9 TYPES OF BUDGET
Budget may be classified as follows:
10.9.1 Master Budget
A master budget is the summary budget for the entire enterprise and embodies the
summarised figures for various activities It is the consolidation of all functional budgets
A functional budget is a budget which relates to any of the functions of an undertaking,
e.g., production, sales, finance, etc
10.9.2 Functional Budgets
Principal functional budgets may be stated thus:
(a) Sales budget: The sales budget is a forecast of total sales expressed in terms of
money and quantity In practise, a quantitative budget is prepared first, then it is
translated into monetary terms
(b) Production budget: It is a forecast of the production for the budget period It may
be expressed in units or standard hours A standard hour is the quantity of output or
amount of work which should be performed in one hour While preparing the
production budget, the production executive will take into account the physical
facilities like plant, power, factory space, material, labour available for the period
(c) Materials budget: It shows the details of raw materials to be consumed It is
expressed in terms of physical quantities and values of materials to be issued from
the stores for production purpose This budget provides that right materials of right
quantity and quality are procured
(d) Labour budget: It shows the details of labour requirements in quantity, with
estimated costs This budget gives detailed information relating to the number of
employees, rates of wages and cost of labour hours to be employed
(e) Manufacturing overhead budget: It shows the estimated costs of indirect materials,
indirect labour and indirect manufacturing expenses during the budget period to
achieve the predetermined targets
(f) Administration cost budget: This comprises of salaries and expenses of
administrative office and management for a specified period It is prepared with
the help of past experience and expected changes in future
(g) Selling expenses budget: All expenses concerned with sale of products to
customers are included in this budget It is generally prepared territory-wise by the
sales manager of each territory, on the basis of past records
(h) Research and development budget: This budget lists all the research and
development activities together with their likely costs
(i) Capital expenditure budget: This budget shows the estimated expenditure on
fixed assets like plant, land, machinery, building etc It is a long-term budget The
capital is necessitated on account of demand for products, expansion of industry,
adoption of new technology, replacement of old machines, etc
(j) Cash budget: It is prepared after all the functional budgets are prepared by the
chief accountant either on a monthly or weekly basis It shows the sum total of the
requirements of cash in respect of various functional budgets and of estimated
cash receipts for a stipulated period
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2 What do you understand by ‘Master Budget’?
10.10 LET US SUM UP
Budgets are useful in planning and control because they enhance co-ordination and communication It is an important tool for the purpose of the controlling because they provide a standard for evaluating performance As such they play a key role in evaluating individual as well as organisational performance, enabling timely corrective action/ counselling as the case may be
Master budget is a comprehensive planning document and usually includes budgets for sales, production, direct material and labour, manufacturing overhead, selling and administrative overhead, capital acquisition, cash receipts and disbursement, a budgeted income statement and a balance sheet
Static budget is not very useful for the purpose of comparison because if the actual level
of production is different from the budgeted one, a comparison is not possible
Flexible budgets are frequently used because they present amounts adjusted to the actual level of production
Budgets are useful for the purpose of controlling, ensuring that managers can be held responsible for any deviation from the planned activity Care should be taken that the managers should be held responsible only for those deviations which are due to controllable factors
10.11 LESSON END ACTIVITY
“Budgeting is an instrument of planning as well as a tool of managerial control.” Do you agree with the statement? Give reason for your answer
10.12 KEYWORDS
Budget: A financial statement prepared for specified activity for future periods Budgeting: Activity of preparing the budget is known as budgeting
Budgetary Control: Quantitative controlling technique to asses the performance of the
organisation
10.13 QUESTIONS FOR DISCUSSION
1 Describe the meaning and functions of budget
2 Discuss the role of budgetary control as a cost control tool
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3 What are the steps involved in budgeting process?
4 Discuss the essentials of effective budgeting
Check Your Progress: Model Answers
1 Budget: A budget is a statement of planned allocation of resources expressed
in financial or numerical terms
Budgetary Control: It is a control technique whereby actual results are
compared with budgets
2 Master Budget: The master budget is a set of interrelated budgets that
constitutes a plan of action for a specified time period It contains two classes
of budget, i.e., operating budget and financial budget
10.14 SUGGESTED READINGS
M.P Pandikumar, Management Accounting, Excel Books.
M N Arora, "Cost and Management Accounting", 8th Edition, Vikas Publishing House (P) Ltd.
Hilton, Maher and Selto, "Cost Management", 2nd Edition, Tata McGraw-Hill Publishing Company
Ltd
B.M Lall Nigam and I.C Jain, "Cost Accounting", Prentice-Hall of India (P) Ltd.