[Budget and Budgetary Control Notes, Management Accounting Notes, Notes For B.Com, BBA and MBA Students, Responsibility Account, Types of Budget]
Meaning and Definition of Budget, Budgeting and Budgetary Control:
Budget: A budget is the monetary and / or
quantitative expression of business plans and policies to be pursued in the
future period of time. Budgeting is preparing budgets and other procedures for
planning, coordination and control or business enterprises.
I.C.M.A.
defines a budget as “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 attaining a given objective”.
Budgeting refers to the process of preparing the
budgets. It involves a detailed study of business environment clearly grasping
the management objectives, the available resources of the enterprise and
capacity of the enterprise.
Budgeting
is defined by J.Batty as under: “The entire process of preparing the budgets is
known as budgeting”.
Thus
budgeting is a process of making the budget plans. Preparation of budgets or
budgeting is a planning function and their implementation is a control
function. ‘Budgetary control’ starts with budgeting and ends with control.
Budgetary control is the process of preparation of
budgets for various activities and comparing the budgeted figures for arriving
at deviations if any, which are to be eliminated in future. Thus budget is a
means and budgetary control is the end result. Budgetary control is a
continuous process which helps in planning and coordination. It also provides a
method of control.
According
to Brown and Howard “Budgetary control is a system of coordinating costs which
includes the preparation of budgets, coordinating the work of departments and
establishing responsibilities, comparing the actual performance with the
budgeted and acting upon results to achieve maximum profitability”.
Wheldon
characterizes budgetary control as planning in advance of the various functions
of a business so that the business as a whole is controlled.
I.C.M.A.
define budgetary control as “the establishment of budgets, relating the
responsibilities of executives to the requirements of a policy, and the
continuous comparison of actual with budgeted results either to secure by
individual actions the objectives of that policy or to provide a basis for its
revision”.
Characteristics / Features of Budgetary Control:
A budgetary control system can be defined as 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 base for its
revision.
The salient features of such a system are the following:
(a) Objectives:
Determining the objectives to be achieved, over the budget period, and the
policy or policies that might be adopted for the achievement of these ends.
(b) Activities:
Determining the variety of activities that should be undertaken for the
achievement of the objectives.
(c) Plans:
Drawing up a plan or a scheme of operation in respect of each class of activity
in physical as well as monetary terms for the full budget period and its part.
(d) Performance
evaluation: Laying out a system of comparison of actual performance by each
person, section or department with the relevant budget arid determination of
causes for the discrepancies, if any.
(e) Control
Action: Ensuring that corrective action will be taken where the plan is not
being achieved and, if that is not
possible, for the revision of the plan.
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Objectives and Importance of Budgetary Control System:
Budgets are very important for management. The need and objectives of a budgetary control system are listed below:
a)
Planning: A budget provides a
detailed plan of action for a business over definite period of time. Detailed
plans relating to production, sales, raw material requirements, labour needs,
advertising and sales promotion performance, research and development
activities, capital additions etc., are drawn up. By planning many problems are
anticipated long before they arise and solutions can be sought through careful
study. Thus most business emergencies can be avoided by planning. In brief,
budgeting forces the management to think ahead, to anticipate and prepare for the
anticipated conditions.
b)
Co-ordination: Budgeting aids
managers in co-coordinating their efforts so that objectives of the
organisation as a whole harmonise with the objectives of its divisions.
Effective planning and organisation contributes a lot in achieving
coordination. There should be coordination in the budgets of various
departments. For example, the budget of sales should be in coordination with
the budget of production. Similarly, production budget should be prepared in
co-ordination with the purchase budget, and so on.
c)
Communication: A budget is a
communication device. The approved budget copies are distributed to all
management personnel who provide not only adequate understanding and knowledge
of the programmes and policies to be followed but also gives knowledge about
the restrictions to be adhered to. It is not the budget itself that facilitates
communication, but the vital information is communicated in the act of
preparing budgets and participation of all responsible individuals in this act.
d)
Motivation: A budget is a useful
device for motivating managers to perform in line with the company objectives.
If individuals have actively participated in the preparation of budgets, it act
as a strong motivating force to achieve the targets.
e)
Control: Control is necessary to
ensure that plans and objectives as laid down in the budgets are being
achieved. Control, as applied to budgeting, is a systematized effort to keep
the management informed of whether planned performance is being achieved or
not. For this purpose, a comparison is made between plans and actual
performance. The difference between the two is reported to the management for
taking corrective action.
f)
Performance Evaluation: A budget
provides a useful means of informing managers how well they are performing in
meeting targets they have previously helped to set. In many companies, there is
a practice of rewarding employees on the basis of their achieving the budget
targets or promotion of a manager may be linked to his budget achievement record.
Advantages and Limitations of Budgetary Control:
Advantages of Budgetary Control System:
A budget is a blue print of a plan expressed
in quantitative terms. Budgeting is technique for formulating budgets. Budgetary Control, on the
other hand, refers to the principles,
procedures and practices of achieving given objectives through budgets. Here are
the some Advantages of Budgetary Control:
a)
Maximization
of Profit: The budgetary control aims at the maximization of profits of the enterprise. To achieve this aim, a proper planning and
co-ordination of different functions is undertaken. There is proper control
over various capital and revenue expenditures. The resources are put to the
best possible use.
b)
Efficiency: It enables the
management to conduct its business activities in an efficient manner. Effective
utilization of scarce resources, i.e. men, material, machinery, methods and
money - is made possible.
c)
Specific
Aims: The plans, policies and goals are decided by the top management.
All efforts are put together to reach the common goal of the organization.
Every department is given a target to be achieved. The efforts are directed towards achieving come specific aims. If there is no
definite aim then the efforts will be wasted in pursuing different aims.
d)
Performance evaluation: It provides
a yardstick for measuring and evaluating the performance of individuals and
their departments.
e)
Economy: The planning of expenditure will be systematic and there will be
economy in spending. The finances will be put to optimum use. The benefits
derived for the concern will ultimately extend to industry and then to national
economy. The national resources will be used economically and wastage will be
eliminated.
f)
Standard Costing and Variance analysis:
It creates suitable conditions for the implementation of standard costing system
in a business organization. It reveals the deviations to management from the
budgeted figures after making a comparison with actual figures.
g)
Corrective
Action: The management will be able to take corrective measures whenever
there is a discrepancy in performance. The deviations will be regularly
reported so that necessary action is taken at the earliest. In the absence of a
budgetary control system the deviation can determined only at the end of the
financial period.
h)
Consciousness: It creates budget consciousness among the employees. By fixing
targets for the employees, they are made conscious of their responsibility.
Everybody knows what he is expected to do and he continues with his work
uninterrupted.
i)
Reduces
Costs: In the present day competitive world budgetary control has a
significant role to play. Every businessman tries to reduce the cost of
production for increasing sales. He tries to have those combinations of
products where profitability is more.
j)
Policy formulation: It helps in the
review of current trends and framing of future policies.
Problems and Limitations of Budgetary Control System:
The list of advantages given above is impressive, but a budget is not a
cure all for organisational ills. Budgetary control system suffers from certain
limitations and those using the system should be fully aware of them.
a)
The budget plan is based on estimates:
Budgets are based on forecasting cannot be an exact science. Absolute accuracy,
therefore, is not possible in forecasting and budgeting. The strength or
weakness of the budgetary control system depends to a large extent, on the
accuracy with which estimates are made. Thus, while using the system, the fact
that budget is based on estimates must be kept in view.
b)
Danger of rigidity: Budgets are
considered as rigid document. Too much emphasis on budgets may affect
day-to-day operations and ignores the dynamic state of organization
functioning.
c)
Budgeting is only a tool of management:
Budgeting cannot take the place of management but is only a tool of management.
‘The budget should be regarded not as a master, but as a servant.’ Sometimes it
is believed that introduction of a budget programme alone is sufficient to
ensure its success. Execution of a budget will not occur automatically. It is
necessary that the entire organisation must participate enthusiastically in the
programme for the realisation of the budgetary goals.
d)
False Sense of Security: Mere
budgeting cannot lead to profitability. Budgets cannot be executed
automatically. It may create a false sense of security that everything has been
taken care of in the budgets.
e)
Lack of coordination: Staff
co-operation is usually not available during budgetary control exercise.
f)
Expensive Technique: The
installation and operation of a budgetary control system is a costly affair as
it requires the employment of specialized staff and involves other expenditure
which small concerns may find difficult to incur. However, it is essential that
the cost of introducing and operating a budgetary control system should not
exceed the benefits derived there from.
Essentials of Effective Budgeting:
A budgetary control system can prove successful only when certain
conditions and attitudes exist, absence of which will negate to a large extent
the value of a budget system in any business. Such conditions and attitudes
which are essential for an effective budgetary control system are as follows:
a)
Support of Top Management: If the
budget system is to be successful, it must be fully supported by every member
of the management and the impetus and direction must come from the very top
management. No control system can be effective unless the organisation is
convinced that the top management considers the system to be import.
b)
Participation by Responsible Executives:
Those entrusted with the performance of the budgets should participate in the
process of setting the budget figures. This will ensure proper implementation
of budget programmes.
c)
Reasonable Goals: The budget figures
should be realistic and represent reasonably attainable goals. The responsible
executives should agree that the budget goals are reasonable and attainable.
d)
Clearly Defined Organisation: In
order to derive maximum benefits from the budget system, well defined
responsibility centers should be built up within the organisation. The
controllable costs for each responsibility centres should be separately shown.
e)
Continuous Budget Education: The
best way to ensure the active interest of the responsible supervisors is
continuous budget education in respect of objectives, potentials &
techniques of budgeting. This may be accomplished through written manuals,
meetings etc., whereby preparation of budgets, actual results achieved etc.,
may be discussed.
f)
Adequate Accounting System: There is
close relationship between budgeting and accounting. For the preparation of
budgets, one has to depend on the accounting department for reliable historical
data which primarily forms the basis for many estimates. The accounting system
should be so designed so as to set up accounts in terms of areas of managerial
responsibility. In other words, responsibility accounting is essential for
successful budgetary control.
g)
Constant Vigilance: Reports
comparing budget and actual results should be promptly prepared and special
attention focused on significant exceptions i.e. figures that are significantly
different from those expected.
h)
Maximum Profit: The ultimate object
of realizing the maximum profit should always be kept uppermost.
i)
Cost of the System: The budget
system should not cost more than it is worth. Since it is not practicable to
calculate exactly what a budget system is worth, it only implies a caution
against adding expensive refinements unless their value clearly justifies them.
j)
Integration with Standard Costing System:
Where standard costing system is also used, it should be completely integrated
with the budget programme, in respect of both budget preparation and variance
analysis.
Essentials Factors and Elements for the Success of Budgetary Control
There
are certain steps which are necessary for the successful implementation of a
budgetary control system. They are as follows:
1.
Organization
for Budgetary Control: The proper organization is essential for the
successful preparation, maintenance and administration of budgets. A budgetary
committee is formed which comprises the departmental heads of various
departments. All the functional heads of various departments are entrusted with
the responsibility of ensuring proper implementation of their respective
departmental budgets. This has been shown in the following chart.
2.
Budget
Centres: A budget centre is that part of the organization for which the
budget is prepared. A budget centre may be a department, section of a
department or any other part of the department. The establishment of budget
centres is essential for covering all parts of the organization. The budget
centres are also necessary for cost control purposes. The appraisal of
performance of different parts of the organization becomes easy when different
centres are established.
3.
Budget
Manual: A budget manual is a document which tells out the duties and also
responsibilities of various executives concerns with the budgets. It specifies
the relation among various functionaries. A budget manual covers the following:
1)
A budget manual clearly defines the objectives
of budgetary control system. It also gives the benefits and principles of this
system.
2)
The duties and responsibilities of various
persons dealing with preparation and execution of budgets are also given in a
budget manual. It enables the management to know of persons dealing with
various aspects of budgets and clarify their duties and responsibilities.
3)
It gives information about the sanctioning authorities
of various budgets. The financial powers of different managers are given in the
manual for enabling the spending of amount on various expenses.
4)
A proper table for budgets including the
sending of performance reports is drawn so that every work starts in time and a
systematic control is exercised.
5)
The specimen forms and number of copies to be
used for preparing budget reports will also be stated. Budget centres involved
should be clearly stated.
6)
The length of various budget periods and
control points be clearly given.
7)
The procedure to be followed in the entire
system should be clearly stated.
8)
A method of accounting to be used for various
expenditures should also be stated in the manual.
4.
Budget
Officers: The chief executive who is at the top of the organization appoints
some person as budget officer. The budget officer is empowered to scrutinize
the budgets prepared by different functional heads and to make changes in them,
if the situation so demands. The actual performance of department is
communicated to the budget officer. He determines the deviation in the budgets
and takes necessary steps to rectify the deficiencies.
5.
Budget
Committee: In small scale concerns, the accountant is made responsible for
preparation and implementation of budgets. In large scale concerns a committee
known as budget committee is formed. The heads of all departments are made
members of this committee. The committee is responsible for preparation and
execution of budgets. The members of this committee put up the case of their
respective departments and help the committee to take collective discussions.
The budget office acts as coordinator of this committee.
6.
Budget
Period: A budget period is the length of time for which a budget is
prepared. The budget period depends upon a number of factors. It may be
different for different industries or even it may be different in the same
industry or business.
7.
Determination
of Key Factors: The budgets are prepared for all functional areas. These budgets
are inter-departmental and inter-related. A proper coordination amount
different budget is necessary for making the budgetary control a success. The
constraints on some budgets may have an effect on other budgets too. A factor
which influences all other budgets is known as Key Factor or Principal Factor.
There may be a limitation on the quality of goods a concern may sell. In this
case, sales will be a key factor and all other budgets will be prepared by
keeping in view the amount of goods the concern will be able to sell. The raw
material supply may be limited; so production, sales and cash budgets will be
decided according to raw materials budget. Similarly, plant capacity may be key
factor if the supply of other factor is easily available.
Zero Based Budgeting
ZBB is defined as ‘a method of budgeting which requires each cost element
to be specifically justified, as though the activities to which the budget
relates were being undertaken for the first time. Without approval, the budget
allowance is zero’.
Zero – base budgeting is so called because it requires each budget to be
prepared and justified from zero, instead of simple using last year’s budget as
a base. In Zero Based budgeting no reference is made to previous level
expenditure. Zero based budgeting is completely indifferent to whether total
budget is increasing or decreasing.
‘Zero base budgeting’ was originally developed by Peter A. Pyher at Texas
Instruments. Peter A. Pyher has defined ZBB as “an operating, planning and
budgeting process which requires each manager to justify his entire budget
request in detail from scratch (hence zero base) and shifts the burden of proof
to each manager to justify why we should spend any money at all”.
CIMA has defined it “as a method of budgeting whereby all activities are
revaluated each time a budget is set."
Zero Base Budgeting Advantages and Disadvantages
Zero Base Budgeting has the folowing advantages:
a) Zero base budgeting examines all existing and new programmes and activities.
It also makes the managers analyse
their functions, establish priorities and rank them. This exercise helps in identifying inefficient or obsolete
functions within the area of responsibility. In this
way resources are allocated from low priority programmes to high priority programmes.
b)
This system facilitates
identification of duplication of efforts among organisational units. Such inefficient activities are eliminated and some other
activities are merged.
c)
All expenditures, under this
system are critically reviewed and justified and all operations activities are evaluated in greater detail in terms of
their cost- effectiveness and
cost-benefits. This requires managers to find alternative ways of performing their activities which may result in more efficient
procedures.
d)
ZBB promotes the tendency to
initiate studies and improvements during the period of operation as the persons
at the helm of affairs know that the process would be exercised next year and their knowledge and training
would enhance efficiency and
cost-effectiveness.
e)
ZBB provides for quick budget
adjustments during the year. If revenue falls short in this process, it offers the capability to quickly and
rationally modify goals and expectations to correspond to a
realistic and affordable plan of operations.
f)
ZBB ensures greater
participation of personnel in formulation and ranking processes. This helps in promoting level of job satisfaction and
thus resulting in better control and operational
efficiency in the organisation.
g)
Zero base budgeting is a
flexible tool that can be applied on a selective basis. It does not have to be applied throughout the entire organisation or
even in all the service departments. Keeping in
view the limitations of time, money and persons available to install, operate and monitor it the management thus
can select priority areas to which zero base
budgeting may be applied.
Zero Base Budgeting has the following disadvantages / Limitations:
a)
It challenges the past
practices, performance, attitudes, of people.
b)
It requires more time and
effort.
c)
Detailed costs and necessary
information for decision packages often are not made available.
d)
It increases paper work to
unmanageable proportions.
e)
Ranking a large number of
decision packages becomes an unwieldy process.
f) Identifying various levels of funding, particularly the minimum
level is a difficult task.
Steps in Zero-Base Budgeting
a)
Determination
of Objectives: The first step in ZBB is the clear definition of the
objectives of budgeting. The objective may be to reduce expenditure on staff,
to discontinue an activity or project in preference to another etc.
b)
Determination
of the Extent of Application: Whether ZBB should be introduced in all
operational areas or only in some selected areas is to be decided.
c)
Identification
of Decision Units: Decision unit refers to a department, a project or a
product line to which ZBB is to be applied. Identification of such units is
done in consultation with managers.
d)
Cost-Benefit
Analysis: Cost benefit analysis is undertaken for each activity of the
decision unit. It provides answers to the following questions.
1.
Is it necessary to perform the activity at all?
If the answer is in the negative, there is no need for proceeding further.
2.
How much is the actual cost and what is the
actual benefit of the activity?
3.
What is the estimated cost and estimated benefit
of the activity?
4.
If the unit is dropped, can the unit be replaced
by outside agency?
e)
Preparation
of budgets: The activities and projects for which benefit is more than the
cost are ranked. Priority is accorded to the most
profitable projects/activities, in the allocation of funds.
Cash Budget
A cash budget is a budget or plan of expected cash receipts and
disbursements during the period. These cash inflows and outflows include
revenues collected, expenses paid, and loans receipts and payments. In other
words, a cash budget is an estimated projection of the company's cash position
in the future.
Management usually develops the cash budget after the sales, purchases,
and capital expenditures budgets are already made. These budgets need to be
made before the cash budget in order to accurately estimate how cash will be
affected during the period. For example, management needs to know a sales
estimate before it can predict how much cash will be collected during the
period. Management uses the cash budget to manage the cash flows of a company.
In other words, management must make sure the company has enough cash to pay
its bills when they come due.
Chartered
Institute of Management Accountant (CIMA) defines cash budgets as a short-term
fiscal plan expressed in money which is prepared in advance. It helps to
determine the cash-inflow and cash-outflow of the business.
Features of Cash Budget
a)
The
cash-budget period is broken down into periods, mainly in months.
b)
The cash-budget
is always in columnar form i.e. column showing each month
c)
Payments
and receipts of cash are identified in different heading and showing total for
each month.
d)
The
surplus of total cash payment over receipts or of receipts over payment for
each month is shown.
e)
The
running balances of cash, which would be determined by taken the balance at the
end of the previous month and adjusting it for either deficit or surplus of
receipts over payments for current month, is identified.
Importance / Uses of Cash Budget
Cash budget is an important tool in the
hands of financial management for the planning and control of the working
capital to ensure the solvency of the firm. The importance of cash budget may be summarised as
follow:
(1) Helpful in Planning. Cash
budget helps planning for the most efficient use of cash. It points out cash
surplus or deficiency at selected point of time and enables the management to
arrange for the deficiency before time or to plan for investing the surplus
money as profitable as possible without any threat to the liquidity.
(2) Forecasting the Future needs. Cash
budget forecasts the future needs of funds, its time and the amount well in
advance. It, thus, helps planning for raising the funds through the most
profitable sources at reasonable terms and costs.
(3) Maintenance of Ample cash Balance. Cash is
the basis of liquidity of the enterprise. Cash budget helps in maintaining the
liquidity. It suggests adequate cash balance for expected requirements and a
fair margin for the contingencies.
(4) Controlling Cash Expenditure. Cash
budget acts as a controlling device. The expenses of various departments in the
firm can best be controlled so as not to exceed the budgeted limit.
(5) Evaluation of Performance. Cash
budget acts as a standard for evaluating the financial performance.
(6) Testing the Influence of proposed
Expansion Programme. Cash budget forecasts the inflows from a proposed
expansion or investment programme and testify its impact on cash position.
(7) Sound Dividend Policy. Cash
budget plans for cash dividend to shareholders, consistent with the liquid
position of the firm. It helps in following a sound consistent dividend policy.
(8) Basis of Long-term Planning and
Co-ordination. Cash budget helps in co-coordinating the various
finance functions, such as sales, credit, investment, working capital etc. it
is an important basis of long term financial planning and helpful in the study
of long term financing with respect to probable amount, timing, forms of
security and methods of repayment.
Methods of Preparation of Cash Budget
(1) Receipts and Payments Method
(2) Adjusted Profit and Loss Method or Adjusted Earnings
Method or Cash Flow Method.
(3) Balance-Sheet Method.
The above methods of preparing cash budget represent different
approaches.
(1) Receipts and Payments Method: It
is the most simple and popular method of preparing cash budget. The method is
most commonly used in forecasting the short term cash position. It is just
like receipts and payment method in technique. It shows yearly cash position
with proper breakups by quarters and months. For the purpose of preparing cash
budget under this method, cash information’s are collected from other budgets
such as sales budget, salary and wages budget, overhead budgets, material
budget etc.
Under this method cash budget is divided into two parts. One part shows
the timing and the amount of cash receipts and other part shows the timing and
the amount of cash disbursements. Cash receipts and cash disbursements are
estimated as under:
(i)
Estimation of Cash Receipts: The
amount of cash receipts can be estimated from the following items:
(a)
Cash receipts arising from
Operations. It includes advances form customers, estimated cash
receipts from sales, debtors and collection of bills receivables. In estimating
the amount of cash sales, cash-discount policy of the firm should be taken into
account. Forecasting the receipts from credit sales, i.e., receipts from
customers, B/R etc. Credit policy, terms of sales, position of customers, customers
of the trade, any time lag between sale and collection should be considered.
(b)
Non-operating Cash Receipts. It
includes revenue receipts of non-operating nature and includes receipts from
interest, dividend, rent, commission, royalty, sale of scrap, refund of tax
etc.
(ii) Estimation of Cash Disbursements. The amount
of cash disbursement can be estimated from the following items:
(a) Disbursement for operations Such as
disbursements for cash purchases, wages and overheads, payment to creditors,
bonus and other remunerations such as gratuities, pensions etc. and advances to
suppliers. Terms of purchases, discounts receivable and time lag between the
time of purchase and payment are taken into consideration.
(b) Disbursement for non-operating functions. It
includes financial expenses on non operative functions such as interest, rent,
dividend, donations, income tax and other taxes etc.
(c) Disbursement for capital transactions. Such
as expenditure for expansion, payment of loans and overdrafts, redemption of
debentures and preference capital etc.
In preparing cash budget, total budgeted cash receipts are
added to the opening balance of cash and then the total budgeted disbursements
are deducted there from to know the closing balance of cash. If opening cash
balance and estimated total cash receipts are much larger than the estimated
payments, there will be cash balance at close and management should take the
necessary steps, to invest surplus funds for short period. On the other hand,
if there is cash shortage, the management must plan the borrowings for short
period to manage the deficiency.
(2) Adjusted
Profit and Loss Method or Adjusted Earnings Method or Cash Flow Method: The
method is suitable for preparing the long term estimates of cash inflows and
outflows. It is also called cash-flow statement. Under this method, profit and
loss account is adjusted to know the cash estimates. This method is useful in
budgetary control technique.
Under this method, closing cash balance can be known by
adding profits for the period to the opening cash balance because the theory is
based on the elementary assumption that profits of a business are equal to
cash. Thus if we assume that there are no credit transactions, capital
transactions, accruals, provisions, stock fluctuations, or appropriations of
profit, the balance of profit as shown by the profit and loss account should b
equal to the cash balance in the case book. However, such a situation will
never exist in actual practice, the assumption needs adjustments. In preparing
the cash forecasts, one proceeds with the budgeted profit for the period and
then adjusts this figure by the items mentioned below-
Items to be Added
(i) All non-cash items shown in the debit side of
profit and loss account should be added to the budgeted profit because these
items do not involve any cash outflows-depreciation, deferred revenue
expenditure, writing off of intangible assets, prepaid expenses etc.
(ii) Changes in working capital which results in
inflow of cash balances such as increase in closing stock, debtors and decrease
in sundry creditors and other liabilities, redemption of preference shares and
debentures, payment of dividend, purchase capital assets, investment etc.
(3) Balance-Sheet
Method: This method is similar to that of profit and loss adjustment
method, a budgeted balance sheet is prepared for the next period showing all
items of assets and liabilities except cash balance which is found out as the
balancing figure of the two sides of balance sheet.
If the asst side exceeds the liability side the balance shall
reveal the bank over-draft and if the liability side is heavier than the asset
side, the difference represents the bank balance.
Types of Budgets
As budgets serve
different purposes, different types of budgets have been developed. The
following are the different classification of budgets developed on the basis of
time, functions, and flexibility or capacity.
(A) Classification on the basis of Time:
1. Long-term
budgets
2. Short-term
budgets
3. Current
budgets
(B) Classification according to functions:
1. Functional or
subsidiary budgets
2. Master budgets
(C) Classification on the basis of capacity:
1. Fixed budgets.
2. Flexible
budgets
(A)
Classification on the basis of time
1. Long-term budgets: Long-term budgets are prepared for a longer period varies between
five to ten years. It is usually developed by the top level management. These
budgets summarise the general plan of operations and its expected consequences.
Long-term budgets are prepared for important activities like composition of its
capital expenditure, new product development and research, long-term finance
etc.
2. Short-term budgets: These budgets are usually prepared for a
period of one year. Sometimes they may be prepared for shorter period as for quarterly
or half yearly. The scope of budgeting activity may vary considerably among
different organization.
3. Current budgets: Current budgets are prepared for the current operations of the
business. The planning period of a budget generally in months or weeks. As per
ICMA London, “Current budget is a budget which is established for use over a
short period of time and related to current conditions.”
(b)
Classification on the basis of function
1. Functional budget: The functional budget is one which relates to any of the functions
of an organization. The number of functional budgets depends upon the size and
nature of business. The following are the commonly used:
(i) Sales budget
(ii) Purchase
budget
(iii) Production
budget
(iv) Selling and
distribution cost budget
(v) Labour cost
budget
(vi) Cash budget
(vii) Capital
expenditure budget
2. Master budget: The master budget is a summary budget. This budget encompasses all
the functional activities into one harmonious unit. The ICMA England defines a
Master Budget as the summary budget incorporating its functional budgets, which
is finally approved, adopted and employed.
(C)
Classification on the basis of capacity
1. Fixed budget: A fixed budget, on the other hand is a budget
which is designed to remain unchanged irrespective of the level of activity
actually attained. In a fixed budgetary control, budgets are prepared for one
level of activity whereas in a flexibility budgetary control system, a series
of budgets are prepared one for each level of alternative production levels or
volumes. According
to ICWA London ‘Fixed budget is a budget which is designed to remain unchanged
irrespective of the level of activity actually attained.”
Fixed budget is
usually prepared before the beginning of the financial year. This type of
budget is not going to highlight the cost variance due to the difference in the
levels of activity. Fixed budgets are suitable under static conditions.
2. Flexible budget: Flexible Budget: A flexible budget is defined
as “a budget which, by recognizing the difference between fixed, semi-variable
and variable cost is designed to change in relation to the level of activity
attained”. Flexible budgets represent the amount of expense that is reasonably
necessary to achieve each level of output specified. In other words, the
allowances given under flexibility budgetary control system serve as standards
of what costs should be at each level of output.
According to
ICMA, England defined Flexible Budget is a budget which is designed to change
in accordance with the level of activity actually attained.”
According to the
principles that guide the preparation of the flexible budget a series of fixed
budgets are drawn for different levels of activity. A flexible budget often
shows the budgeted expenses against each item of cost corresponding to the
different levels of activity. This budget has come into use for solving the
problems caused by the application of the fixed budget.
Advantages
of flexible budget
1. In flexible
budget, all possible volume of output or level of activity can be covered.
2. Overhead costs
are analysed into fixed variable and semi-variable costs.
3. Expenditure
can be forecasted at different levels of activity.
4. It facilitates
at all times related factor can be compared, which essential for intelligent
decision are making.
5. A flexible
budget can be prepared with standard costing or without standard costing
depending upon what the company opts for.
6. A flexible
budget facilitates ascertainment of costs at different levels of activity,
price fixation, placing tenders and quotations.
7. It helps in
assessing the performance of all departmental heads as the same can be judged
by terms of the level of activity attained by the business.
Method
of preparing flexible budget
The following methods
are used in preparing a flexible budget:
1. Multi-activity
method
2. Ratio method
3. Charting
method.
1. Multi-Activity method: This method involves preparing a budget in
response to different level of activity. The different level of activity or capacity
levels are shown in Horizontal columns, and the budgeted figures against such
levels are placed in the Vertical Columns. The expenses involved in production
as per budget are grouped as fixed, variable and semi variable.
2. Ratio method: According to this method, the budget is prepared first showing the
expected normal level of activity and the estimated variable cost per unit at
the side expected level of activity in addition to the fixed cost as estimated.
Therefore, the expenses as per budget, allowed for a particular level of
activity attained, will be calculated on the basis of the following formula:
Budgeted fixed cost + (Variable cost per unit of activity × Actual unit of
activity).
3. Charting method: Under this method total expenses required for any level of
activity, are estimated having classified into three categories, viz.,
variable, semi variable and fixed. These figures are plotted on a graph. The
expenses are plotted on the Y-axis and the level of activity is plotted on
X-axis. The graphs will thus, help in ascertaining the quantum of budgeted
expenses corresponding to the level of activity attained with the help of this
chart.
Difference between Fixed Budget and Flexible Budget
|
|
Fixed Budget
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Flexible Budget
|
|
1.
|
It does
not change with actual volume of activity achieved. Thus it is known as rigid
or inflexible budget.
|
It can
be recasted on the basis of activity level to be achieved. Thus it is not
rigid.
|
|
2.
|
It
operates on one level of activity and under one set of conditions. It assumes
that there will be no change in the prevailing conditions, which is
unrealistic.
|
It
consists of various budgets for different levels of activity.
|
|
3.
|
Here as
all costs like - fixed, variable and semi-variable are related to only one
level of activity. So variance analysis does not give useful information.
|
Here
analysis of variance provides useful information as each cost is analysed
according to its behaviour.
|
|
4.
|
If the
budgeted and actual activity levels differ significantly, then the aspects
like cost ascertainment and price fixation do not give a correct picture.
|
Flexible
budgeting at different levels of activity facilitates the ascertainment of
cost, fixation of selling price and tendering of quotations.
|
|
5.
|
Comparison
of actual performance with budgeted targets will be meaningless specially
when there is a difference between the two activity levels.
|
It
provides a meaningful basis of comparison of the actual performance with the
budgeted targets.
|
Sales Budget
Sales budget is
one of the important functional budgets. Sales estimate is the commencement of
budgeting may be both made in quantitative or in value terms. Sales budget is
primarily concerned with forecasting of what products will be sold in what
quantities and at what prices during the budget period. Sales budget is
prepared by the sales executives taking into account number of relevant and
influencing factors such as: Analysis of past sales, key factors, market
conditions, production capacity, government restrictions, competitor’s strength
and weakness, advertisement, publicity and sales promotion, pricing policy,
consumer behaviour, nature of business, types of product, company objectives,
salesmen’s report, marketing research’s reports, and product life cycle.
Production Budget
Production budget
is usually prepared on the basis of sales budget. But it also takes into
account the stock levels desired to be maintained. The estimated output of
business firm during a budget period will be forecast in production budget. The
production budget determines the level of activity of the produce business and
facilities planning of production so as to maximum efficiency. The production
budget is prepared by the chief executives of the production department. While
preparing the production budget, the factors like estimated sales, availability
of raw materials, plant capacity, availability of labour, budgeted stock
requirements etc. are carefully considered.
Difference
between Sales Budget and Production Budget
a) A sales Budget
is a schedule, which shows expected sales in both units and sales rupees for
the coming period. Whereas a production budget determines only the quantity to
be produced in coming period.
b) A sales Budget
is not prepared on the basis of production budget. But a production budget is
prepared on the basis of sales budget.
c) Stock levels
are not shown in sales budget. But, a production budget takes into account the
stock levels desired to be maintained.
d) Sales budget
is prepared by the sales executives. Whereas, production budget is prepared by
the chief executives of the production department.
e) Estimated
selling price is shown in sales budget. Whereas, production budget helps in
calculating production cost for estimated level of production.
Cost of production Budget
After preparation
of production budget, this budget is prepared. Production cost budgets show the
cost of the production determined in the production budget. Cost of production
budget is grouped in to material cost budget, labour cost budget and overhead
cost budget. Because it break up the cost of each product into three main
elements material, labour and overheads. Overheads may be further subdivided in
to fixed, variable and semi-fixed overheads. Therefore separate budgets
required for each item.
Master Budget
When the functional
budgets have been completed, the budget committee will prepare a master budget
for the target of the concern. Accordingly a budget which is prepared
incorporating the summaries of all functional budgets. It comprises of budgeted
profit and loss account, budgeted balance sheet, budgeted production, sales and
costs. The ICMA England defines a Master Budget as ‘the summary budget
incorporating its functional budgets, which is finally approved, adopted and
employed’. The master budget represents the activities of a business during a
profit plan. This budget is also helpful in coordinating activities of various
functional departments.
Control Ratios
Ratios are used
by the management to determine whether performance of its activities is going
on as per estimates or not. If the ratio is 100% or more, the performance is
considered as unsatisfactory. The following are the ratios generally calculated
for performance evaluation.
1. Capacity ratio: This ratio indicates the extent to which budgeted hours of activity
is actually utilised.
Capacity Ratio =
(Actual hours worked production/Budget hours) × 100
2. Activity ratio: This ratio is used to measure the level of activity attained
during the budget period.
Activity ratio =
(Standard hours for actual production/Budgeted hours) × 100
3. Efficiency ratio: This ratio shows the level of efficiency attained during the
budget period
Efficiency ratio
= (Standard hours for actual production/Actual hours worked) × 100
4. Calendar ratio: This ratio is used to measure the proportion of actual working
days to budgeted working days in a budget period.
Calendar ratio =
(Number of actual working days in a period/ Budgeted working days for the
period) × 100
Differences between Budgetary Control and Standard Costing
Both standard costing and budgetary control achieve the same objective of
maximum efficiency and cost reduction by establishing predetermined standards,
comparing actual performance with the predetermined standards and taking
corrective measures, where necessary. Thus, although both are useful tools to
the management in controlling costs, they differ in the following respects:
|
Budgetary Control
|
Standard Costing
|
|
Budgetary
control deals with the operations of a department of business as a whole.
|
Standard
costing is applied to manufacturing of a product, process or processes or
providing a service.
|
|
It is
extensive in its application, as it deals with the operation of department or
business as a Whole.
|
It is
intensive, as it is applied to manufacturing of a product or providing a
service.
|
|
Budgets are
prepared for sales, production, cash etc.
|
It is
determined by classifying recording and allocating expenses to cost unit.
|
|
It is a
part of financial account, a projection of all financial accounts.
|
It is a
part of cost account, a projection of all cost accounts.
|
|
Control is
exercised by taking into account budgets and actual. Variances are not
revealed through accounts.
|
Variances
are revealed through difference accounts.
|
|
Budgeting
can be applied in parts.
|
It cannot
be applied in parts.
|
|
It is more
expensive and broad in nature, as it relates to production, sales, finance
etc.
|
It is not
expensive because it relates to only elements of cost.
|
|
Budgets can
be operated with standards.
|
This system
cannot be operated without budgets.
|
Concept and Meaning of Responsibility Accounting
Responsibility
accounting is a system used in management accounting for control of costs. It
is used along with other systems like budgetary control and standard costing.
The organization is divided into different centers called “responsibility
centers” and each centre is assigned to a responsible person.
According
to Eric. L. Kohler “ Responsibility Accounting is the classification,
management maintenance, review and appraisal of accounts serving the purpose of
providing information on the quality and standards of performance attained by
persons to whom authority has been assigned.”
Responsibility accounting, therefore, represents a method of measuring
the performances of various divisions of an organization. The test to identify
the division is that the operating performance is separately identifiable and
measurable in some way that is of practical significance to the management.
Responsibility accounting collects and reports planned and actual accounting information
about the inputs and outputs of responsibility centers.
Characteristics / Features of Responsibility Accounting
1. It is a
control system used by top management for monitoring and controlling operations of a business.
2. It is based on
clearly defined functions and responsibilities assigned to executives.
3. The
organization is divided into meaningful segments called responsibility centres.
4. Costs and
revenues of each centre and responsibility of them are fixed on the individuals.
5. There is
continuous reporting of information relating to each centre and appropriate corrective actions are taken
wherever necessary.
6. It is used
along with budgetary and standard costing system
Steps in Responsibility Accounting
1. Identifying
Responsibility centres: The organization
is divided into meaningful segments based on functions. Each centre is assigned to a specified person.
He is responsible for the costs and performance of
that centre.
2. Fixing targets
for Responsibility centres: Targets are fixed
for each centre in terms of inputs and outputs or costs and revenues. The functions and targets are
clearly communicated to the bottom level persons.
3. Measuring the
actual performance: The performance
of each centre is continuously monitored and evaluated. There is a system to communicate this
information to the top management regularly.
4. Evaluating
performance: The actual
performance is compared with targets and variances are analyzed.
5. Taking
corrective measures: Whenever there is
an adverse variance in terms of cost, revenue or resources,
managerial control is exercised by taking corrective actions. Responsibility accounting like budgeting or
standard costing, is a control device. The whole
exercise is done to check inefficiencies, wastages and losses, thereby improving the overall performance of
the organization.
Advantages of Responsibility accounting
1. It is used for
exercising effective control on operations by fixing responsibilities on specific persons in an organization.
2. It helps to
increase profitability of the organization.
3. It helps in
the effective delegation of authority.
4. The managers
and employees will be more vigilant since their performances are constantly evaluated.
5. It helps in
the implementation of budgetary control and standard accounting system.
6. A good
reporting system is inevitable to Responsibility Accounting which facilitates quick decision making by
management.
Disadvantages of Responsibility Accounting
1. It is
difficult to identify and classify the responsibility centres
2. There will always
be conflict of interests among the responsibility centres and that may not be at the interest of the
organization as a whole.
3. It may not be
actually needed especially in small and medium organizations where there is already a system of budgetary control
and standard costing.
4. The
co-ordination of responsibility centres may be difficult if there are too many centres.
5. Resistance of
managers and lack of co-operation from employees may happen.
6. It needs a
detailed communication and reporting system which is very costly.
Performance Budgeting
Management Accounting | |
Chapter Wise Notes | Chapter Wise MCQs |
1. Introduction to Management Accounting 5. Budget and Budgetary Control Also Read: | |
Management Accounting Important Questions for Upcoming Exams (Dibrugarh University) | |
Management Accounting Solved Papers: 2013 2014 2015 2016 2017 2018 2019 | |
Management Accounting Question Papers: 2013 2014 2015 2016 2017 2018 2019 | |
Performance Budgeting had its origin in U.S.A. after the Second World
War. It tries to rectify some of the traditional budget. In the traditional
budget amount are earmarked for the objects of expenditure such as salaries,
travel, office expenses, grant in aid etc. In such system of budgeting the
money concept was given more prominence i.e. estimating or projecting rupee
value for the various accounting heads or classification of revenue and cost.
Such system of budgeting was more popularly used in government departments and
many business enterprises. But is such system of budgeting control of
performance in terms of physical units or the related costs cannot be achieved.
Performance oriented budgets are established in such a manner that each
item of expenditure related to a specific responsibility center is closely
linked with the performance of that center. The basic issue involved in the
fixation of performance budgets is that of developing work programmes and
performance expectation by assigned responsibility, necessary for the
attainments of goals and objectives of the enterprise, it involves
establishment of well defined centers of responsibilities, establishment for
each responsibility center – a programme
of target performance in physical units, forecasting the amount of expenditure
required to meet the physical plan laid down and evaluation of performance.
The main features
of performance budgeting are as follows:
a.
It
helps the management to regulate its each and every activity according to
predetermined standards of performance, targets and objectives.
b.
It
is not only an estimate of future needs but goes beyond that and- includes
functions, programmes, activity schemes and time schedules to help effective
and economic allocation for the programmes.
c.
It
lays great stress on the management of organisational structural and overall
policy, personnel, financial, etc. from traditional to dynamic one.
d.
It
is not merely a projection of trends and targets but planning the business from
grass root level to top level on rational thinking and forecasting.
Difference between Performance Budgeting and Traditional Budgeting
|
Performance
budgeting
|
Traditional
Budgeting
|
|
1)
In it, the flow of decision is upward.
2)
It follows the function – programme – activity
classification.
3)
It makes a prospective approach with its focus
on future markets.
|
1)
In it, the flow of decision is downward.
2)
In it, the classification of expenses is by
objects.
3)
The approach is retrospective in such budgeting.
|
Advantages of Performance Budgeting
a)
It presents clearly the purposes and objectives
for which funds are required.
b)
It gives better appreciation of budgeting by
legislature.
c)
It improves budget formulation process.
d)
It enhances accountability of the executives.
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