Budget, Budgetary Control & Preparation - Cost Accounting | Cost Accounting - B Com PDF Download

Budget and Budgetory Control
Meaning and definition of budget:
A budget is a plan of action for a future period. It simply means a financial plan expressed in terms of money. The budget pertaining to any of the activities of business is always forward looking. The term ‘budget’ has been derived from the French word, ”bougette”, which means a leather bag into which funds are appropriated to meet the anticipated expenses. The CIMA Official Terminology defines a budget as “ A quantitative statement, for a defined period of time, which may include planned revenues, expenses, assets, liabilities and cash flows.”

Budgeting and Budgetary control:
Budgeting simply means preparing budgets. It is a process of preparation, implementation and the operation of budget. Being a plan of action, a budget guides every manager in the decision making process.
In the words of Rowland Harr, “Budgeting is the process of building budgets”. Budgetary control is a system of using budgets for planning and controlling costs. The official terminology of CIMA defines the term ‘budgetary control , as “ the establishment of budgets relating to the responsibilities of executives to the requirement of a policy, and the continuous comparison of actual with budgetary result, either to secure by individual action the objectives of that policy or to provide a basis for its revision.” Thus, when plans are embodied in a budget and the same is used as the basis for regulating operations, we have budgetary control. As such budgetary control starts with budgeting and ends with control.

Objectives of Budget and Budgetary control:
The following points reveal the objectives of Budget and budgetary control:-

1. To aid the planning of annual operations
2. To co ordinate the activities of the various parts of the organization
3. To communicate plans to the various responsibility centre managers
4. To motivate managers to strive to achieve the organizational goals.
5. To control activities
6. To eliminates the wastes of all kinds
7. To provide a yard stick against which actual results can be compared
8. To evaluate the performance of managers.
9. To reduce the uncertainties

Meaning of Estimate, forecast and Budget: 
An estimate is predetermination of future events either on the basis of simple guess work or following scientific principles. Forecast is an assessment of probable future events. Budget is based on the implication of a forecast and related to planned events. To establish a realistic budget, it is necessary to forecast a wide range of factors like sales volume, sales prices, material availability, wage rate, the cost of overheads etc.

Steps involved in Budgetary Control:
The following steps may be considered necessary for a comprehensive budgetary control programme:-

1. Laying down organizational goals or objectives
2. Formulating the necessary plans to ensure that the desired objectives are achieved.
3. Translating plans into budget
4. Relating the responsibilities of executives to the requirements of a policy.
5. Recording and reporting actual performance
6. Continuous comparison of actual with budgeted results
7. Ascertainment of deviations, if any
8. Focusing attention on significant deviations
9. Investigation into deviations to establish causes
10. Presentation of information to management, relating the variations to individual responsibility.
11. Taking corrective action to prevent recurrence of variations.
12. Provide a basis for revision of budgets.

Essentials of a Budgetary Control system: Successful implementation of a budgetary control system depends up on the following essentials. 

1. Support by top management: The wholehearted support of all managerial persons is very necessary for the success of a budgetary control system.
2. Formal organization: The existence of a formal and sound organizational structure is of an absolute necessity for an effective system of budgetary control.
3. Budget centers: For budgetary control purposes, the entire organization will be split into a number of departments, area or functions, known as ‘centres’, and budgets will be prepared for each such centers
4. Clear cut objectives and reasonably attainable goals:- If goals are too high to be attained, the purpose of budgeting is defeated. On the other hand, if the goals are so low that they can be attained very easily, there will be no incentive to special effort.
5. Participative budgeting: Every executive responsible for the implementation of budgets should be given an opportunity to take part in the preparation of budgets.
6. Budget committee: The work of preparing a budget manual should be entrusted to a Budget committee. The work of scrutinizing the budgets as well as approving of the same should be the work of this committee.
7. Comprehensive budgeting: Budgeting should not be partial, it should cover all the functions .
8. Adequate accounting system: There should be an adequate accounting system for the successful budgetary control system, because those who are involved in the preparation of estimates depend heavily on the accounting department.
9. Periodic reporting: - There should be a prompt and timely communication and reporting system for the effective implementation of a budgetary control system.

Budget manual: 
CIMA England, defines a budget manual as “ a document , schedule or booklets which sets out; inter alia, the responsibilities of the persons engaged in the routine of and the forms and records required for budgetary control”. In other words, it is a written document which guides the executives in preparing various budgets.

Budget period: This may be defined as the period for which a budget is prepared and employed. The budget period will depend on the type of business and the control aspects. There is no general rule governing the selection of the budget period.

Classification of Budget

1. Classification according to time factor
2. Classification according to flexibility factor
3. Classification according to function.

I. Classification according to time factor: - On this basis, budgets can be of three types: 

1. Long term budget – for a period of 5 to 10 years
2. Short term budgets – Usually for a period of one to two years
3. Current budgets - Usually covers a period of one month or so,

II. Classification according to flexibility: It includes 

1. Flexible budgets and
2. Fixed budgets

Flexible budgets: It is a dynamic budget. It gives different budgeted cost for different levels of activity. It is prepared after making an intelligent classification of all expenses between fixed , semi variable and variable because the usefulness of such a budget depends up on the accuracy with which the expenses can be classified. 

Steps in preparing flexible budgets:

1. Identifying the relevant range of activity
2. Classify cost according to variability
3. Determine variable cost
4. Determine fixed cost
5. Determine semi variable cost
6. Prepare the budget for selected levels of activity

Advantages of Budgetary Control
Budgetary control makes all the differences between drifting in an unchartered sea and following a well plotted course towards a predetermined distinction. It serves as a valuable aid to management through planning, co-ordination and control.
The principal advantages of a budgetary control system are enumerated below:

1. Budgetary control aims at maximisation of profits through effective planning and control of income and expenditure - directing capital and resources to the best and most profitable channel.
2. There is a planned approach to expenditure and financing of the business so that economy is affected in the utilisation of funds to the optimum benefit of the concern.
3. It provides a clear definition of the objective and policies of the concern and a tool for objecting these policies to periodic examination.
4. The task of managerial co-ordination is facilitated through budgetary control.
5. Since each level of management is aware of the task and is fully conscious as to the best way by which it is to be performed, maximum effective utilisation of men, materials and resources can be attained.
6. Reports are furnished under the principles of management or control by exception. Only deviations from budgets which point out the weak spots and inefficiencies are properly looked into.
7. It cultivates in the management the habit of thinking ahead - making careful study of the problems in advance before taking decisions.
8. A budgetary control system assists delegation of authority and is a powerful tool of responsibility accounting.
9. Budgets are the fore-runners of standard costs in the sense that they create necessary conditions to suit setting up of standard costs.
10. The method of evaluating performance against budgets provides a suitable basis for establishing incentive system of remuneration by results as also spotting people with exceptional qualities of leadership and management.
11. Since it involves foreseeing difficulties of various types, it will lead to their removal in time.

Limitations of Budgetary Control

1. Budgetary control starts with the formulation of budgets which are mere estimates. Therefore, the adequacy or otherwise of budgetary control system, to a very large extent, depends upon the adequacy or accuracy with which estimates are made.
2. Budgets are meant to deal with business conditions which are constantly changing. Therefore, budgets estimates lose much of their usefulness under changing conditions because of their rigidity. It is necessary that budgetary control system should be kept adequately flexible.
3. The system of budgetary control is based on quantitative data and represent only an impersonal appraisal to the conduct of business activity unless it is supported by proper management of personal administration.
4. It has often been found that in practice the organisation of budgetary control system become top heavy and, therefore, costly specially from the point of view of small concern.
5. Budgets and budgetary control have given rise to a very unhealthy tendency to be regarded as the solvent of all business problems. This has resulted in a very luke-warm human effort to deal with such problems and ultimately results in failure of budgetary control system.
6. It is a part of human nature that all controls are resented to. Budgetary control which places restrictions on the authority of executive is also resented by the employees.

The limitations stated above merely point to the need of maintaining the budgetary control system on a realistic and dynamic basis rather than as a routine. 

Preparation of various types of budgets
Master Budget
A master budget is a comprehensive projection of how management expects to conduct all aspects of business over the budget period, usually a fiscal year. The master budget summarizes projected activity by way of a cash budget, budgeted income statement and budgeted balance sheet. Most master budgets include interrelated budgets from the various departments. Managers typically use these subset budgets to plan and set performance objectives. Master budgets are generally used in larger businesses to keep many managers on the same page.

Operational Budgets
The operational budget covers revenues and expenses surrounding the day-to-day core business of a company. Revenues represent sales of products and services; expenses define the costs of goods sold as well as overhead and administrative costs directly related to producing goods and services. While budgeted annually, operating budgets are usually broken down into smaller reporting periods, such as weekly or monthly. Managers compare ongoing results to budget throughout the year, planning and adjusting for variations in revenue.

Cash Flow Budget
A cash flow budget examines the inflows and outflows of cash in a business on a day-to-day basis. It predicts a company's ability to take in more money than it pays out. Managers monitor cash flow budgets to pinpoint shortfalls between expenses and sales -- times when financing may be needed to cover overheads. Cash flow budgets also suggest production cycles and inventory levels so that a company's resources are available for activity, not sitting idle on warehouse shelves.

Financial Budget
A financial budget outlines how a business receives and spends money on a corporate scale, including revenues from core business plus income and costs from capital expenditures. Managing assets such as property, buildings, investments and major equipment may have a significant effect on the financial health of a company, particularly through the peaks and troughs of daily business. Executive managers use financial budgets to leverage financing and value the company for mergers and public offerings of stock.

Static Budget
A static budget contains elements where expenditures remain unchanged with variations to sales levels. Overhead costs represent one type of static budget, but these budgets aren't confined to traditional overhead expenses. Some departments may have a fixed amount of money set in budget to spend, and it is up to managers to make sure such amounts are spent without going over-budget. This condition occurs routinely in public and nonprofit sectors, where organizations or departments are funded largely by grants.

Types:
I. Functional Budgets:
A functional budget is a budget which relates to the individual functions of the organisation like sales, production, purchase, capital expenditure etc. For each function there is usually a separate budget which is controlled by the functional manager.

II. Master Budget:
Master budget is a summary of all the functional budgets and shows the overall budget plan.

According to CIMA terminology:
“A master budget is the summary budget incorporating its component as functional budgets and which is finally approved, adopted and employed.” This budget commonly summarizes functional budgets to produce a budgeted Profit and Loss Account and a budgeted Balance Sheet at the end of the budget period

III. Fixed Budget (Static Budget):
A fixed budget is defined as a budget which is designed to remain unchanged irrespective of the volume of output or turnover attained. The budget remains fixed over a given period and does not change with the change in the volume of production or level of activity attained.
Thus, it does not provide for any change in expenditure arising out of changes in the level of activity or capacity. A fixed budget will, therefore, be useful only when the actual level of activity corresponds to the budgeted level of activity. But if the level of output actually achieved differs considerably from that budgeted, large variances will arise and the budgetary control becomes ineffective and meaningless.

IV. Flexible Budget:
A flexible budget is a budget which is designed to change in accordance with the level of activity actually attained.
According to the ICMA Terminology:
“Flexible budget is a budget which, by recognising the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover, or other variable factors such as number of employees, is designed to change appropriately with such fluctuations.”
Thus, a flexible budget distinguishes between fixed and variable costs and adopts itself to any level of activity. This budget also involves the construction of a series of fixed budgets for different levels of activity. The budget allowance given under this system serves as a standard of what costs should be at each level of activity.
Hence budgeted cost at actual activity is compared with actual cost at actual activity i.e., two things to a like base. It helps both in profit planning and controlling cost.

Budgeting Examples
The following examples of Budgeting provide an understanding of the various types of budget which can be prepared by an organization. In the present competitive world where there is competition prevailing everywhere, budgeting plays an important role as it helps in controlling the cost of the organization and maximizing the profits. It helps in providing awareness to the organization about its future working and requirements. All the examples of the Budgeting are different and one should take the use of the same as per the requirement. Like when the sales are to be analyzed sales budget is prepared and when the production is to be analyzed then the production budget is prepared.

Example 1 – Incremental Budget
For the year 2018-19, Fin International Ltd paid the total salary paid of $ 400,000 to its employees. The budget is required to be prepared for the year 2019-20 with respect to the salary of the employees. It is estimated by the management that during the next year six new employees will be hired and to each employee, the salary of $ 25,000 will be given to each new employee.
Also, it is decided by the company to give the increment to the existing employees of 10%. What will be the budget of the salary for the company for the year 2019 –20?
Solution:
Using incremental budgeting, the budget for the salary will be:
= Previous year salary + Percentage of increment on previous salary + Salary of 6 new employees

• = $ 400,000 + 10% * $ 400,000 + ($ 25,000 * 6)
• = $ 400,000 + $ 40,000 + ($ 25,000 * 6)
• = $ 400,000 + $ 40,000 + $ 150,000

Total Salary Budget = $ 590,000

Example 2 – Sales Budget
Sports international ltd plans to produce balls in the upcoming year ending on 2019. It forecasted the sales to be $ 4,000 in quarter 1, $ 5,000 in quarter 2, $ 6,000 in quarter 3 and $ 7,000 in quarter 4. The selling price of the product for the first two quarters will be $ 5 which is expected to be increased to $ 6 in quarter 3 and quarter 4 by the sales manager of the company.
Also, it is expected that the sales discount and the allowance percentage of the company will continue to be the same in the budgeted period as well which is 2 % of the gross sales. Prepare the sales Budget for the upcoming year ending on 2019 of Sports international ltd.
Solution:
Following is the sales budget of Sports international ltd for the year ended on December 31, 2019

The sales budget shows the sales forecasted by the company for the coming year in both units and value using the information inputs from various sources.

Example 3 – Business Budget
The Income and expense details of Mid-term International Ltd are given as below. Prepare the Business budget for the year ended on December 2018.


Income in the present situation shows the sales of the company per quarter and the other incomes earned by the company during the year. The expenses are divided into operating expense and non-operating expenses. In this business budget, the difference between the budgeted amount and the actual amount is shown which will help the company in analyzing the variances.

Example 4 – Production Budget
Pen international ltd plans to produce marker pens in the upcoming year ending on 2019. It forecasted the sales to be $ 7,000 in quarter 1, $ 8,000 in quarter 2, $ 9,000 in quarter 3 and $ 10,000 in quarter 4. The planned ending inventory is estimated to be $ 1,000 at the end of each quarter by the production manager of the company which in the beginning was $ 1,500.
Prepare the Production Budget for the upcoming year ending on 2019 of Pen international ltd.
Solution:
Following is the Production budget of Pen international ltd for the year ended on December 31, 2019:

The production budget shows the calculation of the number of units to be produced by the organization. As the Planned ending units of inventory are decreased by the production manager from $1,500 to $1,000 despite the fact that the production is expected to increase per quarter, it seems to be the risky forecast as there is cut in the safety stock of the company.