Budget and Budgetary Control Notes
Budget and Budgetary Control Notes
Budget and Budgetary Control Notes
Q1. Define the terms (a) Budget, (b) Budgeting and (c) Budgetary Control.
Ans: Budget:
Budget is a financial and/or quantitative statement, prepared and approved prior to a defined period of time, of the
policy to be pursued during that period for the purpose of attaining a given objective.
It is a plan quantified in monetary terms, prepared and approved prior to a defined period of time, usually showing
planned income to be generated and/or expenditure to be incurred during that period and the capital to be employed
to attain a given objective. It is a plan of future activities for an organization. It is expressed mainly in financial
terms, but also usually incorporates many nonfinancial quantitative measures as well.
Budgeting:
Budgeting is the whole process of designing, implementing and operating budgets. The main emphasis in this is
short – term budgeting process involving the provision of resources to support plans which are being implemented.
Budgetary Control:
Budgetary control means the establishment of budgets relating to the responsibilities of executives to the
requirements of a policy and continuous comparison of actual with budgeted results either to secure by individual
action the objective of that policy or to provide basis for its revisions
Ans: Budgeting is a management tool used for short – term planning and control. Traditionally budgets have been
employed as devices to limit expenditure, but a much more useful and constructive view is to treat the budgeting
process as a means for obtaining the most effective and profitable use of the company’s resources via planning and
control. Short – term planning is formalized in the budgetary process. A budget is merely a collection of plans and
forecasts, expresses largely but not exclusively in financial terms. Even though many organizations do not plan
formally for more than a year ahead, the annual budget must be set in the context of longer – term plans, which are
likely to exist even if they have been made explicit. Budgets should be a management tool rather than merely an
accounting exercise.
Advantages of Budgeting:
a. Budgetary control establishes a basis for internal audit by regularly evaluating departmental results.
b. Only reporting information which has not gone according to plan, it economizes on managerial time and
maximizes efficiency. This is called ‘management by exception’ reporting.
c. Scarce resources should be allocated in an optimal way, thus controlling expenditure.
d. It forces management to plan ahead so that long – term goals are achieved.
e. Communication is increased throughout the firm and coordination should be improved.
f. An effective budgetary control system will allow people to participate in the setting of budgets, and thereby
have a motivational impact on the work force. Individual and corporate goals are aligned.
g. Areas of efficiency and inefficiency are identified. Variance analysis will prompt remedial action where
necessary.
h. The budget provides a yardstick against which the performance of the firm can be evaluated. It is better to
compare actual with budget rather than with the past, since the latter may no longer be suitable for current and
expected conditions.
i. People are made responsible for items of cost and revenue, i.e., areas of responsibility is clearly delineated.
Ans:
Forecast Budget
1. Forecast is merely an estimate of what is likely to 1. Budget shows the policy and programme to be
happen. It is a statement of probable events which followed in a period under planned conditions.
are likely to happen under anticipated conditions
during a specified period of time.
2. Forecasts, being statements of future events, do not 2. A budget is a tool of control since it represents
connote any sense of control. actions which can be shaped according to will so
that it can be suited to the conditions which may or
may not happen.
3. Forecasting is a preliminary step for budgeting. It 3. It begins when forecasting ends. Forecasts are
ends with the forecast of likely events. converted into budgets.
4. Forecasts are wider in scope and it can be made in 4. Budgets have limited scope. It can be made of
those spheres, also where budgets cannot interfere. phenomenon capable of being expressed
quantitatively.
Ans: The sales and revenue budget is the starting point of most master budgets. In manufacturing organizations
sales budgeting begin with the forecasting of the sales of individual products. These forecasts may be by
geographical area, by class of customer or by some other segment. In case of manufacturing companies, the
budgeting will begin with the revenue budget of the organization. Forecasting sales is a difficult task as many
assumptions need to be made about consumer demand, environmental conditions, likely customer demand at
different prices, the probable prices for similar products sold by competitors, the number of economic activity in the
regions where the product is sold, the number of sales personnel required to service the estimated demand, the
appropriate level of advertising and promotional expenditures, the impact of anticipated changes in exchange rates
and changes in the taxes such as the value added tax or customs and excise duties.
Once the sales budget has been determined it would be possible to construct the following other budgets.
a. Production Budget: It is an estimate of the quantity of goods that must be produced during the budget period.
b. Plant Utilization Period: It is prepared for the estimation of plant capacity to meet the budgeted production
during the period considered under the budget.
c. Direct Materials Budget: It specifies the budgeted quantities of each raw material required for the budgeted
production.
d. Direct Labour Budget: It will ensure that the plan will make the required number of employees of relevant
grades, and suitable skills. It will be developed for both direct labour hours and direct labour cost.
e. Manufacturing Expenses Budget: It refers to the aggregate of factory indirect material, indirect labour and
indirect expenses.
f. Administrative Expenses Budget: It includes the administrative expenses incurred for the activities like
formulation of policies, directing the organization and controlling the operations of an organization etc.
g. Selling and Distribution Expense Budget: Selling expenses refers to expenses incurred relating to the
activities like: (a) Creation and simulation of demand of company’s product, and (b) Secure orders. Selling
expenses include salesmen’s salaries, commissions, expenses and related administrative cost, etc. distribution
expenses refers to expenses incurred relating to the activities like: (a) Maintaining and creating demand of
product, and (b) Making the goods available in the hands of the customer. Distribution expenses include
transportation, freight charges, stock control, warehousing, etc. Preparation of selling and distribution expense
budget is based on the sales budget. The selling and distribution expenditure can be estimated with the help of
flexible budgeting technique.
h. Master Budget: Master Budget is a budget which is prepared from, and summarizes the functional budgets. It
is a summary budget that incorporates the key figures and totals of all other budgets.
Q5. Write short notes on: (a) Budget Centre, (b) Budget Period.
Budget Period: Budget period is a period for which the budget is prepared. A budget can be a long – term budget or
short – term budget. A short – term budget is generally prepared for one year or lesser period. Quarterly, monthly or
even weekly budget can be prepared for certain operations of the company. The short – term budget will generally
not exceed the full accounting year. The long – term budget which extend to five or even more years. This long –
term budget will agree with the long – term forecast of sales, organizational schemes for expansion, modernization,
diversification etc.
The long – term budgets are used for planning whereas short – term budget is used for implementation of long range
plans, activities, objectives and also for control purposes. Capital expenditure budget and Research and development
expenditure budget are examples of long – term budgets. Annual sales budget, Income and expenditure budget are
the examples of short – term budgets.
Ans: In small organizations, the person incharge of finance and accounting functions will involve in preparation of
budgets. The setting up of a budget committee in case of large and complex organizations. As the budget involves
the various functional activities, the closest association of functional managers is essential for satisfactory
formulation and implementation of the budget. The budget committee will be composed of major functional heads.
It can be an effective medium for coordination and review of the budget program.
Ans: Proper budget administration is facilitated by the budget controller who is made responsible for the preparation
of the budget and coordinating activities of the individual departments. His functions and responsibilities will
include the following:
a. Generation and dissemination of information needed for decision making and planning to each person in the
organization having such responsibilities. The information may include, but is not limited to, forecasts of
economic and social conditions, governmental influences, organizational goals and standards for decision
making, economic and financial guidelines, performance data, performance standards and the prerequisite plans
of others in the enterprise.
b. Establishing and maintaining a planning system which:
i. Channels of information to each of persons responsible for planning.
ii. Schedules the formulation of plans.
iii. Structures the plans of subsections of the enterprise into composites at which points tests are made for
significant deviations from economic and financial guidelines and from goal achievement and repeats the
process for larger segments to and including the enterprise as a whole, and
iv. Disseminates advice of approval, disapproval or revision of plans to affected individuals in accordance with
established lines of authority and organizational responsibilities.
c. Constructing and using models of the enterprise both in total and by subsections, to test the effect of internal
and external variables upon the achievement of organizational goals.
d. Ensuring the accumulation of performance data related to responsibility centres within the organization,
measured against the plans, whether period or project, for each centre, transmitted to each centre and the
analysis of deviations of actual from planned performance.
The budget controller is responsible for the final preparation, presentation and interpretation of the financial plan of
the company. He is responsible for development of budget procedures. He will act as a staff manager coordinating
all budget functions.
Ans: Budget manual is the documentation of policies and procedures involved in implementation of budgetary
control system. A budget manual will normally set out the following:
a. Responsibility and authority of different levels of management.
b. Establishment of organizational hierarchy.
c. Definition and clarification of various terms used in budgets.
d. Definition of organizational and functional objectives.
e. Fixation of responsibility for preparation and implementation of budgets and budgetary system.
f. Specification and timing of statements and reports.
g. Procedures in management information system in the organization.
h. Procedures in feedback and feed forward control systems.
i. Exhaustive program of budget preparation.
The budget manual contains the standardized form which becomes information generation for preparation of
budgets. It contains a complete program of activities involved in budget preparation. The budget manual should
provide detailed procedure for preparation and development and control of each budget like sales budget, production
budget, direct material budget, direct labour budget, overhead budget, capital expenditure budget, R & D expenses
budget etc.
Q9. “Principal Budget Factor is of vital importance to management in profit planning.” Comment.
Ans: The performance of every organization will be particularly influenced by certain critical success factors. Key
factor will influence the activities of an undertaking and it will limit the volume of outputs and will have direct
impact on the profitability of the organization. The critical success factor is also called as ‘principal budget factor’.
Critical success factors may consist of a specified raw material, a specific type of labour skill, a tool, a service
facility, floor space, cash resources etc. The limitation or shortage of such critical factors may result in restricting
capacity utilization.
The limiting factors may shift from time to time due to external and internal circumstances. In organizations which
are already operating at maximum capacity, the most critical success factor is likely to be productive capacity. In
majority of organizations the critical factor is likely to be consumer demand or the expected level of revenues or
funds. Because of this, the sales or funds budget is usually the first budget to be prepared. It will determine the
content of other related budgets.
Ans: The following are the essential requirements of a sound budgeting system:
a. Clear lines of authority and responsibility have to be established throughout the organization and the authority
and responsibility of different levels of management and departmental executives are clearly defined.
b. The organizational goals should be quantified and clearly stated. These goals should be within the framework of
organizations’ strategic and long range plans.
c. The budget system should be established on the highest possible level of motivation. All levels of management
should participate in setting budgets.
d. The budget control system should provide for a degree of flexibility designed to change in relation to the level
of activity attained and the impact of changes in sales and production levels on revenue, expenses are known.
e. Proper communication systems should be established for management reporting and information service so that
information relating to actual performance is presented to the manager responsible for it promptly to enable the
manager to know the nature of variations so that remedial action is taken whenever necessary.
f. Educating the budget process and creation of cost awareness atmosphere will lead to effective implementation
of budgets.
g. The top management’s involvement in budget process is essential for successful implementation of the budgets.
h. A sound system for generating accurate and reliable and prompt accounting information is basic for successful
implementation of budget system in an organization.
Q11. Define ‘Flexible budget’ and explain its importance as a budgeting technique and tool of control.
Ans: Flexible budget is a budget which, by recognizing the difference in behaviour between fixed and variable costs
in relation to fluctuations in output, turnover, or other variable factors, etc. It is designed to change in relation to the
level of activity actually attained. A flexible budget is one that takes account of a range of possible volumes. It is
sometimes referred to as a multi – volume budget. The range of possible outputs may be known as the relevant
range. “Flexing’ a budget takes place when the original budget is deliberately amended to take account of change in
activity levels.
The flexible budget is based on the fundamental difference in behaviour of fixed costs, variable costs and semi –
variable costs. Since fixed costs do not vary with short – run fluctuations in activity, it can be seen that the flexible
budget will really consist of two parts: The first is a fixed budget begin with made up of fixed costs and the fixed
component of semi – variable costs. The second part is a truly flexible budget that consists solely of variable costs.
Steps in Preparation
Importance
Flexible budgets are important aids to decision making which help the management in the following ways:
i. Flexible budget enable an organization to predict its performance and income levels at a given range of sales
levels and activity levels. It can be seen the impact of changes in sales and production levels on revenue,
expenses and ultimately income.
ii. Flexible budgets enable more accurate assessment of managerial and organizational performance.
Disadvantages
The procedure for drawing up a flexible budget is quite straight forward. The flexible budget is only accurate, if
costs behave in a predicted manner. All too often assumptions are made about cost behaviour which are too
simplistic and hence do not reflect what actually happens.
a. Flexed budgets assume linearity of costs and therefore take no account of, for example discounts for bulk
purchases of materials. Labour costs are unlikely to behave in a linear fashion unless a piecework scheme is in
operation.
b. Such budgets also rely on the assumption of continuity when costs may actually behave in a stepped or
discontinuous manner.
c. The method of determining the fixed and variable elements of costs is often arbitrary and hence the fixed cost
bears little relation to the correct budgeted cost for the flexed level of activity.
d. Although flexed budgets tend to maintain fixed costs at the same level whatever the level of output/sales, very
often fixed costs are actually fixed only over a relevant output range.
Q12. Differentiate between: i) Fixed and Flexible Budget; ii) Traditional and Zero Base Budgeting.
Flexible Budget: A flexible budget takes account of a range of possible volumes. Flexible budget enable an
organization to predict its performance and income levels at a given range of sales levels and activity levels. In
preparation of flexible budgets, costs are to be classified into fixed, variable and semi-variable costs. Since fixed
costs do not vary with short-run fluctuations, fixed cost is estimated to be uniform for all levels of activity, but the
variable costs are estimated volume dependant. The preparation of flexible budgets, require the semi-variable costs
to be segregated into fixed and variable components.
The distinction between fixed budget and flexible budget is summarized as follows:
Fixed Budget Flexible Budget
i. Costs are not classified i. Costs are classified according to the nature of
according to their variability, i.e. fixed, variable and their variability.
semi-variable.
ii. It is inflexible and remains the ii. It can be suitably recasted
same irrespective of the volume of business activity. quickly to suit changed conditions.
iii. It assumes that conditions would
remain static. iii. It is designed to change
iv. Accurate forecasting of results is according to a change in the level of activity.
difficult. iv. Flexible budget clearly shows
the impact of various expenses on the operational
v. Actual and budgeted aspect of the business.
performances cannot be correctly compared if the v. Comparisons are realistic since
volume of output differs. the changed plan figures are placed against actual
vi. This budget has a limited ones.
application and is ineffective as a tool for cost vi. This budget has more
control. applications and can be used as a tool for effective
cost control.
vii. All conditions will remain vii. Under flexible budgeting, series
unaltered is an unrealistic expectation on the part of of fixed budgets are prepared for different levels of
the management. activity.
viii. Costs cannot be ascertained if viii. Costs can be easily ascertained
there is a change in the circumstances. at different levels of activity. The tasks of fixing
prices become easy.
The points of difference between traditional budgeting and ZBB are as follows:
Traditional Budgeting Zero Base Budgeting
i. Traditional budgeting is i. ZBB makes a decision oriented
accounting oriented. Main stress happens to be on approach.
previous level of expenditure.
ii. First reference is made to past ii. A decision unit is broken into
level of spending and then demand is made for understandable decision packages which are ranked
inflation and new program. according to importance to enable top management
to focus attention, only on decision packages which
enjoy priority to others.
iii. A rational analysis of budget
iii. Some managers deliberately proposals is attempted.
inflate their budget request so that after the cuts they
still get what they want. iv. It is clear and responsive.
iv. It is not as clear and responsive v. Their responsibility is shifted
as ZBB from top management to the manager of decision
v. It is for top management to unit.
decide why particular amount should be spent on vi. It makes a very straightforward
particular decision unit. approach and immediately spotlights the decision
vi. It makes a routing approach. packages enjoying priority over others.
Q13. What is meant by Zero Based Budgeting? Explain clearly the steps involved for introduction of ZBB in
an organization. Mention also the advantages and drawbacks of ZBB.
Ans: ZBB is a method of budgeting whereby all activities are reevaluated each time a budget is formulated. It is an
approach to budget review and evaluation that requires a manager to justify the resources requested for all activities
and projects, including on – going activities and projects, in rank order. Each functional budget starts with the
assumption that the function does not exist and it is at zero cost. Increments of costs are compared with increments
of benefit, culminating in the planned maximum benefit for a given budgeted cost. Under this system a number of
alternatives
Q. What is Budgetary Control? Discuss various advantages and essentials for the success of budgetary
control?
Ans: Budgetary Control: “Budgetary control means the establishment of budgets relating to the responsibilities of
executives to the requirements of a policy and continuous comparison of actual with budgeted results either to
secure by individual action the objective of that policy or to provide basis for its revisions”.
Budgetary Control is a system of controlling costs which includes the preparation of budgets, coordinating the
departments & establishing responsibilities, comparing actual performance with the budgeted & action upon results
to achieve maximum profitability.