Chapter18

CONCEPT OF BUDGET CONCEPTOFBUDGET

TheCharteredInstituteofManagementAccountants(CIMA)London,hasdefineda
budgetasafinancialand/orquantitativestatement,preparedpriortoadefinedperiod g / q , p p p p
oftime,ofthepolicytobepursuedduringthatperiodforthepurposeofattaininga
givenobjective.Itmayincludeincome,expenditureandemploymentofcapital.
Characteristics
( )
Abudgetisprimarilyaplanningdevicebutitalsoservesasabasisfor
f l ti d t l
(a)
performanceevaluationandcontrol.
(b)
Abudgetispreparedeitherinmoneytermsorinquantitativetermsorinboth.
(c)
Abudgetispreparedforadefinitefutureperiod.
Purposeofabudgetistoimplementthepoliciesformulatedbymanagementfor
(d)
Purposeofabudgetistoimplementthepoliciesformulatedbymanagementfor
attainingthegivenobjectives.
CONCEPT OF BUDGETARY CONTROL CONCEPTOFBUDGETARYCONTROL
Budgeting:Theactofpreparingbudgetsiscalledbudgeting.InthewordsofJBatty,the
entireprocessofpreparingthebudgetsisknownasbudgeting.
ConceptofBudgetaryControl:AccordingtoCIMA,London,Budgetarycontrolisthe
establishmentofbudgetsrelatingtotheresponsibilitiesofexecutivesofapolicyandthe
continuouscomparisonoftheactualwiththebudgetedresults,eithertosecureby
individualactiontheobjectiveofthepolicyortoprovideabasisforitsrevision. j p y p
Characteristics
(a)
Establishmentofbudgetsforeachfunction/departmentoftheorganization.
(a)
(b)
Comparisonofactualperformancewiththebudgetsonacontinuousbasis.
A l i f i ti f t l f f th tth b d t d f t k th
(c)
Analysisofvariationsofactualperformancefromthatthebudgetedperformancetoknowthe
reasonsthereof.
(d)
Takingsuitableremedialaction,wherenecessary.
(d)
(e)
Revisionofbudgetsinviewofchangesinconditions.
OBJECTIVES OF BUDGETARY CONTROL OBJECTIVESOFBUDGETARYCONTROL
Abudgetprovidesa
detailedplanofaction
f b i
Budgetingaids
managersinco
di i h i ff
Abudgetisacommunication
device.Itprovidesnotonly
d d di d forabusinessovera
definiteperiodof
time.
ordinatingtheirefforts
sothatobjectivesof
theorganization.
adequateunder standingand
knowledgeoftheprogrammesand
policiestobefollowedbutalso
alertsabouttherestrictionstobe
adheredto.
Planning Coordination Communication
Abudgetisauseful
deviceformotivating
managerstoperform
i li i h h
Controlisnecessary
toensurethatplans
andobjectivesaslaid
d i h b d
Abudgetprovidesauseful
meansofinforming
managershowwelltheyare
f i i i inlinewiththe
companyobjectives.
downinthebudgets
arebeingachieved.
performinginmeeting
targetstheyhavepreviously
helpedtoset.
Performance
Motivation Control
Performance
evaluation
ESSENTIALSOFEFFECTIVE
BUDGETING
S f
Participation
R bl Supportoftop
management
Participation
byresponsible
executives
Reasonable
goals
Clearlydefined
organization
Continuous
budget
education
Adequate
accounting
system
Constant
vigilance
Maximum
profits
Costofthe
system vigilance profits system
Integration Integration
withstandard
costs
PRELIMINARIESINTHEINSTALLATION
OFBUDGETSYSTEM
d f f h h b d d
Creationofbudgetcentres
Budgetcentreissectionoforganizationforwhichabudgetisprepared.
Systemisdesignedtobeabletorecordandanalyseinformationrequired.
Introductionofadequateaccountingrecords
Organizationchartshouldbepreparedwhichshowstheplanoforganization.
Preparationofanorganizationchart
Inlargeconcerns thedirectionandexecutionofthebudgetisdelegatedtoa
Establishmentofbudgetcommittee
Inlargeconcerns,thedirectionandexecutionofthebudgetisdelegatedtoa
budgetcommitteewhichreportsdirectlytothetopmanagement.
AbudgetmanualhasbeendefinedbyCIMA,Londonasadocumentwhich
Preparationofbudgetmanual
g y
setsouttheresponsibilitiesforthepersonsengagedintheroutineofandthe
formsandrecordsrequiredforbudgetarycontrol.
Budgetperiodisalengthoftimeforwhichabudgetispreparedandoperated
Budgetperiod
Budgetperiodisalengthoftimeforwhichabudgetispreparedandoperated.
Thekeyfactormeansthefactorwhichlimitsthesizeofoutput.
Determinationofthekeyfactor
CLASSIFICATION OF BUDGETS CLASSIFICATIONOFBUDGETS
Onthebasisof
functionand
scope:
Onthebasisof
flexibility:
scope:
Functional
y
Fixed Functional
budgets
Fixed
budget
Master
budget
Flexible
budget g g
FUNCTIONAL BUDGETS FUNCTIONALBUDGETS
Afunctionalbudgetisonewhichrelatestoaparticularfunctionofthebusiness.
SalesBudget:Thesalesbudgetisastatementofplannedsalesintermsof
quantityandvalue.
ProductionBudget:Theproductionbudgetisaplanofproductionforthebudget
period.
ProductionCostBudget:Thisbudgetshowstheestimatedcostofproduction.
Theproductionbudgetshowsthequantitiesofproduction.Thesequantitiesof
productionareexpressedintermsofcostinproductioncostbudget.
RawMaterialBudget:Thisbudgetshowstheestimatedquantitiesofalltheraw
materialsandcomponentsneededforproductiondemandedbytheproduction
budget.
PurchaseBudget:Thepurchasebudgetprovidesdetailsofthepurchaseswhich
areplannedtobemadeduringtheperiodtomeettheneedsofthebusiness.
FUNCTIONAL BUDGETS(Contd.) FUNCTIONALBUDGETS(Contd.)
LabourBudget:Labourcostisclassifiedintodirectandindirect.Somecompaniespreparea
labourbudgetthatincludesbothdirectandindirectlabour,whileothersincludeonlydirect
labourcostandincludetheindirectlabourintheoverheadcostbudget. g
ProductionOverheadsBudget:Theproductionoverheadsbudgetrepresentstheforecast
ofalltheproductionoverheads(fixed,variableandsemivariable)tobeincurredduringthe
budgetperiod.
SellingandDistributionCostBudget:Thisiscloselyrelatedtosalesbudgetand
representstheforecastofallcostsincurredinsellinganddistributingthecompanys
productsduringthebudgetperiod.
AdministrationCostBudget:Thisbudgetrepresentsforecastofalladministration
expenses,likedirectorsfees,managingdirectorssalary,officelighting,heatingandair
conditioning,etc.
CapitalExpenditureBudget:Thisbudgetrepresentstheexpenditureonallfixedassets
duringthebudgetperiod.Itincludessuchitemsasnewbuildings,machinery,landand
intangibleitemslikepatents,etc.
CashBudget: Itisadetailedestimateofcashreceiptsfromallsourcesandcashpayments
forallpurposesandtheresultantcashbalancesduringthebudgetperiod.
CASHBUDGET C S U G
Itisadetailedestimateofcashreceiptsfromallsourcesandcashpaymentsforall
purposesandtheresultantcashbalancesduringthebudgetperiod.
P i fC hB d PreparationofCashBudget
Thismethodisusuallyusedforshorttermcash.Thecashbudgetbeginswiththeopeningbalance
ofcashinhandandatbank.Tothisareaddedthecashreceiptsfromvarioussourcesandfrom
Receipts
and p
thisaredeductedallpaymentsofcash,whetheroncapitalorrevenueaccount.Theresultant
figureistheclosingcashbalance.
Payments
Method
Thismethodissuitableforlongtermcashforecast.Itisbasedontheviewthatitisthe
profitthatisthesourceofcashinthebusiness.TheprofitasperP&Laccountsisconvertedinto
cashfigurebypreparinganAdjustedProfitandLossAccount.Allthoseitemsofincomeand
expenditure,whichdonotinvolveaninfloworoutflowofcash,areadjustedintheforecasted
profitfiguretoarriveatthefigureofcashmadeavailablebyprofit
Adjusted
Profitand
Loss
Method
profitfiguretoarriveatthefigureofcashmadeavailablebyprofit.
Method
Thi h di l df f i h i f l U d hi h db d d
Balance
Thismethodisalsousedforforecastingcashrequirementsforlong.Underthismethodbudgeted
balancesheetispreparedwithallitemsofassetsandliabilities,exceptingcashorbankbalance.
Thetwosidesofthebalancesheetarethentotalledandthebalancingfigureistakenascash.
Balance
Sheet
Method
MASTER BUDGET MASTERBUDGET
A di CIMA L d b d i b d i i i AccordingtoCIMA,London,masterbudgetisasummarybudgetincorporatingits
componentfunctionalbudgetsandwhichisfinallyapproved,adoptedandemployed.
Amasterbudgethastwoparts
(i)operatingbudget,i.e.,budgetedprofitand
lossaccount,
(ii)financialbudget,i.e.,budgetedbalance
sheet.
Themasterbudgetispreparedbythebudgetdirector(orbudgetofficer)andis
presentedtothebudgetcommitteeforapproval.Ifapproved,itissubmittedtotheBoardof
Di f fi l l Th B d k i d / l i Directorsforfinalapproval.TheBoardmaymakecertainamendments/alterations
beforeitisfinallyapproved.
FIXEDANDFLEXIBLEBUDGETS U G S
FixedBudget:Afixedbudgetisonewhichispreparedkeepinginmindonelevelofoutput.
Itisdefinedasabudgetwhichisdesignedtoremainunchangedirrespectiveofthelevelof
activityattained.
Fl ibl B d I fi db d fl ibl b d i hi hi d i d FlexibleBudget:Incontrasttoafixedbudget,aflexiblebudgetisonewhichisdesignedto
changeinrelationtothelevelofactivityattained.Theunderlyingprincipleofflexible
budgetisthatabudgetisoflittleuseunlesscostandrevenuearerelatedtotheactual
volumeofproduction.
DistinctionbetweenFixedandFlexibleBudgets
Fixedbudgetassumesstatic
Fixedbudgetispreparedfor
l l l f ti it b t
Fixedbudgetfiguresarenot
changedwhenactuallevelof g
businessconditionswhereas
flexiblebudgetisbasedon
theassumptionofchanging
businessconditions.
onlyonelevelofactivitybut
flexiblebudgetsmaybe
preparedfordifferentcapacity
levelsorforanylevelof
activity.
g
activitychanges.Butin
flexiblebudgets,thefigures
areadjustedaccordingtothe
actuallevelofactivity
attained.
Whenactuallevelofactivitydiffers
frombudgetedlevelofactivity,then
infixedbudgetsmeaningful
Underchangingbusiness
environments,fixedbudgetshave
verylimiteduseforcontrol.But
comparisonbetweenactualand
budgetfiguresisnotpossible.Butin
flexiblebudgets,suchcomparisons
arequiterealistic.
flexiblebudgetsareveryusefulfor
costcontrolandperformance
evaluationunderchangingbusiness
environments.
BUDGETREPORTS U G O S
Establishingbudgetsinitselfisofnouseunlessthereisacontinuousflowofbudgetreports
showingcomparisonofactualandbudgetfigures.Budgetreportsshouldbepreparedat
regularintervals(say,everymonth)showingthereasonsforthedifferencesbetweenactual
andbudgetfigures andbudgetfigures.
EssentialsofaBudgetReport
(a)Thebudgetreportsshouldbesimpleandsuitableforthelevelofunderstandingfortheuser.
(b)Reportsshouldbepresentedpromptly.
(c)Reportsshouldbeaccuratebuttheextremeaccuracyshouldnotbeatthecostofpromptness.
(d)Th i i l f ti h ldb tili d h ibl (d)Theprincipleofexceptionshouldbeutilized,wherepossible.
(e)Thereportsshouldcontainonlyessentialinformationaccordingtotheneedsoftheuser.
ZERO BASE BUDGETING (ZBB) ZEROBASEBUDGETING(ZBB)
AccordingtoCIMA,London,ZBBisdefinedasamethodofbudgetingwherebyall
activitiesarerevaluatedeachtimeabudgetisset Discretelevelsofeachactivityarevalued activitiesarerevaluatedeachtimeabudgetisset.Discretelevelsofeachactivityarevalued
andacombinationchosentomatchfundsavailable.
MainFeaturesofZeroBaseBudgeting(ZBB)
1.Allbudgetitems,both
oldandnewlyproposed,
areconsideredtotall
2.Amounttobespenton
eachbudgetitemistobe
3.Adetailedcostbenefit
analysisofeachbudget
programmeisundertaken
andeachprogrammehas areconsideredtotally
afresh
g
totallyjustified
andeachprogrammehas
tocompeteforscarce
resources
4.Departmental
objectivesarelinkedto
corporategoals
5.Themainstressinnot
onhowmucha
departmentwillspendbut
6.Managersatalllevels
participateinZBBprocess
andtheyhave
corresponding corporategoals
p p
onwhyitneedstospend
corresponding
accountabilities.
PERFORMANCEBUDGETING
Performancebudgetingisarelativelynewconceptwhichfocusesonfunctions,programmes
andactivities.Performancebudgetsareestablishedinsuchamannerthateachitemof
expenditurerelatedtoaspecificresponsibilitycentreiscloselylinkedwiththe
performanceofthatcentre performanceofthatcentre.
StepsinPerformanceBudgeting
EstablishmentofresponsibilitycentreResponsibilitycentres,asegmentofan p y p y g
organizationwhereamanagerisresponsiblefortheperformanceareestablished.
EstablishmentofperformancetargetsForeachresponsibilitycentre,targetsareset
intermsofphysicalperformancetobeachieved. intermsofphysicalperformancetobeachieved.
EstimatingfinancialrequirementsInthisstep,thefinancialsupportneededto
achievethephysicaltargetsisestimated.
ComparisonofactualwithbudgetedperformanceThisisausualstepin
budgetarycontroltoevaluatetheactualperformance.
ReportingandactionVariancesfrombudgetedperformanceareanalysedand
reportedforcorrectiveactiontobetaken.