Chapter 18: Budgetary control



On completion of this topic you should be able to
Describe the main stages in budgetary control Differentiate between fixed and flexible budgets Explain the purpose of budgetary control and the requirements for an effective system Describe the advantages and disadvantages of budgetary control 

Independent study
Study Chapter 18 Progress test and practice questions(s) as set
Business Accounting 1

The story so far «  

Unlike financial accounting, there are no statutory regulations governing the preparation of management accounting information, as it is intended for internal users One advantage is that information can be produced about future financial periods
We have already seen that cost accounting techniques can use actual (past) costs or budgeted (future) costs 

This is very important as planning and control are essential if a business is to make a profit
Business Accounting 2

309) Business Accounting 3 . p.Budgetary control  Budgetary control is µthe process by which financial control is exercised by managers preparing budgets for revenue and expenditure for each function of the organization in advance of an accounting period. It involves the continuous comparison of actual performance against the budget to ensure the plan is achieved or to provide a basis for its revision¶ (Collis and Hussey. 2007.

that contains the detailed plans and policies to be pursued during a future accounting period¶ (Collis and Hussey. 310) A budget centre is µa designated part of an entity for which budgets are prepared and controlled by a manager¶ (Collis and Hussey. 2007. p. 2007. 310) Business Accounting 4 .Budgets and budget centres   A budget is µa quantitative or financial statement. p.

p. or the difference between the predetermine revenue and the actual revenue¶ (Collis and Hussey. 2007. each manager compares the actual performance of his/her budget centre against the budget and takes action to remedy any controllable adverse variances A variance is µthe difference between the predetermined cost and the actual cost. 311) An adverse variance is an unfavourable difference Business Accounting 5 .Variances    Once the budget period begins.

interpretation and use of budgets Revision of budgets where amendments are needed to make them appropriate and useful (continued) Business Accounting 6 .Main requirements for an effective system of budgetary control      A sound and clearly defined organization with managers¶ responsibilities clearly defined Effective accounting records and procedures that are clearly understood and applied Support and commitment of top management for the system of budgetary control Education/training of managers in the development.

Main requirements for an effective system of budgetary control (continued)      Recognition that budgetary control is a management activity and not an accounting exercise Participation of managers in the budgetary control system An information system that provides data for managers so they can make realistic predictions Correct integration of budgets and their effective communication to managers Setting of budgets that are reasonable and achievable Business Accounting 7 .

Main stages in budgetary control Consult with managers Make assumptions and predictions Set detailed budgets to meet objectives Measure actual performance and compare with budget Revise budget or take remedial action to achieve plan Business Accounting 8 .

so that management can set out their assumptions about what is going to happen to the firm¶s markets and the business environment Required Using knowledge you have gained from other modules. there needs to be a consultation process. jot down the key factors that managers should consider before setting their financial plans for the forthcoming period Business Accounting 9 .Exercise 1 Role of assumptions in business planning   In order to set realistic financial plans.

social or environmental factors that will affect the demand for the organisation¶s products/services Effects of the activities of other related organisations (eg major customers or suppliers) Business Accounting 10 .Solution 1 Role of assumptions in business planning Key factors include assumptions about Changes in the size of the market and their market share Competitors¶ strategies Changes in interest rates and sources of funding Increases in the cost and availability of energy. materials and labour Changes in legal.

Objectives. strategies and plans  The overall purpose of budgetary control is to help managers plan and control the use of resources in a systematic and logical manner to ensure that they achieve their financial objectives Profit satisficing (making a satisfactory level of profit) Profit maximisation (making the maximum profit)  Having made their assumptions about the forthcoming period. the next stage is to set out their financial strategies in detail by preparing financial and non-financial budgets that cover every aspect of the firm¶s activities Business Accounting 11 .

Example Non-financial and financial budgets Sales and marketing budget Non-financial budgets Sales volume budget (number of units) Sales personnel budget (number of staff) Sales vehicles budget (number of vehicles) Television budget (minutes) Press budget (column inches) Business Accounting Financial budgets Sales revenue budget (£) Sales cost budget (£) Advertising budget (£) 12 .

building each figure into the budget where it can be justified from the expected conditions and policies This makes the budget more relevant than incremental budgeting Business Accounting 13 .Methods for setting budgets  In incremental budgeting managers add a percentage to the previous period¶s budget to take account of expected changes in price levels But this is unlikely to create a budget that is relevant to the particular conditions expected and non-recurring revenue and/or non-recurring expenditure will be included  In zero-base budgeting managers start from zero.

Interrelationship of budgets    Functional budgets are drawn up for each department or function in the business by the specific functional manager Non-functional budgets are also needed (eg capital expenditure budget. budgeted balance sheet) and these require contributions from various managers and the accountant The master budget incorporates all the budgets and is the final coordinated budget for the period Business Accounting 14 . budgeted profit and loss account. cash flow budget.

Types of budget  A fixed budget is one that is not changed if the activity level differs from the planned level Disadvantage is that if the actual activity level is higher than planned. so the budget becomes irrelevant  A flexible budget is designed to change with the level of activity to reflect the different behaviour of fixed and variable costs Advantage is that any cost variance can only be due to an increase or decrease in fixed costs Business Accounting 15 . an adverse cost variance may be due simply to the increase in variable costs at this level.

indicating whether the variances are favourable or adverse Business Accounting 16 .Exercise 2 Variance analysis  Variance analysis is the investigation of the factors that have caused the differences between the actual and budgeted figures A favourable variance is where actual performance is better than planned An adverse variance is where actual performance is worse than planned (eg costs are higher or revenue is lower)  Required Complete the June budget report for Jersey Flowers Ltd.

000 68.000 22.000 22.500 18.000 9.Pro forma Jersey Flowers Ltd Budget report for June Budget £ 28.000 20.250 e £ ? ? ? ? ? ? ? ? ? 17 Revenue Roses Carnations Lavender Costs Salaries Expenses Administration Net profit Business Accounting .000 17.500 46.000 18.500 21.000 16.000 10.750 20.000 46.750 21.500 67.000 A tual Var an £ 27.

500 67.500 46.000 46.000 18.500 21.000 16.000 tu l £ 27.000 17.000) 500 (500) (750) Revenue Roses arnations Lavender Expenditure Salaries Expenses Ad inistration et profit A A F A A F A A Note y An adverse variance is where actual revenue is lower than planned or where actual costs are higher than planned Business Accounting 18 .000 20.000 9.000 22.000 68.750 20.Solution 2 Jersey Flowers Ltd Budget report for June Budget £ 28.250 V ri n e £ (250) (500) 500 (250) 0 (1.500 18.750 21.000 10.000 22.

information is provided to managers responsible for revenue and expenditure Utilisation of resources .capital and effort are used to achieve the financial objectives Motivation of managers through the use of clearly defined objectives and monitoring of achievement Planning ahead gives time to take corrective action Establishes a system of control if plans are reviewed regularly against actual Transfer of authority to individual managers for decisions Business Accounting 19 .Advantages of budgetary control        Co-ordination of all functions and activities Responsibility accounting .

Disadvantages of budgetary control      Set in stone .managers may be constrained by the original budget (eg make no attempt to spend less than maximum or exceed target income) Time consuming process may deflect managers from their prime responsibilities of running the business Unrealistic if fixed budgets are set and actual activity level is not as planned Disillusioning for managers if fixed budgets are set and not achieved merely due to changes in activity Demotivating for managers if budgets are imposed by top management with no consultation Business Accounting 20 .

Conclusions  An effective system of budgetary control helps managers plan and control the use of resources in a systematic and logical manner Planning helps co-ordinate the activities of the business Control is achieved through the frequent monitoring of progress against the plan by managers of budget centres. and taking corrective action where necessary  It is a communication system Financial objectives and constraints are communicated to managers of budget centres and regular monitoring keeps management informed of progress towards objectives Business Accounting 21 .

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