MANAGEMENT ACCOUNTING (PART-6)

UNIT- V

BUDGETING FOR PROFIT PLANNING &

CONTROL (PART-2)

1. INTRODUCTION

Dear students, I welcome to you on lecture series of management accounting.

Today we shall take up unit-V, Under unit-V we are going to discuss in detail
about budgeting for profit planning and control. This is part- 2 of our
discussion on budgeting, in our previous lecture; we have learned in detail
about various concepts relating to budgetary control.

Today we shall take up in detail the rest of the part of budgetary control. The
objective of this lecture is to understand all the advantages and disadvantages
being associated with the tool of management accounting. Which is known as
budgetary control? So we have to learn critically, what’s the advantages of
going for the budgetary control, then we shall learn in detail about the
classification on the budgets or on the basis of various parameters being set.

So that we can analyse that how master budget is going to be presented and
how it is being consolidated to give up broader picture of budgeted profit or
loss and budgeted balance sheet. So we shall start up our discussion and first
of all we will critically analyse the budgetary control. For the purpose of doing
the critical analyse; we shall discuss the advantages and disadvantages being
associated with budgetary control.

2. ADVANTAGES OF BUDGETARY CONTROL

So let us take up advantages of budgetary control first. First one is the

maximization of the profit. Obviously when budgets are being set up on the
basis of the budgetary committee recommendation and working with the
heads of the specific departments. We can be able to access the cost
associated and can enhance the profits by controlling cost which is being set
out in our budgets.

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Secondly effective coordination, since we know that they are various
department on the basis of functionality, budgets are being prepared by the
budget committee and effective actions are being taken there on. So a
coordination is being required with the different department so that we can
adere to the needs of those departments and can frame up the budget, which
will help in the boosting up the profits and controlling the cost. Thirdly
evaluation of the effective performance, now it is being based on the basis of
goals set for each department.

Once the goals are being set and objectives are being laid down under the
budgets so framed for each functional aspect of different departments being
set up in the organisation. It becomes very easy to evaluate the performances
associated with each department. For example: there is a production
department, under production department; once the goals are being set up
that the cost associated with the production should go the way in which
budget is being set.

So here what we are going to do that we are improving the operational

efficiency. We are improving the operational efficiency. We are evaluating the
performance of production. Similarly when we go for the sales budgets, what
we are doing is that we are controlling the sales that means demands
stimulation can be worked upon profits can be enhanced.
Then fourth is the clear cut goals and targets. Since budgets are based on a
objective basis. So clear cut goals and targets would be set for each
department and a consolidated goal and budget of the company can be set up
under the master plan so that the target profit and target P&L a/c can be set
up. Fifth is the economy in operation. By economy in operation means the
synergy being generated when the consolidated data is being prepared.

When there is the coordination between different departments obviously

economy in operation can be achieved. Once the target is being set by for
sales department obviously cost of production will be based on it. So in this
way what happens that synergy is being attained or the economy in operation
can be achieved. Since we are working on economy efficiency, so obviously it
will again enhance our profit. So these are the very important parameters to
set out under budgetary controls. 7th one is the introduction of incentive
scheme of remuneration, which can be set up when a labour budget is being
set up where the labour cost is being controlled and incentive can be taken up
under those budgets.

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Shutting down of unprofitable products and activities. Where budgets are
being specified and we are able to ascertain or predict the future profits and
this is to be used for future reference. Once planning is being done, again
under the planning aspect only on the basis of feedback so said. We can shut
down the unprofitable products and activities and overall the products for
activities which are more on profit generation, they can be given the priority
so these are the advantages of the budgetary control. Now having analysed
one aspect of the picture that means the advantages is being associated to use
to control the cost that means tools of management accounting which is
known as budgetary control when it is being used for the benefit of the
organisation as a whole. Let us find out what are the limitation being
associated for using this tool or technique of management accounting. So
these are its limitation. First one is prediction of uncertain future. Since
budgets are being prepared in advance for the future and they are being
prepared in the quantitative terms for a budgeted period. So the most
important or basic limitations associated with the budgetary control is the
prediction aspect. Since they are the forecasted data and future is so
uncertain. We cannot precisly the predict, what has been done should be
achieved in the near future. Second is the changes in the condition, by
changes in condition we mean that where there is a change in the political
scenario or external policy, same changes need to be imbibed in the budget so
drafted so the external as well as the internal factors are going to impact the
budgeted condition so said, so basic budget is going to be deviated from the
actual performances. So we need to again upgrade the budget, so changes and
uncertainty associated with futures are going to impact the budgeted control
we have set up.

Thirdly difficulty in coordination in a large organisation where there are large

number of department it’s very difficult to precisely coordinate the needs of
all the departments being associated. So what if there is a improper
prediction of the sales targets. It’s going to impact the production and
production budget in turn will give us distorted figures. So most important
feature is coordination and where there is lack of management control over
the various departments the problems associated with coordination may
impact the budgetary control. The last one is conflict among different
department where there are man forces and man power associated there is
obviously chances of the conflict among them.

And the same problem or conflict or the limitation is being associated with the
budgetary control. so these are the limitation, which are going to impact the
use of budgetary control in the management for controlling the cost and
enhancing the profits.

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3. PREPARATION OF BUDGETS

Now let’s move ahead and take up the another aspect, there is preparation of
the budgets. Under preparation of the budget; first of all we need to
determine the key factors. Now what are these key factors? Key factors are
the limiting factors. For example: if the material budget is to be presented,
what happens that if there is scarcity of the material the units or cages
required for the material will become the key factor. In the case of labour
budgets so prepared if the important labour or the man force which is
necessary for any particular assignment is in scarcity.

So for that particular assignment the man power or skilled labour may become
the key factor. So we need to determine the key factor first analysing the
requirement of our budget. Secondary making forecast. Forecast is to made by
taking into consideration in present and the past data’s and making them
adjusted according to our needs. Thirdly evaluation of alternative combination
of factors.

Here we are going to take up alternative combination and work upon it. So
that the proper alternative can be chosen upon. Fourthly preparation of
various financial budgets. Now financial budgets are to be prepared so that we
can get to know the liquidity position. Fifth one is the most important factor
that is preparation of cash budgets and master budget. The cash budget on
one hand will show us the liquidity position as well as the requirement of the
cash for a particular project. Similarly the master budget is the consolidated
data of all the functional budgets.

Which is going to present the targeted profit for the company as a whole and
lastly we will prepare the master budgets, by consolidating the budget of each
department. So that overall picture can be cleared to us. So these are the
steps to be followed when we go for the preparation of budget under
budgetary control.

4. CLASSIFICATION OF BUDGETS

Now the next important aspect to be discussed is the classification of budget.

Under classification of budget, we will take up various bases and on those
bases, we are going to do the classification of budget in order to know.

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What budget is to be used and what is the function of each budget. The first
one is the budget which is based on scope. Scope shows the working area that
what budget we need to prepare and what is extend of preparing that budget.
Secondly based on efficiency.

Efficiency here denotes the fixed and flexibility criteria of making the budgets
based on conditions that whether the conditions are same or they are going to
change again on the basis of the condition is being stipulated. we are going to
prepare the budget? And lastly based on period, on the basis of period
obviously the period can be either long term or short term. So accordingly we
are going to prepare the budgets and can set out the standards. So first one
which we have discussed is based on scope.

When budgets are being based on scope, we can prepare two sort off budgets
either functional budgets or the master budgets. When we move ahead, we
will learn what is falling under functional budget and what’s the significance
of master budgets. Based on efficiency, efficiency here denotes the mode of
working or flexibility in the organisation. So here also we are going to prepare
two short of budgets; fixed budget and flexible budgets.

Thirdly based on conditions, on the basis of condition we have already

discussed that the conditions are not going to remains same for prolong rated
period. So again we are going to make two sort of budgets on the basis of
conditions. The first one is the basic budget which remains almost same and
another is the current budget. Which takes into consideration the changes
taking place and how they are to be implemented in the budget?

So on the basis of the conditions again we have this two classifications. Moving
ahead we have the budgets based on period. So period can be short term or
long term. Similarly the budget so prepared for this period can be short term
budgets and long term budgets. So depending upon the organisation for which
the budget is being prepared the budgets can be classified on the basis of the
short term and long term periods set for those organisation for which the
budget is being prepared.

So this is aspect where where we are going to discuss the further or another
step ahead in the classification. We said that on the basis of scope, we divide
the budgets as functional budgets and master budgets. So again under
functional budgets, let us understand what is the classification criteria or how
many principle functional budget can be set in a organisation. The first one is
the sales budgets, secondly production budgets, thirdly overhead budgets then
financial budgets and R&D here means research and development budgets.

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So these are the primary or the principle functional budgets, which we need
to prepare under the functional budgets. Let us learn about them one by one.
So first of all on the basis of period, we are going to discuss about the long
term and short term budgets. So long term budgets are those budgets, which
are being prepared by top management to reflect long term planning for
special activities like capital expenditure and research and development etc.
So where the top management is going to prepare the budget for long term
planning obviously these budgets would be associated with the period which
extend to a longer period of time and it will be more than one year and it may
vary from three to five year. For example; there is a capital expenditure, so
where capital expenditure is to be taken up by the organisation or it cannot
be at one time exercise that means if a company is going for a construction of
a building. It may go as long as five years. So a long term budget is to be set
for such construction to be undertaken and cost criteria’s are to be
determined.

Secondly short term budgets, budgets generally a duration of one year and
expressed in monetary terms are known as short term budgets. They are being
prepared for a duration of either one year or it can be lesser than that and
generally what happens that where the long term budgets are being framed in
order to facilitate the long term budgets. Secondary or helping the short term
budgets are also being framed so that better control of the cost can be done.

Now on the basis of condition, we have already said that there can be two sort
of budgets; the current budgets and basic budgets. Let us understand first the
current budgets, its duration can be one month and are prepared for current
operation of the business. This budget is more useful than basic budgets as
target it lays down will be corrected to current conditions. So the peculiar
features of current budget is that it is for the current period and it can be for
a month and where the changing condition can be accommodated in this
budget so that the figures reflecting are the appropriate and current figures to
be taken care of then next one is the basic budget. If we go for the current
budgets, we can say that they are sort of the budgets, which we prepare in
our MIS department.

MIS department prepare the current budgets on a monthly basis furnish it to

the top management. Where the current position in relation to the stocks, in
relation to the cash, in relation to the investment can be taken care of? Now
moving ahead to basic budgets let us understand what it represent basic
budget has been defined as a budget which is prepared for use unaltered over
a longer period of a time.

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This does not take into consideration current conditions and can be attainable
under standard conditions. Now when we go for a basic budgets, let us
presume that there is a mall being constructed so there will be a basic budget
being drafted for such mall, that the rental would be such and they will be
enhanced or they will be increased at a rate fixed that means at a 10 percent,
the revenues would be extended then cost criteria would also be defined over
that these over these the cost will be fixed under the given scenario and the
conditions stipulated would be the standard conditions which are being
applicable to the industry as such so under basic budgets obviously we are not
going to make any alteration and conditions would be very specific.

5. CLASSIFICATION OF BUDGETS CONTD…

The next classification of budget, we have learned is the budget based on

efficiency and among it first one is the fixed budget. Fixed budget is one,
which is desired for a specific plant output level and or not adjusted to the
level of activities attained at the time comparison between the budgeted and
actual cost. Fixed budget can be established only for a small period of time
when the actual output is not anticipated to differ much from the budgeted
output. However a fixed budget is liable to revision if due to business
conditions undergoing basic change or due to other reasons.

The actual operation differ widely from the plan in the fixed budget. This
budgets are most suited for fixed expenses but they have only a limited
application and is ineffective as a tool for cost control so under fixed budget
one thing is very certain that they don’t change with the change in the level
of activity. They remain fixed in nature and they are suitable for the fixed
expenses and limitation of fixed budget is that they are not effective tools of
control. Now moving ahead to the flexible budget. A budget which by
recognizing different cost behaviour pattern is designed to change as volume
of output change. It is a budget prepared in manner so as to give the budgeted
cost for any level of activity.

It is a budget which by recognizing the difference between fixed, semi-

variable and variable cost is designed to change in relation to the activity
attained. So we can say that under flexible budget, the budget is going to
change as the level of activity changes.

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By level of activity we mean that the production units if our level of activity
was to prepare the 10,000 units, under fixed budgets the fixed expenses would
remain the same. However under flexible budget if the production has
enhanced from 10,000 unit to 20,000 unit the cost associated with it will
change and the cost behaviour pattern has to be analysed; what are the
variable expenses?

The variable expenses are going to change with the level of activities. Semi-
variable expenses have to be segregated on a suitable basis. Fixed expenses
are to be analysed that up till what level they remain fixed and what changes
is to be made as and when the level of activity changes after a certain point
of time. So these exercises have to be done under the flexible budgets and
they are the most important budget under the budgetary control to prepare
and to analyse cost at different level of activities.

Now on the basis of scope we are having the master budgets. Master budget is
consolidated summary of various functional budgets. A master budget is the
summary budget incooperating its components functional budgets and which is
finally approved adopted and employed. It consists individuality of the budget
profits and loss account budgeted balance sheet and budgeted fund flow
statement. It is being prepared by budget committee coordinating with the
functional budget and becomes the targets of the company during the
budgeted period and it is finally approved.

So we can say that it’s the master or consolidated summary which is being
prepared by the budget committees coordinating with the functional budgets
to reflect the budgeted P&L A/c and budgeted balance sheet and also
budgeted fund flow statements. So it will give the entire picture of the
organisation. Now the another budget which is to be prepared on the basis of
the scope is the functional budget. A functional budget is the budget that is
achievable and is related to the specific unit or process or function or
department of the organisation.

The forecast for the individual activities are prepared and coordinated with
other activity in the organisation and then consolidated to show the total
effect of all the activities as a whole. So we can say that approved targets for
the individual function is known as functional budget and consolidated one is
master budget.

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And functional budget can be sales budget, production budget then it can be
the material, labour head and overhead budgets, research and development
budgets and it can be the cash budgets. So these are the different categories
of functional budgets. Now students, while analysing the classification of the
budgets, let us understand one very important concept under budgetary
control and it is known as zero based budgeting.

Zero based budgeting is concerned with all requisites of budget. It is the

evaluation of existing and new proposed activity and the planning is to be
done for the resources and prioritization and re deployment. That means its
exercise which is to be conducted for all the budgets so said. So we start with
the zero based under the zero based budgeting. Let us understand the
process.

The first one is the specification of decision units for which units or for
decision units the zero based budgeting is to be adopted firstly specification of
same is to be done. Development of decision packages, prioritization of
activity project and programs and finally approval and allotment of fund is to
be done under zero based budgeting.

6. SUMMARY

Now student, we will end up our lecture of today. Let us summarize; what we
have learned in today’s lecture, under today’s lecture, we have critically
analysed the importance of budgetary control by evaluating its advantages and
disadvantages. Then we have tried to learn the methods of preparation of
budget and identifying of the key factors and preparing the budget as such.
When we have learned about the classification of budget on the various
parameters being given that means classification based on the scope, on the
efficiency, on functionality and various parameters have been learned in
detail and finally we have discussed in short about these zero based
budgeting.

With this we are ending up out lecture of today.

Thank You!