6

Budgeting and Budgetary Control

-
-
Aftec you have studied this chapter, you should be able to:
·• llade!Sland the llleaning and define a budget and budget.y control
and 6mitafions of budget.y tonlrol and know the role of
bEge1s 1he
• &plain in ?lanning, COOrdinating and controlling
Desan, the Pltlduction budget, cash budget and other types of functionaJ budgets
aoo know the method of their PffiParation
Distinguish between fixed and flexible budgeting
Prepa,e flexible budgets . . .
• Expeii lhe cnu;,is a1 zen ' - budgeting and l)em:lnilance budgets and their utitily.
Unde.isiald the meaning and purpose of responsibility accounting ..

• , • • the
· st widel used and highest rated manage.ment tool o~
stmJJ mo 1D good mana!IPJllenL,s
• ists the key: - it involves looking svstemati. cally at the
.
~l <aol:f~ in developing financial plm lo guide lh,m m •ILxating
~ . 3llSiness
IJlIZ:. el5 help Dlanagm - - -- -OCesS Of measuring and COrrect:ing
...,. """°""'
,ict:Da1 P'-~
ont
specific fnbire peno .
=-
ova:toa PDSJn::e-that plans roo mp__
0 IS
...
cow,, of action ilie cam
.ed

Meaning and Definition of Budget . d f time expressed in monetaiy and/

l!adg,t 1tfas to a plan relatin!J 1D • definite
.
future peno o
b d el is a fu- "PieSsion of the "P
ected
., - - . , terms. In relation to business, • •. gd. The Chartere! Institute of Management
rr--~ and eq,enditmes for a definite future peno .,, fin ·a1 and/or quantitative statement,
has defined a budget as a am:, fh t eriod f!!!_fhe
•(CIJUJ Lmdon, . of of the policy
P:-epgr<;ti WW: to a defined pen~ . ,, ma include income, expe
of
,a tim~ lo be PW""~~g~: ei,P~
of
Pltpvze nttnmm,, n niven
_u' : I ~
~ -- L
on Or,;,,rfiv,,
n ' Jt y -

6.1
 M.anagementt1

In this words of Gorden Shillinglaw, a business budget is "a fre-determined detailed

action, developed and distributed as a guide to current operations and as a Partial /
subsequent evaluation of performance. II

According to Brown and Howard, '~ budget is a pre-determined statement of 171

. . fi . 'th h ana
policy during a given period which provides a standard or companson wz t e results ;
~~,, I

Characteristics - Budgets have the following characteristics :

(a) A budget is primarily a planning device but it also serves as a basis for Perfn,
evaluation and control.
(b) A- budget 1s prepared either in money terms or in quantitative terms Ot...inj
(c) A budget is prepared for a definite future period. ou
(d) Purpose of a budget is to implement the policies formulated by management for t
the given objectives. · - at
Budgeting
The act of preparing budgets is called budgeting. In the words of J. Batty, "the entire
of preparing the budgets is known as budgeting.
11
P

Meaning and Definition of Budgetary Control

BudgetaJ:Y. control is a system of contr.alling...c:ostS-throu..gb_~pagtion of budgets. Buoi
is thus o·nly a part of the budgetary control. According to C.I.M.A., London, "Buagetary ~
is the establishment of budgets relating to the responsibilities of executives of a policy an
continuous comparison of the actual with . the budget~d results, either to secure by indn
action the objective of the policy or to provide a basis for its revision.
11

In the words of Brown and Howard, "Budge!.E!J!, control system is a system of controllini
which includes the re ation o budgets, co-ordinatin the · de artmenls ana establ
responsj]J.ilities, comparing actual .performance wit the budgeted and acting upon resu

---
achieve maximum profitability.
11
•

.Characteristics-The main characteristics of budgetary control are :

j/l!fi Establishment of budgets for each function/department of the organisation.

_)!1 Comparison of actual performance with the budgets on a continuous basis.
Analysis of variations of actual performance from that the budgeted performance to
the reasons thereof. ·
(sir Taking suitable remedial action, where ·necessary.
(~vision of budgets in view of changes in. conditions. ·
T~e principles involved in budgeting have been likened to those followed by the cap~
5
a ship. B~fore the voya~e, he will plan his route, taking into account such fac~ors as ~
rd
. hazardS, tides and possible adverse weather forecasts. During the journey, he wil~ reco ~
of p,rogress and frequently check actual progress with that planned. Though trying t_o , 1

the pla~, he ma~ have to de~ate from the plan if prevailing circumstances reqw: ;
completion of the Journey, he will compare the conditions he encountered with those he p
Th~ e~perience so gained will be used by him in planning similar voyages in
th
e;
This simple analo_gy serves to illustrate the basic practice used in budgeting and bu
control.
M . d . dt .
In this words of Gorden ~hilling law, a b~smess bu get IS a f re- e ermined detailed
II
1
Managen,"'t,i,,

action, developed and distnbuted as a guide to current operations and as a Partial P~

.
subsequent evaluation oif pe,1 vnnance. " ,,
According to B;own and Howard, '~ budget is a pre-determined statement of m
policy during a given period which. provides
. a standard fior companson
. WI·th the resu/t3anQg~

Characteristics - Budgets have the following characteristics :

(a) A budget is primarily a planning device but it also serves as a basis for E.._erfot-.
evaluation and control. -
(b) A- budget IS prepared either in money terms or in quantitative terms m:..in..b 0
(c) A budget is prepared for a definite future period. ~
(d) Purpose of a budget is to implement the policies formulated by management for .
the given objectives. · - a\
Budgeting
The act of preparing budgets is called budgeting. In the words of J. Batty, "the entire
of preparing the budgets is known as budgeting." .
Meaning and Definition of Budgetary Control
Budgeta_ry_control is a system of co_n.tmlling-costs-thmugh..p,Ep ation of budgets. Bu~
is thus only a part of the budgetary control. According to C.I.M.A., London, "Bu getary ~
is the establishment of budgets relating to the responsibilities of executives of a policy a~
continuous comparison of the actual with _the budgete_d results, either to secure by indm
action the objective of the policy or to provide a basis for its revision."
In the words of Brown and Howard, "Budge!E,_TJ!_ control system is a system of control!in~
which includes the prep_aration of budgets, co-ordinating the · departments an'cl estao!
responsjb.ilim~, comparing actual .perform(l-11.ce with the budgeted and acting upon resu!
achieve maximum profitability. "· .
------
Characteristics-The main characteristics of budgetary control are :
jp!Ji Establishment of budgets for each function/ d~partment of the organisation.
_)!1 Comparison of actual performance with the budgets on a continuous basis. .
Analysis of vari~tions of actual performance from that the budgeted performance to
the reasons thereof.
v'f Taking suitable remedial acti-Qn, where ·necessary.
(~vision of budgets in view of changes in, conditions.
The principles involved in budgeting have been likened to those followed by the cap~
a ship. B~fore the voya~e, he will plan his route, taking into account such fac~ors as 5~
. hazards, tides and possible adverse weather forecasts. During -the journey, he wil~ recor\e
of p_rogress and frequently check actual progress with that planned. Though trymg t~ 1.
the P~, he ma~ have to deviate from the plan if prevailing circumstances requue
completio~ of the JOij~ey, he will compare the conditions he encountered with tho~e he ~
Th~ ~penence so gamed will. be used by him in planning similar voya~es in :uo!
th
This simple analogy serves to illustrate the basic practice used in budgeting and
control.
 ,~
]Judgeta,Y Control
p,td
'

f7 . ue of budg~t~ry control is now widel .

teclllllq 1ack of efficient planning which y used m the business .
1~e tlse of d or that one should h b could have. revealed th world. ~any busmesses
, ti tarte ave een prepared to f a~ the busmess should not
1 bee
5 d audget ace senous dangers ahead.
~s 9st all
,l~
r 'JTIPo
rtant to .understand the distinction b
etween fo
.
rt js 1 t is a .prediction of what may happen recast and a budget.
i forecas Itlent of probable future eve_nts. · as a result of a given set of circumstances. It
ssess h d . .
. ~ a t on the other an , is a planned exercis tO .
8 btldge / forecast. Forecasting thus precedes th e achi?ve a target. It is based on the pros
11
!15 o 3 • • . . e preparation of budget
.., rnain points of distinction between the t.wo are thus .
aJl~ cos ..v,e · ·
d ets relate to 'planned events' i e olic' ·
1')1tl
1s co_ .
i'
. 1, ~u \cerried with 'probable even;s' · p ies and prog.rammes to be pursued. Forecast
' .e., events expected to happen under anticipated
cond1t1ons.
. audget, being a fonnal business plan, can be prepared only by the anthorised management
2 but forecast can be made by anybody.
, audget is a tool of control while the forecast is simply an anticipation of events.
3. forecas~ng is a pre-requisite for budgeting while budgeting is not a pre- requisite for
4
forecasting. .. ·
s. Budgets relate to economic . acti~ties of business, enterprises, government or others.
Forecast may relate to econom1c as well as· non economic activities, e.g., weather
forecast, stock market forecast, etc.

Objectives of Budgetary Control

The following are the main objectives of a budgetary control system.
v:1'lanning. A budget provides a detailed plan of action for a business over a definite period
of time. Detailed plans are drawn up relating to production, sales, raw material requirements,
labour needs, advertising . and .sales promotion performance, research ,and development activities,
capital additions, etc. Planning helps in anticipating many problems long before they may arise
and so1utions can be sought through careful study. Thus most business emergencies can be
avoided by planning. In brief, budgeting forces managements to think ahead, to anticipate and
prepare for the situation. · .
Budgeting aids managers in co-ordinating th~ir efforts so that objectives of
tbe organisation as a whole harmonise with the objectives of .its d,ivisions. Effective planning and
:~anising contribute a lot in achieving co-ordination. There should be co-ordination in the
,::gets of various departments. For example, the. budget of sales should be in co:ordinati~n with
Withbudget of ·production. Similarly, the production budget should be prepar~d m co-ordmatio~
tbe purchase budget, and so on.
~llllltunication. A budget is a comm~nication device. The approved budget co~ies are
kn uted to all management personnel which provides not only adequate understanding ·and
to ~wledge of the programmes and policies to be followed but also alerts about the restrictions
e adhered to~ . . .
' 6.4
111111111111
Ma11agemelltt1.
Ceo
lt~I
It is not the budget itself that facilitates communication, but the vital • f
mmunicated in the act of preparing budgets and participation of all responsible~ 0:tnaij
, • ~ Ila~' 0

. Motivatio~. budget_ is _a. useful device ~or motiv~~ng managers to perform i .

e company obJectives. If mdmduals have actively participated in the preparati n Une
it acts s a strong motivating force to achieve the targets. on of b11d~
ntrol.. Contro_l is necessary to ens~re that pla~s a~d objectives as laid do .
1

udgets are bemg achieved. Control, as applied to budgeting, 1s a systematised effort t'#rt ll\ :
management informed of whether the planned performance is being achieved or n ; keep
purpos comparison is made between plans and actual performance. The differeno · Por t 1

the . o is reported to the management for taking corrective action. ce hetw,

6. Performance evaluation. A budget provides a useful means of informing man .
well they are performing in meeting targets they have previously helped to set. In many agers n
there is a practice of rewarding employees on the basis of their achieving the budget ~0lllPan
promotion of a manager may be linked to his budget achievement record. atge~
Advantages of Budgetary CQntrol
Budgetary control provides the following advantages' :
/ . Budgetin_g compels managers to think ahead-to anticipate and prepare for Chan ,
· conditions. ·
v2:',Judgeting co-ordinates the activities of various departments and functions of the b~
increases production efficiency, eliminates waste and controls the costs.
4. It pinpoints efficiency or lack of it,
Budgetary control aims- at maximisation of profits through careful planning and co ,
. n,1
6. It provides a yardstick against which actual results can be compared.
7. It shows management where action is needed to remedy a situation.
f It ensures that working capital is available for the efficient operation of the busin~
9. It directs capital expenditure in the most profitable direction.
10. It instills into all levels of management a timely, careful and adequate consideration
all factors before reaching important decisions.
i1. A budget motivates executives to attain the given goals.
12. Budgetary control system creates necessary conditions for the introductio!}_of stana,
costing technique.
13; Budgeting also aids in obtaining bank credit.
14. A budgetary control system assists in delegation of authority and assignment ,
. responsibility. ·
15. Budgeting creates cost consciousness and introduces an attitude of mind in which ~1
and efficiency cannot thrive.

Limitations of Budgetary Control "

The list of advantag~s given above is impressive, but a budget is not a cure all for organisati~
ills. Budgetary control system suffers from certain limitations and those using the system shou
be fully aware of them. ·
' ' J'JJ"ag1.w·· J
6.5
r ~g ~fl .
' I
·tations are :
t ~fl
tiittl . base d on estimat
t plan 1s
~e u\l iact science., Ab ~ute accu es. Budg ets are based on f
. dge . •
•",', ren9 o~ weak~ess of the ~;,~"•fore, is ~t ::!,~,:"~3
~ . (Jl'Y with ~Inch estimates are made. T~ control system depends to a large ,'!tent,
'1,,,d on ~,~ates must be kept in view. us, wlu1e using the system, the fact that
t ,s f {ig1d1ty. A budget programme
,.i nJI'net
1 o con d'ti'
' ;ness i ons.. Budgets will losemust
m hbe dyna_mic. and continuously deal with the
t v . bllsievised Wl'th th e changmg. . circumsta uc- · of then use fuln ess if. they acquire rigidity
t r.,;~g
ot r
,e 11 .119 is only a too\ of management B d .
nces.
11 /gell tool of management. "'!he budg;t g~g cannot take the place of management
0
'~011lf~etimes it is believed that introduc: \ be regarded not as a master, but as a
~~t.f ~o success. Execution of a_b_ ud et will n:; 2 a budget Wogramm_e is alone sufficient
~ re its. tion must participate enthusia ti 11 ~ccur automatically. It is necessary that the
"'e rgaillsa s ca Ym the programme for the realisation of the
0
~IJ' tarY goals. ·
1ul!e._iOpp0 51•tion from l staff.
t Employees
A h may .n! t lik·e to be evaluated and thus oppose introduction
~,.iud eta contro . sysd em. .s sue
· .' inefficient
. . .--m
managers may try to create difficulties -the-
of introducing an operating this system.
fl!, ExPensive_ te~hn~que. The ~nstallation _ and operation of a budgetary control system is a
~y affair as it reqwres th~ emp~o-yment :of specialised staff and involves other expenditure
,inch small conceJ11S ~ay find difficult to incur. However, it is essential that the cost of
iJtroducing and operating a budgetary control system should not exceed the benefits derived
th!J!ITOID,
~TIALS OF EFFECTIVE BUDGETING
!budgetary control system can p_rove successful:only when certain conditions and attitudes
mst, absence of which will negate to ·a laJge extent the value of a budget system is any business.
Such conditions and attitudes which are e_ssential for effective budgeting are as follows :

,.,r.{upport-of top management. If the"budget system . . . . - - - - - - - - -- - - ,

uto be successful, it must be fully supported by every Essentials of Budgeting
member of management and the impetus and direction 1. Support~of top management.
must come from the very top management. No control 2. Participation by responsible
::~m can be effective unless the org·anisation is
~~ed that the top management considers the system
executives.
3. Reasonable goals. -
to~ unportant. Thus the top management mu~t be 4. Clearly defined organisation.
PoUct tted to the budget idea as .well as to the principles, 5. Continuous budget education.
es ~d philosophy underlying the system. 6. Adequate accounting system.
2
~c~pation by responsible executives. .Those 7. Constant vigilance.
articled '?th the performance of the budgets should 8. Maximum ptofits.
is 'ln the process of setting the budget figures. 9. tost of the system.

'\
,, ensure proper implementation of budget 10. Integration with standard costs.
es. t

I
I

4P -
 i\fq ,
Jzq~
6.6 . --- . ures should be realistic·and represen e?te~,.
onable goals. The ~udg~~!~ agree that the budget goals are rea~reason
If ':.eas responsible executi~es s_ In order to derive ~axi: ·1m _ttable ~\1
gOals.!JI' I defined org~s~~on~entres should be bmlt up Within ~fi s fro ~
\.)"Clearlyl defined respons1b1lity centres ·should be separately sh he org I
system, we s1 1 oWtt

fo
b s or eac . Th best way to ensure the active int · ·
..: .. uous budget education. d ti'eon in respect of ob.Jee tives, Potentlerest oft~
nl,U, b dget e uca . ls . als ."~
emsors is continuous u . hed through wntten manua ' meetings, etc and t
bsupd
u ge .
tin'g This may be accom~lis. ·d tc may be discussed.
, lts achieve e ., . . .
· 'WhereJ...~
•y
o;.2;bud .. , actual resu There is close relationship between bud . ·
ti g system. • 9etin
dequate accoun n 0
. has to depend on accounting department f 9
For the preparation of budgetsh ~:sis for many estimates. The accounting or re~
data which primarily forms t et in terms of areas of managerial. responsib~Ustein s~1
designed so as tO set up •
accoun
•
s for
ntial . successful budget ary control. 1 ty· In ,
'b1'lity accounting is esse 0
resp~ . . R ports comparing budget and actual results sh
/ C~nstant Vl:g:la:c~tio; focussed on significant exceptions-figures tha~llld ~1
prepared and spec1a a e are
different from those expected. .. . . - 'o .
.
ax1mum pro • fits The ultimate obJect of realism~_
; U.1:: maximum profit shou~
permost.
gy(ost of the system. rhe budget system shdould n_~t co~t mo~ ~ an iUs WortJ
iNt'ot practicable to calculat~ exactly what a bu ; get sys em 1s w_o . ,. 1t on~
against adding expensive refinements unless their value clearly Justifies them.
m.Antegration with standard cost~ng system. Wher~ standard ~osting system~
it~~ld · be completely integrated .w;.tb .the. Pll@.e.LRIQ.Qlamllle, m respect of bt
preparation and variance analysis. .
· BUDGETADMINISTRATION
Pre-requisites. for _the successful implementation of a budgetary control system ~e'
1. Creation of budget, centre·s. A budget c_entre _is a section of the organisal
undertaking for ,which a separate budget is prepared. A budget centre may be a depi
a part thereof, Budget centre must he+Iwrl~ defi~e-a,,.separate budget hai
for each such ·ce · l_ of the head of the department conc·emed. Fore
the .;eeparation of-PJ,1-rcllase.Jmdgst,,Jhe..,. . _ ase m n . Simi!
prepanng labour cost- budget, the personnel manager wi\l be of great help.
2
• Introdu~on of adequate accounting records. The accounting system should bes
as to be able to record and analyse the information required. The budget procedures
th
· ell_!ploy ~ sam:_~~~fication of revenues and expenses as the accountingjepartment. ,~
c:nnot be maaeif The tlifuticafions do not coincide. A chart of"a~ o7nts correspondiJi
budgel: centres should be maintainea.
·3. Preparation of an orga · t· · h . t' t for a
bd · . . nisa ion c art. Proper organisation 1s essen ia ·
o:g~:~: syt·~temE. Ahn .organisation chart should be prepared which cl.early shows. the~
-i.wa 10n. ac member of mana t h .
r~ onsibility ao d-h.4~~relation'Siti - gemen s ould know t_he exact scgp~ ftheor1
chart and written suppleme ts Jrt h o-osHie,r-me~ For this purpose, copies 0
· n s ould be distributed to all concerned.
 a

&
. 4
ation ch art will depend
on chart is given in E ~Pon the 6.7
" o.,isatl Xhibit 6 1 nature and .
l"i119'' • size of th

( ----"T--- ~~~::::~:;;:~:~;::'.J~ e company. A sped.men of

Chief Research &

Accountant Development
Manager
Purchases • Production
sates Budget Labour • Cash Research &
• sudget Budget Cost
• Plant Budget Development
setliI19 Budget • Capital Budget
• cost Utilization
Exp.
sudget Budget
Budget
Distribution • Master
• cost Budget Budget
Advertising
Budget

EXHIBIT 6.1. Organisation chart for budgetary control

4,Establishment of budget committee. In large concerns the direction and execution of the
ge~ is delegated ~o a budget co~mittee which reports di;ectly to the top management. The
l controller 1s usuall a 01nted to se · or. He is incharge of
· g budget ·manual of instructions and accumulates the budget and· actual figures for
rting. Other 'members of the budget committee usually comprise various heads of functional
ents, like sales manager, purchase 'manager, production manager, chief accountant, etc.
wn in the above organisation chart. Each member prepares his own departmental budget(s)
· are then considered by the committee for coordination.
ctions: The main functions of a budget committee are as follows :
(a) To provide historical data to all departmental heads to help them in estimating.
(b) To issue instructions to departJ.fil.nts regarding requirements, dates of submission of
estimates, etc. ·
(c) To define the general pJLij~~s Qf_theJnallaQement in relation t~ the ?udget syst:m.
(d) To receive budg ;f"°est,i,ulates from various departments for consid~ration _a~d review.
(e) To discuss difficulties with departmental heads and suggest possible revisions. _
(f) To evaluate and revise the estimates fieforepreparing the final budget.
(g} To make recommendations on budget matters where there is co,!!tlia:b.etw~n...depamaents.
(h_}To. prepare budget summaries. ·
(t} To prepare a master budget ~.ctio,nal.hud9ce.ts.hav.e. been approved.
6.8
·_ · • their budgets by the comnti~
U) To inform departmental heads of any revisioE!-made in •
(k) To coordinate all budget wo:d<. . where necessary.
(I) To analyse
. . variances
. and recommeng._~~ti . ~l ~- fl
- de ne d by CIMA
has been . . . ., Lo.ltd
5. Preparation of budget manual. A budget manua ns engaged in the routine of c
as "a dOCH!!),W,.w]lich,.set.s-® Lthe_tg,s12onsibiJities for} ~l irtliusasta'tefiient~
;JaJ}'. cont!~l. . l se~ up with duties and resp~
theJ.9.IEJL9-nd.,,r,gcoJds~required_fQr. _blliig<
pud£l:.:ljoli£ies. It lays down the details oft~~ 9,rgamsation~ et director and the procedures
of executives including the budget _committee and bu g. ctivities a:
programmes to be followed for developing budgets for van~us a f ll · .
. l mansed as o ows .
Con.tents: The contents of a budget mattua are sum
the
._A} Desc,nption,.of budget. syste~ and its objectives,- ·
(b) Procedure and forms to be used m budget preparation. . db d t dir ct
(c) Resp~nsibilities ~f operational executives, budget committ_ee an u ge e or.
(d) Budget caleng_ar, specifying definite dates for the completion of each part of the bud\
ancI submission of the reports.
(e) Method of accounting and account codes_in use.
(j) Procetto.re'To-oea-dopt-etlln operating the system.
(g) Follow-u'J)-proceuures.
6. Budget pe~ get period is a lengtb. of time for which a budget is prepared i
opeiat~d. Budget periods vary between shot! term and long term and nupecific period can
laid down for all budgets: It vanes among concerns and industries for several factors.
A budget is usually prepared for one year which corresponds to the accounting year. It ~t:
sub-divided into quarters and in tum each quarter is broken down into three separate mom:
When a business experiences seasonal fluctuations, the budget period may be fixed to cllffl i
seasonal cycle. If -the seasonal cycle covers say two or thtee years, a long term budget str.
be.. prepared to cover that period. The long period may then be broken down into smaller pi
by preparing short term budgets.
Budgets .for capital expenditure are usually prepared on a' long term basis. For ex~
ele·ctricity companies which incur very ·heavy capital expenditure, the need for new
stations is forecast possibly five to. ten years in adva3ce. Such l~ng term budgets are suppteme:
by ' short term -ones. · · · · · ·
7. Detennin~ · n of the principal budget factor or key factor. Also known as
. . '--- ~ . , .th~ key factor means the factor which limits the size of outpat
1s defined. as . e Jae tent o whose in e ce s rst be assessed in order to ~
that functional budgets are ca~ nt" Such·a factor is of vital impo ance and ~
alloudgets to a large extent.
The key f~ct?r ·serves as the starting point for the preparation of budgets For~
sales potentiald h· ·ted ' sales is
· · .~i actor. Therefore, sales· budget should
•
be ptePaieo~
..i
Pro uc on
• fu ti l b dan ot er bu gets 'll f ll th
Wl O ow e sales budget. Thus a key factor deternune tlot'
· · s p n~
m nc ona u gets. Among the various key factors which affect budgeting are the fo .
(a) Sales ·
(i) Low market demand
(ii) Shortage of experienced salesman.