BUDGETING & 1

BUDGETARY CONTROL
part 2
 Budgetary control systems:
Feed forward & feedback control
 Fixed and flexible budgets
 Motivational & behavioural issues,
limitations & Beyond budgeting
 2

BUDGETARY CONTROL
is a process whereby the ‘master
budget, devolved to responsibility
centres, allows continuous monitoring
of actual results vs budget, either to
secure by individual action the budget
objectives or to provide a basis for
budget revision’.
(CIMA Official Terminology)
 3

BUDGETARY CONTROL
SYSTEM (BCS)

is a system of controlling costs which includes:

• the preparation of budgets
• coordinating the various departments, and
• establishing responsibilities to achieve
maximum profitability.
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BCS: THE OBJECTIVES

 To provide a detail plan of action
 As a means of resources allocation
 To coordinate various departments in a firm to
ensure goal congruence in achieving the
objectives of the firm
 To ensure actual activities conform to the plan
 To ensure costs are dealt with by the right
personnel/department
 To measure performance & provision of
incentives
 5

BUDGETARY CONTROL
SYSTEMS

Feed forward control Feedback control

 FIXED BUDGET VS FLEXIBLE 8

BUDGETS
• Fixed budget (static
• Flexible budget is a
budget) is where the
budget that adjusts or
budget amounts do
flexes with changes
not change and
in activity level.
remain unchanged
• It is more
from the amounts
sophisticated and
established at the
useful than a fixed
time that the budget
budget especially for
was first prepared.
costs that vary with
volume or activity.
 9

PREPARING A FLEXIBLE
BUDGET
To flex a budget for different activity levels,
one must know how costs behave with
changes in activity levels (the costs
behaviour):
Total variable costs Total fixed costs
change in direct remain unchanged at
proportion to changes any level within the
in activity levels. relevant range.
Unit variable cost is Unit fixed costs vary
constant. according to activity
level.
 10

PREPARING A FLEXIBLE BUDGET

• Firstly, costs are divided into three segments:
fixed, variable and semi-variable
• Then, the semi- variable costs are further
classified into fixed and variable cost and then
budget is designed accordingly.
• A number of budgets are prepared for
alternative output levels to show the amount of
expense to be reached at each level of activity.
 11

Vivi Resta Sdn Bhd provides hill view lodging in

Mercu Alam . The business activities are expressed in
number of guest stay days.
The actual operating costs incurred for the most recent
month and the budgeted costs are presented below:
BUDGET ACTUAL
No. of guest days 9,000 10,000
RM RM
Costs:
Wages 226,000 228,000
Toiletries and other supplies 5 45,000 49,000
Food and beverages 20 180,000 213,000
General administration overhead 160,000 149,000
Total Costs: 611,000 639,000
 12

Additional Information:
1. The budgeted wages includes RM10,000 fixed
allowance paid to assistant chefs.
2. Toiletries and other supplies costs vary according to
number of guest stay days.
3. The food and beverages are budgeted at RM20 per
guest day.
4. General and administration costs are considered as
fixed costs.
Required: Base on the actual result in the recent month,
prepare a revised flexible budget and performance
report indicating the cost variances.
 13

Revised Flexible Budget

for the most recent year:
Budget Actual
No. of guest stay days 10,000 10,000
RM RM
Costs:
Wages 250,000 228,000
Toiletries and other supplies 50,000 49,000
Food and beverages 200,000 213,000
General administration overhead 160,000 149,000
Total Costs: 660,000 639,000

Wages = (RM24 x10,000 days) + RM10,000 = RM250,000

Toiletries = RM5 x 10,000 days = RM50,000
Food & beverages = RM20 x 10,000 days = RM200,000
 14

Revised Flexible Budget for

the most recent year:
Budget Actual Variance
No. of guest stay days 10,000 10,000 -
RM RM RM
Costs:
Wages 250,000 228,000 22,000 (F)
Toiletries and other supplies 50,000 49,000 1,000 (F)
Food and beverages 200,000 213,000 13,000 (A)
General administration
overhead 160,000 149,000 11,000 (F)
Total Costs: 660,000 639,000 21,000 (F)

Wages = (RM24 x10,000 days) + RM10,000 = RM250,000

Toiletries = RM5 x 10,000 days = RM50,000
Food & beverages = RM20 x 10,000 days = RM200,000
 15

PERFORMANCE REPORTS

• Performance reports provide additional

information relating to budget variances.
• This additional information may relate to
financial or non-financial issues that cause the
budget to go outside its allowable range.
• Variance is the difference between the actual
result and the budget or target.
 16

PERFORMANCE REPORTS
Variance is divided into two types,
favourable variance and unfavourable
variance:

Favourable Adverse or
variance means the unfavourable
actual performance variance will make it
or result will have a difficult for the firm
positive impact on the to achieve profit.
business profit,
 17

eg. PERFORMANCE REPORT

FOR THE MONTH OF OCTOBER 20X0
BUDGET ACTUAL VARIANCE
Sales unit 560,000 560,000 -
RM RM RM
Sales Revenue 2,900,000 3,100,000 200,000 (F)
Costs:
Material and labour costs 245,000 280,000 35,000 (A)
Variable factory overhead 392,000 365,000 27,000 (F)
Fixed factory overhead 206,000 292,000 86,000 (A)
Selling & general overhead 414,000 390,000 24,000 (F)
Profit 1,643,000 1,773,000 130,000 (F)

Note: A – indicates an adverse variance

F – indicates a favourable variance
 18

TIARA ENTERPRISE in Sg Buloh.

1. Each packet of banana crackers requires three types of materials;
Material A, Material B and Material C.
2. The business buys Materials A and B from nearby suppliers, while,
supplies of Material C are obtained from a supplier in Perlis.
3. The business’ account clerk prepared the following production cost
budget for the month of June 20X9:
Production quantity
12,000 15,000 18,000
packets packets packets
RM RM RM
Direct materials:
Material A 3,600 4,500 5,400
Material B 20,000 24,500 29,000
Material C 7,200 9,000 11,800
Direct Labour 7,000 10,000 16,000
Overhead 12,400 12,400 12,400
 19

Additional Information:

1. Each packet consists of 1 kg of banana crackers.

2. Each packet of the crackers requires 100 grams of Material C. The supplier in
Perlis would charge an extra RM1,000 for delivery of 1,500 kgs and above.
3. Production workers are paid based on piecework scheme using the following
scales:
Quantity produced RM per packet
Less than 10,000 0.50
10,000 - 15,000 1.00
Above 15,000 2.00

4. During June 2019, Tiara Enterprise manufactured 16,500 packets banana

crackers and incurred the following production costs:
RM
Direct materials:
Material A 5,500
Material B 22,600
Material C 10,000
Direct Labour 18,900
Overhead 14,230

Required: Prepare a flexible budget statement for the month of June 20X9
showing the variance for each cost item.
 20

TIARA ENTERPRISE
Material A:
• VC per packet = RM4,500–RM3,600 = RM900 = RM0.30
15,000–12,000 3,000
• Total FC = RM4,500 – (15,000 x RM0.30) = RM0
• Total Costs = (16,500 x RM0.30) = RM4,950

Material B:
• VC per packet = RM29,000–RM20,000 = RM9,000 = RM1.50
18,000 – 12,000 6,000
• Total FC = RM29,000 – (18,000 x RM1.50) = RM2,000
• Total Costs = (16,500 x RM1.5) + RM2000 = RM26,750
 21

TIARA ENTERPRISE
Material C:
• VC per packet = RM9,000–RM7200 = RM1,800 = RM0.60
15,000 – 12,000 3,000
• Total FC = RM11,800 – (18,000 x RM0.60) = RM1,000
• Total Costs = (16,500 x RM0.6) + RM1000 = RM10,900

Labour costs = (10k x RM0.50) + (5k x RM1) + (1.5k x RM2)

= RM5,000 + RM5,000 + RM3,000 = RM13,000
Overhead costs (FC) = RM12,400
 22

TIARA ENTERPRISE
Flexible Budget Statement for the month of June 20X9
Flexible Actual
budget Result Variance
Production level (packets) 16,500 16,500
RM RM RM
Direct materials:
Material A 4,950 5,500 550 (A)
Material B 26,750 22,600 4,150 (F)
Material C 10,900 10,000 900 (F)
Direct Labour 13,000 18,900 5,900 (A)
Overhead 12,400 14,230 1,830 (A)
TOTAL COSTS: 68,000 71,230 3,230 (A)
 23

PROFIT RECONCILIATION
STATEMENT
• The statement prepared to reconcile the different in the
actual net profit with the original budgeted net profit:
RM RM
Original budgeted profit XXX
Sales variances:
• Margin volume XXX
• Price XXX XXX
XXX
Costs variances:
• Materials XX(A)
• Labour XX(F)
• Overheads XX(A)
• Others XX(F) XX
Actual net profit: XXX
 24

PERFORMANCE REPORT
Original Flexible Actual Variances
Sales (units) 6,000 8000 8000 -
RM RM RM RM
Sales(SP/unit =RM10) 60,000 80,000 75,000 5,000 [A]

Direct Material [RM3/unit] 18,000 24,000 25,000 1,000 [A]

Direct labor [RM2/unit] 12,000 16,000 15,000 1,000 [F]
Maintenance [UVC = 3,000 3,700 4,000 300 [A]
RM0.35]
Depreciation 5,000 5,000 5,500 500 [A]
Rent and rates 3,000 3,000 3,800 800 [A]
Other costs [UVC = RM1] 8,000 12,000 11,000 1,000 [F]
49,000 63,700 64,300 600 [A]
PROFIT 11,000 16,300 10,700
 25

PROFIT RECONCILIATION
STATEMENT
RM RM RM
Budgeted Profit 11,000
Sales Variance : Margin Volume 5,300 [F]
Sales Variance : Selling Price 5,000 [A] 300 [F]
11,300
Adjust for Cost Variances: [F] [A]
Direct Material 1,000
Direct labor 1,000
Maintenance 300
Depreciation 500
Rent and rates 800
Other costs 1,000
2,000 2,600 600 [A]
Actual Profit 10,700
 MOTIVATIONAL,
26

BEHAVIOURAL & ETHICAL

ISSUES OF BUDGETING
• Budgetary slack & budget padding
 Intentional underestimation of revenues
and/or overestimation of expenses
 Misstating projections of costs and revenues
for this purpose is dysfunctional and unethical
behaviour
• Resistance to accept the budgets prepared
• Budget seen as a limit to spending (rigid)
• YES!
 27

LIMITATIONS OF
BUDGETING
• Budgets may be an essential part of any activity
however, they do have a number of
disadvantages, particularly in perception terms.
• Budgets seen as pressure devices imposed by
management, thus resulting in bad labour
relations & inaccurate record-keeping.
• Departmental conflict arises due to disputes over
resource allocation and departments blaming
each other if targets are not attained.
• It is difficult to reconcile personal/individual and
corporate goals.
 LIMITATIONS OF 28

BUDGETING & BEYOND

BUDGETING
• Waste may arise as managers adopt the view,
"we better spend it or we will lose it". This is
often coupled with "empire building" in order to
enhance the prestige of a department.
• Managers may overestimate costs so that
they will not be blamed in the future should
they overspend.
• Beyond budgeting is one approach to
budgeting that tries to resolve the weaknesses
and limitations of traditional approaches to
budgeting.
 THE WEAKNESSES OF 29

TRADITIONAL BUDGETING
(HOPE & FRASER,2003)
• The budgets prepared add little value and require
too much valuable management time which would
be better spent elsewhere.
• Too heavy reliance on the 'agreed' budget has an
adverse impact on management behaviour, which
can become dysfunctional with regard to the
objectives of the organisation as a whole.
• The use of budgeting for communicating corporate
goals - setting objectives, continuous improvement
etc - is seen as contrary to the original purpose of
budgeting as a financial control mechanism.
 30

THE WEAKNESSES OF TRADITIONAL

BUDGETING (HOPE & FRASER,2003)
• Most budgets are not based on a rational, causal
model of resource consumption, but are often the
result of protracted internal bargaining processes.
• Conformance to budget is not seen as compatible
with a drive towards continuous improvement.
• Traditional budgeting processes have insufficient
external focus.
 31

BEYOND BUDGETING
MODEL – PRIVATE SECTOR
• In private sector, managers are forced to
consider current and future opportunities
and threats, particularly where rolling
monthly forecasts of financial performance
operate together with a focus on other
non-financial 'value drivers'.
• Beyond budgeting model entails devolved
managerial responsibility where power and
responsibility go hand in hand.
 32

BEYOND BUDGETING
IN PRIVATE SECTOR
• This will present considerable behavioural
challenges and individual managers might
become overwhelmed by the complexity
of decision-making in such an unregulated
decision-making environment.
 33

THE BENEFITS OF
BEYOND BUDGETING:
• It motivates individuals by giving clear
responsibilities and challenges.
• It eliminates some behavioral issues by making
rewards team-based.
• Authority is devolved to operational managers
who are closer to the action and so can react
quickly.
• It shifts the focus from beating other managers to
beating the competition by creating a climate
based on competitive success.
 34

THE BENEFITS OF
BEYOND BUDGETING:
• Operational managers are
empowered to deliver key
ratios rather than keep to strict
budget limits.
• It establishes customer-
oriented teams.
• It creates information systems
which provides fast and open
information throughout the
organisation
 PARTICIPATIVE BUDGETING
35

(BOTTOM-UP APPROACH)
• Involvement of many people from various
departments and different levels of management in
budget setting process

• Rationale/advantages:
 More accurate input/information
 Higher motivation & better compliance - Staff are
more likely to accept the target
 Give experience & increased skill
 Better communication - Information sharing process
enables more effective targets to be set out
 36

PARTICIPATIVE BUDGETING:
THE PROBLEMS:
• time consuming and costly
• greater chance to manipulation (slacks)
• require coordination & monitoring from
the top management
• may lead to conflicts among different
divisions
 37

TOP-DOWN BUDGETING
APPROACH
Non-participatory approach – subordinates have
little influence on the budget-setting process
The advantages:
• Straightforward and easy to develop
• Management can set priorities
• Provide early guidelines to management so
that they can tailor their budget to a level that
staff can accept.