BUDGETARY CONTROL
INTRODUCTION:
Determination of objectives and goals of an organization are a primary steps taken by any management. Such objectives
must be clearly defined. Objectives may be short term or long term. However, it is necessary to prepare a comprehensive
plan to transform these objectives into reality. Thus, there is a need for precise planning mechanism and thorough control
systems to fulfill the pre‐determined objectives. Planning facilitates systematic work towards achieving the objectives and
controlling helps to review the progress made and to monitor whether the work is progressing as per the plan or not.
Budgeting is a technique that helps in planning as well as controlling. It is a technique of cost accounting with the twin
objectives of facilitating planning and ensuring controlling.

BUDGET:
The Chartered Institute of Management Accountants, London, defines a budget as ‘a financial and/or quantitative
statement prepared prior to a defined period of time, of the policy to be pursued during that period for the purpose of
achieving a given objective.’ Thus, a budget is a detailed plan of operations for some specific future period. It is an estimate
prepared in advance of the period to which it applies.

Features of a Budget:
a) A budget is prepared in advance and is based upon a future plan of actions. E.g. budget for next quarter, next year etc.
b) A budget is a prepared either in money terms and/ or physical units. E.g. sales budget in sales units and revenue
expected.
c) A budget is prepared for the definite future period. E.g. budget for FY 2015‐16 etc.
d) The policy to be followed must be clear and definite and it must be laid down before the budget is prepared.
e) All departments of an organization co‐operate and coordinate to prepare the budgets.
f) A budget is a written document.
g) A budget needs to be updated and corrected at every instance of change in circumstances. This it is a continuous
process.
h) Budgets help in planning, coordination and control.

BUDGETARY CONTROL:
The Charted Institute of Management Accountants, London defines Budgetary Control as “the establishment of budgets,
relating the responsibilities of executive to the requirements of a policy and the continuous comparison of actual with
budgeted results either to secure by individual action the objectives of that policy or to provide a firm basis for its
revision”. It is a system of management control and accounting in which all the operations are forecasted and planned in
advance and results are compared with actual outcome.

Steps of Budgetary Control:
1. Study the environment (internal & external) and forecasting,
2. Establish Budgets, for various functions and operations,
3. Collecting and systematically recording actual performance,
4. Compare actual outcome with budgeted data,
5. Fix responsibilities for under‐achievement and take corrective action,
6. Revise budgets, if necessary.

We can say that budgeting is the art of planning and budgetary control is the act of sticking to the plan. In fact, budgetary
control involves continuous comparison of actual results with the budgets and taking appropriate remedial action promptly.
The success of budgetary control depends on proper basis of measurement to evaluate performance and efficiency.

Objectives of Budgetary Control:
1. Planning – a well defined plan helps an organization to use the scarce resources in an efficient manner and thus
achieving the predetermined targets becomes easy.
2. Co‐ordination – to co‐ordinate different levels of management for achievement of the objectives, e.g. sales manager will
consult the production manager before committing any deadlines to the customer.
3. Control – budgets facilitate centralized control with delegated authority and responsibility. Budgets provide a basis for
controlling through comparison of actual with budgeted performance.
4. Profitability – to achieve maximum profitability by proper planning and ensuring economic use of available resources.

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5. Assessment – by laying down responsibilities of executives and other personnel so that everyone knows what is
expected of him and how he will be judged. Budgetary control is a technique for an objective assessment of executives.
6. Loss reduction – to reduce losses and wastages to the minimum, through adequate planning and control.
7. Focus – to see that the firm is not diverted from its long term objectives and focused on its targets.

Advantages of Budgetary Control:
1. Budgetary control aims at maximization of profits through effective planning and control.
2. Budgetary control ensures the smooth functioning of various departments of an organization.
3. There is a planned approach to expenditure and financing of the business. This facilitates best utilization of funds and
reduces wastages and losses. It is a powerful tool for controlling expenditure.
4. Budgets provide a clear definition of the objective and policies of the concern.
5. Better managerial co‐ordination is facilitated through budgetary control.
6. There is effective and efficient utilization of men, materials and resources, since each level of management is aware of
their authority and responsibilities.
7. Reporting is done on a periodical basis for continuous control. Thus, it facilitates the principles of Management by
Exception. The concerned managerial personnel are involved only in deviations from budgets showing the weak spots
and inefficiencies.
8. Budgeting encourages the habit of forward thinking, making careful study of future problems and taking decisions.
9. The method of evaluating performance against budgets provides a suitable basis for establishing incentive system of
remuneration by results as also spotting people with exceptional qualities of leadership and management.

INSTALLATION OF BUDGETARY CONTROL:
Budgetary Control is extremely useful for planning and controlling the business operations. But, for successful
implementation of a budgetary control system, certain preparations or pre‐requisites are to be fulfilled. They are
summarized below:

A) Organizational Chart
There should be an organization chart laying out in clear terms the responsibilities and duties of each level of executives
and the delegation of authority to the various levels. The organization chart will define clearly the functions to be
performed by each executive relating to the budget preparation and his relationship with other executives. The
organization chart may have to be adjusted to ensure that each budget is controlled by an appropriate member of the
staff.

B) Budget Centre
A budget centre is a group of activities or section of an organization for which budget can be developed. For example –
manpower planning budget, R & D budget, labour hours budget, production cost budget etc. Budget centres should be
clearly defined so that budget preparation becomes easy. Budget centre is established for cost control and all the
budgets should be related to cost centres.

C) Budget Committee
The budget committee is a group of representatives of various functions in an organization. The committee consists of
Chief Executives or Head of Dept. of various functions. The main function of a budget committee –
i. to receive estimates and forecasts,
ii. to prepare budgets,
iii. scrutinize these budgets,
iv. to lay down broad policies regarding the preparation of budgets,
v. to approve the budgets,
vi. to suggest for revision,
vii. to monitor the implementation,
viii. to recommend the action to be taken in a given situation

D) Budget Period
A budget is always prepared prior to a definite period of time. According to C.I.M.A London, budget period is defined as
“the period for which a budget is prepared and used, which may then the sub‐divided into control periods”. It refers to
the period of time covered by a budget. In deciding the length of the budget period certain factors should be considered
such as production cycle, seasonal nature, availability of funds, production methods, reporting durations etc.
A budget period is a period for which budget is prepared while a control period is the periodical interval for preparation
of reports and sending them to the management for review, interpretation and corrective action.


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E) Budget Manual
A budget manual is a document that lays down the responsibilities of persons engaged in budgetary control. The manual
is in the form of a booklet explaining the procedures, formats and records relating to the preparation and use of budgets
and instructions to be followed. A typical budget manual contains the following:
i. Objectives and managerial policies of the organization,
ii. Structure of authority and responsibility,
iii. Functions of budget committee,
iv. Submission due dates of preliminary forecasts,
v. Budget period,
vi. Forms in which various reports are to be prepared, their periodicity, personnel to whom reports are to be sent;
vii. The matters on which action may be taken only with the approval of top management.
viii. Follow up procedures
The main purpose of the budget manual is to inform the executives in advance about procedures to be followed rather
than issuing frequent instructions.

F) Budget Controller
A Budget Controller is appointed to monitor the various functions of Budget Committee and to co‐ordinate their efforts
for preparation of target figures. The Budget Controller does not control, he is staff man and a link between various
functional departments. His duties will comprise mainly of:
i. Helping in preparation of the various budgets and their coordination and compilation into the master budget.
ii. Compiling of information about actual performance on a continuous basis comparing it against the budget figures,
ascertaining causes of deviation, and preparing reports based thereon and sending them to the appropriate
executive.
iii. Bringing to the notice of the management the need for revision of budgets are assisting them in the task; and
iv. Compiling information of all types for the purpose of efficient preparation of budgets and proper reporting.

G) Budget Key Factor
A budget key factor or principal budget factor is defined as ‘a factor which will limit the activities of an undertaking and
which is taken into account in preparing budgets’. A key factor is also known as limiting factory which would restrict the
activities of an organization. Thus, a key factor has to be considered while preparing budgets. Examples of budget key
factor are sales demand, shortage of raw materials, lack of skilled labour or inadequate machine capacity etc. The
management should verify the influence of the key factor on the budget. If the sales demand is only 50,000 units, it is no
use of producing 100, 000 units. Also, if production capacity is 50,000 units, a sales potential of 100,000 units is of no
importance. Decisions will have to be taken resulting in optimum production keeping in view the different limiting
factors. Thus, we can say that a key factor is the starting point in process of budget preparation.
The following is a list of principal budget factors which will influence the targets:
i. Sales ‐ customer demand, pricing policy, shortage of sales staff, inadequate advertising budget
ii. Material – supply of raw material, restrictions on imports
iii. Plant capacity – availability of free machine hours, no. of machines etc.
iv. Labour ‐ availability of skilled labour, as well as casual, unskilled labour, wages etc.
v. Funds – long term and short term capital available at a low cost,
vi. Governmental restrictions etc.

H) Budget Reports
It is essential that the accounting system should be able to record and analyze the transactions involved. Performance
evaluation and reporting of variances is an integral part of all control systems. Thus, budget reports showing the
comparison between the actual and budgeted expenditure should be presented periodically and promptly. The report
should be prepared to give complete reasons for the differences so that proper corrective action may be taken. The
variations / deviations from budgets are analyzed for each item, so as to locate the responsibility and facilitate
corrective action. To prepare an effective budget report, it must be:
i. Simple to understand, containing a suitable heading and budget period,
ii. Regularly and promptly presented,
iii. Should avoid unnecessary details,
iv. Quantitative data analysis,
v. Free from personal bias of the person preparing it; and
vi. Dated and signed by those who prepare and check it.

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CLASSIFICATION OF BUDGETS:
 Functional and Master Budgets
Budgets for a period are classified according to the various activities / functions of the organization. All such activities
are interrelated. The forecasts for individual activities are prepared and then co‐ordinated with other activities. A
consolidated budget is prepared to show the total effect of all the activities as a whole. Approved targets for individual
functions are known as ‘Functional Budgets’. The consolidation of all functional budgets is known as the ‘Master Budget’.
Principal functional budgets:

1. Sales Budget
The sales budget is a forecast of total sales, expressed in terms of money and quantity. A sales budget may be
prepared product‐wise, territory‐wise, country‐wise, customer group‐wise, month‐wise, weekly etc. The first step in
preparation of sales budget is to forecast as accurately as possible the sales anticipated during the budget period.
Sales forecasts are influenced by various factors such as past sales figures, seasonal fluctuations, customer
preferences, level of competition, data from distributors / dealers, demography, pricing policy, government policy
etc.

2. Production Budget
The production budget is a forecast of the production target to be achieved for budget period. A production budget
is prepared in quantity as well as monetary terms, i.e. production units’ budget and the production cost budget. The
main steps involving in the preparation of a production budget are production planning – after considering
production capacity, integration with sales forecast, inventory‐policy and management’s overall policies. Emphasis
should be given to the key factor. The purpose of a production budget is optimum utilization of productive resources
of the enterprise, scheduled production of goods, achievement of customer delivery dates etc.

3. Materials Purchases Budget
Materials Purchase Budget, commonly known as Materials Budget, facilitates the Purchase department in suitably
planning the material purchases. Production budget is the base for preparation of material budget. If the raw
material availability is the key factor, it becomes the starting point. This budget is prepared in quantity as well as in
the monetary terms and helps in planning the funds for purchases of raw materials. Availability of storage space,
financial resources, various levels of materials like maximum, minimum, re‐order and economic order quantity are
taken into consideration while preparing this budget.

4. Cash Budget
Cash budget is a monthly estimate of cash which would be required and available in a future period. Generally, this
budget has two parts showing detailed estimates of cash receipts and cash payments. The main purpose of cash
budget is to predict the receipts and payments in cash so that the firm will be able to find out the cash balance at the
end of the budget period. This will help the firm to know whether there will be surplus cash or deficit at the end of
the budget period. It will help them to plan for either investing surplus or raise necessary amount to finance the
deficit. Also, decisions may be taken on controlling credit policy, managing seasonal fluctuations etc.
Cash receipts include estimated cash‐sales, collections from debtors, sale of assets, borrowings, issue of shares,
dividends received etc. Estimates of cash disbursements include cash purchases, payment to creditors, employees’
remuneration, bonus, advances to suppliers, interest on loan, income tax, fixed asset purchase etc.

5. Capital Expenditure Budget
Capital expenditure budget is related to purchase of fixed assets. Capital expenditure is a long‐term forecast
covering over a year to five years. It is essential that capital expenditure budget be properly co‐ordinated with other
functions budgets, so as to form an integral part of the overall plan. The purpose of capital expenditure is to increase
the earning capacity of the firm in the long run. Capital expenditure results in either acquisition of fixed asset or
permanent improvement in the existing fixed assets. Another important feature of capital expenditure is that the
amount involved is very heavy and such decisions are irreversible. Hence, careful planning is required for capital
expenditure.

6. Direct Labour Budget
The labour required for production process is determined in terms and grades of workers required and the labour
time for each job, operation and process. The rates of pay, allowances, bonus, etc., of each category are then
considered and labour cost to be set for each budget centre is calculated.

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7. Manufacturing Overhead Budget

This budget is prepared for planning of the factory overheads to be incurred during the budget period. In this budget
the overheads should be shown department‐wise so that responsibility can be fixed on proper persons.
Classification of factory overheads into fixed and variable components should also be shown in this budget.

8. Administration Cost Budget
This budget covers the administrative (office) costs for non‐manufacturing business activities. The administrative
overheads include expenses like office expenses, accounting charges, office salaries, directors’ remuneration, legal
expenses, audit fees, rent, postage, telephone, telegraph etc. These expenses should be classified properly under
different headings to determine the responsibilities regarding cost control and reduction.

9. Selling Expenses Budget
The selling expenses include all items of expenditure on the promotion, maintenance and distribution of finished
products. This budget which is clearly related to the sales budget is the forecast of the cost of selling and
distribution, for the budgeted period. Selling and distribution expenses may be fixed or variable with regard to the
sales volume, separate budgets are usually established for fixed or variable selling and distribution expenses.

10. Research and Development Budget
R &D budget helps management in planning the research and development activities in advance and also the
justification of the expenditure. Research and development is one of the important activities of any firm and hence
proper planning and coordination is required for effectiveness of the same.

11. Master Budget
Master budget is a consolidated summary of the various functional budgets. A master budget is the comprehensive
or summary budget incorporating all functional budgets and which is finally approved, adopted and employed. A
Master Budget shows the budgeted profit and loss account, the balance sheet of the organization. The master budget
is prepared by the budget committee on the basis of coordinated functional budgets and becomes the target of the
company during the budget period when it is finally approved. The figures contained in master budget are the
reflection of the actual intentions of the company relating to the different areas for the forthcoming budget period.

 On the basis of Nature / Capacity Utilization
1) Fixed Budget
A fixed budget is a budget designed to remain unchanged irrespective of the level of activity actually attained. When
a budget is prepared by assuming a fixed percentage of capacity utilization, it is called as a fixed budget. A fixed
budget is not adjusted to the level of activity achieved at the time of comparison between the budgeted and actual
costs. Obviously, fixed budgets 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, if there is a significant change in the business
conditions a fixed budget is to be revised. Such budgets are not suitable for cost control and hence fixed budgets are
rarely used.

2) Flexible Budgets
A flexible budget is a budget that is prepared for different levels of capacity utilizations. C.I.M.A, London defines
flexible budget as a budget which ‘by recognizing different cost behaviour patterns, is designed to change as volume of
output changes’. A flexible budget recognizes the difference between fixed cost, semi‐fixed cost and variable cost and
such budget changes in relation to the activity achieved. It is designed to furnish budgeted cost at any level of
capacity utilized. Thus, a flexible budget provides a reliable basis for comparisons as it is adaptable to changes in
production activity. Hence, such budget covers a range of activity i.e. easy to change with variation in production
levels and it facilitates performance measurement and better evaluation. Flexible budget is useful for decision
making in terms of selling price determination and profit planning at different levels of capacity utilization. It
facilitates deciding the discount to be given by maintaining the same profitability.

Features of flexible budgets:
i. They are prepared for a range of activity instead of a single level.
ii. They provide a very dynamic basis for comparison because they automatically vary to changes in volume.
iii. They provide a tailor‐made budget for a particular volume.
iv. These are based upon adequate knowledge of cost behaviour pattern, i.e. fixed, semi‐fixed and variable.

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Fixed Budget vs. Flexible Budget

Sr. Fixed Budget Flexible Budget
1. It does not change with actual volume of It can be changed on the basis of activity
activity achieved. Thus it is rigid budget. level to be achieved. Thus it is not rigid
2. It operates at one level of activity and under It consists of various budgets for different
single set of conditions. levels of activity.
3. Here, all costs are related to only one level of Here, analysis of variance provides useful
activity, so variance analysis does not give information as each cost is analysed
useful information according to its behaviour.
4. It assumes that there will be no change in It assumes that budget should be changed
prevailing conditions, which is unrealistic. as per changing conditions, hence useful.
5. Not useful for decision making, cost control Useful for decision making, cost control as
not determination of selling price. well as selling price determination.

 On the basis of Time
1) Long Term
Any budget exceeding three years is known as Long Term Budget. Master Budget is normally prepared for long
term. In the modern days due to uncertainty, very few budgets are prepared for long term.

2) Short Term Budget
Any budget that is prepared for a period up to one year is known as Short Term Budget. Functional budgets are
normally prepared for a period of one year and then it is broken down month‐wise.

3) Medium Term Budget
Budget prepared for a period 1‐3 years is Medium Term Budget. Budgets like Capital Expenditure, Manpower
Planning are prepared for medium term.

 Zero Base Budgeting (ZBB)
Zero Base Budgeting is method of budgeting where all activities are determined each time a budget is formulated and
every item of expenditure in the budget is fully justified. Thus, ZBB involves budgeting from scratch or zero. ZBB is also
termed as ‘De‐nova budgeting’ or budgeting from the beginning without any reference to any past budgets. ZBB may be
defined as ‘a planning and budgeting process which requires each manager to justify his entire budget in detail from
scratch (hence zero base). This approach requires that all activities be analyzed and evaluated by systematic analysis
and ranked in order of importance. ZBB tries to identify alternative and efficient methods of utilizing scarce resources.
Thus, ZBB facilitates effective achievement of pre‐decided objectives. Under Zero‐Base Budgeting, there is a detailed
analysis and evaluation of each programme in order to justify its inclusion or exclusion from final budget. ZBB concept
was developed in U.S.A. by Peter Pyhrr in 1970 & first applied in US Govt. by President Mr. Jimmy Carter.

Steps involved in Zero Base Budgeting process –
i. Each separate activity of an organization is identified and is called as ‘decision package.’ Clear determination and
analysis of decision packages is important for management,
ii. Justification of decision packages in relation to the organizational goals,
iii. Alternatives for each decision package are considered for selection of better and cheaper options,
iv. Ranking of alternatives as per cost‐benefit analysis,
v. Based on cost‐benefit analysis, the resources are allocated in accordance with the ranking.

ZBB is based on the assumption that every rupee of expenditure requires justification. The traditional budgeting
approach includes previous years’ expenditure which is automatically included in new budget proposals.

Important Features of Zero Base Budgeting:
i. Emphasis on justification of budget expenditure ‐ “why” any particular expenditure is planned.
ii. Alternative ways are considered.
iii. Participation of all levels in decision‐making.

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Advantages of Zero Base Budgeting:

i. ZBB promotes operational efficiency because it requires managers to review and justify their activities or the fund
requested.
ii. For successful execution of budgetary system, responsibility at all levels of management can be ensured.
iii. ZBB is relatively elastic because budgets are prepared every year on a zero base.
iv. In this technique, inefficiencies are removed and cost of production is reduced as every budget proposal is evaluated
on the basis of cost‐benefit analysis.
v. It is helpful to the management in making optimum allocation of scarce resources because a unique aspect of ZBB is
the evaluation of both current and proposed expenditure and placing it some order of priority.
vi. A lot of thinking is required for cost‐benefit analysis, giving rise to many new ideas and a sense of staff participation.

Limitations of Zero Base Budgeting:
1. Defining the decision units and decision packages is a difficult process.
2. ZBB is a very detailed procedure involving a lot of paper work.
3. ZBB requires a lot of training for managers.
4. Cost of preparing and implementation of this system is very high.
5. Ranking of activities and decision making is a subjective process.

 Performance Budgeting
It is budgetary control system where the input costs are related to the performance i.e. the end results. This budgeting is
used extensively in the Government and Public Sector Undertakings. It is essentially a projection of the Government
activities and expenditure thereon for the budget period. This budgeting starts with the broad classification of
expenditure according to functions such as education, health, irrigation, social welfare etc. Each of the functions is then
classified into programs sub‐classified into activities or projects. Objectives of each program are ascertained clearly and
then the resources are applied after specifying them clearly. The procedure for the performance budgets include
allocation of resources (funding), execution of the budget and periodic reporting at regular intervals.

 Forecast vs. Budget
A forecast is an evaluation of probable future events. It is an estimate of the future happenings on the basis of study and
research conducted by an organization. Environmental scanning may be carried out as a pre‐requisite for forecasting.
Budget is an operating and financial plan of a business enterprise. At the planning stage it is necessary to prepare
forecasts for the possible courses of action in the future. Budget is a type of commitment or a target which the
management wants to attain on the basis of the forecasts made. Forecasts are made regarding sales, production cost and
financial requirements of the business. A forecast denotes some degree of flexibility while a budget denotes a definite
target.

Sr. Forecast Budget
1. Forecast is an estimate of future happenings. Budget is the plan & policy for the future period
2. Forecast is mere prediction of future events. Budget is a control technique for future events.
3. Forecasting is preliminary to budgeting. Budgeting starts where forecasting ends.
4. Forecasting has a wider scope Budgeting is limited to quantitative data

LIMITATIONS OF BUDGETARY CONTROL:
1. Based on Estimates – Budgetary control is based upon forecasting, which is merely an estimate. Therefore, the adequacy
or accuracy of budgetary control system depends upon the correctness of the estimates made.
2. Volatility – Budgets are prepared for future business conditions, however, the future scenario is constantly changing.
Thus, budget estimates may lose their usefulness under changing conditions. Rigid budget are unsuitable for seasonal
businesses.
3. Budgetary control system is based on quantitative data (units & monetary) and does not include the qualitative factors
which affect the business enterprise.
4. Installation of a budgetary control system is a costly affair and may not be useful for a small organization.
5. Co‐operation at all levels of management is needed for successful implementation of budgetary control systems. It is
human nature that controls are not accepted easily. Hence, employees may resist to the implementation of such control
system.