chapter 11

BUDGETS, BUDGETING AND BUDGETARY CONTROL

Meaning and Definition of Budget

A budget simply means a financial plan. It is a plan expressed in
money. It is a detailed plan of action of the business for a definite period of
time.
In business a budget may be defined as a statement showing the
expected income and expenditure for a definite future period.
Meaning of Budgeting
Budgeting simply means preparing budgets. It is a process of
preparation, implementation and the operation of budgets.Thus, budgeting
is the process of formulating budgets.
Meaning and Definition of Budgetary Control
Budgetary control is a system of using budgets for planning and
controlling costs. In short, budgetary control is a system of controlling a
firm's activities through budgets.
According to Rowland and Harr, "budgetary control is a tool of
management used to plan, carry out and control the operations of
business".
Budget, Budgeting and Budgetary Control
Budget is a plan. But budgeting is the process of preparing
budgets. When budget is used for control purpose, it becomes budgetary
control. Following are the important differences among budget, budgeting
and budgetary control:

(1) Budget and budgeting are narrower concepts while budgetary control is
a wider concept.
(2) Budgets are business estimates for future period, budgeting is the
process of preparing these estimates while budgetary control is a system of
achieving performance on the basis of budgets.
(3) Budget and budgeting are the parts of planning whereas budgetary
control is linked with co-ordination and control. In other words, budget is a
financial plan while budgetary control results from the administration of
financial plan.
Steps involved in Budgeting and Budgetary Control
The steps involved in budgeting and budgetary control are summarised as
follows:
1) Establishing budgets for each section of the organisation.
2) Recording the actual performance.
3) Comparing continuously the actual performance with that budgeted.
4) Calculating the differences or variances between budgeted performance
and actual
performance.
5) Analysing the causes for such differences or variances.
6) Furnishing budget reports to top management.
7) Taking corrective action where necessary.
8) Revising budget, if necessary.
Objectives of Budgets and Budgetary Control
The basic objective of budgeting and budgetary control is to
achieve the objectives of management. The subsidiary objectives are
summarised as below:
1) To co-ordinate the activities of different departments of an organisation.
2) To reduce uncertainties.
3) To direct individuals and departments to achieve goals.
4) To plan and control income and expense so as to attain maximum
profitability
5) To fix the responsibility of various individuals in the organisation.
6) To direct the capital expenditure in the most profitable manner.
7) to improve the operational efficiency of the departments and cost centres
8) To eliminate wastes of all kinds to improve economy and efficiency.
9) To ensure that sufficient working capital is available for the efficient
operation of the business
10) To show the management where action is needed to correct
inefficiency.
Essentials of Effective Budgetary Control
 Some preliminary steps are to be taken for a successful and sound
budgetary system. The following are the essential conditions or
requirements or pre-requisites of a good budgetary system:
1. Support of top management:
Budgetary control system should have the full support and the
wholehearted co-operation of every member in the organisation.
2. Clear and realistic goals.
For the successful budgeting and its systematic implementation, it
is essential that the goals should be clear and realistic.
3. Adequate accounting system:
The accounting system should provide the required information in
time.
4. Minimum cost of operation:
The system should not cost more than its worth. The ultimate
object of the budgetary control system should always be maximisation of
profit
5. Effective communication
For the successful budgeting, there should be a free communication
throughout the organisation in order to make them actively interested in the
budgetary control programme.
6. Timely reporting:
A sound and successful budgetary control system requires a timely
and prompt reporting system. This enables management to take remedial
action in time.
7. Flexibility:
A budgetary control system should be kept flexible.
8. Sound organisation:
A sound organisation is needed for successful budgetary control.
The authority and responsibility of each manager should be clearly fixed. A
budget committee may be constituted.
Organisation for Budgetary Control (Steps in the Installation of
Budgetary Control System)
The following steps are involved in setting up a sound organisation
or in the installation of a system of budgetary control:
1. Establishment of budget centres:
 Budget centres or departments should be established for the
purpose of defining responsibility and also for the cost control. A budget
centre is that part of the organisation for which the budget is prepared.
2. Introduction of adequate accounting records:
The accounting system should be such that it should be able to
record and analyse the information required for the operation of the system.
3. Budget training and education:
All personnel should be trained in operating the system of
budgetary control. There must be proper orientation of employees in the
utility and principles of budgeting.
4. Preparation of an organisational chart:
There should be a well defined organisational chart for budgetary
control. Organisational chart defines the functions and responsibilities of
each member of the management team.
5. Establishment of budget committee:
In small concerns, a budget officer or the accountant may perform
all the work connected with the preparation of the budget. But in large
concerns, a budget committee is appointed to formulate a general
programme for preparing budgets and exercising overall control.
6.Preparation of budget manual:
It is the next step.It is a document which specifies the
responsibilities of the persons engaged in the routine of and the forms and
records required for budgetary control. It is considered to be the "Magna
Carta' of the budgetary control.
7. Fixation of budget period:
Another step is the determination of the budget period. A budget
period is the length of time for which a budget is prepared and employed.
There is no right period for any budget. It may be weekly or monthly or
quarterly.
8. Determination of key factor:
In the preparation of the budgets, it is necessary to consider the key
factor/ factors. A key factor is one which limits the activities of an
undertaking. It is a factor which affects all other budgets. Therefore, the
budget relating to the key factor is prepared before other budgets are
formed
9. Determination of the level of activity:
It is necessary to establish the normal level of activity of the
business. Normal level of activity is the level that the company is expected
to achieve under the present conditions. This level of activity is essential in
production planning.
Need for the Preparation of Budgets (Advantages of Budgets and
Budgetary Control)
Budgets play an important role in the effective use of resources.
Budgets are needed for achieving overall organisational goals. They help
management in the allocation of responsibility and authority. Following are
some of the important benefits of budgets and budgetary control: (1) Tool
of planning:
Budgeting compels the management to plan for the future. It makes
planning precise and purposeful,
(2) Promotes profitability:
It minimises wastage of all kinds and promotes efficiency,
productivity and profitability
(3) Evaluates managerial performance:
It is a tool for measuring the managerial performance.
(4) Optimum utilisation of resources:
It ensures optimum utilisation of both human and non- human
resources.
(5) Co-ordination:
It ensures co-ordination of activities of various departments and
facilitates smooth running of the business enterprise.
(6) Tool of control:
It is an important tool to control income and expenditure. Through
budgetary control, the management can find out the deviation from the plan
and
take remedial actions.
(7) Improves communication:
It improves communication throughout the organisation.
(8) Motivates executives:
It motivates executives to attain the given goals.
(9) Facilitates delegation:
 It assists in delegation of authority and assignment of responsibility.
(10) Measures performance of departments:
It provides a tool for measuring the
performance of various departments.
Disadvantages of Budgetary Control
Budgetary control suffers from the following limitations:
(1) Based on estimates and forecasts:
Budget deals with future periods. Therefore, it depends upon
forecasts. Estimates and forecasts can never be accurate.
(2) Rigidity:
It tends to bring about rigidity in control.
(3) Success depends upon support:
A budgetary system cannot be successful understood and
supported by the managers and subordinates
(4) Only a tool of management:
Budgeting is merely a tool of management and not a substitute for
management. It just helps the management in carrying out the decisions.
(5) Expensive:
It is an expensive technique. This is because it requires the
employment specialised staff.
(6) Requires continuous evaluation:
There should be continuous evaluation of the actual performance.
Otherwise, budgeting will hide inefficiencies
(7) Time consuming:
It is a time consuming process. During the period of preparation of
budget the business conditions may change. Then all the estimates may go
wrong.
(8) Employees' resistance:
Inefficient executives and workers may oppose the introduction of
budgetary control system
Classification of Budgets
Budgets can be classified in many ways.
(A) Classification according to time factor (B) Classification according to
flexibility factor
(C) Classification according to function
(A) Calssificaiton according to Time Factor
On the basis of time, budgets can be of following three types:
(1) Long-term budgets:
These budget are related to planning the operation of a firm for a
period of 5 to 10 years.
(2) Short term budgets:
These budgets are drawn usually for a period of one or two years
(3) Current budgets:
These budgets cover a period of one month or so. These are
related to current conditions.
(B) Classification according to Flexibility Factor
On the basis of flexibility, budgets are classified into following two
types: (1) Flexible budget, (2) Fixed budget.
Flexible Budget:
Flexible budget is a dynamic budget. It shows estimated costs and
profits at different levels of output, In flexible budget, costs are analysed
according to behaviour such as fixed and variable. It is also called variable
or sliding scale budget.
Fixed Budget:
Fixed budget is a budget which is designed to remain unchanged
irrespective of the level of activity attained. It does not change with the
change in the level of activity. It is also called static budget.

Difference between Fixed Budget and Flexible Budge

Fixed Budget
1. Based on the assumption that
business conditions do not change.
2. Comparison between actual and
budgeted costs is not possible.
3. Costs are not classified
according to variability.
4. Prepared for a specific level of
activity.
Flexible Budget
1. Based on the assumption that
business conditions change.
2. Comparison between actual and
budgeted costs is possible.
3. Costs are lassified according to
variability.
4. Prepared for different levels of
activities.
5. Not useful for control, price 5. Useful for cost control, l pricing
fixation etc. decisions etc.

(C) Classification according to Function

On the basis of functions, budgets can be of the following two types:
(1) Functional budgets, and (2) Master budgets.
Functional Budgets:
Functional budgets are those which are prepared by heads of
functional departments for their respective departments, Functional budget
is one which relates to the function of a business. Functional budgets are
prepared for each function.
Functional budgets may be further classified into two-operating
budgets and financial budgets.
Operating Budgets:
Operating budgets are those budgets which relate to the different
activities or operations of a firm. These are concerned with the revenues
and expenses arising out of the operations of the firm such as sales,
purchase, production etc. These are the primary budgets.
Financial Budgets:
Financial budgets are those which incorporate financial decisions of
an organisation. They show in details the inflows and outflows of cash and
the overall financial position.
Master Budgets:
Master budget is a summary of all functional budgets. It summarises
sales, production, purchase, labour, finance and plant and equipment
budgets. Thus, master budget is the overall budget.
Preparation of Financial Budgets
Financial Budgets include cash budget, capital budget etc. Here, we
discuss only cash budget.
Cash Budget
Cash budget is the most important of all the functional budgets. It is
prepared only after all the other functional budgets are prepared. It is also
called the financial budgetary.
Zero-Base Budgeting ( ZBB )
 ZBB is a new management technique. It aims at cost reduction and
optimum utilisation of resources. In this technique of budgeting the
unwanted projects and activities get dropped and wanted and desirable
activities and projects get included in the budget. Ithevideya is also known
as priority-based budgeting.
Steps in Zero-Base Budgeting (Process)
The basic steps involved in ZBB are as follows:
1.Determination of the objectives of budgeting:
The first step in ZBB is to decide the purpose of an activity for which
zero base budget is to be prepared. The objective may be to reduce
expenditure on staff, to discontinue an activity or project in preference to
another etc.
2. Identification of decision units:
The organisation is divided into decision units. Decision unit refers to
a department, a project or a product line to which ZBB is to be
applied.Identification of such units is done in consultation with managers.
3. Development of decision packages:
The most important step in ZBB is to develop decision packages. A
decision package is simply a particular activity of a decision unit. Each
decision unit has several decision packages.
4. Evaluation and ranking of decision packages:
After the formulation of the decision
packages, they are to be ranked by the management on the basis of the
benefits.
5. Allocation of resources to decision units and preparation of
budgets:
After ranking the decision packages, the next step is to allot funds to
different decision units. Then budgets relating to each unit are prepared.
Thus, budgets are prepared on the basis of decision packages and the
availability of funds.
Advantages of Zero-Base Budgeting
1. It is possible to eliminate all types of wastages and inefficiencies. This
leads to cost reduction.
2. Allocation of resources is made on the basis of cost benefit analysis.
Hence, it ensures optimum utilisation of resources.
3. It ensures active participation of managers in the budgeting process.
4. It leads to operational efficiency
5. It improves communication and co-ordination within the organistion
Disadvantages or Limitation of ZBB
1. It is very time consuming.
2. It requires a lot of paper work.
3. It is costly.
4. It requires skilled managers at all levels of the organisation.
5. ZBB is not always acceptable to staff or management or trade unions.
6. It lays more and more emphasis on short term costs and benefits than
on long term benefits and costs.