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Budgetary Control Systems

1. THE PLANNING PROCESS. Given the increasing complexity of business and the ever-changing environment faced by firms(social, economic, technological and political) it is doubtful whether any firm can survive by simply continuing to do what it has always done in the past. If the firm must earn satisfactory levels of profit in the future, it must plan its course of action.


objectives concern the firm as a whole. It is essentially a long-run activity which seeks to determine the direction in which the firm should be moving in the future. The corporate objectives are set as part of the corporate planning process which is concerned with the selection of strategies which will achieve the corporate objectives of the organisation.

A frequently asked question in formulating the corporate plan is where do we see ourselves in ten years time? To answer this successfully the firm must consider: what it wants to achieve (its objectives). How it intends to get there (its strategy). What resources would be required (its operating plan). How it is doing in comparison to the plan (control).

Corporate objectives should relate to the key factors for business success. These include; Profitability . Market Share Growth . Customer satisfaction Cash flow . Quality Ret. on capital employed .Industrial Relations Added value . Earnings per share Unit objectives, on the other hand, are specific to individual business units, divisions or functions of an organisation.

For corporate planning purposes it is essential that the objectives chosen are quantified and have a timescale attached to them. A statement such as maximise profits or increase sales would be of little use in corporate planning terms. Some typical egs would be; Increase the no. of customers by 20%(sales). Reduce the no. of rejects by 50% (prodn dept) Produce monthly reports within 5 days of the end of each month (management accounting dept).

Corporate objectives may conflict with divisional objectives in large organizations. A danger is that the organization will divide into a number of selfinterested segments, each acting at times against the wishes and interests of other segments. The setting of the objectives is very much a political process: objectives are formulated following bargaining by the various interested parties whose requirements may conflict. Such conflicts may be resolved via prioritization, compromise, negotiation and satisficing.

(a) Prioritization is where certain goals get priority over the others. This is usually determined by senior managers but there can be quite complicated systems to rank goals and strategies according to certain criteria. (b) Negotiation is the bargaining process that occurs at each stage of the budgeting process. This allows full participation to take place by all budgetees. Any revision to the budget must be after giving full consideration to arguments for including any of the budgeted items.

(c ) Compromise is the central aspect of any process of negotiation where there is disagreement. It can be seen as positive where both parties win something but also negative where both parties lose something. (d) Satisficing occurs when a satisfactory rather than an optimal solution is found. Organizations may not aim to maximise performance in one area if this leads to poor performance elsewhere. Rather they will accept satisfactory, if not excellent performance in a number of areas.

The planning and control cycle has seven steps. Step 1. Identify objectives. Step 2. Identify potential strategies. Step 3. Evaluate strategies. Step 4. Choose alternative courses of action. Step 5. Implement the long-term plan. Step 6. Measure actual results and compare with the plan. Step 7. Respond to divergence from the plan.

(1) Identify objectives; Objectives establish the direction in which the management of the organization wish it to be heading. They answer the question: where do we want to be?. (2) Identify potential strategies; This stage involves information-gathering exercise to ensure that it has a full understanding of where it is now. This is known as position audit or strategic analysis and it involves looking both inwards and outwards.

(a) The organisation must gather information from all of its internal parts to find out what resources it possesses: what its manufacturing capacity and capability is, what is the state of its technical know-how, how well it is able to market itself, how much cash it has in the bank and so on. In short it must assess its own strengths and weaknesses. (b) It must also gather information externally to assess its position in the environment for its competitors (threats) and into current and potential markets (opportunities). Consider state of the world-recession/booming.

(3) Evaluate strategies; The strategies must then be evaluated in terms of suitability, feasibility and acceptability. Management should select those strategies that have the greatest potential for achieving the organization's objectives. (4) Choose alternative courses of action; This stage collects the chosen strategies together and coordinate them into a longterm financial plan. It shows; projected cash flows, balance sheet forecasts, capital expenditure plans, and so on.


Implementing the long-term plan; The long-term plan should be broken down into smaller parts signaling a move from longterm planning to annual budgeting. The budget provides the link between the strategic plans and their implementation in management decisions. The budget should be seen as an integral part of the long-term planning process.


Measure actual results and compare with plan; Actual results are recorded and analysed and information about actual results is fed back to the management concerned, often in the form of accounting reports after having compared it with the budget targets (variance accounting).

(7) Respond to divergence from plan; By comparing actual and planned results, management can do one of three things, depending on how they see the situation. (a) Take control action. By identifying what has gone wrong, and finding out why and take corrective measures. (b) Decide to do nothing. When actual results are better than planned or poor results would not happen again. (c ) Alter the plan or target if actual results are different from planned and that management can do nothing to correct the situation.


Budgets are plans expressed in financial and/or quantitative terms for a specified period of time in the future. Essentially, the budgetary control process consists of two distinct elements. (1) Planning and (2) Control.

This involves the setting of the various budgets for the appropriate future period. Management at the various levels in an organization should be involved in the budgetary planning stage for its own area of responsibility. In the medium and large businesses this activity can take a considerable amount of time. There is a need to co-ordinate the budgets of the various parts of a business to ensure that they are all complementary and in line with overall company objectives and policies.


plans made at the higher levels of performance hierarchy provide a framework within which the plans at the lower levels must be achieved. The plans at the lower levels are the means by which plans at the higher levels are achieved. Corporate plans; Focus on overall performance, set plans/targets for units/depts Operational plans; Based on activities about what to achieve, specifics, short time horizons.


the budgets have been set and agreed for the future period under review, the formal control element of budgetary control is ready to start. This control involves the comparison of the plan in the form of the budget with the actual results achieved for the appropriate period. Any significant divergences between the budgeted and the actual results should be reported to the appropriate management so that the necessary action can be taken.


occurs when the results (outputs) of a system are used to control it, by adjusting the input or behavior of the system. Negative feedback indicates that results or activities must be brought back on course, as they are deviating from the plan. Positive feedback results in control action continuing the current course. (no wrong info) Feedforward control is control based on forecast results. (Action on bad forecast.)


of feedback. (a) Single loop feedback; Is control which regulates the output of a system. For eg. If sales target are not reached control action is taken to ensure it is reached soon. Target itself is not changed though resources might be reviewed. (b) Double loop feedback is of a different order. Information is used to change the plan itself.


Ensure the achievement of the organization's objectives. (2) Compel planning. (3) Communicate ideas and plans. (4) Coordinate activities (5) Provide a framework for responsibility accounting. (6) Establish a system of control. (7) Motivate employees to improve their performance.


Organization's Objectives; Objectives are set for the organization as a whole, and for individual depts. and operations within the organizations. They are quantified to be achieved within a time frame. (2) Planning; Most important part of budgetary planning and control. It forces management to look ahead, set out detailed plans for achieving targets for each dept., operation, manager and anticipate problems.


Communicate ideas and plans; A formal system ensures that each person affected by the plans is aware of what he or she is supposed to be doing. It might be one way from managers to subordinates or two way dialogue and exchange of ideas. (4) coordinate activities; The activities of different departments or sub-units of the organization need to be coordinated to ensure maximum integration of effort towards common goals.


Framework for responsibility accounting; The system requires that managers of budget centres are made responsible for the achievement of budget targets for the operations under their personal control. (6) Establish control system; Control over actual performance is provided by the comparisons of actual results against the budget plan. Departures are investigated into controllable and uncontrollable factors.


Motivate employees to improve their performance; The interest and commitment of employees can be retained via a system of feedback of actual results, which let them know how well or badly they are performing.


a budgetary control system can be introduced, it is essential that: (1) Key executives are committed to the proposed system. (2) The long-term objectives of the organization have been defined. (3) There is an adequate foundation of data on which to base forecasts and costs. (4) An organization chart should be drawn up, clearly defining areas of authority and responsibility. The organization can then be logically divided into budget centres.


budget centre has a budget for each manager such that each manager is given control information about the area which he can control. This is the essence for responsibility accounting. (5) A budget committee should be set up and a budget manual produced. (6) A budget period should be set.

budget centre is a clearly defined part of an organisation for the purposes of operating a budgetary control system. Each function within an organisation will be sub-divided into appropriate budget centres. The manager responsible for a budget centre will be involved in the planning stage of setting the budget for his area of responsibility and will be recipient of control information in due course.

typical budget committee comprises the chief executive, the management accountant (acting as budget officer) and functional heads. The functions of the committee are to: Agree policy with regard to budgets Co-ordinate budgets Suggest amendments to budgets Approve budgets after amendment, as necessary.


comparisons of budgeted and actual results and recommend corrective action if this has not already been taken. The budget officer is secretary to the committee and is responsible for seeing that the timetables are adhered to and for providing the necessary specialist assistance to the functional managers in drawing up their budgets and analyzing results.

budget manual is a document which sets out standing instructions governing the responsibilities of persons, and the procedures, forms and records relating to the preparation and use of budgets. It sets out the procedures to be observed in budgeting, the responsibilities of each person concerned, and the timetable to be observed.


budget period is the period of time for which a budget is prepared and over which the control aspect takes place. The length of such a period will depend on various factors. The nature of the business-in the ship-building or power supply industries budget period of ten to twenty years may be appropriate; period of less than one year may be appropriate for firms in the clothing and fashion industries .


part of the business being budgeted-capital expenditure will usually be budgeted for longer period ahead than the production output. The basic of control many business use a twelve month period as their basic budget period ,but at the same time it is very common to find annual budget broken down into quarterly or monthly sub unit. such a breakdown is usually for control purposes because actual and budgeted result need to be monitored continuously .


is not practicable to wait until the end of a twelve month budget period before making control comparisons.


Managers who set the budget are often not the managers who are responsible for achieving budget targets. (b) Goals of the organisation as expressed in a budget, may not coincide with the personal aspirations of individual managers. (c) Control is applied at different stages by different people. A supervisor might get weekly control reports, his supervisor might get monthly control reports. Thus different managers can get in each others way and resent the interference from others.

budgetary control system can motivate but it can also produce undesirable negative reactions. The control system of budgeting is by providing appropriate control information. The information will only be valuable, however, if it is interpreted correctly and used purposefully by managers and employees. The attitude of these people to control information sometimes colour their views on what they should do with it thereby creating


is what make people behave in the way they do. It comes from individual attitudes or group attitudes. Individuals are motivated by personal desires and interests. It is vital that goals of management and the employees harmonise with the goals of the organisation as a whole. This is known as goal congruence. It is possible to design and run a budgetary control system which will go some way towards ensuring that goal congruence is achieved. Employees need positive attitudes


attitudes or hostile behaviour towards the budgetary control system can begin at the planning stage. The following may happen. (a) Managers complain for lack of time. (b) They may build slack into expenditures. (c) They argue that formalising a budget is too restricting. (d) Inability to coordinate own plans with others. (e) Future plans based on past results.


Managers put in a little effort. (b) Budget encourage rigidity and discourage flexibility. (c) S-T planning can draw attention away from L-T planning consequences of decisions. (d) Minimal cooperation and communication between managers. (e) Managers spend up to their full budget allowance, and do not overspend.


Managers might think they have more pressing jobs than looking at routine reports. (b) Managers might resent information especially if they did not take part in setting. (c) If budgets are seen as pressure devices to push managers to do better information will be resented. (d) They may not understand the information because they are unfamiliar with accounting terms and principles. (e) Managers held responsible for variances outside their control.


can be an important motivator when there is a formal link between higher pay and achieving budget targets. Individuals are likely to work harder if they are rewarded for their successful efforts. There are problems. (a) Formal reward and performance evaluation systems can encourage dysfunctional behaviour. (b) Pay can be a demotivator as well as a motivator. Targets must be challenging but fair.

A budget can be set from the top down (imposed budget) or from the bottom up (participatory budget). A third style is the negotiated budget. PARTICIPATION: Participation in the budgeting process will improve motivation and so will improve the quality of decisions and the efforts of individuals to achieve their budget targets.


management prepare a budget with little or no input from operating personnel which is then imposed upon the employees who have to work to the budgeted figures. Times when imposed budgets are effective. (a) In newly-formed organisations (b) In very small businesses (c) During periods of economic hardship. (d) When operational managers lack the skills (e) When the organisations different units require precise coordination.


Strategic plans are likely to be incorporated into planned activities. (b) Enhance the coordination between the plans and objectives of divisions. (c) Senior managements awareness of total resource availability. (d) Decrease the input from the inexperienced lower-level employees. (e) Decrease the time taken to draw up the budgets.


Dissatisfaction, defensiveness and low morale amongst employees. (b) Feeling of team spirit may disappear. (c) Acceptance of organisational goals and objectives could be limited. (d) The feeling of budget as a punitive device could arise. (e) Lower-level management initiative may be stifled. (f) Unachievable budgets for overseas divisions could result.


are developed by lower-level managers who then submit the budgets to their superiors. CIRCUMSTANCES WHEN EFFECTIVE (a) In well-established organisations. (b) In very large businesses. (c) During periods of economic affluence. (d) When operational managers have strong budgeting skills. (e) When organisations different units act autonomously.


Information from employees most familiar with the department. (b) Knowledge spread is pulled together. (c) Morale and motivation is improved. (d) Increase operational managers commitment to organisational objectives. (e) More realistic. (f) Coordination is improved. (g) Specific resource requirements are included. (h) Senior managers overview mixed with


They consume more time. (b) Changes by senior management may cause dissatisfaction. (c) Budgets may be unachievable if managers are not qualified to participate. (d) Managers may introduce budgetary slack. (e) Can support empire building by subordinates.


budgets are most likely to lie between what top management would really like and what junior managers believe is feasible. The budgeting process is hence a bargaining process and it is this bargaining which is of vital importance, determining whether the budget is an effective management tool or simply a clerical device.


steps taken to structure the budgets are as follows; (1) Prepare: Sales forecast Raw materials availability forecast. Cash availability forecast. Etc. (2) Determine the principal budget factor. (3) Decide whether the limitations can be removed and at what cost. Eg; by advert or intensive recruitment-Budget Committee. (4) Draw up budgets on the agreed basis.


principal budget factor is a factor which will limit the activities of an undertaking and which is often the starting point in budget preparation. The key budget factor is the volume of demand for the product. Others egs are labour, material, cash or machinery. The limiting factor must be identified at the first stage of the budgeting process since it will determine all other budgets. The determination and valuation of the factor is achieved using forecasting methods.


the level of demand is the principal budget factor, the various functional, departmental and master budgets will be drawn up in the following order. Sales budget. Production budget. Raw material, Labour and Factory overhead. Cost of goods sold budget. S&D expenses and Gen & Adm. Exps. Budget. MASTER BUDGET: P/L, Cash budget and B/S Capital expenditure budget.


ltd makes two products A and B. Sales for next year are budgeted at 5,000 units of A and 1,000 units of B. Planned selling prices are 65 and 100 respectively. Regent ltd has the ff. opening stock and required closing stock. A(units) B(units) Opening stock 100 50 Required closing stock 1,100 50 You are also given the ff data about the mats required to produce A and B, the whittling and fettling processes involved in prodn.


products: Kg of RM X, per unit of FG Kg of RM Y, per unit of FG Direct labour hrs per unit of FG

Materials Desired closing stock in kg Opening stock in kg

A B 12 12 6 8 8 12 Raw material X Y 6,000 1,000 5,000 5,000


rates and prices Direct labour Raw material X Raw material Y Production overheads Variable overheads Fixed

2.20 per hour 0.72 per kg 1.56 per kg 1.54 per lab hr. 0.54 per lab hr. 2.08


Sales Budget. The sales budget represents the plan in terms of the quantity and value of sales, for sales management. In practice, this is the most difficult budget to calculate. It would be supported by subsidiary budgets to show analysis according to Responsibility eg. Accra or Kumasi areas. Type of customer eg. Wholesale, retail or government.


units Sales value

TOTAL A B 6,000 5,000 1,000 425,000 325,000 100,000


production budget is usually expressed in quantity and represents the sales budget adjusted for opening/closing finished stocks and work in progress. PRODUCTION BUDGET: A(units) B(units) Sales budget 5,000 1,000 Budgeted stock increase (1,100-100)/(50-50) 1,000 Production in units 6,000 1,000


production budget needs to be translated into requirements and values for: (1) Raw materials. (2) Direct labour. (3) Factory overheads.




production of A; (6,000 * 12kg) 72,000 (6,000*6kg) 36,000 B; (1,000* 12kg) 12,000 (1,000*8kg) 8,000 Raw mats used 84,000 44,000 Budgeted RM stk Increase/(decrease) (6,000-5,000) 1,000 (1,000-5,000)(4,000) Raw materials purchased 85,000 40,000

x(kg) 61200


Budgeted value of purchases x 0.72 per kg x 85000 y 1.56 per kg x 40000



hours budget for A 6000 x8hr for B1000 x12hr

48000 12000 60000 x2.20 132000

Variable costs 60,000 hours * 1.54 92,400 Fixed costs 60,000 hours * 0.54 32,400 124,800


arrive at the figures for cost of goods sold, there is the need to adjust for the opening and closing stock position of both raw materials and finished goods. Opening/Closing stock of raw materials; Closing Opening X (6000kg*0.72) 4,320 (5000kg*0.72) 3,600 Y (1000kg*1.56) 1,560 (5000kg*1.56) 7,800 5,880 11,400


cost of FG A() B() Materials: X(12kg*0.72) 8.64 (12kg*0.72) 8.64 Y(6kg*1.56) 9.36 (8kg*1.56) 12.48 18.00 21.12 Wages (8hrs*2.20) 17.60(12hrs*2.20)26.40 Overheads (8hrs*2.08) 16.64(12hrs*2.08)24.96 52.24 72.48 Closing stock in units 1100 50 Stock value 57,464 3,624 Opening stock(100) 5,224 (50) 3,624


stocks; Raw materials 11,400 Finished goods (5,224+3,624) 8,848 20,248 Raw mats purchased(61,200+62,400) 123,600 Direct labour 132,000 Production overhead 124,800 400,648 Less: Closing stocks-Raw Mat 5,880 FG (57,464+3,624) 61,088 66,968 COGS 333,680


administration and other nonproduction costs budget will be a summary of the budget centres within those functions. For the purpose of the master budget, the marketing/administration budget is assumed to be 45,000.


The Master Budget is the budget into which all subsidiary budgets are consolidated It comprises; Budgeted income statement. Budgeted statement of financial position. Budgeted cashflow statement (cash budget). The master budget may be supported by a capital expenditure budget

Sales Cost

425,000 20,248 123,600 132,000 124,800 400,648 66,968 333,680 91,320 45,000 46,320

of sales; Opening stocks Raw materials Direct labour Production overheads


stocks Operating margin Less marketing/admin Operating profit


above budgets are presented to highlight planned requirements rather than for costing purposes. Most businesses are obviously more complex than that illustrated and supporting analyses would be prepared as required, eg: Production units by month or weeks Raw materials by supplier Direct labour by grade


total company plan will include a statement to show the financial situation at the end of the budget period. Subsidiary budgets will be prepared to analyse movements in fixed and working capital during the budget period based on the operating budgets and reflecting financial policy formulated by the budget committee.


capital expenditure included in the master budget will essentially be an extract from the long-term capital budget. The cash required to finance the capital expenditure will be incorporated in the cash budget. The assets relating to the capital expenditure will be incorporated in the budgeted balance sheet. The depreciation budget is in many respects the budgeted inc. statement(annual charge) and budgeted statement of financial


preparation of cash budgets or budgeted cash flow statements has two main objectives. (1) To provide periodic budgeted cash balances for the budgeted financial position. (2) To anticipate cash shortage/surpluses and thus provide information to assist management in short and medium-term cash planning and longer term financing for the organisation.


sales Forecast time-lag on converting debtors to cash and hence forecast cash receipts from credit sales. Determine stock levels and hence purchase requirements. Forecast time-lag on paying suppliers, and thus cash payments for purchases. Incorporate other cash payments and receipts. Collate all this cash flow information so as to determine the net cash flows.

tabular layout should be used with; Columns for weeks, months or quarters, (as appropriate. rows for cash inflows and outflows. EXAMPLE: A wholesale company ends its financial year on 30th June. You have been requested, in early July 2009 to assist in the preparation of a cash forecast. The following information is available regarding the companys operations


Management believes that the 2008/2009 sales level and pattern are a reasonable estimate of 2009/2010 sales. Sales in 2008/2009 were as follows. 2008 July 360,000 August 420,000 September 600,000 October 540,000 November 480,000 December 400,000

2009 January February March April May June Total

350,000 550,000 500,000 400,000 600,000 800,000 6,000,000


The accounts receivable at 30 June 2009 total GH350,000. Sales collections are generally made as follows. During month of sale 60% In the first subsequent month 30% In the second subsequent month 9% Uncollectable 1% (c) The purchase cost of goods averages 60% of selling price. The stock of goods on hand at 30 June 2009 is GH840,000, of which GH 30,000 is obsolete.


have been made to sell the obsolete stock in July at half the normal selling price on a cash on delivery basis. The company wishes to maintain the stock, as of the first of each month, at a level of three months sales as determined by the sales forecast for the next three months. All purchases are paid for on the tenth of the following month. Accounts payable for purchases at 30 June 2009 total GH370,000.


Payments in respect of fixed and variable expenses are forecast for the first three months of 2009/2010 are as follows. July 160,620 August 118,800 September 158,400 (e) It is anticipated that cash dividends of GH 40,000 will be paid each half year, on the fifteenth day of September and March.


During the year unusual advertising costs will be incurred that will require cash payments of GH10,000 in August and GH 15,000 in September. The advertising costs are in addition to the expenses in item (d) above. (g) Equipment replacements are made at a rate which requires a cash outlay of GH 3,000 per month. The equipment has an average estimated life of six years. (h) A GH60,000 payment for corporation tax is to be made on 15 September 2009.


At 30 June 2009 the company had a bank loan with an unpaid balance of GH280,000. the entire balance is due on 30 September 2009, together with accumulated interest from 1 July 2009 at the rate of 12%pa. (j) The cash balance at 30 June 2009 is GH 100,000. You are required to prepare a cash forecast statement, by months, for the first three months of the 2009/2010 financial year. The statement should show the amount of cash on hand (or deficiency of cash) at the end of


schedules; (a) Cash received from sales; Sales July August Sept. May 600,000 54,000 June 800,000 240,000 72,000 July 360,000 216,000 108,000 32,400
August Sept.

420,000 600,000

252,000 126,000 360,000 510,000 432,000 518,400


Other receipts Obsolete stock Obsolete stock at cost= 30,000 Normal sales price = 100 * 30,000 =50,000 60 Realised 0.5 * 50,000 = 25,000 (c) Payments to trade creditors (i) 10 July Bal b/d 370,000


10 Augsales in July 360,000 Cost of goods sold (60%) 216,000 Less : Opening stock (840,000) Less : Obsolete stock 30,000 810,000 Add: Closing stock 60% (420 + 600 + 540)000s 936,000 126,000 342,000


10 Sept. sales in August 420,000 Cost of goods sold (60%) Less: Opening stock (936,000) Add : Closing stock 60% (600+540+480) 000s 972,000


36,000 288,000


July August Sept Debtors/Customers 510,000 432,000 518,400 Obsolete stock 25,000 535,000 432,000 518,400 Payments: Creditors 370,000 342,000 288,000 Expenses 160,620 118,800 158,400 Dividends - 40,000 Advertising 10,000 15,000 Capital expenditure 3,000 3,000 3,000 Corporation tax - 60,000


288,000 533,620 473,800 852,800 Net cash in/out(flow)1,380(41,800) (334,400) Balance 100,000 101,380 59,580 Bal/(Deficiency) 101,380 59,580 (274,820)



to the cash budget completed, compute the following balances that would appear in the budgeted financial position as at 30 September 2009. (a) Debtors (b) Trade creditors (c) Closing stock


Debtors; Looking back at the working in (1) closing debtors will be made up as follows; From August sales 10% * 420,000 42,000 From Sept. sales 40% * 600,000 240,000 282,000 Assumption; 1% uncollected amounts have been written off.


Trade creditors; The goods purchased in September will be paid for in October and therefore represent creditors. In September, goods purchased for sale in December at a cost of 60% * 400,000 = GH240,000. (c) Stock; The closing stock at 30 September will represent October, November and Decembers sales,at cost. 60% (540,000+480,000+400,000) = GH 852,000.