Budgetary Control

Concept of Budget

 Budget refers to a plan relating to a definite

future period of time expressed in
monetary and/or quantitative terms. In
relation to business, a budget is a formal
expression of the expected incomes and
expenditures for a definite future period.
Characteristics of budget

A budget is primarily a planning device but it

also serves as a basis for performance
evaluation and control.
 A budget is prepared either in money or in
quantitative terms or in both.
 A budget is prepared for a definite future
period.
 Purpose of a budget is to implement the
policies formulated by management for
attaining the given objectives
 Budgeting – The act and entire process of
preparing budget is called budgeting.
 Budgetary control- it is a system of controlling
costs through preparation of budget. Budgeting is
the only part of the budgetary control. It is a system
of controlling costs, which includes the preparation
of budgets coordinating its departments and
establishing responsibility, comparing actual
performance with the budgeted and the acting upon
results to achieve maximum profitability.
Process of Budgetary control
 Establishing budgets of each function, departments
of the organization.
 Comparison of actual performance with the
budgeted figures in a continuous basis.
 Analysis of variance that is, comparision of actual
performance with the budgeted performance to
know the results there of.
 Taking suitable remedial where necessary.
 Revisions of budget time to time in view of changes
in conditions.
Essential of effective Budgeting

 Support of top management

 Participation by responsible executives
 Reasonable goals
 Clearly defined responsibility centre
 Continuous budget education
 Adequate accounting systems
 Maximum profits
 costs of the system
Advantages of Budgetary Control
 Budgeting compels managers to think ahead – to anticipate
and prepare for changing conditions.
 Budgeting co – ordinates the activities of various departments
and functions of the business.
 It increases production efficiency, eliminates waste and
controls the costs.
 It pinpoints efficiency or lack of it.
 Budgetary control aims at maximization of profits through
careful planning and control.
 It provides a yardstick against which actual results can be
compared.
 It ensures that working capital is available for the efficient
operation of the business.
 It directs capital expenditure in the most profitable
directions.
 It instills into all levels of management a timely,
careful and adequate consideration of all factors
before reaching important decisions.
 Budgeting also aids in obtaining bank credit.
 A budgetary control system assists in delegation of
authority and assignment of responsibility.
 Budgeting creates cost consciousness
Limitations of Budgetary Control
 Budget plan is based on estimates. Budgets are based on
forecasts and forecasting cannot be an exact science. Absolute
accuracy, therefore, is not possible in forecasting and budgeting.
The strength or weakness of the budgetary control system
depends to a large extent, on the accuracy with which estimates
are made. Thus, while using the system, the fact that budget is
based on estimates must be kept in view.
 Danger of rigidity. A budget program must be dynamic and
continuously deal with the changing business conditions,
Budgets will lose much of their usefulness if they acquire rigidity
and are not revised with the changing circumstances.
 Opposition from staff. Employees may not like to
be evaluated and thus oppose introduction of
budgetary control system. As such, inefficient
managers may try to create difficulties in the way
of introducing and operating this system.
 Expensive technique. The installation and
operation of a budgetary control system is a costly
affair as it requires the employment of specialized
staff and involves other expenditure which small
concerns may find difficult to incur. However, it is
essential that the cost of introducing and operating
a budgetary control system should not exceed the
benefits derived there from.
Classification of budgets

Classification on the basis of Function and

Scope
 Functional Budget, (ii) Master Budget
Classification on the basis of flexibility
 Fixed Budget, (ii) Flexible Budget
Functional Budget
 It is the one, which relates to particular functions of
the business or organization. The types of functional
budgets are
 Sales budget
 Production budget
 Raw materials budget
 Labour budget etc
 Cash budget
 Capital expenditure budget
 Purchase budget
Master Budget
 Master or final budget is a summary budget which incorporates
all functional budgets in a capsule form. It sets out the plan of
operations for all departments in considerable detail for the
budget period.
 Master budget require the approval of the Budget Committee
before it is put into operation. It may happen, sometimes, that a
number of master budget have to be prepared before the final
one is agreed upon. The budget generally contains details
regarding sales (net), production costs, cash position, and key
account balances (e.g. debtors, fixed assets, bills payable, etc).
It also shows the gross and net profits, and the important
accounting ratios
Fixed and Flexible Budgets
 Fixed Budget: A fixed budget is designed to remain unchanged
irrespective of the level of activity. This budget is prepared on the
basis of a standard of fixed level of activity. Since the budget
does not change with the change of level of activity, it becomes
an unrealistic yardstick in case the level of activity (volume of
production or sales) actually attained does not conform to the
one assumed for budgeting purposes.
 The management will not be in a position to assess the
performance of different heads on the basis of budgets prepared
by them, because they can serve as yardsticks only when the
actual level of activity corresponds to the budgeted level of
activity. On account of the limitation of fixed budget and its
inability to provide for automatic adjustments when the volume
changes, firms whose sales and production cannot be accurately
estimated have given up the practice of fixed budget.
 Flexible Budget: It is designed to change in
accordance with the level of activity attained.
Thus, when a budget is prepared in such a
manner that the budgeted cost for any level
of activity is variable, it is termed as flexible
budget. Such a budget is prepared after
considering the fixed and variable elements
of cost and the changes that may be
expected for each item at various levels of
operations.
ZERO BASE BUDGETING
 It is an alternative of traditional budgeting.
The traditional budgeting is based on
incremental and previous year figure use to
take into consideration. But in Zero Base
Budgeting figures are developed with zero as
the base which means a budget will be
prepared as if it is being prepared as a new
for the first time. It is a method of budgeting
where all activities are revalued each time a
budget is set.
Main Features of Zero Base Budgeting
(ZBB)
 All budget items, both old and newly proposed, are
considered totally afresh.
 Amount to be spent on each budget item is to be
totally justified.
 A detailed cost benefit analysis of each budget
programme is undertaken and each programme
has to compete for scarce resources.
 Departmental objectives are linked to corporate
goals.
 The main stress in not on ‘how much’ a
department will spend but on ‘why’ it needs to
spend.
Advantages
 In ZBB, all activities included in the budget are justified on cost
benefit considerations, which promote more effective allocation
of resources.
 ZBB discards the attitude of accepting the current position.
 In the course of ZBB process, inefficient and loss making
operations are identified and may be removed.
 It adds psychological push to employees to avoid wasteful
expenditure.
 It is an educational process and can promote a management
team of talented and skillful people who tend to promptly
respond to changes in the business environments.
 Cost behaviour patterns are more closely examined.
 Deliberately inflated budget requests get automatically rejected
in the ZBB process.
Disadvantage:
 ZBB leads to an enormous increase in paper work and results
in high cost of preparing budgets every year.
 Managers may resist new ideas and changes. They may feel
threatened by ZBB because all expenditures are questioned
and need to be justified.
 In ZBB, there is danger of emphasizing short-term gains at he
expense of long-term benefits.
 It has a tendency to regard any activity not foreseen and
sanctioned in the most recent ZBB as illegitimate.
 For introducing ZBB managers need to be given proper training
and education regarding this new concept, its pros and cons
and implementation.
 It may not always be easy to properly rank decision packages
and this may give rise to conflicts