Module: 5 Budgetary Control

Qn.1: Budget - Meaning and Definition

A budget is a written plan covering projected activities of a business for a definite future
period of time. Ir is a financial and/or quantitative expression of business plans and policies
to be pursued in the future period of time. A budget is prepared to have effective tilisation of
funds and for the realisation of objectives as efficiently as possible. Budgeting is used for
preparing budgets and other procedures for planning, co-ordination and control of business
enterprise.
The Institute of Cost and Management Accountant (ICMA), London, defines budget as "A
financial and/or quantitative statement, prepared and approved prior to a defined period of
time, of the policy to be pursued during that period for attaining a given objective."

Qn. 2: Budgeting - Meaning and Definition

Budgeting is the management action of formulating and the process of preparing the budget.
It includes the entire processing of making the budget plans. It involves the study of the
business situations and realising the management objectives.
Batty defines budgeting as "the entire process of preparing the budget or the act of building
budget".

Qn. 3: Budgetary Control - Meaning and Definitions

Budgetary control is the control technique in which budgets are prepared and continuous
comparisons are made between the actual and budgeted figures for achieving the desired
results. It facilitates the management to fix the responsibilities and co-ordinate the activities
to achieve the desired results. Comparison of budgeted and actual figures will enable the
management to find out discrepancies and take remedial measures at proper time.
J. Batty defines budgetary control as "A system which uses budgets as a means of planning
and controlling all aspects of producing and/or selling commodities and providing services."
ICMA London defines it as "The establishment of the budgets relating to the responsibilities
of executives 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.

Qn. 4: Characteristics of good budget, budgeting and budgetary control.

1. Setting up of objectives: Before preparing the budget, the organisational goals are to be
fixed. On the basis of organisational goals, budgets are formulated and implemented.
Preparation in advance: A budget is a statement prepared in advance for a definite future
period. It is formulated in advance on future plan of actions.
3. Financial and/or quantitative statement: A budget is a special form of statement in which
management plans are numerically expressed in financial / physical units.
4. Participation of all: A good budgeting system should involve persons at all levels of
management. Active participation of all executives and subordinates is very essential for the
preparation and implementation of budgets.
5. One budget for each department: The head of each department prepares a budget for that
department and the same is sent to the budget committee.
б.Fixing Authority and Responsibility: Inorder to achieve the objectives of the management,
there should be a well planned organisational set-up with clearly demarcated authority and
responsibility.
7. Co-ordination: Inorder to achieve the objectives of the organisation, the budgeting system
should co-ordinate the plans and activities of various departments.
8. Proper reporting system: A proper reporting system should be present, so that, the actual
results could be compared with the budgets.
9. Budget revision: A budget should be realistic. If it is not attainable of if it is not realistic, it
should be revised with maximum care, so that, it becomes realistic.

Qn. 5: Objectives / Purpose / Need for budget / budgeting and budgetary control
1. To formulate a plan of action: Budget helps to formulate a plan of action. The plan of
action depends upon the policy that the business decides to execute.
2. To provide a means of co-ordination: All the activities of the business are to be
coordinated to achieve the objectives. Although different budgets are prepared for different
activities, co-ordination between them is made by preparing a summary budget called master
budget.
3. To facilitate central control: Budget is a means for the top management to control the
business operation centrally. For the proper implementation of the policy and achieving
targets, there should be central control and delegation of authority and responsibility to the
executives.
4. To help in cost control: The main objective of the budget is cost control. Cost control is the
process of controlling the costs by eliminating wastage. Preparation of budgets help in the
control of cost through comparison.
5. To help in cost reduction: Cost reduction is the achievement of real and permanent
reduction in the cost of goods manufactured or services rendered without affecting their
quality. Budgeting system helps to reduce the cost of the products or services.
6.Fixation of responsibility of executives: By preparing an organisation chart, the
responsibilities and authorities of executives are fixed.
7. Fixing norms for performance: Budgeting system provides adequate and satisfactory norms
of performance over the various activities of the enterprise.
8. Proper utilisation of resources: Budgeting and budgetary control helps to use the assets and
resources of the enterprise most efficiently and effectively.
9. To motivate the employees: Budget creates a feeling in employees that the management is
taking interest in budget performance for the success of the enterprise.
10. It may motivate them to achieve the objectives.

Qn. 6: Forecast - Meaning and Definition

Forecast is an estimate or prediction as to what will happen in future which is uncertain.
It is an estimate on certain future events like chance of rainfall, storm, earthquake, etc.
It is nothing morethan an estimate of future condition.
ICMA London defines a forecast as " a statement of probable events"

Qn. 7: Essentials of Budgetary Control

i. The programme of effective budgetary control should possess the following essentials.
A clearly defined organisation: There should be a sound plan of organisation with well
defined responsibilities.
ii. A well defined policy: The policies of the management should be well defined in clear and
unambiguous terms.
iii. Proper Delegation of Authority and Responsibility: Budget preparation and control is
done at every level of management. Though the budgets are finalised at top level,
involvement of persons from lower levels of management is essential for their success. This
requires proper delegation of authority and responsibility.
iv. Effective Communication System: An effective communication system is required for a
successful budgetary control. The flow of information regarding budgets should be quick so
that these are properly implemented.
v. Budget Education: Everyone in the organisation should know the working of the budget
programme and its benefits. They should be educated about their role in the success of the
system.
vi. Logical sequence in budget preparation: It is essential that proper arrangements be made
for the preparation, submission, examination and review of budget in logical sequence.
vi. Participation of all employees: Budgeting requires active participation and involvement of
all employees in the organisation. It is meant for every segment of the business. In addition to
their active participation, the employees should give more practical and useful suggestions.
vii. Flexibility: Budgetary programme should be designed to accommodate unforeseen
circumstances as well as possible changes in future. Flexibility will make the budgets more
appropriate and realistic.
viii. Motivation: Successful implementation of budget depends upon the interest shown by
the employees in the organisation. A proper system of motivation should be introduced for
making it a success.

Qn. 8: Step in the preparation of Budget (Essay).

For the preparation and successful implementation of budget, the following organisational
systems are to be ensured:
1. Appointment of Budget Controller or Budget Officer
A Budget Controller or Budget Director or Budget Officer is a person appointed by the Chief
Executive of the organisation for the purpose of assisting the Chief Executive or the President
of the organisation in the preparation and effective implementation of budget.
The budget controller should have knowledge of the technical details of the business and
should report directly to the President or Chief Executive Officer of the organisation.
2. Formulation of Budget Committee
A Budget Committee is a permanent committee consisting heads of all functional
departments such as sales department, production department, finance department, human
resources department, etc. as members and usually the Chief Executive Officer (CEO) or
President or Managing Director as its Chairman. The budget committee has to assists the
Budget Controller in all the stages of budgeting. The committee makes the budgeting system
more effective. It is the budget committee which receives the budget from each department,
co-ordinates the budgets of different departments and reviews and finalises the budgets.
Functions of Budget Committee / Budget Controller
1.Providing historical data: Inorder to prepare budgets, the functional departments require
historical data. The budget committee is responsible for providing the required data to
different departments.
2. Helping the preparation of budget: The budget committee is entrusted with the duty of
helping the different departments in the preparation of functional budgets.
3. Preparation of programme for budgeting: A general programme for budgeting should be
prepared by the budget committee. The programme should give an overall view of the budget
schedules.
4. Coordinating the departmental budgets: It is the budget committee which has to coordinate
departmental budgets resolving any conflict between them.
5. Preparation of master budget: With the help of the functional budgets prepared by
different functional heads, the budget committee has to prepare a summary budget
known as master budget.
6.Comparing the budget with actual: The budget committee has to compare the ascertained
budgeted figures with the actual performance, so that, the variations may be
and analysed.
7. Revising the budget: If the budget is found unrealistic, the commitee has to revise the
budget, if conditions so warrant.
8. Fixation of Budget Period
A budget period is the length of time for which a budget is prepared and employed.
The length of period depends on the nature of the business, the control aspect, production
period, availability of finance, length of trade cycle, etc. Industries with huge capital
expenditure require long-term budgeting, whereas, seasonal industries may adopt short-term
budgets.
9. Identification of Budget Centres
Budget centres are departments or centres established for budgeting and budgetary control.
Budget centres are established for cost control and cost reduction and all budgets are related
to cost centres. Separate budget may be prepared for each budget centre and the person in
charge of the budget centre may be made responsible for carrying out the budget.
A budget centre is defined as "a department or section of the organisation defined for the
purpose of budgetary control."
10. Identification of Budget Key Factor
A Key Factor or Governing Factor or Limiting Factor is the factor which affects or limits the
entire activities of an organisation. It is a factor whose influence affects all other budgets.
Therefore, budget estimate of key factor is prepared before other budgets are framed. The key
factor may be the shortage of raw-materials or labour, limited plant capacity or sales,
government restrictions, etc. The key factor highlights the limitations of the enterprise. This
will enable the management to improve the working of those departments where scope for
improvement exists.
The ICMA London defines it as "the factor, the extent of whose influence must first be
assessed in order to ensure that the functional budgets are reasonably capable of fulfilment."
List of key factors
Industry Key factor
1. Car manufacturing Sales demand
2. Petroleum refinery Availability of crude oil
3. Aluminium industry Power supply
4. Hydro electric power generation Rain water
5. Handicraft Skilled workers

11. Preparation of Budget Manual

A budget manual is a document or schedule prepared by the Budget Controller showing the
budgeting organisation, budget programmes and procedures. It fixes the responsibilities of
different executives entrusted with the function of implementing the budget. It covers in
detail all aspects of budgeting and its administration.
ICMA London defines Budget Manual as " A document which sets out the responsibilities of
the persons engaged in the routine work and the forms and records required for budgetary
control. "
Budget manual is a document which contains the following information:
1. A brief outline of the budgeting system and its objectives.
2. The process to be followed in its operation.
3. Setting out the responsibilities of various executives and persons involved in its
preparation.
4. The important factors that must be considered for each forecast and plan.
5. Length of the budget period, date of preparation of budget estimates and dates of review,
revision and instructions issued.
6. Method of accounting to be adopted.
7. Procedure for preparation of financial statements and the procedure for reporting.
8. Sanctioning authorities of the various budgets and the financial powers of the different
managers.
10. Setting up of Organisation chart
It is essential that a concern must have a definite plan of organisation for preparing,
maintaining and administering a budget. All the functional heads such as sales manager,
production manager, finance manager, etc. are entrusted with the responsibility of ensuring
proper implementation of their respective departmental budgets. For the purpose, a chart
known as organisation chart is prepared.
An Organisation Chart is a chart prepared for the effective implementation of the budgetary
control system by fixing authority and responsibility to each executive for effective
implementation of the budget.
11. Preparation of Master Budget
Master Budget or Summary Budget is a summary of the budget schedules in capsule form,
made for the purpose of presenting in one report, the highlights of the budget forecast.
A master budget is prepared for the business as a whole, combining all the budgets of the
period.
The Institute of Cost and Management Accounts (ICMA), London defines it as " the
summary budget, incorporating its component functional budgets, which is finally approved,
adopted and employed."
Benefits of Master Budget
i. Co-ordinating the functional budgets: The master budget helps to co-ordinate all the
functional budgets in a summarised form.
ii. Acts as a basis of budgeted Profit and Loss Account and Balance Sheet: Master budget
being a consolidated summary of the various functional budgets, it serves as the basis upon
which budgeted Profit and Loss account and projected Balance Sheet are constructed.
iii. Checking the accuracy of functional budgets: Master budget helps to check the accuracy
of all the functional budgets as it is a summary of various functional budgets.

Qn. 9: Functional Budgets

Functional budgets are those budgets which relate to the functions of different departments in
an organisation. The number of these budgets depends on the size and nature of business. The
commonly used functional budgets are Sales Budget, Production Budget, Material Budget,
Manufacturing Overheads Budget, Administration Cost Budget, Selling and Distribution Cost
Budget, Plant Utilisation Budget, Capital Expenditure Budget, Research and Development
Cost Budget, Cash or Financial Budget, etc.
i. Sales Budget
A Sales budget is a functional budget prepared by the sales department showing the quantities
and values of expected sale of finished products in total as well as product-wise and area-
wise during a definite period of time. Sales budget serves as a basis for the preparation of
production budget and other budgets. In its preparation, the sales manager has to consider the
sales of the previous year, general trade conditions, availability of funds, seasonal
fluctuations, restrictions imposed by the government, competition and consumers' preference,
efficiency of advertising, etc.
ii. Production Budget
Production Budget is a budget prepared by the production department, showing the physical
quantities of the products to be produced during the budget period. Apart from the sales
budget, opening stock and closing stock of finished goods, optimum utilisation of plant
capacity, inventory policy, production policy, normal wastage in production, etc. are
considered while preparing production budget. Production budget serves as a basis for the
preparation of cost budget.
iii. Direct Material Purchase Budget
To carry out production satisfactorily, regular supply of materials has to be ensured.
For the purpose, a direct material purchase budget is prepared. Direct material purchase
budget is the budget prepared by the Purchase Manager or Purchase Director showing the
physical quantities and cost of materials to be purchased during the budget period. The direct
material purchase provides answers to the questions like:
i. What is to be purchased? ii. When is to be purchased? and it. Where is to be purchased?
iv. Direct Labour Cost Budget
Direct labour cost budget is the budget prepared by Personnel Manager or Director showing
the hours and cost of total labour force required during the budget period.
Production requirement, quality standard of each type of labour, standard rate of each type of
labour, efficiency of labour, etc. are the factors to be considered while preparing direct labour
cost budget.
v. Manufacturing Overhead Budget
This budget gives an estimate of the works overhead expenses to be incurred in a budget
period to achieve the production target. The budget includes the cost of indirect materials,
indirect labour and indirect works expenses. The budget cost may be classified in to fixed
cost, variable cost and semi variable cost. Usually the budget is prepared by the Production
Manager/Director or Cost Accountant.
vi. Administrative Cost Budget
This budget covers the expenses incurred in framing policies, directing the organisation and
controlling the business operations. The budget can be prepared with the help of past
experience and anticipated changes. Budget may be prepared separately for each
administration department. The Administration Director/Manager is directly responsible for
the preparation and execution of overall office and administrative cost budget. vi. Selling and
vii. Distribution Cost Budget
Selling and Distribution Cost Budget represents the amount of total selling and distribution
cost to be incurred during budget period. This budget is clearly related to the sales budget. All
expenses relating to selling and distribution of various products are included in it. These
expenses are based on the volume of sales set in the sales budget and budgets are prepared for
each item of selling and distribution overhead. Selling and distribution overheads are divided
into fixed and variable categories with reference to volume of sales. The Sales
Manager/Director is directly responsible for the preparation and execution of overall selling
and distribution cost budget.
viii. Capital Expenditure Budget
This budget gives an estimate of the amount of capital that may be needed for acquiring the
fixed assets required for fulfilling production requirements as specified in the production
budget. This budget is prepared after taking in to consideration the available productive
capacities, probable reallocation of existing assets and possible improvement in production
techniques.
ix. Research and Development Cost Budget
Research cost represents the cost of searching for new or improved production techniques,
new application of materials or improved methods, processes, system or services.
Development cost refers to the commercial application of knowledge gained from research. It
begins with the implementation of the decision to produce new or improved products and
ends with the commencement of formal production of that product.
Research and development cost budget represents the amount of total research and
development cost to be incurred during budget period.

Qn. 10: Cash (Financial) Budget

Cash budget is a statement prepared in advance showing the estimated cash receipts and cash
disbursements during a specifc fuure period of time. It shows the estimated cash inflows,
estimated cash outflows and deficit or surplus over a given budget period.
A cash budget is defined as "an analysis of flow of cash in a business over a future, short or
long period of time. It is a forecast of expected cash inflow and ouflow."
Qn. 11: Need/Importance/Purpose/ Advantage of preparing Cash Budget
i. Ensuring liquidity: Cash budget ensures that cash is available in time for carrying out
business activities and meeting financial obligation.
ii.Maintenance of working capital: A properly designed cash budget helps to maintain
working capital position safe by making financial arrangements in advance to overcome
shortage of funds.
iii. Best utilisation of fund: A properly drawn cash budget helps the management to
use any surplus fund available in the best possible manner.
iv. Capital investment: A cash budget enables the management to plan for financing
expansion, modernisation of existing plant, financing new projects, etc.
v. Preparing borrowing schedule: There may be certain seasons when there is shortage of
funds for storing materials. Cash budget enables management to prepare borrowing schedule.
vi. Preparing repayment schedule: Payments to creditors and others have to made as per
schedule. Cash budget helps management to prepare repayment schedule well in advance.
vii. Planning dividend payment: A well designed cash budget enables the management
to plan for dividend payment well in advance.

Qn. 12: Flexible Budget

Flexible budgets are a series of budgets prepared for different levels of activity or volume of
output. It is also known as 'Variable Budget or 'Sliding Scale Budget'.
ICMA, London defines it as " a budget designed to change in accordance with the level of
activity actually attained."

Qn. 13: Features of Flexible Budget

1. It is prepared for different levels of activity.
2. It changes with the change in the level of activity.
3. Expenses are classified in to fixed, variable and semi variable. Semi variable expenses are
further segregated into fixed and variable expenses.

Qn. 14: Advantages of Budgetary Control

1. Helps to formulate plans of action: Budget sets out plans of actions and targets to be
achieved by the departments as well as individuals. Therefore, everyone knows for what he is
responsible and how much he should do for it for which a team spirit will be developed.
2. Helps to provide means of co-ordination: All the activities of the business are to be co-
ordinated to achieve the objectives of budgeting. Preparation of summary budge helps to
coordinate the activities of different departments.
3. Helps in central control: Budget is a means for the top management to control the business
operation centrally. For the proper implementation of the policy and achieving the target,
there is a need for delegation of authority and responsibility of executives.
4. Helps in cost control: Cost control is the process of controlling the costs by eliminating
wastage. Preparation of budget helps in the control of cost through comparison.
5. Helps in cost reduction: Cost reduction is the achievement of real and permanent reduction
in the cost of goods manufactured or services rendered without affecting their quality.
Budgeting helps to reduce the cost of the products or services.
6. Helps in fixing responsibility of executives: By preparing a chart known as organisation
chart, the responsibilities and authorities of executives are fixed.
7. Helps in fixing norms for performance: Budgeting system provides adequate and
satisfactory norms for performances over the various activities of the enterprise.
8. Helps in proper utilisation of resources: Budgeting and budgetary control helps to use the
assets and resources of the enterprise most efficiently and effectively.
9. Helps in motivating the employees: Budget creates a feeling in employees that the
management is taking interest in budget performance for the success of the enterprise.
It may motivate them to achieve the objectives.
10. Helps in improving efficiency: Budgetary control promotes efficiency and economy by
creating cost consciousness among employees.
11. Helps to pin-point discrepancies: Budgetary control reveals whether things are moving in
right direction or not, by pin- pointing deviation of actual results from budgets.
12. Helps to introduce incentive system of wage payment: Budgetary control acts as an
internal audit system through continuous scrutiny of departmental results. It helps in the
introduction of incentive remuneration system based on performance.

Qn. 15: Disadvantages of Budgetary Control

1.Estimates are likely to go wrong: Budgets are prepared for the future period.
Despite the best estimate made for future, the predictions may not always come true. Future
may be uncertain and the situation which is presumed to prevail in future may change,
upsetting the entire budget.
2. Efficient workers are likely to become lazy: More efficient persons become less efficient if
the target fixed in the budget is low. As one has to achieve only the target fixed, persons who
can surpass the target will be contented with achieving the target.
3. Budgets are made on some assumptions: Budgets are prepared on the assumption that
certain conditions will prevail during the budget period. But, the conditions may fail to
remain.
4. Frequent revision of budget: Future being uncertain and the assumed conditions may not
prevail, frequent revision of budget become essential.
5. Chance of conflict among executives: Budgetary control may lead to conflict among the
different functional departments as each departmental head is concerned only about the goals
to be achieved by his department. Every department try to get maximum allocation of funds
which may lead to conflict among different departments.
6. Dependence on support of top management: Success of budgeting depends on the support
of top management. If there is lack of support from top management, the system will
collapse.
7. Lack of co-operation from staff: Budgetary control system often fails to get support and
cooperation from staff.
8. Rigidity in operation: Budgets are considered as rigid documents. It lacks
flexibility.

Qn. 16: Zero Base Budgeting

Zero Base Budgeting (ZBB as a new managerial tool has become increasingly popular since
1962. It was first introduced by Ex-president Jimmy Carter of America, the then Governor of
the State of Gorgia as a means of controlling State expenditure. It has gained acceptance in
the management field as it integrates the managerial functions of planning and control.
Meaning and Definition
Zero Base Budgeting refers to a system of budgeting which is not based on any historical
data, but is developed on the basis of likely activities of the future period. Since the budgeting
is based on zero or scratch, it is known as zero based budgeting. In zero base budgeting, an
executive has to justify the amount he wants to spend. Preference of spending on various
activities depend upon their justification. For sanctioning certain amount, the executive has to
convince that the activities are essential and the amount requested is reasonable.
Peter A Pyher defines ZBB as "A planning and budgeting process which requires each
manager to justify his entire budget request in detail from scratch"
CIMA London defines Zero Base Budgeting as " a method of budgeting whereby, all
activities are re-evaluated each time a budget is set"

Qn. 17: Need / Importance / Advantages of zero base budgeting

1. Helps in judicious allocation of funds: Zero base budgeting enables management to

allocate funds only to the requirement of the programme. Priority can be fixed for various
activities and funds can be allocated accordingly.
2.Helps in improving efficiency of management: Zero base budgeting improves the efficiency
of the management as each manager has to justify the demand for resources.
3.Only those activities will be undertaken which will have justification and will be essential
for the business.
4.Helps in identifying economic and uneconomic areas: Zero base budgeting helps in
identifying economic and uneconomic areas. Emphasis can be given to economic areas and
any alternative course of action will also be considered.
5. Optimum use of resources: It helps the management to make the oprimum use of available
resources. A list of priorities will be prepared and cost-benefit analysis will be the guiding
principle in fixing the priority.
6.Inefficiency is not carried to the next year: It does not perpetuate inefficiency by carrying it
forward to the next budgeting period as fresh estimate is made each time on allocating fund.
7. Inflated budget allotment requests is brought to light: It brings to light inflated budget
allotment requests. It is well suited to such activities such as marketing, administration,
servicing, etc.
8. Helps in the best alternative use of resources: It is the most effective technique as it aims at
finding out the best alternative use of the scarce resources of the concern.

Qn. 18 : Performance Budgeting

Performance budgeting is developed as a means of controlling and improving the
performance of budget centres or responsibility centres. It helps to evaluate the performance
of each centre as well as the organisation by setting up target and comparing the performance.
Meaning and Definition
Performance budgeting is a technique underwhich responsibility centres are established and
the targets in terms of physical performance are set for each responsibility centre which helps
to evaluate of the performance of the responsibility centres and the organisation as a whole. It
pre-supposes the crystal clarity of organisational objectives in general and short-term
business objectives as stipulated in the budget, in particular. It provides a definite direction to
each employee and also a control mechanism to higher management.

Qn. 18: Activity Based Budgeting (ABB)

Activity Based Budgeting (ABB) is also called as Activity Based Cost Management
(ABCM). This method of budgeting helps to prepare indirect cost budgets more scientifically
on the basis of level of activity rather than on guesswork. This is very important in the
changing scenario where indirect cost outways the direct processing cost in many situations.
This method is different from the traditional method of making budgets where previous years
figures are taken as base to which certain additions are made for increase in cost for the next
year.

Qn. 19: Rolling/Continuous Budgets

CIMA Official Terminology defines a rolling budget as "budget continuously updated by
adding a further period, say a month or quarter, and deducing the earlier period". The need
for preparing a rolling budget arise due to the element of uncertainty in budgeting mainly
because of price level changes. Rolling budgets, also known as continuous budgets, are
prepared for a short-term as the degree of uncertainty is much lower and these budgets are
continuously modified for the next period, keeping in view of the changes that might have
taken place. Thus, control becomes more effective with the use of rolling budget as it is based
upon recent plans. However, it involves more time, effort and money in preparation of rolling
budgets.

Qn. 20 : Programme Budgeting

Programme Budgeting, also known as Planning, Programming and Budgeting System (PBS)
is a budgetary project that is aimed at making government operations more efficient and more
effective. PBS was first introduced in the U.S. department of defence in
1961. The purpose of programme budgeting is to reform the assignments of funds within the
public sector and to improve the allocation of funds between the private and public sectors. In
PPB system, expenditure is classified according to the objectives rather than functions.