BUDGETARY CONTROL

CHAPTER VI

 BUDGETARY CONTROL

Definition

            A budget is detailed plan of operations for some specific future period. A budget is a numerical statement expressing the plans, policies and goals of the enterprise for a definite period in the future. It is a plan laying down the targets to be achieved within a specified period. “Budget is an estimate of future needs arranged according to an orderly basis, covering some or all of the activities of an enterprise for definite period of time”.

Budgeting

            Budgeting refers to the management action of formulating budgets. Preparation of budgets involves study of business situations and understanding of management objectives as also the capacity of the enterprise. It includes the entire processing of making the budget plans. Preparation of budgets or budgeting is a planning function, and their application or implementation is a control function.

Budgetary Control

            “Budgetary control means the establishment of budgets relating to the responsibilities of executives to the requirements of a policy, and continuous comparison of actual with budgeted results either to secure by individual action the objective of that policy or to provide basis for its revision.”

Advantages of budgetary control

1.      Budgets fix the goal and targets, without which operation lacks direction.

2.      Reduction in cost and elimination of inefficiency is achieved automatically.

3.      The budget facilitates to maintain ordered effort and brings about efficiency in results.

4.      An effective system of budgetary control results in co-ordinate effort of all persons involved.

5.      Budgetary control enables the management to decentralize responsibility without losing control of the business since it pin-points inefficiency.

6.      The budgetary control and standard costing go hand in hand and the combination of the two gives the most effective results. It promotes mutual co-operation and team spirits among the persons involved.

7.      Budgetary control ensures that the capital employed at a particular level is kept at a minimum level.

8.      It facilitates and intelligent and planned forecast for future.

9.      It is a good guide to the management for making future plans. It is on the basis of budgetary control, realistic budgets can be drawn.

10.  It aims at maximization of profit through cost control and proper utilization of resources.

11.  It brings to light the inefficiencies and weaknesses on comparing actual performance with budget. Thus management can take remedial measures.

12.  It is a guide to the management in the field of research and development in future.

13.  It evaluates the performance.

14.  Since budget provides advance information, financial crisis can be avoided.

15.  It acts as a safety for the management. It prevents wastages of all types.

Limitations of budgetary control

Budgetary control is a sound technique of control. But it is not a perfect tool. Despite the appreciation, it has its own limitations which are as follows:

1.      Budgets deal with future. Forecasting is necessary for budgeting. Forecasts and estimates are rarely cent per accurate. The success largely depends upon the degree of accuracy of the estimates.

2.      Budgeting is time consuming process. During the preparation period, the business conditions may change and estimates may go wrong by that time.

3.      The successful operation and execution of budgets depends upon the efficiency of the executive personal.

4.      Budgetary control is essentially a tool of decision-making and it helps the management in taking sound decisions. But it cannot replace the management.

5.      Budgeting necessitates the employment of specialized staff and this involves expenditure which small concerns may not afford.

6.      A budget programme should be dynamic, capable of being adapted to changing conditions. But when budgets are prepared with-determined targets, there is a feeling that budgeted figure are final. Thus budgetary programme is bound to become rigid. 

7.      The success of the budgetary control largely depends upon willing, co-operation or team-work of all concerned. If there is no co-operation, the whole system collapses.

Essentials for a sound system of budgetary control (Organization)

1.      Chart: There must be an organizational chart to show the authority and responsibility of each executive of the firm. This will enable him to know his relationship with other executives. The budget director derives power from the chief executive, helps in co-ordination and drawing up of all budgets and suggests changes, if necessary. The sales manager, production manager, purchasing manager, personal manager and accountant will prepare their budgets.

2.      Budget centre: For the purpose of effective budgetary control, budget centers are defined. A budget centre may be a department or a section of the undertaking. Separate budgets are prepared for each department and the departmental head is responsible for carrying out budgets. Departmental heads should have effective control over the execution of the budget, to prevent unfavorable variation.

3.      Budget: In small firms, the chief accountant prepares the budget and co-ordinates various activities. In big concerns, a committee is appointed for this task. The committee consists of various section heads, the chief executive and the budget controller. The budget are prepared by section heads and submitted to the committee for approval; changes are made, if necessary, and approved.

4.      Budget Manual: It is a document which sets out the responsibilities of persons engaged in the routine work. Budget manual lays down the objectives of the organization, responsibilities of all executives and the procedure to be followed for budgetary control. Duties, authorities, powers of each official of the different departments are clearly defined, so as to avoid conflicts among the personnel. It also specifies different forms and records to be used for the purpose of budgetary control.

5.      Budget period: This is the period of time for which the budget is prepared and remains in operation. The length of period depends on the nature of business, the production period, the control aspects etc. there is no budget rule as regards the duration of a budget period. Generally, the budget is prepared for a year, which is preferred by most concerns. For example manufactures of consumer goods may prepare budgets for a year, where as in industries like ship-building the period of the budget may be 5 to 10 years.

6.      Key-Factor: Key factor is also known as ‘limiting factor’ or ‘governing factor’ which means this is the factor, the extent of whose influence must first be assessed, in order to ensure that the functional budgets are responsibility capable of fulfillment. The key factor may be, shortage of raw materials, non-availability of labour, limited sales, government restrictions etc. The key-factor is a limitation on production or sales. First locate the key-factor, before preparing the budget, as it influences all other budgets. For example, shortage of power supply leads to under-utilization of plant capacity. Therefore, the concern will have to first prepare a budget for plant utilization and later the other budgets say sales will be prepared.

Master budget: A master budget is the summary budget for the entire enterprise and embodies the summarized figures for various activities. This is also known as summary budget or finalized profit plan. This budget includes the budgeted position of the profit and loss as well as balance sheet. Master budget is prepared by the committee and becomes a target for the company.

Classification of Budgets

On the basis of time               On the basis of Flexibility                 On the basis of Functions

1.      Long term                   1. Fixed                                               1. Sales

2.      Short term                   2. Flexible                                           2. Production

3.      Current                                                                                    3. Materials

4. Labour

5. Overheads

6. Plant Utilization

7. Cash

8. Capital expenditure

CLASSIFICATION ACCORDING TO TIME

1.      Long Term Budgets

The budgets are prepared to depict long term planning of the business. The period of long term budgets varies between five to ten years. Long term budgets are prepared for some sectors of the concern such as capital expenditure, research and development, long term finances etc. The long planning is done by the top level management.

2.      Short term budgets

These budgets are generally for one or two years and are in the form of monetary terms. The consumer goods industries, like, sugar, cotton, textiles etc. use short budgets.

3.      Current Budgets

The period of current budgets is generally of months and weeks. The budgets are related to the current activities of the business. Current budget is a budget which is established for use over a short period of time and is related to current conditions.

CLASSIFICATION ACCORDING TO FLEXIBILITY

Fixed budgets: This is a budget which is designed to remain unchanged irrespective of the level of activity actually attained. This is prepared for definite production and capacity level. It is not adjusted according to activity level attained. The fixed budgets are not effective tools of cost control. These types of budgets have limited use. A fixed budget has been defined by ICMA, England as “A budget which is designed to remain unchanged irrespective of the level of activity actually attained”.

Flexible budget: This is dynamic budget. It is a budget which is designed to change in accordance with the level of activity. Actual output may differ from the budgeted output; and as such, it is necessary to modify the budget on the basis of changed output. The budget is prepared in such a way as to present the budgeted cost for different levels of activity are given due consideration. It is also called variable budget or sliding scale budget. The expenses are divided into three categories-fixed, variable and semi-variable. It is an important tool of cost control, as it facilitates comparison of actual results with the budgeted figures. ICWA, UK defines flexible budget as “a budget which, by recognizing the difference between fixed, semi-fixed and variable costs, is designed to change in relation to the level of activity”.

CLASSIFICATION ACCORDING TO FUNCTION

A functional budget is a budget which relates to any of the functions of an organization. The following are the functional budgets commonly used.

1.      Sales Budget: Generally sales factor becomes a key-factor in the majority of cases, an therefore, it is the starting point. This is the most important budget, as it is usually the most difficult to forecast. It is prepared by the sales manager. In the preparation, the sales manager should consider the following points:

a)      Analysis of the sales of the previous year.

b)     Salesman’s assessment

c)      General trade conditions

d)     Availability of raw materials

e)      Availability of funds

f)       Plant capacity

g)      Seasonal fluctuations

h)     Restrictions imposed by the government

i)        Competition and consumer’s preference

j)       Efficiency of advertising

          Sales budget must show in terms of finished products, quantities and price; and it is prepared    according to products, territories, periods, types of customer or salesman etc.

2.       Production budget: It is a budget prepared by the production manager, showing the forecast of output. The objective is to determine the quantity of production for a budgeted period. It is in quantity of units to be produced during the budget period. It is based on the sales budget. It is in two parts – one part contains the volume of production and the other part shows the cost of production. A part from the sales budget, optimum utilization of plant, availability of raw materials, labour etc. are to be considered. It must avoid overwork in rush season. It must maintain in minimum stock of finished goods.

Cost of production budget: It is divided into material cost budget, labour cost budget and overhead cost budget, because cost of production includes materials, labour and overheads. Therefore separate budgets are required for each item.

3.      Material budget: To carry out the production satisfactorily regular supply of material during the budget period is ensured by preparing a budget. In this, the decision regarding the quantity of materials as shown at different times during that period is followed. Only direct materials are taken into account; indirect materials are not taken into account and they are considered under overheads. The material budget helps proper planning of purchases. It shows the estimated quantities as well as the cost of raw materials, required for production as per production budget.

4.      Labour budget: It is a part of the production budget. The budget is prepared by the personnel department and it shows an estimate of the requirements of labour to meet the production target, on the basis of previous records and budgeted production. This budget gives detailed information relating to the number of workers, rates of wages and cost of labour hours to be employed.

5.      Works overhead budget: It sets out the estimated costs of indirect materials, indirect labour and indirect factory expenses, during the budget period in order to achieve the target. This is classified into fixed, variable and semi-variable. This facilities preparation of budgets and further department-wise and sub-division to have effective control. The preparation of budget is based on the previous year’s records for fixed overheads; and budget targets are verified for variable expenses, which are bound to change with the change of output.

6.      (a) Administration overheads budget: This budget covers the expenditure of administrative office and management salaries. It is prepared with the help of past experiences and expected changes in future. The administration cost of each budget centre is drawn separately and incorporated in administrative cost budget.

(b) Selling and distribution overhead budget: This budget relates to selling and distribution of products for the budget period and is based on sales budget. It is generally prepared territory-wise by the sales manager of each territory. The costs are divided into fixed, variable and semi-variable; and estimate is taken on the basis of past records.

7.      Capital expenditure budget: This budget shows the estimated expenditure on fixed assets-land, building, plant, machinery etc. It is a long-term budget. The capital expenditure is necessitated on account of replacement of old machines, increased demand of products, expansion of industry, adoption of new technological progresses etc.

8.      Cash budget: This budget represents the amount of cash receipts and payments and a balance during the budgeted period. It is prepared after all the functional budgets are prepared by the chief accountant either monthly or weekly giving the following hints(1) It ensures sufficient cash for business requirements. (2) It purpose arrangements to be made overdraft to meet any shortage of cash. (3) It reveals the surplus amount, and the effect of the seasonal fluctuations on cash position. The objective of cash budget is the proper co-ordination of total working capital, sale, investment and credit.