Budgeting & Budgetary Control PDF

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Students get to learn the budgetary process and steps as well as the budgetary control. They also get to learn about the importance as well as the advantages of budgeting. I was lectured by Dr. Moses Wekesa...

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BUDGETING & BUDGETARY CONTROL Meaning of Budgeting: Budgeting is the process of designing, implementing and operating budgets. It is the managerial process of budget planning and preparation, budgetary control and the related procedures. Budgeting is the highest level of accounting in terms of future which indicates a definite course of action and not merely reporting. It is an integral part of such managerial policies as longrange planning, cash flow, capital expenditure and project management. It must be remembered that budgeting is not forecasting. It is true that budgeting does involve some sort of forecasting particularly in the area of sales budget. But the process is physically one of detailed analyses and planning not merely prognosticating future results. Forecasting is a process of predicting the future state of world, in connection with those aspects of the world which are relevant to and likely to affect on future activities. Any organized business cannot avoid anticipating or calculating future conditions and trends for the framing of its future policy and decision. Forecasting is concerned with probable events whereas budgeting relates to 1

planned events. Budgeting should be preceded by forecasting, but forecasting may be done for purpose other than budgeting. Thus, in forecasting an estimate of what is likely to happen is made whereas budgeting is the process of stating policy and programme to be followed in future. Further, forecasting does not connote any sense of control while budgeting is a tool of control since it represents actions which can be shaped according to sweet will so that it can be suited to the conditions which may or may not happen. In sum, budget is an operating and financial plan spelling out a target which the management seems to attain on the basis of the forecasts made. A forecast denotes some degree of flexibility while a budget denotes a definite target. Purpose and Objectives of Budgeting: The overall purpose of budgeting is to plan different phases of business operations, coordinate activities of different departments of the firm and to ensure effective control over it.  To accomplish this purpose, a budget aims at attaining the following objectives:

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1. To prognosticate the firm’s future sales, production cost and other expenses in order to earn desired amount of income and minimise the possibility of business losses. 2. To anticipate the firm’s future financial condition and future need for funds to be employed in the business with a view to keeping the firm solvent. 3. To decide the composition of capitalisation in order to ensure availability of funds at reasonable cost. 4. To coordinate the efforts of different departments of the firm toward the common objectives. 5. To accelerate efficiency of operations of different departments, divisions and cost centres of the firm. 6. To fix responsibilities of different departmental heads. 7. To ensure effective control over the firm’s cash, inventory and sales, and 8. To facilitate centralised control over the firm through the budgetary system. The Budgeting Process: The budgeting process usually begins when managers receive top management’s forecasts and marketing project objectives for the coming year, along-with a time-table stating when budgets must be completed. The forecasts 3

and objectives provided by the top management represent guidelines within which departments budgets are prepared. Usually, the work on budgeting begins with the task of estimating sales because the total activity of a firm depends on the sales. Preparation of sales estimate demands assessment of the existing market situation and projection of one’s ideas as to what would be the market position in the ensuing period for which the budget is proposed. Several internal as well as external factors are taken into consideration. The sales estimate prepared by the marketing manager is then submitted to the budget committee for consideration. The budget committee comprising of the top management carefully considers the forecast in the light of the past results and the estimates of the future as recommended by economists and statisticians and wherever necessary recommends for changes in estimate or if necessary asks for complete restudy and revision. Upon the recommendation of the budget committee, the President of the organization accords his approval to the sales estimate which then becomes sales budget of the organization. The sales budget is accompanied by budget covering selling and distribution expenses. The two 4

budgets together give the net sales revenue expected to arrive in the coming year. After the preparation of the sales budget and selling and distribution cost budget, Production Budget of the firm is prepared. The production budget is based on the production forecasts which are made after taking into consideration sales budget, the maximum and minimum stock of finished goods to be maintained, the plant capacity and availability of various factors of production. When targeted production for the budget period has been decided, the production budget (expressed in quantities to be produced) can be converted into a Production Cost Budget. Production Cost budget is composed of Materials Cost Budget, Labour Cost Budget and Overheads Budgets. Materials cost budget shows expected cost of materials required for budgeted production and sales purpose. Determination of material cost involves quantities to be used and the rate per unit. The task of determining the quantities required is that of the production engineering department while the purchasing department has the responsibility of deciding the rate. Labour Cost Budget prognosticates the direct labour cost expected to be spent on carrying into effect the targeted 5

production. Preparation of this budget requires information regarding the time required to do one unit of work and the wages to be paid for it. Overheads Budget is a statement of expected overheads (comprising fixed and variable overheads) which the firm will have to incur during the budget period. This budget is prepared on the basis of overhead forecasts of all the departments of the firm. Once materials cost budget, labour cost budget and overheads budget are prepared, a full production cost budget can be drawn. This budget is generally presented in the form of a cost sheet. In order to achieve competitive edge over its rivals on sustainable basis, an organization will have to develop new products or new processes for producing existing products at minimum cost. Thus, the organization has to incur expenditure on research and development effort. The Research and Development Budget is drawn up into two parts: (i) Fixed or constant expenses necessary to maintain research and development work at the irreducible level; and (ii) Costs to be incurred on completing the projects in hand or on those to be taken up. It is the management to 6

decide which new projects are to be taken up and whether any of the existing projects in hand is to be given up. Capital Budget is prepared to estimate receipts and payments on capital account as opposed to revenue account. Following the decision of the management about the capital expenditure to be made during the budget period, capital budget is drawn up to show month-wise receipts and payments on capital account. A Cash Budget showing expected receipts and payments on revenue account is prepared separately. Once separate budgets for sales, production finance and other activities have been prepared and finalised and the targeted sales, cost of sales, expenses are determined, the targeted profit and loss account and balance sheet can be drawn. These statements together are known as Master Budget. The budget process is shown in figure 15.1.

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Fundamental Principles of Budgeting: So as to ensure that budget serves as an effective technique of managerial decision making, certain cardinal principles must be kept in view. These principles are: 1. Management Support: Top management’s support and cooperation is essential for successful implementation of the budget. It should take interest not only in setting the targets and finalising the budgets but also constantly monitoring the actual performance to find out the deviations if any and take curative steps, motivate the personnel and reward the good performers. 2. Employees Involvement: The budget should be established on the highest possible level of motivation. All levels of management should participate in setting targets and preparing budget. This will result in defining realistic targets. Participation of employees in budgeting process will not only make them carefully think about the likely development in the forthcoming period and prepare budget accordingly, but will also motivate them to strive hard to achieve budget levels of efficiency and activity.

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3. Statement of Organizational Goal: The organizational goal should be quantified and clearly stated. These goals should be set within the framework of corporate objectives and strategies. A well-defined corporate policy and strategy is a pre-requisite for budgeting. 4. Responsibility Accounting: Individual employees should be informed about expectations of the management. Only those costs over which an individual has predominant control should be used in evaluating performance of that individual. Responsibility reports often contain budget to actual comparisons. 5. Organizational Structure: There should be well-planned organizational structure with clearly defined authority and responsibility of different levels of management. Role and responsibilities of Budget Committee and its President must be made known to the people in the organization. 6. Flexibility: If the basic assumptions underlying the budget change during the year, the budget should be restated. This will enable the management to compare the actual level of operations with the expected performance at that level. 10

7. Communication of Results: Proper communications systems should be established for management reporting and information service so that information pertaining to actual performance is presented to the concerned manager timely and accurately so that remedial action is taken wherever necessary. 8. Sound Accounting System: Organization should have good accounting system so as to generate precise, accurate, reliable and prompt information which is essential for successful implementation of budget system. Why is Budgeting so Important? Since budgeting allows you to create a spending plan for your money, it ensures that you will always have enough money for the things you need and the things that are important to you. Following a budget or spending plan will also keep you out of debt or help you work your way out of debt if you are currently in debt. What about Budget Forecasting and Planning? Once you create your first budget, begin to use it and get a good feel for how it can keep your finances on track, you may want to map out your spending plan or budget for 6 months to a year down the road. By doing this you can easily forecast which months your finances may be 11

tight and which ones you'll have extra money. You can then look for ways to even out the highs and lows in your finances so that things can be more manageable and pleasant. Extending your budget out into the future also allows you to forecast how much money you will be able to save for important things like your vacation, a new vehicle, your first home or home renovations, an emergency savings account or your retirement. Using a realistic budget to forecast your spending for the year can really help you with your long term financial planning. You can then make realistic assumptions about your annual income and expense and plan for long term financial goals like starting your own business, buying an investment or recreation property or retiring. Budgetary Control: Meaning, Objectives and Essentials Budgetary control is the process of determining various actual results with budgeted figures for the enterprise for the future period and standards set then comparing the budgeted figures with the actual performance for calculating variances, if any. A budget is a means and budgetary control is the end-result

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Budgetary Control in Organization: Meaning, Definition, Objectives, Essentials and Other Details! Meaning: Budgetary control is the process of determining various actual results with budgeted figures for the enterprise for the future period and standards set then comparing the budgeted figures with the actual performance for calculating variances, if any. First of all, budgets are prepared and then actual results are recorded. The comparison of budgeted and actual figures will enable the management to find out discrepancies and take remedial measures at a proper time. The budgetary control is a continuous process which helps in planning and coordination. It provides a method of control too. A budget is a means and budgetary control is the end-result. Definitions: “According to Brown and Howard, “Budgetary control is a system of controlling costs which includes the preparation of budgets, coordinating the departments and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability.” Weldon characterizes budgetary control as planning in advance of the various functions of a business so that the business as a whole is controlled. 13

J. Batty defines it as, “A system which uses budgets as a means of planning and controlling all aspects of producing and/or selling commodities and services. Welsch relates budgetary control with day-to-day control process.” According to him, “Budgetary control involves the use of budget and budgetary reports, throughout the period to co-ordinate, evaluate and control day-to-day operations in accordance with the goals specified by the budget.” From the above given definitions it is clear that budgetary control involves the follows: (a) The objects are set by preparing budgets. (b) The business is divided into various responsibility centres for preparing various budgets. (c) The actual figures are recorded. (d) The budgeted and actual figures are compared for studying the performance of different cost centres. (e) If actual performance is less than the budgeted norms, a remedial action is taken immediately. Objectives of Budgetary Control: Budgetary control is essential for policy planning and control. It also acts an instrument of co-ordination. 14

The main objectives of budgetary control are the follows: 1. To ensure planning for future by setting up various budgets, the requirements and expected performance of the enterprise are anticipated. 3. To operate various cost centres and departments with efficiency and economy. 4. Elimination of wastes and increase in profitability. 5. To anticipate capital expenditure for future. 6. To centralise the control system. 7. Correction of deviations from the established standards. 8. Fixation of responsibility of various individuals in the organization. Essentials of Budgetary Control: There are certain steps which are necessary for the successful implementation budgetary control system. These are as follows: 1. Organisation for Budgetary Control 2. Budget Centres 3. Budget Mammal 15

4. Budget Officer 5. Budget Committee 6. Budget Period 7. Determination of Key Factor. 1. Organization for Budgetary Control: The proper organization is essential for the successful preparation, maintenance and administration of budgets. A Budgetary Committee is formed, which comprises the departmental heads of various departments. All the functional heads are entrusted with the responsibility of ensuring proper implementation of their respective departmental budgets. The Chief Executive is the overall in-charge of budgetary system. He constitutes a budget committee for preparing realistic budgets A budget officer is the convener of the budget committee who co-ordinates the budgets of different departments. The managers of different departments are made responsible for their departmental budgets. 2. Budget Centres: A budget centre is that part of the organization for which the budget is prepared. A budget centre may be a department, section of a department or any other part of 16

the department. The establishment of budget centres is essential for covering all parts of the organization. The budget centres are also necessary for cost control purposes. The appraisal performance of different parts of the organization becomes easy when different centres are established. 3. Budget Manual: A budget manual is a document which spells out the duties and also the responsibilities of various executives concerned with the budgets. It specifies the relations amongst various functionaries. 4. Budget Officer: The Chief Executive, who is at the top of the organization, appoints some person as Budget Officer. The budget officer is empowered to scrutinize the budgets prepared by different functional heads and to make changes in them, if the situations so demand. The actual performance of different departments is communicated to the Budget Officer. He determines the deviations in the budgets and the actual performance and takes necessary steps to rectify the deficiencies, if any. He works as a coordinator among different departments and monitors the relevant information. He also informs the top management about the performance of different departments. The budget officer will be able to carry out 17

his work fully well only if he is conversant with the working of all the departments. 5. Budget Committee: In small-scale concerns the accountant is made responsible for preparation and implementation of budgets. In large-scale concerns a committee known as Budget Committee is formed. The heads of all the important departments are made members of this committee. The Committee is responsible for preparation and execution of budgets. The members of this committee put up the case of their respective departments and help the committee to take collective decisions if necessary. The Budget Officer acts as convener of this committee. 6. Budget Period: A budget period is the length of time for which a budget is prepared and employed. The budget period depends upon a number of factors. It may be different for different industries or even it may be different in the same industry or business. The budget period depends upon the following considerations: (a) The type of budget i.e., sales budget, production budget, raw materials purchase budget, capital expenditure budget. A capital expenditure budget may be 18

for a longer period i.e. 3 to 5 year’s purchase, sale budgets may be for one year. (b) The nature of demand for the products. (c) The timings for the availability of the finances. (d) The economic situation of the country. (e) The length of trade cycles. All the above-mentioned factors are taken into account while fixing period of budgets 7. Determination of Key Factor: The budgets are prepared for all functional areas. These budgets are interdependent and inter-related. A proper coordination among different budgets is necessary for making the budgetary control a success. The constraints on some budgets may have an effect on other budgets too. A factor which influences all other budgets is known as Key Factor or Principal Factor. There may be a limitation on the quantity of goods a concern may sell. In this case, sales will be a key factor and all other budgets will be prepared by keeping in view the amount of goods the concern will be able to sell. The raw material supply may be limited, so production, sales and cash budgets will be decided according to raw 19

materials budget. Similarly, plant capacity may be a key factor if the supply of other factors is easily available. The key factor may not necessarily remain the same. The raw materials supply may be limited at one time but it may be easily available at another time. The sales may be increased by adding more sales staff, etc. Similarly, other factors may also improve at different ...