14.Budgetary Control

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Financial and Management Accounting Unit 14

Sikkim Manipal University 281

Unit 14 Budgetary Control

Structure:

14.1 Introduction

Objectives

14.2 Meaning

Self Assessment Questions 1

14.3 Budgetary control


14.4 Objectives


14.5 MeritsSelf Assessment Questions 4

14.6 Essential features


14.7 Steps


14.8 Types


14.9 Cast Budget


14.10 Flexible Budget


14.11 Limitation


Terminal Questions

Answer to SAQs and TQs

14.1 Introduction

In a competitive environment, the effective operation of a concern resulting into the excess of

income over expenditure fully depends upon “as to what extent the management follower proper

planning, effective coordination and dynamic control “. For all these aspects, it has become

necessary that management should plan for the future financial and physical requirements.





These are the basic criteria that a firm has to adopt to maintain its profitability and productivity.

The procedure for preparing plan in respect of future financial and physical requirements is

generally called “Budgeting”. It is a forward planning exercise. It involves the preparation inn

advance of the quantitative as well as the financial statements to indicate the intention of themanagement in respect of the various aspects of the business. In a broader sense, it is

essentially an economic service. Budgeting requires a deeper understanding of the economic

system of the environment in which the business concern operates.

Learning Objectives:

After studying this unit, you should be able to understand the following

1. Understand the meaning of budget and budgetary control with its objects.

2. Analyze the merits, demerits, essential features of budgetary control.

3. Note the steps involved in the preparation of budgets.

4. Acquaint with various type of budgets.

5. Prepare cash and flexible budgets.

14.2 Meaning of A Budget

It is a numerical statement expressing the plans, policies and goals of an enterprise for a definite

period in the future. Budgets are not actual but are estimated. It is therefore a financial and / or

quantitative statement prepared and approved prior to a definite period of time, of the policy to be

pursued during that period for the purpose of attaining a given objective. (Definition by Cost and

Management Accountants, England).

Self Assessment Questions 2:

1. Budget is ___________ statement.

2. Budget are _____________.

14.3 Budgetary Control

It is applied to a system of management accounting control by which all operations and output

are forecasted far ahead as possible and actual results when known are compared with the

budget estimates.


1. Budgetary control is ___________.





14.4 Objectives

Budgeting is a forward planning. It basically serves as a tool for management control. The

objectives of budgeting may be taken as:

· To forecast and plan for future to avoid losses and to maximize profits.

· To help the concern in planning the activities both physical and financial.

· To bring about coordination between different functions of the enterprise.

· To control; actual actions by ensuring that actual are in tune with targets.

Budgeting and Planning: The planning normally deals with long term and short goals and

operations. The goals can be for the entire organization or department wise or group wise or

segment wise to achieve the maximum results and operational efficiency. After setting up

objectives in terms of plans, it becomes imperative to organize the factors of production to

convert into a reality and workable preposition. In budgeting, planning refers to the preparation of budgets in respect of sales, advertisement, production, inventory, materials cost and

requirements, labor cost and requirements, expenses, research, capital expenditures, financial

plans. Planning through budgets brings together all segments of the concern in a cooperative

way and they are compelled to think seriously about the planning. The views get enlarged than

getting into contraction. Internal refinement, broad indexation of activities, concentrated details is

the essential features in planning. All the staff must be involved in the planning function to make

it more successful and purposeful.

Budgeting and Coordination: It deals with the combined efforts of all the people involved from

the shop floor to the top management. Individual and collective wisdom should be considered in

the preparation of budgets at all levels to make it a workable document for translation into reality.

For this adequate communication at all levels should be established. It is very important that

each member of management is having perfect and clear cut knowledge. There must be

continuity to coordination. Budget may help us to evaluate and examine whether the members of

the management are working in a cooperative way or not

Budgeting and control: When one relates control function to budget, we find a system what is

generally termed as budgetary control. Control signifies such systematic efforts which help the

management to know whether actual performance is in line with predetermined goal, policy and

plans. It is basically a measurement tool. Yardsticks should be laid down. Standards must be

set up.

Therefore, the objectives can be summarized as follows:

· To conform with good business practice by planning for the future.





· To coordinate the various divisions of a business.

· To establish divisional and departmental responsibilities.

· To forecast operating activities and financial position.

· To operate most efficiently the divisions, departments and cost center.

· To avoid waste, to reduce expenses and to obtain the income desired.

· To obtain more economical use of capital available for the efficient operation.

· To provide more definite assurance of earning the proper return on capital employed.

· To centralize management control.

· To show the management where action is needed to remedy a situation.

· To help in controlling cash.

· To help in obtaining better inventory control and turnover.


1. Budgetary is ____________ planning.

2. Planning deals with _________________.

14.5 Merits

In order to help in planning, coordinating and control, budgets need to be prepared for every

organization to get the maximum benefit. Broadly, the merits are as follows:

1. It forces basic policies to initiatives

2. The budgetary control aims at the maximization of profits

3. Budgets fix the goals and targets without which operations lack direction

4. Reduction in cost and elimination of inefficiencies

5. Budgetary control facilitates to make ordered effort and brings about overall efficiency in

results.

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

minimum level

7. Budgetary control enables the management to decentralize responsibility without losing

control

8. It is a good guide to the management for making future plans. Based on budgetary control

realistic budgets can be drawn.

9. Budgetary control facilitates an intelligent and planned forecast of the future

10. Budgetary control acts as a safety signal for the management. It prevents wastages of all

types.





11. Budgetary control brings to light the inefficiencies and weakness on comparing actual

performance with budget. Management can take timely remedial measures.

12. Financial crisis can be avoided since budget provides advance information.

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


1. Major merits are __________.

14.6 Essential Features Of Budgetary Control

An effective budgeting system should have essential features to get best results. In this direction,

the following may be considered as essential features of an effective budgeting.

Business Policies defined: The top management of an organization strives to have an action

plan for every activity and for each department. Every budget should reflect the business policies

formulated from time to time. The policies should be precise and the same must be clearly

defined. No ambiguity should enter the document. Clear knowledge should be provided to all the

personnel concerned who are going to execute the policies. Periodic suggestions should be

called for.

Forecasting: Business forecasts are the foundation of budgets. Time and again discussions

should be arranged to derive the most profitable combinations of forecasts. Better results can be

anticipated based on the sound forecasts. As far as possible, quantitative techniques should be

made use of while forecasting

Formation of Budget Committee: A budget committee is a group of representatives of various

important departments in an organization. The functions of committee should be specified

clearly. The committee plays a vital role in the preparation and execution of budget estimated. It

brings coordination among other departments. It aids in the finalization of policies and programs.

Non financial activities are also considered to make it a wholesome affair.

Accounting System: To make the budget a successful document, there should be proper flow

of accurate and timely information. The accounting adopted by the organization should be proper

and must be fine tuned from time to time

Organizational efficiency: To make the budget preparation and its subsequent implementation

a success, an efficient, adequate and best organization is necessary a budgeting system should

always be supported by a sound organizational structure. There must be a clear cut demarcation





of lines of authority and responsibility. There must also be a delegation of authority from top to

bottom line. .

Management Philosophy: Every management should set a healthy philosophy while opting for

the budget. Management must wholehear4tedly support the activities which developing a

budget. Encouragement should flow from top management. All the members must be involved to

make it a workable preposition and a dream driven document.

Reporting system: Proper feed back system should be established. Provision should be made

for corrective measures whenever comparative measures are proposed.

Availability of statistical information: Since budgets are always prepared and expressed in

quantitative terms, it is essential that sufficient and accurate relevant data should be made

available to each department.

Motivation: Since budget acts as a mirror, the entire organization should become smart in its

approach. Every employees both executive and non executives should be made part of the

overall exercise. Employees should be persuaded than pressurized to appreciate the benefits of

the budgets so that the fruits can be shared by all the members of the organization.


1. Feature are meant for _________.

2. Forecasting is _______________.

3. Budget committee brings in _________.

14.7 Steps In Budgetary Control

The procedure to be followed in the preparation and control of budget may differ from business to

business. But, a general pattern of outline of budget preparation and control may go a long way

to achieve the end results. The steps are as follows:

Formulation of policies: The business policies are the foundation stone of budget construction.

Function policies should be formulated in advance. Long range policies with short term

projections should be made for the functional areas such as sales, production, inventory, cash

management, capital expenditure.

Preparation of forecasts: Based on the formulated policies, forecast should be made in respect

of each function. Activity based concepts should be introduced at the micro level for each

function Forecasts should not be considered as a mere estimates. Scientific methods should be





adopted for forecasting. Analysis of various factors based on past, and present, future forecast

should be made.

Preparation of budgets: Forecasts are converted into written codified document. Such written

documents can be used for coordination purposes. Function budgets will act as guidelines for

implementation.

Forecast combinations: While developing the budgets, through a Master Budget various

permutations and combination processes are considered and developed. Based on this,

establishment of the most preferred one which will yield optimum benefits should be considered.

All the factor components should be identified which are likely to cause disturbances while

implementing the budgets


1. Important steps in B.C _________________.

14.8 Types of Budgets

The budgets are normally classified according to their nature. They are: (a) fixed budget. (b)

Flexible Budget. (c) Functional Budget

Fixed Budget: It is also known as static budgets. It is prepared for a fixed or standard volume of

activity. They do not change with change in the volume of activity. They are prepared well in

advance Due to this, there are bound to be variances at the time of comparison. Hence, the

budget targets become unsuitable for the purpose of comparison. Wide deviations are noticed

due to changes in the volume of activity.

Flexible Budget: It is prepared with a view to take into account the periodic changes in the level

of activity attained. In this case, the revenues and costs targets are set in respect of different

levels of activity even from zero to 100 % of product ion volume. Such mechanism helps to

change revenues and cost targets for the actual level of activity and thus makes the comparison

more logical and scientific.

Functional Budget: These are also known as subsidiary budgets. These are prepared on the

basis of approved forecasts for individual department. Since departments are created based on

the functions, they are known as functional budgets. The functional budgets may vary in number

from business to business. The functional budgets include sales budget. Production budget,

selling and distribution overhead budget, plant budget, research and development budget,

overheads budget, financial budget such as cash budget and capital expenditure budget.






1. Classification of budget is based on __________.

2. Types of budgets are _____________.

14.9 Cash Budget

A proper control over cash is very essential. Cash is an important component in any activity. The

control becomes inescapable. If cash is not properly managed or if it is mismanaged, the ultimate

result would be disastrous .In many times and in many business situations, business failures are

noticed due to the lacunae found in the cash management. Hence a cash budgeting occupies a

pivotal place in the study of Financial Management.

Cash budgeting is the process of forecasting the expected receipts known as cash inflows, and

expected payments known as cash outflows to meet the future obligations. The written statement

of receipts and payments form the cash budget. It is a crystal ball which enables one to observe

the future movements in cash position. It is a mere forecast of cash position of an undertaking

for a definite period of time. The period may be daily, weekly, monthly, quarterly, semi annually,

or annually. The major two components of cash budget would be forecast first the cash receipts

and then second forecasting the cash disbursements.

The receipts of cash are formatted as follows :

1. Opening balance of cash in hand and cash at bank

2. Cash sales

3. Collection from debtors to whom sales are effected on credit basis

4. College from Bills received

5. Interest and advances and loans granted

6. Dividends received from investments

7. Sale proceeds from capital assets

8. Proceeds from issue of shares and debentures

9. Other sources.

After determining the various sources, the quantum of receipt should be estimated. Past analysis

will help to identify the problem areas for effecting collection of cash.


1. It is prepared on _______________.

Problem 1: A large retail stores makes 25% of its sales for cash and the remainder on 30 days

net. Due to faulty collection practice, there have been losses from bad debts to the extent of 1 %





of credit sales on average in the past. The experience of the store tells that normally 60 % of

credit sales are collected in the month following the sale, 25% in the second following month and

14 % in the third following month. Sales in the proceeding three months have been January 2007

Rs.80,000, February Rs.1,00,000 and March Rs.1,40,000. Sales for the next three months areestimated as April Rs.1,50,000, May Rs.1,10,000 and June Rs.1,00,000. Prepare a schedule of

projected cash collection .

Solution:

Statement of expected Cash Receipts

Collection form April May June

Cash sales 37,500 27,500 25,000

Collection from Debtors : January 8,400

February 18,750 10,500 -

March 63,000 36,350 14,700

April 67,500 28,125

May 49,500

Total 1,27,650 1,31,750 1,17,325

Assume that the credit policy is enforced strictly ,what would be the cash receipts.

Cash sales : Debtors 37,500 27,500 25,000

March 1,05,000 -April 1,12,500 -

May 82,500

Total 1,42,500 1,40,000 1,07,500

Forecasts of cash payments : The items of expenditures differ from business to business. The

normal items which come under the lists are :

1. Cash purchases

2. Payment to creditors or suppliers

3. Payments to Bills payable

4. Payment to employees in the nature of wages, salaries

5. Manufacturing, selling and distribution and administration expenses

6. Repayments of bank load and special obligations such as bonus, donations, advances

7. Interest and dividend payments





8. Capital expenditures for acquiring assets of enduring benefit

9. payment of tax liability

10. other expenses of periodic nature

The quantum of amount likely to be spend on the above each item is generally determined with

reference to functional budgets of the concerns. The policy of the management will also play a

crucial role. It is the policy which determines the ratio of cash purchases and credit purchases.

In many cases, the time lag affects the amount of expenditures to be incurred in a particular

period. The formula adopted for the expenses payable in next month is : month’s amount x time

lag

Problem 2:

The following are the forecasts relating to wages and factory expenses.

July Aug Sept Oct Nov

Wages 32,000 32,000 32,000 40,000 32,000

Factory expenses 5,000 5,000 5,000 5,000 5,000

The lag in payment of wages is 1 / 8 month and that in case of factory expenses 1/ 2 month.

Estimate the amounts of wages and factory expenses payable in each month of September to

November.

Solution

Statement showing the disbursements of cash

Particulars Sept Oct Nov

Wages: Aug 32,000 4,000

Sept 32,000 28,000 4,000

Oct 40,000 35,000 5,000

Nov 32,000 28,000

32,000 39,000 33,000

Factory expenses

Aug 5,000 2,500

Sept 5,000 2,500 2,500

Oct 5,000 2,500 2,500

Nov 5,000 2,500





5,000 5,000 5,000

Problem 3:

The following information is provided in respect o DR Ltd. Prepare a Cash Budget for April, Mayand June 2007.

Months Details Sales Purchases Wages Expenses (in Rupees)

Jan Actual 80,000 45,000 20,000 5,000

Feb Actual 80,000 40,000 18,000 6,000

March Actual 75,000 42,000 22,000 6,000

April Budget 90,000 50,000 24,000 7,000

May Budget 85,000 45,000 20,000 6,000

June Budget 80,000 35,000 18,000 5,000

Additional information:

a. 10 % of the purchases and 20 % of sales are for cash

b. The average collection period of the company is 1 / 2 month and the credit purchases are

paid regularly after one month.

c. Wages are paid half monthly and the rent of Rs.500 included in expenses is paid monthly.

Other expenses are paid after one mo nth lag.

d. Cash balance on April 1, 2007 may be assumed to be Rs.15,000.





Solution

DR Limited

CASH BUDGET

For the month ending June 2007

Particulars April May June

RECEIPTS

Opening Balance 15,000 27,200 35,700

Cash Sales 18,000 17,000 16,000

Collection from Debtors 66,000 70,000 66,000

Total , say A 99,000 1,14,200 1,17,700

PAYMENTS

Cash purchases 5,000 4,500 3,500

Payments to creditors 37,800 45,000 40,500

Wages 23,000 22,000 19,000

Rent 500 500 500

Other expenses 5,500 6,500 5,500

Total, say B 71,800 78,500 69,000

CLOSING CASH BALANCE, A – B 27,200 35,700 48,700

Problem 4:

DR is to start production on January 1, 2008. The prime cost of an unit is expected to be Rs.40

(Rs.16 per material and Rs.24 for labor). In addition, variable expenses per unit are expected to

be Rs.8 and fixed expenses per month Rs.30,000. Payment for materials is to be made in the

month following the purchases. One third of sales will be for cash and the rest on credit for

settlement in the following month. Expenses are payable in the month in which they are incurred.

The selling price is fixed at Rs.880 per unit. The number of units to be produced and sold are

expected to be : January 900, February 1,200./ March 1,800. April 2,000. May 2,100. June 2,400.

Draw a cash budget indicating cash requirements.





(a) 50 % of credit sales are realized inn the month following the sales and remaining in the

second following month.

(b) Creditors are paid in the month following the month of purchase

(c) Estimated cash as on June 1 is Rs.50,000

Solution DR

CASH BUDGET

For the period ending 20th August

Particulars JUNE JULY AUGUST

RECEIPTS

Opening balance 50,000 1,12,000 ( 94,000 )

Collection from Debtors 3,72,000 3,00,000 2.82,000

Total, say A 4,22,000 4,12,000 1,88,000PAYMENTS

Payments to creditors 2,88,000 4,86,000 4,92,000

Wages 22,000 20,000 30,000

Total, say B 3,10,000 5,06,000 5,22,000

Closing Balance A – B 1,12,000 94,000 3,34,000

Cr Cr

Overdraft needed NIL 94,000 2,40,000

Problem 6:

Prepare a cash budget from January to April

Expected Purchases Expected Sales

Jan 48,000 60,000

Feb 80,000 40,000

Mar 81,000 45,000

April 90,000 40,000

Wages to be paid to workers will be Rs.5,000 per month. Cash balance on January 1 may be

assumed to be Rs.8,000. Management decides that :a) in case of deficit within the3 limit of Rs.10,000 arrangement can be made with the bank

b) in the case of deficit exceeding Rs.10,000 but within a the limit of Rs.42,000 issue of

debentures is to be preferred.

c) In the case of deficit exceeding Rs.42,000 the issue of equity shares is to be preferred.

Assume that this will be within the Authorized Capital.





Solution

CASH BUDGET

Particulars Jan Feb March AprilRECEIPTS

Opening balance 8,000 15,000 30,000 (Cr) 71,000 (Cr)

Cash sales 60,000 40,000 45,000 40,000

Total, say A 68,000 55,000 75,000 31,000

PAYMENTS

Purchases 48,000 80,000 81,000 90,000

Wages 5,000 5,000 5,000 5,000

Total, say B 53,000 85,000 86,000 95,000

Closing Balance A – B 15,000 30,000 71,000 1,26,000

The total deficit of Rs,1,26,000 should be raised from the issue of Equity Shares.

14.10 Flexible Budget

According to I.C.M.A, London, a flexible budget is “a budget which is designed to change in

accordance with the level of activity actually attained”. The basic idea of a flexible budget is that

there shall be some standard of cost and expenditures. Thus, a budget prepared in a manner togive budgeted costs for any level of activity is, known as flexible budget. Such budget is

prepared after considering the variable and fixed elements of costs and the changes which may

be expected for each item at various levels of operations. .The main focus of flexible budget is to

re cognize the difference in behavior pattern of fixed and variable costs in relation to fluctuations

in production and sales . The flexible budget is, hence, designed to change appropriately with

such fluctuations. In flexible budget, data relating to costs and expenses may progressively be

changed in any month in accordance with actual output achieved. Costs and estimates are made

in advance based on standards. A maximum and a minimum levels of operation is made.

Comparison of budgeted with actual are made. Budgeted activities are taken as basis. The

principles of flexible budgeting concepts are applied to functional budget, master budgets.

Popularly, the flexible budget is adopted for production cost budget. In this area., the costs are

classified. A detailed classification is adopted such as variable, fixed and semi variables..





Adopting micro level classifications, it is intended to pin point the various effects on each class of

overheads.


1. Flexible budget is _______________.

2. Main focus on flexible budget is ___________.

Problem 7:

Draw a flexible budget for the level of operation at 70 %, 80 % and 90 %..

Variable overheads : at 80 % capacity. Indirect labor Rs.12,000. Stores and spares Rs.4,000.

Semi variable overheads at 80% capacity. Power (30 % fixed) Rs.20,000. Repairs and

maintenance at 60 % fixed Rs.2,000.

Fixed overheads : at 80 % : Depreciation Rs.11,000. Insurance Rs.3,000. Salaries Rs.10,000.

The estimated direct labor hours 1,24,000,.

Solution:

FLEXIBLE BUDGET (OVERHEADS)

For the period …………………

Particulars Level of operation

Basis 70 % 80 % 90 %

VARIABLE OVERHEADS

Indirect labor 10,500 12,000 13,500

Spares and 3,500 4,000 4,500

Total, say A 13,500 16,000 18,000

SEMI VARIABLE OVERHEADS

Power ( 30 % fixed ) consider 80 %

Power total 20,000 and segregate between

Variable and fixed . For fixed, maintain

Uniformity for all levels of production

30% x 20,000 6,000 6,000 6,000

Balance 70 % ,

proportionately calculate 12,250 14,000 15,750





Repairs and maintenance

60 % fixed on

Rs.2,000 (i.e. 80 % capacity) 1,200 1.200 1,200

40 % variable 700 800 900

Total, say B 34,150 38,000 41,850

FIXED OVERHEADS

Depreciation 11,000 11,000 11,000

Insurance 3,000 3,000 3,000

Salaries 10,000 10,000 10,000

Total, say C 24,000 24,000 24,000

Grand Total A + B + C 58,150 62,000 65,850

Estimated labor hours 1,08,500 1,24,000 1,39,500

Standard overhead rate / hour 0.54 0.50 0.48

Divide the grand total by estimated Labor hours.

14.11 Limitations Of Budgeting

The main limitations of budgeting are as under :

Budget plan : Since budget plans are based on estimates, the success or otherwise depends on

the accuracy of basic estimates or forecasts. Due to this while making estimates, judgmental

decision may accrue. The results need to be interpreted very cautiously.

Rigidity: Since the estimates are quantitative expression of all relevant data, there is likely that

finality attachment may become very clear. Such consideration may result in rigidity. Rigidity

may become a set back for the changing business conditions.

Replacement: Budgeting is not a substitute for management. It is essentially a tool of

management. Under no circumstances, it should be concluded that the budgeting is alone

sufficient to ensure success and to guarantee future profits.

Costly: The installation of budgeting system to an organization involve too much of costs. Its

scientific approach will definitely call for huge cost allocation. Small concerns cannot afford to

take over huge costs for the establishment of business systems. Since the costs and revenues

and operational activities do not match in many occasions, the entire exercise will become costly.

The system should be adopted only when benefits exceed the costs.





Terminal Questions

1. What are the merits of budgets ?

2. Describe the essential features of budgetary control.

3. What are the steps in budgetary control ?4. What are the limitations of budgeting ?

5. DR Ltd provides the following Profit and Loss Account for the year 2007.

Sales Rs.3,55,000 LESS : Expenses : Raw materials Rs.72,200. Expenses Rs.2,04,000.

Stores Rs.48,800. Interest Rs.20,000. Depreciation Rs.20,000. Loss : (Rs.11,200). The

company had been working at 60 % capacity during the year 2007. Of the expenses of

Rs.2,04,00, 25 % is variable. During the year 2008, production / sales volume at 80 % of

capacity is expected to be achieved. Fixed cost is, however, expected to increase by

Rs.12,000. Draw a 2008 Budget.

6. The expenses budget for production of 10,000 units in a factory are furnished below. In

rupees per unit.

Materials 70, Labor 25, Variable overheads 20, Fixed overheads (Rs.1,00,000) 10, variable

expenses (direct) 5, Selling expenses (10 % fixed) 13. Administrative expenses (Rs.50,000)

5. Distribution expenses (20 % fixed) 7. Prepare a budget for the production of (a) 8,000 units

and (b) 6,000 units. Assume that administrative expenses are rigid for all levels of production.

Answer Self Assessment Questions


1. Numerical

2. Estimated


1. Corrective action.


1. Forward

2. Long and short term goals


1. Fix financial goals


1. Best result

2. Foundation for business activities

3. Group of representatives





4. Coordination


1. Policy formulation, forecasting


1. Fixed, flexible, function


1. Process of cash flow forecast.

2. Weekly, monthly, quarterly, annually


1. Changes with level of activities

2. Recognize behavior pattern.

Answer for Terminal Questions

1. Refer to unit 14.5






14.Budgetary Control

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