Enrollment No. MBISMCT10716140

MBA Information Systems 1st Year - Assignment

Annamalai University

3: Accounting and Finance for Managers

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I declare that the assignment submitted by me is not a verbatim/photo static copy from the website/book/journals/manuscripts.

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Question 1: Explain the accounting concepts that are being followed in organizations and how they are useful in preparing financial statements.Answer:

ACCOUNTING CONCEPTS

Introduction

Basic accounting rules group all finance related things into five fundamental types of accounts. That is, everything that accounting deals with can be placed into one of these five accounts:

Assets - things are own.

Liabilities - things are owe.

Equity - overall net worth.

Income - increases the value in accounts.

Expenses - decreases the value from accounts.

It is clear that it is possible to categorize financial world into these 5 groups. For example, the cash in the bank account is an asset, mortgage is a liability, pay check is income, and the cost of dinner last night is an expense.

Net worth is calculated by subtracting liabilities from the assets:

Assets - Liabilities = EquityEquity can be increased through income, and decreased through expenses. This means pay check make "richer" and expense make "poorer". This is expressed mathematically in what is known as the Accounting Equation:

Assets - Liabilities = Equity + (Income - Expenses)This equation must always be balanced, a condition that can only be satisfied if values are enter to multiple accounts.

Accounting Principles The transactions of the business enterprise are recorded in the business language, which routed through accounting. The entire accounting system is governed by the practice of accountancy. The accountancy is being practiced through the universal principles which are wholly led by the concepts and conventions.

The entire principles of accounting are on the constructive accounting concepts and conventions.Accounting concept refers to the basic assumptions and rules and principles which work as the basis of recording of business transactions and preparing accounts.

The main objective is to maintain uniformity and consistency in accounting records. These concepts constitute the very basis of accounting. All the concepts have been developed over the years from experience and thus they are universally accepted rules. Below are the main accounting concepts that have been discussed in details:

1. Business entity concept;2. Money measurement concept;3. Going concern concept;4. Accounting period concept;5. Accounting cost concept;6. Duality aspect concept;7. Realisation concept;8. Accrual concept;9. Matching concept;1. Business entity concept: This concept assumes that, for accounting purposes, the business enterprise and its owners are two separate independent entities. The business and personal transactions of its owner are separate. The accounting records are made in the books of accounts from the point of view of the business unit and not the person owning the business. This concept is the very basis of accounting.The private expense of the owner is not the expense of the business and it is termed as Drawings. Accordingly, any expenses incurred by owner for himself or his family from business will be considered as expenses and it will be shown as drawings.

Significance This concept helps in ascertaining the profit of the business as only the business expenses and revenues are recorded and all the private and personal expenses are ignored.

These concept restraints accountants from recording of owners private/ personal transactions.

It also facilitates the recording and reporting of business transactions from the business point of view

It is the very basis of accounting concepts, conventions and principles

2. Money Measurement Concept: This concept assumes that all business transactions must be in terms of money, that is in the currency of a country. In our country such transactions are in terms of rupees. Thus, as per the money measurement concept, transactions which can be expressed in terms of money are recorded in the books of accounts. But the transactions which cannot be expressed in monetary terms are not recorded in the books of accounts. For example, sincerity, locality, honesty of employees is not recorded because these cannot be measured in terms of money although they do affect the profits and losses of the business concern.

Another aspect of this concept is that the records of the transactions are to be kept not in the physical units but in the monetary unit. The transactions which can be expressed in terms of money is recorded in the accounts books, that too in terms of money and not in terms of the quantity.

Significance

This concept guides accountants what to record and what not to record.

It helps in recording business transactions uniformly.

If all the business transactions are expressed in monetary terms, it will be easy to understand the accounts prepared by the business enterprise.

It facilitates comparison of business performance of two different periods of the same firm or of the two different firms for the same period.

3. Going Concern Concept: This concept states that a business firm will continue to carry on its activities for an indefinite period of time. Simply stated, it means that every business entity has continuity of life. Thus, it will not be dissolved in the near future. This is an important assumption of accounting, as it provides a basis for showing the value of assets in the balance sheet. According to this concept every year some amount will be shown as expenses and the balance amount as an asset. Only a part of the value is shown as expense in the year of purchase and the remaining balance is shown as an asset.

Significance

This concept facilitates preparation of financial statements.

On the basis of this concept, depreciation is charged on the fixed asset.

It is of great help to the investors, because, it assures them that they will continue to get income on their investments.

In the absence of this concept, the cost of a fixed asset will be treated as an expense in the year of its purchase.

A business is judged for its capacity to earn profits in future.4. Accounting Period Concept: All the transactions are recorded in the books of accounts on the assumption that profits on these transactions are to be ascertained for a specified period. This is known as accounting period concept. Thus, this concept requires that a balance sheet and profit and loss account should be prepared at regular intervals. This is necessary for different purposes like, calculation of profit, ascertaining financial position, tax computation etc. Further, this concept assumes that, indefinite life of business is divided into parts. These parts are known as Accounting Period. It may be 1 month to one year. But usually one year is taken as one accounting period which may be a calendar year or a financial year.

Significance

It helps in predicting the future prospects of the business.

It helps in calculating tax on business income calculated for a particular time period.

It also helps banks, financial institutions, creditors, etc to assess and analyze the performance of business for a particular period.

It also helps the business firms to distribute their income at regular intervals as dividends.5. Accounting Cost Concept: Accounting cost concept states that all assets are recorded in the books of accounts at their purchase price, which includes cost of acquisition, transportation and installation and not at its market price. It means that fixed assets like building, plant and machinery, furniture, etc are recorded in the books of accounts at a price paid for them. The cost concept is also known as historical cost concept. The effect of cost concept is that if the business entity does not pay anything for acquiring an asset this item would not appear in the books of accounts. Thus, goodwill appears in the accounts only if the entity has purchased this intangible asset for a price.

Significance

This concept requires asset to be shown at the price it has been acquired, which can be verified from the supporting documents.

It helps in calculating depreciation on fixed assets.

The effect of cost concept is that if the business entity does not pay anything for an asset, this item will not be shown in the books of accounts.6. Dual Aspect Concept: Dual aspect is the foundation or basic principle of accounting. It provides the very basis of recording business transactions in the books of accounts. This concept assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, the transaction should be recorded at two places. It means, both the aspects of the transaction must be recorded in the books of accounts. For example, goods purchased for cash has two aspects which are (i) Giving of cash (ii) Receiving of goods. These two aspects are to be recorded. Thus, the duality concept is ommonly expressed in terms of fundamental accounting equation :

Assets = Liabilities + Capital

The above accounting equation states that the assets of a business are always equal to the claims of owner/owners and the outsiders. This claim is also termed as capital or owners equity and that of outsiders, as liabilities or creditors equity.

The interpretation of the Dual aspect concept is that every transaction has an equal effect on assets and liabilities in such a way that total assets are always equal to total liabilities of the business.

Significance

This concept helps accountant in detecting error.

It encourages the accountant to post each entry in opposite sides of two affected accounts.7. Realization Concept: This concept states that revenue from any business transaction should be included in the accounting records only when it is realized. The term realization means creation of legal right to receive money. Selling goods is realization, receiving order is not. In other words:

Revenue is said to have been realized when cash has been received or right to receive cash on the sale of goods or services or both has been created. In short, the realization occurs when the goods and services have been sold either for cash or on credit. It also refers to inflow of assets in the form of receivables.

Significance It helps in making the accounting information more objective.

It provides that the transactions should be recorded only when goods are delivered to the buyer.8. Accrual Concept: The meaning of accrual is something that becomes due especially an amount of money that is yet to be paid or received at the end of the accounting period. It means that revenues are recognized when they become receivable. Though cash is received or not received and the expenses are recognized when they become payable though cash is paid or not paid. Both transactions will be recorded in the accounting period to which they relate.

The accrual concept under accounting assumes that revenue is realized at the time of sale of goods or services irrespective of the fact when the cash is received. Similarly, expenses are recognized at the time services provided, irrespective of the fact when actual payments for these services are made.

In brief, accrual concept requires that revenue is recognized when realized and expenses are recognized when they become due and payable without regard to the time of cash receipt or cash payment.

Significance

It helps in knowing actual expenses and actual income during a particular time period.

It helps in calculating the net profit of the business.

9. Matching Concept: The matching concept states that the revenue and the expenses incurred to earn the revenues must belong to the same accounting period. So once the revenue is realized, the next step is to allocate it to the relevant accounting period. This can be done with the help of accrual concept. If the revenue is more than the expenses, it is called profit. If the expenses are more than revenue it is called loss. This is what exactly has been done by applying the matching concept. Therefore, the matching concept implies that all revenues earned during an accounting year, whether received/not received during that year and all cost incurred, whether paid/not paid during the year should be taken into account while ascertaining profit or loss for that year.

Significance

It guides how the expenses should be matched with revenue for determining exact profit or loss for a particular period.

It is very helpful for the investors/shareholders to know the exact amount of profit or loss of the business.

Accounting Concepts for Financial Statement PreparationThe Financial Statements are found to be more useful to many people immediately after presentation only in order to study the financial status of the enterprise in the angle of their own objectives. The preparation of Final accounts the business firm involves two different stages, Preparation of Accounting and Positioning Statement of the enterprises. The preparation of accounting statement involves two different category, Trading account and Profit and Loss account. The preparation of the positional statement involves only one statement, Balance sheet.The following Financial Statement are prepared by considering the accounting concepts:1. Trading Account

2. Profit and Loss Account

3. Balance Sheet

4. Income Statement

1. Trading Account This is first Financial Statement prepared by the owner of the enterprise to determine the gross profit during the year through the matching Concept of Accounting. The gross profit of the enterprise is calculated through the comparison of purchase expenses, manufacturing expenses, and other direct expenses with the sales.

It is prepared normally for one year in accordance with Accounting Period Concept i.e., operating cycle of the enterprise which should not exceed 15 months with reference to the Companies Act 1956. Trading Account for the year endedDR

Rs.

Rs.

Rs. Cr

To Opening Stock xxxxxBy Cash Sales xxxxx

To Cash Purchase xxxxxAdd Credit Sales xxxxx

Add Credit Purchase xxxxxBy Total Sales xxxxx

To Total Purchase xxxxxLess Sales return xxxxx

Less Purchase Return xxxxxBy Net Sales xxxxx

To Net Purchases xxxxxBy Closing Stock xxxxx

To Wages xxxxxBy Gross Loss C/d xxxxx

To Carriage Inward xxxxx

To Factory Lighting xxxxx

To Fuel, Coal, Oil xxxxx

To Duty on Import of Materials xxxxx

To Gross Profit C/d xxxxx

Balancing Process: Gross profit is the resultant of an excess of the credit side total over the total of debit side. It means that the gross profit is the excess of incomes in the credit side over the expenses in the debit side.

Gross Loss is the outcome of an excess of the debit side total over the total of credit side. It means that the gross loss is the excess of expenses in the debit side over the incomes in the credit side.

The purpose of crediting the closing stock in the trading account is to find out the materials or goods consumed for trading purposes.

Material consumed could be calculated Material consumption = Opening stock + Purchases - Closing stock2. Profit & Loss Account It is a second statement of accounting in connection with the earlier to determine the Net profit/loss of the enterprise out of the early found Gross profit/loss. This is an accounting statement matches the administrative, selling and distribution expenses with the gross profit and other incomes of the enterprise.

This is an account prepared for one Operating Cycle of the firm i.e. 12 months in period. The transactions are recorded in accordance with golden rules of nominal account. In the profit & loss account, the expenses and losses are debited and incomes and gains are credited.The expenses which are matched with the credit total of the profit and loss account.

Classified into various categories

i. Administrative Expense

ii. Selling & Distribution Expenses

iii. Financial Expenses

iv. Legal Expense. Performa Profit and Loss account for the year ended.

Dr

Rs

RS Cr

To Gross Loss B/d

Balancing figure

Office and Administrative Expenses

To Salaries

To Rent, Rates and TaxesxxxxxBy Gross Profit xxxxx

By Rent Received

To Office Expenses

To general Expenses

To Miscellaneous Expenses

Selling and Distribution ExpensesTo Salary to Sales staff

To Commission charges

To Advertising expensesBy Commission received

To Carriage outwards

To Bad debts

Packing Expenses

Financial ExpensesTo Interest on capitolBy Increase on drawing

To Interest on LoanBy interest on investment

To trade discount allowedBy trade discount received

Maintenance ExpensesTo Depreciation of Fixed assets

To loss on sale of assetsOther Expenses

To provision for debts

To Net profit c/dTo profit on sale of assetsBy Net loss c/d

Balancing process of the profit and loss account leads to two different categories:Net profit is the resultant of excess of income in the credit side over the expenses in the debit side of the Profit and Loss account.Net Loss is an outcome of excess of expenses in the debit side over the incomes in the credit side .3. Balance Sheet

Balance sheet is the third Financial Statement which reveals the financial status of the enterprise through the total amount of resources raised and applied in the form of assets. This is the fundamental statement of the firm which explores the firm financial stature through the resources mobilized and investments applied i.e. Liabilities and Assets respectively. From the early, according to Double Entry Concept or Duality Concept, the balance sheet can be divided into two distinct sides, known as liabilities and assets.

The balance sheet can be disclosed in two different orders:(i) In the order of long lastingness permanence.(ii) In the order of liquidity.Performa Balance Sheet as on dated

LiabilitiesRsAssetsRs

Capital xxxxLand & Buildingxxxxx

Less: Drawings xxxxPlant & Materialxxxxx

Add: Net Profit xxxxFurniture & fittingsxxxxx

xxxxxFixtures & toolsxxxxx

Long Term BorrowingxxxxxMarketable securitiesxxxxx

Sundrey CreditorsxxxxxClosing stockxxxxx

Bills PayablexxxxxSundry debtorsxxxxx

Bank OverdraftxxxxxBills receivablexxxxx

Outstanding expensesxxxxxPre paid expensesxxxxx

Pre received incomexxxxxCash at Bankxxxxx

Cash in handxxxxx

Total liabilitiesxxxxxTotal Assetsxxxxx

Cash in handxxxxx

Total LiabilitiesxxxxxTotal Assetsxxxxx

Methods of determining the accounting income includes:Cash Method of Accounting : Under this method, cash receipts are matched with the cash payments irrespective of the time period in order to determine the income.Mercantile Method of Accounting: Under this method, time period is given greater importance than the actual receipts and payments. It records the receipts and expenses pertaining to the specified period whether them are actually received /paid or not. The receipts as well as payments of the other periods should be ignored /eliminated in determining the income of the stipulated duration. It is popularly known in other words as "Accrual Accounting System". 4. Income StatementTo determine income of the business, what should be in character either in accounting income or taxable income. Taxable income can be computed from the transactions of the enterprise but they are subject to frequent modifications on the tax provisions from one year to another year. This cannot be uniquely found out unlike the accounting income. The accounting income should have to be found out only to the tune of accounting principles and concepts.Conclusion

Trading Account is first financial statement prepared by the owner of the enterprise to determine the gross profit during the year through the matching concept of accounting. In order to find out the total amount of goods or materials consumed during a year, three different components to be separately considered i.e. Opening stock, Purchases and Closing Stock;Profit & Loss Account is a second statement of accounting in connection with the earlier to determine the Net profit/loss of the enterprise out of the early found Gross profit/loss.Balance sheet is the third financial statement based on Duality Concept; which reveals the financial status of the enterprise through the total amount of resources raised and applied in the form of assets.

Question 3 Budgeting is the one of the main tool to control the cost Give your views.Answer:BUDGTING

Introduction

A budget is a plan of action expressed in financial terms or non financial terms. It is prepared for a definite period of time. It is a planned estimate of future business conditions such as the sales, cost and profit. A budget is a tool which helps the management in planning and control of business activities. Budgets are the common denominator of an organization and a constant in the life of any organization."A budget is Financial and/or quantitative statements, prepared and approved prior to a defined period of time, of the policy to be pursed during the period for the purpose of attaining a given objective. - ICMA, England

"Budget is a blue print of a projected plan of action of a business for a definite period of time."According to the definition, the essential features of a budget are:

It is prepared for a definite period well in advance.

It may be stated in terms of money or quantity or both.

It is a statement defining the objectives to be attained and the policy to be followed to achieve them in a future period.Typically, budgets serve three major purposes: Planning; Coordinating; and Controlling.These three functions dictate that budgeting and the financial management process be flexible but accountable throughout the fiscal period. At all management levels, budgets typically represent an effective element of control, whether on a day-to-day operational basis or on a longer term basis. Controlling and monitoring are terms often used interchangeably; as one considers controlling/monitoring.Types of Budgets

There are many types of budgets. They may be classified into several basic types. Most organizations develop and make use of three different types of budgets: 1. Operating budgets;

2. Capital expenditures budgets; 3. Financial budgets; and

4. Zero-Base Budgets;

1. Operating BudgetsAn operating budget is a statement that presents the financial plan for each responsibility centre during the budget period and reflects operating activities involving revenues and expenses. The most common types of operating budgets are: Expense Budget, Revenue Budget and Profit budgets.i. Expense Budget: An expense budget is an operating budget that documents expected expenses during the budget period. Three different kinds of expenses normally are evaluated in the expense budget - fixed, variable and discretionary. Discretionary expenses - costs that depend on managerial judgment because they cannot be determined with certainty, for example: legal fees, accounting fees and R&D expense. ii. Revenue Budget: A revenue budget identifies the revenues required by the organization. It is a budget that projects future sales.iii. Profit Budget: A profit budget combines both expense and revenue budgets into one statement to show gross and net profits. Profit budgets are used to make final resource allocation, check on the adequacy of expense budgets relative to anticipated revenues, control activities across units, and assign responsibility to managers for their shares of the organization's financial performance.

2. Financial BudgetsFinancial Budgets outline how an organization is going to acquire its cash and how it intends to use the cash. Three important financial budgets are the cash budget, capital expenditure budget and the balance sheet budget.

i. Cash budget : Cash budgets are forecasts of how much cash the organization has on hand and how much it will need to meet expenses. The cash budget helps managers determine whether they will have adequate amounts of cash to handle required disbursements when necessary, when there will be excess cash that needs to be invested, and when cash flows deviate from budgeted amounts.

ii. Capital Expenditure Budget: Capital Expenditure Budgets. Investment in property, buildings and major equipment are called capital expenditure. Such capital expenditure budgets allow management to forecast capital requirements, to on top of important capital projects, and to ensure the adequate cash is available to meet these expenditures as they come due.

iii. The balance sheet budget: The balance sheet budget plans the amount of assets and liabilities for the end of the time period under considerations. A balance sheet budget is also known as a Performa balance sheet. Analysis of the balance sheet budget may suggest problems or opportunities that will require managers to alter some of the other budgets.

3. Variable Budgets Because of the dangers arising from inflexibility in budgets and because of maximum flexibility consistent with efficiency underlines good planning, attention has been increasingly given to variable or flexible budgets. To deal with this difficulty, many managers resort to a variable budget.

Whereas fixed budgeted express that individual costs should be at one specified volume, variable budgets are cost schedules that show how each cost should vary as the level of activity or output varies.

There are three types of costs that must be considered when variable budgets are being developed: fixed, variable, and semi-variable costs. The problem in devising variable budgets is that cost variability is often difficult to determine and that they are often quite expensive to prepare.

4. Zero-Base Budgets The conventional budgeting process does have one major disadvantage. Managers tend to prepare new budget requests by adding an incremental amount to their previous year's budget requests, rather than re-evaluating the need for things already included.Zero-base budgeting (ZBB), in contrast, enables the organization to look at its activities and priorities a fresh. Zero-base budgeting assumes that the previous year's budget is not a valid base from which to work. It forces department managers to thoroughly examine their operations and justify their departments activities based on their direct to the achievement of organizational goals.

The specific steps used in zero-based budgeting are as follows:

1. Break down each of an organization's activities into decisions packages. The decision package includes written statements of the department's objectives, activities, costs, and benefits; alternative ways of achieving objectives; plus the consequences expected if the activity is not approved. Managers then assign a rank order to the activities in their department for the coming year.

2. Evaluate the various activities and rank them in of decreasing benefits to the organization. Rankings for all organizational activities are reviewed and selecting by top managers.The Budget Preparation

There are two type of budgeting process :i. Top-down Budgeting;

ii. Bottom-up Budgeting;

i. Top-down Budgeting: Many traditional companies use, a process of developing budgets in which top management outlines the overall figures and middle and lower-lever managers plan accordingly. The top-down process has certain advantages: Top managers have comprehensive knowledge of the organization and its environment, including their familiarity with the company's goals, strategic plans, and overall resources availability. Thus, the top-down process enables managers set budget targets for each department to meet the needs of overall company revenues and expenditures.

ii. Bottom-up Budgeting: Other organizations use, a process developing budgets in which lower-level and middle managers anticipate their departments' resource needs, which are passed up the hierarchy and approved by top management. The bottom-up approach builds on the specialized knowledge of operating managers about environment and marketplace, which they have gleaned from day-to-day operations. In reality, the budgetary process usually involves a mixture of both styles. Budgetary Control

Budgets are the most widely used control system, because the plan and control resources and revenues are essential to the firm's health and survival. "The establishment of 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 basis for its revision. - ICMA, England"Budgetary control is a system which uses budgets as a means of planning and controlling all aspects of producing and/or selling commodities and services." - J. BattyThe main steps in budgetary control are :

Establishment of budgets for each section of the organization. Recording of actual performance. In case there is a difference between actual and budgeted performance taking suitable remedial action Monitoring of the actual performance with the budget and revise budgets if necessary.

Objectives of Budgetary ControlThe objectives, of budgetary control are: To define the goal and provide long and short period plans for attaining these goals.

To co-ordinate the activities of different departments. To operate various cost centers and departments with efficiency and economy.

To estimate waste and increase the profitability. To estimate future capital expenditure requirements and centralize the control system.

To correct deviations from Established standards.

To fix the responsibility of various individual in the organization.

To indicate to the management as to where action is needed to solve problems without delay.

The following steps should be taken in a sound system of budgetary control:1. Organization Chart;2. Budget Centre;

3. Budget Committee;

4. Budget Manual;

5. Budget Period;

6. Key Factor;1. Organization Chart: There should be a well defined organization chart for budgetary control. This will show the authority and responsibility of each executive.2. Budget Centre: A, budget centre is that part of the organization for which the budget is prepared. A budget centre may be a department, or a section of the department. (say production department or purchase section). The establishment of budget centre is essential for covering all parts of the organization. The budget centre" are also necessary for cost contra] purposes. The evaluation of performance becomes easy when different centers are established.

3. Budget Committee: In small companies, the budget is prepared by the cost accountant. But in big companies, the budget is prepared by the committee. The budget committee consists of the chief executive to managing director, budget officers and the managers of various departments. The Manager of various departments prepares their budgets and submits to this committee. The committee will take necessary adjustments, co-ordinate all the budgets and prepare a master Budget. The main functions of the committee are: To receive and scrutinize all budgets and decide the policy to be followed.

To suggest revision of functional budgets if needed and approve finally revised budgets.

To prepare the Master Budget after functional budget are approved.

To study variations of actual performance from the budget.

To recommend corrective action if and when required.

4. Budget Manual: Budget Manual is a book which contains the procedure to be followed by the executives / concerned with the budget. It guides all executives in preparing various budget. It is the responsibility of the budget officer to prepare and maintain this manual.

The budget manual may contains the following particulars:

A brief explanation of objectives and principles of budgetary control.

Duties and powers and functions of the budget officer and the budget committee.

Budget period, account classification, Reports, statements form and charts to be used.

Procedure to be followed for obtaining approval.

5. Budget Period: A budget period is the length of time for which a budget is prepared and deployed. 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 factors. The type of budget whether it is a sales budget, production budget, raw material purchase budget, by capital expenditure budget. A capital budget may be for a longer period i.e. 3 to 5 years; purchase and sales Budget may be for one year.

The nature of the demand for the producer and timings for the availability of finance.

6. Key Factor: It is also known as limiting factor or governing factor or principal budget factor. A key factor is one which restricts the volume of production. It may arise due to the shortage of material, labor, capital, plant capacity or sales. It is a factor which affects all other budgets. Therefore the budget relating to the key factor is prepared before other budgets are framed. The following ore the requirements of a good budgetary control system:

Budgetary control system should have the whole-hearted support of the top management. A budget committee should be established consisting of the budget director and the executives of various departments of the organization.

There should be a proper fixation of authority and responsibility. The delegation of authority should be done in a proper way.

The budget figures should be realistic and easily attainable.

Variation between actual figures and budgeted figures should be reported properly and clearly to the appropriate levels of management.

A good accounting system is essential to make budgeting successful.

The budget should not cost more to operate than is worth.

Advantages of Budgetary ControlBudgetary control has become an essential tool of the management for controlling costs and maximizing profits. It acts as a friend, philosopher, and guide to the management.

The following are the advantages of budgetary control:

Budgetary control defines the objectives and policies of the undertaking as a whole.

It is an effective method of controlling the activities of various departments of a business unit. It fixes targets and the various departments have efficiently to reach the targets.

It helps the management to fix up responsibility to reduce wasteful expenditure. This leads to reduction in the Cost of production.

It brings in efficiency and economy by promoting cost consciousness among the employees and facilitates introduction of standard costing. It acts as internal audit by a continuous evaluation of departmental results and costs.

It helps in estimating the financial needs of the concern. Hence the possibility of under capitalization is eliminated.

It provides a basis for introducing incentive remuneration plans based on performance.

It helps in the smooth running of the business unit. There will be no stoppage of production on account of shortage of raw materials or working capital. The reason is that everything is planned and provided in advanced.

It indicates to the Management as to where action is needed to solve problems without delay.

Budgeting as a Control Tool

A budget serves as a control tool to provide standards for evaluating performance.

A budget can cover any of the following:

Profit planning forecast of revenues and expenses

Cash budgeting forecast of cash needs and sources

Balance sheet forecasting anticipating future assets, liability and net worth position of the business

Profit Planning: The sales forecast and corresponding costs and expenses are the major inputs to a Profit Plan. Why is profit planning important? It enables the entrepreneur to see the complete picture and to analyze how each cost and expense item behaves in relation to changes in the level of sales. Budgeted amounts are then compared with actual results and variances are analyzed and corrected.

Cash Budgeting: A Cash Budget is used to determine anticipated cash inflows and outflows so that the business maintains the optimum level of cash. It also provides information on whether or not additional financing is required to address cash shortfalls.The first step in preparing a Cash Budget is to list down all transactions having cash flow implications.Cash Disbursements, on the other hand, may include cash operating expenses, raw material purchases, equipment and other asset purchases, and repayments on bank loans. From this exercise, a Net Cash Balance is derived. This is then carried over to the next as the beginning cash balance. Some businesses choose to have a pre-determined minimum required cash balance which they maintain at all times.

Balance Sheet Forecasting: This involves estimating asset levels to support the forecasted sales targets. For example, if the higher sales targets would necessitate opening more retail outlets, then necessarily, investments in fixed assets are a must. Moreover, changes in the funding mix (i.e., a higher level of long-term loans vs. short-term borrowings) may also occur.

Example:

The Sales Director of a manufacturing company reports that next year he expect to sell 50,000 units of a particular product.The production Manager consults the Storekeeper and casts his figures as follows:

Two kinds of raw materials A and B, are required for manufacturing the product. Each unit of the product requires 2 units of A and 3 units of B. The estimated opening balances at the commencement of the next year are:

Finished product : 10,000 units

Raw Materials A: 12,000 units, B: 15,000 units

The desirable closing balances at the end of the next year are: Finished product 14,000 units, A: 13,000 units

B : 16,000 units

Prepare Production Budget and Materials Purchase Budget for the next yearSolution:PRODUCTION BUDGET (Units)Estimated sales

50,000Add: Desired closing stock

14,000

----------

64,000

Less: Opening Stock

10,000

-----------

Estimated Production

54,000

MATERIALS PURCHASE OR PROCUREMENT BUDGET . (units)

Material AMaterial B

Estimated consumption 2 x 54000

1,08,000

3 x 54000

1,62,000

Add: Desired closing stock

13,000 16,000

---------------------------------

1,21,0001,78,000

Less: Opening Stock

12,000 15,000

---------------------------------

Estimated Purchase

1,090001, 63,000____________________________________________________________________________15