Chapter18

CONCEPT OF BUDGET
CONCEPTOFBUDGET
TheCharteredInstituteofManagementAccountants(CIMA)London,hasdefineda
budgetasafinancialand/orquantitativestatement,preparedpriortoadefinedperiod
g
/ q
,p p
p
p
oftime,ofthepolicytobepursuedduringthatperiodforthepurposeofattaininga
givenobjective.Itmayincludeincome,expenditureandemploymentofcapital.

Characteristics

(a)
( )
(b)
(c)
(d)

Abudgetisprimarilyaplanningdevicebutitalsoservesasabasisfor
performanceevaluationandcontrol.
f
l ti d
t l
Abudgetispreparedeitherinmoneytermsorinquantitativetermsorinboth.
Abudgetispreparedforadefinitefutureperiod.
Purposeofabudgetistoimplementthepoliciesformulatedbymanagementfor
attainingthegivenobjectives.

CONCEPT OF BUDGETARY CONTROL

CONCEPTOFBUDGETARYCONTROL
Budgeting:Theactofpreparingbudgetsiscalledbudgeting.InthewordsofJBatty,the
entireprocessofpreparingthebudgetsisknownasbudgeting.
ConceptofBudgetaryControl:AccordingtoCIMA,London,Budgetarycontrolisthe
establishmentofbudgetsrelatingtotheresponsibilitiesofexecutivesofapolicyandthe
continuouscomparisonoftheactualwiththebudgetedresults,eithertosecureby
individualactiontheobjectiveofthepolicyortoprovideabasisforitsrevision.
j
p
y
p

Characteristics
(a)
(b)
(c)
(d)
(e)

Establishmentofbudgetsforeachfunction/departmentoftheorganization.
Comparisonofactualperformancewiththebudgetsonacontinuousbasis.
Analysisofvariationsofactualperformancefromthatthebudgetedperformancetoknowthe
A l i f i ti
f t l f
f
th tth b d t d f
t k
th
reasonsthereof.
Takingsuitableremedialaction,wherenecessary.
Revisionofbudgetsinviewofchangesinconditions.

OBJECTIVES OF BUDGETARY CONTROL

OBJECTIVESOFBUDGETARYCONTROL
Abudgetprovidesa
detailedplanofaction
forabusinessovera
f b i

definiteperiodof
time.

Budgetingaids
managersinco
ordinatingtheirefforts
di i h i ff

sothatobjectivesof
theorganization.

Abudgetisacommunication
device.Itprovidesnotonly
adequateunder
d
d standingand
di d
knowledgeoftheprogrammesand
policiestobefollowedbutalso
alertsabouttherestrictionstobe
adheredto.

Planning

Coordination

Communication

Abudgetisauseful
deviceformotivating
managerstoperform
i li i h h
inlinewiththe
companyobjectives.

Controlisnecessary
toensurethatplans
andobjectivesaslaid
d
downinthebudgets
i h b d

arebeingachieved.

Motivation

Control

Abudgetprovidesauseful
meansofinforming
managershowwelltheyare
performinginmeeting
f
i i
i
targetstheyhavepreviously
helpedtoset.
Performance
evaluation

ESSENTIALSOFEFFECTIVE
BUDGETING
Supportoftop
S
f
management

Participation
byresponsible
executives

Reasonable
R
bl
goals

Clearlydefined
organization

Continuous
budget
education

Adequate
accounting
system

Constant
vigilance

Maximum
profits

Costofthe
system

Integration
withstandard
costs

PRELIMINARIESINTHEINSTALLATION
OFBUDGETSYSTEM
Creationofbudgetcentres
Budgetcentreissectionoforganizationforwhichabudgetisprepared.
d
f
f
h h b d
d
Introductionofadequateaccountingrecords
Systemisdesignedtobeabletorecordandanalyseinformationrequired.
Preparationofanorganizationchart
Organizationchartshouldbepreparedwhichshowstheplanoforganization.
Establishmentofbudgetcommittee
Inlargeconcerns,thedirectionandexecutionofthebudgetisdelegatedtoa
Inlargeconcerns thedirectionandexecutionofthebudgetisdelegatedtoa
budgetcommitteewhichreportsdirectlytothetopmanagement.
Preparationofbudgetmanual
AbudgetmanualhasbeendefinedbyCIMA,Londonasadocumentwhich
g
y
setsouttheresponsibilitiesforthepersonsengagedintheroutineofandthe
formsandrecordsrequiredforbudgetarycontrol.
Budgetperiod
Budgetperiodisalengthoftimeforwhichabudgetispreparedandoperated.
Budgetperiodisalengthoftimeforwhichabudgetispreparedandoperated
Determinationofthekeyfactor
Thekeyfactormeansthefactorwhichlimitsthesizeofoutput.

CLASSIFICATION OF BUDGETS
CLASSIFICATIONOFBUDGETS
Onthebasisof
functionand
scope:

Onthebasisof
flexibility:
y

Functional
budgets

Fixed
budget

Master
g
budget

Flexible
g
budget

FUNCTIONAL BUDGETS
FUNCTIONALBUDGETS
Afunctionalbudgetisonewhichrelatestoaparticularfunctionofthebusiness.
SalesBudget:Thesalesbudgetisastatementofplannedsalesintermsof
quantityandvalue.

ProductionBudget:Theproductionbudgetisaplanofproductionforthebudget
period.

ProductionCostBudget:Thisbudgetshowstheestimatedcostofproduction.
Theproductionbudgetshowsthequantitiesofproduction.Thesequantitiesof
productionareexpressedintermsofcostinproductioncostbudget.
RawMaterialBudget:Thisbudgetshowstheestimatedquantitiesofalltheraw
materialsandcomponentsneededforproductiondemandedbytheproduction
budget.

PurchaseBudget:Thepurchasebudgetprovidesdetailsofthepurchaseswhich
areplannedtobemadeduringtheperiodtomeettheneedsofthebusiness.

FUNCTIONAL BUDGETS(Contd.)
FUNCTIONALBUDGETS(Contd.)
LabourBudget:Labourcostisclassifiedintodirectandindirect.Somecompaniespreparea
labourbudgetthatincludesbothdirectandindirectlabour,whileothersincludeonlydirect
g
labourcostandincludetheindirectlabourintheoverheadcostbudget.
ProductionOverheadsBudget:Theproductionoverheadsbudgetrepresentstheforecast
ofalltheproductionoverheads(fixed,variableandsemivariable)tobeincurredduringthe
budgetperiod.
SellingandDistributionCostBudget:Thisiscloselyrelatedtosalesbudgetand
representstheforecastofallcostsincurredinsellinganddistributingthecompanys
productsduringthebudgetperiod.
AdministrationCostBudget:Thisbudgetrepresentsforecastofalladministration
expenses,likedirectorsfees,managingdirectorssalary,officelighting,heatingandair
conditioning,etc.
CapitalExpenditureBudget:Thisbudgetrepresentstheexpenditureonallfixedassets
duringthebudgetperiod.Itincludessuchitemsasnewbuildings,machinery,landand
intangibleitemslikepatents,etc.

CashBudget: Itisadetailedestimateofcashreceiptsfromallsourcesandcashpayments
forallpurposesandtheresultantcashbalancesduringthebudgetperiod.

CASHBUDGET
C S U G
Itisadetailedestimateofcashreceiptsfromallsourcesandcashpaymentsforall
purposesandtheresultantcashbalancesduringthebudgetperiod.

PreparationofCashBudget
P
i fC hB d
Receipts Thismethodisusuallyusedforshorttermcash.Thecashbudgetbeginswiththeopeningbalance
and
p
ofcashinhandandatbank.Tothisareaddedthecashreceiptsfromvarioussourcesandfrom
Payments thisaredeductedallpaymentsofcash,whetheroncapitalorrevenueaccount.Theresultant
figureistheclosingcashbalance.
Method

Adjusted Thismethodissuitableforlongtermcashforecast.Itisbasedontheviewthatitisthe
profitthatisthesourceofcashinthebusiness.TheprofitasperP&Laccountsisconvertedinto
Profitand cashfigurebypreparinganAdjustedProfitandLossAccount.Allthoseitemsofincomeand
Loss
expenditure,whichdonotinvolveaninfloworoutflowofcash,areadjustedintheforecasted
Method
profitfiguretoarriveatthefigureofcashmadeavailablebyprofit
profitfiguretoarriveatthefigureofcashmadeavailablebyprofit.

Balance
Sheet
Method

Thi
Thismethodisalsousedforforecastingcashrequirementsforlong.Underthismethodbudgeted

h di l df f
i h
i
f l
U d hi
h db d
d
balancesheetispreparedwithallitemsofassetsandliabilities,exceptingcashorbankbalance.
Thetwosidesofthebalancesheetarethentotalledandthebalancingfigureistakenascash.

MASTER BUDGET
MASTERBUDGET
AccordingtoCIMA,London,masterbudgetisasummarybudgetincorporatingits
A
di CIMA L d
b d i
b d i
i i
componentfunctionalbudgetsandwhichisfinallyapproved,adoptedandemployed.

Amasterbudgethastwoparts
(i)operatingbudget,i.e.,budgetedprofitand
lossaccount,
(ii)financialbudget,i.e.,budgetedbalance
sheet.

Themasterbudgetispreparedbythebudgetdirector(orbudgetofficer)andis
presentedtothebudgetcommitteeforapproval.Ifapproved,itissubmittedtotheBoardof
Di
Directorsforfinalapproval.TheBoardmaymakecertainamendments/alterations
f fi l
l Th B d
k
i
d
/ l
i

beforeitisfinallyapproved.

FIXEDANDFLEXIBLEBUDGETS
U G S
FixedBudget:Afixedbudgetisonewhichispreparedkeepinginmindonelevelofoutput.
Itisdefinedasabudgetwhichisdesignedtoremainunchangedirrespectiveofthelevelof
activityattained.
FlexibleBudget:Incontrasttoafixedbudget,aflexiblebudgetisonewhichisdesignedto
Fl ibl B d
I
fi db d
fl ibl b d i
hi hi d i
d
changeinrelationtothelevelofactivityattained.Theunderlyingprincipleofflexible
budgetisthatabudgetisoflittleuseunlesscostandrevenuearerelatedtotheactual
volumeofproduction.

DistinctionbetweenFixedandFlexibleBudgets
g
Fixedbudgetassumesstatic
businessconditionswhereas
flexiblebudgetisbasedon
theassumptionofchanging
businessconditions.

Fixedbudgetispreparedfor
onlyonelevelofactivitybut
l
l l f ti it b t
flexiblebudgetsmaybe
preparedfordifferentcapacity
levelsorforanylevelof
activity.

Whenactuallevelofactivitydiffers
frombudgetedlevelofactivity,then
infixedbudgetsmeaningful
comparisonbetweenactualand
budgetfiguresisnotpossible.Butin
flexiblebudgets,suchcomparisons
arequiterealistic.

Fixedbudgetfiguresarenot
g
changedwhenactuallevelof
activitychanges.Butin
flexiblebudgets,thefigures
areadjustedaccordingtothe
actuallevelofactivity
attained.

Underchangingbusiness
environments,fixedbudgetshave
verylimiteduseforcontrol.But
flexiblebudgetsareveryusefulfor
costcontrolandperformance
evaluationunderchangingbusiness
environments.

BUDGETREPORTS
U G
O S
Establishingbudgetsinitselfisofnouseunlessthereisacontinuousflowofbudgetreports
showingcomparisonofactualandbudgetfigures.Budgetreportsshouldbepreparedat
regularintervals(say,everymonth)showingthereasonsforthedifferencesbetweenactual
andbudgetfigures
andbudgetfigures.
EssentialsofaBudgetReport
(a)Thebudgetreportsshouldbesimpleandsuitableforthelevelofunderstandingfortheuser.
(b)Reportsshouldbepresentedpromptly.
(c)Reportsshouldbeaccuratebuttheextremeaccuracyshouldnotbeatthecostofpromptness.
(d)Th i i l f
(d)Theprincipleofexceptionshouldbeutilized,wherepossible.
ti h ldb tili d h
ibl
(e)Thereportsshouldcontainonlyessentialinformationaccordingtotheneedsoftheuser.

ZERO BASE BUDGETING (ZBB)

ZEROBASEBUDGETING(ZBB)
AccordingtoCIMA,London,ZBBisdefinedasamethodofbudgetingwherebyall
activitiesarerevaluatedeachtimeabudgetisset Discretelevelsofeachactivityarevalued
activitiesarerevaluatedeachtimeabudgetisset.Discretelevelsofeachactivityarevalued
andacombinationchosentomatchfundsavailable.

MainFeaturesofZeroBaseBudgeting(ZBB)

1.Allbudgetitems,both
oldandnewlyproposed,
areconsideredtotally
areconsideredtotall
afresh

2.Amounttobespenton
eachbudgetitemistobe
g
totallyjustified

3.Adetailedcostbenefit
analysisofeachbudget
programmeisundertaken
andeachprogrammehas
tocompeteforscarce
resources

4.Departmental
objectivesarelinkedto
corporategoals

5.Themainstressinnot
onhowmucha
departmentwillspendbut
p
p
onwhyitneedstospend

6.Managersatalllevels
participateinZBBprocess
andtheyhave
corresponding
accountabilities.

PERFORMANCEBUDGETING
Performancebudgetingisarelativelynewconceptwhichfocusesonfunctions,programmes
andactivities.Performancebudgetsareestablishedinsuchamannerthateachitemof
expenditurerelatedtoaspecificresponsibilitycentreiscloselylinkedwiththe
performanceofthatcentre
performanceofthatcentre.

StepsinPerformanceBudgeting
p
y
p
y
g
EstablishmentofresponsibilitycentreResponsibilitycentres,asegmentofan
organizationwhereamanagerisresponsiblefortheperformanceareestablished.
EstablishmentofperformancetargetsForeachresponsibilitycentre,targetsareset
intermsofphysicalperformancetobeachieved.
EstimatingfinancialrequirementsInthisstep,thefinancialsupportneededto
achievethephysicaltargetsisestimated.
ComparisonofactualwithbudgetedperformanceThisisausualstepin
budgetarycontroltoevaluatetheactualperformance.
ReportingandactionVariancesfrombudgetedperformanceareanalysedand
reportedforcorrectiveactiontobetaken.