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CHAPTER- 6

BUDGETING AND
BUDGETARY CONTROL
- Mrs. Geetika Gahlot

MEANING OF BUDGET
A budget is a detailed plan of operations for some specified

future period.
It is an estimate prepared in advance of the period to which

it applies.
The Chartered Institute of Management Accountants,

London, defines a budget as a financial and/or


quantitative statement, prepared prior to a defined period of
time, of the policy to be pursued during that period for the
purpose of attaining a given objective.

MEANING OF BUDGETARY
CONTROL
The Chartered Institute of Management Accountants,

London, defines budgetary control as 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 objective of that policy or
to provide a basis for its revision.
It is the system of management control and accounting in

which all operations are forecasted and so far as possible


planned ahead, and the actual results compared with the
forecasted and planned ones.

DIFFERENCE BETWEEN BUDGETS


AND FORECASTS
BUDGETS

FORECASTS

1. Budget is a plan of action to be 1. Forecast is a prediction or


followed in the future under estimate of what is likely to
prescribed conditions.
happen.
2.
Only
the
authorized 2. Anybody can make a forecast
management of the company can about a companys performance.
prepare budget of the company.
3. Budget is expressed in terms of 3. Forecast is not always
rupees or quantities.
expressed in rupees or quantities.
4. Budgeting starts after making a 4. Forecasting ends with the
forecast. Budgetary control is assessment of the probable
preceded by forecasting.
events.

INSTALLATION OF BUDGETARY
CONTROL SYSTEM
I.
II.

III.

Determination of the Objectives


Organization for Budgeting:
i.
Setting up of a definite plan
ii. Responsibility of each executive should be clearly defined.
Budget Manual: It is a written document or a booklet which
specifies the objectives of the budgeting organization and procedures.
i.
Objectives of organization.
ii. Functions & responsibilities of each executive.
iii. Procedures to be followed for obtaining the necessary approval
of budgets.
iv. Time-tables for all stages of budgeting.
v. Reports, statements, forms to be maintained.
vi. Accounts classification to be employed.

III.

Responsibility for Budgeting:


i.

ii.

Budget Controller : The chief executive is ultimately


responsible for the budget programme but the large part of
supervisory responsibility is delegated to an official designated
as budget controller or budget director.
Budget Committee : The budget controller will be assisted in
his work by the budget committee. It will consist of Heads of
various Departments. Each head of department will have his
own Sub-committee with Executives working under him as its
members.

President
Budget Controller
Or Director
Submit, Discuss &
Finally approve the
Budget figures

Technical side
of the
business

Budget Committee
Head of Departments
Sub-Committees
Executives

IV.

Fixation of the Budget Period: Budget period means the


period for which the budget is prepared. It depends on
i.
The nature of the business.
ii. The control techniques to be applied.

V.

Budget Procedure:
i.
Determination of key factors.
ii. Making of forecasts.
iii. Consideration of alternative combinations of forecasts.
iv. Preparation of budgets.
v. Choice between fixed and flexible budgets.

CLASSIFICATION OF BUDGETS
1.
2.
3.

According to Time.
According to Function.
According to Flexibility.

1. According to Time
a)

b)

c)

d)

Long-term Budget: Budget designed for a long period


(generally for a period of 5 to 10 years). They are generally
prepared in terms of physical quantities.
Short-term Budget: Budget designed for a period generally
not exceeding 5 years. They are generally prepared in physical
as well as monetary units.
Current Budget: Budget covering a very short period say a
month or a quarter. They are adjusted to current conditions or
prevailing circumstances.
Rolling Budget: Some companies follow the practice of
preparing a rolling budget or progressive budget. A new budget
is prepared after the end of each month/quarter for a full year
ahead.

2. According to Function
a)

Sales Budget: The budget forecasts total sales in terms of


quantity, value, items, periods, areas, etc.

b)

Production Budget: The budget is based on Sales budget.


It forecasts quantity of production in terms of items,
periods, areas, etc.

c)

Cost of production Budget: The budget forecasts the


cost of production. Separate budgets are prepared for
different elements of cost such as direct materials budget,
direct labour budget, factory overheads budget, office
overheads budget, selling and distribution budget, etc.

d)

Purchase Budget: The budget forecasts the quantity and


value of purchases required for production. It gives
quantity wise, money wise and period wise information
about the material to be purchased.

e)

Personnel Budget: The budget anticipates the quantity of

personnel required during a period for production activity.


This may be further split up between direct and indirect
personnel budgets.
f)

Research Budget: The budget relates to research work to


be done for improvement in quality of the products or
research for new products.

g)

Capital Expenditure Budget: The budget provides a


guidance regarding the amount of capital that may be
required for the procurement of capital assets during the
budget period.

h)

Cash Budget: The budget is a forecast of the cash


position by time period for a specific duration of time. It
states the estimated amounts of cash receipts and cash
payments and the likely balance of cash in hand at the end
of different periods.

i)

Master Budget: It is a summary budget incorporating all


functional budgets in a capsule form. It interprets different
functional budgets and covers within its range the
preparation of projected income statement and projected
balance sheet.

3. According to Flexibility
a)

Fixed Budget: A budget prepared on the basis of a


standard or a fixed level of activity is called as a Fixed
Budget. It does not change with the change in the level of
activity.

b)

Flexible Budget: A budget designed in a manner so as to


give the budgeted cost of any level of activity is termed as a
Flexible Budget.

CONTROL RATIOS
Three important ratios are commonly used by the

management to find out whether the deviations of actual


from budgeted results are favourable or otherwise.
These ratios are expressed in terms of percentages.
If the ratio is 100% or more, the trend is taken as

favourable. The indication is taken as unfavouarble if the


ratio is less than 100%.

i. Activity Ratio
It is a measure of the level of activity attained over a

period.
It is obtained when the number of standard hours

equivalent to the work produced are expressed as a


percentage of the budgeted hours.
Activity Ratio = Standard hours for actual production

Budgeted hours

100

ii. Capacity Ratio


This ratio indicates whether and to what extent budgeted

hours of activity are actually utilized.


It is the relationship between the actual number of

working hours and the maximum possible number of


working hours in a budget period.
Capacity Ratio = Actual hours worked

Budgeted hours

100

iii. Efficiency Ratio


The ratio indicates the degree of efficiency attained in

production.
It is obtained when the standard hours equivalent to the

work produced are expressed as a percentage of the actual


hours spent in producing that work.
Efficiency ratio = Standard hours for actual production

Actual hours worked

100

ZERO-BASE BUDGETING
Zero-based budgeting is a technique of planning and

decision-making which reverses the working process of


traditional budgeting.
In

traditional incremental budgeting, departmental


managers justify only increases over the previous year
budget and what has been already spent is automatically
sanctioned.

No

reference is made to the previous level of


expenditure.

By contrast, in zero-based budgeting, every department

function is reviewed comprehensively and all


expenditures must be approved, rather than only
increases.
Zero-based budgeting requires the budget request be

justified in complete detail by each division manager


starting from the zero-base.
The zero-base is indifferent to whether the total budget is

increasing or decreasing.

Definition of ZBB
According to Peter A. Phyrr, ZBB is

an operating
planning and budgeting process which requires each
manager to justify his entire budget requests in detail
from scratch (hence) zero basis. Each manager states why
he should spend any money at all. This approach requires
that all activities be identified as decision packages which
would be evaluated by systematic analysis and ranked in
order of importance.

Advantages of ZBB
1.

It provides the organization with a systematic way to


evaluate different operations and programmes
undertaken by the management.

2.

It ensures that every programme undertaken by the


managers is essential for the organization and is being
performed in the best possible way.

3.

It enables the management to approve departmental


budgets on the basis of cost-benefit analysis.

4. It helps in identifying areas of wasteful expenditure and


if, desired, it can also be used for suggesting alternative
courses of action.

5. It links budgets with the corporate objectives. Nothing


will simply be allowed only because it was being done
in the past, if it does not help in achieving the goals of
the enterprise.
6. It can be used for introduction and implementation of
the system management by objectives.

Limitations of ZBB
1.
2.
3.
4.

Implementation problems
Decision packages formulation problems
Ranking process problems
Cost problems

1.

a)
b)
c)
d)
e)
f)
g)

Prepare a Cash Budget for the months of May, June


and July, 20XX on the basis of the following
information:
Cash balance on 1st May, 20XX Rs 8,000
Plant costing Rs 16,000 is due for delivery in July, payable
10% on delivery and the balance after 5 months.
Advance Tax of Rs 8,000 each is payable in March and
June.
Period of credit allowed (i) by suppliers 2 months, and
(ii) to customers 1 month.
Lag in payment of manufacturing expenses month.
Lag in payment of office and selling expenses 1 month.
Income and Expenditure Forecasts:

Month
s

Credit
Sales
(Rs)

Credit Wages Manuf Office Selling


Purcha
(Rs)
acturin Expens Expens
ses (Rs)
g
es (Rs) es (Rs)
Expens
es (Rs)

March

60,000

36,000

9,000

4,000

2,000

4,000

April

62,000

38,000

8,000

3,000

1,500

5,000

May

64,000

33,000

10,000

4,500

2,500

4,500

June

58,000

35,000

8,500

3,500

2,000

3,500

July

56,000

39,000

9,500

4,000

1,000

4,500

Augus
t

60,000

34,000

8,000

3,000

1,500

4,500

The expenses for the budgeted production of 10,000units in a


factory are furnished below:
Per Unit (Rs)
Materials
70
Labour
25
Variable Overhead
20
Fixed Overhead (Rs 1,00,000)
10
Variable Expenses (Direct)
5
Selling Expenses (10% Fixed)
13
Distribution Expenses (20% Fixed)
7
Administration Expenses (Rs 50,000)
5
Total Cost per unit (to make and sell)
155
Administration expenses are fixed for all levels of production.
Prepare a budget for production of: (a) 8,000 units, (b) 6,000 units,
(c) indicate cost per unit at both the levels.
2.