principles, procedures, and practices of achieving given objectives through budgets and budget reports. It has been defined as "the establishment of departmental 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 to the objective of their policy or to provide a basis for its revision." • Classification of Budgets Budgets can be classified on the basis of (a) Time (b) Nature (c) Activity and (d) Functions. I. Classification of Budgets according to Time: (a) Long-term budget - extending five to ten years: (b) Short-term budget - ranging for a period of one or two years, (c) Current budget up to one year; (d) Interim budget in between two budget periods. II. Classification of budget according to Nature : (a) Operating budgets relating to the operations of the enterprise, (b) Financial Budgets concerning with the financial implications of the operating budgets i.e. relating to the capital structure and liquidity of the enterprise; e.g., Cash budget, Capital budget etc. III. Classification according to Activity Level or Capacity: Budgets, according to activity, may be of two types (i) Fixed Budget and (ii) Flexible (variable) Budget. Fixed budget is one which remains unchanged in spite of changes in volume of output or level of activity. This budget is prepared for a specific planned activity and it is not adjusted according to activity level attained. On the other hand, a flexible or variable budget is one which is prepared for changing level of activity. It is also known as ‘Sliding Scale Budget’. The principle of flexible budget lies in making a series of fixed budgets for different levels of activity. A flexible budget considers the difference in the behaviour of fixed and variable costs. IV. Classification according to Functions Involved: (a) Sales Budget: This is probably the most important budget and is prepared to show what finished products can be sold in what quantities and at what prices. It may be prepared (a) product- wise (b) territory-wise (c) customer- wise (d) period-wise and (e) according to salesman. In preparing a sales trend, the following factors should be considered analysis of past sales trend, estimates of salesman, available plant capacity, orders on hand, seasonal fluctuations in demand, competition and market conditions. (b) Production Budget: This budget is based on sales budget as it has to provide for the output needed to meet the requirement of the sales budget. The following points are kept in view while preparing this budget: Production cycle, availability of plant capacity, make or buy decisions, desired inventory levels and sales requirements. (c) Raw Materials (Purchase) Budget: It is based upon production budget, as this budget provides for the materials needed for production. Materials may be direct or indirect. The materials budget generally deals only with the direct materials. Indirect materials are generally included in the works overhead budget. Quantities of raw materials to be used, cost of such materials, desired inventory levels, storage space, economic size of order, price, order already placed, etc., are the main factors influencing this budget. (d) Direct Labour Budget: Direct Labour or Personnel budget covers the estimates of direct labour requirements - trained and untrained, essential for carrying out the budgeted output. This budget is generally prepared on the basis of the different grades and trades of workers needed for each job/process/production. (e) Plant Utilisation Budget: This budget is also based on production budget. The plant utilisation budget determines the machine load in each department during the budget period. (f) Overheads Budgets: Overheads budgets may be (a) Factory Overheads Budget (b) Administrative Overheads Budget (c) Selling and Distribution Overheads Budget. Manufacturing or Factory overheads budget will provide an estimate of cost of indirect labour, indirect material and indirect expenses to be incurred in the budget period. Administrative Overhead budget covers the expenses of all the central offices, and management salaries, selling and distribution overhead budget includes all expenses relating to selling, advertising, delivery of goods to customers, etc. (g) Research and Development Budget: This budget tells the estimated expenditure for development and research during the budget period. It is drawn up taking into account the research projects in hand and the new projects to be taken up. (h) Cash/Finance Budget: It is one of the most important components of the financial budget. The cash budget usually consists of two parts giving detailed estimates of (i) cash receipts and (ii) Cash payments. Estimates of cash receipts are prepared on a monthly basis and depend upon estimated cash sales, collection from debtors, and anticipated receipts from other sources e.g., sale of assets, borrowings, etc. Estimates of cash payments are based on estimated purchases of assets etc. (i) Capital Expenditure Budget: This budget plans for expenditure on fixed assets. It involves heavy amount: its impact is very much felt on the production capacity or profitability of the unit. Usually the plan period of this budget stretches beyond the budget period. (j) Master Budget: It is the summary budget, incorporating its component functional budget, which is finally approved, adopted and employed. The budget may take the form of a Profit and Loss Account and a Balance Sheet at the end of the Budget Period. • These functional budgets can also be regrouped into (i) physical budgets, (ii) cost budgets, (iii) profit budgets and (iv) financial budgets. • Administration of Budgetary Control The process of budgetary control can be reasonably divided into two stages (1) preparation of budgets and (2) implementation of the budget performance. The preparation of a budget can be viewed as an accounting process and its implementation as a management process. Its effectiveness to a large extent depends upon the organisation efficiency. In a large-sized organisation, an effective budgetary control system can be organised on the following lines: (i) Determining Objectives: A budget being a plan for the achievement of certain operational objectives, it is desirable that same are defined very precisely. The objectives should be written out and the areas of control should be clearly demarcated in order to give a clear understanding of the plan and its scope to all those who must cooperate to make it a success. (ii) Establishment of Budget Centres: A budget centre is a section of the organisation of an undertaking defined for the purpose of budgetary control. A budget is prepared for each budget centre and, therefore, the budget centres should be properly selected. A budget which refers to a budget centre is a departmental budget. A budget centre may again consist of a number of cost centres representing different groups of machines. (iii)Introduction of Adequate Accounting Records and Their Codification: The budget department depends on the accounts department for reliable historical data which form the basis of many estimates. (iv)Preparation of Budget Organisation Chart: Organisation chart defines the functions and responsibilities of each member of management and ensures that each one knows his position on the organisation and his relationship to other members. It should also be supplemented by written directives concerning the function of the staff members. The organisation chart depends upon the nature and size of the enterprise; however, a simple chart is given below. . Managing Director Budget Committee Budget Officer
Sales Production Personnel Development
Manager Manager Manager Manager
Sales Budget, Production Labour Research &
Selling & Budget Budget Development Distribution Budget Budget etc., Purchase Finance Manager Manager
Raw Material Budget, Stores &
Cash Budget, Capital Budget Stock Budget (v) Establishment of a Budget Committee: In a small business, it is the (Cost) Accountant who prepares the budget, but in big undertaking, a Budget Committee is appointed for this purpose. The Budget committee consists of Chief Executive or Managing Director, Budget officer or Director or Controller and the heads of main departments. The Chief Executive acts as the chairman, and cost accountant as its secretary. The Managers of different departments prepare their budget and submit to this Committee. This Committee makes necessary adjustments, coordinates all the budgets and prepares a Master Budget. The functions of a budget committee are: • ensuring that everyone appreciates the budget efforts; • reconciling divergent views; • offering technical advice; • coordinating budgeting activities; • reviewing individual budgets; • suggesting revisions, or approving budget proposals without further revision; and • scrutinizing control reports in the latter stages of the budgetary process. (vi) Preparation of Budget Manual: It is document or schedule or rule book which sets out the responsibilities of the persons engaged in the routine of and the forms and records required for budgetary control. This manual lays down the budget programmes, and the specific and general duties of the executives, departmental managers and the Budget Committee. The budget manual usually contains the following: • responsibilities of the persons engaged in budgetary control; • length of budget periods and control periods; • the budget calendar showing the dates of completion for each part of the budget and submission of reports; dates of review, revision and instructions issued; • forms and records required for budgetary control; • the accounts code and classification used by the Company; method of accounting to be adopted; procedure for preparation of financial statements and reporting the same; • budget proforma, etc; • the follow-up Procedures. • Budget Time Table: The budget manual should give a schedule as to who is responsible for what in an organisation. Each responsible person should know by what date he should finish his work. • The following list describes the activities for which different persons- are generally responsible for: Managers Responsible for Sales Sales in terms of quantity, selling prices, discounts, rebates, etc; sales forecast, selling costs including those of sales managements; representation, advertising, etc; forecast of selling and distribution costs; capital requirements. Distribution Distribution costs including those of transports storage etc., quantity of finished goods stock. Production Production in terms of quantity; production costs; forecast of production costs - material, labour and overhead; raw material stocks and work-in-progress; capital requirements. Research and Research costs; forecast research and Development development costs, capital requirements. Managing Profit planning; capital expenditure; Director depreciation; current assets and liabilities e.g., level of trade debtors and the cash position. Company Administration costs - legal Secretary expenses, audit fees, etc; forecast administration costs; capital requirements. Budget Review of sales forecast, current Committee operating results; review and approval of master budget; long-term budget; approval of department budget, monthly cash forecast. • Performance Report Time Table: A budget manual should specify as to when performance reports will be ready and given to managers. For example, performance reports may be made available after 15 days of the end of the accounting period. The accounts departments should ensure that this timetable is being adhered to. Likewise, the budget committee will review the performance results. Reports from managers of budget centres should be submitted to the budget committee before they are discussed in the meeting. (vii) Level of Activity: It is essential to establish a normal level of activity since it forms the basis of the budget. Level of activity can be attained by efficient working under the existing condition. (viii) Selection of the Budget Period: The period covered by a budget is known as budget period. The length of the budget period normally depends upon the nature of the plan, circumstances of the business, the control aspect, production period and timings of availability of finance. Most manufacturing industries use one year as the budget period. For control purposes, the annual totals are divided by 12 to obtain monthly budgets; but if seasonal fluctuations are important, separate budget estimates can be made for each month or season. A budget prepared for a very long time cannot be very accurate as it is very difficult to forecast events for a longer period. (ix) Locating the Principal Budget Factor: Budgets should be evolved around the Principal budget factors (or limiting, scarce or key factors) in business. Every business has its own key factors, which limits the level of activities. These key factors should be correctly identified and diagnosed. In most of the enterprises, sales (demand) is normally the key factor. The success of the budgetary control rests on the accuracy of the sales forecast. If the sales figure proves to be inaccurate, most of the budgets will be affected. Similarly, materials, labour, cash, space, equipment, management etc., may also be the key factors. The following is a detailed list of key factors. Sales (i) Marketing potentialities and consumer demand, (ii) Shortage of pushing salesmen, (iii) inadequate advertising. Materials (i) Availability of supply, (ii)Restrictions imposed by licenses, quota etc. Labour (i) General shortage of workers, (ii) Shortage in certain grades e.g., operation of modem complex machinery. Plant (i) Insufficient capacity due to shortage in supply, (ii) Insufficient capacity due to lack of capital, (iii) Bottlenecks in certain key processes, operations or departments. Management (i) Shortage of efficient executives, (ii) Lack of capital, (iii) Insufficient research into product, design and methods. • Sometimes there may be two or more limiting factors at the same time and the budget committee has to take greater care so as to assess the relative influence of the key-factors. This problem is generally solved with the help of graphs, linear programming, operational research, etc. It may be mentioned that the key factor is not a permanent factor and in the long run management may get suitable opportunities to overcome the key factor limitations by working overtime of shifts, introducing new methods, changing materials mix, hiring new machinery or buying new equipment on hire purchase, providing incentive schemes and producing and selling more profitable products, selecting the optimum level of production, etc. (x) Determination of Budget Cost Allowance: It is the cost which a budget centre is expected to incur during a given period of time in relation to the level of activity attained by the budget centre. (xi) Implementation of the Budget and Recording of Actual Performance: A copy of the section of the master budget appropriate to each department sphere of activity is issued to their respective heads for execution. (xii) Budget Variance Analysis & Reporting: A variance is the divergence between any planned result and the actual result measured in monetary terms. Budget variance is the difference between a budgeted figure and an actual figure. The overall variance between a planned cost and an actual cost is usually due to a number of factors. Ascertaining the contribution of each factor to the overall variance is known as variance analysis. Any budget variance can be either (i) a favourable variance which on its own would result in the ultimate profit being better than that planned or (ii) an adverse variance which on its own would result in the ultimate profit being worse than that planned. A budget variance may be either controllable or uncontrollable. A controllable cost variance is one which be identified as the primary responsibility of a specified person. It should be borne in mind that when computing budget variance it is always the budget allowance (allowed figures) that is compared with the actual figure and the original figure has no relevance. • Elements of a Successful Budgetary Control System • The success of the budgeting process in an organisation depends on the following essential elements: • Objectives: All planning presupposes that objectives have been established, since the plan is merely a means to an end, not an end in itself. Objectives are the end. • Knowledge of Cost Behaviour: It is essential that there be an awareness of the firm's particular cost patterns, and the influences thereon. Cost-volume- profit analysis is a useful adjunct to the budgeting exercise, as it aids considerable in understanding cost behaviour. • Accurate Forecasting of Business Activities: Forecasting is a prerequisite in a budgeting process. It is not only the starting point, but is also critical to the development of an accurate budget. Forecasting can be done regarding activities which are internal and external to an organisation. Internal activities are easier to forecast than external activities such as production forecast. But external factors like state of and nature of market conditions, inflation or deflation and its effect on company products are difficult to predict. Business firms require competent market researchers to forecast accurately such external factors. • Coordinating Business Activities: Budgeting needs to coordinate all the individual budgets into an integrated plan as each budget has certain implications tor the other budgets. There must be coordination between sales, production, purchasing, and personnel budgets. Budgets are useful tools in communicating budgetary expectations and goals and in bringing necessary adjustments among organisational activities. • Education: All levels of management must be convinced of the usefulness of budgets, and know the part that each must play in planning and control through budgets. This requires a continuous programme of training in budgeting methods and their value. • Communicating the Budgets: The success of a comprehensive budgeting programme depends on communication of individual budgets to the different units in the organisation. The basic point is that the preparation of the budget is of no value unless it is known to the person for whom it is meant. Managers are not responsible for budget unless the budget is communicated clearly, concisely and in an authoritative manner to them. • Acceptance and Cooperation: Successful budgeting also requires that budgets should be accepted by the people who must execute them. Budgeting should have the active cooperation of the entire organisation from the top to the bottom. Cooperation for the budget can be achieved in a number of ways. • Reasonable Flexibility: The budgeting programme should contain reasonable flexibility if the situation so demands. However, it should be noted that too much flexibility and too much tightness are both undesirable. Too much flexibility will weaken the cost control and the budget will become inoperative. Similarly, too much regidity not permitting reasonable deviations will create problems and restrictions in the implementation of the budget. If conditions have changed making the estimates and budgets inaccurate, the budgets should be revised. A budget is simply a tool of to serve managements needs and not an irrevocable contract. • Adequate Systems Support: This will come mainly from the accounting sphere, where it must be ensured that records and procedures are sufficient for the task in hand. Thus, the budget should be linked to the accounting system in such a way that the same definitions, etc., relate to common elements. (For example, if inventories in the budget system are valued at standard cost, so should the inventories in the accounting system.) • Providing a Framework for Evaluation: Budgeting provides a basis to evaluate the performance of different departments. A comprehensive budget, properly developed, will contain initially organisational goals and expectation and subsequently can be used as an effective evaluation technique. • Advantages of Budgetary Control: • (i) Budgetary control aims at maximisation of profits through optimum utilisation of resources. • (ii) It is a technique for continuous monitoring of policies and objectives of the organisation. • (iii) It helps in reducing the costs, thereby helps in better utilisation of funds of the organisation. • (iv) All the departments of the organisation are closely coordinated through establishment of plans resulting insmooth functioning of the organisation. • (v) Since budgets fix the responsibilities of the executives, they act as a plan of action for them there by reducing some of their work. • (vi) It facilitates analysis of variances, thereby identifying the areas where deficiencies occur and proper remedial action can be taken. • (vii) It facilitates the management by exception. • (viii) Budgets act as a motivating force to achieve the desired objective of the organisation. • (ix) It assists delegation of authority and is a powerful tool of responsibility accounting. • (x) It helps in stabilizing the conditions in industries which face seasonal fluctuations. • (xi) It helps as a basis for internal audit. • (xii) It provides a suitable basis for introducing the payment by results system. • (xiii) It ensures adequacy of working capital to the organisation. • (xiv) It aids in performance analysis and performance reporting system. • (xv) It aids in obtaining bank credit. • (xvi)Budgets are forerunners of standard costs in the sense that they create necessary conditions to suit setting upof standard costs. • Preliminaries for the Adoption of a System of Budgetary Control: • For the successful implementation of a system of budgetary control certain pre-requisites are to be fulfilled. These are enumerated below: • (i) There should be an organization chart laying out in clear terms the responsibilities and duties of each level of executives, and the delegation of authority to the various levels. For complete success, a solid foundation in this regard should be laid at the outset. • (ii) The objectives, plans and policies of the business should be defined in clear cut and unambiguous terms. • (iii) The output level for which budgets are fixed, i.e., the budgeted output, should be stated. • (iv) The particular budget factor which will be the starting point of the preparation of the various budgets should be indicated. • (v) There should be an efficient system of accounting to record and provide data in line with the budgetary control system. • (vi) For the establishment and efficient execution of the plan, a Budget Committee should be set up. • (vii) There should be a proper system of communication and reporting between the various levels of management. • (viii) There should be a charter of programme. This is usually in the form of a budget manual. • (ix) The budgets should primarily be prepared by those who are responsible for performance. • (x) The budgets should be complete, continuous and realistic. • (xi) There should be an assurance from the top management executives of co-operation and acceptance of the budgetary system. • Functional Budget: • If budgets are prepared of a business concern for a certain period taking each and every function separately such budgets are called functional budgets. • Example: Production, Sales, purchases, cost of production, cash, materials etc. • The following are the various functional budgets, some of which are briefly explained here under: • (i) Sales Budget: The sales budget is a forecast of total sales, expressed in terms of money or quantity or both. The first step in the preparation of the sales budget is to forecast as accurately as possible, the sales anticipated during the budget period. Sales forecasts are usually prepared by the sales manager assisted by the market research personnel. • Factors to be considered in preparing Sales Budget:- • As business existence depends upon the sales it is going to make and therefore it is an important one to be prepared meticulously. It is the forecast of what it can reasonably sell to its customers during the period for which budget is prepared. The company’s profit mostly depends upon the ability to sell its products to customers. In the present era it is indispensable to establish the demand for the product even before it is produced. It is the sales order book that the company’s continuity depends upon. Also, a reasonable degree of accuracy must be there in preparing a sales budget unless its sales are accurately forecast, production estimates will also become erroneous. A good amount of experience must be necessary to prepare the sales budget. Yet the following factors must be considered in preparing the sales budget: • (a) The locality of the market i.e., domestic or export • (b) The target customers i.e., industry or trade or a section or group of general public etc., • (c) The product portfolio i.e., the number of products offered and their popularity among the target customers. • (d) The market share of each product and its influence on the product portfolio and the total market • (e) The effectiveness of existing marketing policy on the current sales volume and value. • (f ) The market share of competitor’s products and their effect on the company’s sales. • (g) Seasonal fluctuation in sales. • (h) Expenditure on advertisement and its impact on sales. • (ii) Production Budget: The production budget is a forecast of the production for the budget period. Production budget is prepared in two parts, viz. production volume budget for the physical units of the products to be manufactured and the cost of production or manufacturing budget detailing the budgeted cost under material, labour, and factory overhead in respect of the products. • Factors to be considered in Production Budget: • Next to the sales budget, the main function of a business concern is the production and for this, a budget is prepared simultaneously with the sales budget. It is the forecast of production during the period for which the budget is prepared. It can also be prepared in two parts viz., production volume budget for the physical units i.e., the number of units, the tonnes of production etc., and the cost of production or manufacture showing details of all elements of the manufacture. While preparing the production budget, the following factors must be taken into consideration:- • (a) Production plan:- • Production planning is an important part of the preparation of the production budget. Optimum utilisation of plant capacity is taken by eliminating or reducing the limiting factors and thereby effective production planning is made. • (b) The capacity of the business concern:- • It is to be ensured that the capacity of the organisation will coincide the budgeted production or not. For this purpose, plant utilisation budget will also be necessary. The production budget must be based on normal capacity likely to be achieved and it should not be too high or too low. • (c) Inventory Policy:- • While preparing the production budget it is also necessary to see to what extent materials are available for producing the budgeted production. For that purpose, a purchase budget or a purchase plan must also be studied. Similarly, on the other hand, it is also necessary to verify the extent to which the inventory of finished goods is to be carried. • (d) Sales Policy:- • Sales budgets must also be considered before preparing production budget because it may so happen that the entire production of the concern may not be sold. In such a case the production budget must be in line with the sales budget. • (e) Sequence of Operations Policy:- • A plan of the sequence of operations of production for effective preparation of a production budget should always be there. • (f) Management Policy:- • Last, but not the least, the policy of the management should also be considered before preparing the production budget. • Objectives and Advantages of Production budget: • • Optimum utilisation of the productive resources of the organisation; • • Maintaining low inventory which results in risk of deterioration and fall in prices; • • Focus on the factors that are necessary to frame policies and plan sequence of operations; • • Projection of policies framed, on the basis of past performance, into the future to get the desired results; • • To see that right materials are provided at right place and at right time; • • Helps in scheduling of production so that delivery dates are met and customer satisfaction is gained; • • Helpful in preparation of projected profit and loss statement, which is useful in evaluation of performance and profitability. • (iii) Materials Budget: The material budget includes quantities of direct materials; the quantities of each raw material needed for each finished product in the budget period is specified. The input data for this budget is obtained by applying standard material usage rates by each type of material to the volume of output budgeted. • (iv) Purchase Budget: The purchase budget establishes the quantity and value of the various items of materials to be purchased for delivery at specified points of time during the budget period taking into account the production schedule of the concern and the inventory requirements. It takes into account the requirements for the entire budget plan as per the sales, materials, maintenance, research and development, and capital budgets. Purchases may be required to be made in respect of direct and indirect materials, finished goods for resale, components and parts, and purchased services. Before incorporation in the purchase budget, these purchase requirements should be suitably ascertained. Purchase budget also includes material procurement budget. • (v) Cash Budget: Cash Budget is estimated receipts and expenses for a definite period, which usually are cash sales, collection from debtors and other receipts and expenses and payment to suppliers, payment of wages, payment of other expenses etc. • (vi) Direct Labour Budget. • (vii) Human Resources Budget. • (viii) Selling and distribution cost budget. • (ix) Administration Cost Budget. • (x) Research and development Cost Budget etc. • (xi) Master Budget: Master budget is the budget prepared to cover all the functions of the business organisation. • It can be taken as the integrated budget of business concern, that means, it shows the profit or loss and financial position of the business concern such as Budgeted Profit and Loss Account, Budgeted Balance Sheet etc. Master budget, also known as summary budget or finalized profit plan, combines all the budgets for a period into one harmonious unit and thus, it shows the overall budget plan. The master budget incorporates all the subsidiary functional budgets and the budgeted Profit and Loss Account and Balance Sheet. Before the budget plan is put into operation, the master budget is considered by the top management and revised if the position of profit disclosed therein is not found to be satisfactory. After suitable revision is made, the master budget is finally approved and put into action. Another view regards the budgeted Profit and Loss Account and the Balance Sheet as the master budget. FIXED, VARIABLE, SEMI- VARIABLE BUDGETS • Fixed or Rigid Budget: • When budgets are prepared for a fixed or standard volume of activity, they are called static or rigid or fixed budgets. They do not change with the changes in the volume of the output. These are prepared normally 3 months in advance of the year. However these will not be much helpful in comparing the actual activity, as these are prepared at a fixed volume of output. It, however, does not mean that the fixed budget is a rigid one, not to be changed at all. Though not adjusted to the actual volume attained, a fixed budget is liable to revision if due to business conditions undergoing a basic change or due to other reasons, actual operations differ widely from those planned in the fixed budget. Fixed budgets are most suited for fixed expenses. In case of discretionary costs situations where the expenditure is optional and has no relation with the output, e.g. expenditure on research and development, advertising, and new projects. A fixed budget has only a limited application and is ineffective as a tool for cost control. Fixed budgets are useful where the plan permits maximum stabilization of production, as for example, for concerns which manufacture to build up inventories of finished products and components. • Flexible Budget: • A flexible budget is a budget that is prepared for different levels of activity or capacity utilization or volume of output. If the budgets are prepared in such a way so as to change in accordance with the volume of output, they are called flexible budgets. These can be prepared from fixed budget which are also called revised budgets. These are much helpful in comparison with actual because the exact deviations are found for which timely corrective action can be taken. 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 to give 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. Thus a flexible budget recognises the difference in behaviour between fixed and variable costs in relation to fluctuations in production or sales and is designed to change appropriately with such fluctuations. In flexible budget, data relating to costs, expenditures may progressively be changed in any month in accordance with actual output achieved. While preparing flexible budgets, estimates of costs and expenditures on the basis of standards determined are made from minimum to maximum level of operations. • Difference between Fixed and Flexible Budgets: Fixed Budget Flexible Budget It does not change with It can be recasted on the actual volume of activity basis of activity level to be achieved. Thus it is known achieved. Thus it is not rigid. as rigid or inflexible budget. It operates on one level of It consists of various budgets activity and under one set of for different levels of conditions. It assumes that activity. there will be no change in the prevailing conditions, which is unrealistic. Here as all costs like – fixed, Here analysis of variance variable and semi-variable provides useful are related to only one level information as each cost is of activity so variance analysed according to its analysis does not give useful behaviour. information. If the budgeted and actual Flexible budgeting at activity levels differ different levels of activity significantly, then the facilitates the aspects like cost ascertainment of cost, ascertainment and price fixation of selling price fixation do not give a and tendering of correct picture. quotations.
Comparison of actual It provides a meaningful
performance with budgeted basis of comparison of the targets will be meaningless actual performance with the specially when there is a budgeted targets. difference between the two activity levels. • Principal Budget Factor: • Budgets cover all the functional areas of the organisation. For the effective implementation of the budgetary system, all the functional areas are to be considered which are interlinked. Because of these interlinks, certain factors have the ability to affect all other budgets. Such factor is known as principle budget factor. Principal Budget factor is the factor the extent of influence of which must first be assessed in order to ensure that the functional budgets are reasonably capable of fulfilment. A principal budget factor may be lack of demand, scarcity of raw material, non- availability of skilled labour, inadequate working capital etc. If for example, the organisation has the capacity to produce 2500 units per annum. But the production department is able to produce only 1800 units due to non-availability of raw materials. In this case, non-availability of raw materials is the principal budget factor (limiting factor). If the sales manger estimates that he can sell only 1500 units due to lack of demand. Then lack of demand is the principal budget factor. This concept is also known as key factor, or governing factor. This factor highlights the constraints with in which the organisation functions. • Responsibility Accounting: • One of the recent developments in the field of management accounting is the responsibility accounting, which is helpful in exercising cost control. ‘Responsibility Accounting is a system of accounting that recognizes various responsibility centers throughout the organization and reflects the plans and actions of each of these centers by assigning particular revenues and costs to the one having the pertinent responsibility. It is also called profitability accounting and activity accounting. • It is a system in which the person holding the supervisory posts as president, function head, foreman, etc are given a report showing the performance of the company or department or section as the case may be. The report will show the data relating to operational results of the area and the items of which he is responsible for control. Responsibility accounting follows the basic principles of any system of cost control like budgetary control and standard costing. It differs only in the sense that it lays emphasis on human beings and fixes responsibilities for individuals. It is based on the belief that control can be exercised by human beings, so responsibilities should be fixed for individuals. Principles of responsibility accounting are as follows: • (a) A target is fixed for each department or responsibility center. • (b) Actual performance is compared with the target. • (c) The variances from plan are analysed so as to fix the responsibility. • (d) Corrective action is taken by higher management and is communicated. • Performance Budgeting: • Performance Budgeting is synonymous with Responsibility Accounting which means thus the responsibility of various levels of management is predetermined in terms of output or result keeping in view the authority vested with them. The main concepts of such a system are enumerated below: • (a) It is based on a classification of managerial level for the purpose of establishing a budget for each level. The individual in charge of that level should be made responsible and held accountable for its performance over a given period of time. • (b) The starting point of the performance budgeting system rests with the organisation chart in which the spheres of jurisdiction have been determined. Authority leads to the responsibility for certain costs and expenses which are forecast or present in the budget with the knowledge of the manager concerned. • (c) The costs in each individual’s or department’s budget should be limited to the cost controllable by him. • (d) The person concerned should have the authority to bear the responsibility. ZERO BASED BUDGETING (ZBB) • It differs from the conventional system of budgeting mainly it starts from scratch or zero and not on the basis of trends or historical levels of expenditure. In the customary budgeting system, the last year’s figures are accepted as they are, or cut back or increases are granted. Zero based budgeting on the other hand, starts with the premise that the budget for next period is zero so long the demand for a function, process, project or activity is not justified for each rupee from the first rupee spent. The assumptions are that without • such a justification no spending will be allowed. The burden of proof thus shifts to each manager to justify why the money should be spent at all and to indicate what would happen if the proposed activity is not carried out and no money is spent. • The first step in the process of zero base budgeting is to develop an operational plan or decision package. A decision package identifies and describes a particular activity with a view to: • (i) Evaluate and allotted ranking the activity against other activities competing for the same scarce resources, and (ii) Decide whether to accept or reject or amend the activity. • For this purpose, each package should give details of costs, returns, purpose, expected results, the alternatives available and a statement of the consequences if the activity is reduced or not performed at all. • The advantages of Zero based budgeting are: • (a) Out of date and inefficient operations are identified. • (b) Allows managers to promptly respond to changes in the business environment. • (c) Instead of accepting the current practice, it creates a challenging and questioning attitude. • (d) Allocation of resources is made according to needs and the benefits derived. • (e) It has a psychological impact on all levels of management which makes each manager to ‘pay his way’. • Areas where zero-base budgeting is applicable • Zero-base Budgeting is more suitably applicable to discretionary cost areas. These costs may have no relation to volume or activity and generally arise as a result of management policies. Where standards are determinable, those costs associated with the inputs should be controlled through the use of standard costing. On the other hand, if output as a function of input cannot be specified. Zero-base Budgeting may be more suitably applied. Thus, service or support- type activities are more suitable for Z.B.B. • PROCESS OF ZERO-BASE BUDGETING OR STEPS INVOLVED IN ZERO-BASE BUDGETING • The process of Zero-Base Budgeting involves the following steps: • 1. Identification of ‘Decision units’ • 2. Preparation and development of decision packages. • 3. Ranking of priority. • 4. Approval and Funding • Identification of ‘Decision units’- A decision unit refers to a tangible activity or group of activities for which a single manager has the responsibility for successful performance. Thus, decision unit is a programme or a project or a segment of the organisation for which separate budgets are to be prepared. • Preparation of Decision Packages: Preparation of decision packages is a set of documents which identify and describe activities of the unit in such a way that the management can evaluate and rank them against others competing for resources (limited) and decide whether to approve or disapprove. • Ranking of Priority: The third step involved in Z.B.B. is the ranking of proposed alternatives included in decision packages for various decision units or of various decision packages for the same decision unit. • Funding: Funding involves the allocation of available resources of the organisation to various decision units keeping in mind the alternative which has been selected and approved through ranking process. Problem: Draw up a flexible budget for overhead expenses on the basis of the following data and determine the overhead rates at 70%, 80% and 90% Plant Capacity At 80% capacity (Rs) Variable Overheads: Indirect labour 12,000 Stores including spares 4,000 Semi Variable: Power (30% - Fixed: 70% -Variable) 20,000 Repairs (60%- Fixed: 40% -Variable) 2,000 Fixed Overheads: depreciation 11,000 Insurance 3,000 Salaries 10,000 Total overheads 62,000 Estimated Direct Labour Hours 1,24,000