PLANNING AND CONTROL: Budgeting and Budgeting Control

A budget is a plan of action for a future period. It simply means a financial plan expressed in terms of money and
covering all the activities of the entity. According to CIMA, budget is defined as “A quantitative statement, for a
defined period of time, which may include planned revenues, expenses, assets, liabilities and cash flows”.

Budget can also be defined as a quantitative statement expressed in money terms, showing expected revenue
or income and the related expenditure to be incurred, prepared and approved prior to a given period of time,
usually a year.
The main characteristics of a budget are;
1. It is prepared in advance and is derived from the long term strategy of the organisation
2. b) It relates to future period for which objectives or goals have already been laid down
3. c) It is expressed in quantitative from, physical or monetary units, or both.

Purpose/benefits of Budget
1. Planning: Planning has been defined as the design of a desired future position for an entity and it rests
on the belief that the future position can be attained by uninterrupted management action. Detailed
plans relating to production, sales, raw‐material requirements, labour needs, capital additions, etc. are
drawn out. By planning many problems estimated long before they arise and solution can be thought of
through careful study. In short, budgeting forces the management to think ahead, to foresee and prepare
for the anticipated conditions. Planning is a constant process since it requires constant revision with
changing conditions.
2. Co‐ordination: Budgeting plays a significant role in establishing and maintaining coordination. Budgeting
assists managers in coordinating their efforts so that problems of the business are solved in harmony
with the objectives of its divisions. Efficient planning and business contribute a lot in achieving the
targets. Lack of co‐ordination in an organization is observed when a department head is permitted to
enlarge the department on the specific needs of that department only, although such development may
negatively affect other departments and alter their performances. Thus, co‐ordination is required at all
vertical as well as horizontal levels.
3. Measurement of Success: Budgets present a useful means of informing managers how well they are
performing in meeting targets they have previously helped to set. In many companies, there is a practice
of rewarding employees on the basis of their accomplished low budget targets or promotion of a
manager is linked to his budget success record. Success is determined by comparing the past
performance with a previous period's performance.
4. Motivation: Budget is always considered a useful tool for encouraging managers to complete things in
line with the business objectives. If individuals have intensely participated in the preparation of budgets,
it acts as a strong motivating force to achieve the goals.
5. Communication: A budget serves as a means of communicating information within a firm. The standard
budget copies are distributed to all management people that provides not only sufficient understanding
and knowledge of the programmes and guidelines to be followed but also gives knowledge about the
restrictions to be adhered to.
6. Control: Control is essential to make sure that plans and objectives laid down in the budget are being
achieved. Control, when applied to budgeting, as a systematized effort is to keep the management
informed of whether planned performance is being achieved or not.

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Budgeting and Budgetary Control:
Budgeting simply means preparing budgets. It is a process of preparation, implementation and the operation of
budget. Being a plan of action, a budget guides every manager in the decision making process.
Budgetary Control: There is a difference between budget and budgetary control. A budget is just an integral part
of budgetary control. Budgetary control is defined as a system of controlling cost which includes preparation of
budgets, coordinating the departments and establishing responsibilities, comparing actual performance with
that budgeted and acting upon results to achieve maximum profitability. Thus, when plans are embodied in a
budget and the same is used as the basis for regulating operations, we have budgetary control. As such,
budgetary control starts with budgeting and ends with control.

The main features of budgetary control are:

 Establishment of budgets for each purpose of the business.
 Revision of budget in view of changes in conditions.
 Comparison of actual performances with the budget on a continuous basis.
 Taking suitable remedial action, wherever necessary.
 Analysis of variations of actual performance from that of the budgeted performance to know the reasons
thereof.
Objectives of Budgetary Control
1. To plan and control income and expenditures
2. To act as a guide for management decision
3. To centralize control
4. To provide a yardstick against which actual result can be compared
5. To coordinate all activities of the business

Advantages of Budgetary control

In the light of above discussion one can see that, coordination and control help the planning. These are the
advantages of budgetary control. But this tool offer many other advantages as follows:
1. This system provides basic policies for initiatives.
2. It enables the management to perform business in the most professional manner because budgets are
prepared to get the optimum use of resources and the objectives framed.
3. It ensures team work and thus encourages the spirit of support and mutual understanding among the
staff.
4. It shows to the management where action is needed to remedy a position.
5. It reviews the present situation and pinpoints the changes which are necessary.

Disadvantages of Budgetary control

1. It tends to bring about rigidity in operation, which is harmful. As budget estimates are quantitative
expression of all relevant data, there is a tendency to attach some sort of rigidity or finality to them.
2. It being expensive is beyond the capacity of small undertakings. The mechanism of budgeting system is
a detailed process involving too much time and costs.
3. It sometimes leads to produce conflicts among the managers as each of them tries to take credit to
achieve the budget targets.
4. The installation and function of a budgetary control system is a costly affair as it requires employing the
specialized staff and involves other expenditure which small companies may find difficult to incur.

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Stages in the Budgeting process
1. Communicating detail of budget policy and guidelines to those people (managers) responsible for the
preparation of budget.
2. Identify the principal budget factor (or key budget factor). The principal budget factor is often sales
volume.
3. Preparation of the Sales budget. A functional budget or plan for the principle budget factor i.e., sales
budget.
4. Prepare the other functional budgets.
5. Submit the functional budgets to the budget committee for review and approval. The functional budgets
coordinated by the budget committee which must make sure that they are both realistic and consistent
with each other.
6. Prepare the ‘master budget’. This is the budget statement that summarizes the plans for the budget
period. The master budget might be presented in the form of:
i. A budgeted statement of profit or loss for the next financial year
ii. A budgeted statement of financial position as at the end of the next financial year
iii. A cash budget or cash flow forecast for the next financial year
NB: it should be possible to prepare the master budget statements from the functional budget.
7. The mater budget and other supporting functional budgets should be submitted to the board of directors
for approval. The board approves and authorizes the budget.
8. The detailed budgets are communicated to the managers responsible for their implementation.
9. Control Process. After the budget has been approved, actual performance should be monitored by
comparing it with the budget.
Terms:
1. Budget manual: a document which set out standing instructions governing the responsibilities of
persons, and the procedures, forms and records relating to the preparation and the use of the budget.
In other words, it is a written document which guides the executives in preparing various budgets.
Contents of a budget manual
 Objective of the Budget
 Functional Budget to be Prepared
 Budget Time Table
 Membership of the Budget Committee
 Procedure for Budget Preparation
2. Budget period: is the time to which the plan of action relates. That is, the period in which the budget
covers usually 12 months.
3. Budget centers: is the segment of an organization where a separate budget is prepared and control is
exercised.
4. Budget committee: are committee that is responsible for budget preparation and administration and the
committee are made up of “Head Departments and Senior Manager”.
5. Budget Negotiation: budget negotiation occurs at all levels of the organization and the role of budget
committee in the negotiation is very critical.

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Classification of Budgets
1. Classification according to time factor: on this basis, budgets can be of three (3) types;
i. Long-term budgets: - A long-term budget can be defined as a budget which is prepared for periods longer
than a year’. The period of long term Budgets varies between three to ten years. Capital expenditure budgets
and research developments budgets are just examples of long-term budgets.
ii. Medium-term budgets: - These budgets are generally for one or two years and are in the form of
monetary terms. The customer’s good industries like sugar, cotton and textile use short term budget.
iii. Short-term budgets: - A short budget can be defined as a budget which is related to the current
conditions and is prepared for use over a short period of time. Usually covers a period of one month
or two months.
2. Classification according to flexibility (behavior) factor: it includes
i. Fixed budgets: it is a budget which is designed to remain unchanged irrespective of the level of
activity attained. It does not change with the change in the level of activity. This type of budget is
most suited for fixed expenses.
Fixed budget is prepared for one level of output and one set of condition. This is a budget in which
targets are tightly fixed. It is known as a “static” budget.
Fixed budgets should be prepared only where sales, production and costs can be accurately
estimated
ii. Flexible budget: this is a budget that is designed to reflect changes in the actual level of activities. It
compares like with likes. Flexible budget is capable of providing the expected costs for any range of
activity level provided this range is within the relevant range. The underlying principle of flexibility is
that a budget is of little use unless cost and revenue are related to the actual volume of production.
Flexible budgeting has been developed with the objective of changing the budget figures so that they
may correspond with the actual output achieved. It is more sensible and practical, because changes
expected at different levels of activity are given due consideration.
Such budgets are especially useful in estimating and controlling factory costs and operating
expenses. It is more realistic and practicable because it gives due consideration to cost behavior at
different level of activity.
3. Classification according to function: it includes
i. Functional budget: are those which are prepared by heads of functional departments for their
respective departments and are subsidiary to the master budget. Types of functional budgets
includes
 Sales budget: it is forecast of total sales expressed in quantities and value. It is prepared by the
sales manager. While preparing sales budget, we have to consider the past sales data, market
conditions, general trade and business conditions etc.
 Production budget: it is the forecast of the quantity of production for the budget period. It is
usually expressed in physical quantities.
 Material required/usage budget: it shows the estimated quantities as well as cost of raw
materials required for the production of different product during the budget period.
 Material purchases budget: it shows the quantity of different type of materials to be purchased
during the budget period taking into consideration the level of activity and the inventory levels.
 Labour budget: it shows the estimated hours as well as cost of labour required for the production
of different product during the budget period.

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  Cash budget: it is prepared only after all the other functional budgets are prepared. It is also
known as financial budget. It is a statement showing estimated cash inflows and cash outflows
over the budgeted period. The cash budget is prepared on the basis of cash forecast.
The main uses of cash budgets:
1. To forecast how much cash receipts and payments are expected to be over the planning period.
2. To monitor actual cash flows during the planning period, by comparing actual cash flows with
the budget.
3. It serves as a better tool in assessing the liquidity position of an organisation.
4. To learn whether there will be a shortage of cash anytime during the period, or possibly a cash
surplus.

Principal Budget Factor

This is also known as the key budgeting factors or limiting factor. The first task in budgeting is to identify the
factors which impose limitation on the level of activities. It is usually sales demand or any other resource such as
material, labour, machine time or cash. Once this factor is identified the rest of the budget can be prepared.

Master Budget
The Master budget requires the approval of the Budget Committee before it is put into operation. It may happen,
sometimes, that a number of master budgets have to be prepared before the final one is agreed upon. The
budget generally contains details regarding sales (net), production costs, cash position, and key account balances
(e.g. debtors, fixed assets, bills payable, etc.). It also shows the gross and net profits and the important accounting
ratios. It provides at a glance the expected profitability and liquidity position of a firm at a given point in time.
The Master or final budget is a summary budget, which incorporates all functional budgets in a capsule form. It
sets out the plan of operations for all departments in considerable detail for the budget period. The budget may
take the form of a Profit and Loss Account and a Balance Sheet as at the end of the budget period.

BUDGETARY SYSTEMS
A budgetary system is a system for preparing budgets (and producing control reports for the purpose of
budgetary control). There are several Budgetary systems, and entities will choose a system that is appropriate
for their needs and circumstances.
1. Top-down budgeting: In a system of top-down budgeting, the budget targets for the year are set at senior
management level, perhaps by the board of directors or by the budget committee. The Top-level decision
might be made, e.g., about the amount of budgeted profit that will be achieved, the growth in sales,
reductions in production costs and other functional departments and so on. Divisions and departments
are then required to prepare a budget for their own operations that is consistent with the budget
imposed on them from above.
The process is called top-down budgeting because it starts at the top with the senior
management and works its way down to most detailed level of budgeting within the
management hierarchy. A system of top down budgeting would normally be associated with an
entity where management control is highly centralized.
2. Bottom-up budgeting: in a system of bottom-up budgeting, budgeting starts at the lowest level in the
management hierarchy where budgets are prepared. This may be at work section level or department
level. The draft lower-level budgets are then submitted to the next level of management in the hierarchy,
which combines them into a coordinated budget. For example, a departmental budget.

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 Departmental budgets might then be submitted up to the next level of management, which might be at
division level, where they will be combined and coordinated into a divisional budget. Eventually, budgets
for each division will be submitted up to budget committee or board of directors.

In a system of bottom-down budgeting, lower levels of management are likely to have more input to
budget decision-making than in a top-down budgeting system, and it is associated with budgeting in
entities where management authority is largely decentralized.

Recent Trends in Budgeting

Earlier we have explained the formulation. of different types of budgets. If the approach adopted in the
formulation and preparation of budgets is based on current level of operations or activities, including current
level of expenditure and revenue, such budgeting is known as traditional budgeting. This type of budgeting
process generally assumes that the allocation of financial resources in the past were correct and will continue to
hold good for the future as well. In most cases, an addition is made to the current figures of cost to allow for
expected (or even unexpected) in-creases. Consequently, the budget generally takes an upward direction year
after year, in spite of generally declining efficiency. Such a system of budgeting cannot be expected to promote
operational efficiency. It may, on the other hand, create several problems for top management. Some of these
problems are:
 Programmes and activities involving wasteful expenditure are not identified, resulting in avoidable
financial and other costs.
 Inefficiencies of a prior year are carried forward in determining subsequent years' levels of performance.
 Managers are not encouraged to identify and evaluate alternative means of accomplishing the same
objective.
 Decision-making is irrational in the absence of rigorous analysis of all proposed costs and benefits.
 Managers tend to inflate their budget requests resulting in more demand for funds than their availability.
This results in recycling the entire budgeting process.
 Thus, the traditional budgeting technique may be quite meaningless in the present context when
management must review or re-evaluate every task with a view to utilize the scarce resources in a better
manner or to improve performance. The technique of zero base budgeting provides a solution for
overcoming the limitations of traditional budgeting by enabling top management to focus on priorities,
key areas and alternatives of action throughout the organisation.

1. Zero based budgeting (ZBB): - A method of budgeting which requires each cost elements to be
specifically justified, as though the activities to which the budget relates were being undertaken for
the first time and from zero situations.
Zero base budgeting, as the term suggests, examines or reviews a programme or function or
responsibility from ‘scratch’. The reviewer proceeds on the assumption that nothing is to be allowed.
The manager proposing the activity has, therefore, to justify that the activity is essential and the
various amounts asked for are reasonable taking into account the outputs or results or volume of
activity envisaged. No activity or expense is allowed simply because it was being allowed or done in
the past. Thus according to this technique each programme, whether new or existing, must be
justified in its entirety each time a new budget is formulated.

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 2. Activity Based Budgeting: - Activity based budgeting is a planning system under which costs are
associated with activities, and budgeted expenditures are then compiled based on the expected
activity level. Activity based budgeting (ABB) is an extension of Activity based costing (ABC) which is
an alternative approach to traditional absorption costing. It is a system of managing costs by
controlling activities that drives cost or activities that causes costs to be incurred.
3. Continuous/Rolling budgets: this is the continuous updating of a short term budget by adding to a
period budget say a further month or quarter so that the budget can reflect current conditions.
That’s, instead of preparing a budget annually, there would be budget every three (3) or six (6)
months so that as the current periods ends, the budget is extended by an extra period.
4. Incremental budget: this is the budget which is prepared by starting with current operating level and
the current budget allowance adjusting for changes which are likely to occur in the budget period.
With incremental budgeting, the budgeted expenditure for the next financial period is estimated by
taking expenditure in the current period as a starting point. An incremental amount is then added
for inflation in cost next year and possibly, the cost of additional activities that will be carried out
next year.

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QUESTION BANK

Q1. SALAKO LIMITED

Salako Limited which produces and sells one product plans to increase production and sales next year.
The plan for the next nine months are provided as follows:
Months Production (units) Sales (units)
October 975 975
November 1,000 1,050
December 1,200 1,200
January 1,500 1,200
February 1,800 1,500
March 1,800 1,800
April 2,100 1,950
May 2,250 2,100
June 2,250 2,400

Notes:
a) The selling price per unit is expected to be N15. The raw materials will cost N6 per unit, wages
will cost N3 per unit and other variable costs will cost N1.50 per unit.
b) Salaries are expected to amount to N2,100 per month during October, November and
December, to rise to N2,400 per month from January to March, and to increase to N3,000 per
month from April to June.
c) Sales collections are to made as follows:
%
During the month of sale 60
In the first subsequent month 30
In the second subsequent month 9
Uncollectible 1
d) Payment of raw materials by Salako Ltd. for its production are paid as at when due.
e) Delay in payment of wages is 1/8 monthly while variable costs of production are expected to be
paid during the month of production.
f) Salaries are planned to be paid 85% in the month in which they are incurred and 15% in the
following month.
g) The company plans to spend N1,500 in January and N2,250 in April on advertisements.
h) In order to cope with increased production, a new machine has been ordered and it should be
delivered in February. The agreement is to pay the N9,000 for the machine in three equal
installments in March, April and May.
i) The firm intends to pay a dividend of N900 to its shareholders in April.
j) The firm expects to have a bank balance of N7,500 on 1 January.

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You are required to prepare cash budget for Salako Ltd. for the first six months of next year, showing
the net cash position at the end of each month.

Q2. EGBUYAH LIMITED

Egbuyah Limited, a multi product company is in the process of preparing its cash budget for the next
quarter starting in April. Budgeted sales and purchases are as follows:
Sales Purchases
N’000 N’000
February 60,000 37,200
March 75,000 46,500
April 65,000 40,300
May 55,000 34,100
June 70,000 43,400
July 75,000 46,000

Sales are received 10% in cash at the point of sale, 65% in the month following and 25% in the month
after. Sales of scrap constitute other income and are estimated at 5% of preceding month’s sales.
Creditors for purchases are paid 60% in the month of purchase and 40% in the month following. Other
monthly cash expenses estimated to be the same for the next three months are:
N’000
Fuel and oil 1,750
Office expenses 800
Transport and travels 300
Salaries 2,650
Telephone 450
Others 1,000
According to the policy of the company, depreciation on fixed assets is estimated at N6,000 per month.
Payment for the purchase of a new fixed asset costing N70 million is to be effected unfailingly in the
months of May and June on equal installment basis.
Ignore opening cash balance.
You are required to:
a) Prepare the cash budget of Egbuyah Ltd. for the quarter April to June
b) Advise the management based on your findings in (a) above.

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Q3. OZOIGBONDU NIGERIA LIMITED
Ozoigbondu Nigeria Limited is a company that is into buying and selling of plastic containers.
The company is financed by a capital of N15million inclusive of reserves in a mix of 30% and 70% of debt
and equity respectively.

The Company has been in trading business for the past six years and has consistently adhered to its
corporate policy on sales, purchases and inventory management.
The company’s policy on sales is to ensure that sales are collected as follows:
(i) Cash sales are 40% of the monthly sales.
(ii) The balance of the month’s sales is to be collected in the month following sales.
The policy on purchases is in agreement with the supplier’s policy which is to pay for all supplies in the
month following. The company’s stock policy is to reserve 30% of the month’s purchases as closing
inventory.
The following information is available for the five years 2010 to 2014:

2010 2011 2012 2013 2014

N N N N N
Monthly sales 3,400,000 3,600,000 4,200,000 4,800,000 7,200,000
Monthly purchases 2,000,000 2,400,000 2,800,000 3,200,000 4,800,000
Monthly salaries 350,000 350,000 430,000 430,000 480,000
Monthly rent 100,000 100,000 100,000 100,000 100,000
Monthly cash expenses 200,000 220,000 240,000 280,000 360,000

Additional information:
i. The company purchased a motor vehicle in July 2013 which was paid for in September 2013. The
cost of the motor vehicle was N5,000,000.
ii. Annual depreciation for the motor vehicle is 20%.
iii. The Cash Balance as at 31st December 2011 was N4,000,000.
iv. The company’s salaries, rent and expenses were paid in the month they were due.

Required:
a. Prepare a Profitability Statement for 2012, 2013 and 2014. (10 Marks)
b. Prepare a Cash Flow Statement for 2012, 2013 and 2014. (7 Marks)
c. Determine and comment on the liquidity ratio (current ratio) for 2014.

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