Budget is a detailed plan of operations for some specific future period.

It is an
estimate prepared in advance of the period to which it applies. It acts as a business
barometer as it is a complete programme of activities of the business for the period
covered. According to Gordon and shilling law budget may be defined as “a
predetermined detailed plan of action developed and distributed as a guide to current
operations and as a partial basis for the subsequent evaluation of performance”
Meaning of control: control means “some sort of systematic effort to compare current
performance to a predetermined plan or objective, presumably in order to take any
remedial action required”
Management control process involves two separate but closely related activities.
Namely planning and controlling. Planning means deciding what is to be done and
how it is to be done. Control is assuring that desired results are attained. Budget is
simply a plan of action hence the technique of budgetary control is an important tool
of management control.
Meaning of budgetary control: Budgetary control refers to the principles, Procedures
and Practice of achieving given objectives through budgets and budget reports. “It is
the system of management control and accounting in which all operations are
forecasted and so for as possible planned ahead, and the actual results compared with
the forecasted and planned ones.
Budgetary control is an essential tool of management for controlling cost and
maximizing profits. It may be conceived as one of the supreme examples of
rationality in management. It is a useful management tool for comparing the current
performance with pre-planned performance with a view to attain equilibrium between
ends and means, output and effort. It corrects the deviation from pre-planned path
through the media of observation, research planning, control and decision making and
thus helps performance of future activities in an orderly way. It uncovers
uneconomies in operations, weakness in the organization structure and minimizes
wasteful spending.
Budgetary control involves the following “
1. Establishment of budgets
2. Continuous comparison of actual with Budget for achievement of budgeted figures.
3. Revision of Budgets in the light of changed circumstances.
Administration of Budgetary control
In a large –sized organization the process of Budgetary control System can be
organized in the following lines:
1. Determination of Objectives: A budget being a plan for the achievement of
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
clear understanding of the plan and its scope to all those who must cooperate to make
it a success.
2. Establishment of Budget centre: A budget centre is a section of the organization of
an undertaking defined for the purpose of budgetary control. A budget is prepared for
each centre and therefore the budget centre should be properly selected. A budget
centre may again consist of a number of cost centre representing different groups of
machines.
3. Introduction of adequate accounting records and their codification: The accounts
department gives data required by the budget department and with the help of it the
budget department can make estimates.
4. Preparation of budget organization chart: Organization chart is a map that depicts
the functions and responsibilities of each member of the management and ensures
that each one knows his position in the organization and his relationship to other
members. It should be supported by written directives concerning the function of the
staff members. The organization chart depends up on the nature and size of the
enterprise.
5. Establishment of Budget Committee: In a small business, the Cost Accountant is
responsible for the preparation of budget, but in large 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 Heads
of main departments. The chief executive acts as the Chairman and Cost Accountant
as its Secretary. The managers of different departments prepare the budget and
submit to this committee. The committee makes necessary adjustments, coordinates
all the budgets and prepares a Master Budget.
6. Preparation of Budget Manual: It’s a document or Schedule or Rule Book which
sets out the responsibilities of the persons engaged in the preparation routine of forms
and records required for budgetary control. This manual lays down the budget
programme, specific and general duties of the executives, departmental managers and
the budget committee.
7. 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.
8. Selection of the Budget period: The period covered by a budget is known as budget
period. The length of the budget period normally depends up on the nature of the
plan, circumstances of the business, the control aspect, production period and timings
of availability of finance. Most manufacturing concerns use one year as the budget
period. For control purposes, the annual totals are divided by 12 to obtain monthly
budgets.
9. Locating the Principle Budget Factor: Budget should be evolved around the
principle budget 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) are 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 in accurate, most of the budget will be affected. Similarly,
materials, labour, cash, space, equipment, management etc may also be the key
factors.
10. 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.
11. 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 the respective heads for execution.
12. Budget Variance Analysis and Reporting: A variance is the divergence between
any planned result and the actual result measured in monetary terms. A 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.
Elements of a Successful Budgetary Control System
The success of the budgeting process in an organization depends up on the following
essential elements:
1. Objectives: All planning requires that objectives have been established since the
plan is merely a means to an end, not an end in itself. The objectives are the end.
2. Knowledge of Cost Behaviour: understanding of the cost pattern of the firm is
essential and the Cost-volume –profit Analysis is a useful tool to the budgeting
exercise because it aids in the understanding cost behaviour.
3. Accurate Forecasting of Business Activities: Forecasting is a prerequisite in
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 organization. Business firms require competent
market researchers to forecast accurately the external factors.
4. Coordinating Business Activities: budgeting coordinates all individual budgets in
to an integrated plan as each budget has certain implications for the other budgets.
There must be coordination between sales, production, purchasing, and personnel
budgets. Budgets are useful in communicating budgetary expectations and goals and
in bringing necessary adjustments in organizational activities.
5. Education: All levels of Management must be educated on the usefulness of the
budget and must be taught the part that each must play in planning and control
through budgets. This necessitates a continuous training in budgeting methods.
6. Communicating the Budget: The success of comprehensive budgeting programme
depends on communication of individual budgets to the different units in the
organization. The preparation of budget is of no use unless it is made known to the
persons for whom it is made.
7. Acceptance and cooperation: successful budgeting also requires that budget should
be accepted by the people who must execute them. Budgeting should have the active
cooperation of the entire organization.
8. Reasonable Flexibility: The budgeting programme should contain reasonable
flexibility. It should also be remembered that too much flexibility and too much
rigidity are both undesirable. Because too much flexibility will weaken the cost
control and the budget will become in operative. Similarly too much rigidity not
permitting reasonable deviations will create problems and restrictions in the
implementation of the budget.
9. Adequate Systems Support: This will come mainly from the accounting, 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
definition, etc relate to common elements.
10. Providing a frame work for Evaluation: Budgeting provides a basis to evaluate
the performance of different departments. A budget, properly developed, will contain
initially organizational goals and expectations and subsequently can be used as an
effective evaluation technique.
Budget and its Types
Budgets are an important tool for effective short term planning and control in
organizations. An operational budget usually covers one year and states the revenues
and expenses planned for that year. It has these characteristics:
1. It estimates the profit potential of the business unit.
2. It is stated in monetary terms, although the monetary amounts may be backed up
by non monetary amounts ( e.g. Units sold or produced)
3. It generally covers a period of one year.
4. It is a management commitment; managers agree to accept responsibility for
attaining the budgeted activities.
5. The budget proposal is reviewed and approved by an authority higher than the one
who prepares the budget.
6. Once approved, the budget can be changed only under specified conditions.
7. Periodically, actual financial performance is compared to budget, and variances are
analyzed and explained.
Flexible Budget
A Flexible Budget is a dynamic budget which is designed to change in accordance
with the level of activity. It is also called as variable budget or Sliding scale budget.
A budget prepared in a manner so as to give the budgeted cost for any level of
activity is known as Flexible Budget. A flexible Budget recognizes the difference in
behaviour between fixed and variable expenses in relation to fluctuations in sales or
production and changes according to the change in the level of activity. When
flexible budget is used budgeted expense are adjusted to the actual activity level
before comparing with actual expenses incurred.
The main idea behind the preparation of flexible budget is that for any given volume
of business there should be some type of expenditures and that type should be known
well in advance to provide assistance for doing the actual expenditures. From the
Control point of view, flexible budget is very effective in those business units where
frequent changes occur in activities due to market fluctuations, seasonal variations
etc.
There are two ways using which flexible budget can be prepared they are (a) Formula
Method. (b) Multi activity or Tabular Method. Generally following steps are followed
in the preparation of flexible budget:
1. Decide the range of activity to develop a flexible budget.
2. Determine the cost behaviour- fixed, variable and semi variable to each element of
cost.
3. Select the activity level (generally in terms of output).
4. Prepare a budget at each activity level.
Benefits of preparing Flexible Budget
1. Ascertainment of Cost with greater degree of accuracy.
2. Control over Cost is made possible because it shows what amount of cost must
have been incurred for each level of activity.
3. Management by Exception is possible because only deviations of significant type
are taken up to the top management for solution purpose and for taking remedial
actions.
4. Achievement of best results with maximum return is possible because a careful
watch is kept on the production, sales, and inventory levels.
Zero Base Budgets
Generally while constructing a functional budget, the previous year’s budget figures
will be taken as the base. This is so because previous year’s figures are adjusted for
the impact of inflation and for the proposed increase or decrease in the level of
activity of the business then are used in the construction of budget for the current
year. This practice brings in the inefficiencies of the previous year to the current year
hence to streamline the allocation of funds and to control cost a new technique called
Zero Base Budgeting came in to existence.
The “Zero-base” means a “nil budget” as the starting point. There is no given base
figure for a budget. ZBB originated in USA. A fresh budgeted figure is determined
keeping in view the circumstances and the requirements. The basic concept of ZBB is
“Starting from Scratch” that is every activity in an organization must be examined
and justified, giving consideration to the alternatives and the results are obtained.
Basic Principles underlying the preparation of ZBB
1. Every budget starts with a Zero base
2. No previous year figure need to be taken as base for adjustments.
3. Fresh examination of each activity
4. Justification of every allocation in the light of anticipated circumstances.
5. Give due consideration to alternatives.
Benefits of ZBB
1. Makes planning and controlling activities in an organization more effective and
efficient.
2. Higher degree of Coordination can be achieved at all levels of activities.
3. Operating efficiency of the firm is greater because responsibility and
accountability can be easily pinpointed.
4. Efficient allocation and optimum utilization of available resources.
5. Better interpersonal relationship is developed among employees.
Thus ZBB is a Planning, resources allocation and Control tool. According to ZBB
system, justification of the expenditure may be required on the basis of the required
output. So while ZBB may be applicable to only a portion of the budgeting effort in
an organization, those areas to which it is directly applicable are the hardest to plan
and control.
Master Budget
The Master budget is the summary budget incorporating all the functional budgets of
the firm. Master budget is prepared in the form of an Income statement, starting with
Sales Revenue, followed by cost of sales, operating income, non-operating expenses
and other income reaching profit before tax and interest and there after arriving at net
profit after deducting financial charges and income tax. Master budget requires the
approval of Budget Committee to put it in to operation.
Performance Budgeting
Budgeting is a technique which expresses in financial terms the management’s
operation and financing the organization for a specific period of time. It is an
effective technique that provides for performance appraisal followed by follow-up
measures. Performance budgeting aims at evaluation of performance of the enterprise
keeping in view the specific and overall objective of the organization. Its main focus
is on the contribution of each employee for the attainment of organizational objective
in general and short term business objectives in particular. It provides a concrete
direction to each employee ad acts as a control mechanism to top management.
The National Institute of Bank Management define the Performance budgeting as
“The process of Analyzing, identifying, simplifying ad crystallizing specific
performance objectives of a job to be achieved over a period in the frame work of
organizational objectives, the purpose and the objective of the job”. The technique is
characterized by its specific direction towards the business objectives of the
organization. Performance budgeting lay emphasis on achievement of specific goals
and in the long run it aims at continuous growth so that the organization can be
sensitive, adoptive and avoid rigidities which may hinder its growth.
Performance budgeting involves preparation of performance report. These reports are
prepared by comparing the budget with the actual data and reveal the variance. These
reports are prepared using the data provided by the accounting system. The head of
the each department is vested with the responsibility of preparing Performance
budgets. He will do so using the copy of section of the master budget. The periodical
reports will be given to the departmental heads that will prepare a summary of all the
sectional budgets and give this to budget committee. The purpose of this report is to
inform promptly about the deviations in actual and budgeted activity so that the
person in charge will take needed actions to correct the deviations.