UNIT THREE

INFORMATIONFOR BUDGETING, PLANNING AND CONTROL PURPOSE

INTRODUCTION
A budget is a form of quantitative expression of policies, plans, objectives and goals
laid down in advance by top management for the concern as a whole and for each sub-
division thereof. A budget is a plan covering all phases of operations for a definite
period in the future. A budget is a method for translating the goals and strategies of an
organization into operational terms. Budgeting describes the overall process of
preparing and using a budget.

Budgeting: It is a means of coordinating the combined intelligence of an entire

organization into a plan of action based on past performance and governed by rational
judgment of factors that will influence the course of business in the future.

Budget: defined as the “Quantitative expression of a plan for a defined period of time.
It may include planned sales volumes and revenues; resource quantities, costs and expenses;
assets, liabilities and cash flows.

In Short, Budgetary Control means laying down monetary and quantitative terms of what
exactly has to be done, how it is to be done, the actual results should not deviate much from
the budgeted results, a course of action if results deviate and also fixing the responsibilities for
various levels of management.
Budgetary Control as: The establishment of budgets relating the responsibilities of executives to the
requirements of 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.

3.1. OBJECTIVES/USES OF BUDGETARY CONTROL

 It is used to achieve the targets set for the company.
 It is used to fix the responsibilities of executives, departments and personnel.
 It is used for comparison purpose.
 It is used to ensure the best use of all available resources.
 It is used for the purpose of co-ordination.
 It is used for revision purpose.
  It is used for long range plans.
 To reduce losses and wastes to the minimum.
 To bring out clearly where effort is needed to remedy the situation.
 It motivates employees if they are actively engaged in budget preparation.
 To see that the firm is not deflected from marching towards its long-term
objectives without being overwhelmed by emergencies.
 It communicates goals of the organization to the employees.
Many companies go through the budgeting process every year simply because they did it the
year before, but they do not know why they continue to create new budgets. What are the
objectives of budgeting? They are:

 Provide structure. A budget is especially useful for giving a company guidance regarding the
direction in which it is supposed to be going. Thus, it forms the basis for planning what to do
next. A CEO would be well advised to impose a budget on a company that does not have a good
sense of direction. Of course, a budget will not provide much structure if the CEO promptly
files away the budget and does not review it again until the next year. A budget only provides a
significant amount of structure when management refers to it constantly, and judges employee
performance based on the expectations outlined within it.

 Predict cash flows. A budget is extremely useful in companies that are growing rapidly, that
have seasonal sales, or which have irregular sales patterns. These companies have a difficult
time estimating how much cash they are likely to have in the near term, which results in
periodic cash-related crises. A budget is useful for predicting cash flows, but yields increasingly
unreliable results further into the future. Thus, providing a view of cash flows is only a
reasonable budgeting objective if it covers the next few months of the budget.

 Allocate resources. Some companies use the budgeting process as a tool for deciding where to
allocate funds to various activities, such as fixed asset purchases. Though a valid objective, it
should be combined with capacity constraint analysis (which is more of an industrial
engineering function than a financial function) to determine where resources should really be
allocated.

 Model scenarios. If a company is faced with a number of possible paths down which it can
travel, you can create a set of budgets, each based on different scenarios, to estimate the
 financial results of each strategic direction. Though useful, this objective can result in highly
unlikely results if management lets itself become overly optimistic in inputting assumptions into
the budget model.

 Measure performance. A common objective in creating a budget is to use it as the basis for
judging employee performance, through the use of variances from the budget. This is a
treacherous objective, since employees attempt to modify the budget to make their personal
objectives easier to achieve (known as budgetary slack).

Conversely, budgeting may not be of much use for a well-established business that has a
consistent track record of performance. In this case, a better approach may be to manage the
organization from a rolling forecast that is updated on a regular basis. Doing so reduces the
work associated with financial predictions, and also allows the business to shift its operational
focus on short notice.

 Budgeting and Behavioral influence

 Factors Affecting the Budget may including;-

 Income of the Family.

 Size of the Family.
 Composition of the Family.
 Occupation of the Family members.
 Intercity Differences.
 Family Goals.
 Socio-economic Status of the Family.
 Gainful Employment.

 Activity-Based Budgeting Definition

 Activity-based budgeting is often used in cost accounting. Managers make budgets and spending
recommendations based on past production activities. Management examines the costs of performing
particular activities, like bending a fender for a car, to budget the overall costs of manufacturing a
product.
or

Activity-Based Budgeting is a management accounting tool that does not look at the past year’s
budget to arrive at the current year’s budget. Instead, the activities that acquire the cost are deeply
studied and analyzed. Based on the study, the resources are allocated to an activity.
 Steps of Activity-Based Budgeting
There are 4 steps in Activity-Based Budgeting:

 Identifying various activities.

 Identifying the costs of various activities.
 Project the number and the costs of units:
 Calculate the total cost.
1, Identifying the Various Activities:

Activity-Based Budgeting starts with identifying activities that revolve around resource consumption.
These activities are mainly classified as major activities and secondary activities that denote
involvement and importance of an activity to the organization as per their priority.

Therefore, major activities are activities that are directly related to the objectives and are essential.

Activities that create added value to the customer and change its preference in the organization’s
favor may involve many resources that are considered secondary activities.

2, Identifying the Costs of Various Activities :

The 2nd step in Activity-Based Budgeting is to identify the cost drivers of various previously
identified activities, that are the cost drivers for a manufacturing facility can be the total labor hours
and wages paid to employees.

3. Project the number and the costs of units

After identifying the various activities and their costs, the next step is to identify the type and the
number of the units (as shown in the table: Type of the units; per person, per item, per product & per
service.
After identifying the type and number of units, we have to evaluate the cost of the total units. For
example, the cost for the accommodation of every person: $20.

4. Calculate Total Cost:

After identifying and projecting the activities and the costs, the next step is to calculate all the values
and the costs to complete the budget.

 Advantages of Activity-Based Budgeting

Activity-based budgeting (ABB) systems support more control over the budgeting process. Revenue
and expense planning takes place at a definite level that provides necessary details regarding
projections. It allows management to have more control over the budgeting process and align the
budget with company objectives.

Here are some advantages of ABB:

a. Evaluation
Activity-Based Budgeting promotes a forward-looking view rather than looking at previous
activities, which is a common feature of traditional budgeting that is it asks queries like ‘what should
be performed’ and ‘where can we make some improvement’ rather than ‘what was done earlier’ and
sort of just allocation of costs according to that.

b. Competitive Edge
Activity-Based Budgeting system eliminates many unnecessary activities, which facilitates the
business to save its costs. The saved cost results in the production of goods and services at a lower
cost than other available competitors. It also helps a business to achieve a competitive edge in the
market.
 c. Business as a Unit
This budgeting system helps in viewing the business as a unit and not as a department. The managers
or the top management prepare the budget for the business unit as a whole and not keeping in mind
any single department as done with other methods of budgeting.

d. Improves Relationships
The Activity-Based Budgeting technique helps to improve the relationship between the organization
and its customers. The primary aim of this budgeting method is to wipe out irrelevant activities and
serve the customers with the best quality and price. This enforces indirectly the employees of the
company to provide the customers in the best way possible and secure customer satisfaction. In this
way, the relationship between the organization and the customer enhances.

 Disadvantages of Activity-Based Budgeting

Activity-based budgeting (ABB) is more cost-sufficient to implement and maintain than traditional
budgeting approaches and more time-consuming as well. ABB systems need additional inferences
and insight from management, which can, occasionally, result in potential budgeting inaccuracies.

Now let’s have a look at the disadvantages of Activity-Based Budgeting:

1. It is Complex
Activity-Based Budgeting system requires research and analysis of various factors. This budgeting
process comprises an estimation of demand and based on that, it does the estimation of resources to
be employed in various activities.

2. It Requires Understanding
ABB requires a deep understanding of various functional sections of the business. If the manager
preparing the budget is unable to understand and evaluate the areas of business, it would lead to
imperfect budget preparation.

3. Cost-Sufficient
Implementation of ABB needs trained employees. An employee who is not trained enough cannot
handle the budgeting process effectively. So the organization needs to spend extra money to train
their employees. Otherwise, top management involves there, and this is more costly.
 4. Resource Consuming
Budgeting in this method consumes a lot of resources for an organization. It requires top officials for
conducting many analyzes. It is also a very time-consuming task. These resources can give better
returns if they are employed in other operations.

5. Short Term
It focuses on the short-term objectives of the business. Sometimes focusing on short-term goals
rather than long-term goals can prove very fatal for the organization.

 Uncertainty and Budgeting

Budgeting describes the overall process of preparing and using a budget.

Uncertainty as used here means the range of possible values within which the true value
of the measurement lies. This definition changes the usage of some other commonly used
terms.

 Types of Budgetary system

Budget classified as Fixed and flexible budgets, zero-based budgets, and incremental, periodic
and continuous budgeting (rolling), Short-term vs. long-term budgets

 Fixed Budget
A budget prepared on the basis of standard or fixed level of activity is known as fixed
budget. It does not change with a change in the level of activities.

 Flexible budget
Flexible Budget
As a budget which by recognizing different cost behavior patterns is designed to
change as volume of output changes.
It is a budget prepared in a manner so as to give the budgeted cost for any level of
activity. It recognizing the difference between fixed, semi-fixed and variable cost is
designed to change in relation to the activity attained. It is designed to furnish
 budgeted cost at any level of activity attained.
The main characteristic of flexible budget is that it shows the expenditure appropriate
to various levels of output. If the volume changes, the expenditure appropriate to it
can be established from the flexible budget for comparison with actual expenditure as
a means of control. It provides a logical comparison of budget allowances with the
actual cost. When flexible budget is prepared, actual cost of actual activity is
compared with budgeted cost of actual activity.
 Long term budgets
A long-term budget can be defined as a budget which is prepared for periods longer
than a year. These budgets help in business forecasting and forward planning. Capital
expenditure budgets and research developments budgets are good examples of long-
term budgets.

 Short term budgets

This budget is defined as a budget which is prepared for a period less than a year and
is very useful to lower levels of management for control purposes. In an ideal
situation a short-term budget should perfectly fit into a long-term budget.

 Zero base budgeting

“a method of budgeting whereby all activities are re-evaluated each time a budget is
set. Discrete levels of each activity are valued and a combination chosen to match
funds available.”

As the term suggests, it examines a programmed or function or responsibility from

scratch. The manager proposing this activity has, therefore, to prove that the
activity is essential and the various amounts asked for are really reasonable taking
into account the volume of activity. Zero base budgeting is based on the premise
that every rupee of expenditure requires justification.

a) Zero base budgeting means budgeting from the beginning i.e. it is prepared
without any reference to any base (past budgets and actual figures).
 b) Zero Base budgeting may be defined as a planning and budgeting process which
requires each manager to justify its budget in detail from scratch and justify why
he should spend any money.
c) Concentration of efforts is not simply on “how much” a unit will spend but “why”
it needs to spend
d) Under zero base budgeting, all activities are identified and evaluated by
systematic analysis and ranked in order of importance.
e) Thus, the burden of proof is on manager to justify why the expenditure should
be made at all and to indicate what would happen if the proposed activity is
stopped and no expenditure is made.
Under zero bases budgeting, all activities and costs are re-evaluated each time budget is set. It
provides number of advantages to the organizational efficiency and effectiveness.