_ Budgeting scree \ ae CHAPTER OUTLINE @ Why budgets? © What is budget? | © Budgetary control e ° e cu RerER ane aeRReA Objectives of budgetary control system Essentials of a good budgetary control system Types of budgets 1.On the basis of period 2.On the basis of functions 3.On the basis of flexibility ¢ Important Illustrations on budgeting e Zero-base budgeting e Performance budgeting Ne Why Budgets? aS Every organisation works to achieve certain objectives or goals. For achieving these objectives, the first step required is that of planning. If plans are based on successful achievements of objectives, the organisation would definitely achieve success, After planning stage, the organisation has to check the feasibility of the plan. That is, whether plan is actually achievable, sufficient resources are available or not, how to consume these resources for achieving objectives of the organisation. Budgets give answer to all these type of queries. What is Budget? Ls AT cial terms for Budget may be defined as a detailed plan expressed in finan the operation and resources of an enterprise for some specified period in the future. As we know, planning and control are integral part of management functions. Without planning, no organisation achieves its objectives as it is first step of management functions. Needless to say that Sneed life line a the business, so it is not possible to achieve any objective of the business eo finance. As finance is a prerequisite for acquiring any resources, p pei ee eee 80 | Management Accounting budgeting which in fact entails a plan about what to acquire and how to acquire, is quite essential for the organisation. So budgets are the plans expresseq in numerical terms .The CIMA (Chartered Institute of Management Accountant) defines “a budget as a financial and/or quantitative statements, prepareg prior to a defined period of time, of the policy to be pursued during the period for the purpose of attaining a given objective.” So essential features of a budget are— It is prepared in advance. ¢ It is based on future plan of action. © It is expressed in monetary terms. Budgetary Control SS When we combine the budget with the control function, it is referred to as _ budgetary control. The Chartered Institute of management Accountants — (CIMA), U.K defines budgetary control as, “the establishment of budgets relating the responsibilities of the executives to the requirements of a policy and the continuous comparison of actual with budgeted results either to secure by individual action the objective of that policy or to provide a basis for its revision.” According to J.A. Scott, “it is the system of management control and accounting in which all operations are forecasted and planned ones.” Objectives of Budgetary Control System eee Budgetary control system is vital for the success of a business, as it’s a _ combination of two essential tools of management that is planning and control. Planning helps to forecast uncertain future and control helps to provide feedback for achieving objectives of the organisations. Proper buds _ control is based on following objectives. i 5| | | Budgeting + a work for their own interest, Coordination integenten the 0al9 of the different ven apartments inf COMMON goal of the Organisation, § is pe are three departments, one is production Suppoxe in an organisation deparement and third one is purchasing depart aaa, ie ‘i aareun i re control system, the production department Produces without st \caring tie demand arising from the sale department, similarly purchase a en give orders without considering the requirement of production a : ant ae only the budgeting that provides estimates to different de ret a eliminates the differences among them, Pastmantiyany Communication Effective communication is vital for any organisation; otherwise people working in the organisations would not Bel information regarding policies, programmes of the organisation, This can be avoided only with the help of proper communication system, Budgets provide information about the functions and plans of different units and subunits of the organisation and help to run organisation in a smooth manner. Control After preparation of budgets, a feedback system is started in which actual performance is compared with the budgeted performance, and on the basis of that variations are found out. Eventually, on the basis of these deviations, suitable reformative actions are taken to correct the variations, if any, In this way budgetary system helps to maintain control in the organisation, Essentials of a Good Budgetary Control System = s=s:sssesem A good budgetary control system should fulfil following requirements; * It should be headed by top management of the organisation, _ : © Representatives of all departments should be made part of the budget committee, 5 Mees Organisational goals should be clearly defined. : Proper management information system should be there, Periodic reports should be made to disclose the performance of the budgeting system. — : y Effective follow up system: wsdineee Ge= (@) Long term budgets A long term budget is that which includes perigg more then @ year These budgets cover specific area of operation like fy! sale, future production, long term capital expenditure, research ¢ development expenses, ete. While preparing long term budgets, factors i: . market trends, goverment and industrial policy, profit forecast, ete, shoulg considered. e (8) Short term budget: A short term budget should cover a period Of tae months to twelve months depending upon the nature of business. In cae seasonal products, the period should cover at least one season. The perigy should be enough to cover one production cycle. Adequate time Should be allowed to arrange resources or funds of the business. (c) Very short period budget: This budget covers day to day operations Of the business. This is basically meant for handling routine activities of the business. $2 | Management Accounting 2. On the basis of functions (a) Sales budget (b) Production budget (ce) Cash budget (@) Purchase budget (e) Master budget (a) Sales Budget: Sales budger is the basis of all other budgets like production budget, material budget, labour budget, cash budget, etc. It is the starting point of every budget, as all other budgets depend upon this one. The foremost requirement of this budget is forecasting of future sales. Past sales data as well as information related to present condition of the business should be considered, while preparing sales budget. While preparing sales budget, sales data are collected product wise, territory wise and demand wise, etc. Sales budget can be prepared product wise, if the company is manufacturing different types of products; territory wise, if product is sold in different territories; and can be on the basis of customers, if there are different types of customers for a particular product such as wholesaler, retailer, governmentBudgeting | 83 (c) Cash Budget: A Cash budget as the name shows provides detailed estimates Of cash inflow and outflow for the budgeted period. The purpose of this budget is to estimate the Fequirement of cash as it shows the excess or shortage of cash during the period. With the help of cash budget, management gatimates the cash requirements for different purposes that is how much cash would be required for operating expenses or how much for capital expenses, so that necessary arrangements could be made accordingly. This budget discloses gifferent sources of cash which would be ayailable in future, ic. how much cash would be possible to be collected from credit customers, how much would it come from cash sales, various other sources from which we might be able to collect cash, etc.. Similarly it reveals requirement of cash during the pudgeted period for various purposes such as payment of various expenses for material, labour and overheads; amount required for purchasing capital assets of the business and cash required for discharging various other obligations that may arise from time to time. (d) Purchase Budget: Purchase budget is prepared to calculate the purchase requirement of the business. With the help of this budget purchase department makes estimates of various types of material requirement of the business and can place order to suppliers accordingly. (e) Master Budget: Master budget is the overall budget or the summary of all functional budgets in the organisation. This budget coordinates all the functional budgets of the organisation during the budgeted period. With its help, the management is cognizant of future goals for revenue, expenses, net income, cash position and financial position of the business in the budgeted period. Hence, it helps management in taking important future decisions for the business and also helps in preparing various policies of the business. 3. On the basis of flexibility (a) Fixed budget (b) Flexible budget (a) Fixed Budget : Fixed budget as the name suggests, remains unchanged irrespective of actual level of activity. If actual operations are different from the budgeted ones, it is not possible to compare budgeted results with actual ones in case of fixed budgeting system because budgets u Sy this type of budget is84 | Management Accounting (b) Flexible Budget : Flexible budget is the budget, which is easily modifieg with the level of activity, as expenditures are divided into fixed, semi-fixed ang variable in case of such system, It is also called variable budget and sliding scale budget. This budget can easily be modified with change at level of output As budget is easily adjusted on the basis of actual level of activity attained, i provides a logical comparison with actual expenditure as a means of control, So, flexible budget helps in both profit planning and operating cost control, As expenses are divided into fixed, variable and semi variable, it becomes easier to, change budget accordingly, Semi-variable expenses are further divided into fixed and variable parts separately to get the correct cost idea at each level in case of flexible budgeting system. Important Illustrations on Budgeting oS ARR IN Sales Budget @ Illustration 7.1 M/s Rana & Co, deals with three products X, Y and Z, and sells these through two divisions South and West, Sales budget for the current year based on the el of the budget committee was as follows: ‘No, of units South 15,000 17,000 | 19,000 Sale price of X, Y and Z are Rs15, Rsi0 arBudgeting 188 On (he basis of ihe above Information, itis estimated that increase in sales: or actual sales would bey South, West product X 10% 15% Product Y 3% 10% Product 4 5% 5% yurther, IL is expected that further sales can be increased by extensive advertisement, The increase will be: South West Product X 300 units 500 units Product Y 500 unity 800 units Product 2 550 units 300 units Prepare a sales budget incorporating the current year budget and actual sales, @ Solution: Current Budget Actuals for current Expected future year budget Divisions} Qty | Price} "Total Qty | Price} Total | Qty |Price} Total South | x. 15,000 ] 1S } 2,25,000 | 17,000 | 15 | 255,000} 19,000] 17 | 3,23,000 y 17,000 | 10 | 1,70,000 } 10,000 | 10} 1,00,000/ 11,0008 | 88,000 z 19,000 | 20 | 3,80,000 | 19,000 }| 20 | 3,80,000}20,500] 20. | 4,10,000 West x 18,000 | 15} 2,70,000 } 20,000 | 13 y 16,000 | 10} 1,60,000 } 12,000 | 10 Z 14,000 | 20 | 2,80,000 | 14,000 | 20 ‘Total | ee: be x | 33.000 | 37,000 | 15. ]5.55,000) 42,500) | aaa ¥ 33,000. }] 22,000 | 10} 2,20,000)25,¢ | z 33,000 33,000 |Sales Purchase Wages Overheads 1,00,000 50,000 15,000 10,000 2.00,000 70,000 5,000 150,000 1,00,000 4,000 250,000 150,000 6,000 Additional Information * 30% of the sale is cash sale. For remaining 50%, one month’s credit ig allowed. * Creditors grant one month credit for goods as well as for overheads. * Wages are payable in the same month. * A machine for Rs 25,000 is purchased in the month of March; cash is paid in the same month. @ Solution:Budgeting | 47 There will be no work in progress at the end of uny month. Finished units equal to half the sales of the next month will be in stock at the end of every month(ineluding June 2008), Budgeted production and production cost for the year ending 31st Dec. 2008 are: Production(units) 22,000 Direct materials per unit Rs 10 Direct wages per unit Rs 4 5, Total factory overhead is Rs 88,000 apportioned to production. ‘You are required to prepare: (a) Production budget for the six months of 2008, and (b) Summarized production cost budget for the same period, Solution: Estimated sales Add - closing stock Less - opening stock Production cost budget for the six month ending Dec. 2008 Direct material + 11,050 units @ Rs 10 Direct wages 1,050 units @ Rs 4 Factory overhead: 1,050 units @Rs4 (See note) Total production cost. J Note: Factory overhead cost Total factory overhead =88 | Management Accounting Variable overheads Fixed overheads (1,00,000) Variable expenses(direct) Selling expenses (10% fixed) Distribution expenses (20% fixed) Administration expenses (Rs 50,000) Total “iss Assuming that administration expenses are fixed for all levels, Prepare ¢ budget for: (a) 8,000 units and (b) 6,000 units @ Solution: Flexible Budget ae 6,000 units _|8,000 units 10,000 i] Material @ Rs 70 per unit 4,20,000 5,60,000 Labour @ Rs 25 per unit. 1,50,000 Direct expenses(variable) @Rs 5 30,000 variable overheads @ Rs.20 120,000 Fixed overheads 1,00,000 Sellingexp. Fixed 13,000 Variable @ 11.70 70,200 Distribution expenses “Fixed 14,000 Variable @ 5.60 33,600 50,000 7,00,000 | 2,50,000 50,000. | 2,00,000 | 1,00,000 13,000, 117,000.Budgeing | 39 Salaries 6,000 Insurance 5,000 . Rent 4000 F Depreciation 2,000 @ Solution: Flexible budget for the perlod...ccecccere Ai6% capacity [At 90% capacity At 80% capaelty Fixed overhends Salaries Insurance Rent Depreciation Variable overheads Store & spares Indirect abour | Semi-variable overheads Power: Fixed Variable Repair & maintenance Fixed Variable Total overheads Zero Base Budgeting Zero base budgeting is a recently developed technique in budgeting. which ined importance ever since Peter Pyhr used it in Texas. Instruments Inc, a based computer and electronic manufacturer, % In traditional budgeting, whenever al budget bis taken ‘as a base. In case of zero based bud; et. Th in thiSE ar 90 | Management Accounting Benefits of Zero Based Budgeting 1. Effective allocation of resources: As all activities in the budget ary justified on the basis of current circumstances and proper cost benefit analysis is done, it facilitates effective allocation of resources, 2. Involvement of staff members: As each activity is justified with gory base, so it helps in involvement of staff members for taking better decisions. 3. Reduces wastages: Zero based budgeting helps to avoid wastefil and inefficient activities of the past. 4. Helps to set priorities: In zero based budgeting, activities are identified on the basis of decision package. Proper analysis of decision. package helps to set priorities, 5. Optimum utilization of resources; Zero based budgeting helps in allocating present resources on the basis of present needs of the organisation which leads to optimum utilization of resources, Performance Budgeting ee Performance budget is a budget based on function and activities which Jay emphasis on performances rather than the expenditure incurred, Performance budgeting concept focuses on work cost measurement and managerial efficiency. Production goals are established and (hen compared with actual performance, Performance budgeting provides answers to the basic questions like what is to be achieved, why is it to be achieved, how is it to be achieved and when is it to be achieved, Performance budgeting requires that __ budgetary decisions should be made by emphasizing output categories such as goals, purposes, objectives and product or services instead of nau like mace _ cost, labour cost in case of traditional budgeting, pha GrBudgeting | 91 analyzing present conditions and priorities and in their context, the necessity or otherwise of each and every (i is pescesed nie system of budgeting offers ample advantages: the major ones being reduction of wastages, effective allocation and optimum utilization of Tesouieen: Performance budgeting is another concept that keeps an eye On managerial efficiency by setting production goals and incorporating the feature of work cost measurement. Key Terms as LUT LLL TI Budget : Budget may be defined as a detailed plan expressed in financial terms for the operation and resources of an enterprise for some specified period in the future. Budgeting : Budgeting is a technique for formulating budget. Budgetary Control : Budgetary control is a technique of planning the budget for the purpose of management control. Flexible Budget : Abudget which is prepared for different level of activity is called flexible budget. In this cost is segregated into fixed, variable and semi-variable cost so budget can be easily changed in relation to the level of activity. This budget is used when level of activity changes from time to time. Master Budget: Master budget is a summary of all functional budgets. When all functional budgets are incorporated in a single budget it is called master budget. Fixed Budget : Fixed budget as the name suggests, remains unchanged irrespective of actual level of activity. It is prepared for the given level of activity. Zero Base Budgeting : Itis a technique of preparing budget from scratch. Whenever a. budget is prepared, it is considered as new, nothing is taken from the past. Performance Bh - Budget : Performance budget is a budget based on function and activities which make emphasis on performances rather than the expenditure incurred. — a } 1, What are budgets? How are they importan! Review Questions for Discussion92 | Management Accounting Test Your Understanding 1. Define budget and budgetary control system. 2. Write a short note on performance budgeting, 3. What do you mean by zero based budgeting? Explain its benefits to the organisation. 4. Write a short note on different types of budgets. 5. Following are expenses per unit of automatic car manufactured by AB Ltd for production of 20,000 units. Per Unit Direct material Rs 600 Direct labour Rs 300 Variable overheads Rs 250 Fixed overheads (Rs 30,00,000) Rs 150 “Variable expenses (direct) Rs 50 _ Selling expenses (10% fixed) Rs 150 "Administration expenses (Rs 10,00,000 fixed) Rs 50 _ Distribution expenses (20% fixed) Rs 50 Prepare budget for production of 12,000 units and 16,000 units. 'uper Power Ltd. wants to estimate its cash requirement for the period Oct, __ to Dec. 2008. During the period of these three months the company will be manufacturing mostly for stock. You are required to prepare cash budget for the above period from the following data indicating the overdraft facility (it any) required by the company at the end of each month.