Skip to document
Welcome to StudocuSign in to access the best study resources
Guest user
0followers
HomeMy LibraryAsk AI
  • You don't have any recent items yet.
My Library
  • You don't have any courses yet.
  • You don't have any books yet.
  • You don't have any Studylists yet.

Unit 14 - Budgetary Control

MBA Notes
Course

Master's in Business Administration (MBA001)

211 Documents
Students shared 211 documents in this course
Academic year: 2022/2023
Uploaded by:
Anonymous Student
This document has been uploaded by a student, just like you, who decided to remain anonymous.
Manipal University Jaipur

Recommended for you

Comments

Please sign in or register to post comments.

Students also viewed

Related documents

Preview text

Unit 14 Budgetary Control

Structure:

14 Introduction

Objectives

14 Definitions

Budget

Budgeting

14 Budgetary Control

14 Objectives of Budgetary Control

14 Merits of Budgetary Control

14 Essential Features of Budgetary Control

14 Steps in Budgetary Control

14 Classification of Budgets

Functional classification of budgets

Based on time

Based on flexibility

14 Cast Budget

14 Flexible Budget

14 Zero Based Budgeting (ZBB)

14 Limitation of Budgetary Control

14 Summary

14 Glossary

14 Terminal Questions

14 Answers

14 Case Study

14 Introduction

In the previous unit we learnt about decisions involving alternative choices

and making or buying decisions. It is important to understand budgetary

control while considering buying decisions which we will be studying in this

unit.

In a competitive environment, profitability depends upon the extent to which

the management has followed proper planning, effective coordination, and

dynamic control. The procedure for preparing a plan with respect to the

future financial and physical requirements is called “budgeting”. It is a

forward planning exercise. It involves the preparation in advance of the

quantitative as well as the financial statements to indicate the intention of

the management with respect to the various aspects of business. In this

unit, we shall understand the uses, types, and the process of budgeting in

business organisations.

Objectives:

After studying this unit, you should be able to:

  • explain the meaning of budget and budgetary control
  • appreciate budgetary control as a tool of management planning and

control

  • explain the processes involved in the preparation of budgets and

implementation of budgetary control

  • explain the various classifications of budgets
  • prepare cash budget and flexibles
  • appreciate the utility of Zero Based Budgeting (ZBB) as a tool of cost

control

.

14 Definitions

Let us understand the definitions of some basic terminologies before going

ahead.

14.2 Budget

"A budget is a financial and/or quantitative statement, prepared prior to a

defined period of time, of the policy to be pursued during that period for the

purpose of attaining a given objective."

  • Chartered Institute of Management Accountants (CIMA) London

The following points are clear from the definition.

  • A budget is a pre-determined statement. The targets for a period are set

in advance.

  • The methodologies to be adopted for achieving those targets are also

determined in advance.

Thus a budget sets a standard for performance. At the end of the period (or

at regular intervals) the actual performance is compared with the targets

(budgeted performance level).

Self Assessment Questions

1. Budgets are not actual but ______.

2. After setting up objectives in terms of plans, it becomes imperative to

organise the factors of production to convert into a ____________ and

______________.

3. _______signifies such systematic efforts, which help the management

to know whether actual performance is in line with the predetermined

goal, policy, and plans.

4. Internal refinement, broad indexation of activities, and concentrated

details are the essential features of _______.

14 Merits of Budgetary Control

The merits of budgetary control are as follows:

1. It aims at the maximisation of profits.

2. Budgets fix the goals and targets without which operations lack

direction.

3. It reduces the cost and eliminates inefficiencies.

4. It facilitates to make ordered effort and brings about overall efficiency

in the results.

5. It ensures that the capital employed at a particular level is kept at a

minimum level.

6. It enables the management to decentralise responsibility without losing

control.

7. It is a good guide to the management for making future plans. Based

on budgetary control, realistic budgets can be drawn.

8. It facilitates an intelligent and planned forecast of the future.

9. It acts as a safety signal for the management. It prevents all types of

wastages.

10. It brings to light the inefficiencies and weaknesses on comparing

actual performance with the budget. Management can take timely

remedial measures.

11. It avoids financial crisis since budget provides advance information.

12. It is a guide to the management in the field of research and

development in the future.

14 Essential Features of Budgetary Control

An effective budgeting system should have essential features to get the best

results. In this direction, the following may be considered as essential

features of an effective budgeting.

  • Business policies defined – The top management of an organisation

should have an action plan for every activity and department. Every

budget should reflect the business policies formulated from time to time.

The policies should be precise, clearly defined, and the same must be

communicated to the persons involved in the execution.

  • Forecasting – Business forecasts are the foundation of budgets. Time

and again, discussions should be arranged to derive the most profitable

combinations of forecasts. As far as possible, quantitative techniques

should be used while forecasting

  • Formation of budget committee – A budget committee is a group of

representatives of various important departments in an organisation.

The functions of the committee should be specified clearly. The

committee plays a vital role in the preparation and execution of the

budget estimated. It brings co-ordination among other departments. It

aids in the finalisation of policies and programs. Non-financial activities

are also considered to make it a wholesome affair.

  • Accounting system – To make the budget a successful document,

there should be proper flow of accurate and timely information. The

accounting adopted by the organisation should be proper and must be

fine-tuned from time to time

  • Organisational efficiency – To make the budget preparation and its

subsequent implementation a success, an efficient, adequate and the

best organisation is necessary. A budgeting system should always be

supported by a sound organisational structure. There must be a clear

cut demarcation of lines of authority and responsibility. There must also

be a delegation of authority from top to bottom line.

  • Management philosophy – Every management should set a healthy

philosophy while opting for the budget. Management must

wholeheartedly support the activities which develop a budget.

Encouragement should flow from the top management. All the members

should not be considered as mere estimates. Scientific methods should

be adopted for forecasting. Analysis of various factors should be made

based on past, present, and future forecast.

3) Preparation of budgets – Forecasts are converted into written codified

documents. Such written documents can be used for co-ordination

purposes. Function budgets will act as guidelines for implementation.

4) Forecast combinations – While developing budgets through a master

budget, various permutation and combination processes are considered

and developed. Based on this, establishment of the most preferred one

which will yield optimum benefits should be considered. All the factor

components should be identified which are likely to cause disturbances

while implementing the budgets.

14 Classification of Budgets

Budgets may be classified based on various criteria. From a utility point of

view, it is important to understand these classifications.

14.8 Functional classification of budgets

Functional budget

These are also known as subsidiary budgets. These are prepared on the

basis of approved forecasts for individual department. Since departments

are created based on the functions, they are known as functional budgets.

The functional budgets may vary in number from business to business. The

functional budgets include sales budget, production budget, selling and

distribution overhead budget, plant budget, research and development

budget, overheads budget, financial budget such as cash budget and capital

expenditure budget.

14.8 Based on time

Based on the time horizon, budgets are classified as follows:

1. Short-term budgets

These budgets involve a time frame of up to one year. Budgets like

production budgets and cash budgets are prepared for one year or less.

2. Medium-term budgets

These budgets involve a time frame of two to three years. Budgets like

plant utilisation or capacity utilisation, HR training, etc. require this kind

of time frame.

3. Long-term budgets

These budgets involve a time frame of more than three years. Budgets

like increasing the plant capacity, expansion diversification, R&D, etc.

require this kind of time frame.

14.8 Based on flexibility

Based on their nature, budgets are classified as follows:

(a) Fixed budget

(b) Flexible budget

Fixed budget

A fixed budget is defined as a budget “which is designed to remain

unchanged irrespective of the level of activity actually attained ”.

It is also known as static budget. It is prepared for a fixed or standard

volume of activity. They do not change with the change in volume of the

activity. They are prepared well in advance and hence there are variances

at the time of comparison. Hence, the budget targets become unsuitable for

the purpose of comparison. Wide deviations are noticed due to the changes

in the volume of activity.

Flexible budget

A flexible budget is defined as a budget “which is designed to change in

relation to the level of activity actually attained ”.

It is prepared with a view to take into account the periodic changes in the

level of activity attained. In this case, the revenues and costs targets are set

with respect to different levels of activity say from 0 to 100% of the

production volume. Such mechanism helps to change revenues and cost

targets for the actual level of activity and thus makes the comparison more

logical and scientific.

Self Assessment Questions

8. ______ is also known as static budget because it is prepared for a

fixed or standard volume of activity.

9. Types of budgets are _____________.

10. In _______ budget, the revenues and costs targets are set with respect

to different levels of activity say from 0 to 100% of the production

volume.

Solution:

Statement of expected Cash Receipts

Collection form April May June
Cash sales 37,500 27,500 25,
Collection from Debtors :
January 8,400 - -
February 18,750 10,500 -
March 63,000 26,250 14,
April - 67,500 28,
May - - 49,
Total 1,27,650 1,31,750 1,17,

Working Notes: Details of Cash and Credit Sales – monthwise

[Fig. in 000’s Rs.]

Jan Feb Mar Apr May June
Sales 80 100 140 150 110 100
Cash 25% 20 25 35 37 27 25
Cr. 75% 60 75 105 112 82 75

Details: Credit sales – monthwise realisation:

[Fig. in 000’s Rs.]

####### Debtors

####### 60:25:14 Feb Mar Apr May June

####### Jan:60 36 - - - 15 - - - 8.

####### Feb:75 - - - 60 - - - 18 - - - 10 - - -

####### Mar:105 - - - - - - 63 - - - 26 - - - 14.

####### Apr:112 - - - - - - - - - 67 - - - 28 -

####### May:82 - - - - - - - - - - - - 49 - -

Forecasts of cash payments

The items of expenditures differ from business to business. The normal

items which come under the lists are:

1. Cash purchases

2. Payment to creditors or suppliers

3. Payments to bills payable

4. Payment to employees in the nature of wages, salaries

5. Manufacturing, selling and distribution, and administration expenses

6. Repayments of bank loan and special obligations such as bonus,

donations, and advances

7. Interest and dividend payments

8. Capital expenditures for acquiring assets of enduring benefit

9. Payment of tax liability

10. Other expenses of periodic nature

The quantum of amount likely to be spent on these items is generally

determined with reference to functional budgets. The time lag affects the

amount of expenditures to be incurred in a particular period. The formula

adopted for the expenses payable in next month is:

Month’s amount x Time lag

Illustration 2:

The following are the forecasts related to wages and factory expenses.

July Aug Sept Oct Nov
Wages 32,000 32,000 32,000 40,000 32,
Factory expenses 5,000 5,000 5,000 5,000 5,

One eighth of wages and half of factory expenses are paid in the

succeeding month. Estimate the amount of wages and factory expenses

payable in September, October, and November.

Solution:

Statement showing the disbursements of cash

Particulars Sept Oct Nov
Wages: Aug 32,000 4,000 - -
Sept 32,000 28,000 4,000 -
Oct 40,000 - 35,000 5,
Nov 32,000 - - 28,
32,000 39,000 33,
Factory expenses
Aug 5,000 2,500 - -
Sept 5,000 2,500 2,500 -
Oct 5,000 - 2,500 2,
Nov 5,000 - - 2,
5,000 5,000 5,

Illustration 4:

Hindustan Ltd. is to start production on 1st January, 2008. The prime cost of

a unit is expected to be Rs (Rs per material and Rs for labour). In

addition, variable expenses per unit are expected to be Rs and fixed

expenses per month are Rs,000. Payment for materials is to be made in

the month following the purchases. One-third of sales will be for cash and

the rest on credit for settlement in the following month. Expenses are

payable in the month in which they are incurred. The selling price is fixed at

Rs per unit. The number of units to be produced and sold is expected to

be: January 900, February 1,200, March 1,800, April 2,000, May 2,100, and

June 2,400. Draw a cash budget indicating cash requirements.

Solution:

Cash Budget

For six months ending 30th June

Particulars Jan Feb Mar Apr May June
RECEIPTS
Opening bal - (34,800) (37,600) (32,400) (5,867) 27,
Cash Sales 24,000 32,000 48,000 53,333 56,000 64,
Collection
from Debtors
  • 48,000 64,000 96,000 1,06,667 1,12,
A. Total 24,000 45,200 74,400 1,16,933 1,56,800 2,03,
PAYMENTS
Creditors - 14,400 19,200 28,800 32,000 33,
Wages 21,600 28,800 43,200 48,000 50,400 57,
Variable
Expenses
7,200 9,600 14,400 16,000 16,800 19,
Fixed
Expenses
30,000 30,000 30,000 30,000 30,000 30,
B. Total 58,800 82,800 1,06,800 1,22,800 1,29,200 1,40,
Closing Bal.
[A – B]
(34,800) (37,600) (32,400) (5,867) 27,600 63,

Working Notes:

Particulars Jan Feb Mar Apr May June
Sales [Units] 900 1,200 1,800 2,000 2,100 2,
Sales [Rs.] 72,000 96,000 1,44,000 1,60,000 1,68,000 1,92,
Cash Sales
[Rs.] – 1/
24,000 32,000 48,000 53,333 56,000 64,

Illustration 5:

Ranjini Ltd. intends to approach her Bankers for temporary overdraft facility

for three months from 1st June to 31st August, 2007. Prepare a cash budget

for the above period.

Months Sales Purchases Wages
April 3,60,000 2,49,600 24,
May 3,84,000 2,88,000 28,
June 2,16,000 4,86,000 22,
July 3,48,000 4,92,000 20,
Aug 2,52,000 5,36,000 30,

(a) The entire sale is on credit basis out of which 50% is realised in the

succeeding month and the balance in the second month following sales.

(b) Creditors are paid in the month following purchase.

(c) Estimated cash as on 1st June is Rs,000.

Solution:

Cash Budget for the period ending 31st August

Particulars June July August
RECEIPTS
Opening balance 50,000 1,12,000 (94,000)
Collection from debtors 3,72,000 3,00,000 2,82,
A. Total 4,22,000 4,12,000 1,88,
PAYMENTS
Payments to creditors 2,88,000 4,86,000 4,92,
Wages 22,000 20,000 30,
B. Total 3,10,000 5,06,000 5,22,
Closing balance [A – B] 1,12,000 (94,000) (3,34,000)
Overdraft needed NIL 94,000 3,34,

14 Flexible Budget

In flexible budget, the data related to costs and expenses may progressively

be changed in any month in accordance with the actual output achieved.

Costs and estimates are made in advance based on the standards.

A maximum and a minimum level of operation are made. Comparison of

budgeted with actual is made. Budgeted activities are taken as the basis.

The principles of flexible budgeting concepts are applied to functional

budget and master budgets. Popularly, the flexible budget is adopted for

production cost budget. A detailed classification is adopted such as variable,

fixed, and semi-variables. By adopting micro-level classifications, it is

intended to pin-point the various effects on each class of overheads.

Illustration 7:

Draw a flexible budget for the level of operation at 70%, 80%, and 90%.

Variable overheads at 80% capacity

Indirect labour Rs,

Stores and spares Rs,

Semi-variable overheads at 80% capacity

Power (30% fixed) Rs,

Repair and maintenance at 60% fixed Rs,

Fixed overheads at 80%

Depreciation Rs,

Insurance Rs,

Salaries Rs,

The estimated direct labour hours is 1,24,

Solution:

Flexible Budget (Overheads)

For the period ..............................

Divide the grand total by the estimated labour hours.

14 Zero Based Budgeting (ZBB)

Zero based budgeting is “a method of budgeting where by all activities are

revaluated each time a budget is set. Discreet levels of each activity are

valued and a combination chosen to match funds available”.

Chartered Institute of Management Accountants (CIMA) London

ZBB is a planning process which requires each manager to justify the entire

budget requests in detail from the scratch. It shifts the burden of proof to

Particulars Level of operation
70% 80% 90%
VARIABLE OVERHEADS
Indirect labour 10,500 12,000 13,
Stores and Spares 3,500 4,000 4,
Total, say A 14,000 16,000 18,
SEMI VARIABLE OVERHEADS
Power - 30% Rs,000 [fixed] 6,000 6,000 6,
Power - 70% [variable] 12,250 14,000 15,
Repairs and Maintenance 60% Rs,
[fixed]
1,200 1,200 1,
Repairs and Maintenance 40% variable 700 800 900
Total, say B 20,150 22,000 23,
FIXED OVERHEADS
Depreciation 11,000 11,000 11,
Insurance 3,000 3,000 3,
Salaries 10,000 10,000 10,
Total, say C 24,000 24,000 24,
Grand Total A + B + C 58,150 62,000 65,
Estimated labour hours 1,08,500 1,24,000 1,39,
Standard overhead rate/hour 0 0 0.

Activity:

Check any company’s budget for the current year and prepare projected

budget.

14 Limitations of Budgeting

The following are the main limitations of budgeting:

  • The success of budgeting depends on the accuracy of the basic

estimates or forecasts.

  • Budgeting may impose rigidity.
  • Budgeting alone is not sufficient as a cost control technique. It needs to

be used along with other cost control techniques.

  • The installation of budgeting system in an organisation involves

considerable outlays.

14 Summary

Let us recapitulate the important concepts discussed in this unit:

  • Budgetary control is an important tool of cost control.
  • Budgets are not actual but estimated statements of cost and revenues.
  • Budgets are classified on the basis of functions like sales, production,

HR budget, cost budget, etc. Based on time, budgets are classified as

operational budgets, short-term budgets, medium-term budgets, and

long- term budgets.

  • Based on flexibility, budgets are classified as fixed budget and flexible

budget.

  • Zero Based Budgeting (ZBB) is a modern method of budgeting where

each rupee spent has to be fully justified.

14 Glossary

Budget: Financial and/or quantitative statement prepared and approved

prior to a definite period of time of the policy to be pursued during that

period for the purpose of attaining a given objective.

Budgeting: The process of preparing budgets.

Budgetary control: A technique of cost control that involves preparing,

implementing, and monitoring of budgets.

14 Terminal Questions

1. What are the merits of budgets?

2. Describe the essential features of budgetary control.

3. What are the steps in budgetary control?

4. What are the limitations of budgeting?

14 Answers

Self Assessment Questions

1. Estimates

2. Reality and workable preposition

3. Control

4. Planning

5. Safety signal

6. Budgets

7. Management

8. Fixed budget

9. Fixed, flexible, functional

10. Flexible

Terminal Questions

1. Budgetary control aims at the maximisation of profits. Refer to unit 14.

2. An effective budgeting system should have essential features to get the

best results. Refer to unit 14.

3. The procedure to be followed in the preparation and control of budget

may differ from business to business. Refer to unit 14.

4. The success of budgeting depends on the accuracy of the basic

estimates or forecasts. Refer to unit 14.

Was this document helpful?

Unit 14 - Budgetary Control

Course: Master's in Business Administration (MBA001)

211 Documents
Students shared 211 documents in this course

University: Manipal University Jaipur

Was this document helpful?
Financial and Management Accounting Unit 14
Manipal University Jaipur Page No.: 348
Unit 14 Budgetary Control
Structure:
14.1 Introduction
Objectives
14.2 Definitions
Budget
Budgeting
14.3 Budgetary Control
14.4 Objectives of Budgetary Control
14.5 Merits of Budgetary Control
14.6 Essential Features of Budgetary Control
14.7 Steps in Budgetary Control
14.8 Classification of Budgets
Functional classification of budgets
Based on time
Based on flexibility
14.9 Cast Budget
14.10 Flexible Budget
14.11 Zero Based Budgeting (ZBB)
14.12 Limitation of Budgetary Control
14.13 Summary
14.14 Glossary
14.15 Terminal Questions
14.16 Answers
14.17 Case Study
14.1 Introduction
In the previous unit we learnt about decisions involving alternative choices
and making or buying decisions. It is important to understand budgetary
control while considering buying decisions which we will be studying in this
unit.
In a competitive environment, profitability depends upon the extent to which
the management has followed proper planning, effective coordination, and
dynamic control. The procedure for preparing a plan with respect to the
future financial and physical requirements is called “budgeting”. It is a

Students also viewed

Related documents