Chapter 6 Budget and Budgetary Control

6.1 Meaning, Principles and Kinds of Budget

Meaning of Budget:- Budgeting has come to be accepted as an efficient
method of short-term planning and control. It is employed, no doubt, in large
business houses, but even the small businesses are using it at least in
some informal manner. Through the budgets, a business wants to know
clearly as to what it proposes to do during an accounting period or a part
thereof. The technique of budgeting is an important application of
Management Accounting.
Budget is a systematic plan for utilization of all types of resources, at its
command. It acts as a barometer of a business as it measures the success
from time to time, against the standard set for achievement.
According to Certified Institute of Management Accountants, Budget is
defined as “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 the objective”
A Budget is a plan which relates to a definite period of time and which is
expressed in quantitative terms
Budgetary Control: - Budgetary control is the process by which budgets are
prepared for the future period and are compared with the actual
performance for finding out variances, if any. The comparison of budgeted
figures with actual figures will help the management to find out variances
and take corrective actions without any delay.
Budgetary Control is the process of establishing budgets relating to various
activities and comparing the budgeted figures with the actual performance
for arriving at deviations, if any. Accordingly, there cannot be budgetary
control without budgets. Budgetary Control is a system which uses budgets
as a means of planning and controlling.
‘Budgetary Control is a planning in advance of the various functions of a
business so that the business as a whole is controlled’. (Wheldon)

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Chapter 6 Budget and Budgetary Control
 Principles of Budgetary Control
The following are fundamental principles of budgetary control:
1. Management Support: Top management’s support and cooperation is
essential for successful implementation of the budget. It should take interest
not only in setting the targets and finalizing the budgets but also constantly
monitoring the actual performance to find out the deviations if any and take
curative steps, motivate the personnel and reward the good performers.
2. Employees Involvement: The budget should be established on the
highest possible level of motivation. All levels of management should
participate in setting targets and preparing budgets. This will result in
defining realistic targets.
Participation of employees in the budgeting process will not only make
them carefully think about the likely development in the forthcoming period
and prepare the budget accordingly, but will also motivate them to strive
hard to achieve budget levels of efficiency and activity.
3. Statement of Organizational Goal: The organizational goal should be
quantified and clearly stated. These goals should be set within the
framework of corporate objectives and strategies. A well defined corporate
policy and strategy is a prerequisite for budgeting. 4. Organizational
Structure: There should be well-planned organizational structure with clearly
defined authority and responsibility of different levels of management. Role
and responsibilities of the Budget Committee and its President must be
made known to the people in the organization.
5. Flexibility: If the basic assumptions underlying the budget change during
the year, the budget should be restated. This will enable the management
to compare the actual level of operations with the expected performance at
that level.
6. Communication of Results: Proper communications systems should be
established for management reporting and information service so that
information pertaining to actual performance is presented to the concerned
manager timely and accurately so that remedial action is taken wherever
necessary.

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Chapter 6 Budget and Budgetary Control
 Kinds of Budgets
1) Production budget: Production budget is prepared on the basis of the
sales budget. But it also takes into account the stock levels required to be
maintained. It contains the manufacturing programmes of the enterprise. It
is helpful in anticipating the cost of production.
The nature of the production budget will differ from enterprise to enterprise.
For practical purposes, the overall budget should be divided into
production per article per month, looking into the estimate of the likely
quantity of demand. It is the responsibility of the production department to
adjust its production according to the sales forecast.
The production budget is often divided into several budgets:
(i) Material Budget- which fixes the quantity, quality and cost of raw
materials needed for uninterrupted production; (ii) Labour Budget-which
specifies the requirements of labour in terms of the number and type of
workers for various jobs; (iii) Plant and equipment Budget- which lays down
the needs of machines, equipment and tools including their repairs and
maintenance; and
(iv) Research and Development Budget-which specifies the estimated
cost on research and development for developing new products and for
improving existing ones.

2) Sales Budget: A sales budget is an estimate of expected total sales

revenue and selling expenses of the firm. It is known as a nerve centre or
backbone of the enterprise. It is the starting point on which other budgets
are also based. It is a forecasting of sales for the period both in quantity and
value. It shows what product will be sold, in what quantities, and at what
prices. The forecast not only relates to the total volume of sales but also its
break-up product wise and area wise. The responsibility for preparing the
sales budget lies with the sales manager who takes into account several
factors for making the sales budget.

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Some of these factors are: Past sales figures and trend, Estimates and
reports by salesmen, General economic conditions, Orders in hand,
Seasonal fluctuations, Competition etc.
3) Cash budget Cash budget contains estimated receipts and payments of
cash over the specified future period. It serves as an effective device for
control and coordination of activities that involves receipt and payment of
cash. It helps to detect possible shortage or excess of cash in business.
The financial budget also contains estimates of the firm’s profits and
expenditure i.e., the operating budget.
4) Flexible Budget: - A flexible budget, also called a variable budget, is a
financial plan of estimated revenues and expenses based on the current
actual amount of output. In other words, a flexible budget uses the
revenues and expenses produced in the current production as a baseline
and estimates how the revenues and expenses will change based on
changes in the output. This is why it’s often called a variable budget.
Management often uses flexible budgets before a period to predict both a
best case and worst case scenario for the upcoming accounting period.
This provides a "what if" look at the future of the company’s financial
performance.
Flexible budgets can also be used after an accounting period to evaluate
the successful areas and unsuccessful areas of the last period
performance. Management carefully compares the budgeted numbers with
the actual performance statistics to see where the company improved and
where the company needs more improvement.

5) Master budget: The Institute of Cost and Management Accountants,

England defines master budget as the summary budget incorporating all the
functional budgets, which is finally approved, adopted and applied. Thus,
master budget is prepared by consolidating departmental or functional
budgets. It is a summarized budget incorporating all functional budgets. It
projects a comprehensive picture of the proposed activities and anticipated
results during the budget period. It must be approved by the top
management of the enterprise. Though practices differ, a master budget
generally includes sales, production, costs-materials,

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labour, factory overhead, profit, appropriation of profit and major financial

ratios.

6.2 Objectives, Importance and Limitations of Budgetary Control

Objectives of Budgetary Control
(1)Compel for planning: As management is forced to look ahead,
responsible for setting of targets, anticipating of problems & giving purpose
& direction to the organization, this feature is the most
(2)Communication of ideas & plans: Communication of ideas & plans to
everyone are affected by budgetary control. In order to make sure that each
person is aware of what he is supposed to do, it is necessary that there is a
formal system.
(3) Coordinating the activities: The budgetary control coordinates the
activities of different departments or subunits of the organization. The
coordination concept implies, for example, on production requirements, the
purchasing department should base its budget & similarly, on sales
expectations, the production budget should in turn be based.
(4) Establishing a system of control: A system of control can be established
by having a plan against which progressive comparison can be made of
actual results.
(5) Motivating employees: Employees are motivated for improving their
performances by budgetary control.
Importance of Budgetary Control
1. Profit Maximization: - The resources are put to best possible use,
eliminating wastage. Proper control is exercised both on revenue and
capital expenditure. To achieve this, proper planning and coordination of
various functions is undertaken. So, the system helps in reducing losses
and increasing profits.
2. Coordination:- Coordination between the plans, policy and control is
established. The budgets of various departments have a bearing with each
other, as activities are interrelated. As the size of operations increases,
coordination amongst the different
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departments for achieving a common goal assumes more importance. This

is possible through a budgetary control system. As all the personnel in the
management team are involved and coordinated, there is bound to be
maximum profits. The Budget control system acts as a friend, philosopher
and guide to the management.
3. Communication: - A budget serves as a means of communicating
information throughout the organisation. A sales manager for a district
knows what is expected of his performance. Similarly, a production
manager knows the amount of material, labour and other expenses that can
be incurred by him to achieve the goal set to him. So, every department
knows the performance expectation and authority for achieving the same.
4. Tool for Measuring Performance: - Budgetary control system provides a
tool for measuring the performance of various departments. The
performance of each department is reported to the top management. The
system helps the management to set the goals. The current performance is
compared with the pre-planned performance to ascertain deviations so that
corrective measures are taken, well at the right time. It helps the
management to economize costs and maximize profits.
5. Economy: - Planning at each level brings efficiency and economy in the
working of the business enterprise. Resources are put to optimum use. All
this leads to elimination of wastage and achievement of overall efficiency.
6. Determining Weaknesses: - Actual performance is compared with the
planned performance, periodically, and deviations are found out. This
shows the variances highlighting the weaknesses, where concentration for
action is needed.
7. Consciousness: - Budgets are prepared in advance. So, every employee
knows what is expected of him and they are made aware of their
responsibility. So, they do their job uninterrupted for achieving, what is set
to him to do.
8. Timely Corrective Action: -The deviations are reported to the attention of
the top management as well as functional heads for

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suitable corrective action, in time. In the absence of budgetary control,

deviations would be known only at the end of the period. There is no time
and opportunity for necessary corrective action.
9. Motivation: -Success is measured by comparing the actual performance
with the planned performance. Suitable recognition and reward systems
can be introduced to motivate the employees, at all levels, provided the
budgets are prepared with adequate planning and foresight.
10. Management by Exception: - The management is required to exercise
action only when there are deviations. So long as the plans are achieved,
management need not be alerted. This system enables the introduction of
‘Management by Exception’ for effective delegation and control.
11. Overall Efficiency: Everyone in the management is associated with the
preparation of budget. There is involvement from the top functionaries and
each one knows how the target fixed can be achieved. Budgets once, finally
approved by the Budget Committee, represent the collective decision of the
organisation. With the implementation of budgetary control, there would be
overall alertness and improved working in all the departments, with better
coordination. Budgetary Control acts like an impersonal policeman to bring
all round efficiency in performance.
12. Optimum Utilization of Resources: -As there is effective control over
production, the resources of the organisation would be put to optimum
utilization.
Limitations of Budgetary Control
The following are certain important limitations.
1 Budgetary control does not replace management: It cannot replace the
management because in business all vital decisions have to be taken by
the management.
2 Too much reliance on budgets is harmful: Budgetary control is only a
technique and tool in the hands of the management. To execute the budget,
all the employees must take active part and co-operate with each other so
that the budgetary goal can be achieved. But the budgets should not be
taken as the only means

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through which the business should run. Though sometimes, through

budgetary control it is possible to have utmost success in business, it
should not be depended upon totally.
3 Less flexibility: A Budgetary control system should be more flexible and
should be changed according to the changing circumstances. The
alternative systems should be added, deleted, improved, replaced or
compared with the present system of budgetary control.
4 Budgets are based on estimated figures: Budgets are prepared in
anticipation of various factors. These factors are estimated by knowing the
past and forecasting for the future. Hence, forecasting is done which may or
may not happen in actual life. Thus, it is not an exact prediction of figures,
but based on estimates.
5 Costly systems: The installation of the system and its execution is an
expensive affair. This is because specialized persons have to be appointed
and extra costs have to be incurred for carrying out the operations. Hence,
small scale units cannot go in for a budgetary control system.
6 Budgetary control deals with quantitative data only: In the budgetary
control system, only the figures are considered and hence the quantitative
data i.e. the facts are not considered. E.g. If a worker is inefficient, we
should analyze the various reasons for his inefficiency as he may be
inefficient because of the conditions or environment where the workers are
not suitable to his health. Here budgets are of no use because budgets will
only measure his efficiency in terms of quantity produced and will not
consider other factors.

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