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6. BUDGETING AND BUDGETARY CONTROL

6.0 Learning outcomes

 

6.1 Introduction

This chapter, in the main, deals with the mechanical aspects of budgeting. It examines theadvantages, problems and behavioural aspects of budgeting.A budget may be defined as : a financial or quantitative statement prepared in advance of a

specified accounting period.Budgetary control refers to: A control technique whereby actual results are compared

with budgets, and any differences (variances arising areidentified and appropriate control action ta!en..

"udgeting and budgetary control are therefore concerned with the preparation of budgets,

establishing areas of responsibility and the comparison of actual results with budget. The chapter,therefore, considers the control and planning functions of the management accountant ,whichensure that corporate ob#ectives are achieved.

Planning involves estimating costs, determining priorities and allocating resources, in order toachieve corporate goals."udgeting is the detailed decision$ma!ing which determines how the resources are to be used."oth are integrated as a unified system of control.

6.2 Advantages of budgeting and budgetary control

%lanning is compelled: formal budget procedures compel management at all levels to thin! about the future, and to ensure that the long term corporate plan is achieved.

%romote coordination and communication: information about proposed activities of the

firm is dispersed throughout the organi&ation to all levels of management, and departmentalactivities are brought in line with each other.

Areas of responsibility are clearly defined so that costs and revenue can be assigned to

those deemed responsible for them.

On completion of tis capter you sould be able to!

• 'efine the terms budgeting) and budgetary control).

• %repare a cash budget.

• *xplain the advantages and problems in budgeting.

• *valuate budgeting and budgetary control as a system of financial control

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A basis for performance evaluation is provided. +nce the budget has been prepared

then it provides a yardstic! against which to measure the performance of the firm both intotal and for each of its subcomponents.

*fficient and inefficient areas of the organi&ation are highlighted in the form of favourable

and adverse variances, thereby prompting remedial action where necessary.

otivation is increased as the budgetary control system encourages participation in thesetting of budgets, gives people more responsibility, and endeavours to align individualgoals with corporate goals.

Improve the allocation of resources and control spending.

*conomise on managerial time by using the management$by$exception principle.

6." Problems in budgeting

Apathy can exist among the wor! force- motivation becomes a difficult tas! if budgets

are seen as pressure devices imposed by management. 'epartmental conflict may arise over resource allocation, and because departments blame

each other if targets are not attained. It is difficult to reconcile personal and corporate goals, as the former continually change

and may be considerably lower than the latter. aste is found in budgets when managers adopt the view /we had better spend it or we

will lose it0. This problem, coupled with /empire building0 in order to enhance the prestige of a department, can be overcome by using the technique called  zero base

budgeting. Inflation and other uncertainties can cause problems in the system.

There is a problem in lin!ing responsibility with controllability- in other words, costs are

only controllable by the manager within a certain time span, and some costs are under the

influence of more than one person. 'ysfunctional decisions may arise when a manager aims to improve his short$run

 performance at the expense of the organi&ation as a whole. anagers may overestimate costs in order that they will not be blamed in the future

should they over spend.

6.# Budgets for planning and budgets for control

 1ormally, budgets for planning are based on what management believes will happen. 2owever, budgets for control may exclude some items which are not thought li!ely to happen and may be based, for motivational purposes, on standards which are li!ely to reflect actual levels of 

achievement. 3or example, in planning for the effects of a possible stri!e, the potential effectswill not usually be formali&ed into the monthly budget allowances of each department.The main points of similarity and difference between the two types include:

(a  Participation. This is encouraged for control purposes, but not for the planning process.

(b Comprehensiveness. %lanning must embrace the whole firm whereas budgetary controlmay embrace only part of it.

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(c Standards. %lanning budgets are based on standards of performance which management believe will exist. 4ontrol budgets have a motivational impact and therefore are based onstandards which are li!ely to influence managerial behaviour in a way which is beneficialto the firm.

(d  Flexibility. %lanning budgets must be flexible to changes in circumstances, and control

 budgets to changes in activity levels.(e  Feedback. This is essential for both types of budgets in order to ensure that standards arerelevant, budgets are feasible and performance is constantly monitored.

(f  Analysis of costs and revenue. "udgets for planning frequently base cost estimates on ananalysis of costs along product lines- budgets for control will analyse the cost intodepartments or cost centres irrespective of product lines dealt with.

6.$ %e&uirements of an effective budgetary control

The following prerequisites are necessary before a system of budgetary control can beimplemented:

(a  Budget centres. These are clearly defined areas of the organi&ation where responsibilitylies for the preparation of budgets- a budget centre may encompass several cost centres.

(b  Budget committee this is comprised of senior members of the organi&ation (departmentalheads and executives, and has the following purposes:(i gives support to the budgetary control system-(ii reviews budgets-(iii authori&es the master budget-(iv establishes long$term plans-(v reviews actual results compared with budgets.

(c  Budget officer controls the budget administration- the #ob involves liaising between the budget committee and the managers responsible for budget preparation, dealing with budgetary control problems, ensuring that deadlines are met, and educating people about budgetary control.

(d  Budget manual.  This charts the organi&ation, and details the budget procedures- itcontains account codes for items of expenditure and revenue, and timetables, and ta!esthe form of a documented ruleboo!, clearly defining the responsibilities of personsinvolved in the budgeting system.

6.6 'ypes of Budgets and Budget preparation

The first thing to determine when preparing budgets is the limiting or principal budget factor,that is, the factor that limits activity. It may be demand, material, finance or labour.

6.6.1 (ales budget

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The budget is expressed in quantitative and financial terms and will involve a realistic salesforecast based on the company)s pricing policy, general economic and political conditions,changes in population, competition, consumers) tastes and incomes, advertising and other sales promotion techniques, strength of sales force, after sales service, credit terms offered, etc.

6.6.2 Production budget

The production budget is expressed in quantitative terms only, and is geared to the sales budget.The production manager)s responsibilities involve plant utili&ation and wor!$in$progress budgets. If requirements exceed capacity, he may subcontract, plan for overtime or shift wor!, or hire or buy additional machinery. +n the hand, if requirements are less than capacity then anyspare capacity may be used for any other profitable purposes by management.

6.6." %a) materials and purcasing budget

The materials usage budget is in quantities, whereas the materials purchases budget is

quantitative and financial. 3actors influencing these budgets include production requirements, planning stoc! levels, storage space, and trends of material prices.

6.6.# Labour budget

This budget is quantitative and financial, and is influenced by production requirements, man$hours available, grades of labour required, wage rates and the need for incentives.

6.6.$ *as budget

The cash budget is a cash plan for a defined period of time. It summari&es monthly cash receipts

and payments, thus highlighting monthly surpluses and deficits.Its main purposes are:

a To maintain control over the firm)s cash requirements, particularly with respect to stoc! and debtor levels-

 b To enable a company to ta!e precautionary measures and arrange in advance for investment and loan facilities where budgeted surpluses and deficits arise-

c To show the feasibility of management)s plans in cash terms-d To illustrate the financial impact of changes in management policy, such as a change of 

the credit terms offered to customers.

6.6.6 +aster budgets

+ther budgets that may be prepared include budgets for administration, research anddevelopment, selling and distribution, capital expenditure and wor!ing capital (showing changesin debtors and creditors.The master budget is the total budget pac!age of a company. It is the end product of the budget process and encompasses all of the above budgets, once they have been authori&ed by the budgetcommittee. The development of the master budget is a sequential process, in which information

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from one budget is carried forward to another budget. 2owever, some elements such as thecapital budget are independent. 3igure 5.6 below shows a simplified sub$classification of themaster budget.

,igure 6.1 An (implified +aster Budget

 consists of

consists of consists of  

The following example serves to illustrate the actual preparation of all the budgets discussedabove and effort must be made to understand every one of them.

Practice -uestions

-/('IO 1

7. 8. 9imited)s budgeted unit sales for the product 7axo) are as follows for the first half of ;6;:

onths: 7an 3eb ar Apr ay 7un

<nits: =;; >;; >;; ?;; 6;;; 6;;

"udgeted unit costs are:

'irect aterial @'irect 9abour @BCariable +verheads (other than selling expenses @3ixed +verheads @

aster budget

3inancial budget+perating budget

4ash budget

"alance Dheet

4ash flow statement

"udgeted %E9

Dales budget

%roduction budget

aterials budget

9abour budget

Admin. budget, etc.

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Delling *xpenses @

 7axo is sold for @5 per unit.>;F of sales are on credit and, of that figure, it is expected that =;F will be paid for during themonth following sale and will be allowed GF discount. The reminder of credit customers are

expected to pay in full months after sale. "ad debts are anticipated to be F of total monthlysales. 4ash customers are allowed a discount of F.

%roduction each month is planned to meet the following month)s sales, whilst purchases of directmaterial meet the following month)s production. All suppliers are to be paid in the month after purchase, to qualify for a F discount.

The wor! force is paid for each month)s labour during the month of production, and a bonus of@6 per unit is paid on production over >;; units.

Cariable +verheads and Delling *xpenses are paid in the month after production.

Annual 3ixed +verhead is @ H;;, equal amounts being paid each month with the exception ofrent. ent is paid quarterly, commencing in 3ebruary each year.

Included in the 3ixed +verhead is @6 ;;; per annum for depreciation and @B ?; per annum for rent.

 1ew machinery costing @65 ;;; will be purchased in arch. A deposit of ;F is to be paid inarch and the remainder over 6 months in equal interest$free monthly installations beginningin ay.

At the end of 3ebruary there is a "an! +verdraft of @> ;;;.

%e&uired!

a 'raw up a 4ash "udget for the months of arch, April and ay.

 b *xplain why a business would prepare a 4ash 3orecast. 9ist the steps to be ta!en if the4ash 3orecast highlights future cash shortages.

-/('IO 2

The following forecasts have been extracted from the boo!s of 1andos *nterprises:

(ales Purcases Overeads ages

 

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 1ov ;6 B ;;; B ;;; B ;; 6 ;;;'ec ;6 H ;;; 5 ;;; ;; ? ;;;7an ;6B > ;;; 6B ;;; H;; ? H;;3eb ;6B ;;; 6H ;;; B;; 6 ;;; ar;6B > ;;; 6> ;;; >;; 6 ;;;

Additional information!

a All purchases are on credit basis and suppliers give month)s credit. b Deventy$five percent sales are for cash, (the balance being credit sales. 'ebtors are

expected to settle their accounts in the month following sale.c ages are paid in the month they are incurred.d The ban! balance on 6 7anuary ;6B had been estimated to be @ H;;.e +verheads include depreciation of @>;; per month and are paid one month in arrears.

%e&uired!

%repare for 1andos *nterprises the following:

a 4ash budget for the quarter ending 6 arch ;6B, and 314 mar5s

  b *xplain why 1andos *nterprises want to prepare a 4ash "udget 36 mar5s