Budgetary Control System and Its Applications

7/27/2019 Budgetary Control System and Its Applications

1/38

COSTING.

1

Name of the project

BUDGETARY CONTROL SYSTEM AND ITS

APPLICATIONS,

SUBM ITTED BY,

DEEPA MOHINANI .SUNI L KANCHAN

ROLL NO. 33

UNDER THE GUIDANCE OF,

PROF. DINESH MOTWANI

I n Ful f i l lment Of the Requirement for the Award of the

Degree of

Master of Commerce

M .COM PART-1

J.W.SADHUBELLA GIRLS COLLEGE

ULHASNAGR-1

University Of M umbai

ACADEM IC YEAR: 2013-2014


2/38

COSTING.

2

DECLARATION

I,DEEPA MOHINANI the student of J.W.SADHUBELLA GIRLS

COLLEGE M. Com Part 1, hereby declare that I have completed

this projectBUDGETARYCONTROL SYSTEM AND ITS

APPLICATIONS,in the acedamic year 2013-1014. The

information submitted is true and original to the best of my

knowledge.

--------------------------

Students Signature


3/38

COSTING.

3

CERTIFICATE

I, PROF.DINESH MOTWANI hereby certify that DEEPA

MOHINANI of M.COM PART 1 Master of Commerce of

J.W.SADHUBELLA GIRLS COLLEGE Ulhasnagar 421001 has

completed the project entitledBUDGETARY CONTROL

SYSTEM AND ITS APPLICATIONS,in the academic year

2013-2014under my guidance.

The information submitted is true and original to the best of myknowledge.

PROF.DINESH MOTWANI

Signature


4/38

COSTING.

4

J.WATUMALL. SADHUBELLA GIRLS COLLEGE

UNIVERSITY OF MUMBAI

CERTIFICATE

This is to certify thatDEEPA MOHINANIMaster of commerce

(semester 1) for the academic year 2013-1014 has completed the

project on BUDGETARY CONTROL SYSTEM AND ITS

APPLICATIONS,under the guidance of PROF.DINESHMOTWANI.

Prof.DINESH MOTWANI Prof.Rajeshsingh

(Project Guide) (Co-ordinator)

Dr.M.M.Hosalkar

(Principal)

SIGNATURE

(EXTERNAL EXAMINER)


5/38

COSTING.

5

ACKNOWLEDGEMENT

I take this opportunity to present a sense of gratitude towards

my project guide PROF.DINESH MOTWANI for his excellent

guidance and letting me know about the topic provided

BUDGETARY CONTROL SYSTEM AND ITS

APPLICATIONS,and its need in todays world. His

understanding and personal guidance have provided a good basis

for my project.

I would also like to thank college authorities, our

principal and co-ordinator sub guide for authorizing my

project.


6/38

COSTING.

6

METHODOLOGY

This project is a mixture of theoretical as well as practical

knowledge.

Also it contains ideas and information imparted by the project

guide.

Secondary data:-

The secondary data required for the project was collected from

various kinds of websits the name of which are mentioned in

bibliography.


7/38

COSTING.

7

OBJECTIVES OF THE PROJECT

To study about the BUDGETARY CONTROL SYSTEM AND ITS

APPLICATION.

To increase my knowledge on the innovative ideas made by

BUDGETARY CONTROL SYSTEM.

To understand the present and future needs of BUDGETARY

CONTROL SYSTEM.

To study about the different situations and settlements.

To know about the solution providing techniques.


8/38

COSTING.

8

INDEX

1. Introduction.2. Meaning and concept of budget.3. Process of budgetary contr ol.4. Defination of budgetary control.5. Character istics of budgetary control.6. Objectives of budgetary control.7. Advantages of budgetary control.8. Other Advantages.9. L imi tations of budgetary control.10. Essenti als of budgetary control.11. Steps in preparing budgetary contr ol.12. Classif ication of budget.

a. Functional budget.

b. Master budget.

c. Fixed budget.

d. Flexible budget.

13. Classif ication of Functional budget.14. Budget Preparation.15. What is the framework in which budget decesions are making.16. Recognizing the useful ness of budget principles.17. I denti fying the responsibil i ty with in the budget system.18. Conclusion.19. Biblography.


9/38

COSTING.

9

Budgetary Control system and Its

Applications.

INTRODUCTION:

According to J.A. Scott, "it is the system of management control and

accounting in which all operations are forecasted and so far as

possible planned ahead, and the actual results compared with for casted and

planned ones."

BUDGET, BUDGETING AND BUDGETARY CONTROL

A budget is a statement of financial resources that have been allocated forthe conduct of particular activities for a three-, six- or 12-month time frame.

Comparing budgets with actual operational results is referred to as

budgetary control. Such budgetary control helps planning, coordination

between departments, decision-making, monitoring of operating results and

motivation of personnel to achieve business objectives. The principle is thesame for small businesses as well as large.

A budget is defined as the formal expression of plans, goals, and

objectives of management that covers all aspects of operations for a

designated time period. The budget is a tool providing targets and direction.

Budgets provide control over the immediate environment, help to master the

financial aspects of the job and department, and solve problems before they

occur. Budgets focus on the importance of evaluating alternative actions

before decisions actually are implemented.

A statement of es timated annual receipt and expenditure

whether, on capital or revenue account of central government is prepared by the


10/38

COSTING.

10

railway board. In other words it can be said that under (article 112) of

constitution of India, the president will call upon astatement from

Railways showing the estimated income and the out-lay amount that has

tocross the Consolidated Fund of India. These statements are known as

'Budget'.A budget is a detailed plan of operations of some specificfuture period. It is anes t imate prepared in advance o f theper iod to which i t ' appl ies . I t acts as a business barometer

as i t i s a complete programmer of act iv i t ies of the bu siness

for the periodcovered.According to Gordon and Shilling law budget may be

defined as "a predetermineddetailed plan of action developed and

distributed as-a guide to current operations and as a partial basisfor subsequent evaluation of performance.

"The Chartered Institute of Management Accountants, London, defines a

budget as "afinancial and/ or quantitative statement, prepared prior for adefined period of time, of the policy to pursued during that period for the

purpose of attaining a given objective."

MEANING & CONCEPT OF BUGDET :

.Budget refers to a plan relating to a definite future period of time expressed

in monetary and/or quantitative terms. In relation to business, a budget is aformal expression of the expected incomes and expenditures for a definite

future period.

Budgeting

The act and entire process of preparing budget is called budgeting. .

Budgetary control-

it is a system of controlling costs through preparation of budget. Budgeting

is the only part of the budgetary control. It is a system of controlling costs,

which includes the preparation of budgets coordinating its departments and

establishing responsibility, comparing actual performance with the budgeted

and the acting upon results to achieve maximum profitability.

Process of Budgetary control

Establishing budgets of each function, departments of the organization.


11/38

COSTING.

11

Comparison of actual performance with the budgeted figures in a continuous

basis.

Analysis of variance that is, comparision of actual performance with the

budgeted performance to know the results there of.

Taking suitable remedial where necessary.

Revisions of budget time to time in view of changes in conditions.

Definition of 'Budget'

An estimation of the revenue and expenses over a specified future period oftime. A budget can be made for a person, family, group of people, business,

government, country, multinational organization or just about anything else

that makes and spends money. A budget is a microeconomic concept that

shows the tradeoff made when one good is exchanged for another.

Definition of Budgetary Control:

The establishment of budgets relating the responsibilities of executives to the

requirements of a policy, and the continuous comparison of actual with

budgeted results, either to secure by individual action the objectives of that

policy or to provide a firm basis of its revision or in simple words, budgetary

control is implementing budgets and making managers responsible for

implementing it.

What are its characteristics?

A budget is a financial document or an action plan which is prepared and

used to project future income and expenses. It outlines an organisations

financial and operational goals. It can also include non- monetary

information with the monetary information. They need to be made and

approved in advance of the year in which they are to be used or implemented.

Following are the character istics of a good budget:

-It is expressed in quantitative or monetary terms.


12/38

COSTING.

12

- It is prepared for a fixed period of time It is prepared before the period in

which it commences.

-Practical to implement.

-It spells out the objects and the policies to be pursued in order to achieve the

objective of the organisation.

-Many people are involved in drawing up a budget.

-Flexible enough to allow changes in the changing environment.

-Prepared on the basis of established standards of performance.

-Analysis of cost and revenues.

-On the basis of budget report performance of the organisation is constantly

monitored.

F ive Character istics of an Effective Budget

Must be realistic

Should be flexible

Should be evaluated regularly

Must be a well planned and clearly communicated

Should have a simple format

Objective of Budgetary Control:

1) Planning:

A budget is a plan of the policy to be pursued during the defined period of

time to attain a given objective. The budgetary control will force

management of all levels to plan in time all the activities to be done during

the future periods.

2) Co-ordination:

The budgetary control coordinates the various activities of the firm and

secures C-operation of all concerned so that the common objective of thefirm may be successfully achieved.


13/38

COSTING.

13

3) Control:

Control consists of the action necessary to ensure that the performance of the

organization conforms to the plans and objectives. Budgetary control makescontrol possible by continuous comparisons of actual performance will that

of the budget so as to report the variations from the budget to the

management for corrective action.

4)Motivation

An agreed-to and reasonable budget serves to motivate managers to achieve

business objectives. The linkage of personnel rewards to the budget process

is an additional incentive for managers to accomplish departmental goals

within pertinent financial constraints.

5)Resource Al location

A budget supports the efficient allocation of scarce resources in that a budget

controls the volume of goods and services that will be produced. The budget

also is used to plan the cost of the output produced.

The essential ingredients of a budget are:

It is a plan for future action, in monetary terms.

Advantages of Budgetary Control

Budgeting compels managers to think aheadto anticipate and prepare for

changing conditions.

Budgeting coordinates the activities of various departments and functions

of the business.

It increases production efficiency, eliminates waste and controls the costs.

It pinpoints efficiency or lack of it.

Budgetary control aims at maximization of profits through careful planning

and control.

It provides a yardstick against which actual results can be compared. .It

ensures that working capital is available for the efficient operation of thebusiness.

Opposition from staff. Employees may not like to be evaluated and thus

oppose introduction of budgetary control system. As such, inefficient


14/38

COSTING.

14

managers may try to create difficulties in the way of introducing and

operating this system.

Expensive technique. The installation and operation of a budgetary control

system is a costly affair as it requires the employment of specialized staff and

involves other expenditure which small concerns may find difficult to incur.

However, it is essential that the cost of introducing and operating a

budgetary control system should not exceed the benefits derived there from.

Reduces Costs:In the present day competitive world budgetary control has a

significant role to play. Every businessman tries to reduce the cost of

production for increasing sales. He tries to have those combinations of

products where profitability is more.

I ntroduction of I ncenti ve Schemes: Budgetary control system also enables

the introduction of incentive schemes of remuneration. The comparison of

budgeted and actual performance will enable the use of such schemes.

Maximization of Profi t:The budgetary control aims at the maximization of

profits of the enterprise. To achieve this aim, a proper planning and co-

ordination of different functions is undertaken. There is proper control over

various capital and revenue expenditures. The resources are put to the best

possible.

Co-ordination:The working of the different departments and sectors is

properly co-ordinate. The budgets of different departments have a bearing on

one another. The co-ordination of various executives and subordinates is

necessary for achieving budgeted targets.

Specif ic Aims: The plans, policies and goals are decided by the top

management. All efforts are put together to reach the common goal of the

organization. Every department is given a target to be achieved. The efforts

are directed towards achieving come specific aims. If there is no definite aim

then the efforts will be wasted in pursuing different aims.

Tool for M easur ing Performance: By providing targets to various

departments, budgetary control provides a tool for measuring managerial

performance. The budgeted targets are compared to actual results and

deviations are determined. The performance of each department is reported

to the top management. This system enables the introduction of management

by exception.

Economy:The planning of expenditure will be systematic and there will be

economy in spending. The finances will be put to optimum use. The benefits


15/38

COSTING.

15

derived for the concern will ultimately extend to industry and then to national

economy. The national resources will be used economically and wastage will

be eliminated.

Determining Weakness:The deviations in budgeted and actual performance

will enable the determination of weak spots. Efforts are concentrated on

those aspects where performance is less than the stipulated.

Corrective Action:The management will be able to take corrective measures

whenever there is a discrepancy in performance. The deviations will be

regularly reported so that necessary action is taken at the earliest. In the

absence of a budgetary control system the deviation can determined only at

the end of the financial period.

Consciousness: It creates budget consciousness among the employees. By

fixing targets for the employees, they are made conscious of their

responsibility. Everybody knows what he is expected to do and he continues

with his work uninterrupted.

OTHERS:

Like other control methods, budgets have the potential to help organizations

and their members reach their goals. Budget control offers several

advantages to managers. Some of these are:

The major strength of budgeting is that it coordinates activities across

departments.

Budgets translate strategic plansinto action. They specify the resources,

revenues, and activities required to carry out the strategic plan for the

coming year.

Budgets provide an excellent record of organizational activities.

Budgets improve communication with employees.

Budgets improve resources allocation, because all requests are clarified and

justified.

Budgets provide a tool for corrective action through reallocations.

However, budgets control can also create problems.

These dysfunctional aspects of budgets systems may interfere with the

attainment of the organization's goals. One generally accepted guideline for

effective budgeting is to establish goals that are difficult but attainable.


16/38

COSTING.

16

Therefore, skilled managers who understand budgets and how to use them

have a powerful control tool with which to attain departmental and

organizational goals.

Limitations of Budgetary Control

Budget plan is based on estimates. Budgets are based on forecasts and

forecasting cannot be an exact science. Absolute accuracy, therefore, is not

possible in forecasting and budgeting.

The strength or weakness of the budgetary control system depends to a large

extent, on the accuracy with which estimates are made. Thus, while using the

system, the fact that budget is based on estimates must be kept in view.

Danger of rigidity. A budget program must be dynamic and continuously deal

with the changing business conditions,

Budgets will lose much of their usefulness if they acquire rigidity and are not

revised with the changing circumstances.

Budget plan is based on estimates. Budgets are based on forecasts and

forecasting cannot be an exact science. Absolute accuracy, therefore, is not

possible in forecasting and budgeting. The strength or weakness of the

budgetary control system depends to a large extent, on the accuracy with

which estimates are made. Thus, while using the system, the fact that budget

is based on estimates must be kept in view.

Danger of r igidity. A budget program must be dynamic and continuously

deal with the changing business conditions, Budgets will lose much of their

usefulness if they acquire rigidity and are not revised with the changing

circumstances.

Opposition from staff . Employees may not like to be evaluated and thus

oppose introduction of budgetary control system. As such, inefficient


17/38

COSTING.

17

managers may try to create difficulties in the way of introducing and

operating this system.

Expensive techn ique. The installation and operation of a budgetary control

system is a costly affair as it requires the employment of specialized staff andinvolves other expenditure which small concerns may find difficult to incur.

However, it is essential that the cost of introducing and operating a

budgetary control system should not exceed the benefits derived there from.

OTHERS:

The major problem occurs when budgets are applied mechanically and

rigidly.

Budgets can demotivate employees because of lack of participation. If thebudgets are arbitrarily imposed top down, employees will not understand the

reason for budgeted expenditures, and will not be committed to them.

Budgets can cause perceptions of unfairness.

Budgets can create competition for resources and politics.

A rigid budget structure reduces initiative and innovation at lower levels,

making it impossible to obtain money for new ideas.

Budgeting involves cost and time to prepare. The benefits of budgeting must

outweigh the drawbacks. A budget can be advantageous because it:

Communicates to managers what is expected of them. Any problems in

communication and working relationships are identified. Resources and

requirements are identified.

For example:

The production department will manufacture based on the sales

department's anticipated sales volume. The purchasing department will buy

raw materials based on the production department's expected production

volume. The personnel department will hire or lay off workers based on

anticipated production levels. Executives are forced to consider relationships

among individual operations and the company as a whole.

Provides a motivational device setting a standard for employees to achieve.

Management can make distasteful decisions and blame it on the budget..

Whilst budgets are widely used to in business, you should appreciate that

they have some important limitations. In particular:


18/38

COSTING.

18

Budgets are only as good as the data being used to create them. Inaccurate

or unreasonable assumptions can quickly make a budget unrealistic

Budgeting is a time consuming process in large businesses, whole

departments are sometimes dedicated to budget setting and control

Budgets can result in short term decisions to keep within the budget rather

than the right long term decision which exceeds the budget

Managers can become too preoccupied with setting and reviewing budgets

and forgetting to focus on the real issues of winning customers

Budgets can also create some behavioural challenges in a business

Budgeting has behavioural implications for the motivation employees

Budgets are de-motivating if they are imposed rather than negotiated

Setting unrealistic targets adds to de-motivation

Budgets contribute to departmental rivalry - battles over budget allocation

Spending up to budget: it can result in a use it or lose it mentality - spend

up to the budget to preserve it for next year

A name, blame and shame culture can develop - but managers should be

answerable only for variations that were under their control

Essentials of Budgetary control:1) Establishment of budgets for each function and section of the

organization.

2) Continuous comparison of the actual performance with that of the budget

so as to know the variations from budget and placing the responsibility ofexecutives for failure to achieve the desires results as given in the budget.

3) Taking suitable remedial action to achieve the desires objective if there isa variation of the actual of the actual performance from the budgeted

performance.

4) Revision of budgets in the light of changed circumstance.

There are certain steps, which are necessary for the successful

implementation of budgetary control system. The proper organization is

essential for preparation, maintenance and administration of budgets

There are certain steps, which are necessary for the successful

implementation of budgetary control system.


19/38

COSTING.

19

1stis organization for budgetary control. The proper organization is

essential for preparation, maintenance and administration of budgets. A

Budgetary Committee is formed, which comprises of the departmental heads

of various departments. All the functional heads re entrusted with

responsibility of ensuring proper implementation of their respective

departmental budgets. The chief executive of the enterprise is the over all in

charge.

2thplace in budgetary control system is of Budget center. This part of the

organization may be a department, section of a department or another part of

the department. Actually budget is being prepared only for this part of the e

organization. The establishment of budget centers is required for covering all

parts of the organization.3rdpart of budgetary control system is Budget Manual. It is a document,

which spells out the duties and also responsibilities of various executives

concerned with the budget. It specifies relation amongst various

functionaries.

4thpart of budgetary control system is Budget Officer who is appointed by

the chief executive. Budget Officer is empowered to scrutinize the budget

prepared by different departments and to make change in them, if situations

so demand. The actual performance of different departments iscommunicated to Budget Officer. He determines the deviations in the budget

and the actual performance and takes necessary steps to rectify the

deficiencies, if any.

5thpart of budgetary control system is Budget Committee. In small-scale

concerns the accountant is made responsible for the preparation and

implementation of the budget. In large-scale concerns a committee known as

Budget Committee is formed. The members of this committee are the heads of

all departments of an organization. It is responsible for preparation andexecution of budget.

1) Establishment of budgets for each function and section of the organization.

2) Continuous comparison of the actual performance with that of the budget

so as to know the variations from budget and placing the responsibility of

executives for failure to achieve the desires results as given in the budget.


20/38

COSTING.

20

3) Taking suitable remedial action to achieve the desires objective if there is

a variation of the actual of the actual performance from the budgeted

performance.

4) Revision of budgets in the light of changed circumstances.Budget Period is another important part of budgetary control system. It is the

length of time for which budget is prepared. This period depends upon the

nature of budget i.e. sales budget, production budget, raw material purchase

budget and the economic situation of the country, the length of trade cycle

and the nature of demand for the product. The budget is prepared for all

functional areas.

7thpart of budgetary control system is Determination of Key Factor. Budget

formation is an inter-departmental and inter-related activity. A propercoordination is necessary amongst different departments for the success of

budgetary control system. A factor, which influences all other budgets, is

known as principal factor or key factor.

Steps in Preparing Budgetary Control:

I n principle, the basic steps in a standard budget preparation

system compri se the following:

The first stepin budget preparation should be the determination of a

macroeconomic framework for the budget year (and ideally at least the next

two years). The macroeconomic projections, prepared by a macroeconomic

unit in the ministry of finance or elsewhere, should be agreed with theminister of finance. This allows the budget department within the ministry of

finance to determine the global level of expenditure that can be afforded

without adverse macroeconomic implications, given expected revenues and

the level of deficit that can be safely financed. In a few countries, there are

fiscal rules in place that may limit total spending or recurrent spending (e.g.,

the "golden rule").16
http://www.imf.org/external/pubs/ft/expend/guide3.htm#16http://www.imf.org/external/pubs/ft/expend/guide3.htm#16http://www.imf.org/external/pubs/ft/expend/guide3.htm#16http://www.imf.org/external/pubs/ft/expend/guide3.htm#16


21/38

COSTING.

21

The second stepshould be the allocation of this global total among line

ministries, leaving room for reserves (a separate planning and a contingency

reserve as explained below) to be managed by the ministry of finance.

The thi rd stepshould be for the budget department to prepare a budgetcircular to give instructions to line ministries, with the indicative aggregate

spending ceiling for each ministry, on how to prepare their estimates in a

way that will be consistent with macro objectives. This circular will include

information on the economic assumptions to be adopted on wage levels, the

exchange rate and price levels (and preferably differentiated price levels for

different economic categories of goods and services).

Step four is the submission of bids by line ministries to the budget

department. Once received there needs to be an effective "challenge"

capacity within the budget department to test the costing of existing and any

new policy proposals.

The fifth stepcomprises the negotiations, usually at official and then

bilateral or collective ministerial level, leading finally to agreement.

Finally, step sixis Cabinet endorsement of the proposals for inclusion in the

budget that will go to parliament.

1)Organisation for budgeting

The setting up of a definite plan of organisation is the first step to be taken

prior to beginning the real work of installing budgetary control. The

responsibility of eachexecutive must be clearly defined. There should be no

uncertainty regarding the point where the jurisdiction of one executive ends

and that of another begins.

2)Budget manual

The budget manual is a written document or booklet which specifiestheobjectives of the budgeting organisation and procedures. The chartered

institute of management accountants, London defines it as a document

which sets out, theresponsibilities of the persons engaged in, the routine of,

and the forms andrecords required for, budgetary control. Following are

some important matterscovered in a budget manual:1)A statement

regarding the objectives of the organisation and how they can beachieved through budgetary control.2)A statement regarding the

functions and responsibil it ies of each executive by designation both

regarding preparation and execution of budgets.3)Procedures to be


22/38

COSTING.

22

fo llowed for obtaining the necessary approval of budgets.The

authority of granting approval should be stated in explicit terms.Whether

one, two or more signatures are to be required on each documentshould also

be clearly stated.4) Ti me -t ab le s fo r al l st ag es of

bu dg et in g. 5)Reports, statements, forms and other records to bemaintained.6)The accounts classification to be employed. It isnecessary that theframework within which the costs, revenues and other

financial accountsare classified must be identical both in the accounts and

the budgetdepartments.There are many advantages attached to the use of

budget manual. It is a formalrecord defining the functions and

responsibilities of each executive. Themethods and procedures of budgetarycontrol are standardised. There issynchronisation. There is synchronisation

of the efforts of all which results inmaximisation of the profits of the

organisation.

3)Responsibil i ty for budgeting

1) Budget controller- the chief executive is ultimately responsible for

the budget programme but it will be better if the large part of thesupervisoryresponsibility is delegated as budget controller or director. The

budgetcontroller or director should have knowledge of the technical side of

the business and should report directly to the president.2) Budget committee-

the budget controller will be assisted

in his work by the budget committee. The budget committee will consist ofheads of the variousdepartments such as production, sales, finance etc. with

budget controller asits chairman. It will be the duty of the department will

have his own sub-committee with executives working under him as itsmember.

While the principles should be broadly familiar in most ministries of finance

(and would even be considered out of date in those industrial countries with

the most advanced budgeting systems), actual practices may fall a long way

short.

For example:

In too many countries the budget department does not prepare a macro

framework, nor even a first outline of the budget, let alone indicative ceilings

by line ministry, before sending out the budget circular. In such cases, the

circular is an administrative mechanism that initiates the budget-making

process, usually providing a timetable for budget submissions--that is,

estimates of financial requirements by line item and by line ministry or


23/38

COSTING.

23

spending agency--but not giving them much guidance in the preparation of

their estimates or overall spending limits. Thus, when preparing their budget

requests, the ministries often merely add percentages, guided by an inflation

projection in the circular, to their previous year's budget. With this "bottom-

up approach," line ministries are able to overstate their needs, exerting

upward pressure on overall spending.

Early in the preparation stage, that is before the budget circular is issued,

those advising on the preparation of the budget should ask:

Is the budget based on an aggregate level of general or central government

expenditure, in cash terms, that is consistent with the macro framework, and

any fiscal rules in place?

Does the budget circular to the line ministries provide adequate guidance on

preparing budget estimates? Does it include a guideline or limit for each line

ministry on this total spending?

Are there suitable reserves? Ideally, within the aggregate total there should

be a planning reserve (not allocated in guidelines given to each line

ministry), so the ministry of finance can assign extra resources later during

budget negotiations for the most urgent priorities, without breaching the

macroeconomic constraint. Moreover, after all final line ministry allocations

have been made, there should still be a contingency reserve within the

aggregate that will be held and administered by the ministry of finance to

meet genuine contingency spending during the budget year.

Classification of budgets

Classification on the basis of Function and Scope

(i)Functional Budget, (i i ) Master Budget

Classifi cation on the basis of fl exibil ity

(i)F ixed Budget, (i i) F lexible Budget

Functional Budget

It is the one, which relates to particular functions of the business or

organization. The types of functional budgets are


24/38

COSTING.

24

1. Sales budget

2. Production budget

3. Raw materials budget

4. Labour budget etc

5. Cash budget

6. Capital expenditure budget

7. Purchase budget.

8. Master Budget

A functional budget is the budget that is achievable and is related to a

specific unit or process or function or department of the organisation. I

t is a group of related activities aimed at accomplishing a major service or

program for which a unit of government is responsible.A functional budget is prepare for a process of function.

By functional budgets, we mean budgets that relate to an area of an

organisation that produces, or does, something. This is not necessarily to say

that we are talking about manufacturing alone. We can have functional

budgets in manufacturing, in commerce, in government. We can have

functional budgeting in non profit making organisations too.

The key principles of functional budget preparation are

Understand the function, process or system you are budgeting Find all of the data you need

Separate the values from the volumes..

. Check for interrelationships, understand and use them.

Check your arithmetic once you have prepared each budget

MASTER BUDGET:. Master or final budget is a summary budget which incorporates all

functional budgets in a capsule form. It sets out the plan of operations for all

departments in considerable detail for the budget period.

. Master budget require the approval of the Budget Committee before it is put

into operation. It may happen, sometimes, that a number of master budget

have to be prepared before the final one is agreed upon. The budget

generally contains details regarding sales (net), production costs, cash


25/38

COSTING.

25

position, and key account balances (e.g. debtors, fixed assets, bills payable,

etc). It also shows the gross and net profits, and the important accounting

ratios .

The master budgetis a summary of company's plans that sets specific targetsfor sales, production, distribution and financing activities. It generally

culminates in a cash budget, a budgeted income statement, and a budgeted

balance sheet. In short, this budget represents a comprehensive expression of

management's plans for future and how these plans are to be accomplished.

It usually consists of a number of separate but interdependent budgets. One

budget may be necessary before the other can be initiated. More one budget

estimate effects other budget estimates because the figures of one budget is

usually used in the preparation of other budget. This is the reason why these

budgets are called interdependent budgets.

Advantages and Disadvantages of a Master

Budget:

Some advantages of a master budgetare that it can give an idea of where acompany wants to go and what it has to do in order to get there. It will also

allow the company to realistically project future cash flows which in turn

would help in getting certain types of financing.

Some disadvantages of a master budget include the time involved in

producing such a budget. This is primarily the reason a smaller company

may not make a master budget if the company has a very small managerial

staff.

Fixed and Flexible Budgets

.Fixed Budget: A fixed budget is designed to remain unchanged

irrespective of the level of activity. This budget is prepared on the basis of a

standard of fixed level of activity. Since the budget does not change with the

change of level of activity, it becomes an unrealistic yardstick in case the

level of activity (volume of production or sales) actually attained does not

conform to the one assumed for budgeting purposes.
http://www.accounting4management.com/master_budget_definition.htmhttp://www.accounting4management.com/cash_budget_definition.htmhttp://www.accounting4management.com/budgeted_income_statement.htmhttp://www.accounting4management.com/budgeted_balance_sheet.htmhttp://www.accounting4management.com/budgeted_balance_sheet.htmhttp://www.accounting4management.com/master_budget_definition.htmhttp://www.accounting4management.com/master_budget_definition.htmhttp://www.accounting4management.com/master_budget_definition.htmhttp://www.accounting4management.com/master_budget_definition.htmhttp://www.accounting4management.com/master_budget_definition.htmhttp://www.accounting4management.com/master_budget_definition.htmhttp://www.accounting4management.com/budgeted_balance_sheet.htmhttp://www.accounting4management.com/budgeted_balance_sheet.htmhttp://www.accounting4management.com/budgeted_income_statement.htmhttp://www.accounting4management.com/cash_budget_definition.htmhttp://www.accounting4management.com/master_budget_definition.htm


26/38

COSTING.

26

. The management will not be in a position to assess the performance of

different heads on the basis of budgets prepared by them, because they can

serve as yardsticks only when the actual level of activity corresponds to the

budgeted level of activity. On account of the limitation of fixed budget and its

inability to provide for automatic adjustments when the volume changes,

firms whose sales and production cannot be accurately estimated have given

up the practice of fixed budget. Any budget in any functional area of an

operation can be established as a fixed budget or a flexible budget. A fixed

budget is established for a specific level of activity and is not adjusted to the

actual level of activity attained at the time of comparison between the

budgeted and actual results. Naturally, a fixed budget is established only for

a short period of time where the budgeted level of activity is expected to be

attained to the maximum possible extent. It is more suitable for fixed

expenses, i.e. the expenses which have no relation with the level of activity.

This budget does not indicate that it cannot be changed at all. It can be

revised if the actual level of activity is likely to differ widely from the

budgeted level of activity. A fixed budget cannot be used as an effective tool

of cost control while computing the variations between the budgeted result

and the actual result. The variance cannot be explained properly. Also, it is

not possible to say whether the variance is due to the changes in the level of

activity or due to the efficiency or inefficiency of the executive responsible for

the execution of the budget.

Flexible Budget:It is designed to change in accordance with the level of

activity attained. Thus, when a budget is prepared in such a manner that the

budgeted cost for any level of activity is variable, it is termed as flexible

budget. Such a budget is prepared after considering the fixed and variable

elements of cost and the changes that may be expected for each item at

various levels of operations A flexible budget is designed to change with thefluctuations in the level of activity and provides a basis of comparison for any

level of activity actually attained. A flexible budget is more elastic and

practical. It can be properly used as an effective tool for the evaluation of

performance and cost control. It explains the variations between the

budgeted and actual results. It also states the variations which are due to

changes in the level of activity (which is beyond the control of operating

executive) and which are due to the operational efficiency or inefficiency (for

which the operating executive is responsible.)


27/38

COSTING.

27

For the purpose of establishment of flexible budgets, it is necessary to

classify the costs as fixed costs, variable costs and semi-variable costs. The

fixed costs remain same at all levels of activity whereas the variable costs

change directly in proportion to the level of activity. As far as the semi-

variable costs are concerned, each item of cost is examined and classified

into its fixed and variable elements and a trend is established regarding the

nature and behavior of each item of cost.

ZERO BASE BUDGETING

.It is an alternative of traditional budgeting. The traditional budgeting is

based on incremental and previous year figure use to take into consideration.

But in Zero Base Budgeting figures are developed with zero as the basewhich means a budget will be prepared as if it is being prepared as a new for

the first time. It is a method of budgeting where all activities are revalued

each time a budget is set.Zero-based budgeting is an approach to planning

and decision-making which reverses the working process of traditional

budgeting. In traditional incremental budgeting (Historic Budgeting),

departmental managers justify only variances versus past years, based on the

assumption that the "baseline" is automatically approved. By contrast, in

zero-based budgeting, every line item of the budget must be approved, ratherthan only changes.During the review process, no reference is made to the

previous level of expenditure. Zero-based budgeting requires the budget

request be re-evaluated thoroughly, starting from the zero-base. This process

is independent of whether the total budget or specific line items are

increasing or decreasing.

The term "zero-based budgeting" is sometimes used in personal finance to

describe "zero-sum budgeting", the practice of budgeting every unit of

income received, and then adjusting some part of the budget downward for

every other part that needs to be adjusted upward.

Zero based budgeting also refers to the identification of a task or tasks and

then funding resources to complete the task independent of current

resourcing.

Performance Budget:
http://en.wikipedia.org/wiki/Budgetinghttp://en.wikipedia.org/wiki/Budgetinghttp://en.wikipedia.org/wiki/Budgeting


28/38

COSTING.

28

This whole framework points us to a newer way of budgeting, the

performance-based budgeting.

As explained by Carter (as quoted in) Performance budgets use statements

of missions, goals and objectives to explain why the money is being spent. Itis a way to allocate resources to achieve specific objectives based on

program goals and measured results. The key to understanding

performance-based budgeting lies beneath the word result. In this method,

the entire planning and budgeting framework is result oriented. There are

objectives and activities to achieve these objectives and these form the

foundation of the overall evaluation.

According to the more comprehensive definition of Segal and Summers,

performance budgeting comprises three elements:

The result (final outcome)

The strategy (different ways to achieve the final outcome)

Activity/outputs (what is actually done to achieve the final outcome)

Segal and Summers point out that within this framework, a connection exists

between the rationales for specific activities and the end results and the

result is not excluded, while individual activities or outputs are. With this

information, it is possible to understand which activities are cost-effective in

terms of achieving the desired result.

As can be seen from some of the definitions used here, Performance-Based

Budgeting is a way to allocate resources for achieving certain objectives,

Harrison elaborates: PBB sets a goal, or a set of goals, to which monies are

connected (i.e. allocated). From these goals, specific objectives are

delineated and funds are then subdivided among them.

Budget supports a manager's efforts to monitor operations, identify

variances and enact corrective action if necessary. It allows an evaluation of

activities in terms of contribution to organizational objectives.

Sales Budget

Sales budget is a functional budget. The product wise as well as regional

breakup of sales estimates are incorporated in the sales budget. The sales


29/38

COSTING.

29

budgetbegins with the previous year actual and incorporates the likely

changes

Production Budget

The production budget is prepared based on the sales estimate incorporated

inthe sales budget. The adjustments with respect to the opening and closing

stockpositions that are policy decisions of the business are then made to

prepare theproduction budget.

Pur chase Budget

The purchase budget is another functional budget that estimates thepurchaserequirement of materials utilized in the production process. Thepurchase

budget is based on the production budget and the standard

materialconsumption requirement for the production estimates.

Management Science-II Prof. R.Madumathi

Expendi tur e Budgets

Expenditure budgets may be drafted as fixed / flexible budgets. A fixed budget

isone which is prepared keeping in mind one level of activity. It is defined asonewhich is designed to remain unchanged irrespective of the level of

activityattained.In contrast, flexible budget is one which is designed tochange in relation to the level of activity attained. Flexible budgets are

prepared where the natureof business is such that it is difficult to predict the

demand/sale of goods.

Cash Budget

A cash budget consolidates all the cash inflows and outflows for the

business.The cash budget is also a functional budget. The cash budget helpsthe businessto plan the project purchases as well as to provide for the loan

requirements. Thecash budgets also help in defining the repayment plans for

short and long termloans of the business.

Management Science-II Prof. R.MadumathiIndian Institute of Technology Madras

The cash budget is based upon the business policy of holding a certain

amountas cash. This is the desired opening cash balance for the business.

Accordingly,the cash budget forecasts the loan requirements or short term

investments thatare to be made with excess cash at any specific time.


30/38

COSTING.

30

Budget Preparation

A full understanding of the budget planning and preparation system is

essential, not just to derive expenditure projections but to be able to advise

policymakers on the feasibility and desirability of specific budget proposals,from a macroeconomic or microeconomic perspective. It is much easier to

control government expenditures at the "upstream" point of budget

preparation than later during the execution of the budget.

Thus, fiscal economists and general budget advisors need to know:

what is the framework in which budget decisions are made;

who is responsible for planning and preparing the budget;

what are the basic steps;

what are the typical weaknesses in procedures and how can these be

overcome; and

how can changes in budget plans be programmed and targeted?

Answers to these questions are set out in the subsections below.

Budget planning and preparation are (or should be) at the heart of goodpublic expenditure management. To be fully effective, public expenditure

management systems require four forms of fiscal and financial discipline:

1. control of aggregate expenditure to ensure affordability; that is, consistencywith the macroeconomic constraints;

2. effective means for achieving a resource allocation that reflects expenditurepolicy priorities;

3. efficient delivery of public services (productive efficiency); and

4. minimization of the financial costs of budgetary management (i.e., efficientbudget execution and cash and debt management practices).

Budget preparation is the principal mechanism for achieving items (1) and

(2); item (3) typically features as an element of budget preparation only in

industrial countries, while item (4) is essentially an issue in budget execution

and cash management (see Sections 4 and5). Moreover, no system of budget

execution or cash planning (the subjects of Sections 4 and 5) can do more

than mitigate the problems caused by poor quality or unrealistic budget

preparation.
http://www.imf.org/external/pubs/ft/expend/guide4.htmhttp://www.imf.org/external/pubs/ft/expend/guide5.htmhttp://www.imf.org/external/pubs/ft/expend/guide5.htmhttp://www.imf.org/external/pubs/ft/expend/guide4.htm


31/38

COSTING.

31

What is the framework in which budget decisions

are made?

Budget preparation is a process with designated organizations and

individuals having defined responsibilities that must be carried out within agiven This process is normally established and controlled by a legal and

regulatory framework. While generally sharing broadly common procedures,

budget preparation (and execution) systems do exhibit differences depending

on their historic origin. Given the common heritage of many countries, it is

possible to identify four main patterns--francophone, Latin American,

(British) Commonwealth, and transition economies.

To understand the budget preparation process in a given country, it is

important to: assess the basic soundness by judging the budget preparation system against

certain internationally accepted standards or "budget principles";

know where to find the rules governing the budget preparation process; and

from those rules, identify who has the responsibility for what elements of the

budget preparation process.

Recognizing the usefulness of budget principles

Based on the objective macroeconomic assessment of available revenues and

financing, ideally, the expenditure budget should aim to be comprehensive,

transparent, realistic, policy-oriented, and allow for clear accountability in

budget execution. These concepts form a standard by which the soundness of

budget systems can be judged (seeBox 1).
http://www.imf.org/external/pubs/ft/expend/guide3.htm#box1http://www.imf.org/external/pubs/ft/expend/guide3.htm#box1http://www.imf.org/external/pubs/ft/expend/guide3.htm#box1http://www.imf.org/external/pubs/ft/expend/guide3.htm#box1


32/38

COSTING.

32

Box 1. Assessing the Soundness of the Budget

The soundness of budget systems can be judged by the following:

Comprehensiveness

Is the coverage of government operations complete?

Are estimates gross or does netting take place?

Transparency

How useful is the budget classification? Are there separate economicand functional classifications that meet international standards?

Is it easy to connect policies and expenditures through a programstructure?

Realism

Is the budget based on a realistic macroeconomic framework?

Are estimates based on reasonable revenue projections? How are these

made, and by whom?

Are the financing provisions realistic?

Is there a realistic costing of policies and programs and hence

expenditures (e.g., assumptions about inflation, exchange rates, etc.)

How are future cost implications taken into account?

Is there a clear separation between present and new policies?

How far are spending priorities determined and agreed under the budget

process?

In most Organization for Economic Cooperation and Development (OECD)

countries, comprehensiveness and transparency are achieved by designing abudget system with three key characteristics.

Annuality. A budget is prepared every year, covering only one year; voted

every year; and executed over one year. While maintaining the core concept

of annual authorization, this principle has been modified at the preparation

stage, such that most OECD countries now develop the annual budget withina multiyear perspective, through the preparation of medium-term revenue


33/38

COSTING.

33

and expenditure frameworks. A very few are moving toward determining

budget appropriations for more than one year at a time.

Unity. Revenue and expenditure (as well as borrowing constraints) should beconsidered together to determine annual budget targets. The budget should

cover all government agencies and other institutions undertaking government

operations, so that the budget presents a consolidated picture of these

operations and is voted on, as a whole, in the parliament.

Universality. All resources should be directed to a common pool or fund, to

be allocated and used for expenditures according to the current priorities of

the government. In general, earmarking of resources for specific purposes is

thus to be discouraged; but the case of extrabudgetary funds is considered in

more detail below.

These three characteristics are essential to ensure that, in budget

preparation, all policy proposals for undertaking government expenditurewill be forced to compete for resources, and that priorities will be established

across the whole range of government operations.

They are usually considered a prerequisite to meeting the first two of the four

main goals of effective public expenditure management noted at the

beginning of this Section: exercising the macroeconomic constraint of

affordability on the total, and ensuring efficiency in the allocation of

resources. These characteristics are typically enshrined in a legal andadministrative framework regulating the budget process.

Knowing the rules

Although the precise legal framework for central government budgeting

varies from country to country, it is usually set out at several levels.

The constitution is the highest in the legal hierarchy. Although it deals only

with broad principles, the constitution may clarify three important aspects:

(1) the relative powers of the executive and legislative branches with respectto public finances; (2) the definition of the financial relations betweennational and subnational levels of government; and (3) the requirement, for

example, in Commonwealth systems, that all public funds be paid into

designated accounts, and that these funds be spent only under the authority of

a law.

The organic law is usually the main vehicle for establishing principles of

public financial management. These laws may take the form of a single law

that guides budget preparation, approval, execution, control, and auditing

(loi organique relative au budget in the francophone system; ley de


34/38

COSTING.

34

administracin financiera in the Latin American system), or there may be

several general laws covering specific areas of public finance management

(e.g., under Commonwealth systems) that may also relate to subnational

levels of government. They are called "organic" because they relate to

organizational matters and systems, and do not therefore require annualreenactment. Moreover, they can often be modified only under certainconditions, such as qualified parliamentary majority.

Financial regulations. The organic budget law also gives to the government,

or the minister responsible for public finance, the authority to issue detailed

regulations and instructions (for instance dcret portant rglement de la

Comptabilit Publique in the francophone system, and decreto para la

contabilidad pblica in the Latin American system). These are often quite

detailed.

The constitution, the budget organic law, and financial regulations are

permanent and form the legal framework within which the annual budget

law, which includes the revenue and expenditure estimates for a given year,

is prepared, approved, executed, and audited. The annual budget law cantake different shapes depending on the system.

In the francophone and Latin American systems, the coverage of the annualbudget law (called budget or loi de finances in francophone countries and ley

anual de presupuestos in Latin America) is rather wide, since it contains the

amount and details of revenue and expenditure, the balance, and also anynew tax legislation measures and some changes to spending. Under the

Commonwealth system, both revenue and expenditure estimates are

presented. Often the latter are further divided into recurrent and developmentestimates, sometimes presented as separate volumes. Typically, the

presentation is detailed by institution and line item. By contrast, the annual

budget in many transition economies has often been rather summary in

format: prior to any recent reforms, budget estimates were presented by

budgetary institution--typically only the major supervisory institutions and

not their subordinate units--and broken down only by broad "functions,"more or less the sectors used in the previous central planning framework.

Identifying the responsibilities within the budget

system

The powers assigned to the legislative and executive branches, and, within

the executive branch, who does what, essentially define the responsibilitiesfor preparing the budget(Box 2)
http://www.imf.org/external/pubs/ft/expend/guide3.htm#box2http://www.imf.org/external/pubs/ft/expend/guide3.htm#box2http://www.imf.org/external/pubs/ft/expend/guide3.htm#box2


35/38

COSTING.

35

.

Box 2. The Framework that Regulates the Budget:

What Do You Need to Know?The following summarizes some of the key questions on the overall

budget preparation framework.

What is the budget timetable?

How are budgeting powers distributed between the executive and

legislative branches?

legislative power to propose spending

power of amendment

one vote--global vote on spending

executive powers to limit spending below appropriations

How are budgeting powers distributed within the executive?

number of agencies involved; who does what?

agenda for setting budget negotiations; how is this determined?

structure of negotiations--who has veto power?

How are activities funded?

revenue accounts

borrowed resources

extrabudgetary mechanisms

multiple funds

contingency funds

special funds

Any legislative limits on:

expenditure?

deficit?


36/38

COSTING.

36

borrowing?

carryover of spending authority to next year?

Any earmarking?special or hypothecated funds

constitutional or legal commitments on specific public services

(education, health)

For instance, when considering expenditure changes at the budget

preparation stage, countries vary in the extent to which the parliament canchange the budget, once it is submitted for their consideration. Many

countries, for example, allow for the composition of the expenditure or

revenue plans to be changed but not the global total; in others, particularly

in a number of transition economies, new expenditure proposals--often

poorly costed--can be put forward, approved by the parliament, and thus

enter into the budget. Although those preparing the budget can help improve

parliamentary understanding through discussions, the budget must ultimately

be negotiated by the executive with the legislature.


37/38

COSTING.

37

Conclusion

A budget should be based on norms and standards. The budget should be

coordinated, integrated, organized, systematic, clear, and comprehensive to

accomplish optimal results. The budget preparation, review, and evaluationprocess must be facilitated. An orderly budgeting process will result in less

cost, less man -hours, and minimization of conflict and turmoil. It will requireless revision at a later date. The budget process must consider input -output

relationships. The budget aids in anticipating problems before they become

critical. Short-term budgets should be used for businesses subject to rapid

change. A budget is a tool for planning and for "what-if" analysis. It aids in

identifying the best course of action.

As it is in the computer worldgarbage in, garbage outso it is withbudgeting. If forecasts are inaccurate so will be the projections, resulting in

bad management decisions to the detriment of the firm. A manager must becautious when analyzing past experience. Unforeseen circumstances such as

economic downturns and future innovations have direct inputs on current

operations. A manager deviating from a budget target must explain why and,

of course, is on the defensive. Without proper justification for missing

targets, the manager may be dismissed.


38/38

COSTING.

www.google.com

www.wikipedia.com

www.budgetarycontrol.com

www.yahooindia.com
http://www.google.com/http://www.wikipedia.com/http://www.budgetarycontrol.com/http://www.yahooindia.com/http://www.yahooindia.com/http://www.budgetarycontrol.com/http://www.wikipedia.com/http://www.google.com/

Budgetary Control System and Its Applications

Documents

Transcript of Budgetary Control System and Its Applications