BSM PG COLLEGE ROORKEE

ASSIGNMENT ON
AUDITING

SUBMITTED TO SUBMITTED BY
BHARAT SIR VIPUL GUPTA
ROLL NO: 1730110411
DATE: 06/08/2020
 ACKNOWLEGDEMENT

I VIPUL GUPTA Would Like To Express My Special Thank Of Gratitude To My

Teacher BHARAT SIR As Well As Our Director Sir ….ALISHA SARI Who Gave
Me Golden Opportunity To Do This Wonderful Project On The Topic Holding
Company Account, Which Also Helped Me In Doing A Lot Of Research And I
Came To Know Many New Things.
I’m Really Very Thankful to Them.
Secondly I Would Like To Thank My Parents And Friend Who Also Helped Me In
Completing My Project Work.
I’m making this project Not Only for Marks but Also to Increase My Knowledge.
Thanks Again To All Who Helped Me.
Budgets & Budgetary Control
Topics to be enlighten…
 Introduction Budgets and Budgetary Control
 Meaning and Definition
 Objectives of Budgetary Control
 Advantages of Budgetary Control
 Limitations of Budgetary Control
 Essentials of Effective Budgeting
 Types of Budget
 Cash Budget
 Master Budget
 Fixed and Flexible Budget
 Performance Budgeting (PB)
 Zero Base Budgeting (ZBB)
 Budget Reports
 Practical Problems
Introduction:
The term ‘Budget’ appears to have been derived from the French
word ‘baguette’ which means ‘little bag' , or a container of
documents and accounts. A budget is an accounting plan. It is a
formal plan of action expressed in monetary terms. It could be
seen as a statement of expected income and expenses under
certain anticipated operating conditions. It is a quantified plan for
future activities – quantitative blue print for action.

Every organization achieves itspurposes by coordinating different

activities. For the execution of goals efficient planning of these
activities is very importantandthat is why the management has a
crucial role to play in drawing out the plans for its business. Various
activities within a company should be synchronized by the
preparation of plans of actions for future periods. These
comprehensive plans are usually referred to as budgets. Budgeting
is a management device used for short‐term planning and
control.It is not just accounting exercise.

Meaning and Definition:

Budget:
According to CIMA (Chartered Institute of Management Accountants)
UK, a budgetis“A plan quantified in monetary terms prepared and
approved prior to a defined period of time, usually showing
planned income to be generated and, expenditure to be incurred
during the period and the capital to be employed to attain a
given objective.”
 In a view of Keller &Ferrara , “a budget is a plan of action to
achieve stated objectives based on predetermined series of
related assumptions.”

G.A.Welsh states, “a budget is a written plan covering projected

activities of a firm for a definite time period.”

One can elicit the explicit characteristics of budget after observing

the above definitions. They are…
 It is mainly a forecasting and controlling device.
 It is prepared in advance before the actual operation of
the company or project.
 It is in connection with adefinite future period.
 Before implementation, it is to be approved by the
management.
 It also shows capital to be employed during the period.

Budgetary Control:
Budgetary Control is a method of managing costs through
preparation of budgets. Budgeting is thus only a part of the
budgetary control. According to CIMA, “Budgetary control is the
establishment of budgets relating to the responsibilities of
executives of a policy and the continuous comparison of the actual
with the budgeted results, either to secure by individual action,
the objective of the policy or to provide a basis for its revision.”
The main features of budgetary control are:

 Establishment of budgets for each purpose of the business.

 Revision of budget in view of changes in conditions.
 Comparison of actual performances with the budget on a
continuous basis.
 Taking suitable remedial action, wherever necessary.
 Analysis of variations of actual performance from that of
the budgeted performance to know the reasons thereof.

Objectives of Budgetary Control:

Budgeting is a forward planning. It serves basically as a tool for
management control; it is rather a pivot of any effective scheme
of control.
G. A. Welsch in his book, 'Budgeting ‐ Profit Planning and Control'
has rightly pointed out that 'Budgeting is the principal tool of
planning and control offered to management by accounting
function.'
The objectives of budgeting may be summarized as follows:
1) Planning:Planning has been defined as the design of a
desired future position for an entity and it rests on the
belief that the future position can be attained by
uninterrupted management action. Detailed plans relating to
production, sales, raw‐material requirements, labour needs,
capital additions, etc. are drawn out. By planning many
problems estimated long before they arise and solution
can be thought of through careful study. In short,
budgeting forces the management to think ahead, to
foresee and prepare for the anticipated conditions. Planning
is a
 constant process since it requires constant revision with
changing conditions.

2) Co‐ordination: Budgeting plays a significant role in

establishing and maintaining coordination. Budgeting
assists managers in coordinating their efforts so that
problems of the businessare solved in harmony with the
objectives of its divisions. Efficient planning and business
contribute a lot in achieving the targets. Lack of co‐
ordination in an organization is observed when a
department head is permitted to enlarge the department on
the specific needs of that department only, although such
development may negatively affect other departments and
alter their performances. Thus, co‐ordination is required at all
vertical as well as horizontal levels.

3) Measurement of Success:Budgets present a useful means

of informing managers how well they are performing in
meeting targets they have previously helped to set. In many
companies, there is a practice of rewarding employees on
the basis of their accomplished low budget targets or
promotion of a manager is linked to his budget success
record. Success is determined by comparing the past
performance witha previous period's performance.

4) Motivation:Budget is always considereda useful tool for

encouraging managers to complete things in line with the
business objectives. If individuals have intensely participated
in
 the preparation of budgets, it acts as a strong motivating
force to achieve the goals.

5) Communication: A budget serves as a means of

communicating information within a firm. The standard
budget copies are distributed to all management
peoplethat provides not only sufficient understanding and
knowledge of the programmes and guidelines to be followed
but also gives knowledge about the restrictions to be
adhered to.

6) Control: Control is essential to make sure that plans and

objectives laid down in the budget are being achieved.
Control, when applied to budgeting, as asystematized
effort is to keep the management informed of whether
planned performance is being achieved or not.

Advantagesof Budgetary control:

In the light of above discussion one can see that, coordination and control
help the planning. These are the advantages of budgetary control.But this
tool offer many other advantages as follows:
1. This system provides basic policies for initiatives.
2. It enables the management to perform business in the most
professional manner because budgets are prepared to get
the optimum use of resources and the objectives framed.
3. It ensures team work and thus encourages the spirit of
support and mutual understanding among the staff.
 4. It increases production efficiency, eliminates waste and
controls the costs.
5. It shows to the management where action is needed to
remedy a position.
6. Budgeting also aids in obtaining bank credit.
7. It reviews the presentsituation and pinpoints the changes
which are necessary.
8. With its help, tasks such as like planning, coordination and
control happen effectively and efficiently.
9. It involves an advance planning which is looked upon with
support by many credit agencies as a marker of sound
management.

Limitations of Budgetary control:

1. It tends to bring about rigidity in operation, which is
harmful. As budget estimates are quantitative expression of
all relevant data, there is a tendency to attach some sort of
rigidity or finality to them.
2. It being expensive is beyond the capacity of small
undertakings. The mechanism of budgeting system is a
detailed process involving too much time and costs.
3. Budgeting cannot take the position of management but it is
only an instrument of management. ‘The budget should be
considered not as a master, but as a servant.’ It is totally
misconception to think that the introduction of budgeting
alone is enough to ensure success and to security of future
profits.
 4. It sometimes leads to produce conflicts among the
managers as each of them tries to take credit to achieve
the budget targets.
5. Simple preparation of budget will not ensure its proper
implementation. If it is not implemented properly, it may
lower morale.
6. The installation and function of a budgetary control system
is a costly affair as it requires employing the specialized
staff and involves other expenditure which small companies
may find difficult to incur.

Essentials of Effective Budgeting:

1) Support of top management: If the budget structure is to
be made successful, the consideration by every member of
the management not onlyis fully supported but also the
impulsion and direction should alsocome from the top
management. No control system can be effective unless the
organization is convinced that the management considers the
system to be important.
2) Team Work: This is an essential requirement, if the budgets
are ready from “the bottom up” in a grass root manner. The
top management must understand and give enthusiastic
support to the system. In fact, it requires education and
participation at all levels. The benefits of budgeting need to
be sold to all.
3) RealisticObjectives: The budget figures should be realistic and
represent logically attainable goals. The responsible
executives should agree that the budget goals are reasonable
and attainable.
4) Excellent Reporting System: Reports comparing budget and
actual results should be promptly prepared and special
attention focused on significant exceptions i.e. figures that are
significantly different from expected. An effective budgeting
system also requires the presence of a proper feed‐back
system.
5) Structure of Budget team: This team receives the forecasts
and targets of each department as well as periodic reports
and confirms the final acceptable targets in form of Master
Budget. The team also approves the departmental budgets.
6) Well defined Business Policies: All budgetsreveal that the
business policies formulated by the higher level management.
In other words, budgets should always be aftertaking into
account the policies set for particular department or function.
But for this purpose, policies should be precise and clearly
defined as well as free from any ambiguity.
7) Integration with Standard Costing System: Where standard
costing system is also used, it should be completely
integrated with the budget programme, in respect of both
budget preparation and variance analysis.
8) Inspirational Approach:All the employees or staff other
than executives should be strongly and properly inspired
towards budgeting system. Human beings by nature do not
like any pressure and they dislike or even rebel against
anything forced upon them.
Classification of Budget:
The extent of budgeting activity varies from firm to firm. In a
smaller firm there may be a sales forecast, a production budget,
or a cash budget. Larger firms generally prepare a master budget.
Budgets can be classified into different ways from different points of
view. The following are the important basis for classification:

Classification of Budget

Function Flexibility Time

Sales Budget Fixed Flexible Long‐Term
Production Budget  Short‐Term
Raw Materials Budget Current
Purchase Budget Rolling
Labour Budget
Production Overhead Budget
Selling & Distribution Budget
Administration Cost Budget
Capital Expenditure Budget
Cash Budget

Functional Classification:
SALES BUDGET:
The sales budget is an estimate of total sales which may be
articulated in financial or quantitative terms. It is normally forms
the fundamental basis on which all other budgets are
constructed. In practice, quantitative budget is prepared first then
it is translated into economic terms. While preparing the Sales
Budget, the Quantitative Budget is generally the starting point in
the operation of budgetary control because sales become, more
often than not, the principal budget factor. The factor to be
consider in forecasting sales are as follows:
  Study of past sales to determine trends in the market.
 Estimates made by salesman various markets of
company products.
 Changes of business policy and method.
 Government policy, controls, rules and Guidelines etc.
 Potential market and availability of material and supply.

PRODUCTION BUDGET:
The production budget is prepared on the basis of
estimatedproduction for budget period. Usually, the production
budget is based on the sales budget. At the time of preparing
the budget, the production manager will consider the physical
facilities like plant, power, factory space, materials and labour,
available for the period. Production budget envisages the
production program for achieving the sales target. The budget
may be expressed in terms of quantities or money or both.
Production may be computed as follows: Units to be produced =
Desired closing stock of finished goods + Budgeted sales –
Beginning stock of finished goods.

PRODUCTION COST BUDGET:

This budget shows the estimated cost of production. The
production budget demonstrates thecapacity of production. These
capacities of production are expressed in terms of cost in
production cost budget. The cost of production is shown in
detail in respect of material cost, labour cost and factory
overhead. Thus production cost budget is based upon
Production Budget, Material Cost Budget, Labour Cost Budget
and Factory overhead.
RAW‐MATERIAL BUDGET:
Direct Materials budget is prepared with an intention to
determine standard material cost per unit and consequently it
involves quantities to be used and the rate per unit. This budget
shows the estimated quantity of all the raw materials and
components needed for production demanded by the production
budget. Raw material serves the following purposes:
 It supports the purchasing department in scheduling the
purchases.
 Requirement of raw‐materials is decided on the basis of
production budget.
 It provides data for raw material control.
 Helps in deciding terms and conditions of purchase like
credit purchase, cash purchase, payment period etc.
It should be noted that raw material budget generally deals with
only the direct materials whereas indirect materials and
supplies are included in the overhead cost budget.

PURCHASE BUDGET:
Strategic planning of purchases offers one of the most
importantareas of reduction cost in many concerns. This will
consist of direct and indirect material and services. The
purchasing budget may be expressed in terms of quantity or
money.
The main purposes of this budget are:
 It designates cash requirement in respect of purchase to be
made during budget period; and
  It is facilitates the purchasing department to plan its operations
in time in respect of purchases so that long term forward
contract may be organized.

LABOUR BUDGET:
Human resourcesare highly expensive item in the operation of
an enterprise. Hence, likeother factors of production, the
management should find out in advance personnel requirements
for various jobs in the enterprise. This budget may be classified
into labour requirement budget and labour recruitment budget.
The labour necessities in the various job categories such as
unskilled, semi‐skilled and supervisory are determined with the
help of all the head of the departments. The labour employment
is made keeping in view the requirement of the job and its
qualifications, the degree of skill and experience required and the
rate of pay.

PRODUCTION OVERHEAD BUDGET:

The manufacturing overhead budget includes direct material,
direct labour and indirect expenses. The production overhead
budget represents the estimate of all the production overhead
i.e. fixed, variable, semi‐variable to be incurred during the
budget period. The reality that overheads include many
different types of expenses creates considerable problems in:
1) Fixed overheads i.e., that which is to remain stable
irrespective of vary in the volume of output,
 2) Apportion of manufacturing overheads to products
manufactured, semi variable cost i.e., thosewhich are partly
variable and partly fixed.
3) Control of production overheads.
4) Variable overheads i.e., that which is likely to vary with the
output.
The production overhead budget engages the preparation of
overheads budget for each division of the factory as it is
desirableto have estimates of manufacturing overheads
prepared by those overheads to have the responsibility for
incurring them. Service departments cost are projected and
allocated to the production departments in the proportion of
the services received by each department.

SELLING AND DISTRIBUTION COST BUDGET:

The Selling and Distribution Cost budget is estimating of the
cost of selling, advertising, delivery of goods to customers etc.
throughout the budget period. This budget is closely associated to
sales budget in the logic that sales forecasts significantly influence
the forecasts of these expenses. Nevertheless, all other linked
information should also be taken into consideration in the
preparation of selling and distribution budget. The sales manager
is responsible for selling and distribution cost budget. Naturally,
he prepares this budget with the help of managers of sub‐
divisions of the sales department. The preparation of this
budget would be based on the analysis of the market condition
by the management, advertising policies, research programs and
many other factors. Some companies prepare a
 separate advertising budget, particularly when spending on
advertisements are quite high.

ADMINISTRATION COST BUDGET:

This budget includes the administrative costs for non‐
manufacturing business activities like directors fees, managing
directors’ salaries, office lightings, heating and air condition etc.
Most of these expenses are fixed so they should not be too
difficult to forecast. There are semi‐variable expenses which get
affected by the expected rise or fall in cost which should be taken
into account. Generally, this budget is prepared in the form of
fixed budget.

CAPITAL‐ EXPENDITURE BUDGET:

This budget stands for the expenditure on all fixed assets for
the duration of the budget period. This budget is normally
prepared for a longer period than the other functional budgets. It
includes such items as new buildings, land, machinery and
intangible items like patents, etc. This budget is designed under
the observation of the accountant which is supported by the
plant engineer and other functional managers. At the time of
preparation of the budget some important information should
be observed:
 Overfilling on the production facilities of certain departments
as revealed by the plant utilization budget.
 Long‐term business policy with regard to technical
developments.
 Potential demand for certain products.
CASH BUDGET:
The cash budget is a sketch of the business estimated cash inflows
and outflows over a specific period of time. Cash budget is one of
the most important and one of the last to be prepared. It is a
detailed projection of cash receipts from all sources and cash
payments for all purposes and the resultants cash balance
during the budget. It is a mechanism for controlling and
coordinating the fiscal side of business to ensure solvency and
provides the basis for forecasting and financing required to
cover up any deficiency in cash. Cash budget thus plays avital
role in the financing management of a business undertaken.
Cash budget assists the management in determining the future
liquidity requirements of the firm, forecasting for business of
those needs, exercising control over cash. So, cash budget thus
plays a vital role in the financial management of a business
enterprise.

Function of Cash Budget:

 It makes sure that enough cash is available when it is required.
 It designates cash excesses and shortages so that steps may
be taken in time to invest any excess cash or to borrow funds
to meet any shortages.
 It shows whether capital expenditure could be financed
internally.
 It provides funds for standard growth.
 It provides a sound basis to manage cash position.
Advantages of Cash Budget:
1. Usage of Cash: Management can plan out the use of cash in
accord with the changes of receipt and payment. Payments can
be planned when sufficient cash is available and continue the
business activity with the minimum amount of working capital.
2.Allocation for Capital Investment: It is dual benefits such as
capital expenditure projects can be financed internally and can
get an idea for cash availability of capital investment.
3. Provision of Excess Funds: It reveals the availability of excess
cash. In this regard management candecide to invest excess funds
for short term or long term according to the requirements in
the business.
4. Pay‐out Policy: This budgetary system may help the
management for future pay‐out policy in the form of dividend.
In case the cash budget liquid position is not favourable, the
management may reduce the rate of dividend or maintain dividend
amount or skip dividend for the year.
5. Provision for acquiring Funds: It gives the top level
management ideas for acquiring funds for a particular time
duration andsources to be explored.
6. Profitable Use of Cash:Business person can take decision for
the best use of liquidity to make more profitable transaction. It
can be used at the time of bulk purchase payments and one get
the benefit of discount.
Limitation of Cash Budget:
1. Complex Assumption: Business is full of uncertainties, so it is
very difficult to have near perfect estimates of cash receipts and
payments, especially for a longer duration. It can be predicted for
short duration such as of three to four months.
2. Inflexibility: If the finance manager fails to show flexibility
in implementing the cash budget, it will incur adverse effects.
If the manager follows strictly adheres to the estimates of cash
inflow it may negatively result in losing customers. Likewise,
loyalty in payments may lead to deterioration of liquid position.
3. Costly:Application of this technique necessitates collecting of
statistical information from various sources and expert personnel
in operation research would be the costliest deal. It becomes
expensive which may not be affordable to small business
houses. In addition, finding out experts is not always possible.
In this situation the long term predictions do not prove correct.

Methods:
1. Receipt and payment:It is most popular and is universally used
for preparing cash budget. The assumption of statistical data is
arrived at calculated on the basis of requirements like monthly,
weekly or fortnightly. On account of elasticity, this method is used
in forecasting cash at different time periods and thus it helps in
controlling cash distributions.
(a) Cash receipts from customers are based on sales forecast. The
term of sale, lag in payment etc., are generally taken into
consideration.
 (b) Cash receipts from other sources, such as dividends and interest
on trade investment, rent received, issue of capital, sale of
investment and fixed assets.
(c) Cash requirements for purchase of materials, labour and salary
cost and overhead expenses based on purchasing, personnel
and overhead budgets.
(d) Cash requirements for capital expenditure as per the capital
expenditure budget.
(e) Cash requirements for other purposes such as payment of
dividends, income‐tax liability, fines and penalties.
(i) Estimating Cash Receipts: Generally main sources of cash
receipts are sales, interest and dividend, sales of assets and
investments, capital borrowings etc.The Company estimates
time‐lag on the basis of past experience of cash receipts on
credit sales while cash sales can be easily determined.
(ii)Estimating Cash Payments: It can be decided on the basis of
various operating budgets prepared for the payment of credit
purchase, payment of labour cost, interest and dividend,
overhead charges, capital investment etc.
2. Adjusted Profit and Loss Account: This method is based on cash
and non‐cash transactions. This method estimates closing cash
balance by converting profit into cash. The hypothesis of this
method is that the earning of profit brings equal amount of cash
into the business. The net profit shown by profit and loss account
does not signify the actual cash flow into the business. This also
leads to another assumption, that is the business will remain static,
i.e. there will be no wearing out or increase
 of assets and changes of working capital so that the total cash on
hand for the business would be equal to the profit earned.
3. Budgeted Balance Sheet Method: This method looks like the
Adjusted Profit and Loss Account method only, except that in this
method a Balance Sheet is projected and in that method Profit and
Loss Account is adjusted. In this method Balance Sheet is prepared
with the projected amount of all assets and liabilities except cash
at the end of budget period. The cash balance will find out
balancing amount. If assets side is higher than liability side it
would be the bank overdraft while liability side is higher than
assets side it gives bank balance. This method is used by the stable
business houses.
4. Working Capital Differential Method:It is based on the estimate
of working capital. It begins with the opening working capital and is
added to or deducted from any changes made in the current assets
except cash and current liabilities. At the end of the budget
period balance shows the real cash balance. This method is quite
similar to the Balance Sheet method.
Model of Cash Budget

Particular January February March

Opening Balance ‐ ‐ ‐
Add: Receipts:
Cash Sales ‐ ‐ ‐
Receipts from Debtors ‐ ‐ ‐
Interest and Dividend ‐ ‐ ‐
Sale of fixed assets ‐ ‐ ‐
Sale of Investments ‐ ‐ ‐
Bank Loan ‐ ‐ ‐
Issue Shares & Debenture ‐ ‐ ‐
Others ‐ ‐ ‐
Total Receipts (A) ‐ ‐ ‐
Less: Payments
Cash Purchases ‐ ‐ ‐
Payment to creditors ‐ ‐ ‐
Salaries & wages ‐ ‐ ‐
Administrative expenses ‐ ‐ ‐
Selling expenses ‐ ‐ ‐
Dividend payable ‐ ‐ ‐
Purchase of Fixed Assets ‐ ‐ ‐
Repayment of Loan ‐ ‐ ‐
Payment of taxes ‐ ‐ ‐
Total Payments (B) ‐ ‐ ‐
Closing Balance (A ‐ B) ‐ ‐ ‐
FIXED AND FLEXIBLE BUDGET:
1.FIXED BUDGET:
A fixed budget is prepared for one level of output
and one set of condition. This is a budget in which targets
are tightly fixed. It is known as a static budget.According to
CIMA, “A budget which is designed to remain unchanged
irrespective of the level of the activity attained.”It is firm and
prepared with the assumption that there will be no change in
the budgeted level of motion. Thus, it does not provide room
for any modification in expenditure due to the change in the
projected conditions and activity. Fixed budgets are
prepared well in advance.
This budget is not useful because the conditions go on
the changing and cannot be expected to be firm. The
management will not be in a position to assess, the
performance of different heads on the basis of budgets
prepared by them because to the budgeted level of activity.
It is hardly of any use as a mechanism of budgetary control
because it does not make any difference between fixed,
semi‐variable and variable costs and does not provide any
space for alteration in the budgeted figures as a result of
change in cost due to change in the level of activity. Fixed
budget can be revised in the light of changing situations,
yet the rigidity and control over costs and expenses would
be lost in such cases. Fixed budgets should be prepared only
where sales, production and costs can be accurately
estimated.
2.FLEXIBLE BUDGET:
This is a dynamic budget. In comparison with a fixed
budget, a flexible budget is one “which is designed to
change in relation to the level of activity attained.” The
underlying principle of flexibility is that a budget is of little use
unless cost and revenue are related to the actual volume of
production. The statistics range from the lowest to the highest
probable percentages of operating activity in relation to the
standard operating performance. Flexible budgets are a part
of the feed advance process and as such are a useful part of
planning. An equally accurate use of the flexible budgets is for
the purposes of control.
Flexible budgeting has been developed with the
objective of changing the budget figures so that they may
correspond with the actual output achieved. It is more sensible
and practical, because changes expected at different levels
of activity are given due consideration. Thus a budget might
be prepared for various levels of activity in accord with
capacity utilization.
Flexible budget may prove more useful in the following
conditions:
 Where the level of activity varies from period to period.
 Where the business is new and as such it is difficult to
forecast the demand.
 Where the organization is suffering from the shortage of
any factor of production. For example, material, labour,
etc. as the level of activity depends upon the availability of
such a factor.
 Where the nature of business is such that sales go on
changing.
  Where the changes in fashion or trend affects the
production and sales.
 Where the organization introduces the new products or
changes the patterns and designs of its products frequently.
 Where a large part of output is intended for the export.

Uses of Flexible Budget:

In flexible budgets numbers are adjustable to any given set
of operating conditions. It is, therefore, more sensible than a
fixed budget which is true only in one set of operating
environment.
Flexible budgets are also useful from the view point of
control. Actual performance of an executive should be
compared with what he should have achieved in the actual
circumstances and not with what he should have achieved
under quite different circumstances. At last, flexible budgets
are more realistic, practical and useful. Fixed budgets, on the
other hand, have a limited application and are suited only
for items like fixed costs.

Preparation of a Flexible Budget

The preparation of a flexible budget requires the analysis of
total costs into fixed and variable components. This analysis of
course is, not unusual to the flexible budgeting, is more
important in flexible budgeting then in fixed budgeting.
This is so because in flexible budgeting, varying levels of
output are considered and each class of overhead will be
different for each level. Thus the flexible budget has the
following main distinguishing features:
 It is prepared for a range of activity instead of a single level.
 It provides a dynamic basis for comparison because it is
automatically related to changes in volume.
The formulation of a flexible budget begins with analyzing
the overhead into fixed and variable cost and determining the
extent to which the variable cost will vary within the normal
range of activity. In a simple equation form it could be put
as:
Y=a+bx and it is illustrated as below:
Cost Flexible budget Y=a+bx
Fixed Rs.5000 + Rs. 0(x)
Variable Rs.0 + Rs.2.5(x)
Semi‐Variable Rs.500 + Rs.1.0(x)
Rs.5500 + Rs.3.5(x)
There are two methods of preparing such a budget:
(i) Formula Method / Ratio Method:This is also known as
the Budget Cost Allowance Method. In this method the budget
should be prepared as follows:
(a) Before the period begins:
 Budget for a normal level of activity,
 Segregate into fixed and variable costs,
 Compute the variable cost per unit of activity

(b) At the end of the period:

 Ascertain the actual activity
 Compute the variable cost allowed for this level, add
the fixed cost to give the budget cost allowance.
The whole process is expressed in the formula:
 Allowed cost = Fixed cost + (Actual units of activity for the
period) (Variable cost per unit of activity)

(ii)Multi‐Activity Method: This method involves computing a budget

for every major level of activity. When the actual level of
activity is known, the allowed cost is found “interpolating”
between the budgets of activity levels on either side.
 Different levels of activity are expressed in terms of
either production units or sales values. The levels of
activity are generally expressed in production units or in
terms of sales values.
 The fixation of the budget cost gives allowance for
the budget centres. According to CIMA London, the
budget cost allowance means, "the cost which a
budget centre is expected to incur during a given period
of time in relation to the level of activity attained by
the budget centre."
 The determination of the different levels of activity
for which the flexible budget is to be prepared.
(3) Graphic Method: In this method, estimates of budget
are presented graphically. In this costs are divided into three
classes, viz., fixed, variable and semi‐variable cost. Values
of costs are obtained for different levels of production.
These values are signified in the form of a graph.
 Model of Flexible Budget
Capacity Utilization
Particulars
60% 80% 100%
1. Prime Cost:
‐ Direct Material ‐ ‐ ‐
‐ Direct Labour ‐ ‐ ‐
‐ Direct expenses (if any) ‐ ‐ ‐
Total (A) ‐ ‐ ‐
2. Variable overheads:
‐ Maintenance & repairs ‐ ‐ ‐
‐ Indirect Labour ‐ ‐ ‐
‐ Indirect Material ‐ ‐ ‐
‐ Factory overheads ‐ ‐ ‐
‐ Administrative ‐ ‐ ‐
Overheads
‐ Selling & distribution O/H ‐ ‐ ‐
Total (B) ‐ ‐ ‐
3. Marginal Cost (A + B) ‐ ‐ ‐
4. Sales ‐ ‐ ‐
5. Contribution ( Sales ‐ MC) ‐ ‐ ‐
6. Fixed cost
‐ Factory overheads ‐ ‐ ‐
‐ Administrative Overheads ‐ ‐ ‐
‐ Selling & distribution O/H ‐ ‐ ‐
Total (C) ‐ ‐ ‐
7. Profit or Loss (C‐ FC) ‐ ‐ ‐
TIME BUDGET:
With regard to time, budgets may be classified into four categories:
(a) Long‐term Budget: These budgets are prepared on the
basis of long‐term projection and portray a long‐range
planning. These budgets generally cover plans for three to ten
years. In this regard it is mostly prepared in terms of physical
quantities rather than in monetary values.
(b) Short‐term Budget: In this budget forecasts and plans are
given in respect of its operations for a period of about one
to five years. They are generally prepared in monetary
units and are more specific than long‐term budgets.
(c) Current Budgets: These budgets cover a very short period,
may be a month or a quarter or maximum one year. The
preparation of these budgets requires adjustments in short‐
term budgets to current conditions.
(d) Rolling Budgets:A few companies follow the practice of
preparing a rolling or progressive budget. In this case
companies prepare the budget for a year in advance. A new
budget is prepared after the end of each month or quarter
for a full year in advance. The figures for the month or
quarter which has rolled down are dropped and the
statistics for the next month or quarter are added.
MASTER BUDGET:
The master budget is a review budget which combines all
functional budgets and it may take the form of Financial
Statements at the end of budget period. It is also called the
operating budget. It embraces the impact of both operating
decisions and financing decisions. It provides the necessary plan
for operations during the period when all detailed budgets have
been completed. A master budget becomes a principal document
for the operations of the industry during the period it covers.
Actually, budgets have to be amended several times before the
position disclosed by the summary budget is accepted. A
master budget is an annual profit plan, which may be broken
into months or quarters.
As a result a master budget is:
 A statement of a company’s operating policy for the
budget period, and
 A budgeted profit and loss account for the budget period
and a balance sheet as at the end the period.
Merits of the Master Budget:
 A review of all the functional budgets in specific form is
available in one report.
 It presents an overall profit position of the organization for
the budget.
 It also contains the information regarding the forecast
balance sheet.
 It examines the fitness of all the functional budgets
Performance Budgeting (PB):
This term was used for the first time in the United States by
the Hoover Commission. In India, Performance Budgeting
was first discussed in 1954 during the Lok‐Sabah debates. But
it was only in 1961 that the government of India issued general
orders drawing the attention of the administrative ministries
to the recommendations of the Estimates Committee, and
requesting them to consider the issuance of suitable
instructions. It was left to the Administrative Reforms
Commission to come out with more elaborate emphasis on PB
in 1967.Performance budgeting is a budgeting system,
which involves the assessment of the performance of the
business, and both its specific and overall objectives. It gives
clarity about organizational objectives and provides an exact
direction to each employee in the business.
Meaning:
The term performance implies results or outputs. ‘ A
performance budget is one which presents the purposes and
objectives for which funds are required, the costs of the
programmes proposed for achieving those objectives, and
quantitative data measuring the accomplishments and work
performed under programme. Thus, PB is a technique of
presenting budgets for costs and revenues in terms of
functions, programmes and activities and correlating the
physical and financial aspects of the individual items
comprising the budget.
As per the National Institute of Bank Management, PB
technique is, "the process of analyzing, identifying, simplifying
and
 crystallizing specific performance objectives of a job to be
achieved over a period in the framework of the
organizational objectives, the purpose and objectives of the
job. The technique is characterized by its specific direction
towards the business objectives of the organization." As a
result, performance budget accentuates the execution of
specific goals over a period of time.
Steps in PerformingBudgeting (PB):
 Establishment of performance targets
 Establishment of responsibility centre
 Estimating financial requirements
 Comparison of actual with budgeted performance
 Reporting and action
The Report of the ARC uses the following terms in an
integrated sequence:
Function Programme Activity Project

Zero Base Budgeting:

The ‘Zero‐Base’ refers to a ‘nil‐budget’ as the starting
point.It starts with a presumption that the budget for the
next period is ‘zero’ until the demand for a function,
process, or project is not justified for single penny. The
assumption is that without such justification, no
expenditure will be allowed. In effect, each manager or
functional head is required to carry out cost‐benefit analysis
of each of the activities, etc. under his control and for
which he is responsible.
 The method of ZBB suggests that the business should
not only make decision about the proposed new
programmes but it should also, regularly, review the
suitability of the existing programmes. This approach of
preparing a budget is called incremental budgeting since
the budget process is concerned mainly with the increases or
changes in operations that are likely to occur during the
budget period.
This method for the first time was used by the
Department of Agriculture, U.S.A. in the 19th century. Other
State Governments of the U.S.A. found this method helpful
and so almost all the states took deep interest in the ZBB
method. A number of states of America use this technique
even today. The ICAI has brought out a research in the form
of a monograph showing the application of the ZBB method
that worries in tandem with the concerns for national
environment and its requirements. In India, however, the ZBB
approach has not been fully accepted and actualized.
"ZBB is a management tool, which provides a
systematic method for evaluating all operations and
programmes, current or new, allows for budget reductions
and expansions in a rational manner and allows re‐
allocation of sources from low to high priority programmes."
‐ David Lieninger
ZBB is a planning, resource allocation and control tool. It,
however, presupposes that
(a) There is an efficient budgeting system within the enterprise.
 (b) Managers can develop quantitative measures for use
in performance evaluation.
(c) Among the new suggestions and programmes, along with
old ones are put to a strict scrutiny.
(d) Funds are diverted from low‐priority suggestions to high
priority suggestions.
Procedure of Zero‐base Budgeting:

(1)Determination of the objective: This is an initial step

for determining the objective to introduce ZBB. It may
result into the decreased cost in personnel overheads
ordebunk the projects which do not fit in the business
structure or which are not likely to help accomplish
the business objectives.
(2) Degree at the ZBB is to be introduced: It is not
possible every time to evaluate every activity of the
whole business. After studying the business structure, the
management can decide whether ZBB is to be
introduced in all areas of business activities or only in a
few selected areas on the trial basis.
(3)Growth of Decision units: Decision units submit their data
as to which cost benefit analysis should be done in
order to arrive at a decision that helps them decide to
continue or abandon. It could be a functional
department, a programme, a product‐line or a sub‐line.
Here the decision unitsexist independent of all the
other units so that when the cost
 analysis turns unfavourable that particular unit could
be closed down.
(4) Growth of Decision packages:Decision units are to be
identified for preparing data relating to the proposals to
be included in the budget,concerned manager analyzes
the activities of his or her own decision units. His job
is to consider possible different ways to fulfill objectives.
The size of the business unit and the volume of goods it
deals with determine the number of decision units and
packages.The decision package has to contain all the
information which helps the management in deciding
whether the information is necessary for the business,
what would be the estimated costs and benefits
expected from it.
(5) Assessment and Grading of decision packages: These
packages invented and formulated are submitted to the
next level of responsibility within the organization for
ranking purposes. Ranking basically decides as to
whether or not to include the proposals in the budget.
The management ranks the different decision packages in
the order from decreasing benefit or importance to the
organization. Preliminary ranking is done by the unit
manager himself and for the further review it is sent to
the superior officers who consider overall objectives of
the organization.
(6) Allotment of money through Budgets: It is the last
step engaged in the ZBB process. According to the cost
 benefit
analysis and availability of the funds management has
ranks and thereby a cut‐off point is established.
Keeping in view reasonable standards, the approved
designed packages are accepted and others are
rejected. The funds are then allotted to different
decision units and budgets relating to each unit are
Advantages: prepared.

 ZBB rejects the attitude of accepting the current

position in support of an attitude of inquiring and
testing each item of budget.
 It helps improve financial planning and management
information system through various techniques.
 It is an educational process and can promote a management
team of talented and skillful people who tend to promptly
respond to changes in the business environment.
 It facilities recognition of inefficient and unnecessary activities
and avoid wasteful expenditure.
 Cost behavior patterns are more closely examined.
 Management has better elasticity in reallocating funds
for optimum utilization of the funds.
Disadvantages:
 It is an expensive method as ZBB incurs a huge cost every
in its preparation..
 It also requires high volume of paper work,hence
sometimes it becomes a tedious job.
 In ZBB there is a danger of emphasizing short‐term benefits at
the expenses of long term ones.
  This is not a new method for evaluating various alternatives,
and cost‐benefit analysis.
 The psychological effects can also not be ignored. It holds out
high hopes as a modern technique, claiming to raise the
profitability and efficiency of the business.

Budgets Reports:
Ascertaining budget in itself is of no use unless there is a
constant flow of budget reports showing assessment of the
actual and the budget figures. It should be prepared at regular
intervalslike every month showing results of the difference
between actual and budgeting figure. The reports should be
prepaid in such a way that they establish responsibility for the
variances. Reports should also disclose whether or not
variances are favourable and that they arecontrollable.
The contents of the budget report vary according to
the need of the managerial level. Reports are prepared in such
a way that the concerned manager is directly concerned to be
provided with detailed information. As the level grows higher,
the amount of detail becomes less although the coverage of
the report will widen.
Essentials of a Budget Report:
The following essentials should be kept in view while
preparing budget reports:
 The budget reports should be simple,
appropriateand understandable for the
concerned person.
 The report should be presented in time.
 The report should be precise. However, its accuracy should
not be at the cost of clarity.
 The principle of exemption should be utilized, where possible.
 It should contain only necessary information according to
the need of the concerned person.