Budgetary Control and Standard Costing

By-
Pratyay Das, MBA/10039/19
Priyanjaly Pandey, MBA/10034/19
Department of Management
Birla Institute of Technology, Mesra
MT 415 Cost Management
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 Budget and Budgetary Control System – Meaning &

Concept, Objectives, Advantages, Limitations

 Types of Budget

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 Contents
3
1. Budget- Meaning & Concept
2. Essentials of a budget
3. Difference Between Budget And Forecast
4. Budgetary Control
5. Objectives of Budgetary Control
6. Process of Budgetary Control
7. Advantages of Budgetary Control
8. Limitations of Budgetary Control
9. Essentials of Effective Budgeting
10. Types of Budget
 Functional Budget
 Master Budget
 Fixed & Flexible Budget
11. Bibliography
12. Questions & Answers
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4 Budget- Meaning & Concept

 In the budgeting process, managers in every department justify the resources they need to
achieve their goals. They explain to their superiors the scope and volume of their activities
as well as ow their task will be performed. The communication between superiors and
subordinates helps affirm their mutual commitment to company goals.

 “quantitative expression of a plan for a defined period of time. It may include planed sales
volumes and revenues, resources quantities, costs and expenses, assets, liabilities and cash
flows.”

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Essentials of a Budget
 It is planed and expressed in monitory terms but can also include physical units.
 It is prepared prior to a defined period of time during which it will operate.
 It is related to a definite future period.
 It is approved by management for implementation.
 It usually shows the planned income to be generated and expenditure to be incurred.
 It also shows capital to be employed during the period.
 It is prepared for implementation the policy framed by management and the objectives to be achieved during
the period.

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Difference Between Budget And Forecast
6 Basis of Budget Forecast
Distinction
Meaning Budget is a plan of action Forecast is a prediction

Persons Only the authorized management of the company can Anybody can make a forecast about the companies
prepare budget performance
authorized for
preparation

Terms of Budget is expressed in terms of rupees and quantities. It Forecast is not always expressed in terms of rupees and
relates to planned events i.e., plans and policy to be physical units. It is concerned with probable events
expression and followed which may happen under anticipated conditions during
Events a specified period

Period It is usually planned separately for each accounting It may cover long periods or years
period

Coverage It comprises the whole business unit It may cover a limited function or activity of business

Control Budget is a tool of control as it shapes according to It does not connotate any sense of control
conditions

Process The process starts where the forecast ends The function of forecast ends with the forecast of
likely events

Spheres It is made
MT415_CostManagement in respect of those spheres which are related It is made in several other spheres which may not be
to business or industry connected with budgeting process.
7 Budgetary Control
 The establishments of the budgets relating to the responsibilities of executives to the
requirements of a policy and continuous comparison of actual with budgeted result
either to secure by individual action the objectives of that policy or to provide a firm
basis for its revision.

 Budgeting is a technique for formulating budgets. It indicates a right path for

managing the business. It helps in anticipating various problems and to put
corrective measures to overcome the problems.

 Budgetary control is a technique of managerial control through budgets. It is

designed to assist management in the allocation of various responsibilities. It is the
system of achieving the firms objectives with minimum cost and provides a powerful
tool to the management for efficient performance of the managerial functions.

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Objectives of Budgetary Control

Planning Co-ordination Control Reporting and Evaluating

1. To ensure planning for future by setting up various budgets, the requirements and expected performance
of the enterprise are anticipated.
2. To operate various cost centers and departments with efficiency and economy.
3. Elimination of wastes and increase in profitability.
4. To anticipate capital expenditure for future.
5. To centralize the control system.
6. Correction of deviations from the established standards.
7. Fixation of responsibility of various individuals in the organization.
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 Planning
A budget provides a detailed plan of action over a definite period of time. By planning, many problems
ae anticipated before they arise and solutions can sought through careful study. Thus most business
emergencies can be avoided by planning.

 Co-ordination
Budgeting helps manager to in coordinating their efforts to that objective of the organization as a whole
harmonies to its divisional goals. There should be coordination in the budgets of various departments.

 Communication
A budget is a communication device. The approved budget copies are distributed to all management
personnel which provides not only adequate understanding and knowledge of the programs but also the
guidelines that are to be adhered to.

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10  Motivation
A budget is a device for motivating manager to perform and work in line with the company’s
objective. If individuals have participated actively in preparing budget, they will show much
more interest in achieving those targets.

 Control
Controls and actions are required to ensure that the targets laid down are achieved. Is a
systemized effort to keep management informed whether planed performance is achieved or not.

 Performance evaluation
Budget helps manager to identifies that whether they are meeting their targets which they have
set. The performance or promotion may be linked to achieving the budget targets.

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11 Process of Budgetary Control
Definition of
Objectives

Budget Reports Budget Period

Location of the Key
Factor

Standard of activity Budget Committee

or output

Organizational Budget Controller

Chart

Budget Centre Budget Manual

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12 Advantages of Budgetary Control
Some of the advantages of budgetary control are:
1. Maximization of Profits:
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 a proper control over various
capital and revenue expenditures. The resources are put to the best possible use.

2. Co-ordination:
The working of different departments and sectors is properly coordinated. 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.

3. Specific 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 some specific aims. If there is no definite aim then the efforts will be wasted
in pursuing different aims.
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 4. Tool for Measuring Performance:
13
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.
5. 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 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.
6. Determining Weaknesses:
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.
7. 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 deviations can be determined only at the end of the
financial period.
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14 8. 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.

9. 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.

10. Introduction of Incentive 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.

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 Limitations of Budgetary Control
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Some of the limitations are discussed as follows:
1. Uncertain Future:
The budgets are prepared for the future period. Despite best estimates made for the future, the predictions
may not always come true. The future is always uncertain and the situation which is presumed to prevail
in future may change. The change in future conditions upsets the budgets which have to be prepared on
the basis of certain assumptions. The future uncertainties reduce the utility of budgetary control system.

2. Budgetary Revision Required:

Budgets arc prepared on the assumptions that certain conditions will prevail. Because of future
uncertainties, assumed conditions may not prevail necessitating the revision of budgetary targets. The
frequent revision of targets will reduce the value of budgets and revisions involve huge expenditures too.

3. Discourage Efficient Persons:

Under budgetary control system the targets are given to every person in the organization. The common
tendency of people is to achieve the targets only. There may be some efficient persons who can exceed the
targets but they will also feel contented by reaching the targets. So budgets may serve as constraints on
managerial initiatives.

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4. Problem of Co-ordination:
The success of budgetary control depends upon the co-ordination among different departments. The
performance of one department affects the results of other departments. To overcome the problem of
co­ordination a Budgetary Officer is needed. Every concern cannot afford to appoint a Budgetary
Officer. The lack of co-ordination among different departments results in poor performance.

5. Conflict Among Different Departments:

Budgetary control may lead to conflicts among functional departments. Every departmental head
worries for his department goals without thinking of business goal. Every department tries to get
maximum allocation of funds and this raises a conflict among different departments.

6. Depends Upon Support of Top Management:

Budgetary control system depends upon the support of top management. The management should be
enthusiastic for the success of this system and should give full support for it. If at any time there is a
lack of support from top management then this system will collapse.

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Essentials of Effective Budgeting
 Support of top management
In order to make budgets effective, each member of top management should cooperate and should involve
themselves enthusiastically in the process of budget making. The whole system of budget making should
enjoy the active and spontaneous support of the top management.

 Participation by responsible executives

Those entrusted with the performance of the budgets should participate in the process of setting the budget
figures. This will ensure proper implementation of budget programs.

 Reasonable goals
The budget figures should be realistic and represent reasonably attainable goals. The responsible executives
should agree that the budget goals are reasonable and attainable.

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  Clearly defined organization
18 In order to derive maximum benefits from the budget system, well defined responsibility centers
should be built up within the organization. The controllable costs for each responsibility centers
should be separately shown.

 Continuous budget education

The best way to ensure the active interest of the responsible supervisors is continuous budget
education in respect of objectives, potentials & techniques of budgeting. This may be accomplished
through written manuals, meetings etc., whereby preparation of budgets, actual results achieved etc.,
may be discussed.

 Adequate accounting system

There is close relationship between budgeting and accounting. For the preparation of budgets, one
has to depend on the accounting department for reliable historical data which primarily forms the
basis for many estimates. The accounting system should be so designed so as to set up accounts in
terms of areas of managerial responsibility. In other words, responsibility accounting is essential for
successful budgetary control.
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  Constant vigilance
19 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 those expected.

 Maximum profits
The ultimate object of realizing the maximum profit should always be kept uppermost.

 Cost of the system

The budget system should not cost more than it is worth. Since it is not practicable to calculate
exactly what a budget system is worth, it only implies a caution against adding expensive
refinements unless their value clearly justifies them.

 Integration with standard cost

Where standard costing system is also used, it should be completely integrated with the budget
program , in respect of both budget preparation and variance analysis.

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20 Types of Budget
Budget

Coverage Capacity Condition Period

Functional Fixed Basic Short Term

Master Flexible Current Medium Term

Long Term

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 Functional Budget
21
A functional budget is that which relates to the functions of the business. There are several types of
functional budget out which following are the most prominent:
1. Sales Budget
2. Production Budget
3. Production Cost Budget
4. Raw Materials Budget
5. Purchase Budget
6. Labor Budget
7. Production Overhead Budget
8. Selling & Distribution Cost Budget
9. Administration Cost Budget
10. Capital Expenditure Budget
11. Cash Budget

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Sales Budget
Sales budget is the most important budget and of primary importance. It forms the basis on which all
the other budgets are built up. This budget is a forecast of quantities and values of sales to be achieved
in a budget period. Every effort should be made to ensure that its figures are as accurate as possible
because this is usually the starting budget (sales being limiting factor on which all the other budgets
are built up).
In the preparation of the sales budget, the sales manager should take into consideration the following
factors:
 Past Sales Figures and Trends
 Salesmen’s Estimates
 Company condition
 Business condition
 Special condition
 Market analysis

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 Production Budget
23 Production budget is a forecast of the total output of the whole organization broken down into
estimates of output of each type of product with a scheduling of operations (by weeks and months)
to be performed and a forecast of the closing finished stock. This budget may be expressed in
quantitative (weight, units etc.) or financial (rupees) units or both.
This budget is prepared after taking into consideration the estimated opening stock, the estimated
sales and the desired closing finished stock of each product.
 In preparing the production budget, the following factors are considered:
 The time lag between the production in the factory and sales to the customer should be
considered so as to allow for the time required for the dispatch of goods from the factory to the
place of the customers.
 The stock of goods to be maintained both at the factory’s godown and at the sales centers.
 The level of production needed to meet the sales program. Monthly production targets should be
fixed and it should be seen that production is kept more or less at a uniform level throughout the
year.

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Production Cost Budget

Production cost budget Production cost budget is also known as manufacturing budget. There are three
components of manufacturing cost budget direct material cost, direct labor cost and Factory overhead
cost. These budgets are based on standard rates or predetermined rates.

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Raw Materials Budget

The materials budget (or materials purchases budget) is used to plan how much raw materials
we need to have available to meet budgeted production. This budget is prepare similarly to the
production budget as the company must decide how much raw materials inventory they want
to have on hand at the end of each quarter.
This is typically determined as a percent of next quarter’s material needs. In a materials
budget, we will deal with units first and then add the budgeted cost near the end. We also need
to know how many direct materials are needed for each unit.

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 Purchase Budget
Purchase Budget is mainly dependent on production budget and material requirement budget. This budget
26 provides information about the materials to be acquired from the market during the budget period.
Following factors should be taken into consideration while preparing a purchase budget:
1. Quantity and quality of each material needed according to the production target
2. Capital items, tools and general supplies required during the budget period
3. The present stock position and materials expected to arrive, already covered by purchase orders
4. The dates on which purchase items are required
5. Prices of items to be bought and possibility of quantity discount;
6. Sources of supply
7. Availability of cash to settle accounts of suppliers
8. Transport requirements
9. Inspection and receiving arrangements
10. Storage capacity and other factors such as handling of stocks, insurance, obsolescence and shrinkage.
Purchase budget should be prepared by the purchase manager by getting relevant information about capital
items, tools, general supplies and direct materials required during the budget period from other related
departments. Like other budgets, the purchase budget has to be approved by the budget committee.

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Labor Budget

This budget gives an estimate of the requirements of direct labor essential to meet the production
target. This budget may be classified into labor requirement budget and labor recruitment budget. The
labor requirement budget is developed on the basis of requirement of the production budget given and
detailed information regarding the different classes of labor, e.g. fitters, welders, turners, millers,
grinders, drillers etc., required for each department, their scales of pay and hours to be spent.

This budget is prepared with a view to enable the personnel department to carry out programs of
training and transfer and to find out sources of labor needed so that every effort may be made to
remove difficulties arising in production through lack of suitable personnel.

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 Labor recruitment budget is prepared on the basis of labor requirement budget after taking into
28 consideration the available workers in each department, the expected changes in the labor force
during the budget period due to the labor turnover.

This budget gives information about the personnel specifications for the jobs for which workers are
to be recruited, the degree of skill and experience required and the rates of pay. In preparing the
labor cost budget, the question of overtime should not be overlooked because workers are to get
higher rates of wages if they work on overtime.

Regular overtime should be avoided by engagement of additional workers and extension of plant.
Where standard costing system is applied, the labor cost budget is developed on the basis of
standard labor cost per unit multiplied by the quantity of anticipated production determined in the
production budget. If standard costing system is not being followed in the organization, the
information of labor cost may be obtained from past records or estimated cost.

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 Product Overhead Budget
This budget gives an estimate of the works overhead expenses to be incurred in a budget period to
29 achieve the production target. The budget includes the cost of indirect materials, indirect labor and
indirect works expenses. The budget may be classified into fixed cost, variable cost and semi-
variable cost. It can be broken into departmental overhead budget to facilitate control.

In preparing the budget, fixed works overhead can be estimated on the basis of past information after
taking into consideration the expected changes which may occur during the budget period. Variable
expenses are estimated on the basis of the budgeted output because these expenses are bound to
change with the change in output.

The Cost Accountant prepares this budget on the basis of figures available in the manufacturing
overhead ledger or the head of the workshop may be asked to give estimates for the manufacturing
expenses. A good method is to combine the estimates of the Cost Accountant and the shop executive.

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Selling and Distribution Cost Budget

Selling and distribution cost budget forecasts the cost of selling and distributing the products.
This budget depends upon the sales budget. These expenses will very with the expected sales
figures during the period. These expenses may be estimates per unit of sales or some
percentage on sales, etc. The persons in-charge of sales and distribution should sit together to
prepare this budget.

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 Administration Cost Budget
31
This budget covers the expenses incurred in framing policies, directing the organisation and controlling the
business operations. In other words, the budget provides an estimate of the
expenses of the central office and of management salaries. The budget can be prepared with the help of past
experience and anticipated changes.

Budget may be prepared for each administration department so that responsibility for increasing such expenses
may be fixed and related to the different executives. Much difficulty is not experienced in developing such budget
as most of the administration expenses are of a fixed nature.

Although fixed expenses remain constant and are not related to sales volume in the short run, they are dependent
upon sales in the long run. With a small change in output, they do not change.

However, if there is a persistent fall in output, administration expenses will have to be reduced by discharging the
services of some members of the staff and taking other economy measures. On the other hand, with persistent
increase in output or business activity, administration expenses will increase but they may lag behind business
activity.

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 Capital Expenditure Budget
32 The capital expenditure budget gives an estimate of the amount of capital that may be needed for
acquiring the fixed assets required for fulfilling production requirements as specified in the
production budget. The budget is prepared after taking into consideration the available productive
capacities, probable reallocation of the existing assets and possible improvement in production
techniques. Separate budgets may La prepared for different items of fixed assets such as plant and
equipment budget, building budget etc.
The capital expenditure budget is an important budget providing for acquisition of assets,
necessitated by the following factors:
 Replacement of existing assets.
 Purchase of additional assets to meet a proposed increase in production due to increase in demand.
 Purchase of additional assets because of starting up of new lines of production.
 Installation of an improved type of machinery so as to reduce cost of production.

Thus, the capital expenditure budget enables one to know what new fixed assets are needed and what
will be their costs and rates of return.

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 Cash Budget
This budget gives an estimate of the anticipated receipts and payments of cash during the budget
33
period. Therefore, this budget is divided into two parts, one showing the estimated cash receipts on
account of cash sales, credit collections and miscellaneous receipts and the other showing the
estimated disbursement on account of cash purchases, amount payable to creditors, wages payable to
workers, indirect expenses payable, income tax payable, dividend payable, budgeted capital
expenditure etc. In short, every factor which affects the receipts and payments of cash is taken into
account in the preparation of this budget.

Cash budget makes a provision for a minimum cash balance which will be available at all times. In
general, this balance should be equal to one month’s operating expenses plus some provision for
contingencies. The minimum balance of cash will help in tiding over adverse conditions of a minor
nature. Meanwhile management can make alternative arrangement for additional cash.

This budget is prepared by the Chief Accountant for the guidance of management so that
arrangements may be made for the requirements of the organisation.

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There are three methods of preparing cash forecasts:

1. Receipt and Payment Method
2. Balance Sheet Forecast Method
3. Profit Forecast Method.

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 Cash Budget for the period….
Particulars Jan Feb Mar Apr
Cash Budget Format Rs. Rs. Rs. Rs.
Opening Balance of Cash
35
Additions:
Budgeted Net Profits
Depreciation
Provisions
Sales of Plant
Issue of Capital & Debentures
Reduction in Debtors
Reduction in stocks
Accrued Expenses
Increase in Liabilities
Total Additions
Total Cash Available
Deductions:
Dividends
Prepayments
Capital Profit
Increase in Stocks
Increase in Debtors
Increase in Liabilities

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Closing Balance of Cash
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Master Budget
 The master budget is the aggregation of all lower-level budgets produced by a company's various
functional areas, and also includes budgeted financial statements, a cash forecast, and a financing
plan. The master budget is typically presented in either a monthly or quarterly format, and usually
covers a company's entire fiscal year. An explanatory text may be included with the master budget,
which explains the company's strategic direction, how the master budget will assist in
accomplishing specific goals, and the management actions needed to achieve the budget. There
may also be a discussion of the headcount changes that are required to achieve the budget.

 A master budget is the central planning tool that a management team uses to direct the activities of
a corporation, as well as to judge the performance of its various responsibility centers. It is
customary for the senior management team to review a number of iterations of the master budget
and incorporate modifications until it arrives at a budget that allocates funds to achieve the desired
results. Hopefully, a company uses participative budgeting to arrive at this final budget, but it may
also be imposed on the organization by senior management, with little input from other employees.

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The budgets that roll up into the master budget include

 Direct labor budget
 Direct materials budget
 Ending finished goods budget
 Manufacturing overhead budget
 Production budget
 Sales budget
 Selling and administrative expense budget

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38 Following are the main advantages of the master budget:
1. A summary of all functional budgets in capsule form is available in one report.
2. The accuracy of all the functional budgets is checked because the summarized
information of all functional budgets should agree with the information given in the
master budget.
3. It gives an overall estimated profit position of the organisation for the budget period.
4. Information relating to forecast balance sheet is available in the master budget.
This budget is very useful the top management because it is usually interested in the
summarized meaningful information provided by this budget.

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 Fixed & Flexible Budget
39

Fixed Budget
 This budget is drawn for one level of activity and one set of conditions. It has been defined as a
budget which is designed to remain unchanged irrespective of the volume of output or turnover
attained. It is rigid budget and is drawn on the assumption that there will be no change in the
budgeted level of activity. It does not take into consideration any change in expenditure arising
out of changes in the level of activity.

 Thus, it does not provide for changes in expenditure arising out of change in the anticipated
conditions and activity. A fixed budget will, therefore, be useful only when the actual level of
activity corresponds to the budgeted level of activity.

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Flexible Budget
 The Chartered Institute of Management Accountants, England, defines a flexible budget (also
called sliding scale budget) as a budget which, by recognizing the difference in behavior
between fixed and variable costs in relation to fluctuations in output, turnover, or other variable
factors such as number of employees, is designed to change appropriately with such
fluctuations. Thus, a flexible budget gives different budgeted costs for different levels of
activity.

 A flexible budget is prepared after making an intelligent classification of all expenses between
fixed, semi-variable and variable because the usefulness of such a budget depends upon the
accuracy with which the expenses can be classified.

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Utility of Flexible Budget

1. Flexible budget provides a logical comparison of budgeted allowances with the actual cost i.e., a
comparison with like basis.

2. Flexible budget reckons operational realities and streamlines control function and profit planning. It gives
balanced perspective on comparison. When flexible budget is prepared, actual cost at actual activity is
compared with budgeted cost at actual activity i.e., two things to a like basis.

3. Flexible budget recognizes concept of variability and provides logical comparison of expenditure with
actual expenditure as a means of control.

4. With flexible budget, it is possible to establish budgeted cost for any range of activity.

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5. A flexible budget is very useful for purposes of budgetary control because it corresponds
with changes in the level of activity.

6. It is helpful in assessing the performance of departmental heads because their performance

can be judged in relation to the level of activity attained by the organization.

7. Cost ascertainment at different levels of activity is possible because a flexible budget is

prepared for various levels of activity.

8. It is helpful in price fixation and sending quotations.

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Bibliography
 http://www.yourarticlelibrary.com/organization/budgetary-control/budgetary-control-
meaning-objectives-and-essentials/53355
 https://freebcomnotes.blogspot.com/2017/07/essentials-of-effective-budgeting.html
 http://www.yourarticlelibrary.com/cost-accounting/budgetary-control-cost-
accounting/fixed-and-flexible-budget-meaning-difference-and-utility/73918
 http://www.yourarticlelibrary.com/cost-accounting/budgetary-control-cost-accounting/10-
functional-budgets-prepared-in-cost-accounting/56084
 Cost Accounting: Principles & Practice, SP Jain, KL Narang, S Agarwal, Kalyani
Publications, Twenty-Fifth Edition, V/2.1-V/2.15

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Questions
&
Answers

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Thank You…

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