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Chapter18

CONCEPTOFBUDGET
TheCharteredInstituteofManagementAccountants(CIMA)London,hasdefineda budget g asafinancialand/or / q quantitativestatement, ,p prepared p p priortoadefinedp period oftime,ofthepolicytobepursuedduringthatperiodforthepurposeofattaininga givenobjective.Itmayincludeincome,expenditureandemploymentofcapital.

Characteristics
Abudgetisprimarilyaplanningdevicebutitalsoservesasabasisfor performance f evaluation l ti and dcontrol. t l Abudgetispreparedeitherinmoneytermsorinquantitativetermsorinboth. Abudgetispreparedforadefinitefutureperiod. Purposeofabudgetistoimplementthepoliciesformulatedbymanagementfor attainingthegivenobjectives.

(a) ( ) (b) (c) (d)

CONCEPTOFBUDGETARYCONTROL
Budgeting:Theactofpreparingbudgetsiscalledbudgeting.InthewordsofJBatty,the entireprocessofpreparingthebudgetsisknownasbudgeting. ConceptofBudgetaryControl:AccordingtoCIMA,London,Budgetarycontrolisthe establishmentofbudgetsrelatingtotheresponsibilitiesofexecutivesofapolicyandthe continuouscomparisonoftheactualwiththebudgetedresults,eithertosecureby individualactiontheobjective j ofthepolicy p yortoprovide p abasisforitsrevision.

Characteristics
(a) (b) (c) (d) (e) Establishmentofbudgetsforeachfunction/departmentoftheorganization. Comparisonofactualperformancewiththebudgetsonacontinuousbasis. Analysis A l i of fvariations i ti of factual t lperformance f from f that th tth thebudgeted b d t dperformance f t toknow k the th reasonsthereof. Takingsuitableremedialaction,wherenecessary. Revisionofbudgetsinviewofchangesinconditions.

OBJECTIVESOFBUDGETARYCONTROL
Abudgetprovidesa detailedplanofaction for overa f abusiness b i definiteperiodof time. Budgetingaids managersinco ordinating di i their h i efforts ff sothatobjectivesof theorganization. Abudgetisacommunication device.Itprovidesnotonly adequate under d d standing di and d knowledgeoftheprogrammesand policiestobefollowedbutalso alertsabouttherestrictionstobe adheredto. Communication

Planning

Coordination

Abudgetisauseful deviceformotivating managerstoperform i line in li with i hthe h companyobjectives.

Controlisnecessary toensurethatplans andobjectivesaslaid d down i inthe h budgets b d arebeingachieved.

Abudgetprovidesauseful meansofinforming managershowwelltheyare performing f i in i meeting i targetstheyhavepreviously helpedtoset. Performance evaluation

Motivation

Control

ESSENTIALSOFEFFECTIVE BUDGETING
Support of S ftop management Participation byresponsible executives Continuous budget education Maximum profits Integration withstandard costs Reasonable R bl goals Adequate accounting system Costofthe system

Clearlydefined organization

Constant vigilance

PRELIMINARIESINTHEINSTALLATION OFBUDGETSYSTEM
Creationofbudgetcentres Budget d centreissectionof forganizationfor f which h habudget b d isprepared. d Introductionofadequateaccountingrecords Systemisdesignedtobeabletorecordandanalyseinformationrequired. Preparationofanorganizationchart Organizationchartshouldbepreparedwhichshowstheplanoforganization. Establishmentofbudgetcommittee Inlargeconcerns, concerns thedirectionandexecutionofthebudgetisdelegatedtoa budgetcommitteewhichreportsdirectlytothetopmanagement. Preparationofbudgetmanual Abudget g manualhasbeendefinedby yCIMA,Londonasadocumentwhich setsouttheresponsibilitiesforthepersonsengagedintheroutineofandthe formsandrecordsrequiredforbudgetarycontrol. Budgetperiod Budgetperiodisalengthoftimeforwhichabudgetispreparedandoperated. operated Determinationofthekeyfactor Thekeyfactormeansthefactorwhichlimitsthesizeofoutput.

CLASSIFICATIONOFBUDGETS
Onthebasisof functionand scope: Onthebasisof flexibility: y

Functional budgets Master g budget

Fixed budget Flexible g budget

FUNCTIONALBUDGETS
Afunctionalbudgetisonewhichrelatestoaparticularfunctionofthebusiness.
SalesBudget:Thesalesbudgetisastatementofplannedsalesintermsof quantityandvalue.

ProductionBudget:Theproductionbudgetisaplanofproductionforthebudget period.

ProductionCostBudget:Thisbudgetshowstheestimatedcostofproduction. Theproductionbudgetshowsthequantitiesofproduction.Thesequantitiesof productionareexpressedintermsofcostinproductioncostbudget. RawMaterialBudget:Thisbudgetshowstheestimatedquantitiesofalltheraw materialsandcomponentsneededforproductiondemandedbytheproduction budget.

PurchaseBudget:Thepurchasebudgetprovidesdetailsofthepurchaseswhich areplannedtobemadeduringtheperiodtomeettheneedsofthebusiness.

FUNCTIONALBUDGETS(Contd.)
LabourBudget:Labourcostisclassifiedintodirectandindirect.Somecompaniespreparea labourbudgetthatincludesbothdirectandindirectlabour,whileothersincludeonlydirect g labourcostandincludetheindirectlabourintheoverheadcostbudget. ProductionOverheadsBudget:Theproductionoverheadsbudgetrepresentstheforecast ofalltheproductionoverheads(fixed,variableandsemivariable)tobeincurredduringthe budgetperiod. SellingandDistributionCostBudget:Thisiscloselyrelatedtosalesbudgetand representstheforecastofallcostsincurredinsellinganddistributingthecompanys productsduringthebudgetperiod. AdministrationCostBudget:Thisbudgetrepresentsforecastofalladministration expenses,likedirectorsfees,managingdirectorssalary,officelighting,heatingandair conditioning,etc. CapitalExpenditureBudget:Thisbudgetrepresentstheexpenditureonallfixedassets duringthebudgetperiod.Itincludessuchitemsasnewbuildings,machinery,landand intangibleitemslikepatents,etc.

CashBudget: Itisadetailedestimateofcashreceiptsfromallsourcesandcashpayments forallpurposesandtheresultantcashbalancesduringthebudgetperiod.

CASH C S BUDGET U G
Itisadetailedestimateofcashreceiptsfromallsourcesandcashpaymentsforall purposesandtheresultantcashbalancesduringthebudgetperiod.

Preparation Budget P i of fCash C hB d


Receipts Thismethodisusuallyusedforshorttermcash.Thecashbudgetbeginswiththeopeningbalance and p fromvarioussourcesandfrom ofcashinhandandatbank.Tothisareaddedthecashreceipts Payments thisaredeductedallpaymentsofcash,whetheroncapitalorrevenueaccount.Theresultant figureistheclosingcashbalance. Method

Adjusted Thismethodissuitableforlongtermcashforecast.Itisbasedontheviewthatitisthe profitthatisthesourceofcashinthebusiness.TheprofitasperP&Laccountsisconvertedinto Profitand cash figurebypreparinganAdjustedProfitandLossAccount.Allthoseitemsofincomeand Loss expenditure,whichdonotinvolveaninfloworoutflowofcash,areadjustedintheforecasted Method profitfiguretoarriveatthefigureofcashmadeavailablebyprofit. profit

Balance Sheet Method

Thi Thismethod h dis i also l used dfor f f forecasting i cash hrequirements i f forl long.U Under d this hi method h db budgeted d d balancesheetispreparedwithallitemsofassetsandliabilities,exceptingcashorbankbalance. Thetwosidesofthebalancesheetarethentotalledandthebalancingfigureistakenascash.

MASTERBUDGET
According A di toCIMA, CIMA London, L d master budget b d is i asummarybudget b d incorporating i i its i componentfunctionalbudgetsandwhichisfinallyapproved,adoptedandemployed. Amasterbudgethastwoparts (i)operatingbudget,i.e.,budgetedprofitand lossaccount, (ii)financialbudget,i.e.,budgetedbalance sheet.

Themasterbudgetispreparedbythebudgetdirector(orbudgetofficer)andis presentedtothebudgetcommitteeforapproval.Ifapproved,itissubmittedtotheBoardof Di Directors for f fi final lapproval. l The Th Board B dmaymake k certain i amendments/alterations d / l i beforeitisfinallyapproved.

FIXEDANDFLEXIBLEBUDGETS U G S
FixedBudget:Afixedbudgetisonewhichispreparedkeepinginmindonelevelofoutput. Itisdefinedasabudgetwhichisdesignedtoremainunchangedirrespectiveofthelevelof activityattained. Flexible In aflexible Fl ibl Budget: B d I contrasttoafixed fi dbudget, b d fl ibl budget b d is i onewhich hi his i designed d i dto changeinrelationtothelevelofactivityattained.Theunderlyingprincipleofflexible budgetisthatabudgetisoflittleuseunlesscostandrevenuearerelatedtotheactual volumeofproduction.

DistinctionbetweenFixedandFlexibleBudgets
g assumesstatic Fixedbudget businessconditionswhereas flexiblebudgetisbasedon theassumptionofchanging businessconditions. Fixedbudgetispreparedfor only l onelevel l lof factivity ti it but b t flexiblebudgetsmaybe preparedfordifferentcapacity levelsorforanylevelof activity. Fixedbudgetfiguresarenot g whenactuallevelof changed activitychanges.Butin flexiblebudgets,thefigures areadjustedaccordingtothe actuallevelofactivity attained.

Whenactuallevelofactivitydiffers frombudgetedlevelofactivity,then infixedbudgetsmeaningful comparisonbetweenactualand budgetfiguresisnotpossible.Butin flexiblebudgets,suchcomparisons arequiterealistic.

Underchangingbusiness environments,fixedbudgetshave verylimiteduseforcontrol.But flexiblebudgetsareveryusefulfor costcontrolandperformance evaluationunderchangingbusiness environments.

BUDGET U G REPORTS O S
Establishingbudgetsinitselfisofnouseunlessthereisacontinuousflowofbudgetreports showingcomparisonofactualandbudgetfigures.Budgetreportsshouldbepreparedat regularintervals(say,everymonth)showingthereasonsforthedifferencesbetweenactual andbudgetfigures. figures EssentialsofaBudgetReport
(a)Thebudgetreportsshouldbesimpleandsuitableforthelevelofunderstandingfortheuser. (b)Reportsshouldbepresentedpromptly. (c)Reportsshouldbeaccuratebuttheextremeaccuracyshouldnotbeatthecostofpromptness. (d)The Th principle i i l of fexception ti should h ldbe b utilized, tili d where h possible. ibl (e)Thereportsshouldcontainonlyessentialinformationaccordingtotheneedsoftheuser.

ZEROBASEBUDGETING(ZBB)
AccordingtoCIMA,London,ZBBisdefinedasamethodofbudgetingwherebyall activitiesarerevaluatedeachtimeabudgetisset. set Discretelevelsofeachactivityarevalued andacombinationchosentomatchfundsavailable.

MainFeaturesofZeroBaseBudgeting(ZBB)
3.Adetailedcostbenefit analysisofeachbudget programmeisundertaken andeachprogrammehas tocompeteforscarce resources

1.Allbudgetitems,both oldandnewlyproposed, areconsideredtotally totall afresh

2.Amounttobespenton eachbudget g itemistobe totallyjustified

4.Departmental objectivesarelinkedto corporategoals

5.Themainstressinnot onhowmucha department p willspend p but onwhyitneedstospend

6.Managersatalllevels participateinZBBprocess andtheyhave corresponding accountabilities.

PERFORMANCEBUDGETING
Performancebudgetingisarelativelynewconceptwhichfocusesonfunctions,programmes andactivities.Performancebudgetsareestablishedinsuchamannerthateachitemof expenditurerelatedtoaspecificresponsibilitycentreiscloselylinkedwiththe performanceofthatcentre. centre

StepsinPerformanceBudgeting
p ycentreResponsibility p ycentres,asegment g Establishmentofresponsibility ofan organizationwhereamanagerisresponsiblefortheperformanceareestablished. EstablishmentofperformancetargetsForeachresponsibilitycentre,targetsareset intermsofphysicalperformancetobeachieved. EstimatingfinancialrequirementsInthisstep,thefinancialsupportneededto achievethephysicaltargetsisestimated. ComparisonofactualwithbudgetedperformanceThisisausualstepin budgetarycontroltoevaluatetheactualperformance. ReportingandactionVariancesfrombudgetedperformanceareanalysedand reportedforcorrectiveactiontobetaken.