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Budgetary Control System

Budgetary control refers to the


principles, procedures, and practices of
achieving given objectives through
budgets and budget reports. It has been
defined as "the establishment of
departmental budgets relating to 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 to the
objective of their policy or to provide a basis
for its revision."
• Classification of Budgets
Budgets can be classified on the basis of
(a) Time (b) Nature (c) Activity and (d)
Functions.
I. Classification of Budgets according to
Time: (a) Long-term budget - extending five
to ten years: (b) Short-term budget - ranging
for a period of one or two years, (c) Current
budget up to one year; (d) Interim budget in
between two budget periods.
II. Classification of budget according to
Nature : (a) Operating budgets relating
to the operations of the enterprise, (b)
Financial Budgets concerning with the
financial implications of the operating
budgets i.e. relating to the capital
structure and liquidity of the enterprise;
e.g., Cash budget, Capital budget etc.
III. Classification according to Activity
Level or Capacity: Budgets, according
to activity, may be of two types (i) Fixed
Budget and (ii) Flexible (variable)
Budget. Fixed budget is one which
remains unchanged in spite of changes
in volume of output or level of activity.
This budget is prepared for a specific
planned activity and it is not adjusted
according to activity level attained.
On the other hand, a flexible or variable
budget is one which is prepared for
changing level of activity. It is also
known as ‘Sliding Scale Budget’. The
principle of flexible budget lies in
making a series of fixed budgets for
different levels of activity. A flexible
budget considers the difference in the
behaviour of fixed and variable costs.
IV. Classification according to
Functions Involved:
(a) Sales Budget: This is probably the
most important budget and is prepared
to show what finished products can be
sold in what quantities and at what
prices. It may be prepared (a) product-
wise (b) territory-wise (c) customer-
wise (d) period-wise and (e) according
to salesman.
In preparing a sales trend, the following
factors should be considered analysis of
past sales trend, estimates of salesman,
available plant capacity, orders on hand,
seasonal fluctuations in demand,
competition and market conditions.
(b) Production Budget: This budget is
based on sales budget as it has to
provide for the output needed to meet
the requirement of the sales budget. The
following points are kept in view while
preparing this budget: Production cycle,
availability of plant capacity, make or
buy decisions, desired inventory levels
and sales requirements.
(c) Raw Materials (Purchase) Budget: It is
based upon production budget, as this budget
provides for the materials needed for
production. Materials may be direct or
indirect. The materials budget generally deals
only with the direct materials. Indirect
materials are generally included in the works
overhead budget. Quantities of raw materials
to be used, cost of such materials, desired
inventory levels, storage space, economic size
of order, price, order already placed, etc., are
the main factors influencing this budget.
(d) Direct Labour Budget: Direct
Labour or Personnel budget covers the
estimates of direct labour requirements -
trained and untrained, essential for
carrying out the budgeted output. This
budget is generally prepared on the basis
of the different grades and trades of
workers needed for each
job/process/production.
(e) Plant Utilisation Budget: This budget
is also based on production budget. The
plant utilisation budget determines the
machine load in each department during
the budget period.
(f) Overheads Budgets: Overheads
budgets may be (a) Factory Overheads
Budget (b) Administrative Overheads
Budget (c) Selling and Distribution
Overheads Budget.
Manufacturing or Factory overheads
budget will provide an estimate of cost of
indirect labour, indirect material and
indirect expenses to be incurred in the
budget period. Administrative Overhead
budget covers the expenses of all the
central offices, and management salaries,
selling and distribution overhead budget
includes all expenses relating to selling,
advertising, delivery of goods to
customers, etc.
(g) Research and Development Budget:
This budget tells the estimated
expenditure for development and
research during the budget period. It is
drawn up taking into account the
research projects in hand and the new
projects to be taken up.
(h) Cash/Finance Budget: It is one of the
most important components of the financial
budget. The cash budget usually consists of
two parts giving detailed estimates of (i)
cash receipts and (ii) Cash payments.
Estimates of cash receipts are prepared on a
monthly basis and depend upon estimated
cash sales, collection from debtors, and
anticipated receipts from other sources e.g.,
sale of assets, borrowings, etc. Estimates of
cash payments are based on estimated
purchases of assets etc.
(i) Capital Expenditure Budget: This
budget plans for expenditure on fixed
assets. It involves heavy amount: its
impact is very much felt on the
production capacity or profitability of
the unit. Usually the plan period of this
budget stretches beyond the budget
period.
(j) Master Budget: It is the summary
budget, incorporating its component
functional budget, which is finally
approved, adopted and employed. The
budget may take the form of a Profit and
Loss Account and a Balance Sheet at the
end of the Budget Period.
• These functional budgets can also be
regrouped into (i) physical budgets,
(ii) cost budgets, (iii) profit budgets
and (iv) financial budgets.
• Administration of Budgetary Control
The process of budgetary control can be
reasonably divided into two stages (1)
preparation of budgets and (2)
implementation of the budget
performance. The preparation of a
budget can be viewed as an accounting
process and its implementation as a
management process.
Its effectiveness to a large extent
depends upon the organisation
efficiency. In a large-sized organisation,
an effective budgetary control system
can be organised on the following lines:
(i) Determining Objectives: A budget
being a plan for the achievement of
certain operational objectives, it is
desirable that same are defined very
precisely. The objectives should be
written out and the areas of control
should be clearly demarcated in order to
give a clear understanding of the plan
and its scope to all those who must
cooperate to make it a success.
(ii) Establishment of Budget Centres: A
budget centre is a section of the
organisation of an undertaking defined for
the purpose of budgetary control. A budget
is prepared for each budget centre and,
therefore, the budget centres should be
properly selected. A budget which refers to
a budget centre is a departmental budget.
A budget centre may again consist of a
number of cost centres representing
different groups of machines.
(iii)Introduction of Adequate Accounting
Records and Their Codification: The
budget department depends on the
accounts department for reliable
historical data which form the basis of
many estimates.
(iv)Preparation of Budget Organisation
Chart: Organisation chart defines the
functions and responsibilities of each
member of management and ensures that
each one knows his position on the
organisation and his relationship to other
members. It should also be supplemented
by written directives concerning the
function of the staff members. The
organisation chart depends upon the nature
and size of the enterprise; however, a
simple chart is given below.
. Managing Director
Budget Committee
Budget Officer

Sales Production Personnel Development


Manager Manager Manager Manager

Sales Budget, Production Labour Research &


Selling & Budget Budget Development
Distribution Budget
Budget etc.,
Purchase Finance
Manager Manager

Raw Material Budget, Stores &


Cash Budget, Capital Budget
Stock Budget
(v) Establishment of a Budget
Committee: In a small business, it is the
(Cost) Accountant who prepares the
budget, but in big undertaking, a Budget
Committee is appointed for this purpose.
The Budget committee consists of Chief
Executive or Managing Director, Budget
officer or Director or Controller and the
heads of main departments. The Chief
Executive acts as the chairman, and cost
accountant as its secretary.
The Managers of different departments
prepare their budget and submit to this
Committee. This Committee makes
necessary adjustments, coordinates all
the budgets and prepares a Master
Budget. The functions of a budget
committee are:
• ensuring that everyone appreciates the
budget efforts;
• reconciling divergent views;
• offering technical advice;
• coordinating budgeting activities;
• reviewing individual budgets;
• suggesting revisions, or approving
budget proposals without further
revision; and
• scrutinizing control reports in the latter
stages of the budgetary process.
(vi) Preparation of Budget Manual: It is
document or schedule or rule book
which sets out the responsibilities of the
persons engaged in the routine of and
the forms and records required for
budgetary control. This manual lays
down the budget programmes, and the
specific and general duties of the
executives, departmental managers and
the Budget Committee. The budget
manual usually contains the following:
• responsibilities of the persons engaged in
budgetary control;
• length of budget periods and control periods;
• the budget calendar showing the dates of
completion for each part of the budget and
submission of reports; dates of review, revision
and instructions issued;
• forms and records required for budgetary control;
• the accounts code and classification used by the
Company; method of accounting to be adopted;
procedure for preparation of financial statements
and reporting the same;
• budget proforma, etc;
• the follow-up Procedures.
• Budget Time Table: The budget manual
should give a schedule as to who is
responsible for what in an organisation.
Each responsible person should know
by what date he should finish his work.
• The following list describes the
activities for which different persons-
are generally responsible for:
Managers Responsible for
Sales Sales in terms of quantity, selling
prices, discounts, rebates, etc; sales
forecast, selling costs including those
of sales managements; representation,
advertising, etc; forecast of selling and
distribution costs; capital requirements.
Distribution Distribution costs including those of
transports storage etc., quantity of
finished goods stock.
Production Production in terms of quantity;
production costs; forecast of
production costs - material, labour
and overhead; raw material stocks
and work-in-progress; capital
requirements.
Research and Research costs; forecast research and
Development development costs, capital
requirements.
Managing Profit planning; capital expenditure;
Director depreciation; current assets and
liabilities e.g., level of trade debtors
and the cash position.
Company Administration costs - legal
Secretary expenses, audit fees, etc; forecast
administration costs; capital
requirements.
Budget Review of sales forecast, current
Committee operating results; review and approval
of master budget; long-term budget;
approval of department budget,
monthly cash forecast.
• Performance Report Time Table: A budget
manual should specify as to when performance
reports will be ready and given to managers.
For example, performance reports may be made
available after 15 days of the end of the
accounting period. The accounts departments
should ensure that this timetable is being
adhered to. Likewise, the budget committee
will review the performance results. Reports
from managers of budget centres should be
submitted to the budget committee before they
are discussed in the meeting.
(vii) Level of Activity: It is essential to
establish a normal level of activity since
it forms the basis of the budget. Level of
activity can be attained by efficient
working under the existing condition.
(viii) Selection of the Budget Period: The
period covered by a budget is known as
budget period. The length of the budget
period normally depends upon the
nature of the plan, circumstances of the
business, the control aspect, production
period and timings of availability of finance.
Most manufacturing industries use one year
as the budget period. For control purposes,
the annual totals are divided by 12 to obtain
monthly budgets; but if seasonal fluctuations
are important, separate budget estimates can
be made for each month or season. A budget
prepared for a very long time cannot be very
accurate as it is very difficult to forecast
events for a longer period.
(ix) Locating the Principal Budget
Factor: Budgets should be evolved
around the Principal budget factors (or
limiting, scarce or key factors) in
business. Every business has its own
key factors, which limits the level of
activities. These key factors should be
correctly identified and diagnosed. In
most of the enterprises, sales (demand)
is normally the key factor.
The success of the budgetary control
rests on the accuracy of the sales
forecast. If the sales figure proves to be
inaccurate, most of the budgets will be
affected. Similarly, materials, labour,
cash, space, equipment, management
etc., may also be the key factors. The
following is a detailed list of key
factors.
Sales (i) Marketing potentialities and
consumer demand,
(ii) Shortage of pushing salesmen,
(iii) inadequate advertising.
Materials (i) Availability of supply,
(ii)Restrictions imposed by licenses,
quota etc.
Labour (i) General shortage of workers,
(ii) Shortage in certain grades e.g.,
operation of modem complex
machinery.
Plant (i) Insufficient capacity due to
shortage in supply,
(ii) Insufficient capacity due to lack
of capital,
(iii) Bottlenecks in certain key
processes, operations or
departments.
Management (i) Shortage of efficient executives,
(ii) Lack of capital,
(iii) Insufficient research into product,
design and methods.
• Sometimes there may be two or more
limiting factors at the same time and the
budget committee has to take greater
care so as to assess the relative influence
of the key-factors. This problem is
generally solved with the help of graphs,
linear programming, operational
research, etc. It may be mentioned that
the key factor is not a permanent factor
and in the long run management may
get suitable opportunities to overcome
the key factor limitations by working
overtime of shifts, introducing new
methods, changing materials mix, hiring
new machinery or buying new
equipment on hire purchase, providing
incentive schemes and producing and
selling more profitable products,
selecting the optimum level of
production, etc.
(x) Determination of Budget Cost Allowance:
It is 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.
(xi) Implementation of the Budget and
Recording of Actual Performance: A copy
of the section of the master budget
appropriate to each department sphere of
activity is issued to their respective heads for
execution.
(xii) Budget Variance Analysis &
Reporting: A variance is the divergence
between any planned result and the actual
result measured in monetary terms. Budget
variance is the difference between a
budgeted figure and an actual figure. The
overall variance between a planned cost and
an actual cost is usually due to a number of
factors. Ascertaining the contribution of each
factor to the overall variance is known as
variance analysis.
Any budget variance can be either (i) a
favourable variance which on its own
would result in the ultimate profit being
better than that planned or (ii) an adverse
variance which on its own would result in
the ultimate profit being worse than that
planned. A budget variance may be either
controllable or uncontrollable. A
controllable cost variance is one which be
identified as the primary responsibility of
a specified person.
It should be borne in mind that when
computing budget variance it is always
the budget allowance (allowed figures)
that is compared with the actual figure
and the original figure has no relevance.
• Elements of a Successful Budgetary
Control System
• The success of the budgeting process in an
organisation depends on the following
essential elements:
• Objectives: All planning presupposes that
objectives have been established, since the
plan is merely a means to an end, not an end
in itself. Objectives are the end.
• Knowledge of Cost Behaviour: It is
essential that there be an awareness of
the firm's particular cost patterns, and
the influences thereon. Cost-volume-
profit analysis is a useful adjunct to the
budgeting exercise, as it aids
considerable in understanding cost
behaviour.
• Accurate Forecasting of Business Activities:
Forecasting is a prerequisite in a budgeting
process. It is not only the starting point, but is also
critical to the development of an accurate budget.
Forecasting can be done regarding activities which
are internal and external to an organisation.
Internal activities are easier to forecast than
external activities such as production forecast. But
external factors like state of and nature of market
conditions, inflation or deflation and its effect on
company products are difficult to predict. Business
firms require competent market researchers to
forecast accurately such external factors.
• Coordinating Business Activities:
Budgeting needs to coordinate all the
individual budgets into an integrated plan as
each budget has certain implications tor the
other budgets. There must be coordination
between sales, production, purchasing, and
personnel budgets. Budgets are useful tools
in communicating budgetary expectations
and goals and in bringing necessary
adjustments among organisational activities.
• Education: All levels of management must be
convinced of the usefulness of budgets, and know the
part that each must play in planning and control
through budgets. This requires a continuous
programme of training in budgeting methods and their
value.
• Communicating the Budgets: The success of a
comprehensive budgeting programme depends on
communication of individual budgets to the different
units in the organisation. The basic point is that the
preparation of the budget is of no value unless it is
known to the person for whom it is meant. Managers
are not responsible for budget unless the budget is
communicated clearly, concisely and in an
authoritative manner to them.
• Acceptance and Cooperation: Successful
budgeting also requires that budgets should be
accepted by the people who must execute them.
Budgeting should have the active cooperation of
the entire organisation from the top to the bottom.
Cooperation for the budget can be achieved in a
number of ways.
• Reasonable Flexibility: The budgeting
programme should contain reasonable flexibility if
the situation so demands. However, it should be
noted that too much flexibility and too much
tightness are both undesirable. Too much
flexibility will weaken the cost control and the
budget will become inoperative. Similarly, too
much regidity not permitting reasonable deviations
will create problems and restrictions in the
implementation of the budget. If conditions have
changed making the estimates and budgets
inaccurate, the budgets should be revised. A
budget is simply a tool of to serve managements
needs and not an irrevocable contract.
• Adequate Systems Support: This will
come mainly from the accounting sphere,
where it must be ensured that records and
procedures are sufficient for the task in
hand. Thus, the budget should be linked to
the accounting system in such a way that
the same definitions, etc., relate to
common elements. (For example, if
inventories in the budget system are
valued at standard cost, so should the
inventories in the accounting system.)
• Providing a Framework for
Evaluation: Budgeting provides a basis
to evaluate the performance of different
departments. A comprehensive budget,
properly developed, will contain initially
organisational goals and expectation and
subsequently can be used as an effective
evaluation technique.
• Advantages of Budgetary Control:
• (i) Budgetary control aims at maximisation of
profits through optimum utilisation of resources.
• (ii) It is a technique for continuous monitoring of
policies and objectives of the organisation.
• (iii) It helps in reducing the costs, thereby helps in
better utilisation of funds of the organisation.
• (iv) All the departments of the organisation are
closely coordinated through establishment of plans
resulting insmooth functioning of the organisation.
• (v) Since budgets fix the responsibilities of the
executives, they act as a plan of action for them
there by reducing some of their work.
• (vi) It facilitates analysis of variances, thereby
identifying the areas where deficiencies occur and
proper remedial action can be taken.
• (vii) It facilitates the management by exception.
• (viii) Budgets act as a motivating force to achieve
the desired objective of the organisation.
• (ix) It assists delegation of authority and is a
powerful tool of responsibility accounting.
• (x) It helps in stabilizing the conditions in industries
which face seasonal fluctuations.
• (xi) It helps as a basis for internal audit.
• (xii) It provides a suitable basis for introducing the
payment by results system.
• (xiii) It ensures adequacy of working capital to the
organisation.
• (xiv) It aids in performance analysis and performance
reporting system.
• (xv) It aids in obtaining bank credit.
• (xvi)Budgets are forerunners of standard costs in the
sense that they create necessary conditions to suit
setting upof standard costs.
• Preliminaries for the Adoption of a System of
Budgetary Control:
• For the successful implementation of a system of
budgetary control certain pre-requisites are to be
fulfilled. These are enumerated below:
• (i) There should be an organization chart laying
out in clear terms the responsibilities and duties of
each level of executives, and the delegation of
authority to the various levels. For complete
success, a solid foundation in this regard should be
laid at the outset.
• (ii) The objectives, plans and policies of the
business should be defined in clear cut and
unambiguous terms.
• (iii) The output level for which budgets are fixed,
i.e., the budgeted output, should be stated.
• (iv) The particular budget factor which will be the
starting point of the preparation of the various
budgets should be indicated.
• (v) There should be an efficient system of
accounting to record and provide data in line with
the budgetary control system.
• (vi) For the establishment and efficient execution of
the plan, a Budget Committee should be set up.
• (vii) There should be a proper system of
communication and reporting between the various
levels of management.
• (viii) There should be a charter of programme.
This is usually in the form of a budget manual.
• (ix) The budgets should primarily be prepared by
those who are responsible for performance.
• (x) The budgets should be complete, continuous
and realistic.
• (xi) There should be an assurance from the top
management executives of co-operation and
acceptance of the budgetary system.
• Functional Budget:
• If budgets are prepared of a business concern for a
certain period taking each and every function
separately such budgets are called functional
budgets.
• Example: Production, Sales, purchases, cost of
production, cash, materials etc.
• The following are the various functional budgets,
some of which are briefly explained here under:
• (i) Sales Budget: The sales budget is a forecast of
total sales, expressed in terms of money or
quantity or both. The first step in the preparation
of the sales budget is to forecast as accurately as
possible, the sales anticipated during the budget
period. Sales forecasts are usually prepared by the
sales manager assisted by the market research
personnel.
• Factors to be considered in preparing Sales
Budget:-
• As business existence depends upon the sales it is
going to make and therefore it is an important one
to be prepared meticulously. It is the forecast of
what it can reasonably sell to its customers during
the period for which budget is prepared. The
company’s profit mostly depends upon the ability
to sell its products to customers. In the present era
it is indispensable to establish the demand for the
product even before it is produced. It is the sales
order book that the company’s continuity depends
upon. Also, a reasonable degree of accuracy must
be there in preparing a sales budget unless its sales
are accurately forecast, production estimates will
also become erroneous. A good amount of
experience must be necessary to prepare the sales
budget. Yet the following factors must be
considered in preparing the sales budget:
• (a) The locality of the market i.e., domestic or export
• (b) The target customers i.e., industry or trade or a section
or group of general public etc.,
• (c) The product portfolio i.e., the number of products
offered and their popularity among the target customers.
• (d) The market share of each product and its influence on
the product portfolio and the total market
• (e) The effectiveness of existing marketing policy on the
current sales volume and value.
• (f ) The market share of competitor’s products and their
effect on the company’s sales.
• (g) Seasonal fluctuation in sales.
• (h) Expenditure on advertisement and its impact on sales.
• (ii) Production Budget: The production budget
is a forecast of the production for the budget
period. Production budget is prepared in two
parts, viz. production volume budget for the
physical units of the products to be manufactured
and the cost of production or manufacturing
budget detailing the budgeted cost under material,
labour, and factory overhead in respect of the
products.
• Factors to be considered in Production Budget:
• Next to the sales budget, the main function of a
business concern is the production and for this, a
budget is prepared simultaneously with the sales
budget. It is the forecast of production during the
period for which the budget is prepared. It can also
be prepared in two parts viz., production volume
budget for the physical units i.e., the number of
units, the tonnes of production etc., and the cost of
production or manufacture showing details of all
elements of the manufacture. While preparing the
production budget, the following factors must be
taken into consideration:-
• (a) Production plan:-
• Production planning is an important part of the
preparation of the production budget. Optimum
utilisation of plant capacity is taken by eliminating
or reducing the limiting factors and thereby
effective production planning is made.
• (b) The capacity of the business concern:-
• It is to be ensured that the capacity of the
organisation will coincide the budgeted production
or not. For this purpose, plant utilisation budget
will also be necessary. The production budget
must be based on normal capacity likely to be
achieved and it should not be too high or too low.
• (c) Inventory Policy:-
• While preparing the production budget it is also
necessary to see to what extent materials are
available for producing the budgeted production.
For that purpose, a purchase budget or a purchase
plan must also be studied. Similarly, on the other
hand, it is also necessary to verify the extent to which
the inventory of finished goods is to be carried.
• (d) Sales Policy:-
• Sales budgets must also be considered before
preparing production budget because it may so
happen that the entire production of the concern may
not be sold. In such a case the production budget must
be in line with the sales budget.
• (e) Sequence of Operations Policy:-
• A plan of the sequence of operations of production for
effective preparation of a production budget should
always be there.
• (f) Management Policy:-
• Last, but not the least, the policy of the
management should also be considered before
preparing the production budget.
• Objectives and Advantages of Production
budget:
• • Optimum utilisation of the productive resources
of the organisation;
• • Maintaining low inventory which results in risk
of deterioration and fall in prices;
• • Focus on the factors that are necessary to frame
policies and plan sequence of operations;
• • Projection of policies framed, on the basis of past
performance, into the future to get the desired
results;
• • To see that right materials are provided at right
place and at right time;
• • Helps in scheduling of production so that
delivery dates are met and customer satisfaction is
gained;
• • Helpful in preparation of projected profit and
loss statement, which is useful in evaluation of
performance and profitability.
• (iii) Materials Budget: The material budget
includes quantities of direct materials; the
quantities of each raw material needed for each
finished product in the budget period is specified.
The input data for this budget is obtained by
applying standard material usage rates by each
type of material to the volume of output budgeted.
• (iv) Purchase Budget: The purchase budget
establishes the quantity and value of the
various items of materials to be purchased for
delivery at specified points of time during the
budget period taking into account the production
schedule of the concern and the inventory
requirements. It takes into account the
requirements for the entire budget plan as per the
sales, materials, maintenance, research and
development, and capital budgets. Purchases may
be required to be made in respect of direct and
indirect materials, finished goods for resale,
components and parts, and purchased services.
Before incorporation in the purchase budget, these
purchase requirements should be suitably
ascertained. Purchase budget also includes
material procurement budget.
• (v) Cash Budget: Cash Budget is estimated
receipts and expenses for a definite period,
which usually are cash sales, collection from
debtors and other receipts and expenses and
payment to suppliers, payment of wages, payment
of other expenses etc.
• (vi) Direct Labour Budget.
• (vii) Human Resources Budget.
• (viii) Selling and distribution cost budget.
• (ix) Administration Cost Budget.
• (x) Research and development Cost Budget etc.
• (xi) Master Budget: Master budget is the
budget prepared to cover all the functions of
the business organisation.
• It can be taken as the integrated budget of business
concern, that means, it shows the profit or loss and
financial position of the business concern such as
Budgeted Profit and Loss Account, Budgeted
Balance Sheet etc. Master budget, also known as
summary budget or finalized profit plan, combines
all the budgets for a period into one harmonious
unit and thus, it shows the overall budget plan.
The master budget incorporates all the subsidiary
functional budgets and the budgeted Profit and
Loss Account and Balance Sheet. Before the
budget plan is put into operation, the master
budget is considered by the top management and
revised if the position of profit disclosed therein is
not found to be satisfactory. After suitable revision
is made, the master budget is finally approved and
put into action. Another view regards the budgeted
Profit and Loss Account and the Balance Sheet as
the master budget.
FIXED, VARIABLE, SEMI-
VARIABLE BUDGETS
• Fixed or Rigid Budget:
• When budgets are prepared for a fixed or standard
volume of activity, they are called static or rigid or
fixed budgets. They do not change with the
changes in the volume of the output. These are
prepared normally 3 months in advance of the
year. However these will not be much helpful in
comparing the actual activity, as these are prepared
at a fixed volume of output. It, however, does not
mean that the fixed budget is a rigid one, not to be
changed at all. Though not adjusted to the actual
volume attained, a fixed budget is liable to
revision if due to business conditions undergoing a
basic change or due to other reasons, actual
operations differ widely from those planned in the
fixed budget.
Fixed budgets are most suited for fixed expenses.
In case of discretionary costs situations where the
expenditure is optional and has no relation with
the output, e.g. expenditure on research and
development, advertising, and new projects. A
fixed budget has only a limited application and is
ineffective as a tool for cost control. Fixed budgets
are useful where the plan permits maximum
stabilization of production, as for example, for
concerns which manufacture to build up
inventories of finished products and components.
• Flexible Budget:
• A flexible budget is a budget that is prepared for
different levels of activity or capacity utilization or
volume of output. If the budgets are prepared in
such a way so as to change in accordance with the
volume of output, they are called flexible budgets.
These can be prepared from fixed budget which
are also called revised budgets. These are much
helpful in comparison with actual because the
exact deviations are found for which timely
corrective action can be taken. The basic idea of a
flexible budget is that there shall be some standard
of cost and expenditures. Thus, a budget prepared
in a manner to give budgeted costs for any level of
activity is known as flexible budget. Such budget
is prepared after considering the variable and fixed
elements of costs and the changes, which may be
expected for each item at various levels of
operations. Thus a flexible budget recognises the
difference in behaviour between fixed and variable
costs in relation to fluctuations in production or
sales and is designed to change appropriately with
such fluctuations. In flexible budget, data relating
to costs, expenditures may progressively be
changed in any month in accordance with actual
output achieved. While preparing flexible budgets,
estimates of costs and expenditures on the basis of
standards determined are made from minimum to
maximum level of operations.
• Difference between Fixed and Flexible Budgets:
Fixed Budget Flexible Budget
It does not change with It can be recasted on the
actual volume of activity basis of activity level to be
achieved. Thus it is known achieved. Thus it is not rigid.
as rigid or inflexible budget.
It operates on one level of It consists of various budgets
activity and under one set of for different levels of
conditions. It assumes that activity.
there will be no change in the
prevailing conditions, which
is unrealistic.
Here as all costs like – fixed, Here analysis of variance
variable and semi-variable provides useful
are related to only one level information as each cost is
of activity so variance analysed according to its
analysis does not give useful behaviour.
information.
If the budgeted and actual Flexible budgeting at
activity levels differ different levels of activity
significantly, then the facilitates the
aspects like cost ascertainment of cost,
ascertainment and price fixation of selling price
fixation do not give a and tendering of
correct picture. quotations.

Comparison of actual It provides a meaningful


performance with budgeted basis of comparison of the
targets will be meaningless actual performance with the
specially when there is a budgeted targets.
difference between the two
activity levels.
• Principal Budget Factor:
• Budgets cover all the functional areas of the
organisation. For the effective implementation of
the budgetary system, all the functional areas are
to be considered which are interlinked. Because of
these interlinks, certain factors have the ability to
affect all other budgets. Such factor is known as
principle budget factor. Principal Budget factor is
the factor the extent of influence of which must
first be assessed in order to ensure that the
functional budgets are reasonably capable of
fulfilment. A principal budget factor may be lack
of demand, scarcity of raw material, non-
availability of skilled labour, inadequate working
capital etc. If for example, the organisation has the
capacity to produce 2500 units per annum. But the
production department is able to produce only
1800 units due to non-availability of raw
materials. In this case, non-availability of raw
materials is the principal budget factor (limiting
factor). If the sales manger estimates that he can
sell only 1500 units due to lack of demand. Then
lack of demand is the principal budget factor. This
concept is also known as key factor, or governing
factor. This factor highlights the constraints with
in which the organisation functions.
• Responsibility Accounting:
• One of the recent developments in the field of
management accounting is the responsibility
accounting, which is helpful in exercising cost
control. ‘Responsibility Accounting is a system of
accounting that recognizes various responsibility
centers throughout the organization and reflects
the plans and actions of each of these centers by
assigning particular revenues and costs to the one
having the pertinent responsibility. It is also called
profitability accounting and activity accounting.
• It is a system in which the person holding the
supervisory posts as president, function head,
foreman, etc are given a report showing the
performance of the company or department or
section as the case may be. The report will show
the data relating to operational results of the area
and the items of which he is responsible for
control. Responsibility accounting follows the
basic principles of any system of cost control like
budgetary control and standard costing. It differs
only in the sense that it lays emphasis on human
beings and fixes responsibilities for individuals.
It is based on the belief that control can be
exercised by human beings, so responsibilities
should be fixed for individuals.
Principles of responsibility accounting are as
follows:
• (a) A target is fixed for each department or
responsibility center.
• (b) Actual performance is compared with the
target.
• (c) The variances from plan are analysed so as to
fix the responsibility.
• (d) Corrective action is taken by higher
management and is communicated.
• Performance Budgeting:
• Performance Budgeting is synonymous with
Responsibility Accounting which means thus the
responsibility of various levels of management is
predetermined in terms of output or result keeping
in view the authority vested with them. The main
concepts of such a system are enumerated below:
• (a) It is based on a classification of managerial
level for the purpose of establishing a budget for
each level. The individual in charge of that level
should be made responsible and held accountable
for its performance over a given period of time.
• (b) The starting point of the performance
budgeting system rests with the organisation chart
in which the spheres of jurisdiction have been
determined. Authority leads to the responsibility
for certain costs and expenses which are forecast
or present in the budget with the knowledge of the
manager concerned.
• (c) The costs in each individual’s or department’s
budget should be limited to the cost controllable
by him.
• (d) The person concerned should have the
authority to bear the responsibility.
ZERO BASED BUDGETING (ZBB)
• It differs from the conventional system of
budgeting mainly it starts from scratch or zero and
not on the basis of trends or historical levels of
expenditure. In the customary budgeting system,
the last year’s figures are accepted as they are, or
cut back or increases are granted. Zero based
budgeting on the other hand, starts with the
premise that the budget for next period is zero so
long the demand for a function, process, project or
activity is not justified for each rupee from the
first rupee spent. The assumptions are that without
• such a justification no spending will be allowed.
The burden of proof thus shifts to each manager to
justify why the money should be spent at all and to
indicate what would happen if the proposed
activity is not carried out and no money is spent.
• The first step in the process of zero base budgeting
is to develop an operational plan or decision
package. A decision package identifies and
describes a particular activity with a view to:
• (i) Evaluate and allotted ranking the activity
against other activities competing for the same
scarce resources, and
(ii) Decide whether to accept or reject or amend the
activity.
• For this purpose, each package should give details
of costs, returns, purpose, expected results, the
alternatives available and a statement of the
consequences if the activity is reduced or not
performed at all.
• The advantages of Zero based budgeting are:
• (a) Out of date and inefficient operations are
identified.
• (b) Allows managers to promptly respond to
changes in the business environment.
• (c) Instead of accepting the current practice, it
creates a challenging and questioning attitude.
• (d) Allocation of resources is made according to needs
and the benefits derived.
• (e) It has a psychological impact on all levels of
management which makes each manager to ‘pay his
way’.
• Areas where zero-base budgeting is applicable
• Zero-base Budgeting is more suitably applicable to
discretionary cost areas. These costs may have no
relation to volume or activity and generally arise as a
result of management policies. Where standards are
determinable, those costs associated with the inputs
should be controlled through the use of standard
costing. On the other hand, if output as a function of
input cannot be specified. Zero-base Budgeting may
be more suitably applied. Thus, service or support-
type activities are more suitable for Z.B.B.
• PROCESS OF ZERO-BASE BUDGETING OR
STEPS INVOLVED IN ZERO-BASE
BUDGETING
• The process of Zero-Base Budgeting involves the
following steps:
• 1. Identification of ‘Decision units’
• 2. Preparation and development of decision
packages.
• 3. Ranking of priority.
• 4. Approval and Funding
• Identification of ‘Decision units’- A decision unit
refers to a tangible activity or group of activities for
which a single manager has the responsibility for
successful performance. Thus, decision unit is a
programme or a project or a segment of the
organisation for which separate budgets are to be
prepared.
• Preparation of Decision Packages: Preparation of
decision packages is a set of documents which
identify and describe activities of the unit in such a
way that the management can evaluate and rank them
against others competing for resources (limited) and
decide whether to approve or disapprove.
• Ranking of Priority: The third step involved in
Z.B.B. is the ranking of proposed alternatives
included in decision packages for various decision
units or of various decision packages for the same
decision unit.
• Funding: Funding involves the allocation of
available resources of the organisation to various
decision units keeping in mind the alternative
which has been selected and approved through
ranking process.
Problem: Draw up a flexible budget for overhead expenses on
the basis of the following data and determine the overhead
rates at 70%, 80% and 90%
Plant Capacity At 80% capacity (Rs)
Variable Overheads:
Indirect labour 12,000
Stores including spares 4,000
Semi Variable:
Power (30% - Fixed: 70% -Variable) 20,000
Repairs (60%- Fixed: 40% -Variable) 2,000
Fixed Overheads:
depreciation 11,000
Insurance 3,000
Salaries 10,000
Total overheads 62,000
Estimated Direct Labour Hours 1,24,000