CHAPTER THREE

BUDGETING & BUDGETARY

CONTROL
 3.1 Introduction

• Planning is the cornerstone of effective

management, and effective planning requires
that managers must predict, with reasonable
precision, the key variables that affect
company performance and conditions.
• These predictions provide management with
a foundation for effective problem solving,
control, and resource allocation.
• During the strategic planning process, managers
attempt to agree on company goals and
objectives and how to achieve them.
• Typically, goals are stated as desired abstract
achievements (such as “to become a market
leader for a particular product”).
• Objectives are desired quantifiable results for a
specified time (such as “to manufacture 200,000
units of a particular product with less than 1
percent defects next year”).
• Achievement of a company’s desired goals
and objectives requires complex activities,
uses diverse resources, and necessitates
formalized planning.
• A plan should include qualitative narratives
of goals, objectives, and means of
accomplishment.
• However, if plans were limited to qualitative
narratives, comparing actual results to
expectations would only allow generalizations,
and no measurement of how well the
organization met its specified objectives would be
possible.
• The process of formalizing plans and translating
qualitative narratives into a documented,
quantitative format is called budgeting.
• The end result of this process is a budget.
• Budgeting is an important part of an
organization’s entire planning process.
 Budgeting and Budgetary Control

• Simply, ‘Budgeting’ means preparing a

budget. Being a plan of action, a budget
guides every manager in the decision making
process.
• Whereas, the term ‘budgetary control’, refers
to the process by which budgets are prepared
for future period and are compared with the
actual performance for finding-out variances,
if any.
 Objectives of Budget and Budgetary
control
1. To communicate plans to the various
responsibility centre managers.
2. To coordinate and control the activities and
efforts of the various departments of the
organization.
3. To provide a yard stick against which actual
results can be compared.
4. To correct the deviations from the established
standards and provide a basis for revision of
policies.
5. To motivate managers to strive to achieve the
organizational goals.
6. To evaluate the performance of managers.
7. To increase profitability by eliminating waste.
 Steps involved in Budgetary Control

1. Laying down organizational goals or objectives

2. Formulating the necessary plans to ensure
that the desired objectives are achieved.
3. Relating the responsibilities of executives to
the requirements of a policy.
4. Recording and reporting actual performance
5. Continuous comparison of actual with
budgeted results
6. Ascertainment of deviations, if any
7. Focusing attention on significant deviations
8. Investigation into deviations to establish causes
9.Presentation of information to management,
relating the variations to individual responsibility
10. Taking corrective action to prevent recurrence
of variations.
11. Provide a basis for revision of budgets.
 Essential Elements of Effective Budgetary
Control

• Successful implementation of a budgetary

control system depends up on the following
essentials.
1. Support of top Management
2. Formal Organization
• In a formal organization, duties of every
employee are clearly defined and assigned.
3. Preparation by Responsible Executives
4. Clear Cut Objectives
5. Attainable Objectives
6. Budget Committee
7. Adequate Accounting System
8. Periodic Reporting
9. Budget Education
 Classifications of Budget

1. Classification according to time factor

2. Classification according to flexibility factor
3. Classification according to function
1. Budget Classification according to time
factor
A. Long term Budget: - for 5 to 10 years
B. Short term Budget: - for 1 to 2 years
C. Current Budget: - for 1 month to 3 months
 2. Budget Classification according to
flexibility factor
A. Fixed Budget :- remains unchanged
B. Flexible Budget: - It gives different budgeted
cost for different levels of activity.
 3. Budget Classification according to
function
A. Functional Budget: - prepared by heads of
functional departments for their respective
departments and are subsidiary to the
master budget.
B. Master Budget: - summary of all functional
budgets. It is considered as the overall
budget of the organization.
• The master budget is composed of both
operating and financial budgets.
• Operating budgets are those budgets which
relate to the different activities or operations
of a firm.
• An operating budget is expressed in both
units and dollars.
• Monetary details from the operating budgets
are aggregated to prepare financial budgets,
which indicate the funds to be generated or
consumed during the budget period.
• Financial budgets include cash and capital
budgets as well as projected or pro-forma
financial statements.
 Components of Master Budget
Master Budget

Operating Budget Financial Budget

• Sales Budget * Cash Budget
• Production Budget * Capital Expenditure Budget
• Purchase Budget * B/sheet
• Direct labor Budget * I/statement
• Overhead Budget * Statement of cash flows
• Selling & Adm. * Statement of R/E
Budget
 THE MASTER BUDGET ILLUSTRATED

• This illustration uses information from ABC

Co., a small company that has been in
business for several years. The company,
which produces a bracket used to attach legs
to tables and chairs, is preparing its 2001
budget and has estimated total annual sales at
900,000 brackets.
• The Company’s December 31, 2000, balance
sheet is presented hereunder.