3.
Budgetary Control and Responsibility Accounting
1.1
Introduction
In our daily life, we use to prepare
budgets for matching the expenses with income; and available funds can be
invested in a profitable manner.
Similarly in business, budgets are prepared on the basis of future
estimated production and sales in order to find out the profit in a specified
period. A budget is in the nature of an
estimate and is a quantified plan for future activities to coordinate and control
the use of resources for a specified period.
Thus budget is a quantitative statement of management plans and policies
for a given period and is used as a guide for the purpose of attaining the
given objectives. It is also used as
standard with which actual performance is measured. Budgets must be prepared with full knowledge
and acceptance by the executives whose performance is to be measured against
the budget. Different types of budgets
are prepared for different purposes.
Budgeting may be defined as the process
of preparing plans for future activities of a business enterprise after
considering and involving the objectives of the said organization. This also
provides process/steps of collection and comparison of data, by which
deviations from the plan, either favourable or
adverse, can be measured. This analysis is helpful in performance analysis,
cost estimation, minimizing wastage and better utilisation
of resources of the organisation.
3.2 Concept of Budget & Budgetary control
Budgeting is a
process, which includes two important functions: Budget and Budgetary control.
Budget is a planning function and budgetary control is a controlling system or
technique. A manager looks to the future, searches for alternative courses of
action and predetermines a course of action to be taken in relation to known
events and the possibilities of future problems. Thus, the budget will do this
work for the activities of a business enterprise. I.C.M.A.,
3.3 Objectives of Budgeting
It is a well known fact that a planned
activity has better chances of success than an unplanned one. The budgeting is
a forward planning and effective control tool. Thus, the objectives of the
budgeting are:
a) To control the cost
and increase revenue and thereby maximise profit, so
as to know profit at different level of production and best production level.
b) To run production
activities in efficient manner by lay behind the chances of interruption in
production process due to lack of material, labour
etc.
c) To bring about
coordination between different functions of an enterprise, which is essential
for the success of any enterprise?
d) To incorporate
measures of calculation of deviations from budgeted results and analysis of the
same, whereby responsibility can be fixed and controlling measures/action can
be taken.
e) To ensure that
actions taken are in accordance with the targets and if required, to take
suitable corrective action.
f) To predict
short-term and long-term financial positions for better financial position and
management of working capital in better manner.
3.4 Advantages of Budgeting
The following are the advantages of
budgeting:
a) Budgeting leads to maximum utilisation of resources with a view to ensuring maximum
return.
b) Budgeting increases
the awareness about business enterprise at all levels of management in the
process of fulfillment of targets.
c) Budgeting is helpful
in better co-ordination between different functions/activities of business/organisation and hence, better understanding between
different functions.
d) Budgeting is a
process of self-examination and self-criticism which is essential for the
success of any organisation.
e) Budgeting makes a
path for active participation and support of top management.
f) Budgeting enables
the organisation to prefix its goals and push up the
forces towards their achievements.
g) Budgeting stimulates
the effective use of resources and creates an attitude of cost consciousness
throughout the organisation.
h) It creates the bases
for measuring performances of different departments as well as different
functions of the production activities.
3.5 Limitation of budgeting
Inspite
of the above advantages, budgeting has the following limitations:
a)
Forecasting, planning or budgeting is not an exact science and a certain amount
of judgement is present in any budgeting plan.
b) The basic requirement for the success of
budgeting is the absolute support and enthusian
provided by the top management. If it is lacking at any time, the whole system
will collapse.
c) Budgeting should be followed up by
effective control action, this is often lacking in many organisations,
which defeats the very purpose of budgeting.
d) The installation of budgeting system is an
elaborate process and it takes time.
e) It requires the experienced man-power,
technical staff, analysis, control etc, hence, it is costly affair.
3.6 Types of Budgets
3.6.1 Master Budget
Master Budget is a combination of all
other budgets prepared for a specific period. It shows the overall budget plan.
All the budgets are coordinated into one harmonious unit.
According to Rowland and William H. Harr, “Master Budget is a summary of the budget schedules
in capsule form made for the purpose of presenting in one report the highlights
of the budget forecast.” Thus, Master Budget sets out the plan of operations
for all departments in considerable detail for the budget period. The budget
may take the form of a Profit and Loss Account and a Balance Sheet as at the
end of the budget period.
The budget generally contains details
regarding sales (net), production costs, cash position, and key account balances
like debtors, fixed assets, bills payable, etc. It also shows the gross and the
net profits and the important accounting ratios. It is prepared by the Budget
Officer and it requires the approval of the Budget Committee before it is put
into operation. If approved, it is submitted to the Board of Directors for
final approval. The Board may make certain alterations if necessary before it
is finally approved.
3.6.2 Sales Budget
The sales
budget is usually the keystone in planning and control of operation of a
business. Sales forecast serves as a base for the sales budget. The sales
budget is prepared in quantitative terms of units expected to be sold and the
value expected to be realised. The Sales Manager
should be made directly responsible for the preparation and execution of sales
budget. This is prepared according to the requirements of the business while
preparing sales budget. The useful classification may be-products, territories,
customers, salesmen, etc. More than one classification may be employed.
However, at the time of preparing sales budget the following factors should be
kept in mind:
(a) salesmen’s
estimates (b) orders in hand (c) Past behaviour (d)
Management policies for future (e) seasonal fluctuations (f) availability of
materials (g) plant capacity (h)
availability of finance (i) potential market (j)
level of competition (k) position of competitors, etc. Look at the following
illustration how a sales budget is to be
prepared.
3.6.3 Production Budget
The Production
Budget is a forecast of the production for the budget period. It provides an
estimate of the total volume of production product-wise with the scheduling of
operations by days, weeks and month and also a forecast of the closing finished
product inventory. It is based on sales budget. The Factory Manager is the
person generally made responsible for its preparation, administration and
execution. This budget can also be prepared department-wise. This budget is
prepared in quantity terms only. The main factors, which are useful in
preparing production budgets, are:
(a) Inventory
Policies (b) Sales Requirements (c) Uniformity of Production (d) Plant
Capacity (e)
Availability of inputs (f) Duration of Production.
Production may
be computed as follows:
Units to be
produced = Budgeted Sales + Desired Closing Stock of finished goods
– Opening
Stock of finished goods.
3.6.4
Materials Budget
Materials are either direct or indirect.
The Material budget generally deals only with the direct materials. Indirect
materials are generally included in overhead budget. The material requirements
are estimated on the basis of quantity of each class of products to be produced
by multiplying the exact material requirement for each class of product by the
number of units of that class. Material budget can be prepared on the basis of
standards or, historical data regarding percentage of raw materials to total
cost, adjusted for current price and normal wastage of material.
The factors to be considered while
preparing the Material Budget are: the
quantity of material required for the production budget, tentative dates by
which required material must be available, the availability of storage
facilities as well as credit facilities, price trends in the market, nature of
the materials required etc.
Only direct materials are to be taken
into account and indirect materials are not taken into account as they are
considered under overheads budget. The
material budget helps the management for proper planning of purchases. The object of the budget is to ensure the
availability of adequate quantities of materials as and when required. It will be included in the Master Budget
after the approval of Budget Committee.
3.6.5 Purchase Budget
Purchase
Budget gives the details of material purchases to be made in the budget
period. It correlates with sales
forecast and production planning. It
deals with purchases that are required for planned production. Purchases would
include both direct and indirect materials and goods. While placing the purchase orders material
manager has to see the orders on hand and unfulfilled orders at the beginning
of the budget period and adjust the purchases accordingly. Purchase budget enables the budget officer to
provide funds in the cash budget according to delivery schedules, terms of
payment and credit period. While
preparing purchase budget the factors like the opening and closing stock to be
maintained, maximum and minimum stock quantities to be maintained, economic
order quantity level, the resources available, the policy of management etc.,
should also be taken into account.
Budgeted
Purchase Quantity = Budgeted Consumption Quantity + Required Closing
Stock – Opening Stock.
3.6.6 Direct Labour Budget
The direct labour budget tells about the estimates of direct labour requirements essential for carrying out the budgeted
output. The quantity of labour, e.g. skilled, unskilled, semi-skilled etc are
estimated first. The time taken by them can be measured in terms of man hours
Thereafter, the total cost of labour is estimated by
multiplying the rates of pay with the labour
hours. The purpose of this budget is to
ensure optimum utilization of labour force.
3.6.7 Overhead Budget
The overheads
budget should be prepared in three parts as follows:
1) Manufacturing
Overhead Budget
2) Administration
Overhead Budget, and
3) Selling
and Distribution Overhead Budget.
Manufacturing
Overhead Budget
The budget is
an estimate of the manufacturing overhead costs to be incurred in the budget
period to achieve the targeted production. Manufacturing overheads include
indirect material, indirect labour, and indirect
expenses related to the factory. The
cost of each and every item of these three components of manufacturing overhead
Is separately estimated as per the requirements of production.
Administration
Overhead Budget
Administration
overhead includes the costs of framing policies, directing the organisation and controlling the business operations. Most
of the administration expenses are normally unconnected with the volume of
activity, therefore, experience and anticipated changes in conditions are the
guides for the preparation of this budget.
Selling and
Distribution Overhead Budget
The budget
includes all expenses relating to selling, advertising, delivery of goods to
customers, etc. The overheads may be determined on the basis of sales targets
being allocated to different territories or salesman etc. Those expenses which
generally vary with the sales quantity are estimated on sales basis, others
which are of a fixed nature, are estimated on the basis of past experience and
anticipated changes. The responsibility
for the preparation of this budget lies with the executives of the sales
departments.
3.6.8 Cash Budget
A Cash Budget is a summary statement of
the firms’ expected cash inflows and outflows over a projected time period. In
other words, cash budget involves a projection of future cash receipts and cash
disbursements over various time intervals. While preparing cash budget seasonal
factors must be taken into account and in practice cash budget is prepared on a
monthly basis. The availability of other
budgets is tested in terms of cash availability. Cash budget is also called as cash flow
statement which indicates cash inflow and cash outflows. It is generally prepared for a maximum period
of one year.
A cash budget helps the management in (i) determining the future cash
needs of the firm, (ii) planning for financing of the needs; (iii) exercising
control over cash and liquidity of the firm.
The overall
objective of a cash budget is to enable the firm to meet all its commitments in
time and at the same time prevent accumulations of unnecessary large balance
with it.
Methods of
Preparing Cash Budgets
There are
basically three methods for preparing cash budgets.
1) Receipts and Payments Method
2) Adjusted Profit and Loss Account
Method
3) Balance Sheet Method
Let us study
about these methods in brief.
1) Receipts and Payments Method
Under this
method, all receipts are added and out of the total, the sum of all payments is
deducted to arrive at the balance in hand. The closing balance in hand say, for
a particular month is the opening balance of the next month and is added to the
total of receipts so as to know the total availability of cash during the
month. The receipts and payments during the budget period are found out from
various functional budgets prepared. The credit allowed to debtors, the credit
allowed to us by suppliers, the delay in payment of wages and other expenses
etc. are the factors, which are taken into account to determine the timing of
receipts and payments. Advance payments and receipts are to be included but the
payment in abeyance and income accrued on outstanding are excluded from cash
budget. Revenue as well as capital receipts and payments are recorded in cash
budget.
2) Adjusted Profit and Loss Account Method
The budgeting
done by Adjusted Profit and Loss account method is known as cash flow statement
and is more suitable for long-term forecasting.
Under this method profit is taken as equivalent to cash and necessary
adjustments are done in respect of non-cash transactions. The net estimated
profit is taken as the base and non-cash items like depreciation, outstanding
expenses, provisions etc. already deducted to arrive at the net profit are
added back. The capital receipts, reduction in debtors, stocks, increase in
liabilities, issue of share capital and debentures are other items which are
added to compute the total cash receipts. The payments of dividends,
prepayments, capital payments, increase in debtors, and increase in stock and
decrease in liabilities are deducted out of the total cash receipts. The profit
adjusted this way denotes the estimated cash available.
3) Balance Sheet Method
Under this
method, at the end of budget period a projected balance sheet is drawn up
setting out the various assets and liabilities, except cash and bank balances.
The balancing figure would be the estimated closing cash/bank balance. Thus,
under this method, closing balances other than cash/bank will have to be found
out first to be put in the budgeted balance sheet. This can be done by
adjusting the anticipated transaction of the year in the opening balances. If the liabilities are more than assets, this
reveals a balance of cash/bank and if assets exceed liabilities, it reveals a
bank overdraft. Thus, under Adjusted
Profit and Loss method, the amount of cash is computed by preparing a Cash Flow
Statement and the same amount is computed as a balancing figure under Balance
Sheet method.
3.6.9 Fixed Budget
According to
C.I.M.A.,
3.6.10 Flexible Budget
Flexible
budget, also known as variable or sliding sale budget, is a budget which is
designed to furnish budgeted costs for any level of activity actually attained.
Flexible budgeting technique may be employed to adjust other budgets according
to current conditions arising out of seasonal variations or changes in the
length of the working period etc.
According to
C.I.M.A.,
Under this
method, a series of budgets would be prepared at different levels of activity.
Variable items are shown in the budget as per the level of output. Fixed costs are shown at the same amount
irrespective of level of output. Sales value is computed and entered into the
flexible budget. The position of profit
or loss will be revealed at the various levels of activity. Management will take a decision to operate at
a particular level of activity where the profit is maximum taking into account
all other factors.
A flexible
budget is more realistic, useful and practical. The likely changes in the
actual circumstances are taken into account while preparing a flexible budget.
The technique is highly useful for control purposes. Actual performance of an executive may be
compared with what he should have achieved in the actual circumstances and not
with what he should have achieved under quite different circumstances.
3.7 Zero Based Budgeting (ZBB)
The technique
of zero based budgeting suggests that an organisation
should not only make decisions about the proposed new programmes
but it should also, from time to time, review the appropriateness of the
existing programmes. Such review should particularly
done of such responsibility centres where there is
relatively high proportion of discretionary costs.
Zero based
budgeting, as the term suggests, examines a programme
or function or responsibility from “ scratch.”
The reviewer proceeds on the assumption that nothing is to be allowed.
The manger proposing the activity has, therefore, to prove that the activity is
essential and the various amounts asked for are reasonable taking into account
the volume of activity. Nothing is allowed simply because it was being done or
allowed in the past. Thus, it means writing on a clean slate.
Peter A. Pyhrr defined the zero based budgeting as “an operating
planning and budgeting process which requires each manager to justify his
entire budget requests in detail from scratch (hence zero basis). Each manager
states why he should spend any money at all. This approach requires that all
activities be identified as decision packages which would be evaluated by
systematic analysis ranked in order of importance.”
Thus, a
cost-benefit analysis is done in respect of every function or process. It has
to be justified while framing budgets. The assumption underlying zero base
budgeting is that the budget for the previous period was zero, therefore
whatever costs are likely to be incurred or spending programmes
are chalked out, justification or the full amount is to be given. Under
conventional system of budgeting, however, the justification is to be submitted
by the manager only in respect of the increase in the demand for allotment of
funds in excess over the budget for the previous period. Thus, instead of
functionally-oriented spending approach, programme-oriented
and decision-oriented approach is followed under zero based budgeting.
Advantages of
ZBB
1) This system is decision oriented.
2) The technique is relatively elastic, because
budgets are prepared every year as zero base.
3) It reduces wastage, eliminates inefficiency
and reduces the overall cost of production because every budget proposal is on
the basis of cost-benefit ratio after careful evaluation of different
alternatives and the one which is ‘best’ is approved.
4) It provides for a greater possibility of
goal congruence.
5) It takes into consideration inflationary
trends, competitor games and consumer behaviour.
6) It vastly improves financial planning and
management information system in view of its revolutionary approach.
Disadvantages
of ZBB
1) It is possible to quantify and evaluate
budget proposals involving financial matters but computation of cost-benefit
analysis is not possible in respect of non-financial matte$
2) The cost of administration of zero based
budgeting is high.
3) It may be difficult to search out various
alternatives for the same activity.
4) Some decision packages are inter-related
which may be difficult to rank.
5) Ranking the decision is a scientific
technique. Every manager cannot be expected to have the necessary technical
expertise in this matter.
6) Zero based budgeting dismisses that the past
is irrelevant and thereby challenges the fundamental theory of continuity.
Budgeting is a continuous process of estimating and forecasting about the
future and is based on past happenings.
3.8 Responsibility Accounting
As the title suggests,
responsibility accounting is a cost accounting system established on a
responsibility basis. A basis is said to
be responsible where actual results are as close to planned results as
possible. As such, the variances are
minimal. Planned results could be stated
in budgets and standards. Properly
speaking, responsibility accounting is a method of budgeting and performance
reporting created around the structure of the organization. Individual managers are hold accountable for
the costs within their jurisdiction. The
purpose, obviously, is to exercise control over the operations.
Hence, in simple words,
it could be described as a system of collecting and reporting accounting data
on the basis of managerial level. Moore
and Jaedicke rightly define it as “the approach to
accountability- identification of cost, with the persons responsible for their
incurrence. Performance is evaluated by assigned responsibilities. Reporting on performance is on the lines of
organizational structure. There is a
separate report for each box of the organization chart.
Responsibility
accounting considers both historical and future costs. For some purposes, the activity of
responsibility centres is expressed in historical
amounts. For others, these are expressed
in estimated future amounts.