Q. What is Budgetary Control?

What are the steps involved in

Budgetary Control?

Budgetary control is the management process of using budgets to monitor and control the performance of
the organization. This is done by comparing the planned values (in the budget) with the actual values as
they occur during the year.

A budget has been defined as a financial and quantitative statement prepared and approved prior to a
defined period of time, of the policy to be pursued during that period for the purpose of attaining a given
objective.

The following steps are involved in Budgetary Control:

1. Establishment of Budgets: Targets are fixed for each function relating tothe responsibilities of individual
executives.

2. Measurement of actual performance.

3. Comparison of actual performance with budgeted performance to detect deviation.

4. Analysis of the causes of variations and reporting

What are the uses of diff budgets?

➢ It serves a declaration of policies
➢ Defines the objectives/ targets for executives, at all levels.
➢ Means of coordination of activities
➢ Means of communication
➢ Facilitates centralised control
➢ Helps in planning activities

Q. Discuss the budgetary control ratios and how they are calculated? The following are the
three budgetary control ratios:

Activity ratio: It is a measure of the level of activity attained over a period of time. It is obtained by expressing the
number of standard hours equivalent to the work produced as a percentage of the budgeted hours.

Mathematically:

Standard hours for actual

     
production

Activity ratio
= x 100

  Budgeted hours    

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Capacity Ratio: This ratio indicates whether and to what extend budgeted hours of activity are actually
utilised. It shows the relationship between the actual number of working hours and the maximum possible
number of working hours in a budget period.

  Mathematically:

  Actual hours worked    

Capacity Ratio = x 100

  Budgeted hours    

Efficiency Ratio: It indicates the degree of efficiency attained in production. It is obtained by expressing
the standard hours equivalent to the work produced as a percentage of the actual hours spent in producing
that work.

 Mathematically:

Standard hours for actual

     
production

Efficiency = x 100
Ratio
 

  Actual hours worked  

Q. What is Reporting?

Report: A major part of the management account’s job consists of preparing reports to provide
information for purposes of control and planning:

The important consideration in drawing up of reports and determining their scope are the
following:

Significance : Are the facts in the report reliable? Does it either called for action
or demonstrate the effect of action? It is material enough.

Timeliness : How late can the information be and still be of use? What is
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 the earliest moment at which it could be used if it were
available? How frequently is it required?

Accuracy : How small should be an inaccuracy which does not alter the
significance of the information?

Appropriateness : Is the recipant the right person to take any action that is needed?
Is there any other information which is required to support the
Information to anyone else jointly interested?

Discrimination : Will anything be lost by omitting the item? Will any of the items
Gain from the omission? Is the responsibility for suppressing the
Acceptable?

Presentation : Is the report clear and unbiased? Is the form of it is suitable to the
Subject? Is the form of it suitable to the receipient?

The following are certain types of reports which are to be prepare and submitted to
management regularly at predetermined time interval:-

Top Management: (Including Board of Directors and financial managers)

i) Balance Sheet
ii) Profit and Loss Statement
iii) Position of stocks
iv) Disposition of funds or working capital
v) Capital expenditure & forward commitments together with progress of projects in hands.
vi) Cash-flow statements.
vii) Sales, production, and other appropriate statistics.

A budget model for a large manufacturing firm.

Budgeting is one of the most important planning and control tools used by managers of small firms. Without some
form of formal budgeting, managers spend too much of their time solving daily problems instead of focusing on the
future. In addition to a short-term budget, firms should have a long-term budget (3 to 10 years), with the most current
year being this period's operating budget.

But what is an operating budget? Basically, it is a plan of action stated in monetary terms and usually for a period of
a year. Yearly budgets are often detailed by months or quarters. These budgets are based on agreed-upon
objectives that have the approval of managers and higher authority. Eventually, actual performance is compared with
the budget, and variances are computed and analyzed to determine the cause. If warranted, corrective action is
immediately undertaken.

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The advantages of a well prepared budget are numerous. Budgets provide a disciplined approach to managing
because they force managers to plan ahead and coordinate their activities with those of other managers, and with
the firm's goals and objectives. In addition, budgets pinpoint potential weaknesses and bottlenecks before they
occur, forcing managers to address problem areas. They also help in directing capital and effort into a company's
most profitable products. As a result, an atmosphere of cost-consciousness and profit-mindedness is developed. A
comparison of actual costs with budget provides valuable information and helps determine where efficiencies as well
as inefficiencies occur. The latter can be corrected, thus avoiding future unnecessary costs. A well managed
budgeting system also motivates managers and employees to optimize performance, and can serve as a basis for
distributing rewards. Clearly, however, budgets do not eliminate the administrative role of managers since budgets
are not meant to be a rigid dictator of behavior. They serve only as a plan to achieve corporate goals.

No company, regardless of size, should operate without a budget. Obviously, the budget should have the solid
backing of top management and be taken seriously by all employees. Large companies frequently have budget
committees whose responsibilities include overseeing budget preparation and coordination. Such firms are likely to
have the resources for sophisticated budgeting procedures, sound accounting and reporting, and corrective action
programs, all time-phased and integrated in their overall planning and control system. Even though small firms may
be lacking in resources, it is imperative that they also have a sound budgeting system. Therefore, the following is a
relatively simple, low-cost budgeting model that a small manufacturing firm can utilize as a planning and control
system.

Master budget

A firm does not have one budget, rather it has a series of budgets which are coordinated into a package called the
master budget. This schematic demonstrates how the budgeting process begins with sales and ends with
projected financial statements. All aspects of the individual budgets are tied together and coordinated with each
other. Hence, even though some of the detail might be in units, the bottom line of each individual budget must be in
dollars.
To the extent feasible, it is usually preferable for non-management employees to participate in establishing the
budgets. Participative budgeting is based on the philosophy that motivation and acceptance of budgets are higher
when individuals participate in the budgeting process. Still, the small firm CEO must resist the temptation of over-
emphasizing participation, as the time, costs, and complexities of budget preparation can increase.

Review of current year's operation

Although much has been written about the advantages of zero-based budgeting, a small firm will usually rely heavily
on past years' performance (including the current year) as the basis for its estimates. Since a two-to four-month time

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frame is needed to prepare a master budget, it is necessary to include in the year-to-date actual figures, a forecast
for the remainder of the current year. Inefficiencies and non-recurring costs should be eliminated from past
performance, and anticipated variables included before these numbers are appropriate for projection into the future.
The update of the current period expectations should terminate with the three basic financial statements - Statement
of Financial Position, Statement of Income, and Cash Flow Statement - in order that the firm has a close estimate of
its expected position at year end.

Goals and strategies

Before detailed preparation of the budget begins, top management must establish the firm's primary goals, ranked in
order of importance. If possible, these goals should be measurable. For example, a goal might be to increase sales
by 3 percent. At the end of the period, a comparison of actual with budgeted sales will confirm if the 3 percent goal
was met.

Next, strategies must be developed. How is the firm going to increase sales? Possible answers include price cutting,
adding new customers, increasing promotions, and improving quality. Clearly, the strategies must be feasible and
consistent with the managers' capabilities and the firm's environment.

Assumptions that support the goals and strategies must also be identified. These include such factors as: inflation
rate; wage and material cost increases; lead time from suppliers; income tax rate; cost of borrowing; and collection
and payment time periods. The goals, strategies, and assumptions should be agreed upon, or at least accepted as
reasonable, by all those involved in the budgeting process. Now, work can commence with the individual budgets,
starting with sales.

Sales department

From the goals and strategies set for the budget year, the sales manager projects total sales and breaks the sales
figures into the various types of products (by dollars and quantity), time-phased by months. The product mix is
evaluated in order to achieve monthly targets as well as annual goals. In lieu of an arbitrary division of the annual
sales goal by twelve months, cyclical sales patterns must be taken into consideration so that each month's sales
figures reflect expected reality.

The sales manager is also responsible for the annual and monthly marketing expense budget. This schedule of
expenses attributable to the sales department includes such expenses as travel and lodging, promotions, auto
expenses, delivery charges, entertainment, and advertising. Of course, such projections must agree with the
strategies adopted to achieve sales goals.

Production department

The sales budget is now forwarded to the production manager who is responsible for the following budgets:

* Production quantity budget - number of units to be produced by product.

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* Inventory budget - estimated ending inventory requirements for each type of inventory.

* Direct material budget - units and cost of raw material necessary to meet production demands.

* Direct labor budget - hours and rates necessary to meet production demands.

* Manufacturing overhead budget - indirect cost of production.

Small firms may or may not have separate engineering and purchasing departments, or these functions may be
under the production manager. If separate, the purchasing manager would prepare the inventory and direct material
budgets. If purchasing and engineering are under the production manager, their managers can still lend expertise to
appropriate portions of the budget.

From the sales budget, the production manager can determine the number of units of each product that must be
produced monthly. Review labor to determine if current personnel can meet the necessary production levels. If not, a
strategy must be adopted, such as adding additional personnel, working overtime, or outside contracting. Similarly,
production must ascertain if existing production facilities can meet production requirements, and if raw material will
be available as needed.

Ideally, the manufacturing overhead budget is organized by variable and fixed costs. Variable cost can be calculated
on a base, such as direct labor dollars, or it can be projected as the number of units to be manufactured times an
estimated variable overhead cost per unit. Fixed costs do not change with output. As a result, these costs can be
projected for the year and assumed to be stable for each month.

Administration department

All of the above budgets are then forwarded to the controller who has the responsibility of coordinating them and
reviewing for errors and incompatibilities. In addition, the controller prepares the administrative expense budget,
which is probably limited to expected cost by account. From the five budgets forwarded by production, a cost of
goods sold budget can be prepared. Data for the projected statement of income is either lifted from one of the
individual budgets or calculated. For example:

1. Sales is taken from the sales budget; 2. Cost of goods sold is forwarded from the cost of goods sold budget; 3.
Administrative expenses come from the administrative expense budget; and 4. Marketing expense is transferred
from the marketing expense budget.

The controller should be aware of any anticipated miscellaneous income or expense. Depreciation expense is
calculated on expected capital assets, and income tax expense is computed on budgeted profit before tax, utilizing
the income tax rates assumed when strategies were established.

The capital expenditure budget is based on the input of sales, production, and engineering in so far as what new
capital acquisitions or expenditures will be necessary to meet production demands. As with other cost budgets, the
capital expenditure budget must conclude with the timing of the cash outflow dollars. When capital expenditures are

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expected to be high, consideration must be given to how the firm expects to raise the cash necessary to pay for
them. The cash outflow portion will be included in the cash budget, whereas cash obtained through borrowing or the
sale of equity securities will also be reflected on the statement of financial position.

The cash budget is critical because it helps management utilize the scarce resource of cash to optimal advantage.
Cash shortages should be avoided so that bills can be paid on time. A firm's good credit rating remains intact, and
required borrowings can be projected to minimize interest cost. On the other hand, a high cash surplus should be
invested in high-yield securities until needed, or distributed to the stockholders.
Utilizing input from the previous budgets, financial statements, and established ratios (i.e., number of days in
accounts receivable, current ratio and debt equity), the statement of financial position is prepared. For example, cash
can be traced to the cash budget. Inventories are based on the inventory budget. Plant assets are increased by the
amount of the capital expenditure budget and decreased by expected dispositions. Accumulated depreciation
includes the depreciation expense previously calculated for the statement of income, minus that attributable to items
expected to be disposed of during the forthcoming year. Retained earnings reflects the projected profit, or loss, from
the statement of income minus planned dividends, if any. The final statement to be prepared is the statement of
changes in cash.
Review and approval

As mentioned previously, the controller is responsible for reviewing all work for accuracy and plausibility. This
includes checking the individual schedules for mathematical accuracy and reconciling with figures presented on
supporting statements. An additional function of the controller is to prepare comments on the various statements.
Topics include, but are not limited to, the feasibility of the figures as presented, the extent to which the company's
goals will be met, and suggestions on how to better achieve stated objectives.

The entire draft budget package is now returned to each manager for review; giving managers an opportunity to write
their own comments and questions for use during a budget meeting. During this meeting, the managers discuss the
individual budgets in the same order prepared. This allows managers a better insight into the preparation process
and the rationale used in preparing each budget. Each manager is given an opportunity to agree or disagree with any
portion of the budget.

Items that are disagreed on are discussed in greater detail, including the reasons for the disagreement. Try to
eliminate or reduce disagreement. This might result in a possible modification of portions of the budgets. Changes to
individual budgets are made by the responsible manager. The revised departmental budgets are then returned to the
controller for revision of the entire master budget.

It may be desirable to repeat the above process if substantial changes are necessary. Still, considerable effort should
be expended to reduce the number of times the budget travels through the chain of command, since too many times
will increase the budget preparation period, boost cost, encourage haphazard budgeting, deteriorate morale, and

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reinforce the notion that budgeting is not to be taken seriously. It is important that managers control the system,
rather than vice-versa.

After all revisions have been made, the master budget is approved by top management. A copy of the entire final
budget package is given to all managers for implementation in their respective areas. Managers are expected to use
the budget to help make decisions and track their own plans and performance. The firm's reward system may or may
not be tied in to meeting the budget.

Financial statements based on actual dollars are prepared by accounting. Monthly and year-to-date actual figures
are reported against the budgeted figures and variances computed. Key ratios and a comparison of targets to actuals
are included in the performance reports along with the controller's comments. Individual managers are asked to
explain large variances as well as suggest and implement procedures to correct recurring inefficiencies.

Conclusion

The essential ingredients for success are to keep the budgetary process as simple as possible, to render relevant,
accurate, and timely reports, and to provide strong management support. Consistency of budget contents,
applications, and implementations provides a strong foundation upon which managers can base their decisions.
Such a system can substantially reduce risk, stress, and human insecurities.

Longevity of a small firm is dependent upon its ability to plan and control operations. Planning is future oriented and
forms the foundation of control. Control is established through calculation and analysis of variances, that is, the
difference between budgeted costs and actual costs. This analysis is extremely important because it either suggests
corrective action, a revision of objectives, and/or a modification of plans.

A well-prepared master budget approved and supported by top manager is essential. Effort should be made to
establish the budget at a reasonable level of performance since extremely tight budgets discourage managers and
subordinates. On the other hand, loose budgets do not motivate employees. Care must be taken about when to hold
employees responsible for meeting or failing to meet budgets. If meeting budgets means success or failure to the
employee, the budget may be looked upon as something to be feared. Employees may retaliate by ignoring it,
suffering anxiety, becoming disgruntled, or putting slack in their budgets. An atmosphere of trust and support for one
another can do much toward alleviating pressure and establishing budgeting as a sound tool for planning and control
decisions.

Reference for budget model: Mary M.K. Fleming, CPA, CMA, is a professor of accounting at California State
University, Fullerton. She has a DBA degree from the University of Southern California

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 Cost And Management Accounting
(Assignment)

Topic:
Budgetary Control and Budgetary Control Ratios and
Reporting

Submitted To:
Prof . S.P.Padhi(Dean S.W.)

Submitted By: Tushar Chaudhury

10DM027
Section:A(2010-12)
Date:10/12/2010

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