BUDGET AND BUDGETARY

CONTROL
• Meaning-
Budget refers to a plan relating to a definite future
period of time expressed in monetary and/or
quantitative terms. In relation to business, a budget is a
formal expression of the expected incomes and
expenditures for a definite future period.
Defination-
The Chartered Institute of Management Accountant of
London (CIMA) defines a Budget as-
“A Budget is a plan quantified in monetary terms,
prepared and approved prior to a defined period of time,
usually showing planned income to be generated and/or
expenditure to be incurred during that period and the
capital to be employed to attain a given objective.”
 Features or characteristics
• An analysis of the above definition reveals the following essential
features of a budget:

• A budget is primarily a planning device but it also serves as a basis

for performance evaluation and control.
• It is prepared beforehand based on a future plan of actions;
• It is related to a definite future period and is based on the objectives
to be attained;
• It is expressed in financial terms;
• It shows planned income to be generated;
• It shows probable expenditure to be incurred;
• purpose of a budget is to implement the policies formulated by
management for attaining the given objectives;
 BUDGET AND FORECAST
• A forecast is a prediction of what may happen
as a result of a given set of circumstances. It is
an assessment of probable future events.

• A budget on the other hand is a planned

exercise to achieve a target. It is based on the
pros and cons of a forecast. Forecasting thus
precedes the preparation of budget.
Basis Budget
Meaning- A budget is a financial plan
expressed in quantitative
terms, prepared by the
management in advance for
forthcoming period.
What is it? It is the financial expression of a
business plan or target.
Target Budget sets target.
Updation Annual basis
Estimates What business wants to achieve
Activities: Budget relates to economic
activities of business, enterprise,
government or others.
Forecast
Forecast means estimation of future
trends and outcomes, based on the past
and present data.
It is the prediction of upcoming events
or trends in business, on the basis of
present business conditions.
There are no targets.
At regular intervals
What business will achieve
Forecast may relate to economic as well
as non economic activities e.g. weather
forecast.
Pre-requisite- forecasting is a prerequisite Budgeting is not a
for budgeting.
Tool budget is a tool of control
Prepared by: Budget being a formal
business plan can be
prepared only by the
authorised managemrent.
Events- budget relates to “planned
events”
prerequisite for
forecasting.
Forecasting is simply an
anticipation of events.
Forecast can be made by
anybody
Forecast relates to
“probable events”
 BUDGETARY CONTROL
• Budgeting-

• The act of preparing budgets is called

budgeting.
• The entire process of preparing the budget is
known as budgeting.
• Meaning-
• Budgetary control is a system of controlling costs through
preparation of budgets.

• Defination
• Budgetary control is defined by the Institute of Cost and
Management Accountants (ICMA) as:
• "The establishment of budgets relating 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 the objective of that
policy, or to provide a basis for its revision".
 Characteristics
• The salient features of Budgetary Control may be
enumerated as follows:

• Establishment of budgets for each function/department of the

organisation.
• Comparison of actual performance with the budgets on a
continuous basis.
• Analysis of variations of actual performance from that the
budgeted performance to know the reasons thereof.
• Taking suitable remedial action, where necessaary.
• Revision of budgets in view of changes in conditions.
 Objectives of Budgetary Control:

• 1. Planning- helps in anticipating many

problems
• 2. co-ordination-aids managers
• 3. communication-understanding and
knowledge of programs and policies
• 4. Motivation-to achieve targets
• 5. Control- comparison
• 6. Performance Evaluation- meeting targets
 Advantages of Budgetary Control:
• 1. Maximisation of Profits:This is achieved through planning, coordination
and control of various activities

• 2. Effective Coordination:
• Budgets of the various functions are interlinked and dependent.

• 3. Evaluation of Performance:
• Goals are set for each department. Actual performance is compared with
standards and deviations are reported to top management for action against
unfavorable deviations.

• 4. Clear-Cut Goals and Targets:

• Through the process of budgeting the goals of different departments are set
in advance . This makes the vision of the organisation clear and employee
motivation and morale boosted by achievement of clearly set objectives.
• 5. Economy in Operations:
• Expenses are properly planned and financial resources are put to optimum use..
Budgetary control is helpful in conservation, effective utilization and elimination of
wastage in scarce resources
• .
• 6. Revelation of Ineffectiveness:Comparison

• 7. Correction of Performance Continuously:corrections are made to rectify the

unfavourable deviations immediately.

• 8. Introduction of Incentive Schemes of Remuneration:

• as the predetermined targets act as base to compare actual performance and determine
efficiency. Higher and lower efficiency are suitably rewarded or discouraged
respectively.

• 9. Shutting Down of Unprofitable Products and Activities:

• Budgetary control reveals inefficiencies in products, processes and departments. This
is helpful in closing down of loss making divisions to improve the overall profitability.
 Limitations of Budgetary Control:
• 1. Prediction of Uncertain Future: Forecasting may not be accurate.
• 2. Changes of Conditions:
• Budgets are prepared on the basis of certain prevailing conditions.
•
• 3. Complacence:
• General tendency of employees is to achieve the targets as budgeting
fixes the targets. Some of the employees who are highly skillful may
also be satisfied in performing up to the goals set without showing full
potential, which will be a loss to the enterprise as well as the employee
in terms of productivity.

• 4. Difficulty in Coordination:
• Effective implementation of budgetary control depends upon proper
coordination among various departments as the performance of a
department depends on the work of other departments and vice versa..
• 5. Conflict among Different Departments:
Budgetary control sets targets for different departments individually.
This will make the departmental heads to be selfish

• 6. Opposition from staff: Employees may not like to be evaluated.

• 7. Danger of rigidity- . If not revised with changing circumstances

will be useless.

• 8. Expensive technique- The installation and operation of a

budgetary control system is a costly affair as it requires the
employment of specialised staff and involves other expenditure
which small concerns may find difficult to incur.
Steps in budgetary control system
• Preparing the budget
• Communicating the budget
• Measuring results
• Comparing results and analyzing deviations
• Reporting the results and taking corrective
actions
• Revising of the budget
 Functional Budget-
  Functional budget is that budget which is
associated with the functions of an
organization.
For examples: sales budget, Production budget,
Labor budget, Cost budget, Overhead budget,
Capital expenditure budget and Cash budget etc.
These are components of master budget.
Specific functional budgets to be prepared vary
from organization to organization.
• Types of Functional budgets

1. Sales Budgets
• It is the first budget which is an estimate of expected sales revenue and
selling expenses during the budget period. It shows what product will be
sold, in what quantities, and at what prices.
• It is also known as the nerve centre or the backbone of the organization.
The sales budget is the starting point in budgeting the other budgets are
based on Sales budget.
• The sales manager is responsible for preparing the sales budget.
• The importance of this budget arises from the fact that if sales figure is
incorrect, then practically all other budgets will be affected.
• The difficulties in the preparation of this budget arise because it is not easy
to estimate consumer demand.
• The factors to be considered in forecasting sales budget are: Data for past
Sales, reports by salesmen, company conditions, business conditions,
market analysis etc.
 2. Production budget
•  The production budget is based on the sales budget. Once the
sales quantity and values are determined, then arises the problem
of how much to produce to meet the budget sales.

• The production budget is an estimate of the quantity of goods

that must be produced during the budget period. While preparing
production budget, the sales forecast, stock of closing stock and
opening stock, plant capacity, purchase of other related part are
taken into account.

• It is the responsibility of production department to adjust its

production according to sales forecast.
 3. Production Cost Budget

• Production cost budget shows in detail the

estimated cost of carrying out the production
plans as per the production budget.
• The production budget shows the quantities of
production. These quantities of production are
expressed in terms of cost in production cost
budget.
• It represents the cost of various elements of
production cost such as material, labor, and
overheads fixed or variables and semi-variables.
 4. Purchase Budget
• Purchase budget is concerned with purchases for the period of the
budget. It is referred to the purchase of raw materials, fixed 
assets, services like electricity and gas etc.
• The main object of the purchase budget is to formulate a plan
which will allow all purchases at a minimum cost.
• It comprises of- the quantities of each type of raw material and
other items to be purchased, the timing of purchases and the
estimated cost of material purchases.
• Factors to be considered-
• 1. opening and closing stock to be maintained
• 2. maximum and minimum stock quantities
• 3. economic order quantities
• 4. financial resources available etc
 5. Labour Budget
• Labour Budget lays emphasis on the labor requirements to
meet the demand of the company during the budget period.
• The labor cost budget always focuses on Direct and Indirect
labor cost. The labor requirements are referred to the
Personnel Department who is responsible for selection,
training and promotion. Purposes-

• 1. estimate labour cost of production

• 2. provide data for determination of cash requirements for
payment of wages
• 3. provide data for managerial control of labour cost
• 4. To plan recruitment activities by personnel department
 6. Production Overhead Budget

• This budget represents the forecast of all

production overheads to be incurred during the
budget period. The factory overheads are
classified as fixed, variable and semi-variable.
• Factors to be considered-Level of activity to be
achieved, classification into fixed and variable,
policy of management regarding- overtime
work, replacement etc
 7. Capital Expenditure Budget

• This budget indicates the plans for addition in Capital

expenditure (acquiring fixed assets), improvement in old
Assets and replacement of fixed assets. These may be: Plant
addition, new building, land and such as plants. Features-
• 1. It deals with items not directly related to profit and loss
account
• 2. other functional budgets are normally prepared for
shorter period , say one year while capital expenditure is
frequently planned a number of year in advance like 5 to 10
years and then broken down into convenient periods.
• 3. This budget involves large amount of expenditure which
needs top management approval.
 8. Cash Budget
It is one of the most important and one of the last to be
prepared. Cash budget represents the cash requirements of
the business during the budget period. It compares the
estimated Cash Receipts and estimated Cash payments of the
company during the budget period. It ensures that sufficient
cash is available when required.
• Purpose-
• To ensure sufficient cash is available when required
• Indicates cash excesses and shortages
• Sound basis for credit
• Shows whether capital expenditure may be financed internally.
 Master Budget
• The Institute of Cost and Management Accountants, defines
master budget as the summary budget incorporating all the
functional budgets, which is finally approved, adopted and
applied. Thus, master budget is prepared by combining all
departmental or functional budgets into one unit.

• It must be approved by the top management of the enterprise.

Once it is accepted and approved it becomes the target for the
company during a specific period to achieve the desired target.

• This budgeting contains the details of sales budget, production

budget, cash budget etc.
 Fixed and Flexible budget
• A FIXED BUDGET is prepared keeping in mind one level
of output.
• It is a kind of budget where the income and the
expenditure are pre-determined.
• Irrespective of any fluctuation or change, this budget
would remain static.
• Companies that are static, execute the same sort of
transactions can greatly benefit from a fixed budget.
But wherever there are fluctuations, a fixed budget
doesn’t turn out to be the most suited one.
• It is prepared on the assumption that output and
sales can be estimated with a fair degree of accuracy.
• FLEXIBLE BUDGET, on the other hand, is a budget that is flexible as
per the needs of the hour.
• It is designed to change in relation to the level of activity attained.
• For example, if the company sees that it can sell off more of its
products by expending more in advertisement costs, a flexible
budget would help execute that. That’s why a flexible budget is very
effective for companies who go through a lot of changes during a
particular period.
• It is developed with the objective of changing the budget figures to
correspond with the actual output achieved.
• It is much more complex than the fixed budget.
• (USES OF FLEXIBLE BUDGETS)
 Fixed budget v/s flexible budget
BASIS FIXED BUDGET FLEXIBLE BUDGET
 Meaning Fixed budget is a budget Flexible budget is a budget
prepared for only one level prepared for different
of activity capacity levels or for any
level of activity.

Assumption  Fixed budget assumes Flexible budget is based on

static business conditions changing business
conditions
Nature Fixed budget is always Flexible budget is very
static dynamic.

Use In a changing business Very useful for cost control

environment limited use and performance
for control. evaluation
Ease of preparation It is easy to prepare fixed   It is quite tough to
budget. prepare flexible budget
since one needs to
prepare for all situations
Consequences The dissonance between The dissonance between
the actual level and the the actual level and the
budgeted level is quite high budgeted level is quite low.
since there is no similarity
in activity level
Comparison Comparison is difficult Comparison is quite easy
since the activity levels are since the activity levels are
different at actual level and quite similar.
budgeted level
  Rigidity Pretty rigid, no fluctuation Quite flexible, almost every
is taken into account. fluctuation is taken into
account.
 How it is estimated? Fixed budget is mostly Flexible budget is prepared
estimated on assumptions with realistic situations in
and anticipations mind.
 Zero Based Budgeting(ZBB)
• Before preparing a budget, a base is determined from which
the budget process begins. Quite often current year’s
budget is taken as the base or the starting point for
preparing the next year’s budget, the figures in the base are
changed as per the plan for the next year. This approach of
preparing a budget is called incremental budgeting since
the budget process is concerned mainly with the increase or
changes in operations that are likely to occur during the
budget period.

• The main drawback – perpetuates the past inefficiencies.

ZBB is an alternative to incremental budgeting.
 Meaning
• What Does Zero-Based Budgeting Mean?
• Zero-based budgeting (ZBB) is a method of budgeting in which all 
expenses must be justified for each new period regardless of whether it
is new or existing. The process of zero-based budgeting starts from a
"zero base," and every function within an organization is analyzed for its
needs and costs. Budgets are then built around what is needed for the
upcoming period, regardless of whether each budget is higher or lower
than the previous one.

• ZBB was introduced by Peter Phyrr who is known as the father of ZBB. It
is not based on incremental approach and previous year’s figures are not
taken as the base for preparing next year’s budget. The budget will be
prepared as if it is being prepared for a new company for the first time.
 Defination
• Peter Phyrr has defined ZBB as “ a planning
and budgeting process which requires each
manager to justify his entire budget request in
detail from scratch (hence zero base). Each
manager states why he should spend any
money at all. This approach requires that all
activities be identified as decision packages
which will be evaluated by systematic analysis
ranked in order of importance.”
• Zero-based budgeting can help lower costs by avoiding
blanket increases or decreases to a prior period's budget.
• It is, however, a time-consuming process that takes much
longer than traditional, cost-based budgeting.
• The practice also favors areas that achieve direct 
revenues or production, as their contributions are more
easily justifiable than in departments such as client
service and research and development.
• It abandons any unproductive projects. This means that
those of the activities which are of no value find no place
in the forthcoming budget even though these might have
been an integral part of the past budget prepared under
the traditional approach. ZBB in a way tries to locate
those activities which are not essential.
 Features-
• 1. All budget items, both old and newly proposed, are
considered totally afresh.
• 2. Amount to be spent on each budget item is to be totally
justified.
• 3. A detailed cost benefit analysis of each budget programme
is undertaken and each programme has to compete for
scarce resources.
• 4. The main stress is not on “how much” a department will
spend but on “why” it needs to spend.
• 5. Managers at all levels participate in ZBB process and they
have corresponding accountabilities,
 Zero Based Budgeting Advantages
• Accuracy: Against the regular methods of budgeting that involve just making
some arbitrary changes to the previous year’s budget, zero-based budgeting
makes every department relook each and every item of the cash flow and
compute their operation costs. This to some extent helps in cost reduction
as it gives a clear picture of costs against the desired performance.
• Efficiency: This helps in efficient allocation of resources (department-wise)
as it does not look at the historical numbers but looks at the actual
numbers.
• Reduction in redundant or inefficient and loss making operations: It leads
to the identification of opportunities and more cost-effective ways of doing
things by removing all the unproductive or redundant activities.
• Budget inflation: zero-based budget overcomes the weakness of 
incremental budgeting of budget inflation. Deliberately inflated budget
requests get automatically weeded out in the ZBB process.
• Coordination and Communication: within the department and motivates
employees by involving them in decision-making.
 Zero Based Budgeting Disadvantages
• Time-Consuming: as against incremental budgeting, which
is a far easier method.
• High Manpower Requirement: Making an entire budget
from the scratch may require the involvement of a large
number of employees. Many departments may not have an
adequate time and human resource for the same.
• Lack of Expertise: Explaining every line item and every cost.
• High cost- ZBB leads to an enormous increase in paper work
• Resist – Managers may resist new ideas and changes. They
may feel threatened by ZBB because all expenditures are
questioned and need to be justified.
Traditional budgeting and Zero based budgeting
BASIS Traditional budgeting Zero-based budgeting
  Meaning It’s computed by keeping It’s computed by keeping
the previous year’s budget the starting point as zero.
as base.
Preparation Quite simple Very complex.
Emphasis Expenditure of previous Each item is considered as
year per the new economic
appraisal
 Approach Based on historical Based on estimated
information information.
 Justification Justification of current Justification of current and
project is not required proposed projects is
required, considering
benefits and costs

Effectiveness Effectiveness depends on Effectiveness depends on

the individuals who did the current top
the previous year’s management of the
budgeting. company.
 Performance Budget
• What Is a Performance Budget?
• A performance budget is a one that reflects both the
input of resources and the output of services for
each unit of an organization. The goal is to identify
and score relative performance based on goal
attainment for specified outcomes. This type of
budget is commonly used by government bodies
and agencies to show the link between
taxpayer funds and the outcome of services
provided by state, or local governments
 Performance budget also referred to as programme budgeting or planning,
programme and budget system (PPBS) is a practice of preparing the budget
based on the evaluation of the productivity of the different operations in an
organization. Operations which are contributing the most to the profitability,
the larger share of the budget is allocated to that division. It leads to optimum
utilization of resources such as finance, skills of the staff, use of the productive
time etc. In 1949, Hoover commission of USA innovated this budget.
• It tries to overcome the limitations of traditional budgeting. In traditional
system of budgeting the main defect is that the control of performance is not
achieved. This is because in such budgeting money concept is given more
importance.
• In other words, in traditional budgeting input and output are measured in
monetary unit while performance budgeting lays emphasis on achievement of
physical targets. Thus performance budgeting lays stress on activities and
programmes. It tries to answer questions like- what, how, when to achieve?
• Basically, performance budget requires an evaluation of the performance and
productivity from one budget period to another budget period. Hence, it is the
process of identifying the results achieved by each division of the organization.
• EXAMPLE OF PERFORMANCE BUDGETING
• 30% reduction in death ratio of HIV-Positive
patients by the end of 2020.
• 20% increase in production in 2018 by staff
training on a monthly basis.
• 50% reduction in infant mortality rate by
implementing robust vaccination centers in all
different parts of the country by 2022.
 ADVANTAGES OF PERFORMANCE BUDGET
• SET ACCOUNTABILITY
• In the public sector organization and not for profit organization, performance budget
helps to increase the accountability. The employees have to quantify a particular goal
based on the priority and the tax payer’s money. Unquestionably, taxpayer and the
donors have interest in knowing where the money is spent.  It evaluates the benefit
accruing to the citizens and society.
• CLEAR PURPOSE
• Performance budgeting indicates clearly the objective on which the money is going to be
spent. By making the purpose clear, it becomes easier to assess the performance and
correct the deviations.
• IMPROVEMENT IN PERFORMANCE OF THE PROGRAMS
• Thus, it leads to the overall operational efficiency of the organization. Also, it overcomes
the limitations of traditional budgeting.
• TRANSPARENCY IN BUDGET PREPARATION
• The performance budget helps in taking better financial decisions for the allocation of
resources. It reviews the operational efficiency of the projects. Hence, one can say, it
links the entire process of planning, implanting and evaluation of the results.
 DISADVANTAGES OF PERFORMANCE BUDGET
• SUBJECTIVE
• Since the performance budget is subjective in nature, it creates disagreement amongst the
management. Also, social projects are with a long-term vision. It is difficult to quantify in money
terms. The costs may differ from one government body to another government body.
• Therefore,  The more use of result based approach helps in improvement of the budgetary
process, accountability, and administration of the organization.
• STRONG SYSTEM OF EVALUATION
• The performance budget requires a strong system of accounting. Therefore, the reporting system
has to be strong for its successful implementation.
• MANIPULATION OF DATA
• Staff may manipulate the data. Further, the calculation of the financial information is not reliable
because of the errors in preparation.Therefore, Proper internal control system helps in
maintaining the accuracy of the data.
• DIFFICULT FOR LONG-TERM
• The time period between the allocation of resources in the project and the achievement of the
result might be more than a year. Undoubtedly, it makes it difficult to measure the results of the
projects in long-term.