BUDGETING AND BUDGETARY

CONTROL

 Management of an organization has the primary responsibility of

planning the activities of the organization. This ensures that, the
organization sets out in the right direction and that, there exist
coordinated approach of handling situations within the organization.

 Organizational planning also ensure that managers focus ahead on the

basis of review of the previous activities. Organizational plans are
formulated into budgets. Thus, the process of preparing budget forms
part of the planning function within the organization.
 MEANING OF BUDGET

 A budget is an organizational plan of action expressed in financial

or quantitative terms for either the whole of the organization or a
section of the organization for a specific period of time in the future.

 It is a quantitative statement for a well-defined period of time which

may include planned revenue, expenditure, assets, liabilities and
cash flow. It is prepared and approved prior to the budget period
and may show income, expenditure and the capital to be employed.
 MEANING OF BUDGET Cont’d

 Budget forecast revenue and expenditure to be made by either a

section of the organization or the organization as a whole for a
specified period of time as well as capital expenditure to be made
during the given period. It provides focus for the organization, aid the
coordination of activities and facilitate cost control.

 Planning is achieved by means of fixed master budget where as control

is generally exercised through the comparison of actual cost with
flexible budget.
 FEATURES OF A BUDGET

A budget may be expressed in monetary terms and/ or non

monetary terms such as units of product, time, number of
employees, etc.
 A budget is concerned with a definite future period and is therefore
prepared in advance of the period it relates.

 It is prepared and approved prior to the budget period and may

show income, expenditure and the capital to be employed
 Budget aimed at implementing the policies formulated by
management for attaining given objective. It therefore expressed the
 THE CONCEPT OF BUDGETARY
CONTROL
 Budgeting is the process of preparing a detailed plan for the functions,
activities and department of an organization with the prime objective of
converting the long-term corporate planning in course of action.
 The annual process of budgeting serves as a means of progress
fulfillment of the long-term plan of the organization.
 Thus, budgeting processes points the organization towards the
achievement of the long term objectives defined in the corporate plan.
 Budgeting is the process of preparing detailed short-term plans for the
functions activities and department of an organization with the aim of
converting the long-term corporate plan into action.
There are several types of budget they can be classified under
capital, fixed or flexible.
 The Capital Expenditure Budget; It is a plan for capital
expenditure in monetary terms. It deals with budgeting for
expenditures whose returns span over one-year period.
 Fixed Budget; A budget which is designed to remain unchanged
irrespective of the volume of output or turnover attained.
 Flexible Budget; A budget which, by recognizing the difference
in behaviour between fixed and variable costs in relation to
fluctuations in output, turnover, or other variable factors such as
 Forecasting; It is the prediction of relevant future factors affecting an
entity and its environment as a basis for formulation or reassessment
of objectives and strategies and as a means to facilitate the
preparation of planning decisions.
 Estimate; A considered but rough judgement usually made before
actual measurement or calculation takes place.
 BUDGETARY CONTROL

 Budgetary Control is a system of controlling through the use of

budgeting
 Budgetary control can be defined establishment of budgets as a tool for
continual comparison of actual result with the budgeted levels in order
to institute a corrective action to stimulate an improve performance.
 It involves the process or system of identifying expected performance
target, measuring actual performance against standard or budget,
instituting measures to ensure compliance with the set targets,
identifying and analyzing variation and instituting the relevant corrective
measures
 BUDGETARY CONTROL PROCESS

Budgetary control involves the following process;

i. Establish budget or target of performance.
ii. Monitor and record the actual performance.
iii. Compare actual performance with that budgeted.
iv. Calculate and analyze difference (variance) and investigate the reasons
for the differences
v. Undertake corrective actions by either revising the budget or controlling
actual performance in line with budget.
 IMPORTANCE OF BUDGETARY CONTROL

The following are inherent benefits of budgetary control system;

Planning
Budget represents a financial plan covering a shorter period (an operational plan) or
long term (strategic plan). Planning through budgeting helps an organization to
anticipate key changes in the business environment that could potentially impact on
business activities and to prepare appropriate responses.
Communication
Budgeting system facilitates communication within the organization both vertically
(between senior and junior managers) and horizontally (between different
organizational functions). Communication also occurs at all stages of the budgetary
control process, especially during budget preparation and during investigation of end-
of-period variances.
Control
Control
Budgetary control facilitate cost control through the continual comparison of budgeted
costs and actual costs. Variances between budgeted and actual costs can be
investigated in order to determine the reason why actual performance has differed
from what was planned. Corrective action can be introduced if necessary in order to
ensure that organizational objectives are achieved.
Read on the following benefits; Motivation, Performance evaluation, Forecasting and
setting targets, and Co-ordination
 Setting up & Administering Budgetary Control System

Before introducing an effective budgetary control system, the following should be

considered;
i. The key executives of the organization should be committed to the proposed
system.
ii. The long-term objectives should be clearly be defined.
iii. Adequate data should be available based on forecast of revenue and cost.
iv. The organizational chart should be clearly be defined showing clearly area of
authority and responsibility. The organization should be logically be divided into
budget centers such that each manager has a budget for, and is given control
information about, the area which he can control.
 BUDGET COMMITTEE

This is a committee set up to coordinate and administers the budget of the

organization. A typical budget committee normally consists of the following
group of people;
i. Executive management, preferably, the Chief Executive (the Chairman of
the committee), must be represented in order to provide executive authority
and to reinforce the need to plan and to achieve corporate objectives.
ii. Senior budget holders, i.e. senior operating managers, are on the
committee to ensure that the budgets arrived at are meaningful and
achievable.

iii. The accounting function or the Management Accountant as budget

director, whose task is to integrate the budgets, highlight
interdependencies and constraints and provide special financial
assistance to the committee.
 BUDGET MANUAL

BUDGET MANUAL is a collection of budgeting instructions governing the

responsibilities of persons, and the procedures, forms and records relating
to the preparation and use of the budget data. The budget manual
indicates which budgets to prepare, how to prepare it, who should do it,
when and the form, it should take.
 BUDGET PERIOD

 Budget Period is the period for which a budget is prepared and used, which
may then be subdivided into control periods. The lengths of the budget period
depend much on various factors such as the nature of the business, the
manufacturing or production cycle, the type of budget, The dependability of
available data, and the resources required to prepared the budget

 A budget period may be one month, a year , five or more years. A budget period
may be chosen to coincide with an organization 's production cycle or
accounting period. While a functional budget may span a period of one year or
less, a capital expenditure budget will certainly cover a period of more than one
year.
 Types of Budgets

There are two main types of budgets and include functional and master
budgets.
Functional Budget; Functional budget are those budget which relates to an
aspects of an organization. Examples of functional budgets includes Sales
budget, production budget, raw material usage budget, raw material purchase
budget personnel budget, and research and development budget.
Master budgets are those that incorporates the various functional budgets
into a whole budget for the entire organization. Examples includes
Budgeted trading and profit and loss accounts, cash budget and budgeted
balance sheet.
 Advantages of Budget

i. It provides clear guidelines for managers and supervisions and is the major way in
which organizational objectives are translated into specific takes and objectives
related to individual managers.

ii. The budgetary process is an important method of communication and coordination

both vertically and horizontally.

iii. Because of the 'exception principle,' which is at the heart of budgetary control,
management time can be saved and attention directed to areas of most concern.

iv. The integration of budgets makes possible better cash and working capital
management.

v. Better control of current operations is helped by regular, systematic monitoring and

 Problems of Budgeting

i. Variances are just as frequently due to changing circumstances

and poor forecasting as due to managerial performance.
ii. Budgets are developing round existing organization structures
which may be inappropriate for current conditions. The annual
budget model has several inherent weaknesses. These exist no
matter what approach to budgeting is used.
iii. The existence of well documented plans may cause inertia and lack
of flexibility in adapting to change.
iv. Badly handled budgetary systems with undue pressure or lack of
regard to behavioral factors may cause antagonism and may be
lower morale
Fundamental Weakness in the Traditional Annual
Budgeting Approach

 The budget is for a one-year period. Targets are set for the 12
months and actual performance is measured on the basis of
achievements in one year. However, to achieve strategic change,
planning needs to be for the longer term and performance should be
measured by progress towards longer-term objectives as well as
shorter- term -achievements.
 Tire annual budget is also seen as a system for imposing
financial discipline and control. This focus on financial targets and
cost control is not compatible with setting corporate objectives,
where external factors and competitiveness are just as important as
internal efficiency and financial returns.
 The annual budget focuses on internal e fficiency and improvements,
and lacks an external focus. However, strategic objectives and strategic
planning have to take account of external factors as well as internal e fficiency.

 It can be argued that the annual budget process adds little value and is
unnecessary. It wastes management time, since management should be
doing other things to add value and contribute to the entity's objectives.

 There is also
 an argument that the annual budget is so rigid and discourages
change once the budget targets have been agreed. Management will
focus their attention and efforts on achieving the agreed targets, even
though circumstances might change and the budget targets might no
longer be the most appropriate.
 ILLUSTRATION 1

An organization is constructing its budget for the coming year. It makes three products: Alpha, Beta and
Gamma. Sales forecasts for the year as follows:
Alpha Beta Gramma
Northern region (in units) 3,000 5,000 4,000
Southern region (in units) 5,000 7,000 6,000
8,000 12,000 10,000

Selling prices are as budgeted

Alpha GH₵60
Beta GH₵110
Gamma GH₵90
You are given the following standard cost data to make one unit:
Material X (in kilos) 2.00 3.00 2.5
Material Y (in kilos) 3.00 4.00 1.5
Labour hours Department 1 0.75 1.25 2.0
Department 2 1.50 2.00 2.5
Machine hours Department 1 1.00 1.50 2.5

Department 2 2.00 2.00 3.0

You are told:
X Y
i) Material cost per kilo (GHC) 3 2
Dept 1 Dept
2
Labour rate per hour (GHC) 4 3
ii) Production overheads are: Dept 1 Dept 2
Overheads in Dept 1 are absorbed on a labour basis and in Dept 2 on a machine basis.
iii) Administration overheads are GH₵350,950 and are to be absorbed on the basis of labour cost.
iv) Opening and Closing stocks are budgeted as follows:
In units In Kilos
Alpha Beta Gramma X Y
Opening stock 1,000 1,200 1,500 5,000 7,500
Closing stock 1,200 1,000 1,800 8,000
10,000

Required:
Prepared the following budgets:
i. Sales budget in revenue
ii. Production budgets in unit for each product
iii. Materials purchase budget
iv. Departmental Labour cost budgets
 Illustration 2

AB Company Limited produces two finished goods, Aand B from raw materials, M1 and M2. The
following information was the budget for the second quarter ended 30th June 2021.
Product A Product
B
Sales in Unit 950 1,900
Expected production losses 50 100
Materials Usage: M1 4kg 3kg
M2 2kg 1kg
Direct Labour Usage: Grade 1 3hrs 2hrs
Grade 2 4hrs 5hrs
Opening finished stocks (units) 200 300
Closing finished stock( units) 300 500
 Approaches to Budgeting

 Zero budgeting

 Incremental budgeting

 Activity Budgeting

 Rolling Budgeting

 Planning Programming Budgeting System(PPBS)

Reading Assignment; Read on the Meaning, advantages, and disadvantages of the
above approaches to budgeting.
 CASH BUDGET

 Cash budget is prepared to show the expected receipt of cash and

payments of cash during budget period. The annual cash budget will be
divided into smaller time periods commonly of one month or four weeks.

 Receipt of cash may be from cash sales, payments by debtors, the sale of
fixed assets, issue of new shares or loan stock, the receipts of interest and
dividends from investment outside the business etc. Not all of these are
profit and loss items;
a. The issue of new shares or loan stock is a balance sheet item;

b. The cash received from selling an asset affect the balance sheet and the
profit on the sale of the asset, which appears in the P& L account, is not the
cash received, the difference between;

1. cash received; and

2. the written down value of the asset at the time of sale.

 Payment of cash may be for purchases of stocks, payment of wages,
the payment of capital items, the payment of interest, dividends, or
taxation. Not all payments are profit and loss accounts items (eg. the
purchase of capital equipment items or the payment of VAT)

 The cash budget predicts the expected cash receipts and payments
during the next year. The annual cash budget as prepared is divided
into shorter periods, say, monthly or on a four-week basis .
 A distinction must be drawn between cash receipts and payments as
depicted in the cash budget on one hand and that of sales and expenses as
depicted in the income statement budget on the other. While some items in
the cash budget affect some items in the income statement, others do not.
On the other hand while some items also in the income statement affect
some items in the cash budget, others do not have any relation at all. So the
cash budget is not the same as the income statement budget. Some items in
the cash budget are also reflected in the budgeted balance sheet.
 Methods of Preparing Cash Budget

I. The receipts and payment method

II. The balance sheet method
 The Specimen Format for Cash Budget

A). Receipts and Payment Method

GH₵ GH₵
Receipts:
Cash sales XX
Payment by debtors XX
Investment income (net) XX
Total Receipts (a) XX
Payments:

Materials and service XX

Wages and Salaries(net) XX

Wages and salaries( PAYE and SSNIT) XX

Capital items XX

Interest payable(not accrued) XX

Taxes XX

Dividend payable XX
 GH₵ GH₵
Total Payments(b) XX
Analysis
Beginning Balance XX
Net cash flow (a – b ) XX
Balance at end XX
 Reasons Or Advantages of Preparing Cash
Budget

 Goal setting

 Working capital management and Investment optimization

 Purchasing Efficiency

 Labour Request support

 Expenses control

 Debt Repayment
 REVIEW EXERCISE

1. The managers of Wa Municipal hospital are in the process of preparing

the annual budget for the next financial year using incremental budgeting.

The hospital's directors are concerned that the approach used will result in a

budget that does not reflect the aims and objectives of the hospital. They

have requested that the budget should be produced using zero based

budgeting.

Required: Explain the potential difficulties that the hospital's managers may

face when setting budgets using zero based budgeting.

2. The managing director of your company believes that the
existing annual budget system is costly to operate and
produces unsatisfactory results due to: long preparation
period; business decisions being made throughout the year;
unpredictable changes in the rate of general inflation; sudden
changes in the availability and price of raw materials. He has
read about rolling budgets and wonders whether these might
be more useful for his decision-making.
You are required, as the management accountant, to prepare a paper for him
covering the following areas.
(a) a brief explanation of rolling budgets;
(b) how a rolling budget system would operate;
(c)three significant advantages of a rolling budget system;
(d)three problems likely to be encountered in using a rolling budget system