Session 1

Introduction to budgets
Planning and controlling Cycle

A budget is defined as the formal expression of plans, goals, and objectives of management
that covers all aspects of operations for a designated time period.
or
A budget is a quantified plan of action for a forthcoming accounting period. A budget is a plan
of what the organisation is aiming to achieve and what it has set as a target whereas a forecast
is an estimate of what is likely to occur in the future.

Purpose
It assists in providing targets and Direction. They work as a control tool and reduce the adverse
impact. Budgeting allocates resources for a specific period.
Budgets link the nonfinancial plans and controls that constitute daily managerial operations
with the corresponding plans and controls designed to obtain satisfactory earnings and financial
position.
Objectives of budgeting
 To ensure the achievement of the organisation's objectives
 To compel planning
 To communicate ideas and plans
 To co-ordinate activities
 To provide a framework for responsibility accounting
 To establish a system of control
 To motivate employees to improve their performance

Effective budgeting requires the existence of:

1. Predictive ability
2. Clear channels of communication, authority, and responsibility
3. Accounting-generated accurate, reliable, and timely information
4. Compatibility and understandability of information
5. Support at all levels of the organization: upper, middle, and lower

To ensure that budgets are more related to actual results. The budgets should be reviewed and
revised by budget committee periodically to incorporate necessary changes. This practice will
also assist in developing a better understanding of variances and how to deal with the
variances.

Duration and timing

Budgets are specified according to their duration. These durations can vary as per the needs of
operations of company. Long term budgets are more uncertain then short term budgets. At
the beginning of the period, the budget is a plan. At the end of the period, the budget is a
control instrument
Characteristics of budgets
Budgets should be understandable and attainable. Flexibility and innovation are needed to
allow for unexpected contingencies. As variables change the results will vary as well.

Budgetary Process
The six steps in the budgeting process are:
 1. Setting objectives
2. Analyzing available resources
3. Negotiating to estimate budget components
4. Coordinating and reviewing components
5. Obtaining final approval
6. Distributing the approved budget

Budget Weaknesses
1. Managerial goals are off target or unrealistic.
2. Management is indecisive.
3. The budget takes too long to prepare.
4. Budget preparers are unfamiliar with the operations being budgeted and do not seek
such information. lack of communication between those involved in budgeting and
operating
5. The budget is prepared using different methods each year.
6. There is a lack of raw information going into the budgeting process.
7. The budget is formulated without input from those affected by it. This will probably
result in budgeting errors. Further, budget preparers do not go into the operations
field.
8. Managers do not know how their budget allowances have been assigned or what the
components of their charges are. If managers do not understand the information, they
will not perform their functions properly.
9. The budget document is excessively long, confusing, or filled with unnecessary
information.
10. There may be inadequate narrative data to explain the numbers.
11. Managers are ignoring their budgets because they appear unusable and unrealistic.
12. Managers feel they are not getting anything out of the budget process. Changes are
made to the budget too frequently.
13. Significant unfavorable variances are not investigated and corrected. These variances
also may not be considered in deriving budgeted figures for the next period. Further, a
large variance between actual and budgeted figures, either positive or negative, that
repeatedly occurs is an indicator of poor budgeting. Perhaps the budgeted figures were
unrealistic.
14. Another problem is that after variances are identified, it is too late to correct their
causes.

Budgetary Slack: Padding the Budget

Budget padding means underestimating revenue or overestimating costs. The difference
between the revenue or cost projection that a manager provides and a realistic estimate of the
revenue or cost is called budgetary slack.

When slack is introduced into budget, employees may fail to maximize sales and minimize cost.

Benefits of Budgets.
 Translate plans into actions-oriented goals and objective.
 The budget is tool that communicated the expected outcome.
 A benchmark to justify success or failure in reaching objectives.
 Identification of relevant bottlenecks and constraints.

Drawbacks
 Budgets can also impose a dysfunctional behavior. The aim should be goal congruence.
 Development of slack.
 Take it as burden.
 Communication of budgetary targets.
 Preparers are not usually user of budget.

Responsibility centres
Responsibility accounting is a system of accounting that segregates revenue and costs into areas of
personal responsibility in order to monitor and assess the performance of each part of an organisation.
A responsibility centre is a function or department of an organisation that is headed by a manager
who has direct responsibility for its performance.
The information is collected from responsibility centers for preparation of budgets.
A cost centre acts as a collecting place for certain costs before they are analysed further.

Cost centres may include the following.

(a) A department
(b) A machine or group of machines
(c) A project (eg the installation of a new computer system)
(d) A new product (allowing development costs to be identified)

Information about cost centres might be collected in terms of total actual costs, total budgeted costs
and total cost variances (the differences between actual and budged costs)

A profit centre is any unit of an organisation (for example, division of a company) to which both
revenues and costs are assigned, so that the profitability of the unit may be measured.

Profit centres differ from cost centres in that they account for both costs and revenues and the key
performance measure of a profit centre is therefore profit.
An investment centre is a profit centre whose performance is measured by its return on capital
employed.

Control can be exercised by reporting information, such as profit/sales ratios, asset turnover ratios,
cost/sales ratios, and cost variances. In addition, the performance of investment centres can be
measured by divisional comparisons.