Budgets and

Budgetary Control
A budget is a statement that is always prepared
prior to a defined period of time. This means that
budget is always prepared for future period and not for
the past. For example, a budget for the year 2018-19
regarding the sales will be prepared in the year 2017-18.
Another important point is that the time for which it is
prepared is certain. Thus a budget may be prepared for
next 3 years/1 year/ 6 months/1 month or even for a
week, but the point is that the time frame for which it is
prepared is certain. It cannot be prepared for indefinite
period of time.
Budgetary Control is actually a means of control in
which the actual results are compared with the
budgeted results so that appropriate action may
be taken with regard to any deviations between
the two.
Budgetary control has the following stages.
1- Developing Budgets: The first stage in budgetary
control is developing various budgets. It will be
necessary to identify the budget centers in the
organization and budgets will have to develop for
each one of them. Thus budgets are developed
for functions like purchase, sale, production,
manpower planning as well as for cash, capital
expenditure, machine hours, labor hours and
so on.
2- Recording Actual Performance: There should be a
proper system of recording the actual performance
 achieved. This will facilitate the comparison between
the budget and the actual.
3- Comparison of Budgeted and Actual
Performance: One of the most important aspects of
budgetary control is the comparison between the
budgeted and the actual performance.
4-Corrective Action: Taking appropriate corrective
action on the basis of the comparison between the
budgeted and actual results is the essence of
budgeting. A budget is always prepared for future
and hence there may be a variation between the
budgeted results and actual results.

Objectives of Budgeting
The budgeting system has the following objectives, which
are of paramount importance in the overall efficiency and
effectiveness of the
business organization.
1- Planning: Planning is necessary for doing any work
in a systematic manner. A well- prepared plan helps
the organization to use the scarce resources in an
efficient manner and thus achieving the
predetermined targets becomes easy. A budget is
always prepared for future period and it lays down
targets regarding various aspects like purchase,
production, sales, manpower planning etc. This
automatically facilitates planning.
2- Co-ordination: For achieving the predetermined
objectives, apart from planning, coordinated efforts
are required. Budgeting facilitates coordination in the
sense that budgets cannot be developed in isolation.
For example, while developing the production
budget, the production manager will have to consult
the sales manager for sales forecast and purchase
 manager for the availability of the raw material.
Production budget cannot be developed in isolation.
Similarly the purchase and sales budget as well as
other functional budgets like cash, capital
expenditure, manpower planning etc cannot be
developed without considering other functions.
Hence the coordination is automatically facilitated.
3-Control: Planning is looking ahead while controlling
is looking back. Preparation of budgets involves
detailed planning about various activities like
purchase, sales, production, and other functions like
marketing, sales promotion, manpower planning. But
planning alone is not sufficient. There should be a
proper system of controlling which will ensure that
the work is progressing as per the plan. Budgets
provide the basis for such controlling in the sense
that the actual performance can be compared with
the budgeted performance.

Benefits of Budgeting
Budgeting plays an important role in planning and
controlling. It helps in directing the scarce resources to
the most productive use and thus ensures overall
efficiency in the organization. The benefits derived by an
organization from an effective system of budgeting can
be summarized as given below.
I. Budgeting facilitates planning of various activities and
ensures that the working of the organization is
systematic and smooth.
II. Budgeting is a coordinated exercise and hence
combines the ideas of different levels of management in
preparation of the same.
III. Any budget cannot be prepared in isolation and
therefore coordination among various departments is
facilitated automatically.
IV. Budgeting helps planning and controlling income and
expenditure so as to achieve higher profitability and also
act as a guide for various management decisions.
V. Budgeting is an effective means for planning and thus
ensures sufficient availability of working capital and other
resources.
VI. It is extremely necessary to evaluate the actual
performance with predetermined parameters. Budgeting
ensures that there are well-defined parameters and thus
the performance is evaluated against these parameters.
VII. As the resources are directed to the most productive
use, budgeting helps in reducing the wastages and
losses.

Preparation for Budgetary Control

A budgetary control is extremely useful for planning and
controlling as described above. However, for getting
these benefits, sufficient preparation should be made. For
complete success, a solid foundation should be laid down
and in view of this the following aspects are of crucial
importance.
I. Budget Committee: For successful implementation of
budgetary control system, there is a need of a budget
committee. In small or medium size organizations, the
budget related work may be carried out by the Chief
Accountant himself. Due to the size of the organization,
there may not be too many problems in implementation
of the budgetary control system. However, in large size
organization, there is a need of a budget committee
consisting of the chief executive, budget officer and
heads of
main departments in the organization. The main functions
of the budget committee are to get the budgets prepared
and then scrutinize the same, to lay down broad policies
regarding the preparation of budgets, to approve the
budgets, to suggest for revision, to monitor the
implementation and to recommend the action to be taken
in a given situation.
II. Budget Centers: Establishment of budget centers is
another important pre-requisite of a sound budgetary
control system. A budget center is a group of activities or
a section of the organization for which budget can be
developed. For example, manpower planning budget,
research and development cost budget, production and
production cost budget, labor hour budget and so on.
Budget centers should be defined clearly so that
preparation becomes easy.
III. Budget Period: A budget is always prepared prior to
a defined period of time. This means that the period for
which a budget is prepared is decided in advance. Thus a
budget may be prepared for three years, one year, six
months, one month or even for one week. The point is
that the period for which the budget is prepared should
be certain and decided in advance. Generally it can be
said that the functional budgets like sales, purchase,
production etc. are prepared for one year and then
broken down on monthly basis. Budgets like capital
expenditure are generally prepared for a period from 1
year to 3 years. Thus depending upon the type of budget,
the period of the same is decided and it is important that
it is decided well in advance.
IV. Preparation of an Organization Chart: There
should be an organization chart that shows clearly
defined authorities and responsibilities of various
executives. The organization chart will define clearly the
functions to be performed by each executive relating to
the budget preparation and his relationship with other
executives. The organization chart may have to be
adjusted to ensure that each budget center is controlled
by an appropriate member of the staff.
V. Budget Manual: A budget manual is defined by ICMA
as ‘ a document which sets out the responsibilities of the
person engaged in, the routine of and the forms and
records required for budgetary control’.
The budget manual thus is a schedule, document or
booklet, which contains different forms to be used,
procedures to be followed, budgeting organization
details, and set of instructions to be followed in the
budgeting system. It also lists out details of the
responsibilities of different persons and the managers
involved in the process. A typical budget manual contains
the following.
1- Objectives and managerial policies of the business
concern.
2- Internal lines of authorities and responsibilities.
3- Functions of the budget committee including the role
of budget officer.
4- Budget period
5- Principal budget factor
6- Detailed program of budget preparation
7- Accounting codes and numbering
8- Follow up procedures.
VI. Principal Budget Factor or Key Factor: A key
factor or a principal budget factor [also called as
constraint] is that factor the extent of whose influence
must first be assessed in order to prepare
the functional budgets. Normally sales are the key factor
or principal budget factor but other factors like
production, purchase, skilled labor may also be the key
factors. For example, a company has production capacity
to produce 30,000 tones per annum but if the sales
forecast tells that the market can absorb only 20,000
units, there is no point in producing 30,000 units. Thus,
the sale is the key
factor in this case. On the other hand, if the company has
capacity to produce 30,000 units and the market has the
capacity to absorb the entire production which means
that sales is not the key factor
but if raw material is available in limited quantity so that
only 25,000 units can be produced, the raw material will
become the key factor. The key factor puts restrictions on
the other functions and hence it must be considered
carefully in advance. So continuous assessment of the
business situation becomes necessary. In all conditions
the key factor is the starting point in the process of
preparation of budgets.

A typical list of some of the key factors is given below.

1- Sales: Consumer demand, shortage of sales staff,
inadequate advertising.
2- Material: Availability of supply, restrictions on
import.
3- Labor: Shortage of labor.
4- Plant: Availability of capacity, bottlenecks in key
processes.
5- Management: Lack of capital, pricing policy,
shortage of efficient executives, lack of know- how,
faulty design of the product etc.

VII. Establishment of Adequate Accounting Records:

It is essential that the accounting system should be able
to record and analyze the transactions involved. A chart
of accounts or accounts code should be maintained which
may correspond with the budget centers for
establishment of budgets and finally control through
budgets.

Types of Budgets
Budgets can be classified as per the following basis.
1- On the basis of Area of Operation
A. Functional Budgets
B. Master Budget
2- On the basis of Capacity Utilization
A. Fixed Budget
B. Flexible Budgets
3- On the basis of Time
A. Short Term
B. Medium Term
C. Long Term
4- On the basis of Conditions
A. Basic Budget
B. Current Budget

1-Classification according to Area of Operation

A. Functional Budgets: The functional budgets are

prepared for each function of the organization.
These budgets are normally prepared for a period of
one year and then broken down to each month. The
following budgets are included in this category.
i- Sales Budget: A Sales Budget shows forecast
of expected sales in the future period [the
period is well defined] and expressed in
quantity of the product to be sold as well as the
monetary value of the same. A Sales Budget
may be prepared product wise,
territories/area/country wise, customer group
 wise, salesmen wise as well as time wise like
quarter wise, month wise, weekly etc. The
following factors are taken into consideration
while preparing a sales budget.
ii- Analysis of past sales: Analysis of sales for
the last 5-10 years will provide valuable
information like the long term trend, seasonal
trends, cyclical fluctuations and other relevant
information like customer preference analysis,
shift in demand, competition and other
environmental factors. This information can be
used to predict the likely future demand of the
product.
iii- Estimates given by the sales staff: Sales
staff of the business organization works in the fi
eld and hence they know the market situation
very well.
iv- Market Potential Analysis: Marketing
Research helps any business organization to
collect the data regarding markets, demand
pattern, customer preferences, market potential
and other factors like economic factors and
environmental factors. From this analysis,
market potential can be worked out which will
be used in the sales budget.
v- Dependent Factor: Demand of a product is
dependent upon certain factors. For example,
the demand for petrol and diesel is dependent
on the number of vehicles plying though the
roads.

Illustration I: A company manufactures two products, A

and B. Its sales department has three area divisions,
North, East and South. Preliminary sales budgets for the
year ending 31st March 2017, based on the assessment
of the divisional managers were as follows.
Product A: North 200,000 units, South 550,000 units
and East 100,000 units
Product B: North 300,000 units, South 400,000 units
and East Nil
Sale price: A at 4 frs and B at 3 frs in all areas.
Arrangements are made for the extensive advertising of
Products A and B and it is estimated that the North
division sales will increase by 100,000 units.
Arrangements are also made to advertise and distribute
product in Eastern area in the second half of the year
2016-17 when sales are expected to be 500,000 units.
Required: Prepare a revised sales budget for the year
ended 31st March after taking into consideration the
above mentioned adjustments.

Production Budget: This budget shows the production

target to be achieved in the next year or the future
period. The production budget is prepared in quantity as
well as in monetary terms. Before
preparation of this budget it is necessary to study the
principal budget factor or the key factor.
The principal budget factor can be sales demand or the
production capacity or availability of raw material. The
policy of the management regarding the inventory is also
taken into consideration.
The production budget is normally prepared for a period
of one year and then broken down on monthly basis.
Production targets are decided by adding the budgeted
closing inventory in the sales
forecast and subtracting the opening inventory from the
total of the same. Production Cost Budget is prepared by
multiplying the production targets by the budgeted
production cost per unit. The
following illustration will clarify the concept.

Illustration II
Prepare Production Budget from the following details for
XYZ Ltd.
Produ Estimated Estimated Sales
ct Inventory Inventory Forecast as
1st April 31st March per Sales
2008 2009 Budget
X 2,500 units 3,000 units 15000 units
Y 3,500 units 4,000 units 20000 units

Material Purchase Budget: This budget shows the

quantity of materials to be purchased during the
coming year. For the preparation of this budget,
production budget is the starting point if it is the
key factor. If the raw material availability is the key
factor, it becomes the starting point. The desired
closing inventory of the raw materials is added to the
requirement as per the production budget
and the opening inventory is subtracted from the gross
requirements. This budget is prepared in
quantity as well as in the monetary terms and helps
immensely in planning of the purchases of raw
materials. Availability of storage space, fi nancial
resources, various levels of materials like maximum,
minimum, re-order and economic order quantity are
taken into consideration while preparing this
budget. A separate material utilization budget may also
be prepared as a preparation of material
purchase budget.
Illustration IV: [Sales, Production, Material Utilization
and Material Purchase Budget] Ltd. manufactures three
products, A, B and C. You are required to prepare for the
month of January
2008, the following budgets from the information given
below.
i. Sales Budget in quantity and value
ii. Production Budget
iii. Material Utilization Budget
iv. Purchase Budget in quantity and value