ADVANTAGES OF BUDGETARY CONTROL SYSTEM

Advantages of Budgetary Control System

Points		Description
1.	Efficiency	The use of budgetary control system enables the management of a business concern to conduct its business activities in the efficient manner.
2.	Control on expenditure	It is a powerful instrument used by business houses for the control of their expenditure. It in fact provide1`s a yardstick for measuring and evaluating the performance of individuals and their departments.
3.	Finding deviations	It reveals the deviations to management, from the budgeted figures after making a comparison with actual figures.
4.	Effective utilisation of resources	Effective utilisation of various resources like—men, material, machinery and money—is made possible, as the production is planned after taking them into account.
5.	Revision of plans	It helps in the review of current trends and framing of future policies.
6.	Implementation of Standard Costing system	It creates suitable conditions for the implementation of standard costing system in a business organisation.
7.	Cost Consciousness	Budgets are studied by  outside  fund  providers  also  such  as  banking  and  financial  institutions,  realising that management encourages cost consciousness and maximum utilisation of available resources.
8.	Credit Rating	Management which have developed a well ordered budget plans and which operate accordingly, receive greater favour from credit agencies.

WORKING OF A BUDGETARY CONTROL SYSTEM

 Working of a budgetary control system

The responsibility for successfully introducing and implementing a Budgetary Control System rests with the Budget Committee acting through the Budget Officer. The Budget Committee would be composed of all functional heads and a member from the Board to preside over and guide the deliberations. 

The main responsibilities of the Budget Officer are:

1. to assist in the preparation of the various budgets by coordinating the work of the accounts department which is normally responsible to compile the budgets—with the relevant functional departments like Sales, Production, Plant maintenance etc.;

2. to forward the budget to the individuals who are responsible to adhere to them, and to guide them in overcoming any practical difficulties in its working;

3. to prepare the periodical budget reports for circulation to the individuals concerned;

4. to follow-up action to be taken on the budget reports;

5. to prepare an overall budget working report for discussion at the Budget Committee meetings and to ensure follow-up on the lines of action suggested by the Committee;

6. to prepare periodical reports for the Board meeting. Comparing the budgeted Profit and Loss Account and the Balance Sheet with the actual results attained.

It is necessary that every budget should be thoroughly discussed with the functional head before it is finalised.

It is the duty of the Budget Officer to see that the periodical budget reports are supplied to the recipients at frequent intervals as far as possible.

The efficiency of the Budget Officer, and through him of the Budget Committee, will be judged more by the smooth working of the system and the agreement between the actual figures and the budgeted figures.

Budgets are primarily an incentive and a challenge for better performance; it is up to the Budget Officer to see that attention of the different functional heads is drawn to it to face the challenge in a successful manner.

OBJECTIVES OF BUDGETARY CONTROL SYSTEM

 Objectives of Budgetary Control System

1. Portraying with precision the overall aims of the business and determining targets of performance for each section or department of the business.

2. Laying down the responsibilities of each of the executives and other personnel so that everyone knows what is expected of him and how he will be judged. Budgetary control is one of the few ways in which an objective assessment of executives or department is possible.

3. Providing a basis for the comparison of actual performance with the predetermined targets and investigation of deviation, if any, of actual performance and expenses from the budgeted figures. This naturally helps in adopting corrective measures.

4. Ensuring the best use of all available resources to maximise profit or production, subject to the limiting factors. Since budgets cannot be properly drawn up without considering all aspects usually there is good co-ordination when a system of budgetary control operates.

5. Co-ordinating the various activities of the business, and centralising control and yet enabling management to decentralise responsibility and delegate authority in the overall interest of the business.

6. Engendering a spirit of careful forethought, assessment of what is possible and an attempt at it. It leads to dynamism without recklessness. Of course, much depends on the objectives of the firm and the vigour of its management.

7. Providing a basis for revision of current and future policies.

8. Drawing up long range plans with a fair measure of accuracy.

9. Providing a yardstick against which actual results can be compared.

BUDGETARY CONTROL (SALIENT FEATURES)

 Budgetary Control 

 The salient features of such a system are the following:

1. Determining the objectives to be achieved, over the budget period, and the policy or policies that might be adopted for the achievement of these ends.

2. Determining the variety of activities that should be undertaken for the achievement of the objectives.

3. Drawing up a plan or a scheme of operation in respect of each class of activity, in physical as well as monetary terms for the full budget period and its parts.

4. Laying out a system of comparison of actual performance by each person, section or department with the relevant budget and determination of causes for the discrepancies, if any.

5. Ensuring that corrective action will be taken where the plan is not being achieved and, if that be not possible, for the revision of the plan.

In brief, it is a system to assist management in the allocation of responsibility and authority, to provide it with aid for making, estimating and planning for the future and to facilitate the analysis of the variation between estimated and actual performance.

In order that budgetary control may function effectively, it is necessary that the concern should develop proper basis of measurement or standards with which to evaluate the efficiency of operations, i.e., it should have in operation a system of standard costing.

Beside this, the organisation of the concern should be so integrated that all lines of authority and responsibility are laid, allocated and defined. This is essential since the system of budgetary control postulates separation of functions and division of responsibilities and thus requires that the organisation shall be planned in such a manner that everyone, from the Managing Director down to the Shop Foreman, will have his duties properly defined.

BUDGETARY CONTROL INVOLVES

Budgetary Control Involves :

1. Establishment of budgets

2. Continuous comparison of actual with budgets for achievement of targets

3. Revision of budgets after considering changed circumstances

4. Placing the responsibility for failure to achieve the budget targets.

MEANING OF BUDGETARY CONTROL

MEANING OF BUDGETARY CONTROL

CIMA has defined the terms ‘budgetary control’ as “Budgetary control is the establishment of budgets relating to the responsibilities of executives of a policy and the continuous comparison of the actual with the budgeted results, either to secure by individual action the objective of the policy or to provide a basis for its revision. “It is the system of management control and accounting in which all the operations are forecasted and planned in advance to the extent possible and the actual results compared with the forecasted and planned ones.

CONTROLLING

Controlling :

•  As time passes, the actual performance of an operation can be compared against the planned targets. This provides prompt feedback to employees about their performance. If necessary, employees can use such feedback to adjust their activities in the future. 
•  Feedback received in the form of budget report from the responsibility centre. This report is helpful to know the performance of the concerned unit. 
• Any unexpected changes into the conditions which were prevailing at the time of preparing budget are taken into account and budgets are revised to show true performance yardstick. 
•  Comparing actual results to the plan also helps prevent unplanned expenditures. The budget encourages employees to establish their spending priorities. 
• The main objective of Budgeting is to help in achieving the overall objective of the organization.

DIRECTING AND COORDINATING

Directing and Coordinating :

• Once the budget plans are in place, they can be used to direct and coordinate operations in order to achieve the stated targets. 
•  A business, however, is much more complex and requires more formal direction and coordination.
•  The budget is one way to direct and coordinate business activities and units to achieve stated targets of performance. 
• The budgetary units of an organisation are called responsibility centers. Each responsibility center is led by a manager who has the authority over and responsibility for the unit’s performance. 
•  Objectives and degree of performance expected from a responsibility centres are communicated rapidly.

PLANNING

Planning :

The process of budgeting begins with the establishment of specific targets of performance and is followed by executing plans to achieve such desired goals and from time to time comparing actual results with the target goals. These targets include both the overall business targets as well as the specific targets for the individual units within the business. Establishing specific targets for future operations is part of the planning function of management, while executing actions to meet the goals is the directing function of management. It may be explained as

•  Budget plans are made in synchronisation with the overall objectives of the organisation, keeping mission and corporate strategy into account. Individual plans at unit level should be in consonance with organisational plan.
•  Budgets reflect plans and that planning should have taken place before budgets are prepared. 
•  Budgets plans are quantified and responsibility is assigned to the persons who are responsible for execution of plan. 
• Using the budget to communicate these expectations throughout the organisation has helped many a companies to reduce expenses during a severe business recession. 
• Planning not only motivates employees to attain goals but also improves overall decision making. During the planning phase of the budget process, all viewpoints are considered, options identified, and cost reduction opportunities assessed. This process may reveal opportunities or threats that were not known prior to the budget planning process.

CHARACTERISTICS OF BUDGET

CHARACTERISTICS OF BUDGET
The main characteristics of budget are as follows:

1. A budget is concerned for a definite future period.

1. A budget is a written document.

2. A budget is a detailed plan of all the economic activities of a business.

3. All the departments of a business unit co-operate for the preparation of a business budget.

4. Budget is a mean to achieve business and it is not an end in itself.

5. Budget needs to be updated, corrected and controlled every time when circumstances change. Therefore, it is a continuous process.

6. Budget helps in planning, coordination and control.

7. Different types of budgets are prepared by industries according to business requirements.

8. A budget acts a business barometer.

9. Budget is usually prepared in the light of past experiences.

10. Budget is a constant endeavour of the Management.

ESSENTIALS OF BUDGET

ESSENTIALS OF BUDGET

Essential elements of a budget are as follows:

1. Organisational structure must be clearly defined and responsibility should be assigned to identifiable units within the organisation.

2. Setting of clear objectives and reasonable targets. Objectives should be in consonance with the long term plan of the organisation.

3. Objectives and degree of responsibility should be clearly stated and communicated to the management or person responsible for.

4. Budgets are prepared for the future periods based on expected course of actions.

5. Budgets are updated for the events that were not kept into the mind while establishing budgets. Hence, budgets should flexible enough for mid- term revision.

6. The entire organisation must be committed to budgeting.

7. Budgets should be quantifiable and master budget should be broken down into various functional budgets.

8. Budgets should be monitored periodically. Variances from the set yardsticks (standards) should be analysed and responsibility should be fixed.

9. Budgetary performance needs to be linked effectively to the reward system.

MEANING OF BUDGET AND BUDGETING

Meaning of Budget and Budgeting
Budget : CIMA Official Terminology has defined the terms ‘budget’ as “Quantitative expression of aplan for a defined period of time. It may include planned sales volumes and revenues; resource quantities, costs and expenses; assets, liabilities and cash flows.”

Budgeting : It is a means of coordinating the combined intelligence of an entire organisation into a plan of action based on past performance and governed by rational judgment of factors that will influence the course of business in the future.

ABSORPTION COSTING

 Absorption Costing

• In absorption costing the classification of expenses is based on functional basis whereas in marginal costing it is based on the nature of expenses. 
•  In absorption costing, the fixed expenses are distributed over products on absorption costing basis that is, based on a predetermined level of output. 
• Since fixed expenses are constant, such a method of recovery will lead to over or under-recovery of expenses depending on the actual output being greater or lesser than the estimate used for recovery. 
• This difficulty will not arise in marginal costing because the contribution is used as a fund for meeting fixed expenses.

DIFFERENCE IN PROFIT UNDER MARGINAL AND ABSORPTION COSTING

 Difference in profit under Marginal and Absorption costing

The above two approaches will compute the different profit because of the dif- ference in the stock valuation. This difference is explained as follows in different circumstances.

1. No opening and closing stock: In this case, profit / loss under absorption and marginal costing will be equal.

2. When opening stock is equal to closing stock: In this case, profit / loss under two approaches will be equal provided the fixed cost element in both the stocks is same amount.

3. When closing stock is more than opening stock: In other words, when production during a period is more than sales, then profit as per absorption approach will be more than that by marginal approach. The reason behind this difference is that a part of fixed overhead included in closing stock value is carried forward to next accounting period.

4. When opening stock is more than the closing stock: In other words, when production is less than the sales, profit shown by marginal costing will be more than that shown by absorption costing. This is because a part of fixed cost from the preceding period is added to the current year’s cost of goods sold in the form of opening stock.

PRODUCT COSTS

Product (Inventoriable) Costs:

•  These are the costs which are associated with the purchase and sale of goods (in the case of merchandise inventory).
•  In the production scenario, such costs are associated with the acquisition and conversion of materials and all other manufacturing inputs into finished product for sale.
•  Hence, under marginal costing, variable manufacturing costs constitute inventoriable or product costs.
• Finished goods are measured at product cost. Work-in-process (WIP) inventories are also measured at product cost on the basis of percentage of completion.

FACTS ABOUT MARGINAL COSTING

FACTS ABOUT MARGINAL COSTING

Some of the facts about marginal costing are depicted below:
Not a distinct method: Marginal costing is not a distinct method of costing like job costing, process costing, operating costing, etc., but a special technique used for man- agerial decision making. Marginal costing is used to provide a basis for the interpreta- tion of cost data to measure the profitability of different products, processes and cost centres in the course of decision making. It can, therefore, be used in conjunction with the different methods of costing such as job costing, process costing, etc., or even with other techniques such as standard costing or budgetary control.

Cost Ascertainment: In marginal costing, cost ascertainment is made on the basis of the nature of cost. It gives consideration to behaviour of costs. In other words, the technique has developed from a particular conception and expression of the nature and behaviour of costs and their effect upon the profitability of an under- taking.

Decision Making: In the orthodox or total cost method, as opposed to marginal costing, the classification of costs is based on functional basis. Under this method the total cost is the sum total of the cost of direct material, direct labour, direct expenses, manufacturing overheads, administration overheads, selling and distribution overheads. In this system, other things being equal, the total cost per unit will remain constant only when the level of output or mixture is the same from period to period. Since these factors are continually fluctuating, the actual total cost will vary from one period to another. Thus, it is possible for the costing department to say one day that an item costs `20 and the next day it costs `18. This situation arises because of changes in volume of output and the peculiar behaviour of fixed expenses included in the total cost. Such fluctuating manufacturing activity, and consequently the variations in the total cost from period to period or even from day to day, poses a serious problem to the management in taking sound decisions. Hence, the application of marginal costing has been given wide recognition in the field of decision making.

CHARACTERISTICS OF MARGINAL COSTING

CHARACTERISTICS OF MARGINAL COSTING

The technique of marginal costing is based on the distinction between product costs and period costs. Only the variables costs are regarded as the costs of the products while the fixed costs are treated as period costs which will be incurred during the period regardless of the volume of output. The main characteristics of marginal costing are as follows:

1. All elements of cost are classified into fixed and variable components. Semi-varia- ble costs are also analyzed into fixed and variable elements.

2. The marginal or variable costs (as direct material, direct labour and variable facto- ry overheads) are treated as the cost of product.

3. Under marginal costing, the value of finished goods and work–in–progress is also comprised only of marginal costs. Variable selling and distribution are excluded for valuing these inventories. Fixed costs are not considered for valuation of clos- ing stock of finished goods and closing WIP.

4. Fixed costs are treated as period costs and are charged to profit and loss account for the period for which they are incurred.

5. Prices are determined with reference to marginal costs and contribution margin.

6. Profitability of departments and products is determined with reference to their contribution margin.

DIFFERENTIAL AND INCREMENTAL COST

 Differential and Incremental Cost:

•  Differential cost is difference between the costs of two different production levels. It is a relative representation of costs for two different levels either increase or decrease in cost. 
• Incremental cost, on the other hand, is the increase in the costs due change in the volume or process of production activities.
•  Incremental costs are sometime compared with marginal cost but in reality there is a thin line difference between the two.
•  Marginal cost is the change in the total cost due to production of one extra unit while incremental cost can be both for increase in one unit or in total volume. 

DIRECT COSTING

 Direct Costing:

 Direct costing and Marginal Costing is used synonymously at various places and it is so also. But the relation of costs with respect to activity level must be understood. Some costs are variable at batch level but fixed for unit level and likewise variable at production line level but fixed for batches and units.

MARGINAL COSTING

 Marginal Costing:

•  It is a costing system where products or services and inventories are valued at variable costs only. It does not take consideration of fixed costs. 
• This system of costing is also known as direct costing as only direct costs forms the part of product and inventory cost. Costs are classified on the basis of behavior of cost (i.e. fixed and variable) rather functions as done in absorption costing method.