Definition, Types, Objective, Disadvantages and Advantages of Budget Control

Advantages of Budget Control

What is Budget Control ?

Meaning:

Budget control This is how budgets are created for the future and compared to actual performance in order to find any variances. Management can quickly identify and correct any variances by comparing budgeted and actual figures.

Management can compare actual and budgeted figures to identify discrepancies and then take appropriate remedial actions. Budgetary control is an ongoing process that aids in planning and coordination. It also provides a means of controlling. Budgetary control is the end result of budgetary control.

Definitions:

“According to Brown and Howard, “Budgetary control is a system of controlling costs which includes the preparation of budgets, coordinating the departments and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability.” Weldon characterizes budgetary control as planning in advance of the various functions of a business so that the business as a whole is controlled.

From the above-given definitions it is clear that budgetary control involves the follows:

(a) The objects are set by preparing budgets.

(b) The business is divided into various responsibility centres for preparing various budgets.

(c) The actual figures are recorded.

(d) The budgeted and actual figures are compared for studying the performance of different cost centres.

(e) If actual performance is less than the budgeted norms, remedial action is taken immediately.

General objectives of budgetary control

Budgetary control’s primary objective is to allocate responsibility using budgeted figures. It also provides a framework for measuring performance in order to determine the efficiency of business operations.

Below are the general objectives of budgetary control

1. Planning: A budget is a plan that is prepared before a definite period of time to attain given objective. The budgetary control compels the management at all levels to prepare the business activities to be performed in the days to come.

The reason is that a budget is prepared and implemented with the following objectives.

  1. A budget is prepared after careful study and research thereby proper guidance is given to the executives.
  2. A budget is used as mechanism through which management’s objectives and policies are affected.
  3. A budget is used as a communication bridge between the top management executives and operatives in an organization. The operatives are implementing policies of top management.
  4. Out of available many alternatives, a suitable profitable course of action is selected.
  5. A budget discloses the policy of the organization in numerical terms and attainable in a specific time.

2. Co-ordination: Co-ordination means an orderly arrangement of business activities in the pursuit of a common purpose. The business activities are properly co-ordinates and achieved with the help of budgetary control technique. The reason is that the line manager alone does not prepare a budget. A budget has close relationship with other budgets.

For example: The sales manager prepares sales budget on the basis of production budget. Likewise, the production budget is prepared on the basis of raw materials budget, direct labor hours budget and machine hours budget. Hence, the departmental budgets are interrelated and interdependent. A master budget is prepared through integration of various budgets. In other words, a business organization is running through the coordination of various functional area executives.

Effective co-ordination is also based on adequate communication network. Every employee of the organization should be informed in advance what is planned, how it is planned and when and by whom it is to be accomplished. In this way, co-ordination is being achieved through budgetary control technique.

3. Control: Nothing can be achieved without exercising control. Mere framing and communicating the objectives are not bringing anything to the organization. Hence there is a need of control mechanism such as budgetary control that is used to achieve the objectives of organization.

Budgetary control places the responsibility of achieving targets on the executives who participated in the budgetary planning function. With regard to the budgetary control, the actual performance of each functional area is measured and compared with per-determined target i.e budget. Based on the comparison, if there is any difference, the reasons for such differences were investigated, analyzed and take corrective action.

The budgetary control makes every executives became cost consciousness. Hence, there is no much difficulty on the part of management to take severe action on executives. In other words, proper control can be exercised over expenditure.

Essentials of Budget Control:

There are certain steps which are necessary for the successful implementation budgetary control system.

These are as follows:

1. Organisation for Budgetary Control

2. Budget Centres

3. Budget Mammal

4. Budget Officer

5. Budget Committee

6. Budget Period

7. Determination of Key Factor.

1. Organization for Budgetary Control:

The proper organization is essential for the successful preparation, maintenance and administration of budgets. A Budgetary Committee is formed, which comprises the departmental heads of various departments. All the functional heads are entrusted with the responsibility of ensuring proper implementation of their respective departmental budgets.

The Chief Executive is the overall in-charge of budgetary system. He constitutes a budget committee for preparing realistic budgets A budget officer is the convener of the budget committee who co-ordinates the budgets of different departments. The managers of different departments are made responsible for their departmental budgets.

2. Budget Centres:

A budget centre is that part of the organization for which the budget is prepared. A budget centre may be a department, section of a department or any other part of the department. The establishment of budget centres is essential for covering all parts of the organization. The budget centres are also necessary for cost control purposes. The appraisal performance of different parts of the organization becomes easy when different centres are established.

3. Budget Manual:

A budget manual is a document which spells out the duties and also the responsibilities of various executives concerned with the budgets. It specifies the relations amongst various functionaries.

4. Budget Officer:

The Chief Executive, who is at the top of the organization, appoints some person as Budget Officer. The budget officer is empowered to scrutinize the budgets prepared by different functional heads and to make changes in them, if the situations so demand. The actual performance of different departments is communicated to the Budget Officer. He determines the deviations in the budgets and the actual performance and takes necessary steps to rectify the deficiencies, if any.

He works as a coordinator among different departments and monitors the relevant information. He also informs the top management about the performance of different departments. The budget officer will be able to carry out his work fully well only if he is conversant with the working of all the departments.

5. Budget Committee:

In small-scale concerns the accountant is made responsible for preparation and implementation of budgets. In large-scale concerns a committee known as Budget Committee is formed. The heads of all the important departments are made members of this committee. The Committee is responsible for preparation and execution of budgets. The members of this committee put up the case of their respective departments and help the committee to take collective decisions if necessary. The Budget Officer acts as convener of this committee.

6. Budget Period:

ADVERTISEMENTS:

A budget period is the length of time for which a budget is prepared and employed. The budget period depends upon a number of factors. It may be different for different industries or even it may be different in the same industry or business.

The budget period depends upon the following considerations:

(a) The type of budget i.e., sales budget, production budget, raw materials purchase budget, capital expenditure budget. A capital expenditure budget may be for a longer period i.e. 3 to 5 years purchase, sale budgets may be for one year.

(b) The nature of demand for the products.

(c) The timings for the availability of the finances.

(d) The economic situation of the country.

(e) The length of trade cycles.

All the above-mentioned factors are taken into account while fixing period of budgets

7. Determination of Key Factor:

The budgets are prepared for all functional areas. These budgets are inter­dependent and inter-related. A proper co-ordination among different budgets is necessary for making the budgetary control a success. The constraints on some budgets may have an effect on other budgets too. A factor which influences all other budgets is known as Key Factor or Principal Factor.

There may be a limitation on the quantity of goods a concern may sell. In this case, sales will be a key factor and all other budgets will be prepared by keeping in view the amount of goods the concern will be able to sell. The raw material supply may be limited, so production, sales and cash budgets will be decided according to raw materials budget. Similarly, plant capacity may be a key factor if the supply of other factors is easily available.

The key factor may not necessarily remain the same. The raw materials supply may be limited at one time but it may be easily available at another time. The sales may be increased by adding more sales staff, etc. Similarly, other factors may also improve at different times. The key factor also highlights the limitations of the enterprise. This will enable the management to improve the working of those departments where scope for improvement exists.

Advantages of Budget Control:

The budgetary control system help in fixing the goals for the organization as whole and concerted efforts are made for its achievements. It enables ‘economies in the enterprise.

Some of the advantages of budgetary control are:

1. Maximization of Profits:

The budgetary control aims at the maximization of profits of the enterprise. To achieve this aim, a proper planning and co ordination of different functions is undertaken. There is a proper control over various capital and revenue expenditures. The resources are put to the best possible use.

2. Co-ordination:

The working of different departments and sectors is properly coordinated. The budgets of different departments have a bearing on one another. The co-ordination of various executives and subordinates is necessary for achieving budgeted targets.

3. Specific Aims:

The plans, policies and goals are decided by the top management. All efforts are put together to reach the common goal, of the organization. Every department is given a target to be achieved. The efforts are directed towards achieving some specific aims. If there is no definite aim then the efforts will be wasted in pursuing different aims.

4. Tool for Measuring Performance:

By providing targets to various departments, budgetary control provides a tool for measuring managerial performance. The budgeted targets are compared to actual results and deviations are determined. The performance of each department is reported to the top management. This system enables the introduction of management by exception.

5. Economy:

The planning of expenditure will be systematic and there will be economy in spending. The finances will be put to optimum use. The benefits derived for the concern will ultimately extend to industry and then to national economy. The national resources will be used economically and wastage will be eliminated.

6. Determining Weaknesses:

The deviations in budgeted and actual performance will enable the determination of weak spots. Efforts are concentrated on those aspects where performance is less than the stipulated.

7. Corrective Action:

The management will be able to take corrective measures whenever there is a discrepancy in performance. The deviations will be regularly reported so that necessary action is taken at the earliest. In the absence of a budgetary control system the deviations can be determined only at the end of the financial period.

8. Consciousness:

It creates budget consciousness among the employees. By fixing targets for the employees, they are made conscious of their responsibility. Everybody knows what he is expected to do and he continues with his work uninterrupted.

9. Reduces Costs:

In the present day competitive world budgetary control has a significant role to play. Every businessman tries to reduce the cost of production for increasing sales. He tries to have those combinations of products where profitability is more.

10. Introduction of Incentive Schemes:

Budgetary control system also enables the introduction of incentive schemes of remuneration. The comparison of budgeted and actual performance will enable the use of such schemes.

Budgetary Control

Limitations of Budgetary Control:

Despite of many good points of budgetary control there are some limitations of this system.

Some of the limitations are discussed as follows:

1. Uncertain Future:

The budgets are prepared for the future period. Despite best estimates made for the future, the predictions may not always come true. The future is always uncertain and the situation which is presumed to prevail in future may change. The change in future conditions upsets the budgets which have to be prepared on the basis of certain assumptions. The future uncertainties reduce the utility of budgetary control system.

2. Budgetary Revision Required:

Budgets arc prepared on the assumptions that certain conditions will prevail. Because of future uncertainties, assumed conditions may not prevail necessitating the revision of budgetary targets. The frequent revision of targets will reduce the value of budgets and revisions involve huge expenditures too.

3. Discourage Efficient Persons:

Under budgetary control system the targets are given to every person in the organization. The common tendency of people is to achieve the targets only. There may be some efficient persons who can exceed the targets but they will also feel contented by reaching the targets. So budgets may serve as constraints on managerial initiatives.

4. Problem of Co-ordination:

The success of budgetary control depends upon the co-ordination among different departments. The performance of one department affects the results of other departments. To overcome the problem of co­ordination a Budgetary Officer is needed. Every concern cannot afford to appoint a Budgetary Officer. The lack of co-ordination among different departments results in poor performance.

5. Conflict Among Different Departments:

Budgetary control may lead to conflicts among functional departments. Every departmental head worries for his department goals without thinking of business goal. Every department tries to get maximum allocation of funds and this raises a conflict among different departments.

6. Depends Upon Support of Top Management:

Budgetary control system depends upon the support of top management. The management should be enthusiastic for the success of this system and should give full support for it. If at any time there is a lack of support from top management then this system will collapse.

Types of Budgets

Budgets can be classified as per the following basis.

  1. Based on Area of Operation.
    1. Functional Budgets.
    2. Master Budget.
  2. Based on Capacity Utilization.
    1. Fixed Budget.
    2. Flexible Budgets.
  3. Based on Time.
    1. Short Term.
    2. Medium Term.
    3. Long Term.
  4. Based on Conditions
    1. Basic Budget.
    2. Current Budget.

Steps of Budgetary Control

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.

Utmost care should be taken while developing the budgets. The factors affecting the planning should be studied carefully and budgets should be developed after a thorough study of the same.

  1. 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. An efficient accounting and cost accounting system will help to record the actual performance effectively.

  1. 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.

The objective of such a comparison is to find out the deviation between the two and provide the base for taking corrective action.

  1. Corrective Action

Taking appropriate corrective action based on the comparison between the budgeted and actual results is the essence of budgeting.

A budget is always prepared for the future and hence there may be a variation between the budgeted results and actual results.

There is a need for investigation of the same and take appropriate action so that the deviations will not repeat in the future. Responsibilities can be fixed on proper persons so that they can be held responsible for any such deviations.

Preparation for Budgetary Control

Budgetary control is extremely useful for planning and control as described above. However, forgetting these benefits, sufficient preparation should be made.

For complete success, a solid foundation should be laid down and given this the following aspects are of crucial importance.

  1. Budget Committee

For the successful implementation of the budgetary control system, there is a need for a budget committee. In small or medium-sized 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 the implementation of the budgetary control system.

However, in large size organization, there is a need for 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.

  1. Budget Centers

The 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.

  1. Budget Period

A budget is always prepared before a defined period. 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 functional budgets like sales, purchase, production, etc. are prepared for one year and then broken down monthly. 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 must be decided well in advance.

  1. 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.

  1. 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.

  1. Principal Budget Factor or Key Factor

A key factor or a principal budget factor [also called constraint] is that factor the extent of whose influence must first be assessed to prepare the functional budgets.

Normally sales are the key factor or principal budget factor but other factors like production, purchase, and skilled labor may also be the key factors.

For example, a company has the 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 can produce 30,000 units and the market can absorb the entire production which means that sales are not the key factor but if the 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.

  1. Establishment of Adequate Accounting Records

The accounting system must 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 the establishment of budgets and finally control through budgets.

Difference between Budget and Budgetary Control

Point of DifferenceBudgetBudgetary Control
NatureBudgeting is the formulation of the plan of the organization.Budgetary control refers to the control of business activities.
AimsThe budget sets the target to be achievedBudgetary control aims at attaining that target.
DependencyBudget can be set without follow up action i.e., without budgetary control.But budgetary control is not possible without a budget. However budget without the budgetary control will not be of much
Assumption and ActualThe budget is forward-looking. It charts out the course of action to be followed in the future.But budgetary control is concerned with actual performance. Its objective is to make the actual performance confirm
ContinuityBudgeting is a one time job done before the budget period.However, due to the changing situation, the budget may require revision during the budget period.Implementation of budgetary control involves the measurement of actual performance and comparison of the same with the target to analyze the variance.The process is continuous and carried out throughout the budget period.

Making Budgetary Control Effective

Budgetary control can be made effective if an organization can ensure the following:

  1. Setting appropriate standard

This is key to successful budgeting. Many budgets fail for lack of such standards, and some upper-level managers hesitate to allow subordinates to submit budget plans for fear that they may have no logical basis for reviewing budget requests.

  1. Ensuring top-management support

Budget making and administration must receive the whole-hearted support of top ‘management.

If top management supports budget making, requires departments and divisions to make and defend their budgets, and participate in this review, then budgets encourage alert management throughout the organization.

  1. Participation by users in budget preparation

Besides the support of top management, the concerned managers at lower levels should also participate in its preparation. Real participation in budget preparation is necessary to ensure success.

It may also prove worthwhile to give department managers a reasonable degree of latitude in changing their budgets and in shifting funds, as long as they meet their total budgets.

  1. Providing information to managers about performance under budget

If budgetary control is to work well, managers need ready information about actual and forecast performance under budgets by their departments. Such information must be so designed as to show them how well they are doing.

Conclusion

Budgeting is the formulation of plans for a given future period in numerical terms. Organizations may establish budgets for units, departments, divisions, or the whole organization.

The usual period for a budget is one year and is generally expressed in financial terms. Budgets are the foundation of most control systems.

They provide yardsticks for measuring performance and facilitate comparisons across divisions, between levels in the organization, and from one period to another.

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