BUDGETING AND BUDGETARY CONTROL.docx

MBA8101-Mnagement Accounting 2022 1
Management Accounting
BUDGETING AND BUDGETARY CONTROL
DEFINITION OF KEY TERMS
Budget - A detailed plan for the future, usually expressed in formal
quantitative terms.
Budget period is conventionally one year. The budget is divided into
either 12 monthly or 13 four weekly periods for control purposes. It could
also be divided into four quarters; 1st quarter subdivided into months to
form monthly budgets. As the year progresses, the 2nd quarter is divided
into months and so on and so forth.
Planning - Developing objectives and preparing various budgets to
achieve those objectives.
Control - involves steps taken by management to increase the likelihood
that the objectives set down at the planning stage are attained and that
all parts of the organization are working together towards that goal.
1.1 A BUDGET
1.1.1Definition of Budget
“A quantitative statement, for a defined period of time, which may include
planned revenues, expenses, assets, liabilities and cash flows. A budget
provides a focus for the organization, aids the coordination of activities
and facilitates control. Planning is achieved by means of a fixed master
budget, whereas control is generally exercised through the comparison of
actual costs with a flexible budget.”
The Chartered Institute of Management Accountants, defines a ‘budget’
as:

“A financial and/or quantitative statement, prepared and approved
prior to define period of time, of the policy to be perused during that
period for the purpose of attaining a given objective.”
According to Brown and Howard of Management Accountant “a budget
is a predetermined statement of managerial policy during the given
period which provides a standard for comparison with the results actually
achieved.”
An analysis of the above said definitions reveal the following essentials
of a budget:
1. It is prepared for a definite future period.
2. It is a statement prepared prior to a defined period of time.
3. The budget is monetary and/or quantitative statement of policy.
4. The budget is a predetermined statement and its purpose is to attain a
given objective.
A budget, therefore, be taken as a document which is closely related to
both the managerial as well as accounting functions of an organization.
Forecast Vs Budget
A Forecast is mainly concerned with an assessment of probable future
events. A Budget is a planned result that an enterprise aims to attain.
Forecasting precedes preparation of a budget as it is an important part of
the budgeting process. It is said that the budgetary process is more a test
of forecasting skill than anything else. A budget is both a mechanism for
profit planning and technique of operating cost control. In order to
establish a budget it is essential to forecast various important variables
like sales, selling prices, availability of materials, prices of materials, wage
rates etc. Both budgets and forecasts refer to the anticipated actions and
events. But still, there are wide differences between budgets and forecasts
as given below:
Forecasts Budgets
1. Forecasts is mainly concerned 1. Budget is related to planned

with anticipated or probable events
2. Forecasts may cover for longer
period or years.
3. Forecast is only a tentative
estimate.
4. Forecast results in planning
5. The function of forecast ends
with the forecast of likely events.
6. Forecast usually covers a specific
business function.
7. Forecasting does not act as a tool
of controlling measurement.
events.
2. Budget is planned or prepared
for a shorter period.
3. Budget is a target fixed for a
period.
4. Result of planning is budgeting
5. The process of budget starts
where forecast ends and converts it
into a budget.
6. Budget is prepared for the
business as a whole.
7. Purpose of budget is not merely
a planning device but also a
controlling tool.
1.2 HUMAN BEHAVIOR AND BUDGETARY CONTROLS
Control in a business is the process of guiding organisation into viable
patterns of activity in an environment. The main objective of a control
system is to make sure that the right things get done. A system such as a
big organisation must be controlled to keep it steady or to enable it to
change safely. Control is therefore required because unpredictable
disturbances might enter the system so that actual results deviate from
the expected results or goals. Examples of such disturbances are entry of
a powerful competitor in the market, unexpected increase in cost, a
decline in quality standards, failure of a supplier to deliver promised raw
material, or the tendency of employees to stop working in order to gossip.
NOTE:
An important feature of control in a business is that, control is exercised
by managers over people. Their attitudes and response to budgetary
planning and control will affect the way in which it operates.
Budgetary control is the process of establishment of budgets relating to
various activities and comparing the budgeted figures with the actual

performance for arriving at deviations, if any. Accordingly, there cannot
be budgetary control without budgets.
Budgetary control is a system which uses budgets as a means of planning
and controlling.
Brown and Howard defines budgetary control as “a system of controlling
costs which includes the preparation of budgets, co-ordinating the
department and establishing responsibilities, comparing actual
performance with the budgeted and acting upon results to achieve
maximum profitability.”
The above definition reveal the following essentials of budgetary control:
 Establishment of objectives for each function and section of the
organization.
 Comparison of actual performance with budget.
 Ascertainment of the causes for such deviations of actual from the
budgeted performance.
 Taking suitable corrective action from different available alternatives
to achieve the desired objectives.
1.2.1 Objectives of Budgetary Control
Budgetary control is planning to assist the management for policy
formulation, planning, controlling and co-ordinating the general
objectives of budgetary control and can be stated in the following ways:
1. Planning:
A budget is a plan of action. Budgeting ensures a detailed plan of action
for a business over a period of time.
2. Co-ordination:
Budgetary control co-ordinates the various activities of the entity or
organization and secure co-operation of all concerned towards the
common goal.
3. Control:
Control is necessary to ensure that plans and objectives are being
achieved. Control follows planning and co-ordination. No control
performance is possible without predetermined standards. Thus,

budgetary control makes control possible by continuous measures
against predetermined targets. If there is any variation between the
budgeted performance and the actual performance the same is subject to
analysis and corrective action.
1.2.3. Scope and Techniques of Budgetary Control
Scope:
1. Budgets are prepared for different functions of business such as
production, sales etc..
2. Actual results are compared with the budgets and control is exercised.
3. Budgets have a wide range of coverage of the entire organization.
Each operation or process is divided into number of elements and
standards are set for each such element.
4. Budgetary control is concerned with origin of expenditure at
functional levels.
5. Budget is a projection of financial accounts whereas standard costing
projects the cost accounts.
Technique:
1. Budgetary control is exercised by putting budgets and actual side by
side. Variances are not normally revealed in the accounts.
2. Budgetary control system can be operated in parts. For example,
advertisement budgets, research and development budgets, etc.
3. Budgetary control of expenses is broad in nature.
1.2.4. Requisites for Effective Budgetary Control
The following are the requisites for effective budgetary control:
1. Clear cut objectives and goals should be well defined.
2. The ultimate objective of realising maximum benefits should always
be kept uppermost.
3. There should be a budget manual which contains all details regarding
plan and procedures for its execution. It should also specify the time
table for budget preparation for approval, details about responsibility,
cost centers etc.

4. Budget committee should be set up for budget preparation and
efficient of the plan.
5. A budget should always be related to a specified time period.
6. Support of top management is necessary in order to get the full
support and co-operation of the system of budgetary control.
7. To make budgetary control successful, there should be a proper
delegation of authority and responsibility.
8. Adequate accounting system is essential to make the budgeting
successful.
9. The employees should be properly educated about the benefits of
budgeting system.
10. The budgeting system should not cost more to operate than it is
worth.
11. Key factor or limiting factor, if any, should consider before preparation
of budget.
12. For budgetary control to be effective, proper periodic reporting
system should be introduced.
1.2.5. Practical perspectives of budgetary control:
In 1953 Chris Argyris identified the following four perspectives of
budgetary control:
1. The budgets are seen as a pressure device used by management to
force lazy employees to work harder. The intention of such pressure is to
improve performance but the unfavorable reaction of sub-ordinates
against it seems to be at the core of the budget problem.
2. Budget men want to see failure. The accounting department is usually
responsible for recording actual achievements and comparing this
against a budget. Accountants are therefore budget men and their
success is to find significant adverse variances and identify the managers
responsible. The success of a budget man is the failure of another
manager and this failure causes loss of interest and declining
performance. The accountant, on the other hand, fearful of having his

budget criticized by management deliberately makes it hard to
understand.
3. Target and goal congruence. The budget usually sets targets for each
department. Achieving the departmental targets becomes of paramount
importance regardless of the effect this may have on other departments
and the overall company performance. This is the problem of goal
congruence.
4. Management style. Budgets are used by managers to express their
character and patterns of leadership on sub-ordinates. Sub-ordinates
resentful of their leader’s styles blame the budget rather than the leader.
1.2.6 CONTIGENCY THEORY:
Some researchers have argued that the context in which budgetary
control is used is as important as the style in which it is implemented and
used. This is known as the contingency theory.
The contingency approach to management accounting is based on the
assumption that there is no universally appropriate accounting system
applicable to organisations in all circumstances. Rather, contingency
theory attempts to specific aspects of an accounting system that are
associated with certain defined circumstances and demonstrate an
appropriate matching.
Environmental factors such as:
 Its degree of predictability
 The degree of competition faced in the market
 The number of different product in the markets
 The degree of hostility exhibited by competition
Organisational Structure Factors including:
 Size of the organisation
 Interdependence of the parts or sub-units
 The degree of decentralization
 Availability of resources

Technological Factors such as:
 The nature of the production process
 The routineness or complexity of the production process
 How well the relationship between inputs and outputs is understood
 The amount of variety in each task that has to be performed
1.2.7. Organization for Budgetary Control
In order to introduce budgetary control system, the following are
essential to be considered for a sound and efficient organization. The
important aspects to be considered are explained as follows:
1. Organisation chart:
For the purpose of effective budgetary control, it is imperative on the part
of each entity to have definite ‘plan of organization ’. This plan of
organization is embodied in the organization chart. The organization
chart explaining clearly the position of each executive’s authority and
responsibility of the firm. All the functional heads are entrusted with the
responsibility of ensuring proper implementation of their respective
departmental budgets. An organization chart for budgetary control is
given showing clearly the type of budgets to be prepared by the
functional heads.
2. Budget Center:
A budget center is defined by the terminology as ‘a section of the
organization of an undertaking defined for the purpose of budgetary
control’. For effective budgetary control budget centre or departments
should be established for each of which budget will be set with the help
of the head of the department concerned.
3. Budget officer:
Budget officer is usually some senior member of the accounting staff who
controls the budgetary process. He does not prepare the budget himself,
but facilitates and coordinates the budgeting activity. He assists the

individual departmental heads and the budget committee, and ensures
that their decisions are communicated to the appropriate people.
4. Budget committee:
Budget committee comprising of the Managing Director, the Production
Manager, Sales Manager and Accountant. The main objective of this
committee is to agree on all departmental budgets, normal standard
hours and allocations. In small concerns, the Budget Officer may co-
ordinate the work for preparation and implementation of budgets. In
large-scale concern a budget committee is setup for preparation of
budgets and execution of budgetary control.
5. Budget manual:
A budget manual has been defined as ‘a document which set out the
responsibilities of persons engaged in the routine of and the forms and
records required for budgetary control”. It contains all details regarding
the plan and procedures for its execution.
It also specifies the time table for budget preparation to approval, details
about responsibility, cost centers, constitution and organisation of
budget committee, duties and responsibilities of budget officer.
6. Budget period:
A budget is always related to specified time period. The budget period is
the length of time for which a budget is prepared and employed. The
period may depend upon the type of budget. There is no specific period
as such. However, for the sake of convenience, the budget period may be
fixed depending upon the following factors:
a) Types of business
b) Types of budget
c) Nature of the demand of the product
d) Length of trade cycle
e) Economic factors
f) Availability of accounting period
g) Availability of finance
1.2.8. Advantages and Limitations of Budgetary Control
Advantages:
 The advantages of budgetary control may be summarized as follows:
 It facilitates reduction of cost.

 Budgetary control guides the management in planning and
formulation of policies.
 Budgetary control facilitates effective co-ordination of activities of the
various departments and functions by setting their limits and goals.
 It ensures maximization of profits through cost control and optimum
utilization of resources.
 It evaluates for the continuous review of performance of different
budget centres.
 It helps to the management efficient and economic production
control.
 It facilitates corrective actions, whenever there are inefficiencies and
weaknesses comparing actual performance with budget.
 It guides management in research and development. From the above
it is clear that the budgetary control is an effective tool for
management control.
However, it has certain important limitations which are identified below:
Limitations:
 The budget plan is based on estimates and forecasting. Forecasting
cannot be considered to be an exact science. If the budget plans are
made on the basis of inaccurate forecasts then the budget
programme may not be accurate and ineffective.
 For reason of uncertainty about future, and changing circumstances
which may develop later on, budget may prove short or excess of
actual requirements.
 Effective implementation of budgetary control depends upon
willingness, co-operation and understanding among people
reasonable for execution.
 Lack of co-operation leads to inefficient performance.
 The system does not substitute for management. It is like a
management tool.
 Budgeting may be cumbersome and time consuming process.
1.3 Stages in the budgeting process:
1. Communicating the details of the budget policy

Any budgeting decision must be done with reference to the long-term
plan of the organization i.e. budgets are there to facilitate the
effectiveness and efficiency of long-term organizational goals.
Before budgets are made, it is up to management to ensure that all
information with regards to the long-term plan of the organization is
communicated to the functional heads. Policy effects include change to
the sales mix or expansion or contraction of certain activities. Important
guidelines to be communicated include:
 Allowances to be made for price and wage increases.
 Expected changes in productivity
 Expected changes in industry demand
2. Determining the factor that limits performance
The principal budget factor (or limiting factor or key factor) is a factor
which at any given time is an overriding planning limitation on the
activities of the organization.
It may be production capacity, shortage of labor, materials, finance or
commonly the level of demand. Due to the high importance of the
limiting factor, the various budgets have to be prepared having regard to
the expected limitations. This factor will determine the point at which the
annual budgeting process should begin. Having one limiting factor is too
simplistic. In reality, organizations may be having multiples of limiting
factors and care should be taken to optimize contribution rather than
maximize contribution relating to any one limiting factor which could lead
to sub optimism. When faced with multiple linear programming will in
this case be applied.
Key Factor
Key Factor is also called as ‘Limiting Factor’ or Governing Factor. While
preparing the budget, it is necessary to consider key factor for successful
budgetary control. The influence of the Key Factor which dominates the
business operations in order to ensure that the functional budgets are
reasonably capable of fulfillment. The key factors include- raw materials
may be in short supply, non-availability of skilled labour, Government

restrictions, limited sales due to insufficient sales promotion, shortage of
power, under utilization of plant capacity, shortage of efficient executives,
management policies regarding lack of capital, and insufficient research
into new product developments.
3. Preparation of the sales budget:
The sales budget is prepared first since in most organizations, the level of
demand is selected as the most important limiting factor. Being the most
important budget it is also the most difficult to come up with because
sales revenue levels depend mostly on the action of the customers or they
may be influenced by the state of the economy or actions of the
competitors.
4. Initial preparation of budgets:
Responsibility accounting suggests that a manager should be held
responsible for those items and only those items-that he actually control
to a significant extent.
Therefore it is up to the functional manager to prepare a budget for areas
of their jurisdiction. A bottom up approach is mostly adopted where
budgets develop form the lowest level to the highest level of
management, (this will be looked at later in the chapter). Its main
advantage is that it enables managers to participate in the preparation if
the budget and increases the chances of it organizational acceptance.
Initial preparation could adopt the use of past data although carefully
since budgets are there to prepare for the future and dependence on past
data should only there just as guidance. Managers should therefore focus
more on the future and changes in future conditions in preparing
budgets. For example, for production activities, standard costs may be
used as a basis for costing activity
volumes which are planned in the budget.
5. Negotiation of budgets

As noted above, a bottom up approach is preferred in most cases. The
higher managers will receive budgets from lower managers for approval.
If approved, they incorporate the budgets with those they have received
from other lower managers. After which, they also submit theirs to their
superiors. This manager also becomes a budgetee. At each stage as the
budget moves up and incorporated with other budgets at a higher level,
what goes on is negotiation between the budgetees and their superiors.
Eventually after much bargaining, the budget will at some point be
agreed.
It is important that the budgets are agreed and changes without
consultation should not be done by superiors as this will lead to
demotivation of lower employees and a lack of trust and commitment to
the budgeting process. It is also important the budgetees do not under
budget in order to set lower targets. At the same time, superiors should
not impose too tough a target to achieve maximum out put form
subordinates. For in the short_run desired results will be achieved but
only at a cost of the loss of morale and increased labor turnover in the
future. The negotiation process is very important. If superiors can
establish a position of trust and confidence with their subordinates the
process will be fruitful.
6. Coordination and review of budgets:
As the different budgets are incorporated into one and move up the
hierarchy, they must be examined in relation to each other. One may find
that some budgets are off balance with other and need to be modified so
that they may be compatible with other conditions, constraints and plans
that are beyond the managers’ knowledge or control. For example, a
production manager might require the purchase of a new piece of
machinery and looking at the finance budget, funds might not be
available at the moment. These inconsistencies are there and need to be
reported to the manager responsible. This may require further
modification until the budgets are all coordinated and acceptable by all
the parties involved.

7. Final acceptance of the budget
A master budget is produced when all budgets are coordinated;
summarized into a profit and loss, balance sheet and cash flow statement.
If the budgets are finally approved, they are passed down to the
appropriate responsibility centers. It is this final approval of the master
budget that gives the manager the go ahead.
8. Budget review
Periodically the actual results shall be compared with the budgeted
results. The comparisons should be done regularly and reports sent to the
appropriate budgetees so that the maximum motivational impact is felt.
Here the managers can identify variances and investigate the reasons for
the differences. It the differences are within the control of the manager,
corrective action can be taken to avoid similar inefficiencies occurring
again in the future. On the other hand the difference could be because
the budget was unrealistic or that the actual conditions during the budget
year were different from those anticipated. If such changes are noticed
the budget should be adjusted.
1.3 Types of Budgets

As budgets serve different purposes, different types of budgets have
been developed. The following are the different classification of budgets
developed on the basis of time, functions, and flexibility or capacity.
(A) Classification on the basis of Time:
1. Long-term budgets
2. Short-term budgets
3. Current budgets
(B) Classification according to functions:
1. Functional or subsidiary budgets
2. Master budgets
(C) Classification on the basis of capacity:
1. Fixed budgets.
2. Flexible budgets
(A) Classification on the basis of time
1. Long-term budgets:
Long-term budgets are prepared for a longer period varies between five
to ten years. It is usually developed by the top level management. These
budgets summarize the general plan of operations and its expected
consequences.
Long-term budgets are prepared for important activities like composition
of its capital expenditure, new product development and research, long-
term finance etc.
2. Short-term budgets:
These budgets are usually prepared for a period of one year. Sometimes
they may be prepared for shorter period as for quarterly or half yearly.
The scope of budgeting activity may vary considerably among different
organization.
3. Current budgets:
Current budgets are prepared for the current operations of the business.
The planning period of a budget generally in months or weeks. As per
ICMA, “Current budget is a budget which is established for use over a
short period of time and related to current conditions.”

(b) Classification on the basis of function
1. Functional budget:
The functional budget is one which relates to any of the functions of an
organization. The number of functional budgets depends upon the size
and nature of business. The following are the commonly used:
(i) Sales budget
(ii) Purchase budget
(iii) Production budget
(iv) Selling and distribution cost budget 212
(v) Labour cost budget
(vi) Cash budget
(vii) Capital expenditure budget
2. Master budget:
The master budget is a summary budget. This budget encompasses all
the functional activities into one harmonious unit. The ICMA England
defines a Master Budget as the summary budget incorporating its
functional budgets, which is finally approved, adopted and employed.
(C) Classification on the basis of capacity
1. Fixed budget:
A fixed budget is designed to remain unchanged irrespective of the
level of activity actually attained.
2. Flexible budget:
A flexible budget is a budget which is designed to change in accordance
with the various level of activity actually attained. The flexible budget also
called as Variable Budget or Sliding Scale Budget, takes both fixed,
variable and semi fixed manufacturing costs into account.
1.3.1. Control Ratios

Ratios are used by the management to determine whether performance
of its activities is going on as per estimates or not. If the ratio is less than
100% or more, the performance is considered as unsatisfactory. The
following are the ratios generally calculated for performance evaluation.
1. Capacity ratio:
This ratio indicates the extent to which budgeted hours of activity is
actually utilized.
Capacity Ratio =
Actual hours worked
Budget hours
x 100
2. Activity ratio:
This ratio is used to measure the level of activity attained during the
budget period.
Activity Ratio =
Standard hours for actual production
Budget hours
x 100
3. Efficiency ratio:
This ratio shows the level of efficiency attained during the budget period
Efficiency Ratio =
Actual horus worked
x 100
4. Calendar ratio:
This ratio is used to measure the proportion of actual working days to
budgeted working days in a budget period.
Calendar Ratio =
Numbr of actual working days in a period
Budgeted working days for the period
x 100
Illustration 1.

A printing company produces two articles A and B. Each unit takes 4 hours
for A and 10 hours for B as production time respectively. The budgeted
production for April, 2019 is 400 units of A and 800 units for B. The actual
production at the end of the months was 320 units of A and 850 units of B.
Actual hours spent on this production were 200.
Required: Find out the capacity, activity and efficiency ratios for April
2003. Also find out the Calendar ratio if the actual working days during
the month be 28 corresponding to 26 days in the budget.
Solution.
Standard budgeted hours:
A – 400 ÷ 4 = 100 hour
B – 800 ÷ 10 = 80 hours
Total 180 hours
Standard hours for actual production:
A – 320 ÷ 4 = 80 hours
B – 850 ÷ 10 = 85 hours
165 hours
(1) Capacity ratio =
Actual hours worked
Budget hours
x 100
=
200
180
x 100
= 111.1%
(2) Activity ratio =
Budget hours
x 100
=
165
180
x 100
= 91.66%
(3) Efficiency ratio =
Actual hours worked
x 100

=
165
200
x 100
= 82.5%
(4) Calendar ratio =
Number of actual working days in a period
Number of working days in a budget period
x 100
=
28
26
x 100
= 107.69%
Illustration 2.
Product A takes 4 hours to make and B requires 8 hours. In a month 27
effective days of 8 hours a day. 500 units of A and 300 units, of Y were
produced. The company employ 25 workers in the production
department. The budgeted hours are 60,000 for the year.
Required:
Calculate capacity ratio, activity ratio and effective ratio.
1.3.2. Sales Budget

Sales budget is one of the important functional budgets. Sales estimate is
the commencement of budgeting made in quantitative terms. Sales
budget is primarily concerned with forecasting of what products will be
sold in what quantities and at what prices during the budget period. Sales
budget is prepared by the sales executives taking into account number of
relevant and influencing factors such as:
a) Analysis of past sales,
b) key factors,
c) market conditions,
d) production capacity,
e) government restrictions,
f) competitor’s strength and weakness,
g) advertisement,
h) publicity and sales promotion,
i) pricing policy,
j) consumer behaviour,
k) nature of business,
l) types of product,
m) company objectives,
n) Sales-men's report,
o) marketing research’s reports,
p) and product life cycle.
Illustration 3.
BXT Pharmaceuticals Co. Ltd. manufacturers two products X and Y. Its
sales department has three divisions: West, South and East. Preliminary
sales budgets for the year ending 31st December 2020, based on the
assessments of the divisional executives is as follows:
Product X: West 40,000 units: South 100,000 units and East 20,000 units
Product Y: West 60,000 units: South 800,000 units and East Nil
Sales price for X is 2,000 Shs and Y is 3,000 Shs per unit in all areas.
Arrangements are made for the extensive advertising of product X and Y
and it is estimated that West division sales will increase by 20,000 units.
Arrangements are also made to advertise and distribute product Y in the

Eastern area in the second half of 2020 when sales are expected to be
100,000 units.
Since the estimated sales of the South division represented an
unsatisfactory target, it is agreed to increase both the estimates by 10%.
Required: Prepare a sales budget for the year that ended 31 December
2020.
Solution:
BXT Pharmaceuticals Co. Ltd
Sales budget for the year ended 31st. December 2020
Divisio
n
Product X Product Y Total
Qty
(Units)
Price
Shs
Sales Values Qty
(Units)
Price Sales Values
West 60,000 2,000 120,000,000 80,000 3,000 240,000,000
South 110,000 2,000 220,000,000 880,000 3,000 2,640,000,000
East 20,000 2,000 40,000,000 100,000 3,000 300,000,000
Total 190,000 380,000,000 1,060,000 3,180,000,000
Working:
1. Product X quantities:
West = 40,000 + 20,000
= 60,000 units
South = 100,000 + (10% x 100,000)
= 100,000 + 10,000
=110,000
East = 20,000
2. Product Y quantities:

West division
Qty = 60,000 + 20,000 = 80,000 units
South Division
Qty = 800,000 + (10% x 800,000)
= 800,000 + 80,000
=880,000
Eastern division:
QTY = 0 + 100,000
Discussion question.
CURE Pharmaceutical (U) Ltd. has four sales territories A, B, C, D. Each
salesman is expected to sell the following number of units during the First
Quarter of 2021. Assume the average selling price to be 10 USD
Month A
(units)
B
(units)
C
(units)
D
(units)
April 500 750 1250 1750
May 1000 900 1400 2000
June 1250 1000 1500 2250
Required:
Prepare a sales budget for the first quarter of 2021.
1.3.3. Cash budget

The objective of this budget is to ensure that sufficient cash is available at
all times to meet the level of operations that are outlined in the various
budgets. In practice monthly or weekly budgets are prepared.
The cash budget is composed of four major sections:
 Receipts section
 Disbursements section
 Cash excess or deficiency section
 Financing section
The receipts section has the listing of all the cash inflows, except for
financing, expected during the budget period. The cash flows are mainly
from sales.
The format of a cash budget:
Details 1 2 3 4 Total
Opening balance xx xx xx xx xx
Add: receipts xx xx xx xx xx
Total available xx xx xx xx xx
Less: Disbursements xx xx xx xx xx
Surplus/deficiency xx xx xx xx xx
Financing:
Borrowing xx xx xx xx xx
Repayment xx xx xx xx xx
Interest xx xx xx xx xx
Total financing xx xx xx xx xx
Cash balance xx xx xx xx xx
Usually, the estimated cash payments include the following:
1. Cash purchase
2. Payment to creditors
3. Payment of wages
4. Payments relate to production expenses
5. Payments relate to office and administrative expenses
6. Payments relate to selling and distribution expenses

7. Any other payments relate to revenue and capital expenditure
8. Income tax payable, dividend payable etc.
Illustration1:
Painters and Co. wishes to prepare cash budget from January. Prepare a
cash budget for the first six months of 2019 from the following estimated
revenue and expenses:
Month Total sales Materials Wages Production
overheads
Selling and
distribution
overheads
January 10,000,000 10,000,000 200,000 1,600,000 400,000
February 11,000,000 7,000,000 2,200,000 1,650,000 450,000
March 14,000,000 7,000,000 2,300,000 1,700,000 450,000
April 18,000,000 11,000,000 2,300,000 1,750,000 500,000
May 15,000,000 10,000,000 2,000,000 1,600,000 450,000
June 20,000,000 12,500,000 2,500,000 1,800,000 600,000
Additional information
1. Cash balance on 1st January was Shs 5,000,000. New machinery is to be
installed at shs. 10,000,000 on credit, to be repaid by two equal
installments in March and April.
2. Sales commission of 5% on total sales is to be paid within a month
following actual sales.
3. 5,000,000 being the amount of 2nd call may be received in March.
Share Premium amounting to shs 1,000,000 is also obtainable with the
2nd call.
4. Period of credit allowed by suppliers is 2 months.
5. Period of credit allowed to customers is 1 month.
6. There is delay in payment of overheads by1 month.
7. Delay in payment of wages is ½ month.
8. Assume cash sales to be 50% of total sales.

PAINTERS AND CO LTD
CASH BUDGET FOR THE PERIOD STARTING JANUARY TO JUNE 2019
Particulars
January
(Amount
UGX) February March Aprial May June
Opening cash balance 5,000,000 10,000,000 17,800,000 16,450,000 15,300,000 19,350,000
Estimated cash receipts
Cash sales 5,000,000 5,500,000 7,000,000 9,000,000 7,500,000 10,000,000
Credit sales - 5,000,000 5,500,000 7,000,000 9,000,000 7,500,000
Second call - - 5,000,000 - - -
Share premium - - 1,000,000 - - -
Total cash receipts (A)
10,000,00
0 20,500,000
36,300,00
0
32,450,00
0
31,800,00
0
36,850,00
0
Estimated cash
payments/disbursements
Materials - - 10,000,000 7,000,000 7,000,000 11,000,000
Wages - 200,000 2,200,000 2,300,000 2,300,000 2,000,000
Production overheads - 1,600,000 1,650,000 1,700,000 1,750,000 1,600,000
Selling and distribution overheads - 400,000 450,000 450,000 500,000 450,000
Sales commision - 500,000 550,000 700,000 900,000 750,000
Purchase of machinery - - 5,000,000 5,000,000 - -
Total cash payments (B) - 2,700,000
19,850,00
0
17,150,00
0
12,450,00
0
15,800,00
0
Closing balance (A - B)
10,000,00
0 17,800,000
16,450,00
0
15,300,00
0
19,350,00
0
21,050,00
0
Illustration II:
From the following data, forecast the cash position at the end of April,
May and June 2015.
Month Sales
(UGX)
Purchases
(UGX)
Wages
(UGX)
Miscellaneous
(UGX)
February 60,000,000 42,000,000 5,000,000 3,500,000
March 65,000,000 50,000,000 6,000,000 4,000,000
April 40,000,000 52,000,000 4,000,000 3,000,000
May 58,000,000 53,000,000 5,000,000 6,000,000
June 44,000,000 40,000,000 4,000,000 3,000,000
Additional information:
1. Sales: 10% realized in the month of sales; balance realised equally in
two subsequent months.

2. Purchases: These are paid in the month following the month of supply.
3. Wages: 10% paid in arrears following month.
4. Miscellaneous expenses: Paid a month in arrears.
5. Rent: shs 500,000 per month paid quarterly in advance due in April.
6. Income tax: First instalment of advance tax shs. 15,000,000 due on or
before 15th June.
7. Income from investment: Shs 3,000,000 received quarterly in April, July
etc.
8. Cash in hand: Shs 3,000,000 on 1st April 2015.
1.3.4. Master Budget
When the functional budgets have been completed, the budget
committee will prepare a master budget for the target of the concern.
Accordingly a budget which is prepared incorporating the summaries of
all functional budgets. It comprises of budgeted profit and loss account,
budgeted statement of financial position, budgeted production, sales and
costs.
The ICMA England defines a Master Budget as ‘the summary budget
incorporating its functional budgets, which is finally approved, adopted
and employed’. The master budget represents the activities of a business
during a profit plan. This budget is also helpful in coordinating activities
of various functional departments.

Illustration:
Sky Co. Ltd is a glass manufacturing company requires you to calculate
and present the budget for the next year from the following information:
Toughened glass $2,00,000
Bent toughened glass $3,00,000
Direct material cost 60% of sales
Direct wages 10 workers @ $100 per month
Factory overheads
Indirect labour:
Work manager $300 per month
Foreman $200 per month
Stores and spares 2% on sales
Depreciation on machinery $6,000
Light and power $2,000
Repairs and maintenance $4,000
Other sundries 10% on direct wages
Administration, selling and distribution expenses $7,000 per year.
1.4 ALTERNATIVE APPROACHES TO BUDGETING
There are two main approaches to budgeting. These are:
1. Incremental budgeting
This system is based on the previous year’s activity which is then adjusted
for volume and price effects.
It is concerned mainly with the increments in costs and revenues which
will occur in the coming period. It is very reasonable to use this if current
operations are as effective, efficient and economical as they can be. It is
also appropriate for costs such as staff costs that may be estimated on
basis of current salaries plus an increment for inflation and hence are
administratively quite easy to prepare.

Incremental budgeting is criticized for encouraging slack and wasteful
spending to creep into budgets. Past inefficiencies are perpetuated
because cost levels are rarely subjected to close scrutiny.
2. Zero-Base Budgeting (ZBB)
The principle behind ZBB is that the budget for each cost center should
be made from scratch or zero.
This method emerged in an attempt to overcome limitations of
incremental budgeting.
ZBB reflects the assumption in incremental budgeting that this year’s
activities will continue at the same level or volume next year and that next
year’s budget can be based on this year’s costs plus an extra amount may
be incorporating inflation.
ZBB requires that every item of expenditure be justified in its entirety in
order to be included in next year’s budget. Besides adopting a zero based
approach, ZBB also focuses on programs or activities instead of functional
departments based on line items which is a feature of traditional
budgeting.
Advantages of ZBB
i. It is possible to identify and remove inefficient or obsolete operations.
ii. It forces employees to avoid wasteful expenditure.
iii. It can increase motivation if participation into the process is allowed.
iv. It responds to changes in the business environment.
v. ZBB documentation provides an in depth appraisal of an organization’s
operations.
vi. ZBB creates a questioning attitude rather than one that assumes that
current practice represents value for money.
vii. ZBB focuses attention on outputs in relation to value for money.
Disadvantages of ZBB
A major disadvantage is the volume of extra paperwork created. Others
include:

i. Short term benefits might be emphasized to the detriment of long term
benefits.
ii. It might give the impression that all decisions have to be made in the
budget. This might limit what management can or cannot do thus
lowering motivation by watering down initiative. The limits are created if
their ideas were not incorporated in the budgeting process.
iii. Management may not be having the skills to perform the techniques
required by ZBB. Thus their training is required.
iv. The organization ’ s information system may not be capable of
providing suitable information.
v. The ranking process could be difficult; so many decision packages,
others of equal importance while others may be having only qualitative
benefits.
To offset the massive use of management time and paperwork, ZBB could
be applied selectively. Instead of annually for all activities, ZBB could be
performed, say; marketing this year, payroll next year or finance this year.
This way all activities will be thoroughly scrutinized in the long run.
3. Activity Based Budgeting - ABB
ABB is merely the use of costs determined using ABC as a basis for
preparing budgets. ABB involves defining the activities that underlie the
financial figures in each function and using the level of activity to decide
how much resource should be allocated, how well it is being managed
and to explain variances from the budget.
Here in contrast with traditional budgeting, costs are grouped according
to their purpose rather than according to their nature.
The use of ABB will assist in the comparison of costs with the activities
which they achieve. This should lead to a greater accuracy in the costs
predicted and thus better management control.
The approach is more modern as there’s is more focus on outputs and
less on inputs.

Results of using ABB:
a. Different activity levels will provide a foundation for the base package
and incremental packages of ZBB.
b. The organization’s strategy and any actual or likely changes in that
strategy will be taken into account because ABB attempts to manage the
business as a sum of its interrelated parts.
c. Critical success factors will be identified and performance measures
devised to monitor progress towards them.
1.5 Roles of Budgets
i. Authorization
Once a budget has been agreed, it is not merely a go ahead for managers
to spend “up to the budget” but spending the budget. There’s an under-
spend attitude that creeps in during the year form managers for fear of
budget cuts in the next budget period. This will be followed by
unnecessary spending towards the end of the period.
ii. Planning
A budget provides a formal coordinated approach to short-term planning
throughout the organization. The budgets give managers the framework
within which to operate and plan for his area of responsibility.
iii. Communicating and coordinating
Information about objectives, strategies and policies has to be
communicated down form the top management and all the individual
budgets in an organization need to be coordinated in order to arrive at
the master budget. This ensures goal congruence.
iv. Motivation
If budgets are ‘agreed’ they should be able to motivate individual
managers towards their achievement which in turn should assist the
organization in attaining the longer term objectives.
v. Evaluation of performance
Comparison between the predetermined budget and the actual results is
the most common way in which individual managers’ performance is
judged on a regular basis.

1.6 Budgetary styles
There are two ways in which a budget can be set.
1. Imposed style (top down)
Here, top management prepares budgets with little or no input from the
operating personnel which is then imposed upon the employees who
have to work to the budgeted figures.
It is suitable:
• In a newly formed organization
• In very small businesses
• During times of economic hardship.
• When operational managers lack budgeting skills
• When the organization’s different units require precise coordination.
Advantages
i. Strategic plans are included into planned activities.
ii. Coordination between plans and objectives of individual divisions is
enhanced.
iii. They use senior management’s awareness of total resource availability.
iv. They decrease the input form inexperienced or uninformed lower level
employees
v. They decrease the period of time taken to draw up the budgets.
Disadvantages
i. Dissatisfaction, defensiveness and low morale among employees.
ii. The feeling of team-spirit might disappear.
iii. Acceptance of organizational goals and objectives would be met with
difficulties.
iv. The budget would be seen as a punitive devise
v. Initiative of lower level management would be stifled.
b. Participatory style of budgeting (bottom up)
Here, the budgets are developed by lower level managers who then
submit the budgets to their superiors. What the lower level managers feel
is achievable and the associated necessary resources are incorporated
into the budgets.
It is suitable:
• In well established organizations

• In very large organizations.
• During economic boom
• When strong budgeting skills are fully inculcated in the managers.
• When the organization is well decentralized.
Advantages
i. They are based on information form employees most familiar with the
department.
ii. Knowledge spread among several of management is pulled together.
iii. Morale and motivation is improved.
iv. They increase operational managers commitment to organizational
objectives.
v. In general, they are more realistic.
vi. Coordination between units is improved.
vii. Specific resource requirements are included.
viii. Senior manager’s overview is mixed with operational level details.
Disadvantages
i. They consume more time
ii. Changes implemented by senior management may cause
dissatisfaction.
iii. Budgets may be unachievable if managers are not qualified to
participate.
iv. They may cause managers to introduce budgetary slack.
v. An earlier start to the budgeting process could be required.
The two styles are on a continuum. What lies in between is actually what
happens in practice; negotiation. Final budgets should lie between what
top management would really like and what junior managers believe is
feasible. The budget process could be taken to be a bargaining process.
1.7 Budgets and Performance Evaluation
Budgets are one of the accounting measures which are used to assess a
manager’s performance.
In most cases, the reward schemes in organizations are often linked to the
achievement of certain levels of performance.

A very important source of motivation to perform well is being kept
informed about how actual results are progressing and how actual results
compare with target. Information fed back about actual results should
have qualities of good information:
• reports should be clear and comprehensive
• significant variances should be highlighted for investigation
• reports should be timely enough to allow the individual to take control
action before adverse results get much worse.
Unfortunately, research evidence suggests that all too often accounting
performance measures lead to a lack of goal congruence. Managers will
seek to improve performance based on the indicator used even though
this is not in the best interests of the firm as a whole. For example a
production manager may be encouraged to achieve high levels of
production and reduce costs, particularly if his bonus is linked to these
factors. High motivation thus follows, but the need to maintain high
production levels could lead to high levels of slow moving stock resulting
in an adverse effect in the company’s cash flows.
Hopwood found 3 distinct ways of using budgetary information to
evaluate managerial performance;
1. Budget constrained style evaluated (B.C)
The manager’s performance is primarily evaluated upon the basis of his
ability to meet the budget continually on a short term basis. Adverse cost
variances would be used to censure a budget holder regardless of
performance elsewhere.
2. Profit conscious style of evaluation (P.C)
Manager’s performance is evaluated on the basis of his ability to increase
the general effectiveness of his unit’s operations in relation to the long
term purposes of the firm. In this case the minimization of long run costs
was seen as the most desirable.
3. Non-accounting style of evaluation (N.A)
The budgetary information plays a relatively unimportant part in the
superior’s evaluation of the manager’s performance.
Here is a summary of effects of the three styles

Style evaluation
BC PC NA
Involvement with costs High High Low
Job related tension High Mediu
m
Low
Manipulation of Accounting
results
Extensive Little Little
Relationship with supervisor Poor Good Good
Relationship with colleagues Poor Good Good

BUDGETING AND BUDGETARY CONTROL.docx

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to BUDGETING AND BUDGETARY CONTROL.docx

Similar to BUDGETING AND BUDGETARY CONTROL.docx (20)

Recently uploaded

Recently uploaded (20)

BUDGETING AND BUDGETARY CONTROL.docx