Budgetary control

ACKNOWLEDGEMENT

Firstly we give thanks to God Almighty for the strength to work on this study. This work could not have materialized without the assistance of certain people who contributed to its success.
Our special gratitude goes to our tutor Mst. Maksuda Begum for her direction during the programme and encourage us when we had difficulties, and also grateful to all the other members of our group for making available to us their wealth of experience and
Knowledge.
Our thanks also go to all the students in the Entrepreneurship & Small Business Management.

Introduction
Budgeting has come to be accepted as an efficient method of short-term planning and control. It is employed, no doubt, in large business houses, but even the small businesses are using it at least in some informal manner. Through the budgets, a business wants to know clearly as to what it proposes to do during an accounting period or a part thereof. The technique of budgeting is an important application of Management Accounting. Probably, the greatest aid to good management that has ever been devised is theuse of budgets and budgetary control. It is a versatile tool and has helped managers cope with manyproblems including inflation.

Budget:
 A formal statement of the financial resources set aside for carrying out specific activities in a given period of time.
 It helps to co-ordinate the activities of the organisation.
An exa mple would be an advertising budget or sales force budget.
Essentials of a Budget
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 I 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 asaccounting functions of an organization.

Types of Budgets

(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
Budgetary control:
 A control technique whereby actual results are compared with budgets.
 Any differences (variances) are made the responsibility of key individuals who can either exercise control action or revise the original budgets.
According to I.C.M.A. England Budgetary control is defined by Terminology as the establishment of budgets relating to the responsibilities of executives to the requirements of a policy and the continuous comparison of actual with the budgeted results, either to secure by individual actions the objectives of that policy or to provide a basis for its revision.

Objectives of Budgetary Control
Budgetary Control is planned 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. ControlFollows planning and co-ordination. No control performance is possible without predetermined standards. Thus, budgetary control makes control possible by continuous measures againstpredetermined targets. If there is any variation between the budgeted performance and theactual performance, the same is subject to analysis and corrective action.
Scope and Techniques of Standard Costing and Budgetary Control
Scope:
(1) Budgets are prepared for different functions of business such as production, sales etc. Actual results are compared with the budgets and control is exercised.
Standards on the other hand are complied by classifying, recording and allocation of the expenses to cost units. Actual costs are compared with standard costs.
(2) 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.
(3) Budgetary control is concerned with origin of expenditure at functional levels.
Standard costing is concerned with the requirements of each element of cost.
(4) Budget is a projection of financial accounts whereas standard costing projects the cost accounts. Technique:
(1) Budgetary control is exercised by putting budgets and actuals side by side.
Variances are not normally revealed in the accounts. Standard costing variances are revealed through accounts.
(2) Budgetary control system can be operated in parts. For example, Advertisement Budgets,
Research and Development Budgets, etc. Standard costing is not put into operation in parts.
(3) Budgetary control of expenses is broad in nature whereas standard costing system is a far more technically improved system by means of which the variances are analysed in detail.
Budget organisation and administration:
In organising and administering a budget system the following characteristics may apply:
a) Budget centres: Units responsible for the preparation of budgets. A budget centre may encompass several cost centres.
b) Budget committee: This may consist of senior members of the organisation, e.g. departmental heads and executives (with the managing director as chairman). Every part of the organisation should be represented on the committee, so there should be a representative from sales, production, marketing and so on. Functions of the budget committee include:
 Coordination of the preparation of budgets, including the issue of a manual
 Issuing of timetables for preparation of budgets
 Provision of information to assist budget preparations
 Comparison of actual results with budget and investigation of variances.
c) Budget Officer: Controls the budget administration The job involves:
 liaising between the budget committee and managers responsible for budget preparation
 dealing with budgetary control problems
 ensuring that deadlines are met
 educating people about budgetary control.
d) Budget manual:
This document:
 charts the organisation
 details the budget procedures
 contains account codes for items of expenditure and revenue
 timetables the process
 clearly defines the responsibility of persons involved in the budgeting system.
Budget preparation
Firstly, determine the principal budget factor. This is also known as the key budget factor or limiting budget factor and is the factor which will limit the activities of an undertaking. This limits output, e.g. sales, material or labour.
a) Sales budget: this involves a realistic sales forecast. This is prepared in units of each product and also in sales value. Methods of sales forecasting include: sales force opinions market research statistical methods (correlation analysis and examination of trends) mathematical models.
In using these techniques consider:
 company's pricing policy
 general economic and political conditions
 changes in the population
 competition
 consumers' income and tastes
 advertising and other sales promotion techniques
 after sales service
 credit terms offered.
b) Production budget: expressed in quantitative terms only and is geared to the sales budget. The production manager's duties include:
 analysis of plant utilisation
 work-in-progress budgets.
If requirements exceed capacity he may:
 subcontract
 plan for overtime
 introduce shift work
 hire or buy additional machinery
 The materials purchases budget's both quantitative and financial.
c) Raw materials and purchasing budget:
 The materials usage budget is in quantities.
 The materials purchases budget is both quantitative and financial.
Factors influencing a) and b) include:
 production requirements
 planning stock levels
 storage space
 trends of material prices.
d) Labour budget: is both quantitative and financial. This is influenced by:
 production requirements
 man-hours available
 grades of labour required
 wage rates (union agreements)
 the need for incentives.
e) Cash budget: a cash plan for a defined period of time. It summarises monthly receipts and payments. Hence, it highlights monthly surpluses and deficits of actual cash. Its main uses are:
 to maintain control over a firm's cash requirements, e.g. stock and debtors
 to enable a firm to take precautionary measures and arrange in advance for investment and loan facilities whenever cash surpluses or deficits arises
 to show the feasibility of management's plans in cash terms
 to illustrate the financial impact of changes in management policy, e.g. change of credit terms offered to customers.
Receipts of cash may come from one of the following:
 cash sales
 payments by debtors
 the sale of fixed assets
 the issue of new shares
 the receipt of interest and dividends from investments.
Payments of cash may be for one or more of the following:
 purchase of stocks
 payments of wages or other expenses
 purchase of capital items
 payment of interest, dividends or taxation.

The quantitative budget for harvesting may be calculated as shown in figure 4.2.
Figure : Quantitative harvesting budget
Harvesting
1st quarter
2nd quarter
3rd quarter
4th quarter
Labour

Cutting nil 9,000 tonnes
16,000 tonnes
10,000 tonnes
Sundry
nil
300 man days
450 man days
450 man days
Tractors
nil
630 hours
1,100 hours
700 hours
Cane trailers nil 9,000 tonnes
16,000 tonnes
10,000 tonnes
Imp, & sundries nil 9,000 tonnes
16,000 tonnes
10,000 tonnes
Each item is measured in different quantitative units - tonnes of cane, man days etc.-and depends on individual judgement of which is the best unit to use.
Once the budget in quantitative terms has been prepared, unit costs can then be allocated to the individual items to arrive at a budget for harvesting in financial terms as shown in table 4.2.
Charge out costs
In table tractors have a unit cost of $7.50 per hour - machines like tractors have a whole range of costs like fuel and oil, repairs and maintenance, driver, licence, road tax and insurance and depreciation. Some of the costs are fixed, e.g. depreciation and insurance, whereas some vary directly with use of the tractor, e.g. fuel and oil. Other costs such as repairs are unpredictable and may be very high or low - an estimated figure based on past experience.
Figure: Harvesting cost budget
Item harvesting
Unit cost
1st quarter
2nd quarter
3rd quarter
4th quarter
Total
Labour

Cutting
$0.75 per tonne
-
6,750
12,000
7,500
26,250
Sundry
$2.50 per day
-
750
1,125
1,125
3,000
Tractors
$7.50 per hour
-
4,725
8,250
5,250
18,225
Cane Trailers
$0.15 per tonne
-
1,350
2,400
1,500
5,250
Imp. & sundries
$0.25 per tonne
-
2,250
4,000
2,500
8,750

-
$15,825
$27,775
$17,875
$61,475
So, overall operating cost of the tractor for the year may be budgeted as shown in figure 4.4.
If the tractor is used for more than 1,000 hours then there will be an over-recovery on its operational costs and if used for less than 1,000 hours there will be under-recovery, i.e. in the first instance making an internal 'profit' and in the second a 'loss'.
Figure : Tractor costs

Unit rate
Cost per annum (1,000 hours)

($)
($)
Fixed costs
Depreciation
2,000.00
2,000.00

Licence and insurance
200.00
200.00

Driver
100.00 per month
1,200.00

Repairs
600.00 per annum
600.00
Variable costs
Fuel and oil
2.00 per hour
2,000.00

Maintenance
3.00 per 200 hours
1,500.00

7,500.00

No. of hours used

1,000.00

Cost per hour

7.50
Master budget
The master budget for the sugar cane farm may be as shown in figure 4.5. The budget represents an overall objective for the farm for the whole year ahead, expressed in financial terms.
Table : Operating budget for sugar cane farm 19X4

1st quarter
2nd quarter
3rd quarter
4th quarter
Total $
Revenue from cane

130,000
250,000
120,000
500,000
Less: Costs

Cultivation
37,261
48,268
42,368
55,416
183,313

Irrigation
7,278
15,297
18,473
11,329
52,377

Field maintenance
4,826
12,923
15,991
7,262
41,002

Harvesting
-
15,825
27,775
17,875
61,475

Transportation
-
14,100
24,750
15,750
54,600

49,365
106,413
129,357
107,632
392,767
Add: Opening valuation
85,800
135,165
112,240
94,260
85,800

135,165
241,578
241,597
201,892
478,567
Less: Closing valuation
135,165
112,240
94,260
90,290
90,290
Net crop cost
-
129,338
147,337
111,602
388,277
Gross surplus
-
66,200
102,663
8,398
111,723
Less: Overheads
5,876
7,361
7,486
5,321
26,044
Net profitless)
(5,876)
(6,699)
95,177
3,077
85,679
Once the operating budget has been prepared, two further budgets can be done, namely:
i. Balance sheet at the end of the year. ii. Cash flow budget which shows the amount of cash necessary to support the operating budget. It is of great importance that the business has sufficient funds to support the planned operational budget.
Reporting back
During the year the management accountant will prepare statements, as quickly as possible after each operating period, in our example, each quarter, setting out the actual operating costs against the budgeted costs. This statement will calculate the difference between the 'budgeted' and the 'actual' cost, which is called the 'variance'.
There are many ways in which management accounts can be prepared. To continue with our example of harvesting on the sugar cane farm, management accounts at the end of the third quarter can be presented as shown in figure 4.6.
Figure 4.6 Management accounts - actual costs against budget costs Management accounts for sugar cane farm 3rd quarter 19X4

Item Harvesting
3rd quarter
Year to date

Actual
Budget
Variance
Actual
Budget
Variance
Labour

- Cutting
12,200
12,000
(200)
19,060
18,750
(310)

- Sundry
742
1,125
383
1,584
1,875
291
Tractors
9,375
8,250
(1,125)
13,500
12,975
(525)
Cane trailers
1,678
2,400
722
2,505
3,750
1,245
Imp & sundries
4,270
4,000
(270)
6,513
6,250
(263)

28,265
27,775
(490)
43,162
43,600
438
Here, actual harvesting costs for the 3rd quarter are $28,265 against a budget of $27,775 indicating an increase of $490 whilst the cumulative figure for the year to date shows an overall saving of $438. It appears that actual costs are less than budgeted costs, so the harvesting operations are proceeding within the budget set and satisfactory. However, a further look may reveal that this may not be the case. The budget was based on a cane tonnage cut of 16,000 tonnes in the 3rd quarter and a cumulative tonnage of 25,000. If these tonnages have been achieved then the statement will be satisfactory. If the actual production was much higher than budgeted then these costs represent a very considerable saving, even though only a marginal saving is shown by the variance. Similarly, if the actual tonnage was significantly less than budgeted, then what is indicated as a marginal saving in the variance may, in fact, be a considerable overspending.
Price and quantity variances
Just to state that there is a variance on a particular item of expenditure does not really mean a lot. Most costs are composed of two elements - the quantity used and the price per unit. A variance between the actual cost of an item and its budgeted cost may be due to one or both of these factors. Apparent similarity between budgeted and actual costs may hide significant compensating variances between price and usage.
For example, say it is budgeted to take 300 man days at $3.00 per man day - giving a total budgeted cost of $900.00. The actual cost on completion was $875.00, showing a saving of $25.00. Further investigations may reveal that the job took 250 man days at a daily rate of $3.50 - a favourable usage variance but a very unfavourable price variance. Management may therefore need to investigate some significant variances revealed by further analysis, which a comparison of the total costs would not have revealed. Price and usage variances for major items of expense are discussed below.
Labour
The difference between actual labour costs and budgeted or standard labour costs is known as direct wages variance. This variance may arise due to a difference in the amount of labour used or the price per unit of labour, i.e. the wage rate. The direct wages variance can be split into:
i) Wage rate variance: the wage rate was higher or lower than budgeted, e.g. using more unskilled labour, or working overtime at a higher rate. ii) Labour efficiency variance: arises when the actual time spent on a particular job is higher or lower than the standard labour hours specified, e.g. breakdown of a machine.
Materials
The variance for materials cost could also be split into price and usage elements:
i) Material price variance: arises when the actual unit price is greater or lower than budgeted. Could be due to inflation, discounts, alternative suppliers etc. ii) Material quantity variance: arises when the actual amount of material used is greater or lower than the amount specified in the budget, e.g. a budgeted fertiliser at 350 kg per hectare may be increased or decreased when the actual fertiliser is applied, giving rise to a usage variance.
Overheads
Again, overhead variance can be split into:
i) Overhead volume variance: where overheads are taken into the cost centres, a production higher or lower than budgeted will cause an over-or under-absorption of overheads. ii) Overhead expenditure variance: where the actual overhead expenditure is higher or lower than that budgeted for the level of output actually produced.
Calculation of price and usage variances
The price and usage variance are calculated as follows:
Price variance = (budgeted price - actual price) X actual quantity
Usage variance = (budgeted quantity - actual quantity) X budgeted price
Now attempt exercise 4.2.
Exercise 4.2 Computation of labour variances
It was budgeted that it would take 200 man days at $10.00 per day to complete the task costing $2,000.00 when the actual cost was $1,875.00, being 150 man days at $12.50 per day. Calculate:
i) Price variance ii) Usage variance

Management action and cost control
Producing information in management accounting form is expensive in terms of the time and effort involved. It will be very wasteful if the information once produced is not put into effective use.
There are five parts to an effective cost control system. These are:
a) preparation of budgets
b) communicating and agreeing budgets with all concerned
c) having an accounting system that will record all actual costs
d) preparing statements that will compare actual costs with budgets, showing any variances and disclosing the reasons for them, and
e) taking any appropriate action based on the analysis of the variances in d) above.
Action(s) that can be taken when a significant variance has been revealed will depend on the nature of the variance itself. Some variances can be identified to a specific department and it is within that department's control to take corrective action. Other variances might prove to be much more difficult, and sometimes impossible, to control.
Variances revealed are historic. They show what happened last month or last quarter and no amount of analysis and discussion can alter that. However, they can be used to influence managerial action in future periods.