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(Budget & Budgetary Control)
By
Dr. K. C Iyer
Dept Of Civil Engg
IIT Delhi
Budget Introduction
z A budget is a formal statement of the financial resources of
a unit of an organisation which are set aside for carrying out
specific activities in a given period of time.
A budget should simultaneously answer two important
questions :‐
– Where and how should money be spent most effectively?
– And how much money should be spent?
Budget Introduction
A budget
z is a detailed plan of operations for a specific future period,
z is an estimate prepared in advance of the period to which it
applies,
z acts as a business barometer as it is a complete programme of
activities of the business for the period covered.
According to Gordon & Shillinglaw, budget may be defined as a pre‐
determined detailed plan of action developed and distributed as a
guide to current operations and as a partial basis for the
subsequent evaluation of performance.
Budget Introduction contd..
z The Chartered Institute of Management Accountants, London,
defines a budget as, a financial and/ or quantitative statement,
prepared prior to a defined period of time, of the policy to be
pursued during that period for the purpose of attaining a given
objective.
z Thus, the following are the essentials of a budget:
a. It is prepared in advance and is based on a future plan of actions.
b. It relates to a future period and is based on objectives to be
attained.
c. It is a statement expressed in monetary and/ or physical units
prepared for the implementation of policy formulated by the
management.
Budget Introduction contd..
z Uses of budget:
a. You know when and where to take actions
b. Budgets provide profitability with accountability
c. Budget variations create actions
Classification of Budget:
z Budgets can be classified into different categories from
different points of views. The following are the most
common basis of classification.
1. According to Time
2. According to Function and
3. According to Flexibility
Classification According to Time
In terms of time, the Budget can broadly be classified into
four categories:
a. Long Term Budget: A budget designed for a long period
(generally for a period of 5 to 10 years) is termed as a Long‐
term Budget. These budgets are concerned with planning of
the operation of a firm over a considerably long period of
time. They are generally prepared in terms of physical
quantities.
b. Short‐ term Budget: These budgets are designed for a
period generally not exceeding 5 years. They are prepared
in physical as well as in monetary units.
Classification According to Time contd..
c. Current Budgets: These budgets cover a very short period
say a month or quarter. They are essentially short‐term
budgets adjusted to current conditions or prevailing
circumstances.
d. Rolling Budgets: Some Companies follow the practice of
preparing a rolling or progressive budget. In case of such
companies there will always be a budget for a year in
advance. A new budget is prepared after the end of each
month/quarter for a full year ahead. The figures for the
month or quarter which has rolled down are dropped and
the figures for the next month or quarter are added.
Classification According to Function
Budgets can be classified on the basis of functions they are
meant to perform. These budgets are, therefore, also
termed as Functional Budgets. Their number depends on
the size and the nature of the business. The following are
the usual Functional Budgets.
a. Sales Budget: The budget forecasts total sales, i.e., the
volume of turnover in terms of quantity, value, items,
periods, areas, etc. This also comprises the expected value
of work period by period on the firm’s projects plus any
other expected income generated from selling and
successful claims on past contracts.
Classification According to Function:
contd..
b. Purchase Budget: The budget forecasts the quantity and
value of purchases required for construction. It gives
quantity‐wise, money‐wise and period‐wise information
about the materials to be purchased.
c. Personnel Budget: The budget anticipates the number of
personnel required during a construction activity. This
may be further split up between direct and indirect
personnel budgets.
Classification According to Function:
contd..
d. Operating budget: The Operating budget is obtained from
cost estimates of the planned requirements for materials,
labour, sub‐contractors, staff and overheads.
The difference in the value between the sales and
operating budgets is the anticipated profit before
deduction of depreciation on assets.
Classification According to Function:
contd..
e. Capital Expenditure Budget: The Capital expenditure
budget depends upon the nature of the volume of work to
be expected during the coming year. This Budget provides
a guidance regarding the amount of capital that may be
required for procurement of capital assets during the
budget period. It includes purchase of plants and
equipment, new premises, costly materials and any other
special item.
Classification According to Function:
contd..
f. Cash Budget: This budget is a forecast of the cash position
by time period for a specific duration of time. It states the
estimated amount of cash receipts and the estimation of
cash payments and the likely balance of cash in hand at
the end of different periods.
The cash flow forecast is produced by integrating the
sales, operating and cash expenditure budgets taking into
account payment delays, interest charges on loans,
corporation tax and capital allowances. In this way the
period‐by‐period cash needs are determined.
Classification According to Function:
contd..
g. Master Budget: The Master Budget is a summary of
budget schedules in capsule form made for the purpose of
presenting, in one report, the highlights of the budget
forecast. It incorporates all functional budgets in a capsule
form.
The Chartered Institute of Management Accountants,
London, defines it as the summary budget, incorporating
its component functional budgets, which is finally
approved, adopted and employed. Thus, it is a summary
budget of all other budgets. The budget may take the form
of a Profit and Loss Account and a Balance Sheet as at the
end of the budget period.
Classification According to Flexibility
On the basis of flexibility, budgets can be divided
into two categories:
1. Fixed Budget
2. Flexible Budget
Classification According to Flexibility
(Contd.)
z Fixed Budget: According to the Chartered Institute of Management
Accountants, London, a fixed budget is a budget, which is designed to
remain unchanged irrespective of the level of activity actually attained.
Thus, a budget prepared on the basis of a standard or fixed level of
activity is known as a fixed budget. It does not change with the change
in the level of activity.
Therefore, it becomes an unrealistic yardstick in case the level of
activity (volume of production or sales) actually attained does not
conform to the one assumed for budgeting purposes. The management
will not be in the position to assess the performance of different heads
on the basis of budgets prepared by them because they can serve as
yardsticks only when the actual level of activity corresponds to the
budgeted level of activity.
Classification According to Flexibility
(Contd.)
z Flexible Budget: According to the Chartered Institute of
Management Accountants, London, a flexible budget is a
budget designed to change in accordance with the level of
activity actually attained. Thus, a budget prepared in a
manner as to give the budgeted cost for any level of activity
is known as a flexible budget. Such a budget is prepared
after considering the fixed and variable elements of cost
and the changes that may be expected for each item at
various levels of operation.
Dangers of Budgeting
Budgets are used for planning and control. Unfortunately,
some budgetary control program are so complete and detail
that they become cumbersome, meaningless and unduly
expensive. Few can be as below
z Over budgeting
z Overriding enterprise goals
z Hiding inefficiencies.
z Causing inflexibility
Dangers of Budgeting (Contd.)
Overbudgeting. There is a danger in overbudgeting through
spelling out minor expenses in detail and depriving
managers of needed freedom in managing their
departments. For example, a department head in a poorly
budgeted company was hindered in an important sales
promotion because expenditures for office supplies
exceeded budgeted estimates; new expenditures had to be
limited, even though his total departmental expenses were
well within the budget and he had funds to pay personnel
for writing sales promotion letters. In another department,
expenses were budgeted in such useless details that the
actual cost of many items exceeded the expenses
controlled.
Dangers of Budgeting (contd.)
Overriding enterprise goals: In their zest to keep within
budget limits, managers may forget that they owe primary
loyalty to enterprise objectives. In one company with a
budgetary control program, the sales department could not
obtain needed information from the engineering
department on the grounds that the latter's budget would
not stand such expense. This conflict between partial and
overall control objectives, the excessive departmental
independence generated, and the lack of coordination are
symptoms of inadequate management, since plans should
constitute a supporting and interlocking network and every
plan should be, reflected in a budget in a way that will aid in
achieving enterprise goals.
Dangers of Budgeting (Contd.)
z Hiding inefficiencies: Budgets have a way of growing from
precedent; the fact that a certain expenditure was made in
the past can become evidence of its reasonableness in the
present. Thus, if a department once spent a given amount
for supplies, this cost becomes a minimum for future
budgets. Also, managers sometimes learn that budget
requests are likely to be pared down in the course of final
approval, and therefore they ask for much more than they
need. Unless budget making is accomplished by constant
reexamination of standards and conversion factors by which
planned action is translated into numerical terms, the
budget may become an umbrella under which slovenly and
inefficient management can hide.
Dangers of Budgeting (Contd.)
Causing inflexibility. It is entirely possible that events will
prove that a larger amount should be spent for this kind of
labour or that kind of material and a smaller amount for
another or that sales will exceed or fall below the amount
forecast. Such differences may make a budget obsolete al‐
most as soon as it is formulated; if managers must stay
within the straitjacket of their budgets in the face of events
like these, the usefulness of budgets is reduced or nullified.
This is especially true when budgets are made for long
periods in advance.
Major deficiencies noticed in a typical
public system Budgeting
Budgeting and planning is in a top to bottom
direction ‐top management handing down
strategies, plans and amounts for implementation
and spending.
Budgets have no contingency plans.
Cost data not dependable and timely.
Emphasis on observing budgetary ceilings. A last
minute rush for spending.
Major deficiencies noticed in a typical
public system Budgeting contd..
Emphasis on “Form" rather than “Content" in
expenditure.
Centralized decision making.
Emphasis on spending out the allotments rather
than on Achieving outputs, far less on creating
outcomes.
Absence of transparency and accountably.
A hostile and corrupt bureaucracy with little client
orientation.
Traditional Budgeting Process
Normally in any govt. organisation, the budgeting process
comprises of the following steps :‐
For preparing next year's budget,
Step I: Find out current year's expenditure level, add
estimates for new program and activities and an extra
element for inflation.
Step II: add up and consolidate the individual budgets of
units and present this to the top management.
Traditional Budgeting Process contd..
Step III: Top mgt. estimates total receipts, takes into
account these (scarce) resources, i.e. the overall availability
of funds, and make arbitrary cuts across the board on
proposed amounts of expenditure. Since this is anticipated
to happen, additional margins are added earlier by budget
preparing agencies.
Step IV : Reallocate this reduced total amount to the units.
The specific and detailed items of expenditure are then
recast so as to conform to the "ceilings" handed down. This
becomes the approved budget and is implemented.
Defects in the traditional approach
The expenditure level of previous years is assumed to be
the desirable and proper amount. All that is done is to
decide what activities and programmes should be added. In
other words, the budgeting is incremental.
This process infuses a bias towards continuing the same
activities year after year ‐ even though their relevance and
utility may have been lost because of changes in
environment, technology or organizational objectives.
To sum up, what happens is:
1. Past activities and past levels of activities become
sacrosanct and are regarded as "desirable" and
"inevitable".
Defects in the traditional approach contd..
2. Past levels of expenditure on activities also become
sacrosanct and there is a fatalistic acceptance of them.
3. Changes in environment, technology, objectives do not
matter in the analysis.
4. Importance is attached to observing ceilings of
expenditure.
5. Bureaucracy can play mischief by slipping in new items of
spending during the March month's spending frenzy items
which had been correctly rejected at the budget
preparation stage.
The breakthrough
In 1970, Peter Pyhrr created a sensation by
presenting a novel approach to budgeting. his
research paper on "zero‐ base budgeting" was
published in Harvard Business Review, Nov.‐Dec.
1970 issue.
He also presented his idea to an elite audience of
America's top executives from Industries and Govt.
agencies. This presentation brought the concept
into limelight all over the world.
What is the zero base approach?
It is a tool for planning, resource allocation and control.
It requires an executive to justify his/her budget
requirement for projected performance starting from
scratch. the approach requires that a structured, systematic
and analytical process of questioning is done in two stages:‐
Stage I: This involves redefining the urgency/ importance/
priority of each program, project, task or activity. It has to
be classified as urgent, essential or desirable.
What is the zero base approach? Contd..
Stage II: Construction of "decision packages" with
identification of specific objectives and alternative
performance methods to achieve these objectives. a
decision package should be capable of being evaluated
through a cost‐ benefit analysis.
– What should a decision package contain?
– Example of a decision package:
What is the zero base approach? Contd..
Stage III: ranking of decision packages by junior
functionaries and presentation to higher management for a
hierarchical review and a re‐ranking.
Stage IV: A final approval / acceptance of selected decision
packages and allocation of resources to managerial units
based on these packages. This is the budget.
Stage V: Monitoring the performance of projects/
programmes/ activities on the basis of criteria established in
the approved decision packages.
Likely Benefits of this approach:
Improved planning of work
Improved deployment of resources
Cost effectiveness by a systematized learning process which
would ensure that the budget for the next year will not be
based on the pitfalls of the previous year's performance or
mistakes of resources allocation.
Greater involvement of managers at decision making stages
and consequent greater commitment to achieve goals.
Alternative or contingency plans get explicitly formed and
can be used if and when required.
Demerits of this approach
Greater needs of time and cost for preparation of
budget ‐Heavy paper work.
Choices of decision packages are often made on
non ‐ informational basis, which reduces the
effectiveness of the concept.
Implementation of ZBB –The Record
1970 : Texas Instruments, USA
1972: State of Georgia, USA (under governor Jimmy Carter)
1973: Federal Govt. of USA (under president Jimmy Carter)
The hardline approach was subsequently diluted and
currently a number of organisations use it in some form or
the other.
Implementation of ZBB –The Record
contd..
Other Countries :‐
New Zealand Govt. has introduced a package containing the
ZBB approach and NPM (New Public Mgt.). The
achievements have been spectacular.
Similar packages have been implemented by Governments
of UK, Australia. Denmark, and Sweden, with varying
success.
There is no doubt that ZBB has triggered off a f wholly new
type of thinking on governmental spending. New Public
Mgt. is an offshoot of ZBB.
BUDGET MONITORING
PERFORMANCE BUDGETING
Any system of budgeting in order to be successful, must
provide for performance appraisal as well as follow‐up
measures. It should be capable of predicting statistically the
performance for the budget period in terms of probabilities
and levels of confidence. For example, if a bank stipulates
that the result of its business budget would be correct up to
a level of 5% it means that performance of majority of the
branches and zones and the bank are likely to be within a
range of ±5% from the budgeted business.
PERFORMANCE BUDGETING contd..
Performance budgeting involves evaluation of the
performance of the organisation in the context of both
specific as well as overall objectives of the organisation.
According to the National Institute of Bank Management,
Mumbai, performance budgeting technique is the process
of analyzing, identifying, simplifying and crystallizing specific
performance objective of a job to be achieved over a
period, in the framework of the organizational objectives,
the purpose and objectives of the job.
PERFORMANCE BUDGETING contd..
The technique is characterized by its specific direction
towards the business objectives of the organisation. Thus,
performance budgeting lays immediate stress on the
achievement of specific goal over a period of time.
However, in the long‐run it aims at continuous growth of
the organisation so that it continues to meet the dynamic
needs of its growing clientele. It enables the organisation to
be sensitive and adaptive, preventing it from developing
rigidities which may retard the process of growth.
PERFORMANCE BUDGETING contd..
Performance budgeting requires preparation of
periodic performance reports. Such reports
compare budget and actual data and show any
existing variances. Their preparation is greatly
facilitated if the authority and responsibility or the
incurrence of each cost element is clearly defined
within the firm's organizational structure
PERFORMANCE BUDGETING contd..
The responsibility for preparing the performance budget of
each department lies on the respective Departmental Head.
Each Departmental Head will be supplied with a copy of the
section of the master budget appropriate to his sphere. For
example, the chief buyer will be supplied with the copy of
the materials purchase budget so that he may arrange for
purchase of necessary materials. Periodical reports from the
various sections of a department will be received by the
departmental head who will in summary form submit a
report about his department to the budget committee.
PERFORMANCE BUDGETING contd..
Illustration. Bharat Consumer Products employ 10 trucks of
10 tonnes capacity to deliver products to their distributors.
The vehicles return empty on the return journey. The
following data refer to the month of May, 2001 :
Budget Actual
Load carried (tonnes) 4,000 3,800
No. of truck trips 500 450
Journey (hours) 3,000 2,500
Loading time (hours) 1,000 800
PERFORMANCE BUDGETING contd..
Budget Actual
Km. travelled 25,000 25,000
Diesel used (litres) 12,500 13,000
No. of drivers 12 12
No. of mechanics 5 5
Fixed costs (Rs.) 8,000 8,000
Cost per litre of diesel (Rs.) 1.00 0.95
Wages per driver per month (Rs.) 1,000 1,050
Wages per mechanic per month (Rs.) 800 900
Spares for repairs (Rs.) 2,000 2,500
PERFORMANCE BUDGETING contd..
Solution: Comparative statement of operating cost
No of Trucks: 10 Capacity: 10 tonnes Month: May 2003
Budget Actual Variance
Cost of diesel 12,500 12,350 150
Spares for repairs 2,000 2,500 ‐500
Wages; Drivers 12,000 12,600 ‐600
Mechanic 4,000 4,500 ‐500
Total Variable Cost 30,500 31,950 ‐1,450
Total Fixed Costs 8,000 8,000 ‐‐‐
Total Operating Costs 38,500 39,950 –1,450
PERFORMANCE BUDGETING contd..
Budget Actual Variance
Load and distance 1,00,000 95,000 ‐5,000
Carried (in 000’ tonne‐km)
Operating cost per 1,000 tonne‐km 0.385 0.422 ‐0.037
Operating cost per truck trip 77 89 ‐12
Cost of diesel per journey hour 4.17 4.94 ‐0.77
Truck loaded per hour (tonne) 4.00 4.75 0.75
Journey hours per trip 6.00 5.55 0.45
Kms Traveled per trip 50.0 55.55 5.55
PERFORMANCE BUDGETING contd..
Comments:
(i) The actual operating costs are Rs. 1450 more than the
budgeted costs. Of course, the cost of diesel has come
down by Rs. 150 due to reduction in its price, out the other
costs such as spares and wages all together have gone up by
Rs. 1,600.
(ii) The operating cost per 1,000 tonne km. has gone up from
38.5 paise to 42.2 paise because of two reasons; (a) the
actual load carried is less than what was budgeted and (b)
total operating costs have gone up as stated in (i) above.
(iii) There is increase in the operating cost per trip also because
of fall in number of trips and rise in operating costs.
PERFORMANCE BUDGETING contd..
Comments:
(iv) In spite of reduction in the cost of petrol and journey hours
per trip (both favorable), the cost of fuel per journey hour
has gone up. This is due to reduction in number of trips.
(v) Loading of trucks per tonne‐hour is favorable. This has gone
up from 4 to 4.75 per tonne‐hour.
(vi) The same distance has been covered by a smaller number
of trips. Thus kms. traveled per trip is also favorable. It also
explains that longer distance was traveled per trip on
account of which reduced load was carried. However,
increase in consumption of diesel needs explanation
because the distance traveled was the same as budgeted.
PERFORMANCE BUDGETING contd..
Comments:
(viii) Increase in the cost of spares indicates a large number of
breakdowns on account of which there has been a fall in
journey hours to some extent
Conclusions
z The budgets should not be imposed from above, i.e.. the top
management.
z For successful programming it is essential that the urge for their
implementation comes from within and for that participation of
all concerned is a must.
z Budgeting should emerge from the middle, management, it
should roll upwards and, downwards, and then finalized by the
top management in the light of suggestions and criticisms
received.
z In view of the rapidly changing circumstances, it is imperative
that the budgets are reviewed regularly by the Budget
Committee and necessary amendments incorporated
continuously on the basis of altered conditions.
A decision package should contain:
a) Purpose (objective);
b) Consequence of not performing the activity
c) measures of performance;
d) Alternate courses of action;
e) Cost and benefit for each alternate course of action.
f) Personnel required for the activity.
Back
Comparison of Decision Packages
Decision pacakage
Activity Level / Cost / Package 1 Package 2 Package 3
Tangible benefits
Current level, Minimum
Activity Level 4 security men 4 security men 6 security men
1 weighing machine 1 weighing machine 4 stores clerks
4 stores clerks 1 supervisor
1 weighing machine
Consturction of
boundary wall
Construction of
observation post
Comparison of Decision Packages
contd..
Activity Level / Cost / Package 1 Package 2 Package 3
Tangible benefits
Cost / Annum 4 security men 4 security men 6 security men
4 x 12 x Rs.1500 4 x 12 x Rs.1500 6 x 12 x Rs.1500
= 72000 = 72000 = 1,08,000
Boundary wall
= 70000
Observation post
=10000
Depreication on
boundary wall and
observation post @ 10%
= 8000
Comparison of Decision Packages
contd..
Activity Level / Cost / Package 1 Package 2 Package 3
Tangible benefits
Total recurring cost Total recurring cost Total recurring cost
= 72000 + 4500 = 1,72,000 = Rs. 2,46,500
= 76500
Back