introduction to Budget an Budgetary Control

 Meaning of Budget

CIMA Defines a Budget as, “A budget is 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.”

In a view of Keller & Ferrara, “A budget is a plan of action to achieve stated objectives based on predetermined series of related assumptions.”

G. A. Welsh states, “A budget is a written plan covering projected activities of a firm for a definite time period.”

 Meaning of Budgetary Control

Budgetary Control is actually a means of control in which the actual results are compared with the budgeted results so that appropriate action may be taken with regard to any deviations between the two.

According to CIMA, “Budgetary control is the establishment of budgets relating to the responsibilities of executives of a policy and the continuous comparison of the actual with the budgeted results, either to secure by individual action, the objective of the policy or to provide a basis for its revision.”

 Features of Budget

v  It is mainly a forecasting and controlling device.

v  It is prepared in advance before the actual operation of the company or project.

v  It is in connection with a definite future period.

v  Before implementation, it is to be approved by the management.

v  It also shows capital to be employed during the period. .

v  Establishment of budgets for each purpose of the business.

v  Revision of budget in view of changes in conditions.

v  Comparison of actual performances with the budget on a continuous basis.

v  Taking suitable remedial action, wherever necessary.

v  Analysis of variations of actual performance from that of the budgeted performance to know the reasons thereof.

Objectives of the Budget

(i)    To Help Plan of Action: A budget is a blue print for the desired plan of action. Since budgets are prepared in accordance with the policies of various functions of the organisation such as purchase, production sales etc., these will be helpful as plan of action to discharge the above functions.

(ii)   Useful to Forecasting: Budgets are useful for forecasting the operating activities and financial position of a business enterprise.

(iii)  To Establish Responsibilities: Budgets are helpful in establishing divisional and departmental responsibilities.

(iv)  Useful in Coordination of Functions:  Budgets provide a means of coordination for the business as a whole. When the budgets are established various factors such as production capacity, sales responsibilities, procurement of material, deployment of labour etc Thereby Budgets are very much useful in coordination of factors and functions.

 (v)  To Effective Communication: Budgets are means of communication. The complex plans that are laid down by the top management are to be passed on to the operative personnel, those who actually put the plans into action. Budgets are very much helpful in processing such information to the lowest personnel in the organisation.

(vi)  To Facilitate Control: Budgets facilitate centralised control with delegated     responsibilities and authorities. Budgets are instruments of managerial control by means of which the management can measure the performances in every part of the business concerns and corrective action can be taken soon after deviations are found out.

 Process (or) Stages of Budgetary control

Developing Budgets

The first stage in budgetary control is developing various budgets. It will be necessary to identify the budget centers in the organization and budgets will have to develop for each one of them. Thus budgets are developed for functions like purchase, sale, production, cash, capital expenditure, machine hours, labour hours and so on.

 Recording Actual Performance

There should be a proper system of recording the actual performance achieved. This will facilitate the comparison between the budget and the actual. An efficient accounting and cost accounting system will help to record the actual performance effectively.

Comparison of Budgeted and Actual Performance

One of the most important aspects of budgetary control is the comparison between the budgeted and the actual performance. The objective of such comparison is to find out the deviation between the two and provide the base for taking corrective action.

Corrective Action

Taking appropriate corrective action on the basis of the comparison between the budgeted and actual results is the essence of budgeting. A budget is always prepared for future and hence there may be a variation between the budgeted results and actual results. There is a need for investigation of the same and take appropriate action so that the deviations will not repeat in the future.

Benefits of Budgets and Budgetary Control

The budget assists planning

By formalising objectives through a budget, a business can ensure that its plans are achievable. It will be able to decide what is needed to produce the output of goods and services, and to make sure that everything will be available at the right time.

The budget communicates and co-ordinates

Because a budget is agreed by the business, all the relevant managers and staff will be working towards the same end. When the budget is being set, any anticipated problems should be resolved and any areas of potential confusion clarified. All departments should be in a position to play their part in achieving the overall goals.

The budget helps with decision-making

By planning ahead through budgets, a business can make decisions on how much output – in the form of goods or services – can be achieved. At the same time, the cost of the output can be planned and changes can be made where appropriate.

The budget can be used to monitor and control

An important reason for producing a budget is that management is able to use budgetary control to monitor and compare the actual results (see diagram below). This is so that action can be taken to modify the operation of the business as time passes, or possibly to change the budget if it becomes unachievable.

The budget can be used to motivate

A budget can be part of the techniques for motivating managers and other staff to achieve the objectives of the business. The extent to which this happens will depend on how the budget is agreed and set, and whether it is thought to be fair and achievable. The budget may also be linked to rewards (for example, bonuses) where targets are met or exceeded.

Limitations of Budgets

(i) Budgets fail if estimates are not accurate

Budgets mainly depend upon the accuracy of the estimates. So estimates should be made on the basis of all the information available. Though forecasting is not an exact science, accurate estimates can be made by using advanced statistical techniques. Thus preparation of budgets involves certain amount of judgment and proper interpretation of reports.

(ii) Risk of Rigidity

Budgeting process creates a sense of rigidity in the minds of people who are working in the organisation. But in the modern business world, which is more dynamic in nature, such rigidity will create problems. Therefore budgeting process should also be dynamic in nature, so that it can be updated according to the situation.

(iii) Budgeting is an expensive process

The installation and implementation of the budgeting process involves too much time and costs. Therefore small organisations can not afford to it. Even for large organisations cost benefit analysis should be conducted before installing such a system. It can be adopted only if the benefits exceed the costs.

(iv) Budgeting is not a substitute for management

Budgeting is only a tool for management. Installation of Budgeting system does not relieve the managers from their duties. It involves only in effective management of the resources of the organisation. It is only a misconception to think that the introduction of budgeting is alone sufficient to ensure success and to guarantee future profits. It is only a means for achieving the end.

(v) Continuous monitoring is required

Installation of budgeting system does not imply that it is effectively implemented. Management must continuously monitor the operating system (whether the goals intended) how far the plans and budgets are helpful in achieving the goals of the organisation. 

Process Costing- Meaning and its Applications

 Meaning of Process Costing

Process Costing is a method of costing used in industries where the material has, to pass through two or more processes for being converted into a final product. It is defined as “a method of Cost Accounting whereby costs are charged to processes or operations and averaged over units produced”. A separate account for each process is opened and all expenditure pertaining to a process is charged to that process account. Such type of costing method is useful in the manufacturing of products. where the production process is continuous and the output of one process becomes the input of the following process till completion.

Process costing is that aspect of operation costing which is used to ascertain the cost of the product at each process or stage of manufacture. This method of accounting used in industries where the process of manufacture is divided into two or more processes. The objective is to find out the total cost of the process and the unit cost of the process for each and every process. Usually the industries where process costing used are textile, oil industries, cement, pharmaceutical, steel, paper, medicines soap, chemicals, rubber, vegetable oil, paints, varnish etc.

 Definitions Process costing

“Process cost accounts are applied to concerns which produce a commodity that has to go through several processes and which requires to know the cost of each process”. – Charles.

 “Process costing is used to ascertain the cost of each stage of manufacture where material is passed through various operations to obtain a final product to result, with by products in many cases at different stages. - Lunt and Ripley

Applications of Process Costing

a)      Identical Products Industries

Process costing is most often used when manufacturers release identical products. If mass produced televisions have the same parts, manufacturers can assign consistent prices to the products based on how much the products cost to manufacture overall.

b)     Industries with Multiple Departments

Businesses that have multiple departments usually use process costing so that management can assess the costs accumulated by each department. For example, one department can take the raw resources and refine them before turning them into finished parts, another department can assemble the parts and a third department can test the finished product to assess both quality and safety. Materials might need to be shipped from one department to another, which may incur additional costs. When the costs of production go up unexpectedly, process costing can allow management to quickly pinpoint the department responsible for the increased costs and identify the source of the increased cost.

c)      Industries with Interchangeable Parts

Process costing comes into play when a factory manufactures identical parts. For example, a computer manufacturing plant will create numerous components that are interchangeable among computers of the same model. Process costing allows manufacturers to sell individual parts separately to computer repair shops or individual buyers, since the manufacturers know the cost of the separate parts.

d)     Industries with Varying Product Features

Products that have multiple extraneous features can benefit from process costing. Manufacturers can release two versions of the product, with one version costing less but having fewer features and another product costing more but having more features. For example, a manufacturer might release two coffee pots, one with a timer and one without. Process costing lets the manufacturer know how much the timer costs to add to the coffee pot, which enables the manufacturer to gauge how much it must raise the price on the coffee pot with the timer.

e)      Innovative Industries

Process costs are important in industries that have high innovation. For example, manufacturers cannot determine an appropriate price for a new type of product without knowing how much the product will cost to manufacture overall. In addition, businesses cannot determine if a product will be profitable until they know the overall cost so they can estimate the maximum price that customers will pay for the product.

Process costing is employed in the following types of industries

1.    Food processes industries, e.g., flour mills, meat products, milk diary, confectionaries, fruits and vegetables processing etc.

2.    Other industries involving a sequence of processes, e.g., paper mills, cement works, coke works, canning factory, textile manufacture, cartoon making, etc.

3.    Metallurgical industries, e.g., iron and steel, aluminum, wire drawing and netting and polishing, alloy production etc.

4.    Chemical industries, e.g., drugs and pharmaceuticals, paints soap making, production of sugar, molasses and alcohol, breweries, distilleries, oil refining, etc.