Budgeting & Budgeting Control

BUDGETING & BUDGETING CONTROL

1-2

Introduction For effective running of a business, management must know: 

where it intends to go i.e. organizational objectives



how it intends to accomplish its objective plans



whether individual plans fit in the overall organizational objective. i.e. coordination



whether operations conform to the plan of operations relating to that period i.e. control

i.e.

“Budgetary control is the device that a company uses for all these purposes.”

1-3

Definition of Budget Budget has been defined by CIMA U.K. 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 achieving a given objective.”  According to Bartizal: “ A budget is a forecast, a detail, of the results of an officially recognized programme of operations based on the highest reasonable expectations operating efficiency” 

1-4

Characteristics of Budget 

Analysis of these definitions elucidate the following characteristics of budget:  







Budget is prepare prior to a defined period of time. Budget is prepared either in quantitative details or monetary details or both. Budget is prepared for the purpose of attaining a given objective. Budget is prepared on a certain operating efficiency. It elucidates the policies to be pursued during a definite period for attaining a given objective.

1-5

What is Budgetary Control?? Budgetary control is the use of the comprehensive system of budgeting to aid management in carrying out its functions like planning, coordination and control. This system involves:  Division of organization on functional basis into different sections known as a budget centre.  Preparation of separate budgets for each “budget centre”.  Consolidation of all functional budgets to present overall organizational objectives during the forthcoming budget period.  Comparison of actual level of performance against budgets.  Reporting the variances with proper analysis to provide basis for future course of action.

1-6

Objectives of Budgetary Control (1)

(2)

(3)

(4)

Planning:- A budget is plan of action. Budgeting ensures a detailed plan of action for a business over a period of time. Co-ordination:- Budgetary control co-ordinates the various activities of the entity or organization and secure cooperation of all concerned towards the common goal. Control:- Control is necessary to ensure that plans and objectives are being achieved. No control performance is possible without predetermined standards. Thus, budgetary control makes control possible by continuous measures against predetermined targets. Fixing Administrative Responsibility:- Fix authority and responsibility of administration so that for every failure and success responsible person may be punished or rewarded.

1-7

Budgetary Control: Advantages 1.

2.

3.

4.

Budgeting facilitates planning of various activities and ensures that the working of the organization is systematic and smooth. Budgeting is a coordinated exercise and hence combines the ideas of different levels of management in preparation of the same. Any budget cannot be prepared in isolation and therefore coordination among various departments is facilitated automatically. Budgeting is an effective means for planning and thus ensures sufficient availability of working capital and other resources.

1-8

Budgetary Control: Advantages contd... 5.

6.

7.

8. 9.

It is extremely necessary to evaluate the actual performance with predetermined parameters. Budgeting ensures that there are well-defined parameters and thus the performance is evaluated against these parameters. It guides the management in taking decision regarding the operations which needs control and not to be controlled. As the resources are directed to the most productive use, budgeting helps in reducing the wastages and losses. It guides management in research and development. It helps in the review of current trends and framing of future policies.

1-9

Budgetary Control : Disadvantages 









Estimates: Budgets may or may not be true, as they are based on estimates. The assumptions about future events may or may not actually happen. Rigidity: Budgets are considered as rigid document. Too much emphasis on budgets may affect day-to-day operations and ignores the dynamic state of organizational functioning. False Sense of Security: Mere budgeting cannot lead to profitability. Budgets cannot be executed automatically. It may create a false sense of security that everything has been taken care of in the budgets. Lack of coordination: Staff cooperation is usually not available during Budgetary Control exercise. Time and Cost: The introduction and implementation of the system may be time consuming and expensive.

1-10

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 realizing 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 execution of the plan. 5. A budget should always be related to a specified time period. 6. The budgeting system should not cost more to operate than it is worth.

1-11

Contd….. 7.

8.

9.

10.

11.

12.

Support of top management is necessary in order to get the full support and co-operation of the system of budgetary control. To make budgetary control successful, there should be a proper delegation of authority and responsibility. Adequate accounting system is essential to make the budgeting successful. The employees should be properly educated about the benefits of budgeting system. Key factor or limiting factor, if any, should consider before preparation of budget. For budgetary control to be effective, proper periodic reporting system should be introduced.

ORGANIZATION FOR BUDGETARY CONTROL

1-13

Preparation of 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 : 1) Organization Chart 2) Budget Center 3) Budget Committee 4) Budget Manual 5) Budget Period 6) Key Factor

1-14

1. Organization Chart 

There should be an organization chart that shows clearly defined authorities and responsibilities of various executives.



The organization chart will define clearly the functions to be performed by each executive relating to the budget preparation and his relationship with other executives.



The organization chart may have to be adjusted to ensure that each budget center is controlled by an appropriate member of the staff.

1-15

Organization Chart contd….

1-16

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. For example, manpower planning budget, research and development cost budget, production and production cost budget, labor hour budget and so on.

1-17

3. Budget Committee 





Budget Committee comprising of the Managing Director, the Production Manager, Sales Manager and Accountant. The main objectives of this committee is to agree on all departmental budgets, normal standard hours and allocations. The main functions of the budget committee are to get the budgets prepared and then scrutinize the same, to lay down broad policies regarding the preparation of budgets, to approve the budgets, to suggest for revision, to monitor the implementation and to recommend the action to be taken in a given situation.

1-18

4. Budget Manual 





A budget manual is defined by ICMA as ‘ a document which sets out the responsibilities of the person engaged in, the routine of and the forms and records required for budgetary control’. The budget manual thus is a schedule, document or booklet, which contains different forms to be used, procedures to be followed, budgeting organization details, and set of instructions to be followed in the budgeting system. It also lists out details of the responsibilities of different persons and the managers involved in the process.

1-19

Contd….. 

A typical budget manual contains the following:

 

    

Objectives and managerial policies of the business concern. Internal lines of authorities and responsibilities. Functions of the budget committee including the role of budget officer. Budget period Principal budget factor Detailed program of budget preparation Accounting codes and numbering Follow up procedures.

1-20

5. 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:    

   

Types of Business Types of Budget Nature of the demand of the product Length of trade cycle Economic factors Availability of accounting period Availability of finance Control operation

1-21

6. Principal Budget Factor or Key Factor 





A key factor or a principal budget factor [also called as constraint] is that factor the extent of whose influence must first be assessed in order to prepare the functional budgets. Normally sales is the key factor or principal budget factor but other factors like production, purchase, skilled labor may also be the key factors. For example, a company has production capacity to produce 30,000 tones per annum but if the sales forecast tells that the market can absorb only 20,000 units, there is no point in producing 30,000 units.

1-22

Contd….. 

In all conditions the key factor is the starting point in the process of preparation of budgets. A typical list of some of the key factors is given below: 



 



Sales: Consumer demand, shortage of sales staff, inadequate advertising Material: Availability of supply, restrictions on import Labor: Shortage of labor Plant: Availability of capacity, bottlenecks in key processes Management: Lack of capital, pricing policy, shortage of efficient executives, lack of know- how, faulty design of the product etc.

CLASSIFICATION OF BUDGET

1-24

Classification of Budget 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.

(A) Classification on the basis of Time:   

Long-Term Budgets Short-Term Budgets Current Budgets

(B) Classification according to Functions: 



Functional or Subsidiary Budgets Master Budgets

(C) Classification on the basis of Capacity:  

Fixed Budgets Flexible Budgets

1-25

Classification of Budget: Chart View 

The following chart can explain this more: Classification of Budget

On the basis of Time

Longterm Budget

Shortterm Budget

On the basis of Capacity

On the basis of Function

Current Budget

Functional Budget

Fixed Budget

Master Budget

Flexible Budget

1-26

Classification on the basis of Time On the basis of Time

Long-term Budget

1. 





Short-term Budget

Current Budget

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.

1-27

Contd…. 2. 



3. 



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.

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 London, "Current budget is a budget which is established for use over a short period of time and related to current conditions."

1-28

Classification on the basis of Capacity On the basis of Capacity

Fixed Budget

1. 



Flexible Budget

Fixed Budgets: When a budget is prepared by assuming a fixed percentage of capacity utilization, it is called as a fixed budget. As per ICMA, London, “the budget which is designed to remain unchanged irrespective of the level of activity actually attained.”

1-29

Contd…. 2. 





Flexible Budgets: 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. The basic principle of flexible budget is that if a budget is prepared for showing the results at say, 15,000 units and the actual production is only 12,000 units, the comparison between the expenditures, budgeted and actual will not be fair as the budget was prepared for 15,000 units. Therefore a flexible budget is developed for a relevant range of production from 12,000 units to 15,000 units.

Points to be remembered while preparing Flexible Budget 





1-30

While preparing flexible budget, it is necessary to study the behavior of costs and divide them in fixed, variable and semi variable. After doing this, the costs can be estimated for a given level of activity. It is also necessary to plan the range of activity. A firm may decide to develop flexible budget for activity level starting from 50% to 100% with an interval of 10% in between. It is necessary to estimate the costs and associate them with the chosen level of activity. Finally the profit or loss at different levels of activity will be computed by comparing the costs with the revenues.

1-31

Difference between Fixed and Flexible Budget Fixed Budget

Flexible Budget

Definition It is a Budget designed It is a Budget, which by to remain unchanged irrespective of the level of activity actually attained.

Rigidity

recognizing the difference between fixed, semivariable and variable costs is designed to change in relation to level of activity attained.

It does not change with It can be re-casted on the actual volume of activity basis of activity level to be achieved. Thus it is achieved. Thus it is not rigid. known as a Rigid or Inflexible budget.

1-32

Fixed Budget Level of Activity

Flexible Budget

It operates on one level of It consists of various activity and under one set of budgets for different levels conditions. It assumes that of activity there will be no change in the prevailing conditions, which is unrealistic.

Effect of Variance Analysis does not Variance Analysis provides Variance give useful information as all useful information as each Costs (fixed, variable and cost is analysed according Analysis semivariable) re related to to its behaviour. only one level of activity.

1-33

Use for Decision Making

Fixed Budget

Flexible Budget

If the budgeted and actual activity levels differ significantly, then aspects like cost ascertainment and price fixation do not give a correct picture.

If facilitates the ascertainment of cost, fixation of selling price and submission of quotations.

Performance Comparison of actual It provides a meaningful Evaluation performance with budgeted basis of comparison of targets will be meaningless, the actual performance especially when there is a with the budgeted difference between two targets. activity levels.

1-34

Illustration: Flexible Budget A factory engaged in manufacturing plastic toys is working at 40% capacity and produces 10,000 toys per month. The present cost break up for one toy is as under.  Material: Rs.10  Labor: Rs.3  Overheads: Rs.5 [60% fixed]  The selling price is Rs.20 per toy.  If it is decided to work the factory at 50% capacity, the selling price falls by 3%. At 90% capacity, the selling price falls by 5% accompanied by a similar fall in the price of material. You are required to prepare a statement showing the profits/losses at 40%, 50% and 90% capacity utilizations.

1-35

Flexible Budget At 40%, 50% and 90% Capacity Utilization Particulars Production - Units Selling Price Per Unit Sales Value [units X selling price per unit] Variable Costs: Material Rs.10 per unit Labor Rs.3 per unit Overheads Rs.2 per unit Total Variable Costs Fixed Costs Total Costs [Variable Cost + Fixed Cost] Profit/Loss [Sales – Total Costs]

40% Capacity Utilization 10, 000 Rs.20

50% Capacity Utilization 12, 500 Rs.19.40

90% Capacity Utilization 22, 500 Rs.19

Rs.2, 00,000

Rs.2, 42, 500

Rs.4, 27, 500

Rs.1, 00,000 Rs.30, 000 Rs.20, 000 Rs.1, 50, 000 Rs.30, 000

Rs.1, 21, 500 * Rs.37, 500 Rs.25, 000 Rs.1, 84, 000 Rs.30, 000

Rs.2, 13, 750 ** Rs.67, 500 Rs.45, 000 Rs.3, 26, 250 Rs.30, 000

Rs.1, 80, 000

Rs.2, 14, 000

Rs.3, 56, 250

Rs.20, 000

Rs.27, 500

Rs.71, 250

* 12, 500 units X Rs.9.70 per unit = Rs.1, 21, 500 ** 22, 500 units X Rs.9.50 per unit = Rs.2, 13, 750

1-36

Classification on the basis of Function On the basis of Function

Master Budget

1. 



Functional or Subsidiary Budget

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.

1-37

Contd…. 2. 



Functional or Subsidiary Budgets: The functional budget is one which relates to any of the functions of an organization. The number of functional budgets depend upon the size and nature of business. Following are some important functional budgets which are frequently used in every standard concern:   





 

Sales Budget for sales related activity Production Budget for production related activity Production Cost Budget for production cost related activity Administrative Cost Budget for administrative expenses related activity Selling & Distributive Cost Budget for selling & distributive expenses related activity Research & Development Cost Budget for new product development related activity Cash Budget for cash related activity Capital Expenditure Budget for capital expenditure related activity

1-38

Functional or Subsidiary Budget Functional Budget Sales Budget

Production Budget

Production Cost Budget

Administrative Cost Budget

Finance Budget

Cost Budget Selling & Distribution Cost Budget

Research & Development Cost Budget Cash Budget

Material Budget Labour Budget Overhead Budget

Capital Expenditure Budget

1-39

1. Sales Budget 

Sales budget is the most important budget based on which all the other budgets are built up.



Sales budget is primarily concerned with forecasting of what products will be sold in what quantities and at what prices during the budget period.



A Sales Budget may be prepared product wise, territories/area/country wise, customer group wise, salesmen wise as well as time wise like quarter wise, month wise, weekly etc.

Factors taken into consideration while preparing Sales Budget

1-40

The following factors are taken into consideration while preparing a sales budget: Analysis of past sales  Estimates given by the sales staff  Market Potential Analysis  Plant Capacity  Seasonal Fluctuations  Availability of raw materials  Future Competition  Financial conditions  Prospective Economic, Social &Political situations

1-41

Illustration: Sales Budget ABC Ltd. Manufactures two articles X and Y. Its sales department has three divisions: West, South and East. Preliminary sales budgets for the year ending 31st December 2011, based on the assessments of the divisional executives:  Product X : West 40,000 units: South 1,00,000 units and East 20,000 units  Product Y : West 60,000 units: South 80,000 units and East Nil  Sales Price X Rs. 2 and Y Rs. 3 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 2011 when sales are expected to be 1,00,000 units.  Since the estimated sales of the South division represented an unsatisfactory target, it is agreed to increase both the estimates by 10 %. Prepare a sales budget for the year to 31st December 2011.

1-42

Solution Sales Budget for the year 2011 Product ‘X’

Product ‘Y’

Total Divisions Amount (Rs.) Quantity Price (Rs.) Value (Rs.) Quantity Price (Rs.) Value (Rs.) West

60,000

2

1,20,000

80,000

3

2,40,000

3,60,000

South

1,10,000

2

2,20,000

88,000

3

2,64,000

4,84,000

East

20,000

2

40,000

1,00,000

3

3,00,000

3,40,000

Total

1,90,000

3,80,000

2,68,000

8,04,000

11,84,000

1-43

2. Production Budget 



Production budget is a pre-estimation of the total production of the concern. This budget is prepared by the production manager. It contains the following information: 





Estimation of the total production: Production of the concern is estimated for each product separately. Time-wise estimation: Production of the concern is estimated time-wise i.e. weekly, fortnightly or monthly etc. Estimation of closing stock: Expected closing stock of the product goods is also estimated in the budget.

Factors taken into consideration while preparing Production Budget

1-44

The following factors are taken into consideration while preparing a production budget:

Plant Capacity



Time consumes in production process



Availability of raw materials and labour



Determination of stock limits



Separate information for each production

1-45

Illustration: Production Budget ABC Ltd. manufactures two products X and Y. As per the sales budget, the budgeted sales for the year 20102011 are 41,000 units of ‘X’ and 30,000 units of ‘Y’. The normal loss in the production is 5%. Estimated stock of production forecast should remain as;  Opening Stock: Product X : 8,500 units; Product Y : 5,000 units  Closing Stock: Product X : 15,000 units; Product Y : 13,000 units Prepare a production budget for 2010-2011.

1-46

Solution Production Budget for the year 2010-11 Total Product ‘X’ Product Amount (in Rs.) ‘Y’ (in Rs.) (Rs.)

Particulars Sales Requirements

41,000

30,000

71,000

Add: Closing stock forecast

15,000

13,000

28,000

56,000

43,000

99,000

8,500

5,000

13,500

47,500

38,000

85,500

2,500

2,000

4,500

50,000

40,000

90,000

Total Less: Opening stock forecast Net Production Requirement Add: Normal Loss (being 5% of Total)** Total Production

1-47

3(a). Production Cost Budget 





Production cost budget is a pre-estimation of the factory cost or cost of production of the budget production. Production targets are fixed by the sales budget and the production budget. It is the combination of following three budgets:  Material Budget  Labour Budget  Overhead Budget

1-48

3(a1). Material Budget 



Material Purchase Budget is concerned with purchase and requirement of direct materials to be made during the budget period. Following pre-estimations are made in this budget: 



 



Estimation of the requirement of different direct materials for production of different products. Estimation of the quantity of opening and closing stock of each of the direct materials. Time period for the purchase and receipt of direct material. Financial requirements for purchase of required quantity of direct materials.

Material Budget may be divided in two parts:  Material Quantity Budget (showing the estimated quantity of material during the budgeted period)  Material Purchase Budget (showing the estimated amount required for the purchase of direct materials)

Factors taken into consideration while preparing Material Budget

1-49

The following factors are taken into consideration while preparing a production budget: Estimated sales and production.  Requirement of materials during budget period.  Expected changes in the prices of raw materials.  Different stock levels, EOQ etc.  Availability of raw materials, i.e., seasonal or otherwise.  Availability of financial resources.  Price trend in the market.  Company's stock policy etc.

1-50

3(a2). Labour Budget 





The labor budget estimates the labor required for smooth and uninterrupted production. The labor budget shows the number of each type or grade of workers required in each period to achieve the budgeted output, budgeted cost of such labor, period wise and period of training necessary for different types of labour. This budget must contains the following informations: Total number of labourers required during production process producing the budget number of units.  Number of skilled and unskilled labourers.  Rate of wages which will be payable to skilled and unskilled workers.  Estimated working labour-hours.  Overtime labour hours.

1-51

3(a3). Overhead Budget 

This budget is prepared for planning of the factory overheads to be incurred during the budget period.



In this budget the overheads should be shown department wise, so that responsibility can be fixed on proper persons.



Classification of factory overheads into fixed and variable components should also be shown in this budget.



This budget deals with the following costs: Estimated cost of indirect materials.  Estimated amount of indirect labour.  Estimated amount of factory overheads.

1-52

3(b). Administrative Cost Budget 









Estimated administration costs of the current year are given in this budget. Fixed and variable administration costs are shown separately in the budget. The budget covers the expenses incurred in framing policies, directing the organization and controlling the business operations. In budget an estimate of expenses is prepared regarding central office and of management salaries. The budget can be prepared with the past experience and anticipated changes.

1-53

3(c). Selling & Distribution Cost Budget 





In this budget experts have to plan for the expected selling and distribution expenses of the firm. This budget is prepared by sales manager, advertisement manager and distribution manager combinedly. Generally, following expenses are shown in this budget:







Direct selling expenses (e.g. Salesman’s Commission, travelling allowances etc.) Sales office expenses (e.g. rent of sales office, tax and maintenance , salaries of employees working in office etc.) Advertisement expenses (e.g. advertisement incurred for sales promotion, in newspapers, TV, hoardings etc., poster exhibition etc.) Distribution expenses (e.g. distribution related to goods, rent of godown, its tax and insurance, salaries of drivers and salaries of workers in godowns, in packaging work etc.)

1-54

3(d). Research & Development Budget 







This budget is one of the important tools for planning and controlling research and development costs. It helps management in planning the research and development activities well in advance and also about the fairness of the expenditure. Research and development is one of the important activities of any firm and hence proper planning and coordination is required for effectiveness of the same. This budget also helps to plan the requirement of necessary staff for carrying out research and development.

1-55

4(a). Cash Budget 



The cash budget is a summary of the firm's expected cash inflows and outflows over a particular period of time. In other words, cash budget involves a projection of future cash receipts and cash disbursements over various time intervals. A cash budget helps the management in:  



Determining the future cash needs of the firm Planning for financing of those needs Exercising control over cash and liquidity of the firm

1-56

Contd…. 





The main purpose of cash budget is to predict the receipts and payments in cash so that the firm will be able to find out the cash balance at the end of the budget period. Cash Budget is prepared in various ways, but the most popular form of the same is by the method of Receipt and Payment method. Remember that the cash budget, as its name suggests, deals only in cash/bank transactions; thus non-cash items, such as depreciation, are never shown.

1-57

Items included in Cash Receipts 

The estimated Cash Receipts include:         

Cash Sales Credit Sales Collection from Sundry Debtors Bills Receivable Interest Received Income from Sale of Investment Commission Received Dividend Received Income from Non-Trading Operations etc.

1-58

Items included in Cash Payments 

The estimated Cash Payments include: 

   







Cash Purchase Payment to Creditors Payment of Wages Payments relate to Production Expenses Payments relate to Office and Administrative Expenses Payments relate to Selling and Distribution Expenses Any other payments relate to Revenue and Capital Expenditure Income Tax Payable, Dividend Payable etc.

1-59

Advantages of Cash Budget 

The use of a cash budget enables a business to: 



 

Identify any possible bank overdraft in advance and take steps to minimize the borrowing (so saving interest payable) Consider rescheduling payments to avoid bank borrowing, e.g. delay purchase of fixed assets, agreement to pay rises, payment of drawings/dividends Arrange any possible bank finance well in advance Identify any possible cash surpluses in advance and take steps to invest the surplus on a short-term basis (so earning interest)

1-60

Illustration: Cash Budget From the following information prepare a CASH BUDGET for four months ending April 2011:- Cash balance on 1st January, 2011 is Rs. 3,000  Estimated Costs: Direct Material @ Rs. 3 per unit  Direct Labour @ Rs. 3 per unit  Factory and Administration on cost Rs. 3,600 per month  Advertisement on cost Rs. 3,000 paid in February, 2011 and paid Rs. 600 in each subsequent month thereafter.  Selling and distribution expenses Rs. 4,500 will be paid in each month from February. Estimated Sales January February March April Units 900 1,350 1,800 1,800 Selling Price @ Rs. 10 per unit  Following are the terms of Purchases and sales: Materials will be purchased on one month’s credit.  20% of sales will be treated as cash & balance will be collected after one month.  All oncosts will be paid within the month which these are incurred.

1-61

Cash Budget (for the months January to April 2011) Particulars

Opening Balance

January (in Rs.) February (in Rs.) March (in Rs.) April (in Rs.)

3,000

-1,500

-9,450

-13,200

1,800

2,700

3,600

3,600

-----

7,200

10,800

14,400

4,800

8,400

4,950

4,800

-----

2,700

4,050

5,400

Direct Labour (Current month)

2,700

4,050

5,400

5,400

Factory and Administrative Expenses (Current month’s)

3,600

3,600

3,600

3,600

Advertisement on cost

-----

3,000

600

600

Selling & Distribution on cost

-----

4,500

4,500

4,500

6,300

17,850

18,150

19,500

-1,500

-9,450

-13,200

-14,700

RECEIPTS: Cash Sales(20% of Sales) Cash from Debtors(80% of previous month sales) Total Cash Receipts(=A) PAYMENTS: Material (Previous month’s purchase)

Cash Payment(=B)

Closing Balance(=A-B)

1-62

4(b). Capital Expenditure Budget 





Capital budget is prepared to estimate the capital expenditure required to purchase or to acquired fixed assets for fulfilling the production targets as fixed by the production budget. Capital budget shows estimated costs required for acquisition of capital assets. Following points should be specially cared for while preparing this budget: Replacement of present assets;  Existing production capacity and impact of the probable improvements on the production capacity;  Purchase of additional asset to fulfill the production targets;  Purchase of additional assets for starting a new production;  Purchase of high efficiency machine to lower down the cost of production.

RESPONSIBILITY ACCOUNTING

1-64

Concept of Responsibility Accounting 

Responsibility accounting is an underlying concept of accounting performance measurement systems.



Responsibility accounting can be used at every level of management that fulfils the following conditions: 

Costs and revenues can be directly associated with the specific level of management responsibility.



The costs and revenues are controllable at the level of responsibility with which they are associated.



Budget data can be developed for evaluating the manager's effectiveness in controlling the costs and revenues.

1-65

Contd….. 

Responsibility accounting is an information reporting system that: 1.

2.



Classifies financial data according to area of responsibility in an organization, and Reports each area's activities by including only the revenue and cost categories that the assigned manager can control.

Responsibility accounting focuses on the reporting and not the recording of the operating cost and revenue data

1-66

Definition of Responsibility Accounting 

According to CIMA, London, "Responsibility accounting is a system of Management Accounting under which accountability is established according to the responsibility delegated to various levels of management and management information and reporting system instituted to give adequate feedback in terms of the delegated responsibility. Under this system division of units of an organization under specified authority in a person are developed as a responsibility centre and evaluated individually for their performance.”

1-67

Definition contd…. Schaltake and Jonson, state that “Responsibility accounting is a system of accounting in which costs and revenues are accumulated and reported to managers on the basis of the manager's control over these costs and revenues. The managerial accounting system that ties budgeting and performance reporting to a decentralized organization is called responsibility accounting."



1-68

Definition contd…. According to Charles T. Horongrent, “Responsibility Accounting is a system that recognizes various decision or responsibility centers throughout the organization and traces costs (and revenue, assets and liabilities) to the individual managers who are primarily responsibility for making decisions about the costs in question 

1-69

Features of Responsibility Accounting 



 



   



Information are used for both output and input resources based on financial information. Information of both Planned and Actual Performance are used Identification of Responsibility Centres Relationship between Organization Structure and Responsibility Accounting System Assigning Costs to Individuals and limiting their Efforts to Controllable Costs Transfer Pricing Policy Performance Reporting Participative Management Management by Exception Human Aspect of Responsibility Accounting

1-70

Significance of Responsibility Accounting 

Easy Identification: It enables the identification of individual managers responsible for satisfactory or unsatisfactory performance.



Motivational Benefits: If a system of responsibility accounting is implemented, consider-able motivational benefits are assured.



Data Availability: A mechanism for presenting performance data is provided. A framework of managerial performance appraisal system can be established on that basis, besides motivating managers to act in the best interests of the enterprise.

1-71

Contd….. 

Ready-hand Information: Relevant and up to the minutes information is made available which can be used to estimate future costs and or revenues and to fix up standards for departmental budgets.



Planning and Decision Making: Responsibility accounting helps not only in control but in planning and decision making too.



Delegation and Control: The twin objectives of management are delegating responsibility while retaining control are achieved by adoption of responsibility accounting system.

1-72

Objectives of Responsibility Accounting 





Determination of Contribution of a Division: To determine the contribution that a division as a subunit makes to the total organization. Evaluation of Quality of performance: To provide a basis for evaluating the quality of the divisional managers performance. Responsibility accounting is used to measure the performance of managers and it therefore, influence the way the managers behave. Motivation consistent with Organization goals: To motivate the divisional manager to operate his division in a manner consistent with the basic goals of the organization as a whole.

1-73

Advantages of Responsibility Accounting 



  

It provides a way to manage an organization that would otherwise be immanageable. Assigning responsibility to lower level managers allows higher level managers to pursue other activities such as long-term planning and policy making. It also provides a controlling technique. Motivation to lower level workers. Information flows vertically rather then horizontally.

1-74

Contd…. 







It emphasizes the budgeting for comparison of actual performance to the budgeted figures. It provides the prompt reporting of performance of executives at various levels of management. It reduces the gap between the higher level managers and lower level managers. It assists in management by exception and enhances managerial capabilities.

1-75

Disadvantages of Responsibility Accounting 







Responsibility Accounting is a costly system due to the proper learning support system. An effective communication system is require to maintain the Responsibility Accounting. The responsibility center may act in the best interest of its own, rather than corporate interest. The management has to bring to the co-ordination between different segments of the enterprise. A basic requisite for efficient responsibility accounting system is practically a difficult process.

1-76

Responsibility Centres 





Responsibility centres is a personalised group of control. A responsibility center is an organization unit that is headed by a manager who is responsible for its activities and results.

According to Robert N. Anthony, “ A responsibility centre is simply an organization unit headed by a responsible person. In Responsibility Accounting revenues and costs information are collected and reported by responsibility centers.

1-77

What is a Responsible Centre??? In simple words: an organizational unit for which a manager is made responsible. Examples:  A specific store in a chain of grocery stores.  A work-station in a production line manufacturing automobile batteries.  The payroll data processing center within a firm. 

1-78

Types of Responsibility Centres 

The following are the main responsibility centres according to the management control system: 1.

2. 3. 4.

Cost Centers or Expense Centers Revenue Centers Profit Centers and Investment Centers

1-79

1. Cost or Expense Centres 







A cost or expense centre is a segment and division of an organization in which the managers are held responsible for the cost incurred in that segment. They may not be responsible for revenue. The expense centre managers have control over some or all of the costs in their segment of business but not over revenues. In a manufacturing organization, the production and service departments are classified as expense centres. In a marketing department, a sales region or a single sales representative may be taken as expense centre. The expense centre managers are responsible for the costs that are controllable by them and their subordinates.

1-80

Cost or Expense Centres contd…  1.

2.

There are two general type of expense centres: Engineered Expense centers: Engineered cost are those elements of costs which can be predicted with fair degree of accuracy e.g. cost of raw material, direct labour, water and electricity etc.

Discretionary Expense centers: They (also called managed costs), are costs for which output can't be measured in monetary terms, e.g. are administrative and support units like accounts department, legal department, public relations department, research and development department, most of the marketing activities etc.

1-81

2. Revenue Centres 





Revenue centre is a segment of the organization which is primarily responsible for generating sales revenue. The revenue centre manager has control over expenses of the marketing department but he has no control over cost, or the investment in assets. The performance of revenue centre manager is evaluated by comparing actual revenues with the budgeted revenue and actual marketing expenses with budgeted marketing expenses.

1-82

3. Profit Centres 





Profit Centre is a segment of business often called a division that is responsible both for revenue and expenses. The main purpose of profit centre is to earn the targeted profit. In fact, the profit centre managers are more concerned with finding ways to increase centre‘s revenue by increasing production or improving distribution methods. The performance of the profit centre is evaluated in term of whether the centre has achieved its budgeted or target profit or not.

1-83

4. Investment Centres 







When a manager is responsible for costs and revenues as well as for the investment in assets, it is called an investment centre. In an investment centre, the performance is measures not by profits alone, but is related to investments effected. The manager of an investment centre is always interested to earn a satisfactory return. The return on investment is usually referred to as ROI, serves as the criterion for the performance evaluation of the manager of an investment centre. Investment centres may be considered as separate entities where the managers are entrusted with the overall responsibilities of inputs, outputs and investment.

1-84

Various Centres and their Performance Evaluation Type of Centre

Objectives

Cost Centre: Incurred cost but Minimize Cost does not directly generate revenues Revenue Centre: Primarily responsible Maximize sales for generating sales revenue

Basis for Evaluation Ability to Control Cost

Ability to generate sales

Performance Report

Reports compare actual controllable costs with flexible budgeted data Reports compare actual revenues with budgeted revenue

Profit Centre: Reports shows Incurred cost and Maximize Profit Profitability of centre budgeted and actual generate revenues controllable revenues and costs Investment Centre: Incurred cost, generate revenues Maximize return Profitability of centre return on and has control over on investment and investment (ROI) investment funds

Reports shows budgeted and actual controllable revenue and expenses and budgeted and actual return on investment

1-85

THANK YOU