BUDGETING AND BUDGETORY CONTROL

A budget is a quantitative expression of money inflows and outflows to determine

whether a financial plan will meet organisational objectives. A budget may also be
defined as a set of projected or planned financial statements.
The basic elements of a budget are;
(i)
It is a comprehensive and coordinated plan.
(ii)
It is expressed in financial terms
(iii) It is a plan for the firms operations and resources
(iv)
It is a future plan for a specific period.
A budget consists of a proforma income statement, a proforma balance sheet and a cash
budget. It is a tool used for planning and control. At the beginning of the period, the
budget is a plan or a standard; at the end of the period it serves as a control device to help
management measure its performance against the plan so that future performance may be
improved.
Budgeting is the process of preparing budgets. Budgets are prepared for specific time
periods to allow managers to compare actual results for the period with planned results.
Difference between actual results and the budget plans are called variances. Variances
provide a signal that operations did not go as planned. Variances are a part of a larger
control system for monitoring results.
Budgets are prepared for various segments of the enterprise, but they are components of
the total budget known as a master budget. The budget for a segment or department has
no much significance unless it is a part of the master budget for the entire enterprise. The
master budget is prepared after coordinating budgets for various segment s of the
enterprise. If budgets for various segments of the enterprise are not prepared jointly and
in harmony with each other, the master budget will lose much of its importance and may
even prove to be harmful in realizing the firms expectations. The major purpose of
budgets or budgeting is:
1. The state the firms expectations (goals), in clear and formal terms to avoid confusion
and to facilitate their attainability.
2. To communicate expectation to all concerned with the management of the firm so
that they are understood, supported and implemented.
3. To provide a detailed plan of action for reducing uncertainty and for the proper
direction of individuals and group effort to achieve organizational goals.
4. To provide a means of measuring and controlling the performance of individuals and
units and to supply information on the basis of which the necessary actin can be
taken.

Essentials of budgeting:
1. Top management should support budgets;
A Company will be able to implement the budget plans proficiently and effectively if
the top management has a positive attitude towards budgeting and gives direction for
budget implementation. The management should not only have a positive attitude
towards budgeting but should also devote necessary time and resources to the

preparation and implementation of budgets. Top management has the responsibility of

coordinating budgets of different departments and approving them finally.
2. A budget should have releasable goals
Budgeting will not succeed if the goals to be attained are not clear and realizable.
In the absence of clear goals, employees will lack a proper direction and the efforts
of management will be wasted. Budget goals should not be too high or too low.
Very high level goals are impossible to attain and as a result, have a depressing
effect on the employees morale. Goals set at a very low level do not provide
challenges to employees.
3. Assignment of authority and responsibility:
A sound organizational structure and a clear-cut assignment of authorities and
responsibilities provide and effective means to achieve the enterprise objectives
and budget goals in a coordinated and effective manner. The budgetary system
should be established in terms of the assigned authority and responsibility. The
performance of each manager should be evaluated in terms of the assigned
authority and responsibility. In the absence of a clear-cut assignment of authority
and responsibility either managers cannot be held accountable for those activities
for which they have no responsibility.
4. Creation of responsibility centers
A responsibility center is a sub-unit of an organization under the control of a
manager who has the responsibility for the activities of that responsibility center.
The responsibility Center can be a big unit, such as a production department or a
small unit, such as a cash section of an accounting department or a machine in the
production department. Responsibility centers for planning and control purposes.
5. Adoption of accounting system:
The accounting system catering only to the needs of external users is not adequate
for the purpose of profit planning and control and internal management. Budgeting
is based on the data generated by the accounting system. Control of performance
involves the comparison of actual performance (results) with the planned
performance. Therefore, an accounting system should be suitable adopted to
facilitate the planing and control process This accounting system should be
structured around the area of responsibility i.e. responsibility accounting system.
6. Participation of managers and their subordinates:
The participation of managers and their subordinates at all levels should be
encouraged in developing the budget goals and targets makes them strive to see
that the budgeting process succeed. Participation tends to increase commitment;
and commitment heightens motivation.
7. Effective communication :
A sound budgeting system requires effective communication of enterprise
objectives and budget goals.
8. Flexibility:
The budgeting system should be flexible enough to take advantage of all
opportunities that arise from time to time and are not covered by the budget.

The various budgets of a business:

Functional budget:
A functional budget is a budget that relates to any of the functions of an undertaking e.g.
Sales, production, research and development, cash etc. The following are functional
budgets:
(i)
(ii)

(iii)
(iv)
(v)
(vi)

Sales budget (including selling and distribution cost budgets )

Production budgets which consists of ;
(a) Raw material budget
(b) Labour budget
(c) Plant utilisation budget
Administration cost budget
Capital expenditure budget
Research and development cost budget
Cash budget.

Sales budget:
Sales being the principal budget factor, a sales budget is the most important budget and
forms the basis on which all other budgets are built up. This budget is a forecast of
quantities and values of sales to be achieved in a budget period. Every effort should be
made to ensure that its figures are as accurate as possible because this is usually the
starting budget (sales being the limiting factor on which all the other budgets are built up)
The following Factors should considered when preparing a sales budget;
(i)
Past sales figures and trends in addition to past sales, factors affecting future sales
should also be considered e.g. seasonal fluctuations, growth of market, trade
cycles e.t.c.
(ii)
Salesmens estimates
(iii) Plant capacity
(iv)
Availability of raw material and other supplies
(v)
General trade prospects
(vi)
Order in hand
(vii) Seasonal fluctuations
(viii) Financial aspects
(ix)
Competition
Production budget:
It is a forecast of the total output of the whole organisation broken down into estimates of
out put of each type of product with a scheduling of operations (by weeks and months)
To be performed and a forecast of the closing finished stock. This budget may be
expressed in quantitative (units) or financial (shillings) units or both. This budget is
prepared after taking into consideration the estimated opening stock, the estimated sales
and the desired closing finished goods stock. Factors to be considered in preparing
production budgets are:
(i)
The time lag between the products in the factory and sales to the customer

(ii)
(iii)

Stock of goods to be maintained both at factorys go down and the sales centre
The level of production needed to meet the sales programme.

The sales and production budgets are inter-dependent because production budget is
governed by the sales budget and the sales budget is largely determined by the production
capacity and by production cost.

Capital expenditure cost budget:

The capital expenditure budget gives an estimate of the amount of capital that may be
needed for acquiring the fixed assets required for fulfilling production requirements as
specified in the production budget. The budget is prepared after taking into consideration
the available production capacities, probable reallocation of the existing assets and
possible improvement in production techniques.
Separate budgets may be prepared for different items of fixed assets such as plant and
equipment budget, building budget e.t.c. The expenditure budget is an important budget
providing for the acquisition of assets necessitated by the following factors;
(i)
Replacement of existing assets
(ii)
Purchase of additional assets to meet a proposed increase in production due to
increase in demand.
(iii) Purchase of additional assets because of starting up of new lines of production.
(iv)
Installations of an improved type of machinery so as to reduce cost of production.
Capital expenditure budgets therefore, enables one to know what new assets are needed
and what will be their costs and rates of return.

Administration expenses budgets:

This budget covers the expenses incurred in framing policies, directing the organisation
and controlling the business operations. In other words the budget provides an estimate of
the central office and of management salaries. The budget can be prepared for each
administration department so that responsibility for increasing such expenses may be
fixed and related to the different executives. Much difficulty is not experienced in
developing such budgets as most of the administration expenses are of fixed nature.

Master budget:
A master budget is a consolidated summary of the various functional budgets. It has been
defined by Roland and William as a summary of the budget schedule in capsule form
made for the purpose of presenting, in one report, the highlights of the budget forecast.
The institutes of cost and management accountants England define a master budget as
the summary budget incorporating its component functional budgets and which is finally
approved, adopted and employed.
The master budget is prepared by the budget committee on the basis of co-ordinated
functional budgets and because the target for the company during the budget period when
it is finally approved, by the committee. This budget summarises functional budgets to

produce a budgeted profit and loss account and a budgeted balance sheet as at the end of
the budget period.
Advantages of a master budget:
(i)
It gives a summary of all functional budgets.
(ii)
It checks the accuracy of all functional budgets.
(iii) It gives an overall estimated profit position of the organisation for the budget
period.
(iv)
It also gives information relating to forecast balance sheet.

Limitations of budgetary control:

Budgetary control as a management control device suffers from the following limitations:
(i)
It may be impossible at times to achieve the budgeted targets since estimated or
forecast relating to the future made in the budget can never be perfectly accurate
for the simple reason that the future is unpredictable.
(ii)
In rapid changing conditions, budgets may have to be revised from time to time
and frequent revisions of budgets may prove to be a costly affair.
(iii) Budgets may serve as constraints on managerial initiative because every executive
tries to achieve the budgeted targets. It tends to bring about rigidity in control.
(iv)
Correlation and co-ordination of various budgets is expensive and hence small
organisations may not afford the employment of budgetary control as a cost
control technique.
(v)
Budgetary control may lead to conflicts among functional executives because
every executive may try to get a larger share of budgetary allocation, shy
responsibility and blame others for failures.

Advantages of budgets:
(i)
They make managers to think through plans in detail in order to prepare a budget.
This serves to formalise the planning process.
(ii)
Preparing budgets encourages managers to be forward thinking.
(iii) Potential short-term problems are identified before they arise.
(iv)
Budgets encourage managers to exercise self-control.
(v)
By quantifying targets, budgets clarify the basis for comparison when appraising
future performance.
(vi)
Budgets are a useful way of co-ordinating and linking the operations in different
parts of a business e.g. sales budget cannot be made independently from
production budgets.
Question 1
(a)

K.S.M.S. is planning to incorporate a company to be known as Biashara Ltd. for

the distribution of monetary literature, which is locally printed or recorded. The
school intends to contribute an initial capital of sh. 450,000 in cash. After
approaching its bank manager for financial assistance, the institution was asked to

submit projected statement of the profits and cash flows of the business for the
next four months commencing 1st July 2001. After careful analysis, K.S.M.S. has
gathered the following information relating to the business operations for the six
months to December 31st 2001:
(i)
At the beginning of July operating furniture and equipment will be
acquired for cash at a total cost of sh. 880,000. In addition, stocks costing
sh 500,000 will be acquired out of which half will be paid for in cash, and
the balance in the following month.
(ii)
Stock levels will be maintained at a level that is sufficient to satisfy sales
for the next month. The company intends to earn a gross profit margin of
50% on sales. Credit from suppliers requires payment after one month
from the date of purchase.
(iii) Sales are expected to average sh. 600,000 per month for the next year. It is
expected that 75%of customers will pay in cash and 25% will take credit.
All credit sales are due within 30 days.
(iv)
The following monthly expenses will be incurred :
Rent sh.100, 000; salaries sh.60, 000; miscellaneous expenses sh.25,000;
depreciation sh.30, 000.
All expenses will be paid in the month in which they are incurred except
for rent, which is payable quarterly in advance.
(v)
The proprietor expects to withdraw sh. 50,000 from the business every
month for personal use.
Required:
Prepare a cash budget for each of the months of July, August, September and
October 2001 for K.S.M.S. The budget should be in columnar form and all
supporting workings should be shown.
(10 marks)
(b)

Discuss the importance of budgeting and budgetary control to a business

organisation like a bank.
(10 marks)