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 i.e.
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

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) Planning:- A budget is plan of action. Budgeting ensures a
detailed plan of action for a business over a period of time.
(2) Co-ordination:- Budgetary control co-ordinates the various
activities of the entity or organization and secure co-
operation of all concerned towards the common goal.
(3) Control:- Control is necessary to ensure that plans and
objectives are being achieved. No control performance is
possible without predetermined standards. Thus, budgetary
control makes control possible by continuous measures
against predetermined targets.
(4) 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. Budgeting facilitates planning of various activities
and ensures that the working of the organization is
systematic and smooth.
2. Budgeting is a coordinated exercise and hence
combines the ideas of different levels of
management in preparation of the same.
3. Any budget cannot be prepared in isolation and
therefore coordination among various departments
is facilitated automatically.
4. 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. 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.
6. It guides the management in taking decision regarding
the operations which needs control and not to be
controlled.
7. As the resources are directed to the most productive
use, budgeting helps in reducing the wastages and
losses.
8. It guides management in research and development.
9. 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. Support of top management is necessary in order to get the
full support and co-operation of the system of budgetary
control.
8. To make budgetary control successful, there should be a
proper delegation of authority and responsibility.
9. Adequate accounting system is essential to make the
budgeting successful.
10. The employees should be properly educated about the
benefits of budgeting system.
11. Key factor or limiting factor, if any, should consider before
preparation of budget.
12. 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
Long-
term
Budget
Short-
term
Budget
Current
Budget
On the basis of
Function
Functional
Budget
Master
Budget
On the basis of
Capacity
Fixed
Budget
Flexible
Budget
1-26
Classification on the basis of Time



1. 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.

On the basis of Time
Long-term Budget Short-term Budget Current Budget
1-27
Contd.
2. 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.

3. 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



1. 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.
On the basis of Capacity
Fixed Budget Flexible Budget
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.

1-30
Points to be remembered while preparing
Flexible Budget
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
to remain unchanged
irrespective of the level
of activity actually
attained.
It is a Budget, which by
recognizing the difference
between fixed, semivariable
and variable costs is designed
to change in relation to level
of activity attained.
Rigidity
It does not change with
actual volume of activity
achieved. Thus it is
known as a Rigid or
Inflexible budget.
It can be re-casted on the
basis of activity level to be
achieved. Thus it is not rigid.
1-32
Fixed Budget Flexible Budget
Level of
Activity
It operates on one level of
activity and under one set of
conditions. It assumes that
there will be no change in
the prevailing conditions,
which is unrealistic.
It consists of various
budgets for different levels
of activity
Effect of
Variance
Analysis
Variance Analysis does not
give useful information as all
Costs (fixed, variable and
semivariable) re related to
only one level of activity.
Variance Analysis provides
useful information as each
cost is analysed according
to its behaviour.
1-33
Fixed Budget Flexible Budget
Use for
Decision
Making
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
Evaluation
Comparison of actual
performance with budgeted
targets will be meaningless,
especially when there is a
difference between two
activity levels.
It provides a meaningful
basis of comparison of
the actual performance
with the budgeted
targets.
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
40% Capacity
Utilization
50% Capacity
Utilization
90% Capacity
Utilization
Production - Units 10, 000 12, 500 22, 500
Selling Price Per Unit Rs.20 Rs.19.40 Rs.19
Sales Value [units X selling
price per unit] Rs.2, 00,000 Rs.2, 42, 500 Rs.4, 27, 500
Variable Costs:
Material Rs.10 per unit Rs.1, 00,000 Rs.1, 21, 500 * Rs.2, 13, 750 **
Labor Rs.3 per unit Rs.30, 000 Rs.37, 500 Rs.67, 500
Overheads Rs.2 per unit Rs.20, 000 Rs.25, 000 Rs.45, 000
Total Variable Costs Rs.1, 50, 000 Rs.1, 84, 000 Rs.3, 26, 250
Fixed Costs Rs.30, 000 Rs.30, 000 Rs.30, 000
Total Costs
[Variable Cost + Fixed Cost] Rs.1, 80, 000 Rs.2, 14, 000 Rs.3, 56, 250
Profit/Loss
[Sales Total Costs] 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



1. 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.
Classification on the basis of Function
On the basis of Function
Master Budget
Functional or Subsidiary
Budget
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
Cost
Budget
Production
Cost Budget
Material
Budget
Labour
Budget
Overhead
Budget
Administrative
Cost Budget
Selling &
Distribution
Cost Budget
Research &
Development
Cost Budget
Finance
Budget
Cash 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.
1-40
Factors taken into consideration while
preparing Sales Budget
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 31
st
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 31
st
December 2011.
1-42
Sales Budget for the year 2011
Divisions
Product X Product Y
Total
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
Solution
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.

1-44
Factors taken into consideration while
preparing Production Budget
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 2010-
2011 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
Production Budget for the year 2010-11
Particulars
Product X
(in Rs.)
Product
Y (in Rs.)
Total
Amount
(Rs.)
Sales Requirements 41,000 30,000 71,000
Add: Closing stock forecast 15,000 13,000 28,000
Total 56,000 43,000 99,000
Less: Opening stock forecast 8,500 5,000 13,500
Net Production Requirement 47,500 38,000 85,500
Add: Normal Loss
(being 5% of Total)**
2,500 2,000 4,500
Total Production 50,000 40,000 90,000
Solution
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)
1-49
Factors taken into consideration while
preparing Material Budget
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. Salesmans 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 1
st
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 months 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 January (in Rs.) February (in Rs.) March (in Rs.) April (in Rs.)
Opening Balance 3,000 -1,500 -9,450 -13,200
RECEIPTS:
Cash Sales(20% of Sales) 1,800 2,700 3,600 3,600
Cash from Debtors(80% of
previous month sales)
----- 7,200 10,800 14,400
Total Cash Receipts(=A) 4,800 8,400 4,950 4,800
PAYMENTS:
Material (Previous months
purchase)
----- 2,700 4,050 5,400
Direct Labour (Current month) 2,700 4,050 5,400 5,400
Factory and Administrative
Expenses (Current months)
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
Cash Payment(=B) 6,300 17,850 18,150 19,500
Closing Balance(=A-B) -1,500 -9,450 -13,200 -14,700
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. Classifies financial data according to area of
responsibility in an organization, and
2. 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 I dentification: 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 I nformation: 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 sub-
unit 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. Cost Centers or Expense Centers
2. Revenue Centers
3. Profit Centers and
4. 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
There are two general type of expense centres:
1. 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.

2. 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
centres 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
Basis for
Evaluation
Performance Report
Cost Centre:
Incurred cost but
does not directly
generate revenues
Ability to Control
Cost
Minimize Cost
Reports compare
actual controllable
costs with flexible
budgeted data
Revenue Centre:
Primarily responsible
for generating sales
Ability to generate
sales
Maximize sales
revenue
Reports compare
actual revenues with
budgeted revenue
Profit Centre:
Incurred cost and
generate revenues
Profitability of centre Maximize Profit
Reports shows
budgeted and actual
controllable revenues
and costs
Investment Centre:
Incurred cost,
generate revenues
and has control over
investment funds
Maximize return
on investment
Reports shows
budgeted and actual
controllable revenue
and expenses and
budgeted and actual
return on investment
Profitability of centre
and return on
investment (ROI)
1-85