MANAGEMENT ACCOUNTING (PART-6) UNIT- V BUDGETING FOR PROFIT PLANNING & CONTROL (PART-2) 1. INTRODUCTION Dear students, I welcome to you on lecture series of management accounting. Today we shall take up unit-v, Under unit-v we are going to discuss in detail about budgeting for profit planning and control. This is part- 2 of our discussion on budgeting, in our previous lecture; we have learned in detail about various concepts relating to budgetary control. Today we shall take up in detail the rest of the part of budgetary control. The objective of this lecture is to understand all the advantages and disadvantages being associated with the tool of management accounting. Which is known as budgetary control? So we have to learn critically, what s the advantages of going for the budgetary control, then we shall learn in detail about the classification on the budgets or on the basis of various parameters being set. So that we can analyse that how master budget is going to be presented and how it is being consolidated to give up broader picture of budgeted profit or loss and budgeted balance sheet. So we shall start up our discussion and first of all we will critically analyse the budgetary control. For the purpose of doing the critical analyse; we shall discuss the advantages and disadvantages being associated with budgetary control. 2. ADVANTAGES OF BUDGETARY CONTROL So let us take up advantages of budgetary control first. First one is the maximization of the profit. Obviously when budgets are being set up on the basis of the budgetary committee recommendation and working with the heads of the specific departments. We can be able to access the cost associated and can enhance the profits by controlling cost which is being set out in our budgets. 1
Secondly effective coordination, since we know that they are various department on the basis of functionality, budgets are being prepared by the budget committee and effective actions are being taken there on. So a coordination is being required with the different department so that we can adere to the needs of those departments and can frame up the budget, which will help in the boosting up the profits and controlling the cost. Thirdly evaluation of the effective performance, now it is being based on the basis of goals set for each department. Once the goals are being set and objectives are being laid down under the budgets so framed for each functional aspect of different departments being set up in the organisation. It becomes very easy to evaluate the performances associated with each department. For example: there is a production department, under production department; once the goals are being set up that the cost associated with the production should go the way in which budget is being set. So here what we are going to do that we are improving the operational efficiency. We are improving the operational efficiency. We are evaluating the performance of production. Similarly when we go for the sales budgets, what we are doing is that we are controlling the sales that means demands stimulation can be worked upon profits can be enhanced. Then fourth is the clear cut goals and targets. Since budgets are based on a objective basis. So clear cut goals and targets would be set for each department and a consolidated goal and budget of the company can be set up under the master plan so that the target profit and target P&L a/c can be set up. Fifth is the economy in operation. By economy in operation means the synergy being generated when the consolidated data is being prepared. When there is the coordination between different departments obviously economy in operation can be achieved. Once the target is being set by for sales department obviously cost of production will be based on it. So in this way what happens that synergy is being attained or the economy in operation can be achieved. Since we are working on economy efficiency, so obviously it will again enhance our profit. So these are the very important parameters to set out under budgetary controls. 7 th one is the introduction of incentive scheme of remuneration, which can be set up when a labour budget is being set up where the labour cost is being controlled and incentive can be taken up under those budgets. 2
Shutting down of unprofitable products and activities. Where budgets are being specified and we are able to ascertain or predict the future profits and this is to be used for future reference. Once planning is being done, again under the planning aspect only on the basis of feedback so said. We can shut down the unprofitable products and activities and overall the products for activities which are more on profit generation, they can be given the priority so these are the advantages of the budgetary control. Now having analysed one aspect of the picture that means the advantages is being associated to use to control the cost that means tools of management accounting which is known as budgetary control when it is being used for the benefit of the organisation as a whole. Let us find out what are the limitation being associated for using this tool or technique of management accounting. So these are its limitation. First one is prediction of uncertain future. Since budgets are being prepared in advance for the future and they are being prepared in the quantitative terms for a budgeted period. So the most important or basic limitations associated with the budgetary control is the prediction aspect. Since they are the forecasted data and future is so uncertain. We cannot precisly the predict, what has been done should be achieved in the near future. Second is the changes in the condition, by changes in condition we mean that where there is a change in the political scenario or external policy, same changes need to be imbibed in the budget so drafted so the external as well as the internal factors are going to impact the budgeted condition so said, so basic budget is going to be deviated from the actual performances. So we need to again upgrade the budget, so changes and uncertainty associated with futures are going to impact the budgeted control we have set up. Thirdly difficulty in coordination in a large organisation where there are large number of department it s very difficult to precisely coordinate the needs of all the departments being associated. So what if there is a improper prediction of the sales targets. It s going to impact the production and production budget in turn will give us distorted figures. So most important feature is coordination and where there is lack of management control over the various departments the problems associated with coordination may impact the budgetary control. The last one is conflict among different department where there are man forces and man power associated there is obviously chances of the conflict among them. And the same problem or conflict or the limitation is being associated with the budgetary control. so these are the limitation, which are going to impact the use of budgetary control in the management for controlling the cost and enhancing the profits. 3
3. PREPARATION OF BUDGETS Now let s move ahead and take up the another aspect, there is preparation of the budgets. Under preparation of the budget; first of all we need to determine the key factors. Now what are these key factors? Key factors are the limiting factors. For example: if the material budget is to be presented, what happens that if there is scarcity of the material the units or cages required for the material will become the key factor. In the case of labour budgets so prepared if the important labour or the man force which is necessary for any particular assignment is in scarcity. So for that particular assignment the man power or skilled labour may become the key factor. So we need to determine the key factor first analysing the requirement of our budget. Secondary making forecast. Forecast is to made by taking into consideration in present and the past data s and making them adjusted according to our needs. Thirdly evaluation of alternative combination of factors. Here we are going to take up alternative combination and work upon it. So that the proper alternative can be chosen upon. Fourthly preparation of various financial budgets. Now financial budgets are to be prepared so that we can get to know the liquidity position. Fifth one is the most important factor that is preparation of cash budgets and master budget. The cash budget on one hand will show us the liquidity position as well as the requirement of the cash for a particular project. Similarly the master budget is the consolidated data of all the functional budgets. Which is going to present the targeted profit for the company as a whole and lastly we will prepare the master budgets, by consolidating the budget of each department. So that overall picture can be cleared to us. So these are the steps to be followed when we go for the preparation of budget under budgetary control. 4. CLASSIFICATION OF BUDGETS Now the next important aspect to be discussed is the classification of budget. Under classification of budget, we will take up various bases and on those bases, we are going to do the classification of budget in order to know. 4
What budget is to be used and what is the function of each budget. The first one is the budget which is based on scope. Scope shows the working area that what budget we need to prepare and what is extend of preparing that budget. Secondly based on efficiency. Efficiency here denotes the fixed and flexibility criteria of making the budgets based on conditions that whether the conditions are same or they are going to change again on the basis of the condition is being stipulated. we are going to prepare the budget? And lastly based on period, on the basis of period obviously the period can be either long term or short term. So accordingly we are going to prepare the budgets and can set out the standards. So first one which we have discussed is based on scope. When budgets are being based on scope, we can prepare two sort off budgets either functional budgets or the master budgets. When we move ahead, we will learn what is falling under functional budget and what s the significance of master budgets. Based on efficiency, efficiency here denotes the mode of working or flexibility in the organisation. So here also we are going to prepare two short of budgets; fixed budget and flexible budgets. Thirdly based on conditions, on the basis of condition we have already discussed that the conditions are not going to remains same for prolong rated period. So again we are going to make two sort of budgets on the basis of conditions. The first one is the basic budget which remains almost same and another is the current budget. Which takes into consideration the changes taking place and how they are to be implemented in the budget? So on the basis of the conditions again we have this two classifications. Moving ahead we have the budgets based on period. So period can be short term or long term. Similarly the budget so prepared for this period can be short term budgets and long term budgets. So depending upon the organisation for which the budget is being prepared the budgets can be classified on the basis of the short term and long term periods set for those organisation for which the budget is being prepared. So this is aspect where where we are going to discuss the further or another step ahead in the classification. We said that on the basis of scope, we divide the budgets as functional budgets and master budgets. So again under functional budgets, let us understand what is the classification criteria or how many principle functional budget can be set in a organisation. The first one is the sales budgets, secondly production budgets, thirdly overhead budgets then financial budgets and R&D here means research and development budgets. 5
So these are the primary or the principle functional budgets, which we need to prepare under the functional budgets. Let us learn about them one by one. So first of all on the basis of period, we are going to discuss about the long term and short term budgets. So long term budgets are those budgets, which are being prepared by top management to reflect long term planning for special activities like capital expenditure and research and development etc. So where the top management is going to prepare the budget for long term planning obviously these budgets would be associated with the period which extend to a longer period of time and it will be more than one year and it may vary from three to five year. For example; there is a capital expenditure, so where capital expenditure is to be taken up by the organisation or it cannot be at one time exercise that means if a company is going for a construction of a building. It may go as long as five years. So a long term budget is to be set for such construction to be undertaken and cost criteria s are to be determined. Secondly short term budgets, budgets generally a duration of one year and expressed in monetary terms are known as short term budgets. They are being prepared for a duration of either one year or it can be lesser than that and generally what happens that where the long term budgets are being framed in order to facilitate the long term budgets. Secondary or helping the short term budgets are also being framed so that better control of the cost can be done. Now on the basis of condition, we have already said that there can be two sort of budgets; the current budgets and basic budgets. Let us understand first the current budgets, its duration can be one month and are prepared for current operation of the business. This budget is more useful than basic budgets as target it lays down will be corrected to current conditions. So the peculiar features of current budget is that it is for the current period and it can be for a month and where the changing condition can be accommodated in this budget so that the figures reflecting are the appropriate and current figures to be taken care of then next one is the basic budget. If we go for the current budgets, we can say that they are sort of the budgets, which we prepare in our MIS department. MIS department prepare the current budgets on a monthly basis furnish it to the top management. Where the current position in relation to the stocks, in relation to the cash, in relation to the investment can be taken care of? Now moving ahead to basic budgets let us understand what it represent basic budget has been defined as a budget which is prepared for use unaltered over a longer period of a time. 6
This does not take into consideration current conditions and can be attainable under standard conditions. Now when we go for a basic budgets, let us presume that there is a mall being constructed so there will be a basic budget being drafted for such mall, that the rental would be such and they will be enhanced or they will be increased at a rate fixed that means at a 10 percent, the revenues would be extended then cost criteria would also be defined over that these over these the cost will be fixed under the given scenario and the conditions stipulated would be the standard conditions which are being applicable to the industry as such so under basic budgets obviously we are not going to make any alteration and conditions would be very specific. 5. CLASSIFICATION OF BUDGETS CONTD The next classification of budget, we have learned is the budget based on efficiency and among it first one is the fixed budget. Fixed budget is one, which is desired for a specific plant output level and or not adjusted to the level of activities attained at the time comparison between the budgeted and actual cost. Fixed budget can be established only for a small period of time when the actual output is not anticipated to differ much from the budgeted output. However a fixed budget is liable to revision if due to business conditions undergoing basic change or due to other reasons. The actual operation differ widely from the plan in the fixed budget. This budgets are most suited for fixed expenses but they have only a limited application and is ineffective as a tool for cost control so under fixed budget one thing is very certain that they don t change with the change in the level of activity. They remain fixed in nature and they are suitable for the fixed expenses and limitation of fixed budget is that they are not effective tools of control. Now moving ahead to the flexible budget. A budget which by recognizing different cost behaviour pattern is designed to change as volume of output change. It is a budget prepared in manner so as to give the budgeted cost for any level of activity. It is a budget which by recognizing the difference between fixed, semivariable and variable cost is designed to change in relation to the activity attained. So we can say that under flexible budget, the budget is going to change as the level of activity changes. 7
By level of activity we mean that the production units if our level of activity was to prepare the 10,000 units, under fixed budgets the fixed expenses would remain the same. However under flexible budget if the production has enhanced from 10,000 unit to 20,000 unit the cost associated with it will change and the cost behaviour pattern has to be analysed; what are the variable expenses? The variable expenses are going to change with the level of activities. Semivariable expenses have to be segregated on a suitable basis. Fixed expenses are to be analysed that up till what level they remain fixed and what changes is to be made as and when the level of activity changes after a certain point of time. So these exercises have to be done under the flexible budgets and they are the most important budget under the budgetary control to prepare and to analyse cost at different level of activities. Now on the basis of scope we are having the master budgets. Master budget is consolidated summary of various functional budgets. A master budget is the summary budget incooperating its components functional budgets and which is finally approved adopted and employed. It consists individuality of the budget profits and loss account budgeted balance sheet and budgeted fund flow statement. It is being prepared by budget committee coordinating with the functional budget and becomes the targets of the company during the budgeted period and it is finally approved. So we can say that it s the master or consolidated summary which is being prepared by the budget committees coordinating with the functional budgets to reflect the budgeted P&L A/c and budgeted balance sheet and also budgeted fund flow statements. So it will give the entire picture of the organisation. Now the another budget which is to be prepared on the basis of the scope is the functional budget. A functional budget is the budget that is achievable and is related to the specific unit or process or function or department of the organisation. The forecast for the individual activities are prepared and coordinated with other activity in the organisation and then consolidated to show the total effect of all the activities as a whole. So we can say that approved targets for the individual function is known as functional budget and consolidated one is master budget. 8
And functional budget can be sales budget, production budget then it can be the material, labour head and overhead budgets, research and development budgets and it can be the cash budgets. So these are the different categories of functional budgets. Now students, while analysing the classification of the budgets, let us understand one very important concept under budgetary control and it is known as zero based budgeting. Zero based budgeting is concerned with all requisites of budget. It is the evaluation of existing and new proposed activity and the planning is to be done for the resources and prioritization and re deployment. That means its exercise which is to be conducted for all the budgets so said. So we start with the zero based under the zero based budgeting. Let us understand the process. The first one is the specification of decision units for which units or for decision units the zero based budgeting is to be adopted firstly specification of same is to be done. Development of decision packages, prioritization of activity project and programs and finally approval and allotment of fund is to be done under zero based budgeting. 6. SUMMARY Now student, we will end up our lecture of today. Let us summarize; what we have learned in today s lecture, under today s lecture, we have critically analysed the importance of budgetary control by evaluating its advantages and disadvantages. Then we have tried to learn the methods of preparation of budget and identifying of the key factors and preparing the budget as such. When we have learned about the classification of budget on the various parameters being given that means classification based on the scope, on the efficiency, on functionality and various parameters have been learned in detail and finally we have discussed in short about these zero based budgeting. With this we are ending up out lecture of today. Thank You! 9