Unit-2

Introduction:

 The term ‘Budget’ appears to have been derived from the French word
‘baguette’ which means ‘little bag' , or a container of documents and
accounts.

 A budget is an accounting plan. It is a formal plan of action expressed in

monetary terms. It could be seen as a statement of expected income and
expenses under certain anticipated operating conditions.

 It is a quantified plan for future activities – quantitative blue print for action.
Concept of Budget, Budgeting, and Budgetary Control

Budget:
 A budget is a financial plan that estimates revenue and expenses over a
specific period. It serves as a guideline for managing finances, ensuring
resources are allocated efficiently to achieve organizational goals. It
helps in planning, monitoring, and controlling financial activities.
 Budgeting:

Budgeting is the process of preparing a budget. It involves forecasting future

financial conditions, setting financial targets, and allocating resources. It
includes deciding how much money will be needed for various expenses and
how it will be earned or generated.
 Budgetary Control:

Budgetary control is the process by which budgets are prepared for the future
period and are compared with the actual performance for finding out variances,
if any. The comparison of budgeted figures with actual figures will help the
management to find out variances and take corrective actions without any
delay.

 The comparison of budgeted and actual figures will enable the management
to find out discrepancies and take remedial measures at a proper time. The
budgetary control is a continuous process which helps in planning and co-
ordination. It provides a method of control too. A budget is a means and
budgetary control is the end-result.
The main features of budgetary control are:

Establishment of budgets for each purpose of the business.

Revision of budget in view of changes in conditions.

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

Taking suitable remedial action, wherever necessary.

Analysis of variations of actual performance from that of the budgeted

performance to know the reasons thereof.
The organisation chart will depend upon the nature and size of the company. A specimen of the
organization chart
Classification of Budget:

 The extent of budgeting activity varies from firm to firm. In a smaller firm
there may be a sales forecast, a production budget, or a cash budget.
Larger firms generally prepare a master budget.
 Budgets can be classified into different ways from different points of
view. The following are the important basis for classification:
 Functional Classification:

SALES BUDGET: A Sales Budget is a financial plan that estimates a company's

expected revenue from the sale of goods or services over a specific period,
typically broken down by product, region, or customer segment. It is one of the
key components of the Master Budget, and it serves as the foundation for other
budgets like production, purchasing, and marketing.
Key Components of a Sales Budget:
1.Sales Forecast: Estimation of the quantity of products or services expected to be sold. This is
based on past sales data, market analysis, and other influencing factors.
2.Selling Price per Unit: The price at which the company plans to sell its goods or services during
the period.
3.Revenue Calculation: Multiplying the estimated units of sales by the selling price gives the total
expected revenue.
4.Time Period: The budget usually covers a specific period (e.g., monthly, quarterly, or annually).
5.Breakdown by Product/Region/Customer: The sales budget may be divided into categories
such as different products, geographical regions, or customer types.
Importance of a Sales Budget:
1.Resource Allocation: Helps allocate resources like marketing expenses or
production capacity based on sales projections.
2.Performance Monitoring: Provides benchmarks for performance evaluation.
3.Cash Flow Management: Helps in forecasting cash inflows for the period.
4.Decision-Making: Aids in strategic planning and decision-making, such as
entering new markets or launching new products.
PRODUCTION BUDGET: The production budget is prepared on the basis of
estimated production for budget period. Usually, the production budget is based
on the sales budget.
 At the time of preparing the budget, the production manager will consider the
physical facilities like plant, power, factory space, materials and labour, available
for the period. Production budget envisages the production program for
achieving the sales target.
 The budget may be expressed in terms of quantities or money or both.
Production may be computed as follows:
Units to be produced = Desired closing stock of finished goods + Budgeted sales –
Beginning stock of finished goods.
PRODUCTION COST BUDGET: This budget shows the estimated cost of
production. The production budget demonstrates the capacity of production.
These capacities of production are expressed in terms of cost in production cost
budget. The cost of production is shown in detail in respect of material cost,
labour cost and factory overhead.
• Thus production cost budget is based upon Production Budget, Material Cost
Budget, Labour Cost Budget and Factory overhead.
PRODUCTION OVERHEAD BUDGET:
The manufacturing overhead budget includes direct material, direct labour and indirect expenses.
The production overhead budget represents the estimate of all the production overhead i.e. fixed,
variable, semi‐variable to be incurred during the budget period.
The reality that overheads include many different types of expenses creates considerable
problems in:
1) Fixed overheads i.e., that which is to remain stable irrespective of vary in the volume of output,
2) Apportion of manufacturing overheads to products manufactured, semi variable cost i.e., those
which are partly variable and partly fixed.
3) Control of production overheads.
4) Variable overheads i.e., that which is likely to vary with the output.
The production overhead budget engages the preparation of overheads budget
for each division of the factory as it is desirableto have estimates of
manufacturing overheads prepared by those overheads to have the responsibility
for incurring them. Service departments cost are projected and allocated to the
production departments in the proportion of the services received by each
department.
RAW‐MATERIAL BUDGET:
Direct Materials budget is prepared with an intention to determine standard
material cost per unit and consequently it involves quantities to be used and the
rate per unit. This budget shows the estimated quantity of all the raw materials
and components needed for production demanded by the production budget.
Raw material serves the following purposes:
Key Components of a Raw Material Budget:
1.Units to be Produced: From the production budget, it specifies how many units of the
finished product will be produced.
2.Raw Materials per Unit: The quantity of raw materials required to produce one unit of the
finished product.
3.Desired Ending Inventory of Raw Materials: The amount of raw materials the company
aims to have in stock at the end of the period.
4.Beginning Inventory of Raw Materials: The amount of raw materials on hand at the start of
the period.
5.Cost per Unit of Raw Material: The cost of purchasing each unit of the raw material.
It supports the purchasing department in scheduling the purchases.
Requirement of raw‐materials is decided on the basis of production budget.
It provides data for raw material control.
Helps in deciding terms and conditions of purchase like credit purchase, cash
purchase, payment period etc.
It should be noted that raw material budget generally deals with only the direct
materials whereas indirect materials and supplies are included in the overhead
cost budget.
PURCHASE BUDGET:
Strategic planning of purchases offers one of the most important areas of
reduction cost in many concerns. This will consist of direct and indirect material
and services. The purchasing budget may be expressed in terms of quantity or
money.
The main purposes of this budget are:
 It designates cash requirement in respect of purchase to be made during budget
period; and
 It is facilitating the purchasing department to plan its operations in time in
respect of purchases so that long term forward contract may be organized.
LABOUR BUDGET:
 Human resources are highly expensive item in the operation of an enterprise.
Hence, like other factors of production, the management should find out in
advance personnel requirements for various jobs in the enterprise.
 This budget may be classified into labour requirement budget and labour
recruitment budget.
 The labour necessities in the various job categories such as unskilled, semi ‐skilled
and supervisory are determined with the help of all the head of the departments.
The labour employment is made keeping in view the requirement of the job and its
qualifications, the degree of skill and experience required and the rate of pay.
SELLING AND DISTRIBUTION COST BUDGET:
The Selling and Distribution Cost budget is estimating of the cost of selling, advertising, delivery
of goods to customers etc. throughout the budget period.
 This budget is closely associated to sales budget in the logic that sales forecasts significantly
influence the forecasts of these expenses. Nevertheless, all other linked information should
also be taken into consideration in the preparation of selling and distribution budget.
 The sales manager is responsible for selling and distribution cost budget. Naturally, he
prepares this budget with the help of managers of sub‐divisions of the sales department. The
preparation of this budget would be based on the analysis of the market condition by the
management, advertising policies, research programs and many other factors.
 separate advertising budget, particularly when spending on advertisements are quite high.
ADMINISTRATION COST BUDGET:
 This budget includes the administrative costs for non‐manufacturing business
activities like directors' fees, managing directors’ salaries, office lightings,
heating and air condition etc.
 Most of these expenses are fixed so they should not be too difficult to forecast.
 There are semi‐variable expenses which get affected by the expected rise or
fall in cost which should be taken into account. Generally, this budget is
prepared in the form of fixed budget.
CAPITAL‐ EXPENDITURE BUDGET:
This budget stands for the expenditure on all fixed assets for the duration of the budget period.
This budget is normally prepared for a longer period than the other functional budgets. It includes
such items as new buildings, land, machinery and intangible items like patents, etc. This budget is
designed under the observation of the accountant which is supported by the plant engineer and
other functional managers. At the time of preparation of the budget some important information
should be observed:
 Overfilling on the production facilities of certain departments as revealed by the plant
utilization budget.
 Long‐term business policy with regard to technical developments.
 Potential demand for certain products.
CASH BUDGET:
 The cash budget is a sketch of the business estimated cash inflows and outflows over a specific
period of time. Cash budget is one of the most important and one of the last to be prepared. It is a
detailed projection of cash receipts from all sources and cash payments for all purposes and the
resultants cash balance during the budget.
 It is a mechanism for controlling and coordinating the fiscal side of business to ensure solvency
and provides the basis for forecasting and financing required to cover up any deficiency in cash.
Cash budget thus plays vital role in the financing management of a business undertaken.
 Cash budget assists the management in determining the future liquidity requirements of the
firm, forecasting for business of those needs, exercising control over cash. So, cash budget thus
plays a vital role in the financial management of a business enterprise.
Function of Cash Budget:
It makes sure that enough cash is available when it is required.
It designates cash excesses and shortages so that steps may be taken in time
to invest any excess cash or to borrow funds to meet any shortages.
It shows whether capital expenditure could be financed internally.
It provides funds for standard growth.
It provides a sound basis to manage cash position.
Classification On The Basis Of Activity Levels
On the basis of activity levels or capacity, the budgets may be classified as:
(i) Fixed Budgets and (ii) Flexible Budgets.
The Institute of Cost and Management Accountants has defined fixed budget as “a
budget which is designed to remain unchanged irrespective of the level of activity
actually attained.”
The fixed budget shows an inflexible or rigid plan. There is one set of conditions,
one volume of output, and a simple collection of costs and the management
expects all conditions etc., to operate without any variation.
On the other hand, flexible budget is a budget which is designed to change in
accordance with the level of activity actually attained. The figures used in this
type of budget are made adaptable to any given set of operating conditions. The
compilation of flexible budgets requires the classification of all costs or
expenses into fixed, variable and semi-variable. Fixed costs remain fixed or
constant at all levels of activity, semi-variable costs vary with different levels of
activity while variable costs vary directly in proportion to changes in the
volume of output or sales.
(C) Classification On The Basis Of Period
On the basis of period for which they are prepared, budgets may be divided into: \
(i) Shon Term Budgets and (ii) Long Term Budgets.
A short-term budget is one which is prepared for a period of one year or less than one
year. Such budgets cover those expenses or activities, the trend in which is difficult to be
foreseen over longer periods. Cash Budget and Materials Budget are examples of short-
term budgets.
A long-term budget is that which is prepared for a period longer than a year. Long term
budgets normally help in business forecasting and future planning. Capital Expenditure
Budget and Research and Development Expenditure Budget are examples of long-term
budgets.
Master Budget:
A Master Budget is a summary of all the functional budgets. It is defined as the Summary
Budget, incorporating its components functional budgets, which is finally approved, adopted
and employed. When the Master Budget is complete, its details shall be considered by the
Budget Committee and if approved, it will be submitted to the Board of Directors.
However, once it is finally approved, it becomes the target for the organization during the
budget period. The master budget is usually prepared in the form of a Budgeted Profit
and Loss Statement. It begins with the sales budget figures, from which Production Cost
Budget figures and overheads are deducted in order to arrive at the figure of budgeted profit.
Components of Master Budget:
The master budget is a comprehensive financial plan for an organization, typically covering a fiscal
year. It consists of two main parts: the Operating Budget and the Financial Budget. Here's a bit
more detail on each component:
A. Operating Budget
This part focuses on the day-to-day operations of the business. It includes projections for revenues
and expenses related to regular operations.
1.Sales Budget: This is the starting point of the operating budget. It outlines the expected sales
revenue for a given period, broken down by product or service category. The accuracy of the sales
budget is crucial because it affects all other components of the budget.
2.Operating Expense Budget: This budget estimates the costs of running the business, such as
wages, utilities, marketing, and other overhead costs. It typically includes both fixed and variable
costs.
3.Purchases and Cost of Goods Sold (COGS) Budget: This budget tracks the cost of acquiring raw
materials (or finished goods) for production and the costs directly tied to producing or selling goods.
For a manufacturer, this would include the cost of raw materials and direct labor. For a retailer, it’s
the cost of acquiring inventory to sell.
4.Budgeted Income Statement: This is a projection of the company’s expected income (revenue)
minus its expected expenses, leading to an estimated profit or loss. It’s often referred to as the "pro
forma" income statement and helps management assess profitability for the period.
B. Financial Budget
This section focuses on cash flow and overall financial position. It supports the
operating budget by providing insight into how operational activities will impact
cash and financing needs.
1.Cash Budget: The cash budget forecasts cash inflows and outflows for a specific
period. It ensures the company has enough liquidity to meet its operational and
financial obligations. It includes estimated receipts (like sales and loans) and
payments (such as operating expenses and loan repayments).
2.Capital Budget: This budget focuses on long-term investments and capital
expenditures, such as purchasing new equipment, expanding facilities, or investing
in technology. It's important for managing the organization’s long-term growth and
ensuring adequate funding for large, one-time expenses.
3.Budgeted Balance Sheet: The budgeted balance sheet is a projection of the
company’s assets, liabilities, and equity at the end of the budgeting period. It gives
an overall picture of the company’s financial position, helping to assess whether the
company can meet its obligations and how its net worth is expected to chang
Zero-based budgeting
Zero-based budgeting (ZBB) is a method of budgeting in which all
expenses must be justified for each new period. The process of zero-
based budgeting starts from a "zero base," and every function within
an organization is analyzed for its needs and costs. Budgets are then
built around what is needed for the upcoming period, regardless of
whether each budget is higher or lower than the previous one.
In a typical budgeting process, previous budgets are used as a
reference, and only the new changes or additions need to be
explained. However, with zero-based budgeting, every item in the
budget is re-evaluated, and managers must justify each expense
based on current needs and priorities. This can help organizations
Let's say that a manufacturing company outsources the manufacturing of a major
part in a key item that they make. Each year the cost of the outsourced part
increases by 5%.
Using a zero-based budgeting process might lead the manufacturing company to
look at other alternatives for producing this key part. They might look internally
to see if the part couldn't be produced internally by the company's own
manufacturing department. A zero-based budgeting process could lead the
company to question not only the ever-increasing cost of this outsourced part, but
perhaps other costs related to the manufacturing and distribution in this key
product for the company.
Advantages of Budgeting
1. Financial Control:
•Benefit: Budgeting allows an organization to set limits on spending,
ensuring that expensāes do not exceed income or available funds.
•Example: A business sets a monthly budget for marketing at
$10,000. By tracking spending, the company can ensure it doesn't
overspend and maintains financial health.
2. Improved Planning and Decision-Making:
•Benefit: Budgeting forces companies to plan for the future by
forecasting revenues and expenses, which helps in making informed
decisions.
•Example: A company creating a budget for the next quarter
forecasts increasing demand and decides to invest in additional
production capacity.
3. Performance Monitoring:
•Benefit: Regularly comparing actual results to the budget allows
businesses to track performance and identify areas of improvement
4. Resource Allocation:
1. Benefit: A budget helps prioritize resources, ensuring that essential activities or projects receive the funding
they need.
2. Example: A nonprofit organization may allocate a larger portion of its budget to a major fundraising event
while limiting administrative costs.
5. Cost Control:
3. Benefit: Budgets help to limit unnecessary expenditures and keep the organization on track to meet
financial goals.
4. Example: A company sets strict limits on office supply purchases, ensuring that employees only buy
necessary items and avoid waste.
6. Encourages Accountability:
5. Benefit: Assigning specific budgetary targets to departments or teams encourages responsibility for
managing costs.
6. Example: Each department manager is responsible for staying within their allocated budget, leading to more
diligent oversight of departmental spending.
7. Helps in Securing Financing:
7. Benefit: A well-prepared budget provides external stakeholders, such as investors or lenders, with clear
financial projections and reassurances about how the funds will be used.
8. Example: A startup company seeking investment can present a detailed budget to potential investors to
demonstrate how their capital will be used effectively.
Limitations of Budgeting
1.Time-Consuming:
•Drawback: Creating and maintaining budgets can take significant time and resources, particularly in
large or complex organizations.
•Example: A large corporation might spend several months preparing an annual budget, which could
delay other business activities or initiatives.
2.Inflexibility:
•Drawback: Once a budget is set, it can be difficult to adjust to unforeseen changes, leading to issues
if circumstances change unexpectedly.
•Example: If a company faces an unexpected drop in sales due to a sudden market shift, a fixed
budget may not allow for quick adjustments, resulting in overspending or missed opportunities.
3.Encourages Short-Term Focus:
•Drawback: Budgeting can sometimes focus too heavily on short-term financial targets, potentially at
the expense of long-term strategic goals.
•Example: A company might cut back on research and development (R&D) to meet quarterly financial
targets, which could harm innovation in the long run.
4.Can Lead to Complacency:
•Drawback: Once a budget is established, employees and managers may focus only on sticking to
the budget rather than seeking ways to improve performance or reduce costs.
•Example: A department may meet its budget targets but not look for ways to improve efficiency or
quality, as the goal becomes simply adhering to the budget.
5.Unrealistic Assumptions:
•Drawback: Budgets are often based on estimates and assumptions that may not accurately reflect
future conditions, leading to inaccurate projections.
•Example: A company might budget for sales growth of 10% based on optimistic forecasts, only to find
that actual sales are flat or decline, making the budget unrealistic.
6.Potential for Disruption:
•Drawback: Employees or managers might prioritize meeting budget goals rather than responding to
actual needs or changing market conditions.
•Example: A department might cut necessary expenses (e.g., training or maintenance) to stay within
the budget, which could hurt productivity or quality in the future.
7.Can Cause Tension:
•Drawback: When budgets are too tight or overly ambitious, it can create tension between
departments, management, or employees.
•Example: Sales teams may feel pressured by a high sales target set in the budget, leading to
unrealistic expectations and potential burnout.
Example 1
 Solution to Example 1

Particulars January February March April

Opening Balance 20,000 29,000 49,000 34,000
Add: Receipts
Collection from 1,30,000 1,60,000 1,65,000 2,30,000
customers
Total Receipts (A) 1,50,000 1,89,000 2,14,000 2,64,000
Less: Payments
Raw Material Purchased - 25,000 45,000 40,000
Salary and Wages 1,00,000 1,05,000 1,00,000 1,14,200
Other Expenses 15,000 10,000 15,000 12,000
Income Tax 6,000
Machinery 20,000
Total Payments (B) 1,21,000 1,40,000 1,80,000 1,66,200
Balance (A-B) 29,000 49,000 34,000 97,800
Closing Balance
Example 2
 Solution to Example 2

Particulars April May June

Op.Balance 25,000 53,000 81,000
Add: Cash Receipt
Cash Sales a23,000 25,000 30,000
Cash received from debtors/ 60,000 69,000 75,000
customers
Total Receipt (A) 1,08,000 1,47,000 1,86,000
Payments
Payment to creditors 40,000 50,000 52,000
Wages 8,000 9,000 10,000
Expenses 7,000 7,000 8,000
Tax Payment 25,000
Total Payments (B) 55,000 66,000 95,000
Closing Balance 53,000 81,000 91,000
Working note of solution 2

Months Cash Sales (25%) Credit Sales (75%) Total

Feb 17,500 52,500 70,000

March 20,000 60,000 80,000

April 23,000 69,000 92,000

May 25,000 75,000 1,00,000

June 30,000 90,000 1,20,000

Example 3
 Solution to Example 3

Particulars June July August

Op. Balance 1,00,000 1,09,500 99,775
Cash Receipts
Cash Received from 80,000 76,500 78,500
customers
Total Receipts (A) 1,80,000 1,86,000 1,78,275
Payments
Payment to creditors 41,000 40,500 38,500
Selling Commission (5%) 4,000 3,825 3,925
On Sales
Wages 5,400 4,800 4,700
Factory Expense 5,100 5,100 6,000
Admin and Selling Exp 15,000a 17,000 13,000
Machinery Purchased 65,000
Dividend Paid 15,000
Total Payments (B) 70,500 86,225 1,31,125
Closing Balance 1,09,500 99,775 47,150
Example 4
 Solution to Example 4 Working Note 1

Month Total Sales Cash Sales (20%) Credit Sales (80%)

(Current Month)
January 1,40,000 28,000 1,12,000
Feb 1,50,000 30,000 1,20,000 (April)
March 1,30,000 26,000 1,04,000 (May)
April 1,40,000 28,000 1,12,000 (June)
May 1,60,000 32,000 1,28,000
June 1,30,000 26,000 1,04,000

Working Note 2

Month Total Purchase Cash Purchase (20%) Credit Purchase

(Current Month) (80%)
January 70,000 14,000 56,000
Feb 80,000 16,000 64,000
March 70,000 14,000 56,000
April 70,000 14,000 56,000
May 90,000 18,000 72,000
June 70,000 14,000 56,000
 Working Note 3

Month Total Wages Same Month Next Month

(1/2) (1/2)
Feb 22,000 11,000 11,000
March 16,000 8,000 8,000 (April)
April 20,000 10,000 10,000 (May)
May 25,000 12,500 12,500 (June)
June 16,000 8,000 8,000

Working Note 4

Month Total Same Month Next Month

Expenses (3/4) (1/4)
Feb 10,000 7,500 2,500
March 12,000 9,000 3,000 (April)
April 12,000 9,000 3,000 (May)
May 14,000 10,500 3,500 (June)
June 14,000 10,500 3,500
Month Total Expenses Same Month Next Month (1/4)
 Flexible budget for the period ………………
Particulars At 70% Capacity (₹) At 80% Capacity (₹) At 90% Capacity (₹)
Variable overheads:
Indirect Labour 10500 12000 13500
Stores including spares 3500 4000 4500

Semi variable overheads :

Power: fixed (30%) 6000 6000 6000

Variable (70%) 12250 14000 15750

Repairs and maintenance: Fixed (60%) 1200 1200 1200

Variable (40%) 700 800 900

Fixed overheads :
Depreciation 11000 11000 11000
Insurance 3000 3000 3000
salaries 10000 10000 10000

Total overheads (A) 58150 62000 65850

Estimated direct labour hours (B) 108500 124000 139500

Direct Labour hour rate (A/B) 0.54 0.5 0.47

 6000 Units 8000 Units 10000 Units
Particulars P.U Amount P.U Amount P.U Amount
Variable Expense
Materials 70 4,20,00 70 5,60,000 70 7,00,000
0
Labour 25 1,50,00 25 2,00,000 25 2,50,000
0
Variable Overhead 20 1,20,00 20 1,60,000 20 2,00,000
0
Variable Expense (Direct) 5 30,000 5 40,000 5 50,000

Fixed Overhead 16. 1,00,00 12.5 1,00,000 10 1,00,000

67 0

WN-1
Selling Expenses
13 Rs * 10,000= 1,30,000 (10% is Fixed) 13000
1,30,000
Less: 13,000
1,17,000/ 10,000= 11.7
 Flexible budget for the period……….
6000 Units 8000 Units 10000 Units
Particulars
Per Unit ₹ Total ₹ Per Unit ₹ Total ₹ Per Unit ₹ Total ₹
Materials 70 420000 70 560000 70 700000
Labour 25 150000 25 200000 25 250000
Direct Expence (Variable) 5 30000 5 40000 5 50000
Variable overhead 20 120000 20 160000 20 200000
Fixed overheads 16.67 100000 12.5 100000 10 100000
Selling Expences :
10% Fixed 2.17 13000 1.63 13000 1.3 13000
90% Variable 11.7 70200 11.7 93600 11.7 117000
Distribution Expences:
20% Fixed 2.33 14000 1.75 14000 1.4 14000
80% variable 5.6 33600 5.6 44800 5.6 56000
Admin Expences 8.33 50000 6.25 50000 5 50000

Total Cost 166.8 1000800 159.43 1275400 155 1550000