Business Accounting 1

Chapter 18: Budgetary control

On completion of this topic you should be able to
Describe the main stages in budgetary control
Differentiate between fixed and flexible budgets
Explain the purpose of budgetary control and the
requirements for an effective system
Describe the advantages and disadvantages of budgetary
control
Independent study
Study Chapter 18
Progress test and practice questions(s) as set
Business Accounting 2
The story so far
Unlike financial accounting, there are no statutory
regulations governing the preparation of
management accounting information, as it is
intended for internal users
One advantage is that information can be produced
about future financial periods
We have already seen that cost accounting techniques
can use actual (past) costs or budgeted (future) costs
This is very important as planning and control are
essential if a business is to make a profit
Business Accounting 3
Budgetary control
Budgetary control is the process by which financial
control is exercised by managers preparing budgets
for revenue and expenditure for each function of the
organization in advance of an accounting period. It
involves the continuous comparison of actual
performance against the budget to ensure the plan
is achieved or to provide a basis for its revision
(Collis and Hussey, 2007, p. 309)
Business Accounting 4
Budgets and budget centres
A budget is a quantitative or financial statement,
that contains the detailed plans and policies to be
pursued during a future accounting period (Collis
and Hussey, 2007, p. 310)
A budget centre is a designated part of an entity for
which budgets are prepared and controlled by a
manager (Collis and Hussey, 2007, p. 310)
Business Accounting 5
Variances
Once the budget period begins, each manager
compares the actual performance of his/her budget
centre against the budget and takes action to
remedy any controllable adverse variances
A variance is the difference between the
predetermined cost and the actual cost, or the
difference between the predetermine revenue and
the actual revenue (Collis and Hussey, 2007, p.
311)
An adverse variance is an unfavourable difference
Business Accounting 6
Main requirements for an effective system of
budgetary control
A sound and clearly defined organization with
managers responsibilities clearly defined
Effective accounting records and procedures that
are clearly understood and applied
Support and commitment of top management for the
system of budgetary control
Education/training of managers in the development,
interpretation and use of budgets
Revision of budgets where amendments are needed
to make them appropriate and useful (continued)
Business Accounting 7
Main requirements for an effective system of
budgetary control (continued)
Recognition that budgetary control is a management
activity and not an accounting exercise
Participation of managers in the budgetary control
system
An information system that provides data for
managers so they can make realistic predictions
Correct integration of budgets and their effective
communication to managers
Setting of budgets that are reasonable and
achievable
Business Accounting 8
Main stages in budgetary control
Consult with managers
Make assumptions and
predictions
Set detailed budgets to
meet objectives
Revise budget or take remedial
action to achieve plan
Measure actual performance
and compare with budget
Business Accounting 9
Exercise 1
Role of assumptions in business planning
In order to set realistic financial plans, there needs
to be a consultation process, so that management
can set out their assumptions about what is going to
happen to the firms markets and the business
environment
Required
Using knowledge you have gained from other modules, jot
down the key factors that managers should consider
before setting their financial plans for the forthcoming
period
Business Accounting 10
Solution 1
Role of assumptions in business planning
Key factors include assumptions about
Changes in the size of the market and their market share
Competitors strategies
Changes in interest rates and sources of funding
Increases in the cost and availability of energy, materials
and labour
Changes in legal, social or environmental factors that will
affect the demand for the organisations products/services
Effects of the activities of other related organisations (eg
major customers or suppliers)
Business Accounting 11
Objectives, strategies and plans
The overall purpose of budgetary control is to help
managers plan and control the use of resources in a
systematic and logical manner to ensure that they
achieve their financial objectives
Profit satisficing (making a satisfactory level of profit)
Profit maximisation (making the maximum profit)
Having made their assumptions about the
forthcoming period, the next stage is to set out their
financial strategies in detail by preparing financial
and non-financial budgets that cover every aspect of
the firms activities
Business Accounting 12
Example
Non-financial and financial budgets
Sales and marketing budget
Non-financial budgets Financial budgets
Sales volume budget
(number of units)

Sales revenue budget
()
Sales personnel budget
(number of staff)
Sales vehicles budget
(number of vehicles)


Sales cost budget
()
Television budget (minutes)
Press budget (column inches)


Advertising budget
()
Business Accounting 13
Methods for setting budgets
In incremental budgeting managers add a
percentage to the previous periods budget to take
account of expected changes in price levels
But this is unlikely to create a budget that is relevant to the
particular conditions expected and non-recurring revenue
and/or non-recurring expenditure will be included
In zero-base budgeting managers start from zero,
building each figure into the budget where it can be
justified from the expected conditions and policies
This makes the budget more relevant than incremental
budgeting

Business Accounting 14
Interrelationship of budgets
Functional budgets are drawn up for each
department or function in the business by the
specific functional manager
Non-functional budgets are also needed (eg capital
expenditure budget; cash flow budget; budgeted
profit and loss account; budgeted balance sheet)
and these require contributions from various
managers and the accountant
The master budget incorporates all the budgets and
is the final coordinated budget for the period
Business Accounting 15
Types of budget
A fixed budget is one that is not changed if the
activity level differs from the planned level
Disadvantage is that if the actual activity level is higher
than planned, an adverse cost variance may be due
simply to the increase in variable costs at this level, so the
budget becomes irrelevant
A flexible budget is designed to change with the
level of activity to reflect the different behaviour of
fixed and variable costs
Advantage is that any cost variance can only be due to an
increase or decrease in fixed costs
Business Accounting 16
Exercise 2
Variance analysis
Variance analysis is the investigation of the factors
that have caused the differences between the actual
and budgeted figures
A favourable variance is where actual performance is
better than planned
An adverse variance is where actual performance is worse
than planned (eg costs are higher or revenue is lower)
Required
Complete the June budget report for Jersey Flowers Ltd,
indicating whether the variances are favourable or adverse
Business Accounting 17
Pro forma Jersey Flowers Ltd
Budget report for June
Budget Actual Variance
Revenue
Roses 28,000 27,750 ?
Carnations 22,000 21,500 ?
Lavender 18,000 18,500 ?
68,000 67,750 ?
Costs
Salaries 20,000 20,000 ?
Expenses 16,000 17,000 ?
Administration 10,000 9,500 ?
46,000 46,500 ?
Net profit 22,000 21,250 ?


Business Accounting 18
Solution 2 Jersey Flowers Ltd
Budget report for June
Budget Actual Variance
Revenue
Roses 28,000 27,750 (250) A
Carnations 22,000 21,500 (500) A
Lavender 18,000 18,500 500 F
68,000 67,750 (250) A
Expenditure
Salaries 20,000 20,000 0
Expenses 16,000 17,000 (1,000) A
Administration 10,000 9,500 500 F
46,000 46,500 (500) A
Net profit 22,000 21,250 (750) A
Note
An adverse variance is where actual revenue is lower than planned or
where actual costs are higher than planned
Business Accounting 19
Advantages of budgetary control
Co-ordination of all functions and activities
Responsibility accounting - information is provided to
managers responsible for revenue and expenditure
Utilisation of resources - capital and effort are used to
achieve the financial objectives
Motivation of managers through the use of clearly defined
objectives and monitoring of achievement
Planning ahead gives time to take corrective action
Establishes a system of control if plans are reviewed
regularly against actual
Transfer of authority to individual managers for decisions
Business Accounting 20
Disadvantages of budgetary control
Set in stone - managers may be constrained by the original
budget (eg make no attempt to spend less than maximum
or exceed target income)
Time consuming process may deflect managers from their
prime responsibilities of running the business
Unrealistic if fixed budgets are set and actual activity level
is not as planned
Disillusioning for managers if fixed budgets are set and not
achieved merely due to changes in activity
Demotivating for managers if budgets are imposed by top
management with no consultation
Business Accounting 21
Conclusions
An effective system of budgetary control helps
managers plan and control the use of resources in a
systematic and logical manner
Planning helps co-ordinate the activities of the business
Control is achieved through the frequent monitoring of
progress against the plan by managers of budget centres,
and taking corrective action where necessary
It is a communication system
Financial objectives and constraints are communicated to
managers of budget centres and regular monitoring keeps
management informed of progress towards objectives