BUDGET IN ACCOUNTING
Budget means a quantitative statement, prepared before a particular period to serve as an estimate of future receipts and disbursements.
ACCORDING TO CHARTERED INSTITUTE OF MANAGEMENT ACCOUNTANTS, LONDON
“Budget is a plan quantified in monetary terms prepared and approved prior to a defined period of time, usually showing planned income to be generated and/or expenditure to be incurred during that period and the capital to be employed to attain a given objective”.
ACCORDING TO BASTABLE
“Budget means the financial arrangement of a given period, with the usual implications that they have been submitted to the legislature for approval.”
ACCORDING TO DIMOCK AND DIMOCK
“A budget is a balanced estimate of expenditure and receipts for a given period of time.”
The integrated process of preparing, implementing and operating budgets is called as Budgeting.
Budgets acts as a map for the future economic activities of the business, which are prepared as per the policies of the different organizational functions. It aims at making optimum utilization of the capital and other resources of the organization.
FEATURES
- It is an estimate of the economic activities of an entity which related to a specified future period.
- It must be written and approved by the appropriate authority.
- It should be modified or corrected, whenever, there is a change in circumstances.
- It plays the role of a business barometer that helps in measuring the performance of the business by comparing actual and budgeted results.
- It is prepared on the basis of past experiences and trends in the business.
- It is a business practice, which is used to forecast the operating activities and financial position of the business.
Budgets are used to fix targets in monetary terms and control the deviations if any. Further, it can also be used as a basis to measure the performance of the organization.
CLASSIFICATION OF BUDGETS
Budgets are classified on various basis:
CLASSIFICATION ON BASIS OF FUNCTIONS
On the basis of functions, the budgets are of two types i.e. Functional budget and Master budget.
FUNCTIONAL BUDGETS
These budgets relate to the individual functions in an organization, such as sales, production, purchase, research and development, capital expenditure and cash, etc.
A list of frequently prepared functional budgets is given below:
- Sales budgets
- Production budgets (in units)
- Direct material usage budgets
- Direct material purchase budgets
- Direct labor budgets
- Factory overhead budgets
- Plant utilization budgets
- Production cost budgets
- Stock budgets – raw material, work-in-progress and finished goods
- Cost of goods sold budgets
- Selling and distribution cost budgets
- Administration cost budgets
- Research and development cost budgets
- Cash budgets
Some of them are explained as follows:
(a) Sales Budgets – The sales budget is a forecast of total sales expressed in terms of money and quantity. In practice, quantitative budget is prepared first, then it is translated into monetary terms.
(b) Production Budgets – It is a forecast of the production for the budget period. It may be expressed in units or standard hours. A standard hour is the quantity of output or amount of work which should be performed in one hour. While preparing the production budget, the production executive will take into account the physical facilities like plant, power, factory space, materials, labour available for the period.
(c) Materials Budgets – It shows the details of raw materials to be consumed. It is expressed in terms of physical quantities and values of materials to be issued from the stores for production purpose. This budget provides that right materials of right quantity and quality are procured.
(d) Labour Budgets – It shows the details of labour requirements in quantity, with estimated costs. This budget gives detailed information relating to the number of employees, rates of wages and cost of labour hours to be employed.
(e) Manufacturing Overhead Budgets – It shows the estimated costs of indirect materials, indirect labour and indirect manufacturing expenses during the budget period to achieve the predetermined targets.
(f) Administration Cost Budgets – This comprises the salaries and expenses of administrative office and management for a specified period. It is prepared with the help of past experience and expected changes in figure.
(g) Selling Expenses Budgets – All expenses concerned with sale of products to customers are included in this budget. It is generally prepared territory wise by the sales manager of each territory, on the basis of past records.
(h) Research and development budgets – This budget lists all the research and development activities together with their likely costs.
(i) Capital Expenditure Budgets – This budget shows the estimated expenditure on fixed assets like plant, land, machinery, building etc. It is a long term budget. The capital is necessitated on account of demand for products, expansion of industry, adoption of new technology, replacement of old machines etc.
(j) Cash Budgets – It is prepared after all the functional budgets are prepared by the chief accountant either on a monthly or weekly basis. It shows the sum total of the requirements of cash in respect of various functional budgets and of estimated cash receipts for a stipulated period.
MASTER BUDGETS
The master budget is a consolidated summary of various functional budgets.
According To The Chartered Institute Of Management Accountants, London
“Master budget is the summary budget incorporating its components as functional budgets and which is finally approved, adopted and employed.”
When all functional budgets are consolidated and summarized they produce two budgets – budgeted income statement and budgeted balance sheet. These taken together are called master budgets. The master budgets when finally approved by the budget committee becomes the target for the company during the budget period.
CLASSIFICATION ON BASIS OF CAPACITY
On the basis of capacity, the budgets can be classified as fixed or flexible.
FIXED BUDGETS
The fixed budget is a budget for a given level of activity or capacity. It does not provide for any change in expenditure arising out of changes in the level of activity or capacity. When the actual level of activity differs from the budgeted level of activity, the use of fixed budget as a basis of performance evaluation does not give correct picture. This budget can be used only when budgeted and actual activity levels are the same.
The features of fixed budget are as follows:
1. Fixed budget is rarely prepared and used. The reason is that the actual output is differing from the budgeted output. Hence, the management cannot exercise cost control.
2. The performance report does not contain useful information and misleading one.
3. If units are overlooked in the cost-to-cost comparison, accurate result is not available.
4. The performance report gives merely whether the actual costs are higher or lower than budgeted costs.
5. Fixed budget is limited by the costs and expenses which are affected by fluctuations in volume. This is a well known accepted fact.
6. There is no meaning of comparing one activity level with some other activity level. A fixed budget can be usefully employed when budgeted output is close to the actual output.
FLEXIBLE BUDGETS
A flexible budget is a budget that adjusts or flexes with changes in volume or activity. The flexible budgets are more sophisticated and useful than a static budgets.
For costs that vary with volume or activity, the flexible budgets will flex because the budgets will include a variable rate per unit of activity instead of one fixed total amount. In short, the flexible budgets is a more useful tool when measuring a manager’s efficiency.
The following are the advantages of flexible budgeting.
- Accurate Budgeting: Flexible budgets are prepared for different range of activity. Hence, the actual performance can be compared with the budget. More accurate budget is prepared by this way.
- Accurate Performance Measurement: It incorporates changes in activity level and compares actual results with the budgets in terms of output achieved. It facilitates more meaningful measurement of actual performance.
- Co-ordination: Flexible budgets brings co-ordination among various departments. A production budget is prepared on the basis of sales budgets, materials budgets and personnel budgets. In this way, co-ordination is obtained in an organization.
- A Tool of Cost Control: The flexible budget facilitates comparisons of budgeted costs with actual costs. Hence, the responsibility is fixed on executives for deviations. In the long run, the employees are motivated themselves in controlling costs for which they are responsible.
CLASSIFICATION ON THE BASIS OF TIME PERIOD
CURRENT BUDGETS
Current budget is related to current conditions and is established for use over a short period of time. As compared to basic budget, a current budget is more useful for control purposes as it takes into consideration current conditions in setting the targets.
LONG-TERM BUDGETS
A budget, which is prepared for a period longer than a year, is called long-term budget. Such a budget is used for future forecasting and forward planning. Capital expenditure and research and development cost budgets are generally prepared for a long period.
SHORT-TERM BUDGETS
It is a budget prepared for less than a year and is very useful to lower levels of management for control purpose. Cash budgets, sales budgets, production budgets, etc., are generally prepared for a short period.
DIFFERENCE BETWEEN FIXED AND FLEXIBLE BUDGET
| BASIS OF DIFFERENCE | FLEXIBLE BUDGET | FIXED BUDGET |
| Meaning | The budget designed to change with the change in the activity levels is Flexible Budgets. | The budget designed to remain constant, regardless of the activity level reached is Fixed Budgets. |
| Flexibility | Due to its nature of flexibility, it may be quickly re-organized according to the level of production. | After the commencement of a period, fixed budgets cannot change according to actual production. |
| Condition | Flexible budgets may change according to change in conditions. | Fixed budgets are based on the assumption that conditions will remain unchanged. |
| Cost classification | Classification of costs is done according to the nature of their variability. | It is suitable for fixed costs only; no classification is done in case of fixed budgets. |
| Comparison | Comparisons of actual figures with revised standard figures are done according to change in the production level of a concern. | If there is change in production level, then it is not possible to do a correct comparison. |
| Ascertainment of cost | It is easy to ascertain costs even at different levels of activity. | If there is change in the production level or circumstances, it is not possible to ascertain costs correctly. |
| Cost control | It is used as an effective tool to control costs. | Due to its limitations, it is not used as cost control tool. |
| Nature | This is dynamic | This is static. |
| Simplicity and ease of preparation | Flexible budget is quite complex and not easy to prepare. | Fixed budgets are quite simple and easy to prepare. |
| Estimates | Its preparation is realistic and practical. | Its preparation is based on assumptions. |
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