Budgetary control

INDEX
Sr. No Particulars
1 INTRODUCTION
2 BENEFITS OF THE BUDGETING PROGRAM
3 DISADVANTAGES OF BUDGETING PROGRAM
4 PRINCIPLES AND PROCEDURES FOR SUCCESSFUL
BUDGETING
5 TYPES OF BUDGETS
6 DATA ANALYSIS (ILLUSTRATION)
71) CONCLUSION
82) BIBLIOGRAPHY

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I. INTRODUCTION:
In every business planning is the most important function to perform. Planning of different firms
depends upon so many factors. Planning is done for comparing the actual performance with
standard performance.
Through forecasting a company attempts to determine whether and to what degree its long-range
plans are feasible. This discipline incorporates two interrelated functions: long-term planning
based on realistic goals and objectives and a prognosis of the various conditions that possibly
will affect these goals and objectives; and short-term planning and budgeting that provide details
about the distribution of income and expenses and a control mechanism for evaluating
performance. Forecasting is a process for maximizing the profitable use of business assets in
relation to: the analyses of all the latest relevant information by tested and logically sound
statistical and econometric techniques; the interpretation and application of these analyses into
future scenarios; and the calculation of reasonable probabilities based on sound business
judgment.
Future projections for extended periods, although necessary and prudent, suffer from a multitude
of unknowns: inflation, supply fluctuations, demand variations, credit shortages, employee
qualifications, regulatory changes, management turnover, and the like. If a budget fails to
distinguish between what management can and cannot control, it also will fail to indicate
whether management is successful or unsuccessful, or merely fortunate or unfortunate. To
increase control over operations, a company narrows its focus to forecasting attainable results
over the short term and identify the assumptions it makes concerning the uncertainties. These
short-term forecasts, called budgets, are formal, comprehensive plans, using quantitative terms to
describe the expected operations of the organization over some specified future period. While a
company may make few modifications to its forecast, for instance, in the first three years, the
company constructs individual budgets for each year. Furthermore, this approach allows a
company to periodically review the assumptions it makes and revise them if necessary.
A budget delineates the expected month-to-month route a company will take in achieving its
goals. It summarizes the expected outcomes of production and marketing efforts, and provides

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management benchmarks against which to compare actual outcomes. A budget acts as a control
mechanism by pointing out soft spots in the planning process or in the execution of the plans.
Consequently, a budget, used as an evaluative tool, augments a company's ability to make
necessary alterations more quickly.Budgets are also prepared in advance. Budgets are prepared
to check the availability of finance according to the demand of project. So budgetary control is
also essential tool of management to control cost and maximizes profits.
Meaning of budget:
A budget is a detail plan of operations for a specific period of time. In the present era everyone is
with the term budget because it essential in life. A budget is prepared for the effective utilization
of resources, which will help in achieving the set objectives. Budgets are also very important in
individual life, as it is important in business firms.
A budget helps its in the following ways :
a) It brings about efficiency and improvement in the working of the organisation.
b) It is a way of communicating the plans to various units of the organisation. By establishing the
divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus minimizes
the possibilities of buck-passing if the budget figures are not met.
c) It is a way of motivating managers to achieve the goals set for the units.
d) It serves as a benchmark for controlling on-going operations.
e) It helps in developing a team spirit where participation in budgeting is encouraged.
f) It helps in reducing wastages and losses by revealing them in time for corrective action.
g) It serves as a basis for evaluating the performance of managers.
h) It serves as a means of educating the managers.
The following are the essential of budget:
 It is prepared in advance and is based on future plan of action.
 It relates to a future period and is based on objectives to be attained.
 It is a statement expressed in monetary or physical unit prepared for the formulation of
policy.

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II. BENEFITS OF THE BUDGETING PROGRAM:
Budgeting has two primary functions: planning and control. The planning process expresses all
the ideas and plans in quantifiable terms. Careful planning in the initial stages creates the
framework for control, which a company initiates when it includes each responsibility center in
the budgeting process, standardizes procedures, defines lines of responsibility, establishes
performance criteria, and sets up timetables.
The careful planning and control of a budget benefit a company in many ways, including:
a) Enhancing Managerial Perspective.
In recent years the pace and complexity of business have out-paced the ability to manage by "the
seat of your pants." On a day-to day basis, most managers focus their attention on routine
problems. In preparing the budget, however, managers are compelled to consider all aspects of a
company's internal activities. The act of making estimates about future economic conditions and
about the company's ability to respond to them, forces managers to synthesize the external
economic environment with their internal objectives.
b) Flagging Potential Problems.
Because the budget is a blueprint and road map, it alerts managers to variations from
expectations that are a cause for concern. When a flag is raised, managers can revise their
immediate plans to change a product mix, revamp an advertising campaign, or borrow money to
cover cash shortfalls.
c) Coordinating Activities.
Preparation of a budget assumes the inclusion and coordination of the activities of the various
segments within a business. The budgeting process demonstrates to managers the
interconnectedness of their activities.

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d) Evaluating Performance.
Budgets provide management with established criteria for quick and easy performance
evaluations. Managers may increase activities in one area where results are well beyond
exceptions. In other instances, managers may need to reorganize activities whose outcomes
demonstrate a consistent pattern of inefficiency.
e) Refining The Historical View.
The importance of clear and detailed historical data cannot be overstated. Yet, the budgeting
process cannot allow the historical perspective to become crystallized. Managers need to distill
the lessons of the most current results and filter them through their historical perspective. The
need for a flexible and relevant historical perspective warrants its vigilant revision and expansion
as conditions and experience warrant.

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III. DISADVANTAGES OF BUDGETING PROGRAM:
The disadvantages of budgeting include:
a) Time required.
It can be very time-consuming to create a budget, especially in a poorly-organized
environment where many iterations of the budget may be required. The time involved is
lower if there is a well-designed budgeting procedure in place, employees are accustomed to
the process, and the company uses budgeting software. The time requirement can be
unusually large if there is a participative budgeting process in place, since such a system
involves an unusually large number of employees.
b) Gaming the system.
An experienced manager may attempt to introduce budgetary slack, which involves
deliberately reducing revenue estimates and increasing expense estimates, so that he can
easily achieve favorable variances against the budget. This can be a serious problem, and
requires considerable oversight to spot and eliminate.
c) Blame for outcomes.
If a department does not achieve its budgeted results, the department manager may blame
any other departments that provide services to it for not having adequately supported his
department.
d) Expense allocations.
The budget may prescribe that certain amounts of overhead costs be allocated to various
departments, and the managers of those departments may take issue with the allocation
methods used.

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e) Spend it or lose it.
If a department is allowed a certain amount of expenditures and it does not appear that the
department will spend all of the funds during the budget period, the department manager may
authorize excessive expenditures at the last minute, on the grounds that his budget will be
reduced in the next period unless he spends all of the amounts authorized in the current
budget.
f) Only considers financial outcomes.
Budgets are primarily concerned with the allocation of cash to specific activities, and the
expected outcome of business transactions - they do not deal with more subjective issues,
such as the quality of products or services provided to customers. These other issues can be
stated as part of the budget, but this is not typically done.
g) Strategic rigidity.
When a company creates an annual budget, the senior management team may decide that the
focus of the organization for the next year will be entirely on meeting the targets outlined in
the budget. This can be a problem if the market shifts in a different direction sometime
during the budget year. In this case, the company should shift along with the market, rather
than adhering to the budget

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IV. PRINCIPLES AND PROCEDURES FOR SUCCESSFUL
BUDGETING :
a) Realistic And Quantifiable Goals.
In a world of limited resources, a company must ration its own resources by setting goals that are
reasonably attainable. Realism engenders loyalty and commitment among employees, motivating
them to their highest performance. In addition, wide discrepancies, caused by unrealistic
projections, have a negative effect on the creditworthiness of a company and may dissuade
lenders.
A company evaluates each potential business activity to determine which will help the company
achieve its goals the most. A company accomplishes this through the quantification of the costs
and benefits of the activities.
b) Historical Component.
The budget reflects a clear understanding of past results and a keen sense of expected future
changes. While past results cannot be a perfect predictor, they flag important events and
benchmarks.
c) Period-Specific Budgeting.
The budget period must be of reasonable length. The shorter the period, the greater the need for
detail and control mechanisms. The length of the budget period dictates the time limitations for
introducing effective modifications. Although plans and projects differ in length and scope, a
company formulates each of its budgets on a 12-month basis.
d) Standardization.
To facilitate the budgeting process, managers should use standardized forms, formulas, and
research techniques. This increases the efficiency and consistency of the input and the quality of
the planning. Computer aided accounting, analyzing, and reporting not only furnish managers

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with comprehensive, current "real time" results, but also afford them the flexibility to test new
models, and to include relevant and high-powered charts and tables with relatively little effort.
e) Inclusive Process.
Efficient companies decentralize the budget process down to the smallest, logical level of
responsibility, i.e., the responsibility center. Responsibility centers often include the revenue
center, the cost center, and the profit center. Those responsible for the results take part in the
development of their budgets, and learn how their activities are interrelated with the other
segments of the company. Each has a hand in creating a budget and setting its goals. Participants
from the various organizational segments meet to exchange ideas and objectives, to discover new
ideas, and to minimize redundancies and counterproductive programs. This way, those
accountable buy into the process, cooperate more, work harder, and, therefore, have more
potential for success.
f) Budget Review.
Decentralization does not exclude the thorough review of budget proposals at successive
management levels. Management review assures a proper fit within the overall "master budget."
g) Adoption And Dissemination.
Top management formally adopts the budgets and communicates their decisions to the
responsible personnel. When top management has assembled the master budget and formally
accepted it as the operating plan for the company, it distributes it in a timely manner.
h) Frequent Evaluation.
Responsible parties use the master budget and their responsibility center budgets for information
and guidance. On a regular basis, according to a schedule and in a standardized manner, they
compare actual results with their budgets. For an annual budget, managers usually report
monthly, quarterly, and semiannually. Since considerable detail is needed, the accountant plays a
vital role in the reporting function.

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A company uses a well-designed budget program as an effective mechanism for forecasting
realizable results over a specific period, planning and coordinating its various operations, and
controlling the implementation of the budget plans.
V. TYPES OF BUDGETS:
Budgets may be divided into :
Types Of Budgets
1. Functional 1. Fixed 1. Basic
2. Master 2. Flexible 2. Current
A. ON THE BASIS OF COVERAGE:
I. Functional Budget
The cost and incomeplan created for a particular process or departmentoperating within a
business. For example, a functional budget for the manufacture of a product line might include
estimated costs of production, marketing, sales, labor, equipment and materials, as well as
projected sales income. Thus functional budgets pertains to different functions or departments.
There are several types of functional budgets depending upon the structure of organization &
need of control in each case. However , generally the following types of budgets are prepared.
1. Sales budget
COVERAGE CAPACITY CONDITIONS

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2. Production budget
3. Cost of Production budget
4. Purchase budget
5. Labour budget
6. R & D budget
7. Capital Expenditure budget
8. Selling & Administration Cost budget
9. Cash budget
1. Sales Budget
Sales budget is the primary budget. It is the most important budget to prepare and the
other budgets are prepared on the basis of sales budget. In this budget the in charge or
expert forecast the future expected sales of the firm. The sales manager is responsible for
the accuracy of the budget. Sales Budget influences many of the other components of
master budget either directly or indirectly. This is due to the reason that the total sales
figure provided by sales budget is used as a base figure in other component budgets. For
example the schedule of receipts from customers, the production budget, pro forma
income statement, etc.
Due to the fact that many components of master budget rely on sales budget, the
estimated sales volume and price must be forecasted with sufficient care and only reliable
forecast techniques should be employed. Otherwise the master budget will be rendered
ineffective for planning and control.
The sales budgets may prepare on basis of product, type of customers, salesman, locality
etc. for the preparation of sales budget the following things should be take under care like
a) past sales,
b) sales man estimates,

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c) plant capacity,
d) raw material,
e) orders in hand,
f) seasonal fluctuations,
g) competition
h) production capacity
i) long term sales trend in various products
j) reports of salesmen etc.
Format
Where the price per unit is expected to remain constant during the period for all units in sales,
the sales budget format will be simple as shown below.
Company A
Sales Budget
For the Year Ending December 30, 2014
Quarter
1 2 3 4 Year
Sales Units
× Price per Unit
Total Sales
However if a business sells more than one product having different prices or the price per unit is
expected to change during the period, its sales budget will be detailed.
2. Production Budget
After preparing sales budget the next budget will be production budget. In this budget works
manager prepare schedule of production by breaking large production in small units to fulfill the

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target production. The production budget is typically presented in either a monthly or quarterly
format. The basic calculation used by the production budget is:
+ Forecasted unit sales
+ Planned finished goods ending inventory balance
= Total production required
- Beginning finished goods inventory
= Products to be manufactured
It can be very difficult to create a comprehensive production budget that incorporates a forecast
for every variation on a product that a company sells, so it is customary to aggregate the forecast
information into broad categories of products that have similar characteristics.
A properly operated budgets leads to
a) inventory control,
b) improved maintenance of production schedules and production targets.
c) Plant and machinary can be utilised to a maximum exten
d) Labour hours can be utilised to a greater exten
e) It help to reduce production expenses as there is uniform producti
f) It is enough to maintain minimum stock of goods
g) Purchase cost budget can be prepared.
h) Production cost budget can be prepared.
Production budgets are based on
a) sales,
b) machine utilization,
c) Purchasing,
d) labor and overhead budgets.
e) Hence it is a summary of all those budgets

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Format
Because the production budget only determines the number of units to be produced, no rupee
signs should be displayed.
3. Cost Of Production Budget
This budget is an estimate of cost of output planned for a budget period and may be
classified into –
• Material Cost Budget
• Labour Cost Budget
• Overhead Cost Budget
The production budget can be converted into production cost budget. It means that
the production budget is first drawn up in quantities & when the above mentioned three
budgets are compiled & cost of production is calculated, the costs are entered into the
production budget to compile a cost of production budget.
4. Purchase budget
Once the production budget is prepared, it is necessary to determine the inputs required.
One such input factor is raw material. Purchase budget shows budgeted beginning and
ending direct material inventory, the quantity of direct material that will be used in
production, the amount of direct material that must be purchased and its cost during a
specific period. Direct material purchases budget is a component of master budget and it
is based on the following formula:
DT. Inc.
Production Budget
Month Ending April 30, 2014
FG units to be sold
+ Desired FG ending inventory
- Beginning FG inventory on hand expected
FG units (Placements) to be produced

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Budgeted Direct Material Purchases in Units= Budgeted Beginning Direct Material in
Units+ Direct Material in Units Needed for Production− Budgeted Ending Direct
Material in Units
In the above formula, the direct material in units that is needed for production is
calculated as follows:
Budgeted Production During the Period× Units of Direct Material Required per Unit
= Direct Material in Units Needed for Production
Since the budgeted production figure is provided by the production budget, the direct
material purchases budget can be prepared only after the preparation of production
budget.
Format
The following example shows the format of a simple direct material purchases budget.
The budgeted production figures are obtained from the production budget of Company A.
Note that the budgeted ending direct material of 1st, 2nd and 3rd period is the beginning
direct material in 2nd, 3rd and 4th period respectively.

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Company A
Direct Material Purchases Budget
For the Year Ending December 30, 2010
Quarter
1 2 3 4 Year
Budgeted Production in Units
× DM Required per Unit (lb.)
DM Required of Production (lb.)
+ Budgeted Ending DM (lb.)
− Beginning Direct Material (lb.)
Budgeted DM Purchases (lb.)
Cost per Pound
Budgeted DM Purchases in $
5. Labour Budget
labour is an important factor in every production organization. Labour plays an important
role in converting raw material into finished product. The labour requirement budgets
prepared on basis of production budget. Labour may be of two types direct and indirect
labour. In this budget company has to budget the required number of hours and the
expected pay scales of the employees. This budget gives information about personnel
specifications for the job for which workers are to be recruited, the degree of skill and
experience required and rates of pay.

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Following are the calculations involved in the direct labor budget:
Planned Production in units× Direct Labor Hours Required per Unit
= Budgeted Direct Labor Hours Required× Cost per Direct Labor Hours
= Budgeted Direct Labor Cost
6. R & D Budget
This budget provides an estimate of expenditure to be incurred on R & D during the
budget period. A R&D budget is prepared taking into consideration the research projects
in hand and new R & D projects to be taken up. The following steps are involved in
budgeting of R & D cost:
a) Define the objectives of R & D programme
b) Define & assign responsibilities
c) Define programme period & its year wise break up
d) Set the annual expenditure limits
e) Each project should be revalued at the time of annual budget review.
7. Capital Expenditure Budget
This is an important budget providing for acquisition of assets necessitated by the
following factors:
a. Replacement of existing assets.
b. Purchase of additional assets to meet increased production
c. Installation of improved type of machinery to reduce costs.
d. Adequacy of financial resources
e. Annual expenditure on repairs & maintenance
f. The pay back period
This budget is long term budget, since capital expenditure is planned a number of years in
advance.

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8. Selling & Distribution Cost Budget
Selling and administrative expense budget is a schedule of planned operating expenses
other than manufacturing costs. It is a component of master budget and it is prepared by
all types of businesses (i.e. manufacturers, retailers and service providers) before the
preparation of budgeted income statement. Usually it is divided in two sections: the
selling expenses and the administrative expenses.
Both selling expenses and administrative expense may be fixed or variable (see cost
behaviour). For example sales commission and freight cost on sales are variable selling
expenses where as sales salaries are fixed selling expenses. Similarly depreciation and
rent on office building are fixed administrative expenses whereas office supplies and
utilities expense are variable administrative expenses.
Different variable selling and administrative expenses vary with different types activities.
For example sales commission vary with number of units sold, entertainment expenses
with number of employees in the organization etc., therefore an accurate selling and
administrative expenses budget can be made by using activity based costing.
9. Cash Budget
The cash budget contains an itemization of the projected sources and uses of cash in a
future period. This budget is used to ascertain whether company operations and other
activities will provide a sufficient amount of cash to meet projected cash requirements. If
not, management must find additional funding sources.
The inputs to the cash budget come from several other budgets. The results of the cash
budget are used in the financing budget, which itemizes investments, debt, and both
interest income and interest expense.
The cash budget is comprised of two main areas, which are Sources of Cash and Uses of
Cash. The Sources of Cash section contains the beginning cash balance, as well as cash
receipts from cash sales, accounts receivable collections, and the sale of assets. The Uses
of Cash section contains all planned cash expenditures, which comes from the Direct
Materials Budget, Direct Labor Budget, Manufacturing Overhead Budget, and Selling

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and Administrative Expense budget. It may also contain line items for fixed asset
purchases and dividends to shareholders.
If there are any unusually large cash balances indicated in the cash budget, these balances
are dealt with in the financing budget, where suitable investments are indicated for them.
Similarly, if there are any negative balances in the cash budget, the financing budget
indicates the timing and amount of any debt or equity needed to offset these balances.
II. MasterBudget
The master budget is the aggregation of all lower-level budgets produced by a company's various
functional areas, and also includes budgeted financial statements, a cash forecast, and a financing
plan. The master budget is typically presented in either a monthly or quarterly format, and
usually covers a company's entire fiscal year. An explanatory text may be included with the
master budget, which explains the company's strategic direction, how the master budget will
assist in accomplishing specific goals, and the management actions needed to achieve the budget.
There may also be a discussion of the headcount changes that are required to achieve the budget.
A master budget is the central planning tool that a management team uses to direct the activities
of a corporation, as well as to judge the performance of its various responsibility centers. It is
customary for the senior management team to review a number of iterations of the master budget
and incorporate modifications until it arrives at a budget that allocates funds to achieve the
desired results. Hopefully, a company uses participative budgeting to arrive at this final budget,
but it may also be imposed on the organization by senior management, with little input from
other employees.
The budgets that roll up into the master budget include:
 Direct labor budget
 Direct materials budget
 Ending finished goods budget
 Manufacturing overhead budget
 Production budget

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 Sales budget
 Selling and administrative expense budget
The selling and administrative expense budget may be further subdivided into budgets for
individual departments, such as the accounting, engineering, facilities, and marketing
departments.
Once the master budget has been finalized, the accounting staff may enter it into the company's
accounting software, so that the software can issue financial reports comparing budgeted and
actual results.
Smaller organizations usually construct their master budgets using electronic spreadsheets.
However, spreadsheets may contain formula errors, and also have a difficult time constructing a
budgeted balance sheet. Larger organizations use budget-specific software, which does not have
these two problems.
a) Example of the MasterBudget
Many lower-level budgets have specific formats that are used to arrive at certain
outcomes, such as the fully absorbed cost of the finished goods inventory, or the number
of units of products to be manufactured. This is not the case for the master budget, which
looks very much like a standard set of financial statements. The income statement and
balance sheet will be in the normal format mandated by Generally Accepted Accounting
Principles or International Financial Reporting Standards. The primary difference is the
cash budget, which does not usually appear in the standard format of the statement of
cash flows. Instead, it serves the more practical purpose of identifying specific cash
inflows and outflows that will result from the rest of the budget model
b) MasterBudget Problems
When a company implements a master budget, there is a strong tendency for senior management
to force the organization to closely adhere to it by including budget goals in employee
compensation plans. Doing so has the following effects:

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 When compiling the budget, employees tend to estimate low revenues and high expenses,
so that they can easily meet the budget and achieve their compensation plans.
 Forcing the organization to follow the budget requires a group of financial analysts who
track down and report on variances from the plan. This adds unnecessary overhead
expense to the business.
 Managers tend to ignore new business opportunities, because all resources are already
allocated toward attaining the budget, and their personal incentives are tied to the budget.
Thus, enforcing a master budget can skew the operational performance of a business. Because of
this problem, it may be better to employ the master budget as just a rough guideline for
management's near-term expectations for the business.
c) Other MasterBudget Issues
Another document sometimes included in the master budget is a set of key performance metrics
that are calculated based on the information in the budget. For example, it may show accounts
receivable turnover, or inventory turnover, or earnings per share. These metrics are useful for
testing the validity of the budget model against actual results in the past. For example, if the
accounts receivable turnover metric is much lower than historical results, that could mean that
the company is over-estimating its ability to collect accounts receivable promptly, which means
that the amount of accounts receivable shown in the balance sheet may be understated, and the
amount of cash may be overstated.
B. ON THE BASIS OF CAPACITY
A. Fixed Budget
This is the rigid budget and it is drawn on the assumption that there will be no change in the
budgeted time period. A fixed budget will be helpful only when actual level of activity is equal
to budgeted level of activities. According to charted institute of management accountants.” A
fixed budget is defined as a budget designed to remain unchanged irrespective of activity
actually attained. A fixed budget is also referred to as a static budget.

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To illustrate a fixed budget, let's assume that a company pays commission on its sales at a rate of
5%. If the company prepares a fixed budget and it is projecting sales of $1 million, its budget for
sales commissions will be fixed at $50,000. If the actual sales end up being only $900,000 the
budget for commissions will remain unchanged at the fixed amount of $50,000.
B. Flexible Budget
It is also called as variable budget. A flexible budget gives different budgeted costs for different
budgeted costs for different levels of activities. This budget is applicable in where activity levels
vary from period to period. Where the business is new and it is difficult to predict. Where
industry is influenced by change in fashion. Where there are changes in sales.
The flexible budget shows an even higher unfavorable variance than the static budget. This does
not always happen but is why flexible budgets are important for giving management an
indication of what questions need to be asked.
 Advantages of Flexible Budget
• Helps Avoid Overspending
With a static budget, you set spending levels based on suppositions regarding historic market
conditions, sales, vendor costs and other factors. As conditions change, your budget continues to
follow spending levels, production outputs, staffing guidelines or other factors that might be too
high, based on changes that occur during the year. For example, if you budgeted $10,000 per
month for labor at the beginning of the year, based on sales of $100,000 per month, and your
sales average $80,000 per month, a flexible budget triggers a decrease in labor costs if you set
the budgeted amount as a percentage of revenue.
• Lets You React to Opportunities
Flexible budgets let you tie spending to sales, allowing you to increase spending to take
advantage of opportunities presented by better-than-expected revenues. For example, if your

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sales increase dramatically, a flexible budget that sets your marketing spending as a percentage
of sales lets you increase your advertising or promotions to further increase sales.
• Adjusts Costs and Margins
It’s important to understand your manufacturing and overhead costs if you wish to know your
true costs of sales. A flexible budget recalculates your production and overhead costs based on
sales data or units sold. You can review these numbers each month to determine which of your
products are providing the best profit margins, helping you determine whether it’s cost effective
to keep producing them.
• Relies on Current Data
A static budget relies on data that is current only at the time the budget is created. During the
course of the year, legislative changes can affect your taxes or expenses. Weather conditions can
change your materials costs or shipping expenses. Sales might come in much higher or lower
than the previous years' figures used to make your initial budget projections. A flexible budget
changes as new data becomes available, allowing you to change spending levels.
 Disadvantages of Flexible Budgeting
The flexible budget at first appears to be an excellent way to resolve many of the difficulties
inherent in a static budget. However, there are also a number of serious issues with it, which we
address in the following points:
 Formulation.
Though the flex budget is a good tool, it can be difficult to formulate and administer. One
problem with its formulation is that many costs are not fully variable, instead having a fixed cost
component that must be calculated and included in the budget formula. Also, a great deal of time
can be spent developing cost formulas, which is more time than the typical budgeting staff has
available in the midst of the budget process. Consequently, the flexible budget tends to include
only a small number of variable cost formulas.

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 Closing delay.
You cannot pre-load a flexible budget into the accounting software for comparison to the
financial statements. Instead, you must wait until a financial reporting period has been
completed, then input revenue and other activity measures into the budget model, extract the
results from the model, and load them into the accounting software. Only then can you issue
financial statements that contain budget versus actual information, with variances between the
two. These extra steps will delay the issuance of financial statements.
 Revenue comparison.
In a flexible budget, there is no comparison of budgeted to actual revenues, since the two
numbers are the same. The model is designed to match actual expenses to expected expenses, not
to compare revenue levels. There is no way to highlight whether actual revenues are above or
below expectations.
 Applicability.
Some companies have so few variable costs of any kind that there is little point in constructing a
flexible budget. Instead, they have a massive amount of fixed overhead that does not vary in
response to any type of activity. For example, consider a web store that downloads software to its
customers; a certain amount of expenditure is required to maintain the store, and there is
essentially no cost of goods sold, other than credit card fees. In this situation, there is no point in
constructing a flexible budget, since it will not vary from a static budget.
In short, a flexible budget requires extra time to construct, delays the issuance of financial
statements, does not measure revenue variances, and may not be applicable under certain budget
models. These are serious issues that tend to restrict its usage.
 Difference between fixed and flexible budgets.
1. A fixed budget is established for a specific level of activity whereas flexible budget is
prepared for various levels of activity.

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2. Fixed budget cannot be changed after the period commences, whereas a flexible budget can be
changed after the period commence.
3. Fixed budget is more suitable for fixed expenses whereas flexible budget takes both fixed as
well as variable expenses in account.
4. Fixed budget includes only fixed costs, whereas a flexible budget includes fixed costs,
variable costs and semi variable costs.
5. Fixed budget is mainly used in planning stage whereas flexible budget is used in controlling
stage.
 Methods Of preparing flexible budget
Methods Of preparing flexible budgets cover methods of segregation of costs, into fixed &
variable, including methods for segregating semi – variable costs into their fixed & variable
componenets.
• Fixed Cost: Fixed costs remain constant within the given range of activity in spite of
change in volume of production. The unit fixed cost per unit decreases as the level of
production increases within the volume. They are the period cost and capacity, should be
incurred for a period of time.
• Variable Cost: Those costs which increase directly and proportionately with the level of
activity are called variable costs. Total cost increases or decreases towards the direction
of production or sales units. Where as the variable cost per unit will remain constant, if
other thing remaining the same.
• Semi-variable Cost (Mixed Cost): Composition of fixed and variable cost is the mixed
cost or semi variable cost. Such costs increase with the level of activity, but by
intermittent jumps than continuously. In other words the cost does not change
proportionately with the level of output.
To segregate semi variable cost into fixed cost and variable cost is necessary because with this,
we can add fixed cost proportion in total fixed cost and variable cost proportion in total variable

26
cost. So, with following method, we can carry out this.
a) Graphical Method
With graphical method, we draw the graphic line of semi variable cost by taking output
on x'ax and total semi variable cost at y'ax. After this, we do judgement and select a point
where will be our fixed cost in semi variable cost. After this, we draw the line of best fit.
This line shows the fixed cost which will not be changed after changing output.
b) High Points and Low Points Method
Under this method, we calculate total sale and total cost at highest level of production.
Then we calculate total sale and total cost at lowest level of production. Because, semi
variable cost have both variable and fixed cost. We first calculate variable rate with
following formula :
= Excess of total cost / Excess Sale X 100
This rate shows variable cost of sale value. By using this rate, we also calculate variable
cost of sale at highest level. Now, same variable cost will be deducted from total cost at
the highest level of production. Reminder will be fixed cost.
For example
sale at higest highest level of production 140000
sale at lowest level of production 80000
---------------------------------------------
Excess sale = 60000

27
---------------------------------------------
total cost at highest level of production 72000
total cost at lowest level of production 6000
-----------------------------------------------
Excess cost = 12000
-------------------------------------------------
Variable cost rate = 12000/60000 X 100 = 20% of sale
Variable cost at highest level of production = 140000 X 20% = 28000
Fixed cost = Rs. 72000 - Rs. 28000
= Rs. 44000
c) Analytical Method
Under this method, cost accountant does some analysis for dividing semi variable cost
into fixed cost and variable cost. After this, he calculate fixed cost on that rate which
analyzed. Suppose, a cost accountant says that in the total semi variable cost, there may
be 30% fixed cost and 70% variable cost. Now total semi variable cost will be divided on
this basis.
If production level will increase, variable cost's proportion will increase with same rate.
But fixed cost will not change.
d) Level of Activity Method
In this method, we compare two level of production with the amount of expenses in these
levels. Variable cost will be calculated with following method:
Change in semi variable cost / Change in production volume

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e) Least Square Method
This is statistical method in which we use this method for calculating a line of best fit.
This method is based on the linear equation y = mx +c , y is total cost, x is volume of
output and c is total fixed cost. By solving this equation mathematically, we can calculate
variable cost(M) at different level of production.
 Preparation of a Flexible Budget
The flexible budget uses the same selling price and cost assumptions as the original
budget. Variable and fixed costs do not change categories. The variable amounts are
recalculated using the actual level of activity, which in the case of the income statement is
sales units. Each flexible budget line will be discussed separately.
a) Sales. The original budget assumed 17,000 Pickup Trucks would be sold at $15
each. To prepare the flexible budget, the units will change to 17,500 trucks, and
the actual sales level and the selling price will remain the same. The $262,500 is
17,500 trucks times $15 per truck. The variance that exists now is simply due to
price. Given that the variance is unfavorable, management knows the trucks were
sold at a price below the $15 budgeted selling price.
b) Cost of Goods Sold. Using the cost data from the budgeted income statement, the
expected total cost to produce one truck was $11.25. The flexible budget cost of
goods sold of $196,875 is $11.25 per pick up truck times the 17,500 trucks sold.
The lack of a variance indicates that costs in total (materials, labor, and overhead)
were the same as planned.
c) Selling Expenses. The original budget for selling expenses included variable and
fixed expenses. To determine the flexible budget amount, the two variable costs
need to be updated. The new budget for sales commissions is $10,500 ($262,500
sales times 4%), and the new budget for delivery expense is $1,750 (17,500 units
times 10%). These are added to the fixed costs of $12,500 to get the flexible
budget amount of $24,750.

29
d) General and Administrative Expenses. This flexible budget is unchanged from
the original (static budget) because it consists only of fixed costs which, by
definition, do not change if the activity level changes.
e) Income Taxes. Income taxes are budgeted as 40% of income before income
taxes. The flexible budget for income before income taxes is $20,625, and 40% of
that balance is $8,250. Actual expenses are lower because the income before
income taxes was lower. The actual tax rate is also 40%.
f) Net Income. Total net income changes as the amount for each line on the income
statement changes. The net variance in this example is mainly due to lower
revenues.
The important thing to remember in preparing a flexible budget is that if an amount, cost
or revenue, was variable when the original budget was prepared, that amount is still
variable and will need to be recalculated when preparing a flexible budget. If, however,
the cost was identified as a fixed cost, no changes are made in the budgeted amount when
the flexible budget is prepared. Differences may occur in fixed expenses, but they are not
related to changes in activity within the relevant range.

30
Format
G. W. JEANS
FLEXIBLE BUDGET FOR THE MONTH JUST ENDED
Income
Statement
line-item
PER
UNIT
RS
PER
UNIT
RS
PER
UNIT
RS
Revenue
Variable costs:
Materials
Labor
Overhead
Total
Contribution margin
Fixed costs:
Manufacturing Overhead
Marketing costs
Total fixed costs
Operating income

31
C. ON THE BASIS OF CONDITIONS:
A. Basic Budget
A basic budget is based on a long term plan and is used as a basis for developing current budgets.
A basic budget is much broader in scope and less detailed than a current budget. It may be fixed
or flexible. The basic data are not updated whenever there are changes in conditions, such as,
increase in material price or wage rates. As a result, the use of basic budgets obscures operating
variances. That is why for control purposes, current budgets are more useful.
B. Current Budget
Current budget is established for use over a short period of time, usually one year but sometimes
even less, and related to current conditions, that is, average conditions which are likely to prevail
during the budget period.
To compute variances that can help you understand why actual results differed from your
expectations, creating a flexible budget is helpful. A flexible budget adjusts the master budget for
your actual sales or production volume.
For example, your master budget may have assumed that you’d produce 5,000 units; however,
you actually produce 5,100 units. The flexible budget rearranges the master budget to reflect this
new number, making all the appropriate adjustments to sales and expenses based on the
unexpected change in volume.
To prepare a flexible budget, you need to have a master budget, really understand cost behavior,
and know the actual volume of goods produced and sold.

32
VI. DATA ANALYSIS (ILLUSTRATION):
Consider Kira, president of the fictional Skate Company, which manufactures roller
skates. Kira’s accountant, Steve, prepared the overhead budget shown.
Skate had a great year; actual sales came to 125,000 units. However, much to the disappointment
of Steve and Kira, the overhead budget report reported major overruns. For each category of
overhead, Steve computed a variance, identifying unfavorable variances in indirect materials,
indirect labor, supervisory salaries, and utilities.

33
Skate’s total overhead exceeded budget by $25,000. Steve made the elementary mistake of
treating variable costs as fixed. After all, portions of overhead, such as indirect materials, appear
to be variable costs. If Skate increased production from 100,000 units to 125,000 units, these
variable costs should also increase.
In other words, comparing the $60,000 actual cost of making 125,000 units to the $50,000
budgeted cost of making just 100,000 units makes no sense. You’re comparing apples and
oranges.
Instead, Steve should flex the budget to determine how much overhead he should have, assuming
that the company makes 130,000 units.
Separate fixed and variable costs
Some costs are variable — they change in response to activity levels — while other costs are
fixed and remain the same. For example, direct materials are variable costs because the more
goods you make, the more materials you need.

34
On the other hand, some overhead costs, such as rent, are fixed; no matter how many units you
make, these costs stay the same. To determine whether a cost is variable or fixed, think about the
nature of the cost.
For Skate, an analysis indicates that indirect materials, indirect labor, and utilities are variable
costs. On the other hand, supervisory salaries, rent, and depreciation are fixed. Steve recomputes
variable costs with the assumption that the company makes 125,000 units.
In the original budget, making 100,000 units resulted in total variable costs of $130,000.
Dividing total cost of each category by the budgeted production level results in variable cost per
unit of $0.50 for indirect materials, $0.40 for indirect labor, and $0.40 for utilities.
To compute the value of the flexible budget, multiply the variable cost per unit by the actual
production volume. Here, the figure indicates that the variable costs of producing 125,000 should
total $162,500 (125,000 units x $1.30).
Compare the flexible budget to actual results
The next step is to combine the variable and fixed costs in order to prepare a new overhead
budget report, inserting the new flexible budget results into the overhead budget report.

35
Look at that! After you adjust for the change in production level, Skate’s variance is suddenly
favorable. Actual overhead of $355,000 was $7,500 less than the $362,500 flexible budget.

36
VII. CONCLUSION:
Budgeting is an important component of financial success and one that's not difficult to
implement.
Budgeting isn't just for poor people or for times when money is tight or your life is undergoing a
major transition. Budgeting is for everyone because it makes it easier to achieve financial goals
of all shapes and sizes, whether that goal is to stay out of debt next month or to pay cash for a
sports car.
 Budgeting allows you to make long- and short-term projections about your financial
situation, prevent crises, get the most out of your money, plan for major life changes and
enjoy peace of mind.
 Budgeting systems - ranging from a simple notepad and pen to online financial
management software - are available for all needs and preferences.
 Budgeting monthly, rather than by the paycheck, can help you learn to take a longer-term
view of your finances.
 Keep track of all your expenses, not just the big ones. Those daily lattes can add up!
 Getting a basic sense of your financial picture is an important component of budgeting.
Make sure you know how much you make after taxes and how your required and optional
expenses fit into that picture.
 Being flexible with your budget categories and allowing yourself affordable rewards will
prevent budgeting from being a drag and help you stick with it.
 A well-maintained budget can help you meet short-term goals, like saving for a vacation,
as well as long-term goals, like saving for retirement.
 Avoid budgeting mistakes like being so frugal it makes you miserable or ignoring thetime
value of money. Since you've already learned about these and other common budgeting
mistakes and how to correct them, you probably won't make them. If you do mess up,

37
remember that you're only human. Forgive yourself, correct the mistake if possible and
vow to do better going forward.
 A budget should evolve as your circumstances change. Don't expect the budget you made
at 25 to still work for you at 35 or even 27. Your income and expenses will change over
time, often annually. For example, if you get a raise, you'll want to adjust your budget to
reflect how you want to spend or save the extra money.
As long as you're spending within your means each month, a budget is a great tool for helping
you sleep soundly at night. You know where your money's going, you know that you're on track
to meet your financial goals and you know that you've planned to weather the storms that will
arise from time to time. If your spending is too high for your income, a budget serves as a pesky
but necessary reminder that you need to change things - and the sooner you listen to those
irksome numbers, the better off you'll be. Living paycheck to paycheck only works temporarily -
sooner or later you will have an expense you can't meet or a goal you can't achieve if you don't
learn how to budget.

38
VIII. BIBLIOGRAPHY:
1) www.centurionbop.co.in/news/press_190505.html12.
2) www.domainb.com/management/m_a/20060904_vijay_kalantri.html23.
3) www.twincitiesbbs.com/php/subra/corporat.htm34.
4) www.blonnet.com/2002/08/07/stories/2002080700050800.htm45.
5) www.sbi.com6.
6) www.sbp.com
7) http://www.accountingtools.com/questions-and-answers/what-are-the-disadvantages-of-
budgeting.html
8) www.investopedia.com/university/budgeting/basics3.asp
9) www.cpapracticeadvisor.com/blog/.../the-disadvantages-of-budgeting
10) https://en.wikipedia.org/wiki/Budget
THANK YOU!

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