Budget and Budgetary Control

1. Budgetary Control: It is the system of management control and accounting in which all the operations are forecasted and planned in advance to the: extent possible and the actual results compared with the forecasted and planned results.

2. Types of Budget:

• Capacity wise – Fixed Budget, Flexible Budget,
• Functions wise – Sales Budget, Production Budget, Plant Utilisation Budget, Direct Material Usage Budget, Direct Material Purchase Budget/etc.,
• Master Budget,
• Period wise – Long Term Budgets, Short Term Budgets, Current Budgets.

3. Budget Ratios: It provide information about the performance level, i.e., the extent of deviation of actual performance from budgeted performance: and whether the actual performance is favourable or unfavourable.
Ratio is 100% or more – Favourable performance
Ratio is less than 100% – Unfavourable performance

Theory Questions

Question 1.
What are the essential characteristics of budget [CA Inter Nov. 2011, 2 Marks]
Answer:
Essential characteristics of budget:

• It is concerned for a definite future period.
• It is a detailed plan of all economic activities of a business.
• It is a mean to achieve business objectives and it is not an end in itself.
• It helps in planning, co-ordination and control.
• It acts as a business barometer.
• It is usually prepared in the light of past experiences.

Question 2.
What are the objectives of Budgetary Control System? [ICAI Module]
Answer:

• Portraying with precision the overall aims of the business and determining targets of performance for each section or department of the business.
• Providing a basis for the comparison of actual performance with the predetermined targets and investigation of deviation, if any, of actual performance and expenses from the budgeted figures.
• Ensuring optimum use of available resources to maximise profit or production, subject to the limiting factors.
• Co-ordinating various activities of the business, and centralising control and yet enabling management to decentralise responsibility and delegate authority in the overall interest of the business.
• Providing a basis for revision of current and future policies.
• Drawing up long range plans with a fair measure of accuracy.

Question 3.
Describe the steps involved in establishing good budgeting control system [CA Inter Nov. 2013, 4 Marks]
Answer:
The following steps are necessary for establishing a good budgetary control system:

• Determining the objectives to be achieved, over the budget period, and the policy or policies that might be adopted for the achievement of these objectives.
• Determining the activities that should be undertaken for the achievement of objectives.
• Drawing up a plan or a scheme of operation in respect of each class of activity, in quantitative as well as monetary terms for the budget period.
• Laying out a system of comparison of actual performance by each person, or department with the relevant budget and determination of causes for the variation, if any.
• Ensuring that corrective action will be taken where the plan has not been achieved and, if that is not possible, for the revision of the plan.

Question 4.
What are the advantages of Budgetary Control System? [ICAI Module]
Answer:

Points	Description
1. Efficiency	The use of budgetary control system enables the management to conduct its business activities in an efficient manner.
2. Control on expenditure	It is a powerful instrument used by business entity for the control of their expenditure. It provides a yardstick for measuring and evaluating the performance of individuals and their departments.
3. Finding deviations	Budget reveals the deviations of the actual from the budgeted figures after making a comparison and communicating the deviation to management.
4. Effective utilisation of resources	Effective utilisation of various resources like men, material, machinery and money, is made possible, as the production is planned after taking these into account.
5. Revision of plans	Budget helps in the review of current trends and framing of future policies.
6. Cost Consciousness	Budgetary control system encourages cost consciousness and maximum utilisation of available resources.

Question 5.
What is ‘Budgetary Control System’ and discuss the components of the same. [CA Inter Dec. 2021, May 2009, 5 Marks]
Answer:
It is the system of management control and accounting in which all the operations are forecasted and planned in advance to the extent possible and the actual results compared with the forecasted and planned results.

Components of Budgetary Control System:
The policy of a business for a defined period is represented by the master budget, the detailed components of which are given, in a number of individual budgets called functional budgets. These functional budgets are broadly grouped under the following heads:
1. Physical budgets: Those budgets which contain information in quantitative terms such as the physical units of sales, production etc. This may include quantity of sales, quantity of production, inventories, and manpower budgets are physical budgets.

2. Cost budgets: Budgets which provides cost information in respect of , manufacturing, administration, selling and distribution, etc. for example, manufacturing costs, selling costs, administration cost, and research and development cost budgets are cost budgets.

3. Profit budgets: A budget which enables the ascertainment of profit. For example, sales budget, profit and loss budget, etc.

4. Financial budgets: A budget which facilitates in ascertaining the financial position of a concern, for example, cash budgets, capital expenditure budget, budgeted balance sheet etc.

Question 6.
State the limitations of Budgetary Control System. [CA Inter January 2021, 5 Marks]
Answer:
Limitations of Budgetary Control System

Points	Description
1. Based on Estimates	Budgets are based on a series of estimates, which are based on the conditions prevalent or expected at the time budget is established. It requires revision in plan if conditions change.
2. Time factor	Budgets cannot be executed automatically. Some preliminary steps are required to be accomplished before budgets are implemented. It requires proper attention and time of management. Management must not expect too much during the initial development period.
3. Co-operation Required	Staff co-operation is usually not available during the initial budgetary control exercise. In a decentralized organisation, each unit has its own objective and these units enjoy some degree of discretion. In this type of organisation structure, coordination among different units is required. The success of the budgetary control depends upon willing co-operation and teamwork.
4. Expensive	The implementation of budget is somewhat expensive. For successful implementation of the budgetary control, proper organisation structure with responsibility is prerequisite. Budgeting process start from the collection of information to for preparing the budget and performance analysis. It consumes valuable resources (in terms of qualified manpower, equipment, etc.) for this purpose; hence, it is an expensive process.
5. Not a substitute for management.	Budget is only a managerial tool and must be intelligently applied for management to get benefited. Budgets are not a substitute for good management.
6. Rigid document	Budgets are sometime considered as rigid documents. But in reality, an organisation is exposed to various uncertain internal and external factors. Budget should be flexible enough to incorporate ongoing developments in the internal and external factors affecting the very purpose of the budget.

Question 7.
Describe the salient features of budget manual. [CA Inter RTP May 2021]
Answer:
Following are the salient features of Budget Manual:

• It contains much information which is required for effective budgetary planning.
• It is a collection of documents that contains key information for those involved in the planning process.
• It includes introductory explanation of the budgetary planning and control process, statement of the budgetary objective and desired results.
• It contains a form of organisation chart to show who is responsible for the preparation of each functional budget and the way in which the budgets are interrelated.
• In contains a timetable for the preparation of each budget.
• Copies of all forms to be completed by those responsible for preparing budgets, with explanations concerning their completion is included in Budget Manual.

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Question 8.

Explain briefly the concept of ‘flexible budget’. [CA inter Nov. 2019, Nov. 2017, Nov. 2008, 2 Marks]
Answer:
Flexible Budget: A flexible budget is defined as “a budget which, by recognizing the difference between fixed, semi-variable and variable cost is designed to change in relation to the level of activity attained”. A fixed budget, on the other hand is a budget which is designed to remain unchanged irrespective of the level of activity actually attained. In a fixed budgetary control, budgets are prepared for one level of activity whereas in a flexibility budgetary control system, a series of budgets are prepared one for the each of a number of alternative production levels or volumes. Flexible budgets represent the amount of expense that is reasonably necessary to achieve each level of output specified. In other words, the allowances given under flexibility budgetary control system serve as standards of what costs should be at each level of output.

Question 9.
What are the cases when a flexible budget is found suitable? [CA Inter May 2019, 5 Marks]
Answer:
Flexible budgeting may be resorted to under following situations:

• In the case of new business venture due to its typical nature it may be difficult to forecast the demand of a product accurately.
• Where the business is dependent upon the mercy of nature e.g., a per-son dealing in wool trade may have enough market if temperature goes below the freezing point.
• In the case of labour-intensive industry where the production of the concern is dependent upon the availability of labour.

Suitability for flexible budget:

• Seasonal fluctuations in sales and/or production, for example in soft drinks industry.
• A company which keeps on introducing new products or makes changes in the design of its products frequently.
• Industries engaged in make-to-order business like ship building.
• An industry which is influenced by changes in fashion; and
• General changes in sales.

Question 10.
Distinguish between ‘Fixed and flexible budget’. [CA Inter Nov. 2011, May 2016, 4 Marks]
Answer:
Difference between fixed and flexible budgets

Fixed Budget	Flexible Budget
1. It does not change with actual volume of activity achieved. Thus it is rigid.	It can be recasted on the basis of activity level to be achieved. Thus it is not rigid.
2. It operates on one level of activity and under one set of conditions.	It consists of various budgets for different level of activity.
3. If the budgeted and actual activity levels differ significantly, then cost ascertainment and price fixation do not give a correct picture.	It facilitates the cost ascertainment and price fixation at different levels of activity.
4. Comparisons of actual and budgeted targets are meaningless particularly when there is difference between two levels.	It provided meaningful basis of comparison of actual and budgeted targets.

Question 11.
List the eight functional budgets prepared by a business. [CA Inter Nov. 2009, 3 Marks]
Answer:
The various commonly used Functional budgets are:

1. Sales Budget
2. Production Budget
3. Plant Utilisation Budget
4. Direct Material Usage Budget
5. Direct Material Purchase Budget
6. Direct Labour (Personnel) Budget
7. Factory Overhead Budget
8. Production Cost Budget.

Question 12.
State the considerations on which capital expenditure budget is prepared. [CA Inter Nov. 2012, 4 Marks]
Answer:
The preparation of Capital Expenditure Budget is based on the following considerations:

1. Overhead on production facilities of certain departments as indicated by the plant utilisation budget.
2. Future development plans to increase output by expansion of plant facilities.
3. Replacement requests from the concerned departments.
4. Factors like sales potential to absorb the increased output, possibility of price reductions, increased costs of advertising and sales promotion to absorb.increased output, etc.

Question 13.

Write a short note on ‘Zero Base Budgeting as an approach towards Productive improvement. [CA Inter Nov. 2005, 4 Marks]
Answer:
Zero Base Budgeting approach plays key role in productivity improvement.
It is beneficial in this regard in the following manner:

1. ZBB ensures that the various functions adopted by the organisation are important and critical for the achievement of its objectives and are being performed in the best possible way.
2. ZBB gives an opportunity to the management to allocate resources for different activities only after proper cost benefit analysis.
3. In this approach, ‘chances of arbitrary cuts and enhancement are thus avoided.
4. Department budgets are closely linked with corporate objectives.
5. It provides a systematic approach for the evaluation of different activities and rank them in order of preference for the allocation of scarce resources.
6. Wasteful expenditures can be easily identified and eliminated.

Question 14.
Why is ‘Zero Base Budgeting’ (ZBB) considered superior to ‘Traditional Budgeting’? Explain. [CA Inter May 2018, 5 Marks]
Answer:
Zero based budgeting is superior to traditional budgeting: Zero based budgeting is superior to traditional budgeting in the following manner:

• It provides a systematic approach for evaluation of different activities.
• It ensures that the function undertaken is critical for the achievement of the objectives.
• It provides an opportunity for management to allocate resources to various activities after a thorough – cost benefit analysis.
• It helps in the identification of wasteful expenditure and then their elimination. It facilitates the close linkage of departmental budgets with corporate objectives.
• It helps in the introduction of a system of Management by Objectives.

Question 15.
What are the advantages and limitations of zero base budgeting? [CA Final Nov. 2004, 4 Marks]
Answer:
Advantages of ZBB:

• It provides a systematic approach for the evaluation of different activities and rank them in order of preference for the allocation of scarce resources.
• It ensures that the various functions undertaken by the organization are critical for the achievement of its objectives and are being performed in the best possible way.
• It provides an opportunity to the management to allocate resources for various activities only after having a thorough cost-benefit-analysis. The chances of arbitrary cuts and enhancement are thus avoided.
• The areas of wasteful expenditure can be easily identified and eliminated.
• Departmental budgets are closely linked with corporation objectives.
• The technique can also be used for the introduction and implementation of the system of ‘management by objective.’ Thus, it cannot only be used for fulfilment of the objectives of traditional budgeting but it can also be used for a variety of other purposes.

Limitations of ZBB:

• The work involves in the creation of decision-making and their subsequent ranking has to be made on the basis of new data. This process is very tedious to management.
• The activities selected for the purpose of ZBB are on the basis of the traditional functional departments. So the consideration scheme may not be implemented properly.

Question 16.
Define Zero Base Budgeting and mention its various stages. [CA Inter Nov. 2019, 5 Marks]
Answer:
Zero-based Budgeting: (ZBB) is an emergent form of budgeting which arises to overcome the limitations of incremental (traditional) budgeting system. Zero- based Budgeting (ZBB) is defined as a method of budgeting which requires each cost element to be specifically justified, although the activities to which the budget relates are being undertaken for the first time, without approval, the budget allowance is zero’.

ZBB is an activity based budgeting system where budgets are prepared for each activities rather than functional department. Justification in the form of cost benefits for the activity is required to be given. The activities are then evaluated and prioritized by the management on the basis of factors like synchronisation with organisational objectives, availability of funds, regulatory requirement etc.

ZBB is suitable for both corporate and non-corporate entities. In case of non-corporate entities like Government department, local bodies, not for profit organisations, where these entities need to justify the benefits of expenditures on social programmes like mid-day meal, installation of street lights, provision of drinking water etc.

ZBB involves the following stages:

• Identification and description of Decision packages
• Evaluation of Decision packages
• Ranking (Prioritisation) of the Decision packages
• Allocation of resources

Question 17.
What are the important points an organization should consider if it wants to adopt Performance Budgeting? [CA Inter Nov. 2020, 5 Marks]
Answer:
For an enterprise that wants to adopt Performance Budgeting, it is thus imperative that:

• The objectives of the enterprise are spelt out in concrete terms.
• The objectives are then translated into specific functions, programmes, activities and tasks for different levels of management within the realities of fiscal constraints.
• Realistic and acceptable norms, yardsticks or standards and performance indicators should be evolved and expressed in quantifiable physical units.
• A style of management based upon decentralised responsibility structure should be adopted, and
• An accounting and reporting system should be developed to facilities monitoring, analysis and review of actual performance in relation to budgets.

Question 18.
Write short note on Budget Ratio. [ICAI Module]
Answer:
Budget ratios provide information about the performance level, i.e., the extent of deviation of actual performance from the budgeted performance and whether the actual performance is favourable or unfavorable. If the ratio is 100% or more, the performance is considered as favourable and if ratio is less than 100% the performance is considered as unfavourable.

The following ratios are usually used by the management to measure development from budget.

Practical Questions

Flexible Budget

Question 1.
G Ltd. manufactures a single product for which market demand exists for additional quantity. Present sales of ₹ 6,00,000 utilises only 60% capacity of the plant. The following data are available:
(1) Selling price : ₹ 100 per unit
(2) Variable cost : ₹ 30 per unit
(3) Semi-variable expenses : ₹ 60,000 fixed + ₹ 5 per unit
(4) Fixed expenses : ₹ 1,00,000at present level, estimated to increase by 25% at and above 80% capacity.
You are required to prepare a flexible budget so as to arrive at the operating profit at 60%, 80% and 100% levels. [ CA Inter Nov. 2020, 5 Marks]
Answer:

Note:
60% level of activity = 6,000 units (given)
80% level or activity = 6,000 units ×80%60% = 8,000 units
100% level of activity = 6,000 units ×100%60% = 10,000 units

Question 2.
The Cost Sheet of a company based on a budgeted volume of Sales of 3,00,000 units per quarter is as under:

	₹ per unit
Direct Materials	5.00
Direct Wages	2.00
Factory overheads (50% fixed)	6.00
S/A dm, overheads (1/3 variable)	3.00
Selling price	18.00

When the budget was discussed it was felt that the company would be able to achieve only a volume of 2,50,000 units of production and sales per quarter. The company therefore decided that an aggressive sales promotion campaign should be launched to achieve the following improved operations:

Proposal I:

• Sell 4,00,000 units per quarter by spending 2,00,000 on special advertising.
• The factory fixed costs will increase by 4,00,000 per quarter.

Proposal II:

• 5,00,000 units per quarter subject to the following conditions.
• An overall price reduction of 2 per unit is allowed on all sales.
• Variable Selling and Administration Costs will increase by 5%.
• Direct Material Costs will be reduced by 1% due to purchase price discounts.
• The fixed factory Costs will increase by 2,00,000 more.

You are required to prepare a Flexible Budget at 2,50,000, 4,00,000 and 5,00,000 units of output per quarter and calculate the Profit at each of the above levels of output. [CA Final May 2002, 9 Marks]
Answer:
Statement of flexible budget and profit per quarter at 2,50,000; 4,00,000 and 5,00,000 units of output levels per quarter

Under proposal II the factory costs were increased by 2,00,000 more over proposal I.

Question 3.
The Accountant of KPMR Ltd, has prepared the following budget for the coining year 2022 for its two products ‘AYE’ and ‘ZYF’:

Particulars	Product ‘AYE’	Product ‘ZYE’
Production and Sales (in Units)	4,000	3,000
	Amount (in ₹)	Amount (in ₹)
Selling Price per unit	200	180
Direct Material per unit	80	70
Direct Labour per unit	40	35
Variable Overhead per unit	20	25
Fixed Overhead per unit	10	10

After reviewing the above budget, the management has called the marketing team for suggesting some measures for increasing the sales. The marketing team has suggested that by promoting the products on social media, the sales quantity of both the products can be increased by 5%. Also, the selling price per unit will go up by 10%. But this will result in increase in expenditure on variable overhead and fixed overhead by 20% and 5% respectively for both the products.
You are required to prepare flexible budget for both the products:
(i) Before promotion on social media.
(ii) After promotion on social media. [CA Inter Dec. 2021, 5 Mar ks]
Answer:
(i) Flexible budget (before promotion)

(ii) Flexible budget (after promotion)

Question 4.
Tricon Co. furnishes the following information for the month of September, 2020.

During the month 10,000 kg. of materials and 3.100 direct labour hours were utilized.
Required:
(i) Prepare a flexible budge! for the month.
(ii) Deter the material usage variance and the direct labour rate variance for the actual vs the flexible budget. [CA Inter MTP]
Answer:
(i) Statement Showing “Flexible Budget for 3,200 units Activity Level”

(ii) Computation of Variances
Material Usage Variance = Standard Cost of Standard Quantity for Actual Production – Standard Cost of Actual Quantity
= (SQ – AQ) × SP
= [(3,200 units × 3 kg.) – 10,000 kg.] × ₹ 30.00
= ₹ 12,000 (A)

Labour Rate Variance = Standard Cost of Actual Time – Actual Cost
= (SR – AR) × AH
= [₹ 72 – (₹2,25,0003,100)] × 3,100
= ₹ 2,400(A)

Question 5.
You are given the following data of a manufacturing concern:

	₹
Variable Expenses (at 50% capacity):
-Materials	48,00,000
-Labour	51,20,000
-Others	7,60,000
Semi variable expenses (at 50% capacity):
-Maintenance and Repairs	5,00,000
-Indirect Labour	19,80,000
-Sales-Dept. Salaries	5,80,000
-Sundry Administrative Expenses	5,20,000
Fixed Expenses:
-Wages & Salaries	16,80,000
-Rent, Rates and Taxes	11,20,000
-Depreciation	14,00,000
-Sundry Administrative Exp.	17,80,000

The fixed expenses remain constant for ail levels of production. Semi variable expenses remain constant between 45% and 65% of capacity whereas it increases by 10% between 65% and 80% capacity of 20% between 80% and 100% capacity.
Sales at various levels are as under:

Capacity	Sales (₹)
75%	2,40,00,000
100%	3,20,00,000

Prepare flexible budget at 75% and 100% capacity. [CA Inter May 2017, 8 Marks]
Answer:

At 75% and 100% capacity level, the semi-variable costs increased by 10% and 20% respectively.

Question 6.
Maharatna Ltd., a public sector undertaking (PSU), produces product A. The company is in process of preparing its revenue budget for the year 2022. The company has the following information which can be useful in preparing the budget:
(i) It has anticipated 12% growth in sales volume from the year 2021 of 4,20,000 tonnes.
(ii) The sales price of ₹ 23,000 per tonne will be increased by 10% provided Wholesale Price Index (WPI) increases by 5%.
(iii) To produce one tonne of product A, 2.3 tonnes of raw material are required. The raw material cost is ₹ 4,500 per tonne. The price of raw material will also increase by 10% if WPI increase by 5%.
(iv) The projected increase in WPI for 2022 is 4%.
(v) A total of 6,000 employees works for the company. The company works 26 days in a month.
(vi) 85% of employees of the company are permanent and getting salary as per 5- year wage agreement. The earnings per manshift (means an employee cost for a shift of 8 hours) is ₹ 3,000 (excluding terminal benefits). The new wage agreement will be implemented from 1st July 2022 and it is expected that a 15% increase in pay will be given.
(vii) The casual employees are getting a daily wage of ₹ 850. The wages in linked to Consumer Price Index (CPI). The present CPI is 165.17 points and it is expected to be 173.59 points in year 2022.
(viii)Power cost for the year 2021 is ₹ 42,00,000 for 7,00,000 units (1 unit = 1 Kwh). 60% of power is used for production purpose (directly related to production volume) and remaining are for employee quarters and administrative offices.
(ix) During the year 2021, the company has paid ₹ 60,00,000 for safety and maintenance works. The amount will increase in proportion to the volume of production.
(x) During the year 2021, the company has paid ₹ 1,20,000 for the purchase of diesel to be used in car hired for administrative purposes. The cost of diesel will increase by 15% in year 2022.
(xi) During the year 2021, the company has paid ₹ 6,00,000 for car hire charges (excluding fuel cost). In year 2022, the company has decided to reimburse the diesel cost to the car rental company. Doing this will attract 5% GST on Reverse Charge Mechanism (RCM) basis on which the company will not get GST input credit.
(xii) Depreciation on fixed assets for the year 2021 is ₹ 80,40,00,000 and it will be 15% lower in 2022.
Required:
From the above information prepare Revenue (Flexible) budget for the year 2022 and also show the budgeted profit/loss for the year. [CA Inter RTP May 2022]
Answer:
Revenue Budget (Flexible Budget) of Maharatna Ltd. for the Year 2022

Working Notes:
1. Calculation of Raw Material Cost:

2. Calculation of Wages and Salary Cost:

3. Calculation of Power Cost:

4. Calculation of Car Hire Charges:

Expense Budget

Question 7.
KLM Limited has prepared its expense budget for 50,000 unIts in its factory for the year 2020-2 1 as detailed below:

	₹ per unit
Direct Materials	125
Direct Labour	50
Variable Overhead	40
Direct Expenses	15
Selling Expenses (20% fixed)	25
Factory Expenses (100% fixed)	15
Administration expenses (100% fixed)	8
Distribution expenses (85% variable)	20
Total	298

Prepare an expense budget for the production of 35,000 units and 70,000 units. [CA Inter May 2013, Nov 2019, RTP]
Answer:
Expense Budget of KLM Ltd.

Selling Expenses:	Fixed cost per unit	= ₹ 25 × 20% = ₹ 5
Fixed Cost	= ₹ 5 × 50,000 units	= ₹ 2,50,000
Variable Cost Per unit	= ₹ 25 – ₹ 5	= ₹ 20
Distribution Expenses:	Fixed cost per unit	= ₹ 20 × 15% = ₹ 3
Fixed Cost	= ₹ 3 × 50,000 units	= ₹ 1,50,000
Variable cost per unit	= ₹ 20 – ₹ 3	= ₹ 17

Question 8.
RST Limited is presently operating at 50% capacity and producing 30,000 units. The entire output is sold at a price of ₹ 200 per unit. The cost structure at the 50% level of activity is as under:

	₹
Direct Material	75 per unit
Direct Wages	25 per unit
Variable Overheads	25 per unit
Direct Expenses	15 per unit
Factory Expenses (25% fixed)	20 per unit
Selling and Distribution Exp. (80% variable)	10 per unit
Office and Administrative Exp. (100% fixed)	5 per unit

The company anticipates that the variable costs will go up by 10% and fixed costs will go up by 15%.
You are required to prepare an Expense budget, on the basis of marginal cost for the company at 50% and 60% level of activity and find out the profits at respective levels. [CA Inter Nov. 2014, 8 Marks]
Answer: