The Process and Purpose of Budgetary Control 4
AC 3.3.Process and Purpose of Budgetary Control and the Budgetary Control Cycle. 4
3.3.1. Process of Budgetary Control 4
126.96.36.199. Establishment of Budget Centers and Budgets. 5
188.8.131.52. Preparation of an Organization Chart 5
184.108.40.206. Fixation of the Budget Period. 5
220.127.116.11. Identification of the Principal Budget Factor/ Key Factor 6
18.104.22.168. Hiring the Budget Officer 6
22.214.171.124. Consent and Cooperation of Concerned Stakeholders. 6
126.96.36.199. Formation of a Budget Committee. 7
188.8.131.52. Recording and Reporting the Actual Results. 8
184.108.40.206. Preparation of a Budget Manual 9
3.3.2. Purpose of Budgetary Control 10
220.127.116.11. Planning. 10
18.104.22.168. Coordination. 10
22.214.171.124. Communication. 11
126.96.36.199. Motivation. 11
188.8.131.52. Control 12
184.108.40.206. Performance Evaluation. 12
220.127.116.11. Clarification of Responsibility and Authority. 12
3.3.3. Budgetary Control Cycle. 12
AC 3.4. Review of the 5 Varance Analysis of Yuri’s Budget 14
3.5. Conclusion. 16
Reference List 17
Budgetary control is the process of comparing the actual results with the budgeted results and reporting upon any evident variances. Budgets are the benchmark for control in any entity, and they assist to accomplish the plans set by a respective business within defined expenditure limits (Agrawal 2010). Additionally, budgetary control incorporates establishing budgets relating to the roles of the executives in a particular policy, and the regular comparison of the actual and budgeted results. Specifically, budgetary control secures by individual action the objective of a particular policy or provides a basis for the revision of such objectives (Dunk 2011). The budgetary control process incorporates nine steps, and these steps are discussed in this dissection. Figure 1 depicts the key figures in a corporate setup whereby the indicated personnel actively participate in the budget control framework.
Figure 1: The Key Personnel Involved in Budgetary Control Processes
For the budgetary control system to be an endowment in any company, it is necessary to divide the organization into several centers or departments (Lee & Epstein 2012). For each of these departments, a budget has to be prepared with the help of the concerned managers and the respective department heads. The budgetary control framework encompasses the input of all the departments in the entity, and this guarantees the success of this systems at all times.
A chart that depicts the functional responsibility of the involved personnel is necessary. Additionally, the organization chart articulates the position and interrelation of various executives and managers in the company, and the budgets they ought to prepare (Guess & LeLoup 2010). The essence of an organization chart is to prevent the blame game when certain results are not evident in a particular department of the organization.
Depending on a company, the formulation of a budget may occur monthly or yearly. Additionally, the fixation of a budget period will depend on the nature of the business and the type of budget (Van 2011). For instance, many governments will only prepare an annual budget. An industry that takes elongated periods to complete its work will usually implement longer budget periods in their operations. In practice, the capital expenditure budgets are typically implemented for longer periods while the sales, production, and cash budgets are short-term budgets (Agrawal 2010). Excellent budget control frameworks articulate that it is essential to prepare budgets over shorter periods, and this guarantees the effectiveness of the budget control structure.
In all companies, there are particular factors that limit the efficiency and influence of all functional budgets. Such factors may include machine capacity, availability of skilled or unskilled personnel, or raw materials. Further, these factors will determine if the company will achieve the set output level or not (Dunk 2011). Important to note, is that the market may also absorb only a certain quantity of the commodities of a business. Any factor that limits the activity level of a company relates to the principal budget factor/key factor. For the budget control process to yield adequate results, it is paramount to establish the principal budget factor of the company (Lee & Epstein 2012).
An entity must employ a budget officer/controller to coordinate the endeavors linked to budgeting in the entire business. Additionally, the budget officer and other departmental managers ought to be similar in rank. The budget officer plays a tremendous role in the budgetary control framework. First, the budget officer ensures the punctual formulation of budgets (Guess & LeLoup 2010). Moreover, the officer assists in the preparation of budgets, and if there is a need, the officer makes necessary modifications to the budget in line with the changed conditions in the company. Secondly, the budget officer regularly compares the actual performance with the budgets (Van 2011). In doing this, the officer identifies the variations and brings such changes to the attention of the heads of department/managers.
The formulation of budgets occurs in line with particular aspects or activities of a business. For the budget control structure to be successful, it is mandatory for all the concerned stakeholders to endorse the budgets linked to their activities in the company (Agrawal 2010). Additionally, it is crucial for these stakeholders to have an opportunity to express their opinions freely, and they ought to have the chance to criticize the proposed company budgets. If the budget control process does not incorporate this step, then the cooperation between the various managers/departments in the enterprise might not be forthcoming (Dunk 2011).
For a small entity, the budget officer is capable of coordinating budget related activities efficiently (Lee & Epstein 2012). However, in a large corporation it is necessary to form a budget committee as figure 2 depicts. The budget committee must prepare a budget manual that articulates the steps applicable when preparing a budget for the organization. Further, this committee suggests the formats for preparing the various budgets. The budget committee also makes a budget timetable, and this enables the preparation of budgets in advance before the beginning of subsequent financial periods (Guess & LeLoup 2010). Additionally, after the preparation of all the budgets the budget committee scrutinizes, complies, and finally endorses the budget. After the endorsement of the budgets by the committee, the circulation of these budgets to the various departments occurs. Thus, this allows these departments to execute their activities as stipulated in the budget.
Figure 2: Budget organization for a large corporation
It is paramount to realize the control objective of the budget control framework, and this necessitates the continuous recording and periodic reporting of the actual results by all the budget centers (Van 2011). The budget centers ought to prepare periodical reports in the form of budget reports or departmental operating statements. Figure 2 depicts a report from a sales manager for the third month of operation into the budget period. The reports must contain the actual figures alongside the estimated figures. Additionally, the report must indicate the variations between the actual and the budgeted figures and the causes of such differences. The reports support a control structure for the managers responsible for budgetary control, and they enable these managers to take appropriate action promptly (Agrawal 2010). Figure 3 depicts an example of a budget control report.
Figure 3: An example of a budget report from the Sales Department
Figure 4: An Example of a Budget Control Report
The budget manual is a document that encompasses an in-depth procedure about the operation of a budgetary control system in an entity. It contains the applicable routine forms and documents, and the responsibilities of the workers tasked with the preparation and implementation of the budgets (Dunk 2011). Additionally, the budget manual indicates the dates related to the preparation and supply of essential data, budgets and reports, and information. All the aspects articulated above constitute the contents of a budget manual. Furthermore, the budget manual acts a benchmark for the implementation of budget programs in the company. It articulates the activities that will occur, how they will happen when they occur, and who will execute such activities. It is prudent to allocate adequate timelines to the preparation of the budget manual, and this eliminates confusion in the execution of various jobs in the company (Lee & Epstein 2012). Moreover, the budget manual guarantees the effective and successful operation of the budgetary control framework. All company managers ought to possess a copy of the budget manual to facilitate the company’s budgeting endeavors.
A budget avails an in-depth plan of action for a company over a definite period. The comprehensive plans relate to the production, sales, requirements for raw materials, labor needs, and advertising and sales (Guess & LeLoup 2010). Moreover, the budget may also provide in-depth plans for research and development, capital additions, and so forth. Budgetary control enhances planning, and this enables the business to foresee imminent problems long before they arise. Thus, the businesses can formulate adequate solutions through an appropriate strategy. Specifically, most business emergencies become non-existent because of proper planning structures, and the elements of budgetary control guarantee an adequate planning structure. Budgetary control dynamics forces the management to think ahead and to anticipate and prepare for imminent problems in the business (Van 2011).
Budgetary control practices aid managers in the process of controlling their efforts. More intently, budgetary controls guarantee the harmonization of the objectives of the various departments with the objectives of the entire group (Agrawal 2010). Budgetary control enhances effective planning and organization, and this guarantees the utmost levels of coordination in the company. Additionally, there is coordination between the budgets attributed to various departments in the business. For example, the production of the budget attributed to the sales department occurs in line with the budget produced by the production department (Dunk 2011). Thus, budgetary control enhances coordination, and this guarantees the endowment of the company.
The dynamics of budgetary control enhance the communication frameworks in business. Approved budget copies are available to all management personnel, and this provides an adequate understanding of the company’s programmes and policies (Lee & Epstein 2012). Moreover, all the managers are privy to the restrictions that relate to their respective budgets. The budgetary control process enhances communication because of the transmission of information that occurs during the budget preparation process. Several workers participate in the budget making process, and the budget control framework enhances the communication among all the workers involved in the budget’s development (Guess & LeLoup 2010).
Budgetary control frameworks motivate managers to perform in line with the objectives of the group. If the managers participate in the budget preparation processes, their levels of motivation to realize the company’s objectives drastically increase (Van 2011). The motivation of the employees is critical to the flourishing of any business in existence, and the elements of budgetary control enhance the levels of motivation among the company managers in a tremendous way.
The vitality of the control aspect is to ensure that laid down plans and objectives become realizable after the fixation period of the budget. The control attributed to budgeting refers to the systematic effort to keep the managers enlightened about the success of the planned budgeting activities (Agrawal 2010).If the activities are not successful, the managers can execute remedial actions. A comparison between the budgeted and actual results occurs, and a report on these comparisons is accessible to managers, who then take corrective action.
Budgetary control frameworks enable managers to gauge themselves, and they can establish if they are on track or not in matters of achieving the company’s objectives (Dunk 2011). Many companies award the managers that realize their budget targets, and a manager’s promotion heavily depends on his/her capability to meet the budget expectations.
The budgetary control processes facilitate the division of the company into budget centers, and there is direct outlining of the responsibilities of each department head. Thus, there is a reduction in the duplication of efforts, and each manager manages items directly under his/her control (Lee & Epstein 2012). More intently, the budgetary control frameworks certify the elements of effective responsibility accounting and authority among the company managers.
As depicted in Figure 5, the budgetary control cycle incorporates six stages, and they are:
- Setting the new budget- The control cycle begins at this point and this is the original budget formulated in line with the size of the company (Guess & LeLoup 2010).
- Defining the performance measurements- Refers to the means of measuring the budget holder’s performance. The performance measures may incorporate a set return on capital, specified sales target or market share, or the profit targets (Van 2011).
- Measuring the actual performance- After formulating the benchmarks for performance standards there ought to be a recording of the actual performance in each department (Agrawal 2010). The process occurs by utilizing cost center numbers when inputting financial transactions in the relevant databases.
- Comparing actual with the budget- measuring the actual performance needs a yardstick, and the yardstick is the original budget or the later revised budget.
- Examining Variances- Variances are the differences between the actual and budget items. It is critical to investigate the causes of significant deviations at all times.
- Taking Action if Necessary- The information obtained may help avoid future mishaps, or a realized benefit can be transferable to other departments in the company. If it is realistically possible, all attempts should focus to revert to the original budget (Dunk 2011). After this stage, the cycle starts again.
AC 3.4. Review of the 5 Variance Analysis of Yuri’s Budget
|Material(£) Labor(£) Price rate variance= Actual Figure – Budgeted Figure =3750-(4500)=8250
|Usage Efficiency Variance= Actual-Budgeted= (5625)-(3000)=(2625)
|Total Variance= Actual-Budgeted= (1875)-(7500)
Table 1: Yuri’s Budget
When actual > expected = favorable variance (F)
When actual < expected = adverse variance (A)
As Table 1 depicts, the budgeted figure for the units sold was 100000. However, the actual units sold by Yuri’s business amounted to 75000. Thus, there is an adverse variance of (25000). An adverse variance is evident because the actual results are poorer than the budgeted projections (Agrawal 2010). The reasons attributed to this relate to the high competition in the market and lack of sufficient raw materials. There was a shortage of quality steel, and this might have caused the lower sales. Additionally, the lack of skilled personnel influenced Yuri’s sales in an immense manner. Secondly, the budgeted figure for the materials was £15000, but the actual cost of the materials was £22500. Thus, this indicates that there is an adverse variance because the actual material cost exceeds the budgeted material costs. The possible reason for this scenario would be due to the shortage of quality steel. Thus, this makes the companies in the cutlery manufacturing business to compete with the available quality steel, which is small in quantity (Dunk 2011). Therefore, that raised Yuri’s material cost considerably.
As Table 1 depicts, the budget cost of direct labor was £22500, and the actual cost was 24375. Thus, an adverse variance of (1875) is evident. The possible causes of this adverse variance could be a negotiated increase in the wage rates. Moreover, the reflection of these current wage rates could still be missing in the applicable standard wage rates (Lee & Epstein 2012). Hence, the variance is not controllable in such a case. Additionally, the aspect of unexpected overtime might have been present in among the workers in Yuri’s business causing the cost of direct labor to increase substantially. Moreover, the cost of direct labor could also rise because of assigning skilled laborers tasks that unskilled workers can perform efficiently. The skilled workers will require higher wage rates and in the end, the direct labor cost rises (Guess & LeLoup 2010). Finally, the direct labor cost would increase if the usage of the wage rate standards were not in line with the changes in actual wage rates.
The price rate variance is favorable as depicted in Table 1. The possible causes for this would be the use of cheaper materials. Yuri might have opted to use the low-quality steel because of the shortage of high-quality steel, and this might have caused the price rate variance to decrease substantially (Van 2011). Additionally, the actual prices might be lower than the budgeted prices because of a change in the market condition that causes the general price of the materials to decrease. As indicated in Table 1, the usage efficiency variance was favorable because the actual result was better than the budgeted projection. The possible cause for such a scenario would be due to changes in the methods of production and changes in the quality control requirements (Agrawal 2010). Additionally, the improvement could attribute to the careful use of materials by Yuri’s workers. Overall, the total variance was favorable, and this attributes to the improvements in the production methods of Yuri’s business and in the efficiency of utilizing the available materials.
Budgetary control frameworks enable the company to prepare a plan to implement the policy of the business. Moreover, a budgetary control system coordinates the endeavors of various departments in the organization (Lee & Epstein 2012). Most importantly, a budgetary control framework controls each function of the business to achieve the best possible outcomes at the end of the budget period. A budgetary control framework certifies the efforts of all businesses in existence. More intently, the budgetary control structure guarantees the realization of critical business elements. Such elements may include return on investments (ROI), consistency in net profits, and so forth (Dunk 2011). There ought to be an implementation of the principles of budgetary control frameworks in all entities in operation.
Agrawal, N 2010, Principles of Management Accounting. Asian Books Pvt Ltd, Delhi, IND.
Dunk, A.S., 2011. ‘Product innovation, budgetary control, and the financial performance of firms’, The British Accounting Review, 43,2, pp. 102-111.
Guess, GM, & LeLoup, LT 2010, Comparative Public Budgeting: Global Perspectives on Taxing and Spending. State University of New York Press, Albany, NY, USA.
Lee, JY, & Epstein, M (eds) 2012, Advances in Management Accounting, Volume 21: Advances in Management Accounting. Emerald Group Publishing Ltd, Bingley, GBR.
Van, D.S., 2011. ‘The emergence and change of management accounting routines’, Accounting, Auditing & Accountability Journal, 24,4, pp. 502-547.