Advantages of Budgetary Control:

The following are the main advantages of budgetary control system:

1. Budgetary control integrates and brings together all activities of the enterprise right from planning to controlling.
2. Budgetary control provides a yardstick against which actual results can be compared.
3. Budgetary control provides a clear definition of the objectives and policies of the concern.
4. Budgetary control is a useful tool in profit-planning.
5. Budgetary control helps to eliminate or reduce unproductive activities and minimizing waste.
6. Budgetary control makes everyone accountable for his work, as it defines the responsibility for performances.
7. Budgetary control system acts as a basis for internal audit by providing a method of continuous appraisal of performance.

Essentials of Budgetary Control System:

• The conventional budgeting system gives a picture of expenditure made in the past. As a business firm becomes interested in cost reduction and control, the accounting manager is forced to become less interested in past history’, and is more interested in the future.
• The budget is a plan for the future and as such it is a base for cost control in the long run. The management may take up several cost reduction measures but without budgetary control there can be no long range process. Most of the managers are of the opinion that budgetary control requires time and money, but it is effective in bringing about cost improvement.
• Managers should remember that the budgetary control is only a tool and it does not replace management. Bearing in mind the limitations of budgetary control, it should be designed to each job. Budgetary control is not just the tool of the budget administrator but it is the tool of all.
• Budget preparation and administration should be fully supported by top management. If the top management encourages, budget will be most effectives.
• Budget estimates should be prepared by those executives who are to be held responsible for performance.
• Another method of making budgets effective is to ensure that all managers participate in budget preparation.
• Managers should get quick information whenever actual performance deviates from forecast performance. This means that actual progress at each and every stage should be made known to the manager.
• Yet another method of making budget effective is that it should not cost more to operate than it is worth.
• Finally, the standards established should be capable of being easily translated for measurement.

Limitations of Budgetary Control:

Though budgetary control provides a lot to management in planning, controlling and coordinating the activities of an organization, it is not a fool- proof system. It has its own limitations. Therefore, managers should be well aware about these problems so as to take adequate precautions to minimize the impact.

1. The main problem in budgetary control comes because of uncertainty of future. It is a known fact that budgets are formulated on the assumptions of future happenings in a certain way.
2. The budgetary programme takes a long time to develop a reasonably good system of budgetary control.
3. The role of budgetary control system in planning is sometimes over emphasized. Any deviation from budgeted figures is looked upon with contempt. This inflexibility contributes negatively to the organizational objectives.
4. The effectiveness of the budget depends largely on the dedication and co- ordination of the top management.
5. Budgetary control system requires a lot of paper work which the technical personnel always resent.
6. Budgetary control may affect the organizational morale. Managers may adopt defensive attitude and this may create many types of problems and conflicts in the organization.

Types of Budgets:

Every business unit has a variety of plans such as production plan, sales plan, financial plan and the like. When the plans are projected in advance, they are called budgets.

The budgets may be classified on the following basis:\

1. Coverage of functions: Master Budget and Functional Budget.
2. Nature of activities: Capital Budget and Revenue Budget.
3. Period: Long Term Budget and Short Term Budget.
4. Flexibility: Fixed Volume Budget and Flexible Budget.
5. Preparation of budget methods: Performance Budget and Zero-base Budget.

Master Budget and Functional Budget:

Master budget is the summary budget which covers all types of budgets such as sales, produc-tion, costs, profit and appropriation of profit, and major financial ratios. Thus this is nothing but the targeted profit and loss statement and balance sheet of the organisation.

The functional budgets have a number of classifications depending upon the type of functions performed and budgeting practices adopted by an organisation. Therefore, there can be budget for each major functions and sub-function like material budget, production budget, financial budget, marketing budget, sales budget, research and development budget, personnel budget and thelike.

Capital Budget and Revenue Budget:

Business activity involves two processes:

1. Creating of facilities for carrying the business activi-ties; and
2. carry out the activities. Budget in respect of the former is called capital budget and the latter is called revenue budget.

Fixed and Flexible Budgets:

A fixed budget is prepared for a specific output level and it has no concern with the changes in the level of activity of the firm. Fixed budgets are called short period budgets. A flexible budget is also called variable budget. In the flexible budget, provision is made for changes in the production levels of the firm. Flexible budget is adaptable to changes in operating conditions.

Performance Budget:

A performance budget is an input-output budget or costs and results budget. It shows costs matching with operation. The concept of performance budgeting originated in the USA around 1960s when defense budgeting led to the thinking of ways and means of linking outputs to inputs.

Afterwards, this became quite popular in many government departments outside the United States. Now it is being used in business and other organisations besides government departments. It emphasizes non-financial measures of performance which can be related to financial measures in explaining changes and deviations from planned performance.

The conventional budget is not effective because the concerned department does not like expenditure with performance. The performance aspect is side-tracked in all government or public sector industries department. It is, therefore, necessary to have performance budgeting. In the performance budget each item of expenditure is related to a specific performance.

Performance budgeting results in the following:

1. It measures progress towards long term objectives.
2. It makes possible more effective performance audit.
3. It correlates the financial and physical aspects of everyprogramme.
4. It facilitates better appreciation and review of organizational activities by top management.
5. It improves budget formulation, review and decision making at all levels of the organisation.
6. To achieve the most important facet of budgeting, that is, control of the performance in terms of physical unit and the related costs.
7. It makes possible to find out sufficient performance measures to represent adequately all important variables in determining the cost of an activity.

Zero- Base Budgeting:

Zero-Base budgeting was originally developed by the Texas Instruments of USA in 1971. Subsequently, it was applied by the State of Georgia in 1973. Since then, it has been used by a number of states and business organisations in the U.S.A. and other countries.

The key element in zero-base budgeting is future objective orientation of past objectives. In the zero-base budgeting, it is assumed that the budget for the next year is zero and starts the demand for the project. It requires each manager to justify his entire budget in detail from scratch that is zero-base.

The burden of execution shifts on each manager and he has to justify the demand for money .Such an analysis indicates which activities are important and which are unimportant. Unimportant activities are eliminated or made into productive and profitable. Thus zero-base budgeting helps in choosing those activities which are essential and important.

Basic Steps of Zero-Base Budgeting:

The process of zero-base budgeting involves the four basic steps:

1. Identification of decision units.
2. Analysis of each decision unit in the context of total decision package.
3. Evaluation and ranking of all decision units to develop the budget request.
4. Allocation of resources to each unit based on ranking.

The benefits of the zero-base budgeting are:

1. Effective allocation of resources.
2. Identification of obsolete operations.
3. Effective means to control cost.
4. Improvement in productivity and cost effectiveness.
5. Better focus on organizational objectives.
6. Saving time of top management.
7. Elimination of unnecessary activities.

Standard Costing

Standard costing is one of the prominently used systems of cost control. It aims at establishing standards of performance and target costs which are to be achieved under a given set up working conditions. It is a pre-determined cost which determines what each product or service should cost under certain situation.

Standard costing is defined as the preparation and use of standard costs, their comparison with actual costs and the measurement and analysis of variances to their causes and points of incidence. Standard costs should be obtained under efficient operations.

It starts with an estimate of what a product should cost during a future period given reasonable efficiency Standard costs are established by bringing together information collected from various sources within the company.

The degree of success is measured by a comparison of actual performance and standard performance. For example, if the standard material input for a unit of production is Rs. 500 and the actual cost is Rs 475 then the variance of Rs. (-) 25 is the measure of performance, which shows that the actual performance is an improvement over the standard.

This comparison of actual costs with standard cost will help in fixing responsibility for non-standard performance and will focus attention on areas in which cost improvement should be sought by showing the source of loss and inefficiency.

Basic Requirements in the Use of Standard Costing:

The basic requirements are the following:

1. The ability to establish a meaningful standard.
2. A system for measuring actual quantities and costs at the same level as the standard costs and quantities.
3. The facilities to calculate variances over time, which will allow corrective action to be taken.

Advantages of Standard Costing

Standard costing has the following merits:

1. It helps in establishing a yardstick with which the efficiency of performance is measured that helps to exercise control.
2. It provides how the clear goal is to be achieved by providing incentive and motivation to work.
3. It provides the management the basic information to fix selling price, transfer pricing,etc.
4. It facilitates delegation of authority and fixation of responsibility.
5. It helps in achieving optimum utilisation of plant capacity.
6. It provides means for cost reduction.
7. Variance analysis and reporting is helpful for taking corrective measures.

Limitations of Standard Costing:

Even though this method confers several benefits, there are certain difficulties which are listed below:

1. Application of standard costs is quite difficult in practice.
2. Frequently, standards become rigid over time and do not keep pace with changes in conditions.
3. If the standards are outdated, loose, inaccurate and unreliable, they are more harmful.
4. It standards set are higher than reasonable, they act as discouraging factor.
5. When there are random factors, it is difficult to explain variance properly.
6. Standard costing may be found to be unsuitable and costly in the case of firms dealing in non-standard products.
7. It is difficult to distinguish between controllable and non-controllable variances.
8. Setting the standard costing are highly technical andmechanical.

Basis of Setting Standard Costs

Without standards, a company’s management has no way of knowing its overall performance. The standard costs are to be established by collecting all information pertaining to different cost functions. The main basis of setting standard costs is technical and engineering aspects. A major issue in standard costing is the determination of the tightness of standards which may range from a desire for engineering perfection to very slack practices.

The other basis of setting standards is:

1. Time of use—current standard and basic standard
2. Performance level—normal, ideal, expected, attainable standards, etc.
3. Price level—ideal, normal, current, basic standard
4. Output level—theoretical, practical, normal expected standards.

(a) Normal Standards:

Normal standards comprise:

(i) Ideal Standards:

The standards represent the maximum level of efficiency, i.e., using mini-mum resources to complete the goal without any loss of time. In control terms, it is essential for standards to motivate individuals towards their attainment. It is very difficult to use ideal standards. Ideal standards are, therefore, more likely to be set for direct material costs and usage rather than for direct labour or overhead costs.

(ii) Target Standards:

These are the standards which can be attained during a future specified budget period. These are a modified version of ideal standard costs. Hence a certain amount of waste is permitted.

(b) Basic Standards:

Basic standards are those standards which are set at their initial level. In fact, basic standards are not very pragmatic as they emphasize the past instead of the future. Their effectiveness is very little in situations of change in production methods, range of products and prices.

(c) Currently attainable Standards:

Currently attainable standard costs are those costs that should be incurred currently under efficient operating conditions, but making allowances for normal spoilage, unavoidable idle time, unavoidable machine breakdown, set up time, etc. In other words, currently attainable standards or expected standards are the target standards minus a realistic allowance for normal or acceptable waste.