Budgetary control motivational tool

The best way to set budget targets is with a probability of achievement by most managers 80 to 90 percent of the time. Performance above the target level should be supplemented with incentives including bonuses, promotion, and additional responsibility. Skip to main content. Budgeting Basics and Beyond by Jae K. Shim, Joel G. Start your free trial. Motivation Budgets can be used to affect employee attitudes and performance.

The benefits are extended to the industry and then to national economy. Budgetary control is helpful in conservation, effective utilization and elimination of wastage in scarce resources.

Comparison of actual performance with budgeted performance reveals week spots so that attention is focused on them to improve the performance. The deviations of actual performance compared with budgets are frequently reported and corrections are made to rectify the unfavourable deviations immediately.

In the absence of budgetary control this may be done at the end of the accounting year by which time corrections may not be fruitful or practicable. Incentive schemes can be easily introduced as the predetermined targets act as base to compare actual performance and determine efficiency. Higher and lower efficiency are suitably rewarded or discouraged respectively. Budgetary control reveals inefficiencies in products, processes and departments.

This is helpful in closing down of loss making divisions to improve the overall profitability. Budgetary control is an effective tool for management control. However it has certain limitations while operating it as a technique.

Budgeting is a process of forecasting and estimation. Forecasting may not be accurate. Therefore budgets based on inaccurate forecasts and estimates may not be accurate and effective. Budgets are prepared on the basis of certain prevailing conditions. If the conditions change budgets are also to be revised. Constant changes in budgets may frustrate the employees and the charm in budgeting and implementation may be lost. General tendency of employees is to achieve the targets as budgeting fixes the targets.

Some of the employees who are highly skillful may also be satisfied in performing up to the goals set without showing full potential, which will be a loss to the enterprise as well as the employee in terms of productivity.

Effective implementation of budgetary control depends upon proper coordination among various departments as the performance of a department depends on the work of other departments and vice versa. It requires budgetary officer to oversee the integration of various activities to successfully implement the budgets. Ineffective coordination leads to inefficient performance.

Budgetary control sets targets for different departments individually. This will make the departmental heads to be selfish to get maximum funds and think in terms of achieving their own set targets, thereby raising conflict among different departments.

Master budget is a summary budget, which has been formally accepted by top management. Compromise may be necessary before a summary budget becomes a Master Budget. A method of budgeting whereby all activities are-re-evaluated each time a budget is set.

Discrete Levels of each activity are valued and a combination chosen to match funds available. For the purpose of effective cost control, the system of budgetary control should take into account the following preliminaries —. An organisation is broken down into a number of budget centres to facilitate the control of planned activities.

A budget centre refers to a department or other location to which income or expenses may be attached and of which the responsibility is borne by an individual. The preparation of various budgets for the purpose of budgetary control, requires the provision of adequate accounting records.

As such, it is necessary that accounting system should be able to provide the required information in an analytical form. For this purpose, a chart of accounts corresponding with the budget centres should be maintained. There should be a well-defined organisation chart for budgetary control. This organisation chart shows the functional responsibilities of each executive and assists him in ascertaining his position in the organisation and his relationship with other executives. The design of the organisation chart shall depend upon the nature and size of the organisation but a simple organisation chart may be given as follows —.

In small concerns, the preparation of the budget is usually the responsibility of Accountant or Cost Accountant. In large concerns, the preparation of the budget is entrusted to a Budget Committee which is headed by the Chief Executive of the organisation.

The budget committee is composed of the representatives of various departments e. The responsibility for operating the system of budgetary control is undertaken by the Budget Officer who is a senior member of the Accounting Department.

In large undertakings, generally, a Budget Manual is prepared which guides the Budget Officer and various departmental heads. Budget period is defined as the period for which a budget is prepared and employed. There is no specific rule governing the selection of the budget period but it should neither be too long nor too short.

In case budget period is too short, it will be very difficult to compare it with the actual performances. If it is too long, the budgets may not conform with actual conditions and therefore, the comparison of two unlike figures will not serve any purpose. The budget period is determined by the nature of the budget to be prepared. The influence of the key factor must be assessed first in order to ensure that functional budgets are reasonably capable of fulfilment.

The following is a list of principal key factors and their causes which will influence the target of the business concern:. In most of the business concerns, sales is the most important key factor.

If a limiting factor cannot be avoided by any means, then all the functional budgets will have to be built around that factor. For the purpose of planning production and controlling costs, it is necessary to establish the normal level of activity of the business concern.

Normal level of activity is the level of activity at which the business concern is expected to operate under the present conditions. The budget estimates should also provide for necessary allowance to the made in the budget figures and suggest what the figure should have been with the level of activity actually attained.

Budget Officer is more or less the Secretary to the Budget Committee. But it should be remembered that Budget Controller does not control the preparation of budgets. He is an advisor and he does not issue instructions. Successful implementation of a budgetary control system depends upon the following essentials:. Budgeting alters the method, working, habits of personnel and their inter-relationship.

As such, there is bound to be some resistance to change. Further, budgets should be prepared and implemented by all managerial personnel. However, the impetus and direction should come from the top.

The wholehearted support of top management is bound to ensure the active support of the line managers also. The existence of a formal and sound organisation structure is of an absolute necessity for an effective system of budgetary control. Organisation structure, together with its pictorial representation, viz. Every member of the organisation knows clearly the scope of his authority and responsibility.

Establishment of budget centers is yet another essential of effective budgetary control system. Enterprise objectives representing goals should be clear and unambiguous. They should be equally realistic and capable of achievement. If goals are too high to be attained, the purpose of budgeting is defeated. The administration of budgets is also rendered useless. On the other hand, if the goals are so low that they can be attained very easily, there will be no incentive to special effort since such goals will not be a real challenge.

Every executive responsible for the implementation of budgets should be given an opportunity to take part in the preparation of budgets.

The work of preparing a budget manual should be entrusted to a Budget Committee. The manual should specify the steps to be taken to prepare budgets. It is also the duty of the Budget Committee to lay down the form in which budgets should be prepared. The work of scrutinising the budgets as well as approving of the same should be the work of this Committee.

Budgeting should not be partial, covering one or two business functions only. It should cover all the functions. Further, budgeting should not be a temporary phenomenon.

Once budgeting work is taken up, it should be made a permanent feature. Historical data form the basis for the budget estimates. As such, those who are involved in the preparation of estimates depend heavily on the accounting department. Further, figures in respect of actual costs and revenue are periodically compared with those of the budgeted figures. Budget procedures should, therefore, be developed in such a way that they employ the same Classification of accounts in respect of revenue and expenses as those of the accounting department.

If classifications are not similar, comparison would be meaningless. It is also necessary that the budgetary plan should follow the organisation chart and accounts should be classified in terms of authority and responsibility to facilitate the introduction of a system of responsibility accounting.

Budgetary control to be effective, there is the need to have a prompt and timely communication and reporting system. Periodic comparison of the actual performance with the budgeted standards may reveal variances. These variances should be reported by those responsible for execution, to their superiors.

In turn, they should get instructions for correction of deviations. Successful implementation of budgets depends, to a very large extent, upon the interest evinced by the supervisory personnel. The best way of making them actively interested in the budgetary control programme is to impart to them a continued budget education, by briefing them on the objectives, potentials and techniques of budgeting. It is also necessary for the budget director to come into close contact with the supervisory personnel.

He should discuss with them problems pertaining to budgets and welcome suggestions from them for improving budget procedures. Persons in the organisation responsible for budgeting and budget implementation should understand clearly the usefulness and limitations of budgeting. No one should entertain the feeling that budgets are imposed on the personnel and that he should participate mechanically in the preparation and implementation regardless of whether he likes it or not.

He should be made to appreciate the need for budgeting, knowing at the same time, and the limitations of budgetary control. Non-budgetary control devices support the successful functioning of the budgetary control system. The performance of the departments need to be captured and presented in terms of tables, charts and graphs from time to time for periodic assessment and review.

Analytical reports and industry trends and patterns need to be prepared in advance to provide a direction and guidance with the help of industry experts and specialists engaged for the specific task. This analysis shows the impact of changes in costs; volume of production and sales on profit. Also, it shows how much minimum volume is to be produced to cover the expenses and prevent losses.

This is also called profit planning and control tool. The purpose of Internal audit is to verify whether the financial transactions are properly reported, accounted for and reflected in the financial statements or not. The purpose of internal audit is to keep all accounts ready for external audit. Any type of irregularity or violation of accounting norms and standards are reported internally and these are addressed before the external audit commences. In other words, internal audit sets the tone and context for external audit.

To ensure that the projects are completed without any cost or time over runs, network analysis is deployed. Here the projects are analysed in terms of activities and events, identification of critical path, probability of completing the project within scheduled time, determination of cost slope and crashing the project so that the projects are completed within the schedules with optimum expenditure.

Standard costing is a process of formulating material standards, labour standards and overheads standards and verifying whether the actual expenses are within the given standard are not.

Where there is difference between the actual and standard expenses, it is called variance. Ratio analysis shows the relationship between two factors. Ratio analysis is a financial analysis tool used to examine whether the liquidity, solvency and profitability of the enterprise are within the acceptable standards or not.

Managers need to spend time by going around the departments, speaking to the employees so that they can get first-hand information about what is happening around. By going around the departments, senior managers may come across many issues which cannot be put on paper but critical in nature can be sorted out on time. Preparation of functional budgets is the planning function.

Their implementation is, however, the controlling function. As such, mere preparation of budgets does not serve any useful purpose. They should be implemented, i.

In the course of doing it, it is equally necessary to compare the actual performance with the budgeted performance. At the commencement of the budget period, each manager will receive a copy of the budget relating to his business segment.

Acting within his scope of authority, every departmental manager proceeds with the work of implementation of budget relating to his sphere of activity. If, in the course of implementation, it is found that everything proceeds exactly according to what is laid down in the budget, no deviation is said to occur.

The result revealed by the financial statements will coincide with that projected by the master budget. However, there may be deviations or discrepancies between the actual performance and budgeted performance. These deviations are of vital interest to management. The best way of bringing these deviations to the knowledge of management is through budget reports. In order that the budget programme may serve management as a control device, systematic plan of performance evaluation and reporting should be established.

Daily, weekly or monthly reports should be prepared by the cost office and sent to management. These reports should show comparison between the budgeted cost and actual cost as well as deviations, if any. The budget reports should be prepared in such a way that they locate the responsibility of a department or an executive for the deviations. While reporting, attention of management should be drawn to controllable costs.

A budget report is essentially a control report. As such, its utility is lost if it is not sent in time to the authorities responsible for control. However, the frequency of reports depends entirely upon the nature of duties of the executive using the report.

Control reports will, usually, be in the form of tabulated statements, although sometimes, the necessary information may be conveyed in the form of diagrams and charts.

Every report should have a distinct heading and it should mention the period covered. The names of persons preparing the reports as well as those receiving the same should be mentioned.

The report should be clear and concise. While reporting, the attention of management should be drawn only to the exceptions and not to those events and transactions which have proceeded as planned. Responsibility accounting is the method of accounting in which costs are identified with persons assigned to their control rather than with products of functions. In this system division of units of an organization under specified authority of a person are developed as a responsibility centre and evaluated individually for their performance.

A responsibility centre is a subunit of the organization whose manager is responsible for a specified set of activities. A responsibility centre may be a cost centre, a profit centre, or an investment centre. The manager of a cost centre is responsible for keeping costs within targets established by the budget. A profit centre manager is responsible for achieving the target profit.

A responsibility accounting system measures the operating results of responsibility centres. It facilitates the delegation of authority. Thus, this system provides autonomy without diluting controls. It is a new approach to budgeting which lays emphasis on work done or services rendered. It focuses attention on the physical aspects of achievement. In this new approach, there is not only a financial plan but also a work plan in terms of work done or end products produced or services rendered.

Performance budget tries to give a broader view as a programme of action rather than an instrument for obtaining funds. It is a more effective management control relating costs to results.

A precise definition of work to be done and a careful estimate of what that work will cost is made. It marks the integration of input with the outputs of a development programme.

Performance budgeting is essentially a process which involves the following steps:. Therefore, performance budgeting is one which looks to obtain the physical measures of work effort and results by establishing a relationship between financial and physical content of the programme. With the introduction of input output concept, an appropriation budget tries to establish fixed amount which can be applied to achieve the objectives of the organization.

Zero Base Budgeting ZBB starts from the position of zero previous expenditure and managers are required to justify all budgeted expenditures. It takes the view that every item of expenditure incurred in any activity should be re-evaluated and re-assessed and fixed. Actual figures of the last year are virtually ignored. The concept of zero-base budgeting is of recent origin and was originally developed by Peter A. Pyhr in Texas Instruments of U. Peter A. As an activity is budgeted, costs are objectively budgeted.

The assumption is that without such justification no spending will be allowed. Each manager is responsible to justify why the money should be spent at all and to explain in detail as to what would happen if the proposed activity is not carried out and no money is spent. Thus, each manager or functional head in the organisation, is required to make cost-benefit-analysis of each of the activities or projects under his control and for which he is responsible.

Zero-base Budgeting is more suitably applicable to discretionary cost areas. These costs may have no relation to volume or activity and generally arise as a result of management policies. Where standards are determinable, those costs associated with the inputs should be controlled through the use of standard costing. On the other hand, if output as a function of input cannot be specified.

Zero-base Budgeting may be more suitably applied. Thus, service or support- type activities are more suitable for Z. A decision unit refers to a tangible activity or group of activities for which a single manager has the responsibility for successful performance.

Thus, decision unit is a programme or a project or a segment of the organisation for which separate budgets are to be prepared. Preparation of decision packages is a set of documents which identify and describe activities of the unit in such a way that the management can evaluate and rank them against others competing for resources limited and decide whether to approve or disapprove.

The third step involved in Z. Funding involves the allocation of available resources of the organisation to various decision units keeping in mind the alternative which has been selected and approved through ranking process. ZBB is popular with Not-for-Profit organisations, local authorities and government departments. Manufacturing organisations use ZBB for service and support activities. Decision packages are evaluated using cost benefit analysis.

Step 3 — Decision packages are ranked based on cost benefit analysis. Uneconomical decision packages are excluded. It helps to allocate scarce resources of the organisation in a more efficient and equitable manner. It challenges the status quo and encourages a questioning approach to activities and expenditure. It requires considerable documentation. Wrong cost benefit analysis may hamper the future growth of the organisation.

For example, cutting of present advertisement costs may affect future sales. The real advantages of budgetary control will materialise when budget preparation is followed by a feed-back system. Reporting through well designed performance report is an integral part of budgetary control. A performance report is a document that periodically communicates to achieved, exceeded or not achieved.

A performance report will give the management an insight into the operational inefficiencies. There should be a separate performance report for each budget centre Performance report should be regularly made to the required level of management.

For designing a reporting system for an organisation, magnitude and multitude of its activities in relation to organizational structure will form major considerations. For each company a suitable system should be developed to conform to its requirements.

A comparison of actual results with budgeted results is an important facet of control. It is vital for the management to know the underlying causes of significant variations, because causes rather than the results provide the basis for appropriate corrective action. The variations should not be significant. Both favourable and unfavourable variations should be investigated, if they are significant. It should be noted whether variation was due to special managerial decision in order to improve efficiency or meet certain exigencies.

The maximum attention should be focused towards the variations for which precise underlying causes are not known. These variations are of primary concern to the management and should be carefully investigated.