OUTLINE OF THE ASSIGNMENT

The report would give a detail on the following topics:

1. Budget
- What is a budget?
- Why budget?
- What are the characteristics of budgeting?
- What are its advantages?
- Problems of budgeting
- Budgeting cycle

2. Budgetary control
- What is budgetary control?
- Advantages of budgetary control?
- Applicability of budget and budgetary control

3. Meaning of strategic planning and forecasting

- Difference between strategic planning vs. Budgeting and forecasting vs. Budgeting

4. Budgetary control and responsibility centres

5. Types of budget
- What are the types of budget?
- What are its characteristics?
- Advantages and disadvantages
I. Introduction

Planning and control are major activities of management in all organisations. Budgets are
central to the process of planning and control. The involvement with budgets places the
management accountant as a key player in the provision of management information. Most
organisations employ some form of budgeting, those of any size have quite formal
mechanisms. A large survey of over 300 companies supported by ACCA, on which the author
was engaged, reported recently that almost all respondents used some form of budgeting and
budgetary control.

Budgets can be prepared for and used by anyone and anything. That is, we can prepare and
use personal budgets and organisations, ministries and non profit making organisations can
all use them.

Budgets, by definition, have to be prepared in advance; and for this reason, they are often
referred to in terms of their being part of a feed forward system. Feedback is a term
frequently heard both in accounting and ordinary use. Feed forward, on the other hand tends
to be less frequently heard, yet this word incorporates the most important aspect of budgeting:
looking at situations in advance, thinking about the impact and implications of things in
advance, and attempting to take control of situations in advance.

Budgets

A budget is a plan expressed in quantitative and money terms. Budgets need to be prepared
and approved in advance of the period in which they are to be used. Budgets can include
some or all of income, expenditure, and the capital to be employed. Moreover, a budget can
be drawn up for an entire organization, any segment of the organization such as a department
or sales territory or division, or for a significant activity such as the production and sale of a
specific product.
We should also add that a budget can include non monetary as well as monetary information
in it.

Budgets and management behaviour

Some would argue that any problems which arise out of the budget system are a result of how
managers use the information provided by it and how such use affects the information that is
entered into the budget. That is, budgets have implications for human behaviour. A few
points on this are briefly mentioned below, note that the syllabus for paper 8 does require
appreciation of behavioural issues at an introductory level.

Budgets as targets

From many psychological studies it is pointed out that better performance is achieved when
targets exist than when this is not the case. Furthermore, demanding targets extract better
performance than weak ones. This is up to a point, totally unattainable targets tend to be
counterproductive. The precision which is applied to a target is seen to be important because
if targets are not accepted by an individual, then poorer performance may result from that
person’s ‘withdrawal’ from the task than would apply if a less demanding target had been set.
It is also important that managers achieve their targets frequently enough to give the positive
reinforcement in their efforts. A practical consequence of this is that a budget which might
get the best performance out of a manager, a demanding target, is unlikely to be achieved
most of the time. It is not therefore, a useful forecast of actual outturn. Conversely a budget
that is an accurate forecast of what is likely to be achieved will only motivate a modest level
of performance.

Budget as forecasts

General observations and academic experiments have suggested that managers behave
conservatively when required to make budgets which are to be used as forecasts for future
achievement. That is, they under estimate sales and over estimate costs. They see it as in their
interests to incorporate ‘slack’ into the budget. Managers also engage in games of building up
slack in good years and converting it to reported profit in poor years. Conversely, there are
observations from other studies that some managers, after a run of mediocre results,
deliberately overstate revenues and understate cost estimates. They no doubt feel the need to
make an immediate favourable impact by promising better performance in the future. It may
be, of course, that this merely delays the problem for which these managers are subsequently
censured when they fail to hit these optimistic targets.

Budgets in performance evaluation

A further use of budgets is as a basis for setting performance standards and rewards, for
example, bonus, status or enhanced promotion prospects are often linked to budget
attainment. Organisations are complex, tasks are interdependent, there are many dimensions
of performance and these are not all easily quantified and certainly not in financial terms.
Problems can occur here because the budgets are quite narrow specifications of what are
desired organisational outcomes.

Placing emphasis on budget achievement can have repercussions on other, perhaps long-term,
aspects of organisational performance. Management might not place emphasis on other
important aspects of their jobs such as maintaining quality or staff morale if, as a
consequence, they run the risk of not achieving the financial budget. Alternatively, stressing
the need to achieve these budget results may result in the budget being met but this may be as
a result of manipulation by managers of both the budget and actual results.

The budgeting process

It would be easy to dismiss the budgeting process as beginning when the first budget is
prepared, and as being complete when the master budget is finalised. In reality, the budgeting
process begins for many organisations a long time before the budget period begins; and the
process ends once the budget period has ended. This means the budgeting process is a very
lengthy process: typically, for a large organisation, the pre budgeting phase can begin up to a
year before the budget period starts.

Jones and Pendlebury (1984), give us some insight into the beginning of the budgeting cycle
when they present a "Timetable for preparation of detailed revenue budget and capital
programme" for a Local Authority. They show that the process starts in June in the year
preceding the budget period with the draft budget manual being sent to Finance Officers, who
will discuss this draft with their departmental staff (with a view to adoption or amendment).
The budgetary planning phase is completed in March (ready for an April start) when the
printed budget book is published and the approved estimates are put into the financial control
system. (Colville (1989) presents a similar view, but this time of the budgeting for a Police
Authority in the UK).

The budget period

The budget period is the period for which a set of budgets is prepared: typically the budget
period is of one year's duration, and will be designed to coincide with an organisation's
financial, or fiscal, year. There is no reason why a budget period has to be one year, but
typically it is.

On the other hand, if we are dealing with a project, then the budget will clearly be linked to
that project. A three month project will have a budget covering the whole project and will
thus be a three months budget.

Most organisations will divide their budget period into calendar months (or periods); whereas
others have thirteen period years (all of an equal four week period). In certain situations, the
budget period will be analysed according some particular feature of the work in that situation:
for example, stockbrokers have their year divided into "accounts" of two and three weeks'
duration. These divisions of a budget period are control periods.

The benefits of budgeting

Many of us prepare budgets on a personal level: how much is my income for the month? How
much am I going to spend? and, most importantly, is there anything left over? It seems true,
however, that many businessmen do not prepare budgets for their businesses. Thus, even
though managers prepare budgets for their relatively simple lives, when it comes to the much
more complex situation of their business, they prefer to let cash inflows and outflows look
after themselves. The purpose of this part of the chapter is to demonstrate that budgets are
useful, informative and communicative. We will see that a budget is a necessity not a luxury.

We will also see some of the problems underlying organisations: the nature of the
organisation and the interactions of the people working in them. By considering these
problems, we will be considering ways in which your budgeting system, or the organisation
itself, can be changed, if necessary, to overcome them.
Problems in budgeting

Whilst budgets may be an essential part of any marketing activity they do have a number of
disadvantages, particularly in perception terms.

· Budgets can be seen as pressure devices imposed by management, thus resulting in:
a) Bad labour relations
b) inaccurate record-keeping.

· Departmental conflict arises due to:

a) Disputes over resource allocation

b) departments blaming each other if targets are not attained.

· It is difficult to reconcile personal/individual and corporate goals.

· Waste may arise as managers adopt the view, "we had better spend it or we will lose it".
This is often coupled with "empire building" in order to enhance the prestige of a department.

Responsibility versus controlling, i.e. some costs are under the influence of more than one
person, e.g. power costs.

· Managers may overestimate costs so that they will not be blamed in the future should they
overspend.

The Budget Cycle

As the financial component of program planning, budgeting should begin with the overall
goals of the LEA/school technology plan and the school’s instructional program as outlined
in the school improvement plan—and these goals should be reflected in the budget priorities
and details.

Effective budget development is a continuous cyclical process. Wise budget planners

continuously complete the cycle of steps shown.
II. Budgetary Control

Budgets are simply exercises in calculation unless they are used. When we use a budget, we
do so as part of a system of budgetary control. That is, we have some basic ideas of what we
want to do, we prepare budgets to help us achieve those ideas; and then once we have done
whatever it is that we wanted to do, we check to see if we kept to our budget.

Budgetary control relates to the establishment of budgets relating the responsibilities of

budget holders the needs of a policy. Budgetary control also relates to the continuous
comparison of actual with budgeted results: it does this to try to ensure that the objectives of
that policy are achieved; or to provide a basis for the change of those objectives.

In summary, a budget is a statement setting out the monetary, numerical or non quantitative
aspects of an organisation's plans for the coming week or month or year. Budgetary control is
the analysis of what happened when those plans came to be put into practice, and what the
organisation did or did not do to correct for any variations from these plans.

Advantages of budgeting and budgetary control

There are a number of advantages to budgeting and budgetary control:

· Compels management to think about the future, which is probably the most important
feature of a budgetary planning and control system. Forces management to look ahead, to set
out detailed plans for achieving the targets for each department, operation and (ideally) each
manager, to anticipate and give the organisation purpose and direction.

· Promotes coordination and communication.

· Clearly defines areas of responsibility. Requires managers of budget centres to be made

responsible for the achievement of budget targets for the operations under their personal
control.

· Provides a basis for performance appraisal (variance analysis). A budget is basically a

yardstick against which actual performance is measured and assessed. Control is provided by
comparisons of actual results against budget plan. Departures from budget can then be
investigated and the reasons for the differences can be divided into controllable and non-
controllable factors.

· Enables remedial action to be taken as variances emerge.

· Motivates employees by participating in the setting of budgets.

· Improves the allocation of scarce resources.

· Economises management time by using the management by exception principle.

Applicability of Budgeting and Budgetary Control

Budgeting can be applied to virtually every situation. It does not matter whether we work in
the Public or Private Sector of the Economy. We may work for a profit making business or a
non profit making business. Your company may be engaged in trading, manufacturing, or
providing a service. In all of these situations, budgeting and budgetary control is of use to
you.

As we will see, there are many issues underlying the use of a budgeting system that need
careful consideration. For example, we will see that budgeting systems cannot just be
imposed on an organisation nor do they run themselves. Managers at all levels often resent
budgets and budget targets for a variety of reasons.
III. Difference between strategic planning, budgeting and forecasting

The requirement for accurate and timely forecasting of corporate results increases every day.
Fuelled by the demands of the web-driven world for instant access to information, financial
managers are expected to be able to predict the financial and operational impact of each big
decision in days, or even hours. The truth is often far removed – most management
accountants still rely on a planning methodology designed in the early Twentieth Century and
a bewildering tower of spreadsheets. Long hours, questionable accuracy, and the ever-present
danger of the spreadsheet tower collapsing under the strain mean that most financial
managers dread the planning process. In the first of a series of six articles, FSN contributing
editor Steve Bows examines aspects of a new process for the Twenty-First Century that
combines best-practice techniques with the latest in enabling technology to help take the
stress out of the planning cycle.
The Planning Cycle

Most organisations currently plan their business on an annual cycle structured around the
financial year – top-down strategic planning by senior management starts about six months
out, leading into the annual budget, a detailed bottom-up exercise designed to align proposed
cost centre expenditure with the top-down plan for the coming year. Once the new year starts,
and the first month's actuals are in, the budget will start to be revised in a forecasting process
that tends to be high-level, quarterly and less structured than the annual budget.
Out of these three distinct planning activities, it is the annual budget process that leads to
most dissatisfaction amongst all concerned, and consumes most time and money. Based on an
outdated model of a command-and-control business structure, the process engenders mistrust
between senior and middle management as both sides engage in a highly-charged political
battle to secure a lower or higher cost budget respectively for the year ahead. This battle can
rage for months, distracting attention from external events and draining the energy of all
involved.

Worst of all, the hard-fought budget outcome becomes redundant within a matter of months,
being overtaken by back-of-an-envelope forecast calculations that are produced in a hurry by
senior management, in response to changing market conditions or big new ideas. Often this
forecast "process" is carried out without consulting the cost centres, further undermining the
morale of middle management.

IV. Budgetary control and responsibility centres

Responsibility Centres

A responsibility centre is an organizational subsystem charged with a well-defined mission

and headed by a manager accountable for the performance of the centre. "Responsibility
centres constitute the primary building blocks for management control." It is also the
fundamental unit of analysis of a budget control system. A responsibility centre is an
organization unit headed by a responsible manager.
There are four major types of responsibility centres: cost centres, revenues centres, profit
centres and investment centres.

Cost Centre

A cost centre is a responsibility centre in which manager is held responsible for

controlling cost inputs. There are two general types of cost centres: engineered
expense centres and discretionary expense centres. Engineered costs are usually
expressed as standard costs. A discretionary expense centre is a responsibility centre
whose budgetary performance is based on achieving its goals by operating within
predetermined expense constraints set through managerial judgement or discretion.

Revenue Centre
 A revenue centre is a responsibility centre whose budgetary performance is measured
primarily by its ability to generate a specified level of revenue.

Profit Centre

In a profit centre, the budget measures the difference between revenues and costs.

Investment Centre

An investment centre is a responsibility centre whose budgetary performance is based

on return on investment. The uses of responsibility centres depend to a great extent on
the type of organization structure involved. Engineered cost centres, discretionary
expense centre, and revenue centres are more often used with functional
organization designs and with the function units in a matrix design.
In contrast, with a divisional organization designs, it is possible use profit centres
because the large divisions in such a structure usually have control over both the
expenses and the revenues associated with profits

V. Types of budget

1. Zero based budgeting

Purpose of Zero-Base Budgeting

The Objective of Zero Based Budgeting is to “reset the clock” each year. The
Traditional incremental budgeting assumes that there is a guaranteed budgetary base-the
previous year’ level of appropriations -and the only question is how much of an increment
will be given. Zero Based Budgeting implies that managers need to build a budget from the
ground up, building a case for their spending as if no baseline existed- to start at zero.
Resources are not necessarily allocated in accordance with previous patterns and
consequently each existing item of expenditure has to be annually re-justified.

Put differently, the purpose of ZBB is to reevaluate and reexamine all programs and
expenditures for each budgeting cycle by analyzing workload and efficiency measures to
determine priorities or alternative levels of funding for each program or expenditure. Through
this system, each program is justified in its entirety each time a new budget is developed.
Historical development of ZBB

ZBB or some modified version of it, has been used in the private- and public -sectors for
decades. The first known application of zero-base budgeting was by the U.S Department of
Agriculture in 1962. However, the general problem of incremental budgeting that zero-base
budgeting attempts to solve has been recognized from a much earlier period.

Indeed, the major next application of ZBB in government has been tracked back to
GOV. Jimmy Carter’s use of it in Georgia in the early 1970s.

In the private sector, the major leap forward occurred with the development at Texas
Instruments Inc. of a way to handle the mass of data. This involved the implementation of a
“Decision Package” approach to prepare the 1970 budget for the Staff & Research Divisions.

Applications of ZBB

The practical application of ZBB involves the use of the “Decision Package”. All budgetary
procedures involve an identification of organizational objectives. In the context of these
objectives, ZBB involves three stages:

1. Identification of decision units.

2. Development of decision package.

3. Review and ranking of decision packages.

Advantages of ZBB

• ZBB unlike incremental traditional line item budget, it dose not assume that last
year’s allocation of resources is necessarily appropriate for the current year, all the
functions of an organization are re-evaluated annually from a zero base. The
systematic nature of such a fundamental review imposes a discipline on the
organization which has produced in practice secondary advantages;
• It produces in a readily accessible form more and better management information.
This in turn will improve the quality of management’s decision.
• Another advantage that stems from this improved management information is that
its production involves the participation of lower - level management in the
 budgetary process, and the smaller the decision units, the greater this involvement
will become.
• Unexpected events that occur during the financial year can be more readily
adjusted for. This is because the basic information for modifying goals has already
been generated.
• If implemented well, ZBB can eliminate a sense of “entitlement” to cost increases.
• Improved discipline in developing budgets.
• More meaningful budget discussions during plan review sessions.

Disadvantages of ZBB

• ZBB vastly overestimates man’s ability to calculate.

• In practice the effects of different levels of effort on each alternative mutually
exclusive decision package are not considered, due to the short budgetary cycle
and the need for expediency. But this might lead to a sub-optimal allocation of
resources.
• By incorporating performance measures in the formation of decision packages, it
forces managers to establish a preference for effectiveness, efficiency, or equity as
they try to rank decision packages. This make the ranking process difficult.
• The use of cutoff point for packages is different in public agencies. As a result,
when funds become tight, even in ZBB systems, each department is asked to make
marginal reductions, rather than eliminate the lowest ranked programs.
• The implementation of a ZBB system requires a great deal of time on the part of
agency staff, limiting their ability to perform other important functions.
• Attempts by agencies to manipulate priority listings by ranking popular items
lower than items that would have little chance of funding.
• Established programs have political support and they will continue to receive their
share of the budget regardless of any analysis produced.
2. Performance budgeting

Tight budgets and demanding citizens put governments under increasing pressure to show
that they are providing good value for money. Providing information about public sector
performance can satisfy the public’s need to know, and could also be a useful tool for
governments to evaluate their performance.

Performance information is not a new concept, but the governments of OECD countries have
taken a closer look at integrating it into the budget process in the past decade as part of efforts
to improve decision making by moving the focus away from inputs (“how much money will I
get?”) towards measurable results (“what can I achieve with this money?”).

The introduction of performance budgeting has been linked to broader efforts to improve
expenditure control as well as public sector efficiency and performance. Thus, performance
budgeting can be combined with increased flexibility for managers in return for stronger
accountability for the results, so as to enable them to decide how to best deliver public
services.

Performance information is a fairly simple concept: providing information on whether

programmes, agencies and public service providers are doing the job required of them
effectively and efficiently. Performance information has a long history in OECD countries:
most of them have been working on it for at least five years, and almost half of them for more
than ten.

Much of this information does find its way into budget documents, but simply including
information on performance in budget documents is a long way from performance budgeting.
If governments want to use performance information in budget setting, they need to find a
way to integrate performance into the budget decision process, not just the budget paperwork.

To complicate matters, there are no single agreed standard definitions of performance

budgeting, of the type of information it should include, or of the stage of the budget process
when it should be introduced. There is also the question of whether performance information
should be used in deciding how to allocate resources and, if so, how.

There is no single model of performance budgeting. Even when countries have adopted
similar models, they have taken diverse approaches to implementing them and have adapted
them to their own national capacities, cultures and priorities.
The OECD has defined performance budgeting as budgeting that links the funds allocated to
measurable results. There are three broad types: presentational, performance-informed, and
direct performance budgeting.

Presentational performance budgeting simply means that performance information is

presented in budget documents or other government documents. The information can refer to
targets, or results, or both, and is included as background information for accountability and
dialogue with legislators and citizens on public policy issues. The performance information is
not intended to play a role in decision making and does not do so.

In performance-informed budgeting, resources are indirectly related to proposed future

performance or to past performance. The performance information is important in the budget
decision-making process, but does not determine the amount of resources allocated and does
not have a predefined weight in the decisions. Performance information is used along with
other information in the decision-making process.

Direct performance budgeting involves allocating resources based on results achieved. This
form of performance budgeting is used only in specific sectors in a limited number of OECD
countries. For example, the number of students who graduate with a Master’s degree will
determine the following year’s funding for the university running the programme.

3. Flexible budgeting

A budget is a plan for the future. Hence, budgets are planning tools, and they are usually
prepared prior to the start of the period being budgeted. However, the comparison of the
budget to actual results provides valuable information about performance. Therefore, budgets
are both planning tools and performance evaluation tools.

Usually, the single most important input in the budget is some measure of anticipated output.
For a factory, this measure of output is the number of units of each product produced. For a
retailer, it might be the number of units of each product sold. For a hospital, it is the number
of patient days (the number of patient admissions multiplied by the average length of stay).

The static budget is the budget that is based on this projected level of output, prior to the
start of the period. In other words, the static budget is the “original” budget. The static
budget variance is the difference between any line-item in this original budget and the
corresponding line-item from the statement of actual results. Often, the line-item of most
interest is the “bottom line”: total cost of production for the factory and other cost centers; net
income for profit centers.

The flexible budget is a performance evaluation tool. It cannot be prepared before the end of
the period. A flexible budget adjusts the static budget for the actual level of output. The
flexible budget asks the question: “If I had known at the beginning of the period what my
output volume (units produced or units sold) would be, what would my budget have looked
like?” The motivation for the flexible budget is to compare apples to apples. If the factory
actually produced 10,000 units, then management should compare actual factory costs for
10,000 units to what the factory should have spent to make 10,000 units, not to what the
factory should have spent to make 9,000 units or 11,000 units or any other production level.

The flexible budget variance is the difference between any line-item in the flexible budget
and the corresponding line-item from the statement of actual results.

The following steps are used to prepare a flexible budget:

1. Determine the budgeted variable cost per unit of output. Also determine the budgeted
sales price per unit of output, if the entity to which the budget applies generates
revenue (e.g., the retailer or the hospital).

2. Determine the budgeted level of fixed costs.

3. Determine the actual volume of output achieved (e.g., units produced for a factory,
units sold for a retailer, patient days for a hospital).

4. Build the flexible budget based on the budgeted cost information from steps 1 and 2,
and the actual volume of output from step 3.

Flexible budgets are prepared at the end of the period, when actual output is known.
However, the same steps described above for creating the flexible budget can be used prior to
the start of the period to anticipate costs and revenues for any projected level of output, where
the projected level of output is incorporated at step 3. If these steps are applied to various
anticipated levels of output, the analysis is called pro forma analysis. Pro forma analysis is
useful for planning purposes. For example, if next year’s sales are double this year’s sales,
what will be the company’s cash, materials, and labor requirements in order to meet
production needs?

Pro Forma Analysis at XYZ Ltd:

Following are pro forma monthly income statements for XYZ Ltd, a small, start-up fashion
jeans manufacturer. The pro forma analysis was prepared at the beginning of the month and
considered three alternative sales levels. The company has no variable marketing costs.
XYZ LTD
PRO FORMA ANALYSIS
FOR THE UPCOMING MONTH
Income Budgeted Pro Forma Analysis for
Statement amount perAlternative Output Levels
line-item unit
10,000 units 20,000 units 30,000 units
Revenue $40 $400,000 $800,000 $1,200,000

Variable costs:
Materials 15 150,000 300,000 450,000
Labor 10 100,000 200,000 300,000
Overhead 5 50,000 100,000 150,000
Total 30 300,000 600,000 900,000

Contribution margin $10 100,000 200,000 300,000

Fixed costs:
Manufacturing
Overhead 100,000 100,000 100,000
Marketing costs 50,000 50,000 50,000
Total fixed costs 150,000 150,000 150,000

Operating income ($50,000) $50,000 $150,000

Since by definition, fixed costs are not expected to change as volume of output changes
within the relevant range, fixed costs remain the same at all three projected levels of output.
Revenue and variable costs vary with output in a linear fashion. Hence, when output increases
100% from 10,000 units to 20,000 units, revenue, each line-item for variable costs, and
contribution margin all increase 100%.

Static Budget Variance at XYZ Ltd:

XYZ Ltd management decides that 10,000 units is the most likely output volume, and sets the
static budget based on this sales and production level. After the end of the month, company
personnel prepare the following table, showing the static budget, actual results, and the static
budget variance.
 XYZ LTD
STATIC BUDGET VARIANCE
FOR THE MONTH JUST ENDED
Income Budgeted Static Actual Static
Statement amount per Budget Results Budget
line-item unit (A) (B) Variance
10,000 units 16,000 units (A) – (B)
Revenue $40 $400,000 $670,000 $270,000

Variable costs:
Materials 15 150,000 230,000 (80,000)
Labor 10 100,000 167,000 (67,000)
Overhead 5 50,000 84,000 (34,000)
Total 30 300,000 481,000 (181,000)

Contribution margin $10 100,000 189,000 89,000

Fixed costs:
Manufacturing Overhead 100,000 105,000 (5,000)
Marketing costs 50,000 49,000 1,000.
Total fixed costs 150,000 154,000 (4,000)

Operating income ($50,000) $35,000 $85,000

In the variance column, positive numbers are favorable variances (good news), and negative
numbers are unfavorable (bad news).

The static budget variance shows a large favorable variance for revenue, and large
unfavorable variances for variable costs. These large variances are due primarily to the fact
that the static budget was built on an output level of 10,000 units, while the company actually
made and sold 16,000 units. The revenue variance might also be due to an average unit sales
price that differed from budget. The variable cost variances might also be due to input prices
that differed from budget (e.g., the price of fabric), or input quantities that differed from the
per-unit budgeted amounts (e.g., yards of fabric per pair of pants).

There are also small variances for fixed costs. These costs should not vary with the level of
output (at least within the relevant range). However, many factors can cause actual fixed costs
to differ from budgeted fixed costs that are unrelated to output volume. For example, property
tax rates and the fixed salaries of front office personnel can change, and depreciation expense
can change if unexpected capital acquisitions or dispositions occur.

The Flexible Budget Variance at XYZ Ltd:

In order to better understand the causes of the large revenue and variable cost variances in the
static budget variance column, XYZ Ltd personnel prepare the following flexible budget.

XYZ LTD
FLEXIBLE BUDGET VARIANCE
 FOR THE MONTH JUST ENDED
Income Budgeted Flexible Actual Flexible
Statement amount per Budget Results Budget
line-item unit (A) (B) Variance
16,000 units 16,000 units (A) – (B)
Revenue $40 $640,000 $670,000 $30,000

Variable costs:
Materials 15 240,000 230,000 10,000
Labor 10 160,000 167,000 (7,000)
Overhead 5 80,000 84,000 (4,000)
Total 30 480,000 481,000 (1,000)

Contribution margin $10 160,000 189,000 29,000

Fixed costs:
Manufacturing Overhead 100,000 105,000 (5,000)
Marketing costs 50,000 49,000 1,000.
Total fixed costs 150,000 154,000 (4,000)

Operating income $10,000 $35,000 $25,000

Once again, positive variances are favorable (good news), and negative variances are
unfavorable (bad news).

From this table, XYZ Ltd management sees that even after adjusting for sales volume,
revenue was higher than would have been expected. The favorable $30,000 variance must be
due entirely to an average sales price that was higher than planned (almost $42 per pair
compared to the original budget of $40 per pair).
Materials costs were lower than would have been expected for a sales volume of 16,000
units. This favorable variance could be due to lower fabric prices, or to more efficient
utilization of fabric (less waste than expected), or a combination of these two factors. Labor
and overhead were higher than expected, even after adjusting for the sales volume of 16,000
units. This unfavorable flexible budget variance implies that either wage rates were higher
than planned, or labor was not as efficient as planned, or both. Similarly, the components of
variable overhead were either more expensive than budgeted, or were used more intensively
than budgeted. For example, electric rates might have been higher than planned, or more
electricity was used than planned per unit of output.

The fixed cost variances are identical in this table to the previous table. In other words, the
flexible budget and flexible budget variance provide no additional information about fixed
costs beyond what can be learned from the static budget variance.

Learning Objectives
• An indication and explanation of the importance of budgetary control as a control
technique
• An overview of the advantages and disadvantages of budgeting
• Difference between strategic planning, budgeting and forecasting
• An introduction to the types of budgets
• Relation of Budgetary control and responsibility centres
 A Report

on

BUDGETARY CONTROL

Submitted to
Mr. Ajay Shah

Submitted by:
Abhilash Guddi
Gowri T R
Pranavi N P
Saurabh Priyadarshi
Vignesh Prabhu
(SECTION A)