43 Budgeting and Budgetary Control

43.1 What is a Budget?

A budget is a financial and quantitative plan, prepared in advance for a definite period of time, expressing the policies of management for that period. A budget is prospective — what the firm plans to do — while financial statements are retrospective — what the firm did.

The CIMA defines a budget as “a plan quantified in monetary terms, prepared and approved prior to a defined period of time, usually showing planned income to be generated and / or expenditure to be incurred during that period and the capital to be employed to attain a given objective” (cima2005?).

Three Working Definitions

Source	Definition	What it foregrounds
CIMA	“A plan quantified in monetary terms, prepared and approved prior to a defined period.”	Quantified plan
Brown & Howard	“A predetermined statement of management policy during a given period which provides a standard for comparison with the results actually achieved.”	Standard for comparison
ICMA	“A plan prepared for the operations of an organisation for a future period.”	Future-oriented

43.1.1 Budget vs Budgeting vs Budgetary Control

Three Related Terms

Term	What it is
Budget	The document — a quantified plan
Budgeting	The process of preparing the budget
Budgetary Control	The system of using budgets for performance control: compare actual to budget; analyse variance; act

43.2 Objectives of Budgeting

Six Objectives of a Budgeting System

Objective	What it does
Planning	Forces management to think ahead
Coordination	Aligns operations across departments
Communication	Conveys plans and expectations to all levels
Motivation	Targets motivate effort when appropriately set
Control	Performance is judged against the budget
Resource allocation	Decides where money goes

43.3 Types of Budgets

Budgets are classified by time horizon, function, level of activity, and purpose.

Classification of Budgets

Basis	Categories
Time	Short-term (≤ 1 year) · Medium-term (1–3 years) · Long-term (> 3 years)
Function	Sales · Production · Materials · Labour · Manufacturing Overhead · Selling & Distribution · Cash · Capital expenditure · R&D
Activity / behaviour	Fixed budget · Flexible budget
Coverage	Master budget · Functional budgets
Purpose / Approach	Traditional / Incremental · Zero-Based · Performance · Programme

43.3.1 Master budget and functional budgets

The master budget is the consolidated, summary budget — bringing together all functional budgets, projected income statement, projected balance sheet, and projected cash-flow statement. The functional budgets are the building blocks.

flowchart LR
  S[Sales Budget] --> P[Production Budget]
  P --> M[Materials Budget]
  P --> L[Labour Budget]
  P --> O[Mfg Overhead Budget]
  S --> SD[Selling &amp; Distribution Budget]
  M & L & O & SD --> C[Cash Budget]
  M & L & O & SD --> CB[Capex Budget]
  C & CB --> MB[Master Budget]
  style S fill:#E3F2FD,stroke:#1565C0
  style MB fill:#E8F5E9,stroke:#1B5E20

The sales budget is normally the starting point — production plans flow from sales, costs from production, cash from costs and sales.

43.3.2 Fixed vs flexible budgets

Fixed vs Flexible Budgets

Feature	Fixed Budget	Flexible Budget
Activity level	Single planned level	Multiple levels
Recognition of cost behaviour	Treats fixed and variable alike	Distinguishes fixed and variable
Use	Stable activity	Volatile activity
Comparability with actuals	Limited	Strong — re-base to actual activity

A flexible budget is the prerequisite for meaningful variance analysis — the basis of comparison should be the budget for the actual level of activity.

43.3.3 Cash budget

The cash budget is a short-term projection of cash inflows and outflows. Three methods of preparation:

Three Methods for Preparing the Cash Budget

Method	How it works
Receipts and Payments method	List all cash receipts and payments expected period by period
Adjusted Profit and Loss method	Start with budgeted profit; adjust for non-cash items
Balance-sheet method	Project the balance sheet; the closing cash falls out as the balancing figure

43.4 Approaches to Budgeting

The approach to setting the numbers matters more than the format. Four classical approaches:

Four Approaches to Budgeting

Approach	Idea	Strength	Weakness
Incremental / Traditional	Last year + adjustment	Simple, easy	Embeds inefficiencies
Zero-Based Budgeting (ZBB)	Build from zero each year; justify every expense	Removes legacy waste	Time-consuming
Performance Budgeting	Link expenditure to performance / outputs	Outcome focus	Hard to define outputs
Programme Budgeting (PPBS)	Group activities by programme / objective	Strategic clarity	Complex to administer
Activity-Based Budgeting (ABB)	Build budget from activities and their drivers	Aligns with ABC	Demands ABC infrastructure
Beyond Budgeting	Replace fixed budgets with rolling forecasts and relative targets	Adaptive	Cultural shift

43.4.1 Zero-Based Budgeting

Zero-Based Budgeting — proposed by Peter A. Pyhrr in the late 1960s and famously used by Jimmy Carter as Governor of Georgia — requires every expense to be justified each year, starting from a zero base (pyhrr1973?). The process:

Identify decision units.
Develop decision packages — alternative ways to perform each activity.
Rank packages.
Allocate resources to top-ranked packages within budget.

ZBB has had a revival as the 3G Capital method (Anheuser-Busch InBev, Kraft Heinz). The Government of India introduced ZBB in the early 1980s; it is referenced in the Union Budget process today.

43.4.2 Performance and Outcome Budgeting in India

The Indian Union Budget has gradually moved from line-item budgeting to Outcome Budgets — linking expenditure to measurable outputs and outcomes (introduced 2005-06).

43.5 Budgetary Control

Budgetary control is the system that uses budgets as a means of planning and controlling all aspects of producing and / or selling commodities or services. The five-step cycle:

The Budgetary-Control Cycle

#	Step
1	Establish budgets
2	Communicate to responsibility centres
3	Record actuals
4	Compare actuals with budget; compute variance
5	Investigate, report, and take corrective action

The two most-tested principles:

Responsibility accounting — match cost / revenue responsibility to the manager who controls it.
Management by exception — investigate only material variances.

43.5.1 Advantages and limitations

Advantages and Limitations of Budgetary Control

Advantages	Limitations
Forces planning and goal-setting	Forecasting accuracy is limited
Coordinates departments	Rigidity if not flexed
Measurable performance standards	Can foster gaming and sandbagging
Forces communication of policy	Time-consuming
Identifies inefficiencies early	Costly to install and maintain

43.6 Practice Questions

Q 01 Definition Easy

A budget is best defined as:

AA statement of past performance
BA financial and quantitative plan, prepared in advance for a defined period
CA type of audit
DA statutory compliance form

View solution

Correct Option: B

A budget is a plan — quantified, financial, and prepared in advance for a defined period.

Q 02 Master Budget Medium

The starting point in preparing functional budgets is normally the:

ACash budget
BProduction budget
CSales budget
DMaterials budget

View solution

Correct Option: C

The sales budget is usually the starting point — production plans flow from sales, costs from production, cash from both.

Q 03 Flexible Medium

A flexible budget is most useful when:

AActivity levels are stable and predictable
BActivity levels fluctuate significantly
CAll costs are fixed
DAll costs are variable

View solution

Correct Option: B

A flexible budget recognises cost behaviour and adjusts to multiple levels of activity. It is the foundation of meaningful variance analysis.

Q 04 ZBB Medium

Zero-Based Budgeting (ZBB) was popularised by:

APeter F. Drucker
BPeter A. Pyhrr
CRobert N. Anthony
DWilliam Ouchi

View solution

Correct Option: B

Peter A. Pyhrr developed ZBB at Texas Instruments in 1969-70; Jimmy Carter applied it as Governor of Georgia and later as US President.

Q 05 Outcome Budget Medium

India's Union Government introduced "Outcome Budgets", linking expenditure to measurable outputs and outcomes, from:

A1991-92
B2005-06
C2014-15
D2020-21

View solution

Correct Option: B

The Government of India introduced Outcome Budgets in 2005-06, with the explicit aim of linking expenditure to measurable outputs and outcomes.

Q 06 MbE Medium

"Investigate only material variances and let normal performance speak for itself" is the spirit of:

AManagement by Objectives (MBO)
BManagement by Exception (MbE)
CManagement by Wandering Around (MBWA)
DSix Sigma

View solution

Correct Option: B

Management by Exception — focus management attention only on significant deviations from plan.

Q 07 Cash Budget Medium

A cash budget can be prepared by which of the following methods?

AReceipts and Payments method
BAdjusted Profit and Loss method
CBalance-sheet method
DAll of the above

View solution

Correct Option: D

All three methods are recognised in CIMA / Indian texts. Receipts and Payments is the most direct.

Q 08 Approaches Medium

Match the budgeting approach with its description:

(i)	Incremental	(a)	Replace fixed budgets with rolling forecasts and relative targets
(ii)	Zero-Based	(b)	Build budget from activities and their cost drivers
(iii)	Activity-Based	(c)	Last year's budget + adjustment
(iv)	Beyond Budgeting	(d)	Justify every expense from a zero base each year

A(i)-(c), (ii)-(d), (iii)-(b), (iv)-(a)
B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
C(i)-(d), (ii)-(c), (iii)-(a), (iv)-(b)
D(i)-(b), (ii)-(a), (iii)-(d), (iv)-(c)

View solution

Correct Option: A

Incremental → previous year + adjustment; ZBB → start from zero; ABB → activity drivers; Beyond Budgeting → rolling forecasts.

Quick recall

Budget = quantified plan for a defined period. Budgeting = process; Budgetary control = system using budgets for control.
Six objectives: planning, coordination, communication, motivation, control, allocation.
Types: by time, function, activity (fixed/flexible), coverage (master/functional), purpose (incremental/ZBB/performance/programme/ABB/beyond budgeting).
Master budget consolidates functional budgets. Sales budget is the usual starting point.
Flexible budget > fixed budget for variance analysis when activity fluctuates.
ZBB: Pyhrr (1969-70). Carter applied it. India introduced Outcome Budget in 2005-06.
Cash budget: receipts-and-payments / adjusted P&L / balance-sheet method.
Two principles: Responsibility accounting + Management by Exception.