Definition And Importance Of A Budget Accounting Essay

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A budget is a document that translates plans into money - money that will need to be spent to get your planned activities done (expenditure) and money that will need to be generated to cover the costs of getting the work done (income). It is an estimate, or informed guess, about what you will need in monetary terms to do your work.

Importance of budget

The budget is an essential management tool-

The budget tells you how much money you need to carry out your activities.

The budget forces you to be rigorous in thinking through the implications of your activity planning. There are times when the realities of the budgeting process force you to rethink your action plans.

Used properly, the budget tells you when you will need certain amounts of money to carry out your activities.

The budget enables you to monitor your income and expenditure and identify any problems.

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The budget is a basis for financial accountability and transparency. When everyone can see how much should have been spent and received, they can ask informed questions about discrepancies.

You cannot raise money from donors unless you have a budget. Donors use the budget as a basis for deciding whether what you are asking for is reasonable and well-planned.

The order in which the four budgets would be prepared is as follows:-

• Sales budget- Sales Budget is one of the important functional budgets. Sales estimate is the commencement of budgeting may be made in quantitative terms. Sales budget is primarily concerned with forecasting of what products will be sold in what quantities and at what prices during the budget period. Sales budget is prepared by the sales executives taking into account number of relevant and influencing factors

• Finished stock budget- After preparing sales budget, production budget, direct materials budget, direct labour budget, and manufacturing overhead budget the management has all the data needed to calculate unit product cost. This calculation is needed for two reasons: first, to determine cost of goods sold on the budgeted income statement; and second, to know what amount to put on the balance sheet inventory account for unsold units. The carrying cost of unsold units is calculated on the ending inventory finished goods budget.

• Production budget- Production budget is usually prepared on the basis of sales budget. But it also takes into account the stock levels desired to be maintained. The estimated output of business firm during a budget period will be forecast in production budget. The production budget determines the level of activity of the produce business and facilities planning of production so as to maximum efficiency. The production budget is prepared by the chief executives of the production department. While preparing the production budget, the factors like estimated sales, availability of raw materials, plant capacity, availability of labour, budgeted stock requirements etc are carefully considered.

• Materials usage budget- Direct materials budget or materials budgeting details the materials that must be purchased to fulfil the production requirements and to provide for adequate inventories. 

Part-1

Define giving examples, the term principal budget factor and explain its importance in budgeting.

The principal budget factor is also known as the key factor or the limiting factor is the factor that is overriding at the given time in the planning of limitations on the organizational activities. This principal budget factor can also be the production capacity, materials, the Labour, finance or primarily the demand level for the goods and services. Due to the fact that these constraints can be pervasive and has effect on the operational budgets and plans for the limiting factor of the planning period cam be identified in order to have various budgets to develop regarding the expected limitations. This implies that does and can changes as the constraint for the removal of the limitation will occur and there will have no limitation of the activities of the organization. For the complex organization, the use of the principal budget factor is commonly simple yet the multi-products are divided wherein more factors can have the simultaneous operations. These also be optimize with the contribution of the organization in general and not only to maximize the contribution that are related to the limiting factor and cause sub-optimality.

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There are many methods of forecasting for the sales of the company and can also be considered as qualitative and quantitative forecasting methods. But, for the quantitative technique, it uses the statistical computations which include the computer simulation, the trend extensions for the pats data, and the economic models. The method which can be use in order to forecast the sales are the Time Series Methods, the Judgmental Method and the Causal Method. In the Time series methods, it can also be use the moving average whether simple or weighted and the exponential smoothing or simple or adjusted and the time series regression models which can estimate the dependent and the dependent variable.

The limiting factor must be identified during the budget preparation process

Examples of principal budget factors are:-

• Shortage of labour material

• Shortage of production capacity.

• Shortage of finance or working capital

• Shortage of demand for goods or services.

Part-2

Discuss the human behavioural problems associated with budgeting. Identify 3 behavioural problems associated with budgetary control.

Budgeting necessarily involves people, and their behaviour. Behavioural problems arise when managers' interests conflict, when budgets are imposed from above, when stretch goals are used, and when budgets are viewed as check-up devices or ends in themselves. For both managers and management accountants, budgets and the budgeting process can also raise ethical conflicts. Moreover, cultural differences can reduce the effectiveness of budgeting, especially for companies operating in several countries.

Budgeting is not considered by participants as a neutral, objective, purely technical process which is a view adopted by many accountants. The human subjective aspects cannot be overemphasized and these are dealt with below under the following headings: goal congruence, participation, motivation, goal definition and communication.

Behavioural problems associated with budgetary control are:

• Managers may complain that budgeting takes too much of their time;

• "Slacks" may be built into expenditure estimates and thus managers may lobby for a higher budget expenditure allowance.

• Co-operation and communication between managers might be minimal.

Part-3

Describe 4 benefits that a system of budgetary planning and control may bring to an organization.

4 benefits are:

• Maximum usage of company available resources;

• Corrective actions on adverse actual results;

• Can achieve the business' objective and

• A basis for measuring efficiency which is useful in rewarding employee.

Some other advantages of budgetary control are:

1. Maximization of Profit: The budgetary control aims at the maximization of profits of the enterprise. To achieve this aim, a proper planning and co-ordination of different functions is undertaken. There is proper control over various capital and revenue expenditures. The resources are put to the best possible use.

2. Co-ordination: The working of the different departments and sectors is properly co-ordinate. The budgets of different departments have a bearing on one another. The co-ordination of various executives and subordinates is necessary for achieving budgeted targets.

3. Specific Aims: The plans, policies and goals are decided by the top management. All efforts are put together to reach the common goal of the organization. Every department is given a target to be achieved. The efforts are directed towards achieving come specific aims. If there is no definite aim then the efforts will be wasted in pursuing different aims.

4. Tool for Measuring Performance: By providing targets to various departments, budgetary control provides a tool for measuring managerial performance. The budgeted targets are compared to actual results and deviations are determined. The performance of each department is reported to the top management. This system enables the introduction of management by exception.

5. Economy: The planning of expenditure will be systematic and there will be economy in spending. The finances will be put to optimum use. The benefits derived for the concern will ultimately extend to industry and then to national economy. The national resources will be used economically and wastage will be eliminated.