CHAPTER TWO LITERATURE REVIEW 2.

0 Meaning and Definition of Budget A budget is a plan expressed in terms of money and resources. It is prepared and approved prior to the period to which it relates and may show income to be earned, expenditure to be incurred and the capital to be employed to attain given objectives. For convenience, budgets are usually grouped together in the same way that financial statements are arranged. Budget items, which are the individual items for which values shown in a budget stand for, are quite often the same items that one finds in the organizations final accounts. Budgets, however often do contain a lot of additional data that may not be found in financial statements, because unlike financial statements, budgets are prepared mainly for internal use. Example, Budgeted income statement, Budgeted balance sheet etc. Thus, budgets may contain non-monetary data reflecting planned requirements for and utilization of resources. Therefore, budget can be defined as a financial and/or quantitative statement, prepared and approved prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a give objective. (CIMA Journal of Accountants) 2.1 Reasons for budget formulation. Budgets facilitate communication, different departments use budget to communicate performance. Budget facilitates coordination, i.e. it forces individual sub units to work together in the organization. Budget motivates managers to achieve the organizational goals. Budget is helpful in controlling whether the organization is running the organization plan. Budget is helpful in performance evaluation within the departments and the organization as a whole. 2.2 Preparation and Administration of Budget Haper W (1976) explained that preparation of budget depends much on the policies of the firm. In some organizations, budgets were prepared exclusively by the top management without

involving the subordinates. The effectiveness of these budgets depends on how the organization is organized and its nature. Other budgets were prepared from the subordinates and finally the top management basing on the recommendation by the subordinates. If the organization is highly spread, may be throughout the country in various zones, regions, districts, departments and units then the budgeting process had to begun from these units, consolidated departments wise, district wise and then regional wise. According to Owler L. W and JL Brown (1985), in large companies the preparation of budget is usually the responsibility of a budget committee. Normally the chief executive is the chairman of the committee, but the responsibility for operating is undertaken by the budget officer. The budget officer is a senior member of the accounting staff. Other members of the committee may be representatives of various departments e.g. sales, purchases, production and engineering. In small companies the preparation is usually the responsibility of the cost accountant or the accountant. The budget committee will formulate a general programme for the preparation of the budget and then the budget officer will be responsible for such functions as; i. ii. iii. iv. v. vi. Receiving and checking budget estimates from managers and help them in their forecasting. Suggesting possible revisions. Discussing difficulties with managers. Ensuring the managers prepare the budgets in time. Prepare budget summaries. Submitting budget to the committee and furnishing explanations on particular points.

As said above, an organization will establish a budget committee that will be made up of the senior representatives who represent the major subunit of the firm. Drury C. (2004) wrote that a budget committee should consist of high-level executives who represent the major segments of the business. Its major task is to ensure that budgets are realistically established and that they are coordinated satisfactorily. Shah P. (2002) wrote that a budget committee is a management committee that brings together activities of all departments in a coordinated way and control those activities in an effective manner. It should have an advisory role only but its advice is very significant and is usually carried out by managers As its first function the committee decide on general polices for the organization and reviews and supplies economic information. It sees that all departments prepare budgets, provides them

with technical advice whenever needed and reviews individual budget estimates. On reviewing budget estimates it may suggest modification, and after necessary revision, the budget will be finally approved by the budget committee. The committee also ensures that the budget goals of the departments are not in conflict with the enterprises objectives. It coordinates the budgetary activities of various departments and reconciles the divergent views of the line executives. The budget committee also enforces control by scrutinizing the budget reports and determining the responsibility for favorable and unfavorable results. 2.3 Stages in the budgeting process. Drury C. (2004); the whole budget process has been divided into stages, which must be followed to come up with an effective budget. The stages are eight, running from gross root communication to budget review. The stages are:i. Communicating details of budget policy and guidelines to those people responsible for preparation of budgets. The persons responsible for budget preparation are placed at various levels of the organisation. The bottom line is composed with persons dealing with routine operations like engineering, marketing or accounting. Therefore, the management communicates the details to those personnel. ii. iii. Determining the factors that restrict output. This involves determining factors like shortage, traffic, trade union pressure and the like. Preparation of sales/revenue budget. Under this stage, the personnel in the cargo traffic section estimate revenue that may be collected in the subsequent financial period and prepare a budget. iv. Initial preparation of various budgets. Like in the preparation of revenue budget, the personnel in various departments like the casual labourers department estimate revenue or expenditure, as the case may be for individual departments. v. Negotiation with supervisors. After the departmental heads have prepared the budgets for their respective departments they are required to negotiate the contents of the budgets with their superiors. If the budgets are rejected re-preparation is a must. vi. Coordination and review of budgets under this stage the budgets so prepared by the individual department are coordinated and reviewed to bring about harmony among them and with time. vii. Financial acceptance of budgets. This stage involves the management arriving at a decision whether or not to accept the budget.

viii.

On-going review of budgets. As it is important to keep more with time and changing economic condition, this stage is involved in the review of the budget in connection with time and economy.

2.4 The Budgetary Process in Non-Profit Making Organization Non-profit organization (abbreviated NPO) is a legally constituted organization whose primary objective is to support or to actively engage in activities of public or private interest without any commercial or monetary profit purposes. This implies that, the organization is required by law, not to hold profits like a for profit organization can. This means that the non profit organization is required by law to redistribute any profits back into the organization (in the form of salaries, new capital etc). This also means that non profit companies do not have the ability to sell stock and therefore, do not have to pay dividends on any earnings, Furthermore, non profit companies are required to have a board of directors to help run the organization. NPO are active in a wide range of areas, including the environment, humanitarian aid, animal protection, education, the arts, social issues, charities, early childhood education, health care, politics, religion, research, sports or other endeavours. The budgetary process in a non-profit-making organization normally begins with the managers of the various activities calculating the expected costs of maintaining current activities and then adding to those costs any further development of the services that are considered desirable. One difficulty encountered in non-profit-making organizations is that precise objectives are difficult to define in a quantifiable way and the actual accomplishments are even more difficult to measure. In most situations outputs cannot be measured in monetary terms. By outputs we mean the quality and amount of the services rendered. Means of funding the planned activities will then be thought, if enough funds are not obtained or promised some planned activities may have to be phased out. In profit-oriented organizations output can be measured in terms of sales revenues. The effect of this is that, for the budgets in non-profit organizations, there is no the same emphasis on what was intended to be achieved for a given input of resources. The budgeting process tends to compare what is happening in cash input terms with the estimated cash inputs. In other words, there is little emphasis on measures of managerial performance in terms of the results achieved. The reason for this is that there is no clear relationship between resource inputs and the benefits flowing from the use of these resources. (Drury C. 2004)

2.5 Approaches to budget formulation Lucey T (2003) narrated the following budgeting approaches; 2.5.1. Line-item budget This is a traditional approach where by amounts based on historical records, adjustments are made to make account of cost changes or changes in operational level. In this case emphasis is in the nature of expenditure not purpose. This budget is also called incremental budget because the current level of operation is the basis of next period budget. 2.5.2 Zero-Based Budgeting or Priority Based Budgeting Is a cost-benefit approach whereby it is assumed that the cost allowance for an item is zero, and so the budget for the period in question does not exist until the manager responsible justifies the existence of the cost items and the benefits the expenditure brings. ZBB can be applied in both profit and non profit-seeking organizations. In manufacturing firm ZBB is best applied and support expenditure including, administration, marketing, personnel, information and computer service, research and development, finance and accounting, production planning and so on. 2.5.3. Planning programming budgeting system. Is a radical approach to budgeting based on programs which are classifying activities with the same benefits. It used much in non-profit organization, local and central government, hospitals, and charities and world organizations, example IMF and so on; where they often prepare detailed conventional budgets showing the different categories of expenditure. A particular problem of such organizations is that the measurement of output is difficult and sometimes impossible. In addition to the problems of relating inputs to benefits achieved, non profit-making organizations also have difficulties with long term strategic planning and realistic resource allocation. In attempt to overcome these problems, the PPBS system was evolved. PPBS are based on system theory and are output and objectives oriented with a substantial emphasis on resource allocation based on economic analysis. The system is not based on traditional organizational structures and divisions but on programmes, that is, grouping activities with common objectives. PPBS require that the organization prepare a long-term plan relating to the objectives of organizations subdivided into programmes.

PPBS require a supplicated information system able to monitor progress towards meeting system objectives. The PPBS reporting system should be able to report upon results in terms of the programmes of activities unlike conventional reporting which is created to existing organizational subdivision and usually deals with only expenditures. 2.5.4. Rolling Budget. Is a budget which is continuously updated by adding a further period, say a month or a quarter, and deducting the earliest period. Although firms prepare budgets on annual basis to plan for the future, the fact remains that they are realistic and as far as prices are concerned. The environment is full of risk and uncertainty. Rolling budgets help to overcome this problem. (Shah P. 2009) 2.6 Budgetary Control Institute of cost and management account (ICMA) has defined the budgetary control in the following words; Establishment of departmental budgets relating the responsibilities of Executives to the requirement of a policy and the continuous comparisons of actual with budgeted results either to secure by Individual action, the objectives of the policy or to provide a firm with a basis for its revision. Geoffrey and Arthur U (1988), define budgetary control as a technique for the establishment of budgets relating the responsibilities of executives to the requirements of a policy and the continuous comparison of actual with budgeted results either to secure by individual action the objectives of the policy or to provide a basis for its revision. 2.7 Effective budgetary control system Maheshwari (1993) states that the following points deserve management attention in order to make system of budgetary control really effective: i. Consultation with the non-financial executives. In order to make each manager emotionally committed to the budget and effective formulation of budgets, consultation should be real and not by the way, or a mere obligation. Also the budget controller should solicit participation of non-financial executives in formality. ii. True delegation of authority and responsibility.

Each executive should have a maximum opportunity to make decision within the scope of his or her authority. This will result in him/her having personal growth, self-realization and recognition. iii. iv. Total corporate exercise. Budget should be a total corporate exercise, piecemeal budgeting can not be effective. Past experience. Past experiences are useful guide for the future. Therefore, it is necessary that the points revealed by past experience should be taken into consideration while formulating plans for the future. v. Good reporting system. A budget cannot be successful unless there is proper feedback system. The reporting system should be so devised, that is, it does not tell only about the major various. For this purpose periodical statements should be prepared. vi. Evaluation The cause of variation should be analysed and the management should be kept informed about major variances. 2.8 Budget Period Budget period is the period for which a budget can be prepared and used and its length will depend on the type of business, length of manufacturing cycle from raw material to finished product, the ease or difficulties of forecasting future market conditions and other factor. No specific period of time can be formulated as being the best budget period, although it can be said that many firms regard the period of a year as being a natural period for budgeting. The budget period is the determination of length of period for which budget is to be drawn, Vinayakam N and I.B Sinha (1996). Shah P. (2009) tries to mention out two types of budget depending on time. i. Long-term budgets are the budgets which are prepared for periods longer than a year. Example, Capital expenditure budget. ii. Short-term budgets are the budgets which are prepared for the periods of less than a year. Example, Cash budget.