What Are The Basic Accounting Concepts Underlying The Income Statement

The Income Statement is previously called the Profit & Loss Account. This Income statement shows the revenues and expenses for the period and calculates the bottom line-net income.

The following are a few fundamental basic accounting concepts which underline the Income Statement namely:

1. Accrual concept/principle of accounting where the income statement does not coincide with the actual receipt and disbursement of cash ( namely the income statement measures profitability NOT cash flow)

2. The Revenue Recognition concept/principle requires that revenue be recognized in the financial statements when the revenue is realized and earned.

• Revenues being realized when products/services are exchanged or performed for cash or claims to cash (accounts receivable)
• Revenue being earned when an entity has substantially completed what is must do to be entitled to the benefits represented by the revenues

3. The Matching principle/concept guides how the Income Statement should recognize the expenses. It requires that expenses be matched with revenues whenever it is reasonable and practical to do so.

[ click here for article to understand the Single Step & Multiple Step Format of Income Statement]

Worked Example On Capital,Revenue Expenditure

Before attempting this question, refresh yourself by going to the main topic on capital & revenue expenditure

1.0 From the following items of expenditure of " Tommy Garage" classify between them capital and revenue expenditure:

(a) Wages for workers
(b) Purchase of a Tow Truck
(c) Telephone accunt
(d) Purchase a Breakdon vehicle
(e) Insurance
(f) Trolley jack
(g) Uniform for his workers
(h) Allowances for his workers
(i) Vehicle lift
(j) Hand cleaner
(k) Lubricating oil pump
(l) Cost of printing business card
(m) Purchase of a new Car
(n) Entertainment charges incurred
(o) Purchase a new office safe
(p) Cost of installing office sale
(q) Heating and lighting-quarterly account
(r) Office files, punch and sundry stationery items
(s) Purchase a new printer for computer


Answer:
(a) revenue expenditure
(b) capital expenditure
(c) revenue expenditure
(d) capital expenditure
(e) revenue expenditure
(f) capital expenditure
(g) & (h) revenue expenditure
(i) capital expenditure
(j) capital expenditure
(k) capital expenditure
(l) revenue expenditure
(m) capital expenditure
(n) revenue expenditure
(o) capital expenditure
(p) capital expenditure
(q) revenue expenditure
(r) revenue expenditure
(s) capital expenditure

Understand the terms:-Capital Expenditure,Revenue Expenditure,Capital Receipts And Revenue Receipts

Candidates in the LCC Bookkeeping, GCE O Level And AS Level are frequently being asked to differentiate and understand the importance of such terms:-Capital Expenditure, Revenue Expenditure, Capital Receipts And Revenue Receipts.

Capital Expenditure is the acquisition of a fixed asset or adding value to it. All expenses incurred like carriage, import duty, testing,installation and legal charges to put the asset in a working condition is also classified as capital expenditure.

Whereas:

Revenue Expenditure is the day-to-day expenses that are paid by the firm for example rent, lighting, insurance,etc


Illustration:

Company A obtained a loan to purchase a fixed asset of $100,000. Every month, the company is required to pay to the bank monthly interest of $1,000. In this case, explain what is capital and revenue expenditure

As the loan is used for buying the fixed asset for company's expansion it is a capital expenditure. However, as the loan interest is paid monthly it becomes a part of day-to-day expense hence it is a revenue expenditure.

Next what is so important to differentiate Capital and Revenue Expenditure?

Capital expenditure is not charged to Income Statement but revenue expenditure is charged into the Income Statement which will affect the bottom-line namely the profits of the company.

Incidentally, there are many accounting fraud/scandal where these concept of capital versus revenue expenditure has been greatly abused. The crooks would cook up the accounting profit of the company but classifying revenue expenditure as capital expenditure namely the expenses do not go into the Income Statement and are taken up into the Balance Sheet item as capital expenditure

In brief, the accounting treatment of capital expenditure and revenue expenditure are different:-

Revenue expenditure must be charged out to the Income Statement using the accrual and or matching concept

whereas

Capital expenditure goes into the Balance Sheet Item therefore not affecting the profits of an entity.


Similarly, Capital Receipts relates to in-flows or proceeds from the disposal of capital items like fixed assets(plant and machinery, land, building,etc,)

whereas

Revenue Receipts received by an entity are proceeds or inflows received in the course of the year like sales, commission received, discount received and others


In this case, both receipts whether they are capital or revenue, they are still taken up into the Cash Book of the company.

Test Your Knowledge: The Role/Purpose Of Accounting

Test Your Knowledge from the following structured questions:

1. Briefly explain what is accounting
2. Identify the users of accounting
3. List three objectives of financial accounting
4. List seven general characteristics of useful information
5. What is the difference between financial accounting from managerial accounting?
6. What are the four primary financial statements?
7. Identify the major similarities between financial accounting and managerial accounting

Opportunity, Incremental or Differential Cost And Avoidable Cost For Short Term Decisions

Earlier article, we discuss about relevant costs-its importance and functions on short term decisions.

In this articles we look at other costs namely OPPORTUNITY COST, INCREMENTAL OR DIFFERENTIAL COST AND AVOIDABLE COST which are also relevant or useful to management decision makings:

OPPORTUNITY COST

Represents the opportunities which have been forgone by following one course of action rather than an alternative course. The opportunity cost in this case is the profit foregone by utilizing scarce resources for one particular course of action.

Example:

Company A may either manufacture or buy a component from an outside supplier. If it buys from outside, the spare capacity can be rented out to another manufacturer for $20,000. The opportunity cost of making the component would be to lose the opportunity to earn the $20,000 Note that the opportunity cost does not involve cash transaction but it is “relevant� to decision making.

INCREMENTAL OR DIFFERENTIAL COST

Incremental cost is used interchangeably with differential cost. Incremental cost is the additional cost and revenue that may result from each degree of change in the level or nature of activity. Whilst Differential cost is the difference in the cost and revenue between two alternatives.

Example:

Company A need to consider whether or not to accept a special order. One relevant piece of information will be the variable cost. The relevant cost before taking this special order is $25,000 and after taking the order it is $35,000. Therefore the differential or incremental cost is $35,000-$25,000 which is $10,000

AVOIDABLE COST

Is cost that can be avoided if a given alternative is not adopted.

Example:

Assuming that a manufacturer decides not to proceed with a new product line which enable total savings in direct material, labor, direct expenses and variable costs of $10,000. In this case, the differential cost of $10,000 can be avoided. The $10,000 is the avoidable cost.

Notional, Sunk And Committed Costs

Earlier articles relate to relevant costs and other alternative costs like opportunity cost, incremental or differential cost and avoidable costs. Below are more costs that we need to understand before we embark on tackling short term decisions making questions often asked by the various examination boards.

Notional Costs

Notional costs are also known as imputed cost. The primary objective of charging notional costs is to enable management to make clearer internal decisions by making sure that internal decision making become more realistic by assuming that the cost of all resources consumed reflects the full economic value - usually by applying market prices. Notional charges are typically used to charge responsibility centres. Notional interest is often charged for the use of internally generated funds.

Examples of using notional cost to enhance internal management making decisions:

Charging of ’market rent’, where buildings have been purchased on a freehold basis. Such a mechanism helps to focus management attention on making best use of space so that surplus space across the whole organisation might then be sold or rented to another user. Intra division charges to enable management to see the true performance of certain departments

Sunk Costs: Sunk cost is defined by ICMA terminology as A past cost not directly relevant in decision making. If we refer to relevant costs, the main feature is that we are referring to FUTURE costs. As Sunk costs are cost which have already been incurred therefore it should be ignored when making any decisions. Sunk costs are irrelevant costs which are simply costs that will not affect the decision. By analyzing these type of sunk costs, management will be wasting their time and efforts as these costs do not affect the decision they are going to make. In short term decision making, fixed costs are generally regarded as sunk costs. Illustration: Say Company A has a factory which produced product A. Earlier last year it has extended and renovated the factory at an additional cost of $500,000 to produce product B. Now management is thinking of whether to let outsiders produce product B or not. Should this $500,000 be considered? $500,000 is sunk costs which existed as a result of previous decision.

Committed Costs: These costs are similar to sunk costs in that they exist as a result of previous decisions although the ‘charge’ has yet to be incurred or the cash released. Committed costs are costs that have been committed by management. Examples are like renovation of factory premises, capital expenditures being incurred as company’s purchase orders have been issued or work done is partially completely and payment to suppliers still outstanding However, the above mentioned costs committed contractually is effectively a sunk cost. Illustration: Question: Say company A is unable to rent out its building/workshop but there is a need to sign off a contract to spend $50,000 on an air conditioning system. Would this make any difference to management decision? Answer: None whatsoever. This type of situation might be awkward but past costs (and mistakes) should not impact upon the logic of financial decision making. The $50,000 that has been committed contractually is effectively a sunk cost.

Relevant Costs-Its Importance or Function or Features

Examination questions often touched on relevant cost. It tests the candidates whether they appreciate them in making short term decisions

Understanding relevant costs is important once we realize that there are many areas where relevant costs concepts are applied namely:

· Limiting factor due to scarce resources;

· Make or Buy decision;

· Accept or Reject special order;

· To continue or discontinue or shut down decisions;

· Pricing

In all the above situation, management needs sufficient and relevant information make the correct decisions. Therefore it leads to the need to understand what really is relevant costs.

A relevant cost:

· Relates to future expected costs that will differ with each alternative used.

· Because of the difference amongst alternative, hence it has a bearing on the decision to be made.

· Irrelevant costs simply are costs that will not affect the decision. By analyzing these type of irrelevant costs, management will be wasting their time and efforts as these costs do not affect the decision they are going to make.

Some of the features or criteria of Relevant costs are as follows:

a. Relevant cost is a cost that will be incurred in the future. Historical costs are sunk costs which has no relevancy in the decision making.

b. The costs must differ between alternatives. If a cost is the same whether we choose alternative A or B then this is an irrelevant cost. A good example is factory rental which remains the same irrespective of management wanting to manufacture product A or B.

c. Only CASH flow item And Incremental fixed costs are relevant. Non cash item like depreciation and absorbed fixed overheads are not relevant costs as they do not involve any additional cash flow.

Worked Example On The Effect Of Sales Expansion On The Working Capital

Earlier article shows the effect of sales expansion on the working capital of a company.

Below is an additional worked example of the impact of sales expansion in the event the company extend its credit term.

Worked Example: Company ABC Ltd has a current sales of $2.6 million. It wants to increase its sales by relaxing its credit policy. The current credit term is 45 days and the proposed terms of credit is 60 days. However the company believes that bad debts will increase from 1.5% to 2% of sales and sales should increase by 10%. The variable operating costs are 72% of the sales. The corporate tax rate is 35% and that the company requires an after-tax return of 15% on its investment. Question: Should Company ABC Ltd extend its credit policy from 45 days to 60 days?

Suggested Solution $ $ Sales Increase (10 % of $2.6m) 260,000 Contribution margin (100-72%=28%) 72,800 Less: Bad debts 1.5% x$2.6m 39,000 2.0% x($2.6×1.1=$2.86m) 58,000 Incremental bad debts (19,000) Operating profit before tax 53,800 Operating profit after tax 34,970 Increase in receivables investment =(New sales/360 days x 60 days) deduct (Old sales/360 days x 45 days) $476,660-$325,000 151,660 Expected rate of return =Operating profits after tax/Increase in receivables investment 34,970/151,660 =23.06% Less: Original rate of return 15% Incremental rate of return 8.06% Yes, it is to the advantage of Company ABC Ltd to extend its credit policy as it achieve a higher rate of return of 8.06%

The Effect of Sales Expansion On Working Capital

This article looks in particular the effect of Sales Expansion On Working Capital.

Managing Accounts Receivables has a critical impact on the company’s working capital. In fact, credit sales normally form a very large portion of the sales re: about 15% to 25% of a firm’s assets. To increase sales, top management will resort to increasing/extending the credit period to the customers. Examination question often ask candidates to assess the viability of such sales expansion in terms of increase in credit period.

Append below showed how we compute the viability when a firm relax or extend its credit period to boost its sales.

HOW TO COMPUTE THE FINANCIAL VIABILITY/IMPACT OF A FIRM WHEN THERE IS AN INCREASE IN ACCOUNTS RECEIVABLE. Step: (1) Compute the additional profit from the increase in sales from the extension of credit terms to its customers (2) Compute the cost of additional investment in accounts receivable (3) Compute the cost of additional bad debts. (4) Finally, sum up step (1) to step (3) to see whether there is a net gain to the firm · Additional profit from in increase in sales minus(-) · additional cost of additional investment in accounts receivable + · Additional cost of additional bad debts SIMPLE ILLUSTRATION Company ABC has a yearly sale volume of $12 million. The cost of goods is 80% of annual sales. Top management wants to increase sales by 10% by extending its credit terms from 30 days to 45 days. Bad debts is estimated to increase from 1% to 2% of yearly sales. Company ABC’s cost of tying up funds in accounts receivable is 10%. Required: Should Company ABC relax or extend its credit terms from 30 to 45 days? Suggested Solution: Step 1: Compute the additional profit from increase in sales · Additional sales =($12 million x 10%) =$1.2 million · Assuming there is no increase in fixed costs, profit/contribution from additional sales =$1.2 million x 20% =$240,000 Step 2: Compute the additional cost of additional investment in accounts receivables · Original investment in accounts receivable · 30/360 x $12 million=$1 million · 45/360 x $12 x 1.1 = $1.65 million · Additional investment of accounts receivable =$1.65m -$1.0 m = $650,000 · Cost = 10%(cost of fund) x $650,000 =$65,00 Step 3: Compute additional cost of bad debts ( 1% to 2% of sales) · (2% x$12m x1.1=$264,000)-(1% x$12m=$120,000) =$144,000 The result of the relaxation or extension of its credit period from 30 days to 45 days: · $240,000-($65,000+$144,000) =$31,000 net gain

Click here to see Worked Example of the effect of sales expansion on working capital

Operating Budget: The Production Budget, Functions & Role in an organization

This article explain some key features,functions and role of the Production Budget

• For the production manager to know how much to produce during the budgeted period, obviously he/she needs to know the sales budgeted. Only then can he consider the production capacity and also to take account the planned closing stocks of finished goods.
• Once the volume of production is ascertained, he has to prepare a statement of expected manufacturing costs. Costs should be classified into fixed and variable costs to allow for flexible budgeting.
• In the initial stages,the production budget is in terms of quantity.Later the quantity is expressed in terms of costs.
• Production budgets are based on sales, machine utilization,purchasing, labor and overhead budgets. Hence it is a summary of all those budgets
• Production budgets may be analyzed by products, production departments and period
• The key factors must be determined before adopting a plan.
• The size and nature of the business will influence the preparation of production budgets.

Operating Budget: The Sales Budget, Functions & Role in an organization.

The Sales Budget is the first budget prepared. It is derived from the sales forecast (estimate of sales revenue for the budget period).

Salient points about the Sales Budget:

• The formula is simple namely Sales Forecast=Quantities forecast X Selling prices

• It has a detailed breakdown by product,area,timing, volume and value. The detailed breakdown is to enable the preparation of production budget as well as the company’s cash budget.

• In preparing the budget,the sales personnel may rely on the following:

• Salesmen reports where the salesmen are in direct contact with the customers and are therefore able to prepare detailed estimates of sales for the budgeted period
• Market survey: some companies employ market researchers to anaylze the demand for their products;
• General business conditions: a political social, economic or technological change must be considered as it may affect the demand for their products
• Company’s policy: any change in company’s policy relating to the products sold must be considered.

• Important to identify the principal budget factor because it will be crucial in the preparation of the sales budget. For example, if the plant capacity is incapable of producing the expected volume of sales then the sales budget must be determined by output.

• Since demand is influenced by price the sales should be prepared only after the selling price has been fixed.

Explain the difference between Summary Budget and Master Budget b

Sometimes we are confused with the term Summary Budget and Master Budget.

This article seeks to explain the difference:

The Summary Budget:-

In earlier articles we have the capital expenditure budget and the various operating budgets like sales, production, overheads and others. Basically, Summary Budget as it being coined is merely a summary of all the abovementioned budgets. The ultimate output of the Summary Budget will show:

1. Budgeted Income Statement
2. Budgeted Balance Sheet
3. Budgeted Cash Flow

Whereas:-

The Master Budget:-

Once the summary budget is prepared, it is a DRAFT Master Budget. This draft master budget is submitted to the budget committee for approval.

Next when the budget committee has thoroughly review the draft master budget, it is then submitted to the Board Of Directors once again for the ultimate approval. Upon the approval from the Board of Directors, the draft master budget then becomes the Master Budget. The budget is now an order from the board and the manager responsible must see to it that it is implemented as effectively as possible.

What Are The Different Types Of Budgets And Their Functions In An Organization.

We can basically classify budgets into two categories namely:

• Capital Budgets
• Operating Budgets

Below explain their functions:

Capital Budget:

• is concerned with the provision of resources for the long-term running of a business for example, the Capital Expenditure Budget

Operating Budget:

• Is concerned with the DAY-TO-DAY operating activities of the business.
• Usually prepared for a normal operating cycle of one year.
• Common operating budgets includes the following:
• Sales Budget
• Production Budget
• Machine Utilization Budget
• Material Budget
• Labor Budget

• Overhead Budget- the Production Overhead Budget, Administration Budget, Selling Overhead Budget and Distribution Overhead Budget
• Research and Development (R&D) Budget
• Working Capital Budgets which includes the Stock Budge, Debtors Budget and Creditor Budget
• Cash Budget

What Do We Mean By Responsibility Accounting In Budgetary Control

Responsibility Accounting is a system where:

• Managers are held responsible for the difference between the actual performance and those budgeted;

• Managers are closely involved in the planning and controlling of the resources and having responsibility center which can be a division or department in the organization to be responsible for their performance.

There are basically the following four types of Responsibility centers:

COST CENTER

Here, the manager is responsible for costs. Examples like the manager for Purchasing department and Maintenance department

REVENUE CENTER

Here, the manager is responsible for generating sales. A typical example is the Sales Department

PROFIT CENTER

The manager is responsible for both revenue and cost. The reason been Revenue minus Cost is the Profit. The manager is therefore overall responsible or accountable for making profit for the company. A company has many restaurants which are all profit center. A manager is assigned to each restaurant to make sure it is a profit center.

INVESTMENT CENTER

An example of an investment center is a Corporate division responsible for project investments. Here, the manager is responsible for the investments which includes all the revenue, costs and investments (invested capital or assets)

How to or Steps To Establish A Flexible Budget

Earlier article describe the steps to prepare a budget and this article looks at how to establish a FLEXIBLE BUDGET.

Select the measure of activity like the units of production;

Define the relevant rage of activity for the budgeted performance based on the step 1;

Identify the cost items to be included in the budget;

Determine the cost behavior of each item over the relevant range;

Separate the cost items into variable, fixed and mixed;

Select the specific levels of activity to be budgeted;

Use the cost behavior under item 4 to estimate the budgeted amounts for each cost item at the different levels selected in step 6.

Role Of Budget Committee And Purpose Of A Budget Manual

Part A of this article look at the roles of a Budget Committee and Part B on the purpose of a Budget Manual.

Part A: Roles/objectives of a Budget Committee:

• Reconciles differences of opinion between departmental managers;
• Resolves disputes between managers;
• Give advice to board of directors and chief executive;
• Reviews department budgets and making recommendations;
• Examines periodic reports showing actual performance compared with the budget Significant variances are identified and recommendation made on actions to be taken;
• Develop and examines long term plans;
• Identifies budget objectives;
• Creates a better understanding and awareness among managers of the role of each others deparment;
• Coordination of budgets or budgeting;
• Review external conditions such as economic conditions for the ensuing period; and
• Considers forecasts compiled by departmental managers.

Part B: Roles/Functions Of Setting Up Budget Manual:

The budget manual documents the administration of budgeting. It contains the purpose of, procedure for and responsibility of the people involved in budgeting.

Others details includes:

• The objectives of the business and the part which budgetary control plays in achieving these objectives;
• The procedures to be adopted in operating the budgetary control system;
• The responsibilities and duties of those connected with the preparation of the budgets;
• The reports and statements required for each budget period;
• The functions of the budget committee and
  
• The accounts classification to be used
  

What are the key features of A Budgetary Control System

Append below some of the key features of a budgetary control system:

• Setting attainable objectives;
• Assigning executive responsibility;
• Planning the activities to achieve the objectives;
• Comparing actual results against the plan;
• Taking corrective actions and
  
• Reviewing and revising plans in the light of changes.
  

Explain the difference between Budget And Budgetary Control

In examination question, under short question, candidates are being asked the difference between budget and budgetary control.

Tabulate below the major differences:

A Budget

Is a predetermined statement of a company’s objectives during a period of time.

The budget is like a plan which guides the managers who are responsible for achieving certain business objectives.

The budget normally has an overall or master budget which is made up of sectional/subsidiary budgets prepared by the different sections in the company.

Be careful that a budget is a plan but a forecast is merely a prediction of what will happen as a result of a given set of circumstances.

Budgetary Control

Is a system which uses the budgets for planning and controlling a business activities.

It quantifies and is financially oriented to guides the managers to achieve certain business objectives..

Managers will compare the actual with the budgeted figures and the variances will then be investigated and corrective actions be taken

How To or Steps to Establish A Budget

The steps are as follow:

(1) Select a budget period:

The length of the budget period depends on the kind of plan being made. Some budget periods will follow the natural cycle time, for example, one year for a sales budget. Other budget periods may be determined by management, for example five years for capital expenditure budget.

(2) Setting or ascertaining the objectives:

The objectives of the business have to be set so that the plans may be prepared to achieve those objectives;

(3) Prepare basic assumptions and forecasts.

A statement of the basic assumptions on which the individual budgets are to be base must be prepared. A forecast is then made of the general economic climate and conditions in the industry and for the company. Forecasts are made for the following areas: sales, productions, selling and distribution expense, administrative expense, production expense, research and development expense, cash, purchases, capital expenditure, working capital and master forecast namely the Income Statement and Balance Sheet Forecasts.

(4) The need to consider any limiting factor.

A limiting factor prevents a company from expanding to infinity. Limiting factors affect budgeting and they must be considered to ensure that the budgets can be attained. Examples are: raw material shortage, labor shortage, insufficient production capacity, low demand for products, lack of capital,etc

(5) Finalizing forecasts:

The forecasts are finalized and now become budgets which are formally accepted.

(6) Implement the budget:

Budgets which are accepted must be implemented. The budget becomes the standard by which performance is measured.

(7) Review forecasts and plans:

Forecasts and budgets have to be reviewed at regular intervals. Changing environment may require changes to be made. Revised budgets may have to be prepared.

Key Factors Or Processes For the Successful Establishment of Budget

We need to understand what factors that can make successful budgets in an organization. Tabulated some of the key factors or process:

The Key Factors/Processes For The Successful Establishment Of Budgets:

There should a clear effective communication of the company’s objectives and strategy to those responsible for preparing budgets.This is quite critical otherwise there is no proper focus on the overall company’s goal like achieving X revenue or XX profitability and others.The strategy document should be clear as to the overall objectives of the organization and should able to reflect the impact on the various division.

There should be a clear effective communication of the overall and detailed procedures for preparation of the budgets.Preferably a budget manual should be set up to communicate all the essential procedures like the time line to complete the budget, formats to be used, organization chart and others

Determine the key and/ limiting factors which normally comprise sales to be achieved, availability of materials, capital and others

The organization need to ensure the proper setting up of budget centers or department. Who to do what is the basic otherwise the relevant managers might be confused of their roles.

There should be availability of adequate/detailed accounting records. If the accounting systems does not maintain the correct detailed past records of transactions, it will make the forthcoming budgeting very difficult and cumbersome

It is important to set up a proper budget committee to coordinate all the work connected with the budgets.This committee can assist to: formulate a general program for preparing the budgets and exercising overall control, review and co-ordinate the budgets, negotiate budgets with line managers finally accept the final form of the budgets

Benefits Of Budgets And Understanding Its Limitations

Earlier article describe the objectives of having budget, here this article describes the benefits that may accrue from budgeting and then what can be its limitations.

Benefits Of Budgeting:

Reinforce the management process of planning ahead. In fact, budget compel the managers to think and anticipate of future challenges, formulate strategies ,etc so as to achieve the desired company’s goals;

A budget is in reality a set of plan. This plan is created by all the relevant managers to create a course of action for future action(s)

Create a basis for Performance Evaluation of Managers’ performance. Incentives are based on how much have been achieved against the budgeted figures. Hence, if budgets are set up realistically will assist to motive manager and employees positively.

Aid in resource planning and allocation, key or scarce resources or capital expenditure are carefully review during the establishment of the budgets;

Promote continuous improvement. In the budgeting stage, non-value adding activities shall be eliminated, new or enhanced processes are designed to increase productivity, etc.;

Budgeting is the best time for all level of manager to co-ordinate together so as to plan ahead, promotes teamwork, process improvement and goal congruency between the company and the employees.

Delegation of duties, authority limit and responsibility are more properly segregated as budgets are set up. With budgets, top management feels that they are in control of the various business activities of the company.

Limitation Of Budgeting:

De-motivation of employees as they feel that the budgeted figures are way too high to achieve;

Budgetary slack or padding the budgets as managers will intentionally blow up their budget figures for fear of top management’s reprimanding them;

A budget tends to emphasize on results and the real reasons are being ignored;

Unrealistic budgets can lead managers to make decisions that might be detrimental to the company. A good example of over-ambitious sales budget will lead to disastrous impact like giving steep discount to increase volume,etc.;

No matter how well prepared a budget might be, it will never be able to reflect truly the reality/complexities faced by the company;

There is a need to revise/update the budget which at the time was based on a certain set of circumstances/best information.

Budgets if not properly buy in by all relevant parties will not get the full cooperation hence it might lead to the motto:Planning to fail

Objectives of Budget

Main objectives of budget:-

The Objectives Of Budgeting are as follows:-

Budget provides the yardstick against which future results can be compared;

With the establishment of the budget, action(s) can be taken by management if there are any material variances against budget;

Budgets enable management to plan and anticipate in areas of adequacy in working capital and scarce or type of availability of resources;

Budgets are able to direct capital expenditure in the most profitable direction;

Assist to plan and control earnings and expenditure so that maximum profitability can be achieved;

It act as a guide for management decisions when unforeseeable conditions affect the budget;

Assist in decentralizing responsibility on to each manager involved. With the setting of budgets, the managers involved will better understand what the company expects from them. Therefore there is a congruence of goals between the company and the employees