Budgeting & Budgetary Control: Types, Process, Variances & Analysis

Core Concepts

1. Definition and Purpose of Budgeting

Budgeting is a formalized planning process that quantifies financial and operational goals, allocates resources, and measures performance. It ensures:

• Efficiency: Optimal use of resources.
• Control: Monitoring deviations from plans.
• Decision-making: Data-driven choices (e.g., expansion, cost-cutting).

Visual: The accounting cycle now includes budgeting as a feedback loop.

flowchart TD
    A["1. Strategic Goals"] --> B["2. Master Budget Preparation"]
    B --> C["3. Functional Budgets\n(Sales, Production, Cash)"]
    C --> D["4. Budgetary Control\n(Variance Analysis)"]
    D --> E["5. Performance Review\n(Actual vs. Budget)"]
    E -->|"Feedback"| A

Types of Budgets

Budgets are classified by scope, time, and function. Key types:

Budgetary Control Process

Step 1: Budget Preparation

1. Sales Budget: Forecast demand (units × price). Example: Khalti expects 50,000 transactions/month at ₹500/transaction → ₹25M revenue.
2. Production Budget: Units to produce = Sales + Desired Ending Inventory – Beginning Inventory.
3. Direct Material/Purchase Budget: Quantity needed × Cost.
4. Direct Labour Budget: Hours × Wage rate.
5. Overhead Budget: Fixed (rent) + Variable (utilities) costs.
6. Cash Budget: Reconcile receipts (sales, loans) and payments (suppliers, salaries).

Worked Example: Kathmandu Retail Shop

• Sales Budget: 200 units/month × ₹5,000/unit = ₹1M.
• Production Budget: 200 units (no inventory change).
• Material Budget: 200 units × 2kg/unit × ₹300/kg = ₹120,000.
• Labour Budget: 200 units × 0.5 hours/unit × ₹1,000/hour = ₹100,000.
• Overhead Budget: ₹50,000 (fixed) + ₹20,000 (variable) = ₹70,000.
• Profit Budget: ₹1M – (₹120K + ₹100K + ₹70K) = ₹610,000.

Visual: T-Account for Budgetary Control Entries

Step 2: Budgetary Control Techniques

Variance Analysis

Variances reveal why actual results differ from budgets. Key types:

1. Sales Volume Variance

Formula: $$\text{Sales Volume Variance}=(\text{Actual Units}-\text{Budgeted Units})\times \text{Contribution Margin/Unit}$$ Example: Kathmandu Retail budgeted 200 units but sold 220.

• Contribution margin/unit = ₹5,000 – ₹3,000 (variable cost) = ₹2,000.
• Variance = (220 – 200) × ₹2,000 = +₹40,000 (Favourable).

2. Material Variance

3. Labour Variance

Visual: Variance Analysis Table for Kathmandu Retail

In the Real World

1. eSewa’s Cash Budget

   • Idea Used: Cash budgeting to ensure liquidity for merchant payouts.
   • How: Projects daily inflows (₹50M from transactions) vs. outflows (₹40M to banks, ₹5M for fraud prevention). Variances trigger emergency funds.

2. Daraz’s Flexible Budget

   • Idea Used: Flexible budgeting for variable costs (delivery fees).
   • How: Adjusts monthly delivery cost budgets based on order volume (e.g., ₹50/order at 10,000 orders vs. ₹45/order at 15,000 orders).

3. Nepal Rastra Bank’s Zero-Based Budget

   • Idea Used: Zero-based budgeting for development spending.
   • How: Every ₹1M allocated to roads/healthcare must justify its need from scratch, not just carry over from prior years.

4. Pathao’s Variance Analysis

   • Idea Used: Labour efficiency variance for driver payouts.
   • How: If drivers complete 80% of trips in budgeted time, Pathao adjusts bonuses. A 10% delay → unfavourable variance → driver training.

Advantages and Disadvantages of Budgeting

Exam Tip

1. Master Budget Flowchart: Draw the master budget preparation flowchart (sales → production → cash) in exams. Examiners love this!
2. Variance Calculations: Always show workings for price/quantity/labour variances. Use the Kathmandu Retail example as a template.
3. Real-World Links: Relate budgets to Nepali businesses (e.g., "How would Ncell use a flexible budget?").
4. T-Accounts: Budgetary control entries often appear in journal + ledger format. Practice posting to:
   • Sales Revenue A/c
   • Material/Labour/Overhead A/c
   • Variance A/c (if applicable).
5. Common Pitfalls:
   • ❌ Forgetting to reconcile cash budgets (receipts vs. payments).
   • ❌ Mixing fixed vs. variable costs in flexible budgets.
   • ❌ Ignoring favourable/unfavourable labels in variance analysis.

Pro Tip: Memorize the 4-step variance analysis formula:

1. Actual Quantity × Actual Price (Total Actual Cost).
2. Actual Quantity × Budgeted Price (Price Variance).
3. Budgeted Quantity × Budgeted Price (Total Budgeted Cost).
4. Actual – Budgeted = Variance.