Accounting & Auditing II

Delhi Law Academy

AUDITING

Definition of Auditing:

•            Auditing is the examination of accounting books & documentary evidences, through which an independent auditor finds out accuracy of figures & marks report on balance sheet and other financial statement.

Principles of Auditing:

•            Auditing is characterized by reliance on a number of principles. These make the audit an effective and reliable tool in support of management policies and controls, providing information on which an organisation can act to improve its performance.

•            Some of the underlining principles of auditing include:

•            Skills, Competence: Such persons who are trained, experienced and efficient        should perform the work of audit.

•            Ethical Conduct & Confidentiality: Trust, integrity, confidentiality and discretion are essential to auditing.

•            Principle of Full Disclosure: The principle implies that the auditor should make full disclosure of his findings in respect of the audit work performed by him. There is obligation to report truthfully and accurately audit findings, audit conclusions and audit reports.

•            Principle of Objectivity: Auditing must be conducted objectively. The auditor must be free from bias, emotions: Due professional care needs to be taken for application of diligence and judgment in auditing.

•            Principle of Independence: Independence is the basis for the impartiality of the audit and objectivity of the audit conclusions.

•            Principle of Materiality: This principle indicates that more attention must be paid to those items, which are materially important, and in the area where the risk of error and fraud is relatively more.

•            Evidence-based approach: The audit process should follow a rational method for reaching reliable and reproducible audit conclusions.

Objectives of Auditing

•            The objectives of an audit may broadly be classified as Primary objectives and Secondary objectives.

Primary Objective

•            The main purpose of audit is to determine the reliability and accuracy of the financial statements and the supporting accounting records for a particular financial period.

Secondary Objectives

•            Detection and Prevention of Errors

•            Detection and Prevention of Frauds

Types of Errors:

Errors of Principle:

•            Such errors are committed when some fundamental principle of accounting is not properly observed in recording a transaction

Clerical Errors:

•            Such an error arises on account of wrong posting.

•            Errors of Commission: When amount of transaction or entry is incorrectly recorded in accounting books / ledger.

•            Errors of Omission: When the transactions are not recorded in the books of original entry or posted to the ledger.

•            Compensating Errors: When two or more errors are committed in such a way that the result df these errors on the debits and credits is nil.

•            Error of Duplication: When a transaction is recorded more than once.

Types of Frauds

Misappropriation of Cash

•            It is very common in big firms and can take place usually through:

•            Suppressing receipts

•            Recording less amount than the actual amount of receipt

•            Fictitious payments

•            Recording more amount than the actual amount of payment.

Misappropriation of Goods:

•            This is common, especially, when goods are of high value but not bulky.

Falsification or Manipulation of account:

•            Accounts may he manipulated by those responsible persons who are in top management of the organisation in order to achieve certain specific objectives.

Window dressing:

•            When accounts are prepared in such a way that apparently on the face of it, they indicate a much better picture than actually what they are.

Secret Reserves:

•            When accounts are prepared in such a way that apparently on the face of it, they disclose a worse picture than actually what they are.

Differences between Errors & Frauds

ErrorsFrauds
Reason of occurrence is ignoranceIt is made deliberately
Unplanned activityPlanned Activity
Generally, not considered an offenceConsidered as Offence
Can cause undue profit, loss or even no impactThese always result in loss
Very easy to detectDifficult to identify

Types of Audits

BasisTypes
ScopeSpecific Audit – Performance Audit, Efficiency Audit, Cash Audit, Receipt AuditGeneral Audit – It can be an internal or an independent Audit.
ActivitiesCommercialNon-Commercial
OrganizationGovernmentPrivate
LegalStatutory/Required – Banking Companies, Trust, Company, Corporations, Co-operative societies.Non-statutory/ Voluntary – Individual, Trader, etc.

Advantages of Auditing:

•            It safeguards the financial interests of persons who are not associated with the management of the organisation e.g. partners or shareholders.

•            It acts as a moral check on employees from committing defalcations or embezzlement.

•            Auditing statements of accounts are helpful in settling of taxes, negotiating loans etc.

•            Auditing accounts facilitates settlement among partners.

INTERNAL CONTROLS

Definition of Internal Control

•            Internal Controls are methods put in place by an organisation to ensure the integrity of financial and accounting information, meet operational and profitability target and transmit management policies throughout the organisation.

•            Internal controls are the process designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

a.           Reliability of financial reporting,

b.           Effectiveness and efficiency of operations, and

c.           Compliance with applicable laws and regulations.

Forms of Internal Controls

There are two forms of Internal Controls that help in ensuring correct and reliable records of transactions and operational efficiency. These are:

•            Accounting Control

o            It ensures correct and reliable records of transactions in conformity with normally accepted accounting principles

•            Administrative Control

o            These are wide in scope and comprise of the plan of organization that are concerned mainly with ‘operational efficiencies’.

Types of Internal Controls

1.           Detective: Designed to detect errors or irregularities that may have occurred.

2.           Corrective: Designed to correct errors or irregularities that have been detected.

3.           Preventive: Designed to keep errors or irregularities from occurring.

Internal Control Objectives

•            Authorisation: To ensure that all transactions are authorized and approved by a responsible associate before that transaction is recorded

•            Completeness: To ensure that records are not any missing entries

•            Accuracy: To ensure that transactions have been entered correctly and in a timely manner

•            Validity: To ensure that transactions are lawful in nature and do not contain any misrepresentations

•            Physical Safeguards & Security: To ensure that that physical assets are safely guarded, and only authorized personnel may access them.

•            Error Handling: To ensure that when errors are discovered management is notified and the errors are corrected in a timely manner

•            Segregation of Duties: To ensure that no one individual is reporting, collecting, and processing a single transaction.

Components of Internal Control

•            Under the (Committee of Sponsoring Organizations of the Treadway Commission) COSO model a system of internal controls is a process that is made up of five interrelated components.

•            These are:

•            Control environment

•            Risk Assessment

•            Control Activities

•            Information and communication

•            Monitoring

Difference Between Internal Control and Internal Audit

•            Internal control is a system that comprises of control environment and procedure, which help the organization in achieving business objectives.

•            On the other hand, internal audit is an activity performed by an agency or department created by the management of the organisation, to ensure that internal control system implemented in the organization are effective.

Limitations of Internal Controls:

Some limitations inherent in all internal control systems include:

1.           Judgment: The effectiveness of controls is limited by human judgment.

2.           Breakdowns: Even well designed internal controls can break down at times. Sometimes due to new technology or due to complexity of computerized information systems.

3.           Management Override: High level personnel may be able to override prescribed policies and procedures for personal gain or advantage.

4.           Collusion: Control systems can be circumvented by employee collusion.

SOCIAL AUDIT

•            Social audit as a term was used as far back as the 1950s. However, in the last decade, the term has acquired new relevance in India.

•            It is generally believed today that it is the duty of the privately owned enterprise to ensure that it does not adversely affect the life of the community in which it operates.

•            It is also expected that businesses should make positive contribution to the life of the community.

•            The increasing demand for socially oriented programmes and disclosure of environmental effects of organisational behaviour has created pressure for adopting some kind of social auditing procedure.

Concept of Social Audit

•            In general, Social Audit refers to a process for measuring, understanding, reporting and improving the social performance of an activity of an organization.

•            Social Audit has been defined as a process of identification and examination of the activities of the firm in order to assess, evaluate, measure and report their impact on the immediate social environment.

Salient Features of Social Audit

•            Areas for social audit include any activity which has a significant social impact. Example: Social Audit of activities of an organisation affecting surrounding environmental quality.

•            It can determine only what an organization is doing in social areas, not the amount of social good that results from these activities. It is a process audit rather than an audit for results.

•            Social performance is difficult to audit because most of the results of social activities occur beyond the organisation’s gate and it cannot get precise data from outside sources.

•            Both the quantitative and qualitative data are used in the social audit. The qualitative data is often used to supplement the quantitative data.

•            No professional standards and qualifications are prescribed for a social auditor.

Key Principles of Social Audit

Eight specific key principles have been identified from Social Auditing practices around the world.

1.           Multi-Perspective/Polyvocal: Aim to reflect the views (voices) of all those people (stakeholders) involved with or affected by the organization/department/ programme.

2.           Comprehensive: Aims to (eventually) report on all aspects of the organisation’s work and performance.

3.           Participatory: Encourages participation of stakeholders and sharing of their values.

4.           Multidirectional: Stakeholders share and give feedback on multiple aspects.

5.           Regular: Aims to produce social accounts on a regular basis so that the concept and the practice become embedded in the culture of the organisation covering all the activities.

6.           Comparative: Provides a means, whereby, the organisation can compare its own performance each year and against appropriate external norms or benchmarks; and provide for comparisons with organisations doing similar work and reporting in similar fashion.

7.           Verification: Ensures that the social accounts are audited by a suitably experienced person or agency with no vested interest in the organisation.

8.           Disclosure: Ensures that the audited accounts are disclosed to stakeholders and the wider community in the interests of accountability and transparency.

Objectives of Social Audit

•            Promote transparency and accountability in the implementation of the programme.

•            Involve all stakeholders

•            To monitor social and ethical impact and performance of the organization;

•            To provide a basis for shaping management strategy in a socially responsible and accountable way and to design strategies;

•            To facilitate organizational learning on how to improve social performance;

•            To facilitate the strategic management of institutions (including concern for their influence and social impact on organizations and communities);

•            To inform the community, public, other organizations and institutions about the allocation of their resources (time and money); this refers to issues of accountability, ethics (e.g., ethical investment) etc.

Advantages of social audit

•            Helps to assess achievement of social objectives of an organisation.

•            Encourages greater concern for social performance throughout the organisation.

•            Provides a recognized method for bringing the social point of view to the attention of management

•            Provides data for comparing effectiveness of the different types of programmes.

•            Develops human resources and social capital

•            Helps the organization to build up the image and reputation in public domain.

Limitations

•            Complicated & time consuming

•            No clear methodology

•            Difficult define the scope

•            Subjective

•            Tack of qualified trainers

•            Limited practical utility

PERFORMANCE  &  EFFICIENCY AUDIT

Performance Audit

•            A performance audit is used to examine how well a process or activity is performed.

•            It can check factors such as the amount of time incurred to complete an activity, the cost-effectiveness of a process, the transaction error rate, the effectiveness of internal controls, the speed of the process, and how well it supports the objectives of the business.

•            Performance audit is usually an independent assessment that a scheme, program or an organization operates economically, efficiently and effectively.

•            Performance Audit is invariably referred to as Value-for- money audit or Operational audit.

Objectives of Performance Audit:

•            Three elements often referred to as the three E’s are classified as main objectives of performance audits.  These are:

Economy

•            Performance audit assess that if measures have been taken to acquire resources of the right quality, in the right quantity, at the right time and place at the lowest possible cost.

Efficiency

•            Performance audit makes sure that the organization / program / scheme is using their resources the best way possible.

•            Efforts have been undertaken to achieve the optimal relationship between output of services or other results and the resources used to produce them

Effectiveness

•            Checks whether the operation activities are meeting objectives, operational goals and producing other intended effects.

•            Besides these, performance audit provides management with information on adequate and inadequate management measures by means of a structured reporting process.

•            It also contributes to accountability and transparency.

EFFICIENCY AUDIT

•            An economy and efficiency audit, or simply efficiency audit, focuses on analysis of the procurement, maintenance and implementation of resources.

•            It is concerned with the utilization of resources in economic and most remunerative manner to achieve the objectives of the concern department/organization.

•            It comprises of studying the plans of department/organization, comparing actual performance with plans and investigating the reasons for variances to take remedial action.

Objectives & Purpose of Efficiency Audit

•            To make sure that the organization has done optimum utilization of the investments in the organization.

•            To identify the operational weaknesses by a review of the organization’s environment.

•            To check that the organization channels the investment in their most profitable ventures.

Parameters of Efficiency Audit

The parameters for measuring efficiency include the following:

•            Overall return on capital,

•            Capacity utilization,

•            Optimum utilization of men, machines and materials,

•            Export performance and import substitution,

•            Liquidity position

•            Payback period

RESPONSIBILITY ACCOUNTING

•            Responsibility accounting is a part of cost & management accounting and has emerged as a widely accepted practice within budgeting.

•            In this system, the responsibility is delegated on a responsibility centre and accounting for the responsibility is on the basis of performance of the responsibility centre.

Definition:

•            Responsibility accounting is a system of accounting that recognizes various decision centres throughout an organisation and traces costs to the individual managers who are primarily responsible for making decisions about the costs in question.

•            Alternatively, responsibility accounting is a system that involves identifying responsibility centers and their objectives, developing performance measurement schemes, and preparing and analyzing performance reports of the responsibility centers.

•            It involves gathering & reporting, costs & revenues by areas of responsibility.

Responsibility Centers

•            A responsibility center is a part or subunit of a company in which the manager has some degree of authority and responsibility.

Cost or Expense Center

•            It is the subunit of the organization that has control over cost only.

•            It has no control over revenues and investments and so are evaluated using variance analysis of costs.

•            Examples include production department, maintenance department, accounting department, legal department, HR department etc.

Revenue Center:

•            Revenue center has control over revenue generation, but has no control over costs and investment, e.g. the sales and marketing department.

•            Revenue centers are evaluated using variance analysis of revenues.

Profit Center:

•            These centers have control over both revenues and costs.

•            For example: a production department may be treated as a profit centre on the basis that it “sells” goods to the sales department.

•            The accounting system can be so designed as to record revenues and profit on a notional basis immediately when the completed products are sent to the godown or sales department.

Investment Center:

•            It is the subunit that has control over revenues, costs, and investments (assets such as receivables, inventory, fixed assets, etc.).

•            Since investment centers are given authority to decide over its investments, it operates like a separate entity. Investment centers are evaluated using different profitability measures such as return on investment, residual income, economic value-added, and others.

Stages of Responsibility Accounting

1.           Fixing up standards or estimates based on responsibilities.

2.           Evaluate the performance.

3.           Analyze the variances and reporting them to top management.

4.           Taking corrective action and communicating to the concerned persons.

Uses of Responsibility Accounting

Responsibility accounting is an important aid in the management control process.

Few of its advantages or uses are:

•            Performance Evaluation:

o            With responsibility localized, it is possible to evaluate individual managers on a cost basis through responsibility accounting.

•            Delegating Authority:

o            Responsible accounting allows for delegation & decentralization, which is necessary for large firms/corporations to function.

•            High Morale and Efficiency:

o            Responsibility accounting allows for rewards to be linked to the performance, this acts as a great morale booster.

•            Promotes Management by Objectives:

o            The heads of divisions and departments are assigned definite objectives before the commencement of the period.

o            They are held answerable for the attainment of these targets. Such a system helps in establishing the principle of management by objectives (MBO).

•            Promotes Management by exception:

o            Responsibility accounting also promotes management by exception as here also attention is paid to matters that materially deviate from established standards.

•            Corrective Action:

o            Under responsibility accounting, as areas of authority are clearly laid down, such corrective action becomes easier.

SOCIAL ACCOUNTING

•            Business is a socio-economic activity; it draws its inputs from the society and so owes certain degree of responsibility towards its welfare.

•            Hence, there is need of an accounting method that focuses on the study of variables related with social results in respect of socio economic non-monetary outcome along with economic outcomes.

•            Social Accounting incorporates social and environmental impact into traditional financial accounting.

•            It is a method by which a firm seeks to place a value on the impact on society of its operations.

•            Social Accounting is the process of measuring, monitoring, and reporting to stakeholders the social and environmental effects of an organization’s actions.

Features of Social Accounting

•            Social Accounting is an expression of a company’s social responsibility.

•            It is related to use of social and community resources.

•            Lays emphasis on Social costs are resulting social benefits.

•            Determines desirability of a firm in society.

•            Application of accounting in Social Science.

Need & Importance of Social Accounting

•            Social Accounting helps management fulfill its social obligations and inform its members, government and general public.

•            It provides management a feedback on its efforts and policies aimed at welfare of the society.

•            Social accounting is also necessary from the viewpoint of public interest group, social organisation, investors and government bodies.

•            Due to changing public need, social expectations of business have also changes.

o            Social Accounting helps firm keep track of these expectations of society.

•            Social accounting helps to determine whether company is properly utilizing their natural resources or not.

o            It can identify and measure the net social contribution of an individual firm consisting of cost and benefits internalized to the firm and externalities affecting social system.

BUDGETING & BUDGETARY CONTROL

•            The efficiency of a management depends upon the attainment of the objectives of the enterprise.

•            It is effective when it achieves the objectives with minimum effort and cost.

•            One systematic approach for attaining effective management performance is profit planning and control or budgeting.

•            Budgeting is an important control technique of cost control.

Definitions:

•            Budgeting is a process, which includes two important functions: Budget and Budgetary control.

•            Budget is a planning function and budgetary control is a controlling system or technique.

Budget:

•            In simple terms, budget is a statement of plans expressed in quantitative, usually monetary terms, covering a specific period of time, usually one year.

•            It can also be defined as, “Budget is financial and/or quantitative statement, prepared prior to a defined period of time for the purpose of attaining given objectives.”

Budgetary Control:

•            Budgetary control is a system and a technique, which uses budgets as a means of controlling all aspects of the business and is designed to assist management in the allocation of responsibility and authority, and to develop basis of measurement to evaluate performance and efficiency of the operations.

•            It is the process of comparing actual output with the budgeted outputs to either secure objectives of the policy or to provide a basis for its revision.

Classification of Budgets

•            Budgets can be classified into different categories on the basis of time, functions or flexibility.

•            These are:

Classification According to Time:

Budget, on the basis of time, may be classified as:

•            Long-term budget

•            Short-term budget

•            Financial budget or Current budget

Long-Term Budget:    

•            A budget designed for a long period of time, generally is of 5 to 10 years.

•            These budgets are concerned with planning of the operations of a firm over a considerably long period of time.

Short-Term Budget:   

•            The budget prepared for a period of less than 5 years is a short-term budget.

•            Generally short-term budgets are prepared for a period of one to two years.

•            They are generally prepared in terms of physical as well as in monetary units.

Current Budget:          

•            The budget prepared for a period of a week, a month, or a quarter is termed as a current budget.

•            They are essentially short-term budgets adjusted to current conditions or prevailing circumstances.

Classification According to Function:

Budgets can be classified on the basis of functions they are meant to perform, like:

Sales Budget: 

•            This is the most important budget on which all other budgets are based.

•            The sales manager is responsible for preparation and execution of the budget.

•            The budget forecasts total sales in terms of quantity, value, items, periods, areas etc.

Production Budget:

•            The budget is basically based on sales budget.

•            It forecasts quantity of production in terms of items, periods, areas, etc.

•            The works manger is responsible for the preparation of overall production budget and departmental works manager is responsible for departmental production budgets.

Cost of Production Budget:   

•            It forecasts the cost of production.

•            Separate budgets are prepared for different elements of costs such as direct materials budget, direct labour budget, factory overheads budget, office overheads budget, selling and distribution overhead budget, etc.

Purchase Budget:       

•            The budget forecasts the quantity and value of purchases required for production.

•            It gives quantity-wise and period-wise information about the materials to be purchased.

•            It correlates with sales forecast and production planning.

Personnel Budget:      

•            The budget anticipates the quantity of personnel required during a period for production activity.

•            This may be further split up between direct and indirect personnel budgets.

Research Budget:       

•            The budget relates to the research work to be done for improvement in quality of the products or research for new products.

Capital Expenditure Budget: 

•            The budget provides a guidance regarding the amount of capital that may be required for procurement of capital assets during the budget period.

Cash Budgets:

•            The budget is a forecast of the cash position, for a specific duration of time for different time periods.

•            It states the estimated amount of cash receipts and cash payments and the likely balance of cash in hand at the end of different periods.

Master              Budget:            

•            It is a summary budget incorporating all functional budgets in a capsule form.

•            It interprets different functional budgets and covers within its range the preparation of projected income statement and projected balance sheet

Appropriation               Budget

•            When budgets are prepared only for a particular activity/work, it is called Appropriation Budget.

•            These budgets are related to only one activity/work and on completion of that particular activity the purpose of this budget end.

Classification According to Flexibility

Budget can also be classified in the following categories:

Fixed Budget: 

•            A budget prepared on the basis of a standard or a fixed level of activity is called a fixed budget.

•            It does not change with the change in the level of activity.

•            If the output and sales do not fluctuate from year to year or if an accurate prediction of the same can be made, a fixed budget can be prepared.

Flexible Budget:          

•            A budget designed in a manner so as to give the budgeted cost of any level of activity is termed as a flexible budget.

•            Such a budget is prepared after considering the fixed and variable elements of cost and the changes that may be expected for each item at various levels of operation.

Difference between Fixed and Flexible Budget: 
Fixed BudgetFlexible Budget
• Assumes that conditions would remain static.• Designed to change according to a change in the level of activity.
• Costs are not classified according to fixed, variable and semi-variable.• Costs are classified according to nature of their variability.
• Comparison of actual results difficult if production level changes.• Comparisons are realistic since the changed plan figures are placed against actual ones.
• Cost cannot be ascertained if there is a change in the circumstances.• Costs can easily be ascertained at different levels of activity
• Inflexible and remains the same irrespective of the volume of business activity.• It can be suitably recast quickly to suit changed conditions.

Approaches to Budgeting      

•            Various organizations use different approaches to budgeting.

•            Few of the approaches include:

•            Incremental Budgeting

•            Formula Budgeting

•            Program Budgeting

•            Performance Budgeting

•            Planning Programming Budgeting System (PPBS)

•            Zero-Based Budgeting (ZBB)

Incremental Budgeting

•            Incremental budgeting means making changes to the existing budget for arriving at the new budget. Hence, this approach is also called as historical budgeting.

•            In this approach, a budget is prepared using a previous period’s budget or actual performance as a basis with incremental amounts added for the new budget period.

•            The budget is prepared with a small increase of say 5 or 10 per cent for each major item of expenditure of the previous year’s allocation, assuming that all current programmes are as good and necessary.

•            The advantage of this method of budgeting is that it is relatively easy to prepare, present and understand.

•            To some extent it also ensures that the funds provided are spent for the purpose stated.

•            However, one primary disadvantage is that this method does not go into the performance evaluation of activities and services and also does not suggest any future projections.

Formula Budgeting

•            In Formula Budgeting, budgets are based on some pre-determined formula.

•            The formulae are used for financial estimation as well as budget justification.

•            This appears to be a broad and quick method and hence saves lot of time.

•            But it does not account for finer variations in respect of each library and its customers and services.

Program Budgeting

•            Program Budgeting approach seeks to more effectively manage fiscal resources by identifying and prioritizing institutional goals and providing funding toward those programs which best support the institution’s goals and objectives.

Performance Budgeting

•            Performance budgeting approach is similar to program budgeting, but the emphasis shifts from programs to performance.

•            In this approach, the expenditure is based on the performance of activities and it lays stress upon operational efficiency.

•            This method requires careful accumulation of quantitative data on all the activities over a period of time.

•            Management techniques such as cost-benefit analysis are used to measure the performance and establish norms.

Planning Programming Budgeting System (PPBS)

•            PPBS is an extension of program budgeting and involves systems analysis, operation research and other cost-effectiveness processes to provide a more systematic and comprehensive comparison of costs and benefits of alternative approaches to a policy goal or program objective.

Zero-Based Budgeting (ZBB)

•            As the name suggests, Zero-based budgeting, assumes a budget of ‘zero’ for each program/activity until one convinces the appropriating authority that the program/activity is worthwhile and deserving support at a specified level.

•            This approach has similarity with PPBS and is quite opposite to incremental budgeting approach.

Objectives of Budgeting

The objectives of the budgeting are:

•            To control the cost and increase revenue and thereby maximise profit, so as to know profit at different level of production and best production level.

•            To run production activities in efficient manner by lay behind the chances of interruption in production process due to lack of material, labour etc.

•            To bring about coordination between different functions of an enterprise, which is essential for the success of any enterprise.

•            To incorporate measures of calculation of deviations from budgeted results and analysis of the same, whereby responsibility can be fixed and controlling measures/action can be taken.

•            To ensure that actions taken are in accordance with the targets and if required, to take suitable corrective action.

•            To predict short-term and long-term financial positions for better financial position and management of working capital in better manner.

Advantages of Budgeting

The following are the advantages of budgeting:

•            Budgeting leads to maximum utilisation of resources with a view to ensuring maximum return.

•            Budgeting increases the awareness about business enterprise at all levels of management in the process of fulfilment of targets.

•            Budgeting is helpful in better co-ordination between different functions/activities of business/organization and hence, better understanding between different functions.

•            Budgeting is a process of self-examination and self-criticism, which is essential for the success of any organization.

•            Budgeting makes a path for active participation and support of top management

•            Budgeting enables the organization to prefix its goals and push up the forces towards their achievements.

•            Budgeting stimulates the effective use of resources and creates an attitude of cost consciousness throughout the organization.

•            It creates the bases for measuring performances of different departments as well as different functions of the production activities.

Limitations of Budgeting:

Budgeting has the following limitations:

•            Forecasting, planning or budgeting is not an exact science and a certain amount of judgement is present in any budgeting plan.

•            The basic requirement for the success of budgeting is the absolute support and enthusiasm provided by the top management. If it is lacking at any time, the whole system will collapse.

•            Budgeting should be followed up by effective control action, this is often lacking in many organizations, which defeats the very purpose of budgeting.

•            The installation of budgeting system is an elaborate process and it takes time.

•            It is only a source and not a target and hence, cannot take the place of management, while it is only a tool of management. Thus, the budget should be regarded not as a master, but as a servant.

•            It requires the experienced man-power, technical staff, analysis, control etc., hence, it is costly affair.