Budgeting
1 Introduction
Budgeting is an essential tool for management accounting for both planning and controlling future activity. In this chapter we will discuss the benefits of budgeting, the types of budget, and the preparation of budgets.
2 What is budgeting
Most companies prepare budgets – generally once a year they budget for the coming year.
Although this usually includes a forecast Income Statement for the year, the budget is actually a set of plans.
For example, a manufacturing company needs to plan their material and labour requirements for the coming year. In order to do this they will generally have to forecast their expected sales units for the year i.e. a sales budget. Then they will be in position to budget their production units for the year i.e. a production budget. Once they have budgeted how many units to produce they are in a position to estimate how much material and how much labour they will require i.e. a materials usage budget and a labour budget.
None of the budgets so far mentioned will be in money terms – they will be expressed in units of production, or kg of material, or hours of labour – but they each represent a plan for the year.
When all the individual budgets (or functional budgets) have been prepared, then it will be possible to cost them out in money terms and prepare a forecast Income Statement.
3 Benefits of budgeting
Planning
Controlling
Co-ordination
Authorising and delegating
Evaluation of performance
Communicating and motivating
4 Principal budget factor
As previously discussed, the budget needs to be prepared in stages – for example we normally will need to know the budget production (in units) before we can budget how much material will be needed (in kg).
The first thing that the person in charge of the budget process must do is decide where to start! For most companies the starting point will be a sales budget. Once it has been decided how many units the company expects to sell it is then possible to produce a production budget and so on.
However, this will not always be the starting point. Suppose, for example, that the company is a manufacturer of desks for which wood is the main material. Suppose also that during the coming year there is expected to be only a limited supply of wood available. In this situation the starting point will be to budget the amount of wood available, then budget how many units the company is capable of producing (a production budget) and then how many they expect to sell (a sales budget).
In general terms, the first budget to be prepared should be whatever factor it is that limits the growth of the company – it may be the level of demand (so a sales budget will be prepared first) or, as for the example in the previous paragraph, it may be the availability of raw material (so a material budget will be prepared first).
The factor that limits the company is known as the principal budget factor. The management accountant needs to identify the principal budget factor and it is this factor that will be budgeted first.
5 The preparation of budgets
The XYZ company produces three products, X, Y, and Z. For the coming accounting period budgets are to be prepared using the following information:
Budgeted sales
Product X 2,000 units at $100 each
Product Y 4,000 units at $130 each
Product Z 3,000 units at $150 each
Standard usage of raw material
Wood | Varnish | ||
Product X | 5 | 2 | |
Product Y | 3 | 2 | |
Product Z | 2 | 1 | |
Standard cost of raw material | $8 | $4 |
Inventories of finished goods
X | Y | Z | |
Opening | 500u | 800u | 700u |
Closing | 600u | 1,000u | 800u |
Inventories of raw materials
Wood | Varnish | ||
Opening | 21,000 | 10,000 | |
Closing | 18,000 | 9,000 |
Labour
X | Y | Z | |
Standard hours per unit | 4 | 6 | 8 |
Labour is paid at the rate of $3 per hour | |||
Prepare the following budgets:
(a) Sales budget (quantity and value)
(b) Production budget (units)
(c) Material usage budget (quantities)
(d) Material purchases budget (quantities and value)
(e) Labour budget (hours and value)
6 Type of budgets
Fixed budget
Flexed budget
Flexible budget
A company has prepared the following fixed budget for the coming year.
Sales | 10,000 units |
Production | 10,000 units |
$ | |
Direct materials | 50,000 |
Direct labour | 25,000 |
Variable overheads | 12,500 |
Fixed overheads | 10,000 |
$97,500 |
Budgeted selling price $10 per unit.
At the end of the year, the following costs had been incurred for the actual production of 12,000 units.
$ | |
Direct materials | 60,000 |
Direct labour | 28,500 |
Variable overheads | 15,000 |
Fixed overheads | 11,000 |
$114,500 |
The actual sales were 12,000 units for $122,000
(a) Prepare a flexed budget for the actual activity for the year
(b) Calculate the variances between actual and flexed budget, and summarise in a form suitable for management.
(Use a marginal costing approach)
7 Cash budgets
7.1 Proforma
Period | 1 | 2 | 3 | 4 | 5 |
$ | $ | $ | $ | $ | |
Receipts | |||||
Cash sales | x | x | x | x | x |
Receipts from credit customers | x | x | x | x | x |
Other income | x | x | |||
x | x | x | x | x | |
Payments | |||||
Cash purchases | x | x | x | x | x |
Payments for credit purchases | x | x | x | x | x |
Rent and rates | x | x | |||
Wages | x | x | x | x | x |
Light and heat | x | x | |||
Salaries | x | x | x | x | x |
Telephone | x | x | |||
Insurance | x | ||||
x | x | x | x | x | |
Surplus/(deficit) | (x) | (x) | x | x | x |
Balance b/f | – | (x) | (x) | (x) | x |
Balance c/f | (x) | (x) | (x) | x | x |
Additionally, cash flows relating to non-current assets or financing should be included as appropriate.
You are presented with the following flow forecasted data for your organisation for the period November 20X1 to March 20X2. It has been extracted from functional flow forecasts that have already been prepared.
NovX1 | DecX1 | JanX2 | FebX2 | MarX2 | |
$ | $ | $ | $ | $ | |
Sales | 80,000 | 100,000 | 110,000 | 130,000 | 140,000 |
Purchases | 40,000 | 60,000 | 80,000 | 90,000 | 110,000 |
Wages | 10,000 | 12,000 | 16,000 | 20,000 | 24,000 |
Overheads | 10,000 | 10,000 | 15,000 | 15,000 | 15,000 |
You are also told the following.
(a) Sales are 40% cash 60% credit. Credit sales are paid two months after the month of sale.
(b) Purchases are paid the month following purchase.
(c) 75% of wages are paid in the current month and 25% the following month.
(d) Overheads are paid the month after they are incurred.
(e) The opening cash balance is $15,000.
Prepare a cash flow forecast for the three-month period January to March 20X2.
Budgeting
4 questionsAnswer the questions one at a time. Your progress is saved so you can leave and come back.
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