BUDGETING AND

BUDGETARY
CONTROL

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You should be able to:
Determine the roles of budgeting in the overall
planning and control framework.
Identify and explain the key purposes of
budgeting.
Prepare the functional and master budgets.
Prepare a cash budget.

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 Budget is a quantitative expression of a plan of
action prepared in advance of the period to
which it relates.
 Budget is a quantitative statement for a defined
period of time, which may include planned
revenues, expenses, assets, liabilities and cash
flows.
◦ The act of preparing a budget is called budgeting.
◦ The use of budgets to control an organization’s activity
is known as budgetary control.

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 Planning – Control – involves
involves developing the steps taken by
objectives and management that
preparing various attempt to ensure
budgets to achieve the objectives are
these objectives. attained.

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 Planning and
coordination
Clarification of
Authority and
The Budget Responsibility
Period

Benefits

Communication
Motivation

Control

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1. Planning and Coordination

◦ Planning is the key to success in business and

budgeting forces planning to take place.

◦ Budgeting process provides coordination of activities

and departments of the organisation so that the
operation contributes towards the overall plan.

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2. Clarification of Authority and
Responsibility
◦ Budgeting process makes it necessary to clarify the
responsibilities of each manager who has a budget.

◦ The adoption of a budget authorises the plans

contained within it so that management by exception
can be practised.

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3. Communication
◦ Budgetary process is an important avenue of
communication that includes all level of management,
especially between top and middle management
regarding the firm’s objective.

◦ In terms of vertical communication, budgetary process

also requires communications between functions to
ensure that coordination is achieved.

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4. Control
◦ This is the most well known aspect of budgeting.

◦ Is the process of comparing actual results with

planned results and reporting on the variations.

◦ Helps expenditure to be kept within agreed limits.

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5. Motivation

◦ The involvement of lower and middle management in

preparing budgets and establishing a clear targets are
found to be a motivating factor.

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6. The Budget Period
◦ Planning must be related to a specific period and
budgets can be prepared for any length of time and
even longer period.

◦ The general process of budgeting can be broken down

into longer term for planning and shorter term for
monitoring and control purposes.

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Profit centres - A part of a business accountable
for costs and revenues.

Budget centres - A section of an entity for which

control may be exercised and budgets prepared.

Hence, a budget centre may be a cost centre or a

group of cost centres, and may coincide with profit
centre.

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Budgets can be both Fixed or Flexible

 Fixed budget

 A single budget that is designed to remain

unchanged irrespective of the volume of output or
turnover attained.

 The major purpose of a fixed budget is at the

planning stage where it serves to define the broad
objectives of the organisation.

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 Flexible budget

 A budget which recognise different cost behaviour

patterns is designed to change as the volume of
activity changes.

 A flexed budget which is designed to allow

adjustments on the permitted cost levels to suit the
level of activity actually attained.

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 Flexible budgeting is used for control purposes.
o Comparing the cost with the expenditure incurred at the
actual activity level.

 Procedure for developing a flexible budget are

simple.

 But
the results to obtain flexing budget is only
accurate if the costs behave in the ways predicted.

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 Starts with the preparation of a budget for each
budget centre, and usually referred to as operating
or functional budgets.

 The budgets must be coordinated.

 The budgets will be governed by the principal

budget factor, which will normally decides which
budget to be prepared first.

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 Sales budget is based upon the forecast demand for the
goods.

 Sales are frequently the key factor in business and will

normally determine the shape of other budgets.

 A simple sales budget will record quantities, prices and

total revenue for a product.

 Further columns may be added when there are more

than 1 product, or when it is necessary to analyse sales.

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Example:

Ali sells a single product, Deevan Beds, at a price of RM160

each. During the 3 months to 31 December 2016, he sold
1,500 beds; turnover was constant per month. He expects the
volume of sales to remain unchanged for January 2017, but
to increase by 5% in February, and by a further 20% in April.
The price of the beds will be increased by 10% in January
and by a further 5% in June.

Required:
Prepare sales budget for Deevan Beds for the six months to
30 June 2017.

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Solution:
Quantity in October – December 2016
= 1,500 / 3
= 500 beds
Month Quantity Price (RM)

January 500 160 + 10% = 176

February 500 + 5% = 525 176

March 525 176

April 525 + 20% = 630 176

May 630 176

June 630 176 + 5% = 184.8

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 Deevan Beds
Sales Budget for the six months ended 30 June 2017
Month Quantity (units) Price per unit (RM) Revenue (RM)
January 500 176 88,000
February 525 176 92,400
March 525 176 92,400
April 630 176 110,880
May 630 176 110,880
June 630 184.80 116,424
3,440 610,984

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 This
is a budget for the production of finished
goods.

 Two
types of production budgets:
oEven Production Budget
oUneven Production Budget

 Production = Sales + Closing Stock – Opening

Stock

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Example:

ABC Berhad manufactures cans of fizzy drinks.

Sales for four months May to August are expected to be as
follows: May 600; June 800; July 1,000; August 600.
Closing stocks required are: April 800; May 950; June 900;
July 650; Aug 800.
Required:
ABC Berhad’s production budget for the four months
May to August.

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 ABC Berhad
Production Budget for the four months ended 31 August
May June July August
Sales 600 800 1,000 600
Closing stock 950 900 650 800
1,550 1,700 1,650 1,400
(-) Opening stock (800) (950) (900) (650)
Production 750 750 750 750

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 A cash budget must contain every type of cash
inflow and cash outflow.

 The timing of receive and payments must also be

forecasted.
Cash Budget

Period 1 Period 2 Etc.

Receipts (details)
Payments (details)
Net receipts / (payments)
Balance brought forward
Balance carried forward

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 Most important budget prepared in an organization.

 It shows in summary, the expected cash received and

expected cash payments during the budget period.

 Cash budgets are prepared in order to ensure that

there are sufficient cash in hand to cope adequately
with budgeted activities.

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Example:

The opening cash balance on 1 January was expected to be

RM30,000. The sales budgeted were as follows:
November RM80,000
December RM90,000
January RM75,000
February RM75,000
March RM80,000

Analysis of records shows that debtors settle according to the

following pattern:
60% within the month of sale,
25% the month following,
15% the month following
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Extracts from the purchases budget were as follows:
December RM60,000
January RM55,000
February RM45,000
March RM55,000
All purchase are on credit and past experience shows that 90% are settled
in the month of purchase and the balance settled the month after.

Wages are RM15,000 per month and overheads of RM20,000 per month
(including RM5,000 depreciation) are settled monthly.

Taxation of RM8,000 has to be settled in February and the company will

receive settlement of an insurance claim of RM25,000 in March.

REQUIRED:
Prepare a cash budget for January, February and March.

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Solution (workings):

The receives from sales are as follows:

January Cash
November (15% x 80,000) RM12,000
December (25% x 90,000) RM22,500
January (60% x 75,000) RM45,000
RM79,500

February Cash
December (15% x 90,000) RM13,500
January (25% x 75,000) RM18,750
February (60% x 75,000) RM45,000
RM77,250

March Cash
January (15% x 75,000) RM11,250
February (25% x 75,000) RM18,750
March (60% x 80,000) RM48,000
RM78,000
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Payments for purchases:
January Cash
December (10% x 60,000) RM6,000
January (90% x 55,000) RM49,500
RM55,500

February Cash
January (10% x 55,000) RM5,500
February (90% x 45,000) RM40,500
RM46,000

March Cash
February (10% x 45,000) RM4,500
March (90% x 55,000) RM49,500
RM54,000

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 Cash Budget for January, February and March
January (RM) February (RM) March (RM)
Balance b/f 30,000 24,000 17,250
Receipts:
Receives from sales 79,500 77,250 78,000
Insurance claim - - 25,000
79,500 77,250 103,000
Payments:
Purchases 55,500 46,000 54,000
Wages 15,000 15,000 15,000
Overheads (exc. dep.) 15,000 15,000 15,000
Taxation - 8,000 -
85,500 84,000 84,000
Surplus / (Deficit) (6,000) (6,750) 19,000
Balance c/f 24,000 17,250 36,250
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 Top
management

Middle Middle
management management

Supervisor Supervisor Supervisor Supervisor

A budget is prepared with the full cooperation and

participation of managers at all levels. A participative
budget is also known as a self-imposed budget.
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 Thebehavioral aspects of budgeting are very
important, but with many aspects of human
behavior, they become contradictory and
imperfectly understood.

 This
is because participants do not consider
budgeting as a neutral, objective, purely
technical process which is a view adopted by
accountants.

 Therefore,human subjective aspects cannot be

over emphasized and these are dealt as the
following:

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1. Goal Congruence (Similarity)
oThe goals of individuals and groups should coincide
with the goals and objectives of the organization as a
whole.

oDifficult to achieve but the objective of budgeting

system cannot be imposed without consideration
of the influences of group and departmental
objectives.

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2. Participation
o Participation promotes common understanding
regarding objectives and makes the acceptance
of organizational goals by individual much more
likely.

o If people are genuinely involved they feel part of

the team and become more motivated.

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3. Motivation
o The whole process of budget preparation and
performance evaluation needs to be carried out to
motivate managers rather than create resentment and
adverse reactions.

o Individual feels motivated if they are involved in the

process of designing, being encourage and given
responsibilities.

o Research shown that motivation increased when the

reward-penalty system is implemented consistently with
the budgetary control system.

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4. Goal definition
o People work more efficiently when they have clearly
defined targets and objectives.

o Personal goals should be coincided with organizational

goal so that individual motivation would be at its highest
and targets would be accepted.

o Clearly defined goals, agreed and acceptable by

individuals concerned, will encourage goal congruence
and increase motivation.

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5. Communication
oProcess of communication in an organisation is
an important factor in all planning and control
systems.

oIf any control system, including budgetary control

is not accepted by the people who have to
operate it, they will hamper and obstruct the flow
of information so that realistic planning and
control decisions will be difficult to take.

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The success of budgeting depends upon three
important factors:

1. Top management must be enthusiastic and

committed to the budget process.
2. Top management must not use the budget to
pressure employees or blame them when something
goes wrong.
3. Highly achievable budget targets are usually
preferred when managers are rewarded based on
meeting budget targets.

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1. Provides clear guidelines for managers and
supervisors to achieve the objectives.
2. Important method of communication.
3. Management time can be saved and attention
can be directed to areas of most concern.
4. Better cash and working capital management.
5. Better control of current operations.
6. Provided there is proper participation, goal
congruence is encouraged and motivation
increased.
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1. Variances due to changing circumstances and
poor forecasting.
2. Budgets developed round the existing
organization structures which may be
inappropriate for current conditions.
3. Existence of well documented plans may cause
lack of flexibility in adapting to change.
4. Badly handled budgetary systems may cause
antagonism and may lower morale.

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 End of Lecture 7

Next: Introduction to Economics

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