PLANNING AND CONTROL

BUDGETING AND BUDGETARY CONTROL

BUDGETING

Definition of budget and budgeting

A budget is a financial plan for a future period. It is prepared considering objectives to be

achieved, and resources to be employed to achieve those objectives.

A budget is useful in every type of organizations. The degree of sophistication of the budget
differs as between organizations. Its use is similar in all organizations. It is a planning and
control tool for managers.

Budgeting and Corporate Planning

Corporate planning is about long-term planning. The environment in which an organization

operates is dynamic, multifaceted and complex. To be able to survive and grow an enterprise
needs to successfully adapt to its environment. One way of doing this is to formulate a
corporate/strategic plan.

This is done by the enterprise having a vision that is an articulation of what the enterprise
wants to be. To achieve its vision an enterprise comes up with a mission. For some
enterprises, this is summarized in a mission statement that is displayed in company premises
and its documents. On the basis of the vision and mission, the enterprise defines its goals and
objectives. Strategies are formulated after analyzing the external and internal environment
(i.e. carrying out environmental analysis to identify opportunities and threats) and corporate
appraisal or position audit to identify strengths and weaknesses. The strategies formulated
for implementation will have to be to exploit opportunities and counter threats by using
strengths and addressing weaknesses.

To implement the strategies in order to achieve the goals and objectives the enterprise will
require implementing the formulated strategies. The annual budget will need to be prepared
in the context/framework of the corporate plan. The approved annual budget will be the basis
of control. While implementing the strategies monitoring and evaluation will be done by
providing feedback information. Actual results will be compared with the budget and any
corrective action will be based on an investigation of significant variances.

Thus, the strategic plan (i.e. formal and systematic plan which purposefully directs and
controls an organization’s future operations towards agreed targets for periods more than one
year) and the budget are intertwined. Budgeting is part of long range and short-term
planning.

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Purposes of Budgeting / Why budget

The purposes of budgeting are:

Budgeting compels management to look ahead and prepare for the future, ie plan. That is
management is forced to define its goals and objectives for a future period after the current
period. It decides what it needs to achieve and prepares for it. It selects the means of
achieving the goals and objectives. In short organizational management decides on what
must be done, how to do it and the resources that will be needed. It gets ready for the future.

Management communicates goal and objectives, targets and policies to all employees in the
various parts of the organization. This makes them aware of what is expected of them and to
prepare to do their part.

Budgeting also helps to coordinate the various parts of the organization to work together in
harmony to achieve organizational objectives. It is a well-known fact that there are different
parts of the organization each responsible for some part of what must be done. Budgeting
makes each part aware of what is expected to achieve the budget. Coordination enables
working together to achieve objectives of the organization, ie integrating the various parts of
the organization. The budget requires the participation of all parts of the organization.
Through the budget, the role of each part of the organization is defined.

Controlling activities by comparing what is actual results with what was budgeted /planned
and taking any corrective action where necessary.

Motivation – The budget, where it is prepared with the participation of all employees
motivates workers and managers to work hard to achieve it.

Performance evaluation – with the budget as a yardstick or benchmark the organization

assesses how it performed in the period of the budget and such knowledge is useful for future
periods. Thus, the budget plays the role of standard to judge how well it performed in a
specified period. In doing so the performance of each responsibility center and manager is
evaluated.

The strategic plan and the budget

The strategic plan is a long-range plan whilst the budget is annual. The former is for a longer
planning horizon whilst the later is short run. The strategic plan is based on the vision and
mission of the organization. It is useful to budget meaningfully within the framework of the
strategic plan so that the short-term objectives reflect the vision of the organization. Hence
budget objectives should be derived from the strategic plan.

Administration of Budgets

Management commitment to budgeting and budgetary control is required for budgeting and
budgetary control to succeed. Therefore, there must be a clear organization structure that
shows authority and responsibility allocations. Budget centers must be established in the
organization structure.

A budget committee must be set up in the organization. Along with the budget committee
there must be a budget manual.

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Budget Committee

The budget committee should be responsible for all aspects of budgeting and budgetary
control. It is composed of:

The Chief Executive Officer (CEO)

Functional Heads and
The Management Accountant as Secretary or Budget Officer.

The Budget Committee’s Secretary’s responsibilities are:

To ensure that the budget is adhered to.

He/she assists Functional heads to draw up the budget and to analyze the results.

The functions of the Budget Committee

To agree on the policies with regard to budgets.
Coordinate budgets of the various parts of the organization.
Suggest amendments to budgets.
Approve budgets
Examine budgetary control reports.

Budget Manual
The budget manual sets formal procedures for the preparation of budgets and use of budgets.

The Budgeting Process

For learning purposes, the steps explained below relate to a manufacturing enterprise. They
can be adapted to a service organization. The first stage in the budgeting process is to
communicate policy guidelines for the budget period and identify the budget factor / limiting
factor.

Example

Sales Budget
Having communicated the policy guidelines including the limiting factor, the sales budget
will be prepared by specifying the products and quantities budgeted to be sold and the
respective selling prices. The sum of the budgeted sales revenue for all products will sum up
to the budgeted sales revenue for the whole firm.
Sales (units) x Selling price per unit = Sales revenue

The Production Budget

The sales budget will be followed by the production budget.

Direct materials/Raw material usage budget

This will incorporate the raw materials used.

Direct materials/Raw material purchase

Then there will be raw material purchase budget based on the production budget.

Direct labour budget

The direct labour usage budget will follow, and the production overhead budgets.

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These will also be followed by the cost of goods sold budget derived from consideration of
the sales budget, the production budget and the finished goods stock budget.
Budgets for the administration expenses and the sales and distribution expenses will be
prepared as well as. These budgets will be taken into account in the preparation of the
budgeted profits.

The sales budget, the production and other budgets will together form part of the operating
budget. The diagram below illustrates this clearly.

The operating budget, which shows the budgeted profit, and the capital budget will be used to
prepare the Cash Budget. Budgeted receipts and budgeted payments will be compared and
when the opening cash balance is incorporated, the closing cash balance will be calculated.

Using information about sales, production and other budgets including the Cash Account will
enable the preparation of the budgeted balance sheet

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 OPERATING BUDGET

SALES BDGT

PROD BGT

DM BGT DL BGT PO BGT

PC BGT

COGS BGT

ADM EX BGT S D EX BGT

BSOI

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Budgeting illustrated
W Ltd produces and sells one product called G. The selling prices of one unit of G is
K170.
The company is preparing budgets for the forth coming period and its expectations
for the period are as follows:
1. Budgeted sales of G in the budget period will be 3,000 units at the above
selling price
2. The opening inventories at the beginning of the budget period:
Raw material 5,000 kgs
Finished products 75 units

Closing inventories at the end of the budget period will be:

Raw materials 2, 250 kgs
Finished product 1,075 units
3. Material requirements per unit 12 kgs

4. Direct labour hours per unit 17 hours

5. Standard rates and prices

Direct labour K1.25 per hour
Raw material K0.70 per kg

6. Production overheads
K
Indirect labour 42,000
Power 5,400
Depreciation 15,000
Other expenses 62,400
124,800
Overheads are absorbed on the basis of direct labour hours.
It is estimated that planned labour hours will approximate to normal working.

7. Selling and administrative expenses will be as follows:

K
Sales commission 12,000
Sales salaries 18,600
Travelling 3,000
Office salaries 6,000
Office expenses 5,400
45,000

8. The company will incur interest on overdraft, and they are estimated to be
K1,100
9. Taxation on profits is at 35%. Income tax payable for the year was settled
accordingly
10.Work in progress is negligible and should be ignored

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Required
Prepare a budgeted statement of income for the budget period
Solution
Sales budget
Units Selling Price/unit Sales revenue
K K
Company product 3000 170 510,000

Production budget
Units
Desired closing inventory (f g) 1,075
Budgeted sales 3,000
Total requirements 4,075
Less Opening inventory 75
Production budget (units) 4,000

Direct material usage

Production budget (units) x Direct materials per unit
4,000 x 12 kgs = 48,000 kgs

Direct materials cost

48,000 kgs x K0.70 = K33,600

NB
If direct material are to be purchased the DM purchases budget would be prepared

Direct labour budget

Production budget (units) x DL cost per hour
4,000 x 17 kgs = 68,000 DLH

DL cost budget
68, 000 x K1.25 = K85,000

Production overhead budget is budgeted at K124,800

Budgeted DLH are 68,000 (ie 4,000 x 17 hrs)
The overhead absorption rate is 1.835/DLH
(Obtained by K124,800/68000 = 1.835/DLH)
Since the budgeted production overhead will approximate to normal working
Overheads are as budgeted above.

Budgeted production cost is:

K
Dm 33,600
Dl 85,000
Production overhead (1.835 x17x 4000) 124,780
Budgeted production cost 243, 380

Product cost per unit = 243,380/4000

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 = 60.845

This can be compared to the cost specified above

K
Dm 12 kgs @ K0.70 per kg 8.40
Dl 17 hrs@ K 1.25 per hr 21.25
Prodn o/h 17@ K1.835/DLH 31.20
Product cost per unit 60.85

NB Difference between K60.845 and K60.85 is due to rounding the production

overhead per unit

Cost of goods sold 3000 x 60.845 = 182,535

Using the long route

Opening inventory 75 x 60.845 = 4,563.375

Production cost 243,380.000

Cost of goods available for sale 247,943.375

Less Closing inventory 65,408.375

Cost of goods sold 182,535

Budgeted Statement of Income

K K
Sales 510,000
Less: Cost of goods sold See above 182,535
Gross profit 327,465
Less Sales and administration cost 45,000
Interest on overdraft 1,100
46,100
Net profit before tax 281,365
Income tax @35% 98,477.75
Net profit after tax 182,887.25

Part or the entire net profit after tax can be distributed in the form of dividends to the
ordinary shareholders.
Additional information is required to be able to carry out the preparation of the
budgeted statement of financial position.

Cash Budgeting
It is crucial for every organization to have adequate liquid resources to meet its
maturing obligations. To ensure this the cash budget has to be one of the
budgets the organization prepares for, say, every quarter or even every half

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year. This will show months when there will be adequate or inadequate cash.
On the basis of the cash budget actions will be initiated in time to look for more
money when shortages are anticipated or to invest the cash that will be in excess
of requirements.

BUGETARY CONTROL
Budgetary control sets the goals which it expects managers to achieve, and then evaluate their
performance by the use of variances [which seem to accentuate ‘adverse’ variance as the fault
of the manager]. Misuse of the system will harm the morale of managers and this affect the
performance of business.

Plan

Evaluate Implement

Monitor

Report significant variances periodically such as monthly.

Reporting after a year may be too long after the event.

Reporting weekly may be too often. Hence choose between the two extremes.

Reporting monthly is used by most organizations.

Aim of budgetary control to provide feedback (information gained from the explanation of
these variances).

So as to take corrective action where appropriate to improve performance (current and future
performance) and to improve budgets for the future periods.

BUDGET REPORTING

In budget costing system feedback reports consists of provision of information with actual
results or actual performance and the computation of variances. Such information should be
relevant to the recipients or the responsible managers. It should be timely and be reliable, at
appropriate level of detail and cost effective.
● Relevant
● Timely
● Reliable
● Cost effective

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FLEXIBLE BUDGETS
Flexible Budgets

Production (units) Budget Actual Variance

K 2000 3000 1000
K K K
DM 6 000 8 500 2 500 U
DL 4 000 4 500 500 U
Maintenance 1 000 1 400 400 U
Depreciation 2 000 2 200 200 U
Rent & Rates 1 500 1 600 200 U
Other costs 3 600 5 000 1 400 U
Total 18 100 23 200 5 400 U

(a) Flexed Budget (b) Actual Results (c) Variance (b – c) K

Production (units) 3,000 3,000
K K K
Variable costs
DM 9 000 8 500 500 F
DL 6 000 4 500 1 500 F
Maintenance 1 500 1 400 100 F

Semi-Variable Costs
Other costs 4 600 5 000 400 U
Fixed costs
Depreciation 2 000 2 200 200 U
Rent & Rates 1 500 1 600 100U
24 600 23 200 1 400 F

A flexible budget is more appropriate for exercising control because the flexible budget is
prepared in retrospect based on actual activity level. If actual output is known a flexible
budget can be prepared based on it.

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