Lecture 5

Budgeting
(Part 1)
Learning Objectives

LO 1) Budget
LO 2) Purpose of Budgets
LO 3) Operational Budgets
 LO 1)
BUDGET
Budget
• A budget is a quantified plan of action for a forthcoming
accounting period.
• A budget can be set from the top down (imposed budget) or
from the bottom up (participatory budget).

• Forecasts and budgets are not the same thing. Forecast is a

prediction of what is likely to happen. A budget is a target, not
a prediction, which has to be achieved.
Budgetary Planning & Control System

Budgetary Planning & Control System

Budgetary Planning & Control System is a system for ensuring
communication, coordination and control within an
organisation. Communication, coordination and control are
general objectives: more information is provided by an
inspection of the specific objectives of a budgetary planning
and control system.
LO 2)
Purpose of a Budget

Purpose of a Budget
oEnsure the achievement of the organisation's objectives.
oCompel planning
oCommunicate ideas and plans
oCoordinate activities
oProvide a framework for responsibility accounting
oEstablish a system of control
oMotivate employees to improve their performance
Budgeting Cycle

Budgeting Cycle
A budget cycle is the life of a budget from creation or
preparation, to evaluation. Most small businesses don't use
the term “budget cycle”.
Performance planning
Providing a frame of reference
Investigating variations
Corrective action
Planning again
Strategy , Planning & Budgets

Long-run Long-run
Planning Budgets

Strategy
Analysis

Short-run Short-run
Planning Budgets
 Master Budget

Master Budget
The master budget is basically management’s strategic plan for
the future of the company. Every aspect of the company
operations is charted and documented for future predictions.

Master Budget

Operating Financial
Decisions Decisions
Master Budget
 LO 3)
Operational Budgets
Operational Budgets
An operating budget consists of all revenues and expenses over a
period of time (typically a quarter or a year) which a corporation
or government or organization uses to plan its operations. An
operating budget is prepared in advance of a reporting period as
a goal or plan that the business expects to achieve.
Example – Hawaii Diving

Example
oHawaii Diving expects 1,100 units to be sold during the month of
August.
oSelling price is expected to be $240 per unit.
oTwo pounds of direct materials are budgeted per unit at a cost of
$2.00 per pound, $4.00 per unit.
oThree direct labor-hours are budgeted per unit at $7.00 per hour,
$21.00 per unit.
oVariable overhead is budgeted at $8.00 per direct labor-hour, $24.00
per unit.
oFixed overhead is budgeted at $5,400 per month.

oVariable nonmanufacturing costs are expected to be $0.14 per

revenue dollar.
oFixed nonmanufacturing costs are $7,800 per month.
Sales Budget

Sales Budget
the budget is expressed in quantitative (units) and financial
terms ($).
This is prepared from the sales forecast and factors to
consider when doing sales forecast are the customer demand,
company’s pricing strategy, general; economic conditions,
political conditions etc.

Question a)
How much are budgeted revenues for the month?
Sales Budget

Solution :
Sales budget for August.
 Production Budget

Production Budget
is expressed in quantitative terms only of the FINISH
GOODS. Its geared to the sales budget and takes into account the
opening and closing stock. This budget helps decide the planned
increase and decrease in the finish goods stock level.
Production Budget :

Budgeted sales (units)

+ Target ending finished goods inventory (units)

– Beginning finished goods inventory (units)

= Budgeted production (units)

 Production Budget
Question b)
Assume that target ending finished goods inventory is 80 units.
Beginning finished goods inventory is 100 units. How many units need to be
produced?

Solution :
 Direct Material Usage Budget

Direct Material Usage Budget

this is the total materials required for production for the period.

Materials Usage :
Budgeted Production Units

X Materials Required Per Unit

= Materials Usage Budget (kg)

 Direct Material Purchases Budget

Direct Material Purchases Budget

A purchases budget contains the amount of inventory that a company
must purchase during each budget period. The amount stated in
the budget is the amount needed to ensure that there is sufficient inventory
on hand to meet customer orders for products.
Purchases Budget :

Materials Usage Budget (kg)

+ Target ending Materials inventory (kg)
– Beginning Materials inventory (kg)
= Purchases Budget (kg)
X Price per kg

= Purchases Budget ($$)

 Determining Inventory Units
Question c)
Each finished unit requires 2 pounds of direct materials at a cost of $2.00 per
pound. Desired ending inventory equals 15% of the materials required to
produce next month’s sales and September sales are forecasted to be 1,600
units.
Solution :
 Usage Budget
Solution :
 Direct Materials Purchases Budget
Solution :
Materials Purchases Budget
 Labour Budget

Labour Budget
This budget is expressed in quantitative and financial terms. This
is influenced by the production requirements, man-hours
available, grades of labour, wage rates, and also the need for
incentives.
Labour Budget :

Budgeted Production Units

x Labour Hours / Unit

= Total Labour Budget (Hours)

X Labour Rate / Hour

= Total Labour Budget (in $$)
 Production Budget
Question d)
Each unit requires 3 direct labor-hours at $7.00 per hour.

Solution :
 Manufacturing Overhead Budget

Manufacturing Overhead Budget

The manufacturing overhead budget contains all manufacturing
costs other than direct materials and direct labor. The overhead
could include variable and fixed manufacturing overhead
 Manufacturing Overhead Budget
Question e)
Variable overhead is budgeted at $8.00 per direct labor-hour. Fixed overhead
is budgeted at $5,400 per month.

Solution :