Budgeting and

Budgetary Control

Lecturer:
Wan Mardyatul Miza Wan Tahir
TOPIC OUTCOME:
• Definition and purpose of budget

• Budgeting process and key budget factor

• Preparation of budgets
Cash budgets
Fixed and flexible budget

• Limitations of budgeting.
DEFINITION
• A budget is a detailed plan summarising the financial consequences
of an organisation’s operating activities for a specific future time
period
• Budget helps to assist in the planning of actual operations through
forcing the managers to consider how the conditions might change
and what steps should be taken now.
• It encourages managers to consider problems before they arise.
• Budget is also seen to help in co-ordinating the activities of the
organization by since managers have to examine the relationships
between their own operation and those of other departments.
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PURPOSES OF BUDGETING
• Planning
• Expresses a plan of action in financial terms
• Facilitating communication and coordination
• Provides a formal mechanism to enable communication and coordination
between all managers
• Allocating resources
• Provides a way of allocating limited resources among competing users

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PURPOSES OF BUDGETING
• Controlling profit and operations
• The budget can serve as a benchmark to allow comparison against
actual results across all levels of a business
• Evaluating performance and providing incentives
• Comparing actual results with a budget helps managers evaluate the
performance of individuals, departments or the entire company
• Achievement of budget targets may be linked to the payment of
cash rewards or profit sharing, and thus budgets may provide
incentives for individuals to improve their performance

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BUDGETING PROCESSES
• In large organisations, formal processes are often used to collect data
and prepare the budget
• Budget administration is often the responsibility of the senior
accounting managers
• A budget manual may be used to communicate who is responsible for
providing various types of information, when the information is
required and what form it will take
• A budget committee may be appointed to advise the accountants
during the preparation of the budget

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STEPS IN BUDGETING PROCESS
1. Set the objective

2. Compile forecasts

3. Consider limiting factors

4. Prepare the budgets

5. Review forecasts and plans

6. Implement the budgets

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STEPS IN BUDGETING PROCESS
1. To set or ascertain the objectives: The objectives of the business
have to be set so that the plans may be prepared to achieve those
objectives.

2. To compile forecasts: Forecasts or estimates will reveal what is

likely to happen in the future, what factors are likely to affect the
company’s future and what factors can be taken advantage of, in
the future. The forecast must be coordinated to become part of an
overall plan. Forecasting requires gathering of information, and
knowledge about the business and the external environment and
the use of statistical techniques to prepare accurate estimates.

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STEPS IN BUDGETING PROCESS
3. To consider limiting factors: Decisions must be taken to
minimize the effects or to amend them. The limiting factors
must be kept in mind when determining the quantity which can
be made or sold. The quantity determined must comply with the
forecasts and meet the objectives of the business.

4. To prepare the budgets: Budgets show the plans in financial

terms. Budgets have to be coordinated with each other so that
there are integration of plans, improved communication and
operational harmony among functions and departments. All
these will enable the organization’s objectives to be achieved
most efficiently.

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STEPS IN BUDGETING PROCESS
5. To review forecasts and plans: Forecasts and budgets have to be
reviewed at regular intervals. Changing environments may require
changes to be made. Revised budgets may have to be prepared.

6. To implement the budget: Budgets that are accepted must be

implemented. The budget becomes the standard by which
performance is measured.

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KEY TO A SUCCESSFUL BUDGETING
1. Clearly identify programmatic objectives inline with the mission
and strategic plan.

2. Determine the financial resources needed & available to achieve

goals

3. Involve staff and board members in the budgeting process

4. Proper documentation is needed by writing down assumptions &

formulas to manage budget in the year

5. Customize the budgeting process as each department has

different plan

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KEY BUDGET FACTOR
• A key budget factor is a factor that limits the quantity that can be
made or sold by an organisation.
• It is also known as principal budget factor or limiting factor.
• Normally, the key budget factor would be the sales demand but it can
also be scarce resources, for example material or labour.

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EXAMPLES OF KEY BUDGET FACTOR
Key Budget Factor
MATERIAL Shortage of supply especially scarce
material
LABOUR Shortage of skilled labour
PLANT & MACHINERY Plant capacity that is limited to
machine time
WORKING CAPITAL Credit control
SALES Customer demand
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 FIXED
BUDGET
CASH FLEXIBLE
BUDGET BUDGET

PREPARATION
OF BUDGET

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CASH BUDGET
 A detailed budget of cash inflows and cash outflows.
 A statement in which estimated future cash receipts and payments
are tabulated.
 The inflows and outflows of money of the business are tracked for
control purposes.
 The longer the period, the less accurate will be the cash forecast.
 Showing whether the business has surplus or deficit at the end of
each period.

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 PURPOSE OF CASH BUDGET

• Ensure sufficient cash is available at all times to meet the level of

operations outlined in various budget
• Avoid cash balances that is excessively surplus to its requirement –
invest the surplus cash in short term investment to get better return.
• Identify in advance the steps to be taken to meet cash deficiencies/
shortage

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FEATURES OF CASH BUDGET
• 2 sections : Cash receipts & payments
• Only deals with cash in nature.
• Depreciation & bad debt are excluded (non-cash).
• Cash receipts (inflow): Cash sales, collection of credit sales,
interest & dividend received, proceed from sales of investments
or assets
• Cash payments (outflow): Payments for direct material, labour,
overhead, selling & administrative expenses, purchase of assets
or investment

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FORMAT FOR CASH BUDGET
Cash Budget for the period ending…
Period 1 Period 2 Period 3
(RM) (RM) (RM)
Opening cash balance b/d
ADD: RECEIPTS
Receipts from cash sales
Receipts from debtors
Sales of capital items
Loans received
Dividends received
Interest received
TOTAL RECEIPTS
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FORMAT FOR CASH BUDGET (cont’d)
Period 1 Period 2 Period 3
(RM) (RM) (RM)
LESS: PAYMENTS
Cash purchases
Payments to creditors
Wages & salaries
Loan repayments
Purchases of assets
Dividends paid
Interest paid
Taxation paid
TOTAL PAYMENTS
Closing cash balance c/d 19
FIXED BUDGET
• A fixed budget is a financial plan that does not change through the
budget period, irrespective of any changes from the plan in actual
activity levels experienced.
• Many times a fixed budget is also known as a static budget.
• Most companies use a fixed budget, which means that they usually
face large variations between actual and budgeted results.
• Since there will be a large variance that have been expected, this can
affect the reliance on the budget by the employees and in the
variances derived from it.

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FLEXIBLE BUDGET
• The reverse of a fixed budget is a flexible budget, where the budget is
designed to change in response to variations in activity levels.
• A flexible budget, or “flex” budget, incorporates different expense
levels into the budget, depending upon changes in the actual activity
level.
• Since the flexible budget is adapted based on the actual results, there
tend to be much smaller variances from the budget as compared to
using the fixed budget.

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ILLUSTRATION 1
Princess Sdn Bhd produces a single product on an assembly line. As the
Budget Officer, you have prepared the following production budgets
from the best information available, to represent both the minimum
and maximum volume of production that are likely to be encountered
by the company over a three-month period.

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ILLUSTRATION 1
Production of Production of
4,000 units 8,000 units
RM RM
Direct materials 80,000 160,000
Indirect materials 12,000 20,000
Direct labour 50,000 100,000
Electricity 18,000 24,000
Repairs and maintenance 20,000 30,000
Supervision 20,000 36,000
Rent and building insurance 9,000 9,000

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ILLUSTRATION 1
During the three months July to September 2020, 5,000
units were produced. Costs incurred during the three-
month period were as follows:
RM
Direct materials 110,000
Indirect materials 14,000
Direct labour 70,000
Electricity 18,000
Repairs and maintenance 30,000
Supervision 20,000
Rent and building insurance 8,000
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ILLUSTRATION 1
Required:
Prepare a performance report of the above figures by applying the
flexible budgeting approach.

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ILLUSTRATION 1 –
APPROACHING THE QUESTION
1. Draw table for 2. Examine each 3. Deal with fixed
flexible budget cost classification costs

6. Complete the 5. Deal with mixed 4. Deal with

flexible budget costs variable costs

7. Determine the
variances

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Step 1 – Draw table for flexible budget
Make sure it is the
Flexed
same with actual Actual Variances
Budget
Activity levels (units) 5,000 5,000
RM RM
Direct materials 110,000
Indirect materials 14,000
Direct labour 70,000
Electricity 18,000
Repairs and maintenance 30,000
Supervision 20,000
Rent and building insurance 8,000

JUST COPY FROM THE QUESTION

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Step 2 – Examine each cost classification
• The easiest is to start by identifying the fixed cost since the amounts
will not change even if the level of activity changes.
• The variable cost can be identified by dividing the total cost at one
activity level by the number of units. If you have two activity levels (in
this case at 4,000 units and 8,000 units), the variable cost per unit
should be the same. If not the same, then it should be a mixed cost.
• The mixed cost should be separated into fixed and variable cost using
the high-low method.

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Step 3 – Deal with fixed cost
• Fixed costs will be the same at all levels of production.
• Based on the information given, the only cost item that remains the
same at both 4,000 and 8,000 units is the Rent and Building Insurance
worth RM9,000.

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 Flexible budget
Flexed Budget Actual Variances
Activity levels (units) 5,000 5,000
RM RM
Direct materials 110,000
Indirect materials 14,000
Direct labour 70,000
Electricity 18,000
Repairs and maintenance 30,000
Supervision 20,000
Rent and building insurance 9,000 8,000
Total costs 270,000

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Step 4 – Deal with variable cost
• At both activity levels, calculate the variable cost per unit
(VCPU) for all of the cost items. If both results in the same
answer, then the cost item is a variable cost. If not, it is a
mixed cost.
4,000 units VCPU 8,000 units VCPU VC or MC
RM RM RM RM
Direct materials 80,000 20 160,000 20 VC
Indirect 12,000 3 20,000 2.50 MC
materials
Direct labour 50,000 12.50 100,000 12.50 VC
Electricity 18,000 4.50 24,000 3.00 MC
Repairs and 20,000 5 30,000 3.75 MC
maintenance
Supervision 20,000 5.00 36,000 4.50 MC
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 Flexible budget
Flexed Budget Actual Variances
Activity levels (units) 5,000 5,000
RM RM
Direct materials (RM20 X 5,000) 100,000 110,000
Indirect materials 14,000
Direct labour (RM12.50 X 5,000) 62,500 70,000
Electricity 18,000
Repairs and maintenance 30,000
Supervision 20,000
Rent and building insurance 9,000 8,000
Total costs 270,000

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Step 5 – Deal with mixed cost
• In step 4, it has been identified that the following four cost
items are mixed costs.
• Thus, the high-low method will be used to separate the fixed
and variable elements from the total costs.
4,000 units VCPU 8,000 units VCPU VC or MC
RM RM RM RM
Indirect
12,000 3 20,000 2.50 MC
materials
Electricity 18,000 4.50 24,000 3.00 MC
Repairs and
20,000 5 30,000 3.75 MC
maintenance
Supervision 20,000 5.00 36,000 4.50 MC

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Step 5 – Deal with mixed cost
High low method

1. Determine variable cost per unit from the following formula:

Variable cost per unit (VCPU) =

Highest Total Costs – Lowest Total Costs
Highest Activity Level – Lowest Activity Level

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Step 5 – Deal with mixed cost
High low method

2. Determine the fixed cost by subtracting the total variable cost at

either the high or the low activity level from the total cost at that
activity level.
Fixed cost = Total cost – (VCPU X activity level)

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Step 5 – Deal with mixed cost
The followings are the workings on calculating VCPU and
total fixed cost for the four cost items:
4,000 units 8,000 units VCPU TFC
RM RM
Indirect = (RM20,000 – RM12,000) ÷ = RM20,000 – (RM2.00 X
12,000 20,000
materials (8,000 – 4,000) = RM2.00 8,000) = RM4,000
Electricity = (RM24,000 – RM18,000) ÷ = RM24,000 – (RM1.50 X
18,000 24,000
(8,000 – 4,000) = RM1.50 8,000) = RM12,000
Repairs and = (RM30,000 – RM20,000) ÷ = RM30,000 – (RM2.50 X
20,000 30,000
maintenance (8,000 – 4,000) = RM2.50 8,000) = RM10,000
Supervision = (RM36,000 – RM20,000) ÷ = RM36,000 – (RM4.00 X
20,000 36,000
(8,000 – 4,000) = RM4.00 8,000) = RM4,000

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 Step 6 – Completing the flexible budget
Flexed Budget Actual Variances
Activity levels (units) 5,000 5,000
RM RM
Direct materials (RM20 X 5,000) 100,000 110,000
Indirect materials [(RM2 X 5,000) + RM4,000] 14,000 14,000
Direct labour (RM12.50 X 5,000) 62,500 70,000
Electricity 19,500 18,000
[(RM1.50 X 5,000) + RM12,000]
Repairs and maintenance 22,500 30,000
[(RM2.50 X 5,000) + RM10,000]
Supervision 24,000 20,000
[(RM4 X 5,000) + RM4,000]
Rent and building insurance 9,000 8,000
Total costs 247,500 270,000
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 Step 7 – Determine the variances
Flexed Budget Actual Variances
Activity levels (units) 5,000 5,000
RM RM
Direct materials (RM20 X 5,000) 100,000 110,000 10,000 A
Indirect materials (RM2 X 5,000)+ RM4,000 14,000 14,000 -
Direct labour (RM12.50 X 5,000) 62,500 70,000 7,500 A
Electricity 19,500 18,000 1,500 F
[(RM1.50 X 5,000) + RM12,000]
Repairs and maintenance 22,500 30,000 7,500 A
[(RM2.50 X 5,000) + RM10,000]
Supervision 24,000 20,000 4,000 F
[(RM4 X 5,000) + RM4,000]
Rent and building insurance 9,000 8,000 1,000 F
Total costs 251,500 270,000 18,500 A
Variance
Revenue : Budget > Actual = Adverse; Budget < Actual = Favourable
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Cost/Expenses : Budget > Actual = Favourable; Budget < Actual = Adverse
LIMITATIONS OF PREPARING
BUDGETS
• TIME REQUIRED.
• It can be very time-consuming to create a budget, especially in a poorly-
organized environment where many iterations of the budget may be required.
The time involved is lower if there is a well-designed budgeting procedure in
place, employees are accustomed to the process, and the company uses
budgeting software.

• GAMING THE SYSTEM.

• An experienced manager may attempt to introduce budgetary slack, which
involves deliberately reducing revenue estimates and increasing expense
estimates, so that he can easily achieve favorable variances against the
budget. This can be a serious problem, and requires considerable oversight to
spot and eliminate.
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LIMITATIONS OF PREPARING
BUDGETS
• BLAME FOR OUTCOMES
• If a department does not achieve its budgeted results, the department manager may
blame any other departments that provide services to it for not having adequately
supported his department.

• EXPENSE ALLOCATIONS
• The budget may prescribe that certain amounts of overhead costs be allocated to
various departments, and the managers of those departments may take issue with
the allocation methods used.

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 LIMITATIONS OF PREPARING
BUDGETS
• ONLY CONSIDERS FINANCIAL OUTCOMES
• Budgets are primarily concerned with the allocation of cash to specific
activities, and the expected outcome of business transactions. They
do not deal with more subjective issues, such as the quality of
products or services provided to customers.

• STRATEGIC RIGIDITY
• When a company creates an annual budget, the senior management
team may decide that the focus of the organization for the next year
will be entirely on meeting the targets outlined in the budget. This can
be a problem if the market shifts in a different direction sometime
during the budget year. In this case, the company should shift along
with the market, rather than adhering to the budget.

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LIMITATIONS OF PREPARING
BUDGETS
• SPEND IT OR LOSE IT
• If a department is allowed a certain amount of expenditures and it does not appear
that the department will spend all of the funds during the budget period, the
department manager may authorize excessive expenditures at the last minute, on
the grounds that his budget will be reduced in the next period unless he spends all of
the amounts authorized in the current budget.

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