BUDGETING

LEARNING OBJECTIVES
 Define and explain the purposes of budget

 Identify the budgeting process and key budget factor

 Forecast using time series analysis

 Prepare three types of budget, that are:

 Functional Budgets
 Cash Budgets
 Master Budget

 Explain the different techniques of budgeting:

 Incremental Budgeting
 Zero-Based Budgeting
 Rolling Budget
 Activity-Based Budget
 • DEFINITION OF BUDGET
A budget
 A detailed plan summarising the financial consequences of
an organisation’s operating activities for a specific future
time period OR a plan of future activities with monetary
implications
 A financial model that summarises future operations
 A core component of an organisation’s planning and control
system
 A critical way of providing information to managers to help
them manage resources and create value
 Regarded as short-term planning with a typical time horizon
of one year
 Budgeting – process of allocating funds and monitoring of
actual performance against that of budgeted
 PURPOSE OF BUDGET

Planning annual operations

Controlling activities
Communicating plans to
the various responsibility
centre managers

Evaluating the
Coordinating the performance
activities of the of managers
various parts of the
organization and Motivating
ensuring that the managers to
parts are harmony strive to achieve
with each other the organizational
goals
 STAGES IN BUDGETING PROCESS
1. Communicate details of budget policy and guidelines to those people responsible for
preparing the budget.

2. Determine the factor that restricts output.

3. Preparation of the sales budget.

4. Initial preparation of budgets.

5. Negotiation of budgets with higher management.

6. Co-ordination and review of budgets

7. Final acceptance of budgets.

8. Ongoing review of budgets,

 BUDGETING PROCESS

• The budgeting function is to be carried out by either the

accountant, in the case of a small business and by a budget
committee, in the case of a bigger company.
Budget • Typically, a budget committee will comprise of the divisional
heads, the chief operating officer and the group accountant.
Committee • Their major task is to ensure that budgets are realistically
established and they are coordinated satisfactorily.

• Sound organizational structure with clearly defined

authority and responsibilities.
Effective • Realistic goals.
Budgeting • Accepted by all levels of management.
• Periodic review of budget with actual performance.
• Corrective actions.
 BUDGETING PROCESS-
CONTINUES….

• The collection of instructions regarding the

Budget responsibilities of preparing the budget.
• Its contents will include organizational structures
manual and procedures for preparing the budget.

• Budget may be prepared for any period of time

depending on the type of budget, nature of
Budget organization, the need for periodic appraisal and
prevailing business conditions.
period • The length of budget period varies but the most
common practice is one year.
 PRINCIPLE BUDGET FACTOR
 Also known as limiting budget factor is the term used when
there is a short supply of key resources and this affects the
planning and decision making process.

 The key resources include cash, raw materials supply, labor

or equipment.

 The early identification of this factor is important because it

indicates which budget should be prepared first.

 i.e. If sales volume is the principal budget factor, and then

the sales budget must be prepared first, based on the
available sales forecasts. All other budgets should then be
linked to this.
 TECHNIQUES OF
FORECASTING
Cost prediction
Using the historical data on
costs at various activity levels
to arrive at a straight line
relationship between them,
which is then extrapolated to
forecast costs for future activity
levels.
5 main methods:
1. The engineering approach
2. The account analysis
approach - use information in
the ledger accounts
3. Scatter diagrams
4. The high-low method
5. Regression analysis
Time series
Relate to a series of values that vary over
time. When plotted on the graph, a time
series may reveal a trend or relationship.
Given to a set of observations taken at
equal intervals of time.
Influenced by a num. of factors:
1. Long term trend (T)– it relates to things
such as change in the size or age
structure of population, change in
average income levels.
2. Cyclical variation (C)– this is the way in
which long-term cycles in trade cause
demand to rise or fall.
3. Seasonal variations (S).
4. Residual or random pattern (R) –
variations due to unpredictable causes
eg: strikes, fire
 TIME SERIES
The main reasons for analyzing a time
series are:
 To be able to predict future values of the variables
i.e. to make forecast

 To attempt to control future events

 To ‘seasonally adjust’ do ‘deseasonalise’ a set of

data. It is a process to remove the seasonal effects.
i.e. seasonally adjust unemployment values are
more useful than actual unemployment values in
studying the effects of the national economy and
government policies on unemployment.
 TIME SERIES
Assumption and Limitations of Time Series
Analysis
Assumption Limitations
 What has happened  Significant changes
in the past can be might occur quite
used to predict what quickly. E.g new
will happen in the technology could
future. revolutionise practice
and products within an
industry.
 Financial figures
collected over a long
period of time for time
series analysis will be
affected by changing
price levels.
 PREPARATION OF BUDGETS

Functional or operating budget – Master of financial budget –

relate to one another; there are 6 summarizes all the functional budgets
types of budget into the budgeted income statement,
cash budget and budgeted statement
of financial position

Production Selling & admin

Sales budget expenses budget
budget

Direct
materials Budgeted Budgeted
budget income statement of Cash budget
statement financial
position
Direct labor
budget

Manufacturing
overheads
budget
 PREPARATION OF
FUNCTIONAL BUDGET
The preparation of functional budgets starts with the sales forecasts as the business
plans for the expected demand in the next budget period.

• Shows the expected sales that are likely to be achieved

Sales budget
for a certain future period of time.

• Shows the expected number of units to be produced

Production incorporating any stock levels to be maintained.
budget

• Shows the movement of the raw materials in terms of

purchase incorporating an stock level with a net effect of
Direct materials
budget raw materials consumed.
 PREPARATION OF FUNCTIONAL
BUDGET – CONTINUES…
• Shows the required direct labour hours with
Direct labor
budget
the associated costs.

• Lists the expected manufacturing overheads

Manufacturing
overheads expenses to be incurred.
budget

• Provides the expected expenses to be

Selling &
distribution incurred for selling and distribution purposes.
budget
 PREPARATION OF FUNCTIONAL
BUDGET

Sales Budget — The first budget to be prepared and is

drawn by multiplying the expected unit sales volume
for each product by its anticipated unit selling price.
Production Budget — Once the sales units have been
established, the production budget is drawn up to
determine the number of units to be produced by
considering the stock levels that have to be
maintained.
 PREPARATION OF FUNCTIONAL
BUDGET
Materials Usage Budget

Once the production units are set, the material

requirement needed to make those products is
established based on the type and quantity
required.

Shows the quantities of materials required to meet

the budgeted production.
 PREPARATION OF
FUNCTIONAL BUDGET

Materials Purchase Budget

 Taking into account the stock levels required for the
materials, the amount of materials to be purchased is
determined from the cost of materials to arrive at the total
costs involved.

Direct Labour Budget

 Another element of production, direct labour requirement
for the production intended must also be set.
 This is expressed in terms of hours per unit multiplied by
the labour rate for the production units.
 CASH BUDGET
 Cash budget is prepared to show the expected receipts and
payments of cash during the next period.

 In practice, often prepared for the year on a monthly basis or

a quarter for control purposes.

 The longer the period, the less accurate will be the cash
forecast.

 The cash budget shows expected cash flows of the

business.

 The cash flows must be properly managed because if a firm

runs out of cash, they might lose a lot of opportunities such
as cash discounts, investment, etc.
 CASH BUDGET
There are three (3) objectives of cash budget:

 To ensure that sufficient cash is available at all times to

meet the level of operations that are outlined in the
various budgets.

 To avoid cash balances that is surplus to its requirement.

This will enable the management to take steps in advance
to invest the surplus cash in any short term investments.

 To identify in advance the steps/actions to be taken to

meet any temporary cash deficiencies.
FEATURES OF CASH BUDGET

 Cash budget contains two sections;

Cash Inflow (receipts) & Cash Outflow
(payments).

 The cash inflow (receipts) section includes

expected receipts from the company’s principal
sources of revenues such as cash sales and
collections from customers on credit sales.

 The cash outflow (payments) section shows

expected payments for direct materials, direct
labor, manufacturing overhead and selling and
administration expenses.
 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
Cash receipts
Receipts from debtors
Sales of capital items
Loans received
Issues of
shares/debentures
Dividends received
Interest received
TOTAL RECEIPTS
TOTAL CASH AVAILABLE
 FORMAT FOR CASH BUDGET (CONTINUES)
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
 PREPARATION OF MASTER
BUDGET
• Shows the expected profit or loss of the business,
detailing the costs and revenues summarized in the
Budgeted income
statement functional budgets.

• Shows the expected financial position of the business

Budgeted
in terms of the assets owned, capital employed and
statement if
financial position
liabilities.

• Shows the inflow and outflows of cash movement for

receipts and payments respectively, with a balance of
Cash budget either surplus or deficit at the end of each sub period.
READ EXAMPLE 13.1 OF THE TEXT BOOK

 PAGE 279
• INDIVIDUAL BUDGET UNTIL BUDGETED
STATEMENT OF FINANCIAL POSITION
 TECHNIQUES OF BUDGETING
1) Rolling (continuous) budget

Can be particularly useful when

future events cannot be forecast
Its prepared when there is an element
reliably. It is a budget which s
of risk and uncertainty, and the future
continuously updated by adding a
events cannot be forecasted reliably.
further budget period when the
earlier budget period is expired.

Advantages:
1) Budgets are more realistic and achievable since
they are continuously revised to reflect changing
circumstances.
2) The annual disruption associated with the
preparation of annual budget is removed.
3) The pressure is stress placed on managers to
achieve unrealistic budget targets are eased.
Disadvantages:
1) Preparing of rolling budget will
take more time, effort and costly.
2) There will be a greater workload
on the managers and additional staff
may be required.
3) Managers may not devote
sufficient time in preparing budgets.
 TECHNIQUES OF BUDGETING
(CONTINUES)
2) Incremental budgeting
The previous year’s budget will be
taken as a base. When preparing
the budget, the budget holder will
add a certain percentage to allow
for the changes in costs or revenue.
There may also be other
adjustments for specific items to be
made in the current budget.
Advantages:
1) It simple and cheap to prepare the budget.
2) It is suitable in a stable situation where
there is not much changes in the
environment.
3) It is also practical in predicting certain
expenses such as telephone expenses,
depreciation or rental.

Disadvantages:
1) It is assumed that the previous and
current inefficiencies may be continuous
and would carry on.
2) It is not suitable for volatile and
changing situations.
3) The budget prepared for each activity
may not be justified.
TECHNIQUES OF BUDGETING
(CONTINUES)
3) Zero–based budgeting (ZBB)
Is a method to budget where all transaction
and production elements are re-evaluated
when budgets are about to be drawn up.
The approach starts from zero as if there is
no past record and that the budget is now
prepared for the very first time. Therefore,
budget preparers need to justify every
expense there is in the budget proposed.
Advantages:
1) It helps to identify and remove any
inefficiency or obsolete activity.
2) Wasteful or over spending activities can
be eliminated.
3) It helps to create an environment where
changes are easily accepted.
4) ZBB focuses on the future rather than the
past.
ZBB promotes efficiency with
operations where the
managers are forced to revisit
their activities regularly and
review accordingly against
budgets.
Disadvantages:
1) It is time consuming and costly
to prepare zero-based budget.
2) Managers sometimes tend to
solve the short term problems at
the expense of long term benefits.
3) In preparing ZBB, it requires
management skill which is
sometimes lacking.
 TECHNIQUES OF BUDGETING
(CONTD)
4) Activity-based budgeting (ABB)
ABB is concerned with
indirect expenses or
overheads rather than direct
expenses. Budgets for direct
materials, direct labor and
direct expenses can easily
be prepared as it varies with
production
ABB refers to the budgeted statement of
proposed activities for the future, by
incorporating expected or budgeted costs and
revenue. The orientation is based on ABC with
emphasis on cost pools and cost driver rates
for apportioning overheads to the activities
and later to the products.

Advantages:
1) ABB is suitable when overheads are
a significant amount.
2) Activities are seen as the key to
effective control
3) Activity unit cost allows easier
analysis of costs trends over time and
intra-departmental comparisons.
Disadvantages:
1) The system is costly and needs
skilled persons to prepare the
budget.
2) It will solely rely on the use of
activity-based costing as the
standard costing system.