FA1334 Management Accounting

CHAPTER 3: BUDGETARY CONTROL

Part 1: Definition and Benefits of Budgeting

A budget is a financial and quantitative plan of operations for a forthcoming accounting period.
It is a tool for planning and control. A budgetary control involves setting budgets and the
continuous comparison of actual results against budgets. Such a comparison is necessary to
indicate whether everything is going according to plan.
Budget = A plan in $$$ (e.g. estimate how much to spend next year)

Benefits of budgeting are as follows:

• It is the major formal way in which the organizational objectives are translated into
specific plans, tasks and objectives related to individual managers and supervisors. It
should provide clear guidelines for current operation. (tell people what to do)
• It is an important medium of communication for organizational plans and objectives
and of the progress towards meeting those objectives. (tell people how to do)
• It helps to achieve co-ordination between the various departments and functions of the
organization.
• It helps to control via compares actual results against the budgets
• To motivate the employees to attain organizational goals and to improve their
performance. (to encourage employees to work harder)
• To evaluate the performance of managers

Departmental budget
Part 2: Functional Budgets

Functional budgets are used to facilitate budgeting and control. An organization is divided into
budget centres. Each centre is under the control of an individual, who is responsible for
controlling the cost of his centre. Functional budgets are prepared for each individual
department or function of a business, showing the budget responsibility of each manager.
Functional budgets are as follows:

(a) Sales budget – units

unit &&
RMRM

Sales are frequently the key factor in a business and the sales budget will then largely determine
the shape of the other functional budgets. A simple sales budget will record quantities, prices
and total revenue.
(b) Production budget – units only
units only
Production budget is a statement of planned production, that is the quantity of products to be
manufactured.

(c) Material usage budget – units only

units only
A plan showing the quantities of material required to meet the budgeted production.

(d) Materials purchase budget – unitsunits & &

RMRM
A plan for the cost of materials that will be purchased in the period. Consideration must be
given to stock levels because it will influence the purchase requirements.

(e) Labour budget – hours & RM

hour & RM
FA1334 Management Accounting

Where standard products are made, labour requirements for each unit are determined by
applying the production budget.

Example 1
R Sdn. Bhd. manufactures 3 products namely, A, B and C. The following information is
available for the month of January:
Sales value
Product Sales Quantity (units) Price (RM)
A 1,000 100
B 2,000 120
C 1,500 140

Materials used in the company are:

Material M1 M2 M3
Cost per kg (RM) 4 6 9

Quantities of materials used per unit:

Material M1 M2 M3
(kgs) (kgs) (kgs)
Product A 4 2 -
Product B 3 3 2
Product C 2 1 1

Finished stocks:
Product A B C
(units) (units) (units)
1 Jan 1,000 1,500 500
31 Jan 1,100 1,650 550

Materials stocks:
Material M1 M2 M3
(kgs) (kgs) (kgs)
1 Jan 26,000 20,000 12,000
31 Jan 31,200 24,000 14,400

Labour hours used:

Labour Skilled Semi-skilled
(hours) (hours)
Product A 6 4
Product B 7 3
Product C 5 2

Skilled labour will be paid RM20 per hour. Semi – skilled labour will be paid RM15 per hour.

Required:
Using the information given above, to prepare the following budgets for the month of January:
FA1334 Management Accounting

Follow this sequence

(a) Sales budget to answer question
(b) Production budget
(c) Material usage budget
(d) Material purchase budget
(e) Labour budget

Answer
(a) Sales budget
A B C Total
Sales units 1,000
1000
100
2,000
2000
120
1,500
1500
140
4,500
× Selling price (RM) 100 120 140 122.22
Budgeted sales (RM) 100,000
100 000 240,000
240,000 210,000
210,000 550,000
550,000

(b) Production budget if this section, calculated wrongly, every part

will be wrong.
A B C Total
(units) (units) (units) (units)
1000
Sales units 1,000 2,000 1,500 4,500
(+) Closing stock 1,100
1100 1,650 550 3,300
2100 2,100 3,650 2,050 7,800
(-) Opening stock (1,000)
(1000)
(1,500) (500) (3,000)
Production budget 11001,100 2,150
2150 1,550
1550 4,800

(c) Material usage budget

M1 M2 M3 Total
(kgs) (kgs) (kgs) (kgs)
4400 (x4kg/unit)
Product A (1,100)
1100 4,4002200(x2kg/unit)2,200 0 6,600
Product B (2,150) 6,450 6,450 4,300 17,200
Product C (1,550) 3,100 1,550 1,550 6,200
Material usage budget Text13,950 10,200 5,850 30,000

(d) Material purchase budget

M1 M2 M3 Total
Material usage budget 13,950 10,200 5,850 30,000
(+) Closing stock 31,200 24,000 14,400 69,600
45,150 34,200 20,250 99,600
(-) Opening stock (26,000) (20,000) (12,000) (58,000)
Material purchase budget (kgs) 19,150 14,200 8,250 41,600
Material purchase budget (RM) 76,600 85,200 74,250 236,050

(e) Labour budget

Skilled Semi-skilled Total
Product A (1,100) 6,600 4,400 11,000
Product B (2,150) 15,050 6,450 21,500
Product C (1,550) 7,750 3,100 10,850
Labour budget (hours) 29,400 13,950 43,350
FA1334 Management Accounting

Labour budget (RM) 588,000 209,250 797,250

Part 3: Cash Budget

The cash budget will show the cash will be needed to finance all the budgeted activities. A cash
budget is prepared to show the expected receipts of cash and payments of cash during a budget
period. It is normally prepared on a monthly basis to show the cash position.

Benefits/Advantages of preparing cash budgets are as follows:

• Cash budgets are essential for the proper management of funds (e.g. to prevent
overspending)
• They indicate likely requirements for additional finance (e.g. indicate cash shortage and
the need to borrow money)
• They indicate possible future surpluses of funds so that suitable arrangements may be
made in advance for investing (e.g. indicate cash surplus for investment)

Example 2
The opening cash balance on 1 January was expected to be RM30,000. The sales budget was
as follows:

RM
November 80,000
December 90,000
January 75,000
February 70,000
March 100,000

Analysis of records shows that debtors settle according to the following pattern:
• 60% within the month of sale same this month
• 25% one month following of sale next month
• 15% two months following of sale next 2 months

Extract from the purchases budget was as follows:

RM
December 60,000
January 55,000
February 45,000
March 70,000

All purchases 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 RM6,000
depreciation) are settled monthly.
FA1334 Management Accounting

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:
Prepared a cash budget for January, February and March.

Answer
(W1) Sales
November December January February March
(RM) (RM) (RM) (RM) (RM)
Sales 80,000 90,000 75,000 70,000 100,000
Receipts:
60% (same month) 48,000 54,000 45,000 42,000 60,000
25% (1 month) 20,000 22,500 18,750 17,500
15% (2 months) 12,000 13,500 11,250
79,500 74,250 88,750

(W2) Purchases
December January February March
(RM) (RM) (RM) (RM)
Purchases 60,000 55,000 45,000 70,000
Payments:
90% (same month) 54,000 49,500 40,500 63,000
10% (1 month) 6,000 5,500 4,500
55,500 46,000 67,500

Cash budget for January, February and March

January February March
(RM) (RM) (RM)
Receipts:
Sales 79,500 74,250 88,750
Insurance claim 25,000
79,500 74,250 113,750
Payments:
Purchase 55,500 46,000 67,500
Wages 15,000 15,000 15,000
Overheads 14,000 14,000 14,000
Taxation 8,000
84,500 83,000 96,500
Net cash (receipts – payments) (5,000) (8,750) 17,250
Opening cash balance 30,000 25,000 16,250
Closing cash balance 25,000 16,250 33,500

Part 4: Master Budget

FA1334 Management Accounting

The master budget is the aggregation of all lower level budgets produced by a company's
various functional areas, and also includes budgeted financial statements, a cash forecast, and
a financing plan. The master budget is typically presented in either a monthly or quarterly
format, and usually covers a company's entire fiscal year. An explanatory text may be included
with the master budget, which explains the company's strategic direction, how the master
budget will assist in accomplishing specific goals, and the management actions needed to
achieve the budget. There may also be a discussion of the headcount changes that are required
to achieve the budget.

Part 5: Fixed Budget and Flexible Budgets

A fixed budget is prepared for a single level of activity and will remain unchanged regardless
of the level of activity actually attained. Comparison of actual results with a fixed budget is of
little use for control purposes.

Flexible budgets are prepared for different levels of activity. Comparison with actual results is
more meaningful because flexible budget is flexed to the actual level of activity.

Example 3

The following information is available:

100% activity represents 60,000 direct labour hours.

Variable costs:
Indirect labour RM0.75 per direct labour hour
Consumable supplies RM0.375 per direct labour hour

Semi – variable costs are expected to correlate with the direct labour hours in the same manner
as for the last five years that was:

Year Direct labour hours Semi – variable costs (RM)

20-4 64,000 20,800
20-5 59,000 19,800
20-6 54,000 18,800
20-7 49,000 17,800
20-8 40,000 16,000

Fixed costs:
RM
Depreciation 18,000
Maintenance 10,000
Insurance 4,000
Rates 15,000
Management salaries 25,000

Required:
FA1334 Management Accounting

(a) Prepare a flexible budget for 20-9 for the overhead expenses of a production department
at the activity levels of 80%, 90% and 100%.

(b) At the end of the year, the following actual information was available:

Direct labour hours 54,000

RM
Variable costs:
Indirect labour 41,000
Consumable supplies 22,000

Semi – variable costs 19,000

Fixed costs:
Depreciation 18,000
Maintenance 11,000
Insurance 4,000
Rates 13,500
Management salaries 23,000

Total overheads expenses 151,500

Prepare flexible budget with variance analysis based on the information above.

Answer

(a)
Activity level 80% 90% 100%
Direct labour hours 48,000 54,000 60,000

RM RM RM
Variable costs:
Indirect labour 36,000 40,500 45,000
Consumable supplies 18,000 20,250 22,500

Semi – variable costs (W1) 17,600 18,800 20,000

Fixed costs:
Depreciation 18,000 18,000 18,000
Maintenance 10,000 10,000 10,000
Insurance 4,000 4,000 4,000
Rates 15,000 15,000 15,000
Management salaries 25,000 25,000 25,000

Total overheads expenses 143,600 151,550 159,500

FA1334 Management Accounting

(W1) High Low Method (Semi variable cost)

Step 1
Variable cost per hour = Changes in cost / Changes in hours
= (RM20,800 – RM16,000) / (64,000 – 40,000)
= RM0.20
Step 2
Total cost = Fixed cost + Variable cost

Let say in Year 20-4….

RM20,800 = Fixed cost + (RM0.20 × 64,000)
RM20,800 = Fixed cost + RM12,800

Fixed cost = RM20,800 – RM12,800 = RM8,000

(b)
Flexible budget Actual results Variance
Activity level 90%
Direct Labour Hours 54,000 54,000

RM RM RM
Variable costs:
Indirect labour 40,500 41,000 500 (A)
Consumable supplies 20,250 22,000 1,750 (A)

Semi – variable costs 18,800 19,000 200 (A)

Fixed costs:
Depreciation 18,000 18,000 0
Maintenance 10,000 11,000 1,000 (A)
Insurance 4,000 4,000 0
Rates 15,000 13,500 1,500 (F)
Management salaries 25,000 23,000 2,000 (F)

Total overheads expenses 151,550 151,500 50 (F)