Budjets & Budgetary control

Definition
• Budjet : A statement in money terms of management 's
plan for the operating of business over a future period
of time and their plans for the position of the business
at the end of time .

• Budjet centre : any part of the organisation for

which a budget is prepared For example revenue centre ,. .

cost centre & profit centre

• Principle
Budjet Factor : anything that restricts the
budgeted level of activity of a business Llimiting factor .

Key factor) For example shortage of material , ,

less demand for products .

F-Actors to be considered when preparing a

budjet .

◦
Long term objectives of business
cooperate strategic planning )
,

◦
Principal budjet or limiting factors
• Internal factors ( behavioral aspects of management
when preparing budjetss
◦
External factors 1 international , political , economic ,
environmental )
ttsesohenetitofbwdrget
•
Budget formalize management plans
•

Bhdjet preparation ensures that all function Ofa

business are properly coordinated .

•
Indicate possible future shortage of
resources so
that remedial action may be taken in
good time .

• provide information for on-going control of

business activity .

trash -

Budget
periods I 2 3 4

Receipts
sales ✗✗ ✗✗ ✗ ✗ ✗✗

Debtors ✗ ✗ ✗✗ ✗ ✗ ✗✗
closing inventory ✗✗
✗ ✗ ✗ ✗ ✗✗
payment
purchases ✗✗ ✗✗ ✗ ✗ ✗✗

wages ✗ ✗ ✗✗ ✗ ✗ ✗✗

Expenses ✗✗ ✗✗ ✗ ✗ ✗✗
opening inventory ✗ ✗ ✗✗ ✗ ✗ ✗✗

Net Receipt / Payment ✗✗ ✗✗ ✗ ✗ ✗✗

Balance blf ✗ ✗ ✗✗ ✗ ✗ ✗✗
Balance elf ✗✗ ✗✗ ✗ ✗ ✗✗

✗ Depreciation
✗ Accthtal basis
New units
old units
= flexed bhdjet

fixed expenses no changes

☆ variable cost = $ ( new - old )

unit ( new old )
-

Fixed :$ old -
( old unit ✗ variable cost )
teraoheneaeinabbe Months
I 2 3 4

trade receivables at start ✗ ✗ ✗ ✗ ✗✗ ✗✗

Add :( 1- edit sales ✗ ✗ ✗ ✗ ✗ ✗ ✗ ✗

✗ ✗ ✗ ✗ ✗✗ ✗ ✗
cash received from
Less : trade teceivables debtors ) ✗ ✗ ✗ ✗ ✗ ✗ ✗✗
(
Bad Debts ✗ ✗ ✗ ✗ ✗ ✗ ✗ ×

Discount allowed ✗ ✗ ✗ ✗ ✗ ✗ ✗✗

Trade receivables ( debtors) ✗✗ ✗✗ ✗ ✗ ✗×

atend

toractepayahhes
Months
1 2 34
trade payableslcteditotsatstait ✗ ✗ ✗ ✗ ✗✗ ✗✗

Add : credit purchases ✗ ✗ ✗ ✗ ✗ ✗ ✗ ✗

✗ ✗ ✗ ✗ ✗✗ ✗ ✗
( creditors )
Less : cash paidtottadepayables ✗ ✗ ✗ ✗ ✗ ✗ ✗✗

Discount received ✗ ✗ ✗ ✗ ✗ ✗ ✗ ×
✗ ✗ ✗ ✗ ✗ ✗ ✗✗

Ttadepayableslcteditots) at end ✗✗ ✗✗ ✗ ✗ ✗×
standard costing
-

• is an accounting system that records the cost of

operations at pre determined standards

-
.

The predetermined costs are known as STANDARD COSTS

The difetence between standard & actual is known
as a VARIANCE .

Gtjhctive of standard
-

costing
• to assist in setting budgets
• to motivate staff and management
• to provide a basis for estimating .

B to provide guidance on possible ways of improving

performance

Advantages -
of standard
-

costing
-

of easier
•
preparation budgets is made
r variances are easier to identify
• activities responsiplefot variances are highlighted
D. facilitate preparation of estimates for costs
of new products & quotations for orders .
Variances
•
variance -
the difference between a standard cost
& an actual cost
•
Adverse - Actual > standard
Favourable -
Actual < standard

formula ( material )
+" A
ve F
-

•
Material Price variance
=L actual quantity ✗ actual price ) -
l actual quantity ✗

standard price )
= LAP ✗ AQ ) -
ISP ✗ AQ )

Material usage variance

•

:( actual quantity ✗ standard price ) -

( standard quantity ✗
standard Price )
:( AQXSP ) - l SQ ✗ SP )

◦ material variance : price variance + usage variance

= Actual cost -
standard cost
IAQXAP ) I SQXSP)
formula Labour )
•
wage rate variance
= ( actual labour hours ✗ actual rate ) -

l standard labour rate ✗ actual labour 1- ate )

= CAR ✗ AH -
I SR ✗ Att )

•
Labour efficiency rate
= ( actual labour hours × standard rate ) -

l standard labour hours ✗ Standard 1- ate )

= ( AH ✗ SR ) -
ISH ✗ SR )

Labour variance :
wage rate variance -11 about
◦

efficiency rate
= Actual cost - standard rate
LAH ✗ AR) ( SH ✗ SR )
 Favourable ( tue )

fOtMMhA( selling prices

Adverse l -
ve )

:( AP SP )AQ
selling price variance
-
•

• sales volume variance :( AQ -

SQISP

◦
sales variance :
selling price variance -1
sales volume variance

statement to reconcile actual profit tobudjeted profit

$ $
ptofitpetmasterbndjet ( sales - cost ) ✗

Add : favourable variances

sales volume ×

material usage ×
Labour rate × ✗

Less : adverse variances

Quantity ×

selling price ✗ ( X )
Actual Profit ✗

☆ Budjet to Actual %Ñ4¥ 't -4¥ Add : Adverse ,

Less : Favourable
tired overheard variance
formula
• Fixed Production overhead Expenditure variance
=
Budgeted Expenditure - Actual Expenditure
• Fixed production overhead volume variance
=
Budgeted Expenditure -
Standard cost Absorbed
( SH ✗ SR )

•
Fixed Production overhead capitis variance
=
Bndjeted Expenditure ( Actual Hours ✗ standard rate)
-

◦
Fixed production overhead efficiency variance
= ( Actual Hour -
standard Hour ) Standard Rate
Activity
-

• An approach
Based costing
-

to in which cost is allocated to the cost

object based on resources used in the production

activity .

•
Activity -
a unit of work performed
• cost driver -
a factor that causes cost
•
cost pool -
accumulation of individual cost which
is related to each set of activity

formula
Estimated overhead per activity
=
Activity -
Based
Expected use of cost Drivers Pet activity overhead Rate
l
 -

capital expenditure
-
It is an fixed assets I including
expenditure on
addition to fixed asset ) which is intend to benefit
future period .

-
Error of judgement made in capital expenditure
decision cannot be easily reversed ,
& may indeed be
irreversible
sometimes management have to take non financial
. -

information into consideration Capital expenditure may .

be necessary even if it is not profitable for example , ,

to install some extra filters to with the health

comply
& safety at work legislation
-
A sunk cost is expenditure which has already incurred

prior project & Should not be taken into consideration

to a ,

which doing capital expenditure appraisal .

•
An opportunity cost is the value of the benefit which
must be sacrificed if a new project is undertaken It .

should be taken into consideration when doing

capital expenditure appraisal .

Accounting Rate of Return

-
calculate the average annual profit as a
percentage
of average capital employed
Average annual profit ✗ 100
Average capital employed
Average capital employed I sold nca

=
( capital outlay l purchases new n ca ) + scrap value )
2

1-
working capital cash flow : revenue
-
payment
profit : cost - depreciation
 Average profit =

15000-1180001-21000-1
21000 -12000
5
= $ 19000

Average investment
$ 160000
=
2

= $ 80000

ARR = $19000
✗ 100=23.750/0
$ 80000
The project will be worth while as the ARR is
greater
than its present rate of ROCE .

average capital
employed :
$400000 t 12000 )
2

$56000

NPV : cash flow ✗ discounting factor

cash flow = revenue - direct costs
profit = cash flow -
depreciation
[ cost )
Advantages of ARR
-
can compare profitability
-
it is relatively easy to calculate
of ARR
Disadvantages
•
Based on average annual profit which may not be
typical
-
The timing of cash inflow & outflow is ignored ( the
risk of the project is not taken into consideration .

the time value of money

-

Ignore
- There is no common method of calculating capital
employed .

It does not take into account the duration of the

•

project

payback period l don't based on profit based on cash ]

-
Risk is an important element in capital expenditure
decision . outlay of the project is covered
the sooner the

with the inflow of cash the smaller the risk ,

.

-
when calculating only ,
cash paid or received is taken
into consideration , other non cash item likedepreciation
etc is ig horned .
It is not concerned with
profitability .

•
It indicates the time over which the business is at
risk .
Shott payback periods are preferred .

payback period :

2 years ( 1%8-00.5 yeats )

6 months .
Advantages payback period
-
calculation of net cash flows more objective .

•
consider the risk factor of the project
-
Itis relatively easy to calculate .

• Short payback periods benefit business liquidity &

facilitate faster growth

Disadvantages
-

Ignore the life expectancy of the project .

-
Different projects may have similar payback
periods but different patterns of cash flow .

. Takes no account of the time value of money .

Discounted Payback Period
. A major drawback in using the payback method was
that it did not take into account the time value of money .

we can take the current cost of capital into account

by
using discounting techniques .

- This method is widely used as a method of selecting

a machine of project.

Discounted payback period :

9660
= 0.22
43560

Payback = 3. 22
years
 cost of capital
- stated in examination questions
It will usually be .

-
If a project is being financed by out of capital subscribed

entirely by the ordinary shareholders who expect dividend

of 640 ,
the cost of capital is clearly 6010 . If the finance
comes from the issue of 9% preference shares >
the
cost of capital is 90/◦