UINT FIVE

Budget
and
Budgetary Control
 Introduction
►“A budget is a formal written statement of
management’s plan for a specified future time period,
expressed in financial terms.
►Budget is a predetermined detailed plan of action
developed and distributed as a guide to current
operations and as a partial basis for the subsequent
evaluation of performance’.
►Budgets are financial plans for the future and are a key
component of planning. They identify objectives and the
actions needed to achieve them.
►The process or art of preparing a budget is called
budgeting.
 Characteristics of budget
1. A budget is concerned for a definite future period.
2. A budget is a written document.
3. A budget is a detailed plan of all the economic activities of a
business.
4. All the departments of a business unit co-operate for the
preparation of a business budget.
5. Budget is a means to achieve a business and it is not an end in
itself.
6. Budget needs to be updated, corrected and controlled every
time when circumstances changes. Therefore , it is a continuous
process.
7. Budget helps in planning ,coordinating and controlling.
8. A budget acts as a business barometer.
9. Budget is usually prepared in the light of past experience.
10. Budget is a constant Endeavour of the management.
 Advantages of Budgeting
Define goals
and objectives
Communicate Think about and
plans plan for the future

Advantages
Coordinate Means of allocating
activities resources

Uncover potential
bottlenecks
1 Cont…
►Budgetary Control is a method of managing costs
through preparation of budgets.
►Budgetary control is the establishment of budgets
relating to the responsibilities of executives of a policy
and the continuous comparison of the actual with the
budgeted results, either to secure by individual action,
the objective of the policy or to provide a basis for its
revision.”
►Budgeting is closely connected with control.
Therefore, budgetary control is the use of budgets to
control an organization's activity.
►The main features of budgetary control are:
1 Cont…
1. Establishment of budgets for each purpose of
the business.
2. Revision of budget in view of changes in
conditions.
3. Comparison of actual performances with the
budget on a continuous basis.
4. Taking suitable remedial action, wherever
necessary.
5. Analysis of variations of actual performance
from that of the budgeted performance to
know the reasons thereof.
 Cont…
►Before preparing a budget, an organization
should develop a strategic plan.
►The strategic plan plots a direction for an
organization’s future activities and operations;
it generally covers at least five years.
►Budgets help business owners and managers to
plan ahead, and later, exercise control by
comparing what actually happened to what was
expected in the budget.
►Budgets formalize managers’ expectations
regarding sales, prices, and costs.
1
Planning, Control, and Budgets
 Cont…
Planning and Controlling
►Planning: involves developing objectives and
preparing various budgets to achieve those
objectives.

►Controlling: involves the steps taken by

management to increase the likelihood that the
objectives set down while planning are attained
and that all parts of the organization are
working together toward that goal.
 1 Participatory Budgeting Versus Imposed Budgeting

Participatory budgeting is a budgeting process in which the

people who are in the lower levels of management are involved in
the budget preparation process.

Participatory Budgets:
 Right to comment before implementation
 Ultimate right to set budgets

Best Time to Use . . .

 In well-established organizations.
 In extremely large businesses.
 In times of economic affluence.
 When operating managers have strong budgetary skills and
perspectives.
1 Cont…

Advantages:
►Obtain information from those persons most familiar
with the needs and constraints of the organizational
units.
►Leads to better morale and higher motivation.
►Integrates knowledge that is diffused among various
levels of management.
►Provides a means to develop fiscal responsibility and
budgetary skills of employees.
►Develop a high degree of acceptance of and
commitment to organizational goals and objectives by
operating management.
►Are generally more realistic.
1 Cont…

Disadvantages:
►Require significantly more time.
►May motivate managers to introduce “slack”
into the budget.
►May support “empire building” by subordinates
as a self-aggrandizement.
 1 Imposed Budgeting

 Also known as top-down budgeting, is the process wherein the top

management of a company prepares a budget and then imposes it
on lower-level managers for implementation.
Best Time to Use . . .
 In start-up organizations
 In extremely small businesses
 In times of economic crises
 When operating managers lack budgetary skills or perspective.
Advantages . . .
 Requires less time.
 Utilize top management’s knowledge of overall resource
availability.
 Increase probability that the firm’s strategic plans are
incorporated.
1

Disadvantages . . .
Reduce feeling of teamwork.
Dissatisfaction and low morale.
Limited acceptance of stated goals and
objectives.
May stifle initiative of lower level managers.
1 The Master Budget
►The master budget is the comprehensive
financial plan for the organization as a whole.
►Typically, the master budget is for a one-year
period, corresponding to the fiscal year of the
company. Yearly budgets are broken down
into quarterly and monthly budgets.
►Most organizations prepare the master
budget for the coming year during the last
four or five months of the current year.
 Cont…
1
►A master budget can be divided into operating and
financial budgets:
►Operating budgets: describe the income-generating
activities of a firm: sales, production, and finished
goods inventories. The ultimate outcome of the
operating budgets is a proforma or budgeted income
statement.
►Financial budgets: detail the inflows and outflows of
cash and the overall financial position. Planned cash
inflows and outflows appear in the cash budget. The
expected financial position at the end of the budget
period is shown in a budgeted, or pro forma, balance
sheet.
 The Master Budget and
1 Its Interrelationships
 2 Preparing the Operating Budget
►The operating budget consists of a budgeted income
statement accompanied by the following supporting
schedules:
►Sales budget
►Production budget
►Direct materials purchases budget
►Direct labor budget
►Overhead budget
►Selling and administrative expenses budget
►Ending finished goods inventory budget
►Cost of goods sold budget
2 Sales Budget
►The sales budget represents the expected
quantity of each type of product/service to be
sold multiplied by its expected selling price.
►Becouse sales budget is the basis for all of the
other operating budgets, it is the first step in
the budget process.
►It comes first because other budgets
cannot be prepared without an estimate of
sales.
2 Preparing a Sales Budget
(Cornerstone 9-1)
 2 Production Budget
►The production budget tells how many units must be
produced to meet sales needs and to satisfy ending
inventory requirements.
►To compute the units to be produced, both unit sales
and units of beginning and ending finished goods
inventory are needed:

Units to be produced = Expected unit sales + Units in

desired ending inventory (EI) – Units in beginning
inventory (BI)
► That is, Predicted sales quantity plus desired ending inventory is equal to
total needed units. To determine the units to be produced, amount already
on hand (beginning inventory) should be deducted from the total needed
units.
2 Preparing a Production Budget
 Preparing a Production Budget
2 (Cornerstone 9-2)
 2 Direct Materials Purchases Budget
►After the production budget is completed, the budgets
for direct materials, direct labor, and overhead can be
prepared.
►The direct materials purchases budget tells the amount
and cost of raw materials to be purchased in each time
period.
►The formula used for calculating purchases is as follows:
 Preparing a Direct Materials Purchases
2 Budget
2 Preparing a Direct Materials Purchases Budget
(Cornerstone 9-3)
 Preparing a Direct Materials Purchases Budget
2 (Cornerstone 9-3)
2 Direct Labor Budget
►The direct labor budget shows the total
direct labor hours and the direct labor cost
needed for the number of units in the
production budget.
►As with direct materials, the budgeted
hours of direct labor are determined by the
relationship between labor and output.
 Preparing a Direct Labor Budget
2 (Cornerstone 9-4)
Information:
The budgeted units to be produced for each quarter are: 1,060, 1,260, 1,600, and
1,800. It takes 0.12 hours to produce t-shirt. The average wage cost per hour is
$10.
Required:
Prepare a direct labor budget.
2 Overhead Budget
►The overhead budget shows the expected
cost of all production costs other than direct
materials and direct labor.
►Many companies use direct labor hours as the
driver for overhead.
►Then costs that vary with direct labor hours
are pooled and called variable overhead.
►The remaining overhead items are pooled into
fixed overhead.
 2
Preparing an Overhead Budget
Information:
Refer to the direct labor budget below. The variable overhead rate is $5
per direct labor hour. Fixed overhead is budgeted at $1,645 per quarter
(this amount includes $540 per quarter for depreciation).
Required:
Prepare an overhead budget.
 2 Preparing an Overhead Budget
(Cornerstone 9-5)

Solution:
2 Ending Finished Goods Inventory
Budget
►The ending finished goods inventory budget
supplies information needed for the balance
sheet and also serves as an important input
for the preparation of the cost of goods sold
budget.
►To prepare this budget, the unit cost of
producing finished goods must be calculated
by using information from the direct materials,
direct labor, and overhead budgets.
 Preparing an Ending
2 Finished Goods Inventory Budget

Information:
Refer to the direct materials, direct labor,
and overhead budgets prepared previously
and shown here.
 Preparing an Ending Finished Goods Inventory
2 Budget(Cornerstone 9-6)
 2 Cost of Goods Sold Budget
►The cost of goods sold budget reveals the
expected cost of the goods to be sold.
►Assuming that the beginning finished goods
inventory is valued at $1,251. and to prepare cost
of goods sold budget it needs an information
from direct materials, direct labor, overhead and
ending finished goods inventory budget
Required :
Prepare cost of goods sold budget.
 Preparing a Cost of Goods Sold Budget
2
(Cornerstone 9-7)
2 Selling and Administrative
Expenses Budget
►The selling and administrative expenses budget
outlines planned expenditures for nonmanufacturing
activities.
►As with overhead, selling and administrative
expenses can be broken down into fixed and variable
components.
►Such items as sales commissions, freight, and
supplies vary with sales activity.
 Preparing a Selling and Administrative
2 Expenses Budget

Information:
Variable expenses are $0.10 per unit sold. Salaries average $1,420 per quarter;
utilities, $50 per quarter; and depreciation, $150 per quarter. Advertising for Quarters
1 through 4 is $100, $200, $800, and $500, respectively.

Required:
Prepare a selling and administrative expenses budget.
 Preparing a Selling and Administrative
2 Expenses Budget (Cornerstone 9-8)
2 Budgeted Income Statement
►With the completion of the budgeted cost of
goods sold schedule and the budgeted selling
and administrative expenses budget, a
company has all the operating budgets
needed to prepare an estimate of operating
income.
 Preparing a Budgeted Income Statement
2
(Cornerstone 9-9)
Information:
. Assume that the tax rate is 40 percent.

Required:
Prepare a budgeted income statement.
3 Preparing the Financial Budget
►The remaining budgets found in the master
budget are the financial budgets.
►The usual financial budgets prepared are:
►cash budget
►budgeted balance sheet
►budget for capital expenditures
3 Cash Budget
► Understanding cash flows is critical in managing a business.
► Often, a business successfully produces and sells products but
fails because of timing problems associated with cash inflows
and outflows.
► Because cash flow is the lifeblood of an organization, the cash
budget is one of the most important budgets in the master
budget.
► The basic structure of a cash budget includes cash receipts,
disbursements, any excess or deficiency of cash, and financing
as shown below:
 3 Cash Budget: Cash Available
► Cash available consists of the beginning cash balance and the
expected cash receipts. Expected cash receipts include all
sources of cash for the period being considered.
► The principal source of cash is from sales.
► Since a large proportion of sales is usually on account, a major
task of an organization is to determine the pattern of collection
for its accounts receivable.
► If a company has been in business for a while, it can use past
experience to determine what percentage of credit sales are paid
in the month of and months following sales.
► This is used to create a schedule of cash collections on accounts
receivable.
3 Preparing a Schedule for Cash Collections
on Accounts Receivable
Information:
From past experience, Texas Rex expects that, on average, 25 percent of total sales
are cash and 75 percent of total sales are on credit. Of the credit sales, Texas Rex
expects that 90 percent will be paid in cash during the quarter of sale, and the
remaining 10 percent will be paid in the following quarter. Recall from sales budget
that Texas Rex expects the following total sales:

Quarter 1 $10,000
Quarter 2 $12,000
Quarter 3 $15,000
Quarter 4 $20,000

The balance in accounts receivable as of the last quarter of 2011 was $1,350. This
will be collected in cash during the first quarter of 2012.
Required:
1. Calculate cash sales expected in each quarter of 2012.
2. Prepare a schedule showing cash receipts from sales expected in each quarter of
2012.
3 Preparing a Schedule for Cash Collections
on Accounts Receivable (Cornerstone 9-10)
3 Cash Budget:
Cash Disbursements
►The cash disbursements section lists all planned cash
outlays for the period.
►All expenses that do not require a cash outlay are
excluded from the list (e.g., depreciation is never
included in the disbursements section).
►Just as sources of cash may require a schedule of
cash collections on accounts receivable to calculate
cash expected from credit sales, the disbursements
section may require care in handling payments on
account.
3 Determining Cash Payments
on Accounts Payable
3 Determining Cash Payments
on Accounts Payable (Cornerstone 9-11)
3 Cash Budget:
Cash Excess or Deficiency
► Some companies expand the basic cash budget format by
adding lines to show any borrowing or repayment necessary
to achieve a minimum desired cash amount.
► When this is done, the preliminary ending cash balance is
called cash excess or deficiency.
► The cash excess or deficiency line is compared to the
minimum cash balance (or lowest amount of cash acceptable
as noted by company policy).
► If a cash deficiency exists with less cash on hand than is
needed, the company usually obtains a short-term loan.
► A cash excess is usually used to repay loans or used to make
temporary investments.
3 Cash Budget: Borrowings and Repayments,
Ending Cash Balance
►Borrowings and Repayments: If a company converts
its preliminary cash balance line to a cash excess
(deficiency) line, it may be borrowing or repaying
money. If there is a deficiency, this section shows the
necessary amount to be borrowed. When excess
cash is available, this section shows planned
repayments, including interest expense.
►Ending Cash Balance: The last line of the cash budget
is the ending cash balance. This is the planned
amount of cash to be on hand at the end of the
period after all receipts and disbursements, as well as
borrowings and repayments, are considered.
3
Preparing a Cash Budget
 Preparing a Cash Budget
3
 1 Some other types of budget
►Zero base budgeting (ZBB) is a method of budget
preparation which begins each period with a clean slate.
►Zero base budgeting requires that all budget
amounts be currently justified even if they were
supported in prior budgets.
►Managers must start from zero and justify budgets
every period.
►Used in government budgeting.
►Due to the cost of the process, this zero base
budgeting is often not used in business(Not
commonly used in business).
 1 Static budget v. Flexible Budget
Static budget:
► A budget designed for only one level of activity.
Differences from the budget can be misleading when an
organization actually operates at a different level of activity.
► It is not adjusted for the actual level of production and is
not suited for performance measurement.

Flexible budget:
► A budget designed to cover a range of activity. Can be
used to compare actual costs incurred to budgeted costs
around that level of activity.
► It is a set of budget relationships that can be adjusted to
various activity levels. It is suited for performance
measurement.
 1 Incremental budgeting

► A budgeting approach that assumes the starting point for

each budget item is the amount spent on it in the previous
budget
► The new budget is seen as last year’s +/- a specified
increment
► Less costly but may not be strategically sound