BUDGETING

ACC 222: COST AND MANAGE-

MENT ACCOUNTING II
 INTRODUCTION
 Management accounting can assist managers in making decisions

 The actions that follow managerial decisions normally involve

several aspects of the business such as marketing, production,
purchasing and finance functions.
 It is important that management should coordinate these various
interrelated aspects of decision making.

2
 INTRODUCTION CONT….
• If they fail to do this, there is a danger that managers may each make deci-
sions that they believe are in the best interests of the organization when, in
fact, taken together they are not.
• The various activities of a company should be coordinated by the prepara-
tion of plans of actions for future periods
• These detailed plans are usually referred to as budgets.

3
BUDGETING
A budget is defined as:
A plan quantified in monetary terms, prepared and
approved prior to a defined period of time usually
showing planned income to be generated and/or ex-
penditure to be incurred during that period and the
capital to be employed to attain a given objective.
The act of preparing a budget is called budgeting. The
use of budgets to control a firm’s activities is known as
budgetary control.
 BUDGET CONT.
 Usually, a defined period of time which covers the budget is one
year. Thus, budgets are prepared on annual basis to meet the
specified objectives. The annual budget, therefore, clearly ex-
presses what is to be undertaken during the next year and autho-
rizes the financial resources that will be needed.
 The preparation of the budget should be a “bottom-up” process.
Budget should originate at the lowest levels of management and
be refined and coordinated at higher levels.
 This approach enables managers in the preparation of their bud-
gets and increases the probability that they will accept the budget
and strive to achieve the budget targets.

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 BENEFITS/PURPOSES OF A BUDGET:

Planning
 A budget forces the management to plan for the fu-
ture very carefully and specifies goals and activities to
be carried out.
Controlling
 Targets set provide a benchmark (standard) by which
the actual performance may be measured. The issues
of variance analysis and investigation for the purpose
of making correction come in here.
 BENEFITS/PURPOSES OF A BUDGET
(CONTINUED):

Coordinating
 A budget causes different parts of the organization to work to-
gether: The production, finance, marketing, procurement and
other departments of an organization must work together in
order to achieve the goals and objectives of the organization
Communication
Intentions and goals of the management must be
communicated to the employees. The employees,
therefore, become informed of what they are supposed
to do.
BENEFITS/PURPOSES OF A BUDGET (CONTINUED):
Motivation
If employees are involved in the preparation of the
budget, they become motivated to implement it since
they feel that it is theirs. Where a budget promises re-
wards for reaching targets, employees become moti-
vated to achieve those targets.
 BENEFITS/PURPOSES OF A BUDGET (CONTIN-
UED):

Vehicle of implementation
A budget becomes a basis of authorization of
expenditure. It also becomes a reference for the
activities performed.
 PREREQUISITES FOR THE SUCCESS OF A BUDGET

-Top management support

 Efficient communication channels
 There should be interactive communication:
 Top-down

 Down-top

 Horizontal

 Team work and participation

 PREREQUISITES FOR THE SUCCESS OF A BUD-
GET (CONTINUED)

 Existence of a well designed organization structure:

▪ To simplify communication.
▪ To create responsibility centres:
▪ Cost centres

▪ Revenue or profit centres

▪ Investment centres

 Existence of proper evaluation mechanism

 Clear and realistic objectives
 PREREQUISITES FOR THE SUCCESS OF A
BUDGET (CONTINUED):

 Flexibility in the budgeting system

 Expertise in budgeting and computing facilities
 Presence of an effective data gathering system
▪ There can be an effective data gathering system as a result of:
▪ Proper accounting system

▪ Statistical services

▪ Computer services to generate, analyze, store and retrieve required data

 BUDGETING PROCESS

Budgeting is the formal procedure of preparing budgets. It involves

the following basic steps:
 Identifying expenses

 Determining different sources of income

 Establishing the budget period

 Allocating income for expenses

 Monitoring the efficiency of the budget

 MASTER BUDGET
• The master budget is a summary of company's plans that sets specific targets
for sales, production, distribution and financing activities.
• It usually consists of a number of separate but interdependent budgets. One
budget may be necessary before the other can be initiated.
• More one budget estimate affect other budget estimates because the fig-
ures of one budget is usually used in the preparation of other budget.
• This is the reason why these budgets are called interdependent budgets.
 MASTER BUDGET INTERRELATIONSHIP
Sales Budget

↓ ↓ ↓
Ending
Inventory
→ Production Budget
↓ Budget ← ↓
↓ ↓ ↓
↓ ↓
Direct Materials Budget Direct Labor Budget Overhead Budget
↓ ↓ ↓ ↓ ↓
Cash Budget
↓ ↓ ↓
Budgeted
Budgeted Balance Selling and Admn.
Income →→→→→ Sheet ←←←←← Budget
Statement
COMPONENTS AND PREPARATION OF A MASTER
BUDGET:
Following are the major components or parts of master budget.
•Sales budget
•Production budget
•Material budget/direct material budget
•Labor Budget
•Manufacturing Overhead Budget
•Ending Finished Goods Inventory Budget
•Selling and Administrative Expense Budget
•Cash budget
•Budgeted Income Statement
•Budgeted Balance Sheet
 MASTER BUDGET PREPARA-
TION

A sales budget is a detailed schedule showing the expected

sales for the budget period; typically, it is expressed in both dol-
lars and units of production.
 An accurate sales budget is the key to the entire budgeting in
some way. If the sales budget is sloppily done then the rest of
the budgeting process is largely a waste of time.
 The sales budget will help determine how many units will have
to be produced. Thus, the production budget is prepared after
the sales budget.
 EXAMPLE OR SAMPLE OF A SALES BUDGET:
 Following is the sales budget of ABC Ltd.
ABC Ltd
Sales Budget
For the Year Ended December 31, 2018

Quarter
1 2 3 4 Year
Budgeted sales in cases 10,000 30,000 40,000 20,000 100,000
Selling price per case $ 20.00 $ 20.00 $ 20.00 $ 20.00 $ 20.00
------------ ------------ ------------ ------------ ------------
$
Total sales $600,000 $800,000 $400,000 2,000,000
200,000
====== ====== ====== ====== ======

Percentage of sales collected in the

70%
period of the sales
Percentage of sales collected in the
30%
following quarter
70% 30%
 EXAMPLE CONT…………
 Schedule of Expected cash collections
Schedule of Expected Cash Collections
Accounts receivable, beginning balance $90,000 $90,000
First quarter sales 140,000 $60,000 200,000
Second quarter sales 420,000 $180,000 600,000
Third quarter sales 560,000 $240,000 800,000
Fourth quarter sales 280,000 280,000

----------- ----------- ----------- ----------- -----------

Total cash collections $230,000 $480,000 $740,000 $520,000 $1,970,000

====== ====== ====== ====== ======
Cash collections from last years fourth-quarter sales.
$200,000 × 70%; $200,000 × 30%
$600,000 × 70%; $600,000 × 30%
$800,000 × 70%; $800,000 × 30%
$400,000 × 70%
Uncollected fourth quarter sales appear as accounts receivable on the company's end of
year balance sheet.
 PRODUCTION BUDGET
• The production budget is prepared after the sales budgets. The pro-
duction budget lists the number of units that must be produced dur-
ing each budget period to meet sales needs and to provide for the
desired ending inventory. Production needs can be determined as
follows.

Budgeted sales in units XXXX

Add desired ending inventory…………………… XXXX
Total need………………………………………… XXXX
less beginning inventory……………………… XXXX
Required production…………………………… XXXX
 EXAMPLE OF A PRODUCTION BUD-
GET:
ABC Ltd
Production Budget
For the Year Ended December 31, 2018
Quarter
1 2 3 4 Year
Budgeted sales (see sales budget) 10,000 30,000 40,000 20,000 100,000
Add desired ending inventory of
6,000 8,000 4,000 3,000 3,000
finished goods*
------------ ------------ ------------ ----------- -----------
Total needs 16,000 38,000 44,000 23,000 103,000
Less Beginning inventory of finished
2,000 6,000 8,000 4,000 2,000
goods**
------------ ------------ ------------ ------------ ------------
Required production 14,000 32,000 36,000 19,000 101,000
====== ====== ====== ====== ======

*Twenty percent of the next quarters sales. The ending inventory of 3,000 cases is
assumed
**The beginning inventory in each quarter is the same as the prior quarter's ending
inventory
 MATERIAL BUDGET
• Direct materials budget is prepared after computing production requirements
by preparing a production budget. Direct materials budget or materials budget-
ing details the raw materials that must be purchased to fulfill the production re-
quirements and to provide for adequate inventories. The required purchases of
raw materials are computed as follows:

• Raw material required to meet the production schedule…………..XXXX

• Add desired ending inventory of raw materials …………………… XXXX
• Total raw materials needs………………………………………… XXXX
• Less beginning inventory of raw material………………………… XXXX
• Raw materials to be purchased…………………… …………… XXXX
EXAMPLE OF DIRECT MATERIALS BUDGET:
ABC Ltd.

Direct Materials Budget

For the Year Ended December 31, 2018
Quarter
1 2 3 4 Year
Required production in cases (see
14,000 32,000 36,000 19,000 101,000
production budget page)
Raw materials needed per case
15 15 15 15 15
(pounds)
----------- ----------- ----------- ----------- -----------
Production needs (pounds) 210,000 480,000 540,000 285,000 1,515,000
Add desired ending inventory of raw
1 48,000 54,000 28,500 22,500 22,500
material
------------ ------------ ------------ ------------ ------------
Total needs 258,000 534,000 568,500 307,500 1,537,500
Less beginning inventory of raw
21,000 48,000 54,000 28,500 21,000
materials
------------ ------------ ------------ ------------ ------------
NOTE: Ending inventory is ten percent of the next quarter’s production needs.

Beginning inventory is same as the prior quarter’s ending inventory.

 EXAMPLE OF DIRECT MATERIAL
CONT…………
Total needs 258,000 534,000 568,500 307,500 1,537,500
Less beginning inventory of raw
21,000 48,000 54,000 28,500 21,000
materials
------------ ------------ ------------ ------------ ------------
Raw materials to be purchased 237,000 486,000 514,000 279,000 1,516,500
Cost of raw materials per pound $0.20 $0.20 $0.20 $0.20 $0.20
------------ ------------ ------------ ------------ ------------
Cost of raw materials to be purchased $47,400 $97,200 $102,900 55,800 $303,300
======= ======= ======= ======= =======
Percentage of purchases paid for in the
50%
period of the purchase
Percentage of purchase paid for in the
50%
following quarter.
50% 50%
 EXAMPLE CONT.………..

Schedule of Expected Cash Disbursement for Materials

Accounts payable, beginning balance $25,800 $25,800
First-quarter purchase 23,700 $23,700 47,400
Second-quarter purchases 48,600 $48,600 97,200
Third-quarter purchase 51,450 $51,450 102,900
Fourth-quarter purchase 27,900 27,900
---------- ---------- ---------- ---------- ----------
Total cash disbursement $49,500 $72,300 $100,050 $79,350 $301,200
 DIRECT LABOR BUDGET
 The direct labor budget is developed from the production budget.
Direct labor requirements must be computed so that the com-
pany will know whether sufficient labor time is available to meet
the budgeted production needs.
 By knowing in advance how much labor will be needed through-
out the budget year, the company can develop plans to adjust the
labor force as situation requires.
 EXAMPLE OF DIRECT LABOR
BUDGET
ABC Ltd
Direct Labor Budget
For the Year Ended December 31, 2018
Quarter
1 2 3 4 Year
Required production in cases
14,000 32,000 36,000 19,000 101,000
(see production budget page)
Direct labor hours per case 0.40 0.40 0.40 0.40 0.40
-------- --------- -------- -------- --------
Total direct labor hours
5,600 12,800 14,400 7,600 40,400
needed
Direct labor cost per hour $15.00 $15.00 $15.00 $15.00 $15.00
-------- -------- -------- -------- --------
Total direct labor cost* $84,000 $192,000 $216,000 $114,000 $606,000
===== ===== ===== ===== =====

* This schedule assumes that the direct labor work force will be fully
adjusted to the total direct labor hours needed each quarter.
 MANUFACTURING OVERHEAD BUD-
GET
The manufacturing overhead budget provides a schedule for all costs
of production other than direct materials and direct labor. It show
the expected manufacturing overhead costs for the budget period.
• Overhead costs of production are differentiated as to their underly-
ing behaviour pattern as being either fixed or variable.
• Therefore the cost per unit of production of each variable cost item
is multiplied by the quantity of units produced. Fixed costs remain
relatively constant.
 EXAMPLE OF A MANUFACTURING OVER-
HEAD BUDGET:
Budgeted direct labor hours (see direct
labor budget) 5,600 12,800 14,400 7,600 40,400
Variable overhead rate $4.00 $4.00 $4.00 $4.00 $4.00
--------- --------- --------- --------- ---------
Variable manufacturing overhead $22,400 $51,200 $57,600 $30,400 $161,600
Fixed manufacturing overhead 60,600 60,600 60,600 60,600 242,400
--------- --------- --------- --------- ---------
Total manufacturing overhead 83,000 111,800 118,200 91,000 404,000
Less depreciation 15,000 15,000 15,000 15,000 60,000
--------- --------- --------- --------- ---------
Cash disbursement for
manufacturing overhead $68,000 $96,800 $103,200 $76,000 $344,000

======= ======= ======= ======= =======

Total manufacturing overhead (a) $404,000

Budgeted direct labor-hours (b) 40,400
------------
pre determined overhead rate for
the year (a)/(b) $10
 ENDING FINISHED GOODS INVENTORY BUD-
GET

• After preparing sales budget, Production budget, direct material

budget, direct labor budget, and manufacturing overhead bud-
get the management has all the data needed to calculate unit
product cost.
• This calculation is needed for two reasons: first, to determine
cost of good sold on the Budgeted income statement; and sec-
ond, to know what amount to put on the balance sheet inven-
tory account for unsold units. The carrying cost of unsold units is
calculated on the ending inventory finished goods budget.
 ENDING FINISHED GOODS INVENTORY
BUDGET
ABC Ltd.
Ending Finished Goods Inventory Budget
Absorption Costing Bases
For the Year Ended December 31, 2018
Item Quantity Cost Total
Production Cost Per Case:
$0.20 per
Direct materials 15 Pounds $3.00
pound
15.00 per
Direct labor 0.40 hours 6.00
hour
10.00 per
Manufacturing overhead 0.40 hours 4.00
hour
---------
Unit product cost $13.00
======
Budgeted finished goods inventory:
Ending finished goods inventory (see production
3,000
budget)
Unit production cost (see above) $13.00
-----------
Ending finished goods inventory in dollars $39,000
======
 SELLING AND ADMINISTRATION EXPENSE BUDGET

 Selling and administrative expense budget lists the budgeted ex-

penses for areas other than manufacturing.
 In large organizations this budget would be a compilation of many
smaller, individual budgets submitted by department heads and
other persons responsible for selling and administrative expenses.
 For example, the marketing manager in a large organization would
submit a budget detailing the advertising expenses for each bud-
get period.
 EXAMPLE OF SELLING AND AD-
MINISTRATIVE
ABC Ltd
Selling and Administrative Expense Budget
For the Year Ended December 31, 2018
Quarter
1 2 3 4 Year
Budgeted sales in cases (see sales
10,000 30,000 40,000 20,000 100,000
budget)
Variable selling and administrative
$1.80 $1.80 $1.80 1.80 $1.80
expenses per case
----------- ----------- ----------- ----------- -----------
Budgeted variable expense $ 18,000 $54,000 $72,000 $36,000 $180,000
====== ====== ====== ====== ======
Budgeted fixed selling and
administrative expenses:
Advertising 20,000 20,000 20,000 20,000 80,000
Executive salaries 55,000 55,000 55,000 55,000 220,000
Insurance 1,900 37,750 39,650
Property taxes 18,150 18,150
Depreciation 10,000 10,000 10,000 10,000 40,000
------------ ------------ ------------ ------------ ------------
Total budgeted fixed selling and
85,000 86,900 122,750 103,150 397,800
administrative exp.
------------ ------------ ------------ ------------ ------------
Total budgeted selling and
103,000 140,900 194,750 139,150 577,800
administrative expenses
Less depreciation 10,000 10,000 10,000 10,000 40,000
------------ ------------ ------------ ------------ ------------
Cash disbursements for selling and
$93,000 $130,900 $184,750 $129,150 $537,800
administrative exp.
====== ====== ====== ====== ======
 CASH BUDGET
 Cash budget is a detailed plan showing how cash resources
will be acquired and used over some specific time period.
 Cash budget is composed of four major sections.

 The receipts section.

 The disbursements section

 The cash excess or deficiency section

 The financing section

 CASH BUDGET CONT.………..
 The cash receipts section consists of a listing of all of the cash in-
flows, except for financing, expected during the budgeting period.
Generally, the major source of receipts will be from sales.
 CASH BUDGET CONT…
 The disbursement section consists of all cash payment that are
planned for the budgeted period.
 These payments will include Raw material purchases, direct labor
payments, manufacturing overhead costs, and so on as contained
in their respective budgets.
 In addition, other cash disbursements such as equipment purchase,
dividends, and other cash withdrawals by owners are listed.
 CASH BUDGET CONT.…………
 The cash excess or deficiency section is computed as fol-
lows:
Cash balance beginning XXXX
Add receipts XXXX
--------
Total cash available XXXX
Less disbursements XXXX
--------
Excess (deficiency) of cash available over XXXX
disbursements
 EXAMPLE OF CASH BUD-
GET
 The following are additional data provided.
 The beginning cash balance is $42,500

 Management plans to spend $130,000 during the year on equipment pur-

chases: $50,000 in the first quarter; $40,000 in the second quarter; $20,000 in
the third quarter; $20,000 in the fourth quarter.
 The board of directors has approved cash dividends of $8,000 per quarter.

 Management would like to have a cash balance of at least $40,000 at the be-
ginning of each quarter for contingencies.
 EXAMPLE CONT.…..
 The company require a minimum balance of $ 40,000. Assume ABC Ltd. will be
able to get agreement from a bank for an open line of credit.
 This would enable the company to borrow at an interest rate of 10% per year.
All borrowings and repayments would be in round $1,000 amount.
 All borrowings would occur at the beginning of the quarters and all repay-
ments are made at the end of a quarter. interest payment relate only on the
amount of principal that is repaid.
 CASH BUDGET EXAMPLE CONT.……..
ABC Ltd.
Cash Budget
For the Year Ended December 31, 2018
Quarter
Other
1 2 3 4 Year
budget ref.
Cash balance, beginning $42,500 $40,000 $40,000 40,500 42,500
Add receipts:
See sales
Collections from customers 230,000 480,000 740,000 520,000 1,970,000
budget
------------ ------------ ------------ ------------ ------------
Total cash available 272,500 520,000 780,000 560,500 2,012,500
------------ ------------ ------------ ------------ ------------
Less disbursements:
material
Direct materials 49,500 72,300 100,050 79,350 301,200
budget
Labor
Direct labor 84,000 192,000 216,000 114,000 606,000
budget
Overhead
Manufacturing overhead 68,000 96,800 103,200 76,000 344,000
budget
sell. &
Selling and Administrative adm. 93,000 130,900 184,750 129,150 537,800
budget
Equipment purchases 50,000 40,000 20,000 20,000 130,000
Dividends 8,000 8,000 8,000 8,000 32,000
------------ ------------ ------------ ------------ ------------
Total disbursements 352,500 540,000 632,000 426,500 1,951,000
------------ ------------ ------------ ------------ ------------
Excess/deficiency of cash
available over (80,000) (20,000) 148,000 134,000 61,500
disbursements
 EXAMPLE CONT…….
Excess/deficiency of cash
available over (80,000) (20,000) 148,000 134,000 61,500
disbursements

Financing:
Borrowings (at beginning)* 120,000 60,000 - - 180,000
Payments (at the end) - - (100,000) (80,000) (180,000)
Interest** - - (7,500) (6,500) (14,000)
------------ ------------ ------------ ------------ ------------
Total financing 120,000 60,000 (107,500) (86,500) (14,000)
------------ ------------ ------------ ------------ ------------
Cash balance, ending $40,000 $40,000 $40,500 $47,500 $47,500
====== ====== ====== ====== ======
 BUDGETED PROCESS IN NON-PROFIT
ORG.
The budgeted process in non-profit making org. normally begins
with the managers of various activities calculating the expected
costs of maintaining current ongoing activities and then adding
to those costs any further developments of services that are con-
sidered desirable.
For example, the education and health departments will propose
specifics activities and related costs for the coming year.

43
 CONT.
These budgets are coordinated by the accounting department
into an overall budget proposal
The available resources for financing that proposed level of
public services should be sufficient to cover the total costs of
such services.
Difficulty encountered in non-profit-making organizations is
that precise objectives are difficult to define in a quantifiable
way, and the actual accomplishments are even more difficult
to measure.

44
 CONT.
In most situations outputs cannot be measured in monetary
terms.
The effect of this is that budgets in non-profit organizations,
tend to be mainly concerned with the input of resources (ex-
penditure), whereas budgets in profit organizations focus on re-
lationships between inputs (expenditure) and outputs (sales
revenue).
The traditional format for budgets in non-profit organizations is
referred to as line item budgets.
45
 CONT.
A line item budget is one in which the expenditures are
expressed in considerable detail, but the activities being
undertaken are given little attention.
It shows nature of the spending but not the purpose.
Compliance with line item budgets provides no assurance
that resources are used wisely, effectively or efficiently in
financing the various activities in a non-profit organization.

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THE END