Chapter Three

Information for
Budgeting, Planning and
Control Purposes
 a budget:- is a detailed plan expressed in
quantitative terms that specif ie s how
resources will be acquired and used during
a specific period of time.
 Budgeting:-The act of preparing a budget
 Budgetary Control:- The use of budgets to
control a firm’s activities .

 Budget deals with a specific entity, covers a

specific future time period and is expressed
in quantitative terms.
 Budget entity - A specif ic budget must
apply to a clearly def ined accounting entity.
For budgeting purpose the entity may
consist of a small part of a business, a single
activity, or a specific project.
 Future time period –Many financial figures
are meaningless unless they are couched in
some time references.
 In planning for profits, managers must consider
two time horizons: the short term and the long
term.
 Short-term planning is the process of deciding what
objectives to pursue during a short, near- future period,
usually one year, and what to do to achieve those objectives.
The typical short-term budget covers one year and is broken
down into monthly or quarterly units.
 Short-term planning is concerned with operating details for
the next accounting period.
 For example, short-term planning in the automotive
industry would be concerned with which and how many of
the current year’s models to manufacture.
 Another method frequently used to prepare a short-term
budget is the continuous budget. This kind of budget starts
with an annual budget broken down into 12 monthly units.
As each month arrives, it is dropped from the plan and
replaced by a new month so that at any given time, the
next 12 months are always shown.
 Long-term planning, also known as strategic planning, is
the process of setting long-term goals and determining
the means to attain them.
 long-term planning addresses broad issues, such as new
product development, plant and equipment replacement,
and other matters that require years of advance planning
 l on g - ran g e plan n in g wo uld f o cus on n e w m o de l
development and major changes, as well as equipment
replacements and modif ications.
 The time frame for long-range planning may extend as far
as 20 years in the future, but its usual range is from 2 to
10 years.
 A n im po rt an t part o f l o n g - t e rm pl an n in g is t h e
preparation of the capital budget, which details plans for
the acquisition and replacement of major portions of
property, plant, and equipment.
 Characteristics of Budget
 It is a primary for planning & controlling
device.

 It is prepared in monetary terms.

 It is prepared for a definite period of time.

 It shows planned income & expenditures.

 It is used to implement policy of management.



PRINCIPAL ADVANTAGES OF BUDGETING


 Companies realize many benef its from a budgeting
program. Among these benefits are the following:
a) Requires periodic planning.
b) F o s t e r s c o o r d i n a t i o n , c o o p e r a t i o n , a n d
communication.
c) Provides a framework for performance evaluation.
d) Means of allocating resources.
e) Satisfies legal and contractual requirements.
f) Created an awareness of business costs.
 Periodic Planning (Formalization of Planning):- budgets
forces managers to think a head to anticipate and prepare
for the changing conditions. The budgeting process makes
planning an explicit management responsibility.
 Coordination, Cooperation and Communication –Planning
by individual managers does not ensure an optimum plan for
the entire organization. Therefore, any organization to be
effective, each manager throughout the organization must
be aware of the plans made by other managers.
 Performance Evaluation or Framework for Judging
Performance –Budgets are estimates of future events, and
as such they serve as estimates of acceptable performance.
Comparing actual result against budgeted results helps
managers to evaluate the performance of individuals,
departments, or entire companies.
 Means of Allocating Resources – organizations resources are limited, and
budgets provide one means of allocating resources among competing uses.
 Legal and Contractual Requirements –Some organizations are required to budget
because of legal requirements. Others commit themselves to budgeting
requirement when signing loan agreements or other operating agreements. For
example, a bank may require a f irm to submit an annual operating budget and
monthly cash budget throughout the life of a bank loan. Local police department,
for example, would be out of funds if the department decided not to submit a
budget this year.
 Cost Awareness –Accountants and f inancial managers are concerned daily about
the cost implications of decisions and activities, but many other managers are not.
Production managers focus on input, marketing manager’s focuses on sales, and
so forth. It is easy for people to overlook costs and cost-benef it relationships. At
budgeting time, however, all managers with budget responsibility must convert
their plans for projects and activities to costs and benef its. This cost awareness
provides a common ground for communication among the various functional
 Points on Budgeting
• Five general principles of budgeting
– Top-management support,
– participation in goal setting,
– timely communication of results,
– flexibility in design, and
– follow-up.
 Budgeting Strategy
• is the manner in which a company
approaches the budgeting process
– who is involved in the budgeting process and how
the budget numbers are derived.
• Mandated Budgeting
– top-down budgeting because top management
develops the budget and passes them down the
organizational hierarchy to various divisions
and/or departments without input from lower
levels of management and employees.
• Participative budgeting
– allows individuals who are affected by the budget
to have input into the budgeting process
– bottom-up budgeting
 Techniques of Budgeting
• Different organizations prepare budget
using different techniques that may be
grouped as follows:
1. Incremental budgeting: is a budget set
based on past year’s actual performance.
In this technique a budget for the coming
year is simply this year budgeted or actual
results plus or minus some amount for
expected change on planned operation or
change in the market price.
 Cont…
2. Zero based budgeting: In a dynamic business
it often makes sense to 'start a fresh' when
developing a budget, rather than basing
ideas too much on past performance.
In this technique each budget is therefore
constructed without much reference to
previous budgets.
Pre p a r i n g a b u d g e t a f re s h i s u s u a l ly
required in most business organizations,
where the business environment is volatile
that require continues effort of incorporating
changes in budget thinking.
 Cont….
3. Continuous/Perpetual/Rolling Budget: is
budget that covers a 12-month period but
which is constantly adding a new month on
the end as the current month’s completed.
 It is a common form of master budget.
 It makes the budgeting an ongoing
process rather than a periodic process.
 Cont…
4. Strategic budgeting: This involves identifying
new, emerging opportunities, and then
building plans to take full advantage of them.
This is clos ely rela ted to zero ba s ed
budgeting and helps to concentrate on
gaining competitive advantage.
5. Activity based budgeting: This examines
i nd i vi d u a l a cti vi ti e s a nd a s s e s s e s the
strength of their contribution to company
s u cce s s . They ca n the n b e ra nke d a nd
prioritized, and be assigned appropriate
budgets.
 TYPES OF BUDGET
• Budgets are classified in different ways:
A. Based on capacity
i) Fixed budget –is a budget that remains unchanged
with level of activity.
ii) Flexible budget –it is the budget that will f lu ctuate
with the level of output.
B. Based on time
i) Long-rang budget –a budget that may cover long
periods.
ii) Short-rang budget –a budget that covers less than
one year.
 C. Based on coverage
i) Functional budge t –budgets related to the various functions of a
business.

Functional budget includes:

a) Physical budget –budgets of quantity of sales & productions.

b) Prof it budget –budgets that ascertains the prof it ; like sales budget,
profit & sales budget, etc.

c) Cost budget –these provide information on costs like manufacturing

cost, selling & administration costs etc.

d) Financial budgets –these provide information on the financial position

of the firm. e.g.; cash budget, capital expenditure budget etc.
ii) Master budget – is a cons ol ida te d
summary of the various operation & f inancial
budgets.

Or
• It is a set of budgets prepared collectively
for all activities of a company.
 Cont..
• Master budget is a consolidated summary
of the various operational and financial
budgets
• Operating decision centers on the
acquisition and use of scarce resources
whereas financial decisions centers on
how to get the funds to acquire resources
• comprehensive, organization-wide set of
budgets.

20
 Cont..
• The two main components of the master
budget are:
– the operating budget
• The operating budget is the budgeted income
statement and its supporting budget
schedules
• sales budget is prepared first
– the financial budget.
• The financial budget consists of the capital
expenditures budget, cash budget, budgeted balance
sheet, and budgeted statement of cash flows.
 Master Budget-manufacturing
company
Sales Budget

Ending Inventory Production Budget

Budget

Direct Material Direct Labor Manufacturing

Budget Budget Overhead Budget

Cost of Goods Sold

Budget
Operating Expense/none
manufacturing overhead/
Budget
Budgeted Income statement

Capital Cash Budget Budgeted Balance Sheet Budgeted

Expenditur Cash Flow
e Budget statement
 Basic Operating Budget Steps
1. Prepare the revenues budget.
2. Prepare the production budget (in units).
3. Prepare the direct materials usage
budget and direct materials purchases
budget.
4. Prepare the direct manufacturing labor
budget.
 Basic Operating Budget Steps
5. Prepare the manufacturing overhead
costs budget.
6. Prepare the ending inventories budget.
7. Prepare the cost of goods sold budget.
8. Prepare the operating expense (period
cost) budget.
9. Prepare the budgeted income statement.
 Basic Financial Budget Steps
Based on the operating budgets:
1. Prepare the capital expenditures budget.
2. Prepare the cash budget.
3. Prepare the budgeted balance sheet.
4. Prepare the budgeted statement of cash
flows.
Preparation of Master Budget
(Manufacturing Company)
Sales Budget
• Great Company manufactures and sells a product whose
peak sales occur in the third quarter. Management is now
preparing detailed budgets for 2014- the coming year and
has assembled the following information to assist in the
budget preparation:
1) The company’s product selling price is Br. 20 per unit. The
marketing department has estimated sales as follows for
the next six quarters.
Year 2014 Budgeted Year 2015 Budgeted sales in
sales in units
units
Quarters 1 10, 000 Quarters 1 15,000
Quarters 2 30,000 Quarters 2 15,000
Quarters 3 40,000
Quarters 4 20,000

27
Sales Budget

28
 Cash Receipts Budget
• Sales are collected in the following
pattern: 70% of sales are collected
in the quarter in which the sales are
made and the remaining 30% are
collected in the following quarter.
On January1, 2014, the company’s
balance sheet showed Br.90, 000 in
account receivable, all of which will
be collected in the f irst quarter of
the year.
Cash Receipts Budget

30
 Production Budget
• The company maintains an
ending inventory of f inished
units equal to 20% of the
n ex t q u a r t e r ’s s a le s . o n
December 31, 2013, the
company had 2, 000 units on
hand to start the New Year.
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Production Budget
 Direct-Material Budget
• Fifteen pounds of raw materials are needed
to com p l e te on e u n it of p rod u c t . Th e
company requires an ending inventory of raw
materials on hand at the end of each quarter
equal to 10% of the following quarter’s
production needs of raw materials. On
December 31, 2013, the company had 21,
000 pounds of raw materials to start the
New Year.

33
Direct-Material Budget

34
 Direct-Material Budget
• The raw material costs Br.0.20 per pound.

35
 Schedule of Cash Disbursements
for Material Purchases
Raw material purchases are paid for in the
following pattern: 50% paid in the quarter the
purchases are made, and the remainder is paid
in the following quarter. On January 1,2014,
the company’s balance sheet showed Br.25,
800 in accounts payable for raw material
purchases, all of which be paid for in the f irst
quarter of the year.

36
Schedule of Cash Disbursements for
Material Purchases

37
 Direct-Labor Cost Budget
• Each unit of Great’s product requires 0.8 hour of
labor time. Estimated direct labor cost per hour is
Br.7.50.

38
 Manufacturing Overhead Budget
• Variable overhead is allocated to production using
labor hours as the allocation base as follows:
– Indirect materials Br.0.40
– Indirect labor 0.75
– Fringe benefits 0.25
– Payroll taxes 0.10
– Utilities 0.15
– Maintenance 0.35
• Fixed overhead for each quarter was budgeted at
Br. 60, 600. Of the fixed overhead amount, Br. 15,
000 each quarter is depreciation. Overhead
expenses are paid as incurred.
39
Manufacturing Overhead Budget

40
 budgeted ending inventory
Manufacturing overhead is applied on the basis of direct labor hours.

*rounded
41
 Selling and Administrative Expense Budget
• The company’s quarterly budgeted fixed selling
and administrative expenses are as follows:
2014 Quarters
1 2 3 4

Advertising Br.20, 000 Br.20, 000 Br.20, 000 Br.20, 000

Executive salaries 55, 000 55, 000 55, 000 55, 000

Insurance - 1, 900 37,750 -

Property taxes - - - 18, 150

Depreciation 10, 000 10, 000 10, 000 10, 000

The only variable selling and administrative expense, sales commission, is

budgeted at Br.1.80 per uni t o f t he budgeted sales. All selli ng and
administrative expenses are paid during the quarter, in cash, with exception of
depreciation.
42
Selling and Administrative Expense Budget

43
Selling and Administrative Expense Budget
Budgeted Income Statement

45
 Cash Budget


• New equipment purchases will be made during each quarter of the budget
year for Br. 50, 000, Br. 40, 000, & Br.20, 000 each for the last two quarter
in cash respectively. The company declares and pays dividends of Br.8, 000
cash each quarter.
• The company can borrow money from its bank at 10% annual interest. All
borrowing must be done at the beginning of a quarter, and repayments
must be made at the end of a quarter. All borrowings and all repayments
are in multiples of Br. 1,000. The company requires a minimum cash
balance of Br.40, 000 at the end of each quarter. Interest is computed and
paid on the principal being repaid only at the time of repayment of
principal. The company whishes to use any excess cash to pay loans off as
rapidly as possible

46


Cash Budget

47
 Cash Budget-

Financing and Repayment

48
Budgeted Balance Sheet

49
50
 Master Budget -Merchandising Company

The usual master budget for a non-manufacturing

company has the following components.
 Preparation of Master
Budget (Merchandising
Company)
 Sales Budget
• Blue Nile Company’s prepare a master budget to aid f in ancial and
operating decisions. The planning horizon is only three months, January
to March. Sales in December (2013) were Br. 40, 000. Monthly sales for
the first four months of the next year (2014) are forecasted as follows:
– January Br. 50, 000
– February 80, 000
– March 60, 000
– April 50, 000

54
 Cash Collection Budget
• Normally 60% of sales are on cash
and the remainders are credit sales.
All credit sales are collected in the
month following the sales.
 Purchase Budget
• Blue Nile wants to have a basic inventory of Br.
20, 000 plus 80% of the expected cost of goods
to be sold in the following month. The cost of
merchandise sold averages 70% of sales.

56
 Disbursement for purchases
• The purchase terms available to the
company are net 30 days. Each month’s
purchase are paid as follows:
– 50% during the month of purchase and,
– 50% during the month following the purchases

57
Operating expense budget

58
Disbursement for operating expenses budget

59
Budgeted Income Statement

60
 Cash Budget


• In January, a used truck will be purchased for Br. 3,
000 cash. The company wants a minimum cash
balance of Br. 10, 000 at the end of each month. Blue
Nile can borrow cash or repay loans in multiples of
Br. 1, 000. Management plans to borrow cash more
than necessary and to repay as promptly as possible.
Assume that the borrowing takes place at the
beginning, and repayment at the end of the months.
Interest is paid when the related loan is repaid. The
interest rate is 18% per annum.

61


Cash budget including receipts& payments

62
 Cash Budget-

Financing and Repayment

63
Budgeted Balance Sheet

64
Budgeted Balance Sheet

65