Lecture 3

LESSON V
BUDGETING AND BUDGETARY CONROL

BUDGETING
Definition:
There are various definitions of a budget.
1. A quantity expression of a plan of action for a specified period of time.
2. A financial and/ or a quantity statement prepared prior to a defined time to serve as a
basis for the implementation of a policy to be followed during that period for the purpose
of obtaining a given objective.
The main purpose of a budget is to implement the policies implemented by management for
attaining the company’s objectives.
A budget can be independent on a particular unit of the organization or for the entire
organization.
Master budgets
It is prepared for the entire organization.
- It is a summary of all phases of the company’s plans and goods for the future
- It sets specific targets for all sub-units of the organization such as production, distribution,
finance etc
Functions of budgets
1. Planning
Budgeting requires managers to give planning top priority among their duties. Planning involves
the development of future objectives and the preparation of various budgets to achieve these
objectives. The budget brings out the firm’s requirements and expectations in terms of inputs and
the outputs and in this way many unforeseen contingencies may be anticipated in advance.
2. Communication
Budgets are devices for communication. The plans summarized in the budget are read and
interpreted throughout the firm, thus budgets are important channels of communicating certain
types of information that will enable the managers in different parts of the organization to co-
ordinate their activities more efficiently
3. Motivation
Budgets often serve as a means of motivating managers to strive towards the achievement of
organization’s objectives. They do this by acting to internal standards that will be accepted by
the manager and his own target thus providing a motivating force. Extrinsic rewards or penalties
may also be attached to budget achievement to increase its motivational effects.
4. Controlling
Budgets can serve as standards against which management performance is evaluated. The budget
offers the only available quantity reference against which performance can be assessed
A danger to this situation is that performance which is relatively reported can become the
dominant measure of the overall performance yet the budget itself represents an imperfect
standard. A strong stress on budget attainment is likely to give budgets that are net but after the
expense of worse long run performance with various harmful side-effects. Nevertheless,
properly planned budgets can be a vital tool in monitoring and controlling managerial and
business performance.
5. Co-ordinating
A budget is important for effective co-ordination. The various departmental managers will
expect to co-ordinate one another so as to be able to determine man-power needs, facilities and
other resources in the organization.This can be done using the relevant budgets.
Limitations of budget
1. Budget plan is based on estimates and therefore absolute accuracy is not possible in
budgeting.
2. The strength and weakness of a budgeting system depend to a large extent on accuracy with
which the estimates are made.
 Danger of rigidity – the budget programme must be dynamic and continuously deal with
changing conditions.
3. Budgets will lose much of their usefulness if they acquire rigidity and are not revised with
increasing circumstances
 Budgeting is only a tool of management but cannot take the place of management.
4. Execution of the budgets will not occur automatically. It is therefore necessary that the entire
organization participate in the budget program if the budgeting goals have to be achieved.
TYPES OF BUDGETS
Sales budget
- Starting point when preparing a master budget.
- Constructed by X expected sales units by selling price.
Production budget
- Follows the sales budget.
- Determine the no. of units to be produced
Units to be produced will be made as follows:
Budgeted sales units XX
Add: desired inventory finished goods. XX
XX
Less: finished goods inventory. XX

Units to be produced XX
 Production required is for the coming budget period is determined and organized in form of
production budgets.
 Sufficient goods will have to be available so that to meet sales needs and to provide for the
desired ending inventory.
 A portion of these goods will already exist in form of beginning inventory and the
remainder will have to be produced.
Direct materials purchase budget

 Shows materials required in production process.
 Sufficient raw materials will have to be available to meet production needs and provide for
the desired raw materials ending inventory. For budget period, part of this raw materials
required will already and form of beginning raw materials inventory. Remainder will have to
be purchased from the suppliers.
Direct labour cost budget
This shows direct labour required for the company by knowing in advance what will be needed
in terms of labour time throughout the budget period. The company may adjust labour force as
the situation may require. To compute direct labour required, no. of units of finished products to
be produced each period is X no. of direct labour required to produce a single unit.
Cash budget
 Plans for an adequate but not an excessive cash balance.
 The goal of the cash budget is to ensure that the business has sufficient liquidity to pay its
bills as they fall due.
It has 3 sections:
i. Cash receipt section – has opening balance and all expected cash receipts
ii. Cash payment (disbursement) section- cash payment plans and disbursements are shown.
iii. Ending balance section - has difference between receipt total and payment total. It can show
a deficit or a surplus.
Example
A company has the following data from which a master budget has to be prepared for the coming
year.
Current year Coming year Year after
4th quarter 1st 2n d 3rd 4th 1st quarter
Expected
Sales units 1800 1000 2000 1500 2000 1000
Expected sales per unit- shs200
Inputs Requirements Cost /unit

Direct materials 2kg shs5/kg
Direct labour 3hours shs10/hour
Additional information
- Beginning inventory of finished goods of each quarter must be equal to 10% of the sales for
the previous quarter and the closing stock must be 10% of sales of the current quarter
- Raw material inventory at the end of any quarter must be equal to requirements to produce
units for sale in the next quarter and the opening stock of raw material must be equal to the
requirements to produce units for sale in the current quarter
- Variable manufacturing O/H are based on direct labour cost at the rate of 80% of direct
labour.
- In addition fixed manufacturing O/H of shs20000 will be incurred each quarter
- In addition to manufacturing overhead, a fixed selling and administration costs of shs32000
are incurred per month.
Required:
 Prepare sales budget
 Prepare production budget
 Prepare raw material purchase budget
 Prepare direct labour budget
 Manufacturing overheads for the year on a quarterly basis
 Budgeted income statement
Sales budget
1st 2nd 3rd 4th
Sales units 1000 2000 1500 2000
Selling price per unit 200 200 200 200
Expected sales revenue 200,000 400,000 300,000 400,000
Production budget
1st 2nd 3rd 4th
Sales units 1000 2000 1500 2000
Add:
Closing stock 100 200 150 200
1100 2200 1650 2200
Less: opening stock 180 100 200 150
Units to be produced 920 2100 1450 2050
Raw materials purchase budget

1st 2nd 3rd 4th
Req. per unit (kg) 2 2 2 2
1840 4200 2900 4100
Add: ending inventory req.(kg) 4000 3000 4000 2000
5840 7200 6900 6100
Less required beginning inventory 2000 4000 3000 4000
Units to be purchased 3840 3200 3900 2100
Price per unit (kg) 5 5 5 5
Budgeted raw materials cost 19200 16000 19500 10500
Direct labour cost

1st 2nd 3rd 4th
Required per unit (hrs) 3 3 3 3
2760 6300 4350 6150
Cost / unit 10 10 10 10
Required labour cost 27600 63000 43500 61500
Manufacturing O/H budget

1st 2nd 3rd 4th
Budgeted labour 27600 63000 43500 61500

cost
Variable overhead 0.8 0.8 0.8 0.8
application rate
22080 50400 34800 49200
Budgeted fixed 20000 20000 20000 20000
O/H
42080 70400 54800 69200
Compute manufacturing cost per unit (Assume variable cost approach)
Input item Quantity Cost per unit Total
Direct materials 2kgs 5 10
Direct labour 3hrs 10 30
Variable 3hrs 8 24
manufacturing O/H
Manufacturing cost per shs64
unit:
Projected income statement for the year ended
1st 2nd 3rd 4th
Sales 200000 400000 300000 400000
Less: variable cost 64000 128000 96000 128000
Contribution 136,000 272,000 204,000 272,000
margin
Less: fixed
Manufacturing cost 20000 20000 20000 20000
Selling and
administration
Cost 96000 96000 96000 96000
20000 156000 88000 156000

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LESSON V

BUDGETING AND BUDGETARY CONROL

Less: finished goods inventory. XX

Direct materials purchase budget

Expected sales per unit- shs200

Inputs Requirements Cost /unit

Raw materials purchase budget

Direct labour cost

Manufacturing O/H budget

Budgeted labour 27600 63000 43500 61500

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