BUDGETARY PLANNING AND CONTROL

INTRODUCTION
7.1 Nature and Purposes of Budgets
Budgeting refers to the process of quantifying the plans of an organization so as to enable it achieve its
objectives in the defined period. The result of the process is budgets, which are used for cost control,
performance evaluation and future decision making.

Budgetary Planning and Control may be seen a s short-term quantification and monitoring of long-term
strategic plans of the organizations. Strategic planning involves preparation of strategic plans, which
define the objectives to be pursued within the framework of corporate policy. It is by budgeting that a
long-term corporate plan is put into action.

Budgets may be prepared for departments, functions or financial and resource items. In fact, some people
refer to budgeting as a means of coordinating the combined intelligence of the entire organization into a
plan of action.

7.1.2 OBJECTIVES OF BUDGETARY PLANNING

1) Coordination
The budgetary process requires that visible detailed budgets are developed to cover each activity,
department or function in the organization. This is only possible when the effort of one
department’s budget is related to the budget of another department. In this way, coordination of
activities, function and department is achieved.

2) Communication
The full budgeting process involves liaison and discussion among all levels of management. Both
vertical and horizontal communication is necessary to ensure proper coordination of activities.

3) Control
This is the process for comparing actual results with the budgeted results and reporting upon
variances. Budgets set a control gauge, which assists to accomplish the plans set within agreed
expenditure limits.

4) Motivation
Budgets may be seen as a bargaining process in which managers compete with each other for scarce
resources. Budges set targets, which have to be achieved. Where budgetary targets are tightly set,
some individuals will be positively motivated towards achieving them.

5) Clarification of Responsibility and Authority

Budgetary process necessitates the organization of a business into responsibility and budget centres
with clear lines of responsibilities of each manager. This reduces duplication of efforts.
6) Planning

1
 It is by Budgetary Planning that long-term plans are put into action. Planning involves determination
of objectives to be attained at a future predetermined time. When monetary values are attached to
plans they become budgets.

7.1.3 Limitations of Budgeting

 Too mush reliance may cause resistance (inflexibility) to change.
 Difficult to set levels of attainment. This may result into too tight budgets that cause loss of morale.
 Antagonism where budgets exert undue pressure.
 Budgeting control is a terminate exercise and therefore any report from investigation of variances
may b of little use to the current operations.

7.2 Organization of budgetary control

Budgetary control ideally involves the following steps:

1. The creation of budget centres.

2. The introduction of adequate accounting records.
3. The preparation of organization charts.
This defines the functional responsibilities of each member of management.
4. The establishment of a budget committee:
It will consist of operating and financial managers, who will be required to review,
discuss and co-ordinate business activities. The main function of this committee
involves:

 To issue instructions regarding budget requirements, deadline dates for the receipt of budgets
e.t.c.
 Draw up the budget preparation timetable. It takes the form of network analysis whereby some
activities are preceded by some others.
 To define the general policies of management in relation to the budget.
 Checking initial draft and problems considered. Limiting factors are usually considered.
 Ensuring that the budgets are synchronized within the boundaries of available resources.
 To analyze comparison of budgets and actual results and to recommend corrective action where
necessary.
 Review of budgets.
 Prepare the master budget after functional budgets have been prepared.
 The preparation of a budget manual. This is a document, which sets out the responsibilities of the
persons engaged in the routing of, and the forms and records required for budgeting control.
Such manual will provide such information as:

- Description of the system and its objectives.

- Definition of the responsibilities and duties.
- Reports and statements required for each budget period.
- Deadline dates by which data are to be submitted.

7.3 PREPARATION OF BUDGETS

THE MASTER BUDGET FRAMEWORK
The master budget is the overall quantifications of the budgeting plan. In it, functional budgets are
incorporated. A functional budget is a budget if income and/or expenditure for a particular function. The
master budget therefore combines all the budgets of the various departments in an organizations. It is

2
useful in ensuring that all the individual budgets are consistent with one another and also presents a ‘unit’
picture of the entire organization.

It is made up of both production and non-production budgets.

Production budgets include:

 Sales Budget
 Finished Goods Budgets
 Material budges
 Labour budgets
 Overheads budgets.

Non-Production Budgets Include

 Selling & Distribution
 Administration Budget
 Cash Budget
 Research and Development – Capex
 All these budgets translate into the
projected profit and loss a/c and the budgeted
Balance Sheet.
 The relationship between all these budgets
is summarized in the next page.

3
 Sales Budget Selling and dist. Budget Admin Budget

Finished goods stock

budget

Production Budget
Cash budget
Budgeted
P/L & B/S

Material Usage Direct Labour Production over

Budget Budget head Budget Research and
development
budget

Material Stock
Budget

Material
Purchases Budget Capital
Sales budget Expenditure
Budget

4
7.3.1 Sales Budget
It gives volume of sales and sales mix of the current operations. The sales forecast is initially prepared
and upon completion the sales budget is finalized. The following are usually considered in coming up
with the sales forecast.

 Actual sales in the previous periods.

 Reports from salesmen.
 Market research information.
 Level of orders already obtained in advance.

It essentially forecasts what the company can reasonably expect to sell to the customer during the budget
period.

7.4.2 Production budget

It is the forecast of the products to be manufactured during the budget period to most forecasted sales
above.

It is expressed as units of each type of product. The following are usually considered:
 Available production capacity.
 The sales forecast.
 Finished goods stock level policy.

The cycle for the preparation of the above budget usually is determined by the budget committee. It is
as follows:

i. Determine the production capacity available.

ii. Consider the possible ways in which the available production capacity may be expanded if
required.
iii. Linkage of production capacity available to the stock level.
iv. Determine the detailed budgets within the production budget.

Format

6 (Units) P (Units) J (Units)

Required Stock 31/12/19-0 xx xx xx
Add: Sales during the year xx xx xx
Less: Estimated Stock 01/01/19-0 (xx) (xx) (xx)
Production Requirements xx xx xx

It has two purposes

 Ensures that production is sufficient to meet sales demand.

 Ensures that economic stock levels are maintained according to the stock policy.

5
7.4.3 Direct Materials Budget

This budget shows the estimated quantities and costs of all the raw materials and components needed for
the output demand by the production budget. This consists of:

i. Direct Materials Usage Budget: Which shows the estimated quantities of materials required
for budgeted production.
ii. Direct Materials Purchases Budget: It ensures that materials are within the planned
materials stock levels i.e. after considering both usage material stock required.

7.4.4 Direct Labour Budget

It represents the forecasts of direct and indirect labour requirements to meet the demands of the company
during the budget period.

The budgeted direct labour cost is therefore determined by multiplying direct labour hours with the wage
rates for every category of labour.

7.4.5 Factory Overhead Budget

This budget represents the forecasts of all the production fixed and variable and semi-variable overheads
to be incurred during the budget period.

The summation of budgeted costs of production for the budget period makes up Production Cost
Budget. It includes:

 Budgeted Materials Cost

 Budgeted Labour Cost
 Budgeted Overhead Cost

7.4.6 Non-Production Budgets

a) Selling and Distribution Cost Budget

It is the forecast of all costs incurred in selling and distributing the company’s product during the
budget period. It is closely concerned with the sales budget in that it is mainly based on the volume
of sales projected for the period.

Expenses included are:

 Selling office costs

 Salesman salaries and commission
 Advertising expenses

b) Administration Costs Budget

It represents the costs of all administration expenses. Each department or budget centre will be
responsible for the preparation of its own budget. Management, Secretarial, Accounting and
Administration costs which cannot be directly related to the production are included here.

6
 The budget will be mainly incremental i.e. previous year’s figure will tend to apply for its next budget
with an allowance for inflation.

c) Research and Development Cost Budget

These are costs, which are discretional in nature i.e. they are determined on need basis by the
managers concerned. Research cost is the cost of original investigation undertaken in order to gain
new scientific or technical knowledge and directed towards a specific practical aim objective.

Development cost is the cost of using scientific or technical knowledge in order to produce new or
substantially improved materials, devices, products, processes systems or services prior to the
commencement of commercial production.

d) Capital expenditure Budget

It represents the expenditure on all fixed assets during the budget period. Addition intended to
benefit future accounting periods, or expenditure which increases the production capacity, efficiency
lifespan or economy of an existing fixed assets are also incorporated.

e) Cash budget
It records the cash inflows and outflows, which are expected to take place in respect of each
functional budget. It may be prepared for a period span of one week, month or quarter of the budget
period. It has the following benefits/advantages:

 It ensures that sufficient cash is available when required.

 It shows whether capital expenditure projects can be financed internally.
 It indicates the cash needed for current operating activities.
 It indicates the effect the position of each seasonal requirements, large stocks, unusual receipts
and laxity in collecting account receivable.
 It indicates the availability of cash for taking advantage of discounts.
 It reveals the availability of excess cash so that short-term investments may be considered.
 It serves as a basis for evaluating the actual cash management performance of responsible
managers.

7
Illustration
Venus plc produces two products Niks and Args. The budget for the next year to 31 st 20X8 is to be
prepared. Expectations for the forthcoming year includes the following:

Venus PLC
BALANCE SHEET AS AT 1 APRIL 20X7

Fixed Assets Shs Shs Shs

Land and buildings 45,000
Plant and Equipment (NBV) 112,000
Current Assets
Raw materials 7,650
Finished goods 23,615
Debtors 19,500
Cash 4,3
00
55,065
Current Liabilities
Creditors 6,800
Taxation 24,500 (31,300) 23,765
180,765
Financed by
150,000 ordinary shares of Shs1 each 150,000
Retained profit 30,765
180,765

(b) Finished Products NIKS ARGS

The Sales Director has estimated the following:
(i) Demand for the Co’s products 4,500 units 4,000 units
(ii) Expected S.P per unit Shs32 Shs44
(iii) Closing stock @ 31 March 20X8 is required to be 400 units 1200 units
(iv) Opening stocks at 01 April 20X7 900 units 200 units
(v) Unit cost of this opening stock will be Shs20 Shs28
(vi) The amount of plant capacity required for each
product is: Machining 15min 24min
Assembling 12min 18min
(vii) The raw material content per unit is
Material A 1.5 kg 0.5 kg
Material B 2.0 k g 4.0 kg
(viii) Direct labour hours required @ unit of each
product is: 6 hrs 9 hrs

Finished goods are valued at FIFO basis at full factory cost.

(c) Raw Materials Material A Material B

(i) Closing stock requirements kilos at 31 March 20X8
600 1000
(ii) Opening stock at 1 April 20X7 kilos 1100 6000
(iii) Budgeted cost of raw materials per kilo Shs1.50 Shs1.0

8
Actual cost per kilo of opening stocks are as budgeted cost for the coming year.

(d) Direct Labour

The standard wage rate of direct labour is Shs1.50/hr.
(e) Factory overhead

Factory overhead is absorbed on the basis of machining hours with separate absorption rates for each
department.

The following are expected overheads in the production cost centre budgets.

Machinery Deport Assembly Deport

Shs Shs
Supervisors salaries 10,000 9,150
Power 2,400 2,000
Maintenance and running costs 2,100 2,000
Consumables 3,400 500
General Expenses 19,600 5,000
39,500 18,650

Depreciation is taken at 5% straight-line on plant and machinery equipment. A machine costing the
company Shs20,000 is due to be installed on 1 October 20X7 in the machining department which already
has machinery installed to the value of Shs100,000 at cost.

(f) Selling and distribution expenses Shs

Sales commission and salaries 14,300
Traveling distribution 3,500
Office salaries 10,100
General administration expenses 2,500
30,400

(g) There is no opening or closing work in progress and inflation should be ignored.

Required
Prepare the following budgets for the year ended 31 March 20X8 for Venus PLC.

i) Sales budget
ii) Production budget (units)
iii) Plant utilization budget
iv) Direct materials utilization budget
v) Direct labour budget
vi) Factory overhead budget
vii) Direct materials purchases budget
viii) Cost of goods sold budget
ix) Budgeted profit and loss account

9
Solutions

Venus PLC

(i) Sales Budget

Qty (units) Revenue (Shs)
NIKS 4,500 144,000*1
ARGS 4,000 176,000*2
TOTALS 320,000

(ii) Production Budget (units)

NIKS (units) ARGS (units)

Sales 4,500 4,000
Add: Closing Stock 400 1,200
Total requirements 4,900 5,200
Less: Opening stock (900) (200)
Production budget 4,000 5,000

(iii) Plant Utilization Budget

Machinery Assembling
NIKS (4,000 units) *3 1000 hrs 800 hrs
ARGS (5000 units) *4 2000 1,500
TOTAL PLANT UTILIZATION 3,000 hrs 2,300 hrs

15 min 12 min
*3 = 4000 x
60 min ; 4000 x 60 min

24 min 18 min
*4 = 5000 x
60 min ; 5000 x 60 min

(iv) Direct Material Uses Budget

Units @ Material A @ Material B

NIKS 4,000 1.5 6,000 2.0 8,000
ARGS 5,000 0.5 2,500 4.0 20,000
Total Direct Materials 8,500 kg 28,000 kg
USAGE

10
 (v) Direct Materials Purchases Budget

Mat A (kg) Mat B (kg)

Current usage 8,500 28,000
Add: Closing stock 600 1,000
Total Req 9,100 29,000
Less: Opening stock (1,100) (6,000)
Material To Be Purchased (Kg) 8,000 23,000
Cost per Kg. Shs1.5 Shs1.0
Material purchase
Budget Shs 12,000 23,000

Total Material Purchases Budget:

Shs.
12,000
+ 23,000
35,000

(vi) Direct Labour Budget

Hrs
NIKS 4000 x 6 24,000
ARGS 5000 X 9 45,000
Direct Labour hrs 69,000
Standard Wage rate/hr Shs 1.6
Direct Labour Cost Budget Shs 110,400

Factory Overhead Budget

Machining Department (Shs) Assembly

department (Shs)
Budgeted Overheads ex 39,500 18,650
Cluding depreciation
Add: Depreciation
Less: Existing plant *5 5,000 4,350
New plant *6 500 -
Total budgeted overheads 45,000 23,000
Absorption Base (Machine hrs) 3,000 2,300
Overhead Absorption Rate *7 Shs1.5/mach hr Shs 10 mach hr

*5 = 100,000 x 5%; 87,000 x 5%

6
*6 = 20,000 x 5% x
12
45000 23000
*7 =
3000 ; 2300

11
 (viii) Cost of goods sold budget

Niks (Shs) Args (Shs)

Opening stock (WI) 18,000 5,600
Add: Production (WII) 78,400 140,750
Less: Closing stock (WIII) 7,840 33,780
Cost of goods sold 88,560 112,570

Workings

I: Opening stocks

Niks: 900 x 20 = 18,000

Args: 200 x 28 = 5,600

II PRODUCTION COST PER UNIT OF FINISHED PRODUCT

NIKS ARG

Materials: A 1.5 x 1.5 2.25 0.5 x 1.5 0.75

B 2.0 x 1.0 2.0 4.0 x 1.0 4.0
Labour: 6hrs x 1.6 9.6 9 hrs x 1.6 14.4
Overheads
15 3.75 24 6.0
Machining 15 x 60 15 x 60
12 18
2.0 3.0
Assembly 10 x 60 10 x 60
Total production @ unit Shs19.6 28.15
Production Units 4000 5000
Valuation 78400 140750

III CLOSING stock valuation

NIKS ARGS

Closing stock units 400 1200

Unit cost 19.6 28.15
Stock units 7840 33780

12
 (iv) BUDGETED PROFIT AND LOSS ACCOUNT

NIKS (Shs) ARGS (Shs) TOTAL (Shs)

Sales 144000 176000 320000

Cost of goods sold 88560 112570 201130
Gross Profit 55440 63430 118870
Less: Selling and administrations expenses 30400
Net Profit 88470

KASNEB JUNE 1996

QUESTION FIVE
The following information related to the proposed budget for K.K Ltd for the months ending 31
December 1996.

Material Production Administration

Month Sales Purchases Wages Overheads Overheads
Sh. ‘000’ Sh. ‘000’ Sh. ‘000’ Sh. ‘000’ Sh. ‘000’

July 72000 250000 10000 6000 55000

August 97000 31000 12100 6300 6700
September 86000 25500 10600 6000 7500
October 88600 30600 25000 6500 8900
November 102500 37000 22000 8000 11000
December 108700 38800 23000 18200 11500

Additional Information
1. Depreciation expenses are expected to be 0.5%of sales.
2. Expected cash balance in hand on 1 July 1996 is Sh. 72,500,000
3. 50% of total sales are cash sales
4. Assets are to be acquired in the months of August and October at Shs. 8,000,000 and Shs.
25,000,000 respectively
5. An application has been made to the bank for the grant of a loan of Shs. 30,000,00 and it is hoped
that it will be received in the month of November
6. It is anticipated that a dividend of Shs. 35,000,000 will be paid in December
7. Debtors are allowed one month’s credit
8. Sales commission at 3% on sales is paid to the salesmen each month

Required
A cash budget for the six months ending 31 December 2003.

13
CASH BUDGET
SUGGESTED SOLUTION: KASNEB JUNE 1996 QUESTION 5

K.K LTD

Workings I: Depreciation = 0.5% of sales

July Aug Sept Oct Nov Dec

Sales 72000 97000 86000 88600 102500 108700
Depreciation 360 485 430 443 512.5 543.5

II Cash Production Overheads

July Aug Sept Oct Nov Dec

Production overheads 6000 6300 6000 6500 8000 8200
Less: Depreciation 360 485 430 443 512.5 543.5
Cash production overheads 5640 5815 5570 6057 7487.5 7656.5

III Receipt from sales

July Aug Sept Oct Nov Dec

Total sales 72000 97000 86000 88600 102500 108700
Cash Sales (50%) 36000 48500 43000 44300 51250 54350
Receipt from Debtors - 36000 48500 43000 44300 51250
Total cash receipts 36000 84500 91500 87500 95550 15560

IV Sales Commission (3% of Sales)

July Aug Sept Oct Nov Dec

Sales 72000 97000 86000 88600 102500 108700

Sales Commission 2160 2910 2580 2658 3075 3261

14
KK
CASH BUDGET FOR SIX MONTHS ENDING 31 DECEMBER 1996

July Aug Sept Oct Nov Dec Total

RECEIPTS ‘000’ ‘000’ ‘000’ ‘000’ ‘000’ ‘000’ ‘000’

Opening b/d 72500 96340 121690 156495 152567 207485 72500

Cash receipts 36000 84500 91500 87500 95550 105600 500450
Loan - - - - 30000 - 30000
108500 180840 213190 243795 278117 313085 602950
PAYMENTS
Materials - 25000 31000 25500 30600 37000 149100
Wages 10000 12100 10600 25000 22000 23000 102700
July Aug Sept Oct Nov Dec Total
RECEIPTS ‘000’ ‘000’ ‘000’ ‘000’ ‘000’ ‘000’ ‘000’

Pdtn overheads - 5640 5815 5570 6057 7487.5 3056.5

Admin overheads - 5500 6700 7500 8900 11000 39600
Cash assets - 8000 - 25000 - - 33000
Dividends - - - - 35000 - 35000
Sales commission 2160 2910 2580 2658 3075 3261 16644
Total payments 12160 59160 56695 91278 70362 . .
Closing balance c/d 96340 121690 156495 152567 207485 196336.5 196336.5

7.4.7 FIXED AND FLEXIBLE BUDGETING

The master budget discussed before is a fixed budget.

A fixed budget is defined by:

 Only one level of activity

 Not adjusted to reflect actual activity level when change occurs

A fixed budget has the following limitations:

 It provides little assistance at the planning stage. It does not give implication of various alternative
strategies which management may wish to consider.
 It fails to provide relevant and reliable base against which to measure actual performance where
actual activity differs from the budget.
 Little motivation to management to use the budgeting control system as a control aid.

Flexible budget is a budget which is designed to change in accordance with the level of activity attained.
It involves budgeting at various levels in anticipation of changes. The original budget is adjusted (flexed)
to reflect the actual conditions in which the performance was done.

It is more useful than fixed budgeting due to:

 It provides a range of information at the planning stage which will assist in short term planning.
 Control: It provides control data when compared with actual performance.

15
 Motivation: More likely to be acceptable to management to provide a positive motivational stimulus
because the control data is adjusted to conform with current activity level.

CHOICE OF BUDGET FLEXING BASIS

The most appropriate flexing basis should be considered in that it assists in the comparison of alternative
budget data at the planning stage and for the comparison of budget and actual data at the control stage.
Different organizations use different flexing bases but the following are most commonly used.

 Machine hours
 Direct labour hours
 Input to a cost centre
 Output from a cost centre

For the above flexing bases to be used a number of requirements must be fulfilled.

1. The flexing bases should be correlated with the way in which costs vary. E.g. does the number of
miles traveled by distribution vehicles affect the repairs and maintenance expenses?
2. The flexible bases should be easily understood by the management and not subject to
manipulation.
3. The flexible bases should be readily obtainable.
4. It should be independent of other factors.

Illustration
Mini Bakeries Ltd. has budgeted to produce and sell 100,000 units of cakes during the next period. The
selling price per cake is Sh. 20 and variable cost per cake is Sh. 12. Fixed overheads are budgeted to at
Sh. 6000,000.

Additional information

1. Fixed costs will increase to Sh. 700,000 where activity is in excess of 110,000 units; Fixed costs
will fall to Sh. 480,000 where activity level is less than 90,000 units.
2. Variable costs will fall by 5% per unit (cake) of all units where activity is in excess of 100,000
cakes because of the economies of scale.

The actual results of the period in which 115,000 units (cakes0 were produced and sold were:

1. Sales revenue Sh. 2,242,500

2. Variable costs Sh. 1,320,000
3. Fixed costs Sh. 67,000

Required
1. Prepare a summary, which shows the budgeted results for activity levels from 80,000 to 120,000
cakes using the above information.
2. Prepare a control statement comparing budgeted with actual results where a fixed budget system
is used based on 100,000 units.

16
Solution
Flexible Budget Summary

Units 80,000 90,000 100,000 110,000 120,000

Sales Revenue 1,600,000 1,800,000 2,000,000 2,200,000 2,400,000
Variable cost 690,000 108,000 120,000 1,254,000 1,368,000
Contribution 640,000 720,000 800,000 946,000 1,032,000
Fixed Costs 480,000 600,000 600,00 600,000 700,000
Net Profit 160,000 120,00 200,000 346,000 332,000

Control Statement (Fixed Budget)

Budget Actual Variance

Units 100,000 115,00 15,00 (F)

Sales Revenue 2,000,000 2,242,500 242,500 (A)
Variable Cost 1,200,000 1,320,000 120,000 F
Contribution 800,000 922,500 122,500 (A)
Fixed Costs 600,000 670,000 70,000 (A)
Net Profit 200,000 252,500 525,000 (F)

7.4.8 ZERO BASED BUDGETING

It is also referred to as priority based budgeting. It is a cost benefit approach budgeting where it is
assumed that the cost allowance is Zero for any item until the manager responsible justifies its existence
in terms of costs and benefits.

CIMA definition: A method of budgeting whereby all activities are re-evaluated each time the budget is
set. It is concerned with alternative means that established activities have been compared with alternative
uses of the same resources.

It takes away the implied right of existing activities to continue receiving resources unless they can be
shown to be the best use of such resources.

Stages of Implementation
1. Definition of decision package.
This is the comprehensive description of the organizations functions or activities.
2. Evaluation and ranking of packages.
This is on benefit basis.
3. Resource allocation according to priorities.

Advantages
1. More efficient allocation of resources.
2. Focus attention on values for money and makes clear relationship between input and output.
3. Develops a questioning altitude and makes it easier to identify obsolete, inefficient and less cost
effective operations.
4. Leads to greater staff and management knowledge of operations.

17
Disadvantages
1. Time consuming.
2. High skills required.
3. May encourage wrong impression that all decisions must be made through budgets.
4. Short – term benefits may be emphasized to the detriment of long-term benefits.

18