COST AND MANAGEMENT ACCOUNTING II

CHAPTER III
BUDGETS AND BUDGETARY
CONTROL
OBJECTIVES OF THE CHAPTER

 Introduction on fundamental concepts

 Types of budgetary systems
 Monitoring and Controlling performance: variance
analysis and determination of their causes
 Master Budget
FUNDAMENTAL CONCEPTS OF BUDGETING
Budget
 Is a short- term financial plan which acts as a guide to achieve the pre -
determined targets.
 It is a comprehensive and coordinated plan, expressed in financial terms, for
the operations and resources of an enterprise for some specific period in the
future.
 It 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
FUNDAMENTAL CONCEPTS OF BUDGETING
 Meaning of budget and budgeting:
 CIMA (UK) defined a budget 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, expenditure
to be incurred during the period and the capital to be employed to
attain a given objective.”
 Other definitions of budget include:
 “a budget is a plan of action to achieve stated objectives based on
predetermined series of related assumptions.” (Keller & Ferrara )
 “a budget is a written plan covering projected activities of a firm for
a definite time period.” (G.A.Welsh)
 Budgeting: is the act of preparing a budget
FUNDAMENTAL CONCEPTS OF BUDGETING
 It is mainly a forecasting and controlling
FEATURES OF A BUDGET device.
 It is prepared in advance before the actual
operation of the company or project.
 It is in connection with a definite future
period.
 Needs approval by management before
implementation.
 It shows capital to be employed during the
period.
FUNDAMENTAL CONCEPTS OF BUDGETING
BUDGET CYCLE
 According to Horngren etal (2003), in well managed companies, a
budget cycles in the following steps:
 Planning the performance of the company (as a whole as well as for its units).
Management at all levels agrees on what is expected
 Providing a frame of reference (a set of specific expectations against which
actual results will be compared)
 Investigating variations from plans to follow corrective actions, if necessary
 Planning again, in light of feedback and changed conditions
FUNDAMENTAL CONCEPTS OF BUDGETING
ADVANTAGES OF BUDGET

• Requires periodic planning.

• Fosters coordination, cooperation, and communication.
• Provides a framework for performance evaluation.
• Means of allocating resources.
• Satisfies legal and contractual requirements.
• Created an awareness of business costs.
FUNDAMENTAL CONCEPTS OF BUDGETING
BUDGETING AND ACCOUNTING

• Historical accounting data on revenues, costs, and expenses help in

formulating future budgets
• Accountants normally responsible for presenting management’s
budgeting goals in financial terms
• Budget and its administration are the responsibility of management

9
FUNDAMENTAL CONCEPTS OF BUDGETING
BUDGETARY CONTROL
 According to CIMA, “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.”
FUNDAMENTAL CONCEPTS OF BUDGETING

ELEMENTS OF BUDGETARY CONTROL

1. Establishment of budgets for each function and division of the organization.
2. Regular comparison of the actual performance with the budget to know the
variations from budget and placing the responsibility of executives to achieve the
desire result as estimated in the budget.
3. Taking necessary remedial action to achieve the desired objectives, if there is a
variation of the actual performance from the budgeted performance.
4. Revision of budgets when the circumstances change.
5. Elimination of wastes and increasing the profitability.
FUNDAMENTAL CONCEPTS OF BUDGETING

BUDGETING AND HUMAN BEHAVIOR

 Participative Budgeting: Each level of management

should be invited to participate
 May inspire higher levels of performance or discourage
additional effort
 Depends on how budget developed and administered

LO 1 12
FUNDAMENTAL CONCEPTS OF BUDGETING
BUDGETING AND HUMAN BEHAVIOR
▪ Advantages of Participative Budgeting
▪ More accurate budget estimates because lower level managers have more detailed
knowledge
▪ Perceive process as fair due to involvement of lower level management
▪ Overall goal - produce fair and achievable budget while still meeting corporate goals

▪ Disadvantages of participative Budgeting

▪ Can be time consuming and costly
▪ Can foster budgetary “gaming” through budgetary slack
FLOW OF BUDGET DATA UNDER PARTICIPATIVE BUDGETING

14
 O2.
TYPES OF BUDGETARY SYSTEMS
TYPES OF BUDGETARY SYSTEMS

 A business creates a budget when it wants to match its

actual future performance to an ideal scenario that
incorporates its best estimates of sales, expenses, asset
replacements, cash flows, and other factors.
 There are a number of alternative budgeting models
available. The following list summarizes the key aspects and
disadvantages of each type of budgeting model.
 TYPES OF BUDGETS

 Static (or Fixed) Budgeting

 This is the classic form of budgeting, where a business creates a model of
its expected results and financial position for the next year, and then
attempts to force actual results during that period to align with the budget
model as closely as possible.
 This budget format is typically based on a single expected outcome, which
can be extremely difficult to achieve.
 It also tends to introduce a great deal of rigidity into an organization, rather
than allowing it to react quickly to ongoing changes in its environment.
 TYPES OF BUDGETS
 Zero-Base Budgeting
 A zero-base budget involves determining what outcomes management
wants, and developing a package of expenditures that will support each
outcome. By combining the various outcome-expenditure packages, a
budget is derived that should result in a specific set of outcomes for the
entire business.
 This approach is most useful in service-level entities, such as
governments, where the provision of services is paramount. However, it
also takes a considerable amount of time to develop, in comparison to
the static budget.
 TYPES OF BUDGETS

 Flexible Budgeting
 A flexible budget model allows you to enter different sales levels in the
model, which will then adjust planned expense levels to match the sales
levels that have been entered.
 This approach is useful when sales levels are difficult to estimate, and a
significant proportion of expenses vary with sales.
 This type of model is more difficult to prepare than a static budget model,
but tends to yield a budget that is reasonably comparable to actual
results.
 TYPES OF BUDGETS

 Incremental Budgeting
 Incremental budgeting is an easy way to update a budget model,
since it assumes that what has happened in the past can be rolled
forward into the future.
 Though this approach results in simplified budget updates, it does
not provoke a detailed examination of company efficiencies and
expenditures, and so does not assist in the creation of a lean and
efficient enterprise.
TYPES OF BUDGETS

 The Rolling Budget

 A rolling budget, also called continuous budget, requires that a new
budget period be added as soon as the most recent period has been
completed. By doing so, the budget always extends a uniform distance
into the future.
 However, it also requires a considerable amount of budgeting work in
every accounting period to formulate the next incremental update. Thus, it
is the least efficient budgeting alternative, though it does focus ongoing
attention on the budget.
TYPES OF BUDGETS

 The Periodic Budget

 A periodic budget is a budget that is prepared for a specified period of
time, usually one year. As each budget period ends, the organization
prepared a new budget for the next one.
 Hence, it is a one-off budget set for a year (e.g.). It is normally broken
down into monthly or weekly amounts.
 Advocates of periodic budgeting argue that continuous budgeting takes
too much time and effort and that periodic budgeting provides virtually the
same benefits at a smaller cost.
 O3.
MONITORING AND CONTROLLING
PERFORMANCE: VARIANCE
ANALYSIS AND DETERMINATION OF
THEIR CAUSES
 Definition

Variance analysis is the study of deviations of

Variance analysis can be broken
actual behavior versus forecasted or planned
down into 2 steps:
behavior in budgeting or management accounting.
This is essentially concerned with how the 1. Calculating and recording
difference of actual and planned behaviors individual variances
indicates how business performance is being
2. Understanding the cause of
impacted.
each variance
 O4.
MASTER BUDGET
 THE MASTER BUDGET
 Is the total budget package for an organization.

 It is the end product that consists of all the individual budgets for each
part of the organization aggregated into one overall budget for the entire
organization.

 The master budget is the aggregation of all lower-level budgets produced

by a company's various functional areas, and also includes budgeted
financial statements, a cash forecast, and a financing plan.

28
ILLUSTRATION ON MASTER BUDGET
 PREPARE THE FOLLOWING BUDGETS
 1. a) A sales budget, by quarter and in total

 b) A schedule of budgeted cash collections, by quarter and in total

 c) A production budget

 d) A direct materials purchase budget

 e) A schedule of budgeted cash payments for purchases by quarter and in total

 f) A direct labor budget

 g) A manufacturing overhead budget

 h) Ending finished goods inventory budget

 i) A selling and administrative budget

 2. A cash budget, by quarter and in total

 3. A budgeted income statement for the four- quarter ending December 31, 20x4

 4. A budgeted balance sheet as of December 31, 20x4.

A] SALES BUDGET

Quarter
1 2 3 4

Expected sales in units 10, 000 30, 000 40, 000 20, 000

Selling price per unit x Br. 20 x Br. 20 x Br.20 x Br.20

Total sales Br. 200, 000 Br. 600, 000 Br.800, 000 Br.400, 000
SALES BUDGET

Quarter
1 2 3 4

Expected sales in units 10, 000 30, 000 40, 000 20, 000

Selling price per unit x Br. 20 x Br. 20 x Br.20 x Br.20

Total sales Br. 200, 000 Br. 600, 000 Br.800, 000 Br.400, 000
 B] A SCHEDULE OF BUDGETED CASH COLLECTIONS, BY QUARTER AND
IN TOTAL
Quarter

1 2 3 4 Total

30% of the previous quarter sales Br. 90, 000 Br.60, 000 Br.180, 000 Br.240, 000 Br.570, 000

70% of the current quarter sales 140, 000 420, 000 560, 000 280, 000 1, 400, 000

Total collections Br. 230, 000 Br. 480, 000 Br. 740, 000 Br. 520, 000 Br.1, 970, 000
C] PRODUCTION BUDGET

 Budgeted sales in units ………………………………………… xxxx

 Add desired ending inventory……………….…………………. xxxx
 Total needs……………………………………………………… xxxx
 Less beginning inventory……………………………………… ..xxxx
 Required production……………………………………………. . xxxx
 C] PRODUCTION BUDGET
Quarter Total

Expected sales(units) 10, 000 30, 000 40, 000 20, 000 100, 000

Add: Desired Ending Inventory 6, 000 8, 000 4, 000 3, 000 3, 000

Total needs 16, 000 38, 000 44, 000 23, 000 103, 000

Lees: Beginning Inventory 2, 000 6, 000 8, 000 4, 000 2, 000

Units to be produced 14, 000 32,000 36, 000 19, 000 101, 000

1 2 3 4
 C] PRODUCTION BUDGET
Quarter Total

Expected sales(units) 10, 000 30, 000 40, 000 20, 000 100, 000

Add: Desired Ending Inventory 6, 000 8, 000 4, 000 3, 000 3, 000

Total needs 16, 000 38, 000 44, 000 23, 000 103, 000

Lees: Beginning Inventory 2, 000 6, 000 8, 000 4, 000 2, 000

Units to be produced 14, 000 32,000 36, 000 19, 000 101, 000

1 2 3 4
 D] DIRECT MATERIALS BUDGET

Quarter Total
1 2 3 4
Production needs of RM (In Ibs)= 14000 32,000 36,000 19,000 101,000
Qty of Prod. X RM in Ib X 15Ib X 15Ib X 15Ib X 15Ib X 15Ib
210, 000 480, 000 540, 000 285, 000 1, 515, 000
Add: Desired DM ending inventory 48, 000 54, 000 28, 500 22, 500 22, 500
Total needs 258, 000 534, 000 568, 500 307, 500 1, 537, 500
Less: Beginning inventory 21, 000 48, 000 54, 000 28, 500 21, 000
Raw Materials to be purchased (in 237, 000 486, 000 514, 500 279, 000 1, 516,500
Ibs)
 D] DIRECT MATERIALS BUDGET

Quarter Total
1 2 3 4
Production needs of RM (In Ibs)= 14000 32,000 36,000 19,000 101,000
Qty of Prod. X RM in Ib X 15Ib X 15Ib X 15Ib X 15Ib X 15Ib
210, 000 480, 000 540, 000 285, 000 1, 515, 000
Add: Desired DM ending inventory 48, 000 54, 000 28, 500 22, 500 22, 500
Total needs 258, 000 534, 000 568, 500 307, 500 1, 537, 500
Less: Beginning inventory 21, 000 48, 000 54, 000 28, 500 21, 000
Raw Materials to be purchased (in 237, 000 486, 000 514, 500 279, 000 1, 516,500
Ibs)
 RAW DIRECT MATERIALS TO BE PURCHASED BUDGET (IN ETB)

Quarter Total

1 2 3 4

Raw materials to be purchased (inIbs) 237, 000 486, 000 514, 500 279, 000 1, 516,500
Raw materials cost per Ib X Br. 0.20 X Br. 0.20 X Br. 0.20 X Br. 0.20 X Br. 0.20

Total needs Br. 47,400 Br. 97,200 Br. 102,900 Br. 55,800 Br. 303,300
 RAW DIRECT MATERIALS TO BE PURCHASED BUDGET (IN ETB)

Quarter Total

1 2 3 4

Raw materials to be purchased (inIbs) 237, 000 486, 000 514, 500 279, 000 1, 516,500
Raw materials cost per Ib X Br. 0.20 X Br. 0.20 X Br. 0.20 X Br. 0.20 X Br. 0.20

Total needs Br. 47,400 Br. 97,200 Br. 102,900 Br. 55,800 Br. 303,300
 E] SCHEDULE OF EXPECTED CASH DISBURSEMENT (FOR MATERIALS PURCHASE)

Quarter Total
1 2 3 4
50% of the previous quarter Br. 25, 800 Br.23, 700 Br.48, 600 Br.51, 450 Br.149, 550

50% of the current quarter 23, 700 48, 600 51, 450 27, 900 151, 650
Total cash disbursement Br.49, 500 Br.72, 300 Br.101, 050 Br.79, 350 Br.301, 200
 E] SCHEDULE OF EXPECTED CASH DISBURSEMENT (FOR MATERIALS PURCHASE)

Quarter Total
1 2 3 4
50% of the previous quarter Br. 25, 800 Br.23, 700 Br.48, 600 Br.51, 450 Br.149, 550

50% of the current quarter 23, 700 48, 600 51, 450 27, 900 151, 650
Total cash disbursement Br.49, 500 Br.72, 300 Br.101, 050 Br.79, 350 Br.301, 200
 F] DIRECT LABOR BUDGET

Quarter Total
1 2 3 4
Production x DL required= 14,000*0.8 32,000 * 0.8 36,000*0.8 19,000*0.8 101,000*0.8
Direct labor time needed 11, 200 25, 600 28, 800 15, 200 80,800
Direct labor cost per Hr. x Br.7.50 x Br.7.50 x Br.7.50 x Br.7.50 x Br.7.50
Total direct labor cost Br. 84, 000 Br. 192, 000 Br. 216, 000 Br. 114, 000 Br. 606, 000
 F] DIRECT LABOR BUDGET

Quarter Total
1 2 3 4
Production x DL required= 14,000*0.8 32,000 * 0.8 36,000*0.8 19,000*0.8 101,000*0.8
Direct labor time needed 11, 200 25, 600 28, 800 15, 200 80,800
Direct labor cost per Hr. x Br.7.50 x Br.7.50 x Br.7.50 x Br.7.50 x Br.7.50
Total direct labor cost Br. 84, 000 Br. 192, 000 Br. 216, 000 Br. 114, 000 Br. 606, 000
 G] MANUFACTURING OVERHEAD (MOH) BUDGET

Quarter Total
1 2 3 4
Variable overhead Br. 22, 400 Br. 51, 200 Br. 57, 600 Br. 30, 400 Br. 161,600
Fixed overhead 60, 600 60, 600 60, 600 60, 600 242,400
Total MOH Br. 83, 000 Br. 111, 800 Br. 118, 200 Br. 91, 000 Br. 404,000
Less: Depreciation 15, 000 15, 000 15, 000 15, 000 60, 000
Cash Disbursements for MOH Br. 68, 000 Br. 96, 800 Br. 103, 200 Br. 76, 000 Br. 344, 000
 G] MANUFACTURING OVERHEAD (MOH) BUDGET

Quarter Total

1 2 3 4

DL Hr needed * Br. 2/DL Hr. 11,200 * 2= 25,600 * 2= 28,800 * 2 = 15,200 * 2 = 80,800*2=

=Variable overhead Br. 22, 400 Br. 51, 200 Br. 57, 600 Br. 30, 400 Br. 161,600
Fixed overhead 60, 600 60, 600 60, 600 60, 600 242,400

Total MOH Br. 83, 000 Br. 111, 800 Br. 118, 200 Br. 91, 000 Br. 404,000

Less: Depreciation 15, 000 15, 000 15, 000 15, 000 60, 000

Cash Disbursements for MOH Br. 68, 000 Br. 96, 800 Br. 103, 200 Br. 76, 000 Br. 344, 000
 G] MANUFACTURING OVERHEAD (MOH) BUDGET

Quarter Total

1 2 3 4

DL Hr needed * Br. 2/DL Hr. 11,200 * 2= 25,600 * 2= 28,800 * 2 = 15,200 * 2 = 80,800*2=

=Variable overhead Br. 22, 400 Br. 51, 200 Br. 57, 600 Br. 30, 400 Br. 161,600
Fixed overhead 60, 600 60, 600 60, 600 60, 600 242,400

Total MOH Br. 83, 000 Br. 111, 800 Br. 118, 200 Br. 91, 000 Br. 404,000

Less: Depreciation 15, 000 15, 000 15, 000 15, 000 60, 000

Cash Disbursements for MOH Br. 68, 000 Br. 96, 800 Br. 103, 200 Br. 76, 000 Br. 344, 000
 H] ENDING FINISHED GOODS INVENTORY BUDGET
▪ After completing schedules (a) to (g), the company had all of the data needed to compute unit product costs.
▪ This computation was needed for two reasons:
▪ first, to know how much to charge as CGS on the budgeted income statement; and
▪ second, to know what amount to put on the balance sheet as FG- Inventory account for unsold units.
▪ The carrying cost of the unsold units is computed on the ending finished goods inventory budget
Budgeted Finished Goods Inventory (refer schedule C (production budget) Q4) 3,000
X Unit product cost Br. 13*
Cost of Ending Finished Goods Inventory Br. 39,000
*Unit product cost:
Unit Direct Material Cost 15Ib/unit x Br. 0.20/Ib = Br. 3/unit
Unit Direct Labor Cost 0.8 Hr./unit x Br. 7.50/ Hr. = Br. 6/unit
MOH 0.8 Hr./unit x Br. 5.00/Hr+ = Br. 4/unit

𝑻𝒐𝒕𝒂𝒍 𝑴𝑶𝑯 𝑩𝒓.𝟒𝟎𝟒,,𝟎𝟎𝟎

+MOH rate = = = Br. 5/DL Hr.
𝑫𝑳 𝑯𝒐𝒖𝒓𝒔 𝟖𝟎,𝟖𝟎𝟎
 I] SELLING AND ADMINISTRATIVE EXPENSE BUDGET
Quarter Total
1 2 3 4
Variable S & E Exp. Br.18, 000 Br.54, 000 Br.72, 000 Br.36, 000 Br.180, 000
Fixed S & A Exp.
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 S & A Exp. Br.103, 000 Br.140, 900 Br.194, 750 Br.139, 150 Br.577, 800
 I] SELLING AND ADMINISTRATIVE EXPENSE BUDGET
Quarter Total
1 2 3 4
Variable S & E Exp. Br.18, 000 Br.54, 000 Br.72, 000 Br.36, 000 Br.180, 000
Fixed S & A Exp.
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 S & A Exp. Br.103, 000 Br.140, 900 Br.194, 750 Br.139, 150 Br.577, 800
 DISBURSEMENT FOR SELLING AND ADMINISTRATIVE EXPENSE

Quarter Total

1 2 3 4

Budgeted S. & Admin. Br. 103, 000 Br. 140, 900 Br. 194, 750 Br. 139, 150 Br. 577, 800

Less: Depreciation 10, 000 10, 000 10, 000 10, 000 40, 000

Total Cash Disbursements Br. 93, 000 Br. 130, 900 Br. 184, 750 Br. 129, 150 Br. 537, 800
CASH BUDGET
 2. A. CASH BUDGET
Quarter Total
1 2 3 4
Cash balance, beginning Br.42, 500 Br.40, 000 Br.40, 000 Br.40, 500 Br.42, 500
Add : Collection from customers 230, 000 480, 000 740, 000 520, 000 1, 970, 000
Total cash available before 272, 500 520, 000 780, 000 560, 500 2, 012, 500
financing
Less: Disbursements for
Direct materials 49, 500 72, 300 100,050 79, 350 301,200
Direct labor 84, 000 192, 000 216,000 114, 000 606,000
Manufacturing overhead 68, 000 96, 800 103,200 76, 000 344,000
Selling & Administrative 93, 000 130, 900 184,750 129, 150 537,800
Equipment purchases 50, 000 40, 000 20,000 20,000 130,000
Dividend 8, 000 8, 000 8, 000 8, 000 32,000
Total disbursements 352, 500 540,000 632,000 426,500 1,951,000
Minimum cash balance 40, 000 40, 000 40, 000 40, 000 40, 000
Total need 392, 500 580, 000 672, 000 466, 500 1, 991,000
Excess (deficiency) of cash available over (120, 000) (60, 000) 108, 000 94, 000 21, 500
total need
Financing:
Borrowing(at beginning) 120,000 60, 000 - - 180, 000
Repayments( at ending) - - (100, 000) (80,000) (180,000)
Interest(at 10% per annum) - - (7,500) (6,500) (14,000)
Total financing 120, 000 60, 000 (107,500) (86,500) (14,000)
Cash balance, ending Br.40,000 Br.40, 000 Br.40, 500 Br.47, 500 Br.47, 500
2 B. AND C. BUDGETED FINANCIAL STATEMENTS

(REFER YOUR MATERIAL FOR THIS)