BSA .III.

SEMESTER: ONE AY: 2021 /22

TOPIC 4: BUDGETING & BUDGETORY CONTROL

A budget; an expression of a firm’s intentions/plans in financial terms.

 It’s done by both profit –making and non-profit entities.
 Also helps in operating most units of the government i.e. schools, churches, hospitals, and other non-
profit institutions.

Budgeting
Budgeting is a method of communicating the goals of the organisation to the appropriate managers in order
to facilitate, coordinate and control various sections of the organisation so that the desired outcomes are
achieved.
 It is important for managers to develop attitudes and strategies that cultivate and maintain supportive
and cooperative relationships with subordinates.
 Budgets must not only be used as a computational tool to control costs: the behavioral aspects must
also be considered so that staff will be motivated enough to achieve the budget’s goals. This can
only be done if staff have a sense of ownership of the budget (participatory).

Objectives of budgeting;
 Establishing specific goals/planning function.
 Executing plans to achieve the goals /directing function.
 Comparison of actual results with the set goals/control function.
Others include;
Authorizing and delegating.
Basis for perfromance

Page 1 of 21
Stages in the Budgetary Process
i. Communication of details of the budget policy
ii. Determination of the factor that restricts performance/budg
iii. Preparation of the sales/revenue budget.
iv. Extraction of other budgets.
v. Negotiation of budgets
vi. Coordination and review of budgets
vii. Final acceptance and implementation of the budgets.
The role of budgets in planning and control

Budgeting is an integral part of the management function of planning, organising, motivating and controlling. One of the central
tools used to carry out the management function is a budget.

Need for planning

All organizations attempt to use scarce resources to achieve their goals. Goals may be long term or short term.

To achieve long term goals (usually five to ten years) it is necessary to develop long term strategic plans.

These plans are concerned with broad objectives and goals—for example to expand into Asia—so they do not indulge
in too much specific detail.

To achieve long term goals, we need to develop short term strategies that are incorporated into annual budgets. These
short term plans are more detailed and consider the means to attain goals.

The means by which these short term plans are converted into action is through the budgeting process.

Short term plans tend to use more quantitative data to estimate the future. These include dollar values, sales quantities,
production units, inventory levels, number of personnel and financial ratios.

Need for controlling

Whether planning is done formally (by the use of budgets) or informally (in the manager’s head) it
does not in itself guarantee business success, as it needs to be monitored and adjusted.

This function of monitoring and adjustments is called controlling.

Keeping in mind that all plans (budgets) are best estimates of the future, management needs to
monitor its progress at regular intervals.

It needs feedback on achievements and shortfalls so that it can take remedial action.

To facilitate this process of monitoring, yearly budgets are broken down into smaller chunks such as
months or even weeks so that if remedial action needs to be taken it will not be too late.

The promptness and accuracy of feedback reports is essential to the whole process of controlling.
Page 2 of 21
 The reports should compare actual results against the budget.

These reports are known as variance reports. They require analysis to assess the progress of budget outcomes.

Minor variances are usually ignored but significant variances must be investigated so that appropriate corrective action
can be undertaken.

BUDGETARY CONTROL
Budgetary control is a process of achieving financial control within a company. It involves preparation of
several budgets regarding income and expenditure and comparing them with actual results to find the
deviations. These deviations are called "variance." The computation of variance helps companies to take
necessary corrective actions. The budgetary control system helps companies in setting and achieving the
goals.
Rationale of budgetary control;

 Maximization of Profits

Budgetary control in an organization leads to maximization of profits. Budgetary control involves fixing of
different budgets concerning capital and revenue expenditure thus making the employees alert in the
organization about costs and performance. The money is incurred on the important activities and resource is
utilized optimally resulting to profit maximization.

 Proper Planning, Co-ordination & Control

Budgetary control aims at proper planning, coordination and control in the organization. It sets standards of
costs, i.e. budgets, and compares it with the actual results. Any deviation between the budgeted figures and
the actual performance is known as variance. A negative variance means that actual cost exceeds the
budgeted cost. It is an alarming situation for the management. Through budgetary control, management
becomes aware about the performance of the enterprise and takes necessary corrective actions. It sets proper
coordination among different departments in the organization so as to achieve the budgeted targets.
 Enhances use of Forecasting Techniques
Budgetary control technique helps management to use the forecasting techniques. There are three
departments in the organization that work together for estimating and forecasting cost and expenditure. The
accounting department provides previous years' data, the department of statistics provides tools and
techniques of forecasting and the management department calculates the future projections of revenues and
expenditures. Budgetary control technique helps these departments in planning budgets and coordinates
with each other for better control on the operations.

 Effective Utilization of Company's resources

Page 3 of 21
Budgetary control eliminates misuse of money and company funds. Budgetary control involves fixing of
various budgets and if any discrepancies arise, the responsible person will be accountable for his action. For
example, a company selling mobile phones has fixed the target of selling 4 million units. The target is
decided after consulting with the sales manager. After one year, if sales are just 1 million units, the sales
manager must explain the shortfall in the number of units sold in the market below the budgeted level.
 Incentive Schemes to the Employees;
Budgetary control systems also provide various financial and non-financial incentives to the employees of
the company for exceeding the budgeted level of performance. The comparison of budgeted and actual
performance will facilitate the use of such schemes.
Others may include;
 Develops an attitude of cost consciousness.
 Enhances productive competition.
 Generates a sense of caution and care.
 Gives a means for gradual evaluation.
 Minimizes the cloud of uncertainty
 Encourages coordination among all business units.

Challenges of budgeting and budgetary Control

In spite of their importance, budgeting and budgetary control methods face challenges arising mostly from
within the organization;

 Perception
Managers and employees do not always receive budgeting and budget control measures well. They perceive
these two of resources and allowing the enterprising of the staff within the organization. When the focus is
on keep processes as limiting and inflexible. Budgets and budget controls compromise between proper
management within the budget, employees may feel constrained to venture into initiatives that develop them
professionally and also prevent company growth.
 Conflict in resource allocation
Conflicts between departments and managers are some of the characteristics of the budgeting process. The
equitable allocation of resources is very challenging especially in organizations where the management
considers some departments more dominant than others. For example, the manager in an IT department,
more influential than the manager in the sales department, is in a position to have more resources allocated
to his department. Additionally, budgetary controls if not carried out properly, may encourage the casting of
blame between departments, especially when they do not meet their budget target or lack accounts to act as
proof of expenditure.

 Participation
Participation of key players such as department managers in budgeting and budget control is ideal and
recommended. Participation in these two processes ensures that budgets reflect the needs of particular
departments and managers take responsibility for any variances in the outcome of the budget. However, a
participatory approach may result into a long-drawn out budgeting and control process. There is also a risk
Page 4 of 21
of losing strategic focus when different managers prepare their own budget as part of the participative
approach.

 Infrastructure inflexibility
Budgeting and budget control systems have very complex infrastructural layouts. These include budget
centers, which include departments in charge of preparing the budget, a budget committee and various
budget officers. In a global economy that shifts so rapidly, the budget and control infrastructure can easily
become redundant. Changing budgeting and control methods to keep up with modern demands of the
markets and the organization then becomes a challenge. Therefore, organizations have the task of ensuring
their budgeting and control infrastructure, both human resources and technology are efficient and flexible
enough to adapt to changes in the market.
Others challenges may include;
 The process takes time
 Existence of many documents that limit flexibility
 Inappropriate organizational structures
Essentials of successful budgeting.
 Support and involvement of top management
 Clear and realistic goals.
 Assignment of authority and responsibility
 Creation of responsibility centers.
 Full participation
 Flexibility
 Effective communication
 Continuous budget education
 Timeliness

Approaches to budgeting

A. Zero-Based-Budgeting (ZBB)

This is a method of budgeting whereby all activities are re-evaluated. Each time a budget is set it requires
the budgeting of every part of an organisation from a zero base (from scratch).

Page 5 of 21
 It forces managers to consider all the costs of an operation, the level of service provided and the cost of
providing that service. To justify an activity, management develops decision packages. A decision package
is a document that identifies and describes a specific activity in such a manner that senior management can;
(a) Evaluate it and rank it against other activities competing for the limited resources. Decision
packages contain the following information;
- Costs and benefits of operating a department at a range of different levels of funding
- A performance measure of a department
- The function of the department
- Consequences of non operating at the identified performance levels

Once the decision packages have been developed, they are then ranked using a cost benefit analysis. On the
basis of the ranking, the organisation resources can then be allocated.

ZBB is particularly useful in local government because it is possible to segregate and assess the benefits of
each activity, e.g. road maintenance, schools, refuse collection.

Benefits of ZBB;
i. Helps to create an organizational environment where change is accepted.
ii. Helps management to focus on company objectives and goals
iii. Concentrates the attention of management on the future rather than the past
iv. Helps to identify inefficient and obsolete operations within the organisation
v. Provides a framework to ensure the optimum utilization of resources by establishing priorities in relation
to operational activity
vi. Should lead to a more logical and beneficial allocation of resources available to an organisation.
vii. Can assist motivation of management at all levels
viii. Provides a plan to follow when more financial resources become available
ix. Establishes minimum requirements from departments
x. It can be done in peace meal.

Demerits.
(1) Takes more management time than conventional systems in part because managers need to learn
what is required of them.
(2) There is a temptation to concentrate on short terms cost saving at the expense of long-term benefits.
(3) It takes time to show the real benefits of implementing such a system.

C) Rolling budget.(Continuous budget)

This is a budget that is continuously updated by adding a further accounting period (month or quarter) when
the earliest accounting period has expired. It is beneficial where future/or forecast activities cannot be
forecast reliably. They are feed forward control, which adjusts subsequent months’ targets for the changes in
circumstances. They lend to rise from a management philosophy, which accepts that change is inevitable,
and fore casts are always imperfect. Organisations that adopt rolling budgets tend to place less emphasis on
budgetary control than those that do not.

Advantages.
(1) Avoids wasting management efforts in deriving detailed targets over long periods, which will
probably not happen. They concentrate on short term accuracy instead.
(2) It forces regular re appraisal of the budget to ensure that it is up to date.

Page 6 of 21
(3) It ensures planning and control is based on the most up to date information available.
(4) It avoids the de-motivational effects of unrealistic and unattainable budgets.
(5) It overcomes the annual disruption of the budget round. There is always a budget covering the next
few months.
(6) It can be used to communicate changes in the organization strategy to management.

Draw backs
(1) Increases the time and effort put into budgeting
(2) Constantly changing targets my make managers cynical or dispirited
(3) May lead to careless budgeting if managers know that targets can be changed later.
(4) It may slip into incremental budgeting
(5) May reduce control and increase bargaining if managers know that they can hide poor performance
behind changed targets.

D) Incremental budgeting
 Involves making adjustments on past budget figures.
 Encourages status quo

Demerits:
 Previous inefficiencies are carried forward.
 Doesn’t seek justification for inclusion of an item /activity.
 Discourages innovation in budget making.

E) Activity based budgeting (ABB)

 This is a modern approach based on the fact activities cause costs.
 Budgets are based on activities to be done by each cost center.

Benefits
 Makes budgeting rational by basing on demand data.
 Efficiency in resource utilization
 Economic service provision.

Roles of the budget’

(1) Planning and coordination. A budget provides a formal planning framework that ensures planning
does take place. It coordinates the various separate aspects of the business by providing the master
plan for the business as whole. Though not all decision can be anticipated, the budget provides a
framework of reference within which later operating decision can be taken.
(2) Authorizing and delegating; adoption of a budget by management explicitly authorizes the decisions
made within it. The need to continuously ask for top management decisions is reduced. The
responsibility for carrying out the decisions delegated to individual managers.
(3) Evaluating performance; by setting targets for each manager to achieve, the budget provides a
benchmark for performance against which actual performance can be assessed objectively. They can
be used in staff performance appraisal.
(4) Communicating and motivating; the application of budgeting within an organisation should led to a
good communication structure. Agreed strategies and policies should be communicated to staff. A
good systems of down and sideways communication. Budgets that have been agreed by some
managers should provide motivation.
(5) Discerning trends. Variance analysis which is associated with budgeting provides a mechanism for
the early detection of any unexpected trend.

Page 7 of 21
(6) Control. By a continuous comparison of actual performance of planned results, deviations are
quickly identified and appropriate action initiated/later.
There is however a danger of adhering to a budget too inflexibly.

The use of budgets in performance measurement

Budgets are prepared for all areas of the organisation and all levels of management are responsible for their
success.
 Until recent times most organisations were extremely reluctant to provide financial or statistical
information to members of middle or lower management.
 Even now some items of information are regarded as confidential and available to top management
only. It is recognised that managers at the lowest level must be given some basic information about
their area of operations if they are to be held accountable for their department or unit.
 There is also an accompanying need to supply the manager with details of both actual performance
and the criteria by which the budget performance was calculated.
 The result is that both middle and lower management are now far better informed about their spheres
of activity, which makes all management more efficient if the principle of management by
exception is followed.
 The management by exception principle puts forward the proposition that the manager should not
waste time supervising or investigating those areas of responsibility that are already performing at or
above the acceptable standard of performance.
 The manager should concentrate on the exceptions that is those areas that are performing below
standard efficiency. Where budgetary control systems are used, the management reporting will be
able to highlight those exceptions.
 The time saved by managers can be used for forward planning and better coordination of activities
under the manager’s control.

The use of budgets as a motivational tool

Budgeting is a method of communicating the goals of the organisation to the appropriate managers so that,
with their involvement, the desired budget outcomes are achieved. It should follow that budget managers
develop attitudes and strategies that cultivate and maintain supportive and cooperative relationships with
staff.
The level of support and participation depends on the management’s approach to budgeting.

Motivation refers to those factors that influence an individual to act in a goal directed manner by addressing
the question of how behaviour is started, stimulated, maintained, guided and ceased.
Of all the modern theories of human motivation, Maslow’s provides the best explanation. Maslow proposed
that motivation comes from within the person and cannot be imposed on an individual. People are viewed as
goal seeking all through life. These needs are arranged in a hierarchy: each level must be satisfied before an
Individual can be motivated by a higher-order need. Once the needs of a level are satisfied, the needs of the
next level come into play and act as further motivators of behaviour. The authoritarian approach and the
participative approach lead to two budget setting processes: one uses the top-down process and the other
uses the bottom-up process. In reality neither model works perfectly, therefore the actual process depends
on the country’s culture, the organisational culture and the management control techniques used

Behavioral aspects of budgeting.

Page 8 of 21
  Difficulty in Hitting Targets/stretch budgets.
A recurring management accounting controversy revolves around how difficult a budget's target should be
to attain. Proponents of stretch budgeting say that budget targets should be difficult, if not nearly
impossible, for employees to obtain, as employees will modify their behavior to try to hit the difficult target.
Critics assert that stretch budgets are demotivating. Highly achievable budget targets are created with the
goal of having most employees achieve the budget results, with detractors stating that a highly achievable
budget does not do enough to motivate and challenge the organization.
 Forecast Bias/mis-match
Managers must be careful to consider the source of budget forecasts. Employees tend to under- estimate
budget forecasts in order to create targets that are easier to obtain, while managers tend to overestimate
employees' ability to meet budget forecasts in order to appear more competent to higher-ups. This mis-
match in perception can lead to difficulties in agreeing on a budget that is perceived as fair by both parties.
 Budget Caps/bonuses
Many budgets are tied to bonus amounts, which provide bonus payments to employees at a preset range of
performance. For example, an employee may be eligible to receive a bonus if he achieves over 75 percent of
the bonus target, with increasing amounts of bonus until he achieves 125 percent of target. These bonus caps
could cause employees to cut corners to make up to the 75 percent bonus target or to lose interest in
improving performance after the 125 percent mark is attained.
 Belief in Budgeting/participation/inclusive.
In many companies, budgets are imposed by top management on mid-level managers and employees. If top
management is not visibly invested in the budgeting process, then lower-level employees may not sign off
on budget targets or strive to attain budget goals. Conversely, involving employees in the creation of budget
targets can help otherwise and invested employees get involved in company initiatives.

 Budget bias/ slack/ pad

Is a process of building room for manpower when setting a budget by over stating the level of budget
expenditure or by understanding the level of budgeted sales?

It is the common process of building room for maneuver when setting a budget by over setting the level of
budgeted expenditure or by understating the level of budgeted sales. The following are possible reasons for
the creation of the bias.

Reasons of budget bias

(1) Leads to the most favorable result when actual performance is compared with budget. This leads to
optimization of personal gain for the individual manager.
(2) In an uncertain business environment it is a way of relieving some of the pressures of a light situation.
The bias will allow some leeway if things do not go according to plan.
(3) Where reward structures are based on comparison of actual with budgeted results bias can help to
influence the out come.
(4) Bias will allow some i.e. away if things do not occur according to plan.
(5) Some people see the creation of bias in the budget as way of legally beating the system.

 Too loose budget goals.

Page 9 of 21
  This is also known as budget slacking/padding.
 An example can be including spare employees in the budget.
 Such gaps provide a cushion for unexpected events to improve the appearance of operations
 Workers develop a spend it all mentality ie when actual spending is less than budgeted.
 Employees attempt to spend the remaining budget on purchase of equipment, hiring consultants in
order to avoid having the budget cut next time.

 Conflicting budget goals.

 Occurs when individual self-interest differ from business objectives.

 When different departments are givn conflicting objectives such as sales maximization differing
from cost minimization.
 Can be avoided if budget goals are carefully designed for consistency across departments of the
organization.

This has necessitated the following new approaches in budgeting;

APPROACHES TO BUDGETING

Incremental budgeting
• This approach is to take the previous years results and then to adjust them by an amount to cover
inflation and any other known changes.
• It is a reasonably quick approach, and for stable companies it tends to be fairly accurate.
Zero-based budgeting
• Under this, we do not consider the previous period. Instead, we consider each activity on its own
merits and draw up the costs and benefits of the different ways of performing it.

Rolling budget (Continuous budget)

• This is a budget that is continuously updated by adding a further accounting period (month or
quarter)
• i.e. when the earliest accounting period has expired.
• It is beneficial where future/or forecast activities cannot be forecast reliably.
• They are feed forward control, which adjusts subsequent months’ targets for the changes in
circumstances
Advantages of rolling budgets
• Avoids wasting management efforts in deriving detailed targets over long periods,
• It forces regular appraisal of the budget to ensure that it is up to date.
• It ensures planning and control is based on the most up to date information available.
• It avoids the de-motivational effects of unrealistic and unattainable budgets.

Disadvantages of rolling budgets

• Increases the time and effort put into budgeting.
• Constantly changing targets may make managers cynical or dispirited
• May lead to careless budgeting if managers know that targets can be changed later.
• It may slip into incremental budgeting

Activity based budgeting (ABB)

• This is a modern approach based on the fact that activities cause costs.
• Budgets are based on activities to be done by each cost center.

Page 10 of 21
 Benefits
• Makes budgeting rational by basing on demand of activities.
• Efficiency in resource utilization
• Economic service provision.
Planning Programming Budgeting Systems (PPBS)
• PPBS was well developed specifically to service the budgeting requirement of non- profit making
organization.
• Under PPBS, budgets are structured according to the program of activities rather than
departmentally.
• A program is then evaluated to identify the most cost effective means of carrying it out by a cost
benefit approach.
• The resources are thus allocated to programs rather than to individual departments.
• Helps to know the degree of priority in resource allocation
• Resources are allocated to programs rather than individual departments

BUDGETING IN NPOS
Uses a system known as PPBS (Planning, programming budgeting systems).

 Planning, programming budgeting systems (PPBS); Well developed specifically to service the
budgeting requirement of non- profit making organisation such as government departments.
 Under PPBS, budgets are structured according to the programme of activities rather than
departmentally.

 A program is then evaluated to identify the most cost effective means of carrying it out by a cost
benefit approach to determine its level of priority in the allocation of resources. The resources are
thus allocated to programs rather than to individual departments.

 PPBS is not easy to implement due to the need to reconcile the different priorities of the various
interest groups.
 Heps to know the degree of priority in resource allocation
 Resources are allocated to programs rather than individual departments
Non-Profit Budget Process

A non-profit organization may not bring in any money for profit, but that does not mean that the
organization does not have money coming in for operational purposes. A budget is needed for a non-profit
organization, as money is needed to establish and run programs, offer help and services to people in need
and make a change in the community, which is often what nonprofit organizations aim for.

Goals and Objectives

 Determine the goals of the non-profit organization, including the help and services it will provide to
people in need. Examine if the funding coming into the organization is enough to pay teachers to offer
educational programs to those in need, if additional schooling is one of the goals of the organization. The
board of executives must agree on these goals and work toward fulfilling them with the donations and tools
in hand.

Page 11 of 21
 Planning the Budget
 Before the non-profit budget can be constructed, sit down with other workers within the organization
and make a solid plan.
Identify the key workers who will be part of constructing the budget and who will be responsible for
updating and operating the budget within the nonprofit organization. Board members and committee
members should be actively involved to ensure all of the organization's needs are met. Schedule budget
meetings and any training meetings that need to take place during the budget construction process.
Communication
 Communication is an important factor in constructing a budget, whether it is nonprofit or a for-profit
organization. It is important that everyone knows the responsibilities and expectations that need to be
addressed in the budget and process, including deadlines and financial figures. For example, it is important
that an employee can actively voice the amount being given by donors to help the operation of the nonprofit
organization on a monthly basis.
Income and Construction
 Calculate a complete income sum that the nonprofit organization has coming in at any given time.
Construct the budget around this income and the fees required for the organization to offer programs and
services. Communicate actively with the workers who are developing the programs and services, so they
know how much funding they have to offer the programs in question.
Balance Sheet
 Create a functional balance sheet that outlines how and where the money going into the organization
is coming from. Determine where it should go to help the goals of the organization best. The balance sheet
should also discuss how much the nonprofit organization has in liabilities and loans that should be paid off,
so the organization can operate properly and meet the community goals it has set.

Characteristics of planning and budgeting in NPOs.

 Budgeting is usually bottom –up without clear focus but based on local wishes.
 National priorities are neither well understood nor communicated by the regions and mostly viewed
as hindrance.
 No overall attempt to align operating priorities strategic goals with resources.
 Absence of relevant operating targets and performance indicators.
 Financial budgets are presented with mostly financial data and with little strategic operational or risk
assessment information.

Types of budgets.
There are basically two types i.e.
 Functional budgets
 Master budgets.
The functional budgets include the following;
 Sales budget
 Production budget
 Direct materials purchases budget
 Direct labor cost budget
 Factory overhead cost budget
 Selling & administrative expenses budget.
Page 12 of 21
 The master budgets include the following;
 The statement of comprehensive incomes budget
 The statement of financial position budget.

Income statement budget.

 This basically summarizes the estimates of all phases of operation.

 Allows managers to assess the effect of the individual budgets on the profit for the year.

Sales budget

Production budget

Material D.labor factory overhead

Purchases budget Cost budget cost budget

Cost of goods sold budget

Selling &administrative exp’ budget

Budgeted statement of comprehensive incomes

Factors that influence the sales budget;

 Backlog of unfulfilled sales

 Planned advertising and promotion
 Expected industry and general economic conditions
 Production capacity
 Planned pricing policy
 Other market research studies.

Sales budget = Estimated sales units/q’ty* expected unit S.P

Production budget
Production units = Expected sales units + desired C.stock units – Estimated O.stock units
Production cost = production units*unit cost of production (D.M, D.L &P.OHs)

Page 13 of 21
D.materials utilization budget
= Budgeted production units*material units needed per unit.

D.materials purchases budget = (R.M units needed 4 production + desired C.stock (R.M)- desired
O.stock(R.M) )* purchase price.

D.labour cost budget

Budgeted production labour hours = B.production units*No. hrs per unit.
Labour cost budget = B.production lbr hrs * Hourly rate

Factory OH cost budget; = Includes indirect labour, materials and indirect expenses
Categorized into fixed and variable elements.

Selling and administrative expense budget

This is usually estimated as a percentage of sales budget.

Balance sheet budgets

Used by managers to plan financially, investing and other cash objectives of the firm.
Comprises of two major budgets i.e;
 Cash budget (receipts and payments for a given period of time)
 Capital expenditure budget.

Cash budget

Period Jan Feb

Bal b/f
Cash receipts
Cash sales
Collections from debtors
Interest income
Loans
Total cash receipts
Cash payments
Payment for manuf’ OHs
Capital expenditures
Quarterly taxes
Interest expenses.
Bal c/f(deficit/ surplus)

Examples on functional budgets

EXAMPLE ONE

Page 14 of 21
 Abamwe Ltd. Is a trading company dealing in a single product. It is preparing its annual budget for the
twelve months ending 30/6/2012. So far, the following budgets have been prepared.
July-Sept Oct-Dec Jan-March April-June
Sales at 3 Shs./Unit 15,000 18,000 21,000 12,000
Purchases at 2Shs/Unit 12,000 14,000 10,000 8,000
Sundry expenses
Distribution 500 800 1,100 200
Administration 1,000 1,000 1,000 1,000
Depreciation 500 500 500 500

Note:
i) Sales are made on one monh’s credit. It may be assumed that debtors outstanding on sales at the
end of each quarter are equivalent to 1/3 of sales in that quarter, and that is received in the
following quarter.
ii) All purchases are for cash. No credit is received.
iii) Distribution and Administration are paid in cash as they are incurred.
iv) The company has no expenses apart from those given.
v) Opening balances as at 1/7/2011 are

Debtors 3,000
Cash 2,000
Stock 1,000
Required:
Compute Abamwe Ltd’s annual budget by preparing:
a) A Debtors budget
b) A Cash budget and
c) A Stock budget.

EXAMPLE TWO
Mafuta factory produces 3 products namely cooking oil, tea leaves and soap. The budgeted sales and selling
prices for the next year are as follows;
Product Budgeted sales(units) Selling price
Cooking oil 15000 195
Tea leaves 3000 300
soap 6000 150

The following data has been provided

Cooking oil (units) Tea leaves(units) Soap(units)

Opening stock 300 150 200
Closing stock 3300 150 760

Materials required to produce the above products are as follows

Direct materials:
Material A Material B
closing stock(KG) 18,000 3,000
Page 15 of 21
opening stock(KG) 15,000 15000
Finished goods:
Kgs per unit of Cooking oil Tea leaves Soap
product
Material A. 36 36 24
Material B . 18 12 30
Direct labour 24 36 36

Standard prices and rates:

Raw material A ugx 2.16/kg
Raw material B ugx 4.86/kg
Direct labor ugx 6.6/kg
Production overheads:
Variable ugx 4.62/LH
Fixed ugx 1.62/LH
Required:
a) Sales budget
b) Production budget
c) Raw material budget
d) Raw material purchases budget
e) Labor cost budget
f) Production overhead budget

a) David, Joseph, Racheal and Pauline graduated and immediately formed “DJRP Team” a foods
production and exporting partnership instead of meandering here and there to hunt for white collar
jobs after scooping a grant from Global Entrepreneurship Network.
The Managing Partners Joseph and Pauline have availed you the following records concerning the
first 6 months of operation.
Anticipated export bags are as tabulated below;
Period Bags
2019, July 1,100
“ August 1,300
“ September 1.700
Page 16 of 21
 “ October 1,900
“ November 2.500
“ December 2.300
2020 January 2,000
 There will be no work in progress at the end of any month.
 Completed bags equal to 50% of the export bags for the next month will be maintained in stock at
the end of each month and this was applicable to June, 2019 also.
 Expected production bags and production costs for the year ending 31 December 2019 is as follows;
Production(bags) 22,000
Direct material cost per bag UShs 100
Direct wages per bag UShs 40
Variable factory overheads per bag 40% of Direct wages
Annual fixed factory overheads UShs 744,858

Required;
a.As a well-known budget expert, the “DJRP” partners have hired you to prepare the following six months
budget commencing July, 2019.
i. Production bags budget
ii. Production cost budget
b. You have further been requested to spearhead the budget committee of DJRP Team above and you have
urgently been required to emphasize any 5 (five) key duties to be noted among others by committee members to
effectively carry out your duties as a committee.

Preparing the financial budget

 The usual financial budgets prepared are the:
 cash budget
 budgeted income statement
 budgeted balance sheet
A CASH BUDGET
 Understanding cash flows is critical in managing a business.
 Often, a business successfully produces and sells products but fails because of timing problems
associated with cash inflows and outflows.
 Because cash flow is the lifeblood of an organisation, the cash budget is one of the most important
budgets in the master budget.
 Cash available consists of the beginning cash balance and the expected cash receipts. Expected cash
receipts include all sources of cash for the period being considered.
 The principal source of cash is from sales.
 Since a large proportion of sales is usually on account, a major task of an organisation is to
determine the pattern of collection for its accounts receivable.
 If a company has been in business for a while, it can use past experience to determine what
percentage of credit sales are paid in the month of and months following sales.
 This is used to create a schedule of cash collections on accounts receivable.

Question
Company XYZ Ltd commences operations on 1 July with a capital of $240,000 cash . Additional estimates
have been further given as below in the process of budgeting for the period commencing July, 2020.

Page 17 of 21
  Plant & equipment costing $ 160,000 will be purchased and installed prior to commencement of
operations.
 The plant & equipment is payable in July and will be depreciated on a straight line basis over 8 years
with no expected disposal value.
 On 1st July an initial stock of goods for operations will be purchased at $96,000 payable in August.
All goods sold from 1 july will be replaced immediately. Purchase will be on two months credit.
 Gross profit will be 20% on the cost of goods sold.
 Forecasted sales revenue for the first three months are July $ 92,000 August $ 108,000 and
September $124,000.
 Sales are on credit payable in the month following sale.
 Rent & rates of $32,000 for twelve months from 1 July is payable in August.
 Wages & other overheads commencing in 1 July are estimated $24,000 per month. 50% will be paid
in the month incurred and the balance payable in the following month.
Required; To prepare a cash budget for each of the three months July, August and September.

Budgetary Control Techniques

Variance Analysis
 The most common budgetary technique is a comparison of the budget to actual results. This is
usually done on a monthly basis, with a summary closing process every quarter. Variances (differences
between the budget and actual results) are noted and accounted for. A decision can be made to reduce
expenses or reallocate resources. This technique greatly reduces the need for comprehensive review cycles.
Control Centers
 Create budgetary control centers with your business groups. There are four types of responsibility
centers: revenue, expense, profit, and investment. These are represented primarily by the income and cash
flow statement. Both statements have natural relationships that can be monitored over time to maintain a
balance to operations. The working capital formula, or "current assets minus current liabilities," is a
common measure used by investors to gauge a company's underlying operational efficiency. Money tied up
in inventory (current assets) or money that customers still owe to the company (current liabilities) cannot be
used to pay off any of the company's obligations. If working capital from one cycle to the next signals slow
collection, this is a sign of inefficiency.

Forecasting
 The most important budgetary technique is forecasting, or the ability to set out a detailed plan for the
future. This forecast is a dialogue about what to look for in the future. Each manager should prepare detailed
plans with targets and resource needs. These needs should be compared with the overall look to ensure
alignment with industry standards. Focus on creating an agile/swift/responsive budget; provide percentages
of common accounts for other groups to compare. Budgeting should be looked at as a tool, not a harness.

Flexing of budgets
This is used when dealing with uncertainty in budgeting. Budgets are open to uncertainty. For example,
non-controllable factors such as a recession or a change in prices charged by suppliers will contribute to

Page 18 of 21
uncertainty in the budget setting process. Uncertainty arises largely because of changes in the external
environment, over which a company will have little control. Reasons may include;
 Social or political unrest could affect productivity (e.g. through industrial action), as could natural
disasters like earthquakes and storms.

 Machines may break down unexpectedly, and the business may fail to meet production schedules.

 Customers may decide to buy more or less goods or services that originally forecast. For example, if
a major customer goes into liquidation, this has a huge effect on a company and could also cause
them to go into liquidation.

 The workforce may not perform as well as expected because of a lack of motivation, illness, etc. On
the other hand, they may perform better than thought.

 Competitors may strengthen or emerge, and take some business away from a company. On the other
hand, a competitor's position may weaken, leading to increased business.

 Technological advances may take place which lead a company's products or services to become out-
dated and therefore less desirable.

 Materials may increase in price because of global changes in commodity prices.

 Inflation, as well as movement in interest rates, can cause the price of all inputs to increase or
decrease.

The techniques that may be used to reduce uncertainties in budgeting may include;
Flexible budgets: these are budgets which, by recognizing different cost behavior patterns, are designed to
change as the volume of activity changes. Flexible budgets are prepared under marginal costing principles,
and so mixed costs are split into their fixed and variable components. This is useful at the control stage. It is
necessary to compare actual results to the actual level of activity achieved against the results that should
have been expected at this level of activity which are shown by the flexible budget (more on next chapter).
Rolling budgets: the budget is updated regularly and, as a result, uncertainty is reduced.
Sensitivity analysis: variables can be changed one at a time and a large number of budgets produced. For
example, what would happen if the actual sales volume was only 75% of the budgeted amount?
Simulation: similar to sensitivity analysis but it is possible to change more than one variable at a time.
Example 6.

Page 19 of 21
Aoife Co manufactures smartphones and has developed a new handset, the ‘H’. The maximum production
capacity of Aoife Co is 150,000 units of the new handset. The company’s management accountant is
currently preparing an annual flexible budget and has collected the following information so far for the ‘H’:
Production units of H’ 100,000 units 120,000 units 150,000 units
Material costs $ 700,000 $840,000 $ 1,050,000
Labour costs $ 750,000 $900,000 $1,125,000
Incremental fixed costs $ 60,000 $60,000 $60,000
Required;
(a) Assuming the budgeted figures are correct, what would the flexed total production cost be if production
is 90% of maximum capacity?
(b) The management accountant has said that the factory’s smartphone quality control system carries a cost
that was not included in the flexible budget, but should be. He estimates that every 1,000 smartphones will
take 5 hours to control; every quality control hour has a variable cost of $120 and fixed quality control costs
amount to $250,000. What is the estimated quality cost if production of the smartphones is 90% of
maximum capacity?

a) Which TWO of the following statements relating to the preparation of a flexible budget for the ‘H’
are true?

i. The budget will encourage all activities and their value to the organisation to be reviewed and
assessed.

ii. The flexible budget will give managers more opportunity to include budgetary slack than a fixed
budget.

iii. The budget could be time-consuming to produce as splitting out semi-variable costs may not be
straightforward.

iv. The range of output over which assumptions about how costs will behave could be difficult to
determine.

Page 20 of 21
Example .7
a) Pakasa (U) Limited is a manufacturing firm located in Nakawa Zone of Kampala. The firm
manufactures Chocolate, Sweets and Ice cream. Below is the budgeted estimates and actual results
for the year, 2012.

Item Budgeted estimates (Ugx Actual results (Ugx 000’s)

000’s)
Production and sales (units) 5,000 8,000
Sales revenue 50,000,000 80,000,000
Direct materials 12,000,000 14,000,000
Direct labour 8,000,000 9,000,000
Maintenance 5,000,000 6,000,000
Depreciation 3,000,000 3,300,000
Rent & rates 2,850,000 3,000,000
Other costs 5,200,000 6,125,000
Additional information;
i. Direct materials, direct labour and maintenance costs are variable while rent and rates are fixed.
Other costs include fixed costs of Ugx 2,600,000 plus a variable cost of Ugx. 3 per unit made and
sold.
ii. The firm is located in Uganda and operating under tough conditions. The marketing manager has
said that competition is so high and it is anticipating that at any time, a new law against Chocolates
is likely to be introduced as a cross section of members of parliament complain about teeth decay.
Required;
i. Prepare a flexed budget that will be useful for management control purposes by clearly bringing out the
budgetary variances and the Net Profit.

ii. Explain the likely causes of the above budget variances and their effect on the overall company performance.

-THE END -

Page 21 of 21