BUDGETING AND CONTROL

Introduction
• Budgeting is one of the most widely studied
topics in management accounting (Luft &
Shields 2003).
• Budgets are an integral part of decision
making and control decision.
 Definition
• Budget:
– Is itemized summary of likely income and
expenses for a given period; which helps to
prioritize your spending and manage your revenue
or money.
–  A formal statement of the financial resources set
aside for carrying out specific activities in a given
period of time.
 Cont..

• A plan quantified in monetary terms prepared and

approved prior to a defined period of time usually
showing planned income to be generated and/ or
expenditure to be incurred during that period and
the capital to be employed to obtain a given
objective.
 Characteristics of a budget

• A good budget is characterized by the following:

– Participation: involve as many people as possible in
drawing up a budget.
– Comprehensiveness: embrace the whole organization.
– Standards: base it on established standards of
performance.
– Flexibility: allow for changing circumstances.
– Feedback: constantly monitor performance.
– Analysis of costs and revenues: this can be done on
the basis of product lines, departments or cost
centres.
 Functions of Budgets
• Planning annual operations
• Coordinating- harmonization
• Communicating plans of various responsibility
center
• Motivating to achieve goals
• Controlling
• Evaluating performance of managers
 Budget process and Human
behavior
• Top down mandated approach to budget
Approval
– Senior management sets strategic targets
Budget is submitted
– Division managers cascade targets
Budget is submitted
– Department heads enter budget.
 Budget process and Human behavior
• Top down mandated approach to budget
Advantages
-Set clear goals
• Disadvantages
– Ethical challenges ie unrealistic targets
– Lower level mgt can view it as a dictatorial standard
– Lack of rich information from different operational
areas in management reports
– Poorly integrated budgeting and reporting
processes
 Cont..
• Bottom up participative approach to budget
– Approval
– Senior management reviews budget.
– Request for change
– Division managers review budget.
– Request for change
– Department heads enter budget.
 Budget process and Human behavior
• Bottom up participative approach to budget
• Advantages
– Viewed as a self imposed, morale and satisfaction
– Foster team base mgt philosophy
– More accurate budgets
Disadvantages
-Time consuming and expensive to develop and
administer
-Managers may pad the budget to allow for mistakes
and inefficiencies
 ACTIVITY 4.1
• What budgeting approach is practiced by your
organization? Why?
• If you are about to start your own company
which budgeting approach will you prefer?
Why
 Master Budget
• Is an integrated set of operating, investing and
financial budgets for a period of time.
• For a manufacturing company, master budget
consist of;
– Operating budget
– Financing budget
– Investment budget
 Cont..
MASTER BUDGET
1. Operating Budgets
-Sales/Revenue budget
-Cost of goods sold budgets
a. Production budget
b. Direct material purchase budget
c. Direct labor cost budget
d. Factory overheads cost budget
Selling and administration expenses budget
2. Financing budget
-cash budget
3. Investing budget
-capital expenditure budget
 Revenue/Sales budget
• Budgeting revenue is the most important and
necessary step in budgeting for most
companies and institution
• It is also the most difficult task because it
signifies the maximum level of uncertain
forecasting.
– uncertain forecasting the performance economy,
– natural disaster,
– a top customer giving its business to a competitor,
– a new law enacted by the government.
 Revenue/Sales Budget
JAN FEBR MAR APR
Product 1
Volume 50,000 50,000 50,000 52,500
Price 10.2 11.08 10.8 10.25
Revenue 510,000 554,000 540,000 538,000
Product 2
Volume 18,500 18,500 18,500 18,500
Price 22.05 23.96 23.35 23.26
Revenue 480,000 443,200 432,000 430,400
Gross Revenue 990,000 997,200 972,000 968,400
 Production Budget
• Production Budget and Budgeted stock
levels:
• Production budget is prepared after
preparation of the sales budget. This budget is
expressed in quantities only.
 Cont..
• Illustration: Annual Production Budget:

Product A Product B
• Units to be sold: XXX XXX
• Add: Planned closing stock: XX XX
• Total units required: XXX XXX
• Less: Planned opening stock: XX XX
• Units to be produced XXX XXX
 Direct Material Usage Budget
• Direct materials Usage Budget:
• It is the budget which shows estimates of
materials which are required to meet
production.
 Direct Material Usage Budget
• Illustration: Annual materials usage budget
• Product A Product B
• Units to be produced XXX XXX

• Multiply by Quantity of material per unit X X

• Materials required for production XXX XXX
• Multiply: Price per unit of material XX XX
• Material cost for production XXX XXX
Direct Materials Purchase budget

• Direct material purchase budget is the

responsibility of the purchase manager who
should ensure that planned quantities of
materials are obtained at the right time and
right planned purchase price.
 Direct materials purchase budget
• Illustration: Direct materials purchase budget
• Product A Product B
• Units to be produced XXX XXX
• Multiply: Material per unit XX XX
• Materials required for production (units) XXX XXX
• Add: Planned closing stock XX XX
• Total material requirement XXX XXX
• Less: Planned opening stock XX XX
• Total units to be purchased XXX XXX
• Planned price per unit XX XX
• Total purchases XXX XXX
 Direct labour budget

• Direct labour budget

• It is the budget which is showing labour hours
required to meet planned production and the
rates at which labour hour will be paid.
• Where different grades of labour exist, they
should be specified separately in the budget.
 Direct Labour budget
• Illustration: Annual direct labour budget
• Product A Product B
• Budgeted production (units) XXX XXX
• Hours per unit XX XX
• Total budgeted hours XXX XXX
• Budgeted rate per hour XX XX
• Total wages XXX XXX
 CASH BUDGET
• Objective of the cash budget is to ensure that
sufficient cash is available at all times to meet
the level of operations as planned in various
budgets.
• Where a cash budget reveals a surplus cash
balance, managers can take steps in advance to
invest it in short term investments.
 Cont..
• Meanwhile, if the budget reveals cash
deficiencies, managers can take initiatives in
to ensure that bank loan (and any other short
term financing options) will be available to
meet any temporary cash deficiencies.
 Cash Budget Format for period ending 31st Dec 20XX
Sept Oct Nov Dec
Opening cash balance b/f
Cash receipts
Receipts from Debtors
Sale of asset
Loan received
Proceeds from issue of shares
Any other cash receipts
Cash available
Less: Cash payments
Payments to creditors/Wages and salary
Loan repayment/capital expenditure
Total payments
Surplus/Deficit
 Budgeting Methods
– Incremental
– Fixed budget
– Flexible budget
– Zero based budget
 Incremental Budget
• Is budgeting based on slight changes from the
preceding period budgeted results or actual
results.(adjusting volume and prices)
• Common Approach
– Management not intend to spend a greater deal
of time formulating budgets.
– Management does not perceive any great need to
conduct a thorough evaluation of the business.
 Incremental Budget
• Advantages
– Simplicity
– Funding stability
– Operational stability
• Disadvantages
– Incremental in nature
– Fostering overspending
– Budget slack (deliberate under-estimation of
budgeted revenue or over-estimation of budgeted
expenses)
 Zero Based Budget (ZBB)
• Under zero-based budgeting (ZBB), each line
item in total must be justified and reviewed
annually.
• Basically, zero based budgeting is comparable
to starting the budgeting process from scratch
every year. Hence, this method will require
more intensive planning and time.
• Departments must defend the entire
expenditure (or program expenditure) each
year, not just the changes.
 Zero Based Budget (ZBB)
• The basis process flow under zero base
budgeting is;
– Identify business objectives
– Create and evaluate alternative methods for
accomplishing each objective
– Evaluate alternative funding levels, depending on
planned performance levels.
– Set priorities
• ZBB is useful in cases where there has been
substantial strategic change or high uncertainty
 Zero Based Budget (ZBB)
• Advantages
– Alternative analysis
– Eliminate non-key activities
– Requires managers to link expenditures to activities
• Disadvantages
– Time consuming
– Focus on expenditures not growth
– Frequency of updating
 Fixed/Static Budgets
• Fixed/static budgets are prepared for a single
planned level of activity.
• Performance evaluation is difficult when
actual activity differs from the planned level of
activity.
 Fixed/Static Budgets
• Advantages
– Simple to prepare
• Disadvantages
– Not effective for evaluating the performance of
cost centers
– Large variations between actual and budgeted
results
 Fixed/Static Budgets
• Example:
• August Company’s budget for the month just ended called
for producing and selling 5,000 units at $8 each. Actual
units produced and sold were 5,200, yielding revenue of
$42,120. Variable costs were budgeted at $3 per unit and
fixed costs were budgeted at $2 per unit. Actual variable
costs were $3.30 and fixed costs were $12,000.
• Required:
• a. Prepare static and flexible budgets for the current
month’s operation.
•  
 Flexible Budgets
• The flexible budget is a performance
evaluation tool. A flexible budget adjusts the
static budget for the actual level of output.
• The flexible budget variance is the difference
between flexible budget and corresponding
statement of actual results.
 Flexible Budgets
• Advantages
– Good tool for evaluating the performance
– Useful planning tool
• Disadvantages
– Time consuming
– Many costs are not fully variable