PRINCIPLES OF PROFESSIONAL ACCOUNTING
(POPA)
WEEK 8 – Budgeting
DEPARTMENT OF ACCOUNTING
2024
Contact Details
Dale Waters CA(SA)
Room 301 – Main Admin Building
dale.waters@ru.ac.za
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Brief Overview
Reading:
 Chapter 12 – Budgets, Planning and Control - Principles
of Management Accounting – A South African
Perspective (3rd edition)
Contents:
 Lecture
 Slides
 Class examples – as per slides
 Tutorial question – TBA – on RU-connected
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Learning objectives
Explain the objectives of budgeting
Explain the concept of a principal budgeting factor
Discuss the steps in the budgeting process
Prepare a production budget
Prepare a cash budget
Explain alternative approaches to budgeting, including incremental budgeting, zero-base budgeting and rolling budgets
Apply projection techniques such as high-low method and regression analysis in preparing a budget
Discuss the concepts of fixed and flexed budgets
Discuss the difference between imposed, participative and negotiated budgets
Discuss the motivational impact of budgets
Explain the rationale behind the concept of Beyond budgeting®
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Introduction
Budgets are used in financial planning
Characteristics of budgets:
• Future-orientated
• Aims to achieve pre-determined goal or objective
• Expressed in quantifiable terms
Usually medium- to short-term
Part of long-term strategic planning process in
organisation
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Objectives of Budgets
Facilitate achievement of organisation’s strategic and tactical objectives
Compel planning
Promote co-ordination of activities
Promote communication in organisation
Provide framework for control and responsibility accounting
Serve as framework for authorisation of decisions within organisation
Provide basis for performance evaluation
Provide motivation for employees to improve their performance
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Strategic, Tactical, Operational Budgets
In context of general business control, distinguish between
the three different levels of planning, control and decisionmaking
Ensure budget period agrees with specific business
requirements for which budget is used
• Strategic budgets
• Long period (3–15 years)
• Tactical budgets
• Period of 1–3 years
• Operational budgets
• One financial period (a year or less)
• Can also be shorter: quarterly, monthly, daily
•  Detail increases with decrease in period length
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Responsibility for the Budget
Budget committee assumes overall responsibility
for co-ordination and administration
Usually issues budget manual
• A collection of instructions setting out general guidelines,
procedures, deadlines and responsibilities
Responsibility in functional department usually
assumed by functional manager
• Example: Sales manager for sales budget
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Budget Preparation
Identify principal budgeting factor
• The factor that restricts output
• Typical principal budgeting factors:
• Sales demand (mostly)
• Availability of raw materials
• Machine capacity (especially for smaller organisation)
• Cash and other sources of funding
Prepare budget relating to principal budgeting factor
Prepare remainder of budgets based on that budget
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Budget Preparation
Determine whether objectives expressed in
terms of key performance indicators are
met when applying the ratios to the
budgeted financial statements
• Key performance indicator is a metric used to quantify
the performance an organisation aims to achieve in
areas such as
• Profitability
• Management effectiveness (asset turnover, debtors’
collection period, etc)
• Liquidity (current ratio, quick ratio)
• Solvency (gearing ratio, debt ratio)
• Investor ratios for listed organisations (EPS, dividend
cover)
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Budgeting Steps for Typical Manufacturing Entity
Prepare the sales budget
• Usually the principal budgeting factor is sales demand
• Info provided by marketing department
Prepare the production budget
• Planned production in number of units
• Consider budgeted sales, opening and desired closing inventory
Budget for production resources
• Raw materials, process times, labour
Raw materials purchases budget
• Consider production requirement, expected wastage, opening and desired closing
inventory
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Budgeting Steps for Typical Manufacturing Entity
General overheads costs budget
• Example: electricity, depreciation
• Enables calculation of overhead absorption rates
Administrative expenditure budget
• All supporting activities
Cash budget
• Most important planning tool  shows cash effect of all plans
• Indicates action required by management to prevent deficits and excessive
surpluses
• Only cash flow items
• E.g. no depreciation provision
• Transaction is recorded in period cash flow takes place
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Budgeting Steps for Typical Manufacturing Entity
Capital expenditure budget
• Long-term capital assets to meet future production
requirements
• Factors: production capacity required, cash outlay of new
equipment, required rate of return on assets
Master budget
• Overall picture of planned performance for budget period
• Summary of all individual functional budgets and the cash
budget
• Contains budgeted balance sheet, income statement and
cash flow statement
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Budgeting Steps for Typical Manufacturing Entity
• Solution –sales budget:
Units
Price
Value
Mondi
3 000
R360
R1 080 000
Rotatrim
6 000
R450
R2 700 000
First half
R3 780 000
Second half
Mondi
4 500
R360
R1 620 000
Rotatrim
3 600
R450
R1 620 000
R3 240 000
Whole year
Mondi
7 500
R360
R2 700 000
Rotatrim
9 600
R450
R4 320 000
R7 020 000
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Budgeting Steps for Typical Manufacturing Entity
• Solution –finished goods budget
• Workings:
Cost per unit :
Mondi
Material A
20 kg x R6/kg
Material B
10 kg x R15/kg
Labour
2 hrs x R60/hr
R120
R150
R120
2.5 hrs x R60/hr
Total cost
Rotatrim
R150
R240
R300
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Budgeting Steps for Typical Manufacturing Entity
• Solution –finished goods budget
Opening inventory at beginning of year
Cost
Value
Mondi
50% x 3 000 = 1 500
R240
R360 000
Rotatrim
50% x 6 000 = 3 000
R300
R900 000
R1 260 000
Opening inventory at beginning of 2nd half
Mondi
50% x 4 500 = 2 250
R240
R540 000
Rotatrim
50% x 3 600 = 1 800
R300
R540 000
R1 080 000
End of year
Mondi
50% x 3 600 = 1 800
R240
R432 000
Rotatrim
50% x 7 500 = 3 750
R300
R1 125 000
R1 557 000
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Budgeting Steps for Typical Manufacturing Entity
• Solution –Production budget
Mondi
1st half
2nd half
Total
Required closing inventory
2 250
1 800
1 800
Less: Opening inventory
1 500
2 250
1 500
750
-450
300
Add: Sales
3 000
4 500
7 500
Budgeted production
3 750
4 050
7 800
Rotatrim
1st half
2nd half
Total
Required closing inventory
1 800
3 750
3 750
Less: Opening inventory
3 000
1 800
3 000
-1 200
1 950
750
Add: Sales
6 000
3 600
9 600
Budgeted production
4 800
5 550
10 350
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Budgeting Steps for Typical Manufacturing Entity
• Solution – Raw materials inventory budget
Opening inventory at beginning of year
Cost
Value
Material A
50% x 3 750 x 20kg = 37 500
R6
R225 000
Material B
50% x 4 800 x 10kg = 24 000
R15
R360 000
R585 000
Opening inventory at beginning of 2nd half
Material A
50% x 4 050 x 20kg = 40 500
R6
R243 000
Material B
50% x 5 550 x 10kg = 27 750
R15
R416 250
R659 250
End of year
Material A
50% x 4 500 x 20kg = 45 000
R6
R270 000
Material B
50% x 7 500 x 10kg = 30 000
R15
R450 000
R720 000
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Budgeting Steps for Typical Manufacturing Entity
• Solution – Raw materials purchases budget
Material A
1st half
2nd half
Total
Required closing inventory
40 500
45 000
45 000
Less: Opening inventory
37 500
40 500
37 500
3 000
4 500
7 500
Add: Materials for production
75 000
81 000
156 000
Current period purchases
78 000
85 500
163 500
R6
R6
R6
R468 000
R513 000
R981 000
Cost
Total cost
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Budgeting Steps for Typical Manufacturing Entity
• Solution – Raw materials purchases budget
Material B
1st half
2nd half
Total
Required closing inventory
27 750
30 000
30 000
Less: Opening inventory
24 000
27 750
24 000
3 750
2 250
6 000
Add: Materials for production
48 000
55 500
103 500
Current period purchases
51 750
57 750
109 500
R15
R15
R15
R776 250
R866 250
R1 642 500
Cost
Total cost
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Budgeting Steps for Typical Manufacturing Entity
• Solution – Labour budget
Mondi
1st half
2nd half
Total
Budget production
3 750
4 050
7 800
Direct labour hours
2
2
2
Total hours
7 500
8 100
15 600
Hourly rate
R60
R60
R60
R450 000
R486 000
R936 000
Direct labour cost
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Budgeting Steps for Typical Manufacturing Entity
• Solution – Labour budget
Rotatrim
1st half
2nd half
Total
Budget production
4 800
5 550
10 350
Direct labour hours
2.5
2.5
2.5
Total hours
12 000
13 875
25 875
Hourly rate
R60
R60
R60
R720 000
R832 500
R1 552 500
Direct labour cost
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Budgeting Steps for Typical Manufacturing Entity
• Solution – Budgeted income statement 1st half
R
Sales
3 780 000
Cost of Sales
2 043 000
Raw materials
Opening inventory
1 170 000
585 000
Purchases
1 244 250
Closing inventory
-659 250
Direct labour (450 000 + 720 000)
1 170 000
Finished goods
-297 000
Opening inventory
1 260 000
Closing inventory
-1 557 000
Profit
1 373 000
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Budgeting Steps for Typical Manufacturing Entity
• Solution – Budgeted income statement 2nd half
R
Sales
3 240 000
Cost of Sales
2 160 000
Raw materials
Opening inventory
1 318 500
659 250
Purchases
1 379 250
Closing inventory
-720 000
Direct labour (832 500 + 486 000)
1 318 000
Finished goods
-477 000
Opening inventory
1 080 000
Closing inventory
-1 557 000
Profit
1 080 000
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Budgeting Steps for Typical Manufacturing Entity
• Solution – Budgeted income statement for the year
R
Sales
7 020 000
Cost of Sales
4 680 000
Raw materials
Opening inventory
2 488 500
585 000
Purchases
2 623 500
Closing inventory
-720 000
Direct labour (936 000+1 552 500)
2 448 500
Finished goods
Opening inventory
1 260 000
Closing inventory
-1 557 000
Profit
-297 000
2 340 000
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Approaches to Budgeting
Incremental budgeting
Zero-base budgeting
• Traditional approach
• Previous period
results used as basis
• Adjust figures for
inflationary increases
and changes in
budgeted volume
• Prepared budget
from ‘scratch’
• Specifically justify
each item
• Should activity be
performed?
• How much should
activity cost?
• What level of
activity is required?
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Approaches to Budgeting
Zero-base budgeting
Stages:
• Decision packages need be identified
• Discrete, stand-alone organisational activities
• Can be outsourced/abandoned without materially
affecting another activity
• Evaluate and rank decision packages in order of
importance
• Allocate resources accordingly
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Approaches to Budgeting
Zero-base budgeting
Relative advantages:
• Challenges current way of doing things
• Facilitates identification and removal of unnecessary activities and
expenditure
• Compels employees to question wasteful expenditure
• Greater staff involvement and therefore job satisfaction
• Provides in-depth insight into organisation’s operations
• Forces staff to stay up to date regarding organisation’s environment
• Advantageous to service departments, as output is difficult to identify or
qualify
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Approaches to Budgeting
Zero-base budgeting
Relative disadvantages:
• Less stable organisational environment, as radical
changes are more likely
• Time-consuming
• More complicated and could require high level of skills
• Information systems may be unable to provide required
information
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Approaches to Budgeting
Rolling/continuous budget
• Prepared on a regular basis for the next short-term
period
• Continuously update existing budget  at any point in
time budget exists for the same length of future period
• Usually done for cash budgets
• Advantages:
• Facilitates continuous planning
• Variances are regularly reviewed and corrective action
taken
• Disadvantages:
• Time-consuming
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Methods of Obtaining Figures Used in Budget
Inquiry and investigation
• Obtain information on future sales from
organisation’s sales personnel
• Conduct market research
Mathematical techniques and methods
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Mathematical Methods
Uncertainty about future events  probability
theory to compute the expected value
Project figures using historical data:
• Projections are an expected future trend pattern obtained by
extrapolation
• Methods (for more detail see Chapter 3):
• High-low method
• Linear regression analysis
• Scatter diagrams
• Valuable only if a strong correlation exists (for more detail see
Chapter 3)
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Questions
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