BUDGETING
CIMA official terminology defines budget as a “plan expressed in money. It is prepared and
approved prior to the budget period and may show income, expenditure and the capital to be
employed”. It could also be defined as ‘a quantified plan of action relating to a given period of time’.
PURPOSES OF BUDGETING
Budgets have two main roles:
(a) They act as authorities to spend, that is, they give authority to budget managers to incur
expenditure in their part of the organization.
(b) They act as comparators for current performance, by providing a yardstick against which
current activities can be monitored, and they may be used targets to motivate managers.
Other Purposes are;
i.
Planning
Planning is necessary for doing any work in a systematic manner. A well- prepared plan helps the
organization to use the scarce resources in an efficient manner and thus achieving the predetermined
targets becomes easy. A budget is always prepared for future period and it lays down targets
regarding various aspects like purchase, production, sales, manpower planning etc. This
automatically facilitates planning.
ii.
Evaluation of performance
A manager’s performance is often evaluated by measuring his or her success in meeting the
budgets. In some companies bonuses are awarded on the basis of an employee’s ability to achieve
the targets specified in the periodic budgets, or promotion may be partly dependent upon a
manager’s budget record. In addition, the manager may wish to evaluate his or her own
performance. The budget thus provides a useful means of informing managers of how well they are
performing in meeting target that they have previously helped to set.
iii.
Co-coordinating activities
The activities of different departments or sub-units of the organization need to be coordinated to
ensure maximum integration of efforts towards common goals. For achieving the predetermined
objectives, apart from planning, coordinated efforts are required. Budgeting facilitates coordination
in the sense that budgets cannot be developed in isolation This concept of coordination implies, for
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example, that the purchasing department should base its budget on production requirement and
that the production budget should in turn be based on sales expectations..
iv.
Implementing plans
v.
Control
Planning is looking ahead while controlling is looking back. Preparation of budgets involves detailed
planning about various activities like purchase, sales, production, and other functions like marketing,
sales promotion, manpower planning. But planning alone is not sufficient. There should be a proper
system of controlling which will ensure that the work is progressing as per the plan. Budgets provide
the basis for such controlling in the sense that the actual performance can be compared with the
budgeted performance.
vi.
Communicating
If an organization is to function effectively, there must be definite lines of communication so
that all the parts will be kept fully informed of the policies, and constraints, to which the
organization is expected to conform. Everyone in the organization should have a clear
understanding of the part they are expected to play in achieving the annual budget. This process
will ensure that the appropriate individuals are made accountable for implementing the budget.
Through the budget, top management communicates its expectations to lower level
management, so that all members of the organization may understand these expectations and
can coordinate their activities to attain them. It is not just the budget itself that facilitates
communication- much vital information is communicated in the actual act of preparing it.
vii.
Motivating
The interest and commitment of employees can be retained via a system of feedback of actual
results, which lets them know how well or badly they are performing. The identification of
controllable reasons for departures from budgets with managers responsible provides an
incentive for improving future performance.
viii.
Provides a framework for authorization
Once the budget has been agreed by the directors and senior managers it acts as an
authorization for each budget holder to incur the costs included in the budget center’s budget.
As long as the expenditure is included in the formalized budget the budget holder can carry out
day to day operations without needing to seek separate authorization for each item of
expenditure.
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REASONS FOR THE PREPARATION OF BUDGETS
i.
To compel planning:-Planning forces management to look ahead, set targets, anticipates
problems and the organization purpose and directions.
ii.
To communicate ideas and plans to everyone affected by them. This will ensure that each one is
aware of what is expected of him.
iii.
To co-ordinate the activities of different departments or sub-unit of the organization. For
instance, the purchasing department should base on sales expectations.
iv.
To provide a framework for responsibility accounting whereby managers of budget centers are
made responsible for the achievement of budget targets for the operations under their personal
control.
v.
To establish a system of control:-Budgetary control usually involves the feedback of actual
results for comparism against the budget plan.
vi.
To motivate employees to improve their performance.
Benefits of Budgeting
Budgeting plays an important role in planning and controlling. It helps in directing the scarce
resources to the most productive use and thus ensures overall effi ciency in the organization. The
benefits derived by an organization from an effective system of budgeting can be summarized as
given below.
i.
Budgeting facilitates planning of various activities and ensures that the working of the
organization is systematic and smooth.
ii.
Budgeting is a coordinated exercise and hence combines the ideas of different levels of
management in preparation of the same.
iii.
Any budget cannot be prepared in isolation and therefore coordination among various
departments is facilitated automatically.
iv.
Budgeting helps planning and controlling income and expenditure so as to achieve
higher profitability and also act as a guide for various management decisions.
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v.
Budgeting is an effective means for planning and thus ensures sufficient availability of
working capital and other resources.
vi.
It is extremely necessary to evaluate the actual performance with predetermined
parameters.
vii.
Budgeting ensures that there are well-defined parameters and thus the performance is
evaluated against these parameters.
viii.
As the resources are directed to the most productive use, budgeting helps in reducing the
wastages and losses.
Stages in the Budgeting Process
1. Communicating details of budget policy and guidelines to those people responsible for the
preparation of budgets
2. Determining the factor that restricts output
3. Preparation of sales budget
4. Initial preparation of the various budgets
5. Negotiation of budgets with superiors
6. Coordination and review of budgets
7. Final acceptance of budgets
8. Ongoing review of budgets
Types of Budgets
i.
Functional or Departmental Budgets: - They are the budgets for the various functions and
departments of an organization. Examples are production budgets, sales budgets, purchasing
budgets and research and development budgets.
ii.
Master Budgets: - When all the functional budgets have been prepared, they are summarized
and consolidated into a master budget which consists of the budgeted profit and loss accounts.
Balance sheet and Cash budget and these provided the overall picture of the planned
performance for the budget.
iii.
Fixed Budgets: - It is a budget which is designed to remain unchanged regardless of the
volume of output or sale. Master budgets are examples of fixed budgets as they are prepared
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on an anticipated volume of production and sales with no plans made for the situation that,
actual volumes of productions and sales with no plans made for the situation that, actual
volumes of productions and sales may be different from planned levels.
iv.
Flexible Budgets: - Is a budget which by recognizing different cost behavior patterns is
designed to change as volumes of output changes. At the planning stage, a fixed master budget
would be prepared to cover the most probable level of activity but a contingency flexible
budget would be also prepared to cover all the other possible levels of activities. It must be
noted that, flexible budget uses the principle of marginal costing.
v.
Continuous or Rolling Budgets: - It is a budget which is continuously updated by adding
further accounting period (a month or quarter) when the earlier accounting period has expired.
vi.
Cash Budgets: - It is a detailed budget of cash inflows and outflows incorporating both
revenue and capital items. The objective of a cash budget is to ensure that sufficient cash is
available at all times to meet the level of operations that are outlined in various budgets.
vii.
Departmental Budget
For cost control the direct labour budget, materials usage budget and factory overhead budget
are combined into separate departmental budgets. These budgets are normally broken down
into twelve separate monthly budgets and the actual monthly expenditure is compared with the
budgeted amounts for each of the items concerned
Methods used in Budgeting
There are two main methods used in budgeting and these are:
i.
Incremental Budgeting: - Is a traditional approach to budgeting and involves basing next
year’s budget on the current year’s result plus an extra amount for estimated growth or
inflation for the budget year.
ii.
Zero Based Budgeting: - It involves preparing a budget for each cost centre from a zero
base. Every item of expenditure has to be justified in its totality in order to be included in
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the next year’s budget. This approach requires that all activities are justified and prioritized
before decisions are taken relating to the amount of resources allocated to each activity. In
incremental budgeting or traditional budgeting, previous year’s figures are taken as base and
based on the same the budgeted figures for the next year are worked out. Thus the previous
year is taken as the base for preparation of the budget. However the main limitation of this
system of budgeting is that an activity is continued in the future only because it is being
continued in the past. Hence in Zero Based Budgeting, the beginning is made from scratch
and each activity and function is reviewed thoroughly before sanctioning the same and all
expenditures are analyzed and sanctioned only if they are justified.
Benefits from Zero Based Budgeting

ZBB facilitates review of various activities right from the scratch and a detailed cost benefit
study is conducted for each activity. Thus an activity is continued only if the cost benefit study
is favorable. This ensures that an activity will not be continued merely because it was conducted
in the previous year.

A detailed cost benefit analysis results in efficient allocation of resources and consequently
wastages and obsolescence is eliminated.

A lot of brainstorming is required for evaluating cost and benefits arising from an activity and
this result into generation of new ideas and also a sense of involvement of the staff.

ZBB facilitates improvement in communication and co-ordination amongst the staff.

Awareness amongst the managers about the input costs is created which helps the organization
to become cost conscious.

An exhaustive documentation is necessary for the implementation of this system and it
automatically leads to record building.
Limitations of Zero Based Budgeting
The following are the limitations of Zero Based Budgeting.

It is a very detailed procedure and naturally if time consuming and lot of paper work is
involved in the same.

Cost involved in preparation and implementation of this system is very high.
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
Morale of staff may be very low as they might feel threatened if a particular activity is
discontinued.

Ranking of activities and decision-making may become subjective at times.

It may not advisable to apply this method when there are non-financial considerations, such as
ethical and social responsibility because this will dictate rejecting a budget claim on low ranking
projects.
Preparation of Functional budgets:
Under the functional budgets, the following budgets are opened:
i.
Sales Budget
A Sales Budget shows forecast of expected sales in the future period [the period is well-defined] and
expressed in quantity of the product to be sold as well as the monetary value of the same. A Sales
Budget may be prepared product wise, territories/area/country wise, customer group wise,
salesmenwise as well as time wise like quarter wise, month wise, weekly etc. The following factors
are taken into consideration while preparing a sales budget:
ii.

Analysis of past sales

Estimates given by the sales staff

Market Potential Analysis

Dependent (demand) Factor
Production Budget
This budget shows the production target to be achieved in the next year or the future period. The
production budget is prepared in quantity as well as in monetary terms. Before preparation of this
budget it is necessary to study the principal budget factor or the key factor. The principal budget
factor can be sales demand or the production capacity or availability of raw material. The policy of
the management regarding the inventory is also taken into consideration. The production budget is
normally prepared for a period of one year and then broken down on monthly basis. Production
targets are decided by adding the budgeted closing inventory in the sales forecast and subtracting the
opening inventory from the total of the same. Production Cost Budget is prepared by multiplying
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the production targets by the budgeted production cost per unit. The following illustration will
clarify the concept
iii.
Direct Material Usage and Purchase Budget
This budget shows the quantity of materials to be purchased during the coming year. For the
preparation of this budget, production budget is the starting point if it is the key factor. If the raw
material availability is the key factor, it becomes the starting point. The desired closing inventory of
the raw materials is added to the requirement as per the production budget and the opening
inventory is subtracted from the gross requirements. This budget is prepared in quantity as well as in
the monetary terms and helps immensely in planning of the purchases of raw materials. Availability
of storage space, financial resources, various levels of materials like maximum, minimum, re-order
and economic order quantity are taken into consideration while preparing this budget. A separate
material utilization budget may also be prepared as a preparation of material purchase budget.
iv.
Direct Labour Budget
The labor budget estimates the labor required for smooth and uninterrupted production. The labor
budget shows the number of each type or grade of workers required in each period to achieve the
budgeted output, budgeted cost of such labor, period wise and period of training necessary for
different types of labor.
v.
Factory Overhead Budget
This budget is prepared for planning of the factory overheads to be incurred during the budget
period. In this budget the overheads should be shown department wise so that responsibility can be
fixed on proper persons. Classification of factory overheads into fixed and variable components
should also be shown in this budget
vi.
Selling Administration Budget
This budget covers the administrative costs for non-manufacturing business activities. The
administrative overheads include expenses like office expenses, office salaries, directors’
remuneration, legal expenses, audit fees, rent, interest, property taxes, postage, telephone, telegraph
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etc. These expenses should be classified properly under different headings to determine the
responsibilities regarding cost control and reduction.
Preparation of Cash Budget:
A cash budget is prepared to show the expected receipts of cash and payments of cash during the
budget period. A cash budget is an estimate of cash receipts and cash payments prepared for each
month. The annual cash budget will be divided into smaller time periods commonly of one month
or four weeks. In this budget all expected payments, revenue as well as capital and all receipts,
revenue and capital are taken into consideration. The main purpose of cash budget is to predict the
receipts and payments in cash so that the firm will be able to find out the cash balance at the end of
the budget period. This will help the firm to know whether there will be surplus cash or deficit at the
end of the budget period. It will help them to plan for either investing the surplus or raise necessary
amount to finance the deficit. Cash Budget is prepared in various ways, but the most popular form
of the same is by the method of Receipt and Payment method. This method is illustrated in the
following illustration.
Why is a cash budget important?
1. Allows companies to predict possible cash shortages and take corrective action before a crisis
occurs.
2. Allows companies to see if large sums of excess cash are lying idle—could be put to better use.
Procedure involved in the preparation of a cash budget:
i.
Determine the actual receipts to be expected from sales.
ii.
Prepare “a debtors and Creditors schedule” to derive expected cash to be collected from
debtors and expected cash to be paid to Suppliers.
iii.
Determine the expected expenses to be incurred and must be noted that all expenses in this
case are cash item.
iv.
Adjust any item that is not a cash item because the cash budget does not take into
consideration non-cash items such as depreciation, profit or loss on the disposal of fixed
assets, notional expenses, provision for bad debts etc.
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Question 1
a) Briefly explain the following concepts as used in budgeting:
i.
Rolling budget
ii.
Fixed budget
iii.
Budget manual
iv.
Functional or Departmental Budgets
v.
Master Budgets
vi.
Flexible Budgets
vii.
Cash Budgets
b) Distinguish between the following three different types of planning :
i.
Strategic planning
ii.
Budgetary planning, and
iii.
Operational planning
Question 2
Coulson industries, a defence contractor, is developing a cash budget for October, November and
December. Coulson’s sales in August and September were GH¢100,000 and GH¢200,000
,respectively. Sales of GH¢400,000 , GH¢300,000 and GH¢200,000 have been forecast for October ,
November and December , respectively. Historically, 20% of the firm’s sales have been for cash ,
50% are generated accounts receivable collected after 1 month and the remaining 30% have
generated accounts receivable collected after 2 months. Bad debt expenses ( uncollectible accounts )
have been negligible. In December , the firm will receive a GH¢30,000 dividend from stock in a
subsidiary.
•
Purchases – The firms purchases represents 70% of sales. Of this amount, 10% is paid in
cash, 70% is paid in the month immediately following the month of purchase and the
remaining 20% is paid 2 months following the month of purchase.
•
Rent Payments – Rent of GH¢5000/month
•
Wages and Salaries – Fixed salary cost for the year is GH¢96,000, or GH¢8000 per month.
Wages are estimated as 10% of monthly sales.
•
Tax Payments – Taxes of GH¢25,000 must be paid in December.
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•
Fixed-Asset Outlays – New machinery costing GH¢130,000 will be purchased and paid for
in November.
•
Interest Payments – An interest payment of GH¢10,000 is due in December.
•
Cash Dividend Payments – Cash dividends of GH¢20,000 will be paid in October.
•
Principal Payments (Loans) – A GH¢20,000 principal payment is due in December.
•
Repurchases or Retirements of Stock – No repurchase or retirement of stock is expected
between October and December.
Question 3
A company manufactures two products, A and B. Standard cost data for the products for the next
year are as follows;
Product A per Unit
Product B per Unit
Direct Materials
X at GH 2 per Kg
24kg
30kg
Y at GH 5 per Kg
10kg
8kg
Z at GH 6 per Kg
5kg
10kg
Unskilled at GH3 per hour
10 hours
5 hours
Skilled at GH 5 per hour
6 hours
5 hours
Direct Wages
Budgeted stocks for next year are as follows:
Product A (Units)
Product B (Units)
01-Jan
400
800
31-Dec
500
1100
Material X
Material Y
Material Z
01-Jan
30000
25000
12000
31-Dec
35000
27000
12500
Budgeted sales for the next year; Product A 2400 units. Product B 3200units.
Prepare the following budgets for next year;
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a. Production budget, in units
b. Material purchases budget, in kg and by value
c. Direct labour budget, in hours and by value
Question 4
Given the information below, you are required to prepare the following budgets for Kek Ltd for the
quarter July to September 2012;
i.
Sales budget in quantity and value
ii.
Production budget in units
iii.
Raw materials usage budget in kgs
iv.
Raw materials purchase budget in kgs and value
v.
Labour requirements budget in hours and value
The company manufactures product X which uses three different materials. The details are as
follows;
Selling price per unit GH¢ 500
Material A
3 kgs
material price GH¢7 per kg
Material B
2 kgs
material price GH¢10.00 per kg
Material C
4 kgs
material price GH¢9 per kg
Direct labour 8 hours
labour rate GH¢16 per hour
The following estimates of sales demand are made for the period July to October:
July
August
September
800units
600units
1200units
October
900units
It is the company’s policy to hold stocks of finished goods at the end of each month equal to 50%
of the following month’s sales demand, and it is expected that the stock at the start of the budget
period will meet this policy.
At the end of the production process, the products are tested: it is usual for 10% of those tested to
be faulty. It is not possible to rectify these faulty units.
Raw material stocks are expected to be as follows on 1 July:
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Material A
2000 kgs
Material B
800 kgs
Material C
1200 kgs
Raw materials stocks are to be increased by 20% in July, and then remain at their new level for the
foreseeable future. Labour is paid on an hourly rate based on attendance. In addition to the unit
direct labour hours shown above, 20% of the attendance time is spent on tasks which support
production activity.
Question 5
Gosky Plc is currently preparing its budgets for the year ending 30th September, 2011. The sales and
production budgets have been completed and an extract from them is shown below:
Production Units
Sales Units
Sales Value
000
000
GH¢'000
January
90
100
5000
February
85
80
4000
March
100
90
4500
April
120
110
5500
May
125
130
6500
June
117.5
120
6000
July
110
115
5750
*
105
5250
August
Budgeted production costs are:
GH¢/unit
Direct materials
140
Direct labour
120
Variable overhead
60
Fixed overhead*
80
Production Cost
400
Fixed overheads are absorbed on a unit basis assuming a normal production level of 14million units
per year.
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Direct material are purchased in the month of usage and, where settlement discounts are available,
Gosky Plc’s policy is to pay suppliers so as to receive these discounts. It is expected that 60% of
Gosky Plc’s material costs will be received from suppliers who offer a 2% discount for payment in
the month of purchase. Other material suppliers are to be paid in the month following purchase.
Direct labour costs are paid 75% in the month in which they are incurred, and 25 % in the following
month. Variable overhead costs are paid in the month in which they are incurred. Fixed overhead
costs include GH¢16m depreciation. Fixed overhead expenditure accrues at a constant rate
throughout the year and is paid 40% in the month in which it is incurred and 60% in the following
month.
In addition to production costs, Gosky Plc expects to incur administration overhead costs of
GH¢500,000 per month and selling overhead costs of 2% of sales value. These costs are to be paid
in the month in which they are incurred.
Gosky Plc’s customers are expected to pay for items as follows:

In the month of sale
20%

In the month after sale
55%

In the month two after sale
15%

In the month three month after sale 5%
Customers paying in the month of sale are given 1% discount. 5% of sales are expected to be bad
debts.
In addition to the above, Gosky Plc expects that:

New machinery is to be acquired on 1st February, 2011, costing GH¢15m. This is to be paid
for in May 2011.

Corporation tax of GH¢15m will be payable in June 2011

A dividend of GH¢ 9m will be paid to shareholders in July 2011

The bank balance at 1st April 2011 will be GH¢20m.
Required:
Prepare Gosky’s cash budget for the period April-July 2011, showing clearly the receipts, payments
and the resulting balances for each month.
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Question 6
Jireh Fabrication Company is in the process of preparing the cash budget for the last four months of
2010 that is September to December. The following information has been made available.
i.
Projected sales
Sept.
Oct.
Nov.
Dec.
Quantity (units) 60000
65000
65000
70000
ii.
Selling price is GH¢10 per unit but expected to drop by 5% from 1st November.
iii.
Payment for goods sold is as follows; 20% in the month of sales, 60% the following
month after sales and the balance in the second month after sales. Bad debt is estimated
at 2% of sales value.
iv.
Purchases of goods at GH¢6 per unit are as follows: September 70000 units, October
70000units, November 72000 units and December 65000 units.
v.
Goods purchased are paid one month in arrears.
vi.
Monthly expenses estimated at 12% on sales revenue are paid in the month of
incurrence
vii.
The company plans to buy a delivery van at GH¢270000, 40% of the cost to be paid in
October and the balance in January 2011.
viii.
The Director withdraws GH¢20000 monthly for personal expenses.
ix.
Extracts from August figures are as follows:
a. Debtors GH¢460000 out of which GH¢100000 is part of July sales before bad debt
b. Creditors for goods GH¢200000
c. Cash GH¢70000
Required:
Prepare Monthly cash budget for the four months ending December 2010
Question 7
Watson Ltd is preparing its budgets for the next quarter. The following information has been drawn
from the budgets prepared in the planning exercise so far.
Sales Value
June (estimate)
GH12500
July(budget)
GH13600
15
August
GH17000
September
GH16800
Direct wages
GH 1300 per month
Direct Material purchases
June (estimate)
GH3450
July(budget)
GH3780
August
GH2890
September
GH3150

Watson sells 10 percent of its goods for cash. The remainder of the customers receive one
month’s credit

Payments to creditors are made in the month following purchase

Wages are paid as they are incurred

Watson takes one month’s credit on all overheads

Production overheads are GH3200 per month

Selling and distribution and administration overheads amounts to GH1890 per month

Included in the amounts for overhead given above are depreciation charges of GH300 and
GH190 respectively

Watson expects to produce a delivery vehicle in August for a cash payment of GH9870

The cash balance at the end of June is forecast to be GH1235
Prepare a cash budget for each of the months July to September
Question 8
Den Ltd is an agro processing company situated in the Nsawam area. The company is preparing its
budget for the first three months of 2013 and has approached you for assistance. The following is
available:
i.
Information extracted from the Sales budget are as follows:
GH¢
November 2012
320,000
December 2012
360,000
January 2013
300,000
February 2013
400,000
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March 2013
ii.
400,000
Debtors settle according to the following pattern:70% within the month of sale
20% in the month following
10% in the second month after sales
iii.
Extracts from the Purchases budget were as follows:
GH¢
December 2012
240,000
January 2013
200,000
February 2013
200,000
March 2013
240,000
All purchases are on credit. 90% are settled in the month following purchase and the
balance settled in the second month after purchase.
iv.
Wages are expected to be as follows:
GHC
January 2013
260,000
February 2013
310,000
March 2013
320,000
These are to be paid one month in arrears.
v.
Electricity of GH¢4,000 per month is to be paid one month in advance.
vi.
Corporate tax GH¢200,000 is expected to be paid in March 2013.
vii.
The company will receive settlement of an insurance claim of GH¢10,000 in March
2013.
viii.
Overheads are expected to be GH¢250,000 every month. (This includes depreciation of
GH¢10,000).
ix.
The company has an overdraft facility with GCB Bank Ltd for the purpose of its day to
day operations up to GH¢1000,000.
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Required:
Prepare a monthly cash budget for the first quarter of 2013.
Question 9
A redundant manager who received compensation of GH¢80000 decides to commence business on
4th January year 8, manufacturing a product for which he knows there is ready market. He intends to
employ some of his former worker who were also made redundant but they will not all commence
on 4th January. Suitable premises have been found to rent. Material stocks costing GH¢10,000 and
second-hand machinery costing GH¢60,000 have already been bought out of the GH¢80,000. The
machinery has an estimated life of five years from January year 8 and no residual value. Other data is
as follows;
Product will begin on 4th January and 25 percent of the following month’s sales will be
i.
manufactured in January. Each month thereafter the production will consist of 75
percent of the current month’s sales and 25 percent of the following month’s sales
ii.
Estimated sales are;
iii.
Units
GH¢
January
0
0
February
3200
80,000
March
3600
90,000
April
4000
100,000
May
4000
100,000
Variable production cost per unit;
GH¢
Direct Material
7
Direct wages
6
Variable Overhead
2
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iv.
Raw material requirements for January’s production will be met from the stock already
purchased. During January, 50 percent of the material required for February’s
production will be purchased. Thereafter it is intended to buy, each month, 50percent of
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the materials required for the following month’s production requirements the other 50
percent will be purchased in the month of production.
v.
Payments for raw material purchases will usually be made 30 days after purchase, but it
will be possible to delay payment if necessary for another month. The manager does not
intend to use business’s credit rating. 10 percent of the business’s purchases will be
eligible for a 5 percent discount if payment is made immediately on delivery.
vi.
Direct workers have agreed to have their wages paid into their bank accounts on the
seventh working day of each month in respect of the previous month’s earnings
vii.
Variable production overhead; 60 percent is to be paid in the month following the
month it was incurred and 40 percent is to be paid one month later
viii.
Fixed overheads are GH¢4000 per month. One-quarter of this is paid in the month
incurred, one-half in the following month, and the remainder represents depreciation on
the second-hand machinery.
ix.
Amounts receivable; a 5 percent cash discounts is allowed for payment in the current
month and 20 percent of each month’s sales qualify for this discount. 50 percent of each
month’s sales are received in the following month, 20 percent in the third month and 8
percent in the fourth month. The balance of 2 percent represents anticipated bad debts.
x.
The manager’s intended cash policy is to maintain a minimum month-end cash balance
of GH¢5000. If cash balances are likely to be lower than this then supplier payments will
be delayed as described above
Prepare a cash budget for each of the first three months of the year 8, taking account of
the requirement to maintain a minimum month-end cash balance of GH¢ 5000. All
calculations should be made to the nearest pound.
Question 10
Ama has been working as a Makola business woman for many years without obtaining finance from
a bank. She intends starting another business from her own working capital, using GH¢300,000. She
maintains an account with a Bank with a minimal balance and intends to approach the bank for the
necessary additional finance.
She asks you for advice and provides the following additional information.
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i.
Arrangements have been made to purchase fixed assets costing GH¢160,000. These will
be paid for at the end of September and are expected to have a five year life, at the end
of which they will possess a nil residual value.
ii.
Stocks costing GH¢100,000 will be acquired on 28th September and subsequently
monthly purchases will be at a level sufficient to replace forecast sales for the month.
iii.
Forecast monthly sales are GH¢60,000 for October, GH¢120,000 for November and
December, and GH¢210,000 from January 2010 onwards.
iv.
Selling price is fixed at the cost of stocks plus 50%
v.
Two month’s credit will be allowed to customers but one month’s credit will be received
from suppliers of stock.
vi.
Running expenses, including rent but excluding depreciation of fixed assets are estimated
at GH¢32,000 per month
vii.
She intends to make monthly cash drawings of GH¢20,000
Required
Prepare a cash budget for six months to 31st March, 2010
Question 11
Gloryland Ltd is preparing its annual budgets for the year to 31st December, 2013. The company
manufactures and sells one product called, “DON”. The product currently sells for GH¢300 but the
results of a survey conducted by the marketing department suggest that the price will increase to
GH¢320 with effect from 1 July 2013. At this price the sales volume for each quarter of 2013 will be
as follows;
Sales volume
Quarter 1
80000
Quarter 2
100000
Quarter 3
60000
Quarter 4
90000
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Sales for each quarter of 2014 are expected to 80000units.This forms the basis for the calculation of
the closing stock in the last quarter. Each unit of the finished product which is manufactured
requires four (4) units of component D and three (3) of component O, together with a body shell N.
These items are purchased from an outside supplier. Their current selling prices are as follows:
GH¢
Component D
16 each
Component O
10 each
Shell N
60each
The prices of the components are expected to increase by 20% with effect from 1 April 2013; no
change is expected in the price of the shell.
Assembling the shell and the components into the finished product requires 12 labour hours: labour
is currently paid GH¢ 10 per hour. A 8 % increase in wage costs is anticipated to take effect from 1
October 2013.
Variable overheads costs are expected to be GH¢20 per unit for whole of 2013; fixed production
overheads are GH¢480,000 for the year, and are absorbed on per unit basis. Stocks on 31 st
December 2012 are expected to be as follows;
Finished units
18000units
Component D
6000 units
Component O
11000 units
Shell N
1000units
Closing stocks at the end of each quarter are to be as follows;
Finished units
10% of the next quarter's sales
Component D
20%of the next quarter's production requirements
Component O
15% of the next quarter's production requirements
Shell N
10%of the next quarter's production requirements
Required:
Prepare for Gloryland Ltd the following budgets for the year ending 31st December 2013 showing
values for each quarter and the year total;
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a. Sales budget (in units and cedis)
b. Production budget (in units)
c. Material usage budget (in units)
d. Overheads costs budget
e. Labour cost budget (in cedis)
f. Production cost budget ( in cedis)
Preparing a Master Budget
The muster budget is a detailed and comprehensive analysis of the first year of the long range plan.
It quantifies targets for sales, purchases, production, distribution, and financing in the form of
forecasted financial statements and supporting operating schedules. These schedules provide
detailed information beyond what appears in the forecasted financial statements. Thus, the master
budget includes forecasts of sales, expenses, balance sheets, and cash receipts and disbursements.
Many companies break
A master budget helps you to plan and coordinate all of the different budgets needed to run an
enterprise. It includes budgets for sales, production or purchases, selling and administrative
expenses, an income statement, a cash flows statement and a balance sheet. In the budgeting
process, the master budget provides a single map explaining how the company intends to earn
profits and positive cash flow for the coming period. It also helps different parts of a business to
coordinate their activities so that together they can meet the overall goals of the business.
Components of the Master Budget
The master budget is the set of budgeted financial statements and supporting schedules for the
entire organization.
1. The operating budget
2. The capital expenditures budget
3. The financial budget
The operating budget is the set of budgets that project sales revenue, cost of goods sold, and
operating expenses, leading to the budgeted income statement that projects operating income for the
period. The first component of the operating budget is the sales budget, the cornerstone of the
master budget. Why? Because sales affect most other components of the master budget. After
projecting sales revenue, cost of goods sold, and operating expenses, management prepares the end
result of the operating budget: the budgeted income statement that projects operating income for
the period.
The second type of budget is the capital expenditures budget. This budget presents the
company’s plan for purchasing property, plant, equipment, and other longterm assets.
The third type of budget is the financial budget. Prior components of the master budget, including
the budgeted income statement and the capital expenditures budget, along with plans for raising
cash and paying debts, provide information for the first element of the financial budget: the cash
budget. The cash budget details how the business expects to go from the beginning cash balance to
the desired ending cash balance and feeds into the budgeted balance sheet, which, in turn, feeds into
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the budgeted statement of cash flows. These budgeted financial statements look exactly like ordinary
statements. The only difference is that they list budgeted (projected) amounts rather than actual
amounts.
Steps Involved in the Preparation of a Master Budget
Step 1. Project sales
Start the budgeting process by estimating sales. Go to the sales or marketing department and request
anticipated sales for the coming period. This estimate could be based on economic projections,
consultants' reports, or a simple analysis of trends in prior years.
Step 2. Plan production
Figure out the number of units of each product that you need to produce, using the following
formula:
Expected sales (in units) + Desired ending inventory (in units) - Beginning inventory (in units) =
Units to be produced.
This assumes that you're a manufacturer. If you're a retailer that doesn't produce its goods, then use
a similar formula to estimate the number of units that need to be purchased;
Expected units to be sold + Desired units of ending inventory - Units of beginning inventory =
Units to be purchased.
Multiply the number of units to be produced (or purchased) by the cost per unit to figure out the
total cost of units to be produced (or purchased). Manufacturers can skip to Step 6.
Step 3. Set materials purchases
Once you know how many units you plan to produce, it's time to figure out how much direct
material you need to purchase. Find out how many units of direct materials are needed for each unit
to be purchased. For example, if you make cheese, then producing a single wheel of cheese might
require two gallons of milk. This is the Units required for production.
Units required for production + Desired units of desired ending inventory of direct materials - Units
of beginning inventory of direct materials = Units of direct materials to be purchased.
Step 4. Design labor budget
The direct labor budget estimates how much work must be done to meet your production plans, and
the number of employees needed. To figure out the direct labor budget, ascertain (1) how many
hours of direct labor are needed to produce each unit and (2) the average direct labor rate. Multiply
both these factors by the number of Units to be produced that you estimated in the Step 2
Production budget:
Hours needed to produce each unit x Average direct labor rate x Units to be produced = Total
direct labor costs.
To figure out the number of employees needed, divide total hours to be worked by the number of
hours worked per week: (Hours needed to produce each unit x Units to be produced) / Average
number of hours worked per week by each employee = Number of employees needed for
production.
Step 5. Plot overhead
To prepare the Overhead budget, multiply the number of Units to be produced by the Variable
overhead cost per unit. Then add Total fixed overhead cost:
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(Units to be produced x Variable overhead cost per unit) + Total fixed overhead = Total overhead.
To estimate the Variable overhead cost per unit and Total fixed overhead, account analysis, a
scattergraph of overhead, the high-low method, or regression analysis will help you understand the
relationship between overhead costs and volume.
Step 6. Estimate selling and administrative expenses
Sales don't happen automatically. You need to pay for sales agents, advertising, and other marketing
costs. All of these estimated costs are tabulated in the Selling and administrative expense budget.
Step 7. Lay out a capital acquisitions budget
Factory equipment requires careful maintenance and occasionally replacement. You may also need
to add more equipment to make the needed number of Units to be produced. Therefore, set up a
capital acquisitions budget that includes the cost of any new equipment or property that needs to be
purchased during the coming period.
Step 8. Budget an income statement
Based on all of the information in the prior steps, you should be able to project an income statement
for the coming period. This will follow the basic formula for net income: Sales - Cost of goods sold
- Other expenses = Net income.
Sales come from the Sales budget (Step 1). To estimate cost of goods sold, multiply the number of
units expected to be sold (see Step 1) by the estimated cost per unit (a sum of Steps 3, 4, and 5).
Other expenses include Selling and administrative expenses (see Step 6), general expenses,
depreciation expenses, and also income tax expenses. When complete, the budgeted income
statement answers a critically important question: Will your company be profitable next year? If
you're dissatisfied with the estimated profits, then you may need to go back to Step 1 and rework
your numbers.
Step 9. Formulate a budgeted cash flows statement
A budgeted cash flows statement adds all of the expected cash receipts and subtracts the
disbursements for the coming period. Cash receipts come from sales - but be careful! Don't list the
sales themselves, but the cash flows from sales. This means adjusting for the rate at which you
collect payment for your sales. Cash disbursements need to be made for purchases of raw materials
(Step 3), direct labor (Step 4), overhead costs (Step 5), selling and administrative expenses (Step 6),
and capital acquisitions (Step 7). Note that cash payments for these costs usually vary from the
amounts of costs themselves. Even though you purchase $1,000,000 worth of raw materials next
year doesn't mean that you pay your supplier exactly this amount next year.
Once complete, your budgeted cash flows statement will indicate whether you will have enough cash
for the coming period. If you will, then great. If not, then you either need to revise your plans so
that you have enough cash to fund them, or find more cash, by borrowing more money or raising
capital from investors.
Step 10. Bring down a budgeted balance sheet
The budgeted balance sheet is based on the following formula: Assets = Liabilities + Stockholders'
Equity
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It explains how the business plan for the coming period will affect the company's finance position at
the end of that period. Budgeting starts with estimating sales, and ends with a budgeted income
statement, balance sheet and cash flows statement. A master budget helps you to figure out
production levels, purchases of direct materials, hiring of employees, overhead, and purchases of
new capital assets, while maintaining profitability and positive cash flow.
Illustration 1
You manage Greg’s Tunes, Inc., which carries a complete line of music CDs and DVDs. You are to
prepare the store’s master budget for April, May, June, and July, the main selling season. The
division manager and the head of the accounting department will arrive from headquarters next
week to review the budget with you.
Your store’s balance sheet at March 31, 2015, the beginning of the budget period, appears in the
table below
Balance Sheet
31-Mar-15
Assets
GH¢
Liabilities
GH¢
Current Assets:
Current Liabilities:
Cash
16400 Accounts payable
16800
Accounts Receivable
16000 Salary and Com payable
4250
Inventory
48000 Total Liab
21050
Prepaid Insurance
1800 Equity
Total Current Assets
82200 Common Stock
20000
Fixed Assets:
Retained Earnings
60350
Equipment and Fixtures
32000 Total Equity
80350
Less: Depn
12800
Total Fixed Assets
19200
Total Assets
101400 Total Liab and Equity 101400
Flexible Budget
A flexible budget is a budget that is a function of one or more levels of activity. Thus, the budget
depends on one or more measures of activity volume rather than being fixed in amount. A flexible
budget is a budget which is designed to change in accordance with the LEVEL OF ACTIVITY
attained.
It is also known as Variable budget as the budget recognizes the difference in cost behavior namely
fixed and variable costs in relations to fluctuations in output or turnover. The budget is designed to
change appropriately with such fluctuation.
For a fixed budget, the budget remains unchanged irrespective of the level of activity actually
attained.
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The fixed budget is prepared based only on one level of output.
Therefore, if the level of output actually achieved differs considerably from that budgeted, large
variances will arise.
For some companies, due to the nature of business does not suit fixed budget preparation:
 Affected by weather condition like the soft drink industry;
 Companies frequently introduce new product line like the food canning industry;
 Production is carried out only when orders are received from customers like shipbuilding,
aircraft industries;
 Affected by changes in fashion like millinery trade;
 Export orientated business
So, what are the difference between Fixed and Flexible Budget? They are:
For a fixed budget, the figures are for a SINGLE level of activity while a flexible budget is
prepared for DIFFERENT levels of activity;
 Under fixed budgets, managers are held responsible for variances not under his control ( both
fixed and variable cost);
 The fixed budget is never able to assess properly the efficiency and actual performance of the
manager.
For example, a fixed budget is set with a planned 8,000 hours but an actual 10,000 hours are



recorded, from both the motivational or control point, it is difficult to gauge the efficiency
of the manager(s) who are involved in the manufacture of the output at that actual level;
The flexible budget allows more meaningful comparison as it flexs to the actual volume. It
computes what costs should have been for the actual level of activity and
The flexible budget has the advantage of assisting the managers deal with uncertainty by allowing
them to see the expected outcomes for a range of activity;
Purpose:--The purpose of a flexible budget is to develop an estimate or estimates of cost for one or
more levels of activity. Activity levels are typically measured in terms of activity inputs, levels, or
outputs. Such a budget is flexible in the sense that it depends upon a specified level of activity
volume. Acquisition budgets focus on the costs to be incurred to acquire actual or planned levels of
resources. Labor budgets, purchasing plans, and similar budgets are resource acquisition oriented.
Activity budgets focus on the resources that should be required to maintain activities at specified
levels based on expected or desired levels of efficiency. Production budgets focus on the resources
that would be required to produce a specified set of products and services. Like activity budgets,
production budgets are necessarily based on assumed levels of efficiency. The idea of a flexible
budget is applicable to all three types of budgets.
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Approach:--A flexible budget requires an estimate of the relationship between total cost and activity
volume. The form of that relationship depends on the structure of the process for which
costs are being estimated. Some criteria for choosing a measure of volume include:
1. Causality -- an individual type of cost should be related whenever possible to that activity
which causes the cost to vary.
2. Independence of activity measure -- to the extent possible, the activity measure should be
independent of other influences. For example, labor or machine hours are independent of
changes in prices.
3. Ease of understanding -- Activity measure units should be easily understandable and
obtainable at reasonable expense. Complicated indices of activity volume are best avoided.
4. Functionality - Activity measures should be functional and thus contribute to
organizational goals. For example, poor performance should not result in a more generous
budget for performance evaluation and control purposes.
Practice: the cost behavior assumption that underlies much of current accounting practice is that
cost is a simple linear function of volume. Specifically, it is assumed that
Total cost C = F + vQ, where F represents total fixed cost, v represents the variable cost per unit
of activity, and Q represents the level of activity for which the budget is to be constructed. When
there are multiple cost drivers for an activity, then the linear equation is of the form
Total cost C = F + v1Q1 + v2Q2 +  + vnQn
(1)
In matrix form, we would write this as
Total cost C = F + vQ
(2)
Flexible budgeting can be implemented whenever a reasonably strong relationship exists between
total cost and some measure of activity volume. The relationship can be curvilinear or linear. The
important concept is that the budget flexes, in a predetermined manner, with changes in volume.
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Measures of Activity
1. Flexible budgets are sometimes based on measures of activity inputs (e.g., direct labor hours)
that indicate the budgeted costs necessary to acquire a given level of resources at specified
prices. These are acquisition budgets, such as might be used to budget for the purchase of raw
materials for a specified period.
2.
Flexible budgets are sometimes based on measures of activity (e.g., hours a production line is
in operation) to forecast the cost of operating an activity, usually for a given level of input or
output (e.g., standard hours allowed for the output achieved). In constructing such budgets,
one must specify the rate at which resources will be consumed to maintain the activity.
3.
Flexible budgets are sometimes based on measures of activity output (e.g., number of units
produced during a period). In constructing such budgets, one must specify both the rate at
which resources will be consumed to maintain the activity and the rate at which the activity will
produce units of output. Thus, a flexible budget based on output must be based on specified
input/output ratios.
Common uses of flexible budgets include:
1.
to estimate total indirect factory costs at different levels of activity to compute budgeted activity cost
rates,
2.
to budget total indirect factory costs at different levels of activity to compute standard activity
cost rates,
to estimate total activity costs at different levels of activity to compute budgeted or standard
activity cost rates.
to estimate total activity cost for the level of activity achieved for control and performance
evaluation purposes,
to forecast total activity costs for cash budgeting purposes,
to forecast activity costs for expense budgeting purposes, and
to forecast total activity costs to forecast earnings under different scenarios.
3.
4.
5.
6.
7.
Steps
The steps involve in the preparation of the flexible budget as follows:







Select the measure of activity like the units of production;
Define the relevant range of activity for the budgeted performance based on step 1;
Identify the cost items to be included in the budget;
Determine the cost behavior of each item over the relevant range;
Separate the cost items into variable, fixed and mixed;
Select the specific levels of activity to be budgeted;
Use the cost behavior under item 4 to estimate the budgeted amounts for each cost item at
the different levels selected in step 6.
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Illustration
Company ABC manufactures a single product and has produced the following flexed budget for the
year.
Level of Activity
70%
80%
90%
Direct materials
17,780
20,320
22,860
Direct labor
44,800
51,200
57,600
Production overhead
30,500
32,000
33,500
Administration overhead
17,000
17,000
17,000
Total cost
110,080
120,520
130,960
Prepare a budget flexed at the 45% level of activity
Answer:[Guide: To flex the budget, we need to determine which costs are semi-variable and
calculate the variable cost per 1% change in activity as (range of cost)/(range of activity) and fixed
costs as total cost minus variable cost at that activity level. Calculate a cost per 1% for all the variable
costs, flex them to 45% and deduct the fixed costs]
Variable costs:
$ per 1%
$
Direct materials
254
11,430
Direct labor
640
28,800
Production overhead
150(working 1)
6,750
Fixed costs:
Production overhead(working 2)
20,000
Administration overhead
17,000
37,000
Total budget cost allowance
83,980
Working 1:
Production overhead is a semi-variable cost
Range of activity=90%-70%=20%
Range of production overhead costs=$(33,500-30,500)=$3,000
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Therefore, variable cost per 1% change in activity=$3,000/20=$150
Working 2:
Fixed cost=$33,500(90% x$150)=$20,000
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