Chapter Three

Information for
Budgeting, Planning and
Control Purposes
 a budget:- is a detailed plan expressed in
quantitative terms that specifies how
resources will be acquired and used during a
specific period of time.
 Budgeting:-The act of preparing a budget
 Budgetary Control:- The use of budgets to
control a firm’s activities .

 Budget deals with a specific entity, covers a

specific future time period and is expressed in
quantitative terms.
Budget entity - A specific budget must apply to
a clearly defined accounting entity. For
budgeting purpose the entity may consist of a
small part of a business, a single activity, or a
specific project.
Future time period –Many financial figures are
meaningless unless they are couched in some
time references.
 In planning for profits, managers must consider
two time horizons: the short term and the long term.
 Short-term planning is the process of deciding what objectives
to pursue during a short, near- future period, usually one year,
and what to do to achieve those objectives. The typical short-
term budget covers one year and is broken down into monthly or
quarterly units.
 Short-term planning is concerned with operating details for the
next accounting period.
 For example, short-term planning in the automotive industry
would be concerned with which and how many of the current
year’s models to manufacture.
 Another method frequently used to prepare a short-term budget is
the continuous budget. This kind of budget starts with an annual
budget broken down into 12 monthly units. As each month
arrives, it is dropped from the plan and replaced by a new
month so that at any given time, the next 12 months are always
shown.
 Long-term planning, also known as strategic planning, is the
process of setting long-term goals and determining the means
to attain them.
 long-term planning addresses broad issues, such as new product
development, plant and equipment replacement, and other
matters that require years of advance planning
 long- range planning would focus on new model development
and major changes, as well as equipment replacements and
modifications.
 The time frame for long-range planning may extend as far as 20
years in the future, but its usual range is from 2 to 10 years.
 An important part of long-term planning is the preparation of
the capital budget, which details plans for the acquisition and
replacement of major portions of property, plant, and
equipment.
 Characteristics of Budget
It is a primary for planning & controlling device.

It is prepared in monetary terms.

It is prepared for a definite period of time.

It shows planned income & expenditures.

It is used to implement policy of management.

 PRINCIPAL ADVANTAGES OF BUDGETING

 Companies realize many benefits from a budgeting

program. Among these benefits are the following:
a) Requires periodic planning.
b) Fosters coordination, cooperation, and communication.
c) Provides a framework for performance evaluation.
d) Means of allocating resources.
e) Satisfies legal and contractual requirements.
f) Created an awareness of business costs.
 Periodic Planning (Formalization of Planning):-budgets forces
managers to think a head to anticipate and prepare for the
changing conditions. The budgeting process makes planning an
explicit management responsibility.
 Coordination, Cooperation and Communication –Planning by
individual managers does not ensure an optimum plan for the entire
organization. Therefore, any organization to be effective, each manager
throughout the organization must be aware of the plans made by other
managers.
 Performance Evaluation or Framework for Judging Performance –
Budgets are estimates of future events, and as such they serve as
estimates of acceptable performance. Comparing actual result against
budgeted results helps managers to evaluate the performance of
individuals, departments, or entire companies.
 Means of Allocating Resources – organizations resources are limited, and budgets provide one
means of allocating resources among competing uses.
 Legal and Contractual Requirements –Some organizations are required to budget because of
legal requirements. Others commit themselves to budgeting requirement when signing loan
agreements or other operating agreements. For example, a bank may require a firm to submit an
annual operating budget and monthly cash budget throughout the life of a bank loan. Local police
department, for example, would be out of funds if the department decided not to submit a budget
this year.
 Cost Awareness –Accountants and financial managers are concerned daily about the cost
implications of decisions and activities, but many other managers are not. Production managers
focus on input, marketing manager’s focuses on sales, and so forth. It is easy for people to
overlook costs and cost-benefit relationships. At budgeting time, however, all managers with
budget responsibility must convert their plans for projects and activities to costs and benefits. This
cost awareness provides a common ground for communication among the various functional
areas of the organization.
 Points on Budgeting
• Five general principles of budgeting
– Top-management support,
– participation in goal setting,
– timely communication of results,
– flexibility in design, and
– follow-up.
 Budgeting Strategy
• is the manner in which a company approaches
the budgeting process
– who is involved in the budgeting process and how the
budget numbers are derived.
• Mandated Budgeting
– top-down budgeting because top management
develops the budget and passes them down the
organizational hierarchy to various divisions and/or
departments without input from lower levels of
management and employees.
• Participative budgeting
– allows individuals who are affected by the budget to
have input into the budgeting process
– bottom-up budgeting
 Techniques of Budgeting
• Different organizations prepare budget using
different techniques that may be grouped as
follows:
1. Incremental budgeting: is a budget set based on
past year’s actual performance.
In this technique a budget for the coming year is
simply this year budgeted or actual results plus
or minus some amount for expected change on
planned operation or change in the market price.
 Cont…
2. Zero based budgeting: In a dynamic business it
often makes sense to 'start a fresh' when
developing a budget, rather than basing ideas too
much on past performance.
In this technique each budget is therefore
constructed without much reference to previous
budgets.
Preparing a budget a fresh is usually required in
most business organizations, where the business
environment is volatile that require continues
effort of incorporating changes in budget
thinking.
 Cont….
3. Continuous/Perpetual/Rolling Budget: is
budget that covers a 12-month period but
which is constantly adding a new month on
the end as the current month’s completed.
It is a common form of master budget.
 It makes the budgeting an ongoing process
rather than a periodic process.
 Cont…
4. Strategic budgeting: This involves identifying
new, emerging opportunities, and then building
plans to take full advantage of them. This is
closely related to zero based budgeting and helps
to concentrate on gaining competitive advantage.
5. Activity based budgeting: This examines
individual activities and assesses the strength of
their contribution to company success. They can
then be ranked and prioritized, and be assigned
appropriate budgets.
 TYPES OF BUDGET
• Budgets are classified in different ways:
A. Based on capacity
i) Fixed budget –is a budget that remains unchanged with level
of activity.
ii) Flexible budget –it is the budget that will fluctuate with the
level of output.

B. Based on time
i) Long-rang budget –a budget that may cover long periods.

ii) Short-rang budget –a budget that covers less than one year.
 C. Based on coverage
i) Functional budget –budgets related to the various functions of
a business.

 Functional budget includes:

a) Physical budget –budgets of quantity of sales & productions.

b) Profit budget –budgets that ascertains the profit; like sales
budget, profit & sales budget, etc.

c) Cost budget –these provide information on costs like

manufacturing cost, selling & administration costs etc.

d) Financial budgets –these provide information on the financial

position of the firm. e.g.; cash budget, capital expenditure budget
etc.
 ii) Master budget – is a consolidated summary
of the various operation & financial budgets.

Or
• It is a set of budgets prepared collectively for
all activities of a company.
 Cont..
• Master budget is a consolidated summary of
the various operational and financial budgets
• Operating decision centers on the acquisition
and use of scarce resources whereas financial
decisions centers on how to get the funds to
acquire resources
• comprehensive, organization-wide set of
budgets.

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 Cont..
• The two main components of the master
budget are:
– the operating budget
• The operating budget is the budgeted income
statement and its supporting budget schedules
• sales budget is prepared first
– the financial budget.
• The financial budget consists of the capital
expenditures budget, cash budget, budgeted balance
sheet, and budgeted statement of cash flows.
Master Budget-manufacturing company
Sales Budget

Ending Inventory Production Budget

Budget

Direct Material Direct Labor Manufacturing

Budget Budget Overhead Budget

Cost of Goods Sold

Budget
Operating Expense/none
manufacturing overhead/ Budget

Budgeted Income statement

Capital Cash Budget Budgeted Balance Sheet Budgeted

Expenditur Cash Flow
e Budget statement
 Basic Operating Budget Steps
1. Prepare the revenues budget.
2. Prepare the production budget (in units).
3. Prepare the direct materials usage budget
and direct materials purchases budget.
4. Prepare the direct manufacturing labor
budget.
 Basic Operating Budget Steps
5. Prepare the manufacturing overhead costs
budget.
6. Prepare the ending inventories budget.
7. Prepare the cost of goods sold budget.
8. Prepare the operating expense (period cost)
budget.
9. Prepare the budgeted income statement.
 Basic Financial Budget Steps
Based on the operating budgets:
1. Prepare the capital expenditures budget.
2. Prepare the cash budget.
3. Prepare the budgeted balance sheet.
4. Prepare the budgeted statement of cash
flows.
Preparation of Master Budget
(Manufacturing Company)
Sales Budget
• Great Company manufactures and sells a product whose peak sales
occur in the third quarter. Management is now preparing detailed
budgets for 2014- the coming year and has assembled the following
information to assist in the budget preparation:
1) The company’s product selling price is Br. 20 per unit. The
marketing department has estimated sales as follows for the next
six quarters.

Year 2014 Budgeted Year 2015 Budgeted sales in units

sales in units
Quarters 1 10, 000 Quarters 1 15,000
Quarters 2 30,000 Quarters 2 15,000
Quarters 3 40,000
Quarters 4 20,000

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Sales Budget

28
 Cash Receipts Budget
• Sales are collected in the following
pattern: 70% of sales are collected in
the quarter in which the sales are
made and the remaining 30% are
collected in the following quarter. On
January1, 2014, the company’s
balance sheet showed Br.90, 000 in
account receivable, all of which will
be collected in the first quarter of the
year.
Cash Receipts Budget

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 Production Budget
• The company maintains an
ending inventory of finished
units equal to 20% of the next
quarter’s sales. on December
31, 2013, the company had 2,
000 units on hand to start the
New Year.
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Production Budget
 Direct-Material Budget
• Fifteen pounds of raw materials are needed to
complete one unit of product. The company
requires an ending inventory of raw materials on
hand at the end of each quarter equal to 10% of
the following quarter’s production needs of raw
materials. On December 31, 2013, the company
had 21, 000 pounds of raw materials to start the
New Year.

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Direct-Material Budget

34
 Direct-Material Budget
• The raw material costs Br.0.20 per pound.

35
 Schedule of Cash Disbursements for
Material Purchases
Raw material purchases are paid for in the
following pattern: 50% paid in the quarter the
purchases are made, and the remainder is paid in
the following quarter. On January 1,2014, the
company’s balance sheet showed Br.25, 800 in
accounts payable for raw material purchases, all of
which be paid for in the first quarter of the year.

36
Schedule of Cash Disbursements for
Material Purchases

37
 Direct-Labor Cost Budget
• Each unit of Great’s product requires 0.8 hour of labor
time. Estimated direct labor cost per hour is Br.7.50.

38
 Manufacturing Overhead Budget
• Variable overhead is allocated to production
using labor hours as the allocation base as
follows:
– Indirect materials Br.0.40
– Indirect labor 0.75
– Fringe benefits 0.25
– Payroll taxes 0.10
– Utilities 0.15
– Maintenance 0.35
• Fixed overhead for each quarter was budgeted at Br.
60, 600. Of the fixed overhead amount, Br. 15, 000
each quarter is depreciation. Overhead expenses are
paid as incurred. 39
Manufacturing Overhead Budget

40
 budgeted ending inventory
Manufacturing overhead is applied on the basis of direct labor hours.

*rounded
41
 Selling and Administrative Expense Budget
• The company’s quarterly budgeted fixed selling and
administrative expenses are as follows:
2014 Quarters
1 2 3 4

Advertising Br.20, 000 Br.20, 000 Br.20, 000 Br.20, 000

Executive salaries 55, 000 55, 000 55, 000 55, 000

Insurance - 1, 900 37,750 -

Property taxes - - - 18, 150

Depreciation 10, 000 10, 000 10, 000 10, 000

The only variable selling and administrative expense, sales commission, is

budgeted at Br.1.80 per unit of the budgeted sales. All selling and
administrative expenses are paid during the quarter, in cash, with exception
of depreciation.
42
Selling and Administrative Expense Budget

43
Selling and Administrative Expense Budget
Budgeted Income Statement

45
 Cash Budget
• New equipment purchases will be made during each quarter of
the budget year for Br. 50, 000, Br. 40, 000, & Br.20, 000 each for
the last two quarter in cash respectively. The company declares
and pays dividends of Br.8, 000 cash each quarter.
• The company can borrow money from its bank at 10% annual
interest. All borrowing must be done at the beginning of a quarter,
and repayments must be made at the end of a quarter. All
borrowings and all repayments are in multiples of Br. 1,000. The
company requires a minimum cash balance of Br.40, 000 at the
end of each quarter. Interest is computed and paid on the
principal being repaid only at the time of repayment of principal.
The company whishes to use any excess cash to pay loans off as
rapidly as possible

46
Cash Budget

47
 Cash Budget-
Financing and Repayment

48
Budgeted Balance Sheet

49
50
 Master Budget -Merchandising Company

The usual master budget for a non-manufacturing

company has the following components.
Preparation of Master Budget
(Merchandising Company)
 Sales Budget
• Blue Nile Company’s prepare a master budget to aid financial and operating
decisions. The planning horizon is only three months, January to March. Sales
in December (2013) were Br. 40, 000. Monthly sales for the first four months
of the next year (2014) are forecasted as follows:
– January Br. 50, 000
– February 80, 000
– March 60, 000
– April 50, 000

54
 Cash Collection Budget
• Normally 60% of sales are on cash and
the remainders are credit sales. All credit
sales are collected in the month
following the sales.
 Purchase Budget
• Blue Nile wants to have a basic inventory of Br. 20,
000 plus 80% of the expected cost of goods to be
sold in the following month. The cost of
merchandise sold averages 70% of sales.

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 Disbursement for purchases
• The purchase terms available to the
company are net 30 days. Each month’s
purchase are paid as follows:
– 50% during the month of purchase and,
– 50% during the month following the purchases

57
Operating expense budget

58
Disbursement for operating expenses budget

59
Budgeted Income Statement

60
 Cash Budget
• In January, a used truck will be purchased for Br.
3, 000 cash. The company wants a minimum cash
balance of Br. 10, 000 at the end of each month.
Blue Nile can borrow cash or repay loans in
multiples of Br. 1, 000. Management plans to
borrow cash more than necessary and to repay as
promptly as possible. Assume that the borrowing
takes place at the beginning, and repayment at
the end of the months. Interest is paid when the
related loan is repaid. The interest rate is 18% per
annum. 61
Cash budget including receipts& payments

62
 Cash Budget-
Financing and Repayment

63
Budgeted Balance Sheet

64
Budgeted Balance Sheet

65