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7/23/2019 Budgeting and Profit Planning 101
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© Tata McGraw-Hill Publishing Company Limited, Management Accounting© Tata McGraw-Hill Publishing Company Limited, Management Accounting !-!-
Budgeting and ProfitBudgeting and Profit
PlanningPlanning
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BUDGETING AND PROFIT
PLANNING
Planning Process
Preparation/Tpes of Budgets
Budget!Definition" #eaning
and Purpose
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Planning ProcessPlanning Process
Budgeting is a tool of planning$ Planning in%ol%es specification of
t&e 'asic o'(ecti%es t&at t&e organisation )ill pursue and t&e
funda*ental policies t&at )ill guide it$ In operational ter*s"
it in%ol%es four steps+
,-. O'(ecti%es
O'(ecti%es are 'road and long!range desired state or position in future$
,. Goals
Goals are 0uantitati%e targets to 'e ac&ie%ed in specified period$
,1. 2trategies2trategies represent specific course of action to ac&ie%e goals$
,3. Plans
T&e final step is t&e preparation of 'udgets/profit plans$ It con%erts goalsand strategies into annual operating plans$$
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BudgetBudget
A 'udget is defined as a co*pre&ensi%e and coordinated plan"
e4pressed in financial ter*s" for t&e operations and resources
of an enterprise for so*e specified period in t&e future$
T&e essential ele*ents of a 'udget are+
,-. Plan
,. Financial ter*s
,1. Operations and resources
,3. 2pecific future period
,5. 6o*pre&ensi%e co%erage
,7. 6oordination
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T&e first ingredient of a 'udget is its plan$ It includes t)o aspects )&ic&
&a%e a 'earing on t&e operations of an enterprise$ One set of factors" )&ic&
deter*ine a fir*8s future operations are )&oll e4ternal and 'eond its
control$ T&e second set of factors affecting future acti%ities are )it&in t&efir*8s control and discretion" t&at is" t&e are internal$
A 'udget is a *ec&anis* to plan for t&e fir*8s operations and resources$
T&e operations are reflected in re%enues and e4penses$T&e plan also co%ers t&e resources of t&e fir*$ T&e planning of resources
*eans t&e planning of t&e %arious assets and t&e sources of capital to
finance t&ese assets$ T&e assets could 'e fi4ed assets as )ell as current
assets$
Budgets are prepared in financial ter*s" t&at is" in ter*s of *onetar %alue
suc& as t&e rupee" dollar" and so on$ T&e reason is t&at t&e *onetar unit is
a co**on deno*inator$
-$ Plan
$ Operations and Resources
1$ Financial Ter*s
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A 'udget relates to a specified period of ti*e" usuall one ear$
A 'udget is co*pre&ensi%e in t&at all t&e acti%ities and operations of
an organisation are included in it$ It co%ers t&e organisation as a
)&ole and not onl so*e seg*ents$ T&e *odus operandi is t&at
'udgets are prepared for eac& seg*ent/facet/acti%it/di%ision of an
organisation$
Budgets are prepared for t&e different co*ponents/
seg*ents/di%isions/ facets/acti%ities of an organisation so as to ta9e
care of t&e situations and pro'le*s of eac& co*ponent$ T&e'udgets for eac& of t&e co*ponents are prepared in &ar*on )it&
eac& anot&er$ T&is is called coordination$
3$ 2pecified Future Period
5$ 6o*pre&ensi%eness
7$ 6oordination
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Budget PurposeBudget Purpose
T&e *ain o'(ecti%es of 'udgeting are+
-$ E4plicit state*ent of e4pectations
$ 6o**unication
1$ 6oordination"
3$ E4pectations as a fra*e)or9 for (udging perfor*ance
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One purpose of 'udgeting is to state e4pectations in for*al ter*s so t&at
*ost of t&e underling assu*ptions *a 'e identified$ A fir* &as t&e
'asic o'(ecti%e of opti*ising long!run profit$ Its long!range goalsalso include sur%i%al" consu*er satisfaction" e*ploee
)elfare" personal po)er and prestige" and so on$
Anot&er purpose of 'udgeting is to co**unicate or infor* ot&ers of t&e
goals and *et&ods selected ' top *anage*ent$ 2ince 'udgetingdeals )it& funda*ental policies and o'(ecti%es" it is
prepared ' top *anage*ent$
:o)e%er" a 'udget does not la do)n a state*ent of e4pectations in rigid
ter*s$ A 'udget s&ould 'e *odified )&en necessar in t&e lig&t of
t&e c&anges in t&e factors/assu*ptions on )&ic& t&e
original esti*ates )ere 'ased$
-$ E4plicit 2tate*ent of E4pectations
$ 6o**unication
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;et anot&er purpose of 'udgeting is coordination$ T&e ter* <coordination8
refers to t&e operation of all depart*ents of an organisation insuc& a )a t&at t&ere is no 'ottlenec9 or i*'alance$
Finall" a 'udget esta'lis&es e4pectations as a fra*e)or9 for (udging
e*ploee perfor*ance$
In %ie) of t&e a'o%e" coordination is a *a(or function of 'udgeting$
Budgets s&ould 'e drafted in suc& a )a t&at t&e operations
of t&e %arious depart*ents are related to eac& ot&er for
t&e ac&ie%e*ent of t&e o%erall goal$
1$ 6oordination
3$ E4pectations as a Fra*e)or9 for =udging Perfor*ance
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T;PE2 OF BUDGET2T;PE2 OF BUDGET2
T&e o%erall 'udget is 9no)n as t&e *aster 'udge$ A*aster 'udget nor*all consists of t&ree
tpes of 'udgets+
,i. Operating Budgets
,ii. Financial Budgets
,iii. 2pecial Decision Budgets
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-$ Operating Budget-$ Operating Budget
-. 2ales 'udget"
. Production 'udget"
1. Purc&ase 'udget"
3. Direct la'our 'udget"
5. #anufacturing e4penses 'udget" and
7. Ad*inistrati%e and selling e4penses 'udget" andso on$
Operating 'udgets relate to p&sical acti%ities/
operations suc& as sales" production"
and so on$
Operating 'udget &as t&e follo)ing co*ponents
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$ Financial Budget$ Financial Budget
-. Budgeted inco*e state*ent"
. Budgeted state*ent of retained earnings"1. 6as& 'udget" and
3. Budgeted 'alance s&eet$
Financial 'udgets are concerned )it& e4pected
cas& flo)s" financial position and
result of operations$
Financial 'udget &as t&e follo)ing co*ponents
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6as& Budget6as& Budget6as& 'udget is a de%ice to &elp a fir* to plan for and control t&e use of
cas&$ It is a state*ent s&o)ing t&e esti*ated cas& inflo)s and cas&outflo)s o%er t&e planning period$ T&e principal ai* of t&e cas&
'udget" as a tool to predict cas& flo)s o%er a period of ti*e"
is to ascertain )&et&er t&ere is li9el to 'e e4cess/s&ortage of cas& at an
ti*e$
T&e preparation of a cas& 'udget in%ol%es se%eral steps$
T&e first ele*ent of a cas& 'udget is t&e selection of t&e period oft&e 'udget" t&at is" t&e planning &ori>on$
T&e second ele*ent of t&e cas& 'udget is t&e selection/identification
of t&e factors t&at &a%e a 'earing on cas& flo)s$T&e factors t&at generate cas& are generall di%ided into t)o 'roadcategories+
,i. Operating ,ii. Financial
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Operating 6as& Flo)Operating 6as& Flo)
T&e *ain operating factors/ite*s )&ic& generate cas&
outlfo)s and inflo)s o%er t&e ti*e span of a
cas& 'udget are ta'ulated in E4&i'it -$
E4&i'it -$ Operating 6as& Flo) Ite*s6as& inflo)s/Receipts 6as& outflo)s/Dis'urse*ents
-$6as& sales
$6ollection of accountsrecei%a'le
1$Disposal of fi4ed assets
-$ Accounts paa'le/Paa'le pa*ents
$ Purc&ase of ra) *aterials
1$ ?ages and salar ,pa roll.
3$ Factor e4penses
5$ Ad*inistrati%e and selling e4penses
7$ #aintenance e4penses
@$ Purc&ase of fi4ed assets
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Financial 6as& Flo) Ite*sFinancial 6as& Flo) Ite*s
T&e *a(or financial factors/ite*s affecting generation
of cas& flo)s are depicted in E4&i'it $
E4&i'it $ Financial 6as& Flo) Ite*s
6as& inflo)s/Receipts 6as& outflo)s/Pa*ents
-$ Loans/'orro)ings
$ 2ale of securities
1$ Interest recei%ed
3$ Di%idend recei%ed
5$ Rent recei%ed
7$ Refund of ta4
@$ Issues of ne) s&ares andsecurities
-$ Inco*e ta4/ta4 pa*ents
$ Rede*ption of loan
1$ Re!purc&ase of s&ares
3$ Interest paid
5$ Di%idends paid
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E4a*ple -
T&e follo)ing data relate to :pot&etical Li*ited+
Balance 2&eet as at #arc& 1-" 6urrent ;ear
Lia'ilities A*ount Assets A*ountAccounts paa'le
,all for #arc& purc&ases.
Ta4es paa'le
,all for #arc& inco*e.
2&are capital
Retained earnings
Rs 3"
5"
--""
-"7"
CCCCCCC -"-"
6as&
Accounts recei%a'le
,all fro* #arc& sales.
In%entories+
Ra) *aterials ,"7 9gs Rs 1.
Finis&ed goods
,-" units Rs 15.
Fi4ed assets+
6ost Rs ""
Less+ Accu*ulated
depreciation ,3"5".
Rs 1""
"5"
"
71"
-5"5"-"-"
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$ 2ales forecasts+ Assu*e t&e *ar9eting depart*ent &as de%eloped t&efollo)ing sales forecast for t&e first 0uarter of t&e ne4t ear and t&e sellingprice of Rs 5 per unit$
#ont& Units sales
April #a
=une
"-"
-7"
1$ T&e *anage*ent desires closing in%entor to e0ual per cent of t&efollo)ing *ont&8s sales$
3$ T&e *anufacturing costs are as follo)sDirect *aterials+ ,5 9gs Rs 1. ,per unit.
Direct la'our
aria'le o%er&eads
Total fi4ed o%er&eads ,per annu*.
Rs -5
5
@""5$ Nor*al capacit is -"" units per annu*$ Assu*e a'sorption costing
'asis$
7$ Eac& unit of final product re0uires 5 9gs of ra) *aterials$ Assu*e*anage*ent desires closing ra) *aterial in%entor to e0ual per centof t&e follo)ing *ont&8s re0uire*ents of production$
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@$ Assu*e fi4ed selling and ad*inistrati%e e4penses are Rs " per*ont& and %aria'le selling and ad*inistrati%e e4penses are Rs 5 perunit sold$
$ All sales are on account$ Pa*ent recei%ed )it&in - das fro* t&e dateof sale are su'(ect to a per cent cas& discount$ In t&e past" 7 per cent
of t&e sales )ere collected during t&e *ont& of sale and 3 per cent arecollected during t&e follo)ing *ont&$ Of collections during t&e *ont& ofsale" 5 per cent are collected during t&e discount period$ Accountsrecei%a'le are recorded at t&e gross a*ount and cas& discounts aretreated as a reduction in arri%ing at net sales during t&e *ont& t&e areta9en$
$ Ta4 rate is 15 per cent$
-$ Additional infor*ation+
,a. All purc&ases are on account$ T)o!t&irds are paid for in t&e *ont&of purc&ase and one!t&ird" in t&e follo)ing *ont&$
,'. Fi4ed *anufacturing costs include depreciation of Rs " per*ont&$
,c. Ta4es are paid in t&e follo)ing *ont&$,d. All ot&er costs and/or e4penses are paid during t&e *ont& in )&ic&
incurred$
Fro* t&e foregoing infor*ation prepare a *aster 'udget for t&e *ont& ofApril onl$
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2olution
-$Production Budget
Particulars April #a
2ales ,units. Add+ Desired closing in%entor ,$ ne4t *ont&8s sales.
Total finis&ed goods re0uire*ent
Less+ Opening in%entor
Re0uired production ,units.
""3
--"3
,-".
"7
-"1"
-5"
,"3.
-"
$#anufacturing 6ost Budget Particulars April
Re0uired production ,units.
Direct *aterial cost ,5 9gs Rs 1 per 9g.
Total direct *aterial cost
Total direct la'our cost ,Rs 5 per unit.Total %aria'le o%er&ead cost ,Rs per unit.
Total %aria'le *anufacturing costs
All fi4ed *anufacturing o%er&eads ,Rs @"" - *ont&s.
Total *anufacturing cost
"7
Rs -5
Rs -"33"
3" 7"3
"@"3
7"
1"1"3
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1$Purc&ase Budget ,Ra) #aterials.
Particulars April #a
Production re0uire*ent ,units.
Ra) *aterial re0uired for production H 5 9gs per unit,9gs.
Add+ Desired closing in%entor ,$ #are0uire*ents.
Total re0uire*ents
Less+ Opening in%entor
Purc&ase re0uire*entPurc&ase re0uire*ent ,a*ount H Rs 1 per 9g.
"7
CCCCCC 3"
-"
7"
,"7.
5-"
Rs -"51"7
-"
CCCCC 73"
3$2elling and Ad*inistrati%e E4penses Budget
Particulars April
Units salesaria'le costs H Rs 5 per unit
Fi4ed costs
Total selling and ad*inistrati%e e4penses
"Rs 35"
"
75"
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5$ 6ost of Goods 2old Budget
Particulars April
Units sold
6ost per unit
aria'leFi4ed ,Rs 7" -" units.
Total cost
Rs 7
"
Rs 15
1"-5"
7$ Budgeted Inco*e 2tate*ent for t&e #ont& of April
Gross sales ," Rs 5.
Less+ 6as& discount ,Rs 3"5" $7 $5 $.Net sales
Less+ 6ost of goods sold
Gross *argin ,unad(usted.
Less+ 6apacit %ariance unfa%oura'le ,3 units Rs 7.
Gross *argin ,ad(usted.
Less+ 2elling and ad*inistrati%e e4pensesEarnings 'efore ta4es
Less+ Ta4es ,$15.
Earning after ta4es
Rs 3"5"
"@3"3@"1
1"-5"
-"1"1
"3
-""
75"73"
"@-5
3"-5
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@$Budgeted 2tate*ent of Retained Earnings
Opening 'alance Add: Earnings after ta4es6losing 'alance
Rs -"7" 3"-5
-"7"5
$6as& Budget ,April.
Opening 'alance6as& inflo)s+ 6ollection fro* de'tors+#arc& salesApril sales ,gross. ,Rs 3"5" $7.Less: 6as& discount
,Rs "@" $5 $.6as& outflo)s+ Pa*ent to creditors+ For #arc& purc&ases For April purc&ases ,Rs -"51"7/1.Direct la'our aria'le *anufacturing o%er&ead
Fi4ed *anufacturing o%er&eadLess: Depreciationaria'le selling and ad*inistrati%eo%er&eadsFi4ed selling and ad*inistrati%eo%er&eadsTa4es6losing 'alance
Rs "@"
"@
Rs "5"
"7@"1
3"
-""3
7",".
Rs 1""
5"-@"1
-"3"33"7"3
3"35"
"5"
Rs "-@"1
3"7"3"-"5
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$ Profor*a Balance 2&eet as at #arc& 1-" Ne4t ;ear
Liabilities Amount Assets Amount
Accounts paa'le
,Rs 3" Rs -"51"7 J
Rs -"3"3.
Ta4es paa'le
,Rs 5" Rs "@-5
J Rs 5".
2&are capitalRetained earnings
Rs 5-"
"@-5
--""-"7"5
CCCCCCCC
"3"
6as&
Accounts recei%a'le ,Rs 3"5" $3.
In%entories+
Ra) *aterial
,-" Rs 1.
Finis&ed goods
,"3 Rs 15.Fi4ed assets+
6ost
Less+ Accu*ulated
depreciation
Rs 1"3
3"
""
,3"@".
Rs 3"-"5
-""
-""3
-5"1"
"3"
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2pecial Decision Budgets2pecial Decision Budgets
T&e t&ird categor of 'udgets are special decision'udgets$ T&e relate to in%entor le%els" 'rea9!e%en
analsis" and so on$
Fi4ed Budgets
Budgets prepared at a single le%el of acti%it" )it& no prospect of*odification in t&e lig&t of c&anged circu*stances" are referred to
as fi4ed 'udgets$Fle4i'le Budgets
T&e alternati%e to fi4ed 'udgets are fle4i'le/%aria'le/sliding'udgets
Fi4ed and Fle4i'le BudgetsFi4ed and Fle4i'le Budgets
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Fle4i'le BudgetsFle4i'le Budgets
T&e ter* <fle4i'le8 is an apt description of t&e essential
features of t&ese 'udgets$ A fle4i'le 'udget esti*ates costs
at se%eral le%els of acti%it$
Its *erit is t&at instead of one esti*ate" it contains se%eralesti*ates/plans in different assu*ed circu*stances$ It
is a useful tool in real )orld situations" t&at is" unpredicta'le
en%iron*ent$
A fle4i'le 'udget" in a sense" is a series of fi4ed 'udgets and
an increase/decrease in t&e le%el/%olu*e of acti%it *ust 'e
reflected in it$
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Eac& e4pense in eac& depart*ent/seg*ent is to 'e
categorised into fi4ed" %aria'le and *i4ed co*ponents$A 'udget *a first 'e prepared at t&e e4pected le%el of
acti%it" sa" - per cent capacit$ Additional
colu*ns *a t&en 'e added for costs 'elo) and a'o%e"
per cent and -- per cent capacit and so on$
T&e conceptual fra*e)or9 of fle4i'le 'udgeting relates
to+ ,i. #easure of %olu*e and ,ii. 6ost 'e&a%iour )it&
c&ange in %olu*e
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Ta'le - :pot&etical LtdKFle4i'le Budget ,#aintenance Depart*ent.
olu*e ,la'our!&ours. 3" 3"5 5" 5"5 7"
aria'le costs+
La'our
#aterial
Ot&ers
#i4ed costs+
La'our
#aintenance
Ot&er suppliesDiscretionar fi4ed costs+
Training
E4peri*ental *et&ods
6o**itted fi4ed costs+
Depreciation
Rent" lease cost
Total
Rs 7"
"3
"1
-"3
"5
-"5
1"5
5"
1"5
"
Rs 7"@5
"@
"3
-"35
"@5
"
3"
5"
1"5
1-"35
Rs @"5
1"
-"
"5
-"5
1"
"
3"
5"
1"5
11"
Rs "5
1"1
-"-
"7
-"55
1"5
"
3"
5"
1"5
13"55
Rs "
1"7
-"
"@
-"7
1"5
"5
3"5
5"
1"5
1@"-
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Ta'le + :pot&etical LtdKFle4i'le Budget ,#anufacturing Depart*ent.
olu*e ,*ac&ine!&ours. 5 7 @
aria'le costs+
Po)er
:elpers
Discretionar fi4ed costs+
Training
Tools
6o**itted fi4ed costs+
Depreciation
Rent
Total
Rs 5
5
-"
-"
1"5
Rs 7
1
-"
-"
3"
Rs @
15
-"
-"
3"15
Rs
3
1
-"
-"
3"7
Rs
35
-"
1
-"
-"
3"5
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#odified Fle4i'le Budgets#odified Fle4i'le BudgetsFle4i'le 'udgets" as a tool of planning and control" are superiorto fi4ed 'udgets$
T&e *a(or )ea9nesses of fi4ed 'udgets are t&eir ina'ilit to+
,i. 2&o) t&e potential %aria'ilit of %arious esti*ates used in t&epreparation of t&e 'udget" and
,ii. Indicate t&e range )it&in )&ic& costs *a 'e e4pected to %ar$ T&eare" t&erefore" not useful in an uncertain and unpredicta'le en%iron*ent$
Fle4i'le 'udgets present esti*ates at different le%els of acti%it" and are*ore useful$
Li*itations
Fle4i'le 'udgets suffer fro* one li*itation in t&at t&e do not e4plicitlconsider t&e relati%e pro'a'ilit of a particular %olu*e/cost 'eing ac&ie%ed$T&is li*itation can 'e o%erco*e ' using a *odifiedfle4i'le 'udget )&ic& )ill include colu*ns for different le%elsof esti*ates+ *ost li9el" opti*istic and pessi*istic$
7/23/2019 Budgeting and Profit Planning 101
http://slidepdf.com/reader/full/budgeting-and-profit-planning-101 30/30
© T t M G Hill P bli hi C Li it d M t !
Ta'le 1+ :pot&etical LtdK#odified Fle4i'le Budget ,#anufacturingDepart*ent.
Pessi*istic #ost li9el Opti*istic
olu*e ,la'our!&ours. 3"5 5" 5"5aria'le costs+
La'our
#aterials
Ot&ers
#i4ed costs+
La'our
#aintenance
Ot&er supplies
Discretionar fi4ed costs+
Training
E4peri*ental *et&ods6o**itted fi4ed costs+
Depreciation
Rent" etc$
Total
Rs 7"1@5
"75
5
"15
-"35
"75
-"@5
1"@5
5"
1"5
1"@5
Rs @"5
1"
-"
"5
-"5
1"
"
3"
5"
1"5
11"
Rs "@@5
1"5-
-"-@
1"35
-"55
"7@
"5
3"5
5"
1"5
17"-15
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