Budgeting for Planning and Control

Budget• Budgets are the quantitative expressions of

plans that identify an organization’s objectives and the actions needed to achieve them.

• Budgets can be used to compare actual outcomes with planned outcomes.

• A budget might be a forecast, a means of allocating resources, a standard or a target.

Budget

• A budget is a 'quantitative expression of a plan for a defined period of time.

• It may include – planned sales volumes and revenues; – resource quantities, – costs and expenses; – assets, liabilities and cash flows

Control• It is the process of setting standards, receiving

feedback on actual performance, and taking corrective action.

• Control is best achieved by comparison of the actual results with the original plan.

• Appropriate action can then be taken to correct any deviations from the plan.

• The comparison of actual results with a budgetary plan, and the taking of action to correct deviations, is known as feedback control.

Budgets may help in …

• Authorising expenditure• Communicating objectives and plans• Controlling operations• Co-ordinating activities• Evaluating performance• Planning and rewarding performance

The purposes of budgeting

• They act as authorities to spend, that is, they give authority to budget managers to incur expenditure in their part of the organisation;

• They act as comparators for current performance, by providing a yardstick against which current activities can be monitored. – These two roles are combined in a system of

budgetary planning and control.

Essentials of Budget• It is prepared for a definite future period.

• It is a statement prepared prior to a defined period of time.

• The Budget is monetary and/or quantitative statement of policy.

• The Budget is a predetermined statement and its purpose is to attain a given objective.

• A budget, therefore, be taken as a document which is closely related to both the managerial as well as accounting functions of an organization.

Differences between Forecasting and Budgets

Steps in the preparation of a budget

• The first task in the budgetary process is to identify the principal budget factor.

• This is also known as the key budget factor or limiting budget factor.

• The principal budget factor is the factor which limits the activities of an organisation.– For example, if sales volume is the principal budget factor, then

the sales budget must be prepared first, based on the available

sales forecasts. All other budgets should then be linked to this. Contd …

• In the second step the budget team needs to concentrate on the order of budget preparation.

• Assuming that the principal budget factor has been identified as being sales, the stages involved in the preparation of a budget can be summarised as follows…

Steps in the preparation of a budget

Contd …

Steps in the Preparation of a Budget– The sales budget is prepared in units of product and

sales value. This budget decides the planned increase or decrease in finished goods inventory levels.

– With the information from the sales and inventory budgets, the production budget can be prepared. The production budget will be stated in terms of units.

– This leads on logically to budgeting the resources for production. This involves preparing a materials usage budget, machine usage budget and a labour budget.

• During the preparation of the sales and production budgets, the managers of the cost centres of the organisation will prepare their draft budgets for the department overhead costs.

• Such overheads will include maintenance, stores, administration, selling and research and development.

• From the above information a budgeted income statement can be produced.

Steps in the Preparation of a Budget

• In addition several other budgets must be prepared in order to arrive at the budgeted statement of financial position.

• These are the capital expenditure budget (for non-current assets), the working capital budget (for budgeted increases or decreases in the level of receivables and accounts payable as well as inventories), and a cash budget.

Steps in the Preparation of a Budget

Types of plans

Strategic Planning – It is concerned with preparing long-term action

plans to attain the organisation’s objectives.

– It is also known as corporate planning or long-range planning.

Budgetary Planning– It is concerned with preparing the short- to

medium-term plans of the organisation.

– It will be carried out within the framework of the strategic plan.

– An organisation’s annual budget could be seen as an interim step towards achieving the long-term or strategic plan.

Operational Planning – It refers to the short-term or day-to-day planning

process.

– It is concerned with planning the utilisation of resources and will be carried out within the framework set by the budgetary plan.

– Each stage in the operational planning process can be seen as an interim step towards achieving the budget for the period.

– Operational planning is also known as tactical planning.

Types of Budgets

On the basis of Time• Long-Term Budgets– These are prepared for a longer period varies

between five to ten years.

• Short-Term Budgets– These budgets are usually prepared for a period of

one year.

• Current Budgets– Current budget is a budget which is established for

use over a short period of time and related to current conditions

According to Function• Functional or Subsidiary Budgets– Sales Budget – Purchase Budget – Production Budget – Selling and Distribution Cost Budget – Labour Cost Budget – Cash Budget – Capital Expenditure Budget

• Master Budgets– Master Budget as the summary budget incorporating its

functional budgets, which is finally approved, adopted and employed.

On the basis of Capacity

• Fixed Budget– A fixed budget is designed to remain unchanged

irrespective of the level of activity actually attained.

• Flexible Budget– A flexible budget is a budget which is designed to

change in accordance with the various level of activity actually attained.

Functional Budgets

Functional/departmental budget

• Functional/departmental budgets include budgets for sales, production, purchases and labour.

• A departmental/functional budget is a 'budget of income and/or expenditure applicable to a particular function frequently including sales budget, production cost budget (based on budgeted production, efficiency and utilisation), purchasing budget, human resources budget, marketing budget and research and development budget'.

Sales Budget

• A sales budget is a detailed schedule showing the expected sales for the budget period; typically, it is expressed in both dollars and units of production.

• An accurate sales budget is the key to the entire budgeting in some way.

Production Budget• The product budget is built up from plant

utilisation budget, which shows the extent of utilisation of plant and machinery. – It shows the extent of utilisation of each machine,

– If the capacity is insufficient, extra-shift working may be required or new machinery may be purchased or a portion of output may have to be manufactured by outsideplants,

– If the capacity is idle, the sales department can be alerted to find out ways and means to get additional sales volume.

Labour and Manpower Budget

• This budget will show the number of each grade of workmen required to produce the target output which has been approved by the budget committee.

• It will also indicate anticipated labour cost for the budget period, and the period of training that would be required for the additional workmen, if required to be recruited.

Purchases/Materials Budget

• It will take into account the projected inventories at the commencement of the budget period and the inventory norms fixed by the management and determine the quantities and value of materials that are needed to be purchased.

Cash Budget• A cash budget is a statement in which estimated

future cash receipts and payments are tabulated in such a way as to show the forecast cash balance of a business at defined intervals.

• A cash budget is a 'detailed budget of estimated cash inflows and outflows incorporating both revenue and capital items'.

• A cash budget can give forewarning of potential problems that could arise so that managers can be prepared for the situation or take action to avoid it.

Master budget

• The master budget is a summary of all the functional budgets.

• It usually comprises the budgeted income statement, budgeted balance sheet and budgeted cash flow statement.

• The master budget provides a consolidation of all the subsidiary budgets and normally consists of a budgeted income statement, budgeted statement of financial position, and a cash budget.

Budget variances

• Control involves comparing a flexible budget (based on the actual activity level) with actual results.

• The differences between the flexible budget figures and the actual results are budget variances.

Capital expenditure budgets

Capital expenditure budgets

• Capital expenditure budgeting is the process of establishing a financial plan for purchases of long-term business assets.

• Because of the monetary amounts involved in capital expenditure, the capital expenditure budget is one of the principal subsidiary budgets.

Steps in the preparation of capital expenditure budgets

• Step 1– An accountant or budget officer should be responsible for the capital

expenditure budget.

• Step 2– Sales, production and related budgets cover, in general, a 12-month

period.

– A detailed capital expenditure budget should be prepared for the budget period but additional budgets should be drawn up for both the medium and long term.

• Step 3– The budget covering the 12 month period should be broken down into

monthly or quarterly spending, and details incorporated into the cash budget.

Steps in the preparation of capital expenditure budgets

•Step 4

– Suitable financing must be arranged as necessary.

•Step 5

– The capital expenditure budget should take account of the principal budget factor.

– If available funds are limiting the organisation's activities then they will more than likely limit capital expenditure.

Steps in the preparation of capital expenditure budgets

•Step 6

– As part of the overall budget coordination process, the capital expenditure budget must be reviewed in relation to the other budgets.

•Step 7

– The capital expenditure budget should be updated on a regular basis since both the timing and amount of expenditure can change at short notice.

Example of a capital expenditure budget

Depreciation

• Any depreciation on budgeted capital expenditure will need to be incorporated into the budgeted income statement, along with depreciation on existing non-current assets.

• The depreciation on planned disposals of non-current assets also needs to be taken into consideration.

Example of a capital expenditure budget

Example: budgeted depreciation

• Suppose, for simplicity, XYZ Company (whose capital expenditure budget is shown above) applies a 10% straight-line depreciation policy to all non-current assets.

• All non-current assets are under ten years old. Non-current assets had a cost value of $4,000,000 at the beginning of 20X4.

• Budgeted additions to non-current assets are shown above.

• The plant being replaced by project LV46 has a cost value of $200,000, and will be disposed of at the very end of September (the new plant becoming operational on 1 October 20X4).

Solution• The budgeted depreciation charge for the year is:

Depreciation on non-current assets held at 1 January 20X4 ($4,000,000 × 10%) 400,000

Less: depreciation not charged on disposals (3/12 × 10% × $200,000) (5,000)

Plus: depreciation on additions

LV45 (9/12 × 10% × $100,000) 7,500

LV46 (3/12 × 10% × $500,000) 12,500

Budgeted depreciation charge for 20X4 4,15,000

Approaches to Budgeting

Incremental Budgeting– The traditional approach to budgeting is to

base next year's budget on the current year's results plus an extra amount for estimated growth or inflation next year. – This approach is known as incremental

budgeting since it is concerned mainly with the increments in costs and revenues which will occur in the coming period.

Zero-based budgeting

• It involves preparing a budget for each cost centre from a zero base.

• Every item of expenditure has then to be justified in its entirety in order to be included in the next year's budget.

Rolling Budgets

• A rolling budget is a budget which is continuously updated by adding a further accounting period (a month or quarter) when the earlier accounting period has expired.

Participative budgeting

• It is ‘a budgeting system in which all budget holders are given the opportunity to participate in setting their own budgets'.