You may have noticed that in each of these 'budgets' the time period was different. The most important budget factor (key budget) is the factor that limits the organization's activities. It will show the cash effect of all decisions made in the planning process.
Preparing cash budgets
You are required to prepare a cash budget for each of the months July through September.
Interpretation of the cash budget
For example, all payments in August may be made at the beginning of the month, but collections may not be expected until the end of the month. The cash deficit can be significantly larger than it appears from just looking at the month-end balance. A 5 percent commission is paid to agents on all credit sales, but this is not paid until the month following the sales to which it relates; this expense is not included in the overall figures presented. k) Assume that overdraft facilities are available if required.
Solution
A complete exercise
Production overhead is estimated at £200,000, which includes £25,000 for property and equipment depreciation. The sales director has predicted that sales of Alfa and Beta will be 5,000 and 1,000 units respectively during year 3. She estimates that the inventory on January 1, year 3, will be 100 units of Alpha and 200 units of Beta.
At the end of year 3, she requires that the inventory level be 150 units of each product. The production director estimates that raw material inventories on January 1, year 3, will be 3,000 units of material M and 4,000 units of material N. The finance director recommends that the tax rate payable on profits in year 3 is equal to 3,000 units of material M and 4,000 units of material N. probably 30 percent.
SG&A is budgeted to be £75,000 in year 3, which includes £5,000 for equipment depreciation. You are required to prepare company budgets for year 3 including a budgeted income statement for the year and a balance sheet at December 31, year 3. The sales budget determines production requirements, which in turn determines the use of materials, i which in turn determines the material - purchases and then payments to suppliers.
Since the sales budget is prepared first, sales is called the most important (important) budget factor.
Rolling budgets
Budgets for non-operating functions
- Incremental budgeting
- Zero-based budgeting
Budgets for non-operating functions such as IT services and research and development are only indirectly related to activity levels. Determining the level of expenses that will be included in these non-functional budgets is not that simple. This means that the budget for each period is based on the actual budget or results for the previous period, adjusting for any changes and expected inflation.
It tends to perpetuate inefficient and unnecessary practices and can result in budget slack, which is unnecessary spending built into the budget. CIMA terminology defines ZBB as a 'method of budgeting that requires all costs to be specifically justified by the expected benefits. Zero-based budgeting is so called because it requires each budget to be prepared and justified from scratch, rather than simply using last year's budget or actual results as a basis.
The incremental spending levels for each activity are evaluated based on the resulting incremental benefits. The major advantage of ZBB exercises is that managers are forced to consider alternative ways of achieving the objectives of their activity and justify the activities they are currently undertaking. This helps eliminate or reduce budget understatement, that is, deliberately overestimating expenses and/or underestimating revenues in the budgeting process.
A detailed discussion of ZBB is beyond the scope of your Fundamentals of Management Accounting syllabus, but you should be aware that there are a number of different approaches to budget planning.
Budgetary control information
- Budget centres
- Budgetary control reports
Based budgeting is so called because it requires that each budget be prepared and justified from scratch, rather than simply using last year's budget or actual results as a basis. Each center will have its own budget and a manager will be responsible for managing the center and controlling the budget. Regular budget control reports will be sent to each budget holder so that they can monitor the activities of their center and take control measures if necessary.
The information must be made available as soon as possible after the end of the control period. Corrective action will be much more effective if taken soon after the event, and adverse trends may persist unnoticed if budget reporting systems are slow. The design of budget reporting systems must allow for sufficient accuracy for the purpose to be achieved.
Subsidiary information can be provided on the items that are in line with the budget. A number of accounting packages have the ability to record actual and budget information against each account code for each budget center. Control information should be directed to the manager who has the responsibility and authority to act on it.
If the information is communicated to the wrong manager, its value will be instantly lost and any negative trends may continue uncorrected.
Fixed and flexible budgets
- Flexible budgets: an example
- Preparing a flexible budget
- The total budget variance
- Using flexible budgets for planning
- Flexible budgets: another example
- Extrapolating outside the relevant range
- Example: producing a flexible budget control statement
Now that managers are aware of the fixed costs and the variable costs per unit, it is possible to 'flex' the original budget to produce a budgeted cost allowance for 1,000 units produced. For the costs that are completely fixed or completely variable, the calculation of the budget cost allowance is quite simple. The budget can be designed in such a way that the fixed costs are distinguished from the variable costs.
Lawrence Ltd operates a system of flexible budgets and the flexible expenditure budgets for the first two quarters of year 3 were as follows: You are to prepare a budgeted cost statement for quarter 3 when sales were 14,500 units and production was 15,000 units. For the remaining costs, you will need to use the high-low method to determine the fixed and variable elements.
Projected sales revenue and budgeted cost adjustments for variable costs are increased by a factor to derive the revised budget for the actual activity achieved during the period. A favorable sales price variance indicates that a higher than standard sales price was charged for the units sold. Expenditures for direct material, direct labor costs and other overhead costs were lower than budget allowances for the achieved level of activity.
Expenditure on production overheads, both fixed and variable, was higher than the budgeted cost allowance for the level of activity achieved.
Using budgets as a basis for rewards
- Example
- Factors to consider in the design of budget reward schemes
Summary
Multiple choice
- When preparing a production budget, the quantity to be produced equals
- The term ‘ budget slack ’ refers to
- Of the four costs shown below, which would not be included in the cash budget of an insurance fi rm?
- The following details have been extracted from the receivables collection records of C Limited
- A fl exible budget is
- The following extract is taken from the production cost budget of S Limited
- A master budget comprises
- A recent budgetary control report shows the following information
Short objective-test questions
- Which of the following items of information would be contained in the budget manual? (Tick all that are correct.)
- Is the following statement true or false?
- Assuming that sales volume is the principal budget factor, place the following budgets in the order that they would be prepared in the budgetary planning process
- The totals from KM Ltd’s budgetary control report for February are as follows;
- F Limited uses a fl exible budgeting system to control the costs incurred in its staff canteen
- The following extract is taken from the catering costs budget of a company that provides training courses
- The distribution manager is paid a bonus of 5% of any savings he achieves against a fl exible budget cost allowance for distribution costs each period
Each unit of product Y requires 8 kg of material Z. Budgeted inventory is as follows: requires 8 kg of material Z. Budgeted inventory is as follows:. Ten percent of the input of liquid L is lost through evaporation in the production process. Complete the following table and check the box to indicate whether the variance is adverse or favorable.
Sending budget reports only to those exceptional managers who can understand their content. Providing detailed reports only on those areas of the business that are performing exceptionally well and providing only subsidiary activities. Providing detailed reports on only those areas of the business that are not performing to budget and only providing.
The budget cost allowance for consumables is flexed according to the average number of employees during the period. Flexible budgeting budgets fixed (budgeted variable average number) cost allowance costs (cost per employee of employees) for consumables. The budget cost allowances for distribution costs for the previous two periods were as follows.
In the last period the number of tonnes distributed was 13,200 and the distribution costs incurred were £130,900.
Functional budgets
Flexible budget budgeted fixed (budgeted variable average number) cost reimbursement costs (cost per employee of employees) for consumables. 2.11 The extract below comes from the catering costs budget of a company that provides training. In each case, 2.5 kg of ingredients are used and the policy is to have an inventory of ingredients at the end of each month so that 50 percent of next month's production can be covered. As of June 1, 750 cases of ready-to-serve ice cream are in stock and the policy is to have stock at the end of each month to cover 10 percent of the following month's sales. A).
Cash budget
Flexible budget
- Answer: (B)
- Answer: (B)
- A system of budgeting whereby the budget is continuously updated by adding a further accounting period when the earliest accounting period has expired is known
- Exception reporting involves providing detailed reports only on those areas of the business that are not performing according to budget and providing only subsid-
- In a fl exible budget for 185 delegates the budget cost allowance for catering costs will be £2,185
- The bonus payable to the distribution manager for the period is £75
In question 1.2 you cannot simply add 20 percent to the actual hours worked to allow for idle time. Downtime is 20 percent of billable hours, so you'll need to think more carefully about how to make the adjustment. The sales volume contribution variance is the reduction of the budgeted contribution for the period.
The sales price variance is the difference between the sales revenue that has been achieved and the sales revenue that would be expected for the actual level of activity that has occurred (ie, the sales revenue in the flexible budget). The sales volume contribution variance is the additional standard contribution that arose as a result of the change in sales volume from the original budget. The expenditure variance is the difference between the actual expenditure and the expenditure that would be expected for the actual activity achieved.
The total budget variance is the difference between the initial budget contribution and the actual contribution achieved. Read the wording of the question carefully to determine the timing of each cash flow. A common mistake in this type of question is to calculate the spending variance (part (b)) by comparing actual results to the budget given in the question.
This is the budget for quite different levels of activity, so the variable budget should be used.
