PGBM01

Financial Management & Control

Lecture 7 Budgeting

By

Andy Turton.

andy.turton@sunderland.ac.uk

Senior Lecturer of Accounting & Finance

The University of Sunderland

School of Business & Law

Learning Objectives Explain how budgeting fits into the overall

framework of decision-making, planning and control

Describe the purposes and uses of budgets in organisations

Identify the various stages in the “traditional” budgeting process

Describe some of the benefits of effective budgeting

Construct cash budgets from relevant data

The Basic Framework of Budgeting

A budget is a detailed quantitative plan for acquiring

and using financial and other resources over a specified

forthcoming time period.

1. The act of preparing a budget is called

budgeting.

2. The use of budgets to control an

organization’s activity is known as

budgetary control.

Planning and ControlPlanning –

involves developing objectives and preparing various budgets to achieve these objectives.

Control –

involves the steps taken by management that attempt to ensure the objectives are attained.

Advantages of Budgeting

Advantages

Uncover potential

bottlenecks

Communicate

plans

Coordinate

activities

Define goals

and objectivesThink about and

plan for the future

Means of allocating

resources

Why do we produce budgets? To aid the planning of actual operations:

by forcing managers to consider how conditions might change and what steps should be taken now.

by encouraging managers to consider problems before they arise.

To co-ordinate the activities of the organization: by compelling managers to examine relationships between

their own operation and those of other departments. To communicate plans to various responsibility centre

managers: everyone in the organization should have a clear

understanding of the part they are expected to play in achieving the annual budget.

by ensuring appropriate individuals are made accountable for implementing the budget.

Why do we produce budgets? To motivate managers to strive to achieve the budget

goals:

by focusing on participation

by providing a challenge/target.

To control activities:

by comparison between actual and budgeted performance.

To evaluate the performance of managers:

by providing a means of informing managers of how well they are performing in meeting targets they have previously set.

Choosing the Budget Period

Operating Budget

2012 2013 2014 2015

The annual operating budget

may be divided into quarterly

or monthly budgets.

Self-Imposed Budget

A participative budget is prepared with the full cooperation

and participation of managers at all levels. A participative

budget is also known as a self-imposed budget.

Supervisor Supervisor

Middle

Management

Supervisor Supervisor

Middle

Management

Top Management

Advantages of Self-Imposed Budgets1. Individuals at all levels of the organization are viewed as

members of the team whose judgments are valued by top

management.

2. Budget estimates prepared by front-line managers are often

more accurate than estimates prepared by top managers.

3. Motivation is generally higher when individuals participate in

setting their own goals than when the goals are imposed from

above.

4. A manager who is not able to meet a budget imposed from

above can claim that it was unrealistic. Self-imposed budgets

eliminate this explanation.

Overview of the planning process Identify the objectives of the organization.

Identify potential strategies.

Evaluate alternative strategic options.

Select course of action.

Implement the long-term plan in the form of the annual budget.

Monitor actual results.

Respond to divergencies from plan.

Stages in the budgeting process Communicate details of budget policy and

guidelines to those people responsible for preparing the budget.

Determine the factor that restricts output. Preparation of the sales budget. Initial preparation of other budgets. Negotiation of budgets with higher management. Co-ordination and review of budgets. Final acceptance of budgets.Ongoing review of the budgets.

The Master Budget: An OverviewSales

budget

Budgetedincome

statement

Budgetedbalance

sheet

Selling andadministrativeexpense budget

Endinginventory

budget

Productionbudget

Cashbudget

Directlabor

budget

Directmaterials

budget

Manufacturingoverhead

budget

The Integrated Process Primary budget drives all others

Planned increase in sales affects

production

purchases

labour

cost of overheads

financing/cash

An Example - ScenarioL Co. manufactures 2 products - M and N M is manufactured in Department 1 and N in

Department 2 The products consume 2 materials - A and B, and also

direct labour Details of standard costs and usage are given below:

Standard costs per unit:

Material A £5.20 per kilo

Material B £8.80 per kilo

Direct labour £10.00 per hour

An Example - Scenario Overhead recovery is on the basis of direct labour

hours.

Standard usage of materials and labour per unit of product

M N

Material A 5 kilos 8 kilos

Material B 3 kilos 4 kilos

Labour 6 hours 10 hours

An Example - Scenario

Other data:

M N

Forecast units sold 9,000 6,000

Selling price per unit £350 £400

Budgeted closing inventory 1,500 700

Budgeted opening inventory 800 300

An Example - Scenario

Other data:

Direct Materials Inventories

Material A Material B

Budgeted opening inventory (kg) 700 600

Budgeted closing inventory (kg) 1,300 1,000

Budgeted Overheads

Dept 1 Dept 2

Variable (controllable) £3.50/LH £2.00/LH

Fixed (non-controllable) £290,000 £150,000

RequiredDraw up the following budgets…

Sales Budget

Production Budget

Direct Materials Usage Budget

Direct Materials Purchases Budget

Direct Labour Budget

Factory Overhead Budget

Sales Budget Product Units sold Price/unit (£) Total Revenue (£)

M 9,000 350 3,150,000

N 6,000 400 2,400,000

5,550,000

Production BudgetDept 1 (M) Dept 2 (N)

Units to be sold 9,000 6,000

Planned closing inv. 1,500 700

Total units required 10,500 6,700

Less opening inv. (800) (300)

Units to produce 9,700 6,400

Direct Materials Usage Budget

Dept 1 Dept 2Units (kg) Unit Price Total Units (kg) Unit Price Total

A 48,500 £5.20 252,200 51,200 £5.20 266,240

B 29,100 £8.80 256,080 25,600 £8.80 225,280508,280 491,520

Total Units calculated as:

Production budget X Kilos per unit =

Product M (material A): 9,700 X 5 = 48,500 Kg

Product M (material B): 9,700 x 3 = 29,100 Kg

(same for product N)

Direct Materials Usage Budget

TotalsTotal Units (kgs) Total Cost (£)

A 99,700 518,440

B 54,700 481,360

999,800

Direct Materials Purchases Budget Material A Material B

Production requirement (DM usage) 99,700 54,700

Planned closing inventory 1,300 1,000

Total needed 101,000 55,700Less opening inventory 700 600

purchases of direct material 100,300 55,100

Planned purchase price £5.20 £8.80

Budgeted Purchases £521,560 £484,880

Direct Labour Budget Dept 1Dept 2

Budgeted production (units) 9,700 6,400

Hours per unit 6 10

Total budgeted hours 58,200 64,000

Budgeted wage rate £10.00 £10.00

Total wages £582,000 £640,000

Factory Overhead Budget Anticipated activity - Department 1 = 58,200 hours

Anticipated activity - Department 2 = 64,000 hours

Dept 1 Dept 2

Controllable overhead *203,700 *128,000

Non-controllable overhead 290,000 150,000

Total overhead 493,700 278,000

Budgeted departmental overhead rate **£8.48 **£4.34

* 58,200 LH X £3.50 & 64,000 LH x £ 2 ** 493,700/58,200 & 278,000/64,000

The Cash Budget Will deal with Cash Budget as separate entity

Workshop example - Harmison Co.

Other budgeting methods – self learning Incremental budgeting

Activity-based budgeting (ABB)

Zero Based Budgeting (ZBB)