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PGBM01 Financial Management & Control Lecture 7 Budgeting

Francis Kuagbela 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 organizations activity is known as budgetary control.

Planning and Control


Planning
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
Define goals and objectives Communicate plans Think about and plan for the future

Advantages
Coordinate activities
Uncover potential bottlenecks

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
Top Management Middle Management Middle Management

Supervisor

Supervisor

Supervisor

Supervisor

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.

1.

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

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 Overview


Sales budget Ending inventory budget Direct materials budget Selling and administrative expense budget

Production budget Direct labor budget Cash budget

Manufacturing overhead budget

Budgeted income statement

Budgeted balance sheet

The Integrated Process


Primary budget drives all others Planned increase in sales affects production purchases labour cost of overheads financing/cash

An Example - Scenario
L 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 Material B Direct labour 5.20 per kilo 8.80 per kilo 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 Material A Material B Labour 5 kilos 3 kilos 6 hours N 8 kilos 4 kilos 10 hours

An Example - Scenario
Other data: M Forecast units sold Selling price per unit Budgeted closing inventory Budgeted opening inventory 9,000 350 1,500 800 N 6,000 400 700 300

An Example - Scenario
Other data:
Direct Materials Inventories
Material A Material B

Budgeted opening inventory (kg)


Budgeted closing inventory (kg)
Budgeted Overheads
Dept 1 Variable (controllable) Fixed (non-controllable)

700
1,300

600
1,000

Dept 2 2.00/LH 150,000

3.50/LH 290,000

Required
Draw 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

6,000

400

2,400,000 5,550,000

Production Budget
Dept 1 (M) Dept 2 (N)

Units to be sold Planned closing inv. Total units required Less opening inv. Units to produce

9,000 1,500 10,500 (800) 9,700

6,000 700 6,700 (300) 6,400

Direct Materials Usage Budget


Dept 1
Units (kg) A 48,500 B 29,100 Unit Price 5.20 8.80 Total 252,200 256,080 508,280 51,200 25,600

Dept 2
Units (kg) Unit Price 5.20 8.80 Total 266,240 225,280 491,520

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

Totals
Total Units (kgs) Total Cost () A B 99,700 54,700 518,440 481,360 999,800

Direct Materials Purchases Budget


Material A
Production requirement (DM usage) Planned closing inventory 99,700 1,300

Material B
54,700 1,000

Total needed Less opening inventory


purchases of direct material Planned purchase price Budgeted Purchases

101,000 700
100,300 5.20 521,560

55,700 600
55,100 8.80 484,880

Direct Labour Budget


Dept 1
Budgeted production (units) Hours per unit Total budgeted hours 9,700 6 58,200

Dept 2
6,400 10 64,000

Budgeted wage rate


Total wages

10.00
582,00

10.00
640,000

Factory Overhead Budget


Anticipated activity - Department 1 = 58,200 hours
Anticipated activity - Department 2 = 64,000 hours Dept 1 Controllable overhead Non-controllable overhead Total overhead *203,700 290,000 493,700 Dept 2 *128,000 150,000 278,000 **4.34

Budgeted departmental overhead rate **8.48

* 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. See textbook for cash budget (page 289 293) Other budgeting methods self learning
Incremental budgeting Activity-based budgeting (ABB) Zero Based Budgeting (ZBB)

End of session 7