BUDGETING PROCESS

TABLE OF CONTENTS
2.1 THE BUDGETING PROCESS ............................................................................................... 2
2.2 RELATIONSHIP BETWEEN BUDGETING AND LONG-TERM PLANNING ............. 2
2.3 THE MULTIPLE FUNCTIONS OF BUDGETS ................................................................... 3
2.3.1 Planning .......................................................................................................................... 4
2.3.2 Coordination.................................................................................................................... 4
2.3.3 Communication ............................................................................................................... 4
2.3.4 Motivation ....................................................................................................................... 5
2.3.5 Control ............................................................................................................................ 5
2.3.6 Performance Evaluation .................................................................................................. 6
2.4 CONFLICTING ROLES OF BUDGETS ............................................................................... 6
2.5 THE BUDGET PERIOD.......................................................................................................... 6
2.6 ADMINISTRATION OF THE BUDGETING PROCESS ................................................... 7
2.6.1 The Budget Committee ............................................................................................................. 7
2.6.2 Accounting Staff ........................................................................................................................ 8
2.6.3 Budget Manual .......................................................................................................................... 8
2.7 STAGES IN THE BUDGETING PROCESS ......................................................................... 8
2.7.1 Communicating Details of the Budget .................................................................................... 9
2.7.2 Determining the Factor that Restricts Performance ............................................................. 9
2.7.3 Preparation of the Sales Budget .............................................................................................. 9
2.7.4 Initial Preparation of Budgets ............................................................................................... 10
2.7.5 Negotiation of Budgets............................................................................................................ 10
2.7.6 Coordination and Review of Budgets .................................................................................... 12
2.7.7 Final Acceptance of the Budgets ............................................................................................ 13
2.7.8 Budget Review ......................................................................................................................... 13
2.8 SUMMARY ............................................................................................................................. 14

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 BUDGETING PROCESS

BUDGETING PROCESS

2.1 THE BUDGETING PROCESS

In the previous four chapters we have considered how management accounting can
assist managers in making decisions. The actions that follow managerial decisions
normally involve several aspects of the business, such as the marketing, production,
purchasing and finance functions, and it is important that management should coordinate
these various interrelated aspects of decision-making. If they fail to do this, there is a
danger that managers may each make decisions that they believe are in the best interests
of the organization when, in fact, taken together they are not, for example, the marketing
department may introduce a promotional campaign that is designed to increase sales
demand to a level beyond that which the production department can handle. The various
activities within a company should be coordinated by the preparation of plans of actions
for future periods. These detailed plans are usually referred to as budgets.

Our objective in this chapter is to focus on the planning process within a business
organization and to consider the role of budgeting within this process. What do we mean
by planning? Planning is the design of a desired futured and of effective ways of
bringing it about (Ackoff, 1981). A distinction is normally made between short-term
planning (budgeting) and long-range planning, alternatively known as strategic or
corporate planning. How is long-range planning distinguished from other forms of
planning? Sizer (1989) defines long-range planning as a systematic and formalized
process for purposely directing and controlling future operations towards desired
objectives for periods extending beyond one year. Short-term planning or budgeting,
on the other hand, must accept the environment of today, and the physical, human and
financial resources at present available to the firm. These are to a considerable extent
determined by the quality of the firm’s long-range planning efforts.

2.2 RELATIONSHIP BETWEEN BUDGETING AND LONG-TERM PLANNING

The annual budget should be set within the context of longer-term plans, which are likely
to exist even if they have not been made explicit. Long-term planning involves strategic
planning over several years and the identification of the basic strategy of the firm (i.e.,
the future direction the organization will take) and the gaps which exist between the
future needs and present capabilities. A long-term plan is a statement of the preliminary

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targets and activities required by an organization to achieve its strategic plans together
with a broad estimate for each year of the resources required. Because long-term
planning involves ‘looking into the future’ for several years the plans tend to be
uncertain, general in nature, imprecise and subject to change.

Budgeting is concerned with the implementation of the long-term plan for the year
ahead. Because of the shorter planning horizon budgets are more precise and detailed.
Budgets are a clear indication of what is expected to be achieved during the budget
period whereas long-term plans represent the broad directions that top management
intend to follow.

The budget is not something that originates ‘from nothing’ each year – it is developed
within the context of ongoing business and is ruled by previous decisions that have been
taken within the long-term planning process. When the activities are initially approved
for inclusion in the long-term plan, they are based on uncertain estimates that are
projected for several years. These proposals must be reviewed and revised in the light
of more recent information. This review and revision process frequently takes place as
part of the annual budgeting process, and it may result in important decisions being
taken on possible activity adjustments within the current budget period. The budgeting
process cannot therefore be viewed as being purely concerned with the current year – it
must be considered as an integrated part of the long-term planning process.

2.3 THE MULTIPLE FUNCTIONS OF BUDGETS

Budgets serve a number of useful purposes. They include:

1. Planning annual operations;

2. Coordinating the activities of the various parts of the organization and ensuring
that the parts are in harmony with each other;
3. Communicating plans to the various responsibility centre managers;
4. Motivating managers to strive to achieve the organizational goals;
5. Controlling activities;
6. Evaluating the performance of managers

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Let us now examine each of these six factors:

2.3.1 Planning

The major planning decisions will already have been made as part of the long-
term planning process. However, the annual budgeting process leads to the
refinement of those plans, since managers must produce detailed plans for the
implementation of the long-term range plan. Without the annual budgeting
process, the pressures of day-to-day operating problems may tempt managers
not to plan for future operations. The budgeting process ensures that managers
do plan for future operations, and that they consider how conditions in the next
year might change and what steps they should take now to respond to these
changed conditions. This process encourages managers to anticipate problems
before they arise, and hasty decisions that are made on the spur of the moment,
based on expediency rather than reasoned judgement, will be minimized.

2.3.2 Coordination

The budget serves as a vehicle through which the actions of the different parts
of an organization can be brought together and reconciled into a common plan.
Without any guidance, managers may each make their own decisions, believing
that they are working in the best interest of the organization. For example, the
purchasing manager may prefer to place large orders so as to obtain large
discounts; the production manager will be concerned with avoiding high stock
levels; and the accountant will be concerned with the impact of the decision on
the cash resources of the business. It is the aim of budgeting to reconcile these
differences for the good of the organization as a whole, rather than for the benefit
of any individual area. Budgeting therefore compels managers to examine the
relationship between their own operations and those of other departments, and,
in the process, to identify and resolve conflicts.

2.3.3 Communication

If an organization is to function effectively, there must be definite lines of

communication so that all the parts will be kept fully informed of theplans and
the policies and constraints, to which the organization is expected to conform.
Everyone in the organization should have a clear understanding of the part they

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are expected to play in achieving the annual budget. This process will ensure
that the appropriate individuals are made accountable for implementing the
budget. Through the budget, top management communicates its expectations to
lower-level management, so that all members of the organization may
understand these expectations and can coordinate their activities to attain them.
It is not just the budget itself that facilitates communication – much vital
information is communicated in the actual act of preparing it.

2.3.4 Motivation

The budget can be a useful device for influencing managerial behaviour and
motivating managers to perform in line with the organizational objectives. A
budget provides a standard that under certain circumstances, a manager may be
motivated to strive to achieve. However, budgets can also encourage
inefficiency and conflict between managers. If individuals have actively
participated in preparing the budget, and it is used as a tool to assist managers in
managing their departments, it can act as a strong motivational device by
providing a challenge. Alternatively, if the budget is dictated from above, and
imposes a threat rather than a challenge, it may be resisted and do more harm
than good.

2.3.5 Control

A budget assists mangers in managing and controlling activities for which they
are responsible. By comparing the actual results with the budgeted amounts for
different categories of expenses, managers can ascertain which costs do not
conform to the original plan and thus require their attention. This process
enables management to operate a system of management by exception which
means that a manager’s attention and effort can be concentrated on significant
deviations from the expected results. By investigating the reasons for the
deviations, managers may be able to identify inefficiencies such as the purchase
of inferior quality materials. When the reasons for the inefficiencies have been
found, appropriate control action should be taken to remedy the situation.

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2.3.6 Performance Evaluation

A manager’s performance is often evaluated by measuring his or her success in

meeting the budgets. In some companies’ bonuses are awarded on the basis of
an employee’s ability to achieve the targets specified in the periodic budgets, or
promotion may be partly dependent upon a manager’s budget record. In
addition, the manager may wish to evaluate his or her own performance. The
budget thus provides a useful means of informing managers of how well they
are performing in meeting targets that they have previously helped to set.

2.4 CONFLICTING ROLES OF BUDGETS

Because a single budget system is normally used to serve several purposes there is a
danger that they may conflict with each other. For instance, the planning and motivation
roles may be in conflict with each other. Demanding budgets that may not be achieved
may be appropriate to motivate maximum performance, but they are unsuitable for
planning purposes. For these a budget should be set based on easier targets that are
expected to be met.

There is also a conflict between the planning and performance evaluation roles. For
planning purposes budgets are set in advance of the budget period based on an
anticipated set of circumstances or environment. Performance evaluation should be
based on a comparison of actual performance with an adjusted budget to reflect the
circumstances under which managers actually operated. In practice, many firms
compare actual performance with the original budget (adjusted to the actual level of
activity, i.e., a flexible budget), but if the circumstances envisaged when the original
budget was set have changed then there will be a planning and evaluation conflict.

2.5 THE BUDGET PERIOD

The conventional approach is that once per year the manager of each budget centre
prepares a detailed budget for one year. The budget is divided into either twelve
monthly or thirteen four-weekly periods for control purposes.

An alternative approach is for the annual budget to be broken down by months for the
first three months, and by quarters for the remaining nine months. The quarterly budgets
are then developed on a monthly basis as the year proceeds. For example, during the
first quarter, the monthly budgets for the second quarter will be prepared; and during

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the second quarter, the monthly budgets for the third quarter will be prepared. The
quarterly budgets may also be reviewed as the year unfolds. For example, during the
first quarter, the budget for the next three quarters may be changed as new information
becomes available. A new budget for a fifth quarter will also be prepared. This process
is known as continuous or rolling budgeting, and ensures that a twelve-month budget
is always available by adding a quarter in the future as the quarter just ended is dropped.
Contrast this with a budget prepared once per year. As the year goes by, the period for
which a budget is available will shorten util the budget for next year is prepared. Rolling
budgets also ensure that planning is not something that takes place once a year when the
budget is being formulated. Instead, budgeting is a continuous process, and managers
are encouraged to constantly look ahead and review future plans. Furthermore, it is
likely that actual performance will be compared with a more realistic target, because
budgets are being constantly reviewed and updated.

Irrespective of whether the budget is prepared on an annual or a continuous basis, it is

important that monthly or four-weekly budgets be used for control purposes.

2.6 ADMINISTRATION OF THE BUDGETING PROCESS

It is important that suitable administration procedures be introduced to ensure that the

budget process works effectively. In practice, the procedures should be tailor-made to
the requirements of the organization, but as a general rule a firm should ensure that
procedures are established for approving the budgets and that the appropriate staff
support is available for assisting managers in preparing their budgets.

2.6.1 The Budget Committee

The budget committee should consist of high-level executives who represent the
major segments of the business. Its major task is to ensure that budgets are
realistically established and that they are coordinated satisfactorily. The normal
procedure is for the functional heads to present their budget to the committee for
approval. If the budget does not reflect a reasonable level of performance, it will
not be approved and the functional head will be required to adjust the budget and
re-submit it for approval. It is important that the person whose performance is
being measured should agree that the revised budget can be achieved; otherwise,
if it is considered to be impossible to achieve, it will not act as a motivational
device. If budget revisions are made, the budgetees should at least feel that they
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were given a fair hearing by the committee. We shall discuss budget negotiation
in more detail later in this chapter.

The budget committee should appoint a budget officer, who will normally be the
accountant. The role of the budget officer is to coordinate the individual budgets
into a budget for the whole organization, so that the budget committee and the
budgetee can see the impact of an individual budget on the organization as a
whole.

2.6.2 Accounting Staff

The accounting staff will normally assist managers in the preparation of their
budgets; they will, for example, circulate and advise on the instructions about
budget preparation, provide past information that may be useful for preparing
the present budget, and ensure that managers submit their budgets on time. The
accounting staff do not determine the content of the various budgets, but they do
provide a valuable advisory and clerical service for the line managers.

2.6.3 Budget Manual

A budget manual should be prepared by the accountant. It will describe the

objectives and procedures involved in the budgeting process and will provide a
useful reference source for managers responsible for budget preparation. In
addition, the manual may include a timetable specifying the order in which the
budgets should be prepared and the dates when they should be presented to the
budget committee. The manual should be circulated to all individuals who are
responsible for preparing budgets.

2.7 STAGES IN THE BUDGETING PROCESS

The important stages are as follows:

1. Communicating details of budget policy and guidelines to those people

responsible for the preparation of budgets;
2. Determining the factor that restricts output;
3. Preparation of the sales budget;
4. Initial preparation of various budgets;
5. Negotiation of budgets with superiors;
6. Coordination and review of budgets;
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7. Final acceptance of budgets;

8. Ongoing review of budgets.

Let us now consider each of these stages in more detail.

2.7.1 Communicating Details of the Budget

Many decisions affecting the budget year will have been taken previously as part
of the long-term planning process. The long-range plan is therefore the starting
point for the preparation of the annual budget. Thus, top management must
communicate the policy effects of the long-term plan to those responsible for
preparing the current year’s budgets. Policy effects might include planned
changes in sales mix, or the expansion or contraction of certain activities. In
addition, other important guidelines that are to govern the preparation of the
budget should be specified – for example the allowances that are to be made for
price and wage increases, and the expected changes in productivity. Also, any
expected changes in industry demand and output should be communicated by
top management to the managers responsible for budget preparation. It is
essential that all managers be made aware of the policy of top management for
implementing the long-term plan in the current year’s budget so that common
guidelines can be established. The process also indicates to the managers
responsible for preparing the budgets how they should respond to any expected
environmental changes.

2.7.2 Determining the Factor that Restricts Performance

In every organization there is some factor that restricts performance for a given
period. In the majority of organizations this factor is sales demand. However,
it is possible for production capacity to restrict performance when sales demand
is in excess of available capacity. Prior to the preparation of the budgets, it is
necessary for top management to determine the factor that restricts performance,
since this factor determines the point at which the annual budgeting process
should begin.

2.7.3 Preparation of the Sales Budget

The volume of sales and the sales mix determine the level of a company’s
operations, when sales demand is the factor that restricts output. For this reason,

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the sales budget is the most important plan in the annual budgeting process. This
budget is also the most difficult plan to produce, because total sales revenue
depends on the actions of customers. In addition, sales demand may be
influenced by the state of the economy or the actions of competitors.

2.7.4 Initial Preparation of Budgets

The managers who are responsible for meeting the budgeted performance should
prepare the budget for those areas for which they are responsible. The
preparation of the budget should be a ‘bottom-up’ process. This means that the
budget should originate at the lowest levels of management and be refined and
coordinated at higher levels. The justification for this approach is that it enables
managers to participate in the preparation of their budgets and increases the
probability that they will accept the budget and strive to achieve the budget
targets.

There is no single way in which the appropriate quantity for a particular budget
item is determined. Past data may be used as the starting point for producing the
budgets, but this does not mean that budgeting is based on the assumption that
what has happened in the past will occur in the future. Changes in future
conditions must be taken into account, but past information may provide useful
guidance for the future. In addition, managers may look to the guidelines
provided by top management for determining the content of their budgets. For
example, the guidelines may provide specific instructions as to the content of
their budgets and the permitted changes that can be made in the prices of
purchases of materials and services. For production activities standard costs may
be used as the basis for costing activity volumes which are planned in the budget.

2.7.5 Negotiation of Budgets

To implement a participative approach to budgeting, the budget should be

originated at the lowest level of management. The managers at this level should
submit their budget to their superiors for approval. The superior should then
incorporate this budget with other budgets for which he or she is responsible and
then submit this budget for approval to his or her superior. The manager who is
the superior then becomes the budgetee at the next higher level. The process is

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illustrated in Figure 1 Sizer (1989) describes this approach as a two-way process

of a top-down approval by senior management.

The lower-level managers are represented by boxes 1-8. Managers 1 and 2 will
prepare their budgets in accordance with the budget policy and the guidelines
laid down by top management.

Figure 1 – An Illustration of Budgets moving up the Organization

Hierarchy

Production Manager

Manager of Plant 1 Manager of Plant 2

Dept A Dept B Dept C Dept D

3 4 5 6 7 8
1 2

The managers will submit their budget to their supervisor, who is in charge of
the whole department (Department A). Once these budgets have been agreed by
the manager of department A, they will be combined by the departmental
manager, who will then present this budget to his or her superior (manager of
plant 1) for approval. The manager of plant 1 is responsible for department B,
and will combine the agreed budgets for departments A and B before presenting
the combined budget to his or her supervisor (the production manager). The
production manager will merge the budget for plants 1 and 2, and this final
budget will represent the production budget that will be presented to the budget
committee for approval.

At each of these stages the budgets will be negotiated between the budgetees and
their superiors, and eventually they will be agreed by both parties. Hence the
figures that are included in the budget are the result of a bargaining process
between a manager and his or her superior. It is important hat the budgetees

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should participate in arriving at the final budget and that the superior does not
revise the budget without giving full consideration to the subordinates’
arguments for including any of the budgeted items. Otherwise, real participation
will not be taking place, and it is unlikely that the subordinate will be motivated
to achieve a budget that he or she did not accept.

It is also necessary to be watchful that budgetees do not deliberately attempt to

obtain approval for easily attainable budgets, or attempt to deliberately
understate budgets in the hope that the budget that is finally agreed will represent
an easily attainable target. It is equally unsatisfactory for a superior to impose
difficult target in the hope that an authoritarian approach will produce the desired
results. The desired results may be achieved in the short term, but only at the
cost of a loss of morale and increased labour turnover in the future.

The negotiation process is of vital importance in the budgeting process, and can
determine whether the budget becomes a really effective management tool or
just a clerical device. If managers are successful in establishing a position of
trust and confidence with their subordinates, the negotiation process will
produce a meaningful improvement in the budgetary process and outcomes for
the period.

2.7.6 Coordination and Review of Budgets

As the individual budgets move up the organizational hierarchy in the

negotiation process, they must be examined in relation to each other. This
examination may indicate that some budgets are out of balance with other
budgets and need modifying so that they will be compatible with other
conditions, constraints and plans that are beyond a manager’s knowledge or
control. For example, a plant manager may include equipment replacement in
his or her budget when funds are simply not available. The accountant must
identify such inconsistencies and bring them to the attention of the appropriate
manager. Any changes in the budgets should be made by the responsible
managers, and this may require that the budgets be recycled from the bottom to
the top for a second or even a third time until all the budgets are coordinated and
are acceptable to all the parties involved. During the coordination process, a
budgeted profit and loss account, a balance sheet and a cash flow statement

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should be prepared to ensure that all the parts combine to produce an acceptable
whole. Otherwise, further adjustments and budget recycling will be necessary
until the budgeted profit and loss account, the balance sheet and the cash flow
statement prove to be acceptable.

2.7.7 Final Acceptance of the Budgets

When all the budgets are in harmony with each other, they are summarized into
a master budget consisting of a budgeted profit and loss account, a balance
sheet and a cash flow statement. After the master budget has been approved, the
budgets are then passed down through the organization to the appropriate
responsibility centres. The approval of the master budget is the authority for the
manager of each responsibility centre to carry out the plans contained in each
budget.

2.7.8 Budget Review

The budget process should not stop when the budgets have been agreed.
Periodically, the actual results should be compared with the budgeted results.
These comparisons should normally be made on a monthly basis and a report
sent to the appropriate budgetees in the first week of the following month, so
that it has the maximum motivational impact. This will enable management to
identify the items that are not proceeding according to plan and to investigate
the reasons for the differences. If these differences are within the control of
management, corrective action can be taken to avoid similar inefficiencies
occurring again in the future. However, the differences may be due to the fact
that the budget was unrealistic to begin with, or that the actual conditions during
the budget year were different from those anticipated; the budget for the
remainder of the year would then be invalid.

During the budget year, the budget committee should periodically evaluate the
actual performance and reappraise the company’s future plans. If there are any
changes in the actual conditions from those originally expected, this will
normally mean that the budget plans should be adjusted. This revised budget
then represents a revised statement of formal operating plans for the remaining
portion of the budget period. The important point to note is that the budgetary

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process does not end for the current year once the budget has begun; budgeting
should be seen as a continuous and dynamic process.

2.8 SUMMARY

Every organization needs to plan and consider how to confront future potential risks and
opportunities. In most organizations this process is formalized by preparing annual
budgets and monitoring performance against the budgets. Budgets are merely a
collection of plans and forecasts. They reflect the financial implications of business
plans, identifying the amount, quantity and timing of resources needed.

The annual budget should be set within the context of longer-term plans, which are likely
to exist even if they have not been made explicit. Long-term planning involves strategic
planning over several years and the identification of the basic strategy of the firm (i.e.,
the future direction the organization will take) and the gaps which exist between the
future needs and present capabilities. A long-term plan is a statement of the preliminary
targets and activities required by an organization to achieve its strategic plans together
with a broad estimate for each year of the resources required. Because long-term
planning involves ‘looking into the future’ for several years ahead, the plans tend to be
uncertain, general in nature, imprecise and subject to change.

Annual budgeting is concerned with the implementation of the long-term plan for the
year ahead. Before the annual budgeting process is begun, top management must
communicate the policy effects of the long-term plan to those responsible for preparing
the current year’s budgets. Normally, the sales budget is the first to be prepared, and
this supplies the basic data for producing the remaining budgets. The managers
responsible for meeting budgeted performance should prepare the budgets for those
areas for which they are responsible and submit them to their superiors for approval. As
the budgets move up the organizational hierarchy, they must be examined in relation to
each other to ensure that all the parts combine to produce an acceptable whole. When
all the budgets are in mutual harmony, they will be summarized into a master budget
consisting of a budgeted profit and loss account, a balance sheet and a cash flow
statement. The approval of the master budget will constitute authority for the managers
of each responsibility centre to carry out the plans contained in each budget. The process
should not stop when all the budgets have been agreed; periodically, the actual results

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should be compared with the budget and remedial action taken to ensure that the results
conform to plan. Budgeting is a continuous and dynamic process, and should not end
once the annual budget has been prepared.

Budgets are required to achieve many different aims within an organization. Not only
are they an aid to planning, coordinating and communicating the activities of a business,
but they are also used as a control and motivating device. In addition, budgets are also
used as a basis for evaluating a manager’s performance.

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Example 1: The Enterprise Company manufactures two products, known as Alpha and
Sigma. Alpha is produced in department 1 and Sigma in department 2. The
following information is available for 200X

Standard material and labour costs:

(£)
Material X 7.20 per unit
Material Y 16.00 per unit
Direct Labour 12.00 per hour

Overhead is recovered on a direct labour hour basis.

The standard material and labour usage for each product is as follows:

Model Alpha Model Sigma

Material X 10 units 8 units

Material Y 5 units 9 units
Direct labour 10 hours 15 hours

The balance sheet for the previous year end 200X was as follows:
(£) (£) (£)

Fixed assets:
Land 170,000
Buildings and equipment 1,292,000
Less depreciation 255,000 1,037,000 1,207,000
Current assets:
Stocks, finished goods 99,076
Raw materials 189,200
Debtors 289,000
Cash 34,000
611,276
Less current liabilities
Creditors 248,800 362,476
Net Assets 1,569,476

Represented by shareholder’s interest:

120,000 ordinary shares of £1 each 1,200,000
Reserves 369,476
1,569,476

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Other relevant data is as follows for the year 200X:

Finished product
Model Alpha Model Sigma
Forecast sales (units) 8,500 1,600
Selling price per unit £400 £500
Ending inventory required (units) 1,870 90
Beginning inventory (units) 170 85

Direct material
Material X Material Y
Budgeted variable overhead rates
(per direct labour hour):
Indirect materials 1.20 0.80
Indirect labour 1.20 1.20
Power (variable portion) 0.60 0.40
Maintenance (variable portion) 0.20 0.40

Budgeted fixed overheads

Depreciation 100,000 80,000
Supervision 100,000 40,000
Power (fixed portion) 40,000 2,000
Maintenance (fixed portion) 45,600 3,196
(£)
Estimated non-manufacturing overheads:
Stationery etc. (Administration) 4,000
Salaries
Sales 74,000
Office 28,000
Commissions 60,000
Car expenses (Sales) 22,000
Advertising 80,000
Miscellaneous (Office) 8,000
276,000

Budgeted cash flows are as follows:

Quarter 1 Quarter 2 Quarter 3 Quarter 4
(£) (£) (£) (£)
Receipts from customers 1,000,000 1,000,000 1,120,000 985,000
Payments:
Materials 400,000 480,000 440,000 547,984
Payments for wages 400,000 440,000 480,000 646,188
Other costs and expenses 120,000 100,000 72,016 13,642

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You are required to prepare a master budget for the year 200X and the following budgets:

1. Sales budget;
2. Production budget;
3. Direct materials usage budget;
4. Direct materials purchase budget;
5. Direct labour budget;
6. Factory overhead budget;
7. Selling and administration budget;
8. Cash budget.

Schedule 2 – Annual production budget

Department 1 Department 2
(Alpha) (Sigma)
Units to be sold 8,500 1,600
Planned closing stock 1,870 90
Total units required for sales and stocks 10,370 1,690
Less planned opening stocks 170 85
Units to be produced 10,200 1,605

The total production for each department should also be analysed on a monthly basis.

Director materials usage budget

The supervisors of departments 1 and 2 will prepare estimates of the materials which are
required to meet the production budget. The materials usage budget for the year will be as
follows:

Schedule 3 – Annual direct material usage budget

Department 1 Department 2
Total
Units Units Total Unit
Units price Total Units price Total units price Total
(£) (£) (£) (£) (£) (£)
Material X 102000a 7.20 734400 12840c 7.20 92448 114840 7.20 826848
Material Y 51000b 16.00 816000 14445d 16.00 231120 65445 16.00 1047120
1550400 323568 1873968
a
10200 units production at 10 units per unit of production.
b
10200 units production at 5 units per unit of production.
c
1605 units production at 8 units per unit of production.
d
1605 units production at 9 units per unit of production.

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Direct Materials Purchase Budget

The direct materials purchase budget is the responsibility of the purchasing manager, since it will
be he or she who is responsible for obtaining the planned quantities of raw materials to meet the
production requirement. The objective is to purchase these materials at the right time at the planned
purchase price. In addition, it is necessary to take into account the planned raw material stock
levels. The annual materials purchase budget for the year will be as follows:

Schedule 4 – Direct material purchase budget

Material X Material Y
(units) (units)

Quantity necessary to meet production

requirement as per material usage budget 114,840 65,445
Planned closing stock 10,200 1,700
125,040 67,145
Less planned opening stock 8,500 8,000
Total units to be purchased 116,540 59,145
Planned unit purchase price £7.20 £16
Total purchases £839,088 £946,320

Note that this budget is a summary budget for the year, but for detailed planning and control it
will be necessary to analyse the annual budget on a monthly basis.

Direct Labour Budget

The direct labour budget is the responsibility of the respective managers of departments 1 and
2. They will prepare estimates of the departments’ labour hours required to meet the planned
production. Where different grades of labour exist, these should be specified separately in the
budget. The budget rate per hour should be determined by the industrial relations department.
The direct labour budget will be as follows:

Schedule 5 – Annual Direct Labour Budget

Department 1 Department 2 Total

Budgeted production (units) 10,200 1,605

Hours per unit 10 15
Total budgeted hours 102,000 24,075 126,075
Budgeted wage rate per hour £12 £12
Total wages £1,224,000 £288,900 £1,512,900

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 BUDGETING PROCESS

Factory Overhead Budget

The factory overhead budget is also the responsibility of the respective production department
managers. The total of the overhead budget will depend on the behaviour of the costs of the
individual overhead items in relation to the anticipated level of production. The overheads must
also be analysed according to whether they are controllable or non-controllable for the purpose
of cost control. The factory overhead budget will be as follows:

Schedule 6 – Annual Factory Overhead Budget

Anticipated Activity – 102 000 direct labour hours (department 1)
24 075 direct labour hours (department2)

Variable overhead rate

Per direct labour hour Overheads

Department Department Department Department Total

1 2 1 2
(£) (£) (£) (£) (£)

Controllable overheads:
Indirect material 1.20 0.80 122,400 19,260
Indirect labour 1.20 1.20 122,400 28,890
Power (variable portion) 0.60 0.40 61,200 9,630
Maintenance (variable portion) 0.20 0.40 20,400 9,630
326,400 67,410 393,810

Non-controllable overheads:
Depreciation 100,000 80,000
Supervision 100,000 40,000
Power (fixed portion) 40,000 2,000
Maintenance (fixed portion) 45,600 3,196
285,600 125,196 410,796
Total overhead 612,000 192,600 804,606
Budgeted departmental overhead rate £6.00a £ 8.00b

a
£612 000 total overheads divided by 102 000 direct labour hours.
b
£192 606 total overheads divided by 24075 direct labour hours.

The budgeted expenditure for the variable overhead items is determined by multiplying the
budgeted direct labour hours for each department by the budgeted variable overhead rate per
hour. It is assumed that all variable overheads vary in relation to direct labour hours.

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 BUDGETING PROCESS

Selling and Administration Budget

The selling and administration budgets have been combined here to simplify the presentation.
In practice, separate budgets should be prepared: the sales manager will be responsible for the
selling budget, the distribution manager will be responsible for the distribution expenses and
the chief administrative officer will be responsible for the administration budget.

Schedule 7 – Annual Selling and Administration Budget

(£) (£)
Selling:
Salaries 74,000
Commission 60,000
Car Expenses 22,000
Advertising 80,000 236,000

Administration:
Stationery 4,000
Salaries 28,000
Miscellaneous 8,000 40,000
276,000

Department Budgets

For cost control the direct labour budget, materials usage budget and factory overhead budget
are combined into separate departmental budgets. These budgets are normally broken down
into twelve separate monthly budgets, and the actual monthly expenditure is compared with the
budgeted amounts for each of the items concerned. This comparison is used for judging how
effective managers are in controlling the expenditure for which they are responsible. The
departmental budget for department 1 will be as follows:

Department 1 – Annual Departmental Operating Budget

Budget Actual
(£) (£) (£)

Direct labour (from schedule 5):

102000 hours at £12 1,224,000
Direct materials (from schedule 3):
102,000 units of material X at £7.20 per unit 734,000
510000 units of material Y at £16 per unit 816,000 1,550,400
Controllable overheads (from schedule 6):
Indirect materials 122,400
Indirect labour 122,400
Power (variable portion) 61,200
Maintenance (variable portion) 20,400 326,400

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 BUDGETING PROCESS

Uncontrollable overheads (from schedule 6):

Depreciation 100,000
Supervision 100,000
Power (fixed portion) 40,000
Maintenance (fixed portion) 45,000 285,600
3,386,400

Master Budget

When all the budgets have been prepared, the budgeted profit and loss account and balance
sheet provide the overall picture of the planed performance for the budget period.

Budgeted Profit and Loss Account for the Year Ending 200X

(£) (£)

Sales (schedule 1) 4,296,000

Opening stock of raw materials (from opening
balance sheet) 189,200
purchase (schedule 4) 1,785,408a
1,974,608
Less closing stock of raw materials (schedule 4) 100,640b
Cost of raw materials consumed 1,873,968
Director labour (schedule 5) 1,512,900
Factory overheads (schedule 6) 804,606
Total manufacturing cost 4,191,474
Add opening stock of finished goods
(from opening balance sheet) 99,076
Less closing stock of finished goods 665,984c
(566,908)
Cost of sales 3,624,566
Gross Profit 671,434
Selling and administration expenses
(schedule 7) 276,000
Budget operating profit for the year 395,434

a
£839,088 (X) + £946,320 (Y) from schedule 4.
b
10200 units at £7.20 plus 1700 units at £16 from schedule 4.
c
1870 units of Alpha valued at £332 per unit, 90 units of Sigma valued at £501.60 per unit. The
product unit costs are calculated as follows:

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 BUDGETING PROCESS

Alpha Sigma

Units (£) Units (£)

Direct materials
X 10 72.00 8 57.00
Y 5 80.00 9 144.00
Direct labour 10 120.00 15 180.00
Factory overheads:
Department 1 10 60.00 - -
Department 2 - - 15 120.00
332.00 501.60

Budgeted Balance Sheet as at 31 December

(£) (£)
Fixed assets:
Land 170,000
Building and equipment 1,292,000
Less depreciationa 435,000 857,000
1,027,000

Current assets:
Raw material stock 100,640
Finished good stock 665,984
Debtorsb 280,000
Cashc 199,170
1,245,794

Current liabilities:
Creditorsd 307,884 937,910
1,964,910

Represented by shareholders’ interest:

300000 ordinary shares of £1 each 1,200,000
Reserves 369,476
Profit and loss account 395,434 1,964,910

a
£255,000 + £180,000 (schedule 6) = £435,000.
b
£289,000 opening balance + £4,296,000 sales - £4,305,000 cash.
c
Closing balance as per cash budget.
d
£248,800 opening balance + £1,785,408 purchases + £141,660 indirect materials - £1,867,984
cash.

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 BUDGETING PROCESS

Cash Budgets

The objective of the cash budget is to ensure that sufficient cash is available at all times to meet
the level of operations that are outlined in the various budgets. The cash budget for Example
13.1 is presented below and is analysed by quarters, but in practice monthly or weekly budgets
will be necessary. Because cash budgeting is subject to uncertainty, it is necessary to provide
for more than the minimum amount required, to allow for some margin of error in planning.
Cash budgets can help a firm to avoid cash balances that are surplus to its requirements by
enabling management to take steps in advance to invest the surplus cash in short-term
investments. Alternatively, cash deficiencies can be identified in advance, and steps can be
taken to ensure that bank loans will be available to meet any temporary cash deficiencies. For
example, by looking at the cash budget for the Enterprise Company, management may consider
that the cash balances are higher than necessary in the second and third quarters of the year, and
they man invest part of the cash balance in short-term investments.

The overall aim should be to manage the cash of the firm to attain maximum cash availability
and maximum interest income on any idle funds.

Cash Budget for Year Ending 200X

Quarter Quarter Quarter Quarter

1 2 3 4 Total
(£) (£) (£) (£) (£)

Opening balance 34,000 114,000 294,000 421,984 34,000

Receipts from debtors 1,000,000 1,200,000 1,120,000 985,000 4,305,000
1,034,000 1,314,000 1,414,000 1,406,984 4,339,000
Payments:
Purchase of materials 400,000 480,000 440,000 547,984 1,867,984
Payment of wages 400,000 440,000 480,000 646,188 1,966,188
Other costs and expenses 120,000 100,000 72,016 13,642 305,658
920,000 1,020,000 992,016 1,207,814 4,139,830
Closing balance 114,000 294,000 421,984 199,170 199,170

Final Review

The budgeted profit and loss account, the balance sheet and the cash budget will be submitted
by the accountant to the budget committee, together with a number of budgeted financial ratios
such as the return on capital employed, working capital, liquidity and gearing ratios. If these
ratios prove to be acceptable, the budgets will be approved. In Example 13.1 the return on
capital employed is approximately 20%, but the working capital ratio (current assets: current
liabilities) is excessive, being over 4:1, so management should consider alternative ways of
reducing investment in working capital before finally approving the budgets.

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 BUDGETING PROCESS

Computerized Budgeting

In the past, budgeting was a task dreaded by many management accountants. You will have
noted from Example 13.1 that many numerical manipulations are necessary to prepare the
budget. In the real world the process is far more complex, and, as the budget is being
formulated, it is altered many times since some budgets are found to be out of balance with each
other or the master budget proves to be unacceptable.

In today’s world, the budgeting process is computerized instead of being primarily concerned
with numerical manipulations, the accounting staff can now become more involved in the real
planning process. Computer-based financial models normally consist of mathematical
statements of inputs and outputs. By simply altering the mathematical statements budgets can
be quickly revised with little effort. However, the major advantage of computerized budgeting
is that management can evaluate many different options before the budget is finally agreed.
Establishing a model enables ‘what-if?’ analysis to be employed. For examples, answers to the
following questions can be displayed in the form of a master budget: What if sales increase or
decrease by 10%? What if unit costs increase or decrease by 5%? What if the credit terms for
sales were reduced from 30 to 20 days?

In addition, computerized models can incorporate actual results, period by period, and carry out
the necessary calculations to produce budgetary control reports. It is also possible to adjust the
budgets for the remainder of the year when it is clear that the circumstances on which the budget
was originally set have changed.

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 BUDGETING PROCESS

REVIEW PROBLEMS

1. When preparing a production budget, the quantity to be produced equals

A. sales quantity + opening stock + closing stock
B. sales quantity – opening stock + closing stock
C. sales quantity – opening stock – closing stock
D. sales quantity + opening stock – closing stock
E. sales quantity

2. BDL plc is current preparing its cash budget for the year to 31 March 2003. An extract
from its sales budget for the same year shows the following sales values:
(£)
March 60000
April 70000
May 55000
June 65000

40% of its sales are expected to be for cash. Of its credit sales, 70% are expected to pay
in the month after sale and take a 2% discount; 27% are expected to pay in the second
month after the sale, and the remaining 3% are expected to be bad debts.
The value of sales receipts to be shown in the cash budget for May 2002 is:
A. £38532
B. £39120
C. £60532
D. £64220
E. £65200

3. A master budget comprises:

A. The budgeted profit and loss account;
B. The budgeted cash flow, budgeted profit and loss account and budgeted balance
sheet;
C. The budgeted cash flow;
D. The capital expenditure budget;
E. The entire set of budgets prepared.

4. R Limited manufactures three products A, B and C.

You are required:

(a) Using the information given below, to prepare budgets for the month of January for
Prepare budgets for the month of January for
(i) Sales in quantity and value, including total value;
(ii) Production quantities;
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 BUDGETING PROCESS

(iii) Material usage in quantities;

(iv) Material purchases in quantity and value, including total value;
(Note that particular attention should be paid to your layout of the budgets).

(b) To explain the term ‘principal budget factor’ and state what it was assumed to be in
(a).
Product Quantity Price each
(Units) (£)
Sales A 1000 100
B 2000 120
C 1500 140
Materials used in the company’s products:
Material M1 M2 M3
Unit cost £4 £6 £9

Quantities used in: M1 M2 M3

(units) (units) (units)
Product A 4 2 -
Product B 3 3 2
Product C 2 1 1

Finished stocks: Product A Product B Product C

(units) (units) (units)
Quantities:
1st January 1000 1500 500
31st January 1100 1650 550

Material stocks: M1 M2 M3
(units) (units) (units)
1st January 26000 20000 12000
31st January 31200 24000 14400

5. The management of Beck plc have been informed that the union representing the direct
production workers at one of their factories where a. standard product is produced,
intends to call a strike. The accountant has been asked to advise the management of the
effect the strike will have on cash flow.
The following data has been made available:

Week 1 Week 2 Week 3

Budged sales 400 units 500 units 400 units
Budgeted production 600 units 400 units Nil

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 BUDGETING PROCESS

The strike will commence at the beginning of week 3 and it should be assumed that it
will continue for at least four weeks. Sales at 400 units per week will continue to be
made during the period of the strike until stocks of finished goods are exhausted.
Production will stop at the end of week 2. The current stock level of finished goods is
600 units. Stocks of work in progress are not carried.

The selling price of the product is £60 and the budgeted manufacturing cost is made up
as follows:
(£)
Direct materials 15
Direct wages 7
Variable overheads 8
Fixed overheads 18
Total £48

Direct wages are regarded as a variable cost.

The company operates a full absorption costing system and the fixed overhead
absorption rate is based upon a budgeted fixed overhead of £9000 per week. Included
in the total fixed overheads is £700 per week for depreciation of equipment.

During the period of the strike direct wages and variable overheads would not be
incurred and the cash expended on fixed overheads would be reduced by £1500 per
week.

The current stock of raw materials are worth £7500; it is intended that these stocks
should increase to £11000 by the end of week 1 and then remain at this level during the
period of the strike. All direct materials are paid for one week after they have been
received. Direct wages are paid one week in arrears. It should be assumed that all
relevant overheads are paid for immediately the expense is incurred. All sales are on
credit, 70% of the sales value is received in cash from the debtors at the end of the first
week after the sales have been made and the balance at the end of the second week.

The current amount outstanding to material suppliers is £8000 and direct wage accruals
amount to £3200. Both of these will be paid in week 1. The current balance owing from
debtors is £31200, of which £24000 will be received during week 1 and the remainder
during week2. The current balance of cash at bank and in hand is £1000.
Required:
(a) (i) Prepare a cash budget for weeks 1 to 6 showing the balance of cash at
the end of each week together with a suitable analysis of the receipts and
payment during each week.
(ii) Comment upon any matters arising from the cash budget which you
consider should be brought to management’s attention.

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 BUDGETING PROCESS

(b) Explain why the reported profit figure for a period does not normally represent
the amount of cash generated in that period.

6. The budgeted balance sheet data of Kwan Tong Umbago Ltd is as follows:

1 March
Depreciation
Cost to date Net
(£) (£) (£)

Fixed assets:
Land and buildings 500,000 - 500,000
Machinery and equipment 124,000 84,500 39,500
Motor vehicles 42,000 16,400 25,000
666,000 100,900 565,100
Working capital:
Current assets
Stock of raw materials (100 units) 4,320
Stock of finished goods (110 units)a 10,450
Debtors (January £7680 February £10400) 18,080
Cash and bank 6,790
39,640
Less current liabilities
Creditors 3,900 35,740
(raw materials) 600,840
Represented by:
Ordinary share capital (fully paid) £1 shares 500,000
Share premium 60,000
Profit and loss account 40,840
600,840
*The stock of finished goods was valued at marginal cost

The estimates for the next four-month period are as follows:

March April May June

Sales (units) 80 84 96 94
Production (units) 70 75 90 90
Purchases of raw materials (units) 80 80 85 85
Wages and variable overheads at
£65 per unit £4550 £4875 £5850 £5850
Fixed overheads £1200 £1200 £1200 £1200

The company intends to sell each unit for £219 and has estimated that it will have to pay £45
per unit for raw materials. One unit of raw material is needed for each unit of finished product.

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 BUDGETING PROCESS

All sales and purchases of raw materials are on credit. Debtors are allowed two months’ credit
and suppliers of raw materials are paid after one month’s credit. The wages, variable overheads
and fixed overheads are paid in the month in which they are incurred.

Cash from a loan secured on the land and buildings of £120000 at an interest rate of 7.5% is
due to be received on 1 May. Machinery costing £112000 will be received in May and paid for
in June.

The loan interest is payable half yearly from September onwards. An interim dividend to 31
March of £12500 will be paid in June.

Depreciation for the four months, including that on the new machinery is:
Machinery and equipment £15733
Motor vehicles £3500
The company uses the FIFO method of stock valuation. Ignore taxation.
Required:
(a) Calculate and present the raw materials budget and finished goods budget in terms of
units, for each month from March to June inclusive.
(b) Calculate the corresponding sales budgets, the production cost budgets and the budgeted
closing debtors, creditors and stocks in terms of value.
(c) Prepare and present a cash budget for each of the four months.
(d) Prepare a master budget, i.e., a budgeted trading and profit and loss account, for the four
months to 30 June, and budgeted balance sheet as at 30 June.
(e) Advise the company about possible ways in which it can improve its cash management.

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 BUDGETING PROCESS

SOLUTIONS TO REVIEW PROBLEMS

SOLUTION 1

Answers = B

SOLUTION 2
(£) (£)

Cash sales 22000

Credit sales
April (70% x 0.6 x 0.98 x £70000) 28812
March (27% x 0.6 x £60000) 9720 38532
60532

SOLUTION 3

Answer = B

SOLUTION 4

(a) (i)
Sales Quantity and Value Budget
Products
A B C Total

Sales quantities 1000 2000 1500

Selling prices £100 £120 £140
Sales value £100000 £250000 £210000 £550000

(ii)
Production Quantities Budget
Products

Sales quantities 1000 2000 1500

Add closing stock 1100 1650 550
2100 3650 2050
Deduct opening stock 1000 1500 500
Units to be produced 1100 2150 1550

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 BUDGETING PROCESS

(iii)
Material Usage Budget (Quantities)
Production Materials
Quantities
M1 M2 M3
Units Total Units Total Units Total
per per per
Product Product Product

A 1100 4 4400 2 2200 - -

B 2150 3 6450 3 6450 2 4300
C 1550 2 3100 1550 1550
Usage in quantities 13950 10200 5850

(iv)
Material Purchases Budget (Quantities and Value)
M1 M2 M3 Total

Materials usage budget 13950 10200 5850

Add closing stock 31200 24000 14400
45150 34200 20250
Deduct opening stock 26000 20000 12000
Purchases in quantities 19150 14200 8250
Price per unit £4 £6 £9
Value of purchases £76600 £85200 £74250 £236050

(b) The principal budget factor is also known as the limiting factor or key factor. The CIMA
Terminology describes the principal budget factor as follows: ‘The factor which, at a
particular time, or over a period, will limit the activities of n undertaking. The limiting
factor is usually the level of demand for the products or services of the undertaking but it
could be a shortage of one of the productive resources, e.g., skilled labour, raw material,
or machine capacity. In order to ensure that the functional budgets are reasonably capable
of fulfilment, the extent of the influence of this factor must first be assessed’.

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SOLUTION 5

(a) (i) Cash budget for weeks 1 – 6

Week: 1 2 3 4 5 6
(£) (£) (£) (£) (£) (£)

Receipts from debtorsa 24000 24000 28200 25800 19800 5400

Payments:
To material suppliersb 8000 12500 6000 nil nil nil
To direct workersc 3200 4200 2800 nil nil nil
For variable overheadsd 4800 3200 nil nil nil nil
For fixed overheade 8300 8300 6800 6800 6800 6800
Total payments 24300 28200 15600 6800 6800 6800
Net movement (300) (4200) 12600 19000 13000 (1400)
Opening balance (week 1 given) 1000 700 (3500) 9100 28100 41100
Closing balance 700 (3500) 9100 28100 41100 39700

Notes
a
Debtors:
Week: 1 2 3 4 5 6

Units sold* 400 500 400 300 - -

Sales (£) 24000 30000 24000 18000 - -
Cash received (70%) 6800 21000 16800 12600
(30%) 7200 9000 7200 5400
Given 24000 7200
Total receipts (£) 24000 24000 28200 25800 19800 5400

*Sales in week 4 = opening stock (600 units) + production in weeks 1 and 2 (100 units) less sales in
weeks 1 – 3 (1300 units) = 300 units.
b
Creditors:

Week: 1 2 3 4 5 6
(£) (£) (£) (£) (£) (£)

Materials consumed at £15 9000 6000 - - - -

Increase in stocks 3500 -
Materials purchased 12500 6000
Payment to suppliers 8000 12500 6000 nil nil nil
(given)

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 BUDGETING PROCESS

c
Wages:
Week: 1 2 3 4 5 6
(£) (£) (£) (£) (£) (£)

Wages consumed at £7 4200 2800 nil nil nil nil

Wages paid 3200 4200 2800 - - -
(given)
d
Variable overhead payment = budgeted production x budgeted cost per unit.
e
Fixed overhead payments for weeks 1-2 = fixed overhead per week (£9000) less weekly depreciation
(£700).
Fixed overhead payments for weeks 3-6 = £1500 per week.

(ii) Comments:

1. Finance will be required to meet the cash deficit in week 2, but a lowering of the
budgeted material stocks at the end of week 1 would reduce the amount of cash to be
borrowed at the end of week 2.
2. The surplus cash after the end of week 2 should be invested on a short-term basis.
3. After week 6, there will be no cash receipts, but cash outflows will be £800 per week.
The closing balance of £39700 at the end of week 6 will be sufficient to finance outflows
for a further 5 or 6 weeks (£39700/£6800 per week).

(b) The answer should include a discussion of the matching concept, emphasizing that revenues
and expenses may not be attributed to the period when the associated cash inflows and
outflows occur. Also, some items of expense do not affect cash outflow (e.g.,
depreciation).

SOLUTION 6

(a) Raw materials:

(Units) March April May June

Opening stock 100 110 115 110
Add: Purchases 80 80 85 85
180 190 200 195
Less: Used in production 70 75 90 90
Closing Stock 110 115 110 105

(Units) Finished production:

Opening stock 110 100 91 85
Add: Production 70 75 90 90
180 175 181 175
Less: Sales 80 84 96 94
Closing stock 100 91 85 81

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 BUDGETING PROCESS

(b) Sales:
Total
(at £219 per unit) £17520 £18396 £21024 £20586 £77526

Production cost:
Raw materials (using FIFO) 3024 (1) 3321 (2) 4050 4050 14445
Wages and variable costs 4550 4875 5850 5850 21125
£7574 £8196 £9900 £9900 £35570

Debtors:
Closing debtors = May + June sales = £41610

Creditors:
June purchases 85 units x £45 = £3825

Notes:
(1) 70 units x £4320/100 units = £3024.
(2) (30 units x £4320/100 units + (45 units x £45) = £3321.

Closing stocks:
Raw materials 105 units x £45 = £4725
Finished good 81 units x £110(1) = £8910

Note:
(1)
Materials (£45) + Labour and Variable Overhead (£65). It is assumed that stocks are
valued on a variable costing basis.

(c) Cash Budget:

March April May June
(£) (£) (£) (£)

Balance b/fwd 6790 4820 5545 132415

Add: Receipts
Debtors (two months’ credit) 7680 10400 17520 18396
Loan - - 120000 -
(A) 14470 15220 143065 150811
Payments:
Creditor (one month’s credit) 3900 3600 3600 3825
(80 x £45)
Wages and variable overheads 4550 4875 5850 5850
Fixed overheads 1200 1200 1200 1200
Machinery - - - 112000
Interim dividend - - - 12500
(B) 9650 9675 10650 135375
Balance c/fwd (A) – (B) 4820 5545 132415 £15436

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 BUDGETING PROCESS

(d) Master Budget:

Budgeted trading and profit and loss account for the four months to 30 June
(£) (£)

Sales 77526
Cost of sales: Opening stock finished goods 10450
Add: Production cost 35570
46020

Less: Closing stock finished goods 8910 37110

40416

Less: Expenses
Fixed overheads (4 x £1200) 4800

Depreciation
Machinery and equipment 15733
Motor vehicles 3500
Loan interest (2/12 x 7½% of £120000) 1500 25533
14883
Less: Interim dividends 12500
2383

Add: Profit and loss account balance b/fwd 40840

£43223

Budgeted Balance Sheet as at 30 June

Depreciation
Fixed Assets Cost to Date Net
(£) (£) (£)
Land and buildings 500000 - 500000
Machinery and equipment 236000 100,000 135767
Motor vehicles 42000 19,900 22100
778000 120133 657867
Current assets:
Stock of raw materials 4725
Stock of finished goods 8910
Debtors 41610
Cash and bank balances 15436
70681
Less: Current liabilities
Creditors 3825
Loan interest owing 1500 5325 65356
£723223

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 BUDGETING PROCESS

Capital Employed (£)

Ordinary share capital £1 shares (fully paid) 500000

Share premium 60000
Profit and loss account 43233
603223
Secured loan (7½%) 120000
£723223

37