Budgeting

Patrick Robert
 Meaning
 Budgeting is the process of preparing and using budgets to achieve management
objectives
 A budget is a quantitative plan prepared for a specified period of time. Normally it is
expressed
Purposes of in financial terms and prepared for one year.
budgeting
1. Planning - in line with the objectives of the organisation.
2. Control - by comparing the plan or the budget with the actual results and investigating
significant differences between the two.
3. Communication - budgets communicate the targets of the organisation to individual
managers
4. Co-ordination - of the different activities of the business by ensuring that managers are
working towards the same common goal (as stated in the budget).
5. Evaluation - the performance of managers is often judged by looking at how well the
manager has performed ‘against budget’.
6. Motivation - budgets can motivate managers by encouraging them to beat targets or
budgets set at the beginning of the budget period. Bonuses are often based on
‘beating budgets’. Budgets, if badly set, can also demotivate employees.
Task 1: Find out-budget
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Principal budget factor (Where to start?)
 The first thing that the person in charge of the budget process must do is decide where
to start!
 For most companies the starting point will be a sales budget. Once it has been decided
how many units the company expects to sell it is then possible to produce a production
budget and so on.
 However, this will not always be the starting point. Suppose, for example, that the
company is a manufacturer of desks for which wood is the main material. Suppose also
that during the coming year there is expected to be only a limited supply of wood
available. In this situation the starting point will be to budget the amount of wood
available, then budget how many units the company is capable of producing (a
production budget) and then how many they expect to sell (a sales budget).
Generally,
 The first budget to be prepared should be whatever factor it is that limits the growth of
the company – it may be the level of demand (so a sales budget will be prepared first)
or, as for the example in the previous paragraph, it may be the availability of raw
material (so a material budget will be prepared first).
Master Budget
 A master budget is a comprehensive budget that represents the summary or total budget
package for a business firm.
 The master budget includes all the functional budgets and financial budgets which
include a forecasted income statement, a forecasted balance sheet and cash flow
statement.
 Components of Master budget
1. Sales budget.
2. Production budget.
3. Direct materials budget.
Functional budgets
4. Direct labour budget.
5. Manufacturing overhead budget.
6. Selling and administrative budget.
7. Capital acquisitions budget.
8. Cash budget.
9. Budgeted statement of profit or loss.
10. Budgeted statement of financial position.
Functional Budgets refers to budgets of income and or expenditure which applies to
particular function of an organization
Example 1
The XYZ Company produces three products, X, Y, and Z. For the coming accounting period budgets are to be prepared
using the following information:
Budgeted sales
Product X 2,000 units at TZS 1,000 each
Product Y 4,000 units at TZS 1,300 each
Product Z 3,000 units at TZS 1,500 each
Standard usage of raw material
Wood (Kg per unit) Vanish (litres per unit)
Products -X 5 2
Products -Y 3 2
Products -Z 2 1
Standard cost of raw material TZS 8,000 TZS 4,000
Inventories of finished goods (units)
X Y Z
Opening 500 800 700
Closing 600 1000 800
Inventories of raw materials
Wood Varnish
Opening 21,000 10,000
Closing 18,000 9,000
Labour is paid at the rate of TZS 3,000 per hour.
X Y Z
Standard hours per unit 4 6 8
Required: Prepare the following budgets:
a. Sales budget (quantity and value) (b) Production budget (units) (c) Material usage budget (quantities)
b. Material purchases budget (quantities and value) (e) Labour budget (hours and value)
Example 2:
A company produces Products PX and TY and has budgeted to produce 3,000 units of
Product
PX and 500 units of Product TY in the coming year.
The following data about the machine hours required to produce Products PX and TY and
the
standard production overheads per machine hour is relevant to the coming year.
PX per unit TY per unit
Machine hour 4 6
Production overheads per machine hour
Variable TZS 1,540 per machine hour
Fixed TZS 540 per machine hour
Required:
Calculate the overhead budget for the coming year.
Example 3
You are presented with the following flow forecasted data for your organisation for the period November
2021 to March 2022. It has been extracted from functional flow forecasts that have already been prepared
Nov-21 Dec-21 Jan-22 Feb-22 Mar-22
Sales 160,000,000 200,000,000 220,000,000 260,000,000 280,000,000
Purchases 80,000,000 120,000,000 160,000,000 180,000,000 220,000,000
Wages 20,000,000 24,000,000 32,000,000 40,000,000 48,000,000
Overheads 20,000,000 20,000,000 30,000,000 30,000,000 30,000,000
You are also told the following.
a) Sales are 40% cash 60% credit. Credit sales are paid two months after month of sale.
b) Purchases are paid the month following purchase.
c) 75% of wages are paid in the current month and 25% the following month.
d) Overheads are paid the month after they are incurred.
e) The company purchases state-of-art equipment for TZS 45,000,000 in January 2022
f) The firm must maintain a minimum cash balance of TZS 1,000,000 and to facilitate this, it maintains a
12% open line of credit for TZS 10,000,000. Loans are repaid at the end of the month.
g) On March 31st 2022, the company received rental income of TZS 18,500,000.
h) The opening cash balance is TZS 30,000,000.
Required: Prepare a cash flow forecast for the three-month period January to March 2022
Example 4 - TYU
Mash makes one product the blue. Sales for next year are budgeted at 10,000 units of Blue.
Planned selling price is TZS130,000. Mash expects to have the following opening inventory and
required closing inventory levels of finished products
Units
Opening inventory 200
Required closing inventory 2,200
Budgeted production data for the product is as follows:
Finished products Units
Raw material Z: Kg per unit 24
Direct labour hours per unit 16
Raw material inventories
Opening inventory (kg) 10,000
Planned closing inventory (kg) 12,000
Standard rates and prices:
Direct labour rate per hour TZS1,400
Material Z purchase price per kg TZS400
Production overhead absorption rates
Variable TZS200 per direct labour hour
Fixed TZS1,600 per direct labour hour
Budgeted administration and marketing overheads are 45,000,000.
The opening Statement of financial position is expected to be as
TZS (000) TZS (000)
Non-current assets 190,000
Inventory 13,200
Trade receivables 52,000
Cash 5,000
Total current Assets 70,200

Trade payables 17,200

Other short-term liabilities 4,800
Total current liabilities 22,000
Net current assets 48,200
Net assets 238,200
Non-current assets in the statement of financial position are expected to increase by TZS8,000,000 but no change
is expected in trade receivables, trade payables and other short-term liabilities.
There are no plans at this stage to raise extra capital by issuing new shares or obtaining new loans. The company
currently has an overdraft facility of TZS60,000,000 with its bank.
Required: Complete the following:
a) The production budget
b) The raw material usage budget
c) The raw material purchases budget
d) The direct labour budget
e) The overhead budget
f) The cost per unit of Blue
g) Budgeted Statement of profit or loss
h) Budgeted Statement of financial position
Budgetary Control
 Control refers to the process whereby management take decisions in an attempt to ensure
that an organisation achieves its objectives
 The key feature of any budgetary control system is the process of comparing actual results
with the budgeted (expected results). The difference between these figures is usually termed
as variance.
 Variances may be either unfavourable (adverse) or favourable.
 Adverse variances (A) implies increase in costs and decrease profits.
 Favourable variances (F) indicates decrease in costs and increase profits.
Fixed and flexible budgets
 A fixed budget is a budget which is produced for a single level of activity. This budget will
remain the same irrespective of changes in the volume of sales or production. It is not useful
for control; it is mainly used in the planning stage of budget preparation and often referred to
as the original budget.
 A flexible budget recognize cost behaviour patterns, is designed to change as volume of
sales of production changes. It should represent what the costs and revenues were
expected to be at different levels of activity. It is particularly useful for control as the original
(fixed) budget can be flexed to show the costs and revenues for the actual level of activity.
 Budgetary Control cycle

Budget
Agreed

Feedback Expenditure incurred

for revision Feedback for
for next revision of
budget Difference between budget and actual analysed performance

Reason for difference sought and obtained, followed

by appropriate management action.
Example 5
A company has prepared the following fixed budget for the coming year.
Sales 10,000 units
Production 10,000 units
TZS
Direct materials 50,000
Direct labour 25,000
Variable overheads 12,500
Fixed overheads 10,000
97,500
Budgeted selling price TZS 10 per unit.
At the end of the year, the following costs had been incurred for the actual production of 12,000 units.
TZS
Direct materials 60,000
Direct labour 28,500
Variable overheads 15,000
Fixed overheads 11,000
114,500
The actual sales were 12,000 units for TZS 122,000
Required:
Prepare a flexed budget for the actual activity for the year
Example 6
Simple Ltd manufactures one product and when operating at 100% capacity can produce 10,000 units
per period, but for the last few periods has been operating below capacity. Below is the flexible budget
prepared at the start of last period, for three levels of activity at below capacity:
Level of activity (units) 7,000 8,000 9,000
TZS TZS TZS
Direct materials 3,500 4,000 4,500
Direct labour 14,000 16,000 18,000
Production overheads 17,000 18,000 19,000
Administration, selling and distribution overheads 7,500 7,500 7,500
Total cost 42,000 45,500 49,000
In the event, the last period turned out to be even worse than expected, with production of only 5,000
units. The following costs were incurred:
TZS
Direct materials 2,250
Direct labour 11,000
Production overheads 14,000
Administration, selling and distribution overheads 8,250
Total cost 35,500
Required:
Use the information provided above to prepare the following.
a) A flexed budget for 5,000 units.
b) A budgetary control statement.
Example 7 - TYU
Bongo Ltd manufactures one product. Activity levels in the production department
department are an average level of activity of 20,000 units production per four-week period.
The actual results for four weeks in April 20223 are:
Level of activity (units)

Budget 20,000 units Actual 17,600 units

TZS TZS
Direct labour 40,000,000 39,080,000
Direct expense 1,600,000 2,000,000
Direct materials 8,400,000 7,320,000
Depreciation 20,000,000 20,000,000
Semi-variable overheads 10,000,000 9,520,000
80,000,000 77,920,000
Assume that at a level of production of 15,000 units, semi-variable overheads are forecast
to be TZS 9,000,000
Required
Produce a budgetary control statement.
Alternative Approaches to Budgeting
This refers to the means used to formulate or originate budgets, and they include:
1. Top down vs bottom up budgeting
 Top down (Imposed style) - a budget which is set without allowing the final budget holder
to have the opportunity to participate in the budgeting process
 Bottom up (Participative budgets ) - is the one in which all budget holders are given the
opportunity to participate in preparing their own budgets
2. Incremental budgeting - An incremental budget starts with the previous period’s budget or
actual results and adjusts for inflation or other known changes by adding (or subtracting) an
incremental amount to the original figures.
3. Zero-based budgeting (ZBB) - This involves preparing a budget for each cost centre from a
zero-base i.e. from scratch. It requires each cost element to be specifically justified, as though
the activities to which the budget relates were being undertaken for the first time.
4. Rolling budgets - This is the budget which is kept continuously up to date by simply adding
another budget period when the earliest budget period has expired. The remaining budget is
re-forecast, as well as the new period being added.
5. Activity-based budgeting (ABB) - ABB is defined as the process of preparing budgets using
overhead costs from activity based costing methodology
Task 2 : Discuss pros and cons of the alternative approaches to budgeting
Behavioural aspects of budgeting
Budget to a greater extent should influence human behaviour as follows:
1. Goal congruency - Individuals, groups and organizational goals should coincide.
All staff should aim at the same goal posts. A budget should instil in the
employee’s the team spirit so that the organization goal can be achieved
2. Participation of staff - Budgets should encourage staff to work willingly in the
budget implementation other than imposing budgets on them. Budgets should
encourage them to participate willingly in decision making at any level
3. Motivation. By all means budgets should be able to motivate employees in
pursuing the set targets. The main factors influencing how well the managers
will be motivated are:
 To what extent they were involved in preparing budgets and therefore in
setting targets
 How easy or difficult will it be for the managers to achieve the targets
 How the managers will be rewarded for achieving their targets (or punished
for not achieving them!
QUESTIONS

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