BUDGETING AND BUDGETARY CONTROL

INTRODUCTION:
 The term ‘Budget’ appears to have been derived from the French word ‘baguette’ which means
‘little bag' , or a container of documents and accounts.
 A budget is an accounting plan. It is a formal plan of action expressed in monetary terms. It
could be seen as a statement of expected income and expenses under certain anticipated
operating conditions. It is a quantified plan for future activities – quantitative blue print for
action
 Every organization achieves its purposes by coordinating different activities. For the execution
of goals efficient planning of these activities is very importantandthat is why the management
has a crucial role to play in drawing out the plans for its business. Various activities within a
company should be synchronized by the preparation of plans of actions for future periods.
These comprehensive plans are usually referred to as budgets. Budgeting is a management
device used for short‐term planning and control.It is not just accounting exercise.

BUDGET
 A budget is a plan of action expressed in quantitative terms. It is prepared and approved prior
to a defined period of time.
 According to CIMA (Chartered Institute of Management Accountants) UK, a budget is“A plan
quantified in monetary terms prepared and approved prior to a defined period of time, usually
showing planned income to be generated and, expenditure to be incurred during the period and
the capital to be employed to attain a given objective.”
 In a view of Keller &Ferrara , “a budget is a plan of action to achieve stated objectives based
on predetermined series of related assumptions.”
 G.A.Welsh states, “a budget is a written plan covering projected activities of a firm for a
definite time period.”
 One can elicit the explicit characteristics of budget after observing the above definitions. They
are:
 It is mainly a forecasting and controlling device.
 It is prepared in advance before the actual operation of the
company or project.
 It is in connection with adefinite future period.
 Before implementation, it is to be approved by the management.
 It also shows capital to be employed during the period

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BUDGETARY CONTROL
 This is a cost control mechanism whereby budgets are prepared for various departments, then
policies are set and should be followed by every department. It is outlining of what is expected
of departments in order to achieve the firms’ objectives during the period. It involves
continuous comparison between budgeted and actual so as to provide a basis of continuous
corrective action.
 According to CIMA, “Budgetary control is the establishment of budgets relating to the
responsibilities of executives of a policy and the continuous comparison of the actual with the
budgeted results, either to secure by individual action, the objective of the policy or to provide
a basis for its revision.”
 Budgetary Control is thus a method of managing costs through preparation of budgets.
 Budgeting is thus only a part of the budgetary control
 The main features of budgetary control are:
1. Establishment of budgets for each purpose of the business.
2. Revision of budget in view of changes in conditions.
3. Comparison of actual performances with the budget on a continuous basis.
4. Taking suitable remedial action, wherever necessary.
5. Analysis of variations of actual performance from that of the budgeted performance
to know the reasons thereof.

USEFULNESS OF BUDGET IN THE ORGANIZATION (FUNCTIONS OF BUDGETS)

1) Coordination
The budgetary process requires that visible detailed budgets are developed to cover each activity,
department or function in the organization. This is only possible when the effort of one
department’s budget is related to the budget of another department. In this way, coordination of
activities, function and department is achieved.
2) Communication
A budget is a communicating tool to the staff because it indicates the wishes /expectations of the
senior managers which should be iterpreted and implemented by the lower level management.
3) Control
This is the process for comparing actual results with the budgeted results and reporting upon
variances. Budgets set a control gauge, which assists to accomplish the plans set within agreed
expenditure limits.
4) Motivation
Budgets may be seen as a bargaining process in which managers compete with each other for
scarce resources. Budgets set targets, which have to be achieved. Where budgetary targets are
tightly set, some individuals will be positively motivated towards achieving them.

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5) Evaluation
A managers performance is often evaluated by meaasuring his/her success in meeting the budget
targets. In some companies bonuses are awarded on the basis of an employee’s ability to achieve
the targets specified in the periodic budgets or promotions may be partly dependent uporn a
manager’s budget record. In addition, the manager may wish to evaluate his own performance.
The budget thus provides a useful means of informing managers of how well they are performing
in meeting targets they have previously helped to set.
6) Planning
It is by Budgetary Planning that long-term plans are put into action. Planning involves
determination of objectives to be attained at a future predetermined time. When monetary values
are attached to plans they become budgets.

ADVANTAGES OF BUDGETARY CONTROL:

Thefollowing are the advantages of budgetary control.
i) This system provides basic policies for initiatives.
ii) It enables the management to perform business in the most professional manner because
budgets are prepared to get the optimum use of resources and the objectives framed.
iii) It ensures team work and thus encourages the spirit of support and mutual understanding
among the staff
iv) It increases production efficiency, eliminates waste and controls the costs.
v) It shows to the management where action is needed to remedy a position
vi) Budgeting also aids in obtaining bank credit.
vii) It reviews the present situation and pinpoints the changes which are necessary.
viii) With its help, tasks such as like planning, coordination and control happen effectively
and efficiently.
ix) It involves an advance planning which is looked upon with support by many credit agencies as
a marker of sound management.

DISADVANTAGES/ LIMITATIONS OF BUDGETARY CONTROL

1. The installation and function of a budgetary control system is a costly affair as it requires
employing the specialized staff and involves other expenditure which small companies may find
difficult to incur.Budgeting process involves a lot of cost hence expensive.
2. Too mush reliance in budgeting may cause resistance (inflexibility) to change.
3. Budgeting control is a terminate exercise and therefore any report from investigation of variances
may be of little use to the current operations
4. Lack of support from the top management may lead to the collapse of the budget.

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5. Budgeting is not an exact science as it involves some elements of personal judgment.
6. Budgetary control system is ineffective in situation where there are strikes.
7. Factors that cannot be controlled by management cannot be incorporated when preparing the
budgets.
8. There is difficultly in setting levels of attainment. This may result into too tight budgets that cause
loss of morale
9. Budgeting cannot take the position of management but it is only an instrument of management.
‘The budget should be considered not as a master, but as a servant.’ It is totally misconception to
think that the introduction of budgeting alone is enough to ensure success and to security of future
profits
10. It sometimes leads to produce conflicts among the managers as each of them tries to take credit to
achieve the budget targets.
11. It tends to bring about rigidity in operation, which is harmful. As budget estimates are quantitative
expression of all relevant data, there is a tendency to attach some sort of rigidity or finality to them.

ESSENTIALS OF EFFECTIVE BUDGETING:

1) Support of top management: If the budget structure is to be made successful, the
consideration by every member of the management not onlyis fully supported but also the
impulsion and direction should alsocome from the top management. No control system can be
effective unless the organization is convinced that the management considers the system to be
important.
2) Team Work: This is an essential requirement, if the budgets are ready from “the bottom up”
in a grass root manner. The top management must understand and give enthusiastic support to
the system. In fact, it requires education and participation at all levels. The benefits of
budgeting need to be sold to all.
3) Realistic Objectives: The budget figures should be realistic and represent logically attainable
goals. The responsible executives should agree that the budget goals are reasonable and
attainable
4) Excellent Reporting System: Reports comparing budget and actual results should be promptly
prepared and special attention focused on significant exceptions i.e. figures that are
significantly different from expected. An effective budgeting system also requires the presence
of a proper feed‐back system.
5) Structure of Budget team: This team receives the forecasts and targets of each department as
well as periodic reports and confirms the final acceptable targets in form of Master Budget.
The team also approves the departmental budgets.

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 6) Well defined Business Policies: All budgetsreveal that the business policies formulated by
the higher level management. In other words, budgets should always be aftertaking into
account the policies set for particular department or function. But for this purpose, policies
should be precise and clearly defined as well as free from any ambiguity.
7) Integration with Standard Costing System: Where standard costing system is also used, it
should be completely integrated with the budget programme, in respect of both budget
preparation and variance analysis.
8) Inspirational Approach:All the employees or staff other than executives should be strongly
and properly inspired towards budgeting system. Human beings by nature do not like any
pressure and they dislike or even rebel against anything forced upon them.

TERMS IN BUDGETING
BUDGET PERIOD.
 This is the period which the budget is applicable. Mostly it is one year but it can be reduced
to shorter periods for control purposes.
BUDGET MANUAL
 This a book of files containing a set of instructions and regulations on the budgetary control
process for the entire organisation.
 It sets out the responsibility of persons engaged in the preparation of budget and records
required for budgetary control.
Contents of Budget Manual
 Definition of function or department goals
 Responsibilities and authorities of different individuals involved in budget preparations.
 Procedures and forms used in budget preparation
 Few copies of previous period’s budget
 Organisation charts
 Method of accounting used
 Budget period

BUDGET COMMITTEE
 A budget committee is made up of representatives of various departments. Their main function
is to review, discuss and coordinate duties to ensure that the budgets are realistically prepared.
The secretary to the committee is the budget officer and the chairperson is the managing
director.

Purposes Of Budget Committee

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1) Coordination of the preparation of budget. This includes drawing up the timetable and distributing
the budget manual.
2) Allocation of responsibilities for the preparation of budgets.
3) Assisting the preparation of budget by providing information that is required.
4) Control of the budgetally process including highlighting the most significant variance.
5) Reviewing the usefulness of the budgeting process and making appropriate improvement.

Master budget
 The master budget is the overall quantifications of the budgeting plan. In it, functional budgets
are incorporated. A functional budget is a budget if income and/or expenditure for a particular
function. The master budget therefore combines all the budgets of the various departments in
an organizations. It is useful in ensuring that all the individual budgets are consistent with one
another and also presents a ‘unit’ picture of the entire organization.

 Master budget shows overall plan for the next period and is prepared by the budget officer then
approved by budget committee then approved by board of directors.

Budget Slack
 A budget slack is the difference between what managers believe can be achieved and what
managers state can be achieved.
 Slack can also be said to be those insufficiencies which creep into the budget by those who
prepare the budget. A common case is where managers set low standards so that they can be
seen to be performing better and to be succeeding.

APPROACHES OF BUDGETING
1. Top-Down Approach
 This is a budget which is set without allowing the junior managers an opportunity to participate
in budget preparation process.
 It is also called authoritative or non participative budget.

2. Bottom-Up Budget Approach

 This is a system of budgeting where junior managers have an opportunity to participate in
budget preparation.
 It is also called participative budgeting.
Advantages of Bottom-Up
 Increases motivation of junior staff
 It improves communication between/within the organisation

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  Increases managers understanding and commitment in achieving budget expectation.
 Senior managers are left to concentrate on other demanding issues.
 It provides an opportunity to junior managers as they learn or train on budget preparation
process.

Disadvantages
 The budget may not be competitive to achieve since junior managers will include a budget
slack.
 Budget preparation is slow as disputes can arise
 Senior managers may not want to loose control
 May lead to bad decisions from inexperienced junior managers.

3. Rolling Budget Approach

 This is a budget kept continuously updated by adding another accounting period when the
earliest accounting period lapses or expires.
Advantages
 Offers good training ground for managers who have to keep themselves conversant with
current management trend.
 Planning and control is up to date since it is based on recent plans and current changes.
 It reduces the degree of uncertainty in budgeting
 It is realistic therefore motivates managers.
 Forces the management to take budgeting process more seriously.

Disadvantages
 Expensive for the organisation to implement.
 It is time consuming since it requires a lot of concentration.
 Increases budgeting work which may lead to less control of actual work.
 Budgeted cost should be constantly revised which consumes a lot of management time.

CLASSIFICATION OF BUDGETS:
 The extent of budgeting activity varies from firm to firm. In a smaller firm there may be a sales
forecast, a production budget, or a cash budget.
 Larger firms generally prepare a master budget. Budgets can be classified into different ways
from different points of view.
 The following are the important basis for classification:

1. Classification according to time

 Long‐Term
 Short‐Term
 Current

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2. Classification according to function
 Sales Budget
 Production Budget
 Raw Materials Budget
 Purchase Budget
 Labour Budget
 Production Overhead Budget
 Selling & Distribution Budget
 Administration Cost Budget
 Capital Expenditure Budget
 Cash Budget
3 Classification according to flexibility
 Fixed
 Flexible

1. CLASSIFICATION ACCORDING TO TIME:

With regard to time, budgets may be classified into the following categories:
(a) Long‐term Budgets:

 These budgets are prepared on the basis of long‐term projection and portray a long‐range
planning.
 The long term planning is done by the top level management.
 These budgets generally cover plans for five to ten years. In this regard it is mostly prepared
in terms of physical quantities rather than in monetary values.

(b) Short‐term Budget:

 In this budget forecasts and plans are given in respect of its operations for a period of about
one to five years.
 They are generally prepared in monetary units and are more specific than long‐term budgets.
 The consumer goods industries like sugar, textile etc use short term budgets

(c) Current Budgets:

 These budgets cover a very short period, may be a month or a quarter or maximum one year.
 The preparation of these budgets requires adjustments in short‐term budgets to current
conditions.

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 2. CLASSIFICATION ACCORDING TO FUNCTION

 A functional budget is one which relates to any of the functions of an organization.

 The following are the functional budgets commonly used:
(a) SALES BUDGET:
 The sales budget is an estimate of total sales which may be articulated in financial or
quantitative terms. It normally forms the fundamental basis on which all other budgets are
constructed. In practice, quantitative budget is prepared first then it is translated into
economic terms.
 While preparing the Sales Budget, the Quantitative Budget is generally the starting point in the
operation of budgetary control because sales become, more often than not, the principal budget
factor.
 The following are usually considered in coming up with the sales forecast:
 Actual sales in the previous periods.
 Reports from salesmen.
 Market research information.
 Level of orders already obtained in advance.
 Changes of business policy and method.
 Government policy, controls, rules and Guidelines etc.
 Potential market and availability of material and supply.
 It essentially forecasts what the company can reasonably expect to sell to the customer during
the budget period.
Product Quantity Price per amount
SOLD unit
A 1200 10 12,000
B 2000 40 80,000
TOTAL REVENUE 92,000

(b) PRODUCTION BUDGET:

 The production budget is prepared on the basis of estimated production for budget period.
 Usually, the production budget is based on the sales budget.
 At the time of preparing the budget, the production manager will consider the physical facilities
like plant, power, factory space, materials and labour available for the period.
 Production budget envisages the production program for achieving the sales target. The budget
may be expressed in terms of quantities or money or both. Production may be computed as
follows:
 Units to be produced = Desired closing stock of finished goods + Budgeted sales – Beginning
stock of finished goods.
OR

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 Expected Sales in Units XX
add Planned Ending Inventory in Units XX
less Begining Inventory in Units (XX)

Planned Produciton in Units XXX

(c) DIRECT MATERIAL BUDGET

 Direct material purchases budget shows budgeted beginning and ending direct material
inventory, the quantity of direct material that will be used in production, the amount of direct
material that must be purchased and its cost during a specific period.
 Direct material purchases budget is a component of master budget and it is based on the
following formula:

Budgeted ending Direct Material in Units XX

Add Direct Material in Units Needed for Production XX
less Budgeted beginning Direct Material in Units (XX)
Budgeted Direct Material Purchases in Units XXX
 In the above formula, the direct material in units that is needed for production is calculated as
follows:
 Budgeted Production During the Period × Units of Direct Material Required per Unit
= Direct Material in Units Needed for Production
 Since the budgeted production figure is provided by the production budget, the direct material
budget can be prepared only after the preparation of production budget.
 Direct Materials Usage Budget: shows the estimated quantities of materials required for
budgeted production.
 Direct Materials Purchases Budget: It ensures that materials are within the planned materials
stock levels i.e. after considering both usage material stock required.
(d) DIRECT LABOUR BUDGET
 Direct labour budget shows the total direct labour cost and number of direct labour hours
needed for production.
 It helps the management to plan its labour force requirements.
 Direct labour budget is a component of master budget. It is prepared after the preparation of
production budget because the budgeted production in units figure provided by the production
budget serves as starting point in direct labour budget.
 Following are the calculations involved in the direct labour budget:

Planned Production in units XX

× Direct Labour Hours Required per Unit XX

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 = Budgeted Direct Labour Hours Required XXX
× Cost per Direct Labour Hours XX
= Budgeted Direct Labour Cost XXX

ILLUSTRATION

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SOLUTIONS
(i) Sales budget
Product Quantity Price/unit amount
W 18000 65 1170000
Z 20,000 80 1600000
Total revenue 2,770,000

(ii) Production budget

W Z
Sales 18,000 20,000
Add closing stock 1500 2500
Less opening stock (3000) (2000)
Production (units) 16,500 20,500

(ii) Material usage budget

Products X Y
W 49500 99000
Z 102500 82000
Material usage (units) 152,000 181,000

(iii) Material purchases in quantity & value

X Y
Material usage 152,000 181,000
Add closing stock 6000 3000
Less opening stock (5000) (4000)
Material purchases (units) 153,000 180,000
Cost per unit 6 3
Material cost 918,000 540,000

Exercise
Illustration
Dullock Ltd manufactures a product branded ‘Delux’. The production of Delux requires a raw material
which costs sh.136 per kilogramme and direct labour which costs sh.600 per hour.
Each unit of Delux requires 2 kilogrammes of the raw materials, 15 minutes of direct labour and
variable overheads of sh.115. Delux retails at sh.1,360 per unit.

Additional information;
1. The company is in the process of preparing budgets for the financial year ending 30 June 2014
2. The budgeted opening and closing inventories of raw material and finished goods (Delux) for the
year ending 30 June 2013 are shown below;
1 July 2013 30 June 2014
Raw material 15,000 kgs 3,000 kgs
Finished goods 1,500 units 7,500 units
3. The company expects to sell 300,000 units of Delux during the year ending 30 June 2014
Required:
Prepare the following budgets for the year ending 30 June 2014;
i) Sales budget (in shillings)

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ii) Production budget (in units)
iii) Direct materials budget (in shillings)
iv) Direct labour budget (in shillings)

(e) PRODUCTION OVERHEAD BUDGET:

 The manufacturing overhead budget includes indirect material, indirect labour and indirect
expenses.
 The production overhead budget represents the estimate of all the production Overhead i.e.
fixed, variable, semi‐variable to be incurred during the budget period.
 The reality that overheads include many different types of expenses creates considerable
problems in:
 Fixed overheads i.e., that which is to remain stable irrespective of vary in the volume of
output,
 Apportion of manufacturing overheads to products manufactured, semi variable cost i.e.,
those which are partly variable and partly fixed.
 Control of production overheads.
 Variable overheads i.e., that which is likely to vary with the output.
 The production overhead budget engages the preparation of overheads budget for each division
of the factory as it is desirable to have estimates of manufacturing overheads prepared by those
overheads to have the responsibility for incurring them. Service departments cost are projected
and allocated to the production departments in the proportion of the services received by each
department

Illustration
The budget manager of XYZ ltd is preparing a budget for the accounting year starting from 1 st July
2020. As part of the budget operations, some items of factory overheard costs have been estimated by
him under specified conditions of volume as follows:

Volume of production (units) 120,000 150,000

Expenses: sh sh
Indirect materials 264,000 330,000
Indirect labour 150,000 187,500
Maintenance 84,000 102,000
Supervision 198,000 234,000
Engineering services 94,000 94,000

Required:
Calculate the cost of factory overheard items given above at 140,000 units of production

Explanation

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 Y
COSTS TC

330000
Change in y

264000
Change in x
F F

0 120000 140000 150000 OUTPUT (X)

TC = F + VX

Y = a +bX

Solution
Factory overheads budget (140,000 units)

Cost item Nature of cost Amount

Indirect materials Variable- 2.2*140000 308,000
Indirect labour Variable – 1.25*140000 175,000
Maintenance Variable= 0.6*140,000=84000
Fixed cost= 12000 96,000
Supervision Variable=1.2*140,000=168000
Fixed= 54,000 222000
Engineering services Fixed 94000
Total factory overheads 895,000

T = VARIABLE COST + FIXED COST

TC = (V X) + F

V= CHANGE IN EXPENSE
CHANGE IN OUTPUT
INDIRECT MATERIAL = 330,000- 264000/30000=2.20

264000= 2. 2*120000 + f
F=0
150,000= 1.25*120,000+f
F= 0
84000= 0.6*120,000+f
F= 12,000

(f) SELLING & DISTRIBUTION COST BUDGET

 The Selling and Distribution Cost budget is estimating of the cost of selling, advertising,
delivery of goods to customers etc. throughout the budget period.

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 This budget is closely associated to sales budget in the logic that sales forecasts significantly
influence the forecasts of these expenses. Nevertheless, all other linked information should
also be taken into consideration in the preparation of selling and distribution budget.
 The sales manager is responsible for selling and distribution cost budget. Naturally, he
prepares this budget with the help of managers of sub‐divisions of the sales department.
 The preparation of this budget would be based on the analysis of the market condition by the
management, advertising policies, research programs and many other factors.
 Some companies prepare a separate advertising budget, particularly when spending on
advertisements are quite high.
(g) ADMINISTRATION COSTS BUDGET
 It represents the costs of all administration expenses. Each department or budget centre will
be responsible for the preparation of its own budget.
 Management, Secretarial, Accounting and Administration costs which cannot be directly
related to the production are included here.
 The budget will be mainly incremental i.e. previous year’s figure will tend to apply for its next
budget with an allowance for inflation.

(h) RESEARCH AND DEVELOPMENT COST BUDGET

 These are costs, which are discretional in nature i.e. they are determined on need basis by the
managers concerned.
 Research cost is the cost of original investigation undertaken in order to gain new scientific or
technical knowledge and directed towards a specific practical aim objective.
 Development cost is the cost of using scientific or technical knowledge in order to produce
new or substantially improved materials, devices, products, processes systems or services prior
to the commencement of commercial production.

(i) CAPITAL EXPENDITURE BUDGET

 It represents the expenditure on all fixed assets during the budget period. Addition intended
to benefit future accounting periods, or expenditure which increases the production capacity,
efficiency lifespan or economy of an existing fixed assets are also incorporated.

(j) CASH BUDGET

 The cash budget is a sketch of the business estimated cash inflows and outflows over a specific
period of time. Cash budget is one of the most important and one of the last to be prepared.
 It is a detailed projection of cash receipts from all sources and cash payments for all purposes
and the resultant cash balance during the budget.

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  It is a mechanism for controlling and coordinating the fiscal side of business to ensure solvency
and provides the basis for forecasting and financing required to cover up any deficiency in
cash. Cash budget thus plays a vital role in the financing management of a business undertaken.
 Cash budget assists the management in determining the future liquidity requirements of the
firm, forecasting for business of those needs, exercising control over cash. So, cash budget thus
plays a vital role in the financial management of a business enterprise

Importance of a cash budget:

i) To reveal in advance point of cash shortages and surplus, so that cash sources and investments can
be arranged in advance.
ii) To ensure the cashflow of a firm is healthy, (there are no shortages).
iii) To allow management to consider the ways in which surpluses can be put into in advance.
iv) To enable management formulate organizational policy e.g. credit policies when purchasing
inputs, payroll policy (when to pay wages and salaries and in what amounts etc)
PREPARATION OF A CASH BUDGET
To prepare a cash budget cash receipts and cash payments must be known:

a) Estimating Cash Receipts: Generally main sources of cash receipts are sales, interest
and dividend, sales of assets and investments, capital borrowings etc. The Company
estimates time‐lag on the basis of past experience of cash receipts on credit sales while
cash sales can be easily determined.
b) Estimating Cash Payments: It can be decided on the basis of various operating budgets
prepared for the payment of credit purchase, payment of labour cost, interest and
dividend, overhead charges, capital investment etc.

Steps involved in developing a cash budget.

Step 1. Determine and adequate minimum cash balance.
Past operating records should indicate the proper cash cushion needed to cover any
unexpected expenses after all normal expenses are deducted from the months cash receipts.

Step 2. Forecasting Sales & Cash Receipts

When a company sells goods and services on credit, a cash budget must count for the delay
between the sale and the actual collection of the proceeds.

Step 3. Forecasting Cash Disbursements

Is when a business has a clear picture of the company's pattern of cash outflow.

Step 4. Estimating the end of the month cash balance.

Individuals should determine the cash balance at the beginning of each month. The beginning
cash balance includes cash on hand as well as cash in savings and checking accounts. The

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 cash balance at the end of the month becomes the beginning balance for the following month
.
FORMAT
Model of Cash Budget Particular January February March
Opening Balance ‐ ‐ ‐
Add: Receipts:
Cash Sales ‐ ‐ ‐
Receipts from Debtors ‐ ‐ ‐
Interest and Dividend ‐ ‐ ‐
Sale of fixed assets ‐ ‐ ‐
Sale of Investments ‐ ‐ ‐
Bank Loan ‐ ‐ ‐
Issue Shares & Debenture ‐ ‐ ‐
Others ‐ ‐ ‐
Total Receipts (A) ‐ ‐ ‐
Less: Payments
Cash Purchases ‐ ‐ ‐
Payment to creditors ‐ ‐ ‐
Salaries & wages ‐ ‐ ‐
Administrative expenses ‐ ‐ ‐
Selling expenses ‐ ‐ ‐
Dividend payable ‐ ‐ ‐
Purchase of Fixed Assets ‐ ‐ ‐
Repayment of Loan ‐ ‐ ‐
Payment of taxes ‐ ‐
Total Payments (B) ‐ ‐ ‐
Closing Balance (A ‐ B) ‐ ‐ ‐

Illustration 1
A company wishes to arrange for an overdraft facility with their bankers during the period October to
December, 2013 when it will be manufacturing largely for stock. Prepare a cash budget for the above
period from the following data, indicating the extent of the bank facilities the company will require at
the end of each month.
Activity Sales Purchases Wages
Amount Sh. Sh. Sh.
August, 2013 180,000 124,000 12,000
September, 2013 192,000 144,000 14,000
October,2013 108,000 243,000 11,000
November,2013 174,000 243,000 10,000
December,2013 126,000 268,000 15,000
The company sells on credit where 50% sales are realized in the month following the month of sales
and the remaining 50% in the second month following the month of sales. Creditors are paid in the
month following the month of purchase. Cash at bank on October 1 was Sh.25,000

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Solution
Cash budget for

OCTOBER NOVEMBER DECEMBER

Opening balance 25,000 56,000 (47000)
Sales 186000 150,000 141000
TOTAL RECEIPTS 211,000 206,000 94,000
PAYMENTS
PURCHASES 144000 243,000 243,000

WAGES 11,000 10,000 15,000

TOTAL PAYMNETS 155,000 253,000 258,000
CLOSING 56,000 (47000) (164,000)
BALANCE

Sales schedule

August sep Oct nov dec

aug - 90,000 90,000
sep - 96000 96000
oct - 54000 54000
Nov - 87000
Dec. -
total 186000 150,000 141000

Illustration 2
The information given below relates to a budget of XYZ ltd for the six months ending 31st December
2020

onth sales Material Wages Production Administration

purchases overheads overheads
July 72000 25000 10000 6000 5500
August 97000 31,000 12100 6300 6700
September 86000 25500 10600 6000 7500
October 88600 38600 25000 6500 8900
November 102500 37000 22000 8000 11000
December 108700 38800 23000 8200 11500
Additional information:

1. Expected cash balance on 1st July 2020 was sh. 72,500

2. 50% of total sales are cash sales
3. It is anticipated that a dividend of sh. 35,000 will be paid in December 2020
4. Creditors for material purchases grant one-month credit

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 5. Assets are to be acquired in august and September 2020 at sh. 8000 and 25,000 respectively
6. An application has been made to the bank for grant of a loan of sh. 30000 and it is expected
to be received in November 2020
7. Debtors are allowed one month’s credit
8. Sales commission at 3% sales is paid each month.

Required:
Prepare a cash budget for the six months ending 31st December 2020

Solution

July August September October November December

Opening balance 72,500 84840 108330 142150 135892 178767
Cash receipts
cash sales 36000 48500 43000 44300 51250 54350
Debtors - 36000 48500 43000 44300 51250
Bank loan 30000
Total cash receipts 108500 169340 199830 229450 261442 284367
Cash disbursement
Material purchases - 25000 31000 25500 38600 37000
Wages 10000 12100 10600 25000 22000 23000
Production overheads 6000 6300 6000 6500 8000 8200
Administration 5500 6700 7500 8900 11000 11500
overheads
Dividends 35000
assets 8000 25000
Sales commission 2160 2910 2530 2653 3475 3261
Total cash 18660 61010 57680 93558 82675 117961
disbursements
Closing balance 89840 108330 142150 135892 178767 166406

Illustration 3

From the following forecasts of income and expenditure prepare a cash budget for the three months
commencing 1st June 2023 when the bank balance was sh. 100,000.

Sales purchases wages factory expenses admin and

selling

expenses

sh. sh. sh. sh. sh.

April 80,000 41,000 5,600 3,900 10,000

May 76,000 40,500 5,400 4,200 14,000

June 78,500 38,500 5,400 5,100 15,000

July 90,000 37,000 4,800 5,100 17,000

August 95,000 35,000 4,700 6,000 13,000

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 A sale commission of 5 per cent on sales, is payable in additional to selling expenses. Plant valued at sh.
65,000 will be purchased and paid for august, and the divided for the last finacial year of sh. 15,000 will be
paid in July 2023. There is two month credited period allowed to customers and received from suppliers.
wages, factory expenses are payable in the following month

Solution:

Cash budget

For three months to 31st August 2023

June July August

sh sh sh.
Receipts:
Opening balance 1,00,000 1,11,400 1,03,075
Sundry debtors 80,000 76,500 78,500
1,80,000 1,87,900 1,81,575
Payments:
Sundry creditors 41,000 40,000 38,500
Wages 5,400 5,400 4,800
Factory expenses 4,200 5,100 4,800
Adm &selling expenses 14,000 15,000 17,000
Sales commission 4,000 3,825 3,925
Purchase of plant - - 65,000
Payment of dividend - 15,000 -
68,600 84,825 1,34,325
Closing balance 1,11,400 1,03,075 47,250

Illustration 4
Prepare a cash budget for the three months ending 30 th June from the following information
(a) Month sales materials wages overheads
$. $. $. $.
February 14,000 9,600 3,000 1,700
March 15,000 9,000 3,000 1,900
April 16,000 9,200 3,200 2,000
May 17,000 10,000 3,600 2,200
June 18,000 10,400 4,000 2,300
(b) Credit terms are:
Sales/Debtors _ 10% sales are on cash, 50% of the credit sales are collected next month and balance
in the following month.
(c) Creditors : materials, 2 months
Wages, ¼ months
Overheads, ½ month.
(d) Cash and bank balance of 1st April is expected to be $. 6,000.
(e) Other relevant information are:
(1) Plant and machinery will be installed in February at a cost of $. 96,000. The monthly
installation of $. 2,000 are payable from April onwards.
(2) Dividend @ 5% on preference share capital of $. 9,000 in June.
(3) Advance to be received for sales of vehicle $. 9,000 in June.

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 (4) Dividend from the investment amounting to $. 1,000 are expected to be received in June.
(5) Income- tax (advance) to be paid in June is $. 2,000.
Solution:
CASH BUDGET

Particulars April May June

$ $ $
Balance 6,000 3,950 3,000
Receipts:
Sales /debtors 14,650 15,650 16,650
Dividend - - 1,000
Advanced against vehicle - - 9,000
Total 14,650 15,650 26,650
Payments:
Credit for materials 9,600 9,000 9,200
(after 2 months)
Wages 3,150 3,500 3,900
Overheads 1,950 2,100 2,250
Capital expenditure 2,000 2,000 2,000
Dividend on preference - - 10,000
share - - 2,000
Income tax and advance 16,700 16,600 29,350
3,950 3,000 300
Total

Balance

Amount against sales/Debtors:

April may June
Rs Rs Rs
February (14,000-10%) × 50% 6,300 - -
March (15,000-10%) × 50% 6,750 6,750 -
April (10% of 16,000) 1,600
(16,000-10%) ×50% 7,200 7,200
May (10% of 17,000) 1,700
(17,000- 10%) 7,650
June: (10% of 18,000)
14,650 15,650 16,650

3. CLASSIFICATION ACCORDING TO FLEXIBILITY

(a) Fixed budgets.
 These are budgets which are designed to remain unchanged irrespective of the level
of activity actually attained. They are prepared on the basis that a certain volume
of production and a certain volume of sales will be achieved (e.g. 10,000 units) no
alternatives are given to this level.

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  A fixed budget is defined by only one level of activity and no adjustment to reflect
actual activity level are made when change occurs.

(b) flexible budget:

 it is a budget that is designed to change as the volume of activities changes. It involves
budgeting at various levels in anticipation of changes. A company may expect to sell
10,000 Units however it may prepare flexible budgets on the basis it produces and sell
8,000 or produces 10,000 Units and sells 8,000 units.
 Thus when preparing flexible budget it will be essential to know which costs vary with
production and which costs are fixed. The original budget is adjusted (flexed) to reflect
the actual conditions in which the performance was done.
A fixed budget has the following limitations:
 It provides little assistance at the planning stage. It does not give implication of various
alternative strategies which management may wish to consider.
 It fails to provide relevant and reliable base against which to measure actual performance
where actual activity differs from the budget.
 Little motivation to management to use the budgeting control system as a control aid.

It is more useful than fixed budgeting due to:

 It provides a range of information at the planning stage which will assist in short term
planning.
 Control: It provides control data when compared with actual performance.
 Motivation: More likely to be acceptable to management to provide a positive
motivational stimulus because the control data is adjusted to conform with current
activity level.
Preparation of a Flexible Budget
 The preparation of a flexible budget requires the analysis of total costs into fixed and variable
components. This analysis of course is, not unusual to the flexible budgeting, more important
in flexible budgeting than in fixed budgeting. This is so because in flexible budgeting, varying
levels of output are considered and each class of overhead will be different for each level.
 Thus the flexible budget has the following main distinguishing features:
 It is prepared for a range of activity instead of a single level.
 It provides a dynamic basis for comparison because it is automatically related to
changes in volume

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Example 1
The following information at 50% capacity is given. Prepare a flexible budget and forecast the profit
or loss at 60%, 70% and 90% capacity.
Fixed expenses sh
Salaries 50,000
Rent an d rates 40,000
Depreciation 60,000
Administration expenses 70,000
Variable expenses
Materials 200,000
Labour 250,000
Others 40,000
Semi-variable
Repairs 100,000
Indirect labour 150,000
Others 90,000
Additional information
 It is estimated that fixed expenses will remain constant at all capacities
 Semi variable expenses will not change between 45% and 60%, will rise by 10% between
60% and 75%, a further increaase of 5% when capacity crosses 75%
 Estimated sales at various levels of capacity are:
60% sh 1,100,000
70% sh 1,300,000
90% sh. 1,500,000

FLEXIBLE BUGDET

Particulars 50% 60% 70% 90%

Fixed expenses
Salaries 50,000 50,000 50,000 50,000
Rent & rates 40,000 40,000 40,000 40,000
Depreciation 60,000 60,000 60,000 60,000
Admin expenses 70,000 70,000 70,000 70,000
Variable expenses

Materials 200,000 240,000 280000 360000

Labour 250,000 300,000 350000 450000
Others 40,000 48,000 56000 72000
SEMI-
VARIABLE
Repairs 100,000 100,000 110000 115000
Indirect labour 150,000 150,000 165000 172,500
Others 90,000 90,000 99000 103,500
TOTAL COSTS 1148000 1230000 1493000
PROFIT /LOSS (48,000) 70000 7000
SALES 1,100,000 1,300,000 1,500,000

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Example 2
Mini Bakeries Ltd. has budgeted to produce and sell 100,000 units of cakes during the next period.
The selling price per cake is Sh. 20 and variable cost per cake is Sh. 12. Fixed overheads are budgeted
to at Sh. 600,000.

Additional information
1. Fixed costs will increase to Sh. 700,000 where activity is in excess of 110,000 units; Fixed costs
will fall to Sh. 480,000 where activity level is less than 90,000 units.
2. Variable costs will fall by 5% per unit (cake) of all units where activity is in excess of 100,000
cakes because of the economies of scale.

The actual results of the period in which 115,000 units (cakes) were produced and sold were:
1. Sales revenue Sh. 2,242,500
2. Variable costs Sh. 1,320,000
3. Fixed costs Sh. 67,000

Required:
1. Prepare a summary, which shows the budgeted results for activity levels from 80,000 to 120,000
cakes using the above information.
2. Prepare a control statement comparing budgeted with actual results where a fixed budget system
is used based on 100,000 units.

Solution
Flexible Budget Summary

Units 80,000 90,000 100,000 110,000 120,000

Sales Revenue 1,600,000 1,800,000 2,000,000 2,200,000 2,400,000
Variable cost 690,000 108,000 120,000 1,254,000 1,368,000
Contribution 640,000 720,000 800,000 946,000 1,032,000
Fixed Costs 480,000 600,000 600,00 600,000 700,000
Net Profit 160,000 120,00 200,000 346,000 332,000

Control Statement (Fixed Budget)

Budget Actual Variance

Units 100,000 115,00 15,00 (F)

Sales Revenue 2,000,000 2,242,500 242,500 (A)
Variable Cost 1,200,000 1,320,000 120,000 F
Contribution 800,000 922,500 122,500 (A)
Fixed Costs 600,000 670,000 70,000 (A)
Net Profit 200,000 252,500 525,000 (F)

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 Example 3

The budgeted output of a factory engaged in the production of a single product, M, at the optimum
capacity of 6400 units per annum amount to sh. 176,048 as indicated below:

sh sh

Fixed cost 20,688

Variable cost:

Power 1,440

Repairs etc. 1,700

Miscellaneous 540

Direct material 49,280

Direct labor 102,400 153,360

176,048

Having regard to possible impact on the sales turnover by market trend, the company decides to have
a flexible budget with a production of 3,200 and 4,800 units ( the actual quantity proposed to be
produced being left at a later date before commencement of the budget period).

Administration, selling and distribution expenses continue at sh. 3,600.

Required:

Prepare a flexible budget for production level at 50% and 75%. Assuming the sales per unit is
maintained at sh. 40 as at a present, indicate the effect on the net profit.

SOLUTION:

FLEXIBLE BUDGET

3200 4800 units 6400 units

units 50 % 75% 100%
Fixed expenses 20,688 20,688 20,688
Variable cost :
Direct materials (sh 7.70) 24,640 36,960 49,280
Direct labour (sh 16.00) 51,200 76,800 1,02,400
Power ( 0.225) 720 1,080 1,400
Repairs: ( 0.266) 850* 1275 1700
Miscellaneous (0.084) 270** 405 540
Total cost 98,368 1,37,298 1,76,048
Selling & distribution 3,600 3,600 3,600
Cost of sales 1,01,968 1,40,808 1,79,648
Sales (sh 40.00) 1,28,200 1,92,000 2,56,000
Profit 26,032 51,192 76,352
∗1700 ∗∗540
× 3200 = 850 ×3200 = 270
6400 6400

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 Example 4

Prepare a flexible budget for overheads on the basis of the following data. Also ascertain the
overheads rate at 50%, 60% and 70% capacity.

At 60% capacity

Variable overheads: sh.

Indirect material 6,000

Indirect labour 18,000

Semi- variable overheads:

Electricity (40% fixed 60% variable) 30,000

Repairs (80% fixed 20% variable) 3,000

Fixed overheads:

Depreciation 16,500

Insurance 4,500

Salaries 15,000

Total overheads 93,000

Estimated direct labour hours 1, 86,000

Solution;

Flexible budget and overhead rates

Items 50% capacity 60% capacity 70% capacity

Variable overheads: sh. sh. sh.
Indirect material 5,000 6,000 7,000
Indirect labour 15,000 18,000 21,000
Semi variable overheads:
Electricity 27,000 30,000 33,000
Repairs & maintenance 2,900 3,000 3,100
Fixed overheads
Depreciation 16,500 16,500 16,500
Insurance 4,500 4,500 4,500
Salaries 15,000 15,000 15,000
Total overheads 89,900 93,000 1,00,100
Estimated direct labour hours 1,55,000 1,86,000 2,17,000
Overhead rate sh. 0.55 sh. 0.50 sh. 0.46

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 ZERO BASED BUDGETING:

 The ‘Zero‐Base’ refers to a ‘nil‐budget’ as the starting point.It starts with a presumption that
the budget for the next period is ‘zero’ until the demand for a function, process, or project is
not justified for single penny. The assumption is that without such justification, no expenditure
will be allowed. In effect, each manager or functional head is required to carry out cost‐benefit
analysis of each of the activities, etc. under his control and for which he is responsible.
 The method of ZBB suggests that the business should not only make decision about the
proposed new programmes but it should also, regularly, review the suitability of the existing
programmes. This approach of preparing a budget is called incremental budgeting since the
budget process is concerned mainly with the increases or changes in operations that are likely
to occur during the budget period.
 This method for the first time was used by the Department of Agriculture, U.S.A. in the 19th
century. Other State Governments of the U.S.A. found this method helpful and so almost all
the states took deep interest in the ZBB method.
 According to David Lieninger "ZBB is a management tool, which provides a systematic
method for evaluating all operations and programmes, current or new, allows for budget
reductions and expansions in a rational manner and allows re‐allocation of sources from low
to high priority programmes." ‐
 ZBB is a planning, resource allocation and control tool. It, however, presupposes that
a. There is an efficient budgeting system within the enterprise.
b. Managers can develop quantitative measures for use in performance evaluation.
c. Among the new suggestions and programmes, along with old ones are put to a strict
scrutiny.
d. Funds are diverted from low‐priority suggestions to high priority suggestions

Procedure of Zero‐based Budgeting:

(1) Determination of the objective: This is an initial step for determining the objective to introduce
ZBB. It may result into the decreased cost in personnel overheads ordebunk the projects which
do not fit in the business structure or which are not likely to help accomplish the business
objectives.
(2) Degree at the ZBB is to be introduced: It is not possible every time to evaluate every activity
of the whole business. After studying the business structure, the management can decide
whether ZBB is to be introduced in all areas of business activities or only in a few selected
areas on the trial basis.
(3) Growth of Decision units: Decision units submit their data as to which cost benefit analysis
should be done in order to arrive at a decision that helps them decide to continue or abandon.

27
 It could be a functional department, a programme, a product‐line or a sub‐line. Here the
decision unitsexist independent of all the other units so that when the cost analysis turns
unfavourable that particular unit could be closed down.
(4) Growth of Decision packages:Decision units are to be identified for preparing data relating to
the proposals to be included in the budget,concerned manager analyzes the activities of his or
her own decision units. His job is to consider possible different ways to fulfill objectives. The
size of the business unit and the volume of goods it deals with determine the number of decision
units and packages.The decision package has to contain all the information which helps the
management in deciding whether the information is necessary for the business, what would be
the estimated costs and benefits expected from it.
(5) Assessment and Grading of decision packages: These packages invented and formulated are
submitted to the next level of responsibility within the organization for ranking purposes.
Ranking basically decides as to whether or not to include the proposals in the budget. The
management ranks the different decision packages in the order from decreasing benefit or
importance to the organization. Preliminary ranking is done by the unit manager himself and
for the further review it is sent to the superior officers who consider overall objectives of the
organization.
(6) Allotment of money through Budgets: It is the last step engaged in the ZBB process. According
to the cost benefit analysis and availability of the funds management has ranks and thereby a
cut‐off point is established. Keeping in view reasonable standards, the approved designed
packages are accepted and others are rejected. The funds are then allotted to different decision
units and budgets relating to each unit are prepared.

Advantages:

 ZBB rejects the attitude of accepting the current position in support of an attitude of inquiring
and testing each item of budget.
 It helps improve financial planning and management information system through various
techniques
 It is an educational process and can promote a management team of talented and skillful people
who tend to promptly respond to changes in the business environment.
 It facilities recognition of inefficient and unnecessary activities and avoid wasteful
expenditure
 Cost behavior patterns are more closely examined.
 Management has better elasticity in reallocating funds for optimum utilization of the funds.

Disadvantages:

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 It is an expensive method as ZBB incurs a huge cost every in its preparation..
 It also requires high volume of paper work,hence sometimes it becomes a tedious job.
 In ZBB there is a danger of emphasizing short‐term benefits at the expenses of long term ones.
 This is not a new method for evaluating various alternatives, and cost‐benefit analysis.
 The psychological effects can also not be ignored. It holds out high hopes as a modern
technique, claiming to raise the profitability and efficiency of the business

29