Nature and Characteristics of Budgets

 A budget is a financial plan of the resources needed to carry out tasks and meet financial goals. It is also a quantitative expression
of the goals the organization wishes to achieve and the cost attaining these goals.
 Budgeting is the act of preparing a budget.
 Budgetary Control means the use of budgets to control a firm’s activities.
 The master budget is summary of all phases of a company’s plans and goals for the future.

Types of Budget
The types of budgets or major composition of the major budget are:
A.) The Operating budget
a. Sales Budget
b. Production Budget
1.) Materials cost budget
2.) Direct labor cost budget
3.) Factory overhead budget
4.) Inventory levels

Function of Budgeting
Budgets make the decision-making process more effective by helping managers meet uncertainties. Budgets should not be
expressions of wishful thinking but rather descriptions of attainable objectives.
The Purposes of the Budget
A budget is a description in quantitative - usually monetary - terms of a desired future result. The process of preparing the budget requires
management at all levels to focus on the future of the business entity. The benefits that may be realized from a budgeting program are:
1. Defining broad objectives and goals and formulating strategies to achieve such objectives;
2. Coordinating the activities of the organization by integrating the plans of the various parts thereby pulling everyone in the same direction,
3. Allocating resources to those parts of the organization where they can be used most effectively:
4. Communicating management's approved plans throughout the organization;
5. Uncovering and preparing for potential bottleneck in the operations before they occur.
6. Motivating managers to achieve the desired results; and
7. Setting a standard or benchmark for evaluating actual performance.

 Planning Function
o Each time a budget is prepared, there is a period of critical self-appraisal during which policies and procedures come up for
review. When planning is done well in advance, many problems are anticipated long before they arise, and solution can be
sought through deliberate study.
 Coordination and Allocating Resources function for Goal Congruence
o The budget serves as a tool through which actions of different parts of an organization can be wielded into a harmonious unit
working toward a common objective.
 Communication Function
o Each employee should have a clear understanding of the company’s goal and the part he or she is expected to play in their
attainment.
 Motivation Function
o Budgeting can be a force for good and evil.

 Control Function
o Budgets represent management’s formal commitment to take positive action to make actual events correspond to the formal
plan.
 Standards in evaluating performance.
o The budget should be used as a positive instrument to assist in establishing goals, in measuring operating results, and in
isolating areas that need extra effort or attention.
ADVANTAGES AND LIMITATIONS OF BUDGETS
The advantages of budgeting include:
1. Il forces planning and exposes situations in which are inadequate to attain the total organization's objectives.
2. It allows a reiterative process to bring the goals of the organization the subcomponents into agreement.
3. It provides a means of communicating organization goals down through the organization and sub-unit operational limitations up though the
organization.
4. It provides a basis for financial planning, sub-unit coordination, resource acquisition, inventory policy, scheduling and output distribution.
5. It provides a basis by which activity can be monitored with actual results being compared to the planned results.
The limitations of budgeting are:
1. Budgets tend to oversimplify the real situation and fail to allow for variations in external factors. They do not reflect qualitative variables.
2. It is difficult to prepare a detailed budget for an organization that has never existed or for a new division, product, or department of an
existing
3. There may be lack of higher and lower management commitment because of lack of understanding of the fundamentals of budget
preparation and utilization.
4. The budget is only a representation of future or a means to the goal of profitable activity and not an end in itself. It may interfere with the
supervisor's style of leadership and can therefore stifle initiative.
5. Budget reports usually emphasize results, not reasons.

The Management Process of Preparing the Master Budget

Organization for Budget Preparation
Budget Committee – generally considered an effective body to oversee preparation and administration of the budget. They decide how
budgets shall be prepared, passes on the final budget and settles disputes in one segment of the business and another when differences of
opinion arise. They also receive budget reports and makes policy decisions with respect to budget decisions and other problems of budget
administration.
Controller – acts as a coordinator in the budgeting operation. He recommends how budgets should be prepared, assembles the budgets,
prepared periodic reports showing variances of the actual results from the budgeting results, interprets variances and offers suggestions for
improvements whenever possible.

The Budget Period

As a general rule, the period covered by a budget should be long enough to show the effect of managerial policies but short enough so that
estimates can be made with reasonable accuracy. This suggests that different types of budgets should be made for different time spans.

Master Budget – overall financial and operating plan for a coming fiscal period and the coordinated program for achieving the plan
– usually prepared on a quarterly or an annual basis
Capital Budgets – long range budgets
– incorporate plans for major expenditures for plant and equipment or the addition of product lines
– might be prepared to cover plans for as long as 5 to 10 years
Responsibility Budgets – segments of the master budget relating to the aspect of the business that is the responsibility of a particular
manager
– often prepared monthly
Cash Budgets – comparison of the cash receipts and cash disbursements for the currents budget period
– may be prepared on a day-to-day or monthly basis
Cash Receipts – normally comes from customers
– cash from other sources should be considered when budgeting
Cash Disbursements – various adjustments and additions will have to be made when preparing the budget for prepayments, accruals
as well as extraneous items that is not included in the computation of other individual budgets

Steps in Developing a Master Budget

1. Establish basic goals and long-range plans for the company
2. Prepare a sales forecast for the budget period
3. Estimate the cost of goods sold and operating expenses
4. Determine the effect of budgeted operating results on assets, liabilities and ownership equity accounts
5. Summarize the estimated data

Sales Budget – shows the quantity of products that will be sold at a specific price
– foundation on which all other short-term budgets are built
– provides the revenue predictions from which cash receipts from customers can be estimated and supplies the basic data
for constructing budgets for production costs and selling and administrative expenses
– keystone of the budget structure
Factors to be considered for sales forecast:
1. Past sales volume 6. Pricing, advertising and other promotion policies
2. General economic and industry conditions 7. Production capacity
3. Relationship of sales to economic indicators 8. Quality of sales force
4. Relative product profitability 9. Seasonal variations
5. Market research studies and competition 10. Long-term sales trends for various products
Production Budget – key factor in the determination of other budgets, including the direct materials budget, direct labor budget and
manufacturing overhead budget
Distribution / Marketing Budget – built up by attempting to establish the causal relationship between sales and the activity of the various
distribution departments which, in turn, creates costs which are budgeted
Administrative Expense Budget – series of departmental budgets, each one of which will be coordinated and correlated with the
responsibility of the person in charge of the department

Comprehensive Budget Illustrated

Gilbert Manufacturing Company manufactures a special line of tools. As of December 31, 2018, the Statement of Financial Position of the firm
is as follows:

Gilbert Company
Statement of Financial Position
December 31, 2018
Assets Equities
Current Assets Current Liabilities
Cash P 150,000 Accounts Payable P 140,000
Accounts receivable 220,000 Taxes Payable 156,000
Inventories 592,000 Current portion of long-term debt 83,000
Other current assets 23,000 Total Current Liabilities P 379,000
Total current assets P 985,000 Non-Current Liabilities 576,000
Total Liabilities P 955,000
Non–Current Assets
Property, plant and equipment P 2,475,000 Equity
Less: Accumulated Share capital P 350,000
………..depreciation 850,000 Retained earnings 1,305,000
Net P 1,625,000 Total P 1,655,000
Total Assets P 2,610,000 Total Equities P 2,610,000

The following information is available for the development of its Master Budget for 2019:

Estimated Sales: Raw Materials: Material

Units 6,400 R S
Price per unit P800 Materials required per unit
Finished goods inventory: of finished product 3 units 5 units
Beginning 900 Units @ P500 Beginning inventory 2,200 4,000
Ending 1000 Ending inventory 1,300 4,600
Work in process inventory: NONE Unit Cost P10 P30
Direct labor P146 per unit

Overhead is estimated as follows: Marketing and Administrative expenses are budgeted as follows:
Variable: Variable Marketing Costs:
Indirect materials and P5.85 per unit Sales commissions P40.625 per unit sold
 Supplies Other marketing costs P16.250 per unit sold
Materials handling 9.07 per unit Fixed Marketing Costs:
Other indirect labor 5.07 per unit Sales salaries P100,000
Fixed: Advertising 193,000
Supervisor labor P175,000 Other 78,000
Maintenance & repair 85,000 Administrative costs (all fixed)
Plant administration 173,000 Administrative salaries 254,000
Utilities 87,000 Data processing services 103,000
Depreciation 280,000 Legal and other professional fees 180,000
Insurance 43,000 Depreciation-building, furniture
Property Taxes 117,000 and equipment 94,000
Other 41,000 Taxes-other than income 160,000
Other 26,000

Additional information: The treasurer’s office also provided the following information and estimates:
1. All sales are on account and collections from customers are expected to amount to P5,185,000.
2. Equipment costing P300,000 with accumulated depreciation of P275,000 will be sold at its net book value. New equipment costing
P320,000 will be purchased during the year.
3. Accounts payable will increase by P15,000 and assumed to be for materials purchases only.
4. Income taxes will be provided at an average rate of 35% of income before taxes while P252,000 will be paid during the year.
5. Dividends amounting to P140,000 will be paid during the year and the current portion of the long-term debt shall also be settled at the end of
the year. Interest rate is 8% per annum.

Sales Budget
For 2019
Units Price Per Unit Total Sales Revenue
Estimated Sales 6,400 800 P5,120,000
 Production Budget Budgeted Statement of Cost of Sales
For 2019 For 2019
Units to be sold 6,400 Beginning work in process inventory P –
Gilbert Manufacturing Company
Add: Desired ending inventory 1,000 Manufacturing costs
Budgeted Statement of Financial Position
Total 7,400DecemberDirect
31,Materials
2019
Less: Beginning inventory
Assets 900 Beginning inventory Equities P 142,000
Units
Current Assetsto be produced 6,500 Purchases
Current liabilities 1,179,000
Cash Raw Materials Purchases P 143,000 TotalAccounts payable P1,321,000 P 155,000
Accounts receivable For 2019 155,000 Less:Taxes
Ending inventory
Payable 151,000 32,000
Inventories Materials 651,000 Total direct materials cost
Current portion of long-term debt P1,170,000 –
Units
Other required
current for production
assets R S 23,000Direct labor
Total current liabilities 949,000 P 187,000
R (6,500 x 3)
Total current assets 19,500 Manufacturing overhead
P 972,000 Long-term liabilities 1,131,000 576,000
S (6,500
Non-Current x 5)
Assets 32,500 Total manufacturing
Total Liabilitiescost P3,250,000 P 763,000
Add: Desired ending inventory 1,300 4,600 Less: Ending work in process inventory –
Property, plant and equipment P2,495,000
Total units required
Less: Accumulated depreciation 20,800 37,100 Cost of
949,000 Equitygoods manufactured P3,250,000
Less: Beginning inventory 2,200 4,000 Add: Beginning finished goods inventory 450,000
Net P1,546,000 Share capital P350,000
Units to be purchased 18,600 33,100 Total available for sale P3,700,000
Total Assets P2,518,000 Retained earnings 1,405,000
Unit price x P10 x P30 Less: Ending finished goods inventory 500,000
Total Equities P2,518,000
Total purchases P186,000 P993,000 Cost of sales P3,200,000
Direct Labor Budget
For 2019 Budgeted Marketing and Administrative Costs
Number of units to be produced 6,500 For 2019
Direct labor cost per unit x P146 Variable marketing costs
Total budgeted direct labor costs P949,000 Sales commission P 260,000
Budgeted Manufacturing Overhead Others 104,000
For 2019 Total P 364,000
Variable overhead: units needed to produce 6,500 units Fixed marketing costs
Indirect materials and supplies (@P5.85) P 38,000 Sales salaries P 100,000
Materials handling (@P9.07) 59,000 Advertising 193,000
Other indirect labor (@P5.07) 33,000 Others 78,000 How can a
Total 130,000 Total P 371,000 Budget be
Fixed manufacturing overhead Total marketing costs P 735,000
Used in
Supervisor labor 175,000 Administrative costs
Operating
Maintenance & repairs 85,000 Administrative salaries P 254,000
Plant administration 173,000 Data processing services 103,000 a
Utilities 87,000 Legal and other professional fees 180,000 Business?
Depreciation 280,000 Depreciation-building, furniture
Insurance 43,000 and equipment 1.) Actions
94,000
Property taxes 117,000 Taxes-other than income to be taken
108,000
Others 41,000 Others by people in
26,000
Total 1,001,000 Total the
765,000
Total manufacturing overhead P1,131,000 Total marketing and administrative costs organization
P1,500,000
Gilbert Manufacturing Company Gilbert Manufacturing Company during the
Cash Budget Budgeted Income Statement coming
For the Budget Year Ending December 31, 2019 For the Budget Year Ending December 31, 2019 period will
Cash balance, January 1, 2018 P 150,000 Sales P5,120,000
be based
Add: Estimated receipts Less: Cost of sales 3,200,000
upon a
Collections from customers P5,185,000 Gross profit P1,920,000
careful
Sale of assets 25,000 Less: Marketing and administrative cost 1,500,000
analysis and
Total P5,210,000 Net operating profit P 420,000
study. Since
Total cash available P5,360,000 Less: Interest expense 52,000*
budgeting is
Less: Estimated disbursements Net income before taxes P 368,000
Payments for material purchases P1,164,000 Less: Provision for income taxes (35%) done well in
128,000*
Direct labor 949,000 Net income after taxes advance of
P 240,000*
Manufacturing overhead 851,000 the period to
Marketing & Administrative expenses 1,458,000 * Rounded off be covered,
Payments for income tax 252,000 there is
Dividends 140,000 ample time
Reduction in lone-term debt 83,000 to study the
Acquisition of new assets 320,000 profitability
Total disbursements P5,217,000 of products;
Cash balance, December 31 P 143,000 to determine
which of several production methods will be the most economical; to study the input-output relationships, such as the amount of sales effort
needed to attain a given sales volume; to study the relationships between prices and the market; and to give careful consideration to
numerous other business problems.

2.) Budgeting enables one to practice “preventive management.” This means planning in such a way that difficulties and problems will be
foreseen and therefore avoided or solved before they arrive. By working out detailed plans for selling, production, office operations, and
finance, and then coordinating and integrating them, one may see critical problems developing which otherwise might not be detected.

3.) If sales and production are in balance with each other, it is then necessary to balance them with the available financial resources of the
company. This involves the detailed planning of cash receipts, disbursements, and computation of the amount of cash on hand throughout the
coming period. There must be adequate cash to pay for labor, materials, operating expenses, and perhaps for the purchase of new equipment.

4.) Budgeting assists in improving efficiency and in eliminating waste from business operations. Each person with responsibility should have
his own budget which has been coordinated and related to all the other budgets in the company. It tells what he should accomplish during the
period, to some extent how he should do it, and definitely how much it should cost for him to do his assigned job.

5.) Operations in all departments of the business are coordinated and are directed toward the goal which has been set in the general business
policies of the company. The budgets of the persons with the responsibility should be developed in such a way that they are all related to each
other and that collectively they will result in economical and efficient operation of the company as a whole.

6.) Budgeting conserves the executive’s time by permitting him to apply the principle of “management by exception.” This principle is applied,
the manager is directed to exceptions from the desired performance of his subordinates. For him to exercise close supervisions over his
subordinate who is performing satisfactory would be waste of time.