A budget is defined as a comprehensive and coordinated

plan, expressed in financial terms for the operations and

resources of an enterprise for a specified period in future.

 A budget is a financial statement prepared prior to a

predetermined period of time of the policy to be

persued during that period for the purpose of
attaining a given objective. -I.C.M.A., London
A budget is a pre-determined statement of
management policy during a given period which
provides a standard for comparison with the results
actually achieved. -Brown and Howard
Budget is an estimate of future needs arranged
according to an orderly basis covering some or all the
activities of an enterprise for a definite period of time.
-George R. Terry

The functions of a system of budgeting are as follows,

To ensure the achievement of the organization's objectives
To compel planning
To communicate ideas and plans
To co-ordinate activities
To provide a frame work for responsibility accounting
To establish a system of control
To motivate employees to improve their performance
A budget is a quantified plan of action for a forthcoming
accounting period.

Ensure the achievement of the

organizations objective

Quantified expressions of objectives

are drawn up as targets to be achieved
within the timescale of the budget
plan.

Compel planning

Planning forces management to look

ahead, to set out detailed plans for
achieving the target for each department,
operation and (ideally) each manager and
to anticipate problems.

Communicate ideas and plans

A formal system is necessary to ensure that

each person affected by the plans is aware
of what he or she is supposed to be doing.
Communication might be one-way, with
manager giving order to subordinates, or
there might be two way

Co-ordinate activities

The activities of different departments

needs to be co-ordinates to ensure
maximum integration of effort toward
common goals. This implies, for example,
that the purchasing department should
base its budget on production
requirements.

Provide a framework for reponsibility

accounting

Budget require that manager of

budget centres are made responsible
for the achievement of budget target
for the operations under their
personal control.

Establish a system of control

Control over actual performance is

provided by the comparisons of actual
results against the budget plan.
Departures from budget can then be
investigated and the reasons for the
departures can be divided into
controllable and uncontrollable factors.

Motivate employees to improve their

performance

The interest and commitment of

employees can be retained if there is a
system which lets them know how well
or badly they are performing. The
identification of controllable reasons
for departures from budget with
managers responsible provides an
incentive for improving future
performance.

Budget period
The budget period is the time period to which the
budget relates. Except for capital expenditure budget,
the budget period is commonly the accounting year.
Budget manual
The budget manual is a collection of instructions
governing the responsibilities of persons and the
procedures, forms and records relating to the
preparation and use of budgetary data.

Content

Detail

Explanation of the objectives of the

budgeting process

The purpose of budgetary planning and

control
The objective of the various stages of the
budgeting process
The importance of budgets in the longterm planning and administration of the
enterprise

Organizational structures

An organization chart
A list of individuals holding budget
responsibilities

Outline of the principle budgets

Relationship between them

Administrative details

Membership, and terms of reference, of

the budget committee
The sequence in which budgets are to be
prepared
A timetable

Procedural matters

Specimen forms and instruction for

completing them
Specimen reports
Account codes (or a chart of accounts)
The name of the budget officer to whom
enquiries must be sent

Managers responsible for preparing budgets should

ideally be the managers who are responsible for
carrying out the budget. For example, the sales
manager should draft the sales budget and selling
overhead cost centre budget and the purchasing
manager should draft the material purchases budget.

The co-ordination and administration of budget is usually the

responsibility of a budget committee. The budget committee is assisted
by a budget officer who is usually an accountant. Every part of the
organization should be a representative from sales, production,
marketing and so on. Functions of the budget committee include the
following.
Co-ordination of the preparation of budgets, which include the issues
of the budget manual.
Issuing of timetables for the preparation of functional budgets
Allocation of responsibilities for the preparation of functional budgets
Provision of information to assist in the preparation of budgets
Communication of final budgets to the appropriate managers.
Comparison of actual results with budget and the investigation of
variances
Continuous assessment of the budgeting and planning process, in
order to improve the planning and control function.

The budget preparation process is as follows

Communicating details of the budget policy and
budget guidelines.
Determining the factor that restricts output
Preparation of the sales budget
Initial preparation of budget with superiors
Co-ordination and review of budgets
Final acceptance of the budgets
Budget review

Types of budgets
Operating
budget
Sales
budget

Production
budget
Material
usage budget

Material

Financial
budget
Cost
budget

Cost of
production
budget

Labour
budget
Factory
overhead
budget
Plant utilization
budget

Direct
labour
budget

Factory
overhead
budget

On the
basis of
flexibility

Long
term

Fixed

Cash
budget

Flexed

Budgete
d P/L

Cash
budget

Master
budget

Short
term

purchase
budget
Direct
material
budget

on the
basis of
time

Capital
expenditure
budget

Current

Flexible

Budgete
d B/S

On the basis of Period:

Long-term Budget: long-term budgets are related
with the long-term planning of the business. The
period of such budgets varies between five to ten years.
Short-term budget: short-term budget is that budget
which is prepared generally for a period of one to five
years.
Current budget: these budgets are in fact a kind of
short-term budgets and their period extends from one
month to twelve months.

 Fixed Budget: fixed budget is also known as Static

Budget. It is prepared for single level of activity and

single set of business conditions.
Flexible Budget: flexible budget is that budget which
presents costs, revenues and profits at various levels of
business activity, i.e., various volumes of output and
sales.

 Master Budget:

The master budget is a consolidated summary of the

various functional budgets. According to some experts,
Budgeted Profit and Loss Account and Budgeted Balance
Sheet may be treated as Master Budget.
Functional Budgets:

There are also known as Departmental Budgets or

Subsidiary Budgets. All those budgets are placed in these
categories which are prepared either on the basis of
functions or departments in a business concern.

 Sales budget:

Sales budget is a forecast of sales during budget period. It

presents the sales projections in terms of quantity, value, period,
sales area, product, etc. it should be noted that sales budget is a
starting point of budgetary system
Cash Budget:
Cash budget is a statement which gives an estimate of the
anticipated receipts and payments of cash during budget period.
Production Budget:
Production budget is a forecast of total output of the whole
organization broken down into estimates of output of various
products to be produced during budget period.
Capital Expenditure Budget:
This budget gives an estimate of the amount of capital that may
be required for purchasing fixed assets needed for fulfilling
production requirements as specified in the production budget.

 Cost budget:

This budget prepared after determination of the volume of

output in production budget and it presents an estimate of cost
of output planned for a budget
Cost Budget are sub divided into:
Direct Materials Budget:

this budget deals with the

requirement and procurement of direct materials
Direct Labour Budget: this budget presents an estimate of
the requirements of direct labour essential to meet the
production targets fixed in production budget.
Manufacturing overhead Budget: this budget gives an
estimate of works or manufacturing overhead expenses to be
Incurred in a budget period to achieve the production targets.
Plant Utilization Budget: this budget lays down the level of
plant capacity to carry out the production as per production
budget.

One that embraces that impact of the financial

decisions of the firm. It is a plan including a budgeted
balance sheet, which shows the effects of planed
operations and capital investments on assets, liabilities
and equities. It also includes a cash budget, which
forecasts the flow of cash and other funds in the
business. Cash budgeting is a critical part of the
budgeting because it is essential to have the right sums
of cash available at the right times.

When all the functional budgets have been prepared,

they are summarized and consolidated in to a number
of budgets which consists of the budgeted profit and
loss account, budgeted balance sheet and cash budget
and which provides the overall picture of the planed
performance for the budget period.

Master Budget Includes:

1. Capital acquisitions (expenditures) budget.
2. Cash receipts and disbursements budget.
3. Budgeted income statement.
4. Budgeted balance sheet.

1. Sales budget is the first step in the budget

process.
2. It comes first because other budgets cannot
be prepared without an estimate of sales.
3. Example: production estimates are based
on forecast sales.

4. Companies use a variety of methods to

forecast sales:

a.
b.
c.
d.

Econometric models.
Previous sales trends.
Trade journals and magazines.
Estimates by sales personnel.

Production budgets are based on the

following relationships:
Finished units to be produced
=

expected sales in units

+
desired ending inventory of finished units

beginning inventory of finished units

1. Direct materials budgets also depend

on:

a. The amount needed for production

b. The amount need for ending
inventory.

2. Calculated as follows:
Required purchases of direct materials
=
amount required for production
+
desired ending inventory of direct materials

beginning inventory of direct materials

Direct labor budget calculated by multiplying:

Number of units to be produced
x
Labor hours per unit
x
rate per hour

1. Cost per unit of production of each variable

cost item is multiplied by the quantity of
units produced.
1. Fixed costs by definition are independent of
production volume, are budgeted as a total
dollar amount for each period.

Selling and administrative expense budgets

include:
1. Salaries.
2. Advertising and Promotion
3. Variable selling and customer service
expenses
4. Office expenses.
5. Other general expenses

 Most companies also have a significant budget for

research and development costs.

1. Sales figures come from the sales budget.

2. Cost of goods sold is based on unit cost of
production (from direct materials, labor and
overhead budgets)
3. Selling and administrative and other
expense budgets, interest and taxes round
out the income statement.

1. Planned Acquisitions of capital assets such

as:

a. Buildings and Equipment.

b. Subsidiary Businesses
2. These must be carefully planned to make
sure that there is adequate cash or
financing to pay for them.

Marsupial Ltd manufactures 2 products - the Echidna and the Platypus.

The Echidna is manufactured in Department 1 and the Platypus in Department

The products consume 2 materials - A and B, and also direct labour

Details of standard costs and usage are given below:

Standard costs per unit

Material A - 5.20 per kilo
Material B - 8.80 per kilo
Direct labour - 10.00 per hour

Overhead recovery is on the basis of direct labour hours.

Standard usage of materials and labour per unit of product

Material A
Material B
Labour

Echidna
5 kilos
3 kilos
6 hours

Platypus
8 kilos
4 kilos
10 hours

32

Other data:

Budgeted opening inventory (kgs)

Budgeted closing inventory (kgs)

Budgeted Overheads

Echidna
Forecast sales
9,000
Selling price per unit
350
Budgeted closing inventory
1,500
Budgeted opening inventory 800

Platypus
6,000
400
700
300

Direct Materials Inventories

Material A Material B

Variable (controllable)
Fixed (non-controllable)

Dept 1
3.50
290,000

700

600

1,300

1,000

Dept 2
2.00
150,000

33

 Draw up the following budgets

Sales Budget
Production Budget

Direct Materials Usage Budget

Direct Materials Purchases Budget
Direct Labour Budget
Factory Overhead Budget

34

 Product

Units sold

Unit selling price Total Revenue ()

Echidna

9,000

350

3,150,000

Platypus

6,000

400

2,400,000

5,550,000

35

Dept 1 (Echidna)

Dept 2 (Platypus)

Units to be sold

9,000

Planned closing inv.

Less opening inventory

1,500
700
10,500 6,700
800
300

Units to produce

9,700

Total units required

6,000

6,400

36

 Dept 1

Units

Dept 2

Unit Price Total

Totals

Units

Unit Price Total

Total Units Cost

48,500 5.20

252,200

51,200

5.20

266,240

99,700

518,440 (A)

29,100 8.80

256,080

25,600

8.80

225,280

54,700

481,360 (B)

508,280

491,520

Material A is first

Material B is second

Total Units calculated as:

Production budget X Kilos per unit = 9,700 X 5 = 48,500

999,800

37

Material A

Material B

Production requirement (DM usage)

99,700

54,700

1,300

1,000

Planned closing inventory

101,000

Less opening inventory

700

600

100,300

Planned purchase price

55,700

5.20

55,100
8.80

Budgeted Purchases

521,560 484,880

38

Dept 1 Dept 2

Budgeted production (units)

9,700

6,400

10

Hours per unit

Total budgeted hours

58,200 64,000

Budgeted wage rate

10.00 10.00

Total wages

582,000

640,000
39

Anticipated activity - Department 1 = 58,200 hours

Anticipated activity - Department 2 = 64,000 hours

Dept 1

Controllable overhead

* 203,700 128,000

Non-controllable overhead
Total overhead

Dept 2

290,000 150,000
493,700 278,000

Budgeted departmental overhead rate

**

8.48

4.34

* 58,200 X 3.50
** 493,700/58,200

40

 Will Deal with Cash Budget as separate entity

See Drury for cash budget link to integrated example

Illustration Alf Smith Example

41

 Incremental/ traditional approaches

Zero based budgeting

Rolling budget
Activity based budgeting

 Early (& simplistic) principle that says

Budget concerned with increment in operations in

coming budget period

Therefore adjust/inflate previous budget in line with
known/anticipated price rises
But much base-level activity does not change
Perpetuates past inefficiencies/errors

43

 Features of TBS:
extrapolating past spending levels into next year;
incrementing the level for inflation and for new Programs or
Projects ;
It assumed that all activities taking up last year

spending levels were essential in achieving outgoing

objectives, strategies and mission and that activities
must be continued in the coming year and more
urgent than newly requested activities;
Also known as Line Item Budgeting as it is based
on line item expenditure and are expressed in terms
of the Objects of Expenditure;
TBS is an input oriented technique
44

 The system is simple and easy to prepare. User and

Preparer of TBS have good understanding of the

budget;
Data and information from TBS is easy to capture
into the accounting system;
Make comparison between Budgeted and Actual
Expenditure or Revenue data

45

 Data and information is only useful in the short term.

Strategic goals of organization may not achieved;

TBS conforms to legal requirement but not management
type information;
TBS focuses on object of expenditure rather than the
program/activities or objectives of the organization;
The performance of the budget is only measured from the
financial aspects
i.e .actual expenditure incurred and no information on the

effect, outcome and benefits of prog.

46

 TBS has no specific Program/Activities to implement.

There is no purpose and objectives of the

expenditure;
There is no budget review process, planning and
evaluations of programs;
Accounting/financial information indicate the
utilization of resources.

47

 The first application was in the USA in 1962

Feature:
The preparation of budgets start from a zero base i.e.

resources are not necessarily allocated according to

the previous pattern
thus each item of expenditure has to be annually
rejustified and demand assurance concerning the
most effective allocation of limited resources

48

 Identification of decision units

Units in the organizations hierarchy that prepare the budget
expense centre, profit centres etc.
Characteristics:
Has a specific manager
Has a well defined and measurable impact

Has a well-defined and measurable objectives

Development of decision packages

To identify the alternative ways of performing the functions of
decision units and to determine the effort for each alternatives
Review and ranking of decision packages
bottom up approach based on effectiveness, requirement by
law or availability of resources
49

 ZBB requires all functions of an organizations be

reevaluated annually from a zero base

ZBB encourages the involvement of lower-level
management in the budgetary processes
Unexpected events during the year can be adjusted
for
However
Over estimates man ability to calculate
development of decision packages
Behavioural impact of cut-off system
50

 Conventional budgeting is inappropriate for those activities

where the consumption of resources does not vary

proportionately with the volume of the final output of products
or services.
For support activities conventional incremental budgets merely
serve as authorization levels for certain levels of spending.
Incremental budgeting results in the cost of non-unit level
activities becoming fixed.
ABB aims to authorize only the supply of those resources that are
needed to perform activities required to meet budgeted
production and sales volumes.
The ABB process is the reverse of the ABC process:
Budgeted output of cost objects
Determine the necessary activities
Determine the resources required for the budget period
51

 Estimate the production and sales volume by

individual products and customers

Estimate the demand for organizational activities
Determine the resources that are required to
perform organizational activities
Estimate for each resource the quantity that must
be supplied to meet the demand
Take action to adjust the capacity of resources to
match the projected supply
Periodically actual results should be compared
with an adjusted (flexible) budget
52

A continuous or rolling budget is a budget which is

continuously updated by adding a further accounting
period (a month or quarter) when the accounting has
expired.
Continuous budgets are an attempt to prepare targets and
plans which are more realistic and certain, particularly with
a regard to price levels, by shortening the period between
preparing budgets. Instead of preparing a periodic budget
annually for the full budget period, there would be budgets
every one, two, three or four months (three to six, or even
twelve budgets each year). Each of these budgets would
plan for the twelve months so that the current budget is
extended by an extra period as the current period end:
hence the name rolling budgets.

Suppose, for example, that a continuous budget is

prepared every three months. The first three months
of the budget period would be planned in great detail,
and the remaining nine months in lesser detail,
because of the greater uncertain about the longer-term
future. If a first continuous budget is prepared for
January to March in detail and April to December in
less detail, a new budget will be prepared towards the
end of March, planning April to June in detail and July
to March in less detail. Four rolling budgets would be
prepared every 12 months on this 3 and 9 month basis,
requiring, inevitably, greater administrative effort.

 They reduce the element of uncertainty in budgeting because

they concentrate detailed planning and control on short-term

prospects where the degree of uncertainty is much smaller.
They force manager to reassess the budget regularly, and to
produce budgets which up to date in the light of current events
and expectations.
Planning and control will be based on a recent plan which is
likely to be far more realistic than a fixed annual budget made
many months ago.
Realistic budgets are likely to have a better motivational
influence on managers.
There is always a budget which extends for several months
ahead. For example, if rolling budgets are prepared quarterly
there will always be a budget extending for the next 9 to 13
months. This is not the case when fixed annual budgets are used.

 They involve more time, effort and money in budget

preparation.
Frequent budgeting might have an off- putting effect
on managers who doubt the value of preparing one
budget after another at regular intervals.
Revisions to the budget might involve revisions to
standard costs too, which in turn would involve
revisions to stock valuations. This could replace a
larger administrative effort from the accounts
department every time a rolling budget is prepared.