BBA 4002

BUDGETING AND CONTROL

(INDUSTRIAL PROJECT PAPER)

KOH YAN TING

921017-01-5468

200474

Mr. Devaraju Joseph

JULY 2013

Page 1 of 31
1.0 Content

NO TOPIC PAGES

1.0 Introduction 3-5

2.0 2.1 Definition of the master budget 6-21

2.1.2 Master budget of Pushpack and Co.

2.2 Definition of the cash budget

2.2.2 Cash budget from January to June

2.3.1 Definition the fixed budget and flexible budget

Advantages of flexible budget

Different methods of preparing flexible budget

2.3 .2 Flexible budget for overheads

3.0 Conclusion 22

4.0 Reference 23

5.0 Coursework 24-28

Page 2 of 31
1.0 Introduction of Budgeting and Control

The most effective financial budget includes both a short-range, month-to-month plan

for at least one calendar year and a long-range, quarter-to-quarter plan you use for

financial statement reporting. It should be prepared during the two months preceding

the fiscal year-end to allow ample time for sufficient information-gathering.

An estimation of the revenue and expenses over a specified future period of time. A

budget can be made for a person, family, group of people, business, government,

country, multinational organization or just about anything else that makes and spends

money. A budget is a microeconomic concept that shows the trade-off made when one

good is exchanged for another.

The long-range plan should cover a period of at least three years (some go up to five

years) on a quarterly basis, or even an annual basis. The long-term budget should be

updated when the short-range plan is prepared.

While some owners prefer to leave the one-year budget unchanged for the year for

which it provides projections, others adjust the budget during the year based on

certain financial occurrences, such as an unplanned equipment purchase or a larger-

than-expected upward sales trend. Using the budget as an ongoing planning tool

during a given year certainly is recommended. However, here is a word to the wise:

Financial budgeting is vital, but it's important to avoid getting so caught up in the

budget process that you forget to keep doing business.

A system of management control in which actual income and spending are compared

with planned income and spending, so that you can see if plans are being followed

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and if those plans need to be changed in order to make a profit.

Methodical control of an organization's operations through establishment of standards

and targets regarding income and expenditure, and a

continuous monitoring and adjustment of performance against them.

It is widely recognized that budget control is essential for effective financial

management of any organization. In view of this, it is the purpose of this policy to

provide clear and specific responsibility for proper budget management and control

among the institutions governed by the Tennessee Board of Regents.

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2.1 Definition the master budget

A master budget refers to a summary of company's plans that set targets for

production, expenses, sales, financing activities and distribution. It helps a company

in setting the spending limits and tracking the expenses.

The master budget is a summary of company's plans that sets specific targets for sales,

production, distribution and financing activities. It generally culminates in a cash

budget, abudgeted income statement, and a budgeted balance sheet. In short, this

budget represents a comprehensive expression of management's plans for future and

how these plans are to be accomplished.

Master Budget is a summary of a company's plans in which specific targets are set for

sales, production, distribution, and financing activities and that generally culminates

in acash budget, budgeted income statement, and budgeted balance sheet.

A budget is a necessity for any business, large or small. However, when a business

gets larger and multiple budgets are created for different departments or divisions,

then it can be hard to keep track of everything. When this is the case, it is a good idea

to set up a master budget. First, you must understand what a master budget is and

what its functions are.

Planning orientation.

The process of creating a budget takes management away from its short-term, day-to-

day management of the business and forces it to think longer-term. This is the chief

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goal of budgeting, even if management does not succeed in meeting its goals as

outlined in the budget - at least it is thinking about the company's competitive and

financial position and how to improve it.

Profitability review.

It is easy to lose sight of where a company is making most of its money, during the

scramble of day-to-day management. A properly structured budget points out what

aspects of the business produce money and which ones use it, which forces

management to consider whether it should drop some parts of the business, or expand

in others.

Assumptions review.

The budgeting process forces management to think about why the company is in

business, as well as its key assumptions about its business environment. A periodic re-

evaluation of these issues may result in altered assumptions, which may in turn alter

the way in which managements decides to operate the business.

Integrates and Coordinates. It has the activities of various functional areas of Orgn.

Helps to ensure all needed inputs are available

Communicates and Motivates. It helps employees to see the efforts made to achieve

goals

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Promotes Continuous Improvement. It encourages managements to improve customer

value and reduce costs.

Guides Performance. It becomes basis for acquisition and utilization of various

Facilitates Evaluation and Control. It provides a method for evaluating and

subsequently controlling performance.

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2.1.2 Master budget of Pushpack and Co.

Pushpack and Co., a glass manufacturing company requires you to calculate and

present the budget for the next year from the following information:

Toughened glass $ 2,00,000

Bent toughened glass $ 3,00,000

Direct material cost 60% of sales

Direct wages 10 workers @ $ 100 per month

Factory overheads

Indirect labour:

Work manager $ 300 per month

Foreman $ 200 per month

Stores and spares 2% on sales

Depreciation on machinery $ 6,000

Light and power $ 2,000

Repairs and maintenance $ 4,000

Other sundries 10% on direct wages

Administration, selling and distribution expenses $ 7,000 per year.

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Master Budget

Particulars Amount Amount

Sales (as per sales budget)
Toughened glass 2,00,000
Bent toughened glass 3,00,000
5,00,000
Less :Cost of production:
(as per cost of production budget)
Direct materials 3,00,000
Direct wages 12,000
Prime cost 3,12,000

Add: Factory overhead:

Variable :Stores and spares 10,000
Light and power 2,000
Repairs and maintenance 4,000
16,000
Fixed :
Work Manager's salary 3,600
Foreman salary 2,400
Depreciation 6,000
Sundries 1,200 13,200
Work's cost 3,41,200
Gross profit 1,58,800
Less: Administration, selling & distribution expenses 7,000

Net profit 1,51,800

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2.2 Definition of cash budget

Cash budget is a review or projection of cash inflows and outflows. It can be used as a

tool for analyzing the revenues and costs of a company or individual.

Most often, cash budgets are used to assess whether or not a business has a sufficient

amount of cash to fulfill regular operations. It can also be used to determine whether

too much of a business' cash is being spent in unproductive ways.

By creating a cash budget - wherein a firm develops a summary of the anticipated

revenues, operating expenditures, purchase and sale of assets, and settlement or

admission of debt one can determine when there will be a need for more cash

resources, and when there will be an excess of cash.

A cash budget is incredibly important, for smaller businesses especially. A cash

budget allows a business to establish the amount of credit that it can extend to

customers without beginning to have problems with liquidity.

Financial plan that is a summary of estimated receipts (cash inflows)

and payments (cash outflows) over a stated period. Two common methods of cash-

budgeting are Adjusted net income approach and Cash receipts and disbursements

approach.

A cash budget is a planning tool used by companies and individuals to evaluate

projected cash flows during a specified period of time (e.g. monthly, quarterly,

annually).

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A cash budget allows companies and individuals to evaluate income versus expenses.

Managing cashresources is the first step toward growing a company or

individual's bottom line. Moreover, lending institutions may use a cash budget to help

determine whether or not to grant a loan or extend credit to a company of individual,

which makes monitoring cash flow even more important.

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2.2.2 Cash budget from January to June

Prasad and Co. wishes to prepare cash budget from January. Prepare a cash budget for
the first six months from the following estimated revenue and expenses:

Month Total sales Materials Wages Production Selling and

($) ($) ($) overheads distribution
($) overheads
($)
January 10,000 10,000 2,000 1,600 400
February 11,000 7,000 2,200 1,650 450
March 14,000 7,000 2,300 1,700 450
April 18,000 11,000 2,300 1,750 500
May 15,000 10,000 2,000 1,600 450
June 20,000 12,500 2,500 1,800 600
Additional information:

1. Cash balance on lst January was $ 5,000. New machinery is to be installed at

$ 10,000 on credit, to be repaid by two equal installments in March and April.

2. Sales commission @ 5% on total sales is to be paid within a month of

following actual sales.

3. $ 5,000 being the amount of 2nd call may be received in March. Share

Premium amounting to $ 1,000 is also obtainable with the 2 nd call.

4. Period of credit allowed by suppliers -1/2 months.

5. Period of credit allowed to customers - 1 month.

6. Delay in payment of overheads - 1 month.

7. Delay in payment of wages-1/2 month.

8. Assume cash sales to be 50% of total sales.

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Particulars January February March April May June

$ $ $ $ $ $

Opening balance 5,000 9,000 14,900 13,500 12,350 16,550

Estimated cash receipts:

Cash sale 5,000 5,500 7,000 9,000 7,500 10,000

Credit sales 5,000 5,500 7,000 9,000 7,500

Second call 5,000

Share premium 1,000

Total cash Receipts (A) 10,000 19,500 33,400 29,500 28,850 34,050

Estimated cash payments:

Materials 10,000 7,000 7,000 11,000

Wages 1,000 2,100 2,250 2,300 2,150 2,250

Production Overheads 1,600 1,650 1,700 1,750 1,600

Selling &Distribution overheads 400 450 450 500 450

Sales commission 500 550 700 900 750

Purchase of machinery 5,000 5,000

Total cash Payment (B) 1,000 4,600 19,900 17,150 12,300 16,050

Closing balance (A-B) 9,000 14,900 13,500 12,350 16,550 18,000

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2.3.1 Definition the fixed budget and flexible budget

A flexible budget is a budget which is designed to change in accordance with the

LEVEL OF ACTIVITY attained.

It is also known as Variable budget as the budget recognizes the difference in cost

behavior namely fixed and variable costs in relations to fluctuations in output or

turnover. The budget is designed to change appropriately with such fluctuation.

For a fixed budget, the budget remains unchanged irrespective of the level of activity

actually attained.

The fixed budget is prepared based only on one level of output.

Therefore, if the level of output actually achieved differs considerably from that

budgeted, large variances will arise.

A fixed budget, also known as a static budget, projects static levels of known income

and expenses over a set period of time. Fixed budgets are much simpler to create and

to read than flexible budgets and are generally acceptable for situations where the

levels of income and expense are not expected to fluctuate through the duration of the

budgeting period.

When a fixed budget is adjusted to account for variable results, it can be referred to as

a flexible budget. When implemented during the budgeting process, a flexible budget

helps a business account for future changes in any expense or income account.

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Multiple flexible budgets drawn up to forecast various levels of economic activity

may be complicated but prepare a business well for any fluctuations in business levels,

planned or otherwise.

The fixed budget is the budget that is based on this projected level of output, prior to

the start of the period. In other words, the static budget is the original budget.

The static budget variance is the difference between any line-item in this original

budget and the corresponding line-item from the statement of actual results. Often, the

line-item of most interest is the bottom line: total cost of production for the factory

and other cost centers; net income for profit centers.

The flexible budget is a performance evaluation tool. It cannot be prepared before the

end of the period. A flexible budget adjusts the static budget for the actual level of

output. The flexible budget asks the question: If I had known at the beginning of the

period what my output volume (units produced or units sold) would be, what would

my budget have looked like? The motivation for the flexible budget is to compare

apples to apples. If the factory actually produced 10,000 units, then management

should compare actual factory costs for 10,000 units to what the factory should have

spent to make 10,000 units, not to what the factory should have spent to make 9,000

units or 11,000 units or any other production level.

Fixed Budget is mainly used in the planning stage to define the broad objectives of

management. Flexible budget, on the other hand is prepared for the volume of activity

actually achieved, in other words the controlling stage. The reason why we had

flexible budget is because for most of the time, the level of activities differ and as a

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result, the fixed budget differs by a lot from the actual result. For instance, in an event

when the actual production doubled as compared to fixed budget, the variable cost for

the production also doubled and the difference between the variable cost differed by a

lot. When the fixed budget is brought to the higher management to compare with the

actual results, the management will ask why the budget and actual differ by so much,

making an assumption that the total actual production should be the same as budgeted

production and held someone liable for it which would be the production manager

since he is in charge of the production. This is not fair to the production manager,

hence, we should introduce flexible budget during the controlling stage.

A flexible budget is a budget that adjusts or flexes for changes in the volume of

activity. The flexible budget is more sophisticated and useful than a static budget,

which remains at one amount regardless of the volume of activity.

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Advantages of flexible budget

A budget can be a document that sets strict spending limits for your small business or

a template that changes and grows with your company as you get a better handle on

your income and expenses. A flexible budget allows you to cut or increase spending,

depending on marketplace and business conditions. This allows you to avoid

unforeseen problems and take advantage of unexpected opportunities.

A flexible budget enables the management to analyse the deviation of actual output

from expected output. The management can compare actual costs at the actual volume

with the budgeted costs at the actual volume. The flexible budget provides a correct

basis for comparison between actual and expected costs for an actual activity. Flexible

budget helps to fulfill the objectives of cost control as it shows where the actual

performance deviated from the planned performance.

Static budgets are relatively simple to develop and implement and allow the company

to assess singular instances of expense during a specified period. This method creates

stability for those in charge of allocating funds since extra revenue or expense does

not change the budget. Flexible budgets reorganize fund allocations based on present

circumstances, giving planners more control during the budget period. Evaluating

profits becomes simpler using a flexible budget because it utilizes more points of

change and analysts can use shorter timelines.

In short, flexible are much more adventagous in comparison to static planned budgets.

Static budgets are prepared before the period, therefore the amount of units sold are

likely to be incorrect. This is fine, because it's a budget, but it is not very useful for

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decision making. Flexible budgets are prepared once the number of actual units sold is

known.

Think about it this way. If a company sells 200 units, but the static budget predicted

100, all of your expenses are going to result in unfavorable variances. However,

expenses would be expected to increase with an increase in sales. Therefore, it is

adventagous in terms of decision making based on the variances. The varainces tell

managers such things as the efficiency of labor and material usages, as well as the

price variances.

Since the flexible budget restructures itself based on activity levels, it is a good tool

for evaluating the performance of managers - the budget should closely align to

expectations at any number of activity levels. It is also a useful planning tool for

managers, who can use it to model the likely financial results at a variety of different

activity levels.

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Disadvantages of flexible budget

Using a static budget allows for inaccurate analysis of budget variances; if there are

significant changes or if the budget period is far into the future, it is difficult to

develop accurate or useful predictions. Another issue with static budgets is the failure

to account for circumstances outside the investor's control. Should something arise

that the budget doesn't account for, it is unprepared to resolve the problem. Flexible

budgets are time consuming and because of constant change, become difficult to

maintain. Depending on the amount of change during the budget period, analyzing

and drawing conclusions using the flexible method can be difficult.

Many costs are not fully variable, instead having a fixed cost component that must be

included in the flex budget formula.

A great deal of time can be spent developing step costs, which is more time than the

typical accounting staff has available, especially when in the midst of creating the

more traditional static budget. Consequently, the flex budget tends to include only a

small number of step costs, as well as variable costs whose fixed cost components are

not fully recognized.

The flexible budget model usually only works within a relatively limited revenue

range; the budget analyst is unlikely to spend the time developing a more wide-

ranging model if it is considered unlikely that outlier revenue amounts will be

encountered.

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Different methods of preparing flexible budget

The flexible budget uses the same selling price and cost assumptions as the original

budget. Variable and fixed costs do not change categories. The variable amounts are

recalculated using the actual level of activity, which in the case of the income

statement is sales units. Each flexible budget line will be discussed separately.

Sales. The original budget assumed 17,000 Pickup Trucks would be sold at $15 each.

To prepare the flexible budget, the units will change to 17,500 trucks, and the actual

sales level and the selling price will remain the same. The $262,500 is 17,500 trucks

times $15 per truck. The variance that exists now is simply due to price. Given that

the variance is unfavorable, management knows the trucks were sold at a price below

the $15 budgeted selling price.

Cost of Goods Sold. Using the cost data from the budgeted income statement, the

expected total cost to produce one truck was $11.25. The flexible budget cost of

goods sold of $196,875 is $11.25 per pick up truck times the 17,500 trucks sold. The

lack of a variance indicates that costs in total (materials, labor, and overhead) were the

same as planned.

Selling Expenses. The original budget for selling expenses included variable and fixed

expenses. To determine the flexible budget amount, the two variable costs need to be

updated. The new budget for sales commissions is $10,500 ($262,500 sales times 4%),

and the new budget for delivery expense is $1,750 (17,500 units times 10%). These

are added to the fixed costs of $12,500 to get the flexible budget amount of $24,750.

General and Administrative Expenses. This flexible budget is unchanged from the

original (static budget) because it consists only of fixed costs which, by definition, do

not change if the activity level changes.

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Income Taxes. Income taxes are budgeted as 40% of income before income taxes.

The flexible budget for income before income taxes is $20,625, and 40% of that

balance is $8,250. Actual expenses are lower because the income before income taxes

was lower. The actual tax rate is also 40%.

Net Income. Total net income changes as the amount for each line on the income

statement changes. The net variance in this example is mainly due to lower revenues.

The important thing to remember in preparing a flexible budget is that if an amount,

cost or revenue, was variable when the original budget was prepared, that amount is

still variable and will need to be recalculated when preparing a flexible budget. If,

however, the cost was identified as a fixed cost, no changes are made in the budgeted

amount when the flexible budget is prepared. Differences may occur in fixed

expenses, but they are not related to changes in activity within the relevant range.

Budget reports can be a useful tool for evaluating a manager's effectiveness only if

they contain the appropriate information. When preparing budget reports, it is

important to include in the report the items the manager can control. If a manager is

only responsible for a department's costs, to include all the manufacturing costs or net

income for the company would not result in a fair evaluation of the manager's

performance. If, however, the manager is the Chief Executive Officer, the entire

income statement should be used in evaluating performance.

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2.3 .2 Flexible budget for overheads

Prepare a flexible budget for overheads on the basis of the following data.

Ascertain the overhead rates at 50%, 60% and 70% capacity.

Variable overheads: At 50% capacity ($)

Indirect material 3,000
Indirect labour 9,000
Semi-variable overheads:
Electricity (40% fixed 60% variable) 15,000
Repairs (80% fixed 20% variable) 1,500
Fixed overheads:
Depreciation 8,250
Insurance 2,250
Salaries 7,500
Total overheads 46,500
Estimated direct labor hours 93,000

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Flexible budget

Particulars overheads: 50% 60% 70%

capacity capacity capacity
Variable overheads:
Indirect materials 3,000 3,600 4,200
Indirect labour 9,000 10,800 12,600
Semi-variable overheads:
Electricity 15,000 16,800 18,600
Repairs and maintenance 15,000 1,560 1,620
Fixed overheads:
Depreciation 8,250 8,250 8,250
Insurance 2,250 2,250 2,250
Sales 7,500 7,500 7,500
Total overheads 46,500 50,760 55,020
Estimated direct labour hours 93,000 111,600 130,200

Working notes:

1. Electricity $15000 is the cost of electricity at 50% capacity, of which 40% are
fixed overhead, i.e. $6000 and variable is $9000;

$15000 X 40%=$6000 (Fixed)

$15000 X 60%=$9000(variable)

For 50% capacity variable overhead: $ 9000

$9000
For 60% capacity variable overhead: 60 = $10800
50

Therefore total cost of electricity cost at 60% capacity = $10800 + $6000

= $16800

$9000
For 70% capacity variable overhead: 70 = $12600
50

Therefore total cost of electricity cost at 70% capacity = $12600 + $6000

= $18600

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2. Repairs and maintenance: $15000 is the cost of repairs and maintenance at 50%

capacity, of which 80% is fixed overheads, i.e. $1200 and variable is $300:

$1500 X 80% =$1200 (Fixed)

$1500 X 20% = $300(variable)

For 50% capacity variable overhead= $300

$300
For 60% capacity variable overhead= 60 = $360
50

Therefore, total cost of repairs and maintenance at 70% capacity = $360 + $1200

= $1560
$300
For 70% capacity variable overhead= 70 = $420
50

Therefore, total cost of repairs and maintenance at 70% capacity = $420 + $1200

= $1620

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3.0 Conclusion

An estimation of the revenue and expenses over a specified future period of time. A

budget can be made for a person, family, group of people, business, government,

country, multinational organization or just about anything else that makes and spends

money.

Master Budget is a summary of a company's plans in which specific targets are set for

sales, production, distribution, and financing activities and that generally culminates

in acash budget, budgeted income statement, and budgeted balance sheet.

Cash budgets are used to assess whether or not a business has a sufficient amount of

cash to fulfill regular operations. It can also be used to determine whether too much of

a business' cash is being spent in unproductive ways.

The fixed budget is the budget that is based on this projected level of output, prior to

the start of the period. In other words, the static budget is the original budget.

The static budget variance is the difference between any line-item in this original

budget and the corresponding line-item from the statement of actual results. Often, the

line-item of most interest is the bottom line: total cost of production for the factory

and other cost centers; net income for profit centers.

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4.0 Reference

1. http://www.cliffsnotes.com/more-subjects/accounting/accounting-principles-

ii/flexible-budgets-and-standard-costs/flexible-budgets

2. http://budgeting.thenest.com/preparation-flexible-budget-21667.html

3. http://www.accountingtools.com/questions-and-answers/what-is-a-flexible-

budget.html

4. http://www.ehow.com/info_7770930_fixed-vs-flexible-budget.html

5. http://www.studymode.com/subjects/advantages-and-disadvantages-master-budget-

page1.html

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5.0 Coursework

Name : KOH YAN TING

Student ID : 200474

Identity card : 921017-01-5468

Contact number: +60137941553

1. Explain carefully the steps in budgetary control.

The procedure to be followed in the preparation and control of budget may differ

from business to business. But, a general pattern of outline of budget preparation and

control may go a long way to achieve the end results. The steps are as follows:

i. Formulation of policies:

The business policies are the foundation stone of budget construction.

Function policies should be formulated in advance. Long-range policies with

short term projections should be made for the functional areas such as sales,

production, inventory, cash management, capital expenditure.

ii. Preparation of forecasts:

Based on the formulated policies, forecast should be made in respect of each

function. Activity based concepts should be introduced at the micro level for

each function Forecasts should not be considered as a mere estimates.

Scientific methods should be adopted for forecasting. Analysis of various

factors based on past, and present, future forecast should be made.

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iii. Preparation of budgets:

Forecasts are converted into written codified document. Such written

documents can be used for coordination purposes. Function budgets will act as

guidelines for implementation.

iv. Forecast combinations:

While developing the budgets, through a Master Budget various permutations

and combination processes are considered and developed. Based on this,

establishment of the most preferred one which will yield optimum benefits

should be considered. All the factor components should be identified which

are likely to cause disturbances while implementing the budgets.

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2. The budgets are normally classified according to their nature.

They are: (a) fixed budget.

(b) flexible budget.

(c) functional budget.

Explain carefully each of them.

(a) fixed budget.

It is also known as static budgets. It is prepared for a fixed or standard volume of

activity. They do not change with change in the volume of activity. They are

prepared well in advance Due to this, there are bound to be variances at the time of

comparison. Hence, the budget targets become unsuitable for the purpose of

comparison. Wide deviations are noticed due to changes in the volume of activity.

(b) flexible budget

It is prepared with a view to take into account the periodic changes in the level of

activity attained. In this case, the revenues and costs targets are set in respect of

different levels of activity even from zero to 100 % of product ion volume. Such

mechanism helps to change* revenues and cost targets for the actual level of activity

and thus makes the comparison more logical and scientific.

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 (c) functional budget

These are also known as subsidiary budgets. These are prepared on the basis of

approved forecasts for individual department. Since departments are created based on

the functions, they are known as functional budgets. The functional budgets may vary

in number from business to business. The functional budgets include sales budget.

Production budget, selling and distribution overhead budget, plant budget, research

and development budget, overheads budget, financial budget such as cash budget and

capital expenditure budget.

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3. List and explain the limitation of budgeting.

a.Budget plan

Since budget a plan are based on estimates, the success or otherwise depends on

the accuracy of basic estimates or forecasts. Due to this while making estimates,

judgmental decision may accrue. The results need to be interpreted very

cautiously.

b.Replacement

Budgeting is not a substitute for management. It is essentially a tool of

management. Under no circumstances, it should be concluded that the budgeting

is alone sufficient to ensure success and to guarantee future profits.

c.Rigidity

Since the estimates are quantitative expression of all relevant data, there is likely

that finality attachment may become very clear. Such consideration may result in

rigidity. Rigidity may become a setback for the changing business conditions.

d.Costly

The installation of budgeting system to an organization involve too much of costs.

Its scientific approach will definitely call for huge cost allocation. Small

concerns cannot afford to take over huge costs for the establishment of business

systems. Since the costs and revenues and operational activities do not match in

many occasions, the entire exercise will become costly.

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