BUDGETING

LEARNING OBJECTIVES

After studying this lesson, you should be able to:

1. Define budgeting and other related terminologies.2. Describe the functions, purposes, advantages and limitations of budgeting.3. Distinguish between an operating budget, financial budget and capital budget.4. Explain the process of preparing the master budget and describe the budget cycle.5. Prepare a sales budget, including a computation of expected cash receipts.6. Prepare a production budget, direct materials budget, direct labor budget including a computation

of expected cash disbursement for purchases of materials and payment of direct labor.7. Prepare a manufacturing overhead budget and a selling and administrative expense budget.8. Prepare a cash budget.9. Prepare a budgeted income statement and a budgeted balance sheet.

DISCUSSION

“Failing to plan is planning to fail”

Budget Defined

o A budget is a financial and/ or quantitative statement, prepared and approved prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a given objective..

o A budget is a plan expressed in quantitative terms on how the management desires to manage or control its operating, investing, and financing resources and activities to promote the overall goal of an enterprise in a given period of time.

o The act of preparing a budget is called budgeting.o The overall or master budget (also known as planning budget or budget plan) indicates the sales

levels, production and cost levels, income and cash flows that are anticipated for the coming year.

o The master budget is a summary of all phases of a company’s plans and goals for the future. In short, it represents a comprehensive expression of management’s plans for the future and how these plans are to be accomplished.

Difference between Planning and Control

Planning involves developing objectives and preparing various budgets to achieve these objectives. Control involves the steps taken by management to ensure that the objectives set down at the planning stage are attained and to ensure that all parts of the organization function in a manner consistent with the goals.

An effective budgeting system must provide for both planning and control. Good planning without effective control is time wasted. On the other hand, unless plans are presented or known in advance, there are no objectives toward which control can be directed.

Functions of Budgeting

o Budgets make the decision-making process more effective by helping managers meet uncertainties. Its objective is to substitute deliberate, well-conceived business judgment for accidental success in enterprise management.

o Budgets should not be expressions of wishful thinking but rather descriptions of attainable objectives.

Advantages and Limitations of Budgets

The advantages of budgeting include:

o It forces planning and exposes situations in which plans of subcomponents are inadequate to attain the objectives.

o It allows a reiterative process to bring the goals of the organization/business and the subcomponents into agreement.

o It provides a means of communicating organizational goals down through the organization and sub-unit operational limitations up through the organization.

o It provides a basis for financial planning, coordination, resource acquisition, inventory policy, scheduling and output distribution.

o It provides a basis by which activity can be monitored, with actual results being compared to the planned results.

The limitations of budgeting are:

o Budgets tend to oversimplify the real situation and fail to allow for variations in external factors. They do not reflect qualitative variables.

o It is difficult to prepare a detailed budget for an organization that has never existed or for a new division or product.

o There may be lack of higher and lower management commitment because of lack of understanding of the fundamentals of budget preparation and utilization.

o The budget is only a representation of future plans or a means to the goal of profitable activity and not an end in itself.

o Budget reports usually emphasize results, not reasons.

Types of Budgets

The types of budgets or the major composition of the master budget are:

A. The Operating budget Budgeted Income Statement

a. Sales budgetb. Production budget

I. Materials cost budgetII. Direct labor cost budget

III. Factory overhead budgetIV. Inventory levels

Cost of Sales Budget Selling and administrative expenses budget Financial expense budget

B. The Financial budget

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Budgeted balance sheet Cash budget Budgeted Statement of Sources and Uses of Funds

C. The Capital budget

Budgeting Terminologies Defined

Budgeted income statement – refers to the projection of revenue, expenses, and results of operations for a definite period of time.

Cash budget – a period-by-period statement of cash at the start of a budget period, expected cash receipts classified by source; expected cash disbursements, classified by function, responsibility, and form; and resulting cash balance at the end of the budget period.

Financial budget – refers to the budget of the financial resources as reflected in the budgeted balance sheet and cash budget.

Operating budget – refers to the plans for the conduct of business for the planning period; it includes the budgeted income statement and all its supporting budgets.

Sales budget – budget that shows the quantity of each product expected to be sold.

The Budget Period

As a general rule, the period covered by a budget should be long enough to show the general effect of managerial policies but short enough so that estimates can be made with reasonable accuracy.

A master budget is an overall financial and operating plan for a coming fiscal period and the coordinated program for achieving the plan. It is usually prepared on a quarterly or an annual basis. Long range budgets called capital budgets which 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.

The Master Budget Interrelationships

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Steps in Developing a Master Budget

The major steps in developing Master Budget may be outlined as follows:

1. Establish basic goals and long range plans for the company. These will serve as guidelines in the preparation of budget estimates.

2. Prepare a sales forecast for the budget period.3. Estimate the cost of goods sold and operating expenses.4. Determine the effect of budgeting operating results on assets, liabilities and ownership equity

accounts. The cash budget is the largest part of this step, since changes in many asset and liability accounts will depend upon the cash flow forecast.

5. Summarize the estimated data in the form of a projected income statement for the budget period and the projected balance sheet of the end of the budget period.

Budget Illustrated

Mr. ABC plans to put up business by selling initially banana chips.

SALES BUDGET

The sales budget showing what products will be sold in what quantities at what prices, is the foundation on which all other short-term budgets are built. The sales budget triggers a chain reaction that leads to the development of many other budget figures. The sales forecast is the key stone of the budget structure. (See appendix “B” for further discussion).

Schedule 1:

Sales Budget For 2014

Units Price/ unit Total sales revenueEstimate sales 5,000 P27 P 135,000

PRODUCTION BUDGET

After the sales budget has been set, a decision can be made on the level of production that will be needed for the period to support sales and the production budget can be set as well. The production budget becomes a key factor in the determination of other budgets, including direct materials budget, the direct labor budget and the manufacturing overhead budget

Production BudgetFor 2014

Units sold 5,000Add: Desired ending Inventory 500Total 5,500Less: Beginning Inventory 0Units to be produced 5,500

Raw materials budget:

Required total purchases P 84,700

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Direct Labor budget:

Number of units to be produced 5,500Multiply by: direct labor per unit 5.7 (285/50)Total budgeted direct labor costs 31,350

Overhead costs budget

Cooking gas 4,034Electricity 2,321Water 930Depreciation 1,880Total 9,165

BUDGETED COST OF SALESProduction BudgetRaw Materials BudgetDirect Labor BudgetOverhead cost budgetBudgeted Statement of cost of sales

Budgeted Statement of Cost of Sales

Beginning work in process inventory -Manufacturing costs

Direct MaterialsBeginning inventoryPurchases P 84,500Less: Ending Inventory Total Direct Materials cost P 84,500

Direct Labor 31,350Manufacturing overhead 9,165

Total Manufacturing cost P 125,015Less: Ending work in process -

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