Mindanao State University
College of Business Administration and Accountancy
DEPARTMENT OF ACCOUNTANCY
Marawi City
OPERATING AND FINANCIAL BUDGETING
Accounting 142
BUDGETING AND PROFIT PLANNING
Profit planning and budgeting are often used inter-
changeably. However, profit planning is a broader term
than budgeting. Profit planning is well thought out op-
erational plan which involves setting of goals or objec-
tives as well as the methods or programs by which such
goals are to be achieved. Specifically, profit planning en-
compasses the following:
A. Sales planning programs.
B. Programs for control of all manufacturing and
non-manufacturing costs,
C. Programs affecting working capital and plant in-
vestment.
D. A review of all factors affecting the return on in-
vestment.
One tool used in profit planning is budgeting, which in-
volves creating a formal plan and translating goals into
quantitative terms.
Setting Profit Objectives
Profit planning involves setting a profit goal. Three proce-
dures are used in practice in setting profit objectives:
A. A priori method – management specifies a de-
sired rate of return and then draws up plans to
achieve such rate.
B. A posteriori method – management draws up
plans and then sets the profit rate resulting from
the plans.
C. Pragmatic method – management uses an ac-
ceptable profit standard that is set based on the
company’s own business experience.
Profit planning may be done on long-range or short-range
bases. However, for successful planning and control of
operations, an entity’s long-range plan must be incorpo-
rated to a shorter-range plan.
BUDGETING AND ITS ADVANTAGES
Budgeting refers to the act of preparing a budget
which a detailed plan expressed in quantitative terms on
how to acquire and use the resources of an entity during
and over a certain future period of time. Most firms use
budgets because they are aware of the advantages that
may be derived from budgeting which includes:
A. Budgeting compels periodic planning resulting
into a more efficient and effective utilization of
scarce resources.
 Budgeting requires managers to plan for
the future.
 Budgeting provides a means of allocating
resources to those parts of the organiza-
tion where they can be used most effec-
tively.
 Budgeting uncovers potential bottlenecks
before they occur.
B. Budgeting enhances coordination, cooperation
and communication within the organization
 Budgeting provides managers with a ve-
hicle for communicating their plans in an
orderly way throughout the entire organi-
zation.
 Budgeting coordinates the activities of
the entire organization.
 Budgeting helps move people in accor-
dance with organizational goals.
C. Budgeting forces quantifying of plans and pro-
posals making plans more meaningful and much
easier to evaluate.
D. Budgeting satisfies some legal and contractual
requirements, i.e. non-profit organizations and
loan approval requirements of financial institu-
tions.
E. Budgets define goals and objectives that can
serve as benchmarks for evaluating subsequent
performance. The use of budgets to control an
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
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organization’s activities is referred to as bud-
getary control.
F. Budgeting enables members of the organization
to be aware of business costs.
G. Budgeting directs the firm’s activities toward the
achievement of organizational goals.
Functions of Budgeting
A good budgeting system must provide for both planning
and control. Planning involves developing objectives and
preparing budgets to achieve those objectives. Control
involves the steps taken by management to ensure that
the objectives set down at the planning stage are at-
tained and that all parts of the organization work to-
gether towards those objectives.
Thus, for a budget (and ultimately, budgeting itself) to be
useful it must be quantified. The quantification of the
budgets would provide a definite target for planning pur-
poses and a yardstick for control purposes.
ORGANIZATION FOR BUDGETING
The organization and installation of a budgetary system
for a firm are greatly influenced by such form’s organiza-
tional structure. For multi-segmental organizations, all
managers are held responsible for the preparation and
implementation of the budget for their respective sec-
tions, although the final responsibility for such budgets
and the consolidated budget for the organization as a
whole rests with management.
Budget Committee
The preparation of budgets entails coordination among
the divisions of a firm. To facilitate the coordination in the
preparation of budgets, some firms create a budget
committee which should comprise of representatives
from all parts of the organization – usually the sales man-
ager, production manager, chief engineer, the treasure
and the controller. The committee’s principal functions
are to:
A. Formulate and decide on general policies relating
to the firm’s budgetary system.
B. Request, review and revise, if necessary, individ-
ual budget estimates from the different seg-
ments of the organization.
C. Approve budgets and subsequent revisions
therein.
D. Receive, evaluate and analyze budget reports.
E. Recommend necessary actions to improve opera-
tional efficiency and effectiveness.
Budget Manual
Effective budgetary planning relies on the provision of
adequate information to the individuals involved in the
planning process. A budget manual, which describes
the policies and procedures of an organization in connec-
tion with the preparation and use of budgets, serve this
purpose. Typical contents of the manual include:
A. General statement regarding the purpose of hav-
ing a budget procedure in the company.
B. Description of the organization phase of budget-
ing including statement with regards to the func-
tions of those persons involved in the budgeting
process.
C. Discussion of the budget period.
D. Basic divisions of the budget in the company
which may include specific instructions for each
division and sample forms and specifications.
E. Procedures concerning the revision of the ap-
proved budget and the various reports to be pre-
pared during the budget period.
A budget manual ordinarily includes the following items:
A. Budget planning calendar – shows the sched-
ule of activities for the development and adop-
tion of the budget. It includes a list of dates indi-
cating when specific information is to be pro-
 vided by or provided to those who are involved in
the budgeting process.
B. Distribution instructions – for all budget
schedules so that those segments involved in the
budget preparation would know to whom/from
whom a computed budget report schedule is to
be given, acquired.
Budget Period
The time period for which a budget is prepared and used
is called the budget period. It can be any length to suit
management purposes but it is usually one year. The
length of time chosen for the budget period will depend
on many factors, including the nature of the organization
and the type of expenditure being considered. Each bud-
get period can be subdivided into control periods, also
of varying lengths, depending on the level of control
which management wishes to exercise. The usual length
of a control period is one month.
BUDGETING PRINCIPLES
Budget Development
A. Adequate and clearly defined guidance should be
provided to all responsible persons in the organi-
zation so that they may work on the same as-
sumptions, agenda and objectives. Each man-
ager should understand his role as well as his
constraints and limitations in the development of
budgets.
B. All individuals concerned should be encouraged
to participate and cooperate in the budgeting
process. Be sure to involve in the development of
the budget those persons who will be responsible
for its implementation and whose performance
will be evaluated based on such budget.
C. Eliminate the feeling of anxiety and defensive-
ness among the participants in the course of pre-
paring the budget by giving such participants
enough freedom and authority to influence and
accept the level of performance that will be set
for their respective units.
D. Budget development should be structured such
that there is reasonably a great chance of attain-
ing the objectives. The goals to be set for each
segment should be challenging yet reasonably
attainable. Moreover, there must be goal congru-
ence.
E. Budget proposals should be subjected to a sys-
tematic evaluation by higher authorities in the
organization prior to implementation. Such
process, known as budget review, will help deter
or uncover budgetary slacks, also known as bud-
get padding or budget shaving.
Budget Implementation
A. Reward systems must be established to motivate
all persons concerned to work toward the attain-
ment of goals. Giving rewards for good perfor-
mance should be emphasized over punishment
for bad results.
B. A performance reporting system should be pro-
vided to get immediate feedback on the result of
operation of each individual or organizational
segment concerned. This is necessary for pur-
poses of monitoring, controlling and evaluating
performance.
C. For budgets to be effective in motivating perfor-
mance, managers should be held responsible for
budget items over which they have control.
Budget Revision
A. A continuous follow-up on actual performance as
compared with budget estimates should be made
so as to bring to light the need for revising the
budget. No matter how carefully the forecast is
prepared, there is always that possibility for
some contingencies to become realities.
B. Budget revisions must be made only when neces-
sary. Managers may not just change the forecasts
or budgets as they please, since a weak policy
along this line would discourage careful budget-
ing at the time the original budget is prepared.
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
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APPROACHES TO BUDGETING AND RELATED CON-
CEPTS
Authoritarian versus Participative Budgeting
Also known as top-down or imposed budgeting, authori-
tarian budgeting is a budgeting system where top
management imposes the budget on the organization. In
this type of system, the ultimate budget holder does not
have the opportunity to participate in the budgeting
process.
On the other hand, in participative budgeting, also
known as bottom-up budgeting, all levels of manage-
ment are involved in the budget process. This type of
budgeting system is favored over authoritarian budgeting
as it leads to:
A. Improved quality of forecasts to use as the basis
for the budget as lower level managers who are
doing a job on a day-to-day basis are likely to
have a better idea of what is achievable, what is
likely to happen in the forthcoming period, local
trading conditions and others.
B. Improved motivation as budget holders are more
likely to want to work to achieve a budget that
they have been involved in setting themselves,
rather than one that has been imposed on them
from above.
The main disadvantage of participative budgeting is that
it tends to result in a more extended and complex bud-
getary process. However, the advantages are generally
accepted to outweigh this disadvantage.
Zero-based versus Incremental Budgeting
Zero-based budgeting (ZBB) or priority based budget-
ing calls for a periodic evaluation, normally through a se-
ries of decision packages, of both existing and potential
programs to determine their relevance in attaining orga-
nizational objectives. ZBB requires each cost element to
be specifically justified, as though the activities to which
the budget relates were being undertaken for the first
time.
In ZBB, an assumption is made to effect that zero will be
spent on each program. Without approval, the budget al-
lowance is zero. Thus, as a starting point, previous year's
budgets are not acceptable as the basis for allocating re-
sources for the current period.
The following are some of the advantages claimed for
ZBB:
A. It avoids the complacency inherent in the tradi-
tional incremental approach, where it is simply
assumed that future activities will be very similar
to current ones.
B. ZBB encourages a questioning approach, by fo-
cusing attention not only on the cost of an activ-
ity, but also on the benefits it provides, as the
relative benefits of different types and levels of
expenditure.
C. Preparation of the decision packages will nor-
mally require the involvement of many employ-
ees, and thus provides an opportunity for their
view to be considered. This involvement may
produce useful ideas, and promote job satisfac-
tion among the wider staff.
However, ZBB has its own share of disadvantages such
as:
A. The work involved in the creation of decision
packages and their subsequent ranking by top
management consumes more time and effort.
B. The ranking process for the decision packages is
inherently difficult, as value judgments are in-
evitable.
C. In applying ZBB, “activities” may continue to be
identified with traditional functional departments,
rather than cross-functional activities, and thus
distract the attention of management from the
real cost-reduction issues.
As opposed to ZBB, incremental budgeting, the tradi-
tional approach to budgeting, simply provides for a per-
centage increase or decrease that is added to or sub-
tracted from last year’s budget to allow changes in
planned production. This approach assumes and accepts
that the current expenditure is adding value to the cus-
tomer and the focus is simply on the justification of any Generally, however, it is composed of two major parts as
proposed increases in that expenditure. Though relatively follows:
quick and simple, the problem with this method is that A. Operating budget – the expected output is the
past over or underfunding is never corrected. budgeted income statement; includes:
Line-items versus Programs Budgeting  Sales forecast and sales budget.
The old familiar format to budgeting is the line-items  Ending inventories budget.
budgeting where each expense has a peso amount. In-  Production budget.
put oriented, this method of budgeting is high on control,  Manufacturing costs budget.
leaving limited flexibility for the manager once the bud-  Budgeted cost of goods sold.
get is approved.  Operating expenses budget.
An alternative approach to the traditional format is pro-  Budgeted income statement.
grams budgeting. Output and objective oriented, this B. Financial budget – the expected output is the
method of budgeting allocates a lump sum for a program budgeted statement of financial position; in-
and the manager has considerable freedom in spending cludes:
it to carry out the program function. This type is very low  Capital expenditure budget.
on control.  Cash budget.
Other Budgeting Concepts  Budgeted statement of financial position.
A. Rolling, continuous, progressive or perpet-  Budgeted statement of cash flows.
ual budgeting – this budgeting system continu- Steps in the Budgeting Process
ously updates the budget by adding a further ac-
counting period (month or quarter) when the ear- There are no strict rules to be followed in the presenta-
liest accounting period has expired. Its use is par- tion of budgets. The most important item to consider is
ticularly beneficial where future costs or activities the satisfaction of the end-user of the report so that the
cannot be forecast accurately. information needed will be included and clearly pre-
sented. It is also advisable to prepare budgets for shorter
B. Life cycle budgeting – a process of estimating
time periods to allow management to plan and control re-
total costs and revenues related to each product
sources in a better manner.
for the complete life cycle of the product. A prod-
uct’s life cycle is the time period covered be- OVERVIEW OF THE MASTER BUDGET
tween the initial design and development of a
product and the termination of its production,
marketing, distribution and customer support.
C. Kaizen or continuous improvements bud-
geting – a budgeting process where the budget
is based not on the existing systems but on
changes or improvements that are to be made.
D. Physical budget – a type of budget expressed
in quantitative terms such as labor hours, ma-
chine hours, units of production and other non-fi-
nancial measures.
E. Responsibility budget – a type of budget that
is prepared by each responsibility centers de-
pending on their requirements and nature of the
particular centers.
F. Government budget – not only a financial plan
but is also an expression of public policy and a
form of control having the force of law. A govern-
ment budget must be complied with by a govern-
ment agency head.
Activity-based Budgeting
The traditional approach to budgeting presents costs un-
der functional headings. That is, costs are presented in a
manner that emphasizes their nature. The weakness of
this approach is that it gives little indication of the link
between the level of activity of the department and the
cost incurred.
To overcome this weakness of traditional budgeting sys-
tems, an entity may apply the ABC principles and proce-
dures to budgeting. In activity-based budgeting, pro-
cesses are broken down into activities, thereby, permit-
ting the identification of value adding activities and their
cost drivers.
A. The activities are identified from the various pro-
cesses of an entity.
PREPARATION OF THE OPERATING BUDGET
B. A cost pool is established for each identified ac-
The operating budget contains the projected revenues,
tivity.
costs and expenses as well as the forecasted net income
C. A cost driver is then identified for each cost pool.
figure for a certain period. The development of a formal
D. The budgeted cost for each cost pool is deter-
operating budget usually starts with the determination of
mined by multiplying the budgeted demand for
some limiting factors which could either be internal or ex-
the activity by the estimated cost per unit of
ternal to the entity. This is important as it indicates which
such activity.
budget should be prepared first.
THE MASTER BUDGET AND ITS COMPONENTS A. Internal factors – these factors prevent the
The master budget represents the overall plan of the company from producing enough volume of prod-
organization for a given budget period. It consists of all ucts to meet the sales requirements.
the individual budgets for each segment of the organiza-
tion aggregated or consolidated into one overall budget
B. External factors – these factors prevent the
company from selling as much units as it wants
for the entire firm. The exact composition of the master
to sell.
budget depends on the type and size of the organization.
If the factors so determined limit the firm’s productive
capacity, the operating budget is developed by first pre-
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
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paring the production budget. In most cases, however, Information needed: the amount of sales to be gen-
the limiting factors affect sales. Thus, the development erated.
of the operating budget starts with the preparation of a Budgeted sales in units x xxx
sales forecast. x Selling price per unit x xxx
Governments in general do not use sales forecast or rev- Budgeted sales in pesos P xxx
enue generation as starting point. Rather, projected ex- The format of the sales budget may show sales classified
penditures are programmed first. Revenue collecting by product lines, periods, sales areas, sales outlets,
agencies will thus need to establish target collections branches or divisions, types of customers or salesmen.
from the given figures.  PRODUCTION BUDGET
 SALES FORECAST The production budget shows the production volume and
The sales forecast is considered as the cornerstone or the direct materials in physical units that the company
foundation of budgeting because all the other budgets in needs to produce or purchase to meet its sales forecast
the entire master plan depend upon it, directly or indi- and its desired minimum inventory level.
rectly. Being the foundation of budgeting, it is important Production Volume Budget
to estimate sales with as much accuracy as possible. A
Information needed: estimated production for the
small error in a sales forecast can cause large errors in
period expressed in units.
other budgets that depend on it.
Desired ending FG inventory in units x xxx
Forecasting Approaches Budgeted sales in units x xxx
Approaches to forecasting sales can be classified into two Total requirements for the period (TGAS) x xxx
major groups: Beginning FG inventory in units (xxx)
A. Statistical approach – involves the study of Budgeted production in units Xxx
general business and market conditions with the Direct Materials Requirement Budget
use of trend and correlation analysis. This ap- Information needed: the volume of direct materials
proach rest heavily on the assumption that the to be purchased for the period.
future resembles the past.
Budgeted in production in units x xxx
 Industry trend analysis – this method x Standard materials per unit x xxx
identifies the relationship between the total Budgeted RM needs for production x xxx
expected industry sales and the company Desired ending RM inventory in units x xxx
sales in terms of the share of the market. Total RM needs x xxx
 Sales trend analysis – the life cycle of the Beginning RM inventory in units (xxx)
product is used as the primary basis. Budgeted RM purchases in units x xxx
 Correlation analysis – uses the cause and x Anticipated RM cost per unit P xxx
effect relationship between the company Budgeted RM purchases in pesos P xxx
sales and some outside economic factors on  MANUFACTURING COSTS BUDGET
which there are published information.
The manufacturing costs budget shows the costs of di-
B. Internal estimates approach – requires the
rects materials, direct labor and manufacturing overhead
participation of all personnel concerned in the
that the entity expects to incur to meet the required pro-
budgeting process.
duction during the budget period.
 Sales force components – the projected
sales is determined by the field personnel Direct Material Cost Budget
who makes the estimate per product, per Information needed: amount of direct materials cost
customer type, per area or any other classi- to be incurred.
fication that may prove useful for purposes Budgeted RM needs for production x xxx
of preparing the sales forecast. This is also x RM cost per unit x xxx
known as sales staff procedure. Total budgeted direct materials cost P xxx
 Executive opinion – the top management Direct Labor Cost Budget
discusses projected sales figures for the pe-
Information needed: amount of direct labor cost to
riod. This is also known as group executive
be incurred.
judgment.
Budgeted in production in units xxx
Factors to Consider in Sales Forecasting x Standard direct labor hours per unit xxx
In making a sales forecast, the following factors should Budgeted direct labor hours needs xxx
be taken into consideration: x Direct labor rate per hour P xxx
A. Historical data such as the firm’s past sales vol- Total budgeted direct labor cost P xxx
ume and trends. Factory Overhead Costs Budget
B. General economic trends or factors such as infla- Information needed: amount of factory overhead
tion rates, population growth and personal costs to be incurred.
spending levels.
Budgeted variable overhead
C. Regional and local factors expected to affect (enumeration of breakdown) P xxx
sales. Budgeted fixed overhead
D. Anticipated price changes in both purchasing (enumeration of breakdown) x xxx
costs and sales prices. Budgeted total overhead P xxx
E. Results of market research studies and antici- Under standard costing the budgeted factory overhead
pated marketing or advertising plans. costs can be determined using the following formula:
F. The company’s productive capacity and other
Budgeted production in units P xxx
limiting factors affecting production. Multiplied by: Standard VOH rate per unit x xxx
G. The impact of new products or changes in prod- Budgeted variable overhead P xxx
uct mix on the entire production line.
H. The firm’s own sales force and its planned adver- Normal capacity in units P xxx
tising and promotional activities. Multiplied by: Standard FxOH rate per unit x xxx
I. Industry conditions and trends such the level of Budgeted fixed overhead P xxx
competition and the demand for the product in-  COST OF GOODS SOLD BUDGET
cluding seasonal variations.
J. Other factors such as political, legal events and The cost of goods sold budget shows the cost of the
weather changes. goods expected to be sold during the budget period.
Information needed: projected cost of goods sold.
 SALES BUDGET
Budgeted beginning FG inventory P xxx
The sales budget shows the sales volume, expressed in Budgeted cost of goods manufactured* x xxx
pesos and physical units that the company expects to Total cost of goods available for sale P xxx
generate in the coming budget period. It is prepared Desired ending FG inventory* x xxx
based on the sales forecast. Budgeted cost of goods sold P xxx

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 The budgeted COGM is derived by multiplying the bud-
geted production in units by the standard unit cost
whereas multiplying the desired ending FG inventory in
units by the standard unit cost results to the desired
ending FG inventory in pesos.
 OPERATING EXPENSES BUDGET
The operating expenses budget shows the various non-
manufacturing costs, primarily selling and administrative
expenses, which the company expects to incur during
the budget period.
Information needed: projected operating expenses.
Budgeted selling expenses
(enumeration of breakdown) P xxx
Budgeted administrative expenses
(enumeration of breakdown) x xxx
Budgeted total operating expenses P xxx
Variable operating expenses are usually expressed as a
percentage of sales whereas fixed operating expenses
are stated in total.
 BUDGETED INCOME STATEMENT
The primary component of the operating budget is the
budgeted income statement. It shows the summary of
the budgeted level of operations.
Information needed: projected net income for the
period.
Budgeted sales P xxx
Budgeted cost of goods sold x xxx
Budgeted gross income P xxx
Budgeted operating expenses x xxx
Budgeted income before tax P xxx
Provision for income tax x xxx
Budgeted net income P xxx
The following must be observed when preparing the bud-
geted income statement:
A. The budgeted income statement must be accom-
panied by supporting budgets and schedules as
discussed.
B. The resulting budgeted net income figures should
be evaluated vis a vis the company’s profit goal.
If the figures fall short of the firm’s profit objec-
tive, the operating plan must be revised so as to
meet the management’s expectations.
C. The income statement should include expected
non-operating income and expenses such as divi-
dends and interests.
PREPARATION OF THE FINANCIAL BUDGET
The financial budget provides the necessary information
for financial management. Unlike operating budgets, the
composition and format of financial budgets for service,
merchandising and manufacturing firms do not differ ma-
terially from each other.
 CAPITAL BUDGET
The capital budget contains planned acquisitions of ma-
jor items like property, plant and equipment. This budget
involves some of the most critical budgeting decisions in
an organization because capital expenditure projects
usually require larger cash outlays and cover longer time
periods.
 CASH BUDGET
The cash budget shows the expected cash balance at the
beginning of the budget period, the projected cash re-
ceipts and disbursements during the period and the ex-
pected ending cash balance. A cash budget:
A. Indicates the effect on the cash position of sea-
sonal requirements, large inventories, unusual re-
ceipts and slowness in collecting receivables.
B. Indicates the cash requirements needed for a
plant or equipment expansion program.
C. Shows the need for additional funds from sources
such as bank loans or sales of securities and the
time factors involved.
D. Indicates the availability of cash for taking ad-
vantage of discounts.
E. Shows the availability of excess funds for short
term or long term investments.
Information needed: amount of cash receipts and
disbursements to determine availability of funds for
capital outlays and need for financing.
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Cash balance, beginning P xxx
Budgeted cash receipts xxx
Total cash available P xxx
Budgeted cash disbursements (xxx)
Cash balance, ending P xxx
Though there is no definitive format used for a cash
budget, the following are essential:
A. There must be a clear distinction between the
cash receipts and cash payments for each con-
trol period, a figure for the net cash flow for
each period and the closing cash balance for
each control period.
B. The depreciation for the budget period is not
included in the cash budget.
C. An allowance must be made for bad and doubt-
ful debts.
D. Should there be any possible overage or short-
age, the format may be expanded to include
proceeds of borrowings and deducting repay-
ment of loans or investments in some place-
ments.
Budgeted Cash Receipts
In budgeting cash receipts, the entity must know the
sources of its cash as well as the timing of their collec-
tion.
What do we expect to collect?
Collections may include cash sales, collection of ac-
counts receivable, loan proceeds, additional invest-
ment from owners or stockholders, sale of company’s
assets aside from inventories, donations and interest
and dividends.
When do we expect to collect the above items?
For credit sales, collection patterns are to be estab-
lished to more accurately estimate the inflows of
cash from operations. A schedule of accounts receiv-
able collections from credit sales is to be made.
Collection from current period’s sales P xxx
Collections from prior period’s sales
(enumeration of breakdown) x xxx
Budgeted collection from credit cus-
tomers P xxx
Budgeted Cash Disbursements
In budgeting cash disbursements, the company must
know what it would pay for and when would it remit such
payment.
What do we plan to pay for?
Disbursements may include cash purchases of mate-
rials or merchandise, payment for other manufactur-
ing costs, payment of accounts payable, payment for
operating expenses, payment of loans, payment for
dividends or withdrawals by owners or partners, ac-
quisition of assets other than inventories, donations,
interest of loans and taxes.
When do we expect to pay for the above items?
For credit purchases, a schedule of accounts payable
payments is to be made to more accurately deter-
mine the timing of cash outflows to suppliers. This is
also applicable to other manufacturing costs and op-
erating expenses.
Payments of current period’s purchases P xxx
Payment of prior period’s purchases
(enumeration of breakdown) x xxx
Budgeted payments to credit suppli-
ers P xxx
Payments of current period’s labor costs P xxx
Payment of prior period’s labor costs
(enumeration of breakdown) x xxx
Budgeted payments of labor costs P xxx
Payments of current period’s variable OH P xxx
Payment of prior period’s variable OH
(enumeration of breakdown) x xxx
Payments of current period’s fixed OH
Payment of prior period’s fixed OH
(enumeration of breakdown)
Budgeted payments of overhead P xxx
Operating expenses incurred P xxx
Accrued expenses, beginning x xxx
Prepaid expenses, ending x xxx
 Total P xxx mation on past performance from the output side of a
Accrued expenses, ending x xxx system, department or process, which is then used to
Prepaid expenses, beginning x xxx govern future performance by adjusting the input side of
Budgeted payments of operating ex- the system.
penses P xxx

 BUDGETED STATEMENT OF FINANCIAL POSITION

The budgeted statement of financial position shows all
the projected balances of all the asset, liability and capi-
tal accounts at the end of the budget period. It is derived
from the budgeted statement of financial position at the
beginning of the budget period and the expected
changes in the account balances reflected in the operat-
ing budgets, cash budget and capital expenditure bud-
get.
The development of a budgeted statement of financial
position does not involve a mere collection of account
changes and determination of expected ending balances.
Certain requirements, voluntary, legal or contractual, The components of the budgetary control system are the
must be reflected in the budget. If not met, the whole op- following.
erating and financial plans must be revised to meet the A. Sensors are the measuring and recording de-
requirements. vices of the system. In the context of budgetary
 BUDGETED STATEMENT OF CASH FLOWS control, the basic management accounting sys-
The budgeted statement of cash flows shows the cash in- tem acts as the sensor by collecting and report-
flows and outflows during the budget period. Cash flows ing information on costs and revenues.
are classified as financing, investing and operating activi- B. Comparator is the mechanism by which actual
ties. results are compared with plan. In the context of
a budgetary control system, the exercise of pre-
Cash may be considered as the beginning and the ending
paring a monthly control report (commonly called
of the business process. Investors’ interest would boil
operating statistics or something similar) is the
down to the ability of the business to return their money
comparator. The report seeks to reconcile budget
and how much more could be given to them as premium
with actual results through the calculation of vari-
for accepting the risk of investing in the business. An
ances.
analysis of the cash inflows and outflows of an entity
C. The usual effector is a manager or supervisor
would provide management vital information on the liq-
acting on the report containing the results of the
uidity needs of the business.
comparison between actual and budget, and tak-
BUDGETS AND STANDARDS – DIFFERENCES AND SIMI- ing the actions required for adjustment to be
LARITIES made. An effector could also be an automatic
Obviously, budgets differ from standards. However, the process.
two possess some similarities such as: Static Budget versus Flexible Budgets
A. Both budgets and standards attempt to pre-de-
When managers are comparing the actual results with
termine expenses.
the budget for a period, it is important to ensure that
B. They both consider departmental expenses ac-
they are making a valid comparison.
cording to accounts (i.e. direct materials, direct
labor and factory overhead). A. Static or fixed budget (or the master budget) –
C. They both assume that costs are controllable are set at the beginning of the period and is
along direct lines of supervision and responsibil- based on only one level of activity, thus, remains
ity. constant. They are useful for planning and oper-
D. They both require issuance of periodic compara- ating purposes but can be problematic when
tive performance reports for control purposes. used for control purposes.
Though some relationships exist between budgets and Control requires the comparison of actual out-
standards, the two are not the same. Some of their dis- comes with desired outcomes. When static bud-
tinguishing characteristics are as follows: gets are used and actual sales are different from
budgeted sales, a comparison is inaccurate.
Budgets Standards
B. Flexible or variable budget – contains alterna-
Standards pertain to what tive provisions based on varying rates of produc-
Budgets are statements of costs “might be” if certain tion or other measures of activity. They are as-
expected costs. highly desirable performance sumed to be prepared at the end of the budget
are attained.
period for the purpose of comparing the actual
Standards emphasize the results with the budgeted levels of activity and
Budgets emphasize costs levels to which costs should
levels that should not be can be made to any activity budget with a vari-
be reduced. Thus, costs able component.
exceeded. should approach standards.
As opposed to static budgets, flexible budgets
Standards are usually set
Budgets are normally set for can be accurately used for control purposes be-
only to the manufacturing
all departments in the firm.
division of the firm. Thus, cause any differences in cost caused by differ-
Thus, budgets include both ences in volume of production have been re-
standards are ordinarily set
income and expenses. moved. However, they are not particularly useful
for manufacturing costs only.
for planning.
When actual costs differ from
When actual costs differ from standards, the nature and LIMITATIONS OF BUDGETING
the budget, it may be an cause of the difference or Though there are various advantages that can be derived
indication of either good or variance is investigated so
from the use budgets, it has some drawbacks and limita-
bad performance. Thus, that necessary corrective
budgets keep an entity away actions are taken. Thus, tions including the following:
from trouble. standards lead the entity to A. A budget in itself, as well as the figures therein,
the road to improvement. is merely estimates requiring a certain amount of
judgment.
BUDGETARY CONTROL B. To be successful, a budgetary system requires
As mentioned, one primary use of budgets is in the con- the cooperation and participation of all the mem-
trol of operations and such is referred to as budgetary bers of the organization.
control. Control within budgetary control systems is con- C. To be fully effective, any system of financial con-
ventionally exercised by feedback loops that gather infor- trol must provide for motivation and incentive.

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Page|6 of 10
 D. Some managers think that budgets restrict their costly for some organizations, such that the ben-
movements and limit their decision making efit that can be derived from budgeting may be
power. outweighed by its cost.
E. When budgetary control is enforced in a rigid or G. In some environments, managers may come to
insensitive manner it may end up doing more consider the budget as a sum of money that has
harm than good. to be spent.
F. The development and installation of a good bud-
getary system may be time consuming and too
ILLUSTRATIVE PROBLEMS

PROBLEM 1: As the controller of Royal Company, you Fixed selling and administrative expenses are

are required to prepare the master budget for 2014. P9,950 per quarter.
Below are the relevant information gathered to  Selling and administrative expenses are paid by
accomplish the task: Royal in the period of their incurrence.
Sales Budget  Royal also paid and incurred P2,800 insurance in
first quarter, and P1,200 taxes in third quarter.
 Budgeted sales of the company’s only product
Cash Budget
for the next year 2014 are:
First quarter 800 units  The beginning cash balance is P10,000 and
Second quarter 700 units company policy dictates that the cash balance
Third quarter 900 units should not go below P5,000.
Fourth quarter 800 units  Equipment purchases of P24,300 are scheduled
 The product’s selling price is P80 per unit. for the second quarter and will be paid in cash.
The equipment is estimated to have a useful life
Schedule of Expected Cash Collections from of 5 years. Royal provides no depreciation on its
Customers property, plant and equipment in the year of
 All sales are on account. Per experience, their acquisition.
collection pattern is:  All borrowing and repayment must be in
Quarter of sales 70% multiples of P500 at an interest rate of 10
Quarter following sales 28% percent per annum. Interest is computed and
Uncollectible 2% paid as the principal is repaid. Borrowing takes
 All P9,500 accounts receivable balance is place at the beginning of each quarter and
assumed to be collectible in the first quarter. repayment at the end of each quarter.
 Royal will pay the P4,000 income tax payable last
Production Budget
year in the first quarter. Income tax rate is 20%.
 The company desires to have inventory on hand Beginning Statement of Financial Position
at the end of each quarter 10 percent of the next
quarter’s sales. Royal Company
 On January 1, 80 units were on hand. The Statement of Financial Position
December 31 desired ending inventory is 100 December 31, 2013
units. ASSETS
Current assets:
Direct Materials Budget Cash P 10,000
 Three pounds of material are required per unit of Accounts receivable, net 9,500
product. The material costs P2 per pound. Raw materials inventory 474
Finished goods inventory 3,280
 Management desires to have materials on hand
Total P 23,254
at the end of each month equal to 10% of the
next quarter’s production needs. Non-current assets:
Land P 50,000
 The beginning materials inventory was 237
Buildings and equipment 100,000
pounds. The December 31 desired ending Accumulated depreciation (60,000)
inventory is 250 pounds. Total P 90,000
Schedule of Expected Cash Disbursements for TOTAL ASSETS P 113,254
Materials
LIABILITIES AND EQUITY
 Half of a quarter’s purchases are paid for in the Current liabilities:
month of purchase; the other half is paid for in Accounts payable P 2,200
the following month.
 The accounts payable balance on January 1 was Income tax payable 4,000
P2,200. Total P 6,200

Direct Labor and Manufacturing Overhead Budget Stockholders’ equity:

Share capital P 50,000
 Each unit produced requires 5 hour of direct Share premium 20,000
labor. Each hour of direct labor costs the Retained earnings 37,054
company P5. Total P 107,054
 Variable manufacturing overhead is P2 per direct TOTAL LIABILITIES AND EQUITY P 113,254
labor hour.
 Fixed manufacturing overhead is P6,000 per PROBLEM 2: The management of New Corporation is
quarter. This includes P3,250 in depreciation, considering a three state economic conditions – strong,
which is not a cash outflow. fair and weak. Based on some macro studies, it has been
 Direct labor cost and manufacturing overhead agreed that the economy in the coming year may be
cost are paid by Royal in the period of their 40% strong, 50% fair and 10% weak. The projected
incurrence. number of units are 120,000 units, 90,000 units and
Ending Finished Goods Inventory Budget 50,000 units for strong, fair and weak economic
 Royal Company uses absorption costing in its conditions, respectively. The budgeted unit sales price
budgeted statement of financial position and given the estimates in units sold is P120. Five percent of
income statement. the gross sales are estimated to be uncollectible.
 Manufacturing overhead is applied to units of Requirements:
product on the basis of direct labor-hours. 1. What is the budgeted number of units to be sold
 The company has no work in process inventories. for the coming year?
Selling and Administrative Expenses Budget 2. What is the budgeted amount of sales, net of
 Variable selling and administrative expenses are doubtful accounts?
P4 per unit sold.

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Page|7 of 10
PROBLEM 3: Virginia State University is preparing its 1. Determine the percent of credit sales collected in
master budget for the upcoming academic year. the month of sale, in the month following sale and
Currently, 12,000 students are enrolled on campus. two months following sale.
However, the admissions office is forecasting a 5% 2. How many units were sold in June, July and August,
growth in the student body despite a tuition hike to P80 respectively?
per credit hour. The following additional information has 3. Determine the accounts receivable balance as of
been gathered from an examination of university records August 31.
and conversations with university officials: 4. What is the total collection from credit sales in Au-
A. The university is planning to award 150 tuition- gust?
free scholarships.
B. The average class has 30 students, and the PROBLEM 7: Bags, Inc. manufactures leather bags with
typical student takes 15 credit hours each 3 zipper type pockets. The company outsources the zip-
semester. pers at P8 per unit. Each bag requires 5 direct labor
C. Each class is three credit hours. hours to produce at a rate of P10 per hour. Budgeted
D. Each faculty member teaches five classes during sales of bags for the first quarter of the year and the
the academic year.
first month of the following quarter are as follows:
Requirements: January 900 units
1. In preparing the university’s master budget, should February 1,000 units
the administration begin with a forecast of March 1,500 units
students or a forecast of faculty members? Briefly April 1,800 units
explain. Inventory data are as follows:
2. Compute the budgeted tuition revenue for the January 1:
upcoming academic year. Leather bags 360 units
3. Determine the number of faculty members needed Zipper 1,620 units
to cover classes. End of each month:
Leather bags: 40% of the following month’s
PROBLEM 4: Delo Corporation has prepared the fol- budgeted sales
lowing sales budget: Zipper: 60% of the following month’s production
Month Cash sales Credit sales requirement
May P 16,000 P 68,000 Bags, Inc.’s variable factory overhead rate per hour is P2
June 20,000 80,000 per hour and has a total fixed factory overhead per
July 18,000 74,000 month of P20,000. It pays its material purchases 60%
August 24,000 92,000 during the month of purchase, 30% in the following
Collections are 40% in the month of sale, 45% in the month and 10% in the subsequent month and its labor
month following the sale and 10% in the second month and overhead costs in the month of their incurrence.
following the sale. The remaining 5% is expected to be Requirements:
uncollectible.
1. Determine the budgeted production of leather bags
Requirements: for the first quarter.
1. Compute for the amount of cash received from 2. Determine the budgeted purchases of zipper for
sales during the month of July. February.
2. Compute for the amount of cash received from 3. Determine the total budgeted production costs for
sales during the month of August. the month of March.
4. Determine the total cash disbursements for
PROBLEM 5: The Avelina Company has the following production costs in March.
historical pattern on its credit sales: 5. Suppose that on average, a full time factory worker
Collected in the month of sale 70% works 188 hours per month and no overtime is
Collected in the first month after sale 15% allowed, how many full time equivalent factory
Collected in the second month after sale 10% workers are needed to produce the budgeted
Collected in the third month after sale 4% output of leather bags in January?
Uncollectible 1%
The sales on open account have been budgeted for the PROBLEM 8: Nicely Wyn Corporation has the following
last six months of 2013 are shown below: budgeted production for four months:
July P 60,000 October P 90,000 April 50,000 June 45,000
August 70,000 November 100,000 May 40,000 July 60,000
September 80,000 December 85,000 Each unit of product requires 2 pieces of raw materials.
Requirements: The desired ending raw materials inventory for each
1. Compute for the estimated total cash collections month is 130% of the following month’s production needs
during the fourth calendar quarter from sales made
on open account during the third calendar quarter.
plus 2,000 pieces. The April 1 inventory meets this
2. Compute for the estimated total cash collections requirement. The product is processed in two
during the fourth calendar quarter from sales made departments (Department A and Department B) and the
on open account during the fourth calendar direct labor standards are as follows:
quarter. Hours Rate per Labor
per Unit Hour Cost per
PROBLEM 6: Ibarra Enterprises reported the follow- Unit
ing cash collections in July, August and September Department A 6 P 30 P 180
from credit sales: Department B 2 40 80
July August Septembe Requirements:
r
1. Calculate the budgeted purchases of raw materials
June receivables ? ?
July sales P 90,000 P 45,000 P 15,000 for the month of June.
August sales 144,000 72,000 2. Calculate the budgeted direct labor cost for the
month of May.
The company sells a single product for P20 and all sales
are collected over a three month period following a PROBLEM 9: Bugnot Corporation’s master budget for
constant pattern. The accounts receivable balance as of the year 2013 includes the following data:
June 30 was P80,000. Budgeted sales 7,200
Requirements: Beginning Ending
Finished goods 300 400

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Page|8 of 10
 WIP in equivalent units 60 160 Inventory, 12/31 (18,500 units) 1,184,000
Compute for the number of equivalent units that Bugnot Materials used P
Corporation plans to produce during the budget period. 8,896,000
Labor 784,000
PROBLEM 10: Titanic produces and sells toy ships. For Variable factory overhead 2,009,600
the month of May, it expects to sell 20,000 units of its Fixed factory overhead 1,120,000
Cost of goods manufactured (140,000 P
passenger ship model SFI at P600 each. Each unit of SFI units) 12,809,600
requires three components as follows: Finished goods, 1/1 (9,300 units) 744,000
Component Units Purchas Cost of goods available for sale P
Part Cod required per e price 13,553,600
e SFI Finished goods, 12/31 (3,300 units) 301,600
Body BO 1 P 30.00 Budgeted cost of goods sold P
Motor assembly MA 1 60.00 13,255,00
Body accessories BA 10 20.00 0
The variable conversion cost for each unit of SFI amounts The actual results for the first quarter of 2013 require the
to P160. Fixed factory overhead per unit is P50 based on following changes in the budget assumptions:
A. The budgeted production for the year is expected
the company’s normal capacity of 25,000 units of SFI.
to increase by 5,000 units. During the first
Titanic uses the standard absorption costing method for quarter, the company has already produced
valuing inventories. Beginning and ending inventories in 25,000 units. The balance of production will be
units for the month of May are as follows: scheduled in equal segments over the last 3
May 1 May 31 quarters of the budget year.
Model SFI 600 units 500 units B. The expected finished goods inventory on
Body 1,050 units 450 units January 1 dropped to only 9,000 units but its
Motor assembly 1,600 units 600 units total value will not be revised anymore. The
Body accessories 7,000 units 3,000 units ending inventory value is computed using the
average manufacturing cost for the year.
Requirements: C. A new labor bill passed by Congress is expected
1. What is the total budgeted cost of all purchased to be signed into a law by the president. The new
components for the month of May? law will take effect beginning the last quarter of
2. What is the book value of the desired May 31 the budget year including a provision for an
inventories? increase of 8% in wage rates.
3. What is the budgeted gross margin from Model SFI D. The company uses the FIFO method in valuing its
for the month of May? materials inventory. During the first quarter, the
company purchased 27,500 units of direct
PROBLEM 11: Cyber, Inc. operates a retail computer materials for P1,760,000. The remaining direct
store in Sta. Mesa, Manila. The result of its operation for materials requirement will be purchased evenly
for the last 9 months of the budget year.
the year 2012 is summarized below: Effective July 1, 2013, the beginning of the third
Sales: quarter, direct materials cost is expected to
Hardware P 5,400,000 increase by 6%. The assumptions regarding the
Software 2,250,000 quantity of materials inventories at the beginning
Services 1,350,000 and end of the year will remain unchanged.
Total P 9,000,000 E. The variable factory overhead of P2,009,600
Costs and expenses: includes indirect materials and factory supplies
Cost of hardware sold P 3,780,000 amounting to 10% of the cost of materials used.
Cost of software sold 1,350,000 The balance of the variable factory overhead
Selling expenses 680,000 varies directly with production. There will be no
Service costs 720,000 change in the budgeted fixed factory overhead
Administrative costs 1,260,000 cost.
Total P 7,790,000 Considering the given actual data for the first quarter, as
Operating income P well as the changes in assumptions and estimates in the
1,210,000 budgeted data for the year, the company’s accountant
The budget for 2013 was based on the operating results prepared a revised budgeted cost of goods sold
in 2012 and on the following assumptions: statement.
A. The selling price of hardware will increase an Requirements:
average of 20%. There will be no changes in the
selling prices of software and services. 1. Calculate the budgeted materials purchases in the
B. Unit sales are expected to increase as follows: revised statements.
hardware – 5%, software – 8% and service – 10%. 2. Calculate the budgeted factory overhead in the
C. The cost of hardware and software are expected revised statements.
to increase by 6% while the cost of service, which 3. Calculate the budgeted total manufacturing costs
is purely fixed cost, will go up by P140,000. in the revised statements.
D. Selling costs will increase by 5% whereas 4. Calculate the budgeted cost of goods sold in the
administrative costs will remain the same. revised statements.
Requirements: PROBLEM 13: Pasol Company has just prepared its
1. Calculate the budgeted total costs and expenses master budget for the year 2012. Some of the
for the year 2013. information used in the preparation of such budget is as
2. Calculate the budgeted operating income for the follows:
year 2013. A. Budgeted sales: January – P500,000; February –
P520,000; March – P560,000; April – P500,000;
PROBLEM 12: The cost of goods sold section of Dale May – P576,000; June – P640,000.
Corporation’s operating budget for 2013 is presented B. Twenty percent of total sales is cash sales. The
below: collections pattern for the sales on credit is as
Inventory, 1/1 (16,000 units) P follows: month of sale – 30%; month after the
960,000 month of sale – 40%; second month after the
Purchases 9,120,000 month of sale – 25%.
Materials available for use P C. Pasol Company’s gross profit margin rate is 60%
10,080,000 of sales.

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Page|9 of 10
 D. Accounts payable arising from merchandise
purchases is paid for in the month following the
purchase.
E. The company desires an inventory at the end of
each month equal to 30% of the next month’s
sales in units.
F. The variable operating expenses other than cost
of goods sold are 10% of sales and are paid for in
the month following the sale.
G. The annual fixed operating expenses are as
follows: depreciation – P336,000; advertising –
P576,000; insurance – P144,000; salaries –
P864,000; property taxes – P192,000.
H. All of the fixed operating expenses are incurred
uniformly throughout the year. Cash fixed
operating expenses are paid in the month of
incurrence except for:
 Insurance – paid quarterly in January, April
and July.
 Property taxes – paid twice a year in April
and October.
Requirements:
1. Determine the total budgeted cash receipts for the
month of April.
2. Determine the total budgeted cash disbursements
for the month of April.
3. If the expected cash balance at the end of April is
P30,000, what was the cash balance at the
beginning of April?
PROBLEM 14: Songco Company is preparing its cash
budget for the last two months of the first quarter of the
calendar year 2013. Following are some pertinent budget
data gathered by the company’s budget committee:
January Februar March
y maximum desired cash balance is P50,000. Excess cash
Sales P 32,000 P 40,000 P 80,000
Accounts payable from
merchandise 24,000 32,000 32,000
purchases
Salaries 48,000 56,000 40,000
Other expenses 25,000 29,000 13,000
Additional information follows:
A. Collection pattern: ½ of each month’s sales is
collected in the month of sale; the balance is
collected in the following month.
B. Payment for accounts payable: ¾ of the current
month’s accounts payable budget is paid during
the month; the balance is paid in the following
month.
C. The budgeted other expenses include
depreciation expense of P5,000 per month.
Expenses requiring cash outlays are paid for in
the month of incurrence.
D. The company intends to maintain a minimum
cash balance of P80,000. Such was complied with
at the end of January. In case of deficits, the
company may borrow from its bank which gave it
a standby credit line of P300,000 at an annual
interest rate of 12%. Per their agreement, the
company must borrow in multiples of P10,000.
Principal repayments are to be made in any
month in which there is a surplus of cash.
Interest is to be paid monthly. There is no
outstanding balance on the line of credit as of
February 1. If there is no outstanding balance on
Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014
Page|10 of 10
the loan, the company will invest any cash in
excess of its desired end of month cash balance
in government securities.
Requirements:
1. After any financing, what is the expected cash
balance at the end of February?
2. For the month of March, is there a need for Songco
Company to borrow cash or repay a portion of his
loan?
PROBLEM 15: Adelaida Sales’ actual sales and
purchases for April and May are shown here along with
forecasted sales and purchases for June through
September:
Sales Purchases
April (actual) P 390,000 P 200,000
May (actual) 420,000 220,000
June (forecast) 390,000 210,000
July (forecast) 350,000 240,000
August (forecast) 420,000 320,000
September (forecast) 410,000 230,000
The company makes 10% of its sales for cash and 90%
on credit. Of the credit sales, 30% are collected in the
month after sale and 70% are collected two months after.
Adelaida Sales pays for 45% of its purchases in the
month after purchase and 55% two months after.
Labor expense equals 15% of the current month’s sales.
General overhead expense equals P10,000 per month.
Interest payments of P35,000 are due in June and
September. A cash dividend of P25,000 is scheduled to
be paid in June. Tax payments of P30,000 are due in June
and September. There is a scheduled purchase for cash
of an equipment, P290,000 in September.
Adelaida Sales’ ending cash balance in May is P25,000.
The minimum desired cash balance is P20,000. The
(above P50,000) is used to buy marketable securities.
Marketable securities are sold before borrowing funds in
case of a cash shortfall (less than P20,000).
Requirements:
1. What is the expected total cash collection from
sales for the month of June?
2. As of July 31, what the cumulative amount of
marketable securities purchased?
3. To maintain the minimum balance of P50,000 cash
as of September 30, what is the amount of loan to
be obtained?
PROBLEM 16: Bavaria Corporation's budget for variable
overhead and fixed overhead revealed the following
information for an anticipated 40,000 hours of activity:
variable overhead, P348,000; fixed overhead, P600,000.
The company actually worked 43,000 hours, and actual
overhead incurred was: variable, P365,500; fixed,
P608,000.
Requirements:
1. Compute the company's total cost variance for
variable overhead and fixed overhead if the firm
uses a static budget to help assess performance.
2. Compute the company's total cost variance for
variable overhead and fixed overhead if the firm
uses a flexible budget to help assess performance.
3. Which of the two budgets (static or flexible) is
preferred for performance evaluations?