Budgets & Budgetary Control Systems: Prepared by

BUDGETS & BUDGETARY
CONTROL SYSTEMS
Prepared by:
Baffuor Osei-Akoto Ntim, {ACIB, PGDMS(banking & fin), MBA(finance),
PGCE(post Comp), MIfL}
 BOOKS:
 Proctor R,(2006) Managerial Accounting for Business Decisions
2nd Edition, Prentice Hall.
 Atrill, P. & McLaney, E (2009) Management Accounting for
Decision Makers , 6th edition, prentice Hall
 Collis J & Hussey R (2007) Business Accounting: An introduction
to Financial & management accounting, Palgrave Macmillan.
 Atrill, P. (2000) Financial Management For Non-specialist 2nd
Edition Prentice Hall
BUDGETS & THEIR CONTEXT
 A budget is a predictive model of organisational
activity quantitatively expressed for a set time
period.
 Annual budgets of organisations are created to
fit the organisations strategic plan.
 Strategic corporate plan is a long term
organisational objectives and policies through
which these goals are to be achieved.
 Various corporate budgets have a specific
relationship with each other
8/13/2018 baff.stc/e215he/ac&fn 2
BUDGET RELATIONSHIPS
Sales Production
Fixed assets
movements Materials usage
Closing creditors Balance sheet forecast Material

purchases
Closing debtors Cash budget Direct labour
Administration Profit & Loss forecast Production
overheads overheads
Marketing Standard product
overheads cost
Cost of sales Closing stocks
TYPES OF BUDGET & BUDGETING
METHODS
 FIXED BUDGET:- This is a budget based on
one predetermined level of activity. Its main
function is to act as a master plan for the
following year.
 FLEXIBLE BUDGET:- This is a budget which by
recognising different cost behaviour patterns, is
designed to change as the volume of activity
changes.
 It can be seen as several fixed budgets shown
side by side at a different level of activity.
 INCREMENTAL BUDGET:- This approach to
budget creation assumes that there will be little
change in activity for next year compare to the
TYPES OF BUDGET & BUDGETING
METHODS
 current year.
 So allowances are made on last years figures by
adding an increment for known changes and
inflation.
 ZERO-BASED BUDGET:- This method requires
each cost element to be specifically justified, just
as the activity being actually undertaken for the
first time.
 Without approval for instance the budget
balance will be zero.
FUNCTIONAL BUDGETS
 THE PRIMARY BUDGET
 Does it matter which budget is created first?
 The answer is start with the activity that
determine all activities, in majority of businesses
it is sales.
 The amount of goods or services a company is
realistically considering to sell is likely to
influence all activities.
 The primary budget can be thought of as a
limiting factor.
 If we are manufacturers and we run out of a
FUNCTIONAL BUDGETS
 Raw material, then this raw material becomes
the limiting factor.
 In that case the limiting factor budget (raw
material) budget will have to be prepared first.
 The sales forecast is the responsibility of the
sales and marketing section and because it is so
crucial it needs approval from the highest
authority.
 The accountant will have very little to do with
this budget
FUNCTIONAL BUDGETS
 THE PRODUCTION VOLUME BUDGET:- To plan
the production volume budget you might need
to know the stock levels of finished goods at the
beginning and end of the period.
 This may be determined by the corporate policy.
E.g. opening stock should equal to one-half of
next month’s sale etc.
 Once the sales volume is known the number of
items to be made is determined by the following
formula: PRODUCTION = SALES + CLOSING
STOCK – OPENING STOCK
EXAMPLE
 The sales of Baff Ltd are planned to be April 100, May
140, June 120 and July 160 items. Stock levels are
planned to one-quarter of the next months sales. What
are the planned production budget for April, May, June?
April May June July

Sales 100 140 120 160
Add Closing stock 35 30 40
Less Opening stock 25 35 30 40
Production 110 135 130
RAW MATERIAL PURCHASING
BUDGET
 You should know your company’s raw material
stock levels.
 You should also have how much raw materials
will be used for the period.
 Organisations may have different policies when
it comes to raw materials.
 E.g. if an organisation deals with a raw material
that is difficult to come by, and are prone to
shortages, they might decide to carry sufficient
stock at the beginning of each period/month.
 The formula for calculating both quantities and
values of raw material usage is:-
BUDGET
 PURCHASES = USAGE + CLOSING STOCK –
OPENING STOCK
 E.g. Baff Ltd plans to spread its production of
1800 items evenly throughout the year. Each
item uses five units of raw material. Baff expects
to start the year with 80 units of raw material in
stock but to reduce this by 25% by the end of
the year. Each unit of stock costs £6 to buy in,
what is the company’s raw material purchasing
budget for the year.?
BUDGET ANSWER
PURCHASES = USAGE + CLOSING STOCK – OPENING STOCK
9000 + 60 – 80
=8,980 units of raw material @ £6
= £53,880
COST OF SALES BUDGET

 For manufacturing organisations, cost of sales is
calculated by the following formula:-
 COST OF SALES = OPENING STOCK +
PRODUCTION COST – CLOSING STOCK
 E.g. If Baff Ltd’s stock of finished goods is
valued
COST OF SALES BUDGET
 at £30,000 on 1 January and £27,000 at 31
March and the cost of production is £20,000 a
month, what is the cost of sales for the quarter?
ANSWER
£
Opening stock 30,000
Add Production 60,000
Less Closing stock 27,000
Cost of sales 63,000
CASH RECEIPTS BUDGET.
 To prepare this budget, it is essential to know
the amount of money planned to be received in
each period.
 For sales made on cash terms, the exchange of
goods for cash are done at the same time.
 The total receipts equal total sales revenue
 For sales made on credit terms, payment will
take place at a later time whereas the exchange
of the goods is done immediately.
 The totals of your receipt in one period depends
on the amount of debtors at the start and finish
of the period as well as the amount sold on
CASH RECEIPTS BUDGET.
 credit
terms during that period.
 RECEIPTS = OPENING DEBTORS +
CREDIT SALES – CLOSING DEBTORS.
 E.g. Baff Ltd plans to sell 2,400 items for £10 each
evenly throughout the year, half on cash terms and half
on credit terms of one month. If its opening debtors
were £1300, what would be the planned total receipts
from all sales during the year? (assume all debtors pay
on the due date) Receipts from £
£ Debtors 12,300
Opening Debtors 1,300 Receipts from
Add Credit sales 12,000 (2,400x10x0.5) Cash sales 12,000
Less Closing Debtors
8/13/2018
1,000
baff.stc/e215he/ac&fn
Receipts for yr 24,30015
CASH PAYMENTS BUDGETS
 In order to prepare cash budget it is essential to
know the amount of money planned to be paid
out.
 When goods are purchased and paid for, the
total payments equal to the totals of purchases.
 If they are however taken on credit terms, then
the total of purchase must be adjusted by the
amount of creditors at the start and finish of the
period to give the total amount of payments.
 The formula is:-
 PAYMENTS = OPENING CREDITORS +
CREDIT PURCHASES – CLOSING
CREDITORS
CASH PAYMENTS BUDGETS
 E.g. Baff Ltd buys 1,600 items at £5 each evenly
through the year, one –quarter on cash term
and three quarters on two month’s credit. If the
company’s opening creditors were £750, what
would be the total of its payment for the year?
(assume all creditors are paid on the due date)
Opening creditors 750

£
Add Credit Purchases 6,000 (1,600 x 0.75 x £5)
Less Closing creditors 1,000 (200@ £5)
Payments to creditors 5,750
Payments on cash terms 2,000 (1,600 x 0.25 x £5)
Total payments for year 7,750
MASTER BUDGETS
THE CASH BUDGET OR CASH FLOW FORECAST
 This budget is of particular importance to all
organisations.
 This helps to manage the cash flow position of
an entity at any particular time.
 The summary cash budget for the period is
simply:-
 OPENING BALANCE + RECEIPTS –
PAYMENTS = CLOSING BALANCE.
 It is normal for organisations to create a detailed
cash budget for each month to help with
monitoring how much cash is coming in and
going out.
MASTER BUDGETS
THE CASH BUDGET OR CASH FLOW FORECAST
 Once this is known, the net cash flow can be

combined with the opening balance to give the
closing balance. Cash in
Less: Cash out
Net cash flow
Add: Opening balance
Closing Balance
 It is conventional to give net inflow a positive

sign and net outflows a negative sign with
brackets
EXAMPLE OF A SIMPLE CASH
BUDGET
Jan Feb Mar Total
Cash in 45 49 54 148
Less Cash out 37 53 41 131
Net Cash flow 8 (4) 13 17
Add Opening balance 850 858 854 850
Closing Balance 858 854 867 867
The budgeted profit and loss account and a balance sheet

are compiled from information on the functional budgets
or provided from elsewhere in the organisation
BUDGETARY CONTROL SYSTEM
 The basic principle of budgetary control system
is very simple if it is thought of as a four step
process as ff:-
1. Create plan
- Reflect and evaluate
4. Compare actual
Performance with plan THE BUDGETARY 2. Implement plan
Calculate the CONTROL LOOP -perform the activities
difference
3. Measure and record

actual
performance
BUDGETARY CONTROLS
 If something starts to go wrong e.g.
expenses treble, a comparison with the
actual and planned cost would reveal this
and corrective measures taken.
 Although budgets are annual statements
it is usually divided into twelve monthly
periods and monitored that way.
 This helps with prompt controlling of cost
VARIANCES
 Variances are the increases or decreases in
profit which occur when things do not go
according to plan
 Profit = sales revenue – total costs and
therefore if any aspect of this equation changes
profit will change accordingly.
 Variance is a change in profit caused by changes
in either sales revenue or costs from their
budgeted levels.
 For every item of cost, the costs variance is
calculated by the following formula:
 COST VARIANCE = BUDGETED COST –
ACTUAL COST
VARIANCES
 Suppose BAFF Ltd’s budget shows that 80kg of a
material was to be used at £15 per kg. the
budgeted cost would be £1200 (80 x 15)
 If actual production record showed that only
65kg was used and that each kg cost £10, then
the actual cost is £650 (65 x 10)
 Cost variance is therefore:
 1200 - 650= +£550 therefore £550 (favourable).
 Note that the answer to this is positive, we could
have a negative variance as well - £550
(adverse) in some instances.
 We use ‘F’ for favourable (+) variances and ‘A’
adverse or ‘U’ unfavourable for (-) variances.
SUB-VARIANCES
 Most often ‘cost’ and ‘price’ are used to mean
the same in colloquial English.
 However in variance analysis these words are
used in the precise sense to mean two different
things.
 To avoid confusion in calculation of variances, it
is good idea to clarify this.
 ‘Price’ refers to one item only
 ‘Cost’ refers to total expenditure for several
things.
 For example if 10kg of flour are bought at the
price of £2/kg, the cost of the purchase is £20.
 COST = PRICE x QUANTITY
SUB-VARIANCES
 With this clear distinction of cost and price, the
cost variance can now be analysed into its two
component variances.
 COST VARIANCE = PRICE VARIANCE +
QUANTITY VARIANCE.
 This then will enable us to find out how much of
the profit change is due to a change in purchase
price or a change in quantity used.
 This information will then enable us to take
corrective action to improve or prompt further
investigation.
PRICE VARIANCE
 PRICE VARIANCE = (BUDGETED PRICE –
ACTUAL PRICE) x ACTUAL QUANTITY
 (BP – AP) x AQ
 Using BAFF Ltd’s example:- PRICE VARIANCE
will be (15 – 10) x 65 = +325 = 325F
 It is conventional always to calculate price
variances at actual quantities used.
 This approach gives the differences in cost due
to price changes only and not any other change.
QUANTITY VARIANCE
 QUANTITY VARIANCE = (BUDGETED
QUANTITY – ACTUAL QUANTITY) x
BUDGETED PRICE.
 (BQ – AQ) x BP
 Using BAFF Ltd example:- QUANTITY VARIANCE
= (80-65) x 15 = +225 = 225F
 It is conventional always to calculate quantity
variances at budgeted prices, this gives the
differences in cost due to changes in quantity
and not price.
 There are two other variable cost that can be
analysed the same way DIRECT LABOUR and
VARIABLE OVERHEADS
DIRECT LABOUR & VARIABLE
OVERHEADS
 They can also be analysed into their constituent
price and quantity variances and are known by
different names
Price variance Quantity variance
(BP – AP) AQ (BQ – AQ) BP
Raw materials Price variance Usage variance
Direct labour Rate variance Efficiency variance
Variable Expenditure Efficiency variance
overheads variance
DIRECT LABOUR & VARIABLE
OVERHEADS
 Note that the same basic formulae are used for
each of these cost types.
 It is possible to calculate all six variances named
on the previous slide if you can remember the
two formulae shown at the top of each column.
 The word ‘standard’ can be used instead of
‘budget’ therefore
 Standard price = budgeted price
 Standard quantity = budgeted quantity
EXAMPLE 1
 STC Ltd planned to use 100kg of material at £5
per kg for last weeks output. Although its
production output was exactly as planned, its
used 110kg of material and paid only £4 per kg
for it.
 Calculate the material cost, price and usage
variances.
Usage variance = (BQ – AQ) x BP
Budget: 100kg @ £5/kg = £500 cost
= (100 – 110) x 5 = (50) A
Actual: 110kg@£4/kg = £440 cost
Cost variance = budgeted cost –
Price variance = (BP – AP) x AQ
actual cost.
= (5 – 4) x 110 = 110F
8/13/2018
= 500 – 440 = 60 F
baff.stc/e215he/ac&fn 31
EXAMPLE 2
 Tooting ltd has a small finishing department
employing two people. The budget showed they
were expected to work for a total of 4000 hours
during the year just ended. The standard rate of
pay used was £6.50 per hour. The payroll shows
they actually worked a total of 4100 hours and
were paid a total of £26,650 to produce the
budgeted output.
 Calculate the direct labour cost, rate and
efficiency variances.
SOLUTION
RATE VARIANCE
Rate variance = (budgeted rate – actual) x actual hours
(BR x AH) – (AR x AH)
(6.50 x 4100) – 26,650
26,650 – 26,650 = 0
The actual rate paid must also equal £6.50/hr
EFFICIENCY VARIANCE
(budgeted hours – actual hours) x budgeted rate
= (4000 – 4100) x 6.50
= - (100) x 6.50
- 650 = 650A
LABOUR COST VARIANCE
Budgeted cost – actual cost
= (4000 x 6.50) – 26,650
= 26,000 – 26,650
= - 650
= 650A
SALES VARIANCES
 Sales are concern with income rather than cost,
therefore sales price variance differ from cost
variances.
 If the actual sales price achieved is greater than
the budgeted price, profits will increase giving a
favourable variance.
 SALES PRICE VARIANCE = (ACTUAL PRICE
– BUDGET PRICE) x ACTUAL QUANTITY.
 SALES VOLUME VARIANCE = FLEXED
BUDGET PROFIT – ORIGINAL BUDGET
PROFIT.
 Example:- The following refers Balham Ltd for
the month of May. Their original budget showed
400 items sold at £25 each, resulting in a
SALES VARIANCES
 profit of £2,000. the actual performance was
300 items sold at £26 each, resulting in a profit
of £1,663. When the budget was flexed, it gave
a revised profit of £1,650. Calculate the sales
price variance and the sales volume variance.
Sales price variance = (actual price – budgeted price) x actual quantity sold
= (26 – 25) x 300
= + 300
= 300F
Sales volume variance = flexed budget profit – original budget profit

= 1,650 – 2,000
= - 350
= 350A

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BUDGETS & BUDGETARY

Closing creditors Balance sheet forecast Material

April May June July

COST OF SALES BUDGET

Opening creditors 750

 Once this is known, the net cash flow can be

 It is conventional to give net inflow a positive

The budgeted profit and loss account and a balance sheet

3. Measure and record

Sales volume variance = flexed budget profit – original budget profit

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