Week 4 Lectures: Budgeting For Planning and Control

Faculty of Management
Bournemouth University Business School

Department of Accounting, Finance & Economics
Week 4 Lectures: Budgeting for

Planning and Control
Dr Akanga
www.bournemouth.ac.uk
Learning Outcomes
By the end of this unit

 Explain the purpose and nature of a budgeting
system
 Explain how budgeting is used for planning and
control
 Understand the different types of budgets
 Explain the benefits of budget
 Prepare different budgets and explain how they
lead to the master budget
Definition and Role of Budgets
• A budget is a quantitative expression of a

proposed plan of action by management for a
future time period
• It can cover both financial and non-financial
aspects (such as planned revenue, expenses,
assets, liabilities and cash-flows) of these plans
and acts as blueprint for the company to follow in
the forthcoming period.
• Serves as an aid to planning and controlling an
organisation’s activities in order to achieve
certain objectives.
Budgeting process
• The first step therefore must be determining

the objectives to be achieved, and this should
be followed by a process where all
departments affected are brought together so
that they can all work together towards a
common goal.
• It is also very useful to look back at the
previous year’s performance.
• It can serve as a good yardstick for preparing
the budget for the coming year.
The Role of Budgeting
in Planning and Control
Planning
Planning
Decision
Decision Organizing
Organizing&&
Evaluating
Evaluating Directing
Making
Making Directing
Controlling
Controlling
Initiate LT &
ST Plans
Evaluate Decision Implement

Performance Making Plans
Measure
Performance
Initiate LT & Planning
ST Plans
Planning -- involves
Evaluate Decision Implement
developing objectives
Performance Makingand Plans
preparing various budgets
to achieve these objectives.
Measure
Performance
Initiate LT &
ST Plans involves
Control the
steps taken by management
Evaluate thatDecision
attempt to ensure the
Implement
Performance objectives
Making are attained.
Plans
Measure
Control Performance
Effects of Budgetary Control
• Budgets are tools that by themselves are neither

good nor bad. How managers control budgets is the
key to their value. When administered wisely,
budgets can serve the following useful purposes:
1. Compel strategic planning including the
implementation of plans
2. Provide performance criteria
3. Promote communication and coordination within the
organisation; and
4. Affect motivating and wider organisational processes.
Effects of Budgetary Control
• In order to use budgets as control mechanisms,

it is necessary that actual results are
subsequently compared with the budgets and
any necessary corrective action taken.
• Budgeting is most useful when done as an
integral part of an organisation’s strategic
analysis.
• Strategy can be viewed as describing how an
organisation matches its own capabilities with
the opportunities in the marketplace to
accomplish its overall objectives.
Strategic Analysis
Long-run Long-run
Planning Budgets
Strategy
Analysis
Short-run Short-run
Planning Budgets
Note that the arrows in the diagram are pointing in two directions
because strategy, plans and budgets are interrelated and affect
one another. Budgets provide feedback to managers about the
likely effects of their strategic plans. Managers then use this
feedback to revise their strategic plans.
Preparation of a budget
• Preparation of a budget requires a number steps:
• a) determining objectives
• b) identifying resources required
• c) estimating the cost of the requirements
• d) reviewing and coordinating objectives and
resources, and assessing the financial
consequences
• e) finally approving the budget.
Preparation of a budget
• Given below are the main different types

of budgets prepared by organisations

• Sales, Production, Materials, Labour,
Overhead, etc
The Sales Budget
• The sales budget shows projected sale

quantities and prices.
• Provides predictions of total revenue from
which cash reception from customers can be
estimated.
• Provides data for constructing other budgets
(production cost, selling and distribution, etc)
Example 1
• You are required using the information

given below, to prepare budgets for the
month of May for:
1. Sales in quantity and value, including
total value;
2. Production quantities.
Example 1: Sales or Revenue
Budget
Product Quantity Price each
(units) (£)
Sales A 1 000 100
B 2 000 120
C 1 500 140
Product Product Product
A B C
Opening stock 1 000 1 500 500
Closing stock 1 100 1 650 550
Solution 1: Sales or Revenue
Budget
Product Product Product Total
A B C
Sales 1000 2000 1500
quantities * * *
Selling £100 £ 120 £ 140
prices
£100.000 £ 240.000 £ £550.00
Sales value 210.000 0
Production Quantity Budget
closing
Sales qty. + stock
= Qty. needed - Ope. stock
Production budget
Units
Sales X
Add : Closing stock X

Less : Opening stock ( X)
Production required X
Solution 2: Production
Quantities Budget
Product Product Product
A B C
Sales quantities 1 000 2 000 1 500
+ Closing stock 1 100 1 650 550
= Quantity needed 2 100 3 650 2 050

- Opening stock (1 000) (1 500) (500)
1 100 2 150 1 550

= Production
Example 2
• TT Company is a distributor of lawnmowers. The following

information is available about the company’s operations:
1. The cash balance on 1 June will be £80 000 and the company
must maintain a minimum cash balance of £40 000. An open
line of credit is available from the company’s bank to bolster
the cash position as needed.
2. Actual sales for April and May and expected sales for June are
as follows:
April(£) May (£) June (£)

Cash Sales 130 000 140 000 166 000
Sales on account 800 000 1 050 000 1 200 000
Example 2
• Sales on account are collected over a three-month period in the

following ratio: 30% collected in the month of sale, 50% collected
in the month following sale, and 17% collected in the second
month following sale. The remaining 3% is uncollectible.
3. Purchases of stock will total £560 000 for June and 40% of a
month’s stock purchases are paid during the month of purchase.
The accounts payable remaining from May’s stock purchases
total £322 000, all of which will be paid in June.
4. Selling and administrative expenses are budgeted at £840 000
for June. Of this amount, £100 000 is for Depreciation. In
addition, a new web server for the Marketing Department costing
£152 000 will be purchased for cash during June, and dividends
totalling £18 000 will be paid during the month.
Required
[a] Prepare a schedule of expected cash

collections for June.
[b] Prepare a schedule of expected cash
disbursements during June to suppliers
for materials for stock purchases.
Solution to Example 2
a). Schedule of cash collections (Sales) as far as June is

concerned :
June
Cash Sales in June
Collections on account:
April sales = £136 000
May sales =
£525 000
June sales = £360 000

Total cash collections for June £1 187 000
b. Schedule of cash payments to suppliers as far as

June is concerned :
June
May purchases (creditors) £322 000
June purchases:
£224 000
Total cash payments in June

£546 000
Sales Budget
• Units xSelling price = Total Sales

• Example 1.
• Our Parents enterprises specialises in the
production of winter coats. Budgeted sales
(units) for the months of April, May, June and
for the quarter were 20.000, 50.000, 30.000,
100.000 respectively. Each coat was sold for
£16. Prepare a sales budget for the three
months and the quarterly sales budget.
Sales Budget: Example 2
The following information is an extract from PK Plc Sales

Ledger for December 2017. Prepare expected sales
collection budget for 2018 assuming that 70% is collected in
period of sale and 30% in period after sale. Assume that
there was a cash balance of £90,000
Quarter
1 2 3 4 Year
Budgeted Sales 10,000 30,000 40,000 20,000 100,000

(units)
Selling Price (£) 20 20 20 20 20
Total Sales (£) 200,000 600,0000 800,000 400,000 2,000,000
Schedule of expected cash
collection
1£ 2£ 3£ 4£ Year
70% of total sales
Opening cash 90,000 (200,000). 90,000
1st quarter sales 140,000 60,000 0 0 200,000
2nd quarter sales 420,000 180,000 0 600,000
3rd quarter sales 560,000 240,000 800,000

30% of total sales (200,000)
4th quarter sales 280,000 280,000
Total Cash 230,000 480,000 740,000 520,000 1,970,000

collections
Example 1
• The following information is an extract from PK Plc Sales Ledger

for December 2017. 2000 units were left in 2017. PK plc has as
policy to maintain closing inventory at 20% of next quarter sales.
Management of PK plc has decided to maintain 3,000 units as
ending inventory for the last quarter of 2018. Prepare Production
budget for 2018.
Quarter
1 2 3 4 Year
Budgeted Sales 10,000 30,000 40,000 20,000 100,000

(units)
Selling Price (£) 20 20 20 20 20
Total Sales (£) 200,000 600,0000 800,000 400,000 2,000,000
Example 1 Solution
2. Equals expected
sales in units 1 3. Plus2 Closing inventory
3 4 Year
Budgeted Sales 10,000 30,000 40,000 20,000 100,000
Add closing inventory 6,000 8,000 4,000 3,000 3,000
16,000 38,000 44,000 23,000 103,000
Less opening inventory 2,000 6,000 8,000 4,000 2,000
Production 14,000 32,000 36,000 19,000 101,000

4. Less opening
inventory in units.
1. Finished units to be produced
Direct materials usage budget
Direct material cost:
i) Quantity of Materials/unit X production required

= Total Quantity of materials
ii) Total Quantity of materials X price per unit

= Direct material cost
Example 2: Material budget
• PK plc has as policy to maintain raw materials at 10% of

the subsequent quarter. Each unit requires 15kg costing
£0.20/kg. Assume that ending inventory for quarter four is
22,500kg and there is cash balance brought forward of
£28,500. The company has agreed with the supplier to
pay for 50% of purchases of raw materials in the quarter
in which the purchase is made, and the remaining 50% in
the following quarter.
• Prepare a direct materials budget and expected cash

disbursement for raw materials
Example 2 Solution
2. Equals amount 3. Plus closing inventory
required for production. 1 2 3 4 Year
Required Production 14,000 32,000 36,000 19,000 101,000
Raw materials needed (kg) 15 15 15 15 15
Production (kg) 201,000 480,000 540,000 285,000 1,515,000
Add closing inventory 48,000 54,000 28,500 22,500 22,500

4. Less opening inventory.
Less opening inventory 21,000 48,000 54,000 28,500 21,000
Quantities to be purchased 237,000 486,000 514,500 279,000 1,516,500
Cost/unit raw materials (£) 0.20 0.20 0.20 0.20 0.20

1. Required purchases of Direct
Cost of raw materials (£) 47,400 Materials102,900
97,200 55,800 303,300
Example 2 Solution Cont: Schedule cash
disbursement for raw materials
1£ 2£ 3£ 4£ Year (£)
47,400 97,200 102,900 55,800 303,300

50% of 47,400
Opening cash 25,800 25,800
1st quarter sales 23,700 23,700 0 0 47,400
2nd quarter sales 48,600 48,600 0 97,200
3rd quarter sales 51,450 51,450 102,900

50% of 47,400
4th quarter sales 27,900 27,900
Total Cash 49,500 72,300 100,050 79,350 301,200

collections
Direct Labour Cost budget
• Direct labour cost:
• i) Production units X direct labour hours

required = Total direct labour hours required
• ii) Total direct labour hours X Direct labour

rate/hour = Direct labour cost
Example 3: Labour budget
• Using the information provided in example 1

above, what is the direct labour budget if each
item to be produced requires 0.4 direct labor
hour at the costs of £15 per hour?
Example 3 Solution
1 2 3 4 Year
Production units 14,000 32,000 36,000 19,000 101,000
Direct labour hours 0.40 0.40 0.40 0.40 0.40
Total labours hours 5,600 12,800 14,400 7,600 40,400

required for production
Cost/labour hour (£) 15 15 15 15 15
Total labour cost (£) 84,000 192,000 216,000 114,000 606,000
Variable Production Overhead
budget
Direct Variable Overhead cost: (Assuming
based on direct labour hours)
i) Production units X direct labour hours
required = Total direct labour hours required
ii) Total direct labour hours X Variable

Overhead rate rate/hour = Direct variable
overhead cost
Cash budget
• A Cash Budget states all the cash inflows and

outflows for a certain period of time.
• Sometimes the cash budget is also called “Statement
of budgeted cash receipts and disbursements”.
• A cash budget is not the same as an income
statement.
• Main Differences with the Income Statement:
 Depreciation is not included
 Loans are included
 Dividends are included
Main elements of a Cash
Budget
The main elements of a cash budget are:
• Cash collections from customers (IN)
• Cash disbursements for purchases (OUT)
• Cash disbursements for operating
expenses (OUT)
• Capital Expenditures (OUT)
• Loans (IN)
• Loan repayments (OUT)
As you can see everything is either IN or OUT.
Types of Budgets
• Flexible budgets
• Zero based budget
• Activity Based Budget (ABB)
• Kaizen Budget
• Continuous budget
Flexible Budgets
Key assumptions of a flexible budget are:
• Total variable costs change in direct proportion to changes in

activity.
• Total fixed costs remain unchanged within the
relevant range.
• A flexible budget is the difference between the actual revenues

and the cost drivers
• If operating income increases relative to the budgeted amount, we
refer to it as a favourable variance. But if the operating income
decreases relative to the budgeted amount, we refer to it as
unfavourable variance.
How to develop a flexible
budget
• Developing a flexible budget requires a five step approach
 Determine the budgeted selling price per unit, the
budgeted variable cost per unit and the budgeted fixed
cost
 Determine the actual quantity sold (revenue driver)
 Determine the flexible budget sales based on the
budgeted sales price and the actual quantity sold
 Determine the actual quantity of cost driver. This should
be the number of units produced and sold
 Determine the flexible budget for costs based on the
budgeted unit variable costs and fixed costs and the actual
quantity
Flexible Budgets
Benefits:
Show revenues and expenses that should
have occurred at the actual level of activity.
May be prepared for any activity level in the
relevant range.
Reveal variances due to good cost control or
lack of cost control.
Improve performance evaluation.
Zero Budgets
• It is also known as ‘priority-based budgeting’

• It requires that all activities are justified and prioritised
(cost-benefit analysis) before decisions are taken
relating to the amount of resources allocated to each
activity.
• It focuses on programmes (extending childcare
facilities) or activities instead of functional departments.
• Budgets are compiled as if the programmes are being
launched for the first time – Projected expenditure for
existing programmes should start from zero.
Zero Budgets
Reasons for its lack of success:

 Too costly and time-consuming
 Insufficient information to support the process
 Other organizational and behaviour factors
• Suited to non-profit organization and

discretionary costs (advertising costs;
research & development costs) and support
activities in profit organizations
Activity-Based Budgets (ABB)
• ABB aims to authorize only the supply of

those resources that are needed to
perform activities required to meet
budgeted volumes.
• Therefore, the starting point for preparing
ABB is the cost object by separating
indirect costs into homogenous activity
cost pools.
Activity-Based Budgets (ABB)
ABB involves a four step process

Determine the budgeted cost to perform each unit of
activity at each activity area
Determine the demand for each individual activity
based on budgeted, production, new product
development, etc
Calculate the cost of performing each activity
Describe the budget as cost for performing various
activities (rather than budgeted costs of functional or
conventional value-chain spending categories).
Kaizen Budgets
• Aims at continuously improving processes and

reducing costs
• Concept can be applied to budgeting by incorporating
expected cost reductions into the planned results of a
business.
• The concept tends to yield gradual improvements over
a long period of time and drive down costs below their
current levels on a continual basis
• Concept requires great planning by management and
requires sufficient time and resources to examine all
aspects of the business
Kaizen Budgets
Problems associated with Kaizen budgeting:

•Useful in the first few years to achieve
initial reductions.
•If reductions are not achieved, cash flows
and profits too cannot be achieved leading
to considerable unfavourable variances in
the budget
Continuous Budgets
• The traditional annual budgets have been criticised: it is

too rigid and based on uncertain forecasts.
• An alternative approach is to break down the budget by
months for the first three months, and quarters for the
remaining nine months.
• As the year proceeds, the quarterly budgets are
reviewed and then developed on a monthly basis.
• By adding and preparing a budget for a fifth quarter, a
12-month budget is always available as the quarter just
ended and is dropped – continuous/rolling planning
Criticism of Budgeting
• Encouraging rigid planning and incremental

thinking;
• Being time-consuming;
• Producing inadequate variance reports leaving
the ‘how’ and ‘why’ questions unanswered;
• Ignoring key drivers of shareholders value by
focusing too much attention on short-term
financial numbers;
• Being yearly rigid ritual;
Criticism of Budgeting
• Tying the company to a 12-month

commitment, which is risky since it is
based on uncertain forecasts;
• Meeting only the lowest targets and not
attempting to beat the targets;
• Spending what is in the budget even if
this is not necessary in order to guard
against next year’s budget being
reduced;
a nk
T h
u!
yo
Reading List
• Drury, C. (2015), Management & Cost

Accounting, 9th Edition, Chapter 15

Week 4 Lectures: Budgeting For Planning and Control

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Faculty of Management

Bournemouth University Business School

Week 4 Lectures: Budgeting for

By the end of this unit

• A budget is a quantitative expression of a

• The first step therefore must be determining

Evaluate Decision Implement

• Budgets are tools that by themselves are neither

• In order to use budgets as control mechanisms,

• Preparation of a budget requires a number steps:

• Given below are the main different types

• The sales budget shows projected sale

• You are required using the information

Add : Closing stock X

= Quantity needed 2 100 3 650 2 050

1 100 2 150 1 550

• TT Company is a distributor of lawnmowers. The following

April(£) May (£) June (£)

• Sales on account are collected over a three-month period in the

[a] Prepare a schedule of expected cash

a). Schedule of cash collections (Sales) as far as June is

June sales = £360 000

b. Schedule of cash payments to suppliers as far as

Total cash payments in June

• Units xSelling price = Total Sales

The following information is an extract from PK Plc Sales

Budgeted Sales 10,000 30,000 40,000 20,000 100,000

Total Sales (£) 200,000 600,0000 800,000 400,000 2,000,000

1st quarter sales 140,000 60,000 0 0 200,000

2nd quarter sales 420,000 180,000 0 600,000

3rd quarter sales 560,000 240,000 800,000

Total Cash 230,000 480,000 740,000 520,000 1,970,000

• The following information is an extract from PK Plc Sales Ledger

Budgeted Sales 10,000 30,000 40,000 20,000 100,000

Total Sales (£) 200,000 600,0000 800,000 400,000 2,000,000

Budgeted Sales 10,000 30,000 40,000 20,000 100,000

Add closing inventory 6,000 8,000 4,000 3,000 3,000

16,000 38,000 44,000 23,000 103,000

Less opening inventory 2,000 6,000 8,000 4,000 2,000

Production 14,000 32,000 36,000 19,000 101,000

Direct material cost:

i) Quantity of Materials/unit X production required

ii) Total Quantity of materials X price per unit

• PK plc has as policy to maintain raw materials at 10% of

• Prepare a direct materials budget and expected cash

Required Production 14,000 32,000 36,000 19,000 101,000

Raw materials needed (kg) 15 15 15 15 15

Production (kg) 201,000 480,000 540,000 285,000 1,515,000

Add closing inventory 48,000 54,000 28,500 22,500 22,500

Quantities to be purchased 237,000 486,000 514,500 279,000 1,516,500

Cost/unit raw materials (£) 0.20 0.20 0.20 0.20 0.20

47,400 97,200 102,900 55,800 303,300

1st quarter sales 23,700 23,700 0 0 47,400

2nd quarter sales 48,600 48,600 0 97,200

3rd quarter sales 51,450 51,450 102,900

Total Cash 49,500 72,300 100,050 79,350 301,200

• Direct labour cost:

• i) Production units X direct labour hours

• ii) Total direct labour hours X Direct labour

• Using the information provided in example 1

Production units 14,000 32,000 36,000 19,000 101,000

Direct labour hours 0.40 0.40 0.40 0.40 0.40

Total labours hours 5,600 12,800 14,400 7,600 40,400