Chapter08.ppt/Management Accounting Budgeting

© McGraw-Hill Education (UK) Limited 2013
Traditional
Budgeting
Chapter 8
1

• LO1 To explain the nature of a budget
• LO2 To be able to discuss the process of budgeting
• LO3 To analyse the functions of budgets within
various contexts
• LO4 To prepare functional budgets
• LO4 To appreciate the devolved nature of
budgeting systems
• LO6 To critically analyse the human behaviour
aspects of budgeting
• LO7 To explain the various roles of the budget
Learning Outcomes
2

• Today’s lecture will focus on traditional
budgeting
• Budgets are part of the management
accounting control system
• It is essential for all managers to understand
the budget
Introduction
3

• A budget is a financial plan which considers income
and expenditure
• Budgeting can be formal or informal depending on
the nature of what you want from the budget
• The CIMA ( 2009) survey demonstrated that
budgeting was the most commonly used
management accounting tool, for companies of all
sizes, industries and sectors
What is budgeting?
4

• All organizations will have their own budgeting
process and this will be determined by their size,
industry and sector
• However, in general there is a logical path when
creating a budget
• There are two alternative ways to create budgets:
– Top down
– Bottom up
The budgeting process
5

6
Summary of the budgeting process

Setting Objectives:
Every organisation has a strategy and from this they
will set objectives.
It is important for each organisation to have clear
objectives before they begin the budgeting process,
providing an opportunity for resources to be placed
in areas where they will achieve the desired goals.
External factors that relate to strategies must be
incorporated
7

Analysing resources :
The resources of an organization are analysed
so that a master budget can be created.
The company will use past master budgets
and variance reports to formulate the
predicted cash budget, income statement and
statement of financial position, which are
created through the use of functional budgets.
8

Negotiating operational requirements :
This process includes the operational needs of
the various departments, processes or units.
The negotiation process will be dependent on
the type of organization you work within.
9

Co-ordinating resources:
The budget committee, (if the organization is
large enough to have one) or a manager/
management accountant if not, will co-ordinate
the resources and needs of the organization.
10

Obtaining approval:
The approval stage will be dependant once
again on the size and nature of the
organization.
It can be a process for the accountant, or the
owner agreeing the budgets. In larger
organizations it can be a budget committee.
11

• Distributing budgets – the final stage
communicates the approved budgets to the
relevant managers.
12

• Functional budgets are day-to-day operational
budgets which focus on specific functions or
aspects of a process or service.
Functional budgets
13

Functional budgets
14
Relationship of the functional budgets and predicted
financial statements

• We will now go through the preparation of functional
budgets which will create the master budget.
Worked example:
Alehouse Rock Limited manufactures metal vats, of a
single capacity, for the distilling industry. The
company’s one model is named the ‘Deepdraft’. The
following information relates to the preparation of
the budget for the year to 31 July 201X.
Functional budgets
15

1) Sales budget details for the ‘Deepdraft’.
Expected selling price per vat: £200
Expected sales: 10,000 vats
All sales are proposed to be on credit terms.
2) Each ‘Deepdraft’ produced requires 5kgs of copper and 10kgs
of aluminium.
3) The purchasing director has forecast that copper is expected
to cost £6.00 per kg and aluminium £8.00 per kg. The
company’s purchasing director also intends to purchase all
metals on credit terms.
Functional budgets
16

4) Two departments are involved in the
manufacture of the ‘Deepdraft’;‘ Pressing’ and
‘Machining and Finishing’.
5) The production director has provided the
following relevant information:
Functional Budgets
17
Direct labour hours per
‘Deepdraft’
Direct labour rate per
hour
Pressing 1.00 £12.00
Machining and finishing 0.50 £16.00

6) The finishing production overhead costs are
expected to amount to £200,000.
7) At 1 August 201X, 800 completed vats of
‘Deepdraft’ are expected to be in inventory at a
value of £104,000.
8) 4,500kgs of copper at a value of £27,000, and
12,000kgs of aluminium at a value of £96,000 are
also expected to be held in inventory.
Functional Budgets
18

9)The production director has requested that the
inventory of both finished goods and raw
materials, throughout the budget period, should
be planned to be 10% above the expected
opening inventory levels as at 1 August 201X.
10) Administration, selling and distribution
overhead is expected to amount to £300,000 for
the budget period.
Functional Budgets
19

11) Other relevant information provided to the
company’s budget committee is as follows:
[a] Opening accounts receivable are expected to be
£160,000. Closing accounts receivable are expected to
amount to a sum equivalent to 15% of the budgeted total
sales for the year.
[b] Opening accounts payable are expected to be
£56,000. Closing accounts payable are expected to
amount to a sum equivalent to 10% of the purchases for
the year.
[c] All other expenses will be paid in cash during the
year.
Functional Budgets
20

[d] Other balances from the previous Statement of
Financial Position are as follows:
Functional Budgets
21
£ £
Share Capital: ordinary
shares
450,000
Retained profits 35,000
Proposed dividend 150,000
Non-current assets at cost 500,000
Less accumulated
depreciation
(200,000) 300,000
Cash at bank and in hand 4,000

12) Capital expenditure for the year is expected
to amount to £100,000 payable in cash on 1
August 201X.
13) Non-current assets are depreciated on a
straight line basis at a rate of 20% per annum
on cost.
Prepare the required functional budgets.
Functional budgets
22

• Student task: examine the worked example
question and write a list of all the functional
budgets you think should be prepared.
Functional budgets
23
Functional budgets: Functional budgets:
Sales Production quantity
Direct material usage Direct materials purchase
Direct labour hours usage Direct labour cost budget
Fixed production overhead Value of Closing raw material inventory
Value of closing inventory of finished
units
Admin, selling and distribution
Capital expenditure Cash budget

Functional budgets
24
Step 1: Prepare the Sales Budget

Functional Budgets
25
Step 2: Prepare the Production Quantity Budget

Functional Budgets
26
Step 3: Prepare the Direct Materials Usage Budget

Functional Budgets
27
Step 4: Prepare the Direct Materials Purchase Budget

Functional Budgets
28
Step 5: Prepare Direct Labour Hours Usage Budget

• Student task:
• Prepare a direct labour hours usage budget
Functional budgets
29

Functional Budgets
30
Step 6: Direct Labour Cost Budget

Functional Budgets
31
Step 7: Prepared Fixed
Production Overhead Budget

Functional Budgets
32
Step 8: Calculate the value of the Budgeted
Closing Raw Material Inventory

Functional Budgets
33
Step 9: Calculate the value of Closing Inventory
of finished units of ‘Deepdraft’

Functional Budgets
34
Step 10: Prepare the Administration, Selling
and Distribution Budgets

Functional Budgets
35
Step 11: Prepare the Capital
Expenditure Budgets

Functional Budgets
36
Step 12: Calculate the costs of
‘Deepdrafts’ sold

Functional Budgets
37
Step 13: Prepare the Cash Budget

Functional budgets
38
Step 14: Prepare the Budgeted Income Statement
• You can now see the relationship to the
predicted Income Statement:

• You can now see the relationship to the
predicted Statement of Financial Position:
Functional Budgets
39
Step 15: Prepare the Budgeted Statement of Financial Position

• There are five distinct roles of budgeting:
– Planning
– Communication
– Co-ordination
– Motivation
– Control
– Of course not ALL organizations will use budgets
for every role, they will select the roles that relate
to the needs of the company.
Different roles for budgeting
40

Planning:
Organizations that have money to invest in
new projects may use budgets to model the
financial outcome or effectiveness when
choosing a particular option.
Budgets are used to plan ahead and analyse
the financial position of a company one, two
and sometimes fifteen years ahead.
41

Communication:
Communication within large organizations can
often be neglected.
A budget can provide a means of fostering
communication across the organization, by
ensuring employees and managers both
understand the goals of the organization.
42

Co-ordination:
Using a master budget provides a structured
framework for the financial needs of the
whole organization.
Co-ordinating through the use of budgets can
result in resources being effectively used in
the right areas.
43

Motivation:
If budgets are used appropriately they can be
motivational.
Motivational benefits depend on whether the
budgets are viewed as a threat or as a
challenge.
44

Control:
Organizations that use budgets to monitor
performance are using the budget as a control device
Setting targets at the beginning of the year and
assessing how the individual managers have
performed that year by using variance analysis
Used incorrectly, this technique can in fact de-
motivate employees and managers
45

• Budgeting does not always achieve what it
sets out to, there are many well documented
problems of budgeting, such as:
–Game playing
–De-motivating
–Budgetary slack
–Time consuming
46

• The focus of a budget will depend on:
–The role of the budget
–The time span of the budgeted period, this
can be short term, medium term or long
term
Focus of budgets
47

• Budgets are no longer the sole responsibility
of the accountant.
• Over the past two decades the budget has
been devolved to the responsibility of
individual managers in many organizations.
• Most system are now automated.
Budget (systems) automation and devolved
responsibilities
48

• Traditional budgets are still used in the majority of
organizations.
• There is a logical process of preparing budget but this
varies depending on the nature of the organization.
• Functional budgets provide operational help to maintain
control.
• The role of budget is also dependent on the needs of the
organization.
Summary
49

• CIMA (2009) Management Accounting tools
for today and tomorrow. www.cimaglobal.com
References
50

Chapter08.ppt/Management Accounting Budgeting

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