BUDGETING CIMA official terminology defines budget as a “plan expressed in money. It is prepared and approved prior to the budget period and may show income, expenditure and the capital to be employed”. It could also be defined as ‘a quantified plan of action relating to a given period of time’. PURPOSES OF BUDGETINGBudgets have two main roles:

(a)They act as authorities to spend, that is, they give authority to budget managers to incur expenditure in their part of the organization.

(b)They act as comparators for current performance, by providing a yardstick against which current activities can be monitored, and they may be used targets to motivate managers.

Other Purposes are;i. PlanningPlanning is necessary for doing any work in a systematic manner. A well- prepared plan helps the organization to use the scarce resources in an efficient manner and thus achieving the predetermined targets becomes easy. A budget is always prepared for future period and it lays down targets regarding various aspects like purchase, production, sales, manpower planning etc. This automatically facilitates planning.

ii. Evaluation of performanceA manager’s performance is often evaluated by measuring his or her success in meeting the budgets. In some companies bonuses are awarded on the basis of an employee’s ability to achieve the targets specified in the periodic budgets, or promotion may be partly dependent upon a manager’s budget record. In addition, the manager may wish to evaluate his or her own performance. The budget thus provides a useful means of informing managers of how well they are performing in meeting target that they have previously helped to set.

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iii. Co-coordinating activitiesThe activities of different departments or sub-units of the organization need to be coordinated to ensure maximum integration of efforts towards common goals. For achieving the predetermined objectives, apart from planning, coordinated efforts are required. Budgeting facilitates coordination in the sense that budgets cannot be developed in isolation This concept of coordination implies, for example, that the purchasing department should base its budget on production requirement and that the production budget should in turn be based on sales expectations..

iv. Implementing plansv. ControlPlanning is looking ahead while controlling is looking back. Preparation of budgets involves detailed planning about various activities like purchase, sales, production, and other functions like marketing, sales promotion, manpower planning. But planning alone is not sufficient. There should be a proper system of controlling which will ensure that the work is progressing as per the plan. Budgets provide the basis for such controlling in the sense that the actual performance can be compared with the budgeted performance.

vi. CommunicatingIf an organization is to function effectively, there must be definite lines of communication so that all the parts will be kept fully informed of the policies, and constraints, to which the organization is expected to conform. Everyone in the organization should have a clear understanding of the part they are expected to play in achieving the annual budget. This process will ensure that the appropriate individuals are made accountable for implementing the budget. Through the budget, top management communicates its expectations to lower level management, so that all members of the organization may understand these expectations and can coordinate their activities to attain them. It

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is not just the budget itself that facilitates communication- much vital information is communicated in the actual act of preparing it.

vii. MotivatingThe interest and commitment of employees can be retained via a system of feedback of actual results, which lets them know how well or badly they are performing. The identification of controllable reasons for departures from budgets with managers responsible provides an incentive for improving future performance.

viii. Provides a framework for authorization Once the budget has been agreed by the directors and senior managers it acts as an authorization for each budget holder to incur the costs included in the budget center’s budget. As long as the expenditure is included in the formalized budget the budget holder can carry out day to day operations without needing to seek separate authorization for each item of expenditure.

REASONS FOR THE PREPARATION OF BUDGETSi. To compel planning:-Planning forces management to look ahead, set

targets, anticipates problems and the organization purpose and directions.

ii. To communicate ideas and plans to everyone affected by them. This will ensure that each one is aware of what is expected of him.

iii. To co-ordinate the activities of different departments or sub-unit of the organization. For instance, the purchasing department should base on sales expectations.

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iv. To provide a framework for responsibility accounting whereby managers of budget centers are made responsible for the achievement of budget targets for the operations under their personal control.

v. To establish a system of control:-Budgetary control usually involves the feedback of actual results for comparism against the budget plan.

vi. To motivate employees to improve their performance.

Benefits of BudgetingBudgeting plays an important role in planning and controlling. It helps in directing the scarce resources to the most productive use and thus ensures overall effi ciency in the organization. The benefits derived by an organization from an effective system of budgeting can be summarized as given below.

i. Budgeting facilitates planning of various activities and ensures that the working of the organization is systematic and smooth.

ii. Budgeting is a coordinated exercise and hence combines the ideas of different levels of management in preparation of the same.

iii. Any budget cannot be prepared in isolation and therefore coordination among various departments is facilitated automatically.

iv. Budgeting helps planning and controlling income and expenditure so as to achieve higher profitability and also act as a guide for various management decisions.

v. Budgeting is an effective means for planning and thus ensures sufficient availability of working capital and other resources.

vi. It is extremely necessary to evaluate the actual performance with predetermined parameters.

vii. Budgeting ensures that there are well-defined parameters and thus the performance is evaluated against these parameters.

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viii. As the resources are directed to the most productive use, budgeting helps in reducing the wastages and losses.

Stages in the Budgeting Process1. Communicating details of budget policy and guidelines to those

people responsible for the preparation of budgets2. Determining the factor that restricts output3. Preparation of sales budget4. Initial preparation of the various budgets5. Negotiation of budgets with superiors 6. Coordination and review of budgets7. Final acceptance of budgets8. Ongoing review of budgets

Types of Budgets

i. Functional or Departmental Budgets: - They are the budgets for the various functions and departments of an organization. Examples are production budgets, sales budgets, purchasing budgets and research and development budgets.

ii. Master Budgets: - When all the functional budgets have been prepared, they are summarized and consolidated into a master budget which consists of the budgeted profit and loss accounts. Balance sheet and Cash budget and these provided the overall picture of the planned performance for the budget.

iii. Fixed Budgets: - It is a budget which is designed to remain unchanged regardless of the volume of output or sale. Master budgets are examples of fixed budgets as they are prepared on an anticipated volume of production and sales with no plans made for the situation that, actual volumes of productions and sales with no plans made for

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the situation that, actual volumes of productions and sales may be different from planned levels.

iv. Flexible Budgets: - Is a budget which by recognizing different cost behavior patterns is designed to change as volumes of output changes. At the planning stage, a fixed master budget would be prepared to cover the most probable level of activity but a contingency flexible budget would be also prepared to cover all the other possible levels of activities. It must be noted that, flexible budget uses the principle of marginal costing.

v. Continuous or Rolling Budgets: - It is a budget which is continuously updated by adding further accounting period (a month or quarter) when the earlier accounting period has expired.

vi. Cash Budgets: - It is a detailed budget of cash inflows and outflows incorporating both revenue and capital items. The objective of a cash budget is to ensure that sufficient cash is available at all times to meet the level of operations that are outlined in various budgets.

vii. Departmental Budget For cost control the direct labour budget, materials usage budget and factory overhead budget are combined into separate departmental budgets. These budgets are normally broken down into twelve separate monthly budgets and the actual monthly expenditure is compared with the budgeted amounts for each of the items concerned

Methods used in BudgetingThere are two main methods used in budgeting and these are:

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i. Incremental Budgeting: - Is a traditional approach to budgeting and involves basing next year’s budget on the current year’s result plus an extra amount for estimated growth or inflation for the budget year.

ii. Zero Based Budgeting: - It involves preparing a budget for each cost centre from a zero base. Every item of expenditure has to be justified in its totality in order to be included in the next year’s budget. This approach requires that all activities are justified and prioritized before decisions are taken relating to the amount of resources allocated to each activity. In incremental budgeting or traditional budgeting, previous year’s figures are taken as base and based on the same the budgeted figures for the next year are worked out. Thus the previous year is taken as the base for preparation of the budget. However the main limitation of this system of budgeting is that an activity is continued in the future only because it is being continued in the past. Hence in Zero Based Budgeting, the beginning is made from scratch and each activity and function is reviewed thoroughly before sanctioning the same and all expenditures are analyzed and sanctioned only if they are justified.

Benefits from Zero Based Budgeting ZBB facilitates review of various activities right from the scratch and a

detailed cost benefit study is conducted for each activity. Thus an activity is continued only if the cost benefit study is favorable. This ensures that an activity will not be continued merely because it was conducted in the previous year.

A detailed cost benefit analysis results in efficient allocation of resources and consequently wastages and obsolescence is eliminated.

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A lot of brainstorming is required for evaluating cost and benefits arising from an activity and this result into generation of new ideas and also a sense of involvement of the staff.

ZBB facilitates improvement in communication and co-ordination amongst the staff.

Awareness amongst the managers about the input costs is created which helps the organization to become cost conscious.

An exhaustive documentation is necessary for the implementation of this system and it automatically leads to record building.

Limitations of Zero Based Budgeting The following are the limitations of Zero Based Budgeting. It is a very detailed procedure and naturally if time consuming and lot

of paper work is involved in the same. Cost involved in preparation and implementation of this system is very

high. Morale of staff may be very low as they might feel threatened if a

particular activity is discontinued. Ranking of activities and decision-making may become subjective at

times. It may not advisable to apply this method when there are non-financial

considerations, such as ethical and social responsibility because this will dictate rejecting a budget claim on low ranking projects.

Preparation of Functional budgets:Under the functional budgets, the following budgets are opened:i. Sales Budget

A Sales Budget shows forecast of expected sales in the future period [the period is well-defined] and expressed in quantity of the product to be sold

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as well as the monetary value of the same. A Sales Budget may be prepared product wise, territories/area/country wise, customer group wise, salesmenwise as well as time wise like quarter wise, month wise, weekly etc. The following factors are taken into consideration while preparing a sales budget:

Analysis of past sales Estimates given by the sales staff Market Potential Analysis Dependent (demand) Factor

ii. Production Budget

This budget shows the production target to be achieved in the next year or the future period. The production budget is prepared in quantity as well as in monetary terms. Before preparation of this budget it is necessary to study the principal budget factor or the key factor. The principal budget factor can be sales demand or the production capacity or availability of raw material. The policy of the management regarding the inventory is also taken into consideration. The production budget is normally prepared for a period of one year and then broken down on monthly basis. Production targets are decided by adding the budgeted closing inventory in the sales forecast and subtracting the opening inventory from the total of the same. Production Cost Budget is prepared by multiplying the production targets by the budgeted production cost per unit. The following illustration will clarify the concept

iii. Direct Material Usage and Purchase Budget

This budget shows the quantity of materials to be purchased during the coming year. For the preparation of this budget, production budget is the starting point if it is the key factor. If the raw material availability is the key

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factor, it becomes the starting point. The desired closing inventory of the raw materials is added to the requirement as per the production budget and the opening inventory is subtracted from the gross requirements. This budget is prepared in quantity as well as in the monetary terms and helps immensely in planning of the purchases of raw materials. Availability of storage space, financial resources, various levels of materials like maximum, minimum, re-order and economic order quantity are taken into consideration while preparing this budget. A separate material utilization budget may also be prepared as a preparation of material purchase budget.

iv. Direct Labour Budget

The labor budget estimates the labor required for smooth and uninterrupted production. The labor budget shows the number of each type or grade of workers required in each period to achieve the budgeted output, budgeted cost of such labor, period wise and period of training necessary for different types of labor.

v. Factory Overhead Budget

This budget is prepared for planning of the factory overheads to be incurred during the budget period. In this budget the overheads should be shown department wise so that responsibility can be fixed on proper persons. Classification of factory overheads into fixed and variable components should also be shown in this budget

vi. Selling Administration Budget

This budget covers the administrative costs for non-manufacturing business activities. The administrative overheads include expenses like office expenses, office salaries, directors’ remuneration, legal expenses, audit fees, rent, interest, property taxes, postage, telephone, telegraph etc. These

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expenses should be classified properly under different headings to determine the responsibilities regarding cost control and reduction.

Preparation of Cash Budget:A cash budget is prepared to show the expected receipts of cash and payments of cash during the budget period. A cash budget is an estimate of cash receipts and cash payments prepared for each month. The annual cash budget will be divided into smaller time periods commonly of one month or four weeks. In this budget all expected payments, revenue as well as capital and all receipts, revenue and capital are taken into consideration. The main purpose of cash budget is to predict the receipts and payments in cash so that the firm will be able to find out the cash balance at the end of the budget period. This will help the firm to know whether there will be surplus cash or deficit at the end of the budget period. It will help them to plan for either investing the surplus or raise necessary amount to finance the deficit. Cash Budget is prepared in various ways, but the most popular form of the same is by the method of Receipt and Payment method. This method is illustrated in the following illustration.

Why is a cash budget important?1. Allows companies to predict possible cash shortages and take corrective action before a crisis occurs.2. Allows companies to see if large sums of excess cash are lying idle—could be put to better use.

Procedure involved in the preparation of a cash budget:i. Determine the actual receipts to be expected from sales.

ii. Prepare “a debtors and Creditors schedule” to derive expected cash to be collected from debtors and expected cash to be paid to Suppliers.

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iii. Determine the expected expenses to be incurred and must be noted that all expenses in this case are cash item.

iv. Adjust any item that is not a cash item because the cash budget does not take into consideration non-cash items such as depreciation, profit or loss on the disposal of fixed assets, notional expenses, provision for bad debts etc.

Question 1a) Briefly explain the following concepts as used in budgeting:

i. Rolling budgetii. Fixed budget iii. Budget manualiv. Functional or Departmental Budgetsv. Master Budgetsvi. Flexible Budgets

vii. Cash Budgetsb) Distinguish between the following three different types of planning :

i. Strategic planningii. Budgetary planning, andiii. Operational planning

Question 2Coulson industries, a defence contractor, is developing a cash budget for October, November and December. Coulson’s sales in August and September were GH¢100,000 and GH¢200,000 ,respectively. Sales of GH¢400,000 , GH¢300,000 and GH¢200,000 have been forecast for October , November and December , respectively. Historically, 20% of the firm’s sales have been for cash , 50% are generated accounts receivable collected after 1 month and the remaining 30% have generated accounts receivable collected after 2 months. Bad debt expenses ( uncollectible accounts ) have

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been negligible. In December , the firm will receive a GH¢30,000 dividend from stock in a subsidiary. • Purchases – The firms purchases represents 70% of sales. Of this

amount, 10% is paid in cash, 70% is paid in the month immediately following the month of purchase and the remaining 20% is paid 2 months following the month of purchase.

• Rent Payments – Rent of GH¢5000/month• Wages and Salaries – Fixed salary cost for the year is GH¢96,000, or

GH¢8000 per month. Wages are estimated as 10% of monthly sales.• Tax Payments – Taxes of GH¢25,000 must be paid in December.• Fixed-Asset Outlays – New machinery costing GH¢130,000 will be

purchased and paid for in November.• Interest Payments – An interest payment of GH¢10,000 is due in

December. • Cash Dividend Payments – Cash dividends of GH¢20,000 will be paid

in October.• Principal Payments (Loans) – A GH¢20,000 principal payment is due

in December.• Repurchases or Retirements of Stock – No repurchase or

retirement of stock is expected between October and December.

Question 3A company manufactures two products, A and B. Standard cost data for the products for the next year are as follows;

Product A per Unit Product B per Unit

Direct MaterialsX at GH 2 per Kg 24kg 30kgY at GH 5 per Kg 10kg 8kgZ at GH 6 per Kg 5kg 10kg

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Direct WagesUnskilled at GH3 per hour 10 hours 5 hoursSkilled at GH 5 per hour 6 hours 5 hours

Budgeted stocks for next year are as follows:

Product A (Units)Product B

(Units)01-Jan 400 80031-Dec 500 1100

Material X Material YMateria

l Z01-Jan 30000 25000 1200031-Dec 35000 27000 12500

Budgeted sales for the next year; Product A 2400 units. Product B 3200units.Prepare the following budgets for next year;a. Production budget, in unitsb. Material purchases budget, in kg and by valuec. Direct labour budget, in hours and by value

Question 4Given the information below, you are required to prepare the following budgets for Kek Ltd for the quarter July to September 2012;

i. Sales budget in quantity and value

ii. Production budget in units

iii. Raw materials usage budget in kgs

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iv. Raw materials purchase budget in kgs and value

v. Labour requirements budget in hours and value

The company manufactures product X which uses three different materials. The details are as follows;Selling price per unit GH¢ 500Material A 3 kgs material price GH¢7 per kgMaterial B 2 kgs material price GH¢10.00 per kgMaterial C 4 kgs material price GH¢9 per kgDirect labour 8 hours labour rate GH¢16 per hour

The following estimates of sales demand are made for the period July to October:July August September October800units 600units 1200units 900unitsIt is the company’s policy to hold stocks of finished goods at the end of each month equal to 50% of the following month’s sales demand, and it is expected that the stock at the start of the budget period will meet this policy.At the end of the production process, the products are tested: it is usual for 10% of those tested to be faulty. It is not possible to rectify these faulty units.Raw material stocks are expected to be as follows on 1 July:Material A 2000 kgsMaterial B 800 kgsMaterial C 1200 kgsRaw materials stocks are to be increased by 20% in July, and then remain at their new level for the foreseeable future. Labour is paid on an hourly rate based on attendance. In addition to the unit direct labour hours shown above, 20% of the attendance time is spent on tasks which support production activity.

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Question 5Gosky Plc is currently preparing its budgets for the year ending 30 th

September, 2011. The sales and production budgets have been completed and an extract from them is shown below:

Production Units

Sales Units

Sales Value

000 000 GH¢'000January 90 100 5000February 85 80 4000March 100 90 4500April 120 110 5500May 125 130 6500June 117.5 120 6000July 110 115 5750August * 105 5250

Budgeted production costs are:

GH¢/unitDirect materials 140Direct labour 120Variable overhead 60Fixed overhead* 80Production Cost 400

Fixed overheads are absorbed on a unit basis assuming a normal production level of 14million units per year.Direct material are purchased in the month of usage and, where settlement discounts are available, Gosky Plc’s policy is to pay suppliers so as to

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receive these discounts. It is expected that 60% of Gosky Plc’s material costs will be received from suppliers who offer a 2% discount for payment in the month of purchase. Other material suppliers are to be paid in the month following purchase.Direct labour costs are paid 75% in the month in which they are incurred, and 25 % in the following month. Variable overhead costs are paid in the month in which they are incurred. Fixed overhead costs include GH¢16m depreciation. Fixed overhead expenditure accrues at a constant rate throughout the year and is paid 40% in the month in which it is incurred and 60% in the following month.

In addition to production costs, Gosky Plc expects to incur administration overhead costs of GH¢500,000 per month and selling overhead costs of 2% of sales value. These costs are to be paid in the month in which they are incurred.Gosky Plc’s customers are expected to pay for items as follows:

In the month of sale 20% In the month after sale 55% In the month two after sale 15% In the month three month after sale 5%

Customers paying in the month of sale are given 1% discount. 5% of sales are expected to be bad debts.In addition to the above, Gosky Plc expects that:

New machinery is to be acquired on 1st February, 2011, costing GH¢15m. This is to be paid for in May 2011.

Corporation tax of GH¢15m will be payable in June 2011 A dividend of GH¢ 9m will be paid to shareholders in July 2011 The bank balance at 1st April 2011 will be GH¢20m.

Required:

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Prepare Gosky’s cash budget for the period April-July 2011, showing clearly the receipts, payments and the resulting balances for each month.

Question 6Jireh Fabrication Company is in the process of preparing the cash budget for the last four months of 2010 that is September to December. The following information has been made available.

i. Projected sales Sept. Oct. Nov. Dec.Quantity (units) 60000 65000 65000 70000

ii. Selling price is GH¢10 per unit but expected to drop by 5% from 1st November.

iii. Payment for goods sold is as follows; 20% in the month of sales, 60% the following month after sales and the balance in the second month after sales. Bad debt is estimated at 2% of sales value.

iv. Purchases of goods at GH¢6 per unit are as follows: September 70000 units, October 70000units, November 72000 units and December 65000 units.

v. Goods purchased are paid one month in arrears.vi. Monthly expenses estimated at 12% on sales revenue are paid in

the month of incurrencevii. The company plans to buy a delivery van at GH¢270000, 40% of

the cost to be paid in October and the balance in January 2011.viii. The Director withdraws GH¢20000 monthly for personal expenses.ix. Extracts from August figures are as follows:

a. Debtors GH¢460000 out of which GH¢100000 is part of July sales before bad debt

b. Creditors for goods GH¢200000c. Cash GH¢70000

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Required:Prepare Monthly cash budget for the four months ending December 2010

Question 7Watson Ltd is preparing its budgets for the next quarter. The following information has been drawn from the budgets prepared in the planning exercise so far.

Sales Value June (estimate) GH12500July(budget) GH13600August GH17000September GH16800

Direct wagesGH 1300 per month

Direct Material purchases June (estimate) GH3450

July(budget) GH3780August GH2890September GH3150

Watson sells 10 percent of its goods for cash. The remainder of the customers receive one month’s credit

Payments to creditors are made in the month following purchase Wages are paid as they are incurred Watson takes one month’s credit on all overheads Production overheads are GH3200 per month Selling and distribution and administration overheads amounts to

GH1890 per month Included in the amounts for overhead given above are depreciation

charges of GH300 and GH190 respectively

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Watson expects to produce a delivery vehicle in August for a cash payment of GH9870

The cash balance at the end of June is forecast to be GH1235Prepare a cash budget for each of the months July to September

Question 8Den Ltd is an agro processing company situated in the Nsawam area. The company is preparing its budget for the first three months of 2013 and has approached you for assistance. The following is available:

i. Information extracted from the Sales budget are as follows: GH¢

November 2012 320,000December 2012 360,000January 2013 300,000February 2013 400,000March 2013 400,000

ii. Debtors settle according to the following pattern:-

70% within the month of sale20% in the month following10% in the second month after sales

iii. Extracts from the Purchases budget were as follows: GH¢

December 2012 240,000January 2013 200,000February 2013 200,000March 2013 240,000

All purchases are on credit. 90% are settled in the month following purchase and the balance settled in the second month after purchase.

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iv. Wages are expected to be as follows: GHC

January 2013 260,000February 2013 310,000March 2013 320,000

These are to be paid one month in arrears.

v. Electricity of GH¢4,000 per month is to be paid one month in advance.

vi. Corporate tax GH¢200,000 is expected to be paid in March 2013.vii. The company will receive settlement of an insurance claim of GH

¢10,000 in March 2013.viii. Overheads are expected to be GH¢250,000 every month. (This

includes depreciation of GH¢10,000).ix. The company has an overdraft facility with GCB Bank Ltd for the

purpose of its day to day operations up to GH¢1000,000.Required:

Prepare a monthly cash budget for the first quarter of 2013.Question 9A redundant manager who received compensation of GH¢80000 decides to commence business on 4th January year 8, manufacturing a product for which he knows there is ready market. He intends to employ some of his former worker who were also made redundant but they will not all commence on 4th January. Suitable premises have been found to rent. Material stocks costing GH¢10,000 and second-hand machinery costing GH¢60,000 have already been bought out of the GH¢80,000. The machinery has an estimated life of five years from January year 8 and no residual value. Other data is as follows;

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i. Product will begin on 4th January and 25 percent of the following month’s sales will be manufactured in January. Each month thereafter the production will consist of 75 percent of the current month’s sales and 25 percent of the following month’s sales

ii. Estimated sales are;

Units GH¢January 0 0February 3200 80,000March 3600 90,000April 4000 100,000May 4000 100,000

iii. Variable production cost per unit;

GH¢Direct Material 7Direct wages 6Variable Overhead 2

15iv. Raw material requirements for January’s production will be met

from the stock already purchased. During January, 50 percent of the material required for February’s production will be purchased. Thereafter it is intended to buy, each month, 50percent of the materials required for the following month’s production requirements the other 50 percent will be purchased in the month of production.

v. Payments for raw material purchases will usually be made 30 days after purchase, but it will be possible to delay payment if necessary for another month. The manager does not intend to use business’s credit rating. 10 percent of the business’s purchases will be

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eligible for a 5 percent discount if payment is made immediately on delivery.

vi. Direct workers have agreed to have their wages paid into their bank accounts on the seventh working day of each month in respect of the previous month’s earnings

vii. Variable production overhead; 60 percent is to be paid in the month following the month it was incurred and 40 percent is to be paid one month later

viii. Fixed overheads are GH¢4000 per month. One-quarter of this is paid in the month incurred, one-half in the following month, and the remainder represents depreciation on the second-hand machinery.

ix. Amounts receivable; a 5 percent cash discounts is allowed for payment in the current month and 20 percent of each month’s sales qualify for this discount. 50 percent of each month’s sales are received in the following month, 20 percent in the third month and 8 percent in the fourth month. The balance of 2 percent represents anticipated bad debts.

x. The manager’s intended cash policy is to maintain a minimum month-end cash balance of GH¢5000. If cash balances are likely to be lower than this then supplier payments will be delayed as described above

Prepare a cash budget for each of the first three months of the year 8, taking account of the requirement to maintain a minimum month-end cash balance of GH¢ 5000. All calculations should be made to the nearest pound.

Question 10Ama has been working as a Makola business woman for many years without obtaining finance from a bank. She intends starting another business from

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her own working capital, using GH¢300,000. She maintains an account with a Bank with a minimal balance and intends to approach the bank for the necessary additional finance.

She asks you for advice and provides the following additional information.i. Arrangements have been made to purchase fixed assets costing GH

¢160,000. These will be paid for at the end of September and are expected to have a five year life, at the end of which they will possess a nil residual value.

ii. Stocks costing GH¢100,000 will be acquired on 28th September and subsequently monthly purchases will be at a level sufficient to replace forecast sales for the month.

iii. Forecast monthly sales are GH¢60,000 for October, GH¢120,000 for November and December, and GH¢210,000 from January 2010 onwards.

iv. Selling price is fixed at the cost of stocks plus 50%v. Two month’s credit will be allowed to customers but one month’s

credit will be received from suppliers of stock.vi. Running expenses, including rent but excluding depreciation of

fixed assets are estimated at GH¢32,000 per monthvii. She intends to make monthly cash drawings of GH¢20,000

RequiredPrepare a cash budget for six months to 31st March, 2010

Question 11Gloryland Ltd is preparing its annual budgets for the year to 31st December, 2013. The company manufactures and sells one product called, “DON”. The product currently sells for GH¢300 but the results of a survey conducted by

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the marketing department suggest that the price will increase to GH¢320 with effect from 1 July 2013. At this price the sales volume for each quarter of 2013 will be as follows;

Sales volumeQuarter 1 80000Quarter 2 100000Quarter 3 60000Quarter 4 90000

Sales for each quarter of 2014 are expected to 80000units.This forms the basis for the calculation of the closing stock in the last quarter. Each unit of the finished product which is manufactured requires four (4) units of component D and three (3) of component O, together with a body shell N. These items are purchased from an outside supplier. Their current selling prices are as follows:

GH¢Component D 16 eachComponent O 10 eachShell N 60each

The prices of the components are expected to increase by 20% with effect from 1 April 2013; no change is expected in the price of the shell.Assembling the shell and the components into the finished product requires 12 labour hours: labour is currently paid GH¢ 10 per hour. A 8 % increase in wage costs is anticipated to take effect from 1 October 2013.Variable overheads costs are expected to be GH¢20 per unit for whole of 2013; fixed production overheads are GH¢480,000 for the year, and are absorbed on per unit basis. Stocks on 31st December 2012 are expected to be as follows;

Finished units 18000units

Component D 6000 units

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Component O 11000 unitsShell N 1000units

Closing stocks at the end of each quarter are to be as follows;

Finished units 10% of the next quarter's salesComponent D

20%of the next quarter's production requirements

Component O

15% of the next quarter's production requirements

Shell N10%of the next quarter's production requirements

Required:Prepare for Gloryland Ltd the following budgets for the year ending 31st

December 2013 showing values for each quarter and the year total;a. Sales budget (in units and cedis)b. Production budget (in units)c. Material usage budget (in units)d. Overheads costs budgete. Labour cost budget (in cedis)f. Production cost budget ( in cedis)

Preparing a Master BudgetThe muster budget is a detailed and comprehensive analysis of the first year of the long range plan. It quantifies targets for sales, purchases, production, distribution, and financing in the form of forecasted financial statements and supporting operating schedules. These schedules provide detailed information beyond what appears in the forecasted financial statements. Thus, the master budget includes forecasts of sales, expenses, balance sheets, and cash receipts and disbursements. Many companies break

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A master budget helps you to plan and coordinate all of the different budgets needed to run an enterprise. It includes budgets for sales, production or purchases, selling and administrative expenses, an income statement, a cash flows statement and a balance sheet. In the budgeting process, the master budget provides a single map explaining how the company intends to earn profits and positive cash flow for the coming period. It also helps different parts of a business to coordinate their activities so that together they can meet the overall goals of the business.

Components of the Master Budget The master budget is the set of budgeted financial statements and supporting schedules for the entire organization.1. The operating budget 2. The capital expenditures budget3. The financial budget

The operating budget is the set of budgets that project sales revenue, cost of goods sold, and operating expenses, leading to the budgeted income statement that projects operating income for the period. The first component of the operating budget is the sales budget, the cornerstone of the master budget. Why? Because sales affect most other components of the master budget. After projecting sales revenue, cost of goods sold, and operating expenses, management prepares the end result of the operating budget: the budgeted income statement that projects operating income for the period. The second type of budget is the capital expenditures budget. This budget presents the company’s plan for purchasing property, plant, equipment, and other longterm assets. The third type of budget is the financial budget. Prior components of the master budget, including the budgeted income statement and the capital expenditures budget, along with plans for raising cash and paying debts, provide information for the first element of the financial budget: the cash budget. The cash budget details how the business expects to go from the beginning cash balance to the desired ending cash balance and feeds into the budgeted balance sheet, which, in turn, feeds into the budgeted statement of cash flows. These budgeted financial statements look exactly like ordinary statements. The only difference is that they list budgeted (projected) amounts rather than actual amounts.

Steps Involved in the Preparation of a Master BudgetStep 1. Project salesStart the budgeting process by estimating sales. Go to the sales or marketing department and request anticipated sales for the coming period. This estimate could be based on economic projections, consultants' reports, or a simple analysis of trends in prior years.

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Step 2. Plan productionFigure out the number of units of each product that you need to produce, using the following formula:Expected sales (in units) + Desired ending inventory (in units) - Beginning inventory (in units) = Units to be produced. This assumes that you're a manufacturer. If you're a retailer that doesn't produce its goods, then use a similar formula to estimate the number of units that need to be purchased;Expected units to be sold + Desired units of ending inventory - Units of beginning inventory = Units to be purchased. Multiply the number of units to be produced (or purchased) by the cost per unit to figure out the total cost of units to be produced (or purchased). Manufacturers can skip to Step 6.

Step 3. Set materials purchasesOnce you know how many units you plan to produce, it's time to figure out how much direct material you need to purchase. Find out how many units of direct materials are needed for each unit to be purchased. For example, if you make cheese, then producing a single wheel of cheese might require two gallons of milk. This is the Units required for production.

Units required for production + Desired units of desired ending inventory of direct materials - Units of beginning inventory of direct materials = Units of direct materials to be purchased.

Step 4. Design labor budgetThe direct labor budget estimates how much work must be done to meet your production plans, and the number of employees needed. To figure out the direct labor budget, ascertain (1) how many hours of direct labor are needed to produce each unit and (2) the average direct labor rate. Multiply both these factors by the number of Units to be produced that you estimated in the Step 2 Production budget:Hours needed to produce each unit x Average direct labor rate x Units to be produced = Total direct labor costs.To figure out the number of employees needed, divide total hours to be worked by the number of hours worked per week: (Hours needed to produce each unit x Units to be produced) / Average number of hours worked per week by each employee = Number of employees needed for production.

Step 5. Plot overheadTo prepare the Overhead budget, multiply the number of Units to be produced by the Variable overhead cost per unit. Then add Total fixed overhead cost:

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(Units to be produced x Variable overhead cost per unit) + Total fixed overhead = Total overhead.

To estimate the Variable overhead cost per unit and Total fixed overhead, account analysis, a scattergraph of overhead, the high-low method, or regression analysis will help you understand the relationship between overhead costs and volume.

Step 6. Estimate selling and administrative expensesSales don't happen automatically. You need to pay for sales agents, advertising, and other marketing costs. All of these estimated costs are tabulated in the Selling and administrative expense budget.

Step 7. Lay out a capital acquisitions budgetFactory equipment requires careful maintenance and occasionally replacement. You may also need to add more equipment to make the needed number of Units to be produced. Therefore, set up a capital acquisitions budget that includes the cost of any new equipment or property that needs to be purchased during the coming period.

Step 8. Budget an income statementBased on all of the information in the prior steps, you should be able to project an income statement for the coming period. This will follow the basic formula for net income: Sales - Cost of goods sold - Other expenses = Net income. Sales come from the Sales budget (Step 1). To estimate cost of goods sold, multiply the number of units expected to be sold (see Step 1) by the estimated cost per unit (a sum of Steps 3, 4, and 5). Other expenses include Selling and administrative expenses (see Step 6), general expenses, depreciation expenses, and also income tax expenses. When complete, the budgeted income statement answers a critically important question: Will your company be profitable next year? If you're dissatisfied with the estimated profits, then you may need to go back to Step 1 and rework your numbers.

Step 9. Formulate a budgeted cash flows statementA budgeted cash flows statement adds all of the expected cash receipts and subtracts the disbursements for the coming period. Cash receipts come from sales - but be careful! Don't list the sales themselves, but the cash flows from sales. This means adjusting for the rate at which you collect payment for your sales. Cash disbursements need to be made for purchases of raw materials (Step 3), direct labor (Step 4), overhead costs (Step 5), selling and administrative expenses (Step 6), and capital acquisitions (Step 7). Note that cash payments for these costs usually vary from the amounts of costs themselves. Even though you purchase $1,000,000 worth of raw materials next year doesn't mean that you pay your supplier exactly this

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amount next year.

Once complete, your budgeted cash flows statement will indicate whether you will have enough cash for the coming period. If you will, then great. If not, then you either need to revise your plans so that you have enough cash to fund them, or find more cash, by borrowing more money or raising capital from investors.

Step 10. Bring down a budgeted balance sheetThe budgeted balance sheet is based on the following formula: Assets = Liabilities + Stockholders' Equity

It explains how the business plan for the coming period will affect the company's finance position at the end of that period. Budgeting starts with estimating sales, and ends with a budgeted income statement, balance sheet and cash flows statement. A master budget helps you to figure out production levels, purchases of direct materials, hiring of employees, overhead, and purchases of new capital assets, while maintaining profitability and positive cash flow.

Illustration 1You manage Greg’s Tunes, Inc., which carries a complete line of music CDs and DVDs. You are to prepare the store’s master budget for April, May, June, and July, the main selling season. The division manager and the head of the accounting department will arrive from headquarters next week to review the budget with you.

Your store’s balance sheet at March 31, 2015, the beginning of the budget period, appears in the table below

Balance Sheet31-Mar-15

Assets GH¢ Liabilities GH¢

Current Assets:Current Liabilities:

Cash1640

0 Accounts payable1680

0Accounts Receivable

16000

Salary and Com payable 4250

Inventory4800

0 Total Liab2105

0Prepaid Insurance 1800 EquityTotal Current Assets

82200 Common Stock

20000

Fixed Assets:Retained Earnings

60350

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Equipment and Fixtures

32000 Total Equity

80350

Less: Depn1280

0Total Fixed Assets

19200

Total Assets101400

Total Liab and Equity

101400

Flexible BudgetA flexible budget is a budget that is a function of one or more levels of activity. Thus, the budget depends on one or more measures of activity volume rather than being fixed in amount. A flexible budget is a budget which is designed to change in accordance with the LEVEL OF ACTIVITY attained.It is also known as Variable budget as the budget recognizes the difference in cost behavior namely fixed and variable costs in relations to fluctuations in output or turnover. The budget is designed to change appropriately with such fluctuation.For a fixed budget, the budget remains unchanged irrespective of the level of activity actually attained.The fixed budget is prepared based only on one level of output.Therefore, if the level of output actually achieved differs considerably from that budgeted, large variances will arise.For some companies, due to the nature of business does not suit fixed budget preparation:

Affected by weather condition like the soft drink industry; Companies frequently introduce new product line like the food

canning industry; Production is carried out only when orders are received from

customers like shipbuilding, aircraft industries; Affected by changes in fashion like millinery trade; Export orientated business

So, what are the difference between Fixed and Flexible Budget? They are:

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For a fixed budget, the figures are for a SINGLE level of activity while a flexible budget is prepared for DIFFERENT levels of activity;

Under fixed budgets, managers are held responsible for variances not under his control ( both fixed and variable cost);

The fixed budget is never able to assess properly the  efficiency and actual performance of the manager.

For example, a fixed budget is set with a planned 8,000 hours but an actual 10,000 hours are recorded, from both the motivational or control point, it is difficult to gauge the  efficiency of the manager(s) who are involved in the manufacture of the output at that actual level;

The flexible budget allows more meaningful comparison as it flexs to the actual volume. It computes what costs should have been for the actual level of activity and

The flexible budget has the advantage of assisting the managers deal with uncertainty by allowing them to see the expected outcomes for a range of activity;

Purpose:--The purpose of a flexible budget is to develop an estimate or estimates of cost for one or more levels of activity. Activity levels are typically measured in terms of activity inputs, levels, or outputs. Such a budget is flexible in the sense that it depends upon a specified level of activity volume. Acquisition budgets focus on the costs to be incurred to acquire actual or planned levels of resources. Labor budgets, purchasing plans, and similar budgets are resource acquisition oriented. Activity budgets focus on the resources that should be required to maintain activities at specified levels based on expected or desired levels of efficiency. Production budgets focus on the resources that would be required to produce a specified set of products and services. Like activity budgets, production budgets are necessarily based on assumed levels of efficiency. The idea of a flexible budget is applicable to all three types of budgets.

Approach:--A flexible budget requires an estimate of the relationship between total cost and activity volume. The form of that relationship depends on the structure of the process for which costs are being estimated. Some criteria for choosing a measure of volume include:

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1. Causality -- an individual type of cost should be related whenever possible to that activity which causes the cost to vary.

2. Independence of activity measure -- to the extent possible, the activity measure should be independent of other influences. For example, labor or machine hours are independent of changes in prices.

3. Ease of understanding -- Activity measure units should be easily understandable and obtainable at reasonable expense. Complicated indices of activity volume are best avoided.

4. Functionality - Activity measures should be functional and thus contribute to organizational goals. For example, poor performance should not result in a more generous budget for performance evaluation and control purposes.

Practice: the cost behavior assumption that underlies much of current accounting practice is that cost is a simple linear function of volume. Specifically, it is assumed that

Total cost C = F + vQ, where F represents total fixed cost, v represents the variable cost per unit of activity, and Q represents the level of activity for which the budget is to be constructed. When there are multiple cost drivers for an activity, then the linear equation is of the form

Total cost C = F + v1Q1 + v2Q2 + + vnQn (1)

In matrix form, we would write this as

Total cost C = F + vQ (2)

Flexible budgeting can be implemented whenever a reasonably strong relationship exists between total cost and some measure of activity volume.

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The relationship can be curvilinear or linear. The important concept is that the budget flexes, in a predetermined manner, with changes in volume.

Measures of Activity1. Flexible budgets are sometimes based on measures of activity inputs

(e.g., direct labor hours) that indicate the budgeted costs necessary to acquire a given level of resources at specified prices. These are acquisition budgets, such as might be used to budget for the purchase of raw materials for a specified period.

2. Flexible budgets are sometimes based on measures of activity (e.g., hours a production line is in operation) to forecast the cost of operating an activity, usually for a given level of input or output (e.g., standard hours allowed for the output achieved). In constructing such budgets, one must specify the rate at which resources will be consumed to maintain the activity.

3. Flexible budgets are sometimes based on measures of activity output (e.g., number of units produced during a period). In constructing such budgets, one must specify both the rate at which resources will be consumed to maintain the activity and the rate at which the activity will produce units of output. Thus, a flexible budget based on output must be based on specified input/output ratios.

Common uses of flexible budgets include:1. to estimate total indirect factory costs at different levels of activity to compute

budgeted activity cost rates,

2. to budget total indirect factory costs at different levels of activity to compute standard activity cost rates,

3. to estimate total activity costs at different levels of activity to compute budgeted or standard activity cost rates.

4. to estimate total activity cost for the level of activity achieved for control and performance evaluation purposes,

5. to forecast total activity costs for cash budgeting purposes,6. to forecast activity costs for expense budgeting purposes, and7. to forecast total activity costs to forecast earnings under different

scenarios.

StepsThe steps involve in the preparation of the flexible budget as follows:

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Select the measure of activity like the units of production; Define the relevant range of activity for the budgeted performance

based on step 1; Identify the cost items to be included in the budget; Determine the cost behavior of each item over the relevant range; Separate the cost items into variable, fixed and mixed; Select the specific levels of activity to be budgeted; Use the cost behavior under item 4 to estimate the budgeted amounts

for each cost item at the different levels selected in step 6.

Illustration Company ABC manufactures a single product and has produced the following flexed budget for the year.

Level of Activity

70% 80% 90%Direct materials 17,780 20,320 22,860Direct labor 44,800 51,200 57,600Production overhead 30,500 32,000 33,500Administration overhead

17,000 17,000 17,000

Total cost 110,080 120,520 130,960

Prepare a budget flexed at the 45% level of activity

Answer:[Guide: To flex the budget, we need to determine which costs are semi-variable and calculate the variable cost per 1% change in activity as (range of cost)/(range of activity) and fixed costs as total cost minus variable cost at that activity level. Calculate a cost per 1% for all the variable costs, flex them to 45% and deduct the fixed costs]

Variable costs: $ per 1% $Direct materials 254 11,430

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Direct labor 640 28,800Production overhead 150(working 1) 6,750Fixed costs:Production overhead(working 2)

20,000

Administration overhead 17,000 37,000Total budget cost allowance

83,980

Working 1:

Production overhead is a semi-variable cost

Range of activity=90%-70%=20%

Range of production overhead costs=$(33,500-30,500)=$3,000

Therefore, variable cost per 1% change in activity=$3,000/20=$150

Working 2:

Fixed cost=$33,500(90% x$150)=$20,000

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