THE AUDITOR AND THE COMPANIES ACT-Questions and Answers
A budget is a detailed plan outlining the acquisition and use of financial and other resources over some period of time in the future.
DEFINITION OF KEY TERMS
A budget center is a section of the organization created for the purpose of budgetary control.
Budget bias (budgetary slack) occurs when managers aim to give themselves easier budget targets by understating budgeted sales revenue or overstating budgeted costs.
Flexible budget is a budget that is designed to change in accordance with the level of activity attained.
Fixed budget is a budget prepared for a specific level of output.
A budget manual is a document, which sets out the responsibilities of the persons engaged in the routine of, and the forms and records required for budgeting control.
Master budget is the overall quantifications of the budgeting plan.
NATURE AND PURPOSES OF BUDGETS
ORGANIZATION OF BUDGETARY CONTROL
Budgetary control ideally involves the following steps:
- The creation of budget centers
A budget center is a section of the organization created for the purpose of budgetary control. Budget centers must be clearly defined because a separate budget has to be set for each center.
- The introduction of adequate accounting records
The accounting system should be designed in such a way that it is able to record and analyze the information required. The budget procedures must also employ the same classification of revenue and expenses as the accounting department for comparison purposes.
- The preparation of organization charts.
They define the hierarchy and responsibilities of officers of the company. This is helpful in identifying the officers to include in the budget committee.
- The establishment of a budget committee: It will consist of operating and financial managers, who will be required to review, discuss and co-ordinate business activities.
Its major task is to ensure that budgets are realistically established and are well coordinated.
The main functions of this committee involve:
- To issue instructions to departments regarding budget requirements, deadline dates for the receipt of budgets, e.t.c.
- Draw up the budget preparation timetable. It takes the form of network analysis whereby some activities are preceded by some others.
- To define the general policies of management in relation to the budget.
- Checking initial draft and problems considered. Limiting factors are usually considered.
- Ensuring that the budgets are synchronized within the boundaries of available
Budget manual
A budget manual contains the purpose of, procedure for and responsibility of the people involved in budgeting. It is a statement of budget policies and lays down the details of the organizational set up with duties and responsibilities of the executives including the budget committee and the budget director and the procedure and programmes to be followed for developing budgets for various activities.
The contents of the budget manual are:
i. Description of the budget system and its objectives
ii. Procedures and forms to be used by budget committee and the director
iii. The responsibilities of operating executives, budget committee and the director
- The budget calendar specifying special dates for the completion of each part of the budget submission of the reports
- Method of accounting and the accounts code in use vi. Procedure to be adopted in operating the system vii. The follow-up activities
Budget bias
Budget bias (budgetary slack) occurs when managers aim to give themselves easier budget targets by understating budgeted sales revenue or overstating budgeted costs.
Cost control using budgets is achieved by comparing actual costs for a budget period with budgeted or planned costs. Significant differences between planned and actual costs can then be investigated and corrective action taken where appropriate.
Budget bias will lead to more favorable results when actual and budgeted costs are compared. Corrective action may not be taken in cases where costs could have been reduced and in consequence inefficiency will be perpetuated and overall profitability reduced.
Managers may incur unnecessary expenditure in order to protect existing budget bias with the aim of making their jobs easier in future periods, since if the bias were detected and removed, future budget targets would be more difficult to achieve. Unnecessary costs will reduce the effectiveness of cost control in supporting the achievement of financial objectives such as value for money or profitability.
Where budget bias exists, managers will be less motivated to look for ways of reducing costs and inefficiency in those parts of the organization for which they bear responsibility. The organization’s costs will consequently be higher than necessary for the level of performance being budgeted for.
The Master Budget Framework and the Various Types of Budgets
The Master budget
is the overall quantifications of the budgeting plan. In it, functional budgets are incorporated. A functional budget is a budget of income and/or expenditure for a particular function. The master budget therefore combines all the budgets of the various departments in an organization. It is useful in ensuring that all the individual budgets are consistent with one another and also presents a ‘unit’ picture of the entire organization.
All these budgets translate into the projected profit and loss a/ c and the budgeted Balance Sheet. The relationship between all these budgets is summarized in the next page.
Sales Budget
this is a detailed schedule showing the expected sales in the period to come. It essentially forecasts what the company can reasonably expect to sell to the customer during the budget period. It is expressed in both units and shillings. The sales budget is the key to the entire budgeting process thus must be prepared accurately. It is key in the sense that all the constituent parts of the master budget are dependent on the sales budget. For instance, the production estimate for the period will be based on the demand in the market and the stocks available. If the sales forecast is not correct, then the production estimate for the period under consideration will not be correct.
Various factors are normally considered in coming up with the sales forecast and sales budget. They include the actual sales in the previous periods, reports from salesmen, market research information and level of orders obtained in advance, among others.
Format
| Item | Quantity | (Units) Revenue (Shs) |
| A | xx | xx |
| B | xx | xx |
| C | xx | xx |
| Total | xx | xx |
Production budget
it summarizes the production requirements for the forthcoming period to match the forecasted sales above. Budgeting of ending inventory is crucial as it ensures that economic stock levels are maintained i.e. no excess stocks are carried thus minimizing on holding costs and avoiding tying of capital and that there is adequate level inventory in to avoid shortage costs and unnecessary ordering costs. The production budget is expressed as units of each type of product. Various factors considered while preparing the production budget include available production capacity, the sales forecast, finished goods stock level policy, among others.
The cycle for the preparation of the production budget usually is determined by the budget committee. It follows the following steps:
- Determine the production capacity available.
- Consider the possible ways in which the available production capacity may be expanded if required.
- Linkage of production capacity available to the stock level
- Determine the detailed budgets within the production budget.
The general format of the production budget is as follows:
A (Units) B (Units) C (Units)
Required ending stock xx xx xx Add: Sales during the year xx xx xx
Total requirement xx xx xx
Less: Estimated opening Stock xx xx xx Production requirement (units) xx xx xx
Direct Materials budget
this shows the estimated quantities and costs of all the raw materials and components needed for the output demand by the production budget. Sufficient raw materials must be available to meet the production process and, in addition, provide ending raw materials working inventory for the period under consideration. Direct raw materials budget is expressed in units. It consists of
- Direct Materials Usage Budget: it shows the estimated quantities of materials required for budgeted production.
Format
| Product | units of product | Units of X req. Per unit of product | Material X (Total Units) | Units of Y req. Per unit of product | Material Y (Total Units) |
| A | xx | k | xx | k | Xx |
| B | xx | k | xx | k | xx |
| C | xx | k | xx | k | xx |
| Total direct materials | xx | xx |
- Direct Materials Purchases Budget: It ensures that materials are within the planned materials stock levels i.e. after considering both usage and material stocks required.
Format
| Material X Units | Material Y Units | |
| Required ending Inventory | xx | Xx |
| Add: Current usage | xx | Xx |
| Total material requirement | xx | Xx |
| Less: Opening Stock | xx | xx |
| Materials to be purchased (Units) | xx | xx |
| Cost per unit | Shs.Y | Shs.Y |
| Material purchase budget (Shs) | xx | xx |
Total purchases budget shall be equal to the summation of the totals for each material. In our case above, the total material budget shall be cost of material X and material Y.
Direct Labour budget: this is crucial as it forecasts the number of labour hours required and thus helps the company to know whether sufficient labour time is available to meet production needs in the budget period. It is based on production budget estimate. This budget helps the company know whether it will need additional labour force in the future and how much it will incur as labour costs.
Factory Overhead Budget:
The budgeted direct labour cost is therefore determined by multiplying direct labour hours with the wage rates for every category of labour.
This budget presents the forecasts of all the production, fixed, variable and semi-variable overheads to be incurred during the budget period. i.e. gives a summary of all costs other than direct costs.
Format
Department A Department B
| Budgeted overheads (Excluding depreciation) | xx | xx |
| Add: Depreciation | ||
| Existing plant | xx | xx |
| New Plant (apportioned per period) | xx | xx |
| Total budgeted overheads (a) | xx | xx |
| Absorption base (b) | b | b |
| Overhead absorption rate (a)/(b) | Shsx | Shsx |
The summation of budgeted costs of production for the budget period makes up Production Cost Budget. It includes:
- Budgeted Materials Cost
- Budgeted Labour Cost
- Budgeted Overhead Cost
Non-Production Budgets
Selling and Distribution Cost Budget: It is the forecast of all costs incurred in selling and distributing the company’s product during the budget period. It is closely concerned with the sales budget in that it is mainly based on the volume of sales projected for the period. Expenses included are selling office costs, salesmen salaries and commission, advertising expenses, e.t.c.
Administration Costs Budget: It represents the costs of all administration expenses. Each department or budget centre will be responsible for the preparation of its own budget. Management, Secretarial, Accounting and Administration costs, which cannot be directly related to the production are included here. The budget will be mainly incremental i.e. previous year’s figure will tend to apply for its next budget with an allowance for inflation.
Research and Development Cost Budget: These are costs, which are discretional in nature i.e. they are determined on need basis by the managers concerned. Research cost is the cost of original investigation undertaken in order to gain new scientific or technical knowledge and directed towards a specific practical aim objective.
Development cost is the cost of using scientific or technical knowledge in order to produce new or substantially improved materials, devices, products, processes systems or services prior to the commencement of commercial production.
Capital Expenditure Budget: It represents the expenditure on all fixed assets during the budget period. Addition intended to benefit future accounting periods, or expenditure which increases the production capacity, efficiency lifespan or economy of existing fixed assets are also incorporated.
Cash Budget; It records the cash inflows and outflows, which are expected to take place in respect of each functional budget. It may be prepared for a period span of one week, month or quarter of the budget period. It has the following benefits/advantages:
- It ensures that sufficient cash is available when required.
- It shows whether capital expenditure projects can be financed internally.
- It indicates the cash needed for current operating activities.
- It indicates the effect the position of each seasonal requirements, large stocks, unusual receipts and laxity in collecting account receivable.
- It indicates the availability of cash for taking advantage of discounts.
- It reveals the availability of excess cash so that short-term investments may be considered.
- It serves as a basis for evaluating the actual cash management performance of responsible managers.
The management of Beck plc have been informed that the union representing the direct production workers at one of their factories, where a standard product is produced, intends to call a strike. The accountant has been asked to advise the management of the effect the strike will have on cash flow.
The following data has been made available:
| Week 1 Week 2 | Week 3 | |
| Budgeted sales | 400 units 500 units | 400 units |
| Budgeted production | 600 units 400 units | Nil |
The strike will commence at the beginning of week 3 and it should be assumed that it will continue for at least four weeks. Sales at 400 units per week will continue to be made during the period of the strike until stocks of finished goods are exhausted. Production will stop at the end of week 2. The current stock level of finished goods is 600 units. Stocks of work in progress are not carried. The selling price of the product of Shs60 and the budgeted manufacturing cost is made up as follows:
| Shs | |
| Direct materials | 15 |
| Direct wages | 7 |
| Variable overheads | 8 |
| Fixed overheads | 18 |
Direct wages are regarded as a variable cost. The company operates a full absorption costing system and the fixed overhead absorption rate is based upon a budgeted fixed overhead of Shs9000 per week. Included in the total overheads is Shs.700 per week for depreciation of equipment. During the period of the strike, direct wages and variable overheads would not be incurred and the cash expended on fixed overheads would be reduced by Shs1500 per week.
The current stock of raw materials are worth Shs7500; it is intended that these stocks should increase to Shs11000 by the end of week 1 and then remain at this level during the period of the strike. All direct materials are paid for one week after they have been received. Direct wages are paid one week in arrears. It should be assumed that all relevant overheads are paid for immediately the expense is incurred. All sales are on credit, 70% of the sales value is received in cash from the debtors at the end of the first week after the sales have been made and the balance at the end of the second week.
The current amount outstanding to material suppliers is Shs.8000 and direct wage accruals amount to Shs.3200. Both of these will be paid for in week 1. The Current balance owing from debtors is Sh.s31200, of which Shs.24000 will be received during week 1 and the remainder during week 2. The current balance of cash in hand and at bank is Shs.1000.
Required:
Prepare a cash budget for weeks 1 to 6 showing the balance of cash at the end of each week, together with a suitable analysis of the receipts and payments during the week
Comment upon any matters arising from the cash budget, which you consider should be brought to the management’s attention
(Management and Cost accounting, Colin Drury)
| Solution | Cash budget for weeks 1 to 6 |
| Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 | |
| Shs Shs Shs Shs Shs Shs | |
| Payments from debtors Payments | 24,000 24000 28200 25800 19800 5400 |
| To material suppliers | 8000 12500 6000 nil nil nil |
| To direct workers | 3200 4200 2800 nil nil nil |
| For variable overheads | 4800 3200 nil nil nil nil |
For fixed overheads 8300 6800 Total payments 28200 15600
Net movement (300) (4200) 12600 19000 13000 (1400)
Opening balance week 1 700 (3500)
Closing balance 9100
Workings
Collection from debtors
| Week 1 Week 2 | Week 3 | Week 4 Week 5 Week 6 | |
| Shs Shs | Shs | Shs Shs Shs | |
| Units sold | 400 500 | 400 | 300 0 0 |
Sales (@Shs60)
Cash received (70%)
(30%) 7200 9000 7200 5400
Given Total receipts
| Payments to creditors | |||
| Week 1 Week 2 | Week 3 | Week 4 Week 5 Week 6 | |
| Shs. Shs. | Shs. | Shs. Shs. Shs. | |
| Materials consumed at Shs15 | 9000 6000 | ||
| Increase in stocks | _3500 ___0 |
Materials purchased
Payment to suppliers 12500 6000 nil nil nil
| Wages | ||||
| Week 1 Week 2 | Week 3 | Week 4 Week 5 Week 6 | ||
| Shs. Shs. | Shs. | Shs. Shs. Shs. | ||
| Wages consumed at Shs7 | 4200 2800 | nil | nil nil nil | |
| Wages paid | 3200 4200 | 2800 | 0 0 0 | |
| Comment: Finance will be required to meet the deficit in week 2, but a lowering of the budgeted material stocks at the end of week 1 would reduce the amount of cash to be borrowed at the end of week 2.The surplus cash at the end of week 2 should be invested on a short-term basis.After week 6, there will be no cash receipts but cash outflows will be Shs.6800 per week. The closing balance of Shs.39700 at the end of week 6 will be sufficient to finance outflows for a further 5 or 6 weeks. |
OTHER TYPES OF BUDGETS
Annual budgets: this is a budget covering a period of 12 months. Under this approach, planning horizon decreases as the year progresses.
Continuous budgets: this budget covers a period of 12 months but constantly adds a new month on the end as the current month is completed. It keeps the management planning and thinking 12 months ahead and thus stabilizing the planning horizon.
Venus Plc produces two products N and A. the budget for next year to 31 Dec xx is to be prepared. Expectations for the forthcoming year include:
Balance sheet as at 1 Jan xx
| Fixed assets | Shs | Shs | Shs |
| Land and buildings | 45,000 | ||
| Plant and equipment (NBV) | 112,000 | ||
| 157,000 | |||
| Current assets | 7,650 | ||
| Raw materials | 23,615 | ||
| Finished goods | 19,500 | ||
| Debtors | 4,300 | ||
| Cash | 55,065 | ||
| Current liabilities | |||
| Creditors | 6,800 | ||
| Taxation | 24,500 | 31,300 | 23,765 |
| 180,765 | |||
| Financed by | |||
| 150,000 ordinary shares of Shs.1 each | 150,000 | ||
| Retained profits | _30,765 | ||
| 180,765 |
Finished products
| The sales director has estimated the following | ||
| N | A | |
| Demand for Company’s products | 4500 | 4000 |
| Expected selling price per unit | Shs.32 | Shs.44 |
| Closing stock @ 31 March 2008 is required to be | 400 units | 1200 units |
| Opening stock at 01 April 2007 | 900 units | 200 units |
| Unit cost of this opening stock will be The amount of plant capacity required for each product is; | Shs.20 | Shs.28 |
| Machining: | 15 min | 24 min |
| Assembling The raw materials content per unit is | 12 min | 18 min |
| Material A | 1.5 kg | 0.5 kg |
| Material B | 2.0 kg | 4.0 kg |
| Direct labour hours required per unit of each product is Finished goods are valued at FIFO basis at full factory cost | 6 hrs | 9 hrs |
| Raw materials | Material X | Material Y |
| Closing stock requirements kilos at 31 March 2008 | 600 | 1000 |
| Opening stock at 1 April 2007 kilos | 1100 | 6000 |
| Budgeted cost of raw materials per kilo | Shs1.50 | Shs1.00 |
Actual cost per kilo of opening stocks are as budgeted cost for the incoming year
Direct labour
The standard wage rate of direct labour id Shs1.60 per hr
Factory overhead
Factory overhead is absorbed on the basis of machining hours with separate absorption rates for each department.
The following are expected overheads in the production cost center budgets
Machining deport Assembly deport
| Shs | Shs | |
| Supervisors salary | 10,000 | 9,150 |
| Power | 2,400 | 2,000 |
| Maintenance and running costs | 2,100 | 2,000 |
| Consumables | 3,400 | 500 |
General expenses 19,600
39,500
Depreciation is taken at 5% straight-line on plant and machinery equipment. A machine costing the company Shs20,000 is due to be installed on 1 October 2007 in the machining department, which already has machinery installed to the value of Shs.l00,000 at cost.
| Selling and distribution expenses | Shs |
| Sales commission and salaries | 14,300 |
| Traveling distribution | 3,500 |
| Office salaries | 10,100 |
| General administration expenses | _2,500 |
| 30,400 |
There is no opening or closing work in progress and inflation should be ignored.
Required
Prepare the following budgets for the year ended 31 March 2008 for Venus PLC.
- Sales budget
- Production budget (units)
- Plant utilization budget
- Direct materials utilization budget
- Direct labour budget
- Factory overhead budget
- Direct materials purchases budget
- Cost of goods sold budget
- Budgeted profit and loss account
Solution
Venus Plc
(i) Sales Budget
| Quantity | Revenue | |||||
| N 4,500 | 144,000 | |||||
| A 4,000 | 176000 | |||||
| Total | 320,000 | |||||
| (ii) Production Budget (units) | ||||||
| N (Units) | A (Units) | |||||
| Required ending stock | 400 | 1,200 | ||||
| Add: Sales during the year | 4,500 | |||||
| Total requirement | 4,900 | |||||
| Less: Estimated opening Stock | (900) | |||||
| Production requirement (unit | s) 4000 | |||||
| (iii) Plant utilization budget | ||||||
| Machinery Assembly | ||||||
| N*3 | 1000 hrs | 800 hrs | ||||
| A*4 | 2,000hrs | 1,500hrs | ||||
| Total Plant utilization | 3,000 hrs | 2,300hrs | ||||
| *3 4000 x 15/60 = 1000 | 4000 x 12/60 = 800 | |||||
| *4 5000 x 24/60 = 2000 | 500 x 18/60 = 1,500 | |||||
- Direct materials usage budget
| Product | Units of product | Units of X req. Per unit of product | Material X (Total Units) | Units of Y req. Per unit of product | Material Y (Total Units) |
| N | 4,000 | 1.50 | 6,000 | 2.0 | 8,000 |
| A | 5,000 | 0.50 | 2,500 | 4.0 | 20,000 |
| Totals | 8,500 | 28,000 |
- Direct materials Purchases Budget
| Material X Units | Material Y Units | |
| Required ending inventory | 600 | 1,000 |
| Add: Current usage | 8,500 | 28,000 |
| Total material requirement | 9,100 | 29,000 |
| Less: Opening Stock | (1,100) | (6,000) |
| Materials to be purchased (Units) | 8,000 | 23,000 |
| Cost per unit | Shs.1.50 | Shs.1.00 |
| Material purchase budget (Shs) | 12,000 | 23,000 |
| Total Materials purchases Budget | Shs.35,000 |
Direct labour budget
| Product | Units | Hrs req. per unit | Total No. of hours |
| A | 4,000 | 6 | 24,000 |
| B | 5,000 | 9 | 45,000 |
| Total No. of hrs | 69,000 | ||
| Standard wage per hr | Shs1.60 | ||
| Direct labour cost budget (Shs) | 110,400 |
- Factory overhead budget
| Machining Assembly | ||
| Budgeted overheads (Excluding depreciation) | 39,500 | 18,650 |
| Add: depreciation | ||
| Existing plant*5 | 5,000 | 4,350 |
| New Plant (apportioned per period) *6 | 500 | 0 |
| Total budgeted overheads (a) | 45,000 | 23,000 |
| Absorption base (machine hrs)(b) | 3,000 | 2,300 |
| Overhead absorption rate (a)/(b) *7 | Shs15/mh | Sh10/mh |
*5 100,000 x 5% 87000 x 5%
*6 20,000 x 5% x 6/12
*7 4,500 /3000 23,000/2,300 (viii) Cost of goods sold budget
| N (Shs) | A (Shs) | |||
| Opening Stock 18,000 | 5,600 | |||
| Add: Production 78,400 | 140,750 | |||
| Less: Closing stock 7,840 | ||||
| Cost of goods sold8 8,560 | ||||
| Workings a. | Opening stock N 900 x 20 | 18,000 | ||
| A 200 x 28 | 5,600 | |||
| b. | Production cost per unit of finished products | |||
| N | A | |||
| Materials A 1.5 x 1.5 | 2.25 | 0.5 x 0.5 | 0.75 | |
| B 2.0 x 1.0 | 2.0 | 4.0 x 1.0 | 4.0 | |
| Labour: 6 hrs x 1.6 | 9.6 | 9hrs x 1.6 | 14.40 | |
| Overheads | ||||
| Machining 15 x 15/60 | 3.75 | 15 x 24/60 | 6.00 | |
| Assembly 10 x 12/60 ____2.0 | 10 x 18/60 ___3.00 | |||
| Total production per unit Shs19.60 | Shs28.15 | |||
| Production in units | 4,000 | 5,000 | ||
| Valuation | 78,400 | 140,750 | ||
| c. | Closing inventory | |||
| N | A | |||
| Closing stock units | 400 | 1,200 | ||
| Unit cost | _19.6 | _28.15 | ||
| Stock units | 7,840 | 33,780 | ||
| (ix) | BUDGETED | PROFIT AND LOS For the period ending 31 | S ACCOUNT March 2008 | |
| N(Shs) | A (Shs) Total(Shs) | |||
| Sales 144,000 | 176,000 320,000 | |||
| Cost of good sold 88,560 | 112,570 201,130 | |||
| Gross profit 55,440 | 63,430 118,870 | |||
| Less: Selling and administration costs | (30,400) | |||
| Net profit | _88,470 |
