Sample Notes: Budgeting And Budgetary Control
A2 Level Accounting – 4.3.1 Budgeting and Budgetary Control
Definition
- Budget: A financial plan estimating revenue and expenses over a specified future period.
- Budgetary control: The process of comparing actual results with the budgeted figures and investigating variances.
Purposes of Budgeting
- Planning: Provides a roadmap to meet financial goals.
- Coordination: Aligns activities across departments.
- Control: Monitors performance via variance analysis.
- Motivation: Encourages staff to meet targets.
- Communication: Ensures goals are known to all stakeholders.
- Decision-making: Informs pricing, production, and investment.
Types of Budgets
- Sales budget – Forecasts revenue based on estimated sales.
- Production budget – Number of units to produce to meet sales targets.
- Purchases budget – Quantity and cost of raw materials required.
- Labour budget – Hours and costs for workforce needed.
- Trade receivables budget – Expected cash inflows from debtors.
- Trade payables budget – Expected payments to suppliers.
- Cash budget – Cash inflows and outflows over a period.
- Budgeted Income Statement – Expected profit or loss.
- Budgeted Financial Position – Projected assets, liabilities, equity.
Master Budget
- A comprehensive budget combining all functional budgets into a consolidated statement including:
- Budgeted income statement
- Budgeted balance sheet
- Cash flow statement
Flexible vs Fixed Budgeting
| Feature | Fixed Budget | Flexible Budget |
|---|---|---|
| Adjusts for activity level? | No | Yes |
| Usefulness | Low in dynamic environments | High |
| Accuracy | Low if activity changes | High |
| Example | 10,000 units fixed | Recalculates based on actual 8,000 or 12,000 units |
Behavioural Aspects of Budgeting
- Targets: Unrealistic targets demotivate; achievable ones improve performance.
- Incentives: Bonuses or recognition tied to meeting budgets.
- Motivation: Employees feel involved if they participate in setting budgets.
- Gaming the system: Managers may understate budgets to appear efficient.
Preparation of Budgets (Examples)
Sales Budget Example:
| Month | Units | Price per Unit | Total Sales |
|---|---|---|---|
| Jan | 1000 | $50 | $50,000 |
Cash Budget Sample:
| Month | Cash Inflows | Cash Outflows | Net Cash Flow | Closing Balance |
|---|---|---|---|---|
| Jan | $60,000 | $40,000 | $20,000 | $20,000 |
Limiting Factor
- A resource constraint such as labour hours or machine time that limits output.
- Budgets should prioritize profitable products per unit of limiting factor.
Variance Analysis and Reconciliation Statements
Flexible Budget Statement Example:
| Item | Budgeted | Actual | Variance | Favourable/Adverse |
|---|---|---|---|---|
| Direct Materials | $10,000 | $11,200 | $1,200 | Adverse |
Reconciliation of Budgeted vs Actual Profit:
- Start with budgeted profit
- Add/subtract cost and revenue variances
- Arrive at actual profit
Non-Financial Factors
- Customer satisfaction
- Product quality
- Staff morale
- Environmental impact
Advantages of Budgetary Control
- Ensures coordination
- Enables performance monitoring
- Encourages efficiency
- Assists in cost control
- Enables long-term planning
Disadvantages of Budgetary Control
- Can demotivate if targets are unrealistic
- Time-consuming
- May discourage innovation
- Potential for conflict between departments
- Over-reliance on quantitative data
Conclusion
Budgeting and budgetary control are vital tools for financial planning, performance monitoring, and decision-making. However, they must be applied carefully, considering both financial and behavioural implications.