Budgets and budgetary control

1
Budgets and budgetary control

• Lecture 3

Dr. Haider Shah
Semester B
2
Learning outcomes

• Continue understanding budget process
• Understand preparation of cash budget
• Understand use of flexed budget

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Cash budgets a proforma

• Month
  1 Month 2
• 
  
• Opening balance (a) x
  x
• Cash Receipts
• Sales
  x x
• Other
  x x
• 
  (b) x x
  
  
• Cash Payments
• Purchases
  x x
• Other
  x x
• 
  (c) x x
• Net cashflow (b-c)
  X X
• 
  X
  X
• Closing balance (ab-c) X
  X

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Example Shuxing designer sportswear
Sales (all cash) Purchases (2 month credit) Expenses 1 month credit
Jan 2,000 1000 300
Feb 3,200 1600 500
Mar 4,320 2,160 600
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Shuxing designer sportswear

• Quarterly rent and rates of 4,000, starting
  on 1st March.
• She receives an interest free loan from her
  parents in February for 1,000
• She buys a computer (2,000) in January
• Equipment(5,000) is to be paid for in on 1st
  January
• Opening cash balance is 1,000
• REQUIRED
• Using the pro forma, prepare a cash budget
  for Shuxing for the first three months of
  trading. Interpret her cash position, explaining
  her options.

6
Control and Controls
Finish
Control is the ability to stay on the path which
leads to the desired end.
Controls are the devices with which you are able
to exercise control. e.g brake, clutch, gear,
mirrors etc
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Budgetary control

• The comparison of actual results with those
  budgeted.
• The variances between these elements are
  calculated and reported to management so that
  appropriate action can be taken

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Budgetary control

• Budgets can be viewed either as
• Fixed
• do not change with the level of activity ( A
  major limitation for control purposes)
• or
• Flexed
• are the opposite they are constructed such that
  they can be altered to reflect the actual
  activity achieved. So excludes any volume
  variance from the total variance.

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Impact of Volume

• A Flexed budget excludes any volume variance
  from the total variance.

• 10

• 8

• 11

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Example

• UH sports café sold 156 mars bars in a week
  for 62.40.
• It had a budget of 150 bars at 67.50.
• This gives a variance of 5.10. What caused this
  variance?

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Answer UH sports cafe

• Qty
  Price Total
• Actual 156
  0.40 62.40
• Budget 150
  0.45 67.50
• Variance
  5.10 U
• Causes
• Volume 6
  0.45 2.70 F
• Price 156
  0.05 7.80 U
• Total variance
  5.10 U
• A Flexible budget would eliminate the volume
  variance

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Cost behaviour

• If budgets are being adjusted to reflect changes
  in activity levels then

1. We need to know how the planned costs/revenue
   react to output
2. The fundamentals of variable costing apply.
3. So for each we ask what type of cost is it?
   Variable?, Fixed? Stepped?....

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Importance of flexible budgets

• At the planning stage
• If output is uncertain then a number of
  flexible budgets may be constructed and then the
  outcomes can be assessed prior to the acceptance
  of one as the fixed. (What if? analysis)
• At the control stage
• Businesses are dynamic, so its improbable
  that actual activity will match that what was
  planned
• Management need to know what elements have
  caused a variance in order to exert control and
  react

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Flexible budget the steps

• Revise the budget to reflect the volume that
  actually or now expected to occur
• Identify what costs are related to the level of
  output (variable costs)
• Identify the fixed costs
• Can now make more valid comparison between this
  budget and the actual one
• This is known as the volume variance
• The other variances can now be investigated

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Example Baxter Ltd
(Solution in Tutorial 3)
Original Budget Actual
Output
Production sales (units) 1100 1150

Sales 110,000 113,500
Raw Materials (44,000) (44,000m) (46,300) (46,300m)
Labour (22,000) (5,500hrs) (23,200) (5,920 hrs)
Fixed OHs (20,000) (19,300)
Profit 24,000 24,700
Requirement Produce a report that illustrates
all potential variances