BUDGETING

LEARNING OBJECTIVES
After studying this lesson, you should be able to:

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2.
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6.

Define budgeting and other related terminologies.

Describe the functions, purposes, advantages and limitations of budgeting.
Distinguish between an operating budget, financial budget and capital budget.
Explain the process of preparing the master budget and describe the budget cycle.
Prepare a sales budget, including a computation of expected cash receipts.
Prepare a production budget, direct materials budget, direct labor budget including a computation
of expected cash disbursement for purchases of materials and payment of direct labor.
Prepare a manufacturing overhead budget and a selling and administrative expense budget.
Prepare a cash budget.
Prepare a budgeted income statement and a budgeted balance sheet.

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9.

DISCUSSION
Failing to plan is planning to fail
Budget Defined
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A budget is a financial and/ or quantitative statement, prepared and approved prior to a defined
period of time, of the policy to be pursued during that period for the purpose of attaining a given
objective..
A budget is a plan expressed in quantitative terms on how the management desires to manage or
control its operating, investing, and financing resources and activities to promote the overall goal
of an enterprise in a given period of time.
The act of preparing a budget is called budgeting.
The overall or master budget (also known as planning budget or budget plan) indicates the sales
levels, production and cost levels, income and cash flows that are anticipated for the coming year.
The master budget is a summary of all phases of a companys plans and goals for the future. In
short, it represents a comprehensive expression of managements plans for the future and how
these plans are to be accomplished.

Difference between Planning and Control

Planning involves developing objectives and preparing various budgets to achieve these
objectives. Control involves the steps taken by management to ensure that the objectives set down at the
planning stage are attained and to ensure that all parts of the organization function in a manner
consistent with the goals.
An effective budgeting system must provide for both planning and control. Good planning without
effective control is time wasted. On the other hand, unless plans are presented or known in advance,
there are no objectives toward which control can be directed.
Functions of Budgeting

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Budgets make the decision-making process more effective by helping managers meet
uncertainties. Its objective is to substitute deliberate, well-conceived business judgment for
accidental success in enterprise management.
Budgets should not be expressions of wishful thinking but rather descriptions of attainable
objectives.

Advantages and Limitations of Budgets

The advantages of budgeting include:
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It forces planning and exposes situations in which plans of subcomponents are inadequate to
attain the objectives.
It allows a reiterative process to bring the goals of the organization/business and the
subcomponents into agreement.
It provides a means of communicating organizational goals down through the organization and
sub-unit operational limitations up through the organization.
It provides a basis for financial planning, coordination, resource acquisition, inventory policy,
scheduling and output distribution.
It provides a basis by which activity can be monitored, with actual results being compared to the
planned results.

The limitations of budgeting are:

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Budgets tend to oversimplify the real situation and fail to allow for variations in external factors.
They do not reflect qualitative variables.
It is difficult to prepare a detailed budget for an organization that has never existed or for a new
division or product.
There may be lack of higher and lower management commitment because of lack of
understanding of the fundamentals of budget preparation and utilization.
The budget is only a representation of future plans or a means to the goal of profitable activity
and not an end in itself.
Budget reports usually emphasize results, not reasons.

Types of Budgets
The types of budgets or the major composition of the master budget are:
A. The Operating budget
Budgeted Income Statement
a. Sales budget
b. Production budget
I.
Materials cost budget
II.
Direct labor cost budget
III.
Factory overhead budget
IV.
Inventory levels
Cost of Sales Budget
Selling and administrative expenses budget
Financial expense budget
B. The Financial budget
Budgeted balance sheet
Budgeting

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 Cash budget
Budgeted Statement of Sources and Uses of Funds
C. The Capital budget
Budgeting Terminologies Defined
Budgeted income statement refers to the projection of revenue, expenses, and results of
operations for a definite period of time.
Cash budget a period-by-period statement of cash at the start of a budget period, expected
cash receipts classified by source; expected cash disbursements, classified by function,
responsibility, and form; and resulting cash balance at the end of the budget period.
Financial budget refers to the budget of the financial resources as reflected in the budgeted
balance sheet and cash budget.
Operating budget refers to the plans for the conduct of business for the planning period; it
includes the budgeted income statement and all its supporting budgets.
Sales budget budget that shows the quantity of each product expected to be sold.
The Budget Period
As a general rule, the period covered by a budget should be long enough to show the general
effect of managerial policies but short enough so that estimates can be made with reasonable accuracy.
A master budget is an overall financial and operating plan for a coming fiscal period and the
coordinated program for achieving the plan. It is usually prepared on a quarterly or an annual basis. Long
range budgets called capital budgets which incorporate plans for major expenditures for plant and
equipment or the addition of product lines, might be prepared to cover plans for as long as 5 to 10 years.
The Master Budget Interrelationships

Budgeting

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Steps in Developing a Master Budget

The major steps in developing Master Budget may be outlined as follows:
1.
2.
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4.
5.

Establish basic goals and long range plans for the company. These will serve as guidelines in the
preparation of budget estimates.
Prepare a sales forecast for the budget period.
Estimate the cost of goods sold and operating expenses.
Determine the effect of budgeting operating results on assets, liabilities and ownership equity
accounts. The cash budget is the largest part of this step, since changes in many asset and
liability accounts will depend upon the cash flow forecast.
Summarize the estimated data in the form of a projected income statement for the budget period
and the projected balance sheet of the end of the budget period.

Budget Illustrated
Mr. ABC plans to put up business by selling initially banana chips.
SALES BUDGET
The sales budget showing what products will be sold in what quantities at what prices, is the foundation
on which all other short-term budgets are built. The sales budget triggers a chain reaction that leads to
the development of many other budget figures. The sales forecast is the key stone of the budget
structure. (See appendix B for further discussion).
Schedule 1:
Sales Budget
For 2014
Estimate sales

Units
5,000

Price/ unit
P27

Total sales revenue

P 135,000

PRODUCTION BUDGET
After the sales budget has been set, a decision can be made on the level of production that will
be needed for the period to support sales and the production budget can be set as well. The
production budget becomes a key factor in the determination of other budgets, including direct
materials budget, the direct labor budget and the manufacturing overhead budget
Production Budget
For 2014
Units sold
Add: Desired ending Inventory
Total
Less: Beginning Inventory
Units to be produced

5,000
500
5,500
0
5,500

Raw materials budget:

Required total purchases
Budgeting

P 84,700
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Direct Labor budget:

Number of units to be produced
Multiply by: direct labor per unit
Total budgeted direct labor costs

5,500
5.7 (285/50)
31,350

Overhead costs budget

Cooking gas
Electricity
Water
Depreciation
Total

4,034
2,321
930
1,880
9,165

BUDGETED COST OF SALES

Production Budget
Raw Materials Budget
Direct Labor Budget
Overhead cost budget
Budgeted Statement of cost of sales
Budgeted Statement of Cost of Sales
Beginning work in process inventory
Manufacturing costs
Direct Materials
Beginning inventory
Purchases
Less: Ending Inventory
Total Direct Materials cost
Direct Labor
Manufacturing overhead
Total Manufacturing cost
Less: Ending work in process

Budgeting

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P 84,500
P 84,500
31,350
9,165
P 125,015
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