Preparation of master budget

Budget A budget is a quantitative statement, for a defined period of time, which may include planned revenue, expenses, assets, liabilities and cash flows

Purpose of preparing budget Planning Coordination Communication Motivation Performance evaluation

Steps in the preparation of budget Consideration of all external factors Preparation of other budgets Production budget, purchases budget, direct labour budget, overheads budget and selling and administrative budget Negotiation of budget Coordination of budget Cash budget, capital expenditure budget, budget balance sheet, budget income statement, budget cash flow statement, budget statement of retained earnings

Final acceptance of budget Budget review

Cash budget

Cash budget The cash budget is a statement of expected cash receipt and payments It help avoid surplus cash and unexpected cash deficiencies Normally, the cash budget consists of the following items: Closing balance of cash = Opening balance of cash + Receipts - Payments

Cash budget Receipts include: Payments include: Cash sales Collection from debtors Other incomes such as investment income, rent received Payments include: Cash purchases Payment to creditors Direct labour Other expenses such as manufacturing overhead, administrative and selling expenses (depreciation does not involve cash flow) Tax payment

Cash budget In drawing up a cash budget, it can be found that all the payments for units produced would very rarely be at the same as production itself. For instance, the raw materials might be bought in March, goods being produced in April ad paid for in May Similarly the date of sales and the date of receipt of cash will not usually be at the same time. For instance, the good might be sold in May and the money received in August

Example

A cash budget for the six months ended 30th June 2003 is to be Drafted from the following information. Opening cash balance at 1st January 2003 $3200 Sales: at $12 per unit: cash received three months after sale units: 2002 2003 Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep 80 90 70 100 60 120 150 140 130 110 100 160 (c) Production: in units 2002 Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep 70 80 90 100 110 130 140 150 120 160 170 180 (d) Raw materials used in production cost $4 per unit of production. They are paid for two months before being used in production Direct labour: $3 per unit paid for in the same month as the unit is produced. (f) Other variable expenses $2 per unit, ¾ of the cost being paid for in the same month as production, the other ¼ paid in the month after production

(f) Other variable expenses $2 per unit, ¾ of the cost being paid for in the same month as production, the other ¼ paid in the month after production. (g) Fixed expenses of $100 per month is paid monthly (h) A motor van is to be bought and paid for in April for $800 Required: Prepare the cash budget for six months ended 30 June 2003

Cash budget for the six months ended 30 June 2003 Jan Feb Mar Apr May Jun $ $ $ $ $ $ Opening balance 3200 Add: Receipts Sales 960 1080 840 1200 720 1440 3045 2920 2420 1545 780 4160 4125 3760 3620 2265 2220 Less: Payments Raw materials 520 560 600 480 640 680 Direct labour 300 330 390 420 450 360 Variable exp 195 215 250 275 295 255 Fixed expenses 100 100 100 100 100 100 Motor van - - - 800 - - 3045 2920 2420 1545 780 825 Closing balance Workings 1 Working 2

Workings 1: Receipts : Jan 80(Oct) * $12= 950 Feb 90 (Nov)*$12= 1080 Mar 70 (Dec)*$12 = 840 Apr 100 (Jan)*$12 = 1200 May 60 (Feb)*$12 = 720 June 120 (Mar)*$12=1440 Workings 2: Raw materials : Jan 130(Mar) * $4= 520 Feb 110 (Apr)*$4= 560 Mar 150 (May)*$4 = 600 Apr 100 (Jun)*$4 = 480 May 160 (Jul)*$4 = 640 June 170 (Aug)*$4=680 The month in which the sales was made Workings 3: Direct labour : Jan 100(Jan) * $3= 300 Feb 110 (Feb)*$3= 330 Mar 130(Mar)*$3 = 390 Apr 140 (Apr)*$3 = 420 May 150 (May)*$3 = 450 June 120 (Jun)*$12=360 Workings 4: Fixed expenses : Jan $100 Feb $100 Mar $100 Apr $100 May $100 June $100 Back

Working 5: Variable expenses: $ $ Jan 100(Jan)*3/4*$2 150 90 (Dec)*1/4*$2 45 195 Feb 110(Feb)*3/4*$2 165 100 (Jan)*1/4*$2 50 215 Mar 130(Mar)*3/4*$2 195 110(Feb)*1/4*$2 55 250 Apr 140(Apr)*3/4*$2 210 130(Mar)*1/4*$2 65 275 May 150(May)*3/4*$2 225 140 (Apr)*1/4*$2 70 295 Jun 120(Jun)*3/4*$2 180 150(May)*1/4*$2 75 255 Back

Budget income statement and balance sheet

Budgeted income statement and balance sheet These financial statements reflect the predicted results to be achieved.

Example

ABC Ltd. Balance sheet as at 31 December 2004 Fixed Assets Cost Dep Net Machinery 4000 1600 2400 Motor vehicles 2000 800 1200 6000 2400 3600 Current Assets Stock: finished goods (75 units) 900 Raw materials 500 Debtors (2004 Oct $540 +Nov $360+Dec $450) 1350 Cash and bank 650 3400 Less: Current liabilities Creditors for raw materials (Nov $120+ Dec $180) 300 Creditors for fixed expenses (Dec) 100 3000 6600

Financed by: $ $ Share capital, 4000 shares of $1 each 4000 Profit and loss account 2600 6600 The plans for the six months ended 30 June 2005 are as follows: Production will be 60 units per month for the first months, followed by 70 units per month for May and June Production costs will be (per unit): Direct materials $5 Direct labour 4 Variable overhead 3 12 Fixed overhead is $100 per month, payable always one month in arrears. Sales, at price of $18 per unit, are expected to be: Jan Feb Mar Apr May Jun no. of units 40 50 60 90 90 70

Purchases of direct materials will be: Jan Feb Mar Apr May Jun $ $ $ $ $ $ 150 200 250 300 400 320 (vi) The creditors for raw materials bought are paid two months after purchase (vii) Debtors are expected to pay their accounts three months after they have bought the goods (viii) Direct labour and variable overhead are paid in the same month as the units are produced (ix) A machine costing $2000 will be bought and paid for in March 3000 shares of $1 each are to be issued at par in May Depreciation for the six months: machinery $450, motor vehicles $200 Required: Prepare budget income statement and balance sheet as at 30 June 2005

Budget income statement

Wong Ltd. Budget income statement for the six months ended 30 June 2005 $ $ Sales (400*$18) 7200 Less: COGS Opening stock of finished goods 900 Add: Cost of goods completed (380*$12) 4560 Less: closing stock of finished goods (55*$12) 660 4800 Gross profit 2400 Less: expenses Fixed overhead ($100*6 mth) 600 Depreciation: Machinery 450 Depreciation: Motors 200 1250 Net profit 1150

Wong Ltd. Budget balance sheet as at 30 June 2005 Fixed asssets Cost Dep Net $ $ $ Machinery 6000 2050 3950 Motor vehicles 2000 1000 1000 8000 3050 4950 Current assets Stock: finished goods 660 raw materials 220 Debtors 4500 Cash and bank 1240 6620 Less: Current liabilities Trade creditors 720 Creditors for overheads 100 5800 10750

Financed by: $ $ Capital and reserves Share capital (4000+3000) 7000 Profit and loss account (2600+1150) 3750 10750

Materials budget: Jan Feb Mar Apr May Jun $ $ $ $ $ $ Opening stock 500 350 250 200 200 250 Add: purchases 150 200 250 300 400 320 650 550 500 500 600 570 Less:used in production300 300 300 300 350 350 350 250 200 200 250 220 Production budget: (in units) Jan Feb Mar Apr May Jun Opening stock 75 95 105 105 75 55 Add: purchases 60 60 60 60 70 70 135 155 165 165 145 125 Less: Sales 40 50 60 90 90 70 95 105 105 75 55 55 Back 1 Back 2

Production budget: (in $) Jan Feb Mar Apr May Jun $ $ $ $ $ $ Materials cost 300 300 300 300 350 350 Labour cost 240 240 240 240 280 280 Variable overhead 180 180 180 180 210 210 720 720 720 720 840 840 Creditors budget: Jan Feb Mar Apr May Jun $ $ $ $ $ $ Opening stock 300 330 350 450 550 700 Add: purchases 150 200 250 300 400 320 450 530 600 750 950 1020 Less: Payments 120 180 150 200 250 300 330 350 450 550 700 720 Back 2

Debtors budget: Jan Feb Mar Apr May Jun $ $ $ $ $ $ Opening stock 1350 1530 2070 2700 3600 4320 Add: Sales 720 900 1080 1620 1620 1260 2070 2430 3150 4320 5220 5580 Less: Received 540 360 450 720 900 1080 1530 2070 2700 3600 4320 4500 Back 2

Cash budget: Jan Feb Mar Apr May Jun $ $ $ $ $ $ Opening balance 650 550 210 (2010) (2010) 1050 Add: Debtors 540 360 450 720 900 1080 Share issue - - - - 3000 - 650 550 500 500 600 570 Less: Creditors 120 180 150 200 250 300 Fixed overhead 100 100 100 100 100 100 Direct labour 240 240 240 240 280 280 Variable O/H 180 180 180 180 210 210 Machinery - - 2000 - - - 550 210 (2010) (2010) 1050 1240 Back 2

Fixed and flexible budget

Fixed budget Fixed budget is a budget which is designed to adjust the permitted cost levels to suit the level of activity actually attained

Fixed budget A fixed budget is a budget, which is designed to remain unchanged irrespective of the volume of output or turnover attained

Example

ABC Ltd. Manufactures and sells a single product. Prepare the flexible budgets for 2005 at the activity levels of 80%, 100% and 120%. In accordance with the following information: 100% activity represents 60000 units produced Variable cost (per unit): $ Materials 40 Direct labour 30 Royalties 2 Electricity 6 Maintenance 5 83 3. Fixed cost Depreciation 20000 Rent 120000 Indirect labour 80000

Flexible budget Level of activity 48000 60000 720000 units Variable cost $ $ $ Materials 1920000 2400000 2880000 Direct labour 1440000 1800000 2160000 Royalties 96000 120000 144000 Electricity 288000 360000 423000 Maintenance 240000 300000 360000 3984000 4980000 5976000 Fixed cost Depreciation 20000 20000 20000 Rent 120000 120000 120000 Indirect labour 80000 80000 80000 4024000 5200000 6196000

Flexible budgets and budgetary control By comparing the actual results with the budgeted amounts, the managers can ascertain which costs do not conform to the original plans and therefore deserve their attention The differences between the actual results and the expected outcomes are called variance

If we compare the actual results with the fixed budgets, we do not know whether the variance are caused by the difference in the levels of activity or the change in efficiency However, by comparing the actual costs with the flexible budget prepared at the actual activity level, we can see how efficient the managers are in controlling the costs

Example

ABC Ltd. Manufactures and sells a single product. In accordance with the following information: 100% activity represents 60000 units produced Variable cost (per unit): $ Materials 40 Direct labour 30 Royalties 2 Electricity 6 Maintenance 5 83 3. Fixed cost Depreciation 20000 Rent 120000 Indirect labour 80000

The budget and actual results for 2005 are shown as follows: Budgeted Actual Variance 60000 units 80000 units $ $ Sales revenue ($100 each) 6000000 8000000 2000000(F) Less: variable cost Materials 2400000 3201000 801000 (A) Labour 1800000 2500000 700000 (A) Royalties 120000 160000 40000(A) Electricity 360000 485000 125000 (A) Maintenance 300000 404000 104000 (A) Fixed overhead: Depreciation 20000 20500 500 (A) Rent 120000 160000 40000 (A) Indirect labour 80000 95000 15000 (A) 800000 974500 174500 (F) * F = favourable, A = Adverse variance

Required: Prepare a flexible budget based on the original budgeted unit costs and selling price With the use of the variances, reconcile the original budget profit with the actual profit

Fixed Flexible Actual Variance budget Budget results 60000 units 80000 units 80000 units (a) (b) ( c) ( c) – (b) $ $ $ $ Sales revenue ($100 each) 6000000 8000000 8000000 - Less: variable cost Materials 2400000 3200000 3201000 1000 (A) Labour 1800000 2400000 2500000 100000 (A) Royalties 120000 160000 160000 - Electricity 360000 480000 485000 5000 (A) Maintenance 300000 400000 404000 4000(A) Fixed overhead: Depreciation 20000 20000 20500 500 (A) Rent 120000 120000 160000 40000 (A) Indirect labour 80000 80000 95000 15000 (A) 800000 1140000 974500 165500 (F) 80000*budget units cost $340000 (F) Volume variance $165500 (A) Expenditure variance Total variance $174500 (F)

(b) The overall reconciliation of profit is shown as follows: $ $ $ $ Fixed budget profit 800000 Variances Sales volume ($100 - $83)*20000 340000 (F) Materials 1000(A) Labour 100000(A) Electricity 5000 (A) Maintenance 4000 (A) Depreciation 500(A) Rent 40000 (A) Indirect labour 15000 (A) 165000 (A) Actual profit 974500 According to the above variance analysis statement, the increase in actual profit is caused by the increase in sales volume However, the adverse cost variance show that there may have been a general price rise of expenditure or inefficient control of expenditure by departmental managers