Budgeting and budgetary control

Accounting A2 · Cost and management accounting. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

A budget is a financial plan for a future period. Budgets are prepared in a set order. The business starts with the limiting factor, usually sales demand, then prepares the production, purchases and labour budgets, then the trade receivables, trade payables and cash budgets. The master budget brings them together as a budgeted statement of profit or loss and statement of financial position.

Budgetary control means comparing actual results with the budget and acting on the differences. A fair comparison uses a flexed budget, which is the budget recalculated for the actual level of output.

Budgets help planning, co-ordination and control and can motivate staff. They take time, may demotivate if they are unrealistic, and are only as good as the forecasts.

Rules to remember

Production budget (units) = budgeted sales + closing inventory of finished goods − opening inventory of finished goods.
Materials used = production units × material per unit. Purchases budget = materials used + closing inventory of materials − opening inventory of materials.
Labour budget = production units × labour hours per unit × rate per hour.
Closing trade receivables = opening trade receivables + credit sales − cash received − discounts allowed.
A cash budget shows cash in the month it is received or paid. Depreciation and other non-cash items are left out.
Flexed budget: variable costs and revenue change in proportion to output; fixed costs stay the same.
Spreadsheets recalculate quickly and allow “what if” tests, but an error in one formula or input runs through every linked figure.

Common mistake

Students subtract the closing inventory and add the opening inventory in the production budget. Closing inventory must still be made, so it is added; opening inventory is already there, so it is subtracted.

Worked example

Budgeted sales for May are 6000 units. Finished goods inventory is 800 units at 1 May and must be 1100 units at 31 May. Each unit uses 3 kg of material costing $4 per kg. Material inventory is 2500 kg at 1 May and must be 3400 kg at 31 May. What is the materials purchases budget for May?

Production = 6000 + 1100 − 800 = 6300 units.
Materials used = 6300 × 3 kg = 18 900 kg.
Purchases = 18 900 + 3400 − 2500 = 19 800 kg.
Cost = 19 800 × $4 = $79 200.

Answer: The purchases budget for May is 19 800 kg, costing $79 200.

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