Topic 8: Budgeting

Dr Muhammad Iqmal Hisham Kamaruddin

Learning Outcome
At the end of this topic, students should be able to:
Explain the concept of budget, its purposes and types.
Prepare the several types of budget.
Budget
 Budgeting – process of planning future business actions and expressing them as formal plans.

 Budget – formal statement of a company’s plans in dollars.

 Budgetary control process – management’s use of budgets to see that planned objectives are met.
Benefits of Budgeting
Plan - focuses on future opportunities and
threats

Control - provides benchmark for evaluating

performance

Coordinate - activities of all employees and

departments to work toward the company’s
overall goals

Communicate - management specific

action plans to all employees

Motivate - budgeting performance levels

provide goals for employees to attain or
exceed
Budgeting and Human Behaviour
 Human behavior problems can arise in the budgeting process in the following situations:
 Budgeted goals are set too tight, which are very hard or impossible to achieve.
 Budgeted goals are set too loose, which are very easy to achieve (budgetary slack)
 Budgeted goals conflict with the objectives of the company and employees.
Budgeting System
 The budgetary period for operating activities normally includes the fiscal year of a company.
 For control purposes, annual budgets are usually subdivided into shorter time periods, such as
quarters of the year, months, or weeks.
 A variation of fiscal-year budgeting, called continuous budgeting, maintains a 12-month
projection into the future.
 The 12-month budget is continually revised by replacing the data for the month just ended with
the budget data for the same month in the next year
Budgeting System
 Developing an annual budget usually begins several months prior to the end of the current year.
 There are several methods of developing budget estimates:
 Zero-based budgeting: requires managers to estimate sales, production, and other operating
data as though operations are being started for the first time.
 Common budgeting: start with last year’s budget and revise it for actual results and expected
changes for the coming year (static budget and flexible budget).
Static Budget
 A static budget shows the expected results of a
responsibility center for only one activity level.
Once the budget has been determined, it is not
changed, even if the activity changes.
 Static budgeting is used by many service
companies, government entities, and for some
functions of manufacturing companies, such as
purchasing, engineering, and accounting.
 A disadvantage of static budgets is that they
do not adjust for changes in activity levels.
Flexible Budget
 Flexible budgets show the expected results of a
responsibility center for several activity levels.
 It is series of static budgets for different levels
of activity.
 Because the flexible budget adjusts for changes
in the level of activity, it is much more accurate
and useful than the static budget.
Static Budget vs. Flexible Budget
 Quick Test
At the beginning of the period, the Landon Awards Enterprise has budgeted labor costs of RM45,000
and supervisor salaries of RM30,000 for 5,000 hours of processing and packaging jobs. It actually
completed 6,000 hours of the jobs. Determine the budget for the business, assuming that it uses
flexible budgeting.
Master Budget
Sales Budget - Scenario
Elite Sports Enterprise is a small merchandising firm that sells sport equipment and accessories.
Elite Sports estimates the following sales volumes for January, February and March, 2018.

The unit-selling price is RM400 each. Sales in December last year were 2,570 units, and forecasted
sales for April are 3,000 units.
Sales Budget
Purchases, Inventory & Cost of Goods Sold
Budgets
 The budgeted amounts for purchases, inventory and cost of goods sold are integrated into a
single budget, which is the purchases budget.
 The budgeted volume of purchases are computed as follows:
Purchases, Inventory & Cost of Goods Sold
Budgets - Scenario
At the end of each month, Elite Sports Enterprise decides to have on hand inventory at a
minimum of 70% of the expected cost of goods sold for the following month.
The cost of goods sold averages 50% of sales.
The budgeted cost of goods sold and desired ending inventory are combined together in the
computation for purchases budget.
Purchases, Inventory & Cost of Goods Sold
Budgets

From Sales Budget Unit Sold April 3,000

COGS January 540,000
Unit Selling Price 400
Desired Ending Inventory % 70%
Sales 1,200,000
Desired Ending Inventory 378,000
COGS April (50%) 600,000
Desired Ending Inventory (70%) 420,000
 Quick Test
Landon Awards Enterprise projected sales of 45,000 brass plaques for 2018. The estimated January 1,
2018, inventory is 3,000 units, and the desired December 31, 2018 inventory is 5,000 units. What are
the budgeted purchases (in units) for 2018?
Selling and Administrative Expenses Budget -
Scenario
Assume that Elite Sports Enterprise pays salaries of RM20,000 at the end of every month, and
gives the commissions equal to 15% of sales. Other expenses include:

0.2%

0.1%
Selling and Administrative Expenses
Budget

From Sales Budget

Statement of Profit or Loss Budget
 The Statement of Profit or Loss Budget is prepared by integrating the following budgets:
 Sales budget
 Purchases budget
 Selling and administrative expenses budget

 In addition, estimates of other income, other expense, and income tax are also integrated into
this budget.
 This budget summarizes the budgeted operating activities of the company.
Statement of Profit or Loss Budget
Elite Sports Enterprise
Statement of Profit or Loss Budget
For the Three Months Ending March 31, 2018
Sales Budget
RM RM
Revenue from sales (from Exhibit 9) 3,290,000
Cost of goods sold (from Exhibit 10) (1,645,000)
Cost of Goods
Sold Budget
Gross profit 1,645,000
Selling and Administrative expenses:
Selling expenses (from Exhibit 11) 589,300 Selling & Administration
Administrative expenses (from Exhibit 11) 116,900 Expenses Budget
(706,200)
Income from operations 938,800
Other expense:
Interest expense (from Exhibit 16) (24,825) Cash Budget
Net Income 913,975
Cash Budget
 The cash budget estimates the expected receipts (inflows) and payments (outflows) of cash for a
period of time.
 Cash budget can be affected by the various operating budgets like the sales and purchases
budgets, as well as the capital expenditures budget, dividend policies and plans for equity or debt
financing.
 To prepare cash budget, we begin by developing the estimated cash receipts and estimated cash
payments portion of the cash budget.
Estimated Cash Receipts
 The primary source of estimated cash receipts is from cash sales and collections on account
(credit sales).
 In addition, cash receipts may be obtained from plans to issue equity or debt financing as well
as other sources such as interest revenue.
 To estimate cash receipts from cash sales and collections on account, a schedule of collections
from sales is prepared.
 The budgeted cash collected for any month is the sum of the cash collected from previous
month’s sales and the cash collected from current month’s sales.
Estimated Cash Receipts - Scenario
Assume the following data for Elite Sports Enterprise:

Elite expects to sell 10% of its merchandises for cash.

The remaining 90% will be credit sales, in which 60% are expected to be collected in the month of
the sale and the other 40% in the following month after sales.
 Estimated Cash Receipts
January February March
Receipts from cash sales:
Cash sales (10% x current
month’s sales RM108,000 RM124,000 RM 97,000
Receipts from sales on account:
Collections from prior month’s
sales (40% of previous month’s
credit sales RM370,000 RM388,800 RM446,400
Collections from current
month’s sales (60%) RM583,200 RM669,600 RM523,800

Total Cash Receipts RM1,061,200 RM1,182,300 RM1,067,200

From Sales Budget RM370,000 = Account Receivable Balance RM583,200 = RM1,080,000 x 90% x 60%
RM388,800 = RM1,080,000 x 90% x 40% RM669,600 = RM1,240,000 x 90% x 60%
RM446,400 = RM1,240,000 x 90% x 40% RM523,800 = RM970,000 x 90% x 60%
Estimated Cash Payments
 Estimated cash payments are planned reductions in cash for operating costs and expenses
such as cost of goods purchased, selling and administrative expenses.
 In addition, estimated cash payments may be planned for capital expenditures, dividends,
interest payments, or long-term debt payments.
 To estimate cash payments for purchases, a schedule of payments for cost of goods purchased
is prepared.
Estimated Cash Payments - Scenario
Assume the following data for Elite Sports Enterprise:
The balance of accounts payable on January 1, 2018 was RM133,050 incurred for merchandise
purchases.
Elite expects to pay 75% of purchases in the current month and the remaining is payable in the
following month.

The budgeted cash payments for any period are the sum of the cash paid from the purchase costs
in the current period (75%) and the cash paid from purchase costs in the previous period (25%).
 Estimated Cash Payments

Unit Sold December 2,570

Unit Selling Price 400
Sales 1,028,000 RM149,000 = RM596,000 x 25%
RM131,375 = RM525,500 x 25%
COGS December (50% Sales) 514,000
(+) Ending Inventory (70% Jan) 378,000
(-) Beginning Inventory (70% Dec) (359,800)
From Sales Budget Purchase December 532,200
January Payment (25% Dec) 133,050
Completing Cash Budget
 We need to estimate other payments.
 Payments for selling & administrative expenses are based on the selling & administrative
expense budget but excluding noncash items like depreciation & prepaid expenses.
Completing Cash Budget - Scenario
Assume the following data for Elite Sports Enterprise:

Short term loan is available from the local bank at an interest rate of 10% per annum. So Elite can
borrow or repay loans in multiples of RM1,000.
Completing Cash Budget
 The cash budget is structured for a budget period as follows:

 The total available cash balance and the total cash needed will determine whether cash
financing is required.
 Borrowing is necessary when cash available plus cash receipts are less than cash payments.
Completing Cash Budget
Estimated Cash Receipts

Estimated Cash Payments

Selling & Administration

Expenses Budget
 Quick Test
Landon Awards Enterprise collects 25% of its sales on account in the month of the sale and 75% in the
month following the sale. If sales on account are budgeted to be RM100,000 for March and
RM126,000 for April, what are the budgeted cash receipts from sales on account for April?
Capital Expenditure Budget
 The capital expenditures budget summarizes plans for acquiring fixed assets.
 Capital expenditures budgets are often prepared for five to ten years into the future.
Statement of Financial Position Budget
 The budgeted statement of financial position is prepared based on the operating and financial
budgets of the master budget.
 It is dated as of the end of the budget period and is similar to a normal statement of financial
position except that estimated amounts are used.
 If the statement indicates a weakness in financial position, revising the financing plans or other
plans may be necessary.