3 Define Budget and Review All Budget Information

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Affiliate 4 - Monetary control

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Chapter objectives
Construction of the affiliate
Budgetary control methods
Direction activeness and cost control
Nothing base budgeting (ZBB)
Fundamental terms

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There are 2 types of control, namely budgetary and financial. This chapter concentrates on monetary control only. This is because financial control was covered in detail in chapters one and two. Budgetary control is defined past the Institute of Cost and Management Accountants (CIMA) equally:

"The establishment of budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with approaching results, either to secure by individual activity the objective of that policy, or to provide a footing for its revision".

Chapter objectives

This chapter is intended to provide:

· An indication and explanation of the importance of budgetary control in marketing as a key marketing control technique

· An overview of the advantages and disadvantages of budgeting

· An introduction to the methods for preparing budgets

· An appreciation of the uses of budgets.

Structure of the chapter

Of all business activities, budgeting is one of the nearly important and, therefore, requires detailed attending. The chapter looks at the concept of responsibleness centres, and the advantages and disadvantages of budgetary command. Information technology then goes on to expect at the detail of budget construction and the use to which budgets can be put. Like all management tools, the chapter highlights the need for detailed information, if the technique is to be used to its fullest advantage.

Budgetary control methods

a) Budget:

· A formal statement of the financial resources set bated for carrying out specific activities in a given flow of time.

· It helps to according the activities of the organization.

An example would be an advertising upkeep or sales strength budget.

b) Budgetary control:

· A control technique whereby bodily results are compared with budgets.

· Any differences (variances) are made the responsibility of key individuals who tin either exercise control activity or revise the original budgets.

Budgetary command and responsibility centres;

These enable managers to monitor organisational functions.

A responsibility eye can be divers every bit any functional unit headed by a manager who is responsible for the activities of that unit of measurement.

There are four types of responsibility centres:

a) Revenue centres

Organisational units in which outputs are measured in budgetary terms just are non straight compared to input costs.

b) Expense centres

Units where inputs are measured in monetary terms but outputs are non.

c) Profit centres

Where functioning is measured by the difference between revenues (outputs) and expenditure (inputs). Inter-departmental sales are frequently made using "transfer prices".

d) Investment centres

Where outputs are compared with the avails employed in producing them, i.e. ROI.

Advantages of budgeting and monetary control

In that location are a number of advantages to budgeting and budgetary control:

· Compels management to think about the future, which is probably the most important feature of a budgetary planning and control system. Forces direction to look ahead, to set out detailed plans for achieving the targets for each department, operation and (ideally) each director, to conceptualize and give the system purpose and direction.

· Promotes coordination and communication.

· Clearly defines areas of responsibility. Requires managers of upkeep centres to be fabricated responsible for the achievement of budget targets for the operations under their personal control.

· Provides a basis for operation appraisal (variance analysis). A budget is basically a yardstick against which actual performance is measured and assessed. Control is provided by comparisons of actual results confronting upkeep plan. Departures from upkeep can then be investigated and the reasons for the differences tin can exist divided into controllable and not-controllable factors.

· Enables remedial action to be taken every bit variances emerge.

· Motivates employees by participating in the setting of budgets.

· Improves the allotment of scarce resource.

· Economises direction fourth dimension by using the management by exception principle.

Issues in budgeting

Whilst budgets may be an essential part of whatsoever marketing activeness they practice accept a number of disadvantages, particularly in perception terms.

· Budgets can be seen every bit pressure devices imposed by management, thus resulting in:

a) bad labour relations
b) inaccurate record-keeping.

· Departmental conflict arises due to:

a) disputes over resource allocation
b) departments blaming each other if targets are not attained.

· Information technology is difficult to reconcile personal/individual and corporate goals.

· Waste product may arise as managers prefer the view, "we had better spend it or we volition lose it". This is often coupled with "empire building" in order to raise the prestige of a department.

Responsibleness versus decision-making, i.e. some costs are under the influence of more than one person, e.g. ability costs.

· Managers may overestimate costs so that they volition not be blamed in the future should they overspend.

Characteristics of a budget

A good upkeep is characterised by the following:

· Participation: involve as many people every bit possible in drawing up a budget.
· Comprehensiveness: comprehend the whole arrangement.
· Standards: base it on established standards of performance.
· Flexibility: let for irresolute circumstances.
· Feedback: constantly monitor performance.
· Analysis of costs and revenues: this tin can be done on the ground of production lines, departments or cost centres.

Upkeep organisation and administration:

In organising and administering a budget system the following characteristics may employ:

a) Budget centres: Units responsible for the grooming of budgets. A budget eye may cover several cost centres.

b) Upkeep committee: This may consist of senior members of the organisation, e.g. departmental heads and executives (with the managing director as chairman). Every function of the arrangement should be represented on the committee, so there should exist a representative from sales, production, marketing and and so on. Functions of the budget committee include:

· Coordination of the grooming of budgets, including the issue of a manual
· Issuing of timetables for preparation of budgets
· Provision of information to assistance upkeep preparations
· Comparison of actual results with upkeep and investigation of variances.

c) Budget Officer: Controls the budget administration The job involves:

· liaising between the budget committee and managers responsible for budget training
· dealing with budgetary control problems
· ensuring that deadlines are met
· educating people near budgetary control.

d) Budget transmission:

This document:

· charts the system
· details the budget procedures
· contains account codes for items of expenditure and revenue
· timetables the procedure
· clearly defines the responsibility of persons involved in the budgeting system.

Upkeep preparation

Firstly, determine the principal budget factor. This is also known as the key budget factor or limiting upkeep factor and is the cistron which will limit the activities of an undertaking. This limits output, due east.thousand. sales, material or labour.

a) Sales upkeep: this involves a realistic sales forecast. This is prepared in units of each production and also in sales value. Methods of sales forecasting include:

· sales force opinions
· market research
· statistical methods (correlation analysis and exam of trends)
· mathematical models.

In using these techniques consider:

· company'southward pricing policy
· general economic and political conditions
· changes in the population
· contest
· consumers' income and tastes
· advertising and other sales promotion techniques
· after sales service
· credit terms offered.

b) Production upkeep: expressed in quantitative terms only and is geared to the sales budget. The product manager'south duties include:

· analysis of establish utilisation
· work-in-progress budgets.

If requirements exceed capacity he may:

· subcontract
· plan for overtime
· introduce shift work
· rent or buy additional machinery
· The materials purchases budget's both quantitative and fiscal.

c) Raw materials and purchasing budget:

· The materials usage upkeep is in quantities.
· The materials purchases upkeep is both quantitative and financial.

Factors influencing a) and b) include:

· production requirements
· planning stock levels
· storage space
· trends of material prices.

d) Labour budget: is both quantitative and financial. This is influenced past:

· product requirements
· man-hours available
· grades of labour required
· wage rates (union agreements)
· the need for incentives.

e) Cash budget: a cash plan for a defined catamenia of time. Information technology summarises monthly receipts and payments. Hence, information technology highlights monthly surpluses and deficits of actual cash. Its main uses are:

· to maintain command over a house's cash requirements, e.thou. stock and debtors

· to enable a business firm to take precautionary measures and conform in advance for investment and loan facilities whenever cash surpluses or deficits arises

· to show the feasibility of management'south plans in cash terms

· to illustrate the financial bear upon of changes in management policy, eastward.one thousand. alter of credit terms offered to customers.

Receipts of cash may come from one of the following:

· greenbacks sales
· payments by debtors
· the sale of stock-still assets
· the issue of new shares
· the receipt of interest and dividends from investments.

Payments of cash may exist for one or more than of the post-obit:

· purchase of stocks
· payments of wages or other expenses
· purchase of upper-case letter items
· payment of involvement, dividends or taxation.

Steps in preparing a cash upkeep

i) Step 1: ready out a pro forma cash budget calendar month past month. Beneath is a suggested layout.

		Month one	Month 2	Month 3
		$	$	$
Cash receipts
	Receipts from debtors
	Sales of majuscule items
	Loans received
	Proceeds from share issues
	Whatever other cash receipts
Greenbacks payments
	Payments to creditors
	Wages and salaries
	Loan repayments
	Majuscule expenditure
	Taxation
	Dividends
	Any other cash expenditure
Receipts less payments
Opening cash balance b/f		W	X	Y
Closing cash balance c/f		X	Y	Z

ii) Step 2: sort out cash receipts from debtors

three) Step 3: other income

iv) Step four: sort out cash payments to suppliers

v) Step 5: establish other cash payments in the month

Figure 4.1 shows the composition of a master budget analysis.

Effigy 4.ane Limerick of a main budget

OPERATING BUDGET	FINANCIAL BUDGET
consists of:-	consists of
Budget P/L acc: go:	Cash budget
Production budget	Rest sheet
Materials upkeep	Funds statement
Labour upkeep
Admin. upkeep
Stocks budget

f) Other budgets:

These include budgets for:

· assistants
· research and development
· selling and distribution expenses
· capital letter expenditures
· working capital (debtors and creditors).

The master budget (figure 4.1) illustrates this. Now try exercise iv.ane.

Practice 4.one Budgeting I

Draw up a cash budget for D. Sithole showing the rest at the end of each calendar month, from the following data provided by her for the half dozen months ended 31 December 19X2.

a) Opening Cash $ ane,200.

	19X2										19X3
Sales at $20 per unit of measurement	MAR	Apr	MAY	JUN	JUL	AUG	SEP	Oct	November	December	January	FEB
	260	200	320	290	400	300	350	400	390	400	260	250

Greenbacks is received for sales after 3 months post-obit the sales.

c) Production in units: 240

270

300

320

350

370

380

340

310

260

250

d) Raw materials toll $5/unit of measurement. Of this fourscore% is paid in the month of product and 20% afterwards production.

e) Direct labour costs of $viii/unit are payable in the calendar month of production.

f) Variable expenses are $2/unit. Of this 50% is paid in the same month as production and 50% in the month following production.

one thousand) Fixed expenses are $400/month payable each month.

h) Machinery costing $2,000 to be paid for in Oct 19X2.

i) Volition receive a legacy of $ two,500 in December 19X2.

j) Drawings to be $300/month.

An example

A saccharide cane farm in the Lowveld district may devise an operating budget equally follows:

· Tillage
· Irrigation
· Field maintenance
· Harvesting
· Transportation.

With each operation, there volition be costs for labour, materials and machinery usage. Therefore, for e.g. harvesting, these may include four resources, namely:

· Labour:

-cut
-sundry

· Tractors
· Cane trailers
· Implements and sundries.

Having identified cost centres, the next step will be to brand a quantitative calculation of the resources to exist used, and to further break this down to shorter periods, say, one month or three months. The length of period chosen is important in that the shorter it is, the greater the control that tin can be exercised by the budget but the greater the expense in preparation of the upkeep and reporting of any variances.

The quantitative budget for harvesting may be calculated as shown in figure 4.2.

Figure 4.two Quantitative harvesting upkeep

Harvesting	1st quarter	2nd quarter	3rd quarter	fourth quarter
Labour
Cutting	nil	9,000 tonnes	16,000 tonnes	10,000 tonnes
Sundry	nil	300 man days	450 man days	450 man days
Tractors	nil	630 hours	1,100 hours	700 hours
Cane trailers	nil	9,000 tonnes	16,000 tonnes	10,000 tonnes
Imp, & sundries	nil	nine,000 tonnes	16,000 tonnes	10,000 tonnes

Each item is measured in different quantitative units - tonnes of cane, human being days etc.-and depends on individual judgement of which is the all-time unit to use.

Once the upkeep in quantitative terms has been prepared, unit costs tin can then be allocated to the private items to arrive at a budget for harvesting in financial terms every bit shown in tabular array four.2.

Charge out costs

In tabular array four.2 tractors accept a unit of measurement cost of $7.l per hour - machines like tractors take a whole range of costs like fuel and oil, repairs and maintenance, driver, licence, road tax and insurance and depreciation. Some of the costs are fixed, east.g. depreciation and insurance, whereas some vary directly with utilise of the tractor, e.m. fuel and oil. Other costs such as repairs are unpredictable and may exist very loftier or depression - an estimated figure based on past feel.

Figure 4.three Harvesting cost budget

Item harvesting	Unit cost	1st quarter	second quarter	tertiary quarter	fourth quarter	Total
Labour
Cut	$0.75 per tonne	-	6,750	12,000	7,500	26,250
Sundry	$2.50 per day	-	750	1,125	i,125	three,000
Tractors	$7.fifty per hour	-	4,725	8,250	5,250	18,225
Cane Trailers	$0.15 per tonne	-	1,350	ii,400	ane,500	5,250
Imp. & sundries	$0.25 per tonne	-	two,250	4,000	two,500	8,750
		-	$xv,825	$27,775	$17,875	$61,475

So, overall operating cost of the tractor for the yr may be approaching as shown in effigy four.4.

If the tractor is used for more than than ane,000 hours then there will be an over-recovery on its operational costs and if used for less than 1,000 hours there will be under-recovery, i.due east. in the first instance making an internal 'profit' and in the 2nd a 'loss'.

Effigy iv.iv Tractor costs

		Unit rate	Cost per annum (one,000 hours)
		($)	($)
Fixed costs	Depreciation	2,000.00	2,000.00
	Licence and insurance	200.00	200.00
	Driver	100.00 per month	1,200.00
	Repairs	600.00 per annum	600.00
Variable costs	Fuel and oil	two.00 per 60 minutes	2,000.00
	Maintenance	3.00 per 200 hours	1,500.00
			seven,500.00
	No. of hours used		ane,000.00
	Cost per hr		7.l

Primary budget

The master budget for the sugar cane farm may be equally shown in figure four.5. The budget represents an overall objective for the subcontract for the whole twelvemonth alee, expressed in financial terms.

Table 4.5 Operating budget for sugar pikestaff subcontract 19X4

		1st quarter	second quarter	3rd quarter	4th quarter	Total $
Revenue from pikestaff			130,000	250,000	120,000	500,000
Less: Costs
	Cultivation	37,261	48,268	42,368	55,416	183,313
	Irrigation	7,278	15,297	18,473	11,329	52,377
	Field maintenance	iv,826	12,923	15,991	vii,262	41,002
	Harvesting	-	15,825	27,775	17,875	61,475
	Transportation	-	14,100	24,750	15,750	54,600
		49,365	106,413	129,357	107,632	392,767
Add: Opening valuation		85,800	135,165	112,240	94,260	85,800
		135,165	241,578	241,597	201,892	478,567
Less: Closing valuation		135,165	112,240	94,260	xc,290	90,290
Net ingather price		-	129,338	147,337	111,602	388,277
Gross surplus		-	66,200	102,663	8,398	111,723
Less: Overheads		5,876	7,361	7,486	five,321	26,044
Net profitless)		(v,876)	(6,699)	95,177	three,077	85,679

One time the operating budget has been prepared, two further budgets can be washed, namely:

i. Remainder sheet at the cease of the year.

ii. Cash menstruum budget which shows the amount of cash necessary to support the operating budget. Information technology is of great importance that the business has sufficient funds to support the planned operational budget.

Reporting back

During the year the management auditor will fix statements, as apace every bit possible after each operating menstruation, in our example, each quarter, setting out the actual operating costs against the approaching costs. This statement volition calculate the departure between the 'budgeted' and the 'actual' cost, which is called the 'variance'.

There are many ways in which management accounts can exist prepared. To continue with our case of harvesting on the carbohydrate cane farm, management accounts at the terminate of the 3rd quarter can exist presented as shown in figure four.6.

Figure iv.6 Direction accounts - actual costs against upkeep costs Management accounts for sugar pikestaff farm 3rd quarter 19X4

Detail Harvesting		third quarter			Year to date
		Actual	Upkeep	Variance	Bodily	Upkeep	Variance
Labour
	- Cutting	12,200	12,000	(200)	xix,060	eighteen,750	(310)
	- Sundry	742	1,125	383	1,584	1,875	291
Tractors		ix,375	8,250	(1,125)	thirteen,500	12,975	(525)
Cane trailers		1,678	2,400	722	2,505	3,750	1,245
Imp & sundries		four,270	4,000	(270)	6,513	half-dozen,250	(263)
		28,265	27,775	(490)	43,162	43,600	438

Here, actual harvesting costs for the 3rd quarter are $28,265 confronting a budget of $27,775 indicating an increment of $490 whilst the cumulative figure for the year to date shows an overall saving of $438. It appears that actual costs are less than budgeted costs, and so the harvesting operations are proceeding within the budget set and satisfactory. However, a further await may reveal that this may not be the case. The upkeep was based on a cane tonnage cut of sixteen,000 tonnes in the third quarter and a cumulative tonnage of 25,000. If these tonnages take been achieved then the statement will be satisfactory. If the actual product was much higher than budgeted then these costs represent a very considerable saving, even though only a marginal saving is shown by the variance. Similarly, if the bodily tonnage was significantly less than approaching, then what is indicated as a marginal saving in the variance may, in fact, be a considerable overspending.

Price and quantity variances

Just to state that there is a variance on a particular particular of expenditure does non really mean a lot. Most costs are composed of two elements - the quantity used and the price per unit of measurement. A variance between the actual cost of an item and its budgeted toll may exist due to one or both of these factors. Credible similarity between budgeted and actual costs may hide pregnant compensating variances between price and usage.

For example, say it is approaching to take 300 man days at $3.00 per man day - giving a full budgeted cost of $900.00. The actual cost on completion was $875.00, showing a saving of $25.00. Further investigations may reveal that the job took 250 man days at a daily charge per unit of $3.50 - a favourable usage variance only a very unfavourable cost variance. Management may therefore need to investigate some significant variances revealed by further analysis, which a comparison of the total costs would not have revealed. Cost and usage variances for major items of expense are discussed beneath.

Labour

The difference between actual labour costs and budgeted or standard labour costs is known as directly wages variance. This variance may arise due to a difference in the amount of labour used or the toll per unit of labour, i.e. the wage rate. The direct wages variance tin can be split into:

i) Wage charge per unit variance: the wage rate was higher or lower than approaching, e.g. using more unskilled labour, or working overtime at a college rate.

ii) Labour efficiency variance: arises when the bodily time spent on a particular job is higher or lower than the standard labour hours specified, e.g. breakdown of a motorcar.

Materials

The variance for materials cost could likewise be split into price and usage elements:

i) Fabric toll variance: arises when the actual unit of measurement toll is greater or lower than approaching. Could be due to inflation, discounts, culling suppliers etc.

ii) Material quantity variance: arises when the actual corporeality of material used is greater or lower than the amount specified in the upkeep, e.g. a budgeted fertiliser at 350 kg per hectare may be increased or decreased when the actual fertiliser is applied, giving rising to a usage variance.

Overheads

Again, overhead variance can exist split into:

i) Overhead volume variance: where overheads are taken into the price centres, a production higher or lower than budgeted will cause an over-or under-absorption of overheads.

two) Overhead expenditure variance: where the actual overhead expenditure is college or lower than that approaching for the level of output actually produced.

Calculation of price and usage variances

The price and usage variance are calculated every bit follows:

Price variance = (budgeted price - bodily price) Ten actual quantity
Usage variance = (approaching quantity - bodily quantity) X budgeted cost

Now attempt practise 4.two.

Exercise 4.2 Computation of labour variances

Information technology was budgeted that information technology would take 200 man days at $10.00 per twenty-four hours to complete the task costing $2,000.00 when the actual toll was $1,875.00, being 150 man days at $12.50 per day. Calculate:

i) Price variance
ii) Usage variance

Comment briefly on the results of your adding.

Direction activity and toll control

Producing information in management accounting form is expensive in terms of the time and endeavour involved. It volition exist very wasteful if the information one time produced is not put into constructive use.

There are v parts to an effective cost control system. These are:

a) preparation of budgets

b) communicating and agreeing budgets with all concerned

c) having an accounting organization that will record all actual costs

d) preparing statements that will compare bodily costs with budgets, showing whatsoever variances and disclosing the reasons for them, and

e) taking any appropriate action based on the analysis of the variances in d) higher up.

Action(s) that tin exist taken when a significant variance has been revealed will depend on the nature of the variance itself. Some variances tin be identified to a specific department and information technology is inside that department's control to have cosmetic activity. Other variances might bear witness to be much more difficult, and sometimes impossible, to control.

Variances revealed are historic. They show what happened last month or last quarter and no amount of analysis and discussion can alter that. However, they can be used to influence managerial activeness in futurity periods.

Zero base budgeting (ZBB)

Later a budgeting organization has been in operation for some time, there is a tendency for side by side yr's budget to be justified by reference to the bodily levels beingness achieved at nowadays. In fact this is part of the financial analysis discussed so far, but the proper analysis procedure takes into account all the changes which should bear on the futurity activities of the company. Fifty-fifty using such an analytical base, some businesses detect that historical comparisons, and particularly the current level of constraints on resources, can inhibit really innovative changes in budgets. This can cause a severe handicap for the business because the budget should be the commencement year of the long range plan. Thus, if changes are not started in the budget period, it volition be difficult for the business to make the progress necessary to achieve longer term objectives.

Ane way of breaking out of this cyclical budgeting problem is to become dorsum to basics and develop the budget from an supposition of no existing resources (that is, a zero base). This means all resources will take to be justified and the chosen way of achieving any specified objectives will take to be compared with the alternatives. For example, in the sales area, the current existing field sales force will be ignored, and the optimum fashion of achieving the sales objectives in that particular marketplace for the particular goods or services should exist developed. This might not include whatsoever field sales force, or a different-sized team, and the company then has to plan how to implement this new strategy.

The obvious problem of this aught-base budgeting process is the massive amount of managerial time needed to behave out the exercise. Hence, some companies carry out the full process every v years, simply in that twelvemonth the business can nearly grind to a halt. Thus, an culling way is to look in depth at one area of the business each year on a rolling ground, then that each sector does a zero base of operations budget every five years or so.

Key terms

Budgeting
Budgetary control
Budget preparation
Management action and cost control
Master budget
Cost and quantity variance
Responsibleness centres
Zero based budgeting

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