CA Final, Paper 5,Advaced Management Accounting, Chapter 4 Dr. (CA) Sanjib Kumar Basu 1
Discuss the uses of budgets in planning and control Introduce the concept of Zero Based Budgeting Explain the procedures for the preparation of master budget and its various components Exhaustive illustration for the preparation of different types of budget 2
Budgets are useful in the planning process because they enhance communication and coordination. The process of developing a formal plan (budget) forces managers to consider carefully their goals and objectives and to specify means of achieving them. Budgets are useful in the control process because they provide a basis for evaluating performance (both management and operations). Often, performance evaluation is carried out by comparing actual performance with planned or budgeted performance. Significant deviations from planned performance are associated with three potential causes 3
Poorly conceived budgets. Business conditions may have changed Managers have done a particularly good or bad job managing operations 4
5
Budgets are prepared for departments, divisions, and the company as a whole. Often the group that is responsible for approval of the various budgets is the budget committee which includes the senior managers, president, CFO, various vice-presidents and controller. A top-down approach is where goals are pushed down from top management A bottom-up approach is where lower-level managers are the primary source of information used in setting the budget. 6
Before a budget can be prepared, managers must decide on an appropriate budget period. There are a wide variety of budgets ranging from months to several years or more. The key point is that there is an inverse relationship, generally, between the length of the budget period and the detail contained within the budget. 7
A common starting point for a budget is a prior period. These amounts are adjusted up or down based on current information and assumptions or estimates of what will happen in the future On the other hand, Zero Base Budgeting (ZBB) is a method of budget preparation which begins each period with a clean slate. Managers must start from zero and justify budgets every period. Although used in government, ZBB is not commonly used in for-profit organizations 8
The master budget is a comprehensive planning document that incorporates a number of individual budgets. These budgets include: Sales Production Direct Materials Direct Labour Manufacturing Overhead Selling and Administrative Capital Acquisitions Cash Receipts Cash Disbursements Budgeted Income Statement Budget Balance Sheet 9
The sales budget is the first step in the budget process. It comes first because other budgets cannot be prepared without an estimate of sales. For example, production estimates are based on forecast sales. Companies use a variety of methods to estimate sales. These estimates are calculated by various methods including econometric models, previous sales trends, trade journals and magazines, and sales force estimates. 10
Once the sales budget has been prepared, the production budget can be developed. Production forecasts are based on the following relationships: Finished units to be produced = expected sales in units + desired ending inventory of finished units beginning inventory of finished units. 11
The amount of direct materials that must be purchased depends on the amount needed for production and the amount need for ending inventory. The amount that must be purchased can be calculated as follows: Required purchases of direct materials = amount required for production + desired ending inventory of direct materials beginning inventory of direct materials. 12
The direct labor budget is generally calculated by multiplying the number of units to be produced by the labour hours per unit and the rate per hour. 13
Here the cost per unit of production of each variable cost item is multiplied by the quantity of units produced. Fixed costs remain relatively constant. 14
Although we have concentrated on production-related budgets, selling and administrative expense budgets include salaries, advertising, office expenses and other general expenses. 15
Much of the data for the budgeted income statement come from other budgets already prepared. For example, sales figures come from the sales budget. Cost of goods sold is based on unit cost of production (and the direct materials budget). The direct labor budget provides labour cost information. And the manufacturing overhead budget provides overhead cost information. 16
Acquisitions of capital assets such as property plant and equipment must be carefully planned because they consume substantial cash reserves. 17
In the Cash budget, managers plan the amount and timing of cash flows. This is a very important budget. And it is a necessary supplement to the budgeted income statement because the timing of cash inflows and outflows may diverge substantially from the recognition of revenues and expenses on an accrual-based income statement. 18
The last component of the master budget that we consider is the budgeted balance sheet. It is a function of all of the other budgets and is sometimes referred to as a pro-forma balance sheet. It is used to assess the effect of planned decisions on future financial position. 19
20
S. G. Ltd. produces two products A and B. The summarised Balance Sheet of the Company as at 31 st March, 2013is as under: Equities and Liabilities Amount (Rs.) Shareholders Fund Share Capital Reserve and Surplus Current Liabilities Trade Payables Provision for Income Tax 12,00,000 96,000 48,000 60,000 14,04,000 Assets Non-current Assets Fixed Assets (Net) Current Assets Inventory Trade Receivables Cash and Cash Equivalent 9,00,000 3,54,000 90,000 60,000 14,04,000 21
The following information has been furnished to you for the preparation of the budget for the year ending 31st March, 2014: 1. Sales forecast: Product A- 24,000 units @ Rs. 30 each Product B- 15,000 units @ Rs. 40 each 2. Raw Materials Products A B Material X @ Rs. 3 per Kg. 2 Kgs 4 kgs Material Y @ Re. 1 per Kg. 1 Kg. 2 Kgs 3. Direct Labour Department P: 2 Hours @ Re. 1 per hour for A 1 Hour @ Rs. 2 per hour for B Department Q: 1 hour @ Rs. 3 per hour for A 1 hour @ Rs. 3 per hour for B 22
4. Overhead Fixed Overheads per annum Dept. P (Rs.) Dept. Q (Rs.) Depreciation Others 48,000 96,000 12,000 30,000 Variable Overheads per hour 0.50 1.50 5. Inventories A. Raw materials X- 36,000 kgs. Y- 6, 000 kgs Closing Stock X- 48,000 Kgs. Y- 12,000 Kgs. - Rs. 1,14,000 23
B. Finished Goods- Opening Stock A- 600 units Rs. 2,40,000 B- 6,000 units Closing Stock A 6,600 units B 3,000 units 6. Selling, Distribution and Administration Expenses are estimated at Rs. 1,80,000 per annum. 7. The cost of raw material purchases, direct wages, factory overheads, selling, distribution and administrative overheads of the year will be met in full in cash during the year. 24
8. The estimated position of debtors and creditors as on 31st March, 2014 is Rs. 1,50,000 and 48,000 respectively. 9. Income tax provision standing at the beginning of the year will be paid during the year. Rate of Income tax is 30%. 10. At equipment purchased at Rs. 1,20,000 will be paid during the year. You are required to prepare for the year ending 31st March, 2014: (a) Cost of Goods Sold Budget (b) Cash Budget (c) Projected Balance Sheet as on 31st March, 2014 in the same format as given in the question. The detailed working for each of the above should be shown. 25
Working Notes; 1. Production Budget (in units) Particulars A B Sales 24,000 15,000 Add: Closing Stock 6,600 3,000 Total 30,600 18,000 Less: Opening Stock 600 6,000 Production 30,000 12,000 26
2. Direct Material Cost Particulars A (Rs.) B (Rs.) Total (Rs.) Material X @ Rs. 3 per Kg. 6 12 Material Y @ Re. 1 per Kg. 1 2 Material Cost per Unit (a) 7 14 Production Units (b) 30,000 12,000 Direct Material Cost (Rs.) (a x b) 2,10,000 1,68,000 3,78,000 27
3. Direct Labour Budget Particulars A 30,000 (Rs.) Dept P: 2 hrs @ Re. 1 per hour for A 2 B (Rs.) Total (Rs.) 1 hr @ Rs. 2 per hour for B 2 Dept Q: 1 hr @ Re. 3 per hour for A 3 1 hr @ Rs. 3 per hour for B 3 Direct Labour Cost per unit (a) 5 5 Production in Units (b) 30,000 12,000 Direct Labour Cost (Rs.) (a x b) 1,50,000 60,000 2,10,000 28
4. Direct Labour Hours Particulars Dept. P Dept. Q A: P= (30,000 x 2hrs); Q= B (30,00 x 1 hr) B: P= (12,000 x 1 hr); Q= (12,000 x 1 hr) 60,000 30,000 12,000 12,000 72,000 42,000 29
5. Overhead Recovery Rate Particulars Dept. P (Rs.) Dept. Q (Rs.) Fixed Overhead: Depreciation Others 48,000 96,000 12,000 30,000 Total 1,44,000 42,000 Direct Labours 72,000 42,000 Fixed Overhead Rate (per hour) (a) Variable Overhead Rate (per hour) (b) Total overhead Rate (per hour) (a + b) 2.00 1.00 0.50 1.50 2.50 2.50 30
6. Overhead Expenses Particulars Dept P (Rs.) Dept Q (Rs.) Total (Rs. ) Fixed (Other than Depreciation) Variable [ 72,000 x Re. 0.50; 42,000 x Rs. 1.50] Total Overhead (other than depreciation) (a) 96,000 30,000 36,000 63.000 1,32,000 93,000 2,25,000 Depreciation (b) 48,000 12,000 60,000 Total Overheads (a + b) 1,80,000 1,05,000 2,95,000 31
7. Cost Sheet Particulars Products A (Rs.) B (Rs.) Total (Rs.) Direct Material (per unit) Direct Wages (per unit) Overhead (per unit): Dept P Dept Q 7.00 5.00 5.00 2.50 14.00 5.00 2.50 2.50 Total Cost (per unit) (a) 19.50 24.00 Production (b) 30,000 12,000 Total Cost (a x b) 5,85,000 2,88,000 8,73,000 32
8. Sales Particulars Rs. A- 24,000 x Rs. 30 B- 15,000 x Rs 40 7,20,000 6,00,000 Total 13,20,000 33
9. Debtors Particulars Rs. Opening Balance 90,000 Add: Sales 13,20,000 Total 14,10,000 Less: Closing Balance 1,50,000 Cash Receipts 12,60,000 34
10. Raw Materials Particulars Materials Total X (Kg) Y (Kg) (Rs..) Consumption for A Consumption for B 60,000 48,000 30,000 24,000 Total Consumption 1,08,000 54,000 Add: Closing Stock 48,000 12,000 Total 1,56,000 66,000 Less: Opening Stock 36,000 6,000 Materials to be purchased 1,20,000 60,000 Purchase Price per Kg. Rs. 3 Re.1 Purchase Value (Rs.) 3,60,000 60,000 4,20,000 35
11. Creditors Particulars Rs. Opening Balance 48,000 Add: Purchases 4,20,000 Total 4,68,000 Less: Closing Balance 48,000 Amount Paid 4,20,000 36
12. Inventories as on 31.3.2014 Particulars Rs. Raw materials- X = 48,000 units @ Rs. 3 per unit 1,44,000 Raw materials- Y = 12,000 units @ Re. 1 per unit 12,000 Finished Goods- A = 6,600 units @ Rs. 19.50 per unit 1,56,000 1,28,700 Finished Goods- B = 3,000 units @ Rs. 24 per unit 72,000 2,00,700 37
13. Fixed Assets Particulars Rs. Opening values of Fixed Assets 9,00,000 Add: Additions 1,20000 Less: Depreciation 60,000 9,60,000 38
Solution (a): Cost of Goods Sold Budget Particulars Direct Materials (Note 2) Direct Wages (Note 3) Overheads (Note 6) Rs. 3,78,000 2,10,000 2,85,000 Total 8,73,000 Add: Opening Stock (Balance Sheet) 2,40,000 Total 11,13,000 Less: Closing Stock (Note 12) 2,00,700 Cost of Goods Sold 9,12,300 39
Solution (b): Cash Budget Particulars Rs. Opening Balance (Balance Sheet) 60,000 Add: Receipts (Note 9) 12,60,000 Total Receipts (A) 13,20,000 40
Solution (b): Cash Budget Particulars Less: Payments Creditors (Note 11) Direct Wages (Note 3) Overheads (Note 6) Selling, Distribution and Administration Expenses Income Tax Capital Expenditure Rs. 4,20,000 2,10,000 2,25,000 1,80,900 60,000 1,20,000 Total Payments (B) 12,15,900 Closing Balance (A- B) 1,04,100 41
Solution (c): Projected Balance Sheet as on March 31, 2014 Equities and Liabilities Shareholders Fund Share Capital Reserve and Surplus* Current Liabilities Trade Payables Provision for Income Tax Rs. 12,00,000 2,54,760 48,000 68,040 15,70,800 Assets Non- current Assets Fixed Assets (Net) Current Assets Inventories Trade Receivables Cash and cash Equivalent 9,60,000 3,56,700 1,50,000 1,04,100 15,70,800 42
Reserve and Surplus Sales (Note 8) Less: Cost of Goods Sold Particulars Gross Profit Less: Selling, Distribution and Administrative Expenses Profit before Tax Less: Provision for Tax (30%) Profit after Tax Add: Opening Balance of Reserve and Surplus Rs. 13,20,000 9,12,300 4,07,700 1,80,900 2,26,800 68,040 1,58,760 96,000 Closing Balance of Reserve and Surplus 2,54,760 43
Uses of budgets in planning and control Concept of Zero Based Budgeting Procedures for the preparation of master budget and its various components Exhaustive illustration for the preparation of different types of budget 44
45