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Topic 9

Topic 9. Budgeting PowerPoint presentation by AFSH University Putra Malaysia. Learning Objectives. Outline the benefits and essential elements of effective budgeting. Identify and describe the components of the master budget. Explain and prepare the various type of budgets.

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Topic 9

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  1. Topic 9 Budgeting PowerPoint presentation by AFSH University Putra Malaysia

  2. Learning Objectives • Outline the benefits and essential elements of effective budgeting. • Identify and describe the components of the master budget. • Explain and prepare the various type of budgets.

  3. Budgeting Basics • A budget is a formal written statement of management’s plan for specified future time period, expressed in financial terms. • The budget is used as a basis for: • Controlling operations • Evaluating performance • A budget promotes efficiency and serves to deter waste and inefficiency.

  4. Benefits of Budgeting • Requires management to plan ahead. • Provides definite financial objectives for all levels of responsibility. • Creates an early warning system for problems. • Facilitates coordination of activities. • Results in greater management awareness of operations and external factors. • Contributes to positive behaviour patterns.

  5. Essentials of Effective Budgeting • Clearly defined areas of authority and responsibility. • Realistic goals. • Acceptance by all levels of management. • Participation by managers in setting budgets. • Review of differences between actual and expected results.

  6. The Budgeting Process • The development of next year’s budget begins before end of current year. • The budget starts with a sales forecast which should consider: • General economic conditions • Industry trends • Market research studies • Anticipated advertising and promotion • Previous market share • Changes in prices • New products • Technological developments

  7. Budgeting and Long-Range Planning • Long-range planning is a formalised process of • Selecting strategies to achieve long-term goals, and • Developing policies and plans to implement the strategies • Usually encompasses 3–5 years. • Long-range budgets • Contain less detail than annual budgets • Have a strategic emphasis

  8. The Master Budget • The master budget is a set of interrelated budgets. • It consists of: • Operating budgets (sales and production) which lead to the budgeted income statement. • Financial budgets (cash budget and budgeted balance sheet) that are concerned with cash resources for expected operations and capital expenditure.

  9. Preparing The Operating Budgets • Sales budget • Production budget • Direct materials budget • Direct labour budget • Manufacturing overhead budget • Selling and administration expense budget • Cash budget

  10. Sales Budget • This budgetis based on the forecast of sales revenue for the budget period. • It acts a starting point for master budget. • It shows expected unit sales volume times anticipated unit selling price. • It sets activity levels for other functions (e.g. production, purchasing).

  11. Exercise- Sales Budget Quick Electronics Ltd produces and sells tow models of pocket calculators, XQ-103 and XQ-104. The calculators sell for $12 and $20, respectively. Because of the intense competition Quick faces, management budgets sales semi-annually. Its projections for the first 2 quarters of 2006 are as follows: Unit Sales Product Quarter 1Quarter 2 XQ-103 45,000 40,000 XQ-104 18,000 20,000 No changes in selling prices are anticipated. Prepare a sales budget for the 2 quarters ending 30June 2006. list the products and show for each quarter and for the 6 months, units, selling price, and total sales by product and in total.

  12. Production Budget • This budget shows the units to be produced in order to meet expected sales. • It involves realistic estimates in order to avoid insufficient or excessive ending inventory.

  13. Exercise- Production Budget Bina Kuat Ent produces and sales two types of car batteries, the heavy duty HD-240 and the long-life LL-250. The 2006 sales budget for the two products is as follows: QuarterHD-240LL-250 1 7,000 12,000 2 9,000 20,000 3 10,000 22,000 4 12,000 40,000 The 1 January 2006 inventory of HD-240 and LL-250 units is 4200 and 7200 respectively. Management desires an ending inventory each quarter equal to 60% of the next quarter’s sales. Sales in the first quarter of 2007 are expected to be 30% higher than sales in the same quarter in 2006. Required: Prepare separate quarterly production budgets for each product by quarters for 2006.

  14. Direct Materials Budget • This budgetestimates quantity and cost of materials to be purchased. • Budgeted cost of direct materials is calculated by multiplying required units of material times anticipated cost per unit.

  15. Exercise- Direct Material Budget Kuih Raya Industries has adopted the following production budget for the first 4 months of 2007. MonthPacketsMonthPackets January 10,000 March 6,000 February 8,000 April 4,000 Each packets requires 5 kg of raw materials costing $1.5 per kg. On 31 December, 2006, the ending raw materials inventory was 25,000 kg. Management wants to have a raw materials ending inventory at the end of each month equal to 50% of next month’s production requirements. Required Prepare a direct materials budget by months for the first quarter.

  16. Direct Labour Budget • This budgetestimates quantity (hours) and cost of labour needed for production requirements. • The budget is calculated by multiplying required labour hours (from production budget) times anticipated hourly wage rate. • It involves realistic estimates of labour force required for anticipated level of production activity.

  17. Exercise- Direct Labour Budget Pro Ent is preparing its direct labour budget for 2007 from the following budget on a calendar year: QuarterUnitsQuarterUnits 1 30,000 3 25,000 2 35,000 4 30,000 Each unit requires 1.7 hours of direct labour. Required: prepare a direct labour cost budget for 2007. Wage rates per hour are expected to be RM15 for the first 2 quarters and RM17 for quarters 3 and 4.

  18. Manufacturing Overhead Budget • This budget distinguishes between variable and fixed overhead costs. • Variable overhead costs fluctuate with changes to production volume. • Total fixed overhead costs are estimated, then divided by cost driver to establish per-unit rate to be applied to production.

  19. Selling and Administrative Expense Budget • This budget distinguishes between variable and fixed expenses. • Variable expenses based on budgeted unit sales. • Fixed expenses based on assumed costs for the period.

  20. Cash Budget • This budget shows anticipated cash flows. • It combines ending cash balance from previous period plus details from other budgets. • The annual cash budget is often detailed on monthly basis to reflect anticipated levels of activities. • It helps plan for cash excesses and shortfalls.

  21. Cash Budget (cont’d) • The cash budget has three sections: • Cash receipts: expected cash inflows from customers, interest, dividends, planned sales of assets and shares • Cash payments: expected cash outflows for direct materials and labour, overheads, selling & administration costs, taxes, dividends, assets • Financing: expected cash borrowings and repayments of borrowings

  22. Exercise- Cash Budget Kuih Raya Industries expects to have a cash balanc of RM32,000 on 1 January 2007. relevant monthly budget data for the first 2 months of 2007 are as follows: • Collections from customers; January RM87,000; February RM169,000. • Payment to suppliers; January RM50,000; February RM88,000 • Direct labour; January RM40,000; February RM45,000. Wages are paid in the month they are incurred. • Manufacturing overhead; January RM21,000; February RM30,000. These costs are include depreciation of RM1000 per month. All other costs are paid as incurred. • Selling and administrative expenses; January RM15,000; February RM20,000. These costs are exclusive of depreciation. They are paid as incurred. • Sales of investments in January are expected to realise RM15,000 in cash. Kuih Raya Industry has a line of credit at a local bank that enables it to borrow up to RM25,000. The entity wants to maintain a minimum monthly cash balance of RM20,000. Required: Prepare cash budget for January and February

  23. Preparing the Budgeted Financial Statements • The final stage in the preparation of the master budget is to prepare the budgeted financial statements. • These are: • Budgeted income statement • Budgeted balance sheet

  24. Budgeted Income Statement • The budgeted income statement is the end product of the operating budgets. • It shows expected profitability for budget period. • It combines individual operating budgets plus additional expenses (e.g. interest, taxes). • It forms a basis for performance evaluation.

  25. Budget Balance Sheet • This is a projection of the financial position at end of budget period. • It combines the previous period’s budgeted balance sheet and budgets for current period (sales, direct materials, direct labour, overheads, selling and administration budgets). • The format is similar to that prepared for external users.

  26. Flexible Budgets • Project budget data for various levels of activity. • Flexible budgets are static budgets at different activity levels. • Master budget adapts to changing operating conditions. • Total fixed costs do not change as activity levels change. • Total variable costs do change as per-unit activities change.

  27. Developing the Flexible Budget • Identify activity index and relevant range. • Identify variable costs and budgeted costs per unit. • Identify fixed costs and establish budgeted amounts. • Prepare budget for selected levels of activity within relevant range.

  28. Flexible Budget Reports • Two sections for analysing production and cost control: • Production data (e.g. direct labour hours) • Cost data (for fixed and variable costs) • Both actual and budgeted costs are based on same activity level. • Flexible budgets are widely used in production and service departments.

  29. Exercise- Flexible Budget The following information had been prepared for KK Ent for the year to 30 June 2006 Level of activity Budget 50% Actual 60% RM RM Costs: Direct materials 50,000 61,000 Direct labour 100,000 118,000 Variable overhead 10,000 14,000 Total variable cost 160,000 193,000 Fixed overhead 40,000 42,000 Total costs 200,000 235,000 Required: Prepare a flexible budget operating statement for KK Ent for the year to 30 June 2006

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