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Preparation of master budget

Budget
A budget is a quantitative statement, for a defined period of time, which may include planned revenue, expenses, assets, liabilities and cash flows

Purpose of preparing budget


Planning Coordination Communication Motivation Performance evaluation

Steps in the preparation of budget


Consideration of all external factors Preparation of other budgets

Production budget, purchases budget, direct labour budget, overheads budget and selling and administrative budget

Negotiation of budget Coordination of budget

Cash budget, capital expenditure budget, budget balance sheet, budget income statement, budget cash flow statement, budget statement of retained earnings
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Final acceptance of budget Budget review

Cash budget

Cash budget
The cash budget is a statement of expected cash receipt and payments It help avoid surplus cash and unexpected cash deficiencies Normally, the cash budget consists of the following items: Closing balance of cash = Opening balance of cash + Receipts - Payments
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Cash budget
Receipts include:

Cash sales Collection from debtors Other incomes such as investment income, rent received

Payments include:

Cash purchases Payment to creditors Direct labour Other expenses such as manufacturing overhead, administrative and selling expenses (depreciation does not involve cash flow) Tax payment
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Cash budget
In drawing up a cash budget, it can be found that all the payments for units produced would very rarely be at the same as production itself. For instance, the raw materials might be bought in March, goods being produced in April ad paid for in May Similarly the date of sales and the date of receipt of cash will not usually be at the same time. For instance, the good might be sold in May and the money received in August
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Example

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A cash budget for the six months ended 30th June 2003 is to be Drafted from the following information. (a) Opening cash balance at 1st January 2003 $3200 (b) Sales: at $12 per unit: cash received three months after sale units: 2002 2003 Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep 80 90 70 100 60 120 150 140 130 110 100 160 (c) Production: in units 2002 Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep 70 80 90 100 110 130 140 150 120 160 170 180 (d) Raw materials used in production cost $4 per unit of production. They are paid for two months before being used in production (e) Direct labour: $3 per unit paid for in the same month as the unit is produced. (f) Other variable expenses $2 per unit, of the cost being paid for in the same month as production, the other paid in the month after producti
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(f) Other variable expenses $2 per unit, of the cost being paid for in the same month as production, the other paid in the month after production. (g) Fixed expenses of $100 per month is paid monthly (h) A motor van is to be bought and paid for in April for $800

Required: Prepare the cash budget for six months ended 30 June 2003

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Cash budget for the six months ended 30 June 2003 Jan Feb Mar Apr May Jun $ $ $ $ $ $ Opening balance 3200 3045 2920 2420 1545 780 Add: Receipts Sales 960 1080 840 1200 720 1440 4160 4125 3760 3620 2265 2220 Less: Payments Raw materials 520 560 600 Direct labour 300 330 390 Variable exp 195 215 250 Fixed expenses 100 100 100 Motor van - 3045 2920 2420 Closing balance Workings 1 Working 2
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480 640 420 450 275 295 100 100 800 1545 780

680 360 255 100 825

Workings 1: Receipts : Jan 80(Oct) * $12= 950 Feb 90 (Nov)*$12= 1080 Mar 70 (Dec)*$12 = 840 Apr 100 (Jan)*$12 = 1200 May 60 (Feb)*$12 = 720 June 120 (Mar)*$12=1440 Workings 3: Direct labour : Jan 100(Jan) * $3= 300 Feb 110 (Feb)*$3= 330 Mar 130(Mar)*$3 = 390 Apr 140 (Apr)*$3 = 420 May 150 (May)*$3 = 450 June 120 (Jun)*$12=360

Workings 2: Raw materials : Jan 130(Mar) * $4= 520 Feb 110 (Apr)*$4= 560 Mar 150 (May)*$4 = 600 Apr 100 (Jun)*$4 = 480 May 160 (Jul)*$4 = 640 June 170 (Aug)*$4=680 Workings 4: Fixed expenses : Jan $100 Feb $100 Mar $100 Apr $100 May $100 June $100

The month in which the sales was made

Back
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Working 5: Variable expenses: Jan 100(Jan)*3/4*$2 90 (Dec)*1/4*$2 Feb 110(Feb)*3/4*$2 100 (Jan)*1/4*$2 Mar 130(Mar)*3/4*$2 110(Feb)*1/4*$2 Apr 140(Apr)*3/4*$2 130(Mar)*1/4*$2 May 150(May)*3/4*$2 140 (Apr)*1/4*$2 Jun 120(Jun)*3/4*$2 150(May)*1/4*$2

$ 150 45 165 50 195 55 210 65 225 70 180 75

$ 195 215 250 275 295 255 Back


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Budget income statement and balance sheet

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Budgeted income statement and balance sheet


These financial statements reflect the predicted results to be achieved.

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Example

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ABC Ltd. Balance sheet as at 31 December 2004 Fixed Assets Cost Dep Machinery 4000 1600 Motor vehicles 2000 800 6000 2400 Current Assets Stock: finished goods (75 units) 900 Raw materials 500 Debtors (2004 Oct $540 +Nov $360+Dec $450) 1350 Cash and bank 650 3400 Less: Current liabilities Creditors for raw materials (Nov $120+ Dec $180) 300 Creditors for fixed expenses (Dec) 100

Net 2400 1200 3600

3000 6600

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Financed by: Share capital, 4000 shares of $1 each Profit and loss account

$ 4000 2600 6600

The plans for the six months ended 30 June 2005 are as follows: (i) Production will be 60 units per month for the first months, followed by 70 units per month for May and June (ii) Production costs will be (per unit): Direct materials $5 Direct labour 4 Variable overhead 3 12 (iii) Fixed overhead is $100 per month, payable always one month in arrears. (iv) Sales, at price of $18 per unit, are expected to be: Jan Feb Mar Apr May Jun no. of units 40 50 60 90 90 70

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(v) Purchases of direct materials will be: Jan Feb Mar Apr May Jun $ $ $ $ $ $ 150 200 250 300 400 320 (vi) The creditors for raw materials bought are paid two months after purchase (vii) Debtors are expected to pay their accounts three months after they have bought the goods (viii) Direct labour and variable overhead are paid in the same month as the units are produced (ix) A machine costing $2000 will be bought and paid for in March (x) 3000 shares of $1 each are to be issued at par in May (xi) Depreciation for the six months: machinery $450, motor vehicles $200 Required: Prepare budget income statement and balance sheet as at 30 June 2005
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Budget income statement

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Wong Ltd. Budget income statement for the six months ended 30 June 2005 $ $ Sales (400*$18) 7200 Less: COGS Opening stock of finished goods 900 Add: Cost of goods completed (380*$12) 4560 Less: closing stock of finished goods (55*$12) 660 4800 Gross profit 2400 Less: expenses Fixed overhead ($100*6 mth) 600 Depreciation: Machinery 450 Depreciation: Motors 200 1250 Net profit 1150

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Wong Ltd. Budget balance sheet as at 30 June 2005 Fixed asssets Cost Dep $ $ Machinery 6000 2050 Motor vehicles 2000 1000 8000 3050 Current assets Stock: finished goods 660 raw materials 220 Debtors 4500 Cash and bank 1240 6620 Less: Current liabilities Trade creditors 720 Creditors for overheads 100

Net $ 3950 1000 4950

5800 10750
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Financed by: Capital and reserves Share capital (4000+3000) Profit and loss account (2600+1150)

$ 7000 3750 10750

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Materials budget:

Jan Feb $ $ Opening stock 500 350 Add: purchases 150 200 650 550 Less:used in production300 300 350 250 Production budget: (in units) Jan Feb Opening stock 75 95 Add: purchases 60 60 135 155 Less: Sales 40 50 95 105
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Mar $ 250 250 500 300 200 Mar 105 60 165 60 105

Apr $ 200 300 500 300 200 Apr 105 60 165 90 75

May $ 200 400 600 350 250 May 75 70 145 90 55

Jun $ 250 320 570 350 220 Jun 55 70 125 70 55


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Production budget: (in $) Jan $ Materials cost 300 Labour cost 240 Variable overhead 180 720 Creditors budget: Jan $ 300 150 450 120 330

Feb $ 300 240 180 720


Feb $ 330 200 530 180 350

Mar $ 300 240 180 720


Mar $ 350 250 600 150 450

Apr $ 300 240 180 720


Apr $ 450 300 750 200 550

May $ 350 280 210 840


May $ 550 400 950 250 700

Jun $ 350 280 210 840


Jun $ 700 320 1020 300 720
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Opening stock Add: purchases


Less: Payments Back 2

Debtors budget:

Opening stock Add: Sales Less: Received

Jan $ 1350 720 2070 540 1530

Feb $ 1530 900 2430 360 2070

Mar $ 2070 1080 3150 450 2700

Apr $ 2700 1620 4320 720 3600

May $ 3600 1620 5220 900 4320

Jun $ 4320 1260 5580 1080 4500

Back 2
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Cash budget:

Jan $ Opening balance 650 Add: Debtors 540 Share issue 650 Less: Creditors 120 Fixed overhead 100 Direct labour 240 Variable O/H 180 Machinery 550

Feb $ 550 360 550 180 100 240 180 210

Mar $ 210 450 500 150 100 240 180 2000 (2010)

Apr $ (2010) 720 500 200 100 240 180 (2010)

May $ (2010) 900 3000 600 250 100 280 210 1050

Jun $ 1050 1080 570 300 100 280 210 1240

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Fixed and flexible budget

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Fixed budget
Fixed budget is a budget which is designed to adjust the permitted cost levels to suit the level of activity actually attained

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Fixed budget
A fixed budget is a budget, which is designed to remain unchanged irrespective of the volume of output or turnover attained

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Example

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ABC Ltd. Manufactures and sells a single product. Prepare the flexible budgets for 2005 at the activity levels of 80%, 100% and 120%. In accordance with the following information: 1. 100% activity represents 60000 units produced 2. Variable cost (per unit): $ Materials 40 Direct labour 30 Royalties 2 Electricity 6 Maintenance 5 83 3. Fixed cost $ Depreciation 20000 Rent 120000 Indirect labour 80000 34

Flexible budget Level of activity

48000

60000

720000 units

Variable cost Materials Direct labour Royalties Electricity Maintenance


Fixed cost Depreciation Rent Indirect labour

$ 1920000 1440000 96000 288000 240000 3984000 20000 120000 80000 4024000

$ 2400000 1800000 120000 360000 300000 4980000 20000 120000 80000 5200000

$ 2880000 2160000 144000 423000 360000 5976000 20000 120000 80000 6196000

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Flexible budgets and budgetary control


By comparing the actual results with the budgeted amounts, the managers can ascertain which costs do not conform to the original plans and therefore deserve their attention The differences between the actual results and the expected outcomes are called variance
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If we compare the actual results with the fixed budgets, we do not know whether the variance are caused by the difference in the levels of activity or the change in efficiency However, by comparing the actual costs with the flexible budget prepared at the actual activity level, we can see how efficient the managers are in controlling the costs
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Example

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ABC Ltd. Manufactures and sells a single product. In accordance with the following information: 1. 100% activity represents 60000 units produced 2. Variable cost (per unit): $ Materials 40 Direct labour 30 Royalties 2 Electricity 6 Maintenance 5 83 3. Fixed cost $ Depreciation 20000 Rent 120000 Indirect labour 80000
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The budget and actual results for 2005 are shown as follows: Budgeted Actual Variance 60000 units 80000 units $ $ Sales revenue ($100 each) 6000000 8000000 2000000(F) Less: variable cost Materials 2400000 3201000 801000 (A) Labour 1800000 2500000 700000 (A) Royalties 120000 160000 40000(A) Electricity 360000 485000 125000 (A) Maintenance 300000 404000 104000 (A) Fixed overhead: Depreciation 20000 20500 500 (A) Rent 120000 160000 40000 (A) Indirect labour 80000 95000 15000 (A) 800000 974500 174500 (F) * F = favourable, A = Adverse variance
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Required: (a) Prepare a flexible budget based on the original budgeted unit costs and selling price (b) With the use of the variances, reconcile the original budget profit with the actual profit

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Fixed Flexible Budget 80000*budget units cost budget 60000 units 80000 units (a) (b) $ $ Sales revenue ($100 each) 6000000 8000000 Less: variable cost Materials 2400000 3200000 Labour 1800000 2400000 Royalties 120000 160000 Electricity 360000 480000 Maintenance 300000 400000 Fixed overhead: Depreciation 20000 20000 Rent 120000 120000 Indirect labour 80000 80000 800000 1140000 $340000 (F) Volume variance

Actual results 80000 units ( c) $ 8000000 3201000 2500000 160000 485000 404000 20500 160000 95000 974500

Variance ( c) (b) $ 1000 (A) 100000 (A) 5000 (A) 4000(A) 500 (A) 40000 (A) 15000 (A) 165500 (F)

$165500 (A) Expenditure variance


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Total variance $174500 (F)

(b) The overall reconciliation of profit is shown as follows: $ Fixed budget profit Variances Sales volume ($100 - $83)*20000 Materials 1000(A) Labour 100000(A) Electricity 5000 (A) Maintenance 4000 (A) Depreciation 500(A) Rent 40000 (A) Indirect labour 15000 (A) Actual profit

$ 800000 340000 (F)

165000 (A) 974500

According to the above variance analysis statement, the increase in actual profit is caused by the increase in sales volume However, the adverse cost variance show that there may have been a general price rise of expenditure or inefficient control of expenditure by departmental managers
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