Base it on the budget

February 2021

Phil Dunn’s overview will be of interest to students studying CIMA P1 Management Accounting and ACCAs preparing for the PM exam.

A budget is defined by CIMA as “a plan expressed in money. It is prepared and approved prior to a budget period and may show income, expenditure and the capital to be employed. It may be drawn up showing incremental effects on former budgeted or actual figures, or be compiled by zero-base budgeting technique.”

The setting of budgets compel planning, and business planning comprises:

• What does the organisation want to do?
• How best can this be done?

The role of planning is based on a series of set procedures which include:

• Establish the firm’s present position.
• Predict future environment.
• Clarify the objectives – which primarily concern improving the return to owners (improving shareholder value).
• Evaluate alternative courses of action.
• Select the best strategy.
• Prepare plans to implement the strategy.

The short-term plan shows how resources will be acquired and used over a period. Preparing it is known as ‘budgeting’, using it as a means of controlling activity is termed ‘budgetary control’. The budget is a short-term manifestation of a longer-term strategy.

The purpose of budgeting includes a number of defined objectives:

• To formulate a short-term plan.
• To provide estimates or requirements of resources: finance, labour, materials and facilities.
• To define normal operating conditions – this is necessary for determining overhead recovery rates.
• To set standards/targets/goals which will motivate.
• To evaluate corporate and departmental efficiency.
• To delegate responsibility for costs to enable management to retain overall control.

In addition to these specific objectives, consideration needs to focus on the concept of control.

Budgeting control

As in other control systems, control is affected by:

• Comparing actual performance with planned.
• Calling for explanation of differences variance accounting.
• Taking appropriate action.

CIMA defines budgetary control as: “The establishment of budgets relating to the responsibilities of executives to the requirements of policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objectives of that policy or to provide a basis for its revision.”

Some control guidelines are:

• Control is attained through people.
• Hence need for responsibility centres.
• Only controllable costs should be charged.
• Every cost is charged to someone.
• Reports should be based on exception priorities.
• Control should recognise changed conditions.

This element of control often involves the use of flexible budgetary control technique.

Flexible budgets

Budgets are prepared for a ‘normal’ capacity usage (or activity level):

• Where actual capacity usage differs from planned usage, the resultant comparison between actual costs and planned costs may be invalid.
• One approach to problem is to have Flexible budgets, which recognise the difference between fixed, variable and semi-variable costs and enable overhead budgets to be prepared at different levels of activity.
• In preparing control statement, the budget at the appropriate level of activity can now be chosen.

Relevance of budgetary control

• Requires short-term objective to be clarified.
• Involves planning as a team.
• Provides opportunity for participation.
• Defines/correlates/co-ordinates departmental interests.
• Facilitates delegation – enables ‘exception principle’ to be applied.
• Provides yardsticks of performance.
• Provides blue-print for:
• Forward buying.
• Recruitment/training of labour.
• Capital expenditure requirements.
• Stock holding/pricing/sales and credit policies.
• Cash needs.
• Production scheduling/planning. Preparation of functional budgets

At the outset a principal budget factor or limiting factor is identified. This determines scale; examples include sales volume, available finance or productive capacity.

Sales budget

This calls on the market and consumer research information available to the firm and includes:

• Market surveys.
• Representatives’ estimates and opinions.
• Pricing structures and policy.
• Advertising policy.
• Target market share.

The sales budget would be in terms of volume and value.

Production budget

This is based on a number of decisions which include:

• What is to be produced?
• How much is to be produced?
• What delivery is required?
• What is the size of the production runs?

In turn these prior decisions, together with expected sales and planned stock level changes, would determine the volume of production for each product within the range.

In addition detailed production plans, material and operations schedules would be produced. From this production overview budgets for material usage and cost, labour utilisation, overhead and resource capacity would generate.

Labour budget

This stems from the production budget as planned production volume can be expressed in terms of standard hours.

The hours would then be matched and standard rates of pay for each grade of labour, together with levels of planned efficiency, and the budgeted labour cost for the period would result.

Material budget

This also stems from the production budget, where products are standardised, aggregating material schedules will indicate precise requirement for each type of standard material.

Where products are ‘one-offs’ detailed material specifications would also be produced.

The materials budget would show detail of usage and cost. This would be based on standard or planned usage, valued at standard prices.

Plant utilisation budget

This is directly linked to the production budget and concerns balancing machine and resource capacity to production requirements.

Factory overhead budget

Preferably presented in marginal costing format, by identifying both fixed and variable elements of cost as this enables controllable costs to be distinguished from those which are outside the managers’ span of control.

Administration, selling and distribution overhead budget

This details main areas of the administrative and distribution function and their cost to support, in an effective manner, the ‘value added’ activities of the business.

• Dr Philip E Dunn is a freelance author and technical editor for Kaplan and Osborne Book