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Thursday, 19 March 2015

MANAGEMENT ACCOUNTING (Budgeting and Budgetary Process)



MANAGEMENT ACCOUNTING

Topic: Budgeting and Budgetary Process  

Note: Watch out for real workings of Cash Budget in the next post 

CONCEPT AND MEANING OF BUDGET

The Institute of Cost and Management Accountants (ICMA) defined budget as a plan quantified in monetary terms, prepared and approved prior to a defined period of time, usually showing planned incomes to be generated and/or expenditure to be incurred during that period, and the capital to be employed to attain a given objective. 
A budget is also defined as a predetermined statement of management policy which provides for comparison of the result actually achieved during a given period.
A budget is further defined as a financial and/or quantitative statement prepared and approved prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining a given objective.  It may include income, expenditure and the employment of capital. 
Note: Budgetary control is the establishment of budgets relating the responsibilities of executives to the requirements of a 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.

OBJECTIVES OF BUDGETS:
A budget is designed to achieve the following;
1.       Planning: - Management is sparred to look ahead, make plans to achieve targets thereby giving the organization purpose and direction.

2.       Co-ordination: - The activities of the various functional areas of the business are co-ordinate through the budgetary cycle.

3.       Performance Evaluation: - The preparation of budget and budgetary control provides a basis for performance evaluation of the business.

4.       Assist Management Action: - Budgets assists and encourages management to be more financially aware of their actions and an area requires most attention.

5.       Motivation: Budgets encourage motivation since employees are aware of the plans for the achievement of the corporate targets or goals.

6.       Communication:- Budgets ensures that plans, actions, reactions and variance are communicated to and fro the functional managers.

BUDGET CENTRE – This is an identified section or department of an organization known for the purpose of the budget as cost centre.  A budget centre should be the responsibility area of a manager so that the manger is aware of the budget performance.


PRINCIPAL BUDGET FACTOR (BUDGET KEY FACTOR OR BUDGET LIMITING FACTOR) – This is a constraint or limitations on the activities of the organization. Principal budget factor may be sales, skilled labour, raw materials, space, customer demand, production capacity.

BUDGET PERIOD – this is the time framework of a budget.  It may be annual (yearly), weekly, monthly, 3 years, 10 years etc. 

PROCESS OF BUDGETING – The budgetary process is coordinated by a budget committee.  A sample outline of the budgetary process is as follows:
a.       Formation of budget committee
b.      Derive key forecasts
c.       Prepare quantity budgets with appropriate managers
d.      Check feasibility and adherence to the policies of quantity budgets
e.      Amend if necessary
f.        Produce Financial budgets
g.       Produce master budgets
h.      Submit budgets to chief executive for approval/amendment
i.         Published agreed budgets for ensuring period
j.        Recording of actual results
k.       Actual/budget comparison and identification of variances
l.         Reporting to budget holders and senior management
m.    Variance investigation
n.      Developing solutions to problem revealed by budgetary control.

BUDGET MANUAL – This is a procedure, guidance or rule book which sets out standing instructions governing the responsibilities of persons, and the procedures, forms and records relating to the preparation and use of budgets.

BUDGET COMMITTEE AND BUDGET OFFICER – The budget committee is the committee that has the overall responsibility for budget preparation and administration.   The membership of the budget committee varies between organizations but usually comprises people from various functions of the company.
The committee would be served by the budget officer who is usually the accountant.  The Chief Executive Officer is usually the Chairman of the budget committee.

BUDGETING METHOD – Management uses various methods of budgeting for planning and control purposes.  The major types of budgeting methods are; 1. Fixed budget 2. Flexible Budget 3. Rolling Budget (continuous) 4. Zero Based Budgeting.

 
TYPES OF BUDGET
The types of budgets found in a typical manufacturing business are:
a.       Sales Budget
b.      Selling and distribution costs budget
c.       Administration cost budget
d.      Debtors budget
e.      Finished Goods stock budget
f.        Production budget
g.       Material usage budget
h.      Machine utilization budget
i.         Material purchases budget
j.        Direct Labour budget
k.       Creditors budget
l.         Production overhead budget
m.    Cash budget
n.      Capital expenditure budget
o.      Research and development budget
p.      Master budget i.e. budgeted statement of profit and loss and statement of financial position sheet. Note that all the budgets from A to P above are known as functional budgets.  Thus functional budgets are segmented on; functional activities of the organization.  The master budget is prepared from summaries of the functional budgets.   

PREPARATION OF SALES – Sales Budget is the primary budget from which the majority of the other budgets are derived.  Sales volume is the principal budget factor for most organizations. Sales budgets are derived from sales forecasts.

CASH BUDGET – is one of the most important budgets because cash flow management and liquidity are vital for efficient working of any organization. The cash budget shows detailed cash flow: Receipts and payments of cash during the budget period.  Only cash items are considered in preparing cash budget.  Cash inflow consists of cash sales, receipt form debtors, sales of assets, income from investment, issue of shares, loan notes, grants etc.  Cash outflow consist of cash purchases, payment to creditors, wages, dividends, tax, all expenses including capital expenditure.
Cash budget shows surplus or deficiency of cash and this is an alarm for management to invest or raise finance.



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