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25Apr

Unit 3 Management Accounting Costing and Budgeting

Unit 3 Management Accounting Costing and Budgeting

P 3.1- Explain the purpose and nature of the budgeting process adoptedUnit 3 Management Accounting Costing and Budgeting

Budget – As future is uncertain; so budget is prepared to overcome this uncertainty. Budget is a plan made for future. In other words, budget is a financial plan of probable expenditure and income for a defined period of time.

Purpose of budgeting process-

The three most important purpose of budgeting process includes the following:-

It acts as a tool:

To forecast income and expenditure –budgeting is an important part in the planning process of the business (Grabski, Leech and Sangster, 2009). Here, the managers should be able to predict whether the business will make profit or loss. For the success of a business, the expenditure part should be tightly controlled.

For Decision making – Budgeting provides a financial overview for the decision making process. For example, in a manufacturing business, the budget shows how much to expend on the production of any product.

To monitor business performance- Budgeting helps to measure the actual business performance with the estimated one. It shows whether the business is living up to the expectation or not (Grabski, Leech and Sangster, 2009).

Other purposes of budgeting process includes:-

  • Budgeting is necessary for survival of the business as it stops the managers to rely on poorly coordinated planning.
  • Actual result is compared with the budgeted one which provides a base to take further action.
  • Budgeting is a formal way of communication between the mangers of different level.
  • Budget motivates the managers to achieve their goals.
  • Allocation of resources
  • Evaluating manager’s performance

Nature of budgeting process

  • Estimate the financial environment on the basis of last budget.
  • Helps in determining the probable amount of revenue that can be generated from sales.
  • Defines the required expenditure such as raw materials, production cost, advertisement expenses (Grabski, Leech and Sangster, 2009).
  • Then, subtracting estimated expenses from estimated revenues.
  • Then after reviewing, the final budget is submitted.

P 3.2- What is the budgeting method used for the case study and reflect its needs. Comment with your advice and suggestions

There are different types of budgeting methods such as:-

  • Zero based budgeting– it is suitable for public sector organization. It starts with a baseline of zero instead of a baseline of last year’s budget.
  • Activity based budgeting– it is based on activity. The volume of an activity is taken into consideration instead of any historical evidences.
  • Bottom to up approach– it starts with the lower level. Here, lower level gets the opportunity to make the budget and have their opinions.
  • Top down approach– the approach starts with the top level of the management. The top level mangers provide the guidelines to the lower level employees on how to calculate the budget.
  • Incremental budget– it is more suitable for stable business. it starts with last year’s budget from where an amount is added or subtracted in order to avoid inflation.
  • Periodic budget – A periodic budget is the one where the budget is prepared for a specific period generally for a month, six months or a year as per requirement.

In case of Antonio Ltd. the company has asked us to prepare different budgets for six months on the basis of the information given at the beginning of the period. It is a Periodic budget.

Suggestion:-Here the company has purchased raw materials in advance without issuing it to the production department. So, the company should avoid this period of holding in order to reduce holding cost. The trade payable budget is showing that one month credit has been allowed by the suppliers, it should be increased as the liquidity position of the company is not so good. The cash budget is showing decrease in cash which should be taken into care by reducing the outflow of cash.

P 3.3- How is the budget prepared, what is the method used for this purpose. Comment with the budgeting statement for the chosen case study.

As we know budget is one of the quantitative expression of plan in a defined period of time. Budget is generally prepared for to purpose of attaining a particular financial goal such as reducing expenditure, increasing the savings etc. So in order to reach the goal of the organization one is to know the process followed to prepare the budget (Bowhill, 1995).

Generally budget is prepared on the basis of regular time period like on yearly or half yearly basis, on monthly basis, on quarterly basis, etc. After preparing the budget it is required to monitor and review the budget so that the organization will be able to obtain the benefit from the preparation of budget.

First and foremost thing in preparing the budget is that we should classify the important types of budget which is to be prepared by the organization. As per case the organization has to prepare raw material budget, cash budget and trade payable budget.

Raw Material Budget:Raw material budget can be prepared by taking historical data regarding raw material which have been used by the production department. This historical data will give the idea in estimating the quantity which is required in future.

Cash budget:To prepare the cash budget the organization must evaluate different cash inflows and outflows of the business like receipts of cash, payments of cash etc. (Bowhill, 1995). In order to evaluate the cash flows the companies need to go through different month’s cash received by the debtors and cash paid to creditor etc. This helps in estimating and preparing the appropriate budget.

Trade budget:This trade budget is prepared when the company is in risk and unable to pay money to the creditors. In such cases if the time given by creditors is completed then the company will start preparing the trade budget (Bowhill, 1995).

These are the different types of budget prepared by the organization to reach the objectives of the business and also to take some effective decision in making investment for the business.

P 3.4 – For the chosen case study of Antonio ltd draw up the following for the six months ending 31 December:

A raw materials inventories budget, showing both physical quantities and financial values.

Raw materials  Production in units  Raw materials purchases (units)  Financial values (£) 
July 500 600 4,800.00
August 600 600 4,800.00
September 600 700 5,600.00
October 700 750 6,000.00
November 750 750 6,000.00
December 750 750 6,000.00
January 750

Trade payable budget.

July 600 500 4,800.00
August 600 600 4,800.00
September 700 600 5,600.00
October 750 700 6,000.00
November 750 750 6,000.00
December 750 750 6,000.00

iii) Cash budget

Opening cash  Sales (B)  Payments to creditors(£)  Advertisement  Direct labor expenses  Overheads Installment  Total expenditure  Closing cash balance 
July     7,500           7,600         4,000    1,000         3,000      1,560      9,560 5,540
Aug.     5,540           9,200         4,800         3,600      1,600    10,000 4,740
Sept.     4,740        10,400         4,800         3,600      1,600   2,200    12,200 2,940
Oct.     2,940        11,800         5,600    1,500         4,200      1,600   2,200    15,100 (360)
 

Nov.

      (360)        13,200         6,000         4,500      1,920   2,200  

14,620

(1,780)
Dec.   (1,780)        14,800         6,000         4,500      2,000    12,500 520

After taking into account the two months credit allowed for 40% of the sales amount and 60% of the sales affected for the current month the cash collection has been computed.

Cash outflow for overhead during the six months

Month Overhead Depreciation Cash expenses Actual expenses
May 1800 400 1400
June 1800 400 1400
July 2000 400 1600 1560
August 2000 400 1600 1600
September 2000 400 1600 1600
October 2000 400 2000 1600
November 2400 400 2000 1920
December 2400 400 2000 2000
January 2400 400 2000

Suggestion– the cash budget is showing cash deficit in the month of October and November. So, the management should avoid excess cash outflow by undertaking the benefit of lease financing.

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