Preparation and

UNIT 9 PREPARATION AND Review of Budgets

REVIEW OF BUDGETS
Structure
9.0 Objectives
9.1 Introduction
9.2 Sales Budget
9.3 Production Budget
9.4 Production Cost Budget
9.5 Materials Budget
9.6 Purchase Budget
9.7 Direct Labour Budget
9.8 Overheads Budget
9.9 Capital Expenditure Budget
9.10 Cash Budget
9.11 Master Budget
9.12 Revision of Budgets
9.13 Budget Report
9.14 Let Us Sum Up
9.15 Key Words
9.16 Answers to Check Your Progress
9.17 Terminal Questions
9.18 Further Readings

9.0 OBJECTIVES
The main objectives of this unit are to make you familiar with :
l the preparation of different types of budgets;
l the preparation of Master budget; and
l review of different budgets.

9.1 INTRODUCTION
In the previous unit you have learnt about the basic concept of budgeting,
establishment of a sound system of budgeting and classification of budgets. You
have also learnt that budgeting is the principal instrument for projecting the future
costs and revenues which is an essential aspect of management accounting and
financial control. Budgeting helps in monitoring the present as well as past.
Preparation of budgets involves a number of forecast or projections. It starts with
sales forecasting and ends with the compilation of the master budget. In this unit you
will study about the construction of functional budgets.

9.2 SALES BUDGET

The sales budget is usually the keystone in planning and control of operation of a
business. Sales forecast serves as a base for the sales budget. The sales budget is
prepared in quantitative terms of units expected to be sold and the value expected to 17
Budgeting and be realised. The Sales Manager should be made directly responsible for the
Budgetary Control preparation and execution of sales budget. This is prepared according to the
requirements of the business while preparing sales budget. The useful classification
may be-products, territories, customers, salesmen, etc. More than one classification
may be employed. However, at the time of preparing sales budget the following
factors should be kept in mind:
(a) salesmen’s estimates (b) orders in hand (c) Past behaviour (d) Management
policies for future (e) seasonal fluctuations (f) availability of materials (g) plant
capacity (h) availability of finance (i) potential market (j) level of competition
(k) position of competitors, etc. Look at the following illustration how a sales budget is
to be prepared.

Illustration 1

Shri Ramu manufactures two types of toys, Raja and Rani and sell them in Agra and
Mumbai markets. The following information is made available for the current year
2003-2004:

Places/ Markets Type of Toys Budgeted Sales Actual Sales

2002-2003 2002-2003

Agra Raja 400 at Rs. 9 each 500 at Rs. 9 each

Rani 300 at Rs. 21 each 200 at Rs. 21 each

Mumbai Raja 600 at Rs. 9 each 700 at Rs. 9 each

Rani 500 at Rs. 21 each 400 at Rs. 21 each

Market studies reveal that toy Raja is popular as it is under priced. It is observed that
if its price is increased by Rs.1 it will find a ready market. On the other hand, Rani is
over-priced and market could absorb more sales if its selling price is reduced to Rs.
20. The management has agreed to give effect to the above price changes.

On the above basis, the following estimates have been prepared by Sales Manager:

Product % increase in Sales Over Current Budget

Agra Mumbai

Raja +10% +5%

Rani +20% +10%

With the help of an intensive advertisement campaign, the following additional sales
above the estimated sale are possible:

Product Agra Mumbai

Raja 60 units 60 units

Rani 40 units 50 units

You are required to prepare a budget for sales incorporating the above estimates.

18
Solution Preparation and
Review of Budgets
Sales Budget Period 2003-2004
Budget for the year 2002-2003 Actual Sales Budget for the future
2002-2003
Place Product Units Price Value Units Price Value Units Price Value
Rs. Rs. Rs. Rs. Rs. Rs.
Raja 400 9 3600 500 9 4500 500 10 5000
Agra Rani 300 21 6300 200 21 4200 400 20 8000
Total 700 - 9900 700 - 8700 900 - 13000
Raja 600 9 5400 700 9 6300 700 10 7000
Mumbai Rani 500 21 10500 400 21 8400 600 20 12000
Total 11 0 0 15900 11 0 0 - 14700 1300 - 19000
Raja 1000 9 9000 1200 9 10800 1200 10 12000
Total Rani 800 21 16800 600 21 12600 1000 20 20000
Total 1800 - 25800 1800 - 73400 2200 - 32000

Working Note:
1) Calculation of Budget Estimates
Agra Mumbai
Raja-Budgeted 400 600
Increase 40 (+10%) 30 (+5%)
440 630
Advertisement effect 60 70
500 700
Rani-Budgeted 300 500
Increase 60 (+20%) 50 (+10%)
360 550
Advertisement effect 40 50
400 600

Thus a preliminary sales budget is prepared product wise, territory-wise and also
customer-wise and then a detailed budget is also prepared on the basis of salesman’s
estimates. Both the budgets are to be compared and necessary adjustments are to
made to the final sales budget after taking into account the policy of the management.
Then the sales budget will be submitted to the budget committee for approval and
incorporation in the master budget.

9.3 PRODUCTION BUDGET

The Production Budget is a forecast of the production for the budget period. It
provides an estimate of the total volume of production product-wise with the
scheduling of operations by days, weeks and month and also a forecast of the
closing finished product inventory. It is based on sales budget. The Factory
Manager is the person generally made responsible for its preparation,
19
Budgeting and administration and execution. This budget can also be prepared department-wise.
Budgetary Control This budget is prepared in quantity terms only. The main factors, which are useful
in preparing production budgets are:

(a) Inventory Policies (b) Sales Requirements (c) Uniformity of Production (d) Plant
Capacity (e) Availability of inputs (f) Duration of Production.

Production may be computed as follows :

Units to be produced = Budgeted Sales + Desired Closing Stock of finished goods –

Opening Stock of finished goods.

Illustration 2
A manufacturing company submits the following figures for the first quarter of 2002 :
Particulars Product X Product Y Product Z

Sales (units) January 50,000 60,000 20,000

February 40,000 50,000 20,000
March 60,000 70,000 20,000

Selling price per unit (Rs.) 10 20 40

Targets for Ist quarter 2003:

Increase in sales quantity 20% 10% 10%
Increase in sales price Nil 10% 25%
Opening stock on Jan. 1, 2003
(Percentage of sales) 50% 50% 50%
Stock position on 31st March, 2003 40,000 50,000 10,000
Closing stock for January and February
(Percentage of subsequent months sales) 50% 50% 50%

You are required to prepare the Sales and Production Budgets for the 1st quarter of
2003.

Solution
Sales Budget

January, 03 February, 03 March, 03 Total

Units Rate Value Units Rate Value Units Rate Value Units Value
(Rs.) ( Rs.) ( Rs.) ( Rs.) ( Rs.) ( Rs.) ( Rs.)

Product X 60,000 10 6,00,000 48,000 10 4,80,000 72,000 10 7,20,000 1,80,000 18,00,000

Product Y 66,000 22 14,52,000 55,000 22 12,10,000 77,000 22 16,94,000 1,98,000 43,56,000

Product Z 22,000 50 11,00,000 22,000 50 11,00,000 22,000 50 11,00,000 66,000 33,00,000

Total 1,48,000 — 31,52,000 1,25,000 — 27,90,000 1,71,000 — 35,14,000 4,44,000 94,56,000

20
Working Note : Preparation and
Review of Budgets
1) Calculation of Budget estimates

January February March

Product X : Budgeted 50,000 40,000 60,000

Increase (20%) 10,000 8,000 12,000
60,000 48,000 72,000
Product Y : Budgeted 60,000 50,000 70,000
Increase (10%) 6,000 5,000 7,000
66,000 55,000 77,000
Product Z : Budgeted 20,000 20,000 20,000
Increase (10%) 2,000 2,000 2,000
22,000 22,000 22,000

Production Budget for the 1st Quarter 2003 (Units)

Particulars January February March Total

Product X : Sales Budget 60,000 48,000 72,000 1,80,000
Add : Closing Stock
(50% of subsequent month sales) 24,000 36,000 40,000 40,000
84,000 84,000 1,12,000 2,20,000
Less : Opening Stock
(50% of sales) 30,000 24,000 36,000 30,000
PRODUCTION BUDGET 54,000 60,000 76,000 1,90,000
Product Y : Sales Budget 66,000 55,000 77,000 1,98,000
Add : Closing Stock
(50% of subsequent month sales) 27,500 38,500 50,000 50,000
93,500 93,500 1,27,000 2,48,000
Less : Opening Stock
(50% of sales) 33,000 27,500 38,500 33,000

PRODUCTION BUDGET 60,500 66,000 88,500 2,15,000

Product Z : Sales Budget
22,000 22,000 22,000 66,000
Add : Closing Stock
(50% of subsequent month sales) 11,000 11,000 10,000 10,000
33,000 33,000 33,000 76,000
Less : Opening Stock
(50% of sales) 11,000 11,000 10,000 11,000
PRODUCTION BUDGET 22,000 22,000 23,000 65,000

Note : Closing stock as on 31st March, 2003 is given in the problem. Opening and
closing stock for January and February months have been calculated as per
the percentages given in the problem. Students should be noted that the
previous months closing stock will become opening stock of subsequent
month. 21
Budgeting and
Budgetary Control 9.4 PRODUCTION COST BUDGET
This budget is a forecast of the cost of production which has been planned in the
production budget. The production budget is prepared in terms of quantity to be
produced. The amount is shown in this budget. The total cost of production is
arrived at by adding the cost of materials, labour and manufacturing overheads.
The quantity of material, the time taken by labour and the estimated costs of
material, labour and expenses- all can be shown as part of production cost budget
also.
Illustration 3
The following information is abstracted from the books of a ABC Co. Ltd., for the six
months of 2005 in respect of product X :
The following units are to be sold in different months of the year 2005:

January 2,200
February 2,200
March 3,400
April 3,800
May 5,000
June 4,600
July 4,000

There will be work in progress at the end of the month. Finished units are equal to
half the sales of the next month’s stock at the end of every month (including
December, 2004). Budgeted production and production cost for the half-year ending
30th June, 2005 are as follows :
Production (units) 40,000
Direct material per unit Rs. 5
Direct wages per unit Rs. 2
Factory Overheads apportioned to production Rs.1,60,000
You are required to prepared Product Budget and Production Cost Budget for the six
months of year 2005.

Solution
Production Budget (in Units)
January February March April May June Total
Estimated Sales 2200 2200 3400 3800 5000 4600
Add : Closing Stock 1100 1700 1900 2500 2300 2000
3300 3900 5300 6300 7300 6600
Less : Opening Stock 1100 1100 1700 1900 2500 2300
Production 2200 2800 3600 4400 4800 4300 22,100
22
 Production Cost Budget Preparation and
Review of Budgets
(Production : 22, 100 units)
Rs.
Direct materials @ Rs. 5 for 22,100 units 1,10,500
Direct wages @ Rs. 2 for 22100 units 44,200
Factory Overheads @ Rs. 4 for 22100 units 88,400
(Rs. 1,60,000/40,000 units)
————
Total Production Cost 2,43,100
————

9.5 MATERIALS BUDGET

Materials are either direct or indirect. The Material budget generally deals only
with the direct materials. Indirect materials are generally included in overhead
budget. The material requirements are estimated on the basis of quantity of each
class of products to be produced by multiplying the exact material requirement
for each class of product by the number of units of that class. Material budget
can be prepared on the basis of standards or, historical data regarding
percentage of raw materials to total cost, adjusted for current price and normal
wastage of material.

The factors to be considered while preparing the Material Budget are : the
quantity of material required for the production budget, tentative dates by which
required material must be available, the availability of storage facilities as well as
credit facilities, price trends in the market, nature of the materials required etc.
Only direct materials are to be taken into account and indirect materials are not
taken into account as they are considered under overheads budget. The material
budget helps the management for proper planning of purchases. The object of the
budget is to ensure the availability of adequate quantities of materials as and when
required. It will be included in the Master Budget after the approval of Budget
Committee.

Illustration 4
The following information relates to a manufacturing company :
Targeted sales of product X 1,00,000 units. Each unit of product X requires 3 units of
material A and 4 units of material B.
Estimated opening balances at the commencement of the next year :
Finished product : 20,000 units
Material A : 24,000 units
Material B : 30,000 units
The desirable closing balances at the end of the next year are :
Finished Products : 28,000 units
Material A : 26,000 units
Material B : 32,000 units
From the above information prepare a Material Budget.
23
Budgeting and Solution
Budgetary Control
Firstly, we have to find out the number of units to be produced. We know that,
Opening Stock + Production = Sales + Closing Stock
Units to be produced = Sales + Closing Stock – Opening Stock
= 1,00,000 + 28,000 – 20,000
= 1,08,000 units
Material required :
Material A = 1,08,000 × 3 = 3,24,000 units
Material B = 1,08,000 × 4 = 4,32,000 units
Material Purchase Budget ( Units)
Particulars Finished Product Material required
A B
Budgeted Production 1,08,000 3,24,000 4,32,000
Add : Opening Stock (+) 20,000 ( --) 24,000 ( --) 30,000
————— ————
1,28,000 3,00,000 4,02,000

Less : Closing Stock ( -- ) 28,000 ( +) 26,000 (+) 32,000

————— ———— ————
Estimated product for sales 1,00,000
—————
Estimated Material required : 3, 26, 000 4, 34, 000

9.6 PURCHASE BUDGET

Purchase Budget gives the details of material purchases to be made in the budget
period. It correlates with sales forecast and production planning. It deals with
purchases that are required for planned production. Purchases would include both
direct and indirect materials and goods. While placing the purchase orders material
manager has to see the orders on hand and unfulfilled orders at the beginning of the
budget period and adjust the purchases accordingly. Purchase budget enables the
budget officer to provide funds in the cash budget according to delivery schedules,
terms of payment and credit period. While preparing purchase budget the factors like
the opening and closing stock to be maintained, maximum and minimum stock
quantities to be maintained, economic order quantity level, the resources available, the
policy of management etc., should also be taken into account.
Budgeted Purchase Quantity = Budgeted Consumption Quantity +
Required Closing Stock – Opening Stock.

9.7 DIRECT LABOUR BUDGET

The direct labour budget tells about the estimates of direct labour requirements
essential for carrying out the budgeted output. The quantity of labour, e.g. skilled,
unskilled, semi-skilled etc are estimated first. The time taken by them can be measured
in terms of man hours. Thereafter, the total cost of labour is estimated by multiplying
the rates of pay with the labour hours. The purpose of this budget is to ensure
24 optimum utilization of labour force.
 Preparation and
9.8 OVERHEADS BUDGET Review of Budgets

The overheads budget should be prepared in three parts as follows :

1) Manufacturing Overhead Budget
2) Administration Overhead Budget, and
3) Selling and Distribution Overhead Budget.
Manufacturing Overhead Budget
The budget is an estimate of the manufacturing overhead costs to be incurred in the
budget period to achieve the targeted production. Manufacturing overheads include
indirect material, indirect labour, and indirect expenses related to the factory. The cost
of each and every item of these three components of manufacturing overhead is
separately estimated as per the requirements of production.
Administration Overhead Budget
Administration overhead includes the costs of framing policies, directing the
organisation and controlling the business operations. Most of the administration
expenses are normally unconnected with the volume of activity, therefore,
experience and anticipated changes in conditions are the guides for the preparation of
this budget.
Selling and Distribution Overhead Budget
The budget includes all expenses relating to selling, advertising, delivery of goods to
customers, etc. The overheads may be determined on the basis of sales targets being
allocated to different territories or salesman etc. Those expenses which generally vary
with the sales quantity are estimated on sales basis, others which are of a fixed nature,
are estimated on the basis of past experience and anticipated changes. The
responsibility for the preparation of this budget lies with the executives of the sales
departments. Let us prepare a sales overheads budget from the following illustration.
Illustration 5
Prepare a Sales Overheads Budget for the quarter ending 31st March, 2005 from the
estimates given below:
Rs.
Advertisement 12,500
Salaries of sales department 25,000
Expenses of sales department 7,500
Counter salesmen salaries and allowances 30,000

Commission to counter salesmen is payable at 1% of sales executed by them.

Travelling salesman are entitled to a commission at 10% on sales effected through
them and a further 5% towards expenses. ( Rs. )
Sales Territories Sales at Sales by Total estimated
Counters Travelling sales
salesmen

A 4,00,000 50,000 4,50,000

B 6,00,000 75,000 6,75,000
C 7,00,000 1,00,000 8,00,000
25
Budgeting and Solution
Budgetary Control
Sales Overheads Budget
For the period ended March 31, 2005

Estimated Sales in Territories

A B C
Rs. Rs. Rs.
4,50,000 6,75,000 8,00,000
Fixed Overheads:
Advertisement 12,500 12,500 12,500
Salaries of Sales Department 25,000 25,000 25,000
Expenses of Sales Department 7,500 7,500 7,500
Counter Salesmen's Salaries
and allowances 30,000 30,000 30,000
(a) 75,000 75,000 75,000

Variable Overheads:
Counter salesmen commission 4,000 6,000 7,000
@ 1% on sales
Traveling salesmen commission 5,000 7,500 10,000
@ 10%
Expenses @ 5% on Sales by
Travelling Salesmen 2,500 3,750 5,000
(b) 11,500 17,250 22,000
Total Sales Overheads (a) + (b) 86,500 92,250 97,000

9.9 CAPITAL EXPENDITURE BUDGET

The budget is the plan of the proposed outlay on fixed assets such as land, buildings,
plant and machinery. The budget is prepared after taking into account the available
productive capacities, probable reallocation of existing assets and possible improvement
in production techniques. etc.
Capital expenditure budget serves the following purposes :
i) It facilitates long-term planning and policy-making.
ii) It facilitates of replacing the old machinery by latest machinery or to change the
methods of production for reducing costs.
iii) It helps in the estimates of capital requirement after taking into account the
disposable value of old assets.
iv) It helps in the preparation of cash budget and also assessing the capital cost of
improving working conditions or adopting safety measures, etc.

9.10 CASH BUDGET

A Cash Budget is a summary statement of the firms’ expected cash inflows and
outflows over a projected time period. In other words, cash budget involves a
26 projection of future cash receipts and cash disbursements over various time intervals.
While preparing cash budget seasonal factors must be taken into account and in Preparation and
practice cash budget is prepared on a monthly basis. The availability of other budgets Review of Budgets
is tested in terms of cash availability. Cash budget is also called as cash flow
statement which indicates cash inflow and cash outflows. It is generally prepared for
a maximum period of one year.
A cash budget helps the management in (i) determining the future cash needs of the
firm, (ii) planning for financing of the needs; (iii) exercising control over cash and
liquidity of the firm.
The overall objective of a cash budget is to enable the firm to meet all its commitments in
time and at the same time prevent accumulations of unnecessary large balance with it.
Methods of Preparing Cash Budgets
There are basically three methods for preparing cash budgets.
1) Receipts and Payments Method
2) Adjusted Profit and Loss Account Method
3) Balance Sheet Method
Let us study about these methods in brief.
1) Receipts and Payments Method
Under this method, all receipts are added and out of the total, the sum of all payments
is deducted to arrive at the balance in hand. The closing balance in hand say, for a
particular month is the opening balance of the next month and is added to the total of
receipts so as to know the total availability of cash during the month. The receipts and
payments during the budget period are found out from various functional budgets
prepared. The credit allowed to debtors, the credit allowed to us by suppliers, the delay
in payment of wages and other expenses etc. are the factors, which are taken into
account to determine the timing of receipts and payments. Advance payments and
receipts are to be included but the payment in abeyance and income accrued on
outstanding are excluded from cash budget. Revenue as well as capital receipts and
payments are recorded in cash budget.
Illustration 6
A company newly starting manufacturing operations on 1st January 2003 has made
adequate arrangement for funds required for fixed assets. It wants you to prepare an
estimate of funds required as working capital. It is to be remembered that:
a) In the first month there will be no sale, in the subsequent month sale will be 25%
cash and 75% credit. Customer will be allowed one month credit.
b) Payments for purchase of raw materials will be made on one month credit basis.
c) Wages will be paid fortnightly on the 22nd and 7th of each month.
d) Other expenses will be paid one month in arrear except that 5% of selling
expenses are to be paid immediately on sale being effected.
The estimated sales and expenses for the first six months, spread evenly over the
period subject to (a) above are as under:
Rs. Rs.
Sales 3,60,000 Administrative Expenses 54,000
Material Consumed 1,50,000 Selling Expenses 42,000
Wages 60,000 Depreciation on fixed assets 50,000
Manufacturing Exp. 48,000 27
Budgeting and The article produced is subject to excise duty equal to 10% of the selling price. The
Budgetary Control duty is payable on March 31, June 30, September 30, and December 31 for sales upto
February 28, May 31, August 31 and November 30 respectively.
Prepare Cash Budget for each of the six months indicating the requirement of working
capital.
Solution

Cash Budget
for the six months ended on June 30, 2003
Particulars January February March April May June
Rs. Rs. Rs. Rs. Rs. Rs.

Receipts:
Opening Balance - (--) 7,500 (--) 45,000 (--) 39,200 (--) 26,200 (--) 13,200
Cash Sales - 18,000 18,000 18,000 18,000 18,000
Receipts from customers - - 54,000 54,000 54,000 54,000
Cash Available (A) - 10,500 27,000 32,800 45,800 58,800
Payments:
Wages 7,500 10,000 10,000 10,000 10,000 10,000
Materials - 25,000 25,000 25,000 25,000 25,000
Manufacturing Exp. - 8,000 8,000 8,000 8,000 8,000
Administrative Exp. - 9,000 9,000 9,000 9,000 9,000
Selling Exp. - 3,500 7,000 7,000 7,000 7,000
Excise Duty - - 7,200 - - 21,600
Total Payments (B) 7,500 55,500 66,200 59,000 59,000 80,600

Closing Balance (A--B) (--) 7,500 (--) 45,000 (--) 39,200 (--) 26,200 (--) 13,200 (--) 21,800

Note : The Company needs overdraft facility to the extend indicated above for every
month.
2) Adjusted Profit and Loss Account Method
The budgeting done by Adjusted Profit and Loss account method is known as cash
flow statement and is more suitable for long-term forecasting. Under this method
profit is taken as equivalent to cash and necessary adjustments are done in respect of
non-cash transactions. The net estimated profit is taken as the base and non-cash
items like depreciation, outstanding expenses, provisions etc. already deducted to arrive
at the net profit are added back. The capital receipts, reduction in debtors, stocks,
increase in liabilities, issue of share capital and debentures are other items which are
added to compute the total cash receipts. The payments of dividends, prepayments,
capital payments, increase in debtors, increase in stock and decrease in liabilities are
deducted out of the total cash receipts. The profit adjusted this way denotes the
estimated cash available. The cash available during budget period is calculated in the
following form:
28
 Cash Budget Preparation and
For the period ending 31st March……………. Review of Budgets
Rs.
Opening balance of Cash xxx
Add :
Net profit for the year xxx
Funds from operations :
Depreciation xxx
Provision and write off xxx
Loss on sale of assets xxx
xxx
Less : Profit on sale of assets xxx xxx
“ Decrease in debtors xxx
“ Decrease in Stocks xxx
“ Decrease in other assets xxx
“ Decrease in prepaid exps. xxx
“ Increase in Capital xxx
“ Increase in liabilities xxx
“ Increase in debentures xxx xxx
xxx
Less :
Dividends xxx
Capital payments xxx
Repayment of loans xxx
Increase in Debtors xxx
Increase in Stock xxx
Decrease in liabilities xxx xxx
Closing balance of Cash xxx

Illustration 7

The following data are available to you. You are required to prepare a cash budget
according to Adjusted Profit and Loss method.

Balance Sheet as on 31st December, 2005

Liabilities Amount Assets Amount

Rs. Rs.
Share Capital 1,00,000 Premises 50,000
General Reserve 20,000 Machinery 25,000
Profit and Loss A/c 10,000 Debtors 40,000
Creditors 50,000 Closing Stock 20,000
Bills Payable 10,000 Bills Receivable 5,000
Outstanding Rent 2,000 Prepaid Commission 1,000
Bank 51,000
1,92,000 1,92,000

29
Budgeting and Projected Trading And Profit and Loss Account
Budgetary Control
for the year ending 31st December, 2005
Rs. Rs.
To Opening Stock 20,000 By Sales 2,00,000
To Purchases 1,50,000 By Closing Stock 15,000
To Octori 2,000
To Gross Profit c/d 43,000
2,15,000 2,15,000
To Interest 3,000 By Gross Profit b/d 43,000
To Salaries 6,000 By Sundry Receipts 5,000
To Depreciation (10% on
Premises and Machinery) 7,500
To Rent 6,000
Less: Outstanding
(Previous Year) 2,000
4,000
Add-Outstanding
(Current Year) 1,000 5,000
To Commission 3,000
Add-Prepaid (Previous Year) 1,000 4,000
To Office Expenses 2,000
To Advertisement Expenses 1,000
To Net Profit c/d 19,500
48,000 48,000
To Dividends 8,000 By Balance of Profit
(from last year) 10,000
To Addition to Reserves 4,000 By Net Profit b/d 19,500
To Balance c/d 17,500
29,500 29,500

Closing Balance of certain items:

Share Capital Rs. 1,20,000, 10% Debentures Rs. 30,000, Creditors Rs. 40,000, Debtors
Rs. 60,000, Bills Payable Rs. 12,000, Bill Receivable Rs. 4,000, Furniture Rs. 15,000
and Plant Rs. 50,000 (both these assets are purchased at the end of the year).
Solution
Cash Budget
For the period ending 31st December, 2005
Rs. Rs.
Opening Balance as on 1st January, 2005 51,000
Add: Net Profit for the year 19,500
Depreciation 7,500
Decrease in Bills Receivable 1,000
Increase in Bills Payable 2,000
Issue of Share Capital 20,000
Issue of Debentures 30,000
Decrease in Prepaid commission 1,000
Decrease of Stock 5,000 86,000
30 1,37,000
Less: Purchase of Plant 50,000 Preparation and
Review of Budgets
Purchase of Furniture 15,000
Increase of Debtors 20,000
Decrease of Creditors 10,000
Decrease in Outstanding Rent 1,000
Dividends Paid 8,000 1,04,000

Closing Balance as on 31st December, 2005 Rs. 33,000

3) Balance Sheet Method

Under this method, at the end of budget period a projected balance sheet is drawn up
setting out the various assets and liabilities, except cash and bank balances. The
balancing figure would be the estimated closing cash/bank balance. Thus, under this
method, closing balances other than cash/bank will have to be found out first to be put
in the budgeted balance sheet. This can be done by adjusting the anticipated
transaction of the year in the opening balances. If the liabilities are more than assets,
this reveals a balance of cash/bank and if assets exceed liabilities, it reveals a bank
overdraft. Thus, under Adjusted Profit and Loss method, the amount of cash is
computed by preparing a Cash Flow Statement and the same amount is computed as a
balancing figure under Balance Sheet method.

Illustration 8

Prepare the Cash Budget using Balance Sheet method on the basis of figures given in
illustration 7.

Solution
Budgeted Balance Sheet
as on 31st December, 2005
Liabilities Amount Assets Rs. Amount
Rs. Rs.

Share Capital 1,20,000 Premises 50,000

10% Debentures 30,000 Less : Depreciation 5,000 45,000
General Reserve 24,000 Machinery 25,000
(Rs. 20,000 +Rs. 4000)
Less: Depreciation 2,500 22,500
Profit and Loss A/c 17,500
Creditors 40,000 Furniture 15,000
Bills payable 12,000 Debtors 60,000
Outstanding Rent 1,000 Bills Receivable 4,000
Plant 50,000
Closing Stock 15,000
Bank (Balancing Figures) 33,000
2,44,500 2,44,500
31
Budgeting and
Budgetary Control 9.11 MASTER BUDGET
Master Budget is a combination of all other budgets prepared for a specific period.
It shows the overall budget plan. All the budgets are coordinated into one
harmonious unit.

According to Rowland and William H. Harr, “Master Budget is a summary of the

budget schedules in capsule form made for the purpose of presenting in one report
the highlights of the budget forecast.” Thus, Master Budget sets out the plan of
operations for all departments in considerable detail for the budget period. The
budget may take the form of a Profit and Loss Account and a Balance Sheet as at
the end of the budget period.

The budget generally contains details regarding sales (net), production costs, cash
position, and key account balances like debtors, fixed assets, bills payable, etc. It
also shows the gross and the net profits and the important accounting ratios. It is
prepared by the Budget Officer and it requires the approval of the Budget
Committee before it is put into operation. If approved, it is submitted to the Board
of Directors for final approval. The Board may make certain alterations if
necessary before it is finally approved.

Illustration 9

A Glass Manufacturing Company requires you to calculate and present the budget for
the next year from the following information.

Sales:
Toughened glass Rs. 3,00,000

Bent toughened glass Rs. 5,00,000

Direct Material Cost 60% of Sales

Direct Wages 20 Workers @ Rs. 150 per month

Stores and spares 2½ % on Sales

Depreciation on Machinery Rs. 12,600

Light and Power Rs. 5,000

Factory Overhead:

Indirect Labour:

Works Manager Rs. 500 per month

Foreman Rs. 400 per month

Repairs and maintenance 10% on direct wages
Administration, selling and distribution expenses Rs. 14,000 per year.
32
 Preparation and
Solution
Review of Budgets
Master Budget

for the period ending on ..................

Sales (as per Sales Budget) Rs. Rs. Rs.

Toughened Glass....... units @ Rs 3,00,000

Bent toughened glass ....... units @ Rs 5,00,000 8,00,000

Less- Cost of Production (as per Cost of Production Budget) :

Direct Materials (.... units @ Rs......) 4,80,000

Direct Wages 36,000
Prime Cost 5,16,000
Factory Overhead:
Variable: Stores and Spares (2½% of Sales) 20,000
Light and Power 5,000
Repairs and Maintenance 8,000 33,000
Fixed : Works Manager’s Salary 6,000
Foreman’s Salary 4,800
Depreciation 12,600
Sundries 3,600 27,000
Works Cost 5,76,000

Gross Profit 2,24,000

Less : Administration, Selling and Distribution Overheads 14,000
Net Profit 2,10,000

9.12 REVISION OF BUDGETS

Once a budget is fixed it should not be revised too frequently, as it loses its
importance. On the other hand, under changing conditions, a fixed or static budget
will lead to serious inaccuracies and will fail to serve as a control document and a
measuring tool. Normally, budgets are prepared well before the period of
commencement and naturally all the factors can not be foreseen with minute
accuracies. It is a recognised fact that business is dynamic and factors are ever
changing. Budget, in order to play its proper role changes must be incorporated if
they are significant. The revision of budgets may be necessitated on account of the
following reasons:

i) Budgeting errors, detected at a later stage.

ii) Change in external factors like material price-spiral, inflation in the prices of
fixed assets, increased wage rates, change in government policy, etc.
33
Budgeting and iii) Additional expenditure to meet contingencies of an unforeseen nature, e.g.
Budgetary Control sudden loss on account of fire, strikes, lockouts, flood, tycoons, etc. If such
contingencies are of a temporary nature, the budgets are again reshaped in their
original form.

Illustration 10

A Company produces two products A and B and budgets at 70% level of activity for
the year 2003. It gives the following information :

Products A B
(Rs.) (Rs.)

Raw material cost per unit 15 7

Direct wages per unit 8 6

Variable overhead per unit 4 3

Fixed overhead per unit 12 9

Selling price per unit 38 27

Production and sales (Units) 12000 18000

The managing director proposed to decrease sales to 8000 units and 12000 units of
Product A and B respectively and increasing the selling price to Rs. 40 in the case of
Product A and Rs. 30 in the case of Product B.

You are required to present the overall profitability under the original budget and
revised budget after taking the above proposal into consideration.
Solution
Budget
For the year 2004
Revised Budget Original Budget
Particulars
A B Total A B Total

Sales Units 8,000 12,000 12000 18000

Sales (Value in Rs.)(A) 3,20,000 3,60,000 6,80,000 456,000 4,86,000 9,42,000

Costs : Rs. Rs. Rs. Rs Rs Rs

Raw Material 1,20,000 84,000 2,04,000 1,80,000 1,26,000 3,06,000

Labour 64,000 72,000 1,36,000 96,000 1,08,000 2,04,000

Variable O.H 32,000 36,000 68,000 48,000 54,000 99,000

Fixed O. H. 96,000 1,08,000 2,04,000 1,44,000 1,62,000 3,06,000

Total Cost (B) 3,12,000 3,00,000 6,12,000 4,68,000 4,50,000 9,18,000

Profit (A-B) 8,000 60,000 68,000 (--) 12,000 36,000 24,000

The managing director’s proposal is to be implemented as the profit is

34 increasing from Rs. 24,000 to Rs. 68,000 keeping in view other factors also.
 Preparation and
9.13 BUDGET REPORT Review of Budgets

Proper reporting is an essential element in budgetary control. The management must

be regularly informed about the results of various functions so that follow up actions
can be taken up without loss of time. The periodicity of reports depends on the nature
of operations involved. The budgetary control reports are prepared on the basis of the
budget reports. The comparison of budgeted and actual figures is made and deviations
taken out- all the relevant figures are presented in the control reports. On the basis of
the principle of management by exception, remedial and corrective action is taken.
The report may indicate the necessity of revision of the budget also.

The budget report should be prompt and factual and should have the requisite degree of
accuracy. The report should be prepared in such a manner that it reveals the
responsibility of a department or an executive and give full reasons for the variances
so that proper corrective action can be taken.

Check Your Progress

1) State the factors that should be kept in mind while preparing Sales Budget.
a) ……………………….. d) …………………………….
b) ………………………… e) …………………………….
c) ………………………… f) …………………………….
2) What are the components of functional budgets ?
..............................................................................................................................
..............................................................................................................................
..............................................................................................................................
..............................................................................................................................
3) Specify the objectives of preparing capital expenditure budget.
..............................................................................................................................
..............................................................................................................................
..............................................................................................................................
..............................................................................................................................
4) Why does revision of budget necessary ?
..............................................................................................................................
..............................................................................................................................
..............................................................................................................................
..............................................................................................................................

5) Fill in the blanks :

a) .................. is responsible for the preparation and execution of sales budget.

b) Production budget is based on ...................................... budget.

c) Purchase budget must correlate .......................... budget and ....................

budget. 35
Budgeting and d) .............................. budget is the combination of all other budgets.
Budgetary Control
e) The preparation of cash budget by the method of adjusted profit and loss
account is also known as............................... .
f) Master budget is the summary of all components of .............................. .
6) State whether each of the following statement is true or false.

a) The cost of materials, labor and manufacturing overheads constitutes total

cost of sales [ ]

b) The purpose of Direct labour budget is to ensure optimum utilisation of

labour force. [ ]

c) Direct materials are generally included in overhead budget. [ ]

d) Once a budget is fixed there is no need to incorporate the changes in the

budget however significant they are. [ ]

e) Cash budget indicates the amount of loan required as well as the time when
it is needed. [ ]

f) A Master Budget is the master plan drawn up by the organisation for the
budget period. [ ]

9.14 LET US SUM UP

Budgeting is the main instrument for projecting the future costs and revenues and for
financial control of the organisation. Preparation of budgets involves a number of
forecasts or projections. It starts with sales forecasting and ends with the compilation
of the master budget. The sales budget is the keystone in planning and control of
operations of a business. Sales forecast serves as a base for the sales budget. The
Sales Manager is responsible for the preparation and execution of sales budget. In
addition to sales budget, other functional budgets are also prepared. The other
functional budgets are : i) Production Budget, ii) Cost of Production Budget,
iii) Material Budget, iv) Purchase Budget, v) Direct Labour Budget,
vi) Manufacturing Overhead Budget, vii) Administration Overhead Budget,
viii) Selling and Distribution Overhead Budget, and ix) Capital Expenditure Budget.

A cash budget is a summary statement of the firms expected cash inflows and
outflows over a projected time period. It is generally prepared for a maximum
period of one year. There are three methods of preparing cash budgets. They are :
i) Receipts and Payment Method, ii) Adjusted Profit and Loss Account Method, and
iii) Balance Sheet Method.

A master budget is a combination of all other budgets prepared for a specific

period. It shows the overall budget plan. The budget generally contains details
regarding sales, production costs, cash position and the key account balances. It
also shows profit and important accounting ratios. Revision of budgets is
necessary to incorporate the changing conditions for effective control. Revision of
budget may be necessitated due to budgeting errors, change in external factors and
additional expenditure to meet unforeseen contingencies. Proper reporting is an
essential element in budgetory control. The management must be regularly
informed about the results of various functions so that remedial and corrective
action may be taken well in time. The report may also indicate the necessity of
36 revision of budget also.
 Preparation and
9.15 KEY WORDS Review of Budgets

Cash Budget : A summary statement of future cash receipts and payments over a
projected time period.
Production Budget : A forecast of production expressed quantitatively for the budget
period.
Sales Budget : A budget expressed in quantitative terms of units expected to be sold
and the value expected to be realised for the budget period.

9.16 ANSWERS TO CHECK YOUR PROGRESS

5) a) Sales Manager b) Sales c) Sales, production d) Master Budget
d) Cash flow statement f) Functional budget
6) a) False b) True c) False d) False e) True f) True

9.17 TERMINAL QUESTIONS

1) What is a Sales Budget ? How is it prepared ?
2) Write short notes on the following :
i) Sales Budget
ii) Material Budget
iii) Production Cost Budget
iv) Overhead Budget
3) What is a Cash Budget ? How is it prepared ?
4) What is a Master Budget ? What are its Components ?
5) From the following particulars, prepare a production budget of a manufacturing
company for the year ended 31st March, 2003.

Product Sales Budget Estimated Stock (Units)

(Units) 1-4-2002 31-3-2003
A 75,000 7,000 7,500
B 50,000 2,500 7,250
C 35,000 4,000 4,000

(Ans. A : 75,500 Units, B : 54, 750 Units, C : 35,000 Units)

6) Prepare a material procurement budget (in units) from the following information :
Estimated sales of a product 40,000 units. Each unit of the product requires 3
units of Material A and 4 units of Material B. Estimated opening balance at the
beginning of the next year:
Units
Finished Products 5,000
Material A 19,000
Material B 31,000
The desired level of closing balances at the end of the next year :
Finished Products 7,000 37
Budgeting and Material A 23,000
Budgetary Control
Material B 35,000
(Ans. Production 42,000 units, Material required : Material A : 1,30,000
units, Material B : 1,72,000 units)
7) The budgeted expenses for production of 10,000 units in a manufacturing
company are given below. From the information prepare a budget for the
production of (a) 8000 units and (b) 6000 units. Assume that the administration
expenses are fixed for all levels of production:

Rs. Per unit

Materials 70
Labour 25
Variable Overheads 20
Fixed Overheads (Rs. 1,00,000) 10
Variable Overheads(Direct) 5
Selling expenses (10% fixed) 13
Administration expenses (Rs. 50,000) 5
Distribution expenses (20% Fixed) 7

Rs.155

( Ans. (a) Rs. 12,75,400 (b) Rs. 10,00,800 )

8) A Company produces and sells three products : Product A, Product B and

Product C. The Company has divided its market into two areas as North zone
and South zone. The actual sales for the year 2003 were as follows :

North Zone South Zone

Products
Price per No. of Units Price per No. of Units
Unit (Rs.) Unit (Rs.)

A 12 8,00,000 12 5,00,000
B 15 5,00,000 15 7,00,000
C 16 6,00,000 16 6,00,000

For the current year i.e, 2002, it is estimated that the sales of product A will go up
by 10% in South zone and of Product C by 50,000 units in North zone. The company
plans to launch an intensive advertisement campaign through which budgeted figures
for product B are to be increased by 20% in both the zones.
There will be no change in the pries of the product A and C but the price of Product B
will be reduced by Rs. 1.

38 You are required to prepare a sales budget for the year 2003.
Ans. : Preparation and
Review of Budgets
North South Total Budget
(Units) (Units) (Rs.)

Product A 8,00,000 5,50,000 162,00,000

Product B 6,00,000 8,40,000 201,60,000
Product C 6,50,000 6,00,000 200,00,000)

9) Andhra Ltd has three sales division at Chennai, Bangalore and Hyderabad.
It sells two products – I and II. The budgeted sales for the year ending
31st December, 2002 at each place are given below:

Chennai Product I 50,000 units @ Rs. 16 each

Product II 35,000 units @ Rs. 10 each
Bangalore Product II 55,000 units @ Rs. 10 each
Hyderabad Product I 75,000 units @ Rs. 16 each

The actual sales during the same period were :

Chennai Product I 62,500 units @ Rs. 16 each

Product II 37,500 units @ Rs. 10 each
Bangalore Product II 62,500 units @ Rs. 10 each
Hyderabad Product I 77,500 units @ Rs. 16 each

From the reports of the sales department it was estimated that the sales budget for the
year ending 31st December, 2003 would be higher than 2002 budget in the following
respects :

Chennai Product I 4000 units

Product II 2,500 units
Bangalore Product II 6,500 units
Hyderabad Product I 5,000 units

Intensive sales campaign in Bangalore and Hyderabad is likely to result in additional

sales of 12, 500 units of Product I in Bangalore and 9,000 units of Product II in
Hyderabad. Let us prepare a sales Budget for the period ending 31st December,
2003.

(Ans. : Chennai : Product I 54000 Units

Product II 37,500 Units

Bangalore : Product I – 12500 units

Product II 61,500 units

Hyderabad : Product I 80,000 units

Product II 9000 units)

10) Draw a Material Procurement Budget (Quantitative) from the following

information:

Estimated sale of a product is 20,000 units. Each units of the product requires
3 units of material X and 5 units of Material Y. 39
Budgeting and Estimated opening balance at the commencement of the next year :
Budgetary Control
Finished product 2,500 kgs.
Material X 6,000 units
Material Y 10,000 units
Materials on Order :
Material X 3,500 units
Material Y 5,500 units
The desirable closing balances at the end of the next year :
Finished Product 3,500 units
Material X 7,500 units
Material Y 12,500 units
Material on order :
Material X 4,000 units
Material Y 5,000 units
11) The Sales Director of Asian Company expects to sell 25,000 units of a particular
product next year. The Production Director consulted the storekeeper who gave
the necessary details as follows :

Two kinds of raw material, P and Q are required for manufacturing the product.
Each unit of the product requires 2 units of P and 3 units of Q. The estimated
opening balance at the commencement of the next year are :
Finished product : 5,000 units
Raw Material P : 6,000 units
Raw Material Q : 7,500 units
The desirable closing balance at the end of the next year are :
Finished Products : 7,000 units
Raw Material P : 6500 units
Raw Material Q : 8000 units
Prepare a statement showing Material Purchase Budget for the next year.
(Ans. : Material required for 25,500 units : P - 54,500 units, Q - 81,500 units)
12) A company is expecting to have Rs. 50,000 cash in hand on 1st April, 2005
and it requires you to prepare an estimate of cash position during the three
months, April to June 2005. The following information is supplied to you :

Sales Purchases Wages Expenses

(Rs.) (Rs.) (Rs.) (Rs.)

February 1,40,000 80,000 16,000 12,000

March 1,60,000 1,00,000 16,000 14,000
April 1,84,000 1,04,000 18,000 14,000
May 2,00,000 1,20,000 20,000 16,000
June 2,40,000 110,000 24,000 18,000
40
Additional Information : Preparation and
Review of Budgets
a) The credit period allowed by supplies is two months.
b) 25% of sales is for cash and credit period allowed to customers is one month.
c) Delay in payment of wages and expenses is one month.
d) Income tax Rs. 50,000 is to be paid in June 2005.
(Ans. : April Rs. 1,06,000, May Rs. 1,62,000, June Rs. 1,82,000)
13) A Company is expected to have Rs. 12,500 cash in hand on 1st July, 2005 and it
requires you to prepare a cash budget for the period July, 2005 to September,
2005 from the following particulars :
Sales Purchases Wages
(Rs.) (Rs.) (Rs.)
May 90,000 62,400 6,000
June 96,000 72,000 7,000
July 54,000 1,21,500 5,500
August 87,000 1,23,000 5,000
September 63,000 1,34,000 7,500

Creditors are paid in the month following the month of purchase. 50% of credit sales
are realised in the month following the credit sales and the remaining 50% in the
second month following. Delay in the payment of wages is one month.
(Ans. Cash balance : July Rs. 26,500 (+), August Rs. 25,500 (--), September
Rs. 83,000(--) )
14) A company expects to have Rs. 37,500 cash in hand on 1st April, and requires
you to prepare an estimate of cash position during the three months, April, May
and June. The following information is supplied to you :
Sales Purchases Wages Factory Office Selling
( Rs.) ( Rs.) ( Rs.) Expenses Expenses Expenses
( Rs.) ( Rs.) ( Rs.)

February 75,000 45,000 9,000 7,500 6,000 4,500

March 84,000 48,000 9,750 8.250 6,000 4,500
April 90,000 52,500 10,500 9,000 6,000 5,250
May 1,20,000 60,000 13,500 11,250 6,000 6,570
June 1,35,000 60,000 14,250 14,000 7,000 7,000

Additional Information :
1) Period of credit allowed by suppliers 2 months
2) 20% of sales is for cash and period of credit allowed to customers for credit is one
month
3) Delay in payment of all expenses – 1 month
4) Income tax of Rs. 57,500 is due to be paid on June 15th.
5) The company is to pay dividends to shareholders and bonus to workers of
Rs. 15,000 and Rs. 22,500 respectively in the month of April. 41
Budgeting and 6) Plant has been ordered to be received and paid in May. It will cost
Budgetary Control Rs. 1,20,000.
(Ans. : Cash balance : April (+) Rs. 11,700, May (--) Rs. 91,050,
June (--) Rs. 1,15,370 )
15) From the following information, you are required to prepare cash budget
according to Adjusted Profit and Loss method as well as Balance Sheet method.

Balance Sheet as on 1-1-2005

Liabilities Rs. Assets Rs.

Share Capital 5,00,000 Debtors 5,00,000

Reserves 10,00,000 Stock and Stores 3,00,000

Debentures 3,00,000 Fixed assets 13,00,000

Public deposits 2,00,000 Cash balance 1,00,000

Current liability 2,00,000

22,00,000 22,00,000

Projected Trading and Profit and Loss A/c for the year ending 31-12-2005

Particulars Rs. Particulars Rs.

To Opening Stock 3,00,000 By Sales 15,00,000

To Direct Cost of Production 12,00,000 By Closing Stock 6,00,000

To Depreciation 1,00,000

To Variable selling and

distribution costs 2,00,000

To Net profit c/d 3,00,000

21,00,000 21,00,000

To Dividends 50,000 By Net Profit b/d 3,00,000

To Balance c/d 2,50,000

3,00,000 3,00,000

Additional Information :

Collection of debtors and sales proceeds during the year Rs. 17,00,000, refund of
public deposits Rs. 1,00,000, increase in current liability Rs. 50,000

(Ans. : Cash balance as on 31.12.2005 : Rs. 3,00,000, Debtors as on 31.12.2005 :

Rs. 3,00,000 (Opening debtors Rs. 5,00,000 + Sales Rs. 15,00,000 – Collection
from debtors Rs. 17,00,000)

16) From the following information prepare a cash budget under the Adjusted Profit
42 and Loss Account Method and Balance Sheet Method.
 Balance Sheet as on 1-1-2005 Preparation and
Review of Budgets
Liabilities Rs. Assets Rs.
Share capital 50,000 Land and buildings 30,000
Capital reserve 5,000 Plant and Machinery 20,000
Profit and loss a/c 9,000 Furniture and fixtures 5,000
Debentures 10,000 Closing stock 4,000
Creditors 28,800 Debtors 26,000
Accrued expenses 200 Bank 18,000
1,03,000 1,03,000

Forecast Trading, and Profit and Loss Account

For the Year ending 31-12-2005
Particulars Rs. Particulars Rs.
Opening Stock 4,000 Sales 80,000
Purchases 60,000 Closing Stock 10,000
Gross Profit c/d 26,000
90,000 90,000
Salary and wages 2500 Gross profit b/d 26,000
Add Outstanding 500 3000 Interest received 100
Depreciation :
Plant and Machinery 2,000
Furniture and fixture 1,000
Administrative expenses 3,500
Selling expenses 2,500
Net Profit c/d 14,100
26,100 26,100
Dividend paid 10,000 Balance b/d 9,000
Balance c/d 13,100 Net profit b/d 14,100
23,100 23,100

The following are the additional information for the year 2005 : shares were
issued for Rs. 10,000, and debentures were issued for Rs. 2,000.
On 31-12-2005, the accrued expenses were Rs. 500, Debtors Rs. 20,000, Creditors
Rs. 30,000, and Land and buildings, Rs. 40,000.
(Ans : Cash balance as on 31.12.2005 : Rs. 28,600, Balance Sheet total : Rs.1,20,600)

Note : These questions will help you to understand the unit better. Try to write
answers for them. But do not submit your answers to the University. These
are for your practice only.

9.18 FURTHER READINGS

Edward B. Deakin and Michael W. Maher, Cost Accounting, Richard D. Erwin, inc.,
Homewood, Illinois.
Lal Nigam B.M. and Sharma G.L., Advanced Cost Accounting, Himalaya Publishing
House, Bombay-4. 43