Cost MGMT Accounting U4

UNIT 4 i
Budgeting
Unit 4
BAC 301/05
Cost and Management
Accounting
Budgeting
ii WAWASAN OPEN UNIVERSITY
BAC 301/05 Cost and Management Accounting
COURSE TEAM
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COURSE COORDINATOR
Dr. Loo Choo Hong
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Associate Professor Dr. Shanmugam Muruswamy, Universiti Tun Abdul Razak
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UNIT 4 iii
Budgeting
Contents
Unit 4 Budgeting
Unit overview 1
Unit objectives 1
4.1 Introduction to the budgeting process 3
Objectives 3
Introduction 3
Strategic and operating plans 3
Budgeting cycle and master budget 4
Advantages of budgets 5
Challenges in administering budgets 5
Developing an operating budget 6
Revenues budget 7
Production budget 8
Direct material usage budget and direct material 10

purchases budget
Direct manufacturing labour costs budget 14
Manufacturing overhead costs budget 16
Ending inventory budget 17
Cost of goods sold budget 20
Non-manufacturing costs budgets 21
Budgeted statement of comprehensive income 22
Cash budget 24
iv WAWASAN OPEN UNIVERSITY
Budgeted statement of financial position 29
Suggested answers to activities 31
4.2 Activity-based budgeting and responsibility 33

accounting
Objectives 33
Introduction 33
Activity-based budgeting (ABB) 33
Responsibility accounting 38
Responsibility and controllability 38
Human aspects of budgeting 39
Flexible budgets 39
Static budget variances 40
Sales volume variances 41
Flexible budget variances 41
Price variances 42
Efficiency variances 42
Standard costing 43
Developing standard overhead costs 44
Variable overhead cost variance 44
Fixed overhead cost variance 45
Actual costing 47
Normal costing 47
Suggested answers to activities 49
Summary of Unit 4 51
Unit practice exercise 53

UNIT 4 v
Budgeting
Case studies 57
Suggested answers to unit practice exercise 59
Suggested answers to case studies 65
Glossary 67
vi WAWASAN OPEN UNIVERSITY
UNIT 4 1
Budgeting
Unit Overview
U nit 4 covers master budgets, flexible budgets and standard costs. This unit
introduces the standard costing system which is used for both job and process
costing. A simple budgeted statement of comprehensive income based on a set of
estimates or budgeted figures is also presented. The unit also demonstrates the steps
involved in preparing budget schedules and flexible budgets. In addition, steps to
prepare a performance report that uses a flexible and static budget are illustrated. The
later part of the unit explains the various variance analyses to control and measure
management performance.
Unit Objectives
By the end of Unit 4, you should be able to:
1. Define master budgets, and describe its major benefits to an organisation.
2. List and construct the major schedules in preparing an operating budget.
3. Describe responsibility accounting and explain how controllability relates

to it.
4. Compute variances using the flexible budget approach.
5. Discuss standard costing system.
6. Explain how to develop standard costs system.
7. Identify actual, normal and standard costing.

2 WAWASAN OPEN UNIVERSITY
UNIT 4 3
Budgeting
4.1 Introduction to the Budgeting

Process
Objectives
By the end of this section, you should be able to:
1. Describe what master budget is.
2. Explain the major benefits and advantages of a master budget to an

organisation.
3. Prepare the operating budget and its supporting schedules.
Introduction
Budget is a quantitative expression of a management’s proposed plan for a specified
period, and is an aid to coordinate what needs to be done to implement the plan.
Budgeting is part of the management process; budget is a primary financial planning

tool for most business organisations. Businesses need to understand the importance
of budget because it is a financial expression of organisational goals in future financial
periods.
Besides being a financial planning tool, budget helps in coordination and

communication among managers, it is useful for performance evaluation, and can
be used to motivate employees.
Budgetary tools include activity-based budgeting, sensitivity analysis and kaizen

budgeting.
Strategic and operating plans

An effective budget requires a well-planned strategy, which integrates the company’s
strategy into the budget process. As a strategy, an organisation needs to match its
own capabilities with the opportunities in the marketplace.
Managers need to know the objectives of the organisation when developing

strategies. It is important for an organisation to create value for its customers while
distinguishing itself from its competitors. In addition, managers must answer the
following questions:
• Are the markets for the products local, regional, national, or global?
• What trends affect the market?

• How do the economy, industry, and competitors affect the firm?
• What is the best organisational and financial structure for the firm?
• What are the risks and opportunities of alternative strategies?
• What are the contingency plans if the preferred plan fails?
Strategic plans are expressed through long-term budgets and operating plans are
expressed through short-term budgets. Feedback from the short-term budgets can
lead to changes in plans and strategies.
Budgeting cycle and master budget

Companies usually follow the following steps in an annual budget cycle:
Plan the performance of the company as a whole

and of the subunits
Communicate to subordinates a set of expectations
Investigate variations from plans, and

take corrective actions
Figure 4.1 Budgeting cycle
Managers and management accountants need to consider market feedback, changed

conditions, and their own experiences when making plans for the next period. In
the first step, managers and management accountants plan the performance of the
company based on past performance and anticipated changes in the future. In the
next step, senior managers communicate a set of expectations against which actual
results will be compared. Finally, management accountants investigate deviations
from plans, and take corrective actions.
The working document for the budgeting process is called the master budget. Master
budget includes management’s operating and financial plans for a financial period.
It is a series of budgets including a set of budgeted financial statements called pro
forma statements.
UNIT 4 5
Budgeting
Advantages of budgets
Budgets are a primary management control tool which has at least three advantages
as below:
1. Promote coordination and communication. Coordination is to ensure that

all aspects of production are in the best way to meet the goals. Communication
is to ensure that those goals are understood by all employees.
2. Budgets provide a framework for judging performance and facilitating

learning. Judging performance based on past performance is subject to past
miscues and substandard performance. Future conditions can be expected
to differ from the past and budgets account for these changed conditions.
For example, it is more acceptable to compare the actual results with the
budgets than comparing the results with the previous year actual results.
3. Budgets can be used to motivate managers and other employees. Studies

have shown that challenging budgets improve employee performance because
employees view deviations from budgeted numbers as a failure. When
employees get closer to a goal, they work harder to achieve it.
If the marketing group is able to obtain information about the launching of a new
product, it can share with the manufacturing group. The manufacturing group must
then coordinate and communicate with the material purchasing group, and so on.
Budget should not be the only benchmark used to evaluate performance because
it creates an incentive for subordinates to set a target that is relatively easier to
achieve. Managers should negotiate with the subordinates to make the budget more
challenging to achieve.
Challenges in administering budgets

The budgeting process is very time-consuming and there are many challenges when
administering budgets. It is vital for management at all levels to understand and
support the budget. Participation and bottom-up approach in budgeting creates
greater commitment and accountability among lower-level managers. Lower-level
managers will unlikely be active participants in a budget process if they feel that top
management does not support the budget.
Budgets must involve all levels of management in the company. The accountant
should be a budget coordinator instead of a budget preparer.
Budgets should not be administered rigidly. Attaining the plan in the original
budget is not the only objective because changing conditions may call for changes
in plans. For example, if a situation arises in which some unplanned repairs would
serve the long-term interests of the company, the manager should undertake the
additional spending.
Developing an operating budget

Budgets are prepared for a set time period, such as a year or annual budget. Normally
an annual budget is broken down into shorter periods such as a month or quarter.
However, some companies utilise rolling budgets or continuous budgeting, which is
created by continually adding a month or quarter to the existing budget to maintain
a 12-month budget at anytime.
Steps in preparing operating budgets
The budgeting process includes both operating budgets and financial budgets.
Operating budgets include budgets for revenues, production, manufacturing costs,

and other expenses for the period. Revenues budget is often the starting point of
the operating budget. The supporting schedules quantify the budgets for various
business functions of the value chain, from the production budget to distribution
costs budget. These schedules build up to the budgeted statement of comprehensive
income as a key summary statement in the operating budget.
Financial budgets consist of a capital expenditures budget, a cash budget, a budgeted

statement of financial position, and a budgeted statement of cash flows. A financial
budget focuses on how operations and capital expenditures affect cash flows.
The cash budget and budgeted statement of comprehensive income are used to
prepare the budgeted statement of financial position and budgeted statement of
cash flows.
Although facts are different among companies, the following basic steps are common
for developing the operating budget of a manufacturing company.
Step 1 Prepare the revenues budget.

Step 2 Prepare the production budget based on the numbers included in the
revenues budget.
Step 3 Prepare the direct materials usage budget and direct materials
purchases budgets based on the production budget.
Step 4 Prepare the direct manufacturing labour cost budget based on the
production budget.
Step 5 Prepare the manufacturing overhead costs budget based on the
production budget.
Step 6 Prepare the ending inventories budget. The number of units in the
revenues budget and the production budget may differ because of a
change in finished goods inventory levels.
Step 7 Prepare the cost of goods sold budget.
Step 8 Prepare the non-manufacturing costs budgets such as selling,
general and administrative expenses budgets.
Step 9 Prepare the budgeted statement of comprehensive income.
UNIT 4 7
Budgeting
Step 10 Prepare the capital expenditure budget.

Step 11 Prepare the cash budget.
Step 12 Prepare the budgeted statement of financial position.
Step 13 Prepare the budgeted statement of cash flows.
Revenues budget
The budgeting process usually begins with a revenues budget. The revenues budget
reflects sales forecast and is affected by current and expected economic conditions,
new or discontinuing products, activities of competitors, and company planned
marketing activities.
The revenues budget identifies the expected level of sales for the company. Although
revenues budget looks simple, its outcome will affect the remainder of the budget
process.
The sales forecast should be primarily based on input from sales managers and
sales representatives. A sales forecast is often the outcome of elaborate information-
gathering and discussions among sales managers.
It is a challenge to come up with an accurate sales forecast because its accuracy

depends on the ability to forecast the state of the general economy, changes in the
industry, actions of the competition, and developments in technology. Each of
these items affects individual products or product lines which are quantified and
aggregated to obtain the sales forecast.
Revenues budget is prepared together with an analysis of the resulting expected cash
collections. Normally, sales are on account, there is a delay between the time of a
sale and the actual cash collections. For the revenues budget to be useful, the timing
and pattern of cash collections must be carefully considered.
Example of Revenues Budget
Wonderful Corporation forecasts sales for three products with the following seasonal
sales pattern for the year ending 31 December 2014:
Products
Quarter A B C
1 40% 30% 10%
2 30% 20% 40%
3 20% 20% 40%
4 10% 30% 10%
The annual sales budget shows forecasts for the different products and their expected selling
price per unit as follows:
Product Units Selling price

A 40,000 RM10
B 60,000 15
C 80,000 20
Required:
Prepare a sales budget, in units and dollars, by quarters for the company for the coming year.
Answer:
Revenues Budget
For the Year Ending 31 December 2014
First Second Third Fourth

Total
quarter quarter quarter quarter
Product A:
Sales (units) 16,000 12,000 8,000 4,000 40,000
Price × RM180 × RM180 × RM180 × RM180 × RM180
Sales RM2,880,000 RM2,160,000 RM1,440,000 RM720,000 RM7,200,000
Product B:
Sales (units) 18,000 12,000 12,000 18,000 60,000
Sales RM3,960,000 RM2,640,000 RM2,640,000 RM3,960,000 RM13,200,000
Product C:
Sales (units) 8,000 32,000 32,000 8,000 80,000
Sales RM2,400,000 RM9,600,000 RM9,600,000 RM2,400,000 RM24,000,000
Total RM9,240,000 RM14,400,000 RM13,680,000 RM7,080,000 RM44,400,000
Production budget
Production budget is prepared based on the forecasted sales. Production is also a
function of the beginning finished goods inventory and the desired ending finished
goods inventory.
Budgeted units of production = Forecasted sales (units) + Desired ending inventory of

finished goods (units) – Beginning inventory of finished
goods (units)
UNIT 4 9
Budgeting
Production capacity and availability of raw materials are to be considered when

preparing the production budget.
Example of Production Budget
Wonderful Corporation forecasts sales for three products for the year ending
31 December 2014:

Total
units
units units units units
Product A 16,000 12,000 8,000 4,000 40,000
Product B 18,000 12,000 12,000 18,000 60,000
Product C 8,000 32,000 32,000 8,000 80,000
Production manager plans to end each quarter with sufficient inventory to cover
25% of the following quarter’s forecasted sales. The company started of Product
A with 4,000 units in finished goods inventory, and planned to end the year with
5,000 units in finished goods inventory. The company started of Product B with
4,500 units in finished goods inventory, and planned to end the year with 4,000
units in finished goods inventory. The company started of Product C with 2,000
units in finished goods inventory, and planned to end the year with 3,000 units in
finished goods inventory.
Required:
Prepare a production budget, in units, by quarters for the three products for the
coming year.
Answer:
Production Budget for Product A

For The Year Ending 31 December 2014
First Second Third Fourth Annual

quarter quarter quarter quarter recap
units units units units units
Product A: 16,000 12,000 8,000 4,000 40,000
Forecasted sales
Desired ending 3,000 2,000 1,000 5,000 5,000
finished goods
inventory
Total units 19,000 14,000 9,000 9,000 45,000
needed
Less: Beginning (4,000) (3,000) (2,000) (1,000) (4,000)
finished goods
inventory
Planned 15,000 11,000 7,000 8,000 41,000
production
Production Budget for Product B


Product B: 18,000 12,000 12,000 18,000 60,000
Forecasted sales
Desired ending 3,000 3,000 4,500 4,000 4,000
finished goods
inventory
Total units 21,000 15,000 16,500 22,000 64,000
needed
Less: Beginning (4,500) (3,000) (3,000) (4,500) (4,500)
finished goods
inventory
Planned 16,500 12,000 13,500 17,500 59,500
production
Production Budget for Product C


Product C: 8,000 32,000 32,000 8,000 80,000
Forecasted sales
Desired ending 8,000 8,000 2,000 3,000 3,000
finished goods
inventory
Total units 16,000 40,000 34,000 11,000 83,000
meeded
Less: Beginning (2,000) (8,000) (8,000) (2,000) (2,000)
Finished Goods
Inventory
Planned 14,000 32,000 26,000 9,000 81,000
Production
Direct material usage budget and direct material purchases budget

These are often prepared as one document. In addition to including projections
about inventory levels for direct materials, management must also make predictions
about direct material prices.
The planned production is the key to prepare the direct material usage budget
in quantities and dollars. Bill of materials is a document stored and updated in
UNIT 4 11
Budgeting
computer systems that identifies how each product is manufactured. It is a list of

the raw materials, sub-components, parts and the quantities of each component
needed to manufacture a product.
Budgeted direct materials usage (units) = Planned production (units) × Quantity of

materials required (units)
Example of Direct Material Usage Budget
Wonderful Corporation planned production for three products for the year ending
31 December 2014:

Total
units
Product A 15,000 11,000 7,000 8,000 41,000
Product B 16,500 12,000 13,500 17,500 59,500
Product C 14,000 32,000 26,000 9,000 81,000
Bill of materials indicates that the following direct materials are required for each
product:
Material X Material Y Material Z

Product A 1 kg 2 pieces 2 metres
Product B 1 kg 4 pieces 2 metres
Product C 1 kg 6 pieces 4 metres
Required:
Prepare the direct material usage budget for the year ending 31 December 2014.
Answer:
Direct Material Usage Budget


Total
Usage of Material X:
Product A 15,000 11,000 7,000 8,000 41,000
Product B 16,500 12,000 13,500 17,500 59,500
Product C 14,000 32,000 26,000 9,000 81,000
Total (in kg) 45,500 55,000 46,500 34,500 181,500
Usage of Material Y:
Product A 30,000 22,000 14,000 16,000 82,000
Product B 66,000 48,000 54,000 70,000 238,000
Product C 84,000 192,000 156,000 54,000 486,000
Total (in pieces) 180,000 262,000 224,000 140,000 806,000
Usage of Material Z:
Product A 30,000 22,000 14,000 16,000 82,000
Product B 33,000 24,000 27,000 35,000 119,000
Product C 56,000 128,000 104,000 36,000 324,000
Total (in metres) 119,000 174,000 145,000 87,000 525,000
Purchasing department prepares the direct material purchase budget based on the
budgeted direct material usage, the beginning and the ending inventory of direct
materials.
Budgeted Purchases of direct materials

= Budgeted direct materials usage (units) + Desired ending inventory of direct
materials (units) – Beginning inventory of direct materials (units)
Example of Direct Material Purchases Budget
Wonderful Corporation direct material usage budget for all materials for the year
ending 31 December 2014:

Total
Material X (in kg) 45,500 55,000 46,500 34,500 181,500
Material Y (in pieces) 180,000 262,000 224,000 140,000 806,000
Material Z (in metres) 119,000 174,000 145,000 87,000 525,000
Production manager plans to end each quarter with sufficient inventory of direct
materials to cover 20% of the following quarter’s production. The company’s plan for
inventory of direct materials for the year ending 31 December 2014 are as follows:
Beginning Ending
inventory inventory
Material X (in kg) 9,100 10,000
Material Y (in pieces) 36,000 40,000
Material Z (in metres) 23,800 30,000
UNIT 4 13
Budgeting
The purchase price for the direct materials are as follows:
Unit price
Material X (in kg) RM5.00
Material Y (in pieces) RM10.00
Material Z (in metres) RM20.00
Required:
Prepare the direct material purchases budget for the year ending 31 December 2014.
Answer:
Direct Material Purchases Budget

Material X: (in kg)

Total
Budgeted direct
material usage 45,500 55,000 46,500 34,500 181,500
Desired ending
inventory of direct
materials 11,000 9,300 6,900 10,000 10,000
Direct material
needed 56,500 64,300 53,400 44,500 191,500
Beginning inventory
of direct materials (9,100) (11,000) (9,300) (6,900) (9,100)
Planned purchases 47,400 53,300 44,100 37,600 182,400

Material Y: (in pieces)

Total
Budgeted direct
material usage 180,000 262,000 224,000 140,000 806,000
Desired ending
inventory of direct
materials 52,400 44,800 28,000 40,000 40,000
Direct material
needed 232,400 306,800 252,000 180,000 846,000
Beginning inventory

Material Z: (in metres)

Total
Budgeted direct
material usage 119,000 174,000 145,000 87,000 525,000
Desired ending
inventory of direct
materials 34,800 29,000 17,400 30,000 30,000
Direct material
needed 153,800 203,000 162,400 117,000 555,000
Beginning inventory
Purchases Cost Budget


Total
Material X
(in kg) 47,400 53,300 44,100 37,600 182,400
Cost per kg RM5.00 RM5.00 RM5.00 RM5.00 RM5.00
RM237,000 RM266,500 RM220,500 RM188,000 RM912,000
Material Y
(in pieces) 196,400 254,400 207,200 152,000 810,000
Cost per
piece RM10.00 RM10.00 RM10.00 RM10.00 RM10.00
RM1,964,000 RM2,544,000 RM2,072,000 RM1,520,000 RM8,100,000
Material Z
(in metres) 130,000 168,200 133,400 99,600 531,200
Cost per
meter RM20.00 RM20.00 RM20.00 RM20.00 RM20.00
RM2,600,000 RM3,364,000 RM2,668,000 RM1,992,000 RM10,624,000
Purchases RM4,801,000 RM6,174,500 RM4,960,500 RM3,700,000 RM19,636,000
Direct manufacturing labour costs budget

Direct labour costs depend on planned production, hours needed to produce an
item, and wage rate. The wage rate is budgeted based on of past experience and
current trend in the job market.
Direct manufacturing labour cost = Planned production × Labour hour per unit × Wage rate
UNIT 4 15
Budgeting
Example of Direct Manufacturing Labour Costs Budget
Wonderful Corporation planned production for three products for the year

Total
units
Product A 15,000 11,000 7,000 8,000 41,000
Product B 16,500 12,000 13,500 17,500 59,500
Product C 14,000 32,000 26,000 9,000 81,000
Standard manufacturing process requires the following labour hours for each
product:
Labour hours per unit Wage rate

Product A 2.0 hours RM8
Product B 2.5 hours RM8
Product C 3.0 hours RM8
Required:
Prepare the Direct Manufacturing Labour Costs Budget for the year ending 31
December 2014.
Answer:
Direct Manufacturing Labour Costs Budget


Total
Planned production:
Product A 15,000 11,000 7,000 8,000 41,000
(in units)
Product B 16,500 12,000 13,500 17,500 59,500
(in units)
Product C 14,000 32,000 26,000 9,000 81,000
(in units)
Labour hours per unit:
Product A 2.00 2.00 2.00 2.00 2.00
(in hours)
Product B 2.50 2.50 2.50 2.50 2.50
(in hours)
Product C 3.00 3.00 3.00 3.00 3.00
(in hours)
Total labour hours:

Product A 30,000 22,000 14,000 16,000 82,000
(in hours)
Product B 41,250 30,000 33,750 43,750 148,750
(in hours)
Product C 42,000 96,000 78,000 27,000 243,000
(in hours)
Wage rate per hour:
Product A RM8.00 RM8.00 RM8.00 RM8.00 RM8.00
(in ringgits)
Product B RM8.00 RM8.00 RM8.00 RM8.00 RM8.00
(in ringgits)
Product C RM8.00 RM8.00 RM8.00 RM8.00 RM8.00
(in ringgits)
Total labour costs:
Product A RM240,00 RM176,000 RM112,000 RM128,00 RM656,000
(in ringgits)
Product B RM330,00 RM240,000 RM270,000 RM350,00 RM1,190,00
(in ringgits)
Product C RM336,00 RM768,000 RM624,000 RM216,00 RM1,944,00
(in ringgits)
RM906,00 RM1,184,000 RM1,006,000 RM694,000 RM3,790,000
Manufacturing overhead costs budget

Manufacturing overhead costs are indirect costs incurred during the manufacturing
process. Examples of manufacturing overhead costs are electricity, salaries for factory
supervisors, depreciation of machineries and costs of factory maintenance.
In traditional costing, these costs are allocated to products using the cost drivers
such as direct labour hours or machine hours. In the activity-based budgeting, these
costs are allocated to products using the activity-based cost drivers such as setup
time or number of production runs.
The overhead costs are divided into variable costs and fixed costs.
Example of Manufacturing Overhead Costs Budget
Wonderful Sdn. Bhd. allocates manufacturing overhead costs to products based on the
direct labour (DL) hours.
DL hours
Product A (in hours) 82,000
Product B (in hours) 148,750
Product C (in hours) 243,000
Total 473,750
UNIT 4 17
Budgeting
Variable costs
Fixed costs
per DL hour
Supplies RM2.00
Indirect labour RM6.00
Electricity RM1.50 RM500,000
Maintenance RM4.00 RM80,000
Depreciation RM400,000
Salaries of supervisors RM200,000
Required:
Prepare the Manufacturing Overhead Costs Budget for the year ending 31 December
2014.
Answer:
Manufacturing Overhead Costs Budget

For the year ending 31 December 2014
Variable costs:
Supplies 473,750 hours × RM2.00 RM947,500
Indirect labour 473,750 hours × RM6.00 RM2,842,500
Electricity 473,750 hours × RM1.50 RM710,625
Maintenance 473,750 hours × RM4.00 RM1,895,000
RM6,395,625
Fixed costs:
Electricity RM500,000
Maintenance RM80,000
Depreciation RM400,000
Salaries of supervisors RM200,000
RM1,180,000
Total manufacturing costs RM7,575,625
Ending inventory budget

Inventories for a manufacturing company include finished goods produced or work-
in- progress, by the company. The includes raw materials and consumables awaiting
use in the production process.
The manufacturing costs of products comprise:
1. costs of purchased materials; and
2. costs of conversion
The costs of conversion are incurred to convert raw materials to finished goods.
These costs include the costs of:
1. direct labour;
2. fixed production overheads; and
3. variable production overheads
Fixed and variable manufacturing overhead costs shall be systematically allocated

into the costs of finished goods.
Fixed manufacturing overhead costs are indirect costs of production that remain
relatively constant regardless of the quantity of production, such as:
1. depreciation and maintenance of factory buildings and equipment; and
2. cost of factory management and administration
Fixed production overheads shall be allocated to the costs of conversion based on

the normal capacity of the production facilities. Normal capacity is the production
expected to be achieved on average over a month or a year under normal circumstances,
taking into account the loss of capacity resulting from planned maintenance.
Example of Ending Inventory Budget
Unit cost
Material X RM5.00
Material Y RM10.00
Material Z RM20.00
Direct labour costs RM8.00
Manufacturing overhead costs* RM15.99
*Manufacturing overhead costs are allocated to finished goods inventory at the

budgeted rate of RM15.99 per direct labour hour. (RM7,575,625 / 473,750 DL hours)
UNIT 4 19
Budgeting
Unit Costs of Ending Finished Goods Inventory
Product A Product B Product C

Quantity Total Quantity Total Quantity Total
Material X 1.00 RM5.00 1.00 RM5.00 1.00 RM5.00
Material Y 2.00 RM20.00 4.00 RM40.00 6.00 RM60.00
Material Z 2.00 RM40.00 2.00 RM40.00 4.00 RM80.00
Direct labour 2.00 RM16.00 2.50 RM20.00 3.00 RM24.00
costs
Manufacturing 2.00 RM31.98 2.50 RM39.98 3.00 RM47.97
overhead costs*
Total RM112.98 RM144.98 RM216.97
Required:
Prepare the Ending Inventory Budget on 31 December 2014.
Answer:
Ending Inventories Budget

On 31 December 2014
Unit cost Quantity Total

Direct materials:
Material X RM5.00 10,000 RM50,000.00
Material Y RM10.00 40,000 RM400,000.00
Material Z RM20.00 30,000 RM600,000.00
RM1,050,000.00
Finished goods:
Product A RM112.98 5,000 RM564,900.00
Product B RM144.98 4,000 RM579,920.00
Product C RM216.97 3,000 RM650,910.00
RM1,795,730.00
Total ending inventories RM2,845,730.00
Activity 4.1
Pinsonic Berhad expects to sell 60,000 electronic calculators for

RM80 each in 2014. Direct materials costs are RM20 per unit.
Below is the data for 2013:
Beginning Ending
inventory inventory
Direct materials 24,000 units 18,000 units
Finished goods inventory 8,000 units 10,000 units
1. Calculate the number of electronic calculators that need to be

manufactured in 2014.
2. Determine the direct material purchases budgeted in 2014.
Cost of goods sold budget

Cost of goods sold is the costs of the goods sold by a business during a financial
period.
Cost of goods sold = Beginning inventory of finished goods + Direct material usage
+ Direct manufacturing labour costs + Manufacturing overhead
costs – Ending inventory of finished goods
Example of Cost of Goods Sold Budget
Wonderful Corporation provides the following information about its inventory of

finished goods for the year ending 31 December 2014:
Beginning inventory Ending inventory

Units RM Units RM
Product A 4,000 110 5,000 112.98
Product B 4,500 140 4,000 144.98
Product C 2,000 220 3,000 216.97
UNIT 4 21
Budgeting
Wonderful Corporation direct material usage budget for all materials for the year
Quantity units Cost

Material X (in kg) 181,500 RM5.00
Material Y (in pieces) 806,000 RM10.00
Material Z (in metres) 525,000 RM20.00
Required:
Prepare the Cost of Goods Sold Budget for the year ending 31 December 2014.
Cost of Goods Sold Budget

Quantity units Cost

Beginning inventory of finished goods RM1,510,000
Direct material usage RM19,467,500
Direct manufacturing labour costs RM3,790,000
Manufacturing overhead costs RM7,575,625
Cost of goods manufactured RM30,833,125
Cost of goods available for sale RM32,343,125
Deduct: Ending inventory of finished goods RM(1,795,730)
Cost of goods sold RM30,547,395
Non-manufacturing costs budgets

The earlier budgets discussed are related to production function of the value chain.
Selling, general and administrative (SGA) expenses are major non-manufacturing
costs presented in an income statement.
SGA expenses consist of the operating costs of a company, which are normally
categorised as:
1. Selling expenses are salaries, advertising expenses, rent, and all expenses
directly related to sales, marketing and distribution activities.
2. General expenses are directly related to general operations of a company

such as the upkeep of office equipment and cleaning of office.
3. Administration expenses are related to overall administration of a company

such as staff salaries for finance and human resource management.
Similar to manufacturing overhead costs, SGA expenses are divided into variable
and fixed components.
Example of Non-manufacturing Costs Budgets
Wonderful Sdn Bhd provides the following information for its non-manufacturing
costs budgets for the year ending 31 December 2014:
i. Sales commission payable to salespeople is equal to 5% of the revenues.
ii. The company will organise four marketing and promotion events during the
year with total cost of RM1,000,000.
iii. Distribution function is outsourced to a logistics company and the charge is

based on 4% of the revenues.
iv. General expenses areequal to RM500,000 for a year.
v. Administrative expenses for the office staff are equal to RM1,500,000 for a
year.
vi. Forecasted revenues for the year amounting to RM44,400,000.
Required:
Prepare the Non-manufacturing Costs Budgets for the year ending 31 December
2014.
Non-manufacturing Costs Budgets

Variable
Fixed costs Total costs
costs
Sales
commissions $44,400,000 5% $2,220,000 $2,220,000
Marketing
expenses $1,000,000 $1,000,000
Distribution
expenses $44,400,000 4% $1,776,000 $1,776,000
General
expenses $500,000 $500,000
Administrative
expenses $1,500,000 $1,500,000
$3,996,000 $3,000,000 $6,996,000
Budgeted statement of comprehensive income

The final output of operating budgets is the budgeted income statement.
Management’s goal to increase the operating income can only be achieved through
the coordination of various activities in the company.
An increase in revenues is due to spending more on marketing efforts. Higher

production costs and distribution costs are also matched with increase in revenues.
In some circumstances, an increase in revenues requires reduction in the selling
price. Moreover, an increase in direct materials prices and labour costs will affect
the performance of a company if no increase in selling price is anticipated.
UNIT 4 23
Budgeting
Example of Budgeted Statement of Comprehensive Income
Based on the operating budgets prepared in Step 1 to 8, the management accountant

of Wonderful Sdn Bhd is requested by the CEO to prepare its budgeted statement
of comprehensive income for the year ending 31 December 2014.
Answer:
Budgeted Statement of Comprehensive Income

RM RM
Revenues 44,400,000
Cost of goods sold (30,547,395)
Gross margin 13,852,605
Operating expenses
Selling expenses 2,220,000
Marketing expenses 1,000,000
Distribution expenses 1,776,000
General expenses 500,000
Administrative expenses 1,500,000 (6,996,000)
Operating income 6,856,605
Activity 4.2
An extract from of the Statement of Comprehensive Income of

Syarikat Helen for the year ended 31 December 2013 is as follows:
Sales (100,000 units) RM500,000

Less: Cost of goods sold 300,000
Gross profit 200,000
Expenses (includes RM20,000 of Depreciation) 120,000
Net profit RM80,000
Helen is developing the 2014 budget. In 2014 the company would

like to increase selling prices by 20%. She expects a decrease in
sales volume of 5%. Cost of goods sold as a percentage of sales is
expected to increase to 62%. All expenses except depreciation are
variable costs.
Required:
Prepare a budgeted Statement of Comprehensive Income for 2014.

Cash budget
Cash budget is part of the financial budget. It reflects all cash inflows and outflows
for the specific period of time. The beginning and end point of a cash budget is the
cash balance, which is equal to cash and bank accounts in the statement of financial
position.
As for cash inflows, the following categories of expected cash receipts should be
considered:
• Cash sales
• Collection of accounts receivable
• Other income
Cash sales must be adjusted for any trade or other discounts and for possible returns.
Collection of accounts receivable is established based on forecasted sales, therefore it

must be adjusted to reflect the amount that will actually be received. For example,
a company may assume that 90% of accounts receivable will be collected in the
quarter in which the sales occur, 9% will be collected in the following quarter, and
1% will remain uncollectible. These assumptions are based on past experience and
industry practice.
Other income is income other than sales. For example, a company may have
investments that will introduce cash during the time period. These types of cash
include rent, dividend and interest.
As for cash outflows, the following categories of expected cash payments should be
considered:
• Raw materials
• Labour costs
• Overhead costs
• Marketing expenses
• Selling expenses
• Distribution expenses
• Administrative expense
• Plant and equipment expenditures
• Other payments
UNIT 4 25
Budgeting
Raw materials are the largest cash expense for a manufacturing company. It is
necessary to factor in the increases to keep up with forecasted sales and to consider
whether any pricing changes are expected. The timing of cash outflows depends on
the credit term with suppliers.
Labour costs are usualy the second largest expense item during an accounting period.
It is necessary to include estimates for all appropriate deduction such as EPF and
SOCSO.
Overhead costs should not include depreciation or amortisation expenses.
Marketing expenses vary by type of business and forecasted revenues. If a company is

projecting an increase in sales, there should be accompanying marketing campaign.
These costs include brochures, mailers, newspaper advertisements, radio, or other
advertising services.
Selling expenses include salaries and commissions for sales staff and sales office
expenses. However, the item can also include travelling or other sales-related expenses.
Distribution expenses are incurred for transportation of goods to customers. Some

companies outsource this function to public transporters.
Administrative expenses are related to general office expenses such as salaries, utilities,
telephone, printing and daily office expenses. Normally, these expenses are estimated
based on past experience.
Plant and equipment expenditures include cash payments for equipment installation
leasing, major repairs and maintenance.
Other payments include interest payable to banks and income taxes payable to
government.
Generally, management accountant will take the following steps to prepare a cash
budget:
Step 1 Prepare revenues budget for each month or quarter during the budget period.
Step 2 Determine the time period when the revenues will actually generate cash.
Step 3 Prepare a cash collections schedule based on the forecasted sales and cash
collection pattern.
Credit sales do not produce immediate cash inflows and customers’ payment
habits tend to be unchanged over time.
Step 4 Prepare a cash payments schedule based the expenses budgets and cash payment
pattern.
Purchases of materials from suppliers do not cause immediate cash outflows.

Normally, payroll costs are incurred in the same month. Cash effects for other
expenses will depend on credit terms of the suppliers.
Step 5 Prepare the cash budget by combining the estimated cash inflows and cash
outflows. The net cash inflows/outflows are added to the cash balance at the
beginning of the budget period to arrive at the cash balance at the end of the
budget period.
Example of Cash budget
Based on the operating budgets prepared in Step 1 to 8, the management accountant of

Wonderful Sdn Bhd is requested by the CEO to prepare its cash budget for the year ending
31 December 2014.
The following assumptions are made:
i. 70% of the sales are collected in the same quarter, the balance to be collected
in the following quarter.
ii. 80% of purchases of direct materials are paid in the same quarter, the balance
to be paid in the following quarter.
iii. Labour costs are paid in the same quarters they are incurred.
iv. Manufacturing overhead costs (excluding depreciation) are paid in the same
quarter and are allocated using direct labour hours.
v. Selling and distribution expenses are incurred in the same quarter as sales.
vi. Other non-manufacturing expenses are incurred evenly during the year.
Answer:
Cash Budget

Total
Cash balance,
beginning 1,500,000 1,108,228 1,972,717 5,157,515 1,500,000
Add: Cash receipts
Collections from
customers 8,868,000 12,852,000 13,896,000 9,060,000 44,676,000
Total cash available 10,368,000 13,960,228 15,868,717 14,217,515 46,176,000
Deduct: Cash
disbursements
Direct materials 4,440,800 5,899,800 5,203,300 3,952,100 19,496,000
Direct labour costs 906,000 1,184,000 1,006,000 694,000 3,790,000
Manufacturing
overhead costs 1,715,334 2,241,673 1,904,665 1,313,953 7,175,625
Selling and
distribution
expenses 831,600 1,296,000 1,231,200 637,200 3,996,000
Marketing expenses 250,000 250,000 250,000 250,000 1,000,000
General expenses 125,000 125,000 125,000 125,000 500,000
UNIT 4 27
Budgeting

Total
Administrative
expenses 375,000 375,000 375,000 375,000 1,500,000
Finance costs 250,000 250,000 250,000 250,000 1,000,000
Income tax 366,038 366,038 366,038 366,038 1,464,151
Total cash
disbursements 9,259,772 11,987,511 10,711,202 7,963,291 39,921,776
Cash balance, ending 1,108,228 1,972,717 5,157,515 6,254,224 6,254,224
Schedule of Cash Collections
2013 2014
Fourth First Second Third Fourth
quarter quarter quarter quarter quarter
Sales 8,000,000 9,240,000 14,400,000 13,680,000 7,080,000
Collections in same
quarter 6,468,000 10,080,000 9,576,000 4,956,000
Collections in the
following quarter 2,400,000 2,772,000 4,320,000 4,104,000
8,868,000 12,852,000 13,896,000 9,060,000
Collections in same 70%

quarter
Collections in the 30%
following quarter 100%
Schedule of Cash Payments for Purchases of Raw Materials
2013 2014
Fourth First Second Third Fourth
quarter quarter quarter quarter quarter
Purchases of materials 3,000,000 4,801,000 6,174,500 4,960,500 3,700,000
Payments in same
quarter 3,840,800 4,939,600 3,968,400 2,960,000
Payments in the
following quarter 600,000 960,200 1,234,900 992,100
Payments for direct
materials 4,440,800 5,899,800 5,203,300 3,952,100
Collections in same
quarter 0.8
Collections in the
following quarter 0.2
1
Schedule of Cash Payments for Manufacturing Overhead Costs
2014
Total First Second Third Fourth
Direct labour
hours 473,750 113,250 148,000 125,750 86,750
Manufacturing
overhead costs 7,175,625 1,715,334 2,241,673 1,904,665 1,313,953
Manufacturing
overhead costs 7,575,625
Deduct:
Depreciation 400,000
7,175,625
Schedule of Cash Payments for Selling and Distribution Costs
2014
Total First Second Third Fourth
Sales 44,400,000 9,240,000 14,400,000 13,680,000 7,080,000
Selling and
Distribution
Costs 3,996,600 831,600 1,296,000 1,231,200 637,200
Selling
expenses 2,220,000
Distribution
expenses 1,776,000
3,996,000
Activity 4.3
The manager of Kedai SAM predicted the following amount of

sales at his store.
January RM 200,000 April RM 180,000

February RM 160,000 May RM 200,000
March RM 220,000 June RM 188,000
Historically, the cash collection of sales has been as follows:
65% of sales collected in the month of sale,

UNIT 4 29
Budgeting
25% of sales collected in the month following the sale,

8% of sales collected in the second month following the sale, and
2% of sales are uncollectible.
Calculate the amount of cash collected for March and April
Budgeted statement of financial position

Budgeted statement of financial position is one of the financial budgets. The cash
budget and the budgeted statement of comprehensive income are necessary to prepare
the budgeted statement of financial position.
The budgeted statement of financial position is similar to a normal statement of

financial position. The normal statement of financial position is prepared using the
historical data. However, budgeted statement of financial position is prepared using
data from the budgets.
The balances such as non-current assets, accumulated depreciation, accounts

receivable, accounts payable, share capital and retained earnings are calculated by
taking the account’s beginning balance and adding or deducting any changes during
the period. The cash and bank balance is taken from the cash budget.
Example of Budgeted Statement of Financial Position
Wonderful Corporation’s statement of financial position as at 31 December 2013

is as follows:
Statement of Financial Position

As at 31 December 2013
ASSETS
Non Current Assets
Property, plant and equipment 20,000,000
Less: Accumulated depreciation (5,000,000)
15,000,000
Current Assets
Cash 1,500,000
Account receivables 2,400,000
Direct materials inventory 881,500
Finished goods inventory 1,510,000
6,291,500
Total Assets 21,291,500
LIABILITIES
Non Current Liabilities
Bank loan 10,000,000
Current Liabilities
Accounts payable 600,000
Total Liabilities 10,600,000
Shareholders’ Equity
Share capital 10,000,000
Retained earnings 691,500
Total Equity 10,691,500
Total Liabilities and Equity 21,291,500
The management accountant is required by the bank to submit the budgeted

statement of financial position for the year ending 31 December 2014.
The management accountant uses the operating budgets, budgeted statement of

comprehensive income and cash budget to prepare the budgeted statement of
financial position for the year ending 31 December 2014.
Statement of Financial Position

As at 31 December 2014
ASSETS
Non Current Assets
Property, plant and equipment 20,000,000
Less: Accumulated depreciation (5,400,000)
14,600,000
Current Assets
Cash 6,254,224
Account receivables 2,124,000
Direct materials inventory 1,050,000
Finished goods inventory 1,795,730
11,223,954
Total Assets 25,823,954
LIABILITIES
Non Current Liabilities
Bank loan 10,000,000
Current Liabilities
Accounts payable 740,000
Total Liabilities 10,740,000
Shareholders’ Equity
Share capital 10,000,000
Retained earnings 5,083,954
Total Equity 15,083,954
Total Liabilities and Equity 25,823,954

UNIT 4 31
Budgeting
Summary
In this section, you have learnt about the advantages and benefits
of a master budget. The master budget expresses management’s
operating and financial plans for a specified period and it includes
a set of budgeted financial statements. The master budget is the
initial plan of what the company intends to accomplish in the
budget period which evolves from both operating and financing
decisions of the organisation.
You have also learnt how to develop an operating budget and how
to prepare its supporting schedules. The steps in developing an
operating budget include preparing the revenue budget, production
budget, direct material usage budget and direct material purchase
budget, manufacturing overhead cost budget, ending inventory
budget, non-manufacturing cost budget and budgeted statement
of comprehensive income. You have also been introduced to how
the master budget helps in coordinating various business functions
of the value chain.
Suggested answers to activities
Feedback
Activity 4.1
a. 60,000 + 10,000 – 8,000 = 62,000
b. (60,000 +10,000 – 8,000) units + 18,000 units – 24,000 units

= Purchases 56,000 units × RM20 = RM1,120,000
Activity 4.2
Helen Enterprises
Budgeted Statement of Comprehensive Income
For the Year 2014
Sales (95,000 × RM6) 570,000

Cost of goods sold (2013 sales × 62%) 323,950
Gross profit 246,050

Expenses [(RM1.00 × 95,000) + RM20,000] 115,000
Net income 131,550
Activity 4.3
March
(RM220,000 × 0.65) + (RM160,000 × 0.25) + (RM200,000 ×

0.08) = RM199,000
April
(RM180,000 × 0.65) + (RM220,000 × 0.25) + (RM160,000 ×

0.08) = RM184,800
UNIT 4 33
Budgeting
4.2 Activity-based Budgeting and

Responsiblity Accounting
Objectives
By the end of this section, you should be able to:
1. Develop flexible budgets.
2. Compute flexible budget variances and sales volume variances.
3. Explain the usage of standard cost in variance analysis.
4. Compute price variances and efficiency variances for direct cost categories.
5. Describe the steps to develop standard costing systems and perform variance
analysis in activity-based budgeting.
Introduction
This section explains how to develop flexible budgets by looking at budget variances
and sales volume variances. This section also covers the concept of responsibility
accounting in terms of budgeting
Activity-based budgeting (ABB)

Activity-based budgeting (ABB) is a method of budgeting whereby the activities are
recorded and the related costs are analysed. ABB incorporates the resources required
to perform the operating activities at the budgeted level. In contrast, traditional
budgeting is a method of budgeting whereby the current year figures are adjusted
for inflation or growth to create next year’s budget.
In ABB, managers must analyse the profit potential of products and services by
reorganising the activities which incur costs. Cost efficiencies can also be improved
by consolidating or rerouting certain activities.
ABB starts at results and analyses the activities that created them. Managers must
analyse each activity in the organisation and find ways to make improvements in
order to reduce costs. For example, a factory may take many steps to manufacture
a product. By eliminating unnecessary steps, the products can be manufactured at
a lower cost. As a result, a company is able to deliver high-quality products to its
customers at lower cost.
In addition, ABB also brings the following benefits to a company:
1. Reinforce culture of customer focus.
2. Save costs by removing unnecessary process steps.
3. Encourages teamwork within and between departments.
4. Identify bottleneck steps and remove them.
ABB allows managers to evaluate each step involved that is needed to get the product
or service to the marketplace. By identifying unnecessary steps and eliminating
them, a company can deliver high-quality products to its customers at lower cost.
ABB measures things in physical rather than in financial terms. The resulting budget
is useful to assess whether there are any excess capacity or resource shortages which
must be resolved if the desired level of operations is to be achieved.
This operational exercise facilitates subsequent financial analysis of the costs

associated with unused capacity and the costs and benefits of eliminating a bottleneck.
Example of activity-based budgeting
This example explains the steps in ABB and reinforces the understanding of the
contribution which ABB can make to resource management in an organisation.
Wonderful Corporation manufactures three products which it sells to several

customers. Production process is highly automated which occurs in large batches,
and goods are shipped to customers in batches. Details of production for a month
are as follows:
Product: A B C Total
Units of output 100000.00 200,000 450,000 750,000
Machine hours (MH), per unit of 0.3 MH 0.2 MH 0.4 MH
output
Production batch size (units) 2,500 4,000 7,500
Shipment batch size (units) 2,000 2,000 5,000
Production Label printing Shipment

machine machine loading machine
Monthly capacity 225,000 MPH 650 hours 400 hours
Usage rates 4 hours per batch 2 hours per
produced batch shipped
UNIT 4 35
Budgeting
Indirect labour Number Salary Activities Rate

Engineers 4 RM4,500 each per Machine setup 4 hours setup
month (180 hours for each batch of time per batch
per month) output produced produced
Production 9 RM3,000 each per Monitoring of 1 hour for every
supervisors month (180 hours production 500 units of
per month) output
Shipping clerks 3 RM2,000 each per Shipment 2 hours per batch
month (180 hours processing work shipped
per month)
Step 1:
Calculate the amount of activities which are required based on planned operations.
Product A Product B Product C Total

Number of 100,000 * 30,000 200,000 * 40,000 450,000 * 250,000
PMH 0.3 PMH 0.2 PMH 0.40 PMH 180,000
Number 100,000/ 40 200,000/ 50 450,000/ 60 150
of label 2,500 per 4,000 per 7,500 per
printing batch batch batch
Number of 100,000/ 200 200,000/ 400 450,000/ 900 1,500
production 500 per 500 per 500 per
supervision batch batch batch
Number 100,000/ 50 200,000/ 100 450,000/ 90 240
of batches 2,000 per 2,000 per 5,000 per
shipped batch batch batch
Step 2:
Calculate the amounts of the various resources (machine hours and indirect labour hours)
which are required in order to perform the amounts of activities identified at Step 1.
Machine hours
Machinery
required
Production machine As above 250000
Label printing machine 150 batches produced * 4 hours 600
Shipment loading machine 240 batches shipped * 2 hours 480
Indirect labour
Indirect labour
hours required
Engineers 150 batches produced * 4 setup hours 600
Production supervisors 1,500 batches * 1 supervision hour 1,500
Shipping clerks 240 batches shipped * 2 processing 480
hours
Step 3:
Assess whether the available capacity is sufficient to meet the resources required as
calculated in Step 2.
Label Shipment
Production Production Shipping
printing loading Engineers
machine supervisors clerks
machine machine
Machine Machine Machine Labour Labour Labour
hours hours hours hours hours hours
Available 225000 650 400 720 1620 540
capacity
Resources 250000 600 480 600 1500 480
required
Surplus (25,000) 50 (80) 120 120 60
(shortfall)
Surplus 0.67 0.67 0.33
(shortfall)
Step 4:
Analysis of ABB for Wonderful Corporation
Two resource shortages have been identified in the operational phase of the ABB as in the
earlier step. The company is facing shortages in production machine and shipping loading
machine capacity. It is necessary for the company to remove these bottlenecks in order to
meet the budgeted level of production.
Sometimes, operational improvements such as redeployment of surplus staff within the

organisation, or servicing of equipment to improve its efficiency can eliminate bottlenecks at
little or no incremental cost to the organisation. However, if such operational improvements
are not sufficient to solve the problem, then the company needs to analyse whether acquiring
extra machineries is justified in terms of cost benefit.
Another issue identified is overcapacity of engineers, production supervisors and shipping

clerks. For example, the company employs 4 engineers which results in an excess capacity
of 0.67 engineers. Since the cost of employing an engineer is RM4,500 per month, the cost
of this spare capacity is (0.67 × RM4,500 = RM3,000).
The company needs to consider how this idle time cost can be avoided. One of the options
may be to redeploy the surplus staff elsewhere in the organisation, either permanently or
temporarily.
ABB, which is based on the activity cost drivers, is able to quickly highlight the
deficiencies of a traditional budget or functional budget. Today, most organisations
are developed on functional lines with a typically hierarchical structure. However,
a function is only a management construction whereby employees of a similar skill
set are grouped into departments to perform particular tasks. This structure can
ease management with regard to pay, discipline and assessment but does not reflect
the way work is actually done.
UNIT 4 37
Budgeting
The truth is that people are merely managed within functions. People work in
processes or workflows that enable certain goals to be achieved and these processes
are multi functional. For example, a typical process of order fulfilment involves a
workflow that begins with the acceptance of a customer order and ends with the
order satisfied and payment in the bank.
Accounting and reporting functions concentrate on financial measures such as the

statement of financial position, profit and loss account, budgetary analysis by cost
centre or line item and volume variance analysis. However, financial measures are
outcomes which are the end of a chain of events for a given period of time. They
give management little or no insight into how those outcomes were derived, thus
provide only a limited understanding of how to do better.
ABB links resources to the level of activity undertaken and the efficiency of activities
performed. ABB uses activity drivers and measures efficiency improvement based
on the reduction in the Unit Driver Costs. Furthermore, ABB captures multiple
functional inputs to both individual activities and to a workflow.
Forecasting for ABB is performed based on activity and is tied closely to the business
plan. For example, how many customers to call, how many orders to process, how
many invoices to send, how many debts to chase and how many deliveries are
activities to support an increase in sales volume for the next year.
Figure 4.2 Activity-based budgeting

Source: Adapted from http://www.emeraldinsight.com/content_images/
fig/3150040306002.png
Responsibility accounting
An organisational structure is an arrangement of lines of responsibility within the
entity.
Responsibility accounting is a system that measures the plans, budgets, actions, and
actual results of a responsibility centre. It focuses on who should be asked about
the information. Responsibility accounting focuses on information and knowledge,
not on control. The fundamental purpose of responsibility accounting is to gather
information when budgets are not achieved.
A responsibility centre is a part, segment, or subunit of an organisation, whose

manager is accountable for a specified set of activities. A responsibility centre can
be structured to promote better alignment of individual with company goals. Each
manager, regardless of level, is in charge of a responsibility centre.
Responsibility centres Examples

1 Cost centre A responsibility centre where Maintenance department
the scope of the manager’s of a factory.
influence is limited to costs.
2 Revenue centre A responsibility centre where Sales department of a
the scope of the manager’s company.
influence is limited to
revenues.
3 Profit centre A responsibility centre where Chief Executive Officer of
the manager influences both a company.
costs and revenues.
4 Investment A responsibility centre where Group Managing

centre the manager’s influence Director of a public listed
includes costs and revenues company.
as well as investments.
Performance reports are prepared for each responsibility centre. Variances between
actual and budgeted amounts inform management about performance relative to
the budget.
Responsibility and controllability

A primary consideration in assigning a cost to a responsibility centre is who can best
control the change in that cost. A controllable cost is any cost that can be influenced
by a responsibility centre manager for a period of time.
A stretch budget is a budget that represents a challenging, but achievable level of

performance.
UNIT 4 39
Budgeting
Human aspects of budgeting

Human factor is a crucial parts of budgeting. Budgetary slack provides management
with a protection against unexpected adverse circumstances.
Budgeting slack is most likely to occur when a firm uses the budget for control.
When the operating budget is used as a control device, managers are less likely to
be motivated to budget higher performance than actually anticipated.
Budget slack occurs when subordinates ask for excess resources beyond what they
need to accomplish budget objectives. Budget slack also occurs when subordinates
claim that they are not as efficient or effective as they actually are.
The budget slack may take a lot of pressure off the subordinate and reduce job
anxiety. However, if incentives in the form of bonuses are given only if subordinates
achieve higher goals, then the subordinate may lose income by selecting lower goals.
When subordinates build in slack, the organisation is either not running as efficiently
as it can, or is losing potential productivity from employees who are not working as
hard as they can. If employees are experiencing workplace stress, then management
may be more forgiving and view some slack building as necessary to keep their
employees from quitting.
In conclusion, to create greater commitment to the budget, lower-level managers

should participate in creating the budget.
Flexible budgets
Master budget is a static budget. A flexible budget adjusts the master budget using
actual output to recalculate revenue and variable costs for the budget period.
Management will compare actual results with budgeted results for that activity level.
Flexible budget is developed in the following steps:
Step 1 Identify the actual output quantity

Step 2 Calculate flexible budget revenues (budgeted selling price × actual
quantity)
Step 3 Calculate flexible budget costs (budgeted per unit variable cost × actual
quantity plus fixed costs).
The static budget is prepared at the start of the budget period. In contrast, a flexible
budget is calculated at the end of the budget period.
The only difference between the static budget and flexible budget is that the static
budget is prepared using planned output whereas the flexible budget is prepared
using actual output.
In other words, a company would not need to use a flexible budget if it had accurate
forecast about actual output units.
A flexible budget calculates budgeted revenue and budgeted costs based on the actual
output in the budget period.
Example of Flexible Budget
Wonderful Corporation planned to use RM164 of Material X per unit but actually
used RM160 of Material X per unit; planned to make 1,200 units but actually made
1,000 units of Product A.
The flexible budget amount is 1,000 units × RM164 = RM164,000
Wonderful Corporation planned to use RM24 of Material Y per unit but actually
used RM25 of Material Y per unit; planned to make 2,000 units but actually made
2,400 units of Product B.
The flexible budget amount is 2,400 units × RM24 = RM57,600
Wonderful Corporation planned to use RM37.50 of Material Z per unit but actually
used RM36.75 of Material Z per unit; planned to make 1,800 units but actually made
1,600 units of Product C.
The flexible budget amount is 1,600 units × RM37.50 = RM60,000
Static budget variances

A static budget variance is the difference between the actual results and the
corresponding budgeted amounts in the static budget.
Static budget variance = Actual amount – Static budget amount
Example of Static Budget Variance
Static Static budget

Actual
budget variance
Units Sold 112,500 103,125
Revenues (RM) 42,080 42,480 (400) U
Variable Costs (RM) 16,060 18,200 (2,140) F
Fixed Costs (RM) 8,280 9,140 (860) F
Operating Income (RM) 17,740 15,140 2,600 F
The static budget variance is RM2,600 favourable.
Static budget variance can be subdivided into the flexible budget variance and the
sales volume.
UNIT 4 41
Budgeting
Sales volume variances

The sales volume variance is the difference between the flexible budget and the
corresponding static budget amount.
Sales volume variance = Flexible budget amount – Static budget amount
Example of Sales Volume Variance
Flexible Static Static budget

budget budget variance
Units Sold 112,500 103,125
Revenues (RM) 41,080 42,480 (1,400)
Variable Costs (RM) 15,860 18,200 (2,340)
Fixed Costs (RM) 9,140 9,140 −
Operating Income (RM) 16,080 15,140 940 F
Sales volume variance is RM940 favourable.
Flexible budget variances

The flexible budget variance is the difference between actual revenues or costs and
the corresponding flexible budget amounts in the budget period.
The flexible budget variance for revenues is called the selling price variance as it
arises only from the difference between the actual selling price and the budgeted
selling price.
Selling price variance = (Actual selling price – Budgeted selling price) × Actual
units sold
Example of Flexible Budget Variance
Actual Flexible Static budget

budget variance
Units Sold 112,500 112,500
Revenues (RM) $42,080 $41,080 $1,000 F
Variable Costs (RM) $16,060 $15,860 $200 U
Fixed Costs (RM) $8,280 $9,140 $(860) F
Operating Income (RM) $17,740 $16,080 $1,660 F
Flexible budget variance is RM1,660 favourable.
Selling price variance is RM1,000 favourable.

Price variances
The total variance for direct materials and direct labour can be subdivided into two
components, price and efficiency. These two variances help explain why the actual
cost differs from the budgeted numbers.
The materials price variance reflects the difference between an actual input price
and a budgeted input price. When referring to direct labour, this is sometimes called
the labour rate variance.
Materials Price Variance = (Actual price per unit – Budgeted price per unit) × Actual
quantity of direct materials used
Labour Rate Variance = (Actual rate per hour – Budgeted rate per hour) × Actual
hours of labour
Example of Price and Rate Variances
Wonderful Corporation developed standard costs for direct material and direct
labour. In 2014, the company estimated the following standard costs for its Product A.
Budgeted quantity Budgeted price

Direct materials 0.10 kg RM30 per kg
Direct labour 0.05 hours RM15 per hour
During 2014, the company produced and sold 10,000 units of Product A using 980
kilograms of direct materials at an average cost per kilogram of RM32 and 500 direct
manufacturing labour hours at an average wage of RM15.25 per hour.
Direct materials price variance is 980 kg × (RM32 – RM30) = RM1,960 U
Direct manufacturing labour rate variance is 500 hours × (RM15.25 – RM15.00) =

RM125 U
Efficiency variances
The efficiency variance reflects the difference between an actual input quantity and
a budgeted input quantity. For direct materials, this is sometimes referred to as the
usage variance.
Materials Usage Variance = (Actual quantity of materials – Budgeted quantity of

materials) × Budgeted price per unit
Labour Efficiency Variance = (Actual hours of labour – Budgeted hours of labour)

× Budgeted rate per hour
UNIT 4 43
Budgeting
Example of Usage and Efficiency Variances
Wonderful Corporation developed standard costs for direct material and direct
labour. In 2014, the company estimated the following standard costs for its Product A.

Direct materials 0.10 kg RM30 per kg
Direct labour 0.05 hours RM15 per hour
During 2014, the company produced and sold 10,000 units of Product A using 980
kilograms of direct materials at an average cost per kilogram of RM32 and 500 direct
manufacturing labour hours at an average wage of RM15.25 per hour.
Direct materials usage variance is RM30 × [980 – (10,000 × 0.10)] = RM600 F
Direct manufacturing labour efficiency variance is 500 hours –(10,000 × 0.05)] ×

RM15 = 0
Standard costing
A standard is a carefully determined price, cost, or quantity that is used as a
benchmark for judging performance. It is usually expressed in terms of cost per unit.
Standard material usage The budgeted quantity of materials or direct labour such
or Standard labour hour as 2 kg of raw materials or 2 direct labour hours for each
completed unit.
Standard material price The budgeted price for a unit of materials or direct
or Standard labour rate labour, such as RM10 per kg or RM5 per direct labour
hour.
The advantages of setting standards as used in variance analysis are:
• To exclude past efficiencies.
• To take into account changes expected to occur in the budget period.
Standards also simplify product costing, enabling the company to cost a product
immediately upon its completion.
Direct material Standard material price × Standard material usage per unit of
output
Direct labour Standard labour rate × Standard labour hours per unit of output
Overhead costs Standard overhead costs rate * Standard quantities of
allocation base per unit of output
Developing standard overhead costs

Effective planning requires examining activities that create a superior product or
service and eliminating non-value-added costs.
An additional strategic issue for fixed overhead costs is choosing the appropriate
level of capacity that will benefit the company in the long run.
Planning for fixed overhead costs should be made at the beginning of the budget
period. In contrast, variable overhead costs are affected by daily operating decisions
during the budget period.
Fixed overhead costs provide capacity and are frequently locked in for an extended
time period. Therefore, it must be determined well in advance of the budget period
due to its long-term effect on company profitability. If a business is forced to
downsize, large losses will be incurred when reducing its capacity.
Standard variable overhead cost allocation rate is developed in the following steps:
Example
Step 1 Choose the budget period 12 months or shorter
Step 2 Select the allocation base to allocate Direct labour hours
variable overhead costs to outputs. Direct labour dollars
Management is seeking a cause-and- Machine hours
effect relationship between the cost and
the allocation base.
Step 3 Identify the variable overhead costs Electricity cost
associated with each allocation base. Maintenance cost
Step 4 Compute the variable overhead cost per Electricity cost is allocated
unit of allocation base. using the rate of RM5 per
machine hour
Variable overhead cost variance

The variable overhead flexible budget variance measures the difference between
actual variable overhead costs incurred and the flexible budget overhead amounts.
Variable overhead flexible budget variance = Actual costs incurred – Flexible –

budget amount
This variance needs to be divided into two components, variable overhead efficiency
variance and the variable overhead spending variance.
The variable overhead efficiency variance measures the efficiency of the allocation
base used. It measures the difference between actual quantities of the allocation base
used andthe budgeted quantities of the allocation base that should have been used
to produce actual output.
UNIT 4 45
Budgeting
Variable overhead efficiency variance = (Actual quantities of allocation base –

Standard quantities of allocation base) × Standard price of allocation base
The variable overhead spending variance is the difference between actual variable
overhead costs per unit of cost allocation base and budgeted variable overhead cost
per unit of cost allocation base.
Variable overhead spending variance = (Actual price of allocation base – Standard

price of allocation base) × Actual quantity of allocation base
Fixed overhead cost variance

Fixed overhead costs remain unchanged in total for a given period despite wide
changes in the level of activity. These fixed costs do not automatically increase or
decrease with the level of activity within the relevant range.
Fixed costs are calculated on per unit basis only to facilitate assigning unit cost to
the product or service. A change in the level of activity changes the unit cost of the
fixed amount, not the total fixed cost.
Standard fixed overhead cost allocation rate is developed in the following steps:
Example
Step 1 Choose the budget period 12 months
Step 2 Select the allocation base to allocate Direct labour hours
fixed overhead costs to outputs. The Machine hours
allocation base is also referred to as Meter square
the denominator level.
Step 3 Identify the fixed overhead costs Supervision cost
associated with each allocation base. Rental cost
Depreciation cost
Step 4 Compute the fixed overhead cost per Rental cost is allocated using
unit of allocation base. the rate of RM20 per metre
square.
In step 2, inventory costs differ depending on the choice of the denominator level
of production volume.
Example of Inventory cost
Actions Corporation incurred fixed manufacturing costs of RM120,000 during 2014.

Other information for 2014 includes:
The budgeted denominator level is 10,000 units.

Units produced total 8,000 units.
Units sold total 7,500 units.
Beginning inventory was zero.
The company uses absorption costing and the fixed manufacturing cost rate is
based on the budgeted denominator level. Manufacturing variances are closed to
cost of goods sold.
a. Fixed manufacturing costs expensed on the statement of comprehensive

income (excluding adjustments for variances) total is RM120,000/10,000 units
= RM12 × 7,500 units = RM90,000
b. Fixed manufacturing costs included in ending inventory total is RM120,000/

10,000 units = RM12 × 500 = RM6,000
c. The production volume variance is RM120,000 / 10,000 units = RM12 × 2,000

= RM24,000
In the above calculations, the fixed manufacturing overhead costs of RM120,000

were incurred in 2014. The total can be reconciled to expense (RM90,000), inventory
(RM6,000) and production volume variance (RM24,000).
The production volume variance will be written off directly to Cost of Goods Sold if
the amount is immaterial. However, if the variance is material, it should be allocated
among Inventory and Cost of Goods Sold.
The flexible budget amount for fixed costs is also the amount included in the static
budget prepared at the beginning of the period because fixed costs are not affected
by changes in output.
The fixed overhead flexible budget variance is the difference between actual fixed
overhead costs and fixed overhead costs in the flexible budget (same amount as
static budget).
Fixed overhead flexible budget variance = Actual costs incurred – Flexible budget
amount
There is no fixed overhead efficiency variance because the amount of fixed overhead
is unaffected by how efficiently the allocation base is used to produce output.
The fixed overhead spending variance and the fixed overhead flexible budget variance
are the same.
UNIT 4 47
Budgeting
Fixed overhead spending variance = Actual costs incurred – Flexible budget amount
The production volume variance arises only for fixed costs. This variance is the
difference between budgeted fixed overhead and fixed overhead allocated based
on the number of units actually produced. It is an indicator of the use of capacity.
The production volume variance is favourable if the company exceeded planned

capacity because fixed overhead is divided by a greater number of units. In contrast,
the variance is unfavourable if the company fell short of planned capacity due to
unused capacity.
Production volume variance = Budgeted fixed overhead costs – Fixed overhead

allocated on actual outputs
At the end of the accounting period, any balance in the variable or fixed overhead
variance accounts may be written off directly to Cost of Goods Sold if they are
immaterial. If they are material, the balances should be allocated among Work-in-
Process, Finished Goods, and Cost of Goods Sold.
Actual costing
Actual costing system traces direct costs to a cost object and allocates overhead
costs based on the actual overhead cost rates times the actual quantities of the cost
allocation bases.
Actual costing system allocates the actual overhead costs for each month to products
using the allocation base. Due to fluctuations in activity, the actual monthly overhead
costs allocated to products will vary from month to month.
Normal costing
Normal costing system traces direct costs to a cost object and allocates overhead
costs based on the budgeted overhead cost rates times the actual quantities of the
cost allocation bases.
Normal costing system uses a budgeted annual overhead rate to allocate manufacturing
overhead to products. The budgeted annual overhead rate is calculated by dividing
the expected overhead costs for the entire year with the expected allocation base
for the year.
Normal costing system will result in an overhead rate that is more consistent and
reasonable for computing unit cost of a product.
Activity 4.4
Dolly Pardon practises standard costing for direct material and direct
labour. In 2013, Dolly Pardon estimated the following standard
costs for the production of a box of matches.

Direct materials 100 grammes RM30 per kilogramme
Direct labour 3 minutes RM15 per hour
In January Dolly Pardon produced and sold 10,000 containers

using 980 kilogrammes of direct materials at an average cost per
kilogramme of RM32 and 500 direct manufacturing labour-hours
at an average wage of RM15.25 per hour.
Calculate the direct material efficiency variance.
Activity 4.5
Complete the table below.
Actual Flexible Flexible Volume Static

results variances budget variances budget
Sales Units 112,500 112,500 103,125
Sales Revenue RM42,080 RM1,000 F (A) RM1,400 U (B)

(RM)
Variable Costs (C) RM200 U RM15,860 RM2,340 F RM18,200
(RM)
Fixed Costs RM8,280 RM860 F RM9,140 RM9,140
(RM)
Profit (RM) RM17,740 (D) RM16,080 (E) RM15,140
UNIT 4 49
Budgeting
Summary
A step-by-step approach has been outlined in this section to enable

you to perform activity-based budgeting. Activity-based budgeting
focuses on the cost of activities necessary to produce and sell
products and services. The four key steps in activity-based budgeting
involve determining the budgeted costs of performing each unit
of activity at each activity area, determining the demand for each
individual activity based on budgeted production, new product
development and so on, computing the costs of performing each
activity, and describing the budget as costs of performing various
activities.
This section also illustrated the relationship of controllability with

responsibility accounting. Controllability is the degree of influence
that a specific manager has over costs, revenues and related items
for which he/she is responsible. To attain the goals of the master
budget, a company must assign responsibility to managers who are
accountable for their actions in planning and controlling human
and other resources. Budgets coupled with responsibility accounting
provide feedback to top management about the performance relative
to the budget of different responsibility centre managers.
Suggested answers to activities
Feedback
Activity 4.4
RM30 × (980 – 1,000) = RM600 F
Activity 4.5
A. RM42,080 – RM1,000 = RM41,080
B. RM41,080 + RM1,400 = RM42,480
C. RM15,860 + RM200 = RM16,060
D. RM17,740 –RM16,080 = RM1,660 favourable
E. RM2,340 favourable + RM1,400 unfavourable = RM940

favourable
UNIT 4 51
Budgeting
Summary of Unit 4
Summary
Budgeting process brings benefits to an organisation. Master budgets

include operating budgets, budgeted income statement, cash budget
and budgeted statement of financial position.
Master budget is a static budget. A flexible budget adjusts the master

budget using actual output to recalculate revenue and variable costs
for the budget period.
In standard costing system, a standard is a carefully determined

price, cost, or quantity that is used as a benchmark for judging
performance. It is usually expressed in terms of cost per unit basis.
Responsibility accounting is a system that measures the plans,

budgets, actions, and actual results of a responsibility centre. It
focuses on who should be asked about the information.
Performance reports are prepared for each responsibility centre.

Variances between actual and budgeted amounts inform
management about performance relative to the budget.
When determining the unit cost for finished goods, the allocated
fixed overhead costs differ depending on the choice of the
denominator level of production volume.
Managers may require varying degrees of managerial accounting

information. In order to comply with the managers requests,
four different variances for manufacturing overhead costs can be
computed.
UNIT 4 53
Budgeting
Unit Practice Exercise

1. Coco Products Sdn. Bhd. prepared the following revenues budget for the year
Revenues Budget
Month Units
January 80,000
February 75,000
March 100,000
April 78,000
May 110,000
June 90,000
July 120,000
August 210,000
September 150,000
October 180,000
November 120,000
December 75,000
There were 16,000 units of finished goods in inventory at the beginning of

January. Plans are to have an inventory of finished products that is equal to 20%
of the unit sales for the next month. The company also plans to have 20,000
units of finished goods on 31 December 2014.
Two kilograms of materials are required for each unit produced. Each kilogram
of material costs RM10. Inventory levels for materials are equal to 25% of the
needs for the next month. Materials inventory at the beginning of January was
45,000 kilograms. The company also plans to have 50,000 kilograms of material
inventory on 31 December 2014.
Required:
a. Prepare production budgets in units for the year ending 31 December 2014.
b. Prepare a purchases budget in kilograms for the year ending 31 December

2014, and give total purchases in ringgit for each month.
2. Hot Metal Sdn Bhd manufactures two types of casing for automobile industry.
The company expects to sell 30,000 units of EX5 and 20,000 units of SYM.
The company plans to have an ending inventory of 4,000 units of EX5 and
2,000 units of SYM. Currently, the company has 5,000 units of EX5 in its
inventory and 3,000 units of SYM. Each product requires two labour operations:
moulding and polishing. EX5 requires one hour of moulding time and one
hour of polishing time. SYM requires one hour of moulding time and two hours
of polishing time. The direct labour rate for moulders is RM20 per moulding
hour, and the direct labour rate for polishers is RM25 per polishing hour.
Required:
Prepare a direct labour budget in hours and dollars for each product.
3. Perfect Living Corporation manufactures curtains. A certain window requires

the following:
Direct materials standard: 12 square feet at RM5 per square foot

Direct manufacturing labour standard: 2 hours at RM10
During the month of March, the company made 1,500 curtains and used
19,000 square feet of fabric costing RM91,200. Direct labour totalled 3,200
hours for RM35,200.
Required:
a. Compute the direct materials price and efficiency variances for the month.
b. Compute the direct manufacturing labour price and efficiency variances for
the month.
4. The management of Wonderful Corporation requires varying degrees of

managerial accounting information. In order to comply with the managers’
requests, four different variances for manufacturing overhead are computed each
month. The information for the March overhead expenditures is as follows:
Budgeted output units: 3,300 units

Budgeted fixed manufacturing overhead costs: RM20,000
Budgeted variable manufacturing overhead costs: RM5 per direct labour hour
Budgeted direct manufacturing labour hours: 2 hours per unit
Fixed manufacturing costs incurred: RM26,000
Direct manufacturing labour hours used: 6,800
Variable manufacturing costs incurred: RM36,000
Actual units manufactured: 3,400
Required:
a. Compute a 4-variance analysis for the costing manager.
b. Compute a 3-variance analysis for the factory manager.
c. Compute a 2-variance analysis for the financial controller.
d. Compute the flexible budget variance for the company’s CEO.

UNIT 4 55
Budgeting
5. Taiyo Corporation produces a special line of plastic containers. The company

produces the containers in batches. To manufacture a batch of the containers,
the company must set up the machines and moulds. Setup costs are batch-
level costs because they are associated with batches rather than individual units
of products. A separate Setup Department is responsible for setting up machines
and moulds for different sizes of containers.
Setup overhead costs consist of some costs that are variable and some costs that
are fixed with respect to the number of setup hours. The following information
is for March 2014:
Actual Static budget

amounts amounts
Units produced and sold 18,000 12,000
Batch size (number of units per batch) 250 225
Setup hours per batch 5 5.50
Variable overhead cost per setup hour RM40 RM35
Fixed setup overhead costs RM14,400 RM14,000
Required:
a. Calculate the efficiency variance for variable setup overhead costs.
b. Calculate the spending variance for variable setup overhead costs.
c. Calculate the flexible budget variance for variable setup overhead costs.
d. Calculate the spending variance for fixed setup overhead costs.
e. Calculate the production volume variance for fixed setup overhead costs.
UNIT 4 57
Budgeting
Case Studies
Case Study 4.1
Mega Corporation manufactures desks, chairs, and tables that are

sold as a set to schools throughout Malaysia. The company estimates
the following sales units and desired units of ending inventory of
finished goods during the first three months of 2014:
Finished goods
Sales
ending inventory
January 10,000 2,400
February 12,000 3,000
March 15,000 3,200
The inventory of finished goods at the end of December 2013 was

expected to be 3,000 units.
The company has determined the following requirements for raw

materials for the first three months of 2014:
Beginning inventory Jan 1 5,000 metres @ RM1.50 per metre
Purchases:
January 20,000 metres @ RM1.60 per metre

February 24,000 metres @ RM1.70 per metre
March 30,000 metres @ RM1.80 per metre
Ending inventory:
January 6,000 metres

February 8,000 metres
March 9,000 metres
Required:
a. Calculate the required units of production for each of the three

months.
b. Calculate the cost of raw materials issued to production for each

month, assuming that the company uses moving average costing
for pricing its inventory. Calculate any per metre costs to 3
decimal places. Calculate all total dollar amounts to the nearest
dollar.
c. Explain how to prepare and the purpose of a flexible budget as

part of the budget preparation and also at the end of budget
period.
Case Study 4.2
Actions Corporation produces bicycles. The following schedule

reveals anticipated monthly production of bicycles for the first
three months of 2014:
January 9,500
February 10,000
March 11,000
The company budgets for 2 direct labour hours per bicycle, at an

average cost of RM10 per hour. Variable manufacturing overhead
is applied at the rate of RM15 per direct labour hour. Fixed
manufacturing overhead is expected to be at RM100,000 per month,
which includes RM20,000 per month of non cash expenses related
to depreciation.
Required:
Prepare the Schedule of Cash Disbursements for labour and

manufacturing overhead costs.
UNIT 4 59
Budgeting
Suggested Answers to Unit Practice

Exercise
Feedback
1. a.
Production Budget
Required Total
Budgeted Beginning Budgeted
Month ending inventory
sales inventory production
inventory requirements
January 80,000 15,000 95,000 16,000 79,000
February 75,000 20,000 95,000 15,000 80,000
March 100,000 15,600 115,600 20,000 95,600
April 78,000 22,000 100,000 15,600 84,400
May 110,000 18,000 128,000 22,000 106,000
June 90,000 24,000 114,000 18,000 96,000
July 120,000 42,000 162,000 24,000 138,000
August 210,000 30,000 240,000 42,000 198,000
September 150,000 36,000 186,000 30,000 156,000
October 180,000 24,000 204,000 36,000 168,000
November 120,000 15,000 135,000 24,000 111,000
December 75,000 20,000 95,000 15,000 80,000
Total 1,388,000 20,000 1,408,000 16,000 1,392,000
b.
Purchases Budget
Desired ending Beginning

Budgeted Budgeted direct Direct material Planned Cost per
Month inventory of inventory of Total
production material usage needed purchases kilogram
direct materials direct materials
A B=Ax2 *C D=B+C E F=D-E G H=FxG
units kg kg kg kg kg $ $
January 79,000 158,000 40,000 198,000 45,000 153,000 $10.00 $1,530,000

February 80,000 160,000 47,800 207,800 40,000 167,800 $10.00 $1,678,000

March 95,600 191,200 42,200 233,400 47,800 185,600 $10.00 $1,856,000
April 84,400 168,800 53,000 221,800 42,200 179,600 $10.00 $1,796,000
May 106,000 212,000 48,000 260,000 53,000 207,000 $10.00 $2,070,000
June 96,000 192,000 69,000 261,000 48,000 213,000 $10.00 $2,130,000
July 138,000 276,000 99,000 375,000 69,000 306,000 $10.00 $3,060,000
August 198,000 396,000 78,000 474,000 99,000 375,000 $10.00 $3,750,000
September 156,000 312,000 84,000 396,000 78,000 318,000 $10.00 $3,180,000
October 168,000 336,000 55,500 391,500 84,000 307,500 $10.00 $3,075,000
November 111,000 222,000 40,000 262,000 55,500 206,500 $10.00 $2,065,000
December 80,000 160,000 50,000 210,000 40,000 170,000 $10.00 $1,700,000
Total 1,392,000 2,784,000 50,000 2,834,000 45,000 2,789,000 $10.00 $27,890,000
*C = 160,000 kg × 0.25 = 40,000 kg

UNIT 4 61
Budgeting
2.
Production Budget
EX5 SYM Total

units units units
Expected sales 30,000 20,000
Desired ending inventory 4,000 2,000
Production needs 34,000 22,000
Less: beginning inventory 5,000 3,000
Desired production 29,000 19,000 48,000
Direct Labour Budget for EX5
Moulding Polishing
Desired production
of EX5 (in units) 29,000 29,000
Hours of labour
required per unit 1 1
Total hours of
labour required 29,000 29,000
Direct labour rate
Cost of direct $20.00 $25.00
labour for EX5 $580,000 $725,000 $1,305,000
Direct Labour Budget for SYM
Moulding Polishing
Desired production
of SYM (in units) 19,000 19,000
Hours of labour
required per unit 1 2
Total hours of
labour required 19,000 38,000
Direct labour rate
Cost of direct $20.00 $25.00
labour for SYM $380,000 $950,000 $1,330,000
Total $960,000 $1,675,000 $2,635,000

3. a. Direct materials variances:
Actual unit cost = RM91,200/19,000 square feet

= RM4.80 per square foot
Price variance = 19,000 × (RM4.80 - RM5.00)

= RM3,800 favourable
Usage variance = RM5.00 × [19,000 - (1,500 × 12)]

= RM5,000 unfavourable
b. Direct manufacturing labour variances:
Actual labour rate = RM35,200/3,200

= RM11.00 per hour
Rate variance = 3,200 × (RM11.00 – RM10.00)

Efficiency variance = RM10.00 × (3,200 – (1,500 × 2)

4. a. 4-variance analysis:
Variable overhead spending variance

= RM36,000 – (6,800 hours × RM5)
Variable overhead efficiency variance

= RM5 × [6,800 hours – (3,400 units × 2 hours)]
=0
Fixed overhead spending variance

= RM26,000 – RM20,000
Fixed overhead production volume variance

= RM20,000 – (3,400 units × 2 hours × RM20,000/
(3,300 units × 2 hours)]
= RM606 favourable
b. 3-variance analysis:
Spending variance
= RM2,000 unfavourable + RM6,000 unfavourable
UNIT 4 63
Budgeting
Efficiency variance = 0
Production volume variance = RM606 favourable
c. 2-variance analysis:
Flexible budget variance = RM2,000 U + 0 + RM6,000 U

Production volume variance = RM606 favourable
d. 1-variance analysis:
Flexible
Actual budget Variances

Fixed overhead RM26,000 RM20,606 * RM5,394 U
Variable
overhead 36,000 34,000 ** 2,000 U
Flexible-budget
variance RM7,394 U
* RM3.0303 × 3,400 × 2 = RM20,606
** 3,400 × 2 × RM5 = RM34,000
5. a. The efficiency variance for variable setup overhead costs

= {[(18,000/ 250) × 5] – [(18,000 / 225) × 5.50]} × RM35
= (360 – 440) * RM35
= RM2,800 (F)
b. The spending variance for variable setup overhead costs

= (18,000 / 250) × 5 × (RM40 – RM35)
= RM1,800 (U)
c. The flexible-budget variance for variable setup overhead costs

= RM2,800 (F) – RM1,800 (U)
= RM1,000 (F)
d. The spending variance for fixed setup overhead costs

= RM14,400 – RM14,000
= RM400 (U)
e. The production volume variance for fixed setup overhead

costs
Normal setup hours = (12,000/225) × 5.50 = 293.33 hours
OH rate = RM14,000 293.33 = RM47.73 per setup hour

[(18,000 / 225) × 5.50 × RM47.73] – RM14,000
= RM7,001.20 favourable
UNIT 4 65
Budgeting
Suggested Answers to Case Studies
Feedback
Case Study 4.1
a.
Production Budget
For the Three Months
January February March

Sales 10,000 12,000 15,000
Ending inventory of
finished goods 2,400 3,000 3,200
Finished goods available 12,400 15,000 18,200
Beginning inventory of
finished goods 3,000 2,400 3,000
Planned production 9,400 12,600 15,200
b.
Direct Materials Budget
Units January February March

direct materials 5,000 6,000 8,000
Purchases 20,000 24,000 30,000
Direct materials available 25,000 30,000 38,000
Ending inventory of
Issued to production 19,000 22,000 29,000
Dollars January February March

Purchases 32,000 40,800 54,000
Direct materials available 39,500 50,280 67,408
Ending inventory of
Issued to production 30,020 36,872 51,443
Dollars available 39,500 50,280 67,408

Units available 25,000 30,000 38,000
Average cost 1.580 1.676 1.774
d. A flexible budget calculated during the budget preparation is

a series of budgets for various levels of activity based on sales
or production. The purpose is to decide the budget level of
activity for the coming year.
A flexible budget at the end of the year is based on the actual

activity level. This is multiplied by the other values that are
based on the original budget figures. The purpose is to evaluate
the performance of a department or manager.
Case Study 4.2
Schedule of Cash Disbursements

January February March

Estimated bicycles
produced 10,000 12,000 15,000
Direct labour hours per
bicycle 2 2 2
Total estimated labour
hours 20,000 24,000 30,000
Cost per direct labour
hour $10.00 $10.00 $10.00
Cash paid for direct
labour $200,000 $240,000 $300,000
Total estimated labour

hours 20,000 24,000 30,000
Variable manufacturing
overhead rate $15.00 $15.00 $15.00
Total variable
manufacturing overhead $300,000 $360,000 $450,000
Fixed manufacturing
overhead $100,000 $100,000 $100,000
Total manufacturing
overhead $400,000 $460,000 $550,000
Less: Depreciation $(20,000) $(20,000) $(20,000)
Cash paid for
manufacturing overhead $380,000 $440,000 $530,000
Cash paid for direct

labour $200,000 $240,000 $300,000
Cash paid for factory
overhead $380,000 $440,000 $530,000
Total cash outflows $580,000 $447,250 $485,875
UNIT 4 67
Budgeting
Glossary
Activity-based budgeting (ABB) Budgeting approach that focuses on the
budgeted cost of the activities necessary to
produce and sell products and services.
Actual costing A costing system that traces direct costs to a cost

object by using the actual direct cost rates times
the actual quantities of the direct cost inputs
and allocates indirect costs based on the actual
indirect cost rates times the actual quantities of
the cost allocation bases.
Bottleneck An operation where the work to be performed

approaches or exceeds the capacity available
to do it.
Budget Quantitative expression of a proposed plan of

action by management for a specified period
and an aid to coordinating what needs to be
done to implement the plan.
Budgetary slack The practice of underestimating budgeted

revenues, or overestimating budgeted costs, to
make budgeted targets more easily achievable.
Budgeted cost Predicted or forecasted cost (future cost) as

distinguished from an actual or historical cost.
Budgeted indirect cost rate Budgeted annual indirect costs in a cost pool
divided by the budgeted annual quantity of the
cost allocation base.
Cash budget Schedule of expected cash receipts and

disbursements.
Controllability Degree of influence that a specific manager has

over costs, revenues, or related items for which
he or she is responsible.
Controllable cost Any cost that is primarily subject to the

influence of a given period.
Efficiency variance The difference between actual input quantity

used and budgeted input quantity allowed for
actual output multiplied by budgeted price.
Also called usage variance.
Financial budget Part of the master budget that focuses on

how operation and planned capital outlays
affect cash. It is made up of the capital
expenditures budget, the cash budget, the
budgeted statement of financial position, and
the budgeted statement of cash flows.
Finished goods inventory Goods completed but not yet sold.
Fixed overhead flexible budget The difference between actual fixed overhead
variance costs in the flexible budget.
Fixed overhead spending Same as the fixed overhead flexible-budget

variance variance. The difference between actual fixed
overhead costs and fixed overhead costs in the
flexible budget.
Flexible budget Budget developed using budgeted revenues and

budgeted costs based on the actual output in
the budget period.
Flexible budget variance The difference between an actual result and the
corresponding flexible-budget amount based on
the actual output level in the budget period.
Master budget Expression of management’s operating and

financial plans for a specified period (usually a
fiscal year) including a set of budgeted financial
statements. Also called pro forma statements.
Normal costing A costing system that traces direct costs to a

cost object by using the actual direct cost rates
times the actual quantities of the direct cost
inputs and allocates indirect costs based on the
budgeted indirect cost rates times the actual
quantities of the cost allocation bases.
Operating budget
Budgeted statement of comprehensive income
and its supporting budget schedules.
Source: The above definitions are adapted from Horngren, C T, Datar, S M and
Rajan, M V (2012) Cost Accounting: A Managerial Emphasis, 14th edn, USA: Pearson
Education Limited and www.businessdictionary.com

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UNIT 4 i

EXTERNAL COURSE ASSESSOR

© 2008 Wawasan Open University

First revision 2011

Wawasan Open University [DU013(P)]

4.1 Introduction to the budgeting process 3

Strategic and operating plans 3

Budgeting cycle and master budget 4

Challenges in administering budgets 5

Developing an operating budget 6

Direct material usage budget and direct material 10

Direct manufacturing labour costs budget 14

Manufacturing overhead costs budget 16

Ending inventory budget 17

Cost of goods sold budget 20

Non-manufacturing costs budgets 21

Budgeted statement of comprehensive income 22

Budgeted statement of financial position 29

Suggested answers to activities 31

4.2 Activity-based budgeting and responsibility 33

Activity-based budgeting (ABB) 33

Responsibility and controllability 38

Human aspects of budgeting 39

Static budget variances 40

Sales volume variances 41

Flexible budget variances 41

Developing standard overhead costs 44

Variable overhead cost variance 44

Fixed overhead cost variance 45

Suggested answers to activities 49

Unit practice exercise 53

Suggested answers to unit practice exercise 59

Suggested answers to case studies 65

1. Define master budgets, and describe its major benefits to an organisation.

2. List and construct the major schedules in preparing an operating budget.

3. Describe responsibility accounting and explain how controllability relates

4. Compute variances using the flexible budget approach.

5. Discuss standard costing system.

6. Explain how to develop standard costs system.

7. Identify actual, normal and standard costing.

4.1 Introduction to the Budgeting

1. Describe what master budget is.

2. Explain the major benefits and advantages of a master budget to an

3. Prepare the operating budget and its supporting schedules.

Budgeting is part of the management process; budget is a primary financial planning

Besides being a financial planning tool, budget helps in coordination and

Budgetary tools include activity-based budgeting, sensitivity analysis and kaizen

Strategic and operating plans

Managers need to know the objectives of the organisation when developing

• What trends affect the market?

• How do the economy, industry, and competitors affect the firm?

• What are the risks and opportunities of alternative strategies?

• What are the contingency plans if the preferred plan fails?

Budgeting cycle and master budget

Plan the performance of the company as a whole

Communicate to subordinates a set of expectations

Investigate variations from plans, and

Figure 4.1 Budgeting cycle

Managers and management accountants need to consider market feedback, changed