432 EP-CMA

account for making estimates. Since this method is based on the concept of cash accounting, accruals and
adjustments obviously cannot find place in the preparation of cash budgets. The opening balance of cash of
a period and the estimated cash receipts are added and from this, the total of estimated cash payments are
deducted to find out the closing balance.

Illustration 1
Prepare a cash budget of M/s Novan Television & Co. on the basis of the following information for the first six
months of 2014:
(a) Cost and prices unchanged.
(b) Cash sales - 25% and credit sales - 75%.
(c) 60% of credit sales are collected in the month after sales, 30% in the second month and 10% in the
third. No bad debts are anticipated.
(d) Sales forecasts are as follows:

` `
October 2013 12,00,000 March 2012 8,00,000
November 2013 14,00,000 April 2012 12,00,000
December 2013 16,00,000 May 2012 10,00,000
January 2014 6,00,000 June 2012 8,00,000
February 2014 8,00,000 July 2012 12,00,000
(e) Gross profit margin 20%.
(f) Anticipated purchases:
`
January 2014 6,40,000
February 2014 6,40,000
March 2014 9,60,000
April 2014 8,00,000
May 2014 6,40,000
June 2014 9,60,000
(g) Wages and Salaries to be paid:

January 2014 1,20,000

February 2014 1,60,000
March 2014 2,00,000
April 2014 2,00,000
May 2014 1,60,000
June 2014 1,40,000
(h) Interest on `10,00,000 @ 12% on debentures is due by the end of March and June.
(i) Excise deposit due in April `2,00,000.
(j) Capital expenditure on plant and machinery planned for June `1,20,000.
(k) Company has a cash balance of `4,00,000 at 31.12.2013.
(l) Company can borrow on monthly basis.
(m) Rent is `8,000 per month.
Solution:

M/s Novan Television Company

Cash Budget for six months, January to June, 2014
January February March April May June
` ` ` ` ` `

Receipts:
Cash sales 1,50,000 2,00,000 2,00,000 3,00,000 2,50,000 2,00,000
Collections from debtors 11,25,000 7,35,000 6,15,000 5,85,000 7,80,000 7,80,000
Total Receipts (A) 12,75,000 9,35,000 8,15,000 8,85,000 10,30,000 9,80,000
Payments:
Purchases 6,40,000 6,40,000 9,60,000 8,00,000 6,40,000 9,60,000
Rent 8,000 8,000 8,000 8,000 8,000 8,000
Wages and Salaries 1,20,000 1,60,000 2,00,000 2,00,000 1,60,000 1,40,000
Excise Deposit    2,00,000  
Capital Expenditure      1,20,000

Lesson 10
Interest   30,000   30,000
Total Payment (B) 7,68,000 8,08,000 11,98,000 12,08,000 8,08,000 12,58,000

Balance:
Net Cash Receipts (A - B) 5,07,000 1,27,000 (3,83,000) (3,23,000) 2,22,000 (2,78,000)

Budget, Budgeting & Budgetary Control 433

Cash balance at the beginning
of the month 4,00,000 9,07,000 10,34,000 6,51,000 4,00,000 5,50,000
Total 9,07,000 10,34,000 6,51,000 3,28,000 6,22,000 2,72,000

Borrowing/(Surplus)    72,000 (72,000) 1,28,000

Cash balance at the close _______ ________ _______ _______ _______ _______
of the month 9,07,000 10,34,000 6,51,000 4,00,000 5,50,000 4,00,000

Note: It is assumed that the company will maintain cash balance of `4,00,000 as in the beginning of the budget period, resorting to borrowing, if necessary. The company could
also place substantial amounts on short duration deposits, of 15 to 30 days during the first three months.
Working Note:

434 EP-CMA
Oct. 2013 Nov. 2013 Dec. 2013 Jan. 2014 Feb. 2014 March 2014 April 2014 May 2014 June 2014

` ` ` ` ` ` ` ` `

Total Sales 12,00,000 14,00,000 16,00,000 6,00,000 8,00,000 8,00,000 12,00,000 10,00,000 8,00,000

Credit Sales 9,00,000 10,50,000 12,00,000 4,50,000 6,00,000 6,00,000 9,00,000 7,50,000 6,00,000

Collections:

1st month, 60% 7,20,000 2,70,000 3,60,000 3,60,000 5,40,000 4,50,000

2nd month, 30% 3,15,000 3,60,000 1,35,000 1,80,000 1,80,000 2,70,000

3rd month, 10% 90,000 1,05,000 1,20,000 45,000 60,000 60,000

*11,25,000 7,35,000 6,15,000 5,85,000 7,80,000 7,80,000

* For example: 60% of credit sales in December 2013;

30% of credit sales in November 2013; and
10% of credit sales in October 2013.
 Lesson 10 Budget, Budgeting & Budgetary Control 435

(ii) Adjusted Profit and Loss Account Method: In this method the opening balance is adjusted with the
anticipated increases or decreases in current assets and liabilities, provision for depreciation, special
receipts and the net profit for the year before taxation and appropriations. From the aggregate amount of
these, the estimated taxation and dividends payable, expenditure on fixed assets and special payments if
any are deducted . The resulting balance is the estimated cash in hand at the end of the budget period.

The vital point of difference between receipts and payments method and adjusted profit and loss method is
that the former takes into account only cash transactions while the latter considers non cash items as it
reverses all accruals. Further, adjusted profit and loss method gives only a broad idea of the cash position
but receipts and payments method furnishes the maximum possible details.

Illustration 2
Following are the Balance Sheets of Metal Engineering Limited one actual as on 31st December, 2013 and
other forecast as on 31st December, 2014:

2013 2014
(Actuals) (Forecast)
` `
Cash 18,400 1,36,800
Debtors 49,000 83,200
Stock 61,900 92,500
Investments 1,00,000 90,000
Plant (at cost) 2,20,000 2,40,000
4,49,300 6,42,500

Accounts Payable 67,300 1,00,000

Debentures 73,500 50,000
Accumulated Depreciation 50,000 30,000
Equity Share Capital 1,25,000 1,75,000
Profit and Loss Account 1,33,500 2,87,500
4,49,300 6,42,500

The forecast Profit and Loss Account in a summarised form for the budget year ended 31st December, 2014
is as follows:

`. `
To Accumulated depreciation 22,000 By Gross profit 2,00,000
“ Administration and selling ” Profit on the sale of investments 2,000
expenses 10,000 ” Interest 10,000
“ Income-tax 5,000
“ Interest charges 3,000
“ Loss on sale of plant 8,000
“ Net profit 1,64,000 _______
2,12,000 2,12,000
To Dividend (including CDT) 10,000 By Net profit 1,64,000
“ Balance c/d 1,54,000 _______
1,64,000 1,64,000

Additional information:
(i) New plant costing `80,000 was purchased during the year.
436 EP-CMA

(ii) An old plant, costing `60,000 and with accumulated depreciation of ` 42,000 was sold for `10,000.
(iii) Investments costing `10,000 were sold for `12,000.

Prepare a cash budget for the management of the company by Adjusted Profit and Loss method.

Solution:

Cash Budget (Adjusted Profit and Loss)

(for the Budget period ended 31st December 2014)
` `
Opening Balance of Cash 18,400
Add: Additions to Cash:
Issue of share capital 50,000
Sale of plant 10,000
Sale of investments 12,000
Depreciation written back 22,000
Loss on sale of plant 8,000
Increase in creditors 32,700
Profit of the year 1,64,000 2,98,700
3,17,100
Less: Reduction in Cash:
Redemption of debentures 23,500
Purchase of plant 80,000
Payment of dividend (including CDT) 10,000
Profit on sale of investments taken back 2,000
Increase in stock 30,600
Increase in debtors 34,200 1,80,300
Closing balance of cash 1,36,800

(iii) Balance Sheet Method: Under this method of preparing cash budget a forecast balance sheet is
prepared as at the end of the budget period with all items of assets and liabilities except cash balance which
is arrived at as a balancing figure. The magnitude of the two sides of the balance sheet excluding cash
balance would determine whether the bank account would show a debit or credit balance i.e. cash balance at
bank or bank overdraft.

(1.6.2) Capital Expenditure Budget: Capital expenditure budget is the plan of the proposed outlay on fixed
assets and is very closely related to the cash budget. Capital expenditure forecasting is a continuous
process and by nature it is a long-term function. Capital forecasts should be made for a number of years.
Alongwith the long-term forecast, there should also be a short-term forecast to cover the general budget
period under consideration. It is also essential that the capital expenditure budget be properly co-ordinated
with all the operational budgets of the concern so as to form an integral part of the overall plan.

2. MASTER BUDGET

Master budget is a consolidated summary of the various functional budgets. A master budget is the summary
budget incorporating its component functional budget and which is finally approved, adopted and employed.
It is the culmination of the preparation of all other budgets like the sales budget, production budget, purchase
budget etc. It consists in reality of the budgeted profit and loss account, the balance sheet and the budgeted
funds flow statement.
 Lesson 10 Budget, Budgeting & Budgetary Control 437

The master budget is prepared by the budget committee on the basis of co-ordinated functional budgets and
becomes the target of the company during the budget period when it is finally approved. This budget acts as
the company’s individualised key to successful financial planning and control. It provides the basis of computing
the effect of any changes in any phase of operations, such as sales volume, product mix, prices, labour costs,
material costs or change in facilities. It segregates income, costs and profits by areas of responsibility. Master
budget presents all this information to the depth appropriate for the top management action.

In the master budget, costs are classified and summarised by types of expenses as well as by departments.
This information extends the range of usefulness of master budget. It is considered as the best mode of
understanding the company’s micro- economic position relating to the forthcoming budget period. Master
Budget is not merely a compendium of theoretical calculations. The figures that it contains, are the reflection
of the actual intentions of the company relating to different areas for the forthcoming budget period.

3. FIXED BUDGETS
A budget may be established either as a fixed budget or a flexible budget. A fixed budget is a budget
designed to remain unchanged irrespective of the level of activity actually attained. A fixed budget is one
which is designed for a specific planned output level and is not adjusted to the level of activity attained at the
time of comparison between the budgeted and actual costs. Obviously, fixed budgets can be established
only for a small period of time when the actual output is not anticipated to differ much from the budgeted
output. However, a fixed budget is liable to revision if due to business conditions undergoing a basic change
or due to other reasons, actual operations differ widely from those planned in the fixed budget. These
budgets are most suited for fixed expenses but they have only a limited application and is ineffective as a
tool for cost control.

4. FLEXIBLE BUDGETS
The Chartered Institute of Management Accountants, London defines flexible budget as a budget which by
recognising different cost behaviour patterns, is designed to change as volume of output changes. It is a
budget prepared in a manner so as to give the budgeted cost for any level of activity. It is a budget which by
recognising the difference between fixed, semi-fixed and variable cost is designed to change in relation to
the activity attained. It is designed to furnish budgeted cost at any level of activity attained. Flexible
budgeting is desirable in the following cases:
(i) Where the level of activity during the year varies from period to period, either due to the seasonal
nature of the industry or to variation in demand.
(ii) Where the business is a new one and is difficult to foresee the demand.
(iii) Where the undertaking is suffering from shortage of a factor of production such as materials, labour,
plant capacity, etc.

The main characteristic of flexible budget is that it shows the expenditure appropriate to various levels of
output. If the volume changes the expenditure appropriate to it can be established from the flexible budget
for comparison with actual expenditure as a means of control. It provides a logical comparison of budget
allowances with actual cost. When flexible budget is prepared, actual cost at actual activity is compared with
budgeted cost at actual activity i.e. two things to a like base. For preparation of flexible budget, items of cost
have to be analysed individually to determine how different items of cost behave to change in volume.
Therefore, in-depth cost analysis and cost identification is required for preparation of flexible budget.
Following are the striking features of flexible budgets:
(i) They are prepared for a range of activity instead of a single level.
438 EP-CMA

(ii) They provide a very dynamic basis for comparison because they are automatically geared to
changes in volume.
(iii) They provide a tailor-made budget for a particular volume.
(iv) These are based upon adequate knowledge of cost behaviour pattern.

Flexible budgets may be prepared in the following method:

(i) Tabular method or multi-activity method
(ii) Formula method or ratio method and
(iii) Graphic method.

Illustration 3
Following information is available from the records of Jay Ltd. for the year end 31st March 2014.
` (lakhs)
Fixed Expenses
Wages and salaries 9.5
Rent, rates and taxes 6.6
Depreciation 7.4
Sundry administrative expenses 6.5
Semi-Variable Expenses
(at 50% of capacity)
Maintenance and repairs 3.5
Indirect labour 7.9
Sales department salaries 3.8
Sundry administrative expenses 2.8
Variable Expenses
(at 50% of capacity)
Materials 21.7
Labour 20.4
Other expenses 7.9
98.0

Assuming that the fixed expenses remain constant for all levels of production, semi-variable expenses
remain constant between 45% and 65% of capacity increasing by 10% between 65% and 80% and by 20%
between 80% and 100%.

Sales at various levels are :

` (lakhs)
50% capacity 100
60% “ 120
75% “ 150
90% “ 180
100% “ 200

Prepare a flexible budget for the year and forecast the profits at 60%, 75%, 90% and 100% of capacity.
 Lesson 10 Budget, Budgeting & Budgetary Control 439

Solution:
Flexible Budget
Period.......................

50% 60% 75% 90% 100%

` ` ` ` `
(lakhs) (lakhs) (lakhs) (lakhs) (lakhs)
Sales 100 120 150 180 200
Variable expenses
Materials 21.70 26.04 32.55 39.06 43.40
Labour 20.40 24.48 30.60 36.72 40.80
Other expenses 7.90 9.48 11.85 14.22 15.80
Semi-variable expenses
Maintenance and repairs 3.50 3.50 3.85 4.20 4.20
Indirect labour 7.90 7.90 8.69 9.48 9.48
Sales Deptt. salary, etc. 3.80 3.80 4.18 4.56 4.56
Sundry administrative
expenses 2.80 2.80 3.08 3.36 3.36
Fixed expenses
Wages and salaries 9.50 9.50 9.50 9.50 9.50
Rent, rates and taxes 6.60 6.60 6.60 6.60 6.60
Depreciation 7.40 7.40 7.40 7.40 7.40
Sundry administrative
Expenses 6.50 6.50 6.50 6.50 6.50
_____ _____ _____ _____ _____
Total 98.00 108.00 124.80 141.60 152.60
Profit 2.00 12.00 25.20 38.40 47.40

Illustration 4
A firm at present operates at 60% of its capacity. At this level and at the level of 50% utilisation of capacity,
the figures relating to its operations could be summarised as stated below:

50% 60%
` `
Materials 10,00,000 12,00,000
Labour 8,00,000 9,00,000
Manufacturing overheads 6,00,000 6,60,000
Administrative overheads 3,50,000 3,50,000
Selling and distribution overheads 4,50,000 5,00,000
Research and development 1,50,000 2,00,000
Total 33,50,000 38,10,000
Profit 1,50,000 3,90,000
Sales 35,00,000 42,00,000

Draw up the budget at 80% utilisation of capacity assuming that -

(i) sales at this level can be maintained only by a flat 5% reduction in the selling price;
440 EP-CMA

(ii) economy in purchase of material will equal to 2-1/2% of the current amounts;
(iii) the research and development expenditure will be pegged at `2,50,000 per annum; and
(iv) administrative overheads will require 10% increase.

Solution:
Budget at 80% capacity utilisation
60% 80%
` `

Materials 12,00,000 15,60,000

Labour 9,00,000 11,00,000
Manufacturing overheads 6,60,000 7,80,000
Administrative overheads 3,50,000 3,85,000
Selling and distribution overheads 5,00,000 6,00,000
Research and development 2,00,000 2,50,000
Total 38,10,000 46,75,000
Profit 3,90,000 6,45,000
Sales 42,00,000 53,20,000

Working Notes:
` `
(1) Materials at 60% capacity 12,00,000
at 80% capacity 16,00,000
Less: 2-1/2% 40,000 15,60,000

(2) Variable fixed portions of various expenses

50% 60% Increase Total Fixed

for 10%
` ` (variable) variable

Labour 8,00,000 9,00,000 1,00,000 6,00,000 3,00,000

Mfg. overhead 6,00,000 6,60,000 60,000 3,60,000 3,00,000
Selling overheads 4,50,000 5,00,000 50,000 3,00,000 2,00,000

(3) At 80% Capacity:

Labour: Fixed 3,00,000
Variable (`1,00,000 for every 10%) 8,00,000 11,00,000
Mfg. overheads: Fixed 3,00,000
Variable (`60,000 for every 10%) 4,80,000 7,80,000
Selling overheads: Fixed 2,00,000
Variable (`50,000 for every 10%) 4,00,000 6,00,000

(4) Sales: at 60% Capacity 42,00,000

at 80% Capacity 56,00,000
Less: 5% 2,80,000 53,20,000
 Lesson 10 Budget, Budgeting & Budgetary Control 441

Illustration 5
ABC Ltd. produces and sells a single product. Sales budget for the calendar year 2014 for each quarter is as
under:

Quarter No. of Units to be Sold

I 12,000
II 15,000
III 16,500
IV 18,000

The year 2014 is expected to open with an inventory of 4,000 units of finished product and close with an
inventory of 6,500 units. Production is customarily scheduled to provide for two-thirds of the current quarter’s
demand plus one-third of the following quarter’s demand. Thus production anticipates sales volume by about
one month. The standard cost details for one unit of the product is as follows:
— Direct materials 10 Kgs. @ 50 paise per kg.
— Direct labour 1 hour 30 minutes @ `4 per hour.
— Variable overheads 1 hour 30 minutes @ `1 per hour.
— Fixed overheads 1 hour 30 minutes @ `2 per hour based on a budgeted production volume of
90,000 direct labour hours for the year.

Answer the following:

(i) Prepare a production budget for the year 2014 by quarters, showing the number of units to be
produced.
(ii) If the budgeted selling price per unit is `17, what would be the budgeted profit for the year as a
whole?
(iii) In which quarter of the year the company is expected to break-even?

Solution:

Number of units to be sold during the year 2014

Quarter I 12,000 units

Quarter II 15,000 units
Quarter III 16,500 units
Quarter IV 18,000 units
Sales during the year 61,500 units

(i) Production Budget (for the year 2014 by quarters)

Quarter I Quarter II Quarter III Quarter IV Total
Units Units Units Units Units
Units to be produced in
each quarter :
442 EP-CMA

2/3rd of the current 8,000 10,000 11,000 12,000 41,000

quarter’s sales demand
2  2  2  2 
 × 12,000   × 15,000   × 16,500   × 18,000 
 3   3   3   3 
Add : 1/3 of the following
quarter’s sales demand in 5,000 5,500 6,000 6,500 23,000
first 3 quarters and
closing inventory in the 1  1  1  1 
4th quarter  × 15,000   × 16,500   × 18,000   × 19,500 
3  3  3  3 
Total 13,000 15,500 17,000 18,500 64,000

(1) Variable Cost per unit

` `
Direct Material : 10 kgs. @ 50 paise per kg. 5.00
Direct labour : 1-½ hours @ `4 per hour 6.00
Variable overheads: 1-½ hours @ `1 per hour 1.50 12.50
(2) Fixed overhead per annum: 90,000 hrs. @ `2 = `1,80,000

(ii) Statement of Budgeted Profit for the year (as a whole)

`
Total Sales : 61,500 units @ `17 per unit 10,45,000
Less : Total Variable Cost : 61,500 units @ 12.50 per unit 7,68,750
Contribution 2,76,750
Less : Fixed cost for the year 1,80,000
Profit for the year 2014 as a whole 96,750

Fixed Overheads
(iii) Beak Even Point =
Selling Price per unit – Variable Cost per unit

`1,80,000
= = 40,000 units.
(`17 – `12.50)

Total sales (in units) by the end of 3rd quarter will be 43,500 (i.e. 12,000 + 15,000 + 16,500).

Therefore, the company will break-even in the later part of the 3rd quarter.

5. BASIC BUDGETS

Basic budget has been defined as a budget which is prepared for use unaltered over a long period of time.
This does not take into consideration current conditions and can be attainable under standard conditions.

6. CURRENT BUDGETS

A current budget can be defined as a budget which is related to the current conditions and is prepared for
use over a short period of time. This budget is more useful than basic budget, as the target it lays down will
be corrected to current conditions.