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Introduction
This is the second page in the
Budgeting and Budgetary Control series on this site.
By functional budgets, we mean budgets that relate to an area of an organisation that produces, or does, something. This is not necessarily to say that we are talking about manufacturing alone. We can have functional budgets in manufacturing, in commerce, in government. We can have functional budgeting in non profit making organisations too.
In the example given in this paper, we will demonstrate functional budgeting using a manufacturing situation.
Don't believe everything you read in a budget!
We could issue a number of warnings concerning budgets. Let's consider a few examples.
1
Spreadsheet errors: it is pretty well established now that the average
spreadsheet contains one or more fundamental errors somewhere within its
structure. If memory serves me correctly, something like 25% of all
spreadsheets are filled with so many errors as to render them useless.
2
Research problems: what about the research on which the budgets are
based? Imagine an accountant has been asked to research the background detail
for a budgeting exercise for a complex organisation. Without some specialist knowledge
and help, the accountant cannot hope to succeed in preparing a decent set of
budgets.
3
Accepting what you're told: there is the case of the consultant who is
invited to work with an organisation that is seeking to apply for a loan to
enable it to invest in capital equipment. The consultant has one week to
prepare all of the background materials for the loan organisation. Given the
constraints, the consultant interviews the Director of the business and between
them they prepare a very attractive loan application cum business plan. This
problem is linked to example 2: how much checking and analysis has the
consultant done? It could be the case that the budget simply reflect what the
Director believes to be the case; and that could be seriously wrong.
4
Out of date: ever heard of a budget that's out of date? It's
not uncommon for organisations to work on budgets prepared upwards of a year
ago. As we saw in the first page in this series, the budget preparation cycle
for a large organisation can take many months to complete. Moreover, the budget
period itself is usually a year. For a two year project, the budget period is
two years. For a three year project, the project could have been established
and agreed up to four years in advance of parts of the project to which it
relates.
Worked example
The key to budget preparation is often in interpreting the situation itself. This takes us back to the warnings we have just seen: we need to understand what we're budgeting for if we're going to be successful. We will work through an accounting examination question to demonstrate the nature of functions budgets.
R Limited manufactures three products: A, B and C. You are required:
using the information given below, to prepare budgets for the month of January for:
i sales in quantity and value, including total value
ii production quantities
iii material usage in quantities
iv materials purchases in quantity and value, including total value
Data for Preparation of January Budgets
|
Product |
Quantity |
Price each |
|
A |
1,000 |
100 |
|
B |
2,000 |
120 |
|
C |
1,500 |
140 |
Materials Used in the Company's Products
|
Material |
M1 |
M2 |
M3 |
|
Unit Cost |
£4 |
£6 |
£9 |
Quantities used
|
Product |
units |
units |
units |
|
A |
4 |
2 |
- |
|
B |
3 |
3 |
2 |
|
C |
2 |
1 |
1 |
Finished stocks
|
Quantities |
A |
B |
C |
|
1st January |
1,000 |
1,500 |
500 |
|
31st January |
1,100 |
1,650 |
550 |
Material stocks
|
|
M1 |
M2 |
M3 |
|
|
units |
units |
units |
|
1st January |
26,000 |
20,000 |
12,000 |
|
31st January |
31,200 |
24,000 |
14,400 |
(CIMA Cost Accounting 1: modified)
Solution to Worked Example: R Limited
Although both real and academic budgeting questions can sometimes prove difficult to solve, they are basically exercises in following through relationships and carrying out arithmetical calculations.
Please bear in mind the interrelationships of budgets that we discussed in the first page in this series. We will see an example of such interrelationships when we get to the Materials Usage Budget.
The budgets presented below should be found to be clearly and logically laid out, although there are alternative forms of layout that we could use for just about any budget we are working on.
(i) Sales
Budget
|
|
Product A |
B |
C |
Total |
|
Sales Units |
1,000 |
2,000 |
1,500 |
|
|
Sales Values |
100,000 |
240,000 |
210,000 |
550,000 |
The workings
here are very straightforward: the sales values are found by multiplying the
number of units sold (given in the question) by the selling price per unit
(also given in the question).
(ii) Production Budget
|
Units |
Product A |
B |
C |
|
Opening Stock |
1,000 |
1,500 |
500 |
|
Production |
1,100 |
2,150 |
1,550 |
|
|
2,100 |
3,650 |
2,050 |
|
Closing Stock |
1,100 |
1,650 |
550 |
|
Sales |
1,000 |
2,000 |
1,500 |
The production budget follows this layout:
Opening stock
Plus What
we have produced this period
Gives How many units
are available to sell or use somewhere else
Less Closing
stock, that we have not sold or used
Gives What we must
have sold or used
Remember, in the case of a production budget, we are dealing with finished goods, not raw materials or work in progress: hence, check where the opening and closing stock figures in this schedule have come from.
Also
remember that there are alternative and acceptable layouts of the Production
budget.
(iii)
Materials Usage Budget
|
|
Product A |
B |
C |
Total |
|
Units Produced |
1,100 |
2,150 |
1,550 |
|
|
Material Usage M1 |
4,400 |
6,450 |
3,100 |
13,950 |
|
Material Usage M2 |
2,200 |
6,450 |
1,550 |
10,200 |
|
Material Usage M3 |
- |
4,300 |
1,550 |
5,850 |
Here we see an example of the inter relationships between budgets that we discussed above. Having prepared the production budget, we use the outputs of that budget as the primary input of the materials usage budget: that is, the units produced.
The
material usages are found by multiplying together the number of units produced
by the number of units of each raw material required for each product. For
example,
(iv) Materials Purchases Budget
|
Units |
Material M1 |
M2 |
M3 |
|
Opening Stock |
26,000 |
20,000 |
12,000 |
|
Purchases |
19,150 |
14,200 |
8,250 |
|
|
45,150 |
34,200 |
20,250 |
|
Closing Stock |
31,200 |
24,000 |
14,400 |
|
Used in Production |
13,950 |
10,200 |
5,850 |
|
Values |
M1 |
M2 |
M3 |
Total |
|
Purchases (units) |
19,150 |
14,200 |
8,250 |
|
|
Cost per unit |
£4 |
6 |
9 |
|
|
Total Cost |
£76,600 |
85,200 |
74,250 |
£236,050 |
Conclusions
Functional
budget preparation is not a difficult affair: work through the above example a
couple of times and you should agree. The key principles of functional budget
preparation are
· Understand the function, process or system you are budgeting
· Find all of the data you need
· Separate the values from the volumes
· Check for interrelationships, understand and use them
· Check your arithmetic once you have prepared each budget
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