CIMA - C1 Fundamentals of Management Accounting
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9: Budget preparation ⏐ Part C Financial planning and control
Quick Quiz
1 Budgets have a number of purposes. Fill in the key words which are missing from the statements below.
(a) To ……………… the activities of different departments towards a single plan.
(b) To ……………… targets to managers responsible for achieving them.
(c) To establish a system of ……………………. by comparing budgeted and actual results.
(d) To compel …………………. .
2 Which of the following is unlikely to be contained with a budget manual?
A Organisational structures
B Objectives of the budgetary process
C Selling overhead budget
D Administrative details of budget preparation
3 The factor which limits the activities of an organisation is known as:
I The key budget factor III The principal budget factor
II The limiting budget factor IV The main budget factor
A I, II and IV C II and III
B I and III D I, II and III
4 If the principal budget factor is sales demand, in which order would the following budgets be prepared?
Materials usage Materials purchase Production Sales Cash
1st
2nd
3rd
4th
5th
5 Match the following cash positions with the appropriate management action.
Short-term surplus Increase payables
Long-term surplus Replace/update non-current assets
Short-term shortfall Issue share capital
Long-term shortfall Increase receivables and inventory
6 Depreciation has an effect on net profit and is therefore included in a cash budget.
True
False
[
]
?
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Part C Financial planning and control ⏐ 9: Budget preparation
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7 Which of the following are included in the master budget?
I Budgeted income statement
II Budgeted statement of financial position
III Budgeted cash flow
IV Functional budgets
A I, II and III
B II and III
C II, III and IV
D IV only
8 The following information is available for Biscuit Co.
Jan Feb
$ $
Budgeted sales 60,000 80,000
Gross profit as a percentage of sales 40% 40%
Closing trade payables as a percentage of cost of sales 50% 50%
Opening inventory nil nil
Closing inventory nil nil
Note that all cost of sales are paid for on credit.
How much money should be budgeted for supplier payments in February?
A $10,500 C $24,500
B $14,000 D $42,000
9 Jay Co produces a product called the Bee. There has been a surge in Bee sales as a result of an advertising campaign
and so Jay Co is paying its staff overtime to build up the inventory levels.
Labour hours per unit 3
Basic wage rate per hour $20
Overtime premium 25%
Normal number of labour hours per month 340,000 hours
Jay Co expects sales of 100,000 units in September and wants to have closing inventory at the end of September of
20,000 units. There will be no opening inventory on 1
st
September.
Calculate the budgeted labour cost. $
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9: Budget preparation ⏐ Part C Financial planning and control
Answers to Quick Quiz
1 (a) Coordinate (c) Control
(b) Communicate (d) Planning
2 C
3 D
4 1st
Sales
2nd
Production
3rd
Material usage
4th
Material purchase
5th
Cash
5 Short term surplus Increase payables
Long-term surplus Replace/update non-current assets
Short-term shortfall Issue share capital
Long-term shortfall Increase receivables and inventory
6 False. Only cash flow items are included in cash budgets. Depreciation is not a cash flow and so is not included in a cash
budget.
7 A
8 D
Jan
Feb
$
$
Sales
60,000
80,000
Gross profit (@ 40%)
24,000
32,000
Cost of sales (sales – GP)
36,000
48,000
Closing trade payables (@ 50%)
18,000
24,000
$
Feb opening payables
18,000
Increase in amounts owing (COS)
48,000
Feb closing payables
(24,000
)
Amount paid in Feb
42,000
]
[
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Part C Financial planning and control ⏐ 9: Budget preparation
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9 $7,300,000
Jay Co needs to produce 100,000 + 20,000 = 120,000 units in September.
Labour hours required = 120,000 units x 3 hours
= 360,000 hours
Only 340,000 hours are usually worked so there will need to be overtime of 360,000 – 340,000 = 20,000 hours.
$
360,000 hours at basic rate (x $20) 7,200,000
20,000 hours at premium (x $20 x 25%)
100,000
Budgeted labour cost
7,300,000
Now try the questions below from the Question Bank
Question numbers Page
47–51 362
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9: Budget preparation ⏐ Part C Financial planning and control
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Topic list Learning outcomes Syllabus references Ability required
1 Flexible budgets E(vi) E(1) Analysis
2 Flexible budgets and control E(v) E(3), (4), (5), (6) Application
3 Budgets and management reward E(vii) E(6) Comprehension
Flexible budgeting
Introduction
You should now be able to prepare functional budgets, a cash budget and a master budget
and have some idea of the budgeting process. This chapter takes the budgeting theme
further.
We begin by looking at flexible budgets, a vital management planning and control tool. This
part of the chapter relies on your understanding of cost behaviour covered in Chapter 2.
We'll also take a look at the way in which budgets can be used in a system of reward
strategies for managers.
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10: Flexible budgeting ⏐ Part C Financial planning and control
1 Flexible budgets
1.1 Fixed budgets versus flexible budgets
• A fixed budget is a budget which is set for a single activity level.
• A flexible budget is a budget which recognises different cost behaviour patterns and is designed to change as
volume of activity changes.
Master budgets are based on planned volumes of production and sales but do not include any provision for the event
that actual volumes may differ from the budget. In this sense they may be described as fixed budgets.
A fixed budget is a 'budget set prior to the control period and not subsequently changed in response to changes in
activity, costs or revenue. It may serve as a benchmark in performance evaluation.' CIMA Official Terminology
Make sure you are clear on the difference between fixed and flexible budgets.
1.2 Advantages of flexible budgets
A flexible budget has two advantages.
(a) At the planning stage, it may be helpful to know what the effects would be if the actual outcome differs
from the prediction. For example, a company may budget to sell 10,000 units of its product, but may
prepare flexible budgets based on sales of, say, 8,000 and 12,000 units. This would enable contingency
plans to be drawn up if necessary.
(b) At the end of each month or year, actual results may be compared with the relevant activity level in the
flexible budget as a control procedure.
1.3 Preparation of flexible budgets
Step 1
The first step in the preparation of a flexible budget is the determination of cost behaviour patterns,
which means deciding whether costs are fixed, variable or semi-variable.
• Fixed costs are easy to spot. They remain constant as activity levels change.
• For non-fixed costs, divide each cost figure by the related activity level. If the cost is a variable cost,
the cost per unit will remain constant. If the cost is a semi-variable cost, the unit rate will reduce as
activity levels increase.
Step 2
The second step in the preparation of a flexible budget is to calculate the budget cost allowance for each
cost item.
Budget cost allowance = budgeted fixed cost* + (number of units × variable cost per unit)**
* nil for variable cost
** nil for fixed cost
Semi-variable costs therefore need splitting into their fixed and variable components so that the budget
cost allowance can be calculated.
FA
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Key term
Assessment
focus point
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Part C Financial planning and control ⏐ 10: Flexible budgeting
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Budget flexing involves 'flexing variable costs from original budgeted levels to the allowances permitted for actual
volume achieved while maintaining fixed costs at original budget levels'. CIMA Official Terminology
1.3.1 Splitting semi-variable costs
One method for splitting semi-variable costs is the high/low method, which we covered in Chapter 2. Attempt the
following question to make sure you remember how to do this.
Question
Cost estimation
The cost of factory power has behaved as follows in past years.
Units of output Cost of factory
produced power
$
20X1 7,900 38,700
20X2 7,700 38,100
20X3 9,800 44,400
20X4 9,100 42,300
Budgeted production for 20X5 is 10,200 units.
Ignoring inflation, the cost of factory power which will be incurred is estimated to be $
.
Answer
The cost of factory power is estimated to be $
45,600
.
Workings
Units
$
20X3 (highest output)
9,800
44,400
20X2 (lowest output)
7,700
38,100
2,100
6,300
The variable cost per unit is therefore $6,300/2,100 = $3.
The level of fixed cost can be calculated by looking at any output level.
$
Total cost of factory power in 20X3
44,400
Less variable cost of factory power (9,800 × $3)
29,400
Fixed cost of factory power
15,000
An estimate of costs is 20X5 is as follows.
$
Fixed cost
15,000
Variable cost of budgeted production (10,200 × $3)
30,600
Total budgeted cost of factory power
45,600
Now you are ready to prepare a flexible budget.
Key term
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10: Flexible budgeting ⏐ Part C Financial planning and control
1.4 Example: preparing a flexible budget
(a) Prepare a budget for 20X6 for the direct labour costs and overhead expenses of a production department flexed
at the activity levels of 80%, 90% and 100%, using the information listed below.
(i) The direct labour hourly rate is expected to be $3.75.
(ii) 100% activity represents 60,000 direct labour hours.
(iii) Variable costs
Indirect labour $0.75 per direct labour hour
Consumable supplies $0.375 per direct labour hour
Canteen and other welfare services 6% of direct and indirect labour costs
(iv) Semi-variable costs are expected to relate to the direct labour hours in the same manner as for the last five
years.
Year Direct labour
hours
Semi-variable
costs
$
20X1 64,000 20,800
20X2 59,000 19,800
20X3 53,000 18,600
20X4 49,000 17,800
20X5 40,000 (estimate) 16,000 (estimate)
(v) Fixed costs
$
Depreciation 18,000
Maintenance 10,000
Insurance 4,000
Rates 15,000
Management salaries 25,000
(vi) Inflation is to be ignored.
(b) Calculate the budget cost allowance (ie expected expenditure) for 20X6 assuming that 57,000 direct labour hours
are worked.
Solution
(a)
80% level
90% level
100% level
48,000 hrs
54,000 hrs
60,000 hrs
$'000
$'000
$'000
Direct labour
180.00
202.50
225.0
Other variable costs
Indirect labour
36.00
40.50
45.0
Consumable supplies
18.00
20.25
22.5
Canteen etc
12.96
14.58
16.2
Total variable costs ($5.145 per hour)
246.96
277.83
308.7
Semi-variable costs (W)
17.60
18.80
20.0
Fixed costs
Depreciation
18.00
18.00
18.0
Maintenance
10.00
10.00
10.0
Insurance
4.00
4.00
4.0
Rates
15.00
15.00
15.0
Management salaries
25.00
25.00
25.0
Budgeted costs
336.56
368.63
400.7
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Part C Financial planning and control ⏐ 10: Flexible budgeting
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Working
Using the high/low method:
$
Total cost of 64,000 hours
20,800
Total cost of 40,000 hours
16,000
Variable cost of 24,000 hours
4,800
Variable cost per hour ($4,800/24,000)
$0.20
$
Total cost of 64,000 hours
20,800
Variable cost of 64,000 hours (× $0.20)
12,800
Fixed costs
8,000
Semi-variable costs are calculated as follows.
$
60,000 hours
(60,000 × $0.20) + $8,000
20,000
54,000 hours
(54,000 × $0.20) + $8,000
18,800
48,000 hours
(48,000 × $0.20) + $8,000
17,600
(b) The budget cost allowance for 57,000 direct labour hours of work would be as follows.
$
Variable costs
(57,000 × $5.145)
293,265
Semi-variable costs
($8,000 + (57,000 × $0.20))
19,400
Fixed costs
72,000
384,665
You must be able to analyse the fixed and variable elements of semi-variable costs in order to be able to produce a
flexible budget.
2 Flexible budgets and control
Control involves comparing a flexible budget (based on the actual activity level) with actual results. The differences
between the flexible budget figures and the actual results are budget variances.
2.1 Flexible budgets for control
Suppose W Co manufactures a single product, the CL. Budgeted results and actual results for June 20X2 are shown below.
Budget
Actual results
Variance
Production and sales of the CL (units)
2,000
3,000
$
$
$
Sales revenue (a)
20,000
30,000
10,000
(F)
Direct materials
6,000
8,500
2,500 (A)
Direct labour
4,000
4,500
500 (A)
Maintenance
1,000
1,400
400 (A)
Depreciation
2,000
2,200
200 (A)
Rent and rates
1,500
1,600
100 (A)
Other costs
3,600
5,000
1,400
(A)
Total costs (b)
18,100
23,200
5,100
Profit (a) – (b)
1,900
6,800
4,900
(F)
Assessment
focus point
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