It may also be useful for a business monitoring its cash situation to look at other components of working capital: inventory, receivables and payables. Inventory usually gets detailed consideration when the functional budgets are prepared. Receivables budgets and payables budgets are very straightforward when patterns of payment to suppliers and from customers are considered for the purpose of preparing the cash budget.
5 Budgeted financial statements
Section overview
• As well as wishing to forecast its cash position, a business might want to estimate its profitability and its financial position for a coming period. This would involve the preparation of a budgeted statement of comprehensive income and statement of financial position, both of which form the master budget.
Worked Example: Budgeted financial statements
Using the information in the example above involving Peter Blair (section 4.1) you are required to prepare Peter Blair's budgeted statement of comprehensive income for the six months ending on 31 March 20X4 and a budgeted statement of financial position as at that date.
3: Budgeting 77
Solution
The statement of comprehensive income is straightforward. The first figure is sales, which can be computed very easily from the information in paragraph (c) in the original question. It is sufficient to add up the monthly sales figures given there; for this statement there is no need to worry about any closing
receivables. Similarly, cost of sales is calculated directly from the information on gross margin contained in the previous example.
INCOME STATEMENT
FORECAST TRADING AND COMPREHENSIVE INCOME STATEMENT FOR THE SIX MONTHS ENDING 31 MARCH 20X4
$ $
Sales (3 000 + (2 × 6 000) + (3 × 10 500)) 46 500
Cost of sales (100/150 × $46 500) 31 000
Gross profit 15 500
Expenses
Running expenses (6 × $1 600) 9 600
Depreciation ($8 000 × 20% × 6/12) 800
10 400
Net profit 5 100
(a) Inventory will comprise the initial purchases of $5 000.
(b) Receivables at the end of March will comprise sales made in February and March, not paid until April and May respectively.
(c) Payables at the end of March will comprise purchases made in March, not paid for until April.
(d) The bank overdraft is the closing cash figure computed in the cash budget.
FORECAST STATEMENT OF FINANCIAL POSITION AT 31 MARCH 20X4
$ $
Non-current assets $(8 000 – 800) 7 200
Current assets
Inventories 5 000
Receivables (2 × $10 500) 21 000
26 000
Current liabilities
Bank overdraft 12 100
Trade payables (March purchases) 7 000
19 100
Net current assets 6 900
Total assets 14 100
Proprietor's interest
Capital introduced 15 000
Profit for the period 5 100
Less drawings 6 000
Retained loss (900)
Total equity 14 100
Budget questions are often accompanied by a large amount of sometimes confusing detail. This should not blind you to the fact that many figures can be entered very simply from the logic of the trading situation described. For example, in the case of Peter Blair you might feel tempted to begin a T-account to compute the figure for closing receivables. This kind of working is rarely necessary, since you are told that credit customers take two months to pay. Closing receivables will equal total credit sales in the last two months of the period.
Similarly, you may be given a simple statement that a business pays rates at $1,500 a year, followed by a lot of detail to enable you to calculate a prepayment at the beginning and end of the year. If you are preparing a budgeted comprehensive income statement for the year do not lose sight of the fact that the rates expense can be entered as $1,500 without any calculation at all.
Management Accounting
78
6 Flexible budgets
Section overview
• A flexible budget is a budget which is designed to change as volume of activity changes.
Definitions
A fixed (static) budget is a budget which is set for a single activity level.
A flexible budget is a budget which, by recognising different cost behaviour patterns, 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 (static) 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.
Flexible budgeting uses the principles of marginal costing. In estimating future costs it is often necessary to begin by looking at cost behaviour in the past. For costs which are wholly fixed or wholly variable no problem arises. But you may be presented with a cost which appears to have behaved in the past as a semi- variable cost (partly fixed and partly variable). A technique for estimating the level of the cost for the future is called the high-low method. This is discussed in more detail in Chapter 4, section 4.2
Worked Example: High-low method
The cost of factory power has behaved as follows in past years:
Units of output produced Cost of factory 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. Estimate the cost of factory power which will be incurred.
Ignore inflation.
Solution
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
3: Budgeting 79 An estimate of costs in 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
We can now look at a full example of preparing a flexible budget:
Worked Example: Preparing a flexible budget
(a) Prepare a budget for 20X6 for the direct labour costs and overhead expenses of a production department at the activity levels of 80%, 90% and 100%, using the information listed below:
• The direct labour hourly rate is expected to be $3.75.
• 100% activity represents 60,000 direct labour hours.
• Variable costs
Indirect labour $0.75 per direct labour hour Consumable supplies $0.375 per direct labour hour Other staff expenses 6% of direct and indirect labour costs
• Semi-variable costs are expected to relate to the direct labour hours in the same manner as for the last five years.
Direct labour Semi-variable
Year hours 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)
• Fixed costs
$
Depreciation 18 000
Maintenance 10 000
Insurance 4 000
Rates 15 000
Management salaries 25 000
• Inflation is to be ignored.
(b) Compile a flexible manufacturing budget 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 ($3.75/DLH) 180.00 202.50 225.00
Other variable costs
Indirect labour ($0.75/DLH) 36.00 40.50 45.00
Consumable supplies ($0.375/DLH) 18.00 20.25 22.50
Other staff expenses 12.96 14.58 16.20
Total variable costs ($5.145 per hour) 246.96 277.83 308.70
Semi-variable costs (W) 17.60 18.80 20.00
Management Accounting
80
Fixed costs
Depreciation 18.00 18.00 18.00
Maintenance 10.00 10.00 10.00
Insurance 4.00 4.00 4.00
Rates 15.00 15.00 15.00
Management salaries 25.00 25.00 25.00
Total manufacturing costs 336.56 368.63 400.70
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 manufacturing cost 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