Budgeting and Budgetary Control
P1 tests the budget as a planning and control system: how functional budgets link, how cash budgets differ from profit forecasts, which budgeting approach fits which environment, and why behavioural effects change outcomes. Expect calculation of production, materials, labour and cash budgets and interpretation of flexed-budget variances.
Purposes and sequence
Budgets plan, coordinate, communicate, motivate and control. The sales budget drives production: production = sales + closing finished goods − opening finished goods. Materials purchases = usage + closing raw materials − opening raw materials. Labour and overhead budgets follow activity, and the cash budget aggregates timing of receipts and payments.
Cash versus profit
A cash budget records when money moves; it excludes depreciation and includes capital expenditure, loan receipts, tax and dividends. A profitable month can still show a cash deficit if receivables are slow or inventory is built.
Budget approaches
- Incremental: last year plus a percentage; quick but perpetuates waste.
- Zero-based: every cost justified from zero; useful for discretionary spend, costly to run.
- Rolling: continuously updated; suits volatile environments.
- Activity-based: driven by cost drivers; links resources to activity.
- Top-down versus participative: participation can improve commitment and information, but also invites budget slack.
Worked example
Sales 10,000 units; opening finished goods 1,000; closing 1,500. Production = 10,000 + 1,500 − 1,000 = 10,500 units. Each unit uses 2 kg; opening raw materials 800 kg; closing 1,000 kg. Purchases = (10,500 × 2) + 1,000 − 800 = 21,200 kg. If materials cost £4/kg, the purchases budget is £84,800. Note that production, not sales, drives material usage.
Control and flexing
Budgetary control compares actual with a flexed budget at actual output. Flexing removes activity-level differences from variable costs; fixed costs should not flex with volume. Variances are investigated selectively, using materiality and controllability.
Traps
- Adding closing inventory when the formula requires subtraction, or vice versa.
- Mixing cash and accruals.
- Including depreciation in a cash budget.
- Flexing fixed costs with output.
- Treating a favourable variance as automatically good; cheaper materials may cause quality problems.