Mada za sehemu hiiUse accounting principlesMada 2
- Classify costs by behaviour and perform Cost-Volume-Profit (CVP) analysis (compute the break-even quantity and revenue, target quantity and revenue excluding multiple products)
- Prepare operating budgets (sales, production, purchases, direct labour, overheads and master budget excluding credit sales and credit purchases)
An operating budget is a detailed financial plan that projects the expected revenue and costs of a business for a specific period. It serves as a roadmap for management, helping them plan daily activities, control operations, and assess performance. The operating budget consists of several interconnected schedules that flow from the sales budget to the master budget.
The sales budget is the foundation of all operating budgets. It shows the expected quantity of goods to be sold and the revenue from those sales. The formula is:
Budgeted Sales Revenue = Budgeted Sales Quantity × Selling Price per Unit
Worked Example
Sarah Enterprises expects to sell products for the first three months as follows:
| Month | Units |
|---|---|
| January | 1,000 |
| February | 1,200 |
| March | 1,500 |
The selling price per unit is TZS 2,000 for all months.
Required: Prepare the sales budget showing budgeted sales revenue.
Solution
| Particulars | January | February | March |
|---|---|---|---|
| Budgeted sales quantity | 1,000 | 1,200 | 1,500 |
| Budgeted selling price | 2,000 | 2,000 | 2,000 |
| Budgeted sales revenue | 2,000,000 | 2,400,000 | 3,000,000 |
The production budget determines how many units must be manufactured to meet sales demand and maintain desired inventory levels. The formula is:
Budgeted Production = Budgeted Sales + Desired Closing Stock - Opening Stock
Worked Example
Mchapakazi Company Ltd. has projected sales for three months:
| Month | Units |
|---|---|
| January | 4,000 |
| February | 5,000 |
| March | 6,000 |
The company policy is to keep closing stock equal to 20% of next month's sales. Opening stock on 1st January is 800 units. April sales are expected to be 4,000 units.
Solution
| Particulars | January | February | March |
|---|---|---|---|
| Budgeted sales quantity | 4,000 | 5,000 | 6,000 |
| Add: Expected closing stock | 1,000 | 1,200 | 800 |
| Total production requirements | 5,000 | 6,200 | 6,800 |
| Less: Expected opening stock | 800 | 1,000 | 1,200 |
| Budgeted production | 4,200 | 5,200 | 4,600 |
Workings:
- January closing stock = 20% × 5,000 = 1,000 units
- February closing stock = 20% × 6,000 = 1,200 units
- March closing stock = 20% × 4,000 = 800 units
This budget shows the quantity and value of raw materials needed for production. The formula is:
Materials to be Purchased = Materials Required for Production + Closing Stock - Opening Stock
Worked Example
A manufacturer expected to use 2 kg of material per unit. Forecasted production:
| Month | Units |
|---|---|
| April | 3,000 |
| May | 3,500 |
| June | 4,000 |
The firm maintains closing stock equal to 20% of next month's material requirement. Opening stock on 1st April is 400 kg. Material price is TZS 1,200 per kg. July production is 3,200 units.
Solution
| Particulars | April | May | June |
|---|---|---|---|
| Budgeted production (units) | 3,000 | 3,500 | 4,000 |
| Quantity of materials per unit | 2 | 2 | 2 |
| Materials required for production (kg) | 6,000 | 7,000 | 8,000 |
| Add: Expected closing stock (kg) | 1,400 | 1,600 | 1,280 |
| Total material requirements (kg) | 7,400 | 8,600 | 9,280 |
| Less: Expected opening stock (kg) | 400 | 1,400 | 1,600 |
| Materials purchases (kg) | 7,000 | 7,200 | 7,680 |
| Price per kg (TZS) | 1,200 | 1,200 | 1,200 |
| Material Purchases Budget (TZS) | 8,400,000 | 8,640,000 | 9,216,000 |
This budget shows the labour hours needed and the cost of direct labour. Since labour cannot be stored, there is no opening or closing stock for labour.
Total Labour Hours = Budgeted Production × Labour Hours per Unit
Total Direct Labour Cost = Total Labour Hours × Labour Rate per Hour
Worked Example
KILITEX Ltd. expects to produce:
| Month | Units |
|---|---|
| October | 3,000 |
| November | 3,600 |
| December | 4,000 |
Each unit needs 2.5 hours to produce. Labour rate is TZS 1,200 per hour.
Solution
| Particulars | October | November | December |
|---|---|---|---|
| Budgeted production quantity | 3,000 | 3,600 | 4,000 |
| Labour hours per unit | 2.5 | 2.5 | 2.5 |
| Total labour hours | 7,500 | 9,000 | 10,000 |
| Labour rate per hour (TZS) | 1,200 | 1,200 | 1,200 |
| Total direct labour cost (TZS) | 9,000,000 | 10,800,000 | 12,000,000 |
Manufacturing overhead includes all indirect costs in the factory. It is divided into variable and fixed overheads.
Variable Overhead Budget
Variable Overhead = Units Produced × Variable Overhead Rate per Unit
Fixed Overhead Budget
Fixed overhead is estimated by listing all constant indirect costs such as rent, salaries, depreciation, and insurance.
Worked Example - Variable Overhead
ASK Co. Ltd expects to produce:
| Month | Units |
|---|---|
| January | 8,000 |
| February | 12,000 |
| March | 14,000 |
Variable manufacturing overhead rate is TZS 300 per unit.
Solution
| Particulars | January | February | March |
|---|---|---|---|
| Units of products | 8,000 | 12,000 | 14,000 |
| Variable overhead rate | 300 | 300 | 300 |
| Variable overhead budget | 2,400,000 | 3,600,000 | 4,200,000 |
Worked Example - Fixed Overhead
Alpha Manufacturers has budgeted fixed overhead for July – September:
- Factory building rent: TZS 800,000 per month
- Salary of production manager: TZS 1,500,000 per month
- Depreciation of factory machine: TZS 600,000 per month
- Fixed maintenance: TZS 400,000 per month
Solution
| Particulars | July | August | September |
|---|---|---|---|
| Factory building rent | 800,000 | 800,000 | 800,000 |
| Salary of production manager | 1,500,000 | 1,500,000 | 1,500,000 |
| Depreciation of factory machine | 600,000 | 600,000 | 600,000 |
| Fixed maintenance | 400,000 | 400,000 | 400,000 |
| Total fixed manufacturing overhead | 3,300,000 | 3,300,000 | 3,300,000 |
This budget covers selling and administrative expenses. These can be variable (like sales commission) or fixed (like office salaries).
Worked Example
Budgeted selling and administrative expenses:
- Sales commission: 5% of sales
- Advertising expenses: TZS 800,000 per month
- Office salaries: TZS 1,200,000 per month
Budgeted sales: January TZS 20,000,000; February TZS 25,000,000; March TZS 30,000,000.
Solution
| Month | Sales Commission (5%) | Advertising | Office Salaries | Total |
|---|---|---|---|---|
| January | 1,000,000 | 800,000 | 1,200,000 | 3,000,000 |
| February | 1,250,000 | 800,000 | 1,200,000 | 3,250,000 |
| March | 1,500,000 | 800,000 | 1,200,000 | 3,500,000 |
The budgeted income statement combines all the preceding budgets to show expected profitability. The format is:
Budgeted Sales Revenue Less: Cost of Goods Sold = Gross Profit Less: Selling and Administrative Expenses = Net Operating Profit/Loss
Key Relationships in the Operating Budget
All operating budgets are interconnected:
- Sales budget determines production budget
- Production budget determines material purchases budget
- Production budget determines labour budget
- Production budget determines manufacturing overhead budget
- All the above feed into the budgeted income statement
A Tanzanian small business owner running a duka la vifaa vya ujenzi (construction materials shop) in Mwanza can use operating budgets to plan inventory purchases. By forecasting sales of cement, iron sheets, and timber for each month, the owner can prepare production budgets for local artisans, calculate material requirements, and budget for labour costs. This helps avoid overstocking or stockouts, ensuring the business runs efficiently while maintaining sufficient cash flow for daily operations.
Swali
Which of the following budgets is prepared first when developing an operating budget?
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