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AAT - PCR (June 2010 Exams)

One of the key topics, if not the key topic, on the unit nine (PCR) syllabus is budgeting. Section one of the exam focuses on the preparation of budgets and associated calculations. You need to be able to explain what a budget is; why it is prepared and what the advantages of using it are. You also need to be able to prepare one or more budgets, but not the entire range, from some detailed information.

Let’s start at the beginning.
What is a budget? A budget is a financial plan for an organisation, prepared in advance for use by managers. You don’t need to know this definition by rote, but you do need to have the basic idea. The key words in this definition are: plan; advance; use. A budget shows intentions for a forthcoming period, which a (good!) manager will monitor.
Why bother to prepare a budget? Essentially, you prepare a budget to plan – not just finances, but staffing, production and stock holdings. It allows an organisation to see what they are going to achieve, and in many instances it encourages a little bit of realism.
What are the advantages of preparing a budget? The whole budgeting process in an organisation compels managers to plan. This in turn encourages understanding and collective working. Done well, the process should motivate, encourage communication, and enable monitoring which is the key to a successful organisation.
The budgeting process is long and complex. You won’t be examined on all of it, only a small part of it, but you do need to know the entire system because you can’t predict what will come up on the exam paper.
The first step in the budgeting process is the sales forecast, which predicts sales volume or revenue by using a statistical method such as time series analysis or linear regression. Once you have a sales forecast, you can construct your sales budget which shows forecast sales in both units and revenue. There is no set layout for a budget, but it needs to be clear, and workings should be shown.
The production budget follows on from the sales budget – after all, if you are going to sell it, you need to produce it. The catch is that you need to take account of the finished goods stock, both current and predicted holdings for the end of the period, and there might be wastage.
Example:
The sales budget of PQ Ltd shows that 800 units will be sold next month. Currently, there are 100 units in stock but it has been decided that this must be increased to 200 units next month. Wastage in production is currently 5%.
Answer:
PQ Ltd is expecting to sell 800 units, but there are currently 100 units in stock. This means 700 units are required from production to fulfil sales obligations for the next month. However, PQ also needs to produce the units to be held in stock at the end of the month – another 200 units. Therefore production must be 900 units in total – 100 more than the budgeted sales volume, because of the increase in the closing stock holdings. This sum would be shown as:
Sales 800 – Opening stock 100 = Closing stock 200 = Production 900
PQ requires 900 satisfactory units from production. Since there is some wastage in production, more than 900 units will have to be produced to allow for the wastage levels of 5%. This means that the 900 “good units” is 95% of production. To work out what actually needs to be produced treat 900 as 95% and calculate 100%:
900 / 95 x 100 = 947.37
We can’t produce 0.37 of a unit so production actually needs to be 948 units to ensure we get our 900 units of satisfactory quality.
Note – don’t treat the “good production” as 100%. This will give you a wrong answer (900 units + 5% = total production of 995 units). The key is to remember that the total production is 100%, the satisfactory production less than 100%.
Once you have production levels, you can produce individual resources budgets. Everything that is required for production needs a budget, detailing both cost and quantity necessary. Examples of such budgets could include: the amount of raw material needed (don’t forget to take into account the opening stocks held and the closing stocks required, and any wastage predicted in exactly the same way as the production budget); the cost of raw material to be purchased; the labour time required (don’t forget to take into account any production staff currently working at less than capacity because of the learning process, using the same technique we used for the production budget); the cost of labour, including overtime hours required.
Example:
Using the information from the previous example, we need to produce 948 units. Each unit takes 2 kilos of raw material, but there is a 10% wastage in production. Current stock holdings of raw material are 150 kilos, but it is intended that this will drop to 100 kilos at the end of the month.
Answer:
948 units need to be produced, each taking 2 kilos of material. This means that (948 units x 2 kilos) 1896 kilos of raw material is needed for production. However, there is currently 150 kilos held as stock, and this should drop to 100 kilos at the end of the month. To work out how many kilos are needed for production, the sum would be:
Basic calculation 1896 – opening stock 150 + closing stock 100 = 1846 kilos needed for production
The number of kilos needed has dropped because of the utilisation of 50 kilos of stock, but we still need to account for the wastage in production (10%). As we saw before, the number of kilos of “good” material is a proportion of the total material going into production – in this case the “good” material is 90% of the whole material going into production. We can therefore work out the total number of kilos to be put into production by using the following calculation:
1846 / 90 x 100 = 2052 (rounded to a whole kilo)
Note – treating the “good” material as 100% put into production and adding 10% for wastage will give you an incorrect figure. If you need a way to remember it, thinking about Simon Cowell telling someone they gave 110% - it isn’t possible!
Example:
Using the information from the first example, each unit to be produced takes 3 hours. Necessary break times mean that only 80% of this working time is productive.
Answer:
We already know that 948 units need to be produced. Each unit takes 3 hours so this means production will take 2844 hours. However, not all working time is productive. The 2844 hours needed is only useful working time and so we need to add in the “unproductive” working time. We can do this by using the following calculation:
2844 / 80 x 100 = 3555 hours for production
Note – just as before, you cannot treat the 2844 as 100% and add 20% because the 2844 hours isn’t the total you are putting into production.
These individual resource budgets will come together to form the cost of production budget, where all the costs related to production are added up. Using this cost of production budget, you can create a budget profit and loss account to show the budgeted profit expected.

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