a) A budget is a financial or quantitative statement, containing the plans and policies to be pursued by an organisation during a specified accounting period usually a fiscal year. (Blocher et al, 2005: Owe and Law, 1999). It is usually prepared prior to the accounting period and it is used as a means for budgetary control. A budget is drawn up for each functional area of the company or organization. Also, a capital budget, a cash flow budget, stock budget and a master budget containing a budgeted income statement and balance sheet is prepared.
(Owe and Law, 1999). Budgets are prepared in a section in the organization referred to as the budget centre, which is responsible for comparing budgets with actual performance as part of the budgetary control process. (Owe and Law, 1999). Regular financial statements are usually prepared on the basis of each budget center and as such each budget centre is aware of its budgeted and actual performance as well as any subsequent variances. (Owe and Law, 1999). Some of the different budgets prepared in the budget centres include, sales budget, production budget, direct materials usage and purchases budget, direct labour budget, factory overhead budget, cost of goods sold budget, selling and general administrative expenses budget, cash receipts budget, cash budget, budget income statement and budget balance sheet.
(Blocher et al, 2005). Two types of budgets have been identified, which include a fixed budget and a flexible budget. A fixed or static budget is a budget that is prepared at the beginning of the accounting period and is based on cost and revenue estimates (Blocher et al, 2005; Owe and Law, 1999).
This budget does not consider the circumstances that lead to the achievement of different levels of activity from that budgeted and as a result the budget cost allowances for each cost item are not changed for the variable items. (Owe and Law, 1999). A flexible budget on the other hand, is a budget prepared at the end of the accounting period when actual results for the period are known. It is prepared by adjusting receipts and payments to the actual level of activity attained. (Blocher et al, 2005).
Deviations from budgeted production level will lead to a change in the firm’s revenues and expenses. (Blocher et al, 2005). Therefore a flexible budget takes into account the fact that changing circumstances will lead to a change in the values for income and expenditure on some items and thus provides allowances for each variable cost item to allow for the actual levels of output achieved. (Owe and Law, 1999). Budget cost allowances refer to the amount of budgeted expenditure that a cost centre or budget centre is allowed to spend according to its budget, having regard to the level of activity (or other basis or cost insurance) actually achieved during the budgeted period.
The budget cost allowance is usually based on the level of activity achieved and whether the cost item is classified as a fixed or a variable cost. (Owe and Law, 1999). For the manufacturing company, it might need to prepare a flexible budget that adjusts for budgeted production units to actual production units, budgeted sales units to actual sales units, budgeted selling price to actual sales price. For a distribution company it will have to adjust for budgeted purchase price to actual purchase price per unit, budgeted sales to actual sales.