AQA A-Level Accounting: Budgeting (7127)

This study guide teaches section 3.9, Budgeting, of the AQA A-level Accounting (7127) specification, version 1.1 (October 2026), for A-level exams from June 2019 onwards. The qualification is linear and untiered. Section 3.9 is examined on Paper 2, which assesses sections 1–3, 8–13 and 17–18. Budgeting is management accounting: forward-looking information for managers, as set out in the role of the accountant. All businesses and figures below are invented.

Course links: AQA A-level Accounting hub and the printable checklist. Afterwards, condense the topic with the revision notes, test yourself with the practice questions, and find your weak spots with the free diagnostics.

What this topic covers

Spec content (3.9)	What you must be able to do
The need for budgeting in business organisations	Explain the purpose of budgeting
The benefits and limitations of budgeting and budgetary control	Evaluate budgeting in general and specific budgets, including zero-based and incremental budgeting
The use of accounting techniques in the preparation and analysis of budgets	Prepare cash, sales, purchases, production and labour budgets, a budgeted income statement and a budgeted statement of financial position
How budgets are used in planning and control	Calculate and interpret variances between budgeted and actual results

Why businesses budget

A budget is a plan for a future period, expressed in money and quantities. Budgetary control compares actual results with the budget, finds the differences (variances), and acts on them.

Budgeting serves several purposes:

• Planning. Managers think ahead about sales, costs and cash before committing resources.
• Co-ordination. The sales, production, purchasing and personnel plans must fit together.
• Communication. Each manager learns what is expected of their department.
• Control. Actual results can be checked against a target, so problems show up early.
• Motivation and responsibility. Each budget has a budget holder who answers for it.
• Performance evaluation. Variances show which managers met their targets.

Budgets are prepared in an order. The principal budget factor (often sales demand) limits activity, so its budget comes first. The sales budget drives the production budget, which drives the materials purchases and labour budgets. All of these feed the cash budget, then the budgeted income statement and budgeted statement of financial position. Together these form the master budget.

Sales, production, purchases and labour budgets

Worked example 1: Thornby Benches

Thornby Benches makes garden benches. Sales forecast: April 400, May 500, June 600, July 550 benches, at £120 each. Closing inventory of finished benches is 20% of the next month’s sales. Each bench uses 2 kg of resin at £5 per kg. Closing resin inventory is 25% of the next month’s usage, and July production is planned at 560 benches. Each bench takes 1.5 labour hours at £14 per hour.

Sales budget (units × price): April £48 000, May £60 000, June £72 000.

Production budget (units). Production = sales + closing inventory − opening inventory.

	April	May	June
Sales	400	500	600
Add closing inventory (20% of next month)	100	120	110
Less opening inventory	(80)	(100)	(120)
Production	420	520	590

April’s opening inventory is 20% of April’s sales (80), because March closed on the same policy. Each month’s closing inventory becomes the next month’s opening inventory. Likewise April’s opening resin is 25% × 840 = 210 kg.

Materials purchases budget. Usage is production × 2 kg: April 840, May 1 040, June 1 180, July 1 120 kg.

	April	May	June
Usage (kg)	840	1 040	1 180
Add closing inventory (25% of next month’s usage)	260	295	280
Less opening inventory	(210)	(260)	(295)
Purchases (kg)	890	1 075	1 165
Purchases at £5 per kg	£4 450	£5 375	£5 825

Labour budget. Hours = production × 1.5: April 630, May 780, June 885. Cost at £14: April £8 820, May £10 920, June £12 390, a quarter total of £32 130.

The labour budget shows whether the workforce can deliver the plan. If normal hours available are fewer than hours needed, the budget must include overtime (at a premium rate), new recruits or reduced output.

The cash budget

A cash budget shows expected receipts and payments month by month, and the bank balance at the end of each month. It records cash flows only. Depreciation, irrecoverable debts written off and provisions never appear, because no cash moves. Capital receipts and payments (loans received, new non-current assets, capital introduced, drawings) do appear.

Worked example 2: Tate Tiles (sole trader)

Rhian Tate’s budgeted sales: May £30 000, June £32 000, July £36 000, August £40 000, September £38 000. 25% of sales are for cash. Of credit sales, 60% are received the month after the sale and 40% two months after. Purchases are 60% of each month’s sales and are paid the following month. Wages: £5 200 in July and August, £5 600 in September. Rent of £4 500 for the quarter is paid in July. General expenses are £1 800 a month. A delivery van costing £15 000 is paid for in August. Drawings are £2 500 a month. The bank balance on 1 July is £3 200.

Step 1: receipts schedule (July shown; August and September follow the same pattern).

July: cash sales           25% × 36 000            =  9 000
      June credit sales    75% × 32 000 × 60%      = 14 400
      May credit sales     75% × 30 000 × 40%      =  9 000
                                                     32 400

Step 2: the cash budget.

£	July	August	September
Receipts	32 400	35 800	38 300
Payments to suppliers	19 200	21 600	24 000
Wages	5 200	5 200	5 600
Rent	4 500	–	–
General expenses	1 800	1 800	1 800
Delivery van	–	15 000	–
Drawings	2 500	2 500	2 500
Total payments	33 200	46 100	33 900
Opening balance	3 200	2 400	(7 900)
Net cash flow	(800)	(10 300)	4 400
Closing balance	2 400	(7 900)	(3 500)

Brackets show an overdraft. The budget warns Rhian, two months ahead, that the van purchase will push the account £7 900 overdrawn. She can arrange an overdraft facility or a loan, delay the van, or reduce drawings. That early warning is the main benefit of a cash budget.

Budgeted financial statements

The budgeted income statement uses the accruals basis, so it differs from the cash budget. On 1 July Tate Tiles had equipment (cost £60 000, accumulated depreciation £18 000), inventory £8 000, trade receivables £33 000, trade payables £19 200, bank £3 200 and capital £67 000. Equipment is depreciated at 10% a year on cost; the van at 20% a year on cost, from August. Inventory stays at £8 000 because each month’s purchases equal that month’s cost of sales.

Budgeted income statement for the quarter ending 30 September

	£	£
Revenue (36 000 + 40 000 + 38 000)		114 000
Cost of sales (60%)		(68 400)
Gross profit		45 600
Wages	16 000
Rent	4 500
General expenses	5 400
Depreciation: equipment (60 000 × 10% × 3/12)	1 500
Depreciation: van (15 000 × 20% × 2/12)	500	(27 900)
Profit for the period		17 700

Budgeted statement of financial position at 30 September

	£	£
Equipment (60 000 − 19 500)		40 500
Van (15 000 − 500)		14 500
Non-current assets		55 000
Inventory	8 000
Trade receivables (75% × 38 000 + 75% × 40 000 × 40%)	40 500	48 500
Trade payables (September purchases)	22 800
Bank overdraft (from the cash budget)	3 500	(26 300)
Net assets		77 200
Capital: 67 000 + 17 700 profit − 7 500 drawings		77 200

Notice the link: a profit of £17 700, yet the bank moves from £3 200 in hand to a £3 500 overdraft. The van, drawings and growing trade receivables absorb the cash.

Budgetary control and variances

A variance is the difference between a budgeted and an actual figure.

• Favourable (F): actual profit higher than budget, i.e. revenue above budget or a cost below it.
• Adverse (A): actual profit lower than budget, i.e. revenue below budget or a cost above it.

Comparing actual results with the original (fixed) budget misleads when output differs, because variable costs rise with volume. A flexed budget recalculates revenue and variable costs at the actual output, with fixed costs unchanged. Variances against the flexed budget show efficiency and pricing; the gap between the flexed and fixed budget profit shows the effect of volume.

Worked example 3: Ridley Lamps

Budget: 2 000 lamps at £60, materials £18 and labour £12 per lamp, fixed overheads £30 000. Actual output and sales were 2 200 lamps.

£	Fixed budget	Flexed budget (2 200)	Actual	Variance (flexed v actual)
Revenue	120 000	132 000	128 700	3 300 A
Materials	36 000	39 600	41 250	1 650 A
Labour	24 000	26 400	25 960	440 F
Fixed overheads	30 000	30 000	31 100	1 100 A
Profit	30 000	36 000	30 390	5 610 A

Reconciliation: budgeted profit £30 000 + volume variance £6 000 F (36 000 − 30 000) − flexed variances £5 610 A = actual profit £30 390.

Interpretation: on the fixed budget, profit is only £390 F and materials look £5 250 A, which hides the real story. Selling 200 more lamps added £6 000 of profit, but that gain was almost wiped out. The selling price averaged £58.50, not £60, perhaps a discount used to win the extra sales. Materials cost £18.75 a lamp instead of £18, through a supplier price rise or more wastage. Labour was efficient. Managers should investigate the large adverse items first and ask whether they are controllable. Section 3.11 splits these variances further into price and usage, rate and efficiency.

Benefits and limitations of budgeting

Generic benefits: planning, co-ordination, a basis for control and appraisal, clear responsibility, and motivation when targets are agreed and achievable.

Generic limitations: budgets rely on forecasts that may be wrong; preparation takes time and money; rigid budgets can stop managers reacting to change; imposed or unrealistic targets demotivate; managers may build in budgetary slack (padding costs) or spend up to the limit to protect next year’s allocation; departments may chase their own budget at the expense of the whole business.

Specific budgets:

• Cash budget: shows shortages early so finance can be arranged; but timing assumptions (when customers pay) are uncertain.
• Sales budget: sets the activity level for every other budget; any error flows through them all.
• Production budget: plans capacity and inventory levels; less useful where demand is volatile.
• Purchases budget: avoids stock-outs and excess inventory; prices may change.
• Labour budget: shows overtime or recruitment needs early; ignores staff absence and productivity changes unless built in.
• Budgeted income statement and statement of financial position: show whether the plans give an acceptable profit and financial position; only as reliable as every budget beneath them.

Incremental and zero-based budgeting

Incremental budgeting takes last period’s budget or actual figures and adjusts them, for example by adding inflation. It is quick, cheap and stable. But it carries forward past inefficiency, assumes existing activities are still worth doing, and encourages “spend it or lose it”.

Zero-based budgeting (ZBB) starts every budget from zero: each activity and every pound must be justified as if it were new. It removes waste and links spending to current objectives. But it is slow and costly, needs skilled managers, and may favour activities with easily measured benefits. Many businesses use ZBB periodically, or only for discretionary costs such as marketing and training, and incremental budgeting otherwise.

Common errors

• Putting depreciation or irrecoverable debts in a cash budget.
• Forgetting that this month’s closing inventory is next month’s opening inventory.
• Applying a credit percentage to total sales when only part of sales is on credit.
• Labelling a cost below budget as adverse; a lower cost is favourable.
• Comparing actual with the fixed budget when output differs, without flexing.
• Treating the cash budget closing balance as profit.

Official syllabus

AQA A-level Accounting (7127) specification, version 1.1, October 2026, A-level exams June 2019 onwards (AQA), section 3.9 Budgeting.