Edexcel A-Level Accounting: Budgeting (YAC11) – Revision Notes

These notes condense topic 2.4, Budgeting, of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting (XAC11/YAC11) specification, Issue 2, September 2018: outcomes 2.4.1 to 2.4.5. It is Unit 2 (Corporate and Management Accounting) content, so Unit 2 (A2) only. For full explanations and three fully worked examples, read the budgeting study guide first. All names and figures are invented; amounts are in dollars.

Links: Edexcel A-Level Accounting hub, printable checklist, budgeting practice questions and free diagnostics. Receivables and payables budgets mirror the control accounts you met in Unit 1.

2.4.1 Why budget?

Three named roles:

• Planning: decide sales, output, purchases, staffing and asset spending before the period begins.
• Forecasting: convert predictions about demand, prices and payment timing into figures, so problems such as a cash shortage appear early.
• Control: compare actual results with budget; the variances show where to act.

Extra benefits: co-ordination of departments, communication of targets, clear responsibility for each budget holder, motivation when targets are agreed.

Drawbacks: forecasts can be wrong; it costs time; imposed or unreachable targets demotivate; budgetary slack (padded costs); “spend it or lose it” behaviour; rigidity when conditions change.

2.4.2 Preparation sequence

Objectives set by directors
  -> budget committee + budget manual
  -> identify principal budget factor (usually sales demand)
  -> revenue budget
  -> production budget
  -> purchases and inventory budgets (plus labour, overheads)
  -> trade receivables, trade payables, capital budgets
  -> cash budget
  -> budgeted statement of comprehensive income + statement of financial position
  -> review, negotiate, approve
  -> monitor actual against budget (flexed if activity changes)

Principal budget factor: whatever limits the business’s activity. Prepare its budget first. If machine hours, not demand, are the limit, the production budget comes first and sales are set to match.

Participative (bottom-up) budgets involve budget holders, which aids motivation but invites slack. Imposed (top-down) budgets are quicker but less owned.

2.4.3 The eight budgets in formulas

Budget	Formula
Revenue	budgeted units x selling price per unit
Production (units)	units to sell + target closing inventory - opening inventory
Purchases (units)	materials used + closing materials - opening materials
Inventory	opening + purchases (or production) - issues (or sales) = closing
Trade receivables	opening + credit sales - receipts - discounts allowed - irrecoverable debts = closing
Trade payables	opening + credit purchases - payments - discounts received = closing
Capital	planned non-current asset purchases and disposals, their timing, and how they are financed
Cash	opening balance + receipts - payments = closing balance

Method in steps: receipts from credit customers

1. Split total sales into cash and credit.
2. For each month’s credit sales, apply the payment pattern (for example, 40% next month, 55% the month after).
3. Deduct cash discount only from the slice that takes it.
4. Leave out the irrecoverable slice: it is never received.
5. Add up by month of receipt, not month of sale.

Method in steps: cash budget

1. Receipts: cash sales, receipts from receivables, share or debenture issues, loans received, disposal proceeds.
2. Payments: suppliers, wages, expenses actually paid, interest, dividends, non-current assets, loan repayments.
3. Net cash flow = receipts - payments.
4. Closing balance = opening + net cash flow. Carry it to next month’s opening.
5. Show an overdraft in brackets.

Never in a cash budget: depreciation, profit or loss on disposal, irrecoverable debts, discounts allowed or received, provisions, accruals, prepayments.

Small reminder: Drummore Ltd

Drummore Ltd pays rent of 7,200 on 1 March for the twelve months ahead. For the quarter March to May:

Cash budget, March:                 7,200 payment
Budgeted SoCI, rent expense:        7,200 x 3/12 = 1,800
Budgeted SoFP, prepayment:          7,200 x 9/12 = 5,400 (current asset)

Small reminder: Ilvane Ltd capital budget

Ilvane Ltd plans to buy machinery for 48,000 in August, paying half on delivery and half in October. It will sell an old machine with a carrying amount of 7,000 for 4,500 in August. A bank loan of 40,000 is received in July to finance the purchase.

July      loan received             40,000   (cash receipt)
August    machinery, first half     24,000   (cash payment)
August    disposal proceeds          4,500   (cash receipt)
October   machinery, second half    24,000   (cash payment)

The loss on disposal, 7,000 - 4,500 = 2,500, goes in the budgeted statement of comprehensive income only. The cash budget shows just the 4,500 received.

2.4.4 Budgeted statements

Item	Cash budget	Budgeted statement of comprehensive income	Budgeted statement of financial position
Credit sales	When received	When made	Unpaid part = trade receivables
Credit purchases	When paid	Through cost of sales	Unpaid part = trade payables
Depreciation	Never	Expense	Increases accumulated depreciation
Non-current asset bought	Payment when paid	Only its depreciation	At cost less depreciation
Share issue	Receipt	Never	Share capital (plus share premium)
Dividend paid	Payment	Never (statement of changes in equity)	Reduces retained earnings
Expense accrued	Not yet	Expense	Current liability
Expense prepaid	Paid now	Only this period’s share	Current asset

Cost of sales = opening inventory + purchases - closing inventory. Closing retained earnings = opening + profit for the period - dividends. Closing bank in the statement of financial position = closing balance in the cash budget. If the statement does not balance, check this link first.

2.4.5 Flexible budgets

Cost type	How to flex
Variable	actual units x budgeted rate per unit
Fixed	no change
Semi-variable	fixed element + actual units x variable rate
Revenue	actual units x budgeted price

Variance = flexible budget figure compared with actual.

• Revenue above flexed revenue: favourable (F).
• Cost below flexed cost: favourable (F).
• Cost above flexed cost, or revenue below: adverse (A).

Flexed profit minus fixed budget profit shows the effect of selling a different volume. Flexible budget variances then show how well prices and costs were controlled at that volume.

Must-know distinctions

• Fixed v flexible budget: one planned activity level v recalculated for actual activity.
• Cash v profit: the cash budget records when money moves; the budgeted statement of comprehensive income records when income is earned and costs are incurred.
• Capital budget v cash budget: the capital budget plans the asset spending and its finance; the cash budget picks up only the payment and receipt dates.
• Production v purchases budget: units of finished product v quantities (and cost) of raw materials.

Quick self-test

1. Corriston Ltd plans sales of 2,400 units. Opening finished goods are 300 units and closing finished goods 360 units. Calculate production.
2. Corriston Ltd uses 3 kg of material per unit. Opening material is 900 kg and closing 1,000 kg. Using your answer to question 1, calculate purchases in kg.
3. Quillon Ltd: opening trade receivables 18,000; credit sales 64,000; receipts 59,500; discounts allowed 900; irrecoverable debts 600. Calculate closing trade receivables.
4. Opening trade payables 12,400; credit purchases 38,000; payments 36,900; discounts received 500. Calculate closing trade payables.
5. Credit sales were 30,000 in March and 36,000 in April. Customers pay 40% in the month after sale and 55% two months after; 5% become irrecoverable. Calculate receipts in May.
6. State where each item appears: depreciation; proceeds of a share issue; an interim dividend paid.
7. Budgeted variable cost is 14 per unit and fixed costs are 22,000. Calculate total flexed cost for 5,600 units.
8. Power costs 3,000 plus 0.80 per machine hour. Calculate the flexed cost for 7,500 hours.
9. A van bought for 30,000 at the start of a six-month budget period is depreciated at 20% a year on cost. Calculate its value in the budgeted statement of financial position.
10. Selvey Ltd’s flexed materials cost is 40,000; actual is 41,300. State the variance.
11. Define the principal budget factor.

Answers

1. 2,400 + 360 - 300 = 2,460 units.
2. Used 2,460 x 3 = 7,380 kg; purchases 7,380 + 1,000 - 900 = 7,480 kg.
3. 18,000 + 64,000 - 59,500 - 900 - 600 = 21,000.
4. 12,400 + 38,000 - 36,900 - 500 = 13,000.
5. 36,000 x 40% + 30,000 x 55% = 14,400 + 16,500 = 30,900.
6. Depreciation: budgeted statement of comprehensive income only. Share issue: cash budget (receipt) and statement of financial position (share capital), never income. Dividend: cash budget and statement of changes in equity, never an expense.
7. 5,600 x 14 + 22,000 = 100,400.
8. 3,000 + 7,500 x 0.80 = 9,000.
9. 30,000 - 30,000 x 20% x 6/12 = 27,000.
10. 1,300 adverse: actual cost is above the flexed cost.
11. The factor that limits the level of activity, usually sales demand, so its budget is prepared first.

Where marks are usually lost

• Writing irrecoverable debts or discounts as cash payments.
• Applying a payment pattern to total sales when part of sales is for cash.
• Treating next month’s opening inventory as different from this month’s closing figure.
• Placing a closing inventory policy on the current month’s sales instead of the next month’s.
• Leaving the van purchase out of the cash budget because it is “capital” (it is still a payment).
• Charging the whole of an annual insurance or rent payment to one quarter.
• Including the dividend as an expense in the budgeted statement of comprehensive income.
• Flexing fixed overheads, or the fixed part of a semi-variable cost.
• Labelling variances without F or A, or calling a lower cost adverse.
• Losing the link between the cash budget’s closing balance and the bank figure in the statement of financial position.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting (XAC11/YAC11) specification, Issue 2, September 2018 (first teaching September 2015), Pearson Education Limited. Unit 2: Corporate and Management Accounting, topic 2.4 Budgeting.