Static budgets are prepared for a single, planned level of activity. Performance evaluation is difficult when actual activity differs from the planned level of activity.
Budgeting is complex comprising inflow and outflow items. As in a market driven economy sales play the determinative role for the survival of a company, budget will also start from sales planning. Accuracy is important because sales are an important base for calculation of other budget components.
Budget Definition and its Purpose Budget a detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time.
The indirect cost which a company has to spend to keep it’s operations going are no predetermined fatality and no legacy from the past. The expense of each indirect cost item should be justified through the indirect function it has been spent for.
When using quantities for cost indirect cost planning (i.e. in the example 36,000 machine hours for production activity 1, 90,000 m2 for production activity 2, 180,000 kg for production activity 3, 18,000 operator hours for production activity x., these quantities have to originate from the annual production programme.
Indirect costs, independent from the purpose they serve, are incurred as types of cost such as salaries, salary related contributions, energy, communication, amortization, utilities, purchased services etc.
The direct labour costs, as a principle, are to be developed on the basis of the individual products planned to be produced. They can be developed on the basis of the products planned to be sold if no change of work-in-progress or finished goods inventory is budgeted for the planning period.
The objective of the direct material budget is to determine what direct material costs need to be incurred by the company when realizing the planned production programme.
Basic rules to observe The sales budget — what products at what prices plans the company to sell – is, as pointed out earlier, the starting point for preparing a budget. Three basic rules have to be observed when preparing the sales budget.
The preparation of the budget should always start with the compilation of the sales budget. The sales budget provides for information as to the quantities of product which the company realistically expects to sell and the prices which it expects to achieve.
