RVU

Training, Teaching and Learning Materials

RIFT VALLEY UNIVERSITY

ACCOUNTING DEPARTMENT

BASIC ACCOUNTING WORKS LEVEL II

Unit of Competence: Develop and Use a Personal Budget

Module Title: Developing and using Personal Budget
LG Code: BUF BAW2 08 0812
TTLM Code: BUF BAW2 M08 1212

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TTLM Development Manual Date: January 12,2019
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Introduction

1 Analyse and discuss budgeting as a financial tool

2. Develop a personal budget
3. Implement and monitor the personal budget

LO1 Analyze and discuss budgeting as a financial tool

The role of budgeting in the lives of different groups and the importance of budgeting appropriately
to meet expenses is analyzed and discussed and related to different stages of life The importance
of setting financial goals is analyzed and discussed Obstacles that might prevent financial goals
being achieved are analyzed and discussed with the types of behaviors and skills required for
successful budgeting explored and analyzed
 Budget refers to: a calculation of all projected income and expenditure for period of time (e.g. on a
weekly or monthly basis)
showing all projections versus actual income and expenses for the period and monitoring variances.
OVER VIEWING BUDGETING
Information Sheet – 1

Most people associate the word “budget” with the approving, rejecting, or arguing over various budgets.
Tax payers demand that governments plan the effective use of their hard earned tax amounts, and budgets
not only allow governments to plan spending, but also allow tax payers to see exactly where and how
their money is being spent.

Most business organizations use budgets to focus attention on company operations and finances. Budgets
highlight potential problems and advantages early, allowing management to take steps to avoid these
problems or use the advantages wisely. Thus, a budget is a tool that helps managers in both their planning
and control functions.

Budget is a quantitative expression of the money inflows and outflows to determine whether a financial
plan will meet organizational goals. Budgeting is the process of preparing budgets.

Budgets help mangers with their control function not only by looking for ward but also by looking back
ward. Budgets, of course, deal with what mangers plan for the future. However, they also can be used to
evaluate what happened in the past. Budgets can be used as a benchmark that allows managers to
compare actual performance with estimated or desired performance.

Recent surveys show just how valuable budgets can be. Study after study has shown budgets to be the
most widely used and highest rated tool for cost reduction and control. Advocates of budgeting go so far

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as to claim that the process of budgeting forces a manager to become a better administrator and puts
planning in the fore font of the manager’s mind.

Budgetary Control

Budgetary Control is the system of controlling costs through budgets. Budgeting is thus only a part of the
budgetary control. Budgetary Control is defined as “the establishment of budgets relating to the
responsibilities of executives of a policy and the continuous comparison of the actual with the budgeted
results, either to secure by individual action the objective of the policy or to provide a basis for its
revision”.

The following are some of the characteristics of budgetary control:

 Establish a budget or target of performance for each department or function of the organization.
 Compare actual performance with the budget.
 Ascertain the reasons for the difference between actual and budgeted performance
 Take suitable remedial action so that budget performance may be achieved.
Budgetary Control is one of the very important tools of planning and control. It involves a constant
comparison of actual performance with the budgeted goals of the business. Many business fail because of
lack of planning. By planning, many problems and dangers are anticipated which the business has to face.

Budgetary Control Based on Management Functions

The objectives of budgetary control may be explained under three heads - Planning, Co-ordination and
Control. These three objectives are so much interrelated that it is not possible to discuss one with out the
other.

1) Planning. A budget provides a detailed plan of action for a business over a definite period.
Detailed plans relating to production, sales, raw material requirements, labor needs, advertising
and sales promotion performances, research and development activities, capital additions, etc. are
drawn up. By planning, many problems are anticipated long before they arise and solutions can
be sought through careful study. Thus, most business emergencies can be avoided by planning. In
brief, budgeting forces management to think ahead-to anticipate and prepare for the anticipated
conditions.
2) Co-ordination. Budgeting aids managers in co-coordinating their efforts so that objectives of the
organization as a whole harmonize with the objective of its parts. Effective planning and

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organization contributes a lot in achieving co-ordination. There should be coordination in the

budgets of various departments. For example, budget of sales should be in coordination with the
budget of production. Similarly, production budget should be prepared in Co-ordination with the
purchase budget, and so on.
3) Control. Control is necessary to ensure that plans and objectives as laid down in the budgets are
being achieved. Control, as applied to budgeting, is a systematized effort to keep management
informed of whether planned performance is being archived or not.
Information Sheet – 2 TYPES OF BUDGETS
There are several different types of budgets used by business. The most for ward-looking budget is the
strategic plan, which sets the overall goals and objectives of the organization. Some business analysts
will not classify the strategic plan as an actual budget, though, because it does not deal with a specific
time frame, and it does not produce forecasted financial statements. In any case, the strategic plan leads to
long-range planning, which produces forecasted financial statements for five to ten-year periods. The
financial statements are estimates of what management would like to see in the company’s future
financial statements. Decisions made during long-range planning include addition or deletion of product
lines, design and location of new plants, acquisitions of buildings and equipment, and other long-term
commitments. Long-range plans are coordinated with capital budgets, which detail the planned
expenditures for facilities, equipment, new products, and other long-term investments.

Long-range plans and budgets give the company direction and goals for the future, while short-term plans
and budgets guide day-to-day operations. Managers who pay attention to only short-term budgets will
quickly lose sight of long-term goals. Similarly, managers who pay attention to only the long-term budget
could wind up mismanaging day-to-day operations. There has to be a happy medium that allows
managers to pay attention to their short-term budgets while still keeping an eye on long-term plans.

The master budget is an extensive analysis of the first year of the long-range plan. A master budget
Summarizes the planned activities of all sub units of an organization-sales, production, distributions and
finance. The master budget quantifies targets for sales, cost-driver activity, purchases, production net
income, cash position, and any other objective that management specifies. It expresses these amounts in
the form of forecasted financial statements and supporting operating schedules. These supporting
schedules provide the information that is too highly detailed to appear in the actual financial statements.

Thus, the master budget is a periodic business plan that includes a coordinated set of detailed operating
schedules and financial statements. It includes forecasts of sales, expenses, cash receipts and
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disbursements, and balance sheets. Master budgets (also called pro forma statements, another term for
forecasted financial statements) might consist of 12 monthly budgets for the year or perhaps monthly
budgets for only the first quarter and quarterly budgets for the three remaining quarters.

Continuous budgets or rolling budgets are a very common form of master budgets that simply add a
month in the future as the month just ended is dropped. Budgeting thus becomes an ongoing instead of
periodic process. Continuous budgets force managers to always think about the next 12 months, not just
the remaining months in a fixed budgeting cycle.

ADVANTAGES OF BUDGETS

Three major benefits of budgeting are as follows:

1. Budgeting compels managers to think ahead by formalizing their responsibilities for planning.
2. Budgeting provides definite expectations that are the best framework for judging subsequent
performance.
3. Budgeting aids managers in coordinating their efforts, so that the objectives of the organization as
a whole match the objectives of its parts.
4. Budgeting helps to motivate employees.
Let’s look more closely at each of these benefits.

FORMALIZATION OF PLANNING :-Budgeting forces managers to think ahead-to anticipate and

prepare for changing conditions. The budgeting process makes planning and explicit management
responsibility. Too often, managers operate from day-to-day, extinguishing one business brush fire after
another. They simple have “no time” for any tough-minded thinking beyond the next day’s problems.
Planning takes a back seat to or is actually obliterated by daily pressures.

The trouble with the day-to-day approach to managing an organization is that objectives are never
crystallized. Managers react to current events rather than plan for the future. To prepare a budget, a
manager should set goals and objectives, and establish policies to aid their achievement. The objectives
are the destination points, and budgets are the road maps guiding us to those destinations. Without goals
and objectives, company operations lack direction; problems are not foreseen; and results are difficult to
interpret after word.

FRAME WORK FOR JUDGING PERFORMANCE

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Budgeted goals and performance are generally a better basis for judging actual results than is past
performance. The news that a company had sales of $ 100 million this year, as compared with $ 80
million the previous year, may or may not indicate that the company has been effective and has met
company objectives. Perhaps sales should have been $ 110 million this year. The major drawback of
using historical results for judging current performance is that inefficiencies may be concealed in the past
performance. Changes in economic conditions, technology, personnel, competition, and so forth also limit
the usefulness of comparisons with the past.

COMMUNICATION AND COORDINATION :-Budgets tell employees what is expected of them. A

good budget process communicates both from the top down and from the bottom up. Management makes
clear the goals and objectives of the organization in its budgetary directives. Employees and lower level
managers then inform higher-level managers how they plan to achieve the goals and objectives.

Budgets also help managers coordinate objectives. For example, a budget forces purchasing personnel to
integrate their plans with production requirements while production managers use the sales budget and
delivery schedule to help them anticipate and plan for the employees and physical facilities they will
need. Similarly, financial officers use the sales budget, purchasing requirements, and so forth to anticipate
the company’s need for cash. Thus the budgetary process forces managers to visualize the relationship of
their departments’ activities to other departments and to the company as a whole.

BUDGETING IN GOVERNMENT :-In profit-seeking organizations, revenues and expenditures are

interrelated; organizations spend money to earn revenues. In many cases, there is a physical relationship
between the amount of money spent (on things such as raw materials) and the amount of revenue. In
government organizations, however, revenues and expenditures are independent.

Governments develop revenue budgets which are estimates of the amount of money that they will raise or
will be allocated. Legislatures approve expenditure budgets, which provide public servants with the
authority to spend government revenues on specific projects.

Occasionally governments pass laws (often called balanced-budget requirements) limiting government
expenditures to the amount of revenues raised, but revenues and expenditures are separate. For most
governments, controlling expenditures means ensuring that authorized government spending has not been
exceeded by actual spending rather than assessing whether the programs on which money was spent
accomplished their objectives.

BUDGETARY APPROACHES:-Budgetary approaches can be divided in to two:

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1. ZERO BASE BUDGETING

In recent development, Zero base budgeting is considered widely by most organizations. Zero base
budgeting forces each manager to answer the question why a cost is incurred. It forces managers to start
from the scratch (zero bases). The principal advantage of zero base budgeting is that each type of cost
incurred in every budget period will be justified. If there is any sort of inefficiency during the current
period, there is no way to continue with that inefficient activity in the future.

2. INCREMENTAL BUDGETING:-In incremental budgeting, previous budgets are considered as a

base. The previous budget figures can be increased or decreased depending on circumstances, which are
determined on the volume of activity the organization wants to perform. The incremental budgets eases
the preparation of budgets since the budget preparer starts from a budget already prepared and adjusts
those data. However, the incremental budgeting has disadvantages. The greatest disadvantage is that prior
period budgets may include inefficiencies.

Moreover, organizations, in particular government organizations, simply add a percentage increase to

their previous budgets with out considering the fact whether they usually need or not and by the end of
the budget period, they rush to spend money on unnecessary activities fearing future reduction in budgets.
This is the usual case for most Ethiopian government organizations.

Self Checke

1. “Budgets are primarily a tool used to limit expenditures.” Do you agree? Explain.
2. How do strategic planning, long-range planning and capital budgeting differ?
3. Capital budgets are plans for managing long-term debt and common stock. “Do you agree?
Explain.
4. Why is budgeted performance better than past performance as a basis for judging actual results?
5. What are the major benefits of budgeting?
6. “Performa statements are those statements prepared in conjunction with continuous budgets.” Do
you agree? Explain?
7. List four characteristics of budgetary control.
8. What are the two budgetary approaches?
Preparing Operating Budget and Financial Budget for
Merchandising Business
Information Sheet 1. 2

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The master budget is a summary of a company’s plans that sets specific targets for sales, production,
distribution, and financing activities. It generally culminates in a cash budget, a budgeted income
statement, and a budgeted balance sheet. In short, it represents comprehensive expression of
management’s plans for the future and how these plans are to be accomplished.

COMPONENTS OF A MASTER BUDGET

The terms used to describe specific budget schedules vary from organization to organization. However,
most master budgets have common elements. The usual master budget for a non-manufacturing company
has the following components:

A. Operating budget

1. Sales budget

2. Purchases budget

3. Cost-of-goods-sold budget

4. Operating expense budget

5. Budgeted income statement

B. Financial budget

1. Capital budget

2. Cash budget

3. Budgeted balance sheet

The two major parts of a master budget are the operating budget and the financial budget. The operating
budget focuses on the income statement and its supporting schedules. Though some times called the
profit plan, an operating budget may show a budgeted loss, or even be used to budget expenses in an
organization or agency with no sales revenues.

In contrast, the financial budget focuses on the effects that the operating budget and other plans (such as
capital budgets and repayments of debt) will have on cash.

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In addition to the master budget, there are count less form of special budgets and related reports. For
example, a report might detail goals and objectives for improvements in quality or customer satisfaction
during the budget period.

Let’s return to Exhibit 2-1 and trace the preparation of the master budget components. Follow each step
carefully. Although the process may seem largely mechanical, remember that the master- budgeting
process generates key decisions regarding all aspects of the company’s value chain.

Therefore, the first draft of the budget leads to decisions that prompt subsequent drafts before a final
budget is chosen.

Develop a personal budget

LO2

All income and expenses for a six month period are recorded to assist in estimating expenditure
requirements
A spreadsheet for recording all budget information is obtained or developed and established to record
income and expenditure for a relevant period of time
All sources of income and regular fixed expenses and variable expenses for the specified period are
identified and listed in a personal budget using the budget spreadsheet
Total expenses recorded are subtracted from the total income to determine a surplus or deficit budget
for the specified period
Reasons for a deficit budget are explored if relevant and ways to reduce expenses or increase
income are investigated
Allocation of surplus funds towards saving and meeting identified financial goals is explored

The different groups who may budget may include families

 governments
 individuals:
 single
 married
 elderly
 students
tourists, travelers

Different stages of life may include:

 approaching and during retirement

 buying your first home
 moving out of home
 starting a family
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studying.

Financial goals may include: accumulating a set amount of money by a specified date in the future
for the purposes of:
 purchasing assets
 financing holidays, educational expenses, home renovations and other known future expenses
 establishing a deposit for an investment such as a home or investment property
 aiming to repay existing debts and be debt free
 establishing a regular savings plan
handling income and expenditure responsibly and avoiding financial difficulties.

Obstacles that might prevent financial goals being achieved may include:

 being unemployed, particularly long term unemployed

 insufficient income to afford items that are beyond the individual's means
 unexpected circumstances such as:
 losing a job
 falling ill
not being able to work.

Behaviours and skills required for successful budgeting may include: controlled spending
 disciplined approach to money
 organisational skills
record keeping skills

A spreadsheet may

 be simple or complex depending upon the extent of the individual's finances

 have one section for recording all money received as income and another section for expenses both
variable and fixed
have a section to record the difference between income and expenses for the period, this being the surplus
or deficit financial situation for the period.

 Sources of income may include: interest on investments, dividends

 proceeds from sale of assets
 social security benefits, pensions, allowances, child assistance
wages, commission, bonuses, tips.

Self Assessment

1. Differentiate between an operating budget and a financial budget.

2. Why is the sales forecast the starting point for budgeting?

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3. Distinguish between operating expenses and disbursements for operating expenses.

4. What is the principal objective of a cash budget?

Implement and monitor the personal budget

LO3

Implement and monitor the personal budget

The budget is followed according to plan for a period of time

Actual expenses and income for the period during which the budget is implemented are recorded
and compared to budgeted expenses and income with any differences in budgeted and actual
amounts looked at and the budget modified where necessary
Ways to reduce expenses may include: comparing prices for essential items
 monitoring use of utilities such as electricity, gas and water
 moving back home
 reducing expenditure on discretionary items such as expensive clothing, magazines, eating out
 share accommodation

Variable expenses may include: car maintenance

 living expenses such as:
 food
 clothing
 medical
 loan repayments if loan is based upon variable interest rates
 miscellaneous expenses such as:
 gifts
 recreation
 entertainment
 fines
 mobile telephone
 mortgage repayments
 utilities such as:
 water
 gas
 electricity
telephone.
 Ways to reduce expenses may include: comparing prices for essential items
 monitoring use of utilities such as electricity, gas and water
 moving back home
 reducing expenditure on discretionary items such as expensive clothing, magazines, eating out
 share accommodation

Handy hints for managing the personal budget are discussed

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Ongoing review of the budget is conducted to ensure it remains relevant and to ensure updates are
incorporated if necessary

Handy hints may include discussing how to avoid getting into financial difficulties
 how to minimise fees and charges imposed by financial institutions
 how to use credit card debt effectively
 the problems of impulsive buying, particularly when under peer pressure
ways to cut back on spending or change negative spending habits.

Self Assessmen:- Enter the word or phrase that best completes the following:

1. The financial budget process includes the following budgets:

a. _______________

b. _______________

c. _______________

2. The master budget process usually begins with the __________ budget.

3. A _________ budget is a plan that is revised monthly or quarterly, dropping one period adding
another.

4. Strategic planning sets the __________________.

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TTLM Development Manual Date: January 12,2019
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