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Tutorial 5 SOLUTIONS – Budgeting I

Model Answers and Detailed Feedback

Question 1 – Model Answer:

For the 6 months ending 30 September, draw up:

a) a finished goods inventories budget, showing the physical quantities in


units (no £’000 values are needed)

b) a raw materials inventories budget, showing both physical quantities


in units AND financial values (in £’000)

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In this budget, all the unit quantities from the raw materials budget are multiplied by
the £40 cost per unit to obtain the financial values in £’000.

c) A trade payables budget in £’000

Notes:
1. The opening balance is the same as the closing balance from the previous
month
2. This is a balancing figure
3. This figure is given in the question

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4. This figure is derived from the finished goods inventories budget
5. This figure is derived from the raw materials inventories budget

Question 1 – Detailed FEEDBACK


(to help you understand how to solve this exercise)

This question is about a business that is starting production on 1 April and sales will
commence on 1 May. You are given information about sales volume from May until
January and then further information about activities in the business. You are then
required to prepare several interlinking budgets for the business.

Part (a)
The first requirement is to prepare a finished inventories budget for April – September
based on volumes (units) (not cost). Most monthly budgets are prepared using the
following format:

April May June July Aug Sept


Units Units Units Units Units Units

Opening:

Closing

Each month has a column; there is also a row for each of the opening and closing
balance. The other rows will be used to show any increases or decreases during the
period.

What are the finished inventories at the start of April?

The question tells us in the first line that production starts on 1 April. As production
doesn’t start until 1 April, the opening finished goods must be zero.

It’s important to note from the question that there is a 1:1 relationship between raw
materials units purchased and finished goods inventories produced and then sold, i.e.
1 unit of raw materials is used to make 1 unit of finished goods.

Let us visualise this:

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Produce 1
Purchase 1
unit of
unit of raw
finished
materials (on
goods
credit)
inventories

Pay suppliers Sell finished


for raw goods
materials inventories

We have enough information in the question to work out what the closing
finished inventories are each month. What is it for April?

It is 500 units – the same as the sales for May. The question tells us that it is planned
that sufficient finished goods inventories for each month’s sales should be available at
the end of the previous month, which means that the closing finished goods volume
must be the same as the sales for the following month.

What are the opening finished inventories for May? It is the same as the closing
inventories of April. The closing inventories for one month will be the same as the
opening inventories for the following month.

What happens during the month that makes the opening finished inventories
different to the closing finished inventories?

Two things happen – the business makes more products so the volume of finished
inventories increases, and also the business sells some of the products so the volume
of finished inventories decreases.

The headings ‘production’ and ‘sales’ need to be added as a description for the
other rows in your budget.

What sales are made in April? You can get this information quite easily from the
question. It tells us in lines one and two that sales will not commence until 1 May so
sales for April are nil. What sales are made in the other months? Sales are given in
the question month by month – these are the figures that you need to add to your
budget.

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What is the production for April? If the business starts with 0 finished goods and
ends up with 500 at the end of the month, without any sales, they must produce 500
during the month i.e. production must be 500.

Production is a balancing figure – we can work it out based on the information we


already have calculated.

Finished goods budget

April May June July Aug Sept


Units Units Units Units Units Units

Opening inventory
0 500 600 700 800 900

Inventory
500 600 700 800 900 900
Production
Less sales 0 500 600 700 800 900
Closing inventory 500 600 700 800 900 900

Part (b)

This part of the question requires you to prepare a raw materials budget in both units
and in financial values for April to September.

Again, you need to start with a template for your budget with each month having its
own column as well as rows for opening positions, closing positions and for the other
things that will affect raw materials during the period.

What is going to affect the volume of raw materials during each month?

The business will purchase more raw materials and also use raw materials to produce
finished goods. Add ‘purchases’ and ‘production’ headings to the appropriate
rows in your budget.

The first budget required is in volume – we will refer to units of raw materials. Each
product will use the same amount of raw materials and that amount will be
referred to as a unit.

How can we work out the closing volume of raw materials for each month?

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The question tells us that from the end of April, sufficient raw materials will be
available at the end of each month to meet the following month’s planned production.
We therefore need to have enough raw materials at the end of the month to meet next
month’s production. Where can we get this information? The finished goods budget
– we worked it out in part (a).

Note: for September’s closing raw materials balance, you need to know about the
plans for October and November. In November, planned sales are 900 units, so they
must be produced during October. So, October production will be 900 units, and so
the raw materials (also 900 units) must be present in closing raw materials inventory
at the end of September.

As this is a new business starting on 1 April, the opening raw materials are 0. The
amount purchased for each month is a balancing figure.

April May June July Aug Sept


Units Units Units Units Units Units

Opening inventory 0 600 700 800 900 900

Purchases 1,100 700 800 900 900 900

Less production 500 600 700 800 900 900

Closing inventory 600 700 800 900 900 900

You are then required to prepare a raw materials budget showing monetary values.

What is the cost of one unit of raw materials?


This is given in the question as £40. As each unit costs £40 and the raw materials
budget is currently in units, each amount in the budget just needs to be multiplied by
£40 to get the budget in monetary values.

April May June July Aug Sept


£000 £000 £000 £000 £000 £000
Opening
- 24 28 32 36 36
Inventories
Purchases 44 28 32 36 36 36

Less Production 20 24 28 32 36 36

Closing inventory 24 28 32 36 36 36

Part (c)
This part requires you to prepare a trade payables budget.

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What is the business getting credit for? (Getting credit is what will lead to trade
payables).

It is for purchasing raw materials – we therefore need to refer to our raw materials
budget. If we are calculating trade payables, do we need the raw materials in
units or monetary amounts?

Our suppliers are going to charge us in monetary amounts so we will need to


monetary amount budget. Trade payables in the month are affected by additional
purchases and repayments made to suppliers. We can find the purchases in the trade
receivables budget.

What are the credit terms? This is detailed in the question - raw materials are
purchased on one month’s credit. This means that the raw materials purchased in one
month are paid for in the following month – we can now work out the cash payments
each month, as they will be the same as the purchases from the previous month.

The closing trade payables are a balancing figure.

April May June July Aug Sept


£000 £000 £000 £000 £000 £000

Opening bal. - 44 28 32 36 36

Purchases 44 28 32 36 36 36

Less cash payments - 44 28 32 36 36

Closing balance 44 28 32 36 36 36

Question 2 - MODEL ANSWER:

The model answer to Question 2 can be found in the textbook, 7th edition, p.528