Unit 9: Management Accounting: Costing and Budgeting Assignment 2: Budgetary Planning and Control Prepared by Secret Gardent Group MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden TABLE OF CONTENT INTRODUCTION .3 Task1 3.1 Explain the purpose and nature of the budgeting process 3.2 Select appropriate budgeting methods for the organization and its needs 3.3 Prepare budgets according to the chosen budgeting method .7 Task2 10 3.4 Prepare a cash budget .10 Task3 10 4.1 Calculate variances, identify possible causes and recommend corrective action 10 4.2 Prepare an operating statement reconciling budgeted and actual results 12 4.3Report findings to management in accordance with identified responsibility centres 12 CONCLUSION 15 REFERENCES 16 MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden INTRODUCTION This asignment is about costing and budgeting We are going to explain the purpose and nature of the budgeting process, select appropriate budgeting methods for the organization and its needs, prepare budgets according to the chosen budgeting method, calculate variances, identify possible causes and recommend corrective action, prepare an operating statement reconciling budgeted and actual results, rexport findings to management in accordance with identified responsibility centres MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden Task1 3.1 Explain the purpose and nature of the budgeting process a Purposes of the budgeting process There are seven purposes of the budgeting process (BPP, 2012): • To ensure the achievement of the organization's objectives: Using the budget, the manager can see how far that they have reached on their targets plan in the timescale and make the further detail strategy for the company (John Freedman, 2012) • To compel planning: Budgeting process not only forces management look ahead to set out the plan for the future,what resources are available and what additional resources will be needed, but also helps them see the problem of the company (John Freedman, 2012) • To communicate ideas and plans: Managers can use budgeting as the tool for communicate between them and their subordinates, to show them the effect of he or she on the process of company.In the budgeting process, managers in every department justify the resourcesthey need to achieve their goals They explain to their superiors the scope and volume of their activities as well as how their tasks will be performed (John Freedman, 2012) • Co-ordinate activities: Different units in the company must also coordinate the many different tasks they perform For example, the number and types of products to be marketed must be coordinated with the purchasing and manufacturing departments to ensure goods are available Equipment may have to be purchased and installed Advertising promotions may need to be planned and implemented And all tasks have to be performed at the appropriate times (John Freedman, 2012) • To provide a framework for responsibility accounting: Budgeting ensures that who makes the budgets must have responsibility for what they summit The reason for that is the budget affect the operation of company and can cause profit or lost (John Freedman, 2012) • To establish a system of control: Once a budget is finalized, it is the plan for the operations of the organization Managers have authority to spend within the budget and responsibility to achieve revenues specified within the budget (John Freedman, 2012) MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden • Motivate employees to improve their performance: Budgets can be used to motivate your staff to be more fiscally minded, to pay greater attention to detail and to think before they act (John Freedman, 2012) b Nature of budgeting process The budgeting process involves: • Setting up budget, it means planning targets of revenue, expenses, assets and liabilities relating to the activities concerned • Measuring actual results against the budgets on a continuous basis • Identifying and analyzing divergences from budgets, and modifying both actual operations and subsequent budgets (Finntrack, 2012) 3.2 Select appropriate budgeting methods for the organization and its needs a Fixed and flexible method • Fixed budget Advantage: - Allowing a business to measure both short-term and long-term budgets - Allocating a set amount of money towards essentials such as overhead costs - Making profit measurement easier, since you allocate the same amount of money towards necessities on a regular basis (Montoya, 2012) Disadvantage: - Not accounting for inflation and rise in costs, so fixed budget will not go as far as the previous years - Do not have any flexibility to deal with change in the environment • (emergencies, personnel, competitive, pressure) (wiseGEEK, 2003) Flexible budget Advantage - At the planning stage, it may be helpful to know what the effects would be if the actual outcome differs from the prediction - At the end of each month of year, actual may be compared with the relevant activity level in the flexible budget as a control procedure (Mclntosh, 2001) Disadvantage - By not allowing the manager to insert set figures, prediction is difficult - When one variable in a flexible budget is subject to changes, other variables in the budget can also change, too - Making the estimate of an organization’s tax burden tough - More complicated and taking longer to prepare than a static budget (eHow, 2012) b Incremental and zero based budgeting system • Incremental budgeting Advantage - The budget operates under a stable and predictable system and any change will be gradual MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden - The impact of change can be seen quickly - Managers can operate their departments on a consistent basis - The system is simple to operate and easy to understand - Conflicts should be avoided if departments can be seen to be treated (tutor2u, 2012) Disadvantage - No incentive for developing new ideas - No incentives to reduce costs - Encourages spending up to the budget so that the budget is maintained next year - The budget may become out of date and no longer relate to the level of activity or type of work being carried out (tutor2u, 2012) • Zero based budgeting Advantage - Allocation of resources linked to results and needs - Develops a questioning attitude - Wastage and budget slack should be eliminated - Prevents creeping budgets based on previous year’s figures with an added on percentage - Encourages managers to look for alternatives (tutor2u, 2012) Disadvantage - It a complex time consuming process - Short term benefits may be emphasized to the detriment of long term planning - Affected by internal politics - can result in annual conflicts over budget allocation (tutor2u, 2012) c.Top down budgeting Advantage - Allowing upper managers to maintain complete financial control over a budget (financial control) - Greater financial accountability and more comparison-shopping for products, services and consulting help (accountability of staff) - Less time intensive, as it includes only the input of key decision- markers (faster process) (eHow, 2012) Disadvantage - Creating a budget without the input of key personnel from the rank and file can result in underfunding or overfunding of a department (inaccurate forecasting) - Avoiding the risk of getting less money the following year (potential for underperformance) MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden - Managers and employees may be resentful that their input is not valued in the budgeting process (employee morale) (eHow, 2012) d.Conclusion Budgeting method will helps Cabot Company for setting budgets and preparing it in the future To make budgetary become more accurately, through top- down method, Cabot company will tend to estimate budgeted sales that is more reliable than sales budget which is set by top- management Production budget setting by senior- management is less accurately than estimate budget for production based on production capacity and expected sales Besides, lowerlevel management can take part in budgeting process On the other hand, zero based budgeting, incremental budgeting, fixed budget, flexible budget also have some limits for the company when preparing budget 3.3 Prepare budgets according to the chosen budgeting method • Sales budget Cabot Co Sales Budget For July of 2006 Products K L 40,000 20,000 Expected unit sales X £30 X £65 Unit selling price £1,200,000 £1,300,000 Total sales £2,500,000 Figure 1: Cabot Co Sales Budget for July of 2006 As it can see that we got the total sales of products K and L are £1,200,000 and £1,300,000 respectively Therefore, sales budget of this company is £2,500,000 • Production budget Cabot Co Production Budget For July of 2006 Products (units) K L 40,000 20,000 Expected unit sales 2,500 2,000 Add: Desired inventories 42,500 22,000 Total required units MA Assignment Lecturer: Mr Jun AlejoBathan Less: Estimated inventories Required product units Group: Secret Garden 3,000 2,700 £39,500 £19,300 £58,800 Figure 2: Cabot Co Production Budget for July of 2006 According to the above table, required product units of product K is £39,500 while required product units of product L is £19,300 So the total required product units of both products are £58,800 • Direct materials purchases budget Cabot Co Direct materials purchases Budget For July of 2006 Material A B 27,650 47,400 Product K (lbs) 67,550 34,740 Product L (lbs) 95,200 82,140 Units to be produced (lbs) 3,000 2,500 Add: Desired inventories (lbs) 4,000 3,500 Less: Estimated inventories (lbs) 94,200 81,140 Direct material purchase (lbs) x £4 x £2 Cost per lb £376,800 £162,280 Total cost of direct materials purchases £539,080 Figure 3: Cabot Co Direct materials purchases Budget for July of 2006 It can be seen that total cost of direct material A purchases £376,800 whereas total cost of direct material B purchases £162,280 As a result, total cost of both direct material purchases £539,080 • Direct labor purchases budget Cabot Co Direct labor purchases Budget For July of 2006 Department MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden 15,800 11,580 27,380 Product K (hrs) Product L (hrs) Hours to be produced (hrs) Direct labor rate Total direct labor cost 5,925 4,825 10,750 x £12 x £16 £328,560 £172,000 £500,560 Figure 4: Cabot Co Direct labor purchases Budget for July of 2006 Based on information from the table, total direct labor cost of two departments are £328,560 and £172,000 After calculating, the total direct labor cost of both departments is £500,560 • Cost of goods sold budget Cabot Co Cost of goods sold Budget For July of 2006 £ 539,080 500,560 299,000 Direct materials cost Direct labor cost Estimated factory overhead cost Total receipts Add: Estimated inventories 1,338,640 145,500 Less: Desired inventories Total cost of goods sold 112,500 1,371,640 Figure 5: Cabot Co Cost of goods sold Budget for July of 2006 From information gathering, the total cost of goods sold of Cabot Company is accounted £1,371,640 Task2 (3.4 Prepare a cash budget) Month Receipt 11/11 12/11 1/12 2/12 3/12 4/12 MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden from sales Sales 70% received 28%receive d Total receipt from sales Payments Payment for purchasing with the old method Payment for purchasing with the new method Total payments with the old method Total payments with the new method Overhead Cost of sales 60% Stock at the end of month Increase of stock Purchase Net cash inflow with the old method Net cash inflow with the new method Difference between methods 110,00 66,00 115,00 77,00 120,000 80,50 30,80 130,000 84,00 32,20 140,000 130,000 91,000 98,000 33,600 36,400 111,300 116,200 124,600 134,400 67,320 75,240 83,160 85,140 67,320 37,620 79,580 84,570 96,320 104,240 112,160 114,140 66,620 29,000 78,00 108,580 29,000 113,570 29,000 69,00 96,320 29,000 72,00 84,000 78,000 58,000 62,000 68,000 70,000 73,000 6,000 2,000 3,000 68,000 4,000 76,00 84,000 86,000 81,000 14,980 11,960 12,440 20,260 14,980 49,580 16,020 20,830 37,620 3,580 570 10 MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden In our opinion, the company should use the new method We can see the different between two methods according to the result of above table, net cash inflow with the new method is higher than net cash inflow with the old method It caused of total payment for purchases calculating with new method is lower than the total payment wich be calculated with old method Task3 4.1 Calculate variances, identify possible causes and recommend corrective action Variance analysis 1.Sales price variance Standard selling price - standard cost = £130-£76 Actual selling price - standard cost = £136-£76 Sales price variance per unit Sales price variance in £ (x 190 units) £ 54 60 (F) 1,140 (F) Recommend: The company should sell products with high quality to be able to raise selling price, or produce more units 2.Sales volume variance Standard sales volume Actual sales volume Sales volume profit variance in units x standard profit per unit Sales volume variance in £ 200 units 190 units 10 units (A) £54 £540 (A) Recommend: The company should produce and sell more products; at least it should be higher than 200 units Material price variance £ 230 units at £10 should cost 2,300 but was (x £11) 2,530 Material price variance 230 (A) Recommend: The company can choose the source, the supplier to buy material which is appropriate with their demand and lower than standard material price Direct labor cost variance £ 230 units at £12 should cost 2,760 but was (x £10) 2,300 Direct labor cost variance 460 (F) Recommend: The company can choose quality of labor that they recruit to lower the labor cost Variable cost overhead £ 230 units of variable cost overhead at £4 920 but was (x £5) 1,150 Variable cost overhead 230 (A) 11 MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden Recommend: The company should manage well all their equipments and maintain on time 6.Fixed product overhead expenditure £ Standard fixed overhead 220 units at £50 11,000 Actual fixed overhead 230 units at £52 11,960 Fixed product overhead expenditure 960 (A) Recommend: The company be tight with fixed product overhead like water, electricity, oil, that they use when producing 7.Fixed overhead volume variance Standard production volume Actual production volume Fixed overhead volume variance in unit Standard fixed overhead Fixed overhead volume variance in £ 220 units 230 units 10 units (F) 50 £500 (F) Recommend: The company should produce more units to keep the variance favorable 8.Fixed administration, selling and distribution expenditure Standard fixed administration, selling and distribution overhead Actual fixed administration, selling and distribution overhead Fixed administration, selling and distribution expenditure £ 8,800 8,650 150 (F) Recommend: The company should adjust selling and distribution expenditure, such as, repairs and maintenance and insurance of delivery vans, transit insurance of finished goods, advertisement, to make it appropriate and more effective 4.2 Prepare an operating statement reconciling budgeted and actual results Sales Units sell Unit price Cost - cost of goods sold + cost production Unit standard cost of production Materials Direct labor Variable overheads Fixed overhead Unit actual cost of production Material Direct labor Variable overheads Fixed overhead Unit produced Standard (£) 26,000 200 130 24,000 15,200 16,720 76 10 12 50 220 12 Actual (£) 25,840 190 136 23,550 14,900 17,940 78 11 10 52 230 MA Assignment Lecturer: Mr Jun AlejoBathan + less stock - Administration overheads Profit Profit variance Group: Secret Garden 1,520 8,800 2,000 3,040 8,650 2,290 290 The operating statement reconciling budgeted and actual results comes from the calculation of variance According to the statement that we get, it can be seen that profit variance of actual is higher than standard Therefore, it shows that the activity of this company is quite good 4.3Report findings to management in accordance with identified responsibility centres According to eight variances that we already calculated, it can be seen that Lowther Limited just use Cost Centre and Revenue Centre • Cost Centre has responsibility for sales price variance and sales volume variance − Sales price variance: It is a favorable variance because the actual sales are higher than standard sales The company should sell products with high quality to be able to raise selling price Furthermore they can reduce expenditures such as newspaper everyday for offices − Sale volume variance: the actual sales volume is lower than the standard sales volume, so it is adverse variance In this case, the company should produce • and sell more products; at least it should be higher than 200 units Revenue Centre has responsibility for material price variance, direct labor cost variance, variable cost overhead, fixed product overhead expenditure, fixed overhead volume variance, and fixed administration, selling and distribution expenditure − Material price variance: It is an adverse variance because the price of material in actual process is higher than they expect It can be influenced by material’s price on market, so the company cannot control However they can choose the source, the supplier to buy material which is appropriate with their demand and lower than standard material price − Direct labor cost variance: The actual labor cost is lower than standard labor cost; it means the variance is favorable Same as material price, labor cost based on market price and labor rate as well The company can choose quality of labor that they recruit to lower the labor cost − Variable cost overhead: it is adverse variance, because actual variable cost overhead is higher than standard variable cost over head It can be caused of cost of repair machinery irregular The solution for this is the company should manage well all their equipments and maintain on time − Fixed product overhead expenditure: Actual fixed overhead is higher than standard, the actual units were sold is higher than standard ones also, therefore, fixed product overhead expenditure is adverse In order to make it favorable, Lowther Limited should 13 MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden be tight with fixed product overhead like water, electricity, oil, that they use when producing − Fixed overhead volume variance: the difference between actual and standard fixed overhead volume variance is from the production volume Actual production volume of production achieved was greater than the standard, so it is favorable It shows that the company produces the goods very well so they make the actual production volume higher They need to keep it up, producing more units − Fixed administration, selling and distribution expenditure: the actual expenditure spends on administration, selling and distribution is lower than the standard ones, so it is favorable The salary pay for administration staff is always fixed; it means the company can adjust selling and distribution expenditure, such as, repairs and maintenance and insurance of delivery vans, transit insurance of finished goods, advertisement, to make it appropriate and more effective 14 MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden CONCLUSION Ater all of our calculation, explain, and recomendation for two companies above, we can see that all companies have their own problems and different solutions to solve them based on the situation of the company We need to stand at the point of manager to think and decide which way to choose to make the business better and company is stronger 15 MA Assignment Lecturer: Mr Jun AlejoBathan Group: Secret Garden REFERENCES eHow (2005) The Disadvantages of a Flexible Budget [online] Available at: http://www.ehow.com/info_7826742_disadvantages-flexible-budget.html [Accessed: 20 Dec 2012] eHow (2012) The Advantages and Disadvantages of Top-Down Budgeting [online] Available at: http://www.ehow.com/info_12031520_advantages-disadvantagestopdown-budgeting.html [Accessed: 20 Dec 2012] Small Business - Chron.com (2012) The Advantages of Using a Fixed Budget [online] Available at: http://smallbusiness.chron.com/advantages-using-fixed-budget43537.html [Accessed: 20 Dec 2012] Mcintosh, K (2001) The Advantages of a Flexible Budget [online] Available at: http://www.ehow.com/info_7779199_advantages-flexible-budget.html [Accessed: 20 Dec 2012] wiseGEEK (2003) What Are the Pros and Cons of a Fixed Budget? [online] Available at: http://www.wisegeek.com/what-are-the-pros-and-cons-of-a-fixed-budget.htm [Accessed: 20 Dec 2012] Small Business - Chron.com (2011) How Is a Budget Used to Motivate a Staff? [online] Available at: http://smallbusiness.chron.com/budget-used-motivate-staff-50432.html [Accessed: 20 December 2012] 16