Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
CONTROL
Learning objectives:
After this lesson, students should be able to understand and explain:
1. What is a budget and budgetary control
2. The types of budgets
3. The purposes of budgets
4. How to prepare all types of budgets
5. Behavioural aspect of budgeting and
6. Advantages and disadvantages of budgeting.
c. Current budget: I s defined as “a budget which is established for use over a short
period of time usually one year but sometimes less, and related to current
conditions likely to prevail during the budget period”- CIMA
e. Flexible budget: Is a budget which take into account the difference between fixed
and variable cost and is designed to change with the level of activity actually
attained.
f. Budgeting: It is the process of preparing budgets. Thus, it is the ways and means of
preparing budget which applies to all aspects of business operation.
PURPOSES OF BUDGETING
This is a very important aspect of our entire studies in this topic. This is because, whatever we
want to achieve and whichever type of budget we would want to prepare, we must return to
the purpose and make our choice. Budgeting is all about PCCCMA: I guess you are asking
“……..what is the meaning of that……………?
Let’s look at it in details.
1. PLANNING: This involves making choices between alternatives and is primarily a
decision making activity. A plan is a course of action to undertake a certain activity. The
plan sets the target for the organization and without a plan; an organization will fail
because it wouldn’t know where it is going. It means that, budgeting helps management
to plan into the future as to what they want to achieve as a corporate entity.
2. CONTROLLING: Since every organization has a plan, this plan facilitates the duty of
controlling all activities to align with the PLAN. Plans set the targets. But control involves
two things: (i) Measurement of actual results against plan and (ii) Take actions to adjust
actual performance to achieve the plan or to change the plan altogether. Control is
therefore impossible without planning.
7. AUTHORISATION TOOL: The budget tells people what to do in a given situation. That’s
the budget authorizes them what they can and cannot do. Without the sales budget, the
production manager may decide to produce any quantity of goods that he feels to
produce and this will course the purchasing and human resources department to
purchase and employ labour respectively which may or may not be needed by the
entity. The budget therefore officially authorizes managers to act within a given scope
of business operation.
One thing you must understand is that, budgeting is a human process or exercise and
hence must be considered with utmost care as possible. The process of budgeting can
be in various ways depending on the entity but the process below is the generalized
steps that an entity can follow to prepare budgets:
2. IDENTIFY PRINCIPAL BUDGET FACTOR: This refers to the limiting factor of the
organization. The organization can set any target but all the targets are subject to the
resources available for the organization and the demand of the product(s). The
organization can be limited in labour hours, machine hours or raw materials available.
However, the key limiting factor of a profit making entity is SALES DEMAND while for a
non-profit making is FUNDING.
3. PREPARE SALES BUDGET: This is a very difficult art because; whatever must be done in
the organization depends solely on the outcome from the ales budget. In order to get it
right, all key functions of the organization must be consulted to help the entity make
good estimate. The marketing and sales department specifically consulted to make
some forecast of the volume of sales that is likely to be sold and the price.
i. They have the local knowledge and hence can prepare accurate budget.
ii. We wish to promote OWNERSHIP. If managers prepare their own budgets, they
would be inclined and work to achieve it rather than imposing something which
they didn’t do themselves. This enhances motivation.
PROBLEM: “WOULD THE MANAGER PREPARE A BUDGET THAT REFLECTS TRULY WHAT
THEY WANT TO ACHIEVE?
5. NEGOTIATION PROCESS (SENIOR AND JUNIOR MANAGERS): Since we allow each
manager to prepare his/her own budget and we are not sure whether the prepared
budgets reflect truly what we want to achieve, the junior managers after preparing their
respective budgets hand them over to senior managers to go through each cost element
to make sure they conform with the budget assumption. What this stage of the process
do it that, we want an efficient budget but we also don’t want to lose the idea of
ownership, hence it must end with an agreement of all parties.
6. REVIEW- PREPARES MASTER BUDGET: Once the negotiation process is over, the master
budget is prepared. This is the budget for the entire organization. We must understand
each budget is:
i. Feasible: Do all the functional budgets work when brought together? Is each
budget connecting with each other?
ii. Acceptable: when we bring all the budgets together, does it achieve our budget
aim (PROFIT)?
7. FORMAL ACCEPTANCE: This is the final stage in the budgeting process. It is when the
Master Budget is accepted for the whole organization and becomes the key
authorization tool.
BUDGETING TYPES
The budgeting types of an organization will depend on a lot of factors, which may
include the size of the organization, the state of the economy, the type of environment
the organization operates (service or production), and the type of product the entity
produces and sells, the level of knowledge or skills of its employees, among others.
However, there are six (6) types of budgeting systems that an organization can use.
These are:
1. INCREMENTAL BUDGETS: This is a very simple budget and does not require much
work. The incremental budgeting system involves changing the present budget by
taking into account the key factors that may change next year (period). It means,
managers look at the current budget and consider how inflation, interest rates,
changes in sales, redraw/introduce new product(s).
2. ZERO-BASED BUDGETING (ZBB): Involves preparing a budget for each cost centre
from a zero base. Every item of expenditure has then been justified in its entirety to
be included in the next year’s budget. It means there is no expectation and we
prepare the budget from nothing.
IMPLEMENTING ZERO BASED BUDGETS:
There is a three- step approach to ZBB. These are; define decision units, evaluate
and rank packages and allocate resources.
a. Identify All Decision Packages: the organization defines all the decision packages.
This involves comprehensive description of all the activities the organization will
undertake and the cost and benefit associated with each activity to be
undertaken with each budget.
b. Evaluate and rank each decision package in order of preference: Even though the
organization wants to undertake a lot of activities, it may not be capable of
undertaking all of the decision it want to undertake because of limited supply of
resources. Hence, the organization prepares a scale of preference and ranks all
the decision packages in order of importance/ priority.
c. Identify resources and allocate (Funding): After the entity has ranked all its
decision packages, it must then identify the sources of resource or funding and
allocate the resources according to how the activities have been ranked.
NB: ZBB is a considered allocation of resources (funds) to the best effect (in the
best efficient manner).
ADVANTAGES OF ZBB (as opposed to Incremental budget)
1. Emphasis is placed on the future not on past actions
2. It enhances the elimination of past errors that may be perpetuated in an incremental
budget
3. A positive disincentive for management to introduce slack into their budget
4. It ensures a considered allocation of resources
5. It encourages cost reduction.
DISADVANTAGES
1. ZBB can be very costly and time consuming
2. It may lead to increase stress for management
3. It may ‘re-invent’ the wheel each year. That is we go through the whole process
4. It may lead to loss of continuity of actions and short term planning
5. The ranking of decision packages may be very difficult.
3. PERIODIC BUDGETING: This is a budget prepared for a specific period which is not
linked to either previous year or future events. This system is normally used when
the environment is likely not to change (STABLE ENVIRONMENT). Here, the entity
doesn’t expect things to change. Hence it prepares budget for each period
separately.
4. CONTINUOUS BUDGET: This is where we continuously update the budgets due to
changes in the environment. This approach to budgeting is implemented when the
entity expects things to change within its environment (DYNAMIC ENVIRONMENT).
With this approach, the entity prepares budget for the four quarters in a period (the
first quarter is prepared in details and the rest in outline). After the first quarter, we
obtain actual results and use that to update the remaining three quarters and add
the first quarter in the next period continuously. It is also referred to as rolling
budget. This approach enhances accuracy.
DISADVANTAGES
6. ACTIVITY BASED BUDGETING (ABB): This involves defining that the activities that
underlie the financial figures in each function and using the level of activity to decide
how much resources should be allocated, how well it is being managed and to explain
variances from budget.
Preparation and analysis – Functional budgets
Functional budgets take the anticipated sales level as their point of reference
Preparing sales and resource budgets
Process
Determining the key budget factor: As we have already discussed, determination of the
key budget factor is critical to the preparation of budgets. It is assumed that the key
budget factor is sale (even though some other factors such as machine, labour or
material may be a limiting factor), and this determines the sales forecast from which the
resource budget flow.
Preparing the activity plans in the case of each production resource which fit with sales
forecast. E.g. determining qualities of material required, labour hours or machine hours
necessary, taking account of inventory levels, wastage, available labour and production
capacity hours.
Taking these activity plans and creating financial plans i.e. converting the physical
quantities into costs, consistent with the organisation’s costing system and reflecting
standard costs; this gives specific resource budgets
Combining all resource budgets, and sales (income) budgets, along with capital and cash
budgets to create a master budget for the organisation.
Let’s now take the Functional budgets one after the other.
1. Sales budget
This is the first budget to be prepared assuming that the key budget factor is sales which shows
the anticipated sales in both units and value.
2. Production budget
A Production budget (finished goods units) is a budget for the number of units of production.
From the sales budget, the production budget will be prepared taking into account planned
changes in inventory levels for finished goods and the anticipated level of defective finished
goods.
Format
Units
Sales quantity xxx
Less opening inventories of finished goods (xxx)
Add closing inventories of finished goods xxx
Production units xxx
Defective output
In many production processes it will be accepted that there will be a certain level of NORMAL
LOSS or faulty production. This normal loss is the percentage of finished goods that it is
anticipated will not be saleable, due to some defect from the production process.
Assuming that the defective output is 5% of finished goods, the Production budget format
will be as follow:
Format
Units
Sales quantity xxx
Less opening inventories of finished goods (xxx)
Add closing inventories of finished goods xxx
Quantity required meeting sales demand (95%) xxx
2 kg = 2.5 kg
2 kg = 0.5 kg
Format
Material usage xxx
Less opening inventory of materials (xxx)
Add closing inventory of materials xxx
Quantity to be purchased xxx
Cost of purchases (Quantity to be purchased price per unit)
Labour efficiency
It is possible that for a situation to arise where the standard hours for labour are taken from the
standard cost card shows that the work force is known how to work efficiently than these
standard hours. Therefore there will be fewer hours required for production than indicated by
the standard cost card. This is referred to as the Learning curve
Illustration:
Let us suppose that a business is to produce 100000 units of its product in a period and the
standard cost card shows that each unit requires four labour hours. However, it is known that
due to their skill level the work force is producing at 110% efficiency. Therefore the number of
hours of labour required to produce the 100 000 units will be calculated as follows:
6. Overheads budget
This refers to the budget for indirect expenses of the business.
In a manufacturing context, the main budgeting effort will be spent determining the budget for
sales revenue, production, materials and labour. However, budgets must also be set for the
overheads and production facilities related to costs, which include for example, factory rent
and cost of running machinery. Overheads will also include depreciation charges.
Preparing and Analysis – Master budget
The master budget is a summary budget comprising a budgeted operating statement, budgeted
statement of financial position and a cash budget.
A budgeted operating statement is a summary of the detailed budgets for the period, which
provides managers with an overview of expected performance. The overview provided by a
budgeted operating statement allows the organisation’s managers to assess whether the
expected performance is acceptable in terms of the organisation’s overall objectives. If this is
not the case, then they can plan to make adjustments to various areas of activity in order to try
to meet their objectives.
The format is as follows
GHS GHS
Revenue xxx
Less cost of sales:
Materials xxx
Labour xxx
Overheads xxx
(xxx)
Gross profit xxx
Capital budget
A capital budget is a budget for the cost of non – current assets, i.e. for the purchase of non –
current assets.
Cash budget (Cash flow forecast) is a method of determining the expected net cash flow for a
future period and the expected cash or overdraft balance at the end of that future period.
Cash budgets are probably the most important tool in practice for the management of any
company’s cash position. They are vital to identifying in advance a likely deficit or surplus in
order that appropriate action can be taken to avoid any problem or profit from any
opportunity.
Cash budgets
Proforma
Period 1 2 3 4 5
$ $ $ $ $
Receipts
Cash sales x x x x x
Receipts from credit
customers x x x x x
Other income x x
x x x x x
Payments
Cash purchases x x x x x
Payments for credit
Purchases x x x x x
Rent and rates x x
Wages x x x x x
Light and heat x x
Salaries x x x x x
Telephone x x
Insurance x
x x x x x
Surplus/ (deficit) (x) (x) x x x
Balance b/f – (x) (x) (x) x x
Balance c/f (x) (x) (x) x x
Question – functional Budgets preparation
The XYZ company produces three products, X, Y, and Z. For the coming accounting period
budgets are to be prepared using the following information:
Budgeted sales
Labour
X Y Z
Standard hours per unit 4 6 8
Solution
(a) Sales budget
$
X 2,000u × $100 = 200,000
Y 4,000u × $130 = 520,000
Z 3,000u × $150 = 450,000
$1,170,000
A fixed budget is a budget which is designed to remain unchanged regardless of the volume of
output or sales achieved.
Question
A company has prepared the following fixed budget for the coming year.
(a) Prepare a flexed budget for the actual activity for the year
(b) Calculate the variances between actual and flexed budget, and summarise in a form
suitable for management. (Use a marginal costing approach)
Solution
Activity based budgeting involves defining the activities that underlie the financial figures in
each function and using the level of activity to decide how much resource should be allocated,
how well it is being managed and to explain variances from budget.
Principles of ABB
ABB involves defining the activities that underlie the financial figures in each function and using
the level of activity to decide how much resource should be allocated, how well it is being
managed and to explain variances from budget.
(a) It is activities which drive costs and the aim is to control the causes (drivers) of costs rather
than the costs themselves, with the result that in the long term, costs will be better managed
and better understood.
(b) Not all activities are value adding and so activities must be examined and split up according
to their ability to add value.
(c) Most departmental activities are driven by demands and decisions beyond the immediate
control of the manager responsible for the department's budget.
(d) Traditional financial measures of performance are unable to fulfil the objective of
continuous improvement. Additional measures which focus on drivers of costs, the quality of
activities undertaken, the responsiveness to change and so on are needed.
Benefits of ABB
Some writers treat ABB as a complete philosophy in itself and attribute to it all the good
features of strategic management accounting, zero base budgeting, total quality management,
and other ideas. For example, the following claims have been made.
(a) Different activity levels will provide a foundation for the 'base' package and incremental
packages of ZBB.
(b) It will ensure that the organisation's overall strategy and any actual or likely changes in that
strategy will be taken into account, because it attempts to manage the business as the sum of
its interrelated parts.
(c) Critical success factors will be identified and performance measures devised to monitor
progress towards them. (A critical success factor is an activity in which a business must perform
well if it is to succeed).
(d) Because concentration is focused on the whole of an activity, not just its separate parts,
there is more likelihood of getting it right first time. For example what is the use of being able
to produce goods in time for their despatch date if the budget provides insufficient resources
for the distribution manager who has to deliver them?
STANDARD COSTING & VARIANCE ANALYSIS
1.1. Introduction
What are the possible advantages for the control function of an organisation of having a
standard costing system?
Standard costing is most suited to mass production and repetitive assembly work.
The responsibility for deriving standard costs should be shared between managers able to
provide the necessary information about levels of expected efficiency, prices and overhead
costs.
Direct materials costs per unit of raw material will be estimated by the purchasing department
from their knowledge of the following.
Direct labour rates per hour will be set by reference to the payroll and to any agreements on
pay rises with trade union representatives of the employees. A separate hourly rate or weekly
wage will be set for each different labour grade/type of employee and an average hourly rate
will be applied for each grade (even though individual rates of pay may vary according to age
and experience).
Similar problems to those which arise when setting material standards in times of high inflation
can be met when setting labour standards.
To estimate the materials required making each product (material usage) and also the labour
hours required (labour efficiency), technical specifications must be prepared for each product
by production experts (either in the production department or the work study department).
When standard costs are fully absorbed costs (standard costs can be used in both marginal and
absorption costing systems), the absorption rate of fixed production overheads will be
predetermined and based on budgeted fixed production overhead and planned production
volume.
(a) Production capacity (or 'volume capacity') measured perhaps in standard hours of output (a
standard hour being the amount of work achievable at standard efficiency levels in an hour),
which in turn reflects direct production labour hours.
(b) Efficiency of working, by labour or machines, allowing for rest time and contingency
allowances.
Suppose that a department has a work force of ten men, each of whom works a 36 hour week
to make standard units, and each unit has a standard time of two hours to make. The expected
efficiency of the work-force is 125%.
(a) Budgeted capacity, in direct labour hours, would be 10 36 = 360 production hours per
week.
(b) Budgeted efficiency is 125% so that the work-force should take only 1 hour of actual
production time to produce 1.25 standard hours of output.
The standard selling price will depend on a number of factors including the following.
The standard sales margin is the difference between the standard cost and the standard selling
price.
There are four types of standard: ideal, attainable, current and basic. These can have an
impact on employee motivation.
An ideal standard is a standard which can be attained under perfect operating conditions: no
wastage, no inefficiencies, no idle time, and no breakdowns
A current standard is standard based on current working conditions (current wastage, current
inefficiencies)
A basic standard is a long-term standard which remains unchanged over the years and is used
to show trends
The different types of standard have a number of advantages and disadvantages.
(a) Ideal standards can be seen as long-term targets but are not very useful for day-to-day
control purposes.
(b) Ideal standards cannot be achieved. If such standards are used for budgeting, an allowance
will have to be included to make the budget realistic and attainable.
(c) Attainable standards can be used for product costing, cost control, inventory valuation,
estimating and as a basis for budgeting.
(d) Current standards or attainable standards provide the best basis for budgeting, because
they represent an achievable level of productivity.
(f) Current standards are useful during periods when inflation is high. They can be set on a
month by month basis.
(g) Basic standards are used to show changes in efficiency or performance over a long period
of time. They are perhaps the least useful and least common type of standard in use.
You will recall from previous chapters that a budget is a quantified monetary plan for a future
period, which managers will try to achieve. Its major function lies in communicating plans and
coordinating activities within an organisation.
On the other hand, a standard is a carefully predetermined quantity target which can be
achieved in certain conditions.
As well as being similar, budgets and standards are interrelated. For example, a standard unit
production cost can act as the basis for a production cost budget. The unit cost is multiplied by
the budgeted activity level to arrive at the budgeted expenditure on production costs.
1.7. Variance analysis is a key element of performance management and is the process by
which the total difference between flexed standard and actual results is analysed.
A number of basic variances can be calculated. If the results are better than expected, the
variance is favourable (F). If the results are worse than expected, the variance is adverse (A).
calculate a variance
explain the meaning of the variance calculated
identify possible causes for each variance.
Once the variances have been calculated, an operating statement can be prepared reconciling
actual profit to budgeted profit, under marginal costing or under absorption costing principles.
Basic variances can be calculated for sales, material, labour, variable overheads and fixed
overheads.
Note: 'Margin' = contribution per unit (marginal costing) or profit per unit (absorption costing).
Note: The material price variance and the material usage variance may be linked. For example,
the purchase of poorer quality materials may result in a favourable price variance but an
adverse usage variance.
. Profit Statement
With a marginal costing profit and loss, no overheads are absorbed, the amount spent is simply
written off to the income statement.
So with marginal costing the only fixed overhead variance is the difference between what was
budgeted to be spent and what was actually spent, i.e. the fixed overhead expenditure
variance.
Under absorption costing we use an overhead absorption rate to absorb overheads. Variances
will occur if this absorption rate is incorrect (just as we will get over/under-absorption).
So with absorption costing we calculate the fixed overhead expenditure variance and the fixed
overhead volume variance (this can be split into a capacity and efficiency variance).
The purpose of calculating variances is to identify the different effects of each item of
cost/income on profit compared to the expected profit. These variances are summarised in a
reconciliation statement or operating statement.
$ $ $
Budgeted profit xxx
Sales variances: price xxx
volume xxx
xxx
Actual sales minus the standard cost of sales xxx
Cost variances
(F) (A)
$ $ $
Material price xxx
Material usage xxx
Labour rate xxx
Labour efficiency xxx
Labour idle time xxx
Variable overhead expenditure xxx
Variable overhead efficiency xxx
Fixed overhead expenditure xxx
Fixed overhead volume xxx
Xxx xxx xxx
Actual profit for January xxx
Check
$ $
Sales xxx
Materials xxx
Labour xxx
Variable overhead xxx
Fixed overhead xxx
xxx
Actual profit xxx
The operating statement under marginal costing is the same as that under absorption costing
except;
$ $ $
Budgeted profit xxx
Budgeted fixed production costs xxx
Budgeted contribution xxx
Sales variances: volume xxx
price xxx
xxx
Actual sales ($95,600) minus the standard
variable cost of sales (4,850 $6.60) xxx
(F) (A)
Variable cost variances $ $ $
Material price xxx
Material usage xxx
Labour rate xxx
Labour efficiency xxx
Labour idle time xxx
Variable overhead expenditure xxx
Variable overhead efficiency xxx
xxx xxx
xxx
Actual contribution xxx
Budgeted fixed production overhead xxx
Expenditure variance xxx
Actual fixed production overhead xxx
Actual profit xxx
Question 1:
A company produces and sells one product only, the Thing, the standard cost for one unit being
as follows.
$
Direct material A – 10 kilograms at $20 per kg 200
Direct material B – 5 litres at $6 per litre 30
Direct wages – 5 hours at $6 per hour 30
Fixed production overhead 50
Total standard cost 310
The fixed overhead included in the standard cost is based on an expected monthly output of
900 units.
Fixed production overhead is absorbed on the basis of direct labour hours.
During April the actual results were as follows.
Production 800 units
Material A 7,800 kg used, costing $159,900
Material B 4,300 litres used, costing $23,650
Direct wages 4,200 hours worked for $24,150
Fixed production overhead $47,000
Required
(a) Calculate price and usage variances for each material.
(b) Calculate labour rate and efficiency variances.
(c) Calculate fixed production overhead expenditure and volume variances and then subdivide
the volume variance.
Solution
Usage variance – A
800 units should have used ( 10 kgs) 8,000 kgs
but did use 7,800 kgs
Usage variance in kgs 200 kgs (F)
standard cost per kilogram $20
Usage variance in $ $4,000 (F)
Price variance – B
$
4,300 litres should have cost ( $6) 25,800
but did cost 23,650
Price variance 2,150 (F)
Usage variance – B
$
800 units should have used ( 5) 4,000
but did use 4,300
Usage variance in litres 300 (A)
standard cost per litre × $6
Usage variance in $ $1,800 (A)
Question 2:
A company manufactures one product, and the entire product is sold as soon as it is produced.
There is no opening or closing inventories and work in progress is negligible. The company
operates a standard costing system and analysis of variances is made every month. The
standard cost card for the product, a widget, is as follows.
Budgeted output for January was 5,100 units. Actual results for January were as follows.
Production of 4,850 units was sold for $95,600
Materials consumed in production amounted to 2,300 kilos at a total cost of $9,800
Labour hours paid for amounted to 8,500 hours at a cost of $16,800
Actual operating hours amounted to 8,000 hours
Variable overheads amounted to $2,600
Fixed overheads amounted to $42,300
Required
Calculate all variances and prepare an operating statement for January.
Solution
(f) 8,000 hours incurring variable o/hd expenditure should cost ( $0.30) 2,400
but did cost 2,600
Variable overhead expenditure variance 200 (A)
$ $
Budgeted profit (5,100 units $6 profit) 30,600
Selling price variance 1,400 (A)
Sales volume variance 1,500 (A)
2,900 (A)
Actual sales ($95,600) less the standard cost of sales (4,850 $14) 27,700
Cost variances
(F) (A)
$ $ $
Material price 600
Material usage 500
Labour rate 200
Labour efficiency 3,400
Labour idle time 1,000
Variable overhead expenditure 200
Variable overhead efficiency 510
Fixed overhead expenditure 4,560
Fixed overhead volume 1,850
4,610 8,210 3,600 (A)
Actual profit for January 24,100
Check
$ $
Sales 95,600
Materials 9,800
Labour 16,800
Variable overhead 2,600
Fixed overhead 42,300
71,500
Actual profit 24,100
Question 3:
Returning to the question above, now assume that the company operates a marginal costing
system.
Required
Recalculate any variances necessary and produce an operating statement.
Answer
(b) The standard contribution per unit is $(20 – 6.60) = $13.40, therefore the sales volume
variance of
250 units (A) is valued at ( $13.40) = $3,350 (A).
The other variances are unchanged; therefore an operating statement might appear as follows.
(F) (A)
Variable cost variances $ $ $
Material price 600
Material usage 500
Labour rate 200
Labour efficiency 3,400
Labour idle time 1,000
Variable overhead expenditure 200
Variable overhead efficiency 510
4,610 1,800
2,810 (F)
Actual contribution 66,400
Budgeted fixed production overhead 37,740
Expenditure variance 4,560 (A)
Actual fixed production overhead 42,300
Actual profit 24,100
Note: The profit here is the same on the profit calculated by standard absorption costing
because there were no changes in inventory levels. Absorption costing and marginal costing
do not always produce an identical profit figure.