Management Accounting - Assigment 2

The report has 3 main tasks bases on 7 outcomes of scenario: Task 1include outcome: - 3.1: Explain the purpose and nature of the budgeting process - 3.2: Select appropriate budgeting met

Management Accounting

Lecturer: Dao Nam Giang

Class F04B

Prepared by: Lucky Group

Nguyen Thi Tu Anh – LeeNhâm Nguyễn Ngọc Anh - DJNguyen Thi Ngoc – GummyNguyen Hien Thanh – TanyTang Thanh Thuy - Mitchie

Submission date: 29 th June, 2012

Executive summary 3

Introduction 4

I Budgeting process 5

1 The purpose and nature of the budgeting process 5

2 Budgeting methods: 12

2.1 Choosing the appropriate method for PhongPhu Ltd 16

2.2 Operating budget 16

The operating budget for Phong Phu will be prepare as below: 16

II Cash budget 23

1 Definition of cash budget 23

For individuals, creating a cash budget is a good method for determining where their cash 24

2 Preparing the cash budget 24

3 Minimum cash balance requirement 27

Conclusion 30

References 31

Executive summary

Managerial Accounting was called as a field of accounting that provides economic and financialinformation for managers and other internal users In this program, you will learn aboutfundamental internal measurement and control systems, including structured measurementmodels, analytical techniques and system biases You also will learn how to align internalmeasurement and control systems with your organization’s strategy and how to maintain controlwithout stunting initiative Whether you are the measurer or the measure in your organization,this program will deliver ideas that will help you do your job better, by promoting better systems,challenging ineffective or inefficient metrics, and creating a lean measurement culture

The report has 3 main tasks bases on 7 outcomes of scenario:

Task 1include outcome:

- 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

Task 2 include outcome:

- 3.4: prepare a cash budget

Task 3 include outcome:

- 4.1: calculate variances identify possible causes and recommendation corrective action

- 4.2: prepare an operating statement reconciling budgeted and actual result

- 4.3: report findings to management in accordance with identified responsibility centers

I Budgeting process

1 The purpose and nature of the budgeting process

a The purposes and benefits of a budget:

 Ensure the achievement of the organization’s objectives

This is the main purpose of budget The organization’s objectives are quantified and drawn up astargets to be achieved within the timescale of the budget plan (BPP, 2004, pg.155)

 Control and Evaluation

Budgeting allows a company to have a certain degree of control over costs, such as not allowingmany types of expenses to take place if they were not budgeted for, or assigning responsibilityfor these expenses A budget also helps company to evaluate business units, departments, andeven individual managers (Tiffany Bradford, 2012)

 Co-ordinate activities

The activities of different departments need to be co-ordinate to ensure maximum integration ofeffort towards common goals This implies, for example, that the purchasing department shouldbase its budget on production requirements and that the production budget should in turn bebased on sales expectations (BPP, 2004, pg.155)

 Planning

Planning is another purpose of budgeting process, and is arguably its primary purpose.Budgeting allows a company to take stock of revenue and expenses from the previous period,and judge where the business will be in future periods It also allows the organization to add andremove products and services from its plan for the future period This allows top management to

get a picture of the entire business so they are able to better plan accordingly (Tiffany Bradford,2012)

 Communication and Motivation

Budgets allow management to communicate goals and to promote goal congruence so resourcescan be coordinated and focused in key areas Budgets also allow a company to motivate itsemployees by involving them in the budget While top-down budgeting does not accomplish thisgoal very effectively, participative budgeting can be motivating When an employee is involved

in creating his or her department’s budget, that person will be more likely to strive to achievethat budget The budgeting process can also allow companies to communicate and achieve theirgoals, and allow them to monitor those achievements as well It is also an important step inoverall of business strategic planning (Tiffany Bradford, 2012)

 Provide a framework for responsibility accounting

Budgets require that managers of budget centers are made responsible for the achievement ofbudget targets for the operations under their personal control (BPP, 2004, pg.155)

b Types of budget:

There are two components in master budgets including operating budgets and financial budgets Various types of budgets are shown in the picture below.

 Operating budgets

Operating budgets include many types

Firstly, it is sales budget which is the first budget prepared It is derived from the sales forecast

such as management’s best estimate of sales revenue for the budget period and every other

budget depends on the sales budget (Ward & Ward, 2012)

The production budget is prepared after the sales budget The production budget lists the

number of units that must be produced during each budget period to meet sales needs and toprovide for the desired ending inventory (Accounting for management, accessed 2011) In

production budget, there are direct material budget, direct labor budget, and manufacturing overhead budget.

 Direct materials budget shows both the quantity and cost of direct materials to be

purchased, which are derived from the direct materials units required for production

(from the production budget) plus the desired change in ending direct materials units.(Ward & Ward, 2012)

 Direct labor budget shows both the quantity of hours and cost of direct labor necessary

to meet production requirements It is critical in maintaining a labor force that can meetexpected production (Ward & Ward, 2012)

 Manufacturing overhead budget shows the expected manufacturing overhead costs for

the budget period, and it distinguishes between fixed and variable overhead costs (Ward

& Ward, 2012)

The next is Selling and Administrative Expense Budget lists the budgeted expenses for areas

other than manufacturing In large organizations this budget would be a compilation of manysmaller, individual budgets submitted by department heads and other persons responsible forselling and administrative expenses For example, the marketing manager in a large organizationwould submit a budget detailing the advertising expenses for each budget period (Accountingfor management, accessed 2011)

The following budget is budgeted income statement It is the summary of various component

projections of revenues and expenses for the budget period It indicates the expected net incomefor the period (All business, 2005)

 Financial budgets

Financial budgets embrace the impacts of the financial decisions of the firm (Answer, accessed2011)

The first financial budget is capital expenditure budget, which is a plan prepared for individual

capital expenditure projects The time span of this budget depends upon the project Capital

expenditures to be budgeted include replacement, acquisition, or construction of plants and majorequipment (All business, accessed 2011)

The second is cash budget considered to be the most important output in preparing financial

budgets It shows anticipated cash flows and contains three sections: cash receipts, cash disbursements, and financing Cash budget also shows beginning and ending cash balances.

(Ward & Ward, 2012)

Lastly, budgeted balance sheet is a projection of financial position at the end of the budget

period It is developed from the budgeted balance sheet for the preceding year and the budgetsfor the current year (Ward & Ward, 2012)

c Steps in the preparation of a budget:

The mechanics of budget preparation need to be concerned as the focus of building up a budget

It is very important because of its function to appreciate the coordinating role of budgets Hence,the follow part of this report is going to describe every step in the preparation of a budget

 Budget committee

Budget committee is a group of people who are responsible for co-ordination and administration

of budgets In a company, this committee usually consists of the top management and the CEO.They play key roles in the success or demise of a company or other corporate entity Committeesthat are able to keep their organizational budgets on track ensure smooth operation and financialsolvency (Investopedia, accessed 2011) For this reason, every part of the organization should berepresented on the committees by representatives coming from every departments such as sales,production, marketing and so on (BPP, 2004, p 159) Commonly, functions of the budgetcommittee include the following:

 Co-ordination and allocation of responsibility for the preparation of budgets

 Issuing of the budget manual

 Timetabling

 Provision of information to assist in the preparation of budgets

 Communication of final budgets to the appropriate managers

 Monitoring the budgeting and planning process by comparing actual and budget results

 Responsibility for budgets

Obviously, the responsibility for preparing the budgets should be tightened with the managerswho are responsible for implementing them Managers in specific department would be thosewho are able to grasp everything in this field So they can give out the most accurate prediction

as well as the most overall view in budget For example, the sales manager should draft the salebudget and the selling overhead cost center budgets or the purchasing manager should draft thematerial purchases budget (BPP, 2004, p.159)

 The budget manual

The administration of budgeting is documented in a budget manual It contains the purpose of,procedure for and responsibility of the people involved in budgeting According to Investopedia(accessed 2011), “Budgeting within large organizations is an extremely complex task Financialanalysts must make assumptions about what the future will look like based on past data Thismeans that even the best budgeting process is subject to considerable inaccuracies Then, as theyear progresses, each group is held to a predefined budget, which may become inadequate due tochanging conditions On the other hand, some groups will find that they have more money than

they require, and may choose to surreptitiously use up the “extra” budget with unnecessaryexpenditures in order to avoid budget cuts” Budget manuals should present to any reader thesystem of clear, easy-to-understand rules and standards for managing the budget created.

 Steps in budgets preparation

In different organization there will be different procedures for preparing a budget applied

However, all these differences also can be indicated shortly by three steps Firstly, budget committee will discuss several times then come into the final agree with master budget which budgeted profit and loss account and balance sheet) At the ends of process, functional budget

which are amalgamated into the master budget may need to be amended many times over as aconsequence of the discussions between departments, changes in market conditions and so onduring the course of budget preparation (BPP, 2004)

 Identifying the principal budget factor

The principle budget or key budget factor is the factor which limits the activities of the

organization The earlier identification of this factor is important in budgetary planning process

because it indicates which budget should be prepared first For example, if sales volume is theprinciple budget factor, and then the sale budgets must be prepared first, based on the availablesales forecasts All other budgets should then be linked to this Failure to identify the principlebudget factor at the early stage could lead to delays at the later stages when manager realize thatthe targets they have been working are not feasible (Walker J, 2009, pg 307)

The stages involved in the preparation of a budget can be summarized as follow:

 Sales budget: this involves a realistic sales forecast This is prepared in units of eachproduct and also in sales value Methods of sales forecasting include: sales forceopinions, market research, statistical methods (correlation analysis and examination

of trends), and mathematical models

 Production budget: expressed in quantitative terms only and is geared to the

sales budget The production manager's duties include: analysis of plant

utilization and work-in-progress budgets

 Raw materials and purchasing budget: the materials usage budget is in

quantities and the materials purchases budget is both quantitative and

financial

 Labor budget: is both quantitative and financial This is influenced by: productionrequirements, man-hours available, grades of labor required, wage rates (unionagreements) and the need for incentives

 Cash budget: a cash plan for a defined period of time It summarizes monthly receiptsand payments Hence, it highlights monthly surpluses and deficits of actual cash

2 Budgeting methods:

a Incremental budgeting method:

According to BPP (2004, pg 177), Incremental budgeting is a budgeting method focusing

mainly in the increasing of costs and revenues which have ability to occur in the next periods Ituses “a previous period’s budget or actual performance as a basis with incremental amountsadded for the new budget period” (tutor2u, accessed 2011) It means that the basis of incrementalbudgeting method is the allocations from the last periods It is also provided to be reasonable

procedure if the current operations are effective, efficient and economical; as well as theorganization and the environments are not in changing circumstances

The table below, taking information from website tutor2u, shows the advantages anddisadvantages of using this method

 The budget changes gradually Most of

the time, it is stable

 Departments can be operated on a

 Encouraging to spend up to the budget

 The budget may become out of date and

no longer relate to the level of activity

or type of work being carried out

 The order of resources can be changed

b Zero-based budgeting method:

“Zero based budgeting (ZBB) is an alternative approach that is sometimes used particularly in

government and not for profit sectors of the economy” (accounting for management, accessed2010) In the other words, “Zero based budgeting involves preparing a budget for each costcentre from a zero based” (BPP, 2004, pg 178) It is required to justify all budgeted expenditures

in the budget from the previous year

By using this budgeting system, the managers are required to prepare a chain of decisionpackages in which the departments’ activities are put in order based on their relative importanceand the cost of each activity is identified as well

The advantages and disadvantages of zero based budgeting are shown in the table followed:

 Allocation of resources is efficient

 Easy to find effective ways in improving

operations

 Detecting inflated budgets

 This practice excludes municipal

planning departments

 Make it easier for output to identify

 Providing initiative to motivate staff

 Clearly identify missions and their

 It requires the managers to be trained

c Fixed budgeting method:

According to BPP (2004, p.168), master budgets are based on planned volumes of productionand sales but do not include any provision for the event that actual volumes may differ from the

budget In this sense they may be described as fixed budgets A fixed budget is a budget which is

set for a single activity level In other words, a fixed budget is a financial plan that does notchange through the budget period, irrespective of any changes from the plan in actual activitylevels experienced (Accounting tools, accessed 2011) Fixed budget has two characteristics asthe followings (All business, accessed 2011):

 It is geared toward only one level of activity.

 Actual results are compared against budgeted (standard) costs only at the original budgetactivity level

d Flexible budgeting method:

According to BPP (2004, p.168), a flexible budget is ‘a budget which, by recognizing different

cost behavior patterns, is designed to change as volume of activity changes’ A flexible budget

has two advantages as the followings:

At the planning stage, it may be helpful to know what the effects would be if the actual outcome

differs from the prediction For example, GOF Company may budget to sell 10,000 units of itsproduct, but may prepare flexible budgets based on sales of, say, 8,000 and 12,000 units This

would enable contingency plans to be drawn up if necessary

At the end of each month or year, actual results may be compared with the relevant activity level

on the flexible budget as a control procedure

There are four main steps which are used to prepare a flexible budget (Dennis Caplan, accessed2011):

 Step 1: Determine the budgeted variable cost per unit of output Also determine thebudgeted sales price per unit of output, if the entity to which the budget applies generatesrevenue (e.g., the retailer or the hospital)

 Step 2: Determine the budgeted level of fixed costs

 Step 3: Determine the actual volume of output achieved (e.g., units produced for afactory, units sold for a retailer, patient days for a hospital)

 Step 4: Build the flexible budget based on the budgeted cost information from steps 1 and

2, and the actual volume of output from step 3

2.1 Choosing the appropriate method for PhongPhu Ltd.

2.2 Operating budget

The operating budget for Phong Phu will be prepare as below:

Revenue/sales budget

Budgeted selling price per

Gross production needed from cost

Less: beginning WIP inventory 150 100

Gross production needed from cost

center P1

In Process 2, we can calculate required finish good for each product Firstly, product A needs

11,400 units of good finished output but we must reject the rates 5% of the process

 The good yield of process 2 of product A = 100% - 5% = 95%

 The gross production = 11,400∗100

95 = 12,000 units.

 Product B, we have the gross production from cost center P2= 12,880∗10092 = 14,000units

To meet the target good final products after P2, there must be certain output produced from P1

Product A and product B, work in process units at the end of P1 needs 12,150 and 14,025 units.

Product A and product B reject the rate about 10% and 15%so

 The gross production from P1 product A = 12,150∗100

90 = 13,500 units

 The gross production from P1 product B = 14,025∗100

85 = 16,500 units

Direct material budget

Less: beginning direct material inventory 500 300

Plus: desired ending direct material

Direct material to be purchased in unit 33,850 49,550

Budgeted cost of direct material to be

Process 1add materials, therefore, the materials needed will be based on production requirements

in the process 1 X is the material used in producing A and Y is used to make B

 2.5 units of X are used to make 1 product A and 13,500 units are required

 Total direct material required = 13,500∗2.5 = 33,750

Based on the beginning inventory and desired ending, direct material purchased is 33,850 units

of X The cost per unit of X is $20

 The total budgeted cost to purchase X = 33,850∗$ 20 = $677,000

 The cost to purchased Y = $396,400

Direct labor budget

Budgeted direct labor cost in Process

2

Budgeted direct labour cost in P2 $240,000 $126,000

 The total direct labour hours required for units of A = 13,500∗1 = 13,500 hours

 The workers is paid $10, so it will cost = 13,500∗$ 10 = $135,000 to make 13,500 units

of A in process 1

 The budgeted cost in P1 for product B is $99,000

 Producing A and B process 2will cost $240,000 and $126,000

Fixed manufacturing overhead budget in P1

Budgeted DL hours required for each

product

Budgeted total DL hours required in P1 23,400

Budgeted fixed manufacturing overhead

In PhongPhu Ltd., the base to calculate overhead is direct labour hours

- In process 1, total fixed cost is $81,600 and the total direct labour hours required is23,400

 The rate to allocate fixed overhead = $ 81,600/23,400= $3.49 per hour

 The budgeted fixed overhead to be allocate to A is $47,076.92 and B is $34,523.08