Management Accounting: Costing and Budgeting (Assignment 2)

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.. Variance analysisStandard selli

Unit 9: Management Accounting: Costing and Budgeting

Assignment 2:

Budgetary Planning and Control

Prepared by Secret Gardent Group

TABLE OF CONTENT

INTRODUCTION 3

Task1 4

3.1 Explain the purpose and nature of the budgeting process 4

3.2 Select appropriate budgeting methods for the organization and its needs 5

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

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

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)

 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

- 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)

- 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, lower-level 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

Expected unit sales

40,000 20,000 Unit selling price X £30 X £65 Total sales £1,200,000 £1,300,000

Figure 1: Cabot Co Sales Budget for July of 2006

As it can see that we got the total sales of 2 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)

Expected unit sales 40,000 20,000 Add: Desired inventories 2,500 2,000 Total required units 42,500 22,000 Less: Estimated

inventories

3,000 2,700

Required product units £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

Product K (lbs) 27,650 47,400 Product L (lbs) 67,550 34,740 Units to be produced

(lbs)

95,200 82,140

Add: Desired inventories (lbs)

3,000 2,500

Less: Estimated inventories (lbs)

4,000 3,500

Direct material purchase (lbs)

94,200 81,140

Total cost of direct materials purchases

£376,80 0

£162,28 0

£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

Product K (hrs) 15,800 5,925 Product L (hrs) 11,580 4,825 Hours to be produced

Direct labor rate x £12 x £16

Total direct labor cost £328,56

0 £172,00 0

£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

£ Direct materials cost 539,080

Estimated factory overhead cost

299,000

Add: Estimated inventories 145,500

Less: Desired inventories 112,500

Total cost of goods sold 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)

Receipt from sales

Sales

110 ,000

115 ,000 120,000 130,000 140,000 130,000 70% received

77 ,000

80 ,500

84,

000

91,

000

98,

000 28%received

30 ,800

32,

200 33,600 36,400

Total receipt from sales 111,300 116,200 124,600 134,400

Payments

Payment for purchasing with the old

Payment for purchasing with the new

Total payments with the old

method 96,320 104,240 112,160 114,140 Total payments with the new

method 96,320 66,620 108,580 113,570

Cost of sales 60%

66 ,000

69 ,000

72 ,000

78,

000

84,

000 78,000

76 ,000 84,000 86,000 81,000

Net cash inflow with the old

method 14,980 11,960 12,440 20,260 Net cash inflow with the new

method 14,980 49,580 16,020 20,830

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

Standard selling price - standard cost = £130-£76 54

Actual selling price - standard cost = £136-£76 60

Recommend: The company should sell products with high quality to be able to raise selling price, or produce more units

2.Sales volume variance

Recommend: The company should produce and sell more products; at least it should be higher than 200 units

Recommend: The company can choose the source, the supplier to buy material which is appropriate with their demand and lower than standard material price

Recommend: The company can choose quality of labor that they recruit to lower the labor cost

Recommend: The company should manage well all their equipments and maintain on time

Recommend: The company be tight with fixed product overhead like water, electricity, oil, that they use when producing

7.Fixed overhead volume variance

Actual production volume 230 units

Fixed overhead volume variance in unit 10 units (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 8,800

Actual fixed administration, selling and distribution overhead 8,650

Fixed administration, selling and distribution expenditure 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

Standard (£) Actual (£)

Unit standard cost of production 76

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 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