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Lecture Example 1
A company manufactures two products, Aye and Bee. Standard cost data for the
products for next year are as follows:
Product Aye Product Bee
per unit per unit
Direct materials:
X at £2 per kg 24kg 30kg
Y at £5 per kg 10kg 8kg
Z at £6 per kg 5kg 10kg
Direct wages:
Unskilled at £6 per hour 10 hrs 5 hrs
Skilled at £8 per hour 6 hrs 5 hrs
Budgeted sales for next year: Product Aye 2,400 units. Product Bee 3,200 units.
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Sales are our limiting factor
(a) Production budget
Aye Bee
(units) (units)
Sales
Closing Inventory
Opening Inventory
Production
(b) Materials
Usage X Y Z
Product Aye
Product Bee
Usage
Closing Inventory
Opening Inventory
Purchases
@ £2/£5/£6
c) Labour budget
Unskille
d Skilled Total
(hours) (hours)
Product Aye
Product Bee
@ £6 / £8
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Lecture Example 2
Item of cost £
Wages 140,000
Materials 28,000
Vehicle hire 35,000
Equipment hire 18,000
Total 221,000
The weakness of this approach is that it gives little indication of the link between
the level of activity of the department and the costs incurred. The budget might
be restated as an activity-based budget as follows:
This approach provides a clear framework for understanding the link between
costs and the level of activity. If you can identify appropriate ‘cost drivers’ then a
very high proportion of costs reveal themselves to be variable.
Of course, ABBs and traditional budgets are not mutually exclusive. The two can
be prepared in parallel or they can be integrated.
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Lecture Example 3
A company manufactures a single product and the following data show the actual
results for the month of April compared with the budgeted figures.
Looking at the costs incurred in April, a cost saving of £3,010 has been made
compared with the budget. However the number of units produced and sold was
200 less than budget, so some savings in expenditure might be expected. It is
not possible to tell from this comparison how much of the saving is due to
efficient cost control, and how much is the result of the reduction in activity.
Management have identified that the following budgeted costs are fixed.
£
Direct labour 8,400
Production overhead 18,000
Administration overhead 21,000
Selling and distribution overhead 14,000
Required
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Flexed Budget (1,000 units)
Fixed Variable Total Actual Variance
£ £/unit £ £ £
Sales revenue
Direct material
Direct labour
Prod O/H
Admin O/H
S&D O/H
Total cost
Profit
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Tutorial / Workshop Questions
He has provided the following estimates for the next three months:
Product P Q R
September 4,000 3,100 2,400
October 4,400 3,500 2,100
November 4,600 3,900 2,700
Product P Q R
Material:
A (kg) 8 11 15
B (kg) 6 9 11
The production manager stated that he feels the company should maintain an
inventory of raw material at the end of each month which is sufficient for 20% of
the production requirement for the next month. The sales manager indicated that
if the plans were properly coordinated, the finished goods inventory could be held
at a constant rate for each product as follows:
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Finished goods inventory (units)
Product P Q R
1,000 500 1,800
It is estimated that at the end of August, the inventory levels will be:
Required:
(b) Explain how Zero Based Budgeting could overcome the problems that
might be faced as a result of the continued use of the current system.
(c) Critically evaluate the role of rolling budgets and whether they would be
suitable for a company like Griffithstown Generators Co.
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2
HIP Co prepared its budget for the year ending 31 December 2011 using an
incremental budgeting system. The budget is set centrally and is then
communicated to each of the managers who have responsibility for achieving
their respective targets.
The following report has been produced for the precision finishing department for
June 2011:
Budget Actual Variance
Number of machine hours 10,000 13,470 3,470 (F)
£ £ £
Consumable materials 104,800 148,000 43,200 (A)
Cleaning materials 12,500 14,200 1,700 (A)
Other direct materials 4,700 5,970 1,270 (A)
Direct labour 135,000 172,500 37,500 (A)
Production overheads 92,300 127,600 35,300 (A)
_______ _______ ______
Total 349,300 468,270 118,970 (A)
_______ _______ ______
The Manager of the precision finishing department has received a memo from
the Financial Controller requiring him to explain the serious overspending within
his department.
The Manager has sought your help and, after some discussion, you have
ascertained the following information:
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A further analysis of the production overhead cost is shown below:
Required
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Typical discussion questions
Define the “controllability principle” and give arguments for and against its
implementation in determining performance measures.
Requirements
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There is no clear evidence as to which of these views will produce the best
performance from a division or a division manager.
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(a) Incremental budgeting uses year 1 budget as the starting point for the
preparation of year 2 budget. It is assumed that the basic structure of the old
budget is acceptable and that adjustments will be made to allow for changes in
volume, efficiency and price levels. The focus, therefore, tends to be on the
existing use of resources rather than on identifying objectives and alternative
strategies for the future budget period. It is argued that incremental budgeting
does not question sufficiently the costs and benefits of operating a particular
resource allocation structure.
the resource allocation is not clearly linked to a business plan and the
consideration of alternative means of achieving objectives;
there is a tendency to constrain new high-priority activities;
there is insufficient focus on efficiency and effectiveness and the alternative
methods by which they may be achieved;
it often leads to arbitrary cuts being made in order to meet overall financial
targets;
it tends not to lead to management commitment to the budget process.
(i) The major focus is on the planning of resource allocation which aims at
efficiency, effectiveness and continuous improvement. Features may
include:
the impact of change from the present activity levels are made more
apparent;
key processes and constraints are identified and resource
requirements related thereto are quantified;
efforts are made to identify critical success factors and the
performance indicators which are most relevant for such factors.
(ii) Activities are seen as the key to effective planning and control.
(iii) It is argued that activities consume resources and that efforts should be
focused on the control of the cause of costs not the point of incidence.
(iv) Costs are traced to activities with the creation of ‘cost pools’ which relate
to an activity.
(v) It is easier to eliminate non-value-adding activities.
(vi) Focus may be on total quality management with emphasis on process
control through identification of cost drivers.
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