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Chapter objectives Structure of the chapter Budgetary control methods Management action and cost control Zero base budgeting (ZBB) Key terms
There are two types of control, namely budgetary and financial. This chapter concentrates on budgetary control only. This is because financial control was covered in detail in chapters one and two. Budgetary control is defined by the Institute of Cost and Management Accountants (CIMA) as: "The establishment of budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy, or to provide a basis for its revision".
Budgetary Control
ACCORDING TO FUNCTION: 1. Sales Budget 2. Production Budget 3. Cost of Production Budget 4. Purchase Budget 5. Personnel budget 6. R & D Budget 7. Capital Expenditure Budget 8. Cash Budget 9. Master Budget
Types of Budget explained below are:1.Cash Budget 2.Sales Budget 3.Flexible Budget 4.Production Budget
Budgetary Control
Cash Budget
What Does Cash Budget Mean? An estimation of the cash inflows and outflows for a business or individual for a specific period of time. Cash budgets are often used to assess whether the entity has sufficient cash to fulfill regular operations and/or whether too much cash is being left in unproductive capacities. Cash Budget A cash budget is extremely important, especially for small businesses, because it allows a company to determine how much credit it can extend to customers before it begins to have liquidity problems. For individuals, creating a cash budget is a good method for determining where their cash is regularly being spent. This awareness can be beneficial because knowing the value of certain expenditures can yield opportunities for additional savings by cutting unnecessary costs. For example, without setting a cash budget, spending a dollar a day on a cup of coffee seems fairly unimpressive. However, upon setting a cash budget to account for regular annual cash expenditures, this seemingly small daily expenditure comes out to an annual total of $365, which may be better spent on other things. If you frequently visit specialty coffee shops, your annual expenditure will be substantially more.
Budgetary Control
Features
1. The sales budget is the first component of the master operating budget. This is because sales affect all other parts of the master budget. It includes the total sales valued in quantity. It consists of three parts; break even, target and projected sales. The budget also includes sales by product, location, customer density and seasonal sales patterns. It provides a plan for both cash and credit sales. The basis of a sales budget is the sale price per unit of goods to be sold multiplied by the quantity of goods to be sold. A sales budget is planned around the competition, the material available, cost of distribution, government controls and the political climate.
Significance
2. A sales budget controls the finances allocated for achieving sales targets of a company. It is the standpoint for comparing the actual sales performance and the budgetary sales performance of a company. The budget guides the company with regard to how much money should be allocated to selling distribution and sometimes for advertising and marketing. A sales budget that sets realistic targets will help the company make a profit.
Effects
3. A good sales budget should serve as a guide to company with regard to its sales target. It should be flexible and resilient to the volatile
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Budgetary Control
changes in the market. The budget should not put too many restraints on the sales functions of the company. A sales budget is a financial plan for the sales of goods and services of a company. It is the basis on which all the financial decisions of a company with regard to sales are taken. The budget also controls the general sales prospects of a company. Online and off line marketing, marketing in the media and other advertising expenditures are planned around a sales budget.
Benefits
4. A sales budget helps a company achieve its sales targets. It helps prevent sales losses and provides a basis for sales evaluation. A sales budget helps to integrate all departments in a company because achieving a sales target is the secret of making profits. It helps each department to assess their performance and correct any mistakes in function. It helps a company distribute goods and services in a cost effective way. It also helps the company to keep its marketing expenditure within affordable limits
Budgetary Control
Now lets illustrate the flexible budget by using some data. If the production equipment is required to operate for 5,000 hours during January, the flexible budget for January will be $90,000 ($40,000 fixed + $10 x 5,000 MH). If the equipment is required to operate in February for 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March requires only 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH). If the plant manager is required to use more machine hours, it is logical to increase the plant managers budget for the additional cost of electricity and supplies. The managers budget should also decrease when the need to operate the equipment is reduced. In short, the flexible budget provides a better opportunity for planning and controlling than does a static budget.
Production budget
A film production budget determines how much money will be spent on the entire film project. It involves the identification and estimation of cost items for each phase of filmmaking(development, pre-production, production, post-production and distribution). The budget structure is normally split into "above-the-line" (creative) and "below-the-line" (technical) costs.
Budgetary Control
Budgetary Control
b) Budgetary control: A control technique whereby actual results are compared with budgets. Any differences (variances) are made the responsibility of key individuals who can either exercise control action or revise the original budgets.
Budgetary Control
Where outputs are compared with the assets employed in producing them, i.e. ROI.
Budgetary Control
Problems in budgeting
Whilst budgets may be an essential part of any marketing activity they do have a number of disadvantages, particularly in perception terms. Budgets can be seen as pressure devices imposed by management, thus resulting in: a) bad labour relations b) inaccurate record-keeping. Departmental conflict arises due to: a) disputes over resource allocation b) departments blaming each other if targets are not attained. It is difficult to reconcile personal/individual and corporate goals. Waste may arise as managers adopt the view, "we had better spend it or we will lose it". This is often coupled with "empire building" in order to enhance the prestige of a department. Responsibility versus controlling, i.e. some costs are under the influence of more than one person, e.g. power costs. Managers may overestimate costs so that they will not be blamed in the future should they overspend.
Characteristics of a budget
A good budget is characterised by the following: Participation: involve as many people as possible in drawing up a budget. Comprehensiveness: embrace the whole organisation. Standards: base it on established standards of performance.
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Flexibility: allow for changing circumstances. Feedback: constantly monitor performance. Analysis of costs and revenues: this can be done on the basis of product lines, departments or cost centres.
Budgetary Control
d) Budget manual: This document: charts the organisation details the budget procedures contains account codes for items of expenditure and revenue timetables the process clearly defines the responsibility of persons involved in the budgeting system. Budget preparation Firstly, determine the principal budget factor. This is also known as the key budget factor or limiting budget factor and is the factor which will limit the activities of an undertaking. This limits output, e.g. sales, material or labour. a) Sales budget: this involves a realistic sales forecast. This is prepared in units of each product and also in sales value. Methods of sales forecasting include: sales force opinions market research statistical methods (correlation analysis and examination of trends) mathematical models. In using these techniques consider: company's pricing policy general economic and political conditions changes in the population competition consumers' income and tastes advertising and other sales promotion techniques
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Budgetary Control
after sales service credit terms offered. b) Production budget: expressed in quantitative terms only and is geared to the sales budget. The production manager's duties include: analysis of plant utilisation work-in-progress budgets. If requirements exceed capacity he may: subcontract plan for overtime introduce shift work hire or buy additional machinery The materials purchases budget's both quantitative and financial. c) Raw materials and purchasing budget: The materials usage budget is in quantities. The materials purchases budget is both quantitative and financial. Factors influencing a) and b) include: production requirements planning stock levels storage space trends of material prices. d) Labour budget: is both quantitative and financial. This is influenced by: production requirements man-hours available grades of labour required
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wage rates (union agreements) the need for incentives. e) Cash budget: a cash plan for a defined period of time. It summarises monthly receipts and payments. Hence, it highlights monthly surpluses and deficits of actual cash. Its main uses are: to maintain control over a firm's cash requirements, e.g. stock and debtors to enable a firm to take precautionary measures and arrange in advance for investment and loan facilities whenever cash surpluses or deficits arises to show the feasibility of management's plans in cash terms to illustrate the financial impact of changes in management policy, e.g. change of credit terms offered to customers. Receipts of cash may come from one of the following: cash sales payments by debtors the sale of fixed assets the issue of new shares the receipt of interest and dividends from investments. Payments of cash may be for one or more of the following: purchase of stocks payments of wages or other expenses purchase of capital items payment of interest, dividends or taxation.
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Budgetary Control
Reporting back
During the year the management accountant will prepare statements, as quickly as possible after each operating period, in our example, each quarter, setting out the actual operating costs against the budgeted costs. This statement will calculate the difference between the 'budgeted' and the 'actual' cost, which is called the 'variance'. There are many ways in which management accounts can be prepared. To continue with our example of harvesting on the sugar cane farm, management accounts at the end of the third quarter can be presented as shown in figure 4.6.
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Budgetary Control
Labour
The difference between actual labour costs and budgeted or standard labour costs is known as direct wages variance. This variance may arise due to a difference in the amount of labour used or the price per unit of labour, i.e. the wage rate. The direct wages variance can be split into: i) Wage rate variance: the wage rate was higher or lower than budgeted, e.g. using more unskilled labour, or working overtime at a higher rate. ii) Labour efficiency variance: arises when the actual time spent on a particular job is higher or lower than the standard labour hours specified, e.g. breakdown of a machine.
Materials
The variance for materials cost could also be split into price and usage elements: i) Material price variance: arises when the actual unit price is greater or lower than budgeted. Could be due to inflation, discounts, alternative suppliers etc. ii) Material quantity variance: arises when the actual amount of material used is greater or lower than the amount specified in the budget, e.g. a budgeted fertiliser at 350 kg per hectare may be increased or decreased when the actual fertiliser is applied, giving rise to a usage variance.
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Budgetary Control
Overheads
Again, overhead variance can be split into: i) Overhead volume variance: where overheads are taken into the cost centres, a production higher or lower than budgeted will cause an overor under-absorption of overheads. ii) Overhead expenditure variance: where the actual overhead expenditure is higher or lower than that budgeted for the level of output actually produced. Calculation of price and usage variances The price and usage variance are calculated as follows: Price variance = (budgeted price - actual price) X actual quantity Usage variance = (budgeted quantity - actual quantity) X budgeted price Computation of labour variances It was budgeted that it would take 200 man days at $10.00 per day to complete the task costing $2,000.00 when the actual cost was $1,875.00, being 150 man days at $12.50 per day. Calculate: i) Price variance ii) Usage variance Comment briefly on the results of your calculation.
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Budgetary Control
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Budgetary Control
year on a rolling basis, so that each sector does a zero base budget every five years or so.
Key terms
Budgeting Budgetary control Budget preparation Management action and cost control Master budget Price and quantity variance Responsibility centres Zero based budgeting
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