Budgeting and Finance Course

8/4/2019 Budgeting and Finance Course

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SESSION 4: BUDGETING & FINANCE

Objectives of this seminar:

To introduce the concept of Accounts and Bookkeeping

Main accounting concepts including double-entry, depreciation, accruals and

prepayments

Accounting Financial statements: Profit and Loss Account, Balance Sheet and

Cash Flow Statement

Budgets and Control

Analysis of Accounts

Introduction to Cost Centre Concept


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The Accounting Concept

Accounting is the language used by businesses to determine not only how their

business is performing, but more importantly, to identify whether the business

is profitable or not.

The Accounting Concept is attributed to the works of a 15th century monk who

studied and developed the concept of bookkeeping as the means of keeping

organizational records.

Accounting subsequently developed from bookkeeping as the method of

maintaining records for profit-oriented organizations.


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The Accounting Equation

The Accounting equation is composed of the following items:

Capital, which is defined as being all those items, and not only money, which

are introduced into an organization by the owner(s) of the business.

Assets, which are all those items which belong to the business, or else aredue to the business.

Liabilities, which are all those items which are borrowed by the business, or

else are due to someone else.

The Accounting Equation is the following:

ASSETS = CAPITAL + LIABILITIES


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Example of the Accounting Equation

When a supermarket is opened, the owner introduces Lm10,000 cash,

Lm25,000 worth of Furniture and Lm15,000 worth of groceries. At this point,

the total Assets of the supermarket amount to Lm50,000. The Accounting

Equation is therefore:


Lm50,000 = Lm50,000 + Lm0

Following the first day of operations, the owner sells Lm2,000 worth of

groceries for cash and reorders another Lm5,000 worth of groceries from

suppliers. The Accounting Equation has now changed to the following:


Lm55,000 = Lm50,000 + Lm5,000


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Classification of Items in Accounting - I

Accounting is composed of the following different groups or items:

Fixed Assets, which refer to those assets which are purchased by the business

or introduced into the business by the owner(s), which will be retained within

the business for a considerably long period of time, normally more than one

year.Examples are Land and Buildings, Machinery, Motor Vehicles and

Furniture.Current Assets, which refer to those assets which are purchased by the

business or introduced into the business by the owner(s), which will be resold

or disposed of within a short period of time, which is normally less than one

year. Examples are Stock, Debtors, Prepaid Expenses, Cash at Bank and

Cash in Hand.

Long-Term Liabilities, which refer to those liabilities which will be repaid

after a considerably long period of time, which is normally more than one

year. Examples are Bank Loans, Loans from individual businesses and any

long-term creditors


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Classification of Items in Accounting - II

Current Liabilities, which refer to those liabilities which will be repaid

within a short period of time, normally within one year. Examples are

Expenses Owing, Creditors, Dividends Payable and Revenues Prepaid.

Revenues, which refer to all those earnings that the business earns during a

financial year. Revenues are accounted for when they are earned, and notwhen the actual money is received. Examples are Sales, Rent Receivable,

Interest Receivable and Commission Receivable.

Expenses, which refer to all those payments made by the business in its daily

operations. Similar to revenues, expenses are accounted for when they are

incurred, and not when the actual money is paid. Examples are Wages &Salaries, Rent, Water & Electricity, Stationery, Motor Vehicles Expenses and

Depreciation.


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Double-Entry Records

Accounting is based on the Double-Entry System, which necessitates that for

every debit entry made in one account, a simultaneous credit entry must be

made in another account. For example, a payment of rent by cash of Lm40

will result in an increase in the rent paid for the year of Lm40, but a decrease

in the amount of cash held by the business of Lm40.

The Double-Entry System for Assets, Liabilities, Capital, Revenues and

Expenses is the following:-

In the case of Assets and Expenses, an increase in the account is illustrated

by debiting the account, whilst a decrease is accounted for by crediting the

account.

In the case of Liabilities, Capital and Revenues, an increase in the accountis illustrated by crediting the account, whilst a decrease is accounted for by

debiting the account.


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Books of Accounts

The main books of accounts are the following:-

The General Ledger, in which all accounts with the exception of debtors and

creditors, cash and bank accounts.

The Sales Ledger, in which are kept the accounts of all debtors.

The Purchases Ledger, in which are kept the accounts of all creditors.Apart from these main books, a business also keeps the following books of prime entry:-

The Cash Book, in which are kept the Cash and Bank accounts.

The Sales Journal, in which are recorded all credit sales.

The Purchases Journal, in which are recorded all purchases made on credit.

The Returns Inwards Journal, in which are recorded all returns inwards from

debtors.

The Returns Outwards Journal, in which are recorded all returns outwards to

creditors.

The Journal, which is kept to record all corrections to errors made in the accounts.


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Main Accounting Statements

The main accounting statements that are kept by businesses are:-

The Trial Balance, in which all outstanding debit and credit balances arematched and the totals of which must agree. If these totals do not agree,

then there are some errors in the accounts.

The Profit and Loss Account, from which a business determines whether it

would have made a profit or loss for a particular period of time, normally

one year.

The Balance Sheet, which illustrates the financial position of a business at

a particular point in time. This statement is a translation of the

Accounting Equation, as the two totals of the balance sheet showing the

assets, liabilities and capital must agree. If these two balances do not

agree, then a mistake has been made in drawing up the Profit and Loss

Account and the Balance Sheet.

The Cash Flow Statement, which is a statement illustrating the financial

liquidity of a business. In this statement are illustrated the main cash

inflows, which are subsequently matched against the main cash outflows to

determine the cash position as at a particular date. Similar to the Balance

Sheet, this is a statement of the business position at a particular point in

time.


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Example of a Trial Balance

The Trial Balance is made up of two columns - one for the debit account balances and the

other for the credit account balances. A typical Trial Balance is the following:

e t a i l s

e b i t (

m ) r e d i t (

m )

Land and Buildings 25,000

Motor Vehicles 16,000

Capital 48,000

Stock 2,500

Cash at Bank 8,500

Creditors 50,000

Debtors 68,000Rent 3,000

Commission Receivable 8,500

Water & Electricity 5,000

Wages & Salaries 80,000

Motor Expenses 6,500

Rent Receivable 15,200

Furniture 14,000

Loan from Bank of Valletta 150,000

Interest on loan 4,000

Cash in Hand 150

Depreciation on Motor Vehicles 5,000

Depreciation on Furniture 3,500

Bad Debts 5,200

Stationery 6,350

Computers 19,000

271,700 271,700


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Example of a Profit & Loss AccountThe Profit and Loss Account involves the matching of all revenues earned by the company against

all expenses incurred by the company during a particular period. A typical Profit and Loss

Account is the following:

Lm Lm

Opening Stock 300 Sales 6,700

add Purchases 4,260

4,560

less Closing Stock (550)Cost of Goods Sold 4,010

Gross Profit c/d 2,690

6,700 6,700

Wages 520 Gross Profit b/d 2,690

Lighting and Heating 190

Rent 240

General Expenses 70

Carriage Outwards 110

Net Profit 1,560

2,690 2,690

Trading and Profi t and Loss Ac count for the year ended 31st ecem ber 1996

wift


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Example of a Balance Sheet

The Balance Sheet illustrates a companys financial position at a particular point in time, similar to

a photograph of the organizations financial health. A typical Balance Sheet is the following:

Lm Lm

Fixed Assets Capital

Buildings 2,000 Balance at 1st January 1999 2,100

Fixtures and Fittings 750 add Net Profit for the year 1,560

2,750 3,660

less Drawings (900)

Current Assets 2,760

Stock 550

Debtors 1,200 Long-Term Liability

Bank 120 Loan from J Marsh 1,000Cash 40

Current Liabilities

Creditors 900

4,660 4,660

B Bryant

Balance Sheet as at 31st December 1999


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Example of a Cash Flow Statement

The Cash Flow Statement enables management determine the financial health of an

organization. A typical Cash Flow Statement is the following:

Lm Lm

Source of Funds

Net t 11,

Depreciation 2, 10

Cash romsaleofFixed Assets 450

Increasein addebts provision 380

Decreasein tock 2,320Increaseincreditors 1,590

SaleofFixed Assets 900

NewCapitalIntroduced 600 8,850

Funds Generated from Operations 19,920

less outsource of funds

Increasein Debtors (5, 20)

Loanrepaidto J orsey (6,000)

Drawings (8,560)

Funds Applied in the Business (20,280)

DecreaseinCash Funds (360)

Represented by:

Cashand BankBalancesat1st January1999 4,060

Cashand BankBalancesat31st December1999 3, 00

(360)

Cash Flow Statement for the year ended 31st December 1999

R Lester


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Question One:

XYZ Ltd presents the following balance sheet as at 30th June 2000:

During the month of July 2000, the company bought Lm50,000 worth of goods. It paid for

Lm47,500 of this and also for the Lm3,500 owed at the beginning of July. Not all the goods

were sold and the value of goods in stock at the end of July was Lm6,500.

The company also paid out Lm80,800 in other expenses, and paid the tax due. There was tax

owing of Lm2,500 at the end of July. In addition, a van was bought for Lm12,000, and the

total depreciation charge for the month worked out at Lm3,200.

Sales during July were Lm140,000, most of which was paid for with cash, except for one

invoice for Lm6,000 which was unpaid at the end of July. The Debtors of Lm1,300 all paid

up what they owed. Finally, it was decided that a dividend of Lm3,000 would be paid at the

end of August 2000.

You are to draw up the Profit and Loss Account, Balance Sheet and Cash Flow Statement for

the month of July 2000

F ixe d A sse ts 4 ,0 0 0 T ra d e C re d ito rs 3 ,5 0 0

S to c k s 2 ,5 0 0 A c c rue d T a xa tio n 1 ,5 0 0

D e b to rs 1 ,3 0 0

C a sh 5 ,0 0 0 C a p ita l 7 ,8 0 0

1 2 ,8 0 0 1 2 ,8 0 0


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TheMain Accounting Concepts I

The Going Concern Concept

For the Final Accounts to be accurate, it is assumed that an organization will continuein existence for the foreseeable future, unless there is strong evidence to suggest thatthis is not the case. It is important to ensure that this assumption is correct, because adifferent set of accounting rules would be adopted if its immediate future is uncertain.

TheMateriality Concept

Strict application of the various accounting rules may not always be practical. Itcould involve work that may be out of proportion to the information that is eventuallyobtained. The materiality rule permits other rules to be ignored if the effects are notconsidered to be MATERIAL, that is, if they are not significant. If a certain item isIMMATERIAL, then it does not matter how it is shown in the accounts, because itcannot possibly have any effect on the results.

The Accruals Concept

A misleading impression would be given if the cash received was simply comparedwith the cash paid out during the same period. Account must also be taken foramounts owed to an organization at the end of an accounting period and amountspayable by the organization at the end of that same period. Such a system enables allthe incomes of one period to be MATCHED fairly against all the costs of the same

period.


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The Prudence Concept

The preparation of the Final Accounts of a particular period must not be over-optimistic and too confident about future events. There may be, for example, undue

optimism over the credit-worthiness of a particular customer. Insufficient

allowance may, therefore, be made for the possibility of a bad debt. This might

have the effect of overstating the profit in one particular period, and understating it

in a future period. The Prudence rule is expressed in the form of a simple maxim:

IF THERE EXISTS A DOUBT, OVERSTATE LOSSES AND UNDERSTATEPROFITS.

The Consistency Concept

This rule states that once specific accounting policies have been adopted, then they

should be followed in all subsequent accounting periods. It would be considered tobe quite unethical to change those rules just because they were unfashionable, or

because alternative ones gave better results. Of course, if the circumstances change

radically, it may be exceptionally necessary to adopt different policies. The

application of this rule gives confidence to users of accounting statements. If the

accounts have been prepared on a CONSISTENT BASIS, the users can be assured

that they are comparable with previous sets of accounts.

TheMain Accounting Concepts II


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Depreciation on Fixed Assets

In the case of most Fixed Assets except Land and Buildings , it is a fact that the value of

such Fixed Assets will diminish over time. This loss of value is called DEPRECIATION,

and is a non-financial cost to the company, included with other expenses in the Profit andLoss Account.

The three basic causes of depreciation are:

Wear and Tear, as things get worn out with use.

Obsolescence, as things become out-of-date or old-fashioned.

Age, as second-hand assets are not as valuable as brand-new items.

The main method of calculating depreciation in accounts is the STRAIGHT-LINE

method.

Having purchased the fixed asset, the steps involved in determining depreciation are:

Estimate the useful life of the asset.

Decide if there will be any value at the end of this period termed the residual

value

The difference between purchase price and residual value is the amount to be writtenoff over the life of the asset.

The Straight-Line method involves charging the same amount of depreciation every

year. This calculation is made from the following formula:-

COST - ESTIMATED RESIDUAL VALUE

ESTIMATED NUMBER OF YEARS OF USEFUL LIFE


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Example of Provision for Depreciation

Eddie bought a van for Lm5,000. He estimated that it would last four years

and would be worth Lm200 at the end.

To calculate the amount of depreciation to be provided for each of the four

years, the formula used is:

COST - ESTIMATED RESIDUAL VALUE

ESTIMATED NUMBER OF YEARS OF USEFUL LIFE

= Lm5,000 - Lm200

4 years

= Lm ,200 per annum


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Capital and Revenue Expenditure

Capital Expenditure refers to that expenditure incurred in procuring

either fixed assets or parts of fixed assets, or else expenses that are

required in order to improve the fixed asset or even to start working

with the fixed asset.

Examples, apart from the purchase price of a fixed asset such as

machinery or motor vehicles, include installation charges, training to

staff to commence working on the respective machinery, extensions

to buildings and other start-up costs.

Revenue Expenditure refers to that expenditure incurred by abusiness in operating the fixed assets.

Such expenses include petrol, service and maintenance, repairs

(motor vehicles), repairs and maintenance (buildings and machinery)

and computer upgrades.


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Interpretation of Accounting Statements

Whilst it is useful to be able to describe the contents of a companys accounts,

and to be able to say what the words mean, it is possible to get considerablymore out of the accounts if these are analysed.

In analysing a companys accounts, it is important to determine for which

reason these are being seen. For example, if accounts are analysed to

determine growth potential, different questions would be asked than if

accounts were to be analysed to determine the risks and rewards of identified

options.

The first step to take in analysing accounts is to classify the different questions

to be asked into categories, so that one can focus attention on one aspect of the

company at a time.

Secondly, the amounts indicated in the financial statements should be reduced

to manageable size and converted into ratios. Having determined the ratios, these should then be compared with other similar

ratios, because the only sensible way of drawing a conclusion about a ratio is to

use it to make a comparison.

Once comparisons have been made, it is possible to draw conclusions which

enable better views to be derived than before such ratios were determined.


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Profitability Ratios

Since it is not possible to tell by a quick glance at the accounts whether any

profits made are satisfactory, measures of profitability are available to help us

decide. The major ratios used are:

Return on Capital Employed (ROCE): Net Profit x100%

Total Capital Employed

Gross Profit to Sales: Gross Profit x 100%

Sales Net Profit to Sales: Net Profit x 100%

Sales

Earnings per Share: Profit after tax and dividends

Number of Issued Ordinary Shares

Dividend per Share: Total Dividends payable

Number of Issued shares

Dividend Cover: Earnings per share

Dividend per share

Dividend Yield: Dividend per share x 100%

Market price per share


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Liquidity Ratios

Liquidity ratios attempt to determine a companys financial health. Such ratios

help us decide whether the company is in danger of being short of money to

meet debts. The major ratios used are:

Current Ratio: Current Assets

Current Liabilities

Acid Test Ratio: Current Assets - Stock

Current Liabilities

Interest Cover: Total Profit

Interest Paid

Loan Cover: Fixed Assets (at book value)

All medium and long-term debt


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Gearing

Gearing analyses a companys capital structure. In other words, throughgearing it is possible to determine how much of the total capital employed is

owned by shareholders, and how much of it is owed to third parties through

loans, long-term credits and other long-term liabilities. Such a position is

found through a single ratio:

Gearing Ratio: Total Borrowed Capital x 100%

Total Share Capital

The question of whether high gearing is better than low gearing is not a clear-

cut case. In times of high profitability, high gearing is preferred since less

shareholding will eventually result in higher dividends being earned.

However, in times of low profitability, companies with high levels ofborrowing are at risk since their commitments will have to be met, irrespective

of the levels of profits earned.

It is very difficult to determine which is the acceptable level of gearing, as this

depends on the company, its products, markets, industry life cycle, how much

risk the owners and directors of the company are prepared to take.


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Example of Interpretation of Accounting Statements The following figures are for AB Engineering Supplies Ltd at 31st December 1999

Lm000s

Turnover 160

Gross Profit 40

Expenses 8

Fixed Assets 108

Current Assets

Stock 10Debtors 8

Bank 2 20

128

Current liabilities 10

Capital 118

128Calculate:

(i) Gross Profit as a percentage of Sales

(ii) Net Profit as a percentage of Sales

(iii) Net Profit as a percentage of Total Capital Employed

(iv) Current Ratio

(v) Acid Test Ratio


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Solution to Example of Interpretation of Accounting Statements

Gross Profit as a percentage of Sales:

Gross Profit x 100% = 40 x 100% = 25%

Sales 160

Net Profit as a percentage of Sales:

Net Profit x 100% = (40 - 8) x 100% = 20%

Sales 160

Net Profit as a percentage of Total Capital Employed:

Net Profit x 100% = (40 - 8) x 100% = 25%

Fixed Assets + Current Assets 128

Current Ratio:Current Assets = 20 = 2 : 1

Current Liabilities 10

Acid Test Ratio:

Current Assets - Stock = (20 - 10) = 1 : 1

Current Liabilities 10


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Question Two The summarized accounts of Hope Ltd for the years 1998 and 1999 are given below. Calculate the following ratios for

1998 and 1999:

Gross Profit as a percentage of Sales

Net Profit as a percentage of SalesCurrent Ratio

Acid Test Ratio

Net Profit as a percentage of Capital Employed

Expenses as a percentage of Sales

Sales as a percentage of Capital Employed

1998 1999Lm s Lm s

Sales 8

Less Cost of Sales 1 1

Gross Pro fit

Less Administration Expenses 8

Less ebenture nterest

Net Profit 1

1998 1999 1998 1999

Lm s Lm s Lm s Lm s

rdinary Share Capital 1 1 ixed assets 11 1

Profit and Loss Account 1 Stoc

8 ebentures ebtors 8

Creditors 1 1 an

an verdraft 1

1 1

Trading and Pro fit and Loss Accounts for the year ended 1st ecember

alance Sheets as at 1st ecember


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Budgets and Budgetary Control

A budget is a statement which expresses somebodys plans in quantitative,

usually monetary, terms.

The purpose of a budget is to give a manager the chance to determine for

himself precisely how the part of the company for which he is responsible will

perform.

A budget also enables the Finance Department to plan how much money to

borrow or invest at different times of the year.

Individual departmental budgets form the basis by which total operating and

financial plans can be made, as well as providing individual managers with a

measure of their own performance.

Apart from companies, budgets may also be used on a personal basis for

individuals private affairs; income and expenditure are estimated and balanced

to ensure that they have enough money in the bank.

Budgetary Control is the name given to the control system which uses budgets

as the basis for monitoring actual performance.


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Key elements of a good control system

There must be a plan, which may be expressed as a target, which must be capable of being

compared with what is actually happening.

Performance must be monitored as planned performance is compared with what is actually

happening. For such monitoring to take place, the accounting information in the budget

must be presented in the same way as the information in the actual accounts.

Such monitoring must be made often to ensure that any variations between planned

performance and actual events are identified before serious effects occur. Variances must be reported to the responsible manager, representing a feedback loop. All

significant variances should then be fed back to the person responsible for the respective

budget, in order to determine the cause and what action will be taken to make up for the

variance.

A decision must be taken by the responsible manager with regards to the action to take.

Such action will be a choice from three options: do nothing at all, change the planned

budget, or adjust operations.

Often an adverse variance is used as a way of checking a managers performance. On the

other hand, if the variance is favourable, too often nothing is said or done. When things are

going according to plan, it is worth informing the people involved of the good news, as this

has a threefold effect: it stops them worrying, it helps them resist the temptation to

overbudget, and they feel good.


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The Benefits of Budgeting

The following benefits may be derived from the budgeting process:

Planning and Coordination. Planning is the key to success in business and budgeting

forces planning to take place. Moreover, budgeting provides for the coordination of

the activities and departments of the organisation so that each facet of the operation

contributes towards the overall plan.

Clarification of Authority and Responsibility. Budgeting makes it necessary to

clarify the responsibilities of each manager who is responsible for a budget. As a

result, employees are able to clarify the authority and responsibility channels withinwhich they have to work.

Communication. Since the budgetary process involves all levels of management, this

is an important avenue of communication between top and middle management

regarding the companys objectives and practical problems of implementing such

objectives. Budgeting also communicates the agreed plans to all staff involved to

ensure that coordination is achieved.Control. The process of comparing actual results with planned results and reporting

on the variations sets a control framework which helps expenditure to be kept within

agreed limits.

Motivation.The involvement of lower and middle management in preparing budgets

and establishing clear targets against which performance is judged have been found to

be motivating factors.


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Typical problems which may arise with budgeting

The following problems may also arise during the budgeting process:

Variances are frequent due to changing circumstances.

Budgets are developed around existing organisation structures

which may be inappropriate for current conditions.

The existence of well documented plans may cause inertia and lack

of flexibility in adapting to change.

Badly handled budgetary systems which cause undue pressure or

lack of regard to human resources may cause antagonism and maylower morale.


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Master Budget The Master Budget refers to the overall Budgeted Operating Statements (normally the Profit and

Loss Account and the Balance Sheet), which is composed of the different budgets that are

compiled by the different departments. The following relates to the relationships between the major budgets in a manufacturing

company:

Production

Overheads Budget

Production Budget

Selling &

istribution Budget

Material

sage

Budget

ebtors Budget

inished oods

Stoc

Budget

Sales Budget

Administration

osts Budget

irect Labour

Budget

apital penditure

Budget

Purchases Budget reditors Budget

esearch & evelopment

Budget

ash Budget

Master Budget ( ie

Budgeted Profit andLoss Account and

Balance Sheet


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Main Budgets

The main budgets that are normally developed are the following:

Sales Budget, incorporating the expected amount of sales revenues

from the different products and/or services that the company sells.

Production Budget, which shows the different estimated costs of

production from labour, materials and overheads expenses.

Normally the Production Budget derives a production cost per unit,

which is then used in defining the total cost of goods sold.

Capital Expenditure Budget, which indicates the major capital

costs that are expected to be incurred during the budget period. Ascapital expenditure affects cash flows, this budget represents an

important input to identifying cash available for investments.

Cash Budget, which illustrates the companys liquidity expected

positions throughout the budgeted period.


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Limiting Factor or Principal Budget Factor

The limiting factor is that factor which at any given time effectively

limits a companys activity. Such a factor may be customer demand,

production capacity, shortage of labour or materials, space or

finance.

Because this factor constrains all plans and budgets, the limiting

factor must be identified together with its effect on each of the

budgets considered during the budget preparation process.

Frequently, the limiting factor is customer demand or sales revenue,

since a company normally has a specified market share. The

company is therefore unable to sell all the output it can produce. The limiting factor can and does change, as when one constraint is

removed some other limitation will occur. Therefore, any increase in

market share will not necessarily enable the company to increase

production, as this may be limited in production capacity.


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Example of Budgets R Ltd manufactures three products: A, B and C. Using the following information, you are required toprepare budgets for the month of January for: (i) sales in quantity and value; (ii) production quantities;(iii) material usage in quantities; (iv) material purchases in quantity and value.

Product Quantity Price each

Sales A 1,000 Lm100

B 2,000 Lm120

C 1,500 Lm140

Materials usedinthe companys products are:

Material M1 M2 M3Unit Cost Lm4 Lm6 Lm9

Quantities usedin units:

Product A 4 2 --

Product B 3 3 2

Product C 2 1 1

Finished Stocks:

Product A B C

Quantities at 1st January 1,000 1,500 500

Quantities at 31st January 1,100 1,650 550

MaterialStocks: M1 M2 M3

Quantities at 1st January 26,000 20,000 12,000

Quantities at 31st January 31,200 24,000 14,400


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Solution to Example of Budgets

A B C Total Value

Sales quantities (units) 1,000 2,000 1,500

Selling Price (per unit) Lm100 Lm120 Lm140

Sales Value Lm100,000 Lm240,000 Lm210,000 Lm550,000

A B C

Sales (units) 1,000 2,000 1,500

Add Closing Stock 1,100 1,650 550

2,100 3,650 2,050

Less Opening Stock (1,000) (1,500) (500)Required Production 1,100 2,150 1,550

Production Budget

M1 M2 M3

Units Total Units Total Units Total

A 1,100 4 4,400 2 2,200 Nil Nil

B 2,150 3 6,450 3 6,450 2 4,300

C 1,550 2 3,100 1 1,550 1 1,550

Material Usage 13,950 10,200 5,850

M1 M2 M3 Total

Usage from budget 13,950 10,200 5,850

Add Closing Stock 31,200 24,000 14,400

45,150 34,200 20,250

Less Opening Stock (26,000) (20,000) (12,000)

Required Purchases 19,150 14,200 8,250

Unit Cost Lm4 Lm6 Lm9

Value of Purchases Lm76,600 Lm85,200 Lm74,250 Lm236,050

Materials

(iii) Material Usage Budget

Materials

(iv) Material Purchases Budget

Products

(i) Sales Budget

Products

(ii) Production Budget


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Variance Analysis

A variance is the difference between the standard or budgeted cost,and the actual cost incurred.

The only purpose of variance analysis is to provide practical

information on the causes of adverse company performance, so that

management can improve operations, increase efficiency, utilise

resources more effectively and reduce costs. The only criteria used to determine whether a variance should be

calculated or not is its usefulness. If the variance to be calculated is

not useful for management purposes, it should not be produced.

Variances are qualified into three main areas: Labour, Materials and

Overheads.

Variances may be adverse (actual cost greater than standard) or

favourable (actual cost less than standard)

Each variance may be calculated according to two measurement

criteria: price or rate, and usage.


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Labour Variances

Labour variances arise from the different wage rates paid as well as the longer

or shorter times required to produce the actual quantities produced.

There are three labour variances normally calculated:

Direct Labour Rate Variance: defined as the difference between the

standard and actual direct labour hour rate per hour for the total hours

worked.

(Actuallabourhours x Actualrate) - (Actuallabourhours x Standardrate)

Direct Labour Efficiency Variance: defined as the difference between the

standard hours for the actual production achieved and the hours actually

worked, valued at the standard labour rate.

(Actuallabourhours x Standardrate) - (Standardlabourhours x Standardrate)Direct Labour Total Variance: defined as the difference between the

standard direct labour cost and the actual direct labour cost incurred for the

production achieved.

This is foundbyaddingthe Direct Labour Rateand Direct Labour Efficiency

variances


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Materials Variances

Materials are charged to production at the standard price. Variances are subsequently

calculated as they arise, resulting in a price variance which may be related to individual

functions.

There are three materials variances normally calculated:

DirectMaterials Price Variance: defined as the difference between the standard

price and actual purchase price for the actual quantity of material. (Actual purchase quantity x Actual price) - (Actual purchase quantity x Standard price)

DirectMaterials Usage Variance: defined as the difference between the standard

quantity specified for the actual production and the actual quantity used, at standard

purchase price.

(Actual quantity used x Standard price) - (Standard quantity used x StandardPrice)

DirectMaterials Total Variance: defined as the difference between the standard

direct material cost of the actual production volume and the actual cost of direct

material.

This is foundbyaddingthe Direct Materials Priceand Direct Materials Usagevariances


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Fixed Overheads Variances I

Fixed overhead variances relate to those overheads which are fixed in nature, and

relate to those expenses that are frequently incurred in equal amounts.

Fixed overheads are normally absorbed into production costs, resulting in the

calculation of a Fixed Overhead Absorption Rate. This is found by dividing the

budgeted fixed overheads with the standard hours produced.

There are five fixed overheads variances normally calculated:

Fixed Overhead Expenditure Variance: defined as the difference between the

budget cost allowance for production for a specified control period and the actual

fixed expenditure attributed and charged to that period.

(Actualexpenditure onfixed overheads) - (Budgetedfixed overheads)

Fixed Overhead Efficiency Variance: defined as the difference between thestandard cost absorbed in the production achieved and the actual direct labour

hours worked.

(Actuallabourhours x Fixed OverheadAbsorption Rate) - (Standard

labourhours x Fixed OverheadAbsorption Rate)


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Fixed Overheads Variances II

Fixed Overhead Capacity Variance: defined as that portion of the fixed

production overhead volume which is due to working at higher or lower

capacity than the standard.

(Budgeted Fixed Overheads) - (Actuallabourhours x Fixed Overhead

Absorption Rate)

Fixed Overhead Volume Variance: defined as the difference between the

standard cost absorbed in the production achieved and the budget cost

allowance for a specified control period.

This is thefoundbyaddingthe Fixed Overhead Efficiencyand Fixed

Overhead Capacityvariances

Fixed Overhead Variance: defined as the difference between the standard

cost of fixed overhead absorbed in the production achieved and the fixed

overhead attributed and charged to that period.

This is foundbyaddingthe Fixed Overhead Expenditureand Fixed

Overhead Volumevariances


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Variable Overheads Variances

Variable overhead variances cover those overheads that are of a variable nature. In

other words, variable overheads are related to the level of production, and are not time-

based or fixed in any other way.

Variable Overheads are normally absorbed into production costs, resulting in the

calculation of a Variable Overhead Absorption Rate. This is found by dividing the

budgeted variable overheads with the standard hours produced.

There are three variable overheads variances normally calculated:

Variable Overhead Expenditure Variance: defined as the difference between theactual variable overheads incurred and the allowed variable overheads based on the

actual hours worked.

(Actualvariable overheads) - (Actuallabourhours x Variable OverheadAbsorption Rate)

Variable Overhead Efficiency Variance: defined as the difference between the

allowed variable overheads and the absorbed variable overhead.

(Actuallabourhours x Variable OverheadAbsorption Rate) - (Standardlabourhours x

Variable OverheadAbsorption Rate)

Total Variable Overhead Variance: defined as the difference between the actual

variable overheads incurred and the variable overheads absorbed.

This is foundbyaddingthe Variable Overhead Expenditureand Variable Overhead

Efficiencyvariances


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Example of Variances I

The following is an abstract from the Standard Cost Card for Part No. 100X, and actual

results for the month of May:Standard Cost Card(abstract) Part No. 100X

Standard Cost/Unit

Raw Materials 50Kgs @ Lm2.50/Kg Lm125

Direct Labour 14 hours @ Lm2.75/hour Lm 38.50

Lm163.50

Actual Results for May

Production 150 units

Direct Material Purchases 7000 Kgs at a cost of Lm18,200

Opening Stock Direct Materials 1300 Kgs

Closing Stock Direct Materials 850 Kgs

Wages paid (2020 hours) Lm5,858


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Solution to Example of Variances IDirect Labour Rate Variance

(Actuallabourhours x Actualrate) - (Actuallabourhours x Standardrate)

(Lm5,858) - (2020 hours @ Lm2.75)

= Lm303 Adverse

Direct Labour Efficiency Variance

(Actuallabourhours x Standardrate) - (Standardlabourhours x Standardrate)

(2020 hours @ Lm2.75) - (150 x 14)hours @ Lm2.75

= Lm220 Favourable

Direct Labour Total Variance

Direct Labour Rate Variance + Direct Labour Efficiency Variance

= Lm303 Adverse + Lm220 Favourable

= Lm83 Adverse

DirectMaterials Price Variance

(Actual purchase quantity x Actual price) - (Actual purchase quantity x Standard price)

(Lm18,200) - (7000 Kgs @ Lm2.50)

= Lm700 Adverse

DirectMaterials Usage Variance

(Actual quantity used x Standard price) - (Standard quantity used x StandardPrice)

(7450 Kgs @ Lm2.50) - (150 x 50) @ Lm2.50

= Lm125 Favourable

DirectMaterials Total Variance

Direct Materials Price Variance + Direct Materials Usage Variance

Lm700 Adverse + Lm125 Favourable

= Lm575 Adverse


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Example of Variances II

The following data refers to budgeted and actual results of February for

Department Number 82:

B

udgetfor February: Department No. 82

Fixed Overheads Lm11,480

Variable Overheads Lm13,120

Labour Hours 3,280 Hours

Standard Hours of Production 3,280 Hours

Actualresults for February: Department No. 82Fixed Overheads Lm12,100

Variable Overheads Lm13,930

Actual Labour Hours 3,150

Standard Hours Produced 3,230


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Solution to Example of Variances II

Based on the budgeted figures, the overhead absorption rates are calculated as follows:

Fixed Overhead Absorption Rate = Budgeted Fixed Overheads = Lm11,460 = Lm3.50 per hourBudgeted Activity Level 3280 Std Hours

Variable Overhead Absorption Rate = Budgeted variable overheads = Lm13,120 = Lm4 per hour

Budgeted Activity Level 3280 Std Hours

Fixed Overhead Expenditure Variance

(Actualexpenditure onfixed overheads) - (Budgetedfixed overheads)=(Lm12,100) - (Lm11,480)

= Lm620 Adverse

Fixed Overhead Efficiency Variance

(Actuallabourhours x Fixed OverheadAbsorption Rate) - (Standardlabourhours x Fixed

OverheadAbsorption Rate)

=(3150 x Lm3.50) - (3230 x Lm3.50)

= Lm280 Favourable

Fixed Overhead Capacity Variance

(Budgeted Fixed Overheads) - (Actuallabourhours x Fixed OverheadAbsorption Rate)

=(Lm11,480) - (3150 x Lm3.50)

= Lm455 Adverse


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Fixed Overhead Volume Variance

Fixed Overhead Efficiency Variance + Fixed Overhead Capacity Variance

= Lm280 Favourable + Lm455 Adverse= Lm175 Adverse

Fixed Overhead Variance

Fixed Overhead Expenditure Variance + Fixed Overhead Volume Variance

= Lm620 Adverse + Lm175 Adverse

= Lm 795 Adverse

Variable Overhead Expenditure Variance (Actualvariable overheads) - (Actuallabourhours x Variable OverheadAbsorption Rate)

=(Lm13,930) - (3150 x Lm4)

= Lm1330 Adverse

Variable Overhead Efficiency Variance

(Actuallabourhours x Variable OverheadAbsorption Rate) - (Standardlabourhours x

Variable OverheadAbsorption Rate)

=(3150 x Lm4) - (3230 x Lm4)

= Lm320 Favourable

Total Variable Overhead Variance

Variable Overhead Expenditure Variance + Variable Overhead Efficiency Variance

= Lm1330 Adverse + Lm320 Favourable

= Lm1010 Adverse

Solution to Example of Variances II ...continued


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Question Three

For Product X, the following data is given:

Standards per unit of product:

Direct Material 4 Kg @ Lm0.75 per Kg

Direct Labour 2 Hours @Lm1.60 per Hour

Actual details for given financial period:

Output produced: 38,000 units

Direct materials purchased: 180,000 Kgs for Lm126,000

Direct materials issued to production: 154,000 Kgs

Direct Labour: 78,000 hours worked for Lm136,500

You are required to calculate the following variances:

direct materials total

direct materials price, based on issues to production

direct materials usage

direct labour total

direct labour rate

direct labour efficiency


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Sources of Finance I

An organization mayraisefinancefrom different sources:

Owners capital. Many organizations start with the owner s putting into the

business some or all of their money. This capital is used to buy assets which

the organizations subsequently use in the daily operations of the business.

Share Capital. If the respective organization is a limited liability company,

the capital is divided into shares which are offered to the public for sale. In

exchange for their money, shareholders receive a share certificate stating

that they have a share in the ownership of the company.

Loans. With small companies, loans are often provided from relatives of the

owners, whilst in the case of larger companies, banks normally provide a

large amount, although loans from individuals are also obtained. All loans

are referred to as Loan or Borrowed Capital, and are shown in the Balance

Sheet as Long-Term Liabilities.


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Suppliers. Rather than obtaining money from suppliers, what happens is

that companies normally delay paying their bills, and so has use of its money

a little longer than it should. The difficulty with such financing is that

suppliers may cease to want to do business with companies adopting this

policy, particularly in the case of small companies.

Other creditors. Apart from suppliers, most companies find that they owe

money but have a while before cash has to be paid out. A typical example is

company tax on profits, which is not due until the following year. Dividends

are another example, which are paid at the end of the financial year.

Retained profits. Once a business is making profits, these become the main

source of finance that is generated by the business itself. In fact, what is not

paid out to suppliers, government or shareholders is retained within the

business for daily operations as an addition to the companys capital.

Sources of Finance II


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Capital Budgeting

The allocation of funds for an investment in a project which involves an

outflow of money now in return for future inflows is known as capital

budgeting.

An investment proposal should be judged in relation to whether it provides a

return equal to, or greater than, that required by investors. One of

managements key roles is the selection of projects on which the income fromthe investment exceeds the interest costs of its financing.

The factors which are taken into account in investment appraisals include

(a) the marginal costs and revenues of the project;

(b) the source of funds for the project;

(c) the certainty of the future cash flows;

(d) the timing of the cash flows;

(e) the existence of alternative opportunities;

(f) taxation;

(g) government policy.


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Capital Investment Appraisal

One of the most important tasks in capital budgeting is estimating future cash

flows for a project.

The reason we express the benefits expected in terms of cash flows rather than

in terms of income is that cash is what is central to all the decisions of a

company.

A company invests cash now in the hope of receiving cash returns in a greater

amount in the future.

Only cash receipts can be re-invested in the company or paid to shareholders in

the form of dividends.

For each investment proposal, we need to provide information on expected

future cash flows on an after-tax basis. In addition, the information must be

provided on an incremental basis so that we analyse only the difference

between the cash flows of the firm with and without the project.


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Cash Flows versus Book Values

We are considering the purchase of a machine to replace an old one. The information

available is the following:

Purchase price of new machine: Lm18,500Cost of installation: Lm1,500

Life of new machine: 5 years

Scrap Value: Nil

The old machine can be sold for its book value of Lm2,000. Yearly cash savings before tax

of the new machine is Lm7,600.

We assume that the old machine had 5 more years to run, and that the depreciation is on astraight-line basis (i.e. Lm400 per annum) On the new machine, depreciation is also spread

over 5 years and is therefore Lm4,000 per annum.

Because we are interested in the incremental impact of the project, we must subtract

depreciation charges on the old machine from depreciation charges on the new one to obtain

the incremental depreciation charges associated with the project:

Book Account (Lm) Cash Flow Account (Lm)Annual Cash Savings 7,600 7,600

less Incremental Depreciation (3,600)

Additional income before tax 4,000

less Income Tax (17%) (1,300) (1,300)

Additional income after tax 2,700 _

Additional Net Cash Flow 6,300


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Method One: Accounting Rate of Return

The Accounting Rate of Return represents the average annual profits after

taxes to the average investment in the project.

The main advantages of this method are that it is simple to calculate; and the

fact that it makes use of readily available accounting information, thus

allowing it to be more easily understood by non-financial people.

The disadvantages of this method include the fact that it fails to allow for the

timing of cash flows; and since it is an average, it gives no weight to the

duration of the earnings. Moreover, it is based upon profits and not cash flows,whereby the former are less relevant than the latter in calculating the returns on

investments made.


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Example of Accounting Rate of Return

We are considering three projects with an initial investment of Lm500, zero scrap value, a

life of 5 years, and the following profits, net of tax and depreciation:

Year Project A Project B Project C

Lm Lm Lm

1 50 0 100

2 50 25 75

3 50 50 50

4 50 75 25

5 50 100 0

250 250 250

Calculate: (a) the Return on Initial capital; (b) the Return on Average capital.

(a) The Return on Initial Capital

1/5 x 250 1/5 x 250 1/5 x 250

500 500 500

= 10% 10% 10%

(b) The Return on Average Capital

The average capital is calculated by reference to the opening and closing book values:

i.e. 500 + 0 = Lm250

2

The rate of return on all projects is therefore: 1/5 x 250 = 20%

1/2 x 500


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Method Two: Payback

The payback period is the time it takes for the cash inflows from a project to

amount to the cash outflows. It is one of the most frequently used methods of

measuring the worth of an investment opportunity.

The inflows involved are the average net incremental cash flows, meaning

the increase in revenue plus the savings, if any, in marginal costs.

The earnings to be taken are those after tax, since tax payments diminsh the net

cash inflow, but before depreciation, since the provision for depreciation is

purely a book-keeping transaction with no effect on cash flows. Under this method, the question is: How soon can we expect to recover the

capital invested in the project?

The main advantages of this method are that it is simple to calculate and easily

understood by non-financial people, and when investment conditions are

expected to improve in the near future, attention is directed to those projects

which will release funds soonest to take advantage of the improving climate.

The main disadvantages of this method are that it ignores cashflows after the

payback period, and is hence biased against long-term investments. Moreover,

as the payback method assumes all cash flows to be equally certain, no formal

assessment is given to the risk factor. Normally, estimates of cash flows are

likely to be less reliable the further into the future they are made.


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Example of Payback

It is proposed to introduce a new machine to increase production capacity. Two machines are available, Type

A and Type B. The following information is available:

Type A Type B

Cost of machine Lm30,000 Lm63,000

Estimated life (years) 5 10

Increase in revenue per annum Lm3,000 Lm4,000

No. of operators saved 9 11

Average earnings of operators per annum Lm500 Lm500

Additional maintenance costs Lm1,000 Lm1,500

Expected savings in indirect materials Lm500 Lm200

Expected savings in scrap losses Lm500 Lm800

Statement of expected returns:

Estimated working life 5 years 10 years

Outflow (cost of machine) Lm30,000 Lm63,000

Inflows:

Increase in revenue per annum: Lm3,000 Lm4,000

Savings in direct labour costs Lm4,500 Lm5,500

Indirect labour costs (Lm1,000) (Lm1,500)

Indirect Material savings Lm500 Lm200

Scrap losses savings Lm500 Lm800

Lm7,500 Lm9,000

Payback period in years 4 7


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Method Three: Discounted Cash Flows

A major disadvantage of both the Payback technique and the Accounting Rate

of Return is their failure to take account of the time value of money.

People prefer money now rather than in the future for four reasons:

Ability to spend it, since money held now can be spent immediately.

Reduction of risk: until the money is received, there is a risk that the offer may collapse.

Opportunity cost: money held now can be used within the business for expansion.

Ability to invest: even if the money is not required now, it could be invested to

accumulate a larger sum in the future. If an investment is offering 10% per annum interest payable annually, then the

value of Lm1 at the end of the first year would be Lm1.10. Provided that the

money was left on deposit at this rate, the value at the end of the second year

would be Lm1.10 plus 10% of the re-invested sum of Lm1.10, equivalent to

Lm1.21, and so on for successive years.

In calculating discounted cash flows, all expected cash flows are discounted to

present value using the required rate of return. If the sum of these discounted

cash flows is equal to, or greater than, zero, the proposal is accepted. In other

words, the project will be accepted if the present value of cash inflows exceeds

the present value of cash outflows.


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Present Value of Lm due at the end of N years

N 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

1 0.95238 0.94340 0.93458 0.92593 0.91743 0.90909 0.9009 0.89286 0.88496 0.87719 0.86957 0.86207 0.8547 0.84746 0.84034 0.83333

2 0.90703 0.89000 0.87344 0.85734 0.84168 0.82645 0.81162 0.79719 0.78315 0.76947 0.75614 0.74316 0.73051 0.71818 0.70616 0.69444

3 0.86384 0.83962 0.81630 0.79383 0.77218 0.75131 0.73119 0.71178 0.69305 0.67497 0.65752 0.64066 0.62437 0.60863 0.59342 0.57870

4 0.82270 0.79209 0.76290 0.73503 0.70843 0.68301 0.65873 0.63552 0.61332 0.59208 0.57175 0.55229 0.53365 0.51579 0.49867 0.48225

5 0.78353 0.74726 0.71299 0.68058 0.64993 0.62092 0.59345 0.56743 0.54276 0.51937 0.49718 0.47611 0.45611 0.43711 0.41905 0.40188

6 0.74622 0.70496 0.66634 0.63017 0.59627 0.56447 0.53464 0.50663 0.48032 0.45559 0.43233 0.41044 0.38984 0.37043 0.35214 0.33490

7 0.71068 0.66506 0.62275 0.58349 0.54703 0.51316 0.48166 0.45235 0.42506 0.39964 0.37594 0.35383 0.33320 0.31392 0.29592 0.27908

8 0.67684 0.62741 0.58201 0.54027 0.50187 0.46651 0.43393 0.40388 0.37616 0.35056 0.32690 0.30503 0.28487 0.26604 0.24867 0.23257

9 0.64461 0.59190 0.54393 0.50025 0.46043 0.42410 0.39092 0.36061 0.33288 0.30751 0.28426 0.26295 0.24340 0.22546 0.20897 0.19381

10 0.61391 0.55839 0.50835 0.46319 0.42241 0.38554 0.35218 0.32197 0.29459 0.26974 0.24718 0.22668 0.20804 0.19106 0.17560 0.16151


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Example of Discounted Cash Flow

X Ltd is considering its capital investment programme. It will have to pay

10% per annum to borrow any money required for investment. The following

table shows the net cash flow per annum associated with three different

projects, each having the same initial capital cost of Lm20,000. Evaluate the

ranking of each project:

Net Cash Flows

Year 1 (Lm) Year 2(Lm) Year 3(Lm)

Project A 10,000 10,000 10,000

Project B 12,000 16,000 10,000

Project C 16,000 16,000 Nil


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Solution to Example of Discounted Cash Flow

Year Discounting Factor

at 10% Net Cash Flow Present Value Net Cash Flow Present Value Net Cash Flow Present Value

1 0.9091 10,000 9,091 12,000 10,909 16,000 14,546

2 0.8264 10,000 8,264 16,000 13,222 16,000 13,222

3 0.7513 10,000 7,513 10,000 7,513 NIL NIL

24,868 31,644 27,768

(20,000) (20,000) (20,000)

Net Present Value 4,868 11,644 7,768

Ranking 3 1 2

Project C

Cost

Gross Present Value

Project A Project B

Note that the relative desirability oftheprojects would change with changes in

the discount rate. The higher the discount rate, the more attractive wouldbe

theproject with the early cash inflows. The lower the rate, the less importantis the timing ofthe cash flows and the more valued is theproposal with the

greatest absolute amount ofcash inflows.


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Question Four

A proposal has come before the Board of Directors of Solera Ltd for thepurchase of a machine to manufacture a new product. The expected results for

the five year life of the machine are as follows:

Year 1 Year 2 Year 3 Year 4 Year 5

Lm Lm Lm Lm Lm

Sales 20,000 22,000 23,000 16,000 12,000

Direct Costs 10,000 12,000 13,000 10,000 8,000

Depreciation 6,000 6,000 6,000 6,000 6,000

Total Costs 16,000 18,000 19,000 16,000 14,000

Profit/Loss 4,000 4,000 4,000 NIL (2,000)

Soleras cost of capital is 12% per annum. Would you advise the company to

invest in this machine?


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The Cost Centre Concept

A Cost Centre may be defined as a location, function or items of equipment in respect of which

costs may be ascertained and related to cost units for control purposes.

In practice, a cost centre is simply a method by which costs are gathered together, according totheir incidence, usually by means of cost centre codes.

Cost Centre Number Cost Centre Name Head of Cost Centre

100 Board Secretariat & Compliance Unit Ray Fava

110 Chairman's Office Ivo Galea

120 General Manager's Office Joe Azzopardi

130 Executive Directors Edgar Borg

150 Legal Department Dr Mario Caruana

200 Strategic Business Development Unit Eng R Azzopardi Caffari

250 Business Continuity Eng P Montanaro

310 Finance Department Brenda Azzopardi

350 Credit Control Peter Mifsud

400 Sales Office Charles Zammit

405 Customer Services Unit Charles Zammit

410 Marketing Office Charles Sacco

415 Cardphones Alfred Scicluna

420 Directory Lino Agius Muscat

445 Gozo Office Edward Mizzi

510 General Administration Jesmond Camilleri

515 Risk Management Frank St John

520 Contracts & Procurement Ray Cini

525 Facilities Management Unit Jesmond Camilleri

530 Utilities Services Joe Briffa

535 Stores Mario Tabone

540 Transport Saviour Seychell

550 Human Resources Management Karmenu Mifsud

701 Office of AGM Access Networks Eng M Cachia

703 Infrastructural Works Saviour Portelli

706 Gozo Eng S Debrincat

707 Operations & Maintenance - Acces s Networks Eng. J. Pace

708 Shareholders Relations John Grima Calleja

710 Operations & Maintenance - Switching Eng. A. Ghigo

720 Transmission Department Eng. A. Cassar

725 International Department Eng. M. Farrugia

730 Central Engineering Services Eng J. Agius

790 I.T. Department Eng. S. Baldacchino

800 Annual General Meeting Ray Fava

805 Internal Audit Ingrid Azzopardi


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Cost Allocation and Apportionment

Cost Allocation refers to the charging of identifiable items of costs to cost

centres. In other words, where a cost, without division or splitting, can beclearly identified with a cost centre, then it can be allocated to that cost centre.

It follows that direct costs, such as wages salaries, cables and other materials

can be allocated to particular cost centres. However, cost allocation can

equally apply to indirect costs such as computers, stationery, water and

electricity and rent of premises. Although sometimes it is not possible to identify an item of cost with a cost

centre, it is necessary to split a cost over several cost centres on some agreed

basis. Rent and Water and Electricity, for example, are normally apportioned

according to the floor area occupied by the various cost centres.

The basis upon which the apportionment is made varies from cost to cost. Thebasis chosen should produce, as far as possible, a fair and equitable share of the

common cost for each of the receiving cost centres. The choice of an

appropriate basis is a matter of judgement to suit the particular circumstances

of the organization and wherever possible there should be a cost/cause

relationship.


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Typical Cost Apportionments

Basis Costs which may be apportioned on this basis

Floor Area Rates, Rent, Heating, Cleaning, Lighting,

Building Depreciation

Volume or Space Occupeid Heating, Lighting, Building Depreciation Number of Employees in Canteen, Welfare, Personnel, Safety,

each Cost Centre General Administration, Industrial Relations

Book Value of Plant,

Equipment, Premises, etc Insurance, Depreciation

Stores Requisitions Store-keepingWeight of Materials Store-keeping, Materials Handling

Documents

Budgeting and Finance Course