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INDEX
Introduction..........................................................................................................................11
Task 1
The purpose and nature of the budgeting process..................................................................11
Appropriate budgeting methods for the Sefton Limited and the preparation for budgets according
to the chosen budgeting method..............................................................................................14
Task 2
Operating statement reconciling budgeted and actual results, the calculation of variances, the
identifying causes and recommendation for corrective action.................................................21
Report findings to management in accordance with identified responsibility centers.............27
Conclusion...............................................................................................................................
Reference list...........................................................................................................................
10
Introduction
The purpose of management accounting in any organizations is to support competitive decision
making by collecting, processing, and communicating information that helps management plan,
control, and evaluate business processes and company strategy. A management system, therefore
supplies reliable, accurate information to the management team of a company. These figures are
used for planning for future goals of the company.
Assigned as Management Accountant of Sefton Ltd, this paper has been prepared to analyze in
two parts
Part 1: The purpose and nature of budgeting process, budgeting methods and preparation for
budgets through Budgeted Income Statement, Cash Budget, and Budgeted balance sheet
Part 2: The calculation variances, the operating statement, possible causes in variances with
recommendation, and report to identify responsibility centers
Based on the information, Managing Director of Sefton can improve the budget through
appropriate budgeting methods, and the standard costing system
Task 1
The purpose and nature of the budgeting process
A. Purpose of budgeting process
In a business, making decisions, which affect the
profitability of the company, are occurred every day. To
make effective decisions and coordinate the decisions
and actions of the various departments, a business needs
to have a plan for its operations. Planning the financial
operations of a business is called budgeting. (Purpose
of budget, no date)
11
A budget is ‘A quantitative statement, for a defined period of time, which may include planned
revenues, expenses, assets, liabilities, and cash flows’ [1]
A budget has five main purposes:
Communication In the budgeting process, managers in every department justify the resources
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.
Thus, this communication between superiors and subordinates will help to
ensure the achievement of company’s goals
Coordination Different units in the company must also coordinate the many different tasks
they perform to maximize integration of effort toward common goals
Planning A budget is ultimately the plan for the operations of an organization for a
period of time. Many decisions are involved, and many questions must be
answered. And the managers will decide the most effective ways to achieve
the budget target for the operation under personal control
Control Spending within the budget and having responsibility to achieve revenues
specified within the budget are very important. Budgets and actual revenues
and expenditures are monitored constantly for variations and to determine
whether the organization is on target. If performance does not meet the
budget, action can be taken immediately to adjust activities.
Evaluation Evaluation can be provided by comparing the budget with actual
performance. It is a part of controlling budget, and also provides an
incentive for improving future performance.
(Purpose of budget, no date)
B. Nature of budgeting process
The nature of budgeting process can be summarised by this graph:
12
However, to prepare the budget effectively as a useful financial tool, business must implement
the proper steps:
Step 1: Identification of the principal budget factor
Determining the principal budget factor is also the first task in the budgetary process of any
businesses. 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.
(Budgetary control, no date)
Step 2: Preparation of sales budget
Step 3: Preparation of finished goods stock budget
Step 4: Preparation of a production budget
Step 5: Preparation of budgets of resources for production
Step 6: Preparation of overhead cost budgets
Step 7: Co-ordinate and preview of budgets
Step 8: Preparation of a master budget
For example, if sales volumes are the principal budget factor, the stages involved in budget
preparation can be:
13
Preparing sales budget and the finished good stock budget firstly to decide the planned
increase or decrease in finished goods stock level.
Then, according to the information of sales, and stock budgets, the production budget can
be prepared
Next, preparing the budget of production resources, which relate to materials usage
budget, machine usage budget, and labour budget.
After that, the managers will prepare their draft budgets for the department overhead
costs, which include maintenance, stores, administration, selling, research, and develop
From the above information, a budgeted profit and loss account can be produced
Besides, several other budgets must be prepared to arrive at the budget balance sheet
( capital expenditure budget, working capital budget)
Appropriate budgeting methods for the Sefton Limited and the preparation
for budgets according to the chosen budgeting method
A. Budgeting methods
A sales budget is a detailed schedule showing the expected sales for the budget period.
Typically, it is expressed in both dollars and units of production. An accurate sales budget is the
key to the entire budgeting in some way, because it helps determine how many units will have to
be produced. (Sales budget, no date)
Besides, it gives a direction to a company with regard to its targeted sales, and improves the
profitability. Moreover, it can be called a financial plan with regard to the amount of goods and
services that it plans to sell in a year and the price at which the goods and services are to be sold.
By the way, it brings lots of detailed benefits for company such as:
14
Helps company achieve its sales targets
Prevents sales losses and provides a basis for sales evaluation
Helps to integrate all departments in a company because achieving a sales target is the
secret of making profits
Helps each department to assess their performance and correct any mistakes in function
Distributes goods and services in a cost effective way
Keeps company’s marketing expenditure within affordable limits
(What is sales budget, no date)
Therefore, sales budget can be chosen as appropriate budgeting methods for Sefton Ltd.
B. Preparation for budgets
I. Budgeted Income Statement
This is the calculation for the Budgeted Income Statement for the year ended 31/12/year3
a) Sales revenue
b) Material purchase value
15
c) Closing inventory of raw material
d) Direct wages
e) Closing inventory of finished goods
16
This is the Budgeted Income Statement of Sefton Ltd for the year ended 31/12/year3,
according to the calculation above
SEFTON
Income Statement
For the year ended 31 December, Year 3
Revenues $1,071,000
Opening inventory of raw materials $20,000
Purchases of raw materials $ 253,700
Less: Closing inventory of raw materials $ 14,000
Material costs used for production $ 259,700
Direct wages $ 448,500
Production overhead (given) $ 200,000
Production cost of goods completed $ 908,200
Opening inventory of finished goods $ 15,000
Finished goods available for sales $ 923,200
Less: Closing inventory of finished goods $ 50,370
Production cost of goods sold $ 872,830
17
Gross profit $ 198,170
Selling and administration overhead $ 75,000
Net profit before taxation $ 123,170
Taxation (33, 33% of net profit before tax) $ 36,951
Net profit after taxation $ 86,219
Retained earnings b/f (opening) $ 81,000
Retained earnings c/f $ 167,219
II. Cash budget
This is the Cash budget of Sefton Ltd for the year ended 31/12/year3
III. Budgeted Balance sheet
This is the calculation for the Budgeted Balance sheet at 31/12/year3
Non-current assets
Buildings and Equipment
Opening cost $ 400,000
Machinery purchase $ 120,000
Total $ 520,000
Less: Opening depreciation balance $ 75,000
Production depreciation $ 25,000
18
Selling depreciation $ 5,000
Total depreciation $105,000
Buildings and Equipment $415,000
Current assets
Inventories
Raw materials
Material M (4000 units*$2) $8,000
Material N (2000units *$3) $6,000
Total $14,000
Finished goods
→ Inventories = Finished goods + Raw materials = $64,370
Receivables
Opening balance $ 25,000
Sales $ 1,071,000
Less: Receipts (cash budget) $ 994,000
Total receivables $102,000
19
Current liabilities
Payables
Closing payables balance
Opening balance of payables $ 9,000
Material purchases from budget $ 253,700
Over head production $ 175,000 ($200,000 - $25,000)
Over head Selling & Administration $ 70,000 ($75,000 - $ 5,000) Total $507,700
Less: Material payments (cash budget) $159,000
Overhead payments (cash budget) $230,000
Total payments $389,000
Total payables $118,700
Taxation
Opening taxation $ 5,000
Less: Taxation Payment $ 5,000
Taxation occurred $ 36,951
Total taxation $36,951
Basing on this calculation above, this is the balance sheet of Sefton Ltd at 31 December,
year 3
SEFTON
Balance sheet
31 December, Year 3
Assets
Non-current assets
Land $50,000
Buildings and Equipment $ 415,000
Total non-current assets $465,000
Current assets
Inventories $ 64,370
20
Receivables $ 102,000
Cash at bank (cash budget) $ 41,500
Total current assets $207,870
Liabilities
Current liabilities
Payables $ 118,700
Taxation $ 36,951
Total current liabilities $155,651
Net assets $517,219
Financed by Equity
Share capital $ 350,000
Retained earnings (income statement) $ 167,219
Total financed by Equity $517,219
Task 2
Operating statement reconciling budgeted and actual results, the calculation
of variances, the identifying causes and recommendation for corrective action
Calculation of Variances : (A)= Adverse; (F) Favorable
$
a) 2,300 kg of material should cost (x $4) 9,200
But did cost 9.800
Material price variance 600 (A)
b) 4,800 units should uses 2,425 kg
But did use 2,300 kg
Material usage variance in kgs 125 kg (F)
X standard cost per kg x $4
Material use in variance $ 500 (F)
$
21
c) 8,500 hours of labour should cost (x $2) 17,000
But did cost 16,800
Labour rate variance 200 (F)
d) 4,850 units should take (x 2hrs) 9,700 hrs
But did take (active hours) 8,000 hrs
Labour efficiency variance in hours 1,700 hrs (F)
X standard cost per hour x $2
Labour efficiency variance in $ $3,400 (F)
e) Idea time variance 500 hours (A) x $2 $1,000 (A)
$
f) 8,000 hours incurring o/hd expenditure should cost (x $0.03) 2,400
But did cost 2,600
Variable overhead expenditure variance 200 (A)
g) Variable overhead efficiency variance in hours is the same as the labour efficiency
variance: 1,700 hours (F) x $0.03 per hour$510 (F)
$
h) Budgeted fixed overhead (5,100 units x 2hrs x $3.70) 37,740
Actual fixed overhead 42,300
Fixed overhead expenditure variance 4,560 (A)
i) Actual production volume 4,850 units
Budgeted production volume 5,100 units
Fixed overhead volume variance in units 250 units (A)
x Standard hours x standard fixed overhead absorption rate x 2hours
Fixed overhead volume variance x $3.70
1,850 (A)
j) Fixed overhead efficiency variance in hours is the same as the labour efficiency
variance: 1,700 hrs (F) x $3.70 per hour $6,290 (F)
k) Budgeted capacity (5,100 units x 2hrs) 10,200 hrs
22
Actual hours of work 8,000 hrs
Capacity variance in hours 2,200 hrs (A)
x standard fixed overhead absorption rate per hour x $3.70
Fixed overhead capacity variance $8,140 (A)
l) Revenue from 4,850 units should be (x $20) 97,000
But was 95,600
Selling price variance 1,400 (A)
m) Budgeted sales volume 5,100 units
Actual sales volume 4,850 units
Sale volume profit variance in units 250 units
x standard profit per unit x $6 (A)
Sales volume profit variance in $ $1,500 (A)
Reconciling budgeted & actual income statement
SEFTON LTD – OPERATING STATEMENT 30th April 2010
$ $
Budgeted profit before sales and administration cost 30,600(5,100 units x $6)
Sales volume variance 1,500 (A)
Budgeted profit from actual sales 29,100
Selling price variance 1,400 (A)
Actual sales minus the standard cost of sales 27,700
(F) (A)
$ $
Material price 600
Material usage 500
Labour rate 200
Labour efficiency 3,400
Labour ideal time 1000
23
Variable overhead expenditure 200
Variable overhead efficiency 510
Fixed overhead expenditure 4,560
Fixed overhead efficiency 6,290
Fixed overhead capacity 8,140
10,900 14,500 3,600 (A)
Actual profit before sales and admin costs 24,100
Less: Sales and administration costs 18,000
Actual profit, April 2010 6,100
Check $ $
Sales 95,600
Materials 9,800
Labour 16,800
Variable overhead 2,600
Fixed overhead 42,300
Sales and administration 18,000
89,500
Actual profit 6,100
Identifying causes and recommendation for corrective action
In budgeting, a variance is the difference between a budgeted, planned or standard amount and
the actual amount incurred/sold. Variances can be computed for both costs and revenues to
know whether it is favorable (F) or adverse (A). [2]
- Favorable variance (F) shows that standard cost is less than actual cost or standard
revenue is more than actual revenue.
- Adverse variance (A) shows that actual cost is more than standard cost or actual revenue
is less than standard revenue
(Types of variance, no date)
The classification of variance can be shown by this graph:
24
According to the Calculation of Variances of Sefton above, the possible reasons for the
occurrence of the variances and the recommendation for corrective action can be seen through this
table below:
Variance Favorable Adverse Corrective action
Material
price
Careless purchasing Prepare a detail material schedule
planning of purchasing raw materials
in accordance scope of work to avoid
the redundancy
Material
usage
Storing good
materials in
warehouse
Maintain and develop more and more
good storage system conform to
warehouse standards for material
storing
Labour
rate
Use of apprentices
or other workers at a
rate of pay lower
than standard
Continue hiring apprentices or other
workers with acceptable wages, and
providing the standard entitlements
(e.g. sick, annual, parental, leave,
overtime etc) to not only make them
satisfied but also maintaining the
25
savings for company
Labour
efficiency
Output produced
more quickly than
expected because of
work motivation,
better quality of
equipment or
materials
Maintain and invest in the best
equipments to improve overall
efficiency.
Develop better work environment and
motivation activities (rewards, bonus,
…) to make sure all employees feel
satisfied
Ideal time Machine breakdown Identify the machine’s errors
occurring frequently and provide
faster electronics repair service to
reduce machine breakdown time as
well as diagnosis for the failure and
guidance to avoid such failures in
future.
Variable
overhead
expenditure
Changing in type of
services used
Find and chose the suitable type of
services, but need to consider about
the standard variable overhead
expenditure to avoid increasing too
much in actual variable overhead
expenditure
Fixed
overhead
expenditure
Changing in type of
services used
Find and chose the suitable type of
services, but need to consider about
the budgeted fixed overhead to avoid
increasing too much in actual fixed
overhead
Sales price Price increase
following increased
demand
Increase in selling price but still
provide the best quality’s products for
customers.
Sales
volume
Increased sales
resulting from new
Create and develop lots of new
advertising campaigns to attract lots of
26
advertisements customers
Report findings to management in accordance with identified responsibility centers
To: Managing Director
From: Management Accountant
Date: 12 Dec 2011
REPORT ON IDENTIFYING RESPONSIBILITY CENTERS
1. Executive summary2. Methods of research3. Findings4. Recommendation
EXECUTIVE SUMMARY
This report highlights the responsibility accounting through controlling profit and cost centers.
METHOD OF RESEARCH
This report has been compiled from research findings designed to show:
Cost center Revenue Profit center
FINDINGS
Cost center
Cost center is a division that adds to the cost of an organization, but only indirectly adds to its profit. In Sefton, the cost center include the
27
REFRENCE LIST
Budgetary control, no date, 6th Dec 2011, < http://www.fao.org/docrep/W4343E/w4343e05.htm>
Purpose of budget, no date, 6th Dec 2011, < http://accmana3d.tripod.com/id2.html>
Sales budget, no date, 6th Dec 2011, <
http://www.accountingformanagement.com/sales_budget.htm>
Types of variance, no date. 6th Dec 2011, < http://www.svtuition.org/2011/06/types-of-
variance.html>
What is sales budget, no date, 6th Dec 2011, < http://www.ehow.com/about_4699902_what-
sales-budget.html>
[1]: Management Accounting: Costing & Budgeting Course book, 2007, 1st edition, Great Britain:
BPP Professional Education, chapter 8, section 1, page 178
[2]: http://en.wikipedia.org/wiki/Variance_(accounting), viewed 6th Dec 2011
28