Management Accounting: Costing and Budgeting

Unit 9: MACB Individual Assignment

BTEC EDEXCDEL HND DIPLOMA IN BUSINESS (MANAGEMENT & HUMAN RESOURCES) OFFERED BY INTERNATIONAL COLLEGE OF BUSINESS AND TECHNOLOGY

UNIT 09: MANAGEMENT ACCOUNTING: COSTING AND BUDGETING

NAME: ADIL MUHAMMED NAZEER

BATCH NUMBER: BM-25

ICBT KANDY CAMPUS

SUBMITTED TO: MR.T.SOORIYARACHCHI

DATE OF SUBMISSION: 14th-October-2013AcknowledgmentIt is with heartfelt gratitude and appreciation I place on record the unstinted guidance of lecturer, MR.T.SOORIYARACHCHI, all my batch mates for the valuable ideas we exchanged with each other on the assignment and my parents who have been behind my every effort.Sincerely,Adil.

Executive Summary:The various costs available for an organization to choose were briefed, including the relevant methods of costing and the appropriate techniques needed to analyze costs.

Furthermore, in relation to efficiency, the methods to reduce costs to increase value within the business were proposed, with aid to performance indicators that can be used to identify potential improvements to increase business value.Thereby, the system of budgeting and forecasting and its methods for an organization were explained and then certain budgets were created in relation to the case given.Lastly, the different types of variances were calculated, to show any adverse or favorable results, and thereby the adverse results being corrected.

ContentsLearning Outcome 15The different types of costs that an organization has to incur and the different costing methods5Calculation of the unit cost, selling price and profit per unit8Operating statement based on marginal and absorption costing9FIFO method10LIFO method11AVCO method12Standard pricing method13Store ledger14Learning Outcome 315The purpose, advantage and disadvantages of budgeting for Royal Auto Mart15Fixed budgets17Flexible budgets18Zero base budgets19Cash budget statement of company zero20Learning outcomes 2 & 422Calculation of different variances22Summary of cost variances27Sales variances28Statement to show the changes from budgeted to actual profit by using variances29How the organization can improve its performance for the next year30References:32

Learning Outcome 1The different types of costs that an organization has to incur and the different costing methodsThere are various costs that any organization incurs and these can be classified into different types, which will be explained in a systematic way.The product costs:These are costs that are part of the cost of production of a product. These product costs can be further classified into costs that are still relative to the manufacturing process,Direct materials cost: Costs that are directly related to the finished product and can be directed back to a specific unit, for example, leather used in car seats, therefore any costs incurred in buying and handling of these raw materials are taken into consideration as direct cost

Indirect materials cost: Costs that are not directly related to a finished product and that cannot be traced back to a specific unit. These are costs of materials that were used to support the production process. For example: Stitching machinery related costs that were used to stitch out the leather used for car seats

Direct labor: Labor costs that are directly related to the manufacturing of a product in the production process. For example: The cost of the wage or salary paid to the tailors used to stitch the leather

Indirect labor: Labor costs that are not directly related to the manufacturing process of a product, but their service is necessary for the finishing point of the production. For example, the cost of wages paid to machinery maintenance workers

Direct overhead costs: Costs or expenses related to the production of a good other than materials or labor cost. For example, the cost of factory electricity used during the production process

Indirect overhead costs: Costs or expenses that are not directly related to the production of a good other than materials and labor cost, or rather the costs incurred in bringing the finished product to the customer. For example, the cost of selling and distribution, or salaries of accountants or office administration workers

Then the period costs:These are costs that are not related to the product or the production process. These are costs treated as expenses in the period in which they are incurred, such as marketing and administrative costs

There are different methods to cost ascertaining based on nature of the type of production a business has. In order to ascertain these costs correctly, they are classified into job costing, batch costing and process costing.

Job costing:Its where the costs are ascertained on various sorts of jobs which have different specifications. All sorts of costs such as labor and material can be traced back to the job done. For example, 5 labors were needed to the job of producing seat leather.

Batch costing: It is where products of mostly identical nature are produced in batches. Each batch is treated as a separate job where the unit cost is the ratio of the total cost of the batch to the number of units in the batch. The cost of a batch can be averaged over the units produced. For example, in bakeries, where bread is produced in batches, where the cost of the materials needed for the bread production and the labor needed for the production of the bread will be ascertained to that particular batch.

Process costing:It is the costing ascertained to products that go through different processes during production. For example, in vehicle manufacturing, the first process is to build the chassis, then the second process is to fit the interior, third process is to paint on the chassis, and so on. The costs such as material and labor are ascertained to the process they were used for.

Calculation of the unit cost, selling price and profit per unit600000Production

570000Sales

35000VC

70000FC

[(570000*2)x2%]= 22800Selling & administration

127800TC

0.213Unit cost of production

0.0852Markup 40%

2.0852 Selling price

1.8722 Profit per unit (SP-TC)

Operating statement based on marginal and absorption costing

Absorption costing:

1188564Sales

0.213*570000=(121410)Less: Cost of goods sold

1067154Gross Profit

Less: expenses

(22800)Selling and administration

1044354Net profit

Marginal costing:

1188564Sales

0.058*570000=(33060)Less: Variable cost of goods sold

1155504GP

Less: expenses

(22800)Fixed and variable selling & admin

1132704Net profit

Workings:Variable cost per unit: 35000/600000 = 0.058

FIFO method

BalanceIssuesReceiptsDate

AmountQtyAmountUnit priceQtyAmountUnit priceQty

1000500100025006/8

8253758252.23756/12

1825875

100025006/18

4402,2200

1440700

385175

6252506252.52506/22

1010425

3852.21756/30

437.52.5175

822.5350

187.575

Closing stock is 75 units at a price of 2.5. Therefore 75 x 2.5 = 187.5

LIFO methodBalanceIssuesRecepitsDate


1000500100025006/8

8253758252.23756/12

1825875

8252.23756/18

6502325

1475700

350175

6252506252.52506/22

975425

6252.52506/30

2002100

825350

15075

Closing stock is 75 units at a price of 2. Therefore 75 x 2 = 150

AVCO method



1000500100025006/8

8253758252.23756/12

1825875

14622.0867006/18

365175

6252506252.52506/22

990425

8162.3293506/30

17475

Workings:Unit price for qty 700 issued= [(500*2)+(375*2.2)] / 875 = 2.086Unit price for qty 350 issued= [(175*2.08)+(250*2.5)] / 425 = 2.329

Closing stock is 75 units at a price of 2.3. Therefore 75 x 2.329 = 174

Standard pricing method



1000500100025006/8

75037575023756/12

1750875

100025006/18

4002200

1400700

350175

50025050022506/22

850425

35021756/30

3502175

700350

15075

Closing stock is 75 units at a price of 2. Therefore 75 x 2 = 150

Store ledger

BalanceIssuesPurchasesDate

5006/8

8753756/12

1757006/18

4252506/22

753506/30

Learning Outcome 3The purpose, advantage and disadvantages of budgeting for Royal Auto MartFor the organization of my choice, Royal Auto Mart, budgeting plays a major role in the daily operations of the business. The business specializes in importing vehicles from external countries and focuses on selling them within Sri Lanka. The use of finance as a resource within the business is of a very critical nature, since it is not a manufacturing business. The main resource for such an importing business would be the funds and finance available in the business that is used for the purchasing and import costs. Budgeting helps the company to forecast their future potential cash inflows from sales of vehicles as well as outflows and thereby set up their financing accordingly whilst also being able to foresee any such downturns. The budgeting information can be passed through the company as a means of communication so that the different parties may adhere to the budgeted norms and thereby avoid any feuds. This may also result in individuals within the organization being able to have a set target as shown in the budgeting information which they can follow up to and see if their resources are as budgeted. There are many advantages that this organization can face through the use of budgeting, as mentioned earlier,- They will be able to control activities within the business by setting out a budget for such certain activities - Employee motivation as they are able to act upon a target set by the budget, as they have employees in Sri Lanka and externally- A core budget could link all departments or branches of that single organization - Resource allocation, or rather, finance allocation will be more efficient within the business - They can review their profitability, as budgeting helps them to forecast their inflows and compare them with outflows - They can review their assumptions through forecasting for different periods - The allocation of cash for different activities such as daily operational activities or even large scale cash allocations such as the cost of importing and purchasing vehicles - They may be able to find a huge downturn when budgeting. For example, the company can look into places bringing about the largest outflow and seek ways to correct them

However, budgeting may also prove heinous for such organizations,- For a company that runs resources in many countries, this may result in conflicts between individuals or managers, since the finance allocation as per the budgeting information may not be accepted by the two parties. Although employees may make use of budgeting to attain targets, they may see it as a pressure point on their activities, fearing that they may not achieve it Since these are forecasts, the costs or values may be over estimated or under estimated, thereby not giving a realistic view for the company Any such forecasting values that arise wrongly, may result in wrongful allocation and may either be wasted or under funded

Fixed budgets

A fixed budget is established for a specific level of activity and is not adjusted to the actual level of activity attained at the time of comparison between the budgeted and actual results.

Naturally, a fixed budget is established only for a short period of time where the budgeted level of activity is expected to be attained to the maximum possible extent. It is more suitable for fixed expenses, i.e. the expenses which have no relation with the level of activity. Budgets remain the same regardless of the activity level actually that takes place within the organization.- It is not adjusted with the actual activity taking place, meaning that the budget remains the same whether the actual activity level increases or decreases. This sort of budget is prepared for a specified level of activity.It may be of importance to a company as they will be able to control the costs within the business using this form of budget, as they will try to keep costs within the fixed budget. However in comparison to other forms of budgets, the fixed budget is less efficient when it comes to budgeting, as this only provides a basic outline to follow and does not take into consideration any possible changes.

Flexible budgets

- These budgets are designed to change in relation to the level of activity attained within the organization.- They are prepared for a range of activities.- The flexibility is due to the reason that it recognizes the behavior of costs such as fixed and variable costs.- It helps in the facilitation to measure and control performance.

It can be important to a company because it enables a company to view realistic and reliable information on the forecasted data in comparison to the actual results. This means that it provides much higher cost control over a business function and makes it more aggressive.

Zero base budgets

- Budgeting starts from zero which means that, in simple words, the total income minus the total expense equals zero.- The budgeting done for each period is started and formulated from zero, meaning that past information will not influence the budgeting process being done.- All activities are evaluated each time a budget is formulated and every item of expenditure in the budget is fully justified.

This would be important for the company due to many reasons.- The resource allocation is carried out more efficiently - It avoids any form of over budgeting- Also avoids any wastages of resources- While budgeting this way, more cost effective ways to improve operations may be found

Cash budget statement of company zero

SeptAugustJulyJuneMay

11560097000657505300050000Opening bal.

12400100004000600010000Sales

1650018600150002500060000

30000275003100084000

174500153100

10000Insurance

125750

75005000375011250Purchases

300002250015000

40004000400040004000Wages

30003000300030003000Overheads

300030003000Tax

(47500)(37500)(28750)(18250)(7000)

127000115600970006575053000Balance

Workings: (Receipts from sales and payments for purchases)May

20000 x 50% = 10000Sales (on month)

20000 x 30% = 6000Sales (2nd month)

20000 x 20% = 4000Sales (3rd month)

June

50000 x 50% = 25000Sales (on month)

50000 x 30% = 15000Sales (2nd month)

50000 x 20% = 10000Sales (3rd month)

15000 x 75% = 11250Purchases (on month)

15000 11250 = 3750Purchases (next month)

July

62000 x 50% = 31000Sales (on month)

62000 x 30% = 18600Sales (2nd month)

62000 x 20% = 12400Sales (3rd month)



August

55000 x 50% = 27500Sales (on month)

55000 x 30% = 16500Sales (2nd month)

55000 x 20% = 11000Sales (3rd month)



September

60000 x 50% = 30000Sales (on month)

60000 x 30% = 18000Sales (2nd month)

60000 x 20% = 12000Sales (3rd month)



Learning outcomes 2 & 4

Calculation of different variances

Operating profit varianceBudgeted

180000Sales

(150000)Less: COS

30000Contribution

(15000)Less: FC

15000Operating profit

Actual

180200Sales

(157600)Less: COS

22600Contribution

(15600)Less: FC

7000Operating profit

Direct material variancePrice variance= (Actual qty x std cost per unit) Actual cost = (55000 x 0.2) 11600 = 11000 11600 = 600 Adverse (Actual price is higher than the standard price by this amount)

Cost variance= (Std cost x Std qty) Actual cost = (1 x 10600) 11600 = 10600 11600 = 1000 Adverse (Actual cost is higher than the standard cost by this amount)

Usage variance= (Actual qty used Std qty for actual prod) x Std cost = (53000 55000) x 0.2 = -2000 x 0.2 = 400 Adverse (Actual qty usage is higher than the standard qty usage)

Direct labor varianceRate variance = (Actual rate per hour Std rate per hour) x actual hours worked = (1.52 1.50) x 41300 = 826 Adverse (Actual rate is higher than the standard rate by this amount)

Cost variance = (Std rate per hour x Std hours) Actual labor cost = (6 x 10600) 63000 = 63600 63000 = 600 Favorable (Actual labor cost is less than standard labor cost)

Efficiency variance = (Actual hours Std hours for actual production) x Std rate per hour = (41300 42400) x 1.5 = 1100 x 1.5 = 1650 Favorable (Actual hours worked is less than the budgeted hours)

Variable overhead varianceCost variance = Actual variable exp (Std hours x Variable prod overhead absorption rate) = 83000 (42400 x 2) = 83000 84800 = 1800 Favorable (Actual cost is lower than the budgeted cost)

Efficiency variance = (Std hours Actual hours) x Std rate per hour = (42400 41300) x 2 = 1100 x 2 = 2200 Favorable (Actual variable o/h is lower than the budgeted)

O/H expenditure variance = (Std var o/h rate Actual var o/h rate) x actual hours allocated = (82600 - 83000) x 1 = 400 Adverse (Actual var o/h rate is higher than standard)

Fixed overhead varianceO/H expenditure variance = (Actual fixed overheads Std fixed overheads) = (15600 15000) = 600 Adverse (Actual fixed costs are higher than budgeted)

Summary of cost variances

Direct material variance

Adverse600Price

Adverse1000Cost

Adverse400Usage

Direct labor variance

Adverse826Rate

Favorable600Cost

Favorable1650Efficiency

Variable overhead variance

Favorable1800Cost

Favorable2200Efficiency

Adverse400Expenditure

Fixed overhead variance

Adverse600Expenditure

Sales variances

Volume = (Actual qty budgeted qty) x Std profit per unit (std contribution) = (10600 10000) x 3 = 600 x 3 = 1800 Favorable (Actual sales volume is higher than budgeted)

Price = (Actual sales price per unit Std sales price per unit) x Actual sales qty = (17 18) x 10600 = 10600 Adverse (Actual price is less than the budgeted price)Working for actual sales price per unit = (total actual sales / qty) = (180200 / 10600) = 17

Overall variance

(10600)Sales price var

Less: cost

600Material price var

826Labor price var

(1826)400Variable o/h exp var

12426 Adverse

Statement to show the changes from budgeted to actual profit by using variances

ValueFavorableAdverse

600Direct material price var

400Direct material usage var

826Direct labor rate var

1650Direct labor eff var

400Variable o/h exp var

2200Variable o/h eff var

600Fixed o/h exp var

10600Sales price var

1800Sales vol var

(7776)565013426

Therefore actual profit = 15000 7776 = 7224

How the organization can improve its performance for the next year

Through the analysis of all the calculated variances, the organization has favorable as well as adverse variances. As calculated above, the organizations direct material variances are all adverse, meaning generally that the actual values are greater than the budgeted values, and this means that the organization has to try to keep its actual variances lower than its expectations.The price, cost and usage variance for material are all adverse. Adverse price variance means that the material prices are greater than the prices the organization budgeted for. In order to overcome this problem, the organization may have to look to achieve lower prices for its raw materials, this can be either by finding a cheap supplier, or by purchasing in bulk. The same can be done to tackle the cost adversity of materials for the organization.The usage of materials is also adverse, meaning that there is wastage of materials. This is due to the actual usage of materials being greater than what they had budgeted for, meaning that they are not efficient enough and are using more materials than required, which in turn brings up the cost of materials as well.

Out of all of its labor variances, the organization has been well managing its labor cost and efficiency, meaning that labor cost is lower than budgeted and there is a productive and efficient workforce for the organization. However, the labor rate variance is adverse. This means that the actual rate for labor that the organization offers is lower than what was supposed to have been. This can be a sign of potential future demotivation of the labor force, which in turn can affect the efficiency. Therefore, to improve its performance, the company will have to try to increase the labor rate per hour all the way upto its budgeted level or higher than that to achieve maximum efficiency.

Out of all its variable overhead variances, the organization has done well in managing the cost and efficiency of its variable overheads. Meaning that it has managed to keep its variable overhead costs lower than what It budgeted for. However, variable overhead expenditure is adverse, meaning that it spends more on variable overheads than what it expected for, although it managed to keep the costs of variable overheads low. In order to overcome this, the company will have to further reduce spending on variable overheads than what it allocated its budgets for.

Finally, the fixed overhead expenditure variance of the organization is adverse, meaning that it spends more to cover up fixed costs than what it had budgeted for. This expenditure may mean that the organization spends on costs such as salary, rent or insurance. Therefore, in order to improve its performance, the organization can cut down its spending on such units. As a recommendation, they can look into the reduction of certain workers salaries, or downsize its workforce, and may also look to rent out cheaper places or cut down on its insurance payments. However, doing so may result in other variables getting effected, such as the labor variances due to the adjustments of the fixed overhead variance.

References:

lecturers aspiration (n.d) Resource information and BTEC assignments [online] [accessed 19th October 2013]. Available at: http://www.lecturersaspiration.com/2012/03/management-accounting-costing-and.html

slideshare (n.d) Absorption and marginal costing [online] [accessed 18th October 2013]. Available at: http://www.slideshare.net/rish10/absorption-and-marginal-costing

principlesofaccounting (n.d) Chapter Nineteen: Job Costing and Modern Cost Management Systems [online] [accessed 17th October 2013]. Available at: http://www.principlesofaccounting.com/chapter19/chapter19.html

BM-25

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Management Accounting: Costing and Budgeting